Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the financial condition and results of operations of the Company as of and for the year ended December 31, 2021. The information contained in this section should be read together with the December 31, 2021 audited Consolidated Financial Statements and the accompanying Notes included in Item 8. Financial Statements And Supplementary Data of this Form 10-K.
This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Form 10-K for the fiscal year ended December 31, 2020.
Overview
Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of our wholly-owned financial institution subsidiary, Heritage Bank. We provide financial services to our local communities with an ongoing strategic focus on our commercial banking relationships, market expansion and asset quality. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to the Bank’s operations.
Our business consists primarily of commercial lending and deposit relationships with small to medium sized businesses and their owners in our market areas and attracting deposits from the general public. We also make real estate construction and land development loans and consumer loans. We additionally originate for sale or for investment purposes residential real estate loans on single family properties located primarily in our markets. During the three months ended March 31, 2020, we ceased indirect auto loan originations, included in our consumer loan portfolio.
Our core profitability depends primarily on our net interest income. Net interest income is the difference between interest income, which is the income that we earn on interest earning assets, comprised primarily of loans and investment securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits. Management manages the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is significantly affected by general and local economic conditions, particularly changes in market interest rates, and by governmental policies and actions of regulatory agencies. Net interest income is additionally affected by changes in the volume and mix of interest earning assets, interest earned on these assets, the volume and mix of interest bearing liabilities and interest paid on these liabilities.
Our net income is affected by many factors, including the provision for credit losses on loans. The provision for credit losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. Management believes that the ACL on loans reflects the amount that is appropriate to provide for current expected credit losses in our loan portfolio based on our methodology.
Net income is also affected by noninterest income and noninterest expense. Noninterest income primarily consists of service charges and other fees and other income. Noninterest expense consists primarily of compensation and employee benefits, occupancy and equipment, data processing and professional services. Compensation and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses are the fixed and variable costs of buildings and equipment and consists primarily of lease expenses, depreciation charges, maintenance and utilities. Data processing consists primarily of processing and network services related to the Bank’s core operating system, including the account processing system, electronic payments processing of products and services, internet and mobile banking channels and software-as-a-service providers. Professional services consists primarily of third-party service providers such as auditors, consultants and lawyers.
Results of operations may also be significantly affected by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities, especially changes resulting from the COVID-19 Pandemic and the governmental actions taken to address it. Net income is also impacted by growth of operations through organic growth or acquisitions.
COVID-19 Pandemic Response
The Company maintains its commitment to supporting its community and customers during the COVID-19 Pandemic and remains focused on keeping its employees safe and the Bank running effectively to serve its customers. As of December 31, 2021, nearly all Bank branches are open with normal hours and substantially all employees are expected to return to their go-forward working environments during the three months ended March 31, 2022. The Bank will continue to monitor branch access and occupancy levels in relation to cases and close contact scenarios and follow governmental restrictions and public health authority guidelines.
Branch Consolidation Plan
The Company reduced the branch count to 49 from 61 branches at December 31, 2020, including the consolidation of
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eight branches during the three months ended March 31, 2021 and four branches in October 2021. The Company integrated these locations into other branches within its network. These actions were the result of the Company’s increased focus on balancing physical locations and digital banking channels, driven by increased customer usage of online and mobile banking and a commitment to improve digital banking technology.
Results of Operations
Net income was $98.0 million, or $2.73 per diluted common share, for the year ended December 31, 2021 compared t o $46.6 million, or $1.29 per diluted common share, for the year ended December 31, 2020. Net income increased $51.5 million, or 110.5% , due primarily to a reversal o f provision for credit losses of $29.4 million during the year ended December 31, 2021 compared to a provision for credit losses of $36.1 million for the same period in 2020.
The Company’s efficiency ratio was 62.09% for the year ended December 31, 2021 compared to 62.52% for the year ended December 31, 2020.
Average Balances, Yields and Rates Paid
The following table provides relevant net interest income information for the periods indicated:
Year Ended December 31,
2021 2020 2019
Average
Balance (1)
Interest
Earned/
Paid Average
Yield/
Rate Average
Balance (1)
Interest
Earned/
Paid Average
Yield/
Rate Average
Balance (1)
Interest
Earned/
Paid Average
Yield/
Rate
(Dollars in thousands)
Interest Earning Assets:
Loans receivable, net (2)(3)
$ 4,181,464 $ 189,832 4.54 % $ 4,335,564 $ 192,417 4.44 % $ 3,668,665 $ 189,515 5.17 %
Taxable securities 846,892 17,492 2.07 731,378 17,541 2.40 827,822 23,045 2.78
Nontaxable securities (3)
158,968 3,899 2.45 152,447 3,659 2.40 135,245 3,396 2.51
Interest earning deposits 1,193,724 1,608 0.13 315,847 703 0.22 98,153 1,894 1.93
Total interest earning assets 6,381,048 212,831 3.34 % 5,535,236 214,320 3.87 % 4,729,885 217,850 4.61 %
Noninterest earning assets 745,202 758,386 681,193
Total assets $ 7,126,250 $ 6,293,622 $ 5,411,078
Interest Bearing Liabilities:
Certificates of Deposit $ 372,279 $ 1,811 0.49 % $ 482,316 $ 5,675 1.18 % $ 512,732 $ 7,021 1.37 %
Savings accounts 598,492 367 0.06 489,471 526 0.11 506,073 2,633 0.52
Interest bearing demand and money market accounts 2,862,504 3,982 0.14 2,491,477 6,064 0.24 2,052,573 6,695 0.33
Total interest bearing deposits 3,833,275 6,160 0.16 3,463,264 12,265 0.35 3,071,378 16,349 0.53
Junior subordinated debentures 21,025 742 3.53 20,730 890 4.29 20,438 1,339 6.55
Securities sold under agreement to repurchase 45,655 140 0.31 27,805 160 0.58 28,457 175 0.61
FHLB advances and other borrowings — — — 1,466 8 0.55 11,899 305 2.56
Total interest bearing liabilities 3,899,955 7,042 0.18 % 3,513,265 13,323 0.38 % 3,132,172 18,168 0.58 %
Noninterest bearing demand deposits 2,256,608 1,835,165 1,389,721
Other noninterest bearing liabilities 127,620 139,612 99,683
Stockholders’ equity 842,067 805,580 789,502
Total liabilities and stock-holders’ equity $ 7,126,250 $ 6,293,622 $ 5,411,078
Net interest income and spread $ 205,789 3.16 % $ 200,997 3.49 % $ 199,682 4.03 %
Net interest margin 3.23 % 3.63 % 4.22 %
(1) Average balances are calculated using daily balances.
(2) Average loan receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of $28.4 million, $14.4 million and $776,000 for the years ended December 31, 2021, 2020, and 2019, respectively.
(3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis.
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Net Interest Income and Margin Overview
One of the Company's key sources of earnings is net interest income. There are several factors that affect net interest income, including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest bearing liabilities; the volume of noninterest earning assets, noninterest bearing demand deposits, other noninterest bearing liabilities and stockholders' equity; market interest rate fluctuations; and asset quality.
The following table provides the changes in net interest income due to changes in average asset and liability balances (volume), changes in average rates (rate) and changes attributable to the combined effect of volume and interest rates allocated proportionately to the absolute value of changes due to volume and changes due to interest rates:
2021 Compared to 2020
Increase (Decrease) Due to changes in 2020 Compared to 2019
Increase (Decrease) Due to changes in
Volume Rate Total Volume Rate Total
(Dollars in thousands) (Dollars in thousands)
Interest Earning Assets:
Loans receivable, net $ (6,934) $ 4,349 $ (2,585) $ 31,716 $ (28,814) $ 2,902
Taxable securities 2,566 (2,615) (49) (2,515) (2,989) (5,504)
Nontaxable securities 159 81 240 418 (155) 263
Interest earning deposits 1,278 (373) 905 1,544 (2,735) (1,191)
Total interest income $ (2,931) $ 1,442 $ (1,489) $ 31,163 $ (34,693) $ (3,530)
Interest Bearing Liabilities:
Certificates of deposit $ (1,082) $ (2,782) $ (3,864) $ (399) $ (947) $ (1,346)
Savings accounts 100 (259) (159) (84) (2,023) (2,107)
Interest bearing demand and money market accounts 803 (2,885) (2,082) 1,265 (1,896) (631)
Total interest bearing deposits (179) (5,926) (6,105) 782 (4,866) (4,084)
Junior subordinated debentures 12 (160) (148) 19 (468) (449)
Securities sold under agreement to repurchase 75 (95) (20) (4) (11) (15)
FHLB advances and other borrowings (4) (4) (8) (157) (140) (297)
Total interest expense $ (96) $ (6,185) $ (6,281) $ 640 $ (5,485) $ (4,845)
Net interest income $ (2,835) $ 7,627 $ 4,792 $ 30,523 $ (29,208) $ 1,315
Net interes t income increased $4.8 million, or 2.4%, to $205.8 million for the year ended December 31, 2021 compared to $201.0 million for 2020 due primarily to the Bank decreasing deposit rates following decreases in short-term market interest rates and secondarily due to an increase in the yield of loans receivable, net, predominately from higher amortization of deferred SBA PPP loan fees recognized from forgiven SBA PPP loans and higher recoveries of interest and fees on loans classified as nonaccrual. These factors increasing net interest income were offset partially by a decrease in average loans receivable, net and a decrease in the yield on taxable securities.
Net interest margin decreased due primarily to the significant increase in low-yielding average interest earning deposits to average total earning assets of 18.7% during the year ended December 31, 2021 compared to 5.7% for the same period in 2020, reducing the yield on interest earning assets for 2021.
The following table presents the loan yield and the impacts of SBA PPP loans and the incremental accretion on purchased loans on this financial measure for the periods presented below:
Year Ended December 31,
2021 2020
(Dollars in thousands)
Loan yield (GAAP) 4.54 % 4.44 %
Exclude impact from SBA PPP loans (0.20) % 0.16 %
Exclude impact from incremental accretion on purchased loans (0.07) % (0.08) %
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) 4.27 % 4.52 %
(1) For additional information, see the "Reconciliations of Non-GAAP Measures" section below.
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Provision for Credit Losses Overview
The aggregate of the provision for credit losses on loans and the provision for credit losses on unfunded commitments is presented on the Consolidated Statements of Income as the provision for credit losses. The ACL on unfunded commitments is included on the Consolidated Statements of Financial Condition within accrued expenses and other liabilities.
The following table presents the provision for credit losses for the periods indicated:
Year Ended December 31,
2021 2020
(In thousands)
Provision for credit losses on loans $ (27,298) $ 35,433
Provision for credit losses on unfunded commitments (2,074) 673
Provision for credit losses $ (29,372) $ 36,106
The reversal of provision for credit losses recognized during the year ended December 31, 2021 was due primarily to improvements in forecasted economic indicators used to calculate credit losses during the year ended December 31, 2021 compared to the worsening of economic indicators during the year ended December 31, 2020 stemming from the onset of the COVID-19 Pandemic.
Noninterest Income Overview
The following table presents the change in the key components of noninterest income for the periods indicated:
Year Ended December 31,
2021 2020 Change % Change
(Dollars in thousands)
Service charges and other fees $ 17,597 $ 16,228 $ 1,369 8.4 %
Gain on sale of investment securities, net 29 1,518 (1,489) (98.1)
Gain on sale of loans, net 3,644 5,044 (1,400) (27.8)
Interest rate swap fees 661 1,691 (1,030) (60.9)
Bank owned life insurance income
2,520 4,319 (1,799) (41.7)
Gain on sale of other assets, net 4,405 955 3,450 361.3
Other income 5,759 7,474 (1,715) (22.9)
Total noninterest income $ 34,615 $ 37,229 $ (2,614) (7.0) %
Nonintere st income decreased due primarily to lower bank owned life insurance income as the year ended December 31, 2020 included the recognition of death benefits of $1.9 million and lower other income as last year included trust income of $1.6 million, including a termination fee of $651,000 from the divestiture of our trust department. Additionally, noninterest income was lower due to reduced gain on sale of investment securities due to fewer sales, a decrease in gain on sale of loans due primarily to lower sales volume of secondary market mortgage loans and a decline in interest rate swap fees due to fewer executions of interest rate swap contracts. Partially offsetting these decreases was an increase in gain on sale of other assets, net for the year ended December 31, 2021, including a $2.7 million gain from the sale and leaseback of the Company's headquarters in Olympia, Washington.
Noninterest Expense Overview
The following table presents changes in the key components of noninterest expense for the periods indicated:
Year Ended December 31,
2021 2020 Change % Change
(Dollars in thousands)
Compensation and employee benefits $ 89,880 $ 88,106 $ 1,774 2.0 %
Occupancy and equipment 17,243 17,611 (368) (2.1)
Data processing 16,533 14,449 2,084 14.4
Marketing 3,039 3,100 (61) (2.0)
Professional services 4,065 5,921 (1,856) (31.3)
State/municipal business and use tax 3,884 3,754 130 3.5
Federal deposit insurance premium 2,106 1,789 317 17.7
Other real estate owned, net — (145) 145 (100.0)
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Year Ended December 31,
2021 2020 Change % Change
(Dollars in thousands)
Amortization of intangible assets 3,111 3,525 (414) (11.7)
Other expense 9,408 10,830 (1,422) (13.1)
Total noninterest expense $ 149,269 $ 148,940 $ 329 0.2 %
Noninterest expen se increased slightly due primari ly to an increase in data processing expense as the Bank continues to invest in technology. Additionally, noninterest expense increased due to compensation and employee benefits primarily as a result of severance payments following a strategic reduction in force and an increase in accrual for incentive payments. The increase in noninterest expense was offset partially by lower professional services expense due to costs incurred during the year ended December 31, 2020 related to the launch of the new mobile and online commercial banking platform "Heritage Direct" last year and secondarily due to t he decrease in ot her expense from lower branch consolidation costs recognized during the year ended December 31, 2021 compared to the same period in 2020.
Income Tax Expense Overview
The following table presents the income tax expense and related metrics and the change for the periods indicated:
Year Ended December 31,
2021 2020 Change % Change
(Dollars in thousands)
Income before income taxes $ 120,507 $ 53,180 $ 67,327 126.6 %
Income tax expense $ 22,472 $ 6,610 $ 15,862 240.0 %
Effective income tax rate 18.6 % 12.4 % 6.2 % 50.0 %
Inco me tax expense and the effective income tax rate both increased due primarily to higher pre-tax income , 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, and secondarily due to a provision in the CARES Act, which permitted the Company to recognize a $1.0 million benefit from net operating losses related to prior acquisitions during the year ended December 31, 2020 . Additionally, the Bank's New Market Tax Credit was fully utilized during the seven year period ending December 31, 2020 and the related entiti es were dissolved in May 2021. In 2021, the Bank formed HBCDE, LLC which was certified as a Community Development Entity by the Department of the Treasury Community Development Financial Institutions Fund in September 2021. The newly created entity is expected to commence funding eligible loans during the year ended December 31, 2022 and apply for New Market Tax Credits in future years.
Financial Condition Overview
The table below provides a comparison of the changes in the Company's financial condition for the periods indicated:
December 31, 2021 December 31, 2020 Change % Change
(Dollars in thousands)
Assets
Cash and cash equivalents $ 1,723,292 $ 743,322 $ 979,970 131.8 %
Investment securities available for sale, at fair value, net 894,335 802,163 92,172 11.5
Investment securities held to maturity, at amortized cost, net 383,393 — 383,393 100.0
Loans held for sale 1,476 4,932 (3,456) (70.1)
Loans receivable, net 3,773,301 4,398,462 (625,161) (14.2)
Premises and equipment, net 79,370 85,452 (6,082) (7.1)
Federal Home Loan Bank stock, at cost 7,933 6,661 1,272 19.1
Bank owned life insurance 120,196 107,580 12,616 11.7
Accrued interest receivable 14,657 19,418 (4,761) (24.5)
Prepaid expenses and other assets 183,543 193,301 (9,758) (5.0)
Other intangible assets, net 9,977 13,088 (3,111) (23.8)
Goodwill 240,939 240,939 — —
Total assets $ 7,432,412 $ 6,615,318 $ 817,094 12.4 %
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December 31, 2021 December 31, 2020 Change % Change
(Dollars in thousands)
Liabilities and Stockholders' Equity
Deposits $ 6,381,337 $ 5,597,990 $ 783,347 14.0 %
Junior subordinated debentures 21,180 20,887 293 1.4
Securities sold under agreement to repurchase 50,839 35,683 15,156 42.5
Accrued expenses and other liabilities 124,624 140,319 (15,695) (11.2)
Total liabilities 6,577,980 5,794,879 783,101 13.5
Common stock 551,798 571,021 (19,223) (3.4)
Retained earnings 293,238 224,400 68,838 30.7
Accumulated other comprehensive income, net 9,396 25,018 (15,622) (62.4)
Total stockholders' equity 854,432 820,439 33,993 4.1
Total liabilities and stockholders' equity $ 7,432,412 $ 6,615,318 $ 817,094 12.4 %
Total assets increased due primarily to increases in cash and cash equivalents and total investment securities due primarily to the significant increase in total deposits, which is discussed in more detail in the "Deposit Activities Overview" section below. The increase in total assets was offset partially by a decrease in loans receivable, net, which is discussed in more detail in the "Lending Activities Overview" section below.
Investment Activities Overview
Our investment policy is established by the Company's board of directors and monitored by the Risk Committee of the board of directors. It is designed primarily to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complements the Bank's lending activities. The policy permits investment in various types of liquid assets permissible under applicable regulations. Investment in non-investment grade bonds and stripped mortgage-backed securities is not permitted under the policy.
The following table provides information regarding our investment securities at the dates indicated:
December 31, 2021 December 31, 2020
Balance % of
Total Balance % of
Total Change % Change
(Dollars in thousands)
Investment securities available for sale, at fair value:
U.S. government and agency securities $ 21,373 1.7 % $ 45,660 5.7 % $ (24,287) (53.2) %
Municipal securities 221,212 17.3 % 209,968 26.2 % 11,244 5.4
Residential CMO and MBS 306,884 24.0 % 201,872 25.2 % 105,012 52.0
Commercial CMO and MBS 315,861 24.7 % 303,746 37.9 % 12,115 4.0
Corporate obligations 2,014 0.2 % 11,096 1.4 % (9,082) (81.8)
Other asset-backed securities 26,991 2.1 % 29,821 3.6 % (2,830) (9.5)
Total $ 894,335 70.0 % $ 802,163 100.0 % $ 92,172 11.5 %
Investment securities held to maturity, at amortized cost:
U.S. government and agency securities $ 141,011 11.0 % $ — — % $ 141,011 100.0 %
Residential CMO and MBS 24,529 1.9 % — — 24,529 100.0
Commercial CMO and MBS 217,853 17.1 % — — 217,853 100.0
Total $ 383,393 30.0 % $ — — % $ 383,393 100.0 %
Total investment securities $ 1,277,728 100.0 % $ 802,163 100.0 % $ 475,565 59.3 %
Total investment securities increased due primarily to purchases of $756.4 million, offset partially by maturities, calls and payments of investment securities of $255.9 million. Additionally, we transferred $244.8 million of investment securities available for sale to investment securities held to maturity in order to mitigate market price volatility and its impact to AOCI within stockholders' equity.
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The following table provides the weighted average yield at December 31, 2021 calculated based upon the fair values of our investment securities available for sale and held to maturity and excluding any income tax benefits of tax-exempt bonds:
In one year or less After one year through five years After five years through ten years After ten years Total
Fair
Value Yield Fair
Value Yield Fair
Value Yield Fair
Value Yield Fair
Value Yield
(Dollars in thousands)
Investment securities available for sale:
U.S. government and agency securities $ — — % $ 1,493 3.01 % $ 11,682 2.07 % $ 8,198 2.32 % $ 21,373 2.23 %
Municipal securities 7,095 3.19 25,746 2.84 58,340 2.61 130,031 2.52 221,212 2.60
Residential CMO and MBS — — 10,978 2.30 34,783 2.00 261,123 1.68 306,884 1.74
Commercial CMO and MBS 20,025 2.15 81,769 2.54 178,906 1.50 35,161 1.99 315,861 1.86
Corporate obligations — — 2,014 0.94 — — — — 2,014 0.94
Other asset-backed securities — — 354 2.77 4,068 2.54 22,569 1.12 26,991 1.35
Total $ 27,120 2.42 % $ 122,354 2.56 % $ 287,779 1.82 % $ 457,082 1.93 % $ 894,335 1.99 %
Investment securities held to maturity:
U.S. government and agency securities $ — — % $ — — % $ 68,014 1.95 % $ 71,349 1.67 % $ 139,363 1.81 %
Residential CMO and MBS — — — — — — 24,376 1.74 24,376 1.74
Commercial CMO and MBS — — — — 181,393 1.50 31,199 1.62 212,592 1.52
Total $ — — % $ — — % $ 249,407 1.62 % $ 126,924 1.67 % $ 376,331 1.64 %
Loan Portfolio Overview
Changes by loan type
The Bank originates a wide variety of loans with a focus on commercial business loans. The following table provides information about our loan portfolio by type of loan at the dates indicated:
December 31, 2021 December 31, 2020
Amortized Cost % of Loans Receivable Amortized Cost % of Loans Receivable Change % Change
(Dollars in thousands)
Commercial business:
Commercial and industrial $ 621,567 16.3 % $ 733,098 16.4 % $ (111,531) (15.2) %
SBA PPP 145,840 3.8 715,121 16.0 (569,281) (79.6)
Owner-occupied CRE 931,150 24.4 856,684 19.2 74,466 8.7
Non-owner occupied CRE 1,493,099 39.2 1,410,303 31.5 82,796 5.9
Total commercial business 3,191,656 83.7 3,715,206 83.1 (523,550) (14.1)
Residential real estate
164,582 4.3 122,756 2.7 41,826 34.1
Real estate construction and land development:
Residential 85,547 2.2 78,259 1.8 7,288 9.3
Commercial and multifamily 141,336 3.7 227,454 5.1 (86,118) (37.9)
Total real estate construction and land development 226,883 5.9 305,713 6.9 (78,830) (25.8)
Consumer 232,541 6.1 324,972 7.3 (92,431) (28.4)
Total $ 3,815,662 100.0 % $ 4,468,647 100.0 % $ (652,985) (14.6) %
Loans receivable decreased due primarily to a decrease in SBA PPP loans as a result of forgiveness payments received from the SBA in excess of SBA PPP originations and elevated prepayments of commercial and industrial loans. Additionally, the consumer loan portfolio decreased due partially to continued runoff of the indirect auto loan portfolio following the cessation of this business line during the three months ended March 31, 2020. Offsetting these decreases was an increase in CRE loans which includes the transfer of several completed projects from real estate construction and land development loans.
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SBA Paycheck Protection Program
The Bank has supported its community and customers during the COVID-19 Pandemic through its participation in the SBA's PPP. The SBA PPP ended on May 31, 2021.
The Bank earns 1% interest on these loans as well as a fee from the SBA to cover processing costs, which is amortized over the life of the loan and recognized fully at payoff or forgiveness. The Bank began processing loan forgiveness applications and receiving SBA PPP forgiveness payments during the three months ended December 31, 2020.
Composition of loans receivable by contractual maturity and interest type
The following table presents the amortized cost of the loan portfolio by segment and contractual maturity at December 31, 2021:
In one year or less After one year through five years After five years through 15 years After 15 years Total
(In thousands)
Commercial business:
Commercial and industrial $ 142,248 $ 227,589 $ 244,025 $ 7,705 $ 621,567
SBA PPP 5,921 139,919 — — 145,840
Owner-occupied CRE 21,919 190,612 674,344 44,275 931,150
Non-owner occupied CRE 78,879 398,844 981,290 34,086 1,493,099
Total commercial business 248,967 956,964 1,899,659 86,066 3,191,656
Residential real estate
— 1,045 29,067 134,470 164,582
Real estate construction and land development:
Residential 65,861 2,563 8,936 8,187 85,547
Commercial and multifamily 58,009 12,563 59,099 11,665 141,336
Total real estate construction and land development 123,870 15,126 68,035 19,852 226,883
Consumer 11,953 94,359 29,972 96,257 232,541
Total $ 384,790 $ 1,067,494 $ 2,026,733 $ 336,645 $ 3,815,662
The following table presents the amortized cost of the loan portfolio by segment and interest rate type that are due after one year at December 31, 2021:
Have predetermined interest rates (1)
Have floating or adjustable interest rates (1)
Total
(In thousands)
Commercial business:
Commercial and industrial $ 317,892 $ 161,427 $ 479,319
SBA PPP 139,919 — 139,919
Owner-occupied CRE 453,836 455,395 909,231
Non-owner occupied CRE 589,292 824,928 1,414,220
Total commercial business 1,500,939 1,441,750 2,942,689
Residential real estate (3)
119,966 44,616 164,582
Real estate construction and land development:
Residential 8,181 11,505 19,686
Commercial and multifamily 39,457 43,870 83,327
Total real estate construction and land development 47,638 55,375 103,013
Consumer 118,471 102,117 220,588
Total $ 1,787,014 $ 1,643,858 $ 3,430,872
(1) Includes $2.2 million of real estate construction and land development loans with predetermined interest rates and $329.2 million of commercial business loans with floating or adjustable interest rates in which the Bank entered into non-hedge interest rate swap contracts with the borrower and a third-party. Under these derivative contract arrangements, the Bank effectively earns a variable rate of interest based on the one-month LIBOR plus a margin, except for interest rate swap contracts on construction loans that earn fixed rates until the end of the construction period and the variable rate swap becomes effective.
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Loans classified as nonaccrual and performing TDR and nonperforming assets
The following table provides information about our nonaccrual loans, performing TDR loans and nonperforming assets for the dates indicated:
December 31,
2021 December 31, 2020 Change % Change
(Dollars in thousands)
Nonaccrual loans: (1)
Commercial business $ 23,107 $ 56,786 $ (33,679) (59.3) %
Residential real estate
47 184 (137) (74.5)
Real estate construction and land development 571 1,022 (451) (44.1)
Consumer 29 100 (71) (71.0)
Total nonaccrual loans 23,754 58,092 (34,338) (59.1)
Other real estate owned — — — n/a
Total nonperforming assets 23,754 58,092 (34,338) (59.1) %
Accruing loans past due 90 days or more $ 293 $ — $ 293 100.0 %
Credit quality ratios:
Nonaccrual loans to loans receivable 0.62 % 1.30 % (0.68) % (52.3) %
Nonaccrual loans to total assets 0.32 0.88 (0.56) (63.6)
Performing TDR loans: (1)
Commercial business $ 57,142 $ 49,403 $ 7,739 15.7 %
Residential real estate 358 188 170 90.4
Real estate construction and land development 450 1,926 (1,476) (76.6)
Consumer 1,160 1,355 (195) (14.4)
Total performing TDR loans $ 59,110 $ 52,872 $ 6,238 11.8 %
(1) At December 31, 2021 and December 31, 2020, $1.4 million and $3.2 million of nonaccrual loans, respectively, and $1.6 million and $1.9 million of performing TDR loans, respectively, were guaranteed by government agencies.
The following table provides the changes in nonaccrual loans during the periods indicated:
Year Ended December 31,
2021 2020 Change % Change
(In thousands)
Balance, beginning of period $ 58,092 $ 44,525 $ 13,567 30.5 %
Additions to nonaccrual loan classification 1,495 33,024 (31,529) (95.5)
Net principal payments and transfers to accruing status (14,786) (6,463) (8,323) 128.8
Payoffs (19,857) (11,033) (8,824) 80.0
Charge-offs (1,190) (1,691) 501 (29.6)
Transfer to OREO — (270) 270 (100.0)
Balance, end of period $ 23,754 $ 58,092 $ (34,338) (59.1) %
The decrease in nonaccrual loans during the year ended December 31, 2021 was due primarily to payoffs, including a payoff of an agricultural business relationship of $10.7 million, which was initially classified as nonaccrual during the three months ended September 30, 2019, and the return to accrual status of an owner-occupied CRE relationship of $7.0 million. The Bank recovered $1.5 million of interest and fees on loans related to the payoff of the agricultural business relationship. Additionally, the volume of additions to the nonaccrual loan classification decreased to $1.5 million during the year ended December 31, 2021 compared to $33.0 million last year which contributed to the lower ending balance of loans classified as nonaccrual. The decrease in nonaccrual loans improved the Bank's credit quality ratios.
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Allowance for Credit Losses on Loans Overview
The following table provides information regarding changes in our ACL on loans for the years indicated:
At or For the Years Ended December 31,
2021 2020 Change % Change
(Dollars in thousands)
ACL on loans at the beginning of the period $ 70,185 $ 36,171 $ 34,014 94.0 %
Impact of CECL Adoption — 1,822 (1,822) (100.0)
Adjusted ACL on loans, beginning of period 70,185 37,993 32,192 84.7
Charge-offs:
Commercial business (1,276) (3,751) 2,475 (66.0)
Real estate construction and land development (1) (417) 416 (99.8)
Consumer (669) (1,454) 785 (54.0)
Total charge-offs (1,946) (5,622) 3,676 (65.4)
Recoveries:
Commercial business 816 1,530 (714) (46.7)
Residential real estate — 3 (3) (100.0)
Real estate construction and land development 32 278 (246) (88.5)
Consumer 572 570 2 0.4
Total recoveries 1,420 2,381 (961) (40.4)
Net charge-offs (526) (3,241) 2,715 (83.8)
Provision for credit losses on loans (27,298) 35,433 (62,731) (177.0)
ACL on loans at the end of period $ 42,361 $ 70,185 $ (27,824) (39.6) %
Credit quality ratios:
ACL on loans to loans receivable 1.11 % 1.57 % (0.46) % (29.3) %
ACL on loans to loans receivable, excluding SBA PPP loans (1)
1.15 1.87 (0.72) (38.5)
ACL on loans to nonaccrual loans 178.33 % 120.82 % 57.51 % 47.6 %
Average balances outstanding during the period: (2)
Commercial business $ 3,540,728 $ 3,569,851 $ (29,123) (0.8) %
Residential real estate 123,875 131,171 (7,296) (5.6)
Real estate construction and land development 301,532 303,591 (2,059) (0.7)
Consumer 271,834 384,134 (112,300) (29.2)
Total $ 4,237,969 $ 4,388,747 $ (150,778) (3.4) %
Net charge-offs (recoveries) during the period to average balances outstanding during the period:
Commercial business 0.01 % 0.06 % (0.05) % (83.3) %
Residential real estate — — — n/a
Real estate construction and land development (0.01) 0.05 (0.06) (120.0)
Consumer 0.04 0.23 (0.19) (82.6)
Total 0.01 % 0.07 % (0.06) % (85.7) %
(1) The ACL on loans does not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA. See "Reconciliations of Non-GAAP Measures" section below.
(2) Average balances exclude the ACL on loans and loans held for sale, but include loans classified as nonaccrual.
The ACL on loans decreased due primarily to a reversal of prov ision for credit losses on loans recorded during the year ended December 31, 2021 following improvements in the economic forecast used in the CECL model at December 31, 2021 as compared to the economic forecast at December 31, 2020 .
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The following table presents the ACL on loans by loan portfolio segment at the indicated dates:
December 31, 2021 December 31, 2020
ACL on loans Percent of
Total (1)
ACL on loans Percent of
Total (1)
Change % Change
(Dollars in thousands)
Commercial business $ 33,049 83.7 % $ 49,608 83.1 % $ (16,559) (33.4) %
Residential real estate 1,409 4.3 1,591 2.7 (182) (11.4)
Real estate construction and land development 5,276 5.9 13,092 6.9 (7,816) (59.7)
Consumer 2,627 6.1 5,894 7.3 (3,267) (55.4)
Total ACL on loans $ 42,361 100.0 % $ 70,185 100.0 % $ (27,824) (39.6) %
(1) Represents the percent of loans receivable by loan category to loans receivable.
Deposits Overview
The following table summarizes the Company's deposits at the dates indicated:
December 31, 2021 December 31, 2020
Balance Percent of Total Balance Percent of Total Change % Change
(Dollars in thousands)
Noninterest demand deposits $ 2,330,956 36.5 % $ 1,980,531 35.4 % $ 350,425 17.7 %
Interest bearing demand deposits 1,946,605 30.5 1,716,123 30.7 230,482 13.4
Money market accounts 1,120,174 17.6 962,983 17.2 157,191 16.3
Savings accounts 640,763 10.0 538,819 9.6 101,944 18.9
Total non-maturity deposits 6,038,498 94.6 5,198,456 92.9 840,042 16.2
Certificates of deposit 342,839 5.4 399,534 7.1 (56,695) (14.2)
Total deposits $ 6,381,337 100.0 % $ 5,597,990 100.0 % $ 783,347 14.0 %
Total deposits increased due primarily to proceeds from SBA PPP loans originated during the year ended December 31, 2021 which were deposited directly into the customers' deposit accounts.
Total deposits includes uninsured deposits of $2.68 billion and $2.17 billion at December 31, 2021 and 2020, respectively, calculated in accordance with FDIC guidelines. The Bank does not hold any foreign deposits.
The following table provides the uninsured portion of certificates of deposit at December 31, 2021, by account, with a maturity of:
(In thousands)
Three months or less $ 10,264
Over three months through six months 24,102
Over six months through twelve months 11,542
Over twelve months 5,623
Total $ 51,531
Stockholders' Equity Overview
The Company’s stockholders' equity to assets ratio was 11.5% as of December 31, 2021 and 12.4% as of December 31, 2020. The following table provides the changes to stockholders' equity during the periods indicated:
Year Ended December 31,
2021 2020 Change % Change
(In thousands)
Balance, beginning of period $ 820,439 $ 809,311 $ 11,128 1.4 %
Cumulative effect from change in accounting policy (1)
— (5,615) 5,615 (100.0)
Net income 98,035 46,570 51,465 110.5
Dividends declared (29,197) (29,029) (168) 0.6
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Year Ended December 31,
2021 2020 Change % Change
(In thousands)
Other comprehensive income, net of tax (15,622) 14,640 (30,262) (206.7)
Repurchase of common stock (22,889) (19,119) (3,770) 19.7
Other 3,666 3,681 (15) (0.4)
Balance, end of period $ 854,432 $ 820,439 $ 33,993 4.1 %
(1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses .
The Company repurchased 904,972 and 795,700 shares of its common stock under the Company's stock repurchase plans during the year ended December 31, 2021 and 2020, respectively. The repurchases represented approximately 2.5% and 2.2% of the Company's stock outstanding at the beginning of each year.
The Company has historically paid cash dividends to its common shareholders. Payments of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, capital requirements, current and anticipated cash needs, plans for expansion, any legal or contractual limitation on our ability to pay dividends and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income. On January 26, 2022, the Company’s board of directors declared a regular quarterly dividend of $0.21 per common share payable on February 23, 2022 to shareholders of record on February 9, 2022.
Liquidity and Capital Resources
The following table provides the material cash requirements and capital resources from known contractual and other obligations and sources as of December 31, 2021:
One Year or Less Over One Year Other (1)
Total
(Dollars in thousands)
Cash requirements:
Unfunded commitments - loans and letters of credits $ 1,125,960 $ — $ — $ 1,125,960
Maturing certificates of deposit 290,497 52,342 — 342,839
Unfunded commitment of LIHTCs 10,648 30,835 — 41,483
Operating leases 4,750 26,571 — 31,321
Junior subordinated debentures — 25,000 — 25,000
Non-maturity deposits — — 6,038,498 6,038,498
Securities sold under agreement to repurchase — — 50,839 50,839
Total cash requirements $ 1,431,855 $ 134,748 $ 6,089,337 $ 7,655,940
Capital resources:
Unrestricted cash and cash equivalents $ 1,713,474 $ — $ — $ 1,713,474
FHLB and FRB borrowing availability (2)
1,113,208 — — 1,113,208
Unencumbered investment securities available for sale 737,454 — — 737,454
Loans receivable scheduled repayments, by contractual maturity date 384,790 3,430,872 — 3,815,662
Fed funds line borrowing availability 215,000 — — 215,000
Investment securities held to maturity, by contractual maturity date — 367,331 — 367,331
Total capital resources $ 4,163,926 $ 3,798,203 $ — $ 7,962,129
(1) Represents the undefined maturity of non-maturity deposits, including noninterest bearing demand deposits, interest bearing demand deposits, money market accounts and savings accounts, and securities sold under agreement to repurchase, which can generally both be withdrawn on demand.
(2) Includes FHLB borrowing availability of $1.06 billion at December 31, 2021 based on pledged assets, however, maximum credit capacity is 45% of the Bank's total assets one quarter in arrears or $3.26 billion.
We maintain sufficient cash and cash equivalents and investment securities to meet short-term liquidity needs and actively monitor our long-term liquidity position to ensure the availability of capital resources for contractual obligations, strategic loan growth objectives and to fund operations. Our funding strategy has been to acquire non-maturity deposits from our retail accounts, acquire noninterest bearing demand deposits from our commercial customers and use our borrowing availability to
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fund growth in assets. We may also acquire brokered deposits when the cost of funds is advantageous to other funding sources. Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of assets. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition so we adhere to internal management targets assigned to the loan to deposit ratio, liquidity ratio, net short-term non-core funding ratio and non-core liabilities to total assets ratio to ensure an appropriate liquidity position.
The Company pays dividends to our shareholders and the primary source of the Company's liquidity is cash obtained from dividends from the Bank. We expect to continue our current practice of paying quarterly cash dividends on our common stock subject to our board of directors’ discretion to modify or terminate this practice at any time and for any reason without prior notice. Our current quarterly common stock dividend rate is $0.21 per share, as approved by our board of directors, which we believe is a dividend rate per share which enables us to balance our multiple objectives of managing and investing in the Bank and returning a substantial portion of our cash to our shareholders. Assuming continued payment during 2022 at this rate of $0.21 per share, our average total dividend paid each quarter would be approximately $7.4 million based on the number of our current outstanding shares (which assumes no increases or decreases in the number of shares).
Management believes the capital sources are adequate to meet all reasonably foreseeable short-term and intermediate-term cash requirements.
Critical Accounting Policies
Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant. The Company considers its critical accounting estimates to be as follows:
ACL on Investment Securities
Investment securities issued by the U.S. government and its agencies are 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 and therefore management concluded 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. The remainder of investment securities available for sale were issued by municipal or corporate issuers. Management examined the combination of credit ratings, at the individual security level, and an analysis of historical defaults by credit rating for municipal and corporate securities since 1970 and determined the probability and magnitude of loss was insignificant.
Management's reliance on credit ratings and an analysis of historical defaults is subjective and these historical inputs may not be suitable predictors of future performance. Unanticipated changes in the credit ratings or the historical defaults could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on investment securities, see Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (2) Investment Securities of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
ACL on Loans
Management's estimate of the ACL on loans relies on the identification, stratification and separate estimates of loss for loans individually evaluated for loss and loans collectively evaluated for loss. The estimate of loss for loans collectively evaluated for loss particularly involves a significant level of estimation uncertainty due to its complexity and quantity of inputs including: management's determination of baseline loss rate multipliers based on a third-party forecast of economic conditions, an estimate of the reasonable and supportable forecast period, an estimate of the baseline loss rate lookback period, an estimate of the reversion period from the reasonable and supportable forecast period to the baseline loss rate, and an estimate of the prepayment rate and related lookback period. Additionally, management considers other qualitative risk factors to further adjust the estimated ACL on loans through a qualitative allowance.
Management's estimates for these inputs are based on past events and current conditions, are inherently subjective, and are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize credit losses on loans, future additions to the allowance may be necessary based on declines in local and national economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s ACL on loans. Such agencies may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the time of their examinations. Unanticipated changes in any of these inputs could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on loans, its relation to the provision for credit losses, its risk related to asset quality and lending activity, see Item 1A. Risk Factors—Our ACL on loans may prove to be insufficient to absorb losses in our loan portfolio as well as Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (4) Allowance for Credit Losses on Loans of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
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ACL on Unfunded Commitments
The allowance methodology for unfunded commitments is similar to the ACL on loans, but additionally includes considerations of the current utilization of the commitment, an estimate of the future utilization, an estimate of utilization of construction loans prior to completion and an estimate of construction loan advance rates as determined appropriate by historical commitment utilization and the Bank's estimates of future utilization given current economic forecasts. Unanticipated changes in loss rates estimated in the ACL on loans, as utilized in the methodology for the ACL on unfunded commitments, or the expected utilization of unfunded commitments could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on unfunded commitments, see Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (20) Commitments and Contingencies of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Goodwill
The Company performed its annual goodwill impairment test during the fourth quarter of 2021 and determined, based on a qualitative assessment utilizing the Company's market capitalization, that it is more likely than not that the fair value of the reporting unit exceeded the carrying value, such that the Company's goodwill was not considered impaired for the year ended December 31, 2021. Changes in the economic environment, operations of the reporting unit or other adverse events, including as a result of COVID-19, could result in future impairment charges which could have a material adverse impact on the Company’s operating results.
For additional information regarding goodwill, see Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (7) Goodwill and Other Intangible Assets of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Reconciliations of Non-GAAP Measures
This Form 10-K contains certain financial measures not presented in accordance with GAAP in addition to financial measures presented in accordance with GAAP. The Company has presented these non-GAAP financial measures in this Form 10-K because it believes that they provide useful and comparative information to assess trends in the Company’s performance and asset quality and to facilitate comparison of its performance with the performance of its peers. These non-GAAP measures have inherent limitations, are not required to be uniformly applied and are not audited. They should not be considered in isolation or as a substitute for financial measures presented in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of the GAAP and non-GAAP financial measures are presented in the tables below.
The Company believes presenting loan yield excluding the effect of discount accretion on purchased loans is useful in assessing the impact of acquisition accounting on loan yield as the effect of loan discount accretion is expected to decrease as the acquired loans mature or roll off its balance sheet. Incremental accretion on purchased loans represents the amount of interest income recorded on purchased loans in excess of the contractual stated interest rate in the individual loan notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified by the adoption of ASU 2016-13. The purchased discount is accreted into income over the remaining life of the loan. The impact of incremental accretion on loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the balance of the purchased loans decreases. Similarly, presenting loan yield excluding the effect of SBA PPP loans is useful in assessing the impact of these special program loans that are anticipated to substantially decrease within a short time frame.
Year Ended December 31,
2021 2020
(Dollars in thousands)
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans:
Interest and fees on loans (GAAP) $ 189,832 $ 192,417
Exclude SBA PPP loan interest and fees (32,109) (19,472)
Exclude incremental accretion on purchased loans (2,638) (3,446)
Adjusted interest and fees on loans (non-GAAP) $ 155,085 $ 169,499
Average loans receivable, net (GAAP) $ 4,181,464 $ 4,335,564
Exclude average SBA PPP loans (549,422) (589,635)
Adjusted average loans receivable, net (non-GAAP) $ 3,632,042 $ 3,745,929
Loan yield (GAAP) 4.54 % 4.44 %
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) 4.27 % 4.52 %
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The Company considers presenting the ratio of ACL on loans to loans receivable, excluding SBA PPP loans, to be a useful measurement in evaluating the adequacy of the Company's ACL on loans as the balance of SBA PPP loans is significant to the loan portfolio, and since SBA PPP loans are guaranteed by the SBA, the Company has not provided an ACL on loans for SBA PPP loans.
December 31,
2021 December 31, 2020
(Dollars in thousands)
ACL on loans to loans receivable, excluding SBA PPP loans
Allowance for credit losses on loans $ 42,361 $ 70,185
Loans receivable (GAAP) $ 3,815,662 $ 4,468,647
Exclude SBA PPP loans 145,840 715,121
Loans receivable, excluding SBA PPP (non-GAAP) $ 3,669,822 $ 3,753,526
ACL on loans to loans receivable (GAAP) 1.11 % 1.57 %
ACL on loans to loans receivable, excluding SBA PPP loans (non-GAAP) 1.15 % 1.87 %