ITEM 1A. RISK FACTORS
Investing in the Company’s common stock involves a high degree of risk. The material risks and uncertainties that management believes affect the Company are described below. Before you decide to invest, you should carefully review and consider the risks described below, together with all other information included in this Form 10-K and other reports and documents the Company files with the SEC. Any of the following risks, as well as risks that the Company does not know or currently deems immaterial, could have a material adverse effect on the Company’s business, reputation, financial condition, results of operations and growth prospects.
Market and Interest Rate Risks
The Company’s business is subject to interest rate risk, and fluctuations in interest rates or monetary policy may adversely affect the Company’s business, financial condition, results of operations and growth prospects.
Fluctuations in interest rates may negatively affect the Company’s business and weaken demand for some of its products. The Company’s earnings and cash flows are primarily dependent on net interest income, which is the difference between the interest income that the Company earns on interest earning assets such as loans and investment securities, and the interest expense that the Company pays on interest-bearing liabilities such as deposits and borrowings. Changes in interest rates also affect the Company’s ability to fund operations with customer deposits and the fair value of securities in the Company’s investment portfolio. Any change in general market interest rates, including changes in federal fiscal and monetary policies, could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects. The Company’s interest earning assets and interest-bearing liabilities may react in different degrees to changes in market interest rates. Interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while rates on other types of assets and liabilities may lag behind. The result of these changes to rates may cause differing spreads on interest earning assets and interest-bearing liabilities.
The Company could also be prevented from altering the interest rates charged on loans or from maintaining the interest rates offered on deposits and money market savings accounts due to “price” competition from other banks and financial institutions with which the Company competes. The Company does not know what market rates will be throughout 2025, including the frequency and significance with which the target range for the federal funds rate may be changed in 2025. If the Company fails to
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offer interest at a sufficient level to keep its non-maturity interest-bearing deposits, core deposits may be reduced, which would require the Company to obtain funding in other ways or risk slowing future asset growth.
The Company could recognize additional losses on securities held in the Company’s securities portfolio, particularly if interest rates increase or economic and market conditions deteriorate.
Factors beyond the Company’s control can influence and cause potential adverse changes to the fair value of securities in the Company’s portfolio. These factors include, but are not limited to, changes in interest rates, rating agency downgrades or the Company’s own analysis of the value of the securities, defaults by the issuers or individual mortgagors with respect to the underlying securities and instability in the credit markets. The foregoing factors, as well as changing economic and market conditions or other factors, could cause write-downs and realized or unrealized losses in future periods and declines in other comprehensive income, which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects. The process for determining whether a write-down is required usually requires complex, subjective judgments, which could subsequently prove to have been wrong, about the future financial performance and liquidity of the issuer, the fair value of any collateral underlying the security and whether and the extent to which the principal and interest on the security will ultimately be paid in accordance with its payment terms. Decreases in the fair value of investment securities available for sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity, specifically AOCI, which is increased or decreased by the amount of change in the estimated fair value of our securities available for sale, net of deferred income taxes. Increases in interest rates generally decrease the fair value of securities available for sale, adversely impacting stockholders’ equity. In recent periods, the company has realized losses on the sale of investment securities in connection with strategic balance sheet repositioning transactions. The Company could recognize impairment loss for any security that has declined in fair value below its amortized cost basis if management has the intent to sell the security, or if it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis.
The Company cannot guarantee that its stock repurchase program will be fully implemented or that it will enhance long-term shareholder value.
On April 24, 2024, the Board approved the repurchase of up to 5% of the Company's outstanding common shares, or 1,734,492 shares. This stock repurchase program supersedes the previous stock repurchase program, authorized in March 2020, which allowed for the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares. The number, timing and price of shares repurchased will depend on business and market conditions, regulatory requirements, availability of funds and other factors, including opportunities to deploy the Company's capital. The Company may, in its discretion, begin, suspend or terminate repurchases at any time prior to the stock repurchase program’s expiration, without any prior notice. Even if fully implemented, the stock repurchase program may not enhance long-term shareholder value.
Credit Risks
The Company’s business depends on its ability to manage credit risk.
The Company’s banking business requires it to manage credit risk; however, default risk may arise from events or circumstances that are difficult to detect, such as fraud, or difficult to predict, such as catastrophic events affecting certain industries. As a lender, the Company is exposed to the risk that its borrowers will be unable to repay their loans according to their terms, and that the collateral securing repayment of their loans, if any, may not be sufficient to ensure repayment. In addition, there are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, proper loan underwriting, changes in economic and industry conditions and those inherent in dealing with specific borrowers, including the risk that a borrower may not provide information to the Company about its business in a timely manner, may present inaccurate or incomplete information to the Company or risks relating to the value of collateral.
To manage credit risk, the Company must maintain disciplined and prudent underwriting standards and ensure that the Company’s bankers follow those standards. The weakening of these standards for any reason, such as an attempt to attract higher yielding loans, a lack of discipline or diligence by the Company’s employees in underwriting and monitoring loans, the Company’s inability to adequately adapt policies and procedures to changes in economic or any other conditions affecting borrowers and the quality of the Company’s loan portfolio may result in loan defaults, foreclosures and charge-offs and may necessitate that the Company significantly increase its allowance for credit losses, each of which could adversely affect net income. As a result, the Company’s inability to successfully manage credit risk could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company’s high concentration of large loans to certain borrowers may increase the Company’s credit risk.
The Company has developed relationships with certain individuals and businesses that have resulted in a concentration of large loans to a small number of borrowers. As of December 31, 2024, the Company’s 10 largest borrowing relationships accounted for approximately 6.5% of the total loan portfolio. The Company has established an informal, internal limit on loans to one borrower, principal or guarantor, but the Company may, under certain circumstances, consider going above this internal limit in situations where management’s understanding of the industry, the borrower’s business and the credit quality of the borrower are commensurate with the increased size of the loan. Along with other risks inherent in these loans, such as the deterioration of the underlying businesses or property securing these loans, this high concentration of borrowers presents a risk to the Company’s lending operations. If any one of these borrowers becomes unable to repay its loan obligations as a result of business, economic or market conditions, the Company’s nonaccruing loans and provision for loan losses could increase significantly, which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company’s allowance for credit losses may prove to be insufficient to absorb potential losses in its loan portfolio.
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Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
•the cash flow of the borrower, guarantors and/or the project being financed;
•the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
•the character and creditworthiness of a particular borrower or guarantor;
•changes in economic and industry conditions; and
•the duration of the loan.
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-off through the ACL on loans when management believes the uncollectibility of a loan balance is considered probable. Subsequent recoveries, if any, are recorded to the ACL on loans. The Company records the changes in the ACL on loans through earnings as a "Provision for (reversal of) credit losses" on the Consolidated Statements of Income.
The determination of the appropriate level of ACL on loans inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the ACL on loans may not be sufficient to cover expected losses in our loan portfolio, resulting in the need for increases in our ACL on loans through the provision for credit losses. Management also recognizes that significant new growth in loan segments and new loan products can result in loans segments comprised of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our ACL on loans may be insufficient to absorb losses without significant additional provisions.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the ACL on loans. If current conditions in the housing and real estate markets weaken, we expect we will experience increased delinquencies and credit losses. Bank regulatory agencies also periodically review our ACL on loans and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on their judgments about information available to them at the time of their examination. In addition, if charge-offs in future periods exceed the ACL on loans, we will need additional provisions to increase the ACL on loans. Any increases in the allowance for credit losses will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.
A decline in the business and economic conditions in the Company’s market areas could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company’s business activities and credit exposure, including real estate collateral for many of its loans, are concentrated in the states of Washington, Oregon and Idaho, although the Company also pursues business opportunities nationally. Adverse economic developments in our market areas, among other things, could affect the volume of loan originations, increase the level of nonperforming assets, increase the rate of foreclosure losses on loans, reduce the value of the Company’s loans and affect the Company’s business, financial condition, results of operations and growth prospects. Any regional or local economic downturn that affects the Company’s market areas or existing or prospective borrowers or property values in such areas may affect the Company and the Company’s profitability more significantly and more adversely than the Company’s competitors whose operations are less geographically concentrated.
Negative changes in the economy affecting real estate values and liquidity, as well as environmental factors, could impair the value of collateral securing the Company’s real estate loans and result in loan and other losses.
At December 31, 2024, approximately 79.1% of the Company’s total loan portfolio was comprised of loans with real estate as the primary component of collateral. The repayment of such loans is highly dependent on the ability of the borrowers to meet their loan repayment obligations to us, which can be adversely affected by economic downturns and other factors. The market value of real estate can fluctuate significantly in a short period of time as a result of interest rates and market conditions in the area in which the real estate is located and some of these values have been negatively affected by the recent rise in prevailing interest rates. Additionally, the repayment of commercial real estate loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Adverse changes affecting real estate values, including decreases in office occupancy due to the shift to remote and hybrid working environments following the COVID-19 pandemic, could increase the credit risk associated with the Company’s loan portfolio, significantly impair the value of property pledged as collateral on loans and affect the Company’s ability to sell the collateral upon foreclosure without a loss or additional losses or the Company’s ability to sell those loans on the secondary market. If real estate values decline, it is also more likely that the Company would be required to increase the Company’s allowance for credit losses, which would have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Many of the Company’s loans are to commercial borrowers, which have a higher degree of risk than other types of loans.
Commercial and industrial loans represented 17.5% of the Company’s total loan portfolio at December 31, 2024. These loans can be larger in size and involve greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation of the business involved, repayment is often more sensitive than other types of loans to the general business climate and economy. A challenging business and economic environment generally, or in certain specific industries, may increase the Company’s risk related to commercial loans. Cumulative effects of inflation, labor shortages or employee turnover, supply chain constraints and the threat of new tariffs, mass deportations and changes in tax regulations implemented by the new Presidential administration may adversely affect commercial and industrial loans, especially if general economic conditions worsen. The Company’s commercial and industrial loans are primarily made based on the identified cash flow of the
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borrower and secondarily on the collateral underlying the loans. Most often, this collateral consists of accounts receivable, inventory and equipment. Inventory and equipment may depreciate over time, be difficult to appraise and fluctuate in value based on the success of the business and economic trends. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired. Due to the larger average size of each commercial loan as compared with other loans such as residential loans, as well as collateral that is generally less readily-marketable, losses recorded on a small number of commercial loans could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Nonperforming assets take significant time and resources to resolve and adversely affect the Company’s net interest income.
The Company’s nonperforming assets adversely affect net interest income in various ways. The Company does not record interest income on nonaccrual loans or foreclosed assets, thereby adversely affecting net income and returns on assets and equity. When the Company takes collateral in foreclosure and similar proceedings, the Company is required to mark the collateral to its then-fair market value, which may result in a loss. These nonperforming loans and foreclosed assets also increase the Company’s risk profile and the level of capital the Company’s regulators believe is appropriate for it to maintain in light of such risks. The resolution of nonperforming assets requires significant time commitments from management, which increase the Company’s loan administration costs and adversely affects its efficiency ratio and can be detrimental to the performance of their other responsibilities. If the Company experiences increases in nonperforming assets, net interest income may be negatively impacted and the Company’s loan administration costs could increase, each of which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Liquidity and Funding Risks
Liquidity risks could affect the Company’s operations and jeopardize its business, financial condition, results of operations and growth prospects.
Liquidity is essential to the Company’s business. Generally, liquidity risk is the risk of being unable to fund obligations to creditors, including, in the case of financial institutions, obligations to depositors, as such obligations become due and/or fund the acquisition of assets, as they come due, and is inherent in the Company’s operations. An inability to raise funds through deposits, borrowings, the sale of loans or investment securities, and from other sources could have a substantial negative effect on our liquidity. The Company’s most important source of funds consists of customer deposits, which can decrease for a variety of reasons, including when customers perceive alternative investments, such as bonds, treasuries or stocks, as providing a better risk/return trade off. The Company’s future growth will largely depend on its ability to maintain and grow a strong deposit base.
Additionally, uninsured deposits have historically been viewed by the FDIC as less stable than insured deposits. According to statements made by the FDIC staff and the leadership of the federal banking agencies, customers with larger uninsured deposit account balances often are small- to mid-sized businesses that rely upon deposit funds for payment of operational expenses and, as a result, are more likely to closely monitor the financial condition and performance of their depository institutions. As a result, in the event of financial distress, uninsured depositors historically have been more likely to withdraw their deposits. If a significant portion of our deposits were to be withdrawn within a short period of time such that additional sources of funding would be required to meet withdrawal demands, the Company may be unable to obtain funding at favorable terms, which may have an adverse effect on our net interest margin. Moreover, obtaining adequate funding to meet our deposit obligations may be more challenging during periods of higher prevailing interest rates, such as the present period. Our ability to attract depositors during a time of actual or perceived distress or instability in the marketplace may be limited. Further, interest rates paid for borrowings generally exceed the interest rates paid on deposits. This spread may be exacerbated by higher prevailing interest rates. In addition, because our available for sale securities lose value when interest rates rise, after-tax proceeds resulting from the sale of such assets may be diminished during periods when interest rates are elevated. Under such circumstances, we may be required to access funding from sources such as the FRB’s discount window in order to manage our liquidity risk.
Other primary sources of funds consist of cash from operations, investment security maturities and sales and proceeds from the issuance and sale of the Company’s equity and debt securities to investors. Additional liquidity is provided by the ability to borrow from the FRB and the FHLB. The Company may also borrow from third party lenders from time to time. The Company’s access to funding sources in amounts adequate to finance or capitalize the Company’s activities or on terms that are acceptable to the Company could be impaired by factors that affect the Company directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. Economic conditions and a loss of confidence in financial institutions may increase the Company’s cost of funding and limit access to certain customary sources of capital, including inter-bank borrowings and borrowings from the discount window of the FRB. Any decline in available funding could adversely impact the Company’s ability to continue to implement its strategic plan, including originating loans and investing in securities, or to fulfill obligations such as paying expenses, repaying borrowings or meeting deposit withdrawal demands, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company may not be able to maintain a strong core deposit base or other low cost funding sources.
The Company depends primarily on core deposits from its customers, which consist of noninterest demand deposits, interest bearing demand deposits, money market accounts, savings accounts and certificates of deposit as its primary source of funding for lending activities. The Company’s future growth will largely depend on its ability to maintain and grow this core deposit base. Deposit and account balances can decrease when customers perceive alternative investments, such as the stock market or real estate, as providing a better risk/return trade off. If customers move money out of bank deposit accounts and into investments (or
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similar deposit products at other institutions that may provide a higher rate of return), the Company could lose a relatively low-cost source of funds, increasing funding costs and reducing net interest income. The Company supplements its core deposit funding with non-core, short-term funding sources, including brokered deposits, FHLB advances and borrowings from the FRB. If the Company is unable to pledge sufficient qualifying collateral to secure funding from the FHLB, it may lose access to this source of liquidity. If the Company is unable to access any of these types of funding sources or if its costs related to them increases, its liquidity and ability to support demand for loans could be materially adversely affected.
The Company’s liquidity is largely dependent on dividends from the Bank.
The Company is a legal entity separate and distinct from the Bank. A substantial portion of the Company’s cash flow, including cash flow to pay principal and interest on the Company’s debt, comes from dividends the Company receives from the Bank. Federal and state laws and regulations limit the amount of dividends that the Bank may pay to the Company. In the event the Bank is unable to pay dividends to the Company, it may not be able to service its debt, which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company may need to raise additional capital in the future, and failure to maintain sufficient capital would adversely affect its business, financial condition, results of operations, growth prospects and ability to maintain regulatory compliance with capital requirements.
The Company faces significant capital and other regulatory requirements as a financial institution. The Company may need to raise additional capital in the future to provide sufficient capital resources and liquidity to meet its commitments and business needs, including possible acquisition financing. In addition, the Company, on a consolidated basis, and the Bank, on a stand-alone basis, must meet certain regulatory capital requirements and maintain sufficient liquidity. Regulatory capital requirements could increase from current levels, which could require the Company to raise additional capital or contract the Company’s operations. The Company’s ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions, governmental activities, the Company’s credit ratings, its ability to maintain a listing on Nasdaq and its financial condition and performance. Accordingly, the Company cannot provide assurances that it will be able to raise additional capital if needed or on terms acceptable to the Company. If the Company fails to maintain capital to meet regulatory requirements, or is unable to raise capital to meet its business needs, its business, financial condition, results of operations and growth prospects would be materially and adversely affected.
The Company may be adversely affected by changes in the actual or perceived soundness or condition of other financial institutions.
Financial services institutions that deal with each other are interconnected as a result of trading, investment, liquidity management, clearing, counterparty, reputational and other relationships. Concerns about, or a default by, one institution could lead to significant liquidity problems and losses or defaults by other institutions, as the commercial and financial soundness of many financial institutions is closely related as a result of these credit, trading, clearing and other relationships. Even the perceived lack of creditworthiness of, or questions about, a counterparty may lead to market-wide liquidity problems and losses or defaults by various institutions. For example, certain community banks experienced deposit outflows following the bank failures in 2023. This systemic risk may adversely affect financial intermediaries with which the Company interacts on a daily basis or key funding providers such as the FHLB, any of which could have a material adverse effect on the Company’s access to liquidity or otherwise have a material adverse effect on its business, financial condition, results of operations and growth prospects.
Operational, Strategic and Reputational Risks
The Company may not be successful in implementing its organic growth strategy, which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Part of the Company’s business strategy is to focus on organic growth, which includes leveraging the Company’s business lines across the Company’s entire customer base, enhancing brand awareness and building the Company’s infrastructure. The Company may not be successful in generating organic growth if as a result of numerous factors, including delays in introducing and implementing new products and services and other impediments resulting from regulatory oversight or lack of qualified personnel at the Company’s office locations. In addition, the success of the Company’s organic growth strategy will depend on maintaining sufficient regulatory capital levels, the Company’s ability to raise additional capital to implement its business plan and on favorable economic conditions in the Company’s primary market areas. Failure to adequately manage the risks associated with the Company’s anticipated organic growth could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
In addition to the Company’s organic growth strategy, it intends to expand business by acquiring other banks and financial services companies, but may not be successful in doing so, either because of an inability to find suitable acquisition candidates, constrained capital resources or otherwise.
While a key element of the Company’s business strategy is to grow the Company’s banking franchise and increase the Company’s market share through organic growth, the Company has historically supplemented its organic growth through acquisitions of other financial institutions. The Company intends to continue to take advantage of opportunities to acquire other financial institutions, whether in whole or in part, however, the Company may not be able to identify suitable acquisition targets, or may not succeed in seizing such opportunities when they arise or in integrating any such companies within the Company’s existing business framework following acquisition. In addition, even if suitable targets are identified, the Company expects to compete for such businesses with other potential bidders, some of which may have greater financial resources than the
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Company, which may adversely affect the Company’s ability to make acquisitions at attractive prices. The Company’s ability to execute on acquisition opportunities may require the Company to raise additional capital and to increase the Company’s capital position to support the growth of the Company’s franchise. It will also depend on market conditions over which the Company has no control. Moreover, most acquisitions require the approval of the Company’s bank regulators, and the Company may not be able to obtain such approvals on acceptable terms, or at all. Acquiring other financial institutions involve risks commonly associated with acquisitions, including:
•potential exposure to unknown or contingent liabilities of the banks and businesses the Company acquires;
•exposure to potential asset and credit quality issues of the acquired bank or related business;
•difficulty and expense of integrating the operations, culture and personnel of banks and businesses the Company acquires, including higher than expected deposit attrition;
•potential disruption to the Company’s business;
•potential restrictions on the Company’s business resulting from the regulatory approval process;
•an inability to realize the expected revenue increases, costs savings, gains in market share or other anticipated benefits;
•potential diversion of the Company’s management’s time and attention; and
•the possible loss of key employees and customers of the banks and businesses the Company acquires.
The occurrence of fraudulent activity, breaches or failures of the Company’s information security controls or cybersecurity related incidents could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
As a financial institution, the Company is susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against the Company, its customers or third parties with whom it interacts, which may result in financial losses or increased costs to the Company or its customers, disclosure or misuse of the Company’s information or its customer information, misappropriation of assets, privacy breaches against the Company’s customers, litigation or damage to the Company’s reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by the Company or its customers, denial or degradation of service attacks and malware or other cyber-attacks.
In recent periods, there continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector, due to insider fraud or cyber criminals targeting commercial bank accounts and as a result of increasingly sophisticated methods of conducting cyber-attacks, including those employing artificial intelligence. Consistent with industry trends, the Company has also experienced an increase in attempted electronic fraudulent activity, security breaches and cybersecurity related incidents in recent periods. During 2024, the Company is not aware of having experienced any misappropriation, loss or other unauthorized disclosure of confidential or personally identifiable information having a material impact on the Company as a result of a direct cyber security breach or other act on the Bank; however, some of the Company’s customers and third party vendors may have been affected by such breaches, which could increase their risks of identity theft and other fraudulent activity that could involve customer accounts at the Bank.
Information pertaining to the Company and its customers is maintained, and transactions are executed, on networks and systems maintained by the Company and certain third party partners, such as the Company’s online banking, mobile banking, record-keeping or accounting systems. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect the Company and the Company’s customers against fraud and security breaches and to maintain the confidence of the Company’s customers. Breaches of information security also may occur through intentional or unintentional acts by those having access to the Company’s systems or the confidential information of the Company’s customers, including employees. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that the Company uses to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions, as well as the technology used by our customers to access our systems. The Company’s third party partners’ inability to anticipate, or failure to adequately mitigate, breaches of security could result in a number of negative events, including losses to the Company or its customers, loss of business or customers, damage to the Company’s reputation, the incurrence of additional expenses, disruption to the Company’s business, additional regulatory scrutiny or penalties or the Company’s exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Issues with the use of artificial intelligence in our marketplace may result in reputational harm or liability, or could otherwise adversely affect the Company’s business.
Artificial intelligence, including generative artificial intelligence, is or may be enabled by or integrated into the Company’s products or those developed by its third party partners. As with many developing technologies, artificial intelligence presents risks and challenges that could affect its further development, adoption, and use, and therefore our business. Artificial intelligence algorithms may be flawed, for example datasets may contain biased information or otherwise be insufficient, and inappropriate or controversial data practices could impair the acceptance of artificial intelligence solutions and result in burdensome new regulations. If the analyses of those products incorporating artificial intelligence assist in producing for the Company or its third party partners are deficient, biased or inaccurate, the Company could be subject to competitive harm, potential legal liability and brand or reputational harm. The use of artificial intelligence may also present ethical issues. If the Company or its third party partners offer artificial intelligence enabled products that are controversial because of their purported or real impact on human rights, privacy, or other issues, the Company may experience competitive harm, potential legal liability and brand or reputational
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harm. In addition, the Company expects that governments will continue to assess and implement new laws and regulations concerning the use of artificial intelligence, which may affect or impair the usability or efficiency of products and services and those developed by the Company’s third party partners.
The Company depends on information technology and telecommunications systems, and any systems failures, interruptions or data breaches involving these systems could adversely affect the Company’s operations and financial condition.
The Company’s business is highly dependent on the successful and uninterrupted functioning of its information technology and telecommunications systems, third party servicers, accounting systems, mobile and online banking platforms and financial intermediaries. The risks resulting from use of these systems result from a variety of factors, both internal and external. The Company is vulnerable to the impact of failures of its systems to operate as needed or intended. Such failures could include those resulting from human error, unexpected transaction volumes, intentional attacks or overall design or performance issues.
The Company outsources to third parties many of its major systems, such as data processing and mobile and online banking. The failure of these systems, or the termination of a third party software license or service agreement on which any of these systems is based, could interrupt the Company’s operations. Because the Company’s information technology and telecommunications systems interface with and depend on third party systems, the Company could experience service denials if demand for such services exceeds capacity or such third party systems fail or experience interruptions. A system failure or service denial could result in a deterioration of the Company’s ability to process loans or gather deposits and provide customer service, compromise the Company’s ability to operate effectively, result in potential noncompliance with applicable laws or regulations, damage the Company’s reputation, result in a loss of customer business or subject the Company to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on its business, financial condition, results of operations and growth prospects. In addition, failures of third parties to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of these third parties, could disrupt the Company’s operations or adversely affect its reputation.
It may be difficult for the Company to replace some of its third party vendors, particularly vendors providing the Company’s core banking and information services, in a timely manner if they are unwilling or unable to provide the Company with these services in the future for any reason and even if the Company is able to replace them, it may be at higher cost or result in the loss of customers. Any such events could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company has a continuing need for technological change, and may not have the resources to effectively implement new technologies or may experience operational challenges when implementing new technologies.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Company’s future success will depend in part upon its, and its third party partners’, ability to address the needs of the Company’s customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in operations. The widespread adoption of new technologies, including mobile banking services, artificial intelligence, digital assets and payment systems, could require the Company in the future to make substantial expenditures to modify or adapt the Company’s existing products and services as it grows and develops new products to satisfy the Company’s customers’ expectations, remain competitive and comply with regulatory rules and guidance. The Company may experience operational challenges as it implements these new technology enhancements, which could result in the Company not fully realizing the anticipated benefits from such new technology or require the Company to incur significant costs to remedy any such challenges in a timely manner. Many of the Company’s larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that the Company will be able to offer, which would put the Company at a competitive disadvantage. Accordingly, a risk exists that the Company will not be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to the Company’s customers.
In addition, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may also cause service interruptions, transaction processing errors and system conversion delays and may cause the Company to fail to comply with applicable laws. The Company expects that new technologies and business processes applicable to the financial services industry will continue to emerge, and these new technologies and business processes may be better than those the Company currently uses. Because the pace of technological change is high and the Company’s industry is intensely competitive, it may not be able to sustain the Company’s investment in new technology as critical systems and applications become obsolete or as better ones become available. A failure to successfully keep pace with technological change affecting the financial services industry and failure to avoid interruptions, errors and delays could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company’s use of third party vendors and its other ongoing third party business relationships is subject to increasing regulatory requirements and attention.
The Company’s use of third party vendors for certain information systems is subject to increasingly demanding regulatory requirements and attention by the Company’s federal bank regulators. Recent regulations require the Company to enhance its due diligence, ongoing monitoring and control over the Company’s third party vendors and other ongoing third party business relationships. In certain cases, the Company may be required to renegotiate the Company’s agreements with these vendors to meet these enhanced requirements, which could increase costs. The Company expects that regulators will hold the Company responsible for deficiencies in oversight and control of its third party relationships and in the performance of the parties with
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which the Company has these relationships. As a result, if the Company’s regulators conclude that it has not exercised adequate oversight and control over the Company’s third party vendors or other ongoing third party business relationships or that such third parties have not performed appropriately, the Company could be subject to enforcement actions, including civil money penalties or other administrative or judicial penalties or fines, as well as requirements for customer remediation, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company is highly dependent on its management team and employees, and the loss of any of these individuals, or the inability to attract and retain qualified personnel, could harm the Company’s ability to implement its strategic plan and impair the Company’s relationships with customers.
The Company’s success is dependent, to a large degree, upon the continued service and skills of the Company’s executive management team and its employees. The loss of any of the members of the Company’s executive management team or any other key personnel, including successful individuals employed by banks or other businesses that the Company may acquire, to a new or existing competitor or otherwise, could have an adverse impact on the Company’s ability to retain valuable relationships and some of its customers could choose to use the services of a competitor instead of the Company’s services. As such, the Company needs to continue to attract and retain key personnel and to recruit qualified individuals who fit the Company’s culture to succeed existing key personnel and ensure the continued growth and successful operation of the Company’s business. Leadership changes may occur from time to time, and the Company cannot predict whether significant retirements or resignations will occur or whether the Company will be able to recruit additional qualified personnel.
Competition for high quality personnel is strong and the Company may not be successful in attracting or retaining the personnel it requires, and means the cost of hiring, incentivizing and retaining skilled personnel may continue to increase. In particular, many of the Company’s competitors are significantly larger with greater financial resources and may be able to offer more attractive compensation packages and broader career opportunities. Additionally, the Company may incur significant expenses and expend significant time and resources on training, integration, and business development before the Company is able to determine whether a new employee will be profitable or effective in their role. The loss of the services of any senior executive or other key personnel, the inability to recruit and retain qualified personnel in the future or the failure to develop and implement a viable succession plan could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company faces intense competition from other banks and non-bank financial services companies that could hurt its business.
The Company competes with national commercial banks, regional banks, private banks, mortgage companies, online lenders, savings banks, credit unions, non-bank financial services companies and other financial institutions, including investment advisory and wealth management firms, Fintech companies and digital asset service providers and securities brokerage firms, operating within or near the areas the Company serves. Many of the Company’s non-bank competitors are not subject to the same extensive regulations that govern the Company’s activities and may have greater flexibility in competing for business. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation.
While the Company does not offer products relating to digital assets, including cryptocurrencies, stablecoins and other similar assets, there has been a significant increase in digital asset adoption globally over the past several years. Certain characteristics of digital asset transactions, such as the speed with which such transactions can be conducted, the ability to transact without the involvement of regulated intermediaries, the ability to engage in transactions across multiple jurisdictions, and the anonymous nature of the transactions, are appealing to certain consumers notwithstanding the various risks posed by such transactions. Accordingly, digital asset service providers—which, at present are not subject to the same degree of scrutiny and oversight as banking organizations and other financial institutions—are becoming active competitors to more traditional financial institutions. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from using those deposits to fund loans and investment securities. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
The Company’s dividend policy may change.
Although the Company has historically paid dividends to its shareholders and currently intends to maintain or increase its dividend levels in future quarters, the Company has no obligation to continue doing so and may change its dividend policy at any time without notice to the Company’s shareholders. Holders of the Company’s common shares are only entitled to receive such cash dividends as the Board, in its discretion, may declare out of funds legally available for such payments. Further, consistent with the Company’s strategic plans, growth initiatives, capital availability, projected liquidity needs, and other factors, the Company has made, and will continue to make, capital management decisions and policies that could adversely impact the amount of dividends paid to the Company’s common shareholders.
The Company’s ability to declare and pay dividends is also dependent on federal regulatory considerations, including guidelines of the Federal Reserve regarding capital adequacy and dividends. It is the policy of the Federal Reserve that bank holding companies should generally pay dividends on capital stock only out of earnings, and only if prospective earnings retention is consistent with the organization’s expected future needs, asset quality and financial condition. The Company is a separate and distinct legal entity from its subsidiaries, including the Bank. The Company receives substantially all of its revenue from dividends from the Bank, which it uses as the principal source of funds to pay dividends. Various federal and state laws and regulations limit the amount of dividends that the Bank may pay to the Company. If the Bank does not receive regulatory approval or if its
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earnings are not sufficient to make dividend payments to the Company while maintaining adequate capital levels, the Company’s ability to pay dividends could be materially and adversely impacted.
Future issuances of common stock could result in dilution, which could cause the Company’s common stock price to decline.
The Company is generally not restricted from issuing additional shares of common stock up to the amount authorized in its Articles of Incorporation. Currently, there are 50,000,000 shares of common stock authorized in the Company’s Articles of Incorporation, which may be increased by a vote of the holders of a majority of the Company’s shares of common stock. The Company may issue additional shares of common stock in the future pursuant to current or future equity compensation plans, upon conversions of preferred stock or debt, or in connection with future acquisitions or financings. If the Company chooses to raise capital by selling shares of common stock for any reason, the issuance would have a dilutive effect on the holders of the Company’s common stock and could have a material negative effect on the market price of the Company’s common stock.
The Company may issue shares of preferred stock in the future, which could make it difficult for another company to acquire the Company or could otherwise adversely affect holders of the Company’s common stock, which could depress the price of the Company’s common stock.
Although there are currently no shares of the Company’s preferred stock issued and outstanding, the Company’s Articles of Incorporation authorize it to issue up to 2,500,000 shares of one or more series of preferred stock. The Board also has the power, without shareholder approval, to set the terms of any series of preferred stock that may be issued, including voting rights, dividend rights, preferences over the Company’s common shares with respect to dividends or in the event of a dissolution, liquidation or winding up, and other terms. If the Company issues preferred stock in the future that has a preference over the Company’s common stock with respect to the payment of dividends or upon the Company’s liquidation, dissolution or winding up, or if the Company issues preferred stock with voting rights that dilute the voting power of the Company’s common stock, the rights of the holders of the Company’s common stock or the market price of its common stock could be adversely affected. In addition, the ability of the Board to issue shares of preferred stock without any action on the part of the Company’s shareholders may impede a takeover of the Company and prevent a transaction perceived to be favorable to the Company’s shareholders.
The Company’s business and operations may be adversely affected by weak economic conditions and global trade.
The Company’s businesses and operations are sensitive to general business and economic conditions. If the U.S. economy weakens, the Company’s growth and profitability from its lending, deposit and investment operations could be constrained. Uncertainty about the federal fiscal policymaking process, the medium- and long-term fiscal outlook of the federal government, potential imposition of tariffs and changes in future tax rates is a concern for businesses, consumers and investors. In addition, economic conditions in foreign countries and weakening global trade due to increased anti-globalization sentiment and tariff activity could affect the stability of global financial markets, which could hinder the economic growth of the U.S. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Severe weather, natural disasters, pandemics, acts of war or terrorism or other adverse external events could significantly impact the Company’s business.
Severe weather, natural disasters, effects of climate change, widespread disease or pandemics, acts of war or terrorism, civil unrest or other adverse external events could have a significant impact on the Company’s ability to conduct business. In addition, such events could affect the stability of the Company’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue or cause the Company to incur additional expenses. The occurrence of any of these events in the future could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Legal, Accounting and Compliance Risks
The Company’s risk management framework may not be effective in mitigating risks or losses to the Company.
The Company’s risk management framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which the Company is subject, including, among others, credit, market, liquidity, interest rate and compliance risk. The Company’s risk management framework also includes financial or other modeling methodologies that involve management assumptions and judgment. The Company’s risk management framework may not be effective under all circumstances, and may not adequately mitigate any risk or loss. If the Company’s framework is not effective, the Company could suffer unexpected losses and its business, reputation, financial condition, results of operations and growth prospects could be materially and adversely affected. The Company may also be subject to potentially adverse regulatory consequences.
The Company’s accounting estimates and risk management processes and controls rely on analytical and forecasting techniques and models and assumptions, which may not accurately predict future events.
The Company’s accounting policies and methods are fundamental to the way it records and reports its financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report the Company’s financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet which may result in the Company’s reporting materially different results than would have been reported under a different alternative. Certain accounting policies are critical to presenting the Company’s financial condition and results of operations. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts
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could be reported under different conditions or using different assumptions or estimates. If the Company’s underlying assumptions or estimates prove to be incorrect, it could have a material adverse effect on its business, financial condition, results of operations and growth prospects.
The Company’s risk management processes, internal controls, disclosure controls and corporate governance policies and procedures are based in part on certain assumptions and can provide only reasonable (not absolute) assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls, processes and procedures or failure to comply with applicable regulations could necessitate changes in those controls, processes and procedures, which may increase the Company’s compliance costs, divert management attention from its business or subject the Company to regulatory enforcement actions and increased regulatory scrutiny. Any of these could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
Changes in accounting policies or standards could materially impact the Company’s financial statements.
From time to time, FASB, PCAOB or the SEC may change the financial accounting and reporting standards that govern the preparation of the Company’s financial statements. Such changes may result in the Company becoming subject to new or changing accounting and reporting standards. In addition, the agencies and other entities that interpret the accounting standards (such as banking regulators or outside auditors) may change their interpretations or positions on how these standards should be applied. In addition, trends in financial and business reporting, including environmental, social and governance related disclosures, could require the Company to incur additional reporting expense. These changes may be beyond the Company’s control, can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, or apply an existing standard differently, in each case resulting in the Company’s needing to revise or restate prior period financial statements.
The obligations associated with being a public company require significant resources and management attention, which divert time and attention from the Company’s business operations.
As a public company, the Company is subject to the reporting requirements of the Exchange Act and SOX. The Exchange Act requires, among other things, that the Company file annual, quarterly and current reports with respect to its business and financial condition with the SEC. SOX requires, among other things, that the Company establish and maintain effective internal controls and procedures for financial reporting. Compliance with these reporting requirements and other rules and regulations, including periodic revisions to and additional rules and regulations of the SEC, could increase the Company’s legal and financial compliance costs and make some activities more time consuming and costly. Further, the need to maintain the corporate infrastructure demanded of a public company is expensive and may divert management’s attention from implementing the Company’s strategic plan, which could prevent the Company from successfully implementing the Company’s growth initiatives and improving its business, results of operations and financial condition.
The financial reporting resources the Company has put in place may not be sufficient to ensure the accuracy of the additional information the Company is required to disclose as a publicly listed company.
As a public company, the Company is subject to heightened financial reporting standards under GAAP and SEC rules, including extensive levels of disclosure. Complying with these standards requires consistent monitoring of and periodic enhancements to the design and operation of the Company’s internal control over financial reporting as well as additional financial reporting and accounting staff with appropriate training and experience in GAAP and SEC rules and regulations. If the Company is unable to meet the demands required of the Company as a public company, the Company may be unable to report its financial results accurately, or report them within the timeframes required by law or stock exchange regulations and could be subject to sanctions or investigations by the SEC or other regulatory authorities. If material weaknesses or other deficiencies occur, the Company’s ability to report its financial results accurately and timely could be impaired, which could result in late filings of the Company’s annual and quarterly reports under the Exchange Act, restatements of its consolidated financial statements, a decline in stock price, suspension or delisting of the Company’s common stock, and could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects. Even if the Company is able to report its financial statements accurately and in a timely manner, any disclosure of material weaknesses in the Company’s future filings with the SEC could cause the Company’s reputation to be harmed and the Company’s stock price to decline significantly.
Litigation and regulatory actions, including possible enforcement actions, could subject the Company to significant fines, penalties, judgments or other requirements resulting in increased expenses or restrictions on the Company’s business.
The Company’s business is subject to increased litigation and regulatory risks because of a number of factors, including the highly regulated nature of the financial services industry and the focus of state and federal prosecutors on banks and the financial services industry generally. In the normal course of business, from time to time, the Company has in the past and may in the future be named as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with the Company’s current or prior business activities. Legal actions could include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. The Company may also, from time to time, be the subject of subpoenas, requests for information, reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding the Company’s current or prior business activities. Any such legal or regulatory actions may subject the Company to substantial compensatory or punitive damages, significant fines, penalties, obligations to change the Company’s business practices or other requirements resulting in increased expenses, diminished income and damage to the Company’s reputation. The Company’s involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined in the Company’s favor, could also cause significant harm to the Company’s reputation and divert
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management attention from the operation of the Company’s business. Further, any settlement, enforcement action or adverse judgment in connection with any formal or informal proceeding or investigation by government agencies may result in litigation, investigations or proceedings as other litigants and government agencies begin independent reviews of the same activities. As a result, the outcome of legal and regulatory actions could have a material adverse effect on the Company’s business, reputation, financial condition, results of operations and growth prospects.
The Company is subject to extensive regulation, and the regulatory framework that applies to the Company, together with any future legislative or regulatory changes, may significantly affect its operations.
The banking industry is highly regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, the federal deposit insurance fund and the banking system as a whole, and not for the protection of the Company’s shareholders. The Company is subject to supervision and regulation by the Federal Reserve, and the Bank is subject to supervision and regulation by the FDIC and the DFI. The laws and regulations applicable to the Company govern a variety of matters, including permissible types, amounts and terms of loans and investments the Company may make, the maximum interest rate that may be charged, the types of deposits the Company may accept and the amount of reserves the Company must hold on such deposits, maintenance of adequate capital and liquidity, changes in the control of the Company and the Bank, restrictions on dividends and the establishment of new offices. The Company must obtain approval from its regulators before engaging in certain activities, and there is the risk that such approvals may not be obtained, either in a timely manner or at all. The Company’s regulators also have the ability to compel it to take certain actions, or restrict it from taking certain actions, such as actions that the Company’s regulators deem to constitute an unsafe or unsound banking practice. The Company’s failure to comply with any applicable laws or regulations, or regulatory policies and interpretations of such laws and regulations, could result in the imposition of enforcement actions or sanctions by regulatory agencies, civil money penalties or damage to the Company’s reputation, all of which could have a material adverse effect on its business, financial condition, results of operations and growth prospects.
While the Company endeavors to maintain safe banking practices and controls beyond the regulatory requirements applicable to the Company, its internal controls may not match those of larger banking institutions that are subject to increased regulatory oversight. Financial institutions generally have also been subjected to increased scrutiny from regulatory authorities, which has resulted, and may continue to result in, increased costs of doing business, and may in the future, result in decreased revenues and net income, reduce the Company’s ability to compete effectively, to attract and retain customers, or make it less attractive for the Company to continue providing certain products and services. Any future changes in federal and state laws and regulations, as well as the interpretation and implementation of such laws and regulations, could affect the Company in substantial and unpredictable ways, including those listed above or other ways that could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
There is uncertainty surrounding potential legal, regulatory and policy changes by new presidential administrations in the United States that may directly affect financial institutions and the global economy.
Changes in federal policy and at regulatory agencies occur over time through policy and personnel changes following elections and changes in federal administration, including the change in the presidential administration which occurred in January 2025. These changes typically impact the level of oversight and focus on the financial services industry. The nature, timing and economic and political effects of potential changes to the current legal and regulatory framework affecting financial institutions remain highly uncertain, and may take time to be implemented. Uncertainty surrounding future changes may adversely affect our operating environment and therefore our business, financial condition, results of operations and growth prospects.
Banking regulators periodically examine the Company’s business, and the Company may be required to remediate adverse examination findings.
The Federal Reserve, FDIC and DFI periodically examine the Company and the Bank, including their operations and compliance with laws and regulations. If, as a result of an examination, a banking agency were to determine that the Company’s financial condition, capital resources, asset quality, asset concentrations, earnings prospects, management, liquidity, sensitivity to market risk or other aspects of any of the Company’s operations had become unsatisfactory, or that the Company was in violation of any law or regulation, they may take a number of different remedial actions as they deem appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in the Company’s capital, to restrict the Company’s growth, to assess civil monetary penalties, to fine or remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate the Company’s deposit insurance and place the Company into receivership or conservatorship. Any regulatory action against the Company could have a material adverse effect on its business, reputation, financial condition, results of operations and growth prospects.
Regulations relating to privacy, information security and data protection could increase the Company’s costs, affect or limit how the Company collects and use personal information and adversely affect its business opportunities.
The Company is subject to various privacy, information security and data protection laws, including requirements concerning security breach notification, and the Company could be negatively affected by these laws. Various state and federal banking regulators and states have also enacted data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Legislators and regulators are also increasingly adopting or revising privacy, information security and data protection laws, including with respect to the use of artificial intelligence by financial institutions and their service providers, that potentially could have a significant impact on the Company’s current and planned privacy, data protection and information security-related practices, the Company’s collection, use, sharing, retention and safeguarding of consumer or employee information and some of the Company’s current or
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planned business activities. This could also increase the Company’s costs of compliance and business operations and could reduce income from certain business initiatives.
The Federal Reserve may require the Company to commit capital resources to support the Bank.
A bank holding company is required by law to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it and therefore may be required to borrow the funds or raise capital, which could result in a material adverse effect on its business, financial condition, results of operations and growth prospects, and could negatively impact the price of its common stock.
The level of the Company’s commercial real estate portfolio may subject the Company to heightened regulatory scrutiny.
The federal banking regulators have issued the Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance, or CRE Guidance, which provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land development loans exceeding 100% of capital. The CRE Guidance does not limit the Bank’s levels of commercial real estate lending activities, but rather, guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. The federal bank agencies expect FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management practices to identify, measure, monitor, and manage the risks arising from CRE lending. In addition, FDIC-insured institutions must maintain capital commensurate with the level and nature of their CRE concentration risk. As of December 31, 2024, the Bank did not exceed these guidelines.
If the goodwill that the Company recorded in connection with the Company’s recent acquisitions becomes impaired, it could have a negative impact on its financial condition and results of operations.
As of December 31, 2024, the Company had goodwill of $240.9 million, or 27.9% of the Company’s total stockholders’ equity. The excess purchase price over the fair value of net assets acquired in certain mergers and acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if specific events suggest potential impairment. In testing for impairment, the Company conducts a qualitative assessment, and also estimates the fair value of net assets based on analyses of its market value, discounted cash flows and peer values. Consequently, the determination of the fair value of goodwill is sensitive to market-based economics and other key assumptions. Variability in market conditions or in key assumptions could result in impairment of goodwill, which is recorded as a non-cash adjustment to income. An impairment of goodwill could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects.
ITEM 1B. UNRESOLVED STAFF COMMENTS
The Company has no unresolved staff comments from the SEC as it relates to the Company's financial information as reported in this Form 10-K.
ITEM 1C. CYBERSECURITY
Risk Management and Strategy
Enterprise Risk Management and Technology Risk Management.The Company's Enterprise Risk Management program and team plays a pivotal role in overseeing the organization's risk posture, specifically focusing on the implementation of a holistic risk management program for overseeing the assessment and appropriate control of information and cybersecurity risks. Annually, the Information and Cyber Security Policy and Program and Risk Assessments are presented for approval to the Board to ensure the program is representative and supportive of the Bank’s risk appetite and security testing expectations. Risks identified are subject to rigorous controls, ensuring both design and operational effectiveness and adherence to regulatory requirements. Instances where a risk is identified as inadequately controlled are promptly reported to Management requiring formal remediation activities that are tracked and reported to the Risk and Technology Committee of the Board, until measures are implemented to reduce the risk to an acceptable level
Identification of risks is a multifaceted process, encompassing diverse activities such as the execution of formal risk assessments, as described above, management self-disclosures, monitoring of regulatory and interagency authorities, engagement with professional and industry forums, internal and external audits, collaboration with third-party professional services, policy reviews and walkthroughs, adherence to best practice frameworks, leveraging subject matter expertise and industry experience, and maintaining a collaborative relationship with third party service providers/vendors. The dedicated Technology Risk Management team operates a continuous risk management framework, utilizing information gathered daily, weekly, monthly, quarterly and annually to provide insights into the state of controlled risk within the organization. Security testing and assurance activities are performed internally and are outsourced to independent audit and security firms based on factors such as resource capacity, subject matter expertise, regulatory requirements, and the prevailing rate and condition of risk.
Daily operational activities are in place to ensure the achievement and implementation of security requirements, including the management of the Bank’s security architecture, monitoring for potential security events or incidents, and the reporting and
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response to detected threats in our technology environments. The Information and Cyber Security Policy and Program establishes the additional policies and standards the Bank is required to implement in support of these practices and processes. Additionally, we maintain a compliant and comprehensive Security Incident Response Plan, incorporating accessible resources such as insurance providers, digital and cyber forensic experts and law enforcement, along with documentation of regulatory notification requirements. Our practices are interdependent with third party vendors, and we collaborate appropriately with these partners on notification and investigation processes to ensure complete visibility into security risks and events.
From time-to-time, we have identified cybersecurity threats that require us to make changes to our processes and to implement additional safeguards. While none of these identified threats or incidents have materially affected us, it is possible that threats and incidents we identify in the future could have a material adverse effect on our business strategy, reputation, results of operations and financial condition. During the reporting period, the Company had not experienced any material cybersecurity events or incidents. Although third party service providers that the Bank engages have encountered cybersecurity events or incidents during the year ended December 31, 2024, the Bank’s investigation of each event or incident has shown that these occurrences have not resulted in a material impact on our systems, computing environments, customers, or data.
Governance
Board Oversight: The Board provides active oversight of cybersecurity threats in accordance with the Board-approved Information and Cyber Security Policy and Program. These policies and programs aim to achieve a controlled risk environment while meeting regulatory, legislative, and compliance requirements, including but not limited to the Gramm-Leach-Bliley Act (GLBA), Health Insurance Portability and Accountability Act (HIPAA), Information Technology Sarbanes-Oxley Act (IT SOX) Compliance, and Payment Card Industry Data Security Standard (PCI-DSS) Compliance.
Direct oversight of information and cybersecurity risks is delegated to the Risk and Technology Committee of the Board.The Risk and Technology Committee meets at least quarterly and receives reports detailing current risks, maturity and functioning of associated processes and controls, and emerging or anticipated risks and threats. Additionally, the Risk and Technology Committee Chair provides a verbal summarized report to the full Board following each quarterly meeting, and as needed on an interim basis to address developing risk. All Risk and Technology Committee reports are available to the full Board for review. In the event critical matters arise between scheduled meetings, the Chief Risk Officer promptly notifies the Board and Risk and Technology Committee.
To further ensure independence and effectiveness, the Board has delegated authority for the Information and Cybersecurity Policy and Program, including the referenced reports, to the Technology Risk Management Director. This position fulfills the role and responsibilities of a Chief Information Security Officer and reports to the Chief Risk Officer who in turn reports independently to the Chair of the Risk and Technology Committee. Additional layers of oversight are integrated into the program through the Director of Internal Audit, who conducts independent audits of critical information technology and cybersecurity activities. The results of these audits are reported to the Board's Audit and Finance Committee, providing an extra layer of assurance and accountability. The Director of Internal Audit reports independently to the Chair of the Board's Audit and Finance Committee.
Management's Role in Assessing and Managing Cybersecurity Risks. Management's role in assessing and managing material risks from cybersecurity threats is integral to the Company's governance framework. As discussed above, the Information and Cyber Security Policy and Program outline specific roles and responsibilities delegated to management and the Enterprise Risk Management Program, which includes the Technology Risk Management team, and responsibilities assigned to various employees and the Risk and Technology Committee.
The Technology Risk Management Director, a seasoned information and cyber security expert with significant experience in financial institutions, oversees the Technology Risk Management function. This expert conducts comprehensive assessments of cybersecurity risks inherent in the industry and the Company's business activities, evaluating controls implemented to address identified risks.
The Technology Risk Management Director is responsible for maintaining the Company's information and cyber security risk management framework. This framework establishes standards and processes for the continuous assessment of material cybersecurity risks, covering identification, measurement, mitigation activities, monitoring and reporting of the risk posture at any given time. Additionally, the Director ensures oversight and compliance with the Security Incident Response Plan, providing guidance during security incidents, whether within the Company or involving service provider/vendor engagements.
The Company’s information technology department, including a dedicated security operations group, plays a crucial role in implementing practices aligned with the Information and Cyber Security Policy and Program requirements. Responsibilities include the maintenance and monitoring of systems, network(s), and application access and error logs, identification of unauthorized access attempts, adherence to access controls standards, configuration management, and the implementation of controls to mitigate risks related to information availability, integrity, and confidentiality.
Business activities, products, and services are managed by experts in their respective fields, with employees receiving training to detect and prevent material cybersecurity threats. Business leaders are expected to understand specific threats within their areas of responsibility and adhere to established processes and standards to control such threats.
To facilitate a transparent and collaborative approach to managing cybersecurity risk, an executive management level committee has been established. Chaired by the Chief Risk Officer and administered by the Technology and Risk Management Director, the committee ensures continual awareness of the information and cybersecurity risk posture, emerging threats, known threat actors, and vulnerabilities. Its purpose is to foster a security culture within the Company through active participation in planning and managing threat and security risk activities.
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All committee activities are reported to the Risk and Technology Committee through committee minutes and formal activity reports provided by the Technology and Risk Management Director. The Risk and Technology Committee provides similar reports to the full Board quarterly, as well as on an as-needed basis. Results of cybersecurity-related audits are also reported to the Board's Audit and Finance Committee.
ITEM 2. PROPERTIES
The main office of the Company and the Bank is located at 201 Fifth Avenue SW, in downtown Olympia, Washington. In addition to this main office, which includes a full-service banking office, the Company has three administrative office locations in Tacoma, Everett and Burlington, Washington. The Bank's branch network at December 31, 2024 was comprised of 50 branches located throughout Washington, Oregon and Idaho. The Company leases 24 properties and owns 29 properties at December 31, 2024. In the opinion of management, all properties are adequately covered by insurance, are in good state of repair and are adequate to meet our present and immediately foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is a party, and no property of these entities is subject, to any material pending legal proceedings, other than ordinary routine litigation incidental to their businesses.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the Nasdaq Global Select Market under the symbol "HFWA".
Shareholders
At February 18, 2025, we had approximately 1,039 shareholders of record (which does not include the number of beneficial owners of stock in nominee or street name through various brokerage firms).
Dividends
The Company has historically paid cash dividends to its common shareholders. On January 22, 2025, the Board declared a regular quarterly dividend of $0.24 per common share payable on February 20, 2025 to shareholders of record at the close of business on February 6, 2025. Payments of future cash dividends, if any, will be at the discretion of our Board, taking into account various factors, including our business, operating results, financial condition, capital requirements, current and anticipated cash needs, plans for expansion, any legal or contractual limitation on our ability to pay dividends and other relevant factors. It is management's expectation based on current projections that cash dividends will continue for the foreseeable future, however, no assurances can be given that any dividends will be paid or that, if paid, such dividends will not be reduced in amount in future periods. The payment of dividends on the Company's common stock depends substantially upon receipt by the Company of dividends from the Bank, which is the Company’s predominant source of income.
Dividend Restrictions
As a Washington corporation, the Company is subject to certain restrictions on dividends under corporate law. In general, these restrictions do not allow us to pay dividends if, after payment of such dividends, we would not be able to pay our liabilities as they become due in the usual course of business, or our total assets would be less than total liabilities.
The FDIC and the DFI have the authority under their supervisory powers to prohibit the payment of dividends by the Bank to the Company. Additionally, current guidance from the Federal Reserve provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the FDIC. See “Supervision And Regulation—Supervision and Regulation of the Company—Dividend Payments” and “Supervision And Regulation—Supervision and Regulation of the Bank—Dividend Payments” above, for additional detail regarding restrictions on the payment of dividends by the Company and the Bank.
The Company also has certain contractual restrictions on its ability to pay dividends. The Company has acquired debt securities through transactions. Under the terms of the securities, the Company may be prohibited, under certain circumstances, from paying dividends on shares of its common stock. None of these circumstances existed through the date of filing of this Form 10-K. See Note (9) Junior Subordinated Debentures of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Form 10-K for additional information regarding dividend restrictions.
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Purchases of Equity Securities by the Issuer
The following table sets forth information about the Company’s purchases of its outstanding common stock during the quarter ended December 31, 2024:
(1) Of the common shares repurchased by the Company between October 1, 2024 and December 31, 2024, 568 shares represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units and were not repurchased pursuant to the publicly announced stock repurchase program.
On April 24, 2024, the Board approved the repurchase of up to 5% of the Company's outstanding common shares, or 1,734,492 shares. This stock repurchase program supersedes the previous stock repurchase program, authorized in March 2020, which allowed for the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares.
Performance Graph
The following graph shows the five-year comparison of the cumulative total return to shareholders of the Company’s common stock as compared to the Nasdaq Composite Index and the S&P U.S. SmallCap Banks Index during the five-year period beginning December 31, 2019 and ending December 31, 2024. Total return includes appreciation or depreciation in market value of the Company’s common stock as well as actual cash and stock dividends paid to common shareholders. The Nasdaq Composite Index is a broad equity market index comprised of all domestic and international common stocks listed on the Nasdaq Stock Market ("Nasdaq"). The S&P U.S. SmallCap Banks Index is comparative peer index comprised of banks and related holding companies within the same market capitalization range as the Company. The graph assumes the value of the investment in Company’s common stock and each index was $100 on December 31, 2019, and all dividends were reinvested.
.
Years Ended December 31,
*Information for the graph was provided by S&P Global Market Intelligence.
ITEM 6. [RESERVED]
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of our financial condition and results of operations and should be read in conjunction with our financial statements and notes thereto included in Item 8 Financial Statements and Supplementary Data of this Form 10-K. In addition to historical information, this discussion contains forward‐looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections of this Form 10-K entitled “Cautionary Note Regarding Forward Looking Statements” and Item 1A. Risk Factors.
Management’s discussion focuses on 2024 results compared to 2023 results. For a discussion of 2023 results compared to 2022 results, refer to Part II, Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023, filed with the SEC on February 27, 2024.
Overview
Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of our wholly-owned financial institution subsidiary, Heritage Bank. We provide financial services to our customers in our market areas with an ongoing strategic focus on our commercial banking relationships, market expansion and asset quality. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to the Bank’s operations.
Our business consists primarily of commercial lending and deposit relationships with small- to medium-sized businesses and their owners in our market areas, as well as attracting deposits from the general public. We also make real estate construction and land development loans, consumer loans and residential real estate loans on single family properties located primarily in our markets.
Our core profitability depends primarily on our net interest income. Net interest income is the difference between interest income, which is the income that we earn on interest earning assets, consisting primarily of loans and investment securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits and borrowings. Management manages the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is significantly affected by general and local economic conditions, particularly changes in market interest rates, and by governmental policies and actions of regulatory agencies. Net interest income is additionally affected by changes in the volume and mix of interest earning assets, interest earned on these assets, the volume and mix of interest bearing liabilities and interest paid on these liabilities.
Our net income is affected by many factors, including the provision for credit losses on loans. The provision for credit losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio, as well as prevailing economic and market conditions. Management believes that the ACL on loans reflects the amount that is appropriate to provide for current expected credit losses in our loan portfolio based on the CECL methodology.
Net income is also affected by noninterest income and noninterest expense. Noninterest income primarily consists of gains or losses on the sale of investment securities, service charges and other fees, card revenue and other income. Noninterest expense primarily consists of compensation and employee benefits, occupancy and equipment, data processing and professional services expense. Compensation and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses are the fixed and variable costs of buildings and equipment and consist primarily of lease expenses, depreciation charges, maintenance and utilities. Data processing expense consists primarily of processing and network services related to the Bank’s core operating system, including the account processing system, electronic payments processing of products and services, internet and mobile banking channels and software-as-a-service providers. Professional services expense consists primarily of third-party service providers such as auditors, consultants and lawyers.
Results of operations may also be significantly affected by general and local economic and competitive conditions, changes in accounting, tax and regulatory rules, governmental policies and actions of regulatory authorities, including changes resulting from inflation and the governmental actions taken to address this issue, as well as changes in policies driven by the new presidential administration. Net income is also impacted by growth of operations through organic growth or acquisitions. See also "Cautionary Note Regarding Forward-Looking Statements."
Results of Operations
Net income was $43.3 million, or $1.24 per diluted common share, for the year ended December 31, 2024 down from $61.8 million, or $1.75 per diluted common share, for the year ended December 31, 2023. Net income decreased $18.5 million, or 30.0%, compared to the year ended December 31, 2023 due primarily to a decrease in net interest income of $15.8 million to $209.4 million from $225.2 million and an increase in losses on sales of investment securities of $10.5 million to $22.7 million from $12.2 million, largely as a result of investment portfolio repositioning, which decreased noninterest income. These decreases were partially offset by a decrease in noninterest expense of $8.3 million. During the year ended December 31, 2024, the company also restructured its BOLI portfolio, incurring additional tax expense of $2.4 million and other costs of $508,000 related to the surrender of certain BOLI policies.
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Net Interest Income and Margin Overview
One of the Company's key sources of revenue is net interest income. Several factors affect net interest income, including, but not limited to: the volume, pricing, mix and maturity of interest earning assets and interest bearing liabilities; the volume of noninterest earning assets, noninterest bearing demand deposits, other noninterest bearing liabilities and stockholders' equity; market interest rate fluctuations; and asset quality.
Market rates impact the results of the Company's net interest income, including the significant changes in the federal funds target rate that have been made by the Federal Reserve since 2022 in response to inflationary pressures. The following table provides the federal funds target rate history and changes since December 31, 2021:
Change Date Rate (%) Rate Change (%)
Average Balances, Yields and Rates Paid
The following table provides relevant net interest income information for the periods indicated:
Year Ended December 31,
(Dollars in thousands)
Interest Earning Assets:
Interest Bearing Liabilities:
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Year Ended December 31,
(Dollars in thousands)
(1) Average balances are calculated using daily balances. Average yield/rate is annualized.
(2) Average loans receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of $3.6 million, $3.3 million and $7.4 million for the years ended December 31, 2024, 2023 and 2022, respectively.
(3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis.
The following tables provide the changes in net interest income for the periods indicated due to changes in average asset and liability balances (volume), changes in average yields/rates (rate) and changes attributable to the combined effect of volume and rates allocated proportionately to the absolute value of changes due to volume and changes due to rates:
Increase (Decrease) Due to changes in
Volume Yield/Rate Total
(Dollars in thousands)
Interest Earning Assets:
Interest Bearing Liabilities:
Interest bearing demand and money market accounts (1,193) 14,325 13,132
Junior subordinated debentures 28 37 65
Securities sold under agreement to repurchase (77) (76) (153)
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Increase (Decrease) Due to changes in
Volume Yield/Rate Total
(Dollars in thousands)
Interest Earning Assets:
Interest Bearing Liabilities:
Interest bearing demand and money market accounts (470) 19,581 19,111
Junior subordinated debentures 16 902 918
Securities sold under agreement to repurchase (46) 61 15
Total interest income increased $25.2 million, or 8.9%, to $309.7 million for the year ended December 31, 2024 compared to $284.5 million for the year ended December 31, 2023. The increase was primarily due to a 40 basis point increase in the yield on interest earning assets to 4.93% for the year ended December 31, 2024, compared to 4.53% for the year ended December 31, 2023 following increases in market interest rates and secondarily due to a change in the mix of earning assets to higher yielding loan balances.
Total interest expense increased $41.0 million, or 69.2%, to $100.3 million for the year ended December 31, 2024 compared to $59.3 million for the year ended December 31, 2023 due primarily to increased costs of interest bearing deposits resulting from competitive rate pressures as well as customers transferring balances from non-maturity deposits to higher rate certificates of deposits and an increase in borrowing balances and rates. The total cost of interest bearing liabilities increased 87 basis points to 2.27% for the year ended December 31, 2024, compared to 1.40% for the year ended December 31, 2023.
The net interest margin decreased 25 basis points to 3.33% for the year ended December 31, 2024 compared to 3.58% for the year ended December 31, 2023. The decrease in net interest margin was due primarily to increases in the average cost of interest bearing liabilities as a result of upward market pressure related to deposit rates and an increase in borrowing balances and rates. This was partially offset by increases in average yields on total interest earning assets as a result of increases in market interest rates.
Provision for Credit Losses Overview
The aggregate of the provision for (reversal of) credit losses on loans and on unfunded commitments is presented in the Consolidated Statements of Income as the "Provision for (reversal of) credit losses." The ACL on unfunded commitments is included in the Consolidated Statements of Financial Condition within "Accrued expenses and other liabilities."
The following table presents the provision for (reversal of) credit losses for the periods indicated:
Year Ended December 31, Change
(Dollars in thousands)
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The provision for credit losses on loans recognized during the year ended December 31, 2024 was due primarily to growth in balances of collectively evaluated loans. The ACL on loans to loans receivable decreased to 1.09% at December 31, 2024, compared to 1.11% at December 31, 2023 due to changes in the loan mix as loan growth occurred in segments requiring a lower calculated reserve as a percentage of loans. The reversal of provision for credit losses on unfunded commitments recognized during the year ended December 31, 2024 was due primarily to an increase in utilization rates on lines of credit and a decrease in the unfunded exposure on construction loans.
Noninterest Income Overview
The following table presents the change in the key components of noninterest income for the periods indicated:
Year Ended December 31, Change
(Dollars in thousands)
Noninterest income decreased $11.2 million, or 60.0%, during the year ended December 31, 2024 compared to the same period in 2023. This decline was primarily driven by a pre-tax loss of $22.7 million incurred on the sale of investment securities available for sale during the year ended December 31, 2024, compared to a pre-tax loss of $12.2 million incurred during the same period in 2023. The loss on the sale of investment securities in 2024 was a consequence of strategically repositioning the Company's investment portfolio, involving the sale of $296.4 million in investment securities, with the aim of enhancing future earnings. Card revenue declined due to lower deposit transaction volumes. The decrease in other income during the year ended December 31, 2024 was primarily due to a one-time sale of Visa Inc. Class B common stock of $1.6 million and a $610,000 gain on sale of the Ellensburg branch recognized during the year ended December 31, 2023. Gain on sale of loans, net declined as the Company is no longer originating mortgage loans for sale.
These decreases were partially offset by an increase in the gain on sale of other assets, net due to a $1.5 million gain on the sale of an administrative building recognized during the year ended December 31, 2024 and an increase in service charges due primarily to an increase in service charge income on commercial deposit accounts.
Noninterest Expense Overview
The following table presents changes in the key components of noninterest expense for the periods indicated:
Year Ended December 31, Change
(Dollars in thousands)
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Noninterest expense decreased $8.3 million, or 5.0%, during the year ended December 31, 2024 compared to the same period in 2023. Compensation and employee benefits decreased $1.6 million due primarily to a decrease in the average number of full-time equivalent employees to 751 as of December 31, 2024, compared to 803 as of December 31, 2023, in connection with expense management initiatives. These expense management initiatives also impacted data processing expense, which decreased primarily due to a decline in ongoing costs resulting from prior technology-related contract renewals and terminations and decreased marketing and other expense. Professional services expense decreased during the year ended December 31, 2024 due primarily to a $1.5 million expense related to renewal of the core vendor contract recognized during the prior year. Amortization of intangible assets decreased due to the full amortization of the core deposit intangible related to a prior acquisition. This was offset partially by an increase in state/municipal business and use tax expense due primarily to an increase in gross revenue.
Income Tax Expense Overview
The following table presents the income tax expense and related metrics and the change for the periods indicated:
Year Ended December 31, 2024 Compared to 2023Change
(Dollars in thousands)
Income tax expense decreased during the year ended December 31, 2024 primarily due to lower pre-tax income. This decrease was partially offset by additional tax expense of $2.4 million related to the surrender of certain BOLI policies as part of a BOLI restructuring which occurred in the fourth quarter of 2024. The effective income tax rate increased due primarily to the additional tax expense related to the surrender of BOLI policies.
Financial Condition Overview
The table below provides a comparison of changes in key components of the Company's financial condition for the periods indicated:
December 31, Change
(Dollars in thousands)
Assets
Liabilities and Stockholders' Equity
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December 31, Change
Total assets decreased due primarily to decreases in investment securities and cash and cash equivalents offset partially by an increase in loans receivable. Total liabilities decreased due primarily to a decrease in borrowings and accrued expenses and other liabilities offset partially by an increase in deposits. Total stockholders' equity increased due primarily to net income as well as an increase in AOCI as a result of a decrease in other comprehensive income (loss), net of tax, which was positively impacted by the fair value of our investment securities available for sale as well as the sale of securities at a loss. The changes are discussed in more detail in the sections below.
Investment Activities Overview
Our investment policy is established by the Board and monitored by the Risk Committee of the Board. It is designed primarily to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complements the Company's lending activities. The policy permits investment in various types of liquid assets permissible under applicable regulations. Investment in sub-investment grade bonds is not permitted under the policy.
The following table provides information regarding our investment securities at the dates indicated:
Balance % ofTotal Balance % ofTotal $ %
(Dollars in thousands)
Investment securities available for sale, at fair value:
Investment securities held to maturity, at amortized cost:
(1) U.S. government agency and government-sponsored enterprise CMO and MBS obligations.
Total investment securities decreased $406.1 million to $1.47 billion at December 31, 2024 from $1.87 billion at December 31, 2023 due to sales of investment securities available for sale in connection with a strategic repositioning of the Company's investment portfolio, as well as maturities and repayments of $165.7 million, offset partially by purchases of investment securities available for sale.
During the year ended December 31, 2024, the Company incurred a pre-tax loss of $22.7 million on the sale of investment securities available for sale due to the aforementioned strategic repositioning of its investment portfolio. The Company sold $296.4 million in investment securities with an estimated weighted average book yield of 2.23% and purchased $33.1 million of investment securities with an estimated weighted average book yield of 6.05%. The remaining proceeds were used for other balance sheet initiatives such as the funding of higher yielding loan growth.
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The following table provides the weighted average yield of the Company's investment portfolio at December 31, 2024 calculated based upon the fair values of our investment securities available for sale and held to maturity, and excluding any income tax benefits of tax-exempt bonds:
(Dollars in thousands)
Investment securities available for sale:
Investment securities held to maturity:
(1) U.S. government agency and government-sponsored enterprise CMO and MBS obligations.
Loan Portfolio Overview
Changes by loan type
The Company originates a wide variety of loans with a focus on commercial business loans. In addition to originating loans, the Company may also acquire loans through pool purchases, participation purchases and syndicated loan purchases. The following table provides information about our loan portfolio by type of loan at the dates indicated:
Amortized Cost % of Loans Receivable Amortized Cost % of Loans Receivable $ %
(Dollars in thousands)
Commercial business:
Real estate construction and land development:
Loans receivable increased $466.5 million, or 10.8%, to $4.80 billion at December 31, 2024 from $4.34 billion at December 31, 2023. New loans funded in the year ended December 31, 2024 totaled $626.2 million and loan prepayments were $176.7 million.
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Non-owner occupied CRE loans increased $211.5 million, or 12.5%, due primarily to new loan production during the year ended December 31, 2024 and advances on outstanding commitments. Commercial and industrial loans increased $124.4 million, or 17.3%, due primarily to new loan production of $232.5 million during the year ended December 31, 2024, offset by pay downs on outstanding balances. Commercial and multifamily construction loans increased $59.7 million, or 17.8%, during the year ended December 31, 2024 due primarily to new loan commitments of $149.3 million and advances on new and outstanding commitments. Residential real estate loans increased $27.6 million, or 7.4%, due primarily to loan purchases during the year ended December 31, 2024.
Owner-occupied CRE and non-owner occupied CRE loans increased $256.2 million to $2.91 billion at December 31, 2024 compared to $2.66 billion at December 31, 2023. The following table provides information about owner occupied CRE and non-owner occupied CRE loans by collateral type at the dates indicated:
Amortized Cost % of CRE Loans Amortized Cost % of CRE Loans $ %
(Dollars in thousands)
Owner occupied and non-owner occupied CRE loans by collateral type:
Office loans represented the largest segment of owner-occupied and non-owner occupied CRE loans totaling $565.9 million, or 19.4% of the total owner-occupied CRE and non-owner occupied CRE at December 31, 2024. Of this total, $291.5 million, or 51.5%, were owner-occupied CRE loans which have a lower risk profile as there is less tenant rollover risk, 81.0% have recourse to the owners and 24.6% of loans are borrowers in the health care and social assistance sectors, who are less likely to reduce office space. The average individual loan balance of owner-occupied CRE and non-owner occupied CRE was $1.3 million at December 31, 2024. See also Item 1. Business - Commercial Business Lending of this Form 10-K for CRE underwriting standards.
Composition of loans receivable by contractual maturity and interest type
The following table presents the amortized cost of the loan portfolio by segment and contractual maturity at December 31, 2024:
(Dollars in thousands)
Commercial business:
Real estate construction and land development:
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The following table presents the amortized cost of the loan portfolio by segment and interest rate type that are due after one year, at December 31, 2024:
(Dollars in thousands)
Commercial business:
Real estate construction and land development:
(1) Includes $285.7 million of commercial business loans with floating or adjustable interest rates in which the Company entered into non-hedge interest rate swap contracts with the borrower and a third-party. Under these derivative contract arrangements, the Company effectively earns a variable rate of interest based on the one-month SOFR plus a margin, except for interest rate swap contracts on construction loans that earn fixed rates until the end of the construction period and the variable rate swap becomes effective.
Loans classified as nonaccrual, performing modified loans and nonperforming assets
The following tables provide information about our nonaccrual loans, performing modified loans and nonperforming assets at the dates indicated:
Change
(Dollars in thousands)
Nonaccrual loans:(1)
Other real estate owned — — — —
Credit quality ratios:
Nonaccrual loans to loans receivable 0.08 % 0.10 % (0.02) % (20.0) %
Nonperforming loans to loans receivable 0.11 0.13 (0.02) (15.4)
(1) At December 31, 2024 and December 31, 2023, $1.0 million, and $3.2 million, respectively, of nonaccrual loans were guaranteed by government agencies.
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Year Ended December 31, Change
(Dollars in thousands)
Modified loans:
The following table provides the changes in nonaccrual loans during the periods indicated:
Year Ended December 31, Change
(Dollars in thousands)
Nonaccrual loans decreased $0.4 million, or 8.7%, due primarily to ongoing collection efforts. Additions during the year ended December 31, 2024 were due primarily to one $5.0 million owner occupied CRE loan of which $2.5 million was charged off. Payoffs during the year ended December 31, 2024 were due primarily to the payoff of one commercial and industrial loan relationship.
Allowance for Credit Losses on Loans Overview
The following table provides information regarding changes in our ACL on loans for the years indicated:
At or For the Years Ended December 31,
(Dollars in thousands)
Charge-offs:
Residential real estate — — (30)
Recoveries:
Residential real estate — — 3
Real estate construction and land development — — 384
Provision for (reversal of) credit losses on loans 6,983 4,736 (563)
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At or For the Years Ended December 31,
(Dollars in thousands)
Credit quality ratios:
ACL on loans to:
Nonaccrual loans to loans receivable 0.08 % 0.10 % 0.15 %
Balances at the end of the period:
Average balances outstanding during the period:(1)
Residential real estate — — 0.01
Real estate construction and land development — — (0.16)
(1) Average balances exclude the ACL on loans and loans held for sale, but include loans classified as nonaccrual.
The provision for credit losses on loans of $7.0 million recognized during the year ended December 31, 2024 was due primarily to growth in balances of collectively evaluated loans and secondarily to $2.5 million in charge-offs. The ACL on loans to loans receivable decreased to 1.09% as December 31, 2024, compared to 1.11% at December 31, 2023 due to changes in the loan mix as loan growth occurred in segments requiring a lower calculated reserve as a percentage of loans as well as a reduction in the baseline loss rates applied and weighted average life of the residential real estate and real estate construction and land development segments which contributed to a decrease in the ACL as a % of loans in these loan segments.
The following table presents the ACL on loans by loan portfolio segment at the indicated dates:
(Dollars in thousands)
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Deposits Overview
The following table summarizes the Company's deposits at the dates indicated:
Balance % of Total Balance % of Total $ %
(Dollars in thousands)
Total deposits increased $84.7 million, or 1.5%, to $5.68 billion at December 31, 2024, compared to $5.60 billion at December 31, 2023. Certificates of deposit increased $284.3 million, or 41.0%, to $977.3 million from $693.0 million and money market accounts increased $72.6 million, or 6.6%, to $1.17 billion from $1.09 billion primarily due to transfers from lower yielding non-maturity deposit accounts as customers moved balances to higher yielding accounts.
Total deposits include uninsured deposits of approximately $2.27 billion and $2.10 billion at December 31, 2024 and 2023, respectively, calculated in accordance with FDIC guidelines. Uninsured deposits included $267.8 million and $256.4 of fully collateralized deposits as of December 31, 2024 and December 31, 2023. The Bank does not hold any foreign deposits.
The following table provides the estimated uninsured portion of certificates of deposit that are in excess of the FDIC insurance limit, by remaining time until maturity at December 31, 2024, by account, with a maturity of:
(Dollars in thousands)
Over three months through six months 172,544
Over six months through twelve months 54,050
Over twelve months 4,880
Stockholders' Equity Overview
The Company’s stockholders' equity to assets ratio was 12.2% and 11.9% at December 31, 2024 and 2023, respectively. The following table provides the changes to stockholders' equity during the periods indicated:
Year Ended December 31, Change
(Dollars in thousands)
Stockholders' equity increased for the year ended December 31, 2024 primarily as a result of net income and an increase in AOCI as a result of a decrease in other comprehensive income (loss), net of tax, which was positively impacted by the fair value of our investment securities available for sale and losses recognized on investment sales. AOCI has no effect on our regulatory capital ratios as the Company opted to exclude it from its common equity tier 1 capital. Cash dividends and stock repurchases partially offset the increase in stockholders' equity during the year ended December 31, 2024.
On April 24, 2024, the Board authorized the repurchase of up to 5% of the Company's outstanding common shares, or 1,734,492 shares in total, under a new stock repurchase program. The stock repurchase program does not obligate the Company to repurchase any shares of its common stock, and other than repurchases that have been completed to date, there is no assurance that the Company will make any repurchases in the future. Under the stock repurchase program, the Company may
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repurchase shares of common stock from time to time in open market or privately negotiated transactions. The number, timing and price of shares repurchased will depend on business and market conditions, regulatory requirements, availability of funds and other factors, including opportunities to deploy the Company's capital. The Company may, in its discretion, begin, suspend or terminate repurchases at any time prior to the stock repurchase program’s expiration, without any prior notice. The stock repurchase program authorized in April 2024 superseded the previous stock repurchase program authorized in March 2020, which allowed for the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares. At the time the April 2024 stock repurchase program was authorized, 3,910 shares remained available for purchase under the March 2020 stock repurchase program.
The Company repurchased 1,051,760 and 330,424 shares of its common stock under the Company's stock repurchase plan during the years ended December 31, 2024 and December 31, 2023, respectively. The Company also repurchased 31,850 and 32,792 shares during the years ended December 31, 2024 and December 31, 2023, respectively, which represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units. As of December 31, 2024, 990,522 shares remained available for future repurchases under the April 2024 stock repurchase program.
Liquidity and Capital Resources
Liquidity
Liquidity refers to the Company’s ability to provide funds at an acceptable cost to meet loan demand and deposit withdrawals, as well as contingency plans to meet unanticipated funding needs or loss of funding sources. These objectives can be met from either our assets or liabilities.
Asset liquidity sources consist of the repayments and maturities of loans, sales of loans, maturities of investment securities and sales of investment securities available for sale. These activities are generally included as investing activities in the Consolidated Statements of Cash Flows. Net cash used by investing activities was $85.9 million during the year ended December 31, 2024. Net increases in loan balances from both loan originations and purchases used $464.6 million of cash, while investment securities sales and maturities, net of purchases provided $406.2 million in cash.
Liquidity may also be affected by liabilities as a result of changes in deposits and borrowings. These activities are included in financing activities in the Consolidated Statements of Cash Flows. During the year ended December 31, 2024, financing activities used $86.5 million of funds resulting primarily from a decrease in short-term borrowings of $117.0 million, $31.8 million in dividend payments and $22.4 million in repurchases of common stock, offset partially by an increase in deposits of $84.7 million.
At December 31, 2024, we had outstanding loan commitments of $1.18 billion, primarily relating to undisbursed loans in process and unused credit lines as discussed in Note (18) Commitments and Contingencies of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Form 10-K. Loan commitments represent potential growth in the loan portfolio and lending activities. The current level of commitments is proportionally consistent with our historical experience and does not represent a departure from traditional operations. As of December 31, 2024, we had $17.8 million of purchase obligations under contracts with our key vendors to provide services, mainly information technology related contracts. In addition, as of December 31, 2024, we had $27.6 million of commitments under operating lease agreements.
We maintain sufficient cash and cash equivalents and investment securities to meet short-term liquidity needs and also actively monitor our long-term liquidity position to ensure the availability of capital resources for contractual obligations, strategic loan growth objectives and to fund operations. Our funding strategy has been to acquire non-maturity deposits from our retail accounts, acquire noninterest bearing demand deposits from our commercial customers and use our borrowing availability to fund growth in assets. We may also acquire brokered deposits when the cost of funds is advantageous compared to other funding sources. Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of assets. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition so we adhere to internal management targets assigned to the loan to deposit ratio, liquidity ratio, net short-term non-core funding ratio and non-core liabilities to total assets ratio to ensure an appropriate liquidity position.
We maintain credit facilities with the FHLB, which provide for advances that in the aggregate would equal the lesser of 45% of the Bank’s assets or adjusted qualifying collateral (subject to a sufficient level of ownership of FHLB stock). At December 31, 2024, under these credit facilities based on pledged loan collateral, the Bank had $976.3 million of available credit capacity. The Bank had $383.0 million in outstanding borrowings from the FHLB at December 31, 2024, and none at December 31, 2023. In addition, the Bank has access to the FRB Discount Window and had access to the BTFP at December 31, 2023 and 2024, until the FRB ceased making new loans under the BTFP on March 11, 2024. Based on pledged investment collateral, the Bank had available lines of credit from the FRB of approximately $360.1 million as of December 31, 2024. The Bank had no outstanding borrowings from the FRB at December 31, 2024 and $500.0 million in outstanding borrowings under the BTFP at December 31, 2023. At December 31, 2024, the Bank also had uncommitted federal funds line of credit agreements with other financial institutions totaling $145.0 million. No balances were outstanding under these agreements as of either December 31, 2024 or 2023. Availability of lines of credit is subject to federal funds balances available for loan and continued borrower eligibility. These lines of credit are intended to support short-term liquidity needs and the agreements may restrict consecutive day usage. Management believes it has adequate resources and funding potential to meet our foreseeable liquidity requirements.
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The following table summarizes the Company's available liquidity as of the dates indicated:
(Dollars in thousands)
On-balance sheet liquidity
Unencumbered investment securities available for sale (1) 746,163 756,258
Off-balance sheet liquidity
Fed funds line borrowing availability with correspondent banks 145,000 145,000
(1) Investment securities available for sale at fair value.
(2) Includes FHLB borrowing availability of $1.36 billion at December 31, 2024 based on pledged assets, however, maximum credit capacity is 45% of the Bank's total assets one quarter in arrears or $3.22 billion.
Capital Resources
The Company pays dividends to its shareholders. The primary source of the Company's liquidity is dividends from the Bank to the Company. The Bank is subject to strict regulatory capital ratios, and may not be able to issue dividends to the Company in an amount sufficient to maintain our current or anticipated dividend practices. We expect to continue our current practice of paying quarterly cash dividends on our common stock subject to our Board's discretion to modify or terminate this practice at any time and for any reason without prior notice. No assurances can be given that any dividends will be paid on our common stock in future periods or that, if paid, such dividends will not be reduced in amount. Our current quarterly common stock dividend rate is $0.24 per share, as approved by our Board on January 22, 2025. We believe this dividend rate per share enables us to balance our multiple objectives of managing and investing in the Bank and returning a substantial portion of our cash to our shareholders. Assuming continued payment during 2025 at this rate, our average total dividend paid each quarter would be approximately $8.2 million based on the current number of our outstanding shares (assuming no increases or decreases in the number of shares).
From time to time, our Board has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such stock repurchase plans may also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. The Company's current stock repurchase program authorizes us to repurchase up to 5% of the Company's outstanding common shares, or 1,734,492 in total, of which 990,522 shares remained available for future repurchases as of December 31, 2024. The actual timing, number and value of shares repurchased under the stock repurchase program will depend on a number of factors, including constraints specified pursuant to any trading plan that may be adopted under Rule 10b5-1 of the SEC, price, general business and market conditions, and alternative investment opportunities. See Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities of this Form 10-K for additional information relating to stock repurchases.
Management believes that the Company's capital sources are adequate to meet all of the Company's reasonably foreseeable short-term and intermediate-term requirements.
Critical Accounting Estimates
Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the Company's financial condition or results of operations. The Company considers its critical accounting estimates to be as follows:
ACL on Loans
Management's estimate of the ACL on loans relies on the identification, stratification and separate estimates of loss for both loans individually evaluated for loss and loans collectively evaluated for loss. The estimate of loss for loans collectively evaluated for loss in particular involves a significant level of estimation uncertainty due to its complexity and the quantity of relevant inputs, including: management's determination of baseline loss rate multipliers based on a third party forecast of economic conditions, estimates of the reasonable and supportable forecast period, estimates of the baseline loss rate lookback period, estimates of the reversion period from the reasonable and supportable forecast period to the baseline loss rate and estimates of the prepayment rate and related lookback period. Additionally, management considers other qualitative risk factors to further adjust the estimated ACL on loans through a qualitative allowance.
Management's estimates for these inputs are based on past events and current conditions, are inherently subjective and are susceptible to significant revision as new or different information becomes available. While management utilizes its best judgment and information available at the time of evaluation to recognize credit losses on loans, future additions to the allowance
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may be necessary based on declines in local and national economic conditions or other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s ACL on loans. Such agencies may require the Company make adjustments to the allowance based on their interpretation of information available to them at the time of their examinations. Unanticipated changes in any of these inputs could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on loans, its relation to the provision for credit losses and its risk related to asset quality and lending activity, see Item 1A. Risk Factors—The Company’s allowance for credit losses may prove to be insufficient to absorb potential losses in its loan portfolio, as well as Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (4) Allowance for Credit Losses on Loans of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data of this Form 10-K.
Goodwill
Goodwill is tested for impairment at the reporting unit level on an annual basis as of December 31 each year, and more frequently if events or circumstances indicate that there may be impairment. Goodwill impairment is determined by comparing the fair value of a reporting unit to its carrying amount. If the fair value of the reporting unit is less than its carrying value, the difference is the amount of impairment and goodwill is written down to the fair value of the reporting unit. The Company has a single reporting unit.
In testing goodwill, the Company may assess qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. In this qualitative assessment, the Company evaluates events and circumstances which may include, but are not limited to: the general economic environment; banking industry and market conditions; a significant adverse change in legal factors; significant decline in our stock price and market capitalization; unanticipated competition; the testing for recoverability of a significant asset group within the reporting unit; and an adverse action or assessment by a regulator.
If the quantitative impairment test is required or the decision to bypass the qualitative assessment is elected, the Company performs the goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, including goodwill. The determination of the fair value of a reporting unit is a subjective process that involves the use of estimates and judgments about economic and industry factors and the growth and earnings prospects of the Bank. Variability in the market and changes in assumptions or subjective measurements used to estimate fair value are reasonably possible and may have a material impact on our consolidated financial statements or results of operations.
The Company performed its annual goodwill impairment test during the fourth quarter of 2024 which consisted of a qualitative assessment and determined that it is more likely than not that the fair value of the reporting unit exceeded the carrying value, such that the Company's goodwill was not considered impaired for the year ended December 31, 2024. Changes in the economic environment, operations of the reporting unit or other adverse events, could result in future impairment charges which could have a material adverse impact on the Company’s operating results.
For additional information regarding goodwill, see Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (6) Goodwill and Other Intangible Assets of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Like other financial institutions, the Company is subject to direct and indirect market risk. Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur direct market risk in the normal course of business through our exposure to market interest rates, equity prices and credit spreads. Our primary market risk is interest rate risk, which is the risk of loss of net interest income or net interest margin resulting from changes in market interest rates. Interest rate risk results primarily from the traditional banking activities in which the Company engages, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences, affect the difference between the interest earned on our assets and the interest paid on our liabilities.
Our Asset/Liability Management Committee is responsible for developing, monitoring and reviewing asset/liability processes, interest rate risk exposures, strategies and tactics and reporting to the Risk and Technology Committee of the Board. It is the responsibility of the Board to establish policies and interest rate limits and to approve these policies and interest rate limits annually. It is the responsibility of management to execute the approved policies, develop and implement risk management strategies and to report to the Board on a regular basis. We maintain an asset/liability management policy that provides guidelines for controlling exposure to interest rate risk. The policy guidelines direct management to assess the impact of changes in interest rates upon both earnings and capital. These guidelines establish limits for interest rate risk sensitivity.
Net interest income simulation
We use an income simulation model as the primary tool to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Modeling the sensitivity of net interest income is highly dependent on numerous assumptions incorporated into the modeling process. Key assumptions in the model include prepayment speeds on loans and investment securities, repricing betas on non-maturity deposits, and repricing on investment securities, loans, and borrowings. In order to measure the interest rate risk sensitivity as of December 31, 2024, this simulation model uses a “static balance sheet” assumption, meaning the size and mix of the balance sheet remains the same as maturing cash flows from assets and liabilities
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are reinvested into the same categories at the current level of interest rates. The simulation also assumes an instantaneous and sustained uniform change in market interest rates at all maturities.
The following table summarizes the estimated effect on net interest income over a 12 month period measured against a flat rate (no interest rate change) scenario for the periods indicated:
Change in Interest Rates (Basis Points) (Dollars in thousands)
+0(flat) — — — —
The Company’s balance sheet sensitivity to changes in market rates remains somewhat neutral, meaning results are similar in the rates up and down scenarios over a twelve month time horizon. Current results are similar to prior year results when the Company's modeled balance sheet results first shifted from an asset sensitive position to more of a neutral position. The simulation results are within the Board-established policy limits for all listed scenarios. Additionally, for all of the various interest rate scenarios modeled and measured by management as presented in the preceding table, the results at December 31, 2024 were well within established risk tolerances as established by policy.
The simulation results noted above do not incorporate any management actions that might moderate the negative consequences of interest rate deviations. In addition, the simulation results noted above contain various assumptions such as a static balance sheet, and the rate that deposit interest rates change as market interest rates change. Therefore, these simulation results do not likely reflect actual results, but continue to serve as estimates of interest rate risk.
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the preceding table. For example, although certain of the Company’s assets and liabilities may have similar maturities or repricing time frames, they may react in different degrees to changes in market interest rates. In addition, the interest rates on certain of the Company’s asset and liability categories may precede, or lag behind, changes in market interest rates. Also, the actual rates of prepayments on loans and investments could vary significantly from the assumptions utilized in deriving the results as presented in the preceding table. Further, a change in Treasury rates accompanied by a change in the shape of the treasury yield curve could result in different estimations from those presented herein. Accordingly, the results in the preceding table should not be relied upon as indicative of actual results in the event of changing market interest rates.
Liquidity risk
Economic conditions have made liquidity risk, primarily funding liquidity risk, a more prevalent concern among financial institutions in recent years. In general, liquidity risk is the risk of being unable to fund obligations to creditors, including, in the case of financial institutions, obligations to depositors, as such obligations become due and/or fund the acquisition of assets. Liquidity refers to our ability to fund operations, meet depositor withdrawals, provide for our customers’ credit needs and meet maturing obligations and existing commitments as they come due. Our liquidity principally depends on cash flows from the Bank’s operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings and our ability to borrow funds. To manage liquidity risk, the Bank has several sources of liquidity in place to maximize funding availability and increase the diversification of funding sources, including credit facilities with the FHLB, access to the FRB Discount Window and uncommitted federal funds line of credit agreements with other financial institutions. These sources of liquidity are described in more detail in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note (10) Other Borrowings of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data of this Form 10-K. The criteria for evaluating the use of these sources include volume concentration (percentage of liabilities), cost, volatility and the fit with the current asset/liability management plan.
Other market risks
In addition to the foregoing, the Company is also subject to operational risks, such as the risk of loss due to human behavior, inadequate or failed internal systems and controls or external influences such as market conditions, fraudulent activities, disasters and other security risks. The Company’s management engages in ongoing monitoring of and efforts to strengthen its system of internal controls, enterprise risk management, operating processes and employee awareness to improve oversight of the Company’s operational risk. The Company is also subject to compliance risks, including the risk of regulatory sanctions, reputational impact or financial loss resulting from failure to comply with rules and regulations issued by the various banking agencies and standards of good banking practice, and to strategic/operation risks, including the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, failure to assess current and new opportunities in business and other events not identified in the risk types mentioned previously. Mitigation of the various risk elements that represent
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compliance, strategic and/or reputation risk is achieved through initiatives to help management better understand and report on various indicators and causes of these risks, including those related to the development of new products and business initiatives.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors of Heritage Financial Corporation
Olympia, Washington
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying Consolidated Statements of Financial Condition of Heritage Financial Corporation and Subsidiaries (the "Company") as of December 31, 2024 and 2023, the related Consolidated Statements of Income, Comprehensive Income (Loss), Stockholders’ Equity, and Cash Flows, for each of the years in the three-year period ended December 31, 2024, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2024, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2024 and 2023, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2024 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31,2024, based on criteria established in the 2013 Internal Control – Integrated Framework issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.