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HMST HomeStreet

Filed: 6 Nov 20, 4:04pm

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: 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: 001-35424
________________________________ 
HOMESTREET, INC.
(a Washington Corporation )
91-0186600
________________________________ 

601 Union Street, Suite 2000
Seattle, Washington 98101
(Address of principal executive offices)

Telephone Number - Area Code (206) 623-3050

Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common StockHMSTNasdaq Global Select Market


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, a 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 

The number of outstanding shares of the registrant's common stock as of November 3, 2020 was 21,787,938.





Unless we state otherwise or the content otherwise requires, references in this Form 10-Q to "HomeStreet," "we," "our," "us" or the "Company" refer collectively to HomeStreet, Inc., a Washington corporation, HomeStreet Bank ("Bank"), HomeStreet Capital Corporation ("HomeStreet Capital") and other direct and indirect subsidiaries of HomeStreet, Inc.

2


PART I
ITEM 1 FINANCIAL STATEMENTS


HOMESTREET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)September 30,
2020
December 31,
2019
(Unaudited)
ASSETS
Cash and cash equivalents$79,066 $57,880 
Investment securities1,111,468 943,150 
Loans held for sale ("LHFS")421,737 208,177 
Loans held for investment ("LHFI") (net of allowance for credit losses of $64,892 and $41,772)5,229,477 5,072,784 
Mortgage servicing rights78,824 97,603 
Premises and equipment, net69,438 76,973 
Other real estate owned ("OREO")958 1,393 
Goodwill and other intangible assets33,222 34,252 
Other assets385,451 291,595 
Assets of discontinued operations28,628 
Total assets$7,409,641 $6,812,435 
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits$5,815,690 $5,339,959 
Borrowings514,590 471,590 
Long-term debt125,791 125,650 
Accounts payable and other liabilities257,264 192,910 
Liabilities of discontinued operations2,603 
Total liabilities6,713,335 6,132,712 
Commitments and contingencies
Shareholders' equity:
Common stock, 0 par value, authorized 160,000,000 shares, issued and outstanding, 21,994,204 shares and 23,890,855 shares280,422 300,729 
Retained earnings383,107 374,673 
Accumulated other comprehensive income32,777 4,321 
Total shareholders' equity696,306 679,723 
Total liabilities and shareholders' equity$7,409,641 $6,812,435 

See accompanying notes to consolidated financial statements
3


HOMESTREET, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands, except share and per share data)2020201920202019
Interest income:
Loans$57,538 $64,779 $172,275 $194,713 
Investment securities5,667 4,879 16,053 15,327 
Cash, Fed Funds and other532 419 960 799 
Total interest income63,737 70,077 189,288 210,839 
Interest expense:
Deposits5,986 20,502 28,944 51,754 
Borrowings2,067 2,441 7,730 15,207 
Total interest expense8,053 22,943 36,674 66,961 
Net interest income55,684 47,134 152,614 143,878 
Provision for credit losses20,469 1,500 
Net interest income after provision for credit losses55,684 47,134 132,145 142,378 
Noninterest income:
Net gain on loan origination and sale activities33,130 15,951 85,698 30,736 
Loan servicing (loss) income(1,582)3,196 6,921 7,119 
Deposit fees1,769 2,079 5,225 5,848 
Other2,838 3,354 7,543 8,798 
Total noninterest income36,155 24,580 105,387 52,501 
Noninterest expense:
Compensation and benefits34,570 33,341 101,429 93,934 
Information services7,401 8,173 22,330 24,001 
Occupancy8,354 6,228 23,082 19,168 
General, administrative and other7,732 7,979 24,052 25,296 
Total noninterest expense58,057 55,721 170,893 162,399 
Income from continuing operations before income taxes33,782 15,993 66,639 32,480 
Income taxes from continuing operations7,433 2,328 14,247 4,865 
Income from continuing operations26,349 13,665 52,392 27,615 
Income (loss) from discontinued operations before income taxes190 (24,928)
Income taxes for discontinued operations28 (3,837)
Income (loss) from discontinued operations162 (21,091)
Net income$26,349 $13,827 $52,392 $6,524 
Net income (loss) per share
Basic:
Income from continuing operations$1.16 $0.55 $2.26 $1.04 
Income (loss) from discontinued operations0.01 (0.81)
Total$1.16 $0.55 $2.26 $0.23 
Diluted:
  Income from continuing operations$1.15 $0.54 $2.24 $1.03 
Income (loss) from discontinued operations0.01 (0.80)
Total$1.15 $0.55 $2.24 $0.22 
Weighted average shares outstanding:
Basic22,665,06924,419,79323,226,10926,020,172
Diluted22,877,22624,625,93823,403,72926,204,414

See accompanying notes to consolidated financial statements
4


HOMESTREET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Net income$26,349 $13,827 $52,392 $6,524 
Other comprehensive income:
Unrealized gain (loss) investment securities available for sale ("AFS")5,386 6,675 36,336 32,019 
Reclassification for net (gains) losses included in income15 19 (316)129 
Other comprehensive income before tax5,401 6,694 36,020 32,148 
Income tax impact of:
Unrealized gain (loss) investment securities AFS1,131 1,402 7,630 6,607 
Reclassification for net (gains) losses included in income(66)27 
Total1,134 1,406 7,564 6,634 
Other comprehensive income4,267 5,288 28,456 25,514 
Total comprehensive income$30,616 $19,115 $80,848 $32,038 


See accompanying notes to consolidated financial statements
5


HOMESTREET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
 
(in thousands, except share data)Number
of shares
Common stockRetained
earnings
Accumulated
other
comprehensive
income (loss)
Total temporary equityTotal permanent equity
For the three months ended September 30, 2019
Balance June 30, 201926,085,164 $309,216 $359,252 $2,707 $52,735 $671,175 
Net income— — 13,827 — — 13,827 
Common stock issued15,750 95 — — — 95 
Share-based compensation expense— 849 (98)— — 751 
Other comprehensive income— — — 5,288 — 5,288 
Common stock repurchased(1,692,401)— — (52,735)
Balance, September 30, 201924,408,513 $310,160 $372,981 $7,995 $$691,136 
For the nine months ended September 30, 2019
Balance, December 31, 201826,995,348 $342,950 $412,009 $(15,439)$$739,520 
Net income— — 6,524 — — 6,524 
Common stock issued69,166 176 — — — 176 
Share-based compensation expense— 1,109 (98)— — 1,011 
Cumulative effect of adoption of new accounting standards— — 1,532 (2,080)— (548)
Other comprehensive income— — — 25,514 — 25,514 
Common stock repurchased(2,656,001)(12,199)(16,127)— (52,735)(28,326)
Reclassification to temporary equity— (21,876)(30,859)— 52,735 (52,735)
Balance, September 30, 201924,408,513 $310,160 $372,981 $7,995 $$691,136 
For the three months ended September 30, 2020
Balance, June 30, 202023,007,400 $290,871 $375,268 $28,510 $$694,649 
Net income— — 26,349 — — 26,349 
Dividends declared on common stock— — (3,450)— — (3,450)
Common stock issued5,576 108 — — — 108 
Share-based compensation expense— 738 — — — 738 
Other comprehensive income— — — 4,267 — 4,267 
Common stock repurchased(1,018,772)(11,295)(15,060)— — (26,355)
Balance, September 30, 202021,994,204 $280,422 $383,107 $32,777 $$696,306 
For the nine months ended September 30, 2020
Balance, December 31, 201923,890,855 $300,729 $374,673 $4,321 $$679,723 
Net income— — 52,392 — — 52,392 
Dividends declared on common stock— — (10,556)— — (10,556)
Common stock issued127,273 1,006 — — — 1,006 
Share-based compensation expense— 1,806 — — — 1,806 
Cumulative effect of adoption of new accounting standards— — (3,740)— — (3,740)
Other comprehensive income— — — 28,456 — 28,456 
Common stock repurchased(2,023,924)(23,119)(29,662)— — (52,781)
Balance, September 30, 202021,994,204 $280,422 $383,107 $32,777 $$696,306 

See accompanying notes to consolidated financial statements
6


HOMESTREET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) 
Nine Months Ended September 30,
(in thousands)20202019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income$52,392 $6,524 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation, amortization and accretion29,415 29,834 
Provision for credit losses20,469 1,500 
Net fair value adjustment and gain on sale of LHFS(55,443)(72,287)
Gain on sale of mortgage servicing rights(6,206)
Origination of mortgage servicing rights(19,071)(27,823)
Change in fair value of mortgage servicing rights34,033 37,293 
Net (gain) loss on sale of investment securities(316)128 
Net gain on sale of loans originated as held for investment(3,760)(6,405)
Loss on lease abandonment and exit costs4,623 15,816 
Change in deferred income taxes(6,998)(40,409)
Share-based compensation expense2,030 1,187 
Origination of LHFS(1,670,272)(3,232,664)
Proceeds from sale of loans originated as held for sale1,605,064 3,496,809 
Changes in operating assets and liabilities:
(Increase) decrease in other assets(24,526)4,195 
Increase (decrease) in accounts payable and other liabilities(7,971)(25,217)
Net cash provided by (used in) operating activities(40,331)182,275 
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities(348,384)(146,780)
Proceeds from sale of investment securities58,487 144,602 
Principal payments on investment securities152,643 84,890 
Proceeds from sale of OREO650 744 
Proceeds from sale of loans originated as held for investment349,498 528,745 
Purchase of loans(20,124)
Proceeds from sale of mortgage servicing rights2,958 
Net cash provided by disposal of discontinued operations2,759 174,333 
Net increase in LHFI(583,723)(593,292)
Proceeds from sale of property and equipment1,460 
Purchase of premises and equipment(2,972)(1,196)
Net cash used for acquisitions(47,390)
Proceeds from sale of Federal Home Loan Bank stock112,808 138,099 
Purchases of Federal Home Loan Bank stock(116,993)(101,366)
Net cash provided by (used in) investing activities(393,891)184,347 
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Nine Months Ended September 30,
(in thousands)20202019
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits475,639 678,016 
Repayment of borrowings(56,000)
Changes in short term borrowings, net43,000 (890,000)
Repayment of lease principal(973)(1,375)
Repurchase of common stock(51,939)(81,061)
Proceeds from stock issuance, net237 
Dividends paid on common stock(10,556)
Net cash provided by (used in) financing activities455,408 (350,420)
Net increase in cash and cash equivalents21,186 16,202 
Cash and cash equivalents beginning of period57,880 58,586 
Cash and cash equivalents end of period$79,066 $74,788 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest$36,645 $70,738 
Federal and state income taxes11,236 17,600 
Non-cash activities:
Decrease in lease liabilities and lease assets38,754 
LHFI foreclosed and transferred to OREO915 
Loans transferred from held for investment to held for sale418,880 617,778 
Loans transferred from held for sale to held for investment6,661 6,488 
Ginnie Mae liability recognized with the right to repurchase, net105,727 (26,418)
Receivable from sale of mortgage servicing rights6,945 
Acquisition:
Assets acquired114,725 
Liabilities assumed74,941 
Goodwill7,606 

See accompanying notes to consolidated financial statements
8


HomeStreet, Inc. and Subsidiaries
Notes to Interim Consolidated Financial Statements (Unaudited)

NOTE 1–SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

HomeStreet, Inc. and its wholly owned subsidiaries (the "Company") is a diversified financial services company serving customers primarily in the Western United States. The Company is principally engaged in commercial banking, mortgage banking and consumer/retail banking activities. The Company's consolidated financial statements include the accounts of HomeStreet, Inc. and its wholly owned subsidiaries, HomeStreet Capital Corporation, HomeStreet Statutory Trusts and HomeStreet Bank (the "Bank") and the Bank's subsidiaries, HomeStreet Reinsurance, Ltd., Continental Escrow Company, HomeStreet Foundation, HS Properties, Inc., HS Evergreen Corporate Center LLC, Union Street Holdings LLC and HS Cascadia Holdings LLC. HomeStreet Bank was formed in 1986 and is a state-chartered commercial bank.

The Company's accounting and financial reporting policies conform with accounting principles generally accepted in the United States of America ("GAAP"). Inter-company balances and transactions have been eliminated in consolidation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and revenues and expenses during the reporting periods and related disclosures. We have reclassified certain amounts in our consolidated financial statements for prior periods to conform with our current presentation.

Immaterial Restatement: Subsequent to issuance of the June 30, 2020 financial statements, management concluded that purchases of and proceeds from the sale of Federal Home Loan Bank stock were incorrectly classified as financing activities, rather than investing activities, in the consolidated statements of cash flows. To correct this classification error, amounts previously reported for the purchases of and proceeds from the sale of Federal Home Loan Bank stock for the nine months ended September 30, 2019 as financing activities are reported as investing activities in the consolidated statement of cash flows.

These unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results of the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Quarterly Report on Form 10-Q. The results of operations in the interim financial statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission ("2019 Annual Report on Form 10-K").

Risks and Uncertainties

The worldwide spread of coronavirus (“COVID-19”) has created significant uncertainty in the global, national, regional and local economies. There have been no comparable recent events that provide guidance to the effects of the spread of COVID-19 as a global pandemic may have, and, as a result, the near-term, short-term and ultimate impacts of COVID-19 and the extent to which COVID-19 impacts the Company’s business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict.


Share Repurchase Program

At the beginning of 2020, the Company had in place a share repurchase program under which the Company could purchase up to $8.1 million of its common stock. During the first quarter of 2020 and again in the third quarter of 2020, the Board authorized 2 additional programs, each for the repurchase of an additional $25 million of the Company’s common stock. During the first nine months of 2020, the Company repurchased 1,995,845 shares of its common stock at an average price of $26.03 per share.



9


Recent Accounting Developments

In December 2019, the Financial Accounting Standards Board ("FASB") issued ASU No 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” (“ASU 2019-12”). ASU 2019-12 removes certain exceptions to the general principles in Topic 740 in Generally Accepted Accounting Principles. ASU 2019-12 is effective for public entities for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company does not expect ASU 2019-12 to have a material effect on the Company’s current financial position, results of operations or financial statement disclosures.

On January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology ("ALLL") with an expected loss methodology that is referred to as the current expected credit losses ("CECL") methodology. The measurement of the expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures such as loan commitments. In addition, ASC 326 made changes to the accounting for credit losses for AFS debt securities.
The Company adopted CECL using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet ("OBS") credit exposure. Results for reporting periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a decrease of $3.7 million to the beginning balance of retained earnings on January 1, 2020 for the cumulative effect of adopting this guidance.
The Company adopted ASU 2016-13 using the prospective transition approach for debt securities for which other-than-temporary impairment had been recognized prior to January 1, 2020. As a result, the amortized cost basis remains the same before and after the effective date of this guidance.
The following table illustrates the impact of the adoption of CECL on January 1, 2020.
(in thousands)As reported under ASC 450-20Impact of ASC 326 adoptionAs reported under ASC 326
Assets (1)
LHFI
Consumer loans
Single family$6,450 $468 $6,918 
Home equity and other6,233 4,635 10,868 
Total12,683 5,103 17,786 
Commercial real estate loans
Non-owner occupied commercial real estate7,245 (3,392)3,853 
Multifamily7,015 (2,977)4,038 
Construction/land development
Multifamily construction2,848 693 3,541 
Commercial real estate construction624 (115)509 
Single family construction3,800 4,280 8,080 
Single family construction to permanent1,003 200 1,203 
Total22,535 (1,311)21,224 
Commercial and industrial loans
Owner occupied commercial real estate3,639 (2,459)1,180 
Commercial business2,915 510 3,425 
Total6,554 (1,949)4,605 
Total allowance for credit losses41,772 1,843 43,615 
Liabilities
Allowance for credit losses on unfunded loan commitments1,065 1,897 2,962 
Total$42,837 $3,740 $46,577 
(1) There was no impact from the adoption of this standard for either held to maturity ("HTM") or AFS investment securities.
10



The following accounting policies have been updated to reflect the adoption of CECL.

Allowance for Credit Losses for LHFI
The allowance for credit losses ("ACL") for LHFI is a valuation account that is deducted from the loans amortized cost basis to present the net amount expected to be collected on the loans. Loan balances are charged off against the allowance when management believes the non-collectability of a loan balance is confirmed. Expected recoveries may not exceed the aggregate of amounts previously charged-off and expected to be charged-off. The ACL for LHFI, as reported in our consolidated balance sheets, is adjusted by a provision for credit losses and reduced by the charge-offs of loan amounts, net of recoveries.
Management estimates the ACL balance using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix or delinquency levels or other relevant factors.
The credit loss estimation process involves procedures to appropriately consider the unique characteristics of its two loan portfolio segments, the consumer loan portfolio segment and the commercial loan portfolio segment. These two segments are further disaggregated into loan pools, the level at which credit risk is monitored. When computing allowance levels, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the ACL is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods, evaluations of the overall loan portfolio, based on the factors and forecasts then prevailing, may result in material changes in the ACL and provision for credit losses in those future periods.
Credit Loss Measurement
The allowance level is influenced by current conditions related to loan volumes, loan asset quality ratings ("AQR") migration or delinquency status, historic loss experience and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses has two basic components: first, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics and second an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans.
Loans that Share Similar Risk Characteristics with Other Loans
In estimating the component of the ACL, for loans that share similar risk characteristics with other loans, loans are segregated into loan pools based on similar risk characteristics, like product types or areas of risk concentration.
The Company's ACL model methodology is to build a reserve rate using historical life of loan default rates combined with assessments of current loan portfolio information and forecasted economic environment and business cycle information. The model uses statistical analysis to determine the life of loan default rates for the quantitative component and analyzes qualitative factors (Q-Factors) that assess the current loan portfolio conditions and forecasted economic environment. Below is the general overview our ACL model.
Historical Loss Rate
The Company chose to analyze loan data from a full economic cycle, to the extent that data was available, to calculate life of loan loss rates. Based on the current economic environment and available loan level data, it was determined the Loss Horizon Period (LHP) should begin prior to the economic recession that began in 2007. The Company plans to monitor and review the LHP on an annual basis to determine appropriate time frames to be included based on economic indicators.
Under CECL, the Company groups pools of loans by similar risk characteristics. Using these pools, sub-pools are established at a more granular level incorporating delinquency status and original FICO or original LTV (for consumer loans) and risk ratings (for commercial loans). Using the pool and sub-pool structure, cohorts are established historically on a quarterly basis containing the population in these sets as of that point in time. After the establishment of these cohorts, the loans within the cohorts are then tracked from that point forward to establish long-term Probability of Default ("PD") at the sub-pool level and Loss Given Default ("LGD") for the pool level. These historical cohorts and their PD/LGD outcomes are then averaged together to establish expected PDs and LGDs for each sub-pool.

11


Once historical cohorts are established, the loans in the cohort are tracked moving forward for default events. The Company has defined default events as the first dollar of loss. If a loan in the cohort has experienced a default event over the LHP then the balance of the loan at the time of cohort establishment becomes part of the numerator of the PD calculation. The Loss Given Probability of Default ("LGPD") or Expected Loss ("EL") is the weighted average PD for each sub-pool cohort times the average LGD for each pool. The output from the model then is a series of EL rates for each loan sub-pool, which are applied to the related outstanding balances for each loan sub-pool to determine the ACL reserve based on historical loss rates.
Q-Factors
The Q-Factors adjust the expected historic loss rates for current and forecasted conditions that are not provided for in the historical loss information. The Company has established a methodology for adjusting historical expected loss rates based on these more recent or forecasted changes. The Q-Factor methodology is based on a blend of quantitative analysis and management judgment and reviewed on a quarterly basis.
Each of the thirteen factors in the FASB standard were analyzed for common risk characteristics and grouped into seven consolidated Q-Factors as listed below.
Qualitative FactorFinancial Instruments - Credit Losses
Portfolio Credit QualityThe borrower's financial condition, credit rating, credit score, asset quality or business prospects
The borrower's ability to make scheduled interest or principal payments
The volume and severity of past due financial assets and the volume and severity of adversely classified or rated financial assets
Remaining PaymentsThe remaining payment terms of the financial assets
The remaining time to maturity and the timing and extent of prepayments on the financial assets
Volume & NatureThe nature and volume of the entity's financial assets
Collateral ValuesThe value of underlying collateral on financial assets in which the collateral-dependent practical expedient has not been utilized
EconomicThe environmental factors of a borrower and the areas in which the entity's credit is concentrated, such as: Changes and expected changes in national, regional and local economic and business conditions and developments in which the entity operates, including the condition and expected condition of various market segments
Credit CultureThe entity's lending policies and procedures, including changes in lending strategies, underwriting standards, collection, write-off and recovery practices, as well as knowledge of the borrower's operations or the borrower's standing in the community
The quality of the entity's credit review system
The experience, ability and depth of the entity's management, lending staff, and other relevant staff
Business EnvironmentThe environmental factors of a borrower and the areas in which the entity's credit is concentrated, such as: Regulatory, legal, or technological environment to which the entity has exposure
The environmental factors of a borrower and the areas in which the entity's credit is concentrated, such as: Changes and expected changes in the general market condition of either the geographical area or the industry to which the entity has exposure

An eighth Q-Factor, Management Overlay, has been created to allow the Bank to adjust specific pools when conditions exist that were not contemplated in the model design that warrant an adjustment. The economic downturn caused by the COVID-19 pandemic and resulting accounting treatment of forbearances is an example of such a condition.
The Company has chosen two years as the forecast period based on management judgment and has determined that reasonable and supportable forecasts should be made for two of the Q-Factors: Economic and Collateral values.
12


Management has assigned weightings for each qualitative factor as well as individual metrics within each qualitative factor as to the relative importance of that factor or metric specific to each portfolio type. The Q-Factors above are evaluated using a seven-point scale ranging from significant improvement to significant deterioration.
The CECL Q-Factor methodology bounds the Q-Factor adjustments by a minimum and maximum range, based on the Bank’s own historical expected loss rates for each respective pool. The rating of the Q-Factor on the seven-point scale, along with the allocated weight, determines the final expected loss adjustment. The model is constructed so that the total of the Q-Factor adjustments plus the current expected loss rate cannot exceed the maximum or minimum two-year loss rate for that pool, which is aligned with the Bank's chosen forecast period. Loss rates beyond two years are not adjusted in the Q-Factor process and the model reverts to the historical mean loss rates. Management Overlays are not bounded by the historical maximums.
Quarterly, loan data is gathered to update the portfolio metrics analyzed in the Q-Factor model. The model is updated with current data and applicable forecasts, then the results are reviewed by management. After consensus is reached on all Q-Factor ratings, the results are input into the Q-Factor model and applied to the pooled loans which are reviewed to determine the adequacy of the reserve.
Additional details describing the model by portfolio segment are below:
Consumer Loan Portfolio
The consumer loan portfolio segment is comprised of the single family and home equity loan classes, which are underwritten after evaluating a borrower's capacity, credit and collateral. Other consumer loans are grouped with home equity loans. Capacity refers to a borrower's ability to make payments on the loan. Several factors are considered when assessing a borrower's capacity, including the borrower's employment, income, current debt, assets and level of equity in the property. Credit refers to how well a borrower manages current and prior debts as documented by a credit report that provides credit scores and current and past information about the borrower's credit history. Collateral refers to the type and use of property, occupancy and market value. Property appraisals are obtained to assist in evaluating collateral. Loan-to-property value and debt-to-income ratios, loan amount and lien position are considered in assessing whether to originate a loan. These borrowers are particularly susceptible to downturns in economic trends such as conditions that negatively affect housing prices, demand for housing and levels of unemployment.
Consumer Loan Portfolio Segment Estimated Loss Rate Model
Under CECL, the Bank utilizes pools of loans that are grouped by similar risk characteristics: Single Family and Home Equity Loans which includes Consumer loans. Sub-Pools are established at a more granular level for the calculation of PDs, incorporating delinquency status, original FICO and original LTV.
Consumer portfolio cohorts are established by grouping each ACL sub-pool at a point in time. Once historical cohorts are established, the loans in the cohort are tracked moving forward for default events.

The Q-Factors adjust the expected historic loss rates for current and forecasted conditions that are not provided for in the historical loss information. For Single Family loans all Q-Factors noted above are evaluated. For the Home Equity and Consumer loans, collateral values are not evaluated as the Bank has determined the FICO score trends are a more relevant predictor of default than current collateral value for those types of loans. These factors are evaluated based on current conditions and forecasts (as applicable), using a seven-point scale ranging from significant improvement to significant deterioration.
Commercial Loan Portfolio
The commercial loan portfolio segment is comprised of the non-owner occupied commercial real estate, multifamily, construction and land development, owner occupied commercial real estate and commercial business loan classes, whose underwriting standards consider the factors described for single family and home equity loan classes as well as others when assessing the borrower's and associated guarantors or other related party’s financial position. These other factors include assessing liquidity, net worth, leverage, other outstanding indebtedness of the borrower, the quality and reliability of cash expected to flow through the borrower (including the outflow to other lenders) and prior known experiences with the borrower.
This information is used to assess financial capacity, profitability and experience. Ultimate repayment of these loans is sensitive to interest rate changes, general economic conditions, liquidity and availability of long-term financing.
Commercial Loan Portfolio Segment Loss Rate Model
The Bank maintained loan classes above but has subdivided the construction and land development, which includes lot, land and acquisition and development loans, into the following ACL reporting pools to more accurately group risk characteristics:
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Multifamily, Commercial Real Estate, Single Family and Single Family construction to permanent. ACL sub-pools are established at a more granular level for the calculation of PDs, utilizing risk rating.
As outlined in the Bank’s policies, commercial loans pools are non-homogenous and are regularly assessed for credit quality. For purposes of CECL, loans are sub-pooled according to the following AQR Ratings:

1-6: These loans meet the definition of “Pass" assets. They are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less costs to acquire and sell in a timely manner, of any underlying collateral. The Bank further uses the available AQR ratings for components of the sub-pools.
7: These loans meet the regulatory definition of “Special Mention.” They contain potential weaknesses, that if uncorrected may result in deterioration of the likelihood of repayment or in the Bank’s credit position.
8: These loans meet the regulatory definition of “Substandard”. They are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. They have well-defined weaknesses and have unsatisfactory characteristics causing unacceptable levels of risk.

Commercial segment cohorts are established by grouping each ACL sub-pool at a point in time. Once historical cohorts are established, the loans in the cohort are tracked moving forward for default events. The Q-Factors adjust the expected historic loss rates for current and forecasted conditions that are not provided for in the historical loss information. All the Q-Factors noted above are evaluated for Commercial portfolio loans except for Commercial Business and Owner Occupied Commercial Real Estate ("CRE") loans which exclude the collateral values Q-Factor. The Company has determined that these loans are primarily underwritten by evaluating the cash flow of the business and not the underlying collateral. Factors above are evaluated based on current conditions and forecasts (as applicable), using a seven-point scale ranging from significant improvement to significant deterioration.
Loans That Do Not Share Risk Characteristics with Other Loans
For a loan that does not share risk characteristics with other loans, expected credit loss is measured on net realizable value that is the difference between the discounted value of the expected future cash flows, based on the original effective interest rate and the amortized cost basis of the loan. For these loans, we recognize expected credit loss equal to the amount by which the net realizable value of the loan is less than the amortized cost basis of the loan (which is net of previous charge-offs and deferred loan fees and costs), except when the loan is collateral dependent, which is when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In these cases, expected credit loss is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral. The fair value of the collateral is adjusted for the estimated costs to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral.
The starting point for determining the fair value of collateral is through obtaining external appraisals. Generally, collateral values for collateral dependent loans are updated every twelve months, either from external third parties or in-house certified appraisers. A third-party appraisal is required at least annually for substandard loans and OREO. Third party appraisals are obtained from a pre-approved list of independent, third party, local appraisal firms. Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. Generally, appraisals are internally reviewed by the appraisal services group to ensure the quality of the appraisal and the expertise and independence of the appraiser. For performing consumer segment loans secured by real estate that are classified as collateral dependent, the Bank determines the fair value estimates quarterly using automated valuation services. Once the expected loss amount is determined, an allowance is recorded equal to the calculated expected credit loss and included in the ACL. If the calculated expected loss is determined to be permanent or not recoverable, the expected credit loss will be charged off. Factors considered by management in determining if the expected credit loss is permanent or not recoverable include whether management judges the loan to be uncollectible, repayment is deemed to be protracted beyond reasonable time frames, or the loss becomes evident owing to the borrower's lack of assets or, for single family loans, the loan is 180 days or more past due unless both well-secured and in the process of collection.
Allowance for Credit Losses for Off-Balance Sheet Credit Exposures
The Bank estimates expected credit losses over the contractual period in which the Bank is exposed to risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Bank. Reserves are required for OBS credit exposures that are not unconditionally cancellable. The allowance for credit losses on unfunded loan commitments is based on an estimate of unfunded commitment utilization over the life of the loan, applying the EL to the estimated utilization balance as of the reporting period. As these estimated credit loss calculations are similar to the funded LHFI they share similar risks plus the additional risk from estimating commitment utilization.
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Allowance for Credit Losses for Other Financial Instruments
The Company evaluates AFS securities in an unrealized loss position, using a qualitative approach, at the end of each quarter to determine whether the decline in value is temporary or permanent. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. When qualitative factors indicate that a credit loss may exist, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. The Company recognizes an ACL measured as the difference between the present value of expected cash flows and the amortized cost basis of the security, limited by the amount that the security’s fair value is less than its amortized cost basis. The Company does not believe any of these securities that were in an unrealized loss position at September 30, 2020 represent a credit loss impairment.

The Company carries a limited amount of HTM debt securities. Utilizing the CECL approach, the Company determined that the expected credit loss on this portfolio was immaterial, and therefore, an ACL for investment securities was not recorded as of September 30, 2020.


NOTE 2–DISCONTINUED OPERATIONS:

On March 29, 2019, the Company successfully closed and settled 2 sales of the rights to service $14.3 billion in total unpaid principal balance of single family mortgage loans serviced for Federal National Mortgage Association ("Fannie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac") and Government National Mortgage Association ("Ginnie Mae"), representing 71% of HomeStreet's total single family mortgage loans serviced for others portfolio as of December 31, 2018. The sales resulted in a $333 thousand pre-tax income and $941 thousand pre-tax loss from discontinued operations for the three and nine months ended September 30, 2019, respectively. The Company finalized the servicing transfer for these loans in 2019 and subserviced these loans through the transfer dates. These loans are excluded from the Company's mortgage servicing rights portfolio at September 30, 2019.
On March 31, 2019, based on mortgage market conditions and the operating environment, the Board adopted a Resolution of Exit or Disposal of Home Loan Center ("HLC") Based Mortgage Banking Operations to sell or abandon the assets and related personnel associated with those operations. The assets that were sold or abandoned largely represented the Company's former Mortgage Banking segment, the activities of which related to originating, servicing, underwriting, funding and selling single family residential mortgage loans.

The Company determined that the above actions constituted commitment to a plan of exit or disposal of certain long-lived assets (through sale or abandonment) and termination of employees. Further, the Company determined that the shift from a large-scale HLC based originator and servicer to a branch-focused product offering represented a strategic shift. As a result, the HLC-related mortgage banking operations are reported separately from the continuing operations as discontinued operations. In addition, the former Mortgage Banking operating segment and reporting unit were eliminated. This has resulted in a recast of the financial statements in 2019.

On April 4, 2019 the Company entered into a definitive agreement related to the sale of the HLC based mortgage origination business assets and transfer of personnel to Homebridge Financial Services, Inc. ("Homebridge").

On June 24, 2019 the Company completed the sale with Homebridge. This sale included assets related to 47 stand-alone HLCs, sublease or lease assignments of the related offices and the transfer of certain related mortgage personnel. These HLCs, along with certain other mortgage banking related assets and liabilities that were to be sold or abandoned within one year, are classified as discontinued operations in 2019 in the accompanying consolidated financial statements. HLCs that were not subleased or assigned were closed during the second quarter of 2019 and none remain. Certain components of the Company's former Mortgage Banking segment, including mortgage servicing rights ("MSRs") on certain mortgage loans that were not part of the sales and right-of-use assets and lease liabilities where we did not obtain full landlord release were classified as continuing operations based on the Company's intent.

At the end of the second quarter 2019, the Company also entered into a non-binding letter of interest to sell its ownership interest in WMS LLC at which time related operations also met the criteria to be classified as discontinued operations for the periods presented. The sales transaction was closed in November 2019, resulting in an immaterial loss on disposal.

These discontinued operations activities, including the exit or disposal of the former Mortgage Banking Segment, were concluded by December 31, 2019. Consequently, we ceased discontinued operations accounting effective January 1, 2020.

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The following table summarizes the calculation of the net gain (loss) on disposal of discontinued operations.
(in thousands)Three Months Ended September 30, 2019Nine Months Ended September 30, 2019
Proceeds from asset sales$$186,612 
Book value of asset sales(4)180,978 
Gain on assets sold5,634 
Transaction costs (recovery) expenses(386)8,791 
Compensation expense related to the transactions596 4,388 
Facility and IT related costs (recovery) expenses(1,466)14,215 
Total costs (recovery) expenses(1,256)27,394 
Net gain (loss) on disposal$1,260 $(21,760)


The carrying amount of major classes of assets and liabilities related to discontinued operations consisted of the following.
(in thousands)December 31, 2019
Assets of discontinued operations
LHFS, at fair value$26,123 
Other assets2,505 
Total$28,628 
Liabilities of discontinued operations
Accounts payable and other liabilities$2,603 

Income Statement of Discontinued Operations
(in thousands)Three Months Ended September 30, 2019Nine Months Ended September 30, 2019
Net interest income$842 $5,604 
Noninterest income1,604 64,331 
Noninterest expense2,256 94,863 
Income (loss) before income taxes190 (24,928)
Income tax expense (benefit)28 (3,837)
Income (loss) from discontinued operations$162 $(21,091)


Cash Flows for Discontinued Operations
(in thousands)Nine Months Ended September 30, 2019
Net cash provided by operating activities$196,712 
Net cash provided by investing activities177,291 


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NOTE 3–INVESTMENT SECURITIES:

The following table sets forth certain information regarding the amortized cost basis and fair values of our investment securities AFS and HTM.
 
At September 30, 2020
(in thousands)Amortized
cost
Gross
unrealized
gains
Gross
unrealized
losses
Fair
value
    
AFS
Mortgage backed securities ("MBS"):
Residential$59,259 $1,378 $(184)$60,453 
Commercial43,660 2,332 (6)45,986 
Collateralized mortgage obligations ("CMOs"):
Residential256,488 7,408 (10)263,886 
Commercial159,733 3,744 (270)163,207 
   Municipal bonds530,243 26,528 (137)556,634 
   Corporate debt securities14,452 707 15,159 
   Agency debentures1,846 1,846 
Total$1,065,681 $42,097 $(607)$1,107,171 
HTM
   Municipal bonds$4,297 $234 $$4,531 

At December 31, 2019
(in thousands)Amortized
cost
Gross
unrealized
gains
Gross
unrealized
losses
Fair
value
    
AFS
MBS:
Residential$93,283 $120 $(1,708)$91,695 
Commercial37,972 411 (358)38,025 
CMOs:
Residential292,370 935 (1,687)291,618 
Commercial156,693 684 (1,223)156,154 
   Municipal bonds333,303 8,997 (982)341,318 
   Corporate debt securities18,391 313 (43)18,661 
   U.S. Treasury securities1,296 11 1,307 
Total$933,308 $11,471 $(6,001)$938,778 
HTM
   Municipal bonds$4,372 $129 $$4,501 

MBS and CMOs represent securities issued by government sponsored enterprises ("GSEs"). Most of the MBS and CMO securities in our investment portfolio are guaranteed by Fannie Mae, Ginnie Mae or Freddie Mac. Municipal bonds are comprised of general obligation bonds (i.e., backed by the general credit of the issuer) and revenue bonds (i.e., backed by either collateral or revenues from the specific project being financed) issued by various municipal corporations. As of September 30, 2020 and December 31, 2019, all securities held, including municipal bonds and corporate debt securities, were rated investment grade, based upon external ratings where available and, where not available, based upon internal ratings which correspond to ratings as defined by Standard and Poor's Rating Services ("S&P") or Moody's Investors Services ("Moody's").
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As of September 30, 2020 and December 31, 2019, substantially all investment securities held had ratings available by external ratings agencies.

Investment securities AFS that were in an unrealized loss position are presented in the following tables based on the length of time the individual securities have been in an unrealized loss position.
At September 30, 2020
 Less than 12 months12 months or moreTotal
(in thousands)Gross
unrealized
losses
Fair
value
Gross
unrealized
losses
Fair
value
Gross
unrealized
losses
Fair
value
MBS:
Residential$$$(184)$2,557 $(184)$2,557 
Commercial(6)1,337 (6)1,337 
CMOs:
Residential(10)7,492 (10)7,492 
Commercial(119)9,236 (151)15,350 (270)24,586 
Municipal bonds(119)22,872 (18)3,626 (137)26,498 
Total$(254)$40,937 $(353)$21,533 $(607)$62,470 

At December 31, 2019
 Less than 12 months12 months or moreTotal
(in thousands)Gross
unrealized
losses
Fair
value
Gross
unrealized
losses
Fair
value
Gross
unrealized
losses
Fair
value
MBS:
Residential$(409)$18,440 $(1,299)$68,362 $(1,708)$86,802 
Commercial(352)21,494 (6)2,483 (358)23,977 
CMOs:
Residential(965)171,708 (722)29,264 (1,687)200,972 
Commercial(680)67,160 (543)41,605 (1,223)108,765 
Municipal bonds(334)39,127 (648)45,869 (982)84,996 
Corporate debt securities(5)3,689 (38)1,743 (43)5,432 
Total$(2,745)$321,618 $(3,256)$189,326 $(6,001)$510,944 


There were 0 HTM in an unrealized loss position at September 30, 2020 or December 31, 2019.

The Company has evaluated investment securities AFS that are in an unrealized loss position and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The decline in value is not related to the occurrence of any issuer-specific or industry-specific credit event. In addition, as of September 30, 2020 and December 31, 2019, the Company had not made a decision to sell any of its debt securities held, nor did the Company consider it more likely than not that it would be required to sell such securities before recovery of their amortized cost basis.

The following tables present the fair value of investment securities AFS and HTM by contractual maturity along with the associated contractual yield for the periods indicated below. The weighted-average yield is computed using the contractual
18


coupon of each security weighted based on the fair value of each security and does not include adjustments to a tax equivalent basis.
 At September 30, 2020
 Within one yearAfter one year
through five years
After five years
through ten years
After
ten years
Total
(dollars in thousands)Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
AFS          
   Municipal bonds$2,043 2.88 %$13,943 3.83 %$57,011 3.22 %$483,637 3.29 %$556,634 3.29 %
   Corporate debt securities188 4.30 %7,101 3.73 %2,758 4.19 %5,112 4.98 %15,159 4.25 %
   Agency debentures%%%1,846 1.65 %1,846 1.65 %
Total$2,231 3.00 %$21,044 3.80 %$59,769 3.26 %$490,595 3.30 %$573,639 3.31 %
HTM
   Municipal bonds$%$1,774 2.93 %$2,757 2.16 %$%$4,531 2.47 %
 
 At December 31, 2019
 Within one yearAfter one year
through five years
After five years
through ten years
After
ten years
Total
(dollars in thousands)Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
Fair
Value
Weighted
Average
Yield
          
AFS
   Municipal bonds$5,337 3.41 %$555 3.90 %$13,000 3.01 %$322,426 3.61 %$341,318 3.59 %
   Corporate debt securities1,007 3.40 %7,544 3.64 %10,022 3.70 %88 6.10 %18,661 3.67 %
   U.S. Treasury securities1,307 2.82 %%%%1,307 2.82 %
Total$7,651 3.31 %$8,099 3.66 %$23,022 3.31 %$322,514 3.62 %$361,286 3.59 %
HTM
   Municipal bonds$%$1,787 2.90 %$2,714 2.09 %$%$4,501 2.41 %

MBS and CMOs are excluded from the tables above because such securities are not due at a single maturity date. The weighted average yield of MBS and CMOs as of September 30, 2020 and December 31, 2019 was 1.94% and 2.34%, respectively.

The net realized gain or loss from the sale of investment securities AFS was a gain of $0.3 million and a loss of $0.1 million for the nine months ended September 30, 2020 and 2019, respectively. Proceeds from the sale of investment securities were $3 million and $25 million for the quarters ended September 30, 2020 and 2019, respectively.


The following table summarizes the carrying value of securities pledged as collateral to secure borrowings, public deposits and other purposes as permitted or required by law:
(in thousands)At September 30,
2020
At December 31,
2019
Washington and California to secure public deposits$158,634 $200,571 
Other securities pledged607 4,332 
Total securities pledged as collateral$159,241 $204,903 


The Company assesses the creditworthiness of the counterparties that hold the pledged collateral and has determined that these arrangements have minimal risk.

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Tax-exempt interest income on securities was $2.8 million and $2.5 million for the quarters ended September 30, 2020 and 2019, respectively and $7.9 million and $7.8 million for the nine months ended September 30, 2020 and 2019.


NOTE 4-LOANS AND CREDIT QUALITY:
As a result of the adoption of CECL on January 1, 2020, there is a lack of comparability in both the reserves and provisions for credit losses for the periods presented. Results for reporting periods beginning after January 1, 2020 are presented using the CECL methodology, while comparative period information continues to be reported in accordance with the incurred loss methodology in effect for prior periods.

The Company's LHFI is divided into 2 portfolio segments, consumer loans and commercial loans. Within each portfolio segment, the Company monitors and assesses credit risk based on the risk characteristics of each of the following loan classes: single family and home equity and other loans within the consumer loan portfolio segment and non-owner occupied commercial real estate, multifamily, construction and land development, owner occupied commercial real estate and commercial business loans within the commercial loan portfolio segment.
LHFI consist of the following.
(in thousands)At September 30,
2020
At December 31,
2019
Consumer loans
Single family (1)
$936,774 $1,072,706 
Home equity and other446,123 553,376 
Total1,382,897 1,626,082 
Commercial real estate loans
Non-owner occupied commercial real estate847,079 895,546 
Multifamily1,327,156 999,140 
Construction/land development590,707 701,762 
Total2,764,942 2,596,448 
Commercial and industrial loans
Owner occupied commercial real estate462,613 477,316 
Commercial business683,917 414,710 
Total1,146,530 892,026 
                  Total LHFI5,294,369 5,114,556 
ACL(64,892)(41,772)
Total LHFI less ACL$5,229,477 $5,072,784 (2)

(1)    Includes $7.6 million and $3.5 million at September 30, 2020 and December 31, 2019, respectively, of loans where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in the consolidated income statements.
(2)    Net deferred loans fees and costs of $24.5 million are now included within the carrying amounts of the loan balances as of December 31, 2019, in order to conform to the current period presentation.


Loans totaling $1.5 billion and $2.0 billion at September 30, 2020 and December 31, 2019, respectively, were pledged to secure borrowings from the Federal Home Loan Bank ("FHLB") and loans totaling $594 million and $491 million at September 30, 2020 and December 31, 2019, respectively, were pledged to secure borrowings from the Federal Reserve Bank.

Credit Risk Concentrations

Concentrations of credit risk arise when a number of customers are engaged in similar business activities or activities in the same geographic region, or when they have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions.

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LHFI are primarily secured by real estate located in the Pacific Northwest, California and Hawaii. At September 30, 2020, the Company had one concentration representing 10% or more of the total portfolio by state and property type for the loan class of multifamily in the state of California, which represented 16.9% of the total portfolio. At December 31, 2019, we had concentrations representing 10% or more of the total portfolio by state and property type for the loan classes of single family in Washington and multifamily in California, which represented 10.7% and 12.2% of the total portfolio, respectively.

Credit Quality
Management considers the level of allowance of credit losses to be appropriate to cover credit losses expected over the life of the loans for the LHFI portfolio as of September 30, 2020. The cumulative loss rate used as the basis for the estimate of credit losses is comprised of the Bank’s historical loss experience and eight qualitative factors for current and forecasted periods.
During the nine months ended September 30, 2020 the historical expected loss rates decreased from January 1, 2020 implementation due to minimal losses and our stable portfolio credit composition. During the nine months ended September 30, 2020, the Qualitative Factors increased significantly due to the forecasted impacts of the COVID-19 pandemic. As of September 30, 2020, the Bank expects that the markets in which it operates will have deterioration in collateral values and economic outlook over the two-year forecast period, with negative risk factors peaking in the first year and modestly improving in the second year.
In addition to the ACL for LHFI, the Company maintains a separate allowance for credit losses on unfunded loan commitments which is included in accounts payable and other liabilities on our consolidated balance sheets. The allowance for credit losses on unfunded commitments was $1.8 million and $1.1 million at September 30, 2020 and December 31, 2019, respectively.
The Bank has elected to exclude accrued interest receivable from the evaluation of the ACL. Accrued interest on LHFI was $21.1 million at September 30, 2020 and was reported in other assets in the consolidated balance sheets.

Activity in the ACL was as follows.
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Beginning balance$65,000 $43,254 $41,772 $41,470 
Provision for credit losses273 17721,633 1,746
Net (charge-offs) recoveries(381)6(356)221 
Impact of ASC 326 adoption
— 1,843 — 
Ending balance$64,892 $43,437 $64,892 $43,437 
Allowance for unfunded commitments:
Beginning balance$2,071 $1,065 
Provision for credit losses(273)(1,164)
Impact of ASC 326 adoption
— 1,897 
Ending balance$1,798 $1,798 
Provision for credit losses:
Allowance for credit losses - loans$273 $21,633 
Allowance for unfunded commitments(273)(1,164)
Total$$20,469 









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Activity in the ACL by loan portfolio and loan sub-class was as follows.
Three Months Ended September 30, 2020
(in thousands)Beginning balanceCharge-offsRecoveriesProvisionEnding
balance
Consumer loans
Single family$8,070 $(3)$$(1,349)$6,720 
Home equity and other11,126 (39)82 (5,165)6,004 
            Total19,196 (42)84 (6,514)12,724 
Commercial real estate loans
Non-owner occupied commercial real estate7,325 1,598 8,923 
Multifamily5,387 (516)4,871 
Construction/land development
Multifamily construction3,811 2,109 5,920 
Commercial real estate construction440 1,269 1,709 
Single family construction5,869 (362)5,507 
Single family construction to permanent1,515 (309)1,206 
     Total24,347 3,789 28,136 
Commercial and industrial loans
Owner occupied commercial real estate5,641 47 5,688 
Commercial business15,816 (447)24 2,951 18,344 
     Total21,457 (447)24 2,998 24,032 
Total ACL$65,000 $(489)$108 $273 $64,892 

Three Months Ended September 30, 2019
(in thousands)Beginning
balance
Charge-offsRecoveriesProvisionEnding
balance
Consumer loans
Single family$7,540 $$$(321)$7,220 
Home equity and other6,784 (68)59 25 6,800 
            Total14,324 (68)60 (296)14,020 
Commercial real estate loans
Non-owner occupied commercial real estate6,149 331 6,480 
Multifamily7,047 (357)6,690 
Construction/land development9,171 169 9,341 
     Total22,367 143 22,511 
Commercial and industrial loans
Owner occupied commercial real estate3,459 136 3,595 
Commercial business3,104 13 194 3,311 
     Total6,563 13 330 6,906 
Total ACL$43,254 $(68)$74 $177 $43,437 
    
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Nine Months Ended September 30, 2020
(in thousands)Prior to adoption of ASC 326Impact of ASC 326 adoptionCharge-offsRecoveriesProvisionEnding
balance
Consumer loans
Single family$6,450 $468 $(3)$56 $(251)$6,720 
Home equity and other6,233 4,635 (345)291 (4,810)6,004 
     Total12,683 5,103 (348)347 (5,061)12,724 
Commercial real estate loans
Non-owner occupied commercial real estate7,245 (3,392)5,070 8,923 
Multifamily7,015 (2,977)833 4,871 
Construction/land development
Multifamily construction2,848 693 2,379 5,920 
Commercial real estate construction624 (115)1,200 1,709 
Single family construction3,800 4,280 163 (2,736)5,507 
Single family construction to permanent1,003 200 1,206 
     Total22,535 (1,311)163 6,749 28,136 
Commercial and industrial loans
Owner occupied commercial real estate3,639 (2,459)4,508 5,688 
Commercial business2,915 510 (590)72 15,437 18,344 
     Total6,554 (1,949)(590)72 19,945 24,032 
Total ACL$41,772 $1,843 $(938)$582 $21,633 $64,892 

Nine Months Ended September 30, 2019
(in thousands)Beginning
balance
Charge-offsRecoveriesProvisionEnding
balance
Consumer loans
Single family$8,217 $$143 $(1,140)$7,220 
Home equity and other6,850 (209)212 (53)6,800 
     Total15,067 (209)355 (1,193)14,020 
Commercial real estate loans
Non-owner occupied commercial real estate5,495 985 6,480 
Multifamily5,754 936 6,690 
Construction/land development9,001 48 292 9,341 
     Total20,250 48 2,213 22,511 
Commercial and industrial loans
Owner occupied commercial real estate3,278 317 3,595 
Commercial business2,875 27 409 3,311 
     Total6,153 27 726 6,906 
Total ACL$41,470 $(209)$430 $1,746 $43,437 

Credit Quality Indicators
Management regularly reviews loans in the portfolio to assess credit quality indicators and to determine appropriate loan classification and grading in accordance with applicable bank regulations. The Company's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The risk rating of 9 is not used.
Per the Company's policies, most commercial loans pools are non-homogenous and are regularly assessed for credit quality. The rating categories can be generally described by the following groupings for non-homogeneous loans:
23


1-6: These loans meet the definition of “Pass" assets. They are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less costs to acquire and sell in a timely manner, of any underlying collateral.
7: These loans meet the regulatory definition of “Special Mention.” They contain potential weaknesses, that if uncorrected may result in deterioration of the likelihood of repayment or in the Bank’s credit position.
8: These loans meet the regulatory definition of “Substandard”. They are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. They have well-defined weaknesses and have unsatisfactory characteristics causing unacceptable levels of risk.
10: A loan, or the portion of a loan determined to meet the regulatory definition of “Loss.” The amounts classified as loss have been charged-off.


The risk rating categories can be generally described by the following groupings for homogeneous loans:
1-6: These loans meet the definition of “Pass" assets. A homogenous “Pass” loan is typically risk rated based on payment performance.
7: These loans meet the regulatory definition of “Special Mention.” A homogeneous special mention loan, risk rated 7, is less than 90 days past due from the required payment date at month-end.
8: These loans meet the regulatory definition of “Substandard”. A homogeneous substandard loan, risk rated 8, is 90 days or more past due from the required payment date at month-end.
10: These loans meet the regulatory definition of “Loss”. A closed-end homogeneous loan not secured by real estate is risk rated 10 when past due 120 cumulative days or more from the contractual due date. Closed-end homogenous loans secured by real estate and all open-end homogenous loans are risk rated 10 when past due 180 cumulative days or more from the contractual due date. These loans, or the portion of these loans classified as loss, are generally charged-off in the month in which the applicable past due period elapses.

Small balance commercial loans are generally considered homogenous unless 30 days or more past due or modified in a troubled debt restructuring that was an interest rate concession or payment modification with a significant balloon and the concession period has not been completed. The risk rating classification for such loans are based on the non-homogenous definitions noted above.

Residential, home equity and consumer loans modified in a troubled debt restructuring are considered homogeneous unless the modification was an interest rate concession or payment modification with a significant balloon and the concession modification period has not been completed. The risk rating classification for such loans are based on the non-homogeneous definitions noted above.

24


The following table presents a vintage analysis of the consumer portfolio segment by loan sub-class and delinquency status.
At September 30, 2020
(in thousands)202020192018201720162015 and priorRevolvingRevolving-termTotal
CONSUMER PORTFOLIO
Single family
Current$120,348 $98,136 $185,787 $191,364��$69,662 $268,162 $$$933,459 
Past due:
30-59 days208 208 
60-89 days
90+ days869 432 386 1,415 3,102 
Total (1)
120,348 99,005 186,219 191,750 69,662 269,790 936,774 
Home equity and other
Current1,263 1,850 1,492 1,698 642 6,119 423,225 8,948 445,237 
Past due:
30-59 days16 36 
60-89 days13 24 27 66 
90+ days275 502 784 
Total1,264 1,878 1,494 1,700 917 6,143 423,770 8,957 446,123 
Total consumer portfolio$121,612 $100,883 $187,713 $193,450 $70,579 $275,933 $423,770 $8,957 $1,382,897 

(1)    Includes $7.6 million of loans where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in the consolidated income statements.


The following table presents a vintage analysis of the commercial portfolio segment by loan sub-class, risk rating and delinquency status.
At September 30, 2020
(in thousands)202020192018201720162015 and priorRevolvingRevolving-termTotal
COMMERCIAL PORTFOLIO
Non-owner occupied commercial real estate
1-6 Pass$43,252 $178,975 $165,775 $149,344 $154,706 $150,510 $1,152 $1,132 $844,846 
7- Special Mention2,233 2,233 
8 - Substandard
Total43,252 178,975 165,775 149,344 154,706 152,743 1,152 1,132 847,079 
Multifamily
1-6 Pass529,841 352,147 87,127 72,823 178,227 97,681 9,310 1,327,156 
7- Special Mention
8 - Substandard
Total529,841 352,147 87,127 72,823 178,227 97,681 9,310 1,327,156 
Multifamily construction
1-6 Pass3,191 16,531 87,466 11,866 119,054 
7- Special Mention24,306 24,306 
8 - Substandard
Total3,191 16,531 87,466 11,866 24,306 143,360 
25


At September 30, 2020
(in thousands)202020192018201720162015 and priorRevolvingRevolving-termTotal
Commercial real estate construction
1-6 Pass3,963 2,139 34,023 625 4,299 45,049 
7- Special Mention
8 - Substandard
Total3,963 2,139 34,023 625 4,299 45,049 
Single family construction
1-6 Pass88,961 56,107 25,891 605 66,687 238,251 
7- Special Mention
8 - Substandard
Total88,961 56,107 25,891 605 66,687 238,251 
Single family construction to permanent
Current41,432 100,282 20,707 1,626 164,047 
Past due:
30-59 days
60-89 days
90+ days
Total41,432 100,282 20,707 1,626 164,047 
Owner occupied commercial real estate
1-6 Pass29,511 60,237 53,197 86,728 106,953 51,267 6,171 394,064 
7- Special Mention12,062 11,930 224 24,217 
8 - Substandard19,511 1,111 3,189 17,217 1,198 2,106 44,332 
Total29,511 79,748 66,370 101,847 124,170 52,465 8,501 462,613 
Commercial business
1-6 Pass345,361 77,834 54,636 34,086 20,849 18,549 87,579 3,370 642,264 
7- Special Mention794 384 7,360 1,756 175 10,469 
8 - Substandard5,578 12,129 1,902 1,805 1,184 8,494 92 31,184 
Total345,361 84,206 67,149 43,348 22,654 19,733 97,829 3,637 683,917 
Total commercial portfolio$1,085,512 $867,996 $522,624 $414,877 $504,063 $323,852 $179,278 $13,270 $3,911,472 
Total LHFI$1,207,124 $968,879 $710,337 $608,327 $574,642 $599,785 $603,048 $22,227 $5,294,369 
26




The following tables present a vintage analysis of year to date charge-offs and year to date recoveries of the consumer portfolio and commercial portfolio segment by loan sub-class.
At September 30, 2020
(in thousands)202020192018201720162015 and priorRevolvingRevolving-termTotal
CONSUMER PORTFOLIO
Single family
Charge-offs$$(3)$$$$$$$(3)
Recoveries56 56 
Net(3)56 53 
Home equity and other
Charge-offs(60)(32)(1)(252)(345)
Recoveries12 123 140 291 
Net(48)(28)123 (112)(54)
Consumer Portfolio
Charge-offs(63)(32)(1)(252)(348)
Recoveries12 179 140 347 
Total net$$(51)$(28)$$$179 $(112)$$(1)

At September 30, 2020
(in thousands)202020192018201720162015 and priorRevolvingRevolving-termTotal
COMMERCIAL PORTFOLIO
Single family construction
Charge-offs$$$$$$$$$
Recoveries163 163 
Net163 163 
Commercial business
Charge-offs(41)(102)(447)(590)
Recoveries72 72 
Net(41)(102)(375)(518)
Commercial portfolio
Charge-offs(41)(102)(447)(590)
Recoveries235 235 
Total net$$$$(41)$(102)$(212)$$$(355)
All loans
Charge-offs(63)(32)(42)(102)(447)(252)(938)
Recoveries12 414 140 582 
Total net$$(51)$(28)$(36)$(96)$(33)$(112)$$(356)

27


Collateral Dependent Loans
A loan is collateral dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In these cases, expected credit loss is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral. The fair value of the collateral is adjusted for the estimated costs to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral.
The following table presents the amortized cost basis of collateral-dependent loans by loan sub-class and collateral type. All collateral dependent loans are reviewed quarterly and loan amounts are charged down to fair value of the collateral, less costs to sell if the loss is confirmed and the expected repayment is from the sale of the collateral. If the expected repayment of the loan is from the operation of the collateral, then the cost of sale is not deducted from the fair value of the collateral.
At September 30, 2020
(in thousands)Land1-4 FamilyMultifamilyNon-residential real estateOther non-real estateTotal
Consumer loans
Single family
$$1,067 $$$$1,067 
Home equity loans and other
   Total1,067 1,067 
Commercial and industrial loans
Owner occupied commercial real estate1,789 4,296 6,085 
Commercial business1,787 715 228 5,947 8,677 
   Total3,576 715 4,524 5,947 14,762 
  Total collateral-dependent loans$3,576 $1,782 $$4,524 $5,947 $15,829 

Nonaccrual and Past Due Loans
Loans are placed on nonaccrual status when the full and timely collection of principal and interest is doubtful, generally when the loan becomes 90 days or more past due for principal or interest payment or if part of the principal balance has been charged off. Loans whose repayments are insured by the Federal Housing Administration ("FHA") or guaranteed by the Veterans Administration ("VA") are generally maintained on accrual status even if 90 days or more past due.

The following table presents nonaccrual status for loans in compliance with ASC 326-20-50-16.
At September 30, 2020At December 31, 2019
(in thousands)NonaccrualNonaccrual with no related ACL90 days or
more past
due and
accruing
NonaccrualNonaccrual with no related ACL90 days or
more past
due and
accruing
Consumer loans
Single family$4,617 $1,479 $13,051 $5,364 $1,652 $19,702 
Home equity and other1,747 1,160 
Total6,364 1,481 13,051 6,524 1,661 19,702 
Commercial and industrial loans
Owner occupied commercial real estate6,085 6,085 2,891 2,892 
        Commercial business8,677 5,973 2,637 3,446 2,954 
Total14,762 12,058 2,637 6,337 5,846 
Total nonaccrual loans$21,126 $13,539 $15,688 $12,861 $7,507 $19,702 



28


The following tables present an aging analysis of past due loans by loan portfolio segment and loan sub-class.
At September 30, 2020
Past Due and Still Accruing
(in thousands)30-59 days
60-89 days
90 days or
more
Nonaccrual
Total past
due and nonaccrual (4)
CurrentTotal
loans
Consumer loans
Single family$2,092 $1,030 $13,051 (2)$4,617 $20,790 $915,984 $936,774 (1)
Home equity and other34 60 1,747 1,841 444,282 446,123 
Total2,126 1,090 13,051 6,364 22,631 1,360,266 1,382,897 
Commercial real estate loans
Non-owner occupied commercial real estate847,079 847,079 
Multifamily1,327,156 1,327,156 
Construction/land development
Multifamily construction143,360 143,360 
Commercial real estate construction45,049 45,049 
Single family construction— 238,251 238,251 
Single family construction to permanent164,047 164,047 
Total2,764,942 2,764,942 
Commercial and industrial loans
Owner occupied commercial real estate6,085 6,085 456,528 462,613 
Commercial business2,637 8,677 11,314 672,603 683,917 
Total2,637 14,762 17,399 1,129,131 1,146,530 
Total loans$2,126 $1,090 $15,688 $21,126 $40,030 $5,254,339 $5,294,369 
%0.04 %0.02 %0.30 %0.40 %0.76 %99.24 %100.00 %

29


At December 31, 2019
Past Due and Still Accruing
(in thousands)30-59 days
60-89 days
90 days or
more
Nonaccrual
Total past
due and nonaccrual(4)
CurrentTotal
loans
Consumer loans
Single family$5,694 $4,261 $19,702 (2)$5,364 $35,021 $1,037,685 $1,072,706 (1)
Home equity and other837 372 1,160 2,369 551,007 553,376 
Total6,531 4,633 19,702 6,524 37,390 1,588,692 1,626,082 
Commercial real estate loans
Non-owner occupied commercial real estate895,546 895,546 
Multifamily999,140 999,140 
Construction and land development701,762 701,762 
Total2,596,448 2,596,448 
Commercial and industrial loans
Owner occupied commercial real estate2,891 2,891 474,425 477,316 
Commercial business44 3,446 3,490 411,220 414,710 
Total44 6,337 6,381 885,645 892,026 
Total loans$6,575 $4,633 $19,702 $12,861 $43,771 $5,070,785 $5,114,556 (3)
%0.13 %0.09 %0.39 %0.25 %0.86 %99.14 %100.00 %

(1)Includes $7.6 million and $3.5 million of loans at September 30, 2020 and December 31, 2019, respectively, where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in our consolidated income statements.
(2)FHA-insured and VA-guaranteed single family loans that are 90 days or more past due are maintained on accrual status if they are determined to have little to no risk of loss.
(3)Net deferred loans fees and costs of $24.5 million were included within the carrying amounts of the loan balances as of December 31, 2019, in order to conform with the current period presentation.
(4)Includes loans whose repayments are insured by the FHA or guaranteed by the VA or SBA of $17.7 million and $28.4 million at September 30, 2020 and December 31, 2019, respectively.

30


The following tables present information about troubled debt restructuring ("TDR") activity during the periods indicated.

Quarter Ended September 30, 2020Nine Months Ended September 30, 2020
(dollars in thousands)Number of loan
modifications
Recorded
investment
Related charge-
offs
Number of loan
modifications
Recorded
investment
Related charge-
offs
Consumer loans
Single family
Concession type:
Interest rate reduction$1,642 $23 $4,878 $
Payment restructure411 10 2,067 
Total2,053 33 6,945 
Commercial and industrial loans
Owner occupied commercial real estate
Concession type:
Payment restructure678 
Commercial business
Concession type:
Payment restructure1,125 
Total commercial and industrial
Concession type:
Payment restructure1,803 
Total1,803 
Total loans
Concession type:
Interest rate reduction1,642 23 4,878 
Payment restructure411 12 3,870 
Total9$2,053 $35$8,748 $
31


Quarter Ended September 30, 2019Nine Months Ended September 30, 2019
(dollars in thousands)Number of loan
modifications
Recorded
investment
Related charge-
offs
Number of loan
modifications
Recorded
investment
Related charge-
offs
Consumer loans
Single family
Concession type:
Interest rate reduction$1,112 $13 $2,386 $
Payment restructure21 5,420 111 23,904 
Home equity and other
Concession type:
Payment restructure116 
Total consumer
Concession type:
Interest rate reduction1,112 13 2,386 
Payment restructure21 5,420 112 24,020 
Total27 6,532 125 26,406 
Commercial real estate loans
Construction and land development
Concession type:
Payment restructure4,675 
Total commercial real estate
Concession type:
Payment restructure4,675 
Total4,675 
Commercial and industrial loans
Owner occupied commercial real estate
Concession type:
Payment restructure5,840 
Commercial business
Concession type:
Payment restructure259 
Total commercial and industrial
Concession type:
Payment restructure6,099 
Total6,099 
Total loans
Concession type:
Interest rate reduction1,112 13 2,386 
Payment restructure21 5,420 115 34,794 
Total27 $6,532 $128 $37,180 $



32


The following table presents loans that were modified as TDRs within the previous 12 months and subsequently re-defaulted during the three and nine months ended September 30, 2020 and 2019, respectively. A TDR loan is considered re-defaulted when it becomes doubtful that the objectives of the modifications will be met, generally when a consumer loan TDR becomes 60 days or more past due on principal or interest payments or when a commercial loan TDR becomes 90 days or more past due on principal or interest payments.
Three Months Ended September 30,
20202019
(dollars in thousands)Number of loan relationships that re-defaultedRecorded
investment
Number of loan relationships that re-defaultedRecorded
investment
Consumer loans - single family$1,038 $643 
Nine Months Ended September 30,
20202019
(dollars in thousands)Number of loan relationships that re-defaultedRecorded
investment
Number of loan relationships that re-defaultedRecorded
investment
Consumer loans - single family16 $3,237 $1,873 


The CARES Act 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 experiencing financial difficulty if they meet the following qualifying criteria:

The modification is in response to the National Emergency related to the COVID pandemic;
The borrower was current at the time the modification program was implemented; and
The modification is short-term

We have elected to apply temporary relief under Section 4013 of the CARES Act to certain eligible short-term modifications and will not treat qualifying loan modifications as TDRs for accounting or disclosure purposes. Additionally, eligible short-term loan modifications subject to the practical expedient in the interagency guidance will not be treated as TDRs for accounting or disclosure purposes if they qualify. 

As of September 30, 2020, excluding any SBA guaranteed loans for which the government is making payments as provided for under the CARES Act, or single family loans that are guaranteed by FHA or VA, the Company has outstanding balances of $206 million on 375 loans that were approved for forbearance under this program.

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 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.

33


This section reports results prior to the January 1, 2020 adoption of ASC 326 and is presented in accordance with previously applicable GAAP.
The following table summarizes designated loan grades by loan portfolio segment and loan class.
At December 31, 2019
(in thousands)PassSpecial mentionSubstandardTotal
Consumer loans
Single family$1,056,166 (1)$8,802 $5,364 $1,070,332 
Home equity and other531,102 664 1,160 532,926 
Total1,587,268 9,466 6,524 1,603,258 
Commercial real estate loans
Non-owner occupied commercial real estate894,896 894,896 
Multifamily996,498 996,498 
Construction/land development681,445 20,954 702,399 
Total2,572,839 20,954 2,593,793 
Commercial and industrial loans
Owner occupied commercial real estate460,319 12,709 5,144 478,172 
Commercial business402,060 9,405 3,415 414,880 
Total862,379 22,114 8,559 893,052 
Total LHFI$5,022,486 $52,534 $15,083 $5,090,103 
(1)    Includes $3.5 million of loans where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in the consolidated income statements.

As of December 31, 2019, NaN of the Company's loans were rated Loss.

34


The following tables disaggregate our ACL and recorded investment in loans by impairment methodology.
At December 31, 2019
(in thousands)Allowance:
collectively
evaluated for
impairment
Allowance:
individually
evaluated for
impairment
TotalLoans:
collectively
evaluated for
impairment
Loans:
individually
evaluated for
impairment
Total
Consumer loans
Single family$6,333 $117 $6,450 $1,005,386 $61,503 $1,066,889 
Home equity and other6,815 28 6,843 532,038 863 532,901 
            Total13,148 145 13,293 1,537,424 62,366 1,599,790 
Commercial real estate loans
Non-owner occupied commercial real estate7,249 7,249 894,896 894,896 
Multifamily7,015 7,015 996,498 996,498 
Construction/land development8,679 8,679 702,399 702,399 
     Total22,943 22,943 2,593,793 2,593,793 
Commercial and industrial loans
Owner occupied commercial real estate3,640 3,640 475,281 2,891 478,172 
Commercial business2,953 2,961 411,386 3,494 414,880 
     Total6,593 6,601 886,667 6,385 893,052 
Total loans evaluated for impairment42,684 153 42,837 5,017,884 68,751 5,086,635 
Loans carried at fair value (1)
— — — 3,468 
Total LHFI$42,684 $153 $42,837 $5,017,884 $68,751 $5,090,103 
(1)    Comprised of single family loans where a fair value option election was made at the time of origination and, therefore, are carried at fair value with changes recognized in the consolidated income statements.


35


The following tables present impaired loans by loan portfolio segment and loan class.
At December 31, 2019
(in thousands)
Recorded
investment (1)
Unpaid
principal
balance (2)
Related
allowance
With no related allowance recorded:
Consumer loans
Single family(3)
$60,009 $60,448 $— 
Home equity and other472 472 — 
                     Total60,481 60,920 — 
Commercial and industrial loans
Owner occupied commercial real estate2,891 3,013 — 
Commercial business2,954 3,267 — 
             Total5,845 6,280 — 
Total$66,326 $67,200 $— 
With an allowance recorded:
Consumer loans
Single family$1,494 $1,494 $117 
Home equity and other391 391 28 
                     Total1,885 1,885 145 
Commercial and industrial loans
Commercial business540 919 
Total540 919 
Total$2,425 $2,804 $153 
Combined:
Consumer loans
Single family (3)
$61,503 $61,942 $117 
Home equity and other863 863 28 
Total62,366 62,805 145 
Commercial and industrial loans
Owner occupied commercial real estate2,891 3,013 
Commercial business3,494 4,186 
Total6,385 7,199 
Total impaired loans$68,751 $70,004 $153 
 
(1)Includes partial charge-offs and nonaccrual interest paid and purchase discounts and premiums.
(2)Unpaid principal balance does not include partial charge-offs, purchase discounts and premiums or nonaccrual interest paid. Related allowance is calculated on net book balances not unpaid principal balances.
(3)Includes $59.8 million in single family performing TDRs.

36


The following tables provide the average recorded investment and interest income recognized on impaired loans by portfolio segment and class.
Three Months Ended September 30, 2019
(in thousands)
Average Recorded InvestmentInterest Income Recognized
Consumer loans
Single family$67,814 $662 
Home equity and other1,044 14 
Total68,858 676 
Commercial real estate loans
Multifamily242 
Construction/land development677 
             Total919 
Commercial and industrial loans
Owner occupied commercial real estate1,744 
Commercial business1,842 
Total3,586 
Total impaired loans$73,363 $685 
    
Nine Months Ended September 30, 2019
(in thousands)
Average Recorded InvestmentInterest Income Recognized
Consumer loans
Single family$68,181 $2,088 
Home equity and other1,112 46 
Total69,293 2,134 
Commercial real estate loans
Non-owner occupied commercial real estate
Multifamily366 14 
Construction/land development1,689 
Total2,058 14 
Commercial and industrial loans
Owner occupied commercial real estate2,936 112 
Commercial business1,889 29 
Total4,825 141 
Total impaired loans$76,176 $2,289 









37


NOTE 5–DEPOSITS:

Deposit balances, including stated rates, were as follows:
 
(in thousands)At September 30,
2020
Weighted Average RateAt December 31,
2019
Weighted Average Rate
Noninterest-bearing demand deposits$1,323,794 — %$907,918 — %
Interest-bearing demand deposits545,890 0.10 %373,832 0.38 %
Savings258,727 0.07 %219,182 0.21 %
Money market2,512,440 0.23 %2,224,494 1.25 %
Certificates of deposit1,174,839 1.20 %1,614,533 2.24 %
     Total$5,815,690 0.36 %$5,339,959 1.23 %


Certificates of deposit outstanding mature as follows:
 
(in thousands)At September 30,
2020
Within one year$1,021,713 
One to two years104,781 
Two to three years27,938 
Three to four years15,253 
Four to five years5,123 
Thereafter31 
Total$1,174,839 

The aggregate amount of certificate of deposits in denominations of more than $250 thousand at September 30, 2020 and December 31, 2019 were $137 million and $223 million, respectively. There were $195 million and $266 million of brokered deposits at September 30, 2020 and December 31, 2019, respectively.


NOTE 6–DERIVATIVES AND HEDGING ACTIVITIES:

To reduce the risk of significant interest rate fluctuations on the value of certain assets and liabilities, such as certain mortgage LHFS or MSRs, the Company utilizes derivatives, such as forward sale commitments, futures, option contracts, interest rate swaps and interest rate swaptions as risk management instruments in its hedging strategy. Derivative transactions are measured in terms of notional amount, which is not recorded in the consolidated balance sheets. The notional amount is generally not exchanged and is used as the basis for interest and other contractual payments.

Derivatives are reported at their respective fair values in the other assets or accounts payable and other liabilities line items on the consolidated balance sheets, with changes in fair value recognized in current period earnings.

As permitted under U.S. GAAP, the Company nets derivative assets and liabilities when a legally enforceable master netting agreement exists between the Company and the derivative counterparty, which are documented under industry standard master agreements and credit support annexes. The Company's master netting agreements provide that following an uncured payment default or other event of default, the non-defaulting party may promptly terminate all transactions between the parties and determine a net amount due to be paid to, or by, the defaulting party.

The collateral used under the Company's master netting agreements is typically cash, but securities may be used under agreements with certain counterparties. Receivables related to cash collateral that has been paid to counterparties is included in other assets. Payables related to cash collateral that has been received from counterparties is included in accounts payable and other liabilities. Interest is owed on amounts received from counterparties and we earn interest on cash paid to counterparties. Any securities pledged to counterparties as collateral remain on the consolidated balance sheets. The Company had liabilities of
38


$6.9 million and $15.2 million in cash collateral received from counterparties and receivables of $16.7 million and $2.9 million in cash collateral paid to counterparties at September 30, 2020 and December 31, 2019, respectively.

In addition, the Company periodically enters into certain commercial loan interest rate swap agreements in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to a swap agreement. This swap agreement effectively converts the customer’s variable rate loan into a fixed rate. The Company then enters into a corresponding swap agreement with a third-party in order to offset its exposure on the variable and fixed components of the customer loan agreement. The interest rate swap agreements with the customers and third parties are marked to market in earnings. The notional amount of open interest rate swap agreements at September 30, 2020 and December 31, 2019 were $217 million and $144 million, respectively. 

For further information on the policies that govern derivative and hedging activities, see Note 1, Summary of Significant Accounting Policies, and Note 12, Derivatives and Hedging Activities, within our 2019 Annual Report on Form 10-K.


39


The notional amounts and fair values for derivatives consist of the following.
 
At September 30, 2020
Notional amountFair value derivatives
(in thousands) AssetLiability
Forward sale commitments$878,021 $799 $(2,186)
Interest rate lock commitments534,506 20,963 (3)
Interest rate swaps696,436 30,279 (26,057)
Eurodollar futures454,000 (5)
Total derivatives before netting$2,562,963 52,041 (28,251)
Netting adjustment/Cash collateral (1)
(17,168)26,966 
Carrying value on consolidated balance sheet$34,873 $(1,285)

At December 31, 2019
Notional amountFair value derivatives
(in thousands) AssetLiability
Forward sale commitments$651,838 $830 $(492)
Interest rate lock commitments124,379 2,281 (58)
Interest rate swaps688,516 27,097 (10,889)
Eurodollar futures2,232,000 
Total derivatives before netting$3,696,733 30,211 (11,439)
Netting adjustment/Cash collateral (1)
(21,414)9,101 
Carrying value on consolidated balance sheet(2)
$8,797 $(2,338)

(1)    Includes net cash collateral paid of $9.8 million and net cash collateral received of $12.3 million at September 30, 2020 and December 31, 2019, respectively.
(2)    Includes both continuing and discontinued operations.

The following tables present gross and net information about derivative instruments.
At September 30, 2020
(in thousands)Gross fair value
Netting adjustments/ Cash collateral (1)
Carrying valueSecurities not offset in consolidated balance sheet (disclosure-only netting)Net amount
Derivative assets$52,041 $(17,168)$34,873 $$34,873 
Derivative liabilities(28,251)26,966 (1,285)(1,285)
At December 31, 2019
(in thousands)Gross fair value
Netting adjustments/ Cash collateral (1)
Carrying valueSecurities not offset in consolidated balance sheet (disclosure-only netting)Net amount
Derivative assets$30,211 $(21,414)$8,797 $$8,797 
Derivative liabilities(11,439)9,101 (2,338)(2,338)

(1)    Includes net cash collateral paid of $9.8 million and net cash collateral received of $12.3 million at September 30, 2020 and December 31, 2019, respectively.
40


The following table presents the net gain (loss) recognized on derivatives, including economic hedge derivatives, within the respective line items in the consolidated income statements for the periods indicated.
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Recognized in noninterest income:
Net gain (loss) on loan origination and sale activities (1)
$(3,810)$(6,884)$583 $(17,983)
Loan servicing income (loss) (2)
(91)9,040 22,148 19,917 
Other (3)
632 115 (84)149 
Total$(3,269)$2,271 (4)$22,647 $2,083 (4)
 

(1)Comprised of interest rate lock commitments ("IRLCs") and forward contracts used as an economic hedge of IRLCs and single family LHFS.
(2)Comprised of interest rate swaps, interest rate swaptions, futures and forward contracts used as an economic hedge of single family MSRs.
(3)Comprised of interest rate swaps used as an economic hedge of LHFI.
(4)Includes both continuing and discontinued operations in the three and nine months ended September 30, 2019.


NOTE 7–MORTGAGE BANKING OPERATIONS:

LHFS consisted of the following.
 
(in thousands)At September 30,
2020
At December 31,
2019
Single family$159,834 $105,458 
Commercial real estate, multifamily and SBA261,903 128,841 
Amounts attributed to discontinued operations(26,122)
Total LHFS$421,737 $208,177 

LHFS are valued at fair value, primarily single family loans, or at lower of cost or market, primarily commercial real estate loans transferred from held for investment.

Loans sold consisted of the following for the periods indicated: 
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Single family (1)
$686,280 $893,959 $1,393,283 $3,352,872 
Commercial real estate, multifamily and SBA170,980 270,484 502,059 586,217 
Total loans sold$857,260 $1,164,443 $1,895,342 $3,939,089 

(1)    2019 amounts include both continuing and discontinued operations.

41


Gain on loan origination and sale activities, including the effects of derivative risk management instruments, consisted of the following.
 
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Single family$27,632 $9,628 $73,751 $78,612 
Commercial real estate, multifamily and SBA5,498 6,693 11,947 12,179 
Amounts attributed to discontinued operations(370)(60,055)
Gain on loan origination and sale activities$33,130 $15,951 $85,698 $30,736 


The Company's portfolio of loans serviced for others is primarily comprised of loans held in U.S. government and Agency MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae. Loans serviced for others are not included in the consolidated balance sheets as they are not assets of the Company.

The composition of loans serviced for others that contribute to loan servicing income is presented below at the unpaid principal balance.
(in thousands)At September 30,
2020
At December 31,
2019
Single family$6,188,206 $7,023,441 
Commercial real estate, multifamily and SBA1,704,434 1,618,876 
Total loans serviced for others$7,892,640 $8,642,317 


The Company has made representations and warranties that the loans sold meet certain requirements. The Company may be required to repurchase mortgage loans or indemnify loan purchasers due to defects in the origination process of the loan, such as documentation errors, underwriting errors and judgments, appraisal errors, early payment defaults and fraud.

The following is a summary of changes in the Company's liability for estimated mortgage repurchase losses.
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Balance, beginning of period$2,083 $3,237 $2,871 $3,120 
Additions, net of adjustments (1)
252 (22)(275)482 
Realized losses (2)
(240)(28)(501)(415)
Balance, end of period$2,095 $3,187 $2,095 $3,187 
 
(1)Includes additions for new loan sales and changes in estimated probable future repurchase losses on previously sold loans.
(2)Includes principal losses and accrued interest on repurchased loans, "make-whole" settlements, settlements with claimants and certain related expenses.

The Company has agreements with certain investors to advance scheduled principal and interest amounts on delinquent loans. Advances are also made to fund the foreclosure and collection costs of delinquent loans prior to the recovery of reimbursable amounts from investors or borrowers. Advances of $3.1 million and $2.5 million were recorded in other assets as of September 30, 2020 and December 31, 2019, respectively.

The Company has a unilateral right to repurchase certain delinquent or defaulted Ginnie Mae early buyout option ("GNMA EBO") pool loans it has previously sold, and, as required under GAAP, recognized a liability and an asset totaling $115 million and $9 million as of September 30, 2020 and December 31, 2019, respectively.


42


Revenue from mortgage servicing, including the effects of derivative risk management instruments, consisted of the following.
 
 Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Servicing income, net:
Servicing fees and other$7,220 $7,963 $23,073 $32,124 
Amortization of single family MSRs(1)
(4,401)(4,489)(12,246)(16,894)
Amortization of multifamily and SBA MSRs(1,350)(1,315)(4,084)(3,802)
Total1,469 2,159 6,743 11,428 
Risk management, single family MSRs:
Changes in fair value of MSRs due to assumptions (2)(3)
(2,960)(7,501)(21,970)(22,193)
Net gain (loss) from derivative hedging(91)9,040 22,148 19,917 
Total(3,051)1,539 178 (2,276)
Amounts attributed to discontinued operations(502)(2,033)
Loan servicing income$(1,582)$3,196 $6,921 $7,119 
 
(1)Represents changes due to collection/realization of expected cash flows and curtailments.
(2)Principally reflects changes in market inputs, which include current market interest rates and prepayment model updates, both of which affect future prepayment speeds and cash flow projections.
(3)Includes pre-tax income of $333 thousand and pre-tax loss of $941 thousand resulting from the sales of single family MSRs during the three and nine months ended September 30, 2019, respectively.

All MSRs are initially measured and recorded at fair value at the time loans are sold. Single family MSRs are subsequently carried at fair value with changes in fair value reflected in earnings in the periods in which the changes occur, while multifamily and SBA MSRs are subsequently carried at the lower of amortized cost or fair value.

The fair value of MSRs is determined based on the price that would be received to sell the MSRs in an orderly transaction between market participants at the measurement date. The Company determines fair value using a valuation model that calculates the net present value of estimated future cash flows. Estimates of future cash flows include contractual servicing fees, ancillary income and costs of servicing, the timing of which are impacted by assumptions, primarily expected prepayment speeds and discount rates, which relate to the underlying performance of the loans.

The fair value measurement of MSRs is adjusted up or down depending on whether the underlying loan pool interest rate is at a premium, discount or par. Key economic assumptions used in measuring the fair value of capitalized single family MSRs were as follows.
 
Three Months Ended September 30,Nine Months Ended September 30,
(rates per annum)2020201920202019
Constant prepayment rate ("CPR") (1)
20.0% -30.0%18.9 %17.1%-30.0%18.8 %
Discount rate (2)
7.71 %8.96 %7.78 %9.39 %

(1)Represents an estimated lifetime average prepayment rate.
(2)Discount rate is based on market observations.

43


Key economic assumptions and the sensitivity of the current fair value for single family MSRs to immediate adverse changes in those assumptions were as follows.
(dollars in thousands)At September 30, 2020
Fair value of single family MSR$47,018 
Expected weighted-average life (in years)4.01
Constant prepayment rate (1)
14.43 %
Impact on fair value of 25 basis points adverse change in interest rates$(2,638)
Impact on fair value of 50 basis points adverse change in interest rates$(5,141)
Discount rate8.11 %
Impact on fair value of 100 basis points increase$(1,063)
Impact on fair value of 200 basis points increase$(2,537)
 
(1)Represents the expected lifetime average.

These sensitivities are hypothetical and subject to key assumptions of the underlying valuation model. As the table above demonstrates, the Company's methodology for estimating the fair value of MSRs is highly sensitive to changes in key assumptions. For example, actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another (for example, decreases in market interest rates may provide an incentive to refinance; however, this may also indicate a slowing economy and an increase in the unemployment rate, which reduces the number of borrowers who qualify for refinancing), which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made as of a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.

In March 2019, the Company successfully closed and settled 2 sales of the rights to service an aggregate of $14.3 billion in total unpaid principal balance of single family mortgage loans serviced for Fannie Mae, Ginnie Mae and Freddie Mac. These sales resulted in a $333 thousand pre-tax income and $941 thousand pre-tax loss from discontinued operations for the three and nine months ended September 30, 2019, respectively.

The changes in single family MSRs measured at fair value are as follows.
 
Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Beginning balance$47,804 $67,723 $68,109 $252,168 
Additions and amortization:
Originations6,569 6,422 12,942 23,893 
Sales(176,944)
Amortization (1)
(4,401)(4,489)(12,246)(16,894)
Net additions and amortization2,168 1,933 696 (169,945)
Changes in fair value assumptions (2)
(2,954)(7,833)(21,787)(20,400)
Ending balance$47,018 $61,823 $47,018 $61,823 
 
(1)Represents changes due to collection/realization of expected cash flows and curtailments.
(2)Principally reflects changes in model assumptions, including prepayment sped assumptions, which are primarily reflected by changes in mortgage interest rates.

MSRs resulting from the sale of multifamily loans are recorded at fair value and subsequently carried at the lower of amortized cost or fair value. Multifamily MSRs are amortized in proportion to, and over, the estimated period the net servicing income will be collected.

The changes in multifamily MSRs measured at the lower of amortized cost or fair value were as follows.
 
44


Three Months Ended September 30,Nine Months Ended September 30,
(in thousands)2020201920202019
Beginning balance$30,583 $27,227 $29,494 $28,328 
Origination2,524 2,770 6,129 3,930 
Amortization(1,301)(1,196)(3,817)(3,457)
Ending balance$31,806 $28,801 $31,806 $28,801 




NOTE 8–GUARANTEES:

In the ordinary course of business, the Company sells and services loans through the Fannie Mae Multifamily DUS® program and shares in the risk of loss with Fannie Mae under the terms of the DUS® contracts (pari passu loss sharing agreement). Under such agreements, the Company and Fannie Mae share losses on a pro rata basis, where the Company is responsible for losses incurred up to one-third of the principal balance on each loan and with two-thirds of the loss covered by Fannie Mae. For loans that have been sold through this program, a liability is recorded for this loss sharing arrangement under the accounting guidance for guarantees. As of September 30, 2020 and December 31, 2019, the total unpaid principal balance of loans sold under this program was $1.6 billion and $1.5 billion, respectively. The Company's reserve liability related to this arrangement totaled $2.2 million and $2.8 million at September 30, 2020 and December 31, 2019, respectively. There were 0 actual losses incurred under this arrangement during the three and nine months ended September 30, 2020 and 2019.

In the ordinary course of business, the Company sells residential mortgage loans to GSEs and other entities. In addition, the Company pools FHA-insured and VA-guaranteed mortgage loans into Ginnie Mae guaranteed mortgage-backed securities. The Company has made representations and warranties that the loans sold meet certain requirements. The Company may be required to repurchase mortgage loans or indemnify loan purchasers due to defects in the origination process of the loan, such as documentation errors, underwriting errors and judgments, early payment defaults and fraud.

These obligations expose the Company to mark-to-market and credit losses on the repurchased mortgage loans after accounting for any mortgage insurance that we may receive. Generally, the maximum amount of future payments the Company would be required to make for breaches of these representations and warranties would be equal to the unpaid principal balance of such loans that are deemed to have defects that were sold to purchasers plus, in certain circumstances, accrued and unpaid interest on such loans and certain expenses.

The Company does not typically receive repurchase requests from the FHA or VA. As an originator of FHA-insured or VA-guaranteed loans, the Company is responsible for obtaining the insurance with FHA or the guarantee with the VA. If loans are later found not to meet the requirements of FHA or VA, through required internal quality control reviews or through agency audits, the Company may be required to indemnify FHA or VA against losses. The Company's mortgage repurchase liability incorporates probable losses associated with such indemnification.

The total unpaid principal balance of loans sold on a servicing-retained basis that were subject to the terms and conditions of these representations and warranties totaled $6.3 billion and $7.1 billion as of September 30, 2020 and December 31, 2019, respectively. At September 30, 2020 and December 31, 2019, the Company had recorded a mortgage repurchase liability for loans sold on a servicing-retained and servicing-released basis, included in accounts payable and other liabilities on the consolidated balance sheet, of $2.1 million and $2.9 million, respectively.




45


NOTE 9–FAIR VALUE MEASUREMENT:

Valuation Processes
The Company has various processes and controls in place to ensure that fair value measurements are reasonably estimated. The Finance Committee of the Board provides oversight and approves the Company's Asset/Liability Management Policy ("ALMP"). The Company's ALMP governs, among other things, the application and control of the valuation models used to measure fair value. On a quarterly basis, the Company's Asset/Liability Management Committee ("ALCO") and the Finance Committee of the Board review significant modeling variables used to measure the fair value of the Company's financial instruments, including the significant inputs used in the valuation of single family MSRs. Additionally, ALCO periodically obtains an independent review of the MSR valuation process and procedures, including a review of the model architecture and the valuation assumptions. The Company obtains an MSR valuation from an independent valuation firm monthly to assist with the validation of the fair value estimate and the reasonableness of the assumptions used in measuring fair value.

The Company's real estate valuations are overseen by the Company's appraisal department, which is independent of the Company's lending and credit administration functions. The appraisal department maintains the Company's appraisal policy and recommends changes to the policy subject to approval by the Company's Loan Committee and the Credit Committee of the Board. The Company's appraisals are prepared by independent third-party appraisers and the Company's internal appraisers. Single family appraisals are generally reviewed by the Company's single family loan underwriters. Single family appraisals with unusual, higher risk or complex characteristics, as well as commercial real estate appraisals, are reviewed by the Company's appraisal department.

We obtain pricing from third party service providers for determining the fair value of a substantial portion of our investment securities AFS. We have processes in place to evaluate such third party pricing services to ensure information obtained and valuation techniques used are appropriate. For fair value measurements obtained from third party services, we monitor and review the results to ensure the values are reasonable and in line with market experience for similar classes of securities. While the inputs used by the pricing vendor in determining fair value are not provided and therefore unavailable for our review, we do perform certain procedures to validate the values received, including comparisons to other sources of valuation (if available), comparisons to other independent market data and a variance analysis of prices by Company personnel that are not responsible for the performance of the investment securities.

Estimation of Fair Value
Fair value is based on quoted market prices, when available. In cases where a quoted price for an asset or liability is not available, the Company uses valuation models to estimate fair value. These models incorporate inputs such as forward yield curves, loan prepayment assumptions, expected loss assumptions, market volatilities and pricing spreads utilizing market-based inputs where readily available. The Company believes its valuation methods are appropriate and consistent with those that would be used by other market participants. However, imprecision in estimating unobservable inputs and other factors may result in these fair value measurements not reflecting the amount realized in an actual sale or transfer of the asset or liability in a current market exchange.
The following table summarizes the fair value measurement methodologies, including significant inputs and assumptions and classification of the Company's assets and liabilities.
46


Asset/Liability class  Valuation methodology, inputs and assumptions  Classification
Investment securities
Investment securities AFS  Observable market prices of identical or similar securities are used where available.
 
  Level 2 recurring fair value measurement.
If market prices are not readily available, value is based on discounted cash flows using the following significant inputs:
 
•      Expected prepayment speeds 
•      Estimated credit losses 
•      Market liquidity adjustments
Level 3 recurring fair value measurement.
LHFS    
Single family loans, excluding loans transferred from held for investment  
Fair value is based on observable market data, including:
 
•       Quoted market prices, where available 
•       Dealer quotes for similar loans 
•       Forward sale commitments
  Level 2 recurring fair value measurement.
When not derived from observable market inputs, fair value is based on discounted cash flows, which considers the following inputs:
•       Benchmark yield curve  
•       Estimated discount spread to the benchmark yield curve 
•       Expected prepayment speeds
Estimated fair value classified as Level 3.
Mortgage servicing rights    
Single family MSRs  
For information on how the Company measures the fair value of its single family MSRs, including key economic assumptions and the sensitivity of fair value to changes in those assumptions, see Note 7, Mortgage Banking Operations.
  Level 3 recurring fair value measurement.
Derivatives    
Eurodollar futuresFair value is based on closing exchange prices.Level 1 recurring fair value measurement.
Interest rate swaps
Interest rate swaptions
Forward sale commitments
Fair value is based on quoted prices for identical or similar instruments, when available.
 
When quoted prices are not available, fair value is based on internally developed modeling techniques, which require the use of multiple observable market inputs including:
 
•       Forward interest rates 
•       Interest rate volatilities
Level 2 recurring fair value measurement.
Interest rate lock commitments
The fair value considers several factors including:

•       Fair value of the underlying loan based on quoted prices in the secondary market, when available. 
•       Value of servicing
•       Fall-out factor
Level 3 recurring fair value measurement.

 



47


The following table presents the levels of the fair value hierarchy for the Company's assets and liabilities measured at fair value on a recurring basis.
 
(in thousands)Fair Value at September 30, 2020Level 1Level 2Level 3
Assets:
Investment securities AFS
Mortgage backed securities:
Residential$60,453 $$57,739 $2,714 
Commercial45,986 45,986 
Collateralized mortgage obligations:
Residential263,886 263,886 
Commercial163,207 163,207 
Municipal bonds556,634 556,634 
Corporate debt securities15,159 15,076 83 
Agency debentures1,846 1,846 
Single family LHFS159,834 159,834 
Single family LHFI7,638 7,638 
Single family mortgage servicing rights47,018 47,018 
Derivatives
Forward sale commitments799 799 
Interest rate lock commitments20,963 20,963 
Interest rate swaps30,279 30,279 
Total assets$1,373,702 $$1,295,286 $78,416 
Liabilities:
Derivatives
Eurodollar futures$$$$
Forward sale commitments2,186 2,186 
Interest rate lock and purchase loan commitments
Interest rate swaps26,057 26,057 
Total liabilities$28,251 $$28,243 $

48


(in thousands)Fair Value at December 31, 2019Level 1Level 2Level 3
Assets:
Investment securities AFS
Mortgage backed securities:
Residential$91,695 $$89,831 $1,864 
Commercial38,025 38,025 
Collateralized mortgage obligations:
Residential291,618 291,618 
Commercial156,154 156,154 
Municipal bonds341,318 341,318 
Corporate debt securities18,661 18,573 88 
U.S. Treasury securities1,307 1,307 
Single family LHFS (1)
105,458 105,458 
Single family LHFI3,468 3,468 
Single family mortgage servicing rights68,109 68,109 
Derivatives
Eurodollar futures
Forward sale commitments830 830 
Interest rate lock commitments2,281 2,281 
Interest rate swaps27,097 27,097 
Total assets$1,146,024 $$1,070,211 $75,810 
Liabilities:
Derivatives
Forward sale commitments$492 $$492 $
Interest rate lock commitments58 58 
Interest rate swaps10,889 10,889 
Total liabilities$11,439 $$11,381 $58 

(1) Includes both continuing and discontinued operations.

There were 0 transfers between levels of the fair value hierarchy during the three and nine months ended September 30, 2020 and 2019.

Level 3 Recurring Fair Value Measurements

The Company's Level 3 recurring fair value measurements consist of investment securities AFS, single family MSRs, single family LHFI where fair value option was elected, certain single family LHFS and interest rate locks and purchase loan commitments, which are accounted for as derivatives. For information regarding fair value changes and activity for single family MSRs during the three and nine months ended September 30, 2020 and 2019, see Note 7, Mortgage Banking Operations of this Quarterly Report on Form 10-Q.

The fair value of IRLCs considers several factors, including the fair value in the secondary market of the underlying loan resulting from the exercise of the commitment, the expected net future cash flows related to the associated servicing of the loan (referred to as the value of servicing) and the probability that the commitment will not be converted into a funded loan (referred to as a fall-out factor). The fair value of IRLCs on LHFS, while based on interest rates observable in the market, is highly dependent on the ultimate closing of the loans. The significance of the fall-out factor to the fair value measurement of an individual IRLC is generally highest at the time that the rate lock is initiated and declines as closing procedures are performed and the underlying loan gets closer to funding. The fall-out factor applied is based on historical experience. The value of servicing is impacted by a variety of factors, including prepayment assumptions, discount rates, delinquency rates, contractually specified servicing fees, servicing costs and underlying portfolio characteristics. Because these inputs are not observable in market trades, the fall-out factor and value of servicing are considered to be level 3 inputs. The fair value of IRLCs decreases in
49


value upon an increase in the fall-out factor and increases in value upon an increase in the value of servicing. Changes in the fall-out factor and value of servicing do not increase or decrease based on movements in other significant unobservable inputs.

The Company recognizes unrealized gains and losses from the time that an IRLC is initiated until the gain or loss is realized at the time the loan closes, which generally occurs within 30-90 days. For IRLCs that fall out, any unrealized gain or loss is reversed, which generally occurs at the end of the commitment period. The gains and losses recognized on IRLC derivatives generally correlates to volume of single family interest rate lock commitments made during the reporting period (after adjusting for estimated fallout) while the amount of unrealized gains and losses realized at settlement generally correlates to the volume of single family closed loans during the reporting period.

The Company uses the discounted cash flow model to estimate the fair value of certain loans that have been transferred from held for sale to held for investment and single family LHFS when the fair value of the loans is not derived using observable market inputs. The key assumption in the valuation model is the implied spread to benchmark interest rate curve. The implied spread is not directly observable in the market and is derived from third party pricing which is based on market information from comparable loan pools. The fair value estimate of these certain single family loans that have been transferred from held for sale to held for investment and these certain single family LHFS are sensitive to changes in the benchmark interest rate which might result in a significantly higher or lower fair value measurement.

The Company transferred certain loans from held for sale to held for investment. These loans were originated as held for sale loans where the Company had elected fair value option. The Company determined these loans to be level 3 recurring assets as the valuation technique included a significant unobservable input. The total amount of held for investment loans where fair value option election was made was $7.6 million and $3.5 million at September 30, 2020 and December 31, 2019, respectively.

The following information presents significant Level 3 unobservable inputs used to measure fair value of certain investment securities AFS.
(dollars in thousands)Fair ValueValuation
Technique
Significant Unobservable
Input
LowHighWeighted Average
September 30, 2020
Investment securities AFS$2,797 Income approachImplied spread to benchmark interest rate curve2.00%2.00%2.00%
December 31, 2019
Investment securities AFS1,952 Income approachImplied spread to benchmark interest rate curve2.00%2.00%2.00%


The following information presents significant Level 3 unobservable inputs used to measure fair value of single family LHFI where fair value option was elected.
(dollars in thousands)Fair ValueValuation
Technique
Significant Unobservable
Input
LowHighWeighted Average
September 30, 2020
LHFI, fair value option$7,638 Income approachImplied spread to benchmark interest rate curve4.07%21.37%7.84%
December 31, 2019
LHFI, fair value option3,468 Income approachImplied spread to benchmark interest rate curve4.56%6.87%5.63%


The following information presents significant Level 3 unobservable inputs used to measure fair value of certain single family LHFS where fair value option was elected. We had no LHFS with fair value option that were subject to Level 3 fair value due to a significant unobservable input at September 30, 2020 and December 31, 2019.

The following information presents significant Level 3 unobservable inputs used to measure fair value of interest rate lock and purchase loan commitments.
50


(dollars in thousands)Fair ValueValuation
Technique
Significant Unobservable
Input
LowHighWeighted Average
September 30, 2020
Interest rate lock commitments$20,960 Income approachFall-out factor1.21%37.39%15.39%
Value of servicing0.38%1.47%1.02%
December 31, 2019
Interest rate lock commitments2,223 Income approachFall-out factor0%59.69%12.20%
Value of servicing0.55%1.77%1.14%


The following table presents fair value changes and activity for Level 3 investment securities AFS.
Beginning balanceAdditionsTransfersPayoffs/SalesChange in mark to marketEnding balance
(in thousands)
Three Months Ended September 30, 2020
Investment securities AFS$2,861 $$$(48)$(16)$2,797 
Three Months Ended September 30, 2019
Investment securities AFS1,981 (40)83 $2,024 
Nine Months Ended September 30, 2020
Investment securities AFS1,952 985 (387)247 $2,797 
Nine Months Ended September 30, 2019
Investment securities AFS2,379 (120)(235)$2,024 




The following tables present fair value changes and activity for Level 3 LHFS and LHFI.
Beginning balanceAdditionsTransfersPayoffs/SalesChange in mark to marketEnding balance
(in thousands)
Three Months Ended September 30, 2020
LHFI$5,847 $2,169 $$