Mechanics Bancorp 10-K

ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the shareholders and the Board of Directors of HomeStreet, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of HomeStreet, Inc. and subsidiaries (the "Company") as of December 31, 2022 and 2021, the related consolidated income statements, statements of comprehensive income (loss), shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2023, expressed an unqualified opinion on the Company's internal control over financial reporting. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits 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. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Allowance for Credit Losses for Loans Held for Investment — Economic Qualitative Factor — Refer to Notes 1 and 3 to the financial statements Critical Audit Matter Description The Company accounts for its allowance for credit losses (“ACL”) for loans held for investment in accordance with Accounting Standards Update No. 2016-13, Financial Instruments —Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the measurement of the current expected credit losses for financial assets held at the reporting date. The ACL is a valuation account that is deducted from the amortized cost basis to present the net amount expected to be collected on the loans. Management estimates the ACL balance using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. The Company's ACL model uses statistical analysis to determine life of loan default rates for the quantitative component and analyzes qualitative factors (“Q-Factors”) that assess the current loan portfolio and forecasted economic environment. The Q-Factors adjust the expected historic loss rates for current and forecasted conditions that are not provided for in the historical loss information. The significant qualitative adjustment relates to the economic Q-Factor. We identified the estimate of the current conditions and reasonable and supportable forecast within the economic Q-Factor as a critical audit matter because of the significant judgment applied by management in determining the qualitative adjustment. 44 Auditing the Company’s qualitative adjustment for the economic Q-Factor required a high degree of auditor judgment and an increased extent of effort. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to the portion of the ACL attributable to the economic Q-Factor included the following: • We tested the effectiveness of controls over Q-Factor adjustments within the ACL model, including management’s review of the economic Q-Factor. • We assessed the appropriateness of the framework for the Q-Factor adjustments. • We tested the mathematical accuracy of Q-Factor adjustments within the ACL model. • We evaluated management’s forecasts used in its qualitative adjustments by comparing the forecasts to relevant external data. • We tested management’s process to evaluate the relationship between changes in economic data and historical credit losses and to determine qualitative adjustments attributable to the economic Q-Factor by evaluating whether, and to what extent, the current and forecasted conditions warranted a qualitative adjustment. Single Family Mortgage Servicing Rights — Projected Prepayment Speed and Discount Rate Assumptions — Refer to Notes 1, 9, and 13 to the financial statements Critical Audit Matter Description The Company initially records, and subsequently measures, single family mortgage servicing rights (“MSRs”) at fair value and categorizes its single family MSRs as “Level 3” financial instruments. Management uses a valuation model that calculates the present value of estimated future net servicing cash flows to estimate the fair value of single family MSRs. Changes in the fair value of single family MSRs result from changes in (1) model inputs and assumptions and (2) modeled amortization, representing the collection and realization of expected cash flows and curtailments over time. The significant model inputs used to estimate the fair value of single family MSRs include assumptions regarding projected prepayment speeds and discount rates. The Company's methodology for estimating the fair value of single family MSRs is highly sensitive to changes in these assumptions. We identified the projected prepayment speed and discount rate assumptions used in the single family MSRs valuation as a critical audit matter because of the significant judgment applied by management in determining these assumptions. Auditing the Company’s single family MSRs valuation required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists to evaluate the reasonableness of management’s assumptions related to the selection of projected prepayment speeds and discount rates used in the valuation of the single family MSRs. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to the reasonableness of projected prepayment speed and discount rate assumptions used in the valuation of the single family MSRs included the following: • We tested the effectiveness of controls over the fair value of single family MSRs, including controls over management’s review of the projected prepayment speeds and discount rates. • We compared management’s estimate of fair value for selected pools of single family MSRs to a fair value estimate independently determined by our fair value specialists using projected prepayment speeds and discount rates obtained from market survey data. • We compared management’s single family MSR fair value estimate and projected prepayment speed and discount rate assumptions to a third-party valuation report for the same portfolio. • We performed analytical procedures to compare changes in certain interest and mortgage rates to changes in single family MSR values and projected prepayment speeds. /s/ Deloitte & Touche LLP Seattle, Washington March 3, 2023 We have served as the Company’s auditor since 2013. 45 HOMESTREET, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS At December 31, (in thousands, except share data) 2022 2021 ASSETS Cash and cash equivalents $ 72,828 $ 65,214 Investment securities 1,400,212 1,006,691 Loans held for sale ("LHFS") 17,327 176,131 Loans held for investment ("LHFI") (net of allowance for credit losses of $ 41,500 and $ 47,123 ) 7,384,820 5,495,726 Mortgage servicing rights ("MSRs") 111,873 100,999 Premises and equipment, net 51,172 58,154 Other real estate owned ("OREO") 1,839 735 Goodwill and other intangible assets 29,980 31,709 Other assets 294,709 268,732 Total assets $ 9,364,760 $ 7,204,091 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits $ 7,451,919 $ 6,146,509 Borrowings 1,016,000 41,000 Long-term debt 224,404 126,026 Accounts payable and other liabilities 110,290 175,217 Total liabilities 8,802,613 6,488,752 Commitments and contingencies (Note 10) Shareholders' equity: Common stock, no par value, authorized 160,000,000 shares; issued and outstanding, 18,730,380 shares and 20,085,336 shares 226,592 249,856 Retained earnings 435,085 444,343 Accumulated other comprehensive income (loss) ( 99,530 ) 21,140 Total shareholders' equity 562,147 715,339 Total liabilities and shareholders' equity $ 9,364,760 $ 7,204,091 See accompanying notes to consolidated financial statements. 46 HOMESTREET, INC. AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS Years Ended December 31, (in thousands, except share and per share data) 2022 2021 2020 Interest income: Loans $ 266,841 $ 222,166 $ 228,999 Investment securities 33,825 21,560 21,786 Cash, Fed Funds and other 3,622 569 1,227 Total interest income 304,288 244,295 252,012 Interest expense: Deposits 32,013 11,411 33,797 Borrowings 38,968 5,827 9,553 Total interest expense 70,981 17,238 43,350 Net interest income 233,307 227,057 208,662 Provision for credit losses ( 5,202 ) ( 15,000 ) 20,469 Net interest income after provision for credit losses 238,509 242,057 188,193 Noninterest income: Net gain on loan origination and sale activities 17,701 92,318 122,564 Loan servicing income 12,388 7,233 9,491 Deposit fees 8,875 8,068 7,083 Other 12,606 12,356 10,226 Total noninterest income 51,570 119,975 149,364 Noninterest expense: Compensation and benefits 115,533 132,015 136,826 Occupancy 24,528 23,832 35,323 Information services 29,981 27,913 30,004 General, administrative and other 35,377 31,583 33,510 Total noninterest expense 205,419 215,343 235,663 Income before income taxes 84,660 146,689 101,894 Income tax expense 18,120 31,267 21,904 Net income $ 66,540 $ 115,422 $ 79,990 Net income per share Basic $ 3.51 $ 5.53 $ 3.50 Diluted $ 3.49 $ 5.46 $ 3.47 Weighted average shares outstanding: Basic 18,931,107 20,885,509 22,867,268 Diluted 19,041,111 21,143,414 23,076,822 See accompanying notes to consolidated financial statements. 47 HOMESTREET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Years Ended December 31, (in thousands) 2022 2021 2020 Net income $ 66,540 $ 115,422 $ 79,990 Other comprehensive income (loss): Unrealized gain (loss) on investment securities available for sale ("AFS") ( 158,499 ) ( 17,934 ) 39,627 Reclassification for net (gains) losses included in income ( 24 ) ( 62 ) ( 341 ) Other comprehensive income (loss) before tax ( 158,523 ) ( 17,996 ) 39,286 Income tax impact of: Unrealized gain (loss) on investment securities AFS ( 37,847 ) ( 3,766 ) 8,322 Reclassification for net (gains) losses included in income ( 6 ) ( 13 ) ( 72 ) Total ( 37,853 ) ( 3,779 ) 8,250 Other comprehensive income (loss) ( 120,670 ) ( 14,217 ) 31,036 Total comprehensive income (loss) $ ( 54,130 ) $ 101,205 $ 111,026 See accompanying notes to consolidated financial statements. 48 HOMESTREET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands, except share data) Number of shares Common stock Retained earnings Accumulated other comprehensive income (loss) Total Balance, December 31, 2019 23,890,855 $ 300,729 $ 374,673 $ 4,321 $ 679,723 Net income — — 79,990 — 79,990 Share-based compensation expense — 2,693 — — 2,693 Common stock issued - Option exercise; stock grants 140,386 782 — — 782 Cumulative effect of adoption of new accounting standards — — ( 3,740 ) — ( 3,740 ) Other comprehensive income (loss) — — — 31,036 31,036 Dividends declared ($ 0.60 per share) — — ( 13,865 ) — ( 13,865 ) Common stock repurchased ( 2,234,337 ) ( 25,699 ) ( 33,170 ) — ( 58,869 ) Balance, December 31, 2020 21,796,904 278,505 403,888 35,357 717,750 Net income — — 115,422 — 115,422 Share-based compensation expense — 3,398 — — 3,398 Common stock issued - Option exercise; stock grants 260,267 2,418 — — 2,418 Other comprehensive income (loss) — — — ( 14,217 ) ( 14,217 ) Dividends declared ($ 1.00 per share) — — ( 21,338 ) — ( 21,338 ) Common stock repurchased ( 1,971,835 ) ( 34,465 ) ( 53,629 ) — ( 88,094 ) Balance, December 31, 2021 20,085,336 249,856 444,343 21,140 715,339 Net income — — 66,540 — 66,540 Share-based compensation expense — 4,106 — — 4,106 Common stock issued - Stock grants 143,369 — — — — Other comprehensive income (loss) — — — ( 120,670 ) ( 120,670 ) Dividends declared ($ 1.40 per share) — — ( 26,847 ) — ( 26,847 ) Common stock repurchased ( 1,498,325 ) ( 27,370 ) ( 48,951 ) — ( 76,321 ) Balance, December 31, 2022 18,730,380 $ 226,592 $ 435,085 $ ( 99,530 ) $ 562,147 See accompanying notes to consolidated financial statements. 49 HOMESTREET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, (in thousands) 2022 2021 2020 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 66,540 $ 115,422 $ 79,990 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses ( 5,202 ) ( 15,000 ) 20,469 Depreciation and amortization, premises and equipment 9,707 9,908 9,438 Amortization of premiums and discounts: investment securities, deposits, debt 3,126 6,002 9,013 Operating leases: excess of payments over amortization ( 4,081 ) ( 4,029 ) ( 3,488 ) Amortization of finance leases 580 1,066 1,277 Amortization of core deposit intangibles 963 1,171 1,372 Amortization of deferred loan fees and costs ( 1,182 ) ( 8,569 ) 1,195 Share-based compensation expense 4,106 3,398 2,693 Lease impairment costs — — 10,873 Deferred income tax expense (benefit) ( 12,996 ) 7,884 ( 10,065 ) Loss on debt extinguishment — — 1,492 Origination of LHFS ( 670,905 ) ( 2,251,090 ) ( 2,453,110 ) Proceeds from sale of LHFS 831,095 2,379,116 2,407,287 Net fair value adjustment and gain on sale of LHFS 6,450 ( 42,358 ) ( 81,439 ) Origination of MSRs ( 11,778 ) ( 34,445 ) ( 31,012 ) Net gain on sale of loans originated as LHFI ( 88 ) ( 11,377 ) ( 6,895 ) Change in fair value of MSRs ( 6,788 ) 12,290 37,567 Amortization of servicing rights 7,692 7,581 5,657 Gain on sale of branches ( 4,270 ) — — Net change in trading securities ( 18,989 ) — — (Increase) decrease in other assets 17,797 ( 5,796 ) ( 39,069 ) Increase (decrease) in accounts payable and other liabilities 6,551 1,861 11,210 Net cash provided by (used in) operating activities 218,328 173,035 ( 25,545 ) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investment securities ( 759,501 ) ( 179,398 ) ( 373,264 ) Proceeds from sale of investment securities 98,915 28,187 62,378 Principal payments on investment securities 125,848 197,253 208,610 Proceeds from sale of OREO 952 541 650 Proceeds from sale of loans originated as LHFI 4,613 504,584 576,388 Purchase of LHFI — — ( 20,124 ) Net cash provided by disposal of discontinued operations — — 2,800 Net cash distributed in sale of branches ( 138,756 ) — — Net increase in LHFI ( 1,940,489 ) ( 683,822 ) ( 690,302 ) Proceeds from sale of premises and equipment — — 1,460 Purchases of premises and equipment ( 6,786 ) ( 2,941 ) ( 3,298 ) Proceeds from sale of Federal Home Loan Bank stock 147,486 109,484 145,801 Purchases of Federal Home Loan Bank stock ( 186,430 ) ( 99,526 ) ( 143,721 ) Net cash used in investing activities ( 2,654,148 ) ( 125,638 ) ( 232,622 ) 50 Years Ended December 31, (in thousands) 2022 2021 2020 CASH FLOWS FROM FINANCING ACTIVITIES: Increase in deposits, net $ 1,472,834 $ 347,867 $ 481,464 Changes in short-term borrowings, net ( 25,000 ) ( 281,800 ) ( 143,200 ) Proceeds from other long-term borrowings 1,000,000 50,000 — Repayment of other long-term borrowings — ( 50,000 ) ( 7,082 ) Proceeds from debt issuance, net 98,036 — — Repayment of finance lease principal ( 589 ) ( 1,070 ) ( 1,209 ) Repurchases of common stock ( 75,000 ) ( 84,154 ) ( 58,009 ) Proceeds from exercise of stock options — 263 237 Dividends paid on common stock ( 26,847 ) ( 21,338 ) ( 13,865 ) Net cash provided by (used in) financing activities 2,443,434 ( 40,232 ) 258,336 Net increase in cash and cash equivalents 7,614 7,165 169 Cash and cash equivalents, beginning of year 65,214 58,049 57,880 Cash and cash equivalents, end of year $ 72,828 $ 65,214 $ 58,049 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 66,364 $ 17,303 $ 44,466 Federal and state income taxes 5,201 34,429 20,992 Non-cash activities: LHFI foreclosed and transferred to OREO 1,160 — 370 Loans transferred from LHFI to LHFS, net 12,361 392,555 569,534 Ginnie Mae loans recognized with the right to repurchase, net — — 92,366 Ginnie Mae loans derecognized with the right to repurchase, net 5,424 89,408 — Repurchase of common stock - award shares 1,321 3,940 860 See accompanying notes to consolidated financial statements. 51 HomeStreet, Inc. and Subsidiaries Notes to Consolidated Financial Statements NOTE 1– SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Business HomeStreet, Inc., a State of Washington corporation organized in 1921, (the "Corporation"), is a Washington-based diversified financial services holding company whose operations are primarily conducted through its wholly owned subsidiaries (collectively the "Company") HomeStreet Capital Corporation, HomeStreet Statutory Trusts and HomeStreet Bank (the "Bank"), and the Bank's subsidiaries, Continental Escrow Company, HomeStreet Foundation, HS Properties, Inc., HS Evergreen Corporate Center LLC, Union Street Holdings LLC and HomeStreet Mortgage Depositor, Inc. The Company is principally engaged in commercial banking, mortgage banking and consumer/retail banking activities serving customers primarily in the Western United States. The Bank, the Company’s principal operating subsidiary, is engaged in commercial banking, mortgage banking and consumer/retail banking activities. The Bank was incorporated in the State of Washington in 1986, and, as a state-chartered non-member commercial bank, is subject to examination by the State of Washington Department of Financial Institutions and the Federal Deposit Insurance Corporation ("FDIC"). Basis of Presentation The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. The Company allocates resources and assesses financial performance on a consolidated basis and therefore has one reporting segment. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ significantly from those estimates. Reclassifications Certain amounts in the financial statements from prior periods have been reclassified to conform to the current financial statement presentation. These reclassifications had no effect on prior years' net income or stockholders’ equity. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash, due from banks, certificates of deposits with original maturities of less than ninety days, investment securities with original maturities of less than ninety days and federal funds sold. The Bank maintains most of its excess cash at the Federal Reserve Bank of San Francisco ("FRBSF"), with well-capitalized correspondent banks or with other depository institutions at amounts less than the FDIC insured limits. Restricted cash of $ 6.7 million and $ 8.1 million at December 31, 2022 and 2021, respectively, is included in cash and cash equivalents . Investment Securities Investment securities for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Investments not classified as trading securities nor as held-to-maturity ("HTM") securities are classified as AFS securities and recorded at fair value. Unrealized gains or losses on AFS securities are excluded from net income and reported net of taxes as a separate component of other comprehensive income included in shareholders’ equity. Purchase premiums and discounts are recognized in interest income using the effective interest method over the contractual life of the securities. Purchase premiums or discounts related to mortgage-backed securities are amortized or accreted using projected prepayment speeds. Gains and losses on the sale of AFS securities are recorded on the trade date and are determined using the specific identification method. Trading securities, consisting of US Treasury notes, are used as economic hedges of our mortgage servicing rights, which are carried at fair value and included as investment securities on the balance sheet. Net gain or loss on trading securities, are included in loan servicing income in the consolidated income statements. 52 The Company evaluates AFS securities in an unrealized loss position at the end of each quarter to determine whether the decline in value is temporary or permanent. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. When qualitative factors indicate that a credit loss may exist, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. The Company recognizes an allowance for credit loss ("ACL") if a loss is considered to exist, measured as the difference between the present value of expected cash flows and the amortized cost basis of the security, limited by the amount that the security’s fair value is less than its amortized cost basis. The Company does not believe any of these securities that were in an unrealized loss position at December 31, 2022 or 2021 have a credit loss impairment. The Company evaluates HTM securities at the end of each quarter to determine if any expected credit losses exist. The Company does not believe any expected credit losses exist for these securities as of December 31, 2022 and 2021. Federal Home Loan Bank Stock The Bank is a member of the Federal Home Loan Bank of Des Moines ("FHLB"), and as such, is required to own a certain amount of FHLB stock based on the level of borrowings and other factors. FHLB stock is carried at cost and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are recorded as a component of interest income. LHFS Loans originated for sale in the secondary market or designated for whole loan sales are classified as LHFS. Management has elected the fair value option for all single family LHFS (originated with the intent to market for sale) and records these loans at fair value. Gains and losses from changes in fair value on LHFS are recognized in net gain on mortgage loan origination and sale activities within noninterest income. Direct loan origination costs and fees for single family loans originated as held for sale are recognized as noninterest expenses. Multifamily and Small Business Administration ("SBA") LHFS are accounted for at the lower of amortized cost or fair value ("LOCOM"). LOCOM valuations are performed quarterly or at the time of transfer to or from LHFS. Related gains and losses are recognized in net gain on mortgage loan origination and sale activities. Direct loan origination costs and fees for multifamily and SBA loans classified as held for sale are deferred at origination and recognized in earnings at the time of sale. LHFI LHFI are reported at the principal amount outstanding, net of cumulative charge-offs, interest applied to principal (for loans accounted for using the cost recovery method), unamortized net deferred loan origination fees and costs and unamortized premiums or discounts on purchased loans. When a loan is designated as held for investment, the intent is to hold these loans for the foreseeable future or until maturity or pay-off. If subsequent changes occur as part of the balance sheet management process, the Company may change its intent to hold these loans. Once a determination has been made to sell such loans, they are transferred to LHFS and carried at the lower of amortized cost or fair value. Interest on loans is recognized at the contractual rate of interest and is only accrued if deemed collectible. Deferred fees and costs and premiums and discounts are amortized over the contractual terms of the underlying loans using the constant effective yield (the interest method) or straight-line method. Nonaccrual Loans Loans for which the accrual of interest has been discontinued are designated as nonaccrual loans. Loans are placed on nonaccrual status when the full and timely collection of principal and interest is doubtful, generally when the loan becomes 90 days or more past due for principal or interest payment or if part of the principal balance has been charged off. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. All payments received on nonaccrual loans are accounted for using the cost recovery method. Under the cost recovery method, all cash collected is applied first to reduce the outstanding principal balance. A loan may be returned to accrual status if all delinquent principal and interest payments are brought current and the collectability of the remaining principal and interest payments in accordance with the loan agreement is reasonably assured. Loans whose repayments are insured by the Federal Housing Administration ("FHA"), guaranteed by the Department of Veterans' Affairs ("VA") or Ginnie Mae ("GNMA") are maintained on accrual status even if 90 days or more past due. 53 Modifications for Financially Distressed Borrowers ("MFDB") The Company provides MFDBs which may include other than insignificant delays in payment of amounts due, extension of the terms of the notes or reduction in the interest rates on the notes. In certain instances, the Company may grant more than one type of modification. The granting of modifications for the year ended December 31, 2022 did not have a material impact on the ACL. When a borrower experiences financial difficulty, we sometimes modify or restructure loans, which may include delays in payment of amounts due, extension of the terms of the notes or a reduction in the interest rates on the notes. These loans are classified as MFDBs. MFDBs are loans modified for the purpose of alleviating temporary impairments to the borrower’s financial condition or cash flows. A workout plan between us and the borrower is designed to provide a bridge for borrower cash flow shortfalls in the near term. ACL for LHFI The ACL for LHFI is a valuation account that is deducted from the loans amortized cost basis to present the net amount expected to be collected on the loans. Loan balances are charged off against the ACL when management believes the non-collectability of a loan balance is confirmed. Recoveries are recorded as an increase to the ACL for LHFI to the extent they do not exceed the related charge-off amounts. The ACL for LHFI, as reported in our consolidated balance sheets, is adjusted by a provision for credit losses and reduced by the charge-offs of loan amounts, net of recoveries. Management estimates the ACL balance using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix or delinquency levels or other relevant factors. The credit loss estimation process involves procedures to appropriately consider the unique characteristics of its two loan portfolios, the consumer loan portfolio and the commercial loan portfolio. These two portfolios are further disaggregated into loan pools, the level at which credit risk is monitored. When computing ACL levels, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts. Determining the appropriateness of the ACL is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods, evaluations of the overall loan portfolio, based on the factors and forecasts then prevailing, may result in material changes in the ACL and provision for credit losses. Credit Loss Measurement The ACL level is influenced by current conditions related to loan volumes, loan asset quality ratings ("AQR") migration or delinquency status, historic loss experience and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses has two basic components: first, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics and second an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans. The Company's ACL model methodology is to build a reserve rate using historical life of loan default rates combined with assessments of current loan portfolio information and current and forecasted economic environment and business cycle information. The model uses statistical analysis to determine the life of loan default rates for the quantitative component and analyzes qualitative factors (Q-Factors) that assess the current loan portfolio conditions and forecasted economic environment and collateral values. Below is the general overview our ACL model. Loans that Share Similar Risk Characteristics with Other Loans For loans that share similar risk characteristics, loans are segregated into loan pools based on similar risk characteristics, like product types or areas of risk concentration to estimate the ACL. Historical Loss Rates The Company analyzed loan data from a full economic cycle, to the extent that data was available, to calculate life of loan loss rates. Based on the current economic environment and available loan level data, it was determined the Loss Horizon Period ("LHP") should begin prior to the economic recession that began in 2007. The Company monitors and reviews the LHP on an annual basis to determine appropriate time frames to be included based on economic indicators. 54 Under current expected credit losses methodology ("CECL"), the Company groups pools of loans by similar risk characteristics. Using these pools, sub-pools are established at a more granular level incorporating delinquency status and original FICO or original LTV (for consumer loans) and risk ratings (for commercial loans). Using the pool and sub-pool structure, cohorts are established historically on a quarterly basis containing the population in these sets as of that point in time. After the establishment of these cohorts, the loans within the cohorts are then tracked from that point forward to establish long-term Probability of Default ("PD") at the sub-pool level and Loss Given Default ("LGD") for the pool level. These historical cohorts and their PD/LGD outcomes are then averaged together to establish expected PDs and LGDs for each sub-pool. Once historical cohorts are established, the loans in the cohort are tracked moving forward for default events. The Company has defined default events as the first dollar of loss. If a loan in the cohort has experienced a default event over the LHP then the balance of the loan at the time of cohort establishment becomes part of the numerator of the PD calculation. The Loss Given Probability of Default ("LGPD") or Expected Loss ("EL") is the weighted average PD for each sub-pool cohort times the average LGD for each pool. The output from the model then is a series of EL rates for each loan sub-pool, which are applied to the related outstanding balances for each loan sub-pool to determine the ACL reserve based on historical loss rates. Q-Factors The Q-Factors adjust the expected historic loss rates for current and forecasted conditions that are not provided for in the historical loss information. The Company has established a methodology for adjusting historical expected loss rates based on these more recent or forecasted changes. The Q-Factor methodology is based on a blend of quantitative analysis and management judgment and reviewed on a quarterly basis. 55 Each of the thirteen factors in the FASB standard were analyzed for common risk characteristics and grouped into seven consolidated Q-Factors as listed below: Qualitative Factor Financial Instruments - Credit Losses Portfolio Credit Quality The borrower's financial condition, credit rating, credit score, asset quality or business prospects The borrower's ability to make scheduled interest or principal payments The volume and severity of past due financial assets and the volume and severity of adversely classified or rated financial assets Remaining Payments The remaining payment terms of the financial assets The remaining time to maturity and the timing and extent of payments on the financial assets Volume & Nature The nature and volume of the entity's financial assets Collateral Values The value of underlying collateral on financial assets in which the collateral-dependent practical expedient has not been utilized Economic The environmental factors of a borrower and the areas in which the entity's credit is concentrated, such as: changes and expected changes in national, regional and local economic and business conditions and developments in which the entity operates, including the condition and expected condition of various market segments Credit Culture The entity's lending policies and procedures, including changes in lending strategies, underwriting standards, collection, write-off and recovery practices, as well as knowledge of the borrower's operations or the borrower's standing in the community The quality of the entity's credit review system The experience, ability and depth of the entity's management, lending staff, and other relevant staff Business Environment The environmental factors of a borrower and the areas in which the entity's credit is concentrated, such as: regulatory, legal, or technological environment to which the entity has exposure The environmental factors of a borrower and the areas in which the entity's credit is concentrated, such as: changes and expected changes in the general market condition of either the geographical area or the industry to which the entity has exposure An eighth Q-Factor, Management Overlay, allows the Bank to adjust specific pools when conditions exist that were not contemplated in the model design that warrant an adjustment. The economic downturn caused by the COVID-19 pandemic and resulting accounting treatment of forbearances is an example of such a condition. The Company has chosen two years as the forecast period based on management judgment and has determined that reasonable and supportable forecasts should be made for two of the Q-Factors: Economic and Collateral values. Management has assigned weightings for each qualitative factor as well as individual metrics within each qualitative factor as to the relative importance of that factor or metric specific to each portfolio type. The Q-Factors above are evaluated using a seven-point scale ranging from significant improvement to significant deterioration. The CECL Q-Factor methodology bounds the Q-Factor adjustments by a minimum and maximum range, based on the Bank’s own historical expected loss rates for each respective pool. The rating of the Q-Factor on the seven-point scale, along with the allocated weight, determines the final expected loss adjustment. The model is constructed so that the total of the Q-Factor adjustments plus the current expected loss rate cannot exceed the maximum or minimum two-year loss rate for that pool, which is aligned with the Bank's chosen forecast period. Loss rates beyond two years are not adjusted in the Q-Factor process and the model reverts to the historical mean loss rates. Management Overlays are not bounded by the historical maximums. Quarterly, loan data is gathered to update the portfolio metrics analyzed in the Q-Factor model. The model is updated with current data and applicable forecasts, then the results are reviewed by management. After consensus is reached on all Q-Factor ratings, the results are input into the Q-Factor model and applied to the pooled loans which are reviewed to determine the adequacy of the reserve. 56 Additional details describing the model by portfolio are below: Consumer Loan Portfolio The consumer loan portfolio is comprised of the single family and home equity loan classes, which are underwritten after evaluating a borrower's capacity, credit and collateral. Other consumer loans are grouped with home equity loans. Capacity refers to a borrower's ability to make payments on the loan. Several factors are considered when assessing a borrower's capacity, including the borrower's employment, income, current debt, assets and level of equity in the property. Credit refers to how well a borrower manages current and prior debts as documented by a credit report that provides credit scores and current and past information about the borrower's credit history. Collateral refers to the type and use of property, occupancy and market value. Property appraisals may be obtained to assist in evaluating collateral. Loan-to-property value and debt-to-income ratios, loan amount and lien position are considered in assessing whether to originate a loan. These borrowers are particularly susceptible to downturns in economic trends such as conditions that negatively affect housing prices, demand for housing and levels of unemployment. Consumer Loan Portfolio Loss Rate Model Under CECL, the Bank utilizes pools of loans that are grouped by similar risk characteristics: Single Family and Home Equity Loans. Sub-Pools are established at a more granular level for the calculation of PDs, incorporating delinquency status, original FICO and original LTV. Consumer portfolio cohorts are established by grouping each ACL sub-pool at a point in time. Once historical cohorts are established, the loans in the cohort are tracked moving forward for default events. The Q-Factors adjust the expected historic loss rates for current and forecasted conditions that are not provided for in the historical loss information. For Single Family loans all Q-Factors noted above are evaluated. For the Home Equity loans, collateral values are not evaluated as the Bank has determined the FICO score trends are a more relevant predictor of default than current collateral value for those types of loans. These factors are evaluated based on current conditions and forecasts (as applicable), using a seven-point scale ranging from significant improvement to significant deterioration. Commercial Loan Portfolio The commercial loan portfolio is comprised of the non-owner occupied commercial real estate ("CRE"), multifamily, construction and land development, owner occupied CRE and commercial business loan classes, whose underwriting standards consider the factors described for single family and home equity loan classes as well as others when assessing the borrower's and associated guarantors or other related party’s financial position. These other factors include assessing liquidity, net worth, leverage, other outstanding indebtedness of the borrower, the quality and reliability of cash expected to flow through the borrower (including the outflow to other lenders) and prior experiences with the borrower. This information is used to assess financial capacity, profitability and experience. Ultimate repayment of these loans is sensitive to interest rate changes, general economic conditions, liquidity and availability of long-term financing. Commercial Loan Portfolio Loss Rate Model The Bank has subdivided the commercial loan portfolio into the following ACL reporting pools to more accurately group risk characteristics: Commercial Business, Owner Occupied CRE, Multifamily, Multifamily Construction, CRE, CRE Construction, Single Family Construction to Permanent, and Single Family Construction, which includes lot, land and acquisition and development loans. ACL sub-pools are established at a more granular level for the calculation of PDs, utilizing risk rating. As outlined in the Bank’s policies, commercial loans pools are non-homogenous and are regularly assessed for credit quality. For purposes of CECL, loans are sub-pooled according to the following AQR Ratings: • 1-6: These loans meet the definition of “Pass" assets. They are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less costs to acquire and sell in a timely manner, of any underlying collateral. The Bank further uses the available AQR ratings for components of the sub-pools. • 7: These loans meet the regulatory definition of “Special Mention.” They contain potential weaknesses, that if uncorrected may result in deterioration of the likelihood of repayment or in the Bank’s credit position. • 8: These loans meet the regulatory definition of “Substandard.” They are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. They have well-defined weaknesses and have unsatisfactory characteristics causing unacceptable levels of risk. 57 Commercial portfolio cohorts are established by grouping each ACL sub-pool at a point in time. Once historical cohorts are established, the loans in the cohort are tracked moving forward for default events. The Q-Factors adjust the expected historic loss rates for current and forecasted conditions that are not provided for in the historical loss information. All the Q-Factors noted above are evaluated for Commercial portfolio loans except for Commercial Business and Owner Occupied CRE loans which exclude the collateral values Q-Factor. The Company has determined that these loans are primarily underwritten by evaluating the cash flow of the business and not the underlying collateral. Factors above are evaluated based on current conditions and forecasts (as applicable), using a seven-point scale ranging from significant improvement to significant deterioration. Loans That Do Not Share Risk Characteristics with Other Loans For a loan that does not share risk characteristics with other loans, expected credit loss is measured on net realizable value that is the difference between the discounted value of the expected future cash flows, based on the original effective interest rate and the amortized cost basis of the loan. For these loans, we recognize expected credit loss equal to the amount by which the net realizable value of the loan is less than the amortized cost basis of the loan (which is net of previous charge-offs and deferred loan fees and costs), except when the loan is collateral dependent, which is when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In these cases, expected credit loss is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral. The fair value of the collateral is adjusted for the estimated costs to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral. The starting point for determining the fair value of collateral is through obtaining external appraisals. Generally, collateral values for collateral dependent loans are updated every twelve months, either from external third parties or in-house certified appraisers. A third-party appraisal is required at least annually for substandard loans and OREO. For performing consumer loans secured by real estate that are classified as collateral dependent, the Bank determines the fair value estimates quarterly using automated valuation services. Once the expected credit loss amount is determined, an ACL is recorded equal to the expected credit loss and included in the ACL. If no credit loss is expected to occur, then no ACL is recognized for this loan. If the expected credit loss is determined to be permanent or not recoverable, the expected credit loss will be charged off. Factors considered by management in determining if the expected credit loss is permanent or not recoverable include whether management judges the loan to be uncollectible, repayment is deemed to be protracted beyond reasonable time frames, or the loss becomes evident owing to the borrower's lack of assets or, for single family loans, the loan is 180 days or more past due unless both well-secured and in the process of collection. ACL for Off-Balance Sheet Credit Exposures The Bank estimates expected credit losses over the contractual period in which the Bank is exposed to risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Bank. Reserves are required for off-balance sheet credit exposures that are not unconditionally cancellable. The ACL on unfunded loan commitments is based on an estimate of unfunded commitment utilization over the life of the loan, applying the EL rate to the estimated utilization balance as of the reporting period end date. Q-factors are not included in the calculation of expected credit losses for off-balance sheet credit exposures. Other Real Estate Owned Real estate properties acquired through, or in lieu of, loan foreclosure are recorded at net realizable value (fair value of collateral less estimated costs to sell). At the time of possession, an appraisal is obtained and any excess of the loan balance over the net realizable value is charged against the ACL. After foreclosure, valuations are periodically performed by management. Any subsequent declines in fair value are recorded as a charge to current period earnings with a corresponding write-down to the asset. All legal fees and direct costs, including foreclosure and other related costs are expensed as incurred. Mortgage Servicing Rights MSRs are recognized as separate assets on our consolidated balance sheets upon purchase of the rights or when we retain the right to service loans that we have sold. We initially record all MSRs at fair value. For subsequent measurements, single family MSRs are accounted for at fair value, with changes in fair value recorded through current period earnings, while multifamily and SBA MSRs are accounted for at the lower of amortized cost or fair value. 58 Subsequent fair value measurements of MSRs are determined by considering the present value of estimated future net servicing cash flows. Changes in the fair value of MSRs result from changes in (1) model inputs and assumptions and (2) modeled amortization, representing the collection and realization of expected cash flows and curtailments over time. The significant model inputs used to measure the fair value of MSRs include assumptions regarding market interest rates, projected prepayment speeds, discount rates, estimated costs of servicing and other income and additional expenses associated with the collection of delinquent loans. Mortgage servicing assets for multifamily and SBA MSRs are evaluated periodically for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by comparing the fair value of the portfolio based on predominant risk characteristic loan type, to amortized cost. Impairment is recognized to the extent that fair value is less than the capitalized amount of the portfolio. For single family MSRs, loan servicing income includes fees earned for servicing the loans and the changes in fair value over the reporting period of both our MSRs and the derivatives used to economically hedge our MSRs. For other MSRs, loan servicing income includes fees earned for servicing the loans less the amortization of the related MSRs and any impairment adjustments. Revenue Recognition Descriptions of our primary revenue-generating activities that fall within the scope of Accounting Standards Committee ("ASC") Topic 606 Revenue Recognition and are presented in our consolidated income statements as follows: Depositor and other retail banking fees (in Deposit Fees) Depositor and other retail banking fees consist of monthly service fees and other deposit account related fees. The Company's performance obligation for these fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Commission Income (in Other Income) Commission income primarily consists of revenue received on insurance policies. The Company's performance obligation for commissions is generally satisfied, and the related revenue generally recognized, over the course of the policy. Credit Card Fees (in Other Income) The Company offers credit cards to its customers through a third party and earns a fee on each transaction and a fee for each new account activation on a net basis. Revenue is recognized when the services are performed. Sale of Other Real Estate Owned (in General, Administrative and Other) A gain or loss, the difference between the cost basis of the property and its sale price, on other real estate owned is recognized when the performance obligation is met, which is at the time the property title is transferred to the buyer. To record a sale of OREO, the Company evaluates if: (a) a commitment on the buyer’s part exists, (b) collection is probable in circumstances where the initial investment is minimal and (c) the buyer has obtained control of the asset, including the significant risks and rewards of ownership. If there is no commitment on the buyer’s part, collection is not probable or the buyer has not obtained control of the asset, then a gain cannot be recognized. Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which generally range from 3 to 20 years. The cost of leasehold improvements is amortized using the straight-line method over the shorter of the estimated useful life of the asset or the term of the related leases. The Company periodically evaluates premises and equipment for impairment. 59 Leases We determine if an arrangement is a lease at inception. Operating and finance leases are included in lease right-of-use ("ROU") assets, and lease liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. The lease liability is recognized at commencement date based on the present value of lease payments over the lease term. The right-of-use asset is based on the lease liability adjusted for the reclassification of certain balance sheet amounts such as prepaid rent, lease incentives and deferred rent. As the rate implicit in most of our leases are not readily determinable, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease contract at commencement date. We have lease agreements with lease and non-lease components, which are generally accounted for separately for real estate leases. Certain of our lease agreements include rental payments that adjust periodically based on changes in the Consumer Price Index ("CPI"). Subsequent increases in the CPI are treated as variable lease payments and recognized in the period in which the obligation for those payments is incurred. The ROU assets and lease liabilities are not re-measured as a result of changes in the CPI. Lease expense for operating leases is recognized on a straight-line basis over the lease term. Lease expense for our financing leases is comprised of the amortization of the right-of-use asset and interest expense recognized based on the effective interest method. We use the long-lived assets impairment guidance under ASC Topic 360-10-35, "Property, Plant and Equipment," to determine whether an ROU asset is impaired, and if impaired, the amount of loss to recognize. Long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. These could include vacating the leased space, obsolescence, or physical damage to a facility. If an impairment loss is recognized for a ROU asset, the adjusted carrying amount of the ROU asset would be its new accounting basis. The remaining ROU asset (after the impairment write-down) is amortized on a straight-line basis over the remaining lease term. Goodwill and Other Intangible Assets Goodwill is recorded upon completion of a business combination as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill has been determined to have an indefinite useful life and is not amortized, but tested for impairment at least annually or more frequently if events and circumstances occur that indicate it is more likely than not the fair value of the reporting unit is less than its carrying value necessitating an impairment test. Historically, the Company performed its annual impairment testing at June 30. In 2022, we moved the annual impairment testing date to August 31 and based on that testing determined goodwill was not impaired. The change in impairment measurement date did not have a material effect on the valuation results. Intangible assets with definite useful lives, such as core deposit intangible assets arising from bank acquisitions, are amortized over their estimated useful lives. Securities Sold Under Agreements to Repurchase From time to time, the Company may enter into sales of securities under agreements to repurchase ("repurchase agreements"). Repurchase agreements are accounted for as financing arrangements with the obligation to repurchase securities sold reflected as a liability on the consolidated balance sheets. The securities underlying the repurchase agreements continue to be recognized as AFS securities in the consolidated balance sheet. Income Taxes Deferred tax assets and liabilities arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. Deferred tax assets and tax carryforwards are only recognized if, in the opinion of management, it is more likely than not that the deferred tax assets will be fully realized. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. We are subject to federal income tax and also state income taxes in a number of different states. 60 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 recognizes interest and penalties related to income tax matters in income tax expense. Derivatives and Hedging Activities In the ordinary course of business, the Company enters into derivative transactions to manage various risks and to accommodate the business requirements of its customers. The fair value of derivative instruments are recognized as either assets or liabilities on the consolidated balance sheet. All derivatives are evaluated at inception as to whether or not they are hedge accounting or non-hedge accounting activities. For derivative instruments designated as non-hedge accounting activities (also referred to as economic hedges), the change in fair value is recognized currently in earnings. Gains and losses on derivative contracts utilized for economically hedging the mortgage pipeline are recognized as part of the net gain on mortgage loan origination and sale activities within noninterest income. Gains and losses on derivative contracts utilized for economically hedging our single family MSRs are recognized as part of loan servicing income within noninterest income. For derivative instruments designated as hedge accounting activities, a qualitative analysis is performed at inception to determine if the derivative instrument is highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk during the period that the hedge is designated. Subsequently, a qualitative assessment of a hedge’s effectiveness is performed on a quarterly basis. All derivative instruments that qualify and are designated for hedge accounting are recorded at fair value and classified as either a hedge of the fair value of a recognized asset or liability ("fair value hedge") or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow hedge"). Changes in the fair value of a derivative that is highly effective and designated as a fair value hedge is recognized in earnings and the change in fair value on the hedged item attributable to the hedged risk adjusts the carrying amount of the hedged item and is recognized currently in earnings. Changes in the fair value of a derivative that is highly effective and designated as a cash flow hedge are recorded in other comprehensive income (loss) until cash flows of the hedged item are realized. All hedge amounts recognized in earnings are presented in the same income statement line item as the earnings effect of the hedged item. If a derivative designated as a cash flow hedge is terminated or ceases to be highly effective, the gain or loss in other comprehensive income (loss) is amortized to earnings over the period the forecasted hedged transactions impact earnings. If a hedged forecasted transaction is no longer probable, hedge accounting is ceased and any gain or loss included in other comprehensive income (loss) is reported in earnings immediately, unless the forecasted transaction is at least reasonably possible of occurring, whereby the amounts remain within other comprehensive income (loss). Derivative instruments expose us to credit risk in the event of nonperformance by counterparties. This risk consists primarily of the termination value of agreements where the Company is in a favorable position. The Company minimizes counterparty credit risk through credit approvals, limits, monitoring procedures, and obtaining collateral, as appropriate. The Company also executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. These interest rate swaps are economically hedged by simultaneously entering into an offsetting interest rate swap that the Company executes with a third party, such that the Company minimizes its net risk exposure. Share-Based Compensation The Company issues various forms of stock-based compensation awards annually, including restricted stock units ("RSUs") and performance stock units ("PSUs"). Compensation expense related to RSUs is based on the fair value of the underlying stock on the award date and is recognized over the period in which an employee is required to provide services in exchange for the award, generally the vesting period. PSUs are subject to market-based vesting criteria in addition to a requisite service period and cliff vest based on those conditions at the end of three years . The grant date fair value of PSUs is determined through the use of an independent third party which employs the use of a Monte Carlo simulation. The Monte Carlo simulation estimates grant date fair value using certain input assumptions such as: expected volatility, award term, expected risk-free rate of interest and expected dividend yield on the Company’s common stock and also incorporates into the grant date fair value calculation the probability that the performance targets will be achieved. Forfeitures of stock-based awards are recognized when they occur. 61 Fair Value Measurement Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value is an exit price, representing the amount that would be received to sell an asset or transfer a liability in an orderly transaction between market participants. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Fair value measures are classified according to a three-tier fair value hierarchy, which is based on the observability of inputs used to measure fair value. Changes in assumptions or in market conditions could significantly affect these estimates. Transfers of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Contingencies Contingent liabilities, including those that exist as a result of a guarantee or indemnification, are recognized when it becomes probable that a loss has been incurred and the amount of the loss is reasonably estimable. For indemnifications provided in sales agreements, a portion of the sale proceeds is allocated to the guarantee, which adjusts the gain or loss that would otherwise result from the transaction. Earnings per Share Earnings per share of common stock is calculated on both a basic and diluted basis, based on the weighted average number of common and common equivalent shares outstanding. Basic earnings per share excludes potential dilution from common equivalent shares, such as those associated with stock-based compensation awards, and is computed by dividing net income allocated to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as common equivalent shares associated with stock-based compensation awards, were exercised or converted into common stock that would then share in the net earnings of the Company. Potential dilution from common equivalent shares is determined using the treasury stock method, reflecting the potential settlement of stock-based compensation awards resulting in the issuance of additional shares of the Company’s common stock. Stock-based compensation awards that would have an anti-dilutive effect have been excluded from the determination of diluted earnings per share. Marketing Costs The Company expenses marketing costs, including advertising, in the period incurred. We incurred $ 6.2 million, $ 4.1 million and $ 2.3 million in marketing costs during 2022, 2021 and 2020, respectively. Recent Accounting Developments In March 2020, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2020-04, Reference Rate Reform (Topic 848). This ASU provides optional expedients and exceptions for contracts, hedging relationships, and other transactions that reference London Interbank Offered Rate ("LIBOR") rates expected to be discontinued because of reference rate reform. In January 2021, the FASB issued ASU 2021-01, "Reference Rate Reform (Topic 848)," which clarifies certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting applied to derivatives that are affected by the transition to alternative rates. In December 2022, the FASB issued ASU No. 2022-06, "Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848," which defers the sunset date of Topic 848 from December 31, 2022 to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848. The adoption of these ASUs is not expected to have a material impact on the Company’s financial position or results of operations. In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments-Credit Losses (Topic 326). The amendments in this ASU eliminate the accounting guidance for Troubled Debt Restructuring ("TDRs") by creditors, while enhancing disclosure 62 requirements for certain loan refinancing and restructurings by creditors when a borrower experiences financial difficulty. In addition, the amendments require that an entity disclose current period gross charge-offs by year of origination in a vintage table. We prospectively adopted the portion of ASU No. 2022-02 with respect to amendments about TDRs and related disclosure enhancements as of January 1, 2022. This adoption did not have a material impact on the Company’s financial position or results of operations. As the change is disclosure only in nature, we do not expect the vintage table disclosure requirement of ASU 2022-02 to have a material impact on the Company's financial position or results of operations when adopted. NOTE 2– INVESTMENT SECURITIES: The following tables set forth certain information regarding the amortized cost and fair values of our investment securities AFS and HTM: At December 31, 2022 (in thousands) Amortized cost Gross unrealized gains Gross unrealized losses Fair value AFS Mortgage-backed securities ("MBS"): Residential $ 207,445 $ — $ ( 10,183 ) $ 197,262 Commercial 65,411 — ( 9,362 ) 56,049 Collateralized mortgage obligations ("CMOs") Residential 592,449 12 ( 39,422 ) 553,039 Commercial 77,909 — ( 7,390 ) 70,519 Municipal bonds 469,346 41 ( 57,839 ) 411,548 Corporate debt securities 46,672 74 ( 3,801 ) 42,945 U.S. Treasury securities 23,005 — ( 3,071 ) 19,934 Agency debentures 27,499 8 ( 29 ) 27,478 Total $ 1,509,736 $ 135 $ ( 131,097 ) $ 1,378,774 HTM Municipal bonds $ 2,441 $ — $ ( 56 ) $ 2,385 At December 31, 2021 (in thousands) Amortized cost Gross unrealized gains Gross unrealized losses Fair value AFS MBS: Residential $ 32,905 $ 396 $ ( 338 ) $ 32,963 Commercial 62,094 933 ( 235 ) 62,792 CMOs: Residential 186,703 2,012 ( 1,321 ) 187,394 Commercial 135,102 1,890 ( 333 ) 136,659 Municipal bonds 516,693 24,154 ( 924 ) 539,923 Corporate debt securities 18,918 699 ( 1 ) 19,616 U.S. Treasury securities 23,348 — ( 173 ) 23,175 Total $ 975,763 $ 30,084 $ ( 3,325 ) $ 1,002,522 HTM Municipal bonds $ 4,169 $ 136 $ — $ 4,305 The Company held $ 19.0 million of trading securities which are used as economic hedges of our mortgage servicing rights and are not included in the above tables. Net trading losses of $ 7.0 million were recorded in servicing income in the consolidated income statements in 2022. 63 MBS and CMOs represent securities primarily issued by government sponsored enterprises ("GSEs"). Most of the MBS and CMO securities in our investment portfolio are guaranteed by Fannie Mae, Ginnie Mae or Freddie Mac. Municipal bonds are comprised of general obligation bonds (i.e., backed by the general credit of the issuer) and revenue bonds (i.e., backed by either collateral or revenues from the specific project being financed) issued by various municipal organizations. As of December 31, 2022 and 2021, all securities held, including municipal bonds and corporate debt securities, were rated investment grade based upon external ratings where available and, where not available, based upon internal ratings which correspond to ratings as defined by Standard and Poor’s Rating Services or Moody's Investors Services. Investment securities AFS that were in an unrealized loss position are presented in the following tables based on the length of time the individual securities have been in an unrealized loss position: At December 31, 2022 Less than 12 months 12 months or more Total (in thousands) Gross unrealized losses Fair value Gross unrealized losses Fair value Gross unrealized losses Fair value AFS MBS: Residential $ ( 8,845 ) $ 191,398 $ ( 1,338 ) $ 5,763 $ ( 10,183 ) $ 197,161 Commercial ( 5,729 ) 41,416 ( 3,633 ) 14,619 ( 9,362 ) 56,035 CMOs: Residential ( 27,789 ) 498,333 ( 11,633 ) 45,689 ( 39,422 ) 544,022 Commercial ( 4,787 ) 56,671 ( 2,603 ) 13,848 ( 7,390 ) 70,519 Municipal bonds ( 44,513 ) 350,918 ( 13,326 ) 46,377 ( 57,839 ) 397,295 Corporate debt securities ( 3,801 ) 32,871 — — ( 3,801 ) 32,871 U.S. Treasury securities — — ( 3,071 ) 19,934 ( 3,071 ) 19,934 Agency debentures ( 29 ) 15,970 — — ( 29 ) 15,970 Total $ ( 95,493 ) $ 1,187,577 $ ( 35,604 ) $ 146,230 $ ( 131,097 ) $ 1,333,807 HTM Municipal bonds $ ( 56 ) $ 2,385 $ — $ — $ ( 56 ) $ 2,385 At December 31, 2021 Less than 12 months 12 months or more Total (in thousands) Gross unrealized losses Fair value Gross unrealized losses Fair value Gross unrealized losses Fair value MBS: Residential $ ( 38 ) $ 5,324 $ ( 300 ) $ 2,406 $ ( 338 ) $ 7,730 Commercial ( 235 ) 18,127 — — ( 235 ) 18,127 CMOs: Residential ( 1,007 ) 53,068 ( 314 ) 7,116 ( 1,321 ) 60,184 Commercial ( 135 ) 14,806 ( 198 ) 5,132 ( 333 ) 19,938 Municipal bonds ( 914 ) 64,237 ( 10 ) 1,058 ( 924 ) 65,295 Corporate debt securities ( 1 ) 3,164 — — ( 1 ) 3,164 U.S. Treasury securities ( 173 ) 23,175 — — ( 173 ) 23,175 Total $ ( 2,503 ) $ 181,901 $ ( 822 ) $ 15,712 $ ( 3,325 ) $ 197,613 The Company has evaluated AFS securities that are in an unrealized loss position and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The decline in value is not related to any issuer- or industry-specific credit event. The Company has not identified any expected credit losses on its debt securities as of December 31, 2022 and 2021. In addition, as of December 31, 2022 and 2021, the Company had not made a decision to sell any of its debt securities held, nor did the Company consider it more likely than not that it would be required to sell such securities before recovery of their amortized cost basis. 64 The following tables present the fair value of investment securities AFS and HTM by contractual maturity along with the associated contractual yield. At December 31, 2022 Within one year After one year through five years After five years through ten years After ten years Total (dollars in thousands) Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield AFS Municipal bonds $ — — % $ 3,644 1.96 % $ 38,977 3.04 % $ 368,927 2.83 % $ 411,548 2.84 % Corporate debt securities — — % 15,342 5.13 % 27,603 4.25 % — — % 42,945 4.54 % U.S. Treasury securities — — % — — % 19,934 1.11 % — — % 19,934 1.11 % Agency debentures 10,485 4.74 % 16,993 4.94 % — — % — — % 27,478 4.86 % Total $ 10,485 4.74 % $ 35,979 4.69 % $ 86,514 2.97 % $ 368,927 2.83 % $ 501,905 3.01 % HTM Municipal bonds $ — — % $ 2,385 2.04 % $ — — % $ — — % $ 2,385 2.04 % At December 31, 2021 Within one year After one year through five years After five years through ten years After ten years Total (dollars in thousands) Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield AFS Municipal bonds $ 4,933 3.79 % $ 14,366 3.26 % $ 68,025 3.60 % $ 452,599 3.23 % $ 539,923 3.28 % Corporate debt securities — — % 6,563 3.60 % 13,053 5.03 % — — % 19,616 4.55 % U.S. Treasury securities — — % — — % 23,175 1.27 % — — % 23,175 1.27 % Total $ 4,933 3.79 % $ 20,929 3.37 % $ 104,253 3.23 % $ 452,599 3.23 % $ 582,714 3.24 % HTM Municipal bonds $ 1,684 2.86 % $ 2,621 2.12 % $ — — % $ — — % $ 4,305 2.42 % The weighted-average yield is computed using the contractual coupon for each security weighted based on the fair value of each security and does not include adjustments to a tax equivalent basis. MBS and CMOs are excluded from the tables above because such securities are not due on a single maturity date. The weighted average yield of MBS and CMOs as of December 31, 2022 and 2021 was 3.08 % and 1.82 %, respectively. Sales of AFS investment securities were as follows for the periods indicated: Years Ended December 31, (in thousands) 2022 2021 2020 Proceeds $ 98,915 $ 28,187 $ 62,378 Gross gains 1,585 288 1,334 Gross losses ( 1,561 ) ( 226 ) ( 993 ) 65 The following table summarizes the carrying value of securities pledged as collateral to secure public deposits, borrowings and other purposes as permitted or required by law. At December 31, (in thousands) 2022 2021 Washington, Oregon and California State to secure public deposits $ 212,806 $ 206,153 Other securities pledged 2,011 5,258 Total securities pledged as collateral $ 214,817 $ 211,411 The Company assesses the creditworthiness of the counterparties that hold the pledged collateral and has determined that these arrangements have little credit risk. Tax-exempt interest income on AFS securities was $ 11.9 million, $ 10.2 million and $ 10.7 million for 2022, 2021 and 2020, respectively. .NOTE 3- LOANS AND CREDIT QUALITY: The Company's LHFI is divided into two portfolio segments, commercial loans and consumer loans. Within each portfolio segment, the Company monitors and assesses credit risk based on the risk characteristics of each of the following loan classes: non-owner occupied commercial real estate ("CRE"), multifamily, construction and land development, owner occupied CRE and commercial business loans within the commercial loan portfolio segment and single family and home equity and other loans within the consumer loan portfolio segment. LHFI consists of the following: At December 31, (in thousands) 2022 2021 CRE Non-owner occupied CRE $ 658,085 $ 705,359 Multifamily 3,975,754 2,415,359 Construction/land development 627,663 496,144 Total 5,261,502 3,616,862 Commercial and industrial loans Owner occupied CRE 443,363 457,706 Commercial business 359,747 401,872 Total 803,110 859,578 Consumer loans Single family 1,009,001 763,331 Home equity and other 352,707 303,078 Total (1) 1,361,708 1,066,409 Total LHFI 7,426,320 5,542,849 ACL ( 41,500 ) ( 47,123 ) Total LHFI less ACL $ 7,384,820 $ 5,495,726 (1) Includes $ 5.9 million and $ 7.3 million at December 31, 2022 and 2021, respectively, of loans where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in the consolidated income statements. Loans totaling $ 5.2 billion and $ 2.8 billion at December 31, 2022 and 2021, respectively, were pledged to secure borrowings from the FHLB and loans totaling $ 497 million and $ 419 million at December 31, 2022 and 2021, respectively, were pledged to secure borrowings from the FRBSF. 66 It is the Company's policy to make loans to officers, directors and their associates in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with other persons. The following is a summary of activity during the years ended December 2022 and 2021 with respect to such aggregate loans to these related parties and their associates: Years Ended December 31, (in thousands) 2022 2021 Beginning balance $ 1,548 $ 73 New loans and advances, net of principal repayments 430 1,475 Ending balance $ 1,978 $ 1,548 Credit Risk Concentrations Concentrations of credit risk arise when a number of customers are engaged in similar business activities or activities in the same geographic region, or when they have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. LHFI are primarily secured by real estate located in the Pacific Northwest, California and Hawaii. At December 31, 2022 and 2021, multifamily loans in the state of California represented 36 % and 33 % of the total LHFI portfolio, respectively. Credit Quality Management considers the level of ACL to be appropriate to cover credit losses expected over the life of the loans for the LHFI portfolio as of December 31, 2022. The cumulative loss rate used as the basis for the estimate of credit losses is comprised of the Bank’s historical loss experience and eight qualitative factors for current and forecasted periods. During 2022, the historical expected loss rates decreased from December 31, 2021 due to minimal charge-offs and favorable product mix risk composition. Additionally, the Qualitative Factors decreased significantly due to the continued favorable performance or our loan portfolio and the improved outlook of the estimated impact of the COVID-19 pandemic on our loan portfolio. As of December 31, 2022, the Bank expects deterioration in collateral values and economic conditions over the two-year forecast period in the markets in which it operates. In addition to the ACL for LHFI, the Company maintains a separate allowance for unfunded loan commitments which is included in accounts payable and other liabilities on our consolidated balance sheets. The allowance for unfunded commitments was $ 2.2 million and $ 2.4 million at December 31, 2022 and 2021, respectively. The Bank has elected to exclude accrued interest receivable from the evaluation of the ACL. Accrued interest on LHFI was $ 26.9 million and $ 17.8 million at December 31, 2022 and 2021, respectively and was reported in other assets on the consolidated balance sheets. 67 Activity in the ACL for LHFI and the allowance for unfunded commitments was as follows: Years Ended December 31, (in thousands) 2022 2021 2020 Beginning balance $ 47,123 $ 64,294 $ 41,772 Provision for credit losses ( 4,995 ) ( 15,816 ) 21,843 Net (charge-offs) recoveries ( 628 ) ( 1,355 ) ( 1,164 ) Impact of ASC 326 adoption — — 1,843 Ending balance $ 41,500 $ 47,123 $ 64,294 Allowance for unfunded commitments Beginning balance $ 2,404 $ 1,588 $ 1,065 Provision for credit losses ( 207 ) 816 ( 1,374 ) Impact of ASC 326 adoption — — 1,897 Ending balance $ 2,197 $ 2,404 $ 1,588 Provision for credit losses: Allowance for credit losses-loans $ ( 4,995 ) $ ( 15,816 ) $ 21,843 Allowance for unfunded commitments ( 207 ) 816 ( 1,374 ) Total $ ( 5,202 ) $ ( 15,000 ) $ 20,469 Activity in the ACL by loan portfolio and loan sub-class was as follows: Year Ended December 31, 2022 (in thousands) Beginning balance Charge-offs Recoveries Provision Ending balance CRE Non-owner occupied CRE $ 7,509 $ — $ — $ ( 5,407 ) $ 2,102 Multifamily 5,854 — — 5,120 10,974 Construction/land development Multifamily construction 507 — — 491 998 CRE construction 150 — — 46 196 Single family construction 6,411 — — 6,007 12,418 Single family construction to permanent 1,055 — — 116 1,171 Total 21,486 — — 6,373 27,859 Commercial and industrial loans Owner occupied CRE 5,006 — — ( 3,976 ) 1,030 Commercial business 12,273 ( 1,098 ) 163 ( 8,091 ) 3,247 Total 17,279 ( 1,098 ) 163 ( 12,067 ) 4,277 Consumer loans Single family 4,394 — 143 1,073 5,610 Home equity and other 3,964 ( 168 ) 332 ( 374 ) 3,754 Total 8,358 ( 168 ) 475 699 9,364 Total ACL $ 47,123 $ ( 1,266 ) $ 638 $ ( 4,995 ) $ 41,500 68 Year Ended December 31, 2021 (in thousands) Beginning balance Charge-offs Recoveries Provision Ending balance CRE Non-owner occupied CRE $ 8,845 $ — $ — $ ( 1,336 ) $ 7,509 Multifamily 6,072 — — ( 218 ) 5,854 Construction/land development Multifamily construction 4,903 — — ( 4,396 ) 507 CRE construction 1,670 — — ( 1,520 ) 150 Single family construction 5,130 — — 1,281 6,411 Single family construction to permanent 1,315 — — ( 260 ) 1,055 Total 27,935 — — ( 6,449 ) 21,486 Commercial and industrial loans Owner occupied CRE 4,994 — — 12 5,006 Commercial business 17,043 ( 1,739 ) 146 ( 3,177 ) 12,273 Total 22,037 ( 1,739 ) 146 ( 3,165 ) 17,279 Consumer loans Single family 6,906 ( 127 ) 291 ( 2,676 ) 4,394 Home equity and other 7,416 ( 483 ) 557 ( 3,526 ) 3,964 Total 14,322 ( 610 ) 848 ( 6,202 ) 8,358 Total ACL $ 64,294 $ ( 2,349 ) $ 994 $ ( 15,816 ) $ 47,123 Year Ended December 31, 2020 (in thousands) Prior to adoption of ASC 326 Impact of ASC 326 adoption Charge-offs Recoveries Provision Ending balance CRE Non-owner occupied CRE $ 7,245 $ ( 3,392 ) $ — $ — $ 4,992 $ 8,845 Multifamily 7,015 ( 2,977 ) — — 2,034 6,072 Construction/land development Multifamily construction 2,848 693 — — 1,362 4,903 CRE construction 624 ( 115 ) — — 1,161 1,670 Single family construction 3,800 4,280 — 163 ( 3,113 ) 5,130 Single family construction to permanent 1,003 200 — — 112 1,315 Total 22,535 ( 1,311 ) — 163 6,548 27,935 Commercial and industrial loans Owner occupied CRE 3,639 ( 2,459 ) ( 896 ) — 4,710 4,994 Commercial business 2,915 510 ( 640 ) 110 14,148 17,043 Total 6,554 ( 1,949 ) ( 1,536 ) 110 18,858 22,037 Consumer loans Single family 6,450 468 ( 17 ) 187 ( 182 ) 6,906 Home equity and other 6,233 4,635 ( 456 ) 385 ( 3,381 ) 7,416 Total 12,683 5,103 ( 473 ) 572 ( 3,563 ) 14,322 Total ACL $ 41,772 $ 1,843 $ ( 2,009 ) $ 845 $ 21,843 $ 64,294 Credit Quality Indicators Management regularly reviews loans in the portfolio to assess credit quality indicators and to determine appropriate loan classification and grading in accordance with applicable bank regulations. The Company's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The risk rating of 9 is not used. 69 Per the Company's policies, most commercial loans pools are non-homogenous and are regularly assessed for credit quality. The rating categories can be generally described by the following groupings for non-homogeneous loans: • 1-6: These loans meet the definition of "Pass" assets. They are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less costs to acquire and sell in a timely manner, of any underlying collateral. • 7: These loans meet the regulatory definition of "Special Mention." They contain potential weaknesses, that if uncorrected may result in deterioration of the likelihood of repayment or in the Bank’s credit position. • 8: These loans meet the regulatory definition of "Substandard." They are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. They have well-defined weaknesses and have unsatisfactory characteristics causing unacceptable levels of risk. • 10: A loan, or the portion of a loan determined to meet the regulatory definition of “Loss.” The amounts classified as loss have been charged-off. The risk rating categories can be generally described by the following groupings for homogeneous loans: • 1-6: These loans meet the definition of "Pass" assets. A homogenous "Pass" loan is typically risk rated based on payment performance. • 7: These loans meet the regulatory definition of “Special Mention.” A homogeneous special mention loan, risk rated 7, is less than 90 days past due from the required payment date at month-end. • 8: These loans meet the regulatory definition of “Substandard.” A homogeneous substandard loan, risk rated 8, is 90 days or more past due from the required payment date at month-end. • 10: These loans meet the regulatory definition of "Loss." A closed-end homogeneous loan not secured by real estate is risk rated 10 when past due 120 cumulative days or more from the contractual due date. Closed-end homogenous loans secured by real estate and all open-end homogenous loans are risk rated 10 when past due 180 cumulative days or more from the contractual due date. These loans, or the portion of these loans classified as loss, are generally charged-off in the month in which the applicable past due period elapses. Small balance commercial loans are generally considered homogenous unless 30 days or more past due. The risk rating classification for such loans are based on the non-homogenous definitions noted above. 70 The following table presents a vintage analysis of the commercial portfolio segment by loan sub-class and risk rating or delinquency status: At December 31, 2022 (in thousands) 2022 2021 2020 2019 2018 2017 and prior Revolving Revolving-term Total COMMERCIAL PORTFOLIO Non-owner occupied CRE Pass $ 68,301 $ 68,356 $ 42,181 $ 139,760 $ 87,197 $ 242,544 $ 2,016 $ 786 $ 651,141 Special Mention — — — — 2,702 4,242 — — 6,944 Substandard — — — — — — — — — Total 68,301 68,356 42,181 139,760 89,899 246,786 2,016 786 658,085 Multifamily Pass 1,828,568 1,165,434 528,077 221,974 59,340 140,126 — — 3,943,519 Special Mention — — 4,893 19,834 — 7,508 — — 32,235 Substandard — — — — — — — — — Total 1,828,568 1,165,434 532,970 241,808 59,340 147,634 — — 3,975,754 Multifamily construction Pass 18,110 63,394 13,613 — — — — — 95,117 Special Mention — — — — — — — — — Substandard — — — — — — — — — Total 18,110 63,394 13,613 — — — — — 95,117 CRE construction Pass 341 14,348 3,960 — — 305 — — 18,954 Special Mention — — — — — — — — — Substandard — — — — — — — — — Total 341 14,348 3,960 — — 305 — — 18,954 Single family construction Pass 149,133 50,936 24,807 519 — 74 123,303 — 348,772 Special Mention — — — — — — — — — Substandard — 6,782 — — — — — — 6,782 Total 149,133 57,718 24,807 519 — 74 123,303 — 355,554 Single family construction to permanent Current 66,034 76,814 11,128 3,268 794 — — — 158,038 Past due: 30-59 days — — — — — — — — — 60-89 days — — — — — — — — — 90+ days — — — — — — — — — Total 66,034 76,814 11,128 3,268 794 — — — 158,038 Owner occupied CRE Pass 70,192 51,919 44,778 71,652 36,457 139,691 3 1,104 415,796 Special Mention — 743 — — 6,179 13,485 — — 20,407 Substandard — — — — 2,149 5,011 — — 7,160 Total 70,192 52,662 44,778 71,652 44,785 158,187 3 1,104 443,363 Commercial business Pass 65,566 42,921 45,940 18,594 13,548 18,779 130,427 2,041 337,816 Special Mention — 612 — 3,577 9 3,444 403 — 8,045 Substandard — 338 2,638 4,449 2,591 2,206 1,563 101 13,886 Total 65,566 43,871 48,578 26,620 16,148 24,429 132,393 2,142 359,747 Total commercial portfolio $ 2,266,245 $ 1,542,597 $ 722,015 $ 483,627 $ 210,966 $ 577,415 $ 257,715 $ 4,032 $ 6,064,612 71 The following table presents a vintage analysis of the consumer portfolio segment by loan sub-class and delinquency status: At December 31, 2022 (in thousands) 2022 2021 2020 2019 2018 2017 and prior Revolving Revolving-term Total CONSUMER PORTFOLIO Single family Current $ 273,786 $ 253,937 $ 152,773 $ 49,302 $ 43,511 $ 231,277 $ — $ — $ 1,004,586 Past due: 30-59 days — — — — 340 2,113 — — 2,453 60-89 days — — — — — 258 — — 258 90+ days — — — 290 273 1,141 — — 1,704 Total (1) 273,786 253,937 152,773 49,592 44,124 234,789 — — 1,009,001 Home equity and other Current 4,156 692 220 150 72 1,593 340,567 4,017 351,467 Past due: 30-59 days — 6 — — — 9 446 — 461 60-89 days 6 24 — — — 48 517 — 595 90+ days — — — — — 151 33 — 184 Total 4,162 722 220 150 72 1,801 341,563 4,017 352,707 Total consumer portfolio $ 277,948 $ 254,659 $ 152,993 $ 49,742 $ 44,196 $ 236,590 $ 341,563 $ 4,017 $ 1,361,708 Total LHFI $ 2,544,193 $ 1,797,256 $ 875,008 $ 533,369 $ 255,162 $ 814,005 $ 599,278 $ 8,049 $ 7,426,320 (1) Includes $ 5.9 million of loans where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in the consolidated income statements. 72 The following table presents a vintage analysis of the commercial portfolio segment by loan sub-class and risk rating or delinquency status: At December 31, 2021 (in thousands) 2021 2020 2019 2018 2017 2016 and prior Revolving Revolving-term Total COMMERCIAL PORTFOLIO Non-owner occupied CRE Pass $ 68,647 $ 50,571 $ 169,711 $ 130,877 $ 100,674 $ 183,024 $ 963 $ 892 $ 705,359 Special Mention — — — — — — — — — Substandard — — — — — — — — — Total 68,647 50,571 169,711 130,877 100,674 183,024 963 892 705,359 Multifamily Pass 1,315,204 561,666 286,826 60,372 26,065 165,225 1 — 2,415,359 Special Mention — — — — — — — — — Substandard — — — — — — — — — Total 1,315,204 561,666 286,826 60,372 26,065 165,225 1 — 2,415,359 Multifamily construction Pass 7,825 22,863 7,173 — — — — — 37,861 Special Mention — — — — — — — — — Substandard — — — — — — — — — Total 7,825 22,863 7,173 — — — — — 37,861 CRE construction Pass 7,694 3,960 — 1,962 — 556 — — 14,172 Special Mention — — — — — — — — — Substandard — — — — — — — — — Total 7,694 3,960 — 1,962 — 556 — — 14,172 Single family construction Pass 146,595 35,640 14,509 — — 77 99,206 — 296,027 Special Mention — — — — — — — — — Substandard — — — — — — — — — Total 146,595 35,640 14,509 — — 77 99,206 — 296,027 Single family construction to permanent Current 90,311 42,636 13,362 1,775 — — — — 148,084 Past due: 30-59 days — — — — — — — — — 60-89 days — — — — — — — — — 90+ days — — — — — — — — — Total 90,311 42,636 13,362 1,775 — — — — 148,084 Owner occupied CRE Pass 70,902 47,536 57,423 47,716 67,042 106,659 798 2,839 400,915 Special Mention — — — 2,196 6,019 145 — 60 8,420 Substandard — — 18,665 1,111 10,151 18,444 — — 48,371 Total 70,902 47,536 76,088 51,023 83,212 125,248 798 2,899 457,706 Commercial business Pass 88,139 51,453 44,882 24,711 11,859 21,258 112,759 2,104 357,165 Special Mention — — 7,396 — 4,396 — 5,613 134 17,539 Substandard 9,716 3,399 1,667 5,928 1,096 1,328 3,932 102 27,168 Total 97,855 54,852 53,945 30,639 17,351 22,586 122,304 2,340 401,872 Total commercial portfolio $ 1,805,033 $ 819,724 $ 621,614 $ 276,648 $ 227,302 $ 496,716 $ 223,272 $ 6,131 $ 4,476,440 73 The following table presents a vintage analysis of the consumer portfolio segment by loan sub-class and delinquency status: At December 31, 2021 (in thousands) 2021 2020 2019 2018 2017 2016 and prior Revolving Revolving-term Total CONSUMER PORTFOLIO Single family Current $ 176,110 $ 156,360 $ 62,369 $ 66,063 $ 95,988 $ 204,229 $ — $ — $ 761,119 Past due: 30-59 days — — 291 — — — — — 291 60-89 days — — — — 314 471 — — 785 90+ days — — 561 452 — 123 — — 1,136 Total (1) 176,110 156,360 63,221 66,515 96,302 204,823 — — 763,331 Home equity and other Current 2,005 474 393 532 516 2,609 290,512 5,273 302,314 Past due: 30-59 days — 3 — — — 94 40 — 137 60-89 days — — — — — — 12 62 74 90+ days 3 — — — — 6 544 — 553 Total 2,008 477 393 532 516 2,709 291,108 5,335 303,078 Total consumer portfolio $ 178,118 $ 156,837 $ 63,614 $ 67,047 $ 96,818 $ 207,532 $ 291,108 $ 5,335 $ 1,066,409 Total LHFI $ 1,983,151 $ 976,561 $ 685,228 $ 343,695 $ 324,120 $ 704,248 $ 514,380 $ 11,466 $ 5,542,849 (1) Includes $ 7.3 million of loans where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in the consolidated income statements. 74 Collateral Dependent Loans The following table presents the amortized cost basis of collateral-dependent loans by loan sub-class and collateral type: At December 31, 2022 (in thousands) Land 1-4 Family Non-residential real estate Other non-real estate Total Commercial and industrial loans Owner occupied CRE $ 1,111 $ — $ 1,410 $ — $ 2,521 Commercial business 62 3,186 562 — 3,810 Total collateral-dependent loans $ 1,173 $ 3,186 $ 1,972 $ — $ 6,331 At December 31, 2021 (in thousands) Land 1-4 Family Non-residential real estate Other non-real estate Total Commercial and industrial loans Owner occupied CRE $ 1,111 $ — $ 2,456 $ — $ 3,567 Commercial business 362 27 562 286 1,237 Total 1,473 27 3,018 286 4,804 Consumer loans Single family — 1,598 — — 1,598 Home equity loans and other — 19 — — 19 Total — 1,617 — — 1,617 Total collateral-dependent loans $ 1,473 $ 1,644 $ 3,018 $ 286 $ 6,421 Nonaccrual and Past Due Loans The following table presents nonaccrual status for loans: At December 31, 2022 At December 31, 2021 (in thousands) Nonaccrual with no related ACL Total Nonaccrual Nonaccrual with no related ACL Total Nonaccrual Commercial and industrial loans Owner occupied CRE $ 2,521 $ 2,521 $ 3,568 $ 3,568 Commercial business 785 4,269 1,210 5,023 Total 3,306 6,790 4,778 8,591 Consumer loans Single family 332 2,584 1,324 2,802 Home equity and other 3 681 23 808 Total 335 3,265 1,347 3,610 Total nonaccrual loans $ 3,641 $ 10,055 $ 6,125 $ 12,201 75 The following tables present an aging analysis of past due loans by loan portfolio segment and loan sub-class: At December 31, 2022 Past Due and Still Accruing (in thousands) 30-59 days 60-89 days 90 days or more Nonaccrual Total past due and nonaccrual (1) Current Total loans CRE Non-owner occupied CRE $ — $ — $ — $ — $ — $ 658,085 $ 658,085 Multifamily — — — — — 3,975,754 3,975,754 Construction/land development Multifamily construction — — — — — 95,117 95,117 CRE construction — — — — — 18,954 18,954 Single family construction — — — — — 355,554 355,554 Single family construction to permanent — — — — — 158,038 158,038 Total — — — — — 5,261,502 5,261,502 Commercial and industrial loans Owner occupied CRE — — — 2,521 2,521 440,842 443,363 Commercial business — — — 4,269 4,269 355,478 359,747 Total — — — 6,790 6,790 796,320 803,110 Consumer loans Single family 4,556 1,724 4,372 (2) 2,584 13,236 995,765 1,009,001 (3) Home equity and other 267 296 — 681 1,244 351,463 352,707 Total 4,823 2,020 4,372 3,265 14,480 1,347,228 1,361,708 Total loans $ 4,823 $ 2,020 $ 4,372 $ 10,055 $ 21,270 $ 7,405,050 $ 7,426,320 % 0.06 % 0.03 % 0.06 % 0.14 % 0.29 % 99.71 % 100.00 % 76 At December 31, 2021 Past Due and Still Accruing (in thousands) 30-59 days 60-89 days 90 days or more Nonaccrual Total past due and nonaccrual (1) Current Total loans CRE Non-owner occupied CRE $ — $ — $ — $ — $ — $ 705,359 $ 705,359 Multifamily — — — — — 2,415,359 2,415,359 Construction/land development Multifamily construction — — — — — 37,861 37,861 CRE construction — — — — — 14,172 14,172 Single family construction — — — — — 296,027 296,027 Single family construction to permanent — — — — — 148,084 148,084 Total — — — — — 3,616,862 3,616,862 Commercial and industrial loans Owner occupied CRE — — — 3,568 3,568 454,138 457,706 Commercial business 198 — — 5,023 5,221 396,651 401,872 Total 198 — — 8,591 8,789 850,789 859,578 Consumer loans Single family 892 820 6,717 (2) 2,802 11,231 752,100 763,331 (3) Home equity and other 118 74 — 808 1,000 302,078 303,078 Total 1,010 894 6,717 3,610 12,231 1,054,178 1,066,409 Total loans $ 1,208 $ 894 $ 6,717 $ 12,201 $ 21,020 $ 5,521,829 $ 5,542,849 % 0.02 % 0.02 % 0.12 % 0.22 % 0.38 % 99.62 % 100.00 % (1) Includes loans whose repayments are insured by the FHA or guaranteed by the VA or SBA of $ 10.6 million and $ 8.4 million at December 31, 2022 and 2021, respectively. (2) FHA-insured and VA-guaranteed single family loans that are 90 days or more past due are maintained on accrual status if they are determined to have little to no risk of loss. (3) Includes $ 5.9 million and $ 7.3 million of loans at December 31, 2022 and 2021, respectively, where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in our consolidated income statements. Loan Modifications The Company provides MFDBs which may include other than insignificant delays in payment of amounts due, extension of the terms of the notes or reduction in the interest rates on the notes. In certain instances, the Company may grant more than one type of modification. The granting of modifications for the year ended December 31, 2022 did not have a material impact on the ACL. The following tables provide information related to MFDBs during the year ended December 31, 2022, disaggregated by class of financing receivable and type of concession granted: Significant Payment Delay Year Ended December 31, 2022 (in thousands) Amortized Cost Basis at Period End % of Total Class of Financing Receivable Single family $ 1,377 0.14 % Home equity and other 69 0.02 % Term Extension Year Ended December 31, 2022 (in thousands) Amortized Cost Basis at Period End % of Total Class of Financing Receivable Commercial business $ 1,562 0.43 % Single family 269 0.03 % 77 Interest Rate Reduction and Significant Payment Delay Year Ended December 31, 2022 (in thousands) Amortized Cost Basis at Period End % of Total Class of Financing Receivable Commercial business $ 459 0.13 % Interest Rate Reduction and Term Extension Year Ended December 31, 2022 (in thousands) Amortized Cost Basis at Period End % of Total Class of Financing Receivable Single family $ 814 0.08 % Significant Payment Delay and Term Extension Year Ended December 31, 2022 (in thousands) Amortized Cost Basis at Period End % of Total Class of Financing Receivable Single family $ 13,742 1.36 % Home equity and other 51 0.01 % Interest Rate Reduction, Significant Payment Delay and Term Extension Year Ended December 31, 2022 (in thousands) Amortized Cost Basis at Period End % of Total Class of Financing Receivable Single family $ 6,500 0.64 % The following table describes the financial effect of the MFDBs: Interest Rate Reduction Year Ended December 31, 2022 Commercial business Reduced weighted-average contractual interest rate from 5.72 % to 4.00 %. Single family Reduced weighted-average contractual interest rate from 4.25 % to 3.31 %. Significant Payment Delay Year Ended December 31, 2022 Single family Provided payment deferrals to borrowers. A weighted average 0.22 % of loan balances were capitalized and added to the remaining term of the loan. Home equity and other Provided payment deferrals to borrowers. A weighted average 3.47 % of loan balances were capitalized and added to the remaining term of the loan. Term Extension Year Ended December 31, 2022 Commercial business Added a weighted average 0.8 years to the life of loans, which reduced the monthly payment amounts to the borrowers. Single family Added a weighted average 4.4 years to the life of loans, which reduced the monthly payment amounts to the borrowers. Home equity and other Added a weighted average 16.1 years to the life of loans, which reduced the monthly payment amounts to the borrowers. Upon determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount. 78 The following table depicts the payment status of loans that were modified to borrowers experiencing financial difficulties on or after January 1, 2022, the date we adopted ASU 2022-02, through September 30, 2022: Payment Status (Amortized Cost Basis) at December 31, 2022 (in thousands) Current 30-89 Days Past Due 90+ Days Past Due Commercial business $ 2,021 $ — $ — Single family 19,908 1,831 198 Home equity and other 120 — — Total $ 22,049 $ 1,831 $ 198 The following tables provide the amortized cost basis as of December 31, 2022 of MFDBs, on or after January 1, 2022, the date we adopted ASU 2022-02 through September 30, 2022 and subsequently had a payment default. Amortized Cost Basis of Modified Loans That Subsequently Defaulted Year Ended December 31, 2022 (in thousands) Significant Payment Delay Term Extension Interest Rate Reduction and Term Extension Significant Payment Delay and Term Extension Interest Rate Reduction, Significant Payment Delay and Term Extension Single family $ 340 $ — $ — $ 1,198 $ 764 NOTE 4– PREMISES AND EQUIPMENT, NET: Premises and equipment consisted of the following: At December 31, (in thousands) 2022 2021 Furniture and equipment $ 55,539 $ 54,548 Leasehold improvements 40,970 41,426 Land and buildings 35,898 36,121 Total 132,407 132,095 Less: accumulated depreciation ( 81,235 ) ( 73,941 ) Net $ 51,172 $ 58,154 NOTE 5– DEPOSITS: Deposit balances, including their weighted average rates, were as follows: At December 31, 2022 2021 (dollars in thousands) Amount Weighted Average Rate Amount Weighted Average Rate Noninterest-bearing demand deposits $ 1,399,912 — % $ 1,617,069 — % Interest bearing: Interest-bearing demand deposits 466,490 0.10 % 513,810 0.10 % Savings 258,977 0.06 % 302,389 0.06 % Money market 2,383,209 1.22 % 2,806,313 0.15 % Certificates of deposit 2,943,331 3.07 % 906,928 0.51 % Total interest bearing deposits 6,052,007 1.98 % 4,529,440 0.21 % Total deposits $ 7,451,919 1.61 % $ 6,146,509 0.15 % There were $ 351 million and $ 342 million in public funds included in deposits at December 31, 2022 and 2021, respectively. 79 Certificates of deposit outstanding mature as follows: (in thousands) December 31, 2022 Within one year $ 2,375,310 One to two years 557,307 Two to three years 6,329 Three to four years 1,998 Four to five years 1,940 Thereafter 447 Total $ 2,943,331 The aggregate amount of time deposits in denominations of more than the FDIC limit of $250,000 at December 31, 2022 and 2021 was $ 189 million and $ 108 million, respectively. There were $ 1.4 billion and $ 145 million of brokered deposits at December 31, 2022 and 2021, respectively. NOTE 6– BORROWINGS: The Company borrows funds through advances from the Des Moines FHLB. The balances, maturity and rate of the outstanding FHLB advances were as follows: At December 31, 2022 2021 (dollars in thousands) Amount Weighted Average Rate Amount Weighted Average Rate Within one year $ 16,000 4.60 % $ 41,000 0.30 % One to three years 450,000 4.31 % — — % Three through five years 550,000 4.35 % — — % Total $ 1,016,000 4.33 % $ 41,000 0.30 % As of December 31, 2022 and 2021, the Company held $ 49.3 million and $ 10.4 million, respectively, of FHLB stock. NOTE 7– LONG-TERM DEBT: On January 19, 2022, we completed a $ 100 million subordinated notes offering due in 2032 (the “Notes”). Interest on the Notes initially will accrue at a rate equal to 3.5 % per annum from and including the date of original issuance to, but excluding, January 30, 2027, payable semiannually in arrears. From and including January 30, 2027, to, but excluding, the maturity date or the date of earlier redemption, the Notes will bear interest equal to the three-month term Secured Overnight Financing Rate ("SOFR") plus 215 basis points, payable quarterly in arrears. Net proceeds to the Company were $ 98 million, after deducting underwriting fees and offering expenses, all of which were still outstanding at December 31, 2022. At December 31, 2022 and 2021, the Company had outstanding $ 64 million of Senior Notes which bear interest at a rate of 6.50 % and mature in 2026. The Company issued trust preferred securities ("TRUPS") during the period from 2005 through 2007, resulting in a debt balance of $ 62 million that remains outstanding at December 31, 2022 and 2021. In connection with the issuance of trust preferred securities, HomeStreet, Inc. issued to HomeStreet Statutory Trust, Junior Subordinated Deferrable Interest Debentures. The sole assets of the HomeStreet Statutory Trust are the Subordinated Debt Securities I, II, III, and IV. 80 The TRUPS outstanding as of December 31, 2022 and 2021 are as follows: HomeStreet Statutory Trust (dollars in thousands) I II III IV Date issued June 2005 September 2005 February 2006 March 2007 Amount $ 5,155 $ 20,619 $ 20,619 $ 15,464 Interest rate 3 MO LIBOR + 1.70 % 3 MO LIBOR + 1.50 % 3 MO LIBOR + 1.37 % 3 MO LIBOR + 1.68 % Maturity date June 2035 December 2035 March 2036 June 2037 Call option (1) Quarterly Quarterly Quarterly Quarterly (1) Call options are exercisable at par and are callable, without penalty on a quarterly basis. NOTE 8– DERIVATIVES AND HEDGING ACTIVITIES: To reduce the risk of significant interest rate fluctuations on the value of certain assets and liabilities, such as single family mortgage LHFS and MSRs, the Company utilizes derivatives as economic hedges. The notional amounts and fair values for derivatives, which are included in other assets or accounts payable and other liabilities on the consolidated balance sheets consist of the following: At December 31, 2022 Notional amount Fair value derivatives (in thousands) Asset Liability Forward sale commitments $ 51,252 $ 293 $ ( 151 ) Interest rate lock commitments 17,463 141 ( 36 ) Interest rate swaps 236,533 13,093 ( 13,093 ) Futures 23,000 18 — Options 14,000 218 — Total derivatives before netting $ 342,248 $ 13,763 $ ( 13,280 ) Netting adjustment/Cash collateral (1) ( 12,870 ) 101 Carrying value on consolidated balance sheet $ 893 $ ( 13,179 ) At December 31, 2021 Notional amount Fair value derivatives (in thousands) Asset Liability Forward sale commitments $ 793,208 $ 723 $ ( 640 ) Interest rate lock commitments 115,025 2,487 ( 3 ) Interest rate swaps 287,352 4,381 ( 4,541 ) Futures 139,900 334 — Total derivatives before netting $ 1,335,485 7,925 ( 5,184 ) Netting adjustment/Cash collateral (1) 1,355 3,921 Carrying value on consolidated balance sheet $ 9,280 $ ( 1,263 ) (1) Includes net cash collateral received of $ 12.8 million and paid of $ 5.3 million at December 31, 2022 and 2021, respectively. The Company nets derivative assets and liabilities when a legally enforceable master netting agreement exists between the Company and the derivative counterparty. Derivatives are reported at their respective fair values in the other assets or accounts payable and other liabilities line items on the consolidated balance sheets, with changes in fair value reflected in current period earnings. 81 The following tables present gross fair value and net carrying value information about derivative instruments: (in thousands) Gross fair value Netting adjustments/Cash collateral (1) Carrying value At December 31, 2022 Derivative assets $ 13,763 $ ( 12,870 ) $ 893 Derivative liabilities ( 13,280 ) 101 ( 13,179 ) At December 31, 2021 Derivative assets $ 7,925 $ 1,355 $ 9,280 Derivative liabilities ( 5,184 ) 3,921 ( 1,263 ) (1) Includes net cash collateral received of $ 12.8 million and paid of $ 5.3 million at December 31, 2022 and 2021, respectively. The collateral used under the Company's master netting agreements is typically cash, but securities may be used under agreements with certain counterparties. Receivables related to cash collateral that has been paid to counterparties is included in other assets. Payables related to cash collateral that has been received from counterparties is included in accounts payable and other liabilities. Interest is owed on amounts received from counterparties and we earn interest on amounts paid to counterparties. Any securities pledged to counterparties as collateral remain on the consolidated balance sheets. At December 31, 2022 and 2021, the Company had liabilities of $ 12.8 million and zero , respectively, in cash collateral received from counterparties and receivables of $ 0.03 million and $ 5.3 million, respectively, in cash collateral paid to counterparties. The following table presents the net gain (loss) recognized on economic hedge derivatives, within the respective line items in the consolidated income statements for the periods indicated: Years Ended December 31, (in thousands) 2022 2021 2020 Recognized in noninterest income: Net gain (loss) on loan origination and sale activities (1) $ 8,587 $ ( 6,057 ) $ ( 7,675 ) Loan servicing income (loss) (2) ( 11,769 ) ( 8,238 ) 20,820 Other (3) 160 386 ( 421 ) (1) Comprised of interest rate lock commitments (" IRLCs") and forward contracts used as economic hedges of single family mortgage LHFS. (2) Comprised of interest rate swaps, interest rate swaptions, futures, US Treasury options and forward contracts used as economic hedges of single family MSRs. (3) Impact of interest rate swap agreements executed with commercial banking customers. The notional amount of open interest rate swap agreements executed with commercial banking customers at December 31, 2022 and 2021 were $ 237 million and $ 287 million, respectively. NOTE 9– MORTGAGE BANKING OPERATIONS: LHFS consisted of the following: At December 31, (in thousands) 2022 2021 Single family $ 14,075 $ 128,041 CRE, multifamily and SBA 3,252 48,090 Total $ 17,327 $ 176,131 82 Loans sold consisted of the following for the periods indicated: Years Ended December 31, (in thousands) 2022 2021 2020 Single family $ 693,348 $ 2,046,811 $ 1,985,944 CRE, multifamily and SBA 145,622 773,378 908,776 Total $ 838,970 $ 2,820,189 $ 2,894,720 Gain on loan origination and sale activities, including the effects of derivative risk management instruments, consisted of the following: Years Ended December 31, (in thousands) 2022 2021 2020 Single family $ 13,054 $ 66,850 $ 100,795 CRE, multifamily and SBA 4,647 25,468 21,769 Total $ 17,701 $ 92,318 $ 122,564 The Company's portfolio of loans serviced for others is primarily comprised of loans held in U.S. government and agency MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae. The unpaid principal balance of loans serviced for others is as follows: At December 31, (in thousands) 2022 2021 Single family $ 5,436,899 $ 5,539,180 CRE, multifamily and SBA 1,938,484 2,031,087 Total $ 7,375,383 $ 7,570,267 Under the terms of the sales agreements for loans sold to GSEs and other entities, the Company has made representations and warranties that the loans sold meet certain requirements. The Company may be required to repurchase mortgage loans or indemnify loan purchasers due to defects in the origination process of the loan, such as documentation errors, underwriting errors and judgments, appraisal errors, early payment defaults and fraud. The total unpaid principal balance of loans sold on a servicing-retained basis that were subject to the terms and conditions of these representations and warranties totaled $ 5.4 billion and $ 5.5 billion as of December 31, 2022 and 2021, respectively. At December 31, 2022 and 2021, the Company had recorded a mortgage repurchase liability for loans sold on a servicing-retained and servicing-released basis, included in accounts payable and other liabilities, of $ 2.2 million and $ 1.3 million, respectively. The following is a summary of changes in the Company's liability for estimated single family mortgage repurchase losses: Years Ended December 31, (in thousands) 2022 2021 Balance, beginning of period $ 1,312 $ 2,122 Additions, net of adjustments (1) 1,629 ( 334 ) Realized losses (2) ( 709 ) ( 476 ) Balance, end of period $ 2,232 $ 1,312 (1) Includes additions for new loan sales and changes in estimated probable future repurchase losses on previously sold loans. (2) Includes principal losses and accrued interest on repurchased loans, "make-whole" settlements, settlements with claimants and certain related expenses. The Company has agreements with investors to advance scheduled principal and interest amounts on delinquent loans. Advances are also made to fund the foreclosure and collection costs of delinquent loans prior to the recovery of reimbursable amounts from investors or borrowers. Advances of $ 1.6 million and $ 1.9 million were recorded in other assets as of December 31, 2022 and 2021, respectively. When the Company has the unilateral right to repurchase Ginnie Mae pool loans it has previously sold (generally loans that are more than 90 days past due), the Company records the balance of the loans as other assets and other liabilities. At December 31, 2022 and 2021, delinquent or defaulted mortgage loans currently in Ginnie Mae pools that the Company has recognized on its 83 consolidated balance sheets totaled $ 6.9 million and $ 12.3 million, respectively. The recognition of previously sold loans does not impact the accounting for the previously recognized MSRs. Revenue from mortgage servicing, including the effects of derivative risk management instruments, consisted of the following.: Years Ended December 31, (in thousands) 2022 2021 2020 Servicing income, net: Servicing fees and other $ 32,082 $ 35,342 $ 32,037 Amortization of single family MSRs (1) ( 9,951 ) ( 19,669 ) ( 17,754 ) Amortization of multifamily and SBA MSRs ( 7,692 ) ( 7,581 ) ( 5,657 ) 14,439 8,092 8,626 Risk management, single family MSRs: Changes in fair value of MSRs due to assumptions (2) 16,739 7,379 ( 19,955 ) Net gain (loss) from economic hedging ( 18,790 ) ( 8,238 ) 20,820 Total ( 2,051 ) ( 859 ) 865 Loan servicing income $ 12,388 $ 7,233 $ 9,491 (1) Represents changes due to collection/realization of expected cash flows and curtailments. (2) Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily reflected by changes in mortgage interest rates. The Company determines fair value of single family MSRs using a valuation model that calculates the net present value of estimated future cash flows. Estimates of future cash flows include contractual servicing fees, ancillary income and costs of servicing, the timing of which are impacted by assumptions, primarily expected prepayment speeds and discount rates, which relate to the underlying performance of the loans. The changes in single family MSRs measured at fair value are as follows: Years Ended December 31, (in thousands) 2022 2021 2020 Beginning balance $ 61,584 $ 49,966 $ 68,109 Additions and amortization: Originations 8,245 23,908 19,424 Amortization (1) ( 9,951 ) ( 19,669 ) ( 17,754 ) Net additions and amortization ( 1,706 ) 4,239 1,670 Changes in fair value assumptions (2) 16,739 7,379 ( 19,813 ) Ending balance $ 76,617 $ 61,584 $ 49,966 (1) Represents changes due to collection/realization of expected cash flows and curtailments. (2) Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily reflected by changes in mortgage interest rates. Key economic assumptions used in measuring the initial fair value of capitalized single family MSRs were as follows: Years Ended December 31, (rates per annum) (1) 2022 2021 2020 Constant prepayment rate ("CPR") (2) 10.91 % 8.84 % 11.37 % Discount rate 9.35 % 8.23 % 7.82 % (1) Based on a weighted average. (2) Represents the expected lifetime average CPR used in the model. 84 For single family MSRs, we use a discounted cash flow valuation technique which utilizes CPRs and discount rates as significant unobservable inputs as noted in the table below: At December 31, 2022 At December 31, 2021 Range of Inputs Average (1) Range of Inputs Average (1) CPRs 6.01 % - 11.10 % 8.19 % 7.90 %- 17.35 % 10.35 % Discount Rates 9.74 % - 16.88 % 10.66 % 6.94 % - 13.96 % 7.97 % (1) Weighted averages of all the inputs within the range. To compute hypothetical sensitivities of the value of our single MSRs to immediate adverse changes in key assumptions, we computed the impact of changes in CPRs and in discount rates as outlined below: (dollars in thousands) At December 31, 2022 Fair value of single family MSRs $ 76,617 Expected weighted-average life (in years) 7.77 CPR Impact on fair value of 25 basis points adverse change in interest rates $ ( 447 ) Impact on fair value of 50 basis points adverse change in interest rates $ ( 1,045 ) Discount rate Impact on fair value of 100 basis points increase $ ( 3,150 ) Impact on fair value of 200 basis points increase $ ( 6,062 ) Generally, increases in the CPR or the discount rate utilized in the fair value measurements of single family MSRs will result in a decrease in fair value. Conversely, decreases in the CPR or the discount rate will result in an increase in fair value. These sensitivities are hypothetical and subject to key assumptions of the underlying valuation model. As the table above demonstrates, the Company's methodology for estimating the fair value of MSRs is highly sensitive to changes in key assumptions. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another, which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made as of a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time. MSRs resulting from the sale of multifamily loans are recorded at fair value and subsequently carried at the lower of amortized cost or fair value. Multifamily MSRs are amortized in proportion to, and over, the estimated period the net servicing income will be collected. The changes in multifamily and SBA MSRs measured at LOCOM or fair value were as follows: Years Ended December 31, (in thousands) 2022 2021 2020 Beginning balance $ 39,415 $ 35,774 $ 29,494 Origination 3,533 11,222 11,587 Amortization ( 7,692 ) ( 7,581 ) ( 5,307 ) Ending balance $ 35,256 $ 39,415 $ 35,774 85 At December 31, 2022, the expected weighted-average life of the Company's multifamily and SBA MSRs was 11.58 years. Projected amortization expense for the gross carrying value of multifamily and SBA MSRs is estimated as follows: (in thousands) At December 31, 2022 2023 $ 5,483 2024 5,309 2025 5,068 2026 4,582 2027 3,868 2028 and thereafter 10,946 Carrying value of multifamily and SBA MSRs $ 35,256 The projected amortization expense of multifamily and SBA MSRs is an estimate and subject to key assumptions of the underlying valuation model. The amortization expense for future periods was calculated by applying the same quantitative factors, such as actual MSR prepayment experience and discount rates, which were used to determine amortization expense. These factors are inherently subject to significant fluctuations, primarily due to the effect that changes in interest rates may have on expected loan prepayment experience. Accordingly, any projection of MSR amortization in future periods is limited by the conditions that existed at the time the calculations were performed and may not be indicative of actual amortization expense that will be recorded in future periods. NOTE 10– COMMITMENTS, GUARANTEES AND CONTINGENCIES: Commitments In the ordinary course of business, the Company extends secured and unsecured open-end loans to meet the financing needs of its customers. In addition, the Company makes certain unfunded loan commitments as part of its lending activities that have not been recognized in the Company's financial statements. These include commitments to extend credit made as part of the Company's lending activities on loans the Company intends to hold in its LHFI portfolio. These commitments include the following: At December 31, (in thousands) 2022 2021 Unused consumer portfolio lines $ 531,784 $ 405,992 Commercial portfolio lines (1) 788,108 820,131 Commitments to fund loans 46,067 90,852 Total $ 1,365,959 $ 1,316,975 (1) Includes undistributed construction loan proceeds, where the Company has an obligation to advance funds for construction progress payments of $ 525 million and $ 584 million at December 31, 2022 and 2021, respectively. The total amounts of unused commitments do not necessarily represent future credit exposure or cash requirements in that commitments may expire without being drawn upon. The Company has recorded an ACL on unfunded loan commitments, included in accounts payable and other liabilities on the consolidated balance sheets of $ 2.2 million and $ 2.4 million at December 31, 2022 and 2021, respectively. The Company has entered into certain agreements to invest in qualifying small businesses and small enterprises and a tax exempt bond partnership that have not been recognized in the Company's financial statements. At December 31, 2022 and 2021 we had $ 11.8 million and $ 15.2 million, respectively, of future commitments to invest in these enterprises. 86 Guarantees In the ordinary course of business, the Company sells loans through the Fannie Mae Multifamily Delegated Underwriting and Servicing Program ("DUS" ® ) that are subject to a credit loss sharing arrangement. The Company services the loans for Fannie Mae and shares in the risk of loss with Fannie Mae under the terms of the DUS contracts. Under the DUS program, the Company and Fannie Mae share losses on a pro rata basis, where the Company is responsible for losses incurred up to one-third of principal balance on each loan with two-thirds of the loss covered by Fannie Mae. For loans that have been sold through this program, a liability is recorded for this loss sharing arrangement under the accounting guidance for guarantees. As of December 31, 2022 and 2021, the total unpaid principal balance of loans sold under this program was $ 1.8 billion and $ 1.9 billion, respectively. The Company's reserve liability related to this arrangement totaled $ 0.6 million at both December 31, 2022 and 2021. There were no actual losses incurred under this arrangement during 2022, 2021 or 2020. Contingencies In the normal course of business, the Company may have various legal claims and other similar contingent matters outstanding for which a loss may be realized. For these claims, the Company establishes a liability for contingent losses when it is probable that a loss has been incurred and the amount of loss can be reasonably estimated. For claims determined to be reasonably possible but not probable of resulting in a loss, there may be a range of possible losses in excess of the established liability. The Company did not have any material amounts reserved for legal claims as of December 31, 2022. NOTE 11– INCOME TAXES: Income tax expense consisted of the following: Years Ended December 31, (in thousands) 2022 2021 2020 Current expense Federal $ 2,829 $ 20,074 $ 27,166 State and local 1,633 3,191 4,804 Deferred (benefit) expense Federal 7,304 4,325 ( 11,076 ) State and local 1,545 511 ( 1,596 ) Tax credit investment amortization 4,809 3,166 2,606 Total $ 18,120 $ 31,267 $ 21,904 Income tax expense differed from amounts computed at the federal income tax statutory rate as follows: Years Ended December 31, 2022 2021 2020 (in thousands, except rate) Rate Amount Rate Amount Rate Amount Income before taxes $ 84,660 $ 146,689 $ 101,894 Federal tax statutory rate 21.00 % 17,779 21.00 % 30,805 21.00 % 21,398 State tax - net of federal tax benefit 3.44 % 2,912 2.20 % 3,220 2.54 % 2,587 Tax-exempt investments ( 4.62 ) % ( 3,908 ) ( 1.40 ) % ( 2,049 ) ( 1.81 ) % ( 1,849 ) Stock-based compensation expense 0.14 % 121 ( 0.77 ) % ( 1,132 ) ( 0.16 ) % ( 159 ) Other 1.44 % 1,216 0.29 % 423 ( 0.07 ) % ( 73 ) Total 21.40 % $ 18,120 21.32 % $ 31,267 21.50 % $ 21,904 87 The following is a summary of the Company's deferred tax assets and liabilities: At December 31, (in thousands) 2022 2021 Deferred tax assets Provision for credit losses $ 10,501 $ 11,477 Unrealized loss on investments AFS 31,431 — Federal and state net operating loss carryforwards 628 628 Accrued liabilities 2,536 2,268 Other investments 572 471 Lease liabilities 10,877 12,028 Nonaccrual interest 513 213 Stock based compensation 737 969 Loan valuation 311 289 Other 694 1,744 Total 58,800 30,087 Deferred tax liabilities Mortgage servicing rights ( 25,725 ) ( 22,221 ) Deferred loan fees and costs ( 9,565 ) ( 7,336 ) Lease right-of-use assets ( 8,415 ) ( 8,572 ) Unrealized gain on investments AFS — ( 5,630 ) Premises and equipment ( 2,486 ) ( 1,843 ) Intangibles ( 694 ) ( 742 ) Other ( 14 ) ( 54 ) Total ( 46,899 ) ( 46,398 ) Net deferred tax asset (liability) $ 11,901 $ ( 16,311 ) Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to fully utilize the existing deferred tax assets. As of December 31, 2022, management determined that sufficient evidence exists to support the future utilization of all of the Company's deferred tax assets. The Company has state net operating loss carryforwards of $ 7.5 million and $ 12.1 million as of December 31, 2022 and 2021 that will expire at various dates from 2027 to 2036. Utilization of net operating loss carryforwards may be subject to an annual limitation due to the "change in ownership" provisions of the Internal Revenue Code of 1986, as amended. Retained earnings at December 31, 2022 and 2021 include approximately $ 12.7 million in tax basis bad debt reserves for which no income tax liability has been recorded. This represents the balance of bad debt reserves created for tax purposes as of December 31, 1987. These amounts are subject to recapture (i.e., included in taxable income) if certain events occur, such as in the event HomeStreet Bank ceases to be a bank. In the event of recapture, the Company will incur both federal and state tax liabilities on this pre-1988 bad debt reserve balance at the then prevailing corporate tax rates. The Company had no recorded unrecognized tax position as of December 31, 2022 or 2021. We are currently under examination, or subject to examination, by various U.S. federal and state taxing authorities. The Company is no longer subject to federal income tax examinations for tax years prior to 2019 or state income tax examination for tax years prior to 2018, generally. NOTE 12– RETIREMENT BENEFIT PLAN: The Company maintains a 401(k) Savings Plan for the benefit of its employees. Substantially all of the Company's employees are eligible to participate in the HomeStreet, Inc. 401(k) Savings Plan (the "Plan"). The Plan provides for payment of retirement benefits to employees pursuant to the provisions of the Plan and in conformity with Section 401(k) of the Internal Revenue Code. Employees may elect to have a portion of their salary contributed to the Plan. Participants receive a vested employer 88 matching contribution equal to 100 % of the first 3.0 % and 50 % of the next 2.0 % of eligible compensation deferred by the participant. Employer contributions of $ 4.0 million, $ 3.9 million and $ 3.8 million were incurred in 2022, 2021, and 2020, respectively. NOTE 13– FAIR VALUE MEASUREMENT: The term "fair value" is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The Company's approach is to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Fair Value Hierarchy A three-level valuation hierarchy has been established under ASC 820 for disclosure of fair value measurements. The valuation hierarchy is based on the observability of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement. The levels are defined as follows: • Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. • Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. This includes quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability for substantially the full term of the financial instrument. • Level 3 – Unobservable inputs for the asset or liability. These inputs reflect the Company's assumptions of what market participants would use in pricing the asset or liability. The Company's policy regarding transfers between levels of the fair value hierarchy is that all transfers are assumed to occur at the end of the reporting period. Estimation of Fair Value Fair value is based on quoted market prices, when available. In cases where a quoted price for an asset or liability is not available, the Company uses valuation models to estimate fair value. These models incorporate inputs such as forward yield curves, loan prepayment assumptions, expected loss assumptions, market volatilities and pricing spreads utilizing market-based inputs where readily available. The Company believes its valuation methods are appropriate and consistent with those that would be used by other market participants. However, imprecision in estimating unobservable inputs and other factors may result in these fair value measurements not reflecting the amount realized in an actual sale or transfer of the asset or liability in a current market exchange. 89 The following table summarizes the fair value measurement methodologies, including significant inputs and assumptions, and classification of the Company's assets and liabilities valued at fair value on a recurring basis. Asset/Liability class Valuation methodology, inputs and assumptions Classification Investment securities Trading securities Fair Value is based on quoted prices in an active market. Level 1 recurring fair value measurement. Investment securities AFS Observable market prices of identical or similar securities are used where available. Level 2 recurring fair value measurement. If market prices are not readily available, value is based on discounted cash flows using the following significant inputs: • Expected prepayment speeds • Estimated credit losses • Market liquidity adjustments Level 3 recurring fair value measurement. LHFS Single family loans, excluding loans transferred from held for investment Fair value is based on observable market data, including: • Quoted market prices, where available • Dealer quotes for similar loans • Forward sale commitments Level 2 recurring fair value measurement. When not derived from observable market inputs, fair value is based on discounted cash flows, which considers the following inputs: • Benchmark yield curve • Estimated discount spread to the benchmark yield curve • Expected prepayment speeds Estimated fair value classified as Level 3. Mortgage servicing rights Single family MSRs For information on how the Company measures the fair value of its single family MSRs, including key economic assumptions and the sensitivity of fair value to changes in those assumptions, see Note 9 , Mortgage Banking Operations . Level 3 recurring fair value measurement. Derivatives Futures and Options Fair value is based on closing exchange prices. Level 1 recurring fair value measurement. Forward sale commitments Interest rate swaps Fair value is based on quoted prices for identical or similar instruments when available. When quoted prices are not available, fair value is based on internally developed modeling techniques, which require the use of multiple observable market inputs, including: • Forward interest rates • Interest rate volatilities Level 2 recurring fair value measurement. Interest rate lock commitments The fair value considers several factors including: • Fair value of the underlying loan based on quoted prices in the secondary market, when available. • Value of servicing • Fall-out factor Level 3 recurring fair value measurement. 90 The following tables present the levels of the fair value hierarchy for the Company's assets and liabilities measured at fair value on a recurring basis: As of December 31, 2022 (in thousands) Fair Value Level 1 Level 2 Level 3 Assets: Trading securities - U.S. Treasury securities $ 18,997 $ 18,997 $ — $ — Investment securities AFS Mortgage backed securities: Residential 197,262 — 195,321 1,941 Commercial 56,049 — 56,049 — Collateralized mortgage obligations: Residential 553,039 — 553,039 — Commercial 70,519 — 70,519 — Municipal bonds 411,548 — 411,548 — Corporate debt securities 42,945 — 42,877 68 U.S. Treasury securities 19,934 — 19,934 — Agency debentures 27,478 — 27,478 — Single family LHFS 14,075 — 14,075 — Single family LHFI 5,868 — — 5,868 Single family mortgage servicing rights 76,617 — — 76,617 Derivatives Futures 18 18 — — Options 218 218 — Forward sale commitments 293 — 293 — Interest rate lock commitments 141 — — 141 Interest rate swaps 13,093 — 13,093 — Total assets $ 1,508,094 $ 19,233 $ 1,404,226 $ 84,635 Liabilities: Derivatives Forward sale commitments $ 151 $ — $ 151 $ — Interest rate lock commitments 36 — — 36 Interest rate swaps 13,093 — 13,093 — Total liabilities $ 13,280 $ — $ 13,244 $ 36 91 As of December 31, 2021 (in thousands) Fair Value Level 1 Level 2 Level 3 Assets: Investment securities AFS Mortgage backed securities: Residential $ 32,963 $ — $ 30,556 $ 2,407 Commercial 62,792 — 62,792 — Collateralized mortgage obligations: Residential 187,394 — 187,394 — Commercial 136,659 — 136,659 — Municipal bonds 539,923 — 539,923 — Corporate debt securities 19,616 — 19,541 75 U.S. Treasury securities 23,175 — 23,175 — Single family LHFS 128,041 — 128,041 — Single family LHFI 7,287 — — 7,287 Single family mortgage servicing rights 61,584 — — 61,584 Derivatives Futures 334 334 — — Forward sale commitments 723 — 723 — Interest rate lock commitments 2,487 — — 2,487 Interest rate swaps 4,381 — 4,381 — Total assets $ 1,207,359 $ 334 $ 1,133,185 $ 73,840 Liabilities: Derivative Forward sale commitments $ 640 $ — $ 640 $ — Interest rate lock commitments 3 — — 3 Interest rate swaps 4,541 — 4,541 — Total liabilities $ 5,184 $ — $ 5,181 $ 3 There were no transfers between levels of the fair value hierarchy during 2022 and 2021. Level 3 Recurring Fair Value Measurements The Company's level 3 recurring fair value measurements consist of investment securities AFS, single family MSRs, single family LHFI where fair value option was elected, certain single family LHFS and IRCLs, which are accounted for as derivatives. For information regarding fair value changes and activity for single family MSRs during 2022 and 2021, see Note 9, Mortgage Banking Operations . The fair value of IRLCs considers several factors, including the fair value in the secondary market of the underlying loan resulting from the exercise of the commitment, the expected net future cash flows related to the associated servicing of the loan (referred to as the value of servicing) and the probability that the commitment will not be converted into a funded loan (referred to as a fall-out factor). The fair value of IRLCs on LHFS, while based on interest rates observable in the market, is highly dependent on the ultimate closing of the loans. The significance of the fall-out factor to the fair value measurement of an individual IRLC is generally highest at the time that the rate lock is initiated and declines as closing procedures are performed and the underlying loan gets closer to funding. The fall-out factor applied is based on historical experience. The value of servicing is impacted by a variety of factors, including prepayment assumptions, discount rates, delinquency rates, contractually specified servicing fees, servicing costs and underlying portfolio characteristics. Because these inputs are not observable in market trades, the fall-out factor and value of servicing are considered to be level 3 inputs. The fair value of IRLCs decreases in value upon an increase in the fall-out factor and increases in value upon an increase in the value of servicing. Changes in the fall-out factor and value of servicing do not increase or decrease based on movements in other significant unobservable inputs. 92 The Company recognizes unrealized gains and losses from the time that an IRLC is initiated until the gain or loss is realized at the time the loan closes, which generally occurs within 30-90 days. For IRLCs that fall out, any unrealized gain or loss is reversed, which generally occurs at the end of the commitment period. The gains and losses recognized on IRLC derivatives generally correlates to volume of single family interest rate lock commitments made during the reporting period (after adjusting for estimated fall-out) while the amount of unrealized gains and losses realized at settlement generally correlates to the volume of single family closed loans during the reporting period. The Company uses the discounted cash flow model to estimate the fair value of certain loans that have been transferred from held for sale to held for investment and single family LHFS when the fair value of the loans is not derived using observable market inputs. The key assumption in the valuation model is the implied spread to benchmark interest rate curve. The implied spread is not directly observable in the market and is derived from third party pricing which is based on market information from comparable loan pools. The fair value estimate of single family loans that have been transferred from held for sale to held for investment are sensitive to changes in the benchmark interest rate which might result in a significantly higher or lower fair value measurement. The Company transferred certain loans from held for sale to held for investment. These loans were originated as held for sale loans where the Company had elected the fair value option. The Company determined these loans to be level 3 recurring assets as the valuation technique included a significant unobservable input. The total amount of held for investment loans where fair value option election was made was $ 5.9 million and $ 7.3 million at December 31, 2022 and 2021, respectively. The following information presents significant Level 3 unobservable inputs used to measure fair value of certain assets: (dollars in thousands) Fair Value Valuation Technique Significant Unobservable Input Low High Weighted Average December 31, 2022 Investment securities AFS $ 2,009 Income approach Implied spread to benchmark interest rate curve 2.00 % 2.00 % 2.00 % Single family LHFI 5,868 Income approach Implied spread to benchmark interest rate curve 2.87 % 5.15 % 4.14 % Interest rate lock commitments, net 105 Income approach Fall-out factor 0.10 % 17.50 % 6.43 % Value of servicing 0.54 % 1.11 % 0.95 % December 31, 2021 Investment securities AFS $ 2,482 Income approach Implied spread to benchmark interest rate curve 2.00 % 2.00 % 2.00 % Single family LHFI 7,287 Income approach Implied spread to benchmark interest rate curve 2.39 % 7.96 % 3.56 % Interest rate lock commitments, net 2,484 Income approach Fall-out factor 0.15 % 21.93 % 8.44 % Value of servicing 0.35 % 1.46 % 1.15 % We had no LHFS where the fair value was not derived with significant observable inputs at December 31, 2022 or 2021. The following table presents fair value changes and activity for certain Level 3 assets: (in thousands) Beginning balance Additions Transfers Payoffs/Sales Change in mark to market (1) Ending balance Year Ended December 31, 2022 Investment securities AFS $ 2,482 $ — $ — $ ( 193 ) $ ( 280 ) $ 2,009 Single family LHFI 7,287 — — — ( 1,419 ) 5,868 Year Ended December 31, 2021 Investment securities AFS $ 2,710 $ — $ — $ ( 192 ) $ ( 36 ) $ 2,482 Single family LHFI 7,108 4,051 — ( 4,279 ) 407 7,287 (1) Changes in fair value for singe family LHFI are recorded in other noninterest income on the consolidated income statements. 93 The following table presents fair value changes and activity for Level 3 interest rate lock commitments: Years Ended December 31, (in thousands) 2022 2021 Beginning balance, net $ 2,484 $ 17,392 Total realized/unrealized gains 68 11,888 Settlements ( 2,447 ) ( 26,796 ) Ending balance, net $ 105 $ 2,484 Nonrecurring Fair Value Measurements Certain assets held by the Company are not included in the tables above, but are measured at fair value on a periodic basis. These assets include certain LHFI and OREO that are carried at the lower of cost or fair value of the underlying collateral, less the estimated cost to sell. The estimated fair values of real estate collateral are generally based on internal evaluations and appraisals of such collateral, which use the market approach and income approach methodologies. We have omitted disclosure related to quantitative inputs given the insignificance of assets measured on a nonrecurring basis. The fair value of commercial properties are generally based on third-party appraisals that consider recent sales of comparable properties, including their income-generating characteristics, adjusted (generally based on unobservable inputs) to reflect the general assumptions that a market participant would make when analyzing the property for purchase. The Company uses a fair value of collateral technique to apply adjustments to the appraisal value of certain commercial LHFI that are collateralized by real estate. The Company uses a fair value of collateral technique to apply adjustments to the stated value of certain commercial LHFI that are not collateralized by real estate and to the appraisal value of OREO. Residential properties are generally based on unadjusted third-party appraisals. Factors considered in determining the fair value include geographic sales trends, the value of comparable surrounding properties as well as the condition of the property. These adjustments include management assumptions that are based on the type of collateral dependent loan and may increase or decrease an appraised value. Management adjustments vary significantly depending on the location, physical characteristics and income producing potential of each individual property. The quality and volume of market information available at the time of the appraisal can vary from period-to-period and cause significant changes to the nature and magnitude of the unobservable inputs used. Given these variations, changes in these unobservable inputs are generally not a reliable indicator for how fair value will increase or decrease from period to period. The following tables presents assets classified as Level 3 assets that had changes in their recorded fair value during 2022 and 2021 and what we still held at the end of the respective reporting period: (in thousands) Fair Value Total Gains (Losses) As of or for the year ended December 31, 2022 LHFI (1) $ 3,186 $ ( 385 ) As of or for the year ended December 31, 2021 LHFI (1) $ 1,214 $ ( 43 ) (1) Represents the carrying value of loans for which adjustments are based on the fair value of the collateral. 94 Fair Value of Financial Instruments The following presents the carrying value, estimated fair value and the levels of the fair value hierarchy for the Company's financial instruments other than assets and liabilities measured at fair value on a recurring basis: At December 31, 2022 (in thousands) Carrying Value Fair Value Level 1 Level 2 Level 3 Assets: Cash and cash equivalents $ 72,828 $ 72,828 $ 72,828 $ — $ — Investment securities HTM 2,441 2,385 — 2,385 — LHFI 7,378,952 6,988,363 — — 6,988,363 LHFS – multifamily and other 3,252 3,291 — 3,291 — Mortgage servicing rights – multifamily and SBA 35,256 39,792 — — 39,792 Federal Home Loan Bank stock 49,305 49,305 — 49,305 — Other assets - GNMA EBO loans 6,918 6,918 — — 6,918 Liabilities: Certificates of deposit $ 2,943,331 $ 2,910,301 $ — $ 2,910,301 $ — Borrowings 1,016,000 1,014,973 — 1,014,973 — Long-term debt 224,404 202,338 — 202,338 — At December 31, 2021 (in thousands) Carrying Value Fair Value Level 1 Level 2 Level 3 Assets: Cash and cash equivalents $ 65,214 $ 65,214 $ 65,214 $ — $ — Investment securities HTM 4,169 4,305 — 4,305 — LHFI 5,488,439 5,588,719 — — 5,588,719 LHFS multifamily and other 48,090 48,425 — 48,425 — Mortgage servicing rights – multifamily and SBA 39,415 43,199 — — 43,199 Federal Home Loan Bank stock 10,361 10,361 — 10,361 — Other assets - GNMA EBO loans 12,342 12,342 — — 12,342 Liabilities: Certificates of deposit $ 906,928 $ 906,064 $ — $ 906,064 $ — Borrowings 41,000 41,000 — 41,000 — Long-term debt 126,026 116,845 — 116,845 — Fair Value Option Single family loans held for sale accounted for under the fair value option are measured initially at fair value with subsequent changes in fair value recognized in earnings. Gains and losses from such changes in fair value are recognized in net gain on mortgage loan origination and sale activities within noninterest income. The change in fair value of loans held for sale is primarily driven by changes in interest rates subsequent to loan funding and changes in fair value of the related servicing asset, resulting in revaluations adjustments to the recorded fair value. The use of the fair value option allows the change in the fair 95 value of loans to more effectively offset the change in fair value of derivative instruments that are used as economic hedges of loans held for sale. The following table presents the difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale accounted for under the fair value option: At December 31, 2022 At December 31, 2021 (in thousands) Fair Value Aggregate Unpaid Principal Balance Fair Value Less Aggregate Unpaid Principal Balance Fair Value Aggregate Unpaid Principal Balance Fair Value Less Aggregate Unpaid Principal Balance Single family LHFS $ 14,075 $ 13,914 $ 161 $ 128,041 $ 124,933 $ 3,108 NOTE 14– REGULATORY CAPITAL REQUIREMENTS: The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company's operations and financial statements. Under capital adequacy guidelines, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about risk components, asset risk weighting, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to assets (as defined). Management believes, as of December 31, 2022 that the Company and the Bank met all capital adequacy requirements. The following table presents the capital and capital ratios of the Company (on a consolidated basis) and the Bank (on a stand-alone basis) as of the respective dates and as compared to the respective regulatory requirements applicable to them: At December 31, 2022 Actual For Minimum Capital Adequacy Purposes To Be Categorized As “Well Capitalized” Under Prompt Corrective Action Provisions (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio HomeStreet, Inc. Tier 1 leverage capital (to average assets) $ 693,112 7.25 % $ 382,467 4.0 % NA NA Common equity tier 1 capital (to risk-weighted assets) 633,112 8.72 % 326,876 4.5 % NA NA Tier 1 risk-based capital (to risk-weighted assets) 693,112 9.54 % 435,834 6.0 % NA NA Total risk-based capital (to risk-weighted assets) 837,828 11.53 % 581,112 8.0 % NA NA HomeStreet Bank Tier 1 leverage capital (to average assets) $ 822,891 8.63 % $ 381,506 4.0 % $ 476,883 5.0 % Common equity tier 1 capital (to risk-weighted assets) 822,891 11.92 % 310,582 4.5 % 448,618 6.5 % Tier 1 risk-based capital (to risk-weighted assets) 822,891 11.92 % 414,109 6.0 % 552,146 8.0 % Total risk-based capital (to risk-weighted assets) 868,993 12.59 % 552,146 8.0 % 690,182 10.0 % 96 At December 31, 2021 Actual For Minimum Capital Adequacy Purposes To Be Categorized As “Well Capitalized” Under Prompt Corrective Action Provisions (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio HomeStreet, Inc. Tier 1 leverage capital (to average assets) $ 723,232 9.94 % $ 291,098 4.0 % NA NA Common equity tier 1 capital (to risk-weighted assets) 663,232 10.84 % 275,281 4.5 % NA NA Tier 1 risk-based capital (to risk-weighted assets) 723,232 11.82 % 367,041 6.0 % NA NA Total risk-based capital (to risk-weighted assets) 774,695 12.66 % 489,388 8.0 % NA NA HomeStreet Bank Tier 1 leverage capital (to average assets) $ 727,753 10.11 % $ 287,990 4.0 % $ 359,988 5.0 % Common equity tier 1 capital (to risk-weighted assets) 727,753 12.87 % 254,442 4.5 % 367,527 6.5 % Tier 1 risk-based capital (to risk-weighted assets) 727,753 12.87 % 339,256 6.0 % 452,341 8.0 % Total risk-based capital (to risk-weighted assets) 778,723 13.77 % 452,341 8.0 % 565,426 10.0 % As of each of the dates set forth in the above table, the Company exceeded the minimum required capital ratios applicable to it and Bank’s capital ratios exceeded the minimums necessary to qualify as a well-capitalized depository institution under the prompt corrective action regulations. No conditions or events have occurred since December 31, 2022 that we believe have changed the Company’s or the Bank’s capital adequacy classifications from those set forth in the above table. In addition to the minimum capital ratios, both the Company and the Bank are required to maintain a “conservation buffer" consisting of additional Common Equity Tier 1 Capital which is at least 2.5% above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. The required ratios for capital adequacy set forth in the above table do not include the additional capital conservation buffer, though each of the Company and Bank maintained capital ratios necessary to satisfy the capital conservation buffer requirements as of the dates indicated. At December 31, 2022, capital conservation buffers for the Company and the Bank were 3.53 % and 4.59 %, respectively. The following table sets forth the minimum capital ratios plus the applicable increment of the capital conservation buffer: Common equity to Tier-1 to risk-weighted assets 7.00 % Tier 1 capital to risk-weighted assets 8.50 % Total capital to risk-weighted assets 10.50 % 97 NOTE 15– EARNINGS PER SHARE: The following table summarizes the calculation of earnings per share: Years Ended December 31, (in thousands, except share and per share data) 2022 2021 2020 Net income $ 66,540 $ 115,422 $ 79,990 Weighted average shares: Basic weighted-average number of common shares outstanding 18,931,107 20,885,509 22,867,268 Dilutive effect of outstanding common stock equivalents (1) 110,004 257,905 209,554 Diluted weighted-average number of common shares outstanding 19,041,111 21,143,414 23,076,822 Net income per share Basic earnings per share $ 3.51 $ 5.53 $ 3.50 Diluted earnings per share 3.49 5.46 3.47 (1) Excluded from the computation of diluted earnings per share (due to their antidilutive effect) for the years ended December 31, 2022, 2021 and 2020 were certain unvested RSUs and PSUs. The aggregate number of common stock unvested restricted shares, which could potentially be dilutive in future periods, was 176,259 , zero and 201 at December 31, 2022, 2021 and 2020, respectively. NOTE 16– LEASES: We have operating and finance leases for certain office space and finance leases for certain equipment. Our leases have remaining lease terms of up to 13 years. The Company, as sublessor, subleases certain office and retail space in which the terms of any significant subleases end by 2027. Under all of our executed sublease arrangements, the sublessees are obligated to pay the Company sublease payments of $ 4.9 million in 2023, $ 3.3 million in 2024, $ 2.8 million in 2025, $ 2.9 million in 2026 and $ 2.7 million in 2027. For 2020 we incurred $ 2.5 million in impairment charges on lease right-of-use assets. The components of lease expense were as follows: Years Ended December 31, (in thousands) 2022 2021 2020 Operating lease cost $ 8,762 $ 9,610 $ 11,989 Finance lease cost: Amortization of right-of-use assets 580 1,066 1,277 Interest on lease liabilities 19 22 151 Variable lease costs and nonlease components 3,123 3,716 5,502 Sublease income ( 2,565 ) ( 3,449 ) ( 6,662 ) Total $ 9,919 $ 10,965 $ 12,257 98 Supplemental cash flow information related to leases were as follows: Years Ended December 31, (in thousands) 2022 2021 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 12,845 $ 13,647 $ 15,452 Operating cash flows from finance leases 19 22 151 Financing cash flows from finance leases 589 1,070 1,209 Right-of-use assets obtained Operating leases $ 6,347 $ 1,894 $ 5,666 Finance leases 145 707 — Other changes in right-of-use assets (1) Operating leases $ — $ ( 460 ) $ ( 39,924 ) Finance leases — ( 2 ) ( 29 ) (1) Change in 2020 primarily relates to changes in assumptions regarding the exercise of renewal options available under real estate lease agreements. Supplemental information related to leases was as follows: At December 31, (in thousands, except lease term and discount rate) 2022 2021 Operating lease right-of-use assets, included in other assets $ 34,070 $ 38,010 Operating lease liabilities, included in accounts payable and other liabilities 42,848 49,574 Finance lease right-of-use assets, included in other assets $ 359 $ 777 Finance lease liabilities, included in accounts payable and other liabilities 359 787 Weighted Average Remaining lease term in years Operating leases 5.07 5.87 Finance leases 0.88 0.96 Weighted Average Discount Rate Operating leases 1.91 % 1.71 % Finance leases 3.50 % 1.43 % Maturities of lease liabilities and obligations under leases classified as nonlease components were as follows: Lease Liabilities (in thousands) Operating Leases Finance Leases Nonlease Components Year ended December 31, 2023 $ 11,098 $ 360 $ 4,846 2024 9,492 8 4,490 2025 7,976 — 4,357 2026 6,862 — 4,454 2027 6,137 — 3,850 2028 and thereafter 3,546 — 123 Total lease payments 45,111 368 $ 22,120 Less imputed interest 2,263 9 Total $ 42,848 $ 359 99 NOTE 17– SHARE-BASED COMPENSATION PLANS: In May 2014, the shareholders approved the Company's 2014 Equity Incentive Plan (the "2014 EIP Plan") that provided for the grant of stock options, shares of restricted stock, RSUs, PSUs, stock bonus awards, stock appreciation rights, performance share awards and performance compensation awards and unrestricted stock (collectively, "Equity Incentive Awards") to the Company’s executive officers, other key employees and directors. This plan was amended in May 2017 and allows the grant of up to 1,875,000 shares of the Company’s common stock. For 2022, 2021, and 2020, the Company recognized stock-based compensation cost of $ 3.3 million, $ 2.9 million and $ 2.4 million, respectively. RSUs generally vest over a three year period with the fair market value of the awards determined at the grant date based on the Company's stock price. PSUs vest at the end of a three year period with the fair market value of the awards determined using a Monte Carlo simulation technique. A summary of the status of the combined RSUs and PSUs is as follows: Number Weighted Average Grant Date Fair Value Outstanding at December 31, 2021 268,531 $ 26.83 Granted 91,942 51.55 Cancelled or forfeited ( 11,921 ) 33.58 Vested ( 121,477 ) 27.90 Outstanding at December 31, 2022 227,075 $ 33.95 The assumptions used in the Monte Carlo simulations used to determine fair market value of the PSUs granted in 2022, 2021 and 2020 are set forth in the table below: 2022 2021 2020 Volatility of common stock 40.3 % 40.5 % 33.9 % Average volatility of peer companies 44.2 % 43.5 % 34.8 % Average correlation coefficient of peer companies 0.8079 % 0.8004 % 0.7561 % Risk-free interest rate 1.0 % 0.2 % 0.3 % Expected term in years 3.00 years 3.00 years 2.76 years 100 NOTE 18– PARENT COMPANY FINANCIAL STATEMENTS (UNAUDITED): Condensed financial information for HomeStreet, Inc. is as follows: Condensed Balance Sheets At December 31, (in thousands) 2022 2021 Assets: Cash and cash equivalents $ 5,804 $ 12,756 Other assets 4,601 5,082 Investment in stock of HomeStreet Bank 752,211 779,851 Investment in stock of other subsidiaries 26,954 45,175 Total assets $ 789,570 $ 842,864 Liabilities: Other liabilities $ 3,019 $ 1,499 Long-term debt 224,404 126,026 Total liabilities 227,423 127,525 Shareholders' Equity: Common stock, no par value 226,592 249,856 Retained earnings 435,085 444,343 Accumulated other comprehensive income (loss) ( 99,530 ) 21,140 Total shareholder's equity 562,147 715,339 Total liabilities and shareholders' equity $ 789,570 $ 842,864 Condensed Income Statements Years Ended December 31, (in thousands) 2022 2021 2020 Noninterest income Dividend income $ 51,000 $ 109,000 $ 82,909 Equity in undistributed income from subsidiaries 24,898 10,801 3,374 Other noninterest income 2,053 1,838 1,773 Total revenues 77,951 121,639 88,056 Expenses Interest expense-net 8,315 4,576 5,731 Noninterest expense 6,123 2,939 4,136 Total expenses 14,438 7,515 9,867 Income before income taxes (benefit) 63,513 114,124 78,189 Income taxes (benefit) ( 3,027 ) ( 1,298 ) ( 1,801 ) Net income $ 66,540 $ 115,422 $ 79,990 101 Condensed Statements of Cash Flows Years Ended December 31, (in thousands) 2022 2021 2020 Cash flows from operating activities Net income $ 66,540 $ 115,422 $ 79,990 Adjustments to reconcile net income to net cash provided by (used in) operating activities Undistributed earnings from investment in subsidiaries ( 24,898 ) ( 10,801 ) ( 3,374 ) Other 6,386 ( 8,669 ) ( 4,483 ) Net cash provided by operating activities 48,028 95,952 72,133 Cash flows from investing activities: AFS securities: Principal collections net of purchases 831 2,012 2,886 Investments in subsidiaries ( 52,000 ) — — Net cash provided by (used in) investing activities ( 51,169 ) 2,012 2,886 Cash flows from financing activities: Repurchases of common stock ( 75,000 ) ( 84,154 ) ( 58,009 ) Proceeds from exercise of stock options — 263 238 Proceeds from issuance of long-term debt 98,036 — — Dividends paid on common stock ( 26,847 ) ( 21,338 ) ( 13,865 ) Net cash used in financing activities ( 3,811 ) ( 105,229 ) ( 71,636 ) Net (decrease) increase in cash and cash equivalents ( 6,952 ) ( 7,265 ) 3,383 Cash and cash equivalents, beginning of year 12,756 20,021 16,638 Cash and cash equivalents, end of year $ 5,804 $ 12,756 $ 20,021 NOTE 19– SUBSEQUENT EVENTS: In February 2023, we completed an acquisition of three branches in southern California whereby we assumed $ 373 million in deposits and purchased $ 22 million in loans. On January 26, 2023 the Board of Directors authorized a dividend of $ 0.35 per share, payable on February 22, 2023 to shareholders of record on February 8, 2023. 102 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None