Heritage Financial Corp: Form 10-Q for the period ended Mar 31, 2025

The following discussion is intended to assist in understanding the financial condition and results of operations of the Company as of and for the three months ended March 31, 2025. The information contained in this section should be read together with the unaudited Condensed Consolidated Financial Statements and the accompanying Notes included herein, the Cautionary Note Regarding Forward-Looking Statements included herein and the December 31, 2024 audited Consolidated Financial Statements, and the accompanying Notes included in our 2024 Annual Form 10-K.

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 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 and 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 which may impact our operations or those of our customers. 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

Comparison of the quarter ended March 31, 2025 to the comparable quarter in the prior year

Net income increased $8.2 million, or 142.0%, to $13.9 million, or $0.40 per diluted common share, for the three months ended March 31, 2025, compared to $5.7 million, or $0.16 per diluted common share, for the same period in 2024.

The increase in net income was primarily due to a reduction in a pre-tax loss of $3.9 million on the sale of investment securities in connection with management's strategic repositioning of the Company's balance sheet during the three months ended March

31, 2025, compared to a pre-tax loss of $10.0 million on the sale of investment securities recognized during the same period in 2024. Net income also improved because of an increase in interest income of $3.0 million due to increased yields earned on interest earning assets as a result of higher market interest rates.

The increases in certain components of net income were partially offset by a $0.9 million increase in interest expense from higher funding costs and a $1.0 million increase in noninterest expense.

Net Interest Income and Margin

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.

Comparison of the quarter ended March 31, 2025 to the comparable quarter in the prior year

The following table provides relevant net interest income information for the periods indicated:

(Dollars in thousands)

(1) Average balances are calculated using daily balances. Average yield/rate is annualized.

(2) Average loans receivable includes loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable includes the amortization of net deferred loan fees of $753,000 and $809,000 for the three months ended March 31, 2025 and 2024, respectively.

(3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis.

The following table provides the changes in net interest income for the three months ended March 31, 2025 compared to the same period in 2024, 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:

(Dollars in thousands)

Net interest income increased $2.2 million, or 4.2%, to $53.7 million for the three months ended March 31, 2025, compared to $51.5 million for the same period in 2024, due primarily to a $3.0 million increase in total interest income, offset partially by a $0.9 million increase in total interest expense.

Total interest income increased to $77.4 million for the three months ended March 31, 2025, compared to $74.4 million for the same period in 2024. The increase was primarily due to a $6.6 million increase in interest income on loans receivable, offset partially by a $3.1 million decrease in interest income on investment securities during the three months ended March 31, 2025 as compared to the same period in 2024. Interest income on loans receivable increased due to increases in both the average yield earned on and the average outstanding balance of those assets. The average yield earned on loans receivable increased 10 basis points to 5.45% and the average balance of loans receivable increased $441.8 million to $4.79 billion during the three months ended March 31, 2025, as compared to the same period in 2024.

Interest income on investment securities decreased $3.1 million due to a decrease in the average balance of investment securities, offset partially by an increase in the yield earned on these securities due primarily to rising interest rates and sales of lower yielding securities. The yield on taxable securities increased 4 basis points to 3.33% and average balances decreased $382.7 million to $1.43 billion during the three months ended March 31, 2025, compared to 3.29% and average balances of $1.81 billion during the same period in 2024.

Total interest expense increased to $23.7 million during the three months ended March 31, 2025 compared to $22.8 million for the same period in 2024. The increase was due primarily to a $3.1 million increase in interest expense on interest bearing deposits, offset partially by a $2.2 million decrease in interest expense on borrowings during the three months ended March 31, 2025, as compared to the same period in 2024. The increase in interest expense on interest bearing deposits was due primarily to a 22 basis point increase in the average rate to 1.92% for the three months ended March 31, 2025, as compared to 1.70% for the same period in 2024, due to competitive rate pressures, and a $246.5 million increase in the average balance of certificates of deposit, which are generally at higher rates than other deposit products. The decrease in borrowing expense was due primarily to a $180.4 million decrease in the average balance of outstanding borrowings for the three months ended March 31, 2025, as compared to the same period in 2024.

Net interest margin increased 15 basis points to 3.44% for the three months ended March 31, 2025, compared to 3.29% for the same period in 2024.

Provision for Credit Losses

The aggregate of the provision for (reversal of) credit losses on loans and on unfunded commitments is presented on the unaudited Condensed Consolidated Statements of Income as the provision for credit losses. The ACL on unfunded commitments is included on the unaudited Condensed Consolidated Statements of Financial Condition within accrued expenses and other liabilities.

Comparison of the quarter ended March 31, 2025 to the comparable quarter in the prior year

The following table presents the provision for (reversal of) credit losses for the periods indicated:

(Dollars in thousands)

The (reversal of) provision for credit losses on loans reflects the amount required to maintain the ACL on loans at an appropriate level based upon management’s evaluation of the adequacy of collective and individual loss reserves and is impacted by quarterly charge-offs and recoveries. The reversal of provision for credit losses on loans was $9,000 during the three months ended March 31, 2025 and was primarily driven by a reduction in loan balances during the quarter.

Future assessments of expected credit losses will be impacted not only by changes in the composition of and amount of loans and to the reasonable and supportable forecast, but also by an updated assessment of qualitative factors, as well as consideration of any changes in the reasonable and supportable forecast reversion period. The provision for credit losses on unfunded commitments recognized during the three months ended March 31, 2025 was due primarily to a decrease in loan utilization rates which resulted in larger unfunded capacity.

The provision for credit losses on loans was $1.7 million during the three months ended March 31, 2024, and was driven primarily by loan growth during the quarter.

Noninterest Income

Comparison of the three months ended March 31, 2025 to the comparable period in the prior year

The following table presents the change in the key components of noninterest income for the periods indicated:

(Dollars in thousands)

Noninterest income increased $6.8 million from the same period in 2024, due primarily to a smaller $3.9 million pre-tax loss on the sale of investment securities during the three months ended March 31, 2025, as compared to a $10.0 million pre-tax loss on the sale of investment securities recognized in the same period in 2024, both as part of the Company's strategic balance sheet repositioning efforts. Other income increased due to an increase in FHLB dividends received during the three months ended March 31, 2025, as compared to the same period in 2024.

Noninterest Expense

Comparison of three months ended March 31, 2025 to the comparable period in the prior year

The following table presents changes in the key components of noninterest expense for the periods indicated:

(Dollars in thousands)

37

(Dollars in thousands)

Noninterest expense increased $1.0 million, or 2.5%, during the three months ended March 31, 2025 compared to the same period in 2024. Data processing expense increased due primarily to annual cost increases and a $230,000 refund recognized in the first quarter of 2024 related to a contract termination. Professional services and marketing expense increased due primarily to timing of services performed.

Income Tax Expense

Comparison of the three months ended March 31, 2025 to the comparable period in the prior year

The following table presents the income tax expense, and related metrics and change for the periods indicated:

(Dollars in thousands)

Income tax expense increased due primarily to higher pre-tax income during the three months ended March 31, 2025 compared to the same period in 2024. The effective income tax rate decreased during the three months ended March 31, 2025 compared to the same period in 2024 due to an increase in favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and investments in low-income housing tax credits as well as a decrease in unfavorable permanent stock-based compensation differences.

Financial Condition

The following table provides a comparison of the changes in the Company's financial condition at the periods indicated:

(Dollars in thousands)

38

Total assets increased due to an increase in cash and cash equivalents, offset partially by a decrease in investment securities available for sale, due to sales of investment securities as part of the Company's strategic balance sheet repositioning efforts discussed above, and a decline in loans receivable. Total liabilities and stockholders' equity increased due primarily to an increase in deposits and an increase in stockholders' equity due to primarily a decline in accumulated other comprehensive loss, net, offset partially by a decrease in borrowings and accrued expenses and other liabilities.

Investment Activities

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 complement 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:

(Dollars in thousands)

Investment securities available for sale, at fair value:

(1) U.S. government agency and government-sponsored enterprise CMO and MBS obligations.

Total investment securities decreased $53.8 million, or 3.7%, to $1.41 billion at March 31, 2025 from $1.47 billion at December 31, 2024. As previously noted, the Company sold $60.9 million of investment securities at a pre-tax loss of $3.9 million as part of its strategic balance sheet repositioning. In addition, there were investment maturities and repayments of $36.8 million during the three months ended March 31, 2025. The decrease was partially offset by investment purchases of $28.2 million during the three months ended March 31, 2025 and a $15.5 million decrease in unrealized losses on available for sale securities, due primarily to changes in market rates.

Loan Portfolio

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:

(Dollars in thousands)

Loans receivable decreased $37.3 million, or 0.8%, to $4.76 billion at March 31, 2025 from $4.80 billion at December 31, 2024. New loans funded declined during the three months ended March 31, 2025 to $95.8 million, as compared to $181.0 million during the prior quarter; however, this volume was similar to new loans funded during the first quarter of 2024 of $101.7 million and reflects the seasonality of loan originations. Loan prepayments increased to $79.9 million during the three months ended March 31, 2025, compared to $44.4 million during the prior quarter. Loan payoffs also increased to $47.5 million, compared to $23.8 million the prior quarter.

Commercial and industrial loans increased $8.1 million, or 1.0%, due primarily to new loan production of $25.6 million during the three months ended March 31, 2025, partially offset by pay downs on outstanding balances. Owner-occupied CRE loans decreased $18.0 million, or 1.8%, during the three months ended March 31, 2025, due primarily to pay downs on outstanding balances, offset partially by new loan production of $23.3 million. Non-owner occupied CRE loans increased $6.7 million, or 0.3%, during the three months ended March 31, 2025, due primarily to new loan production of $33.3 million, offset by pay downs on outstanding balances. Residential construction and commercial and multifamily construction loans decreased $26.2 million or 5.5% due to primarily to pay downs on outstanding balance during the quarter and secondarily to conversion to term loans.

The following table provides information about owner occupied CRE and non-owner occupied CRE loans by collateral type at the dates indicated:

(Dollars in thousands)

Owner occupied and non-owner occupied CRE loans by collateral type:

40

Office loans represented the largest segment of owner-occupied and non-owner occupied CRE loans, totaling $571.9 million, or 19.7% of total CRE loans, at March 31, 2025. Of this total, $297.7 million, or 52.0%, were owner-occupied CRE loans. Owner-occupied CRE loans have a lower risk profile than non-owner occupied CRE loans, as there is less tenant rollover risk and they generally include guarantees from the company occupying the space as well as the owners of the company. Multi-family loans increased $26.5 million to $441.2 million, or 15.2% of total CRE loans, due primarily to the completion of $14.0 million in commercial construction loans converting to term CRE loans. The average loan balance of CRE loans was $1.3 million at March 31, 2025.

Loans classified as nonaccrual and nonperforming assets

The following table provides information about our nonaccrual loans and nonperforming assets at the dates indicated:

(Dollars in thousands)

(1) At March 31, 2025 and December 31, 2024, $0.9 million and $1.0 million, respectively, of nonaccrual loans, were guaranteed by government agencies.

Nonaccrual loans increased $359,000 to $4.4 million at March 31, 2025, as compared to $4.1 million at December 31, 2024. Additions during the three months ended March 31, 2025 were due primarily to one $0.8 million residential real estate loan migrating to nonaccrual status. The following table provides the changes in nonaccrual loans during the three months ended March 31, 2025:

(Dollars in thousands)

41

Allowance for Credit Losses on Loans

The following table provides information regarding our ACL on loans for the periods indicated:

(Dollars in thousands)

The ACL on loans as a percentage of loans receivable was 1.09% at March 31, 2025 and December 31, 2024. The ACL on loans decreased $0.3 million, or 0.6%, to $52.2 million at March 31, 2025, compared to $52.5 million at December 31, 2024, due primarily to a decrease in loans receivable.

The ACL on loans as a percentage of loans receivable declined 3 basis points to 1.09% at March 31, 2025 from 1.12% at March 31, 2024 due primarily to a change in mix of loans from real estate construction and land development loans requiring a larger ACL to commercial business loans.

The following table presents the ACL on loans by loan portfolio segment at the dates indicated:

(Dollars in thousands)

Deposits

The following table summarizes the Company's deposits at the dates indicated:

(Dollars in thousands)

42

Total deposits increased $160.7 million, or 2.8%, to $5.85 billion at March 31, 2025 from $5.68 billion at December 31, 2024. Non-maturity deposits increased by $152.7 million, or 3.2%, from December 31, 2024 due primarily to new accounts opened during the quarter and transfers of funds into existing accounts. Certificates of deposit increased $8.0 million, or 0.8%, to $985.3 million at March 31, 2025 from $977.3 million at December 31, 2024, primarily due to new accounts opened during the quarter.

Borrowings

The FHLB functions as a member-owned cooperative providing credit for member financial institutions. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Limitations on the amount of advances are based on a percentage of the Bank's assets or on the FHLB’s assessment of the institution’s creditworthiness. At March 31, 2025, the Bank maintained a credit facility with the FHLB with available borrowing capacity of $1.35 billion. The Bank had $264.4 million in FHLB advances outstanding at March 31, 2025, and $383.0 million in FHLB advances outstanding at December 31, 2024. Advances from the FHLB may be collateralized by FHLB stock owned by the Bank, deposits at the FHLB, certain commercial and residential real estate loans, investment securities or other assets. All FHLB advances at March 31, 2025 were short-term and mature in less than one year.

The Bank maintains a credit facility with the FRB through the Discount Window with available borrowing capacity of $365.6 million at March 31, 2025. The Bank had no FRB borrowings outstanding at March 31, 2025, or December 31, 2024.

In addition to funds obtained in the ordinary course of business, the Company assumed trust preferred securities and the related junior subordinated debentures as part of a prior acquisition. For regulatory capital purposes, the trust preferred securities are included in Tier 2 capital. The junior subordinated debentures outstanding were $22.1 million as of March 31, 2025 and December 31, 2024, net of unaccreted discount.

The Bank maintains available unsecured federal funds lines with four correspondent banks totaling $145.0 million, with no outstanding borrowings at March 31, 2025 and December 31, 2024

Stockholders' Equity

Total stockholders' equity increased $18.0 million, or 2.1%, to $881.5 million at March 31, 2025, compared to $863.5 million at December 31, 2024, due primarily to $13.9 million of net income recognized for the three months ended March 31, 2025 and a $11.9 million decrease in accumulated other comprehensive loss, net, offset partially by $8.3 million in dividends paid to common shareholders and $0.8 million in common stock repurchases. The Company’s stockholders' equity to assets ratio was 12.4% at March 31, 2025, compared to 12.2% at December 31, 2024.

The Company has historically paid cash dividends to its common shareholders. Payments of future cash dividends, if any, will be at the discretion of our Board after taking into account various factors, including our business, operating results and 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. Dividends on common stock from the Company depend substantially upon the receipt of dividends from the Bank, which is the Company’s predominant source of income. On April 23, 2025, the Board declared a regular quarterly dividend of $0.24 per common share payable on May 21, 2025 to shareholders of record on May 7, 2025.

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, with 990,522 shares remaining available for repurchase as of March 31, 2025. 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 do so. Under the stock repurchase program, the Company may 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 Program’s expiration, without any prior notice.

Regulatory Requirements

The Company is a bank holding company under the supervision of the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. The Bank is a federally insured institution and thereby is subject to the capital requirements established by the FDIC. The Federal Reserve capital requirements generally parallel the FDIC requirements. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect in the unaudited Condensed Consolidated Financial Statements and operations. Additionally, the Company and the Bank are required to maintain a capital conservation buffer of common equity Tier 1 capital above 2.5% to avoid restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers. Management believes that, as of March 31, 2025, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of March 31, 2025 and December 31, 2024, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's categories.

The following table summarizes the Company's consolidated and the Bank's capital actual ratios compared to the regulatory "adequately capitalized" capital ratio and the regulatory minimum capital ratio needed to qualify as a "well capitalized" institution, as calculated under regulatory guideline at the dates presented:

(Dollars in thousands)

(1) The ratios to meet the requirements to be deemed “well-capitalized” under prompt corrective action regulations are only applicable to the Bank. However, the Company manages its capital position as if the requirements apply to the consolidated Company and has presented the ratios as if they also applied on a consolidated basis.

At December 31, 2024, the capital measures reflected the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC that provided banking organizations that implemented CECL before the end of 2020 the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of capital benefit provided during the initial two-year delay.

Liquidity and Capital Resources

We maintain sufficient cash and cash equivalents and investment securities to meet short-term liquidity needs and 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 focus on acquiring non-maturity deposits from our retail accounts, and noninterest bearing demand deposits from our commercial customers and to use our borrowing availability to fund growth in assets. Our liquidity policy permits the purchase of brokered deposits in an amount not to exceed 15% of the Company's total deposits as a secondary source for funding. The Company’s total uninsured deposits, which are the amounts of deposit accounts that exceed the FDIC insurance limit, currently $250,000, were approximately $2.32 billion, or 39.8% of total deposits, at March 31, 2025 and $2.27 billion, or 40.0% of total deposits, at December 31, 2024. These amounts were estimated based on the same methodologies and assumptions used for regulatory reporting purposes. At March 31, 2025, we had $109.0 million in brokered deposits, or 1.86% of total deposits, compared to $110.0 million, or 1.93% of total deposits, at December 31, 2024. 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. The Company regularly monitors liquidity, models liquidity stress scenarios to ensure that adequate liquidity is available, and has contingency funding plans in place, which are reviewed and tested on a regular, recurring basis.

The following table summarizes the Company's available liquidity as of the dates indicated:

(Dollars in thousands)

(1) Investment securities available for sale at fair value.

(2) Includes FHLB borrowing availability of $1.35 billion at March 31, 2025 based on pledged assets, however, maximum credit capacity is 45% of the Bank's total assets one quarter in arrears or $3.20 billion.

Management believes the capital sources are adequate to meet all reasonably foreseeable short-term and long-term cash requirements and there has not been a material change in our capital resources since the information disclosed in our 2024 Annual Form 10-K. We are not aware of any reasonably likely material changes in the mix and relative cost of such resources.

Critical Accounting Estimates

Our critical accounting estimates are described in detail in the "Critical Accounting Estimates" section within Item 7 of our 2024 Annual Form 10-K. The SEC defines "critical accounting estimates" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. The Company's critical accounting estimates include estimates of the ACL on loans and goodwill. There have been no material changes in these estimates during the three months ended March 31, 2025.

Like other financial institutions, the Company is subject to 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 March 31, 2025, 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 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 dates indicated:

(Dollars in thousands)

The Company’s balance sheet sensitivity to changes in market rates shows a small increase in asset sensitivity compared to December 31, 2024. This is due primarily to balance sheet changes that include a reduction in short-term wholesale funding and a reduction in fixed rate securities. For each of the interest rate scenarios modeled and measured by management as presented in the preceding table, results at March 31, 2025 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.

(a) Evaluation of Disclosure Controls and Procedures

Our management has evaluated, with the participation and under the supervision of our Chief Executive Officer (the Company’s principal executive officer) and Chief Financial Officer (the Company’s principal financial officer), the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that that information required to be disclosed in reports that it files under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the three months ended March 31, 2025 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.