Equibles

10-Q

HERITAGE FINANCIAL CORP /WA/ (HFWA)

10-Q 2022-11-09 For: 2022-09-30
View Original
Added on April 04, 2026

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 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<br>incorporation or organization) (I.R.S. Employer<br>Identification No.)
201 Fifth Avenue SW, Olympia WA 98501
(Address of principal executive offices) (Zip Code)

(360) 943-1500

(Registrant’s telephone number, including area code)

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

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

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

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

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

Large accelerated filer ☒ Accelerated filer ☐
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐

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

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

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

As of October 31, 2022, there were 35,104,248 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

September 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 SEPTEMBER 30, 2022 AND DECEMBER 31, 2021 5
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021 6
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021 7
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021 8
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE NINE MONTHS ENDED SEPTEMBER 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 32
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 33
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 47

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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 48
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:

•potential adverse impacts to economic conditions in our local market areas, other markets where the Company has lending relationships, or other aspects of the Company’s business operations or financial markets, including, without limitation, as a result of employment levels, labor shortages and the effects of inflation, a potential recession or slowed economic growth caused by increasing political instability from acts of war including Russia’s invasion of Ukraine, as well as increasing oil prices and supply chain disruptions, and any governmental or societal responses to the COVID-19 pandemic, including the possibility of new COVID-19 variants

•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 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;

•the impact of repricing and competitors' pricing initiatives on loan and deposit products;

•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;

•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;

•risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;

•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;

•the quality and composition of our securities portfolio and the impact of any 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;

•the effects of climate change, severe weather events, natural disasters, pandemics, epidemics and other public health crises, acts of war or terrorism, and other external events on our business; 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)

September 30,<br>2022 December 31,<br>2021
ASSETS
Cash on hand and in banks $ 100,428 $ 61,377
Interest earning deposits 306,896 1,661,915
Cash and cash equivalents 407,324 1,723,292
Investment securities available for sale, at fair value, net (amortized cost of $1,491,440 and $883,832, respectively) 1,356,142 894,335
Investment securities held to maturity, at amortized cost, net (fair value of $677,335 and $376,331, respectively) 773,319 383,393
Total investment securities 2,129,461 1,277,728
Loans held for sale — 1,476
Loans receivable 4,001,295 3,815,662
Allowance for credit losses on loans (42,089) (42,361)
Loans receivable, net 3,959,206 3,773,301
Premises and equipment, net 76,683 79,370
Federal Home Loan Bank stock, at cost 8,916 7,933
Bank owned life insurance 121,369 120,196
Accrued interest receivable 17,812 14,657
Prepaid expenses and other assets 230,704 183,543
Other intangible assets, net 7,898 9,977
Goodwill 240,939 240,939
Total assets $ 7,200,312 $ 7,432,412
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 6,214,964 $ 6,394,290
Deposits held for sale 22,771 —
Total deposits 6,237,735 6,394,290
Federal Home Loan Bank advances — —
Junior subordinated debentures 21,399 21,180
Securities sold under agreement to repurchase 40,449 50,839
Accrued expenses and other liabilities 124,027 111,671
Total liabilities 6,423,610 6,577,980
Commitments and contingencies (Note 10)
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; 35,104,248 and 35,105,779 shares issued and outstanding, respectively 551,419 551,798
Retained earnings 330,284 293,238
Accumulated other comprehensive (loss) income, net (105,001) 9,396
Total stockholders’ equity 776,702 854,432
Total liabilities and stockholders’ equity $ 7,200,312 $ 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<br>September 30, Nine Months Ended<br>September 30,
2022 2021 2022 2021
INTEREST INCOME:
Interest and fees on loans $ 43,847 $ 46,863 $ 125,762 $ 147,137
Taxable interest on investment securities 12,362 4,711 25,972 12,295
Nontaxable interest on investment securities 892 931 2,645 2,836
Interest on interest earning deposits 4,009 537 7,057 975
Total interest income 61,110 53,042 161,436 163,243
INTEREST EXPENSE:
Deposits 1,478 1,444 4,315 4,696
Junior subordinated debentures 312 184 745 557
Other borrowings 34 36 98 109
Total interest expense 1,824 1,664 5,158 5,362
Net interest income 59,286 51,378 156,278 157,881
Provision for (reversal of) credit losses 1,945 (3,149) (2,836) (24,335)
Net interest income after provision for (reversal of) credit losses 57,341 54,527 159,114 182,216
NONINTEREST INCOME:
Service charges and other fees 2,688 2,400 7,739 6,728
Card revenue 2,365 2,150 6,774 6,216
Gain on sale of investment securities, net — — — 29
Gain on sale of loans, net 133 765 593 3,138
Interest rate swap fees 78 126 383 487
Bank owned life insurance income 723 647 3,182 2,020
Gain on sale of other assets, net 265 942 469 1,688
Other income 1,201 1,198 3,867 4,470
Total noninterest income 7,453 8,228 23,007 24,776
NONINTEREST EXPENSE:
Compensation and employee benefits 24,206 21,963 67,236 65,967
Occupancy and equipment 4,422 4,373 12,924 12,918
Data processing 4,185 4,029 12,431 11,839
Marketing 358 486 968 1,566
Professional services 639 776 1,867 3,083
State/municipal business and use taxes 963 1,071 2,626 3,034
Federal deposit insurance premium 500 550 1,525 1,478
Amortization of intangible assets 671 758 2,079 2,352
Other expense 3,203 3,160 8,918 8,567
Total noninterest expense 39,147 37,166 110,574 110,804
Income before income taxes 25,647 25,589 71,547 96,188
Income tax expense 4,657 4,997 12,216 17,550
Net income $ 20,990 $ 20,592 $ 59,331 $ 78,638
Basic earnings per share $ 0.60 $ 0.58 $ 1.69 $ 2.19
Diluted earnings per share $ 0.59 $ 0.58 $ 1.67 $ 2.18
Dividends declared per share $ 0.21 $ 0.20 $ 0.63 $ 0.60
Average number of basic shares outstanding 35,103,984 35,644,192 35,103,048 35,854,258
Average number of diluted shares outstanding 35,468,890 35,929,518 35,438,672 36,152,052

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<br>September 30, Nine Months Ended<br>September 30,
2022 2021 2022 2021
Net Income $ 20,990 $ 20,592 $ 59,331 $ 78,638
Change in fair value of investment securities available for sale, net of tax of $(12,027), $(362), $(31,778) and $(2,844), respectively (43,143) (1,305) (114,022) (10,239)
Amortization of net unrealized gain for the reclassification of investment securities available for sale to held to maturity, net of tax of $(20), $(6), $(103) and $(6), respectively (75) (22) (375) (22)
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 (43,218) (1,327) (114,397) (10,284)
Comprehensive (loss) income $ (22,228) $ 19,265 $ (55,066) $ 68,354

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 September 30, 2022
Number of<br>common<br>shares Common<br>stock Retained<br>earnings AOCI Total<br>stockholders’<br>equity
Balance at June 30, 2022 35,103,929 $ 550,417 $ 316,732 $ (61,783) $ 805,366
Restricted stock units vested 419 — — — —
Stock-based compensation expense — 1,004 — — 1,004
Common stock repurchased (100) (2) — — (2)
Net income — — 20,990 — 20,990
Other comprehensive loss, net of tax — — — (43,218) (43,218)
Cash dividends declared on common stock ($0.21 per share) — — (7,438) — (7,438)
Balance at September 30, 2022 35,104,248 $ 551,419 $ 330,284 $ (105,001) $ 776,702
Nine Months Ended September 30, 2022
--- --- --- --- --- --- --- --- --- ---
Number of<br>common<br>shares Common<br>stock Retained<br>earnings AOCI Total<br>stockholders’<br>equity
Balance at December 31, 2021 35,105,779 $ 551,798 $ 293,238 $ 9,396 $ 854,432
Restricted stock units vested 124,839 — — — —
Stock-based compensation expense — 2,797 — — 2,797
Common stock repurchased (126,370) (3,176) — — (3,176)
Net income — — 59,331 — 59,331
Other comprehensive loss, net of tax — — — (114,397) (114,397)
Cash dividends declared on common stock ($0.63 per share) — — (22,285) — (22,285)
Balance at September 30, 2022 35,104,248 $ 551,419 $ 330,284 $ (105,001) $ 776,702
Three Months Ended September 30, 2021
--- --- --- --- --- --- --- --- --- ---
Number of<br>common<br>shares Common<br>stock Retained<br>earnings AOCI Total<br>stockholders’<br>equity
Balance at June 30, 2021 36,006,560 $ 572,060 $ 267,863 $ 16,061 $ 855,984
Restricted stock units vested 1,347 — — — —
Stock-based compensation expense — 966 — — 966
Common stock repurchased (841,308) (20,641) — — (20,641)
Net income — — 20,592 — 20,592
Other comprehensive loss, net of tax — — — (1,327) (1,327)
Cash dividends declared on common stock ($0.20 per share) — — (7,170) — (7,170)
Balance at September 30, 2021 35,166,599 $ 552,385 $ 281,285 $ 14,734 $ 848,404

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Nine Months Ended September 30, 2021
Number of<br>common<br>shares Common<br>stock Retained<br>earnings AOCI Total<br>stockholders’<br>equity
Balance at December 31, 2020 35,912,243 $ 571,021 $ 224,400 $ 25,018 $ 820,439
Restricted stock units vested 121,467 — — — —
Stock-based compensation expense — 2,762 — — 2,762
Common stock repurchased (867,111) (21,398) — — (21,398)
Net income — — 78,638 — 78,638
Other comprehensive loss, net of tax — — — (10,284) (10,284)
Cash dividends declared on common stock ($0.60 per share) — — (21,753) — (21,753)
Balance at September 30, 2021 35,166,599 $ 552,385 $ 281,285 $ 14,734 $ 848,404

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)

Nine Months Ended<br>September 30,
2022 2021
Cash flows from operating activities:
Net income $ 59,331 $ 78,638
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion (620) (18,356)
Reversal of provision for credit losses (2,836) (24,335)
Stock-based compensation expense 2,797 2,762
Amortization of intangible assets 2,079 2,352
Origination of mortgage loans held for sale (15,190) (74,325)
Proceeds from sale of mortgage loans held for sale 17,259 79,759
Bank owned life insurance income (3,182) (2,020)
Valuation adjustment on interest rate swaps (67) (296)
Gain on sale of mortgage loans held for sale, net (593) (3,138)
Gain on sale of investment securities available for sale, net — (29)
Gain on sale of assets held for sale (403) (1,691)
Other 3,865 11,332
Net cash provided by operating activities 62,440 50,653
Cash flows from investing activities:
Loan originations and purchases, net of payments (176,700) 555,784
Maturities and repayments of investment securities available for sale 132,854 200,242
Maturities and repayments of investment securities held to maturity 21,620 423
Purchase of investment securities available for sale (742,801) (421,566)
Purchase of investment securities held to maturity (412,835) (66,821)
Purchase of premises and equipment (2,295) (2,148)
Purchases of bank owned life insurance (105) (104)
Proceeds from bank owned life insurance death benefit 2,114 —
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 2,102 5,642
Proceeds from sales of premises and equipment 106 12
Capital contributions to low-income housing tax credit partnerships (9,245) (23,349)
Cash received from return of New Market Tax Credit equity method investment — 9,642
Net cash (used) provided by investing activities (1,186,168) 257,733
Cash flows from financing activities:
Net (decrease) increase in deposits (156,555) 617,568
Federal Home Loan Bank advances 50 10
Repayment of Federal Home Loan Bank advances (50) (10)
Common stock cash dividends paid (22,119) (21,552)
Net (decrease) increase in securities sold under agreement to repurchase (10,390) 8,413
Repurchase of common stock (3,176) (21,398)
Net cash (used) provided by financing activities (192,240) 583,031
Net (decrease) increase in cash and cash equivalents (1,315,968) 891,417
Cash and cash equivalents at beginning of period 1,723,292 743,322
Cash and cash equivalents at end of period $ 407,324 $ 1,634,739

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Nine Months Ended<br>September 30,
2022 2021
Supplemental disclosures of cash flow information:
Cash paid for interest $ 4,939 $ 5,162
Cash paid for income taxes, net of refunds 1,987 10,944
Supplemental non-cash disclosures of cash flow information:
Transfer of investment securities available for sale to held to maturity — 244,778
Investment in LIHTC partnership and related funding commitment 10,728 17,458
Right of use assets obtained in exchange for new operating lease liabilities 2,869 12,134
Transfers of premises and equipment classified as held for sale to prepaid expenses and other assets from premises and equipment, net 910 3,556
Loans received from return of New Market Tax Credit equity method investment — 15,596
Transfer of deposits to deposits held for sale 22,771 —

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 nine months ended September 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.

(c) Significant Accounting Policies

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 nine months ended September 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 September 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:

September 30, 2022
Amortized<br>Cost Gross<br>Unrealized<br>Gains Gross<br>Unrealized<br>Losses Fair<br>Value
(In thousands)
Investment securities available for sale:
U.S. government and agency securities $ 68,912 $ — $ (5,163) $ 63,749
Municipal securities 206,767 51 (21,105) 185,713
Residential CMO and MBS 494,330 6 (55,966) 438,370
Commercial CMO and MBS 691,836 29 (52,424) 639,441
Corporate obligations 6,001 — (167) 5,834
Other asset-backed securities 23,594 19 (578) 23,035
Total $ 1,491,440 $ 105 $ (135,403) $ 1,356,142
Investment securities held to maturity:
U.S. government and agency securities $ 150,948 $ — $ (32,916) $ 118,032
Residential CMO and MBS 296,432 — (19,168) 277,264
Commercial CMO and MBS 325,939 — (43,900) 282,039
Total $ 773,319 $ — $ (95,984) $ 677,335 December 31, 2021
--- --- --- --- --- --- --- --- ---
Amortized<br>Cost Gross<br>Unrealized<br>Gains Gross<br>Unrealized<br>Losses Fair<br>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 September 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 $ 26,280 $ 25,952 $ — $ —
Due after one year through five years 63,151 60,858 — —
Due after five years through ten years 67,834 63,738 83,219 68,150
Due after ten years 124,415 104,748 67,729 49,882
Total investment securities due at a single maturity date 281,680 255,296 150,948 118,032
Mortgage-backed securities (1) 1,209,760 1,100,846 622,371 559,303
Total investment securities $ 1,491,440 $ 1,356,142 $ 773,319 $ 677,335

(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 September 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:

September 30, 2022
Less than 12 Months 12 Months or Longer Total
Fair<br>Value Unrealized<br>Losses Fair<br>Value Unrealized<br>Losses Fair<br>Value Unrealized<br>Losses
(In thousands)
U.S. government and agency securities $ 58,025 $ (4,176) $ 5,724 $ (987) $ 63,749 $ (5,163)
Municipal securities 148,054 (12,031) 27,731 (9,074) 175,785 (21,105)
Residential CMO and MBS 308,142 (28,668) 128,304 (27,298) 436,446 (55,966)
Commercial CMO and MBS 611,399 (49,077) 18,636 (3,347) 630,035 (52,424)
Corporate obligations 5,834 (167) — — 5,834 (167)
Other asset-backed securities 17,410 (563) 834 (15) 18,244 (578)
Total $ 1,148,864 $ (94,682) $ 181,229 $ (40,721) $ 1,330,093 $ (135,403) December 31, 2021
--- --- --- --- --- --- --- --- --- --- --- --- ---
Less than 12 Months 12 Months or Longer Total
Fair<br>Value Unrealized<br>Losses Fair<br>Value Unrealized<br>Losses Fair<br>Value Unrealized<br>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)

(c) ACL on Investment Securities

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

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

(d) Realized Gains and Losses

No realized gains or losses on the sale of investment securities available for sale were recognized during the three months ended September 30, 2022 and 2021. No realized gains or losses and $29,000 in gross realized gains on the sale of investment securities available for sale were recognized during the nine months ended September 30, 2022 and 2021, respectively.

(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:

September 30, 2022 December 31, 2021
Amortized<br>Cost Fair<br>Value Amortized<br>Cost Fair<br>Value
(In thousands)
Washington and Oregon state public deposits $ 158,082 $ 138,003 $ 128,216 $ 130,217
Federal Reserve Bank credit facility 60,763 49,037 61,057 59,674
Securities sold under agreement to repurchase 64,087 55,825 59,887 59,655
Other securities pledged 55,600 48,785 56,419 55,633
Total $ 338,532 $ 291,650 $ 305,579 $ 305,179

(f) Accrued Interest Receivable

Accrued interest receivable excluded from the amortized cost of investment securities available for sale totaled $4.7 million and $3.5 million at September 30, 2022 and December 31, 2021, respectively. Accrued interest receivable excluded from the amortized cost on investment securities held to maturity totaled $2.3 million and $1.1 million at September 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 nine months ended September 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. The loan review process complements and reinforces the risk identification and assessment decisions made by loan officers and credit personnel.

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The amortized cost of loans receivable, net of ACL on loans, consisted of the following portfolio segments and classes at the dates indicated:

September 30,<br>2022 December 31,<br>2021
(In thousands)
Commercial business:
Commercial and industrial $ 735,028 $ 621,567
SBA PPP 3,593 145,840
Owner-occupied CRE 959,486 931,150
Non-owner occupied CRE 1,547,114 1,493,099
Total commercial business 3,245,221 3,191,656
Residential real estate 296,019 164,582
Real estate construction and land development:
Residential 92,297 85,547
Commercial and multifamily 160,723 141,336
Total real estate construction and land development 253,020 226,883
Consumer 207,035 232,541
Loans receivable 4,001,295 3,815,662
Allowance for credit losses on loans (42,089) (42,361)
Loans receivable, net $ 3,959,206 $ 3,773,301
Balances included in the amortized cost of loans receivable:
Unamortized net discount on acquired loans $ 2,686 $ 3,938
Unamortized net deferred fee $ 5,479 $ 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.

(c) Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, (v) past due status, and (vi) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon.

The Bank utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 10. 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 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

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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:

September 30, 2022
Term Loans<br>Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (1) Loans Receivable
2022 2021 2020 2019 2018 Prior
(In thousands)
Commercial business:
Commercial and industrial
Pass $ 133,352 $ 97,240 $ 89,078 $ 68,237 $ 36,505 $ 83,371 $ 193,558 $ 108 $ 701,449
SM 223 — 715 4,759 1,898 5,311 6,678 — 19,584
SS 764 275 1,057 3,141 687 5,381 2,322 368 13,995
Total 134,339 97,515 90,850 76,137 39,090 94,063 202,558 476 735,028
SBA PPP
Pass — 3,455 138 — — — — — 3,593
Owner-occupied CRE
Pass 111,751 168,437 93,272 172,494 71,795 302,107 — — 919,856
SM — 1,009 — 1,237 2,558 16,313 — — 21,117
SS — 259 675 — 3,739 13,840 — — 18,513
Total 111,751 169,705 93,947 173,731 78,092 332,260 — — 959,486
Non-owner occupied CRE
Pass 182,804 189,307 162,954 240,088 133,478 571,457 — — 1,480,088
SM — 8,392 — 3,619 — 24,127 — — 36,138
SS — — — — 3,627 27,261 — — 30,888
Total 182,804 197,699 162,954 243,707 137,105 622,845 — — 1,547,114
Total commercial business
Pass 427,907 458,439 345,442 480,819 241,778 956,935 193,558 108 3,104,986
SM 223 9,401 715 9,615 4,456 45,751 6,678 — 76,839
SS 764 534 1,732 3,141 8,053 46,482 2,322 368 63,396
Total 428,894 468,374 347,889 493,575 254,287 1,049,168 202,558 476 3,245,221
Residential real estate
Pass(1) 94,144 140,093 24,191 17,030 4,501 15,885 — — 295,844
SS — — — — — 175 — — 175
Total 94,144 140,093 24,191 17,030 4,501 16,060 — — 296,019
Real estate construction and land development:
Residential
Pass 33,244 37,666 7,617 11,810 885 1,075 — — 92,297
Commercial and multifamily
Pass 36,362 103,541 7,601 1,096 2,565 1,513 — — 152,678
SM — — 1,913 5,687 — — — — 7,600
SS — — — 45 — 400 — — 445
Total 36,362 103,541 9,514 6,828 2,565 1,913 — — 160,723
Total real estate construction and land development
Pass 69,606 141,207 15,218 12,906 3,450 2,588 — — 244,975
SM — — 1,913 5,687 — — — — 7,600
SS — — — 45 — 400 — — 445
Total 69,606 141,207 17,131 18,638 3,450 2,988 — — 253,020
Consumer
Pass 3,266 616 11,078 31,077 18,201 22,828 117,070 539 204,675

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September 30, 2022
Term Loans<br>Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (1) Loans Receivable
2022 2021 2020 2019 2018 Prior
SS — — 164 582 361 1,241 11 1 2,360
Total 3,266 616 11,242 31,659 18,562 24,069 117,081 540 207,035
Loans receivable
Pass 594,923 740,355 395,929 541,832 267,930 998,236 310,628 647 3,850,480
SM 223 9,401 2,628 15,302 4,456 45,751 6,678 — 84,439
SS 764 534 1,896 3,768 8,414 48,298 2,333 369 66,376
Total $ 595,910 $ 750,290 $ 400,453 $ 560,902 $ 280,800 $ 1,092,285 $ 319,639 $ 1,016 $ 4,001,295

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

December 31, 2021
Term Loans<br>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
Real estate construction and land development:
Residential
Pass 44,892 23,728 12,266 2,921 389 1,351 — — 85,547

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December 31, 2021
Term Loans<br>Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (1) Loans Receivable
2021 2020 2019 2018 2017 Prior
(In thousands)
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:

September 30, 2022
Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual
(In thousands)
Commercial business:
Commercial and industrial $ 5,060 $ 299 $ 5,359
Owner-occupied CRE — 875 875
Total $ 5,060 $ 1,174 $ 6,234 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
Real estate construction and land development:
Commercial and multifamily — 571 571
Consumer — 29 29
Total $ 10,763 $ 12,991 $ 23,754

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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<br>September 30, 2022 Three Months Ended<br>September 30, 2021
Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized
(In thousands)
Commercial business:
Commercial and industrial $ — $ 31 $ (1) $ 184
Consumer — — — 32
Total $ — $ 31 $ (1) $ 216 Nine Months Ended<br>September 30, 2022 Nine Months Ended<br>September 30, 2021
--- --- --- --- --- --- --- --- ---
Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized
(in thousands)
Commercial business:
Commercial and industrial $ (14) $ 260 $ (11) $ 2,228
Owner-occupied CRE — 53 — 117
Non-owner occupied CRE — 774 — 313
Total commercial business (14) 1,087 (11) 2,658
Residential real estate — 19 — —
Real estate construction and land development:
Residential — — — 73
Consumer — 68 — 32
Total $ (14) $ 1,174 $ (11) $ 2,763

For the three and nine months ended September 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 September 30, 2022 and December 31, 2021 were as follows:

September 30, 2022
30-89 Days 90 Days or<br>Greater Total Past <br>Due Current Loans Receivable
(In thousands)
Commercial business:
Commercial and industrial $ 1,774 $ 4,130 $ 5,904 $ 729,124 $ 735,028
SBA PPP 167 — 167 3,426 3,593
Owner-occupied CRE 30 189 219 959,267 959,486
Non-owner occupied CRE 296 — 296 1,546,818 1,547,114
Total commercial business 2,267 4,319 6,586 3,238,635 3,245,221
Residential real estate — — — 296,019 296,019
Real estate construction and land development:
Residential — — — 92,297 92,297
Commercial and multifamily — — — 160,723 160,723
Total real estate construction and land development — — — 253,020 253,020

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September 30, 2022
30-89 Days 90 Days or<br>Greater Total Past <br>Due Current Loans Receivable
(In thousands)
Consumer 736 20 756 206,279 207,035
Total $ 3,003 $ 4,339 $ 7,342 $ 3,993,953 $ 4,001,295 December 31, 2021
--- --- --- --- --- --- --- --- --- --- ---
30-89 Days 90 Days or<br>Greater Total Past <br>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 $20,000 and $293,000 as of September 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 September 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:

September 30, 2022
CRE Farmland Residential Real Estate Total
(In thousands)
Commercial business:
Commercial and industrial $ 1,239 $ 2,082 $ 1,271 $ 4,592
Owner-occupied CRE 189 — — 189
Total $ 1,428 $ 2,082 $ 1,271 $ 4,781 December 31, 2021
--- --- --- --- --- --- --- --- --- --- ---
CRE Farmland Residential Real Estate Other Total
(In thousands)
Commercial business:
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:

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December 31, 2021
CRE Farmland Residential Real Estate Other Total
(In thousands)
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 nine months ended September 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 September 30,
2022 2021
Number of<br>Contracts Amortized Cost (1) (2) Number of<br>Contracts Amortized Cost (1) (2)
(Dollars in thousands)
Commercial business:
Commercial and industrial 4 $ 2,150 5 $ 1,861
Owner-occupied CRE — — 2 7,124
Non-owner occupied CRE — — — —
Total commercial business 4 2,150 7 8,985
Real estate construction and land development:
Commercial and multifamily 1 5,687 1 450
Consumer 2 238 5 94
Total 7 $ 8,075 13 $ 9,529 Nine Months Ended September 30,
--- --- --- --- --- --- ---
2022 2021
Number of<br>Contracts Amortized Cost (1) (2) Number of<br>Contracts Amortized Cost (1) (2)
(Dollars in thousands)
Commercial business:
Commercial and industrial 8 $ 3,119 32 $ 10,380
Owner-occupied CRE — — 6 16,710
Non-owner occupied CRE — — 3 5,673
Total commercial business 8 3,119 41 32,763
Residential real estate — — 1 180
Real estate construction and land development:
Commercial and multifamily 1 5,687 1 450
Consumer 9 307 22 487
Total 18 $ 9,113 65 $ 33,880

(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 nine months ended September 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 $30,000 and $3.4 million at September 30, 2022 and September 30, 2021, respectively, related to these TDR loans which were restructured during the nine months ended September 30, 2022 and September 30, 2021, respectively.

The unfunded commitment to borrowers related to TDR loans was $5.9 million and $5.7 million at September 30, 2022 and December 31, 2021, respectively.

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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 September 30,
2022 2021
Number of<br><br>Contracts (1) Amortized Cost (1) Number of<br><br>Contracts (1) Amortized Cost (1)
(Dollars in thousands)
Commercial business:
Commercial and industrial — $ — 1 $ 336 Nine Months Ended September 30,
--- --- --- --- --- --- ---
2022 2021
Number of<br><br>Contracts (1) Amortized Cost (1) Number of<br><br>Contracts (1) Amortized Cost (1)
(Dollars in thousands)
Commercial business:
Commercial and industrial — $ — 3 $ 976
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 nine months ended September 30, 2022 and 2021.

The Bank had $4,000 ACL on loans at September 30, 2022 and $13,000 at September 30, 2021 related to these TDR loans which defaulted during the nine months ended September 30, 2022 and 2021.

(h) Accrued interest receivable on loans receivable

Accrued interest receivable on loans receivable totaled $10.5 million and $10.1 million at September 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 September 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 September 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 nine months ended September 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 September 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 nine months ended September 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 nine months ended September 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 nine months ended September 30, 2022, the ACL on loans decreased $272,000, or 0.6%, due primarily to a reversal of provision for credit losses on loans of $1.3 million driven by a $3.4 million reduction in the ACL on loans individually evaluated for losses and their related ACL offset partially by an increase related to the growth in loans receivable. The ACL on loans at September 30, 2022 and December 31, 2021 did not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.

During the nine months ended September 30, 2021, the ACL on loans decreased $21.9 million or 31.2%, due primarily to a reversal of provision for credit losses on loans of $21.8 million. The reversal of provision for credit losses was primarily driven by improvements in the economic forecast at September 30, 2021 as compared to the forecast at December 31, 2020.

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

Nine Months Ended<br>September 30,
2022 2021
(In thousands)
Beginning balance $ 42,361 $ 70,185
Charge-offs (742) (1,267)
Recoveries of loans previously charged-off 1,722 1,207
Reversal of provision for credit losses on loans (1,252) (21,808)
Ending balance $ 42,089 $ 48,317

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

Three Months Ended September 30, 2022
Beginning Balance Charge-offs Recoveries Provision for (Reversal of) Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 14,033 $ — $ 455 $ 180 $ 14,668
Owner-occupied CRE 8,162 — — (443) 7,719
Non-owner occupied CRE 9,512 — — 41 9,553
Total commercial business 31,707 — 455 (222) 31,940
Residential real estate 2,137 — — 408 2,545
Real estate construction and land development:
Residential 1,081 — 5 208 1,294
Commercial and multifamily 2,203 — 102 1,505 3,810
Total real estate construction and land development 3,284 — 107 1,713 5,104
Consumer 2,568 (138) 50 20 2,500
Total $ 39,696 $ (138) $ 612 $ 1,919 $ 42,089 Nine Months Ended September 30, 2022
--- --- --- --- --- --- --- --- --- --- ---
Beginning Balance Charge-offs Recoveries Provision for (Reversal of) Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 17,777 $ (280) $ 876 $ (3,705) $ 14,668
Owner-occupied CRE 6,411 (36) — 1,344 7,719
Non-owner occupied CRE 8,861 — — 692 9,553
Total commercial business 33,049 (316) 876 (1,669) 31,940
Residential real estate 1,409 (30) 3 1,163 2,545
Real estate construction and land development:
Residential 1,304 — 19 (29) 1,294
Commercial and multifamily 3,972 — 155 (317) 3,810
Total real estate construction and land development 5,276 — 174 (346) 5,104
Consumer 2,627 (396) 669 (400) 2,500
Total $ 42,361 $ (742) $ 1,722 $ (1,252) $ 42,089

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Three Months Ended September 30, 2021
Beginning Balance Charge-offs Recoveries Provision for (Reversal of) Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 17,485 $ (743) $ 373 $ 1,531 $ 18,646
Owner-occupied CRE 8,562 — 12 (1,644) 6,930
Non-owner occupied CRE 10,630 — — (1,133) 9,497
Total commercial business 36,677 (743) 385 (1,246) 35,073
Residential real estate 1,153 — — (67) 1,086
Real estate construction and land development:
Residential 1,636 — 8 136 1,780
Commercial and multifamily 8,835 — — (1,530) 7,305
Total real estate construction and land development 10,471 — 8 (1,394) 9,085
Consumer 3,261 (204) 161 (145) 3,073
Total $ 51,562 $ (947) $ 554 $ (2,852) $ 48,317 Nine Months Ended September 30, 2021
--- --- --- --- --- --- --- --- --- --- ---
Beginning Balance Charge-offs Recoveries Provision for (Reversal of) Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 30,010 $ (757) $ 710 $ (11,317) $ 18,646
Owner-occupied CRE 9,486 — 25 (2,581) 6,930
Non-owner occupied CRE 10,112 — — (615) 9,497
Total commercial business 49,608 (757) 735 (14,513) 35,073
Residential real estate 1,591 — — (505) 1,086
Real estate construction and land development:
Residential 1,951 — 28 (199) 1,780
Commercial and multifamily 11,141 (1) — (3,835) 7,305
Total real estate construction and land development 13,092 (1) 28 (4,034) 9,085
Consumer 5,894 (509) 444 (2,756) 3,073
Total $ 70,185 $ (1,267) $ 1,207 $ (21,808) $ 48,317

(5)Goodwill and Other Intangible Assets

(a) Goodwill

There were no additions to goodwill during the three and nine months ended September 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 nine months ended September 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

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with another financial institution. The transaction allows the Company’s customer to effectively convert a variable rate loan to a fixed rate and the Company recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third-party. 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:

September 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) $ 298,601 32,523 $ 322,726 $ 15,219
Interest rate swap liability (1) 298,601 (32,523) 322,726 (15,286)

(1) The estimated fair value of derivatives with customers was $(32.5) million and $9.8 million as of September 30, 2022 and December 31, 2021, respectively. The estimated fair value of derivatives with third-parties was $32.5 million and $(9.8) million as of September 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<br>September 30, Nine Months Ended<br>September 30,
2022 2021 2022 2021
(In thousands, except shares)
Net income $ 20,990 $ 20,592 $ 59,331 $ 78,638
Basic:
Weighted average common shares outstanding 35,103,984 35,644,192 35,103,048 35,854,258
Diluted:
Basic weighted average common shares outstanding 35,103,984 35,644,192 35,103,048 35,854,258
Effect of potentially dilutive common shares (1) 364,906 285,326 335,624 297,794
Total diluted weighted average common shares outstanding 35,468,890 35,929,518 35,438,672 36,152,052
Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (2) 3,026 16,002 13,662 7,083

(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,

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capital requirements, financial condition and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income.

The following table summarizes the dividend activity during the nine months ended September 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
July 20, 2022 $0.21 August 3, 2022 August 17, 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.

(c) Stock Repurchase Program

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 repurchase plan for the periods indicated:

Three Months Ended<br>September 30, Nine Months Ended<br>September 30,
2022 2021 2022 2021 Plan Total(1)
Repurchased shares — 841,088 100,090 841,088 1,160,840
Stock repurchase average share price $ — $ 24.54 $ 25.07 $ 24.54 $ 23.94

(1)Represents shares repurchased and average price per share paid during the duration of the repurchase 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<br>September 30, Nine Months Ended<br>September 30,
2022 2021 2022 2021
Repurchased shares to pay withholding taxes 100 220 26,280 26,023
Stock repurchase to pay withholding taxes average share price $ 26.94 $ 23.91 $ 25.40 $ 29.29

(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 September 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:

September 30, 2022
Total Level 1 Level 2 Level 3
(In thousands)
Assets
Investment securities available for sale:
U.S. government and agency securities $ 63,749 $ 19,770 $ 43,979 $ —
Municipal securities 185,713 — 185,713 —
Residential CMO and MBS 438,370 — 438,370 —

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September 30, 2022
Total Level 1 Level 2 Level 3
(In thousands)
Commercial CMO and MBS 639,441 — 639,441 —
Corporate obligations 5,834 — 5,834 —
Other asset-backed securities 23,035 — 23,035 —
Total investment securities available for sale 1,356,142 19,770 1,336,372 —
Equity security 192 192 — —
Derivative assets - interest rate swaps 32,523 — 32,523 —
Liabilities
Derivative liabilities - interest rate swaps $ 32,523 $ — $ 32,523 $ — 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 September 30, 2022
Basis(1) Total Level 1 Level 2 Level 3
(In thousands)
Collateral-dependent loans:
Commercial business:
Owner-occupied CRE 613 186 — — 186
Total assets measured at fair value on a nonrecurring basis $ 613 $ 186 $ — $ — $ 186

(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
Real estate construction and land development:

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Fair Value at December 31, 2021
Basis(1) Total Level 1 Level 2 Level 3
(In thousands)
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 and was sold during the three months ended March 31, 2022.

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<br>September 30, Nine Months Ended<br>September 30,
2022 2021 2022 2021
(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial $ — $ (54) $ 24 $ (563)
Owner-occupied CRE — 15 (4) (61)
Total commercial business — (39) 20 (624)
Real estate construction and land development:
Commercial and multifamily — — — (38)
Total — (39) 20 (662)
Prepaid expenses and other assets:
Branch held for sale — (38) — (38)
Net (loss) gain from nonrecurring fair value adjustments $ — $ (77) $ 20 $ (700)

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:

September 30, 2022
Fair<br>Value Valuation<br>Technique(s) Unobservable Input(s) Range of Inputs; Weighted<br>Average
(Dollars in thousands)
Collateral-dependent loans $ 186 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<br>Value Valuation<br>Technique(s) Unobservable Input(s) Range of Inputs; Weighted<br>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 N/A

(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

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the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

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

September 30, 2022
Carrying<br>Value Fair<br>Value Fair Value Measurements Using:
Level 1 Level 2 Level 3
(In thousands)
Financial Assets:
Cash and cash equivalents $ 407,324 $ 407,324 $ 407,324 $ — $ —
Investment securities available for sale 1,356,142 1,356,142 19,770 1,336,372 —
Investment securities held to maturity 773,319 677,335 — 677,335 —
Loans held for sale — — — — —
Loans receivable, net 3,959,206 3,848,546 — — 3,848,546
Accrued interest receivable 17,812 17,812 351 6,962 10,499
Derivative assets - interest rate swaps 32,523 32,523 — 32,523 —
Equity security 192 192 192 — —
Financial Liabilities:
Non-maturity deposits $ 5,950,312 $ 5,950,312 $ 5,950,312 $ — $ —
Certificates of deposit 287,423 287,837 — 287,837 —
Securities sold under agreement to repurchase 40,449 40,449 40,449 — —
Junior subordinated debentures 21,399 20,250 — — 20,250
Accrued interest payable 101 101 36 13 52
Derivative liabilities - interest rate swaps 32,523 32,523 — 32,523 —
December 31, 2021
--- --- --- --- --- --- --- --- --- --- --- ---
Carrying<br>Value Fair<br>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 $ 6,051,451 $ 6,051,451 $ 6,051,451 $ — $ —
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 —

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(9)Cash Restriction

The Bank had no cash restrictions at September 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.

(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:

September 30,<br>2022 December 31, 2021
(In thousands)
Commercial business:
Commercial and industrial $ 528,690 $ 570,156
Owner-occupied CRE 4,260 2,252
Non-owner occupied CRE 12,334 7,487
Total commercial business 545,284 579,895
Real estate construction and land development:
Residential 52,098 51,838
Commercial and multifamily 237,204 209,217
Total real estate construction and land development 289,302 261,055
Consumer 314,216 285,010
Total outstanding commitments $ 1,148,802 $ 1,125,960

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

Three Months Ended<br>September 30, Nine Months Ended<br>September 30,
2022 2021 2022 2021
(In thousands)
Balance, beginning of period $ 997 $ 2,451 $ 2,607 $ 4,681
Provision for (reversal of) credit losses on unfunded commitments 26 (297) (1,584) (2,527)
Balance, end of period $ 1,023 $ 2,154 $ 1,023 $ 2,154

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

The following discussion is intended to assist in understanding the financial condition and results of operations of the Company as of and for the three and nine months ended September 30, 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

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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.

Our core profitability depends primarily on our net interest income. Net interest income is the difference between interest income, which is the income that we earn on interest earning assets, comprised primarily of loans and investment securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits. Management manages the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is significantly affected by general and local economic conditions, particularly changes in market interest rates 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.

Results of Operations

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

Net income was $21.0 million, or $0.59 per diluted common share, for the three months ended September 30, 2022 compared to $20.6 million, or $0.58 per diluted common share, for the same period in 2021. Net income increased $398,000, or 1.9%, due primarily to an increase in interest earned on interest earning assets following increases in market interest rates partially offset by a $1.9 million provision for credit losses, compared to a $3.1 million reversal of provision for credit losses for the three months ended September 30, 2021 and increased noninterest expense. The Company’s efficiency ratio was 58.66% for the three months ended September 30, 2022 compared to 62.35% for the same period in 2021.

Comparison of nine months ended September 30, 2022 to the comparable period in the prior year.

Net income was $59.3 million, or $1.67 per diluted common share, for the nine months ended September 30, 2022 compared to $78.6 million, or $2.18 per diluted common share, for the nine months ended September 30, 2021. Net income decreased $19.3 million, or 24.6%, due primarily to a lower reversal of provision for credit losses. The Company’s efficiency ratio was 61.67% for the nine months ended September 30, 2022 compared to 60.66% for the same period in 2021.

Average Balances, Yields and Rates Paid

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

Three Months Ended September 30,
2022 2021 Change
Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate
(Dollars in thousands)
Interest Earning Assets:

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Three Months Ended September 30,
2022 2021 Change
Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate
(Dollars in thousands)
Loans receivable, net (2)(3) $ 3,859,839 $ 43,847 4.51 % $ 4,005,585 $ 46,863 4.64 % $ (145,746) $ (3,016) (0.13) %
Taxable securities 1,868,900 12,362 2.62 893,374 4,711 2.09 975,526 7,651 0.53
Nontaxable securities (3) 133,022 892 2.66 157,907 931 2.34 (24,885) (39) 0.32
Interest earning deposits 730,600 4,009 2.18 1,417,661 537 0.15 (687,061) 3,472 2.03
Total interest earning assets 6,592,361 61,110 3.68 % 6,474,527 53,042 3.25 % 117,834 8,068 0.43 %
Noninterest earning assets 775,375 740,433 34,942
Total assets $ 7,367,736 $ 7,214,960 $ 152,776
Interest Bearing Liabilities:
Certificates of Deposit $ 297,786 $ 290 0.39 % $ 365,278 $ 407 0.44 % $ (67,492) $ (117) (0.05) %
Savings accounts 654,697 99 0.06 609,818 90 0.06 44,879 9 —
Interest bearing demand and money market accounts 3,065,007 1,089 0.14 2,881,567 947 0.13 183,440 142 0.01
Total interest bearing deposits 4,017,490 1,478 0.15 3,856,663 1,444 0.15 160,827 34 —
Junior subordinated debentures 21,356 312 5.80 21,060 184 3.47 296 128 2.33
Securities sold under agreement to repurchase 42,959 34 0.31 52,197 36 0.27 (9,238) (2) 0.04
Total interest bearing liabilities 4,081,805 1,824 0.18 % 3,929,920 1,664 0.17 % 151,885 160 0.01 %
Noninterest bearing demand deposits 2,356,688 2,313,145 43,543
Other noninterest bearing liabilities 118,191 116,187 2,004
Stockholders’ equity 811,052 855,708 (44,656)
Total liabilities and stock-holders’ equity $ 7,367,736 $ 7,214,960 $ 152,776
Net interest income and spread $ 59,286 3.50 % $ 51,378 3.08 % $ 7,908 0.42 %
Net interest margin 3.57 % 3.15 % 0.42 %

(1) Average balances are calculated using daily balances.

(2) Average loans 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 $857,000 and $7.8 million for the three months ended September 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 September 30, 2022 compared to the three months ended September 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 $ (1,678) $ (1,338) $ (3,016) (6.4) %
Taxable securities 6,206 1,445 7,651 162.4
Nontaxable securities (158) 119 (39) (4.2)
Interest earning deposits (382) 3,854 3,472 646.6
Total interest income $ 3,988 $ 4,080 $ 8,068 15.2 %

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Increase (Decrease) Due to Changes In:
Volume Yield/Rate Total % Change
(Dollars in thousands)
Interest Bearing Liabilities:
Certificates of deposit $ (70) $ (47) $ (117) (28.7) %
Savings accounts 7 2 9 10.0
Interest bearing demand and money market accounts 62 80 142 15.0
Total interest bearing deposits (1) 35 34 2.4
Junior subordinated debentures 3 125 128 69.6
Securities sold under agreement to repurchase (7) 5 (2) (5.6)
Total interest expense $ (5) $ 165 $ 160 9.6 %
Net interest income $ 3,993 $ 3,915 $ 7,908 15.4 %

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

Net interest income increased primarily as a result of higher yields earned on interest earning assets following increases in market interest rates as well as an increased average balance of taxable investment securities, offset partially by a decrease in deferred SBA PPP loan fees recognized due to a decline in the volume of forgiven SBA PPP loans. SBA PPP interest and fee income decreased $7.8 million compared to the three months ended September 30, 2021.

Net interest margin increased due to a shift in the mix of interest-earning assets towards higher yielding loans and taxable investment securities as well as increased average yields on all interest earning assets, excluding the impact from SBA PPP loans.

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
September 30,<br>2022 September 30,<br>2021
Loan yield (GAAP) 4.51 % 4.64 %
Exclude impact from SBA PPP loans (0.02) (0.38)
Exclude impact from incremental accretion on acquired loans (0.05) (0.07)
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans (non-GAAP) (1) 4.44 % 4.19 %

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

There was no impact to loan yield from recoveries of interest and fees on loans classified as nonaccrual during the three months ended September 30, 2022 compared to two basis points during the same period in 2021.

Comparison of nine months ended September 30, 2022 to the comparable period in the prior year

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

Nine Months Ended September 30,
2022 2021 Change
Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate
(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net (2)(3) $ 3,815,387 $ 125,762 4.41 % $ 4,297,875 $ 147,137 4.58 % $ (482,488) $ (21,375) (0.17) %
Taxable securities 1,532,450 25,972 2.27 789,691 12,295 2.08 742,759 13,677 0.19
Nontaxable securities (3) 138,904 2,645 2.55 160,748 2,836 2.36 (21,844) (191) 0.19
Interest earning deposits 1,146,183 7,057 0.82 1,034,690 975 0.13 111,493 6,082 0.69
Total interest earning assets 6,632,924 161,436 3.25 % 6,283,004 163,243 3.47 % 349,920 (1,807) (0.22) %
Noninterest earning assets 762,877 749,781 13,096
Total assets $ 7,395,801 $ 7,032,785 $ 363,016

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Nine Months Ended September 30,
2022 2021 Change
Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate Average<br><br>Balance(1) Interest<br>Earned/<br>Paid Average<br>Yield/<br>Rate
(Dollars in thousands)
Interest Bearing Liabilities:
Certificates of Deposit $ 318,547 $ 952 0.40 % $ 379,885 $ 1,447 0.51 % $ (61,338) $ (495) (0.11) %
Savings accounts 651,292 274 0.06 587,358 274 0.06 63,934 — —
Interest bearing demand and money market accounts 3,066,229 3,089 0.13 2,817,353 2,975 0.14 248,876 114 (0.01)
Total interest bearing deposits 4,036,068 4,315 0.14 3,784,596 4,696 0.17 251,472 (381) (0.03)
Junior subordinated debentures 21,286 745 4.68 20,987 557 3.55 299 188 1.13
Securities sold under agreement to repurchase 47,057 98 0.28 45,221 109 0.32 1,836 (11) (0.04)
Total interest bearing liabilities 4,104,411 5,158 0.17 % 3,850,804 5,362 0.19 % 253,607 (204) (0.02) %
Noninterest bearing demand deposits 2,355,285 2,227,281 128,004
Other noninterest bearing liabilities 113,534 115,098 (1,564)
Stockholders’ equity 822,571 839,602 (17,031)
Total liabilities and stock-holders’ equity $ 7,395,801 $ 7,032,785 $ 363,016
Net interest income and spread $ 156,278 3.08 % $ 157,881 3.28 % $ (1,603) (0.20) %
Net interest margin 3.15 % 3.36 % (0.21) %

(1) Average balances are calculated using daily balances.

(2) Average loans 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 $6.7 million and $23.2 million for the nine months ended September 30, 2022 and 2021, respectively.

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

The following table provides the changes in net interest income for the nine months ended September 30, 2022 compared to the nine months ended September 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 $ (16,057) $ (5,318) $ (21,375) (14.5) %
Taxable securities 12,500 1,177 13,677 111.2
Nontaxable securities (405) 214 (191) (6.7)
Interest earning deposits 116 5,966 6,082 623.8
Total interest income $ (3,846) $ 2,039 $ (1,807) (1.1) %
Interest Bearing Liabilities:
Certificates of deposit $ (212) $ (283) $ (495) (34.2) %
Savings accounts 28 (28) — —
Interest bearing demand and money market accounts 255 (141) 114 3.8
Total interest bearing deposits 71 (452) (381) (8.1)
Junior subordinated debentures 8 180 188 33.8
Securities sold under agreement to repurchase 4 (15) (11) (10.1)
Total interest expense $ 83 $ (287) $ (204) (3.8) %
Net interest income $ (3,929) $ 2,326 $ (1,603) (1.0) %

Comparison of nine months ended September 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 decline in the volume of forgiven SBA PPP loans, offset partially by a higher average balance of taxable investment securities and higher

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yield earned on taxable securities and interest earning deposits following increases in market interest rates. SBA PPP interest and fee income decreased $22.0 million compared to the nine months ended September 30, 2021.

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:

Nine Months Ended<br>September 30,
2022 2021
Loan yield (GAAP) 4.41 % 4.58 %
Exclude impact from SBA PPP loans (0.13) (0.17)
Exclude impact from incremental accretion on acquired loans (0.04) (0.08)
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans (non-GAAP) (1) 4.24 % 4.33 %

(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 four basis points during the nine months ended September 30, 2022 compared to nine 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 provision for (reversal of) 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 September 30, 2022 to the comparable quarter in the prior year

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

Three Months Ended<br>September 30,
2022 2021 Change % Change
(Dollars in thousands)
Provision for (reversal of) credit losses on loans $ 1,919 $ (2,852) $ 4,771 (167.3) %
Provision for (reversal of) credit losses on unfunded commitments 26 (297) 323 (108.8)
Provision for (reversal of) credit losses $ 1,945 $ (3,149) $ 5,094 (161.8) %

The provision for credit losses on loans recognized during the three months ended September 30, 2022 was due primarily to an increase related to the growth in loans receivable offset partially by a reduction to the ACL on loans individually evaluated for losses.

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

Comparison of nine months ended September 30, 2022 to the comparable period in the prior year

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

Nine Months Ended<br>September 30,
2022 2021 Change Percentage Change
(Dollars in thousands)
Reversal of provision for credit losses on loans $ (1,252) $ (21,808) $ 20,556 (94.3) %
Reversal of provision for credit losses on unfunded commitments (1,584) (2,527) 943 (37.3)
Reversal of provision for credit losses $ (2,836) $ (24,335) $ 21,499 (88.3) %

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

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

Noninterest Income Overview

Comparison of quarter ended September 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<br>September 30,
2022 2021 Change % Change
(Dollars in thousands)
Service charges and other fees $ 2,688 $ 2,400 $ 288 12.0 %
Card revenue 2,365 2,150 215 10.0
Gain on sale of loans, net 133 765 (632) (82.6)
Interest rate swap fees 78 126 (48) (38.1)
Bank owned life insurance income 723 647 76 11.7
Gain on sale of other assets, net 265 942 (677) (71.9)
Other income 1,201 1,198 3 0.3
Total noninterest income $ 7,453 $ 8,228 $ (775) (9.4) %

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 lower gain on sale of other assets, net due to a higher gain on sale of branches held for sale recognized during the three months ended September 30, 2021.

Comparison of nine months ended September 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:

Nine Months Ended<br>September 30,
2022 2021 Change % Change
(Dollars in thousands)
Service charges and other fees $ 7,739 $ 6,728 $ 1,011 15.0 %
Card revenue 6,774 6,216 558 9.0
Gain on sale of investment securities, net — 29 (29) (100.0)
Gain on sale of loans, net 593 3,138 (2,545) (81.1)
Interest rate swap fees 383 487 (104) (21.4)
Bank owned life insurance income 3,182 2,020 1,162 57.5
Gain on sale of other assets, net 469 1,688 (1,219) (72.2)
Other income 3,867 4,470 (603) (13.5)
Total noninterest income $ 23,007 $ 24,776 $ (1,769) (7.1) %

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 lower gain on sale of other assets, net due to a higher gain on sale of branches held for sale recognized during the nine months ended September 30, 2021. The decrease was 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 nine months ended September 30, 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.

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Noninterest Expense Overview

Comparison of quarter ended September 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<br>September 30,
2022 2021 Change % Change
(Dollars in thousands)
Compensation and employee benefits $ 24,206 $ 21,963 $ 2,243 10.2 %
Occupancy and equipment 4,422 4,373 49 1.1
Data processing 4,185 4,029 156 3.9
Marketing 358 486 (128) (26.3)
Professional services 639 776 (137) (17.7)
State/municipal business and use tax 963 1,071 (108) (10.1)
Federal deposit insurance premium 500 550 (50) (9.1)
Amortization of intangible assets 671 758 (87) (11.5)
Other expense 3,203 3,160 43 1.4
Total noninterest expense $ 39,147 $ 37,166 $ 1,981 5.3 %

Noninterest expense increased due primarily to an increase in salaries and wages effective July 1, 2022 due to upward market pressure and an increase in accrual for incentive compensation.

Comparison of nine months ended September 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:

Nine Months Ended<br>September 30,
2022 2021 Change % Change
(Dollars in thousands)
Compensation and employee benefits $ 67,236 $ 65,967 $ 1,269 1.9 %
Occupancy and equipment 12,924 12,918 6 —
Data processing 12,431 11,839 592 5.0
Marketing 968 1,566 (598) (38.2)
Professional services 1,867 3,083 (1,216) (39.4)
State/municipal business and use tax 2,626 3,034 (408) (13.4)
Federal deposit insurance premium 1,525 1,478 47 3.2
Amortization of intangible assets 2,079 2,352 (273) (11.6)
Other expense 8,918 8,567 351 4.1
Total noninterest expense $ 110,574 $ 110,804 $ (230) (0.2) %

Noninterest expense decreased due primarily to a decrease in professional services, which was elevated during the nine months ended September 30, 2021 due to costs associated with our participation in the SBA PPP, as well as a decrease in marketing expenses due to less activity. This decrease was offset partially by an increase in compensation and employee benefits due to increases in both salaries and wages and in accrual for incentive compensation as noted above, as well as an increase in data processing as the Bank continues to invest in its technology platforms.

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Income Tax Expense Overview

Comparison of quarter ended September 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<br>September 30,
2022 2021 Change % Change
(Dollars in thousands)
Income before income taxes $ 25,647 $ 25,589 $ 58 0.2 %
Income tax expense $ 4,657 $ 4,997 $ (340) (6.8) %
Effective income tax rate 18.2 % 19.5 % (1.3) % (6.7) %

Income tax expense decreased due primarily to a lower effective tax rate as a result of lower estimated annual pre-tax income for the year ended December 31, 2022 as compared to year ended December 31, 2021, which increased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance, and LIHTC.

Comparison of nine months ended September 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:

Nine Months Ended<br>September 30,
2022 2021 Change % Change
(Dollars in thousands)
Income before income taxes $ 71,547 $ 96,188 $ (24,641) (25.6) %
Income tax expense $ 12,216 $ 17,550 $ (5,334) (30.4) %
Effective income tax rate 17.1 % 18.2 % (1.1) % (6.0) %

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:

September 30,<br>2022 December 31, 2021 Change % Change
(Dollars in thousands)
Assets
Cash and cash equivalents $ 407,324 $ 1,723,292 $ (1,315,968) (76.4) %
Investment securities available for sale, at fair value, net 1,356,142 894,335 461,807 51.6 %
Investment securities held to maturity, at amortized cost, net 773,319 383,393 389,926 101.7 %
Loans held for sale — 1,476 (1,476) (100.0) %
Loans receivable, net 3,959,206 3,773,301 185,905 4.9 %
Premises and equipment, net 76,683 79,370 (2,687) (3.4) %
Federal Home Loan Bank stock, at cost 8,916 7,933 983 12.4 %
Bank owned life insurance 121,369 120,196 1,173 1.0 %
Accrued interest receivable 17,812 14,657 3,155 21.5 %
Prepaid expenses and other assets 230,704 183,543 47,161 25.7 %
Other intangible assets, net 7,898 9,977 (2,079) (20.8) %
Goodwill 240,939 240,939 — —
Total assets $ 7,200,312 $ 7,432,412 $ (232,100) (3.1) %

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September 30,<br>2022 December 31, 2021 Change % Change
(Dollars in thousands)
Liabilities and Stockholders' Equity
Deposits $ 6,214,964 $ 6,394,290 $ (179,326) (2.8) %
Deposits held for sale 22,771 — $ 22,771 100.0 %
Total deposits 6,237,735 6,394,290 (156,555) (2.4)
Junior subordinated debentures 21,399 21,180 219 1.0
Securities sold under agreement to repurchase 40,449 50,839 (10,390) (20.4)
Accrued expenses and other liabilities 124,027 111,671 12,356 11.1
Total liabilities 6,423,610 6,577,980 (154,370) (2.3)
Common stock 551,419 551,798 (379) (0.1)
Retained earnings 330,284 293,238 37,046 12.6
Accumulated other comprehensive (loss) income, net (105,001) 9,396 (114,397) (1,217.5)
Total stockholders' equity 776,702 854,432 (77,730) (9.1)
Total liabilities and stockholders' equity $ 7,200,312 $ 7,432,412 $ (232,100) (3.1) %

Total assets decreased due primarily to a decrease in cash and cash equivalents reflecting deployment of excess liquidity into purchases of higher yielding investment securities and loans. Total liabilities and stockholders' equity decreased due primarily to a decrease in deposits as well as an increased loss in AOCI following an increase in market interest rates during the nine months ended September 30, 2022, which negatively impacted the fair value of our investment securities available for sale portfolio at September 30, 2022.

Investment Activities Overview

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

September 30, 2022 December 31, 2021
Balance % of<br>Total Balance % of<br>Total Change % Change
(Dollars in thousands)
Investment securities available for sale, at fair value:
U.S. government and agency securities $ 63,749 3.0 % $ 21,373 1.7 % $ 42,376 198.3 %
Municipal securities 185,713 8.7 221,212 17.3 % (35,499) (16.0)
Residential CMO and MBS 438,370 20.6 306,884 24.0 % 131,486 42.8
Commercial CMO and MBS 639,441 30.0 315,861 24.7 % 323,580 102.4
Corporate obligations 5,834 0.3 2,014 0.2 % 3,820 189.7
Other asset-backed securities 23,035 1.1 26,991 2.1 % (3,956) (14.7)
Total $ 1,356,142 63.7 % $ 894,335 70.0 % $ 461,807 51.6 %
Investment securities held to maturity, at amortized cost:
U.S. government and agency securities $ 150,948 7.1 % $ 141,011 11.0 % $ 9,937 7.0 %
Residential CMO and MBS 296,432 13.9 24,529 1.9 271,903 1,108.5
Commercial CMO and MBS 325,939 15.3 217,853 17.1 108,086 49.6
Total $ 773,319 36.3 % $ 383,393 30.0 % $ 389,926 101.7 %
Total investment securities $ 2,129,461 100.0 % $ 1,277,728 100.0 % $ 851,733 66.7 %

Total investment securities increased due primarily to purchases to deploy excess liquidity into higher yielding, longer duration assets. Purchases of investment securities available for sale were offset partially by a $145.8 million decrease in the fair value of these investment securities as a result of an increase in market interest rates resulting in an unrealized loss at September 30, 2022 compared to an unrealized gain at December 31, 2021.

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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:

September 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 $ 735,028 18.4 % $ 621,567 16.3 % $ 113,461 18.3 %
SBA PPP 3,593 0.1 145,840 3.8 (142,247) (97.5)
Owner-occupied CRE 959,486 24.0 931,150 24.4 28,336 3.0
Non-owner occupied CRE 1,547,114 38.6 1,493,099 39.2 54,015 3.6
Total commercial business 3,245,221 81.1 3,191,656 83.7 53,565 1.7
Residential real estate 296,019 7.4 164,582 4.3 131,437 79.9
Real estate construction and land development:
Residential 92,297 2.3 85,547 2.2 6,750 7.9
Commercial and multifamily 160,723 4.0 141,336 3.7 19,387 13.7
Total real estate construction and land development 253,020 6.3 226,883 5.9 26,137 11.5
Consumer 207,035 5.2 232,541 6.1 (25,506) (11.0)
Total $ 4,001,295 100.0 % $ 3,815,662 100.0 % $ 185,633 4.9 %

Loans receivable increased due primarily to higher commercial and industrial loan demand including an increased usage of lines of credit and an increase in residential real estate loans, including $98.5 million of purchased residential real estate loans as well as lower prepayments. This increase was offset partially by repayments of SBA PPP loans and a decrease in consumer loans due primarily to a $42.2 million decline in indirect loans outstanding as the Bank ceased indirect auto loan originations in 2020.

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:

September 30,<br>2022 December 31, 2021 Change % Change
(Dollars in thousands)
Nonaccrual loans: (1)
Commercial business $ 6,234 $ 23,107 $ (16,873) (73.0) %
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 6,234 23,754 (17,520) (73.8)
Other real estate owned — — — n/a
Total nonperforming assets $ 6,234 $ 23,754 $ (17,520) (73.8) %
Accruing loans past due 90 days or more $ 20 $ 293 $ (273) (93.2) %
Credit quality ratios:
Nonaccrual loans to loans receivable 0.16 % 0.62 % (0.46) % (74.2) %
Nonaccrual loans to total assets 0.09 0.32 (0.23) (71.9)
Performing TDR loans: (1)
Commercial business $ 64,739 $ 57,142 $ 7,597 13.3 %
Residential real estate 175 358 (183) (51.1)
Real estate construction and land development 6,137 450 5,687 1,263.8

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September 30,<br>2022 December 31, 2021 Change % Change
(Dollars in thousands)
Consumer 812 1,160 (348) (30.0)
Total performing TDR loans $ 71,863 $ 59,110 $ 12,753 21.6 %

(1) At September 30, 2022 and December 31, 2021, $1.7 million and $1.4 million of nonaccrual loans, respectively, and $2.2 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 nine months ended September 30, 2022:

(In thousands)
Balance, beginning of period $ 23,754
Additions 720
Net principal payments, sales and transfers to accruing status (13,784)
Payoffs (4,285)
Charge-offs (171)
Balance, end of period $ 6,234

Nonaccrual loans decreased $17.5 million, or 73.8%, due primarily to ongoing collection efforts, including the partial payoff of three large commercial and industrial loan relationships, the payoff of four commercial business loan relationships, and the transfer of five commercial business loan relationships totaling $10.1 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 Nine Months Ended September 30,
2022 2021 Change % Change
(Dollars in thousands)
ACL on loans at the end of period $ 42,089 $ 48,317 $ (6,228) (12.9) %
Credit quality ratios:
ACL on loans to loans receivable 1.05 % 1.22 % (0.06) % (5.4)
ACL on loans to loans receivable, excluding SBA PPP loans (1) 1.05 1.31 (0.10) (8.7)
ACL on loans to nonaccrual loans 675.15 186.60 496.82 278.60
Net (recoveries) charge-offs $ (980) $ 60 $ (1,040) 0.02
Average loans receivable, net during the period (2) 3,815,387 4,297,875 (482,488) (11.2)
Net recoveries on loans to average loans receivable, net(3) (0.03) % — % (0.03) % — %

(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 nine months ended September 30, 2022 due primarily to a reduction of loans individually evaluated for losses and as a result, their related ACL of $3.9 million as well as improvements in the economic forecast at September 30, 2022 as compared to the forecast at September 30, 2021 as the economic forecast as of September 30, 2021 still considered a more significant impact as as a result of COVID-19 and related variants.

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

September 30, 2022 December 31, 2021
ACL on loans % of<br><br>Total (1) ACL on loans % of<br><br>Total (1) Change % Change
(Dollars in thousands)
Commercial business $ 31,940 81.1 % $ 33,049 83.7 % $ (1,109) (3.4) %
Residential real estate 2,545 7.4 1,409 4.3 1,136 80.6
Real estate construction and land development 5,104 6.3 5,276 5.9 (172) (3.3)
Consumer 2,500 5.2 2,627 6.1 (127) (4.8)
Total ACL on loans $ 42,089 100.0 % $ 42,361 100.0 % $ (272) (0.6) %

(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:

September 30, 2022 December 31, 2021
Balance % of Total Balance % of Total Change % Change
(Dollars in thousands)
Noninterest demand deposits $ 2,308,583 37.0 % $ 2,343,909 36.7 % $ (35,326) (1.5) %
Interest bearing demand deposits 1,997,989 32.0 % 1,946,605 30.4 51,384 2.6
Money market accounts 996,214 16.0 % 1,120,174 17.5 (123,960) (11.1)
Savings accounts 647,526 10.4 % 640,763 10.0 6,763 1.1
Total non-maturity deposits 5,950,312 95.4 6,051,451 94.6 (101,139) (1.7)
Certificates of deposit 287,423 4.6 342,839 5.4 (55,416) (16.2)
Total deposits $ 6,237,735 100.0 % $ 6,394,290 100.0 % $ (156,555) (2.4) %

Total deposits decreased due primarily to competitive pricing pressures and customers moving excess funds to alternative higher yielding investments.

The Bank entered into a purchase and sale agreement with a third party to sell and transfer assets, deposits and other liabilities of its branch in Ellensburg during the three months ended September 30, 2022. As a result of entering into this purchase and sale agreement, $22.7 million in deposits were transferred to held for sale. The lower of amortized cost or fair value adjustment upon transferring these deposits to held for sale was not material. The sale is expected to be completed during the three months ended March 31, 2023; however, the completion of this sale depends on many factors including regulatory approval.

Stockholders' Equity Overview

The Company’s stockholders' equity to assets ratio was 10.8% and 11.5% at September 30, 2022 and December 31, 2021, respectively, and decreased due primarily to a decrease in AOCI of $114.4 million following increases in market interest rates during the nine months ended September 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 October 19, 2022, the Company’s board of directors declared a regular quarterly dividend of $0.21 per common share payable on November 16, 2022 to shareholders of record on November 2, 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

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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 September 30, 2022, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of September 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 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
September 30, 2022 December 31, 2021 September 30, 2022 December 31, 2021
Common equity Tier 1 capital ratio 12.8 % 13.5 % 13.0 % 13.8 %
Leverage ratio 9.2 8.7 9.0 8.6
Tier 1 capital ratio 13.3 13.9 13.0 13.8
Total capital ratio 14.0 14.8 13.8 14.7
Capital conservation buffer 6.0 6.8 5.8 6.7

As of both September 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 allowed 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 nine months ended September 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.

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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 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 have substantially decreased within a short time frame.

Three Months Ended<br>September 30, Nine Months Ended<br>September 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) $ 43,847 $ 46,863 $ 125,762 $ 147,137
Exclude interest and fees on SBA PPP loans (275) (8,042) (5,138) (27,181)
Exclude incremental accretion on acquired loans (398) (681) (1,252) (2,250)
Adjusted interest and fees on loans (non-GAAP) $ 43,174 $ 38,140 $ 119,372 $ 117,706
Average loans receivable, net (GAAP) $ 3,859,839 $ 4,005,585 $ 3,815,387 $ 4,297,875
Exclude average SBA PPP loans (5,726) (392,570) (49,423) (665,681)
Adjusted average loans receivable, net (non-GAAP) $ 3,854,113 $ 3,613,015 $ 3,765,964 $ 3,632,194
Loan yield, annualized (GAAP) 4.51 % 4.64 % 4.41 % 4.58 %
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans, annualized (non-GAAP) 4.44 % 4.19 % 4.24 % 4.33 %

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 was 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.

September 30,<br>2022 December 31,<br>2021
(Dollars in thousands)
ACL on Loans to Loans Receivable, excluding SBA PPP Loans:
Allowance for credit losses on loans (GAAP) $ 42,089 $ 42,361
Loans receivable (GAAP) $ 4,001,295 $ 3,815,662
Exclude SBA PPP loans (3,593) (145,840)
Loans receivable, excluding SBA PPP (non-GAAP) $ 3,997,702 $ 3,669,822
ACL on loans to loans receivable (GAAP) 1.05 % 1.11 %
ACL on loans to loans receivable, excluding SBA PPP loans (non-GAAP) 1.05 % 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.

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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 September 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.

(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 September 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.

(c) Repurchase Plans

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

Period Total Number<br><br>of Shares<br><br>Purchased (1) Average Price<br><br>Paid Per<br><br>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)
July 1, 2022—July 31, 2022 — $ — 9,986,863 638,214
August 1, 2022— August 31, 2022 — — 9,986,863 638,214
September 1, 2022—September 30, 2022 100 26.94 9,986,863 638,214
Total 100 $ 26.94

(1)Of the common shares repurchased by the Company between July 1, 2022 and September 30, 2022, all 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

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ITEM 6.     EXHIBITS

Incorporated by Reference
Exhibit No. Description of Exhibit Form Exhibit Filing Date/Period End Date
10.39 Transitional Retirement Agreement made and entered into on September 26, 2022, effective as of January 1, 2023 by and between Heritage Financial Corporation and Cindy M. Hirman 8-K 10.1 09/26/2022
10.40* Deferred Compensation Plan and Participation Agreement - Addendum by and between Heritage and Jeffrey J. Deuel 10-Q 11/8/2022
10.41* Deferred Compensation Plan and Participation Agreement - Addendum by and between Heritage and Donald J. Hinson 10-Q 11/8/2022
10.42* Deferred Compensation Plan and Participation Agreement - Addendum by and between Heritage and Bryan McDonald 10-Q 11/8/2022
10.43* Deferred Compensation Plan and Participation Agreement - Addendum by and between Heritage and Tony Chalfant 10-Q 11/8/2022
31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
32.1 Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)
101.INS XBRL Instance Document (1)
101.SCH XBRL Taxonomy Extension Schema Document (1)
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document (1)
101.DEF XBRL Taxonomy Extension Definition Linkbase Document (1)
101.LAB XBRL Taxonomy Extension Label Linkbase Document (1)
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document (1)

(*) Indicates management contract or compensatory plan or arrangement.

(1) Filed herewith.

SIGNATURES

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

HERITAGE FINANCIAL CORPORATION
Date:
November 8, 2022 /S/ JEFFREY J. DEUEL
Jeffrey J. Deuel
President and Chief Executive Officer
Date:
November 8, 2022 /S/ DONALD J. HINSON
Donald J. Hinson
Executive Vice President and Chief Financial Officer

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ex-1040093022deuelxparti

2188960.v1 HERITAGE FINANCIAL CORPORATION DEFERRED COMPENSATION PLAN PARTICIPATION AGREEMENT - ADDENDUM This Participation Agreement Addendum (“Addendum”) is hereby entered into by and between HERITAGE FINANCIAL CORPORATION (the “Company”) and Jeffrey Deuel an employee of the Company (the “Participant,” and together with the Company, the “Parties”). RECITALS A. The Company has adopted the Heritage Financial Corporation Deferred Compensation Plan, effective July 1, 2012, as amended and restated August 29, 2012 (the “Plan”); B. The Parties entered into a Participation Agreement, dated July 1, 2012 as amended by the Participation Agreement – Addendums dated December 19, 2016 and November 4, 2019 (the “Participation Agreement”); C. The Committee has determined that the Participation Agreement should be extended pursuant to this Addendum to provide additional benefits to the Participant for the 2023, 2024 and 2025 calendar years; and D. This Addendum is attached to and made a part of the Participation Agreement, incorporates all defined terms therein unless otherwise defined herein, and in the event of any conflict between the terms contained in this Addendum and the terms contained in the Participation Agreement, the terms contained in this Addendum shall supersede and control the obligations and liabilities of the Parties. AGREEMENT In consideration of the foregoing and the mutual promises and covenants of the parties hereto set forth in this Addendum, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby expressly covenant and agree as follows: Section 1. Company Contributions. The Company shall continue to make a Company Contribution for Plan Years 2023, 2024, and 2025, on the same terms and conditions set forth in the Participant Agreement, with the performance metrics and targets in connection with such Company Contributions for such Plan Years to be established in the sole discretion of the Committee, following consultation with the Chief Executive Officer of the Company. Section 2. Entire Agreement. This Addendum, in addition to the Participation

2188960.v1 Agreement and the Plan, constitutes the entire agreement between the Parties concerning the subject matter hereof, and supersedes all prior negotiations, undertakings, agreements, and arrangements with respect thereto, whether written or oral. IN WITNESS WHEREOF, the Company and the Participant have duly executed this Addendum as of the date set forth below. HERITAGE FINANCIAL CORPORATION By: /S/ Ann Watson ANN WATSON Its: Director and Compensation Committee Chair PARTICIPANT /S/ JEFFREY J. DEUEL JEFFREY J. DEUEL Date: November 8, 2022

ex-1041093022hinsonxpart

2188960.v1 HERITAGE FINANCIAL CORPORATION DEFERRED COMPENSATION PLAN PARTICIPATION AGREEMENT - ADDENDUM This Participation Agreement Addendum (“Addendum”) is hereby entered into by and between HERITAGE FINANCIAL CORPORATION (the “Company”) and Donald J. Hinson an employee of the Company (the “Participant,” and together with the Company, the “Parties”). RECITALS A. The Company has adopted the Heritage Financial Corporation Deferred Compensation Plan, effective July 1, 2012, as amended and restated August 29, 2012 (the “Plan”); B. The Parties entered into a Participation Agreement, dated July 1, 2012 as amended by the Participation Agreement – Addendums dated December 19, 2016 and November 4, 2019 (the “Participation Agreement”); C. The Committee has determined that the Participation Agreement should be extended pursuant to this Addendum to provide additional benefits to the Participant for the 2023, 2024 and 2025 calendar years; and D. This Addendum is attached to and made a part of the Participation Agreement, incorporates all defined terms therein unless otherwise defined herein, and in the event of any conflict between the terms contained in this Addendum and the terms contained in the Participation Agreement, the terms contained in this Addendum shall supersede and control the obligations and liabilities of the Parties. AGREEMENT In consideration of the foregoing and the mutual promises and covenants of the parties hereto set forth in this Addendum, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby expressly covenant and agree as follows: Section 1. Company Contributions. The Company shall continue to make a Company Contribution for Plan Years 2023, 2024, and 2025, on the same terms and conditions set forth in the Participant Agreement, with the performance metrics and targets in connection with such Company Contributions for such Plan Years to be established in the sole discretion of the Committee, following consultation with the Chief Executive Officer of the Company. Section 2. Entire Agreement. This Addendum, in addition to the Participation

2188960.v1 Agreement and the Plan, constitutes the entire agreement between the Parties concerning the subject matter hereof, and supersedes all prior negotiations, undertakings, agreements, and arrangements with respect thereto, whether written or oral. IN WITNESS WHEREOF, the Company and the Participant have duly executed this Addendum as of the date set forth below. HERITAGE FINANCIAL CORPORATION By: /S/ JEFFREY J. DEUEL JEFFREY J. DEUEL Its: CEO & President Date: November 8, 2022 PARTICIPANT /S/ DONALD J. HINSON DONALD J. HINSON

ex-1042093022mcdonaldxpa

2188960.v1 HERITAGE FINANCIAL CORPORATION DEFERRED COMPENSATION PLAN PARTICIPATION AGREEMENT - ADDENDUM This Participation Agreement Addendum (“Addendum”) is hereby entered into by and between HERITAGE FINANCIAL CORPORATION (the “Company”) and Bryan McDonald an employee of the Company (the “Participant,” and together with the Company, the “Parties”). RECITALS A. The Company has adopted the Heritage Financial Corporation Deferred Compensation Plan, effective July 1, 2012, as amended and restated August 29, 2012 (the “Plan”); B. The Parties entered into a Participation Agreement, dated January 1, 2015 as amended by the Participation Agreement – Addendums dated December 19, 2016 and November 4, 2019 (the “Participation Agreement”); C. The Committee has determined that the Participation Agreement should be extended pursuant to this Addendum to provide additional benefits to the Participant for the 2023, 2024 and 2025 calendar years; and D. This Addendum is attached to and made a part of the Participation Agreement, incorporates all defined terms therein unless otherwise defined herein, and in the event of any conflict between the terms contained in this Addendum and the terms contained in the Participation Agreement, the terms contained in this Addendum shall supersede and control the obligations and liabilities of the Parties. AGREEMENT In consideration of the foregoing and the mutual promises and covenants of the parties hereto set forth in this Addendum, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby expressly covenant and agree as follows: Section 1. Company Contributions. The Company shall continue to make a Company Contribution for Plan Years 2023, 2024, and 2025, on the same terms and conditions set forth in the Participant Agreement, with the performance metrics and targets in connection with such Company Contributions for such Plan Years to be established in the sole discretion of the Committee, following consultation with the Chief Executive Officer of the Company. Section 2. Entire Agreement. This Addendum, in addition to the Participation

2188960.v1 Agreement and the Plan, constitutes the entire agreement between the Parties concerning the subject matter hereof, and supersedes all prior negotiations, undertakings, agreements, and arrangements with respect thereto, whether written or oral. IN WITNESS WHEREOF, the Company and the Participant have duly executed this Addendum as of the date set forth below. HERITAGE FINANCIAL CORPORATION By: /S/ JEFFREY J. DEUEL JEFFREY J. DEUEL Its: CEO & President Date: November 8, 2022 PARTICIPANT /S/ BRYAN MCDONALD BRYAN McDONALD

ex-1043093022chalfantxpa

2188960.v1 HERITAGE FINANCIAL CORPORATION DEFERRED COMPENSATION PLAN PARTICIPATION AGREEMENT - ADDENDUM This Participation Agreement Addendum (“Addendum”) is hereby entered into by and between HERITAGE FINANCIAL CORPORATION (the “Company”) and Tony Chalfant an employee of the Company (the “Participant,” and together with the Company, the “Parties”). RECITALS A. The Company has adopted the Heritage Financial Corporation Deferred Compensation Plan, effective July 1, 2012, as amended and restated August 29, 2012 (the “Plan”); B. The Parties entered into a Participation Agreement, dated June 25, 2020 as subsequently amended (the “Participation Agreement”); C. The Committee has determined that the Participation Agreement should be extended pursuant to this Addendum to provide additional benefits to the Participant for the 2023, 2024 and 2025 calendar years; and D. This Addendum is attached to and made a part of the Participation Agreement, incorporates all defined terms therein unless otherwise defined herein, and in the event of any conflict between the terms contained in this Addendum and the terms contained in the Participation Agreement, the terms contained in this Addendum shall supersede and control the obligations and liabilities of the Parties. AGREEMENT In consideration of the foregoing and the mutual promises and covenants of the parties hereto set forth in this Addendum, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby expressly covenant and agree as follows: Section 1. Company Contributions. The Company shall continue to make a Company Contribution for Plan Years 2023, 2024, and 2025, on the same terms and conditions set forth in the Participant Agreement, with the performance metrics and targets in connection with such Company Contributions for such Plan Years to be established in the sole discretion of the Committee, following consultation with the Chief Executive Officer of the Company. Section 2. Entire Agreement. This Addendum, in addition to the Participation Agreement and the Plan, constitutes the entire agreement between the Parties concerning the subject matter hereof, and supersedes all prior negotiations, undertakings, agreements, and

2188960.v1 arrangements with respect thereto, whether written or oral. IN WITNESS WHEREOF, the Company and the Participant have duly executed this Addendum as of the date set forth below. HERITAGE FINANCIAL CORPORATION By: /S/ JEFFREY J. DEUEL JEFFREY J. DEUEL Its: CEO and President Date: November 8, 2022 PARTICIPANT /S/ TONY CHALFANT TONY CHALFANT

Document

EXHIBIT 31.1

Certification of Principal Executive Officer

I, Jeffrey J. Deuel, certify that:

1.    I have reviewed this quarterly report on Form 10-Q of Heritage Financial Corporation;

2.    Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.    Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of and for the periods presented in this report;

4.    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a.    designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.    designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.    evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d.    disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.    all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

November 8, 2022

/s/ Jeffrey J. Deuel
Jeffrey J. Deuel
Chief Executive Officer<br>Principal Executive Officer

Document

EXHIBIT 31.2

Certification of Principal Financial Officer

I, Donald J. Hinson, certify that:

1.    I have reviewed this quarterly report on Form 10-Q of Heritage Financial Corporation;

2.    Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.    Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of and for the periods presented in this report;

4.    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a.    designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.    designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.    evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d.    disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.    all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

November 8, 2022

/s/ Donald J. Hinson
Donald J. Hinson
Executive Vice President and Chief Financial Officer<br>Principal Financial and Accounting Officer

Document

EXHIBIT 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Heritage Financial Corporation (the “Company”) on Form 10-Q for the quarter ended September 30, 2022 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Jeffrey J. Deuel, Chief Executive Officer, and Donald J. Hinson, Executive Vice President and Chief Financial Officer of the Company, certify in our capacity as officers of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods presented in the financial statements included in such Report.

November 8, 2022 /s/ Jeffrey J. Deuel
Jeffrey J. Deuel
Chief Executive Officer<br>Principal Executive Officer
November 8, 2022 /s/ Donald J. Hinson
Donald J. Hinson
Executive Vice President and Chief Financial Officer<br>Principal Financial and Accounting Officer

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