UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~June~~September 30, 2020 or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number 000-29480

HERITAGE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Washington

91-1857900

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

201 Fifth Avenue SW,

Olympia

98501

(Address of principal executive offices)

(Zip Code)

(360) 943-1500

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading symbol	Name of each exchange on which registered
Common stock, no par value	HFWA	NASDAQ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☒

Accelerated filer

☐

Non-accelerated filer

☐

Smaller reporting company

☐

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

As of ~~July 27,~~October 30, 2020, there were ~~35,908,908~~35,910,300 shares of the registrant's common stock, no par value per share, outstanding.

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HERITAGE FINANCIAL CORPORATION

FORM 10-Q

~~June~~September 30, 2020

TABLE OF CONTENTS


				Page
GLOSSARY OF ACRONYMS, ABBREVIATIONS AND TERMS							43
FORWARD LOOKING STATEMENTS							54

PART I.	FINANCIAL INFORMATION					76
ITEM 1.	FINANCIAL STATEMENTS					76
		CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) AS OF ~~JUNE~~SEPTEMBER 30,, 2020 AND DECEMBER 31, 2019			76
		CONDENSED CONSOLIDATED STATEMENTS OF ~~OPERATIONS~~INCOME (UNAUDITED) FOR THE THREE AND ~~SIX~~NINE MONTHS ENDED ~~JUNE~~SEPTEMBER 30, 2020 AND 2019			87
		CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) FOR THE THREE AND ~~SIX~~ NINE MONTHS ENDED ~~JUNE~~ 3 0 ,SEPTEMBER 30, 2020, AND 2019			98
		CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) FOR THE THREE AND ~~SIX~~NINE MONTHS ENDED ~~JUNE~~ 3 0 ,SEPTEMBER 30, 2020 AND 2019			109
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE ~~SIX~~NINE MONTHS ENDED ~~JUNE~~ 3 0 ,SEPTEMBER 30, 2020 AND 2019			1211
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS			1413
		NOTE 1.	DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS	1413
		NOTE 2.	INVESTMENT SECURITIES	2019
		NOTE 3.	LOANS RECEIVABLE	2321
		NOTE 4.	ALLOWANCE FOR CREDIT LOSSES ON LOANS	3331
		NOTE 5.	OTHER REAL ESTATE OWNED	3735
		NOTE 6.	GOODWILL AND OTHER INTANGIBLE ASSETS	3736
		NOTE 7.	JUNIOR SUBORDINATED DEBENTURES	3836
		NOTE 8.	SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE	3937
		NOTE 9.	OTHER BORROWINGS	3937
		NOTE 10.	DERIVATIVE FINANCIAL INSTRUMENTS	4038
		NOTE 11.	STOCKHOLDERS’ EQUITY	4038
		NOTE 12.	~~ACCUMULATED OTHER COMPREHENSIVE INCOME~~FAIR VALUE MEASUREMENTS	4240
		NOTE 13.	~~FAIR VALUE MEASUREMENTS~~CASH REQUIREMENT	4245
		NOTE 14.	~~CASH REQUIREMENT~~COMMITMENTS AND CONTINGENCIES	4745
		NOTE 15.	~~COMMITMENTS AND CONTINGENCIES~~	47
		~~NOTE 16.~~	INCOME TAXES	4745

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS					4846
	OVERVIEW					4846
	COVID-19 IMPACT					4947
	EARNINGS SUMMARY					5251
	NET INTEREST INCOME					5352
	PROVISION FOR CREDIT LOSSES ON LOANS			58
	NONINTEREST INCOME			59
	NONINTEREST ~~INCOME~~EXPENSE					61
	~~NONINTEREST EXPENSE~~					62
	INCOME TAX EXPENSE					6463
	FINANCIAL CONDITION OVERVIEW					6563
	LENDING ACTIVITIES					64
	DEPOSITS AND OTHER BORROWINGS					7170
	LIQUIDITY AND CASH FLOW			71
	STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL REQUIREMENTS OVERVIEW			72
	NON-GAAP FINANCIAL MEASURES			73

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~~STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL REQUIREMENTS OVERVIEW~~

~~NON-GAAP FINANCIAL MEASURES~~

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

7574

ITEM 4.

CONTROLS AND PROCEDURES

7675

Part II.

OTHER INFORMATION

ITEM 1.

ITEM 1A.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

7978

ITEM 4.

MINE SAFETY DISCLOSURES

ITEM 5.

ITEM 6.

~~Table~~ ~~of Contents~~

GLOSSARY OF ACRONYMS, ABBREVIATIONS, AND TERMS

The acronyms, abbreviations, and terms listed below are used in various sections of the Form 10-Q, including “Item 1. Financial Statements” and “Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations." As used throughout this report, the terms “we”, “our”, or “us” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.


2019 Annual Form 10-K			Company's Annual Report on Form 10-K for the year ended December 31, 2019
ACL			Allowance for Credit Losses
ALL			Allowance for Loan Losses
AOCI			Accumulated other comprehensive income, net
ASC			Accounting Standards Codification
ASU			Accounting Standards Update
Bank			Heritage Bank
~~BOLI~~			~~Bank owned life insurance~~
CARES Act			Coronavirus Aid, Relief, and Economic Security Act of 2020
~~CDI~~			~~Core Deposit Intangible~~
CECL			Current Expected Credit Loss
CECL Adoption			~~Adoption~~Company's adoption on January 1, 2020 of FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology
~~CEO~~CMO			~~Chief Executive Officer~~
~~CFO~~			~~Chief Financial Officer~~Collateralized Mortgage Obligation
Company			Heritage Financial Corporation
COVID-19			Coronavirus Disease of 2019 pandemic
CRE			Commercial real estate
FASB			Financial Accounting Standards Board
FDIC			Federal Deposit Insurance Corporation
Federal Reserve			Board of Governors of the Federal Reserve System
Federal Reserve Bank			Federal Reserve Bank of San Francisco
FHLB			Federal Home Loan Bank of Des Moines
GAAP			U.S. Generally Accepted Accounting Principles
GDP			U.S. Gross Domestic Product
Heritage			Heritage Financial Corporation
LIBOR			London Interbank Offering Rate
~~PCI~~MBS			Purchased Credit Impaired; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 310-30Mortgage-backed security
PCD			Purchased Credit Deteriorated; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 326
PCI			Purchased Credit Impaired; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 310-30

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PPP			Paycheck Protection Program
PPPLF			Paycheck Protection Program Liquidity Facility
SBA			Small Business Administration
SEC			Securities and Exchange Commission
TDR			Troubled Debt Restructured
Unfunded Commitments			Off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments

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FORWARD LOOKING ~~STATEMENTS:~~STATEMENTS

This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” The COVID-19, pandemic is adversely affecting us, our customers, counterparties, employees, and third-party service providers, and the ultimate extent of the impacts on our business, financial position, results of operations, liquidity, and prospects is uncertain. Continued deterioration in general business and economic conditions, including further increases in unemployment rates, or turbulence in domestic or global financial markets could adversely affect our revenues and the values of our assets and liabilities, reduce the availability of funding, lead to a tightening of credit, and further increase stock price volatility. In addition, changes to statutes, regulations, or regulatory policies or practices as a result of, or in response to COVID-19, could affect us in substantial and unpredictable ways. Other factors that could cause or contribute to such differences include, but are not limited to:

•the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our ACL on loans and provision for credit losses on loans that may be effected by deterioration in the housing and commercial real estate markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our ACL on loans no longer being adequate to cover actual losses, and require us to increase our allowance for credit losses on loans;

•changes in general economic conditions, either nationally or in our market areas;

•changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;

•risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;

•fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;

•results of examinations of us by the bank regulators, including the possibility that any such regulatory authority may, among other things, initiate an enforcement action against the Company or our bank subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings;

•legislative or regulatory changes that adversely affect our business

•implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;

•our ability to control operating costs and expenses;

•increases in premiums for deposit insurance;

•the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

•difficulties in reducing risk associated with the loans on our Condensed Consolidated Statements of Financial Condition;

•staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

•disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;

•our ability to retain key members of our senior management team;

•costs and effects of litigation, including settlements and judgments;

•our ability to implement our growth strategies;

•our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings

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within expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected;

•increased competitive pressures among financial service companies;

•changes in consumer spending, borrowing and savings habits;

•the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

•adverse changes in the securities markets;

•inability of key third-party providers to perform their obligations to us;

~~Table~~ ~~of Contents~~

•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including from the COVID-19 pandemic, and the other risks detailed from time to time in our filings with the SEC including our 2019 Annual Form 10-K.

The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating results and stock price performance.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)

(In thousands, except shares)


		June 30, 2020		December 31, 2019			September 30, 2020		December 31, 2019
ASSETS	ASSETS					ASSETS
Cash on hand and in banks	Cash on hand and in banks	$	100,872	$	95,039	Cash on hand and in banks	$	89,039	$	95,039
Interest earning deposits	Interest earning deposits	314,203		133,529		Interest earning deposits	487,203		133,529
Cash and cash equivalents	Cash and cash equivalents	415,075		228,568		Cash and cash equivalents	576,242		228,568
Investment securities available for sale, at fair value, net (amortized cost of $846,839 and $939,160, respectively)		879,927		952,312
Investment securities available for sale, at fair value, net (amortized cost of $802,391 and $939,160, respectively)						Investment securities available for sale, at fair value, net (amortized cost of $802,391 and $939,160, respectively)	834,492		952,312
Loans held for sale	Loans held for sale	3,783		5,533		Loans held for sale	8,250		5,533
Loans receivable	Loans receivable	4,666,333		3,767,879		Loans receivable	4,666,730		3,767,879
Allowance for credit losses on loans	Allowance for credit losses on loans	(71,501)		(36,171)		Allowance for credit losses on loans	(73,340)		(36,171)
Loans receivable, net	Loans receivable, net	4,594,832		3,731,708		Loans receivable, net	4,593,390		3,731,708
Other real estate owned	Other real estate owned	—		841		Other real estate owned	0		841
Premises and equipment, net	Premises and equipment, net	86,897		87,888		Premises and equipment, net	89,831		87,888
Federal Home Loan Bank stock, at cost	Federal Home Loan Bank stock, at cost	6,661		6,377		Federal Home Loan Bank stock, at cost	6,661		6,377
Bank owned life insurance	Bank owned life insurance	107,401		103,616		Bank owned life insurance	108,311		103,616
Accrued interest receivable	Accrued interest receivable	17,813		14,446		Accrued interest receivable	18,888		14,446
Prepaid expenses and other assets	Prepaid expenses and other assets	194,224		164,129		Prepaid expenses and other assets	194,938		164,129
Other intangible assets, net	Other intangible assets, net	14,807		16,613		Other intangible assets, net	13,947		16,613
Goodwill	Goodwill	240,939		240,939		Goodwill	240,939		240,939
Total assets	Total assets	$	6,562,359	$	5,552,970	Total assets	$	6,685,889	$	5,552,970
LIABILITIES AND STOCKHOLDERS' EQUITY	LIABILITIES AND STOCKHOLDERS' EQUITY					LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits	Deposits	$	5,567,733	$	4,582,676	Deposits	$	5,689,048	$	4,582,676

Junior subordinated debentures	Junior subordinated debentures	20,741		20,595		Junior subordinated debentures	20,814		20,595
Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	24,444		20,169		Securities sold under agreement to repurchase	29,043		20,169
Accrued expenses and other liabilities	Accrued expenses and other liabilities	155,789		120,219		Accrued expenses and other liabilities	143,855		120,219
Total liabilities	Total liabilities	5,768,707		4,743,659		Total liabilities	5,882,760		4,743,659
Stockholders’ equity:	Stockholders’ equity:					Stockholders’ equity:
Preferred stock, 0 par value, 2,500,000 shares authorized; 0 shares issued and outstanding, respectively	Preferred stock, 0 par value, 2,500,000 shares authorized; 0 shares issued and outstanding, respectively	—		—		Preferred stock, 0 par value, 2,500,000 shares authorized; 0 shares issued and outstanding, respectively	0		0
Common stock, 0 par value, 50,000,000 shares authorized; 35,908,908 and 36,618,729 shares issued and outstanding, respectively		569,329		586,459
Common stock, 0 par value, 50,000,000 shares authorized; 35,910,300 and 36,618,729 shares issued and outstanding, respectively						Common stock, 0 par value, 50,000,000 shares authorized; 35,910,300 and 36,618,729 shares issued and outstanding, respectively	570,170		586,459
Retained earnings	Retained earnings	198,342		212,474		Retained earnings	207,751		212,474
Accumulated other comprehensive income, net	Accumulated other comprehensive income, net	25,981		10,378		Accumulated other comprehensive income, net	25,208		10,378
Total stockholders’ equity	Total stockholders’ equity	793,652		809,311		Total stockholders’ equity	803,129		809,311
Total liabilities and stockholders’ equity	Total liabilities and stockholders’ equity	$	6,562,359	$	5,552,970	Total liabilities and stockholders’ equity	$	6,685,889	$	5,552,970

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(In thousands, except per share amounts and shares outstanding)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
INTEREST INCOME
Interest and fees on loans	$	47,647	$	47,845	$	142,328	$	142,651
Taxable interest on investment securities	3,865		5,704		14,068		17,460
Nontaxable interest on investment securities	953		798		2,686		2,641
Interest on interest earning deposits	98		537		561		1,155
Total interest income	52,563		54,884		159,643		163,907
INTEREST EXPENSE
Deposits	2,639		4,250		10,272		11,870
Junior subordinated debentures	196		332		699		1,026
Other borrowings	50		59		130		444
Total interest expense	2,885		4,641		11,101		13,340
Net interest income	49,678		50,243		148,542		150,567
Provision for credit losses	2,730		466		39,239		2,753
Net interest income after provision for credit losses	46,948		49,777		109,303		147,814
NONINTEREST INCOME
Service charges and other fees	4,039		4,779		12,015		14,109
Gain on sale of investment securities, net	40		281		1,463		329
Gain on sale of loans, net	1,443		993		3,125		1,613
Interest rate swap fees	396		152		1,461		313
Other income	2,292		2,253		7,880		7,087
Total noninterest income	8,210		8,458		25,944		23,451
NONINTEREST EXPENSE
Compensation and employee benefits	21,416		21,733		65,849		65,629
Occupancy and equipment	5,676		5,268		16,936		16,177
Data processing	2,363		2,333		7,046		6,615
Marketing	755		816		2,317		3,020
Professional services	1,086		1,434		4,632		3,912
State/municipal business and use taxes	964		1,370		2,626		2,977
Federal deposit insurance premium	848		9		1,086		720
Other real estate owned, net	0		(35)		(145)		340
Amortization of intangible assets	860		975		2,666		3,026
Other expense	2,077		2,816		7,365		8,375
Total noninterest expense	36,045		36,719		110,378		110,791
Income before income taxes	19,113		21,516		24,869		60,474
Income tax expense	2,477		3,621		2,181		10,043
Net income	$	16,636	$	17,895	$	22,688	$	50,431
Basic earnings per share	$	0.46	$	0.49	$	0.63	$	1.37
Diluted earnings per share	$	0.46	$	0.48	$	0.63	$	1.36
Dividends declared per share	$	0.20	$	0.19	$	0.60	$	0.55
Average number of basic shares outstanding	35,908,845		36,742,862		36,049,369		36,812,548
Average number of diluted shares outstanding	35,988,734		36,876,548		36,193,615		36,973,024

See accompanying Notes to Condensed Consolidated Financial Statements.

Table ~~of Contents~~

~~HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES~~

~~CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)~~

~~(In thousands, except per share amounts and shares outstanding)~~

Three Months Ended
June 30, Six Months Ended
June 30,
2020 2019 2020 2019
INTEREST INCOME
Interest and fees on loans $ 48,404 $ 48,107 $ 94,681 $ 94,806
Taxable interest on investment securities 4,570 5,933 10,203 11,756
Nontaxable interest on investment securities 977 893 1,733 1,843
Interest on other interest earning assets 43 283 463 618
Total interest income 53,994 55,216 107,080 109,023
INTEREST EXPENSE
Deposits 3,417 4,017 7,633 7,620
Junior subordinated debentures 218 340 503 694
Other borrowings 46 323 80 385
Total interest expense 3,681 4,680 8,216 8,699
Net interest income 50,313 50,536 98,864 100,324
Provision for credit losses 28,563 1,367 36,509 2,287
Net interest income after provision for credit losses 21,750 49,169 62,355 98,037
NONINTEREST INCOME
Service charges and other fees 3,600 4,845 7,976 9,330
Gain on sale of investment securities, net 409 33 1,423 48
Gain on sale of loans, net 1,135 368 1,682 620
Interest rate swap fees 769 161 1,065 161
Other income 2,335 2,157 5,588 4,834
Total noninterest income 8,248 7,564 17,734 14,993
NONINTEREST EXPENSE
Compensation and employee benefits 21,927 21,982 44,433 43,896
Occupancy and equipment 5,529 5,451 11,260 10,909
Data processing 2,323 2,109 4,683 4,282
Marketing 696 1,106 1,562 2,204
Professional services 2,169 1,305 3,546 2,478
State/municipal business and use taxes 905 809 1,662 1,607
Federal deposit insurance premium 238 426 238 711
Other real estate owned, net (170) 289 (145) 375
Amortization of intangible assets 903 1,026 1,806 2,051
Other expense 2,553 3,044 5,288 5,559
Total noninterest expense 37,073 37,547 74,333 74,072
(Loss) income before income taxes (7,075) 19,186 5,756 38,958
Income tax (benefit) expense (936) 3,202 (296) 6,422
Net (loss) income $ (6,139) $ 15,984 $ 6,052 $ 32,536
Basic (losses) earnings per share $ (0.17) $ 0.43 $ 0.17 $ 0.88
Diluted (losses) earnings per share $ (0.17) $ 0.43 $ 0.17 $ 0.88
Dividends declared per share $ 0.20 $ 0.18 $ 0.40 $ 0.36
Average number of basic shares outstanding 35,898,716 36,870,159 36,120,403 36,847,969
Average number of diluted shares outstanding 35,898,716 37,014,873 36,275,391 37,011,736

~~See accompanying Notes to Condensed Consolidated Financial Statements.~~

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(In thousands)

Three Months Ended
June 30, Six Months Ended
June 30,
2020 2019 2020 2019
Net (loss) income $ (6,139) $ 15,984 $ 6,052 $ 32,536
Change in fair value of investment securities available for sale, net of tax of $2,224, $2,463, $4,643 and $4,608, respectively 8,009 9,219 16,716 17,247
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(89), $(7), $(310) and $(10), respectively (320) (26) (1,113) (38)
Other comprehensive income 7,689 9,193 15,603 17,209
Comprehensive income $ 1,550 $ 25,177 $ 21,655 $ 49,745


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Net income	$	16,636	$	17,895	$	22,688	$	50,431
Change in fair value of investment securities available for sale, net of tax of $(206), $799, $4,437 and $5,407, respectively	(741)		2,993		15,975		20,240
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(8), $(59), $(318) and $(69), respectively	(32)		(222)		(1,145)		(260)
Other comprehensive (loss) income	(773)		2,771		14,830		19,980
Comprehensive income	$	15,863	$	20,666	$	37,518	$	70,411

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)

(In thousands, except per share amounts)

Three Months Ended June 30, 2020
Number of
common
shares Common
stock Retained
earnings Accumulated
other
comprehensive income, net Total
stockholders’
equity
Balance at March 31, 2020 35,889 $ 568,439 $ 211,707 $ 18,292 $ 798,438
Restricted stock units vested, net of forfeitures, of restricted stock awards 19 — — — —
Exercise of stock options 3 51 — — 51
Stock-based compensation expense — 877 — — 877
Common stock repurchased (2) (38) — — (38)
Net loss — — (6,139) (6,139)
Other comprehensive income, net of tax — — — 7,689 7,689
Cash dividend declared on common stock ($0.20 per share) (7,226) (7,226)
Balance at June 30, 2020 35,909 $ 569,329 $ 198,342 $ 25,981 $ 793,652


	Three Months Ended September 30, 2020
	Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive income, net		Total stockholders’ equity
Balance at June 30, 2020	35,909	$	569,329	$	198,342	$	25,981	$	793,652

Restricted stock units vested, net of forfeitures of restricted stock awards	2	—		—		—		—

Stock-based compensation expense	—	848		—		—		848
Common stock repurchased	(1)	(7)		—		—		(7)
Net income	—	—		16,636				16,636
Other comprehensive loss, net of tax	—	—		—		(773)		(773)

Cash dividend declared on common stock ($0.20 per share)	—	—		(7,227)		—		(7,227)
Balance at September 30, 2020	35,910	$	570,170	$	207,751	$	25,208	$	803,129


		Six Months Ended June 30, 2020																	Nine Months Ended September 30, 2020
		Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive income, net		Total stockholders’ equity			Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive income, net		Total stockholders’ equity
Balance at December 31, 2019	Balance at December 31, 2019	36,619	$	586,459	$	212,474	$	10,378	$	809,311	Balance at December 31, 2019	36,619	$	586,459	$	212,474	$	10,378	$	809,311
Cumulative effect from change in accounting policy ⁽¹⁾	Cumulative effect from change in accounting policy ⁽¹⁾	—	—		(5,615)		—		(5,615)		Cumulative effect from change in accounting policy (1)	—	—		(5,615)		—		(5,615)
Restricted stock units vested, net of forfeitures of restricted stock awards	Restricted stock units vested, net of forfeitures of restricted stock awards	106	—		—		—		—		Restricted stock units vested, net of forfeitures of restricted stock awards	108	—		—		—		—
Exercise of stock options	Exercise of stock options	8	122		—		—		122		Exercise of stock options	8	122		—		—		122
Stock-based compensation expense	Stock-based compensation expense	—	1,846		—		—		1,846		Stock-based compensation expense	—	2,694		—		—		2,694
Common stock repurchased	Common stock repurchased	(824)	(19,098)		—		—		(19,098)		Common stock repurchased	(825)	(19,105)		—		—		(19,105)
Net income	Net income	—	—		6,052		—		6,052		Net income	—	—		22,688		—		22,688
Other comprehensive income, net of tax	Other comprehensive income, net of tax	—	—		—		15,603		15,603		Other comprehensive income, net of tax	—	—		—		14,830		14,830

Cash dividend declared on common stock ($0.40 per share)		—	—		(14,569)		—		(14,569)
Balance at June 30, 2020		35,909	$	569,329	$	198,342	$	25,981	$	793,652
Cash dividend declared on common stock ($0.60 per share)											Cash dividend declared on common stock ($0.60 per share)	—	—		(21,796)		—		(21,796)
Balance at September 30, 2020											Balance at September 30, 2020	35,910	$	570,170	$	207,751	$	25,208	$	803,129

⁽¹⁾Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses.

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		Three Months Ended June 30, 2019																	Three Months Ended September 30, 2019
		Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive income, net		Total stockholders’ equity			Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive income, net		Total stockholders’ equity
Balance at March 31, 2019		36,899	$	591,767	$	185,863	$	561	$	778,191
Balance at June 30, 2019											Balance at June 30, 2019	36,883	$	591,703	$	195,168	$	9,754	$	796,625

Restricted stock units vested, net of forfeitures of restricted stock awards	Restricted stock units vested, net of forfeitures of restricted stock awards	13	—		—		—		—		Restricted stock units vested, net of forfeitures of restricted stock awards	1	—		—		—		0
Exercise of stock options	Exercise of stock options	1	20		—		—		20		Exercise of stock options	1	2		—		—		2
Stock-based compensation expense	Stock-based compensation expense	—	795		—		—		795		Stock-based compensation expense	—	830		—		—		830
Common stock repurchased	Common stock repurchased	(30)	(879)		—		—		(879)		Common stock repurchased	(267)	(6,954)		—		—		(6,954)
Net income	Net income	—	—		15,984		—		15,984		Net income	—	—		17,895		—		17,895
Other comprehensive income, net of tax	Other comprehensive income, net of tax	—	—		—		9,193		9,193		Other comprehensive income, net of tax	—	—		—		2,771		2,771

Cash dividends declared on common stock ($0.18 per share)		—	—		(6,679)		—		(6,679)
Balance at June 30, 2019		36,883	$	591,703	$	195,168	$	9,754	$	796,625
Cash dividends declared on common stock ($0.19 per share)											Cash dividends declared on common stock ($0.19 per share)	—	—		(7,042)		—		(7,042)
Balance at September 30, 2019											Balance at September 30, 2019	36,618	$	585,581	$	206,021	$	12,525	$	804,127


		Six Months Ended June 30, 2019																	Nine Months Ended September 30, 2019
		Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive (loss) income, net		Total stockholders’ equity			Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive (loss) income, net		Total stockholders’ equity
Balance at December 31, 2018	Balance at December 31, 2018	36,874	$	591,806	$	176,372	$	(7,455)	$	760,723	Balance at December 31, 2018	36,874	$	591,806	$	176,372	$	(7,455)	$	760,723
Cumulative effect from change in accounting policy ⁽¹⁾	Cumulative effect from change in accounting policy ⁽¹⁾	—	—		(399)		—		(399)		Cumulative effect from change in accounting policy (1)	—	—		(399)		—		(399)
Restricted stock units vested, net of forfeitures of restricted stock awards	Restricted stock units vested, net of forfeitures of restricted stock awards	62	—		—		—		—		Restricted stock units vested, net of forfeitures of restricted stock awards	63	—		—		—		0
Exercise of stock options	Exercise of stock options	3	42		—		—		42		Exercise of stock options	4	44		—		—		44
Stock-based compensation expense	Stock-based compensation expense	—	1,536		—		—		1,536		Stock-based compensation expense	—	2,366		—		—		2,366
Common stock repurchased	Common stock repurchased	(56)	(1,681)		—		—		(1,681)		Common stock repurchased	(323)	(8,635)		—		—		(8,635)
Net income	Net income	—	—		32,536		—		32,536		Net income	—	—		50,431		—		50,431
Other comprehensive income, net of tax	Other comprehensive income, net of tax	—	—		—		17,209		17,209		Other comprehensive income, net of tax	—	—		—		19,980		19,980

Cash dividends declared on common stock ($0.36 per share)		—	—		(13,341)		—		(13,341)
Balance at June 30, 2019		36,883	$	591,703	$	195,168	$	9,754	$	796,625
Cash dividends declared on common stock ($0.55 per share)											Cash dividends declared on common stock ($0.55 per share)	—	—		(20,383)		—		(20,383)
Balance at September 30, 2019											Balance at September 30, 2019	36,618	$	585,581	$	206,021	$	12,525	$	804,127

⁽¹⁾Effective January 1, 2019, the Company adopted ASU 2016-02, Leases.

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)


		Six Months Ended June 30,							Nine Months Ended September 30,
		2020		2019			2020		2019
Cash flows from operating activities:	Cash flows from operating activities:					Cash flows from operating activities:
Net income	Net income	$	6,052	$	32,536	Net income	$	22,688	$	50,431
Adjustments to reconcile net income to net cash provided by operating activities:	Adjustments to reconcile net income to net cash provided by operating activities:					Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment, amortization of securities available for sale, and amortization of discount of junior subordinated debentures		4,547		4,255
Changes in net deferred loan costs, net of amortization		26,020		829
Depreciation, amortization and accretion						Depreciation, amortization and accretion	28,337		3,463
Provision for credit losses	Provision for credit losses	36,509		2,287		Provision for credit losses	39,239		2,753
Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities	Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities	(3,096)		(3,645)		Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities	(12,298)		303
Stock-based compensation expense	Stock-based compensation expense	1,846		1,536		Stock-based compensation expense	2,694		2,366
Amortization of intangible assets	Amortization of intangible assets	1,806		2,051		Amortization of intangible assets	2,666		3,026
Origination of mortgage loans held for sale	Origination of mortgage loans held for sale	(48,848)		(20,328)		Origination of mortgage loans held for sale	(93,422)		(45,852)
Proceeds from sale of mortgage loans held for sale	Proceeds from sale of mortgage loans held for sale	52,280		18,811		Proceeds from sale of mortgage loans held for sale	93,830		43,544
Earnings on bank owned life insurance	Earnings on bank owned life insurance	(1,530)		(1,014)		Earnings on bank owned life insurance	(2,440)		(1,578)
Valuation adjustment on other real estate owned	Valuation adjustment on other real estate owned	—		51		Valuation adjustment on other real estate owned	0		51
(Gain) loss on sale of other real estate owned, net	(Gain) loss on sale of other real estate owned, net	(179)		279		(Gain) loss on sale of other real estate owned, net	(179)		227
Gain on sale of loans, net		(1,682)		(620)
Gain on sale of mortgage loans held for sale, net						Gain on sale of mortgage loans held for sale, net	(3,125)		(1,613)
Gain on sale of investment securities, net	Gain on sale of investment securities, net	(1,423)		(48)		Gain on sale of investment securities, net	(1,463)		(329)
Gain on sale of assets held for sale	Gain on sale of assets held for sale	(9)		—		Gain on sale of assets held for sale	(9)		0

Impairment for right of use asset		—		117
Impairment of right of use asset						Impairment of right of use asset	102		117
Gain on sale of premises and equipment, net	Gain on sale of premises and equipment, net	(25)		(10)		Gain on sale of premises and equipment, net	(25)		(14)
Net cash provided by operating activities	Net cash provided by operating activities	72,268		37,087		Net cash provided by operating activities	76,595		56,895
Cash flows from investing activities:	Cash flows from investing activities:					Cash flows from investing activities:
Loans originated, net of principal payments	Loans originated, net of principal payments	(928,792)		(65,972)		Loans originated, net of principal payments	(924,930)		(79,000)
Maturities, calls and payments of investment securities available for sale	Maturities, calls and payments of investment securities available for sale	154,194		105,400		Maturities, calls and payments of investment securities available for sale	207,955		145,778
Purchase of investment securities available for sale	Purchase of investment securities available for sale	(103,079)		(104,324)		Purchase of investment securities available for sale	(117,456)		(156,501)
Proceeds from sales of investment securities available for sale	Proceeds from sales of investment securities available for sale	40,930		34,479		Proceeds from sales of investment securities available for sale	44,970		43,872
Purchase of premises and equipment	Purchase of premises and equipment	(1,739)		(6,374)		Purchase of premises and equipment	(6,136)		(10,526)
Proceeds from sales of other loans	Proceeds from sales of other loans	—		54		Proceeds from sales of other loans	0		3,562
Proceeds from sales of other real estate owned	Proceeds from sales of other real estate owned	1,290		429		Proceeds from sales of other real estate owned	1,290		864
Proceeds from sales of assets held for sale	Proceeds from sales of assets held for sale	394		—		Proceeds from sales of assets held for sale	394		0
Proceeds from redemption of Federal Home Loan Bank stock	Proceeds from redemption of Federal Home Loan Bank stock	2,560		12,684		Proceeds from redemption of Federal Home Loan Bank stock	2,560		18,032
Purchases of Federal Home Loan Bank stock	Purchases of Federal Home Loan Bank stock	(2,844)		(16,613)		Purchases of Federal Home Loan Bank stock	(2,844)		(18,333)
Proceeds from sales of premises and equipment	Proceeds from sales of premises and equipment	53		31		Proceeds from sales of premises and equipment	53		35
Purchase of bank owned life insurance	Purchase of bank owned life insurance	(3,579)		—		Purchase of bank owned life insurance	(3,579)		(8,000)
Proceeds from bank owned life insurance death benefit	Proceeds from bank owned life insurance death benefit	1,324		—		Proceeds from bank owned life insurance death benefit	1,324		0
Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net	Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net	(2,335)		(2,242)		Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net	(7,109)		(16,992)

Net cash used in investing activities		(841,623)		(42,448)
Net cash used by investing activities						Net cash used by investing activities	(803,508)		(77,209)

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		Six Months Ended June 30,							Nine Months Ended September 30,
		2020		2019			2020		2019
Cash flows from financing activities:	Cash flows from financing activities:					Cash flows from financing activities:
Net increase (decrease) in deposits		985,057		(84,694)
Net increase in deposits						Net increase in deposits	1,106,372		129,855
Federal Home Loan Bank advances	Federal Home Loan Bank advances	19,000		402,800		Federal Home Loan Bank advances	19,000		445,800
Repayment of Federal Home Loan Bank advances	Repayment of Federal Home Loan Bank advances	(19,000)		(312,100)		Repayment of Federal Home Loan Bank advances	(19,000)		(445,800)
Common stock cash dividends paid	Common stock cash dividends paid	(14,494)		(13,280)		Common stock cash dividends paid	(21,676)		(20,288)
Net increase (decrease) in securities sold under agreement to repurchase	Net increase (decrease) in securities sold under agreement to repurchase	4,275		(8,346)		Net increase (decrease) in securities sold under agreement to repurchase	8,874		(5,604)
Proceeds from exercise of stock options	Proceeds from exercise of stock options	122		42		Proceeds from exercise of stock options	122		44
Repurchase of common stock	Repurchase of common stock	(19,098)		(1,681)		Repurchase of common stock	(19,105)		(8,635)
Net cash provided by (used in) financing activities		955,862		(17,259)
Net increase (decrease) in cash and cash equivalents		186,507		(22,620)
Net cash provided by financing activities						Net cash provided by financing activities	1,074,587		95,372
Net increase in cash and cash equivalents						Net increase in cash and cash equivalents	347,674		75,058
Cash and cash equivalents at beginning of period	Cash and cash equivalents at beginning of period	228,568		161,910		Cash and cash equivalents at beginning of period	228,568		161,910
Cash and cash equivalents at end of period	Cash and cash equivalents at end of period	$	415,075	$	139,290	Cash and cash equivalents at end of period	$	576,242	$	236,968

Supplemental disclosures of cash flow information:	Supplemental disclosures of cash flow information:					Supplemental disclosures of cash flow information:
Cash paid for interest	Cash paid for interest	$	8,144	$	8,535	Cash paid for interest	$	10,972	$	13,099
Cash paid for income taxes, net of refunds	Cash paid for income taxes, net of refunds	118		5,545		Cash paid for income taxes, net of refunds	8,279		7,098

Supplemental non-cash disclosures of cash flow information:	Supplemental non-cash disclosures of cash flow information:					Supplemental non-cash disclosures of cash flow information:
Transfers of loans receivable to other real estate owned	Transfers of loans receivable to other real estate owned	$	270	$	—	Transfers of loans receivable to other real estate owned	$	270	$	0
Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets	Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets	—		763		Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets	0		1,533
Investment in low income housing tax credit partnership and related funding commitment	Investment in low income housing tax credit partnership and related funding commitment	10,237		—		Investment in low income housing tax credit partnership and related funding commitment	10,237		15,254

Cumulative effect from change in accounting policy⁽¹⁾	Cumulative effect from change in accounting policy⁽¹⁾	7,175		29,754		Cumulative effect from change in accounting policy (1)	7,175		29,754
Transfer of bank owned life insurance to prepaid expenses and other assets	Transfer of bank owned life insurance to prepaid expenses and other assets	—		209		Transfer of bank owned life insurance to prepaid expenses and other assets	0		209
Impact of new or modified leases		591		335
Right of use assets obtained in exchange for new operating lease liabilities						Right of use assets obtained in exchange for new operating lease liabilities	273		698

⁽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.

See accompanying Notes to Condensed Consolidated Financial Statements.

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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

(a) Description of Business

The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 62 branch offices as of ~~June~~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.

The 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 branch count from 62 to 53. The Company plans to integrate these locations into other branches within its network.

(b) Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by 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 2019 Annual Form 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 ~~six~~nine months ended ~~June~~September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.

To prepare unaudited Condensed Consolidated Financial Statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. Material estimates that are particularly 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 ~~$71.5~~$73.3 million at ~~June~~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 ~~June~~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 ~~(13)~~(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 prior years' net income or stockholders’ equity.

The significant accounting policies used in preparation of the Company's Condensed Consolidated Financial Statements are disclosed in the 2019 Annual Form 10-K. Other 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 2019 Annual Form 10-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, ~~which replaces~~replacing the incurred loss methodology with an expected loss methodology, ~~that~~which is commonly referred to as the ~~CECL~~"CECL" methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at

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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, ~~the adoption of~~ 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

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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 prior 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 rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL on investment securities available for sale is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any 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 ACL on investment securities available for sale are recorded as provision ~~(reversal of provision)~~ for credit losses expense. Losses are charged against the ACL when management believes the uncollectability of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met.

Accrued interest receivable on investment securities available for sale is excluded from the estimate 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 ~~in prepaid expenses and other assets~~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

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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 loan. The initial ACL on purchased loans is determined using the same methodology as originated loans. For non-PCD loans, the initial ACL is recorded tothrough earnings as a provision for credit ~~losses expense.~~losses. For PCD loans, the initial ACL is incorporated into the calculation of the fair value of net assets acquired on the merger date and the net of the PCD loan purchase price and the initial ACL becomes the initial amortized cost basis. The difference between the initial amortized cost basis

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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 ~~Operations~~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 expense.~~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 ~~under the CARES Act~~ if they are less than 30 days past due on ~~their~~the contractual payments as of December 31, 2019 under the CARES Act and at the time a modification program is ~~implemented.~~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 ~~Operations.~~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 ~~allowance~~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 ~~"Pass",~~"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 ~~allowance~~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 Bank evaluates the historical period on a quarterly basis, with the assumption that economic cycles have historically lasted

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between 10 and 15 years. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the baseline loss estimate for each loan. Estimated cash flows consider the principal and interest in accordance with the contractual term of the loan and estimated prepayments. Contractual cash flows are based on the amortized cost, asand 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 unconditionally cancellable by the Company.

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Prepayments are established for each segment based on rolling historical averages for the segments, which management believes is an accurate representation of future 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 bias 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 identified risk.

In general, management's estimate of the ACL on loans uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

The evaluation of ACL on loans ~~evaluation~~ 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 Bank’s ACL on loans. Such agencies may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the ACL on loans is appropriate given all of the above considerations.

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 ~~Company.~~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 the Bank's estimates of future utilizations given current economic forecasts. The credit risks associated with the unfunded commitments are consistent with the risks outlined for each loan class under the ACL for loans.

The ACL for unfunded commitments is recognized in ~~accrued~~Accrued expenses and other liabilities on the Condensed Consolidated Statements of Financial Condition and ~~is adjusted~~changes are recorded through earnings as a provision ~~(reversal of provision)~~ for credit losses on the Condensed Consolidated Statements of ~~Operations.~~Income.

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Provision for Credit Losses

The provision for credit losses as presented in the Company's Condensed Consolidated Statements of ~~Operations~~Income includes the provision for credit losses on loans and the provision for credit losses on unfunded commitments.

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(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. This ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. For public business entities, this ASU 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. The Company adopted ASU 2016-13 on January 1, 2020 as discussed in the Significant 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 decreases in market interest rates on floating rate investment securities since the purchase of the securities 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 investment 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 at least investment-grade securities. As a result of the analysis, 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 ~~Operations,~~Income, net of provision for credit losses on ~~loans and~~ unfunded commitments.

The adoption was completed in a specific order beginning with the transition of PCI loans 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. First, an ACL was determined for each PCI loan. The ACL on PCI loans was added to the ~~loans'~~loan's carrying amount to establish a PCD loan at its amortized cost basis. The difference between the ~~unpaid~~outstanding principal balance and the amortized cost basis 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 at January 1, 2020 based on its CECL methodology as part of the cumulative-effect adjustment to beginning retained earnings. The pretax increase to the ACL 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 ~~a $1.8 million~~an increase in the ACL on loans of $1.8 million at January 1, 2020. Upon adoption, the adjusted beginning balance of the ACL on loans as a percentage of loans receivable was 1.01% as compared to 0.96% at December 31, 2019 under the prior incurred loss methodology.

The PCI to PCD transition also resulted in a net discount of $4.3 million for PCD loans, or an increase in the net discount for PCD loans of $1.6 million. Following the transition, the total net discount for purchased loans increased to $10.0 million at January 1, 2020 compared to $8.4 million as of December 31, 2019. ~~The Company accretes the net discount or premium on purchased loans to interest and fees on loans using the effective interest method.~~

See Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans for more information.

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Unfunded Commitments

ASU 2016-13 was applied prospectively and replaced the reserve for unfunded commitments with the ACL on unfunded commitments as included in ~~accrued~~Accrued liabilities and other expenses on the Condensed Consolidated Statements of Financial Condition and replaced the provision for unfunded commitments with the provision for credit losses as presented on the Condensed Consolidated Statements of ~~Operations,~~Income, net of provision for credit losses on ~~unfunded commitment and~~ loans. Upon adoption, the Bank recorded a

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pretax increase in the beginning ACL on unfunded commitments of $3.7 million. See Note ~~(15)~~(14) Commitments and Contingencies for more information.

Overall CECL Impact

The 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 adjustment to beginning retained earnings on January 1, 2020 was $5.6 million, net of tax.

FASB ASU 2017-04, Goodwill (Topic 350), was issued in January 2017 and eliminates Step 2 from the goodwill impairment test. The ASU 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. ~~The~~Although the Company cannot anticipate future goodwill impairment assessments, based on the most recent assessment prior to adoption, ~~did~~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 ~~have a material impact on its Condensed Consolidated Financial Statements as of or~~changed, except for the ~~six months ended June 30, 2020 as~~elimination of the ~~Company's quantitative assessment indicated no~~Step 2 analysis. For additional information regarding goodwill ~~impairment.~~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 ~~(13)~~(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 ~~six~~nine months ended ~~June~~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 ~~have~~has not yet determined whether LIBOR transition and this ASU will have material effects on its business operations and Condensed Consolidated Financial Statements.

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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 ASU will have a material impact on its Condensed Consolidated Financial Statements.

(2)Investment Securities

(a) Securities by Type and Maturity

The following tables present the amortized cost and fair value of investment securities available for sale at the dates indicated and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss):


		June 30, 2020															September 30, 2020
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value			Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
		(In thousands)															(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies		$	50,791	$	1,396	$	(136)	$	52,051
U.S. government and agency securities										U.S. government and agency securities	$	50,752	$	1,165	$	(24)	$	51,893
Municipal securities	Municipal securities	183,296		10,972		(337)		193,931		Municipal securities	193,300		12,247		(237)		205,310
Mortgage-backed securities and collateralized mortgage obligations:
Residential		260,944		8,286		(246)		268,984
Commercial		305,041		13,602		(302)		318,341

Residential CMO and MBS										Residential CMO and MBS	216,719		6,129		(267)		222,581
Commercial CMO and MBS										Commercial CMO and MBS	292,163		12,785		(266)		304,682
Corporate obligations	Corporate obligations	23,922		335		(8)		24,249		Corporate obligations	19,947		231		(7)		20,171
Other asset-backed securities ⁽¹⁾	Other asset-backed securities ⁽¹⁾	22,845		94		(568)		22,371		Other asset-backed securities ⁽¹⁾	29,510		460		(115)		29,855
Total	Total	$	846,839	$	34,685	$	(1,597)	$	879,927	Total	$	802,391	$	33,017	$	(916)	$	834,492

⁽¹⁾ ~~Issued and guaranteed by U.S. Government-sponsored agencies.~~


		December 31, 2019															December 31, 2019
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value			Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
		(In thousands)															(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies		$	104,709	$	598	$	(84)	$	105,223
U.S. government and agency securities										U.S. government and agency securities	$	104,709	$	598	$	(84)		$	105,223
Municipal securities	Municipal securities	128,183		4,933		(102)		133,014		Municipal securities	128,183		4,933		(102)			133,014
Mortgage-backed securities and collateralized mortgage obligations:
Residential		336,929		3,184		(505)		339,608
Commercial		322,169		5,575		(649)		327,095

Residential CMO and MBS										Residential CMO and MBS	336,929		3,184		(505)			339,608
Commercial CMO and MBS										Commercial CMO and MBS	322,169		5,575		(649)			327,095
Corporate obligations	Corporate obligations	23,893		316		(15)		24,194		Corporate obligations	23,893		316		(15)			24,194
Other asset-backed securities ⁽¹⁾	Other asset-backed securities ⁽¹⁾	23,277		54		(153)		23,178		Other asset-backed securities ⁽¹⁾	23,277		54		(153)			23,178
Total	Total	$	939,160	$	14,660	$	(1,508)	$	952,312	Total	$	939,160	$	14,660	$	(1,508)		$	952,312

⁽¹⁾ ~~Issued and guaranteed by U.S. Government-sponsored agencies.~~

There were 0 securities classified as trading or held to maturity at ~~June~~September 30, 2020 or December 31, 2019.

For the three and ~~six~~nine months ended ~~June~~September 30, 2020, there was 0 provision for credit loss on investment securities available for sale recorded in the Condensed Consolidated Statements of ~~Operations.~~Income. There was 0 ACL on investment securities available for sale at ~~June~~September 30, 2020.

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The amortized cost and fair value of investment securities available for sale at ~~June~~September 30, 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			Amortized Cost		Fair Value
		(In thousands)							(In thousands)
Due in one year or less	Due in one year or less	$	47,246	$	47,813	Due in one year or less	$	63,147	$	63,749
Due after one year through five years	Due after one year through five years	146,626		151,911		Due after one year through five years	138,244		144,457
Due after five years through ten years	Due after five years through ten years	217,935		228,844		Due after five years through ten years	203,897		214,141
Due after ten years	Due after ten years	435,032		451,359		Due after ten years	397,103		412,145
Total	Total	$	846,839	$	879,927	Total	$	802,391	$	834,492

There were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity at ~~June~~September 30, 2020 and December 31, 2019.

(b) Unrealized Losses and Other-Than-Temporary Impairments

The following tables show the gross unrealized losses and fair value of the Company's investment securities available for sale, for which an ACL has not been recorded, aggregated by investment category and length of time that the individual securities have been in continuous unrealized loss positions as of ~~June~~September 30, 2020 and December 31, 2019:


		June 30, 2020																							September 30, 2020
		Less than 12 Months						12 Months or Longer								Total					Less than 12 Months				12 Months or Longer		Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
		(In thousands)																							(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies		$	5,865	$	(136)	$	—	$	—	$	5,865	$	(136)
U.S. government and agency securities														U.S. government and agency securities	$	3,976	$	(24)	$	0	$	0	$	3,976	$	(24)
Municipal securities	Municipal securities	10,386		(337)		—		—		10,386		(337)		Municipal securities	11,918		(237)		0		0		11,918		(237)
Mortgage-backed securities and collateralized mortgage obligations:
Residential		2,243		(1)		27,278		(245)		29,521		(246)
Commercial		5,792		(16)		21,538		(286)		27,330		(302)

Residential CMO and MBS														Residential CMO and MBS	543		(2)		26,344		(265)		26,887		(267)
Commercial CMO and MBS														Commercial CMO and MBS	11,124		(9)		18,125		(257)		29,249		(266)

Corporate obligations	Corporate obligations	—		—		1,992		(8)		1,992		(8)		Corporate obligations	1,993		(7)		0		0		1,993		(7)
Other asset-backed securities ⁽¹⁾	Other asset-backed securities ⁽¹⁾	16,917		(538)		1,476		(30)		18,393		(568)		Other asset-backed securities ⁽¹⁾	6,914		(47)		4,666		(68)		11,580		(115)
Total	Total	$	41,203	$	(1,028)	$	52,284	$	(569)	$	93,487	$	(1,597)	Total	$	36,468	$	(326)	$	49,135	$	(590)	$	85,603	$	(916)

⁽¹⁾ ~~Issued and guaranteed by U.S. Government-sponsored agencies.~~


	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)

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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. Treasury and U.S. Government-sponsored agencies $ 45,999 $ (84) $ — $ — $ 45,999 $ (84)
Municipal securities 13,761 (102) — — 13,761 (102)
Mortgage-backed securities and collateralized mortgage obligations:
Residential 14,272 (66) 60,232 (439) 74,504 (505)
Commercial 56,263 (177) 43,623 (472) 99,886 (649)
Corporate obligations 998 (2) 1,987 (13) 2,985 (15)
Other asset-backed securities ⁽¹⁾
14,383 (127) 1,609 (26) 15,992 (153)
Total $ 145,676 $ (558) $ 107,451 $ (950) $ 253,127 $ (1,508)

⁽¹⁾ ~~Issued and guaranteed by U.S. Government-sponsored agencies.~~

The Company has evaluated these investment securities available for sale as of ~~June~~September 30, 2020 and December 31, 2019 and determined that 0 ACL is necessary. Unrealized losses on investment securities available for sale have not been recognized into ~~income~~earnings because the issuers of bonds are investment grade, ~~(rated A- or higher),~~ 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 fair value is largely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payments on the bonds and the fair value is expected to recover as the bonds approach maturity.

The following table presents the gross realized gains and losses on the sale of securities available for sale for the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended September 30,				Nine Months Ended September 30,
		2020		2019		2020		2019			2020		2019		2020		2019
		(In thousands)															(In thousands)
Gross realized gains	Gross realized gains	$	414	$	187	$	1,442	$	276	Gross realized gains	$	40	$	281	$	1,482	$	557
Gross realized losses	Gross realized losses	(5)		(154)		(19)		(228)		Gross realized losses	0		0		(19)		(228)
Net realized gains	Net realized gains	$	409	$	33	$	1,423	$	48	Net realized gains	$	40	$	281	$	1,463	$	329

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(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 ~~June~~September 30, 2020 and December 31, 2019:


		June 30, 2020						December 31, 2019							September 30, 2020				December 31, 2019
		Amortized Cost		Fair Value		Amortized Cost		Fair Value			Amortized Cost		Fair Value		Amortized Cost		Fair Value
		(In thousands)															(In thousands)
Washington and Oregon state public deposits	Washington and Oregon state public deposits	$	188,233	$	196,117	$	187,700	$	190,773	Washington and Oregon state public deposits	$	178,332	$	186,198	$	187,700	$	190,773

Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	29,323		29,765		22,156		22,294		Securities sold under agreement to repurchase	43,557		44,822		22,156		22,294
Other securities pledged	Other securities pledged	33,583		34,697		19,333		19,850		Other securities pledged	31,688		32,724		19,333		19,850
Total	Total	$	251,139	$	260,579	$	229,189	$	232,917	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 ~~$3.9~~$3.3 million and $3.7 million at ~~June~~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 ~~six~~nine months ended ~~June~~September 30, 2020 and 2019.

(3)Loans Receivable

(a) Loan Origination/Risk Management

The Company originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions. Accrued interest receivable was excluded from disclosures presenting the Company's amortized cost of loans receivable as it was deemed insignificant. Accrued interest receivable on loans totaled ~~$13.9~~$15.6 million and $10.7 million at ~~June~~September 30, 2020 and December 31, 2019, respectively. No ACL on accrued interest receivable was recorded at September 30, 2020.

The Company categorizes loans in one of the 4 segments of the total loan portfolio: commercial ~~business,~~business; one-to-four family ~~residential,~~residential; real estate construction and land ~~development~~development; 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 Bank 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 designed to provide near term relief to help small businesses sustain operations. ~~The~~ These

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loans ~~are~~have either a two-year or five-year ~~maturities that~~maturity date and earn interest at 1%. The Bank also earned a fee based on the size of the loan, which is recognized over the ~~duration~~life of the loan. The balance of unamortized net deferred fees on SBA PPP loans was ~~$25.3~~$22.0 million at ~~June~~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 disclosure requirements for TDRs for certain loan modifications that are the result 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 FASB staff has indicated that borrowers who receive relief are not TDRs if they meet qualifying criteria. The Company 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 granted relief under these programs will generally not be reported as nonaccrual during the deferral period.

The Company adopted ASU 2016-13 effective January 1, 2020, which increased the beginning ACL on loans as discussed in Note (4) Allowance for Credit Losses on Loans.

~~Table~~ ~~of Contents~~

The amortized cost of loans receivable, net of ACL on loans at ~~June~~September 30, 2020 and December 31, 2019 consisted of the following portfolio segments and classes:


		June 30, 2020		December 31, 2019			September 30, 2020		December 31, 2019
		(In thousands)							(In thousands)
Commercial business:	Commercial business:					Commercial business:
Commercial and industrial	Commercial and industrial	$	793,217	$	852,220	Commercial and industrial	$	750,557	$	852,220
SBA PPP	SBA PPP	856,490		—		SBA PPP	867,782		0
Owner-occupied commercial real estate		838,303		805,234
Non-owner occupied commercial real estate		1,351,775		1,288,779
Owner-occupied CRE						Owner-occupied CRE	859,338		805,234
Non-owner occupied CRE						Non-owner occupied CRE	1,384,973		1,288,779
Total commercial business	Total commercial business	3,839,785		2,946,233		Total commercial business	3,862,650		2,946,233
One-to-four family residential	One-to-four family residential	132,546		131,660		One-to-four family residential	131,921		131,660
Real estate construction and land development:	Real estate construction and land development:					Real estate construction and land development:
One-to-four family residential	One-to-four family residential	108,821		104,296		One-to-four family residential	99,650		104,296
Five or more family residential and commercial properties	Five or more family residential and commercial properties	197,163		170,350		Five or more family residential and commercial properties	215,472		170,350
Total real estate construction and land development	Total real estate construction and land development	305,984		274,646		Total real estate construction and land development	315,122		274,646
Consumer	Consumer	388,018		415,340		Consumer	357,037		415,340
Loans receivable	Loans receivable	4,666,333		3,767,879		Loans receivable	4,666,730		3,767,879
Allowance for credit losses on loans	Allowance for credit losses on loans	(71,501)		(36,171)		Allowance for credit losses on loans	(73,340)		(36,171)
Loans receivable, net	Loans receivable, net	$	4,594,832	$	3,731,708	Loans receivable, net	$	4,593,390	$	3,731,708

(b) Concentrations of Credit

As of ~~June~~September 30, 2020, and December 31, 2019, there were 0 concentrations of loans related to any single industry in excess of 10% of the Company’s total loans.

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 loan on a numerical scale of 1 to 10. Risk grades are aggregated to create the risk categories

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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, including qualitative information on how the risk grades relate to the risk of loss, are contained in the 2019 Annual Form 10-K. There were no loans with a risk grade of doubtful or loss at ~~June~~September 30, 2020.

Numerical loan grades for loans are established at the origination of the loan. Changes to loan grades are considered at the time new information about the performance of a loan becomes available, including the receipt of updated financial information from the borrower, and scheduled loan reviews performed by the Bank’s internal Loan Review department. For consumer loans, the Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event of payment delinquencies or default. Typically, an individual loan grade will not be changed from the prior period unless there is a specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications with the borrower, or other borrower information that becomes known to management. Credit improvements are evidenced by known facts regarding the borrower or the collateral property.

~~Table~~ ~~of Contents~~

The following table presents the amortized cost of loans receivable by risk grade as of ~~June~~September 30, 2020:


		Term Loans Amortized Cost Basis by Origination Year																													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		Revolving Loans		Revolving Loans Converted to Term Loans ⁽¹⁾		Loans Receivable			2020		2019		2018		2017		2016		Prior		Revolving Loans			Revolving Loans Converted to Term Loans (1)			Loans Receivable
		(In thousands)																																			(In thousands)
Commercial business:	Commercial business:																																								Commercial business:
Commercial and industrial	Commercial and industrial																																							Commercial and industrial
Pass	Pass	$	60,290	$	152,475	$	86,904	$	59,048	$	49,096	$	123,041	$	176,396	$	3,654	$	710,904	Pass	$	64,817	$	142,409	$	79,659	$	53,491	$	45,436	$	116,934		$	144,505		$	802				$	648,053
SM	SM	2,071		3,232		3,128		1,268		1,876		1,872		14,830		42		28,319		SM	13,117		6,355		5,622		2,244		1,683		2,104		18,188			98			49,411
SS	SS	1,859		11,198		4,555		8,278		2,286		12,732		9,227		3,859		53,994		SS	2,580		11,418		5,160		8,884		2,361		10,440		8,324			3,926			53,093

Total	Total	64,220		166,905		94,587		68,594		53,258		137,645		200,453		7,555		793,217		Total	80,514		160,182		90,441		64,619		49,480		129,478		171,017			4,826			750,557
SBA PPP	SBA PPP																																							SBA PPP
Pass	Pass	856,490		—		—		—		—		—		—		—		856,490		Pass	867,782		0		0		0		0		0		0			0			867,782

Total																				Total	867,782		0		0		0		0		0		0			0			867,782
Owner-occupied CRE	Owner-occupied CRE																																							Owner-occupied CRE
Pass	Pass	46,237		157,457		105,974		89,912		84,671		306,133		—		1,051		791,435		Pass	78,911		167,369		99,922		88,349		78,693		275,986		0			0			789,230
SM	SM	—		—		—		9,836		1,461		12,691		—		—		23,988		SM	0		0		3,344		7,789		5,499		23,170		0			0			39,802
SS	SS	—		—		117		4,686		3,380		14,697		—		—		22,880		SS	0		0		117		7,379		3,348		19,462		0			0			30,306

Total	Total	46,237		157,457		106,091		104,434		89,512		333,521		—		1,051		838,303		Total	78,911		167,369		103,383		103,517		87,540		318,618		0			0			859,338
Non-owner-occupied CRE	Non-owner-occupied CRE																																							Non-owner-occupied CRE
Pass	Pass	93,518		163,318		151,550		193,928		284,553		449,656		—		—		1,336,523		Pass	151,158		167,691		154,288		186,969		258,168		418,767		0			0			1,337,041
SM	SM	—		—		—		—		6,214		1,939		—		—		8,153		SM	0		0		0		0		11,842		3,364		0			0			15,206
SS	SS	—		—		65		—		—		7,034		—		—		7,099		SS	0		0		3,623		0		12,811		16,292		0			0			32,726

Total	Total	93,518		163,318		151,615		193,928		290,767		458,629		—		—		1,351,775		Total	151,158		167,691		157,911		186,969		282,821		438,423		0			0			1,384,973
Total commercial business	Total commercial business																																							Total commercial business
Pass	Pass	1,056,535		473,250		344,428		342,888		418,320		878,830		176,396		4,705		3,695,352		Pass	1,162,668		477,469		333,869		328,809		382,297		811,687		144,505			802			3,642,106
SM	SM	2,071		3,232		3,128		11,104		9,551		16,502		14,830		42		60,460		SM	13,117		6,355		8,966		10,033		19,024		28,638		18,188			98			104,419
SS	SS	1,859		11,198		4,737		12,964		5,666		34,463		9,227		3,859		83,973		SS	2,580		11,418		8,900		16,263		18,520		46,194		8,324			3,926			116,125

Total	Total	1,060,465		487,680		352,293		366,956		433,537		929,795		200,453		8,606		3,839,785		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	One-to-four family residential																																							One-to-four family residential
Pass	Pass	19,960		42,790		19,958		15,334		9,304		24,507		—		—		131,853		Pass	24,100		46,513		17,913		12,436		8,649		21,751		0			0			131,362

SS	SS	—		—		—		61		124		508		—		—		693		SS	0		0		0		60		0		499		0			0			559

Total	Total	19,960		42,790		19,958		15,395		9,428		25,015		—		—		132,546		Total	24,100		46,513		17,913		12,496		8,649		22,250		0			0			131,921
Real estate construction and land development:	Real estate construction and land development:																																							Real estate construction and land development:
One-to-four family residential	One-to-four family residential																																							One-to-four family residential
Pass	Pass	17,955		75,844		8,366		2,229		971		1,705		—		—		107,070		Pass	25,519		62,220		6,203		1,364		971		1,561		0			0			97,838

SS	SS	—		—		—		1,751		—		—		—		—		1,751		SS	0		0		0		1,812		0		0		0			0			1,812

Total	Total	17,955		75,844		8,366		3,980		971		1,705		—		—		108,821		Total	25,519		62,220		6,203		3,176		971		1,561		0			0			99,650
Five or more family residential and commercial properties
Pass		16,898		107,857		61,589		6,993		797		2,536		—		—		196,670
SM		—		—		—		—		—		38		—		—		38
SS		—		—		—		—		—		455		—		—		455

Total		16,898		107,857		61,589		6,993		797		3,029		—		—		197,163
Total real estate and land development
Pass		34,853		183,701		69,955		9,222		1,768		4,241		—		—		303,740
SM		—		—		—		—		—		38		—		—		38
SS		—		—		—		1,751		—		455		—		—		2,206

Total		34,853		183,701		69,955		10,973		1,768		4,734		—		—		305,984

2523

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		Term Loans Amortized Cost Basis by Origination Year																													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		Revolving Loans		Revolving Loans Converted to Term Loans ⁽¹⁾		Loans Receivable			2020		2019		2018		2017		2016		Prior		Revolving Loans			Revolving Loans Converted to Term Loans (1)			Loans Receivable
		(In thousands)																																				(In thousands)
Five or more family residential and commercial properties																				Five or more family residential and commercial properties
Pass																				Pass	22,710		131,850		49,678		7,070		784		1,464				0			0			213,556
SM																				SM	0		0		0		0		0		33		0			0			33
SS																				SS	989		450		0		0		0		444		0			0			1,883

Total																				Total	23,699		132,300		49,678		7,070		784		1,941		0			0			215,472
Total real estate construction and land development																				Total real estate construction and land development
Pass																				Pass	48,229		194,070		55,881		8,434		1,755		3,025		0			0			311,394
SM																				SM	0		0		0		0		0		33		0			0			33
SS																				SS	989		450		0		1,812		0		444		0			0			3,695

Total																				Total	49,218		194,520		55,881		10,246		1,755		3,502		0			0			315,122
Consumer	Consumer																			Consumer
Pass	Pass	36,752		95,262		67,245		40,617		19,622		30,448		94,162		230		384,338		Pass	40,061		86,402		59,782		35,068		16,361		20,521		94,849			473			353,517

SM																				SM	0		0		0		0		0		0		329			0			329
SS	SS	20		257		486		492		471		1,520		430		4		3,680		SS	20		330		532		480		422		1,156		86			165			3,191

Total	Total	36,772		95,519		67,731		41,109		20,093		31,968		94,592		234		388,018		Total	40,081		86,732		60,314		35,548		16,783		21,677		95,264			638			357,037
Loans receivable	Loans receivable																																							Loans receivable
Pass	Pass	1,148,100		795,003		501,586		408,061		449,014		938,026		270,558		4,935		4,515,283		Pass	1,275,058		804,454		467,445		384,747		409,062		856,984		239,354			1,275			4,438,379
SM	SM	2,071		3,232		3,128		11,104		9,551		16,540		14,830		42		60,498		SM	13,117		6,355		8,966		10,033		19,024		28,671		18,517			98			104,781
SS	SS	1,879		11,455		5,223		15,268		6,261		36,946		9,657		3,863		90,552		SS	3,589		12,198		9,432		18,615		18,942		48,293		8,410			4,091			123,570

Total	Total	$	1,152,050	$	809,690	$	509,937	$	434,433	$	464,826	$	991,512	$	295,045	$	8,840	$	4,666,333	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 ~~June~~September 30, 2020 which was converted from a revolving loan to an amortizing loan during the ~~six~~nine months ended ~~June~~September 30, 2020.

The following table presents the amortized cost of loans receivable by credit quality indicator as of December 31, 2019 in accordance with disclosure requirements prior to CECL Adoption:


		December 31, 2019																			December 31, 2019
		Pass		Special Mention		Substandard		Doubtful/Loss		Total			Pass		Special Mention		Substandard		Doubtful/Loss		Total
		(In thousands)																			(In thousands)
Commercial business:	Commercial business:											Commercial business:
Commercial and industrial	Commercial and industrial	$	771,559	$	16,340	$	64,321	$	—	$	852,220	Commercial and industrial	$	771,559	$	16,340	$	64,321	$	0	$	852,220
Owner-occupied CRE	Owner-occupied CRE	765,411		24,659		15,164		—		805,234		Owner-occupied CRE	765,411		24,659		15,164		0		805,234
Non-owner occupied CRE	Non-owner occupied CRE	1,274,513		5,662		8,604		—		1,288,779		Non-owner occupied CRE	1,274,513		5,662		8,604		0		1,288,779
Total commercial business	Total commercial business	2,811,483		46,661		88,089		—		2,946,233		Total commercial business	2,811,483		46,661		88,089		0		2,946,233
One-to-four family residential	One-to-four family residential	130,818		—		842		—		131,660		One-to-four family residential	130,818		0		842		0		131,660
Real estate construction and land development:	Real estate construction and land development:											Real estate construction and land development:
One-to-four family residential	One-to-four family residential	101,973		1,516		807		—		104,296		One-to-four family residential	101,973		1,516		807		0		104,296
Five or more family residential and commercial properties	Five or more family residential and commercial properties	169,668		682		—		—		170,350		Five or more family residential and commercial properties	169,668		682		0		0		170,350
Total real estate construction and land development	Total real estate construction and land development	271,641		2,198		807		—		274,646		Total real estate construction and land development	271,641		2,198		807		0		274,646
Consumer	Consumer	411,141		—		3,675		524		415,340		Consumer	411,141		0		3,675		524		415,340
Loans receivable	Loans receivable	$	3,625,083	$	48,859	$	93,413	$	524	$	3,767,879	Loans receivable	$	3,625,083	$	48,859	$	93,413	$	524	$	3,767,879

Potential problem loans are ~~loans defined as~~ risk ~~rating of~~rated Special Mention or worse that are not classified as a TDR or nonaccrual loan and are not 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

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terms. Potential problem loans as of ~~June~~September 30, 2020 and December 31, 2019 were ~~$100.6~~$159.8 million and $87.8 million, respectively.

~~Table~~ ~~of Contents~~

(d) Nonaccrual Loans

The following table presents the amortized cost of nonaccrual loans for the dates indicated:


		June 30, 2020										December 31, 2019			September 30, 2020				December 31, 2019
		Nonaccrual with No ACL		Nonaccrual with ACL		Total Nonaccrual ⁽¹⁾		Nonaccrual ⁽²⁾			Nonaccrual without ACL		Nonaccrual with ACL		Total Nonaccrual		Nonaccrual (1)
		(In thousands)															(In thousands)
Commercial business:	Commercial business:									Commercial business:
Commercial and industrial	Commercial and industrial	$	23,359	$	2,458	$	25,817	$	33,544	Commercial and industrial	$	23,410	$	3,750	$	27,160	$	33,544
Owner-occupied CRE	Owner-occupied CRE	3,042		724		3,766		4,714		Owner-occupied CRE	4,765		11,795		16,560		4,714
Non-owner occupied CRE	Non-owner occupied CRE	3,799		—		3,799		6,062		Non-owner occupied CRE	3,478		3,732		7,210		6,062
Total commercial business	Total commercial business	30,200		3,182		33,382		44,320		Total commercial business	31,653		19,277		50,930		44,320
One-to-four family residential	One-to-four family residential	16		144		160		19		One-to-four family residential	38		119		157		19
Real estate construction and land development:										Real estate construction and land development:

Five or more family residential and commercial properties										Five or more family residential and commercial properties	0		1,439		1,439		0

Consumer	Consumer	—		86		86		186		Consumer	0		78		78		186
Total	Total	$	30,216	$	3,412	$	33,628	$	44,525	Total	$	31,691	$	20,913	$	52,604	$	44,525

⁽¹⁾ ~~Includes $429,000 of PCI loans which were converted to PCD loans and classified as nonaccrual on January 1, 2020 as part of CECL Adoption.~~

⁽²⁾ 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 ~~period:~~periods:


		Three Months Ended June 30, 2020						Three Months Ended June 30, 2019							Three Months Ended September 30, 2020					Three Months Ended September 30, 2019
		Interest Income Reversed		Interest Income Recognized		Interest Income Reversed		Interest Income Recognized			Interest Income Reversed		Interest Income Recognized			Interest Income Reversed		Interest Income Recognized
		(In thousands)														(In thousands)
Commercial business:	Commercial business:									Commercial business:
Commercial and industrial	Commercial and industrial	$	—	$	89	$	(35)	$	11	Commercial and industrial	$	(59)	$	111		$	(336)	$	37
Owner-occupied CRE	Owner-occupied CRE	—		14		(1)		39		Owner-occupied CRE	(219)		29			0		182
Non-owner occupied CRE	Non-owner occupied CRE	—		22		—		—		Non-owner occupied CRE	(102)		0			0		181
Total commercial business	Total commercial business	—		125		(36)		50		Total commercial business	(380)		140			(336)		400

One-to-four family residential										One-to-four family residential	(1)		2			0		0
Real estate construction and land development:	Real estate construction and land development:									Real estate construction and land development:
One-to-four family residential	One-to-four family residential	—		—		—		23		One-to-four family residential	0		0			0		10
Five or more family residential and commercial properties										Five or more family residential and commercial properties	(11)		0			0		0
Total real estate construction and land development										Total real estate construction and land development	(11)		0			0		10

Consumer		—		37		—		—
Total	Total	$	—	$	162	$	(36)	$	73	Total	$	(392)	$	142		$	(336)	$	410

Six Months Ended
June 30, 2020 Six months ended
June 30, 2019
Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized
(in thousands)
Commercial business:
Commercial and industrial $ (16) $ 308 $ (56) $ 60
Owner-occupied CRE — 60 — 46
Non-owner occupied CRE — 67 (34) —
Total commercial business (16) 435 (90) 106
Real estate construction and land development:
One-to-four family residential — — (3) 23
Consumer — 47 — 6
Total $ (16) $ 482 $ (93) $ 135

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	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 ~~six~~nine months ended ~~June~~September 30, 2020 and 2019, 0no interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the ~~table~~tables above.

(e) Past due loans

The Company performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due. The amortized cost of past due loans as of ~~June~~September 30, 2020 were as follows:


		June 30, 2020																			September 30, 2020
		30-89 Days		90 Days or Greater		Total Past Due		Current		Loan Receivable			30-89 Days		90 Days or Greater		Total Past Due		Current		Loans Receivable
		(In thousands)																			(In thousands)
Commercial business:	Commercial business:											Commercial business:
Commercial and industrial	Commercial and industrial	$	4,273	$	5,300	$	9,573	$	783,644	$	793,217	Commercial and industrial	$	2,414	$	8,415	$	10,829	$	739,728	$	750,557
SBA PPP	SBA PPP	—		—		—		856,490		856,490		SBA PPP	0		0		0		867,782		867,782
Owner-occupied CRE	Owner-occupied CRE	46		441		487		837,816		838,303		Owner-occupied CRE	0		403		403		858,935		859,338
Non-owner occupied CRE	Non-owner occupied CRE	—		111		111		1,351,664		1,351,775		Non-owner occupied CRE	754		267		1,021		1,383,952		1,384,973
Total commercial business	Total commercial business	4,319		5,852		10,171		3,829,614		3,839,785		Total commercial business	3,168		9,085		12,253		3,850,397		3,862,650
One-to-four family residential	One-to-four family residential	140		—		140		132,406		132,546		One-to-four family residential	32		16		48		131,873		131,921
Real estate construction and land development:	Real estate construction and land development:											Real estate construction and land development:
One-to-four family residential	One-to-four family residential	—		—		—		108,821		108,821		One-to-four family residential	150		0		150		99,500		99,650
Five or more family residential and commercial properties	Five or more family residential and commercial properties	—		—		—		197,163		197,163		Five or more family residential and commercial properties	1,200		0		1,200		214,272		215,472
Total real estate construction and land development	Total real estate construction and land development	—		—		—		305,984		305,984		Total real estate construction and land development	1,350		0		1,350		313,772		315,122
Consumer	Consumer	687		4		691		387,327		388,018		Consumer	883		0		883		356,154		357,037
Total	Total	$	5,146	$	5,856	$	11,002	$	4,655,331	$	4,666,333	Total	$	5,433	$	9,101	$	14,534	$	4,652,196	$	4,666,730

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The following table presents the amortized cost of past due loans as of December 31, 2019 in accordance with disclosure requirements prior to CECL Adoption:


		December 31, 2019																											December 31, 2019
		30-89 Days		90 Days or Greater		Total Past Due		Current		Total		PCI Loans		Loan Receivable			30-89 Days		90 Days or Greater		Total Past Due		Current		Total		PCI Loans		Loans Receivable
		(In thousands)																											(In thousands)
Commercial business:	Commercial business:															Commercial business:
Commercial and industrial	Commercial and industrial	$	10,479	$	6,772	$	17,251	$	832,601	$	849,852	$	2,368	$	852,220	Commercial and industrial	$	10,479	$	6,772	$	17,251	$	832,601	$	849,852	$	2,368	$	852,220
Owner-occupied CRE	Owner-occupied CRE	607		806		1,413		798,907		800,320		4,914		805,234		Owner-occupied CRE	607		806		1,413		798,907		800,320		4,914		805,234
Non-owner occupied CRE	Non-owner occupied CRE	554		1,843		2,397		1,280,891		1,283,288		5,491		1,288,779		Non-owner occupied CRE	554		1,843		2,397		1,280,891		1,283,288		5,491		1,288,779
Total commercial business	Total commercial business	11,640		9,421		21,061		2,912,399		2,933,460		12,773		2,946,233		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	One-to-four family residential	797		—		797		127,288		128,085		3,575		131,660		One-to-four family residential	797		0		797		127,288		128,085		3,575		131,660
Real estate construction and land development:	Real estate construction and land development:															Real estate construction and land development:
One-to-four family residential	One-to-four family residential	1,516		—		1,516		102,780		104,296		—		104,296		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	Five or more family residential and commercial properties	—		—		—		170,350		170,350		—		170,350		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	Total real estate construction and land development	1,516		—		1,516		273,130		274,646		—		274,646		Total real estate construction and land development	1,516		0		1,516		273,130		274,646		0		274,646
Consumer	Consumer	2,071		—		2,071		411,507		413,578		1,762		415,340		Consumer	2,071		0		2,071		411,507		413,578		1,762		415,340
Total	Total	$	16,024	$	9,421	$	25,445	$	3,724,324	$	3,749,769	$	18,110	$	3,767,879	Total	$	16,024	$	9,421	$	25,445	$	3,724,324	$	3,749,769	$	18,110	$	3,767,879

There were 0 loans 90 days or more past due that were still accruing interest as of ~~June~~September 30, 2020 or December 31, 2019.

(f) Collateral-dependent Loans

The types of collateral securing loans individually evaluated ~~loans~~ for ~~ACL on loans,~~credit losses and for which the repayment was expected to be provided substantially through the operation or sale of the collateral as of ~~June~~September 30, 2020 were as follows:


		Loans receivable⁽¹⁾ at June 30, 2020																			Loans receivable(1)
		CRE		Farmland		Single Family Residence		Equipment or Accounts Receivable		Total			CRE		Farmland		Single Family Residence		Equipment or Accounts Receivable			Total
		(In thousands)																			(In thousands)
Commercial business:	Commercial business:											Commercial business:
Commercial and industrial	Commercial and industrial	$	2,013	$	19,617	$	1,394	$	1,788	$	24,812	Commercial and industrial	$	1,953	$	18,979	$	1,331	$	1,696		$	24,155
Owner-occupied CRE	Owner-occupied CRE	3,042		—		—		—		3,042		Owner-occupied CRE	4,764		0		0		0			4,764
Non-owner occupied CRE	Non-owner occupied CRE	5,215		—		—		—		5,215		Non-owner occupied CRE	5,218		0		0		0			5,218
Total commercial business	Total commercial business	10,270		19,617		1,394		1,788		33,069		Total commercial business	11,935		18,979		1,331		1,696			34,137
One-to-four family residential	One-to-four family residential	—		—		16		—		16		One-to-four family residential	0		0		38		0			38
Real estate construction and land development:	Real estate construction and land development:											Real estate construction and land development:
One-to-four family residential	One-to-four family residential	—		—		1,751		—		1,751		One-to-four family residential	0		0		1,812		0			1,812

Total	Total	$	10,270	$	19,617	$	3,161	$	1,788	$	34,836	Total	$	11,935	$	18,979	$	3,181	$	1,696		$	35,987

⁽¹⁾ Balances represent the amortized cost of loans receivable ~~at date indicated.~~evaluated for credit losses using collateral valuation. If multiple collateral sources secured the loan, the entire loan receivable balance is presented in the ~~primary~~ collateral category deemed primary, which generally represents the majority of the collateral balance.

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There have been no significant changes to the collateral ~~that secures these financial assets~~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 ~~six~~nine months ended ~~June~~September 30, 2020, except changes due to payoffs and additions of loans ~~being individually evaluated for ACL on 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 ~~six~~nine months ended ~~June~~September 30, 2019 are similar to the disclosures for impaired loans. Impaired loans include nonaccrual loans, performing TDR loans, and other loans with a specific valuation allowance, excluding PCI loans. The amortized cost of impaired loans as of December 31, 2019 are set forth in the following table:


		December 31, 2019																			December 31, 2019
		Amortized Cost With No Specific Valuation Allowance		Amortized Cost With Specific Valuation Allowance		Total Amortized Cost		Unpaid Contractual Principal Balance		Related Specific Valuation Allowance			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)																			(In thousands)
Commercial business:	Commercial business:											Commercial business:
Commercial and industrial	Commercial and industrial	$	30,179	$	13,629	$	43,808	$	45,585	$	1,372	Commercial and industrial	$	30,179	$	13,629	$	43,808	$	45,585	$	1,372
Owner-occupied CRE	Owner-occupied CRE	3,921		2,415		6,336		6,764		426		Owner-occupied CRE	3,921		2,415		6,336		6,764		426
Non-owner occupied CRE	Non-owner occupied CRE	5,309		1,015		6,324		6,458		146		Non-owner occupied CRE	5,309		1,015		6,324		6,458		146
Total commercial business	Total commercial business	39,409		17,059		56,468		58,807		1,944		Total commercial business	39,409		17,059		56,468		58,807		1,944
One-to-four family residential	One-to-four family residential	—		215		215		223		56		One-to-four family residential	0		215		215		223		56
Real estate construction and land development:	Real estate construction and land development:											Real estate construction and land development:
One-to-four family residential	One-to-four family residential	237		—		237		237		—		One-to-four family residential	237		0		237		237		0

Consumer	Consumer	—		561		561		570		143		Consumer	0		561		561		570		143
Total	Total	$	39,646	$	17,835	$	57,481	$	59,837	$	2,143	Total	$	39,646	$	17,835	$	57,481	$	59,837	$	2,143

The average amortized cost of impaired loans for the three and ~~six~~nine months ended ~~June~~September 30, 2019 are set forth in the following table:


		Three Months Ended June 30, 2019		Six Months Ended June 30, 2019			Three Months Ended September 30, 2019		Nine Months Ended September 30, 2019
		(In thousands)							(In thousands)
Commercial business:	Commercial business:					Commercial business:
Commercial and industrial	Commercial and industrial	$	25,215	$	24,422	Commercial and industrial	$	35,017	$	28,925
Owner-occupied CRE	Owner-occupied CRE	6,178		6,058		Owner-occupied CRE	5,918		5,927
Non-owner occupied CRE	Non-owner occupied CRE	8,221		7,506		Non-owner occupied CRE	9,790		8,106
Total commercial business	Total commercial business	39,614		37,986		Total commercial business	50,725		42,958
One-to-four family residential	One-to-four family residential	248		259		One-to-four family residential	221		249
Real estate construction and land development:	Real estate construction and land development:					Real estate construction and land development:
One-to-four family residential	One-to-four family residential	858		872		One-to-four family residential	676		794

Consumer	Consumer	613		584		Consumer	600		581
Total	Total	$	41,333	$	39,701	Total	$	52,222	$	44,582

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(g) Troubled Debt Restructured Loans

The amortized cost and related ACL on loans of performing and nonaccrual TDR loans as of ~~June~~September 30, 2020 and December 31, 2019 were as follows:


		June 30, 2020						December 31, 2019							September 30, 2020				December 31, 2019
		Performing TDR loans		Nonaccrual TDR loans		Performing TDR loans		Nonaccrual TDR loans			Performing TDR loans		Nonaccrual TDR loans		Performing TDR loans		Nonaccrual TDR loans
		(In thousands)															(In thousands)
TDR loans	TDR loans	$	20,687	$	20,907	$	14,469	$	26,338	TDR loans	$	19,615	$	20,468	$	14,469	$	26,338
ACL on TDR loans	ACL on TDR loans	1,624		371		1,259		218		ACL on TDR loans	1,536		348		1,259		218

~~Table~~ ~~of Contents~~

The unfunded commitment to borrowers related to TDR loans was ~~$2.6~~$2.3 million and $736,000 at ~~June~~September 30, 2020 and December 31, 2019, respectively.

Loans that were modified as TDR loans during the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019 are set forth in the following tables:


		Three months ended June 30,											Three months ended September 30,
		2020				2019						2020			2019
		Number of Contracts	Amortized Cost ⁽¹⁾		Number of Contracts	Amortized Cost ⁽¹⁾			Number of Contracts	Amortized Cost (1)		Number of Contracts	Amortized Cost (1)
		(Dollars in thousands)											(Dollars in thousands)
Commercial business:	Commercial business:							Commercial business:
Commercial and industrial	Commercial and industrial	31	$	11,849	14	$	8,626	Commercial and industrial	12	$	7,217	15	$	5,267
Owner-occupied CRE	Owner-occupied CRE	4	1,657		1	710		Owner-occupied CRE	5	2,312		2	1,214
Non-owner occupied CRE	Non-owner occupied CRE	2	398		2	3,554		Non-owner occupied CRE	2	438		3	2,597
Total commercial business	Total commercial business	37	13,904		17	12,890		Total commercial business	19	9,967		20	9,078
One-to-four family residential								One-to-four family residential	1	22		0	0
Real estate construction and land development:	Real estate construction and land development:							Real estate construction and land development:
One-to-four family residential	One-to-four family residential	4	1,751		—	—		One-to-four family residential	4	1,812		0	0

Consumer	Consumer	9	82		3	53		Consumer	9	127		3	27
Total	Total	50	$	15,737	20	$	12,943	Total	33	$	11,928	23	$	9,105


		Six Months Ended June 30,											Nine Months Ended September 30,
		2020				2019						2020			2019
		Number of Contracts ⁽²⁾	Amortized Cost ^{(1) (2)}		Number of Contracts ⁽²⁾	Amortized Cost ^{(1) (2)}			Number of Contracts (2)	Amortized Cost (1) (2)		Number of Contracts (2)	Amortized Cost (1) (2)
		(Dollars in thousands)											(Dollars in thousands)
Commercial business:	Commercial business:							Commercial business:
Commercial and industrial	Commercial and industrial	36	$	13,893	20	$	18,061	Commercial and industrial	38	$	18,871	33	$	22,408
Owner-occupied CRE	Owner-occupied CRE	6	3,067		3	1,628		Owner-occupied CRE	7	3,227		3	1,612
Non-owner occupied CRE	Non-owner occupied CRE	3	2,143		3	5,642		Non-owner occupied CRE	4	2,417		4	5,568
Total commercial business	Total commercial business	45	19,103		26	25,331		Total commercial business	49	24,515		40	29,588
One-to-four family residential								One-to-four family residential	1	22		0	0
Real estate construction and land development:	Real estate construction and land development:							Real estate construction and land development:
One-to-four family residential	One-to-four family residential	4	1,751		1	560		One-to-four family residential	4	1,812		1	560

Consumer	Consumer	14	173		8	166		Consumer	20	251		10	158
Total TDR loans	Total TDR loans	63	$	21,027	35	$	26,057	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

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the date of modification (pre-modification) did not change as a result of the modification (post-modification).

⁽²⁾ Number of contracts and ~~outstanding principal balance~~amortized cost represent loans which have balances as of period ~~end as certain~~end. Certain modified loans may have been paid-down or charged-off during the ~~six~~nine months ended ~~June~~September 30, 2020 and 2019.

The tables above ~~incl~~include 22 and 31 loa~~ude 34 and 37 loans,~~ns, respectively, for the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 127 and ~~20,~~17, respectively, for the three and ~~six~~nine months ended ~~June~~September 30, 2019 that were previously reported as TDR loans. The Bank typically grants shorter extension periods to continually monitor these TDR loans despite the fact that the extended date might not be the date the Bank expects sufficient cash flow from these borrowers. The Bank 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 TDR loans are 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 ACL at ~~June~~September 30, 2020 for loans that were modified as TDR loans during the ~~six~~nine months ended ~~June~~September 30, 2020 was $1.6 million.

~~Table~~ ~~of Contents~~

Loans that were modified during the previous twelve months that subsequently defaulted during the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019 are set forth in the following tables:


		Three months ended June 30,											Three months ended September 30,
		2020				2019						2020			2019
		Number of Contracts	Amortized Cost		Number of Contracts	Amortized Cost			Number of Contracts	Amortized Cost		Number of Contracts	Amortized Cost
		(Dollars in thousands)											(Dollars in thousands)
Commercial business:	Commercial business:							Commercial business:
Commercial and industrial	Commercial and industrial	2	$	302	6	$	1,278	Commercial and industrial	1	$	229	4	$	2,056
Owner-occupied CRE		1	445		1	399

Non-owner occupied CRE	Non-owner occupied CRE	1	280		—	—		Non-owner occupied CRE	0	0		1	2,971
Total commercial business	Total commercial business	4	$	1,027	7	$	1,677	Total commercial business	1	$	229	5	$	5,027
Real estate construction and land development:
One-to-four family residential		—	—		1	560

Total	Total	4	$	1,027	8	$	2,237	Total	1	$	229	5	$	5,027

Six Months Ended June 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 $ 2,155 6 $ 1,278
Owner-occupied CRE 1 445 2 1,109
Non-owner occupied CRE 2 398 1 586
Total commercial business 7 2,998 9 2,973
Real estate construction and land development:
One-to-four family residential — — 1 560
Total 7 $ 2,998 10 $ 3,533

^{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 ~~outstanding principal balance~~amortized cost represent loans which have balances as of period ~~end as certain~~end. Certain loans may have been paid-down or charged-off during the ~~six~~nine months ended ~~June~~September 30, 2020 and 2019.

During the three and ~~six~~nine months ended ~~June~~September 30, 2020 ~~and 2019~~all of thethe 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 ~~has chosen~~chose not to extend further the maturity date on these loans. The Bank had an ACL on loans of ~~$494,000~~$512,000 at ~~June~~September 30, 2020 related to these TDR loans which defaulted during the ~~six~~nine months ended ~~June~~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 ~~$304,000~~$412,000 at ~~June~~September 30, 2019 related to these TDR loans which defaulted during the ~~six~~nine months ended ~~June~~September 30, 2019.

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For the three and ~~six~~nine months ended ~~June~~September 30, 2020, the Bank recorded ~~$274,000~~$263,000 and ~~$882,000,~~$1.1 million, respectively, of interest income related to performing TDR loans. For the three and ~~six~~nine months ended ~~June~~September 30, 2019, the Bank recorded ~~$397,000~~$282,000 and ~~$698,000,~~$980,000, respectively, of interest income related to performing TDR loans.

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(h) Purchased Credit Impaired Loans

Upon CECL Adoption, the Company transitioned PCI loans to PCD loans. The following table reflects the outstanding principal balance and ~~recorded investment~~amortized cost of PCI loans at December 31, 2019:


		December 31, 2019							December 31, 2019
		Outstanding Principal		Recorded Investment			Outstanding Principal		Amortized Cost
		(In thousands)							(In thousands)
Commercial business:	Commercial business:					Commercial business:
Commercial and industrial	Commercial and industrial	$	4,439	$	2,368	Commercial and industrial	$	4,439	$	2,368
Owner-occupied CRE	Owner-occupied CRE	4,925		4,914		Owner-occupied CRE	4,925		4,914
Non-owner occupied CRE	Non-owner occupied CRE	7,028		5,491		Non-owner occupied CRE	7,028		5,491
Total commercial business	Total commercial business	16,392		12,773		Total commercial business	16,392		12,773
One-to-four family residential	One-to-four family residential	3,095		3,575		One-to-four family residential	3,095		3,575

Consumer	Consumer	1,463		1,762		Consumer	1,463		1,762
Gross PCI loans		$	20,950	$	18,110
PCI loans						PCI loans	$	20,950	$	18,110

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 was the “accretable yield.” The accretable yield was then measured at each financial reporting date and represented 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 ~~six~~nine months ended ~~June~~September 30, 2019:


		Three Months Ended June 30, 2019		Six Months Ended June 30, 2019			Three Months Ended September 30, 2019		Nine Months Ended September 30, 2019
		(In thousands)							(In thousands)
Balance at the beginning of the period	Balance at the beginning of the period	$	8,460	$	9,493	Balance at the beginning of the period	$	8,572	$	9,493
Accretion	Accretion	(513)		(1,094)		Accretion	(423)		(1,517)
Disposal and other	Disposal and other	(198)		(650)		Disposal and other	(94)		(744)
Reclassification from nonaccretable difference	Reclassification from nonaccretable difference	823		823		Reclassification from nonaccretable difference	0		823
Balance at the end of the period	Balance at the end of the period	$	8,572	$	8,572	Balance at the end of the period	$	8,055	$	8,055

(4)Allowance for Credit Losses on Loans

Effective January 1, 2020, the Bank adopted ASU 2016-13. ~~The adoption~~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~~Bank's average quarterly historical loss information from December 31, 2007 through December 31, 2019. The baseline loss rate ~~period~~ for the ACL at ~~June~~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 ~~otherwise known as the Global Coronavirus Recession.~~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 ~~methodology~~CECL model at January 1, 2020 and ~~June~~September 30, 2020 were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of

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future prepayment activity. ~~Management's allowance estimates~~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 ~~June~~was increased to five quarters in the CECL model at September 30, 2020 ~~used a four quarter reasonable and supportable period, as~~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 two quarter reversion period in calculating ~~its allowance~~the ACL as of January 1, 2020 and ~~June~~September 30, 2020 as it believes the

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historical loss information is relevant to the 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. ~~Risk characteristics by segment considered~~

The macroeconomic forecast used in the CECL ~~methodology are~~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 ~~same as those disclosed~~COVID-19 pandemic resulted in identification of an economic recession during the second quarter of 2020. The macroeconomic forecast used in the ~~2019 Annual Form 10-K.~~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 ACL on loans disaggregated by segment and class for the three and ~~six~~nine months ended ~~June~~September 30, 2020:


		Three Months Ended June 30, 2020																			Three Months Ended September 30, 2020
		Beginning Balance		Charge-offs		Recoveries		Provision for Credit Losses		Ending Balance			Beginning Balance		Charge-offs		Recoveries		Provision for Credit Losses		Ending Balance
		(In thousands)																			(In thousands)
Commercial business:	Commercial business:											Commercial business:
Commercial and industrial	Commercial and industrial	$	13,900	$	(1,824)	$	69	$	17,628	$	29,773	Commercial and industrial	$	29,773	$	(507)	$	78	$	1,815	$	31,159
SBA PPP	SBA PPP	—		—		—		—		—		SBA PPP	0		0		0		0		0
Owner-occupied CRE	Owner-occupied CRE	6,216		—		2		3,785		10,003		Owner-occupied CRE	10,003		0		2		3,027		13,032
Non-owner occupied CRE	Non-owner occupied CRE	7,750		—		—		2,916		10,666		Non-owner occupied CRE	10,666		0		0		(124)		10,542
Total commercial business	Total commercial business	27,866		(1,824)		71		24,329		50,442		Total commercial business	50,442		(507)		80		4,718		54,733
One-to-four family residential	One-to-four family residential	3,026		—		—		(803)		2,223		One-to-four family residential	2,223		0		0		(398)		1,825
Real estate construction and land development:	Real estate construction and land development:											Real estate construction and land development:
One-to-four family residential	One-to-four family residential	864		—		7		(304)		567		One-to-four family residential	567		0		139		(42)		664
Five or more family residential and commercial properties	Five or more family residential and commercial properties	11,444		—		—		(2,887)		8,557		Five or more family residential and commercial properties	8,557		0		0		70		8,627
Total real estate construction and land development	Total real estate construction and land development	12,308		—		7		(3,191)		9,124		Total real estate construction and land development	9,124		0		139		28		9,291
Consumer	Consumer	4,340		(431)		197		5,606		9,712		Consumer	9,712		(335)		142		(2,028)		7,491

Total	Total	$	47,540	$	(2,255)	$	275	$	25,941	$	71,501	Total	$	71,501	$	(842)	$	361	$	2,320	$	73,340

Six Months Ended June 30, 2020
Balance at Beginning 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 $ (2,911) $ 1,126 $ 21,167 $ 29,773
SBA PPP — — — — — — —
Owner-occupied CRE 4,512 452 4,964 (135) 14 5,160 10,003
Non-owner occupied CRE 7,682 (2,039) 5,643 — — 5,023 10,666
Total commercial business 23,933 (2,935) 20,998 (3,046) 1,140 31,350 50,442
One-to-four family residential 1,458 1,471 2,929 — 3 (709) 2,223
Real estate construction and land development:
One-to-four family residential 1,455 (571) 884 — 21 (338) 567
Five or more family residential and commercial properties 1,605 7,240 8,845 — — (288) 8,557
Total real estate construction and land development 3,060 6,669 9,729 — 21 (626) 9,124
Consumer 6,821 (2,484) 4,337 (806) 291 5,890 9,712
Unallocated 899 (899) — — —
Total $ 36,171 $ 1,822 $ 37,993 $ (3,852) $ 1,455 $ 35,905 $ 71,501


	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

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	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

The Bank recognized net charge-offs of ~~$2.4~~$2.9 million during the ~~six~~nine months ended ~~June~~September 30, 2020 primarily due to a commercial and industrial charge-off of $1.7 million related to a lending relationship that ~~has~~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 ~~charge-off~~net charge-offs on a large volume of consumer loans of ~~$806,000 and~~$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 ~~six~~nine months ended ~~June~~September 30, 2020, which was charged-off during the three months ended December 31, 2019.

The provision for credit losses on loans of ~~$35.9~~$38.2 million for the ~~six~~nine months ended ~~June~~September 30, 2020 was necessary to build the allowance to account for the current and forecasted economic conditions amidst ~~COVID-19. The macroeconomic forecast used in~~COVID-19, including the ~~June 30, 2020 CECL model was as of June 9, 2020,~~credit losses estimated on collectively and included the actual results of the sharp recession, followed by forecasted widened "U-shaped" recovery with unemployment rate spiking to 13% in second quarter 2020 and decreasing to 5% by 2023, and GDP slumping 6.1% in 2020, but rebounding 6.3% in 2021, with modest increases in GDP in future years. This forecast is in stark contrast to that used in CECL model as of January 1, 2020, which predicted steady GDP growth and unemployment rates, among other factors.individually evaluated loans.

The following tables detail activity in the allowance for loan losses disaggregated by segment and class for the three and ~~six~~nine months ended ~~June~~September 30, 2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:


		Three Months Ended June 30, 2019																			Three Months Ended September 30, 2019
		Beginning Balance		Charge-offs		Recoveries		Provision for Loan Losses		Ending Balance			Beginning Balance		Charge-offs		Recoveries		Provision for Loan Losses		Ending Balance
		(In thousands)																			(In thousands)
Commercial business:	Commercial business:											Commercial business:
Commercial and industrial	Commercial and industrial	$	11,755	$	(774)	$	62	$	950	$	11,993	Commercial and industrial	$	11,993	$	(306)	$	43	$	449	$	12,179
Owner-occupied CRE	Owner-occupied CRE	5,256		—		—		(190)		5,066		Owner-occupied CRE	5,066		0		46		(656)		4,456
Non-owner occupied CRE	Non-owner occupied CRE	7,825		—		—		239		8,064		Non-owner occupied CRE	8,064		0		292		(525)		7,831
Total commercial business	Total commercial business	24,836		(774)		62		999		25,123		Total commercial business	25,123		(306)		381		(732)		24,466
One-to-four family residential	One-to-four family residential	1,247		(15)		—		113		1,345		One-to-four family residential	1,345		(15)		0		81		1,411
Real estate construction and land development:	Real estate construction and land development:											Real estate construction and land development:
One-to-four family residential	One-to-four family residential	1,422		—		7		42		1,471		One-to-four family residential	1,471		0		3		(133)		1,341
Five or more family residential and commercial properties		995		—		—		65		1,060
Total real estate construction and land development		2,417		—		7		107		2,531
Consumer		6,480		(566)		130		496		6,540
Unallocated		1,172		—		—		(348)		824
Total		$	36,152	$	(1,355)	$	199	$	1,367	$	36,363

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Six Months Ended June 30, 2019
Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 11,343 $ (877) $ 69 $ 1,458 $ 11,993
Owner-occupied CRE 4,898 — 3 165 5,066
Non-owner occupied CRE 7,470 — 149 445 8,064
Total commercial business 23,711 (877) 221 2,068 25,123
One-to-four family residential 1,203 (30) — 172 1,345
Real estate construction and land development:
One-to-four family residential 1,240 — 625 (394) 1,471
Five or more family residential and commercial properties 954 — — 106 1,060
Total real estate construction and land development 2,194 — 625 (288) 2,531
Consumer 6,581 (1,152) 247 864 6,540
Unallocated 1,353 — — (529) 824
Total $ 35,042 $ (2,059) $ 1,093 $ 2,287 $ 36,363


	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, 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 — 1,296 159 1,455
Five or more family residential and commercial properties — 1,527 78 1,605
Total real estate construction and land development — 2,823 237 3,060
Consumer 143 6,327 351 6,821
Unallocated — 899 — 899
Total $ 2,143 $ 31,759 $ 2,269 $ 36,171


	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

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	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 amortized cost of the loan receivables disaggregated on the basis of the Company’s impairment method as of December 31, 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			Loans Individually Evaluated for Impairment		Loans Collectively Evaluated for Impairment		PCI Loans		Loans Receivable
		(In thousands)															(In thousands)
Commercial business:	Commercial business:									Commercial business:
Commercial and industrial	Commercial and industrial	$	43,808	$	806,044	$	2,368	$	852,220	Commercial and industrial	$	43,808	$	806,044	$	2,368	$	852,220
Owner-occupied CRE	Owner-occupied CRE	6,336		793,984		4,914		805,234		Owner-occupied CRE	6,336		793,984		4,914		805,234
Non-owner occupied CRE	Non-owner occupied CRE	6,324		1,276,964		5,491		1,288,779		Non-owner occupied CRE	6,324		1,276,964		5,491		1,288,779
Total commercial business	Total commercial business	56,468		2,876,992		12,773		2,946,233		Total commercial business	56,468		2,876,992		12,773		2,946,233
One-to-four family residential	One-to-four family residential	215		127,870		3,575		131,660		One-to-four family residential	215		127,870		3,575		131,660
Real estate construction and land development:	Real estate construction and land development:									Real estate construction and land development:
One-to-four family residential	One-to-four family residential	237		104,059		—		104,296		One-to-four family residential	237		104,059		0		104,296
Five or more family residential and commercial properties	Five or more family residential and commercial properties	—		170,350		—		170,350		Five or more family residential and commercial properties	0		170,350		0		170,350
Total real estate construction and land development	Total real estate construction and land development	237		274,409		—		274,646		Total real estate construction and land development	237		274,409		0		274,646
Consumer	Consumer	561		413,017		1,762		415,340		Consumer	561		413,017		1,762		415,340
Total	Total	$	57,481	$	3,692,288	$	18,110	$	3,767,879	Total	$	57,481	$	3,692,288	$	18,110	$	3,767,879

(5)Other Real Estate Owned

Changes in other real estate owned during the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019 were as follows:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended September 30,				Nine Months Ended September 30,
		2020		2019		2020		2019			2020		2019		2020		2019
		(In thousands)															(In thousands)
Balance at the beginning of the period	Balance at the beginning of the period	$	841	$	1,904	$	841	$	1,983	Balance at the beginning of the period	$	0	$	1,224	$	841	$	1,983
Additions	Additions	—		—		270		—		Additions	0		0		270		0

Proceeds from dispositions	Proceeds from dispositions	(1,024)		(350)		(1,290)		(429)		Proceeds from dispositions	0		(435)		(1,290)		(864)
Gain (loss) on sales, net	Gain (loss) on sales, net	183		(279)		179		(279)		Gain (loss) on sales, net	0		52		179		(227)
Valuation adjustment	Valuation adjustment	—		(51)		—		(51)		Valuation adjustment	0		0		0		(51)
Balance at the end of the period	Balance at the end of the period	$	—	$	1,224	$	—	$	1,224	Balance at the end of the period	$	0	$	841	$	0	$	841

At ~~June~~September 30, 2020, there were 0 consumer mortgage loans secured by residential real estate properties (included in the one-to-four family residential loans in Note (3) Loans Receivable) for which formal foreclosure proceedings were in process.

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(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 Company on May 1, 2014; Valley Community Bancshares on July 15, 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 ~~six~~nine months ended ~~June~~September 30, 2020 and 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

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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. WeManagement 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, wemanagement determined that the fair value of the reporting unit more likely than not exceeded the carrying value.

At September 30, 2020, the Company completed its qualitative 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 future impairment charges which could have a material adverse impact on the Company’s operating results.

(b) Other Intangible Assets

Other intangible assets represent ~~CDI~~core deposit intangibles acquired in business combinations. The useful life of the ~~CDI~~core deposit intangible was estimated to be ten years for the acquisitions of Premier Commercial Bancorp, Puget Sound Bancorp, Washington Banking Company, and Valley Community Bancshares.

The following table presents the change in other intangible assets for the periods indicated:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended September 30,				Nine Months Ended September 30,
		2020		2019		2020		2019			2020		2019		2020		2019
		(In thousands)															(In thousands)
Balance at the beginning of the period	Balance at the beginning of the period	$	15,710	$	19,589	$	16,613	$	20,614	Balance at the beginning of the period	$	14,807	$	18,563	$	16,613	$	20,614

Amortization	Amortization	(903)		(1,026)		(1,806)		(2,051)		Amortization	(860)		(975)		(2,666)		(3,026)
Balance at the end of the period	Balance at the end of the period	$	14,807	$	18,563	$	14,807	$	18,563	Balance at the end of the period	$	13,947	$	17,588	$	13,947	$	17,588

(7)Junior Subordinated Debentures

As part of the acquisition of Washington Banking Company on May 1, 2014, the Company assumed trust preferred securities and junior subordinated debentures with a total fair value of $18.9 million at the merger date. At ~~June~~September 30, 2020 and December 31, 2019, the balance of the junior subordinated debentures, net of unaccreted discount, was ~~$20.7~~$20.8 million and $20.6 million, respectively.

The adjustable rate of the trust preferred securities at ~~June~~September 30, 2020 was ~~1.86%~~1.79%. The following table presents the weighted average rate of the junior subordinated debentures for the periods indicated:

Three Months Ended
June 30, Six Months Ended
June 30,
2020 2019 2020 2019
Weighted average rate ⁽¹⁾
4.24 % 6.68 % 4.90 % 6.87 %


	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.

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(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:

June 30,
2020 December 31,
2019
(In thousands)
Mortgage-backed securities and collateralized mortgage obligations:
Residential $ 862 $ 8,452
Commercial 23,582 11,717
Securities sold under agreement to repurchase $ 24,444 $ 20,169


	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. At ~~June~~September 30, 2020, the Bank maintained a credit facility with the FHLB with available borrowing capacity of ~~$942.8~~$891.7 million. At ~~June~~September 30, 2020 and December 31, 2019, the Bank had 0 FHLB advances outstanding.

The following table sets forth the details of FHLB advances during the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Three Months Ended June 30,									Six Months Ended June 30,										Three Months Ended September 30,						Nine Months Ended September 30,
		2020			2019			2020			2019				2020			2019			2020			2019
		(In thousands)																						(In thousands)
Average balance during the period	Average balance during the period	$	4,909		$	42,101		$	2,949		$	22,086		Average balance during the period	$	0		$	3,755		$	1,959		$	15,909
Maximum month-end balance during the period	Maximum month-end balance during the period	$	—		$	90,700		$	—		$	90,700		Maximum month-end balance during the period	$	0		$	0		$	0		$	90,700
Weighted average rate during the period	Weighted average rate during the period	0.57		%	2.65		%	0.55		%	2.68		%	Weighted average rate during the period	0		%	1.16		%	0.55		%	2.56		%

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, 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, Pacific Coast Bankers’ Bank and JP Morgan Chase to purchase federal funds of up to $215.0 million as of ~~June~~September 30, 2020. The lines generally mature annually or are reviewed annually. As of ~~June~~September 30, 2020 and December 31, 2019, there were 0 federal funds purchased.

The Bank maintains a credit facility with the Federal Reserve Bank with available borrowing capacity of ~~$60.3~~$55.0 million as of ~~June~~September 30, 2020. There were 0 borrowings outstanding as of ~~June~~September 30, 2020 and December 31, 2019. Any advances on the credit facility would have to be first secured by the Bank's investment securities or loans receivable.

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(d) PPPLF Facility

The Federal Reserve established the PPPLF under Section 13(3) of the Federal Reserve Act to bolster the effectiveness of the ~~SBA PPP, which provides relief to American workers and businesses from the impacts of COVID-19.~~SBA's PPP. Under the PPPLF, the Bank may pledge its PPP loans as collateral at face value to obtain Federal Reserve ~~will supply liquidity to participating financial institutions through term financing backed by PPP~~Bank non-recourse loans. PPPLF advances may be obtained until December 31, 2020. As of ~~June~~September 30, 2020, although the Bank was approved to utilize the PPPLF, the Bank had 0t participated in ~~the PPPLF program.~~it.

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(10)Derivative Financial Instruments

The Company has entered into certain interest rate swap contracts that are not designated as hedging instruments. The following table presents the notional amounts and estimated fair values of interest rate derivative contracts outstanding at ~~June~~September 30, 2020 and December 31, 2019:


		June 30, 2020						December 31, 2019							September 30, 2020				December 31, 2019
		Notional Amounts		Estimated Fair Value		Notional Amounts		Estimated Fair Value			Notional Amounts		Estimated Fair Value		Notional Amounts		Estimated Fair Value
		(In thousands)															(In thousands)
Non-hedging interest rate derivatives	Non-hedging interest rate derivatives									Non-hedging interest rate derivatives
Interest rate swap asset ⁽¹⁾	Interest rate swap asset ⁽¹⁾	$	271,348	$	31,618	$	221,436	$	8,318	Interest rate swap asset (1)	$	296,709	$	30,024	$	221,436	$	8,318
Interest rate swap liability ⁽¹⁾	Interest rate swap liability ⁽¹⁾	271,348		(31,618)		221,436		(8,318)		Interest rate swap liability (1)	296,709		(30,460)		221,436		(8,318)

⁽¹⁾The estimated fair value of derivatives with customers was ~~$31.6~~$30.0 million and $8.1 million as of ~~June~~September 30, 2020 and December 31, 2019, respectively. The estimated fair value of derivatives with third parties was ~~$(31.6)~~$(30.5) million and $(8.1) million as of ~~June~~September 30, 2020 and December 31, 2019, respectively.

The gains and losses due to changes in fair values on the Company's interest rate derivatives, including credit valuation adjustments to appropriately reflect nonperformance risk in the fair value measurement, are included in Other income on the Condensed Consolidated Statements of Income. Generally, the gains and losses of the interest rate derivatives offset due to the back-to-back nature of the contracts. However, as of September 30, 2020, 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, 2019. Various factors impact changes in the credit valuation adjustments over time, including changes in the risk ratings of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments.

(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 ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended September 30,				Nine Months Ended September 30,
		2020		2019		2020		2019			2020		2019		2020		2019
		(In thousands)															(In thousands, except shares)
Net (loss) income:
Net (loss) income		$	(6,139)	$	15,984	$	6,052	$	32,536
Net income:										Net income:
Net income										Net income	$	16,636	$	17,895	$	22,688	$	50,431
Dividends and undistributed earnings allocated to participating securities ⁽¹⁾	Dividends and undistributed earnings allocated to participating securities ⁽¹⁾	—		(11)		(3)		(38)		Dividends and undistributed earnings allocated to participating securities (1)	0		(10)		(5)		(48)
Net (loss) income allocated to common shareholders		$	(6,139)	$	15,973	$	6,049	$	32,498
Net income allocated to common shareholders										Net income allocated to common shareholders	$	16,636	$	17,885	$	22,683	$	50,383
Basic:	Basic:									Basic:
Weighted average common shares outstanding	Weighted average common shares outstanding	35,899,361		36,895,625		36,128,586		36,888,601		Weighted average common shares outstanding	35,909,148		36,764,810		36,054,906		36,846,884
Restricted stock awards	Restricted stock awards	(645)		(25,466)		(8,183)		(40,632)		Restricted stock awards	(303)		(21,948)		(5,537)		(34,336)
Total basic weighted average common shares outstanding	Total basic weighted average common shares outstanding	35,898,716		36,870,159		36,120,403		36,847,969		Total basic weighted average common shares outstanding	35,908,845		36,742,862		36,049,369		36,812,548
Diluted:	Diluted:									Diluted:
Basic weighted average common shares outstanding	Basic weighted average common shares outstanding	35,898,716		36,870,159		36,120,403		36,847,969		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⁾	Effect of potentially dilutive common shares ⁽²⁾	—		144,714		154,988		163,767		Effect of potentially dilutive common shares (2)	79,889		133,686		144,246		160,476
Total diluted weighted average common shares outstanding	Total diluted weighted average common shares outstanding	35,898,716		37,014,873		36,275,391		37,011,736		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.

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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 ~~six~~nine months

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ended ~~June~~September 30, 2020, there were ~~258,412~~222,818 and ~~124,904~~140,217 anti-dilutive shares outstanding, respectively. For the three and ~~six~~nine months ended ~~June~~September 30, 2019, there were ~~89,507~~108,501 and ~~61,333~~70,372 anti-dilutive shares outstanding, 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 ~~six~~nine months ended ~~June~~September 30, 2020 and calendar year 2019:

Declared

Cash Dividend per Share

Record Date

Paid Date

January 23, 2019

$0.18

February 7, 2019

February 21, 2019

April 24, 2019

$0.18

May 8, 2019

May 22, 2019

July 24, 2019

$0.19

August 8, 2019

August 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 22, 2020

$0.20

August 5, 2020

August 19, 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 Federal Reserve provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the FDIC.

The Company has had various stock repurchase programs since March 1999. On October 23, 2014. the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,000 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.

NoNaN shares were repurchased under the Company's stock repurchase plans during the three months ended ~~June~~September 30, 2020 as the Company has suspended repurchases in response to the COVID-19 pandemic.

During the ~~six~~nine months ended ~~June~~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 price of $20.34 under the twelfth 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 three and ~~six~~nine months ended ~~June~~September 30, 2019, the Company repurchased ~~28,000~~264,712 and 292,712 shares, ~~available~~respectively, under the eleventh stock repurchase plan at a weighted average price per share of ~~$29.12.~~$26.23 and $26.50, respectively.

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In addition to the stock repurchases under a stock repurchase plan, the Company repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units. The following table provides total shares repurchased to pay withholding taxes during the periods indicated:

Three Months Ended
June 30, Six Months Ended
June 30,
2020 2019 2020 2019
Repurchased shares to pay withholding taxes 2,046 2,175 27,928 28,029
Stock repurchase to pay withholding taxes average share price $ 18.62 $ 29.31 $ 21.56 $ 30.88

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~~(12)Accumulated Other Comprehensive Income~~

~~The changes in AOCI, all of which are due to changes in the fair value of available for sale securities and are net of tax, during the three and six months ended June 30, 2020 and 2019 are as follows:~~

Three Months Ended
June 30, Six Months Ended
June 30,
2020 2019 2020 2019
(In thousands)
Balance of AOCI at the beginning of period $ 18,292 $ 561 $ 10,378 $ (7,455)
Other comprehensive income before reclassification 8,009 9,219 16,716 17,247
Amounts reclassified from AOCI for gain on sale of investment securities included in net (loss) income (320) (26) (1,113) (38)
Net current period other comprehensive income 7,689 9,193 15,603 17,209
Balance of AOCI at the end of period $ 25,981 $ 9,754 $ 25,981 $ 9,754


	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

~~(13)~~(12)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.

Collateral-Dependent Loans:

Collateral-dependent loans are identified as part of the calculation of the ACL on loans. The fair value used to measure credit loss for this type of loan is commonly based on recent real estate appraisals which are generally obtained at least every 18 months or earlier if there are changes to risk characteristics of the underlying loan. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. 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

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the valuation and management’s expertise and knowledge of the ~~client~~customer and ~~client’s~~customer’s business (Level 3). Individually evaluated loans are evaluated for credit loss on a quarterly basis and ~~their~~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

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value less costs to sell. Fair value is commonly based on recent real estate 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 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 ~~June~~September 30, 2020 and December 31, 2019:


		June 30, 2020															September 30, 2020
		Total		Level 1		Level 2		Level 3			Total		Level 1		Level 2		Level 3
		(In thousands)															(In thousands)
Assets	Assets									Assets
Investment securities available for sale:	Investment securities available for sale:									Investment securities available for sale:
U.S. Treasury and U.S. Government-sponsored agencies		$	52,051	$	—	$	52,051	$	—
U.S. government and agency securities										U.S. government and agency securities	$	51,893	$	0	$	51,893	$	0
Municipal securities	Municipal securities	193,931		—		193,931		—		Municipal securities	205,310		0		205,310		0
Mortgage-backed securities and collateralized mortgage obligations:
Residential		268,984		—		268,984		—
Commercial		318,341		—		318,341		—

Residential CMO and MBS										Residential CMO and MBS	222,581		0		222,581		0
Commercial CMO and MBS										Commercial CMO and MBS	304,682		0		304,682		0

Corporate obligations	Corporate obligations	24,249		—		24,249		—		Corporate obligations	20,171		0		20,171		0
Other asset-backed securities	Other asset-backed securities	22,371		—		22,371		—		Other asset-backed securities	29,855		0		29,855		0
Total investment securities available for sale	Total investment securities available for sale	879,927		—		879,927		—		Total investment securities available for sale	834,492		0		834,492		0
Equity security	Equity security	112		112		—		—		Equity security	111		111		0		0
Derivative assets - interest rate swaps	Derivative assets - interest rate swaps	31,618		—		31,618		—		Derivative assets - interest rate swaps	30,024		0		30,024		0
Liabilities	Liabilities									Liabilities
Derivative liabilities - interest rate swaps	Derivative liabilities - interest rate swaps	$	31,618	$	—	$	31,618	$	—	Derivative liabilities - interest rate swaps	$	30,460	$	0	$	30,460	$	0

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		December 31, 2019															December 31, 2019
		Total		Level 1		Level 2		Level 3			Total		Level 1		Level 2		Level 3
		(In thousands)															(In thousands)
Assets	Assets									Assets
Investment securities available for sale:	Investment securities available for sale:									Investment securities available for sale:
U.S. Treasury and U.S. Government-sponsored agencies		$	105,223	$	—	$	105,223	$	—
U.S. government and agency securities										U.S. government and agency securities	$	105,223	$	0	$	105,223	$	0
Municipal securities	Municipal securities	133,014		—		133,014		—		Municipal securities	133,014		0		133,014		0
Mortgage-backed securities and collateralized mortgage obligations:
Residential		339,608		—		339,608		—
Commercial		327,095		—		327,095		—

Residential CMO and MBS										Residential CMO and MBS	339,608		0		339,608		0
Commercial CMO and MBS										Commercial CMO and MBS	327,095		0		327,095		0

Corporate obligations	Corporate obligations	24,194		—		24,194		—		Corporate obligations	24,194		0		24,194		0
Other asset-backed securities	Other asset-backed securities	23,178		—		23,178		—		Other asset-backed securities	23,178		0		23,178		0
Total investment securities available for sale	Total investment securities available for sale	952,312		—		952,312		—		Total investment securities available for sale	952,312		0		952,312		0
Equity Security	Equity Security	148		148		—		—		Equity Security	148		148		0		0
Derivative assets - interest rate swaps	Derivative assets - interest rate swaps	8,318		—		8,318		—		Derivative assets - interest rate swaps	8,318		0		8,318		0
Liabilities	Liabilities									Liabilities
Derivative liabilities - interest rate swaps	Derivative liabilities - interest rate swaps	$	8,318	$	—	$	8,318	$	—	Derivative liabilities - interest rate swaps	$	8,318	$	0	$	8,318	$	0

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 ~~June~~September 30, 2020 and December 31, 2019 and the net losses recorded in earnings during the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Basis⁽¹⁾		Fair Value at June 30, 2020																					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
						Total		Level 1		Level 2		Level 3		Net Gains Recorded in Earnings During the Three Months Ended June 30, 2020				Net Gains Recorded in Earnings During the Six Months Ended June 30, 2020	Basis(1)		Total		Level 1		Level 2		Level 3		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
		(In thousands)																														(In thousands)
Collateral-dependent loans:	Collateral-dependent loans:															Collateral-dependent loans:
Commercial business:	Commercial business:															Commercial business:
Commercial and industrial	Commercial and industrial	$	293	$	270	$	—	$	—	$	270	$	9	$	3	Commercial and industrial	$	42	$	27	$	0	$	0	$	27	$	0	$	10

Total assets measured at fair value on a nonrecurring basis	Total assets measured at fair value on a nonrecurring basis	$	293	$	270	$	—	$	—	$	270	$	9	$	3	Total assets measured at fair value on a nonrecurring basis	$	42	$	27	$	0	$	0	$	27	$	0	$	10

⁽¹⁾Basis represents the ~~unpaid~~outstanding principal balance of impaired loans. ~~Excludes loans whose fair value was determined to be $0.~~

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		Basis⁽¹⁾		Fair Value at December 31, 2019																					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
						Total		Level 1		Level 2		Level 3		Net Gains Recorded in Earnings During the Three Months EndedJune 30, 2019				Net Gains Recorded in Earnings During the Six Months EndedJune 30, 2019	Basis(1)		Total		Level 1		Level 2		Level 3		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
		(In thousands)																														(In thousands)
Impaired loans:	Impaired loans:															Impaired loans:
Commercial business:	Commercial business:															Commercial business:
Commercial and industrial	Commercial and industrial	$	4,111	$	3,380	$	—	$	—	$	3,380	$	1	$	1	Commercial and industrial	$	4,111	$	3,380	$	0	$	0	$	3,380	$	249	$	249

Total assets measured at fair value on a nonrecurring basis	Total assets measured at fair value on a nonrecurring basis	$	4,111	$	3,380	$	—	$	—	$	3,380	$	1	$	1	Total assets measured at fair value on a nonrecurring basis	$	4,111	$	3,380	$	0	$	0	$	3,380	$	249	$	249

⁽¹⁾Basis represents the ~~unpaid~~outstanding principal balance of impaired loans.

The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at ~~June~~September 30, 2020 and December 31, 2019:

~~June~~September 30, 2020

Fair
Value

Valuation
Technique(s)

Unobservable Input(s)

Range of Inputs; Weighted
Average

(Dollars in thousands)

Collateral-dependent loans

~~270~~27

Market approach

Adjustment for differences between the comparable sales

N/A⁽¹⁾

⁽¹⁾Quantitative disclosures are not provided for collateral-dependent loans because there were no adjustments made to the appraisal or stated values during the current period.

December 31, 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%

(b) Fair Value of Financial Instruments

~~Because broadly~~Broadly traded markets do not exist for most of the Company’s financial instruments therefore the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

~~Table~~ ~~of Contents~~

The following tables present the carrying value amount of the Company’s financial instruments and their

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corresponding estimated fair values at ~~June~~September 30, 2020 and December 31, 2019:


		June 30, 2020																										September 30, 2020
		Carrying Value		Fair Value		Fair Value Measurements Using:														Carrying Value				Fair Value				Fair Value Measurements Using:
										Level 1			Level 2			Level 3			Carrying Value							Level 1				Level 2		Level 3
		(In thousands)																								(In thousands)
Financial Assets:	Financial Assets:												Financial Assets:
Cash and cash equivalents	Cash and cash equivalents	$	415,075	$	415,075	$	415,075	$	—		$	—	Cash and cash equivalents	$	576,242		$	576,242				$	576,242			$	0			$	0
Investment securities available for sale	Investment securities available for sale	879,927		879,927		—		879,927			—		Investment securities available for sale	834,492			834,492			0				834,492				0
Loans held for sale	Loans held for sale	3,783		3,908		—		—			3,908		Loans held for sale	8,250			8,562			0				0				8,562
Loans receivable, net	Loans receivable, net	4,594,832		4,762,913		—		—			4,762,913		Loans receivable, net	4,593,390			4,752,565			0				0				4,752,565
Accrued interest receivable	Accrued interest receivable	17,813		17,813		10		3,887			13,916		Accrued interest receivable	18,888			18,888			9				3,316				15,563
Derivative assets - interest rate swaps	Derivative assets - interest rate swaps	31,618		31,618		—		31,618			—		Derivative assets - interest rate swaps	30,024			30,024			0				30,024				0
Equity security	Equity security	112		112		112		—			—		Equity security	111			111			111				0				0
Financial Liabilities:	Financial Liabilities:												Financial Liabilities:
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	$	5,077,086	$	5,077,086	$	5,077,086	$	—		$	—	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	Certificate of deposit accounts	490,647		494,093		—		494,093			—		Certificate of deposit accounts	444,040			447,017			0				447,017				0

Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	24,444		24,444		24,444		—			—		Securities sold under agreement to repurchase	29,043			29,043			29,043				0				0
Junior subordinated debentures	Junior subordinated debentures	20,741		18,000		—		—			18,000		Junior subordinated debentures	20,814			18,500			0				0				18,500
Accrued interest payable	Accrued interest payable	124		124		52		51			21		Accrued interest payable	109			109			44				45				20
Derivative liabilities - interest rate swaps	Derivative liabilities - interest rate swaps	31,618		31,618		—		31,618			—		Derivative liabilities - interest rate swaps	30,460			30,460			0				30,460				0


		December 31, 2019																										December 31, 2019
		Carrying Value		Fair Value		Fair Value Measurements Using:														Carrying Value				Fair Value				Fair Value Measurements Using:
										Level 1			Level 2			Level 3			Carrying Value							Level 1				Level 2		Level 3
		(In thousands)																								(In thousands)
Financial Assets:	Financial Assets:												Financial Assets:
Cash and cash equivalents	Cash and cash equivalents	$	228,568	$	228,568	$	228,568	$	—		$	—	Cash and cash equivalents	$	228,568		$	228,568				$	228,568			$	0			$	0
Investment securities available for sale	Investment securities available for sale	952,312		952,312		—		952,312			—		Investment securities available for sale	952,312			952,312			0				952,312				0
Loans held for sale	Loans held for sale	5,533		5,704		—		—			5,704		Loans held for sale	5,533			5,704			0				0				5,704
Loans receivable, net	Loans receivable, net	3,731,708		3,791,557		—		—			3,791,557		Loans receivable, net	3,731,708			3,791,557			0				0				3,791,557
Accrued interest receivable	Accrued interest receivable	14,446		14,446		79		3,668			10,699		Accrued interest receivable	14,446			14,446			79				3,668				10,699
Derivative assets - interest rate swaps	Derivative assets - interest rate swaps	8,318		8,318		—		8,318			—		Derivative assets - interest rate swaps	8,318			8,318			0				8,318				0
Equity security	Equity security	148		148		148		—			—		Equity security	148			148			148				0				0

Financial Liabilities:	Financial Liabilities:												Financial Liabilities:
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	$	4,058,098	$	4,058,098	$	4,058,098	$	—		$	—	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	Certificate of deposit accounts	524,578		529,679		—		529,679			—		Certificate of deposit accounts	524,578			529,679			0				529,679				0

Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	20,169		20,169		20,169		—			—		Securities sold under agreement to repurchase	20,169			20,169			20,169				0				0
Junior subordinated debentures	Junior subordinated debentures	20,595		20,000		—		—			20,000		Junior subordinated debentures	20,595			20,000			0				0				20,000
Accrued interest payable	Accrued interest payable	199		199		95		64			40		Accrued interest payable	199			199			95				64				40
Derivative liabilities - interest rate swaps	Derivative liabilities - interest rate swaps	8,318		8,318		—		8,318			—		Derivative liabilities - interest rate swaps	8,318			8,318			0				8,318				0

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~~(14)~~(13)Cash Requirement

The Company is required to maintain an average reserve balance with the Federal Reserve Bank or maintain such reserve balance in the form 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 ~~June~~September 30, 2020 and 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.

~~(15)~~(14)Commitments and Contingencies

In the ordinary course of business, the Company may enter into various types of transactions that include commitments to extend credit that are not included in its Condensed Consolidated Financial Statements. The ~~Company~~Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The majority of the commitments presented below are variable rate. Loan commitments can be either revolving or nonrevolving. The ~~Company’s~~Bank’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.

The following table presents outstanding commitments to extend credit, including letters of credit, at the dates indicated:


	September 30, 2020		December 31, 2019
	(In thousands)
Commercial business:
Commercial and industrial	$	637,407	$	584,287
Owner-occupied CRE	6,089		17,193
Non-owner occupied CRE	24,863		35,573
Total commercial business	668,359		637,053

Real estate construction and land development:
One-to-four family residential	62,300		75,066
Five or more family residential and commercial properties	156,629		230,343
Total real estate construction and land development	218,929		305,409
Consumer	255,011		269,898
Total outstanding commitments	$	1,142,299	$	1,212,360

Upon CECL adoption, as described in Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements, the Company recorded an increase in the beginning ACL on unfunded commitments of $3.7 million, representing the change in methodology from an estimate of incurred losses at the balance sheet date, with an estimated probability of funding, to an estimate of losses on future utilization over the entire contractual period.

The following table ~~presents outstanding commitments to extend credit, including letters of credit, at the dates indicated:~~

June 30, 2020 December 31, 2019
(In thousands)
Commercial business:
Commercial and industrial $ 644,184 $ 584,287
Owner-occupied CRE 9,611 17,193
Non-owner occupied CRE 22,296 35,573
Total commercial business 676,091 637,053
Real estate construction and land development:
One-to-four family residential 63,144 75,066
Five or more family residential and commercial properties 193,650 230,343
Total real estate construction and land development 256,794 305,409
Consumer 255,477 269,898
Total outstanding commitments $ 1,188,362 $ 1,212,360

~~The following table~~ details the activity in the ACL on unfunded commitments during the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Three Months Ended						Six Months Ended							Three Months Ended				Nine months ended
		June 30, 2020		June 30, 2019		June 30, 2020		June 30, 2019			September 30, 2020		September 30, 2019		September 30, 2020		September 30, 2019
		(In thousands)															(In thousands)
Balance, beginning of period	Balance, beginning of period	$	1,990	$	306	$	306	$	306	Balance, beginning of period	$	4,612	$	306	$	306	$	306
Impact of CECL Adoption	Impact of CECL Adoption	—		—		3,702		—		Impact of CECL Adoption	0		0		3,702		0
Adjusted balance, beginning of period	Adjusted balance, beginning of period	1,990		306		4,008		306		Adjusted balance, beginning of period	4,612		306		4,008		306
Provision for credit losses on unfunded commitments	Provision for credit losses on unfunded commitments	2,622		—		604		—		Provision for credit losses on unfunded commitments	410		0		1,014		0
Balance, end of period	Balance, end of period	$	4,612	$	306	$	4,612	$	306	Balance, end of period	$	5,022	$	306	$	5,022	$	306

~~(16)~~(15)Income Taxes

The Company files a consolidated income tax return using the accrual method of accounting. The effective tax rate was ~~13.2%~~8.8% for the ~~three~~nine months ended ~~June~~September 30, 2020 compared to an effective tax rate of ~~16.7%~~16.6% for ~~the three months ended June 30, 2019. The effective tax rate was 5.1% for the six months ended~~

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~~June 30, 2020 compared to an effective tax rate of 16.5% for~~ the ~~six~~nine months ended ~~June~~September 30, ~~2019. The decrease in the effective tax rate for both periods was~~2019 due primarily ~~due a provision in the CARES Act, which permitted the Company~~ to ~~recognize~~ a benefit from net operating losses related to prior acquisitions of $1.0 million ~~during the three months ended March 31, 2020 and secondarily due to~~from a ~~decrease~~provision in the ~~pre-tax income during the three and six months ended June 30, 2020, also reflective of increasing tax-exempt investments.~~CARES Act.

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 ~~six~~nine months ended ~~June~~September 30, 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, 2019 audited Consolidated Financial Statements and the accompanying Notes included in our 2019 Annual Form 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 ~~June~~September 30, 2020, we had total assets of ~~$6.56~~$6.69 billion, total liabilities of ~~$5.77~~$5.88 billion and total stockholders’ equity of ~~$793.7~~$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 ~~June 30,~~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 credit losses on loans. The provision for credit 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 ACL on loans was impacted during the ~~six~~nine months ended ~~June~~September 30, 2020 due to the CECL Adoption, which estimates losses over the life of the loans as compared to ~~the~~ prior ~~model of~~GAAP which required estimating incurred ~~loss~~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 is appropriate to provide for current expected credit losses in our loan 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 and other income. Noninterest expense consists primarily of compensation and employee benefits, occupancy and equipment, data processing and 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 consists 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

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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.

~~Table~~ ~~of Contents~~

Results of operations may also be affected significantly by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities. ~~Other~~Net income ~~and other expenses are~~is 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.~~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.

~~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.~~

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

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will be billed for the deferred months of accrued interest and the Bank will work with those borrowers unable to pay

~~Table~~ ~~of Contents~~

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.

~~Based on the depth and breadth of the COVID-19 pandemic, the Bank~~ The risk rating will ~~extend similar relief options~~be reviewed for a ~~subsequent or second~~more severe classification for any secondary modification ~~to certain consumer borrowers. The Bank has a preference for offering interest only payments on these secondary modifications.~~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~~COVID-19 Modifications:

During the ~~six~~nine months ended ~~June~~September 30, 2020 and as a direct result of ~~cited~~ COVID-19 related issues cited by the borrower and the Bank's lending assistance programs described above, the Bank made ~~initial~~ 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 ~~initial~~ modifications by each loan class that were made during the nine months ended September 30, 2020, with amortized costs presented as of ~~June 30, 2020.~~March 31, 2020, before the onset of the COVID-19 pandemic:


		Interest Only					Payment Deferral				Other							Total				Interest Only			Payment Deferral			Other	Total
		Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count		Amortized Cost		Count		Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count
		(Dollars in thousands)																									(Dollars in thousands)
Commercial business:	Commercial business:													Commercial business:
Commercial and industrial	Commercial and industrial	$	66,392	271	$	47,000	238	$	15,969	39	$	129,361	548	Commercial and industrial	$	74,561	284		$	41,301	239	$	21,939	48	$	137,801	571

Owner-occupied CRE	Owner-occupied CRE	110,047		80	68,056		84	474		2	178,577		166	Owner-occupied CRE	116,064		90		82,125		91	1,304		2	199,493		183
Non-owner occupied CRE	Non-owner occupied CRE	120,331		71	75,949		45	23,103		9	219,383		125	Non-owner occupied CRE	130,948		80		75,252		44	22,715		8	228,915		132
Total commercial business	Total commercial business	296,770��		422	191,005		367	39,546		50	527,321		839	Total commercial business	321,573		454		198,678		374	45,958		58	566,209		886
One-to-four family residential	One-to-four family residential	—		—	9,704		25	770		2	10,474		27	One-to-four family residential	1,704		2		14,905		30	613		3	17,222		35
Real estate construction and land development:	Real estate construction and land development:													Real estate construction and land development:
One-to-four family residential	One-to-four family residential	1,317		2	4,399		2	1,096		3	6,812		7	One-to-four family residential	733		1		—		—	6,173		23	6,906		24
Five or more family residential and commercial properties	Five or more family residential and commercial properties	11,381		9	4,876		9	6,340		4	22,597		22	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	Total real estate construction and land development	12,698		11	9,275		11	7,436		7	29,409		29	Total real estate construction and land development	11,123		11		1,632		6	14,433		31	27,188		48
Consumer	Consumer	—		—	24,254		926	—		—	24,254		926	Consumer	606		25		25,596		977	55		1	26,257		1,003
Total	Total	$	309,468	433	$	234,238	1,329	$	47,752	59	$	591,458	1,821	Total	$	335,006	492		$	240,811	1,387	$	61,059	93	$	636,876	1,972

~~These modifications were not classified as TDRs at June 30, 2020 in accordance with the guidance of the CARES Act.~~

Of the ~~initial~~ modifications presented in the table above ~~124~~that also had loan balances at September 30, 2020, the risk classification of 206 loans totaling ~~$122.3~~$197.5 million were downgraded ~~in conjunction with or shortly after~~during the ~~initial modification.~~nine months ended September 30, 2020. The majority of the downgrades ~~by count and amount~~ were to a "Watch" grade and were therefore not classified as potential problem loans.

~~During~~The following table details the ~~six months ended June~~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, ~~the Bank made secondary modifications to 24 loans totaling $27.7 million as of June~~with balances and count at September 30, ~~2020, of which $26.1 million was for commercial business loans.~~

2020:

5048

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~~COVID~~


	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:

~~In addition to modifications and related downgrades described above in the COVID Modifications section, the~~The Bank downgraded 74 loans ~~totaling $50.5 million without a related modification during the six months ended June 30, 2020. These downgrades were also~~due to heightened risk as a direct result of ~~cited~~ COVID-19 related ~~issues. In total, 197 loans totaling $172.5 million were downgraded~~issues cited by the borrower. All COVID-19 downgrades, including those with and without a modification, as of ~~June~~September 30, ~~2020. Of these downgrades, 185 loans totaling $154.6 million~~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 ~~a "Watch" grade. The remaining loans were risk rated "Special Mention"~~Special Mention or worse ~~and were~~are classified as potential problem ~~loans.~~loans, except for loans totaling $17.2 million at September 30, 2020 that were classified as nonaccrual.

SBA Paycheck Protection Program

~~During the quarter ended June 30,~~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 ~~during the quarter ended June 30, 2020~~ 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 on April 6, 2020.~~program. The

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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.

~~As of June 30,~~The SBA's PPP program ended on August 8, 2020 and the Bank ~~has~~ funded ~~4,498~~4,642 loans totaling ~~$883.9 million.~~$897.4 million during the program's existence. The average loan balance for funded loans was ~~$197,000.~~$193,000. Of the funded loans, approximately ~~20%~~21% of both the number of loans funded and amount originated were to ~~new customers.~~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 ~~$25.3~~$22.0 million at ~~June~~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 PPP, which provides relief to American workers and businesses from the impacts of COVID-19.~~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 ~~supply liquidity~~be the maturity date of the PPP loan pledged to ~~participating financial institutions through term financing backed~~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 ~~loans. As~~loan securing the PPPLF advance; or (ii) the date of ~~June 30, 2020,~~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.~~ PPPLF, the Bank has chosen not to participate during the nine months ended September 30, 2020.

The Bank ~~may utilize~~will begin processing loan forgiveness applications, as allowed under the ~~Federal Reserve Bank's PPPLF pursuant to which~~SBA's PPP during the Bank will pledge PPP loans as collateral to obtain Federal Reserve Bank non-recourse loans to support the origination of these loans. The PPPLF will take the PPP loans as collateral at face value and the transfer will have a pass through effect on our liquidity position. During the six monthsquarter ended ~~and as of June 30, 2020, the Bank did not utilize the PPPLF as it had sufficient other sources of funds.~~December 31, 2020.

SBA Relief

Heritage is an active SBA lender in the Pacific Northwest and had SBA loans totaling ~~$63.0~~$64.8 million and $64.1 million at ~~June~~September 30, 2020 and December 31, 2019, respectively. During the ~~six~~nine months ended ~~June~~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

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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.

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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 ~~June~~September 30, 2020 to the comparable quarter in the prior year.

Net ~~loss~~income was ~~$6.1~~$16.6 million, or ~~$(0.17) per common share, for the three months ended June 30, 2020 compared to net income of $16.0 million, or $0.43~~$0.46 per diluted common share, for the three months ended ~~June~~September 30, 2020 compared to net income of $17.9 million, or $0.48 per diluted common share, for the three months ended September 30, 2019. Net income decreased ~~$22.1~~$1.3 million, or ~~138.4%~~7.0%, for the three months ended ~~June~~September 30, 2020 compared to the same period in 2019 primarily due to ~~provision~~increases in the ACL for ~~credit losses on~~nonperforming loans ~~of $25.9 million as a result of~~caused by the ~~worsening impact of~~ COVID-19 ~~on the economy.~~pandemic. The provision for loan losses ~~of $1.4 million~~ during the ~~three months ended June 30,~~same period in 2019 was estimated under the incurred loss methodology.

Net interest income as a percentage of average interest earning assets, or net interest margin, decreased 6983 basis points to ~~3.64%~~3.38% for the three months ended ~~June~~September 30, 2020 compared to ~~4.33%~~4.21% for the same period in 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 ~~origination~~addition of low-yielding SBA PPP loans, combined with ~~an average balance of $667.4 million earning a yield of 2.97%,~~ ~~and~~the decreases in yields ~~of interest earning assets as a result of~~on adjustable instruments following decreases in short-term market rates. The decrease in net interest ~~rates~~,margin was offset partially by decreases in the cost of interest bearing liabilities ~~during~~following the ~~period.~~decreases in the market rates.

The efficiency ratio consists of noninterest expense divided by the sum of net interest income before provision for credit losses plus noninterest income. The Company’s efficiency ratio was ~~63.31%~~62.27% for the three months ended ~~June~~September 30, 2020 compared to ~~64.62%~~62.55% for the three months ended ~~June~~September 30, 2019. The change in the efficiency ratio was attributable primarily to ~~the decrease in noninterest expense being slightly greater than the net of the increase in noninterest income and~~ the decrease in net interest income.

Comparison of ~~six~~nine months ended ~~June~~September 30, 2020 to the comparable period in the prior year.

Net income was ~~$6.1~~$22.7 million, or ~~$0.17~~$0.63 per diluted common share, for the ~~six~~nine months ended ~~June~~September 30, 2020 compared ~~to $32.5~~to $50.4 million, or ~~$0.88~~$1.36 per diluted common share, for the ~~six~~nine months ended ~~June~~September 30, 2019. Net income decreased ~~$26.5~~$27.7 million, or ~~81.4%~~55.0%, for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to the same period in 2019 primarily due to an increase in the provision for credit losses on loans ~~of $35.9~~to $38.2 million compared to a provision for loan losses of ~~$2.3~~$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 ~~$6.7~~$7.9 million due to lower pre-tax income ~~and~~as well as a provision in the CARES Act permitting the recognition of a benefit from net operating losses related to prior ~~acquisitions;~~acquisitions and an increase in noninterest income of ~~$2.7~~$2.5 million, or ~~18.3%~~10.6%, due primarily to increased gain on sale of ~~loans and gain on sale of investment securities.~~loans.

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The net interest margin decreased 5062 basis points to ~~3.84%~~3.67% for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~4.34%~~4.29% for the same period in 2019. The decrease in net interest 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 ~~$333.7~~$511.5 million earning a yield of ~~2.97%~~2.80%, and decreases in yields of interest earning assets as a result of decreases in short-term market interest rates,, offset partially by decreases in the cost of interest bearing liabilities during the period.

The Company’s efficiency ratio was ~~63.75%~~63.26% for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~64.23%~~63.67% for the ~~six~~nine months ended ~~June~~September 30, 2019. The change in the efficiency ratio was attributable primarily ~~attributable~~ to anthe increase in noninterest ~~income, offset partially by the decrease in the net interest~~ income.

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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, other noninterest bearing liabilities and stockholders' equity; 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 ~~the three months ended~~ March ~~31,~~ 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 ~~15,~~16, 2020	0.00 - 0.25%	-1.00%

Comparison of quarter ended ~~June~~September 30, 2020 to the comparable quarter in the prior year.

Net interest income decreased ~~$223,000,~~$565,000, or ~~0.4%~~1.1%, to ~~$50.3~~$49.7 million for the three months ended ~~June~~September 30, 2020 compared to ~~$50.5~~$50.2 million for the same period in 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

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	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)

~~Three Months Ended June 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)}

~~4,442,108~~

~~48,404~~

~~4.38~~

~~3,654,475~~

~~48,107~~

~~5.28~~

~~Taxable securities~~

~~764,691~~

~~4,570~~

~~2.40~~

~~840,254~~

~~5,933~~

~~2.83~~

~~Nontaxable securities~~ ⁽³⁾

~~160,296~~

~~977~~

~~2.45~~

~~139,278~~

~~893~~

~~2.57~~

~~Other interest earning assets~~

~~185,399~~

~~0.09~~

~~47,581~~

~~283~~

~~2.39~~

~~Total interest earning assets~~

~~5,552,494~~

~~53,994~~

~~3.91~~

~~4,681,588~~

~~55,216~~

~~4.73~~

~~Noninterest earning assets~~

~~757,530~~

~~669,217~~

~~Total assets~~

~~6,310,024~~

~~5,350,805~~

~~Interest Bearing Liabilities:~~

~~Certificates of deposit~~

~~513,539~~

~~1,810~~

~~1.42~~

~~514,220~~

~~1,694~~

~~1.32~~

~~Savings accounts~~

~~476,312~~

~~115~~

~~0.10~~

~~500,135~~

~~707~~

~~0.57~~

~~Interest bearing demand and money market accounts~~

~~2,440,691~~

~~1,492~~

~~0.25~~

~~2,016,901~~

~~1,616~~

~~0.32~~

~~Total interest bearing deposits~~

~~3,430,542~~

~~3,417~~

~~0.40~~

~~3,031,256~~

~~4,017~~

~~0.53~~

~~Junior subordinated debentures~~

~~20,693~~

~~218~~

~~4.24~~

~~20,400~~

~~340~~

~~6.68~~

~~Securities sold under agreement to repurchase~~

~~23,702~~

~~0.66~~

~~29,265~~

~~0.62~~

~~FHLB advances and other borrowings~~

~~4,909~~

~~0.57~~

~~42,101~~

~~278~~

~~2.65~~

~~Total interest bearing liabilities~~

~~3,479,846~~

~~3,681~~

~~0.43~~

~~3,123,022~~

~~4,680~~

~~0.60~~

~~Noninterest bearing demand deposits~~

~~1,883,227~~

~~1,345,917~~

~~Other noninterest bearing liabilities~~

~~139,412~~

~~99,147~~

~~Stockholders’ equity~~

~~807,539~~

~~782,719~~

~~Total liabilities and stockholders’ equity~~

~~6,310,024~~

~~5,350,805~~

~~Net interest income~~

~~50,313~~

~~50,536~~

~~Net interest spread~~

~~3.48~~

~~4.13~~

~~Net interest margin~~

~~3.64~~

~~4.33~~

~~Average interest earning assets to average interest bearing liabilities~~

~~159.56~~

~~149.91~~

⁽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 ~~$1.2~~$2.3 million, or ~~2.2%~~4.2%, to ~~$54.0~~$52.6 million for the three months ended ~~June~~September 30, 2020 compared to ~~$55.2~~$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 ~~significant~~several decreases in ~~the federal funds target rate by the Federal Reserve~~ short-term market rates, offset partially by increases in interest earning assets, primarily due to ~~the~~ SBA PPP loans. The yield on total interest earning assets decreased 82103 basis points to ~~3.91%~~3.57% for the three months ended ~~June~~September 30, 2020 compared to ~~4.73%~~4.60% for the three months ended ~~June~~September 30, ~~2019 and the~~2019. The balance of average interest earning ~~assets~~assets increased ~~$870.9 million,~~$1.12 billion, or ~~18.6%~~23.6%, to ~~$5.55~~$5.86 billion for the three months ended ~~June~~September 30, 2020 from ~~$4.68~~$4.74 billion for the three months ended ~~June~~September 30, 2019, ~~including an increase~~including increases in the average balances of ~~the balance of average~~ SBA PPP ~~loans.~~

~~Interest~~loans of $863.1 million and ~~fees on~~interest earning deposits of $282.9 million. There were no SBA PPP loans ~~increased $297,000, or 0.6%, to~~ ~~$48.4 million~~outstanding during the three months ended ~~June~~September 30, ~~2020~~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 ~~$48.1~~$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, offset partially by a decrease in the loan yield.~~balance. ~~Average loan balance increased $787.6 million, or 21.6%,~~Loan yield decreased 104 basis points to $4.44 billion during the three months ended June 30, 2020 compared to $3.65 billion during the three months ended June 30, 2019 due primarily to the origination of SBA PPP loans. The average balance of SBA PPP loans was $667.4 million4.12% for the three months ended ~~June~~September 30, ~~2020.~~ ~~Loan yield decreased~~ ~~90 basis points to 4.38%~~2020 from 5.16% for the three months ended ~~June 30, 2020 from 5.28% for the three months ended June~~September 30, 2019 du~~due~~e primarily to the multiple and sustained decreases in ~~interest rates on adjustable rate instruments following the decreases to~~ short-term market rates and secondarily due to the impact of low-yielding SBA PPP loans.~~The loan~~Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, ~~decreased~~ d56ecreased 69 basis points to ~~4.56%~~4.35% for three months ended ~~June~~September 30, 2020

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compared to ~~5.12%~~5.04% for the comparable quarter ended ~~June~~September 30, 2019. Loan yields decreased 2431 basis points as a result of SBA PPP loans yielding a rate of ~~2.97%~~2.68%, inclusive of the recognition of the related deferred fee, for the three months ended ~~June~~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.

~~Loan yield is also affected by incremental accretion on purchased loans.~~ ~~The impact~~Table of incremental accretion on loan yield decreased ten basis points from 0.16% for the quarter ended June 30, 2019. 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.Contents

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 June 30, 2020 and 2019:~~:


		Three Months Ended June 30,							Three Months Ended September 30,
		2020		2019			2020		2019
		(Dollars in thousands)							(Dollars in thousands)
Non-GAAP reconciliation of loan yield:⁽²⁾⁽¹⁾	Non-GAAP reconciliation of loan yield:⁽²⁾⁽¹⁾									Non-GAAP reconciliation of loan yield:⁽²⁾⁽¹⁾
Loan yield (GAAP)	Loan yield (GAAP)	4.38	%	5.28	%	Loan yield (GAAP)	4.12	%	5.16		%
Exclude Impact on loan yield from SBA PPP loan interest and fees	Exclude Impact on loan yield from SBA PPP loan interest and fees	0.24		—		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⁽¹⁾⁽²⁾	Exclude impact on loan yield from incremental accretion on purchased loans⁽¹⁾⁽²⁾	(0.06)		(0.16)		Exclude impact on loan yield from incremental accretion on purchased loans⁽¹⁾⁽²⁾	(0.08)		(0.12)
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) ^{(1) (2)}		4.56	%	5.12	%
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP)						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⁾~~For additional information, see "Non-GAAP Financial Measures."~~ 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 ~~$1.3~~$1.7 million, or ~~18.7%~~25.9%, to ~~$5.5~~$4.8 million during the three months ended ~~June~~September 30, 2020 from ~~$6.8~~$6.5 million during the three months ended ~~June~~September 30, 2019 due primarily to decreases in market interest rates impacting adjustable rate securities and ~~decreases in average balances due primarily to prepayments and calls of~~yields on investment securities inpurchased lower than the ~~currently low interest rate environment. T~~heexisting investment portfolio. The yield on the aggregate investment portfolio decreased 3948 basis points to ~~2.41%~~2.23% for the quarter ended ~~June~~September 30, 2020 from ~~2.80%~~2.71% for the same period in 2019, including decreases of 4354 and 1213 basis points on the yield on taxable securities and nontaxable securities, respectively. The average balance of investment securities decreased ~~by $54.5~~$92.4 million, or ~~5.6%~~9.7%, to ~~$925.0~~$860.2 million during the three months ended ~~June~~September 30, 2020 from ~~$979.5~~$952.6 million during the three months ended ~~June~~September 30, 2019. The decrease in the average balance of investment securities included a ~~$75.6~~$126.4 million, or ~~9.0%~~15.3%, decrease in the average balance of taxable securities, offset partially by a ~~$21.0~~$34.0 million, or ~~15.1%~~26.4%, increase in the average balance of nontaxable securities.

Interest income on ~~other~~ interest earning ~~assets, comprised of~~ deposits ~~at other financial institutions~~ decreased ~~$240,000~~,$439,000, or ~~84.8%~~81.8%, to ~~$43,000~~$98,000 during the three months ended ~~June~~September 30, 2020 from ~~$283,000~~$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 ~~230~~190 basis points to ~~0.09%~~0.10% during the three months ended ~~June~~September 30, 2020 compared to ~~2.39%~~2.00% during the same period in 2019 due to decreases in short-term market rates. The average balance of interest earning deposits increased ~~$137.8~~$282.9 million, or ~~289.6%~~265.05%, to ~~$185.4~~$389.7 million during the three months ended ~~June~~September 30, 2020 compared to ~~$47.6~~$106.7 million during the same period in 2019 due primarily to the increase in ~~deposit balances.~~deposits.

Interest Expense

Total interest expense decreased ~~$999,000,~~$1.8 million, or ~~21.3%~~37.8%, to ~~$3.7~~$2.9 million for the three months ended ~~June~~September 30, 2020 compared to ~~$4.7~~$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 1728 basis points to ~~0.43%~~0.31% for the three months ended ~~June~~September 30, 2020 from ~~0.60%~~0.59% for the three months ended ~~June~~September 30, 2019. The balance of average interest bearing liabilities increased ~~$356.8~~$564.1 million, or ~~11.4%~~18.1%, to ~~$3.48~~$3.67 billion during the three months ended ~~June~~September 30, 2020 compared to ~~$3.12~~$3.11 billion during the same period in 2019.

Interest expense on total interest bearing deposits decreased ~~$600,000,~~$1.6 million, or ~~14.9%~~37.9%, to ~~$3.4~~$2.6 million during the three months ended ~~June~~September 30, 2020 compared to ~~$4.0~~$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

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~~decrease in the cost of deposits following decreases in market rates, offset partially by the increase in the average balance. The cost~~balance of total interest bearing deposits ~~decreased 13 basis points to 0.40% for the three months ended June 30, 2020 from 0.53% for the three months ended June 30, 2019.~~ ~~The average balance~~ of ~~interest bearing deposits increased $399.3~~$564.0 million, or ~~13.2%~~18.5%, to ~~$3.43~~$3.62 billion for the three months ended ~~June~~September 30, 2020 compared to ~~$3.03~~$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 ~~decrease in interest expense on total interest bearing deposits is primarily related to a decrease in~~Company's deposit costs were favorably impacted by the ~~cost of interest bearing demand and money market deposits of seven basis points to 0.25% during the~~ ~~three months ended June 30, 2020~~ ~~from 0.32% for the same period in 2019, offset partially by an~~ increase in ~~the average balances of $423.8 million, or 21.0%, to $2.44 billion during the~~ ~~three months ended June 30, 2020~~ compared to $2.02 billion during the same period in 2019. The decrease in interest expense on total interest bearing deposits was offset partially by an increase in interest expense on cost of certificates of deposit due primarily to an increase in the cost of certificates of deposit of 10 basis points to 1.42% for the ~~three months ended June 30, 2020~~ ~~from 1.32% for the same period in 2019.~~

~~The Company was able to further mitigate the cost of interest bearing deposits by increasing~~ the average balance of noninterest bearing demand deposits compared to total interest bearing deposits. The average balance of noninterest bearing demand deposits increased ~~$537.3~~$582.4 million, or ~~39.9%~~41.1%, to ~~$1.88~~$2.00 billion (or ~~35.9%~~35.0% of total deposits at ~~June~~September 30, 2020) for the three months ended ~~June~~September 30, 2020 compared to ~~$1.35~~$1.42 billion (or ~~30.3%~~31.3% of total deposits at ~~June~~September 30, 2019) for the same period in 2019. The increase in the average balance of noninterest bearing deposits ~~caused a~~contributed to the decrease in the cost of total deposits of 1119 basis points to ~~0.26%~~0.19% for the three months ended ~~June~~September 30, 2020 compared to ~~0.37%~~0.38% for the same period in 2019.

~~The decrease in interest expense was additionally the result of a decrease in the cost of FHLB advances of 208 basis points to 0.57%for the three months ended June 30, 2020~~compared to 2.65% for the same period in 2019 due to the decrease in short-term market rates and the decrease in the average balance of FHLB advances of $37.2 million, or 88.3%, to $4.9 million during the three months ended June 30, 2020 compared to $42.1 million during the same period in 2019 funded by the increase in deposits.

Net Interest Margin

Net interest margin decreased 6983 basis points to ~~3.64%~~3.38% for the three months ended ~~June~~September 30, 2020 from ~~4.33%~~4.21% for the same period in 2019 primarily due to the above mentioned changes in asset yields and ~~costs~~the mix of ~~funds.~~interest earning assets, offset partially by a decrease in the cost of interest bearing liabilities. The net interest spread decreased 6575 basis points to ~~3.48%~~3.26% for the three months ended ~~June~~September 30, 2020 from ~~4.13%~~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.

~~Table~~ ~~of Contents~~

Comparison of ~~six~~nine months ended ~~June~~September 30, 2020 to the comparable period in the prior year

Net interest income decreased ~~$1.5~~$2.0 million, or ~~1.5%~~1.3%, to ~~$98.9~~$148.5 million for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$100.3~~$150.6 million for the same period in 2019. The following table provides relevant net interest income information for the dates indicated:

~~Six Months Ended June 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)}

~~4,095,340~~

~~94,681~~

~~4.65~~

~~3,638,573~~

~~94,806~~

~~5.25~~

~~Taxable securities~~

~~790,189~~

~~10,203~~

~~2.60~~

~~830,671~~

~~11,756~~

~~2.85~~

~~Nontaxable securities~~ ⁽³⁾

~~141,224~~

~~1,733~~

~~2.47~~

~~144,522~~

~~1,843~~

~~2.57~~

~~Other interest earning assets~~

~~155,379~~

~~463~~

~~0.60~~

~~51,747~~

~~618~~

~~2.41~~

~~Total interest earning assets~~

~~5,182,132~~

~~107,080~~

~~4.16~~

~~4,665,513~~

~~109,023~~

~~4.71~~

~~Noninterest earning assets~~

~~752,986~~

~~668,644~~

~~Total assets~~

~~5,935,118~~

~~5,334,157~~

~~Interest Bearing Liabilities:~~

~~Certificates of deposit~~

~~520,774~~

~~3,822~~

~~1.48~~

~~508,220~~

~~3,133~~

~~1.24~~

~~Savings accounts~~

~~455,386~~

~~303~~

~~0.13~~

~~503,882~~

~~1,381~~

~~0.55~~

~~Interest bearing demand and money market accounts~~

~~2,321,305~~

~~3,508~~

~~0.30~~

~~2,033,878~~

~~3,106~~

~~0.31~~

~~Total interest bearing deposits~~

~~3,297,465~~

~~7,633~~

~~0.47~~

~~3,045,980~~

~~7,620~~

~~0.50~~

~~Junior subordinated debentures~~

~~20,657~~

~~503~~

~~4.90~~

~~20,364~~

~~694~~

~~6.87~~

~~Securities sold under agreement to repurchase~~

~~21,474~~

~~0.67~~

~~31,149~~

~~0.59~~

~~FHLB advances and other borrowings~~

~~2,949~~

~~0.55~~

~~22,086~~

~~294~~

~~2.68~~

~~Total interest bearing liabilities~~

~~3,342,545~~

~~8,216~~

~~0.49~~

~~3,119,579~~

~~8,699~~

~~0.56~~

~~Noninterest bearing demand deposits~~

~~1,651,737~~

~~1,339,108~~

~~Other noninterest bearing liabilities~~

~~134,031~~

~~100,840~~

~~Stockholders’ equity~~

~~806,805~~

~~774,630~~

~~Total liabilities and stockholders’ equity~~

~~5,935,118~~

~~5,334,157~~

~~Net interest income~~

~~98,864~~

~~100,324~~

~~Net interest spread~~

~~3.67~~

~~4.15~~

~~Net interest margin~~

~~3.84~~

~~4.34~~

~~Average interest earning assets to average interest bearing liabilities~~

~~155.04~~

~~149.56~~


	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	%

⁵⁵

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	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	%

(1)Annualized

⁽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 decreased ~~$1.9~~$4.3 million, or ~~1.8%~~2.6%, to ~~$107.1~~$159.6 million for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$109.0~~$163.9 million for the same period in 2019 due primarily to decreases in yields on adjustable rate instruments following ~~significant~~several decreases in short-term market ~~rates.~~rates, offset partially by increases in interest earning assets, primarily due to SBA PPP loans. The yield on total interest earning assets decreased 5573 basis points to ~~4.16%~~3.94%, for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~4.71%~~4.67% for the ~~six~~nine months ended ~~June~~September 30, ~~2019 and the~~2019. The balance of average interest earning assets increased ~~$516.6~~$718.6 million, or ~~11.1%~~15.3%, to ~~$5.18~~$5.41 billion for the ~~six~~nine months ended ~~June~~September 30, 2020 from $4.69 billion for the nine months ended September 30, 2019, including ~~the~~increases in average ~~balance~~balances of SBA PPP loans of ~~$333.7~~$511.5 million ~~from $4.67 billion for the six months ended June 30, 2019.~~and interest earning deposits of $163.8 million.

Interest and fees onon loans decreased ~~$125,000,~~$323,000, or ~~0.1%~~0.2%, to ~~$94.7~~$142.3 million during the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$94.8~~$142.7 million for the same period in 2019 due primarily to ~~decreases~~a decrease in the loan ~~yields,~~yield, offset partially by ~~increases~~an increase in the average loan ~~balances.~~balance. Loan yield decreased 6076 basis points to ~~4.65%~~4.46% for t~~he six~~the nine months ended ~~June~~September 30, 2020 from ~~5.25%~~5.22% for the ~~six~~nine months ended ~~June~~September 30, 2019 due primarily to the multiple and sustained decreases in ~~the short term~~short-term market rates and secondarily due to the impact of ~~originations of lower yielding~~low-yielding SBA PPP loans. ~~Approximately 57.8% of the loan portfolio at December 31, 2019 was adjustable and 41.2% of those adjustable loans (23.9% of the loan portfolio) repriced within six months.~~ Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, decreased 49 basis points to 4.59% for nine months ended September 30, 2020 compared to 5.08% for the comparable period ended September 30, 2019. Loan yields decreased 21 basis points as result of SBA PPP loans yielding a rate of 2.80%, inclusive of the related deferred fee, for the nine months ended September 30, 2020. The average loan balance increased $614.9 million, or 16.8%, to $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, 2020. There were no SBA PPP loans outstanding during the nine months ended September 30, 2019.

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~~purchased loans decreased 39 basis points to 4.71% for six months ended June 30, 2020 from 5.10% for the same period in~~ ~~2019~~. ~~The yield for SBA PPP loans was 2.97% for the six months ended June 30, 2020, negatively impacting the loan yield by 14 basis points.~~

~~Loan yield is also affected by incremental accretion~~ ~~on purchased loans. The impact of incremental accretion on loan yield decreased seven basis points from 0.15% for six months ended June 30, 2019.~~ 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.

~~The decrease in interest income on loans was offset partially by an increase in the average balance of loans receivable of~~ ~~$456.8 million, or 12.5~~%~~, to~~ ~~$4.10 billion~~ ~~during the six months ended June 30, 2020 compared to~~ ~~$3.64 billion~~ ~~during the six months ended June 30, 2019. Average SBA PPP loans was $333.7 million during the six months ended June 30, 2020.~~


		Six Months Ended June 30,							Nine Months Ended September 30,
		2020		2019			2020		2019
		(Dollars in thousands)							(Dollars in thousands)
Non-GAAP reconciliation of loan yield:⁽²⁾⁽¹⁾	Non-GAAP reconciliation of loan yield:⁽²⁾⁽¹⁾					Non-GAAP reconciliation of loan yield:⁽²⁾⁽¹⁾
Loan yield (GAAP)	Loan yield (GAAP)	4.65	%	5.25	%	Loan yield (GAAP)	4.46	%	5.22	%
Exclude Impact on loan yield from SBA PPP loans	Exclude Impact on loan yield from SBA PPP loans	0.14		—		Exclude Impact on loan yield from SBA PPP loans	0.21		—
Exclude impact on loan yield from incremental accretion on purchased loans⁽¹⁾⁽²⁾	Exclude impact on loan yield from incremental accretion on purchased loans⁽¹⁾⁽²⁾	(0.08)		(0.15)		Exclude impact on loan yield from incremental accretion on purchased loans⁽¹⁾⁽²⁾	(0.08)		(0.14)
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) ^{(1) (2)}		4.71	%	5.10	%
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP)						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 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 ~~under our~~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.

⁽²⁾~~For additional information, see "Non-GAAP Financial Measures."~~

Interest income on investment securities decreased ~~$1.7~~$3.3 million, or ~~12.2%~~16.7%, to ~~$11.9~~$16.8 million during the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~$13.6~~$20.1 million during the ~~six~~nine months ended ~~June~~September 30, 2019 due primarily to decreases in market interest rates impacting adjustable rate ~~securities~~ ~~and decreases in the average balance of investment securities due primarily to prepayments and calls of securities due to the currently low interest rate environment.~~ securities. The yield on the aggregate investment portfolio decreased 2331 points to ~~2.58%~~2.47% for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~2.81%~~2.78% for the same period in 2019, including ~~a decrease~~decreases of 2534 basis points and ~~ten~~11 basis points on the yield on taxable securities and nontaxable securities, respectively. ~~The~~Also contributing to the decline in interest income on investment securities was a decrease in average balance of ~~investment securities decreased $43.8~~$60.1 million, or ~~4.5%~~6.2%, to ~~$931.4~~$907.5 million during the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~$975.2~~$967.6 million during the ~~six~~nine months ended ~~June~~September 30, ~~2019.~~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 ~~$40.5~~$69.3 million, or ~~4.9%~~8.4%, in the average balance of taxable securities, ~~and a decrease~~offset partially by an increase of ~~$3.3~~$9.2 million, or ~~2.3%~~6.6%, in the average balance of nontaxable ~~securities.~~securities during the nine months ended September 30, 2020.

Interest income on interest earning deposits decreased ~~$155,000~~,$594,000, or ~~25.1%~~51.4%, to ~~$463,000~~$561,000 during the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~$618,000~~$1.2 million during the ~~six~~nine months ended ~~June~~September 30, 2019 due primarily to ~~decreases~~a decrease in the yield on interest earning deposits, ~~as a result of decreases in short-term market rates,~~ offset partially by ~~increases~~an increase in the average ~~balance of interest earning deposits.~~balance. The yield on interest earning deposits decreased ~~181~~188 basis points to ~~0.60%~~0.32% during the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~2.41%~~2.20% during the same period in ~~2019. Average~~2019 due to decreases in the short-term market rates. The average interest earning deposits increased ~~$103.5~~$163.8 million, or ~~200.3%~~233.0%, to ~~$155.4~~$234.0 million during the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$51.7~~$70.3 million during the same period in ~~2019.~~2019 due primarily to the increase in deposits.

Interest Expense

Total interest expense decreased ~~$483,000,~~$2.2 million, or ~~5.6%~~16.8%, to ~~$8.2~~$11.1 million for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$8.7~~$13.3 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, ~~mostly~~ offset partially by an increase in the average balance of total interest bearing liabilities. The cost of total interest bearing liabilities decreased ~~seven~~14 basis points to ~~0.49%~~0.43% for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~0.56%~~0.57% for the ~~six~~nine months ended ~~June~~September 30, 2019. The balance of average interest bearing liabilities increased ~~$223.0~~$337.5 million, or ~~7.1%~~10.8%, to ~~$3.34~~$3.45 billion for the ~~six~~nine months ended ~~June~~September 30, 2020 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 0.52% 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.

Table of Contents

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, 2020 compared to $3.05 billion for the same period in 2019 due primarily to proceeds from SBA PPP loans

~~Table~~ ~~of Contents~~

deposited directly into customer ~~deposit~~ accounts and an increase in ~~deposits due to reduced withdrawals from~~customer deposit accounts due to a change in ~~customer~~ spending habits ~~due to~~as a result of COVID-19.

~~While~~The Company's deposit costs were favorably impacted by the interest expense on deposits remained at $7.6 million during both the six months ended June 30, 2020 and 2019, the deposit mix changed between the periods. The six months ended June 30, 2020 included a decrease in interest expense of $1.0 million due to decrease in cost and average balance of savings accounts, offset by an increase in interest expense of $689,000 due to increases in the cost and average balance of certificates of deposit and $402,000 due primarily to increases in interest bearing deposit accounts as compared to the same period last year.

~~The Company was able to further mitigate the cost of interest bearing deposits by increasing~~ the average balance of noninterest bearing demand deposits compared to total interest bearing deposits. The average balance of noninterest bearing demand deposits increased ~~$312.6~~$403.1 million, or ~~23.3%~~29.5%, to ~~$1.65~~$1.77 billion for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$1.34~~$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 ~~four~~nine basis points to ~~0.31%~~0.27% for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~0.35%~~0.36% for the same period in 2019.

~~The decrease in interest expense was additionally the result of the cost of FHLB advances decreasing 213 basis points to 0.55%for the three months ended June 30, 2020~~compared to 2.68% for the same period in 2019 due to decreases in short-term market rates and the decrease in the average balance of FHLB advances of $19.1 million, or 86.7%, to $2.9 million during the three months ended June 30, 2020 compared to $22.1 million during the same period in 2019 funded by the increase in deposits.

Net Interest Margin

~~Net~~Net interest margin decreased 5062 basis points to ~~3.84%~~3.67% for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~4.34%~~4.29% for the same period in 2019 primarily due to the above mentioned ~~decreases~~changes in asset yields and ~~changes~~the mix of interest earning assets, offset partially by a decrease in the cost of ~~funds.~~interest bearing liabilities. The net interest spread decreased 4859 basis points to ~~3.67%~~3.51% for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~4.15%~~4.10% for the same period in 2019 ~~primarily~~primarily due to the decrease in the yield of total interest earning ~~assets.~~assets, offset partially by a decrease in the cost of total interest bearing liabilities.

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 presented on the Company's Condensed Consolidated Statements of ~~Operations~~Income as the provision for credit losses. The ACL on 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 provision for credit losses for the periods presented below:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended September 30,				Nine Months Ended September 30,
		2020		2019		2020		2019			2020		2019		2020		2019
		(In thousands)															(In thousands)
Provision for credit losses on loans	Provision for credit losses on loans	$	25,941	$	1,367	$	35,905	$	2,287	Provision for credit losses on loans	$	2,320	$	466	$	38,225	$	2,753
Provision for credit losses on unfunded commitments	Provision for credit losses on unfunded commitments	2,622		—		604		—		Provision for credit losses on unfunded commitments	410		—		1,014		—
Provision for credit losses	Provision for credit losses	$	28,563	$	1,367	$	36,509	$	2,287	Provision for credit losses	$	2,730	$	466	$	39,239	$	2,753

Provision for Credit Losses on Loans

The Bank has established a comprehensive methodology for determining its ACL on loans. The ACL on loans is increased by provision for credit losses on loans charged to earnings. The amount of the provision expense recognized during the three and ~~six~~nine months ended ~~June~~September 30, 2020 was calculated based on a thorough review of the loan portfolio and in accordance with the Bank's CECL methodology for determining the current expected credit losses on loans. The amount of the provision expense recognized during the three and ~~six~~nine months ended ~~June~~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 Credit Losses on Loans" below.

~~Table~~ ~~of Contents~~

The provision for credit 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 credit losses on loans and have a material adverse effect on the Company’s net income.

Table of Contents

Comparison of quarter ended ~~June~~September 30, 2020 to the comparable quarter in the prior year.

The provision for credit losses on loans increased ~~$24.6~~$1.9 million, or ~~1797.7%~~397.9%, to ~~$25.9~~$2.3 million for the three months ended ~~June~~September 30, 2020 from ~~$1.4 million~~$466,000 for the three months ended ~~June~~September 30, 2019 due primarily ~~due~~ to increases in the ~~worsening of~~ACL for nonperforming loans, caused by the ~~economic conditions during the three months ended June 30, 2020~~COVID-19 pandemic, as explained in the "Analysis of Allowance for Credit Losses on Loans" below. ~~The provision for loan losses during the three months ended June 30, 2019 was estimated under the previously utilized incurred loss methodology.~~

Comparison of ~~six~~nine months ended ~~June~~September 30, 2020 to the comparable period in the prior year.

The provision for credit ~~losses~~losses on loans increased ~~$33.6~~$35.5 million, or ~~1470.0%~~1288.5%, to ~~$35.9~~$38.2 million for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~$2.3~~$2.8 million for the ~~six~~nine months ended ~~June~~September 30, 2019 due primarily to the worsening of the economic conditions as a result of the COVID-19 pandemic as explained in the "Analysis of Allowance for Credit Losses on Loans" below. ~~The provision for loan losses recognized during the six months ended June 30, 2019 was estimated under the previously utilized incurred loss methodology.~~

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 commitment. 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 ~~six~~nine months ended ~~June~~September 30, 2020 was calculated based on a thorough review of the loan portfolio and in accordance with the Bank's CECL methodology for determining the current expected credit losses on unfunded commitments. The amount of the provision expense recognized during the three and ~~six~~nine months ended ~~June~~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 Credit Losses on Loans" below.~~

Comparison of quarter ended ~~June~~September 30, 2020 to the comparable quarter in the prior year.

The Bank recorded a provision for credit losses on unfunded commitments of ~~$2.6 million~~$410,000 during the three months ended ~~June~~September 30, 2020 primarily ~~as a result of an increase in estimated loss rates as a result of worsening economic conditions~~ due to ~~COVID-19 and a~~the decrease in ~~the~~ utilization ~~rates~~rate of revolving commercial and industrial loans to 23.3% at September 30, 2020 compared to 26.2% at June 30, 2020 ~~compared~~and worsening economic conditions applied to ~~37.5% at March 31, 2020. The Company did not record a provision for credit losses on unfunded commitments during~~ the ~~same period in 2019 under the incurred loss methodology.~~commercial and industrial loan segment due to COVID-19.

Comparison of ~~six~~nine months ended ~~June~~September 30, 2020 to the comparable period in the prior year.

The Bank recorded a provision for credit losses on ~~unfunded~~unfunded commitments of ~~$604,000~~$1.0 million during the ~~six~~nine months ended ~~June~~September 30, 2020 primarily as a result of ~~an increase in the estimated loss rates~~ worsening economic conditions due to COVID-19 and a decrease in the utilization rates for revolving lines of ~~revolving commercial and industrial loans from 34.5%~~credit to 38.4% at ~~December 31, 2019, offset partially by an increase in the utilization rate of commercial construction loans to 46.6% at June~~September 30, 2020 compared to ~~35.6%~~39.3% at December 31, 2019. ~~The Company did not record a provision for credit losses on unfunded commitments during the same period in 2019 under the incurred loss methodology.~~

~~Table~~ ~~of Contents~~

Noninterest Income

Comparison of quarter ended ~~June~~September 30, 2020 to the comparable quarter in the prior year.

Total ~~noninterest~~noninterest income ~~increased~~ ~~$684,000~~,decreased $248,000, or ~~9.0%~~2.9%, to $8.2 million for the three months ended ~~June~~September 30, 2020 from ~~$7.6~~$8.5 million for the same period in 2019. The following table presents the change in the key components of noninterest income for the periods noted:


		Three Months Ended June 30,											Three Months Ended September 30,
		2020		2019		Change		Percentage Change			2020		2019		Change		Percentage Change
		(Dollars in thousands)															(Dollars in thousands)
Service charges and other fees	Service charges and other fees	$	3,600	$	4,845	$	(1,245)	(25.7)	%	Service charges and other fees	$	4,039	$	4,779	$	(740)	(15.5)	%
Gain on sale of investment securities, net	Gain on sale of investment securities, net	409		33		376		1,139.4		Gain on sale of investment securities, net	40		281		(241)		(85.8)
Gain on sale of loans, net	Gain on sale of loans, net	1,135		368		767		208.4		Gain on sale of loans, net	1,443		993		450		45.3
Interest rate swap fees	Interest rate swap fees	769		161		608		377.6		Interest rate swap fees	396		152		244		160.5
Other income	Other income	2,335		2,157		178		8.3		Other income	2,292		2,253		39		1.7
Total noninterest income	Total noninterest income	$	8,248	$	7,564	$	684	9.0	%	Total noninterest income	$	8,210	$	8,458	$	(248)	(2.9)	%

~~Gain on sale~~

Table of ~~loans, net, increased $767,000,~~Contents

Service charges and other fees decreased of $740,000, or ~~208.4%~~15.5%, to ~~$1.1~~$4.0 million for the three months ended ~~June~~September 30, 2020 compared to ~~$368,000~~$4.8 million for the same pperiod in 2019 due primarily to a decrease ~~eriod~~in overdraft fees of $561,000 from changes in customer spending habits during the COVID-19 pandemic.

The decrease in noninterest income was offset partially by an increase in gain on sale of loans, net, of $450,000, or 45.3%, to $1.4 million for the three months ended September 30, 2020 compared to $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.~~environment, offset partially by a lower average loan sale margin. Mortgage ~~originations~~loans held for sale originations increased by ~~$21.1~~$19.1 million, or ~~180.0%~~162.5%, to ~~$32.8 millio~~n$44.6 million for the three months ended ~~June~~September 30, 2020 from ~~$11.7~~$25.5 million for the same period in 2019.

~~Interest rate swap fees increased $608,000, or 377.6%, to~~ ~~$769,000~~ ~~for the three months ended June 30, 2020 compared to $161,000 in the same period in 2019 based on an increase in customer transactions.~~

The increase in noninterest income was offset partially by a decrease in service charges and other fees of $1.2 million, or 25.7%, to $3.6 million for the three months ended June 30, 2020 compared to $4.8 million for the same period in 2019 due primarily to a decrease in overdraft fees of $711,000 and interchange fees of $256,000. The decrease in overdraft fees and interchange fees is attributed to a decrease in transactions due to a change in customer spending habits during the COVID-19 pandemic.

Comparison of ~~six~~nine months ended ~~June~~September 30, 2020 to the comparable period in the prior year

Total ~~noninterest~~noninterest income increased ~~$2.7~~$2.5 million, or ~~18.3%~~10.6%, to ~~$17.7~~$25.9 million for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$15.0~~$23.5 million for the same period in 2019. The following table presents the change in the key components of noninterest income for the periods noted:


		Six Months Ended June 30,											Nine Months Ended September 30,
		2020		2019		Change		Percentage Change			2020		2019		Change		Percentage Change
		(Dollars in thousands)															(Dollars in thousands)
Service charges and other fees	Service charges and other fees	$	7,976	$	9,330	$	(1,354)	(14.5)	%	Service charges and other fees	$	12,015	$	14,109	$	(2,094)	(14.8)	%
Gain on sale of investment securities, net	Gain on sale of investment securities, net	1,423		48		1,375		2,864.6		Gain on sale of investment securities, net	1,463		329		1,134		344.7
Gain on sale of loans, net	Gain on sale of loans, net	1,682		620		1,062		171.3		Gain on sale of loans, net	3,125		1,613		1,512		93.7
Interest rate swap fees	Interest rate swap fees	1,065		161		904		561.5		Interest rate swap fees	1,461		313		1,148		366.8
Other income	Other income	5,588		4,834		754		15.6		Other income	7,880		7,087		793		11.2
Total noninterest income	Total noninterest income	$	17,734	$	14,993	$	2,741	18.3	%	Total noninterest income	$	25,944	$	23,451	$	2,493	10.6	%

Gain on sale of loans, net increased $1.5 million, or 93.7%, to $3.1 million for the nine months ended September 30, 2020 compared to $1.6 million for the same period in 2019 primarily as a result of an increase in the volume of loans sold 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 by $47.6 million, or 103.7%, to $93.4 million for the nine months ended September 30, 2020 from $45.9 millionfor the nine months ended September 30, 2019.

Gain on sale of investment ~~securities,~~securities, net increased ~~$1.4~~$1.1 million, or ~~2,864.6%~~344.7%, to ~~$1.4~~$1.5 million for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~$48,000~~$329,000 during the same period in 2019 as a result of the Bank's active management of the investment portfolio in the current ~~interest rate environment.~~

~~Gain on sale of loans, net increased $1.1 million, or 171.3%, to $1.7 million for the six months ended June 30, 2020 compared to $620,000 for the same period in 2019 primarily~~ ~~as a result of an increase in sales due to an~~

~~Table~~ ~~of Contents~~

~~increase in origination volume generated by the currently~~ low interest rate environment.~~Mortgage loan held for sale originations increased~~ ~~by $28.5 million, or 140.3%, to $48.8 million for the six months ended June 30, 2020 from $20.3 millionfor the six months ended June 30, 2019.~~

Interest rate swap fees increased ~~$904,000,~~$1.1 million, or ~~561.5%~~366.8%, to ~~$1.1~~$1.5 million for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$161,000~~$313,000 in the same period in 2019 based on customer transactions.

Other income increased ~~$754,000,~~$793,000, or ~~15.6%~~11.2%, to ~~$5.6~~$7.9 million for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$4.8~~$7.1 million for the same period in 2019 due primarily to $653,000 ~~received~~of gain from a ~~BOLI~~bank owned life insurance death benefit ~~recognized~~paid during the ~~six~~nine months ended ~~June~~September 30, 2020.

The increase in noninterest income was offset partially by a decrease in service charges and other fees of ~~$1.4~~$2.1 million, or 14.8%, to ~~$8.0~~$12.0 million for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~$9.3~~$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 ~~interchange~~a decrease in activity-based fees ~~for~~on deposit accounts, in each case due to the ~~same reasons as discussed above for the current quarter.~~COVID-19 pandemic.

Table of Contents

Noninterest Expense

Comparison of quarter ended ~~June~~September 30, 2020 to the comparable quarter in the prior year.

Noninterest ~~expense~~expense decreased ~~$474,000,~~$674,000, or ~~1.3%~~1.8%, to ~~$37.1~~$36.0 million during the three months ended ~~June~~September 30, 2020 from ~~$37.5~~$36.7 million during the three months ended September 30, 2019. The following table presents changes in the key components of noninterest expense for the periods 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)	%

Other expense decreased $739,000, or 26.2%, to $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, 2019.

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, 2020 partially offset by the usage of the remainder of the Bank's small bank credit during the quarter ended June 30, 2020. The Bank utilized its small bank credit for the full premium due during the three months ended September 30, 2019.

The ratio of noninterest expense to average total assets (annualized) was 2.17%for the three months ended September 30, 2020 compared to 2.69% for the three months ended September 30, 2019. The decrease was primarily due to an increase in average total assets primarily due to the SBA PPP loans originated during 2020.

Table of Contents

Comparison of nine months ended September 30, 2020 to the comparable period in the prior year

Noninterest expense decreased $413,000, or 0.4%, to $110.4 million during the nine months ended September 30, 2020 compared to $110.8 million for the nine months ended September 30, 2019. The following table presents changes in the key components of noninterest expense for the periods noted:


		Three Months Ended June 30,											Nine Months Ended September 30,
		2020		2019		Change		Percentage Change			2020		2019		Change		Percentage Change
		(Dollars in thousands)															(Dollars in thousands)
Compensation and employee benefits	Compensation and employee benefits	$	21,927	$	21,982	$	(55)	(0.3)	%	Compensation and employee benefits	$	65,849	$	65,629	$	220	0.3	%
Occupancy and equipment	Occupancy and equipment	5,529		5,451		78		1.4		Occupancy and equipment	16,936		16,177		759		4.7
Data processing	Data processing	2,323		2,109		214		10.1		Data processing	7,046		6,615		431		6.5
Marketing	Marketing	696		1,106		(410)		(37.1)		Marketing	2,317		3,020		(703)		(23.3)
Professional services	Professional services	2,169		1,305		864		66.2		Professional services	4,632		3,912		720		18.4
State/municipal business and use tax	State/municipal business and use tax	905		809		96		11.9		State/municipal business and use tax	2,626		2,977		(351)		(11.8)
Federal deposit insurance premium	Federal deposit insurance premium	238		426		(188)		(44.1)		Federal deposit insurance premium	1,086		720		366		50.8
Other real estate owned, net	Other real estate owned, net	(170)		289		(459)		(158.8)		Other real estate owned, net	(145)		340		(485)		(142.6)
Amortization of intangible assets	Amortization of intangible assets	903		1,026		(123)		(12.0)		Amortization of intangible assets	2,666		3,026		(360)		(11.9)
Other expense	Other expense	2,553		3,044		(491)		(16.1)		Other expense	7,365		8,375		(1,010)		(12.1)
Total noninterest expense	Total noninterest expense	$	37,073	$	37,547	$	(474)	(1.3)	%	Total noninterest expense	$	110,378	$	110,791	$	(413)	(0.4)	%

Other expense decreased ~~$491,000,~~ $1.0 million, or ~~16.1%~~12.1%, to ~~$2.6~~$7.4 million for the ~~three~~nine months ended ~~June~~September 30, 2020 from ~~$3.0~~$8.4 million for the same period in 2019 due ~~primarily to~~substantially from the reduction of employee travel, conference, and entertainment expenses related to the ~~Bank's~~Company's suspension of non-essential travel due to ~~COVID-19~~.COVID-19.

~~Other real estate owned, net~~Marketing expense decreased ~~$459,000,~~$703,000, or ~~158.8%~~23.3%, to ~~a gain of $170,000 for~~$2.3 million during the ~~three~~nine months ended ~~June~~September 30, 2020 from ~~an expense of $289,000 for the same period in 2019 as a result of a gain on sale recognized~~$3.0 million during the ~~three~~nine months ended ~~June~~September 30, ~~2020 compared to a loss on sale recognized during the three months ended June 30, 2019.~~

~~Marketing expense decreased $410,000, or 37.1%, to $696,000 for the three months ended June 30, 2020 from $1.1 million for the same period in~~ 2019 due primarily to the delayed timing of contributions for community ~~community~~ sponsorships and sponsored events due to COVID-19 restrictions.

~~Federal deposit insurance premium expense decreased~~ ~~$188,000, or~~ ~~44.1%, to~~ ~~$238,000~~ ~~for the~~ ~~three months ended June 30, 2020 from $426,000 for the same period in 2019~~ ~~due to the use of the Bank's remaining small bank credits during the three months ended June 30, 2020 compared to no credit available to be recognized during the three months ended June 30, 2019. Federal deposit insurance premium expense will return to normal levels next quarter.~~

~~Table~~ ~~of Contents~~

~~These~~The decreases in noninterest expense were partially offset ~~partially~~ by an increase in ~~professional services~~occupancy and equipment expense of ~~$864,000~~$759,000, or 4.7%, to ~~$2.2~~$16.9 million for the ~~three~~nine months ended ~~June~~September 30, 2020 ~~compared~~from $16.2 million during the nine months ended September 30, 2019 due primarily to depreciation expense related to the Southern Operation Cente~~$1.3~~r placed into operation in December 2019.

Professional services expense increased $720,000, or 18.4%, to $4.6 million ~~for~~ during the ~~same period in~~nine months ended September 30, 2020 from $3.9 million during the nine months ended September 30, 2019 related primarily to the launch of the new mobile and online commercial banking platform, "Heritage ~~Direct,~~Direct." ~~starting in first quarter 2020.~~ The implementation of ~~Heritage Direct~~the new banking platform was completed during the ~~three~~second quarter of 2020.

Federal deposit insurance premium expense increased $366,000, or 50.8%, to $1.1 million during the nine months ended ~~June~~September 30, ~~2020.~~2020 from $720,000 during the nine months ended September 30, 2019 due to the impact of the 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, 2020 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, 2020.

The ratio of noninterest expense to average total assets (annualized) was ~~2.36%~~2.39% for the ~~three~~nine months ended ~~June~~September 30, 2020, compared to ~~2.81%~~2.76% for the ~~three~~nine months ended ~~June~~September 30, 2019. The decrease was primarily due to an increase in average total assets, due primarily to SBA PPP ~~originations~~loans originated during ~~the three months ended June 30,~~ 2020.

~~Comparison of six months ended June 30, 2020 to the comparable period in the prior year~~

Noninterest expense increased $261,000, or 0.4%, to $74.3 million during the six months ended June 30, 2020 compared to $74.1 million for the six months ended June 30, 2019. The following table presents changes in the key components of noninterest expense for the periods noted:

Six Months Ended
June 30,
2020 2019 Change Percentage Change
(Dollars in thousands)
Compensation and employee benefits $ 44,433 $ 43,896 $ 537 1.2 %
Occupancy and equipment 11,260 10,909 351 3.2
Data processing 4,683 4,282 401 9.4
Marketing 1,562 2,204 (642) (29.1)
Professional services 3,546 2,478 1,068 43.1
State/municipal business and use tax 1,662 1,607 55 3.4
Federal deposit insurance premium 238 711 (473) (66.5)
Other real estate owned, net (145) 375 (520) (138.7)
Amortization of intangible assets 1,806 2,051 (245) (11.9)
Other expense 5,288 5,559 (271) (4.9)
Total noninterest expense $ 74,333 $ 74,072 $ 261 0.4 %

~~Professional services increased $1.1 million, or 43.1%, to $3.5 million during the six months ended June 30, 2020 from $2.5 million during the six months ended June 30, 2019~~ ~~related primarily to the Heritage Direct platform previously mentioned.~~ ~~The implementation of the new banking platform was completed during the six months ended June 30, 2020.~~

Compensation and employee benefits increased $537,000, or 1.2%, to $44.4 million during the six months ended June 30, 2020 from $43.9 million during the six months ended June 30, 2019 due primarily to standard increases in salaries as well as extra pay to retail branch staff due to customer-facing interactions during the COVID-19 pandemic of $410,000, increase in overtime expenses of $237,000 related mostly to SBA PPP loan processing, and an increase in sales commission expense related to the mortgage department's increased production, offset partially by the deferral of $900,000 of compensation related to origination costs of SBA PPP loans.

~~Marketing decreased $642,000, or 29.1%, to $1.6 million~~ ~~during the six months ended June 30, 2020 from $2.2 million during the six months ended June 30, 2019 due primarily to the delayed timing of contributions for community~~ ~~sponsorships and sponsored events due to COVID-19 restrictions.~~

~~Other real estate owned, net decreased $520,000, or 138.7%, to a gain of $145,000 during the six months ended June 30, 2020 from an expense of $375,000 during the six months ended June 30, 2019 as a result of net gains on sale recognized during the six months ended June 30, 2020 compared to a loss on sales recognized during the six months ended June 30, 2019.~~

~~Federal deposit insurance premium expense decreased~~ ~~$473,000, or~~ ~~66.5%, to~~ ~~$238,000during the six months ended June 30, 2020 from $711,000 during the six months ended June 30, 2019~~ ~~due to the recognition of~~

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~~the remaining small bank credits awarded by the FDIC during the six months ended June 30, 2020 compared to no credits available to be recognized during the same period ended 2019~~.

The ratio of noninterest expense to average total assets (annualized) was 2.52% for the six months ended June 30, 2020, compared to 2.80% for the six months ended June 30, 2019. The decrease was primarily due to an increase in average total assets due primarily to SBA PPP originations during the six months ended June 30, 2020.

Income Tax Expense

~~Comparison~~Comparison of quarter ended ~~June~~September 30, 2020 to the comparable quarter in the prior year.

Income tax expense decreased ~~$4.1~~$1.1 million, or ~~129.2%~~31.6%, to ~~an income tax benefit of~~ ~~$936,000~~ ~~for the three months ended June 30, 2020 from an income tax expense of $3.2~~$2.5 million for the three months ended ~~June~~September 30, ~~2019.~~2020 from $3.6 million for the three months ended September 30, 2019 primarily due to lower pre-tax income. The effective tax rate was ~~13.2%~~13.0% for the three months ended ~~June~~September 30, 2020 compared to ~~16.7%~~16.8% for the same period in 2019. The decrease in the effective tax rate from the ~~quarter~~three months ended ~~June~~September 30, ~~2019~~2020 was due primarily to the year-over-year decrease in estimated annual pre-tax income, which results in an increased impact for favorable permanent tax items such as ~~was as an increase~~tax-exempt investments, investments in ~~tax-exempt investments.~~bank owned life insurance and low-income housing tax credits.

Comparison of ~~six~~nine months ended ~~June~~September 30, 2020 to the comparable period in the prior year.

~~Income~~Income tax expense decreased ~~$6.7~~$7.9 million, or ~~104.6%~~78.3%, to ~~an income tax benefit of~~ ~~$296,000~~$2.2 million for the ~~six~~nine months ended ~~June~~September 30, 2020 from ~~an income tax expense of $6.4~~$10.0 million for the ~~six~~nine months ended ~~June~~September 30, 2019. The effective tax rate was ~~5.1%~~8.8% for the ~~six~~nine months ended ~~June~~September 30, 2020 compared to ~~16.5%~~16.6% for the same period in 2019. The decrease in ~~the~~ income tax expense and effective tax rate during the ~~six~~nine months ended ~~June~~September 30, 2020 was due primarily to a provision in the CARES Act, which permitted the Company to recognize a $1.0 million benefit from net operating losses related to prior acquisitions during the ~~six~~nine months ended ~~June~~September 30, 2020 and secondarily due to a decrease in pre-tax income ~~which results in an~~and increased ~~impact of favorable permanent tax items such as~~ tax-exempt investments ~~and low income housing tax credits~~.in 2020.

~~Table~~ ~~of Contents~~

Financial Condition Overview

The table below provides a comparison of the changes in the Company's financial condition from December 31, 2019 to ~~June~~September 30, 2020:


		June 30, 2020		December 31, 2019		Change		% Change			September 30, 2020		December 31, 2019		Change		% Change
		(Dollars in thousands)															(Dollars in thousands)
Assets	Assets									Assets
Cash and cash equivalents	Cash and cash equivalents	$	415,075	$	228,568	$	186,507	81.6	%	Cash and cash equivalents	$	576,242	$	228,568	$	347,674	152.1	%
Investment securities available for sale, at fair value, net	Investment securities available for sale, at fair value, net	879,927		952,312		(72,385)		(7.6)		Investment securities available for sale, at fair value, net	834,492		952,312		(117,820)		(12.4)
Loans held for sale	Loans held for sale	3,783		5,533		(1,750)		(31.6)		Loans held for sale	8,250		5,533		2,717		49.1
Loans receivable, net	Loans receivable, net	4,594,832		3,731,708		863,124		23.1		Loans receivable, net	4,593,390		3,731,708		861,682		23.1
Other real estate owned	Other real estate owned	—		841		(841)		(100.0)		Other real estate owned	—		841		(841)		(100.0)
Premises and equipment, net	Premises and equipment, net	86,897		87,888		(991)		(1.1)		Premises and equipment, net	89,831		87,888		1,943		2.2
Federal Home Loan Bank stock, at cost	Federal Home Loan Bank stock, at cost	6,661		6,377		284		4.5		Federal Home Loan Bank stock, at cost	6,661		6,377		284		4.5
Bank owned life insurance	Bank owned life insurance	107,401		103,616		3,785		3.7		Bank owned life insurance	108,311		103,616		4,695		4.5
Accrued interest receivable	Accrued interest receivable	17,813		14,446		3,367		23.3		Accrued interest receivable	18,888		14,446		4,442		30.7
Prepaid expenses and other assets	Prepaid expenses and other assets	194,224		164,129		30,095		18.3		Prepaid expenses and other assets	194,938		164,129		30,809		18.8
Other intangible assets, net	Other intangible assets, net	14,807		16,613		(1,806)		(10.9)		Other intangible assets, net	13,947		16,613		(2,666)		(16.0)
Goodwill	Goodwill	240,939		240,939		—		—		Goodwill	240,939		240,939		—		—
Total assets	Total assets	$	6,562,359	$	5,552,970	$	1,009,389	18.2	%	Total assets	$	6,685,889	$	5,552,970	$	1,132,919	20.4	%

Liabilities	Liabilities									Liabilities
Deposits	Deposits	$	5,567,733	$	4,582,676	$	985,057	21.5	%	Deposits	$	5,689,048	$	4,582,676	$	1,106,372	24.1	%

Junior subordinated debentures	Junior subordinated debentures	20,741		20,595		146		0.7		Junior subordinated debentures	20,814		20,595		219		1.1
Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	24,444		20,169		4,275		21.2		Securities sold under agreement to repurchase	29,043		20,169		8,874		44.0
Accrued expenses and other liabilities	Accrued expenses and other liabilities	155,789		120,219		35,570		29.6		Accrued expenses and other liabilities	143,855		120,219		23,636		19.7
Total liabilities	Total liabilities	5,768,707		4,743,659		1,025,048		21.6		Total liabilities	5,882,760		4,743,659		1,139,101		24.0
Stockholders' equity	Stockholders' equity									Stockholders' equity
Common stock	Common stock	569,329		586,459		(17,130)		(2.9)		Common stock	570,170		586,459		(16,289)		(2.8)
Retained earnings	Retained earnings	198,342		212,474		(14,132)		(6.7)		Retained earnings	207,751		212,474		(4,723)		(2.2)
Accumulated other comprehensive income, net	Accumulated other comprehensive income, net	25,981		10,378		15,603		150.3		Accumulated other comprehensive income, net	25,208		10,378		14,830		142.9
Total stockholders' equity	Total stockholders' equity	793,652		809,311		(15,659)		(1.9)		Total stockholders' equity	803,129		809,311		(6,182)		(0.8)
Total liabilities and stockholders' equity	Total liabilities and stockholders' equity	$	6,562,359	$	5,552,970	$	1,009,389	18.2	%	Total liabilities and stockholders' equity	$	6,685,889	$	5,552,970	$	1,132,919	20.4	%

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Total assets increased ~~$1.01~~$1.13 billion, or ~~18.2%~~20.4%, to ~~$6.56~~$6.69 billion as of ~~June~~September 30, 2020 compared to $5.55 billion as of December 31, 2019.

Loans receivable, net, increased ~~$863.1~~$861.7 million, or 23.1%, to $4.59 billion at ~~June~~September 30, 2020 compared to $3.73 billion ~~as of~~at December 31, 2019 due primarily to SBA PPP ~~loan originations~~loans of ~~$856.5~~$867.8 million originated in 2020, and increases in non-owner occupied CRE loans of ~~$63.0~~$96.2 million, owner-occupied CRE loans of ~~$33.1~~$54.1 million and real estate construction and land development loans of ~~$31.3~~$40.5 million, offset partially by decreases in commercial and industrial loans of ~~$59.0~~$101.7 million and consumer loans of ~~$27.3~~$58.3 million. The decrease in commercial and industrial loans was due primarily to ~~decreases~~a decrease in the utilization rate of lines of credit ~~balances. The utilization rate for commercial and industrial lines of credit was 26.2% and~~to 23.3% at September 30, 2020 from 34.5% at ~~June 30, 2020 and~~ December 31, ~~2019, respectively.~~2019. The decrease in consumer loans was primarily due to the cessation of indirect auto loan ~~originations.~~originations in March 2020.

Investment securities available for sale decreased ~~$72.4~~$117.8 million, or ~~7.6%~~12.4%, to ~~$879.9~~$834.5 million at ~~June~~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 ~~$195.1~~$252.9 million, offset partially by ~~new~~ purchases of ~~$103.1~~$117.5 million and an increase in net unrealized gains of $18.9 million due to a decrease in market interest rates during the ~~six~~nine months ended ~~June~~September 30, 2020 that positively impacted the fair value of our bond portfolio.

Prepaid expenses and other assets increased ~~$30.1~~$30.8 million, or ~~18.3%~~18.8%, to ~~$194.2~~$194.9 million at ~~June~~September 30, 2020 from $164.1 million at December 31, 2019 primarily as a result of an increase in the fair value of ~~back-to-back~~

~~Table~~ ~~of Contents~~

interest rate swap contracts of ~~$23.3~~$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 ~~$35.6~~$23.6 million, or ~~29.6%~~19.7%, to ~~$155.8~~$143.9 million at ~~June~~September 30, 2020 compared to $120.2 million as of December 31, ~~2019.~~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 ~~$985.1 million,~~$1.11 billion, or ~~21.5%~~24.1%, to ~~$5.57~~$5.69 billion at ~~June~~September 30, 2020 from $4.58 billion at December 31, 2019 due primarily to increases in noninterest bearing demand deposits of ~~$553.3~~$542.7 million, or ~~38.2%~~37.5%, to ~~$2.00~~$1.99 billion, money market accounts of $326.1 million, or 43.3%, to $1.08 billion, and interest bearing demand deposits of ~~$244.3~~$303.8 million, or ~~18.1%~~22.5%, to ~~$1.59~~$1.65 billion, ~~money market accounts of $228.1 million, or 30.3%, to $981.8 million,~~ offset partially by ~~decreases~~a decrease in certificate of deposit accounts of ~~$33.9~~$80.5 million, or ~~6.5%~~15.4%, to ~~$490.6 million and savings accounts of $6.6 million, or 1.3%, to $502.5~~$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 ~~reduced withdrawals from deposit accounts due to a change~~changes in customer spending habits due to ~~COVID-19.~~the COVID-19 pandemic. Non-maturity deposits as a percentage of total deposits increased to ~~91.2%~~92.2% as of ~~June~~September 30, 2020 from 88.6% at December 31, 2019.

Lending Activities

The Bank is a full service commercial bank, which originates a wide variety of loans with a focus on commercial business loans. Loans ~~receivable~~receivable increased ~~$898.5~~$898.9 million, or ~~23.8%~~23.9%, to $4.67 billion at ~~June~~September 30, 2020 from $3.77 billion at December 31, 2019.

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.


		June 30, 2020						December 31, 2019													September 30, 2020				December 31, 2019
		Balance⁽¹⁾		% of Total ⁽²⁾		Balance⁽¹⁾		% of Total ⁽²⁾		Change		% of Balance Change			Balance (1)		% of Total (2)		Balance (1)		% of Total (2)		Change		% of Balance Change
		(Dollars in thousands)																							(Dollars in thousands)
Commercial business:	Commercial business:													Commercial business:
Commercial and industrial	Commercial and industrial	$	793,217	17.0	%	$	852,220	22.6	%	$	(59,003)	(6.9)	%	Commercial and industrial	$	750,557	16.1	%	$	852,220	22.6	%	$	(101,663)	(11.9)	%
SBA PPP	SBA PPP	856,490		18.4		—		—		856,490		100.0		SBA PPP	867,782		18.6		—		—		867,782		100.0
Owner-occupied CRE	Owner-occupied CRE	838,303		18.0		805,234		21.4		33,069		4.1		Owner-occupied CRE	859,338		18.4		805,234		21.4		54,104		6.7
Non-owner occupied CRE	Non-owner occupied CRE	1,351,775		29.0		1,288,779		34.2		62,996		4.9		Non-owner occupied CRE	1,384,973		29.7		1,288,779		34.2		96,194		7.5
Total commercial business	Total commercial business	3,839,785		82.4		2,946,233		78.2		893,552		30.3		Total commercial business	3,862,650		82.8		2,946,233		78.2		916,417		31.1
One-to-four family residential ⁽³⁾	One-to-four family residential ⁽³⁾	132,546		2.8		131,660		3.5		886		0.7		One-to-four family residential (3)	131,921		2.8		131,660		3.5		261		0.2
Real estate construction and land development:
One-to-four family residential		108,821		2.3		104,296		2.8		4,525		4.3
Five or more family residential and commercial properties		197,163		4.2		170,350		4.5		26,813		15.7
Total real estate construction and land development		305,984		6.5		274,646		7.3		31,338		11.4
Consumer		388,018		8.3		415,340		11.0		(27,322)		(6.6)
Loans receivable		$	4,666,333	100.0	%	$	3,767,879	100.0	%	$	898,454	23.8

⁶⁴

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	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 ~~undisbursed~~unfunded loan commitments.

⁽²⁾ Percent of loans receivable.

⁽³⁾Excludes loans held for sale of ~~$3.8~~$8.3 million and $5.5 million at ~~June~~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 ~~the adoption of~~ 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 ~~$8.3~~$7.4 million aat~~t June~~ September 30, 2020 compared to $8.4 million at December 31, 2019.

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Nonperforming Assets and Credit Quality Metrics

The following table provides information about our nonaccrual loans, other real estate owned and performing TDR loans for the indicated dates:


		June 30, 2020			December 31, 2019				September 30, 2020			December 31, 2019
		(Dollars in thousands)										(Dollars in thousands)
Nonaccrual loans:	Nonaccrual loans:							Nonaccrual loans:
Commercial business	Commercial business	$	33,382		$	44,320		Commercial business	$	50,930		$	44,320
One-to-four family residential	One-to-four family residential	160			19			One-to-four family residential	157			19

Real estate construction and land development								Real estate construction and land development	1,439			—
Consumer	Consumer	86			186			Consumer	78			186
Total nonaccrual loans ⁽¹⁾	Total nonaccrual loans ⁽¹⁾	33,628			44,525			Total nonaccrual loans (1)	52,604			44,525
Other real estate owned	Other real estate owned	—			841			Other real estate owned	—			841
Total nonperforming assets	Total nonperforming assets	$	33,628		$	45,366		Total nonperforming assets	$	52,604		$	45,366

ACL on loans	ACL on loans	$	71,501		$	36,171		ACL on loans	$	73,340		$	36,171
Nonperforming loans to loans receivable	Nonperforming loans to loans receivable	0.72		%	1.18		%	Nonperforming loans to loans receivable	1.13		%	1.18		%
ACL on loans to loans receivable	ACL on loans to loans receivable	1.53			0.96			ACL on loans to loans receivable	1.57			0.96
ACL on loans to loans receivable, excluding SBA PPP loans ⁽²⁾	ACL on loans to loans receivable, excluding SBA PPP loans ⁽²⁾	1.88			0.96			ACL on loans to loans receivable, excluding SBA PPP loans (2)	1.93			0.96
ACL on loans to nonperforming loans	ACL on loans to nonperforming loans	212.62			81.24			ACL on loans to nonperforming loans	139.42			81.24
Nonperforming assets to total assets	Nonperforming assets to total assets	0.51		%	0.82		%	Nonperforming assets to total assets	0.79		%	0.82		%

Performing TDR loans:	Performing TDR loans:							Performing TDR loans:
Commercial business	Commercial business	$	18,367		$	13,661		Commercial business	$	17,179		$	13,661
One-to-four family residential	One-to-four family residential	192			196			One-to-four family residential	190			196
Real estate construction and land development	Real estate construction and land development	1,751			237			Real estate construction and land development	1,812			237
Consumer	Consumer	377			375			Consumer	434			375
Total performing TDR loans	Total performing TDR loans	$	20,687		$	14,469		Total performing TDR loans	$	19,615		$	14,469
Accruing loans past due 90 days or more	Accruing loans past due 90 days or more	$	—		$	—		Accruing loans past due 90 days or more	$	—		$	—
Potential problem loans	Potential problem loans	100,554			87,788			Potential problem loans	159,764			87,788

⁽¹⁾At ~~June~~September 30, 2020 and December 31, 2019, ~~$20.9~~$20.5 million and $26.3 million of nonaccrual loans were considered nonperforming TDR loans, respectively.

⁽²⁾See ~~NonGAAP~~"Non-GAAP Financial ~~Measures section herein.~~Measures" section.

Nonaccrual Loans. ~~Nonaccrual~~Nonaccrual loans ~~decreased $10.9~~increased $8.1 million to ~~$33.6~~$52.6 million, or ~~0.72%~~1.13% of loans receivable at ~~June~~September 30, 2020 from $44.5 million, or 1.18% of ~~loan~~sloans receivable at December 31, 2019. The ~~decrease~~increase was due primarily to the ~~net~~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 ~~related to~~on a significant agricultural lending relationship of $7.8 million and athe full payoff of a commercial business relationship of $2.3 million.

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The following table reflects the changes in nonaccrual loans during the ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Six Months Ended June 30,							Nine Months Ended September 30,
		2020		2019			2020		2019
		(In thousands)							(In thousands)
Nonaccrual loans	Nonaccrual loans					Nonaccrual loans
Balance, beginning of period	Balance, beginning of period	$	44,525	$	13,696	Balance, beginning of period	$	44,525	$	13,696
Addition of previously classified pass graded loans	Addition of previously classified pass graded loans	259		3,581		Addition of previously classified pass graded loans	18,132		3,856
Addition of previously classified potential problem loans ⁽¹⁾	Addition of previously classified potential problem loans ⁽¹⁾	3,568		6,353		Addition of previously classified potential problem loans ⁽¹⁾	6,547		21,989

Addition of previously classified TDR loans						Addition of previously classified TDR loans	—		7,048
Net principal payments and transfer to accruing status	Net principal payments and transfer to accruing status	(13,799)		(3,940)		Net principal payments and transfer to accruing status	(15,228)		(4,393)
Charge-offs	Charge-offs	(655)		(400)		Charge-offs	(1,102)		(699)
Transfer to OREO	Transfer to OREO	(270)		—		Transfer to OREO	(270)
Balance, end of period	Balance, end of period	$	33,628	$	19,290	Balance, end of period	$	52,604	$	41,497

⁽¹⁾ ~~Includes $1.3 million of PCI loans which were converted to PCD loans as part of CECL Adoption.~~

At ~~June~~September 30, 2020, nonaccrual loans of ~~$3.4~~$20.9 million had a related ACL on loans of ~~$946,000~~$6.4 million and nonaccrual loans of ~~$30.2~~$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.

~~At June 30, 2020, nonperforming TDR loans, included in the nonaccrual loan table above, were $20.9 million and had a related ACL on loans of $371,000, including $19.7 million of non~~performing TDR loans with no related ACL on loans. At December 31, 2019, nonperforming TDR loans were $26.3 million and had a related allowance for loan losses of $218,000, including $24.2 million of nonperforming TDR loans with no related ACL on loans.

Nonperforming Assets. Nonperforming assets consist of nonaccrual loans and other real estate owned. ~~Nonperforming~~Nonperforming assets ~~decreased $11.7~~increased $7.2 million to ~~$33.6~~$52.6 million, or ~~0.51%~~0.79% of total assets, at ~~June~~September 30, 2020 from $45.4 million, or 0.82% of total assets, at December 31, 2019 due to the ~~decrease~~increase in nonaccrual loans discussed above and the decrease in other real estate owned resulting from the disposition of the two remaining properties at December 31, 2019 during the ~~six~~nine months ended ~~June~~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 as outlined in our accounting policies. Performing TDR loans are not considered nonperforming assets as they continue to accrue interest despite the restructured status. ~~The performing~~Performing TDR loans increased ~~$6.2~~$5.1 million, or ~~43.0%~~35.6%, to ~~$20.7~~$19.6 million at ~~June~~September 30, 2020 from $14.5 million at December 31, 2019. The increase was due primarily to ~~additions of previously classified pass graded loans, including~~ three commercial business lending relationships totaling ~~$3.5~~$3.6 million ~~of which $2.1 million was modified as a result of the adverse economic impact from COVID-19,~~ and ~~additions of previously classified potential problem loans, including~~ one residential construction relationship of $1.5 million which was previously reported as a potential problem loan. The increase in TDR loans for the nine months ended September 30, 2020 was offset partially by loans paid in full totaling $2.6 million.

The following table reflects the changes in performing TDR loans during the ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Six Months Ended June 30,							Nine Months Ended September 30,
		2020		2019			2020		2019
		(In thousands)							(In thousands)
Performing TDR loans	Performing TDR loans					Performing TDR loans
Balance, beginning of period	Balance, beginning of period	$	14,469	$	22,744	Balance, beginning of period	$	14,469	$	22,744
Addition of previously classified pass graded loans	Addition of previously classified pass graded loans	4,058		2,631		Addition of previously classified pass graded loans	4,495		2,631
Addition of previously classified potential problem loans	Addition of previously classified potential problem loans	2,814		4,671		Addition of previously classified potential problem loans	3,014		8,347
Loans added formerly nonaccrual	Loans added formerly nonaccrual	281		—		Loans added formerly nonaccrual	281		—

Transfers of loans to nonaccrual status						Transfers of loans to nonaccrual status	—		(7,048)
Charge-offs	Charge-offs	—		(10)		Charge-offs	—		(20)
Net principal payments	Net principal payments	(935)		(4,108)		Net principal payments	(2,644)		(7,234)
Balance, end of period	Balance, end of period	$	20,687	$	25,928	Balance, end of period	$	19,615	$	19,420

~~Table~~ ~~of Contents~~

The related ACL on loans for performing TDR loans was ~~$1.6~~$1.5 million as of ~~June~~September 30, 2020 and $1.3 million as of December 31, 2019.

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Potential Problem Loans. Potential pr~~oblem~~problem loans are loans risk rated special mention or worse that are not classified as a TDR or nonaccrual loan and are not 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 increased ~~$12.8~~$72.0 million, or ~~14.5%~~82.0%, to ~~$100.6~~$159.8 million at ~~June~~September 30, 2020 compared to $87.8 million at December 31, ~~2019. The increase was~~2019 primarily attributed to risk classification downgrades related to COVID-19. Included in the ~~addition~~balance of ~~six commercial business relationships,~~potential problem loans at September 30, 2020 are $71.4 million of loans that were modified under the CARES Act, including ~~two hotels, totaling $20.6~~$20.3 million ~~which~~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 ~~a result of the adverse economic impact from COVID-19.~~ ~~The Company's practice on COVID-19 related loan issues was~~potential problem loans if additional factors were identified to ~~downgrade to a "Watch" grade if the loan was modified, unless the borrower exhibited strong financial position, or other factors indicated~~cause a more severe risk grade ~~was necessary.~~than watch. At September 30, 2020, loans totaling $102.4 million and $57.3 million were rated special mention and substandard, respectively. ~~The additions to potential problem loans also included 11 commercial business relationships totaling $16.2 million which were downgraded to increase oversight of these credits due to other concerns.~~ The increase in potential problem loans for the ~~six~~nine months ended ~~June~~September 30, 2020 was offset partially ~~offset~~ by net principal payments of ~~$18.2~~$23.0 million, including payment in full of ~~three commercial~~$11.8 million and ~~industrial relationships totaling $4.7 million.~~by transfers of loans to nonaccrual and TDR status.

The following table reflects the changes in potential problem loans during the ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Six Months Ended June 30,								Nine Months Ended September 30,
		2020		2019			2020			2019

Potential problem loans	Potential problem loans								Potential problem loans
Balance, beginning of period	Balance, beginning of period	$	87,788	$	101,320	Balance, beginning of period	$	87,788		$	101,320
Addition of previously classified pass graded loans	Addition of previously classified pass graded loans	43,942		40,708		Addition of previously classified pass graded loans	114,119			46,274

Upgrades to pass graded loan status	Upgrades to pass graded loan status	(6,592)		(2,858)		Upgrades to pass graded loan status	(9,540)			(8,816)
Net principal payments	Net principal payments	(18,202)		(13,650)		Net principal payments	(23,042)			(22,593)
Transfers of loans to nonaccrual and TDR status	Transfers of loans to nonaccrual and TDR status	(6,382)		(11,024)		Transfers of loans to nonaccrual and TDR status	(9,561)			(30,336)
Charge-offs	Charge-offs	—		(427)		Charge-offs	—			(510)
Balance, end of period	Balance, end of period	$	100,554	$	114,069	Balance, end of period	$	159,764		$	85,339

Analysis of Allowance for Credit Losses on Loans

~~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 ~~Operations.~~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 ~~allowance~~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, ~~the~~ baseline loss rates are separately calculated using the ~~bank's~~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, including prepayment estimates.~~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 ~~add to~~adjust the ACL if internal or external conditions suggest ~~adjustments~~changes to the ~~historical loss information or the macroeconomic forecast.~~modeled ACL are appropriate.

6968

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The following table provides information regarding changes in our ACL on loans and the allowance for loan losses at and for the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019, respectively:


		Three Months Ended June 30,									Six Months Ended June 30,										Three Months Ended September 30,						Nine Months Ended September 30,
		2020			2019			2020			2019				2020			2019			2020			2019
		(Dollars in thousands)																						(Dollars in thousands)
ACL on loans at the beginning of the period	ACL on loans at the beginning of the period	$	47,540		$	36,152		$	36,171		$	35,042		ACL on loans at the beginning of the period	$	71,501		$	36,363		$	36,171		$	35,042
Impact of CECL adoption	Impact of CECL adoption	—			—			1,822			—			Impact of CECL adoption	—			—			1,822			—
Adjusted ACL on loans, beginning of the period	Adjusted ACL on loans, beginning of the period	47,540			36,152			37,993			35,042			Adjusted ACL on loans, beginning of the period	71,501			36,363			37,993			35,042

Charge-offs:	Charge-offs:													Charge-offs:
Commercial business	Commercial business	(1,824)			(774)			(3,046)			(877)			Commercial business	(507)			(306)			(3,553)			(1,183)
One-to-four family residential	One-to-four family residential	—			(15)			—			(30)			One-to-four family residential	—			(15)			—			(45)

Consumer	Consumer	(431)			(566)			(806)			(1,152)			Consumer	(335)			(501)			(1,141)			(1,653)
Total charge-offs	Total charge-offs	(2,255)			(1,355)			(3,852)			(2,059)			Total charge-offs	(842)			(822)			(4,694)			(2,881)
Recoveries:	Recoveries:													Recoveries:
Commercial business	Commercial business	71			62			1,140			221			Commercial business	80			381			1,220			602
One-to-four family residential	One-to-four family residential	—			—			3			—			One-to-four family residential	—			—			3			—
Real estate construction and land development	Real estate construction and land development	7			7			21			625			Real estate construction and land development	139			3			160			628
Consumer	Consumer	197			130			291			247			Consumer	142			127			433			374
Total recoveries	Total recoveries	275			199			1,455			1,093			Total recoveries	361			511			1,816			1,604
Net charge-offs	Net charge-offs	(1,980)			(1,156)			(2,397)			(966)			Net charge-offs	(481)			(311)			(2,878)			(1,277)

Net Credit Loss		1,980			1,156			2,397			966
Reserve Build		23,961			211			33,508			1,321
Provision for credit losses on loans	Provision for credit losses on loans	25,941			1,367			35,905			2,287			Provision for credit losses on loans	2,320			466			38,225			2,753

ACL on loans at the end of the period	ACL on loans at the end of the period	$	71,501		$	36,363		$	71,501		$	36,363		ACL on loans at the end of the period	$	73,340		$	36,518		$	73,340		$	36,518

ACL on loans to loans receivable	ACL on loans to loans receivable	1.53		%	0.98		%	1.53		%	0.98		%	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⁾	ACL on loans to loans receivable, excluding SBA PPP loans ⁽³⁾	1.88			0.98			1.88			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, net ⁽¹⁾		0.18		%	0.13		%	0.12		%	0.05		%
Net charge-offs on loans to average loans receivable, net (1)														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⁾	Loans receivable at the end of the period ⁽²⁾	$	4,666,333		$	3,718,283		$	4,666,333		$	3,718,283		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 ⁽²⁾		4,442,108			3,654,475			4,095,340			3,638,573
Average loans receivable, net during the period														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 ~~$35.3~~$37.2 million, or ~~97.7%~~102.8%, to ~~$71.5~~$73.3 million at ~~June~~September 30, 2020 from $36.2 million at December 31, 2019, and increased ~~$33.5~~$35.3 million, or ~~88.2%~~93.0%, from the adjusted beginning balance of ~~$38.0.~~$38.0 million. The increase in ACL was primarily the result of the provision for credit losses on loans of ~~$35.9~~$38.2 million recognized during the ~~six~~nine months ended ~~June~~September 30, 2020 due primarily to forecasted credit deterioration reflecting economic conditions as a result of the COVID-19 pandemic.

~~Table~~ ~~of Contents~~

The macroeconomic forecast used in the CECL model as of ~~June~~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 ~~was as~~reflected a slow and long recovery from the COVID-19 recession. The modeled recovery is expected to last through the end of ~~June 9,~~2021, including a contraction in GDP of 3.7% for 2020 and ~~included the actual results~~a rebound of ~~the sharp recession, followed by forecasted widened "U-shaped" recovery with unemployment rate spiking to 13% in second quarter 2020~~3.7% for 2021, and ~~decreasing to 5% by 2023, and GDP slumping 6.1% in 2020, but rebounding 6.3% in 2021, with~~ modest increases in GDP in future years. ~~This forecast is in stark contrast~~Unemployment rates are expected to ~~that used in CECL model as~~average 8.7% during the remainder of ~~January 1,~~ 2020 ~~which predicted steady GDP growth~~ and ~~unemployment rates similar~~gradually reduce to ~~the 4% at December 31, 2019, among other factors.~~4.0% by 2025.

The Company recorded charge-offs of ~~$3.9~~$4.7 million during the ~~six~~nine months ended ~~June~~September 30, 2020 primarily due ~~primarily~~ to one commercial and industrial loan ~~charge-offs of $3.0 million, including one loan~~ of $1.7 million that had been experiencing financial difficulties.

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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. 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 ~~$1.5~~$1.8 million during the ~~six~~nine months ended ~~June~~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.~~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 ~~$71.5~~$73.3 million ~~(1.53%~~(1.57% of loans receivable and ~~212.62%~~139.42% of nonperforming loans) at ~~June~~September 30, 2020 appropriate to provide for current expected ~~credit~~credit losses in the portfolio. This compares to an allowance for loan losses of $36.2 million (0.96% of loans receivable and 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 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 ACL on loans and may adversely affect the Company’s financial condition and results of operations. In addition, the determination of the amount of the ACL 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 ACL on loans based upon their judgment of information available to them at the time of their examination. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing ACL on loans is appropriate or that increased provisions will not be necessary should the quality of the loans deteriorate. Any material increase in the ACL on loans would adversely affect the Company’s financial condition and results of operations.

Deposits and Other Borrowings

Total deposits increased ~~$985.1 million,~~$1.11 billion, or ~~21.5%~~24.1%, to ~~$5.57~~$5.69 billion at ~~June~~September 30, 2020 from $4.58 billion at December 31, 2019. Non-maturity deposits as a percentage of total deposits increased ~~2.6%~~3.6% to ~~91.2%~~92.2% at ~~June~~September 30, 2020 compared to 88.6% at December 31, 2019.

The following table summarizes the Company's deposits as of ~~June~~September 30, 2020 and December 31, 2019:


		June 30, 2020						December 31, 2019											September 30, 2020				December 31, 2019
		Balance		% of Total		Balance		% of Total		Change		% of Balance Change			Balance		% of Total		Balance		% of Total		Change		% of Balance Change
		(Dollars in thousands)																							(Dollars in thousands)
Noninterest demand deposits	Noninterest demand deposits	$	1,999,754	35.9	%	$	1,446,502	31.6	%	$	553,252	38.2	%	Noninterest demand deposits	$	1,989,247	35.0	%	$	1,446,502	31.6	%	$	542,745	37.5	%
Interest bearing demand deposits	Interest bearing demand deposits	1,593,074		28.6		1,348,817		29.4		244,257		18.1		Interest bearing demand deposits	1,652,661		29.0		1,348,817		29.4		303,844		22.5
Money market accounts	Money market accounts	981,750		17.6		753,684		16.4		228,066		30.3		Money market accounts	1,079,814		19.0		753,684		16.4		326,130		43.3
Savings accounts	Savings accounts	502,508		9.1		509,095		11.2		(6,587)		(1.3)		Savings accounts	523,286		9.2		509,095		11.2		14,191		2.8
Total non-maturity deposits	Total non-maturity deposits	5,077,086		91.2		4,058,098		88.6		1,018,988		25.1		Total non-maturity deposits	5,245,008		92.2		4,058,098		88.6		1,186,910		29.2
Certificates of deposit	Certificates of deposit	490,647		8.8		524,578		11.4		(33,931)		(6.5)		Certificates of deposit	444,040		7.8		524,578		11.4		(80,538)		(15.4)
Total deposits	Total deposits	$	5,567,733	100.0	%	$	4,582,676	100.0	%	$	985,057	21.5		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, ~~reduced withdrawals from~~an increase in customer deposit accounts based on changes in spending habits during the COVID-19 pandemic, and an increase in new deposit accounts. At ~~June~~September 30, 2020, the Bank had approximately ~~839~~553 deposit accounts with balances of approximately ~~$100.6~~$82.9 million related to new customers that received a SBA PPP loan from the Bank.

~~Table~~ ~~of Contents~~

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 also utilizes securities sold under agreement to repurchase as a supplement to its funding sources, which are secured by available for sale investment securities. During the latter part of 2019, the Bank made an effort to transition customers from securities sold under agreement to repurchase to other deposit products. As of ~~June~~September 30, 2020 and December 31, 2019, only three customers utilized this product with total balances ~~$24.4~~$29.0 million at ~~June~~

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September 30, 2020, an increase of ~~$4.3~~$8.9 million, or ~~21.2%~~44.0%, from $20.2 million at December 31, 2019 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 ~~$20.7~~$20.8 million at ~~June~~September 30, 2020, which reflects the fair value of the junior subordinated debentures established as part of the merger with Washington Banking Company on May 1, 2014, adjusted for the accretion of discount from purchase accounting fair value adjustment.

At ~~June~~September 30, 2020, the Bank maintained credit facilities with the FHLB for ~~$942.8~~$891.7 million and credit facilities with the Federal Reserve Bank for ~~$60.3~~$55.0 million. The Company had no FHLB or Federal Reserve Bank advances outstanding at both ~~June~~September 30, 2020 and December 31, 2019.

The Bank maintains lines of credit with five correspondent banks to purchase federal funds totaling $215.0 million as of ~~June~~September 30, 2020. There were no federal funds purchased as of ~~June~~September 30, 2020 or December 31, 2019.

~~At June 30, 2020, the~~The Bank was ~~also~~ approved to utilize the PPPLF at September 30, 2020; however, ~~had~~the Bank has chosen not ~~yet participated in~~to participate during the ~~program.~~nine months ended September 30, 2020.

Liquidity and Cash Flows

Our primary sources of funds are customer and local government deposits; loan principal and interest payments; maturities, calls, and payments of investment securities including related interest earned; and proceeds from sales 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 predictable sources 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 ~~June~~September 30, 2020, the Company (on an unconsolidated basis) had cash and cash equivalents of ~~$2.3 million and a receivable from the Bank of $7.0~~$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 ~~June~~September 30, 2020, cash and cash equivalents totaled ~~$415.1~~$576.2 million, or ~~6.3%~~8.6% of total assets and the fair value of investment securities available for sale totaled ~~$879.9~~$834.5 million of which ~~$260.6~~$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 ~~$619.3~~$570.7 million, or ~~9.4%~~8.5% of total assets at ~~June~~September 30, 2020. The fair value of investment securities available for sale with contractual maturities of one year or less were ~~$47.8~~$63.7 million, or ~~0.7%~~1.0% of total assets, at ~~June~~September 30, 2020.

Consolidated Cash Flows: As disclosed in the Condensed Consolidated Statements of Cash Flows, net cash provided by operating activities was ~~$72.3~~$76.6 million for the ~~six~~nine months ended ~~June~~September 30, 2020, and primarily consisted of net ~~loss~~income of ~~$6.1~~$22.7 million ~~net of~~and non-cash adjustments to reconcile net income to cash provided by operating activities, including provision for credit losses of ~~$36.5~~$39.2 million and ~~changes in net deferred loan fees, net~~

~~Table~~ depreciation, amortization, and accretion of ~~Contents~~

~~of amortization of $26.0~~$28.3 million. During the ~~six~~nine months ended ~~June~~September 30, 2020, net cash used by investing activities was ~~$841.6~~$803.5 million, which consisted primarily of net loan originations of ~~$928.8~~$924.9 million, including ~~$883.9~~$897.4 million related to SBA PPP loan originations, offset partially by net investment securities activity of ~~$92.0~~$135.5 million. Net cash provided by financing activities was ~~$955.9 million~~$1.07 billion for the ~~six~~nine months ended ~~June~~September 30, 2020 and primarily consisted of a net increase in deposits of ~~$985.1 million~~$1.11 billion primarily ~~related~~due to the proceeds from SBA PPP loans ~~being~~ deposited directly into the customers' deposit accounts, an increase in customer deposit accounts ~~and reduced withdrawals from deposit accounts due to~~based

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on changes in ~~customer~~ spending habits during the COVID-19 pandemic, and an increase in new deposit accounts partially offset by dividends paid of $21.7 million and repurchases of common stock of $19.1 ~~million and dividends paid of $14.5~~ million during the period.

Stockholders' Equity and Regulatory Capital Requirements

Stockholders’ equity was ~~$793.7~~$803.1 million at ~~June~~September 30, 2020 compared to $809.3 million at December 31, 2019. The Company’s stockholders' equity to assets ratio was ~~12.1%~~12.0% as of ~~June~~September 30, 2020 and 14.6% as of December 31, 2019. The following table reflects the changes to stockholders' equity during the three and ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended September 30,				Nine Months Ended September 30,
		2020		2019		2020		2019			2020		2019		2020		2019
		(In Thousands)															(In Thousands)
Balance, beginning of period	Balance, beginning of period	$	798,438	$	778,191	$	809,311	$	760,723	Balance, beginning of period	$	793,652	$	796,625	$	809,311	$	760,723
Cumulative effect from change in accounting policy⁽¹⁾	Cumulative effect from change in accounting policy⁽¹⁾	—		—		(5,615)		(399)		Cumulative effect from change in accounting policy (1)	—		—		(5,615)		(399)
Net income	Net income	(6,139)		15,984		6,052		32,536		Net income	16,636		17,895		22,688		50,431
Dividends declared	Dividends declared	(7,226)		(6,679)		(14,569)		(13,341)		Dividends declared	(7,227)		(7,042)		(21,796)		(20,383)
Other comprehensive income, net of tax	Other comprehensive income, net of tax	7,689		9,193		15,603		17,209		Other comprehensive income, net of tax	(773)		2,771		14,830		19,980
Repurchase of common stock	Repurchase of common stock	(38)		(879)		(19,098)		(1,681)		Repurchase of common stock	(7)		(6,954)		(19,105)		(8,635)
Other	Other	928		815		1,968		1,578		Other	848		832		2,816		2,410
Balance, end of period	Balance, end of period	$	793,652	$	796,625	$	793,652	$	796,625	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 ~~June~~September 30, 2020 as the Company suspended repurchases in response to the COVID-19 pandemic.

During the ~~six~~nine months ended ~~June~~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 price of $20.34 under the twelfth 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 three and ~~six~~nine months ended ~~June~~September 30, 2019, the Company repurchased ~~28,000~~264,712 and 292,712 shares, respectively, available under the eleventh stock repurchase plan at a weighted average price per share of ~~$29.12.~~$26.23 and $26.50, respectively.

The Company has historically paid cash dividends to its common shareholders. Payments of future cash dividends, if 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 ability 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 ~~July 22,~~October 21, 2020, the Company’s Board of Directors declared a regular dividend of $0.20 per common share which is payable on ~~August 19,~~November 18, 2020 to shareholders of record on ~~August 5,~~November 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 ~~June~~September 30, 2020, the Company and the Bank meet all capital adequacy requirements to which they are subject.

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As of ~~June~~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

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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					Minimum Requirements				Well-Capitalized Requirements		Actual
		(Dollars in thousands)																							(Dollars in thousands)
As of June 30, 2020:
As of September 30, 2020:														As of September 30, 2020:
The Company consolidated	The Company consolidated													The Company consolidated
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	$	208,575	4.5	%	N/A		N/A		$	527,768	11.4	%	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	Tier 1 leverage capital to average assets	215,024		4.0		N/A		N/A		548,509		10.2		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	Tier 1 capital to risk-weighted assets	278,100		6.0		N/A		N/A		548,509		11.8		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	Total capital to risk-weighted assets	370,800		8.0		N/A		N/A		606,469		13.1		Total capital to risk-weighted assets	368,557		8.0		N/A		N/A		617,914		13.4
Heritage Bank	Heritage Bank													Heritage Bank
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	208,409		4.5		$	300,362	6.5	%	536,674		11.6		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	Tier 1 leverage capital to average assets	214,882		4.0		268,529		5.0		536,674		10.0		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	Tier 1 capital to risk-weighted assets	277,879		6.0		369,676		8.0		536,674		11.6		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	Total capital to risk-weighted assets	370,506		8.0		462,096		10.0		594,634		12.8		Total capital to risk-weighted assets	$	368,238	8.0	%	$	460,298	10.0	%	$	605,609	13.2	%

As of December 31, 2019:	As of December 31, 2019:													As of December 31, 2019:
The Company consolidated	The Company consolidated													The Company consolidated
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	$	211,110	4.5	%	N/A		N/A		$	541,154	11.5	%	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	Tier 1 leverage capital to average assets	212,578		4.0		N/A		N/A		561,749		10.6		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	Tier 1 capital to risk-weighted assets	281,479		6.0		N/A		N/A		561,749		12.0		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	Total capital to risk-weighted assets	375,306		8.0		N/A		N/A		598,226		12.8		Total capital to risk-weighted assets	375,306		8.0		N/A		N/A		598,226		12.8
Heritage Bank	Heritage Bank													Heritage Bank
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	211,017		4.5		$	304,803	6.5	%	538,560		11.5		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	Tier 1 leverage capital to average assets	211,187		4.0		263,984		5.0		538,560		10.2		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	Tier 1 capital to risk-weighted assets	281,356		6.0		375,142		8.0		538,560		11.5		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	Total capital to risk-weighted assets	375,142		8.0		468,927		10.0		575,037		12.3		Total capital to risk-weighted assets	$	375,142	8.0	%	$	468,927	10.0	%	$	575,037	12.3	%

As of ~~June~~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 ~~June~~September 30, 2020, the capital conservation buffer was ~~5.1%~~5.4% and ~~4.8%~~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

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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

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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 ~~six~~nine months ended ~~June~~September 30, 2020 and 2019:


		Three Months Ended June 30,									Six Months Ended June 30,										Three Months Ended September 30,						Nine Months Ended September 30,
		2020			2019			2020			2019				2020			2019			2020			2019
		(Dollars in thousands)																						(Dollars in thousands)
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized:	Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized:																								Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized:
Interest and fees on loans (GAAP)	Interest and fees on loans (GAAP)	$	48,404		$	48,107		$	94,681		$	94,806		Interest and fees on loans (GAAP)	$	47,647		$	47,845		$	142,328		$	142,651
Exclude SBA PPP loan interest and fees	Exclude SBA PPP loan interest and fees	(4,923)			—			(4,923)			—			Exclude SBA PPP loan interest and fees	(5,810)			—			(10,733)			—
Exclude incremental accretion on purchased loans	Exclude incremental accretion on purchased loans	(696)			(1,416)			(1,708)			(2,789)			Exclude incremental accretion on purchased loans	(944)			(1,090)			(2,651)			(3,879)
Adjusted interest and fees on loans (non-GAAP)	Adjusted interest and fees on loans (non-GAAP)	$	42,785		$	46,691		$	88,050		$	92,017		Adjusted interest and fees on loans (non-GAAP)	$	40,893		$	46,755		$	128,944		$	138,772

Average loans receivable, net	Average loans receivable, net	$	4,442,108		$	3,654,475		$	4,095,340		$	3,638,573		Average loans receivable, net	$	4,605,389		$	3,677,405		$	4,266,598		$	3,651,659
Exclude average SBA PPP loans	Exclude average SBA PPP loans	(667,390)			—			(333,695)			—			Exclude average SBA PPP loans	(863,127)			—			(511,461)			—
Adjusted average loans receivable, net (non-GAAP)	Adjusted average loans receivable, net (non-GAAP)	$	3,774,718		$	3,654,475		$	3,761,645		$	3,638,573		Adjusted average loans receivable, net (non-GAAP)	$	3,742,262		$	3,677,405		$	3,755,137		$	3,651,659

Loan yield, annualized (GAAP)	Loan yield, annualized (GAAP)	4.38		%	5.28		%	4.65		%	5.25		%	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)	Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized (non-GAAP)	4.56		%	5.12		%	4.71		%	5.10		%	Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized (non-GAAP)	4.35		%	5.04		%	4.59		%	5.08		%


		June 30, 2020			December 31, 2019				September 30, 2020			December 31, 2019
		(Dollars in thousands)										(Dollars in thousands)
ACL on loans to loans receivable, excluding SBA PPP loans	ACL on loans to loans receivable, excluding SBA PPP loans												ACL on loans to loans receivable, excluding SBA PPP loans
Allowance for credit losses on loans	Allowance for credit losses on loans	$	(71,501)		$	(36,171)		Allowance for credit losses on loans	$	(73,340)		$	(36,171)

Loans receivable (GAAP)	Loans receivable (GAAP)	$	4,666,333		$	3,767,879		Loans receivable (GAAP)	$	4,666,730		$	3,767,879
Exclude SBA PPP loans	Exclude SBA PPP loans	856,490			—			Exclude SBA PPP loans	867,782			—
Loans receivable, excluding SBA PPP (non-GAAP)	Loans receivable, excluding SBA PPP (non-GAAP)	$	3,809,843		$	3,767,879		Loans receivable, excluding SBA PPP (non-GAAP)	$	3,798,948		$	3,767,879

ACL on loans to Loans receivable (GAAP)	ACL on loans to Loans receivable (GAAP)	1.53		%	0.96		%	ACL on loans to Loans receivable (GAAP)	1.57		%	0.96		%
ACL on loans to Loans receivable, excluding SBA PPP loans (non-GAAP)	ACL on loans to Loans receivable, excluding SBA PPP loans (non-GAAP)	1.88		%	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.

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As a result of the COVID-19 pandemic, our interest rate risk exposure has changed since the information disclosed in our 2019 Annual Form 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:


		June 30, 2020		December 31, 2019			September 30, 2020		December 31, 2019
		(Dollars in thousands)							(Dollars in thousands)
Up 100	Up 100					Up 100
Year 1	Year 1	$	11,928	$	8,149	Year 1	$	13,459	$	8,149
Year 2	Year 2	24,652		15,933		Year 2	26,015		15,572
Up 200	Up 200					Up 200
Year 1	Year 1	23,671		15,572		Year 1	26,726		15,933
Year 2	Year 2	48,464		29,806		Year 2	51,418		29,806
Down 100	Down 100					Down 100
Year 1	Year 1	(2,644)		(7,415)		Year 1	(2,845)		(7,415)
Year 2	Year 2	(6,884)		(15,178)		Year 2	$	(7,172)	$	(15,178)

These scenarios are based on interest rates as of the last 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 ~~six~~nine months ended ~~June~~September 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 risk derivative instruments. Moreover, neither we, nor 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 ~~June~~September 30, 2020 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

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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 ~~June~~September 30, 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

We, and our 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 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. InThe 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 ~~many~~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

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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 ~~recent reductions in~~ 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

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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 ~~via a streamlined approval process~~ for ~~90-day~~ 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.

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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 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.

The Company has had various stock repurchase programs since March 1999. On March 12, 2020 the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock repurchase plan. The number, timing and price of shares repurchased will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.

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In addition to the stock repurchases under a plan, the Company repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units. The following table provides total repurchased shares for the periods indicated:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended September 30,				Nine Months Ended September 30,
		2020		2019		2020		2019			2020		2019		2020		2019
Repurchased shares to pay withholding taxes	Repurchased shares to pay withholding taxes	2,046		2,175		27,928		28,029		Repurchased shares to pay withholding taxes	378		405		28,306		28,434
Stock repurchase to pay withholding taxes average share price	Stock repurchase to pay withholding taxes average share price	$	18.62	$	29.31	$	21.56	$	30.88	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 ~~June~~September 30, 2020:

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
April 1, 2020— April 30, 2020 — $ — 8,981,801 1,643,276
May 1, 2020— May 31, 2020 543 19.40 8,981,801 1,643,276
June 1, 2020— June 30, 2020 1,503 18.34 8,981,801 1,643,276
Total 2,046 $ 18.62


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

⁽¹⁾Of the common shares repurchased by the Company between ~~April~~July 1, 2020 and ~~June~~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

Table of Contents

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

Incorporated by Reference
Exhibit No. Description of Exhibit Form Exhibit Filing Date/Period End Date
3.3.
Amended and Restated Bylaws of the Company
8-K 3.3 06/30/2020
10.37*
Employment Agreement by and between Heritage and Tony Chalfant
8-K 10.1 06/30/2020
10.38*
Deferred Compensation Plan and Participation Agreement by and between Heritage and Tony Chalfant
8-K 10.3 06/30/2020
10.39*
Transitional Retirement Agreement by and between Heritage and David A. Spurling
8-K 10.2 06/30/2020
31.1
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 ⁽¹⁾

~~Table~~ ~~of Contents~~

~~31.2~~

~~Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002~~⁽¹⁾

~~32.1~~

~~Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002~~⁽¹⁾

~~101.INS~~

~~XBRL Instance Document~~ ⁽¹⁾

~~101.SCH~~

~~XBRL Taxonomy Extension Schema Document~~ ⁽¹⁾

~~101.CAL~~

~~XBRL Taxonomy Extension Calculation Linkbase Document~~ ⁽¹⁾

~~101.DEF~~

~~XBRL Taxonomy Extension Definition Linkbase Document~~ ⁽¹⁾

~~101.LAB~~

~~XBRL Taxonomy Extension Label Linkbase Document~~ ⁽¹⁾

~~101.PRE~~

~~XBRL Taxonomy Extension Presentation Linkbase Document~~ ⁽¹⁾

Incorporated by Reference

Exhibit No.

Description of Exhibit

Form

Exhibit

Filing Date/Period End Date

3.3.

Amended and Restated Bylaws of the Company

8-K

3.3

06/30/2020

10.37*

Employment Agreement by and between Heritage and Tony Chalfant

8-K

10.1

06/30/2020

10.38*

Deferred Compensation Plan and Participation Agreement by and between Heritage and Tony Chalfant

8-K

10.3

06/30/2020

10.39*

Transitional Retirement Agreement by and between Heritage and David A. Spurling

8-K

10.2

06/30/2020

31.1

Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)

31.2

Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)

32.1

Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

101.INS

XBRL Instance Document (1)

101.SCH

XBRL Taxonomy Extension Schema Document (1)

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document (1)

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document (1)

101.LAB

XBRL Taxonomy Extension Label Linkbase Document (1)

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document (1)

*Indicates management contract or compensatory plan or arrangement

⁽¹⁾ Filed herewith.

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.


						HERITAGE FINANCIAL CORPORATION

Date:
~~August 5,~~November 9, 2020						/S/ JEFFREY J. DEUEL
						Jeffrey J. Deuel
						President and Chief Executive Officer

Date:
~~August 5,~~November 9, 2020						/S/ DONALD J. HINSON
						Donald J. Hinson
						Executive Vice President and Chief Financial Officer

8079


	Six Months Ended June 30, 2020						Six months ended June 30, 2019
	Interest Income Reversed		Interest Income Recognized		Interest Income Reversed		Interest Income Recognized
	(in thousands)
Commercial business:
Commercial and industrial	$	(16)	$	308	$	(56)	$	60
Owner-occupied CRE	—		60		—		46
Non-owner occupied CRE	—		67		(34)		—
Total commercial business	(16)		435		(90)		106

Real estate construction and land development:
One-to-four family residential	—		—		(3)		23


Consumer	—		47		—		6
Total	$	(16)	$	482	$	(93)	$	135


	Six Months Ended June 30, 2020
	Balance at Beginning		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	$	(2,911)	$	1,126	$	21,167	$	29,773
SBA PPP	—		—		—		—		—		—		—
Owner-occupied CRE	4,512		452		4,964		(135)		14		5,160		10,003
Non-owner occupied CRE	7,682		(2,039)		5,643		—		—		5,023		10,666
Total commercial business	23,933		(2,935)		20,998		(3,046)		1,140		31,350		50,442
One-to-four family residential	1,458		1,471		2,929		—		3		(709)		2,223
Real estate construction and land development:
One-to-four family residential	1,455		(571)		884		—		21		(338)		567
Five or more family residential and commercial properties	1,605		7,240		8,845		—		—		(288)		8,557
Total real estate construction and land development	3,060		6,669		9,729		—		21		(626)		9,124
Consumer	6,821		(2,484)		4,337		(806)		291		5,890		9,712
Unallocated	899		(899)		—						—		—
Total	$	36,171	$	1,822	$	37,993	$	(3,852)	$	1,455	$	35,905	$	71,501


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
April 1, 2020— April 30, 2020	—	$	—	8,981,801	1,643,276
May 1, 2020— May 31, 2020	543	19.40		8,981,801	1,643,276
June 1, 2020— June 30, 2020	1,503	18.34		8,981,801	1,643,276
Total	2,046	$	18.62