See accompanying Notes to Condensed Consolidated Financial Statements.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1)Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements | |
(1) | Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements |
(a) Description of Business
Heritage Financial Corporation ("Heritage" or the “Company”) is a bank holding company that was incorporated in the State of Washington in August 1997. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank (the “Bank”). The Bank is a Washington-chartered commercial bank and its deposits are insured by the FDIC.Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 5962 branch offices as of September 30, 2020 located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas. The Bank's deposits are insured by the FDIC.
On July 26, 2017, theThe Company announced a plan in October 2020 to consolidate 9 branches to create a more efficient branch footprint, including 1 branch during October 2020 and 8 branches during January 2021. This will reduce the execution of a definitive agreementbranch count from 62 to purchase Puget Sound Bancorp, Inc., ("Puget Sound"), the holding company of Puget Sound Bank, a business bank headquartered in downtown Bellevue, Washington with one branch location and $567.2 million in total assets, $366.6 million in total loans receivables, net and $505.1 million in total deposits as of June 30, 2017. Upon consummation of the merger, the shareholders of Puget Sound will own approximately 13.5% of the combined company and Puget Sound will be merged53. The Company plans to integrate these locations into Heritage Bank. For additional information regarding the proposed transaction, see Note (16), Definitive Agreement.other branches within its network.
(b) Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the accounting principles generally accepted in the United States (“U.S. GAAP”)GAAP for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC").SEC. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. It is recommended that these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 (“20162019 Annual Form 10-K”).10-K. In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 20172020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. In preparing the2020.
To prepare unaudited Condensed Consolidated Financial Statements in conformity with GAAP, management is required to makemakes estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Management believes that the judgments,based on available information. These estimates and assumptions usedaffect the amounts reported in the preparation of the financial statements and the disclosures provided, and actual results could differ. Material estimates that are appropriate basedparticularly susceptible to significant change relate to management's estimate of ACL on loans, management's evaluation of goodwill impairment and the fair value of financial instruments. It is reasonably possible that management's estimate of ACL on loans of $73.3 million at September 30, 2020 as disclosed in Note (4) Allowance for Credit Losses on Loans, management's conclusion that the fair value of the reporting unit more likely than not exceeds its carrying value at September 30, 2020 as disclosed in Note (6) Goodwill and Other Intangible Assets and the estimates of fair value of financial instruments as disclosed in Note (12) Fair Value Measurements could materially change.
Certain prior year amounts have been reclassified to conform to the current year’s presentation. Namely, loan receivable balances in the disclosures of Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans have been reclassified to conform to the current period presentation, which is net of deferred fees and costs. Reclassifications had no effect on the facts and circumstances at the time. Actual results, however, could differ significantly from those estimates.prior years' net income or stockholders’ equity.
(c) Significant Accounting Policies
The significant accounting policies used in preparation of the Company's Condensed Consolidated Financial Statements are disclosed in the 20162019 Annual Form 10-K. ThereOther than the adoption of the new accounting standard discussed below, there have not been any material changes in the Company's significant accounting policies from those contained in the 20162019 Annual Form 10-K, except10-K.
(d) Adoption of FASB ASU 2016-13
On January 1, 2020, the Company adopted FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, replacing the incurred loss methodology with an expected loss methodology, which is commonly referred to as the "CECL" methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at
amortized cost, including loans receivable. It also applies to off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition, CECL Adoption made changes to the accounting for credit losses on investment securities available for sale.
The Company adopted ASU 2016-13 using the modified retrospective method for all financial assets measured at amortized cost and unfunded commitments. The Company elected not to measure an ACL on accrued interest receivable on loans receivable or accrued interest receivable on investment securities available for sale as Company policy is to reverse interest income for uncollectible accrued interest receivable balances in a timely manner. Due to the significant number of loan payment deferral modifications which have been made in accordance with the CARES Act, the Company assessed the need for an allowance on credit losses of its accrued interest receivable on loans and determined no allowance was required to be recorded as the ACL on accrued interest receivable on loans was not significant at September 30, 2020.
Results for the reporting period beginning after January 1, 2020 are presented under ASU 2016-13, while prior period amounts were not restated and continue to be reported in accordance with previously applicable GAAP. The accounting policies for stock-based compensation relatingprior periods are included in the 2019 Form 10-K.
The accounting policies for all financial instruments impacted by CECL Adoption are as follows:
Investment Securities
A debt security is placed on nonaccrual status at the time any principal or payments become more than 90 days delinquent. Interest accrued, but not received for a security placed on nonaccrual, is reversed against interest income during the period that the debt security is placed on nonaccrual status.
Allowance for Credit Losses on Investment Securities Available for Sale
Management evaluates the need for an ACL on investment securities available for sale on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities available for sale in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For investment securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the issuancerating of restricted stock units, including grants subjectthe security by a rating agency and adverse conditions specifically related to performance-based and market-based vesting conditions, adopted January 1, 2017 as discussed below.
Stock-Based Compensation
Compensation costthe security, among other factors. The credit loss is recognized for stock options, restricted stock awards and restricted stock units issued to employees and directors, based on the fair value of these awards at the date of grant. Compensation cost is recognized over the requisite service period, generally defined as the vesting period, on a straight-line basis. Compensation cost for restricted stock units with market-based vesting is recognized overdifference between the service period to the extent the restricted stock units are expected to vest. With the adoption of FASB Accounting Standards Update ("ASU" or "Update") 2016-09 on January 1, 2017, forfeitures are recognized as they occur.
The market price of the Company’s common stock at the date of grant is used to determine the fairpresent value of the restricted stock awardscash flows expected to be collected and restricted stock units. The fairthe amortized cost basis. If the present value of stock options grantedcash flows expected to be collected is estimated basedless than the amortized cost basis, a credit loss exists and an ACL on investment securities available for sale is recorded for the date of grant usingcredit loss, limited by the Black-Scholes-Merton option pricing model. Certain restricted stock unit grants are subject to performance-based vesting as well as other approved vesting conditions and
cliff vest based on those conditions, andamount that the fair value is estimated using a Monte Carlo simulation pricing model. The assumptions usedless than the amortized cost basis. Any decline in fair value that has not been recorded through an ACL on investment securities available for sale is recognized in other comprehensive income.
Changes in the Black-Scholes-Merton option pricing model andACL on investment securities available for sale are recorded as provision for credit losses expense. Losses are charged against the Monte Carlo simulation pricing model includeACL when management believes the expected term based on the valuation date and the remaining contractual termuncollectability of an investment security available for sale is confirmed or when either of the award; the risk-freecriteria regarding intent or requirement to sell is met.
Accrued interest rate basedreceivable on the U.S. Treasury curve at the valuation date of the award; the expected dividend yield based on expected dividends being payable to the holders; and the expected stock price volatility over the expected term based on the historical volatility over the equivalent historical term.
(d) Recently Issued Accounting Pronouncements
FASB ASU 2014-09, Revenue from Contracts with Customers, was issued in May 2014. Under this Update, FASB created a new Topic 606 whichinvestment securities available for sale is in response to a joint initiative of FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and international financial reporting standards that would:
Remove inconsistencies and weaknesses in revenue requirements.
Provide a more robust framework for addressing revenue issues.
Improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets.
Provide more useful information to users of financial statements through improved disclosure requirements.
Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The original effective date for this Update was deferred in FASB ASU 2015-14 below.
FASB ASU 2015-14, Revenue from Contracts with Customers (Topic 606), was issued in August 2015 and defers the effective date of the above-mentioned FASB ASU 2014-09 for certain entities. Public business entities, certain not-for-profit entities and certain employee benefit plans should apply the guidance in Update 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is now permitted, but only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company expects to adopt the revenue recognition guidance on January 1, 2018 using the modified retrospective approach. A significant amount of the Company’s revenues are derived from net interest income on financial assets and liabilities, which are excluded from the scopeestimate of credit losses as interest accrued, but not received, is reversed timely in accordance with the policy for investment securities stated above.
Loans Receivable
Loans receivable include loans originated and indirect loans purchased by the Bank as well as loans acquired in business combinations.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the outstanding principal balance, net of purchased premiums and discounts, unearned discounts, and net deferred loan origination fees and costs. Accrued interest receivable for loans receivable is reported within Accrued interest receivable on the Condensed Consolidated Statements of Financial Condition.
Purchased Loans:
Loans acquired in a business combination are designated as “purchased” loans. Upon adoption of ASU 2016-13, the Bank's PCI loans were transitioned to PCD loans. The Bank elected to account for the
PCD loans individually, terminating the pools of loans that were previously accounted for under ASC 310-30.
Loans purchased after January 1, 2020 are recorded at their fair value at acquisition date net of an ACL on loans expected to be incurred over the life of the amended guidance. With respect to noninterest income and related disclosures,loan. The initial ACL on purchased loans is determined using the Companysame methodology as originated loans. For non-PCD loans, the initial ACL is in its preliminary stages of identifying and evaluatingrecorded through earnings as a provision for credit losses. For PCD loans, the revenue streams and underlying revenue contracts withininitial ACL is incorporated into the scope of the guidance. To date, the Company has not yet identified any significant changes in the timing of revenue recognition when considering the amended accounting guidance; however, the Company’s implementation efforts are ongoing and such assessments may change prior to the January 1, 2018 implementation date. The Company expects to develop processes and procedures to ensure it is fully compliant with these amendments at the adoption date.
FASB ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10), was issued in January 2016, to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. This Update contains several provisions, including but not limited to 1) requiring equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; 2) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) eliminating the requirement to disclose the method(s) and significant assumptions used to estimate fair value; and 4) requiring separate presentation of financial assets and liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. The Update also changes certain financial statement disclosure requirements, including requiring disclosurescalculation of the fair value of financial instruments benet assets acquired on the merger date and the net of the PCD loan purchase price and the initial ACL becomes the initial amortized cost basis. The difference between the initial amortized cost basis and the par value of PCD loans is the noncredit discount or premium for PCD loans. The noncredit discount or premium for PCD loans and both the noncredit and credit discount or premium for non-PCD loans are accreted through the interest and fees on loans line item on the Condensed Consolidated Statements of Income over the life of the loan using the effective interest method for non-revolving credits or the straight-line method, which approximates the effective interest method, for revolving credits. Any unrecognized discount or premium for a purchased loan that is subsequently repaid in full is recognized immediately into income. Subsequent changes to the ACL on loans for purchased loans are recorded through earnings as a provision for credit losses.
Troubled Debt Restructures:
The CARES Act and regulatory agencies provided guidance around the modification of loans as a result of the COVID-19 pandemic, and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined by the CARES Act and related regulatory guidance prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current if they are less than 30 days past due on the contractual payments as of December 31, 2019 under the CARES Act and at the time a modification program is implemented under related regulatory guidance.
Allowance for Credit Losses on Loans
The ACL on loans is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. Loans are charged against the ACL when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off. Subsequent recoveries, if any, are credited to the ACL. The Bank records the changes in the ACL through earnings as a provision for credit losses on the Condensed Consolidated Statements of Income.
Accrued interest receivable on loans receivable is excluded from the estimate of credit losses. Instead, interest accrued, but not received, is reversed timely in accordance with the policy for loans receivable.
Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans. The same methodology is applied to all loans consistent with the guidance of the accounting standard which does not require undue complexity. Under this methodology, the Company has identified segments of loans with similar risk characteristics that align with their identified loan classes. Nonaccrual loans are not considered similar to other loans; therefore, they are evaluated for credit losses on an individual basis. The allowance for individually evaluated loans is calculated using either the collateral value method, which considers the likely source of repayment as the value of the collateral, less estimated costs to sell, or the net present value method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt.
A performing TDR loan is evaluated for allowance on a collective basis with loans with similar risk characteristics if a) it is classified as a risk rating of exit price."Pass," b) it has paid a minimum of six months of principal and interest in accordance with the restructured terms, and c) it has not been over 30 days delinquent in the most recent six month period. If all three criteria on a performing TDR loan are not met, the loan is evaluated for credit losses on an individual basis as it is not deemed to have similar characteristics of other loans in the portfolio. Nonaccrual TDR loans, including defaulted TDR loans, and performing TDR loans that do not meet the similar characteristics criteria, are evaluated for allowance on an individual basis as described above except that the original interest rate is used to discount the expected cash flows, not the rate specified in the restructuring.
For each loan segment collectively measured for allowance, the baseline loss rates are calculated using the Bank's average quarterly historical loss information for an economic cycle. The Update is effective for public entities for fiscal years beginning after December Bank evaluates the historical period on a quarterly basis, with the assumption that economic cycles have historically lasted
15 2017, including interim periods within those fiscal
between 10 and 15 years. The Company doesbaseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the baseline loss estimate for each loan. Estimated cash flows consider the principal and interest in accordance with the contractual term of the loan and estimated prepayments. Contractual cash flows are based on the amortized cost, and are adjusted for balances guaranteed by governmental entities, such as SBA or USDA, or the unguaranteed amortized cost. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: 1) management has a reasonable expectation at the reporting date that a TDR will be executed with an individual borrower or 2) the extension or renewal options are included in the original or modified contract at the reporting date and are not expectunconditionally cancellable by the adoptionCompany. Prepayments are established for each segment based on rolling historical averages for the segments, which management believes is an accurate representation of this Updatefuture prepayment activity. Management reviews the adequacy of the prepayment period assumption on a quarterly basis.
The CECL methodology includes consideration of the forecasted direction of the economic and business environment and its likely impact to the estimated allowance as compared to the historical losses over the reasonable and supportable time frame. Economic forecast models for the current period are uploaded to the model, which targets 16 forecasted macroeconomic factors, such as unemployment rate, GDP, housing price index, commercial real estate price index, disposable income growth, mortgage rates, and certain rate indices. Each of the forecasted segments is impacted by a mix of these macroeconomic factors. Further, each of the macroeconomic factors is utilized differently by segment, including the application of lagged factors and various transformations such as percent change year over year.
The macroeconomic sensitive model is developed for each segment given the current and forecasted conditions, and a macroeconomic multiplier is calculated for each forecast period considering the forecasted losses as compared to the long-term average actual losses of the dataset. The impact of those macroeconomic factors to each segment, both positive or negative, using the reasonable and supportable period, are added to the calculated baseline loss rate. After the reasonable and supportable period, forecasted loss rates revert to historical baseline loss levels over the predetermined reversion period on a straight-lined basis.
The Bank also considers other qualitative risk factors to adjust the estimated ACL calculated by the above mentioned model. The Bank will have a significant impactbias for minimal factors unless internal or external factors outside those considered in its historical losses or macroeconomic forecast indicate otherwise. The Bank will establish metrics to estimate the qualitative risk factor by segment based on the Company’s statementsidentified risk.
In general, management's estimate of financial condition or income. Managementthe ACL on loans uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
The evaluation of ACL on loans is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize losses on loans, future additions to the allowance may be necessary based on further declines in local and national economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the planning stagesBank’s ACL on loans. Such agencies may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the time of developing processestheir examinations. The Company believes the ACL on loans is appropriate given all of the above considerations.
Allowance for Credit Losses on Unfunded Commitments
The Bank estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in which the Bank is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Bank. The Bank has determined that no allowance is necessary for its credit card portfolio as it has the ability to unconditionally cancel the available lines of credit.
The allowance methodology for unfunded commitments is similar to the ACL on loans, but additionally includes an estimate of the future utilization of the commitment as determined by historical commitment utilizations and procedures to complythe Bank's estimates of future utilizations given current economic forecasts. The credit risks associated with the disclosures requirements of this Update, which could impactunfunded commitments are consistent with the disclosuresrisks outlined for each loan class under the Company makes related to fair value of its financial instruments.ACL for loans.
FASB ASU 2016-02, Leases (Topic 842) was originally issued in February 2016, to increase transparency and comparability of leases among organizations and to disclose key information about leasing arrangements. The Update sets out the principlesACL for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The Update requires lessees to apply a dual approach, classifying leases as either a finance or operating lease. This classification will determine whether the lease expenseunfunded commitments is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use assetin Accrued expenses and a
lease liability for all leases with a term greater than 12 months regardless of their classification. All cash payments will be classified within operating activities in the statement of cash flows. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Update is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company anticipates adopting the Update on January 1, 2019. Upon adoption of the guidance, the Company expects to report increased assets and increasedother liabilities on itsthe Condensed Consolidated Statements of Financial Condition and changes are recorded through earnings as a result of recognizing right-of-use assets and lease liabilities related to certain banking offices and certain equipment under noncancelable operating lease agreements, which currently are not reflected in itsprovision for credit losses on the Condensed Consolidated Statements of Financial Condition. During 2017, management began its evaluationIncome.
Provision for Credit Losses
The provision for credit losses as presented in the initial stages of developing its methodology to estimate the right-of use assets and lease liabilities. The Company anticipates electing an accounting policy to not recognize lease assets and lease liabilities for leases with a term of twelve months or less. The Company was committed to $14.7 million of minimum lease payments under noncancelable operating lease agreements at December 31, 2016. The Company does not expect the adoption of this amendment will have a significant impact to its Condensed Consolidated Financial Statements.
FASB ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, was issued in March 2016 and it clarifies the implementation guidance of the above-mentioned FASB ASU 2014-09 as it relates to principal versus agent considerations. The Update addresses identifying the unit of account and nature of the goods or services as well as applying the control principle and interactions with the control principle. The amendments to the Update do not change the core principle of the guidance. The effective date, transition requirements and impact on the Company's Condensed Consolidated Financial Statements of Income includes the provision for this Update are the same as those described in FASB ASU 2015-14 above.
FASB ASU 2016-09, Stock Compensation (Topic 718), issued in March 2016, is intended to simplify several aspects of the accounting for share-based payment award transactions. For public business entities, the guidance is effective for annual periods after December 15, 2016, including interim periods within those annual periods with early adoption permitted. Certain amendments are required to be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Other amendments are applied retroactively (such as presentation of employee taxes paidcredit losses on the statement of cash flows) or prospectively (such as recognition of excess tax benefits on the income statement). The Company adopted this standard effective January 1, 2017. The Company made an accounting policy election to account for forfeitures as they occur and this change resulted in a cumulative adjustment that was immaterial to all periods presented. Changes to the statement of cash flows have been applied prospectivelyloans and the Company recorded excess tax benefits in its income tax expense. Adoption of all other changes under this Update did not have a material impactprovision for credit losses on the Condensed Consolidated Financial Statements.unfunded commitments.
FASB ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, was issued in April 2016 which clarifies the implementation guidance of the above-mentioned FASB ASU 2014-09 as it relates to identifying performance obligations and licensing. The effective date, transition requirements and impact on the Company's Condensed Consolidated Financial Statements for this Update are the same as those described in FASB ASU 2015-14 above.
FASB ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-scope Improvements and Practical Expedients, was issued in May 2016. The amendments in this Update do not change the core principle of the guidance in Topic 606. Rather, the amendments in this Update affect only the narrow aspects of Topic 606. The effective date, transition requirements and impact on the Company's Condensed Consolidated Financial Statements for this Update are the same as those described in FASB ASU 2015-14 above.(e) Recently Issued Accounting Pronouncements
FASB ASU 2016-13, Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and 2020-02, was originally issued in June 2016. Commonly referred to as the current expected credit loss model ("CECL"), this UpdateThis ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events including historical experience, current conditions and reasonable and supportable forecasts that affect the collectibility of the reported amount. The amendment affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables and any other financial asset not excluded from the scope that have the contractual right to receive cash. The Update replaces the incurred loss impairment methodology, which generally only considered past events and current conditions, with a methodology that reflects the expected credit losses and required consideration of a broader range of reasonable and supportable information to estimate all expected
credit losses. The Update additionally addresses purchased assets and introduces the purchased financial asset with a more-than-insignificant amount of credit deterioration since origination ("PCD"). The accounting for these PCD assets is similar to the existing accounting guidance of FASB Accounting Standards Codification ("ASC") 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, for purchased credit impaired ("PCI") assets, except the subsequent improvements in estimated cash flows will be immediately recognized into income, similar to the immediate recognition of subsequent deteriorations in cash flows. Current guidance only allows for the prospective recognition of these cash flow improvements. Because the terminology has been changed to a "more-than-insignificant" amount of credit deterioration, the presumption is that more assets might qualify for this accounting under the Update than those under current guidance. For public business entities, the Updatethis ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15, 2018. An entity will applyThe Company adopted ASU 2016-13 on January 1, 2020 as discussed in the Update through a cumulative-effect adjustmentSignificant Accounting Policies section above. The adoption had the following impacts:
Investment Securities
As of December 31, 2019, the Company had no historical charge-off or recovery history and did not have any investment securities available for sale outstanding at the adoption date for which an other-than-temporary impairment was previously recorded. At the adoption date of ASU 2016-13, the unrealized losses present in the portfolio of investment securities available for sale were primarily due to retained earnings asdecreases in market interest rates on floating rate investment securities since the purchase of the beginningsecurities and the fair value of these securities was expected to recover as the securities approach their maturity dates. The basis of management’s conclusion was that at December 31, 2019, 83.5% of the first reporting periodinvestment securities were issued by or guaranteed by the United States government or its agencies, 14.0% were issued and guaranteed by State and local governments and the remainder of the portfolio was invested in whichat least investment-grade securities. As a result of the guidance is adopted. A prospectiveanalysis, no ACL on investment securities available for sale was recorded upon adoption. See Note (2) Investment Securities for more information.
Loan Receivable
ASU 2016-13 was applied prospectively and replaced the allowance for loan losses with the ACL on loans on the Condensed Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on unfunded commitments.
The adoption was completed in a specific order beginning with the transition approach is requiredof PCI loans to PCD loans. The Bank elected to account for debt securities. An entitythe PCD loans individually, terminating the pools of loans that haswere previously appliedaccounted for under ASC 310-30. First, an ACL was determined for each PCI loan. The ACL on PCI loans was added to the guidance of FASB ASC 310-30 will prospectively applyloan's carrying amount to establish a PCD loan at its amortized cost basis. The difference between the guidance in this Update for PCD assets. A prospective transition approach should be used for PCD assets where upon adoption,outstanding principal balance and the amortized cost basis should be adjusted to reflect the addition of the PCD loan is a noncredit premium or discount, which will be amortized into interest income over the remaining life of the PCD loan. The PCI to PCD transition did not have an impact on beginning retained earnings; however, it did have the effect of reducing the existing allowance for PCI loans by $1.6 million under the CECL methodology as compared to ASC 310-30 methodology.
Following the PCI to PCD transition, the Bank recorded a pretax increase to the ACL on loans of $3.4 million to increase the reserve to the estimated credit losses.losses at January 1, 2020 based on its CECL methodology as part of the cumulative-effect adjustment to beginning retained earnings. The Company is anticipating adoptingpretax increase to the UpdateACL on loans of $3.4 million and the reduction in ACL on loans due to the PCI to PCD transition of $1.6 million resulted in an increase in the ACL on loans of $1.8 million at January 1, 2020. Upon adoption, the Company expects a change in the processes, internal controls and procedures to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the lifeadjusted beginning balance of the loan versusACL on loans as a percentage of loans receivable was 1.01% as compared to 0.96% at December 31, 2019 under the current accounting practice that utilizes theprior incurred loss model. methodology.
The new guidance may resultPCI to PCD transition also resulted in a net discount of $4.3 million for PCD loans, or an increase in the allowancenet discount for loan losses which will also reflectPCD loans of $1.6 million. Following the new requirementtransition, the total net discount for purchased loans increased to include$10.0 million at January 1, 2020 compared to $8.4 million as of December 31, 2019.
See Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans for more information.
Unfunded Commitments
ASU 2016-13 was applied prospectively and replaced the nonaccretable principal differencesreserve for unfunded commitments with the ACL on PCI loans; however, the Company is stillunfunded commitments as included in the process of determining the magnitude of the increaseAccrued liabilities and its impactother expenses on the Condensed Consolidated Statements of Financial Statements. In addition,Condition and replaced the current accounting policy and proceduresprovision for other-than-temporary impairment on investment securities available for sale will be replaced with an allowance approach. During 2017, the Company's management created a CECL steering committee which will begin developing and implementing processes and procedures to ensure it is fully compliantunfunded commitments with the amendments atprovision for credit losses as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on loans. Upon adoption, date. To date, the CECL steering committee has reviewed proposals from several vendors to assist the CompanyBank recorded a pretax increase in the adoption.beginning ACL on unfunded commitments of $3.7 million. See Note (14) Commitments and Contingencies for more information.
FASB ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, was issued in August 2016. Overall CECL Impact
The Update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. For public business entities, the guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted and must be applied using a retrospective transitional method to each period presented. The Company has evaluated the new guidance and does not anticipate that its adoption of ASU 2016-13, including the above mentioned increase to the ACL on loans of $3.4 million and the increase to the ACL on unfunded commitments of $3.7 million, resulted in a pretax cumulative-effect adjustment of $7.1 million. The impact of this Updateadjustment to beginning retained earnings on January 1, 2018 will have a significant impact on its Condensed Consolidated Financial Statements.2020 was $5.6 million, net of tax.
FASB ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments—Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings (SEC Update), was issued in January 2017. The SEC staff view is that a registrant should evaluate FASB ASC Updates that have not yet been adopted to determine the appropriate financial disclosures about the potential material effects of the updates on the financial statements when adopted. If a registrant does not know or cannot reasonably estimate the impact of an update, then in addition to making a statement to that effect, the registrant should consider additional qualitative financial statement disclosures to assist the reader in assessing the significance of the impact. The staff expects the additional qualitative disclosures to include a description of the effect of the accounting policies expected to be applied compared to current accounting policies. Also, the registrant should describe the status of its process to implement the new standards and the significant implementation matters yet to be addressed. The amendments specifically addressed recent FASB ASC amendments to Topic 326, Financial Instruments - Credit Losses; Topic 842, Leases; and Topic 606, Revenue from Contracts with Customers; although, the amendments apply to any subsequent amendments to guidance in the FASB ASC. The Company adopted the amendments in this Update during the fourth quarter of 2016 and appropriate disclosures have been included in this Note for each recently issued accounting standard.
FASB ASU 2017-04, Goodwill (Topic 350), was issued in January 2017 and eliminates Step 2 from the goodwill impairment test. Under the amendments, an entity should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized, however, should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The UpdateASU is effective for annual periods or any interim goodwill impairment tests beginning after December 15, 2019 using a prospective transition method and early adoption is permitted. The Company has goodwill from prior business combinations, performs an annual impairment test during the quarter ended December 31 or more frequently if changes or circumstances occur that would more-likely-than-not reduce the fair value of the reporting unit below its carrying value and adopted the guidance on January 1, 2020. Although the Company cannot anticipate future goodwill impairment assessments, based on the most recent assessment prior to adoption, it is unlikely that an impairment amount would need to be calculated and, therefore, at adoption there was no impact from these amendments to the Company’s financial position and results of operations. In addition, the current accounting policies and processes were not changed, except for the elimination of the Step 2 analysis. For additional information regarding goodwill impairment testing, see Note (6) Goodwill and Other Intangible Assets.
FASB ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, was issued in August 2018 and modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company adopted the guidance on January 1, 2020. The adoption did not have a material impact to Note (12) Fair Value Measurements in its Condensed Consolidated Financial Statements.
FASB ASU 2020-03, Codification Improvements to Financial Instruments, was issued in March 2020 and revised a wide variety of topics in the Codification with the intent to make the Codification easier to understand and apply by eliminating inconsistencies and providing clarifications. The ASU was effective immediately upon its release and did not have a material impact on the Company's Condensed Consolidated Financial Statements as of or for the nine months ended September 30, 2020.
FASB ASU 2020-04, Reference Rate Reform (Topic 848), was issued in March 2020 and provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or remeasurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts. ASU 2020-04 also provides numerous optional expedients for derivative accounting and is effective March 12, 2020 through December 31, 2022. An entity may elect to apply the ASU for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within the Codification, the amendments in this ASU must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The Company anticipates this ASU will simplify any modifications we execute between the selected start date (yet to be determined) and December 31, 2022 that are directly related to LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized fees/costs. The Company is evaluating the impacts of this ASU and has not yet determined whether LIBOR transition and this ASU will have material effects on its business operations and Condensed Consolidated Financial Statements.
FASB ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs, was issued in October 2020 and modifies the premium amortization on purchased callable debt securities on a prospective basis. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application is not permitted. The Company does not expect the UpdateASU will have a material impact on its Condensed Consolidated Financial Statements.
FASB ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt(2)Investment Securities was issued in March 2017 and changes the accounting for certain purchased callable debt securities held at a premium to shorten the amortization period for the premium to the earliest call date rather than to the maturity date. Accounting for purchased callable debt securities held at a discount does not change. The discount would continue to amortize to the maturity date. The updated is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. The Company does not expect the Update will have a material impact on its Condensed Consolidated Financial Statements as the Company had been accounting for premiums as prescribed under this guidance. The Company anticipates early adopting this Update in January 2018.
FASB ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting was issued in May 2017 to provide clarity as to when to apply modification accounting when there is a change in the terms or conditions of a share-based payment award. According to this Update, an entity should account for the effects of a modification unless the fair value, vesting conditions and balance sheet classification of the award is the same after the modification as compared to the original award prior to the modification. The Update is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company does not expect the Update will have a material impact on its Condensed Consolidated Financial Statements.
The Company’s investment policy is designed primarily to provide and maintain liquidity, generate a favorable return on assets without incurring undue interest rate and credit risk, and complement the Bank’s lending activities.
(a) Securities by Type and Maturity
The following tables present the amortized cost gross unrealized gains, gross unrealized losses and fair valuesvalue of investment securities available for sale at the dates indicated were as follows:and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss):
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 |
| Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Fair
Value |
| (In thousands) |
| U.S. government and agency securities | $ | 50,752 | | | $ | 1,165 | | | $ | (24) | | | $ | 51,893 | |
| Municipal securities | 193,300 | | | 12,247 | | | (237) | | | 205,310 | |
| | | | | | | |
| Residential CMO and MBS | 216,719 | | | 6,129 | | | (267) | | | 222,581 | |
| Commercial CMO and MBS | 292,163 | | | 12,785 | | | (266) | | | 304,682 | |
| Corporate obligations | 19,947 | | | 231 | | | (7) | | | 20,171 | |
| Other asset-backed securities | 29,510 | | | 460 | | | (115) | | | 29,855 | |
| Total | $ | 802,391 | | | $ | 33,017 | | | $ | (916) | | | $ | 834,492 | |
|
| | | | | | | | | | | | | | | |
| | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
| | (In thousands) |
| September 30, 2017 | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 9,464 |
| | $ | 12 |
| | $ | (73 | ) | | $ | 9,403 |
|
| Municipal securities | 248,420 |
| | 5,429 |
| | (1,043 | ) | | 252,806 |
|
Mortgage-backed securities and collateralized mortgage obligations(1): | | | | | | | |
| Residential | 275,128 |
| | 879 |
| | (1,646 | ) | | 274,361 |
|
| Commercial | 214,793 |
| | 699 |
| | (2,209 | ) | | 213,283 |
|
| Collateralized loan obligations | 6,007 |
| | 15 |
| | — |
| | 6,022 |
|
| Corporate obligations | 15,583 |
| | 247 |
| | — |
| | 15,830 |
|
| Other securities | 27,850 |
| | 505 |
| | — |
| | 28,355 |
|
| Total | $ | 797,245 |
| | $ | 7,786 |
| | $ | (4,971 | ) | | $ | 800,060 |
|
| | | | | | | | |
| December 31, 2016 | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 1,563 |
| | $ | 6 |
| | $ | — |
| | $ | 1,569 |
|
| Municipal securities | 237,305 |
| | 2,427 |
| | (2,476 | ) | | 237,256 |
|
Mortgage-backed securities and collateralized mortgage obligations(1): | | | | | | | |
| Residential | 310,391 |
| | 985 |
| | (2,200 | ) | | 309,176 |
|
| Commercial | 211,259 |
| | 599 |
| | (3,540 | ) | | 208,318 |
|
| Collateralized loan obligations | 10,505 |
| | 4 |
| | (31 | ) | | 10,478 |
|
| Corporate obligations | 16,611 |
| | 104 |
| | (9 | ) | | 16,706 |
|
| Other securities | 11,005 |
| | 156 |
| | (19 | ) | | 11,142 |
|
| Total | $ | 798,639 |
| | $ | 4,281 |
| | $ | (8,275 | ) | | $ | 794,645 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | | | Fair
Value |
| (In thousands) |
| U.S. government and agency securities | $ | 104,709 | | | $ | 598 | | | $ | (84) | | | | | $ | 105,223 | |
| Municipal securities | 128,183 | | | 4,933 | | | (102) | | | | | 133,014 | |
| | | | | | | | | |
| Residential CMO and MBS | 336,929 | | | 3,184 | | | (505) | | | | | 339,608 | |
| Commercial CMO and MBS | 322,169 | | | 5,575 | | | (649) | | | | | 327,095 | |
| Corporate obligations | 23,893 | | | 316 | | | (15) | | | | | 24,194 | |
| Other asset-backed securities | 23,277 | | | 54 | | | (153) | | | | | 23,178 | |
| Total | $ | 939,160 | | | $ | 14,660 | | | $ | (1,508) | | | | | $ | 952,312 | |
| |
(1) | Issued and guaranteed by U.S. Government-sponsored agencies. |
There were no0 securities classified as trading or held to maturity at September 30, 20172020 or December 31, 2016.2019.
For the three and nine months ended September 30, 2020, there was 0 provision for credit loss on investment securities available for sale recorded in the Condensed Consolidated Statements of Income. There was 0 ACL on investment securities available for sale at September 30, 2020.
The amortized cost and fair value of investment securities available for sale at September 30, 2017,2020, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | | | | | | | | |
| Amortized Cost | | Fair
Value |
| (In thousands) |
| Due in one year or less | $ | 63,147 | | | $ | 63,749 | |
| Due after one year through five years | 138,244 | | | 144,457 | |
| Due after five years through ten years | 203,897 | | | 214,141 | |
| Due after ten years | 397,103 | | | 412,145 | |
| Total | $ | 802,391 | | | $ | 834,492 | |
|
| | | | | | | |
| | Amortized Cost | | Fair Value |
| | (In thousands) |
| Due in one year or less | $ | 6,556 |
| | $ | 6,595 |
|
| Due after one year through five years | 121,518 |
| | 122,740 |
|
| Due after five years through ten years | 248,291 |
| | 248,603 |
|
| Due after ten years | 420,835 |
| | 421,972 |
|
| Investment securities with no stated maturities | 45 |
| | 150 |
|
| Total | $ | 797,245 |
| | $ | 800,060 |
|
securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity at September 30, 2020 and December 31, 2019.
(b) Unrealized Losses and Other-Than-Temporary Impairments
The following table showstables show the gross unrealized losses and fair value of the Company's investment securities available for sale, that arefor which an ACL has not deemed to be other-than-temporarily impaired,been recorded, aggregated by investment category and length of time that the individual securities have been in continuous unrealized loss positions as of September 30, 20172020 and December 31, 2016:2019:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 |
| Less than 12 Months | | 12 Months or Longer | | Total |
| Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses |
| (In thousands) |
| U.S. government and agency securities | $ | 3,976 | | | $ | (24) | | | $ | 0 | | | $ | 0 | | | $ | 3,976 | | | $ | (24) | |
| Municipal securities | 11,918 | | | (237) | | | 0 | | | 0 | | | 11,918 | | | (237) | |
| | | | | | | | | | | |
| Residential CMO and MBS | 543 | | | (2) | | | 26,344 | | | (265) | | | 26,887 | | | (267) | |
| Commercial CMO and MBS | 11,124 | | | (9) | | | 18,125 | | | (257) | | | 29,249 | | | (266) | |
| | | | | | | | | | | |
| Corporate obligations | 1,993 | | | (7) | | | 0 | | | 0 | | | 1,993 | | | (7) | |
| Other asset-backed securities | 6,914 | | | (47) | | | 4,666 | | | (68) | | | 11,580 | | | (115) | |
| Total | $ | 36,468 | | | $ | (326) | | | $ | 49,135 | | | $ | (590) | | | $ | 85,603 | | | $ | (916) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| Less than 12 Months | | 12 Months or Longer | | Total |
| Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses |
| (In thousands) |
| U.S. government and agency securities | $ | 45,999 | | | $ | (84) | | | $ | 0 | | | $ | 0 | | | $ | 45,999 | | | $ | (84) | |
| Municipal securities | 13,761 | | | (102) | | | 0 | | | 0 | | | 13,761 | | | (102) | |
| | | | | | | | | | | |
| Residential CMO and MBS | 14,272 | | | (66) | | | 60,232 | | | (439) | | | 74,504 | | | (505) | |
| Commercial CMO and MBS | 56,263 | | | (177) | | | 43,623 | | | (472) | | | 99,886 | | | (649) | |
| | | | | | | | | | | |
| Corporate obligations | 998 | | | (2) | | | 1,987 | | | (13) | | | 2,985 | | | (15) | |
| Other asset-backed securities | 14,383 | | | (127) | | | 1,609 | | | (26) | | | 15,992 | | | (153) | |
| Total | $ | 145,676 | | | $ | (558) | | | $ | 107,451 | | | $ | (950) | | | $ | 253,127 | | | $ | (1,508) | |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | Less than 12 Months | | 12 Months or Longer | | Total |
| | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
| | (In thousands) |
| September 30, 2017 | | | | | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 6,484 |
| | $ | (73 | ) | | $ | — |
| | $ | — |
| | $ | 6,484 |
| | $ | (73 | ) |
| Municipal securities | 24,415 |
| | (362 | ) | | 23,629 |
| | (681 | ) | | 48,044 |
| | (1,043 | ) |
Mortgage-backed securities and collateralized mortgage obligations(1): | | | | | | | | | | | |
| Residential | 135,648 |
| | (1,111 | ) | | 23,937 |
| | (535 | ) | | 159,585 |
| | (1,646 | ) |
| Commercial | 112,595 |
| | (1,478 | ) | | 38,099 |
| | (731 | ) | | 150,694 |
| | (2,209 | ) |
| Total | $ | 279,142 |
| | $ | (3,024 | ) | | $ | 85,665 |
| | $ | (1,947 | ) | | $ | 364,807 |
| | $ | (4,971 | ) |
| | | | | | | | | | | | |
| December 31, 2016 | | | | | | | | | | | |
| Municipal securities | $ | 90,188 |
| | $ | (2,476 | ) | | $ | — |
| | $ | — |
| | $ | 90,188 |
| | $ | (2,476 | ) |
Mortgage-backed securities and collateralized mortgage obligations(1): | | | | | | | | | | | |
| Residential | 181,562 |
| | (2,148 | ) | | 10,854 |
| | (52 | ) | | 192,416 |
| | (2,200 | ) |
| Commercial | 157,055 |
| | (3,446 | ) | | 12,597 |
| | (94 | ) | | 169,652 |
| | (3,540 | ) |
| Collateralized loan obligations | 2,976 |
| | (1 | ) | | 2,969 |
| | (30 | ) | | 5,945 |
| | (31 | ) |
| Corporate obligations | 4,032 |
| | (9 | ) | | — |
| | — |
| | 4,032 |
| | (9 | ) |
| Other securities | 6,998 |
| | (19 | ) | | — |
| | — |
| | 6,998 |
| | (19 | ) |
| Total | $ | 442,811 |
| | $ | (8,099 | ) | | $ | 26,420 |
| | $ | (176 | ) | | $ | 469,231 |
| | $ | (8,275 | ) |
The Company has evaluated these investment securities available for sale as of September 30, 20172020 and December 31, 20162019 and has determined that 0 ACL is necessary. Unrealized losses on investment securities available for sale have not been recognized into earnings because the issuers of bonds are investment grade, the securities carry governmental guarantees, management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery and the decline in theirfair value is temporary. The unrealized losses are primarilylargely due to increaseschanges in market interest rates and larger spreads inother market conditions. The issuers continue to make timely principal and interest payments on the market for mortgage-related products. Thebonds and the fair value of these securities is expected to recover as the bonds approach maturity.
(c) Realized Gains and Losses
The following table presents the gross realized gains and losses on the sale of securities approach their maturity date and/or as the pricing spreads narrow on mortgage-related securities. None of the underlying issuers of the municipal securities had credit ratings that were below investment grade levels at September 30, 2017 or December 31, 2016. The Company has the ability and intent to hold the investments until recovery of the securities' amortized cost, which may be the maturity date of the securities.
Foravailable for sale for the three and nine months ended September 30, 20172020 and 2016, there were no investment securities determined to be other-than-temporarily impaired.2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (In thousands) |
| Gross realized gains | $ | 40 | | | $ | 281 | | | $ | 1,482 | | | $ | 557 | |
| Gross realized losses | 0 | | | 0 | | | (19) | | | (228) | |
| Net realized gains | $ | 40 | | | $ | 281 | | | $ | 1,463 | | | $ | 329 | |
(c)(d) Pledged Securities
The following table summarizes the amortized cost and fair value of investment securities available for sale that are pledged as collateral for the following obligations at September 30, 20172020 and December 31, 2016:2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 | | December 31, 2019 |
| Amortized
Cost | | Fair
Value | | Amortized
Cost | | Fair
Value |
| (In thousands) |
| Washington and Oregon state public deposits | $ | 178,332 | | | $ | 186,198 | | | $ | 187,700 | | | $ | 190,773 | |
| | | | | | | |
| Securities sold under agreement to repurchase | 43,557 | | | 44,822 | | | 22,156 | | | 22,294 | |
| Other securities pledged | 31,688 | | | 32,724 | | | 19,333 | | | 19,850 | |
| Total | $ | 253,577 | | | $ | 263,744 | | | $ | 229,189 | | | $ | 232,917 | |
(e) Accrued Interest Receivable
Accrued interest receivable excluded from amortized cost on investment securities available for sale totaled $3.3 million and $3.7 million at September 30, 2020 and December 31, 2019, respectively. No amounts of accrued interest receivable were reversed against interest income on investment securities available for sale during the three and nine months ended September 30, 2020 and 2019.
(3)Loans Receivable
|
| | | | | | | | | | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
| | (In thousands) |
| Washington and Oregon state to secure public deposits | $ | 40,997 |
| | $ | 40,772 |
| | $ | 214,834 |
| | $ | 215,247 |
|
| Repurchase agreements | 12,620 |
| | 12,724 |
| | 29,481 |
| | 29,294 |
|
| Other securities pledged | 201,783 |
| | 203,482 |
| | 3,557 |
| | 3,546 |
|
| Total | $ | 255,400 |
| | $ | 256,978 |
| | $ | 247,872 |
| | $ | 248,087 |
|
The Company originates loans in the ordinary course of business and has also acquired loans through FDIC-assistedmergers and open bank transactions. Disclosures related toacquisitions. Accrued interest receivable was excluded from disclosures presenting the Company's recorded investment inamortized cost of loans receivable generally excludeas it was deemed insignificant. Accrued interest receivable on loans totaled $15.6 million and $10.7 million at September 30, 2020 and December 31, 2019, respectively. No ACL on accrued interest receivable and net deferred costs because they are insignificant.
Loans acquired in a business combination are further classified as “purchased” loans. Loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. These loans are identified as "PCI" loans. Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20, Receivables—Nonrefundable Fees and Other Costs, and are referred to as "non-PCI" loans.
(a) Loan Origination/Risk Managementwas recorded at September 30, 2020.
The Company categorizes loans in one of the four4 segments of the total loan portfolio: commercial business,business; one-to-four family residential,residential; real estate construction and land developmentdevelopment; and consumer. Within these segments are classes of loans for which management monitors and assesses credit risk in the loan portfolios. A detailed description of the portfolio segments and classes is contained in the 2019 Annual Form 10-K, except for SBA PPP loans. The Company has certain lending policiesBank began originating SBA PPP loans during the three months ended June 30, 2020 following the passage of the CARES Act. SBA PPP loans are fully guaranteed by the SBA, intended for businesses impacted by COVID-19 and procedures in place that are designed to maximize loan income within an acceptable levelprovide near term relief to help small businesses sustain operations. These
loans have either a two-year or five-year maturity date and approves these policies and procedures onearn interest at 1%. The Bank also earned a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. The Company also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management. The loan review process complements and reinforces the risk identification and assessment decisions made by loan officers and credit personnel, as well as the Company’s policies and procedures.
A discussion of the risk characteristics of each loan portfolio segment is as follows:
Commercial Business:
There are three significant classes of loans in the commercial business portfolio segment: commercial and industrial, owner-occupied commercial real estate and non-owner occupied commercial real estate. The owner and non-owner occupied commercial real estate are both considered commercial real estate loans. As the commercial and industrial loans carry different risk characteristics than the commercial real estate loans, they are discussed separately below.
Commercial and industrial. Commercial and industrial loans are primarily madefee based on the identified cash flowssize of the borrowerloan, which is recognized over the life of the loan. The balance of unamortized net deferred fees on SBA PPP loans was $22.0 million at September 30, 2020. The Bank expects that the great majority of SBA PPP borrowers will seek full or partial forgiveness of their loan obligations in accordance with the CARES Act.
The CARES Act also provides temporary relief from the accounting and secondarily ondisclosure requirements for TDRs for certain loan modifications that are the underlying collateral providedresult of a hardship that is related, either directly or indirectly, to the COVID-19 pandemic. In addition, interagency guidance issued by federal banking regulators and endorsed by the borrower.FASB staff has indicated that borrowers who receive relief are not TDRs if they meet qualifying criteria. The cash flowsCompany elected to apply the temporary relief under the CARES Act and related regulatory guidance to certain eligible short-term modifications, and therefore will not treat qualifying loan modifications as TDRs for accounting or disclosure purposes.
The regulatory agencies have also provided guidance regarding credit risk ratings, delinquency reporting and nonaccrual status for loans adversely impacted by COVID-19. The Bank will exercise judgment in determining the risk rating for impacted borrowers and will not automatically adversely classify credits that are affected by COVID-19. The Bank also will not designate loans with payment deferrals granted due to COVID-19 as past due because of the deferral. Due to the short-term nature of the forbearance and other relief programs we are offering as a result of the COVID-19 pandemic, we expect that borrowers however, maygranted relief under these programs will generally not be reported as expected andnonaccrual during the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may include a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Commercial and industrial loans carry more risk than other loans because the borrowers’ cash flow is less predictable, and in the event of a default, the amount of loss is potentially greater and more difficult to quantify because the value of the collateral securing these loans may fluctuate, may be uncollectible, or may be obsolete or of limited use, among other things.
Commercial real estate. The Company originates commercial real estate loans primarily within its primary market areas. These loans are subject to underwriting standards and processes similar to commercial and industrial loans in that these loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate properties. Commercial real estate lending typically involves higher loan principal amounts and payments on loans, and repayment is dependent on successful operation and management of the properties. The value of the real estate securing these loans can be adversely affected by conditions in the real estate market or the economy. There is little difference in risk between owner-occupied commercial real estate loans and non-owner occupied commercial real estate loans.
One-to-Four Family Residential:
The majority of the Company’s one-to-four family residential loans are secured by single-family residences located in its primary market areas. The Company’s underwriting standards require that single-family portfolio loans generally are owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the underlying collateral. Terms of maturity typically range from 15 to 30 years. The Company sells most of its single-family loans in the secondary market and retains a smaller portion in its loan portfolio.
Real Estate Construction and Land Development:deferral period.
The Company originates constructionadopted ASU 2016-13 effective January 1, 2020, which increased the beginning ACL on loans as discussed in Note (4) Allowance for one-to-four family residential and for five or more family residential and commercial properties. Credit Losses on Loans.
The one-to-four family residential construction loans generally include construction of custom homes whereby the home buyer is the borrower. The Company also provides financing to builders for the construction of pre-sold homes and, in selected cases, to builders for the construction of speculative residential property. Substantially all construction loans are short-term in nature and priced with variable rates of interest. Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, the Company’s estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss if the borrower does not repay the loan. Sources of repayment for these typesamortized cost of loans may be pre-committed permanentreceivable, net of ACL on loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being dependent upon successful completion of the construction project, interest rate changes, government regulation of real property, general economic conditions and the availability of long-term financing.
Consumer:
The Company originates consumer loans and lines of credit that are both secured and unsecured. The underwriting process for these loans ensures a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans are significantly influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. The majority of consumer loans are for relatively small amounts disbursed among many individual borrowers which reduces the credit risk for this type of loan. To further reduce the risk, trend reports are reviewed by management on a regular basis.
The Company also originates indirect consumer loans. These loans are for new and used automobile and recreational vehicles that are originated indirectly by selected dealers located in the Company's market areas. The Company has limited its purchase of indirect loans primarily to dealerships that are established and well-known in their market areas and to applicants that are not classified as sub-prime.
Loans receivable at September 30, 20172020 and December 31, 20162019 consisted of the following portfolio segments and classes:
| | | | | | | | | | | |
| September 30,
2020 | | December 31,
2019 |
| (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 750,557 | | | $ | 852,220 | |
| SBA PPP | 867,782 | | | 0 | |
| Owner-occupied CRE | 859,338 | | | 805,234 | |
| Non-owner occupied CRE | 1,384,973 | | | 1,288,779 | |
| Total commercial business | 3,862,650 | | | 2,946,233 | |
| One-to-four family residential | 131,921 | | | 131,660 | |
| Real estate construction and land development: | | | |
| One-to-four family residential | 99,650 | | | 104,296 | |
| Five or more family residential and commercial properties | 215,472 | | | 170,350 | |
| Total real estate construction and land development | 315,122 | | | 274,646 | |
| Consumer | 357,037 | | | 415,340 | |
| Loans receivable | 4,666,730 | | | 3,767,879 | |
| Allowance for credit losses on loans | (73,340) | | | (36,171) | |
| Loans receivable, net | $ | 4,593,390 | | | $ | 3,731,708 | |
|
| | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 665,582 |
| | $ | 637,773 |
|
| Owner-occupied commercial real estate | 602,238 |
| | 558,035 |
|
| Non-owner occupied commercial real estate | 930,188 |
| | 880,880 |
|
| Total commercial business | 2,198,008 |
| | 2,076,688 |
|
| One-to-four family residential | 81,422 |
| | 77,391 |
|
| Real estate construction and land development: | | | |
| One-to-four family residential | 51,451 |
| | 50,414 |
|
| Five or more family residential and commercial properties | 122,981 |
| | 108,764 |
|
| Total real estate construction and land development | 174,432 |
| | 159,178 |
|
| Consumer | 340,643 |
| | 325,140 |
|
| Gross loans receivable | 2,794,505 |
| | 2,638,397 |
|
| Net deferred loan costs | 3,008 |
| | 2,352 |
|
| Loans receivable, net | 2,797,513 |
| | 2,640,749 |
|
| Allowance for loan losses | (31,400 | ) | | (31,083 | ) |
| Total loans receivable, net | $ | 2,766,113 |
| | $ | 2,609,666 |
|
(b) Concentrations of Credit
MostAs of the Company’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County in Oregon, as well as other contiguous markets. The majority of the Company’s loan portfolio consists of (in order of balances at September 30, 2017) non-owner occupied commercial real estate, commercial2020, and industrial and owner-occupied commercial real estate. As of September 30, 2017 and December 31, 2016,2019, there were no0 concentrations of loans related to any single industry in excess of 10% of the Company’s total loans.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans and (v) the general economic conditions of the United States of America and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are gradedloan on a numerical scale of 1 to 10. A descriptionRisk grades are aggregated to create the risk categories
of "Pass" for grades 1 to 6, "Special Mention" ("SM") for grade 7, "Substandard" ("SS") for grade 8, "Doubtful" for grade 9 and "Loss" for grade 10. Descriptions of the general characteristics of the risk grades, is as follows:
Grades 1including qualitative information on how the risk grades relate to 5: These gradesthe risk of loss, are considered “pass grade” and includecontained in the 2019 Annual Form 10-K. There were no loans with negligible to above average but acceptable risk. These borrowers generally have strong to acceptable capital levels and consistent earnings and debt service capacity. Loans with the higher grades within the “pass” category may include borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Increased monitoringa risk grade of financial information and/doubtful or collateral may be appropriate. Loans with this grade show no immediate loss exposure.
Grade 6: This grade includes "Watch" loans and is considered a “pass grade”. The grade is intended to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-modifying action is anticipated in the near term.
Grade 7: This grade includes “Other Assets Especially Mentioned” (“OAEM”) loans in accordance with regulatory guidelines, and is intended to highlight loans with elevated risks. Loans with this grade show signs of deteriorating profits and capital, and the borrower might not be strong enough to sustain a major setback. The borrower is typically higher than normally leveraged, and outside support might be modest and likely illiquid. The loan is at risk of further decline unless active measures are taken to correct the situation.
Grade 8: This grade includes “Substandard” loans in accordance with regulatory guidelines, which the Company has determined have a high credit risk. These loans also have well-defined weaknesses which make payment default or principal exposure likely, but not yet certain. The borrower may have shown serious negative trends in financial ratios and performance. Such loans may be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business. Loans with this grade can be placed on accrual or nonaccrual status based on the Company’s accrual policy.
Grade 9: This grade includes “Doubtful” loans in accordance with regulatory guidelines, and the Company has determined these loans to have excessive credit risk. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance or have been partially charged-off for the amount considered uncollectible.
Grade 10: This grade includes “Loss” loans in accordance with regulatory guidelines, and the Company has determined these loans have the highest risk of loss. Such loans are charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.
September 30, 2020.Numerical loan grades for loans are established at the origination of the loan. LoanChanges to loan grades are reviewed onconsidered at the time new information about the performance of a quarterly basis, or more frequently if necessary,loan becomes available, including the receipt of updated financial information from the borrower, and scheduled loan reviews performed by the creditBank’s internal Loan Review department. TheFor consumer loans, the Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event of payment delinquencies or default. Typically, an individual loan grade will not be changed from the prior period unless there is a specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications with the borrower, or other borrower information that becomes known to management. Credit improvements are evidenced by known facts regarding the borrower or the collateral property.
The loan grades relate tofollowing table presents the likelihoodamortized cost of losses in that the higher theloans receivable by risk grade the greater the loss potential. Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades. The OAEM loan grade is transitory in that the Company is waiting on additional information to determine the likelihood and extentas of the potential loss. The likelihood of loss for OAEM graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration. Loans with a Substandard grade are generally loans for which the Company has individually analyzed for potential impairment. For Doubtful and Loss graded loans, the Company is almost certain of the losses, and the outstanding principal balances are generally charged-off to the realizable value.September 30, 2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Term Loans
Amortized Cost Basis by Origination Year | | Revolving Loans | | Revolving Loans Converted to Term Loans (1) | | Loans Receivable | | |
| 2020 | | 2019 | | 2018 | | 2017 | | 2016 | | Prior | | | | | |
| (In thousands) |
| Commercial business: | | |
| Commercial and industrial | | |
| Pass | $ | 64,817 | | | $ | 142,409 | | | $ | 79,659 | | | $ | 53,491 | | | $ | 45,436 | | | $ | 116,934 | | | $ | 144,505 | | | $ | 802 | | | $ | 648,053 | | | |
| SM | 13,117 | | | 6,355 | | | 5,622 | | | 2,244 | | | 1,683 | | | 2,104 | | | 18,188 | | | 98 | | | 49,411 | | | |
| SS | 2,580 | | | 11,418 | | | 5,160 | | | 8,884 | | | 2,361 | | | 10,440 | | | 8,324 | | | 3,926 | | | 53,093 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 80,514 | | | 160,182 | | | 90,441 | | | 64,619 | | | 49,480 | | | 129,478 | | | 171,017 | | | 4,826 | | | 750,557 | | | |
| SBA PPP | | |
| Pass | 867,782 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 867,782 | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 867,782 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 867,782 | | | |
| Owner-occupied CRE | | |
| Pass | 78,911 | | | 167,369 | | | 99,922 | | | 88,349 | | | 78,693 | | | 275,986 | | | 0 | | | 0 | | | 789,230 | | | |
| SM | 0 | | | 0 | | | 3,344 | | | 7,789 | | | 5,499 | | | 23,170 | | | 0 | | | 0 | | | 39,802 | | | |
| SS | 0 | | | 0 | | | 117 | | | 7,379 | | | 3,348 | | | 19,462 | | | 0 | | | 0 | | | 30,306 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 78,911 | | | 167,369 | | | 103,383 | | | 103,517 | | | 87,540 | | | 318,618 | | | 0 | | | 0 | | | 859,338 | | | |
| Non-owner-occupied CRE | | |
| Pass | 151,158 | | | 167,691 | | | 154,288 | | | 186,969 | | | 258,168 | | | 418,767 | | | 0 | | | 0 | | | 1,337,041 | | | |
| SM | 0 | | | 0 | | | 0 | | | 0 | | | 11,842 | | | 3,364 | | | 0 | | | 0 | | | 15,206 | | | |
| SS | 0 | | | 0 | | | 3,623 | | | 0 | | | 12,811 | | | 16,292 | | | 0 | | | 0 | | | 32,726 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 151,158 | | | 167,691 | | | 157,911 | | | 186,969 | | | 282,821 | | | 438,423 | | | 0 | | | 0 | | | 1,384,973 | | | |
| Total commercial business | | |
| Pass | 1,162,668 | | | 477,469 | | | 333,869 | | | 328,809 | | | 382,297 | | | 811,687 | | | 144,505 | | | 802 | | | 3,642,106 | | | |
| SM | 13,117 | | | 6,355 | | | 8,966 | | | 10,033 | | | 19,024 | | | 28,638 | | | 18,188 | | | 98 | | | 104,419 | | | |
| SS | 2,580 | | | 11,418 | | | 8,900 | | | 16,263 | | | 18,520 | | | 46,194 | | | 8,324 | | | 3,926 | | | 116,125 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 1,178,365 | | | 495,242 | | | 351,735 | | | 355,105 | | | 419,841 | | | 886,519 | | | 171,017 | | | 4,826 | | | 3,862,650 | | | |
| One-to-four family residential | | |
| Pass | 24,100 | | | 46,513 | | | 17,913 | | | 12,436 | | | 8,649 | | | 21,751 | | | 0 | | | 0 | | | 131,362 | | | |
| | | | | | | | | | | | | | | | | | | |
| SS | 0 | | | 0 | | | 0 | | | 60 | | | 0 | | | 499 | | | 0 | | | 0 | | | 559 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 24,100 | | | 46,513 | | | 17,913 | | | 12,496 | | | 8,649 | | | 22,250 | | | 0 | | | 0 | | | 131,921 | | | |
| Real estate construction and land development: | | |
| One-to-four family residential | | |
| Pass | 25,519 | | | 62,220 | | | 6,203 | | | 1,364 | | | 971 | | | 1,561 | | | 0 | | | 0 | | | 97,838 | | | |
| | | | | | | | | | | | | | | | | | | |
| SS | 0 | | | 0 | | | 0 | | | 1,812 | | | 0 | | | 0 | | | 0 | | | 0 | | | 1,812 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 25,519 | | | 62,220 | | | 6,203 | | | 3,176 | | | 971 | | | 1,561 | | | 0 | | | 0 | | | 99,650 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Term Loans
Amortized Cost Basis by Origination Year | | Revolving Loans | | Revolving Loans Converted to Term Loans (1) | | Loans Receivable | | |
| 2020 | | 2019 | | 2018 | | 2017 | | 2016 | | Prior | | | | | |
| (In thousands) |
| Five or more family residential and commercial properties | | |
| Pass | 22,710 | | | 131,850 | | | 49,678 | | | 7,070 | | | 784 | | | 1,464 | | | 0 | | | 0 | | | 213,556 | | | |
| SM | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 33 | | | 0 | | | 0 | | | 33 | | | |
| SS | 989 | | | 450 | | | 0 | | | 0 | | | 0 | | | 444 | | | 0 | | | 0 | | | 1,883 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 23,699 | | | 132,300 | | | 49,678 | | | 7,070 | | | 784 | | | 1,941 | | | 0 | | | 0 | | | 215,472 | | | |
| Total real estate construction and land development |
| Pass | 48,229 | | | 194,070 | | | 55,881 | | | 8,434 | | | 1,755 | | | 3,025 | | | 0 | | | 0 | | | 311,394 | | | |
| SM | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 33 | | | 0 | | | 0 | | | 33 | | | |
| SS | 989 | | | 450 | | | 0 | | | 1,812 | | | 0 | | | 444 | | | 0 | | | 0 | | | 3,695 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 49,218 | | | 194,520 | | | 55,881 | | | 10,246 | | | 1,755 | | | 3,502 | | | 0 | | | 0 | | | 315,122 | | | |
| Consumer | | |
| Pass | 40,061 | | | 86,402 | | | 59,782 | | | 35,068 | | | 16,361 | | | 20,521 | | | 94,849 | | | 473 | | | 353,517 | | | |
| SM | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 329 | | | 0 | | | 329 | | | |
| SS | 20 | | | 330 | | | 532 | | | 480 | | | 422 | | | 1,156 | | | 86 | | | 165 | | | 3,191 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 40,081 | | | 86,732 | | | 60,314 | | | 35,548 | | | 16,783 | | | 21,677 | | | 95,264 | | | 638 | | | 357,037 | | | |
| Loans receivable | | |
| Pass | 1,275,058 | | | 804,454 | | | 467,445 | | | 384,747 | | | 409,062 | | | 856,984 | | | 239,354 | | | 1,275 | | | 4,438,379 | | | |
| SM | 13,117 | | | 6,355 | | | 8,966 | | | 10,033 | | | 19,024 | | | 28,671 | | | 18,517 | | | 98 | | | 104,781 | | | |
| SS | 3,589 | | | 12,198 | | | 9,432 | | | 18,615 | | | 18,942 | | | 48,293 | | | 8,410 | | | 4,091 | | | 123,570 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | $ | 1,291,764 | | | $ | 823,007 | | | $ | 485,843 | | | $ | 413,395 | | | $ | 447,028 | | | $ | 933,948 | | | $ | 266,281 | | | $ | 5,464 | | | $ | 4,666,730 | | | |
(1) Represents loans receivable balance at September 30, 2020 which was converted from a revolving loan to an amortizing loan during the nine months ended September 30, 2020.
The following tables presenttable presents the balanceamortized cost of the loans receivable by credit quality indicator as of September 30, 2017 and December 31, 2016.2019 in accordance with disclosure requirements prior to CECL Adoption:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| Pass | | Special Mention | | Substandard | | Doubtful/Loss | | Total |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 771,559 | | | $ | 16,340 | | | $ | 64,321 | | | $ | 0 | | | $ | 852,220 | |
| Owner-occupied CRE | 765,411 | | | 24,659 | | | 15,164 | | | 0 | | | 805,234 | |
| Non-owner occupied CRE | 1,274,513 | | | 5,662 | | | 8,604 | | | 0 | | | 1,288,779 | |
| Total commercial business | 2,811,483 | | | 46,661 | | | 88,089 | | | 0 | | | 2,946,233 | |
| One-to-four family residential | 130,818 | | | 0 | | | 842 | | | 0 | | | 131,660 | |
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 101,973 | | | 1,516 | | | 807 | | | 0 | | | 104,296 | |
| Five or more family residential and commercial properties | 169,668 | | | 682 | | | 0 | | | 0 | | | 170,350 | |
| Total real estate construction and land development | 271,641 | | | 2,198 | | | 807 | | | 0 | | | 274,646 | |
| Consumer | 411,141 | | | 0 | | | 3,675 | | | 524 | | | 415,340 | |
| Loans receivable | $ | 3,625,083 | | | $ | 48,859 | | | $ | 93,413 | | | $ | 524 | | | $ | 3,767,879 | |
|
| | | | | | | | | | | | | | | | | | | |
| | September 30, 2017 |
| | Pass | | OAEM | | Substandard | | Doubtful/Loss | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 625,387 |
| | $ | 11,067 |
| | $ | 29,128 |
| | $ | — |
| | $ | 665,582 |
|
| Owner-occupied commercial real estate | 576,313 |
| | 8,305 |
| | 17,620 |
| | — |
| | 602,238 |
|
| Non-owner occupied commercial real estate | 897,677 |
| | 15,790 |
| | 16,721 |
| | — |
| | 930,188 |
|
| Total commercial business | 2,099,377 |
| | 35,162 |
| | 63,469 |
| | — |
| | 2,198,008 |
|
| One-to-four family residential | 79,882 |
| | — |
| | 1,540 |
| | — |
| | 81,422 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 48,101 |
| | 273 |
| | 3,077 |
| | — |
| | 51,451 |
|
| Five or more family residential and commercial properties | 121,854 |
| | 722 |
| | 405 |
| | — |
| | 122,981 |
|
| Total real estate construction and land development | 169,955 |
| | 995 |
| | 3,482 |
| | — |
| | 174,432 |
|
| Consumer | 335,073 |
| | — |
| | 5,045 |
| | 525 |
| | 340,643 |
|
| Gross loans receivable | $ | 2,684,287 |
| | $ | 36,157 |
| | $ | 73,536 |
| | $ | 525 |
| | $ | 2,794,505 |
|
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2016 |
| | Pass | | OAEM | | Substandard | | Doubtful/Loss | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 601,273 |
| | $ | 5,048 |
| | $ | 31,452 |
| | $ | — |
| | $ | 637,773 |
|
| Owner-occupied commercial real estate | 532,585 |
| | 4,437 |
| | 21,013 |
| | — |
| | 558,035 |
|
| Non-owner occupied commercial real estate | 841,383 |
| | 14,573 |
| | 24,924 |
| | — |
| | 880,880 |
|
| Total commercial business | 1,975,241 |
| | 24,058 |
| | 77,389 |
| | — |
| | 2,076,688 |
|
| One-to-four family residential | 76,020 |
| | — |
| | 1,371 |
| | — |
| | 77,391 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 44,752 |
| | 500 |
| | 5,162 |
| | — |
| | 50,414 |
|
| Five or more family residential and commercial properties | 105,723 |
| | 1,150 |
| | 1,891 |
| | — |
| | 108,764 |
|
| Total real estate construction and land development | 150,475 |
| | 1,650 |
| | 7,053 |
| | — |
| | 159,178 |
|
| Consumer | 320,140 |
| | — |
| | 5,000 |
| | — |
| | 325,140 |
|
| Gross loans receivable | $ | 2,521,876 |
| | $ | 25,708 |
| | $ | 90,813 |
| | $ | — |
| | $ | 2,638,397 |
|
Potential problem loans are loans classified as OAEMrisk rated Special Mention or worse that are currently accruing interestnot classified as a TDR or nonaccrual loan and are not considered impaired,individually evaluated for credit loss, but which management is closely monitoring because the financial information of the borrower causes concern as to their ability to meet their loan repayment terms. Potential problem loans may include PCI loans as these loans continue to accrete loan discounts established at acquisition based on the guidance
terms. Potential problem loans as of September 30, 20172020 and December 31, 20162019 were $84.1$159.8 million and $87.8 million, respectively. The balance of potential problem loans guaranteed by a governmental agency, which guarantee reduces
the Company's credit exposure, was $1.7 million and $1.1 million as of September 30, 2017 and December 31, 2016, respectively.
(d) Nonaccrual Loans
Nonaccrual loans, segregated by segments and classes of loans, were as follows as of September 30, 2017 and December 31, 2016:
|
| | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 4,056 |
| | $ | 3,531 |
|
| Owner-occupied commercial real estate | 3,720 |
| | 3,728 |
|
| Non-owner occupied commercial real estate | 1,907 |
| | 1,321 |
|
| Total commercial business | 9,683 |
| | 8,580 |
|
| One-to-four family residential | 84 |
| | 94 |
|
| Real estate construction and land development: | | | |
| One-to-four family residential | 869 |
| | 2,008 |
|
| Consumer | 316 |
| | 227 |
|
| Nonaccrual loans | $ | 10,952 |
| | $ | 10,909 |
|
The Company had $2.5 million and $2.8 millionfollowing table presents the amortized cost of nonaccrual loans guaranteed by governmental agencies atfor the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 | | December 31,
2019 | | |
| Nonaccrual without ACL | | Nonaccrual with ACL | | Total Nonaccrual | | Nonaccrual (1) | | |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 23,410 | | | $ | 3,750 | | | $ | 27,160 | | | $ | 33,544 | | | |
| Owner-occupied CRE | 4,765 | | | 11,795 | | | 16,560 | | | 4,714 | | | |
| Non-owner occupied CRE | 3,478 | | | 3,732 | | | 7,210 | | | 6,062 | | | |
| Total commercial business | 31,653 | | | 19,277 | | | 50,930 | | | 44,320 | | | |
| One-to-four family residential | 38 | | | 119 | | | 157 | | | 19 | | | |
| Real estate construction and land development: | | | | | | | | | |
| | | | | | | | | |
| Five or more family residential and commercial properties | 0 | | | 1,439 | | | 1,439 | | | 0 | | | |
| | | | | | | | | |
| Consumer | 0 | | | 78 | | | 78 | | | 186 | | | |
| Total | $ | 31,691 | | | $ | 20,913 | | | $ | 52,604 | | | $ | 44,525 | | | |
(1) Presentation of December 31, 2019 balances is in accordance with disclosure requirements prior to CECL Adoption.
The following table presents the reversal of interest income on loans due to the write-off of accrued interest receivable upon the initial classification of loans as nonaccrual loans and the interest income recognized due to payment in full of previously classified nonaccrual loans during the following periods:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, 2020 | | | | Three Months Ended
September 30, 2019 |
| Interest Income Reversed | | Interest Income Recognized | | | | Interest Income Reversed | | Interest Income Recognized |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | (59) | | | $ | 111 | | | | | $ | (336) | | | $ | 37 | |
| Owner-occupied CRE | (219) | | | 29 | | | | | 0 | | | 182 | |
| Non-owner occupied CRE | (102) | | | 0 | | | | | 0 | | | 181 | |
| Total commercial business | (380) | | | 140 | | | | | (336) | | | 400 | |
| One-to-four family residential | (1) | | | 2 | | | | | 0 | | | 0 | |
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 0 | | | 0 | | | | | 0 | | | 10 | |
| Five or more family residential and commercial properties | (11) | | | 0 | | | | | 0 | | | 0 | |
| Total real estate construction and land development | (11) | | | 0 | | | | | 0 | | | 10 | |
| | | | | | | | | |
| Total | $ | (392) | | | $ | 142 | | | | | $ | (336) | | | $ | 410 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended
September 30, 2020 | | Nine months ended
September 30, 2019 |
| Interest Income Reversed | | Interest Income Recognized | | Interest Income Reversed | | Interest Income Recognized |
| (in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | (75) | | | $ | 419 | | | $ | (394) | | | $ | 97 | |
| Owner-occupied CRE | (219) | | | 89 | | | 0 | | | 228 | |
| Non-owner occupied CRE | (102) | | | 67 | | | (32) | | | 181 | |
| Total commercial business | (396) | | | 575 | | | (426) | | | 506 | |
| One-to-four family residential | (1) | | | 2 | | | 0 | | | 0 | |
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 0 | | | 0 | | | (3) | | | 33 | |
| Five or more family residential and commercial properties | (11) | | | 0 | | | 0 | | | 0 | |
| Total real estate construction and land development | (11) | | | 0 | | | (3) | | | 33 | |
| Consumer | 0 | | | 47 | | | 0 | | | 6 | |
| Total | $ | (408) | | | $ | 624 | | | $ | (429) | | | $ | 545 | |
For the three and nine months ended September 30, 20172020 and December 31, 2016, respectively.
PCI loans are not included2019, no interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the nonaccrual loan table above because these loans are accounted for under FASB ASC 310-30, which provides that accretable yield is calculated based on a loan's expected cash flow even if the loan is not performing under its contractual terms.tables above.
(e) Past due loans
The Company performs an aging analysis of past due loans using thepolicies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due. This policy is consistent with regulatory reporting requirements.
The balancesamortized cost of past due loans segregated by segments and classesas of September 30, 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 |
| 30-89 Days | | 90 Days or
Greater | | Total Past
Due | | Current | | Loans Receivable |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 2,414 | | | $ | 8,415 | | | $ | 10,829 | | | $ | 739,728 | | | $ | 750,557 | |
| SBA PPP | 0 | | | 0 | | | 0 | | | 867,782 | | | 867,782 | |
| Owner-occupied CRE | 0 | | | 403 | | | 403 | | | 858,935 | | | 859,338 | |
| Non-owner occupied CRE | 754 | | | 267 | | | 1,021 | | | 1,383,952 | | | 1,384,973 | |
| Total commercial business | 3,168 | | | 9,085 | | | 12,253 | | | 3,850,397 | | | 3,862,650 | |
| One-to-four family residential | 32 | | | 16 | | | 48 | | | 131,873 | | | 131,921 | |
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 150 | | | 0 | | | 150 | | | 99,500 | | | 99,650 | |
| Five or more family residential and commercial properties | 1,200 | | | 0 | | | 1,200 | | | 214,272 | | | 215,472 | |
| Total real estate construction and land development | 1,350 | | | 0 | | | 1,350 | | | 313,772 | | | 315,122 | |
| Consumer | 883 | | | 0 | | | 883 | | | 356,154 | | | 357,037 | |
| Total | $ | 5,433 | | | $ | 9,101 | | | $ | 14,534 | | | $ | 4,652,196 | | | $ | 4,666,730 | |
The following table presents the amortized cost of past due loans as of September 30, 2017 and December 31, 2016 were as follows:2019 in accordance with disclosure requirements prior to CECL Adoption:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| 30-89 Days | | 90 Days or
Greater | | Total Past
Due | | Current | | Total | | PCI Loans | | Loans Receivable |
| (In thousands) |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 10,479 | | | $ | 6,772 | | | $ | 17,251 | | | $ | 832,601 | | | $ | 849,852 | | | $ | 2,368 | | | $ | 852,220 | |
| Owner-occupied CRE | 607 | | | 806 | | | 1,413 | | | 798,907 | | | 800,320 | | | 4,914 | | | 805,234 | |
| Non-owner occupied CRE | 554 | | | 1,843 | | | 2,397 | | | 1,280,891 | | | 1,283,288 | | | 5,491 | | | 1,288,779 | |
| Total commercial business | 11,640 | | | 9,421 | | | 21,061 | | | 2,912,399 | | | 2,933,460 | | | 12,773 | | | 2,946,233 | |
| One-to-four family residential | 797 | | | 0 | | | 797 | | | 127,288 | | | 128,085 | | | 3,575 | | | 131,660 | |
| Real estate construction and land development: | | | | | | | | | | | | | |
| One-to-four family residential | 1,516 | | | 0 | | | 1,516 | | | 102,780 | | | 104,296 | | | 0 | | | 104,296 | |
| Five or more family residential and commercial properties | 0 | | | 0 | | | 0 | | | 170,350 | | | 170,350 | | | 0 | | | 170,350 | |
| Total real estate construction and land development | 1,516 | | | 0 | | | 1,516 | | | 273,130 | | | 274,646 | | | 0 | | | 274,646 | |
| Consumer | 2,071 | | | 0 | | | 2,071 | | | 411,507 | | | 413,578 | | | 1,762 | | | 415,340 | |
| Total | $ | 16,024 | | | $ | 9,421 | | | $ | 25,445 | | | $ | 3,724,324 | | | $ | 3,749,769 | | | $ | 18,110 | | | $ | 3,767,879 | |
|
| | | | | | | | | | | | | | | | | | | |
| | September 30, 2017 |
| | 30-89 Days | | 90 Days or Greater | | Total Past Due | | Current | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 790 |
| | $ | 1,014 |
| | $ | 1,804 |
| | $ | 663,778 |
| | $ | 665,582 |
|
| Owner-occupied commercial real estate | 498 |
| | 1,270 |
| | 1,768 |
| | 600,470 |
| | 602,238 |
|
| Non-owner occupied commercial real estate | — |
| | 2,085 |
| | 2,085 |
| | 928,103 |
| | 930,188 |
|
| Total commercial business | 1,288 |
| | 4,369 |
| | 5,657 |
| | 2,192,351 |
| | 2,198,008 |
|
| One-to-four family residential | — |
| | — |
| | — |
| | 81,422 |
| | 81,422 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 1,038 |
| | 309 |
| | 1,347 |
| | 50,104 |
| | 51,451 |
|
| Five or more family residential and commercial properties | 366 |
| | — |
| | 366 |
| | 122,615 |
| | 122,981 |
|
| Total real estate construction and land development | 1,404 |
| | 309 |
| | 1,713 |
| | 172,719 |
| | 174,432 |
|
| Consumer | 1,738 |
| | 657 |
| | 2,395 |
| | 338,248 |
| | 340,643 |
|
| Gross loans receivable | $ | 4,430 |
| | $ | 5,335 |
| | $ | 9,765 |
| | $ | 2,784,740 |
| | $ | 2,794,505 |
|
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2016 |
| | 30-89 Days | | 90 Days or Greater | | Total Past Due | | Current | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 2,687 |
| | $ | 1,733 |
| | $ | 4,420 |
| | $ | 633,353 |
| | $ | 637,773 |
|
| Owner-occupied commercial real estate | 1,807 |
| | 2,915 |
| | 4,722 |
| | 553,313 |
| | 558,035 |
|
| Non-owner occupied commercial real estate | 733 |
| | — |
| | 733 |
| | 880,147 |
| | 880,880 |
|
| Total commercial business | 5,227 |
| | 4,648 |
| | 9,875 |
| | 2,066,813 |
| | 2,076,688 |
|
| One-to-four family residential | 523 |
| | — |
| | 523 |
| | 76,868 |
| | 77,391 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 90 |
| | 2,008 |
| | 2,098 |
| | 48,316 |
| | 50,414 |
|
| Five or more family residential and commercial properties | — |
| | 377 |
| | 377 |
| | 108,387 |
| | 108,764 |
|
| Total real estate construction and land development | 90 |
| | 2,385 |
| | 2,475 |
| | 156,703 |
| | 159,178 |
|
| Consumer | 2,292 |
| | 105 |
| | 2,397 |
| | 322,743 |
| | 325,140 |
|
| Gross loans receivable | $ | 8,132 |
| | $ | 7,138 |
| | $ | 15,270 |
| | $ | 2,623,127 |
| | $ | 2,638,397 |
|
There were no0 loans 90 days or more past due that were still accruing interest as of September 30, 20172020 or December 31, 2016, excluding PCI loans.2019.
(f) ImpairedCollateral-dependent Loans
The types of collateral securing loans individually evaluated for credit losses and for which the repayment was expected to be provided substantially through the operation or sale of the collateral as of September 30, 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans receivable(1) |
| CRE | | Farmland | | Single Family Residence | | Equipment or Accounts Receivable | | | | Total |
| (In thousands) |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | $ | 1,953 | | | $ | 18,979 | | | $ | 1,331 | | | $ | 1,696 | | | | | $ | 24,155 | |
| Owner-occupied CRE | 4,764 | | | 0 | | | 0 | | | 0 | | | | | 4,764 | |
| Non-owner occupied CRE | 5,218 | | | 0 | | | 0 | | | 0 | | | | | 5,218 | |
| Total commercial business | 11,935 | | | 18,979 | | | 1,331 | | | 1,696 | | | | | 34,137 | |
| One-to-four family residential | 0 | | | 0 | | | 38 | | | 0 | | | | | 38 | |
| Real estate construction and land development: | | | | | | | | | | | |
| One-to-four family residential | 0 | | | 0 | | | 1,812 | | | 0 | | | | | 1,812 | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Total | $ | 11,935 | | | $ | 18,979 | | | $ | 3,181 | | | $ | 1,696 | | | | | $ | 35,987 | |
(1) Balances represent the amortized cost of loans receivable evaluated for credit losses using collateral valuation. If multiple collateral sources secured the loan, the entire loan receivable balance is presented in the collateral category deemed primary, which generally represents the majority of the collateral balance.
There have been no significant changes to the collateral securing individually evaluated loans for credit losses and for which repayment was expected to be provided substantially through the operation or sale of the collateral during the nine months ended September 30, 2020, except changes due to payoffs and additions of loans to this classification.
Under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans, comparative disclosures of collateral-dependent loans as of December 31, 2019 and for the three and nine months ended September 30, 2019 are similar to the disclosures for impaired loans. Impaired loans include nonaccrual loans, performing TDR loans, and performing troubled debt restructured ("TDR")other loans with a specific valuation allowance, excluding PCI loans. The balancesamortized cost of impaired loans as of September 30, 2017 and December 31, 20162019 are set forth in the following tables.table:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| Amortized Cost With
No Specific
Valuation
Allowance | | Amortized Cost With
Specific
Valuation
Allowance | | Total
Amortized Cost | | Outstanding
Principal
Balance | | Related
Specific
Valuation
Allowance |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 30,179 | | | $ | 13,629 | | | $ | 43,808 | | | $ | 45,585 | | | $ | 1,372 | |
| Owner-occupied CRE | 3,921 | | | 2,415 | | | 6,336 | | | 6,764 | | | 426 | |
| Non-owner occupied CRE | 5,309 | | | 1,015 | | | 6,324 | | | 6,458 | | | 146 | |
| Total commercial business | 39,409 | | | 17,059 | | | 56,468 | | | 58,807 | | | 1,944 | |
| One-to-four family residential | 0 | | | 215 | | | 215 | | | 223 | | | 56 | |
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 237 | | | 0 | | | 237 | | | 237 | | | 0 | |
| | | | | | | | | |
| | | | | | | | | |
| Consumer | 0 | | | 561 | | | 561 | | | 570 | | | 143 | |
| Total | $ | 39,646 | | | $ | 17,835 | | | $ | 57,481 | | | $ | 59,837 | | | $ | 2,143 | |
|
| | | | | | | | | | | | | | | | | | | |
| | September 30, 2017 |
| | Recorded Investment With No Specific Valuation Allowance | | Recorded Investment With Specific Valuation Allowance | | Total Recorded Investment | | Unpaid Contractual Principal Balance | | Related Specific Valuation Allowance |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 3,131 |
| | $ | 8,581 |
| | $ | 11,712 |
| | $ | 12,060 |
| | $ | 1,254 |
|
| Owner-occupied commercial real estate | 1,082 |
| | 4,676 |
| | 5,758 |
| | 6,068 |
| | 767 |
|
| Non-owner occupied commercial real estate | 4,749 |
| | 6,034 |
| | 10,783 |
| | 10,927 |
| | 895 |
|
| Total commercial business | 8,962 |
| | 19,291 |
| | 28,253 |
| | 29,055 |
| | 2,916 |
|
| One-to-four family residential | — |
| | 304 |
| | 304 |
| | 311 |
| | 96 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 1,347 |
| | — |
| | 1,347 |
| | 2,305 |
| | — |
|
| Five or more family residential and commercial properties | — |
| | 658 |
| | 658 |
| | 658 |
| | 39 |
|
| Total real estate construction and land development | 1,347 |
| | 658 |
| | 2,005 |
| | 2,963 |
| | 39 |
|
| Consumer | 160 |
| | 274 |
| | 434 |
| | 457 |
| | 60 |
|
| Total | $ | 10,469 |
| | $ | 20,527 |
| | $ | 30,996 |
| | $ | 32,786 |
| | $ | 3,111 |
|
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2016 |
| | Recorded Investment With No Specific Valuation Allowance | | Recorded Investment With Specific Valuation Allowance | | Total Recorded Investment | | Unpaid Contractual Principal Balance | | Related Specific Valuation Allowance |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 1,739 |
| | $ | 10,636 |
| | $ | 12,375 |
| | $ | 13,249 |
| | $ | 1,199 |
|
| Owner-occupied commercial real estate | 1,150 |
| | 3,574 |
| | 4,724 |
| | 5,107 |
| | 511 |
|
| Non-owner occupied commercial real estate | 4,905 |
| | 6,413 |
| | 11,318 |
| | 11,386 |
| | 797 |
|
| Total commercial business | 7,794 |
| | 20,623 |
| | 28,417 |
| | 29,742 |
| | 2,507 |
|
| One-to-four family residential | — |
| | 321 |
| | 321 |
| | 325 |
| | 97 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 2,243 |
| | 828 |
| | 3,071 |
| | 3,755 |
| | 6 |
|
| Five or more family residential and commercial properties | — |
| | 1,079 |
| | 1,079 |
| | 1,079 |
| | 60 |
|
| Total real estate construction and land development | 2,243 |
| | 1,907 |
| | 4,150 |
| | 4,834 |
| | 66 |
|
| Consumer | 48 |
| | 262 |
| | 310 |
| | 325 |
| | 64 |
|
| Total | $ | 10,085 |
| | $ | 23,113 |
| | $ | 33,198 |
| | $ | 35,226 |
| | $ | 2,734 |
|
The Company had governmental guarantees of $3.9 million and $3.5 million related to the impaired loan balances at September 30, 2017 and December 31, 2016, respectively.
The average recorded investmentamortized cost of impaired loans for the three and nine months ended September 30, 2017 and 20162019 are set forth in the following table.table:
| | | | | | | | | | | |
| Three Months Ended
September 30, 2019 | | Nine Months Ended
September 30, 2019 |
| (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 35,017 | | | $ | 28,925 | |
| Owner-occupied CRE | 5,918 | | | 5,927 | |
| Non-owner occupied CRE | 9,790 | | | 8,106 | |
| Total commercial business | 50,725 | | | 42,958 | |
| One-to-four family residential | 221 | | | 249 | |
| Real estate construction and land development: | | | |
| One-to-four family residential | 676 | | | 794 | |
| | | |
| | | |
| Consumer | 600 | | | 581 | |
| Total | $ | 52,222 | | | $ | 44,582 | |
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2017 | | 2016 | | 2017 | | 2016 |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 11,171 |
| | $ | 9,625 |
| | $ | 11,190 |
| | $ | 9,750 |
|
| Owner-occupied commercial real estate | 5,289 |
| | 4,553 |
| | 5,049 |
| | 4,560 |
|
| Non-owner occupied commercial real estate | 11,037 |
| | 12,107 |
| | 11,198 |
| | 12,232 |
|
| Total commercial business | 27,497 |
| | 26,285 |
| | 27,437 |
| | 26,542 |
|
| One-to-four family residential | 307 |
| | 265 |
| | 312 |
| | 267 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 2,157 |
| | 3,177 |
| | 2,530 |
| | 3,253 |
|
| Five or more family residential and commercial properties | 860 |
| | 1,619 |
| | 967 |
| | 1,746 |
|
| Total real estate construction and land development | 3,017 |
| | 4,796 |
| | 3,497 |
| | 4,999 |
|
| Consumer | 346 |
| | 885 |
| | 328 |
| | 907 |
|
| Total | $ | 31,167 |
| | $ | 32,231 |
| | $ | 31,574 |
| | $ | 32,715 |
|
For the three and nine months ended September 30, 2017 and 2016, no interest income was recognized subsequent to a loan’s classification as nonaccrual. For the three and nine months ended September 30, 2017, the Bank recorded $366,000 and $1.0 million, respectively, of interest income related to performing TDR loans. For the
three and nine months ended September 30, 2016, the Bank recorded $156,000 and $501,000, respectively, of interest income related to performing TDR loans.
(g) Troubled Debt Restructured Loans
A TDR loan is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDRs are considered impaired and are separately measured for impairment under FASB ASC 310-10-35, whether on accrual ("performing") or nonaccrual ("nonperforming") status. The Company has more stringent definitions of concessions and impairment measures for PCI loans as these loans have known credit deterioration and are generally accreting income at a lower discounted rate as compared to the contractual note rate based on the guidance of FASB ASC 310-30.
The majority of the Bank’s TDR loans are a result of granting extensions of maturity on troubled credits which have already been adversely classified. The Bank grants such extensions to reassess the borrower’s financial status and to develop a plan for repayment. The second most prevalent concessions are certain modifications with extensions that also include interest rate reductions. Certain TDRs were additionally re-amortized over a longer period of time. These modifications would all be considered a concession for a borrower that could not obtain similar financing terms from another source other than from the Bank.
The financial effects of each modification will vary based on the specific restructure. For the majority of the Bank’s TDR loans, the loans were interest-only with a balloon payment at maturity. If the interest rate is not adjusted and the modified terms are consistent with other similar credits being offered, the Bank may not experience any loss associated with the restructure. If, however, the restructure involves forbearance agreements or interest rate modifications, the Bank may not collect all the principal and interest based on the original contractual terms. The Bank estimates the necessary allowance for loan losses on TDRs using the same guidance as used for other impaired loans.
The recorded investment balanceamortized cost and related allowance for loan lossesACL on loans of performing and nonaccrual TDR loans as of September 30, 20172020 and December 31, 20162019 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 | | December 31, 2019 |
| Performing
TDR loans | | Nonaccrual
TDR loans | | Performing
TDR loans | | Nonaccrual
TDR loans |
| (In thousands) |
| TDR loans | $ | 19,615 | | | $ | 20,468 | | | $ | 14,469 | | | $ | 26,338 | |
| ACL on TDR loans | 1,536 | | | 348 | | | 1,259 | | | 218 | |
|
| | | | | | | | | | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | Performing TDRs | | Nonaccrual TDRs | | Performing TDRs | | Nonaccrual
TDRs |
| | (In thousands) |
| TDR loans | $ | 20,044 |
| | $ | 5,903 |
| | $ | 22,288 |
| | $ | 6,900 |
|
| Allowance for loan losses on TDR loans | 2,136 |
| | 555 |
| | 1,965 |
| | 437 |
|
The unfunded commitment to borrowers related to TDRsTDR loans was $160,000$2.3 million and $249,000$736,000 at September 30, 20172020 and December 31, 2016,2019, respectively.
Loans that were modified as TDRsTDR loans during the three and nine months ended September 30, 20172020 and 20162019 are set forth in the following tables:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, |
| 2020 | | 2019 |
| Number of
Contracts | | Amortized Cost (1) | | Number of
Contracts | | Amortized Cost (1) |
| (Dollars in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | 12 | | $ | 7,217 | | | 15 | | $ | 5,267 | |
| Owner-occupied CRE | 5 | | 2,312 | | | 2 | | 1,214 | |
| Non-owner occupied CRE | 2 | | 438 | | | 3 | | 2,597 | |
| Total commercial business | 19 | | 9,967 | | | 20 | | 9,078 | |
| One-to-four family residential | 1 | | 22 | | | 0 | | 0 | |
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 4 | | 1,812 | | | 0 | | 0 | |
| | | | | | | |
| | | | | | | |
| Consumer | 9 | | 127 | | | 3 | | 27 | |
| Total | 33 | | $ | 11,928 | | | 23 | | $ | 9,105 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2020 | | 2019 |
| Number of Contracts (2) | | Amortized Cost (1) (2) | | Number of Contracts (2) | | Amortized Cost (1) (2) |
| (Dollars in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | 38 | | $ | 18,871 | | | 33 | | $ | 22,408 | |
| Owner-occupied CRE | 7 | | 3,227 | | | 3 | | 1,612 | |
| Non-owner occupied CRE | 4 | | 2,417 | | | 4 | | 5,568 | |
| Total commercial business | 49 | | 24,515 | | | 40 | | 29,588 | |
| One-to-four family residential | 1 | | 22 | | | 0 | | 0 | |
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 4 | | 1,812 | | | 1 | | 560 | |
| | | | | | | |
| | | | | | | |
| Consumer | 20 | | 251 | | | 10 | | 158 | |
| Total TDR loans | 74 | | $ | 26,600 | | | 51 | | $ | 30,306 | |
(1) Includes subsequent payments after modifications and reflects the balance as of period end. As the Bank did not forgive any principal or interest balance as part of the loan modifications, the Bank’s amortized cost in each loan at
|
| | | | | | | | | | | | | |
| | Three Months Ended September 30, |
| | 2017 | | 2016 |
| | Number of Contracts (1) | | Outstanding
Principal Balance
(1)(2) | | Number of Contracts (1) | | Outstanding Principal Balance (1)(2) |
| | (Dollars in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | 4 |
| | $ | 1,353 |
| | 8 |
| | $ | 2,324 |
|
| Owner-occupied commercial real estate | 2 |
| | 1,299 |
| | 2 |
| | 576 |
|
| Non-owner occupied commercial real estate | 1 |
| | 655 |
| | 1 |
| | 818 |
|
| Total commercial business | 7 |
| | 3,307 |
| | 11 |
| | 3,718 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | — |
| | — |
| | 5 |
| | 2,274 |
|
| Five or more family residential and commercial properties | — |
| | — |
| | 1 |
| | 1,606 |
|
| Total real estate construction and land development | — |
| | — |
| | 6 |
| | 3,880 |
|
| Consumer | 4 |
| | 52 |
| | 2 |
| | 26 |
|
| Total TDR loans | 11 |
| | $ | 3,359 |
| | 19 |
| | $ | 7,624 |
|
|
| | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2017 | | 2016 |
| | Number of Contracts (1) | | Outstanding
Principal Balance
(1)(2) | | Number of Contracts (1) | | Outstanding Principal Balance (1)(2) |
| | (Dollars in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | 13 |
| | $ | 5,564 |
| | 15 |
| | $ | 2,915 |
|
| Owner-occupied commercial real estate | 3 |
| | 1,351 |
| | 2 |
| | 576 |
|
| Non-owner occupied commercial real estate | 2 |
| | 1,596 |
| | 1 |
| | 818 |
|
| Total commercial business | 18 |
| | 8,511 |
| | 18 |
| | 4,309 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 2 |
| | 1,038 |
| | 5 |
| | 2,274 |
|
| Five or more family residential and commercial properties | — |
| | — |
| | 1 |
| | 1,606 |
|
| Total real estate construction and land development | 2 |
| | 1,038 |
| | 6 |
| | 3,880 |
|
| Consumer | 5 |
| | 60 |
| | 6 |
| | 70 |
|
| Total TDR loans | 25 |
| | $ | 9,609 |
| | 30 |
| | $ | 8,259 |
|
| |
(1) | Number of contracts and outstanding principal balance represent loans which have balances as of period end as certain(2) Number of contracts and amortized cost represent loans which have balances as of period end. Certain modified loans may have been paid-down or charged-off during the three and nine months ended September 30, 2017 and 2016. |
| |
(2) | Includes subsequent payments after modifications and reflects the balance as of period end. As the Bank did not forgive any principal or interest balance as part of the loan modification, the Bank’s recorded investment in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-modification). |
Of the 11 loans modified during the three months ended September 30, 2017, seven loans with a total outstanding principal balance of $2.1 million had no prior modifications. Of the 25 loans modified during the nine months
ended September 30, 2017, 15 loans with a total outstanding principal balance of $5.0 million had no prior modifications. Of the 19 loans modified during the three months ended September 30, 2016, eight loans with a total outstanding principal balance of $1.4 million had no prior modifications. Of the 30 loans modified during the nine months ended September 30, 2016, 15 loans with a total outstanding principal balance of $1.7 million had no prior modifications. 2020 and 2019.
The remaining loans included in the tabletables above include 22 and 31 loans, respectively, for the three and nine months ended September 30, 20172020 and 20167 and 17, respectively, for the three and nine months ended September 30, 2019 that were previously reported as TDRs.TDR loans. The Bank typically grants shorter extension periods to continually monitor these TDRsTDR loans despite the fact that the extended date might not be the date the Bank expects sufficient cash flow from these borrowers. The CompanyBank does not consider these modifications a subsequent default of a TDR as new loan terms, specifically new maturity dates, were granted. Of the remaining first-reported TDR loans, the concessions granted largely consisted of maturity extensions, interest rate modifications or a combination of both. The potential losses related to theseTDR loans would have beenare considered in the period the loan was first reported as a TDR loan and are adjusted, as necessary, in the current period based on more recent information. The related specific valuation allowanceACL at September 30, 2017 was $1.1 million2020 for loans that were modified as TDRsTDR loans during the nine months ended September 30, 2017.2020 was $1.6 million.
There was one commercial and industrial loan totaling $234,000 at September 30, 2017 that was modified during the previous twelve months that subsequently defaulted during the three and nine months ended September 30, 2017 because the borrower was more than 90 days delinquent on their scheduled loan payments. There were no loansLoans that were modified during the previous twelve months that subsequently defaulted during the three and nine months ended September 30, 2016.2020 and 2019 are set forth in the following tables:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, |
| 2020 | | 2019 |
| Number of
Contracts | | Amortized Cost | | Number of
Contracts | | Amortized Cost |
| (Dollars in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | 1 | | $ | 229 | | | 4 | | $ | 2,056 | |
| | | | | | | |
| Non-owner occupied CRE | 0 | | 0 | | | 1 | | 2,971 | |
| Total commercial business | 1 | | $ | 229 | | | 5 | | $ | 5,027 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Total | 1 | | $ | 229 | | | 5 | | $ | 5,027 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2020 | | 2019 |
| Number of Contracts (1) | | Amortized Cost (1) | | Number of Contracts (1) | | Amortized Cost (1) |
| (Dollars in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | 4 | | $ | 2,152 | | | 9 | | $ | 3,229 | |
| Owner-occupied CRE | 1 | | 431 | | | 2 | | 1,101 | |
| Non-owner occupied CRE | 2 | | 376 | | | 2 | | 3,541 | |
| Total commercial business | 7 | | 2,959 | | | 13 | | 7,871 | |
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 0 | | 0 | | | 1 | | 560 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Total | 7 | | $ | 2,959 | | | 14 | | $ | 8,431 | |
(1) Number of contracts and amortized cost represent loans which have balances as of period end. Certain loans may have been paid-down or charged-off during the nine months ended September 30, 2020 and 2019.
During the three and nine months ended September 30, 2020 all of the loans in the tables above defaulted because each was past its modified maturity date and the borrower has not subsequently repaid the credits. The Bank chose not to extend further the maturity date on these loans. The Bank had an ACL on loans of $512,000 at September 30, 2020 related to these TDR loans which defaulted during the nine months ended September 30, 2020.
During the three and nine months ended September 30, 2019, 3 and 12 TDR loans, respectively, defaulted because each was past its modified maturity date and the borrower has not subsequently repaid the credits. The Bank chose not to extend further the maturity date on these loans. In addition, during both the three and nine months ended September 30, 2019, 2 TDR loans defaulted because the borrowers were more than 90 days delinquent on their scheduled loan payments. The Bank had a specific valuation allowance of $412,000 at September 30, 2019 related to these TDR loans which defaulted during the nine months ended September 30, 2019.
For the three and nine months ended September 30, 2020, the Bank recorded $263,000 and $1.1 million, respectively, of interest income related to performing TDR loans. For the three and nine months ended September 30, 2019, the Bank recorded $282,000 and $980,000, respectively, of interest income related to performing TDR loans. (h) Purchased Credit Impaired Loans
TheUpon CECL Adoption, the Company acquired loans and designated them astransitioned PCI loans which are accounted for under FASB ASC 310-30, in the Washington Banking Merger on May 1, 2014 and in previously completed acquisitions, including the FDIC-assisted acquisitions of Cowlitz Bank ("Cowlitz") and Pierce Commercial Bank ("Pierce") on July 30, 2010 and November 8, 2010, respectively, and the acquisitions of Northwest Commercial Bank ("NCB") on January 9, 2013 and Valley Community Bancshares, Inc. ("Valley") on July 15, 2013.
to PCD loans. The following table reflects the outstanding principal balance and recorded investmentamortized cost of the PCI loans at September 30, 2017 and December 31, 2016:2019:
| | | | | | | | | | | |
| December 31, 2019 |
| Outstanding Principal | | Amortized Cost |
| (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 4,439 | | | $ | 2,368 | |
| Owner-occupied CRE | 4,925 | | | 4,914 | |
| Non-owner occupied CRE | 7,028 | | | 5,491 | |
| Total commercial business | 16,392 | | | 12,773 | |
| One-to-four family residential | 3,095 | | | 3,575 | |
| | | |
| | | |
| | | |
| | | |
| Consumer | 1,463 | | | 1,762 | |
| PCI loans | $ | 20,950 | | | $ | 18,110 | |
|
| | | | | | | | | | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | Outstanding Principal | | Recorded Investment | | Outstanding Principal | | Recorded Investment |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 9,220 |
| | $ | 5,001 |
| | $ | 13,067 |
| | $ | 9,317 |
|
| Owner-occupied commercial real estate | 14,059 |
| | 12,492 |
| | 17,639 |
| | 15,973 |
|
| Non-owner occupied commercial real estate | 15,026 |
| | 13,058 |
| | 25,037 |
| | 23,360 |
|
| Total commercial business | 38,305 |
| | 30,551 |
| | 55,743 |
| | 48,650 |
|
| One-to-four family residential | 4,426 |
| | 3,983 |
| | 5,120 |
| | 4,905 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 2,928 |
| | 1,749 |
| | 2,958 |
| | 2,123 |
|
| Five or more family residential and commercial properties | 2,392 |
| | 2,284 |
| | 2,614 |
| | 2,488 |
|
| Total real estate construction and land development | 5,320 |
| | 4,033 |
| | 5,572 |
| | 4,611 |
|
| Consumer | 3,998 |
| | 5,129 |
| | 5,296 |
| | 6,282 |
|
| Gross PCI loans | $ | 52,049 |
| | $ | 43,696 |
| | $ | 71,731 |
| | $ | 64,448 |
|
On the acquisition dates, the amount by which the undiscounted expected cash flows of the PCI loans exceeded the estimated fair value of the loan iswas the “accretable yield.” The accretable yield iswas then measured at each financial reporting date and representsrepresented the difference between the remaining undiscounted expected cash flows and the current carrying value of the PCI loans.
The following table summarizes the accretable yield on the PCI loans for the three and nine months ended September 30, 2017 and 2016.2019:
| | | | | | | | | | | |
| Three Months Ended
September 30, 2019 | | Nine Months Ended
September 30, 2019 |
| (In thousands) |
| Balance at the beginning of the period | $ | 8,572 | | | $ | 9,493 | |
| Accretion | (423) | | | (1,517) | |
| Disposal and other | (94) | | | (744) | |
| Reclassification from nonaccretable difference | 0 | | | 823 | |
| Balance at the end of the period | $ | 8,055 | | | $ | 8,055 | |
(4)Allowance for Credit Losses on Loans
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| | | (In thousands) |
| Balance at the beginning of the period | | $ | 12,296 |
| | $ | 15,359 |
| | $ | 13,860 |
| | $ | 17,592 |
|
| Accretion | | (796 | ) | | (1,178 | ) | | (2,725 | ) | | (3,900 | ) |
| Disposal and other | | (1,287 | ) | | (491 | ) | | (2,430 | ) | | (2,921 | ) |
| Change in accretable yield | | 939 |
| | 1,214 |
| | 2,447 |
| | 4,133 |
|
| Balance at the end of the period | | $ | 11,152 |
| | $ | 14,904 |
| | $ | 11,152 |
| | $ | 14,904 |
|
| |
(4) | Allowance for Loan Losses |
TheEffective January 1, 2020, the Bank adopted ASU 2016-13. CECL Adoption replaced the allowance for loan losses with the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans. Risk characteristics by segment considered in the CECL methodology are the same as those disclosed in the 2019 Annual Form 10-K.
The baseline loss rates used to calculate the ACL on loans at January 1, 2020 utilized the Bank's average quarterly historical loss information from December 31, 2007 through December 31, 2019. The baseline loss rate for the ACL at September 30, 2020 used historical losses beginning December 31, 2012 through the balance sheet date. The Bank updated the historical loss period as it believes the economic cycle has ended, as evidenced by certain economic forecasts signaling that a recession has started given the prolonged, profound, and pervasive contraction in economic activities due to COVID-19. The Bank believes the historic loss rates are viable inputs to the current expected credit loss methodology as the Bank's lending practice and business has remained relatively stable throughout the periods. While the Bank's assets have grown, the credit culture has stayed consistent.
Prepayments included in the CECL model at January 1, 2020 and September 30, 2020 were based on the 48-month rolling historical averages for each segment, which management believes is maintainedan accurate representation of
future prepayment activity. There were no changes to this methodology during the nine months ended September 30, 2020.
The reasonable and supportable period used in the CECL model at January 1, 2020 was four quarters and was increased to five quarters in the CECL model at September 30, 2020 to include the additional impact of certain macroeconomic factors with lagged periods. Management believes that forecasts beyond this time period tend to diverge in economic assumptions and may be less comparable to actual future events. As the length of the reasonable and supportable period increases, the degree of judgment involved in estimating the allowance will likely increase.
The Bank used a level deemed appropriate by managementtwo quarter reversion period in calculating the ACL as of January 1, 2020 and September 30, 2020 as it believes the historical loss information is relevant to provide for probable incurredthe expected credit losses and recognizes the declining precision and increasing uncertainty of estimating credit losses in those periods beyond which it can make reasonable and supportable forecasts.
The macroeconomic forecast used in the loan portfolio. CECL model as of January 1, 2020 predicted continued economic expansion with steady GDP growth of 1.8% and low unemployment rates of 3.5% in 2020, among other factors. The onset of the COVID-19 pandemic resulted in identification of an economic recession during the second quarter of 2020. The macroeconomic forecast used in the CECL model as of September 30, 2020 reflected a slow and long recovery from the COVID-19 recession. The modeled recovery is expected to last through the end of 2021, including a contraction in GDP of 3.7% for 2020 and a rebound of 3.7% for 2021, and modest increases in GDP in future years. Unemployment rates are expected to average 8.7% during the remainder of 2020 and gradually reduce to 4.0% by 2025.
The ACL on loans at September 30, 2020 does not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.
The following tables detail the activity in the allowance for loan lossesACL on loans disaggregated by segment and class for the three and nine months ended September 30, 2017:2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2020 |
| Beginning Balance | | Charge-offs | | Recoveries | | Provision for Credit Losses | | Ending Balance |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 29,773 | | | $ | (507) | | | $ | 78 | | | $ | 1,815 | | | $ | 31,159 | |
| SBA PPP | 0 | | | 0 | | | 0 | | | 0 | | | 0 | |
| Owner-occupied CRE | 10,003 | | | 0 | | | 2 | | | 3,027 | | | 13,032 | |
| Non-owner occupied CRE | 10,666 | | | 0 | | | 0 | | | (124) | | | 10,542 | |
| Total commercial business | 50,442 | | | (507) | | | 80 | | | 4,718 | | | 54,733 | |
| One-to-four family residential | 2,223 | | | 0 | | | 0 | | | (398) | | | 1,825 | |
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 567 | | | 0 | | | 139 | | | (42) | | | 664 | |
| Five or more family residential and commercial properties | 8,557 | | | 0 | | | 0 | | | 70 | | | 8,627 | |
| Total real estate construction and land development | 9,124 | | | 0 | | | 139 | | | 28 | | | 9,291 | |
| Consumer | 9,712 | | | (335) | | | 142 | | | (2,028) | | | 7,491 | |
| | | | | | | | | |
| Total | $ | 71,501 | | | $ | (842) | | | $ | 361 | | | $ | 2,320 | | | $ | 73,340 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2020 |
| Beginning Balance | | Impact of CECL Adoption | | Beginning Balance,
as Adjusted | | Charge-offs | | Recoveries | | Provision for Credit Losses | | Ending Balance |
| (In thousands) |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 11,739 | | | $ | (1,348) | | | $ | 10,391 | | | $ | (3,418) | | | $ | 1,204 | | | $ | 22,982 | | | $ | 31,159 | |
| SBA PPP | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | |
| Owner-occupied CRE | 4,512 | | | 452 | | | 4,964 | | | (135) | | | 16 | | | 8,187 | | | 13,032 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2020 |
| Beginning Balance | | Impact of CECL Adoption | | Beginning Balance,
as Adjusted | | Charge-offs | | Recoveries | | Provision for Credit Losses | | Ending Balance |
| (In thousands) |
| Non-owner occupied CRE | 7,682 | | | (2,039) | | | 5,643 | | | 0 | | | 0 | | | 4,899 | | | 10,542 | |
| Total commercial business | 23,933 | | | (2,935) | | | 20,998 | | | (3,553) | | | 1,220 | | | 36,068 | | | 54,733 | |
| One-to-four family residential | 1,458 | | | 1,471 | | | 2,929 | | | 0 | | | 3 | | | (1,107) | | | 1,825 | |
| Real estate construction and land development: | | | | | | | | | | | | | |
| One-to-four family residential | 1,455 | | | (571) | | | 884 | | | 0 | | | 160 | | | (380) | | | 664 | |
| Five or more family residential and commercial properties | 1,605 | | | 7,240 | | | 8,845 | | | 0 | | | 0 | | | (218) | | | 8,627 | |
| Total real estate construction and land development | 3,060 | | | 6,669 | | | 9,729 | | | 0 | | | 160 | | | (598) | | | 9,291 | |
| Consumer | 6,821 | | | (2,484) | | | 4,337 | | | (1,141) | | | 433 | | | 3,862 | | | 7,491 | |
| Unallocated | 899 | | | (899) | | | 0 | | | 0 | | | 0 | | | 0 | | | 0 | |
| Total | $ | 36,171 | | | $ | 1,822 | | | $ | 37,993 | | | $ | (4,694) | | | $ | 1,816 | | | $ | 38,225 | | | $ | 73,340 | |
|
| | | | | | | | | | | | | | | | | | | |
| | Balance at Beginning of Period | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Balance at End of Period |
| | (In thousands) |
| Three Months Ended September 30, 2017 | | | | | | | | | |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 10,651 |
| | $ | (3 | ) | | $ | 4 |
| | $ | (772 | ) | | $ | 9,880 |
|
| Owner-occupied commercial real estate | 4,154 |
| | (1,494 | ) | | 4 |
| | 1,397 |
| | 4,061 |
|
| Non-owner occupied commercial real estate | 7,709 |
| | — |
| | — |
| | (415 | ) | | 7,294 |
|
| Total commercial business | 22,514 |
| | (1,497 | ) | | 8 |
| | 210 |
| | 21,235 |
|
| One-to-four family residential | 1,073 |
| | (15 | ) | | — |
| | (21 | ) | | 1,037 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 821 |
| | (556 | ) | | 191 |
| | 337 |
| | 793 |
|
| Five or more family residential and commercial properties | 1,666 |
| | — |
| | — |
| | (271 | ) | | 1,395 |
|
| Total real estate construction and land development | 2,487 |
| | (556 | ) | | 191 |
| | 66 |
| | 2,188 |
|
| Consumer | 5,710 |
| | (478 | ) | | 112 |
| | 453 |
| | 5,797 |
|
| Unallocated | 967 |
| | — |
| | — |
| | 176 |
| | 1,143 |
|
| Total | $ | 32,751 |
| | $ | (2,546 | ) | | $ | 311 |
| | $ | 884 |
| | $ | 31,400 |
|
| | | | | | | | | | |
| Nine Months Ended September 30, 2017 | | | | | | | | | |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 10,968 |
| | $ | (361 | ) | | $ | 679 |
| | $ | (1,406 | ) | | $ | 9,880 |
|
| Owner-occupied commercial real estate | 3,661 |
| | (1,579 | ) | | 155 |
| | 1,824 |
| | 4,061 |
|
| Non-owner occupied commercial real estate | 7,753 |
| | — |
| | — |
| | (459 | ) | | 7,294 |
|
| Total commercial business | 22,382 |
| | (1,940 | ) | | 834 |
| | (41 | ) | | 21,235 |
|
| One-to-four family residential | 1,015 |
| | (15 | ) | | 1 |
| | 36 |
| | 1,037 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 797 |
| | (556 | ) | | 201 |
| | 351 |
| | 793 |
|
| Five or more family residential and commercial properties | 1,359 |
| | — |
| | — |
| | 36 |
| | 1,395 |
|
| Total real estate construction and land development | 2,156 |
| | (556 | ) | | 201 |
| | 387 |
| | 2,188 |
|
| Consumer | 5,024 |
| | (1,419 | ) | | 329 |
| | 1,863 |
| | 5,797 |
|
| Unallocated | 506 |
| | — |
| | — |
| | 637 |
| | 1,143 |
|
| Total | $ | 31,083 |
| | $ | (3,930 | ) | | $ | 1,365 |
| | $ | 2,882 |
| | $ | 31,400 |
|
The following table detailsBank recognized net charge-offs of $2.9 million during the nine months ended September 30, 2020 primarily due to a commercial and industrial charge-off of $1.7 million related to a lending relationship that had been experiencing difficulties. Due to issues surrounding the control of the underlying loan collateral, the Bank determined it appropriate to charge-off the entire balance and pursue an aggressive collection strategy. Net charge-offs also included two commercial and industrial loan relationships totaling $447,000 as a result of impacts from the COVID-19 pandemic and small dollar net charge-offs on a large volume of consumer loans of $708,000. Net charge-offs were offset partially by a full recovery of a commercial and industrial agricultural lending relationship of $963,000 during the nine months ended September 30, 2020, which was charged-off during the three months ended December 31, 2019.
The provision for credit losses on loans of $38.2 million for the nine months ended September 30, 2020 was necessary to build the allowance to account for loanthe current and forecasted economic conditions amidst COVID-19, including the credit losses disaggregatedestimated on the basis of the Company's impairment method as of September 30, 2017.
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Allowance for Loan Losses |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 1,254 |
| | $ | 7,589 |
| | $ | 1,037 |
| | $ | 9,880 |
|
| Owner-occupied commercial real estate | 767 |
| | 2,434 |
| | 860 |
| | 4,061 |
|
| Non-owner occupied commercial real estate | 895 |
| | 5,389 |
| | 1,010 |
| | 7,294 |
|
| Total commercial business | 2,916 |
| | 15,412 |
| | 2,907 |
| | 21,235 |
|
| One-to-four family residential | 96 |
| | 740 |
| | 201 |
| | 1,037 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | — |
| | 568 |
| | 225 |
| | 793 |
|
| Five or more family residential and commercial properties | 39 |
| | 1,259 |
| | 97 |
| | 1,395 |
|
| Total real estate construction and land development | 39 |
| | 1,827 |
| | 322 |
| | 2,188 |
|
| Consumer | 60 |
| | 4,991 |
| | 746 |
| | 5,797 |
|
| Unallocated | — |
| | 1,143 |
| | — |
| | 1,143 |
|
| Total | $ | 3,111 |
| | $ | 24,113 |
| | $ | 4,176 |
| | $ | 31,400 |
|
The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method as of September 30, 2017:
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Gross Loans Receivable |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 11,712 |
| | $ | 648,869 |
| | $ | 5,001 |
| | $ | 665,582 |
|
| Owner-occupied commercial real estate | 5,758 |
| | 583,988 |
| | 12,492 |
| | 602,238 |
|
| Non-owner occupied commercial real estate | 10,783 |
| | 906,347 |
| | 13,058 |
| | 930,188 |
|
| Total commercial business | 28,253 |
| | 2,139,204 |
| | 30,551 |
| | 2,198,008 |
|
| One-to-four family residential | 304 |
| | 77,135 |
| | 3,983 |
| | 81,422 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 1,347 |
| | 48,355 |
| | 1,749 |
| | 51,451 |
|
| Five or more family residential and commercial properties | 658 |
| | 120,039 |
| | 2,284 |
| | 122,981 |
|
| Total real estate construction and land development | 2,005 |
| | 168,394 |
| | 4,033 |
| | 174,432 |
|
| Consumer | 434 |
| | 335,080 |
| | 5,129 |
| | 340,643 |
|
| Total | $ | 30,996 |
| | $ | 2,719,813 |
| | $ | 43,696 |
| | $ | 2,794,505 |
|
collectively and individually evaluated loans.
The following tables detail activity in the allowance for loan losses disaggregated by segment and class for the three and nine months ended September 30, 2016.2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2019 |
| Beginning Balance | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Ending Balance |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 11,993 | | | $ | (306) | | | $ | 43 | | | $ | 449 | | | $ | 12,179 | |
| Owner-occupied CRE | 5,066 | | | 0 | | | 46 | | | (656) | | | 4,456 | |
| Non-owner occupied CRE | 8,064 | | | 0 | | | 292 | | | (525) | | | 7,831 | |
| Total commercial business | 25,123 | | | (306) | | | 381 | | | (732) | | | 24,466 | |
| One-to-four family residential | 1,345 | | | (15) | | | 0 | | | 81 | | | 1,411 | |
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 1,471 | | | 0 | | | 3 | | | (133) | | | 1,341 | |
|
| | | | | | | | | | | | | | | | | | | |
| | Balance at Beginning of Period | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Balance at End of Period |
| | (In thousands) |
| Three Months Ended September 30, 2016 | | | | | | | | | |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 9,970 |
| | $ | (240 | ) | | $ | 993 |
| | $ | 182 |
| | $ | 10,905 |
|
| Owner-occupied commercial real estate | 3,578 |
| | (88 | ) | | — |
| | 222 |
| | 3,712 |
|
| Non-owner occupied commercial real estate | 6,924 |
| | — |
| | — |
| | 303 |
| | 7,227 |
|
| Total commercial business | 20,472 |
| | (328 | ) | | 993 |
| | 707 |
| | 21,844 |
|
| One-to-four family residential | 950 |
| | — |
| | — |
| | 26 |
| | 976 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 754 |
| | — |
| | — |
| | 96 |
| | 850 |
|
| Five or more family residential and commercial properties | 1,277 |
| | — |
| | — |
| | 5 |
| | 1,282 |
|
| Total real estate construction and land development | 2,031 |
| | — |
| | — |
| | 101 |
| | 2,132 |
|
| Consumer | 4,816 |
| | (572 | ) | | 197 |
| | 665 |
| | 5,106 |
|
| Unallocated | 157 |
| | — |
| | — |
| | (4 | ) | | 153 |
|
| Total | $ | 28,426 |
| | $ | (900 | ) | | $ | 1,190 |
| | $ | 1,495 |
| | $ | 30,211 |
|
| | | | | | | | | | |
| Nine Months Ended September 30, 2016 | | | | | | | | | |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 9,972 |
| | $ | (2,810 | ) | | $ | 1,352 |
| | $ | 2,391 |
| | $ | 10,905 |
|
| Owner-occupied commercial real estate | 4,370 |
| | (538 | ) | | — |
| | (120 | ) | | 3,712 |
|
| Non-owner occupied commercial real estate | 7,722 |
| | (350 | ) | | — |
| | (145 | ) | | 7,227 |
|
| Total commercial business | 22,064 |
| | (3,698 | ) | | 1,352 |
| | 2,126 |
| | 21,844 |
|
| One-to-four family residential | 1,157 |
| | — |
| | 2 |
| | (183 | ) | | 976 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 1,058 |
| | (100 | ) | | 83 |
| | (191 | ) | | 850 |
|
| Five or more family residential and commercial properties | 813 |
| | (54 | ) | | — |
| | 523 |
| | 1,282 |
|
| Total real estate construction and land development | 1,871 |
| | (154 | ) | | 83 |
| | 332 |
| | 2,132 |
|
| Consumer | 4,309 |
| | (1,370 | ) | | 496 |
| | 1,671 |
| | 5,106 |
|
| Unallocated | 345 |
| | — |
| | — |
| | (192 | ) | | 153 |
|
| Total | $ | 29,746 |
| | $ | (5,222 | ) | | $ | 1,933 |
| | $ | 3,754 |
| | $ | 30,211 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2019 |
| Beginning Balance | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Ending Balance |
| (In thousands) |
| Five or more family residential and commercial properties | 1,060 | | | 0 | | | 0 | | | 229 | | | 1,289 | |
| Total real estate construction and land development | 2,531 | | | 0 | | | 3 | | | 96 | | | 2,630 | |
| Consumer | 6,540 | | | (501) | | | 127 | | | 621 | | | 6,787 | |
| Unallocated | 824 | | | 0 | | | 0 | | | 400 | | | 1,224 | |
| Total | $ | 36,363 | | | $ | (822) | | | $ | 511 | | | $ | 466 | | | $ | 36,518 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2019 |
| Beginning Balance | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Ending Balance |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 11,343 | | | $ | (1,183) | | | $ | 112 | | | $ | 1,907 | | | $ | 12,179 | |
| Owner-occupied CRE | 4,898 | | | 0 | | | 49 | | | (491) | | | 4,456 | |
| Non-owner occupied CRE | 7,470 | | | 0 | | | 441 | | | (80) | | | 7,831 | |
| Total commercial business | 23,711 | | | (1,183) | | | 602 | | | 1,336 | | | 24,466 | |
| One-to-four family residential | 1,203 | | | (45) | | | 0 | | | 253 | | | 1,411 | |
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 1,240 | | | 0 | | | 628 | | | (527) | | | 1,341 | |
| Five or more family residential and commercial properties | 954 | | | 0 | | | 0 | | | 335 | | | 1,289 | |
| Total real estate construction and land development | 2,194 | | | 0 | | | 628 | | | (192) | | | 2,630 | |
| Consumer | 6,581 | | | (1,653) | | | 374 | | | 1,485 | | | 6,787 | |
| Unallocated | 1,353 | | | 0 | | | 0 | | | (129) | | | 1,224 | |
| Total | $ | 35,042 | | | $ | (2,881) | | | $ | 1,604 | | | $ | 2,753 | | | $ | 36,518 | |
The following table details the allowance for loan losses disaggregated on the basis of the Company's impairment method as of December 31, 2016.2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:
| | | | | | | | | | | | | | | | | | | | | | | |
| Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Allowance for Loan Losses |
| (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 1,372 | | | $ | 9,772 | | | $ | 595 | | | $ | 11,739 | |
| Owner-occupied CRE | 426 | | | 3,558 | | | 528 | | | 4,512 | |
| Non-owner occupied CRE | 146 | | | 7,064 | | | 472 | | | 7,682 | |
| Total commercial business | 1,944 | | | 20,394 | | | 1,595 | | | 23,933 | |
| One-to-four family residential | 56 | | | 1,316 | | | 86 | | | 1,458 | |
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 0 | | | 1,296 | | | 159 | | | 1,455 | |
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Allowance for Loan Losses |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 1,199 |
| | $ | 8,048 |
| | $ | 1,721 |
| | $ | 10,968 |
|
| Owner-occupied commercial real estate | 511 |
| | 1,834 |
| | 1,316 |
| | 3,661 |
|
| Non-owner occupied commercial real estate | 797 |
| | 5,142 |
| | 1,814 |
| | 7,753 |
|
| Total commercial business | 2,507 |
| | 15,024 |
| | 4,851 |
| | 22,382 |
|
| One-to-four family residential | 97 |
| | 643 |
| | 275 |
| | 1,015 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 6 |
| | 538 |
| | 253 |
| | 797 |
|
| Five or more family residential and commercial properties | 60 |
| | 1,168 |
| | 131 |
| | 1,359 |
|
| Total real estate construction and land development | 66 |
| | 1,706 |
| | 384 |
| | 2,156 |
|
| Consumer | 64 |
| | 3,912 |
| | 1,048 |
| | 5,024 |
|
| Unallocated | — |
| | 506 |
| | — |
| | 506 |
|
| Total | $ | 2,734 |
| | $ | 21,791 |
| | $ | 6,558 |
| | $ | 31,083 |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Allowance for Loan Losses |
| (In thousands) |
| Five or more family residential and commercial properties | 0 | | | 1,527 | | | 78 | | | 1,605 | |
| Total real estate construction and land development | 0 | | | 2,823 | | | 237 | | | 3,060 | |
| Consumer | 143 | | | 6,327 | | | 351 | | | 6,821 | |
| Unallocated | 0 | | | 899 | | | 0 | | | 899 | |
| Total | $ | 2,143 | | | $ | 31,759 | | | $ | 2,269 | | | $ | 36,171 | |
The following table details the recorded investment balanceamortized cost of the loan receivables disaggregated on the basis of the Company’s impairment method as of December 31, 2016:2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:
| | | | | | | | | | | | | | | | | | | | | | | |
| Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Loans Receivable |
| (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 43,808 | | | $ | 806,044 | | | $ | 2,368 | | | $ | 852,220 | |
| Owner-occupied CRE | 6,336 | | | 793,984 | | | 4,914 | | | 805,234 | |
| Non-owner occupied CRE | 6,324 | | | 1,276,964 | | | 5,491 | | | 1,288,779 | |
| Total commercial business | 56,468 | | | 2,876,992 | | | 12,773 | | | 2,946,233 | |
| One-to-four family residential | 215 | | | 127,870 | | | 3,575 | | | 131,660 | |
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 237 | | | 104,059 | | | 0 | | | 104,296 | |
| Five or more family residential and commercial properties | 0 | | | 170,350 | | | 0 | | | 170,350 | |
| Total real estate construction and land development | 237 | | | 274,409 | | | 0 | | | 274,646 | |
| Consumer | 561 | | | 413,017 | | | 1,762 | | | 415,340 | |
| Total | $ | 57,481 | | | $ | 3,692,288 | | | $ | 18,110 | | | $ | 3,767,879 | |
(5)Other Real Estate Owned
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Gross Loans Receivable |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 12,375 |
| | $ | 616,081 |
| | $ | 9,317 |
| | $ | 637,773 |
|
| Owner-occupied commercial real estate | 4,724 |
| | 537,338 |
| | 15,973 |
| | 558,035 |
|
| Non-owner occupied commercial real estate | 11,318 |
| | 846,202 |
| | 23,360 |
| | 880,880 |
|
| Total commercial business | 28,417 |
| | 1,999,621 |
| | 48,650 |
| | 2,076,688 |
|
| One-to-four family residential | 321 |
| | 72,165 |
| | 4,905 |
| | 77,391 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 3,071 |
| | 45,220 |
| | 2,123 |
| | 50,414 |
|
| Five or more family residential and commercial properties | 1,079 |
| | 105,197 |
| | 2,488 |
| | 108,764 |
|
| Total real estate construction and land development | 4,150 |
| | 150,417 |
| | 4,611 |
| | 159,178 |
|
| Consumer | 310 |
| | 318,548 |
| | 6,282 |
| | 325,140 |
|
| Total | $ | 33,198 |
|
| $ | 2,540,751 |
| | $ | 64,448 |
| | $ | 2,638,397 |
|
| |
(5) | Other Real Estate Owned |
Changes in other real estate owned during the three and nine months ended September 30, 20172020 and 20162019 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (In thousands) |
| Balance at the beginning of the period | $ | 0 | | | $ | 1,224 | | | $ | 841 | | | $ | 1,983 | |
| Additions | 0 | | | 0 | | | 270 | | | 0 | |
| | | | | | | |
| Proceeds from dispositions | 0 | | | (435) | | | (1,290) | | | (864) | |
| Gain (loss) on sales, net | 0 | | | 52 | | | 179 | | | (227) | |
| Valuation adjustment | 0 | | | 0 | | | 0 | | | (51) | |
| Balance at the end of the period | $ | 0 | | | $ | 841 | | | $ | 0 | | | $ | 841 | |
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2017 | | 2016 | | 2017 | | 2016 |
| | (In thousands) |
| Balance at the beginning of the period | $ | 786 |
| | $ | 1,560 |
| | $ | 754 |
| | $ | 2,019 |
|
| Additions | — |
| | 25 |
| | 32 |
| | 677 |
|
| Proceeds from dispositions | (374 | ) | | (1,716 | ) | | (374 | ) | | (2,486 | ) |
| Gain on sales, net | 111 |
| | 131 |
| | 111 |
| | 173 |
|
| Valuation adjustment | — |
| | — |
| | — |
| | (383 | ) |
| Balance at the end of the period | $ | 523 |
| | $ | — |
| | $ | 523 |
| | $ | — |
|
At September 30, 2017, the carrying amount of other real estate owned that was the result of foreclosure and obtaining physical possession of residential real estate properties was $523,000. At September 30, 2017, the recorded investment of2020, there were 0 consumer mortgage loans secured by residential real estate properties (included in the one-to-four family residential loan classloans in Note (3) Loans Receivable) for which formal foreclosure proceedings were in process was $657,000.process.
| |
(6) | Goodwill and Other Intangible Assets |
(6)Goodwill and Other Intangible Assets
(a) Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in the following mergers: Premier Commercial Bancorp on July 2, 2018; Puget Sound Bancorp on January 16, 2018; Washington Banking MergerCompany on May 1, 2014, and the acquisitions of2014; Valley Community Bancshares on July 15, 2013,2013; Western Washington Bancorp in 2006 and North Pacific Bank in 1998. The Company’s goodwill is assigned to the Bank and is evaluated for impairment at the Bank level (reporting unit).
There were no additions to goodwill during the three and nine months ended September 30, 20172020 and 2016.2019.
The Company performed its annual goodwill impairment test during the fourth quarter of 2019 and determined based on its Step 1 analysis that the fair value of the reporting unit exceeded the carrying value, such that the Company's goodwill was 0t considered impaired. Due to the deteriorating financial market and economic conditions as a result of the COVID-19 pandemic, the Company determined a triggering event occurred during the quarter ended June 30, 2020 and consequently performed a quantitative assessment of goodwill as of May 31, 2020. Management estimated the fair value of the reporting unit by weighting results from the market approach and the income approach. Significant assumptions inherent in the valuation methodologies for goodwill were employed and included, but were not limited to, prospective financial information, growth rates, terminal value, discount rates, and comparable multiples from publicly traded companies in our industry. Based on this quantitative test, management determined that the fair value of the reporting unit more likely than not exceeded the carrying value.
At September 30, 2017,2020, the Company’s step-one analysis concluded that the reporting unit’s fair value was greater thanCompany completed its carrying value and therefore no goodwill impairment charges were required, or recorded, for the three and nine months ended September 30, 2017. Similarly, no goodwill impairment charges were required, or recorded, for the three and nine months ended September 30, 2016. Even though there was no goodwill impairment at September 30, 2017, adverse events may impact the recoverabilityqualitative assessment of goodwill and concluded that it is more likely than not that the fair value of the reporting unit exceeded the carrying value. Changes in the economic environment, operations of the reporting unit or other adverse events could result in a future impairment chargecharges which could have a material adverse impact on the Company’s operating results.
(b) Other Intangible Assets
The otherOther intangible assets represent the core deposit intangible ("CDI")intangibles acquired in business combinations. The useful life of the CDI related to the Washington Banking Merger, the acquisitions of Valley, NCB and Cowlitz werecore deposit intangible was estimated to be ten ten, fiveyears for the acquisitions of Premier Commercial Bancorp, Puget Sound Bancorp, Washington Banking Company, and nine years, respectively.Valley Community Bancshares.
The following table presents the change in the other intangible assets for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (In thousands) |
| Balance at the beginning of the period | $ | 14,807 | | | $ | 18,563 | | | $ | 16,613 | | | $ | 20,614 | |
| | | | | | | |
| Amortization | (860) | | | (975) | | | (2,666) | | | (3,026) | |
| Balance at the end of the period | $ | 13,947 | | | $ | 17,588 | | | $ | 13,947 | | | $ | 17,588 | |
(7)Junior Subordinated Debentures
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| | | (In thousands) |
| Balance at the beginning of the period | | $ | 6,727 |
| | $ | 8,091 |
| | $ | 7,374 |
| | $ | 8,789 |
|
| Less: Amortization | | 319 |
| | 359 |
| | 966 |
| | 1,057 |
|
| Balance at the end of the period | | $ | 6,408 |
| | $ | 7,732 |
| | $ | 6,408 |
| | $ | 7,732 |
|
(a) Federal Home Loan Bank AdvancesAs part of the acquisition of Washington Banking Company on May 1, 2014, the Company assumed trust preferred securities and junior subordinated debentures with a total fair value of $18.9 million at the merger date. At September 30, 2020 and December 31, 2019, the balance of the junior subordinated debentures, net of unaccreted discount, was $20.8 millionand $20.6 million, respectively.
The Federal Home Loan Bank ("FHLB")adjustable rate of Des Moinesthe trust preferred securities at September 30, 2020 was 1.79%. The following table presents the weighted average rate of the junior subordinated debentures for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
Weighted average rate (1) | 3.75 | % | | 6.43 | % | | 4.51 | % | | 6.72 | % |
(1)The weighted average rate includes the accretion of the discount established at the merger date which is amortized over the life of the trust preferred securities.
(8)Securities Sold Under Agreement to Repurchase
The Company utilizes securities sold under agreement to repurchase with one day maturities secured by pledged investment securities available for sale as a supplement to funding sources. For additional information on the total value of investment securities pledged for securities sold under agreement to repurchase see Note (2) Investment Securities.
The following table presents the Company's securities sold under agreement to repurchase obligations by class of collateral pledged at the dates indicated:
| | | | | | | | | | | |
| September 30,
2020 | | December 31,
2019 |
| (In thousands) |
| | | |
| | | |
| Residential CMO and MBS | $ | 3,844 | | | $ | 8,452 | |
| Commercial CMO and MBS | 25,199 | | | 11,717 | |
| Securities sold under agreement to repurchase | $ | 29,043 | | | $ | 20,169 | |
(9)Other Borrowings
(a) FHLB
The FHLB functions as a member-owned cooperative providing credit for member financial institutions. Advances are made pursuant to several different programs. Each credit program
has its own interest rate and range of maturities. Limitations on the amount of advances are based on a percentage of the Bank's assets or on the FHLB’s assessment of the institution’s creditworthiness. At September 30, 2017,2020, the Bank maintained a credit facility with the FHLB with available borrowing capacity of Des Moines for $662.4 million$891.7 million. At September 30, 2020 and December 31, 2019, the Bank had short-term0 FHLB advances outstanding of $117.4 million with maturity dates within 30 days. At December 31, 2016 there were FHLB advances outstanding of $79.6 million.outstanding.
The following table sets forth the details of FHLB advances during the three and nine months ended September 30, 20172020 and 2016:2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (In thousands) |
| Average balance during the period | $ | 0 | | | $ | 3,755 | | | $ | 1,959 | | | $ | 15,909 | |
| Maximum month-end balance during the period | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 90,700 | |
| Weighted average rate during the period | 0 | % | | 1.16 | % | | 0.55 | % | | 2.56 | % |
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2017 | | 2016 | | 2017 | | 2016 |
| | (Dollars in thousands) |
| Average balance during the period | $ | 111,293 |
| | $ | 5,618 |
| | $ | 106,553 |
| | $ | 11,608 |
|
| Maximum month-end balance during the period | $ | 126,200 |
| | $ | 17,700 |
| | $ | 137,450 |
| | $ | 57,300 |
|
| Weighted average rate during the period | 1.53 | % | | 0.57 | % | | 1.09 | % | | 0.54 | % |
Advances from the FHLB are collateralized by a blanket pledge on FHLB stock owned by the Bank, deposits at the FHLB, certain commercial real estate and one-to-four single family residential loans, or other assets, principally investment securities which are obligations of or guaranteed by the United States or other assets. In accordance with the pledge agreement, the Company must maintain unencumbered collateral in an amount equal to varying percentages ranging from 100% to 160% of outstanding advances depending on the type of collateral.
(b) Federal Funds Purchased
The Bank maintains advance lines with Wells Fargo Bank, US Bank, The Independent Bankers Bank, and Pacific Coast Bankers’ Bank and JP Morgan Chase to purchase federal funds of up to $90.0$215.0 million as of September 30, 2017.2020. The lines generally mature annually or are reviewed annually. As of September 30, 20172020 and December 31, 2016,2019, there were no0 federal funds purchased.
(c) Credit facilitiesFacilities
The Bank maintains a credit facility with the Federal Reserve Bank with available borrowing capacity of San Francisco for $50.6$55.0 million as of September 30, 2017, of which there2020. There were no0 borrowings outstanding as of September 30, 2017 or2020 and December 31, 2016.2019. Any advances on the credit facility would have to be first secured by the Bank's investment securities or loans receivable.
(d) PPPLF Facility
| |
(8) | Junior Subordinated Debentures |
As partThe Federal Reserve established the PPPLF under Section 13(3) of the Washington Banking Merger,Federal Reserve Act to bolster the Company assumed trust preferred securities and junior subordinated debentures with a total fair value of $18.9 million at the May 1, 2014 merger date.
Washington Banking Master Trust, a Delaware statutory business trust, was a wholly-owned subsidiary of Washington Banking created for the exclusive purposes of issuing and selling capital securities and utilizing sale proceeds to acquire junior subordinated debt issued by Washington Banking. During 2007, the Trust issued $25.0 million of trust preferred securities with a 30-year maturity, callable after the fifth year by Washington Banking. The trust preferred securities have a quarterly adjustable rate based upon the three-month London Interbank Offered Rate (“LIBOR”) plus 1.56%. On the Washington Banking Merger date of May 1, 2014, the Company acquired the Trust, which retained the Washington Banking Master Trust name, and assumed the performance and observanceeffectiveness of the covenants underSBA's PPP. Under the indenture relatedPPPLF, the Bank may pledge its PPP loans as collateral at face value to the trust preferred securities.
The adjustable rateobtain Federal Reserve Bank non-recourse loans. PPPLF advances may be obtained until December 31, 2020. As of the trust preferred securities at September 30, 20172020, although the Bank was 2.89%. The weighted average rate ofapproved to utilize the junior subordinated debentures was 5.20% and 5.05% forPPPLF, the three and nine months ended September 30, 2017, respectively, and 4.49% and 4.43% for the three and nine months ended September 30, 2016, respectively. The weighted average rate includes the accretion of the discount established at the merger date which is amortized over the life of the trust preferred securities.Bank had 0t participated in it.
The junior subordinated debentures are the sole assets of the Trust and payments under the junior subordinated debentures are the sole revenues of the Trust. At September 30, 2017 and December 31, 2016, the balance of the junior subordinated debentures, net of unaccreted discount, was $19.9 million and $19.7 million, respectively. All of the common securities of the Trust are owned by the Company. Heritage has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements.
(10)Derivative Financial Instruments
The Company utilizes repurchase agreements with one-day maturities as a supplement to funding sources. Repurchase agreements are secured by pledged investment securities available for sale. Under the repurchase agreements, the Company is required to maintain an aggregate market value of securities pledged greater than the balance of the repurchase agreements. The Company is required to pledge additional securities to cover any declines below the balance of the repurchase agreements. For additional information on the total value of investment securities pledged for repurchase agreements see Note (2) Investment Securities.
The following table presents the Company's repurchase agreement obligations by class of collateral pledged:
|
| | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | (In thousands) |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | — |
| | $ | 2,944 |
|
Mortgage-backed securities and collateralized mortgage obligations(1): | | | |
| Residential | 12,336 |
| | 5,191 |
|
| Commercial | 16,332 |
| | 13,969 |
|
| Total repurchase agreements | $ | 28,668 |
| | $ | 22,104 |
|
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
| |
(10) | Derivative Financial Instruments |
The Company has entered into certain interest rate swap contracts that are not designated as hedging instruments. The purpose of these derivative contracts is primarily to provide commercial business loan customersfollowing table presents the ability to convert their loans from variable to fixed interest rates. Upon the origination of a derivative contract with a customer, the Company simultaneously enters into an offsetting derivative contract with a third party in order to offset its exposure on the variable and fixed rate components of the customer agreement. The Company recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third party, which is recorded in interest rate swap fees on the Condensed Consolidated Statements of Income. Because the Company acts only as an intermediary for its customer, subsequent changes in the fair value of the underlying derivative contracts offset each other and do not significantly impact the Company’s results of operations.
The notional amounts and estimated fair values of interest rate derivative contracts outstanding at September 30, 20172020 and December 31, 2016 are presented in the following table.2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 | | December 31, 2019 |
| Notional Amounts | | Estimated Fair Value | | Notional Amounts | | Estimated Fair Value |
| (In thousands) |
| Non-hedging interest rate derivatives | | | | | | | |
Interest rate swap asset (1) | $ | 296,709 | | | $ | 30,024 | | | $ | 221,436 | | | $ | 8,318 | |
Interest rate swap liability (1) | 296,709 | | | (30,460) | | | 221,436 | | | (8,318) | |
|
| | | | | | | | | | | | | | | | |
| | | September 30, 2017 | | December 31, 2016 |
| | | Notional Amounts | | Estimated Fair Value | | Notional Amounts | | Estimated Fair Value |
| | | (In thousands) |
| Non-hedging interest rate derivatives | | | | | | | | |
Interest rate swaps with customer (1) | | $ | 134,295 |
| | $ | 74 |
| | $ | 102,709 |
| | $ | (1,099 | ) |
Interest rate swap with third party (1) | | 134,295 |
| | (74 | ) | | 102,709 |
| | 1,099 |
|
(1) The estimated fair value of derivatives with customers was $30.0 million and $8.1 million as of September 30, 2020 and December 31, 2019, respectively. The estimated fair value of derivatives with third parties was $(30.5) million and $(8.1) million as of September 30, 2020 and December 31, 2019, respectively.
The gains and losses due to changes in fair values on the derivativeCompany's interest rate derivatives, including credit valuation adjustments to appropriately reflect nonperformance risk in the fair value measurement, are included in prepaid and other assetsOther income on the Condensed Consolidated Statements of Financial Condition was $3.3 millionIncome. Generally, the gains and $2.8 millionlosses of the interest rate derivatives offset due to the back-to-back nature of the contracts. However, as of September 30, 20172020, the settlement values of the Bank's net derivative assets decreased due to the recognition of a credit valuation adjustment of $436,000 during both the three and nine months ended September 30, 2020. A credit valuation adjustment was not recorded on the Bank's net derivative assets as of December 31, 2016, respectively. The estimated fair value2019. Various factors impact changes in the credit valuation adjustments over time, including changes in the risk ratings of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative included in accrued expenses and other liabilities on the Condensed Consolidated Statements of Financial Condition was $3.3 million and $2.8 million as of September 30, 2017 and December 31, 2016, respectively.instruments.
35(11)Stockholders’ Equity
(a) Earnings Per Common Share
The following table illustrates the reconciliation of weighted average shares used for earnings per common share computations for the three and nine months ended September 30, 20172020 and 2016:2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (In thousands, except shares) |
| Net income: | | | | | | | |
| Net income | $ | 16,636 | | | $ | 17,895 | | | $ | 22,688 | | | $ | 50,431 | |
Dividends and undistributed earnings allocated to participating securities (1) | 0 | | | (10) | | | (5) | | | (48) | |
| Net income allocated to common shareholders | $ | 16,636 | | | $ | 17,885 | | | $ | 22,683 | | | $ | 50,383 | |
| Basic: | | | | | | | |
| Weighted average common shares outstanding | 35,909,148 | | | 36,764,810 | | | 36,054,906 | | | 36,846,884 | |
| Restricted stock awards | (303) | | | (21,948) | | | (5,537) | | | (34,336) | |
| Total basic weighted average common shares outstanding | 35,908,845 | | | 36,742,862 | | | 36,049,369 | | | 36,812,548 | |
| Diluted: | | | | | | | |
| Basic weighted average common shares outstanding | 35,908,845 | | | 36,742,862 | | | 36,049,369 | | | 36,812,548 | |
Effect of potentially dilutive common shares (2) | 79,889 | | | 133,686 | | | 144,246 | | | 160,476 | |
| Total diluted weighted average common shares outstanding | 35,988,734 | | | 36,876,548 | | | 36,193,615 | | | 36,973,024 | |
(1)Represents dividends paid and undistributed earnings allocated to unvested restricted stock awards.
(2)Represents the effect of the assumed exercise of stock options and vesting of restricted stock awards and units.
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2017 | | 2016 | | 2017 | | 2016 |
| | (Dollars in thousands) |
| Net income: | | | | | | | |
| Net income | $ | 10,624 |
| | $ | 11,039 |
| | $ | 31,768 |
| | $ | 29,025 |
|
| Less: Dividends and undistributed earnings allocated to participating securities | (64 | ) | | (102 | ) | | (228 | ) | | (280 | ) |
| Net income allocated to common shareholders | $ | 10,560 |
| | $ | 10,937 |
| | $ | 31,540 |
| | $ | 28,745 |
|
| Basic: | | | | | | | |
| Weighted average common shares outstanding | 29,929,721 |
| | 29,962,270 |
| | 29,940,276 |
| | 29,968,034 |
|
| Less: Restricted stock awards | (146,425 | ) | | (277,495 | ) | | (192,186 | ) | | (292,832 | ) |
| Total basic weighted average common shares outstanding | 29,783,296 |
| | 29,684,775 |
| | 29,748,090 |
| | 29,675,202 |
|
| Diluted: | | | | | | | |
| Basic weighted average common shares outstanding | 29,783,296 |
| | 29,684,775 |
| | 29,748,090 |
| | 29,675,202 |
|
Effect of potentially dilutive common shares (1) | 107,414 |
| | 11,031 |
| | 86,004 |
| | 12,543 |
|
| Total diluted weighted average common shares outstanding | 29,890,710 |
| | 29,695,806 |
| | 29,834,094 |
| | 29,687,745 |
|
| |
(1) | Represents the effect of the assumed exercise of stock options and vesting of restricted stock units. |
Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. Anti-dilution occurs when the exercise price of a stock option or the unrecognized compensation cost per share of a restricted stock award exceeds the market price of the Company’s stock. For the three and nine months ended September 30, 2017 and the three months ended September 30, 2016,2020, there were no222,818 and 140,217 anti-dilutive shares outstanding, related to options to acquire common stock.respectively. For the three and nine months ended September 30, 2016,2019, there were 108,501 and 70,372 anti-dilutive shares outstanding, related to options to acquire common stock totaled 580 as the assumed proceeds from exercise price, tax benefits and future compensation were in excess of the market value.respectively.
(b) Dividends
The timing and amount of cash dividends paid on the Company's common stock depends on the Company’s earnings, capital requirements, financial condition and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income.
The following table summarizes the dividend activity for the nine months ended September 30, 20172020 and calendar year 2016.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Declared | | Cash Dividend per Share | | Record Date | | Paid Date | | |
| | | | | | | |
Declared | | Cash Dividend per Share | | Record Date | | Paid Date | |
January 27, 2016 | | $0.11 | | February 10, 2016 | | February 24, 2016 | | |
April 20, 2016 | | $0.12 | | May 5, 2016 | | May 19, 2016 | | |
July 20, 2016 | | $0.12 | | August 4, 2016 | | August 18, 2016 | | |
October 26, 2016 | | $0.12 | | November 8, 2016 | | November 22, 2016 | | |
October 26, 2016January 23, 2019 | | $0.250.18 | | November 8, 2016February 7, 2019 | | November 22, 2016February 21, 2019 | * | |
January 25, 2017April 24, 2019 | | $0.120.18 | | February 9, 2017May 8, 2019 | | February 23, 2017May 22, 2019 | | |
April 25, 2017July 24, 2019 | | $0.130.19 | | May 10, 2017August 8, 2019 | | May 24, 2017August 22, 2019 | | |
| October 23, 2019 | | $0.19 | | November 7, 2019 | | November 21, 2019 | | |
| October 23, 2019 | | $0.10 | | November 7, 2019 | | November 21, 2019 | | * |
| January 22, 2020 | | $0.20 | | February 6, 2020 | | February 20, 2020 | | |
| April 29, 2020 | | $0.20 | | May 13, 2020 | | May 27, 2020 | | |
July 25, 201722, 2020 | | $0.130.20 | | August 10, 20175, 2020 | | August 24, 201719, 2020 | | |
* Denotes a special dividend.
The FDIC and the Washington State Department of Financial Institutions, Division of Banks have the authority under their supervisory powers to prohibit the payment of dividends by the Bank to the Company. Additionally, current guidance from the Board of Governors of the Federal Reserve System ("Federal Reserve Board") provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve Board and the FDIC.
(c) Stock Repurchase Program
The Company has had various stock repurchase programs since March 1999. On October 23, 2014,2014. the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,000 shares, under the eleventh stock repurchase plan. As of March 2020, all shares have been repurchased under this plan. On March 12, 2020 the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock repurchase plan. The number, timing and price of shares repurchased will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.
The following table provides totalNaN shares were repurchased shares and average share prices under the Company's stock repurchase plans during the three months ended September 30, 2020 as the Company has suspended repurchases in response to the COVID-19 pandemic.
During the nine months ended September 30, 2020, the Company repurchased 639,922 shares under the eleventh stock repurchase plan for the periods indicated:
|
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, | | |
| | 2017 | | 2016 | | 2017 | | 2016 | | Plan Total (1) |
| Eleventh Plan | | | | | | | | | |
| Repurchased shares | — |
| | 38,000 |
| | — |
| | 138,000 |
| | 579,996 |
|
| Stock repurchase average share price | $ | — |
| | $ | 17.46 |
| | $ | — |
| | $ | 17.16 |
| | $ | 16.76 |
|
(1) Represents shares repurchased andat a weighted average price per share paid duringof $23.95 and repurchased 155,778 shares at a weighted average share price of $20.34 under the durationtwelfth stock repurchase plan, which is a total of 795,700 shares under both plans at a weighted average share price of $23.25.
During the plan.three and nine months ended September 30, 2019, the Company repurchased 264,712 and 292,712 shares, respectively, under the eleventh stock repurchase plan at a weighted average price per share of $26.23 and $26.50, respectively.
In addition to the stock repurchases disclosed in the table above,under a stock repurchase plan, the Company repurchasedrepurchases shares to pay withholding taxes on the vesting of restricted stock. During the threestock awards and nine months ended September 30, 2017, the Companyunits. The following table provides total shares repurchased 344 and 27,711 shares of common stock at an average price per share of $25.80 and $24.61 to pay withholding taxes on the vesting of restricted stock that vested during the respective periods. During the three and nine months ended September 30, 2016, the Company repurchased 5,276 and 29,206 shares of common stock at an average price per share of $18.64 and $17.77 to pay withholding taxes on the vesting of restricted stock that vested during the respective periods.periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| Repurchased shares to pay withholding taxes | 378 | | | 405 | | | 28,306 | | | 28,434 | |
| Stock repurchase to pay withholding taxes average share price | $ | 19.84 | | | $ | 27.67 | | | $ | 21.54 | | | $ | 30.83 | |
| |
(12) | Accumulated Other Comprehensive Income |
The changes in accumulated other comprehensive income (loss) (“AOCI”) by component, during the three and nine months ended September 30, 2017 and 2016 are as follows:
|
| | | | | | | | |
| | | Three Months Ended September 30, 2017 (1) | | Nine Months Ended September 30, 2017 (1) |
| | | (In thousands) |
| Balance of AOCI at the beginning of period | | $ | 1,557 |
| | $ | (2,606 | ) |
| Other comprehensive income before reclassification | | 289 |
| | 4,528 |
|
| Amounts reclassified from AOCI for gain on sale of investment securities included in net income | | (28 | ) | | (104 | ) |
| Net current period other comprehensive income | | 261 |
| | 4,424 |
|
| Balance of AOCI at the end of period | | $ | 1,818 |
| | $ | 1,818 |
|
(1) All amounts are due to the changes in fair value of available for sale securities and are net of tax.
|
| | | | | | | | |
| | | Three Months Ended September 30, 2016 (1) | | Nine Months Ended September 30, 2016 (1) |
| | | (In thousands) |
| Balance of AOCI at the beginning of period | | $ | 12,343 |
| | $ | 2,559 |
|
| Other comprehensive income before reclassification | | (1,055 | ) | | 9,223 |
|
| Amounts reclassified from AOCI for gain on sale of investment securities available for sale included in net income | | (224 | ) | | (718 | ) |
| Net current period other comprehensive income | | (1,279 | ) | | 8,505 |
|
| Balance of AOCI at the end of period | | $ | 11,064 |
| | $ | 11,064 |
|
(1) All amounts are due to the changes in fair value of available for sale securities and are net of tax.
| |
(13) | Stock-Based Compensation |
Stock options generally vest ratably over three years and expire five years after they become exercisable or vest ratably over four years and expire ten years from date of grant. Restricted stock awards issued generally have a four-year cliff vesting or four-year ratable vesting schedule. Restricted stock units vest ratably over three years. Performance restricted stock units issued generally have a three-year cliff vesting schedule. Additionally, performance restricted stock unit grants may be subject to performance-based vesting as well as other approved vesting conditions. The Company issues new shares of common stock to satisfy share option exercises, restricted stock awards and restricted stock units.
On July 24, 2014, the Company's shareholders approved the Heritage Financial Corporation 2014 Omnibus Equity Plan (the "Plan") that provides for the issuance of 1,500,000 shares of the Company's common stock in the form of stock options, stock appreciation rights, stock awards (which includes restricted stock units, restricted stock, performance units, performance shares or bonus shares) and cash incentive awards.
Under the Company's stock-based compensation plans, 1,073,146 shares remain available for future issuance as of September 30, 2017.
(a) Stock Option Awards
For the three and nine months ended September 30, 2017 and 2016, the Company did not recognize any compensation expense or related tax benefit related to stock options as all of the compensation expense related to the outstanding stock options had been previously recognized. The intrinsic value and cash proceeds from options exercised during the nine months ended September 30, 2017 was $156,000 and $159,000, respectively. The intrinsic value and cash proceeds from options exercised during the nine months ended September 30, 2016 was $99,000 and $401,000, respectively.
The following table summarizes the stock option activity for the nine months ended September 30, 2017 and 2016:
|
| | | | | | | | | | | | |
| | Shares | | Weighted-Average Exercise Price | | Weighted-Average Remaining Contractual Term (In years) | | Aggregate Intrinsic Value (In thousands) |
| Outstanding at December 31, 2015 | 79,408 |
| | $ | 14.19 |
| | | | |
| Exercised | (27,867 | ) | | 14.37 |
| | | | |
| Forfeited or expired | (4,200 | ) | | 16.80 |
| | | | |
| Outstanding at September 30, 2016 | 47,341 |
| | $ | 13.85 |
| | 2.80 | | $ | 194 |
|
| | | | | | | | |
| Outstanding at December 31, 2016 | 37,495 |
| | $ | 13.77 |
| | | | |
| Exercised | (12,304 | ) | | 12.92 |
| | | | |
| Forfeited or expired | (1,308 | ) | | 13.53 |
| | | | |
| Outstanding, vested and expected to vest and exercisable at September 30, 2017 | 23,883 |
| | $ | 14.23 |
| | 2.45 | | $ | 365 |
|
(b) Restricted Stock Awards
For the three and nine months ended September 30, 2017, the Company recognized compensation expense related to restricted stock awards of $292,000 and $1.1 million, respectively, and a related tax benefit of $102,000 and $384,000, respectively. For the three and nine months ended September 30, 2016, the Company recognized compensation expense related to restricted stock awards of $494,000 and $1.4 million, respectively, and a related tax benefit of $173,000 and $479,000, respectively. As of September 30, 2017, the total unrecognized compensation expense related to non-vested restricted stock awards was $1.8 million and the related weighted average period over which the compensation expense is expected to be recognized is approximately 1.78 years. The vesting date fair value of the restricted stock awards that vested during the nine months ended September 30, 2017 and 2016 was $2.7 million and $2.0 million, respectively.
The following table summarizes the restricted stock award activity for the nine months ended September 30, 2017 and 2016:
|
| | | | | | |
| | Shares | | Weighted-Average Grant Date Fair Value |
| Nonvested at December 31, 2015 | 264,521 |
| | $ | 15.92 |
|
| Granted | 119,939 |
| | 17.53 |
|
| Vested | (111,357 | ) | | 15.62 |
|
| Forfeited | (9,216 | ) | | 16.57 |
|
| Nonvested at September 30, 2016 | 263,887 |
| | $ | 16.76 |
|
| | | | |
| Nonvested at December 31, 2016 | 261,296 |
| | $ | 16.80 |
|
| Granted | — |
| | — |
|
| Vested | (107,202 | ) | | 16.49 |
|
| Forfeited | (10,418 | ) | | 16.80 |
|
| Nonvested at September 30, 2017 | 143,676 |
| | $ | 17.02 |
|
(c) Restricted Stock Units
For the three and nine months ended September 30, 2017, the Company recognized compensation expense related to restricted stock units of $236,000 and $472,000, respectively, and a related tax benefit of $83,000 and $165,000, respectively. As of September 30, 2017, the total unrecognized compensation expense related to non-vested restricted stock units was $1.8 million and the related weighted average period over which the compensation expense is expected to be recognized is approximately 2.26 years.
The following table summarizes the restricted stock unit activity for the nine months ended September 30, 2017:
|
| | | | | | |
| | Shares | | Weighted-Average Grant Date Fair Value |
| Nonvested at December 31, 2016 | — |
| | $ | — |
|
| Granted | 92,019 |
| | 25.29 |
|
| Vested | — |
| | — |
|
| Forfeited | (1,812 | ) | | 25.35 |
|
| Nonvested at September 30, 2017 | 90,207 |
| | $ | 25.29 |
|
The following table summarizes the assumptions used in the Monte Carlo model for restricted stock unit grants with market-based conditions during the nine months ended September 30, 2017:
|
| | | | | | | | | | | | | | | |
| Shares | | Expected Term in Years | | Weighted-Average Risk Free Interest Rate | | Expected Volatility | | Expected Dividend Yield | | Weighted-Average Fair Value |
| 6,089 | | 2.85 | | 1.40 | % | | 21.8 | % | | — | % | | $ | 24.39 |
|
| |
(14) | Fair Value Measurements |
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual funds that allow the Company to sell its ownership interest back to the fund at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities, or funds.
Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or valuations using methodologies with observable inputs.
Level 3: Valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models, discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.
(a) Recurring and Nonrecurring Basis
The Company used the following methods and significant assumptions to measure the fair value of certain assets on a recurring and nonrecurring basis:
Investment Securities Available for Sale:
The fair values of all investment securities are based upon the assumptions that market participants would use in pricing the security. If available, fair values of investment securities are determined by quoted market prices (Level 1). For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using observable and unobservable inputs such as discounted cash flows or other market indicators (Level 3). Security valuations are obtained from third party pricing services for comparable assets or liabilities.
ImpairedCollateral-Dependent Loans:
At the time a loan is considered impaired, its impairment is measured based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the observable market price, or the fair market valueCollateral-dependent loans are identified as part of the collateral if the loan is collateral-dependent. Impaired loans for which impairment is measured using the discounted cash flow approach are not considered to be measured at fair value because the loan’s effective interest rate is generally not a fair value input, and for the purposes of fair value disclosures, the fair value of these loans are measured commensurate with non-impaired loans. If the Company utilizes the fair market valuecalculation of the collateral method, theACL on loans. The fair value used to measure impairmentcredit loss for this type of loan is commonly based on recent real estate appraisals.appraisals which are generally obtained at least every 18 months or earlier if there are changes to risk characteristics of the underlying loan. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value based on the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the clientcustomer and client’scustomer’s business (Level 3). ImpairedIndividually evaluated loans are evaluated for credit loss on a quarterly basis for additional impairment and the ACL on loans is adjusted accordingly.as required based in the evaluation.
Other Real Estate Owned:
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair
value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals.appraisals which are generally obtained at least every 18 months or earlier. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in Level 3 classification of the inputs for determining fair value.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose
qualifications and licenses have been reviewed and verified by the Company. Once received, the Company reviews the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On a quarterly basis, the Company compares the actual selling price of collateral that has been liquidated to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.
Derivative Financial Instruments:
The Company obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of the measurement date (Level 2), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3). Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as borrower risk ratings, to evaluate the likelihood of default by itself and its counterparties. As of September 30, 2020, the Bank assessed the significance of the impact of the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined that the credit valuation adjustment was not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy. The Bank did not recognize a credit valuation adjustment in the valuation of its interest rate swap derivatives as of December 31, 2019; therefore, the interest rate swap derivatives are also classified in Level 2 of the fair value hierarchy for the comparative period end.
The following tables summarize the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 20172020 and December 31, 2016.2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 |
| Total | | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. government and agency securities | $ | 51,893 | | | $ | 0 | | | $ | 51,893 | | | $ | 0 | |
| Municipal securities | 205,310 | | | 0 | | | 205,310 | | | 0 | |
| | | | | | | |
| Residential CMO and MBS | 222,581 | | | 0 | | | 222,581 | | | 0 | |
| Commercial CMO and MBS | 304,682 | | | 0 | | | 304,682 | | | 0 | |
| | | | | | | |
| Corporate obligations | 20,171 | | | 0 | | | 20,171 | | | 0 | |
| Other asset-backed securities | 29,855 | | | 0 | | | 29,855 | | | 0 | |
| Total investment securities available for sale | 834,492 | | | 0 | | | 834,492 | | | 0 | |
| Equity security | 111 | | | 111 | | | 0 | | | 0 | |
| Derivative assets - interest rate swaps | 30,024 | | | 0 | | | 30,024 | | | 0 | |
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 30,460 | | | $ | 0 | | | $ | 30,460 | | | $ | 0 | |
|
| | | | | | | | | | | | | | | |
| | September 30, 2017 |
| | Total | | Level 1 | | Level 2 | | Level 3 |
| | (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 9,403 |
| | $ | — |
| | $ | 9,403 |
| | $ | — |
|
| Municipal securities | 252,806 |
| | — |
| | 252,806 |
| | — |
|
| Mortgage-backed securities and collateralized mortgage obligations: | | | | | | | |
| Residential | 274,361 |
| | — |
| | 274,361 |
| | — |
|
| Commercial | 213,283 |
| | — |
| | 213,283 |
| | — |
|
| Collateralized loan obligations | 6,022 |
| | — |
| | 6,022 |
| | — |
|
| Corporate obligations | 15,830 |
| | — |
| | 15,830 |
| | — |
|
| Other securities | 28,355 |
| | 150 |
| | 28,205 |
| | — |
|
| Total investment securities available for sale | 800,060 |
| | 150 |
| | 799,910 |
| | — |
|
| Derivative assets - interest rate swaps | 3,308 |
| | — |
| | 3,308 |
| | — |
|
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 3,308 |
| | $ | — |
| | $ | 3,308 |
| | $ | — |
|
|
| | | | | | | | | | | | | | | |
| | December 31, 2016 |
| | Total | | Level 1 | | Level 2 | | Level 3 |
| | (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 1,569 |
| | $ | — |
| | $ | 1,569 |
| | $ | — |
|
| Municipal securities | 237,256 |
| | — |
| | 237,256 |
| | — |
|
| Mortgage-backed securities and collateralized mortgage obligations: | | | | | | | |
| Residential | 309,176 |
| | — |
| | 309,176 |
| | — |
|
| Commercial | 208,318 |
| | — |
| | 208,318 |
| | — |
|
| Collateralized loan obligations | 10,478 |
| | — |
| | 10,478 |
| | — |
|
| Corporate obligations | 16,706 |
| | — |
| | 16,706 |
| | — |
|
| Other securities | 11,142 |
| | 123 |
| | 11,019 |
| | — |
|
| Total investment securities available for sale | 794,645 |
| | 123 |
| | 794,522 |
| | — |
|
| Derivative assets - interest rate swaps | 2,804 |
| | — |
| | 2,804 |
| | — |
|
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 2,804 |
| | $ | — |
| | $ | 2,804 |
| | $ | — |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| Total | | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. government and agency securities | $ | 105,223 | | | $ | 0 | | | $ | 105,223 | | | $ | 0 | |
| Municipal securities | 133,014 | | | 0 | | | 133,014 | | | 0 | |
| | | | | | | |
| Residential CMO and MBS | 339,608 | | | 0 | | | 339,608 | | | 0 | |
| Commercial CMO and MBS | 327,095 | | | 0 | | | 327,095 | | | 0 | |
| | | | | | | |
| Corporate obligations | 24,194 | | | 0 | | | 24,194 | | | 0 | |
| Other asset-backed securities | 23,178 | | | 0 | | | 23,178 | | | 0 | |
| Total investment securities available for sale | 952,312 | | | 0 | | | 952,312 | | | 0 | |
| Equity Security | 148 | | | 148 | | | 0 | | | 0 | |
| Derivative assets - interest rate swaps | 8,318 | | | 0 | | | 8,318 | | | 0 | |
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 8,318 | | | $ | 0 | | | $ | 8,318 | | | $ | 0 | |
There were no transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2017 and 2016.
Nonrecurring Basis
The Company may be required to measure certain financial assets and liabilities at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following tables below represent assets measured at fair value on a nonrecurring basis at September 30, 20172020 and December 31, 20162019 and the net losses (gains) recorded in earnings during the three and nine months ended September 30, 20172020 and 2016.2019:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Fair Value at September 30, 2020 | | Net Losses
Recorded in
Earnings
During the
Three Months Ended September 30, 2020 | | Net Losses
Recorded in
Earnings
During the
Nine Months Ended September 30, 2020 |
| Basis(1) | | Total | | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Collateral-dependent loans: | | | | | | | | | | | | | |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 42 | | | $ | 27 | | | $ | 0 | | | $ | 0 | | | $ | 27 | | | $ | 0 | | | $ | 10 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Total assets measured at fair value on a nonrecurring basis | $ | 42 | | | $ | 27 | | | $ | 0 | | | $ | 0 | | | $ | 27 | | | $ | 0 | | | $ | 10 | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Basis(1) | | Fair Value at September 30, 2017 | | | | |
| | Total | | Level 1 | | Level 2 | | Level 3 | | Net Losses Recorded in Earnings During the Three Months Ended September 30, 2017 | | Net Losses (Gains) Recorded in Earnings During the Nine Months Ended September 30, 2017 |
| | (In thousands) |
| Impaired loans: | | | | | | | | | | | | | |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 172 |
| | $ | 163 |
| | $ | — |
| | $ | — |
| | $ | 163 |
| | $ | — |
| | $ | 7 |
|
| Owner-occupied commercial real estate | 182 |
| | 179 |
| | — |
| | — |
| | 179 |
| | — |
| | 8 |
|
| Total commercial business | 354 |
| | 342 |
| | — |
| | — |
| | 342 |
| | — |
| | 15 |
|
| Total assets measured at fair value on a nonrecurring basis | $ | 354 |
| | $ | 342 |
| | $ | — |
| | $ | — |
| | $ | 342 |
| | $ | — |
| | $ | 15 |
|
| |
(1)
| Basis represents the unpaid principal balance of impaired loans. |
(1)Basis represents the outstanding principal balance of impaired loans.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Basis(1) | | Fair Value at December 31, 2016 | | | | |
| | Total | | Level 1 | | Level 2 | | Level 3 | | Net Losses (Gains) Recorded in Earnings During the Three Months Ended September 30, 2016 | | Net Losses (Gains) Recorded in Earnings During the Nine Months Ended September 30, 2016 |
| | (In thousands) |
| Impaired loans: | | | | | | | | | | | | | |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 205 |
| | $ | 200 |
| | $ | — |
| | $ | — |
| | $ | 200 |
| | $ | 24 |
| | $ | 25 |
|
| Owner-occupied commercial real estate | 780 |
| | 603 |
| | — |
| | — |
| | 603 |
| | 23 |
| | (2 | ) |
| Total commercial business | 985 |
| | 803 |
| | — |
| | — |
| | 803 |
| | 47 |
| | 23 |
|
| Real estate construction and land development: | | | | | | | | | | | | | |
| One-to-four family residential | 828 |
| | 822 |
| | — |
| | — |
| | 822 |
| | (13 | ) | | (26 | ) |
| Total real estate construction and land development | 828 |
| | 822 |
| | — |
| | — |
| | 822 |
| | (13 | ) | | (26 | ) |
| Consumer | 16 |
| | 9 |
| | — |
| | — |
| | 9 |
| | — |
| | — |
|
| Total assets measured at fair value on a nonrecurring basis | $ | 1,829 |
| | $ | 1,634 |
| | $ | — |
| | $ | — |
| | $ | 1,634 |
| | $ | 34 |
| | $ | (3 | ) |
| |
(1)
| Basis represents the unpaid principal balance of impaired loans. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Fair Value at December 31, 2019 | | Net Losses
Recorded in
Earnings
During the Three Months Ended September 30, 2019 | | Net Losses
Recorded in
Earnings
During the Nine Months Ended September 30, 2019 |
| Basis(1) | | Total | | Level 1 | | Level 2 | | Level 3 | |
| (In thousands) |
| Impaired loans: | | | | | | | | | | | | | |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 4,111 | | | $ | 3,380 | | | $ | 0 | | | $ | 0 | | | $ | 3,380 | | | $ | 249 | | | $ | 249 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Total assets measured at fair value on a nonrecurring basis | $ | 4,111 | | | $ | 3,380 | | | $ | 0 | | | $ | 0 | | | $ | 3,380 | | | $ | 249 | | | $ | 249 | |
(1)Basis represents the outstanding principal balance of impaired loans.
The following table presentstables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 20172020 and December 31, 2016.2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 |
| Fair
Value | | Valuation
Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted
Average |
| (Dollars in thousands) |
| Collateral-dependent loans | $ | 27 | | | Market approach | | Adjustment for differences between the comparable sales | | N/A(1) |
|
| | | | | | | | | |
| | September 30, 2017 |
| | Fair Value | | Valuation Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted Average |
| | (Dollars in thousands) |
| Impaired loans | $ | 342 |
| | Market approach | | Adjustment for differences between the comparable sales | | (23.8%) - 23.0%; (2.8%) |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| Fair
Value | | Valuation
Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted
Average |
| (Dollars in thousands) |
| Impaired loans | $ | 3,380 | | | Market approach | | Adjustment for differences between the comparable sales | | 173.5% - (18.5%); 36.8% |
|
| | | | | | | | | |
| | December 31, 2016 |
| | Fair Value | | Valuation Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted Average |
| | (Dollars in thousands) |
| Impaired loans | $ | 1,634 |
| | Market approach | | Adjustment for differences between the comparable sales | | (23.8%) - 63.9%; 20.4% |
(b) Fair Value of Financial Instruments
Because broadlyBroadly traded markets do not exist for most of the Company’s financial instruments therefore the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.
The following tables below present the carrying value amount of the Company’s financial instruments and their
corresponding estimated fair values at the dates indicated.September 30, 2020 and December 31, 2019:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 |
| Carrying
Value | | Fair
Value | | Fair Value Measurements Using: |
| | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Financial Assets: | | | | | | | | | |
| Cash and cash equivalents | $ | 576,242 | | | $ | 576,242 | | | $ | 576,242 | | | $ | 0 | | | $ | 0 | |
| Investment securities available for sale | 834,492 | | | 834,492 | | | 0 | | | 834,492 | | | 0 | |
| Loans held for sale | 8,250 | | | 8,562 | | | 0 | | | 0 | | | 8,562 | |
| Loans receivable, net | 4,593,390 | | | 4,752,565 | | | 0 | | | 0 | | | 4,752,565 | |
| Accrued interest receivable | 18,888 | | | 18,888 | | | 9 | | | 3,316 | | | 15,563 | |
| Derivative assets - interest rate swaps | 30,024 | | | 30,024 | | | 0 | | | 30,024 | | | 0 | |
| Equity security | 111 | | | 111 | | | 111 | | | 0 | | | 0 | |
| Financial Liabilities: | | | | | | | | | |
| Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts | $ | 5,245,008 | | | $ | 5,245,008 | | | $ | 5,245,008 | | | $ | 0 | | | $ | 0 | |
| Certificate of deposit accounts | 444,040 | | | 447,017 | | | 0 | | | 447,017 | | | 0 | |
| | | | | | | | | |
| Securities sold under agreement to repurchase | 29,043 | | | 29,043 | | | 29,043 | | | 0 | | | 0 | |
| Junior subordinated debentures | 20,814 | | | 18,500 | | | 0 | | | 0 | | | 18,500 | |
| Accrued interest payable | 109 | | | 109 | | | 44 | | | 45 | | | 20 | |
| Derivative liabilities - interest rate swaps | 30,460 | | | 30,460 | | | 0 | | | 30,460 | | | 0 | |
|
| | | | | | | | | | | | | | | | | | | |
| | September 30, 2017 |
| | Carrying Value |
| Fair Value |
| Fair Value Measurements Using: |
| |
| Level 1 |
| Level 2 |
| Level 3 |
| | (In thousands) |
| Financial Assets: | | | | | | | | | |
| Cash and cash equivalents | $ | 111,258 |
| | $ | 111,258 |
| | $ | 111,258 |
| | $ | — |
| | $ | — |
|
| Investment securities available for sale | 800,060 |
| | 800,060 |
| | 150 |
| | 799,910 |
| | — |
|
| Federal Home Loan Bank stock | 9,343 |
| | N/A |
| | N/A |
| | N/A |
| | N/A |
|
| Loans held for sale | 5,368 |
| | 5,553 |
| | — |
| | 5,553 |
| | — |
|
| Total loans receivable, net | 2,766,113 |
| | 2,772,338 |
| | — |
| | — |
| | 2,772,338 |
|
| Accrued interest receivable | 12,295 |
| | 12,295 |
| | 3 |
| | 3,770 |
| | 8,522 |
|
| Derivative assets - interest rate swaps | 3,308 |
| | 3,308 |
| | — |
|
| 3,308 |
| | — |
|
| Financial Liabilities: | | | | | | | | | |
| Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts | 2,925,637 |
| | 2,925,637 |
| | 2,925,637 |
| | — |
| | — |
|
| Certificate of deposit accounts | 395,181 |
| | 394,164 |
| | — |
| | 394,164 |
| | — |
|
| Federal Home Loan Bank advances | 117,400 |
| | 117,400 |
| | — |
| | 117,400 |
| | — |
|
| Securities sold under agreement to repurchase | 28,668 |
| | 28,668 |
| | 28,668 |
| | — |
| | — |
|
| Junior subordinated debentures | 19,936 |
| | 15,250 |
| | — |
| | — |
| | 15,250 |
|
| Accrued interest payable | 148 |
| | 148 |
| | 42 |
| | 73 |
| | 33 |
|
| Derivative liabilities - interest rate swaps | 3,308 |
| | 3,308 |
| | — |
| | 3,308 |
| | — |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2019 |
| Carrying
Value | | Fair
Value | | Fair Value Measurements Using: |
| | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Financial Assets: | | | | | | | | | |
| Cash and cash equivalents | $ | 228,568 | | | $ | 228,568 | | | $ | 228,568 | | | $ | 0 | | | $ | 0 | |
| Investment securities available for sale | 952,312 | | | 952,312 | | | 0 | | | 952,312 | | | 0 | |
| Loans held for sale | 5,533 | | | 5,704 | | | 0 | | | 0 | | | 5,704 | |
| Loans receivable, net | 3,731,708 | | | 3,791,557 | | | 0 | | | 0 | | | 3,791,557 | |
| Accrued interest receivable | 14,446 | | | 14,446 | | | 79 | | | 3,668 | | | 10,699 | |
| Derivative assets - interest rate swaps | 8,318 | | | 8,318 | | | 0 | | | 8,318 | | | 0 | |
| Equity security | 148 | | | 148 | | | 148 | | | 0 | | | 0 | |
| | | | | | | | | |
| Financial Liabilities: | | | | | | | | | |
| Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts | $ | 4,058,098 | | | $ | 4,058,098 | | | $ | 4,058,098 | | | $ | 0 | | | $ | 0 | |
| Certificate of deposit accounts | 524,578 | | | 529,679 | | | 0 | | | 529,679 | | | 0 | |
| | | | | | | | | |
| Securities sold under agreement to repurchase | 20,169 | | | 20,169 | | | 20,169 | | | 0 | | | 0 | |
| Junior subordinated debentures | 20,595 | | | 20,000 | | | 0 | | | 0 | | | 20,000 | |
| Accrued interest payable | 199 | | | 199 | | | 95 | | | 64 | | | 40 | |
| Derivative liabilities - interest rate swaps | 8,318 | | | 8,318 | | | 0 | | | 8,318 | | | 0 | |
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2016 |
| | Carrying Value | | Fair Value | | Fair Value Measurements Using: |
| | | Level 1 | | Level 2 | | Level 3 |
| | (In thousands) |
| Financial Assets: | | | | | | | | | |
| Cash and cash equivalents | $ | 103,745 |
| | $ | 103,745 |
| | $ | 103,745 |
| | $ | — |
| | $ | — |
|
| Investment securities available for sale | 794,645 |
| | 794,645 |
| | 123 |
| | 794,522 |
| | — |
|
| Federal Home Loan Bank stock | 7,564 |
| | N/A |
| | N/A |
| | N/A |
| | N/A |
|
| Loans held for sale | 11,662 |
| | 11,988 |
| | — |
| | 11,988 |
| | — |
|
| Loans receivable, net of allowance for loan losses | 2,609,666 |
| | 2,675,811 |
| | — |
| | — |
| | 2,675,811 |
|
| Accrued interest receivable | 10,925 |
| | 10,925 |
| | 3 |
| | 3,472 |
| | 7,450 |
|
| Derivative assets - interest rate swaps | 2,804 |
| | 2,804 |
| | — |
| | 2,804 |
| | — |
|
| Financial Liabilities: | | | | | | | | | |
| Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts | $ | 2,872,247 |
| | $ | 2,872,247 |
| | $ | 2,872,247 |
| | $ | — |
| | $ | — |
|
| Certificate of deposit accounts | 357,401 |
| | 357,536 |
| | — |
| | 357,536 |
| | — |
|
| Federal Home Loan Bank advances | 79,600 |
| | 79,600 |
| | — |
| | 79,600 |
| | — |
|
| Securities sold under agreement to repurchase | 22,104 |
| | 22,104 |
| | 22,104 |
| | — |
| | — |
|
| Junior subordinated debentures | 19,717 |
| | 15,000 |
| | — |
| | — |
| | 15,000 |
|
| Accrued interest payable | 215 |
| | 215 |
| | 44 |
| | 142 |
| | 29 |
|
| Derivative liabilities - interest rate swaps | 2,804 |
| | 2,804 |
| | — |
| | 2,804 |
| | — |
|
The methods and assumptions, not previously presented, usedCompany is required to estimate fair value are described as follows:
Cash and Cash Equivalents:
The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value equal to carrying value (Level 1).
Federal Home Loan Bank Stock:
FHLB stock is not publicly traded; thus, it is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.
Loans Held for Sale:
The fair value of loans held for sale is estimated based upon binding contracts or quotes from third party investors for similar loans. (Level 2).
Loans Receivable:
Except for certain impaired loans discussed previously, fair value is based on discounted cash flows using current market rates applied to the estimated life (Level 3). While these methodologies are permitted under U.S. GAAP, they are not based on the exit price concept of the fair value required under FASB ASC 820-10, Fair Value Measurements and Disclosures, and generally produce a higher value.
Accrued Interest Receivable/Payable:
The fair value of accrued interest receivable/payable balances approximates the carrying value. The fair value measurements are commensuratemaintain an average reserve balance with the assetFederal Reserve Bank or liability from whichmaintain such reserve balance in the accrued interest is generated (Level 1, Level 2form of cash. Effective March 24, 2020 the Federal Reserve lowered the reserve ratios on transaction accounts maintained at a depository institution to zero percent. There was 0 required reserve balance at September 30, 2020 and Level 3).a required balance of $17.1 million at December 31, 2019 was met by holding cash and maintaining an average balance with the Federal Reserve Bank.
45(14)Commitments and Contingencies
the nine months ended September 30, 2019 due primarily to a benefit from net operating losses related to prior acquisitions of $1.0 million from a provision in the CARES Act.
| |
ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the financial condition and results of the Company as of and for the three and nine months ended September 30, 2017.2020. The information contained in this section should be read with the unaudited Condensed Consolidated Financial Statements and the accompanying Notes included herein, the Forward Looking Statements included herein, the Risk Factors included herein, and the December 31, 20162019 audited Consolidated Financial Statements and the accompanying Notes included in our 2019 Annual Report on Form 10-K for the year ended December 31, 2016.10-K.
Overview
Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of our wholly-owned financial institution subsidiary, Heritage Bank. We provide financial services to our local communities with an ongoing strategic focus on our commercial banking relationships, market expansion and asset quality. At September 30, 2017,2020, we had total assets of $4.05$6.69 billion, total liabilities of $5.88 billion and total stockholders’ equity of $507.6$803.1 million. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to the Bank’s operations.
Our business consists primarily of commercial lending and deposit relationships with small businesses and their owners in our market areas and attracting deposits from the general public. We also make real estate construction and land development loans and consumer loans. We additionally originate for sale or for investment purposes one-to-four family residential loans on residential properties located primarily in our markets. During the quarter ended March 31, 2020, we ceased indirect auto loan originations.
Our core profitability depends primarily on our net interest income. Net interest income is the difference between interest income, which is the income that we earn on interest earning assets, comprised primarily of loans and investment securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits. Management strives to match the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is affected significantly by general and local economic conditions, particularly changes in market interest rates, and by governmental policies and actions of regulatory agencies. Net interest income is additionally affected by changes on the volume and mix of interest earning assets, interest earned on these assets, the volume and mix of interest bearing liabilities and interest paid on these liabilities.
Because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the 150 basis point reduction in the targeted federal funds rate during the quarter ended March 31, 2020, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely affected in the near term, if not longer.
Our net income is affected by many factors, including the provision for loan losses.credit losses on loans. The provision for loancredit losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. The allowance for loanACL on loans was impacted during the nine months ended September 30, 2020 due to the CECL Adoption, which estimates losses over the life of the loans as compared to prior GAAP which required estimating incurred losses as of period end, and by forecasted credit deterioration due to the COVID-19 pandemic, as discussed in the COVID-19 Impact section below. Management believes that the ACL on loans reflects the amount that we believe is appropriate to provide for probable incurredcurrent expected credit losses in our loan portfolio.portfolio based on our consistent methodology.
Net income is also affected by noninterest income and noninterest expense. Noninterest income primarily consists of service charges and other fees gain on sale of loans (net) and other income. Noninterest expense consists primarily of compensation and employee benefits, occupancy and equipment, data processing and data processing.professional services. Compensation and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses are the fixed and variable costs of buildings and equipment, and consistconsists primarily of lease payments,expenses, depreciation charges, maintenance and costs of utilities. Data processing consists primarily of processing and network services related to the Bank’s core operating system, including the account processing systems,system, electronic payments processing of
products and services, and internet and mobile banking channels. Professional services consists primarily of third party service providers, such as consultants and software-as-a-service providers, and legal fees.
Results of operations may also be affected significantly by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities. OtherNet income and other expenses areis also impacted by growth of operations and growth in the number of loan and deposit accounts through acquisitions and core banking business growth.
COVID-19 Impact
In response to the COVID-19 pandemic, and in an effort to mitigate the adverse impact on our employees, customers and the communities we serve, the Bank has implemented various lending measures to address customer and community needs, including commercial, mortgage and consumer lending assistance. The Bank has also implemented various retail-impacting measures for the safety and health of customers and employees. The following provides details of the Bank's special programs and policies.
Commercial Lending Assistance
The Bank has made available the following initial short-term relief options to commercial borrowers affected by COVID-19:
•Interest only payments on term debt for up to 90 days;
•Temporary increases to line of credit commitments when supported by underlying assets, including changing the borrowing base formula or changing existing commitment restrictions to allow higher advance rates;
•Full payment deferrals for up to 90 days when an interest only period does not provide sufficient relief (contingent on credit administration approval);
•Loan re-amortization, especially in cases where significant prepayments of principal have occurred;
•Covenant waivers and resets;
•Processing new loan requests, such as a line of credit for working capital support;
•Maturity extensions of up to 90 days for maturing lines of credit or term loans.
The Bank has implemented a special, streamlined initial 90-day interest only payment modification process for borrowers in certain industries as a result of the COVID-19 "stay at home" orders.
Based on the depth and breadth of the COVID-19 pandemic, the Bank will extend similar relief options for a subsequent or second modification to certain commercial borrowers. The Bank has a preference for offering interest only payments on these secondary modifications. The Bank has determined that in most instances, a request for a third payment deferral modification will be considered a TDR loan instead of a modification as the Bank incorporated policies consistent with regulatory guidance.
The Bank will work constructively with commercial borrowers to identify loan modifications that are based on the facts and circumstances of each borrower, and to protect the safety and soundness of the Bank.
All commercial loans modified due to COVID-19 will be risk rated "Watch" or worse, except in certain cases where a borrower has performed well prior to the modification request and exhibits a strong financial position, or the loan has significant guarantor support, or if more severe risk rating is determined appropriate given facts and circumstances of the borrower. Further requests for relief beyond the initial modification will be reassessed for a more severe risk rating as part of the review process to grant further relief.
Mortgage and Consumer Lending Assistance
In order to effectively manage or mitigate adverse impacts on mortgage and consumer borrowers affected by COVID-19, the Bank has implemented the initial relief action through a streamlined approval process to include 90-day payment deferrals when the borrower meets the following criteria:
•The borrower's ability to pay has been negatively impacted by COVID-19;
•The loan is not over 30 days past due on the date of the request; and
•The loan is risk rated "Pass" prior to the request for payment deferral.
Mortgage and consumer loans that do not meet the criteria to receive streamlined approval qualifications are considered outside of the automatic deferral process and will be evaluated on a case-by-case basis by the Bank's credit team. Certain consumer term loans with current balances over $100,000 with original terms over 96 months will also be reviewed on a case-by-case basis and will not qualify for the streamlined approval process. For consumer lines of credit, for borrowers that have sufficient available credit on their line, the borrower can draw on their line of credit to make payments in lieu of payment deferrals, and for borrowers that do not have sufficient available credit, the Bank will offer a 90-day payment deferral. However, after the deferral period these borrowers
will be billed for the deferred months of accrued interest and the Bank will work with those borrowers unable to pay all months of interest at that time. For credit card customers, a skip payment option was included in the borrowers' billing statements between April 1, 2020 and May 30, 2020.
Based on the depth and breadth of the COVID-19 pandemic, the Bank will extend similar relief options for a subsequent or second modification to certain consumer borrowers. The Bank has a preference for offering interest only payments, or partial principal and interest payments, on these secondary modifications.
All mortgage and consumer loans modified via the initial streamlined process due to COVID-19 will remain risk rated "Pass" through the initial 90-day relief period. This risk rating is subject to change should the Bank receive additional information within the 90-day relief period that the borrower does not intend to repay the loan, which may result in a risk rating downgrade and the implementation of further collection efforts. The risk rating will be reviewed for a more severe classification for any secondary modification request.
Borrowers under COVID-19 related deferral programs will not have negative data reported to the credit reporting agencies. Credit reporting will not be turned off on these accounts, but contractual due dates will be advanced in the core loan system with appropriate loan documentation to legally support the new due dates.
COVID-19 Modifications:
During the nine months ended September 30, 2020 and as a direct result of COVID-19 related issues cited by the borrower and the Bank's lending assistance programs described above, the Bank made modifications on loans. These modifications were not classified as TDRs at September 30, 2020 in accordance with the CARES Act and related regulatory guidance.
The following table details the amortized cost, count, and type of modifications by each loan class that were made during the nine months ended September 30, 2020, with amortized costs presented as of March 31, 2020, before the onset of the COVID-19 pandemic:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Only | | Payment Deferral | | Other | | Total |
| Amortized Cost | | Count | | Amortized Cost | | Count | | Amortized Cost | | Count | | Amortized Cost | | Count |
| (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | | | | | |
| Commercial and industrial | $ | 74,561 | | | 284 | | | $ | 41,301 | | | 239 | | | $ | 21,939 | | | 48 | | | $ | 137,801 | | | 571 | |
| | | | | | | | | | | | | | | |
| Owner-occupied CRE | 116,064 | | | 90 | | | 82,125 | | | 91 | | | 1,304 | | | 2 | | | 199,493 | | | 183 | |
| Non-owner occupied CRE | 130,948 | | | 80 | | | 75,252 | | | 44 | | | 22,715 | | | 8 | | | 228,915 | | | 132 | |
| Total commercial business | 321,573 | | | 454 | | | 198,678 | | | 374 | | | 45,958 | | | 58 | | | 566,209 | | | 886 | |
| One-to-four family residential | 1,704 | | | 2 | | | 14,905 | | | 30 | | | 613 | | | 3 | | | 17,222 | | | 35 | |
| Real estate construction and land development: | | | | | | | | | | | | | | | |
| One-to-four family residential | 733 | | | 1 | | | — | | | — | | | 6,173 | | | 23 | | | 6,906 | | | 24 | |
| Five or more family residential and commercial properties | 10,390 | | | 10 | | | 1,632 | | | 6 | | | 8,260 | | | 8 | | | 20,282 | | | 24 | |
| Total real estate construction and land development | 11,123 | | | 11 | | | 1,632 | | | 6 | | | 14,433 | | | 31 | | | 27,188 | | | 48 | |
| Consumer | 606 | | | 25 | | | 25,596 | | | 977 | | | 55 | | | 1 | | | 26,257 | | | 1,003 | |
| Total | $ | 335,006 | | | 492 | | | $ | 240,811 | | | 1,387 | | | $ | 61,059 | | | 93 | | | $ | 636,876 | | | 1,972 | |
Of the modifications presented in the table above that also had loan balances at September 30, 2020, the risk classification of 206 loans totaling $197.5 million were downgraded during the nine months ended September 30, 2020. The majority of the downgrades were to a "Watch" grade and were therefore not classified as potential problem loans.
The following table details the amortized cost, count, and type of modifications by each loan class for any loan that was in active payment modification deferral status as of September 30, 2020, with balances and count at September 30, 2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Only | | Payment Deferral | | | | Total |
| Amortized Cost | | Count | | Amortized Cost | | Count | | | | | | Amortized Cost | | Count |
| (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | | | | | |
| Commercial and industrial | $ | 13,069 | | | 33 | | | $ | 5,158 | | | 22 | | | | | | | $ | 18,227 | | | 55 | |
| | | | | | | | | | | | | | | |
| Owner-occupied CRE | 5,712 | | | 9 | | | 30,071 | | | 15 | | | | | | | 35,783 | | | 24 | |
| Non-owner occupied CRE | 20,839 | | | 13 | | | 28,441 | | | 12 | | | | | | | 49,280 | | | 25 | |
| Total commercial business | 39,620 | | | 55 | | | 63,670 | | | 49 | | | | | | | 103,290 | | | 104 | |
| One-to-four family residential | 1,272 | | | 1 | | | 1,036 | | | 4 | | | | | | | 2,308 | | | 5 | |
| Real estate construction and land development: | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Five or more family residential and commercial properties | 7,329 | | | 1 | | | 450 | | | 1 | | | | | | | 7,779 | | | 2 | |
| | | | | | | | | | | | | | | |
| Consumer | 588 | | | 24 | | | 3,115 | | | 125 | | | | | | | 3,703 | | | 149 | |
| Total | $ | 48,809 | | | 81 | | | $ | 68,271 | | | 179 | | | | | | | $ | 117,080 | | | 260 | |
Of the loans in active payment modification deferral status at September 30, 2020, $94.5 million, or 80.7%, were on their second loan deferral modification and the risk classification of a majority of these loans were downgraded. The Bank classified $17.2 million of these loans as nonaccrual as of September 30, 2020.
COVID-19 Downgrades:
The Bank downgraded loans due to heightened risk as a direct result of COVID-19 related issues cited by the borrower. All COVID-19 downgrades, including those with and without a modification, as of September 30, 2020 are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Pass | Watch | | Special Mention | | Substandard | | Total |
| Amortized Cost | | Count | | Amortized Cost | | Count | | Amortized Cost | | Count | | Amortized Cost | | Count | | Amortized Cost | | Count |
| (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | | | | | | | | | |
| Commercial and industrial | $ | 8,966 | | | 58 | | | $ | 37,349 | | | 122 | | | $ | 34,796 | | | 47 | | | $ | 3,778 | | | 20 | | | $ | 84,889 | | | 247 | |
| | | | | | | | | | | | | | | | | | | |
| Owner-occupied CRE | 32,091 | | | 22 | | | 24,775 | | | 37 | | | 15,570 | | | 6 | | | 13,316 | | | 6 | | | 85,752 | | | 71 | |
| Non-owner occupied CRE | 26,526 | | | 13 | | | 71,340 | | | 35 | | | 12,971 | | | 3 | | | 25,913 | | | 3 | | | 136,750 | | | 54 | |
| Total commercial business | 67,583 | | | 93 | | | 133,464 | | | 194 | | | 63,337 | | | 56 | | | 43,007 | | | 29 | | | 307,391 | | | 372 | |
| One-to-four family residential | 1,114 | | | 8 | | | — | | | — | | | — | | | — | | | — | | | — | | | 1,114 | | | 8 | |
| Real estate construction and land development: | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Five or more family residential and commercial properties | 16,205 | | | 5 | | | 2,029 | | | 3 | | | — | | | — | | | 450 | | | 1 | | | 18,684 | | | 9 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | $ | 84,902 | | | 106 | | | $ | 135,493 | | | 197 | | | $ | 63,337 | | | 56 | | | $ | 43,457 | | | 30 | | | $ | 327,189 | | | 389 | |
Loans in the table above which were downgraded to Special Mention or worse are classified as potential problem loans, except for loans totaling $17.2 million at September 30, 2020 that were classified as nonaccrual.
SBA Paycheck Protection Program
Beginning April 6, 2020, the Bank began to offer SBA PPP loans to its existing and new customers as a result of the COVID-19 pandemic. SBA PPP loans are designed to provide a direct incentive for small businesses to keep their workers on the payroll. The CARES Act and its subsequent amendments allocated $669.0 billion to the program. Utilizing our internal technology solutions team, the Bank was able to develop an automated platform to control and manage processing for SBA PPP loans and immediately began originations under this program. The
Bank accepted applications for SBA PPP loans, including loans to independent contractors, sole proprietors and partnerships as allowed under the guidance from the U.S. Treasury and SBA that was issued April 14, 2020.
The SBA's PPP program ended on August 8, 2020 and the Bank funded 4,642 loans totaling $897.4 million during the program's existence. The average loan balance for funded loans was $193,000. Of the funded loans, approximately 21% of both the number of loans funded and amount originated were to customers with no prior banking relationship to the Bank.
The Bank earns 1% interest on these loans as well as a fee from the SBA to cover processing costs, which is amortized over the life of the loan. The balance of unamortized net deferred fees on SBA PPP loans was $22.0 million at September 30, 2020.
Additionally, the Federal Reserve established the PPPLF under Section 13(3) of the Federal Reserve Act to bolster the effectiveness of the SBA's PPP. Under the PPPLF, the Bank may pledge its PPP loans as collateral at face value to obtain Federal Reserve Bank non-recourse loans. The maturity date of any PPPLF advance (the “Maturity Date”) will be the maturity date of the PPP loan pledged to secure the PPPLF advance. The Maturity Date of any PPPLF advance will be accelerated on and to the extent of (i) the date of any loan forgiveness reimbursement by the SBA for any PPP loan securing the PPPLF advance; or (ii) the date of purchase by the SBA from the Bank of any PPP loan securing the PPPLF loan advance to realize on the SBA’s guarantee of the PPP loan. PPPLF advances may be obtained until December 31, 2020. Although the Bank was approved to utilize the PPPLF, the Bank has chosen not to participate during the nine months ended September 30, 2020.
The Bank will begin processing loan forgiveness applications, as allowed under the SBA's PPP during the quarter ended December 31, 2020.
SBA Relief
Heritage is an active SBA lender in the Pacific Northwest and had SBA loans totaling $64.8 million and $64.1 million at September 30, 2020 and December 31, 2019, respectively. During the nine months ended September 30, 2020, Heritage participated in the SBA's Debt Relief Program under the CARES Act. The CARES Act appropriated $17.0 billion to subsidize small business loans. Under this program, the SBA will pay principal and interest for existing current SBA loans for a period of six months, commencing with payments due after March 27, 2020 as well as new SBA 7(a), 504, and microloans disbursed prior to September 27, 2020.
Under this program, the borrowers will not have to reimburse the SBA or the Bank for these payments. If a borrower had already requested a payment deferral, and the deferral was granted, the six month period begins after the deferment period. There is no limitation to the monthly principal and interest amount that the SBA will pay on behalf of the borrower. The borrower can also make other principal-only payments during the six month period.
The Bank did not consider any loans for which the SBA was making the principal and interest payment as a loan with COVID-19 modification as only the source of payment was changed and not the payment terms of the SBA loan.
Retail Policy Changes
The COVID-19 pandemic has caused significant disruptions to the Bank's operations and resulted in the implementation by the Bank of various social distancing measures to address customer and community needs.
•Branch Lobby Closures. To ensure the safety of our customers and employees, most branch lobbies were closed in March 2020 with most services processed through the drive-up or by appointment. On June 22, 2020, management elected to open lobbies for its three branches located within Island County, which has moved into Phase 3 as part of Washington State's Phased Approach: Reopening Business and Modifying Physical Distancing Measures, of which the fourth phase is the least restrictive phase ahead of a full reopening. Management believes this initial and limited approach in Island County will provide valuable insights on how to effectively implement the Bank's safety precautions and to better understand any risks or changes that will need to be addressed before considering opening other locations.
•Early Withdrawal Penalty Waivers. For customers that may need access to funds in their certificate of deposits to assist with living expenses during the COVID-19 pandemic, the Bank will assist these customers by waiving early withdrawal penalties for withdrawals up to $25,000.
•Overdraft & Fee Reversals. Overdraft and fee reversals are waived on a case-by-case basis. The Bank is cautious when paying overdrafts beyond the customer's total deposit relationship, overdraft protection options or their overdraft coverage limits.
Employee Changes
Heritage has committed to keeping its employees safe during this COVID-19 pandemic. As a result, many policy changes have been implemented including the following measures:
•Heritage follows the guidelines recommended by the Centers for Disease Control and/or local officials, such as social distancing and maintaining six feet of separation between employees.
•Heritage has provided additional cleaning and disinfecting solutions to each location.
•A significant number of back-office employees are working remotely.
•Essential business travel is limited to those situations where business cannot reasonably be conducted without face-to-face interaction or visits to specific locations.
•Certain front-line employees were given additional hourly pay.
•Heritage has offered up to 80 hours for full time employees of COVID-19 related absences, to use in lieu of sick or vacation time, for the employee's own illness, to care for an ill family member, due to a required self-isolation/quarantine or school/day care closures.
Heritage continues to monitor the situation and makes additional accommodations as necessary.
Earnings Summary
Comparison of quarter ended September 30, 20172020 to the comparable quarter in the prior yearyear.
Net income was $10.6$16.6 million, or $0.35$0.46 per diluted common share, for the three months ended September 30, 20172020 compared to $11.0net income of $17.9 million, or $0.37$0.48 per diluted common share, for the three months ended September 30, 2016. The $415,000,2019. Net income decreased $1.3 million, or 3.8% decrease in net income7.0%, for the three months ended September 30, 20172020 compared to the three months ended September 30, 2016 wassame period in 2019 primarily due to increases in the result of a $1.5 million, or 14.9% decrease in noninterest
income and a $1.1 million, or 4.2% increase in noninterest expense, partially offsetACL for nonperforming loans caused by a $1.4 million, or 4.1%, increase in net interest income and a $611,000, or 40.9%, decrease inthe COVID-19 pandemic. The provision for loan losses.losses during the same period in 2019 was estimated under the incurred loss methodology.
Net interest income as a percentage of average interest earning assets, (netor net interest margin)margin, decreased 1083 basis points to 3.85%3.38% for the three months ended September 30, 20172020 compared to 3.95%4.21% for the same period in 2016.2019. The decrease in net interest margin was due primarily to the changes in the mix of interest earning assets, including decreases in investment securities, increases in interest earning deposits, and the addition of low-yielding SBA PPP loans, combined with the decreases in yields on adjustable instruments following decreases in short-term market rates. The decrease in net interest margin was offset partially by decreases in the cost of interest bearing liabilities following the decreases in the market rates.
The efficiency ratio consists of noninterest expense divided by the sum of net interest income before provision for loancredit losses plus noninterest income. The Company’s efficiency ratio was 64.4%62.27% for the three months ended September 30, 20172020 compared to 61.7%62.55% for the three months ended September 30, 2016 and2019. The change in the changeefficiency ratio was attributable primarily to the decrease in noninterest income and the increase in noninterest expense.net interest income.
Comparison of nine months ended September 30, 20172020 to the comparable period in the prior yearyear.
Net income was $31.8$22.7 million, or $1.06$0.63 per diluted common share, for the nine months ended September 30, 20172020 compared to $29.0to $50.4 million, or $0.97$1.36 per diluted common share, for the nine months ended September 30, 2016. The $2.72019. Net income decreased $27.7 million, or 9.5%55.0%, for the nine months ended September 30, 2020 compared to the same period in 2019 primarily due to an increase in the provision for credit losses on loans to $38.2 million compared to a provision for loan losses of $2.8 million for the same period in 2019 as a result of estimated credit losses forecasted due to COVID-19 and its impact on the economy, offset partially by a decrease in income tax expense of $7.9 million due to lower pre-tax income as well as a provision in the CARES Act permitting the recognition of a benefit from net operating losses related to prior acquisitions and an increase in noninterest income of $2.5 million, or 10.6%, due primarily to increased gain on sale of loans.
The net interest margin decreased 62 basis points to 3.67% for the nine months ended September 30, 20172020 compared to 4.29% for the nine months ended September 30, 2016 was primarily the result of a $3.0 million, or 12.7%increasesame period in noninterest income and a $2.9 million, or 2.9%, increase2019. The decrease in net interest income,margin was due primarily to changes in the mix of interest earning assets, including the origination of SBA PPP loans with an average balance of $511.5 million earning a yield of 2.80%, and decreases in yields of interest earning assets as a result of decreases in short-term market interest rates, offset partially offset by a $3.3 million, or 4.2% increasedecreases in noninterest expense.the cost of interest bearing liabilities during the period.
The net interest margin decreased 11 basis points to 3.89%Company’s efficiency ratio was 63.26% for the nine months ended September 30, 20172020 compared to 4.00% for the same period in 2016.
The Company’s efficiency ratio improved to 64.5%63.67% for the nine months ended September 30, 2017 from 64.8% for the nine months ended September 30, 2016.2019. The improvementchange in the efficiency ratio for the nine months ended September 30, 2017 comparedwas attributable primarily to the nine months ended September 30, 2016 was primarily attributable to the increasesincrease in noninterest income and net interest income.
Net Interest Income
One of the Company's key sources of earnings is net interest income. There are several factors that affect net interest income including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest bearing liabilities; the volume of noninterest earning assets, noninterest bearing demand deposits, and other noninterest bearing liabilities and stockholders' equity; the volume of noninterest earning assets; market interest rate fluctuations; and asset quality.
Market rates impact the results of the Company's net interest income, including the significant decreases in the federal funds target rate by the Federal Reserve in response to the COVID-19 pandemic during March 2020. The following table provides the federal funds target rate history and changes from each period since December 31, 2018:
| | | | | | | | | | | | | | | | | | |
| Change Date | | Rate (%) | | Rate Change (%) | | | | |
| December 31, 2018 | | 2.25 - 2.50% | | N/A | | | | |
| July 31, 2019 | | 2.00 - 2.25% | | -0.25% | | | | |
| September 18, 2019 | | 1.75 - 2.00% | | -0.25% | | | | |
| October 30, 2019 | | 1.50 - 1.75% | | -0.25% | | | | |
| March 3, 2020 | | 1.00 - 1.25% | | -0.50% | | | | |
| March 16, 2020 | | 0.00 - 0.25% | | -1.00% | | | | |
Comparison of quarter ended September 30, 20172020 to the comparable quarter in the prior yearyear.
Net interest income increased $1.4 million,decreased $565,000, or 4.1%1.1%, to $35.0$49.7 million for the three months ended September 30, 20172020 compared to $33.6$50.2 million for the same period in 2016.2019. The following table provides relevant net interest income information for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, |
| | 2020 | | 2019 |
| | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) | | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) |
| | (Dollars in thousands) |
| Interest Earning Assets: | | | | | | | | | | | |
Total loans receivable, net (2) (3) | $ | 4,605,389 | | | $ | 47,647 | | | 4.12 | % | | $ | 3,677,405 | | | $ | 47,845 | | | 5.16 | % |
| Taxable securities | 697,128 | | | 3,865 | | | 2.21 | | | 823,498 | | | 5,704 | | | 2.75 | |
Nontaxable securities (3) | 163,070 | | | 953 | | | 2.32 | | | 129,061 | | | 798 | | | 2.45 | |
| Interest earning deposits | 389,653 | | | 98 | | | 0.10 | | | 106,740 | | | 537 | | | 2.00 | |
| Total interest earning assets | 5,855,240 | | | 52,563 | | | 3.57 | % | | 4,736,704 | | | 54,884 | | | 4.60 | % |
| Noninterest earning assets | 765,740 | | | | | | | 679,687 | | | | | |
| Total assets | $ | 6,620,980 | | | | | | | $ | 5,416,391 | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, |
| | 2020 | | 2019 |
| | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) | | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) |
| Interest Bearing Liabilities: | | | | | | | | | | | |
| Certificates of deposit | $ | 466,920 | | | $ | 1,133 | | | 0.97 | % | | $ | 508,092 | | | $ | 1,861 | | | 1.45 | % |
| Savings accounts | 514,072 | | | 117 | | | 0.09 | | | 507,533 | | | 680 | | | 0.53 | |
| Interest bearing demand and money market accounts | 2,639,511 | | | 1,389 | | | 0.21 | | | 2,040,926 | | | 1,709 | | | 0.33 | |
| Total interest bearing deposits | 3,620,503 | | | 2,639 | | | 0.29 | | | 3,056,551 | | | 4,250 | | | 0.55 | |
| Junior subordinated debentures | 20,766 | | | 196 | | | 3.75 | | | 20,474 | | | 332 | | | 6.43 | |
| Securities sold under agreement to repurchase | 32,856 | | | 50 | | | 0.61 | | | 29,258 | | | 48 | | | 0.65 | |
| FHLB advances and other borrowings | — | | | — | | | — | | | 3,755 | | | 11 | | | 1.16 | |
| Total interest bearing liabilities | 3,674,125 | | | 2,885 | | | 0.31 | % | | 3,110,038 | | | 4,641 | | | 0.59 | % |
| Noninterest bearing demand deposits | 1,998,772 | | | | | | | 1,416,336 | | | | | |
| Other noninterest bearing liabilities | 148,345 | | | | | | | 88,624 | | | | | |
| Stockholders’ equity | 799,738 | | | | | | | 801,393 | | | | | |
| Total liabilities and stockholders’ equity | $ | 6,620,980 | | | | | | | $ | 5,416,391 | | | | | |
| Net interest income | | | $ | 49,678 | | | | | | | $ | 50,243 | | | |
| Net interest spread | | | | | 3.26 | % | | | | | | 4.01 | % |
| Net interest margin | | | | | 3.38 | % | | | | | | 4.21 | % |
| Average interest earning assets to average interest bearing liabilities | | | | | 159.36 | % | | | | | | 152.30 | % |
(1) Annualized
(2) The average loan balances presented in the table are net of allowances for credit losses on loans. Nonaccrual loans have been included in the table as loans carrying a zero yield.
(3) Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis.
Interest Income
Total interest income decreased $2.3 million, or 4.2%, to $52.6 million for the three months ended September 30, 2020 compared to $54.9 million for the same period in 2019 due primarily to the change in the mix of interest earning assets and decreases in yields on adjustable rate instruments following several decreases in short-term market rates, offset partially by increases in interest earning assets, primarily due to SBA PPP loans. The yield on total interest earning assets decreased 103 basis points to 3.57% for the three months ended September 30, 2020 compared to 4.60% for the three months ended September 30, 2019. The balance of average interest earning assets increased $1.12 billion, or 23.6%, to $5.86 billion for the three months ended September 30, 2020 from $4.74 billion for the three months ended September 30, 2019, including increases in the average balances of SBA PPP loans of $863.1 million and interest earning deposits of $282.9 million. There were no SBA PPP loans outstanding during the three months ended September 30, 2019.
Interest and fees on loans decreased $198,000, or 0.4%, to $47.6 million during the three months ended September 30, 2019 compared to $47.8 million for the same period in 2019 due primarily to a decrease in the loan yield, offset partially by an increase in the average loan balance. Loan yield decreased 104 basis points to 4.12% for the three months ended September 30, 2020 from 5.16% for the three months ended September 30, 2019 due primarily to the multiple and sustained decreases in short-term market rates and secondarily due to the impact of low-yielding SBA PPP loans.Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, decreased 69 basis points to 4.35% for three months ended September 30, 2020 compared to 5.04% for the comparable quarter ended September 30, 2019. Loan yields decreased 31 basis points as result of SBA PPP loans yielding a rate of 2.68%, inclusive of the recognition of the related deferred fee, for the three months ended September 30, 2020. The impact of SBA PPP loans on loan yields will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are met, but is expected to cease completely after maturity of the loans. The average loan balance increased $928.0 million, or 25.2%, to $4.61 billion during the three months ended September 30, 2020 compared to $3.68 billion during the three months ended September 30, 2019 due primarily to SBA PPP loans with an average balance of $863.1 million for the three months ended September 30, 2020.
The following table presents the loan yield and the impacts of the balances and interest and fees earned on SBA PPP loans and the incremental accretion on purchased loans on this financial measure for the periods presented below:
| | | | | | | | | | | |
| | Three Months Ended
September 30, |
| | 2020 | | 2019 |
| (Dollars in thousands) |
Non-GAAP reconciliation of loan yield:(1) |
| Loan yield (GAAP) | 4.12 | % | | 5.16 | % |
| Exclude Impact on loan yield from SBA PPP loan interest and fees | 0.31 | | | — | |
Exclude impact on loan yield from incremental accretion on purchased loans(2) | (0.08) | | | (0.12) | |
| Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) | 4.35 | % | | 5.04 | % |
| | | |
| | | |
(1) For additional information, see "Non-GAAP Financial Measures."
(2) Represents the amount of interest income recorded on purchased loans in excess of the contractual stated interest rate in the individual loan notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified by CECL Adoption. The purchased discount is accreted into income over the remaining life of the loan. The impact of incremental accretion on loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the balance of the purchased loans decreases.
Interest income on investment securities decreased $1.7 million, or 25.9%, to $4.8 millionduring the three months ended September 30, 2020 from $6.5 million during the three months ended September 30, 2019 due primarily to decreases in market interest rates impacting adjustable rate securities and yields on investment securities purchased lower than the existing investment portfolio. The yield on the aggregate investment portfolio decreased 48 basis points to 2.23% for the quarter ended September 30, 2020 from 2.71% for the same period in 2019, including decreases of 54 and 13 basis points on the yield on taxable securities and nontaxable securities, respectively. The average balance of investment securities decreased $92.4 million, or 9.7%, to $860.2 millionduring the three months ended September 30, 2020 from $952.6 millionduring the three months ended September 30, 2019. The decrease in the average balance of investment securities included a $126.4 million, or 15.3%, decrease in the average balance of taxable securities, offset partially by a $34.0 million, or 26.4%, increase in the average balance of nontaxable securities.
Interest income on interest earning deposits decreased $439,000, or 81.8%, to $98,000 during the three months ended September 30, 2020 from $537,000 for the same period in 2019 due primarily to decreases in the yield on interest earning deposits, offset partially by an increase in the average balance. The yield on interest earning deposits decreased 190 basis points to 0.10% during the three months ended September 30, 2020 compared to 2.00% during the same period in 2019 due to decreases in short-term market rates. The average balance of interest earning deposits increased $282.9 million, or 265.05%, to $389.7 million during the three months ended September 30, 2020 compared to $106.7 million during the same period in 2019 due primarily to the increase in deposits.
Interest Expense
Total interest expense decreased $1.8 million, or 37.8%, to $2.9 million for the three months ended September 30, 2020 compared to $4.6 million for the same period in 2019 due primarily to decreases in market interest rates following decreases in the federal funds target rate mentioned previously, offset partially by an increase in the average balance of total interest bearing liabilities. The cost of total interest bearing liabilities decreased 28 basis points to 0.31% for the three months ended September 30, 2020 from 0.59% for the three months ended September 30, 2019. The balance of average interest bearing liabilities increased $564.1 million, or 18.1%, to $3.67 billion during the three months ended September 30, 2020 compared to $3.11 billion during the same period in 2019.
Interest expense on total interest bearing deposits decreased $1.6 million, or 37.9%, to $2.6 million during the three months ended September 30, 2020 compared to $4.3 million during the same period in 2019 due primarily to decreases in market interest rates following decreases in the federal funds target rate previously mentioned, offset partially by an increase in the average balance of total deposits. The cost of total interest bearing deposits decreased 26 basis points to 0.29% for the three months ended September 30, 2020 from 0.55% for the three months ended September 30, 2019 due primarily to a decrease in the cost of interest bearing demand and money market accounts of 12 basis points, a decrease in cost of certificates of deposit of 48 basis points, and a decrease in the cost of savings accounts of 44 basis points. This decrease was offset partially by an increase in the average
balance of total interest bearing deposits of $564.0 million, or 18.5%, to $3.62 billion for the three months ended September 30, 2020 compared to $3.06 billion for the same period in 2019 due primarily to proceeds from SBA PPP loans deposited directly into customer accounts and reduced withdrawals from deposit accounts due to a change in customer spending habits as a result of COVID-19.
The Company's deposit costs were favorably impacted by the increase in the average balance of noninterest bearing demand deposits compared to total interest bearing deposits. The average balance of noninterest bearing demand deposits increased $582.4 million, or 41.1%, to $2.00 billion (or 35.0% of total deposits at September 30, 2020) for the three months ended September 30, 2020 compared to $1.42 billion (or 31.3% of total deposits at September 30, 2019) for the same period in 2019. The increase in the average balance of noninterest bearing deposits contributed to the decrease in the cost of total deposits of 19 basis points to 0.19% for the three months ended September 30, 2020 compared to 0.38% for the same period in 2019.
Net Interest Margin
Net interest margin decreased 83 basis points to 3.38% for the three months ended September 30, 2020 from 4.21% for the same period in 2019 primarily due to the above mentioned changes in asset yields and the mix of interest earning assets, offset partially by a decrease in the cost of interest bearing liabilities. The net interest spread decreased 75 basis points to 3.26% for the three months ended September 30, 2020 from 4.01% for the same period in 2019 primarily due to the decrease in the yield of total interest earning assets, offset partially by a decrease in the cost of total interest bearing liabilities.
Comparison of nine months ended September 30, 2020 to the comparable period in the prior year
Net interest income decreased $2.0 million, or 1.3%, to $148.5 million for the nine months ended September 30, 2020 compared to $150.6 million for the same period in 2019. The following table provides relevant net interest income information for the dates indicated.indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2020 | | 2019 |
| | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) | | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) |
| | (Dollars in thousands) |
| Interest Earning Assets: | | | | | | | | | | | |
Total loans receivable, net (2) (3) | $ | 4,266,598 | | | $ | 142,328 | | | 4.46 | % | | $ | 3,651,659 | | | $ | 142,651 | | | 5.22 | % |
| Taxable securities | 758,941 | | | 14,068 | | | 2.48 | | | 828,254 | | | 17,460 | | | 2.82 | |
Nontaxable securities (3) | 148,560 | | | 2,686 | | | 2.42 | | | 139,312 | | | 2,641 | | | 2.53 | |
| Interest earning deposits | 234,040 | | | 561 | | | 0.32 | | | 70,280 | | | 1,155 | | | 2.20 | |
| Total interest earning assets | 5,408,139 | | | 159,643 | | | 3.94 | % | | 4,689,505 | | | 163,907 | | | 4.67 | % |
| Noninterest earning assets | 757,269 | | | | | | | 672,365 | | | | | |
| Total assets | $ | 6,165,408 | | | | | | | $ | 5,361,870 | | | | | |
| | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | |
| Certificates of deposit | $ | 502,691 | | | $ | 4,955 | | | 1.32 | % | | $ | 508,177 | | | $ | 4,994 | | | 1.31 | % |
| Savings accounts | 475,091 | | | 420 | | | 0.12 | | | 505,112 | | | 2,061 | | | 0.55 | |
| Interest bearing demand and money market accounts | 2,428,148 | | | 4,897 | | | 0.27 | | | 2,036,253 | | | 4,815 | | | 0.32 | |
| Total interest bearing deposits | 3,405,930 | | | 10,272 | | | 0.40 | | | 3,049,542 | | | 11,870 | | | 0.52 | |
| Junior subordinated debentures | 20,693 | | | 699 | | | 4.51 | | | 20,401 | | | 1,026 | | | 6.72 | |
| Securities sold under agreement to repurchase | 25,296 | | | 122 | | | 0.64 | | | 30,512 | | | 139 | | | 0.61 | |
| FHLB advances and other borrowings | 1,959 | | | 8 | | | 0.55 | | | 15,909 | | | 305 | | | 2.56 | |
| Total interest bearing liabilities | 3,453,878 | | | 11,101 | | | 0.43 | % | | 3,116,364 | | | 13,340 | | | 0.57 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2020 | | 2019 |
| | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) | | Average
Balance | | Interest
Earned/
Paid | | Average
Yield/
Rate (1) |
| Noninterest bearing demand deposits | 1,768,260 | | | | | | | 1,365,134 | | | | | |
| Other noninterest bearing liabilities | 138,837 | | | | | | | 96,723 | | | | | |
| Stockholders’ equity | 804,433 | | | | | | | 783,649 | | | | | |
| Total liabilities and stockholders’ equity | $ | 6,165,408 | | | | | | | $ | 5,361,870 | | | | | |
| Net interest income | | | $ | 148,542 | | | | | | | $ | 150,567 | | | |
| Net interest spread | | | | | 3.51 | % | | | | | | 4.10 | % |
| Net interest margin | | | | | 3.67 | % | | | | | | 4.29 | % |
| Average interest earning assets to average interest bearing liabilities | | | | | 156.58 | % | | | | | | 150.48 | % |
|
| | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, |
| | 2017 | | 2016 |
| | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate (1) | | Average Balance | | Interest Earned/ Paid | | Average
Yield/
Rate (1) |
| | (Dollars in thousands) |
| Interest Earning Assets: | | | | | | | | | | | |
Total loans receivable, net (2) (3) | $ | 2,737,535 |
| | $ | 32,595 |
| | 4.72 | % | | $ | 2,526,150 |
| | $ | 30,915 |
| | 4.87 | % |
| Taxable securities | 562,256 |
| | 3,117 |
| | 2.20 |
| | 588,749 |
| | 2,888 |
| | 1.95 |
|
Nontaxable securities (3) | 229,683 |
| | 1,354 |
| | 2.34 |
| | 225,994 |
| | 1,235 |
| | 2.17 |
|
| Other interest earning assets | 72,643 |
| | 258 |
| | 1.41 |
| | 42,934 |
| | 76 |
| | 0.70 |
|
| Total interest earning assets | 3,602,117 |
| | 37,324 |
| | 4.11 | % | | 3,383,827 |
| | 35,114 |
| | 4.13 | % |
| Noninterest earning assets | 418,100 |
| | | | | | 408,634 |
| | | | |
| Total assets | $ | 4,020,217 |
| | | | | | $ | 3,792,461 |
| | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | |
| Certificates of deposit | $ | 394,345 |
| | $ | 633 |
| | 0.64 | % | | $ | 378,407 |
| | $ | 468 |
| | 0.49 | % |
| Savings accounts | 494,990 |
| | 360 |
| | 0.29 |
| | 507,523 |
| | 214 |
| | 0.17 |
|
| Interest bearing demand and money market accounts | 1,499,335 |
| | 635 |
| | 0.17 |
| | 1,480,220 |
| | 587 |
| | 0.16 |
|
| Total interest bearing deposits | 2,388,670 |
| | 1,628 |
| | 0.27 |
| | 2,366,150 |
| | 1,269 |
| | 0.21 |
|
| FHLB advances and other borrowings | 111,293 |
| | 428 |
| | 1.53 |
| | 5,618 |
| | 8 |
| | 0.57 |
|
| Securities sold under agreement to repurchase | 28,999 |
| | 16 |
| | 0.22 |
| | 18,861 |
| | 10 |
| | 0.21 |
|
| Junior subordinated debentures | 19,897 |
| | 261 |
| | 5.20 |
| | 19,602 |
| | 221 |
| | 4.49 |
|
| Total interest bearing liabilities | 2,548,859 |
| | 2,333 |
| | 0.36 | % | | 2,410,231 |
| | 1,508 |
| | 0.25 | % |
| Demand and other noninterest bearing deposits | 916,074 |
| | | | | | 844,468 |
| | | | |
| Other noninterest bearing liabilities | 50,022 |
| | | | | | 44,378 |
| | | | |
| Stockholders’ equity | 505,262 |
| | | | | | 493,384 |
| | | | |
| Total liabilities and stockholders’ equity | $ | 4,020,217 |
| | | | | | $ | 3,792,461 |
| | | | |
| Net interest income |
| | $ | 34,991 |
| | | | | | $ | 33,606 |
| | |
| Net interest spread | | | | | 3.75 | % | | | | | | 3.88 | % |
| Net interest margin | | | | | 3.85 | % | | | | | | 3.95 | % |
| Average interest earning assets to average interest bearing liabilities | | | | | 141.32 | % | | | | | | 140.39 | % |
(3)Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis.
| |
(2)
| The average loan balances presented in the table are net of allowances for loan losses. Nonaccrual loans have been included in the table as loans carrying a zero yield. |
| |
(3)
| Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis. |
Interest Income
Total interest income increased $2.2decreased $4.3 million, or 6.3%2.6%, to $37.3$159.6 million for the threenine months ended September 30, 20172020 compared to $35.1$163.9 million for the same period in 2016.2019 due primarily to decreases in yields on adjustable rate instruments following several decreases in short-term market rates, offset partially by increases in interest earning assets, primarily due to SBA PPP loans. The yield on total interest earning assets decreased 73 basis points to 3.94%, for the nine months ended September 30, 2020 compared to 4.67% for the nine months ended September 30, 2019. The balance of average interest earning assets increased $218.3$718.6 million, or 6.5%15.3%, to $3.60$5.41 billion for the threenine months ended September 30, 20172020 from $3.38$4.69 billion for the threenine months ended September 30, 20162019, including increases in average balances of SBA PPP loans of $511.5 million and the average yield on total interest earning assetsdeposits of $163.8 million.
Interest and fees on loans decreased two basis points$323,000, or 0.2%, to 4.11% for$142.3 million during the threenine months ended September 30, 20172020 compared to 4.13% for the three months ended September 30, 2016.
Interest income from interest and fees on loans increased $1.7 million, or 5.4%, to $32.6 million for the three months ended September 30, 2017 from $30.9$142.7 million for the same period in 2016 primarily due to an increase in average loans receivable of $211.4 million, or 8.4%, as a result of loan growth, offset partially by a 15 basis point decrease in the average loan yield to 4.72% for the three months ended September 30, 2017 from 4.87% for the three months ended September 30, 2016. The decrease in average loan yield was2019 due primarily to a decrease in incremental accretion income on purchased loans and secondarily to a decreasethe loan yield, offset partially by an increase in contractual note rates.
The following table presents the average loan balance. Loan yield decreased 76 basis points to 4.46% for the nine months ended September 30, 2020 from 5.22% for the nine months ended September 30, 2019 due primarily to the multiple and effectssustained decreases in short-term market rates and secondarily due to the impact of thelow-yielding SBA PPP loans. Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, for the three months ended September 30, 2017 and 2016:
|
| | | | | | | | |
| | | Three Months Ended September 30, |
| | | 2017 | | 2016 |
| | | (Dollars in thousands) |
Average loan yield, excluding incremental accretion on purchased loans (1) | | 4.57 | % | | 4.63 | % |
| Impact on average loan yield from incremental accretion on purchased loans (1) | | 0.15 | % | | 0.24 | % |
| Average loan yield | | 4.72 | % | | 4.87 | % |
| | | | | |
Incremental accretion on purchased loans (1) | | $ | 1,036 |
| | $ | 1,530 |
|
| |
(1)
| As of the dates of the completion of each of the merger and acquisition transactions, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is modified quarterly as a result of cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes. |
Incremental accretion income was $1.0 million and $1.5 million for the three months ended September 30, 2017 and 2016, respectively. The decrease in the incremental accretion was primarily a result of a continued decline in the purchased loan balances and a decrease in the prepayments of purchased loans during the three months ended September 30, 2017 compareddecreased 49 basis points to the same period in 2016. The incremental accretion is expected to continue to decrease as the balance of the purchased loans continues to decrease.
Total interest income increased primarily due to the increase in interest and fees on loans discussed above and secondarily due to a $348,000, or 8.4%, increase in interest income on investment securities to $4.5 million during the three months ended September 30, 2017 from $4.1 million4.59% for the three months ended September 30, 2016. The increase in income on investment securities was a result of an increase in average investment yields for the three months ended September 30, 2017 compared to the same period in 2016, offset partially by a decrease in the average balance of investment securities. Average yields on taxable securities increased 25 basis points to 2.20% for the three months ended September 30, 2017 from 1.95% for the same period in 2016. Average yields on nontaxable securities increased 17 basis points to 2.34% for the three months ended September 30, 2017 from 2.17% for the same period in 2016. The average balance of investment securities decreased $22.8 million, or 2.8%, to $791.9 million during the three months ended September 30, 2017 from $814.7 million during the three months ended September 30, 2016. The Company has actively managed its investment securities portfolio to mitigate declining trends in loan yields.
Average other interest earning assets increased $29.7 million, or 69.2%, to $72.6 million for the three months ended September 30, 2017 compared to $42.9 million for the three months ended September 30, 2016. The increase was due primarily to an increase in interest earning deposits, as the Bank held more funds in interest earning accounts at the Federal Reserve Bank of San Francisco compared to the same period in the prior year.
Interest Expense
Total interest expense increased $825,000, or 54.7%, to $2.3 million for the three months ended September 30, 2017 compared to $1.5 million for the same period in 2016. The average cost of interest bearing liabilities increased 11 basis points to 0.36% for the three months ended September 30, 2017 from 0.25% for the three months ended September 30, 2016 as a result of increases in market rates. Total average interest bearing liabilities increased by $138.6 million, or 5.8%, to $2.55 billion for the three months ended September 30, 2017 from $2.41 billion for the three months ended September 30, 2016.
The average cost of interest bearing deposits increased six basis points to 0.27% for the three months ended September 30, 2017 from 0.21% for the same period in 2016 primarily as a result of increases in both the average balance and cost of certificates of deposit and an increase in the average cost of savings accounts.
Interest expense on certificates of deposit increased $165,000, or 35.3%, to $633,000 during the three months ended September 30, 2017 from $468,000 for the same period in 2016 due to increases in the average balance and the cost of the certificates of deposits accounts. The average balance of certificates of deposits increased $15.9 million, or 4.2%, to $394.3 million, for the three months ended September 30, 2017 from $378.4 million for the same period in 2016. The cost of certificates of deposits increased 15 basis points to 0.64% for the three months ended September 30, 2017 from 0.49% for the same period in 2016.
Interest expense on savings accounts increased $146,000, or 68.2%, to $360,000 during the three months ended September 30, 2017 from $214,000 for the same period in 2016 due primarily to the 12 basis point increase of the cost of the savings accounts to 0.29% for the three months ended September 30, 2017 from 0.17% for the same period in 2016.
Interest expense on FHLB advances and other borrowings increased $420,000, or 52.5%, to $428,000 for the three months ended September 30, 2018 from $8,000 for the same period in 2016 due to a combination of an increase in both average balances and cost of funds. The average balance for FHLB advances and other borrowings increased $105.7 million, or 1,881.0%, to $111.3 million for the three months ended September 30, 2017 from $5.6 million for the same period in 2016, due primarily to fund loan growth. The average rate of the FHLB advances for the three months ended September 30, 2017 was 1.53%, an increase of 96 basis points from 0.57% for the same period in 2016, due primarily to continued increases in short-term borrowing rates over the last year.
The average rate of the junior subordinated debentures, including the effects of accretion of the discount established as of the date of the merger with Washington Banking Company, for the three months ended September 30, 2017 was 5.20%, an increase of 71 basis points from 4.49% for the same period in 2016. The rate increase on the debentures was due to an increase in the three-month LIBOR rate to 1.33% at September 30, 2017 from 0.85% on September 30, 2016.
Net Interest Margin
Net interest margin for the three months ended September 30, 2017 decreased ten basis points to 3.85% from 3.95% for the same period in 2016 primarily due to the decline in the incremental accretion on purchased loans, as discussed below. The net interest spread for the three months ended September 30, 2017 decreased 13 basis points to 3.75% from 3.88% for the same period in 2016. The decrease was primarily due to the above mentioned increases in the cost of funds of interest bearing liabilities.
Net interest margin is impacted by the incremental accretion on purchased loans. The following table presents the net interest margin and effects of the incremental accretion on purchased loans for the three months ended September 30, 2017 and 2016:
|
| | | | | | |
| | | Three Months Ended September 30, |
| | | 2017 | | 2016 |
Net interest margin, excluding incremental accretion on purchased loans (1) | | 3.74 | % | | 3.77 | % |
Impact on net interest margin from incremental accretion on purchased loans (1) | | 0.11 |
| | 0.18 |
|
| Net interest margin | | 3.85 | % | | 3.95 | % |
| |
(1)
| As of the dates of the completion of each of the merger and acquisition transactions, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is modified quarterly as a result of cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes. |
Comparison of nine months ended September 30, 20172020 compared to 5.08% for the comparable period inended September 30, 2019. Loan yields decreased 21 basis points as result of SBA PPP loans yielding a rate of 2.80%, inclusive of the prior year
Net interest incomerelated deferred fee, for the nine months ended September 30, 2020. The average loan balance increased $2.9$614.9 million, or 2.9%16.8%, to $102.3$4.27 billion during the nine months ended September 30, 2020 compared to $3.65 billion during the nine months ended September 30, 2019 due primarily to the impact of SBA PPP loans with average balance of $511.5 million for the nine months ended September 30, 2017 compared2020. There were no SBA PPP loans outstanding during the nine months ended September 30, 2019.
The following table presents the loan yield and the impacts of the balances and interest and fees earned on SBA PPP loans and the incremental accretion on purchased loans on this financial measure for the periods presented below:
| | | | | | | | | | | |
| | Nine Months Ended
September 30, |
| | 2020 | | 2019 |
| (Dollars in thousands) |
Non-GAAP reconciliation of loan yield:(1) | | | |
| Loan yield (GAAP) | 4.46 | % | | 5.22 | % |
| Exclude Impact on loan yield from SBA PPP loans | 0.21 | | | — | |
Exclude impact on loan yield from incremental accretion on purchased loans(2) | (0.08) | | | (0.14) | |
| Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) | 4.59 | % | | 5.08 | % |
| | | |
| | | |
(1) For additional information, see "Non-GAAP Financial Measures."
(2) Represents the amount of interest income recorded on purchased loans in excess of the contractual stated interest rate in the individual loan notes due to $99.5incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified by the CECL Adoption. The purchased discount is accreted into income over the remaining life of the loan. The impact of incremental accretion on loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the balance of the purchased loans decreases.
Interest income on investment securities decreased $3.3 million, or 16.7%, to $16.8 million during the nine months ended September 30, 2020 from $20.1 million during the nine months ended September 30, 2019 due primarily to decreases in market interest rates impacting adjustable rate securities. The yield on the aggregate investment portfolio decreased 31 points to 2.47% for the nine months ended September 30, 2020 from 2.78% for the same period in 2016. The following table provides relevant net2019, including decreases of 34 basis points and 11 basis points on the yield on taxable securities and nontaxable securities, respectively. Also contributing to the decline in interest income information foron investment securities was a decrease in average balance of $60.1 million, or 6.2%, to $907.5 million during the dates indicated.nine months ended September 30, 2020 from $967.6 million during the nine months ended September 30, 2019 due primarily to prepayments and calls of securities as a result of the currently low interest rate environment. The decrease in the average balance of investment securities included a decrease of $69.3 million, or 8.4%, in the average balance of taxable securities, offset partially by an increase of $9.2 million, or 6.6%, in the average balance of nontaxable securities during the nine months ended September 30, 2020.
Interest income on interest earning deposits decreased $594,000, or 51.4%, to $561,000 during the nine months ended September 30, 2020 from $1.2 million during the nine months ended September 30, 2019 due primarily to a decrease in the yield on interest earning deposits, offset partially by an increase in the average balance. The yield on interest earning deposits decreased 188 basis points to 0.32% during the nine months ended September 30, 2020 compared to 2.20% during the same period in 2019 due to decreases in the short-term market rates. The average interest earning deposits increased $163.8 million, or 233.0%, to $234.0 million during the nine months ended September 30, 2020 compared to $70.3 million during the same period in 2019 due primarily to the increase in deposits.
|
| | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2017 | | 2016 |
| | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate (1) | | Average Balance | | Interest Earned/ Paid | | Average
Yield/
Rate (1) |
| | (Dollars in thousands) |
| Interest Earning Assets: | | | | | | | | | | | |
| Total loans receivable, net (2) (3) | $ | 2,676,153 |
| | $ | 94,580 |
| | 4.73 | % | | $ | 2,461,856 |
| | $ | 91,595 |
| | 4.97 | % |
| Taxable securities | 565,528 |
| | 9,307 |
| | 2.20 |
| | 594,301 |
| | 8,522 |
| | 1.92 |
|
| Nontaxable securities (3) | 225,583 |
| | 3,926 |
| | 2.33 |
| | 220,038 |
| | 3,599 |
| | 2.18 |
|
| Other interest earning assets | 51,049 |
| | 461 |
| | 1.21 |
| | 47,829 |
| | 225 |
| | 0.63 |
|
| Total interest earning assets | 3,518,313 |
| | 108,274 |
| | 4.11 | % | | 3,324,024 |
| | 103,941 |
| | 4.18 | % |
| Noninterest earning assets | 418,837 |
| | | | | | 391,342 |
| | | | |
| Total assets | $ | 3,937,150 |
| | | | | | $ | 3,715,366 |
| | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | |
| Certificates of deposit | $ | 369,724 |
| | $ | 1,527 |
| | 0.55 | % | | $ | 397,070 |
| | $ | 1,496 |
| | 0.50 | % |
| Savings accounts | 499,353 |
| | 940 |
| | 0.25 |
| | 478,762 |
| | 540 |
| | 0.15 |
|
| Interest bearing demand and money market accounts | 1,489,149 |
| | 1,834 |
| | 0.16 |
| | 1,457,399 |
| | 1,729 |
| | 0.16 |
|
| Total interest bearing deposits | 2,358,226 |
| | 4,301 |
| | 0.24 |
| | 2,333,231 |
| | 3,765 |
| | 0.22 |
|
| FHLB advances and other borrowings | 106,556 |
| | 870 |
| | 1.09 |
| | 11,608 |
| | 47 |
| | 0.54 |
|
| Securities sold under agreement to repurchase | 23,660 |
| | 38 |
| | 0.21 |
| | 20,031 |
| | 31 |
| | 0.21 |
|
| Junior subordinated debentures | 19,823 |
| | 748 |
| | 5.05 |
| | 19,527 |
| | 647 |
| | 4.43 |
|
| Total interest bearing liabilities | 2,508,265 |
| | 5,957 |
| | 0.32 | % | | 2,384,397 |
| | 4,490 |
| | 0.25 | % |
| Demand and other noninterest bearing deposits | 885,467 |
| | | | | | 811,043 |
| | | | |
| Other noninterest bearing liabilities | 47,283 |
| | | | | | 35,266 |
| | | | |
| Stockholders’ equity | 496,135 |
| | | | | | 484,660 |
| | | | |
| Total liabilities and stockholders’ equity | $ | 3,937,150 |
| | | | | | $ | 3,715,366 |
| | | | |
| Net interest income | | | $ | 102,317 |
| | | | | | $ | 99,451 |
| | |
| Net interest spread | | | | | 3.79 | % | | | | | | 3.93 | % |
| Net interest margin | | | | | 3.89 | % | | | | | | 4.00 | % |
| Average interest earning assets to average interest bearing liabilities | | | | | 140.27 | % | | | | | | 139.41 | % |
| |
(2)
| The average loan balances presented in the table are net of allowances for loan losses. Nonaccrual loans have been included in the table as loans carrying a zero yield. |
| |
(3)
| Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis. |
Interest IncomeExpense
Total interest income increased $4.3expense decreased $2.2 million, or 4.2%16.8%, to $108.3$11.1 million for the nine months ended September 30, 20172020 compared to $103.9$13.3 million for the same period in 2016.2019 due primarily to decreases in market interest rates following decreases in the federal funds target rate mentioned previously, offset partially by an increase in the average balance of total interest bearing liabilities. The cost of total interest bearing liabilities decreased 14 basis points to 0.43% for the nine months ended September 30, 2020 from 0.57% for the nine months ended September 30, 2019. The balance of average interest earning assetsbearing liabilities increased $194.3$337.5 million, or 5.8%10.8%, to $3.52$3.45 billion for the nine months ended September 30, 20172020 compared to $3.12 billion for the same period in 2019.
Interest expense on total interest bearing deposits decreased $1.6 million, or 13.5%, to $10.3 million during the nine months ended September 30, 2020 compared to $11.9 million during the same period in 2019 due primarily to decreases in market interest rates following decreases in the federal funds target rate previously mentioned, offset partially by an increase in the average balance. The cost of total interest bearing deposits decreased 12 basis points to 0.40% from $3.320.52% due primarily to a decrease in the cost of savings accounts of 43 basis points to 0.12% from 0.55% and secondarily to a decrease in the cost of interest bearing demand and money market accounts of five basis points to 0.27% for the nine months ended September 30, 2020 from 0.32% for the same period in 2019.
The decrease in cost of total interest bearing deposits was offset partially by an increase in the average balance of total interest bearing deposits of $356.4 million, or 11.7%, to $3.41 billion for the nine months ended September 30, 2016 and the yield on total interest earning assets decreased seven basis points to 4.11% for the nine months ended September 30, 20172020 compared to 4.18% for the nine months ended September 30, 2016.
Interest income from interest and fees on loans increased $3.0 million, or 3.3%, to $94.6 million for the nine months ended September 30, 2017 from $91.6 million$3.05 billion for the same period in 20162019 due primarily to proceeds from SBA PPP loans deposited directly into customer accounts and an increase in customer deposit accounts due to a change in spending habits as a result of COVID-19.
The Company's deposit costs were favorably impacted by the increase in the average loans receivable, offset partially by a decrease inbalance of noninterest bearing demand deposits compared to total interest bearing deposits. The average loan yields. Average loans receivablebalance of noninterest bearing demand deposits increased $214.3$403.1 million, or 8.7%29.5%, to $2.68$1.77 billion for the nine months ended September 30, 20172020 compared to $2.46$1.37 billion for the same period in 2019. The increase in the average balance of noninterest bearing deposits caused a decrease in the total cost of deposits of nine basis points to 0.27% for the nine months ended September 30, 2016. Average loan yields2020 from 0.36% for the same period in 2019.
Net Interest Margin
Net interest margin decreased 2462 basis points to 4.73%3.67% for the nine months ended September 30, 20172020 from 4.97%4.29% for the same period in 2019 primarily due to the above mentioned changes in asset yields and the mix of interest earning assets, offset partially by a decrease in the cost of interest bearing liabilities. The net interest spread decreased 59 basis points to 3.51% for the nine months ended September 30, 2016 due mostly to a decrease in incremental accretion income.
The following table presents the average loan yield and effects of the incremental accretion on purchased loans2020 from 4.10% for the nine months ended September 30, 2017 and 2016:
|
| | | | | | | | |
| | | Nine Months Ended September 30, |
| | | 2017 | | 2016 |
| | | (Dollars in thousands) |
Average loan yield, excluding incremental accretion on purchased loans (1) | | 4.55 | % | | 4.66 | % |
| Impact on average loan yield from incremental accretion on purchased loans (1) | | 0.18 | % | | 0.31 | % |
| Average loan yield | | 4.73 | % | | 4.97 | % |
| | | | | |
Incremental accretion on purchased loans (1) | | $ | 3,687 |
| | $ | 5,669 |
|
| |
(1)
| As of the dates of the completion of each of the merger and acquisition transactions, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is modified quarterly as a result of cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes. |
Incremental accretion income was $3.7 million and $5.7 million for the nine months ended September 30, 2017 and 2016, respectively. The decrease in the incremental accretion was primarily a result of a continued decline in the purchased loan balances and a decrease in the prepayments of purchased loans during the nine months ended September 30, 2017 compared to the same period in 2016. The incremental accretion is expected to continue to decrease as the balance of the purchased loans continues to decrease.
Total interest income increased2019 primarily due to the increasedecrease in the yield of total interest and fees on loans discussed above and secondarily due to a $1.1 million, or 9.2%, increase in interest income on investment securities to $13.2 million during the nine months ended September 30, 2017 from $12.1 million for the nine months ended September 30, 2016. The increase in interest income on investment securities was the result of an increase in average investment yields for the nine months ended September 30, 2017 compared to the same period in 2016,earning assets, offset partially by a decrease in the average balance of investment securities. Average yields on taxable securities increased 28 basis points to 2.20% for the nine months ended September 30, 2017 from 1.92% for the same period in 2016. Average yields on nontaxable securities increased 15 basis points to 2.33% for the nine months ended September 30, 2017 from 2.18% for the same period in 2016. The average balance of investment securities decreased $23.2 million, or 2.9%, to $791.1 million during the nine months ended September 30, 2017 from $814.3 million during the nine months ended September 30, 2016. The Company has actively managed its investment securities portfolio to mitigate declining, but recently improving, loan yields.
Average other interest earning assets increased $3.2 million, or 6.7%, to $51.0 million for the nine months ended September 30, 2017 compared to $47.8 million for the nine months ended September 30, 2016. The increase was due primarily to an increase in interest earning deposits, as the Bank held more funds in interest earning accounts at the Federal Reserve Bank of San Francisco compared to the same period in 2016.
Interest Expense
Total interest expense increased $1.5 million, or 32.7%, to $6.0 million for the nine months ended September 30, 2017 compared to $4.5 million for the same period in 2016. The average cost of interest bearing liabilities increased seven basis points to 0.32% for the nine months ended September 30, 2017 from 0.25% for the nine months ended September 30, 2016. Total average interest bearing liabilities increased by $123.9 million, or 5.2%, to $2.51 billion for the nine months ended September 30, 2017 from $2.38 billion for the nine months ended September 30, 2016.
The average cost of interest bearing deposits increased two basis points to 0.24% for the nine months ended September 30, 2017 from 0.22% for the same period in 2016 due primarily to the changes in savings accounts.
Interest expense on savings accounts increased $400,000, or 74.1%, to $940,000 for the nine months ended September 30, 2017 from $540,000 for the same period in 2016 due to increases in both the average balance and cost of the savings accounts. The average balance of savings accounts increased $20.6 million, or 4.3%, to $499.4 million for the nine months ended September 30, 2017 from $478.8 million for the same period in 2016. The cost of savings accounts increased ten basis points to 0.25% for the nine months ended September 30, 2017 from 0.15% for the same period in 2016.
Interest expense of certificates of deposit accounts increased only $31,000, or 2.1%, to $1.5 million for the nine months ended September 30, 2017. The average balance of certificates of deposit decreased $27.3 million, or
6.9%, to $369.7 million for the nine months ended September 30, 2017 compared to $397.1 million for the nine months ended September 30, 2016 while the cost of certificates of deposits increased to 0.55% for the nine months ended September 30, 2017 from 0.50% for the same period in 2016.
Interest expense on FHLB advances and other borrowings increased $823,000 to $870,000 for the nine months ended September 30, 2017 from $47,000 for the nine months ended September 30, 2016 due to a combination of an increase in average balances and an increase in the cost of funds. The average balance for FHLB advances and other borrowings increased $94.9 million to $106.6 million for the nine months ended September 30, 2017 from $11.6 million for the same period in 2016, due primarily to fund loan growth. The average rate of the FHLB advances and other borrowings for the nine months ended September 30, 2017 was 1.09%, an increase of 55 basis points from 0.54% for the same period in 2016.
The average rate of the junior subordinated debentures, including the effects of accretion of the discount established as of the date of the merger with Washington Banking Company, for the nine months ended September 30, 2017 was 5.05%, an increase of 62 basis points from 4.43% for the same period in 2016. The rate increase on the debentures was due to an increase in the three-month LIBOR rate to 1.33% at September 30, 2017 from 0.85% on September 30, 2016.
Net Interest Margin
Net interest margin for the nine months ended September 30, 2017 decreased 11 basis points to 3.89% from 4.00% for the same period in 2016 primarily due to the decline in the incremental accretion on purchased loans, as discussed below. The net interest spread for the nine months ended September 30, 2017 decreased 14 basis points to 3.79% from 3.93% for the same period in 2016. This decrease was primarily due to the above mentioned decrease in average yields on total interest earning assets and increase in the average cost of funds of total interest bearing liabilities.
Net interest margin
Provision for Credit Losses
Effective January 1, 2020, the Bank adopted ASU 2016-13. CECL Adoption replaced the allowance for loan losses with the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans. CECL Adoption also replaced the allowance for unfunded commitments with the ACL on unfunded commitments and replaced the related provision for unfunded commitments with the provision for credit losses on unfunded commitments. The aggregate of the provision for credit losses on loans and the provision for credit losses on unfunded commitments is impacted bypresented on the incremental accretionCompany's Condensed Consolidated Statements of Income as the provision for credit losses. The ACL on purchased loans. unfunded commitments is included on the Company's Condensed Consolidated Statements of Financial Condition as accrued expenses and other liabilities.
The following table presents the net interest margin and effects of the incremental accretion on purchased loansprovision for credit losses for the nine months ended September 30, 2017 and 2016:periods presented below:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (In thousands) |
| Provision for credit losses on loans | $ | 2,320 | | | $ | 466 | | | $ | 38,225 | | | $ | 2,753 | |
| Provision for credit losses on unfunded commitments | 410 | | | — | | | 1,014 | | | — | |
| Provision for credit losses | $ | 2,730 | | | $ | 466 | | | $ | 39,239 | | | $ | 2,753 | |
|
| | | | | | |
| | | Nine Months Ended September 30, |
| | | 2017 | | 2016 |
Net interest margin, excluding incremental accretion on purchased loans (1) | | 3.75 | % | | 3.77 | % |
Impact on net interest margin from incremental accretion on purchased loans (1) | | 0.14 |
| | 0.23 |
|
| Net interest margin | | 3.89 | % | | 4.00 | % |
| |
(1)
| As of the dates of the completion of each of the merger and acquisition transactions, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is modified quarterly as a result of cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes. |
Provision for LoanCredit Losses on Loans
The Bank has established a comprehensive methodology for determining its allowance for loan losses.ACL on loans. The allowance for loan lossesACL on loans is increased by provisionsprovision for loancredit losses on loans charged to earnings. The amount of the provision expense recognized during the three and is reduced by loans charged-off, netnine months ended September 30, 2020 was calculated based on a thorough review of the loan recoveries or a recoveryportfolio and in accordance with the Bank's CECL methodology for determining the current expected credit losses on loans. The amount of previous provision.the provision expense recognized during the three and nine months ended September 30, 2019 was calculated in accordance with the Bank's incurred loss methodology. For additional information, see the section entitled "Analysis of Allowance for Loan Losses"Credit Losses on Loans" below.
The provision for loancredit losses on loans is dependent on the Bank’s ability to manage asset quality and control the level of net charge-offs through prudent underwriting standards. In addition, a further decline in general economic conditions, including as a result of COVID-19, could increase future provisions for loancredit losses on loans and have a material adverse effect on the Company’s net income.
Comparison of quarter ended September 30, 20172020 to the comparable quarter in the prior yearyear.
The provision for loancredit losses decreased $611,000,on loans increased $1.9 million, or 40.9%397.9%, to $884,000$2.3 million for the three months ended September 30, 20172020 from $1.5 million$466,000for the three months ended September 30, 2016. The decrease2019 due primarily to increases in the provisionACL for loan lossesnonperforming loans, caused by the COVID-19 pandemic, as explained in the "Analysis of Allowance for the threeCredit Losses on Loans" below.
Comparison of nine months ended September 30, 2017 from2020 to the samecomparable period in 2016 wasthe prior year.
The provision for credit losses on loans increased $35.5 million, or 1288.5%, to $38.2 million for the nine months ended September 30, 2020 from $2.8 million for the nine months ended September 30, 2019 due primarily to the worsening of the economic conditions as a result of a changethe COVID-19 pandemic as explained in the composition"Analysis of Allowance for Credit Losses on Loans" below.
Provision for Credit Losses on Unfunded Commitments
The Bank has established a comprehensive methodology for determining its ACL on unfunded commitments, which is similar to the ACL on loans with additional considerations for the likelihood of funding over the contractual life of the loan portfolio, changes in certain environmental factorscommitment. The ACL on unfunded commitments is increased by the provision for credit losses recorded through earnings. The amount of the provision expense recognized during the three and improvements in certain historical loss factors. Basednine months ended September 30, 2020 was calculated based on a thorough review of the loan portfolio and in accordance with the Bank determined thatBank's CECL methodology for determining the current expected credit losses on unfunded commitments. The amount of the provision for
loan losses forexpense recognized during the three and nine months ended September 30, 2017 was appropriate as it2019 was calculated in accordance with the Bank's methodologyincurred loss methodology.
Comparison of quarter ended September 30, 2020 to the comparable quarter in the prior year.
The Bank recorded a provision for determiningcredit losses on unfunded commitments of $410,000 during the allowance forthree months ended September 30, 2020 primarily due to the decrease in utilization rate of revolving commercial and industrial loans to 23.3% at September 30, 2020 compared to 26.2% at June 30, 2020 and worsening economic conditions applied to the commercial and industrial loan losses.segment due to COVID-19.
Comparison of nine months ended September 30, 20172020 to the comparable period in the prior yearyear.
The Bank recorded a provision for loancredit losses decreased $872,000, or 23.2% to $2.9on unfunded commitments of $1.0 million forduring the nine months ended September 30, 2017 from $3.8 million for the nine months ended September 30, 2016. The2020 primarily as a result of worsening economic conditions due to COVID-19 and a decrease in the provisionutilization rates for loan losses for the nine months endedrevolving lines of credit to 38.4% at September 30, 2017 from the same period in 2016 was primarily the result of a change in the volume and mix of loans, changes in certain environmental factors and improvements in certain historical loss factors. Based on a thorough review of the loan portfolio, the Bank determined that the provision for loan losses for the nine months ended September 30, 2017 was appropriate as it was calculated in accordance with the Bank's methodology for determining the allowance for loan losses.2020 compared to 39.3% at December 31, 2019.
Noninterest Income
Comparison of quarter ended September 30, 20172020 to the comparable quarter in the prior yearyear.
Total noninterestnoninterest income decreased $1.5 million,$248,000, or 14.9%2.9%, to $8.4$8.2 million for the three months ended September 30, 2017 compared to $9.92020 from $8.5 million for the same period in 2016.2019. The following table presents the change in the key components of noninterest income for the periods noted.noted:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | | | |
| 2020 | | 2019 | | Change | | Percentage Change |
| (Dollars in thousands) |
| Service charges and other fees | $ | 4,039 | | | $ | 4,779 | | | $ | (740) | | | (15.5) | % |
| Gain on sale of investment securities, net | 40 | | | 281 | | | (241) | | | (85.8) | |
| Gain on sale of loans, net | 1,443 | | | 993 | | | 450 | | | 45.3 | |
| Interest rate swap fees | 396 | | | 152 | | | 244 | | | 160.5 | |
| Other income | 2,292 | | | 2,253 | | | 39 | | | 1.7 | |
| Total noninterest income | $ | 8,210 | | | $ | 8,458 | | | $ | (248) | | | (2.9) | % |
|
| | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | | |
| | 2017 | | 2016 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Service charges and other fees | $ | 4,769 |
| | $ | 3,630 |
| | $ | 1,139 |
| | 31.4 | % |
| Gain on sale of investment securities, net | 44 |
| | 345 |
| | (301 | ) | | (87.2 | ) |
| Gain on sale of loans, net | 1,229 |
| | 3,435 |
| | (2,206 | ) | | (64.2 | ) |
| Interest rate swap fees | 328 |
| | 742 |
| | (414 | ) | | (55.8 | ) |
| Other income | 2,024 |
| | 1,715 |
| | 309 |
| | 18.0 |
|
| Total noninterest income | $ | 8,394 |
| | $ | 9,867 |
| | $ | (1,473 | ) | | (14.9 | )% |
Gain on the saleService charges and other fees decreased of loans, net decreased $2.2 million,$740,000, or 64.2%15.5%, to $1.2$4.0 million for the three months ended September 30, 20172020 compared to $3.4$4.8 million for the same period in 2016, due primarily to a $2.1 million gain on sale of a previously classified purchased credit impaired loan recognized in 2016. The detail of gain on sale of loans, net is included in the following schedule.
|
| | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | |
| | 2017 | | 2016 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Mortgage loans | $ | 875 |
| | $ | 1,087 |
| | $ | (212 | ) | | (19.5 | )% |
| SBA loans | 354 |
| | 285 |
| | 69 |
| | 24.2 |
|
| Other loans | — |
| | 2,063 |
| | (2,063 | ) | | (100.0 | ) |
| Total gain on sale of loans, net | $ | 1,229 |
| | $ | 3,435 |
| | $ | (2,206 | ) | | (64.2 | )% |
Interest rate swap fees decreased $414,000, or 55.8% to $328,000 for the three months ended September 30, 2017 compared to $742,000 the same period in 2016,2019 due primarily to a decrease in the numberoverdraft fees of swaps executed$561,000 from changes in customer spending habits during the three months ended September 30, 2017 compared to the three months ended September 30, 2016.COVID-19 pandemic.
The decrease in noninterest income was offset partially offset by an increase in service charges and other feesgain on sale of $1.1 million,loans, net, of $450,000, or 31.4%45.3%, to $4.8$1.4 million for the three months ended September 30, 20172020 compared to $3.6$993,000 for the same period in 2019 primarily as a result of an increase in sales due to an increase in origination volume generated by the currently low interest rate environment, offset partially by a lower average loan sale margin. Mortgage loans held for sale originations increased by $19.1 million, or 162.5%, to $44.6 million for the three months ended September 30, 2020 from $25.5 million for the same period in 2016, due primarily to a consumer deposit account consolidation process completed at the end of 2016 and a business deposit consolidation process completed during second quarter 2017 and the related changes in fee structures, as well as increases in deposit balances.2019.
Comparison of nine months ended September 30, 20172020 to the comparable period in the prior year
Total noninterestnoninterest income increased $3.0$2.5 million, or 12.7%10.6%, to $26.4$25.9 million for the nine months ended September 30, 20172020 compared to $23.4$23.5 million for the same period in 2016.2019. The following table presents the change in the key components of noninterest income for the periods noted.noted:
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended
September 30, | | | | |
| 2020 | | 2019 | | Change | | Percentage Change |
| (Dollars in thousands) |
| Service charges and other fees | $ | 12,015 | | | $ | 14,109 | | | $ | (2,094) | | | (14.8) | % |
| Gain on sale of investment securities, net | 1,463 | | | 329 | | | 1,134 | | | 344.7 | |
| Gain on sale of loans, net | 3,125 | | | 1,613 | | | 1,512 | | | 93.7 | |
| Interest rate swap fees | 1,461 | | | 313 | | | 1,148 | | | 366.8 | |
| Other income | 7,880 | | | 7,087 | | | 793 | | | 11.2 | |
| Total noninterest income | $ | 25,944 | | | $ | 23,451 | | | $ | 2,493 | | | 10.6 | % |
|
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | | | | |
| | 2017 | | 2016 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Service charges and other fees | $ | 13,408 |
| | $ | 10,462 |
| | $ | 2,946 |
| | 28.2 | % |
| Gain on sale of investment securities, net | 161 |
| | 1,106 |
| | (945 | ) | | (85.4 | ) |
| Gain on sale of loans, net | 6,562 |
| | 5,406 |
| | 1,156 |
| | 21.4 |
|
| Interest rate swap fees | 743 |
| | 1,105 |
| | (362 | ) | | (32.8 | ) |
| Other income | 5,532 |
| | 5,354 |
| | 178 |
| | 3.3 |
|
| Total noninterest income | $ | 26,406 |
| | $ | 23,433 |
| | $ | 2,973 |
| | 12.7 | % |
Service charges and other feesGain on sale of loans, net increased $2.9$1.5 million, or 28.2%93.7%, to $13.4$3.1 million for the nine months ended September 30, 20172020 compared to $10.5$1.6 million for the same period in 2016, due2019 primarily toas a consumer deposit account consolidation process completed atresult of an increase in the end of 2016 and a business deposit consolidation process completed during second quarter 2017 and the related changes in fee structures, as well as increases in deposit balances.
Gain on salevolume of loans netsold due to an increase in originations reflecting the low interest rate environment during the nine months ended September 30, 2020. Mortgage loan held for sale originations increased $1.2by $47.6 million, or 21.4%103.7%, to $6.6$93.4 million for the nine months ended September 30, 2017 compared to $5.42020 from $45.9 millionfor the same period in 2016, due primarily to a $935,000 increase in sale of other loans. During each of the nine months ended September 30, 2017 and 2016, the Bank sold one loan previously classified as purchased credit impaired. In addition, gain2019.
Gain on sale of SBA loansinvestment securities, net increased $272,000 due primarily to an increase in proceeds from sale of SBA loans of $7.8$1.1 million, or 90.9%344.7%, to $16.4$1.5 million for the nine months ended September 30, 2017 compared to $8.6 million for2020 from $329,000 during the same period in 2016. The detail2019 as a result of gain on salethe Bank's active management of loans, net is includedthe investment portfolio in the following schedule.current low interest rate environment.
|
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | | |
| | 2017 | | 2016 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Mortgage loans | $ | 2,515 |
| | $ | 2,566 |
| | $ | (51 | ) | | (2.0 | )% |
| SBA loans | 1,049 |
| | 777 |
| | 272 |
| | 35.0 |
|
| Other loans | 2,998 |
| | 2,063 |
| | 935 |
| | 45.3 |
|
| Total gain on sale of loans, net | $ | 6,562 |
| | $ | 5,406 |
| | $ | 1,156 |
| | 21.4 | % |
The increase in noninterest income was partially offset by a decrease in gain on sale of investment securities, net of $945,000,Interest rate swap fees increased $1.1 million, or 85.4%366.8%, to $161,000 for the nine months ended September 30, 2017 from $1.1$1.5 million for the nine months ended September 30, 2016. The decrease was primarily2020 compared to $313,000 in the result of fewer sales as the Bank actively managed its investment portfolio. The proceeds from sale of investment securities was $21.9same period in 2019 based on customer transactions.
Other income increased $793,000, or 11.2%, to $7.9 million for the nine months ended September 30, 20172020 compared to $94.4$7.1 million for the same period in 2016.2019 due primarily to $653,000 of gain from a bank owned life insurance death benefit paid during the nine months ended September 30, 2020.
The increase in noninterest income was offset partially by a decrease in service charges and other fees of $2.1 million, or 14.8%, to $12.0 million for the nine months ended September 30, 2020 compared to $14.1 million for the same period in 2019 due primarily to a decrease in overdraft fees of $1.4 million from changes in customer spending habits and a decrease in activity-based fees on deposit accounts, in each case due to the COVID-19 pandemic.
Noninterest Expense
Comparison of quarter ended September 30, 20172020 to the comparable quarter in the prior yearyear.
Noninterest expense increased $1.1 million,expense decreased $674,000, or 4.2%1.8%, to $28.0$36.0 million during the three months ended September 30, 2017 compared to $26.82020 from $36.7 million forduring the three months ended September 30, 2016.2019. The following table presents changes in the key components of noninterest expense for the periods noted.noted:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | | | |
| 2020 | | 2019 | | Change | | Percentage Change |
| (Dollars in thousands) |
| Compensation and employee benefits | $ | 21,416 | | | $ | 21,733 | | | $ | (317) | | | (1.5) | % |
| Occupancy and equipment | 5,676 | | | 5,268 | | | 408 | | | 7.7 | |
| Data processing | 2,363 | | | 2,333 | | | 30 | | | 1.3 | |
| Marketing | 755 | | | 816 | | | (61) | | | (7.5) | |
| Professional services | 1,086 | | | 1,434 | | | (348) | | | (24.3) | |
| State/municipal business and use tax | 964 | | | 1,370 | | | (406) | | | (29.6) | |
| Federal deposit insurance premium | 848 | | | 9 | | | 839 | | | 9,322.2 | |
| Other real estate owned, net | — | | | (35) | | | 35 | | | (100.0) | |
| Amortization of intangible assets | 860 | | | 975 | | | (115) | | | (11.8) | |
| Other expense | 2,077 | | | 2,816 | | | (739) | | | (26.2) | |
| Total noninterest expense | $ | 36,045 | | | $ | 36,719 | | | $ | (674) | | | (1.8) | % |
|
| | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | | |
| | 2017 | | 2016 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Compensation and employee benefits | $ | 15,823 |
| | $ | 15,633 |
| | $ | 190 |
| | 1.2 | % |
| Occupancy and equipment | 3,979 |
| | 3,926 |
| | 53 |
| | 1.3 |
|
| Data processing | 2,090 |
| | 1,943 |
| | 147 |
| | 7.6 |
|
| Marketing | 933 |
| | 745 |
| | 188 |
| | 25.2 |
|
| Professional services | 1,453 |
| | 830 |
| | 623 |
| | 75.1 |
|
| State and local taxes | 640 |
| | 820 |
| | (180 | ) | | (22.0 | ) |
| Federal deposit insurance premium | 433 |
| | 296 |
| | 137 |
| | 46.3 |
|
| Other real estate owned, net | (88 | ) | | (142 | ) | | 54 |
| | (38.0 | ) |
| Amortization of intangible assets | 319 |
| | 359 |
| | (40 | ) | | (11.1 | ) |
| Other expense | 2,373 |
| | 2,408 |
| | (35 | ) | | (1.5 | ) |
| Total noninterest expense | $ | 27,955 |
| | $ | 26,818 |
| | $ | 1,137 |
| | 4.2 | % |
Professional services increased $623,000,Other expense decreased $739,000, or 75.1%26.2%, to $1.5$2.1 million for the three months ended September 30, 2020 from $2.8 million for the same period in 2019 due primarily from the reduction of employee travel, conference, and entertainment expenses related to the Bank's suspension of non-essential travel due to COVID-19.
State/municipal business and use taxes expense decreased $406,000, or 29.6%, as a result of an assessment in the amount of $537,000 from a Washington State Department of Revenue Business and Occupation audit recognized during the three months ended September 30, 2017 from $830,0002019.
The decreases in noninterest expense were partially offset by an increase in federal deposit insurance premium expense of $839,000 due primarily to the impact of the decrease in the Bank's Tier 1 leverage ratio on the Bank's assessment rate during the three months ended September 30, 2016.2020 partially offset by the usage of the remainder of the Bank's small bank credit during the quarter ended June 30, 2020. The increase inBank utilized its small bank credit for the three months ended September 30, 2017 compared to the same period in 2016 was primarilyfull premium due to legal costs incurred for our pending merger with Puget Sound as discussed in Note (16) Definitive Agreement as well as benefit-based consulting fees related to the consumer and business deposit account consolidation processes, which correspondingly generated an increase in service charges and other fees.
Compensation and employee benefits increased $190,000, or 1.2%, to $15.8 million during the three months ended September 30, 2017 from $15.6 million during the three months ended September 30, 2016. The increase in the three months ended September 30, 2017 compared to the same period in 2016 was primarily due to senior level staffing increases and standard salary increases.2019.
The ratio of noninterest expense to average total assets (annualized) was 2.76% 2.17%for the three months ended September 30, 20172020 compared to 2.81%2.69% for the three months ended September 30, 2016.2019. The decrease was primarily a result ofdue to an increase in average total assets and cost efficiencies gained through efforts byprimarily due to the Company to manage noninterest expenses.SBA PPP loans originated during 2020.
Comparison of nine months ended September 30, 20172020 to the comparable period in the prior year
Noninterest expense increased $3.3 million,decreased $413,000, or 4.2%0.4%, to $83.0$110.4 million during the nine months ended September 30, 20172020 compared to $79.7$110.8 million for the nine months ended September 30, 2016.2019. The following table presents changes in the key components of noninterest expense for the periods noted.noted:
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended
September 30, | | | | |
| 2020 | | 2019 | | Change | | Percentage Change |
| (Dollars in thousands) |
| Compensation and employee benefits | $ | 65,849 | | | $ | 65,629 | | | $ | 220 | | | 0.3 | % |
| Occupancy and equipment | 16,936 | | | 16,177 | | | 759 | | | 4.7 | |
| Data processing | 7,046 | | | 6,615 | | | 431 | | | 6.5 | |
| Marketing | 2,317 | | | 3,020 | | | (703) | | | (23.3) | |
| Professional services | 4,632 | | | 3,912 | | | 720 | | | 18.4 | |
| State/municipal business and use tax | 2,626 | | | 2,977 | | | (351) | | | (11.8) | |
| Federal deposit insurance premium | 1,086 | | | 720 | | | 366 | | | 50.8 | |
| Other real estate owned, net | (145) | | | 340 | | | (485) | | | (142.6) | |
| Amortization of intangible assets | 2,666 | | | 3,026 | | | (360) | | | (11.9) | |
| Other expense | 7,365 | | | 8,375 | | | (1,010) | | | (12.1) | |
| Total noninterest expense | $ | 110,378 | | | $ | 110,791 | | | $ | (413) | | | (0.4) | % |
|
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | | | | |
| | 2017 | | 2016 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Compensation and employee benefits | $ | 48,119 |
| | $ | 45,652 |
| | $ | 2,467 |
| | 5.4 | % |
| Occupancy and equipment | 11,607 |
| | 11,873 |
| | (266 | ) | | (2.2 | ) |
| Data processing | 6,007 |
| | 5,564 |
| | 443 |
| | 8.0 |
|
| Marketing | 2,545 |
| | 2,254 |
| | 291 |
| | 12.9 |
|
| Professional services | 3,515 |
| | 2,508 |
| | 1,007 |
| | 40.2 |
|
| State and local taxes | 1,828 |
| | 2,031 |
| | (203 | ) | | (10.0 | ) |
| Federal deposit insurance premium | 1,090 |
| | 1,316 |
| | (226 | ) | | (17.2 | ) |
| Other real estate owned, net | (36 | ) | | 330 |
| | (366 | ) | | (110.9 | ) |
| Amortization of intangible assets | 966 |
| | 1,057 |
| | (91 | ) | | (8.6 | ) |
| Other expense | 7,346 |
| | 7,079 |
| | 267 |
| | 3.8 |
|
| Total noninterest expense | $ | 82,987 |
| | $ | 79,664 |
| | $ | 3,323 |
| | 4.2 | % |
Compensation and employee benefits increased $2.5Other expense decreased $1.0 million, or 5.4%12.1%, to $48.1$7.4 million for the nine months ended September 30, 2020 from $8.4 million for the same period in 2019 due substantially from the reduction of employee travel, conference, and entertainment expenses related to the Company's suspension of non-essential travel due to COVID-19.
Marketing expense decreased $703,000, or 23.3%, to $2.3 million during the nine months ended September 30, 20172020 from $45.7$3.0 million during the nine months ended September 30, 2016. 2019 due primarily to the delayed timing of contributions for community sponsorships and sponsored events due to COVID-19 restrictions.
The decreases in noninterest expense were partially offset by an increase in occupancy and equipment expense of $759,000, or 4.7%, to $16.9 million for the nine months ended September 30, 2017 compared to the same period in 2016 was primarily due to senior level staffing increases, including the addition of the new Portland, Oregon lending team members who started in May 2017, and standard salary increases.
Professional services increased $1.0 million, or 40.2%, to $3.52020 from $16.2 million during the nine months ended September 30, 2017 from $2.52019 due primarily to depreciation expense related to the Southern Operation Center placed into operation in December 2019.
Professional services expense increased $720,000, or 18.4%, to $4.6 million during the nine months ended September 30, 2016. The increase in the nine months ended September 30, 2017 compared to the same period in 2016 was primarily due to due to benefit-based consulting fees related to the consumer deposit account consolidation process, which correspondingly generated an increase in service charges and other fees. Professional services also increased as a result of Trust-related expenses based on a renegotiated contract for 2017, which also increased other noninterest income, and legal costs incurred for our pending merger with Puget Sound as discussed in Note (16) Definitive Agreement.
Data processing increased $443,000, or 8.0%, to $6.02020 from $3.9 million during the nine months ended September 30, 2017 from $5.62019 related primarily to the launch of the new mobile and online commercial banking platform, "Heritage Direct." The implementation of the new banking platform was completed during the second quarter of 2020.
Federal deposit insurance premium expense increased $366,000, or 50.8%, to $1.1 million during the nine months ended September 30, 2016 primarily due to higher transactional activity in the core operating system and internet banking as a result of the growth in loans and deposits..
Other real estate owned, net decreased $366,000 or 110.9%, to income of $36,0002020 from $720,000 during the nine months ended September 30, 2017 compared2019 due to expensethe impact of $330,000the decrease in the Bank's Tier 1 leverage ratio on the Bank's assessment rate, offset partially by the use of the small bank credit for two quarters during the nine months ended September 30, 2016. The income recorded2020 compared to one quarter during the same period in 2019.
Compensation and employee benefits increased $220,000, or 0.3%, due primarily to premium pay to certain front-line employees of $408,000 as a result of impacts from COVID-19, an increase in overtime of $226,000 due primarily to SBA PPP loan processing, and an increase in commission expense of $390,000 related to increased mortgage loan sale activity. These increases were offset partially by $928,000 in the deferral of compensation as a result of SBA PPP origination volume recognized during the nine months ended September 30, 2017 was due to gain on sale of properties of $111,000, offset by maintenance expense of $75,000. For the nine months ended September 30, 2016, the Bank recorded a valuation adjustment of $383,000 and maintenance expense of $120,000, which was offset by the gain on sale of properties of $173,000.2020.
The ratio of noninterest expense to average total assets (annualized) was 2.82%2.39% for the nine months ended September 30, 2017,2020, compared to 2.86%2.76% for the nine months ended September 30, 2016.2019. The decrease was primarily a result ofdue to an increase in average total assets, and cost efficiencies gained through efforts by the Companydue primarily to manage noninterest expenses.SBA PPP loans originated during 2020.
Income Tax Expense
ComparisonComparison of quarter ended September 30, 20172020 to the comparable quarter in the prior yearyear.
Income tax expense decreased by $199,000,$1.1 million, or 4.8%31.6%, to $3.9$2.5 million for the three months ended September 30, 20172020 from $4.1$3.6 million for the three months ended September 30, 2016.2019 primarily due to lower pre-tax income. The effective tax rate was 27.0%13.0% for the three months ended September 30, 20172020 compared to 27.2%16.8% for the same period in 2016.2019. The decrease in the effective tax rate duringfrom the three months ended September 30, 2017 compared to the same period in 20162020 was due primarily to the year-over-year decrease in estimated annual pre-tax income, which results in an increaseincreased impact for favorable permanent tax items such as tax-exempt investments, investments in tax benefits from low incomebank owned life insurance and low-income housing tax credits, offset partially by the implementation of FASB ASU 2016-09 requiring the excess tax benefits on option exercises and restricted stock vesting to be recognized in earnings prospectively starting on January 1, 2017.credits.
Comparison of nine months ended September 30, 20172020 to the comparable period in the prior yearyear.
IncomeIncome tax expense increased by $645,000,decreased $7.9 million, or 6.2%78.3%, to $11.1$2.2 million for the nine months ended September 30, 20172020 from $10.4$10.0 million for the nine months ended September 30, 2016.2019. The effective tax rate was 25.9%8.8% for the nine months ended September 30, 20172020 compared to 26.5%16.6% for the same period in 2016.2019. The decrease in theincome tax expense and effective tax rate during the nine months ended September 30, 2017 compared to the same period in 20162020 was due primarily to the implementation of FASB ASU 2016-09 requiring the excess tax benefits on option exercises and restricted stock vesting to be recognized in earnings prospectively starting on January 1, 2017.
Financial Condition Overview
Total assets increased $171.1 million, or 4.4%, to $4.05 billion as of September 30, 2017 compared to $3.88 billion as of December 31, 2016. Total loans receivable, net, increased $156.4 million, or 6.0%, to $2.77 billion at September 30, 2017 compared to $2.61 billion at December 31, 2016. Loans were mostly funded through an increase in deposits. Deposits increased by $91.2 million, or 2.8%, to $3.32 billion as of September 30, 2017 compared to $3.23 billion as of December 31, 2016. Total non-maturity deposits decreased to 88.1% of total deposits at September 30, 2017 from 88.9% at December 31, 2016 and certificates of deposits increased to 11.9% of total deposits at September 30, 2017 from 11.1% at December 31, 2016.
Prepaid expenses and other assets increased $8.4 million, or 10.6%, to $87.7 million at September 30, 2017 from $79.4 million at December 31, 2016 primarily as a result of the Company's investment in two new low income housing tax credit partnerships totaling $14.3 million. These investments had corresponding obligations recorded in accrued expenses and other liabilities of $14.3 million at September 30, 2017. These obligations will decrease as
projectsprovision in the partnerships are funded. During the nine months ended September 30, 2017CARES Act, which permitted the Company made capital contributionsto recognize a $1.0 million benefit from net operating losses related to other low income housing tax credit partnerships of $8.5 million, partially offsetting the increase in accrued expenses and other liabilities.
Federal Home Loan Bank advances increased $37.8 million, or 47.5%, to $117.4 million as of September 30, 2017 from $79.6 million as of December 31, 2016. The increase in advances was required as a supplement to deposits in order to fund loan growth.
Total stockholders’ equity increased $25.8 million, or 5.4%, to $507.6 million as of September 30, 2017 from $481.8 million at December 31, 2016. The increaseprior acquisitions during the nine months ended September 30, 2017 was2020 and secondarily due primarily to neta decrease in pre-tax income of $31.8 million and a $4.4 million improvementincreased tax-exempt investments in accumulated other comprehensive income, net of tax, offset partially by cash dividends declared of $11.4 million. The Company’s equity position was 12.5% of total assets as of September 30, 2017 and 12.4% as of December 31, 2016.2020.
Financial Condition Overview
The table below provides a comparison of the changes in the Company's financial condition from December 31, 20162019 to September 30, 2017.2020:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30,
2020 | | December 31, 2019 | | Change | | % Change |
| (Dollars in thousands) |
| Assets | | | | | | | |
| Cash and cash equivalents | $ | 576,242 | | | $ | 228,568 | | | $ | 347,674 | | | 152.1 | % |
| Investment securities available for sale, at fair value, net | 834,492 | | | 952,312 | | | (117,820) | | | (12.4) | |
| Loans held for sale | 8,250 | | | 5,533 | | | 2,717 | | | 49.1 | |
| Loans receivable, net | 4,593,390 | | | 3,731,708 | | | 861,682 | | | 23.1 | |
| Other real estate owned | — | | | 841 | | | (841) | | | (100.0) | |
| Premises and equipment, net | 89,831 | | | 87,888 | | | 1,943 | | | 2.2 | |
| Federal Home Loan Bank stock, at cost | 6,661 | | | 6,377 | | | 284 | | | 4.5 | |
| Bank owned life insurance | 108,311 | | | 103,616 | | | 4,695 | | | 4.5 | |
| Accrued interest receivable | 18,888 | | | 14,446 | | | 4,442 | | | 30.7 | |
| Prepaid expenses and other assets | 194,938 | | | 164,129 | | | 30,809 | | | 18.8 | |
| Other intangible assets, net | 13,947 | | | 16,613 | | | (2,666) | | | (16.0) | |
| Goodwill | 240,939 | | | 240,939 | | | — | | | — | |
| Total assets | $ | 6,685,889 | | | $ | 5,552,970 | | | $ | 1,132,919 | | | 20.4 | % |
| | | | | | | |
| Liabilities | | | | | | | |
| Deposits | $ | 5,689,048 | | | $ | 4,582,676 | | | $ | 1,106,372 | | | 24.1 | % |
| | | | | | | |
| Junior subordinated debentures | 20,814 | | | 20,595 | | | 219 | | | 1.1 | |
| Securities sold under agreement to repurchase | 29,043 | | | 20,169 | | | 8,874 | | | 44.0 | |
| Accrued expenses and other liabilities | 143,855 | | | 120,219 | | | 23,636 | | | 19.7 | |
| Total liabilities | 5,882,760 | | | 4,743,659 | | | 1,139,101 | | | 24.0 | |
| Stockholders' equity | | | | | | | |
| Common stock | 570,170 | | | 586,459 | | | (16,289) | | | (2.8) | |
| Retained earnings | 207,751 | | | 212,474 | | | (4,723) | | | (2.2) | |
| Accumulated other comprehensive income, net | 25,208 | | | 10,378 | | | 14,830 | | | 142.9 | |
| Total stockholders' equity | 803,129 | | | 809,311 | | | (6,182) | | | (0.8) | |
| Total liabilities and stockholders' equity | $ | 6,685,889 | | | $ | 5,552,970 | | | $ | 1,132,919 | | | 20.4 | % |
|
| | | | | | | | | | | | | | | |
| | | September 30, 2017 | | December 31, 2016 | | Change | | Percent Change |
| | | (Dollars in thousands) |
| Assets | | | | | | | | |
| Cash and cash equivalents | | $ | 111,258 |
| | $ | 103,745 |
| | $ | 7,513 |
| | 7.2 | % |
| Investment securities | | 800,060 |
| | 794,645 |
| | 5,415 |
| | 0.7 |
|
| Loans held for sale | | 5,368 |
| | 11,662 |
| | (6,294 | ) | | (54.0 | ) |
| Total loans receivable, net | | 2,766,113 |
| | 2,609,666 |
| | 156,447 |
| | 6.0 |
|
| Other real estate owned | | 523 |
| | 754 |
| | (231 | ) | | (30.6 | ) |
| Premises and equipment, net | | 60,457 |
| | 63,911 |
| | (3,454 | ) | | (5.4 | ) |
| Federal Home Loan Bank stock, at cost | | 9,343 |
| | 7,564 |
| | 1,779 |
| | 23.5 |
|
| Bank owned life insurance | | 71,474 |
| | 70,355 |
| | 1,119 |
| | 1.6 |
|
| Accrued interest receivable | | 12,295 |
| | 10,925 |
| | 1,370 |
| | 12.5 |
|
| Prepaid expenses and other assets | | 87,728 |
| | 79,351 |
| | 8,377 |
| | 10.6 |
|
| Other intangible assets, net | | 6,408 |
| | 7,374 |
| | (966 | ) | | (13.1 | ) |
| Goodwill | | 119,029 |
| | 119,029 |
| | — |
| | — |
|
| Total assets | | $ | 4,050,056 |
| | $ | 3,878,981 |
| | $ | 171,075 |
| | 4.4 | % |
| | | | | | | | | |
| Liabilities | | | | | | | | |
| Deposits | | $ | 3,320,818 |
| | $ | 3,229,648 |
| | $ | 91,170 |
| | 2.8 |
|
| Federal Home Loan Bank advances | | 117,400 |
| | 79,600 |
| | 37,800 |
| | 47.5 |
|
| Junior subordinated debentures | | 19,936 |
| | 19,717 |
| | 219 |
| | 1.1 |
|
| Securities sold under agreement to repurchase | | 28,668 |
| | 22,104 |
| | 6,564 |
| | 29.7 |
|
| Accrued expenses and other liabilities | | 55,626 |
| | 46,149 |
| | 9,477 |
| | 20.5 |
|
| Total liabilities | | 3,542,448 |
| | 3,397,218 |
| | 145,230 |
| | 4.3 |
|
| Stockholders' equity | | | | | |
| | |
| Common stock | | 360,113 |
| | 359,060 |
| | 1,053 |
| | 0.3 |
|
| Retained earnings | | 145,677 |
| | 125,309 |
| | 20,368 |
| | 16.3 |
|
| Accumulated other comprehensive income (loss), net | | 1,818 |
| | (2,606 | ) | | 4,424 |
| | 169.8 |
|
| Total stockholders' equity | | 507,608 |
| | 481,763 |
| | 25,845 |
| | 5.4 |
|
| Total liabilities and stockholders' equity | | $ | 4,050,056 |
| | $ | 3,878,981 |
| | $ | 171,075 |
| | 4.4 | % |
Total assets increased $1.13 billion, or 20.4%, to $6.69 billion as of September 30, 2020 compared to $5.55 billion as of December 31, 2019.
Lending Activities
As indicated in the table below, loansLoans receivable, net, was $2.80increased $861.7 million, or 23.1%, to $4.59 billion at September 30, 2017, an increase of $156.8 million, or 5.9%, from $2.642020 compared to $3.73 billion at December 31, 2016. The increase2019 due primarily to SBA PPP loans of $867.8 million originated in loans receivable for the nine months ended September 30, 2017 was primarily due to2020, and increases in commercial businessnon-owner occupied CRE loans of $121.3$96.2 million, consumerowner-occupied CRE loans of $15.5$54.1 million and real estate construction and land development loans of $15.3$40.5 million, offset partially by decreases in commercial and industrial loans of $101.7 million and consumer loans of $58.3 million. The decrease in commercial and industrial loans was due primarily to a decrease in the utilization rate of lines of credit to 23.3% at September 30, 2020 from 34.5% at December 31, 2019. The decrease in consumer loans was primarily due to the cessation of indirect auto loan originations in March 2020.
Investment securities available for sale decreased $117.8 million, or 12.4%, to $834.5 million at September 30, 2020 from $952.3 million at December 31, 2019 primarily as a result of calls, maturities, principal payments and sales of investment securities of $252.9 million, offset partially by purchases of $117.5 million and an increase in net unrealized gains of $18.9 million due to a decrease in market interest rates during the nine months ended September 30, 2020 that positively impacted the fair value of our bond portfolio.
Prepaid expenses and other assets increased $30.8 million, or 18.8%, to $194.9 million at September 30, 2020 from $164.1 million at December 31, 2019 primarily as a result of an increase in the fair value of interest rate swap contracts of $21.7 million and an investment in a Low Income Housing Tax Credit partnership of $10.2 million, both of which had a nearly corresponding increase in accrued expenses and other liabilities. Accrued expenses and other liabilities increased $23.6 million, or 19.7%, to $143.9 million at September 30, 2020 compared to $120.2 million as of December 31, 2019 due to the changes described for prepaid expenses and other assets, partially offset by a decrease related to capital contributions of Low Income Housing Tax Credit partnership investments of $7.1 million.
Total deposits increased $1.11 billion, or 24.1%, to $5.69 billion at September 30, 2020 from $4.58 billion at December 31, 2019 due primarily to increases in noninterest bearing demand deposits of $542.7 million, or 37.5%, to $1.99 billion, money market accounts of $326.1 million, or 43.3%, to $1.08 billion, and interest bearing demand deposits of $303.8 million, or 22.5%, to $1.65 billion, offset partially by a decrease in certificate of deposit accounts of $80.5 million, or 15.4%, to $444.0 million. The increase in total deposits was due primarily to proceeds from SBA PPP loans deposited directly into customer deposit accounts and an increase in customer deposits due to changes in customer spending habits due to the COVID-19 pandemic. Non-maturity deposits as a percentage of total deposits increased to 92.2% as of September 30, 2020 from 88.6% at December 31, 2019.
Lending Activities
|
| | | | | | | | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | Balance | | % of Total | | Balance | | % of Total |
| | (Dollars in thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 665,582 |
| | 23.8 | % | | $ | 637,773 |
| | 24.2 | % |
| Owner-occupied commercial real estate | 602,238 |
| | 21.5 |
| | 558,035 |
| | 21.1 |
|
| Non-owner occupied commercial real estate | 930,188 |
| | 33.3 |
| | 880,880 |
| | 33.4 |
|
| Total commercial business | 2,198,008 |
| | 78.6 |
| | 2,076,688 |
| | 78.7 |
|
| One-to-four family residential | 81,422 |
| | 2.9 |
| | 77,391 |
| | 2.9 |
|
| Real estate construction and land development: | | | | | | |
|
| One-to-four family residential | 51,451 |
| | 1.8 |
| | 50,414 |
| | 1.9 |
|
| Five or more family residential and commercial properties | 122,981 |
| | 4.4 |
| | 108,764 |
| | 4.1 |
|
| Total real estate construction and land development | 174,432 |
| | 6.2 |
| | 159,178 |
| | 6.0 |
|
| Consumer | 340,643 |
| | 12.2 |
| | 325,140 |
| | 12.3 |
|
| Gross loans receivable | 2,794,505 |
| | 99.9 |
| | 2,638,397 |
| | 99.9 |
|
| Deferred loan costs, net | 3,008 |
| | 0.1 |
| | 2,352 |
| | 0.1 |
|
| Loans receivable, net | $ | 2,797,513 |
| | 100.0 | % | | $ | 2,640,749 |
| | 100.0 | % |
The following table provides information about our loan portfolio by type of loan at the dates indicated and the change between these dates. These balances are net of deferred fees, costs, and are prior to deduction for the ACL on loans.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 | | December 31, 2019 | | |
| Balance (1) | | % of Total (2) | | Balance (1) | | % of Total (2) | | Change | | % of Balance Change |
| (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | $ | 750,557 | | | 16.1 | % | | $ | 852,220 | | | 22.6 | % | | $ | (101,663) | | | (11.9) | % |
| SBA PPP | 867,782 | | | 18.6 | | | — | | | — | | | 867,782 | | | 100.0 | |
| Owner-occupied CRE | 859,338 | | | 18.4 | | | 805,234 | | | 21.4 | | | 54,104 | | | 6.7 | |
| Non-owner occupied CRE | 1,384,973 | | | 29.7 | | | 1,288,779 | | | 34.2 | | | 96,194 | | | 7.5 | |
| Total commercial business | 3,862,650 | | | 82.8 | | | 2,946,233 | | | 78.2 | | | 916,417 | | | 31.1 | |
One-to-four family residential (3) | 131,921 | | | 2.8 | | | 131,660 | | | 3.5 | | | 261 | | | 0.2 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 | | December 31, 2019 | | |
| Balance (1) | | % of Total (2) | | Balance (1) | | % of Total (2) | | Change | | % of Balance Change |
| (Dollars in thousands) |
| Real estate construction and land development: | | | | | | | | | | | |
| One-to-four family residential | 99,650 | | | 2.1 | | | 104,296 | | | 2.8 | | | (4,646) | | | (4.5) | |
| Five or more family residential and commercial properties | 215,472 | | | 4.6 | | | 170,350 | | | 4.5 | | | 45,122 | | | 26.5 | |
| Total real estate construction and land development | 315,122 | | | 6.7 | | | 274,646 | | | 7.3 | | | 40,476 | | | 14.7 | |
| Consumer | 357,037 | | | 7.7 | | | 415,340 | | | 11.0 | | | (58,303) | | | (14.0) | |
| Loans receivable | $ | 4,666,730 | | | 100.0 | % | | $ | 3,767,879 | | | 100.0 | % | | $ | 898,851 | | | 23.9 | % |
(1) Balances do not include unfunded loan commitments.
(2) Percent of loans receivable.
(3) Excludes loans held for sale of $8.3 million and $5.5 million at September 30, 2020 and December 31, 2019, respectively.
Included in the amortized cost of loans are net discounts on loans purchased in mergers and acquisitions. Upon CECL Adoption, the Bank increased the net discount for PCD loans by $1.6 million related to the PCI to PCD transition. The remaining total net discount for purchased loans, including PCD loans and non-PCD loans, was $7.4 million at September 30, 2020 compared to $8.4 million at December 31, 2019.
Nonperforming Assets and Credit Quality Metrics
The following table describesprovides information about our nonperforming assetsnonaccrual loans, other real estate owned and other credit quality metrics atperforming TDR loans for the dates indicated:indicated dates: |
| | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | (Dollars in thousands) |
| Nonaccrual loans: | | | |
| Commercial business | $ | 9,683 |
| | $ | 8,580 |
|
| One-to-four family residential | 84 |
| | 94 |
|
| Real estate construction and land development | 869 |
| | 2,008 |
|
| Consumer | 316 |
| | 227 |
|
| Total nonaccrual loans (1)(2) | 10,952 |
| | 10,909 |
|
| Other real estate owned | 523 |
| | 754 |
|
| Total nonperforming assets | $ | 11,475 |
| | $ | 11,663 |
|
| | | | |
| Allowance for loan losses | $ | 31,400 |
| | $ | 31,083 |
|
| Allowance for loan losses to loans receivable, net | 1.12 | % | | 1.18 | % |
| Allowance for loan losses to nonperforming loans | 286.71 | % | | 284.93 | % |
| Nonperforming loans to loans receivable, net | 0.39 | % | | 0.41 | % |
| Nonperforming assets to total assets | 0.28 | % | | 0.30 | % |
| | | | |
| Performing TDR loans: | | | |
| Commercial business | $ | 18,571 |
| | $ | 19,837 |
|
| One-to-four family residential | 219 |
| | 227 |
|
| Real estate construction and land development | 1,136 |
| | 2,141 |
|
| Consumer | 118 |
| | 83 |
|
| Total performing TDR loans (3) | $ | 20,044 |
| | $ | 22,288 |
|
| Accruing loans past due 90 days or more (4) | $ | — |
| | $ | — |
|
| Potential problem loans (5) | 84,089 |
| | 87,762 |
|
| |
(1)
| At September 30, 2017 and December 31, 2016, $5.9 million and $6.9 million of nonperforming loans, respectively, were considered TDR loans. |
| |
(2)
| At September 30, 2017 and December 31, 2016, $2.5 million and $2.8 million of nonperforming loans, respectively, were guaranteed by government agencies. |
| |
(3)
| At September 30, 2017 and December 31, 2016, $1.4 million and $682,000 of performing TDR loans, respectively, were guaranteed by government agencies. |
| |
(4)
| There were no accruing loans past due 90 days or more that were guaranteed by government agencies at September 30, 2017 or December 31, 2016. |
| |
(5)
| At September 30, 2017 and December 31, 2016, $1.7 million and $1.1 million of potential problem loans, respectively, were guaranteed by government agencies. |
| | | | | | | | | | | |
| September 30,
2020 | | December 31, 2019 |
| (Dollars in thousands) |
| Nonaccrual loans: | | | |
| Commercial business | $ | 50,930 | | | $ | 44,320 | |
| One-to-four family residential | 157 | | | 19 | |
| Real estate construction and land development | 1,439 | | | — | |
| Consumer | 78 | | | 186 | |
Total nonaccrual loans (1) | 52,604 | | | 44,525 | |
| Other real estate owned | — | | | 841 | |
| Total nonperforming assets | $ | 52,604 | | | $ | 45,366 | |
| | | |
| ACL on loans | $ | 73,340 | | | $ | 36,171 | |
| Nonperforming loans to loans receivable | 1.13 | % | | 1.18 | % |
| ACL on loans to loans receivable | 1.57 | | | 0.96 | |
ACL on loans to loans receivable, excluding SBA PPP loans (2) | 1.93 | | | 0.96 | |
| ACL on loans to nonperforming loans | 139.42 | | | 81.24 | |
| Nonperforming assets to total assets | 0.79 | % | | 0.82 | % |
| | | |
| Performing TDR loans: | | | |
| Commercial business | $ | 17,179 | | | $ | 13,661 | |
| One-to-four family residential | 190 | | | 196 | |
| Real estate construction and land development | 1,812 | | | 237 | |
| Consumer | 434 | | | 375 | |
| Total performing TDR loans | $ | 19,615 | | | $ | 14,469 | |
| Accruing loans past due 90 days or more | $ | — | | | $ | — | |
| Potential problem loans | 159,764 | | | 87,788 | |
Nonperforming assets were $11.5 million, or 0.28% of total assets and $11.7 million, or 0.30% of total assets as of(1)At September 30, 20172020 and December 31, 2016, respectively. The balance2019, $20.5 million and $26.3 million of nonaccrual loans were considered nonperforming TDR loans, respectively.
(2) See "Non-GAAP Financial Measures" section.
Nonaccrual Loans. Nonaccrual loans increased $43,000,$8.1 million to $52.6 million, or 0.4%, to $11.0 million ($2.5 million guaranteed by governmental agencies)1.13% of loans receivable at September 30, 20172020 from $10.9$44.5 million, ($2.8 million guaranteed by governmental agencies)or 1.18% of loans receivable at December 31, 2016. For2019. The increase was due primarily to the addition of $19.6 million of loans that were previously modified under the CARES Act and related regulatory guidance and exhibited a continued decline in credit quality, warranting transfer to nonaccrual status. Within these additions were three commercial lending relationships totaling $17.4 million, including a parking facility, a hotel, and a group of restaurants under common ownership. The Bank is actively working with the borrowers to secure a positive resolution. These additions to nonaccrual loans were offset partially by a principal payment on a significant agricultural lending relationship of $7.8 million and the full payoff of a commercial business relationship of $2.3 million.
The following table reflects the changes in nonaccrual loans during the nine months ended September 30, 2017,2020 and 2019:
| | | | | | | | | | | |
| Nine Months Ended
September 30, |
| 2020 | | 2019 |
| (In thousands) |
| Nonaccrual loans | | | |
| Balance, beginning of period | $ | 44,525 | | | $ | 13,696 | |
| Addition of previously classified pass graded loans | 18,132 | | | 3,856 | |
| Addition of previously classified potential problem loans | 6,547 | | | 21,989 | |
| | | |
| Addition of previously classified TDR loans | — | | | 7,048 | |
| Net principal payments and transfer to accruing status | (15,228) | | | (4,393) | |
| Charge-offs | (1,102) | | | (699) | |
| Transfer to OREO | (270) | | | |
| Balance, end of period | $ | 52,604 | | | $ | 41,497 | |
At September 30, 2020, nonaccrual loans of $20.9 million had a related ACL on loans of $6.4 million and nonaccrual loans of $31.7 million had no related ACL on loans. At December 31, 2019, nonaccrual loans of $4.4 million had a related allowance for loan losses of $763,000 and nonaccrual loans of $40.1 million had no allowance for loan losses.
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans and other real estate owned. Nonperforming assets increased $7.2 million to $52.6 million, or 0.79% of total assets, at September 30, 2020 from $45.4 million, or 0.82% of total assets, at December 31, 2019 due to the increase in nonaccrual loans was primarily due to additions to nonaccrual loans of $5.1 million, offset partially by net principal reductions of $4.3 milliondiscussed above and charge-offs of $750,000. Thethe decrease in other real estate owned balance decreasedresulting from the disposition of the two remaining properties at December 31, 2019 during the nine months ended September 30, 2020.
Troubled Debt Restructured Loans. Performing TDR loans are TDRs on accrual status. They may be individually or collectively evaluated for ACL based on criteria outlined in our accounting policies. Performing TDR loans are not considered nonperforming assets as they continue to $523,000accrue interest despite the restructured status. Performing TDR loans increased $5.1 million, or 35.6%, to $19.6 million at September 30, 20172020 from $754,000$14.5 million at December 31, 20162019. The increase was due primarily to three commercial business lending relationships totaling $3.6 million and one residential construction relationship of $1.5 million which was previously reported as a result of the sale of two properties.
Performing TDR loans were $20.0 million and $22.3 million as of September 30, 2017 and December 31, 2016, respectively.potential problem loan. The $2.2 million, or 10.1%, decreaseincrease in performing TDR loans for the nine months ended September 30, 20172020 was primarilyoffset partially by loans paid in full totaling $2.6 million.
The following table reflects the result of net principal payments of $8.3 million and loans transferred to nonaccrual of $1.1 million, partially offset by troubled loans restructured during the period of $7.1 million. At September 30, 2017 and
December 31, 2016, the Company had an allowance for loan losses on thechanges in performing TDR loans of $2.1during the nine months ended September 30, 2020 and 2019:
| | | | | | | | | | | |
| Nine Months Ended
September 30, |
| 2020 | | 2019 |
| (In thousands) |
| Performing TDR loans | | | |
| Balance, beginning of period | $ | 14,469 | | | $ | 22,744 | |
| Addition of previously classified pass graded loans | 4,495 | | | 2,631 | |
| Addition of previously classified potential problem loans | 3,014 | | | 8,347 | |
| Loans added formerly nonaccrual | 281 | | | — | |
| Transfers of loans to nonaccrual status | — | | | (7,048) | |
| Charge-offs | — | | | (20) | |
| Net principal payments | (2,644) | | | (7,234) | |
| Balance, end of period | $ | 19,615 | | | $ | 19,420 | |
The related ACL on loans for performing TDR loans was $1.5 million and $2.0 million, respectively.
Potential problem loans as of September 30, 20172020 and $1.3 million as of December 31, 2016 were $84.1 million and $87.8 million, respectively.2019.
Potential Problem Loans. Potential problem loans are those loans risk rated special mention or worse that are currently accruing interestnot classified as a TDR or nonaccrual loan and are not considered impaired,individually evaluated for credit loss, but which we aremanagement is closely monitoring because the financial information of the borrower causes concernsconcern as to their ability to meet their loan repayment terms. Loans that are past due 90 daysPotential problem loans increased $72.0 million, or more and still accruing interest are both well secured and82.0%, to $159.8 million at September 30, 2020 compared to $87.8 million at December 31, 2019 primarily attributed to risk classification downgrades related to COVID-19. Included in the processbalance of collection. potential problem loans at September 30, 2020 are $71.4 million of loans that were modified under the CARES Act, including $20.3 million in active payment modification deferral status at September 30, 2020, and $35.4 million that were downgraded due to COVID-19. Loans with COVID-19 issues were classified as potential problem loans if additional factors were identified to cause a more severe risk grade than watch. At September 30, 2020, loans totaling $102.4 million and $57.3 million were rated special mention and substandard, respectively. The $3.7 million, or 4.2%, decreaseincrease in potential problem loans for the nine months ended September 30, 2020 was offset partially by net principal payments of $23.0 million, including payment in full of $11.8 million and by transfers of loans to nonaccrual and TDR status.
The following table reflects the changes in potential problem loans during the nine months ended September 30, 2020 and 2019:
| | | | | | | | | | | |
| Nine Months Ended
September 30, |
| 2020 | | 2019 |
| |
| Potential problem loans | |
| Balance, beginning of period | $ | 87,788 | | | $ | 101,320 | |
| Addition of previously classified pass graded loans | 114,119 | | | 46,274 | |
| | | |
| Upgrades to pass graded loan status | (9,540) | | | (8,816) | |
| Net principal payments | (23,042) | | | (22,593) | |
| Transfers of loans to nonaccrual and TDR status | (9,561) | | | (30,336) | |
| Charge-offs | — | | | (510) | |
| Balance, end of period | $ | 159,764 | | | $ | 85,339 | |
Analysis of Allowance for Credit Losses on Loans
Effective January 1, 2020, the Bank adopted ASU 2016-13. The adoption replaced the allowance for loan losses with the ACL on loans on the Condensed Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses on loans on the Condensed Consolidated Statements of Income.
Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans. The same methodology is applied to all loans consistent with the guidance of the accounting standard which does not require undue complexity. Under this allowance approach, the Company has identified segments of loans with similar risk characteristics that align with its identified loan classes. Nonaccrual loans and certain TDR loans are not considered similar to other loans; therefore, they are evaluated for credit loss on an individual basis. The allowance for individually evaluated loans is calculated using either the collateral value method, which considers the likely source of repayment as the value of the collateral, less estimated costs to sell, or the net present value method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt.
For each loan segment collectively measured, baseline loss rates are separately calculated using the Bank's average quarterly historical loss information. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method, including prepayment estimates, to determine the baseline loss estimate for each loan. The CECL methodology also includes consideration of the forecasted direction of the economic and business environment and its likely impact to the estimated allowance as compared to the historical losses over the reasonable and supportable time frame. The impact of those macroeconomic factors to each segment, positive or negative, using the reasonable and supportable period, are added to the calculated baseline loss rate. After the reasonable and supportable period, the estimated credit losses are reverted back to historical baseline loss levels under a reversion period on a straight-lined, input reversion basis. Management can also consider other qualitative factors to adjust the ACL if internal or external conditions suggest changes to the modeled ACL are appropriate.
The following table provides information regarding changes in our ACL on loans and the allowance for loan losses at and for the three and nine months ended September 30, 2020 and 2019, respectively:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (Dollars in thousands) |
| ACL on loans at the beginning of the period | $ | 71,501 | | | $ | 36,363 | | | $ | 36,171 | | | $ | 35,042 | |
| Impact of CECL adoption | — | | | — | | | 1,822 | | | — | |
| Adjusted ACL on loans, beginning of the period | 71,501 | | | 36,363 | | | 37,993 | | | 35,042 | |
| | | | | | | |
| Charge-offs: | | | | | | | |
| Commercial business | (507) | | | (306) | | | (3,553) | | | (1,183) | |
| One-to-four family residential | — | | | (15) | | | — | | | (45) | |
| | | | | | | |
| Consumer | (335) | | | (501) | | | (1,141) | | | (1,653) | |
| Total charge-offs | (842) | | | (822) | | | (4,694) | | | (2,881) | |
| Recoveries: | | | | | | | |
| Commercial business | 80 | | | 381 | | | 1,220 | | | 602 | |
| One-to-four family residential | — | | | — | | | 3 | | | — | |
| Real estate construction and land development | 139 | | | 3 | | | 160 | | | 628 | |
| Consumer | 142 | | | 127 | | | 433 | | | 374 | |
| Total recoveries | 361 | | | 511 | | | 1,816 | | | 1,604 | |
| Net charge-offs | (481) | | | (311) | | | (2,878) | | | (1,277) | |
| | | | | | | |
| Provision for credit losses on loans | 2,320 | | | 466 | | | 38,225 | | | 2,753 | |
| | | | | | | |
| ACL on loans at the end of the period | $ | 73,340 | | | $ | 36,518 | | | $ | 73,340 | | | $ | 36,518 | |
| | | | | | | |
| ACL on loans to loans receivable | 1.57 | % | | 0.98 | % | | 1.57 | % | | 0.98 | % |
ACL on loans to loans receivable, excluding SBA PPP loans (3) | 1.93 | | | 0.98 | | | 1.93 | | | 0.98 | |
Net charge-offs on loans to average loans receivable, net (1) | 0.04 | % | | 0.03 | % | | 0.09 | % | | 0.05 | % |
| | | | | | | |
Loans receivable at the end of the period (2) | $ | 4,666,730 | | | $ | 3,731,343 | | | $ | 4,666,730 | | | $ | 3,731,343 | |
| Average loans receivable, net during the period | 4,605,389 | | | 3,677,405 | | | 4,266,598 | | | 3,651,659 | |
(1) Annualized.
(2) Excludes loans held for sale.
(3) See NonGAAP Financial Measures herein.
The ACL on loans increased $37.2 million, or 102.8%, to $73.3 million at September 30, 2020 from $36.2 millionat December 31, 2019, and increased $35.3 million, or 93.0%, from the adjusted beginning balance of $38.0 million. The increase in ACL was primarily the result of net principal payments of $18.9 million, loans transferred to heldthe provision for sale of $5.8 million, loans transferred to nonaccrual status of $4.6 million and loan grade improvements of $4.4 million, partially offset by the addition of loans graded as potential problemcredit losses on loans of $31.4$38.2 million recognized during the nine months ended September 30, 2020 due primarily to forecasted credit deterioration reflecting economic conditions as a result of the COVID-19 pandemic.
The macroeconomic forecast used in the CECL model as of January 1, 2020 predicted continued economic expansion with steady GDP growth of 1.8% and low unemployment rates of 3.5% in 2020, among other factors. The onset of the COVID-19 pandemic resulted in identification of an economic recession during the second quarter of 2020. The macroeconomic forecast used in the CECL model as of September 30, 2020 reflected a slow and long recovery from the COVID-19 recession. The modeled recovery is expected to last through the end of 2021, including a contraction in GDP of 3.7% for 2020 and a rebound of 3.7% for 2021, and modest increases in GDP in future years. Unemployment rates are expected to average 8.7% during the remainder of 2020 and gradually reduce to 4.0% by 2025.
The Company recorded charge-offs of $4.7 million during the nine months ended September 30, 2017.2020 primarily due to one commercial and industrial loan of $1.7 million that had been experiencing financial difficulties.
AnalysisDue to issues surrounding the control of Allowancethe underlying loan collateral, the Bank determined it appropriate to charge-off the entire balance and pursue an aggressive collection strategy. Charge-offs also included two commercial and industrial loan relationships totaling $447,000 as a result of impacts from the COVID-19 pandemic and small dollar charge-offs on a large volume of consumer loans of $1.1 million. The Company recorded recoveries of $1.8 million during the nine months ended September 30, 2020 primarily due to the full recovery of an agricultural lending relationship of $963,000 which was charged-off during the three months ended December 31, 2019 and small dollar recoveries on a large volume of consumer loans of $433,000.
Based on the Bank's established comprehensive CECL methodology, management deemed the ACL on loans of $73.3 million (1.57% of loans receivable and 139.42% of nonperforming loans) at September 30, 2020 appropriate to provide for Loan Losses
Management maintainscurrent expected credit losses in the portfolio. This compares to an allowance for loan losses (“ALL”) to provide for estimated probable incurred losses in the loan portfolio at the balance sheet date. The adequacy of the ALL is monitored through our ongoing quarterly loan quality assessments.
We assess the estimated credit losses inherent in our loan portfolio by considering a number of elements including:
•Historical loss experience in the loan portfolio;
•Impact of environmental factors, including:
| |
▪ | Levels of and trends in delinquencies and classified and impaired loans; |
| |
▪ | Levels of and trends in charge-offs and recoveries; |
| |
▪ | Trends in volume and terms of loans; |
| |
▪ | Effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; |
| |
▪ | Experience, ability and depth of lending management and other relevant staff; |
| |
▪ | National and local economic trends and conditions; |
| |
▪ | Other external factors such as competition, legal and regulatory; |
| |
▪ | Effects of changes in credit concentrations; and |
We calculate an appropriate ALL for loans in our loan portfolio, except PCI loans, by applying historical loss factors for homogeneous classes of the portfolio, adjusted for changes to the above-noted environmental factors. We may record specific provisions for impaired loans, including loans on nonaccrual status and TDRs, after a careful analysis of each loan’s credit and collateral factors. Our analysis of an appropriate ALL combines the provisions made for our non-impaired loans and the specific provisions made for each impaired loan.
The allowance for loan losses on loans designated as non-PCI loans is similar to the methodology described above except that for non-PCI loans, the remaining unaccreted discounts resulting from the fair value adjustments recorded at the time the loans were purchased are additionally factored into the allowance methodology.
For the PCI loans, the acquisition date fair value incorporated our estimate of future expected cash flows until the ultimate resolution of these credits. To the extent actual or projected cash flows are less than previously estimated, additional provisions for loan losses on the PCI loan portfolio will be recognized immediately into earnings. To the extent actual or projected cash flows are more than previously estimated, the increase in cash flows is recognized immediately as a recapture of provision for loan losses up to the previously recognized provision for that loan or pool$36.2 million (0.96% of loans if any,receivable and then prospectively recognized in interest income as a yield adjustment.81.24% of nonperforming loans) at December 31, 2019 under the incurred loss methodology.
While we believe we use the best information available to determine the allowance for loan losses,ACL on loans, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan lossesACL on loans and may adversely affect the Company’s financial condition and results of operations. In addition, the determination of the amount of the allowance for loan lossesACL on loans is subject to review by bank regulators, as part of their routine examination process, which may result in the establishment of an additional allowance for loan lossesACL on loans based upon their judgment of information available to them at the time of their examination.
The following table provides information regarding changes in our allowance for loan losses as of and for the three and nine months ended September 30, 2017 and 2016:
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2017 | | 2016 | | 2017 | | 2016 |
| | (Dollars in thousands) |
| Loans receivable, net at the end of the period | $ | 2,797,513 |
| | $ | 2,578,977 |
| | $ | 2,797,513 |
| | $ | 2,578,977 |
|
| Average loans receivable during the period | 2,737,535 |
| | 2,526,150 |
| | 2,676,153 |
| | 2,461,856 |
|
| | | | | | | | |
| Allowance for loan losses on loans at the beginning of the period | $ | 32,751 |
| | $ | 28,426 |
| | $ | 31,083 |
| | $ | 29,746 |
|
| Provision for loan losses | 884 |
| | 1,495 |
| | 2,882 |
| | 3,754 |
|
| Charge-offs: | | | | | | | |
| Commercial business | (1,497 | ) | | (328 | ) | | (1,940 | ) | | (3,698 | ) |
| One-to-four family residential | (15 | ) | | — |
| | (15 | ) | | — |
|
| Real estate construction and land development | (556 | ) | | — |
| | (556 | ) | | (154 | ) |
| Consumer | (478 | ) | | (572 | ) | | (1,419 | ) | | (1,370 | ) |
| Total charge-offs | (2,546 | ) | | (900 | ) | | (3,930 | ) | | (5,222 | ) |
| Recoveries: | | | | | | | |
| Commercial business | 8 |
| | 993 |
| | 834 |
| | 1,352 |
|
| One-to-four family residential | — |
| | — |
| | 1 |
| | 2 |
|
| Real estate construction and land development | 191 |
| | — |
| | 201 |
| | 83 |
|
| Consumer | 112 |
| | 197 |
| | 329 |
| | 496 |
|
| Total recoveries | 311 |
| | 1,190 |
| | 1,365 |
| | 1,933 |
|
| Net (charge-offs) recoveries | (2,235 | ) | | 290 |
| | (2,565 | ) | | (3,289 | ) |
| Allowance for loan losses at the end of the period | $ | 31,400 |
| | $ | 30,211 |
| | $ | 31,400 |
| | $ | 30,211 |
|
| | | | | | | | |
| Allowance for loan losses to loans receivable, net | 1.12 | % | | 1.17 | % | | 1.12 | % | | 1.17 | % |
| Net charge-offs (recoveries) on loans to average loans, annualized | 0.32 | % | | (0.05 | )% | | 0.13 | % | | 0.18 | % |
The allowance for loan losses increased to $31.4 million at September 30, 2017 from $31.1 millionat December 31, 2016. The increase was the result of provision for loan losses of $2.9 million, partially offset by net charge-offs of $2.6 million recorded during the nine months ended September 30, 2017, which included PCI loan pool charge-offs of $1.7 million. The allowance for loan losses to loans receivable, net, decreased to 1.12% at September 30, 2017 from 1.18% at December 31, 2016.
The ratio of net charge-offs (recoveries) on loans to average loans, annualized deteriorated to net charge-off of 0.32% for the three months ended September 30, 2017 compared to net recoveries of 0.05% for the three months ended September 30, 2016, primarily due to PCI loan pool charge-offs of $1.5 million for the three months ended September 30, 2017. The ratio of net charge-offs (recoveries) on loans to average loans, annualized improved to a net charge-off of 0.13% for the nine months ended September 30, 2017 from 0.18% for the nine months ended September 30, 2016. The improvement of the ratio was due primarily to fewer net charge-offs recorded during the nine months ended September 30, 2017 compared to the same period in 2016 in addition to growth in the loan portfolio.
Nonperforming loans were $11.0 million and $10.9 million at September 30, 2017 and December 31, 2016, respectively, or 0.39% and 0.41% of loans receivable, net, respectively. The allowance for loan losses to nonperforming loans was 286.71% at September 30, 2017 and 284.93% at December 31, 2016. As of September 30, 2017, the Bank identified $31.0 million of impaired loans, of which $10.5 million had no specific valuation allowance as their estimated collateral value or discounted estimated cash flow was equal to or exceeds their carrying value. The remaining $20.5 million of impaired loans at September 30, 2017 had related specific valuation allowances totaling $3.1 million. Impaired loans totaled $33.2 million at December 31, 2016, of which $10.1 million had no specific valuation allowance and $23.1 million had $2.7 million of specific valuation allowance.
Based on the established comprehensive methodology, management deemed the allowance for loan losses of $31.4 million at September 30, 2017 appropriate to provide for probable incurred credit losses based on an evaluation of known and inherent risks in the loan portfolio at that date. This compares to an allowance for loan losses at December 31, 2016 of $31.1 million. At the applicable acquisition or merger dates, no allowance for loan losses was established on purchased loans as the loans were accounted for at their fair value and a discount was established for the loans. At September 30, 2017 and December 31, 2016, the remaining fair value discount for these purchased loans was $11.7 million and $13.5 million, respectively.
The following table outlines the allowance for loan losses and related loan balances at September 30, 2017 and December 31, 2016:
|
| | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | (Dollars in thousands) |
| General Valuation Allowance: | | | |
| Allowance for loan losses | $ | 24,113 |
| | $ | 21,791 |
|
| Gross loans, excluding PCI and impaired loans | $ | 2,719,813 |
| | $ | 2,540,751 |
|
| Percentage | 0.89 | % | | 0.86 | % |
| | | | |
| PCI Allowance: | | | |
| Allowance for loan losses | $ | 4,176 |
| | $ | 6,558 |
|
| Gross PCI loans | $ | 43,696 |
| | $ | 64,448 |
|
| Percentage | 9.56 | % | | 10.18 | % |
| | | | |
| Specific Valuation Allowance: | | | |
| Allowance for loan losses | $ | 3,111 |
| | $ | 2,734 |
|
| Gross impaired loans | $ | 30,996 |
| | $ | 33,198 |
|
| Percentage | 10.04 | % | | 8.24 | % |
| | | | |
| Total Allowance for Loan Losses: | | | |
| Allowance for loan losses | $ | 31,400 |
| | $ | 31,083 |
|
| Gross loans receivable | $ | 2,794,505 |
| | $ | 2,638,397 |
|
| Percentage | 1.12 | % | | 1.18 | % |
While the Bank believes it has established its existing allowances for loan losses in accordance with U.S. GAAP, there can be no assurance that bank regulators, in reviewing the Bank’s loan portfolio, will not request the Bank to increase significantly its allowance for loan losses. In addition, because Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan lossesACL on loans is appropriate or that increased provisions will not be necessary should the credit quality of the loans deteriorate. Any material increase in the allowance for loan lossesACL on loans would adversely affect the Company’s financial condition and results of operations.
Based on management’s assessment of loan quality and current economic conditions, the Company believes that its allowance for loan losses was appropriate to absorb the probable incurred losses and inherent risks of loss in the loan portfolio at September 30, 2017.
Deposits and Other Borrowings
As indicated in the table below, totalTotal deposits were $3.32increased $1.11 billion, or 24.1%, to $5.69 billion at September 30, 2017, an increase of $91.2 million, or 2.8%,2020 from $3.23$4.58 billion at December 31, 2016.
|
| | | | | | | | | | | | | |
| | September 30, 2017 | | December 31, 2016 |
| | Balance | | % of Total | | Balance | | % of Total |
| | (Dollars in thousands) |
| Noninterest bearing demand deposits | $ | 916,265 |
| | 27.6 | % | | $ | 882,091 |
| | 27.3 | % |
| Interest bearing demand deposits | 1,031,449 |
| | 31.0 |
| | 963,821 |
| | 29.8 |
|
| Money market accounts | 480,899 |
| | 14.5 |
| | 523,875 |
| | 16.2 |
|
| Savings accounts | 497,024 |
| | 15.0 |
| | 502,460 |
| | 15.6 |
|
| Total non-maturity deposits | 2,925,637 |
| | 88.1 |
| | 2,872,247 |
| | 88.9 |
|
| Certificates of deposit | 395,181 |
| | 11.9 |
| | 357,401 |
| | 11.1 |
|
| Total deposits | $ | 3,320,818 |
| | 100.0 | % | | $ | 3,229,648 |
| | 100.0 | % |
2019. Non-maturity deposits (totalas a percentage of total deposits less certificates of deposit) increased $53.4 million, or 1.9%,3.6% to $2.93 billion92.2% at September 30, 2017 from $2.87 billion2020 compared to 88.6% at December 31, 2016. Certificate2019.
The following table summarizes the Company's deposits as of September 30, 2020 and December 31, 2019:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2020 | | December 31, 2019 | | | | |
| Balance | | % of Total | | Balance | | % of Total | | Change | | % of Balance Change |
| (Dollars in thousands) |
| Noninterest demand deposits | $ | 1,989,247 | | | 35.0 | % | | $ | 1,446,502 | | | 31.6 | % | | $ | 542,745 | | | 37.5 | % |
| Interest bearing demand deposits | 1,652,661 | | | 29.0 | | | 1,348,817 | | | 29.4 | | | 303,844 | | | 22.5 | |
| Money market accounts | 1,079,814 | | | 19.0 | | | 753,684 | | | 16.4 | | | 326,130 | | | 43.3 | |
| Savings accounts | 523,286 | | | 9.2 | | | 509,095 | | | 11.2 | | | 14,191 | | | 2.8 | |
| Total non-maturity deposits | 5,245,008 | | | 92.2 | | | 4,058,098 | | | 88.6 | | | 1,186,910 | | | 29.2 | |
| Certificates of deposit | 444,040 | | | 7.8 | | | 524,578 | | | 11.4 | | | (80,538) | | | (15.4) | |
| Total deposits | $ | 5,689,048 | | | 100.0 | % | | $ | 4,582,676 | | | 100.0 | % | | $ | 1,106,372 | | | 24.1 | % |
The increase in deposits is primarily due to the proceeds from SBA PPP loans deposited directly into the customers' deposit accounts, increased $37.8 million, or 10.6%, to $395.2 million atan increase in customer deposit accounts based on changes in spending habits during the COVID-19 pandemic, and an increase in new deposit accounts. At September 30, 20172020, the Bank had approximately 553 deposit accounts with balances of approximately $82.9 million related to new customers that received a SBA PPP loan from $357.4 million at December 31, 2016 due primarily to the addition of $44.1 million of brokered certificates of deposit, which were used to supplement deposit growth in the funding of loan growth. Based on the change in the mix and volume of deposits, the percentage of certificates of deposit to total deposits increased to 11.9% at September 30, 2017 from 11.1% at December 31, 2016.Bank.
Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of assets. The Bank is utilizingalso utilizes securities sold under agreement to repurchase as a supplement to its funding sources. Our repurchase agreementssources, which are secured by available for sale investment securities. At September 30, 2017,During the latter part of 2019, the Bank hadmade an effort to transition customers from securities sold under agreement to repurchase to other deposit products. As of $28.7September 30, 2020 and December 31, 2019, only three customers utilized this product with total balances $29.0 million at
September 30, 2020, an increase of $6.6$8.9 million, or 29.7%44.0%, from $22.1$20.2 million at December 31, 2016. The increase was the result of2019 due primarily to customer activity during the period.
The Company also has junior subordinated debentures with a par value of $25.0 million which pay quarterly interest based on three-month LIBOR plus 1.56%. The debentures mature in 2037. The balance of the junior subordinated debentures was $19.9$20.8 million at September 30, 2017,2020, which reflects the fair value of the junior subordinated debentures established duringas part of the merger with Washington Banking Merger,Company on May 1, 2014, adjusted for the accretion of discount from purchase accounting fair value adjustment.
At September 30, 2017,2020, the Bank maintained credit facilities with the FHLB of Des Moines for $662.4$891.7 million and credit facilities with the Federal Reserve Bank of San Francisco for $50.6$55.0 million. The Company had no FHLB or Federal Reserve Bank advances outstanding of $117.4 million and $79.6 million at both September 30, 20172020 and December 31, 2016, respectively. The average cost of the FHLB advances during the nine months ended September 30, 2017 was1.09%. 2019.
The Bank also maintains lines of credit with fourfive correspondent banks to purchase federal funds totaling $90.0$215.0 million as of September 30, 2017.2020. There were no federal funds purchased as of September 30, 20172020 or December 31, 2016.2019.
We are requiredThe Bank was approved to maintain an adequate level of liquidity to ensureutilize the availability of sufficient funds to fund loan originations and deposit withdrawals, satisfy other financial commitments and fund operations. We generally maintain sufficient cash and short-term investments to meet short-term liquidity needs. At September 30, 2017, cash and cash equivalents totaled $111.3 million, or 2.7% of total assets. The fair value of investment securities available for sale totaled $800.1 millionPPPLF at September 30, 2017 of which $257.0 million were pledged2020; however, the Bank has chosen not to secure public deposits or borrowing arrangements. The fair value of investment securities available for sale that were not pledged totaled $543.1 million, or 13.4%, of total assets atparticipate during the nine months ended September 30, 2017. The fair value of investment securities available for sale with maturities of one year or less were $6.6 million, or 0.2%, of total assets at September 30, 2017.2020.
Liquidity and Cash Flows
Our primary sources of funds are customer and local government deposits,deposits; loan principal and interest payments; maturities, calls, and payments loan sales andof investment securities including related interest earned onearned; and proceeds from sales and maturities of investment securities. These funds, together with retained earnings, equity, and other borrowed funds, are used to make loans, acquire investment
securities and other assets, and fund continuing operations. While maturities and scheduled amortization of loans and investments are a predictable sourcesources of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition.
Heritage Bank: The principal objective of the Bank’s liquidity management program is to maintain the ability to meet day-to-day cash flow requirements of its customers who either wish to withdraw funds or to draw upon credit facilities to meet their cash needs. The Bank monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and the repayment and maturities of loans and investments, the Bank can utilize established credit facilities and lines with correspondent banks or initiate the sale of investment securities. As a result of the Federal Reserve Bank response to the COVID-19 pandemic, the Bank’s liquidity can be supplemented through the PPPLF as mentioned above in the "COVID-19 Impact" section above.
Heritage Financial Corporation: The Company is a separate legal entity from the Bank and must provide for its own liquidity. Substantially all of the Company’s revenues are obtained from dividends declared and paid by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Company. However, management believes that such restrictions will not have an adverse impact on the ability of the Company to meets its ongoing cash obligations. At September 30, 2017,2020, the Company (on an unconsolidated basis) had cash and cash equivalents of $9.5 million.
We are required to maintain an adequate level of liquidity to ensure the availability of sufficient funds for loan originations and deposit withdrawals, satisfy other financial commitments and fund operations. We generally maintain sufficient cash and short-term investments to meet short-term liquidity needs. At September 30, 2020, cash and cash equivalents totaled $576.2 million, or 8.6% of total assets and the fair value of investment securities available for sale totaled $834.5 million of which $263.7 million were pledged to secure public deposits or borrowing arrangements. The fair value of investment securities available for sale that were not pledged totaled $570.7 million, or 8.5% of total assets at September 30, 2020. The fair value of investment securities available for sale with no statedcontractual maturities of $11.6 million.one year or less were $63.7 million, or 1.0% of total assets, at September 30, 2020.
Consolidated Cash Flows: As disclosed in the Condensed Consolidated Statements of Cash Flows, net cash provided by operating activities was $53.8$76.6 million for the nine months ended September 30, 2017,2020, and primarily consisted of net income of $31.8 million, net proceeds from origination and sale of loans held for sale of $2.2$22.7 million and non-cash adjustments to reconcile net change in accrued interest receivable, prepaid expensesincome to cash provided by operating activities, including provision for credit losses of $39.2 million and other assets, accrued expensesdepreciation, amortization, and other liabilitiesaccretion of $8.3$28.3 million. During the nine months ended September 30, 2017,2020, net cash used inby investing activities was $169.9$803.5 million, which consisted primarily of net loan originations of $178.8$924.9 million, investment in low income housing tax credit partnerships of $8.5including $897.4 million andrelated to SBA PPP loan originations, offset partially by net proceeds from purchase and sale of investment securities available for saleactivity of $3.4$135.5 million. Net cash provided by financing activities was $123.6 million$1.07 billion for the nine months ended September 30, 2017,2020 and primarily consisted of a net increase in deposits of $91.2 million, net FHLB advances$1.11 billion primarily due to the proceeds from SBA PPP loans deposited directly into the customers' deposit accounts, an increase in customer deposit accounts based
on changes in spending habits during the COVID-19 pandemic, and an increase in new deposit accounts partially offset by dividends paid of $21.7 million and a net increase in securities sold under agreements to repurchaserepurchases of $6.6 million, offset partially by cash dividends on common stock of $11.4$19.1 million during the period.
CapitalStockholders' Equity and Regulatory Capital Requirements
Stockholders’ equity was $803.1 million at September 30, 2017 was $507.6 million2020 compared with $481.8to $809.3 million at December 31, 2016. 2019. The Company’s stockholders' equity to assets ratio was 12.0% as of September 30, 2020 and 14.6% as of December 31, 2019. The following table reflects the changes to stockholders' equity during the three and nine months ended September 30, 2020 and 2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| (In Thousands) |
| Balance, beginning of period | $ | 793,652 | | | $ | 796,625 | | | $ | 809,311 | | | $ | 760,723 | |
Cumulative effect from change in accounting policy (1) | — | | | — | | | (5,615) | | | (399) | |
| Net income | 16,636 | | | 17,895 | | | 22,688 | | | 50,431 | |
| Dividends declared | (7,227) | | | (7,042) | | | (21,796) | | | (20,383) | |
| Other comprehensive income, net of tax | (773) | | | 2,771 | | | 14,830 | | | 19,980 | |
| Repurchase of common stock | (7) | | | (6,954) | | | (19,105) | | | (8,635) | |
| Other | 848 | | | 832 | | | 2,816 | | | 2,410 | |
| Balance, end of period | $ | 803,129 | | | $ | 804,127 | | | $ | 803,129 | | | $ | 804,127 | |
(1) Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses. Effective January 1, 2019, the Company adopted ASU 2016-02, Leases.
No shares were repurchased under the Company's stock repurchase plans during the three months ended September 30, 2020 as the Company suspended repurchases in response to the COVID-19 pandemic.
During the nine months ended September 30, 2017,2020, the Company realized net incomerepurchased the remaining 639,922 shares available under the eleventh stock repurchase plan at a weighted average price per share of $31.8 million, declared cash dividends$23.95 and repurchased 155,778 shares at a weighted average share price of $11.4 million, recorded other comprehensive income$20.34 under the twelfth stock repurchase plan, which is a total of $4.4 million, recognized stock-based compensation expense795,700 shares under both plans at a weighted average share price of $1.6 million,$23.25.
During the three and recorded a net decrease to common stock due to common stock repurchases and exercises of stock options, net of tax, of $515,000.
Pursuant to minimum capital requirements of the FDIC effective on January 1, 2015, all FDIC-insured financial institutions, including Heritage Bank, are required to maintain a minimum common equity Tier 1 risk-based capital to risk-weighted assets ratio of 4.5%, a minimum Tier 1 leverage ratio to average assets of 4.0% and minimum risk-based capital ratios of Tier 1 capital to risk-weighted assets and total capital to risk-weighted assets of 6.0% and 8.0%, respectively.
As ofnine months ended September 30, 20172019, the Company repurchased 264,712 and December 31, 2016, the most recent regulatory notifications categorized Heritage Bank as well capitalized292,712 shares, respectively, available under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s categories. eleventh stock repurchase plan at a weighted average price per share of $26.23 and $26.50, respectively.
The following table provides our capital requirements and actual results.
|
| | | | | | | | | | | | | | | | | | | | | |
| | | Minimum Requirements | | Well-Capitalized Requirements | | Actual |
| | | (Dollars in thousands) |
| As of September 30, 2017: | | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | $ | 151,086 |
| | 4.5 | % | | N/A |
| | N/A |
| | $ | 383,546 |
| | 11.4 | % |
| Tier 1 leverage capital to average assets | | 155,761 |
| | 4.0 |
| | N/A |
| | N/A |
| | 403,444 |
| | 10.4 |
|
| Tier 1 capital to risk-weighted assets | | 201,448 |
| | 6.0 |
| | N/A |
| | N/A |
| | 403,444 |
| | 12.0 |
|
| Total capital to risk-weighted assets | | 268,598 |
| | 8.0 |
| | N/A |
| | N/A |
| | 435,119 |
| | 13.0 |
|
| Heritage Bank | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | 150,874 |
| | 4.5 |
| | $ | 217,929 |
| | 6.5 | % | | 388,852 |
| | 11.6 |
|
| Tier 1 leverage capital to average assets | | 155,582 |
| | 4.0 |
| | 194,478 |
| | 5.0 |
| | 388,852 |
| | 10.0 |
|
| Tier 1 capital to risk-weighted assets | | 201,165 |
| | 6.0 |
| | 268,221 |
| | 8.0 |
| | 388,852 |
| | 11.6 |
|
| Total capital to risk-weighted assets | | 268,221 |
| | 8.0 |
| | 335,276 |
| | 10.0 |
| | 420,422 |
| | 12.5 |
|
| | | | | | | | | | | | | |
| As of December 31, 2016: | | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | $ | 142,688 |
| | 4.5 | % | | N/A |
| | N/A |
| | $ | 362,350 |
| | 11.4 | % |
| Tier 1 leverage capital to average assets | | 148,144 |
| | 4.0 |
| | N/A |
| | N/A |
| | 381,989 |
| | 10.3 |
|
| Tier 1 capital to risk-weighted assets | | 190,250 |
| | 6.0 |
| | N/A |
| | N/A |
| | 381,989 |
| | 12.0 |
|
| Total capital to risk-weighted assets | | 253,667 |
| | 8.0 |
| | N/A |
| | N/A |
| | 413,320 |
| | 13.0 |
|
| Heritage Bank | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | 142,573 |
| | 4.5 |
| | $ | 205,938 |
| | 6.5 | % | | 369,915 |
| | 11.7 |
|
| Tier 1 leverage capital to average assets | | 148,024 |
| | 4.0 |
| | 185,030 |
| | 5.0 |
| | 369,915 |
| | 10.0 |
|
| Tier 1 capital to risk-weighted assets | | 190,097 |
| | 6.0 |
| | 253,462 |
| | 8.0 |
| | 369,915 |
| | 11.7 |
|
| Total capital to risk-weighted assets | | 253,462 |
| | 8.0 |
| | 316,828 |
| | 10.0 |
| | 401,168 |
| | 12.7 |
|
Although new capital requirements were effective on January 1, 2015, certain provisions of the new rule will be phased-in from the effective date through 2019, including, among others, a new capital conservation buffer requirement, which requires financial institutions to maintain a common equity capital ratio more than 2.5% above the required minimum levels in order to avoid limitations on capital distributions, including dividend payments, and certain discretionary bonus payments based on percentages of eligible retained income that could be utilized for such actions. The new capital conservation buffer requirement began to be phased-in on January 1, 2016 at 0.625% of risk-weighted assets and will continue to increase by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019. At September 30, 2017, the capital conservation buffer was 5.07% and 4.65% for the Company and the Bank, respectively, and the minimum conservation buffer requirement was 1.25%.
Quarterly, the Company reviews the potential payment ofhas historically paid cash dividends to its common shareholders. The timing and amountPayments of future cash dividends, paidif any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, capital requirements, current and anticipated cash needs, plans for expansion, any legal or contractual limitation on our common stock depends on the Company’s earnings, capital requirements, financial conditionability to pay dividends and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income. On October 25, 2017,21, 2020, the Company’s Board of Directors declared a regular dividend of $0.13$0.20 per common share and a special dividend of $0.10 per common sharewhich is payable on November 22, 2017 18, 2020to shareholders of record on November 8, 2017.4, 2020.
The Company is a bank holding company under the supervision of the Federal Reserve Bank. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. Heritage Bank is a federally insured institution and thereby is subject to the capital requirements established by the FDIC. The Federal Reserve capital requirements generally parallel the FDIC requirements. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements and operations. Management believes as of September 30, 2020, the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of September 30, 2020 and December 31, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's categories. The following table
represents the minimum required ratios of the Company and the Bank and the actual capital ratios at the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Minimum Requirements | | Well-Capitalized Requirements | | Actual |
| | (Dollars in thousands) |
| As of September 30, 2020: | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | $ | 207,313 | | | 4.5 | % | | N/A | | N/A | | $ | 539,440 | | | 11.7 | % |
| Tier 1 leverage capital to average assets | 253,978 | | | 4.0 | | | N/A | | N/A | | 560,254 | | | 8.8 | |
| Tier 1 capital to risk-weighted assets | 276,418 | | | 6.0 | | | N/A | | N/A | | 560,254 | | | 12.2 | |
| Total capital to risk-weighted assets | 368,557 | | | 8.0 | | | N/A | | N/A | | 617,914 | | | 13.4 | |
| Heritage Bank | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | 207,134 | | | 4.5 | | | $ | 299,194 | | | 6.5 | % | | 547,979 | | | 11.9 | |
| Tier 1 leverage capital to average assets | 253,826 | | | 4.0 | | | 317,282 | | | 5.0 | | | 547,979 | | | 8.6 | |
| Tier 1 capital to risk-weighted assets | 276,179 | | | 6.0 | | | 368,238 | | | 8.0 | | | 547,979 | | | 11.9 | |
| Total capital to risk-weighted assets | $ | 368,238 | | | 8.0 | % | | $ | 460,298 | | | 10.0 | % | | $ | 605,609 | | | 13.2 | % |
| | | | | | | | | | | |
| As of December 31, 2019: | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | $ | 211,110 | | | 4.5 | % | | N/A | | N/A | | $ | 541,154 | | | 11.5 | % |
| Tier 1 leverage capital to average assets | 212,578 | | | 4.0 | | | N/A | | N/A | | 561,749 | | | 10.6 | |
| Tier 1 capital to risk-weighted assets | 281,479 | | | 6.0 | | | N/A | | N/A | | 561,749 | | | 12.0 | |
| Total capital to risk-weighted assets | 375,306 | | | 8.0 | | | N/A | | N/A | | 598,226 | | | 12.8 | |
| Heritage Bank | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | 211,017 | | | 4.5 | | | $ | 304,803 | | | 6.5 | % | | 538,560 | | | 11.5 | |
| Tier 1 leverage capital to average assets | 211,187 | | | 4.0 | | | 263,984 | | | 5.0 | | | 538,560 | | | 10.2 | |
| Tier 1 capital to risk-weighted assets | 281,356 | | | 6.0 | | | 375,142 | | | 8.0 | | | 538,560 | | | 11.5 | |
| Total capital to risk-weighted assets | $ | 375,142 | | | 8.0 | % | | $ | 468,927 | | | 10.0 | % | | $ | 575,037 | | | 12.3 | % |
As of September 30, 2020, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC, that allows us the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period.
Under applicable capital requirements both the Company and the Bank are required to have a common equity Tier 1 capital ratio of 4.5%, a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio of 8.0%. Both the Company and the Bank are also required to maintain a capital conservation buffer of common equity Tier 1 capital above 2.5% to avoid restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers. At September 30, 2020, the capital conservation buffer was 5.4% and 5.2% for the Company and the Bank, respectively.
Non-GAAP Financial Measures
This report contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America. These measures include net interest income, interest and fees on loans, ACL, loan yield and net interest margin excluding the effect of the incremental accretion on purchased loans acquired through mergers and income from SBA PPP loans. Our management uses these non-GAAP measures, together with the related GAAP measures, in its analysis of our performance and in making business decisions. Management also uses these measures for peer comparisons. Management believes that presenting loan yield and net interest margin excluding the effect of the acquisition accounting discount accretion on loans acquired through mergers is useful in assessing the impact of acquisition accounting on loan
yield and net interest margin, as the effect of loan discount accretion is expected to decrease as the acquired loans mature or roll off our balance sheet. Management believes that presenting loan yield and net interest margin excluding the effect of the SBA PPP loans is useful in assessing the impact of special program loans that are anticipated to substantially decrease upon forgiveness by the SBA within a short time frame. These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
Reconciliations of the GAAP and non-GAAP financial measures are presented below for the three and nine months ended September 30, 2020 and 2019:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| | 2020 | | 2019 | | 2020 | | 2019 |
| (Dollars in thousands) |
| Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized: |
| Interest and fees on loans (GAAP) | $ | 47,647 | | | $ | 47,845 | | | $ | 142,328 | | | $ | 142,651 | |
| Exclude SBA PPP loan interest and fees | (5,810) | | | — | | | (10,733) | | | — | |
| Exclude incremental accretion on purchased loans | (944) | | | (1,090) | | | (2,651) | | | (3,879) | |
| Adjusted interest and fees on loans (non-GAAP) | $ | 40,893 | | | $ | 46,755 | | | $ | 128,944 | | | $ | 138,772 | |
| | | | | | | |
| Average loans receivable, net | $ | 4,605,389 | | | $ | 3,677,405 | | | $ | 4,266,598 | | | $ | 3,651,659 | |
| Exclude average SBA PPP loans | (863,127) | | | — | | | (511,461) | | | — | |
| Adjusted average loans receivable, net (non-GAAP) | $ | 3,742,262 | | | $ | 3,677,405 | | | $ | 3,755,137 | | | $ | 3,651,659 | |
| | | | | | | |
| Loan yield, annualized (GAAP) | 4.12 | % | | 5.16 | % | | 4.46 | % | | 5.22 | % |
| Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized (non-GAAP) | 4.35 | % | | 5.04 | % | | 4.59 | % | | 5.08 | % |
| | | | | | | | | | | |
| September 30,
2020 | | December 31,
2019 |
| (Dollars in thousands) |
| ACL on loans to loans receivable, excluding SBA PPP loans |
| Allowance for credit losses on loans | $ | (73,340) | | | $ | (36,171) | |
| | | |
| Loans receivable (GAAP) | $ | 4,666,730 | | | $ | 3,767,879 | |
| Exclude SBA PPP loans | 867,782 | | | — | |
| Loans receivable, excluding SBA PPP (non-GAAP) | $ | 3,798,948 | | | $ | 3,767,879 | |
| | | |
| ACL on loans to Loans receivable (GAAP) | 1.57 | % | | 0.96 | % |
| ACL on loans to Loans receivable, excluding SBA PPP loans (non-GAAP) | 1.93 | % | | 0.96 | % |
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk through our lending and deposit gathering activities. Our results of operations are highly dependent upon our ability to manage interest rate risk. We consider interest rate risk to be a significant market risk that could have a material effect on our financial condition and results of operations. Interest rate risk is measured and assessed on a quarterly basis. In our opinion, there has not been
As a material change inresult of the COVID-19 pandemic, our interest rate risk exposure has changed since the information disclosed in our 2019 Annual ReportForm 10-K. The following table presents the change in our net interest income as a result of parallel rate shock scenarios presented in the periods after the dates shown:
| | | | | | | | | | | |
| September 30,
2020 | | December 31,
2019 |
| (Dollars in thousands) |
| Up 100 | | | |
| Year 1 | $ | 13,459 | | | $ | 8,149 | |
| Year 2 | 26,015 | | | 15,572 | |
| Up 200 | | | |
| Year 1 | 26,726 | | | 15,933 | |
| Year 2 | 51,418 | | | 29,806 | |
| Down 100 | | | |
| Year 1 | (2,845) | | | (7,415) | |
| Year 2 | $ | (7,172) | | | $ | (15,178) | |
These scenarios are based on Form 10-K forinterest rates as of the yearlast day of a reporting period published by independent sources and incorporate relevant spread of instruments that are actively traded in the open market. Given that the short-term rates have declined during the nine months ended December 31, 2016.
WeSeptember 30, 2020, we do not believe that the result of the "Down 200" analysis provide meaningful results and have been excluded. For the "Down 100" scenario, the Bank's modeling assumption is that all deposit rates are floored to one or two basis points and new loan production is recalibrated to incorporate a chosen net interest spread over index. The simulations used to manage market risk are based on numerous assumptions regarding the effect of changes in interest rates on the timing and extent of reprice characteristics, future cash flows and customer behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower net interest income. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes as well as changes in market condition, customer behavior and management strategies, among other factors.
Neither we, nor the Bank, maintain a trading account for any class of financial instrument, nor do we, or the Bank, engage in hedging activities or purchase high-riskhigh risk derivative instruments. Moreover, neither we, have no materialnor the Bank, are subject to foreign currency exchange rate risk or commodity price risk.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
An evaluation of the Company’s disclosure controls and procedure (as defined in Section 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934 (the “Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and the Company’s Disclosure Committee as of the end of the period covered by this quarterly report. In designing and evaluating the Company’s disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of September 30, 20172020 are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
(b) Changes in Internal Control Over Financial Reporting
Effective January 1, 2020, Heritage adopted FASB ASU 2016-13, Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended. The Company designed new
controls and modified existing controls as part of its adoption. These additional controls over financial reporting included controls over model creation and design, model governance, assumptions and expanded controls over loan level data.
There have been no other changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended September 30, 2017,2020, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company does not expect that its internal control over financial reporting will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
HeritageWe, and Heritageour Bank, are not a party to any material pending legal proceedings other than ordinary routine litigation incidental to the business of the Bank.
ITEM 1A. RISK FACTORS
There have been no material changes to the risk factors set forth in Part I. Item 1A of the Company’s 2019 Annual Form 10-K related to the COVID-19 pandemic. The following provides a discussion of certain risks that management believes are specific to our business as a result of the COVD-19 pandemic.
The outbreak of COVID-19 has adversely impacted certain industries in which our customers operate and may impair their ability to fulfill their obligations to us. Further, the spread of the outbreak has disrupted banking and other financial activity in the areas in which we operate, and could lead to an economic recession or other additional severe disruptions in the U.S. economy, and could potentially create business continuity issues for us.
The COVID-19 pandemic started to cause major economic disruption and volatility as a result of governmental mandates (e.g., “shelter in place” mandates, school closures) and voluntary changes in consumer behavior (e.g., “social distancing”) in March 2020. The ultimate impact of the COVID-19 pandemic will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic. Since the termination of the shelter in place orders in our market areas and phased re-opening of business, the Company has taken steps to resume more normal branch activities with specific guidelines in place to ensure the safety of the Company’s customers and personnel. As of September 30, 2020, all of our branch lobbies remain closed since March 2020 with most services processed through the drive-up or by appointment, except three branches located within Island County which are operating with an open lobby.
Although shelter in place orders have terminated, currently a portion of our employees are working remotely to enable us to continue to provide banking services to our customers. Heightened cybersecurity, information security and operational risks may result from these work-from-home arrangements. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic. Further, we also rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.
There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic. As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on its credit quality, revenues and asset
values. To date, the COVID-19 pandemic has resulted in declines in loan demand and loan originations other than through government sponsored programs such as the SBA's Payroll Protection Program, deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the continued low targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected in the near term, if not longer. Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as revenues declined precipitously, especially in businesses related to travel, hospitality, leisure, and physical personal services. Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to the Pacific Northwest region over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.
The impact of the pandemic is expected to continue to adversely affect us during 2020 as the ability of many of our customers to make loan payments has been significantly affected. Although the Company has made estimates of credit losses related to the pandemic as part of its evaluation of the ACL on loans, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact that the pandemic will have on the credit quality of our loan portfolio. The extent of the economic impact of the pandemic is also impossible to determine with certainty at this time as it is partly dependent on a still evolving virus. Accordingly, estimates of the pandemic's effect on credit losses could change over time as additional information becomes available. If our estimates are incorrect, our ACL on loans may not be sufficient to cover losses in our loan portfolio, resulting in the need for increases in our ACL on loans through the provision for credit losses which is recorded and charged against income. Any increases in the ACL on loans will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.
As of September 30, 2020, we hold and service a portfolio of SBA PPP loans totaling $867.8 million. The SBA PPP loans are subject to the provisions of the CARES Act as well as complex and evolving rules and guidance issued by the SBA and other government agencies.We expect that the great majority of our SBA PPP borrowers will seek full or partial forgiveness of their loan obligations.We could face additional risks in our administrative capabilities to service our SBA PPP loans, and risk with respect to the determination of loan forgiveness, depending on the final procedures for determining loan forgiveness.
In addition to SBA PPP loans, the Company is providing assistance to commercial business loan borrowers in response to the economic disruption caused by COVID-19 by offering short-term modifications such as interest only payments, payment deferrals, loan re-amortization, and increases of lines of credit. Also, the Company is assisting mortgage and consumer loan borrowers by offering short-term modifications for payment deferrals when the borrower meets certain criteria, or on a case-by-case analysis.Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans once the COVID-19 pandemic is resolved. If the economic disruption from the COVID-19 pandemic continues for several months or worsens, it may result in increased loan delinquencies, adversely classified loans and loan charge-offs. As a result, our ACL on loans may prove to be insufficient to absorb losses in our loan portfolio, which would cause our results of operations, liquidity and financial condition to be adversely affected.
Further, given the widespread level of disruption to commercial and consumer activity due to COVID-19, the Company decided to adopt certain measures to assist its deposit customers in affected areas. These measures include the waiver of certain fees and charges, such as early withdrawal penalties for certificates of deposit and overdrafts, and while important to assist our customers, these concessions will negatively impact our results of operations.
In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on our results of operations and financial condition.
We are an entity separate and distinct from our principal subsidiary, Heritage Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. If the COVID-19 pandemic were to materially adversely affect Heritage Bank’s regulatory capital levels or liquidity, it may result in Heritage Bank being unable to pay dividends to us, which may result in our not being able to pay dividends on our common stock at the same rate or at all.
Even after the COVID-19 pandemic subsides, the U.S. economy may experience a recession, and we anticipate our business would be materially and adversely affected by a prolonged recession. To the extent the COVID-19 pandemic adversely affects our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled "Risk Factors" in our 2019 Annual Report on Form 10-K for the year ended December 31, 2016.and any subsequent Quarterly Reports on Form 10-Q.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Not applicable.
(b) Not applicable.
(c) Repurchase Plans
The Company has had various stock repurchase programs since March 1999. On October 23, 2014,March 12, 2020 the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,0001,799,054 shares, under the eleventhtwelfth stock repurchase plan. The number, timing and price of shares repurchased will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.
No shares were repurchased under the Company's stock repurchase plans during the three months ended September 30, 2020 as the Company suspended repurchases in response to the COVID-19 pandemic.
The following table provides totalDuring the nine months ended September 30, 2020, the Company repurchased the remaining 639,922 shares available under the eleventh stock repurchase plan at a weighted average price per share of $23.95 and repurchased 155,778 shares at a weighted average share pricesprice of $20.34 under the applicabletwelfth stock repurchase plan, forwhich is a total of 795,700 shares under both plans at a weighted average share price of $23.25.
During the periods indicated:three and nine months ended September 30, 2019, the Company repurchased 264,712 and 292,712 shares, respectively, under the eleventh stock repurchase plan at a weighted average price per share of $26.23 and $26.50, respectively.
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| | Three Months Ended September 30, | | Nine Months Ended September 30, | | |
| | 2017 | | 2016 | | 2017 | | 2016 | | Plan Total (1) |
| Eleventh Plan | | | | | | | | | |
| Repurchased shares | — |
| | 38,000 |
| | — |
| | 138,000 |
| | 579,996 |
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| Stock repurchase average share price | $ | — |
| | $ | 17.46 |
| | $ | — |
| | $ | 17.16 |
| | $ | 16.76 |
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(1) | Represents shares repurchased and average price per share paid during the duration of the plan. |
In addition to the stock repurchases disclosed in the table above,under a plan, the Company repurchasedrepurchases shares to pay withholding taxes on the vesting of restricted stock. Duringstock awards and units. The following table provides total repurchased shares for the three and nine months ended September 30, 2017, the Company repurchased 344 and 27,711 shares of common stock at an average price per share of $25.80 and $24.61 to pay withholding taxes on the vesting of restricted stock that vested during the respective periods. During the three and nine months ended September 30, 2016, the Company repurchased 5,276 and 29,206 shares of common stock at an average price per share of $18.64 and $17.77 to pay withholding taxes on the vesting of restricted stock that vested during the respective periods.periods indicated:
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| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2020 | | 2019 | | 2020 | | 2019 |
| Repurchased shares to pay withholding taxes | 378 | | | 405 | | | 28,306 | | | 28,434 | |
| Stock repurchase to pay withholding taxes average share price | $ | 19.84 | | | $ | 27.67 | | | $ | 21.54 | | | $ | 30.83 | |
The following table sets forth information about the Company’s purchases of its outstanding common stock during the quarter ended September 30, 2017.2020:
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| Period | Total Number of Shares Purchased (1) | | Average Price Paid Per Share (1) | | Cumulative Total Number of Shares Purchased as
Part of Publicly
Announced Plans or Programs | | Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs |
| July 1, 2020— July 31, 2020 | — | | | $ | — | | | 8,981,801 | | | 1,643,276 | |
| August 1, 2020— August 31, 2020 | — | | | — | | | 8,981,801 | | | 1,643,276 | |
| September 1, 2020— September 30, 2020 | 378 | | | 19.84 | | | 8,981,801 | | | 1,643,276 | |
| Total | 378 | | | $ | 19.84 | | | | | |
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| | | | | | | | | | | | | |
| Period | | Total Number of Shares Purchased(1) | | Average Price Paid Per Share(1) | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs |
| July 1, 2017— July 31, 2017 | | — |
| | $ | — |
| | 7,893,389 |
| | 935,034 |
|
| August 1, 2017— August 31, 2017 | | — |
| | — |
| | 7,893,389 |
| | 935,034 |
|
| September 1, 2017— September 30, 2017 | | 344 |
| | 25.80 |
| | 7,893,389 |
| | 935,034 |
|
| Total | | 344 |
| | $ | 25.80 |
| | 7,893,389 |
| | 935,034 |
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(1) | All of the common shares repurchased by the Company between July 1, 2017 and September 30, 2017 were shares of restricted stock that represented the cancellation of stock to pay withholding taxes. |
(1)Of the common shares repurchased by the Company between July 1, 2020 and September 30, 2020, all of the shares represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
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| | | | Incorporated by Reference |
| Exhibit No. | | Description of Exhibit | | Form | | Exhibit | | Filing Date/Period End Date |
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| 3.3. | | | | 8-K | | 3.3 | | 06/30/2020 |
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| 10.37* | | | | 8-K | | 10.1 | | 06/30/2020 |
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| 10.38* | | | | 8-K | | 10.3 | | 06/30/2020 |
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| 10.39* | | | | 8-K | | 10.2 | | 06/30/2020 |
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| 101.INS | | XBRL Instance Document (1) | | | | | | |
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| 101.SCH | | XBRL Taxonomy Extension Schema Document (1) | | | | | | |
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| 101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document (1) | | | | | | |
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| 101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document (1) | | | | | | |
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| 101.LAB | | XBRL Taxonomy Extension Label Linkbase Document (1) | | | | | | |
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| 101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document (1) | | | | | | |
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*Indicates management contract or compensatory plan or arrangement |
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| | | | | Incorporated by Reference |
| Exhibit No. | | Description of Exhibit | | Form | | Exhibit | | Filing Date/Period End Date |
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| 2.5 |
| | | | 8-K | | 2.1 | | 7/27/17 |
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| 31.1 |
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| 31.2 |
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| 32.1 |
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| 101 |
| | The following financial information from Heritage Financial Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 is formatted in XBRL: (i) the Unaudited Condensed Consolidated Statements of Financial Condition, (ii) the Unaudited Condensed Consolidated Statements of Income, (iii) the Unaudited Condensed Consolidated Statements Comprehensive Income, (iv) the Unaudited Condensed Consolidated Statements of Stockholders’ Equity, (v) the Unaudited Condensed Consolidated Statements of Cash Flows and (vi) the Unaudited Notes to Condensed Consolidated Financial Statements. | | | | | | |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| | HERITAGE FINANCIAL CORPORATION |
| | |
| Date: | | HERITAGE FINANCIAL CORPORATION |
| November 9, 2020 | | /S/ JEFFREY J. DEUEL |
Date: | | Jeffrey J. Deuel |
November 9, 2017 | | /S/ BRIAN L. VANCE |
| | Brian L. Vance |
| | President and Chief Executive Officer |
| | (Duly Authorized Officer) |
| Date: | | |
Date: | | |
November 9, 20172020 | | /S/ DONALD J. HINSON |
| | Donald J. Hinson |
| | Executive Vice President and Chief Financial Officer |
| | (Principal Financial and Accounting Officer) |