HERITAGE FINANCIAL CORP /WA/ 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Shareholders and the Board of Directors of Heritage Financial Corporation Olympia, Washington Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Statements of Financial Condition of Heritage Financial Corporation and Subsidiaries (the "Company") as of December 31, 2022 and 2021, the related Consolidated Statements of Income, Comprehensive (Loss) Income, Stockholders’ Equity, and Cash Flows for each of the years in the three-year period ended December 31, 2022, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2022, 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, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022 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 31,2022, based on criteria established in the 2013 Internal Control – Integrated Framework issued by COSO. Basis for Opinions The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. 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 company; 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. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 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 44 Table of Contents 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 $43.0 million at December 31, 2022 and reversal of provision for credit losses on loans was $563,000 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 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 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 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 We have served as the Company's auditor since 2012. Denver, Colorado February 24, 2023 45 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (In thousands, except shares) December 31, 2022 December 31, 2021 ASSETS Cash on hand and in banks $ 74,295 $ 61,377 Interest earning deposits 29,295 1,661,915 Cash and cash equivalents 103,590 1,723,292 Investment securities available for sale, at fair value, net (amortized cost of $ 1,460,033 and $ 883,832 , respectively) 1,331,443 894,335 Investment securities held to maturity, at amortized cost, net (fair value of $ 673,434 and $ 376,331 , respectively) 766,396 383,393 Total investment securities 2,097,839 1,277,728 Loans held for sale — 1,476 Loans receivable 4,050,858 3,815,662 Allowance for credit losses on loans ( 42,986 ) ( 42,361 ) Loans receivable, net 4,007,872 3,773,301 Premises and equipment, net 76,930 79,370 Federal Home Loan Bank stock, at cost 8,916 7,933 Bank owned life insurance 122,059 120,196 Accrued interest receivable 18,547 14,657 Prepaid expenses and other assets 296,181 183,543 Other intangible assets, net 7,227 9,977 Goodwill 240,939 240,939 Total assets $ 6,980,100 $ 7,432,412 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 5,907,420 $ 6,394,290 Deposits held for sale 17,420 — Total deposits 5,924,840 6,394,290 Junior subordinated debentures 21,473 21,180 Securities sold under agreement to repurchase 46,597 50,839 Accrued expenses and other liabilities 189,297 111,671 Total liabilities 6,182,207 6,577,980 Commitments and contingencies (Note 20) Stockholders’ equity: Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding, respectively — — Common stock, no par value, 50,000,000 shares authorized; 35,106,697 and 35,105,779 shares issued and outstanding, respectively 552,397 551,798 Retained earnings 345,346 293,238 Accumulated other comprehensive (loss) income, net ( 99,850 ) 9,396 Total stockholders’ equity 797,893 854,432 Total liabilities and stockholders’ equity $ 6,980,100 $ 7,432,412 See accompanying Notes to Consolidated Financial Statements. 46 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts and shares outstanding) Year Ended December 31, 2022 2021 2020 INTEREST INCOME: Interest and fees on loans $ 174,275 $ 189,832 $ 192,417 Taxable interest on investment securities 40,627 17,492 17,541 Nontaxable interest on investment securities 3,488 3,899 3,659 Interest on interest earning deposits 9,067 1,608 703 Total interest income 227,457 212,831 214,320 INTEREST EXPENSE: Deposits 6,772 6,160 12,265 Junior subordinated debentures 1,156 742 890 Other borrowings 144 140 168 Total interest expense 8,072 7,042 13,323 Net interest income 219,385 205,789 200,997 (Reversal of) provision for credit losses ( 1,426 ) ( 29,372 ) 36,106 Net interest income after (reversal of) provision for credit losses 220,811 235,161 164,891 NONINTEREST INCOME: Service charges and other fees 10,390 9,207 8,995 Card revenue 8,885 8,325 7,233 Gain (loss) on sale of investment securities, net ( 256 ) 29 1,518 Gain on sale of loans, net 633 3,644 5,044 Interest rate swap fees 402 661 1,691 Bank owned life insurance income 3,747 2,520 4,319 Gain on sale of other assets, net 469 4,405 955 Other income 5,321 5,824 7,474 Total noninterest income 29,591 34,615 37,229 NONINTEREST EXPENSE: Compensation and employee benefits 92,092 88,765 88,106 Occupancy and equipment 17,465 17,243 17,611 Data processing 16,800 16,533 14,449 Marketing 1,643 2,143 3,100 Professional services 2,497 3,846 5,921 State/municipal business and use taxes 3,634 3,884 3,754 Federal deposit insurance premium 2,015 2,106 1,789 Other real estate owned, net — — ( 145 ) Amortization of intangible assets 2,750 3,111 3,525 Other expense 12,070 11,638 10,830 Total noninterest expense 150,966 149,269 148,940 Income before income taxes 99,436 120,507 53,180 Income tax expense 17,561 22,472 6,610 Net income $ 81,875 $ 98,035 $ 46,570 Basic earnings per share $ 2.33 $ 2.75 $ 1.29 Diluted earnings per share $ 2.31 $ 2.73 $ 1.29 Dividends declared per share $ 0.84 $ 0.81 $ 0.80 Average number of basic shares outstanding 35,103,465 35,677,851 36,014,445 Average number of diluted shares outstanding 35,463,896 35,973,386 36,170,066 See accompanying Notes to Consolidated Financial Statements. 47 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (In thousands) Year Ended December 31, 2022 2021 2020 Net income $ 81,875 $ 98,035 $ 46,570 Change in fair value of investment securities available for sale, net of tax of $( 30,372 ), $( 4,298 ) and $ 4,506 , respectively ( 108,977 ) ( 15,472 ) 15,828 Amortization of net unrealized gain for the reclassification of investment securities available for sale to held to maturity, net of tax of $( 130 ), $( 35 ) and $ 0 , respectively ( 469 ) ( 127 ) — Reclassification adjustment for net loss (gain) from sale of investment securities available for sale included in income, net of tax of $ 56 , $( 6 ) and $( 330 ), respectively 200 ( 23 ) ( 1,188 ) Other comprehensive (loss) income ( 109,246 ) ( 15,622 ) 14,640 Comprehensive (loss) income $ ( 27,371 ) $ 82,413 $ 61,210 See accompanying Notes to Consolidated Financial Statements. 48 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except shares and per share amounts) Year Ended December 31, 2022 Number of common shares Common stock Retained earnings AOCI Total stockholders’ equity Balance at December 31, 2021 35,105,779 $ 551,798 $ 293,238 $ 9,396 $ 854,432 Restricted stock units vested 127,952 — — — — Stock-based compensation expense — 3,795 — — 3,795 Common stock repurchased ( 127,034 ) ( 3,196 ) — — ( 3,196 ) Net income — — 81,875 — 81,875 Other comprehensive loss, net of tax — — — ( 109,246 ) ( 109,246 ) Cash dividends declared on common stock ($ 0.84 per share) — — ( 29,767 ) — ( 29,767 ) Balance at December 31, 2022 35,106,697 $ 552,397 $ 345,346 $ ( 99,850 ) $ 797,893 Year Ended December 31, 2021 Number of common shares Common stock Retained earnings AOCI Total stockholders’ equity Balance at December 31, 2020 35,912,243 $ 571,021 $ 224,400 $ 25,018 $ 820,439 Restricted stock units vested 125,377 — — — — Stock-based compensation expense — 3,666 — — 3,666 Common stock repurchased ( 931,841 ) ( 22,889 ) — — ( 22,889 ) Net income — — 98,035 — 98,035 Other comprehensive loss, net of tax — — — ( 15,622 ) ( 15,622 ) Cash dividends declared on common stock ($ 0.81 per share) — — ( 29,197 ) — ( 29,197 ) Balance at December 31, 2021 35,105,779 $ 551,798 $ 293,238 $ 9,396 $ 854,432 Year Ended December 31, 2020 Number of common shares Common stock Retained earnings AOCI Total stockholders’ equity Balance at December 31, 2019 36,618,729 $ 586,459 $ 212,474 10,378 $ 809,311 Cumulative effect from change in accounting policy (1) — — ( 5,615 ) — ( 5,615 ) Restricted stock units vested 109,853 — — — — Exercise of stock options 8,248 122 — — 122 Stock-based compensation expense — 3,559 — — 3,559 Common stock repurchased ( 824,587 ) ( 19,119 ) — — ( 19,119 ) Net income — — 46,570 — 46,570 Other comprehensive income, net of tax — — — 14,640 14,640 Cash dividends declared on common stock ($ 0.80 per share) — — ( 29,029 ) — ( 29,029 ) December 31, 2020 35,912,243 $ 571,021 $ 224,400 $ 25,018 $ 820,439 (1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses . See accompanying Notes to Consolidated Financial Statements. 49 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended December 31, 2022 2021 2020 Cash flows from operating activities: Net income $ 81,875 $ 98,035 $ 46,570 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and accretion 341 ( 21,739 ) ( 3,612 ) (Reversal of) provision for credit losses ( 1,426 ) ( 29,372 ) 36,106 Stock-based compensation expense 3,795 3,666 3,559 Amortization of intangible assets 2,750 3,111 3,525 Origination of mortgage loans held for sale ( 15,190 ) ( 86,443 ) ( 136,979 ) Proceeds from sale of mortgage loans held for sale 17,299 93,543 142,624 Bank owned life insurance income ( 3,747 ) ( 2,520 ) ( 4,319 ) Valuation adjustment on interest rate swaps ( 66 ) ( 355 ) 422 Gain on sale of other real estate owned — — ( 179 ) Gain on sale of mortgage loans held for sale, net ( 633 ) ( 3,644 ) ( 5,044 ) Gain (loss) on sale of investment securities, net 256 ( 29 ) ( 1,518 ) Gain on sale of assets held for sale ( 403 ) ( 4,440 ) ( 1,043 ) Other 9,605 19,717 ( 9,781 ) Net cash provided by operating activities 94,456 69,530 70,331 Cash flows from investing activities: Loan originations and purchases, net of payments ( 225,149 ) 699,107 ( 692,720 ) Maturities and repayments of investment securities available for sale 181,487 254,668 264,223 Maturities and repayments of investment securities held to maturity 28,296 1,255 — Purchase of investment securities available for sale ( 790,871 ) ( 616,123 ) ( 152,618 ) Purchase of investment securities held to maturity ( 412,835 ) ( 140,288 ) — Proceeds from sales of investment securities available for sale 30,390 1,248 55,030 Purchase of premises and equipment ( 4,016 ) ( 3,018 ) ( 6,997 ) Proceeds from sales of other real estate owned — — 1,290 Proceeds from sales of assets held for sale 2,102 10,556 2,407 Proceeds from redemption of Federal Home Loan Bank stock 2,002 — 2,560 Purchases of Federal Home Loan Bank stock ( 2,985 ) ( 1,272 ) ( 2,844 ) Proceeds from sales of premises and equipment 106 65 554 Purchases of bank owned life insurance ( 230 ) ( 10,166 ) ( 3,641 ) Proceeds from bank owned life insurance death benefit 2,114 — 1,324 Cash received from return of NMTC equity method investment — 9,642 — Capital contributions to tax credit partnerships ( 18,190 ) ( 41,911 ) ( 7,117 ) Net cash (used) provided by investing activities ( 1,207,779 ) 163,763 ( 538,549 ) 50 Table of Contents Year Ended December 31, 2022 2021 2020 Cash flows from financing activities: Net (decrease) increase in deposits ( 469,450 ) 783,347 1,015,314 Federal Home Loan Bank advances 50,050 — 64,000 Repayment of Federal Home Loan Bank advances ( 50,050 ) — ( 64,000 ) Common stock cash dividends paid ( 29,491 ) ( 28,937 ) ( 28,859 ) Net (decrease) increase in securities sold under agreement to repurchase ( 4,242 ) 15,156 15,514 Proceeds from exercise of stock options — — 122 Repurchase of common stock ( 3,196 ) ( 22,889 ) ( 19,119 ) Net cash (used) provided by financing activities ( 506,379 ) 746,677 982,972 Net (decrease) increase in cash and cash equivalents ( 1,619,702 ) 979,970 514,754 Cash and cash equivalents at beginning of period 1,723,292 743,322 228,568 Cash and cash equivalents at end of period $ 103,590 $ 1,723,292 $ 743,322 Supplemental disclosures of cash flow information: Cash paid for interest $ 7,709 $ 6,790 $ 13,136 Cash paid for income taxes, net of refunds 5,035 9,888 13,432 Supplemental non-cash disclosures of cash flow information: Transfer of investment securities available for sale to held to maturity — 244,778 — Investment in tax credit partnerships and related funding commitment 85,888 29,551 10,237 Loans received from return of NMTC equity method investment — 15,596 — ROU assets obtained in exchange for new operating lease liabilities 2,869 13,966 1,265 Transfers of premises and equipment classified as held for sale to prepaid expenses and other assets from premises and equipment, net 910 3,556 3,243 Cumulative effect from change in accounting policy (1) — — 7,175 Transfer of bank owned life insurance to prepaid expenses and other assets due to death benefit accrued, but not paid — — 2,672 Transfers of loans receivable to other real estate owned — — 270 Transfer of deposits to deposits held for sale 17,420 — — (1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses, respectively. See accompanying Notes to Consolidated Financial Statements. 51 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 2022, 2021 and 2020 (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements (a) Description of Business The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, the Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 50 branch offices located throughout Washington State, the greater Portland, Oregon area and Eugene, Oregon. The Bank’s business consists primarily of commercial lending and deposit relationships with small and medium-sized businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas. The Bank's deposits are insured by the FDIC. (b) Basis of Presentation The accompanying audited Consolidated Financial Statements have been prepared in accordance with GAAP for annual financial information and pursuant to the rules and regulations of the SEC. To prepare the audited Consolidated Financial Statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided. Management believes that the judgments, estimates, and assumptions used in the preparation of the Consolidated Financial Statements are appropriate based on the facts and circumstances at the time. Actual results, however, could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to management's estimate of the ACL on investment securities, management's estimate of the ACL on loans, management's estimate of the ACL on unfunded commitments, management's evaluation of goodwill impairment and management's estimate of the fair value of financial instruments. The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. All significant intercompany balances and transactions among the Company and the Bank have been eliminated in consolidation. 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 year's net income or stockholders’ equity. (c) Significant Accounting Policies Cash and Cash Equivalents 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 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 (loss) 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. If either of the criteria regarding intent or requirement 52 Table of Contents to sell is met, the security’s amortized cost basis is written down to fair value through a provision for credit loss against income. For investment securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL on investment securities available for sale is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. 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 uncollectibility 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 uncollectibility 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, 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, 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. 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 acquired loans is determined using the same methodology as originated loans. For non-PCD loans, the initial ACL on loans is recorded through earnings as a provision for credit losses. For PCD loans, the initial ACL is incorporated into the calculation of the fair value of net assets acquired on the merger date and the net of the PCD loan purchase price and the initial ACL becomes the initial amortized cost basis. 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 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. Subsequent changes to the ACL on loans for acquired loans are recorded through earnings as a provision for credit losses. Delinquent Loans : Loans are considered past due or delinquent when principal or interest payments are past due 30 days or more. Delinquent loans 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 : Loans for which the accrual of interest has been discontinued are designated as nonaccrual loans. The accrual of interest is generally discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of 53 Table of Contents collection. Loans are placed on nonaccrual at an earlier date if collection of the contractual principal or interest is doubtful. All interest accrued, but not collected, on loans deemed nonaccrual during the period is reversed against interest income in that period. 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. Due to the short-term nature of the forbearance and other relief programs we were offering as a result of the COVID-19 Pandemic, borrowers granted relief under these programs generally were not reported as nonaccrual during the deferral period. Loans are generally charged off to their net realizable value if collection of the contractual principal or interest as scheduled in the loan agreement is doubtful. Consumer loans are typically charged off no later than 90 days past due. Troubled Debt Restructures : 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 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. The Bank also considers insignificant delays in payments when determining if a loan should be classified as a TDR. A loan that has been placed on nonaccrual status that is subsequently restructured will usually remain on nonaccrual status until the borrower is able to demonstrate repayment performance in compliance with the restructured terms for a sustained period, typically for six months. A restructured loan may return to accrual status sooner based on other significant events or mitigating circumstances. A loan that has not been placed on nonaccrual status may be restructured and such loan may remain on accrual status after such restructuring. In these circumstances, the borrower has made payments before the restructuring and is expected to continue to perform after the restructuring. Generally, this type of restructuring involves a reduction in the loan interest rate and/or a change to interest-only payments for a period of time. A TDR is considered defaulted if, during the 12-month period after the restructure, the loan has not performed in accordance to the restructured terms. Defaults generally include loans whose payments are 90 days or more past due and loans whose revised maturity date passed and no further modifications will be granted for that borrower. Once a loan is classified as a TDR loan, it generally continues to be reported as such until it is paid off or charged off. During 2020, the CARES Act and regulatory agencies provided guidance around the modification of loans as a result of the COVID-19 Pandemic and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined by the CARES Act and related regulatory guidance prior to any relief are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers were 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. ACL on 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 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 "(Reversal of) 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. 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 if the original interest rate is used to discount the expected cash flows, not the rate specified in the restructuring. 54 Table of Contents 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. 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. Estimated cash flows consider the principal and interest in accordance with the contractual term of the loan and estimated prepayments. Contractual cash flows are based on the amortized cost and are adjusted for balances guaranteed by governmental entities, such as SBA or USDA, resulting in the unguaranteed amortized cost. The contractual term excludes expected extensions, renewals and modifications unless either of the following applies: 1) management has a reasonable expectation at the reporting date that a TDR will be executed with an individual borrower or 2) the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Prepayments are established for each segment based on rolling historical averages for the segment, which management believes is an accurate representation of future prepayment activity. Management reviews the adequacy of the prepayment assumption on a quarterly basis. 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. Further, each of the macroeconomic factors is utilized differently by segment, including the application of lagged factors and various transformations such as percent change year over year. A macroeconomic sensitive model is developed for each segment given the current and forecasted conditions and a macroeconomic multiplier is calculated for each forecast period considering the forecasted losses as compared to the long-term average actual losses of the dataset. The impact of those macroeconomic factors on each segment, both positive or negative, using the reasonable and supportable period, are added to the calculated baseline loss allowance. 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’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 be 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. The evaluation of ACL on loans is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize estimated losses on loans, future additions to the allowance may be necessary based on further 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. The Company believes the ACL on loans is appropriate given all of the above considerations. ACL on Unfunded Commitments 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 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. The ACL for unfunded commitments is recorded in "Accrued expenses and other liabilities" on the Consolidated Statements of Financial Condition and changes are recognized through earnings in the "(Reversal of) provision for credit losses" on the Consolidated Statements of Income. Mortgage Banking Operations The Bank originates and sells certain residential real estate loans on a servicing-released basis. 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. 55 Table of Contents 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. 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, 2022 or December 31, 2021. Commercial Loan Sales, Servicing, and Commercial Servicing Asset The Company, on a limited basis, sells the guaranteed portion of SBA and USDA loans, with servicing retained, for cash proceeds and records a related servicing asset. 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 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. The servicing asset is reported within "Prepaid expenses and other assets" on the Consolidated Statements of Financial Condition. 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. 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 income" on the Consolidated Statements of Income. 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, 2022, December 31, 2021 and December 31, 2020. Servicing fee income is recorded for fees earned for servicing loans and reported as "Other 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 servicing fee income. Late fees and ancillary fees related to loan servicing were not material for the years ended December 31, 2022, 2021, and 2020. 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. 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. The balance of the deferred gain was immaterial at December 31, 2022, December 31, 2021 and December 31, 2020. Other Real Estate Owned 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, net" on the Consolidated Statements of Income. Premises and Equipment Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation. 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; and for furniture, fixtures and equipment is three to seven years. 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. Bank Owned Life Insurance 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 56 Table of Contents 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 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 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. Goodwill 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 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 assesses 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. If the implied fair value of goodwill is less than the recorded goodwill, an impairment charge would be recorded for the difference. Income Taxes The Company and the Bank file a United States consolidated federal income tax return and an Oregon State income tax return. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applicable to taxable income in the periods in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. A valuation allowance, if needed, reduces deferred tax assets to the amounts expected to be realized. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in "Income tax expense" in the Consolidated Statements of Income as the amounts are generally insignificant each year. Operating Leases 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. As the Company's leases typically do not provide an implicit rate; the Company uses its incremental borrowing rate based on the information available at the operating lease commencement date in determining the present value of lease payments. The operating lease ROU asset is further reduced by any lease pre-payments made and lease incentives. The leases may contain various provisions for increases in rental rates based either on changes in the published Consumer Price Index or a predetermined escalation schedule and such variable lease payments are recognized as lease expense as they are incurred. The majority of the Company's leases include variable lease payments such as real estate taxes, maintenance, insurance and other similar costs in addition to the base rent. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company does not separate non-lease components from lease components and excludes operating leases with a term of twelve months or less from being capitalized as ROU assets and ROU liabilities. The Company follows a policy to capitalize lease agreements with total contractual lease payments of $ 25,000 or more. The Company does not account for any leases at a portfolio level. Stock-Based Compensation The Company maintains a number of stock-based incentive programs, which are discussed in more detail in Note (17) 57 Table of Contents 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. Compensation cost is generally recognized over the requisite service period, generally defined as the vesting period, on a straight-line basis. Compensation cost for restricted stock units with market-based vesting is recognized over the service period to the extent the restricted stock units are expected to vest. Forfeitures are recognized as they occur. The market price of the Company’s common stock at the date of grant is used to determine the fair value of the restricted stock awards and restricted stock units. The fair value of stock options granted is estimated based on the date of grant using the Black-Scholes-Merton option pricing model. Certain restricted stock unit grants are subject to performance-based vesting as well as other approved vesting conditions and cliff-vest based on those conditions, and the fair value is estimated using a Monte Carlo simulation pricing model. The assumptions used in the Monte Carlo simulation pricing model include the expected term based on the valuation date and the remaining contractual term of the award; the risk-free interest rate based on the U.S. Treasury curve at the valuation date of the award; the expected dividend yield based on expected dividends being payable to the holders; and the expected stock price volatility over the expected term based on the historical volatility over the equivalent historical term. Tax Credit Investments The Company has equity investments in LIHTC partnerships, which are indirect federal subsidies that finance low-income housing projects. As a limited liability investor in these partnerships, the Company receives tax benefits in the form of tax deductions from partnership operating losses and federal income tax credits. The federal income tax credits are earned over a 10-year period as a result of the investment properties meeting certain criteria and are subject to recapture for noncompliance with such criteria over a 15-year period. The Company accounts for the LIHTCs under the proportional amortization method and amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance on the Consolidated Statements of Income as a component of "Income tax expense". The Company reports the carrying value of the equity investments in the unconsolidated LIHTCs as Prepaid expenses and other assets and the unfunded contingent commitments related to the equity investments as Accrued expenses and other liabilities on the Company’s Statements of Financial Condition. 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 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. 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. The NMTC is available to investors over a seven-year period and is subject to recapture if certain events occur during such period. The Company is required to fund 85 % of a tranche by a predetermined deadline to claim the entire tax credit. The Company funded its tranche before the deadline. 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 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. Such discretionary contributions are generally approved by the Compensation Committee of the Company's Board of Directors. The notional account balances of participants under the Deferred Compensation Plan earn interest on an annual basis. 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 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. The Company’s obligation to make payments under the Deferred Compensation Plan and the Salary Continuation Plan is a general obligation of the Company and is to be paid from the Company’s general assets. As such, participants are general unsecured creditors of the Company with respect to their participation under both plans. The Company records a liability within "Accrued expenses and other liabilities" on the Consolidated Statements of Financial Condition and records the expense as "Compensation and employee benefits" 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. 58 Table of Contents Earnings per Share The two-class method is used in the calculation of basic and diluted earnings per common share. Basic earnings per common share is net income allocated to common shareholders divided by the weighted average number of common shares outstanding during the period. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. Dividends and undistributed earnings allocated to participating securities are excluded from net income allocated to common shareholders and participating securities are excluded from weighted average common shares outstanding. Diluted earnings per common share is calculated using the treasury stock method and includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements. Derivative Financial Instruments The Company utilizes interest rate swap derivative contracts to facilitate the needs of its commercial customers whereby it enters into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. 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. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the Company’s customer to effectively convert a variable rate loan to a fixed rate and the Company recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third-party. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company’s results of operations. These interest rate swaps are not designated as hedging instruments. The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements. Credit risk for derivatives with the customer is controlled through the credit approval process, amount limits, and monitoring procedures and is concentrated within our primary market areas. Credit risk for derivatives with third-parties is concentrated among four well-known broker dealers. Fee income related to interest rate swap derivative contract transactions is recorded in "Interest rate swap fees" on the Consolidated Statements of Income. The fair value of derivative positions outstanding is included in "Prepaid expenses and other assets" and "Accrued expenses and other liabilities" in the Consolidated Statements of Financial Condition. The gains and losses due to changes in fair value and all cash flows are included in "Other income" in the Consolidated Statements of Income, but typically net to zero based on the identical back-to-back interest rate swaps unless a credit valuation adjustment is recorded to appropriately reflect nonperformance risk in the fair value measurement. Various factors impact changes in the credit valuation adjustments over time, including changes in the risk ratings of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments. Advertising Expenses Advertising costs are expensed as incurred. Costs related to production of advertising are considered incurred when the advertising is first used. (Reversal of) 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 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 are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment. Revenue from Contracts with Customers The Company's revenues are primarily composed of interest income on financial instruments, such as loans and investment securities. The Company's revenue derived from contracts with customers are generally presented in "Service charges and other fees" and "Other income" on the Consolidated Statement of Income and includes the following: • Service Charges on Deposit Accounts: The Company earns fees from its deposit customers from a variety of deposit products and services. Non-transaction based fees such as account maintenance fees and monthly statement fees are considered to be provided to the customer under a day-to-day contract with ongoing renewals. Revenues for these non-transaction fees are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Transaction-based fees such as non-sufficient fund charges, stop payment charges and wire fees are recognized at the time the transaction is executed as the contract duration does not extend beyond the service performed. • Wealth Management: 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. 59 Table of Contents • Merchant Processing Services and Debit and Credit Card Fees: The Company earns fees from cardholder transactions conducted through third-party payment network providers which consist of (i) interchange fees earned from the payment network as a debit card issuer, (ii) referral fee income, and (iii) ongoing merchant fees earned for referring customers to the payment processing provider. These fees are recognized when the transaction occurs, but may settle on a daily or monthly basis. (d) Recently Issued or Adopted Accounting Pronouncements 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 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 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. Upon adoption of this ASU, the Company recorded an increase to the ACL on loans of $ 3.4 million and an increase to the ACL on unfunded commitments of $ 3.7 million, which resulted in a pretax cumulative-effect adjustment of $ 7.1 million. The impact of this adjustment to beginning retained earnings on January 1, 2020 was $ 5.6 million, net of tax. FASB ASU 2020-04 , Reference Rate Reform (Topic 848) , as amended by ASU 2021-01, and ASU 2022-06 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. In December 2022, FASB amended this ASU and deferred the sunset date of Topic 848 from December 31, 2022, to December 31, 2024. 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. The Company does not expect the adoption of this ASU to have a material impact on its business operations or Consolidated Statements of Financial Condition. FASB ASU 2022-02 , Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures , was issued in March 2022. The ASU eliminates the accounting guidance for TDR loans by creditors while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying the recognition and measurement guidance for TDRs, the entity will apply the loan refinancing and restructuring guidance to determine whether a modification or other form of restructuring results in a new loan or continuation of an existing loan. Additionally, the ASU requires public business entities to disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases. These amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, since the Company previously adopted the amendments in ASU 2016-13. Early adoption is permitted in any interim period if an entity has adopted ASU 2016-13 and such election may be made individually to adopt the guidance related to TDRs, including related disclosures, and the presentation of gross write-offs in the vintage disclosure. This update requires prospective transition for the disclosures related to loan restructurings for borrowers experiencing financial difficulty and the presentation of gross write-offs in the vintage disclosures. The guidance related to the recognition and measurement of TDRs may be adopted on a prospective or modified retrospective transition method. The Company has not yet adopted this ASU for the year ended December 31, 2022 does not expect the adoption of this ASU to have a material impact on its business operations or Consolidated Statements of Financial Condition. (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. During 2021, the Company 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 remained in AOCI and is 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, 2022 or December 31, 2021. 60 Table of Contents (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, 2022 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (In thousands) Investment securities available for sale: U.S. government and agency securities $ 68,912 $ — $ ( 5,053 ) $ 63,859 Municipal securities 171,087 172 ( 18,233 ) 153,026 Residential CMO and MBS 479,473 — ( 55,087 ) 424,386 Commercial CMO and MBS 714,136 19 ( 49,734 ) 664,421 Corporate obligations 4,000 — ( 166 ) 3,834 Other asset-backed securities 22,425 14 ( 522 ) 21,917 Total $ 1,460,033 $ 205 $ ( 128,795 ) $ 1,331,443 Investment securities held to maturity: U.S. government and agency securities $ 150,936 $ — $ ( 33,585 ) $ 117,351 Residential CMO and MBS 290,318 — ( 17,440 ) 272,878 Commercial CMO and MBS 325,142 — ( 41,937 ) 283,205 Total $ 766,396 $ — $ ( 92,962 ) $ 673,434 December 31, 2021 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (In thousands) Investment securities available for sale: U.S. government and agency securities $ 21,494 $ 55 $ ( 176 ) $ 21,373 Municipal securities 213,158 8,908 ( 854 ) 221,212 Residential CMO and MBS 307,366 2,111 ( 2,593 ) 306,884 Commercial CMO and MBS 313,169 3,891 ( 1,199 ) 315,861 Corporate obligations 2,007 7 — 2,014 Other asset-backed securities 26,638 369 ( 16 ) 26,991 Total $ 883,832 $ 15,341 $ ( 4,838 ) $ 894,335 Investment securities held to maturity: U.S. government and agency securities $ 141,011 $ 120 $ ( 1,768 ) $ 139,363 Residential CMO and MBS 24,529 — ( 153 ) 24,376 Commercial CMO and MBS 217,853 — ( 5,261 ) 212,592 Total $ 383,393 $ 120 $ ( 7,182 ) $ 376,331 61 Table of Contents The amortized cost and fair value of investment securities at December 31, 2022, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities Available for Sale Securities Held to Maturity Amortized Cost Fair Value Amortized Cost Fair Value (In thousands) Due in one year or less $ 30,176 $ 29,723 $ — $ — Due after one year through five years 41,687 39,777 — — Due after five years through ten years 58,981 55,552 83,227 67,817 Due after ten years 113,155 95,667 67,709 49,534 Total investment securities due at a single maturity date 243,999 220,719 150,936 117,351 Mortgage-backed securities (1) 1,216,034 1,110,724 615,460 556,083 Total investment securities $ 1,460,033 $ 1,331,443 $ 766,396 $ 673,434 (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, 2022 and December 31, 2021. (b) Unrealized Losses on Investment Securities Available for Sale The following tables show the gross unrealized losses and fair value of the Company’s investment securities available for sale for which an ACL on investment securities available for sale has not been recorded, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position at the dates indicated: December 31, 2022 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (In thousands) U.S. government and agency securities $ 51,900 $ ( 2,031 ) $ 11,959 $ ( 3,022 ) $ 63,859 $ ( 5,053 ) Municipal securities 82,580 ( 5,585 ) 40,945 ( 12,648 ) 123,525 ( 18,233 ) Residential CMO and MBS 217,949 ( 14,770 ) 206,437 ( 40,317 ) 424,386 ( 55,087 ) Commercial CMO and MBS 473,580 ( 16,971 ) 181,692 ( 32,763 ) 655,272 ( 49,734 ) Corporate obligations 3,834 ( 166 ) — — 3,834 ( 166 ) Other asset-backed securities 16,489 ( 510 ) 721 ( 12 ) 17,210 ( 522 ) Total $ 846,332 $ ( 40,033 ) $ 441,754 $ ( 88,762 ) $ 1,288,086 $ ( 128,795 ) December 31, 2021 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (In thousands) U.S. government and agency securities $ 14,828 $ ( 176 ) $ — $ — $ 14,828 $ ( 176 ) Municipal securities $ 29,774 $ ( 619 ) $ 9,351 $ ( 235 ) 39,125 ( 854 ) Residential CMO and MBS 204,039 ( 2,470 ) 19,862 ( 123 ) 223,901 ( 2,593 ) Commercial CMO and MBS 83,283 ( 1,161 ) 1,936 ( 38 ) 85,219 ( 1,199 ) Other asset-backed securities 2,763 ( 9 ) 1,118 ( 7 ) 3,881 ( 16 ) Total $ 334,687 $ ( 4,435 ) $ 32,267 $ ( 403 ) $ 366,954 $ ( 4,838 ) (c) ACL on Investment Securities The Company evaluated investment securities available for sale as of December 31, 2022 and December 31, 2021 and determined that any declines in fair value were attributable to changes in interest rates relative to where these investments fall within the yield curve and individual characteristics. Management monitors published credit ratings for adverse changes for all rated investment securities and none of these securities had a below investment grade credit rating as of both December 31, 62 Table of Contents 2022 and December 31, 2021. In addition, the Company does not intend to sell these securities nor does the Company consider it more likely than not that it will be required to sell these securities before the recovery of the amortized cost basis, which may be upon maturity. Therefore, no ACL on investment securities available for sale was recorded as of December 31, 2022 and December 31, 2021. The Company also evaluated investment securities held to maturity for current expected credit losses as of December 31, 2022 and December 31, 2021. There were no investment securities held to maturity classified as nonaccrual or past due as of December 31, 2022 and December 31, 2021 and all were issued by the U.S. government and its agencies and either explicitly or implicitly guaranteed by the U.S. government, highly rated by major credit rating agencies and had a long history of no credit losses. Accordingly, the Company did not measure expected credit losses on investment securities held to maturity since the historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Therefore, no ACL on investment securities held to maturity was recorded as of December 31, 2022 and December 31, 2021. (d) Realized Gains and Losses The following table presents the gross realized gains and losses on the sale of investment securities available for sale during the following periods: Year ended December 31, 2022 2021 2020 (In thousands) Gross realized gains $ 4 $ 29 $ 1,537 Gross realized losses ( 260 ) — ( 19 ) Net realized gains/(losses) $ ( 256 ) $ 29 $ 1,518 (e) Pledged Securities The following table summarizes the amortized cost and fair value of investment securities that are pledged as collateral for the following obligations at the dates indicated: December 31, 2022 December 31, 2021 Amortized Cost Fair Value Amortized Cost Fair Value (In thousands) Washington and Oregon state public deposits $ 156,784 $ 137,931 $ 128,216 $ 130,217 Federal Reserve Bank credit facility 60,660 49,506 61,057 59,674 Securities sold under agreement to repurchase 63,685 55,836 59,887 59,655 Other securities pledged 54,910 48,358 56,419 55,633 Total $ 336,039 $ 291,631 $ 305,579 $ 305,179 (f) Accrued Interest Receivable Accrued interest receivable excluded from the amortized cost of investment securities available for sale totaled $ 4.8 million and $ 3.5 million at December 31, 2022 and December 31, 2021, respectively. Accrued interest receivable excluded from the amortized cost on investment securities held to maturity totaled $ 2.4 million and $ 1.1 million at December 31, 2022 and December 31, 2021, respectively. No amounts of accrued interest receivable on investment securities available for sale or held to maturity were reversed against interest income on investment securities during the years ended December 31, 2022, 2021, and 2020. (G) Non-Marketable Securities As a member bank of Visa U.S.A., we held 6,549 shares of Visa Inc. Class B common stock at December 31, 2022 and December 31, 2021. These shares have a carrying value of zero and are restricted from resale to non-member banks of Visa U.S.A. until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s Covered Litigation escrow account. Because of the restriction and the uncertainty on the conversion rate to Class A shares, these shares lack a readily determinable fair value. (3) Loans Receivable The Bank originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions. Accrued interest receivable was excluded from disclosures presenting the Bank's amortized cost of loans receivable as it was deemed insignificant. In addition to originating loans, the Bank may also purchase loans through pool purchases, participation purchases and syndicated loan purchases. 63 Table of Contents (a) Loan Origination/Risk Management The Bank categorizes the individual loans in the total loan portfolio into four segments: commercial business; residential real estate; real estate construction and land development; and consumer. Within these segments are classes of loans for which management monitors and assesses credit risk. The Bank has certain lending policies and guidelines in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and guidelines on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and criticized loans. The Bank also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management. The loan review process complements and reinforces the risk identification and assessment decisions made by loan officers and credit personnel. The amortized cost of loans receivable, net of ACL on loans consisted of the following portfolio segments and classes at the dates indicated: December 31, 2022 December 31, 2021 (In thousands) Commercial business: Commercial and industrial $ 692,100 $ 621,567 SBA PPP 1,468 145,840 Owner-occupied CRE 937,040 931,150 Non-owner occupied CRE 1,586,632 1,493,099 Total commercial business 3,217,240 3,191,656 Residential real estate 343,631 164,582 Real estate construction and land development: Residential 80,074 85,547 Commercial and multifamily 214,038 141,336 Total real estate construction and land development 294,112 226,883 Consumer 195,875 232,541 Loans receivable 4,050,858 3,815,662 Allowance for credit losses on loans ( 42,986 ) ( 42,361 ) Loans receivable, net $ 4,007,872 $ 3,773,301 Balances included in the amortized cost of loans receivable: Unamortized net discount on acquired loans $ ( 2,501 ) $ ( 3,938 ) Unamortized net deferred fee $ ( 10,016 ) $ ( 7,953 ) 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 discussed separately below: Commercial and industrial. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may include a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Commercial and industrial loans carry more risk than other loans because the borrowers’ cash flow is less predictable and in the event of a default the amount of loss is potentially greater and more difficult to quantify because the value of the collateral securing these loans may fluctuate, may be uncollectible or may be obsolete or of limited use, among other things. SBA PPP. The Bank began originating SBA PPP loans following the enactment of the CARES Act in April 2020. SBA PPP loans are fully guaranteed by the SBA, intended for businesses impacted by the COVID-19 Pandemic and designed to provide near term relief to help small businesses sustain operations. These loans have either a two-year or five-year maturity date and earn interest at 1 %. The Bank also earned a fee based on the size of the loan, which is recognized over the life of the loan. The Bank no longer originates SBA PPP loans as the program expired on May 31, 2021. 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 64 Table of Contents loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate 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 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 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 Bank sells a portion of originated residential real estate loans in the secondary market. In addition to originating residential real estate loans, the Bank began purchasing pools of residential real estate loans during the year ended 2022. All purchased loans adhere to the Bank's underwriting standards. Real Estate Construction and Land Development : 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. Construction loans are typically short-term in nature and priced with variable rates of interest. Construction loans may also include construction to permanent financing where the loan term includes both the construction phase and term loan. 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 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 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. 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 Bank 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. Consumer : 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. Underwriting standards for home equity loans are significantly influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80 %, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. 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 overall credit risk for this segment. To further reduce the risk, trend reports are reviewed by management on a regular basis. 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 Bank ceased indirect auto loan originations in March 2020. (b) Concentrations of Credit Most of the Bank’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State, and Multnomah, Washington and Lane County in Oregon, as well as other contiguous markets and represents a geographic concentration. Additionally, the Bank's loan portfolio is concentrated in commercial business loans, including commercial and industrial, owner and nonowner-occupied CRE and commercial and multifamily real estate construction and land development loans. Commercial business loans, excluding SBA PPP loans, are generally considered as having more inherent risk of default than residential real estate loans or other consumer loans. Also, the commercial loan balance per borrower is typically larger than that for residential real estate loans and consumer loans, implying higher potential losses on an individual loan basis. (c) Credit Quality Indicators As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, (v) past due status, and (vi) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon. The Bank utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 10. A description of the general characteristics of the risk grades is as follows: 65 Table of Contents • Grades 1 to 5: 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. Loans with the higher grades within the “Pass” category may include borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Increased monitoring of financial information and/or collateral may be appropriate. Loans with this grade show no immediate loss exposure. • Grade 6: 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. • Grade 7: 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. Loans with this grade show signs of deteriorating profits and capital and the borrower might not be strong enough to sustain a major setback. The borrower is typically higher than normally leveraged and outside support might be modest and likely illiquid. The loan is at risk of further credit decline unless active measures are taken to correct the situation. • Grade 8: This grade includes “Substandard” ("SS") loans in accordance with regulatory guidelines, which the Company has determined have a high credit risk. These loans also have well-defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. The borrower may have shown serious negative trends in financial ratios and performance. Such loans may be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business. • Grade 9: 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. • Grade 10: 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. Numerical loan grades for loans are established at the origination of the loan. Changes to loan grades are considered at the time new information about the performance of a loan becomes available, including the receipt of updated financial information from the borrower, results of annual term loan reviews and scheduled loan reviews. For consumer loans, the Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event of payment delinquencies or default. Typically, an individual loan grade will not be changed from the prior period unless there is a specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications with the borrower or other borrower information that becomes known to management. Credit improvements are evidenced by known facts regarding the borrower or the collateral property. Loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential. Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades. The SM loan grade is transitory in that the Bank is waiting on additional information to determine the likelihood and extent of any potential loss. The 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 have further credit deterioration and include both accrual loans and nonaccrual loans. 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 exercised judgment in determining the risk rating for impacted borrowers and did not automatically adversely classify credits that were 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 offered 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 at the dates indicated: December 31, 2022 Term Loans Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (1) Loans Receivable 2022 2021 2020 2019 2018 Prior (In thousands) Commercial business: Commercial and industrial Pass $ 168,818 $ 93,302 $ 82,437 $ 61,160 $ 33,957 $ 74,181 $ 146,795 $ 172 $ 660,822 SM 212 109 443 4,637 362 4,447 5,433 — 15,643 66 Table of Contents December 31, 2022 Term Loans Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (1) Loans Receivable 2022 2021 2020 2019 2018 Prior SS 773 188 1,710 3,465 559 5,098 3,674 168 15,635 Total 169,803 93,599 84,590 69,262 34,878 83,726 155,902 340 692,100 SBA PPP Pass — 1,351 117 — — — — — 1,468 Owner-occupied CRE Pass 134,432 167,927 93,834 157,096 62,876 282,212 — — 898,377 SM — 1,744 — — 2,540 16,664 — 247 21,195 SS — — 671 — 3,722 13,075 — — 17,468 Total 134,432 169,671 94,505 157,096 69,138 311,951 — 247 937,040 Non-owner occupied CRE Pass 240,151 189,300 160,930 258,778 121,369 561,645 — — 1,532,173 SM — 8,349 — 4,172 — 12,190 — — 24,711 SS — — — — 3,627 26,121 — — 29,748 Total 240,151 197,649 160,930 262,950 124,996 599,956 — — 1,586,632 Total commercial business Pass 543,401 451,880 337,318 477,034 218,202 918,038 146,795 172 3,092,840 SM 212 10,202 443 8,809 2,902 33,301 5,433 247 61,549 SS 773 188 2,381 3,465 7,908 44,294 3,674 168 62,851 Total 544,386 462,270 340,142 489,308 229,012 995,633 155,902 587 3,217,240 Residential real estate Pass 132,510 149,934 24,668 16,803 4,207 15,337 — — 343,459 SS — — — — — 172 — — 172 Total 132,510 149,934 24,668 16,803 4,207 15,509 — — 343,631 Real estate construction and land development: Residential Pass 45,521 26,675 2,891 3,061 871 1,055 — — 80,074 Commercial and multifamily Pass 71,168 123,626 6,272 1,084 2,562 995 — — 205,707 SM — — 2,213 5,687 — — — — 7,900 SS — — — 37 — 394 — — 431 Total 71,168 123,626 8,485 6,808 2,562 1,389 — — 214,038 Total real estate construction and land development Pass 116,689 150,301 9,163 4,145 3,433 2,050 — — 285,781 SM — — 2,213 5,687 — — — — 7,900 SS — — — 37 — 394 — — 431 Total 116,689 150,301 11,376 9,869 3,433 2,444 — — 294,112 Consumer Pass 3,379 509 9,848 27,370 15,563 19,855 116,605 435 193,564 SS — — 168 559 320 1,120 44 100 2,311 Total 3,379 509 10,016 27,929 15,883 20,975 116,649 535 195,875 Loans receivable Pass 795,979 752,624 380,997 525,352 241,405 955,280 263,400 607 3,915,644 SM 212 10,202 2,656 14,496 2,902 33,301 5,433 247 69,449 SS 773 188 2,549 4,061 8,228 45,980 3,718 268 65,765 Total $ 796,964 $ 763,014 $ 386,202 $ 543,909 $ 252,535 $ 1,034,561 $ 272,551 $ 1,122 $ 4,050,858 (1) Represents the loans receivable balance at December 31, 2022 which was converted from a revolving loan to an amortizing loan during the year ended December 31, 2022. 67 Table of Contents December 31, 2021 Term Loans Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (1) Loans Receivable 2021 2020 2019 2018 2017 Prior (In thousands) Commercial business: Commercial and industrial Pass $ 95,960 $ 100,193 $ 94,657 $ 54,707 $ 28,558 $ 77,294 $ 127,651 $ 1,035 $ 580,055 SM 326 884 5,998 1,425 2,223 2,401 2,048 353 15,658 SS 1,443 1,287 5,912 2,809 2,526 6,907 4,402 568 25,854 Total 97,729 102,364 106,567 58,941 33,307 86,602 134,101 1,956 621,567 SBA PPP Pass 139,253 6,587 — — — — — — 145,840 Total 139,253 6,587 — — — — — — 145,840 Owner-occupied CRE Pass 182,742 90,609 188,380 73,714 66,039 273,518 — 72 875,074 SM 264 — 3,079 7,521 3,937 16,724 — — 31,525 SS — 1,332 — 3,787 3,014 16,418 — — 24,551 Doubtful or Loss — — — — — — — — — Total 183,006 91,941 191,459 85,022 72,990 306,660 — 72 931,150 Non-owner-occupied CRE Pass 187,860 185,650 244,863 149,090 144,896 499,486 — — 1,411,845 SM — — 5,674 — 15,482 2,400 — — 23,556 SS — — — 3,379 — 54,319 — — 57,698 Total 187,860 185,650 250,537 152,469 160,378 556,205 — — 1,493,099 Total commercial business Pass 605,815 383,039 527,900 277,511 239,493 850,298 127,651 1,107 3,012,814 SM 590 884 14,751 8,946 21,642 21,525 2,048 353 70,739 SS 1,443 2,619 5,912 9,975 5,540 77,644 4,402 568 108,103 Total 607,848 386,542 548,563 296,432 266,675 949,467 134,101 2,028 3,191,656 Residential real estate Pass 85,089 27,090 23,295 5,672 6,141 16,891 — — 164,178 SM — — — — — — — — — SS — — — — — 404 — — 404 Total 85,089 27,090 23,295 5,672 6,141 17,295 — — 164,582 Real estate construction and land development: Residential Pass 44,892 23,728 12,266 2,921 389 1,351 — — 85,547 Total 44,892 23,728 12,266 2,921 389 1,351 — — 85,547 Commercial and multifamily Pass 56,448 41,616 34,117 5,794 710 1,379 — — 140,064 SM — — 68 — — 213 — — 281 SS — 571 — — — 420 — — 991 Total 56,448 42,187 34,185 5,794 710 2,012 — — 141,336 Total real estate construction and land development Pass 101,340 65,344 46,383 8,715 1,099 2,730 — — 225,611 SM — — 68 — — 213 — — 281 SS — 571 — — — 420 — — 991 Total 101,340 65,915 46,451 8,715 1,099 3,363 — — 226,883 68 Table of Contents December 31, 2021 Term Loans Amortized Cost Basis by Origination Year Revolving Loans Revolving Loans Converted (1) Loans Receivable 2021 2020 2019 2018 2017 Prior Consumer Pass 1,286 15,737 46,041 29,819 15,068 13,026 108,492 120 229,589 SM — — — — — — — — — SS — 181 657 476 542 1,043 36 17 2,952 Total 1,286 15,918 46,698 30,295 15,610 14,069 108,528 137 232,541 Loans receivable Pass 793,530 491,210 643,619 321,717 261,801 882,945 236,143 1,227 3,632,192 SM 590 884 14,819 8,946 21,642 21,738 2,048 353 71,020 SS 1,443 3,371 6,569 10,451 6,082 79,511 4,438 585 112,450 Total $ 795,563 $ 495,465 $ 665,007 $ 341,114 $ 289,525 $ 984,194 $ 242,629 $ 2,165 $ 3,815,662 (1) Represents the loans receivable balance at December 31, 2021 which was converted from a revolving loan to an amortizing loan during the year ended December 31, 2021 (d) Nonaccrual Loans The following tables present the amortized cost of nonaccrual loans for the dates indicated: December 31, 2022 Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual (In thousands) Commercial business: Commercial and industrial $ 4,503 $ 1,154 $ 5,657 Owner-occupied CRE — 212 212 Total commercial business 4,503 1,366 5,869 Real estate construction and land development: Commercial and multifamily — 37 37 Total $ 4,503 $ 1,403 $ 5,906 December 31, 2021 Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual (In thousands) Commercial business: Commercial and industrial $ 6,454 $ 3,827 $ 10,281 Owner-occupied CRE 3,036 5,138 8,174 Non-owner occupied CRE 1,273 3,379 4,652 Total commercial business 10,763 12,344 23,107 Residential real estate — 47 47 Real estate construction and land development: Commercial and multifamily — 571 571 Consumer — 29 29 Total $ 10,763 $ 12,991 $ 23,754 69 Table of Contents The following table presents the reversal of interest income on loans due to the write-off of accrued interest receivable upon the initial classification of loans as nonaccrual loans and the interest income recognized due to payment in full or sale of previously classified nonaccrual loans during the following periods: Year Ended December 31, 2022 Year Ended December 31, 2021 Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized (In thousands) Commercial business: Commercial and industrial $ ( 14 ) $ 263 $ ( 10 ) $ 2,295 Owner-occupied CRE — 53 — 117 Non-owner occupied CRE — 774 — 601 Total commercial business ( 14 ) 1,090 ( 10 ) 3,013 Residential real estate — 19 — — Real estate construction and land development: Residential — — — 71 Commercial and multifamily ( 14 ) 65 — — Total real estate construction and land development ( 14 ) 65 — 71 Consumer — 68 ( 1 ) 52 Total $ ( 28 ) $ 1,242 $ ( 11 ) $ 3,136 For the years ended December 31, 2022 and 2021, no interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the tables above due to payment in full or sale. (e) Past due loans The Bank performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due. The amortized cost of past due loans as of December 31, 2022 and December 31, 2021 were as follows: December 31, 2022 30-89 Days 90 Days or Greater Total Past Due Current Loans Receivable (In thousands) Commercial business: Commercial and industrial $ 586 $ 6,104 $ 6,690 $ 685,410 $ 692,100 SBA PPP 236 — 236 1,232 1,468 Owner-occupied CRE — 189 189 936,851 937,040 Non-owner occupied CRE — — — 1,586,632 1,586,632 Total commercial business 822 6,293 7,115 3,210,125 3,217,240 Residential real estate 3,066 — 3,066 340,565 343,631 Real estate construction and land development: Residential — — — 80,074 80,074 Commercial and multifamily — — — 214,038 214,038 Total real estate construction and land development — — — 294,112 294,112 Consumer 1,561 — 1,561 194,314 195,875 Total $ 5,449 $ 6,293 $ 11,742 $ 4,039,116 $ 4,050,858 December 31, 2021 30-89 Days 90 Days or Greater Total Past Due Current Loans Receivable (In thousands) Commercial business: Commercial and industrial $ 1,858 $ 6,821 $ 8,679 $ 612,888 $ 621,567 SBA PPP 223 293 516 145,324 145,840 70 Table of Contents December 31, 2021 30-89 Days 90 Days or Greater Total Past Due Current Loans Receivable (In thousands) Owner-occupied CRE 2,397 112 2,509 928,641 931,150 Non-owner occupied CRE — — — 1,493,099 1,493,099 Total commercial business 4,478 7,226 11,704 3,179,952 3,191,656 Residential real estate 420 10 430 164,152 164,582 Real estate construction and land development: Residential 792 — 792 84,755 85,547 Commercial and multifamily 3,474 571 4,045 137,291 141,336 Total real estate construction and land development 4,266 571 4,837 222,046 226,883 Consumer 1,026 — 1,026 231,515 232,541 Total $ 10,190 $ 7,807 $ 17,997 $ 3,797,665 $ 3,815,662 Loans 90 days or more past due and still accruing interest were $ 1.6 million and $ 293,000 as of December 31, 2022 and December 31, 2021, respectively. (f) Collateral-dependent Loans The type of collateral securing loans individually evaluated for credit losses and for which the repayment was expected to be provided substantially through the operation or sale of the collateral as of December 31, 2022 and December 31, 2021 was 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, 2022 CRE Farmland Residential Real Estate Total (In thousands) Commercial business: Commercial and industrial $ 1,239 $ 1,977 $ 929 $ 4,145 Owner-occupied CRE 189 — — 189 Total $ 1,428 $ 1,977 $ 929 $ 4,334 December 31, 2021 CRE Farmland Residential Real Estate Other Total (In thousands) Commercial business: Commercial and industrial $ 1,499 $ 4,362 $ 1,036 $ 245 $ 7,142 Owner-occupied CRE 3,035 — — — 3,035 Non-owner occupied CRE 1,273 — — — 1,273 Total commercial business 5,807 4,362 1,036 245 11,450 Real estate construction and land development: Commercial and multifamily 571 — — — 571 Total $ 6,378 $ 4,362 $ 1,036 $ 245 $ 12,021 There have been no significant changes to the collateral securing loans individually evaluated for credit losses and for which repayment was expected to be provided substantially through the operation or sale of the collateral during the year ended December 31, 2022, except changes due to additions or removals of loans in this classification. 71 Table of Contents (g) Troubled Debt Restructured Loans Loans that were modified as TDR loans are set forth in the following tables for the periods indicated: Year Ended December 31, 2022 2021 2020 Number of Contracts Amortized Cost (1) (2) Number of Contracts Amortized Cost (1) (2) Number of Contracts Amortized Cost (1) (2) (Dollars in thousands) Commercial business: Commercial and industrial 8 $ 2,556 31 $ 9,710 75 $ 36,118 Owner-occupied CRE 1 247 7 16,565 14 19,326 Non-owner occupied CRE — — 4 17,640 9 25,728 Total commercial business 9 2,803 42 43,915 98 81,172 Residential real estate — — 1 178 1 22 Real estate construction and land development: Residential — — — — 4 1,926 Commercial and multifamily 1 5,687 1 450 1 450 Total real estate construction and land development 1 5,687 1 450 5 2,376 Consumer 9 320 22 511 48 1,198 Total 19 $ 8,810 66 $ 45,054 152 $ 84,768 (1) Number of contracts and amortized cost represent loans which have balances as of period end, net of subsequent payments after modifications. Certain TDR loans may have been paid-down or charged-off during the years ended December 31, 2022, 2021 and 2020. (2) As the Bank did not forgive any principal or interest balance as part of the loan modifications, the Bank’s amortized cost in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-modification). The Bank had an ACL on loa ns of $ 12,000 , $ 3.1 million, and $ 7.5 million at December 31, 2022, December 31, 2021, and December 31, 2020, respectively, related to these TDR loans which were restructured during the year ended December 31, 2022, 2021 and 2020, respectively. The unfunded commitment to borrowers related to TDR loans was $ 5.8 million and $ 5.7 million at December 31, 2022 and December 31, 2021, respectively. The following table presents loans that were modified in a TDR and subsequently defaulted within twelve months from the modification date during the periods indicated: Year Ended December 31, 2022 2021 2020 Number of Contracts (1) Amortized Cost (1) Number of Contracts (1) Amortized Cost (1) Number of Contracts (1) Amortized Cost (1) (Dollars in thousands) Commercial business: Commercial and industrial — $ — 6 $ 1,379 4 $ 2,136 Owner-occupied CRE 1 189 — — 2 1,369 Non-owner occupied CRE — — — — 2 1,811 Total commercial business 1 189 6 1,379 8 5,316 Total 1 $ 189 6 $ 1,379 8 $ 5,316 (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, 2022, 2021 and 2020. During the years ended December 31, 2022, 2021, and 2020, one , six and eight 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 Bank had an ACL on loans for these TDR loans which defaulted during the related years of $ 7,000 , $ 111,000 , and $ 229,000 at December 31, 2022, 2021, and 2020. 72 Table of Contents (h) Related Party Loans In the ordinary course of business, the Company has granted loans to certain directors, executive officers and their affiliates. Activity in related party loans during the periods indicated was as follows: Year Ended December 31, 2022 2021 2020 (In thousands) Balance outstanding at the beginning of year $ 7,122 $ 7,694 $ 8,144 Principal additions — — 199 Principal reductions ( 243 ) ( 572 ) ( 649 ) Balance outstanding at the end of year $ 6,879 $ 7,122 $ 7,694 The Company had $ 5,000 and $ 255,000 of unfunded commitments to related parties and all related party loans were performing in accordance with the underlying loan agreements as of December 31, 2022 and December 31, 2021. (i) Residential Real Estate Loan Sales The Bank originates residential real estate loans; a portion of which are sold on the secondary market. The Bank does not retain servicing on loans sold in the secondary market. There were no loans held for sale at December 31, 2022 and $ 1.5 million at December 31, 2021. 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, 2022 2021 2020 (In thousands) Originated (1) $ 15,190 $ 190,734 $ 191,207 Sold 16,666 89,899 137,580 Gain on sale of loans, net (2) 633 3,644 5,044 (1) Includes loans originated for sale in the secondary market or for the Bank's loan portfolio. (2) Excludes net gains on sales of SBA and other loans. (j) Commercial Loan Sales, Servicing, and Commercial Servicing Asset The following table presents the d etails of loans serviced for others for the periods indicated: December 31, 2022 December 31, 2021 (In thousands) Loans serviced for others with participating interest, gross loan balance $ 17,375 $ 30,852 Loans serviced for others with participating interest, participation balance owned by Bank (1) 3,791 7,088 (1) Included in the balance of "Loans receivable " on the Consolidated Statements of Financial Condition. The Company recognized $ 217,000 , $ 320,000 and $ 423,000 of servicing income for the years ended December 31, 2022, 2021 and 2020, respectively. The Company's servicing asset at December 31, 2022 and December 31, 2021 was $ 192,000 and $ 343,000 , respectively. There was no valuation allowance on the Company's servicing asset as of December 31, 2022 and December 31, 2021. (k) Accrued interest receivable on loans receivable Accrued interest receivable on loans receivable totaled $ 11.3 million and $ 10.1 million at December 31, 2022 and December 31, 2021, respectively. It is excluded from the calculation of the ACL on loans as interest accrued, but not received, is reversed timely. (4) Allowance for Credit Losses on Loans Effective January 1, 2020, the Bank adopted ASU 2016-13. 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, 2022 utilized the Bank's average quarterly historical loss information from December 31, 2012 through the balance sheet date. There were no changes to this assumption during the year ended December 31, 2022. The Bank believes the historic loss rates are viable inputs to the current CECL model as the Bank's lending practice and business has remained relatively stable throughout the periods. While the Bank's assets have grown, the credit culture has stayed relatively consistent. 73 Table of Contents Prepayments included in the CECL model at December 31, 2022 were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of future prepayment activity. There were no changes to this assumption during the year ended December 31, 2022. The reasonable and supportable period and subsequent reversion period used in the CECL model was five quarters and two quarters, respectively at December 31, 2022. There were no changes to these assumptions during the year ended December 31, 2022. Management believes forecasts beyond this seven quarter time period tend to diverge in economic assumptions and may be less comparable to actual future events. As the length of the reasonable and supportable period increases, the degree of judgment involved in estimating the allowance increases. During the year ended December 31, 2022, the ACL on loans increased $ 625,000 , or 1.5 %, due primarily to net recoveries of $ 1.2 million offset partially by a reversal of provision for credit losses on loans of $ 563,000 . The reversal of provision for credit losses was driven by a $ 3.4 million reduction in the ACL on loans individually evaluated for losses and their related ACL offset partially by an increase related to the growth in balances of certain segments of collectively evaluated loans. The ACL on loans at December 31, 2022 and December 31, 2021 did not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA. The following table presents a summary of the changes in the ACL for the periods indicated: Year Ended December 31, 2022 2021 2020 (In thousands) Balance at the beginning of the year $ 42,361 $ 70,185 $ 36,171 Impact of CECL Adoption — — 1,822 Balance at the beginning of the year, as adjusted 42,361 70,185 37,993 Charge-offs ( 893 ) ( 1,946 ) ( 5,622 ) Recoveries of loans previously charged-off 2,081 1,420 2,381 (Reversal of) provision for credit losses on loans ( 563 ) ( 27,298 ) 35,433 Balance at the end of the year $ 42,986 $ 42,361 $ 70,185 The following tables detail the activity in the ACL on loans by segment and class for the periods indicated: Year Ended December 31, 2022 Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance (In thousands) Commercial business: Commercial and industrial $ 17,777 $ ( 280 ) $ 929 $ ( 4,464 ) $ 13,962 Owner-occupied CRE 6,411 ( 36 ) — 1,105 7,480 Non-owner occupied CRE 8,861 — — 415 9,276 Total commercial business 33,049 ( 316 ) 929 ( 2,944 ) 30,718 Residential real estate 1,409 ( 30 ) 3 1,490 2,872 Real estate construction and land development: Residential 1,304 — 229 121 1,654 Commercial and multifamily 3,972 — 155 1,282 5,409 Total real estate construction and land development 5,276 — 384 1,403 7,063 Consumer 2,627 ( 547 ) 765 ( 512 ) 2,333 Total $ 42,361 $ ( 893 ) $ 2,081 $ ( 563 ) $ 42,986 Year Ended December 31, 2021 Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance (In thousands) Commercial business: Commercial and industrial $ 30,010 $ ( 917 ) $ 791 $ ( 12,107 ) $ 17,777 Owner-occupied CRE 9,486 ( 359 ) 25 ( 2,741 ) 6,411 74 Table of Contents Year Ended December 31, 2021 Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance (In thousands) Non-owner occupied CRE 10,112 — — ( 1,251 ) 8,861 Total commercial business 49,608 ( 1,276 ) 816 ( 16,099 ) 33,049 Residential real estate 1,591 — — ( 182 ) 1,409 Real estate construction and land development: Residential 1,951 — 32 ( 679 ) 1,304 Commercial and multifamily 11,141 ( 1 ) — ( 7,168 ) 3,972 Total real estate construction and land development 13,092 ( 1 ) 32 ( 7,847 ) 5,276 Consumer 5,894 ( 669 ) 572 ( 3,170 ) 2,627 Total $ 70,185 $ ( 1,946 ) $ 1,420 $ ( 27,298 ) $ 42,361 Year Ended December 31, 2020 Beginning Balance Impact of CECL Adoption Beginning Balance, as Adjusted Charge-offs Recoveries (Reversal of) 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: Residential 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 (5) Other Real Estate Owned For the years ended December 31, 2022 and December 31, 2021 the Bank had no other real estate owned. The following table provided the c hanges in other real estate owned during the year ended December 31, 2020: December 31, 2020 (In thousands) Balance at the beginning of the year $ 841 Additions 270 Proceeds from dispositions ( 1,290 ) Gain (loss) on sale, net 179 Balance at the end of the year $ — 75 Table of Contents At December 31, 2022, there were no consumer mortgage loans secured by residential real estate properties (included in "Loans receivable" on the Consolidated Statements of Financial Position) for which formal foreclosure proceedings were in process. (6) Premises and Equipment The following table presents a summary of premises and equipment at the dates indicated: December 31, 2022 December 31, 2021 (In thousands) Land $ 19,565 $ 19,973 Buildings and building improvements 65,853 65,550 Furniture, fixtures and equipment 24,825 23,815 Total premises and equipment 110,243 109,338 Less: Accumulated depreciation 33,313 29,968 Premises and equipment, net $ 76,930 $ 79,370 Total depreciation expense on premises and equipment was $ 5.4 million, $ 5.3 million and $ 5.5 million for the years ended December 31, 2022, 2021 and 2020, respectively. (7) Goodwill and Other Intangible Assets (a) Goodwill 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 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). There were no additions to goodwill during the years ended December 31, 2022, 2021, and 2020. At December 31, 2022, 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, 2021 and 2020. Even though there was no goodwill impairment at December 31, 2022, 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 Other intangible assets represent core deposit intangible acquired in business combinations with estimated useful lives of ten years . There were no additions during the years ended December 31, 2022, 2021, and 2020 and the estimated aggregate amortization expense related to other intangible assets for future years as of December 31, 2022 is as follows, in thousands: 2023 $ 2,435 2024 1,640 2025 1,173 2026 1,006 2027 821 Thereafter 152 Total $ 7,227 76 Table of Contents (8) Derivative Financial Instruments The following table presents the notional amounts and estimated fair values of derivatives at the dates indicated: December 31, 2022 December 31, 2021 Notional Amounts Estimated Fair Value Notional Amounts Estimated Fair Value (In thousands) Non-hedging interest rate derivatives: Interest rate swap asset (1) 288,785 $ 30,107 $ 322,726 $ 15,219 Interest rate swap liability (1) 288,785 ( 30,107 ) 322,726 ( 15,286 ) (1) The estimated fair value of derivatives with customers was $( 30.1 ) million and $ 9.8 million as of December 31, 2022 and December 31, 2021, respectively. The estimated fair value of derivatives with third-parties was $ 30.1 million and $( 9.8 ) million as of December 31, 2022 and December 31, 2021, 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 $ 66,000 and $ 355,000 , and reduced by $ 422,000 as of December 31, 2022, December 31, 2021, and December 31, 2020, respectively, due to the change in the credit valuation adjustment. (9) Deposits The following table summarizes the Company's deposits at the dates indicated: December 31, 2022 December 31, 2021 Change Amount % of Total Amount % of Total $ % (Dollars in thousands) Noninterest demand deposits $ 2,099,464 35.5 % $ 2,343,909 36.7 % $( 244,445 ) ( 10.4 ) % Interest bearing demand deposits 1,830,727 30.9 1,946,605 30.4 ( 115,878 ) ( 6.0 ) Money market accounts 1,063,243 17.9 1,120,174 17.5 ( 56,931 ) ( 5.1 ) Savings accounts 623,833 10.5 640,763 10.0 ( 16,930 ) ( 2.6 ) Total non-maturity deposits 5,617,267 94.8 6,051,451 94.6 ( 434,184 ) ( 7.2 ) Certificates of deposit 307,573 5.2 342,839 5.4 ( 35,266 ) ( 10.3 ) Total deposits $ 5,924,840 100.0 % $ 6,394,290 100.0 % $ ( 469,450 ) ( 7.3 ) % Deposit accounts overdrawn and reclassified to loans receivable were $ 317,000 and $ 216,000 as of December 31, 2022 and December 31, 2021, respectively. Accrued interest payable on deposits was $ 143,000 and $ 53,000 as of December 31, 2022 and December 31, 2021, respectively and is included in "Accrued expenses and other liabilities" in the Consolidated Statements of Financial Condition. The following table presents Interest expense, by category, for the periods indicated: Year Ended December 31, 2022 2021 2020 (In thousands) Interest bearing demand deposits $ 3,239 $ 2,497 $ 3,234 Money market accounts 1,745 1,485 2,830 Savings accounts 381 367 527 Certificates of deposit 1,407 1,811 5,674 Total interest expense $ 6,772 $ 6,160 $ 12,265 Scheduled maturities of certificates of deposit for future years as of December 31, 2022 are as follows, in thousands: 2023 $ 270,575 2024 15,913 2025 4,948 2026 4,894 77 Table of Contents 2023 $ 270,575 2027 11,243 Total $ 307,573 Certificates of deposit issued in denominations equal to or in excess of $250,000 totaled $ 103.7 million and $ 100.0 million as of December 31, 2022 and December 31, 2021, respectively. Deposits received from related parties as of December 31, 2022 and December 31, 2021 totaled $ 6.8 million and $ 8.8 million, respectively. (10) Junior Subordinated Debentures As part of the acquisition of Washington Banking Company on May 1, 2014, the Company assumed trust preferred securities and junior subordinated debentures with a total fair value of $ 18.9 million at the merger date. At December 31, 2022 and December 31, 2021, the balance of the junior subordinated debentures, net of unaccreted discount, was $ 21.5 million and $ 21.2 million, respectively. Washington Banking Master Trust, a Delaware statutory business trust, was a wholly owned subsidiary of the Washington Banking Company created for the exclusive purposes of issuing and selling capital securities and utilizing sale proceeds to acquire junior subordinated debentures issued by the Washington Banking Company. During 2007, the Trust issued $ 25.0 million of trust preferred securities with a 30 -year maturity, callable after the fifth year. The trust preferred securities have a quarterly adjustable rate based upon the three-month LIBOR plus 1.56 %. On the merger date, the Company acquired the Trust, which retained the Washington Banking Master Trust name, and assumed the performance and observance of the covenants under the indenture related to the trust preferred securities. The adjustable rate of the trust preferred securities at December 31, 2022 and December 31, 2021 was 6.33 % and 1.77 %, respectively. The weighted average rate of the junior subordinated debentures for the years ended December 31, 2022, 2021 and 2020 was 5.42 %, 3.53 % and 4.29 %, respectively. The weighted average rate includes the accretion of the discount established at the merger date which is amortized over the life of the trust preferred securities. The junior subordinated debentures are the sole assets of the Trust and payments under the junior subordinated debentures are the sole revenues of the Trust. All of the common securities of the Trust are owned by the Company. 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. The junior subordinated debentures issued and guaranteed by the Company and held by the Master Trust are reflected as "Junior subordinated debentures" on the Consolidated Statements of Financial Condition. (11) Securities Sold Under Agreement to Repurchase The Company utilizes securities sold under agreement to repurchase with one day maturities as a supplement to funding sources. Securities sold under agreement to repurchase are secured by pledged investment securities. Under the securities sold under agreement to repurchase , the Company is required to maintain an aggregate market value of securities pledged greater than the balance of the securities sold under agreement to repurchase . The Company is required to pledge additional securities to cover any declines below the balance of the securities sold under agreement to repurchase . For additional information on the total value of investment securities pledged for securities sold under agreement to repurchase see Note (2) Investment Securities. The following table presents the balance of the Company's securities sold under agreement to repurchase obligations by class of collateral pledged at the dates indicated: December 31, 2022 December 31, 2021 (In thousands) U.S. Treasury and U.S. Government-sponsored agencies $ — $ 4,914 Residential CMO and MBS — 4,134 Commercial CMO and MBS 46,597 41,791 Total $ 46,597 $ 50,839 (12) Other Borrowings (a) FHLB The FHLB functions as a member-owned cooperative providing credit for member financial institutions. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Limitations on the amount of advances are based on a percentage of the Bank's assets or on the FHLB’s assessment of the institution’s 78 Table of Contents creditworthiness. At December 31, 2022, the Bank maintained a credit facility with the FHLB with available borrowing capacity of $ 1.23 billion. At December 31, 2022 and December 31, 2021 the Bank had no FHLB advances outstanding. Advances from the FHLB may be collateralized by FHLB stock owned by the Bank, deposits at the FHLB, certain commercial and residential real estate loans, investment securities or other assets. 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 five correspondent banks to purchase federal funds totaling $ 215.0 million as of December 31, 2022. The lines generally mature annually or are reviewed annually. As of December 31, 2022 and December 31, 2021, there were no federal funds purchased. (c) Credit Facilities The Bank maintains a credit facility with the Federal Reserve Bank with available borrowing capacity of $ 46.8 million as of December 31, 2022. There were no borrowings outstanding as of December 31, 2022 and December 31, 2021. 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, 2022 or December 31, 2021. (13) Leases The Company's noncancelable operating lease agreements relate to certain banking offices, back-office operational facilities, office equipment and sublease agreements. The majority of the leases contain renewal options and provisions for increases in rental rates based on an agreed upon index or predetermined escalation schedule. As of December 31, 2022 and December 31, 2021, the Company’s operating lease ROU asset was $ 22.7 million and $ 27.6 million, respectively and is included in "Prepaid expenses and other assets" on the Consolidated Statements of Financial Condition. The related operating lease ROU liability was $ 24.4 million and $ 28.8 million, respectively and is included in " Accrued expenses and other liabilities " on the Consolidated Statements of Financial Condition. The Company does not have any leases designated as finance leases. The table below summarizes the information about our leases during the periods or at period end presented: Year Ended December 31, 2022 2021 (In thousands) Operating lease cost $ 4,942 $ 4,758 Short-term lease cost 80 49 Variable lease cost 1,118 947 Sublease income ( 87 ) ( 24 ) Total net lease cost during the period $ 6,053 $ 5,730 Operating cash used for amounts included in the measurement of lease liabilities during the period $ 4,748 $ 5,004 ROU assets obtained in exchange for lease liabilities during the period 2,869 13,966 Weighted average remaining lease term of operating leases, in years, at period end 6.5 7.1 Weighted average discount rate of operating leases, at period end 2.42 % 2.32 % The following table presents the lease payment obligations as of December 31, 2022 as outlined in the Company’s lease agreements for each of the next five years and thereafter, in thousands: 2023 $ 4,744 2024 4,314 2025 4,025 2026 3,621 2027 3,243 Thereafter 6,547 Total lease payments 26,494 79 Table of Contents Implied interest ( 2,125 ) ROU liability $ 24,369 During the year ended December 31, 2022, the Company entered into two lease agreements for $ 1.9 million and $ 3.3 million commencing on January 1, 2023 and May 1, 2023. These lease agreements are not included in the lease payment obligations in the table above. (14) Employee Benefit Plans (a) 401(k) Plan 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. All participants are 100 % vested in all accounts at all times. Employer matching contributions for the years ended December 31, 2022, 2021 and 2020 were $ 1.8 million, $ 1.7 million and $ 1.7 million, respectively. The Plan may make profit sharing and discretionary contributions which are completely discretionary. Participants are eligible for profit sharing contributions upon credit of 1,000 hours of service during the plan year, the attainment of 18 years of age and employment on the last day of the year. Employees are 100 % vested in profit sharing contributions at all times. For the years ended December 31, 2022, 2021 and 2020, the Company made no employer profit sharing contributions. (b) Employment Agreements The Company has entered into contracts with certain senior officers that provide benefits under certain conditions following termination without cause or following a change in control of the Company. (c) Deferred Compensation Plan The Company has a Deferred Compensation Plan which provides its directors and select executive officers with the opportunity to defer current compensation. The following table presents a summary of the changes in the Deferred Compensation Plan during the periods indicated: Year Ended December 31, 2022 2021 2020 (In thousands) Balance outstanding at the beginning of the year $ 3,854 $ 4,101 $ 4,244 Employer contributions 793 634 207 Employer contributions 110 — — Interest credited 99 78 128 Benefits Paid ( 519 ) ( 959 ) ( 478 ) Balance outstanding at the end of the year $ 4,337 $ 3,854 $ 4,101 (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: Year Ended December 31, 2022 2021 2020 (In thousands) Obligation, at the beginning of the year $ 3,835 $ 4,162 $ 4,334 Benefits paid ( 450 ) ( 536 ) ( 460 ) Expenses incurred 191 209 288 Obligation, at the end of the year $ 3,576 $ 3,835 $ 4,162 80 Table of Contents (15) Stockholders’ Equity (a) Earnings Per Common Share The following table illustrates the weighted average shares used for earnings per common share computations for the periods indicated: Year Ended December 31, 2022 2021 2020 (In thousands, except shares) Net income: Net income $ 81,875 $ 98,035 $ 46,570 Dividends and undistributed earnings allocated to participating securities (1) — — ( 7 ) Net income allocated to common shareholders $ 81,875 $ 98,035 $ 46,563 Basic: Weighted average common shares outstanding 35,103,465 35,677,851 36,018,627 Restricted stock awards — — ( 4,182 ) Total basic weighted average common shares outstanding 35,103,465 35,677,851 36,014,445 Diluted: Basic weighted average common shares outstanding 35,103,465 35,677,851 36,014,445 Effect of potentially dilutive common shares (2) 360,431 295,535 155,621 Total diluted weighted average common shares outstanding 35,463,896 35,973,386 36,170,066 Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (3) 872 7,043 137,093 (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. (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 The timing and amount of cash dividends paid on the Company's common stock depends on the Company’s earnings, capital requirements, financial condition and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income. The following table summarizes the dividend activity during the most recent three year period: Declared Cash Dividend per Share Record Date Paid Date January 22, 2020 $ 0.20 February 6, 2020 February 20, 2020 April 29, 2020 $ 0.20 May 13, 2020 May 27, 2020 July 22, 2020 $ 0.20 August 5, 2020 August 19, 2020 October 21, 2020 $ 0.20 November 4, 2020 November 18, 2020 January 27, 2021 $ 0.20 February 10, 2021 February 24, 2021 April 21, 2021 $ 0.20 May 5, 2021 May 19, 2021 July 21, 2021 $ 0.20 August 4, 2021 August 18, 2021 October 20, 2021 $ 0.21 November 3, 2021 November 17, 2021 January 26, 2022 $ 0.21 February 9, 2022 February 23, 2022 April 20, 2022 $ 0.21 May 4, 2022 May 18, 2022 July 20, 2022 $ 0.21 August 3, 2022 August 17, 2022 October 19, 2022 $ 0.21 November 2, 2022 November 16, 2022 The FDIC and the Washington State Department of Financial Institutions, Division of Banks have the authority under their supervisory powers to prohibit the payment of dividends by the Bank to the Company. Additionally, current guidance from the Federal Reserve provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the FDIC. 81 Table of Contents (c) Stock Repurchase Program 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 1,512,600 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, 2022 2021 2020 Plan Total (1) Eleventh Stock Repurchase Plan Repurchased shares — — 639,922 1,512,600 Stock repurchase average share price $ — $ — $ 23.95 $ 21.69 Twelfth Stock Repurchase Plan Repurchased shares 100,090 904,972 155,778 1,160,840 Stock repurchase average share price $ 25.07 $ 24.43 $ 20.34 $ 23.94 (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. The following table provides total shares repurchased to pay withholding taxes during the periods indicated: Year Ended December 31, 2022 2021 2020 Repurchased shares to pay withholding taxes 26,944 26,869 28,887 Stock repurchase to pay withholding taxes average share price $ 25.52 $ 29.10 $ 21.57 (d) Issuance of Common Stock Common stock was issued during the year ended December 31, 2020 related to the exercise of stock options as further described in Note (17) Stock-Based Compensation. (16) Fair Value Measurements Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. There are three levels of inputs that may be used to measure fair values: Level 1 : Valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual funds that allow the Company to sell its ownership interest back to the fund at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities, or funds. Level 2 : Valuations for assets and liabilities traded in less active dealer or broker markets, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or valuations using methodologies with observable inputs. Level 3 : Valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models, discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. (a) Recurring and Nonrecurring Basis The Company used the following methods and significant assumptions to measure the fair value of certain assets on a recurring and nonrecurring basis: Investment Securities : The fair values of all investment securities are based upon the assumptions that market participants would use in pricing the security. If available, fair values of investment securities are determined by quoted market prices (Level 1). For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using observable and unobservable inputs such as discounted cash flows or other market indicators (Level 3). Investment security valuations are obtained from third-party pricing services. 82 Table of Contents Collateral-Dependent Loans : Collateral-dependent loans are identified for the calculation of the ACL on loans. The fair value used to measure credit loss for this type of loan is commonly based on recent real estate appraisals which are generally obtained at least every 18 months or earlier if there are changes to risk characteristics of the underlying loan. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. The Bank also incorporates an estimate of cost to sell the collateral when the sale is probable. Such adjustments may be significant and result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value based on the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the customer and customer’s business (Level 3). Individually evaluated loans are analyzed for credit loss on a quarterly basis and the ACL on loans is adjusted as required based on the results. Appraisals on collateral-dependent loans are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by the Bank. Once received, the Bank's internal appraisal department reviews and approves the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Derivative Financial Instruments : The Bank obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of the measurement date (Level 2), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3). Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as borrower risk ratings, to evaluate the likelihood of default by itself and its counterparties. As of December 31, 2022 and December 31, 2021, the Bank assessed the significance of the impact of the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined the credit valuation adjustment was not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy. Branches held for sale : Branches held for sale are recorded at fair value less costs to sell when transferred from premises and equipment, net to "Prepaid expenses and other assets" on the Consolidated Statements of Financial Condition with any valuation adjustment recorded within "Other expense" on the Consolidated Statements of Income. The fair value of branches held for sale is determined based on a real estate appraisal or broker price opinion. Adjustments are routinely made in the appraisal and broker price opinion process by independent appraisers and commercial real estate brokers, respectively, to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in Level 3 classification of the inputs for determining fair value. Additionally, the fair value of branches held for sale can be adjusted based on executed agreements of sale to be completed at a future date. Recurring Basis The following tables summarize the balances of assets and liabilities measured at fair value on a recurring basis at the dates indicated: December 31, 2022 Total Level 1 Level 2 Level 3 (In thousands) Assets Investment securities available for sale: U.S. government and agency securities $ 63,859 $ 19,779 $ 44,080 $ — Municipal securities 153,026 5,399 147,627 — Residential CMO and MBS 424,386 — 424,386 — Commercial CMO and MBS 664,421 — 664,421 — Corporate obligations 3,834 — 3,834 — Other asset-backed securities 21,917 — 21,917 — Total investment securities available for sale 1,331,443 25,178 1,306,265 — Equity security 185 185 — — Derivative assets - interest rate swaps 30,107 — 30,107 — Liabilities Derivative liabilities - interest rate swaps $ 30,107 $ — $ 30,107 $ — 83 Table of Contents December 31, 2021 Total Level 1 Level 2 Level 3 (In thousands) Assets Investment securities available for sale: U.S. government and agency securities $ 21,373 $ — $ 21,373 $ — Municipal securities 221,212 — 221,212 — Residential CMO and MBS 306,884 — 306,884 — Commercial CMO and MBS 315,861 — 315,861 — Corporate obligations 2,014 — 2,014 — Other asset-backed securities 26,991 — 26,991 — Total investment securities available for sale 894,335 — 894,335 — Equity security 240 240 — — Derivative assets - interest rate swaps 15,219 — 15,219 — Liabilities Derivative liabilities - interest rate swaps $ 15,286 $ — $ 15,286 $ — Nonrecurring Basis The Company may be required to measure certain financial assets and liabilities at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The following tables below represent assets measured at fair value on a nonrecurring basis at the dates indicated: Basis (1) Fair Value at December 31, 2022 Total Level 1 Level 2 Level 3 (In thousands) Collateral-dependent loans: Commercial business: Owner-occupied CRE $ 613 $ 182 $ — $ — $ 182 Total assets measured at fair value on a nonrecurring basis $ 613 $ 182 $ — $ — $ 182 (1) Basis represents the outstanding principal balance of collateral-dependent loans. Basis (1) Fair Value at December 31, 2021 Total Level 1 Level 2 Level 3 (In thousands) Collateral-dependent loans: Commercial business: Commercial and industrial $ 1,911 $ 1,049 $ — $ — $ 1,049 Owner-occupied CRE 613 189 — — 189 Total commercial business 2,524 1,238 — — 1,238 Real estate construction and land development: Commercial and multifamily 991 534 — — 534 Total 3,515 1,772 — — 1,772 Prepaid expenses and other assets: Branch held for sale (2) 698 698 — — 698 Total assets measured at fair value on a nonrecurring basis $ 4,213 $ 2,470 $ — $ — $ 2,470 (1) Basis represents the outstanding principal balance of collateral-dependent loans and the carrying value of the branch held for sale. (2) In December 2021, one branch was written down to its net realizable value concurrent with the signing of an agreement for sale and was sold during the three months ended March 31, 2022. 84 Table of Contents 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, 2022 2021 2020 (In thousands) Collateral-dependent loans: Commercial business: Commercial and industrial $ 23 $ ( 691 ) $ ( 8 ) Owner-occupied CRE ( 7 ) ( 359 ) — Total commercial business 16 ( 1,050 ) ( 8 ) Real estate construction and land development: Commercial and multifamily — ( 38 ) — Prepaid expenses and other assets: Branch held for sale — $ ( 145 ) $ ( 630 ) Net gain (loss) from nonrecurring fair value adjustments $ 16 $ ( 1,233 ) $ ( 638 ) 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: December 31, 2022 Fair Value Valuation Technique(s) Unobservable Input(s) Range of Inputs; Weighted Average (Dollars in thousands) Collateral-dependent loans $ 182 Market approach Adjustment for differences between the comparable sales N/A (1) (1) Quantitative disclosures are not provided for collateral-dependent loans because there were no adjustments made to the appraisal or stated values during the current period. December 31, 2021 Fair Value Valuation Technique(s) Unobservable Input(s) Range of Inputs; Weighted Average (Dollars in thousands) Collateral-dependent loans $ 1,772 Market approach Adjustment for differences between the comparable sales 35.0 % - ( 11.0 %); 13.8 % Branch held for sale $ 698 Market approach Sale agreement N/A (b) Fair Value of Financial Instruments Broadly traded markets do not exist for most of the Company’s financial instruments; therefore, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company. The following tables present the carrying value amount of the Company’s financial instruments and their corresponding estimated fair values at the dates indicated: December 31, 2022 Carrying Value Fair Value Fair Value Measurements Using: Level 1 Level 2 Level 3 (In thousands) Financial Assets: Cash and cash equivalents $ 103,590 $ 103,590 $ 103,590 $ — $ — Investment securities available for sale 1,331,443 1,331,443 25,178 1,306,265 — Investment securities held to maturity 766,396 673,434 — 673,434 — Loans receivable, net 4,007,872 3,841,821 — — 3,841,821 85 Table of Contents December 31, 2022 Carrying Value Fair Value Fair Value Measurements Using: Level 1 Level 2 Level 3 Accrued interest receivable 18,547 18,547 349 6,892 11,306 Derivative assets - interest rate swaps 30,107 30,107 — 30,107 — Equity security 185 185 185 — — Financial Liabilities: Non-maturity deposits $ 5,617,267 $ 5,617,267 $ 5,617,267 $ — $ — Certificates of deposit 307,573 308,325 — 308,325 — Securities sold under agreement to repurchase 46,597 46,597 46,597 — — Junior subordinated debentures 21,473 20,000 — — 20,000 Accrued interest payable 143 143 57 13 73 Derivative liabilities - interest rate swaps 30,107 30,107 — 30,107 — December 31, 2021 Carrying Value Fair Value Fair Value Measurements Using: Level 1 Level 2 Level 3 (In thousands) Financial Assets: Cash and cash equivalents $ 1,723,292 $ 1,723,292 $ 1,723,292 $ — $ — Investment securities available for sale 894,335 894,335 — 894,335 — Investment securities held to maturity 383,393 376,331 — 376,331 — Loans held for sale 1,476 1,527 — 1,527 — Loans receivable, net 3,773,301 3,849,602 — — 3,849,602 Accrued interest receivable 14,657 14,657 14 4,582 10,061 Derivative assets - interest rate swaps 15,219 15,219 — 15,219 — Equity security 240 240 240 — — Financial Liabilities: Non-maturity deposits $ 6,051,451 $ 6,051,451 $ 6,051,451 $ — $ — Certificates of deposit 342,839 344,025 — 344,025 — Securities sold under agreement to repurchase 50,839 50,839 50,839 — — Junior subordinated debentures 21,180 18,750 — — 18,750 Accrued interest payable 73 73 33 19 21 Derivative liabilities - interest rate swaps 15,286 15,286 — 15,286 — (17) Stock-Based Compensation 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. As of December 31, 2022, shares remaining available for future issuance under the Equity Plan totaled 330,398 . (a) Stock Option Awards All outstanding stock options were exercised during the year ended December 31, 2020. The intrinsic value from options exercised during the year ended December 31, 2020 was $ 61,000 . The cash proceeds from options exercised during the year ended December 31, 2020 was $ 122,000 . The following table summarizes the stock option activity during the year ended December 31, 2020: Shares Weighted-Average Exercise Price Outstanding at December 31, 2019 8,657 $ 14.77 Exercised ( 8,248 ) 14.77 86 Table of Contents Forfeited or expired ( 409 ) 14.77 Outstanding at December 31, 2020 — — (b) Restricted Stock Awards 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 year ended December 31, 2020, the Company recognized compensation expense related to restricted stock awards of $ 76,000 , and a related tax benefit of $ 17,000 . The vesting date fair value of restricted stock awards that vested during the year ended December 31, 2020 was $ 442,000 . The following table summarizes the restricted stock award activity for the year ended December 31, 2020: Shares Weighted-Average Grant Date Fair Value Nonvested at December 31, 2019 20,707 $ 17.59 Vested ( 20,707 ) 17.59 Nonvested at December 31, 2020 — — (c) Restricted Stock Units Restricted stock units generally vest ratably over three years and are subject to service conditions in accordance with each award agreement. 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 the percentile level of the market condition, which includes the ratio of the Company's total shareholder return and the ratio of the Company's return on average assets and return on tangible common equity 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 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: Year Ended December 31, 2022 2021 2020 Shares issued 15,464 14,347 15,200 Expected Term in Years 2.9 2.9 2.8 Weighted-Average Risk Free Interest Rate 1.7 % 0.3 % 1.1 % Weighted Average Fair Value 25.87 24.49 23.5 Correlation coefficient ABA NASDAQ Community Bank Index ABA NASDAQ Community Bank Index ABA NASDAQ Community Bank Index Range of peer company volatilities 31.6 %- 77.8 % 31.4 %- 136.4 % 18.1 %- 107.6 % Range of peer company correlation coefficients 49.7 %- 94.4 % 34.1 %- 94.8 % 16.1 %- 90.2 % Company volatility 41.3 % 40.2 % 23.2 % Company correlation coefficient 90.4 % 90.1 % 80.5 % Expected volatilities in the model were estimated using a historical period consistent with the performance period of approximately three years . The risk-free interest rate was based on the United States Treasury rate for a term commensurate with the expected life of the grant. For the years ended December 31, 2022, 2021 and 2020, the Company recognized compensation expense related to restricted stock units of $ 3.8 million, $ 3.7 million, and $ 3.5 million respectively, and a related tax benefit of $ 833,000 , $ 802,000 , and $ 757,000 , respectively. As of December 31, 2022, the total unrecognized compensation expense related to non-vested restricted stock units was $ 6.1 million and the related weighted-average period over which the compensation expense is expected to be recognized is approximately 2.2 years. The vesting date fair value of the restricted stock units that vested during the years ended December 31, 2022, 2021 and 2020 was $ 3.3 million, $ 3.6 million and $ 2.4 million, respectively. 87 Table of Contents The following table summarizes the unit activity for the periods indicated: Units Weighted-Average Grant Date Fair Value Nonvested at December 31, 2019 233,540 $ 30.41 Granted 200,972 23.61 Vested ( 109,853 ) 29.21 Forfeited ( 8,543 ) 28.07 Nonvested at December 31, 2020 316,116 26.57 Granted 147,944 25.70 Vested ( 125,377 ) 26.84 Forfeited ( 23,669 ) 27.20 Nonvested at December 31, 2021 315,014 26.01 Granted 230,402 25.72 Vested ( 127,952 ) 26.99 Forfeited ( 38,572 ) 26.73 Nonvested at December 31, 2022 378,892 $ 25.42 (18) Cash Restriction The Bank had no cash restrictions at December 31, 2022 and had restricted cash included in interest earning deposits of $ 9.8 million at December 31, 2021, relating to collateral required on interest rate swaps from third-parties as discussed in Note (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 consisted of the following for the periods indicated: Year Ended December 31, 2022 2021 2020 (In thousands) Current tax expense $ 16,690 $ 20,896 $ 15,186 Deferred tax expense (benefit) 871 1,576 ( 8,576 ) Income tax expense $ 17,561 $ 22,472 $ 6,610 The CARES Act, among other things, permitted net operating loss carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allowed net operating loss carrybacks incurred in 2018, 2019 and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. During the year ended December 31, 2020, the Company recorded a tax benefit from net operating loss carryback related to prior acquisitions of $ 967,000 . The effective tax rate was 17.7 % for the December 31, 2022 compared to an effective tax rate of 18.6 % and 12.4 % for the years ended December 31, 2021 and 2020, respectively. The decrease in the effective tax rate during the year ended December 31, 2022 was due primarily to the change in income before income taxes earned between the periods, including a decrease in annual pre-tax income for the year ended December 31, 2022 which increased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and 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, 2022 2021 2020 (In thousands) Income tax expense at Federal statutory rate $ 20,882 $ 25,307 $ 11,168 State tax, net of Federal tax benefit 936 960 359 Tax-exempt instruments ( 1,733 ) ( 1,929 ) ( 1,785 ) 88 Table of Contents Year Ended December 31, 2022 2021 2020 (In thousands) Federal tax credits and other benefits (1) ( 1,979 ) ( 1,630 ) ( 1,928 ) Effects of BOLI ( 735 ) ( 474 ) ( 827 ) Tax benefit of CARES Act carryback — — ( 967 ) Other, net 190 238 590 Income tax expense $ 17,561 $ 22,472 $ 6,610 (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 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: December 31, 2022 December 31, 2021 (In thousands) Deferred tax assets: Allowance for credit losses $ 9,796 $ 9,756 Accrued compensation 3,538 3,480 Stock compensation 726 689 Market discount on acquired loans 714 944 Foregone interest on nonaccrual loans 705 967 Net operating loss carryforward acquired 166 186 ROU lease liability 5,337 6,257 Net unrealized losses on investment securities 28,061 — Other deferred tax assets 120 1,156 Total deferred tax assets 49,163 23,435 Deferred tax liabilities: Deferred loan fees, net ( 1,508 ) ( 1,838 ) Premises and equipment ( 2,999 ) ( 2,436 ) FHLB stock ( 577 ) ( 572 ) Goodwill and other intangible assets ( 1,211 ) ( 1,659 ) Junior subordinated debentures ( 937 ) ( 991 ) ROU lease asset ( 4,967 ) ( 5,995 ) Net unrealized gains on investment securities — ( 2,537 ) Other deferred tax liabilities ( 163 ) ( 181 ) Total deferred tax liabilities ( 12,362 ) ( 16,209 ) Deferred tax asset, net $ 36,801 $ 7,226 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. A valuation allowance is required to be recognized for the portion of the deferred tax asset that will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. As of December 31, 2022, 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, 2022 and December 31, 2021, the Company had a net operating loss carryforward of $ 789,000 and $ 888,000 , respectively, that 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, 2022 and December 31, 2021. As of December 31, 2022 and December 31, 2021, the Company had an insignificant amount of unrecognized tax benefits, none of which would materially affect its effective tax rate if recognized. The Company does not anticipate that the amount of unrecognized tax benefits will significantly increase or decrease in the next 12 months. The amount of interest and 89 Table of Contents penalties accrued as of December 31, 2022 and December 31, 2021 and recognized during the years ended December 31, 2022, 2021 and 2020 were immaterial. The Company has qualified under provisions of the Internal Revenue Code to compute income taxes after deductions of additions to the bad debt reserves when it was registered as a Savings Bank. At December 31, 2022, 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, 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 Bank subsidiary file a United States consolidated federal income tax return and Oregon State and local income tax returns, and the tax years subject to examination by the Internal Revenue Service are the years ended December 31, 2022, 2021, 2020 and 2019. (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, 2022 December 31, 2021 (In thousands) Commercial business: Commercial and industrial $ 548,438 $ 570,156 Owner-occupied CRE 3,083 2,252 Non-owner occupied CRE 13,396 7,487 Total commercial business 564,917 579,895 Real estate construction and land development: Residential 43,460 51,838 Commercial and multifamily 348,956 209,217 Total real estate construction and land development 392,416 261,055 Consumer 323,016 285,010 Total outstanding commitments $ 1,280,349 $ 1,125,960 The following table details the activity in the ACL on unfunded commitments during the periods indicated: Year Ended December 31, 2022 2021 2020 (In thousands) Balance, beginning of period $ 2,607 $ 4,681 $ 306 Impact of CECL Adoption — — 3,702 Adjusted balance, beginning of period 2,607 4,681 4,008 (Reversal of) provision for credit losses on unfunded commitments ( 863 ) ( 2,074 ) 673 Balance, end of period $ 1,744 $ 2,607 $ 4,681 (b) Variable Interests - LIHTC Investments The carrying values of investments in unconsolidated LIHTCs were $ 191.3 million and $ 116.3 million as of December 31, 2022 and December 31, 2021, respectively. During the years ended December 31, 2022, 2021 and 2020 the Company recognized tax benefits of $ 12.9 million, $ 11.4 million and $ 7.5 million, respectively, and proportional amortization of $ 10.9 million, $ 9.7 million and $ 6.5 million, respectively. Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $ 109.2 million and $ 41.5 million at December 31, 2022 and December 31, 2021, respectively. The Company expects to fund LIHTC commitments of $ 30.4 million during the year ending December 31, 2023 and $ 25.4 million during the year ending December 31, 2024, with the remaining commitments of $ 50.3 million funded by December 31, 2040. There were no impairment losses on the Company’s LIHTC investments during the years ended December 31, 2022, 2021 or 2020. 90 Table of Contents (c) Variable Interests - NMTC Investments 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 ended December 31, 2020. 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 and $ 694,000 during the years ended December 31, 2021 and 2020, 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. 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. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Consolidated Financial Statements and operations. Management believes as of December 31, 2022, the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 2022 and December 31, 2021, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's categories. The following table presents the actual capital ratios of the Company and the Bank at the periods indicated: Company Heritage Bank December 31, 2022 December 31, 2021 December 31, 2022 December 31, 2021 Common equity Tier 1 capital ratio 12.8 % 13.5 % 12.9 % 13.8 % Leverage ratio 9.7 8.7 9.4 8.6 Tier 1 capital ratio 13.2 13.9 12.9 13.8 Total capital ratio 14.0 14.8 13.7 14.7 Capital conservation buffer 6.0 6.8 5.7 6.7 As of both December 31, 2022 and December 31, 2021, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC that allowed the Bank the option to delay for two years until December 31, 2021 an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period. (22) Heritage Financial Corporation (Parent Company Only) Following are the condensed financial statements of the Parent Company. HERITAGE FINANCIAL CORPORATION (PARENT COMPANY ONLY) Condensed Statements of Financial Condition December 31, 2022 December 31, 2021 (In thousands) ASSETS Cash and cash equivalents $ 12,926 $ 3,513 Investment in subsidiary bank 804,123 869,862 Other assets 2,838 2,608 Total assets $ 819,887 $ 875,983 LIABILITIES AND STOCKHOLDERS’ EQUITY Junior subordinated debentures $ 21,473 $ 21,180 Other liabilities 521 371 Total stockholders’ equity 797,893 854,432 Total liabilities and stockholders’ equity $ 819,887 $ 875,983 91 Table of Contents HERITAGE FINANCIAL CORPORATION (PARENT COMPANY ONLY) Condensed Statements of Income Year Ended December 31, 2022 2021 2020 (In thousands) INTEREST INCOME: Interest on interest earning deposits $ 15 $ 30 $ 16 INTEREST EXPENSE: Junior subordinated debentures 1,156 742 890 Net interest expense ( 1,141 ) ( 712 ) ( 874 ) NONINTEREST INCOME: Dividends from subsidiary bank 44,000 46,000 39,000 Equity in undistributed income of subsidiary bank 43,507 57,058 12,685 Other income 33 117 5 Total noninterest income 87,540 103,175 51,690 NONINTEREST EXPENSE: Professional services 476 394 495 Other expense 5,631 5,430 5,172 Total noninterest expense 6,107 5,824 5,667 Income before income taxes 80,292 96,639 45,149 Income tax benefit ( 1,583 ) ( 1,396 ) ( 1,421 ) Net income $ 81,875 $ 98,035 $ 46,570 HERITAGE FINANCIAL CORPORATION (PARENT COMPANY ONLY) Condensed Statements of Cash Flows Year Ended December 31, 2022 2021 2020 (In thousands) Cash flows from operating activities: Net income $ 81,875 $ 98,035 $ 46,570 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiary bank ( 43,507 ) ( 57,058 ) ( 12,685 ) Stock-based compensation expense 3,795 3,666 3,559 Net change in other assets and other liabilities ( 63 ) 960 ( 1,333 ) Net cash provided by operating activities 42,100 45,603 36,111 Cash flows from financing activities: Common stock cash dividends paid ( 29,491 ) ( 28,937 ) ( 28,859 ) Proceeds from exercise of stock options — — 122 Repurchase of common stock ( 3,196 ) ( 22,889 ) ( 19,119 ) Net cash used in financing activities ( 32,687 ) ( 51,826 ) ( 47,856 ) Net (decrease) increase in cash and cash equivalents 9,413 ( 6,223 ) ( 11,745 ) Cash and cash equivalents at the beginning of year 3,513 9,736 21,481 Cash and cash equivalents at the end of year $ 12,926 $ 3,513 $ 9,736 92 Table of Contents ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None