What changed in this filing

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Item 8. Financial Statements and Supplementary Data

2022-02-25 compared with 2021-02-26 · 623 added, 986 removed, 1455 unchanged (53% of the section changed)

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Report of Independent Registered Public Accounting Firm

Stockholders and the Board of Directors of Heritage Financial Corporation

Shareholders and the Board of Directors of Heritage Financial Corporation

Olympia, Washington

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We also have audited the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America.

Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in the 2013 Internal Control – Integrated Framework issued by COSO.

Change in Accounting Principle

As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for allowance for credit losses effective January 1, 2020 due to the adoption of Financial Accounting Standards Board Accounting Standards Codification No.

326, Financial Instruments – Credit Losses (ASC 326).

The Company adopted the new current expected credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles.

The adoption of the new credit loss standard and its subsequent application is also communicated as a critical audit matter below.

Basis for Opinions

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A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the

and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that:

(1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments.

The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Credit Losses on Loans – Modeling Techniques and Qualitative Risk Factor Adjustments

As described in Note 1, “Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements” and Note 5, “Allowance for Credit Losses (“ACL”) on Loans” to the consolidated financial statements, the Company’s consolidated allowance for credit losses on loans was $70.2 million at December 31, 2020.

Provision for credit losses on loans was $35.4 million for the year then ended.

On January 1, 2020, the Company adopted ASC 326 which replaced the probable incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology.

Upon adoption, the Company recorded a reduction to retained earnings, net of tax of $5.6 million, which includes the impact for both loans and unfunded commitments, as a cumulative-effect adjustment using a modified retrospective approach.

See change in accounting principle explanatory paragraph above.

The ACL on loans evaluation, upon adoption and at December 31, 2020, is inherently subjective, as it utilizes estimates that require a high degree of judgment relating to risk characteristics of loan segments, macroeconomic variables used in forecasting, and other qualitative risk factors.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that:

(1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments.

The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Credit Losses on Loans – Qualitative Allowance

As described in Note 1, “Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements” and Note 4, “Allowance for Credit Losses (“ACL”) on Loans” to the consolidated financial statements, the Company’s consolidated allowance for credit losses on loans was $42.4 million at December 31, 2021 and reversal of provision for credit losses on loans was $27.3 million for the year then ended.

The ACL on loans evaluation is inherently subjective, as it utilizes estimates that require a high degree of judgment relating to risk characteristics of loan segments, macroeconomic variables used in forecasting, and other qualitative risk factors.

Changes in these judgments and estimates could have a material effect on the Company’s financial results.

The Company primarily uses a historic loss, open pool CECL methodology to calculate the ACL on loans, which the Company has applied to identified loan segments with similar risk characteristics.

The methodology incorporates a macroeconomic sensitive model which calculates multipliers for each loan segment to account for the current and forecasted conditions that adjust the baseline historical loss rates over a reasonable and supportable forecast period.

The forecasted segment balances are impacted by a mix of macroeconomic factors not limited to, but including unemployment rate, GDP, housing price index, commercial real estate price index, disposable income growth, mortgage rates, and certain rate indices.

The macroeconomic sensitive model was developed utilizing regression analysis to determine the factors that were predictive of loss rates based on historical data for each forecasted segment.

Regression modeling is a complex estimation approach for determining loss rates during the forecast period which required significant judgment by management.

The process involved the selection of macroeconomic factors and the evaluation of regression analysis outputs to determine the statistical fit of each macroeconomic factor used to forecast expected losses in each statistically modeled portfolio segment.

The Company also utilizes qualitative risk factor adjustments to account for credit losses that are not inherently considered in the quantitative analyses.

The Company primarily uses a historic loss, open pool credit loss methodology to calculate the ACL on loans, which the Company has applied to identified loan segments with similar risk characteristics.

The allowance for collectively evaluated loans is comprised of the baseline loss allowance, the macroeconomic allowance, and the qualitative allowance.

The baseline loss allowance begins with the baseline loss rates calculated using average quarterly historical loss information for an economic cycle.

The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the baseline loss estimate for each loan.

The macroeconomic methodology incorporates a macroeconomic sensitive model which calculates multipliers for each loan segment to account for the current and forecasted conditions that adjust the baseline historical loss rates over a reasonable and supportable forecast period.

Management also considers other qualitative risk factors to further adjust the estimated ACL on loans through a qualitative allowance.

These adjustments are subjectively selected by management and are based on established metrics to estimate risk.

The subjective nature of the qualitative risk factor adjustments requires significant judgment by management both in the selection of qualitative factors to apply, if any, and the magnitude of the adjustment once selected.

The audit procedures over the modeling techniques used to develop the macroeconomic sensitive model involved a high degree of auditor judgment and required significant audit effort including the use of more experienced audit personnel and internal credit and valuation specialists due to its complexity.

Additionally, the audit procedures over the qualitative adjustments utilized in management’s methodology involved especially challenging and subjective auditor judgment.

Therefore, we identified auditing the ACL modeling techniques and qualitative risk factors as a critical audit matter.

Our audit procedures to address this critical audit matter primarily included the following:

• Tested the operating effectiveness of controls over the implementation and application of the macroeconomic sensitive model and related factors including:

◦ The Company’s ACL committee’s oversight and approval of management’s judgments and estimates utilized in the model for ACL on loans.

◦ The Company’s ACL committee’s oversight and approval of management’s application of accounting policies, selection and implementation of model methodologies, and evaluation of qualitative risk adjustments determined by management.

◦ Management’s controls over the completeness and accuracy of the data utilized in the macroeconomic sensitive model

◦ Management’s controls over third-party model validation and testing of model performance.

• Substantively tested management’s process over the implementation and application of the macroeconomic sensitive model and related factors including:

◦ Evaluated the reasonableness and appropriateness of the methodologies employed including, but not limited to, evaluating the soundness and appropriateness of the model’s significant assumptions and judgments.

◦ Utilized internal valuation services as specialists to assist in evaluating the development of the Company’s loss model used for CECL with specific emphasis on the development of the macroeconomic sensitive model.

◦ Tested the completeness and accuracy of the data utilized in management’s CECL methodology to adjust baseline loss rates by loan segment, primarily relating to macroeconomic factors and qualitative risk factors.

◦ Evaluated model sensitivity of different economic scenarios.

◦ Evaluated the reliability and relevancy of data used as a basis for the qualitative risk factor adjustments and the reasonableness of management’s judgments used in the determination of the qualitative risk factor adjustment by loan segment and the resulting allocation to the allowance.

Goodwill Impairment Evaluation

As described in Note 1 “Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements” and Note 8 “Goodwill and Other Intangible Assets” to the consolidated financial statements, the Company’s consolidated goodwill balance was $240.9 million at December 31, 2020, which is allocated to the Company’s single reporting unit.

Goodwill is tested for impairment at the reporting unit at least annually, or more frequently if events or circumstances occur that indicate that it is more-likely-than not that the fair value of the reporting unit is less that it’s carrying value.

Due to deteriorating financial market and economic conditions as a result of the COVID-19 pandemic, the Company determined a triggering event occurred prior to its annual assessment date and consequently engaged a third-party valuation specialist to assist management in performing a quantitative assessment of goodwill as of May 31, 2020.

Based on the quantitative assessment, management estimated the fair value of the reporting unit by weighting results from the market approach and the income approach.

Significant assumptions inherent in the valuation methodologies for goodwill were employed and included, but were not limited to, prospective financial information, growth rates, terminal value, discount rates, and comparable multiples from publicly traded companies in the financial institution industry.

The evaluation of the methodology and the selection and weighting of these assumptions could have a significant impact on either the fair value of the reporting unit, or the determination of goodwill impairment, which could have a material effect on the Company’s financial results.

We identified auditing the Company’s May 31, 2020 goodwill impairment test as a critical audit matter.

The principal considerations for this determination were the degree of auditor judgment in performing procedures over the significant assumptions, which included discount rate, growth rates, terminal value, prospective financial information, selection of relevant market comparable data, and weighting allocation to valuation methodologies, and the use of our internal valuation services as specialists due to its complexity.

The audit procedures over the qualitative allowance utilized in management’s methodology involved especially challenging and subjective auditor judgment, including the use of more experienced audit personnel.

Therefore, we identified auditing the ACL qualitative allowance as a critical audit matter.

Our audit procedures to address this critical audit matter primarily included the following:

• Tested the operating effectiveness of controls over the evaluation of goodwill impairment including controls addressing:

◦ Management’s quarterly evaluation of potential triggering events regarding goodwill impairment.

◦ Management’s evaluation of the methodology and significant assumptions utilized by third-party valuation specialist.

• Substantively tested management’s evaluation of goodwill impairment including:

◦ Tested the completeness and accuracy of data utilized in the model.

◦ Evaluated the reasonableness of management’s judgments regarding forecasted cash flows utilized in the methodology.

◦ Utilized our internal valuation services as specialists to assist in evaluating the appropriateness of the valuation methodologies employed, significant assumptions, and the overall reasonableness of the fair value of the reporting unit.

◦ Evaluated the sensitivity of the fair value to variable financial forecasting scenarios.

• Tested the operating effectiveness of controls over application of the macroeconomic sensitive model and related factors including:

◦ The Company’s ACL committee’s review and approval of the qualitative risk factor adjustments used to derive the qualitative allowance for the ACL on loans, and the relevance and reliability of the data used therein.

◦ Management’s controls over the completeness and accuracy of the data utilized in the qualitative allowance for the ACL on loans.

• Substantively tested management’s application of the macroeconomic sensitive model and related factors including:

◦ Evaluated the reasonableness of management’s judgments used in the determination of the qualitative risk factor adjustments by loan segment and the resulting allocation to the qualitative allowance for the ACL on loans.

◦ Evaluated the reliability and relevancy of data used as a basis for the qualitative risk factor adjustments.

◦ Tested the completeness and accuracy of the data utilized in management’s ACL methodology to derive the qualitative allowance for the ACL on loans.

/s/ Crowe LLP

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894,335 802,163

Investment securities held to maturity, at amortized cost, net (fair value of $ 376,331 and $ 0 , respectively)

Total investment securities 1,277,728 802,163

Loans held for sale 1,476 4,932

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Net interest income 205,789 200,997 199,682

Provision for credit losses 36,106 4,311 5,129

Net interest income after provision for credit losses 164,891 195,371 181,864

(Reversal of) provision for credit losses ( 29,372 ) 36,106 4,311

Net interest income after (reversal of) provision for credit losses 235,161 164,891 195,371

NONINTEREST INCOME:

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Bank owned life insurance income 2,520 4,319 2,160

Gain on sale of other assets, net 4,405 955 246

Other income 5,759 7,474 7,358

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( 23 ) ( 1,188 ) ( 261 )

Other comprehensive income (loss) 14,640 17,833 ( 6,064 )

Amortization of net unrealized gain for the reclassification of investment securities available for sale to held to maturity, net of tax of $( 35 ), $ 0 and $ 0 , respectively

Other comprehensive (loss) income ( 15,622 ) 14,640 17,833

Comprehensive income $ 82,413 $ 61,210 $ 85,390

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CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(In thousands, except per share amounts)

(In thousands, except shares and per share amounts)

Year Ended December 31, 2021

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stock Retained

earnings Accumulated other comprehensive income, net Total

earnings AOCI Total

stockholders’

Balance at December 31, 2020 35,912,243 $ 571,021 $ 224,400 $ 25,018 $ 820,439

Cumulative effect from change in accounting policy (1)

— — ( 5,615 ) — ( 5,615 )

Restricted stock units vested, net of forfeitures of restricted stock awards 110 — — — —

Exercise of stock options 8 122 — — 122

Restricted stock units vested 125,377 — — — —

Stock-based compensation expense — 3,666 — — 3,666

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Net income — — 98,035 — 98,035

Other comprehensive income, net of tax — — — 14,640 14,640

Other comprehensive loss, net of tax — — — ( 15,622 ) ( 15,622 )

Cash dividends declared on common stock ($ 0.81 per share)

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Balance at December 31, 2021 35,105,779 $ 551,798 $ 293,238 $ 9,396 $ 854,432

(1) Effective January 1, 2020, the Company adopted ASU 2016-13, Financial Instruments - Credit Losses .

Year Ended December 31, 2020

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stock Retained

earnings Accumulated other comprehensive (loss) income, net Total

earnings AOCI Total

stockholders’

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— — ( 5,615 ) — ( 5,615 )

Restricted stock units vested, net of forfeitures of restricted stock awards 62 — — — —

Restricted stock units vested 109,853 — — — —

Exercise of stock options 8,248 122 — — 122

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Balance at December 31, 2020 35,912,243 $ 571,021 $ 224,400 $ 25,018 $ 820,439

(1) Effective January 1, 2019, the Company adopted ASU 2016-02, Leases .

(1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses .

Year Ended December 31, 2019

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stock Retained

earnings Accumulated other comprehensive loss, net Total

earnings AOCI Total

stockholders’

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Other comprehensive loss, net of tax — — — 17,833 17,833

Common stock issued in business combination 6,960 230,043 — — 230,043

Cash dividends declared on common stock ($ 0.84 per share)

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Balance at December 31, 2019 36,618,729 $ 586,459 $ 212,474 $ 10,378 $ 809,311

(1) Effective January 1, 2018, the Company adopted ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities .

(1) Effective January 1, 2019, the Bank adopted ASU 2016-02, Leases .

See accompanying Notes to Consolidated Financial Statements.

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Depreciation, amortization and accretion ( 21,739 ) ( 3,612 ) 14,113

Provision for credit losses 36,106 4,311 5,129

Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities ( 11,154 ) 5,757 10,195

(Reversal of) provision for credit losses ( 29,372 ) 36,106 4,311

Stock-based compensation expense 3,666 3,559 3,231

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Bank owned life insurance income ( 2,520 ) ( 4,319 ) ( 2,160 )

Valuation adjustment on other real estate owned — 51 49

Valuation adjustment on interest rate swap 422 — —

(Gain) loss on sale of other real estate owned, net ( 179 ) 227 —

(Gain) loss on sale of other real estate owned — ( 179 ) 227

Gain on sale of mortgage loans held for sale, net ( 3,644 ) ( 5,044 ) ( 2,424 )

Gain on sale of investment securities, net ( 1,518 ) ( 330 ) ( 137 )

Gain on sale of assets held for sale ( 1,043 ) ( 169 ) ( 798 )

Gain on sale of investment securities available for sale, net ( 29 ) ( 1,518 ) ( 330 )

Gain on sale of other assets, net ( 4,405 ) ( 955 ) ( 246 )

Impairment of assets held for sale 145 630 102

Impairment of right of use asset 655 117 —

Loss (gain) on sale of premises and equipment, net 88 ( 75 ) 32

Impairment of ROU asset 160 655 117

Other 19,022 ( 10,732 ) 5,810

Net cash provided by operating activities 69,530 70,331 92,490

Cash flows from investing activities:

Loans originated, net of principal payments ( 692,720 ) ( 126,142 ) ( 106,527 )

Maturities, calls and payments of investment securities available for sale 264,223 242,348 92,563

Loan repayments (originations), net 699,107 ( 692,720 ) ( 126,142 )

Maturities and repayments of investment securities available for sale 254,668 264,223 242,348

Maturities and repayments of investment securities held to maturity 1,255 — —

Purchase of investment securities available for sale ( 616,123 ) ( 152,618 ) ( 242,776 )

Purchase of investment securities held to maturity ( 140,288 ) — —

Proceeds from sales of investment securities available for sale 1,248 55,030 43,962

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Proceeds from bank owned life insurance death benefit — 1,324 —

Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net ( 7,117 ) ( 27,485 ) ( 8,303 )

Net cash received from acquisitions — — 105,974

Net cash used by investing activities ( 538,549 ) ( 125,302 ) ( 109,598 )

Cash received from return of New Market Tax Credit equity method investment 9,642 — —

Capital contributions to low-income housing tax credit partnerships ( 41,911 ) ( 7,117 ) ( 27,485 )

Net cash provided (used) by investing activities 163,763 ( 538,549 ) ( 125,302 )

Year Ended December 31,

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Supplemental non-cash disclosures of cash flow information:

Transfers of loans receivable to other real estate owned $ 270 $ — $ 434

Transfers of properties classified as held for sale to prepaid expenses and other assets from premises and equipment, net 3,243 1,533 1,836

Transfer of investment securities available for sale to held to maturity 244,778 — —

Investment in low-income housing tax credit partnership and related funding commitment 29,551 10,237 46,677

Loans received from return of New Market Tax Credit equity method investment 15,596 — —

ROU assets obtained in exchange for new operating lease liabilities 13,966 1,265 1,505

Transfers of properties classified as held for sale to prepaid expenses and other assets from premises and equipment, net 3,556 3,243 1,533

Cumulative effect from change in accounting policy (1)

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Transfer of bank owned life insurance to prepaid expenses and other assets due to death benefit accrued, but not paid — 2,672 209

Right of use assets obtained in exchange for new operating lease liabilities 1,265 1,505 —

Business Combinations:

Common stock issued for business combinations $ — $ — $ 230,043

Assets acquired (liabilities assumed) in acquisitions:

Investment securities available for sale — — 84,846

Loans receivable — — 718,620

Other real estate owned — — 1,796

Premises and equipment — — 3,785

Federal Home Loan Bank stock — — 1,743

Accrued interest receivable — — 2,454

Bank owned life insurance — — 17,116

Prepaid expenses and other assets — — 2,957

Other intangible assets — — 18,345

Goodwill — — 121,910

Deposits — — ( 824,602 )

Federal Home Loan Bank advances — — ( 16,000 )

Securities sold under agreement to repurchase — — ( 462 )

Accrued expenses and other liabilities — — ( 8,439 )

(1) Effective January 1, 2020, 2019, and 2018, the Company adopted ASU 2016-13, Financial Instruments - Credit Losses ;

ASU 2016-02, Leases ;

and ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities ;

respectively.

Transfers of loans receivable to other real estate owned $ — $ 270 $ —

(1) Effective January 1, 2020 and 2019, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses, and ASU 2016-02, Leases, respectively.

See accompanying Notes to Consolidated Financial Statements.

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(a) Description of Business

The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank.

The Bank is headquartered in Olympia, Washington and conducts business from its 53 branch offices at February 26, 2021 located throughout Washington State and the greater Portland, Oregon area.

The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, the Bank.

The Bank is headquartered in Olympia, Washington and conducts business from its 49 branch offices located throughout Washington State and the greater Portland, Oregon area.

The Bank’s business consists primarily of commercial lending and deposit relationships with small and medium-sized businesses and their owners in its market areas and attracting deposits from the general public.

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Actual results, however, could differ significantly from those estimates.

Material estimates that are particularly susceptible to significant change relate to management's estimate of ACL on loans, management's estimate of ACL on unfunded commitments, management's evaluation of goodwill impairment and the fair value of financial instruments.

It is reasonably possible that management's estimate of the ACL on loans of $ 70.2 million at December 31, 2020 as disclosed in Note (5) Allowance for Credit Losses on Loans, management's estimate of the ACL on unfunded commitments of $ 4.7 million as disclosed in Note (15) Commitments and Contingencies, management's conclusion that the fair value of the reporting unit more likely than not exceeds its carrying value at December 31, 2020 as disclosed in Note (8) Goodwill and Other Intangible Assets and the estimates of fair value of financial instruments as disclosed in Note (18) Fair Value Measurements could materially change.

In particular, these estimates have been and will continue to be affected by the ongoing COVID-19 pandemic.

The severity, magnitude and duration, as well as the economic consequences of the COVID-19 pandemic, are uncertain, rapidly changing and difficult to predict.

As a result, our accounting estimates and assumptions may change over time in response to the COVID-19 pandemic.

Material estimates that are particularly susceptible to significant change relate to management's estimate of the ACL on investment securities, management's estimate of the ACL on loans, management's estimate of the ACL on unfunded commitments, management's evaluation of goodwill impairment and management's estimate of the fair value of financial instruments.

The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiary, the Bank.

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Certain prior year amounts in the Consolidated Statements of Income have been reclassified to conform to the current year’s presentation.

Reclassifications had no effect on the prior years' net income or stockholders’ equity.

Reclassifications had no effect on the prior year's net income or stockholders’ equity.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and due from banks and interest-bearing balances due substantially from the Federal Reserve Bank.

Cash and cash equivalents include cash on hand and in banks and interest earning deposits due substantially from the Federal Reserve Bank.

Cash equivalents have a maturity of 90 days or less at the time of purchase.

Investment Securities

The Company identifies investments as held to maturity or available for sale at the time of acquisition.

Securities are classified as held to maturity when the Company has the ability and positive intent to hold them to maturity.

Securities classified as available for sale are available for future liquidity requirements and may be sold prior to maturity.

As of December 31, 2020 and December 31, 2019, the Bank does not hold any securities classified as held to maturity.

Securities available for sale are carried at fair value.

Interest income includes amortization of purchase premiums or accretion of purchase discounts using the interest method.

Unrealized gains and losses on securities available for sale are excluded from earnings and are reported in other comprehensive income (loss), net.

Realized gains and losses on sale of investment securities are computed on the specific identification method.

Transfers of securities between the available for sale and held to maturity categories, if executed, are accounted for at fair value.

A debt security is placed on nonaccrual status at the time any principal or payments become more than 90 days delinquent.

Interest accrued, but not received for a security placed on nonaccrual, is reversed against interest income during the period that the debt security is placed on nonaccrual status.

Investment securities for which the Bank has the positive intent and ability to hold to maturity are classified as held to maturity and are carried at amortized cost.

Investment securities held primarily for the purpose of selling in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses included in income.

Investment securities not classified as held to maturity or trading are classified as available for sale and are reported at fair value with unrealized gains and losses, net of income taxes, as a separate component of other comprehensive income.

The Bank determines the appropriate classification of investment securities at the time of purchase and reassesses the classification at each reporting date.

Any subsequent reassessment of classification and transfer of investment securities available for sale to held to maturity are completed at the amortized cost basis plus or minus the amount of any remaining unrealized holding gain or loss reported in AOCI of the individual investment securities available for sale.

The unrealized holding gain or loss at the date of the transfer continues to be recognized in AOCI, but that gain or loss is amortized over the remaining life of the security using the interest method.

When the Company acquires another entity, all investment securities are recorded at fair value and classified as available for sale at the acquisition date.

Realized gains and losses on sales of investment securities are recorded on the trade date in gain on sale of investment securities, net on the Consolidated Statements of Income and determined using the specific identification method.

Premiums and discounts on investment securities available for sale and held to maturity are amortized or accreted into income using the interest method.

An investment security available for sale or held to maturity is placed on nonaccrual status at the time any principal or payments become more than 90 days delinquent and classified as past due after 30 days of nonpayment.

Interest accrued, but not received for an investment security classified as nonaccrual is reversed against interest income during the period that the investment security is placed on nonaccrual status.

ACL on Investment Securities Available for Sale

Management evaluates the need for an ACL on investment securities available for sale on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

For investment securities available for sale in an unrealized loss position, the Company first assesses whether it intends to sell or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis.

For investment securities available for sale in

an unrealized loss position, the Company first assesses whether it intends to sell or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis.

If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through a provision for credit loss against income.

4 unchanged sentences

Any unrealized decline in fair value that has not been recorded through an ACL on investment securities available for sale is recognized in other comprehensive income.

Accrued interest receivable on investment securities available for sale is excluded from the estimate of expected credit losses.

Changes in the ACL on investment securities available for sale are recorded as provision for credit losses expense.

Losses are charged against the ACL when management believes the uncollectability of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met.

ACL on Investment Securities Held to Maturity

The Company measures expected credit losses on investment securities held to maturity on a pooled, collective basis by major investment security type with similar risk characteristics.

A historical lifetime probability of default and severity of loss in the event of default is derived or obtained from external sources and adjusted for the expected effects of reasonable and supportable forecasts over the expected lives of the investment securities on those historical credit losses.

Expected credit losses on investment securities in the held to maturity portfolio that do not share similar risk characteristics with any of the pools are individually measured based on net realizable value, or the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the recorded amortized cost basis of the investment securities.

Accrued interest receivable on investment securities held to maturity is excluded from the estimate of expected credit losses.

Changes in the ACL on investment securities held to maturity are recorded as provision for credit losses expense.

Losses are charged against the ACL when management believes the uncollectability of an investment security held to maturity is confirmed.

Loans Held for Sale

Mortgage loans held for sale are carried at the lower of amortized cost or fair value.

Any loan that management does not have the intent and ability to hold for the foreseeable future or until maturity or payoff is classified as held for sale at the time of origination, purchase, or securitization, or when such decision is made.

Unrealized losses on loans held for sale are recorded as a valuation allowance and included in other expense on the Consolidated Statements of Income .

Loans Receivable

Loans receivable includes loans originated and indirect loans purchased by the Bank as well as loans acquired in business combinations that management has the intent and ability to hold for the foreseeable future or until maturity or payoff and is reported at amortized cost.

Amortized cost is the outstanding principal balance, net of purchased premiums and discounts, unearned discounts, and net deferred loan origination fees and costs.

Interest on loans is calculated using the simple interest method based on the daily balance of the principal amount outstanding and is credited to income as earned.

Loans receivable includes loans originated, indirect loans purchased by the Bank and loans acquired in business combinations that management has the intent and ability to hold for the foreseeable future or until maturity or payoff and is reported at amortized cost.

Amortized cost is the outstanding principal balance, net of purchased premiums and discounts and net deferred loan origination fees and costs.

Interest on loans is calculated using the interest method based on the daily balance of the principal amount outstanding and is credited to interest income as earned.

Accrued interest receivable for loans receivable is reported within accrued interest receivable on the Consolidated Statements of Financial Condition.

The Company's policies for loans receivable generally do not differ by loan segments or classes unless specified in the following policies.

Purchased Loans:

Loans acquired in a business combination are designated as “purchased” loans.

Upon adoption of ASU 2016-13, the Bank's PCI loans were transitioned to PCD loans.

The Bank elected to account for the PCD loans individually, terminating the pools of loans that were previously accounted for under ASC 310-30.

Loans purchased after January 1, 2020 are recorded at their fair value at acquisition date net of an ACL on loans expected to be incurred over the life of the loan.

Acquired Loans:

Acquired loans are recorded at their fair value at acquisition date net of an ACL on loans expected to be incurred over the life of the loan.

The initial ACL on purchased loans is determined using the same methodology as originated loans.

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The difference between the initial amortized cost basis and the par value of PCD loans is the noncredit discount or premium for PCD loans.

The noncredit discount or premium for PCD loans and both the noncredit and credit discount or premium for non-PCD loans are accreted through the interest and fees on loans line item on the Consolidated Statements of Income over the life of the loan using the effective interest method for non-revolving credits or the straight-line method, which approximates the effective interest method, for revolving credits.

The noncredit discount or premium for PCD loans and both the noncredit and credit discount or premium for non-PCD loans are accreted through the interest and fees on loans line item on the Consolidated Statements of Income over the life of the loan using the interest method for non-revolving credits or the straight-line method, which approximates the effective interest method, for revolving credits.

Any unrecognized discount or premium for a purchased loan that is subsequently repaid in full is recognized immediately into income.

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Loans are considered past due or delinquent when principal or interest payments are past due 30 days or more.

Delinquent loans may remain on accrual status between 30 days and 89 days past due.

The Credit Administration department is also involved in specifically reviewing larger loans that are delinquent more than 30 days past due.

The Bank did not designate loans with payment deferrals granted due to the COVID-19 pandemic as past due in accordance with the CARES Act and related regulatory guidance.

Delinquent loans may generally remain on accrual status between 30 days and 89 days past due.

The Bank did not designate loans with payment deferrals granted due to the COVID-19 Pandemic as past due during their modification period in accordance with the CARES Act and related regulatory guidance.

Nonaccrual and Charged-off Loans :

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All interest accrued, but not collected, on loans deemed nonaccrual during the period is reversed against interest income in that period.

The interest payments received on nonaccrual loans are generally accounted for on the cost-recovery method whereby

the interest payment is applied to the principal balances.

Interest payments received on nonaccrual loans are generally accounted for on the cost-recovery method whereby the interest payment is applied to the principal balances.

Loans may be returned to accrual status when improvements in credit quality eliminate the doubt as to the full collectability of both interest and principal and a period of sustained performance has occurred.

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A TDR is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider.

These concessions may include changes of the interest rate, extension of the maturity date, delay in the timing of the regular payment, or any other actions intended to minimize potential losses.

These concessions may include changes to the interest rate, extension of the maturity date, delay in the timing of the regular payment or any other actions intended to minimize potential losses.

The Bank does not generally forgive principal as part of a TDR, but in those situations where principal is forgiven, the entire amount of such principal forgiveness is immediately charged off to the extent not done so prior to the modification.

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six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.

Borrowers are considered current if they are less than 30 days past due on the contractual payments as of December 31, 2019 under the CARES Act, which the Bank determined was the implementation date of its modification program under related regulatory guidance.

Unfunded Loan Commitments :

Unfunded loan commitments are generally related to the unused portion of the total commitment of a loan or providing credit facilities to clients of the Bank, including standby letters of credit.

These financial instruments are not actively traded and represent off-balance sheet risk to the Bank in excess of the disbursed amounts recognized in the Consolidated Statements of Financial Condition.

Loan Fees and Costs

Direct loan origination fees and costs on originated loans and premiums and discounts on acquired loans, are referred to as "net deferred fees," are deferred and subsequently amortized or accreted as a yield adjustment over the expected life of the loan without prepayment considerations utilizing the interest method, except revolving loans, for which the straight-line method is used.

The objective of the interest method is to calculate periodic interest income at a constant effective yield.

When a loan is paid off prior to maturity, the remaining net deferred fees are immediately recognized into interest income.

In the event loans are sold, the unamortized net deferred fees are recognized as a component of the gain or loss on the sale of loans.

Fees related to lending activities, other than the origination or purchase of loans, are recognized as noninterest income during the period the related services are performed.

Allowance for Credit Losses on Loans

Borrowers are considered current if they were less than 30 days past due on the contractual payments as of December 31, 2019 under the CARES Act, which the Bank determined was the implementation date of its modification program under related regulatory guidance.

The CA Act extended relief offered under the CARES Act through January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier.

The Bank elected to apply the temporary relief under the applicable guidance to certain eligible short-term modifications and did not classify the modifications as TDRs for accounting or disclosure purposes.

However, COVID Modifications whose payment deferral exceeded 180 days following the loans' initial modification were classified as TDRs based on the Bank's internal policy.

Deferred Loan Origination Fees and Costs

Direct loan origination fees and costs on originated loans and premiums and discounts on acquired loans are deferred and subsequently amortized or accreted as a yield adjustment over the expected life of the loan without prepayment considerations utilizing the interest method, except revolving loans for which the straight-line method is used.

When a loan is paid off prior to maturity, the remaining net deferred balance is immediately recognized into interest income.

In the event loans are sold, the unamortized net deferred balance is recognized as a component of the gain or loss on the sale of loans.

The ACL on loans is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected.

Loans are charged against the ACL on loans when management believes the uncollectibility of a loan balance is confirmed.

Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off.

Subsequent recoveries, if any, are credited to the ACL on loans.

Loans are debited against the ACL on loans when management believes the uncollectibility of a loan balance is confirmed and subsequent recoveries, if any, are credited to the ACL on loans.

The Bank records the changes in the ACL on loans through earnings as a provision for credit losses on the Consolidated Statements of Income.

Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans.

The same methodology is applied to all loans consistent with the guidance of the accounting standard which does not require undue complexity.

Under this methodology, the Company has identified segments of loans with similar risk characteristics that align with their identified loan classes.

Loans are determined to be collectively evaluated if they share similar risk characteristics in the segment, or individually evaluated if they do not share similar risk characteristics.

Nonaccrual loans are not considered similar to other loans;

therefore, they are evaluated for credit losses on an individual basis.

The allowance for individually evaluated loans is calculated using either the collateral value method, which considers the likely source of repayment as the value of the

collateral, less estimated costs to sell, or the net present value method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt.

For each loan segment collectively measured for allowance, the allowance is comprised of the baseline loss allowance, the macroeconomic allowance, and the qualitative allowance.

A performing TDR loan is evaluated for allowance on a collective basis with loans with similar risk characteristics.

Nonaccrual TDR loans do not meet the similar characteristics criteria and are evaluated for allowance on an individual basis as described above except that the original interest rate is used to discount the expected cash flows, not the rate specified in the restructuring.

Baseline allowance begins with the baseline loss rates calculated using the Bank's average quarterly historical loss information for an economic cycle.

Under this methodology, loans are either collectively evaluated if they share similar risk characteristics, including performing TDR loans, or individually evaluated if they do not share similar risk characteristics, including nonaccrual loans.

The allowance for individually evaluated loans is calculated using either the collateral value method, which considers the likely source of repayment as the value of the collateral less estimated costs to sell, or the net present value method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt.

Nonaccrual TDR loans are individually evaluated for credit loss except the original interest rate is used to discount the expected cash flows, not the rate specified in the restructuring.

The allowance for collectively evaluated loans is comprised of the baseline loss allowance, the macroeconomic allowance and the qualitative allowance.

The baseline loss allowance begins with the baseline loss rates calculated using the Bank's average quarterly historical loss information for an economic cycle.

The Bank evaluates the historical period on a quarterly basis with the assumption that economic cycles have historically lasted between 10 and 15 years.

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Management reviews the adequacy of the prepayment assumption on a quarterly basis.

Macroeconomic allowance includes consideration of the forecasted direction of the economic and business environment and its likely impact on the estimated allowance as compared to the historical losses over the reasonable and supportable time frame.

Economic forecast models for the current period are uploaded to the model, which targets 16 forecasted macroeconomic factors, such as unemployment rate, GDP, housing price index, commercial real estate price index, disposable income growth, mortgage rates, and certain rate indices.

Macroeconomic factor multipliers are determined through regression analysis and applied to loss rates for each portfolio segment.

The macroeconomic allowance includes consideration of the forecasted direction of the economic and business environment and its likely impact on the estimated allowance as compared to the historical losses over the reasonable and supportable time frame.

Economic forecast models for the current period are uploaded to the model, which targets 16 forecasted macroeconomic factors, such as unemployment rate, gross domestic product, housing price index, commercial real estate price index, disposable income growth, mortgage rates and certain rate indices.

Macroeconomic factor multipliers are determined through regression analysis and applied to loss rates for each segment of loans with similar risk characteristics.

Each of the forecasted segment balances is impacted by a mix of these macroeconomic factors.

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After the reasonable and supportable period, forecasted loss rates revert to historical baseline loss levels over the predetermined reversion period on a straight-lined basis.

The Bank also considers other qualitative risk factors to adjust the estimated ACL on loans calculated by the above mentioned model.

The Bank has a bias for minimal factors unless internal or external factors outside those considered in its historical losses or macroeconomic forecast indicate otherwise.

The Bank has established metrics to estimate the qualitative risk factor by segment based on the identified risk.

The Bank’s ACL model also includes adjustments for qualitative factors, where appropriate.

Since historical information (such as historical net losses and economic cycles) may not always, by themselves, provide a sufficient basis for determining future expected credit losses, the Bank periodically considers the need for qualitative adjustments to the ACL.

The Bank has a bias for minimal qualitative risk factors unless internal or external factors indicate otherwise.

Qualitative adjustments may be related to and include, but not limited to, factors such as:

(i) management’s assessment of economic forecasts used in the model and how those forecasts align with management’s overall evaluation of current and expected economic conditions, (ii) organization specific risks such as credit concentrations, collateral or industry specific risks, regulatory risks, and external factors that may ultimately impact credit quality, (iii) other limitations associated with factors such as underwriting changes, acquisition of new portfolios, changes in portfolio segmentation, and (iv) management’s overall assessment of the adequacy of the ACL, including an assessment of model data inputs used to determine the ACL.

The Bank has established metrics to estimate the qualitative risk factors by segment based on the identified risk.

In general, management's estimate of the ACL on loans uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

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The Bank estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in which the Bank is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Bank.

The Bank has determined that no allowance is necessary for the off-balance sheet portion of the credit card portfolio as it has the ability to unconditionally cancel the available lines of credit.

The allowance methodology for unfunded commitments is similar to the ACL on loans, but additionally includes considerations of the current utilization of the commitment and an estimate of the future utilization as determined appropriate by historical commitment utilization and the Bank's estimates of future utilization given current economic forecasts.

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The Bank originates and sells certain residential real estate loans on a servicing-released basis.

The Bank recognizes a gain or loss to the extent that the sale proceeds of the loan sold differs from the net book value at the time of sale.

The Bank recognizes a gain or loss on sale to the extent that the sale proceeds of the loan sold differs from the net book value at the time of sale.

Income from residential real estate loans brokered to other lenders is recognized into income on date of loan closing.

Commitments to sell residential real estate loans are made primarily during the period between the taking of the loan application and the closing of the loan.

The timing of making these sale commitments is dependent upon the timing of the borrower’s election to lock-in the mortgage interest rate and fees prior to loan closing.

Most of these sale commitments are made on a best-efforts basis whereby the Bank is only obligated to sell the loan if the loan is approved and closed by the Bank.

Commitments to fund residential real estate loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these loans are accounted for as free-standing derivatives.

Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates between the date the interest on the loan was locked and the balance sheet date.

Commitments to fund residential real estate loans and commitments to subsequently sell residential real estate loans are made during the period between the taking of the loan application and the closing of the loan.

The timing of making these commitments is dependent upon the timing of the borrower’s election to lock-in the mortgage interest rate and fees prior to loan closing.

The Company enters into forward commitments for the future delivery of residential real estate loans when interest rate locks are entered into in order to hedge the interest rate risk resulting from its commitments to fund the loans.

Changes in the fair values of these derivatives are included in other income.

These sale commitments are typically made on a best-efforts basis whereby the Bank is only obligated to sell the loan if the loan is approved and closed by the Bank.

Commitments to fund residential real estate loans to be sold into the secondary market and forward commitments for the future delivery of these loans are accounted for as free-standing derivatives, however, the fair values of these freestanding derivatives were not significant at December 31, 2021 or December 31, 2020.

Commercial Loan Sales, Servicing, and Commercial Servicing Asset

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The Company does not sell loans with servicing retained unless it retains a participating interest.

A servicing asset is recorded at fair value upon sale, and the fair value is estimated by discounting estimated net future cash flows from servicing using discount rates that approximate current market rates and using estimated prepayment rates.

A servicing asset is recorded at fair value upon sale which is estimated by discounting estimated net future cash flows from servicing using discount rates that approximate current market rates and using estimated prepayment rates.

Subsequent to initial recognition, all classes of servicing rights are carried at the lower of amortized cost or fair value and are amortized in proportion to and over the period of the estimated net servicing income.

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For purposes of evaluating and measuring impairment, the fair value of servicing rights is measured using a discounted estimated net future cash flow model as described above at least annually.

Any impairment is measured as the amount by which the carrying value of servicing rights exceeds its fair value.

Impairment is determined by stratifying rights into groupings based on predominant risk characteristics including investor type, loan type, and maturity.

Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the carrying amount.

If the Company later determines that all or a portion of the impairment no longer exists for a particular stratum, a reduction of the allowance may be recorded as an increase to income.

Impairment is determined by stratifying rights into groupings based on predominant risk characteristics including investor type, loan type and maturity and recognized through a valuation allowance for an individual stratum to the extent fair value is less than the carrying amount.

If the Company later determines all or a portion of the impairment no longer exists for a particular stratum, a reduction of the allowance may be recorded as an increase to income.

Changes in valuation allowances are reported within other noninterest income on the Consolidated Statements of Income.

The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayments speeds, default rates and losses.

In connection with the sales, the Bank typically makes representations and warranties about the underlying assets conforming to specified guidelines.

If the underlying assets do not conform to the specifications, the Bank may have an obligation to repurchase the assets or indemnify the purchaser against any loss.

The Bank believes the potential for material loss under these arrangements is remote at December 31, 2020, December 31, 2019 and December 31, 2018.

Servicing fee income, which is reported as other noninterest income on the Consolidated Statements of Income, is recorded for fees earned for servicing loans.

In connection with the loan sales, the Bank typically makes representations and warranties about the underlying loans conforming to specified guidelines.

If the underlying loans do not conform to the specifications, the Bank may have an obligation to repurchase the loans or indemnify the purchaser against any loss.

The Bank believes the potential for material loss under these arrangements was remote at December 31, 2021, December 31, 2020 and December 31, 2019.

Servicing fee income is recorded for fees earned for servicing loans and reported as other noninterest income on the Consolidated Statements of Income.

The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned.

The amortization of mortgage servicing rights is netted against loan servicing fee income.

The amortization of mortgage servicing rights is netted against servicing fee income.

Late fees and ancillary fees related to loan servicing were not material for the years ended December 31, 2021, 2020, and 2019.

A premium over the adjusted carrying value is received upon the sale of the guaranteed portion of a SBA or USDA loan.

The Bank's investment in a SBA or USDA loan is allocated among the sold and retained portions of the loan based on the relative fair value of each portion at the time of loan origination, adjusted for payments and other activities.

The Bank's investment in an SBA or USDA loan is allocated among the sold and retained portions of the loan based on the relative fair value of each portion at the time of loan origination, adjusted for payments and other activities.

Because the portion retained does not carry a SBA or USDA guarantee, part of the gain recognized on the sold portion of the loan is deferred and amortized as a yield enhancement on the retained portion in order to obtain a market equivalent yield.

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Other Real Estate Owned

Other real estate acquired by the Company in partial or full satisfaction of a loan obligation is classified as held for sale.

When acquired, the property is recorded at the estimated fair value (less the costs to sell) at the date of acquisition, not to exceed net realizable value, and any resulting write-down is charged against the ACL on loans.

Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure, or when the borrower conveys all interest in the properly to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.

Other real estate owned is recorded at the estimated fair value (less the costs to sell) at the date of acquisition, not to exceed net realizable value, and any resulting write-down is charged against the ACL on loans.

Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the properly to satisfy the loan through completion of a deed in lieu of foreclosure or similar legal agreement.

After acquisition, all costs incurred in maintaining the property are expensed except for costs relating to the development and improvement of the property which are capitalized to the extent of the property’s net realizable value.

If the estimated realizable value of the other real estate owned property declines after the acquisition date, the valuation adjustment is charged to other real estate owned expense, net on the Consolidated Statements of Income.

If the estimated realizable value of the other real estate owned property declines after the acquisition date, the valuation adjustment is charged to other real estate owned, net on the Consolidated Statements of Income.

Premises and Equipment

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Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the lease period, whichever is shorter.

The estimated useful lives used to compute depreciation and amortization for buildings and building

improvements, including lease improvements, is 15 to 39 years;

The estimated useful lives used to compute depreciation and amortization for buildings and building improvements, including lease improvements, is 15 to 39 years;

and for furniture, fixtures and equipment is three to seven years .

The Company reviews buildings, leasehold improvements and equipment for impairment whenever events or changes in the circumstances indicate that the undiscounted cash flows for the property are less than its carrying value.

The Company reviews premises and equipment, including leasehold improvements, for impairment whenever events or changes in the circumstances indicate that the undiscounted cash flows for the property are less than its carrying value.

If identified, an impairment loss is recognized through a charge to earnings based on the fair value of the property.

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The Company's BOLI policies insure the lives of certain current or former Bank officers and name the Bank as beneficiary.

Noninterest income is generated tax-free (subject to certain limitations) from the increase in the policies' underlying investments made by the insurance company.

The Company records BOLI at the amount that can be realized under the insurance contract at the statement of financial condition date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Noninterest income is generated tax-free (subject to certain limitations) from the increase in the policies' underlying

investments made by the insurance company.

The Company records BOLI at the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

ACL on Accrued Interest Receivable

Accrued interest receivable on investment securities available for sale is excluded from the estimate of credit losses on investment securities available for sale.

No allowance has been established as interest accrued, but not received, is reversed timely in accordance with the policy for investment securities stated above.

Accrued interest receivable on loans receivable is excluded from the ACL on loans as interest accrued, but not received, is reversed timely in accordance with the policy for loans receivable stated above.

Additional analysis was completed on ACL of accrued interest receivable during 2020 based on the significance of loan modifications in accordance with the CARES Act and regulatory guidance.

Accrued interest receivable on investment securities and loans receivable are excluded from their estimates of credit losses.

Additionally, no allowance has been established for accrued interest receivable on investment securities and loans receivable as interest accrued, but not received, is reversed timely in accordance with the policies stated above.

Other Intangible Assets

Other intangible assets represent CDI acquired in business combinations.

The fair value of the CDI stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative source of funding.

The CDI is amortized over an estimated useful life which approximates the existing deposit relationships acquired on an accelerated method.

Other intangible assets represent core deposit intangibles acquired in business combinations.

The fair value of the core deposit intangible stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative source of funding.

The core deposit intangibles are amortized on an accelerated basis following a pattern of the economic benefits of the core deposit intangible over an estimated useful life of the deposit relationships acquired.

The Company evaluates such identifiable intangibles for impairment annually or more frequently if an indication of impairment exists.

The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in certain mergers and acquisitions.

Goodwill is assigned to Heritage Bank and is evaluated for impairment at the Bank level (single reporting unit) on an annual basis, or more frequently if an indication of impairment exists between the annual tests.

Factors to consider may include, among others:

a significant change in legal factors or in the general business climate;

significant change in the Company’s stock price and market capitalization;

unanticipated competition;

and an action or assessment by a regulator.

For the goodwill impairment assessment, the Company has the option to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more-likely-than-not that the fair value of the reporting unit is less than its carrying value.

If the Company opts to bypass the qualitative analysis or the qualitative analysis indicates that events or circumstances exist that it is more-likely-than-not that the fair value of the reporting unit is less than its carrying value, the Company performs a quantitative analysis.

Goodwill is assigned to the Bank and is evaluated for impairment at the Bank level (single reporting unit) on an annual basis or more frequently if an indication of impairment exists between the annual tests.

For the goodwill impairment assessment, the Company either assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more-likely-than-not the fair value of the reporting unit is less than its carrying value and a quantitative test is needed or opts to bypass the qualitative analysis and performs a quantitative analysis only.

The quantitative analysis requires the Company to make assumptions and judgments regarding the fair value of the reporting unit.

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Operating Leases

The Company has only identified leases classified as operating leases which are recorded as ROU assets and ROU liabilities within prepaid expenses and other assets and accrued expenses and other liabilities, respectively, in the Consolidated Statements of Financial Condition.

The Company has only identified leases classified as operating leases.

Operating leases are recorded as ROU assets and ROU liabilities within prepaid expenses and other assets and accrued expenses and other liabilities, respectively, in the Consolidated Statements of Financial Condition.

ROU assets represent the Company's right to use an underlying asset for the lease term and ROU liabilities represent the Company's obligation to make lease payments arising from the lease.

Operating lease ROU assets and ROU liabilities are recognized at the lease agreement commencement date based on the present value of lease payments over the lease term.

The lease term incorporates options to extend the lease when it is reasonably certain that the Company will

exercise that option.

The lease term incorporates options to extend the lease when it is reasonably certain that the Company will exercise that option.

As the Company's leases typically do not provide an implicit rate;

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Stock-Based Compensation

The Company maintains a number of stock-based incentive programs, which are discussed in more detail in Note (19) Stock-Based Compensation.

The Company maintains a number of stock-based incentive programs, which are discussed in more detail in Note (17)

Stock-Based Compensation.

Compensation cost is recognized for stock options, restricted stock awards and restricted stock units issued to employees and directors based on the fair value of these awards at the date of grant.

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The maximum exposure to loss in the LIHTCs is the amount of equity invested and credit extended by the Company.

Loans to these entities are underwritten in substantially the same manner as are other loans and are secured.

The Company has evaluated the variable interests held by the Company in each LIHTC investment and determined that the Company does not have controlling financial interests in such investments and is not the primary beneficiary.

Loans to these entities are underwritten in substantially the same manner as other loans and are secured.

The Company has evaluated the variable interests held by the Company in each LIHTC investment and determined the Company does not have controlling financial interests in such investments and is not the primary beneficiary.

New Market Tax Credit Investments

The Company has a total of $ 25.0 million of qualified equity investments into three certified development entities which are eligible to receive NMTC.

Through May 2021, the Company held $ 25.0 million of qualified equity investments in three certified development entities eligible to receive NMTC.

The NMTC program provides federal tax incentives to investors to make investments in distressed communities and promotes economic improvements through the development of successful businesses in these communities.

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The Company funded its tranche before the deadline.

The Company accounts for its NMTC on the equity method and reports the investment balance in Prepaid expenses and other assets on the Consolidated Statements of Financial Condition and the related investment income is recognized in Other income on the Consolidated Statements of Income.

The Company dissolved the NMTC investment during the year ended December 31, 2021 after gross tax credits related to the Company's certified development entities totaling $ 9.8 million were utilized during the seven year period ending December 31, 2020.

Prior to dissolution, the Company accounted for its NMTC on the equity method and reported the investment balance in prepaid expenses and other assets on the Consolidated Statements of Financial Condition and the related investment income was recognized in other income on the Consolidated Statements of Income.

Deferred Compensation Plans

The Company has a Deferred Compensation Plan and has entered into arrangements with certain executive officers.

The Company has a Deferred Compensation Plan and has entered into similar arrangements with certain executive officers.

Under the Deferred Compensation Plan, participants are permitted to elect to defer compensation and the Company has the discretion to make additional contributions to the Deferred Compensation Plan on behalf of any participant based on a number of factors.

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The applicable interest rate is the Moody’s Seasoned Aaa Corporate Bond Yield as of January 1 of each year.

Generally, a participant’s account is payable upon the earliest of the participant’s separation from service with the Company, the participant’s

death or disability, or a specified date that is elected by the participant in accordance with applicable rules of the Internal Revenue Code, as amended.

Additionally, in conjunction with the Premier Merger, the Company assumed a Salary Continuation Plan.

The Salary Continuation Plan is an unfunded non-qualified deferred compensation plan for select former Premier Commercial executive officers, some of which are current Heritage officers.

Generally, a participant’s account is payable upon the earliest of the participant’s separation from service with the Company, the participant’s death or disability, or a specified date that is elected by the participant in accordance with applicable rules of the Internal Revenue Code, as amended.

Additionally, in conjunction with the Company's merger with Premier Commercial Bancorp in 2018, the Company assumed a Salary Continuation Plan.

The Salary Continuation Plan is an unfunded non-qualified deferred compensation plan for select former Premier Commercial executive officers, some of which are current Company officers.

Under the Salary Continuation Plan, the Company will pay each participant, or their beneficiary, specified amounts over specified periods beginning with the individual's termination of service due to retirement subject to early termination provisions.

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The Company records a liability within accrued expenses and other liabilities on the Consolidated Statements of Financial Condition and records compensation and employee benefits expense on the Consolidated Statements of Income in a systematic and rational manner.

Since the amounts earned under the Deferred Compensation Plan are generally based on the Company’s annual performance, the Company records deferred compensation expense each year for an amount calculated based on that year’s financial performance.

Since the amounts earned under the Deferred Compensation Plan are generally based on the Company’s annual performance, the Company

records deferred compensation expense each year for an amount calculated based on that year’s financial performance.

Earnings per Share

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Derivative Financial Instruments

The commitments to originate residential real estate loans held for sale and the related forward delivery contracts are considered derivatives.

The Company also utilizes interest rate swap derivative contracts to facilitate the needs of its commercial customers whereby it enters into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution.

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

In connection with each swap transaction, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate.

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The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements.

Credit risk of the financial contract is controlled through the credit approval, limits, and monitoring procedures and management does not expect the counterparties to fail their obligations.

Credit risk for derivatives with the customer is controlled through the credit approval process, amount limits, and monitoring procedures and is concentrated within our primary market areas.

Credit risk for derivatives with third-parties is concentrated among four well-known broker dealers.

Fee income related to interest rate swap derivative contract transactions is recorded in interest rate swap fees on the Consolidated Statements of Income.

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Provision for Credit Losses

The provision for credit losses as presented in the Consolidated Statements of Income includes the provision for credit losses on loans, the provision for credit losses on unfunded commitments, the provision for credit losses on accrued interest receivable and the provision for credit losses on investment securities available for sale.

The provision for credit losses as presented in the Consolidated Statements of Income includes the provision for credit losses on loans, the provision for credit losses on unfunded commitments and the provision for credit losses on investment securities.

Operating Segments

While the Company’s chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis as operating results for all segments

Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

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The Company earns fees from contracts with customers for fiduciary and brokerage activities.

Revenues are generally recognized on a monthly basis and are generally based on a percentage of the customer’s assets under management or based on investment or insurance solutions that are implemented for the customer.

Revenues are generally recognized on a monthly basis and are generally based on a percentage of the customer’s

assets under management or based on investment or insurance solutions that are implemented for the customer.

• Merchant Processing Services and Debit and Credit Card Fees:

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These fees are recognized when the transaction occurs, but may settle on a daily or monthly basis.

(d) Recently Issued Accounting Pronouncements

FASB ASU 2016-01 , Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10) , was issued in January 2016, to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information.

This Update contained several provisions, including but not limited to (1) requiring equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income;

(2) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment;

(3) eliminating the requirement to disclose the method(s) and significant assumptions used to estimate fair value;

and (4) requiring separate presentation of financial assets and liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements.

The Update also changed certain financial statement disclosure requirements, including requiring disclosures of the fair value of financial instruments be made on the basis of exit price.

The Company adopted this Update effective January 1, 2018 using the cumulative catch-up transition method.

This change resulted in a cumulative adjustment of $ 93,000 from accumulated other comprehensive loss, net to retained earnings for the unrealized gain related to the Company's equity security.

The Company's processes and procedures utilized to estimate the fair value of loans receivable and certificate of deposit accounts for disclosure requirements were additionally changed due to adoption of this Update.

Previously, the Company valued these items using an entry price notion.

This ASU emphasized that these instruments be measured using the exit price notion;

accordingly, the Company refined its calculation as part of adopting this Update.

Prior period information has not been updated to conform with the new guidance.

See the Consolidated Statements of Stockholders' Equity and Note (18) Fair Value Measurements.

(d) Recently Issued or Adopted Accounting Pronouncements

FASB ASU 2016-02 , Leases (Topic 842), as amended by ASU 2017-13, 2018-01, 2018-10, 2018-11 and ASU 2018-11 and ASU 2019-01, was originally issued in February 2016, to increase transparency and comparability of leases among organizations and to disclose key information about leasing arrangements.

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This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease.

A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term greater than 12 months regardless of their classification.

All cash payments will be classified within operating activities in the statement of cash flows.

A lessee is also required to record a ROU asset and liability for all leases with a term greater than 12 months regardless of their classification.

All cash payments are classified within operating activities in the statement of cash flows.

In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach.

The ASU was effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

The Company adopted the ASU on January 1, 2019 and elected an exclusion accounting policy for lease assets and lease liabilities for leases with a term of twelve months or less.

The adoption of this ASU resulted in the recognition of operating lease assets and liabilities of approximately $ 29.3 million and $ 30.2 million, respectively, in Prepaid expenses and other assets and Accrued expenses and other liabilities in the Consolidated Statements of Financial Condition.

The Company adopted the ASU on January 1, 2019 and elected an exclusion accounting policy for lease assets and lease liabilities of leases with a term of twelve months or less.

The adoption of this ASU resulted in the recognition of operating lease ROU assets and liabilities of approximately $ 29.3 million and $ 30.2 million, respectively, in prepaid expenses and other assets and accrued expenses and other liabilities in the Consolidated Statements of Financial Condition.

This change also resulted in a cumulative-effect adjustment to beginning retained earnings of $ 399,000 , net of tax, under the modified retrospective approach.

FASB ASU 2016-13 , Financial Instruments - Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments , as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and 2020-02, was originally issued in June 2016.

Measurement of Credit Losses on Financial Instruments , as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and ASU 2020-02, was originally issued in June 2016.

This ASU replaced the incurred loss methodology with an expected loss methodology, which is commonly referred to as the "CECL" methodology.

The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans receivable.

It also applies to off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments.

In addition, CECL Adoption made changes to the accounting for credit losses on investment securities available for sale.

This ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected.

For public business entities, this ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15, 2018, and can be delayed under a provision of the CARES Act until the end of the official health emergency declaration.

adopted ASU 2016-13 on January 1, 2020.

For public business entities, this ASU was effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15, 2018, and can be delayed under a provision of the CARES Act until the end of the official health emergency declaration.

The Company adopted ASU 2016-13 on January 1, 2020 using the modified retrospective method for all financial assets measured at amortized cost, investment securities available for sale and unfunded commitments.

At adoption, the Bank elected not to measure an ACL on accrued interest receivable on loans receivable or accrued interest receivable on investment securities available for sale as Bank policy is to reverse interest income for uncollectible accrued interest receivable balances in a timely manner.

The Significant Accounting Policies section above reflects the policies after adoption.

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Investment Securities

As of December 31, 2019, the Company had no historical charge-off or recovery history and did not have any investment securities available for sale outstanding at the adoption date for which an other-than-temporary impairment was previously recorded.

As of December 31, 2019, the Company only held investment securities available for sale, had no historical charge-off or recovery history and did not have any investment securities available for sale outstanding at the adoption date for which an other-than-temporary impairment was previously recorded.

At the adoption date of ASU 2016-13, the unrealized losses present in the portfolio of investment securities available for sale were primarily due to decreases in market interest rates on floating rate investment securities since the purchase of the securities and the fair value of these securities was expected to recover as the securities approach their maturity dates.

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Loan Receivable

ASU 2016-13 was applied prospectively and replaced the ALL with the ACL on loans on the Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses as presented on the Consolidated Statements of Income, net with the provision for credit losses on unfunded commitments.

ASU 2016-13 replaced the allowance for loan losses with the ACL on loans on the Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses as presented on the Consolidated Statements of Income, which now additionally includes the provision for credit losses on unfunded commitments discussed below.

The adoption was completed in a specific order beginning with the transition of PCI loans to PCD loans.

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The difference between the outstanding principal balance and the amortized cost basis of the PCD loan is a noncredit premium or discount, which is amortized into interest income over the remaining life of the PCD loan.

The PCI to PCD transition did not have an impact on beginning retained earnings;

The PCI to PCD transition did not have an impact on

beginning retained earnings;

however, it did have the effect of reducing the existing allowance for PCI loans by $ 1.6 million under the CECL methodology as compared to the previous ASC 310-10 methodology.

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Unfunded Commitments

ASU 2016-13 was applied prospectively and replaced the reserve for unfunded commitments with the ACL on unfunded commitments as included in Accrued liabilities and other expenses on the Consolidated Statements of Financial Condition and replaced the provision for unfunded commitments which was previously recorded in Other expense with the provision for credit losses as presented on the Consolidated Statements of Income, net with the provision for credit losses on loans.

ASU 2016-13 replaced the reserve for unfunded commitments with the ACL on unfunded commitments as included in Accrued liabilities and other expenses on the Consolidated Statements of Financial Condition and replaced the provision for unfunded commitments which was previously recorded in Other expense with the provision for credit losses as presented on the Consolidated Statements of Income, which now additionally includes the provision for credit losses on loans discussed above.

Upon adoption, the Bank recorded a pretax increase in the beginning ACL on unfunded commitments of $ 3.7 million.

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The impact of this adjustment to beginning retained earnings on January 1, 2020 was $ 5.6 million, net of tax.

FASB ASU 2017-04 , Goodwill (Topic 350) , was issued in January 2017 and eliminates Step 2 from the goodwill impairment test.

The ASU was effective for annual periods or any interim goodwill impairment tests beginning after December 15, 2019 using a prospective transition method and early adoption was permitted.

The Company adopted the guidance on January 1, 2020.

The Company has goodwill from prior business combinations and performs an annual impairment test during the quarter ended December 31, or more frequently if changes or circumstances occur that would more-likely-than-not reduce the fair value of the reporting unit below its carrying value.

Although the Company cannot anticipate future goodwill impairment assessments, based on the most recent assessment prior to adoption, it is unlikely that an impairment amount would need to be calculated and, therefore, at adoption there was no impact from these amendments to the Company’s financial position and results of operations.

In addition, the current accounting policies and processes were not changed, except for the elimination of the Step 2 analysis.

For additional information regarding goodwill impairment testing, see Note (8) Goodwill and Other Intangible Assets.

FASB ASU 2018-13 , Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement , was issued in August 2018 and modifies the disclosure requirements on fair value measurements in Topic 820.

The amendments

in this ASU were effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.

The Company adopted the guidance on January 1, 2020.

The adoption did not have a material impact to Note (18) Fair Value Measurements.

FASB ASU 2020-03 , Codification Improvements to Financial Instruments , was issued in March 2020 and revised a wide variety of topics in the Codification with the intent to make the Codification easier to understand and apply by eliminating inconsistencies and providing clarifications.

The ASU was effective immediately upon its release and did not have a material impact on the Consolidated Financial Statements.

FASB ASU 2020-04 , Reference Rate Reform (Topic 848) , as amended by ASU 2021-01, was issued in March 2020 and provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks.

For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or remeasurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts.

ASU 2020-04 also provides numerous optional expedients for derivative accounting and is effective March 12, 2020 through December 31, 2022.

An entity may elect to apply the ASU for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued.

Once elected for a Topic or an Industry Subtopic within the Codification, the amendments in this ASU must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic.

The Company’s swap related transactions are the majority of its LIBOR exposure.

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.

FASB ASU 2020-04 , Reference Rate Reform (Topic 848) , as amended by ASU 2021-01, was issued in March 2020 and provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting.

The amendments in this ASU are effective for all entities as of March 12, 2020 through December 31, 2022.

The amendments are elective, apply to all entities, and provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met.

The Bank’s interest rate swap-related transactions are the majority of the Company's LIBOR exposure.

Effective January 25, 2021, the Company adhered to the Interbank Offered Rate Fallbacks Protocol as published by the International Swaps and Derivatives Association, Inc.

and recommended by the Alternative Reference Rates Committee.

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.

The Company further anticipates this ASU will simplify any modifications executed between the selected start date (yet to be determined) and December 31, 2022 that are directly related to LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized net deferred fees.

The Company does not expect this ASU to have a material impact on its business operations and the Consolidated Financial Statements.

FASB ASU 2020-08 , Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs , was issued in October 2020 and modifies the premium amortization of purchased callable debt securities on a prospective basis.

The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020.

Early application is not permitted.

The Company does not expect the ASU will have a material impact on its Consolidated Financial Statements.

(2) Business Combinations

There were no acquisitions or mergers completed during the years ended December 31, 2020 and 2019.

During the year ended December 31, 2018, the Company completed the acquisitions of Puget Sound Bancorp and Premier Commercial Bancorp.

Puget Sound Merger:

On July 26, 2017, the Company, along with the Bank, and Puget Sound Bancorp, Inc.

and its wholly owned subsidiary bank, Puget Sound Bank, jointly announced the signing of a definitive agreement.

The Puget Sound Merger was effective on January 16, 2018.

As of the acquisition date, Puget Sound merged into Heritage and Puget Sound Bank merged into Heritage Bank.

Pursuant to the terms of the Puget Sound Merger, all outstanding Puget Sound restricted stock awards became immediately vested on the acquisition date of the Puget Sound Merger.

Puget Sound shareholders received 1.1688 shares of Heritage common stock per share of Puget Sound stock.

Heritage issued an aggregate of 4,112,258 shares of its common stock based on the January 12, 2018 closing price of Heritage Common stock of $ 31.80 for total fair value of common shares issued of $ 130.8 million and paid cash of $ 3,000 for fractional shares in the transaction for total consideration paid of $ 130.8 million.

Total consideration included $ 851,000 , representing 26,741 shares which were forfeited by the Puget Sound shareholders to pay their applicable taxes.

The Company incurred no acquisition-related costs for the year ended December 31, 2020 and $ 75,000 and $ 5.4 million for the years ended December 31, 2019 and 2018, respectively, for the Puget Sound Merger.

Premier Merger:

On March 24, 2018, the Company, along with the Bank, and Premier Commercial Bancorp and its wholly-owned subsidiary bank, Premier Community Bank, jointly announced the signing of a definitive agreement.

The Premier Merger was effective on July 2, 2018.

As of the acquisition date, Premier Commercial Bancorp merged into Heritage and Premier Community Bank merged into Heritage Bank.

Pursuant to the terms of the Premier Merger, Premier Commercial shareholders received 0.4863 shares of Heritage common stock per share of Premier Commercial common stock.

Heritage issued an aggregate of 2,848,579 shares of its

common stock based on the closing date price per share of Heritage common stock on June 29, 2018 of $ 34.85 and paid cash of $ 2,000 for fractional shares in the transaction for total consideration paid of $ 99.3 million.

The Company incurred no acquisition-related costs for the year ended December 31, 2020 and $ 57,000 , and $ 4.9 million for the years ended December 31, 2019 and 2018, respectively, for the Premier Merger.

Business Combination Accounting:

The Premier Merger and Puget Sound Merger resulted in $ 53.4 million and $ 68.5 million, respectively, of goodwill.

This goodwill is not deductible for tax purposes.

The primary reason for the Premier and Puget Mergers was to create depth in the Company's geographic footprint consistent with its ongoing growth strategy, focused heavily on metro markets, and to achieve operational scale and realize efficiencies of a larger combined organization.

The mergers constitute business acquisitions as defined by FASB ASC 805, Business Combinations.

FASB ASC 805 establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired and the liabilities assumed.

Heritage was considered the acquirer in these transactions.

Accordingly, the preliminary estimates of fair values of Premier Commercial and Puget Sound assets, including the identifiable intangible assets, and the assumed liabilities, were measured and recorded as of the respective acquisition dates.

Fair values on the acquisition dates are preliminary and represent management’s best estimates based on available information and facts and circumstances in existence on the acquisition date.

Fair values are subject to refinement for up to one year after the closing date of the acquisitions as additional information regarding the closing date fair values becomes available.

The Company finalized the purchase price allocation for both mergers as of December 31, 2018.

The fair value estimates of the assets acquired and liabilities assumed in the mergers were as follows:

Premier Merger Puget Sound Merger

(In thousands)

Cash and cash equivalents $ 22,534 $ 25,889

Interest earning deposits 3,309 54,247

Investment securities available for sale 4,493 80,353

Loans receivable (1)

330,158 388,462

Other real estate owned 1,796 —

Premises and equipment, net 3,053 732

Federal Home Loan Bank stock, at cost 1,120 623

Bank owned life insurance 10,852 6,264

Accrued interest receivable 1,006 1,448

Prepaid expenses and other assets 1,603 1,354

Other intangible assets 7,075 11,270

Total assets acquired $ 386,999 $ 570,642

Deposits $ 318,717 $ 505,885

Federal Home Loan Bank advances 16,000 —

Securities sold under agreement to repurchase 462 —

Accrued expenses and other liabilities 5,935 2,504

Total liabilities acquired $ 341,114 $ 508,389

Fair value of net assets acquired $ 45,885 $ 62,253

(1) The outstanding loan balance acquired in the Premier Merger and Puget Sound Merger was $ 335.4 million and $ 392.7 million, respectively, at the acquisition date.

Goodwill represents the excess of the consideration transferred over the estimated fair value of the net assets acquired and liabilities assumed.

A summary of the net assets purchased and the estimated fair value adjustments and resulting goodwill recognized from the mergers are presented in the following table:

Premier Merger Puget Sound Merger

(In thousands)

Consideration transferred $ 99,275 $ 130,773

Cost basis of net assets on merger date $ 40,629 $ 54,405

Fair value adjustments:

Investment securities ( 135 ) ( 348 )

Total loans receivable, net ( 111 ) 1,400

Other real estate owned ( 1,017 ) —

Premises and equipment 1,312 ( 121 )

Other intangible assets 7,075 9,207

Prepaid expenses and other assets ( 1,912 ) ( 2,282 )

Deposits ( 310 ) ( 62 )

Accrued expenses and other liabilities 354 54

Fair value of net assets on merger date $ 45,885 $ 62,253

Goodwill recognized from the mergers $ 53,390 $ 68,520

The following table presents certain pro forma information, for illustrative purposes only, for the year ended December 31, 2018 as if both the Premier Merger and Puget Sound Merger had occurred on January 1, 2017.

The estimated pro forma information combines the historical results of Premier Commercial and Puget Sound with the Company's consolidated historical results and includes certain adjustments reflecting the estimated impact of certain fair value adjustments for the respective periods.

The pro forma information is not indicative of what would have occurred had the mergers occurred on January 1, 2017.

In particular, the pro forma information does not consider any changes to the ACL on loans from recorded loans at fair value.

Additionally, Heritage expected to achieve further operating savings and other business synergies, including interest income growth, as a result of the mergers which are not reflected in the pro forma amounts in the following table.

As a result, actual amounts will differ from the pro forma information presented.

Pro Forma for the Year Ended December 31, 2018

(In thousands, except per share amounts)

Net interest income $ 194,989

Net income 69,515

Basic earnings per common share 1.88

Dilutive Earnings per common share 1.87

The Company believes that the historical Premier Commercial and Puget Sound operating results, individually or collectively, are not considered of enough significance to be meaningful to the Company’s results of operations.

The Company does not expect this ASU to have a material impact on its business operations and the Condensed Consolidated Financial Statements.

(2) Investment Securities

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

There were no securities classified as trading or held to maturity at December 31, 2020 or December 31, 2019.

(a) Securities by Type and Maturity

The following tables present the amortized cost and fair value of investment securities available for sale at the dates indicated and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income:

During the three months ended September 30, 2021, the Company reassessed and transferred, at fair value, $ 244.8 million of U.S.

government and agency securities from the available for sale classification to the held to maturity classification.

The net unrealized after tax gain of $ 1.3 million remained in AOCI to be amortized over the remaining life of the securities, offsetting the related amortization of discount or premium on the transferred securities.

No gains or losses were recognized at the time of the transfer.

There were no investment securities classified as trading at December 31, 2021 or December 31, 2020.

There were no investment securities classified as held to maturity at December 31, 2020.

(a) Investment Securities by Classification Type and Maturity

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

December 31, 2021

Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value

(In thousands)

Investment securities available for sale:

government and agency securities $ 21,494 $ 55 $ ( 176 ) $ 21,373

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Residential CMO and MBS 307,366 2,111 ( 2,593 ) 306,884

December 31, 2021

Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value

(In thousands)

Commercial CMO and MBS 313,169 3,891 ( 1,199 ) 315,861

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Total $ 883,832 $ 15,341 $ ( 4,838 ) $ 894,335

Investment securities held to maturity:

government and agency securities $ 141,011 $ 120 $ ( 1,768 ) $ 139,363

Residential CMO and MBS 24,529 — ( 153 ) 24,376

Commercial CMO and MBS 217,853 — ( 5,261 ) 212,592

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

December 31, 2020

Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair

(In thousands)

Investment securities available for sale:

government and agency securities $ 44,713 $ 947 $ — $ 45,660

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Total $ 770,195 $ 32,521 $ ( 553 ) $ 802,163

For the years ended December 31, 2020 and 2019, there was no provision for credit loss on investment securities available for sale recorded in the Consolidated Statements of Income.

There was no ACL on investment securities available for sale at December 31, 2020 and December 31, 2019.

The amortized cost and fair value of investment securities available for sale at December 31, 2020, by contractual maturity, are set forth below.

The amortized cost and fair value of investment securities at December 31, 2021, by contractual maturity, are set forth below.

Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

Amortized Cost Fair Value

Securities Available for Sale Securities Held to Maturity

Amortized Cost Fair Value Amortized Cost Fair Value

(In thousands)

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Due after ten years 156,528 160,798 72,801 71,349

Total investment securities due at a single maturity date 263,297 271,590 141,011 139,363

Mortgage-backed securities (1)

620,535 622,745 242,382 236,968

Total $ 883,832 $ 894,335 $ 383,393 $ 376,331

There were no holdings of securities of any one issuer, other than the U.S.

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

There were no holdings of investment securities of any one issuer, other than the U.S.

government and its agencies, in an amount greater than 10% of stockholders’ equity at December 31, 2021 and December 31, 2020.

(b) Unrealized Losses and Other-Than-Temporary Impairments

The following tables show the gross unrealized losses and fair value of the Company's investment securities available for sale aggregated by investment category and length of time that the individual securities have been in continuous unrealized loss positions as of December 31, 2020 and December 31, 2019:

(b) Unrealized Losses on Investment Securities Available for Sale

The following tables show the gross unrealized losses and fair value of the Company’s investment securities available for sale for which an ACL on investment securities available for sale has not been recorded, aggregated by investment category

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

December 31, 2021

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(In thousands)

government and agency securities $ 14,828 $ ( 176 ) $ — $ — $ 14,828 $ ( 176 )

Municipal securities 29,774 ( 619 ) 9,351 ( 235 ) 39,125 ( 854 )

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(In thousands)

government and agency securities $ 45,999 $ ( 84 ) $ — $ — $ 45,999 $ ( 84 )

Municipal securities $ 10,264 $ ( 227 ) $ — $ — $ 10,264 $ ( 227 )

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Commercial CMO and MBS 11,404 ( 29 ) 7,499 ( 61 ) 18,903 ( 90 )

Corporate obligations 998 ( 2 ) 1,987 ( 13 ) 2,985 ( 15 )

Other asset-backed securities — — 4,570 ( 27 ) 4,570 ( 27 )

Total $ 21,668 $ ( 256 ) $ 37,362 $ ( 297 ) $ 59,030 $ ( 553 )

The Company has evaluated these investment securities available for sale as of December 31, 2020 and December 31, 2019 and determined that no ACL on investment securities available for sale is necessary.

Unrealized losses on investment securities available for sale have not been recognized into earnings because the issuers of bonds are investment grade, the securities carry governmental guarantees, management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery and the decline in fair value is largely due to changes in interest rates and other market conditions.

The issuers continue to make timely principal and interest payments on the bonds and the fair value is expected to recover as the bonds approach maturity.

The Company evaluated investment securities available for sale as of December 31, 2021 and December 31, 2020 and determined that any declines in fair value were attributable to changes in interest rates relative to where these investments fall within the yield curve and individual characteristics.

Management monitors published credit ratings for adverse changes for all rated investment securities and none of these securities had a below investment grade credit rating as of both December 31, 2021 and December 31, 2020.

In addition, the Company does not intend to sell these securities nor does the Company consider it more likely than not that it will be required to sell these securities before the recovery of the amortized cost basis, which may be upon maturity.

Therefore, no ACL on investment securities available for sale was recorded as of December 31, 2021 and December 31, 2020.

The Company also evaluated investment securities held to maturity for current expected credit losses.

There were no investment securities held to maturity classified as nonaccrual or past due as of December 31, 2021 and all were issued by the U.S.

government and its agencies and either explicitly or implicitly guaranteed by the U.S.

government, highly rated by major credit rating agencies and have a long history of no credit losses.

Accordingly, the Company did not measure expected credit losses on investment securities held to maturity since the historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero.

Therefore, no ACL on investment securities held to maturity was recorded as of December 31, 2021.

(d) Realized Gains and Losses

The following table presents the gross realized gains and losses on the sale of investment securities available for sale for the years ended December 31, 2021, December 31, 2020 and December 31, 2019:

5 unchanged sentences

Net realized gains $ 29 $ 1,518 $ 330

(d) Pledged Securities

The following table summarizes the amortized cost and fair value of investment securities available for sale that are pledged as collateral for the following obligations at December 31, 2020 and December 31, 2019:

(e) Pledged Securities

The following table summarizes the amortized cost and fair value of investment securities that are pledged as collateral for the following obligations at December 31, 2021 and December 31, 2020:

December 31, 2021 December 31, 2020

2 unchanged sentences

Washington and Oregon state public deposits $ 128,216 $ 130,217 $ 119,652 $ 124,228

Securities sold under agreement to repurchase

Federal Reserve Bank credit facility

61,057 59,674 — —

Securities sold under agreement to repurchase 59,887 59,655 38,630 39,945

Other securities pledged 56,419 55,633 29,665 30,717

Total $ 305,579 $ 305,179 $ 187,947 $ 194,890

(e) Accrued Interest Receivable

Accrued interest receivable, excluded from amortized cost on investment securities available for sale, totaled $ 3.6 million and $ 3.7 million at December 31, 2020 and December 31, 2019, respectively.

No amounts of accrued interest receivable on investment securities available for sale were reversed against interest income on investment securities available for sale during the years ended December 31, 2020 and December 31, 2019.

(f) Accrued Interest Receivable

Accrued interest receivable excluded from the amortized cost on investment securities available for sale totaled $ 3.5 million and $ 3.6 million at December 31, 2021 and December 31, 2020, respectively.

Accrued interest receivable excluded from the amortized cost on investment securities held to maturity totaled $ 1.1 million at December 31, 2021.

No amounts of accrued interest receivable on investment securities available for sale or held to maturity were reversed against interest income on investment securities available for sale during the years ended December 31, 2021, 2020, and 2019.

(3) Loans Receivable

The Company originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions.

Accrued interest receivable was excluded from disclosures presenting the Company's amortized cost of loans receivable as it was deemed insignificant.

Accrued interest receivable on loans totaled $ 15.8 million and $ 10.7 million at December 31, 2020 and December 31, 2019, respectively.

No ACL on accrued interest receivable on loans was recorded at December 31, 2020 and December 31, 2019.

The Company adopted ASU 2016-13 effective January 1, 2020, which prospectively changed disclosure requirements for loans receivable and increased the beginning ACL on loans as discussed in Note (5) Allowance for Credit Losses on Loans.

The Bank originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions.

Accrued interest receivable was excluded from disclosures presenting the Bank's amortized cost of loans receivable as it was deemed insignificant.

(a) Loan Origination/Risk Management

The Company categorizes the individual loans in the total loan portfolio into four segments:

The Bank categorizes the individual loans in the total loan portfolio into four segments:

commercial business;

2 unchanged sentences

and consumer.

Within these segments are classes of loans for which management monitors and assesses credit risk in the loan portfolios.

The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk.

Within these segments are classes of loans for which management monitors and assesses credit risk.

The Bank has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk.

Management reviews and approves these policies and procedures on a regular basis.

A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and criticized loans.

The Company also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management.

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

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

10 unchanged sentences

164,582 122,756

December 31, 2020 December 31, 2019

(In thousands)

Real estate construction and land development:

5 unchanged sentences

Loans receivable 3,815,662 4,468,647

December 31, 2021 December 31, 2020

(In thousands)

Allowance for credit losses on loans ( 42,361 ) ( 70,185 )

Loans receivable, net $ 3,773,301 $ 4,398,462

Balances included in amortized cost of Loans receivable:

Balances included in the amortized cost of loans receivable:

Unamortized net discount on acquired loans $ ( 3,938 ) $ ( 6,575 )

Unamortized net deferred (fee) cost $ ( 15,458 ) $ 2,441

Unamortized net deferred fee $ ( 7,952 ) $ ( 15,458 )

A discussion of the risk characteristics of each loan portfolio segment is as follows:

Commercial Business :

There are four significant classes of loans in the commercial business portfolio segment:

commercial and industrial, SBA PPP, owner-occupied commercial real estate and non-owner occupied commercial real estate.

The owner and non-owner occupied commercial real estate classes are both considered commercial real estate loans.

As the commercial and industrial loans, SBA PPP loans and commercial real estate loans carry different risk characteristics, they are discussed separately below:

There are four significant classes of loans in the commercial business portfolio segment discussed separately below:

Commercial and industrial.

9 unchanged sentences

The Bank also earns a fee based on the size of the loan, which is recognized over the life of the loan.

The balance of unamortized net deferred fees on SBA PPP loa ns was $ 15.4 million at December 31, 2020.

The Bank expects that the great majority of SBA PPP borrowers will seek full or partial forgiveness of their loan obligations in accordance with the CARES Act.

Commercial real estate.

The Company originates commercial real estate loans primarily within its primary market areas.

Owner-occupied and non-owner occupied CRE.

The Bank originates CRE loans primarily within its primary market areas.

These loans are subject to underwriting standards and processes similar to commercial and industrial loans in that these loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate properties.

Commercial real estate lending typically involves higher loan principal amounts and payments on loans, and repayment is dependent on successful operation and management of the properties.

CRE lending typically involves higher loan principal amounts and payments on loans and repayment is dependent on successful operation and management of the properties.

The value of the real estate securing these loans can be adversely affected by conditions in the real estate market or the economy.

There is some common risk characteristics with owner-occupied commercial real estate loans and non-owner occupied commercial real estate loans.

However, owner-occupied commercial real estate loans are generally considered to have a slightly lower risk profile as we typically have the guarantee of the owner-occupant and can underwrite risk using the complete financial information on the entity that occupies the property.

There is some common risk characteristics with owner-occupied CRE loans and non-owner occupied CRE loans.

However, owner-occupied CRE loans are generally considered to have a slightly lower risk profile as we typically have the guarantee of the owner-occupant and can underwrite risk using the complete financial information on the entity that occupies the property.

Residential Real Estate :

The majority of the Company’s residential real estate loans are secured by one-to-four family residences located in its primary market areas.

The majority of the Bank’s residential real estate loans are secured by one-to-four family residences located in its primary market areas.

The Company’s underwriting standards require that residential real estate loans maintained in the portfolio generally are owner-occupied and do not exceed 80 % of the lower of appraised value at origination or cost of the underlying collateral.

Terms of maturity typically range from 15 to 30 years.

The Company generally sells its originated residential real estate loans in the secondary market and retains a smaller portion in its loan portfolio.

The Bank sells a portion of originated residential real estate loans in the secondary market.

Real Estate Construction and Land Development :

The Company originates construction loans for residential and for commercial and multifamily properties.

The residential construction loans generally include construction of custom single-family homes whereby the home buyer is the

The Company also provides financing to builders for the construction of pre-sold residential homes and, in selected cases, to builders for the construction of speculative single-family residential property.

The Bank originates construction loans for residential and for commercial and multifamily properties.

The residential construction loans generally include construction of custom single-family homes whereby the home owner is the borrower.

The Bank also provides financing to builders for the construction of pre-sold residential homes and, in selected cases, to builders for the construction of speculative single-family residential property.

Substantially all construction loans are short-term in nature and priced with variable rates of interest.

Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion.

Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, the Company’s estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results.

Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, the Bank’s estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results.

As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness.

If the Company’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss if the borrower does not repay the loan.

Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained.

These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being dependent upon successful completion of the construction project, market interest rate changes, government regulation of real property, general economic conditions and the availability of long-term financing.

The Company originates consumer loans and lines of credit that are both secured and unsecured.

If the Bank’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss if the borrower does not repay the loan.

regulation of real property, general economic conditions and the availability of long-term financing.

The Bank originates consumer loans and lines of credit that are both secured and unsecured.

The underwriting process for these loans ensures a qualifying primary and secondary source of repayment.

1 unchanged sentence

To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed.

The majority of consumer loans are for relatively small amounts disbursed among many individual borrowers which reduces the credit risk for this type of loan.

The majority of consumer loans are for relatively small amounts disbursed among many individual borrowers which reduces the overall credit risk for this segment.

To further reduce the risk, trend reports are reviewed by management on a regular basis.

The Company also purchased indirect consumer loans.

The Bank also purchased indirect consumer loans.

These indirect consumer loans were secured by new and used automobile and recreational vehicles and were originated indirectly by established and well-known dealers located in our market areas.

In addition, the indirect loans purchased were made to only prime borrowers.

The Company ceased indirect auto loan originations in March 2020.

The Bank ceased indirect auto loan originations in March 2020.

(b) Concentrations of Credit

Most of the Company’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County and Washington County in Oregon, as well as other contiguous markets and represents a geographic concentration.

In addition, approximately 88.2 % and 82.7 % of our loan portfolio at December 31, 2020 and December 31, 2019, respectively, consisted of commercial-type loans, including commercial business loans and commercial and multifamily real estate construction and land development loans.

Commercial-type loans are generally viewed as having more inherent risk of default than residential real estate loans or other consumer loans.

Also, the commercial-type loan balance per borrower is typically larger than that for residential real estate loans and other consumer loans, implying higher potential losses on an individual loan basis.

Most of the Bank’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County and Washington County in Oregon, as well as other contiguous markets and represents a geographic concentration.

Additionally, our loan portfolio is concentrated in commercial loans, including commercial business loans and commercial and multifamily real estate construction and land development loans.

Commercial loans are generally viewed as having more inherent risk of default than residential real estate loans or other consumer loans.

Also, the commercial loan balance per borrower is typically larger than that for residential real estate loans and consumer loans, implying higher potential losses on an individual loan basis.

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

The Company utilizes a risk grading matrix to assign a risk grade to each of its loans.

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

The Bank utilizes a risk grading matrix to assign a risk grade to each of its loans.

Loans are graded on a scale of 1 to 10.

1 unchanged sentence

• Grades 1 to 5:

These grades are considered “pass grade” ("Pass") and include loans with negligible to above average, but acceptable, risk.

These grades are considered “Pass” and include loans with negligible to above average, but acceptable, risk.

These borrowers generally have strong to acceptable capital levels and consistent earnings and debt service capacity.

2 unchanged sentences

Loans with this grade show no immediate loss exposure.

This grade includes "Watch" loans and is considered a “pass grade.” The grade is intended to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-modifying action is anticipated in the near term.

This grade includes "Watch" loans.

The grade is intended to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-modifying action is anticipated in the near term.

This grade includes "Special Mention" ("SM") loans and is intended to highlight loans deemed by management to have some elevated risks that deserve management's close attention.

6 unchanged sentences

Such loans may be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business.

Loans with this grade are placed on accrual or nonaccrual status based on the Company’s accrual policy.

This grade includes “Doubtful” loans in accordance with regulatory guidelines and the Company has determined these loans to have excessive credit risk.

This grade includes “Doubtful” loans in accordance with regulatory guidelines and the Bank has determined these loans to have excessive credit risk.

Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty.

Additionally, these loans generally have been partially charged off for the amount considered uncollectible.

This grade includes “Loss” loans in accordance with regulatory guidelines and the Company has determined these loans have the highest risk of loss.

This grade includes “Loss” loans in accordance with regulatory guidelines and the Bank has determined these loans have the highest risk of loss.

Such loans are charged off or charged down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined.

“Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

Numerical loan grades for loans are established at the origination of the loan.

Changes to loan grades are considered at the time new information about the performance of a loan becomes available, including the receipt of updated financial information from the borrower, results of annual term loan reviews performed by the Bank's credit department and scheduled loan reviews performed by the Bank’s internal Loan Review department.

For consumer loans, the Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event of payment delinquencies or default.

Typically, an individual loan grade will not be changed from the prior period unless there is a specific indication of credit deterioration or improvement.

Typically, an individual loan grade will not be changed from the prior period unless there is a

specific indication of credit deterioration or improvement.

Credit deterioration is evidenced by delinquency, direct communications with the borrower or other borrower information that becomes known to management.

Credit improvements are evidenced by known facts regarding the borrower or the collateral property.

The loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential.

Loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential.

Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades.

The Special Mention loan grade is transitory in that the Company is waiting on additional information to determine the likelihood and extent of the potential loss.

The likelihood of loss for Special Mention graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration.

Loans with a Substandard grade are generally loans which the Company individually evaluates for an ACL on loans.

For Doubtful and Loss graded loans, the Company is almost certain of the losses and the outstanding principal balances are generally charged off to the realizable value.

During the year ended December 31, 2020, the Bank did not automatically adversely classify credits that were affected by the COVID-19 pandemic or were granted a COVID Modification.

The following table presents the amortized cost of loans receivable by risk grade as of December 31, 2020:

Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted to Term Loans (1)

The SM loan grade is transitory in that the Bank is waiting on additional information to determine the likelihood and extent of the potential loss.

The likelihood of loss for SM graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration.

Loans with a SS grade are generally accrual loans at risk of being classified as nonaccrual loans and includes all of our loans classified as nonaccrual.

For Doubtful and Loss graded loans, the Bank is almost certain of the losses and the outstanding principal balances are generally charged off to the realizable value.

Regulatory agencies provided guidance regarding credit risk ratings, delinquency reporting and nonaccrual status for loans adversely impacted by the COVID-19 Pandemic.

The Bank has and will continue to exercise judgment in determining the risk rating for impacted borrowers and will not automatically adversely classify credits that have been affected by the COVID-19 Pandemic.

The Bank did not designate loans with payment deferrals granted due to the COVID-19 Pandemic as past due because of the deferral.

Due to the short-term nature of the forbearance and other relief programs the Bank was offering as a result of the COVID-19 Pandemic, borrowers granted relief under these programs were generally not reported as nonaccrual during the deferral period.

The following table presents the amortized cost of loans receivable by risk grade as of December 31, 2021 and December 31, 2020:

December 31, 2021 Revolving Loans Revolving Loans Converted to Term Loans (1)

Loans Receivable

Amortized Cost Basis by Origination Year

2021 2020 2019 2018 2017 Prior

7 unchanged sentences

Pass 139,253 6,587 — — — — — — 145,840

Total 715,121 — — — — — — — 715,121

Owner-occupied CRE

3 unchanged sentences

Total 183,006 91,941 191,459 85,022 72,990 306,660 — 72 931,150

Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted to Term Loans (1)

Non-owner occupied CRE

Pass 187,860 185,650 244,863 149,090 144,896 499,486 — — 1,411,845

SM — — 5,674 — 15,482 2,400 — — 23,556

SS — — — 3,379 — 54,319 — — 57,698

Total 187,860 185,650 250,537 152,469 160,378 556,205 — — 1,493,099

Total commercial business

Pass 605,815 383,039 527,900 277,511 239,493 850,298 127,651 1,107 3,012,814

SM 590 884 14,751 8,946 21,642 21,525 2,048 353 70,739

SS 1,443 2,619 5,912 9,975 5,540 77,644 4,402 568 108,103

Total 607,848 386,542 548,563 296,432 266,675 949,467 134,101 2,028 3,191,656

Residential real estate

Pass 85,089 27,090 23,295 5,672 6,141 16,891 — — 164,178

SS — — — — — 404 — — 404

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

Real estate construction and land development:

Pass 44,892 23,728 12,266 2,921 389 1,351 — — 85,547

December 31, 2021 Revolving Loans Revolving Loans Converted to Term Loans (1)

Loans Receivable

Amortized Cost Basis by Origination Year

2021 2020 2019 2018 2017 Prior

Commercial and multifamily

Pass 56,448 41,616 34,117 5,794 710 1,379 — — 140,064

SM — — 68 — — 213 — — 281

SS — 571 — — — 420 — — 991

Total 56,448 42,187 34,185 5,794 710 2,012 — — 141,336

Total real estate construction and land development

Pass 101,340 65,344 46,383 8,715 1,099 2,730 — — 225,611

SM — — 68 — — 213 — — 281

SS — 571 — — — 420 — — 991

Total 101,340 65,915 46,451 8,715 1,099 3,363 — — 226,883

Pass 1,286 15,737 46,041 29,819 15,068 13,026 108,492 120 229,589

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

Total 1,286 15,918 46,698 30,295 15,610 14,069 108,528 137 232,541

Loans receivable

Pass 793,530 491,210 643,619 321,717 261,801 882,945 236,143 1,227 3,632,192

SM 590 884 14,819 8,946 21,642 21,738 2,048 353 71,020

SS 1,443 3,371 6,569 10,451 6,082 79,511 4,438 585 112,450

Total $ 795,563 $ 495,465 $ 665,007 $ 341,114 $ 289,525 $ 984,194 $ 242,629 $ 2,165 $ 3,815,662

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

December 31, 2020 Revolving Loans Revolving Loans Converted to Term Loans (1)

Loans Receivable

Amortized Cost Basis by Origination Year

2020 2019 2018 2017 2016 Prior

(In thousands)

Commercial business:

Commercial and industrial

Pass $ 118,971 $ 127,919 $ 70,766 $ 44,231 $ 37,658 $ 95,958 $ 121,440 $ 819 $ 617,762

SM 14,430 9,162 10,878 4,171 5,700 3,579 11,790 814 60,524

SS 2,199 11,835 3,416 9,348 1,052 7,651 15,484 3,827 54,812

Total 135,600 148,916 85,060 57,750 44,410 107,188 148,714 5,460 733,098

Pass 715,121 — — — — — — — 715,121

Owner-occupied CRE

Pass 89,224 167,095 94,830 80,138 74,902 254,864 — — 761,053

SM 6,146 4,540 16,386 11,231 5,464 12,105 — — 55,872

SS — — 114 7,320 3,313 29,012 — — 39,759

Total 95,370 171,635 111,330 98,689 83,679 295,981 — — 856,684

Non-owner-occupied CRE

34 unchanged sentences

Total $ 1,279,419 $ 804,177 $ 460,216 $ 381,636 $ 433,213 $ 867,824 $ 236,339 $ 5,823 $ 4,468,647

(1) Represents loans receivable balance at December 31, 2020 which was converted from a revolving loan to an amortizing loan during the year ended December 31, 2020.

The following table presents the amortized cost of loans receivable by credit quality indicator as of December 31, 2019 in accordance with disclosure requirements prior to CECL Adoption:

(1) Represents the loans receivable balance at December 31, 2020 which was converted from a revolving loan to an amortizing loan during the year ended December 31, 2020.

(d) Nonaccrual Loans

The following table presents the amortized cost of nonaccrual loans for the dates indicated:

December 31, 2021

Pass Special Mention Substandard Doubtful/Loss Total

Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual

(In thousands)

5 unchanged sentences

Residential real estate

130,818 — 842 — 131,660

Real estate construction and land development:

101,973 1,516 807 — 104,296

Commercial and multifamily

Total real estate construction and land development 271,641 2,198 807 — 274,646

Consumer — 29 29

Loans receivable $ 3,625,083 $ 48,859 $ 93,413 $ 524 $ 3,767,879

Potential problem loans are risk rated "Special Mention" or worse that are not classified as a performing TDR or nonaccrual loan and are not individually evaluated for credit loss, but which management is closely monitoring because the financial information of the borrower causes concern as to their ability to meet their loan repayment terms.

Potential problem loans as of December 31, 2020 and December 31, 2019 were $ 182.3 million and $ 87.8 million, respectively.

(d) Nonaccrual Loans

The following table presents the amortized cost of nonaccrual loans for the dates indicated:

December 31, 2020 December 31,

Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual Nonaccrual (1)

Total $ 10,763 $ 12,991 $ 23,754

December 31, 2020

Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual

(In thousands)

5 unchanged sentences

Residential real estate

67 117 184 19

Real estate construction and land development:

3 unchanged sentences

Total $ 30,826 $ 27,266 $ 58,092

(1) Presentation of December 31, 2019 balances is in accordance with disclosure requirements prior to CECL Adoption.

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

14 unchanged sentences

Total $ ( 11 ) $ 3,136 $ ( 555 ) $ 639

For the years ended December 31, 2020 and 2019, no interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the tables above.

For the years ended December 31, 2021 and 2020, no interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the tables above due to payment in full.

(e) Past due loans

The Company performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due.

The amortized cost of past due loans as of December 31, 2020 were as follows:

The Bank performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due.

The amortized cost of past due loans as of December 31, 2021 and December 31, 2020 were as follows:

December 31, 2021

9 unchanged sentences

Total commercial business 4,478 7,226 11,704 3,179,952 3,191,656

December 31, 2021

30-89 Days 90 Days

or Greater Total Past

Due Current Loans Receivable

(In thousands)

Residential real estate

7 unchanged sentences

Total $ 10,190 $ 7,807 $ 17,997 $ 3,797,665 $ 3,815,662

The following table presents the amortized cost of past due loans as of December 31, 2019 in accordance with disclosure requirements prior to CECL Adoption:

December 31, 2020

30-89 Days 90 Days or Greater Total Past

Due Current Total PCI Loans Loans Receivable

30-89 Days 90 Days or

Greater Total Past

Due Current Loans Receivable

(In thousands)

1 unchanged sentence

Commercial and industrial $ 4,621 $ 8,082 $ 12,703 $ 720,395 $ 733,098

SBA PPP — — — 715,121 715,121

Owner-occupied CRE 991 403 1,394 855,290 856,684

10 unchanged sentences

Total $ 10,421 $ 10,501 $ 20,922 $ 4,447,725 $ 4,468,647

There were no loans 90 days or more past due that were still accruing interest as of December 31, 2020 or December 31, 2019.

There was one SBA PPP loan 90 days or more past due that was still accruing interest as of December 31, 2021 with an amortized cost of $ 293,000 .

There were no loans 90 days or more past due that were still accruing interest as of December 31, 2020 .

(f) Collateral-dependent Loans

Loans receivable (1)

CRE Farmland Residential Real Estate Equipment or Accounts Receivable Other Total

The type of collateral securing loans individually evaluated for credit losses and for which the repayment was expected to be provided substantially through the operation or sale of the collateral as of December 31, 2021 and December 31, 2020 were as follows, with b alances representing the amortized cost of the loan classified by the primary collateral category of each loan if multiple collateral sources secure the loan :

December 31, 2021

CRE Farmland Residential Real Estate Other Total

(In thousands)

4 unchanged sentences

Total commercial business 5,807 4,362 1,036 245 11,450

Residential real estate

— — 67 — — 67

Real estate construction and land development:

1 unchanged sentence

571 — — — 571

Consumer — — 30 — — 30

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

(1) Balances represent the amortized cost of the loan.

If multiple collateral sources secure the loan, the entire balance is presented in the primary collateral category, which generally represents the majority of the collateral balance.

There have been no significant changes to the collateral securing individually evaluated loans for credit losses and for which repayment was expected to be provided substantially through the operation or sale of the collateral during the year ended December 31, 2020, except changes due to payoffs and additions of loans to this classification.

Under the probable incurred loss methodology, including the ASC 310-30 methodology for PCI loans, comparative

disclosures of collateral-dependent loans as of December 31, 2019 are similar to the disclosures for impaired loans.

Impaired loans include nonaccrual loans, performing TDR loans, and other loans with a specific valuation allowance, excluding PCI loans.

The amortized cost of impaired loans as of December 31, 2019 is set forth in the following table:

December 31, 2020

Amortized Cost With

Allowance Amortized Cost With

Allowance Total

Amortized Cost Outstanding

Balance Related

(In thousands)

Commercial business:

Commercial and industrial $ 30,179 $ 13,629 $ 43,808 $ 45,585 $ 1,372

Owner-occupied CRE 3,921 2,415 6,336 6,764 426

Non-owner occupied CRE 5,309 1,015 6,324 6,458 146

Total commercial business 39,409 17,059 56,468 58,807 1,944

Residential real estate

— 215 215 223 56

Real estate construction and land development:

237 — 237 237 —

Consumer — 561 561 570 143

Total $ 39,646 $ 17,835 $ 57,481 $ 59,837 $ 2,143

The average amortized cost of impaired loans for the year ended December 31, 2019 and 2018 are set forth in the following table:

Year Ended December 31,

CRE Farmland Residential Real Estate Other Total

(In thousands)

7 unchanged sentences

Commercial and multifamily

Total real estate construction and land development 682 1,220

572 — — — 572

Consumer — — 30 — 30

Total $ 10,582 $ 18,738 $ 681 $ 1,405 $ 31,406

There have been no significant changes to the collateral securing loans individually evaluated for credit losses and for which repayment was expected to be provided substantially through the operation or sale of the collateral during the year ended December 31, 2021, except changes due to additions or removals of loans in this classification.

(g) Troubled Debt Restructured Loans

The majority of the Bank’s TDR loans are a result of granting extensions of maturity on troubled credits which have already been adversely classified.

The Bank grants such extensions to reassess the borrower’s financial status and to develop a plan for repayment.

The second most prevalent concessions are certain modifications with extensions that also include interest rate reductions.

Certain TDR loans were additionally re-amortized over a longer period of time.

These modifications would all be considered a concession for a borrower that could not obtain similar financing terms from another source other than from the Bank.

The financial effects of each modification will vary based on the specific restructure.

The Bank’s TDR loans are primarily fully amortizing term loans.

If the interest rate is not adjusted and the modified terms are consistent with other similar credits being offered, the Bank may not experience any loss associated with the restructure.

If, however, the restructure involves forbearance agreements or interest rate modifications, the Bank may not collect all the principal and interest based on the original contractual terms.

During the year ended December 31, 2020, the Company elected to apply the temporary relief under the CARES Act and related regulatory guidance to certain eligible short-term modifications and did not classify the modifications as TDRs for accounting or disclosure purposes.

COVID Modifications whose payment deferral exceeded 180 days following the loans' initial modification were classified as TDR based on the Bank's internal policy.

The unfunded commitment to borrowers related to TDR loans was $ 2.6 million and $ 736,000 at December 31, 2020 and December 31, 2019, respectively.

For the years ended December 31, 2020, 2019 and 2018 , the Bank recorded $ 1.8 million , $ 1.2 million , and $ 1.4 million respectively, of interest income related to performing TDR loans.

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

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

Year Ended December 31,

2021 2020 2019

Contracts (2)

Amortized Cost (1) (2)

Contracts (2)

Amortized Cost (1) (2)

Contracts (2)

Amortized Cost (1) (2)

Contracts Amortized Cost (1) (2)

(Dollars in thousands)

5 unchanged sentences

Residential real estate

1 178 1 22 — —

Real estate construction and land development:

6 unchanged sentences

(1) Number of contracts and amortized cost represent loans which have balances as of period end, net of subsequent payments after modifications.

Certain modified loans may have been paid-down or charged-off during the years ended December 31, 2020, 2019 and 2018.

Certain TDR loans may have been paid-down or charged-off during the years ended December 31, 2021, 2020 and 2019.

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

The increase in TDR loans during the year ended December 31, 2020 was due primarily to the impacts of the COVID-19 pandemic and the Bank's policy to classify COVID Modifications where the payment deferral period exceeded 180-days as a TDR.

For non-COVID modifications, the concessions granted largely consisted of maturity extensions.

The Bank typically grants shorter extension periods to continually monitor these TDR loans despite the fact that the extended date might not be the date the Bank expects sufficient cash flow from these borrowers to repay the debt.

The Bank does not consider these modifications a subsequent default of a TDR as new loan terms, specifically new maturity dates, were granted.

The Bank had a related ACL on loans that were modified as TDR loans of $ 7.5 million, $ 1.0 million, and $ 2.3 million at December 31, 2020, December 31, 2019 and December 31, 2018, respectively.

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

The Bank had an ACL on loa ns of $ 3.1 million, $ 7.5 million and $ 1.0 million at December 31, 2021, December 31, 2020, and December 31, 2019, respectively, related to these TDR loans which were restructured during the year ended December 31, 2021, 2020 and 2019, respectively.

The unfunded commitment to borrowers related to TDR loans was $ 5.7 million and $ 2.6 million at December 31, 2021 and December 31, 2020, respectively.

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

Year Ended December 31,

11 unchanged sentences

Non-owner occupied CRE — — 2 1,811 1 52

Total commercial business 8 5,316 17 14,048 6 1955

Year Ended December 31,

2020 2019 2018

Contracts (1)

Amortized Cost (1)

Contracts (1)

Amortized Cost (1)

Contracts (1)

Amortized Cost (1)

(Dollars in thousands)

Real estate construction and land development:

— — — — 2 665

Total 6 $ 1,379 8 $ 5,316 17 $ 14,048

(1) Number of contracts and amortized cost represent loans which have balances as of period end, net of subsequent payments after modifications.

Certain modified loans may have been paid-down or charged-off during the years ended December 31, 2020, 2019 and 2018.

During the years ended December 31, 2020, 2019, and 2018, eight , 11 and seven TDR loans defaulted because each was past its modified maturity date and the borrower has not subsequently repaid the credits.

The Bank chose not to extend further the maturity date on these loans.

The remaining six and one TDR loan for the years ended December 31, 2019 and 2018, respectively, defaulted because the borrower was more than 90 days delinquent on their scheduled loan payments.

(1) Number of contracts and amortized cost represent TDR loans which have balances as of period end, net of subsequent payments after modifications.

Certain TDR loans may have been paid-down or charged-off during the years ended December 31, 2021, 2020 and 2019.

During the years ended December 31, 2021, 2020, and 2019, six , eight and 11 TDR loans defaulted because each was past its modified maturity date and the borrower had not subsequently repaid the credits.

The Bank chose not to further extend the maturity date on these TDR loans.

The remaining six TDR loans for the year ended December 31, 2019 defaulted because the borrower was more than 90 days delinquent on their scheduled loan payments.

The Bank had an ACL on loans for these TDR loans which defaulted during the related years of $ 111,000 , $ 229,000 , and $ 88,000 at December 31, 2021, 2020, and 2019.

(h) Purchased Credit Impaired Loans

Upon CECL Adoption, the Company transitioned PCI loans to PCD loans.

The following table reflects the outstanding principal balance and amortized cost of PCI loans at December 31, 2019:

December 31, 2019

Outstanding Principal Amortized Cost

(In thousands)

Commercial business:

Commercial and industrial $ 4,439 $ 2,368

Owner-occupied CRE 4,925 4,914

Non-owner occupied CRE 7,028 5,491

Total commercial business 16,392 12,773

Residential real estate

Consumer 1,463 1,762

Total $ 20,950 $ 18,110

On the acquisition dates, the amount by which the undiscounted expected cash flows of the PCI loans exceeded the estimated fair value of the loan was the “accretable yield.” The accretable yield was then measured at each financial reporting date and represented the difference between the remaining undiscounted expected cash flows and the current carrying value of the PCI loans.

The following table summarizes the accretable yield on the PCI loans during the periods indicated:

Year Ended December 31,

(In thousands)

Balance at the beginning of the year $ 9,493 $ 11,224

Accretion ( 1,936 ) ( 2,674 )

Disposal and other ( 1,600 ) ( 2,871 )

Reclassification from nonaccretable difference 884 3,814

Balance at the end of the year $ 6,841 $ 9,493

(i) Related Party Loans

(h) Related Party Loans

In the ordinary course of business, the Company has granted loans to certain directors, executive officers and their affiliates.

7 unchanged sentences

Balance outstanding at the end of year $ 7,122 $ 7,694 $ 8,144

All related party loans were performing in accordance with the underlying loan agreements as of December 31, 2020 and December 31, 2019.

The Company had $ 545,000 and $ 557,000 of unfunded commitments to related parties as of December 31, 2020 and December 31, 2019, respectively.

The Company did no t have any borrowings from related parties at December 31, 2020 or December 31, 2019.

(j) Residential Real Estate Loan Sales

The Company had $ 255,000 and $ 545,000 of unfunded commitments to related parties and all related party loans were performing in accordance with the underlying loan agreements as of December 31, 2021 and December 31, 2020.

(i) Residential Real Estate Loan Sales

The Bank originates residential real estate loans;

2 unchanged sentences

At December 31, 2021 and December 31, 2020, the balance of loans held for sale was $ 1.5 million and $ 4.9 million, respectively.

The following table presents information concerning the origination and sale of the Bank's residential real estate loans and the gains from their sale:

The following table presents information concerning the origination and sale of the Bank's residential real estate loans and the gains from their sale during the periods indicated:

Year Ended December 31,

1 unchanged sentence

(In thousands)

Residential real estate:

Originated (1)

5 unchanged sentences

(2) Excludes net gains on sales of SBA and other loans.

The Bank may additionally make commitments to fund residential real estate loans (interest rate locks) to be sold into the secondary market.

The contractual amounts of commitments to sell and fund residential real estate loans at December 31, 2020 and December 31, 2019 were as follows:

December 31, 2020 December 31, 2019

(In thousands)

Commitments to sell residential real estate loans $ 18,127 $ 8,815

Commitments to fund residential real estate loans (at interest rates approximating market rates) for portfolio or for sale:

Fixed rate 19,640 15,509

Variable or adjustable rate 98 3,111

Total commitments to fund residential real estate loans $ 19,738 $ 18,620

The fair values of freestanding derivatives related to the commitments to fund residential real estate loans and sell at locked interest rates were not significant at December 31, 2020 or December 31, 2019.

(k) Commercial Loan Sales, Servicing, and Commercial Servicing Asset

(j) Commercial Loan Sales, Servicing, and Commercial Servicing Asset

Details of loans serviced for others are as follows:

6 unchanged sentences

The Company's servicing asset at December 31, 2021 and December 31, 2020 was $ 343,000 and $ 583,000 , respectively.

The activity and balances for the year ended December 31, 2018 were no t significant.

Fair value for the annual impairment analysis at December 31, 2020 was determined using a discount rate of 10.0 % and prepayment speeds ranging from 12.5 % to 18.6 %.

Fair value for the annual impairment analysis at December 31, 2019 was determined using discount rates ranging from 10.0 % to 12.8 % and prepayment speeds from 11.5 % to 19.7 %.

There was no valuation allowance on the Company's servicing asset as of December 31, 2020, December 31, 2019 and December 31, 2018.

There was no valuation allowance on the Company's servicing asset as of December 31, 2021 and December 31, 2020.

(k) Accrued interest receivable on loans receivable

Accrued interest receivable on loans receivable totaled $ 10.1 million and $ 15.8 million at December 31, 2021 and December 31, 2020, respectively.

It is excluded from the calculation of the ACL on loans as interest accrued, but not received, is reversed timely.

(4) Allowance for Credit Losses on Loans

Effective January 1, 2020, the Bank adopted ASU 2016-13.

CECL Adoption replaced the ALL with the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans.

The baseline loss rates used to calculate the ACL on loans at January 1, 2020 utilized the Bank's average quarterly historical loss information from December 31, 2007 through December 31, 2019.

The baseline loss rate for the ACL at December 31, 2020 used historical losses beginning December 31, 2012 through the balance sheet date.

The Bank updated the historical loss period during the year ended December 31, 2020 as it believed the economic cycle has ended with the onset of the COVID-19 recession.

The Bank believes the historic loss rates are viable inputs to the current expected credit loss methodology as the Bank's lending practice and business has remained relatively stable throughout the periods.

CECL Adoption replaced the allowance for loan losses with the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans.

The baseline loss rates used to calculate the ACL on loans at December 31, 2021 utilized the Bank's average quarterly historical loss information from December 31, 2012 through the balance sheet date.

There were no changes to this assumption during the year ended December 31, 2021.

The Bank believes the historic loss rates are viable inputs to the current CECL model as the Bank's lending practice and business has remained relatively stable throughout the periods.

While the Bank's assets have grown, the credit culture has stayed relatively consistent.

Prepayments included in the CECL model at January 1, 2020 were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of future prepayment activity.

Prepayments included in the CECL model at December 31, 2021 were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of future prepayment activity.

There were no changes to this assumption during the year ended December 31, 2021.

The reasonable and supportable period used in the CECL model as of January 1, 2020 was four quarters and was increased to five quarters for the model as of December 31, 2020 to include the additional impact of certain macroeconomic factors with lagged periods.

Management believes that forecasts beyond this five quarter time period tend to diverge in economic assumptions and may be less comparable to actual future events.

As the length of the reasonable and supportable period increases, the degree of judgment involved in estimating the allowance will likely increase.

The Bank used a two-quarter reversion period in calculating the ACL as of January 1, 2020 and December 31, 2020 as it believes the historical loss information is relevant to the expected credit losses and recognizes the declining precision and increasing uncertainty of estimating credit losses in those periods beyond which it can make reasonable and supportable forecasts.

The macroeconomic forecast used in the CECL model as of January 1, 2020 predicted continued economic expansion with steady GDP growth and low unemployment rates, among other factors.

The onset of the COVID-19 pandemic resulted in the identification of an economic recession during the second quarter of 2020 as evidenced by certain economic forecasts signaling prolonged, profound, and pervasive contraction in economic activities due to the COVID-19 pandemic.

The GDP contracted and unemployment rates increased, amount other factors, during the year ended December 31, 2020.

The macroeconomic forecast used in the CECL model as of December 31, 2020 reflected a slow recovery from the COVID-19 recession, modeled to last through the end of 2021.

The macroeconomic forecast as of December 31, 2020 considered the COVID-19 vaccine progress as well as anticipated government stimulus plans;

however, uncertainty remained over the time necessary to return the economy to pre-pandemic levels.

The ACL on loans at December 31, 2020 does not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.

The reasonable and supportable period and subsequent reversion period used in the CECL model was five quarters and two quarters at December 31, 2021.

There were no changes to these assumptions during the year ended December 31, 2021.

Management believes forecasts beyond this seven quarter time period tend to diverge in economic assumptions and may be less comparable to actual future events.

As the length of the reasonable and supportable period increases, the degree of judgment involved in estimating the allowance increases.

During the year ended December 31, 2021, the ACL on loans decreased $ 27.8 million, or 39.6 %, due primarily to a reversal of provision for credit losses on loans of $ 27.3 million.

The reversal of provision for credit losses was primarily driven by improvements in the economic forecast used in the CECL model at December 31, 2021 as compared to the forecast used in the CECL model at December 31, 2020.

The ACL on loans at December 31, 2021 and December 31, 2020 did not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.

A summary of the changes in the ACL on loans during the years ended December 31, 2021, December 31, 2020 and December 31, 2019 is as follows:

7 unchanged sentences

Recoveries of loans previously charged-off 1,420 2,381 1,807

Provision for loan losses 35,433 4,311 5,129

(Reversal of) provision for credit losses on loans ( 27,298 ) 35,433 4,311

Balance at the end of the year $ 42,361 $ 70,185 $ 36,171

The following table details the activity in the ACL on loans disaggregated by segment and class for the year ended December 31, 2020:

Beginning Balance Impact of CECL Adoption Beginning Balance,

as Adjusted Charge-offs Recoveries Provision for Credit Losses Ending Balance

(In thousands)

Commercial business:

Commercial and industrial $ 11,739 $ ( 1,348 ) $ 10,391 $ ( 3,616 ) $ 1,513 $ 21,722 $ 30,010

— — $ — — — — —

Owner-occupied CRE 4,512 452 4,964 ( 135 ) 17 4,640 9,486

Non-owner occupied CRE 7,682 ( 2,039 ) 5,643 — — 4,469 10,112

Total commercial business 23,933 ( 2,935 ) 20,998 ( 3,751 ) 1,530 30,831 49,608

Residential real estate

1,458 1,471 2,929 — 3 ( 1,341 ) 1,591

Real estate construction and land development:

1,455 ( 571 ) 884 — 278 789 1,951

Commercial and multifamily

1,605 7,240 8,845 ( 417 ) — 2,713 11,141

Total real estate construction and land development 3,060 6,669 9,729 ( 417 ) 278 3,502 13,092

Consumer 6,821 ( 2,484 ) 4,337 ( 1,454 ) 570 2,441 5,894

Unallocated 899 ( 899 ) — — — — —

Total $ 36,171 $ 1,822 $ 37,993 $ ( 5,622 ) $ 2,381 $ 35,433 $ 70,185

The Bank recog nized net charge-offs of $ 3.2 million during the year ended December 31, 2020 primarily due to a commercial and industrial charge-off of $ 1.7 million related to issues surrounding control of the underlying loan collateral.

The Bank determined it appropriate to charge-off this entire loan relationship balance and pursue an aggressive collection strategy.

Net charge-offs also included two commercial and industrial loan relationships totaling $ 447,000 as a result of impacts from the COVID-19 pandemic, a partial charge-off of one commercial and multifamily real estate construction and land development loan totaling $ 417,000 as a result of cost overruns and delays in constructio n and small dollar net charge-offs on a large volume of consumer loans of $ 884,000 .

Net charge-offs were offset partially by the full recovery of a commercial and industrial agricultural lending relationship of $ 963,000 during the year ended December 31, 2020, which was charged-off during the year ended December 31, 2019.

The provision for credit losses on loans of $ 35.4 million for the year ended December 31, 2020 was necessary to build the allowance to account for the current and forecasted economic conditions amidst the COVID-19 pandemic, including the credit losses estimated on collectively and individually evaluated loans.

The following table details the activity in the ALL disaggregated by segment and class for the year ended December 31, 2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:

Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance

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

Year Ended December 31, 2021

Beginning Balance Charge-offs Recoveries Reversal of Provision for Credit Losses Ending Balance

(In thousands)

12 unchanged sentences

Consumer 5,894 ( 669 ) 572 ( 3,170 ) 2,627

Unallocated 1,353 — — ( 454 ) 899

Total $ 70,185 $ ( 1,946 ) $ 1,420 $ ( 27,298 ) $ 42,361

The following table details the ALL disaggregated on the basis of the Company's impairment method as of December 31, 2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:

Loans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total ALL

Year Ended December 31, 2020

Beginning Balance Impact of CECL Adoption Beginning Balance,

as Adjusted Charge-offs Recoveries Provision (Reversal of Provision) for Credit Losses Ending Balance

(In thousands)

5 unchanged sentences

Residential real estate 1,458 1,471 2,929 — 3 ( 1,341 ) 1,591

56 1,316 86 1,458

Real estate construction and land development:

6 unchanged sentences

Total $ 36,171 $ 1,822 $ 37,993 $ ( 5,622 ) $ 2,381 $ 35,433 $ 70,185

The following table details the amortized cost of the loan receivables disaggregated on the basis of the Company’s impairment method as of December 31, 2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:

Loans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Loans Receivable

(In thousands)

Commercial business:

Commercial and industrial $ 43,808 $ 806,044 $ 2,368 $ 852,220

Owner-occupied CRE 6,336 793,984 4,914 805,234

Non-owner occupied CRE 6,324 1,276,964 5,491 1,288,779

Total commercial business 56,468 2,876,992 12,773 2,946,233

Residential real estate

215 127,870 3,575 131,660

Real estate construction and land development:

237 104,059 — 104,296

Commercial and multifamily

— 170,350 — 170,350

Total real estate construction and land development 237 274,409 — 274,646

Consumer 561 413,017 1,762 415,340

Total $ 57,481 $ 3,692,288 $ 18,110 $ 3,767,879

The following table details the activity in the ALL disaggregated by segment and class for the year ended December 31, 2018 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:

Balance at Beginning of Year Charge-offs Recoveries Provision for Loan Losses Balance at End of Year

The following table details activity in the allowance for loan losses by segment and class for the period indicated:

Year Ended December 31, 2019

Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance

(In thousands)

6 unchanged sentences

1,203 ( 60 ) — 315 1,458

Year Ended December 31, 2019

Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance

Real estate construction and land development:

13 unchanged sentences

Additions — 270 —

Additions from acquisitions — — 1,796

Proceeds from dispositions — ( 1,290 ) ( 864 )

16 unchanged sentences

The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in the following mergers:

Premier Commercial Bancorp on July 2, 2018;

Puget Sound Bancorp on January 16, 2018;

Washington Banking Company on May 1, 2014;

Valley Community Bancshares on July 15, 2013;

Premier Commercial Bancorp and Puget Sound Bancorp in 2018;

Washington Banking Company in 2014;

Valley Community Bancshares in 2013;

Western Washington Bancorp in 2006 and North Pacific Bank in 1998.

The Company’s goodwill is assigned to the Bank and is evaluated for impairment at the Bank level (reporting unit).

The following table presents the change in goodwill for the periods indicated:

Year Ended December 31,

2020 2019 2018

(In thousands)

Balance at the beginning of the period $ 240,939 $ 240,939 $ 119,029

Additions as a result of acquisitions (1)

Balance at the end of the period $ 240,939 $ 240,939 $ 240,939

(1) See Note (2) Business Combinations

Due to the deteriorating financial market and economic conditions as a result of the COVID-19 pandemic, the Company determined a triggering event occurred prior to its annual assessment date and consequently engaged an independent third-party valuation specialist to assist management in performing a quantitative assessment of goodwill as of May 31, 2020.

Based on the quantitative assessment, management estimated the fair value of the reporting unit by weighting results from the market approach and the income approach.

Based on this quantitative test, management determined that the fair value of the reporting unit more likely than not exceeded the carrying value.

The Company performed a qualitative assessment during its annual impairment test, and determined that it was more likely than not that the fair value of the reporting unit exceeded the carrying value, such that the Company's goodwill was no t considered impaired at December 31, 2020.

Similarly, no goodwill impairment charges were required, or recorded, for the years ended December 31, 2019 or 2018.

Changes in the economic environment, operations of the reporting unit or other adverse events could result in future impairment charges which could have a material adverse impact on the Company’s operating results.

There were no additions to goodwill during the years ended December 31, 2021, 2020, and 2019.

At December 31, 2021, the Company’s analysis concluded the fair value of the reporting unit exceeded the carrying value so the Company's goodwill was not considered impaired.

Similarly, no goodwill impairment charges were recorded for the years ended December 31, 2020 and 2019.

Even though there was no goodwill impairment at December 31, 2021, changes in

the economic environment, operations of the reporting unit or other adverse events could result in future impairment charges which could have a material impact on the Company’s operating results.

(b) Other Intangible Assets

O ther intangible assets represent CDI acquired in business combinations.

The useful life of the CDI was estimated to be ten years for the acquisitions of Premier Commercial Bancorp, Puget Sound Bancorp, Washington Banking Company, and Valley Community Bancshares.

The following table presents the change in other intangible assets for the periods indicated:

Year Ended December 31,

2020 2019 2018

(In thousands)

Balance at the beginning of the period $ 16,613 $ 20,614 $ 6,088

Additions as a result of acquisitions (1)

Amortization ( 3,525 ) ( 4,001 ) ( 3,819 )

Balance at the end of the period $ 13,088 $ 16,613 $ 20,614

(1) See Note (2) Business Combinations

The estimated aggregate amortization expense related to these intangible assets for future years is as follows:

Year Ending December 31,

(In thousands)

Other intangible assets represent core deposit intangible acquired in business combinations with estimated useful lives of ten years .

There were no additions to goodwill during the years ended December 31, 2021, 2020, and 2019 and the estimated aggregate amortization expense related to other intangible assets for future years as of December 31, 2021 is as follows, in thousands:

Thereafter 973

Total $ 9,977

(8) Derivative Financial Instruments

The following table presents the notional amounts and estimated fair values of derivatives:

December 31, 2021 December 31, 2020

Notional Amounts Estimated Fair Value Notional Amounts Estimated Fair Value

(In thousands)

Non-hedging interest rate derivatives:

Interest rate swap asset (1)

322,726 $ 15,219 $ 308,126 $ 25,740

Interest rate swap liability (1)

322,726 ( 15,286 ) 308,126 ( 26,162 )

(1) The estimated fair value of derivatives with customers was $ 9.8 million and $ 25.4 million as of December 31, 2021 and December 31, 2020, respectively.

The estimated fair value of derivatives with third-parties was $( 9.8 ) million and $( 25.9 ) million as of December 31, 2021 and December 31, 2020, respectively.

Generally, the gains and losses of the interest rate derivatives offset due to the back-to-back nature of the contracts.

However, the settlement values of the Bank's net derivative assets with customers were increased by $ 355,000 and reduced by $ 422,000 as of December 31, 2021 and December 31, 2020, respectively, due to the recognition of a credit valuation adjustment.

A credit valuation adjustment was not recorded on the Bank's net derivative assets as of December 31, 2019.

Deposits consisted of the following:

20 unchanged sentences

Total interest expense $ 6,160 $ 12,265 $ 16,349

Scheduled maturities of certificates of deposit for future years are as follows:

Year Ending December 31,

(In thousands)

Scheduled maturities of certificates of deposit for future years as of December 31, 2021 are as follows, in thousands:

2022 $ 290,497

Thereafter 30

Total $ 342,839

13 unchanged sentences

All of the common securities of the Trust are owned by the Company.

Heritage has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements.

The Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements.

For financial reporting purposes, the Company's investment in the Master Trust is accounted for under the equity method and is included in prepaid expenses and other assets on the Consolidated Statements of Financial Condition.

2 unchanged sentences

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 available for sale.

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 .

4 unchanged sentences

(In thousands)

Treasury and U.S.

Government-sponsored agencies $ 4,914 $ —

Residential CMO and MBS 4,134 7,388

6 unchanged sentences

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.

At December 31, 2020, the Bank maintained a credit facility with the FHLB with available borrowing capacity of $ 991.7 million.

At December 31, 2021, the Bank maintained a credit facility with the FHLB with available borrowing capacity of $ 1.06 billion.

At December 31, 2021 and December 31, 2020 the Bank had no FHLB advances outstanding.

The following table sets forth the details of FHLB advances during and as of the years ended December 31, 2020 and 2019:

As of or For the Year Ended

December 31, 2020 December 31, 2019

(In thousands)

Average balance during the year $ 1,466 $ 11,899

Maximum month-end balance during the year $ — $ 90,700

Weighted average rate during the year 0.55 % 2.57 %

Weighted average rate at the end of year n/a n/a

Advances from the FHLB are collateralized by a blanket pledge on FHLB stock owned by the Bank, deposits at the FHLB, certain commercial and residential real estate loans, investment securities which are obligations of or guaranteed by the United States, or other assets.

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.

In accordance with the pledge agreement, the Company must maintain unencumbered collateral in an amount equal to varying percentages ranging from 100 % to 160 % of outstanding advances depending on the type of collateral.

(b) Federal Funds Purchased

The Bank maintains advance lines with Wells Fargo Bank, US Bank, The Independent Bankers Bank, Pacific Coast Bankers’ Bank, and JP Morgan Chase to purchase federal funds of up to $ 215.0 million as of December 31, 2020.

The Bank maintains advance lines with five correspondent banks to purchase federal funds totaling $ 215.0 million as of December 31, 2021.

The lines generally mature annually or are reviewed annually.

3 unchanged sentences

There were no borrowings outstanding as of December 31, 2021 and December 31, 2020.

Any advances on the credit facility would be secured by certain types of the Bank's loans receivable.

(d) PPPLF Facility

The Federal Reserve established the PPPLF under Section 13(3) of the Federal Reserve Act to bolster the effectiveness of the SBA's PPP.

Under the PPPLF, the Bank had the option to pledge its SBA PPP loans as collateral at face value to obtain Federal Reserve Bank non-recourse loans.

PPPLF advances were available to be obtained until December 31, 2020.

As of and for the year ended December 31, 2020, although the Bank was approved to utilize the PPPLF, the Bank had no t participated in it.

See Note (25) Subsequent Events regarding the renewal of this facility subsequent to December 31, 2020.

Any advances on the credit facility would be secured by either investment securities or certain types of the Bank's loans receivable.

(d) Related Party Borrowings

The Company did no t have any borrowings from related parties as of December 31, 2021 or December 31, 2020.

The Company's noncancelable operating lease agreements relate to certain banking offices, back-office operational facilities, office equipment and sublease agreements.

2 unchanged sentences

The Company does not have any leases designated as finance leases.

The table below summarizes the net lease cost recognized during the periods presented:

On December 30, 2021, the Company sold its Olympia, Washington headquarters campus for total proceeds of $ 5.4 million resulting in a net gain of $ 2.7 million.

Contemporaneously with the closing of the sale, the Company entered into two leases pursuant to which the Company leased back the first and second floors of the main building for an initial annual rent of $ 227,000 , subject to annual escalations of 3 % over the lease terms.

The leases are being accounted for as operating leases and have initial lease terms of ten and five years for the first and second floor, respectively, and both leases additionally provide the Company with two five-year options to extend.

The new operating leases were incorporated into the required disclosures below.

The table below summarizes the information about our leases during the periods or at period end presented:

Year Ended December 31,

4 unchanged sentences

Sublease income ( 24 ) ( 55 )

Total net lease cost $ 5,678 $ 5,755

Comparative disclosure of rental expense of leased premises and equipment calculated under ASC 840 methodology was $ 6.1 million for the year ended December 31, 2018 and is included in Occupancy and equipment expense on the Consolidated Statements of Income.

The tables below summarize other information related to the Company's operating leases during the periods presented:

Year Ended December 31,

(In thousands)

Operating cash used for amounts included in the measurement of lease liabilities $ 4,881 $ 4,858

ROU assets obtained in exchange for lease liabilities, excluding adoption impact 1,265 1,505

2020 December 31,

Weighted average remaining lease term of operating leases, in years 7.2 8.1

Weighted average discount rate of operating leases 3.12 % 3.27 %

The following table outlines lease payment obligations as of December 31, 2020 as outlined in the Company’s lease agreements for each of the next five years and thereafter in addition to a reconciliation to the Company’s ROU liability at the date indicated:

Year Ending December 31,

(In thousands)

Total net lease cost during the period $ 5,730 $ 5,678

Operating cash used for amounts included in the measurement of lease liabilities during the period $ 5,004 $ 4,881

ROU assets obtained in exchange for lease liabilities during the period 13,966 1,265

Weighted average remaining lease term of operating leases, in years, at period end 7.1 7.2

Weighted average discount rate of operating leases, at period end 2.32 % 3.12 %

The following table presents the lease payment obligations as of December 31, 2021 as outlined in the Company’s lease agreements for each of the next five years and thereafter, in thousands:

Thereafter 8,703

2 unchanged sentences

ROU liability $ 28,841

During the year ended December 31, 2019, the Company entered into a $ 7.7 million lease agreement to renew, restructure and add additional leased space at one of its branch locations commencing on January 1, 2021.

The lease agreement is not included in the lease payment obligations table above.

The new agreement replaced a lease included in the table above that terminated on December 31, 2020.

(14) Employee Benefit Plans

(a) 401(k) Plan

The Company provides its eligible employees with a 401(k) plan ("Plan").

The Company funds certain Plan costs as incurred.

The Plan includes the Company’s salary savings 401(k) plan for its employees.

All employees hired may participate in the Plan the first of the month following employment or concurrent to their hire date if starting the first of the month.

The Company provides its eligible employees with a Plan, including funding certain Plan costs as incurred.

All employees may participate in the Plan commencing with the first of the month following the start of employment or concurrent to their hire date if starting the first of the month.

Participants may contribute a portion of their salary, which is matched by the Company at 50 %, not to be greater than 3 % of eligible compensation, up to Internal Revenue Service limits.

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The Company has a Deferred Compensation Plan which provides its directors and select executive officers with the opportunity to defer current compensation.

Under the Deferred Compensation Plan, participants are permitted to elect to defer compensation and the Company has the discretion to make additional contributions on behalf of any participant based on a number of factors.

The following table presents a summary of the changes in the Deferred Compensation Plan during the periods indicated:

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Balance outstanding at the end of the year $ 3,854 $ 4,101 $ 4,244

(d) Split-Dollar Life Insurance Benefit Plan

In conjunction with the Washington Banking Merger, the Company assumed the split-dollar life insurance benefit plan previously maintained by Washington Banking.

Life insurance policies are maintained for current or former officers of the Bank or former Washington Banking officers that are subject to split-dollar life insurance agreements, which continue after the participant's employment and retirement.

All participants are fully vested in their split-dollar life insurance benefits.

The accrued benefit liability for the split-dollar life insurance agreements represents the present value of the future death benefits payable to the participants' beneficiaries.

The split-dollar life insurance projected benefit obligation is included in Accrued expenses and other liabilities on the Consolidated Statements of Financial Condition.

As of December 31, 2020 and December 31, 2019, the carrying value of the obligation was $ 165,000 and $ 200,000 , respectively.

(e) Salary Continuation Plan

In conjunction with the Premier Merger in 2018, the Company assumed an unfunded deferred compensation plan for select former Premier Commercial executive officers, some of which are current Heritage officers.

Under this salary continuation plan, the Company will pay each participant, or their beneficiary, specified benefits over specified periods beginning with the individual's termination of service due to retirement subject to early termination provisions.

A liability is accrued for this obligation and is included in Accrued expenses and other liabilities on the Consolidated Statements of Financial Condition.

(d) Salary Continuation Plan

In conjunction with the Company's merger with Premier Commercial Bancorp in 2018, the Company assumed an unfunded deferred compensation plan for select former Premier Commercial executive officers, some of which are current

Company officers.

The following table presents a summary of the changes in the salary continuation plan during the periods indicated:

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Obligation, at the beginning of the year $ 4,162 $ 4,334 $ 4,600

Balance acquired in Premier Merger — — 4,718

Benefits paid ( 536 ) ( 460 ) ( 554 )

1 unchanged sentence

Obligation, at the end of the year $ 3,835 $ 4,162 $ 4,334

(15) Commitments and Contingencies

(a) Commitments to Extend Credit

In the ordinary course of business, the Company may enter into various types of transactions that include commitments to extend credit that are not included in its Consolidated Financial Statements.

The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations.

The majority of the commitments presented below are variable rate.

Loan commitments can be either revolving or non-revolving.

The Bank’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.

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

December 31, 2020 December 31, 2019

(In thousands)

Commercial business:

Commercial and industrial $ 640,018 $ 584,287

Owner-occupied CRE 3,488 17,193

Non-owner occupied CRE 18,396 35,573

Total commercial business 661,902 637,053

Real estate construction and land development:

Residential 52,453 75,066

Commercial and multifamily

127,821 230,343

Total real estate construction and land development 180,274 305,409

Consumer 263,249 269,898

Total outstanding commitments $ 1,105,425 $ 1,212,360

Upon CECL adoption, as described in Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements, the Company recorded an increase in the beginning ACL on unfunded commitments of $ 3.7 million, representing the change in methodology from an estimate of incurred losses at the balance sheet date, with an estimated probability of funding, to an estimate of credit losses on future utilization over the entire contractual period.

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

Year Ended December 31,

2020 2019 2018

(In thousands)

Balance, beginning of period $ 306 $ 306 $ 170

Impact of CECL Adoption 3,702 — —

Adjusted balance, beginning of period 4,008 306 170

Provision for credit losses on unfunded commitments 673 — 136

Balance, end of period $ 4,681 $ 306 $ 306

(b) Variable Interests - Low Income Housing Tax Credit Investments

The carrying values of investments in unconsolidated LIHTCs were $ 96.4 million and $ 92.7 million as of December 31, 2020 and December 31, 2019, respectively.

During the years ended December 31, 2020, 2019 and 2018 the Company recognized tax benefits of $ 7.5 million, $ 5.7 million and $ 2.4 million, respectively, and proportional amortization of $ 6.5 million, $ 5.0 million and $ 3.1 million, respectively.

Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $ 53.8 million and $ 50.7 million at December 31, 2020 and December 31, 2019, respectively.

The Company expects to fund LIHTC commitments of $ 37.9 million during the year ended December 31, 2021 and $ 9.7 million during the year ended December 31, 2022, with the remaining commitments of $ 6.2 million funded by December 31, 2034.

There were no impairment losses on the Company’s LIHTC investments during the years ended December 31, 2020, 2019 or 2018.

The equity method balance of the NMTC investment was $ 25.2 million and $ 25.4 million at December 31, 2020 and December 31, 2019, respectively.

The Company recognized related investment income of $ 694,000 , $ 701,000 and $ 708,000 during the years ended December 31, 2020, 2019 and 2018, respectively.

Gross tax credits related to the Company's certified development entities totaling $ 9.8 million were utilized during the seven year period ending December 31, 2020.

There were no impairment losses on the Company’s NMTC investments during the years ended December 31, 2020, 2019 or 2018.

(16) Derivative Financial Instruments

The Company has entered into certain interest rate swap contracts that are not designated as hedging instruments.

The following table presents the notional amounts and estimated fair values of interest rate derivative contracts outstanding at December 31, 2020 and December 31, 2019:

December 31, 2020 December 31, 2019

Notional Amounts Estimated Fair Value Notional Amounts Estimated Fair Value

(In thousands)

Non-hedging interest rate derivatives

Interest rate swap asset (1)

308,126 $ 25,740 $ 221,436 $ 8,318

Interest rate swap liability (1)

308,126 ( 26,162 ) 221,436 ( 8,318 )

(1) The estimated fair value of derivatives with customers was $ 25.4 million and $ 8.1 million as of December 31, 2020 and December 31, 2019, respectively.

The estimated fair value of derivatives with third-parties was $( 25.9 ) million and $( 8.1 ) million as of December 31, 2020 and December 31, 2019, respectively.

Generally, the gains and losses of the interest rate derivatives offset due to the back-to-back nature of the contracts.

However, as of December 31, 2020, the settlement values of the Bank's net derivative assets decreased due to the recognition of a credit valuation adjustment of $ 422,000 during the year ended December 31, 2020.

A credit valuation adjustment was not recorded on the Bank's net derivative assets as of December 31, 2019.

Credit risk for derivatives with customers is concentrated within our primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County and Washington County in Oregon, as well as other contiguous markets and represents a geographic concentration.

Credit risk for derivatives with third-parties is concentrated among four well-known broker dealers.

(15) Stockholders’ Equity

(a) Earnings Per Common Share

The following table illustrates the calculation of weighted average shares used for earnings per common share computations at December 31, 2020, December 31, 2019 and December 31, 2018:

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

Year Ended December 31,

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Total diluted weighted average common shares outstanding 35,973,386 36,170,066 36,985,766

Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (3)

7,043 137,093 1,501

(1) Represents dividends paid and undistributed earnings allocated to unvested restricted stock awards.

(2) Represents the effect of the assumed exercise of stock options and vesting of restricted stock awards and units.

Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive.

Anti-dilution occurs when the exercise price of a stock option or the unrecognized compensation cost per share of a restricted stock award exceeds the market price of the Company’s stock.

For the years ended December 31, 2020 and December 31, 2019, there were 137,093 and 1,501 anti-dilutive shares outstanding, respectively.

For the year ended December 31, 2018, there were no anti-dilutive shares outstanding.

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

(b) Dividends

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October 21, 2020 $ 0.20 November 4, 2020 November 18, 2020

October 23, 2019 $ 0.10 November 7, 2019 November 21, 2019 *

January 27, 2021 $ 0.20 February 10, 2021 February 24, 2021

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The Company has had various stock repurchase programs since March 1999.

On October 23, 2014.

the Company's Board of Directors authorized the repurchase of up to 5 % of the Company's outstanding common shares, or approximately 1,513,000 shares, under the eleventh stock repurchase plan.

As of March 2020, all shares had been repurchased under this plan.

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

The number, timing and price of shares repurchased will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.

During the year ended December 31, 2020, the Company repurchased 639,922 shares under the eleventh stock repurchase plan at a weighted average price per share of $ 23.95 and repurchased 155,778 shares under the twelfth stock repurchase plan at a weighted average share price of $ 20.34 , which is a total of 795,700 shares under both plans at a weighted average share price of $ 23.25 .

During the year ended December 31, 2019, the Company repurchased 292,712 shares under the eleventh stock repurchase plan with a weighted average price per share of $ 26.50 .

No shares were repurchased under the eleventh stock repurchase plan during the year ended December 31, 2018.

On October 23, 2014, the Company's board of directors authorized the repurchase of up to 5 % of the Company's outstanding common shares, or approximately 1,512,600 shares, under the eleventh stock repurchase plan.

On March 12, 2020, the Company's board of directors authorized the repurchase of up to 5 % of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock repurchase plan after all shares under the eleventh stock repurchase plan had been repurchased.

The number, timing and price of shares repurchased under the twelfth stock repurchase plan will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.

The following table provides total repurchased shares and average share prices under the applicable plans for the periods indicated:

Year Ended December 31,

2021 2020 2019 Plan Total (1)

Eleventh Stock Repurchase Plan

Repurchased shares — 639,922 292,712 1,512,600

Stock repurchase average share price $ — $ 23.95 $ 26.50 $ 21.69

Twelfth Stock Repurchase Plan

Repurchased shares 904,972 155,778 — 1,060,750

Stock repurchase average share price $ 24.43 $ 20.34 $ — $ 23.83

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

In addition to the stock repurchases under a stock repurchase plan, the Company repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units.

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Repurchased shares to pay withholding taxes 26,869 28,887 28,479

28,887 28,479 53,256

Stock repurchase to pay withholding taxes average share price $ 29.10 $ 21.57 $ 30.83

(1) During the year ended December 31, 2018, the Company repurchased 26,741 shares related to the withholding taxes due on the accelerated vesting of the restricted stock units of Puget Sound which were converted to Heritage common stock shares with an average share price of $ 31.80 under the terms of the Puget Sound Merger.

See Note (2) Business Combinations.

(d) Issuance of Common Stock

In conjunction with the Premier Merger effective on July 2, 2018 and the Puget Sound Merger effective on January 16, 2018, Heritage issued 2,848,579 and 4,112,258 shares, respectively, of the Company's common stock at the merger date share price of $ 34.85 and $ 31.80 , respectively, for a fair value of $ 99.3 million and $ 130.8 million, respectively.

In addition, common stock was issued during the years ended December 31, 2020, 2019 and 2018 related to the exercise of stock options and issuance of restricted stock awards as further described in Note (19) Stock-Based Compensation.

Common stock was issued during the years ended December 31, 2020 and 2019 related to the exercise of stock options as further described in Note (17) Stock-Based Compensation.

(16) Fair Value Measurements

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

Valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models, discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or broker traded transactions.

Valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models,

discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or broker traded transactions.

Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

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

Investment Securities Available for Sale :

Investment Securities :

The fair values of all investment securities are based upon the assumptions that market participants would use in pricing the security.

2 unchanged sentences

For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using observable and unobservable inputs such as discounted cash flows or other market indicators (Level 3).

Security valuations are obtained from third-party pricing services.

Investment security valuations are obtained from third-party pricing services.

Collateral-Dependent Loans :

Collateral-dependent loans are identified as part of the calculation of the ACL on loans.

Collateral-dependent loans are identified for the calculation of the ACL on loans.

The fair value used to measure credit loss for this type of loan is commonly based on recent real estate appraisals which are generally obtained at least every 18 months or earlier if there are changes to risk characteristics of the underlying loan.

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Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available.

Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

The Bank also incorporates an estimate of cost to sell the collateral when the sale is probable.

Such adjustments may be significant and result in a Level 3 classification of the inputs for determining fair value.

Non-real estate collateral may be valued using an appraisal, net book value based on the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the customer and customer’s business (Level 3).

Individually evaluated loans are analyzed for credit loss on a quarterly basis and the ACL on loans is adjusted as required based on the results.

Other Real Estate Owned :

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.

These assets are subsequently accounted for at lower of cost or fair value less costs to sell.

Fair value is commonly based on recent real estate appraisals which are generally obtained at least every 18 months or earlier.

These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available.

Such adjustments are usually significant and typically result in Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent loans and other real estate owned are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by the Company.

Once received, the Company reviews the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

On a quarterly basis, the Company compares the actual selling price of collateral that has been

liquidated to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.

Appraisals on collateral-dependent loans are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by the Bank.

Once received, the Bank's internal appraisal department reviews and approves the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

Derivative Financial Instruments :

The Company obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of the measurement date (Level 2), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3).

The Bank obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of the measurement date (Level 2), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3).

Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as borrower risk ratings, to evaluate the likelihood of default by itself and its counterparties.

As of December 31, 2020, the Bank assessed the significance of the impact of the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined that the credit valuation adjustment was not significant to the overall valuation of its interest rate swap derivatives.

As of December 31, 2021 and December 31, 2020, the Bank assessed the significance of the impact of the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined the credit valuation adjustment was not significant to the overall valuation of its interest rate swap derivatives.

As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy.

The Bank did not recognize a credit valuation adjustment in the valuation of its interest rate swap derivatives as of December 31, 2019;

therefore, the interest rate swap derivatives are also classified in Level 2 of the fair value hierarchy for the comparative period end.

Branches held for sale :

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Such adjustments are usually significant and typically result in Level 3 classification of the inputs for determining fair value.

Additionally, the fair value of branches held for sale can be adjusted based on executed agreements of sale to be completed at a future date.

Recurring Basis

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government and agency securities $ 21,373 $ — $ 21,373 $ —

December 31, 2021

Total Level 1 Level 2 Level 3

(In thousands)

Municipal securities 221,212 — 221,212 —

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Commercial and industrial $ 1,911 $ 1,049 $ — $ — $ 1,049

Owner-occupied CRE 613 189 — — 189

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

Real estate construction and land development:

Commercial and multifamily

991 534 — — 534

Total 3,515 1,772 — — 1,772

Prepaid expenses and other assets:

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

(2) In October 2020, one branch was reclassified as held for sale in accordance with ASC 360-10.

As part of the transfer, the branch was written down to its net realizable value at that time.

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

Fair Value at December 31, 2020

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(In thousands)

Impaired loans:

Collateral-dependent loans:

Commercial business:

Commercial and industrial $ 1,305 $ 1,289 $ — $ — $ 1,289

Prepaid expenses and other assets:

Branch held for sale (2)

1,330 1,330 — — 1,330

Total assets measured at fair value on a nonrecurring basis $ 2,635 $ 2,619 $ — $ — $ 2,619

(1) Basis represents the outstanding principal balance of impaired loans.

The following table represents the net realized losses (gains) recorded in earnings resulting from nonrecurring fair value adjustments during the periods indicated:

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

(2) In October 2020, one branch was reclassified as held for sale in accordance with ASC 360-10.

As part of the transfer, the branch was written down to its net realizable value at that time.

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

Year ended December 31,

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Commercial and industrial $ ( 691 ) $ ( 8 ) $ ( 78 )

Non-owner occupied CRE — — 150

Owner-occupied CRE ( 359 ) — —

Total commercial business ( 1,050 ) ( 8 ) ( 78 )

Consumer — — 8

Real estate construction and land development:

Commercial and multifamily

Prepaid expenses and other assets:

Branch held for sale ( 145 ) $ ( 630 ) $ —

Net losses recorded in earnings resulting from nonrecurring fair value adjustments $ 638 $ 78 $ 168

Net loss from nonrecurring fair value adjustments $ ( 1,233 ) $ ( 638 ) $ ( 78 )

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

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Collateral-dependent loans $ 1,772 Market approach Adjustment for differences between the comparable sales 35.0 % - ( 11.0 %);

Branch held for sale 1,330 Market approach Adjustment for differences between the comparable sales 140.7 % - ( 40.3 %);

Branch held for sale $ 698 Market approach Sale agreement Not applicable

December 31, 2020

2 unchanged sentences

(Dollars in thousands)

Impaired loans $ 3,380 Market approach Adjustment for differences between the comparable sales 173.5 % - ( 18.5 %);

Collateral-dependent loans $ 1,289 Market approach Adjustment for differences between the comparable sales 0.6 % - ( 40.1 %);

Branch held for sale $ 1,330 Market approach Adjustment for differences between the comparable sales 140.7 % - ( 40.3 %);

(b) Fair Value of Financial Instruments

12 unchanged sentences

Cash and cash equivalents $ 1,723,292 $ 1,723,292 $ 1,723,292 $ — $ —

December 31, 2020

Value Fair Value Fair Value Measurements Using:

Level 1 Level 2 Level 3

Investment securities available for sale 894,335 894,335 — 894,335 —

Investment securities held to maturity 383,393 376,331 — 376,331 —

Loans held for sale 1,476 1,527 — 1,527 —

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Accrued interest receivable 14,657 14,657 14 4,582 10,061

Bank owned life insurance 107,580 107,580 107,580 — —

Derivative assets - interest rate swaps 15,219 15,219 — 15,219 —

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Financial Liabilities:

Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts $ 5,198,456 $ 5,198,456 $ 5,198,456 $ — $ —

Non-maturity deposits $ 6,038,498 $ 6,038,498 $ 6,038,498 $ — $ —

Certificates of deposit 342,839 344,025 — 344,025 —

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Accrued interest receivable 19,418 19,418 2 3,648 15,768

Bank owned life insurance 103,616 103,616 103,616

Derivative assets - interest rate swaps 25,740 25,740 — 25,740 —

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Financial Liabilities:

Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts $ 4,058,098 $ 4,058,098 $ 4,058,098 $ — $ —

Non-maturity deposits $ 5,198,456 $ 5,198,456 $ 5,198,456 $ — $ —

Certificates of deposit 399,534 402,701 — 402,701 —

1 unchanged sentence

Junior subordinated debentures 20,887 18,500 — — 18,500

December 31, 2020

Value Fair Value Fair Value Measurements Using:

Level 1 Level 2 Level 3

(In thousands)

Accrued interest payable 94 94 42 33 19

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On July 24, 2014, the Company's shareholders approved the Equity Plan that provides for the issuance of 1,500,000 shares of the Company's common stock in the form of various types of stock-based compensation.

The Company issues new shares of common stock to satisfy share option exercises and restricted stock award vests.

As of December 31, 2021, shares remaining available for future issuance under the Equity Plan totaled 522,228 .

1 unchanged sentence

Stock options generally vested ratably over three years and expired five years after they become exercisable or vested ratably over four years and expired ten years from date of grant.

For the years ended December 31, 2020, 2019 and 2018, the Company did no t recognize any compensation expense or related tax benefit related to stock options as all of the compensation expense related to the outstanding stock options had been previously recognized.

All outstanding stock options were exercised during the year ended December 31, 2020.

The intrinsic value from options exercised during the years ended December 31, 2020 and 2019 was $ 61,000 and $ 60,000 , respectively.

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Exercised ( 3,901 ) 14.77

Forfeited or expired ( 831 ) 14.77

Outstanding at December 31, 2019

Exercised ( 8,248 ) 14.77

Outstanding at December 31, 2019

Exercised ( 8,248 ) 14.77

Forfeited or expired ( 409 ) 14.77

Outstanding, vested and expected to vest and exercisable at December 31, 2020

Outstanding at December 31, 2020

(b) Restricted Stock Awards

Restricted stock awards granted generally had a four-year cliff vesting or four-year ratable vesting schedule.

Restricted stock awards generally had a four-year cliff vesting or four-year ratable vesting schedule.

The remaining restricted stock awards vested during the year ended December 31, 2020.

For the years ended December 31, 2020 and 2019, the Company recognized compensation expense related to restricted stock awards of $ 76,000 and $ 440,000 , respectively, and a related tax benefit of $ 17,000 and $ 93,000 , respectively.

The vesting date fair value of restricted stock awards that vested during the years ended December 31, 2020, 2019 and 2018 was $ 442,000 , $ 1.3 million and $ 2.2 million, respectively.

The vesting date fair value of restricted stock awards that vested during the years ended December 31, 2020 and 2019 was $ 442,000 and $ 1.3 million, respectively.

The following table summarizes the restricted stock award activity for the periods indicated

6 unchanged sentences

Vested ( 20,707 ) 17.59

Forfeited ( 2,178 ) 18.32

Nonvested at December 31, 2020

Vested ( 20,707 ) 17.59

Nonvested at December 31, 2020

Restricted stock units generally vest ratably over three years and are subject to service conditions in accordance with each award agreement.

A category of restricted stock units called performance-based restricted stock units have a three-year cliff vesting schedule, participate in dividends and are additionally subject to performance-based vesting.

The number of shares actually delivered pursuant to each performance-based restricted stock unit award agreement depends on the performance of the Company's Total Shareholder Return and Return on Average Assets over the performance period in relation to the performance of the common stock of a predetermined peer group.

Performance-based restricted stock units have a three-year cliff vesting schedule, participate in dividends and are additionally subject to performance-based vesting.

The conditions of the grants allow for an actual payout ranging between no payout and 150 % of target.

The payout level is calculated based on actual performance achieved during the performance period compared to a defined peer group.

The fair value of each performance-based restricted stock unit was determined using a Monte Carlo simulation and will be recognized over the vesting period.

The payout level is calculated based on the percentile level of the market condition, which is the ratio of the Company's total shareholder return and the ratio of the Company's return on average assets over the performance period in relation to the performance of these metrics of a predetermined peer group.

The fair value of each performance-based

restricted stock unit, inclusive of the market condition, was determined using a Monte Carlo simulation and will be recognized over the vesting period.

The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model;

however, it also further incorporates into the fair value

determination the possibility that the market condition may not be satisfied.

Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided.

however, it also further incorporates into the fair value determination the possibility the market condition may not be satisfied.

Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided the requisite service has been provided.

The Company used the following assumptions to estimate the fair value of performance-based restricted share units granted for the periods indicated:

12 unchanged sentences

34.5 %- 90.7 %

Heritage volatility 23.2 % 23.9 % 22.3 %

Heritage correlation coefficient 80.5 % 79.9 % 76.4 %

Company volatility 40.2 % 23.2 % 23.9 %

Company correlation coefficient 90.1 % 80.5 % 79.9 %

Expected volatilities in the model were estimated using a historical period consistent with the performance period of approximately three years .

22 unchanged sentences

315,014 $ 26.01

(20) Cash Restrictions

The Company is required to maintain an average reserve balance with the Federal Reserve Bank or maintain such reserve balance in the form of cash.

Effective March 24, 2020 the Federal Reserve lowered the reserve ratios on transaction accounts maintained at a depository institution to zero percent.

There was no required reserve balance at December 31, 2020 and a required balance of $ 17.1 million at December 31, 2019 was met by holding cash and maintaining an average balance with the Federal Reserve Bank.

The Company had restricted cash included in Interest earning deposits on the Consolidated Statements of Financial Condition of $ 34.2 million and $ 15.8 million as of December 31, 2020 and December 31, 2019, respectively, relating to collateral required on interest rate swaps from third-parties as discussed in Note (16) Derivative Financial Instruments.

The Company does not have a collateral requirement with customers.

(18) Cash Restriction

The Bank had restricted cash included in interest earning deposits of $ 9.8 million and $ 25.9 million as of December 31, 2021 and December 31, 2020, respectively, relating to collateral required on interest rate swaps from third-parties as discussed in Note (8) Derivative Financial Instruments.

The Bank does not have a collateral requirement with customers.

(19) Income Taxes

Income tax expense is substantially due to Federal income taxes as the provision for the state of Oregon income taxes is insignificant and the state of Washington does not charge an income tax in lieu of a business and occupation tax.

Income tax expense for the years ended December 31, 2020, 2019 and 2018 consisted of the following:

Income tax expense consisted of the following for the periods indicated:

Year Ended December 31,

2 unchanged sentences

Current tax expense $ 20,896 $ 15,186 $ 12,504

Deferred tax expense ( 8,576 ) 984 1,372

Deferred tax expense (benefit) 1,576 ( 8,576 ) 984

Income tax expense $ 22,472 $ 6,610 $ 13,488

3 unchanged sentences

The effective tax rate was 18.6 % for the year ended December 31, 2021 compared to an effective tax rate of 12.4 % and 16.6 % for the years ended December 31, 2020 and 2019, respectively.

The decrease in the effective tax rate during the year ended December 31, 2020 was due primarily to the tax benefit of the recognized net operating loss carryback mentioned above.

A reconciliation of the Company's effective income tax rate with the Federal statutory income tax rate of 21% for the years ended December 31, 2020, 2019 and 2018 is as follows:

The increase in the effective tax rate during the year ended December 31, 2021 was due primarily to the change in income before income taxes earned between the periods, including an increase in annual pre-tax income for the year ended December 31, 2021 which decreased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and low-income housing tax credits.

The following table presents the reconciliation of income taxes computed at the Federal statutory income tax rate of 21% to the actual effective rate for the periods indicated:

Year Ended December 31,

2 unchanged sentences

Income tax expense at Federal statutory rate $ 25,307 $ 11,168 $ 17,020

State tax, net of Federal tax benefit 960 359 357

Tax-exempt instruments ( 1,929 ) ( 1,785 ) ( 1,745 )

Non-deductible acquisition costs — — 336

Federal tax credits and other benefits (1)

5 unchanged sentences

(1) Federal tax credits are provided for under the NMTC and LIHTC programs as described in Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements.

Gross tax credits related to the Company's NMTC totaling $ 9.8 million were utilized during the seven year period ending December 31, 2020.

Gross tax credits related to the Company's NMTC totaling $ 9.8 million were utilized during the seven year period ended December 31, 2020.

The following table presents major components of the deferred income tax asset (liability) resulting from differences between financial reporting and tax basis:

11 unchanged sentences

Total deferred tax assets 23,435 26,559

December 31, 2021 December 31, 2020

(In thousands)

Deferred tax liabilities:

5 unchanged sentences

Junior subordinated debentures ( 991 ) ( 1,050 )

Other deferred tax liabilities ( 264 ) ( 239 )

ROU lease asset ( 5,995 ) ( 3,879 )

Net unrealized gains on investment securities ( 2,537 ) ( 6,805 )

Other deferred tax liabilities ( 181 ) ( 264 )

Total deferred tax liabilities ( 16,209 ) ( 22,124 )

Deferred tax asset (liability), net $ 4,435 $ ( 1,581 )

Deferred tax asset, net $ 7,226 $ 4,435

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

2 unchanged sentences

As of December 31, 2021, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management expects to realize the benefits of these deductible differences.

At December 31, 2020 and December 31, 2019, the Company had a net operating loss carryforward of $ 986,000 and $ 1.1 million, respectively, that will begin to expire in 2024.

The Company is limited to the amount of the net operating loss carryforward that it can deduct each year under Section 382.

Due to sufficient earnings history and other positive evidence, management has no t recorded a valuation allowance as of December 31, 2020 and December 31, 2019.

At December 31, 2021 and December 31, 2020, the Company had a net operating loss carryforward of $ 888,000 and $ 986,000 , respectively, and do not expire.

The Company is limited to the amount of the net operating loss carryforward that it can deduct each year under Section 382 of the Internal Revenue Code.

Due to sufficient earnings history and other positive evidence, management has no t recorded a valuation allowance on the net operating loss carryforward as of December 31, 2021 and December 31, 2020.

As of December 31, 2021 and December 31, 2020, the Company had an insignificant amount of unrecognized tax benefits, none of which would materially affect its effective tax rate if recognized.

3 unchanged sentences

At December 31, 2021, the Company had a taxable temporary difference of approximately $ 2.8 million that arose before 1988 (base-year amount).

In accordance with FASB ASC 740, a deferred tax liability of an estimated $ 588,000 has not been recognized for the temporary difference.

In accordance with FASB ASC 740, an estimated deferred tax liability of $ 588,000 has not been recognized for the temporary difference.

Management does not expect this temporary difference to reverse in the foreseeable future.

The Company and its subsidiary file a United States consolidated federal income tax return and an Oregon State income tax return, and the tax years subject to examination by the Internal Revenue Service are the years ended December 31, 2020, 2019, 2018 and 2017.

The Company and its Bank subsidiary file a United States consolidated federal income tax return and an Oregon State income tax return, and the tax years subject to examination by the Internal Revenue Service are the years ended December 31, 2021, 2020, 2019 and 2018.

(20) Commitments and Contingencies

(a) Commitments to Extend Credit

In the ordinary course of business, the Bank may enter into various types of transactions that include commitments to extend credit that are not included in its Consolidated Financial Statements.

The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations.

The majority of the commitments presented below are variable rate.

Loan commitments can be either revolving or non-revolving.

The Bank’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.

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

December 31, 2021 December 31, 2020

(In thousands)

Commercial business:

Commercial and industrial $ 570,156 $ 640,018

Owner-occupied CRE 2,252 3,488

December 31, 2021 December 31, 2020

(In thousands)

Non-owner occupied CRE 7,487 18,396

Total commercial business 579,895 661,902

Real estate construction and land development:

Residential 51,838 52,453

Commercial and multifamily

209,217 127,821

Total real estate construction and land development 261,055 180,274

Consumer 285,010 263,249

Total outstanding commitments $ 1,125,960 $ 1,105,425

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

Year Ended December 31,

2021 2020 2019

(In thousands)

Balance, beginning of period $ 4,681 $ 306 $ 306

Impact of CECL Adoption — 3,702 —

Adjusted balance, beginning of period 4,681 4,008 306

(Reversal of) provision for credit losses on unfunded commitments ( 2,074 ) 673 —

Balance, end of period $ 2,607 $ 4,681 $ 306

(b) Variable Interests - Low Income Housing Tax Credit Investments

The carrying values of investments in unconsolidated LIHTCs were $ 116.3 million and $ 96.4 million as of December 31, 2021 and December 31, 2020, respectively.

During the years ended December 31, 2021, 2020 and 2019 the Company recognized tax benefits of $ 11.4 million, $ 7.5 million and $ 5.7 million, respectively, and proportional amortization of $ 9.7 million, $ 6.5 million and $ 5.0 million, respectively.

Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $ 41.5 million and $ 53.8 million at December 31, 2021 and December 31, 2020, respectively.

The Company expects to fund LIHTC commitments of $ 10.6 million during the year ended December 31, 2022 and $ 23.6 million during the year ended December 31, 2023, with the remaining commitments of $ 7.3 million funded by December 31, 2035.

There were no impairment losses on the Company’s LIHTC investments during the years ended December 31, 2021, 2020 or 2019.

The equity method balance of the NMTC investment was $ 25.2 million at December 31, 2020.

The Company recognized related investment income of $ 247,000 , $ 694,000 and $ 701,000 during the years ended December 31, 2021, 2020 and 2019, respectively.

(21) Regulatory Capital Requirements

The Company is a bank holding company under the supervision of the Federal Reserve Bank.

Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as

amended, and the regulations of the Federal Reserve.

Heritage Bank is a federally insured institution and thereby is subject to the capital requirements established by the FDIC.

Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve.

The Bank is a federally insured institution and thereby is subject to the capital requirements established by the FDIC.

The Federal Reserve capital requirements generally parallel the FDIC requirements.

28 unchanged sentences

Total capital to risk-weighted assets 361,087 8.0 451,359 10.0 620,124 13.7

As of December 31, 2020, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC, that allows us the option to delay for two years 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.

As of December 31, 2021 and December 31, 2020, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC that allowed us the option to delay for two years 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 starting January 1, 2022 until December 31, 2024.

Under applicable capital requirements both the Company and the Bank are required to have a common equity Tier 1 capital ratio of 4.5%, a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio of 8.0%.

25 unchanged sentences

Interest on interest earning deposits $ 30 $ 16 $ 57

Total interest income 16 57 7

INTEREST EXPENSE:

Junior subordinated debentures 742 890 1,339

Total interest expense 890 1,339 1,263

Net interest expense ( 712 ) ( 874 ) ( 1,282 )

24 unchanged sentences

Net cash provided by operating activities 45,603 36,111 46,365

Cash flows from investing activities:

Net cash received from acquisitions — — 1,782

Net cash provided by investing activities — — 1,782

Cash flows from financing activities:

6 unchanged sentences

Cash and cash equivalents at the end of year $ 3,513 $ 9,736 $ 21,481

Supplemental non-cash disclosures of cash flow information:

Common stock issued for business combinations $ — $ — $ 230,043

Capital contribution of net assets acquired in business combinations to Bank — — 228,261

(24) Selected Quarterly Financial Data (Unaudited)

Results of operations on a quarterly basis were as follows:

Year Ended December 31, 2020

Quarter Second

Quarter Third

Quarter Fourth

(Dollars in thousands, except per share amounts)

Interest income $ 53,086 $ 53,994 $ 52,563 $ 54,677

Interest expense 4,535 3,681 2,885 2,222

Net interest income 48,551 50,313 49,678 52,455

Provision for credit losses 7,946 28,563 2,730 ( 3,133 )

Net interest income after provision for credit losses 40,605 21,750 46,948 55,588

Noninterest income 9,486 8,248 8,210 11,285

Noninterest expense 37,260 37,073 36,045 38,562

Income (loss) before income taxes 12,831 ( 7,075 ) 19,113 28,311

Income tax expense (benefit) 640 ( 936 ) 2,477 4,429

Net income (loss) $ 12,191 $ ( 6,139 ) $ 16,636 $ 23,882

Basic earnings per common share $ 0.34 $ ( 0.17 ) $ 0.46 $ 0.66

Diluted earnings per common share 0.34 ( 0.17 ) 0.46 0.66

Cash dividends declared on common stock 0.20 0.20 0.20 0.20

Year Ended December 31, 2019

Quarter Second

Quarter Third

Quarter Fourth

(Dollars in thousands, except per share amounts)

Interest income $ 53,807 $ 55,216 $ 54,884 $ 53,943

Interest expense 4,019 4,680 4,641 4,828

Net interest income 49,788 50,536 50,243 49,115

Provision for credit losses 920 1,367 466 1,558

Net interest income after provision for credit losses 48,868 49,169 49,777 47,557

Noninterest income 7,429 7,564 8,458 9,011

Noninterest expense 36,525 37,547 36,719 35,997

Income before income taxes 19,772 19,186 21,516 20,571

Income tax expense 3,220 3,202 3,621 3,445

Net income $ 16,552 $ 15,984 $ 17,895 $ 17,126

Basic earnings per common share $ 0.45 $ 0.43 $ 0.49 $ 0.47

Diluted earnings per common share 0.45 0.43 0.48 0.47

Cash dividends declared on common stock 0.18 0.18 0.19 0.29

(25) Subsequent Events (Unaudited)

The CA Act was enacted into law on December 27, 2020.

In accordance with the provisions, the Bank began originating the second round of SBA PPP loans to existing and new customers effective January 11, 2021.

As of February 19, 2021, the Bank has funded 1,724 loans totaling $ 297.1 million.

The average loan balance for funded SBA PPP loans under the CA Act was $ 172,000 .

The Bank earns 1 % interest on these loans as well as a fee to cover processing costs.

Liquidity for the originations of these SBA PPP loans was provided from cash reserves.

The Company was additionally approved to participate in the Federal Reserve's Paycheck Protection Program Liquidity Facility as a backup funding source effective January 20, 2021.

The Paycheck Protection Program Liquidity Facility expires on March 31, 2021.

The Company does not expect to participate in the facility.

Additionally, subsequent to year end through February 19, 2021, the Bank received principal and interest forgiveness payments from the SBA of $ 124.5 million, which represented approximately 13.9 % of total originated first round SBA PPP loans and 17.4 % of the outstanding balance of SBA PPP loans at December 31, 2020.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

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 8. Financial Statements and Supplementary Data