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Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-29480 
 
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter) 
 
 
 
Washington
 
91-1857900
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
201 Fifth Avenue SW, Olympia, WA
 
98501
(Address of principal executive offices)
 
(Zip Code)
(360) 943-1500
(Registrant’s telephone number, including area code) 

 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨
  
Accelerated filer
x
Non-accelerated filer
¨
  
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
As of October 26, 2016 there were 29,946,823 shares of the registrant's common stock, no par value per share, outstanding.



Table of Contents


HERITAGE FINANCIAL CORPORATION
FORM 10-Q
INDEX
September 30, 2016
 
 
Page
 
 
 
 
Part I.
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Part II.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
CERTIFICATIONS
 




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FORWARD LOOKING STATEMENTS:

“Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995: This Quarterly Report on Form 10-Q ("Form 10-Q") contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to: our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired, including those from the Cowlitz Bank, Pierce Commercial Bank, Northwest Commercial Bank, Valley Community Bancshares, Inc. and the Washington Banking Company transactions described in this Form 10-Q, or may in the future acquire, into our operations and our ability to realize related revenue synergies and cost savings within expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected; the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be effected by deterioration in the housing and commercial real estate markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan losses no longer being adequate to cover actual losses, and require us to increase our allowance for loan losses; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Board of Governors of the Federal Reserve System and of our bank subsidiary by the Federal Deposit Insurance Corporation ("FDIC"), the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, initiate an enforcement action against the Company or our bank subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings; legislative or regulatory changes; our ability to control operating costs and expenses; further increases in premiums for deposit insurance; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our Condensed Consolidated Statements of Financial Condition; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our expansion strategy of pursuing acquisitions and de novo branching; increased competitive pressures among financial service companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed from time to time in our filings with the Securities and Exchange Commission including our Annual Report on Form 10-K for the year ended December 31, 2015.
The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating results and stock price performance.
As used throughout this report, the terms “we”, “our”, “us”, or the “Company” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.


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PART I.     FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
 
 
September 30, 2016
 
December 31, 2015
 
 
(Dollars in thousands)
ASSETS
 
 
 
 
Cash on hand and in banks
 
$
86,142


$
63,816

Interest earning deposits
 
26,618


62,824

Cash and cash equivalents
 
112,760


126,640

Other interest earning deposits
 
5,461


6,719

Investment securities available for sale, at fair value
 
819,159


811,869

Loans held for sale
 
8,964

 
7,682

Loans receivable, net
 
2,578,977

 
2,402,042

Allowance for loan losses
 
(30,211
)
 
(29,746
)
Total loans receivable, net
 
2,548,766

 
2,372,296

Other real estate owned
 


2,019

Premises and equipment, net
 
63,312


61,891

Federal Home Loan Bank stock, at cost
 
5,088


4,148

Bank owned life insurance
 
69,962

 
60,876

Accrued interest receivable
 
11,327


10,469

Prepaid expenses and other assets
 
74,816


58,365

Other intangible assets, net
 
7,732


8,789

Goodwill
 
119,029


119,029

Total assets
 
$
3,846,376


$
3,650,792

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Deposits
 
$
3,242,421

 
$
3,108,287

Federal Home Loan Bank advances
 
17,700

 

Junior subordinated debentures
 
19,644

 
19,424

Securities sold under agreement to repurchase
 
22,425

 
23,214

Accrued expenses and other liabilities
 
48,174

 
29,897

Total liabilities
 
3,350,364

 
3,180,822

Stockholders’ equity:
 
 
 
 
Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at September 30, 2016 and December 31, 2015
 

 

Common stock, no par value, 50,000,000 shares authorized; 29,946,823 and 29,975,439 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
 
358,451

 
359,451

Retained earnings
 
126,497

 
107,960

Accumulated other comprehensive income, net
 
11,064

 
2,559

Total stockholders’ equity
 
496,012

 
469,970

Total liabilities and stockholders’ equity
 
$
3,846,376

 
$
3,650,792

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(Dollars in thousands, except per share amounts)
INTEREST INCOME
 
 
 
 
 
 
 
 
Interest and fees on loans
 
$
30,915

 
$
30,179

 
$
91,595

 
$
91,213

Taxable interest on investment securities
 
2,888

 
2,187

 
8,522

 
7,199

Nontaxable interest on investment securities
 
1,235

 
1,056

 
3,599

 
3,137

Interest and dividends on other interest earning assets
 
76

 
62

 
225

 
173

Total interest income
 
35,114

 
33,484

 
103,941

 
101,722

INTEREST EXPENSE
 
 
 
 
 
 
 
 
Deposits
 
1,269

 
1,335

 
3,765

 
3,961

Junior subordinated debentures
 
221

 
195

 
647

 
627

Other borrowings
 
18

 
14

 
78

 
50

Total interest expense
 
1,508

 
1,544

 
4,490

 
4,638

Net interest income
 
33,606

 
31,940

 
99,451

 
97,084

Provision for loan losses
 
1,495

 
851

 
3,754

 
3,247

Net interest income after provision for loan losses
 
32,111

 
31,089

 
95,697

 
93,837

NONINTEREST INCOME
 
 
 
 
 
 
 
 
Service charges and other fees
 
3,630

 
3,593

 
10,462

 
10,575

Gain on sale of investment securities, net
 
345

 
393

 
1,106

 
1,362

Gain on sale of loans, net
 
3,435

 
1,411

 
5,406

 
3,828

Gain on termination of FDIC shared-loss agreements
 

 
1,747

 

 
1,747

Gain on sale of Merchant Visa portfolio
 

 

 

 
1,650

Other income
 
2,457

 
2,400

 
6,459

 
5,607

Total noninterest income
 
9,867

 
9,544

 
23,433

 
24,769

NONINTEREST EXPENSE
 
 
 
 
 
 
 
 
Compensation and employee benefits
 
15,633

 
14,918

 
45,652

 
42,984

Occupancy and equipment
 
3,926

 
3,970

 
11,873

 
11,511

Data processing
 
1,943

 
2,398

 
5,564

 
5,950

Marketing
 
745

 
899

 
2,254

 
2,595

Professional services
 
830

 
894

 
2,508

 
2,602

State and local taxes
 
820

 
619

 
2,031

 
1,808

Federal deposit insurance premium
 
296

 
499

 
1,316

 
1,537

Other real estate owned, net
 
(142
)
 
(5
)
 
330

 
854

Amortization of intangible assets
 
359

 
523

 
1,057

 
1,577

Other expense
 
2,408

 
2,607

 
7,079

 
8,021

Total noninterest expense
 
26,818

 
27,322

 
79,664

 
79,439

Income before income taxes
 
15,160

 
13,311

 
39,466

 
39,167

Income tax expense
 
4,121

 
3,819

 
10,441

 
11,171

Net income
 
$
11,039

 
$
9,492

 
$
29,025

 
$
27,996

Basic earnings per common share
 
$
0.37

 
$
0.32

 
$
0.97

 
$
0.93

Diluted earnings per common share
 
$
0.37

 
$
0.32

 
$
0.97

 
$
0.93

Dividends declared per common share
 
$
0.12

 
$
0.11

 
$
0.35

 
$
0.32

See accompanying Notes to Condensed Consolidated Financial Statements.

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

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(In thousands)
Net income
 
$
11,039

 
$
9,492

 
$
29,025

 
$
27,996

Change in fair value of investment securities available for sale, net of tax of $(570), $1,657, $4,983 and $1,300, respectively
 
(1,055
)
 
3,064

 
9,223

 
2,407

Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(121), $(138), $(388) and $(520), respectively
 
(224
)
 
(255
)
 
(718
)
 
(967
)
Accretion of other-than-temporary impairment on investment securities, net of tax of $0, $0, $0 and $4, respectively
 

 

 

 
108

Reclassification of remaining unaccreted other-than-temporary impairment upon sale of investment securities held to maturity included in income, net of tax $0, $0, $0 and $44, respectively
 

 

 

 
81

Other comprehensive (loss) income
 
(1,279
)
 
2,809

 
8,505

 
1,629

Comprehensive income
 
$
9,760

 
$
12,301

 
$
37,530

 
$
29,625

See accompanying Notes to Condensed Consolidated Financial Statements.


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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
 
Number of
common
shares
 
Common
stock
 
Retained
earnings
 
Accumulated
other
comprehensive income, net
 
Total
stock-
holders’
equity
 
(In thousands, except per share amounts)
Balance at December 31, 2014
30,260

 
$
364,741

 
$
86,387

 
$
3,378

 
$
454,506

Restricted and unrestricted stock awards issued, net of forfeitures
118

 

 

 

 

Exercise of stock options (including excess tax benefits from nonqualified stock options)
53

 
686

 

 

 
686

Restricted stock compensation expense

 
1,125

 

 

 
1,125

Net excess tax benefits from vesting of restricted stock

 
105

 

 

 
105

Common stock repurchased
(464
)
 
(7,730
)
 

 

 
(7,730
)
Net income

 

 
27,996

 

 
27,996

Other comprehensive income, net of tax

 

 

 
1,629

 
1,629

Cash dividends declared on common stock ($0.32 per share)

 

 
(9,621
)
 

 
(9,621
)
Balance at September 30, 2015
29,967

 
$
358,927

 
$
104,762

 
$
5,007

 
$
468,696

 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
29,975

 
$
359,451

 
$
107,960

 
$
2,559

 
$
469,970

Restricted and unrestricted stock awards issued, net of forfeitures
111

 

 

 

 

Exercise of stock options (including excess tax benefits from nonqualified stock options)
28

 
421

 

 

 
421

Restricted stock compensation expense

 
1,367

 

 

 
1,367

Net excess tax benefits from vesting of restricted stock

 
99

 

 

 
99

Common stock repurchased
(167
)
 
(2,887
)
 

 

 
(2,887
)
Net income

 

 
29,025

 

 
29,025

Other comprehensive income, net of tax

 

 

 
8,505

 
8,505

Cash dividends declared on common stock ($0.35 per share)

 

 
(10,488
)
 

 
(10,488
)
Balance at September 30, 2016
29,947

 
$
358,451

 
$
126,497

 
$
11,064

 
$
496,012

See accompanying Notes to Condensed Consolidated Financial Statements.


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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
 
(In thousands)
Cash flows from operating activities:
 
 
 
 
Net income
 
$
29,025

 
$
27,996

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
9,543

 
10,486

Changes in net deferred loan costs, net of amortization
 
(971
)
 
(1,257
)
Provision for loan losses
 
3,754

 
3,247

Net change in accrued interest receivable, FDIC indemnification asset, prepaid expenses and other assets, accrued expenses and other liabilities
 
(193
)
 
(4,085
)
Restricted stock compensation expense
 
1,367

 
1,125

Net excess tax benefit from exercise of stock options and vesting of restricted stock
 
(119
)
 
(125
)
Amortization of intangible assets
 
1,057

 
1,577

Gain on sale of investment securities, net
 
(1,106
)
 
(1,362
)
Origination of loans held for sale
 
(99,513
)
 
(102,310
)
Gain on sale of loans, net
 
(5,406
)
 
(3,828
)
Proceeds from sale of loans
 
103,637

 
103,739

Earnings on bank owned life insurance
 
(1,086
)
 
(769
)
Valuation adjustment on other real estate owned
 
383

 
415

(Gain) loss on sale of other real estate owned, net
 
(173
)
 
94

Gain on termination of FDIC shared-loss agreements
 

 
(1,747
)
Loss (gain) on sale or write-off of furniture, equipment and leasehold improvements
 
107

 
(1
)
Net cash provided by operating activities
 
40,306

 
33,195

Cash flows from investing activities:
 
 
 
 
Loans originated, net of principal payments
 
(179,930
)
 
(156,106
)
Maturities of other interest earning deposits
 
1,248

 
4,836

Maturities, calls and payments of investment securities available for sale
 
94,328

 
91,915

Maturities, calls and payments of investment securities held to maturity
 

 
1,897

Purchase of investment securities available for sale
 
(188,164
)
 
(158,048
)
Purchase of premises and equipment
 
(5,128
)
 
(1,409
)
Proceeds from sales of other real estate owned
 
2,486

 
3,199

Proceeds from sales of investment securities available for sale
 
94,380

 
102,937

Proceeds from sales of investment securities held to maturity
 

 
972

Proceeds from redemption of FHLB stock
 
15,416

 
8,040

Purchases of FHLB stock
 
(16,356
)
 

Proceeds from sale of premises and equipment
 
659

 
10

Purchase of bank owned life insurance
 
(8,000
)
 
(25,000
)
Investment in low-income housing tax credit partnership
 
(3,315
)
 
(442
)
Net cash used for termination of FDIC shared-loss agreements
 

 
(7,110
)
Net cash used in investing activities
 
(192,376
)
 
(134,309
)

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Nine Months Ended September 30,
 
 
2016
 
2015
 
 
(In thousands)
Cash flows from financing activities:
 
 
 
 
Net increase in deposits
 
134,134

 
147,867

FHLB advances
 
403,100

 

Repayments of FHLB advances
 
(385,400
)
 

Common stock cash dividends paid
 
(10,488
)
 
(9,621
)
Net decrease in securities sold under agreement to repurchase
 
(789
)
 
(9,352
)
Proceeds from exercise of stock options
 
401

 
666

Net excess tax benefit from exercise of stock options and vesting of restricted stock
 
119

 
125

Repurchase of common stock
 
(2,887
)
 
(7,730
)
Net cash provided by financing activities
 
138,190

 
121,955

Net (decrease) increase in cash and cash equivalents
 
(13,880
)
 
20,841

Cash and cash equivalents at beginning of period
 
126,640

 
121,636

Cash and cash equivalents at end of period
 
$
112,760

 
$
142,477

 
 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
 
Cash paid for interest
 
$
4,533

 
$
4,841

Cash paid for income taxes
 
9,000

 
12,286

 
 
 
 
 
Supplemental non-cash disclosures of cash flow information:
 
 
 
 
Transfers of loans receivable to other real estate owned
 
$
677

 
$
2,424

Investment in low income housing tax credit partnership and related funding commitment
 
19,663

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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

(1)
Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements
(a) Description of Business
Heritage Financial Corporation ("Heritage" or the “Company”) is a bank holding company that was incorporated in the State of Washington in August 1997. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank (the “Bank”). The Bank is a Washington-chartered commercial bank and its deposits are insured by the FDIC under the Deposit Insurance Fund. The Bank is headquartered in Olympia, Washington and conducts business from its 63 branch offices located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans and consumer loans and originates first mortgage loans on residential properties primarily located in its market area.
The Company has expanded its footprint through mergers and acquisitions. The largest of these transactions was the strategic merger with Washington Banking Company (“Washington Banking”) and its wholly owned subsidiary bank, Whidbey Island Bank ("Whidbey"). Effective May 1, 2014, Washington Banking merged with and into Heritage and Whidbey merged with and into Heritage Bank and this transaction is referred to herein as the "Washington Banking Merger". In connection with the Washington Banking Merger, Heritage also acquired as a subsidiary the Washington Banking Master Trust, a Delaware statutory business trust. Pursuant to the merger agreement, Heritage assumed the performance and observance of the covenants to be performed by Washington Banking under an indenture relating to $25.0 million in trust preferred securities issued in 2007 and the due and punctual payment of the principal of and premium and interest on such trust preferred securities. For additional information, see Note (8) Junior Subordinated Debentures.
(b) Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. It is recommended that these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 (“2015 Annual Form 10-K”). In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. In preparing the unaudited Condensed Consolidated Financial Statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the facts and circumstances at the time. Actual results, however, could differ from those estimates.
Certain prior period amounts have been reclassified to conform to the current period’s presentation. The Company reclassified $56.6 million of loans receivable previously classified as owner-occupied commercial real estate at December 31, 2015 to non-owner occupied commercial real estate for all comparative tables in Note (3) Loans Receivable. The related allowance for loan losses and provision for loan losses for all historical periods in Note (4) Allowance for Loan Losses were also reclassified. None of these loans were considered impaired at September 30, 2016 or December 31, 2015. The reclassification was due to a review of certain loan products, including hotels, assisted-living housing and self-storage units, for which the Bank determined the risk characteristics were more akin to non-owner occupied loans. The Company also reclassified $179.0 million fair value ($179.8 million amortized cost) of mortgage backed securities and collateralized mortgage obligations previously classified as residential to commercial based on a detailed review of the investment types. The reclassifications had no effect on prior periods' net income or stockholders’ equity.
(c) Significant Accounting Policies
The significant accounting policies used in preparation of the Company's Condensed Consolidated Financial Statements are disclosed in the 2015 Annual Report on Form 10-K. There have not been any material changes in the Company's significant accounting policies from those contained in the 2015 Annual Report on Form 10-K.

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(d) Recently Issued Accounting Pronouncements
Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU" or "Update") 2014-09, Revenue from Contracts with Customers, was issued in May 2014. Under this Update, FASB created a new Topic 606 which is in response to a joint initiative of FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and international financial reporting standards that would:
Remove inconsistencies and weaknesses in revenue requirements.
Provide a more robust framework for addressing revenue issues.
Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.
Provide more useful information to users of financial statements through improved disclosure requirements.
Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The original effective date for this Update was deferred in FASB ASU 2015-14 below. The Company is currently evaluating the impact that the Update will have on its Condensed Consolidated Financial Statements.
FASB ASU 2015-14, Revenue from Contracts with Customers, was issued in August 2015 and defers the effective date of the above-mentioned FASB ASU 2014-09 for certain entities. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in Update 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is now permitted, but only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is a public business entity and will not early adopt the guidance in Update 2014-09 as permitted in this Update. The Company is currently evaluating the impact that Update 2014-09 will have on its Condensed Consolidated Financial Statements upon adoption.
FASB ASU 2015-16, Business Combinations (Topic 805), was issued in September 2015. Topic 805 requires that an acquirer retrospectively adjust provisional amounts recognized in a business combination, during the measurement period. To simplify the accounting for adjustments made to provisional amounts, the Update requires that the acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amount is determined. The acquirer is required to also record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date.  In addition, an entity is required to present separately on the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Update did not have an impact on the Company's Condensed Consolidated Financial Statements as of September 30, 2016.
FASB ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10), was issued in January 2016, to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. This Update contains several provisions, including but not limited to 1) requiring equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; 2) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) eliminating the requirement to disclose the method(s) and significant assumptions used to estimate fair value; and 4) requiring separate presentation of financial assets and liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. The Update also changes certain financial statement disclosure requirements, including requiring disclosures of the fair value of financial instruments be made on the basis of exit price. The Update is effective for public entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact that the Update will have on its Condensed Consolidated Financial Statements.
FASB ASU 2016-02, Leases (Topic 842), was issued in February 2016, to increase transparency and comparability of leases among organizations and to disclose key information about leasing arrangements. The Update sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The Update requires lessees to apply a dual approach, classifying leases as either a finance or operating lease. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term greater than 12 months regardless of their classification. All cash payments

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will be classified within operating activities in the statement of cash flows. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Update is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact that the Update will have on its Condensed Consolidated Financial Statements.

FASB ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations, was issued in March 2016 and it clarifies the implementation guidance of the above-mentioned FASB ASU 2014-09 as it relates to principal versus agent considerations. The Update addresses identifying the unit of account and nature of the goods or services as well as applying the control principle and interactions with the control principle. The amendments to the Update do not change the core principle of the guidance. The effective date and transition requirements for this Update are the same as FASB ASU 2014-09. The Company is currently evaluating the impact that the Update will have on its Condensed Consolidated Financial Statements.

FASB ASU 2016-09, Stock Compensation (Topic 718), issued in March 2016, is intended to simplify several aspects of the accounting for share-based payment award transactions. For public business entities, the guidance is effective for annual periods after December 15, 2016, including interim periods within those annual periods with early adoption permitted. Certain amendments will be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Other amendments will be applied retroactively (such as presentation of employee taxes paid on the statement of cash flows) or prospectively (such as recognition of excess tax benefits on the income statement). The Company is currently evaluating the impact that this Update will have on its Condensed Consolidated Financial Statements.

FASB ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, was issued in April 2016 which clarifies the implementation guidance of the above-mentioned FASB ASU 2014-09 as it relates to identifying performance obligations and licensing. The effective date and transition requirements for this Update are the same as FASB ASU 2014-09. The Company is currently evaluating the impact that this Update will have on its Condensed Consolidated Financial Statements.

FASB ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-scope Improvements and Practical Expedients, was issued in May 2016. The amendments in this Update do not change the core principle of the guidance in Topic 606. Rather, the amendments in this Update affect only the narrow aspects of Topic 606. The effective date and transition requirements for this Update are the same as FASB ASU 2014-09. The Company is currently evaluating the impact that this Update will have on its Condensed Consolidated Financial Statements.

FASB ASU 2016-13, Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued in June 2016. Commonly referred to as the current expected credit loss model("CECL"), this Update requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. The amendment affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial asset not excluded from the scope that have the contractual right to receive cash. The Update replaces the incurred loss impairment methodology, which generally only considered past events and current conditions, with a methodology that reflects the expected credit losses and required consideration of a broader range of reasonable and supportable information to estimate all expected credit losses. The Update additionally addresses purchased assets and introduces the purchased financial asset with a more-than-insignificant amount of credit deterioration since origination ("PCD"). The accounting for these PCD assets is similar to the existing accounting guidance of FASB Accounting Standards Codification ("ASC") 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, for purchased credit impaired ("PCI") assets, except the subsequent improvements in estimated cash flows will be immediately recognized into income, similar to the immediate recognition of subsequent deteriorations in cash flows. Current guidance only allows for the prospective recognition of these cash flow improvements. Because the terminology has been changed to a "more-than-insignificant" amount of credit deterioration, the presumption is that more assets might qualify for this accounting under the Update than those under current guidance. For public business entities, the Update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15, 2018. An entity will apply the amendments through a cumulative-effect adjustment to retained

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earnings as of the beginning of the first reporting period in which the guidance is adopted. A prospective transition approach is required for debt securities. An entity that has previously applied the guidance of ASC 310-30 will prospectively apply the guidance in this Update for PCD assets. A prospective transition approach should be used for PCD assets where upon adoption, the amortized cost basis should be adjusted to reflect the addition of the allowance for credit losses. The Company is currently evaluating the impact that this Update will have on its Condensed Consolidated Financial Statements.

FASB ASU 2016-15, Statement of Cash Flows (Topic 213): Classification of Certain Cash Receipts and Cash Payments, was issued in August 2016. The Update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. For public business entities, the guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted and must be applied using a retrospective transitional method to each period presented. The Company is currently evaluating the impact that this Update will have on its Condensed Consolidated Financial Statements.

(2)
Investment Securities
The Company’s investment policy is designed primarily to provide and maintain liquidity, generate a favorable return on assets without incurring undue interest rate and credit risk, and complement the Bank’s lending activities. Securities are classified as either available for sale or held to maturity when acquired. During the year ended December 31, 2015, the Company transferred all of its investment securities previously classified as held to maturity to available for sale. As a result of the transfer and subsequent sales, the Company believes its held to maturity classification process has been compromised and careful evaluation and analysis will be required going forward in determining when circumstances are suitable for management to assert with a sufficient degree of credibility that it has the intent and ability to hold investments to maturity.

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(a) Securities by Type and Maturity
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of investment securities available for sale at the dates indicated were as follows:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
September 30, 2016
 
 
 
 
 
 
 
U.S. Treasury and U.S. Government-sponsored agencies
$
5,565

 
$
29

 
$

 
$
5,594

Municipal securities
236,913

 
9,169

 
(378
)
 
245,704

Mortgage backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
Residential
337,689

 
5,340

 
(272
)
 
342,757

Commercial
194,666

 
3,276

 
(105
)
 
197,837

Collateralized loan obligations
14,032

 
9

 
(52
)
 
13,989

Corporate obligations
13,201

 
7

 
(25
)
 
13,183

Other equities
45

 
50

 

 
95

Total
$
802,111

 
$
17,880

 
$
(832
)
 
$
819,159

 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
U.S. Treasury and U.S. Government-sponsored agencies
$
35,618

 
$
145

 
$
(186
)
 
$
35,577

Municipal securities
216,352

 
4,826

 
(185
)
 
220,993

Mortgage backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
Residential
351,606

 
1,749

 
(1,331
)
 
352,024

Commercial
179,797

 
343

 
(1,129
)
 
179,011

Collateralized loan obligations
15,251

 

 
(154
)
 
15,097

Corporate obligations
9,252

 

 
(139
)
 
9,113

Other equities
45

 
9

 

 
54

Total
$
807,921

 
$
7,072

 
$
(3,124
)
 
$
811,869

(1) U.S. Government-sponsored agencies.
There were no securities classified as trading or held to maturity at September 30, 2016 or December 31, 2015.
The amortized cost and fair value of investment securities available for sale at September 30, 2016, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
 
Amortized Cost
 
Fair Value
 
(In thousands)
Due in one year or less
$
3,564

 
$
3,578

Due after one year through five years
121,014

 
123,124

Due after five years through ten years
232,087

 
237,820

Due after ten years
445,401

 
454,542

Investment securities with no stated maturities
45

 
95

Total
$
802,111

 
$
819,159


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(b) Unrealized Losses and Other-Than-Temporary Impairments
The following table shows the gross unrealized losses and fair value of the Company's investment securities available for sale that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that the individual securities have been in continuous unrealized loss positions as of September 30, 2016 and December 31, 2015 were as follows:
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Municipal securities
$
22,030

 
$
(378
)
 
$

 
$

 
$
22,030

 
$
(378
)
Mortgage backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
 
 
 
 
Residential
27,459

 
(128
)
 
17,416

 
(144
)
 
44,875

 
(272
)
Commercial
38,378

 
(79
)
 
8,240

 
(26
)
 
46,618

 
(105
)
Collateralized loan obligations

 

 
11,130

 
(52
)
 
11,130

 
(52
)
Corporate obligations
6,021

 
(21
)
 
4,022

 
(4
)
 
10,043

 
(25
)
Total
$
93,888

 
$
(606
)
 
$
40,808

 
$
(226
)
 
$
134,696

 
$
(832
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and U.S. Government-sponsored agencies
$
30,381

 
$
(186
)
 
$

 
$

 
$
30,381

 
$
(186
)
Municipal securities
21,929

 
(174
)
 
2,068

 
(11
)
 
23,997

 
(185
)
Mortgage backed securities and collateralized mortgage obligations(1):
 
 
 
 
 
 
 
 
 
 
 
Residential
173,959

 
(870
)
 
39,891

 
(461
)
 
213,850

 
(1,331
)
Commercial
79,103

 
(1,117
)
 
4,047

 
(12
)
 
83,150

 
(1,129
)
Collateralized loan obligations
15,097

 
(154
)
 

 

 
15,097

 
(154
)
Corporate obligations
8,134

 
(110
)
 
979

 
(29
)
 
9,113

 
(139
)
Total
$
328,603

 
$
(2,611
)
 
$
46,985

 
$
(513
)
 
$
375,588

 
$
(3,124
)
(1) U.S. Government-sponsored agencies.
The Company has evaluated these investment securities available for sale as of September 30, 2016 and December 31, 2015 and has determined that the decline in their value is temporary. The unrealized losses are primarily due to increases in market interest rates. The fair value of these securities is expected to recover as the securities approach their maturity date. None of the underlying bonds of the municipal securities had credit ratings that were below investment grade levels at September 30, 2016 or December 31, 2015. The Company has the ability and intent to hold the investments until recovery of the securities' amortized cost which may be the maturity date of the securities.
All of the other-than-temporary impairment experienced by the Company in historical periods has been related to its portfolio of private-residential collateralized mortgage obligations. As there were no private-residential collateralized mortgage obligations at September 30, 2016 and December 31, 2015, the Company did not perform an other-than-temporary impairment analysis for the three and nine months ended September 30, 2016 on these securities. For the three and nine months ended September 30, 2015, there were no investment securities held to maturity determined to be other-than-temporarily impaired and the Company recorded no unrealized losses for the three and nine months ended September 30, 2015 in earnings or other comprehensive income. To analyze the unrealized losses, the Company estimated expected future cash flows of the investments by estimating the expected future cash flows of the underlying collateral and applying those collateral cash flows, together with any credit enhancements such as subordinated interests owned by third parties, to the security. The expected future cash flows of the underlying collateral were determined using the remaining contractual cash flows adjusted for future expected credit losses (which considers

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current delinquencies and nonperforming assets, future expected default rates and collateral value by vintage and geographic region) and prepayments. The expected cash flows of the security were then discounted at the interest rate used to recognize interest income on the security to arrive at a present value amount. The Company did not use any impairment assumptions as of September 30, 2015 as the unrealized losses were insignificant.

(c) Pledged Securities
The following table summarizes the amortized cost and fair value of investment securities available for sale that are pledged as collateral for the following obligations at September 30, 2016 and December 31, 2015:
 
September 30, 2016
 
December 31, 2015
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
(In thousands)
Washington and Oregon state to secure public deposits
$
220,203

 
$
226,536

 
$
212,325

 
$
215,284

Federal Reserve Bank of San Francisco and Federal Home Loan Bank to secure borrowing arrangements

 

 
506

 
506

Repurchase agreements
25,934

 
26,312

 
28,500

 
28,503

Other securities pledged
3,590

 
3,683

 
2,125

 
2,160

Total
$
249,727

 
$
256,531

 
$
243,456

 
$
246,453


(3)
Loans Receivable
The Company originates loans in the ordinary course of business and has also acquired loans through FDIC-assisted and open bank transactions. Loans acquired in a business combination may be further classified as “purchased” loans. Loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are accounted for under FASB ASC310-30. These loans are identified as PCI, or purchased credit impaired loans. Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20, Receivables—Nonrefundable Fees and Other Costs, and are referred to as "non-PCI" loans.
Disclosures related to the Company's recorded investment in loans receivable generally exclude accrued interest receivable and net deferred loan origination fees and costs because they are insignificant.
(a) Loan Origination/Risk Management
The Company categorizes loans in one of the four segments of the total loan portfolio: commercial business, one-to-four family residential, real estate construction and land development and consumer. Within these segments are classes of loans for which management monitors and assesses credit risk in the loan portfolios. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies, and nonperforming and potential problem loans. The Company also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management. The loan review process complements and reinforces the risk identification and assessment decisions made by loan officers and credit personnel, as well as the Company’s policies and procedures.
A discussion of the risk characteristics of each loan portfolio segment is as follows:
Commercial Business:
There are three significant classes of loans in the commercial portfolio segment: commercial and industrial loans, owner-occupied commercial real estate and non-owner occupied commercial real estate. The owner and non-owner occupied commercial real estate are both considered commercial real estate loans. As the commercial and industrial loans carry different risk characteristics than the commercial real estate loans, they are discussed separately below.
Commercial and industrial. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may include a personal guarantee; however, some short-term loans may be made on an unsecured

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basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Commercial real estate. The Company originates commercial real estate loans within its primary market areas. These loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate involves more risk than other classes of loans in that the lending typically involves higher loan principal amounts, and payments on loans secured by real estate properties are dependent on successful operation and management of the properties. Repayment of these loans may be more adversely affected by conditions in the real estate market or the economy. Owner-occupied commercial real estate loans are generally of lower credit risk than non-owner occupied commercial real estate loans as the borrowers' businesses are likely dependent on the properties.
One-to-Four Family Residential:
The majority of the Company’s one-to-four family residential loans are secured by single-family residences located in its primary market areas. The Company’s underwriting standards require that single-family portfolio loans generally are owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the underlying collateral. Terms of maturity typically range from 15 to 30 years. Historically, the Company sold most single-family loans in the secondary market and retained a smaller portion in its loan portfolio. From the second quarter of 2013 until May 1, 2014, the Company only originated single-family loans for its loan portfolio. As a result of the Washington Banking Merger, since May 1, 2014 the Company has been originating and selling a majority of its single-family mortgages.
Real Estate Construction and Land Development:
The Company originates construction loans for one-to-four family residential and for five or more family residential and commercial properties. The one-to-four family residential construction loans generally include construction of custom homes whereby the home buyer is the borrower. The Company also provides financing to builders for the construction of pre-sold homes and, in selected cases, to builders for the construction of speculative residential property. Substantially all construction loans are short-term in nature and priced with variable rates of interest. Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, the Company’s estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss if the borrower does not repay the loan. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being dependent upon successful completion of the construction project, interest rate changes, government regulation of real property, general economic conditions and the availability of long-term financing.
Consumer:
The Company originates consumer loans and lines of credit that are both secured and unsecured. The underwriting process for these loans ensures a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans are significantly influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. The majority of consumer loans are for relatively small amounts disbursed among many individual borrowers which reduces the credit risk for this type of loan. To further reduce the risk, trend reports are reviewed by management on a regular basis.
As a result of the Washington Banking Merger, the Company is originating indirect consumer loans. These loans are for new and used automobile and recreational vehicles that are originated indirectly by selected dealers located in the Company's market areas. The Company has limited its purchase of indirect loans primarily to dealerships that are established and well known in their market areas and to applicants that are not classified as sub-prime.

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Loans receivable at September 30, 2016 and December 31, 2015 consisted of the following portfolio segments and classes:
 
September 30, 2016
 
December 31, 2015
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
638,082

 
$
596,726

Owner-occupied commercial real estate
578,147

 
572,609

Non-owner occupied commercial real estate
802,502

 
753,986

Total commercial business
2,018,731

 
1,923,321

One-to-four family residential
78,253

 
72,548

Real estate construction and land development:
 
 
 
One-to-four family residential
52,052

 
51,752

Five or more family residential and commercial properties
97,108

 
55,325

Total real estate construction and land development
149,160

 
107,077

Consumer
330,933

 
298,167

Gross loans receivable
2,577,077

 
2,401,113

Net deferred loan costs
1,900

 
929

 Loans receivable, net
2,578,977

 
2,402,042

Allowance for loan losses
(30,211
)
 
(29,746
)
 Total loans receivable, net
$
2,548,766

 
$
2,372,296

(b) Concentrations of Credit
Most of the Company’s lending activity occurs within Washington State, and to a lesser extent Oregon. The Company’s primary market areas are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County in Oregon, as well as other contiguous markets. The majority of the Company’s loan portfolio consists of, in order of balances at September 30, 2016, non-owner occupied commercial real estate, commercial and industrial and owner-occupied commercial real estate. As of September 30, 2016 and December 31, 2015, there were no concentrations of loans related to any single industry in excess of 10% of the Company’s total loans.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, and (v) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 10. A description of the general characteristics of the risk grades is as follows:
Grades 1 to 5: These grades are considered “pass grade” and include loans with negligible to above average but acceptable risk. These borrowers generally have strong to acceptable capital levels and consistent earnings and debt service capacity. Loans with the higher grades within the “pass” category may include borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Increased monitoring of financial information and/or collateral may be appropriate. Loans with this grade show no immediate loss exposure.
Grade 6: This grade includes "Watch" loans and is considered a “pass grade”. The grade is intended to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-modifying action is anticipated in the near term.
Grade 7: This grade includes “Other Assets Especially Mentioned” (“OAEM”) loans in accordance with regulatory guidelines, and is intended to highlight loans with elevated risks. Loans with this grade show signs of deteriorating profits and capital, and the borrower might not be strong enough to sustain a major setback. The borrower is typically higher than normally leveraged, and outside support might

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be modest and likely illiquid. The loan is at risk of further decline unless active measures are taken to correct the situation.
Grade 8: This grade includes “Substandard” loans in accordance with regulatory guidelines, which the Company has determined have a high credit risk. These loans also have well-defined weaknesses which make payment default or principal exposure likely, but not yet certain. The borrower may have shown serious negative trends in financial ratios and performance. Such loans may be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business. Loans with this grade can be placed on accrual or nonaccrual status based on the Company’s accrual policy.
Grade 9: This grade includes “Doubtful” loans in accordance with regulatory guidelines, and the Company has determined these loans to have excessive credit risk. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance or have been partially charged-off for the amount considered uncollectible.
Grade 10: This grade includes “Loss” loans in accordance with regulatory guidelines, and the Company has determined these loans have the highest risk of loss. Such loans are charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.
Numerical loan grades for loans are established at the origination of the loan. Loan grades are reviewed on a quarterly basis, or more frequently if necessary, by the credit department. The Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event of payment delinquencies or default. Typically, an individual loan grade will not be changed from the prior period unless there is a specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications with the borrower, or other borrower information that becomes known to management. Credit improvements are evidenced by known facts regarding the borrower or the collateral property.
The loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential. Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades. The OAEM loan grade is transitory in that the Company is waiting on additional information to determine the likelihood and extent of the potential loss. The likelihood of loss for OAEM graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration. Loans with a Substandard grade are generally loans for which the Company has individually analyzed for potential impairment. For Doubtful and Loss graded loans, the Company is almost certain of the losses, and the outstanding principal balances are generally charged-off to the realizable value.

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The following tables present the balance of the loans receivable by credit quality indicator as of September 30, 2016 and December 31, 2015.
 
September 30, 2016
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
599,694

 
$
5,952

 
$
32,376

 
$
60

 
$
638,082

Owner-occupied commercial real estate
550,065

 
6,412

 
21,413

 
257

 
578,147

Non-owner occupied commercial real estate
759,097

 
15,799

 
27,606

 

 
802,502

Total commercial business
1,908,856

 
28,163

 
81,395

 
317

 
2,018,731

One-to-four family residential
76,735

 

 
1,518

 

 
78,253

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
45,287

 
824

 
5,941

 

 
52,052

Five or more family residential and commercial properties
92,562

 
1,004

 
3,542

 

 
97,108

Total real estate construction and land development
137,849

 
1,828

 
9,483

 

 
149,160

Consumer
325,832

 
54

 
5,047

 

 
330,933

Gross loans receivable
$
2,449,272

 
$
30,045

 
$
97,443

 
$
317

 
$
2,577,077


 
December 31, 2015
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
563,002

 
$
8,093

 
$
25,333

 
$
298

 
$
596,726

Owner-occupied commercial real estate
544,429

 
11,662

 
16,260

 
258

 
572,609

Non-owner occupied commercial real estate
699,759

 
23,447

 
30,780

 

 
753,986

Total commercial business
1,807,190

 
43,202

 
72,373

 
556

 
1,923,321

One-to-four family residential
71,457

 

 
1,091

 

 
72,548

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
44,069

 
896

 
6,787

 

 
51,752

Five or more family residential and commercial properties
50,678

 

 
4,647

 

 
55,325

Total real estate construction and land development
94,747

 
896

 
11,434

 

 
107,077

Consumer
291,892

 

 
6,275

 

 
298,167

Gross loans receivable
$
2,265,286

 
$
44,098

 
$
91,173

 
$
556

 
$
2,401,113


Potential problem loans are loans classified as OAEM or worse that are currently accruing interest and are not considered impaired, but which management is monitoring because the financial information of the borrower causes concern as to their ability to meet their loan repayment terms. Potential problem loans may include PCI loans as these loans continue to accrete loan discounts established at acquisition based on the guidance of FASB ASC 310-30. Potential problem loans as of September 30, 2016 and December 31, 2015 were $101.0 million and $110.4 million, respectively. The balance of potential problem loans guaranteed by a governmental agency, which guarantee reduces the Company's credit exposure, was $2.2 million and $3.0 million as of September 30, 2016 and December 31, 2015, respectively.

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(d) Nonaccrual Loans
Nonaccrual loans, segregated by segments and classes of loans, were as follows as of September 30, 2016 and December 31, 2015:
 
September 30, 2016
 
December 31, 2015
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
3,849

 
$
5,095

Owner-occupied commercial real estate
2,984

 
2,027

Non-owner occupied commercial real estate
1,983

 

Total commercial business
8,816

 
7,122

One-to-four family residential
35

 
38

Real estate construction and land development:
 
 
 
One-to-four family residential
2,008

 
2,414

Five or more family residential and commercial properties

 

Total real estate construction and land development
2,008

 
2,414

Consumer
681

 
94

Nonaccrual loans
$
11,540

 
$
9,668

The Company had $3.0 million and $1.3 million of nonaccrual loans guaranteed by governmental agencies at September 30, 2016 and December 31, 2015, respectively.
PCI loans are not included in the nonaccrual loan table above because these loans are accounted for under FASB ASC 310-30, which provides that accretable yield is calculated based on a loan's expected cash flow even if the loan is not performing under its contractual terms.
(e) Past due loans
The Company performs an aging analysis of past due loans using the categories of 30-89 days past due and 90 or more days past due. This policy is consistent with regulatory reporting requirements.
The balances of past due loans, segregated by segments and classes of loans, as of September 30, 2016 and December 31, 2015 were as follows:
 
September 30, 2016
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
587

 
$
1,165

 
$
1,752

 
$
636,330

 
$
638,082

Owner-occupied commercial real estate
2,063

 
1,871

 
3,934

 
574,213

 
578,147

Non-owner occupied commercial real estate
759

 
1,983

 
2,742

 
799,760

 
802,502

Total commercial business
3,409

 
5,019

 
8,428

 
2,010,303

 
2,018,731

One-to-four family residential
112

 

 
112

 
78,141

 
78,253

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

 
865

 
865

 
51,187

 
52,052

Five or more family residential and commercial properties
459

 

 
459

 
96,649

 
97,108

Total real estate construction and land development
459

 
865

 
1,324

 
147,836

 
149,160

Consumer
1,407

 
620

 
2,027

 
328,906

 
330,933

Gross loans receivable
$
5,387

 
$
6,504

 
$
11,891

 
$
2,565,186

 
$
2,577,077



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December 31, 2015
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,900

 
$
2,679

 
$
5,579

 
$
591,147

 
$
596,726

Owner-occupied commercial real estate
2,240

 
2,609

 
4,849

 
567,760

 
572,609

Non-owner occupied commercial real estate
2,177

 
184

 
2,361

 
751,625

 
753,986

Total commercial business
7,317

 
5,472

 
12,789

 
1,910,532

 
1,923,321

One-to-four family residential
490

 

 
490

 
72,058

 
72,548

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

 
2,392

 
2,392

 
49,360

 
51,752

Five or more family residential and commercial properties
118

 
42

 
160

 
55,165

 
55,325

Total real estate construction and land development
118

 
2,434

 
2,552

 
104,525

 
107,077

Consumer
3,029

 
202

 
3,231

 
294,936

 
298,167

Gross loans receivable
$
10,954

 
$
8,108

 
$
19,062

 
$
2,382,051

 
$
2,401,113


There were no loans 90 days or more past due that were still accruing interest as of September 30, 2016 or December 31, 2015, excluding PCI loans.

(f) Impaired loans
Impaired loans include nonaccrual loans and performing troubled debt restructured ("TDR") loans. The balances of impaired loans as of September 30, 2016 and December 31, 2015 are set forth in the following tables.
 
September 30, 2016
 
Recorded
Investment With
No Specific
Valuation
Allowance
 
Recorded
Investment With
Specific
Valuation
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,544

 
$
6,320

 
$
8,864

 
$
9,470

 
$
907

Owner-occupied commercial real estate
847

 
3,723

 
4,570

 
4,927

 
458

Non-owner occupied commercial real estate
5,595

 
6,464

 
12,059

 
12,113

 
832

Total commercial business
8,986

 
16,507

 
25,493

 
26,510

 
2,197

One-to-four family residential

 
263

 
263

 
266

 
81

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
2,310

 
829

 
3,139

 
3,824

 
4

Five or more family residential and commercial properties

 
1,606

 
1,606

 
1,606

 
176

Total real estate construction and land development
2,310

 
2,435

 
4,745

 
5,430

 
180

Consumer
576

 
191

 
767

 
1,028

 
49

Total
$
11,872

 
$
19,396

 
$
31,268

 
$
33,234

 
$
2,507


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December 31, 2015
 
Recorded
Investment With
No Specific
Valuation
Allowance
 
Recorded
Investment With
Specific
Valuation
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
872

 
$
8,769

 
$
9,641

 
$
11,368

 
$
1,173

Owner-occupied commercial real estate

 
4,295

 
4,295

 
4,342

 
809

Non-owner occupied commercial real estate
3,696

 
6,834

 
10,530

 
10,539

 
943

Total commercial business
4,568

 
19,898

 
24,466

 
26,249

 
2,925

One-to-four family residential

 
275

 
275

 
276

 
85

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
1,403

 
2,065

 
3,468

 
4,089

 
66

Five or more family residential and commercial properties

 
1,960

 
1,960

 
1,960

 
203

Total real estate construction and land development
1,403

 
4,025

 
5,428

 
6,049

 
269

Consumer
48

 
145

 
193

 
200

 
29

Total
$
6,019

 
$
24,343

 
$
30,362

 
$
32,774

 
$
3,308


The Company had governmental guarantees of $3.7 million and $1.8 million related to the impaired loan balances at September 30, 2016 and December 31, 2015, respectively.
The average recorded investment of impaired loans for the three and nine months ended September 30, 2016 and 2015 are set forth in the following table.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
Commercial and industrial
$
9,625

 
$
8,692

 
$
9,750

 
$
10,776

Owner-occupied commercial real estate
4,553

 
4,882

 
4,560

 
4,151

Non-owner occupied commercial real estate
12,107

 
10,256

 
12,232

 
8,893

Total commercial business
26,285

 
23,830

 
26,542

 
23,820

One-to-four family residential
265

 
259

 
267

 
315

Real estate construction and land development:
 
 
 
 
 
 
 
One-to-four family residential
3,177

 
3,639

 
3,253

 
4,312

Five or more family residential and commercial properties
1,619

 
1,997

 
1,746

 
2,032

Total real estate construction and land development
4,796

 
5,636

 
4,999

 
6,344

Consumer
885

 
159

 
907

 
329

Total
$
32,231

 
$
29,884

 
$
32,715

 
$
30,808

For the three and nine months ended September 30, 2016 and 2015, no interest income was recognized subsequent to a loan’s classification as nonaccrual. For the three and nine months ended September 30, 2016, the

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