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, 2023 and 2022, the related Consolidated Statements of Income, Comprehensive Income (Loss), Stockholders’ Equity, and Cash Flows, for each of the years in the three-year period ended December 31, 2023, 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, 2023, 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, 2023 and 2022, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2023 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 31,2023, 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 that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The 44 Table of Contents 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 $48.0 million at December 31, 2023 and provision for credit losses on loans was $4.7 million for the year then ended. 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. 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 Company uses macroeconomic scenarios from an independent third party. These scenarios are based on past events, current conditions, the likelihood of future events occurring and include 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. 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 primarily on established macroeconomic factors 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. 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 qualitative 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 relevance 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 27, 2024 45 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands, except share data) December 31, 2023 December 31, 2022 ASSETS Cash on hand and in banks $ 55,851 $ 74,295 Interest earning deposits 169,122 29,295 Cash and cash equivalents 224,973 103,590 Investment securities available for sale, at fair value, net (amortized cost of $ 1,227,787 and $ 1,460,033 , respectively) 1,134,353 1,331,443 Investment securities held to maturity, at amortized cost, net (fair value of $ 662,450 and $ 673,434 , respectively) 739,442 766,396 Total investment securities 1,873,795 2,097,839 Loans receivable 4,335,627 4,050,858 Allowance for credit losses on loans ( 47,999 ) ( 42,986 ) Loans receivable, net 4,287,628 4,007,872 Premises and equipment, net 74,899 76,930 Federal Home Loan Bank stock, at cost 4,186 8,916 Bank owned life insurance 125,655 122,059 Accrued interest receivable 19,518 18,547 Prepaid expenses and other assets 318,571 296,181 Other intangible assets, net 4,793 7,227 Goodwill 240,939 240,939 Total assets $ 7,174,957 $ 6,980,100 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 5,599,872 $ 5,907,420 Deposits held for sale — 17,420 Total deposits 5,599,872 5,924,840 Borrowings 500,000 — Junior subordinated debentures 21,765 21,473 Securities sold under agreement to repurchase — 46,597 Accrued expenses and other liabilities 200,059 189,297 Total liabilities 6,321,696 6,182,207 Commitments and contingencies (Note 19) 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; 34,906,233 and 35,106,697 shares issued and outstanding, respectively 549,748 552,397 Retained earnings 375,989 345,346 Accumulated other comprehensive loss, net ( 72,476 ) ( 99,850 ) Total stockholders’ equity 853,261 797,893 Total liabilities and stockholders’ equity $ 7,174,957 $ 6,980,100 See accompanying Notes to Consolidated Financial Statements. 46 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except shares and per share data) Year Ended December 31, 2023 2022 2021 INTEREST INCOME: Interest and fees on loans $ 217,284 $ 174,275 $ 189,832 Taxable interest on investment securities 58,509 40,627 17,492 Nontaxable interest on investment securities 1,854 3,488 3,899 Interest on interest earning deposits 6,818 9,067 1,608 Total interest income 284,465 227,457 212,831 INTEREST EXPENSE: Deposits 39,350 6,772 6,160 Junior subordinated debentures 2,074 1,156 742 Securities sold under agreement to repurchase 153 138 140 Borrowings 17,733 6 — Total interest expense 59,310 8,072 7,042 Net interest income 225,155 219,385 205,789 Provision for (reversal of) credit losses 4,280 ( 1,426 ) ( 29,372 ) Net interest income after provision for (reversal of) credit losses 220,875 220,811 235,161 NONINTEREST INCOME: Service charges and other fees 10,966 10,390 9,207 Card revenue 8,340 8,885 8,325 (Loss) gain on sale of investment securities, net ( 12,231 ) ( 256 ) 29 Gain on sale of loans, net 343 633 3,644 Interest rate swap fees 230 402 661 Bank owned life insurance income 2,934 3,747 2,520 Gain on sale of other assets, net 2 469 4,405 Other income 8,079 5,321 5,824 Total noninterest income 18,663 29,591 34,615 NONINTEREST EXPENSE: Compensation and employee benefits 100,083 92,092 88,765 Occupancy and equipment 19,156 17,465 17,243 Data processing 18,071 16,800 16,533 Marketing 1,930 1,643 2,143 Professional services 4,227 2,497 3,846 State/municipal business and use taxes 4,059 3,634 3,884 Federal deposit insurance premium 3,312 2,015 2,106 Amortization of intangible assets 2,434 2,750 3,111 Other expense 13,351 12,070 11,638 Total noninterest expense 166,623 150,966 149,269 Income before income taxes 72,915 99,436 120,507 Income tax expense 11,160 17,561 22,472 Net income $ 61,755 $ 81,875 $ 98,035 Basic earnings per share $ 1.76 $ 2.33 $ 2.75 Diluted earnings per share $ 1.75 $ 2.31 $ 2.73 Dividends declared per share $ 0.88 $ 0.84 $ 0.81 Average number of basic shares outstanding 35,022,247 35,103,465 35,677,851 Average number of diluted shares outstanding 35,258,189 35,463,896 35,973,386 See accompanying Notes to Consolidated Financial Statements. 47 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Dollars in thousands) Year Ended December 31, 2023 2022 2021 Net income $ 61,755 $ 81,875 $ 98,035 Change in fair value of investment securities available for sale, net of tax of $ 4,850 , $( 30,372 ) and $( 4,298 ), respectively 18,075 ( 108,977 ) ( 15,472 ) Amortization of net unrealized gain for the reclassification of investment securities available for sale to held to maturity, net of tax of $( 69 ), $( 130 ) and $( 35 ), respectively ( 248 ) ( 469 ) ( 127 ) Reclassification adjustment for net loss (gain) from sale of investment securities available for sale included in income, net of tax benefit (expense) of $ 2,684 , $ 56 and $( 6 ), respectively 9,547 200 ( 23 ) Other comprehensive income (loss) 27,374 ( 109,246 ) ( 15,622 ) Comprehensive income (loss) $ 89,129 $ ( 27,371 ) $ 82,413 See accompanying Notes to Consolidated Financial Statements. 48 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands, except shares and per share data) Year Ended December 31, 2023 Number of common shares Common stock Retained earnings AOCI Total stockholders’ equity Balance at December 31, 2022 35,106,697 $ 552,397 $ 345,346 $ ( 99,850 ) $ 797,893 Restricted stock units vested 162,752 — Stock-based compensation expense 4,325 4,325 Common stock repurchased ( 363,216 ) ( 6,974 ) ( 6,974 ) Net income 61,755 61,755 Other comprehensive income, net of tax 27,374 27,374 Cash dividends declared on common stock ($ 0.88 per share) ( 31,112 ) ( 31,112 ) Balance at December 31, 2023 34,906,233 $ 549,748 $ 375,989 $ ( 72,476 ) $ 853,261 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 ) December 31, 2021 35,105,779 $ 551,798 $ 293,238 $ 9,396 $ 854,432 See accompanying Notes to Consolidated Financial Statements. 49 Table of Contents HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) Year Ended December 31, 2023 2022 2021 Cash flows from operating activities: Net income $ 61,755 $ 81,875 $ 98,035 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and accretion 3,170 341 ( 21,739 ) Provision for (reversal of) credit losses 4,280 ( 1,426 ) ( 29,372 ) Stock-based compensation expense 4,325 3,795 3,666 Amortization of intangible assets 2,434 2,750 3,111 Origination of mortgage loans held for sale ( 14,833 ) ( 15,190 ) ( 86,443 ) Proceeds from sale of mortgage loans held for sale 15,176 17,299 93,543 Bank owned life insurance income ( 2,934 ) ( 3,747 ) ( 2,520 ) Valuation adjustment on interest rate swaps — ( 66 ) ( 355 ) Gain on sale of mortgage loans held for sale, net ( 343 ) ( 633 ) ( 3,644 ) Loss (gain) on sale of investment securities, net 12,231 256 ( 29 ) Gain on sale of premises and equipment — ( 403 ) ( 4,440 ) Gain on sale of branch including related deposits, net ( 610 ) — — Other 24,872 9,605 19,717 Net cash provided by operating activities 109,523 94,456 69,530 Cash flows from investing activities: Loan originations and purchases, net of payments ( 280,664 ) ( 225,149 ) 699,107 Maturities and repayments of investment securities available for sale 178,855 181,487 254,668 Maturities and repayments of investment securities held to maturity 26,063 28,296 1,255 Purchase of investment securities available for sale ( 178,396 ) ( 790,871 ) ( 616,123 ) Purchase of investment securities held to maturity — ( 412,835 ) ( 140,288 ) Proceeds from sales of investment securities available for sale 219,700 30,390 1,248 Purchase of premises and equipment ( 10,376 ) ( 4,016 ) ( 3,018 ) Proceeds from sales of assets held for sale — 2,102 10,556 Proceeds from redemption of Federal Home Loan Bank stock 50,318 2,002 — Purchases of Federal Home Loan Bank stock ( 45,588 ) ( 2,985 ) ( 1,272 ) Proceeds from sales of premises and equipment 78 106 65 Purchases of bank owned life insurance ( 1,382 ) ( 230 ) ( 10,166 ) Proceeds from bank owned life insurance death benefit 20 2,114 — Cash received from return of NMTC equity method investment — — 9,642 Capital contributions to tax credit partnerships ( 38,248 ) ( 18,190 ) ( 41,911 ) Net cash paid related to branch divestiture ( 13,826 ) — Net cash (used) provided by investing activities ( 93,446 ) ( 1,207,779 ) 163,763 Cash flows from financing activities: Net (decrease) increase in deposits ( 310,303 ) ( 469,450 ) 783,347 Proceeds from borrowings 1,889,700 50,050 — Repayment of borrowings ( 1,389,700 ) ( 50,050 ) — Common stock cash dividends paid ( 30,820 ) ( 29,491 ) ( 28,937 ) Net (decrease) increase in securities sold under agreement to repurchase ( 46,597 ) ( 4,242 ) 15,156 Repurchase of common stock ( 6,974 ) ( 3,196 ) ( 22,889 ) Net cash provided (used) by financing activities 105,306 ( 506,379 ) 746,677 Net increase (decrease) in cash and cash equivalents 121,383 ( 1,619,702 ) 979,970 50 Table of Contents Year Ended December 31, 2023 2022 2021 Cash and cash equivalents at beginning of period 103,590 1,723,292 743,322 Cash and cash equivalents at end of period $ 224,973 $ 103,590 $ 1,723,292 Supplemental disclosures of cash flow information: Cash paid for interest $ 46,135 $ 7,709 $ 6,790 Cash paid for income taxes, net of refunds 2,974 5,035 9,888 Supplemental non-cash disclosures of cash flow information: Transfer of investment securities available for sale to held to maturity — — 244,778 Investment in LIHTC partnerships and related funding commitment 37,007 85,888 29,551 Loans received from return of NMTC equity method investment — — 15,596 ROU assets obtained in exchange for new operating lease liabilities 6,880 2,869 13,966 Transfers of premises and equipment classified as held for sale to prepaid expenses and other assets from premises and equipment, net 5,974 910 3,556 Transfer of bank owned life insurance to prepaid expenses and other assets due to death benefit accrued, but not received 700 — — Transfer of deposits to deposits held for sale — 17,420 — 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, 2023, 2022 and 2021 (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, Eugene, Oregon, and Boise, Idaho. 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 Company 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 Company 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 "(Loss) gain on sale of investment securities, net" on the Consolidated Statements of Income and determined using the specific identification method. Premiums and discounts on investment securities available for sale and held to maturity are amortized or accreted into income using the interest method. An investment security available for sale or held to maturity is placed on nonaccrual status at the time any principal or payments become more than 90 days delinquent and classified as past due after 30 days of nonpayment. Interest accrued, but not received for an investment security classified as nonaccrual is reversed against interest income during the period that the investment security is placed on nonaccrual status. ACL on Investment Securities Available for Sale Management evaluates the need for an ACL on investment securities available for sale on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities available for sale in an unrealized loss position, the Company first assesses whether it intends to sell or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. 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 (loss). 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 Company 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. 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 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 53 Table of Contents 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. 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. 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 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. 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 modified 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 modified 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. 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 Company's average quarterly historical loss information for an economic cycle. The Company 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 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 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. The Company uses macroeconomic scenarios from an independent third party. These scenarios are based on past events, current conditions, the likelihood of future events occurring and include 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 certain forecasted macroeconomic factors, such as unemployment rate, gross domestic product, housing price index, commercial real estate price index, and certain rate and market 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. At September 30, 2023, the Company upgraded its model used to calculate the ACL for collectively evaluated loans. This upgraded version involves modifications to the macroeconomic variables for each loan segment. Changes were based on regression testing, assessing the macroeconomic variable relationships to expected results and adjusting the lookback period from 1991 to 2000 for improved data relevance. The most significant changes to macroeconomic variables were in the commercial and industrial and commercial real estate segments. The commercial and industrial segment had previously used unemployment as a macroeconomic variable which was removed and replaced with a market index, rate index and real estate price index. The commercial real estate segment had previously used gross domestic product as a macroeconomic variable 54 Table of Contents which was removed and replaced with a housing price index. Additionally, a new segment for home equity lines of credit was introduced in this version. The overall impact on the ACL for collectively evaluated loans, before applying qualitative adjustments, was not considered to be material. The Company’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 Company periodically considers the need for qualitative adjustments to the ACL. 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 specific risks, regulatory risks, and external factors that may ultimately impact credit quality, (iii) potential model limitations such as those identified through back-testing, underwriting changes, acquisition of new portfolios and 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. As of December 31, 2023, qualitative adjustments primarily related to certain segments of the loan portfolio deemed by management to be of a higher-risk profile where management believes the quantitative component of the Company’s ACL model may not have fully captured the associated impact to the ACL. Qualitative adjustments also related to heightened uncertainty as to future macroeconomic conditions and the related impact on certain loan segments. Management reviews the need for an appropriate level of qualitative adjustments on a quarterly basis, and as such, the amount and allocation of qualitative adjustments may change in future periods. 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 Company’s ACL on loans. Such agencies may require the Company to adjust 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 the above considerations. ACL on Unfunded Commitments The Company estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in which the Company is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. 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 Company'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 "Provision for (reversal of) credit losses" on the Consolidated Statements of Income 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. Provision for (reversal of) 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. Mortgage Banking Operations The Company originates and sells certain residential real estate loans on a servicing-released basis. The Company recognizes a gain or loss on sale to the extent that the sale proceeds of the loan sold differs from the net book value at the time of sale. Income from residential real estate loans brokered to other lenders is recognized into income on date of loan closing. Commitments to 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 Company is only obligated to sell the loan if the loan is approved and closed by the Company. 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, 2023 or December 31, 2022. In January 2024, we ceased the origination of residential real estate loans for the purpose of sales on the secondary market. 55 Table of Contents 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 in "Other income" on the Consolidated Statements of Income. In connection with the loan sales, the Company typically makes representations and warranties about the underlying loans conforming to specified guidelines. If the underlying loans do not conform to the specifications, the Company may have an obligation to repurchase the loans or indemnify the purchaser against any loss. The Company believes the potential for material loss under these arrangements was remote at December 31, 2023 and December 31, 2022. Servicing fee income is recorded for fees earned for servicing loans and reported in "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, 2023, 2022, and 2021. A premium over the adjusted carrying value is received upon the sale of the guaranteed portion of an SBA or USDA loan. The Company's investment in an SBA or USDA loan is allocated among the sold and retained portions of the loan based on the relative fair value of each portion at the time of loan origination, adjusted for payments and other activities. Because the portion retained does not carry an 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, 2023 and December 31, 2022. 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 Company officers and name the Company as beneficiary. Noninterest income is generated tax-free (subject to certain limitations) from the increase in the policies' underlying investments made by the insurance company. The Company records BOLI at the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. 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. 56 Table of Contents 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 and Idaho 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. Deferred tax assets are reported in "Prepaid expenses and other assets" on the Consolidated Statements of Financial Condition. We hold equity investments in certain structures which deliver tax benefits, including LIHTC funds and a Solar Tax Credit investment (“STC”). For those LIHTC investments that qualify for application of the proportional amortization method, we apply such method. Under the proportional amortization method, such investment is amortized in proportion to the allocation of tax benefits received in each period, and the investment amortization and the tax benefits are presented on a net basis within “Income tax expense” on our Consolidated Statements of Income. 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 (16) 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 57 Table of Contents 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. The Company has an equity investment in a solar tax credit investment. As a limited liability investor in this partnership, the Company receives tax benefits in the form of tax deductions from partnership operating losses and federal income tax credits. The Company accounts for the solar tax credits under the deferral method where the tax credit is recognized over the useful life of the asset on the Consolidated Statements of Income as a component of "Income tax expense". The Company has evaluated the variable interest held by the Company and determined that the Company does not have controlling financial interests in such investment 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. 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 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 monthly and are generally based on a percentage of the customer’s assets under management or based on investment or insurance solutions that are implemented for the customer. • Merchant Processing Services and Debit and Credit Card Fees: 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. 59 Table of Contents (d) Recently Issued or Adopted Accounting Pronouncements 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. 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 majority of the Company’s instruments indexed to LIBOR were transferred to another index during the year ended December 31, 2023. The remaining instruments including loans and investments are either in the process of transition or will transition to a new index at the next repricing date. 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. 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 adopted ASU 2022-02 on a prospective basis January 1, 2023. The Company elected at the date of adoption to account for existing TDR loans as of December 31, 2022 under the Company's TDR accounting policy which is disclosed in the 2022 Annual Form 10-K. All loan modifications post adoption are accounted for under the loan modification guidance in ASC 310-20. The adoption of this ASU did not have a material impact on business operations or the Consolidated Statements of Financial Condition. FASB ASU 2023-02 , Investments - Equity Method and Joint Ventures (Topic 323) : Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (a consensus of the Emerging Issues Task Force), was issued in February 2023. The amendments in this ASU permit companies to elect to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method, if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the income tax credits and other income tax benefits received and recognizes the net amortization and income tax credits and other income tax benefits in the statement of operations as a component of income tax expense (benefit). The amendments also require that a reporting entity disclose certain information in annual and interim reporting periods that enable investors to understand the investments that generate income tax credits and other income tax benefits from a tax credit program. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2023, with early adoption permitted. The amendments in the ASU can be applied either on a modified retrospective or a retrospective basis. 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 2023-09 , Income Taxes (Topic 740) : Improvements to Income Tax Disclosures, was issued in December 2023. The amendments in this ASU requires a public business entity to disclose, on an annual basis, a tabular rate reconciliation using both percentages and currency amounts, broken out into specified categories with certain reconciling items further broken out by nature and jurisdiction to the extent those items exceed a specified threshold. In addition, all entities are required to disclose income taxes paid, net of refunds received disaggregated by federal, state/local, and foreign and by jurisdiction if the amount is at least 5% of total income tax payments, net of refunds received. The new standard is effective for annual periods beginning after December 15, 2024, with early adoption permitted. An entity may apply the amendments in this ASU prospectively by providing the revised disclosures for the period ending December 31, 2025 and continuing to provide the pre-ASU disclosures for the prior periods, or may apply the amendments retrospectively by providing the revised disclosures for all period presented. The Company expects this ASU to only impact its disclosure requirements and 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 Company’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. 60 Table of Contents There were no investment securities classified as trading at December 31, 2023 or December 31, 2022. (a) Investment Securities by Classification, Type and Maturity The following tables present the amortized cost and fair value of investment securities and the corresponding amounts of gross unrealized and unrecognized gains and losses, including the corresponding amounts of gross unrealized gains and losses on investment securities available for sale recognized in AOCI, at the dates indicated: December 31, 2023 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Dollars in thousands) Investment securities available for sale: U.S. government and agency securities $ 16,047 $ — $ ( 2,297 ) $ 13,750 Municipal securities 92,231 9 ( 12,715 ) 79,525 Residential CMO and MBS (1) 555,518 2,656 ( 46,125 ) 512,049 Commercial CMO and MBS (1) 538,910 88 ( 34,740 ) 504,258 Corporate obligations 7,745 2 ( 134 ) 7,613 Other asset-backed securities 17,336 31 ( 209 ) 17,158 Total $ 1,227,787 $ 2,786 $ ( 96,220 ) $ 1,134,353 (1) U.S. government agency and government-sponsored enterprise CMO and MBS. December 31, 2023 Amortized Cost Gross Unrecognized Gains Gross Unrecognized Losses Fair Value (Dollars in thousands) Investment securities held to maturity: U.S. government and agency securities $ 151,075 $ — $ ( 27,701 ) $ 123,374 Residential CMO and MBS (1) 267,204 — ( 14,101 ) 253,103 Commercial CMO and MBS (1) 321,163 — ( 35,190 ) 285,973 Total $ 739,442 $ — $ ( 76,992 ) $ 662,450 (1) U.S. government agency and government-sponsored enterprise CMO and MBS. December 31, 2022 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Dollars 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 (1) 479,473 — ( 55,087 ) 424,386 Commercial CMO and MBS (1) 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 (1) U.S. government agency and government-sponsored enterprise CMO and MBS . 61 Table of Contents December 31, 2022 Amortized Cost Gross Unrecognized Gains Gross Unrecognized Losses Fair Value (Dollars in thousands) Investment securities held to maturity: U.S. government and agency securities $ 150,936 $ — $ ( 33,585 ) $ 117,351 Residential CMO and MBS (1) 290,318 — ( 17,440 ) 272,878 Commercial CMO and MBS (1) 325,142 — ( 41,937 ) 283,205 Total $ 766,396 $ — $ ( 92,962 ) $ 673,434 (1) U.S. government agency and government-sponsored enterprise CMO and MBS. The following table presents the amortized cost and fair value of investment securities by contractual maturity at the date indicated. 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. December 31, 2023 Securities Available for Sale Securities Held to Maturity Amortized Cost Fair Value Amortized Cost Fair Value (Dollars in thousands) Due in one year or less $ 3,792 $ 3,744 $ — $ — Due after one year through five years 2,602 2,557 — — Due after five years through ten years 39,711 36,331 93,260 78,570 Due after ten years 69,918 58,256 57,815 44,804 Total investment securities due at a single maturity date 116,023 100,888 151,075 123,374 MBS (1) 1,111,764 1,033,465 588,367 539,076 Total investment securities $ 1,227,787 $ 1,134,353 $ 739,442 $ 662,450 (1) MBS, 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, 2023 and December 31, 2022. (b) Unrealized Losses on Investment Securities Available for Sale The following tables present 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, 2023 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars in thousands) U.S. government and agency securities $ — $ — $ 13,750 $ ( 2,297 ) $ 13,750 $ ( 2,297 ) Municipal securities 3,548 ( 18 ) 71,458 ( 12,697 ) 75,006 ( 12,715 ) Residential CMO and MBS (1) — — 358,316 ( 46,125 ) 358,316 ( 46,125 ) Commercial CMO and MBS (1) 37,899 ( 228 ) 448,197 ( 34,512 ) 486,096 ( 34,740 ) Corporate obligations 911 ( 20 ) 3,887 ( 114 ) 4,798 ( 134 ) Other asset-backed securities 4,338 ( 22 ) 7,291 ( 187 ) 11,629 ( 209 ) Total $ 46,696 $ ( 288 ) $ 902,899 $ ( 95,932 ) $ 949,595 $ ( 96,220 ) (1) U.S. government agency and government-sponsored enterprise CMO and MBS. 62 Table of Contents December 31, 2022 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars 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 (1) 217,949 ( 14,770 ) 206,437 ( 40,317 ) 424,386 ( 55,087 ) Commercial CMO and MBS (1) 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 ) (1) U.S. government agency and government-sponsored enterprise CMO and MBS. (c) ACL on Investment Securities The Company evaluated investment securities available for sale as of December 31, 2023 and December 31, 2022 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, 2023 and December 31, 2022. 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, 2023 and December 31, 2022. The Company also evaluated investment securities held to maturity for current expected credit losses as of December 31, 2023 and December 31, 2022. There were no investment securities held to maturity classified as nonaccrual or past due as of December 31, 2023 and December 31, 2022 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, 2023 and December 31, 2022. (d) Realized Gains and Losses The following table presents the gross realized gains and losses on the sale of investment securities available for sale determined using the specific identification method for the dates indicated: Year ended December 31, 2023 2022 2021 (Dollars in thousands) Gross realized gains $ 36 $ 4 $ 29 Gross realized losses ( 12,267 ) ( 260 ) — Net realized gains/(losses) $ ( 12,231 ) $ ( 256 ) $ 29 (e) Pledged Securities The following table summarizes the amortized cost and fair value of investment securities that were pledged as collateral for the following obligations at the dates indicated: December 31, 2023 December 31, 2022 Amortized Cost Fair Value Amortized Cost Fair Value (Dollars in thousands) State and local governments public deposits $ 238,060 $ 224,879 $ 156,784 $ 137,931 FRB 845,098 742,197 60,660 49,506 Securities sold under agreement to repurchase — — 63,685 55,836 Other securities pledged 54,636 49,032 54,910 48,358 Total $ 1,137,794 $ 1,016,108 $ 336,039 $ 291,631 63 Table of Contents (f) Accrued Interest Receivable Accrued interest receivable excluded from the amortized cost of investment securities available for sale totaled $ 3.8 million and $ 4.8 million at December 31, 2023 and December 31, 2022, respectively. Accrued interest receivable excluded from the amortized cost on investment securities held to maturity totaled $ 2.3 million and $ 2.4 million at December 31, 2023 and December 31, 2022, 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, 2023, 2022, and 2021. (G) Non-Marketable Securities At December 31, 2022, as a member bank of Visa U.S.A., we held 6,549 shares of Visa Inc. Class B common stock. These shares had a carrying value of zero and were 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. During the year ended December 31, 2023, the Company sold all shares of Visa Inc. Class B common stock and recognized a $ 1.6 million gain which is included in "Other income" on the Consolidated Statements of Income. (3) Loans Receivable The Company originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions. Accrued interest receivable was excluded from disclosures presenting the Company's amortized cost of loans receivable as it was deemed insignificant. In addition to originating loans, the Company may also purchase loans through pool purchases, participation purchases and syndicated loan purchases. (a) Loan Origination/Risk Management The Company 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 in the loan portfolios. The Company 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 Company also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management. The 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, 2023 December 31, 2022 (Dollars in thousands) Commercial business: Commercial and industrial $ 718,291 $ 693,568 Owner-occupied CRE 958,620 937,040 Non-owner occupied CRE 1,697,574 1,586,632 Total commercial business 3,374,485 3,217,240 Residential real estate 375,342 343,631 Real estate construction and land development: Residential 78,610 80,074 Commercial and multifamily 335,819 214,038 Total real estate construction and land development 414,429 294,112 Consumer 171,371 195,875 Loans receivable 4,335,627 4,050,858 ACL on loans ( 47,999 ) ( 42,986 ) Loans receivable, net $ 4,287,628 $ 4,007,872 Balances included in the amortized cost of loans receivable: Unamortized net discount on acquired loans $ ( 1,923 ) $ ( 2,501 ) Unamortized net deferred fee $ ( 11,063 ) $ ( 10,016 ) 64 Table of Contents A discussion of the risk characteristics of each loan portfolio segment is as follows: Commercial Business : 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. Owner-occupied and non-owner occupied CRE. The Company originates CRE loans primarily within its primary market areas. These loans are subject to underwriting standards and processes similar to commercial and industrial loans in that these loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate properties. 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 Company’s residential real estate loans are secured by one-to-four family residences located in its primary market areas. The Company’s underwriting standards require that residential real estate loans maintained in the portfolio generally are owner-occupied and do not exceed 80 % of the lower of appraised value at origination or cost of the underlying collateral. Terms of maturity typically range from 15 to 30 years. The Company sells a portion of originated residential real estate loans in the secondary market. In addition to originating residential real estate loans, the Company began purchasing pools of residential real estate loans during the year ended 2022. All purchased loans adhere to the Company's underwriting standards. Real Estate Construction and Land Development : The Company originates construction loans for residential and for commercial and multifamily properties. The residential construction loans generally include construction of custom single-family homes whereby the homeowner is the borrower. The Company also provides financing to builders for the construction of pre-sold residential homes and, in selected cases, to builders for the construction of speculative single-family residential property. Construction loans are typically short-term in nature and priced with variable rates of interest. Construction loans may also be originated as a construction-to-permanent financing loan whereby upon completion of the construction phase, the loan is automatically converted to a permanent 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 Company’s estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss if the borrower does not repay the loan. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being dependent upon successful completion of the construction project, market interest rate changes, government regulation of real property, general economic conditions and the availability of long-term financing. Consumer : The Company 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 Company also purchased indirect consumer loans. These indirect consumer loans were made by well-known dealers located in our market areas to prime borrowers and secured by new and used automobile and recreational vehicles. The Company ceased indirect consumer loan originations in March 2020. 65 Table of Contents (b) Concentrations of Credit Most of the Company’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County, Washington to Lane County, Oregon, as well as Yakima County in Washington and Ada County in Idaho. Additionally, the Company's loan portfolio is concentrated in commercial business loans, which include commercial and industrial, owner-occupied and nonowner-occupied CRE, and real estate construction and land development loans which include commercial and multifamily real estate construction and land development loans. Commercial business loans and commercial and multifamily real estate construction and land development loans are generally considered as having a more inherent risk of default than residential real estate loans or other consumer loans. Also, the 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 Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, (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 Company 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: • 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 and are considered Pass grade for reporting purposes. • 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 Company 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 Company 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 Company 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 Company 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 Company 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 Company is almost certain of the losses and the outstanding principal balances are generally charged off to the realizable value. There were no loans graded Doubtful or Loss as of December 31, 2023 and 2022. 66 Table of Contents The following tables present the amortized cost of loans receivable by risk grade and origination year, and the gross charge-offs by loan class and origination year, at the dates indicated. The Company adopted the vintage disclosure requirements of ASU 2022-02 prospectively as described in Note 1 beginning January 1, 2023. December 31, 2023 Revolving Loans Revolving Loans Converted (1) Loans Receivable Term Loans Amortized Cost Basis by Origination Year 2023 2022 2021 2020 2019 Prior (Dollars in thousands) Commercial business: Commercial and industrial Pass $ 120,973 $ 150,854 $ 74,231 $ 66,364 $ 40,307 $ 76,924 $ 141,740 $ 188 $ 671,581 SM — 2,495 104 292 4,556 1,458 9,124 — 18,029 SS — 1,215 2,734 3,548 1,076 7,875 12,168 65 28,681 Total 120,973 154,564 77,069 70,204 45,939 86,257 163,032 253 718,291 Owner-occupied CRE Pass 90,775 138,505 159,490 82,296 146,869 299,609 — — 917,544 SM — — 2,219 2,775 705 16,266 — — 21,965 SS — — 4,908 654 — 13,549 — — 19,111 Total 90,775 138,505 166,617 85,725 147,574 329,424 — — 958,620 Non-owner occupied CRE Pass 153,239 260,431 216,811 157,424 239,928 628,489 — — 1,656,322 SM — — 8,172 — 570 19,300 — — 28,042 SS — 598 — — — 12,612 — — 13,210 Total 153,239 261,029 224,983 157,424 240,498 660,401 — — 1,697,574 Total commercial business Pass 364,987 549,790 450,532 306,084 427,104 1,005,022 141,740 188 3,245,447 SM — 2,495 10,495 3,067 5,831 37,024 9,124 — 68,036 SS — 1,813 7,642 4,202 1,076 34,036 12,168 65 61,002 Total 364,987 554,098 468,669 313,353 434,011 1,076,082 163,032 253 3,374,485 Commercial business gross charge-offs Current period — — 254 323 27 115 — — 719 Residential real estate Pass 36,321 141,201 141,430 24,108 15,022 16,297 — — 374,379 SS — — 801 — — 162 — — 963 Total 36,321 141,201 142,231 24,108 15,022 16,459 — — 375,342 Real estate construction and land development: Residential Pass 41,663 24,760 1,050 1,289 804 719 1 — 70,286 SM — — 2,139 — — — — — 2,139 SS 1,000 319 4,866 — — — — — 6,185 Total 42,663 25,079 8,055 1,289 804 719 1 — 78,610 Commercial and multifamily Pass 42,499 187,827 91,460 337 749 3,145 — — 326,017 SM — — — 3,777 5,660 365 — — 9,802 Total 42,499 187,827 91,460 4,114 6,409 3,510 — — 335,819 Total real estate construction and land development Pass 84,162 212,587 92,510 1,626 1,553 3,864 1 — 396,303 SM — — 2,139 3,777 5,660 365 — — 11,941 SS 1,000 319 4,866 — — — — — 6,185 Total 85,162 212,906 99,515 5,403 7,213 4,229 1 — 414,429 67 Table of Contents December 31, 2023 Revolving Loans Revolving Loans Converted (1) Loans Receivable Term Loans Amortized Cost Basis by Origination Year 2023 2022 2021 2020 2019 Prior Consumer Pass 1,897 1,980 293 6,221 15,841 20,402 122,007 1,123 169,764 SS — — — 134 207 893 333 40 1,607 Total 1,897 1,980 293 6,355 16,048 21,295 122,340 1,163 171,371 Consumer gross charge-offs: Current period 7 10 30 29 106 152 252 — 586 Loans receivable Pass 487,367 905,558 684,765 338,039 459,520 1,045,585 263,748 1,311 4,185,893 SM — 2,495 12,634 6,844 11,491 37,389 9,124 — 79,977 SS 1,000 2,132 13,309 4,336 1,283 35,091 12,501 105 69,757 Total $ 488,367 $ 910,185 $ 710,708 $ 349,219 $ 472,294 $ 1,118,065 $ 285,373 $ 1,416 $ 4,335,627 Gross charge-offs: Total $ 7 $ 10 $ 284 $ 352 $ 133 $ 267 $ 252 $ — $ 1,305 (1) Represents the loans receivable balance at December 31, 2023 which was converted from a revolving loan to a non-revolving amortizing loan during the year ended December 31, 2023. December 31, 2022 Revolving Loans Revolving Loans Converted (1) Loans Receivable Term Loans Amortized Cost Basis by Origination Year 2022 2021 2020 2019 2018 Prior (Dollars in thousands) Commercial business: Commercial and industrial Pass $ 168,818 $ 94,653 $ 82,554 $ 61,160 $ 33,957 $ 74,181 $ 146,795 $ 172 $ 662,290 SM 212 109 443 4,637 362 4,447 5,433 — 15,643 SS 773 188 1,710 3,465 559 5,098 3,674 168 15,635 Total 169,803 94,950 84,707 69,262 34,878 83,726 155,902 340 693,568 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 68 Table of Contents December 31, 2022 Revolving Loans Revolving Loans Converted (1) Loans Receivable Term Loans Amortized Cost Basis by Origination Year 2022 2021 2020 2019 2018 Prior 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 a non-revolving amortizing loan during the year ended December 31, 2022 (d) Nonaccrual Loans The following tables present the amortized cost of nonaccrual loans at the dates indicated: December 31, 2023 Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual (Dollars in thousands) Commercial business: Commercial and industrial $ 1,706 $ 2,557 $ 4,263 Owner-occupied CRE — 205 205 Total commercial business 1,706 2,762 4,468 Total $ 1,706 $ 2,762 $ 4,468 December 31, 2022 Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual (Dollars in thousands) Commercial business: Commercial and industrial $ 4,503 $ 1,154 $ 5,657 69 Table of Contents December 31, 2022 Nonaccrual without ACL Nonaccrual with ACL Total Nonaccrual (Dollars in thousands) 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 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, 2023 Year Ended December 31, 2022 Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized (Dollars in thousands) Commercial business: Commercial and industrial $ ( 61 ) $ 347 $ ( 14 ) $ 263 Owner-occupied CRE — — — 53 Non-owner occupied CRE — — — 774 Total commercial business ( 61 ) 347 ( 14 ) 1,090 Residential real estate — — — 19 Real estate construction and land development: Commercial and multifamily — — ( 14 ) 65 Consumer — — — 68 Total $ ( 61 ) $ 347 $ ( 28 ) $ 1,242 For the year ended December 31, 2023 and 2022, 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 Company performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due. The following tables present the amortized cost of past due loans at the dates indicated: December 31, 2023 30-89 Days 90 Days or Greater Total Past Due Current Loans Receivable (Dollars in thousands) Commercial business: Commercial and industrial $ 2,289 $ 3,857 $ 6,146 $ 712,145 $ 718,291 Owner-occupied CRE — 189 189 958,431 958,620 Non-owner occupied CRE 1,489 — 1,489 1,696,085 1,697,574 Total commercial business 3,778 4,046 7,824 3,366,661 3,374,485 Residential real estate 162 — 162 375,180 375,342 Real estate construction and land development: Residential — 319 319 78,291 78,610 Commercial and multifamily — — — 335,819 335,819 Total real estate construction and land development — 319 319 414,110 414,429 Consumer 615 87 702 170,669 171,371 Total $ 4,555 $ 4,452 $ 9,007 $ 4,326,620 $ 4,335,627 70 Table of Contents December 31, 2022 30-89 Days 90 Days or Greater Total Past Due Current Loans Receivable (Dollars in thousands) Commercial business: Commercial and industrial $ 822 $ 6,104 $ 6,926 $ 686,642 $ 693,568 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 Loans 90 days or more past due and still accruing interest were $ 1.3 million and $ 1.6 million as of December 31, 2023 and December 31, 2022, respectively. (f) Collateral-dependent Loans The following tables present 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 at the dates indicated, 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, 2023 CRE Farmland Residential Real Estate Equipment Total (Dollars in thousands) Commercial business: Commercial and industrial $ 260 $ 389 $ 621 $ 304 $ 1,574 Owner-occupied CRE 189 — — — 189 Total commercial business 449 389 621 304 1,763 Total $ 449 $ 389 $ 621 $ 304 $ 1,763 December 31, 2022 CRE Farmland Residential Real Estate Total (Dollars in thousands) Commercial business: Commercial and industrial $ 1,239 $ 1,977 $ 929 $ 4,145 Owner-occupied CRE 189 — — 189 Total commercial business 1,428 1,977 929 4,334 Total $ 1,428 $ 1,977 $ 929 $ 4,334 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, 2023, except changes due to additions or removals of loans in this classification. (g) Modification of Loans In January 2023, the Company adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for TDRs while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. This guidance was applied on a prospective basis. 71 Table of Contents Modifications of loans to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. The following table presents loan modifications by type of modification at amortized cost that were modified as a result of experiencing both financial difficulty and modified during the period indicated: Year Ended December 31, 2023 Term Extension Term Extension & Int. Rate Reduction Total Modified Loans % of Modified Loans to Loans Receivable, net (Dollars in thousands) Commercial business: Commercial and industrial $ 16,822 $ — $ 16,822 2.34 % Owner-occupied CRE 209 — $ 209 0.02 Non-owner occupied CRE 2,701 237 2,938 0.17 Total commercial business 19,732 237 19,969 0.59 Real estate construction and land development: Residential 5,866 — 5,866 7.46 Commercial and multifamily 3,777 — 3,777 1.12 Total real estate construction and land development 9,643 — 9,643 2.33 Consumer 26 15 41 0.02 Total $ 29,401 $ 252 $ 29,653 0.68 % The following tables present the financial effect of the loan modifications presented in the preceding table during the periods indicated: Year Ended December 31, 2023 Weighted Average % of Interest Rate Reductions Weighted Average Years of Term Extensions Commercial business: Commercial and industrial — % 0.48 Owner-occupied CRE — % 0.75 Non-owner occupied CRE 3.00 1.09 Total commercial business 3.00 0.57 Real estate construction and land development: Commercial and multifamily — 0.83 Consumer 1.00 2.64 Total 3.00 % 0.61 There were no modified loans included in the tables above that were past due or on nonaccrual as of December 31, 2023. There were no loans to borrowers experiencing financial difficulty that had a payment default within the year ended December 31, 2023 that were modified in the twelve months prior to that default. There were $6.6 million in commitments to lend additional funds to borrowers experiencing financial difficulty whose terms have been modified during the year ended December 31, 2023 through either principal forgiveness, interest rate reduction, term extension, or other than insignificant payment delay. (h) Related Party Loans In the ordinary course of business, the Company has granted loans to certain directors, executive officers and their affiliates. The following table presents the activity in related party loans during the periods indicated: Year Ended December 31, 2023 2022 2021 (Dollars in thousands) Balance outstanding at the beginning of year $ 6,879 $ 7,122 $ 7,694 Principal additions 122 — — 72 Table of Contents Principal reductions ( 252 ) ( 243 ) ( 572 ) Balance outstanding at the end of year $ 6,749 $ 6,879 $ 7,122 All related party loans were performing in accordance with the underlying loan agreements as of December 31, 2023 and December 31, 2022. The Company had $ 113,000 and $ 5,000 of unfunded commitments to related parties as of December 31, 2023 and December 31, 2022. (i) Commercial Loan Sales, Servicing, and Commercial Servicing Asset The following table presents the details of loans serviced for others at the dates indicated: December 31, 2023 December 31, 2022 (Dollars in thousands) Loans serviced for others with participating interest, gross loan balance $ 11,715 $ 17,375 Loans serviced for others with participating interest, participation balance owned by Company (1) 2,466 3,791 (1) Included in the balance of "Loans receivable " on the Consolidated Statements of Financial Condition. The Company recognized $ 135,000 , $ 217,000 and $ 320,000 of servicing income for the years ended December 31, 2023, 2022 and 2021, respectively. The Company's servicing asset at December 31, 2023 and December 31, 2022 was $ 128,000 and $ 192,000 , respectively. There was no valuation allowance on the Company's servicing asset as of December 31, 2023 and December 31, 2022. (j) Accrued interest receivable on loans receivable Accrued interest receivable on loans receivable totaled $ 13.3 million and $ 11.3 million at December 31, 2023 and December 31, 2022, respectively and 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 During the year ended December 31, 2023, the ACL on loans increased $ 5.0 million, or 11.7 %, due primarily to a provision for credit losses on loans of $ 4.7 million. The provision for credit losses on loans recognized during the year ended December 31, 2023 was due primarily to growth in balances of collectively evaluated loans. The ACL on loans to Loans receivable increased to 1.11% as December 31, 2023, compared to 1.06% at December 31, 2022 due to changes in the loan mix as loan growth occurred in segments requiring a higher calculated reserve as a percentage of loans including real estate construction and land development loans. The following tables detail the activity in the ACL on loans by segment and class for the periods indicated: Year Ended December 31, 2023 Beginning Balance Charge-offs Recoveries Provision for (Reversal of) Credit Losses Ending Balance (Dollars in thousands) Commercial business: Commercial and industrial $ 13,962 $ ( 719 ) $ 1,372 $ ( 3,487 ) $ 11,128 Owner-occupied CRE 7,480 — — 1,519 8,999 Non-owner occupied CRE 9,276 — — 1,900 11,176 Total commercial business 30,718 ( 719 ) 1,372 ( 68 ) 31,303 Residential real estate 2,872 — — 601 3,473 Real estate construction and land development: Residential 1,654 — — ( 11 ) 1,643 Commercial and multifamily 5,409 — — 3,824 9,233 Total real estate construction and land development 7,063 — — 3,813 10,876 Consumer 2,333 ( 586 ) 210 390 2,347 Total $ 42,986 $ ( 1,305 ) $ 1,582 $ 4,736 $ 47,999 73 Table of Contents Year Ended December 31, 2022 Beginning Balance Charge-offs Recoveries (Reversal of) Provision for Credit Losses Ending Balance (Dollars 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 (Dollars 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 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 The following table details the activity in the ACL on unfunded commitments during the periods indicated: Year Ended December 31, 2023 2022 2021 (Dollars in thousands) Balance, beginning of period $ 1,744 $ 2,607 $ 4,681 Reversal of credit losses on unfunded commitments ( 456 ) ( 863 ) ( 2,074 ) Balance, end of period $ 1,288 $ 1,744 $ 2,607 74 Table of Contents (5) Premises and Equipment The following table presents a summary of premises and equipment at the dates indicated: December 31, 2023 December 31, 2022 (Dollars in thousands) Land $ 18,721 $ 19,565 Buildings and building improvements 63,986 65,853 Furniture, fixtures and equipment 28,325 24,825 Total premises and equipment 111,032 110,243 Less: Accumulated depreciation ( 36,133 ) ( 33,313 ) Premises and equipment, net $ 74,899 $ 76,930 Total depreciation expense on premises and equipment was $ 6.3 million, $ 5.4 million and $ 5.3 million for the years ended December 31, 2023, 2022 and 2021, respectively. (6) 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, 2023, 2022, and 2021. Due to a sustained decline in stock price during the three months ended June 30, 2023, the Company determined a triggering event occurred and consequently performed a quantitative assessment of goodwill as of May 31, 2023. We estimated the fair value of the reporting unit by weighting results from the market approach and the income approach. Significant assumptions inherent in the valuation methodologies for goodwill were employed and included, but were not limited to, prospective financial information, growth rates, terminal value, discount rates, and comparable multiples from publicly traded companies in our industry. Based on this quantitative test, we determined that the fair value of the reporting unit more likely than not exceeded the carrying value. At December 31, 2023, the Company determined that goodwill was not considered impaired as no material adverse changes had occurred since the quantitative assessment performed as of May 31, 2023 and the fair value of the reporting unit still exceeded the carrying value. Similarly, no goodwill impairment charges were recorded for the years ended December 31, 2022 and 2021. (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, 2023, 2022, and 2021. The following table presents the changes in carrying value of other intangible assets at the dates indicated: December 31, 2023 December 31, 2022 (Dollars in thousands) Gross Carrying Value $ 30,455 30,455 Accumulated amortization ( 25,662 ) ( 23,228 ) Net carrying value $ 4,793 $ 7,227 The following table presents the estimated aggregate amortization of other intangible assets at the dates indicated: December 31, 2023 Estimated amortization expense 2024 $ 1,640 2025 1,173 2026 1,006 2027 974 Total $ 4,793 75 Table of Contents (7) Derivative Financial Instruments The following table presents the notional amounts and estimated fair values of derivatives at the dates indicated: December 31, 2023 December 31, 2022 Notional Amounts Estimated Fair Value Notional Amounts Estimated Fair Value (Dollars in thousands) Non-hedging interest rate derivatives: Interest rate swap asset (1) $ 291,740 $ 23,195 $ 288,785 $ 30,107 Interest rate swap liability (1) 291,740 ( 23,195 ) 288,785 ( 30,107 ) (1) The estimated fair value of derivatives with customers was $( 22.5 ) million and $( 30.1 ) million as of December 31, 2023 and December 31, 2022, respectively. The estimated fair value of derivatives with third-parties was $ 22.5 million and $ 30.1 million as of December 31, 2023 and December 31, 2022, respectively. Generally, the gains and losses of the interest rate derivatives offset each other due to the back-to-back nature of the contracts. However, the settlement values of the Company's net derivative assets with customers had no change as of December 31, 2023, and increased $ 66,000 , and $ 355,000 as of December 31, 2022, and December 31, 2021, respectively, due to the change in the credit valuation adjustment. (8) Deposits The following table summarizes the Company's deposits at the dates indicated: December 31, 2023 2022 Amount Amount (Dollars in thousands) Noninterest demand deposits $ 1,715,847 $ 2,099,464 Interest bearing demand deposits 1,608,745 1,830,727 Money market accounts 1,094,351 1,063,243 Savings accounts 487,956 623,833 Certificates of deposit 692,973 307,573 Total deposits $ 5,599,872 $ 5,924,840 Deposit accounts overdrawn and reclassified to loans receivable were $ 293,000 and $ 317,000 as of December 31, 2023 and December 31, 2022, respectively. Accrued interest payable on deposits was $ 250,000 and $ 70,000 as of December 31, 2023 and December 31, 2022, respectively and is included in "Accrued expenses and other liabilities" in the Consolidated Statements of Financial Condition. Scheduled maturities of certificates of deposit for years after December 31, 2023 are as follows, in thousands: 2024 $ 666,454 2025 12,011 2026 4,052 2027 4,588 2028 5,848 Thereafter 20 Total $ 692,973 Certificates of deposit issued in denominations equal to or in excess of $250,000 totaled $ 375.9 million and $ 103.7 million as of December 31, 2023 and December 31, 2022, respectively. Deposits received from related parties as of December 31, 2023 and December 31, 2022 totaled $ 4.2 million and $ 6.8 million, respectively. (9) 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, 2023 and December 31, 2022, the balance of the junior subordinated debentures, net of unaccreted discount, was $ 21.8 million and $ 21.5 million, respectively. 76 Table of Contents 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 SOFR 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, 2023 and December 31, 2022 was 7.23 % and 6.33 %, respectively. 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 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. As of December 31, 2023, the junior subordinated debentures qualified as tier 1 capital of the Parent Company under the FRB's capital adequacy guidelines. (10) Securities Sold Under Agreement to Repurchase The Company has utilized securities sold under agreement to repurchase with one day maturities as a supplement to funding sources in the past. Securities sold under agreement to repurchase were secured by pledged investment securities. Under the securities sold under agreement to repurchase , the Company was required to maintain an aggregate market value of securities pledged greater than the balance of the securities sold under agreement to repurchase . The Company was required to pledge additional securities to cover any declines below the balance of the securities sold under agreement to repurchase . The Company discontinued utilizing these instruments during the year ended December 31, 2023. The following table presents the balance of the Company's securities sold under agreement to repurchase obligations by class of collateral pledged at the date indicated: December 31, 2023 December 31, 2022 (Dollars in thousands) Commercial CMO and MBS $ — $ 46,597 Total $ — $ 46,597 (11) 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 creditworthiness. At December 31, 2023, the Bank maintained a credit facility with the FHLB with available borrowing capacity of $ 1.42 billion. At December 31, 2023 and December 31, 2022 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) FRB The Bank maintains a credit facility with the FRB through both the Discount Window and BTFP with available borrowing capacity of $ 819.5 million as of December 31, 2023. The Bank had $ 500.0 million in BTFP borrowings outstanding at December 31, 2023. The BTFP offers loans of up to one year in length to institutions pledging eligible investment securities. The advance rate on the collateral is at par value. The average rate on borrowings from the BTFP was 4.74 %. The Bank had no FRB borrowings outstanding at December 31, 2022. All advances are currently secured by investment securities. Any advances on the credit facility would be secured by either investment securities or certain types of the Bank's loans receivable. (c) Federal Funds Purchased The Bank maintains advance lines with four correspondent banks to purchase federal funds totaling $ 145.0 million as of December 31, 2023. The lines generally mature annually or renewed annually. As of December 31, 2023 and December 31, 2022, there were no federal funds purchased. 77 Table of Contents (d) Related Party Borrowings The Company did no t have any borrowings from related parties as of December 31, 2023 or December 31, 2022. (12) 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, 2023 and December 31, 2022, the Company’s operating lease ROU asset was $ 23.6 million and $ 22.7 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 $ 25.5 million and $ 24.4 million, respectively and is included in " Accrued expenses and other liabilities " on the Consolidated Statements of Financial Condition. In addition, the Company has one operating sublease agreement in which the Company is the intermediate lessor. The operating sublease is for five years with rental increases on a predetermined escalation schedule with a projected future cash flow of $ 1.7 million. 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, 2023 2022 (Dollars in thousands) Operating lease cost $ 5,279 $ 4,942 Short-term lease cost 80 80 Variable lease cost 1,243 1,118 Sublease income ( 392 ) ( 87 ) Total net lease cost during the period $ 6,210 $ 6,053 Operating cash used for amounts included in the measurement of lease liabilities during the period $ 4,982 $ 4,748 ROU assets obtained in exchange for lease liabilities during the period 6,880 2,869 Weighted average remaining lease term of operating leases, in years, at period end 6.2 6.5 Weighted average discount rate of operating leases, at period end 2.95 % 2.42 % The following table presents the lease payment obligations as of December 31, 2023 as outlined in the Company’s lease agreements for each of the next five years and thereafter, in thousands: 2024 $ 5,163 2025 4,977 2026 4,575 2027 4,134 2028 2,583 Thereafter 6,754 Total lease payments 28,186 Implied interest ( 2,644 ) ROU liability $ 25,542 During the year ended December 31, 2023, the Company entered into two lease agreements for $ 2.9 million and $ 700,000 commencing on January 22, 2024 and February 1, 2024. These lease agreements are not included in the lease payment obligations in the table above. (13) 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, 2023, 2022 and 2021 were $ 1.9 million, $ 1.8 million and $ 1.7 million, respectively. 78 Table of Contents 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, 2023, 2022 and 2021, 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 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. The expense incurred for the deferred compensation for the years ended December 31, 2023, 2022, and 2021 was $ 409,000 , $ 882,000 , and $ 713,000 . As a result, the Company recorded a deferred compensation liability of $ 4.5 million and $ 4.3 million at December 31, 2023 and 2022. (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, 2023 2022 2021 (Dollars in thousands) Obligation, at the beginning of the year $ 3,576 $ 3,835 $ 4,162 Benefits paid ( 881 ) ( 450 ) ( 536 ) Expenses incurred 142 191 209 Obligation, at the end of the year $ 2,837 $ 3,576 $ 3,835 (14) Stockholders’ Equity (a) Earnings Per Common Share The following table illustrates the calculation of weighted average shares used for earnings per common share computations for the periods indicated: Year Ended December 31, 2023 2022 2021 (Dollars in thousands, except shares) Net income allocated to common shareholders $ 61,755 $ 81,875 $ 98,035 Basic: Weighted average common shares outstanding 35,022,247 35,103,465 35,677,851 Diluted: Basic weighted average common shares outstanding 35,022,247 35,103,465 35,677,851 Effect of potentially dilutive common shares (1) 235,942 360,431 295,535 Total diluted weighted average common shares outstanding 35,258,189 35,463,896 35,973,386 Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (2) 171,010 872 7,043 (1) Represents the effect of the vesting of restricted stock units. (2) Anti-dilution occurs when the unrecognized compensation cost per share of a restricted stock 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. 79 Table of Contents The following table summarizes the dividend activity during the most recent three year period: Declared Cash Dividend per Share Record Date Paid Date 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 January 25, 2023 $ 0.22 February 8, 2023 February 22, 2023 April 19, 2023 $ 0.22 May 4, 2023 May 18, 2023 July 19, 2023 $ 0.22 August 2, 2023 August 16, 2023 October 18, 2023 $ 0.22 November 1, 2023 November 15, 2023 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. (c) Stock Repurchase Program The Company has implemented stock repurchase programs since March 1999. 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. 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 repurchase plan for the periods indicated: Year Ended December 31, 2023 2022 2021 Plan Total (1) Twelfth Stock Repurchase Plan Repurchased shares 330,424 100,090 904,972 1,491,264 Stock repurchase average share price $ 18.92 $ 25.07 $ 24.43 $ 22.82 (1) Represents total shares repurchased and average price per share paid during the duration of the repurchase 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 units. The following table provides total shares repurchased to pay withholding taxes during the periods indicated: Year Ended December 31, 2023 2022 2021 Repurchased shares to pay withholding taxes 32,792 10 26,944 26,869 Stock repurchase to pay withholding taxes average share price $ 22.01 $ 25.52 $ 29.10 (15) 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, 80 Table of Contents 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. 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 Company 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 Company. Once received, the Company's internal appraisal department reviews and approves the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Derivative Financial Instruments : The Company obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of the measurement date (Level 2), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3). Although the Company 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, 2023 and December 31, 2022, the Company 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 Company has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy. 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, 2023 Total Level 1 Level 2 Level 3 (Dollars in thousands) Assets Investment securities available for sale: U.S. government and agency securities $ 13,750 $ — $ 13,750 $ — Municipal securities 79,525 — 79,525 — Residential CMO and MBS (1) 512,049 — 512,049 — Commercial CMO and MBS (1) 504,258 — 504,258 — Corporate obligations 7,613 — 7,613 — Other asset-backed securities 17,158 — 17,158 — Total investment securities available for sale 1,134,353 — 1,134,353 — Equity security 314 314 — — 81 Table of Contents December 31, 2023 Total Level 1 Level 2 Level 3 (Dollars in thousands) Derivative assets - interest rate swaps 23,195 — 23,195 — Liabilities Derivative liabilities - interest rate swaps $ 23,195 $ — $ 23,195 $ — (1) U.S. government agency and government-sponsored enterprise CMO and MBS. December 31, 2022 Total Level 1 Level 2 Level 3 (Dollars 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 (1) 424,386 — 424,386 — Commercial CMO and MBS (1) 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 $ — (1) U.S. government agency and government-sponsored enterprise CMO and MBS. 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 presents assets measured at fair value on a nonrecurring basis at the dates indicated: Fair Value at December 31, 2023 Total Level 1 Level 2 Level 3 Collateral-dependent loans: Commercial business: Owner-occupied CRE $ 173 $ — $ — $ 173 Total assets measured at fair value on a nonrecurring basis $ 173 $ — $ — $ 173 Fair Value at December 31, 2022 Total Level 1 Level 2 Level 3 Collateral-dependent loans: Commercial business: Owner-occupied CRE $ 182 $ — $ — $ 182 Total assets measured at fair value on a nonrecurring basis $ 182 $ — $ — $ 182 82 Table of Contents 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, 2023 Fair Value Valuation Technique(s) Unobservable Input(s) Range of Inputs Weighted Average (1) (Dollars in thousands) Collateral-dependent loans $ 173 Market approach Adjustments to reflect current conditions and selling costs 16.5 % - 16.5 % 16.5 % (1) Weighted by net discount to net appraisal fair value December 31, 2022 Fair Value Valuation Technique(s) Unobservable Input(s) Range of Inputs Weighted Average (1) (Dollars in thousands) Collateral-dependent loans $ 182 Market approach Adjustments to reflect current conditions and selling costs 14.6 % - 14.6 % 14.6 % (1) Weighted by net discount to net appraisal fair value (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 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, 2023 Carrying Value Fair Value Fair Value Measurements Using: Level 1 Level 2 Level 3 (Dollars in thousands) Financial Assets: Cash and cash equivalents $ 224,973 $ 224,973 $ 224,973 $ — $ — Investment securities available for sale 1,134,353 1,134,353 — 1,134,353 — Investment securities held to maturity 739,442 662,450 — 662,450 — Loans receivable, net 4,287,628 4,159,513 — — 4,159,513 Accrued interest receivable 19,518 19,518 96 6,127 13,295 Derivative assets - interest rate swaps 23,195 23,195 — 23,195 — Equity security 314 314 314 — — Financial Liabilities: Non-maturity deposits $ 4,906,899 $ 4,906,899 $ 4,906,899 $ — $ — Certificates of deposit 692,973 701,029 — 701,029 — Borrowings 500,000 499,861 — 499,861 — Junior subordinated debentures 21,765 19,750 — — 19,750 Accrued interest payable 13,026 13,026 63 12,880 83 Derivative liabilities - interest rate swaps 23,195 23,195 — 23,195 — 83 Table of Contents December 31, 2022 Carrying Value Fair Value Fair Value Measurements Using: Level 1 Level 2 Level 3 (Dollars 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 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 — (16) Stock-Based Compensation On May 3, 2023, based upon the recommendation of the Compensation Committee, the Company's shareholders approved the Heritage Financial Corporation 2023 Omnibus Equity Plan, or "Equity Plan", that provides for the issuance of 1,250,000 shares of the Company's common stock in the form of various types of stock-based compensation. As of December 31, 2023, there were 1,200,714 shares available for future issuance under the Equity Plan. The Equity Plan replaces the Heritage Financial Corporation 2014 Omnibus Equity Plan (the "2014 Plan"). All remaining shares available for future issuance under the 2014 Plan were terminated upon approval of the Equity Plan. All shares issued under the 2014 Plan remain outstanding and are governed by the 2014 Plan. (a) Restricted Stock Units Restricted stock units generally vest ratably over three years , participate in dividends 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, 2023 2022 2021 Shares issued 15,112 15,464 14,347 Expected Term in Years 2.9 2.9 2.9 Weighted-Average Risk Free Interest Rate 4.4 % 1.7 % 0.3 % Weighted Average Fair Value 23.85 25.87 24.49 Range of peer company volatilities 25.8 %- 107.5 % 31.6 %- 77.8 % 31.4 %- 136.4 % Company volatility 35.8 % 41.3 % 40.2 % 84 Table of Contents 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, 2023, 2022 and 2021, the Company recognized compensation expense related to restricted stock units of $ 4.3 million, $ 3.8 million, and $ 3.7 million respectively, and a related tax benefit of $ 949,000 , $ 833,000 , and $ 802,000 , respectively. As of December 31, 2023, the total unrecognized compensation expense related to non-vested restricted stock units was $ 6.8 million and the related weighted-average period over which the compensation expense is expected to be recognized was approximately 2.1 years. The vesting date fair value of the restricted stock units that vested during the years ended December 31, 2023, 2022 and 2021 was $ 3.5 million, $ 3.3 million and $ 3.6 million, respectively. The following table summarizes the unit activity for the periods indicated: Units Weighted-Average Grant Date Fair Value 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 Granted 225,107 25.53 Vested ( 162,752 ) 25.05 Forfeited ( 33,359 ) 26.08 Nonvested at December 31, 2023 407,888 $ 25.59 (17) Cash Restriction The Company had no cash restrictions at December 31, 2023 and December 31, 2022. (18) 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, 2023 2022 2021 (Dollars in thousands) Current tax expense $ 24,364 $ 16,690 $ 20,896 Deferred tax expense (benefit) ( 13,204 ) 871 1,576 Income tax expense $ 11,160 $ 17,561 $ 22,472 The effective tax rate was 15.3 % for the December 31, 2023 compared to an effective tax rate of 17.7 % and 18.6 % for the years ended December 31, 2022 and 2021, respectively. The decrease in the effective tax rate during the year ended December 31, 2023 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, 2023 which increased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and low-income housing and solar tax credits. 85 Table of Contents 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, 2023 2022 2021 (Dollars in thousands) Income tax expense at Federal statutory rate $ 15,312 $ 20,882 $ 25,307 State tax, net of Federal tax benefit 827 936 960 Tax-exempt instruments ( 1,311 ) ( 1,733 ) ( 1,929 ) Federal tax credits and other benefits (1) ( 3,205 ) ( 1,979 ) ( 1,630 ) Effects of BOLI ( 564 ) ( 735 ) ( 474 ) Other, net 101 190 238 Income tax expense $ 11,160 $ 17,561 $ 22,472 (1) Federal tax credits are provided for under the NMTC, Solar Tax Credits and LIHTC programs as described in Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements. The following table presents major components of the deferred income tax asset (liability) resulting from differences between financial reporting and tax basis at the dates indicated: December 31, 2023 December 31, 2022 (Dollars in thousands) Deferred tax assets: Allowance for credit losses $ 10,798 $ 9,796 Accrued compensation 2,918 3,538 Stock compensation 793 726 Market discount on acquired loans 654 714 Foregone interest on nonaccrual loans 425 705 Net operating loss carryforward acquired 145 166 ROU lease liability 5,596 5,337 Net unrealized losses on investment securities 20,395 28,061 Tax Credit Carryforward 11,085 — Other deferred tax assets 503 120 Total deferred tax assets 53,312 49,163 Deferred tax liabilities: Deferred loan fees, net ( 1,263 ) ( 1,508 ) Premises and equipment ( 2,268 ) ( 2,999 ) FHLB stock ( 216 ) ( 577 ) Goodwill and other intangible assets ( 816 ) ( 1,211 ) Junior subordinated debentures ( 873 ) ( 937 ) ROU lease asset ( 5,170 ) ( 4,967 ) Other deferred tax liabilities ( 167 ) ( 163 ) Total deferred tax liabilities ( 10,773 ) ( 12,362 ) Deferred tax asset, net $ 42,539 $ 36,801 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, 2023, 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, 2023 and December 31, 2022, the Company had a net operating loss carryforward of $ 691,000 and $ 789,000 , respectively, that does 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, 2023 and December 31, 2022. At December 31, 2023, the Company had a tax credit carryforward of $11,085,000 that expires in 2043. 86 Table of Contents Due to sufficient earnings history and other positive evidence, management has not recorded a valuation allowance on the tax credit carryforward as of December 31, 2023. As of December 31, 2023 and December 31, 2022, 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 penalties accrued as of December 31, 2023 and December 31, 2022 and recognized during the years ended December 31, 2023, 2022 and 2021 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, 2023, 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, Oregon State and local income tax returns, and Idaho State tax return. The tax years subject to examination by the Internal Revenue Service are the years ended December 31, 2023, 2022, 2021 and 2020. (19) Commitments and Contingencies (a) Commitments to Extend Credit In the ordinary course of business, the Company may enter into various types of transactions that include commitments to extend credit that are not included in its Consolidated Financial Statements. The Company 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 Company’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, 2023 December 31, 2022 (Dollars in thousands) Commercial business: Commercial and industrial $ 542,975 $ 548,438 Owner-occupied CRE 8,731 3,083 Non-owner occupied CRE 26,534 13,396 Total commercial business 578,240 564,917 Real estate construction and land development: Residential 46,924 43,460 Commercial and multifamily 308,206 348,956 Total real estate construction and land development 355,130 392,416 Consumer 335,729 323,016 Total outstanding commitments $ 1,269,099 $ 1,280,349 (b) Variable Interests - LIHTC Investments The carrying values of investments in unconsolidated LIHTCs were $ 206.8 million and $ 191.3 million as of December 31, 2023 and December 31, 2022, respectively. During the years ended December 31, 2023, 2022 and 2021 the Company recognized tax benefits of $ 19.6 million, $ 12.9 million and $ 11.4 million, respectively, and proportional amortization of $ 20.9 million, $ 10.9 million and $ 9.7 million, respectively. Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $ 107.9 million and $ 109.2 million at December 31, 2023 and December 31, 2022, respectively. The Company expects to fund LIHTC commitments totaling $ 29.5 million during the year ending December 31, 2024 and $ 62.6 million during the year ending December 31, 2025, with the remaining commitments of $ 15.9 million to be funded by December 31, 2041. There were no impairment losses on the Company’s LIHTC investments during the years ended December 31, 2023, 2022 and 2021. (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 during the year ended December 31, 2021. 87 Table of Contents (20) 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, 2023, the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 2023 and December 31, 2022, 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 dates indicated: Company Heritage Bank December 31, 2023 December 31, 2022 December 31, 2023 December 31, 2022 Common equity Tier 1 capital ratio 12.9 % 12.8 % 12.9 % 12.9 % Leverage ratio 10.0 9.7 9.8 9.4 Tier 1 capital ratio 13.3 13.2 12.9 12.9 Total capital ratio 14.1 14.0 13.8 13.7 Capital conservation buffer 6.1 6.0 5.8 5.7 As of December 31, 2023 and 2022, 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. (21) 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, 2023 December 31, 2022 (Dollars in thousands) ASSETS Cash and cash equivalents $ 15,752 $ 12,926 Investment in subsidiary bank 856,460 804,123 Other assets 3,455 2,838 Total assets $ 875,667 $ 819,887 LIABILITIES AND STOCKHOLDERS’ EQUITY Junior subordinated debentures $ 21,765 $ 21,473 Other liabilities 641 521 Total stockholders’ equity 853,261 797,893 Total liabilities and stockholders’ equity $ 875,667 $ 819,887 88 Table of Contents HERITAGE FINANCIAL CORPORATION (PARENT COMPANY ONLY) Condensed Statements of Income Year Ended December 31, 2023 2022 2021 (Dollars in thousands) INTEREST INCOME: Interest on interest earning deposits $ 26 $ 15 $ 30 INTEREST EXPENSE: Junior subordinated debentures 2,074 1,156 742 Net interest expense ( 2,048 ) ( 1,141 ) ( 712 ) NONINTEREST INCOME: Dividends from subsidiary bank 43,500 44,000 46,000 Equity in undistributed income of subsidiary bank 24,963 43,507 57,058 Other income 192 33 117 Total noninterest income 68,655 87,540 103,175 NONINTEREST EXPENSE: Professional services 455 476 394 Other expense 6,282 5,631 5,430 Total noninterest expense 6,737 6,107 5,824 Income before income taxes 59,870 80,292 96,639 Income tax benefit ( 1,885 ) ( 1,583 ) ( 1,396 ) Net income $ 61,755 $ 81,875 $ 98,035 HERITAGE FINANCIAL CORPORATION (PARENT COMPANY ONLY) Condensed Statements of Cash Flows Year Ended December 31, 2023 2022 2021 (Dollars in thousands) Cash flows from operating activities: Net income $ 61,755 $ 81,875 $ 98,035 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiary bank ( 24,963 ) ( 43,507 ) ( 57,058 ) Stock-based compensation expense 4,325 3,795 3,666 Net change in other assets and other liabilities ( 497 ) ( 63 ) 960 Net cash provided by operating activities 40,620 42,100 45,603 Cash flows from financing activities: Common stock cash dividends paid ( 30,820 ) ( 29,491 ) ( 28,937 ) Repurchase of common stock ( 6,974 ) ( 3,196 ) ( 22,889 ) Net cash used in financing activities ( 37,794 ) ( 32,687 ) ( 51,826 ) Net (decrease) increase in cash and cash equivalents 2,826 9,413 ( 6,223 ) Cash and cash equivalents at the beginning of year 12,926 3,513 9,736 Cash and cash equivalents at the end of year $ 15,752 $ 12,926 $ 3,513 89 Table of Contents ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None