HERITAGE FINANCIAL CORP /WA/ - Quarter Report: 2022 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2022 or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number 000-29480

HERITAGE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Washington

91-1857900

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

201 Fifth Avenue SW,

Olympia

98501

(Address of principal executive offices)

(Zip Code)

(360) 943-1500

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☒

Accelerated filer

☐

Non-accelerated filer

☐

Smaller reporting company

☐

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

As of August 1, 2022, there were 35,103,929 shares of the registrant's common stock, no par value per share, outstanding.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

FORM 10-Q

June 30, 2022

TABLE OF CONTENTS


			Page
GLOSSARY OF ACRONYMS, ABBREVIATIONS AND TERMS			3
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS			3

PART I.	FINANCIAL INFORMATION		5
ITEM 1.	FINANCIAL STATEMENTS		5
	CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) AS OF JUNE 30, 2022 AND DECEMBER 31, 2021		5
	CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 AND 2021		6
	CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS ) INCOME (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 AND 2021		7
	CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 AND 2021		8
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE SIX MONTHS ENDED JUNE 30, 2022 AND 2021		10
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)		12
	NOTE 1.	DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS	12
	NOTE 2.	INVESTMENT SECURITIES	13
	NOTE 3.	LOANS RECEIVABLE	15
	NOTE 4.	ALLOWANCE FOR CREDIT LOSSES ON LOANS	23

	NOTE 5.	GOODWILL AND OTHER INTANGIBLE ASSETS	25
	NOTE 6.	DERIVATIVE FINANCIAL INSTRUMENTS	25
	NOTE 7.	STOCKHOLDERS’ EQUITY	26
	NOTE 8.	FAIR VALUE MEASUREMENTS	27
	NOTE 9.	CASH RESTRICTION	31
	NOTE 10.	COMMITMENTS AND CONTINGENCIES	32

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		32
	OVERVIEW		32
	RESULTS OF OPERATIONS		33
		AVERAGE BALANCES, YIELDS AND RATES PAID	34
		NET INTEREST INCOME AND MARGIN OVERVIEW	34
		PROVISION FOR CREDIT LOSSES OVERVIEW	37
		NONINTEREST INCOME OVERVIEW	38
		NONINTEREST EXPENSE OVERVIEW	39
		INCOME TAX EXPENSE OVERVIEW	40
	FINANCIAL CONDITION OVERVIEW		40
		INVESTMENT ACTIVITIES OVERVIEW	41
		LOAN PORTFOLIO OVERVIEW	42
		ALLOWANCE FOR CREDIT LOSSES ON LOANS OVERVIEW	43
		DEPOSITS OVERVIEW	44
		STOCKHOLDERS' EQUITY OVERVIEW	44
	REGULATORY REQUIREMENTS OVERVIEW		44
	LIQUIDITY AND CAPITAL RESOURCES		45
	CRITICAL ACCOUNTING POLICIES		45
	RECONCILIATIONS OF NON-GAAP MEASURES		45
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		46
ITEM 4.	CONTROLS AND PROCEDURES		46

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PART II.	OTHER INFORMATION	47
ITEM 1.	LEGAL PROCEEDINGS	47
ITEM 1A.	RISK FACTORS	47
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	47
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	47
ITEM 4.	MINE SAFETY DISCLOSURES	47
ITEM 5.	OTHER INFORMATION	47
ITEM 6.	EXHIBITS	47
	SIGNATURES	48

GLOSSARY OF ACRONYMS, ABBREVIATIONS, AND TERMS

The acronyms, abbreviations, and terms listed below are used in various sections of this Form 10-Q. As used throughout this report, the terms “we”, “our”, or “us” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.


2021 Annual Form 10-K			Company's Annual Report on Form 10-K for the year ended December 31, 2021
ACL			Allowance for credit losses
AOCI			Accumulated other comprehensive income (loss), net

ASU			Accounting Standards Update
Bank			Heritage Bank
CECL			Current Expected Credit Loss
CMO			Collateralized Mortgage Obligation
Company			Heritage Financial Corporation
COVID-19 Pandemic			Coronavirus Disease of 2019 pandemic
CRE			Commercial real estate
FASB			Financial Accounting Standards Board
FDIC			Federal Deposit Insurance Corporation
Federal Reserve			Board of Governors of the Federal Reserve System
Federal Reserve Bank			Federal Reserve Bank of San Francisco

GAAP			U.S. Generally Accepted Accounting Principles
LIBOR			London Interbank Offering Rate
LIHTC			Low-Income Housing Tax Credit
MBS			Mortgage-backed security
PPP			Paycheck Protection Program
SBA			Small Business Administration
SEC			Securities and Exchange Commission
SM			Special Mention
SS			Substandard
TDR			Troubled debt restructured

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in

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any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating results and stock price performance including, but not limited to:

•the effect of the COVID-19 pandemic, including on the Company’s credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate customers, including economic activity, employment levels and market liquidity;

•the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our 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, including the risks of inflation;

•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, including as a result of the COVID-19 Pandemic;

•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 our loans;

•staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

•disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;

•our ability to retain key members of our senior management team;

•costs and effects of litigation, including settlements and judgments;

•our ability to implement our growth strategies;

•our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected;

•increased competitive pressures among financial service companies;

•changes in consumer spending, borrowing and savings habits;

•the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

•adverse changes in the securities markets;

•inability of key third-party providers to perform their obligations to us;

•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, and the other risks detailed from time to time in our filings with the SEC including our 2021 Annual Form 10-K.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)

(In thousands, except shares)


	June 30, 2022		December 31, 2021
ASSETS
Cash on hand and in banks	$	93,675	$	61,377
Interest earning deposits	900,380		1,661,915
Cash and cash equivalents	994,055		1,723,292
Investment securities available for sale, at fair value, net (amortized cost of $1,267,715 and $883,832, respectively)	1,187,588		894,335
Investment securities held to maturity, at amortized cost, net (fair value of $559,312 and $376,331, respectively)	615,653		383,393
Total investment securities	1,803,241		1,277,728
Loans held for sale	1,311		1,476
Loans receivable	3,874,064		3,815,662
Allowance for credit losses on loans	(39,696)		(42,361)
Loans receivable, net	3,834,368		3,773,301

Premises and equipment, net	77,164		79,370
Federal Home Loan Bank stock, at cost	8,916		7,933
Bank owned life insurance	120,646		120,196
Accrued interest receivable	15,908		14,657
Prepaid expenses and other assets	211,350		183,543
Other intangible assets, net	8,569		9,977
Goodwill	240,939		240,939
Total assets	$	7,316,467	$	7,432,412
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits	$	6,330,190	$	6,394,290

Junior subordinated debentures	21,326		21,180
Securities sold under agreement to repurchase	41,827		50,839
Accrued expenses and other liabilities	117,758		111,671
Total liabilities	6,511,101		6,577,980
Commitments and contingencies (Note 12)
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; 35,103,929 and 35,105,779 shares issued and outstanding, respectively	550,417		551,798
Retained earnings	316,732		293,238
Accumulated other comprehensive (loss) income, net	(61,783)		9,396
Total stockholders’ equity	805,366		854,432
Total liabilities and stockholders’ equity	$	7,316,467	$	7,432,412

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
INTEREST INCOME:
Interest and fees on loans	$	40,890	$	50,750	$	81,915	$	100,274
Taxable interest on investment securities	7,607		4,050		13,610		7,584
Nontaxable interest on investment securities	893		947		1,753		1,905
Interest on interest earning deposits	2,342		263		3,048		438
Total interest income	51,732		56,010		100,326		110,201
INTEREST EXPENSE:
Deposits	1,413		1,524		2,837		3,252
Junior subordinated debentures	239		186		433		373
Other borrowings	32		35		64		73
Total interest expense	1,684		1,745		3,334		3,698
Net interest income	50,048		54,265		96,992		106,503
Reversal of provision for credit losses	(1,204)		(13,987)		(4,781)		(21,186)
Net interest income after reversal of provision for credit losses	51,252		68,252		101,773		127,689
NONINTEREST INCOME:
Service charges and other fees	2,391		2,067		4,687		3,959
Card revenue	2,332		2,338		4,773		4,435
Gain on sale of investment securities, net	—		—		—		29
Gain on sale of loans, net	219		1,003		460		2,373
Interest rate swap fees	26		209		305		361
Bank owned life insurance income	764		717		2,459		1,373
Gain on sale of other assets, net	—		724		204		746
Other income	1,284		1,239		2,666		3,272
Total noninterest income	7,016		8,297		15,554		16,548
NONINTEREST EXPENSE:
Compensation and employee benefits	21,778		21,803		43,030		44,004
Occupancy and equipment	4,171		4,091		8,502		8,545
Data processing	4,185		3,998		8,246		7,810
Marketing	344		567		610		1,080
Professional services	529		1,037		1,228		2,307
State/municipal business and use taxes	867		991		1,663		1,963
Federal deposit insurance premium	425		339		1,025		928

Amortization of intangible assets	704		797		1,408		1,594
Other expense	2,704		2,773		5,715		5,407
Total noninterest expense	35,707		36,396		71,427		73,638
Income before income taxes	22,561		40,153		45,900		70,599
Income tax expense	3,977		7,451		7,559		12,553
Net income	$	18,584	$	32,702	$	38,341	$	58,046
Basic earnings per share	$	0.53	$	0.91	$	1.09	$	1.61
Diluted earnings per share	$	0.52	$	0.90	$	1.08	$	1.60
Dividends declared per share	$	0.21	$	0.20	$	0.42	$	0.40
Average number of basic shares outstanding	35,110,334		35,994,740		35,102,572		35,961,032
Average number of diluted shares outstanding	35,409,524		36,289,464		35,412,722		36,268,861

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (Unaudited)

(In thousands)


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Net Income	$	18,584	$	32,702	$	38,341	$	58,046
Change in fair value of investment securities available for sale, net of tax of $(7,638), $722, $(19,751) and $(2,482), respectively	(27,397)		2,600		(70,879)		(8,934)
Amortization of net unrealized gain for the reclassification of investment securities available for sale to held to maturity, net of tax of $(44), $0, $(83) and $0, respectively	(158)		—		(300)		—
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $0, $0, $0 and $(6), respectively	—		—		—		(23)
Other comprehensive (loss) income	(27,555)		2,600		(71,179)		(8,957)
Comprehensive (loss) income	$	(8,971)	$	35,302	$	(32,838)	$	49,089

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)

(In thousands, except shares and per share amounts)


	Three Months Ended June 30, 2022
	Number of common shares	Common stock		Retained earnings		AOCI		Total stockholders’ equity
Balance at March 31, 2022	35,102,372	$	550,096	$	305,581	$	(34,228)	$	821,449

Restricted stock units vested	22,737	—		—		—		—
Stock-based compensation expense	—	843		—		—		843
Common stock repurchased	(21,180)	(522)		—		—		(522)
Net income	—	—		18,584		—		18,584
Other comprehensive loss, net of tax	—	—		—		(27,555)		(27,555)

Cash dividends declared on common stock ($0.21 per share)	—	—		(7,433)		—		(7,433)
Balance at June 30, 2022	35,103,929	$	550,417	$	316,732	$	(61,783)	$	805,366


	Six Months Ended June 30, 2022
	Number of common shares	Common stock		Retained earnings		AOCI		Total stockholders’ equity
Balance at December 31, 2021	35,105,779	$	551,798	$	293,238	$	9,396	$	854,432

Restricted stock units vested	124,420	—		—		—		—
Stock-based compensation expense	—	1,793		—		—		1,793
Common stock repurchased	(126,270)	(3,174)		—		—		(3,174)
Net income	—	—		38,341		—		38,341
Other comprehensive loss, net of tax	—	—		—		(71,179)		(71,179)

Cash dividends declared on common stock ($0.42 per share)	—	—		(14,847)		—		(14,847)
Balance at June 30, 2022	35,103,929	$	550,417	$	316,732	$	(61,783)	$	805,366


	Three Months Ended June 30, 2021
	Number of common shares	Common stock		Retained earnings		AOCI		Total stockholders’ equity
Balance at March 31, 2021	35,981,317	$	571,204	$	242,486	$	13,461	$	827,151

Restricted stock units vested	27,800	—		—		—		—
Stock-based compensation expense	—	926		—		—		926
Common stock repurchased	(2,557)	(70)		—		—		(70)
Net income	—	—		32,702		—		32,702
Other comprehensive income, net of tax	—	—		—		2,600		2,600

Cash dividends declared on common stock ($0.20 per share)	—	—		(7,325)		—		(7,325)
Balance at June 30, 2021	36,006,560	$	572,060	$	267,863	$	16,061	$	855,984

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	Six Months Ended June 30, 2021
	Number of common shares	Common stock		Retained earnings		AOCI		Total stockholders’ equity
Balance at December 31, 2020	35,912,243	$	571,021	$	224,400	$	25,018	$	820,439

Restricted stock units vested	120,120	—		—		—		—
Stock-based compensation expense	—	1,796		—		—		1,796
Common stock repurchased	(25,803)	(757)		—		—		(757)
Net income	—	—		58,046		—		58,046
Other comprehensive loss, net of tax	—	—		—		(8,957)		(8,957)

Cash dividends declared on common stock ($0.40 per share)	—	—		(14,583)		—		(14,583)
Balance at June 30, 2021	36,006,560	$	572,060	$	267,863	$	16,061	$	855,984

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)


	Six Months Ended June 30,
	2022		2021
Cash flows from operating activities:
Net income	$	38,341	$	58,046
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion	(1,654)		(13,901)
Reversal of provision for credit losses	(4,781)		(21,186)
Stock-based compensation expense	1,793		1,796
Amortization of intangible assets	1,408		1,594
Origination of mortgage loans held for sale	(12,396)		(53,807)
Proceeds from sale of mortgage loans held for sale	13,021		58,373
Bank owned life insurance income	(2,459)		(1,373)

Valuation adjustment on interest rate swaps	(64)		(254)
Gain on sale of mortgage loans held for sale, net	(460)		(2,373)
Gain on sale of investment securities available for sale, net	—		(29)

Gain on sale of assets held for sale	(204)		(746)
Other	1,360		3,630
Net cash provided by operating activities	33,905		29,770
Cash flows from investing activities:
Loan originations and purchases, net of payments	(51,198)		295,618
Maturities and repayments of investment securities available for sale	86,678		126,669
Maturities and repayments of investment securities held to maturity	11,767		—
Purchase of investment securities available for sale	(472,361)		(388,636)
Purchase of investment securities held to maturity	(244,911)		—
Purchase of premises and equipment	(1,191)		(1,748)
Purchases of bank owned life insurance	(105)		(105)
Purchases of Federal Home Loan Bank stock	(985)		(1,272)


Proceeds from sales of investment securities available for sale	—		1,248
Proceeds from redemption of Federal Home Loan Bank stock	2		—
Proceeds from sales of assets held for sale	1,173		3,730
Proceeds from sales of premises and equipment	—		10
Capital contributions to low-income housing tax credit partnerships	(978)		(12,637)
Cash received from return of New Market Tax Credit equity method investment	—		9,642


Net cash (used) provided by investing activities	(672,109)		32,519
Cash flows from financing activities:
Net (decrease) increase in deposits	(64,100)		463,716
Federal Home Loan Bank advances	50		10
Repayment of Federal Home Loan Bank advances	(50)		(10)
Common stock cash dividends paid	(14,747)		(14,383)
Net (decrease) increase in securities sold under agreement to repurchase	(9,012)		10,746
Repurchase of common stock	(3,174)		(757)
Net cash (used) provided by financing activities	(91,033)		459,322
Net (decrease) increase in cash and cash equivalents	(729,237)		521,611
Cash and cash equivalents at beginning of period	1,723,292		743,322
Cash and cash equivalents at end of period	$	994,055	$	1,264,933

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	Six Months Ended June 30,
	2022		2021
Supplemental disclosures of cash flow information:
Cash paid for interest	$	3,188	$	3,571
Cash paid for income taxes, net of refunds	167		7,967

Supplemental non-cash disclosures of cash flow information:


Investment in LIHTC partnership and related funding commitment	11,284		—
Right of use assets obtained in exchange for new operating lease liabilities	2,222		8,393
Transfer of bank owned life insurance to prepaid expenses and other assets due to death benefit accrued	2,114		—
Transfers of properties classified as held for sale to prepaid expenses and other assets from premises and equipment, net	730		1,685
Loans received from return of New Market Tax Credit equity method investment	—		15,596

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(1)Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements

(a) Description of Business

The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, the Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 50 branch offices located throughout Washington State, the greater Portland, Oregon area, and Eugene, Oregon. 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 unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. It is recommended these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the 2021 Annual Form 10-K. In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022.

To prepare unaudited Condensed Consolidated Financial Statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided. Management believes the judgments, estimates and assumptions used in the preparation of the unaudited Condensed 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 impairment and management's estimate of the fair value of financial instruments.

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

There have been reclassifications in certain prior year amounts in the unaudited Condensed Consolidated Statements of Financial Condition, the unaudited Condensed Consolidated Statements of Income and the unaudited Condensed Consolidated Statements of Cash Flows. Reclassifications had no effect on the prior year's net income or stockholders’ equity.

The significant accounting policies used in preparation of the unaudited Condensed Consolidated Financial Statements are disclosed in greater detail in the 2021 Annual Form 10-K. There have not been any material changes in the Company's significant accounting policies from those contained in the 2021 Annual Form 10-K during the six months ended June 30, 2022.

(d) Recently Issued or Adopted Accounting Pronouncements

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. Additionally, effective January 1, 2022, the Bank is no longer initiating or renewing loans using LIBOR as an index. The Company does not expect this ASU to have a material impact on its business operations and the Consolidated Financial Statements.

FASB ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, was issued in March 2022. The ASU eliminates the accounting guidance for TDR loans by creditors while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Additionally, the ASU requires public business entities to disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases. These amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, since Heritage previously adopted the amendments in ASU 2016-13, which is commonly referred to as the current expected credit loss methodology, on January 1, 2020. Early adoption is permitted and should be applied prospectively; however, the transition method related to the recognition and

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measurement of TDR loans may be applied under a modified retrospective transition method. The Company is evaluating the effect this ASU will have on its Consolidated Financial Statements and related disclosures.

(2)Investment Securities

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

There were no investment securities classified as trading at June 30, 2022 or December 31, 2021.

(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:


	June 30, 2022
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Investment securities available for sale:
U.S. government and agency securities	$	68,912	$	—	$	(3,244)	$	65,668
Municipal securities	213,402		977		(14,369)		200,010
Residential CMO and MBS	433,903		70		(35,817)		398,156
Commercial CMO and MBS	520,772		466		(27,618)		493,620
Corporate obligations	6,003		—		(25)		5,978
Other asset-backed securities	24,723		6		(573)		24,156
Total	$	1,267,715	$	1,519	$	(81,646)	$	1,187,588

Investment securities held to maturity:
U.S. government and agency securities	$	150,960	$	—	$	(23,416)	$	127,544

Residential CMO and MBS	159,007		257		(5,774)		153,490
Commercial CMO and MBS	305,686		—		(27,408)		278,278


Total	$	615,653	$	257	$	(56,598)	$	559,312


	December 31, 2021
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Investment securities available for sale:
U.S. government and agency securities	$	21,494	$	55	$	(176)	$	21,373
Municipal securities	213,158		8,908		(854)		221,212
Residential CMO and MBS	307,366		2,111		(2,593)		306,884
Commercial CMO and MBS	313,169		3,891		(1,199)		315,861
Corporate obligations	2,007		7		—		2,014
Other asset-backed securities	26,638		369		(16)		26,991
Total	$	883,832	$	15,341	$	(4,838)	$	894,335

Investment securities held to maturity:
U.S. government and agency securities	$	141,011	$	120	$	(1,768)	$	139,363

Residential CMO and MBS	24,529		—		(153)		24,376
Commercial CMO and MBS	217,853		—		(5,261)		212,592


Total	$	383,393	$	120	$	(7,182)	$	376,331

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The amortized cost and fair value of investment securities at June 30, 2022, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.


	Securities Available for Sale				Securities Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In thousands)
Due in one year or less	$	8,283	$	8,306	$	—	$	—
Due after one year through five years	82,106		80,881		—		—
Due after five years through ten years	67,161		65,321		83,210		72,516
Due after ten years	130,767		117,148		67,750		55,028
Total investment securities due at a single maturity date	288,317		271,656		150,960		127,544
Mortgage-backed securities (1)	979,398		915,932		464,693		431,768
Total investment securities	$	1,267,715	$	1,187,588	$	615,653	$	559,312

(1) Mortgage-backed securities, which have prepayment provisions, are not assigned to maturity categories due to 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 June 30, 2022 and December 31, 2021.

(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 and length of time the individual securities have been in a continuous unrealized loss position at the dates indicated:


	June 30, 2022
	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	$	64,200	$	(2,995)	$	1,468	$	(249)	$	65,668	$	(3,244)
Municipal securities	106,205		(11,287)		15,712		(3,082)		121,917		(14,369)
Residential CMO and MBS	352,074		(32,446)		31,008		(3,371)		383,082		(35,817)
Commercial CMO and MBS	406,835		(27,145)		8,711		(473)		415,546		(27,618)
Corporate obligations	5,978		(25)		—		—		5,978		(25)
Other asset-backed securities	19,054		(552)		921		(21)		19,975		(573)
Total	$	954,346	$	(74,450)	$	57,820	$	(7,196)	$	1,012,166	$	(81,646)


	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	$	(176)
Municipal securities	29,774		(619)		9,351		(235)		39,125		(854)
Residential CMO and MBS	204,039		(2,470)		19,862		(123)		223,901		(2,593)
Commercial CMO and MBS	83,283		(1,161)		1,936		(38)		85,219		(1,199)

Other asset-backed securities	2,763		(9)		1,118		(7)		3,881		(16)
Total	$	334,687	$	(4,435)	$	32,267	$	(403)	$	366,954	$	(4,838)

The Company evaluated investment securities available for sale as of June 30, 2022 and December 31, 2021 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

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rated investment securities and none of these securities had a below investment grade credit rating as of both June 30, 2022 and December 31, 2021. 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 June 30, 2022 and December 31, 2021.

The Company also evaluated investment securities held to maturity for current expected credit losses as of June 30, 2022 and December 31, 2021. There were no investment securities held to maturity classified as nonaccrual or past due as of June 30, 2022 and 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 had 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 June 30, 2022 and 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 during the following periods:


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
	(In thousands)
Gross realized gains	$	—	$	—	$	—	$	29

(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 the dates indicated:


	June 30, 2022				December 31, 2021
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In thousands)
Washington and Oregon state public deposits	$	139,868	$	128,842	$	128,216	$	130,217
Federal Reserve Bank credit facility	60,865		52,530		61,057		59,674
Securities sold under agreement to repurchase	69,358		62,647		59,887		59,655
Other securities pledged	49,941		45,739		56,419		55,633
Total	$	320,032	$	289,758	$	305,579	$	305,179

(f) Accrued Interest Receivable

Accrued interest receivable excluded from the amortized cost of investment securities available for sale totaled $4.6 million and $3.5 million at June 30, 2022 and December 31, 2021, respectively. Accrued interest receivable excluded from the amortized cost on investment securities held to maturity totaled $1.8 million and $1.1 million at June 30, 2022 and December 31, 2021, respectively.

No amounts of accrued interest receivable on investment securities available for sale or held to maturity were reversed against interest income on investment securities during the three or six months ended June 30, 2022 and 2021.

(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 in the loan portfolios. A detailed description of the portfolio segments and classes is contained in the 2021 Annual Form 10-K.

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, concentrations of credit, loan delinquencies and nonperforming and criticized loans. The Bank also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management.

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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, consisted of the following portfolio segments and classes at the dates indicated:


	June 30, 2022		December 31, 2021
	(In thousands)
Commercial business:
Commercial and industrial	$	698,828	$	621,567
SBA PPP	11,334		145,840
Owner-occupied CRE	950,699		931,150
Non-owner occupied CRE	1,515,796		1,493,099
Total commercial business	3,176,657		3,191,656
Residential real estate	265,382		164,582
Real estate construction and land development:
Residential	90,546		85,547
Commercial and multifamily	128,060		141,336
Total real estate construction and land development	218,606		226,883
Consumer	213,419		232,541
Loans receivable	3,874,064		3,815,662
Allowance for credit losses on loans	(39,696)		(42,361)
Loans receivable, net	$	3,834,368	$	3,773,301

Balances included in the amortized cost of loans receivable:
Unamortized net discount on acquired loans	$	3,084	$	3,938
Unamortized net deferred fee	$	4,947	$	7,954

(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, Multnomah County and Washington County in Oregon, as well as other contiguous markets and represents a geographic concentration. Additionally, the Bank's loan portfolio is concentrated in commercial loans, including commercial business loans and commercial and multifamily real estate construction and land development loans. Commercial loans are generally considered 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.

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. Risk grades are aggregated to create the risk categories of Pass for grades 1 to 6, Special Mention or "SM" for grade 7, Substandard or "SS" for grade 8, Doubtful for grade 9 and Loss for grade 10. Descriptions of the general characteristics of the risk grades, including qualitative information on how the risk grades relate to the risk of loss, are contained in the 2021 Annual Form 10-K. Numerical loan grades for loans are established at the origination of the loan. Changes to loan grades are considered at the time new information about the performance of a loan becomes available, including the receipt of updated financial information from the borrower, 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 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 any potential loss. The

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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.

The following table presents the amortized cost of loans receivable by risk grade at the dates indicated:


	June 30, 2022
	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans		Revolving Loans Converted (2)		Loans Receivable
	2022		2021(1)		2020		2019		2018		Prior
	(In thousands)
Commercial business:
Commercial and industrial
Pass	$	96,128	$	101,302	$	93,475	$	73,299	$	38,742	$	90,980	$	168,030	$	45	$	662,001
SM	234		253		729		4,842		8,764		2,981		1,619		—		19,422
SS	882		169		696		4,581		1,163		6,866		2,171		877		17,405

Total	97,244		101,724		94,900		82,722		48,669		100,827		171,820		922		698,828
SBA PPP
Pass	—		11,175		159		—		—		—		—		—		11,334




Owner-occupied CRE
Pass	78,387		171,470		91,633		180,596		73,797		316,424		—		—		912,307
SM	—		—		—		1,698		2,573		12,042		—		—		16,313
SS	—		261		679		—		3,755		17,384		—		—		22,079

Total	78,387		171,731		92,312		182,294		80,125		345,850		—		—		950,699
Non-owner occupied CRE
Pass	125,451		185,105		166,150		240,396		139,626		578,421		—		—		1,435,149
SM	—		8,435		—		3,652		—		16,655		—		—		28,742
SS	—		—		—		—		3,626		48,279		—		—		51,905

Total	125,451		193,540		166,150		244,048		143,252		643,355		—		—		1,515,796
Total commercial business
Pass	299,966		469,052		351,417		494,291		252,165		985,825		168,030		45		3,020,791
SM	234		8,688		729		10,192		11,337		31,678		1,619		—		64,477
SS	882		430		1,375		4,581		8,544		72,529		2,171		877		91,389

Total	301,082		478,170		353,521		509,064		272,046		1,090,032		171,820		922		3,176,657
Residential real estate
Pass(1)	60,870		140,448		24,564		17,699		4,716		16,907		—		—		265,204

SS	—		—		—		—		—		178		—		—		178

Total	60,870		140,448		24,564		17,699		4,716		17,085		—		—		265,382
Real estate construction and land development:
Residential
Pass	21,664		43,877		10,330		12,002		1,005		1,668		—		—		90,546




Commercial and multifamily
Pass	8,832		75,096		23,991		6,952		3,186		2,013		—		—		120,070
SM	—		—		1,871		5,714		—		—		—		—		7,585
SS	—		—		—		—		—		405		—		—		405

Total	8,832		75,096		25,862		12,666		3,186		2,418		—		—		128,060
Total real estate construction and land development
Pass	30,496		118,973		34,321		18,954		4,191		3,681		—		—		210,616
SM	—		—		1,871		5,714		—		—		—		—		7,585
SS	—		—		—		—		—		405		—		—		405

Total	30,496		118,973		36,192		24,668		4,191		4,086		—		—		218,606

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	June 30, 2022
	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans		Revolving Loans Converted (2)		Loans Receivable
	2022		2021(1)		2020		2019		2018		Prior
Consumer
Pass	2,475		770		12,451		35,722		21,337		19,062		118,826		329		210,972

SS	—		—		169		558		366		1,346		8		—		2,447

Total	2,475		770		12,620		36,280		21,703		20,408		118,834		329		213,419
Loans receivable
Pass	393,807		729,243		422,753		566,666		282,409		1,025,475		286,856		374		3,707,583
SM	234		8,688		2,600		15,906		11,337		31,678		1,619		—		72,062
SS	882		430		1,544		5,139		8,910		74,458		2,179		877		94,419

Total	$	394,923	$	738,361	$	426,897	$	587,711	$	302,656	$	1,131,611	$	290,654	$	1,251	$	3,874,064

(1) The 2021 origination year includes $42.2 million of pass grade residential real estate loans purchased during the six months ended June 30, 2022 which were originated during the year ended December 31, 2021.

(2) Represents the loans receivable balance at June 30, 2022 which was converted from a revolving loan to an amortizing loan during the six months ended June 30, 2022.


	December 31, 2021
	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans		Revolving Loans Converted (1)		Loans Receivable
	2021		2020		2019		2018		2017		Prior
	(In thousands)
Commercial business:
Commercial and industrial
Pass	$	95,960	$	100,193	$	94,657	$	54,707	$	28,558	$	77,294	$	127,651	$	1,035	$	580,055
SM	326		884		5,998		1,425		2,223		2,401		2,048		353		15,658
SS	1,443		1,287		5,912		2,809		2,526		6,907		4,402		568		25,854

Total	97,729		102,364		106,567		58,941		33,307		86,602		134,101		1,956		621,567
SBA PPP
Pass	139,253		6,587		—		—		—		—		—		—		145,840




Owner-occupied CRE
Pass	182,742		90,609		188,380		73,714		66,039		273,518		—		72		875,074
SM	264		—		3,079		7,521		3,937		16,724		—		—		31,525
SS	—		1,332		—		3,787		3,014		16,418		—		—		24,551

Total	183,006		91,941		191,459		85,022		72,990		306,660		—		72		931,150
Non-owner-occupied CRE
Pass	187,860		185,650		244,863		149,090		144,896		499,486		—		—		1,411,845
SM	—		—		5,674		—		15,482		2,400		—		—		23,556
SS	—		—		—		3,379		—		54,319		—		—		57,698

Total	187,860		185,650		250,537		152,469		160,378		556,205		—		—		1,493,099
Total commercial business
Pass	605,815		383,039		527,900		277,511		239,493		850,298		127,651		1,107		3,012,814
SM	590		884		14,751		8,946		21,642		21,525		2,048		353		70,739
SS	1,443		2,619		5,912		9,975		5,540		77,644		4,402		568		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	85,089		27,090		23,295		5,672		6,141		16,891		—		—		164,178

SS	—		—		—		—		—		404		—		—		404

Total	85,089		27,090		23,295		5,672		6,141		17,295		—		—		164,582

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	December 31, 2021
	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans		Revolving Loans Converted (1)		Loans Receivable
	2021		2020		2019		2018		2017		Prior
	(In thousands)
Real estate construction and land development:
Residential
Pass	44,892		23,728		12,266		2,921		389		1,351		—		—		85,547




Commercial and multifamily
Pass	56,448		41,616		34,117		5,794		710		1,379		—		—		140,064
SM	—		—		68		—		—		213		—		—		281
SS	—		571		—		—		—		420		—		—		991

Total	56,448		42,187		34,185		5,794		710		2,012		—		—		141,336
Total real estate construction and land development
Pass	101,340		65,344		46,383		8,715		1,099		2,730		—		—		225,611
SM	—		—		68		—		—		213		—		—		281
SS	—		571		—		—		—		420		—		—		991

Total	101,340		65,915		46,451		8,715		1,099		3,363		—		—		226,883
Consumer
Pass	1,286		15,737		46,041		29,819		15,068		13,026		108,492		120		229,589

SS	—		181		657		476		542		1,043		36		17		2,952

Total	1,286		15,918		46,698		30,295		15,610		14,069		108,528		137		232,541
Loans receivable
Pass	793,530		491,210		643,619		321,717		261,801		882,945		236,143		1,227		3,632,192
SM	590		884		14,819		8,946		21,642		21,738		2,048		353		71,020
SS	1,443		3,371		6,569		10,451		6,082		79,511		4,438		585		112,450

Total	$	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.

(d) Nonaccrual Loans

The following tables present the amortized cost of nonaccrual loans for the dates indicated:


	June 30, 2022
	Nonaccrual without ACL		Nonaccrual with ACL		Total Nonaccrual
	(In thousands)
Commercial business:
Commercial and industrial	$	5,604	$	569	$	6,173
Owner-occupied CRE	—		4,302		4,302








Total	$	5,604	$	4,871	$	10,475


	December 31, 2021
	Nonaccrual without ACL		Nonaccrual with ACL		Total Nonaccrual
	(In thousands)
Commercial business:
Commercial and industrial	$	6,454	$	3,827	$	10,281
Owner-occupied CRE	3,036		5,138		8,174
Non-owner occupied CRE	1,273		3,379		4,652
Total commercial business	10,763		12,344		23,107
Residential real estate	—		47		47

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	December 31, 2021
	Nonaccrual without ACL		Nonaccrual with ACL		Total Nonaccrual
	(In thousands)
Real estate construction and land development:

Commercial and multifamily	—		571		571

Consumer	—		29		29
Total	$	10,763	$	12,991	$	23,754

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 or sale of previously classified nonaccrual loans during the following periods:


	Three Months Ended June 30, 2022				Three Months Ended June 30, 2021
	Interest Income Reversed		Interest Income Recognized		Interest Income Reversed		Interest Income Recognized
	(In thousands)
Commercial business:
Commercial and industrial	$	(12)	$	90	$	(5)	$	1,981
Owner-occupied CRE	—		—		—		3








Total	$	(12)	$	90	$	(5)	$	1,984


	Six Months Ended June 30, 2022				Six Months Ended June 30, 2021
	Interest Income Reversed		Interest Income Recognized		Interest Income Reversed		Interest Income Recognized
	(in thousands)
Commercial business:
Commercial and industrial	$	(14)	$	229	$	(10)	$	2,044
Owner-occupied CRE	—		53		—		117
Non-owner occupied CRE	—		774		—		313
Total commercial business	(14)		1,056		(10)		2,474
Residential real estate	—		19		—		—
Real estate construction and land development:
Residential	—		—		—		73


Consumer	—		68		—		—
Total	$	(14)	$	1,143	$	(10)	$	2,547

For the three and six months ended June 30, 2022 and 2021, 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 or sale.

(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 June 30, 2022 and December 31, 2021 were as follows:


	June 30, 2022
	30-89 Days		90 Days or Greater		Total Past Due		Current		Loans Receivable
	(In thousands)
Commercial business:
Commercial and industrial	$	259	$	7,190	$	7,449	$	691,379	$	698,828
SBA PPP	—		—		—		11,334		11,334
Owner-occupied CRE	1,056		189		1,245		949,454		950,699
Non-owner occupied CRE	—		—		—		1,515,796		1,515,796

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	June 30, 2022
	30-89 Days		90 Days or Greater		Total Past Due		Current		Loans Receivable
	(In thousands)
Total commercial business	1,315		7,379		8,694		3,167,963		3,176,657
Residential real estate	—		—		—		265,382		265,382
Real estate construction and land development:
Residential	—		—		—		90,546		90,546
Commercial and multifamily	—		—		—		128,060		128,060
Total real estate construction and land development	—		—		—		218,606		218,606
Consumer	651		199		850		212,569		213,419
Total	$	1,966	$	7,578	$	9,544	$	3,864,520	$	3,874,064


	December 31, 2021
	30-89 Days		90 Days or Greater		Total Past Due		Current		Loans Receivable
	(In thousands)
Commercial business:
Commercial and industrial	$	1,858	$	6,821	$	8,679	$	612,888	$	621,567
SBA PPP	223		293		516		145,324		145,840
Owner-occupied CRE	2,397		112		2,509		928,641		931,150
Non-owner occupied CRE	—		—		—		1,493,099		1,493,099
Total commercial business	4,478		7,226		11,704		3,179,952		3,191,656
Residential real estate	420		10		430		164,152		164,582
Real estate construction and land development:
Residential	792		—		792		84,755		85,547
Commercial and multifamily	3,474		571		4,045		137,291		141,336
Total real estate construction and land development	4,266		571		4,837		222,046		226,883
Consumer	1,026		—		1,026		231,515		232,541
Total	$	10,190	$	7,807	$	17,997	$	3,797,665	$	3,815,662

Loans 90 days or more past due and still accruing interest were $2.0 million and $293,000 as of June 30, 2022 and December 31, 2021, respectively.

(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 June 30, 2022 and December 31, 2021 was 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:


	June 30, 2022
	CRE		Farmland		Residential Real Estate		Total
	(In thousands)
Commercial business:
Commercial and industrial	$	1,239	$	2,492	$	1,316	$	5,047
Owner-occupied CRE	189		—		—		189








Total	$	1,428	$	2,492	$	1,316	$	5,236

December 31, 2021

CRE

Farmland

Residential Real Estate

Other

Total

(In thousands)

Commercial business:

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	December 31, 2021
	CRE		Farmland		Residential Real Estate		Other		Total
	(In thousands)
Commercial and industrial	$	1,499	$	4,362	$	1,036	$	245	$	7,142
Owner-occupied CRE	3,035		—		—		—		3,035
Non-owner occupied CRE	1,273		—		—		—		1,273
Total commercial business	5,807		4,362		1,036		245		11,450

Real estate construction and land development:

Commercial and multifamily	571		—		—		—		571


Total	$	6,378	$	4,362	$	1,036	$	245	$	12,021

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 six months ended June 30, 2022, except changes due to additions or removals of loans from this classification.

(g) Troubled Debt Restructured Loans

Loans that were modified as TDR loans are set forth in the following table for the periods indicated:


	Three Months Ended June 30,
	2022			2021
	Number of Contracts	Amortized Cost (1) (2)		Number of Contracts	Amortized Cost (1) (2)
	(Dollars in thousands)
Commercial business:
Commercial and industrial	3	$	1,727	18	$	5,673
Owner-occupied CRE	—	—		1	2,200
Non-owner occupied CRE	—	—		1	251
Total commercial business	3	1,727		20	8,124

Real estate construction and land development:

Commercial and multifamily	—	—		1	443

Consumer	3	44		6	146
Total	6	$	1,771	27	$	8,713


	Six Months Ended June 30,
	2022			2021
	Number of Contracts	Amortized Cost (1) (2)		Number of Contracts	Amortized Cost (1) (2)
	(Dollars in thousands)
Commercial business:
Commercial and industrial	4	$	2,610	31	$	8,713
Owner-occupied CRE	—	—		2	5,857
Non-owner occupied CRE	—	—		2	2,222
Total commercial business	4	2,610		35	16,792
Residential real estate	—	—		1	181
Real estate construction and land development:

Commercial and multifamily	—	—		1	443

Consumer	8	95		21	511
Total	12	$	2,705	58	$	17,927

(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 six months ended June 30, 2022 and 2021.

(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 $4,000 and $1.7 million at June 30, 2022 and June 30, 2021, respectively, related to these TDR loans which were restructured during the six months ended June 30, 2022 and June 30, 2021, respectively.

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The unfunded commitment to borrowers related to TDR loans was $3.4 million and $5.7 million at June 30, 2022 and December 31, 2021, respectively.

The following table presents loans that were modified in a TDR and subsequently defaulted within twelve months from the modification date during the periods indicated:


	Three Months Ended June 30,
	2022			2021
	Number of Contracts (1)	Amortized Cost (1)		Number of Contracts (1)	Amortized Cost (1)
	(Dollars in thousands)
Commercial business:
Commercial and industrial	—	$	—	1	$	46


	Six Months Ended June 30,
	2022			2021
	Number of Contracts (1)	Amortized Cost (1)		Number of Contracts (1)	Amortized Cost (1)
	(Dollars in thousands)
Commercial business:
Commercial and industrial	—	$	—	2	$	789
Owner-occupied CRE	1	189		—	—

(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 six months ended June 30, 2022 and 2021.

The Bank had $3,000 ACL on loans at June 30, 2022 and $7,000 at June 30, 2021 related to these TDR loans which defaulted during the six months ended June 30, 2022 and 2021.

(h) Accrued interest receivable on loans receivable

Accrued interest receivable on loans receivable totaled $9.5 million and $10.1 million at June 30, 2022 and December 31, 2021, respectively. It is excluded from the calculation of the ACL on loans as interest accrued, but not received, is reversed timely.

(i) Foreclosure proceedings in process

At June 30, 2022, there were no consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process.

(4)Allowance for Credit Losses on Loans

The baseline loss rates used to calculate the ACL on loans at June 30, 2022 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 six months ended June 30, 2022. 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 June 30, 2022 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 six months ended June 30, 2022.

The reasonable and supportable period and subsequent reversion period used in the CECL model was five quarters and two quarters, respectively, at December 31, 2021. There were no changes to these assumptions during the six months ended June 30, 2022. 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 six months ended June 30, 2022, the ACL on loans decreased $2.7 million, or 6.3%, due primarily to a reversal of provision for credit losses on loans of $3.2 million driven by a $2.9 million reduction in the ACL on loans individually evaluated for losses and their related ACL as well as changes in the loan mix and continued improvement in forecasted economic indicators used to calculate credit losses. The ACL on loans at June 30, 2022 and December 31, 2021 did not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.

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A summary of the changes in the ACL on loans during the six months ended June 30, 2022 and 2021 is as follows:


	Six Months Ended June 30,
	2022		2021
	(In thousands)
Beginning balance	$	42,361	$	70,185
Charge-offs	(604)		(320)
Recoveries of loans previously charged-off	1,110		653
Reversal of provision for credit losses on loans	(3,171)		(18,956)
Ending balance	$	39,696	$	51,562

The following tables detail the activity in the ACL on loans by segment and class for the periods indicated:


	Three Months Ended June 30, 2022
	Beginning Balance		Charge-offs		Recoveries		(Reversal of) Provision for Credit Losses		Ending Balance
	(In thousands)
Commercial business:
Commercial and industrial	$	15,265	$	(117)	$	149	$	(1,264)	$	14,033
Owner-occupied CRE	7,085		—		—		1,077		8,162
Non-owner occupied CRE	9,582		—		—		(70)		9,512
Total commercial business	31,932		(117)		149		(257)		31,707
Residential real estate	1,803		—		—		334		2,137
Real estate construction and land development:
Residential	1,124		—		6		(49)		1,081
Commercial and multifamily	3,175		—		53		(1,025)		2,203
Total real estate construction and land development	4,299		—		59		(1,074)		3,284
Consumer	2,299		(132)		53		348		2,568
Total	$	40,333	$	(249)	$	261	$	(649)	$	39,696


	Six Months Ended June 30, 2022
	Beginning Balance		Charge-offs		Recoveries		(Reversal of) Provision for Credit Losses		Ending Balance
	(In thousands)
Commercial business:
Commercial and industrial	$	17,777	$	(280)	$	421	$	(3,885)	$	14,033
Owner-occupied CRE	6,411		(36)		—		1,787		8,162
Non-owner occupied CRE	8,861		—		—		651		9,512
Total commercial business	33,049		(316)		421		(1,447)		31,707
Residential real estate	1,409		(30)		3		755		2,137
Real estate construction and land development:
Residential	1,304		—		14		(237)		1,081
Commercial and multifamily	3,972		—		53		(1,822)		2,203
Total real estate construction and land development	5,276		—		67		(2,059)		3,284
Consumer	2,627		(258)		619		(420)		2,568
Total	$	42,361	$	(604)	$	1,110	$	(3,171)	$	39,696

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	Three Months Ended June 30, 2021
	Beginning Balance		Charge-offs		Recoveries		(Reversal of) Provision for Credit Losses		Ending Balance
	(In thousands)
Commercial business:
Commercial and industrial	$	21,770	$	(13)	$	132	$	(4,404)	$	17,485
Owner-occupied CRE	10,464		—		11		(1,913)		8,562
Non-owner occupied CRE	12,970		—		—		(2,340)		10,630
Total commercial business	45,204		(13)		143		(8,657)		36,677
Residential real estate	1,402		—		—		(249)		1,153
Real estate construction and land development:
Residential	2,048		—		4		(416)		1,636
Commercial and multifamily	11,223		—		—		(2,388)		8,835
Total real estate construction and land development	13,271		—		4		(2,804)		10,471
Consumer	4,348		(120)		144		(1,111)		3,261
Total	$	64,225	$	(133)	$	291	$	(12,821)	$	51,562


	Six Months Ended June 30, 2021
	Beginning Balance		Charge-offs		Recoveries		(Reversal of) Provision for Credit Losses		Ending Balance
	(In thousands)
Commercial business:
Commercial and industrial	$	30,010	$	(14)	$	337	$	(12,848)	$	17,485
Owner-occupied CRE	9,486		—		13		(937)		8,562
Non-owner occupied CRE	10,112		—		—		518		10,630
Total commercial business	49,608		(14)		350		(13,267)		36,677
Residential real estate	1,591		—		—		(438)		1,153
Real estate construction and land development:
Residential	1,951		—		20		(335)		1,636
Commercial and multifamily	11,141		(1)		—		(2,305)		8,835
Total real estate construction and land development	13,092		(1)		20		(2,640)		10,471
Consumer	5,894		(305)		283		(2,611)		3,261
Total	$	70,185	$	(320)	$	653	$	(18,956)	$	51,562

(5)Goodwill and Other Intangible Assets

(a) Goodwill

There were no additions to goodwill during the three and six months ended June 30, 2022 and 2021. Additionally, management analyzes its goodwill on an annual basis on December 31 and between annual tests in certain circumstances such as material adverse changes in legal, business, regulatory and economic factors. An impairment loss is recorded to the extent the carrying amount of goodwill exceeds its implied fair value. The Company performed an annual impairment assessment as of December 31, 2021 and concluded that there was no impairment.

(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 other intangible assets during the three and six months ended June 30, 2022 and 2021.

(6)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. The transaction allows the Company’s customer to effectively convert a variable rate loan to a

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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. These interest rate swaps are not designated as hedging instruments.

The Company is exposed to interest rate risk as part of the transaction. However, the Company acts as an intermediary for its customer therefore 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.

Fee income related to interest rate swap derivative contract transactions is recorded in Interest rate swap fees on the unaudited Condensed 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 unaudited Condensed 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 unaudited Condensed Consolidated Statements of Income, but typically net to zero based on the identical back-to-back interest rate swap derivative contracts 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.

The following table presents the notional amounts and estimated fair values of interest rate derivative contracts outstanding at the dates indicated:


	June 30, 2022			December 31, 2021
	Notional Amounts		Estimated Fair Value	Notional Amounts		Estimated Fair Value
	(In thousands)
Non-hedging interest rate derivatives
Interest rate swap asset (1)	$	305,902	19,842	$	322,726	$	15,219
Interest rate swap liability (1)	305,902		(19,842)	322,726		(15,286)

(1) The estimated fair value of derivatives with customers was $(19.0) million and $9.8 million as of June 30, 2022 and December 31, 2021, respectively. The estimated fair value of derivatives with third-parties was $19.0 million and $(9.8) million as of June 30, 2022 and December 31, 2021, respectively.

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.

(7)Stockholders’ Equity

(a) Earnings Per Common Share

The following table illustrates the calculation of weighted average shares used for earnings per common share computations for the periods indicated:


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
	(In thousands, except shares)

Net income	$	18,584	$	32,702	$	38,341	$	58,046


Basic:
Weighted average common shares outstanding	35,110,334		35,994,740		35,102,572		35,961,032


Diluted:
Basic weighted average common shares outstanding	35,110,334		35,994,740		35,102,572		35,961,032
Effect of potentially dilutive common shares (1)	299,190		294,724		310,150		307,829
Total diluted weighted average common shares outstanding	35,409,524		36,289,464		35,412,722		36,268,861
Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (2)	16,978		7,065		14,334		4,766

(1)Represents the effect of the vesting of restricted stock units.

(2) Anti-dilution occurs when the unrecognized compensation cost per share of a restricted stock 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

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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 six months ended June 30, 2022 and the calendar year 2021:

Declared

Cash Dividend per Share

Record Date

Paid Date

January 27, 2021

$0.20

February 10, 2021

February 24, 2021

April 21, 2021

$0.20

May 5, 2021

May 19, 2021

July 21, 2021

$0.20

August 4, 2021

August 18, 2021

October 20, 2021

$0.21

November 3, 2021

November 17, 2021

January 26, 2022

$0.21

February 9, 2022

February 23, 2022

April 20, 2022

$0.21

May 4, 2022

May 18, 2022

The FDIC and the Washington State Department of Financial Institutions, Division of Banks have the authority under their supervisory powers to prohibit the payment of dividends by the Bank to the Company. Additionally, current guidance from the Federal Reserve provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the FDIC.

The Company has had various stock repurchase programs since March 1999. On March 12, 2020, the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock repurchase plan. The number, timing and price of shares repurchased 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 plan for the periods indicated:


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021		Plan Total(1)





Repurchased shares	19,531		—		100,090		—		1,160,840
Stock repurchase average share price	$	24.63	$	—	$	25.07	$	—	$	23.94

(1)Represents shares repurchased and average price per share paid during the duration of the plan.

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Repurchased shares to pay withholding taxes	1,649		2,557		26,180		25,803
Stock repurchase to pay withholding taxes average share price	$	24.43	$	27.47	$	25.40	$	29.33

(8)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, 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.

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(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 June 30, 2022 and December 31, 2021, 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 unaudited Condensed Consolidated Statements of Financial Condition with any valuation adjustment recorded within other noninterest expense on the unaudited Condensed 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:


	June 30, 2022
	Total		Level 1		Level 2		Level 3
	(In thousands)
Assets
Investment securities available for sale:
U.S. government and agency securities	$	65,668	$	19,939	$	45,729	$	—
Municipal securities	200,010		—		200,010		—
Residential CMO and MBS	398,156		—		398,156		—

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	June 30, 2022
	Total		Level 1		Level 2		Level 3
	(In thousands)
Commercial CMO and MBS	493,620		—		493,620		—
Corporate obligations	5,978		—		5,978		—
Other asset-backed securities	24,156		—		24,156		—
Total investment securities available for sale	1,187,588		19,939		1,167,649		—
Equity security	186		186		—		—
Derivative assets - interest rate swaps	19,842		—		19,842		—
Liabilities
Derivative liabilities - interest rate swaps	$	19,842	$	—	$	19,842	$	—


	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	$	—
Municipal securities	221,212		—		221,212		—
Residential CMO and MBS	306,884		—		306,884		—
Commercial CMO and MBS	315,861		—		315,861		—
Corporate obligations	2,014		—		2,014		—
Other asset-backed securities	26,991		—		26,991		—
Total investment securities available for sale	894,335		—		894,335		—
Equity security	240		240		—		—
Derivative assets - interest rate swaps	15,219		—		15,219		—
Liabilities
Derivative liabilities - interest rate swaps	$	15,286	$	—	$	15,286	$	—

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 represent assets measured at fair value on a nonrecurring basis at the dates indicated:


			Fair Value at June 30, 2022
	Basis(1)		Total		Level 1		Level 2		Level 3
	(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial	$	1,054	$	969	$	—	$	—	$	969
Owner-occupied CRE	613		186		—		—		186











Total assets measured at fair value on a nonrecurring basis	$	1,667	$	1,155	$	—	$	—	$	1,155

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


			Fair Value at December 31, 2021
	Basis(1)		Total		Level 1		Level 2		Level 3
	(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial	$	1,911	$	1,049	$	—	$	—	$	1,049
Owner-occupied CRE	613		189		—		—		189

Total commercial business	2,524		1,238		—		—		1,238

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Real estate construction and land development:

Commercial and multifamily	991		$	534	—		—		534


Total	3,515		1,772		—		—		1,772
Prepaid expenses and other assets:
Branch held for sale (2)	698		698		—		—		698
Total assets measured at fair value on a nonrecurring basis	$	4,213	$	2,470	$	—	$	—	$	2,470

(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.

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
	(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial	$	35	$	6	$	23	$	(28)
Owner-occupied CRE	(3)		(76)		(3)		(76)

Total commercial business	32		(70)		20		(104)

Real estate construction and land development:

Commercial and multifamily	—		(23)		—		(38)



Net loss from nonrecurring fair value adjustments	$	32	$	(93)	$	20	$	(142)

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:

June 30, 2022

Fair
Value

Valuation
Technique(s)

Unobservable Input(s)

Range of Inputs; Weighted
Average

(Dollars in thousands)

Collateral-dependent loans

1,155

Market approach

Adjustment for differences between the comparable sales

N/A(1)

(1)Quantitative disclosures are not provided for collateral-dependent loans because there were no adjustments made to the appraisal or stated values during the current period.

December 31, 2021

Fair
Value

Valuation
Technique(s)

Unobservable Input(s)

Range of Inputs; Weighted
Average

(Dollars in thousands)

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

(b) Fair Value of Financial Instruments

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

The following tables present the carrying value amount of the Company’s financial instruments and their corresponding

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estimated fair values at the dates indicated:


	June 30, 2022
	Carrying Value		Fair Value		Fair Value Measurements Using:
					Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	994,055	$	994,055	$	994,055	$	—	$	—
Investment securities available for sale	1,187,588		1,187,588		19,939		1,167,649		—
Investment securities held to maturity	615,653		559,312		—		559,312		—
Loans held for sale	1,311		1,353		—		1,353		—
Loans receivable, net	3,834,368		3,760,294		—		—		3,760,294
Accrued interest receivable	15,908		15,908		272		6,185		9,451
Derivative assets - interest rate swaps	19,842		19,842		—		19,842		—
Equity security	186		186		186		—		—
Financial Liabilities:
Non-maturity deposits	$	6,019,421	$	6,019,421	$	6,019,421	$	—	$	—
Certificates of deposit	310,769		311,481		—		311,481		—

Securities sold under agreement to repurchase	41,827		41,827		41,827		—		—
Junior subordinated debentures	21,326		19,250		—		—		19,250
Accrued interest payable	83		83		31		16		36
Derivative liabilities - interest rate swaps	19,842		19,842		—		19,842		—


	December 31, 2021
	Carrying Value		Fair Value		Fair Value Measurements Using:
					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	894,335		894,335		—		894,335		—
Investment securities held to maturity	383,393		376,331		—		376,331		—
Loans held for sale	1,476		1,527		—		1,527		—
Loans receivable, net	3,773,301		3,849,602		—		—		3,849,602
Accrued interest receivable	14,657		14,657		14		4,582		10,061
Derivative assets - interest rate swaps	15,219		15,219		—		15,219		—
Equity security	240		240		240		—		—
Financial Liabilities:
Non-maturity deposits	$	6,038,498	$	6,038,498	$	6,038,498	$	—	$	—
Certificates of deposit	342,839		344,025		—		344,025		—

Securities sold under agreement to repurchase	50,839		50,839		50,839		—		—
Junior subordinated debentures	21,180		18,750		—		—		18,750
Accrued interest payable	73		73		33		19		21
Derivative liabilities - interest rate swaps	15,286		15,286		—		15,286		—

(9)Cash Restriction

The Bank had no cash restrictions at June 30, 2022 and had restricted cash included in interest earning deposits of $9.8 million at December 31, 2021 relating to collateral required on interest rate swaps from third-parties as discussed in Note (6) Derivative Financial Instruments. The Bank does not have a collateral requirement with customers.

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(10)Commitments and Contingencies

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 unaudited Condensed Consolidated Financial Statements. The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The majority of the commitments presented below are variable rate. Loan commitments can be either revolving or non-revolving. The Bank’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.

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


	June 30, 2022		December 31, 2021
	(In thousands)
Commercial business:
Commercial and industrial	$	553,134	$	570,156
Owner-occupied CRE	3,612		2,252
Non-owner occupied CRE	13,310		7,487
Total commercial business	570,056		579,895

Real estate construction and land development:
Residential	52,374		51,838
Commercial and multifamily	217,177		209,217
Total real estate construction and land development	269,551		261,055
Consumer	307,906		285,010
Total outstanding commitments	$	1,147,513	$	1,125,960

The following table details the activity in the ACL on unfunded commitments during the periods indicated:


	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
	(In thousands)
Balance, beginning of period	$	1,552	$	3,617	$	2,607	$	4,681
Reversal of provision for credit losses on unfunded commitments	(555)		(1,166)		(1,610)		(2,230)
Balance, end of period	$	997	$	2,451	$	997	$	2,451

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in understanding the financial condition and results of operations of the Company as of and for the three and six months ended June 30, 2022. The information contained in this section should be read together with the unaudited Condensed Consolidated Financial Statements and the accompanying Notes included herein, the Forward-Looking Statements included herein and the December 31, 2021 audited Consolidated Financial Statements and the accompanying Notes included in our 2021 Annual Form 10-K.

Overview

Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of our wholly-owned financial institution subsidiary, Heritage Bank. We provide financial services to our local communities with an ongoing strategic focus on our commercial banking relationships, market expansion and asset quality. 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.

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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 including most recently significant changes as a result of inflation, 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, card revenue 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, including changes resulting from the COVID-19 Pandemic and inflation and the governmental actions taken to address these issues. 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. 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 during the year ended December 31, 2021, including the consolidation of eight branches and four branches during the three months ended March 31, 2021 and December 31, 2021, respectively. 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

Comparison of quarter ended June 30, 2022 to the comparable quarter in the prior year

Net income was $18.6 million, or $0.52 per diluted common share, for the three months ended June 30, 2022 compared to $32.7 million, or $0.90 per diluted common share, for the same period in 2021. Net income decreased $14.1 million, or 43.2%, due primarily to a lower reversal of provision for credit losses and secondarily due to lower interest and fees on loans. The Company’s efficiency ratio was 62.57% for the three months ended June 30, 2022 compared to 58.18% for the same period in 2021.

Comparison of six months ended June 30, 2022 to the comparable period in the prior year.

Net income was $38.3 million, or $1.08 per diluted common share, for the six months ended June 30, 2022 compared to $58.0 million, or $1.60 per diluted common share, for the six months ended June 30, 2021. Net income decreased $19.7 million, or 33.9%, also due primarily to lower reversal of provision for credit losses and secondarily due to lower interest and fees on loans. The Company’s efficiency ratio was 63.46% for the six months ended June 30, 2022 compared to 59.84% for the same period in 2021.

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Average Balances, Yields and Rates Paid

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


	Three Months Ended June 30,
	2022						2021						Change
	Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate		Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate		Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate
	(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net (2)(3)	$	3,812,045	$	40,890	4.30	%	$	4,402,868	$	50,750	4.62	%	$	(590,823)	$	(9,860)	(0.32)	%
Taxable securities	1,450,328		7,607		2.10		799,023		4,050		2.03		651,305		3,557		0.07
Nontaxable securities (3)	137,429		893		2.61		160,489		947		2.37		(23,060)		(54)		0.24
Interest earning deposits	1,213,156		2,342		0.77		964,791		263		0.11		248,365		2,079		0.66
Total interest earning assets	6,612,958		51,732		3.14	%	6,327,171		56,010		3.55	%	285,787		(4,278)		(0.41)	%
Noninterest earning assets	772,658						752,034						20,624
Total assets	$	7,385,616					$	7,079,205					$	306,411
Interest Bearing Liabilities:
Certificates of Deposit	$	321,926	$	324	0.40	%	$	381,417	$	481	0.51	%	$	(59,491)	$	(157)	(0.11)	%
Savings accounts	652,407		88		0.05		591,616		89		0.06		60,791		(1)		(0.01)
Interest bearing demand and money market accounts	3,067,373		1,001		0.13		2,836,717		954		0.13		230,656		47		—
Total interest bearing deposits	4,041,706		1,413		0.14		3,809,750		1,524		0.16		231,956		(111)		(0.02)
Junior subordinated debentures	21,287		239		4.50		20,986		186		3.55		301		53		0.95
Securities sold under agreement to repurchase	48,272		32		0.27		43,259		35		0.32		5,013		(3)		(0.05)

Total interest bearing liabilities	4,111,265		1,684		0.16	%	3,873,995		1,745		0.18	%	237,270		(61)		(0.02)	%
Noninterest bearing demand deposits	2,349,746						2,261,373						88,373
Other noninterest bearing liabilities	113,644						108,076						5,568
Stockholders’ equity	810,961						835,761						(24,800)
Total liabilities and stock-holders’ equity	$	7,385,616					$	7,079,205					$	306,411
Net interest income and spread			$	50,048	2.98	%			$	54,265	3.37	%			$	(4,217)	(0.39)	%
Net interest margin					3.04	%					3.44	%					(0.40)	%

(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 $2.4 million and $8.2 million for the three months ended June 30, 2022 and 2021, respectively.

(3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis.

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 for the three months ended June 30, 2022 compared to the three months ended June 30, 2021 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:


	Increase (Decrease) Due to Changes In:
	Volume		Yield/Rate		Total		% Change
	(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net	$	(6,499)	$	(3,361)	$	(9,860)	(19.4)	%

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	Increase (Decrease) Due to Changes In:
	Volume		Yield/Rate		Total		% Change
	(Dollars in thousands)
Taxable securities	3,411		146		3,557		87.8
Nontaxable securities	(144)		90		(54)		(5.7)
Interest earning deposits	84		1,995		2,079		790.5
Total interest income	$	(3,148)	$	(1,130)	$	(4,278)	(7.6)	%
Interest Bearing Liabilities:
Certificates of deposit	$	(68)	$	(89)	$	(157)	(32.6)	%
Savings accounts	9		(10)		(1)		(1.1)
Interest bearing demand and money market accounts	76		(29)		47		4.9
Total interest bearing deposits	17		(128)		(111)		(7.3)
Junior subordinated debentures	3		50		53		28.5
Securities sold under agreement to repurchase	4		(7)		(3)		(8.6)

Total interest expense	$	24	$	(85)	$	(61)	(3.5)	%
Net interest income	$	(3,172)	$	(1,045)	$	(4,217)	(7.8)	%

Comparison of quarter ended June 30, 2022 to the comparable quarter in the prior year

Net interest income decreased primarily as a result of the decrease in deferred SBA PPP loan fees recognized due to a decrease in the volume of forgiven SBA PPP loans, offset partially by a higher average balance of taxable investment securities and higher yield earned on interest earning deposits.

Net interest margin decreased due primarily to the change in the mix of total interest earning assets into a higher proportion of lower yielding investment securities and interest earning deposits, resulting mostly from a significant decrease in SBA PPP loan balances.

The following table presents the loan yield and the impacts of SBA PPP loans and the incremental accretion on acquired loans on this financial measure for the periods presented below:


	Three Months Ended
	June 30, 2022		June 30, 2021

Loan yield (GAAP)	4.30	%	4.62	%
Exclude impact from SBA PPP loans	(0.15)		(0.12)
Exclude impact from incremental accretion on acquired loans	(0.03)		(0.05)
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans (non-GAAP) (1)	4.12	%	4.45	%

(1) For additional information, see the "Reconciliations of Non-GAAP Measures" section below.

The impact to loan yield from recoveries of interest and fees on loans classified as nonaccrual was one basis point during the three months ended June 30, 2022 compared to 18 basis points during the same period in 2021.

Comparison of six months ended June 30, 2022 to the comparable period in the prior year

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


	Six Months Ended June 30,
	2022						2021						Change
	Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate		Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate		Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate
	(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net (2)(3)	$	3,792,792	$	81,915	4.36	%	$	4,446,442	$	100,274	4.55	%	$	(653,650)	$	(18,359)	(0.19)	%
Taxable securities	1,361,437		13,610		2.02		736,990		7,584		2.08		624,447		6,026		(0.06)
Nontaxable securities (3)	141,894		1,753		2.49		162,192		1,905		2.37		(20,298)		(152)		0.12
Interest earning deposits	1,357,420		3,048		0.45		840,030		438		0.11		517,390		2,610		0.34
Total interest earning assets	6,653,543		100,326		3.04	%	6,185,654		110,201		3.59	%	467,889		(9,875)		(0.55)	%

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	Six Months Ended June 30,
	2022						2021						Change
	Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate		Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate		Average Balance(1)		Interest Earned/ Paid		Average Yield/ Rate
	(Dollars in thousands)
Noninterest earning assets	756,523						754,533						1,990
Total assets	$	7,410,066					$	6,940,187					$	469,879
Interest Bearing Liabilities:
Certificates of Deposit	$	329,100	$	662	0.41	%	$	387,310	$	1,040	0.54	%	$	(58,210)	$	(378)	(0.13)	%
Savings accounts	649,562		175		0.05		575,942		184		0.06		73,620		(9)		(0.01)
Interest bearing demand and money market accounts	3,066,849		2,000		0.13		2,784,714		2,028		0.15		282,135		(28)		(0.02)
Total interest bearing deposits	4,045,511		2,837		0.14		3,747,966		3,252		0.17		297,545		(415)		(0.03)
Junior subordinated debentures	21,250		433		4.11		20,950		373		3.59		300		60		0.52
Securities sold under agreement to repurchase	49,140		64		0.26		41,676		73		0.35		7,464		(9)		(0.09)

Total interest bearing liabilities	4,115,901		3,334		0.16	%	3,810,592		3,698		0.20	%	305,309		(364)		(0.04)	%
Noninterest bearing demand deposits	2,354,571						2,183,638						170,933
Other noninterest bearing liabilities	111,167						114,542						(3,375)
Stockholders’ equity	828,427						831,415						(2,988)
Total liabilities and stock-holders’ equity	$	7,410,066					$	6,940,187					$	469,879
Net interest income and spread			$	96,992	2.88	%			$	106,503	3.39	%			$	(9,511)	(0.51)	%
Net interest margin					2.94	%					3.47	%					(0.53)	%

(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 $5.8 million and $15.4 million for the six months ended June 30, 2022 and 2021, respectively.

(3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis.

Net Interest Income and Margin Overview

The following table provides the changes in net interest income for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 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:


	Increase (Decrease) Due to Changes In:
	Volume		Yield/Rate		Total		% Change
	(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net	$	(14,257)	$	(4,102)	$	(18,359)	(18.3)	%
Taxable securities	6,248		(222)		6,026		79.5
Nontaxable securities	(247)		95		(152)		(8.0)
Interest earning deposits	410		2,200		2,610		595.9
Total interest income	$	(7,846)	$	(2,029)	$	(9,875)	(9.0)	%
Interest Bearing Liabilities:
Certificates of deposit	$	(142)	$	(236)	$	(378)	(36.3)	%
Savings accounts	22		(31)		(9)		(4.9)
Interest bearing demand and money market accounts	195		(223)		(28)		(1.4)
Total interest bearing deposits	75		(490)		(415)		(12.8)
Junior subordinated debentures	5		55		60		16.1
Securities sold under agreement to repurchase	12		(21)		(9)		(12.3)

Total interest expense	$	92	$	(456)	$	(364)	(9.8)	%
Net interest income	$	(7,938)	$	(1,573)	$	(9,511)	(8.9)	%

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Comparison of six months ended June 30, 2022 to the comparable period in the prior year

Net interest income decreased due primarily to a decrease in deferred SBA PPP loan fees recognized due to a decrease in the volume of forgiven SBA PPP loans, offset partially by a higher average balance of taxable investment securities and higher yield earned on interest earning deposits.

Net interest margin decreased due primarily to the change in the mix of total interest earning assets into a higher proportion of lower yielding investment securities and interest earning deposits.

The following table presents the loan yield and the impacts of SBA PPP loans and the incremental accretion on acquired loans on this financial measure for the periods presented below:


	Six Months Ended June 30,
	2022		2021
Loan yield (GAAP)	4.36	%	4.55	%
Exclude impact from SBA PPP loans	(0.18)		(0.05)
Exclude impact from incremental accretion on acquired loans	(0.05)		(0.09)
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans (non-GAAP) (1)	4.13	%	4.41	%

(1) For additional information, see "Reconciliations of Non-GAAP Measures."

The impact to loan yield from recoveries of interest and fees on loans classified as nonaccrual was six basis points during the six months ended June 30, 2022 compared to 13 basis points during the same period in 2021.

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 unaudited Condensed Consolidated Statements of Income as the (reversal of) provision for credit losses. The ACL on unfunded commitments is included on the unaudited Condensed Consolidated Statements of Financial Condition within accrued expenses and other liabilities.

Comparison of quarter ended June 30, 2022 to the comparable quarter in the prior year

The following table presents the reversal of provision for credit losses for the periods indicated:


	Three Months Ended June 30,
	2022		2021		Change		% Change
	(Dollars in thousands)
Reversal of provision for credit losses on loans	$	(649)	$	(12,821)	$	12,172	(94.9)	%
Reversal of provision for credit losses on unfunded commitments	(555)		(1,166)		611		(52.4)
Reversal of provision for credit losses	$	(1,204)	$	(13,987)	$	12,783	(91.4)	%

The reversal of provision for credit losses on loans recognized during the three months ended June 30, 2022 was due primarily to a reduction of loans individually evaluated for losses and as a result their related ACL. The reversal of provision for credit losses on unfunded commitments recognized during the three months ended June 30, 2022 was due primarily to higher utilization rates on commercial and industrial lines of credit.

The reversal of provision for credit losses on loans and unfunded commitments recognized during the three months ended June 30, 2021 was due primarily to continued improvements in the economic forecast at June 30, 2021 as compared to the forecast at March 31, 2021.

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Comparison of six months ended June 30, 2022 to the comparable period in the prior year

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


	Six Months Ended June 30,
	2022		2021		Change		Percentage Change
	(Dollars in thousands)
Reversal of provision for credit losses on loans	$	(3,171)	$	(18,956)	$	15,785	(83.3)	%
Reversal of provision for credit losses on unfunded commitments	(1,610)		(2,230)		620		(27.8)
Reversal of provision for credit losses	$	(4,781)	$	(21,186)	$	16,405	(77.4)	%

The reversal of provision for credit losses recognized during the six months ended June 30, 2022 was also due primarily to a reduction of loans individually evaluated for losses and as a result their related ACL.

The reversal of provision for credit losses recognized during the six months ended June 30, 2021 was also due substantially to continued improvements in the economic forecast at June 30, 2021 as compared to the forecast at December 31, 2020.

Noninterest Income Overview

Comparison of quarter ended June 30, 2022 to the comparable quarter in the prior year

The following table presents the change in the key components of noninterest income for the periods indicated:


	Three Months Ended June 30,
	2022		2021		Change		% Change
	(Dollars in thousands)
Service charges and other fees	$	2,391	$	2,067	$	324	15.7	%
Card revenue	2,332		2,338		(6)		(0.3)

Gain on sale of loans, net	219		1,003		(784)		(78.2)
Interest rate swap fees	26		209		(183)		(87.6)
Bank owned life insurance income	764		717		47		6.6
Gain on sale of other assets, net	—		724		(724)		(100.0)
Other income	1,284		1,239		45		3.6
Total noninterest income	$	7,016	$	8,297	$	(1,281)	(15.4)	%

Noninterest income decreased due primarily to reduced gain on sale of loans, net as sales volume of secondary market mortgage loans declined and secondarily due to gain on sale other assets, net reflecting the sale of of branches recognized during the second quarter of 2021.

Comparison of six months ended June 30, 2022 to the comparable period in the prior year

The following table presents the change in the key components of noninterest income for the periods indicated:


	Six Months Ended June 30,
	2022		2021		Change		% Change
	(Dollars in thousands)
Service charges and other fees	$	4,687	$	3,959	$	728	18.4	%
Card revenue	4,773		4,435		338		7.6
Gain on sale of investment securities, net	—		29		(29)		(100.0)
Gain on sale of loans, net	460		2,373		(1,913)		(80.6)
Interest rate swap fees	305		361		(56)		(15.5)
Bank owned life insurance income	2,459		1,373		1,086		79.1
Gain on sale of other assets, net	204		746		(542)		(72.7)

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	Six Months Ended June 30,
	2022		2021		Change		% Change
	(Dollars in thousands)
Other income	2,666		3,272		(606)		(18.5)
Total noninterest income	$	15,554	$	16,548	$	(994)	(6.0)	%

Noninterest income decreased due primarily to reduced gain on sale of loans, net as sales volume of secondary market mortgage loans declined and higher gain on sale of other assets, net reflecting the sale of branches recognized during the six months end June 30, 2021, offset partially by an increase in bank owned life insurance income due to the recognition of a death benefit of $1.0 million during the three months ended March 31, 2022 as well as increases in service charges and other fees and card revenue reflecting increased customer transactions as businesses reopened in our market areas.

Noninterest Expense Overview

Comparison of quarter ended June 30, 2022 to the comparable quarter in the prior year

The following table presents changes in the key components of noninterest expense for the periods indicated:


	Three Months Ended June 30,
	2022		2021		Change		% Change
	(Dollars in thousands)
Compensation and employee benefits	$	21,778	$	21,803	$	(25)	(0.1)	%
Occupancy and equipment	4,171		4,091		80		2.0
Data processing	4,185		3,998		187		4.7
Marketing	344		567		(223)		(39.3)
Professional services	529		1,037		(508)		(49.0)
State/municipal business and use tax	867		991		(124)		(12.5)
Federal deposit insurance premium	425		339		86		25.4

Amortization of intangible assets	704		797		(93)		(11.7)
Other expense	2,704		2,773		(69)		(2.5)
Total noninterest expense	$	35,707	$	36,396	$	(689)	(1.9)	%

Noninterest expense decreased due primarily to third-party expenses related to SBA PPP loan forgiveness and higher legal costs related to loan collection efforts included in professional services expense for the second quarter of 2021.

Comparison of six months ended June 30, 2022 to the comparable period in the prior year

The following table presents changes in the key components of noninterest expense for the periods indicated:


	Six Months Ended June 30,
	2022		2021		Change		% Change
	(Dollars in thousands)
Compensation and employee benefits	$	43,030	$	44,004	$	(974)	(2.2)	%
Occupancy and equipment	8,502		8,545		(43)		(0.5)
Data processing	8,246		7,810		436		5.6
Marketing	610		1,080		(470)		(43.5)
Professional services	1,228		2,307		(1,079)		(46.8)
State/municipal business and use tax	1,663		1,963		(300)		(15.3)
Federal deposit insurance premium	1,025		928		97		10.5

Amortization of intangible assets	1,408		1,594		(186)		(11.7)
Other expense	5,715		5,407		308		5.7
Total noninterest expense	$	71,427	$	73,638	$	(2,211)	(3.0)	%

Noninterest expense decreased due primarily to a decrease in professional services which was elevated during the six months ended June 30, 2021 due to costs associated with our participation in the SBA PPP as well as a decrease in

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compensation and employee benefits from a lower headcount and a decrease in marketing expenses due to less activity offset partially by an increase in data processing as the Bank continues to invest in its technology platforms.

Income Tax Expense Overview

Comparison of quarter ended June 30, 2022 to the comparable quarter in the prior year

The following table presents the income tax expense, related metrics and their changes for the periods indicated:


	Three Months Ended June 30,
	2022			2021			Change			% Change
	(Dollars in thousands)
Income before income taxes	$	22,561		$	40,153		$	(17,592)		(43.8)	%
Income tax expense	$	3,977		$	7,451		$	(3,474)		(46.6)	%
Effective income tax rate	17.6		%	18.6		%	(1.0)		%	(5.4)	%

Income tax expense decreased due primarily to the change in income before income taxes earned between the periods and decreases in the effective income tax rate due primarily to lower estimated annual pre-tax income for the year ended December 31, 2022, which increased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance, and LIHTC.

Comparison of six months ended June 30, 2022 to the comparable period in the prior year.

The following table presents the income tax expense and related metrics and the change for the periods indicated:


	Six Months Ended June 30,
	2022			2021			Change			% Change
	(Dollars in thousands)
Income before income taxes	$	45,900		$	70,599		$	(24,699)		(35.0)	%
Income tax expense	$	7,559		$	12,553		$	(4,994)		(39.8)	%
Effective income tax rate	16.5		%	17.8		%	(1.3)		%	(7.3)	%

Income tax expense decreased also due primarily to the change in income before income taxes earned between the periods and lower estimated annual pre-tax income for the year ended December 31, 2022.

Financial Condition Overview

The table below provides a comparison of the changes in the Company's financial condition at the periods indicated:


	June 30, 2022		December 31, 2021		Change		% Change
	(Dollars in thousands)
Assets
Cash and cash equivalents	$	994,055	$	1,723,292	$	(729,237)	(42.3)	%
Investment securities available for sale, at fair value, net	1,187,588		894,335		293,253		32.8
Investment securities held to maturity, at amortized cost, net	615,653		383,393		232,260		60.6
Loans held for sale	1,311		1,476		(165)		(11.2)
Loans receivable, net	3,834,368		3,773,301		61,067		1.6

Premises and equipment, net	77,164		79,370		(2,206)		(2.8)
Federal Home Loan Bank stock, at cost	8,916		7,933		983		12.4
Bank owned life insurance	120,646		120,196		450		0.4
Accrued interest receivable	15,908		14,657		1,251		8.5
Prepaid expenses and other assets	211,350		183,543		27,807		15.2
Other intangible assets, net	8,569		9,977		(1,408)		(14.1)
Goodwill	240,939		240,939		—		—
Total assets	$	7,316,467	$	7,432,412	$	(115,945)	(1.6)	%

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	June 30, 2022		December 31, 2021		Change		% Change
	(Dollars in thousands)
Liabilities and Stockholders' Equity
Deposits	$	6,330,190	$	6,394,290	$	(64,100)	(1.0)	%

Junior subordinated debentures	21,326		21,180		146		0.7
Securities sold under agreement to repurchase	41,827		50,839		(9,012)		(17.7)
Accrued expenses and other liabilities	117,758		111,671		6,087		5.5
Total liabilities	6,511,101		6,577,980		(66,879)		(1.0)
Common stock	550,417		551,798		(1,381)		(0.3)
Retained earnings	316,732		293,238		23,494		8.0
Accumulated other comprehensive (loss) income, net	(61,783)		9,396		(71,179)		(757.5)
Total stockholders' equity	805,366		854,432		(49,066)		(5.7)
Total liabilities and stockholders' equity	$	7,316,467	$	7,432,412	$	(115,945)	(1.6)	%

Total assets decreased due primarily as a result of the decrease in cash and cash equivalents reflecting purchases to deploy excess liquidity into higher yielding investment securities and loans. Purchases of investment securities available for sale were partially offset by a decrease in AOCI as a result of the increase in market interest rates during the six months ended June 30, 2022 which negatively impacted the fair value of our investment securities available for sale at June 30, 2022.

Investment Activities Overview

The following table provides information regarding our investment securities at the dates indicated:


	June 30, 2022				December 31, 2021
	Balance		% of Total		Balance		% of Total		Change		% Change
	(Dollars in thousands)
Investment securities available for sale, at fair value:
U.S. government and agency securities	$	65,668	3.6	%	$	21,373	1.7	%	$	44,295	207.2	%
Municipal securities	200,010		11.1		221,212		17.3	%	(21,202)		(9.6)
Residential CMO and MBS	398,156		22.1		306,884		24.0	%	91,272		29.7
Commercial CMO and MBS	493,620		27.4		315,861		24.7	%	177,759		56.3
Corporate obligations	5,978		0.3		2,014		0.2	%	3,964		196.8
Other asset-backed securities	24,156		1.3		26,991		2.1	%	(2,835)		(10.5)
Total	$	1,187,588	65.8	%	$	894,335	70.0	%	$	293,253	32.8	%

Investment securities held to maturity, at amortized cost:
U.S. government and agency securities	$	150,960	8.4	%	$	141,011	11.0	%	$	9,949	7.1	%

Residential CMO and MBS	159,007		8.8		24,529		1.9		134,478		548.2
Commercial CMO and MBS	305,686		17.0		217,853		17.1		87,833		40.3


Total	$	615,653	34.2	%	$	383,393	30.0	%	$	232,260	60.6	%

Total investment securities	$	1,803,241	100.0	%	$	1,277,728	100.0	%	$	525,513	41.1	%

Total investment securities increased due primarily to purchases to deploy excess liquidity into higher yielding assets, offset partially by a $90.6 million decrease in the fair value of investment securities available for sale resulting in an unrealized loss at June 30, 2022 compared to an unrealized gain at December 31, 2021 as a result of an increase in market rates during the six months ended June 30, 2022.

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Loan Portfolio Overview

Changes by loan type

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:


	June 30, 2022				December 31, 2021
	Amortized Cost		% of Loans Receivable		Amortized Cost		% of Loans Receivable		Change		% Change
	(Dollars in thousands)
Commercial business:
Commercial and industrial	$	698,828	18.0	%	$	621,567	16.3	%	$	77,261	12.4	%
SBA PPP	11,334		0.3		145,840		3.8		(134,506)		(92.2)
Owner-occupied CRE	950,699		24.6		931,150		24.4		19,549		2.1
Non-owner occupied CRE	1,515,796		39.1		1,493,099		39.2		22,697		1.5
Total commercial business	3,176,657		82.0		3,191,656		83.7		(14,999)		(0.5)
Residential real estate	265,382		6.9		164,582		4.3		100,800		61.2
Real estate construction and land development:
Residential	90,546		2.3		85,547		2.2		4,999		5.8
Commercial and multifamily	128,060		3.3		141,336		3.7		(13,276)		(9.4)
Total real estate construction and land development	218,606		5.6		226,883		5.9		(8,277)		(3.6)
Consumer	213,419		5.5		232,541		6.1		(19,122)		(8.2)
Total	$	3,874,064	100.0	%	$	3,815,662	100.0	%	$	58,402	1.5	%

Loans receivable increased due primarily to higher commercial and industrial loan demand including an increases usage of lines of credit and an increase in residential real estate loans, including $69.5 million of purchased residential real estate loans offset partially by repayments of SBA PPP loans. 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:


	June 30, 2022			December 31, 2021			Change			% Change
	(Dollars in thousands)
Nonaccrual loans: (1)
Commercial business	$	10,475		$	23,107		$	(12,632)		(54.7)	%
Residential real estate	—			47			(47)			(100.0)
Real estate construction and land development	—			571			(571)			(100.0)
Consumer	—			29			(29)			(100.0)
Total nonaccrual loans	10,475			23,754			(13,279)			(55.9)
Other real estate owned	—			—			—			n/a
Total nonperforming assets	$	10,475		$	23,754		$	(13,279)		(55.9)	%

Accruing loans past due 90 days or more	$	2,036		$	293		$	1,743		594.9	%

Credit quality ratios:
Nonaccrual loans to loans receivable	0.27		%	0.62		%	(0.35)		%	(56.5)	%

Nonaccrual loans to total assets	0.14			0.32			(0.18)			(56.3)
Performing TDR loans: (1)
Commercial business	$	62,316		$	57,142		$	5,174		9.1	%
Residential real estate	178			358			(180)			(50.3)
Real estate construction and land development	450			450			—			—

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	June 30, 2022		December 31, 2021		Change		% Change
	(Dollars in thousands)
Consumer	750		1,160		(410)		(35.3)
Total performing TDR loans	$	63,694	$	59,110	$	4,584	7.8	%

(1) At June 30, 2022 and December 31, 2021, $2.0 million and $1.4 million of nonaccrual loans, respectively, and $2.3 million and $1.6 million of performing TDR loans, respectively, were guaranteed by government agencies.

The following table provides the changes in nonaccrual loans during the six months ended June 30, 2022:




	(In thousands)
Balance, beginning of period	$	23,754
Additions	720
Net principal payments, sales and transfers to accruing status	(9,768)
Payoffs	(4,060)
Charge-offs	(171)

Balance, end of period	$	10,475

Nonaccrual loans decreased $13.3 million, or 55.9%, due primarily to ongoing collection efforts, including the partial payoff of two large commercial and industrial loan relationships, the payoff of one non-owner occupied CRE relationship, and the transfer of four commercial business loan relationships totaling $6.7 million back to accruing status. The Bank also sold a pool of 14 nonaccrual loans totaling $1.0 million during the period ending March 31, 2022.

Allowance for Credit Losses on Loans Overview

The following table provides information regarding our ACL on loans for the periods indicated:


	At or For the Six Months Ended June 30,
	2022			2021			Change			% Change
	(Dollars in thousands)
ACL on loans at the end of period	$	39,696		$	51,562		$	(11,866)		(23.0)	%

Credit quality ratios:
ACL on loans to loans receivable	1.02		%	1.11		%	(0.09)		%	(8.1)	%
ACL on loans to loans receivable, excluding SBA PPP loans (1)	1.03			1.15			(0.12)			(10.4)
ACL on loans to nonaccrual loans	378.96		%	178.33		%	200.63		%	112.5	%

Net recoveries	(506)			(333)			(173)			52.0
Average loans receivable, net during the period (2)	3,792,792			4,446,442			(653,650)			(14.7)
Net recoveries on loans to average loans receivable, net (3)	(0.03)		%	(0.02)		%	(0.01)		%	50.0	%

(1) The ACL on loans does not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA. See "Reconciliations of Non-GAAP Measures" section below.

(2) Average loan receivable, net includes loans held for sale.

(3) Annualized.

The ACL on loans decreased during the six months ended June 30, 2022 due primarily to a reduction of loans individually evaluated for losses and as a result, their related ACL.

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The following table presents the ACL on loans by loan portfolio segment at the indicated dates:


	June 30, 2022				December 31, 2021
	ACL on loans		% of Total (1)		ACL on loans		% of Total (1)		Change		% Change
	(Dollars in thousands)
Commercial business	$	31,707	82.0	%	$	33,049	83.7	%	$	(1,342)	(4.1)	%
Residential real estate	2,137		6.9		1,409		4.3		728		51.7
Real estate construction and land development	3,284		5.6		5,276		5.9		(1,992)		(37.8)
Consumer	2,568		5.5		2,627		6.1		(59)		(2.2)
Total ACL on loans	$	39,696	100.0	%	$	42,361	100.0	%	$	(2,665)	(6.3)	%

(1) Represents the percent of loans receivable by loan category to loans receivable.

Deposits Overview

The following table summarizes the Company's deposits at the dates indicated:


	June 30, 2022				December 31, 2021
	Balance		% of Total		Balance		% of Total		Change		% Change
	(Dollars in thousands)
Noninterest demand deposits	$	2,325,139	36.7	%	$	2,343,909	36.7	%	$	(18,770)	(0.8)	%
Interest bearing demand deposits	1,977,527		31.3		1,946,605		30.4		30,922		1.6
Money market accounts	1,062,178		16.8		1,120,174		17.5		(57,996)		(5.2)
Savings accounts	654,577		10.3		640,763		10.0		13,814		2.2
Total non-maturity deposits	6,019,421		95.1		6,051,451		94.6		(32,030)		(0.5)
Certificates of deposit	310,769		4.9		342,839		5.4		(32,070)		(9.4)
Total deposits	$	6,330,190	100.0	%	$	6,394,290	100.0	%	$	(64,100)	(1.0)	%

Stockholders' Equity Overview

The Company’s stockholders' equity to assets ratio was 11.0% and 11.5% at June 30, 2022 and December 31, 2021, respectively, and decreased due primarily to a decrease in AOCI of $71.2 million following increases in market interest rates during the six months ended June 30, 2022, which negatively impacted the fair value of our investment securities available for sale. AOCI has no effect on our regulatory capital ratios as the Company opted to exclude it from our common equity tier 1 capital calculations as set forth below.

The Company has historically paid cash dividends to its common shareholders. Payments of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, capital requirements, current and anticipated cash needs, plans for expansion, any legal or contractual limitation on our ability to pay dividends and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income. On July 20, 2022, the Company’s board of directors declared a regular quarterly dividend of $0.21 per common share payable on August 17, 2022 to shareholders of record on August 3, 2022.

Regulatory Requirements Overview

The Company is a bank holding company under the supervision of the Federal Reserve Bank. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. Heritage Bank is a federally insured institution and thereby is subject to the capital requirements established by the FDIC. The Federal Reserve capital requirements generally parallel the FDIC requirements. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the unaudited Condensed Consolidated Financial Statements. Additionally, the Company and the Bank are required to maintain a capital conservation buffer of common equity Tier 1 capital above 2.5% to avoid restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers. Management believes that as of June 30, 2022, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of June 30, 2022 and December 31, 2021, 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

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that management believes have changed the Bank's categories. The following table presents the actual capital ratios of the Company and the Bank at the periods indicated:


	Company				Heritage Bank
	June 30, 2022		December 31, 2021		June 30, 2022		December 31, 2021
Common equity Tier 1 capital to risk-weighted assets	13.2	%	13.5	%	13.4	%	13.8	%
Tier 1 leverage capital to average assets	8.9		8.7		8.8		8.6
Tier 1 capital to risk-weighted assets	13.6		13.9		13.4		13.8
Total capital to risk-weighted assets	14.4		14.8		14.1		14.7
Capital conservation buffer	6.4		6.8		6.1		6.7

As of both June 30, 2022 and December 31, 2021, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC that allow the Bank the option to delay for two years until December 31, 2021 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.

Liquidity and Capital Resources

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 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.

Management believes the capital sources are adequate to meet all reasonably foreseeable short-term and long-term cash requirements and there has not been a material change in our liquidity and capital resources since the information disclosed in our 2021 Annual Form 10-K. We are not aware of any reasonably likely material changes in the mix and relative cost of such resources.

Critical Accounting Policies

Our critical accounting policies are described in detail in the "Critical Accounting Policies" section within Item 7 of our 2021 Annual Form the Form 10-K. The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. The Company's critical accounting policies include estimates of the ACL on investment securities, the ACL on loans, the ACL on unfunded commitments and goodwill. There have been no material changes in these policies during the six months ended June 30, 2022.

Reconciliations of Non-GAAP Measures

This Form 10-Q 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-Q because it believes 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 below.

The Company believes presenting loan yield excluding the effect of discount accretion on acquired 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 acquired loans represents the amount of interest income recorded on acquired 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

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balance of the acquired 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.


	Three Months Ended June 30,						Six Months Ended June 30,
	2022			2021			2022			2021
	(Dollars in thousands)
Loan yield, excluding SBA PPP Loans and Incremental Accretion on Acquired Loans, annualized:
Interest and fees on loans (GAAP)	$	40,890		$	50,750		$	81,915		$	100,274
Exclude interest and fees on SBA PPP loans	(1,782)			(10,003)			(4,863)			(19,139)
Exclude incremental accretion on acquired loans	(270)			(495)			(854)			(1,570)
Adjusted interest and fees on loans (non-GAAP)	$	38,838		$	40,252		$	76,198		$	79,565

Average loans receivable, net (GAAP)	$	3,812,045		$	4,402,868		$	3,792,792		$	4,446,442
Exclude average SBA PPP loans	(34,090)			(777,156)			(71,633)			(804,500)
Adjusted average loans receivable, net (non-GAAP)	$	3,777,955		$	3,625,712		$	3,721,159		$	3,641,942

Loan yield, annualized (GAAP)	4.30		%	4.62		%	4.36		%	4.55		%
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans, annualized (non-GAAP)	4.12		%	4.45		%	4.13		%	4.41		%

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.


	June 30, 2022			December 31, 2021
	(Dollars in thousands)
ACL on Loans to Loans Receivable, excluding SBA PPP Loans:
Allowance for credit losses on loans (GAAP)	$	39,696		$	42,361

Loans receivable (GAAP)	$	3,874,064		$	3,815,662
Exclude SBA PPP loans	(11,334)			(145,840)
Loans receivable, excluding SBA PPP (non-GAAP)	$	3,862,730		$	3,669,822

ACL on loans to loans receivable (GAAP)	1.02		%	1.11		%
ACL on loans to loans receivable, excluding SBA PPP loans (non-GAAP)	1.03		%	1.15		%

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In our opinion, there has not been a material change in our interest rate risk exposure since the information disclosed in our 2021 Annual Form 10-K. Neither we, nor the Bank, maintain a trading account for any class of financial instrument, nor do we, or the Bank, engage in hedging activities or purchase high risk derivative instruments. Moreover, neither we, nor the Bank, are subject to foreign currency exchange rate risk or commodity price risk.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

An evaluation of the Company’s disclosure controls and procedures (as defined in Section 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934 (the “Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and the Company’s Disclosure Committee as of the end of the period covered by this quarterly report. Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of June 30, 2022 are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

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(b) Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the three months ended June 30, 2022, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Neither the Company nor the Bank is a party to any material pending legal proceedings other than ordinary routine litigation incidental to the business of the Bank.

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors set forth in Item 1A of the Company’s 2021 Annual Form 10-K.

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

(a) Not applicable.

(b) Not applicable.

The following table provides information about repurchases of common stock by the Company during the three months ended June 30, 2022:


Period	Total Number of Shares Purchased (1)	Average Price Paid Per Share (1)		Total number of shares purchased as part of publicly announced plans or programs	Maximum number of shares that may yet be purchased under the plans or programs (2)
April 1, 2022— April 30, 2022	—	$	—	9,967,332	657,745
May 1, 2022— May 31, 2022	404	24.85		9,967,332	657,745
June 1, 2022— June 30, 2022	20,776	24.61		9,986,863	638,214
Total	21,180	$	24.62

(1)Of the common shares repurchased by the Company between April 1, 2022 and June 30, 2022, 1,649 shares represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units.

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

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

Incorporated by Reference

Exhibit No.

Description of Exhibit

Form

Exhibit

Filing Date/Period End Date

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)

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101.LAB

XBRL Taxonomy Extension Label Linkbase Document (1)

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document (1)

(1) Filed herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


						HERITAGE FINANCIAL CORPORATION
Date:
August 9, 2022						/S/ JEFFREY J. DEUEL
						Jeffrey J. Deuel
						President and Chief Executive Officer
Date:
August 9, 2022						/S/ DONALD J. HINSON
						Donald J. Hinson
						Executive Vice President and Chief Financial Officer