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Item 1A. Risk Factors

2024-02-27 compared with 2023-02-24 · 143 added, 182 removed, 213 unchanged (60% of the section changed)

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Risks Related to our Lending Activities

Our loan portfolio is concentrated in loans with a higher risk of loss.

Repayment of our commercial business loans, consisting of commercial and industrial loans as well as owner-occupied and non-owner occupied commercial real estate loans, is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.

We offer different types of commercial business loans to a variety of businesses in industries such as real estate and rental and leasing, healthcare, accommodation and food services, retail trade and construction.

The primary types of commercial business loans offered are lines of credit, term equipment financing and term real estate loans.

We also originate loans that are guaranteed by the SBA and we are a “preferred lender” of the SBA.

Commercial business lending involves risks that are different from those associated with residential real estate lending.

We offer a variety of commercial business loans across various industries such as real estate, healthcare, accommodation and food services, retail trade and construction.

Our primary loan offerings comprise lines of credit, term equipment financing, and term real estate loans.

Additionally, we facilitate loans guaranteed by the SBA, holding the designation of a “preferred lender” by the SBA.

Commercial business lending involves distinct risks compared to residential real estate lending.

Our commercial business loans are primarily made based on our assessment of the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower.

The borrower's cash flow may be unpredictable, and collateral securing these loans may fluctuate in value.

Although these commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things.

Accordingly, the repayment of commercial business loans depends primarily on the cash flow and creditworthiness of the borrower and secondarily on the underlying collateral provided by the borrower.

At December 31, 2022, our commercial business loans totaled $3.22 billion, or 79.4% of our total loan portfolio, of which $5.9 million, or 0.2%, were classified as nonaccrual at December 31, 2022.

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

Within commercial business loans, agricultural loans totaled $57.3 million, or 1.4% of our total loan portfolio and 1.8% of our commercial business loans at December 31, 2022 of which $2.6 million, or 4.5% were classified as nonaccrual loans at December 31, 2022.

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

We originate commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties.

The unpredictability of a borrower's cash flow and the potential fluctuations in collateral values underscore the inherent risks in these loans.

While our commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things.

Accordingly, the repayment of commercial business loans primarily relies on the borrower’s cash flow and creditworthiness, supplemented by the underlying collateral.

At December 31, 2023, our commercial business loans totaled $3.37 billion, or 77.8% of our total loan portfolio, of which $4.5 million, or 0.1% of commercial business loans were classified as nonaccrual.

Within commercial business loans, agricultural

loans totaled $65.7 million, or 1.5% of our total loan portfolio and 1.9% of our commercial business loans at December 31, 2023 of which $825,000, or 1.3% of agricultural loans were classified as nonaccrual loans.

Our portfolio encompasses owner and non-owner occupied commercial real estate loans, including multifamily residential real estate loans.

These loans often involve higher principal amounts compared to other loan types, and their repayment may be contingent on factors beyond our or our borrowers' control.

We originate commercial real estate loans for individuals and businesses, which are secured by commercial properties.

These loans typically involve higher principal amounts than other types of loans and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions.

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

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

For example, if the project's cash flow diminishes due to unobtained or unrenewed leases, the borrower’s capacity to repay the loan could be impaired.

Additionally, many of these loans have adjustable rates and reprice periodically.

A significant increase in rates could increase the payment amount and could impact the borrower’s ability to repay the loan.

Commercial real estate lending also exposes us to greater credit risk than loans secured by residential real estate.

Typically, the collateral securing these loans is not as easily liquidated as residential properties.

In addition, many of our commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity.

Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment.

If we foreclose on a commercial real estate loan, our holding period for the collateral typically is longer than for residential real estate loans because there are fewer potential purchasers of the collateral.

Additionally, commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers.

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

As of December 31, 2022, our owner and non-owner occupied commercial real estate loans totaled $2.52 billion, or 62.3% of our total loan portfolio, of which $212,000 were classified as nonaccrual at December 31, 2022.

Such balloon payments may require the borrower to either sell or refinance the underlying property, potentially elevating the risk of default or non-payment.

If we foreclose on a commercial real estate loan, our holding period for the collateral typically is longer compared to residential real estate loans due to fewer potential purchasers.

Additionally, commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers, magnifying the impact of any errors in judgment regarding their collectability.

Consequently, resulting charge-offs per loan may be larger than those incurred with our residential or consumer loan portfolios.

As of December 31, 2023, our owner and non-owner occupied commercial real estate loans totaled $2.66 billion, or 61.2% of our total loan portfolio, of which $205,000 were classified as nonaccrual.

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

These estimates may be inaccurate.

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

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

Changes in demand and higher than anticipated building costs may cause actual results to vary significantly from those estimated.

This type of lending also typically involves higher loan principal amounts and may be concentrated with a small number of builders.

A downturn in housing, or the real estate market, could increase delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure.

Some of our borrowers are builders with more than one loan outstanding with us.

Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.

As a result, these loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest.

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

Estimating construction costs, the project's market value upon completion, and the impact of regulatory changes on real property involve inherent uncertainties.

Accurately evaluating the total funds required for a project and the resulting loan-to-value ratio upon completion is challenging.

Unforeseen changes in demand or higher building costs may significantly deviate from initial estimates.

This type of lending also typically involves large loan principal amounts and may be concentrated among a limited number of builders.

A downturn in the housing or the real estate market could increase delinquencies, defaults and foreclosures, significantly impairing the value of our collateral and our ability to sell it upon foreclosure.

Further, some borrowers have multiple loans outstanding with us, exposing us to higher risk if one credit relationship encounters adverse developments.

Construction loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest.

If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss.

Because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and more costly to monitor.

Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchaser's borrowing costs, thereby possibly reducing the borrower's ability to finance the project upon completion or the overall demand for the project.

Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working out problem construction loans.

enable us to fully recover unpaid loan funds and associated construction and liquidation costs.

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

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

Increases in market rates of interest can significantly impact construction loans, escalating end-purchasers' borrowing costs and potentially hindering project financing or reducing overall demand for the project.

Moreover, properties under construction are often difficult to sell and typically must be completed to be successfully sold, complicating the resolution of problematic construction loans.

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

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

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

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

As of December 31, 2023, our real estate construction and land development loans totaled $414.4 million, or 9.5% of our total loan portfolio, of which $78.6 million, or 1.8% of our total loan portfolio, were residential construction and $335.8 million, or 7.7% of our total loan portfolio, were commercial and multifamily construction.

Within this category, $37,000 of our total real estate construction and land development loans, were classified as nonaccrual at December 31, 2022.

All of these loans were performing in accordance with their repayment terms as of December 31, 2023.

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

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

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

Loans are charged-off through the ACL on loans when management believes the uncollectibility of a loan balance is considered probable.

Subsequent recoveries, if any, are recorded 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.

The Company records the changes in the ACL on loans through earnings as a "Provision for (reversal of) credit losses" on the Consolidated Statements of Income.

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

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

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

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

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If current conditions in the housing and real estate markets weaken, we expect we will experience increased delinquencies and credit losses.

In addition, bank regulatory agencies periodically review our ACL on loans and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on their judgments about information available to them at the time of their examination.

Bank regulatory agencies also periodically review our ACL on loans and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on their judgments about information available to them at the time of their examination.

In addition, if charge-offs in future periods exceed the ACL on loans, we will need additional provisions to increase the ACL on loans.

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

Risks Related to our Business Strategy

Our strategy of pursuing acquisitions and de novo branching exposes us to financial and operational risks that could adversely affect us.

We are pursuing a strategy of supplementing organic growth by acquiring other financial institutions or their businesses that we believe will help us fulfill our strategic objectives and enhance our earnings.

There are risks associated with this strategy, however, including the following:

• we may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets and liabilities we acquire.

If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;

• higher than expected deposit attrition;

• potential diversion of our management's time and attention;

• we may be exposed to previously known or unknown regulatory compliance deficiencies from the acquired institution;

• prices at which acquisitions are made can fluctuate with market conditions.

We have experienced times during which acquisitions could not be made in specific markets at prices we considered acceptable and expect that we may continue to experience this condition in the future;

• the acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful.

This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business.

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

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

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

• from 2006 through 2022, we completed eight acquisitions or mergers, including one acquisition in 2006, two acquisitions during 2010, two acquisitions during 2013, one merger in 2014 and two acquisitions in 2018 that enhanced our rate of growth.

We may not be able to continue to sustain our past rate of growth or to grow at all in the future;

• we expect our net income will increase following our acquisitions;

however, we also expect our general and administrative expenses and consequently our efficiency ratios may also increase.

Ultimately, we would expect our efficiency ratio to improve;

however, if we are not successful in our integration process, this may not occur, and our acquisitions or branching activities may not be accretive to earnings in the short or long-term;

• to the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill.

As discussed below under the risk factor heading “We may experience future goodwill impairment, which could reduce our earnings” we are required to assess our goodwill for impairment at least annually, and any goodwill impairment charge could have a material adverse effect on our results of operations and financial condition;

• we are required to record acquired loans through acquisitions at fair value, which may differ from the outstanding balance of such loans.

Estimating the fair value of such loans requires management to make estimates based on available information and facts and circumstances on the acquisition date.

The difference between the fair value and the outstanding balance of such loans is accreted into net interest income.

Thus, our net interest margins may initially increase due to accretion.

The yields on our loans could decline as our acquired loan portfolio pays down or matures, and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan portfolio is not replaced with comparable high-yielding loans.

This could result in higher net interest margins and interest income in current periods and lower net interest rate margins and lower interest income in future periods.

Our business strategy includes significant growth plans, and our financial condition and results of operations could be negatively affected if we are not successful in executing this strategy or if we fail to grow or manage our growth effectively.

We intend to pursue a growth strategy for our business.

We regularly evaluate potential acquisitions and expansion opportunities.

If appropriate opportunities present themselves, we expect to engage in selected acquisitions of financial institutions in the future, including branch acquisitions, or other business growth initiatives or undertakings.

There can be no assurance that we will successfully identify appropriate opportunities, that we will be able to negotiate or finance such activities or that such activities, if undertaken, will be successful.

As part of our business strategy, we seek to supplement our organic growth by acquiring other financial institutions or their businesses to achieve our strategic objectives and bolster earnings.

However, this strategy entails several risks:

• Acquired banks or businesses might carry unforeseen asset quality issues or contingent liabilities.

If these exceed our estimates, it could significantly impact our financial condition and operational results;

• There is a risk of higher-than-anticipated deposit attrition following an acquisition, potentially affecting our funding base;

• The acquisition process may divert our management's time and attention, impacting day-to-day operations and strategic initiatives;

• Acquired entities might have known or unknown regulatory compliance deficiencies, exposing us to associated risks;

• Market conditions can influence acquisition prices.

Difficulty in making acceptable-priced acquisitions in specific markets could affect our growth strategy;

• The integration of systems, procedures, and personnel from acquired entities into our company is complex and time-consuming.

It can disrupt the acquired business and its customer base, potentially leading to customer and employee losses if not managed effectively;

• Financing acquisitions using borrowed funds will increase our leverage and diminish our liquidity.

Raising additional capital to finance acquisition could dilute existing shareholders’ interests;

• Sustaining our historical growth rate may be difficult due to market constraints and/or acquisition complexities.

We have completed eight acquisitions from 2006 through 2018, which has enhanced our growth rate over the years;

• While our acquisitions and branching activities are expected to boost net income, they might also increase general and administrative expenses initially, potentially affecting our efficiency ratios.

Successful integration is crucial for achieving expected efficiencies.

If we are unsuccessful in our integration process, this may not occur, and our acquisitions or branching activities may not be accretive to earnings in the short or long-term;

• When acquisition costs exceed the fair value of the net assets acquired, goodwill is recorded.

Any future impairment of goodwill could adversely affect our financial condition.

See, the risk factor titled “We may experience future goodwill impairment, which could reduce our earnings” below;

• Acquired loans are recorded at fair value, which may differ from their outstanding balance.

Changes in yields and replacement of high-yielding loans can impact our net interest margins and interest income over time.

Our financial condition and results of operations could be negatively affected if we fail to execute our growth strategy or manage our growth effectively.

Our intention is to supplement our growth through selective acquisitions of financial institutions, including branch expansions, and other growth opportunities.

However, there is no guarantee that we will identify suitable opportunities or effectively negotiate and finance these activities.

Even if undertaken, the success of such undertakings cannot be assured.

Our growth initiatives may require us to recruit experienced personnel to assist in such initiatives, which will increase our compensation costs.

In addition, the failure to identify and retain such personnel would place significant limitations on our ability to successfully execute our growth strategy.

To the extent we expand our lending beyond our current market areas, we also could incur additional risk related to those new market areas.

To the extent we expand our lending beyond our current market areas, we could also incur additional risk related to those new market areas.

We may not be able to expand our market presence in our existing market areas or successfully enter new markets.

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

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

Inability to execute our acquisition-focused growth plan might adversely affect various aspects of our business, including finances, operations, reputation, and growth prospects.

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

Risks Related to Economic Conditions

The current economic condition in the market areas we serve may adversely impact our earnings and could increase the credit risk associated with our loan portfolio.

Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon.

Substantially all of our loans are to businesses and individuals in the states of Washington, Oregon and Idaho.

A return of recessionary conditions or adverse economic conditions in the primary market areas of the Pacific Northwest in which we operate could reduce our rate of growth, affect our customers' ability to repay loans and have a material adverse effect on our business, financial condition, and results of operations.

General economic conditions, including inflation, unemployment and money supply fluctuations, also may adversely affect our profitability.

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

Weakness in the global economy and global supply chain issues have adversely affected many businesses operating in our markets that are dependent upon international trade.

Changes in agreements or relationships between the United States and other countries may also affect these businesses.

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

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

• Loan delinquencies, problem assets and foreclosures may increase;

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

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

such as earthquakes and flooding.

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

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

Inflation can have an adverse impact on our business and on our customers.

Inflation risk is the risk that the value of assets or income from investments will be worth less in the future as inflation decreases the value of money.

External economic factors, such as changes in monetary policy and inflation and deflation, may have an adverse effect on our business, financial condition and results of operations.

Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Board of Governors of the Federal Reserve System, or the Federal Reserve.

Actions by monetary and fiscal authorities, including the Federal Reserve, could lead to inflation, deflation, or other economic phenomena that could adversely affect our financial performance.

Inflation has risen sharply since the end of 2021 and throughout 2022 at levels not seen for over 40 years.

As discussed below under “Fluctuating interest rates can adversely affect our profitability,” as inflation increases and market interest rates rise the value of our investment securities, particularly those with longer maturities, would decrease, although this effect can be less pronounced for floating-rate instruments.

In addition, inflation increases the cost of goods and services we use in our business operations, such as electricity and other utilities, which increases our noninterest expenses.

Furthermore, our customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.

The economic impact of the COVID-19 Pandemic could continue to affect our financial condition and results of operations.

The COVID-19 Pandemic could continue to pose risks and could harm our business, our results of operations and the prospects of the Company.

The COVID-19 Pandemic has adversely impacted the global and national economy and certain industries and geographies in which our clients operate.

Given its ongoing and dynamic nature, it is difficult to predict the full impact of the COVID-19 Pandemic on the business of the Company, its clients, employees and third-party service providers.

The extent of such impact will depend on future developments.

Additionally, the responses of various governmental and nongovernmental authorities and consumers to the pandemic may have material long-term effects on the Company and its clients which are difficult to quantify.

We could be subject to a number of risks as a result of the COVID-19 Pandemic, any of which could have a material, adverse effect on our business, financial condition, liquidity, results of operations, ability to execute our growth strategy, and ability to pay dividends.

These risks include, but are not limited to, changes in demand for our products and services;

increased loan losses or other impairments in our loan portfolios and increases in our ACL;

a decline in collateral for our loans, especially real estate;

unanticipated unavailability of employees;

increased cyber security risks as employees work remotely;

a prolonged weakness in economic conditions resulting in a reduction of future projected earnings could necessitate a valuation allowance against our current outstanding deferred tax assets;

a triggering event leading to impairment testing on our goodwill or core deposit and customer relationships intangibles, which could result in an impairment charge;

and increased costs as the Company and our regulators, customers and vendors adapt to evolving pandemic conditions.

Inflationary pressures, while easing recently, remained elevated throughout the first half of 2023.

Small to medium-sized businesses may be impacted more during periods of high inflation as they are not able to leverage economics of scale to mitigate cost pressures compared to larger businesses.

Consequently, the ability of our business clients to repay their loans may deteriorate quickly, which would adversely impact our results of operations and financial condition.

Furthermore, a prolonged period of inflation could cause wages and other costs to the Company to increase, which could adversely affect our results of operations and financial condition.

Virtually all our assets and liabilities are monetary in nature.

As a result, interest rates tend to have a more significant impact on our performance than general levels of inflation or deflation.

Interest rates do not necessarily move in the same direction or by the same magnitude as the prices of goods and services.

Risks Related to Market and Interest Rate Changes

Fluctuating interest rates can adversely affect our profitability.

Our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”) between the interest earned on loans, investment securities and other interest earning assets and the interest paid on deposits, borrowings, and other interest bearing liabilities.

Our profitability is dependent primarily upon net interest income, which is the difference (or “spread”) between the interest earned on loans, investment securities and other interest earning assets and the interest paid on deposits, borrowings, and other interest bearing liabilities.

Because of the differences in maturities and repricing characteristics of our interest earning assets and interest bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest earning assets and interest paid on interest bearing liabilities.

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

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

Earnings could also be adversely

affected if interest rates decrease as assets tend to reprice more quickly than liabilities.

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

If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.

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

During the year ended December 31, 2022, in response to inflation, the FOMC of the Federal Reserve has increased the target range for the federal funds rate by 400 basis points to a range of 4.25% to 4.50% as of December 31, 2022 compared to a range of 0.00% to 0.25% at December 31, 2021 as it seeks to control inflation without creating a recession.

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

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

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

we do not raise interest rates we are paying on deposits to effectively compete with other banks or alternative investment options, we may see deposits decline leading to either a lower level of earning assets or higher borrowings, either of which would could potentially cause a decline in earnings.

Changes in interest rates also affect the value of our interest earning assets and in particular our investment securities portfolio.

During the year ended December 31, 2023, in response to inflation, the FOMC of the Federal Reserve has increased the target range for the federal funds rate by 100 basis points to a range of 5.25% to 5.50% as of December 31, 2023 compared to a range of 0.00% to 0.25% at December 31, 2021 with the intention of controlling inflation without creating a recession.

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

As is the case with many financial institutions, we have focused on growing core deposits—deposits with no or low interest rates and no specified maturity—which has been challenging over the past couple years.

In a rising interest rate environment, retaining these deposits could result in higher funding costs.

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

Conversely, if we do not adjust our deposit interest rates to remain competitive with other banks or alternative investment options, we might experience a decrease in deposits, potentially leading to either reduced earning assets or higher borrowings.

Both scenarios could potentially cause a decline in earnings.

Changes in interest rates also affect the value of our available for sale investment securities portfolio.

Generally, the fair value of fixed-rate investment securities fluctuates inversely with changes in interest rates.

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Increases in interest rates generally decrease the fair value of securities available for sale, which adversely impacts stockholders' equity.

The Company could recognize an impairment loss for any security that has declined in fair value below its amortized cost basis if management has the intent to sell the security or if it is more likely than not it will be required to sell the security before recovery of its amortized cost basis.

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.

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Climate change and related legislative and regulatory initiatives may materially affect the Company’s business and results of operations.

The potential effects of climate change are creating a heightened level of concern for the state of the global environment.

The potential effects of climate change are creating a heightened level of concern for the state of the environment.

As a result, the global business community has increased its political and social awareness surrounding the issue, and the United States has entered into international agreements in an attempt to reduce global temperatures, such as reentering the Paris Agreement.

Further, the U.S.

Congress, state legislatures and federal and state regulatory agencies continue to propose numerous initiatives to supplement the global effort to combat climate change.

assessments, revising expectations for credit portfolio concentrations based on climate-related factors and encouraging investment by banks in climate-related initiatives and lending to communities disproportionately impacted by the effects of climate change.

Congress, state legislatures and federal and state regulatory agencies continue to propose initiatives to supplement the global effort to combat climate change.

Similar and even more expansive initiatives are expected under the current administration, including potentially increasing supervisory expectations with respect to banks’ risk management practices, accounting for the effects of climate change in stress testing scenarios and systemic risk assessments, revising expectations for credit portfolio concentrations based on climate-related factors and encouraging investment by banks in climate-related initiatives and lending to communities disproportionately impacted by the effects of climate change.

The lack of empirical data surrounding the credit and other financial risks posed by climate change render it difficult, or even impossible, to predict how specifically climate change may impact our financial condition and results of operations;

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Risks Related to Cybersecurity, Third-Parties and Technology

We rely on other companies to provide key components of our business infrastructure.

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

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

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

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

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

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

We rely on third party services and products to provide key components of our technology and banking product business infrastructure.

We rely on third party services to provide products and services in support of day-to-day operations.

Due to the nature of the outsourced services, some portions of our technology offerings, computing environments, architecture, and infrastructure, and banking operational processes are exposed to vendor service risks.

Risks include failure to contractually perform, fraud, errors, delays, omissions, failure to comply with regulatory and/or or legal requirements;

and failure to ensure security and availability and integrity of service and/or accuracy of the provided service.

The bank’s regulatory agencies require financial institutions to ensure risks associated with outsourced providers and services are appropriately identified, assessed, controlled, and continuously monitored to ensure risk is appropriately managed.

client attrition;

regulatory fines, penalties or intervention;

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Our security measures may not be sufficient to mitigate the risk of a cyber-attack.

Communications and information systems are essential to the conduct of our business as we use such systems to manage our customer relationships, our core operating systems, our general ledger and virtually all other aspects of our business.

Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks.

Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware or other malicious code and cyber-attacks that could have a security impact.

If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties.

We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.

Technology architecture, infrastructure, and information systems and platforms are essential to conduct our business.

Systems to manage our customer relationships, our core operating systems, our general ledger,and virtually all other aspects of our business rely on the secure processing, storage, and transmission of confidential and private information in our computing environments.

Although we take every protective measure and endeavor to ensure the security of our computing environments and the data within the environments, systems, software and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service, misuse of information, viruses, malicious code and malware and/or ransomware cybercrime incidents.

If one or more of these events occur, systems, software and/or network availability, and integrity could be compromised resulting in the loss of the Company’s and/or customers’ confidential and private information.

In the event of a security incident, significant additional resources may be expended to modify our protective measures or to investigate and remediate vulnerabilities or other exposures and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.

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

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

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

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

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

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

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

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

We have established policies and procedures to prevent or limit the impact of system breaches, failures, and interruptions.

We have established policies and procedures to identify threats and vulnerabilities and prevent or limit the impact of system breaches, failures, and interruptions.

In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers.

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

Threats to information security also exist in the processing of customer information

through various other vendors and their personnel.

We cannot assure that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third-parties on which we rely.

Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

We cannot ensure that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely.

Further, while we believe we maintain adequate insurance to cover these risks, our insurance coverage may not cover all losses resulting from breaches, system failures or other disruptions.

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

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

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

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

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While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.

Managing reputational risk is important to attracting and maintaining customers, investors and employees.

Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies and questionable or fraudulent activities of our customers.

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

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

costly litigation;

a decline in revenues and increased governmental regulation.

The financial services market is undergoing rapid technological changes, and if we are unable to stay current with those changes, we may not be able to effectively compete.

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

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

institution's ACL.

These bank regulators also have the ability to impose conditions in the approval of merger and acquisition transactions.

We may experience future goodwill impairment, which could reduce our earnings.

Accounting standards require that we account for acquisitions or business combinations using the purchase method of accounting.

We may experience goodwill impairment, which could reduce our earnings.

Accounting standards require that we use the purchase method of accounting for acquisitions and business combinations.

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

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

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

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

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

In accordance with GAAP, we assess our goodwill for impairment annually, or more frequently if specific events suggest potential impairment.

This evaluation incorporates various quantitative factors, such as the quoted price of our common stock, market prices of common stock of other banking organizations, common stock trading multiples, discounted cash flows and data from comparable acquisitions.

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

Assessing the fair value of goodwill involves considerable judgment.

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

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Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K.

Other Risks Related to Operational Matters

We will be required to transition from the use of the LIBOR in the future.

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

ICE Benchmark Administration, the authorized and regulated administrator of LIBOR, ended publication of the one-week and two-month USD LIBOR tenors on December 31, 2021 and the remaining USD LIBOR tenors will end publication in June 2023.

Financial services regulators and industry groups have collaborated to develop alternate reference rate indices or reference rates.

The transition to a new reference rate requires changes to contracts, risk and pricing models, valuation tools, systems, product design and hedging strategies.

At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight repurchase agreements, which are expected to be based on SOFR).

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

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

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

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

For more information, refer to “Loan Portfolio Overview” included in Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K.

An increase in interest rates, change in the programs offered by secondary market purchasers or our ability to qualify for their programs may reduce our mortgage revenues, which would negatively impact our non-interest income.

We originate and sell residential real estate loans, or mortgage loans.

The related mortgage income is a significant portion of our noninterest income.

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

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

Mortgage banking is generally considered a volatile source of income because it depends largely on the level of loan volume which, in turn, depends largely on prevailing market interest rates.

In a rising or higher interest rate environment, the demand for mortgage loans, particularly refinancing of existing mortgage loans, tends to fall and our originations of mortgage loans may decrease, resulting in

fewer loans that are available to be sold to investors.

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

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

occupancy and equipment expense;

data processing expense and other operating costs.

During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan originations.

Other Risks Related to Our Business

Managing reputational risk is important to attracting and maintaining customers, investors and employees.

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

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

costly litigation;

a decline in revenues and increased governmental regulation.

Ineffective liquidity management could adversely affect our financial results and condition.

Liquidity is essential to our business.

We rely on a number of different sources in order to meet our potential liquidity demands.

We rely on several sources to meet our potential liquidity demands.

Our primary sources of liquidity are increases in deposit accounts, cash flows from loan payments and our securities portfolio.

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

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

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

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

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Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to the environment, health and safety, diversity, labor conditions and human rights.

Increased ESG related compliance costs could result in increases to our

overall operational costs.

Increased ESG related compliance costs could result in increases to our overall operational costs.

Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation, ability to do business with certain partners, and our stock price.

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

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

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

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

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

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

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

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

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

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Also, our right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors.

UNRESOLVED STAFF COMMENTS

The Company has no unresolved staff comments from the SEC as it relates to the Company's financial information as reported in the Form 10-K.

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

What changed 10-K

Item 1A. Risk Factors