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Section 1: 10-Q (10-Q)

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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 March 31, 2020 or

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

 
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter) 
 
 
Washington
 
91-1857900
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
 
201 Fifth Avenue SW,
Olympia
WA
 
98501
(Address of principal executive offices)
 
(Zip Code)
(360) 943-1500
(Registrant’s telephone number, including area code) 
 
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol
Name of each exchange on which registered
Common stock, no par value
HFWA
NASDAQ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer  
 
Non-accelerated filer  
Smaller reporting company  
 
 
 
Emerging growth company 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes      No  
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
As of April 27, 2020 there were 35,888,494 shares of the registrant's common stock, no par value per share, outstanding.






HERITAGE FINANCIAL CORPORATION
FORM 10-Q
March 31, 2020
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.
 
 
NOTE 15.
ITEM 2.
 
 
 
 
 
 
 
 
 
 

2




 
 
 
 
ITEM 3.
ITEM 4.
Part II.
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5.
ITEM 6.
 

3




GLOSSARY OF ACRONYMS, ABBREVIATIONS, AND TERMS

The acronyms, abbreviations, and terms listed below are used in various sections of the Form 10-Q, including “Item 1. Financial Statements” and “Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations." As used throughout this report, the terms “we”, “our”, or “us” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.
2019 Annual Form 10-K
 
Company's Annual Report on Form 10-K for the year ended December 31, 2019
ACL
 
Allowance for Credit Losses
ALL
 
Allowance for Loan Losses
AOCI
 
Accumulated other comprehensive income (loss), net
ASC
 
Accounting Standards Codification
ASU
 
Accounting Standards Update
Bank
 
Heritage Bank
BOLI
 
Bank owned life insurance
CARES Act
 
Coronavirus Aid, Relief, and Economic Security Act of 2020
CDI
 
Core Deposit Intangible
CECL
 
Current Expected Credit Loss
CECL Adoption
 
Adoption of FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology on January 1, 2020
CEO
 
Chief Executive Officer
CFO
 
Chief Financial Officer
Company
 
Heritage Financial Corporation
COVID-19
 
Coronavirus Disease of 2019 pandemic
FASB
 
Financial Accounting Standards Board
FDIC
 
Federal Deposit Insurance Corporation
Federal Reserve
 
Board of Governors of the Federal Reserve System
Federal Reserve Bank
 
Federal Reserve Bank of San Francisco
FHLB
 
Federal Home Loan Bank of Des Moines
GAAP
 
U.S. Generally Accepted Accounting Principles
GDP
 
U.S. Gross Domestic Product
Heritage
 
Heritage Financial Corporation
LIBOR
 
London Interbank Offering Rate
PCI
 
Purchased Credit Impaired; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 310-30
PCD
 
Purchased Credit Deteriorated; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 326
PPP
 
Paycheck Protection Program
PPPLF
 
Paycheck Protection Program Liquidity Facility
SBA
 
Small Business Administration
SEC
 
Securities and Exchange Commission
TDR
 
Troubled Debt Restructured
Unfunded Commitments
 
Off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments
Washington Banking Merger
 
Merger with Washington Banking Company & Whidbey Island Bank completed on May 1, 2014


4




FORWARD LOOKING STATEMENTS:
This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” 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:
the effect of the COVID-19 pandemic, including on our credit quality and business operations, as well as its impact on general economic and financial market conditions including economic activity, employment levels and market liquidity;
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our ACL on loans and provision for credit losses on loans that may be effected by deterioration in the housing and commercial real estate markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our ACL on loans no longer being adequate to cover actual losses, and require us to increase our allowance for credit losses on loans;
changes in general economic conditions, either nationally or in our market areas;
changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;
risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;
fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;
results of examinations of us by the bank regulators, including the possibility that any such regulatory authority may, among other things, initiate an enforcement action against the Company or our bank subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings;
legislative or regulatory changes that adversely affect our business
implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;
our ability to control operating costs and expenses;
increases in premiums for deposit insurance;
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
difficulties in reducing risk associated with the loans on our Condensed Consolidated Statements of Financial Condition;
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;
disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;
our ability to retain key members of our senior management team;
costs and effects of litigation, including settlements and judgments;
our ability to implement our growth strategies;
our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected;
increased competitive pressures among financial service companies;
changes in consumer spending, borrowing and savings habits;
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
adverse changes in the securities markets;
inability of key third-party providers to perform their obligations to us;
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

5




other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including from the COVID-19 pandemic, and the other risks detailed from time to time in our filings with the SEC including our 2019 Annual Form 10-K.
The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating results and stock price performance.


6




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, 2020
 
December 31, 2019
ASSETS
 
 
 
 
Cash on hand and in banks
 
$
105,097


$
95,039

Interest earning deposits
 
57,816


133,529

Cash and cash equivalents
 
162,913


228,568

Investment securities available for sale, at fair value, net (amortized cost of $937,828 and $939,160 at March 31, 2020 and December 31, 2019)
 
961,092


952,312

Loans held for sale
 
3,808

 
5,533

Loans receivable
 
3,852,376

 
3,767,879

Allowance for credit losses on loans
 
(47,540
)
 
(36,171
)
Loans receivable, net
 
3,804,836

 
3,731,708

Other real estate owned
 
841


841

Premises and equipment, net
 
87,958


87,888

Federal Home Loan Bank stock, at cost
 
6,661


6,377

Bank owned life insurance
 
106,756

 
103,616

Accrued interest receivable
 
14,940


14,446

Prepaid expenses and other assets
 
180,846


164,129

Other intangible assets, net
 
15,710


16,613

Goodwill
 
240,939


240,939

Total assets
 
$
5,587,300


$
5,552,970

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Deposits
 
$
4,617,948

 
$
4,582,676

Junior subordinated debentures
 
20,668

 
20,595

Securities sold under agreement to repurchase
 
11,792

 
20,169

Accrued expenses and other liabilities
 
138,454

 
120,219

Total liabilities
 
4,788,862

 
4,743,659

Stockholders’ equity:
 
 
 
 
Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at March 31, 2020 and December 31, 2019
 

 

Common stock, no par value, 50,000,000 shares authorized; 35,888,494 and 36,618,729 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively
 
568,439

 
586,459

Retained earnings
 
211,707

 
212,474

Accumulated other comprehensive income, net
 
18,292

 
10,378

Total stockholders’ equity
 
798,438

 
809,311

Total liabilities and stockholders’ equity
 
$
5,587,300

 
$
5,552,970


See accompanying Notes to Condensed Consolidated Financial Statements.

7




HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended March 31,
 
 
2020
 
2019
INTEREST INCOME
 
 
 
 
Interest and fees on loans
 
$
46,277

 
$
46,699

Taxable interest on investment securities
 
5,639

 
5,823

Nontaxable interest on investment securities
 
756

 
950

Interest on other interest earning assets
 
420

 
335

Total interest income
 
53,092

 
53,807

INTEREST EXPENSE
 
 
 
 
Deposits
 
4,216

 
3,603

Junior subordinated debentures
 
285

 
354

Other borrowings
 
34

 
62

Total interest expense
 
4,535

 
4,019

Net interest income
 
48,557

 
49,788

Provision for credit losses
 
7,946

 
920

Net interest income after provision for credit losses
 
40,611

 
48,868

NONINTEREST INCOME
 
 
 
 
Service charges and other fees
 
4,376

 
4,485

Gain on sale of investment securities, net
 
1,014

 
15

Gain on sale of loans, net
 
547

 
252

Interest rate swap fees
 
296

 

Other income
 
3,247

 
2,677

Total noninterest income
 
9,480

 
7,429

NONINTEREST EXPENSE
 
 
 
 
Compensation and employee benefits
 
22,506

 
21,914

Occupancy and equipment
 
5,731

 
5,458

Data processing
 
2,360

 
2,173

Marketing
 
866

 
1,098

Professional services
 
1,377

 
1,173

State/municipal business and use taxes
 
757

 
798

Federal deposit insurance premium
 

 
285

Other real estate owned, net
 
25

 
86

Amortization of intangible assets
 
903

 
1,025

Other expense
 
2,735

 
2,515

Total noninterest expense
 
37,260

 
36,525

Income before income taxes
 
12,831

 
19,772

Income tax expense
 
640

 
3,220

Net income
 
$
12,191

 
$
16,552

Basic earnings per common share
 
$
0.34

 
$
0.45

Diluted earnings per common share
 
$
0.33

 
$
0.45

Dividends declared per common share
 
$
0.20

 
$
0.18

     
See accompanying Notes to Condensed Consolidated Financial Statements.

8




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

 
 
Three Months Ended March 31,
 
 
2020
 
2019
Net income
 
$
12,191

 
$
16,552

Change in fair value of investment securities available for sale, net of tax of $2,419 and $2,145, respectively
 
8,707

 
8,028

Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(221) and $(3), respectively
 
(793
)
 
(12
)
Other comprehensive income
 
7,914

 
8,016

Comprehensive income
 
$
20,105

 
$
24,568

See accompanying Notes to Condensed Consolidated Financial Statements.


9




HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(In thousands, except per share amounts)
 
Three Months Ended March 31, 2020
 
Number of
common
shares
 
Common
stock
 
Retained
earnings
 
Accumulated
other
comprehensive income, net
 
Total
stockholders’
equity
Balance at December 31, 2019
36,619

 
$
586,459

 
$
212,474

 
$
10,378

 
$
809,311

Cumulative effect from change in accounting policy (1)

 

 
(5,615
)
 

 
(5,615
)
Restricted stock units vested, net of forfeitures, of restricted stock awards
87

 

 

 

 

Exercise of stock options
5

 
71

 

 

 
71

Stock-based compensation expense

 
969

 

 

 
969

Common stock repurchased
(822
)
 
(19,060
)
 

 

 
(19,060
)
Net income

 

 
12,191

 

 
12,191

Other comprehensive income, net of tax

 

 

 
7,914

 
7,914

Cash dividends declared on common stock ($0.20 per share)


 

 
(7,343
)
 

 
(7,343
)
Balance at March 31, 2020
35,889

 
$
568,439

 
$
211,707

 
$
18,292

 
$
798,438

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2019
 
Number of
common
shares
 
Common
stock
 
Retained
earnings
 
Accumulated
other
comprehensive (loss) income, net
 
Total
stockholders’
equity
Balance at December 31, 2018
36,874

 
$
591,806

 
$
176,372

 
$
(7,455
)
 
$
760,723

Cumulative effect from change in accounting policy (1)

 

 
(399
)
 

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

 
$
591,767

 
$
185,863

 
$
561

 
$
778,191

(1) Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses. Effective January 1, 2019, the Company adopted ASU 2016-02, Leases.

See accompanying Notes to Condensed Consolidated Financial Statements.


10




HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
 
 
Three Months Ended
March 31,
 
 
2020
 
2019
Cash flows from operating activities:
 
 
 
 
Net income
 
$
12,191

 
$
16,552

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
 
2,095

 
2,234

Changes in net deferred loan costs, net of amortization
 
(239
)
 
276

Provision for credit losses
 
7,946

 
920

Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities
 
(7,581
)
 
1,345

Stock-based compensation expense
 
969

 
741

Amortization of intangible assets
 
903

 
1,025

Origination of mortgage loans held for sale
 
(16,026
)
 
(8,607
)
Proceeds from sale of mortgage loans held for sale
 
18,298

 
7,458

Earnings on bank owned life insurance
 
(885
)
 
(487
)
Loss on sale of other real estate owned, net
 
4

 

Gain on sale of loans, net
 
(547
)
 
(252
)
Gain on sale of investment securities, net
 
(1,014
)
 
(15
)
Gain on sale of assets held for sale
 
(9
)
 

Impairment for right of use asset
 

 
117

(Gain) loss on sale of premises and equipment, net
 
(9
)
 
5

Net cash provided by operating activities
 
16,096

 
21,312

Cash flows from investing activities:
 
 
 
 
Loans originated, net of principal payments
 
(86,596
)
 
(42,357
)
Maturities, calls and payments of investment securities available for sale
 
74,320

 
47,004

Purchase of investment securities available for sale
 
(90,517
)
 
(57,606
)
Proceeds from sales of investment securities available for sale
 
25,177

 
10,932

Purchase of premises and equipment
 
(1,423
)
 
(1,030
)
Proceeds from sales of other real estate owned
 
266

 
79

Proceeds from sales of assets held for sale
 
394

 

Proceeds from redemption of Federal Home Loan Bank stock
 
760

 
2,276

Purchases of Federal Home Loan Bank stock
 
(1,044
)
 
(3,577
)
Proceeds from sales of premises and equipment
 
9

 

Purchase of bank owned life insurance
 
(3,579
)
 

Proceeds from bank owned life insurance death benefit
 
1,324

 

Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net
 
(1,434
)
 
(80
)
Net cash used in investing activities
 
(82,343
)
 
(44,359
)
Cash flows from financing activities:
 
 
 
 
Net increase (decrease) in deposits
 
35,272

 
(38,687
)
Federal Home Loan Bank advances
 
19,000

 
76,900

Repayment of Federal Home Loan Bank advances
 
(19,000
)
 
(51,900
)
Common stock cash dividends paid
 
(7,314
)
 
(6,662
)
Net decrease in securities sold under agreement to repurchase
 
(8,377
)
 
(6,564
)
Proceeds from exercise of stock options
 
71

 
22

Repurchase of common stock
 
(19,060
)
 
(802
)
Net cash provided by (used in) financing activities
 
592

 
(27,693
)

11




 
 
Three Months Ended
March 31,
 
 
2020
 
2019
Net decrease in cash and cash equivalents
 
(65,655
)
 
(50,740
)
Cash and cash equivalents at beginning of period
 
228,568

 
161,910

Cash and cash equivalents at end of period
 
$
162,913

 
$
111,170

 
 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
 
Cash paid for interest
 
$
4,507

 
$
3,801

Cash paid for income taxes, net of refunds
 
58

 

 
 
 
 
 
Supplemental non-cash disclosures of cash flow information:
 
 
 
 
Transfers of loans receivable to other real estate owned
 
$
270

 
$

Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets
 

 
763

Purchase of investment securities available for sale not settled
 
7,303

 

Cumulative effect from change in accounting policy (1)
 
7,175

 
29,754

Impact of new or modified leases
 
591

 
335

(1) Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses. Effective January 1, 2019, the Company adopted ASU 2016-02, Leases.

See accompanying Notes to Condensed Consolidated Financial Statements.

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

(1)
Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements
(a) Description of Business
Heritage Financial Corporation 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 is a Washington-chartered commercial bank and its deposits are insured by the FDIC. The Bank is headquartered in Olympia, Washington and conducts business from its 62 branch offices as of March 31, 2020 located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas.

(b) Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. It is recommended that these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the 2019 Annual Form 10-K. In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.
To prepare unaudited Condensed Consolidated Financial Statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. It is reasonably possible management's estimate of ACL on loans and the fair value of financial instruments could change from $47.5 million and the amounts disclosed in Note (13) Fair Value Measurements, respectively. The resulting change in these estimates would be material to the unaudited Condensed Consolidated Financial Statements.
Certain prior year amounts have been reclassified to conform to the current year’s presentation. Namely, loan receivable balances in the disclosures of Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans have been reclassified to conform to the current period presentation, which is net of deferred fees and costs. Reclassifications had no effect on the prior years' net income or stockholders’ equity.

(c) Significant Accounting Policies
The significant accounting policies used in preparation of the Company's Condensed Consolidated Financial Statements are disclosed in the 2019 Annual Form 10-K. Other than the adoption of new accounting standard discussed below, there have not been any material changes in the Company's significant accounting policies from those contained in the 2019 Annual Form 10-K.
Adoption of New Accounting Standard
On January 1, 2020, the Company adopted FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans receivable. It also applies to off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition, the CECL Adoption made changes to the accounting for investment securities available for sale.
The Company adopted ASU 2016-13 using the modified retrospective method for all financial assets measured at amortized cost and unfunded commitments. The Company elected not to measure an ACL on accrued interest receivable on loans receivable or accrued interest receivable on investment securities available for sale as Company policy is to reverse interest income for uncollectible accrued interest receivable balances in a timely manner.

13




Results for the reporting period beginning after January 1, 2020 are presented under ASU 2016-13, while prior period amounts were not restated and continue to be reported in accordance with previously applicable GAAP. The accounting policies for prior periods are included in the 2019 Form 10-K.
The accounting policies for all financial instruments impacted by the CECL adoption are as follows:

Investment Securities
A debt security is placed on nonaccrual status at the time any principal or payments become more than 90 days delinquent. Interest accrued, but not received for a security placed on nonaccrual, is reversed against interest income during the period that the debt security is placed on nonaccrual status.
Allowance for Credit Losses on Investment Securities
Management evaluates the need for an ACL on investment securities on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities available for sale in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For investment securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL on investment securities available for sale is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any decline in fair value that has not been recorded through an ACL on investment securities for sale is recognized in other comprehensive income.
Changes in the ACL on investment securities available for sale are recorded as provision (reversal of provision) for credit losses expense. Losses are charged against the allowance when management believes the uncollectability of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met.
Accrued interest receivable on investment securities available for sale is excluded from the estimate of credit losses as interest accrued, but not received, is reversed timely in accordance with the policy for investment securities above.
Loans Receivable
Loans receivable include loans originated and indirect loans purchased by the Bank as well as loans acquired in business combinations.    
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the outstanding principal balance, net of purchased premiums and discounts, unearned discounts, and net deferred loan origination fees and costs. Accrued interest receivable for loans receivable is reported in prepaid expenses and other assets on the Condensed Consolidated Statements of Financial Condition.
Purchased Loans:
Loans acquired in a business combination are designated as “purchased” loans. Upon adoption of ASU 2016-13, the Bank's PCI loans were transitioned to PCD loans. The Bank elected to account for the PCD loans individually, terminating the pools of loans that were previously accounted for under ASC 310-30.
Loans purchased after January 1, 2020 are recorded at their fair value at acquisition date net of an ACL on loans expected to be incurred over the life of the loan. The initial ACL on purchased loans is determined using the same methodology as originated loans. For non-PCD loans, the initial ACL is recorded to provision for credit losses expense. For PCD loans, the initial ACL is incorporated into the calculation of the fair value of net assets acquired on the merger date and the net of the PCD loan purchase price and the initial ACL becomes the initial amortized cost basis. The difference between the initial amortized cost basis and the par value of PCD loans is the noncredit discount or premium for PCD loans. The noncredit discount or premium for PCD loans and both the noncredit and credit discount or premium for non-PCD loans are accreted through the interest and fees on loans line item on the Condensed Consolidated Statements of Income over the life

14




of the loan using the effective interest method for non-revolving credits or the straight-line method, which approximates the effective interest method, for revolving credits. Any unrecognized discount or premium for a purchased loan that is subsequently repaid in full is recognized immediately into income. Subsequent changes to the ACL on loans for purchased loans are recorded through provision for credit losses expense.
Troubled Debt Restructures:
The CARES Act provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined by the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act if they are less than 30 days past due on their contractual payments at the time a modification program is implemented.
Allowance for Credit Losses on Loans
The ACL on loans is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. Loans are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off. Subsequent recoveries, if any, are credited to the allowance. The Bank record the changes in the ACL through earnings, as a provision for credit losses on the Condensed Consolidated Statements of Income.
Accrued interest receivable on loans receivable is excluded from the estimate of credit losses. Instead, interest accrued, but not received, is reversed timely in accordance with the policy for loans receivable above.
Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans. The same methodology is applied to all loans consistent with the guidance of the accounting standard which does not require undue complexity. Under this allowance approach, the Company has identified segments of loans with similar risk characteristics that align with its identified loan classes. Nonaccrual loans are not considered similar to other loans; therefore, they are evaluated for allowance on an individual basis. The allowance for individually evaluated loans is calculated using either the collateral value method, which considers the likely source of repayment as the value of the collateral, less estimated costs to sell, or the net present value method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt. When the net present value method is used, management adjusts the effective interest rate used to discount expected cash flows to incorporate expected prepayments.
The ACL on a TDR loan is measured using the same method as all other loans, except that the original interest rate is used to discount the expected cash flows, not the rate specified in the restructuring. Nonperforming TDR loans, including defaulted TDR loans, are evaluated for allowance on an individual basis. A performing TDR loan is evaluated for allowance on a collective basis with loans with similar risk characteristics if a) it is classified as a risk rating of "Pass", b) it has paid a minimum of six months of principal and interest in accordance with the restructured terms and c) it has not been over 30 days delinquent in the most recent six month period. If all three criteria on a performing TDR loan are not met, the loan is evaluated for allowance on an individual basis as it is not deemed to have similar characteristics of other loans in the portfolio.
For each loan segment collectively measured, the baseline loss rates are calculated using the bank's average quarterly historical loss information. The Bank evaluates the historical period on a quarterly basis, with the assumption that economic cycles have historically lasted between 10 and 15 years. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the baseline loss estimate for each loan. Estimated cash flows consider the principal and interest in accordance with the contractual term of the loan and estimated prepayments. Contractual cash flows are based on the amortized cost, as adjusted for balances guaranteed by governmental entities, such as SBA or USDA, or the unguaranteed amortized cost. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: 1) management has a reasonable expectation at the reporting date that a TDR will be executed with an individual borrower or 2) the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Prepayments are established for each segment based on rolling historical averages for the segments, which management believes is an accurate representation of future prepayment activity. Management reviews the adequacy of the prepayment period assumption on a quarterly basis.

15




The CECL methodology includes consideration of the forecasted direction of the economic and business environment and its likely impact to the estimated allowance as compared to the historical losses over the reasonable and supportable time frame. Economic forecast models for the current period are uploaded to the model, which targets 16 forecasted macroeconomic factors, such as unemployment rate, GDP, housing price index, commercial real estate price index, disposable income growth, mortgage rates, and certain rate indices. Each of the forecasted segments is impacted by a mix of these macroeconomic factors. Further, each of the macroeconomic factors is utilized differently by segment, including the application of lagged factors and various transformations such as percent change year over year.
The macroeconomic sensitive model is developed for each segment given the current and forecasted conditions, and a macroeconomic multiplier is calculated for each forecast period considering the forecasted losses as compared to the long-term average actual losses of the dataset. The impact of those macroeconomic factors to each segment, positive or negative, using the reasonable and supportable period, are added to the calculated baseline loss rate. After the reasonable and supportable period, the estimated credit losses are reverted back to historical baseline loss levels under a reversion period on a straight-lined, input reversion basis.
The Bank also considers other qualitative risk factors to adjust the estimated ACL calculated by the above mentioned model. The Bank will have a bias for minimal factors unless internal or external factors outside those considered in its historical losses or macroeconomic forecast indicate otherwise. The Bank will establish metrics to estimate the qualitative risk factor by segment based on the identified risk.
In general, management's estimate of the ACL on loans uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
The allowance for loan losses evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize losses on loans, future additions to the allowance may be necessary based on further declines in local and national economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s ACL on loans. Such agencies may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the ACL on loans is appropriate given all of the above considerations.
Allowance for Credit Losses on Unfunded Commitments
The Bank estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in which the Bank is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The Bank has determined that no allowance is necessary for its credit card portfolio as it has the ability to unconditionally cancel the available lines of credit.
The allowance methodology is similar to the ACL on loans, but additionally includes an estimate of the future utilization of the commitment as determined by historical commitment utilizations and the Bank's estimates of future utilizations given current economic forecasts. The credit risks associated with the unfunded commitments are consistent with the risks outlined for each loan class.
The allowance is recognized in accrued expenses and other liabilities on the Condensed Consolidated Statements of Financial Condition and is adjusted as a provision (reversal of provision) for credit losses on the Condensed Consolidated Statements of Income.
Provision for Credit Losses
The provision for credit losses as presented in the Company's Condensed Consolidated Statements of Income includes the provision for credit losses on loans and the provision for credit losses on unfunded commitments.
    
(d) Recently Issued Accounting Pronouncements
FASB ASU 2016-13Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and 2020-02, was originally issued in June 2016. This ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. For public business entities, this ASU is effective for fiscal

16




years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15, 2018. The Company adopted the Update on January 1, 2020 as discussed in the Significant Accounting Policies section above. The adoption had the following impacts:
Investment Securities    
As of December 31, 2019, the Company had no historical charge-off or recovery history and did not have any investment securities available for sale outstanding at the adoption date for which an other-than-temporary impairment was previously recorded. At the adoption date of ASU 2016-13, the unrealized losses present in the portfolio of investment securities available for sale were primarily due to decreases in market interest rates on floating rate investment securities since the purchase of the securities and the fair value of these securities was expected to recover as the securities approach their maturity dates. The basis of management’s conclusion was that at December 31, 2019, 83.5% of the investment securities were issued by or guaranteed by the United States government or its agencies, 14.0% were issued and guaranteed by State and local governments and the remainder of the portfolio was invested in at least investment-grade securities. As a result of the analysis, no allowance for credit losses on investment securities available for sale was recorded upon adoption. See Note (2) Investment Securities for more information.
Loan Receivable    
ASU 2016-13 was applied prospectively and replaced the allowance for loan losses with the ACL on loans on the Condensed Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses on loans as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on unfunded commitments.
The adoption was completed in a specific order beginning with the transition of PCI loans to PCD loans. The Bank elected to account for the PCD loans individually, terminating the pools of loans that were previously accounted for under ASC 310-30. First, an ACL was determined for each PCI loan. The ACL on PCI loans was added to the loans' carrying amount to establish a PCD loan at its amortized cost basis. The difference between the unpaid principal balance and the amortized cost basis of the PCD loan is a noncredit premium or discount, which will be amortized into interest income over the remaining life of the PCD loan. The PCI to PCD transition did not have an impact on beginning retained earnings; however, it did have the effect of reducing the existing allowance for PCI loans by $1.6 million under the CECL methodology as compared to ASC 310-30 methodology.
Following the PCI to PCD transition, the Bank recorded a pretax increase to the ACL on loans of $3.4 million to increase the reserve to the estimated credit losses at January 1, 2020 based on its CECL methodology as part of the cumulative-effect adjustment to beginning retained earnings. The pretax increase to the ACL on loans of $3.4 million and the reduction in ACL on loans due to the PCI to PCD transition of $1.6 million resulted in a $1.8 million increase in the ACL on loans at January 1, 2020. Upon adoption, the adjusted beginning balance of the ACL on loans as a percentage of loans receivable was 1.01% as compared to 0.96% at December 31, 2019 under the prior incurred loss methodology. At March 31, 2020, the ACL on loans as a percentage of loans receivable was 1.23%.
The PCI to PCD transition also resulted in a net discount of $4.3 million for PCD loans, or an increase in the net discount for PCD loans of $1.6 million. Following the transition, the total net discount for purchased loans increased to $10.0 million at January 1, 2020 compared to $8.4 million as of December 31, 2019. The total net discount for purchased loans was $9.0 million at March 31, 2020. The Company accretes the net discount or premium on purchased loans to interest and fees on loans using the effective interest method.
See Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans for more information.
Unfunded Commitments    
ASU 2016-13 was applied prospectively and replaced the reserve for unfunded commitments with the ACL on unfunded commitments as included in accrued liabilities and other expenses on the Condensed Consolidated Statements of Financial Condition and replaced the provision for unfunded commitments with the provision for credit losses on unfunded commitments as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on loans. Upon adoption, the Bank recorded a pretax increase in the beginning ACL on unfunded commitments of $3.7 million. See Note (15) Commitments and Contingencies for more information.

17




Overall CECL Impact
The adoption of ASU 2016-13, including the above mentioned increase to the ACL on loans of $3.4 million and the increase to the ACL on unfunded commitments of $3.7 million, resulted in a pretax cumulative-effect adjustment of $7.1 million. The impact of this adjustment to beginning retained earnings on January 1, 2020 was $5.6 million, net of tax.

FASB ASU 2017-04Goodwill (Topic 350), was issued in January 2017 and eliminates Step 2 from the goodwill impairment test. The ASU is effective for annual periods or any interim goodwill impairment tests beginning after December 15, 2019 using a prospective transition method and early adoption is permitted. The Company adopted the guidance on January 1, 2020. The adoption did not have a material impact on its Condensed Consolidated Financial Statements as of or for the three month ended March 31, 2020 as the Company's qualitative assessment indicated no goodwill impairment.
FASB ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, was issued in August 2018 and modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company adopted the guidance on January 1, 2020. The adoption did not have a material impact to Note (13) Fair Value Measurements in its Condensed Consolidated Financial Statements.
FASB ASU 2020-03, Codification Improvements to Financial Instruments was issued in March 2020 and revised a wide variety of topics in the Codification with the intent to make the Codification easier to understand and apply by eliminating inconsistencies and providing clarifications. The Update was effective immediately upon its release and did not have a material impact on the Company's Condensed Consolidated Financial Statements.
FASB ASU 2020-04, Reference Rate Reform (Topic 848) was issued in March 2020 and provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or remeasurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts. The Update also provides numerous optional expedients for derivative accounting. The Update is effective March 12, 2020 through December 31, 2022. An entity may elect to apply the Update for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within the Codification, the amendments in this Update must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The Company anticipates this Update will simplify any modifications we execute between the selected start date (yet to be determined) and December 31, 2022 that are directly related to LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized fees/costs. The Company is evaluating the impacts of this Update and have not yet determined whether LIBOR transition and this Update will have material effects on our business operations and Condensed Consolidated Financial Statements.


18




(2)
Investment Securities
(a) Securities by Type and Maturity
The following tables present the amortized cost and fair value of investment securities available for sale at the dates indicated and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss):
 
March 31, 2020
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
85,868

 
$
1,314

 
$
(120
)
 
$
87,062

Municipal securities
174,614

 
5,409

 
(415
)
 
179,608

Mortgage-backed securities and collateralized mortgage obligations:
 
 
 
 
 
 
 
Residential
313,710

 
9,204

 
(230
)
 
322,684

Commercial
316,683

 
10,348

 
(1,275
)
 
325,756

Corporate obligations
23,897

 
195

 
(260
)
 
23,832

Other asset-backed securities (1)
23,056

 

 
(906
)
 
22,150

Total
$
937,828

 
$
26,470

 
$
(3,206
)
 
$
961,092


(1) 
Issued and guaranteed by U.S. Government-sponsored agencies.
 
December 31, 2019
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
104,709

 
$
598

 
$
(84
)
 
$
105,223

Municipal securities
128,183

 
4,933

 
(102
)
 
133,014

Mortgage-backed securities and collateralized mortgage obligations:
 
 
 
 
 
 
 
Residential
336,929

 
3,184

 
(505
)
 
339,608

Commercial
322,169

 
5,575

 
(649
)
 
327,095

Corporate obligations
23,893

 
316

 
(15
)
 
24,194

Other asset-backed securities (1)
23,277

 
54

 
(153
)
 
23,178

Total
$
939,160

 
$
14,660

 
$
(1,508
)
 
$
952,312

(1) 
Issued and guaranteed by U.S. Government-sponsored agencies.
There were no securities classified as trading or held to maturity at March 31, 2020 or December 31, 2019.
For the three months ended March 31, 2020, there was no provision for credit loss on investment securities available for sale recorded to net income. There was no ACL on investment securities at March 31, 2020.

19




The amortized cost and fair value of investment securities available for sale at March 31, 2020, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
 
Amortized Cost
 
Fair Value
 
(In thousands)
Due in one year or less
$
33,547

 
$
33,806

Due after one year through five years
162,455

 
166,232

Due after five years through ten years
255,123

 
263,149

Due after ten years
486,703

 
497,905

Total
$
937,828

 
$
961,092


There were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity at March 31, 2020 and December 31, 2019.
(b) Unrealized Losses and Other-Than-Temporary Impairments
The following tables show the gross unrealized losses and fair value of the Company's investment securities available for sale, for which an ACL has not been recorded, aggregated by investment category and length of time that the individual securities have been in continuous unrealized loss positions as of March 31, 2020 and December 31, 2019:
 
March 31, 2020
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
5,880

 
$
(120
)
 
$

 
$

 
$
5,880

 
$
(120
)
Municipal securities
27,434

 
(415
)
 

 

 
27,434

 
(415
)
Mortgage-backed securities and collateralized mortgage obligations:
 
 
 
 
 
 
 
 
 
 
 
Residential
2,045

 
(6
)
 
27,992

 
(224
)
 
30,037

 
(230
)
Commercial
32,562

 
(683
)