Equibles

10-Q

HERITAGE FINANCIAL CORP /WA/ (HFWA)

10-Q 2022-08-09 For: 2022-06-30
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 June 30, 2022 or

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

For the transition period from __________ to __________

Commission File Number 000-29480

HERITAGE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Washington 91-1857900
(State or other jurisdiction of<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 August 1, 2022, there were 35,103,929 shares of the registrant's common stock, no par value per share, outstanding.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

FORM 10-Q

June 30, 2022

TABLE OF CONTENTS

Page
GLOSSARY OF ACRONYMS, ABBREVIATIONS AND TERMS 3
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS 3
PART I. FINANCIAL INFORMATION 5
ITEM 1. FINANCIAL STATEMENTS 5
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) AS OF JUNE 30, 2022 AND DECEMBER 31, 2021 5
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 AND 2021 6
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE(LOSS)INCOME(UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 AND 2021 7
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 AND 2021 8
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE SIX MONTHS ENDED JUNE 30, 2022 AND 2021 10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 12
NOTE 1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS 12
NOTE 2. INVESTMENT SECURITIES 13
NOTE 3. LOANS RECEIVABLE 15
NOTE 4. ALLOWANCE FOR CREDIT LOSSES ON LOANS 23
NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS 25
NOTE 6. DERIVATIVE FINANCIAL INSTRUMENTS 25
NOTE 7. STOCKHOLDERS’ EQUITY 26
NOTE 8. FAIR VALUE MEASUREMENTS 27
NOTE 9. CASH RESTRICTION 31
NOTE 10. COMMITMENTS AND CONTINGENCIES 32
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 32
OVERVIEW 32
RESULTS OF OPERATIONS 33
AVERAGE BALANCES, YIELDS AND RATES PAID 34
NET INTEREST INCOME AND MARGIN OVERVIEW 34
PROVISION FOR CREDIT LOSSES OVERVIEW 37
NONINTEREST INCOME OVERVIEW 38
NONINTEREST EXPENSE OVERVIEW 39
INCOME TAX EXPENSE OVERVIEW 40
FINANCIAL CONDITION OVERVIEW 40
INVESTMENT ACTIVITIES OVERVIEW 41
LOAN PORTFOLIO OVERVIEW 42
ALLOWANCE FOR CREDIT LOSSES ON LOANS OVERVIEW 43
DEPOSITS OVERVIEW 44
STOCKHOLDERS' EQUITY OVERVIEW 44
REGULATORY REQUIREMENTS OVERVIEW 44
LIQUIDITY AND CAPITAL RESOURCES 45
CRITICAL ACCOUNTING POLICIES 45
RECONCILIATIONS OF NON-GAAP MEASURES 45
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 46
ITEM 4. CONTROLS AND PROCEDURES 46

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

GLOSSARY OF ACRONYMS, ABBREVIATIONS, AND TERMS

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

2021 Annual Form 10-K Company's Annual Report on Form 10-K for the year ended December 31, 2021
ACL Allowance for credit losses
AOCI Accumulated other comprehensive income (loss), net
ASU Accounting Standards Update
Bank Heritage Bank
CECL Current Expected Credit Loss
CMO Collateralized Mortgage Obligation
Company Heritage Financial Corporation
COVID-19 Pandemic Coronavirus Disease of 2019 pandemic
CRE Commercial real estate
FASB Financial Accounting Standards Board
FDIC Federal Deposit Insurance Corporation
Federal Reserve Board of Governors of the Federal Reserve System
Federal Reserve Bank Federal Reserve Bank of San Francisco
GAAP U.S. Generally Accepted Accounting Principles
LIBOR London Interbank Offering Rate
LIHTC Low-Income Housing Tax Credit
MBS Mortgage-backed security
PPP Paycheck Protection Program
SBA Small Business Administration
SEC Securities and Exchange Commission
SM Special Mention
SS Substandard
TDR Troubled debt restructured

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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

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

•the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our ACL on loans and provision for credit losses on loans that may be affected by deterioration in the housing and CRE markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our ACL on loans no longer being adequate to cover actual losses, and require us to increase our ACL on loans;

•changes in general economic conditions, either nationally or in our market areas, including the risks of inflation;

•changes in the levels of general interest rates, and the relative differences between short-term and long-term interest rates, deposit interest rates, our net interest margin and funding sources;

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

•fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;

•results of examinations of us by the bank regulators, including the possibility that any such regulatory authority may, among other things, initiate an enforcement action against the Company or our bank subsidiary which could require us to increase our ACL on loans, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings;

•legislative or regulatory changes that adversely affect our business, including as a result of the COVID-19 Pandemic;

•implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;

•our ability to control operating costs and expenses;

•increases in premiums for deposit insurance;

•the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

•difficulties in reducing risk associated with our loans;

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

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

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

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

•our ability to implement our growth strategies;

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

•increased competitive pressures among financial service companies;

•changes in consumer spending, borrowing and savings habits;

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

•adverse changes in the securities markets;

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

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

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

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PART I.     FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)

(In thousands, except shares)

June 30,<br>2022 December 31,<br>2021
ASSETS
Cash on hand and in banks $ 93,675 $ 61,377
Interest earning deposits 900,380 1,661,915
Cash and cash equivalents 994,055 1,723,292
Investment securities available for sale, at fair value, net (amortized cost of $1,267,715 and $883,832, respectively) 1,187,588 894,335
Investment securities held to maturity, at amortized cost, net (fair value of $559,312 and $376,331, respectively) 615,653 383,393
Total investment securities 1,803,241 1,277,728
Loans held for sale 1,311 1,476
Loans receivable 3,874,064 3,815,662
Allowance for credit losses on loans (39,696) (42,361)
Loans receivable, net 3,834,368 3,773,301
Premises and equipment, net 77,164 79,370
Federal Home Loan Bank stock, at cost 8,916 7,933
Bank owned life insurance 120,646 120,196
Accrued interest receivable 15,908 14,657
Prepaid expenses and other assets 211,350 183,543
Other intangible assets, net 8,569 9,977
Goodwill 240,939 240,939
Total assets $ 7,316,467 $ 7,432,412
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 6,330,190 $ 6,394,290
Junior subordinated debentures 21,326 21,180
Securities sold under agreement to repurchase 41,827 50,839
Accrued expenses and other liabilities 117,758 111,671
Total liabilities 6,511,101 6,577,980
Commitments and contingencies (Note 12)
Stockholders’ equity:
Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding, respectively — —
Common stock, no par value, 50,000,000 shares authorized; 35,103,929 and 35,105,779 shares issued and outstanding, respectively 550,417 551,798
Retained earnings 316,732 293,238
Accumulated other comprehensive (loss) income, net (61,783) 9,396
Total stockholders’ equity 805,366 854,432
Total liabilities and stockholders’ equity $ 7,316,467 $ 7,432,412

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

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

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

Three Months Ended<br>June 30, Six Months Ended<br>June 30,
2022 2021 2022 2021
INTEREST INCOME:
Interest and fees on loans $ 40,890 $ 50,750 $ 81,915 $ 100,274
Taxable interest on investment securities 7,607 4,050 13,610 7,584
Nontaxable interest on investment securities 893 947 1,753 1,905
Interest on interest earning deposits 2,342 263 3,048 438
Total interest income 51,732 56,010 100,326 110,201
INTEREST EXPENSE:
Deposits 1,413 1,524 2,837 3,252
Junior subordinated debentures 239 186 433 373
Other borrowings 32 35 64 73
Total interest expense 1,684 1,745 3,334 3,698
Net interest income 50,048 54,265 96,992 106,503
Reversal of provision for credit losses (1,204) (13,987) (4,781) (21,186)
Net interest income after reversal of provision for credit losses 51,252 68,252 101,773 127,689
NONINTEREST INCOME:
Service charges and other fees 2,391 2,067 4,687 3,959
Card revenue 2,332 2,338 4,773 4,435
Gain on sale of investment securities, net — — — 29
Gain on sale of loans, net 219 1,003 460 2,373
Interest rate swap fees 26 209 305 361
Bank owned life insurance income 764 717 2,459 1,373
Gain on sale of other assets, net — 724 204 746
Other income 1,284 1,239 2,666 3,272
Total noninterest income 7,016 8,297 15,554 16,548
NONINTEREST EXPENSE:
Compensation and employee benefits 21,778 21,803 43,030 44,004
Occupancy and equipment 4,171 4,091 8,502 8,545
Data processing 4,185 3,998 8,246 7,810
Marketing 344 567 610 1,080
Professional services 529 1,037 1,228 2,307
State/municipal business and use taxes 867 991 1,663 1,963
Federal deposit insurance premium 425 339 1,025 928
Amortization of intangible assets 704 797 1,408 1,594
Other expense 2,704 2,773 5,715 5,407
Total noninterest expense 35,707 36,396 71,427 73,638
Income before income taxes 22,561 40,153 45,900 70,599
Income tax expense 3,977 7,451 7,559 12,553
Net income $ 18,584 $ 32,702 $ 38,341 $ 58,046
Basic earnings per share $ 0.53 $ 0.91 $ 1.09 $ 1.61
Diluted earnings per share $ 0.52 $ 0.90 $ 1.08 $ 1.60
Dividends declared per share $ 0.21 $ 0.20 $ 0.42 $ 0.40
Average number of basic shares outstanding 35,110,334 35,994,740 35,102,572 35,961,032
Average number of diluted shares outstanding 35,409,524 36,289,464 35,412,722 36,268,861

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

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

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

(In thousands)

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

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

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)

(In thousands, except shares and per share amounts)

Three Months Ended June 30, 2022
Number of<br>common<br>shares Common<br>stock Retained<br>earnings AOCI Total<br>stockholders’<br>equity
Balance at March 31, 2022 35,102,372 $ 550,096 $ 305,581 $ (34,228) $ 821,449
Restricted stock units vested 22,737 — — — —
Stock-based compensation expense — 843 — — 843
Common stock repurchased (21,180) (522) — — (522)
Net income — — 18,584 — 18,584
Other comprehensive loss, net of tax — — — (27,555) (27,555)
Cash dividends declared on common stock ($0.21 per share) — — (7,433) — (7,433)
Balance at June 30, 2022 35,103,929 $ 550,417 $ 316,732 $ (61,783) $ 805,366
Six Months Ended June 30, 2022
--- --- --- --- --- --- --- --- --- ---
Number of<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 124,420 — — — —
Stock-based compensation expense — 1,793 — — 1,793
Common stock repurchased (126,270) (3,174) — — (3,174)
Net income — — 38,341 — 38,341
Other comprehensive loss, net of tax — — — (71,179) (71,179)
Cash dividends declared on common stock ($0.42 per share) — — (14,847) — (14,847)
Balance at June 30, 2022 35,103,929 $ 550,417 $ 316,732 $ (61,783) $ 805,366
Three Months Ended June 30, 2021
--- --- --- --- --- --- --- --- --- ---
Number of<br>common<br>shares Common<br>stock Retained<br>earnings AOCI Total<br>stockholders’<br>equity
Balance at March 31, 2021 35,981,317 $ 571,204 $ 242,486 $ 13,461 $ 827,151
Restricted stock units vested 27,800 — — — —
Stock-based compensation expense — 926 — — 926
Common stock repurchased (2,557) (70) — — (70)
Net income — — 32,702 — 32,702
Other comprehensive income, net of tax — — — 2,600 2,600
Cash dividends declared on common stock ($0.20 per share) — — (7,325) — (7,325)
Balance at June 30, 2021 36,006,560 $ 572,060 $ 267,863 $ 16,061 $ 855,984

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Six Months Ended June 30, 2021
Number of<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 120,120 — — — —
Stock-based compensation expense — 1,796 — — 1,796
Common stock repurchased (25,803) (757) — — (757)
Net income — — 58,046 — 58,046
Other comprehensive loss, net of tax — — — (8,957) (8,957)
Cash dividends declared on common stock ($0.40 per share) — — (14,583) — (14,583)
Balance at June 30, 2021 36,006,560 $ 572,060 $ 267,863 $ 16,061 $ 855,984

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

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)

Six Months Ended<br>June 30,
2022 2021
Cash flows from operating activities:
Net income $ 38,341 $ 58,046
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion (1,654) (13,901)
Reversal of provision for credit losses (4,781) (21,186)
Stock-based compensation expense 1,793 1,796
Amortization of intangible assets 1,408 1,594
Origination of mortgage loans held for sale (12,396) (53,807)
Proceeds from sale of mortgage loans held for sale 13,021 58,373
Bank owned life insurance income (2,459) (1,373)
Valuation adjustment on interest rate swaps (64) (254)
Gain on sale of mortgage loans held for sale, net (460) (2,373)
Gain on sale of investment securities available for sale, net — (29)
Gain on sale of assets held for sale (204) (746)
Other 1,360 3,630
Net cash provided by operating activities 33,905 29,770
Cash flows from investing activities:
Loan originations and purchases, net of payments (51,198) 295,618
Maturities and repayments of investment securities available for sale 86,678 126,669
Maturities and repayments of investment securities held to maturity 11,767 —
Purchase of investment securities available for sale (472,361) (388,636)
Purchase of investment securities held to maturity (244,911) —
Purchase of premises and equipment (1,191) (1,748)
Purchases of bank owned life insurance (105) (105)
Purchases of Federal Home Loan Bank stock (985) (1,272)
Proceeds from sales of investment securities available for sale — 1,248
Proceeds from redemption of Federal Home Loan Bank stock 2 —
Proceeds from sales of assets held for sale 1,173 3,730
Proceeds from sales of premises and equipment — 10
Capital contributions to low-income housing tax credit partnerships (978) (12,637)
Cash received from return of New Market Tax Credit equity method investment — 9,642
Net cash (used) provided by investing activities (672,109) 32,519
Cash flows from financing activities:
Net (decrease) increase in deposits (64,100) 463,716
Federal Home Loan Bank advances 50 10
Repayment of Federal Home Loan Bank advances (50) (10)
Common stock cash dividends paid (14,747) (14,383)
Net (decrease) increase in securities sold under agreement to repurchase (9,012) 10,746
Repurchase of common stock (3,174) (757)
Net cash (used) provided by financing activities (91,033) 459,322
Net (decrease) increase in cash and cash equivalents (729,237) 521,611
Cash and cash equivalents at beginning of period 1,723,292 743,322
Cash and cash equivalents at end of period $ 994,055 $ 1,264,933

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Six Months Ended<br>June 30,
2022 2021
Supplemental disclosures of cash flow information:
Cash paid for interest $ 3,188 $ 3,571
Cash paid for income taxes, net of refunds 167 7,967
Supplemental non-cash disclosures of cash flow information:
Investment in LIHTC partnership and related funding commitment 11,284 —
Right of use assets obtained in exchange for new operating lease liabilities 2,222 8,393
Transfer of bank owned life insurance to prepaid expenses and other<br><br>assets due to death benefit accrued 2,114 —
Transfers of properties classified as held for sale to prepaid expenses and other assets from premises and equipment, net 730 1,685
Loans received from return of New Market Tax Credit equity method investment — 15,596

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

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

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

(a) Description of Business

The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, the Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 50 branch offices located throughout Washington State, the greater Portland, Oregon area, and Eugene, Oregon. The Bank’s business consists primarily of commercial lending and deposit relationships with small and medium-sized businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas. The Bank's deposits are insured by the FDIC.

(b) Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. It is recommended these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the 2021 Annual Form 10-K. In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022.

To prepare unaudited Condensed Consolidated Financial Statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided. Management believes the judgments, estimates and assumptions used in the preparation of the unaudited Condensed Consolidated Financial Statements are appropriate based on the facts and circumstances at the time. Actual results, however, could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to management's estimate of the ACL on investment securities, management's estimate of the ACL on loans, management's estimate of the ACL on unfunded commitments, management's evaluation of goodwill impairment and management's estimate of the fair value of financial instruments.

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

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

(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 six months ended June 30, 2022.

(d) Recently Issued or Adopted Accounting Pronouncements

FASB ASU 2020-04, Reference Rate Reform (Topic 848), as amended by ASU 2021-01, was issued in March 2020 and provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments in this ASU are effective for all entities as of March 12, 2020 through December 31, 2022. The amendments are elective, apply to all entities, and provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The Bank’s interest rate swap-related transactions are the majority of the Company's LIBOR exposure. Effective January 25, 2021, the Company adhered to the Interbank Offered Rate Fallbacks Protocol as published by the International Swaps and Derivatives Association, Inc. and recommended by the Alternative Reference Rates Committee. Additionally, effective January 1, 2022, the Bank is no longer initiating or renewing loans using LIBOR as an index. The Company does not expect this ASU to have a material impact on its business operations and the Consolidated Financial Statements.

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

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

(2)Investment Securities

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

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

(a) Investment Securities by Classification, Type and Maturity

The following tables present the amortized cost and fair value of investment securities at the dates indicated and the corresponding amounts of gross unrealized gains and losses, including the corresponding amounts of gross unrealized gains and losses on investment securities available for sale recognized in AOCI:

June 30, 2022
Amortized<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 $ — $ (3,244) $ 65,668
Municipal securities 213,402 977 (14,369) 200,010
Residential CMO and MBS 433,903 70 (35,817) 398,156
Commercial CMO and MBS 520,772 466 (27,618) 493,620
Corporate obligations 6,003 — (25) 5,978
Other asset-backed securities 24,723 6 (573) 24,156
Total $ 1,267,715 $ 1,519 $ (81,646) $ 1,187,588
Investment securities held to maturity:
U.S. government and agency securities $ 150,960 $ — $ (23,416) $ 127,544
Residential CMO and MBS 159,007 257 (5,774) 153,490
Commercial CMO and MBS 305,686 — (27,408) 278,278
Total $ 615,653 $ 257 $ (56,598) $ 559,312 December 31, 2021
--- --- --- --- --- --- --- --- ---
Amortized<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 June 30, 2022, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

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

(1) Mortgage-backed securities, which have prepayment provisions, are not assigned to maturity categories due to fluctuations in their payment speed.

There were no holdings of investment securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity at June 30, 2022 and December 31, 2021.

(b) Unrealized Losses on Investment Securities Available for Sale

The following tables show the gross unrealized losses and fair value of the Company’s investment securities available for sale for which an ACL on investment securities available for sale has not been recorded, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position at the dates indicated:

June 30, 2022
Less than 12 Months 12 Months or Longer Total
Fair<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 $ 64,200 $ (2,995) $ 1,468 $ (249) $ 65,668 $ (3,244)
Municipal securities 106,205 (11,287) 15,712 (3,082) 121,917 (14,369)
Residential CMO and MBS 352,074 (32,446) 31,008 (3,371) 383,082 (35,817)
Commercial CMO and MBS 406,835 (27,145) 8,711 (473) 415,546 (27,618)
Corporate obligations 5,978 (25) — — 5,978 (25)
Other asset-backed securities 19,054 (552) 921 (21) 19,975 (573)
Total $ 954,346 $ (74,450) $ 57,820 $ (7,196) $ 1,012,166 $ (81,646) December 31, 2021
--- --- --- --- --- --- --- --- --- --- --- --- ---
Less than 12 Months 12 Months or Longer Total
Fair<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 June 30, 2022 and December 31, 2021 and determined that any declines in fair value were attributable to changes in interest rates relative to where these investments fall within the yield curve and individual characteristics. Management monitors published credit ratings for adverse changes for all

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rated investment securities and none of these securities had a below investment grade credit rating as of both June 30, 2022 and December 31, 2021. In addition, the Company does not intend to sell these securities nor does the Company consider it more likely than not that it will be required to sell these securities before the recovery of the amortized cost basis, which may be upon maturity. Therefore, no ACL on investment securities available for sale was recorded as of June 30, 2022 and December 31, 2021.

The Company also evaluated investment securities held to maturity for current expected credit losses as of June 30, 2022 and December 31, 2021. There were no investment securities held to maturity classified as nonaccrual or past due as of June 30, 2022 and December 31, 2021 and all were issued by the U.S. government and its agencies and either explicitly or implicitly guaranteed by the U.S. government, highly rated by major credit rating agencies and had a long history of no credit losses. Accordingly, the Company did not measure expected credit losses on investment securities held to maturity since the historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Therefore, no ACL on investment securities held to maturity was recorded as of June 30, 2022 and December 31, 2021.

(d) Realized Gains and Losses

The following table presents the gross realized gains and losses on the sale of investment securities available for sale during the following periods:

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

(e) Pledged Securities

The following table summarizes the amortized cost and fair value of investment securities that are pledged as collateral for the following obligations at the dates indicated:

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

(f) Accrued Interest Receivable

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

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

(3)Loans Receivable

The Bank originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions. Accrued interest receivable was excluded from disclosures presenting the Bank's amortized cost of loans receivable as it was deemed insignificant.

(a) Loan Origination/Risk Management

The Bank categorizes the individual loans in the total loan portfolio into four segments: commercial business; residential real estate; real estate construction and land development; and consumer. Within these segments are classes of loans for which management monitors and assesses credit risk in the loan portfolios. A detailed description of the portfolio segments and classes is contained in the 2021 Annual Form 10-K.

The Bank has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and criticized loans. The Bank also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management.

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The loan review process complements and reinforces the risk identification and assessment decisions made by loan officers and credit personnel.

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

June 30,<br>2022 December 31,<br>2021
(In thousands)
Commercial business:
Commercial and industrial $ 698,828 $ 621,567
SBA PPP 11,334 145,840
Owner-occupied CRE 950,699 931,150
Non-owner occupied CRE 1,515,796 1,493,099
Total commercial business 3,176,657 3,191,656
Residential real estate 265,382 164,582
Real estate construction and land development:
Residential 90,546 85,547
Commercial and multifamily 128,060 141,336
Total real estate construction and land development 218,606 226,883
Consumer 213,419 232,541
Loans receivable 3,874,064 3,815,662
Allowance for credit losses on loans (39,696) (42,361)
Loans receivable, net $ 3,834,368 $ 3,773,301
Balances included in the amortized cost of loans receivable:
Unamortized net discount on acquired loans $ 3,084 $ 3,938
Unamortized net deferred fee $ 4,947 $ 7,954

(b) Concentrations of Credit

Most of the Bank’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State, Multnomah County and Washington County in Oregon, as well as other contiguous markets and represents a geographic concentration. Additionally, the Bank's loan portfolio is concentrated in commercial loans, including commercial business loans and commercial and multifamily real estate construction and land development loans. Commercial loans are generally considered as having more inherent risk of default than residential real estate loans or other consumer loans. Also, the commercial loan balance per borrower is typically larger than that for residential real estate loans and consumer loans, implying higher potential losses on an individual loan basis.

(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

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likelihood of loss for SM graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration. Loans with a SS grade are generally accrual loans at risk of being classified as nonaccrual loans and includes all of our loans classified as nonaccrual. For Doubtful and Loss graded loans, the Bank is almost certain of the losses and the outstanding principal balances are generally charged off to the realizable value.

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

June 30, 2022
Term Loans<br>Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (2) Loans Receivable
2022 2021(1) 2020 2019 2018 Prior
(In thousands)
Commercial business:
Commercial and industrial
Pass $ 96,128 $ 101,302 $ 93,475 $ 73,299 $ 38,742 $ 90,980 $ 168,030 $ 45 $ 662,001
SM 234 253 729 4,842 8,764 2,981 1,619 — 19,422
SS 882 169 696 4,581 1,163 6,866 2,171 877 17,405
Total 97,244 101,724 94,900 82,722 48,669 100,827 171,820 922 698,828
SBA PPP
Pass — 11,175 159 — — — — — 11,334
Owner-occupied CRE
Pass 78,387 171,470 91,633 180,596 73,797 316,424 — — 912,307
SM — — — 1,698 2,573 12,042 — — 16,313
SS — 261 679 — 3,755 17,384 — — 22,079
Total 78,387 171,731 92,312 182,294 80,125 345,850 — — 950,699
Non-owner occupied CRE
Pass 125,451 185,105 166,150 240,396 139,626 578,421 — — 1,435,149
SM — 8,435 — 3,652 — 16,655 — — 28,742
SS — — — — 3,626 48,279 — — 51,905
Total 125,451 193,540 166,150 244,048 143,252 643,355 — — 1,515,796
Total commercial business
Pass 299,966 469,052 351,417 494,291 252,165 985,825 168,030 45 3,020,791
SM 234 8,688 729 10,192 11,337 31,678 1,619 — 64,477
SS 882 430 1,375 4,581 8,544 72,529 2,171 877 91,389
Total 301,082 478,170 353,521 509,064 272,046 1,090,032 171,820 922 3,176,657
Residential real estate
Pass(1) 60,870 140,448 24,564 17,699 4,716 16,907 — — 265,204
SS — — — — — 178 — — 178
Total 60,870 140,448 24,564 17,699 4,716 17,085 — — 265,382
Real estate construction and land development:
Residential
Pass 21,664 43,877 10,330 12,002 1,005 1,668 — — 90,546
Commercial and multifamily
Pass 8,832 75,096 23,991 6,952 3,186 2,013 — — 120,070
SM — — 1,871 5,714 — — — — 7,585
SS — — — — — 405 — — 405
Total 8,832 75,096 25,862 12,666 3,186 2,418 — — 128,060
Total real estate construction and land development
Pass 30,496 118,973 34,321 18,954 4,191 3,681 — — 210,616
SM — — 1,871 5,714 — — — — 7,585
SS — — — — — 405 — — 405
Total 30,496 118,973 36,192 24,668 4,191 4,086 — — 218,606

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June 30, 2022
Term Loans<br>Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (2) Loans Receivable
2022 2021(1) 2020 2019 2018 Prior
Consumer
Pass 2,475 770 12,451 35,722 21,337 19,062 118,826 329 210,972
SS — — 169 558 366 1,346 8 — 2,447
Total 2,475 770 12,620 36,280 21,703 20,408 118,834 329 213,419
Loans receivable
Pass 393,807 729,243 422,753 566,666 282,409 1,025,475 286,856 374 3,707,583
SM 234 8,688 2,600 15,906 11,337 31,678 1,619 — 72,062
SS 882 430 1,544 5,139 8,910 74,458 2,179 877 94,419
Total $ 394,923 $ 738,361 $ 426,897 $ 587,711 $ 302,656 $ 1,131,611 $ 290,654 $ 1,251 $ 3,874,064

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

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

December 31, 2021
Term Loans<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

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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)
Real estate construction and land development:
Residential
Pass 44,892 23,728 12,266 2,921 389 1,351 — — 85,547
Commercial and multifamily
Pass 56,448 41,616 34,117 5,794 710 1,379 — — 140,064
SM — — 68 — — 213 — — 281
SS — 571 — — — 420 — — 991
Total 56,448 42,187 34,185 5,794 710 2,012 — — 141,336
Total real estate construction and land development
Pass 101,340 65,344 46,383 8,715 1,099 2,730 — — 225,611
SM — — 68 — — 213 — — 281
SS — 571 — — — 420 — — 991
Total 101,340 65,915 46,451 8,715 1,099 3,363 — — 226,883
Consumer
Pass 1,286 15,737 46,041 29,819 15,068 13,026 108,492 120 229,589
SS — 181 657 476 542 1,043 36 17 2,952
Total 1,286 15,918 46,698 30,295 15,610 14,069 108,528 137 232,541
Loans receivable
Pass 793,530 491,210 643,619 321,717 261,801 882,945 236,143 1,227 3,632,192
SM 590 884 14,819 8,946 21,642 21,738 2,048 353 71,020
SS 1,443 3,371 6,569 10,451 6,082 79,511 4,438 585 112,450
Total $ 795,563 $ 495,465 $ 665,007 $ 341,114 $ 289,525 $ 984,194 $ 242,629 $ 2,165 $ 3,815,662

(1) Represents the loans receivable balance at December 31, 2021 which was converted from a revolving loan to an amortizing loan during the year ended December 31, 2021.

(d) Nonaccrual Loans

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

June 30, 2022
Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual
(In thousands)
Commercial business:
Commercial and industrial $ 5,604 $ 569 $ 6,173
Owner-occupied CRE — 4,302 4,302
Total $ 5,604 $ 4,871 $ 10,475 December 31, 2021
--- --- --- --- --- --- ---
Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual
(In thousands)
Commercial business:
Commercial and industrial $ 6,454 $ 3,827 $ 10,281
Owner-occupied CRE 3,036 5,138 8,174
Non-owner occupied CRE 1,273 3,379 4,652
Total commercial business 10,763 12,344 23,107
Residential real estate — 47 47

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December 31, 2021
Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual
(In thousands)
Real estate construction and land development:
Commercial and multifamily — 571 571
Consumer — 29 29
Total $ 10,763 $ 12,991 $ 23,754

The following table presents the reversal of interest income on loans due to the write-off of accrued interest receivable upon the initial classification of loans as nonaccrual loans and the interest income recognized due to payment in full or sale of previously classified nonaccrual loans during the following periods:

Three Months Ended<br>June 30, 2022 Three Months Ended<br>June 30, 2021
Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized
(In thousands)
Commercial business:
Commercial and industrial $ (12) $ 90 $ (5) $ 1,981
Owner-occupied CRE — — — 3
Total $ (12) $ 90 $ (5) $ 1,984 Six Months Ended<br>June 30, 2022 Six Months Ended<br>June 30, 2021
--- --- --- --- --- --- --- --- ---
Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized
(in thousands)
Commercial business:
Commercial and industrial $ (14) $ 229 $ (10) $ 2,044
Owner-occupied CRE — 53 — 117
Non-owner occupied CRE — 774 — 313
Total commercial business (14) 1,056 (10) 2,474
Residential real estate — 19 — —
Real estate construction and land development:
Residential — — — 73
Consumer — 68 — —
Total $ (14) $ 1,143 $ (10) $ 2,547

For the three and six months ended June 30, 2022 and 2021, no interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the tables above due to payment in full or sale.

(e) Past due loans

The Bank performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due. The amortized cost of past due loans as of June 30, 2022 and December 31, 2021 were as follows:

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

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June 30, 2022
30-89 Days 90 Days or<br>Greater Total Past <br>Due Current Loans Receivable
(In thousands)
Total commercial business 1,315 7,379 8,694 3,167,963 3,176,657
Residential real estate — — — 265,382 265,382
Real estate construction and land development:
Residential — — — 90,546 90,546
Commercial and multifamily — — — 128,060 128,060
Total real estate construction and land development — — — 218,606 218,606
Consumer 651 199 850 212,569 213,419
Total $ 1,966 $ 7,578 $ 9,544 $ 3,864,520 $ 3,874,064 December 31, 2021
--- --- --- --- --- --- --- --- --- --- ---
30-89 Days 90 Days or<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 $2.0 million and $293,000 as of June 30, 2022 and December 31, 2021, respectively.

(f) Collateral-dependent Loans

The type of collateral securing loans individually evaluated for credit losses and for which the repayment was expected to be provided substantially through the operation or sale of the collateral as of June 30, 2022 and December 31, 2021 was as follows, with balances representing the amortized cost of the loan classified by the primary collateral category of each loan if multiple collateral sources secure the loan:

June 30, 2022
CRE Farmland Residential Real Estate Total
(In thousands)
Commercial business:
Commercial and industrial $ 1,239 $ 2,492 $ 1,316 $ 5,047
Owner-occupied CRE 189 — — 189
Total $ 1,428 $ 2,492 $ 1,316 $ 5,236 December 31, 2021
--- --- --- --- --- ---
CRE Farmland Residential Real Estate Other Total
(In thousands)
Commercial business:

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December 31, 2021
CRE Farmland Residential Real Estate Other Total
(In thousands)
Commercial and industrial $ 1,499 $ 4,362 $ 1,036 $ 245 $ 7,142
Owner-occupied CRE 3,035 — — — 3,035
Non-owner occupied CRE 1,273 — — — 1,273
Total commercial business 5,807 4,362 1,036 245 11,450
Real estate construction and land development:
Commercial and multifamily 571 — — — 571
Total $ 6,378 $ 4,362 $ 1,036 $ 245 $ 12,021

There have been no significant changes to the collateral securing loans individually evaluated for credit losses and for which repayment was expected to be provided substantially through the operation or sale of the collateral during the six months ended June 30, 2022, except changes due to additions or removals of loans from this classification.

(g) Troubled Debt Restructured Loans

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

Three Months Ended June 30,
2022 2021
Number of<br>Contracts Amortized Cost (1) (2) Number of<br>Contracts Amortized Cost (1) (2)
(Dollars in thousands)
Commercial business:
Commercial and industrial 3 $ 1,727 18 $ 5,673
Owner-occupied CRE — — 1 2,200
Non-owner occupied CRE — — 1 251
Total commercial business 3 1,727 20 8,124
Real estate construction and land development:
Commercial and multifamily — — 1 443
Consumer 3 44 6 146
Total 6 $ 1,771 27 $ 8,713 Six Months Ended June 30,
--- --- --- --- --- --- ---
2022 2021
Number of<br>Contracts Amortized Cost (1) (2) Number of<br>Contracts Amortized Cost (1) (2)
(Dollars in thousands)
Commercial business:
Commercial and industrial 4 $ 2,610 31 $ 8,713
Owner-occupied CRE — — 2 5,857
Non-owner occupied CRE — — 2 2,222
Total commercial business 4 2,610 35 16,792
Residential real estate — — 1 181
Real estate construction and land development:
Commercial and multifamily — — 1 443
Consumer 8 95 21 511
Total 12 $ 2,705 58 $ 17,927

(1) Number of contracts and amortized cost represent loans which have balances as of period end, net of subsequent payments after modifications. Certain TDR loans may have been paid-down or charged-off during the six months ended June 30, 2022 and 2021.

(2) As the Bank did not forgive any principal or interest balance as part of the loan modifications, the Bank’s amortized cost in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-modification).

The Bank had an ACL on loans of $4,000 and $1.7 million at June 30, 2022 and June 30, 2021, respectively, related to these TDR loans which were restructured during the six months ended June 30, 2022 and June 30, 2021, respectively.

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

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

Three Months Ended June 30,
2022 2021
Number of<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 $ 46 Six Months Ended June 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 — $ — 2 $ 789
Owner-occupied CRE 1 189 — —

(1) Number of contracts and amortized cost represent TDR loans which have balances as of period end, net of subsequent payments after modifications. Certain TDR loans may have been paid-down or charged-off during the six months ended June 30, 2022 and 2021.

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

(h) Accrued interest receivable on loans receivable

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

(i) Foreclosure proceedings in process

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

(4)Allowance for Credit Losses on Loans

The baseline loss rates used to calculate the ACL on loans at June 30, 2022 utilized the Bank's average quarterly historical loss information from December 31, 2012 through the balance sheet date. There were no changes to this assumption during the six months ended June 30, 2022. The Bank believes the historic loss rates are viable inputs to the current CECL model as the Bank's lending practice and business has remained relatively stable throughout the periods. While the Bank's assets have grown, the credit culture has stayed relatively consistent.

Prepayments included in the CECL model at June 30, 2022 were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of future prepayment activity. There were no changes to this assumption during the six months ended June 30, 2022.

The reasonable and supportable period and subsequent reversion period used in the CECL model was five quarters and two quarters, respectively, at December 31, 2021. There were no changes to these assumptions during the six months ended June 30, 2022. Management believes forecasts beyond this seven quarter time period tend to diverge in economic assumptions and may be less comparable to actual future events. As the length of the reasonable and supportable period increases, the degree of judgment involved in estimating the allowance increases.

During the six months ended June 30, 2022, the ACL on loans decreased $2.7 million, or 6.3%, due primarily to a reversal of provision for credit losses on loans of $3.2 million driven by a $2.9 million reduction in the ACL on loans individually evaluated for losses and their related ACL as well as changes in the loan mix and continued improvement in forecasted economic indicators used to calculate credit losses. The ACL on loans at June 30, 2022 and December 31, 2021 did not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.

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

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

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

Three Months Ended June 30, 2022
Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 15,265 $ (117) $ 149 $ (1,264) $ 14,033
Owner-occupied CRE 7,085 — — 1,077 8,162
Non-owner occupied CRE 9,582 — — (70) 9,512
Total commercial business 31,932 (117) 149 (257) 31,707
Residential real estate 1,803 — — 334 2,137
Real estate construction and land development:
Residential 1,124 — 6 (49) 1,081
Commercial and multifamily 3,175 — 53 (1,025) 2,203
Total real estate construction and land development 4,299 — 59 (1,074) 3,284
Consumer 2,299 (132) 53 348 2,568
Total $ 40,333 $ (249) $ 261 $ (649) $ 39,696 Six Months Ended June 30, 2022
--- --- --- --- --- --- --- --- --- --- ---
Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 17,777 $ (280) $ 421 $ (3,885) $ 14,033
Owner-occupied CRE 6,411 (36) — 1,787 8,162
Non-owner occupied CRE 8,861 — — 651 9,512
Total commercial business 33,049 (316) 421 (1,447) 31,707
Residential real estate 1,409 (30) 3 755 2,137
Real estate construction and land development:
Residential 1,304 — 14 (237) 1,081
Commercial and multifamily 3,972 — 53 (1,822) 2,203
Total real estate construction and land development 5,276 — 67 (2,059) 3,284
Consumer 2,627 (258) 619 (420) 2,568
Total $ 42,361 $ (604) $ 1,110 $ (3,171) $ 39,696

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Three Months Ended June 30, 2021
Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 21,770 $ (13) $ 132 $ (4,404) $ 17,485
Owner-occupied CRE 10,464 — 11 (1,913) 8,562
Non-owner occupied CRE 12,970 — — (2,340) 10,630
Total commercial business 45,204 (13) 143 (8,657) 36,677
Residential real estate 1,402 — — (249) 1,153
Real estate construction and land development:
Residential 2,048 — 4 (416) 1,636
Commercial and multifamily 11,223 — — (2,388) 8,835
Total real estate construction and land development 13,271 — 4 (2,804) 10,471
Consumer 4,348 (120) 144 (1,111) 3,261
Total $ 64,225 $ (133) $ 291 $ (12,821) $ 51,562 Six Months Ended June 30, 2021
--- --- --- --- --- --- --- --- --- --- ---
Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 30,010 $ (14) $ 337 $ (12,848) $ 17,485
Owner-occupied CRE 9,486 — 13 (937) 8,562
Non-owner occupied CRE 10,112 — — 518 10,630
Total commercial business 49,608 (14) 350 (13,267) 36,677
Residential real estate 1,591 — — (438) 1,153
Real estate construction and land development:
Residential 1,951 — 20 (335) 1,636
Commercial and multifamily 11,141 (1) — (2,305) 8,835
Total real estate construction and land development 13,092 (1) 20 (2,640) 10,471
Consumer 5,894 (305) 283 (2,611) 3,261
Total $ 70,185 $ (320) $ 653 $ (18,956) $ 51,562

(5)Goodwill and Other Intangible Assets

(a) Goodwill

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

(b) Other Intangible Assets

Other intangible assets represent core deposit intangible acquired in business combinations with estimated useful lives of ten years. There were no additions to other intangible assets during the three and six months ended June 30, 2022 and 2021.

(6)Derivative Financial Instruments

The Company utilizes interest rate swap derivative contracts to facilitate the needs of its commercial customers whereby it enters into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. The transaction allows the Company’s customer to effectively convert a variable rate loan to a

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fixed rate and the Company recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third-party. These interest rate swaps are not designated as hedging instruments.

The Company is exposed to interest rate risk as part of the transaction. However, the Company acts as an intermediary for its customer therefore changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company’s results of operations.

Fee income related to interest rate swap derivative contract transactions is recorded in Interest rate swap fees on the unaudited Condensed Consolidated Statements of Income. The fair value of derivative positions outstanding is included in Prepaid expenses and other assets and Accrued expenses and other liabilities in the unaudited Condensed Consolidated Statements of Financial Condition. The gains and losses due to changes in fair value and all cash flows are included in Other income in the unaudited Condensed Consolidated Statements of Income, but typically net to zero based on the identical back-to-back interest rate swap derivative contracts unless a credit valuation adjustment is recorded to appropriately reflect nonperformance risk in the fair value measurement. Various factors impact changes in the credit valuation adjustments over time, including changes in the risk ratings of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments.

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

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

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

The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements. Credit risk for derivatives with the customer is controlled through the credit approval process, amount limits, and monitoring procedures and is concentrated within our primary market areas. Credit risk for derivatives with third-parties is concentrated among four well-known broker dealers.

(7)Stockholders’ Equity

(a) Earnings Per Common Share

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

Three Months Ended <br>June 30, Six Months Ended<br>June 30,
2022 2021 2022 2021
(In thousands, except shares)
Net income $ 18,584 $ 32,702 $ 38,341 $ 58,046
Basic:
Weighted average common shares outstanding 35,110,334 35,994,740 35,102,572 35,961,032
Diluted:
Basic weighted average common shares outstanding 35,110,334 35,994,740 35,102,572 35,961,032
Effect of potentially dilutive common shares (1) 299,190 294,724 310,150 307,829
Total diluted weighted average common shares outstanding 35,409,524 36,289,464 35,412,722 36,268,861
Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (2) 16,978 7,065 14,334 4,766

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

(2) Anti-dilution occurs when the unrecognized compensation cost per share of a restricted stock unit exceeds the market price of the Company’s stock.

(b) Dividends

The timing and amount of cash dividends paid on the Company's common stock depends on the Company’s earnings, capital requirements, financial condition and other relevant factors. Dividends on common stock from the Company depend

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substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income.

The following table summarizes the dividend activity during the six months ended June 30, 2022 and the calendar year 2021:

Declared Cash Dividend per Share Record Date Paid Date
January 27, 2021 $0.20 February 10, 2021 February 24, 2021
April 21, 2021 $0.20 May 5, 2021 May 19, 2021
July 21, 2021 $0.20 August 4, 2021 August 18, 2021
October 20, 2021 $0.21 November 3, 2021 November 17, 2021
January 26, 2022 $0.21 February 9, 2022 February 23, 2022
April 20, 2022 $0.21 May 4, 2022 May 18, 2022

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

(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 plan for the periods indicated:

Three Months Ended <br>June 30, Six Months Ended<br>June 30,
2022 2021 2022 2021 Plan Total(1)
Repurchased shares 19,531 — 100,090 — 1,160,840
Stock repurchase average share price $ 24.63 $ — $ 25.07 $ — $ 23.94

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

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

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

(8)Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual funds that allow the Company to sell its ownership interest back to the fund at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities, or funds.

Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or valuations using methodologies with observable inputs.

Level 3: Valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models, discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

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(a) Recurring and Nonrecurring Basis

The Company used the following methods and significant assumptions to measure the fair value of certain assets on a recurring and nonrecurring basis:

Investment Securities:

The fair values of all investment securities are based upon the assumptions that market participants would use in pricing the security. If available, fair values of investment securities are determined by quoted market prices (Level 1). For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using observable and unobservable inputs such as discounted cash flows or other market indicators (Level 3). Investment security valuations are obtained from third-party pricing services.

Collateral-Dependent Loans:

Collateral-dependent loans are identified for the calculation of the ACL on loans. The fair value used to measure credit loss for this type of loan is commonly based on recent real estate appraisals which are generally obtained at least every 18 months or earlier if there are changes to risk characteristics of the underlying loan. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. The Bank also incorporates an estimate of cost to sell the collateral when the sale is probable. Such adjustments may be significant and result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value based on the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the customer and customer’s business (Level 3). Individually evaluated loans are analyzed for credit loss on a quarterly basis and the ACL on loans is adjusted as required based on the results.

Appraisals on collateral-dependent loans are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by the Bank. Once received, the Bank's internal appraisal department reviews and approves the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

Derivative Financial Instruments:

The Bank obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of the measurement date (Level 2), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3). Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as borrower risk ratings, to evaluate the likelihood of default by itself and its counterparties. As of June 30, 2022 and December 31, 2021, the Bank assessed the significance of the impact of the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined the credit valuation adjustment was not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy.

Branches held for sale:

Branches held for sale are recorded at fair value less costs to sell when transferred from premises and equipment, net to prepaid expenses and other assets on the unaudited Condensed Consolidated Statements of Financial Condition with any valuation adjustment recorded within other noninterest expense on the unaudited Condensed Consolidated Statements of Income. The fair value of branches held for sale is determined based on a real estate appraisal or broker price opinion. Adjustments are routinely made in the appraisal and broker price opinion process by independent appraisers and commercial real estate brokers, respectively, to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in Level 3 classification of the inputs for determining fair value. Additionally, the fair value of branches held for sale can be adjusted based on executed agreements of sale to be completed at a future date.

Recurring Basis

The following tables summarize the balances of assets and liabilities measured at fair value on a recurring basis at the dates indicated:

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

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June 30, 2022
Total Level 1 Level 2 Level 3
(In thousands)
Commercial CMO and MBS 493,620 — 493,620 —
Corporate obligations 5,978 — 5,978 —
Other asset-backed securities 24,156 — 24,156 —
Total investment securities available for sale 1,187,588 19,939 1,167,649 —
Equity security 186 186 — —
Derivative assets - interest rate swaps 19,842 — 19,842 —
Liabilities
Derivative liabilities - interest rate swaps $ 19,842 $ — $ 19,842 $ — December 31, 2021
--- --- --- --- --- --- --- --- ---
Total Level 1 Level 2 Level 3
(In thousands)
Assets
Investment securities available for sale:
U.S. government and agency securities $ 21,373 $ — $ 21,373 $ —
Municipal securities 221,212 — 221,212 —
Residential CMO and MBS 306,884 — 306,884 —
Commercial CMO and MBS 315,861 — 315,861 —
Corporate obligations 2,014 — 2,014 —
Other asset-backed securities 26,991 — 26,991 —
Total investment securities available for sale 894,335 — 894,335 —
Equity security 240 240 — —
Derivative assets - interest rate swaps 15,219 — 15,219 —
Liabilities
Derivative liabilities - interest rate swaps $ 15,286 $ — $ 15,286 $ —

Nonrecurring Basis

The Company may be required to measure certain financial assets and liabilities at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The following tables represent assets measured at fair value on a nonrecurring basis at the dates indicated:

Fair Value at June 30, 2022
Basis(1) Total Level 1 Level 2 Level 3
(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial $ 1,054 $ 969 $ — $ — $ 969
Owner-occupied CRE 613 186 — — 186
Total assets measured at fair value on a nonrecurring basis $ 1,667 $ 1,155 $ — $ — $ 1,155

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

Fair Value at December 31, 2021
Basis(1) Total Level 1 Level 2 Level 3
(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial $ 1,911 $ 1,049 $ — $ — $ 1,049
Owner-occupied CRE 613 189 — — 189
Total commercial business 2,524 1,238 — — 1,238

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Real estate construction and land development:
Commercial and multifamily 991 $ 534 — — 534
Total 3,515 1,772 — — 1,772
Prepaid expenses and other assets:
Branch held for sale (2) 698 698 — — 698
Total assets measured at fair value on a nonrecurring basis $ 4,213 $ 2,470 $ — $ — $ 2,470

(1) Basis represents the outstanding principal balance of collateral-dependent loans and the carrying value of the branch held for sale.

(2) In December 2021, one branch was written down to its net realizable value concurrent with the signing of an agreement for sale at a future date.

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

Three Months Ended <br>June 30, Six Months Ended<br>June 30,
2022 2021 2022 2021
(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial $ 35 $ 6 $ 23 $ (28)
Owner-occupied CRE (3) (76) (3) (76)
Total commercial business 32 (70) 20 (104)
Real estate construction and land development:
Commercial and multifamily — (23) — (38)
Net loss from nonrecurring fair value adjustments $ 32 $ (93) $ 20 $ (142)

The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at the dates indicated:

June 30, 2022
Fair<br>Value Valuation<br>Technique(s) Unobservable Input(s) Range of Inputs; Weighted<br>Average
(Dollars in thousands)
Collateral-dependent loans $ 1,155 Market approach Adjustment for differences between the comparable sales N/A(1)

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

December 31, 2021
Fair<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 Not applicable

(b) Fair Value of Financial Instruments

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

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

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estimated fair values at the dates indicated:

June 30, 2022
Carrying<br>Value Fair<br>Value Fair Value Measurements Using:
Level 1 Level 2 Level 3
(In thousands)
Financial Assets:
Cash and cash equivalents $ 994,055 $ 994,055 $ 994,055 $ — $ —
Investment securities available for sale 1,187,588 1,187,588 19,939 1,167,649 —
Investment securities held to maturity 615,653 559,312 — 559,312 —
Loans held for sale 1,311 1,353 — 1,353 —
Loans receivable, net 3,834,368 3,760,294 — — 3,760,294
Accrued interest receivable 15,908 15,908 272 6,185 9,451
Derivative assets - interest rate swaps 19,842 19,842 — 19,842 —
Equity security 186 186 186 — —
Financial Liabilities:
Non-maturity deposits $ 6,019,421 $ 6,019,421 $ 6,019,421 $ — $ —
Certificates of deposit 310,769 311,481 — 311,481 —
Securities sold under agreement to repurchase 41,827 41,827 41,827 — —
Junior subordinated debentures 21,326 19,250 — — 19,250
Accrued interest payable 83 83 31 16 36
Derivative liabilities - interest rate swaps 19,842 19,842 — 19,842 — December 31, 2021
--- --- --- --- --- --- --- --- --- --- --- ---
Carrying<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 $ 6,038,498 $ 6,038,498 $ 6,038,498 $ — $ —
Certificates of deposit 342,839 344,025 — 344,025 —
Securities sold under agreement to repurchase 50,839 50,839 50,839 — —
Junior subordinated debentures 21,180 18,750 — — 18,750
Accrued interest payable 73 73 33 19 21
Derivative liabilities - interest rate swaps 15,286 15,286 — 15,286 —

(9)Cash Restriction

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

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(10)Commitments and Contingencies

In the ordinary course of business, the Bank may enter into various types of transactions that include commitments to extend credit that are not included in its unaudited Condensed Consolidated Financial Statements. The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The majority of the commitments presented below are variable rate. Loan commitments can be either revolving or non-revolving. The Bank’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.

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

June 30,<br>2022 December 31, 2021
(In thousands)
Commercial business:
Commercial and industrial $ 553,134 $ 570,156
Owner-occupied CRE 3,612 2,252
Non-owner occupied CRE 13,310 7,487
Total commercial business 570,056 579,895
Real estate construction and land development:
Residential 52,374 51,838
Commercial and multifamily 217,177 209,217
Total real estate construction and land development 269,551 261,055
Consumer 307,906 285,010
Total outstanding commitments $ 1,147,513 $ 1,125,960

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

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

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

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

Overview

Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of our wholly-owned financial institution subsidiary, Heritage Bank. We provide financial services to our local communities with an ongoing strategic focus on our commercial banking relationships, market expansion and asset quality. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to the Bank’s operations.

Our business consists primarily of commercial lending and deposit relationships with small to medium sized businesses and their owners in our market areas and attracting deposits from the general public. We also make real estate construction and land development loans and consumer loans. We additionally originate for sale or for investment purposes residential real estate loans on single family properties located primarily in our markets. During the three months ended March 31, 2020, we ceased indirect auto loan originations, included in our consumer loan portfolio.

Our core profitability depends primarily on our net interest income. Net interest income is the difference between interest income, which is the income that we earn on interest earning assets, comprised primarily of loans and investment securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits.

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Management manages the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is significantly affected by general and local economic conditions, particularly changes in market interest rates including most recently significant changes as a result of inflation, and by governmental policies and actions of regulatory agencies. Net interest income is additionally affected by changes in the volume and mix of interest earning assets, interest earned on these assets, the volume and mix of interest bearing liabilities and interest paid on these liabilities.

Our net income is affected by many factors, including the provision for credit losses on loans. The provision for credit losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. Management believes that the ACL on loans reflects the amount that is appropriate to provide for current expected credit losses in our loan portfolio based on our methodology.

Net income is also affected by noninterest income and noninterest expense. Noninterest income primarily consists of service charges and other fees, card revenue and other income. Noninterest expense consists primarily of compensation and employee benefits, occupancy and equipment, data processing and professional services. Compensation and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses are the fixed and variable costs of buildings and equipment and consists primarily of lease expenses, depreciation charges, maintenance and utilities. Data processing consists primarily of processing and network services related to the Bank’s core operating system, including the account processing system, electronic payments processing of products and services, internet and mobile banking channels and software-as-a-service providers. Professional services consists primarily of third-party service providers such as auditors, consultants and lawyers.

Results of operations may also be significantly affected by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities, including changes resulting from the COVID-19 Pandemic and inflation and the governmental actions taken to address these issues. Net income is also impacted by growth of operations through organic growth or acquisitions.

COVID-19 Pandemic Response

The Company maintains its commitment to supporting its community and customers during the COVID-19 Pandemic and remains focused on keeping its employees safe and the Bank running effectively to serve its customers. The Bank will continue to monitor branch access and occupancy levels in relation to cases and close contact scenarios and follow governmental restrictions and public health authority guidelines.

Branch Consolidation Plan

The Company reduced the branch count to 49 from 61 branches during the year ended December 31, 2021, including the consolidation of eight branches and four branches during the three months ended March 31, 2021 and December 31, 2021, respectively. The Company integrated these locations into other branches within its network. These actions were the result of the Company’s increased focus on balancing physical locations and digital banking channels, driven by increased customer usage of online and mobile banking and a commitment to improve digital banking technology.

Results of Operations

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

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

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

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

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Average Balances, Yields and Rates Paid

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

Three Months Ended June 30,
2022 2021 Change
Average<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) $ 3,812,045 $ 40,890 4.30 % $ 4,402,868 $ 50,750 4.62 % $ (590,823) $ (9,860) (0.32) %
Taxable securities 1,450,328 7,607 2.10 799,023 4,050 2.03 651,305 3,557 0.07
Nontaxable securities (3) 137,429 893 2.61 160,489 947 2.37 (23,060) (54) 0.24
Interest earning deposits 1,213,156 2,342 0.77 964,791 263 0.11 248,365 2,079 0.66
Total interest earning assets 6,612,958 51,732 3.14 % 6,327,171 56,010 3.55 % 285,787 (4,278) (0.41) %
Noninterest earning assets 772,658 752,034 20,624
Total assets $ 7,385,616 $ 7,079,205 $ 306,411
Interest Bearing Liabilities:
Certificates of Deposit $ 321,926 $ 324 0.40 % $ 381,417 $ 481 0.51 % $ (59,491) $ (157) (0.11) %
Savings accounts 652,407 88 0.05 591,616 89 0.06 60,791 (1) (0.01)
Interest bearing demand and money market accounts 3,067,373 1,001 0.13 2,836,717 954 0.13 230,656 47 —
Total interest bearing deposits 4,041,706 1,413 0.14 3,809,750 1,524 0.16 231,956 (111) (0.02)
Junior subordinated debentures 21,287 239 4.50 20,986 186 3.55 301 53 0.95
Securities sold under agreement to repurchase 48,272 32 0.27 43,259 35 0.32 5,013 (3) (0.05)
Total interest bearing liabilities 4,111,265 1,684 0.16 % 3,873,995 1,745 0.18 % 237,270 (61) (0.02) %
Noninterest bearing demand deposits 2,349,746 2,261,373 88,373
Other noninterest bearing liabilities 113,644 108,076 5,568
Stockholders’ equity 810,961 835,761 (24,800)
Total liabilities and stock-holders’ equity $ 7,385,616 $ 7,079,205 $ 306,411
Net interest income and spread $ 50,048 2.98 % $ 54,265 3.37 % $ (4,217) (0.39) %
Net interest margin 3.04 % 3.44 % (0.40) %

(1) Average balances are calculated using daily balances.

(2) Average loan receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of $2.4 million and $8.2 million for the three months ended June 30, 2022 and 2021, respectively.

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

Net Interest Income and Margin Overview

One of the Company's key sources of earnings is net interest income. There are several factors that affect net interest income, including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest bearing liabilities; the volume of noninterest earning assets, noninterest bearing demand deposits, other noninterest bearing liabilities and stockholders' equity; market interest rate fluctuations; and asset quality.

The following table provides the changes in net interest income for the three months ended June 30, 2022 compared to the three months ended June 30, 2021 due to changes in average asset and liability balances (volume), changes in average rates (rate) and changes attributable to the combined effect of volume and interest rates allocated proportionately to the absolute value of changes due to volume and changes due to interest rates:

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

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Increase (Decrease) Due to Changes In:
Volume Yield/Rate Total % Change
(Dollars in thousands)
Taxable securities 3,411 146 3,557 87.8
Nontaxable securities (144) 90 (54) (5.7)
Interest earning deposits 84 1,995 2,079 790.5
Total interest income $ (3,148) $ (1,130) $ (4,278) (7.6) %
Interest Bearing Liabilities:
Certificates of deposit $ (68) $ (89) $ (157) (32.6) %
Savings accounts 9 (10) (1) (1.1)
Interest bearing demand and money market accounts 76 (29) 47 4.9
Total interest bearing deposits 17 (128) (111) (7.3)
Junior subordinated debentures 3 50 53 28.5
Securities sold under agreement to repurchase 4 (7) (3) (8.6)
Total interest expense $ 24 $ (85) $ (61) (3.5) %
Net interest income $ (3,172) $ (1,045) $ (4,217) (7.8) %

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

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

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

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

Three Months Ended
June 30,<br>2022 June 30,<br>2021
Loan yield (GAAP) 4.30 % 4.62 %
Exclude impact from SBA PPP loans (0.15) (0.12)
Exclude impact from incremental accretion on acquired loans (0.03) (0.05)
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans (non-GAAP) (1) 4.12 % 4.45 %

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

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

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

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

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

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Six Months Ended June 30,
2022 2021 Change
Average<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)
Noninterest earning assets 756,523 754,533 1,990
Total assets $ 7,410,066 $ 6,940,187 $ 469,879
Interest Bearing Liabilities:
Certificates of Deposit $ 329,100 $ 662 0.41 % $ 387,310 $ 1,040 0.54 % $ (58,210) $ (378) (0.13) %
Savings accounts 649,562 175 0.05 575,942 184 0.06 73,620 (9) (0.01)
Interest bearing demand and money market accounts 3,066,849 2,000 0.13 2,784,714 2,028 0.15 282,135 (28) (0.02)
Total interest bearing deposits 4,045,511 2,837 0.14 3,747,966 3,252 0.17 297,545 (415) (0.03)
Junior subordinated debentures 21,250 433 4.11 20,950 373 3.59 300 60 0.52
Securities sold under agreement to repurchase 49,140 64 0.26 41,676 73 0.35 7,464 (9) (0.09)
Total interest bearing liabilities 4,115,901 3,334 0.16 % 3,810,592 3,698 0.20 % 305,309 (364) (0.04) %
Noninterest bearing demand deposits 2,354,571 2,183,638 170,933
Other noninterest bearing liabilities 111,167 114,542 (3,375)
Stockholders’ equity 828,427 831,415 (2,988)
Total liabilities and stock-holders’ equity $ 7,410,066 $ 6,940,187 $ 469,879
Net interest income and spread $ 96,992 2.88 % $ 106,503 3.39 % $ (9,511) (0.51) %
Net interest margin 2.94 % 3.47 % (0.53) %

(1) Average balances are calculated using daily balances.

(2) Average loan receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of $5.8 million and $15.4 million for the six months ended June 30, 2022 and 2021, respectively.

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

Net Interest Income and Margin Overview

The following table provides the changes in net interest income for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 due to changes in average asset and liability balances (volume), changes in average rates (rate) and changes attributable to the combined effect of volume and interest rates allocated proportionately to the absolute value of changes due to volume and changes due to interest rates:

Increase (Decrease) Due to Changes In:
Volume Yield/Rate Total % Change
(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net $ (14,257) $ (4,102) $ (18,359) (18.3) %
Taxable securities 6,248 (222) 6,026 79.5
Nontaxable securities (247) 95 (152) (8.0)
Interest earning deposits 410 2,200 2,610 595.9
Total interest income $ (7,846) $ (2,029) $ (9,875) (9.0) %
Interest Bearing Liabilities:
Certificates of deposit $ (142) $ (236) $ (378) (36.3) %
Savings accounts 22 (31) (9) (4.9)
Interest bearing demand and money market accounts 195 (223) (28) (1.4)
Total interest bearing deposits 75 (490) (415) (12.8)
Junior subordinated debentures 5 55 60 16.1
Securities sold under agreement to repurchase 12 (21) (9) (12.3)
Total interest expense $ 92 $ (456) $ (364) (9.8) %
Net interest income $ (7,938) $ (1,573) $ (9,511) (8.9) %

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

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

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

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

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

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

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

Provision for Credit Losses Overview

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

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

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

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

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

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

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

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

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

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

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

Noninterest Income Overview

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

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

Three Months Ended <br>June 30,
2022 2021 Change % Change
(Dollars in thousands)
Service charges and other fees $ 2,391 $ 2,067 $ 324 15.7 %
Card revenue 2,332 2,338 (6) (0.3)
Gain on sale of loans, net 219 1,003 (784) (78.2)
Interest rate swap fees 26 209 (183) (87.6)
Bank owned life insurance income 764 717 47 6.6
Gain on sale of other assets, net — 724 (724) (100.0)
Other income 1,284 1,239 45 3.6
Total noninterest income $ 7,016 $ 8,297 $ (1,281) (15.4) %

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

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

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

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

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

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

Noninterest Expense Overview

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

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

Three Months Ended <br>June 30,
2022 2021 Change % Change
(Dollars in thousands)
Compensation and employee benefits $ 21,778 $ 21,803 $ (25) (0.1) %
Occupancy and equipment 4,171 4,091 80 2.0
Data processing 4,185 3,998 187 4.7
Marketing 344 567 (223) (39.3)
Professional services 529 1,037 (508) (49.0)
State/municipal business and use tax 867 991 (124) (12.5)
Federal deposit insurance premium 425 339 86 25.4
Amortization of intangible assets 704 797 (93) (11.7)
Other expense 2,704 2,773 (69) (2.5)
Total noninterest expense $ 35,707 $ 36,396 $ (689) (1.9) %

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

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

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

Six Months Ended<br>June 30,
2022 2021 Change % Change
(Dollars in thousands)
Compensation and employee benefits $ 43,030 $ 44,004 $ (974) (2.2) %
Occupancy and equipment 8,502 8,545 (43) (0.5)
Data processing 8,246 7,810 436 5.6
Marketing 610 1,080 (470) (43.5)
Professional services 1,228 2,307 (1,079) (46.8)
State/municipal business and use tax 1,663 1,963 (300) (15.3)
Federal deposit insurance premium 1,025 928 97 10.5
Amortization of intangible assets 1,408 1,594 (186) (11.7)
Other expense 5,715 5,407 308 5.7
Total noninterest expense $ 71,427 $ 73,638 $ (2,211) (3.0) %

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

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

Income Tax Expense Overview

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

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

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

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

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

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

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

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

Financial Condition Overview

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

June 30,<br>2022 December 31, 2021 Change % Change
(Dollars in thousands)
Assets
Cash and cash equivalents $ 994,055 $ 1,723,292 $ (729,237) (42.3) %
Investment securities available for sale, at fair value, net 1,187,588 894,335 293,253 32.8
Investment securities held to maturity, at amortized cost, net 615,653 383,393 232,260 60.6
Loans held for sale 1,311 1,476 (165) (11.2)
Loans receivable, net 3,834,368 3,773,301 61,067 1.6
Premises and equipment, net 77,164 79,370 (2,206) (2.8)
Federal Home Loan Bank stock, at cost 8,916 7,933 983 12.4
Bank owned life insurance 120,646 120,196 450 0.4
Accrued interest receivable 15,908 14,657 1,251 8.5
Prepaid expenses and other assets 211,350 183,543 27,807 15.2
Other intangible assets, net 8,569 9,977 (1,408) (14.1)
Goodwill 240,939 240,939 — —
Total assets $ 7,316,467 $ 7,432,412 $ (115,945) (1.6) %

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June 30,<br>2022 December 31, 2021 Change % Change
(Dollars in thousands)
Liabilities and Stockholders' Equity
Deposits $ 6,330,190 $ 6,394,290 $ (64,100) (1.0) %
Junior subordinated debentures 21,326 21,180 146 0.7
Securities sold under agreement to repurchase 41,827 50,839 (9,012) (17.7)
Accrued expenses and other liabilities 117,758 111,671 6,087 5.5
Total liabilities 6,511,101 6,577,980 (66,879) (1.0)
Common stock 550,417 551,798 (1,381) (0.3)
Retained earnings 316,732 293,238 23,494 8.0
Accumulated other comprehensive (loss) income, net (61,783) 9,396 (71,179) (757.5)
Total stockholders' equity 805,366 854,432 (49,066) (5.7)
Total liabilities and stockholders' equity $ 7,316,467 $ 7,432,412 $ (115,945) (1.6) %

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

Investment Activities Overview

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

June 30, 2022 December 31, 2021
Balance % of<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 $ 65,668 3.6 % $ 21,373 1.7 % $ 44,295 207.2 %
Municipal securities 200,010 11.1 221,212 17.3 % (21,202) (9.6)
Residential CMO and MBS 398,156 22.1 306,884 24.0 % 91,272 29.7
Commercial CMO and MBS 493,620 27.4 315,861 24.7 % 177,759 56.3
Corporate obligations 5,978 0.3 2,014 0.2 % 3,964 196.8
Other asset-backed securities 24,156 1.3 26,991 2.1 % (2,835) (10.5)
Total $ 1,187,588 65.8 % $ 894,335 70.0 % $ 293,253 32.8 %
Investment securities held to maturity, at amortized cost:
U.S. government and agency securities $ 150,960 8.4 % $ 141,011 11.0 % $ 9,949 7.1 %
Residential CMO and MBS 159,007 8.8 24,529 1.9 134,478 548.2
Commercial CMO and MBS 305,686 17.0 217,853 17.1 87,833 40.3
Total $ 615,653 34.2 % $ 383,393 30.0 % $ 232,260 60.6 %
Total investment securities $ 1,803,241 100.0 % $ 1,277,728 100.0 % $ 525,513 41.1 %

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

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Loan Portfolio Overview

Changes by loan type

The Bank originates a wide variety of loans with a focus on commercial business loans. The following table provides information about our loan portfolio by type of loan at the dates indicated:

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

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

The following table provides information about our nonaccrual loans, performing TDR loans and nonperforming assets for the dates indicated:

June 30,<br>2022 December 31, 2021 Change % Change
(Dollars in thousands)
Nonaccrual loans: (1)
Commercial business $ 10,475 $ 23,107 $ (12,632) (54.7) %
Residential real estate — 47 (47) (100.0)
Real estate construction and land development — 571 (571) (100.0)
Consumer — 29 (29) (100.0)
Total nonaccrual loans 10,475 23,754 (13,279) (55.9)
Other real estate owned — — — n/a
Total nonperforming assets $ 10,475 $ 23,754 $ (13,279) (55.9) %
Accruing loans past due 90 days or more $ 2,036 $ 293 $ 1,743 594.9 %
Credit quality ratios:
Nonaccrual loans to loans receivable 0.27 % 0.62 % (0.35) % (56.5) %
Nonaccrual loans to total assets 0.14 0.32 (0.18) (56.3)
Performing TDR loans: (1)
Commercial business $ 62,316 $ 57,142 $ 5,174 9.1 %
Residential real estate 178 358 (180) (50.3)
Real estate construction and land development 450 450 — —

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

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

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

(In thousands)
Balance, beginning of period $ 23,754
Additions 720
Net principal payments, sales and transfers to accruing status (9,768)
Payoffs (4,060)
Charge-offs (171)
Balance, end of period $ 10,475

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

Allowance for Credit Losses on Loans Overview

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

At or For the Six Months Ended June 30,
2022 2021 Change % Change
(Dollars in thousands)
ACL on loans at the end of period $ 39,696 $ 51,562 $ (11,866) (23.0) %
Credit quality ratios:
ACL on loans to loans receivable 1.02 % 1.11 % (0.09) % (8.1) %
ACL on loans to loans receivable, excluding SBA PPP loans (1) 1.03 1.15 (0.12) (10.4)
ACL on loans to nonaccrual loans 378.96 % 178.33 % 200.63 % 112.5 %
Net recoveries (506) (333) (173) 52.0
Average loans receivable, net during the period (2) 3,792,792 4,446,442 (653,650) (14.7)
Net recoveries on loans to average loans receivable, net (3) (0.03) % (0.02) % (0.01) % 50.0 %

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

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

(3) Annualized.

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

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

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

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

Deposits Overview

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

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

Stockholders' Equity Overview

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

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

Regulatory Requirements Overview

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

As of June 30, 2022 and December 31, 2021, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification

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

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

As of both June 30, 2022 and December 31, 2021, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC that allow the Bank the option to delay for two years until December 31, 2021 an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period.

Liquidity and Capital Resources

We maintain sufficient cash and cash equivalents and investment securities to meet short-term liquidity needs and actively monitor our long-term liquidity position to ensure the availability of capital resources for contractual obligations, strategic loan growth objectives and to fund operations. Our funding strategy has been to acquire non-maturity deposits from our retail accounts, acquire noninterest bearing demand deposits from our commercial customers and use our borrowing availability to fund growth in assets. We may also acquire brokered deposits when the cost of funds is advantageous to other funding sources. Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of assets. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition so we adhere to internal management targets assigned to the loan to deposit ratio, liquidity ratio, net short-term non-core funding ratio and non-core liabilities to total assets ratio to ensure an appropriate liquidity position.

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

Critical Accounting Policies

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

Reconciliations of Non-GAAP Measures

This Form 10-Q contains certain financial measures not presented in accordance with GAAP in addition to financial measures presented in accordance with GAAP. The Company has presented these non-GAAP financial measures in this Form 10-Q because it believes they provide useful and comparative information to assess trends in the Company’s performance and asset quality and to facilitate comparison of its performance with the performance of its peers. These non-GAAP measures have inherent limitations, are not required to be uniformly applied and are not audited. They should not be considered in isolation or as a substitute for financial measures presented in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of the GAAP and non-GAAP financial measures are presented below.

The Company believes presenting loan yield excluding the effect of discount accretion on acquired loans is useful in assessing the impact of acquisition accounting on loan yield as the effect of loan discount accretion is expected to decrease as the acquired loans mature or roll off its balance sheet. Incremental accretion on acquired loans represents the amount of interest income recorded on acquired loans in excess of the contractual stated interest rate in the individual loan notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified by the adoption of ASU 2016-13. The purchased discount is accreted into income over the remaining life of the loan. The impact of incremental accretion on loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the

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balance of the acquired loans decreases. Similarly, presenting loan yield excluding the effect of SBA PPP loans is useful in assessing the impact of these special program loans that are anticipated to substantially decrease within a short time frame.

Three Months Ended <br>June 30, Six Months Ended<br>June 30,
2022 2021 2022 2021
(Dollars in thousands)
Loan yield, excluding SBA PPP Loans and Incremental Accretion on Acquired Loans, annualized:
Interest and fees on loans (GAAP) $ 40,890 $ 50,750 $ 81,915 $ 100,274
Exclude interest and fees on SBA PPP loans (1,782) (10,003) (4,863) (19,139)
Exclude incremental accretion on acquired loans (270) (495) (854) (1,570)
Adjusted interest and fees on loans (non-GAAP) $ 38,838 $ 40,252 $ 76,198 $ 79,565
Average loans receivable, net (GAAP) $ 3,812,045 $ 4,402,868 $ 3,792,792 $ 4,446,442
Exclude average SBA PPP loans (34,090) (777,156) (71,633) (804,500)
Adjusted average loans receivable, net (non-GAAP) $ 3,777,955 $ 3,625,712 $ 3,721,159 $ 3,641,942
Loan yield, annualized (GAAP) 4.30 % 4.62 % 4.36 % 4.55 %
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans, annualized (non-GAAP) 4.12 % 4.45 % 4.13 % 4.41 %

The Company considers presenting the ratio of ACL on loans to loans receivable, excluding SBA PPP loans, to be a useful measurement in evaluating the adequacy of the Company's ACL on loans as the balance of SBA PPP loans is significant to the loan portfolio, and since SBA PPP loans are guaranteed by the SBA, the Company has not provided an ACL on loans for SBA PPP loans.

June 30,<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) $ 39,696 $ 42,361
Loans receivable (GAAP) $ 3,874,064 $ 3,815,662
Exclude SBA PPP loans (11,334) (145,840)
Loans receivable, excluding SBA PPP (non-GAAP) $ 3,862,730 $ 3,669,822
ACL on loans to loans receivable (GAAP) 1.02 % 1.11 %
ACL on loans to loans receivable, excluding SBA PPP loans (non-GAAP) 1.03 % 1.15 %

ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4.     CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

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

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(b) Changes in Internal Control Over Financial Reporting

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

PART II.    OTHER INFORMATION

ITEM 1.     LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

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

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

(a) Not applicable.

(b) Not applicable.

(c) Repurchase Plans

The following table provides information about repurchases of common stock by the Company during the three months ended June 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)
April 1, 2022— April 30, 2022 — $ — 9,967,332 657,745
May 1, 2022— May 31, 2022 404 24.85 9,967,332 657,745
June 1, 2022— June 30, 2022 20,776 24.61 9,986,863 638,214
Total 21,180 $ 24.62

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

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

ITEM 3.     DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4.     MINE SAFETY DISCLOSURES

Not applicable

ITEM 5.    OTHER INFORMATION

None

ITEM 6.     EXHIBITS

Incorporated by Reference
Exhibit No. Description of Exhibit Form Exhibit Filing Date/Period End Date
31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
32.1 Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)
101.INS XBRL Instance Document (1)
101.SCH XBRL Taxonomy Extension Schema Document (1)
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document (1)
101.DEF XBRL Taxonomy Extension Definition Linkbase Document (1)

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101.LAB XBRL Taxonomy Extension Label Linkbase Document (1)
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document (1)

(1) Filed herewith.

SIGNATURES

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

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

48

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.

August 9, 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.

August 9, 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 June 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.

August 9, 2022 /s/ Jeffrey J. Deuel
Jeffrey J. Deuel
Chief Executive Officer<br>Principal Executive Officer
August 9, 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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