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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
 
 
 
FORM 10-Q
 
 


x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019 or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from __________ to __________
Commission File Number 000-29480 

 
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter) 
 
 
Washington
 
91-1857900
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
201 Fifth Avenue SW, Olympia, WA
 
98501
(Address of principal executive offices)
 
(Zip Code)
(360) 943-1500
(Registrant’s telephone number, including area code) 
 
 
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  ý    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  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ý
 
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  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
As of May 1, 2019 there were 36,899,138 shares of the registrant's common stock, no par value per share, outstanding.
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common stock, no par value
HFWA
NASDAQ



Table of Contents


HERITAGE FINANCIAL CORPORATION
FORM 10-Q
March 31, 2019
TABLE OF CONTENTS

 
 
 
 
Page
 
 
 
 
 
 
PART I.
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NOTE 1.
 
 
NOTE 2.
 
 
NOTE 3.
 
 
NOTE 4.
 
 
NOTE 5.
 
 
NOTE 6.
 
 
NOTE 7.
 
 
NOTE 8.
 
 
NOTE 9.
 
 
NOTE 10.
 
 
NOTE 11.
 
 
NOTE 12.
 
 
NOTE 13.
 
 
NOTE 14.
 
 
NOTE 15.
 
 
NOTE 16.
ITEM 2.
ITEM 3.
ITEM 4.
Part II.
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5.
ITEM 6.
 

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FORWARD LOOKING STATEMENTS:
This Quarterly Report on Form 10-Q ("Form 10-Q") may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including but not limited to: customer and employee retention, which might be greater than expected; the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be effected by deterioration in the housing and commercial real estate markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan losses no longer being adequate to cover actual losses, and require us to increase our allowance for loan losses; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the bank regulators, including the possibility that any such regulatory authority may, among other things, initiate an enforcement action against the Company or our bank subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including but not limited to, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules as a result of Basel III; our ability to control operating costs and expenses; increases in premiums for deposit insurance; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our Condensed Consolidated Statements of Financial Condition; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our growth strategies; increased competitive pressures among financial service companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board ("FASB"), including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed from time to time in our filings with the Securities and Exchange Commission including our Annual Report on Form 10-K for the year ended December 31, 2018.
The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating results and stock price performance.
As used throughout this report, the terms “we”, “our”, “us”, or the “Company” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.

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PART I.     FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)
(In thousands, except shares)
 
 
March 31, 2019
 
December 31, 2018
ASSETS
 
 
 
 
Cash on hand and in banks
 
$
71,252


$
92,704

Interest earning deposits
 
39,918


69,206

Cash and cash equivalents
 
111,170


161,910

Investment securities available for sale, at fair value
 
985,009


976,095

Loans held for sale
 
2,956

 
1,555

Loans receivable, net
 
3,696,431

 
3,654,160

Allowance for loan losses
 
(36,152
)
 
(35,042
)
Total loans receivable, net
 
3,660,279

 
3,619,118

Other real estate owned
 
1,904


1,983

Premises and equipment, net
 
80,130


81,100

Federal Home Loan Bank stock, at cost
 
7,377


6,076

Bank owned life insurance
 
94,099

 
93,612

Accrued interest receivable
 
15,621


15,403

Prepaid expenses and other assets
 
123,026


98,522

Other intangible assets, net
 
19,589


20,614

Goodwill
 
240,939


240,939

Total assets
 
$
5,342,099


$
5,316,927

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Deposits
 
$
4,393,715

 
$
4,432,402

Federal Home Loan Bank advances
 
25,000

 

Junior subordinated debentures
 
20,375

 
20,302

Securities sold under agreement to repurchase
 
24,923

 
31,487

Accrued expenses and other liabilities
 
99,895

 
72,013

Total liabilities
 
4,563,908

 
4,556,204

Stockholders’ equity:
 
 
 
 
Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at March 31, 2019 and December 31, 2018
 

 

Common stock, no par value, 50,000,000 shares authorized; 36,899,138 and 36,874,055 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively
 
591,767

 
591,806

Retained earnings
 
185,863

 
176,372

Accumulated other comprehensive income (loss), net
 
561

 
(7,455
)
Total stockholders’ equity
 
778,191

 
760,723

Total liabilities and stockholders’ equity
 
$
5,342,099

 
$
5,316,927

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended March 31,
 
 
2019
 
2018
INTEREST INCOME
 
 
 
 
Interest and fees on loans
 
$
46,699

 
$
38,159

Taxable interest on investment securities
 
5,823

 
3,529

Nontaxable interest on investment securities
 
950

 
1,341

Interest on other interest earning assets
 
356

 
218

Total interest income
 
53,828

 
43,247

INTEREST EXPENSE
 
 
 
 
Deposits
 
3,603

 
1,960

Junior subordinated debentures
 
354

 
283

Other borrowings
 
62

 
167

Total interest expense
 
4,019

 
2,410

Net interest income
 
49,809

 
40,837

Provision for loan losses
 
920

 
1,152

Net interest income after provision for loan losses
 
48,889

 
39,685

NONINTEREST INCOME
 
 
 
 
Service charges and other fees
 
4,485

 
4,543

Gain on sale of investment securities, net
 
15

 
35

Gain on sale of loans, net
 
252

 
874

Interest rate swap fees
 

 
51

Other income
 
2,656

 
2,045

Total noninterest income
 
7,408

 
7,548

NONINTEREST EXPENSE
 
 
 
 
Compensation and employee benefits
 
21,914

 
21,367

Occupancy and equipment
 
5,458

 
4,627

Data processing
 
2,173

 
2,605

Marketing
 
1,098

 
808

Professional services
 
1,173

 
2,837

State/municipal business and use taxes
 
798

 
688

Federal deposit insurance premium
 
285

 
355

Other real estate owned, net
 
86

 

Amortization of intangible assets
 
1,025

 
795

Other expense
 
2,515

 
2,665

Total noninterest expense
 
36,525

 
36,747

Income before income taxes
 
19,772

 
10,486

Income tax expense
 
3,220

 
1,399

Net income
 
$
16,552

 
$
9,087

Basic earnings per common share
 
$
0.45

 
$
0.27

Diluted earnings per common share
 
$
0.45

 
$
0.27

Dividends declared per common share
 
$
0.18

 
$
0.15

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In thousands)

 
 
Three Months Ended March 31,
 
 
2019
 
2018
Net income
 
$
16,552

 
$
9,087

Change in fair value of investment securities available for sale, net of tax of $2,145 and $(2,008), respectively
 
8,028

 
(7,516
)
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(3) and $(8), respectively
 
(12
)
 
(27
)
Other comprehensive income (loss)
 
8,016

 
(7,543
)
Comprehensive income
 
$
24,568

 
$
1,544

See accompanying Notes to Condensed Consolidated Financial Statements.


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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(In thousands, except per share amounts)
 
Number of
common
shares
 
Common
stock
 
Retained
earnings
 
Accumulated
other
comprehensive income (loss), net
 
Total
stock-
holders’
equity
Balance at December 31, 2017
29,928

 
$
360,590

 
$
149,013

 
$
(1,298
)
 
$
508,305

Restricted stock units vested, net of forfeitures of restricted stock awards
22

 

 

 

 

Exercise of stock options
1

 
21

 

 

 
21

Stock-based compensation expense

 
623

 

 

 
623

Common stock repurchased
(45
)
 
(1,438
)
 

 

 
(1,438
)
Net income

 

 
9,087

 

 
9,087

Other comprehensive loss, net of tax

 

 

 
(7,543
)
 
(7,543
)
Common stock issued in business combination
4,112

 
130,770

 

 

 
130,770

Cash dividends declared on common stock ($0.15 per share)

 

 
(5,117
)
 

 
(5,117
)
Effects of implementation of accounting change related to equity investments, net

 

 
93

 
(93
)
 

Balance at March 31, 2018
34,018

 
$
490,566

 
$
153,076

 
$
(8,934
)
 
$
634,708

 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
36,874

 
$
591,806

 
$
176,372

 
$
(7,455
)
 
$
760,723

Restricted stock units vested, net of forfeitures of restricted stock awards
49

 

 

 

 

Exercise of stock options
2

 
22

 

 

 
22

Stock-based compensation expense

 
741

 

 

 
741

Common stock repurchased
(26
)
 
(802
)
 

 

 
(802
)
Net income

 

 
16,552

 

 
16,552

Other comprehensive income, net of tax

 

 

 
8,016

 
8,016

Cash dividends declared on common stock ($0.18 per share)

 

 
(6,662
)
 

 
(6,662
)
Effects of implementation of accounting change related to operating leases

 

 
(399
)
 

 
(399
)
Balance at March 31, 2019
36,899

 
$
591,767

 
$
185,863

 
$
561

 
$
778,191

See accompanying Notes to Condensed Consolidated Financial Statements.


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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
 
 
Three Months Ended March 31,
 
 
2019
 
2018
Cash flows from operating activities:
 
 
 
 
Net income
 
$
16,552

 
$
9,087

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation of premises and equipment, amortization of securities available for sale, and amortization of discount of junior subordinated debentures
 
2,234

 
2,631

Changes in net deferred loan costs, net of amortization
 
276

 
9

Provision for loan losses
 
920

 
1,152

Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities
 
1,345

 
(4,191
)
Stock-based compensation expense
 
741

 
623

Amortization of intangible assets
 
1,025

 
795

Origination of loans held for sale
 
(8,607
)
 
(20,380
)
Proceeds from sale of loans
 
7,458

 
20,651

Earnings on bank owned life insurance
 
(487
)
 
(335
)
Gain on sale of loans, net
 
(252
)
 
(874
)
Gain on sale of investment securities, net
 
(15
)
 
(35
)
Impairment of right of use asset
 
117

 

Loss on sale or write-off of premises and equipment, net
 
5

 
6

Net cash provided by operating activities
 
21,312

 
9,139

Cash flows from investing activities:
 
 
 
 
Loans originated, net of principal payments
 
(42,357
)
 
(46,959
)
Maturities, calls and payments of investment securities available for sale
 
47,004

 
24,443

Purchase of investment securities available for sale
 
(57,606
)
 
(69,352
)
Purchase of premises and equipment
 
(1,030
)
 
(2,146
)
Proceeds from sales of other loans
 

 
2,813

Proceeds from sales of other real estate owned
 
79

 

Proceeds from sales of investment securities available for sale
 
10,932

 
103,032

Proceeds from redemption of Federal Home Loan Bank stock
 
2,276

 
10,130

Purchases of Federal Home Loan Bank stock
 
(3,577
)
 
(7,984
)
Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net
 
(80
)
 
(7,696
)
Net cash received from acquisitions
 

 
80,133

Net cash (used in) provided by investing activities
 
(44,359
)
 
86,414

Cash flows from financing activities:
 
 
 
 
Net (decrease) increase in deposits
 
(38,687
)
 
5,796

Federal Home Loan Bank advances
 
76,900

 
191,450

Repayments of Federal Home Loan Bank advances
 
(51,900
)
 
(253,250
)
Common stock cash dividends paid
 
(6,662
)
 
(5,117
)
Net decrease in securities sold under agreement to repurchase
 
(6,564
)
 
(5,721
)
Proceeds from exercise of stock options
 
22

 
21

Repurchase of common stock
 
(802
)
 
(1,438
)
Net cash used in financing activities
 
(27,693
)
 
(68,259
)

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Three Months Ended March 31,
 
 
2019
 
2018
Net (decrease) increase in cash and cash equivalents
 
(50,740
)
 
27,294

Cash and cash equivalents at beginning of period
 
161,910

 
103,015

Cash and cash equivalents at end of period
 
$
111,170

 
$
130,309

 
 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
 
Cash paid for interest
 
$
3,801

 
$
2,398

Cash paid for income taxes
 

 

 
 
 
 
 
Supplemental non-cash disclosures of cash flow information:
 
 
 
 
Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets
 
763

 

     Business Combinations:
 
 
 
 
Common stock issued for business combinations
 

 
130,770

Assets acquired (liabilities assumed) in acquisitions:
 
 
 
 
Investment securities available for sale
 

 
80,353

Loans receivable
 

 
388,462

Premises and equipment
 

 
732

Federal Home Loan Bank stock
 

 
623

Accrued interest receivable
 

 
1,448

Bank owned life insurance
 

 
6,264

Prepaid expenses and other assets
 

 
1,354

Other intangible assets
 

 
11,270

Deposits
 

 
(505,885
)
Accrued expenses and other liabilities
 

 
(2,504
)
See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(1)
Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements
(a) Description of Business
Heritage Financial Corporation ("Heritage" or the “Company”) is a bank holding company that was incorporated in the State of Washington in August 1997. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank (the “Bank”). The Bank is a Washington-chartered commercial bank and its deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is headquartered in Olympia, Washington and conducts business from its 63 branch offices as of March 31, 2019 located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas.
Effective January 16, 2018, the Company completed the acquisition of Puget Sound Bancorp, Inc. (“Puget Sound”), the holding company for Puget Sound Bank, both of Bellevue, Washington (“Puget Sound Merger”) and on July 2, 2018, the Company completed the acquisition of Premier Commercial Bancorp ("Premier Commercial"), the holding company for Premier Community Bank, both of Hillsboro, Oregon ("Premier Merger"). See Note (2) Business Combinations for additional information on the Puget Sound Merger and the Premier Merger (collectively the "Premier and Puget Mergers").

(b) Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. It is recommended that these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Annual Form 10-K”). In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. In preparing the unaudited Condensed Consolidated Financial Statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the facts and circumstances at the time. Actual results, however, could differ significantly from those estimates.

(c) Significant Accounting Policies
The significant accounting policies used in preparation of the Company's Condensed Consolidated Financial Statements are disclosed in the 2018 Annual Form 10-K. There have not been any material changes in the Company's significant accounting policies from those contained in the 2018 Annual Form 10-K, except for the accounting policy relating to operating leases adopted January 1, 2019, as discussed below.
Operating leases
The Company enters into noncancelable operating lease agreements, related to certain banking offices, back-office operational facilities, office equipment, and sublease agreements. The agreements are recorded as right of use assets and liabilities within prepaid expenses and other assets and accrued expenses and other liabilities, respectively, in the Condensed Consolidated Statements of Financial Condition. The Company elected an exclusion policy for right of use assets and liabilities for operating leases with a term of twelve months or less and a capitalization threshold policy for total contractual lease payments of $25,000 or more. The Company does not account for any leases at a portfolio level. The balance of right of use assets and liabilities was $28.4 million and $29.5 million, respectively, as of March 31, 2019.


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(d) Recently Issued Accounting Pronouncements
FASB ASU 2016-02Leases (Topic 842), as amended by ASU 2017-13, 2018-01, 2018-10, ASU 2018-11, and ASU 2019-01 was originally issued in February 2016, to increase transparency and comparability of leases among organizations and to disclose key information about leasing arrangements. The Update sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The Company adopted the Update on January 1, 2019 and elected an exclusion accounting policy for lease assets and lease liabilities for leases with a term of twelve months or less and the package of practical expedients permitted under the transition guidance within the new standard, which allowed us to carry forward the historical determination of contracts as leases, lease classification and not reassess initial direct costs for historical lease arrangements. The Company applied a capitalization threshold policy of total contractual lease payments of $25,000 or more for recognition under the Update. The adoption of this ASU resulted in the recognition of operating lease right of use assets and liabilities of approximately $29.2 million and $29.8 million, respectively, in prepaid expenses and other assets and accrued expenses and other liabilities in the Condensed Consolidated Statements of Financial Condition related to certain banking offices, back-office operational facilities, office equipment and sublease agreements under noncancelable operating lease agreements. This change also resulted in a $399,000 net of tax cumulative-effect adjustment to beginning retained earnings under the modified retrospective approach. As a result of electing this transition method, prior periods have not been restated.
FASB ASU 2016-13Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended by ASU 2018-19, was issued in June 2016. Commonly referred to as the current expected credit loss model ("CECL"), this Update requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. For public business entities, the Update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15, 2018. The Company is anticipating adopting the Update on January 1, 2020. Upon adoption, the Company expects a change in the processes, internal controls and procedures to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. The new guidance may result in an increase in the allowance for loan losses which will also reflect the new requirement to include the nonaccretable principal differences on PCI loans; however, the Company is still in the process of determining the magnitude of the increase and its impact on the Condensed Consolidated Financial Statements. In addition, the current accounting policy and procedures for other-than-temporary impairment on investment securities available for sale will be replaced with an allowance approach. During 2017, the Company's management created a CECL steering committee to develop and implement processes and procedures to ensure it is fully compliant with the amendments at the adoption date. During 2018, the CECL steering committee selected a vendor to assist the Company in the adoption, completed the implementation discovery sessions, and selected appropriate methodologies. During 2019, the CECL steering committee is compiling necessary historical loan data and is in the process of reviewing qualitative factors. The Company anticipates running parallel existing ALLL and CECL models using second quarter 2019 data.
FASB ASU 2017-04Goodwill (Topic 350), was issued in January 2017 and eliminates Step 2 from the goodwill impairment test. The Update is effective for annual periods or any interim goodwill impairment tests beginning after December 15, 2019 using a prospective transition method and early adoption is permitted. The Company does not expect the Update will have a material impact on its Condensed Consolidated Financial Statements.
FASB ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, was issued in August 2018 and modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company does not expect the Update will have a material impact on its Condensed Consolidated Financial Statements.

(2)
Business Combinations
There were no acquisitions or mergers completed during the three months ended March 31, 2019. During the three months ended March 31, 2018, the Company completed the acquisition of Puget Sound Bancorp. The Premier Merger was completed during the three months ended September 30, 2018 and is included below for comparability of results for the quarter ended March 31, 2019 compared to March 31, 2018. The Company finalized the purchase price allocation for both mergers as of December 31, 2018.

11

Table of Contents


Puget Sound Merger:
The Puget Sound Merger was effective on January 16, 2018. As of the acquisition date, Puget Sound merged into Heritage and Puget Sound Bank merged into Heritage Bank. The Puget Sound Merger resulted in $68.5 million of goodwill.
During the three months ended March 31, 2019 and 2018, the Company incurred acquisition-related costs of approximately $75,000 and $4.5 million, respectively, for the Puget Sound Merger.
Premier Merger:
The Premier Merger was effective on July 2, 2018. As of the acquisition date, Premier merged into Heritage and Premier Commercial Bank merged into Heritage Bank. The Premier Merger resulted in $53.4 million of goodwill.
During the three months ended March 31, 2019 and 2018, the Company incurred acquisition-related costs of approximately $57,000 and $317,000, respectively, for the Premier Merger.

(3)
Investment Securities
(a) Securities by Type and Maturity
The following tables present the amortized cost, gross unrealized gains, gross unrealized losses and fair values of investment securities available for sale at the dates indicated:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
March 31, 2019
 
 
 
 
 
 
 
U.S. Treasury and U.S. Government-sponsored agencies
$
98,900

 
$
398

 
$
(44
)
 
$
99,254

Municipal securities
144,399

 
2,590

 
(127
)
 
146,862

Mortgage-backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
Residential
349,189

 
1,224

 
(3,555
)
 
346,858

Commercial
342,102

 
2,417

 
(2,891
)
 
341,628

Corporate obligations
25,684

 
223

 
(20
)
 
25,887

Other asset-backed securities
24,023

 
500

 
(3
)
 
24,520

Total
$
984,297

 
$
7,352

 
$
(6,640
)
 
$
985,009

 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
U.S. Treasury and U.S. Government-sponsored agencies
$
101,595

 
$
155

 
$
(147
)
 
$
101,603

Municipal securities
158,461

 
1,209

 
(806
)
 
158,864

Mortgage-backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
Residential
337,295

 
426

 
(6,119
)
 
331,602

Commercial
338,250

 
1,035

 
(5,524
)
 
333,761

Corporate obligations
25,662

 
36

 
(135
)
 
25,563

Other asset-backed securities
24,278

 
424

 

 
24,702

Total
$
985,541

 
$
3,285

 
$
(12,731
)
 
$
976,095

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

There were no securities classified as trading or held to maturity at March 31, 2019 or December 31, 2018.
The amortized cost and fair value of investment securities available for sale at March 31, 2019, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

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Table of Contents


 
Amortized Cost
 
Fair Value
 
(In thousands)
Due in one year or less
$
31,994

 
$
31,967

Due after one year through five years
207,244

 
207,852

Due after five years through ten years
274,601

 
275,127

Due after ten years
470,458

 
470,063

Total
$
984,297

 
$
985,009

(b) Unrealized Losses and Other-Than-Temporary Impairments
The following table shows the gross unrealized losses and fair value of the Company's investment securities available for sale that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that the individual securities have been in continuous unrealized loss positions as of March 31, 2019 and December 31, 2018:
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In thousands)
March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and U.S. Government-sponsored agencies
$
5,079

 
$
(23
)
 
$
2,411

 
$
(21
)
 
$
7,490

 
$
(44
)
Municipal securities
827

 
(4
)
 
31,990

 
(123
)
 
32,817

 
(127
)
Mortgage-backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
 
 
 
 
Residential
27,725

 
(170
)
 
184,166

 
(3,385
)
 
211,891

 
(3,555
)
Commercial
23,798

 
(231
)
 
174,130

 
(2,660
)
 
197,928

 
(2,891
)
Corporate obligations
3,874

 
(12
)
 
1,992

 
(8
)
 
5,866

 
(20
)
Other asset-backed securities
1,881

 
(3
)
 

 

 
1,881

 
(3
)
Total
$
63,184

 
$
(443
)
 
$
394,689

 
$
(6,197
)
 
$
457,873

 
$
(6,640
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and U.S. Government-sponsored agencies
$
46,992

 
$
(58
)
 
$
7,350

 
$
(89
)
 
$
54,342

 
$
(147
)
Municipal securities
31,157

 
(159
)
 
38,792

 
(647
)
 
69,949

 
(806
)
Mortgage-backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
 
 
 
 
Residential
66,620

 
(247
)
 
193,726

 
(5,872
)
 
260,346

 
(6,119
)
Commercial
43,531

 
(272
)
 
190,585

 
(5,252
)
 
234,116

 
(5,524
)
Corporate obligations
13,736

 
(87
)
 
1,951

 
(48
)
 
15,687

 
(135
)
Total
$
202,036

 
$
(823
)
 
$
432,404

 
$
(11,908
)
 
$
634,440

 
$
(12,731
)
(1) Issued and guaranteed by U.S. Government-sponsored agencies.

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The Company has evaluated these investment securities available for sale as of March 31, 2019 and December 31, 2018 and has determined that the decline in their value is not other-than-temporary. The unrealized losses are primarily due to increases in market interest rates. The fair value of these securities is expected to recover as the securities approach their maturity date. None of the underlying issuers of the municipal securities and corporate obligations had credit ratings that were below investment grade levels at March 31, 2019 or December 31, 2018. The Company has the ability and intent to hold the investments until recovery of the securities' amortized cost, which may be the maturity date of the securities.
For the three months ended March 31, 2019 and 2018, there were no other-than-temporary charges recorded to net income.

(c) Realized Gains and Losses
The following table presents the gross realized gains and losses on the sale of securities available for sale for the three months ended March 31, 2019 and 2018:
 
Three Months Ended March 31,
 
2019
 
2018
 
(In thousands)
Gross realized gains
$
89

 
$
104

Gross realized losses
(74
)
 
(69
)
   Net realized gains
$
15

 
$
35

    
(d) Pledged Securities
The following table summarizes the amortized cost and fair value of investment securities available for sale that are pledged as collateral for the following obligations at March 31, 2019 and December 31, 2018:
 
March 31, 2019
 
December 31, 2018
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
(In thousands)
Washington and Oregon state to secure public deposits
$
198,226

 
$
198,044

 
$
199,026

 
$
196,786

Repurchase agreements
47,209

 
46,872

 
48,173

 
47,407

Other securities pledged
20,533

 
20,549

 
20,778

 
20,482

Total
$
265,968

 
$
265,465

 
$
267,977

 
$
264,675


(4)
Loans Receivable
(a) Loan Origination/Risk Management
The Company originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions. Disclosures related to the Company's recorded investment in loans receivable generally exclude accrued interest receivable and net deferred fees or costs as they were deemed insignificant.
Loans acquired in a business combination are further classified as “purchased” loans. Loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are accounted for under FASB ASC 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality. These loans are identified as "PCI" loans. Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20, Receivables—Nonrefundable Fees and Other Costs, and are referred to as "non-PCI" loans. There were no PCI loans acquired in the Premier and Puget Mergers.
The Company categorizes loans in one of the four segments of the total loan portfolio: commercial business, one-to-four family residential, real estate construction and land development and consumer. Within these segments are classes of loans for which management monitors and assesses credit risk in the loan portfolios.

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Table of Contents


Loans receivable at March 31, 2019 and December 31, 2018 consisted of the following portfolio segments and classes:
 
March 31, 2019
 
December 31, 2018
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
838,403

 
$
853,606

Owner-occupied commercial real estate
785,316

 
779,814

Non-owner occupied commercial real estate
1,335,596

 
1,304,463

Total commercial business
2,959,315

 
2,937,883

One-to-four family residential
106,502

 
101,763

Real estate construction and land development:
 
 
 
One-to-four family residential
110,699

 
102,730

Five or more family residential and commercial properties
126,379

 
112,730

Total real estate construction and land development
237,078

 
215,460

Consumer
390,303

 
395,545

Gross loans receivable
3,693,198

 
3,650,651

Net deferred loan costs
3,233

 
3,509

 Loans receivable, net
3,696,431

 
3,654,160

Allowance for loan losses
(36,152
)
 
(35,042
)
 Total loans receivable, net
$
3,660,279

 
$
3,619,118

(b) Concentrations of Credit
As of March 31, 2019 and December 31, 2018, there were no concentrations of loans related to any single industry in excess of 10% of the Company’s total loans.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans and (v) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign a risk grade to each loan on a scale of 1 to 10. Risk grades are aggregated to create the risk categories of "Pass" for grades 1 to 6, Other Asset Especially Mentioned ("OAEM") for grade 7, "Substandard" for grade 8, "Doubtful" for grade 9 and "Loss" for grade 10.

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Table of Contents


The following tables present the balance of loans receivable by credit quality indicator as of March 31, 2019 and December 31, 2018:
 
March 31, 2019
 
Pass
 
OAEM
 
Substandard
 
Doubtful/Loss
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
780,469

 
$
11,594

 
$
46,340

 
$

 
$
838,403

Owner-occupied commercial real estate
747,294

 
22,576

 
15,446

 

 
785,316

Non-owner occupied commercial real estate
1,310,310

 
15,149

 
10,137

 

 
1,335,596

Total commercial business
2,838,073

 
49,319

 
71,923

 

 
2,959,315

One-to-four family residential
105,158

 

 
1,344

 

 
106,502

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
109,748

 

 
951

 

 
110,699

Five or more family residential and commercial properties
126,330

 
49

 

 

 
126,379

Total real estate construction and land development
236,078

 
49

 
951

 

 
237,078

Consumer
385,674

 

 
4,105

 
524

 
390,303

Gross loans receivable
$
3,564,983

 
$
49,368

 
$
78,323

 
$
524

 
$
3,693,198

 
December 31, 2018
 
Pass
 
OAEM
 
Substandard
 
Doubtful/Loss
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
788,395

 
$
16,168

 
$
49,043

 
$

 
$
853,606

Owner-occupied commercial real estate
741,227

 
27,724

 
10,863

 

 
779,814

Non-owner occupied commercial real estate
1,283,077

 
9,438

 
11,948

 

 
1,304,463

Total commercial business
2,812,699

 
53,330

 
71,854

 

 
2,937,883

One-to-four family residential
100,401

 

 
1,362

 

 
101,763

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
101,519

 
258

 
953

 

 
102,730

Five or more family residential and commercial properties
112,678

 
52

 

 

 
112,730

Total real estate construction and land development
214,197

 
310

 
953

 

 
215,460

Consumer
390,808

 

 
4,213

 
524

 
395,545

Gross loans receivable
$
3,518,105

 
$
53,640

 
$
78,382

 
$
524

 
$
3,650,651

Potential problem loans are loans classified as OAEM or worse that are currently accruing interest and are not considered impaired, but which management is closely monitoring because the financial information of the borrower causes concern as to their ability to meet their loan repayment terms. Potential problem loans may include PCI loans as these loans continue to accrete loan discounts established at acquisition based on the guidance of FASB ASC 310-30. Potential problem loans as of March 31, 2019 and December 31, 2018 were $94.1 million and $101.3 million, respectively.

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Table of Contents


(d) Nonaccrual Loans
Nonaccrual loans, segregated by segments and classes of loans, were as follows as of March 31, 2019 and December 31, 2018:
 
March 31, 2019
 
December 31, 2018
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
9,394

 
$
6,639

Owner-occupied commercial real estate
4,465

 
4,212

Non-owner occupied commercial real estate
2,445

 
1,713

Total commercial business
16,304

 
12,564

One-to-four family residential
68

 
71

Real estate construction and land development:
 
 
 
One-to-four family residential
923

 
899

Total real estate construction and land development
923

 
899

Consumer
166

 
169

Nonaccrual loans
$
17,461

 
$
13,703

PCI loans are not included in the nonaccrual loan table above because these loans are accounted for under FASB ASC 310-30, which provides that accretable yield is calculated based on a loan's expected cash flow even if the loan is not performing under its contractual terms.
(e) Past due loans
The Company performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due.

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Table of Contents


The balances of past due loans, segregated by segments and classes of loans, as of March 31, 2019 and December 31, 2018 were as follows:
 
March 31, 2019
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
550

 
$
3,593

 
$
4,143

 
$
834,260

 
$
838,403

Owner-occupied commercial real estate
1,677

 
349

 
2,026

 
783,290

 
785,316

Non-owner occupied commercial real estate
3,283

 
1,843

 
5,126

 
1,330,470

 
1,335,596

Total commercial business
5,510

 
5,785

 
11,295

 
2,948,020

 
2,959,315

One-to-four family residential
38

 

 
38

 
106,464

 
106,502

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
105

 
258

 
363

 
110,336

 
110,699

Five or more family residential and commercial properties

 

 

 
126,379

 
126,379

Total real estate construction and land development
105

 
258

 
363

 
236,715

 
237,078

Consumer
1,347

 
17

 
1,364

 
388,939

 
390,303

Gross loans receivable
$
7,000

 
$
6,060

 
$
13,060

 
$
3,680,138

 
$
3,693,198

 
December 31, 2018
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,988

 
$
2,281

 
$
5,269

 
$
848,337

 
$
853,606

Owner-occupied commercial real estate
563

 
600

 
1,163

 
778,651

 
779,814

Non-owner occupied commercial real estate
5,347

 
1,461

 
6,808

 
1,297,655

 
1,304,463

Total commercial business
8,898

 
4,342

 
13,240

 
2,924,643

 
2,937,883

One-to-four family residential
227

 

 
227

 
101,536

 
101,763

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
665

 
234

 
899

 
101,831

 
102,730

Five or more family residential and commercial properties

 

 

 
112,730

 
112,730

Total real estate construction and land development
665

 
234

 
899

 
214,561

 
215,460

Consumer
2,568

 

 
2,568

 
392,977

 
395,545

Gross loans receivable
$
12,358

 
$
4,576

 
$
16,934

 
$
3,633,717

 
$
3,650,651

There were no loans 90 days or more past due that were still accruing interest as of March 31, 2019 or December 31, 2018, excluding PCI loans.

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Table of Contents


(f) Impaired loans
Impaired loans include nonaccrual loans and performing troubled debt restructured ("TDR") loans. The balances of impaired loans as of March 31, 2019 and December 31, 2018 are set forth in the following tables:
 
March 31, 2019
 
Recorded
Investment With
No Specific
Valuation
Allowance
 
Recorded
Investment With
Specific
Valuation
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
4,791

 
$
17,844

 
$
22,635

 
$
24,051

 
$
2,780

Owner-occupied commercial real estate
463

 
5,591

 
6,054

 
6,451

 
1,347

Non-owner occupied commercial real estate
5,163

 
1,800

 
6,963

 
7,032

 
228

Total commercial business
10,417

 
25,235

 
35,652

 
37,534

 
4,355

One-to-four family residential

 
274

 
274

 
289

 
74

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
923

 

 
923

 
1,020

 

Total real estate construction and land development
923

 

 
923

 
1,020

 

Consumer

 
598

 
598

 
607

 
151

Total
$
11,340

 
$
26,107

 
$
37,447

 
$
39,450

 
$
4,580

 
December 31, 2018
 
Recorded
Investment With
No Specific
Valuation
Allowance
 
Recorded
Investment With
Specific
Valuation
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,523

 
$
20,119

 
$
22,642

 
$
24,176

 
$
2,607

Owner-occupied commercial real estate
816

 
5,000

 
5,816

 
6,150

 
1,142

Non-owner occupied commercial real estate
3,352

 
2,924

 
6,276

 
6,414

 
206

Total commercial business
6,691

 
28,043

 
34,734

 
36,740

 
3,955

One-to-four family residential

 
279

 
279

 
293

 
76

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
899

 

 
899

 
1,662

 

Total real estate construction and land development
899

 

 
899

 
1,662

 

Consumer

 
527

 
527

 
538

 
139

Total
$
7,590

 
$
28,849

 
$
36,439

 
$
39,233

 
$
4,170


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Table of Contents


The average recorded investment of impaired loans for the three months ended March 31, 2019 and 2018 are set forth in the following table:
 
Three Months Ended March 31,
 
2019
 
2018
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
22,639

 
$
14,261

Owner-occupied commercial real estate
5,935

 
12,841

Non-owner occupied commercial real estate
6,619

 
10,358

Total commercial business
35,193

 
37,460

One-to-four family residential
277

 
297

Real estate construction and land development:
 
 
 
One-to-four family residential
911

 
1,197

Five or more family residential and commercial properties

 
322

Total real estate construction and land development
911

 
1,519

Consumer
562

 
411

Total
$
36,943

 
$
39,687

For the three months ended March 31, 2019 and 2018, no interest income was recognized subsequent to a loan’s classification as nonaccrual. For the three months ended March 31, 2019 and 2018, the Bank recorded $301,000 and $326,000, respectively, of interest income related to performing TDR loans.
(g) Troubled Debt Restructured Loans
The recorded investment balance and related allowance for loan losses of performing and nonaccrual TDR loans as of March 31, 2019 and December 31, 2018 were as follows:
 
March 31, 2019
 
December 31, 2018
 
Performing
TDRs
 
Nonaccrual
TDRs
 
Performing
TDRs
 
Nonaccrual
TDRs
 
(In thousands)
TDR loans
$
19,986

 
$
5,488

 
$
22,736

 
$
6,943

Allowance for loan losses on TDR loans
2,181

 
601

 
2,257

 
658

The unfunded commitment to borrowers related to TDR loans was $1.4 million and $943,000 at March 31, 2019 and December 31, 2018, respectively.

20

Table of Contents


Loans that were modified as TDR loans during the three months ended March 31, 2019 and 2018 are set forth in the following table:
 
Three Months Ended March 31,
 
2019
 
2018
 
Number of
Contracts
(1)
 
Recorded Investment
(1)(2)
 
Number of
Contracts
(1)
 
Recorded Investment
(1)(2)
 
(Dollars in thousands)
Commercial business:
 
 
 
 
 
 
 
Commercial and industrial
9

 
$
10,100

 
9

 
$
4,323

Owner-occupied commercial real estate
2

 
934

 

 

Non-owner occupied commercial real estate
1

 
2,112

 
1

 
2,201

Total commercial business
12

 
13,146

 
10

 
6,524

Real estate construction and land development:
 
 
 
 
 
 
 
One-to-four family residential
2

 
665

 

 

Total real estate construction and land development
2

 
665

 

 

Consumer
6

 
122

 
3

 
78

Total loans modified as TDR loans
20

 
$
13,933

 
13

 
$
6,602

(1) 
Number of contracts and outstanding principal balance represent loans which have balances as of period end as certain loans may have been paid-down or charged-off during the three months ended March 31, 2019 and 2018.
(2) 
Includes subsequent payments after modifications and reflects the balance as of period end. As the Bank did not forgive any principal or interest balance as part of the loan modification, the Bank’s recorded investment in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-modification), except when the modification was the initial advance on a one-to-four family residential real estate construction and land development loan under a master guidance line. There were no advances on these types of loans during the three months ended March 31, 2019 and 2018.
 
 
 
 
 
 
 
 
The table above includes 11 loans that were previously reported as TDR loans. The Bank typically grants shorter extension periods to continually monitor these TDR loans despite the fact that the extended date might not be the date the Bank expects sufficient cash flow from these borrowers. The Bank does not consider these modifications a subsequent default of a TDR as new loan terms, specifically new maturity dates, were granted. Of the remaining first-time TDR loans, the concessions granted largely consisted of maturity extensions, interest rate modifications or a combination of both. The potential losses related to TDR loans are considered in the period the loan was first reported as a TDR loan and are adjusted, as necessary, in the current period based on more recent information. The related specific valuation allowance at March 31, 2019 for loans that were modified as TDR loans during the three months ended March 31, 2019 was $1.6 million.

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Loans that were modified during the previous twelve months that subsequently defaulted during the three months ended March 31, 2019 and 2018 are set forth in the following table:
 
Three Months Ended March 31,
 
2019
 
2018
 
Number of
Contracts
 
Recorded Investments
 
Number of
Contracts
 
Recorded Investments
 
(Dollars in thousands)
Commercial business:
 
 
 
 
 
 
 
Commercial and industrial
1

 
$
829

 
1

 
$
283

Owner-occupied properties
1

 
717

 

 

Non-owner occupied commercial real estate
1

 
601

 
1

 
75

Total commercial business
3

 
2,147

 
2

 
358

Real estate construction and land development:
 
 
 
 
 
 
 
One-to-four family residential

 

 
2

 
838

Total real estate construction and land development

 

 
2

 
838

Total
3

 
$
2,147

 
4

 
$
1,196

 
 
 
 
 
 
 
 
During the three months ended March 31, 2019, the three loans defaulted because each was past its modified maturity date, and the borrower has not subsequently repaid the credits. The Bank has chosen not to further extend the maturity date on these loans. The Bank had a $314,000 specific valuation allowance at March 31, 2019 related to these TDR loans which defaulted during the three months ended March 31, 2019.    
During the three months ended March 31, 2018, the four loans defaulted because they were past their modified maturity dates and the borrowers had not subsequently repaid the credits. The Bank had chosen not to extend the maturities on these loans. The Bank had no specific valuation allowance at March 31, 2018 related to these TDR loans which defaulted during the three months ended March 31, 2018.

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(h) Purchased Credit Impaired Loans
The following table reflects the outstanding principal balance and recorded investment of the PCI loans at March 31, 2019 and December 31, 2018:
 
March 31, 2019
 
December 31, 2018
 
Outstanding Principal
 
Recorded Investment
 
Outstanding Principal
 
Recorded Investment
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
Commercial and industrial
$
5,521

 
$
2,713

 
$
6,319

 
$
3,433

Owner-occupied commercial real estate
7,938