HERITAGE FINANCIAL CORPORATION 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 months endedMarch 31, 2023 . 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 theDecember 31, 2022 audited Consolidated Financial Statements and the accompanying Notes included in our 2022 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. Our core profitability depends primarily on our net interest income. Net interest income is the difference between interest income, which is the income that we earn on interest earning assets, comprised primarily of loans and investment securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits. Management manages the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is significantly affected by general and local economic conditions, particularly changes in market interest rates including most recently significant changes as a result of inflation, and by governmental policies and actions of regulatory agencies. Net interest income is additionally affected by changes in the volume and mix of interest earning assets, interest earned on these assets, the volume and mix of interest bearing liabilities and interest paid on these liabilities. 31
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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 consist 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, changes in accounting, tax, and regulatory rules, governmental policies and actions of regulatory authorities, including changes resulting from inflation and the governmental actions taken to address this issue. Net income is also impacted by growth of operations through organic growth or acquisitions. Recent Developments While economic conditions have generally improved since the onset of the COVID-19 pandemic in early 2020, inflation has resulted in higher prices for food, energy, housing, and various supply chain inputs, among others. These inflationary pressures have persisted throughout 2022 and 2023, resulting in higher costs for consumers and businesses. To address the persistent levels of inflation, theFederal Open Market Committee ("FOMC") has taken steps to tighten monetary policy through a cumulative 475 basis point increase to the federal funds rate fromMarch 2022 throughMarch 2023 . TheFOMC has stated that it remains committed to monetary policy measures that are designed to bring inflation down. The impact of these measures, including future actions taken by theFOMC , on the Company's business are uncertain. While the recent increases in interest rates have generally resulted in higher levels of interest income for the Company, they may also reduce economic activity overall or result in recessionary conditions in future periods. Should these ongoing economic pressures persist, we anticipate it could have an impact on the following: •Loan growth and interest income - If economic activity begins to wane, it may have an impact on our borrowers, the businesses they operate, and their financial condition. Our borrowers may have less demand for credit needed to invest in and expand their businesses, as well as less demand for real estate loans. Such factors would place pressure on the level of interest-earning assets, which may negatively impact our interest income. •Credit quality - Should there be a decline in economic activity, the markets we serve could experience increases in unemployment, declines in consumer confidence, and a reluctance on the part of businesses to invest in and expand their operations, among other things. Such factors may result in weakened economic conditions, place strain on our borrowers, and ultimately impact the credit quality of our loan portfolio. We expect this could result in increases in the level of past due, nonaccrual, and classified loans, as well as higher net charge-offs. While economic conditions have generally been favorable thus far, notwithstanding higher levels of inflation, there can be no assurance favorable economic conditions will continue. As such, should we experience future deterioration in the credit quality of our loan portfolio, it may contribute to the need for additional provisions for credit losses. •ACL - The Company is required to record credit losses on certain financial assets in accordance with the CECL model stipulated under ASC 326, which is highly dependent upon expectations of future economic conditions and requires management judgment. Should expectations of future economic conditions deteriorate, the Company may be required to record additional provisions for credit losses. •Impairment charges - If economic conditions deteriorate, it could adversely impact the Company's operating results and the value of certain of our assets. As a result, the Company may be required to write-down the value of certain assets such as goodwill, intangible assets, or deferred tax assets when there is evidence to suggest their value has become impaired or will not be realizable at a future date. •Accumulated other comprehensive income (loss) - Unrealized gains and losses on AFS investment securities are recognized in stockholders' equity as accumulated other comprehensive income (loss). If economic conditions deteriorate, and/or if the interest rates continue to increase, the valuation of the Company's AFS investment securities could be negatively impacted, which may lead to increases in other comprehensive loss, decreases to the Company's stockholders' equity. •Deposits and deposit costs - Given the significant rate increases by theFOMC , it is likely that deposit costs will continue to increase and it may become more challenging for the Company to retain and attract deposit relationships. •Liquidity - Consistent with our prudent, proactive approach to liquidity management, we may take certain actions to further enhance our liquidity, including but not limited to, increasing our FHLB borrowings, and increasing our brokered deposits.
The Company continues to focus on serving its customers and communities, maintaining the well-being of its employees, and executing its strategic initiatives. The Company continues to monitor the economic environment and will make changes as appropriate.
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Results of Operations
Comparison of quarter ended
Net income increased$700,000 , or 3.5%, to$20.5 million , or$0.58 per diluted common share, for the three months endedMarch 31, 2023 , compared to$19.8 million , or$0.56 per diluted common share, for the same period in 2022. Net interest income increased$12.9 million , or 27.5%, to$59.8 million for the three months endedMarch 31, 2023 , compared to$46.9 million for the same period in 2022 due primarily to an increase in interest earned on interest earning assets following increases in market interest rates. This increase was partially offset by a$1.8 million provision for credit losses for the three months endedMarch 31, 2023 , compared to a$3.6 million reversal of provision for credit losses for the three months endedMarch 31, 2022 , and an increase in noninterest expense of$5.9 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The Company's efficiency ratio was 61.1% for the three months endedMarch 31, 2023 compared to 64.4% for the same period in 2022.
Average Balances, Yields and Rates Paid
The following table provides relevant net interest income information for the periods indicated:
Three Months Ended
2023 2022 Change
Interest Average Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/
Balance(1) Paid Rate Balance(1) Paid Rate Balance(1) Paid Rate
(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net (2)(3) $ 4,039,395 $ 50,450 5.07 % $ 3,773,325 $ 41,025 4.41 % $ 266,070 $ 9,425 0.66 %
Taxable securities 2,007,339 14,657 2.96 1,271,557 6,003 1.91 735,782 8,654 1.05
Nontaxable securities (3) 82,893 586 2.87 146,409 860 2.38 (63,516) (274) 0.49
Interest earning deposits 83,376 972 4.73 1,503,287 706 0.19 (1,419,911) 266 4.54
Total interest earning assets 6,213,003 66,665 4.35 % 6,694,578 48,594 2.94 % (481,575) 18,071 1.41 %
Noninterest earning assets 848,956 740,209 108,747
Total assets $ 7,061,959 $ 7,434,787 $ (372,828)
Interest Bearing Liabilities:
Certificates of Deposit $ 350,206 $ 1,224 1.42 % $ 336,353 $ 338 0.41 % $ 13,853 $ 886 1.01 %
Savings accounts 601,166 142 0.10 646,684 87 0.05 (45,518) 55 0.05
Interest bearing demand and money
market accounts 2,829,198 3,162 0.45 3,066,320 999 0.13 (237,122) 2,163 0.32
Total interest bearing deposits 3,780,570 4,528 0.49 4,049,357 1,424 0.14 (268,787) 3,104 0.35
Junior subordinated debentures 21,501 482 9.09 21,214 194 3.71 287 288 5.38
Securities sold under agreement
to repurchase 43,202 47 0.44 50,017 32 0.26 (6,815) 15 0.18
FHLB advances and other
borrowings 145,605 1,766 4.92 - - - 145,605 1,766 4.92
Total interest bearing
liabilities 3,990,878 6,823 0.69 % 4,120,588 1,650 0.16 % (129,710) 5,173 0.53 %
Noninterest bearing demand
deposits 2,068,688 2,359,451 (290,763)
Other noninterest bearing liabilities 189,893 108,663
81,230
Stockholders' equity 812,500 846,085
(33,585)
Total liabilities and stock-holders' equity$ 7,061,959 $ 7,434,787 $ (372,828) Net interest income and spread$ 59,842 3.66 %$ 46,944 2.78 %$ 12,898 0.88 % Net interest margin 3.91 % 2.84 % 1.07 % (1) Average balances are calculated using daily balances. (2) Average loans receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of$752,000 and$3.5 million for the three months endedMarch 31, 2023 and 2022, respectively. (3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis. 33
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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. Market rates impact the results of the Company's net interest income, including the significant increases in the federal funds target rate by theFederal Reserve in response to inflation during 2022 and 2023. The following table provides the federal funds target rate history and changes from each period sinceDecember 31, 2021 : Change Date Rate (%) Rate Change (%) December 31, 2021 0.00% - 0.25% N/A March 17, 2022 0.25% - 0.50% 0.25 % May 5, 2022 0.75% - 1.00% 0.50 % June 16, 2022 1.50% - 1.75% 0.75 % July 28, 2022 2.25% - 2.50% 0.75 % September 22, 2022 3.00% - 3.25% 0.75 % November 3, 2022 3.75% - 4.00% 0.75 % December 15, 2022 4.25% - 4.50% 0.50 % February 2, 2023 4.50% - 4.75% 0.25 % March 23, 2023 4.75% - 5.00% 0.25 % The following table provides the changes in net interest income for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 due to changes in average asset and liability balances (volume), changes in average yields/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 $ 3,031 $ 6,394 $ 9,425 23.0 %
Taxable securities 4,449 4,205 8,654 144.2
Nontaxable securities (425) 151 (274) (31.9)
Interest earning deposits (1,271) 1,537 266 37.7
Total interest income $ 5,784 $ 12,287 $ 18,071 37.2 %
Interest Bearing Liabilities:
Certificates of deposit $ 15 $ 871 $ 886 262.1 %
Savings accounts (6) 61 55 63.2
Interest bearing demand and money market accounts (83) 2,246 2,163 216.5
Total interest bearing deposits (74) 3,178 3,104 218.0
Junior subordinated debentures 3 285 288 148.5
Securities sold under agreement to repurchase (4) 19 15 46.9
FHLB advances and other borrowings 1,766 - 1,766 100.0
Total interest expense $ 1,691 $ 3,482 $ 5,173 313.5 %
Net interest income $ 4,093 $ 8,805 $ 12,898 27.5 %
Comparison of quarter ended
Net interest income increased
Total interest income increased$18.1 million , or 37.2%, to$66.7 million for the three months endedMarch 31, 2023 compared to$48.6 million for the three months endedMarch 31, 2022 . The increase in total interest income was primarily due to an increase in yields earned on interest earning assets following increases in market interest rates, and secondarily due to an increase in average balances of loans and taxable securities, offset partially by a$3.1 million decrease in interest earned on loans receivable, net resulting from a decrease in interest and deferred SBA PPP loan fees recognized. 34
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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
March 31, March 31,
2023 2022
Loan yield (GAAP) 5.07 % 4.41 %
Exclude impact from SBA PPP loans (0.01) (0.21)
Exclude impact from incremental accretion on acquired loans (0.02) (0.06)
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans (non-GAAP) (1)
5.04 % 4.14 %
(1) For additional information, see the "Reconciliations of Non-GAAP Measures" section below.
There was no impact to loan yield from recoveries of interest and fees on loans classified as nonaccrual during the three months endedMarch 31, 2023 compared to 11 basis points during the same period in 2022. Total interest expense increased$5.2 million or 313.5% to$6.8 million during the three months endedMarch 31, 2023 compared$1.7 million for the same period in 2022 due primarily to increased costs of interest bearing deposits due to competitive rate pressures as well as the addition of borrowing costs. Net interest margin increased 107 basis points to 3.91% for the three months endedMarch 31, 2023 compared to 2.84% for the same period in 2022.The increase in the net interest margin was due to a shift into higher yielding interest earning assets as well as higher average yields on all interest earning assets following increases in market interest rates offset partially by an increase in cost of interest bearing liabilities.
Provision for Credit Losses Overview
The aggregate of the provision for credit losses on loans and the provision for credit losses on unfunded commitments is presented on the unaudited Condensed Consolidated Statements of Income as the provision for (reversal of) credit losses. The ACL on unfunded commitments is included on the unaudited Condensed Consolidated Statements of Financial Condition within accrued expenses and other liabilities.
Comparison of quarter ended
The following table presents the provision for (reversal of) credit losses for
the periods indicated:
Three Months Ended
March 31, Change
2023 2022 $ %
(Dollars in thousands)
Provision for (reversal of) credit
losses on loans $ 1,713 $ (2,522) $ 4,235 167.9 %
Provision for (reversal of) credit
losses on unfunded commitments 112 (1,055) 1,167 110.6
Provision for (reversal of) credit
losses $ 1,825 $ (3,577) $ 5,402 151.0 %
The provision for credit losses on loans reflects the amount required to
maintain the allowance for credit losses on loans at an appropriate level based
upon management's evaluation of the adequacy of collective and individual loss
reserves. The provision for credit losses on loans recognized during the three
months ended March 31, 2023 was due primarily to an increase in loans receivable
as well as a change in mix of loans. Future assessments of the expected credit
losses will not only be impacted by changes in the composition of and amount of
loans and to the reasonable and supportable forecast, but will also include an
updated assessment of qualitative factors, as well as consideration of any
required changes in the reasonable and supportable forecast reversion period.
The provision for credit losses on unfunded commitments increased due primarily
to an increase in unfunded commitment balances.
The reversal of provision for credit losses recognized during the three months
ended March 31, 2022 was due primarily to a reduction of 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 as compared to the forecast at December 31, 2021 .
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Noninterest Income Overview
Comparison of quarter ended
The following table presents the change in the key components of noninterest income for the periods indicated:
Three Months Ended
March 31, Change
2023 2022 $ %
(Dollars in thousands)
Service charges and other fees $ 2,624 $ 2,474 $ 150 6.1 %
Card revenue 2,000 2,263 (263) (11.6)
Gain (loss) on sale of investment
securities, net (286) - (286) 100.0
Gain on sale of loans, net 49 241 (192) (79.7)
Interest rate swap fees 53 279 (226) (81.0)
Bank owned life insurance income 709 1,695 (986) (58.2)
Gain on sale of other assets, net 2 204 (202) (99.0)
Other income 3,107 1,382 1,725 124.8
Total noninterest income $ 8,258 $ 8,538 $ (280) (3.3) %
Noninterest income decreased during the three months ended March 31, 2023
compared to the same period in 2022 due to a decline in card revenue, interest
rate swap fees and gain on sale of loans as well as a decline in bank owned life
insurance income due to a death benefit recognized during the three months ended
March 31, 2022 . These declines were offset partially by an increase in other
income which included the gain on sale of Visa Inc. Class B common stock of $1.6
million and an increase in service charges and other fees.
Noninterest Expense Overview
Comparison of quarter ended
The following table presents changes in the key components of noninterest expense for the periods indicated:
Three Months Ended
March 31, Change
2023 2022 $ %
(Dollars in thousands)
Compensation and employee benefits $ 25,536 $ 21,252 $ 4,284 20.2 %
Occupancy and equipment 4,892 4,331 561 13.0
Data processing 4,342 4,061 281 6.9
Marketing 402 266 136 51.1
Professional services 628 699 (71) (10.2)
State/municipal business and use tax 1,008 796 212 26.6
Federal deposit insurance premium 850 600 250 41.7
Amortization of intangible assets 623 704 (81) (11.5) Other expense 3,324 3,011 313 10.4 Total noninterest expense$ 41,605 $ 35,720 $ 5,885 16.5 % Noninterest expense increased during the three months endedMarch 31, 2023 compared to the same period in 2022 due primarily to an increase in compensation and employee benefits resulting from an increase in the number of full-time equivalent employees including the addition of commercial and relationship banking teams in 2022 and an increase in salaries and wages due to upward market pressure. Occupancy and equipment expense increased due to the expansion intoEugene, Oregon andBoise, Idaho as well as an increase in maintenance costs related to winter weather conditions. Data processing costs increased due primarily to the expansion of digital services including the addition of the ability to open accounts online. The federal deposit insurance premium increased due to an increase in assessment rates effectiveJanuary 1, 2023 . 36
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Income Tax Expense Overview
Comparison of quarter ended
The following table presents the income tax expense, related metrics and their changes for the periods indicated:
Three Months Ended
March 31, Change
2023 2022 $ %
(Dollars in thousands)
Income before income taxes $ 24,670 $ 23,339 $ 1,331 5.7 %
Income tax expense $ 4,213 $ 3,582 $ 631 17.6 %
Effective income tax rate 17.1 % 15.3 % 1.8 % 11.8 %
Income tax expense increased compared to the same period in 2022 primarily due to higher estimated pre-tax income in 2023 than in 2022.
Financial Condition Overview
The table below provides a comparison of the changes in the Company's financial condition at the periods indicated:
March 31, December 31,
2023 2022 $ Change % Change
(Dollars in thousands)
Assets
Cash and cash equivalents $ 301,481 $ 103,590 $ 197,891 191.0 %
Investment securities available for sale,
at fair value, net 1,318,072 1,331,443 (13,371) (1.0)
Investment securities held to maturity, at
amortized cost, net 760,163 766,396 (6,233) (0.8)
Loans receivable, net 4,083,003 4,007,872 75,131 1.9
Premises and equipment, net 80,094 76,930 3,164 4.1
Federal Home Loan Bank stock, at cost 23,697 8,916 14,781 165.8
Bank owned life insurance 122,767 122,059 708 0.6
Accrued interest receivable 18,548 18,547 1 -
Prepaid expenses and other assets 281,438 296,181 (14,743) (5.0)
Other intangible assets, net 6,604 7,227 (623) (8.6)
Goodwill 240,939 240,939 - -
Total assets $ 7,236,806 $ 6,980,100 $ 256,706 3.7 %
Liabilities and Stockholders' Equity
Deposits $ 5,771,787 $ 5,907,420 $ (135,633) (2.3) %
Deposits held for sale 17,235 17,420 (185) (1.1)
Total deposits 5,789,022 5,924,840 (135,818) (2.3)
Federal Home Loan Bank advances 383,100 - 383,100 100.0
Junior subordinated debentures 21,546 21,473 73 0.3
Securities sold under agreement to
repurchase 39,161 46,597 (7,436) (16.0)
Accrued expenses and other liabilities 177,895 189,297 (11,402) (6.0)
Total liabilities 6,410,724 6,182,207 228,517 3.7
Common stock 550,869 552,397 (1,528) (0.3)
Retained earnings 358,010 345,346 12,664 3.7
Accumulated other comprehensive (loss)
income, net (82,797) (99,850) 17,053 17.1
Total stockholders' equity 826,082 797,893 28,189 3.5
Total liabilities and stockholders' equity
3.7 %
Total assets increased due primarily to an increase in cash and cash equivalents
and an increase in loans receivable, net due to loan growth. Total liabilities
and stockholders' equity increased due primarily to an increase in borrowings
offset partially by a decrease in deposits.
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Investment Activities Overview
Our investment policy is established by the Company's Board of Directors and monitored by the Risk Committee of the Board of Directors. It is designed primarily to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complements the Company's lending activities. The policy permits investment in various types of liquid assets permissible under applicable regulations. Investments in non-investment grade bonds and stripped mortgage-backed securities are not permitted under the policy.
The following table provides information regarding our investment securities at the dates indicated:
March 31, 2023 December 31, 2022 Change
% of % of
Balance Total Balance Total $ %
(Dollars in thousands)
Investment securities available for sale, at fair value:
U.S. government and agency
securities $ 64,550 3.1 % $ 63,859 3.0 % $ 691 1.1 %
Municipal securities 132,497 6.4 153,026 7.3 (20,529) (13.4)
Residential CMO and MBS(1) 433,712 20.9 424,386 20.2 9,326 2.2
Commercial CMO and MBS(1) 663,497 31.8 664,421 31.8 (924) (0.1)
Corporate obligations 3,817 0.2 3,834 0.2 (17) (0.4)
Other asset-backed securities 19,999 1.0 21,917 1.0 (1,918) (8.8)
Total $ 1,318,072 63.4 % $ 1,331,443 63.5 % $ (13,371) (1.0) %
Investment securities held to maturity, at amortized cost:
U.S. government and agency
securities $ 150,969 7.3 % $ 150,936 7.2 % $ 33 - %
Residential CMO and MBS(1) 285,337 13.7 290,318 13.8 (4,981) (1.7)
Commercial CMO and MBS(1) 323,857 15.6 325,142 15.5 (1,285) (0.4)
Total $ 760,163 36.6 % $ 766,396 36.5 % $ (6,233) (0.8) %
Total investment securities $ 2,078,235 100.0 % $ 2,097,839 100.0 % $ (19,604) (0.9) %
(1)
Total investment securities decreased$19.6 million , or 0.9%, to$2.08 billion atMarch 31, 2023 from$2.10 billion atDecember 31, 2022 due primarily to maturities and prepayments of$32.9 million and sales of$22.7 million , partially offset by purchases of$15.0 million . In addition, net unrealized and unrecognized losses on investment securities declined by$39.1 million due primarily to improvement in fair market values of investment securities available for sale and held to maturity sinceDecember 31, 2022 . Loan Portfolio Overview Changes by loan type The Company originates a wide variety of loans with a focus on commercial business loans. In addition to originating loans, the Company may also acquire loans through pool purchases, participation purchases and syndicated loan purchases. The following table provides information about our loan portfolio by type of loan at the dates indicated: March 31, 2023 December 31, 2022 Change % of Loans Amortized % of Loans Amortized Cost Receivable Cost Receivable $ % (Dollars in thousands) Commercial business: Commercial and industrial$ 684,998 16.6 %$ 692,100 17.1 %$ (7,102) (1.0) % SBA PPP 900 - 1,468 - (568) (38.7) Owner-occupied CRE 949,064 23.0 937,040 23.1 12,024 1.3 Non-owner occupied CRE 1,601,789 38.8 1,586,632 39.2 15,157 1.0 Total commercial business 3,236,751 78.4 3,217,240 79.4 19,511 0.6 Residential real estate 363,777 8.8 343,631 8.5 20,146 5.9 38
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March 31, 2023 December 31, 2022 Change
% of Loans % of Loans
Amortized Cost Receivable Amortized Cost Receivable $ %
(Dollars in thousands)
Real estate construction and land development:
Residential 72,926 1.8 80,074 2.0 (7,148) (8.9)
Commercial and multifamily 270,547 6.6 214,038 5.3 56,509 26.4
Total real estate construction
and land development 343,473 8.4 294,112 7.3 49,361 16.8
Consumer 183,471 4.4 195,875 4.8 (12,404) (6.3)
Total $ 4,127,472 100.0 % $ 4,050,858 100.0 % $ 76,614 1.9 %
Loans receivable increased $76.6 million , or 1.9% (7.7% annualized), at March
31, 2023 . New loans funded in the during the three months ended March 31, 2023
and during the three months ended December 31, 2022 were $138.1 million and
$203.1 million , respectively. The fourth quarter of 2022 included purchased
residential real estate loans of $40.5 million . Loan repayments decreased during
the three months ended March 31, 2023 to $60.8 million , compared to $147.0
million during the three months ended December 31, 2022 , exclusive of SBA PPP
loan repayments, net deferred fees, and net acquired discounts. The largest
increase in the loan portfolio occurred in the commercial and multifamily
construction loans, which increased by $56.5 million or 26.4% due to new loan
originations and advances on outstanding loans during the three months ended
March 31, 2023 . Total new commitments for commercial and multifamily
construction loans were $76.3 million during the three months ended March 31,
2023 .
Total owner-occupied CRE loans and non-owner occupied CRE loans were $2.5
billion at March 31, 2023 . Office loans were the largest segment of
owner-occupied and non-owner occupied CRE loans at $582.5 million or 22.8%. The
average loan balance was $1.1 million . Of this total, $277.7 million or 47.7%
were owner-occupied CRE properties. Owner-occupied CRE loans have a lower risk
profile as there is less tenant rollover risk and generally have guarantees from
the company occupying the space as well as the owners of the company.
Loans classified as nonaccrual and performing modified loans and nonperforming assets
The following table provides information about our nonaccrual loans, performing modified loans and nonperforming assets for the dates indicated:
March 31,
2023 December 31, 2022 Change % Change
(Dollars in thousands)
Nonaccrual loans: (1)
Commercial business $ 4,815 $ 5,869 $ (1,054) (18.0) %
Real estate construction and land
development - 37 (37) (100.0)
Total nonaccrual loans 4,815 5,906 (1,091) (18.5)
Other real estate owned - - - n/a
Total nonperforming assets $ 4,815 $ 5,906 $ (1,091) (18.5) %
Accruing loans past due 90 days or more
45.1 %
Credit quality ratios:
Nonaccrual loans to loans receivable 0.12 % 0.15 % (0.03) % (20.0) %
Nonaccrual loans to total assets 0.07 0.08 (0.01) (12.5)
Modified loans: (2)
Commercial business $ 3,035
Consumer 25
Total performing modified loans $ 3,060 (1) At
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The following table provides the changes in nonaccrual loans during the three
months ended
(In thousands)
Balance, beginning of period $
5,906
Additions
468
Net principal payments, sales and transfers to accruing status (909) Payoffs (650) Charge-offs - Balance, end of period$ 4,815
Nonaccrual loans decreased
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 Three Months Ended March
31, Change
2023 2022 $ %
(Dollars in thousands)
ACL on loans at the end of period $ 44,469 $ 40,333 $ 4,136 10.3 %
Credit quality ratios:
ACL on loans to loans receivable 1.08 % 1.06 % 0.02 1.9
ACL on loans to nonaccrual loans 923.55 244.04 679.51 278.4
Net (charge-offs) recoveries $ (230) $ 494 $ (724) (146.6)
Average loans receivable, net during the
period (1) 4,039,395 3,773,325 266,070 7.1
Net charge-offs (recoveries) on loans to
average loans receivable, net(2) 0.02 % (0.05) % 0.07 % 140.0 %
(1) Average loan receivable, net includes loans held for sale. (2) Annualized.
The ACL on loans increased during the three months ended
The following table presents the ACL on loans by loan portfolio segment at the
indicated dates:
March 31, 2023 December 31, 2022
ACL as a % of % of Loans in ACL as a % of % of Loans in
Loans in Loan Loan Category to Loans in Loan Loan Category to
ACL on Loans Category Total Loans ACL on Loans Category Total Loans
(Dollars in thousands)
Commercial business $ 29,937 0.92 % 78.4 % $ 30,718 0.95 % 79.4 %
Residential real estate 2,902 0.80 % 8.8 2,872 0.84 8.5
Real estate construction and land
development 8,985 2.62 % 8.4 7,063 2.40 7.3
Consumer 2,645 1.44 % 4.4 2,333 1.19 4.8
Total ACL on loans $ 44,469 1.08 % 100.0 % $ 42,986 1.06 % 100.0 %
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Deposits Overview
The following table summarizes the Company's deposits at the dates indicated:
March 31, 2023 December 31, 2022 Change
% of Total % of Total
Balance (1) Deposits Balance Deposits $ %
(Dollars in thousands)Noninterest demand deposits$ 1,982,909 34.3 %$ 2,099,464 35.5 %$ (116,555) (5.6) % Interest bearing demand deposits 1,675,393 28.9 1,830,727 30.9 (155,334) (8.5) Money market accounts 1,155,559 20.0 1,063,243 17.9 92,316 8.7 Savings accounts 578,807 10.0 623,833 10.5 (45,026) (7.2) Total non-maturity deposits 5,392,668 93.2 5,617,267 94.8 (224,599) (4.0) Certificates of deposit 396,354 6.8 307,573 5.2 88,781 28.9 Total deposits$ 5,789,022 100.0 %$ 5,924,840 100.0 %$ (135,818) (2.3) %
(1) Deposit balances include deposits held for sale of
Total deposits decreased$135.8 million , or 2.3%, atMarch 31, 2023 fromDecember 31, 2022 . The decrease was due to competitive pricing pressures and customers moving excess funds to alternative higher yielding investments as well as general declines in individual customer balances. Money market accounts increased due to an increase in public deposits. Certificate of deposit balances increased mostly due to the addition of$52 million in brokered deposits. The Bank entered into a purchase and sale agreement with a third party to sell and transfer certain assets, deposits and other liabilities of its branch inEllensburg during the three months endedSeptember 30, 2022 . As a result of entering into this purchase and sale agreement, approximately$17.2 million and$17.4 million in deposits were classified as held for sale as ofMarch 31, 2023 andDecember 31, 2022 , respectively. The sale is expected to be completed during the three months endedJune 30, 2023 ; however, the completion of this sale depends on many factors including regulatory approval.
Federal Home Loan Bank Advances and Other Borrowings
The Federal Home Loan Bank (FHLB) functions as a member-owned cooperative providing credit for member financial institutions. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Limitations on the amount of advances are based on a percentage of the Bank's assets or on the FHLB's assessment of the institution's creditworthiness. AtMarch 31, 2023 , the Bank maintained a credit facility with the FHLB with available borrowing capacity of$1.2 billion with$383.1 million in advances outstanding. All FHLB borrowings atMarch 31, 2023 were overnight advances. AtDecember 31, 2022 , the Bank had no FHLB advances outstanding. Advances from the FHLB may be collateralized by FHLB stock owned by the Bank, deposits at the FHLB, certain commercial and residential real estate loans, investment securities or other assets.
The Bank maintains a credit facility with the
The Company utilizes securities sold under agreement to repurchase with one day maturities as a supplement to funding sources. Securities sold under agreement to repurchase are secured by pledged investment securities. Under the securities sold under agreement to repurchase, the Company is required to maintain an aggregate market value of securities pledged greater than the balance of the securities sold under agreement to repurchase. AtMarch 31, 2023 andDecember 31, 2022 , we had repurchase agreements of$39.2 million and$46.6 million , respectively. In addition to funds obtained in the ordinary course of business, the Company assumed trust preferred securities and junior subordinated debentures as part of the acquisition ofWashington Banking Company . For regulatory capital purposes, the trust preferred securities are included in Tier 2 capital atMarch 31, 2023 . The junior subordinated debentures outstanding as ofMarch 31, 2023 andDecember 31, 2022 were$21.5 million , net of unaccreted discount.
The Bank maintains available unsecured federal funds lines with five
correspondent banks totaling
Stockholders' Equity Overview The Company's stockholders' equity to assets ratio was 11.4% at bothMarch 31, 2023 andDecember 31, 2022 . Total stockholders' equity increased$28.2 million , or 3.5%, to$826.1 million atMarch 31, 2023 from$797.9 million atDecember 31, 2022 . The increase was due primarily to$20.5 million in net income recognized and a decrease of$17.1 million in accumulated other comprehensive loss as a result of improved fair market values of available for sale investment securities, offset partially by 41
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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. OnApril 19, 2023 , the Company's board of directors declared a regular quarterly dividend of$0.22 per common share payable onMay 18, 2023 to shareholders of record onMay 4, 2023 .
Regulatory Requirements Overview
The Company is a bank holding company under the supervision of theFederal Reserve Bank . Bank holding companies are subject to capital adequacy requirements of theFederal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of theFederal Reserve . The Bank is a federally insured institution and thereby is subject to the capital requirements established by theFDIC . TheFederal Reserve capital requirements generally parallel theFDIC 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 ofMarch 31, 2023 , the Company and the Bank met all capital adequacy requirements to which they are subject. As ofMarch 31, 2023 andDecember 31, 2022 , the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's categories. The following table presents the actual capital ratios of the Company and the Bank at the periods indicated: Company Bank March 31, 2023 December 31, 2022 March 31, 2023 December 31, 2022 Common equity Tier 1 capital ratio 12.9 % 12.8 % 13.0 % 12.9 % Leverage ratio 9.9 9.7 9.7 9.4 Tier 1 capital ratio 13.3 13.2 13.0 12.9 Total capital ratio 14.1 14.0 13.9 13.7 Capital conservation buffer 6.1 6.0 5.9 5.7 As of bothMarch 31, 2023 andDecember 31, 2022 , the capital measures reflect the revised CECL capital transition provisions adopted by theFederal Reserve and theFDIC that allowed the Bank the option to delay for two years untilDecember 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. Our liquidity policy permits the purchase of brokered deposits in an amount not to exceed 15% of the Bank's total deposits as a secondary source for funding. AtMarch 31, 2023 , we had$52.3 million in brokered deposits, which constituted 0.90% of total deposits. Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of assets. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition so we adhere to internal management targets assigned to the loan to deposit ratio, liquidity ratio, net short-term non-core funding ratio and non-core liabilities to total assets ratio to ensure an appropriate liquidity position. The Company regularly monitors liquidity, models liquidity stress scenarios to ensure that adequate liquidity is available, and has contingency funding plans in place, which are reviewed and tested on a regular, recurring basis. 42
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The following table summarizes the Company's available liquidity as of the date
indicated:
March 31, 2023
Total Available Amount Used Net Availability
(Dollars in thousands)
Internal Sources
Cash and cash equivalents $ 301,481 $ - $ 301,481
Unencumbered investment securities available for
sale(1) 1,116,013 - 1,116,013
External Sources -
Federal Home Loan Bank (FHLB) borrowing
availability(2) 1,197,964 383,100 814,864
Federal Reserve Bank (FRB) borrowing availability(3) 640,635 - 640,635
Fed funds line borrowing availability with
correspondent banks 215,000 - 215,000
Total liquidity $ 3,471,093 $ 383,100 $ 3,087,993 (1) Investment securities available for sale at fair value.
(2) Includes FHLB borrowing availability of
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 capital resources since the information disclosed in our 2022 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 Estimates
Our critical accounting estimates are described in detail in the "Critical Accounting Estimates" section within Item 7 of our 2022 Annual Form the Form 10-K. TheSEC defines "critical accounting estimates" 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 estimates include estimates of the ACL on loans, the ACL on unfunded commitments and goodwill. There have been no material changes in these estimates during the three months endedMarch 31, 2023 .
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 balance of the acquired loans decreases. Similarly, presenting loan yield excluding the effect of SBA PPP loans is useful in assessing the impact of these special program loans that have substantially decreased within a short time frame. Three Months Ended March 31, 2023 2022 (Dollars in thousands) Loan yield, excluding SBA PPP Loans and Incremental Accretion on Acquired Loans, annualized: Interest and fees on loans (GAAP)$ 50,450 $ 41,025 Exclude interest and fees on SBA PPP loans (26) (3,081) 43
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Three Months Ended
March 31,
2023 2022
(Dollars in thousands)
Exclude incremental accretion on acquired loans (253) (584)
Adjusted interest and fees on loans (non-GAAP) $
50,171
Average loans receivable, net (GAAP)$ 4,039,395 $ 3,773,325 Exclude average SBA PPP loans (1,071) (109,594) Adjusted average loans receivable, net (non-GAAP) $
4,038,324
Loan yield, annualized (GAAP) 5.07 % 4.41 %
Loan yield, excluding SBA PPP loans and incremental accretion on acquired loans, annualized (non-GAAP)
5.04 % 4.14 %
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