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Item 1A. Risk Factors

2022-02-25 compared with 2021-02-26 · 115 added, 147 removed, 266 unchanged (50% of the section changed)

We assume and manage a certain degree of risk in order to conduct our business strategy.

The following provides a discussion of material risks that management believes are specific to our business.

The following provides a

discussion of material risks that management believes are specific to our business.

This discussion should not be viewed as an all-inclusive list or in any particular order.

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economy, and could potentially create business continuity issues for us.

The worldwide COVID-19 pandemic has negatively affected our business and is likely to continue to do so.

The COVID-19 pandemic has caused major economic disruption and volatility in the financial markets both in the United States and globally.

In our market areas, stay-at-home orders, social distancing and travel restrictions, and similar orders imposed across the United States to restrict the spread of COVID-19, resulted in significant business and operational disruptions, including business closures, supply chain disruptions, and significant layoffs and furloughs.

While the stay-at-home orders have terminated or been phased-out along with reopening of businesses in certain markets, localities in the Pacific Northwest, where we do primarily the most business, have resumed such orders in November 2020 and still apply capacity restrictions and health and safety recommendations that encourage continued social distancing and working remotely, thereby limiting the ability of businesses to return to pre-pandemic levels of activity.

As of December 31, 2020, all of our branch lobbies remain closed with most services processed through the drive-up, where applicable, or by appointment.

Further branch reopening will occur based on further guidance received from the state and local governments and our determination that is safe for our customers and employees.

Currently, a portion of our employees are working remotely to enable us to continue to provide banking services to our customers during the shelter in place orders.

Heightened cybersecurity, information security and operational risks may result from these work-from-home arrangements.

We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic.

Further, we also rely upon our third-party vendors to conduct business and to process, record, and monitor transactions.

If any of these vendors are unable

to continue to provide us with these services, it could negatively impact our ability to serve our customers.

Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic.

As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on the Company's business, prospects, credit quality, revenues and asset values.

To date, the COVID-19 pandemic has resulted in declines in loan demand and loan originations other than through government sponsored programs such as the SBA's PPP.

The COVID-19 pandemic has also impacted market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments.

Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the continued low targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected in the near term, if not longer.

Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as revenues declined precipitously, especially in businesses related to travel, hospitality, leisure, and physical personal services.

Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to the Pacific Northwest region over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.

The impact of the pandemic is expected to continue to adversely affect us during 2021 as the ability of many of our customers to make loan payments has been significantly affected.

Although the Company has made estimates of credit losses related to the pandemic as part of its evaluation of the ACL on loans, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact that the pandemic will have on the credit quality of our loan portfolio.

The extent of the economic impact of the pandemic is also impossible to determine with certainty at this time as it is partly dependent on a still evolving virus.

Accordingly, estimates of the pandemic's effect on credit losses could change over time as additional information becomes available.

If our estimates are incorrect, our ACL on loans may not be sufficient to cover losses in our loan portfolio, resulting in the need for increases in our ACL on loans through the provision for credit losses which is recorded and charged against income.

Any increases in the ACL on loans will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.

As of December 31, 2020, we hold and service a portfolio of SBA PPP loans totaling $715.1 million.

These SBA PPP loans are subject to the provisions of the CARES Act as well as complex and evolving rules and guidance issued by the SBA and other government agencies.

We expect that the great majority of our SBA PPP borrowers will seek full or partial forgiveness of their loan obligations.

We have credit risk on SBA PPP loans if the SBA determines that there is a deficiency in the manner in which we originated, funded or serviced loans, including any issue with the eligibility of a borrower to receive a SBA PPP loan.

We could face additional risks in our administrative capabilities to service our SBA PPP loans, and risk with respect to the determination of loan forgiveness, depending on any further updates to the final procedures for determining loan forgiveness.

In the event of a loss resulting from a default on a SBA PPP loan and a determination by the SBA that there was a deficiency in the manner in which we originated, funded or serviced a SBA PPP loan, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty or, if the SBA has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

As of December 31, 2020, there was no ACL on SBA PPP loans.

In addition to SBA PPP loans, the Company is providing assistance to commercial business loan borrowers in response to the economic disruption caused by COVID-19 by offering short-term modifications such as interest only payments, payment deferrals, loan re-amortization, and increases of lines of credit.

Also, the Company is assisting mortgage and consumer loan borrowers by offering short-term modifications for payment deferrals when the borrower meets certain criteria, or on a case-by-case analysis.

Notwithstanding these COVID Modifications, these borrowers may not be able to resume making full payments on their loans once the COVID-19 pandemic is resolved.

If the economic disruption from the COVID-19 pandemic continues for several months or worsens, it may result in increased loan delinquencies, adversely classified loans and loan charge-offs.

As a result, our ACL on loans may require additional provision for credit losses to absorb losses in our loan portfolio, which may cause our results of operations, liquidity and financial condition to be adversely affected.

Further, given the widespread level of disruption to commercial and consumer activity due to COVID-19, the Company decided to adopt certain measures to assist its deposit customers in affected areas.

These measures include the waiver of certain fees and charges, such as early withdrawal penalties for certificates of deposit and overdrafts, and while important to assist our customers, these concessions will negatively impact our results of operations.

In accordance with GAAP, and as a part of our prior business combinations, we recorded assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired, resulting in the recognition of goodwill.

If adverse economic conditions persist or we experience a decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges.

Any impairment charge could have a material adverse effect on our results of operations and financial condition.

We are an entity separate and distinct from our principal subsidiary, Heritage Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary.

If the COVID-19 pandemic were to materially adversely affect Heritage Bank’s regulatory capital levels or liquidity, it may result in Heritage Bank being unable to pay dividends to us, which may result in our not being able to pay dividends on our common stock at the same rate or at all.

The ultimate impact of the COVID-19 pandemic on our business, results of operations and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the

Even after the COVID-19 pandemic subsides, the U.S.

economy may continue to experience the recession, and we anticipate our business would be materially and adversely affected by a prolonged recession.

The COVID-19 Pandemic continues to negatively impact economic and commercial activity and financial markets, both globally and within the United States.

In our market areas, stay-at-home orders, travel restrictions and closure of non-essential business and similar orders imposed across the United States to restrict the spread of the COVID-19 Pandemic in 2020 resulted in significant business and operational disruptions, including business closures, supply chain disruptions and significant layoffs and furloughs.

Although local jurisdictions have subsequently lifted stay-at-home orders and moved to the opening of businesses, worker shortages, vaccine and testing requirements, new variants of COVID-19 and other health and safety recommendations have impacted the ability of businesses to return to pre-pandemic levels of activity and employment.

While the overall economy has improved, disruptions to supply chains continue and significant inflation has been seen in the market.

If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated, including the following risks from the COVID-19 Pandemic, any of which could have a material, adverse effect on our business, financial condition, liquidity and results of operations of the Company:

• effects on key employees, including operational management personnel and those charged with preparing, monitoring and evaluating our financial reporting and internal controls;

• declines in demand for loans and other banking services and products, as well as a decline in the credit quality of our loan portfolio owing to the effects of the COVID-19 Pandemic in the markets served by us;

• if the economy is unable to remain open in an efficient manner, loan delinquencies, problem assets and foreclosures may increase, resulting in increased charge-offs and reduced income;

• collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

• our allowance for credit losses on loans may increase if borrowers experience financial difficulties, which will adversely affect net income;

• the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments;

• as long as the Federal Reserve Board’s target federal funds rate remains near 0%, the yield on assets may decline to a greater extent than the decline in the cost of interest-bearing liabilities, reducing net interest margin and spread and reducing net income;

• higher operating costs, increased cybersecurity risks and potential loss of productivity as a result of an increase in the number of employees working remotely;

• increasing or protracted volatility in the price of the Company’s common stock, which may also impair our goodwill;

• risks to the capital markets that may impact the performance of our investment securities portfolio as well as limit our access to capital markets and other funding sources.

Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent of the COVID-19 Pandemic’s effects on our business, operations or the global economy as a whole.

Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, possible future virus variants, the effectiveness of our work-from-home arrangements, third party providers’ ability to support our operations and any actions taken by governmental authorities and other third parties in response to the pandemic.

The uncertain future development of this crisis could materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.

Risks Related to our Business Strategy

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If the integration process is not conducted successfully and with minimal effect on the acquired business and its customers, we may not realize the anticipated economic benefits of an acquisition within the expected time frame, and we may lose customers or employees of the acquired business.

We may also experience greater than anticipated customer losses even if the integration process is successful.

We may also experience greater than anticipated customer losses even if the

integration process is successful.

• to finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or raise additional capital, which could dilute the interests of our existing shareholders;

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If we do not successfully execute our acquisition growth plan, it could adversely affect our business, financial condition, results of operations, reputation and growth prospects.

In addition, if we were to conclude that the value of an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in an impairment of goodwill charge

to us, which would adversely affect our results of operations.

While we believe we have the executive management resources and internal systems in place to successfully manage our future growth, there can be no assurance that suitable growth opportunities will be available or that we will successfully manage our growth.

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In addition, as part of our commercial business lending activities, we originate agricultural loans.

Agricultural lending involves a greater degree of risk.

Payments on agricultural loans are typically dependent on the profitable operation or management of the related farm property.

The success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products (both domestically and internationally), changes in the economy (such as tariffs) and the impact of government regulations (including changes in price supports, subsidies and environmental regulations).

Payments on agricultural loans are typically dependent on the profitable operation or management of the related farm property and the success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products (both domestically and internationally), changes in the economy (such as tariffs) and the impact of

government regulations (including changes in price supports, subsidies and environmental regulations).

In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm.

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In such cases, any repossessed collateral for a defaulted agricultural operating loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation or because the assessed value of the collateral exceeds the eventual realization value.

At December 31, 2020, our commercial business loans totaled $3.72 billion, or approximately 83.1% of our total loan portfolio.

Approximately $56.8 million, or 1.5% of our commercial business loans, were nonperforming at December 31, 2020.

At December 31, 2021, our commercial business loans totaled $3.19 billion, or 83.7% of our total loan portfolio, of which $23.1 million, or 0.7%, were classified as nonaccrual at December 31, 2021.

The majority of the nonperforming commercial business loans were secured by real estate.

Our agricultural loans totaled $81.6 million, or 1.8% of our total loan portfolio and 2.2% of our commercial business loans at December 31, 2020.

Nonperforming agricultural loans totaled $17.8 million, or 30.6% of nonperforming loans at December 31, 2020.

Within commercial business loans, agricultural loans totaled $64.7 million, or 1.7% of our total loan portfolio and 2.0% of our commercial business loans at December 31, 2021.

Nonaccrual agricultural loans totaled $5.1 million, or 21.5% of nonaccrual loans at December 31, 2021.

Our owner and non-owner occupied commercial real estate loans, which include multifamily residential real estate loans, involve higher principal amounts than other loans and repayment of these loans may be dependent on factors outside our control or the control of our borrowers.

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For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired.

There is little difference in risk between owner-occupied commercial real estate loans and non-owner occupied commercial real estate loans.

Commercial real estate loans also expose us to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate.

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Accordingly, if we make any errors in judgment regarding the collectability of our commercial real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.

As of December 31, 2020, our owner and non-owner occupied commercial real estate loans totaled $2.27 billion, or 50.7% of our total loan portfolio.

Approximately $25.5 million, or 1.1% of our owner and non-owner occupied commercial real estate loans, were nonperforming at December 31, 2020.

Our real estate construction and land development loans are based upon estimates of costs and the related value associated with the completed project.

As of December 31, 2021, our owner and non-owner occupied commercial real estate loans totaled $2.42 billion, or 63.6% of our total loan portfolio, of which $12.8 million, or 0.5%, were classified as nonaccrual at December 31, 2021.

Our real estate construction and land development loans are based upon estimates of costs and net operating income and the related value associated with the completed project.

These estimates may be inaccurate.

Construction lending involves additional risks when

compared with permanent commercial and residential lending because funds are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion.

Construction lending involves additional risks when compared with permanent commercial and residential lending because funds are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion.

Because of the uncertainties inherent in estimating construction costs, as well as the market value of the complete project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio.

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This may require us to advance additional funds and/or contract with another builder to complete construction and assume the market risk of selling the project at a future market price, which may or may not enable us to fully recover unpaid loan funds and associated construction and liquidation costs.

Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an end-purchaser for the finished project.

Furthermore, in the case of speculative construction loans, there is added risk associated with identifying an end-tenant or end-purchaser for the finished project.

Land development loans also pose additional risk because of the lack of income being produced by the property and potential illiquid nature of the collateral.

These risks can be significantly impacted by supply and demand conditions.

As of December 31, 2020, our real estate construction and land development loans totaled $305.7 million, or 6.9% of our total loan portfolio.

Of these loans, $78.3 million, or 1.8% of our total loan portfolio, were residential construction and $227.5 million, or 5.1% of our total loan portfolio, were commercial and multifamily construction.

Approximately $1.0 million, or 0.3% of our total real estate construction and land development loans, were nonperforming at December 31, 2020.

As of December 31, 2021, our real estate construction and land development loans totaled $226.9 million, or 5.9% of our total loan portfolio, of which $85.5 million, or 2.2% of our total loan portfolio, were residential construction and $141.3 million, or 3.7% of our total loan portfolio, were commercial and multifamily construction.

Within this category, $571,000, or 0.3% of our total real estate construction and land development loans, were classified as nonaccrual at December 31, 2021.

Our ACL on loans may prove to be insufficient to absorb losses in our loan portfolio.

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The determination of the appropriate level of ACL on loans inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes.

If our estimates are incorrect, the ACL on loans may not be sufficient to cover credit losses inherent in our loan portfolio, resulting in the need for increases in our ACL on loans through the provision for credit losses which is charged against income.

Management also recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our ACL on loans may be insufficient to absorb losses without significant additional provisions.

Management also recognizes that significant new growth in loan segments and new loan products can result in loans segments comprised of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our ACL on loans may be insufficient to absorb losses without significant additional provisions.

Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the ACL on loans.

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If our ACL on loans is not sufficient to cover actual loan losses our earnings could decrease.

For the year ended December 31, 2020 we recorded a provision for credit losses on loans of $35.4 million compared to $4.3 million for the year ended December 31, 2019, primarily due to forecasted economic conditions amidst the COVID-19 pandemic.

We recorded net charge-offs of loans of $3.2 million for both of the years ended December 31, 2020 and December 31, 2019.

Our allowance for credit losses on loans was 1.57% of the loan portfolio at December 31, 2020 compared to 1.01% at January 1, 2020, the adjusted beginning balance after CECL adoption, and represented management's best estimate of current expected credit losses over the life of the loans given the current economic conditions.

At December 31, 2020 our total

nonperforming loans were $58.1 million, or 1.30% of loans receivable compared to $44.5 million or 1.18% of loans receivable at December 31, 2019.

Generally, our nonperforming loans reflect operating difficulties of individual borrowers, which may be the result of current economic conditions.

If economic conditions deteriorate, including as a result of COVID-19, we expect that we could experience significantly higher delinquencies and loan charge-offs.

As a result, we may be required to make further increases in our provision for credit losses in the future, which could adversely affect our financial condition and results of operations.

For the year ended December 31, 2021 we recorded a reversal of provision for credit loss on loans of $27.3 million compared to a provision for credit loss on loans of $35.4 million for the year ended December 31, 2020 due primarily to changes in forecasted economic conditions attributable to the COVID-19 Pandemic during each period.

At December 31, 2021 our total nonaccrual loans were $23.8 million, or 0.62% of loans receivable, compared to $58.1 million, or 1.30% of loans receivable, at December 31, 2020.

Generally, our nonaccrual loans reflect operating difficulties of individual borrowers, which may be the result of current economic conditions.

General economic conditions tend to impact loan segments at varying degrees.

At December 31, 2020, our commercial and industrial loan portfolio had the greatest percentage of nonaccrual loans of 53.8% as the borrowers are primarily business owners whose business results are influenced by current economic conditions.

Our owner-occupied commercial real estate loans and non-owner occupied commercial real estate loans portfolio, which contained 31.7% and 12.3%, respectively, of our nonaccrual loans at December 31, 2020, generally have a larger percentage of nonperforming loans because of the same reasons as the commercial and industrial loan portfolio noted above.

At December 31, 2021, our commercial and industrial loan portfolio represented 43.3% of our nonaccrual loans, which was the greatest percentage of any loan category, as the borrowers are primarily business owners whose business results are influenced by current economic conditions.

Owner-occupied commercial real estate loans and non-owner occupied commercial real estate loans represented 34.4% and 19.6%, respectively, of our nonaccrual loans at December 31, 2021.

Risks Related to Economic Conditions

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A decline in the economies of our primary market areas of the Pacific Northwest in which we operate could have a material adverse effect on our business, financial condition, results of operations and prospects.

Weakness in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade and it is not known how the recent changes in tariffs being imposed on international trade may also affect these businesses.

A deterioration in economic conditions in our market areas of the Pacific Northwest could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:

Weakness in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade and it is not known how changes in tariffs being imposed on international trade may also affect these businesses.

A deterioration in economic conditions in our market areas of the Pacific Northwest as a result of the COVID-19 Pandemic or other factors could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:

• loan delinquencies, problem assets and foreclosures may increase;

• we may increase our ACL on loans;

• we may increase our ACL on loans and provision for credit losses;

• the sale of foreclosed assets may be slow;

• our provision for credit losses may increase;

• demand for our products and services may decline, possibly resulting in a decrease in our total loans;

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Deterioration in the real estate markets where collateral for a loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan.

Real estate values are affected by various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as earthquakes and flooding.

Real estate values are affected by various

other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as earthquakes and flooding.

If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected.

Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.

Changes in the United States government and its agencies’ monetary or fiscal policies, including stimulus enacted in response to the COVID-19 Pandemic, could adversely affect our results of operations and financial condition.

Our earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies.

The United States government and its agencies have an important impact on the operating results of banks through their power to implement national monetary policy, among other things, in order to curb inflation, combat a recession or react to impacts from the COVID-19 Pandemic.

We cannot predict the nature or impact of future changes in such monetary and fiscal policies, including stimulus enacted in response to the COVID-19 Pandemic.

Risks Related to Market Interest Rates

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If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected.

Earnings could also be adversely affected if the interest rates decrease, as assets tend to reprice more quickly than liabilities.

Earnings could also be adversely affected if interest rates decrease as assets tend to reprice more quickly than liabilities.

In a changing interest rate environment, we may not be able to manage this risk effectively.

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Interest rates are highly sensitive to many factors that are beyond our control, including general and forecasted economic conditions reflected in the rates offered along the yield curve and the FHLB's fixed-rate advance index, and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve.

In an attempt to help the overall economy recover from the economic slowdown of 2008, the Federal Reserve kept interest rates low through its targeted Fed Funds rate for a number of years.

Starting in 2015, the Federal Reserve steadily increased the targeted Fed Funds rate until March 2020 when it reduced the targeted Fed Funds rate to 25 basis points in response to the COVID-19 pandemic.

If the Federal Reserve increases the targeted federal funds rates, overall interest rates will likely rise, which may negatively impact both the housing market by reducing refinancing activity and new home purchases, and the U.S.

In March 2020, in response to the COVID-19 Pandemic, the FOMC lowered the target range for the federal funds rate 150 basis points to a range of 0.00% to 0.25%.

The reduction in the targeted federal funds rate has resulted in a decline in overall interest rates which has negatively impacted our net interest income.

However, the FOMC has recently indicated it expects to increase rates starting in 2022.

If the FOMC increases the targeted federal funds rate, overall interest rates are expected to rise, which will positively impact our net interest income, but may negatively impact both the housing market, by reducing refinancing activity and new home purchases, and the U.S.

In addition, deflationary pressures, while possibly lowering our operational costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral securing loans which could negatively affect our financial performance.

A sustained increase in market interest rates could adversely affect our earnings.

As is the case with many banks and saving institutions, our emphasis on increasing the development of core deposits (those deposits bearing no or a relatively low rate of interest with no state maturity date) has resulted in our interest bearing liabilities having a shorter duration than our assets.

As is the case with many banks and saving institutions, our emphasis on increasing the development of core deposits (those deposits bearing no or a relatively low rate of interest with no stated maturity date) has resulted in our interest bearing liabilities having a shorter duration than our assets.

We would incur a higher cost of funds to retain these deposits in a rising interest rate environment.

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Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet.

For further discussion of how changes in interest rates could impact us and additional information about our interest rate risk management, see Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

Our investment securities portfolio may be negatively impacted by fluctuations in market value and interest rates.

Our investment securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income (loss), net and/or earnings.

Our investment securities portfolio may be impacted by fluctuations in market value, potentially reducing AOCI and/or earnings.

Fluctuations in market value may be caused by changes in market interest rates, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, lower market prices for securities and limited investor demand.

Our investment securities portfolio is evaluated for estimated credit losses, and an ACL on investment securities available for sale, as appropriate, is recorded as a contra asset on the financial statement of condition.

If this evaluation shows actual or projected cash flows associated with one or more securities is less than the fair value of the security, a potential loss to earnings may occur through a provision for credit loss on investment securities available for sale through earnings.

Our investment securities portfolio is evaluated for estimated credit losses and an ACL on investment securities, as appropriate, is recorded as a contra asset on the financial statement of condition and a provision for credit loss on investment securities through earnings.

There can be no assurance that the declines in market value will not result in credit losses, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.

Risks Related to Laws and Regulations

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Failure to comply with these regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions.

Recently several banking institutions have received large fines for non-compliance with these laws and regulations.

While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.

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We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations.

Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements.

The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations.

Accordingly, our operations are exposed to the risk these vendors will not perform in accordance with contracted arrangements under service level agreements.

The failure of an external vendor to perform in accordance with contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition, level of support for existing products and services, strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations.

We also could be adversely affected to the extent a service agreement is not renewed by the third-party vendor or is renewed on terms less favorable to us.

Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties.

Disruptions or failures in the physical infrastructure or

operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.

Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in client attrition;

regulatory fines, penalties or intervention;

reputational damage;

reimbursement or other compensation costs and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.

We are subject to certain risks in connection with our use of technology .

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Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation .

Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, and vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions.

Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries and vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and/or controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions.

Any compromise of our security could deter customers from using our internet banking services that involve the transmission of confidential information.

We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data.

Although we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these precautions may not protect our systems from compromises or breaches of our security measures and could result in losses to us or our customers, our loss of business and/or customers, damage to our reputation, the incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.

incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.

Our security measures may not protect us from system failures or interruptions.

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While the Company selects third-party vendors carefully, it does not control their actions.

If our third-party providers encounter difficulties, including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted.

If our third-party providers encounter difficulties, including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected and to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted.

Replacing these third-party vendors could also entail significant delay and expense.

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We may not be insured against all types of losses as a result of third-party failures and insurance coverage may be inadequate to cover all losses resulting from breaches, system failures or other disruptions.

If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all.

If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services and we cannot assure we could negotiate terms that are as favorable to us or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all.

Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny or could expose us to legal liability.

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While we assess and improve these programs on an ongoing basis, there can be no assurance that our risk management or compliance programs, along with other related controls, will effectively mitigate all risk and limit losses in our business.

However, as with any

risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately anticipated or identified.

However, as with any risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately anticipated or identified.

If our risk management framework proves ineffective, we could suffer unexpected losses and our business, financial condition and results of operations could be materially adversely affected.

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Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.

As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customer’s information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation.

The Company and the Bank are susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customer’s information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation.

Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts.

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We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective.

Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.

Negative publicity regarding

our business, employees or customers, with or without merit, may result in the loss of customers, investors and employees;

costly litigation;

a decline in revenues and increased governmental regulation.

We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.

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We may not be able to effectively implement new technology-driven products or services or be successful in marketing these products and services.

Additionally, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may cause services interruptions, transaction processing errors and system conversion delays and may cause us to fail to comply with applicable laws.

Additionally, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may cause service interruptions, transaction processing errors and system conversion delays and may cause us to fail to comply with applicable laws.

There can be no assurance that we will be able to successfully manage the risks associated with increased dependency on technology.

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These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time.

impact on our operations, increase our costs of regulatory compliance and of doing business and adversely affect our profitability.

Any new regulations or legislation, change in existing regulation or oversight, whether a change in regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory compliance and of doing business and adversely affect our profitability.

Regulatory authorities also have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and adequacy of an institution's ACL.

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Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carried on the acquirer’s balance sheet as goodwill.

In accordance with GAAP, our goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists.

The evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of common stock of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable acquisitions.

At December 31, 2020, we had goodwill with a carrying amount of $240.9 million.

Declines in our stock price or a prolonged weakness in the operating environment of the financial services industry may result in a future impairment charge.

Any such impairment charge could have a material adverse effect on our operating results and financial condition.

In accordance with GAAP, our goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances indicate a potential impairment exists.

The evaluation may be based on a variety of quantitative factors, including the quoted price of our common stock, market prices of common stock of other banking organizations, common stock trading multiples, discounted cash flows and data from comparable acquisitions.

Additionally, we may perform a qualitative assessment that takes into consideration macroeconomic conditions, industry and market conditions, cost or margin factors, and financial performance.

Our evaluation of the fair value of goodwill involves a substantial amount of judgment.

If our judgment was incorrect, or if events or circumstances change, and an impairment of goodwill was deemed to exist, we would be required to write down our goodwill resulting in a charge against income, which could adversely affect our results of operations and financial condition, perhaps materially;

however, it would have no impact on our liquidity, operations or regulatory capital.

Other Risks Related to Our Business

Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR may adversely affect our results of operations.

We have certain loans and investment securities indexed to LIBOR to calculate the loan interest rate.

The continued availability of the LIBOR index is not guaranteed after 2021.

We will be required to transition from the use of the London Interbank Offered Rate ("LIBOR") in the future.

FHLB advances, loans receivable, investment securities, subordinated debentures and trust preferred securities may be indexed to LIBOR to calculate the interest rate.

The continued availability of the LIBOR index is not guaranteed after 2021 and LIBOR is scheduled to be eliminated entirely by June 2023.

We cannot predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted.

At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR with the exception of overnight repurchase agreements, which are expected to be based on the Secured Overnight Financing Rate, or SOFR, and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally.

SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members.

Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR).

SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions.

Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question and the future of LIBOR remains uncertain at this time.

Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser extent investment securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our subordinated debentures and trust preferred securities.

If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers or our existing borrowings, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.

At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight

repurchase agreements, which are expected to be based on SOFR).

Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our trust preferred securities.

The language in our LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor rate to the designated rate would be selected.

If a trigger is satisfied, contracts and financial instruments may give the calculation agent discretion over the substitute index or indices for the calculation of interest rates to be selected.

The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers or our borrowings may result in our incurring significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices and may result in disputes or litigation with clients and creditors over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations .

To mitigate the uncertainty surrounding the LIBOR transition, the Bank has been utilizing specific contract language in new loan agreements that provides for changes in the index used to calculate the loan's interest rate.

Additionally, effective January 25, 2021, the Company has agreed to adhere 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.

As of January 25, 2021, more than 12,000 entities across nearly 80 jurisdictions have adhered to this protocol which is expected to support a smooth transition from LIBOR to a replacement index.

Additionally, effective January 25, 2021, the Company agreed to adhere to the Interbank Offered Rate Fallbacks Protocol as published by the International Swaps and Derivatives Association, Inc recommended by the Alternative Reference Rates Committee.

Decreased volumes and lower gains on sales of mortgage loans sold could adversely impact our noninterest income.

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We generate gains on the sale of residential real estate loans pursuant to programs currently offered by the Federal Home Loan Mortgage Corporation and other secondary market purchasers.

Any future changes in their purchase programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations.

Any future changes in these purchase programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations.

Further, in a rising or higher interest rate environment, our originations of mortgage loans may decrease resulting in fewer loans that are available to be sold to investors.

This would result in a decrease in mortgage banking income and a corresponding decrease in noninterest income.

This would result in a decrease in gain on loans, net and a corresponding decrease in noninterest income.

In addition, our results of operations are affected by the amount of noninterest expense associated with mortgage banking activities, such as salaries and employee benefits;

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Effective liquidity management is essential to our business.

We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash

commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress.

We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress.

An inability to raise funds through deposits, borrowings, the sale of loans or investment securities and other sources could have a substantial negative effect on our liquidity.

We rely on customer deposits and at times, borrowings from the FHLB and certain other wholesale funding sources to fund our operations.

We rely on customer deposits and borrowings from the FHLB and certain other wholesale funding sources to fund our operations.

Deposit flows and the prepayment of loans and mortgage-related investment securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived, and the competition for deposits and loans in the markets we serve.

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Although we have historically been able to replace maturing deposits and borrowings if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB or market conditions change.

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry or deterioration in credit markets.

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable could be impaired by factors that affect us, the financial services industry or the economy in general, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry or deterioration in credit markets.

Additional factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our deposits and loans are concentrated, negative operating results or adverse regulatory action against us.

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Although these funds historically have been a relatively stable source of funds for us, availability depends on the individual municipality's fiscal policies and cash flow needs.

Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high;

further, the resulting dilution of our equity may adversely affect the market price of our common stock.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.

At some point, we may need to raise additional capital to support our growth or replenish future losses.

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance.

If we are able to raise capital it may not be on terms that are acceptable to us.

Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all.

If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our financial condition and liquidity could be materially and adversely affected.

In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common stock.

Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.

Societal responses to climate change could adversely affect our business and performance, including indirectly through impacts on our customers.

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The impact on our customers will likely vary depending on their specific attributes, including reliance on or role in carbon intensive activities.

Among the impacts to us could be a drop in demand for our products and services, particularly in certain industry sectors.

Among the impacts to us could be a drop in demand for our products and services,

particularly in certain industry sectors.

In addition, we could face reductions in creditworthiness on the part of some customers or in the value of assets securing loans.

Our efforts to take these risks into account in making lending and other decisions, including by increasing our business with climate-friendly companies, may not be effective in protecting us from the negative impact of new laws and regulations or changes in consumer or business behavior.

We rely on dividends from Heritage Bank for substantially all of our revenue at the holding company level.

We are an entity separate and distinct from our subsidiary, Heritage Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary.

Risk Related to Holding Our Common Stock

Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high;

further, the resulting dilution of our equity may adversely affect the market price of our common stock.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.

At some point, we may need to raise additional capital to support our growth or replenish future losses.

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance.

Accordingly, we cannot make assurances we will be able to raise additional capital, if needed, on terms that are acceptable to us or at all.

In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common stock.

Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.

We rely on dividends from the Bank for substantially all of our revenue at the holding company level.

We are an entity separate and distinct from our subsidiary, the Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary.

Accordingly, we are, and will be, dependent upon dividends from the Bank to pay the principal of and interest on our indebtedness, to satisfy our other cash needs and to pay dividends on our common stock.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 1A. Risk Factors