COLUMBIA BANKING SYSTEM, INC. (COLB) FY 2022 MD&A

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion should be read in conjunction with our Consolidated Financial Statements and related notes in “Item 8. Financial Statements and Supplementary Data” of this report. In the following discussion, unless otherwise noted, references to increases or decreases in average balances in items of income and expense for a particular period and balances at a particular date refer to the comparison with corresponding amounts for the period or date for the previous year. For comparison of 2021 to 2020 results and other 2020 information not included herein, refer to “Management Discussion and Analysis of Financial Condition and Results of Operations” under Part II, Item 7 of our 2021 Form 10-K filed with the SEC on February 25, 2022.

Critical Accounting Policies and Estimates

We have established certain accounting policies in preparing our Consolidated Financial Statements that are in accordance with accounting principles generally accepted in the United States. Our significant accounting policies are presented in Note 1 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report. Certain of these policies require the use of judgments, estimates and economic assumptions which may prove inaccurate or are subject to variation that may significantly affect our reported results of operations and financial position for the periods presented or in future periods. Management believes that the judgments, estimates and economic assumptions used in the preparation of the Consolidated Financial Statements are appropriate given the factual circumstances at the time. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our Consolidated Financial Statements.

Allowance for Credit Losses

The Company’s determination of its ACL is a critical accounting estimate. The allowance for credit losses under ASC 326 is an accounting estimate of expected losses over the contractual life of assets carried at amortized cost within the Company’s loan portfolio at the balance sheet date. The ASU requires a financial asset (or group of financial assets) measured at amortized cost 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 quantitative allowance is calculated using a DCF approach with a probability of default methodology. The probability of default is an assumption derived from regression models which determine the relationship between historical defaults and certain economic variables. The Company determines a reasonable and supportable forecast and applies that forecast to the model to determine defaults over the forecast period. The forecast includes estimates for key economic variables. While there are several economic variables included, the ones most predominantly used in our models are unemployment rate, consumer price index, real gross domestic product and disposable personal income. Following the forecast period, the economic variables used to calculate the probability of default revert to a historical average. Other assumptions relevant to the discounted cash flow model to derive the quantitative allowance include the loss given default, which is the estimate of loss for a defaulted loan, and the discount rate applied to future cash flows. The model calculates the net present value of each loan using both the contractual and expected cash flows, respectively. The ACL is determined at the end of each quarter and is based on all relevant information and expectations at that time in accordance with GAAP and the ACL guidance. Future changes to the estimate are likely as new information becomes available regarding economic conditions, loan composition and identifiable risk factors. While quantifiable estimates are generated, management judgements regarding credit risks and the inherent imprecision with the models utilized support the overall ACL.

In addition to the quantitative portion of the allowance for credit losses, the Company also considers the effects of the following qualitative factors in its calculation of expected losses in the loan portfolio:

•Economic and business conditions;

•Concentration of credit;

•Lending management and staff;

•Lending policies and procedures;

•Loss and recovery trends;

•Nature and volume of the portfolio;

•Trends in problem loans, loan delinquencies and nonaccrual loans;

•Quality of internal loan review; and

•Other external factors such as the effect of economic stimulus and loan modification programs.

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These qualitative factors are based in quantitative factors but also include a high degree of subjectivity and changes in any of the factors could have a significant impact on our calculation of the allowance.

Loans for which repayment is expected to be provided substantially through the operation or sale of collateral are considered collateral-dependent. The allowance for credit losses for collateral-dependent loans is measured on the basis of the fair value of the collateral when foreclosure is probable.

Our ACL at December 31, 2022 was $158.4 million. Given the dynamic relationships between economic variables, it is difficult to estimate the impact of a change in any one individual variable on the ACL. To illustrate a hypothetical sensitivity, however, we performed an analysis on the unemployment rate economic variable to evaluate the impact of a change in that assumption over the reasonable and supportable forecast period. If the unemployment rate increased by 100 basis points, the quantitative ACL estimate would increase by $2.9 million and if the unemployment rate were decreased by 100 basis points, the quantitative ACL estimate would decrease by $2.4 million.

Our allowance policy and the judgments, estimates and economic assumptions involved are described in greater detail in the “Allowance for Credit Losses and Unfunded Commitments and Letters of Credit” section of this discussion and in Note 1 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

Business Combinations

The Company applies the acquisition method of accounting for business combinations. Under the acquisition method, the acquiring entity in a business combination recognizes the assets acquired and liabilities assumed at their acquisition date fair values. Management utilizes prevailing valuation techniques appropriate for the asset or liability being measured in determining these fair values. Any excess of the purchase price over amounts allocated to assets acquired, including identifiable intangible assets, and liabilities assumed is recorded as goodwill. Where amounts allocated to assets acquired and liabilities assumed is greater than the purchase price, a bargain purchase gain is recognized. Merger-related costs are expensed as incurred.

Valuation and Recoverability of Goodwill

Goodwill represented $823.2 million of our $20.27 billion in total assets as of December 31, 2022. The Company has a single reporting unit. We review goodwill for impairment annually as of July 31, and also test for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting unit below its carrying amount. Such events and circumstances may include among others: a significant adverse change in legal factors or in the general business climate; significant decline in our stock price and market capitalization; unanticipated competition; the testing for recoverability of a significant asset group within the reporting unit; and an adverse action or assessment by a regulator. Any adverse change in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our Consolidated Financial Statements.

Under the Intangibles-Goodwill and Other topic of the FASB ASC, goodwill is not amortized but rather is tested for impairment at the reporting unit level on at least an annual basis. The test for impairment requires the Company to compare the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit is less than its carrying value, the difference is the amount of impairment and goodwill is written down to the fair value of the reporting unit. Prior to completing the impairment test, however, the Company may assess qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If such an assessment indicates the fair value of the reporting unit is more likely than not greater than its carrying value, then the impairment test need not be completed.

The accounting estimates related to our goodwill require us to make considerable assumptions about fair value. Our assumptions regarding fair value require significant judgment about economic and industry factors and the growth and earnings prospects of the Bank. Changes in these judgments, either individually or collectively, may have a significant effect on the estimated fair value.

Based on the results of the annual goodwill impairment test, we determined that no goodwill impairment charges were required as our single reporting unit’s fair value exceeded its carrying amount. As of December 31, 2022, we determined there were no events or circumstances which would more likely than not reduce the fair value of our reporting unit below its carrying amount.

Please refer to Note 9 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report for further discussion.

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2022 Financial Summary

Income Statement

•Consolidated net income for 2022 was $250.2 million, or $3.20 per diluted common share, compared with net income of $202.8 million, or $2.78 per diluted common share in 2021.

◦Net interest income in 2022 increased 18% to $622.8 million compared to $527.5 million in 2021. Interest income was $646.5 million in 2022, compared to $536.1 million in 2021. The increase was primarily due to higher interest income from loans. Interest expense for 2022 increased $15.1 million to $23.6 million compared to $8.5 million in 2021, due to higher deposit interest expense as a result of higher average rates and increased average balances of FHLB advances.

◦Provision for credit loss on loans was $2.0 million in 2022, compared to $4.8 million in 2021. The decrease in provision expense for 2022 reflects improving credit quality, the removal of allowance for credit loss on loans transferred to held for sale in connection with the branch divestitures related to our pending merger with Umpqua, a reduction in COVID-19 related reserve impacts and recoveries outpacing charge-offs.

◦Noninterest income was $99.1 million in 2022, an increase from $94.1 million in 2021. The increase in 2022 was primarily due to a $3.7 million gain from the sale-leaseback of owned real estate, increased deposit account and treasury management fees, card revenue, financial services and trust revenue. This was partially offset by a decrease in mortgage banking revenue.

◦Noninterest expense in 2022 increased $42.1 million to $402.4 million compared to $360.3 million in 2021. The increase was primarily due to higher compensation and employee benefits and occupancy expense mainly driven by our acquisition of Bank of Commerce Holdings in the fourth quarter of 2021. Higher other noninterest expense, data processing and software, regulatory premiums and merger-related expenses also contributed to the increase from the prior period.

Balance Sheet

•Total assets at December 31, 2022 were $20.27 billion, down 3%, or $679.5 million from $20.95 billion at the end of 2021.

•The Company is well-capitalized with a total risk-based capital ratio of 13.98% at December 31, 2022.

◦Cash and cash equivalents at December 31, 2022 were $291.7 million, down 65% from $824.7 million at December 31, 2021 due to a decrease in interest-earning deposits with banks.

◦Debt securities at December 31, 2022 were $6.62 billion, down 18% from $8.06 billion at December 31, 2021 due to a combination of fair value movement and repayments and maturities.

◦Loans were $11.61 billion, an increase of $969.0 million from $10.64 billion at the end of 2021.

◦The ACL increased to $158.4 million at December 31, 2022 compared to $155.6 million at December 31, 2021 due to loan growth. The Company’s allowance was 1.36% of total loans, compared with 1.46% at the end of 2021 as a result of improving credit quality.

◦Nonperforming assets totaled $23.4 million at December 31, 2022, down from $35.4 million at December 31, 2021. Nonperforming assets to year end assets decreased to 0.11% at December 31, 2022 compared to 0.21% at December 31, 2021.

◦Deposits were $16.71 billion at December 31, 2022, a decrease of $1.30 billion compared to $18.01 billion at December 31, 2021.

◦FHLB advances were $954.3 million at December 31, 2022, an increase of $947.0 million compared to December 31, 2021.

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Business Combinations

On October 1, 2021, the Company completed its acquisition of Bank of Commerce. The Company acquired approximately $2.04 billion in assets, including $1.08 billion in loans measured at fair value and $1.74 billion in deposits. See Note 2 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report for further information regarding this acquisition. At December 31, 2022 our merger with Umpqua was still pending. See Note 26 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report for further information regarding this merger.

COVID-19 Update

We continue to follow recommended guidelines of healthcare officials in order to provide a safe environment for our associates and customers. The measures we have implemented remain effective in mitigating the spread of the virus in our organization and have allowed for the continued safe operation of our branches and facilities. Flexibility and adaptability have been key factors throughout the pandemic. As cases in communities slowed and local and state governments responded by adjusting guidelines, we adjusted controls accordingly. Throughout the COVID-19 pandemic, our preparedness allowed us to continue building our business while responding with appropriate precautions and protections for associates and customers.

For additional information on the impact and potential impact of COVID-19 on our business, financial condition, liquidity, capital and results of operations, see Part I, Item 1A “Risk Factors” of this report.

RESULTS OF OPERATIONS

Summary

A summary of the Company’s results of operations for each of the last three years ended December 31 follows:

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Net Interest Income

Net interest income is the difference between interest income and interest expense. Net interest income on a fully taxable-equivalent basis expressed as a percentage of average total interest-earning assets is referred to as the net interest margin, which represents the average net effective yield on interest-earning assets.

The following table sets forth the average balances of all major categories of interest-earning assets and interest-bearing liabilities, the total dollar amounts of interest income on interest-earning assets and interest expense on interest-bearing liabilities, the average yield earned on interest-earning assets and average cost of interest-bearing liabilities by category and in total, net interest income, net interest spread, net interest margin and the ratio of average interest-earning assets to interest-bearing liabilities:

Net Interest Income Summary

__________

(1)Nonaccrual loans have been included in the table as loans carrying a zero yield. Amortized net deferred loan fees and unearned net discounts on acquired loans were included in the interest income calculations. The amortization of net deferred loan fees was $11.2 million, $32.2 million and $21.6 million for the years ended December 31, 2022, 2021 and 2020, respectively. The incremental amortization of net unearned discounts on acquired loans was $3.9 million for the year ended December 31, 2022 compared to net accretion of $2.8 million and $6.2 million for the years ended December 31, 2021 and 2020.

(2)Yields are shown on a fully taxable equivalent basis. The tax equivalent yield adjustment to interest earned on loans was $4.3 million, $4.7 million and $4.9 million for the years ended December 31, 2022, 2021 and 2020, respectively. The tax equivalent yield adjustment to interest earned on tax exempt securities was $3.9 million, $3.1 million and $2.5 million for the years ended December 31, 2022, 2021 and 2020, respectively.

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Net interest income is impacted by the volume (changes in volume multiplied by prior rate), interest rate (changes in rate multiplied by prior volume) and the mix of interest-earning assets and interest-bearing liabilities. The following table shows changes in net interest income on a fully taxable-equivalent basis between 2022 and 2021, as well as between 2021 and 2020 broken down between volume and rate. Changes attributable to the combined effect of volume and interest rates have been allocated proportionately to the changes due to volume and the changes due to interest rates:

Changes in Net Interest Income

__________

(1) The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amount of the change in each.

Comparison of 2022 with 2021

Taxable-equivalent net interest income totaled $631.1 million in 2022, compared with $535.3 million for 2021. The increase in net interest income during 2022 resulted from the increase in the size and average rate of the loan and investment securities portfolios. This was partially offset by increased interest expense on deposits due to the higher rate environment and higher FHLB advance balances.

The Company’s net interest margin (tax equivalent) increased from 3.17% for the year ended December 31, 2021 to 3.34% for the current year. The increase in the net interest margin (tax equivalent) was predominantly driven by the increase in the size and average rate of the loan and investment securities portfolios. This was partially offset by a shift in the funding mix from deposits to higher-costing FHLB advances. The Company’s operating net interest margin (tax equivalent) increased from 3.17% for the year ended December 31, 2021 to 3.39% for the current year for the same reasons noted in the net interest margin increase discussed above. For additional information on Non-GAAP measures, see the Non-GAAP Measures section of this discussion.

For a discussion of the methodologies used by management in recording interest income on loans, please see Note 1 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

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Provision for Credit Losses

The Company accounts for the credit risk associated with lending activities through its ACL and provision for credit losses. The provision is the expense recognized in the Consolidated Statements of Income to adjust the allowance to the level deemed appropriate by management, as determined through its application of the Company’s allowance methodology procedures. For discussion of the methodology used by management in determining the adequacy of the ACL, see the “Allowance for Credit Losses and Unfunded Commitments and Letters of Credit” and “Critical Accounting Policies” sections of this discussion.

The Company recorded provision expense of $2.0 million for credit losses during 2022 compared to a provision expense of $4.8 million for 2021. A provision expense of $77.7 million was recorded in 2020. The decrease in provision expense for 2022 was due to improved credit quality, the removal of allowance for credit loss on loans transferred to held for sale in connection with the branch divestitures related to our pending merger with Umpqua, a reduction in COVID-19 related reserve impacts and recoveries outpacing charge-offs. In addition, the provision recorded in 2022 included management’s ongoing assessment of the credit quality of the Company’s loan portfolio. Factors affecting the provision include net charge-offs, credit quality migration and size and composition of the loan portfolio and changes in the economic environment during the period. See “Allowance for Credit Losses and Unfunded Commitments and Letters of Credit” section of this discussion for further information on factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the ACL.

Net loan recoveries for the year ended December 31, 2022 were $910 thousand. For the years ended December 31, 2021 and 2020, net loan charge-offs amounted to $978 thousand, and $14.2 million, respectively.

Noninterest Income

The following table presents the significant components of noninterest income and the related dollar and percentage change from period to period:

Comparison of 2022 with 2021

The $5.1 million increase in noninterest income was due to increases in other noninterest income, deposit account and treasury management fees, card revenue and financial services and trust revenue partially offset by decreases in loan revenue. The increase in other noninterest income was primarily related to a $3.7 million gain from the sale-leaseback of owned real estate. The increases in noninterest income were partially offset by a decrease in loan revenue primarily driven by a decrease in mortgage banking revenue, which was caused by an overall reduction in loan volumes due to the higher rate environment.

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Noninterest Expense

The following table presents the significant components of noninterest expense and the related dollar and percentage changes from period to period:

The following table shows the impact of the merger-related expenses for the periods indicated to the various components of noninterest expense:

__________

(1)The Company completed the Bank of Commerce acquisition on October 1, 2021.

(2)The Company expects to close this transaction after the close of business on February 28, 2023.

Comparison of 2022 with 2021

Noninterest expense was $402.4 million in 2022, an increase of $42.1 million over 2021. Merger-related expenses in the current year were $19.1 million, an increase of $4.6 million over 2021. After removing the effect of merger-related expenses, noninterest expense increased $37.5 million mainly due to higher compensation and employee benefits stemming from additional personnel costs associated with the Bank of Commerce acquisition and lower loan origination costs related to the prior year PPP loan production. Higher occupancy expense was also associated with the Bank of Commerce acquisition. In addition, data processing expense and regulatory premiums increased. Other noninterest expense increased mainly due to higher net loan expense, travel and entertainment expenses and fraud losses. These increases were partially offset by a provision recapture for unfunded loan commitments.

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The provision (recapture) for unfunded loan commitments, a component of other noninterest expense, are as follows for the periods indicated:

Income Tax

For the years ended December 31, 2022, 2021 and 2020, we recorded income tax provisions of $67.5 million, $53.7 million and $38.1 million, respectively. The effective tax rate was 21% in 2022 and 2021 and 20% in 2020. For additional information, see Note 25 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

Financial Condition

Our total assets decreased 3% to $20.27 billion at December 31, 2022 from $20.95 billion at December 31, 2021. Cash and cash equivalents decreased $533.0 million. Total debt securities decreased $1.44 billion due to a combination of maturities, repayments and fair value movement. The loan portfolio, net of the allowance for credit losses, increased $966.2 million.

Liabilities decreased $303.9 million, or 2% to $18.05 billion due to a decrease in total deposits partially offset by increases in FHLB advances. Total deposits decreased $1.30 billion. Total shareholders’ equity decreased $375.6 million to $2.21 billion primarily as a result of market value decreases in our available for sale securities portfolio, which are recorded to accumulated other comprehensive income, net of tax.

Investment Portfolio

We invest in securities to generate revenue for the Company, to manage liquidity while minimizing interest rate risk and to provide collateral for certain public deposits and short-term borrowings. The amortized cost amounts represent the Company’s original cost for the investments, adjusted for accumulated amortization or accretion of any yield adjustments related to the security. The estimated fair values are the amounts we believe the securities could be sold for as of the dates indicated. At December 31, 2022, gross unrealized losses in our debt securities available for sale portfolio were $694.3 million related to 1,378 separate available for sale securities. Based on past experience with these types of securities and our own financial performance, we do not currently intend to sell any securities in a loss position nor does available evidence suggest it is more likely than not that management will be required to sell any securities currently in a loss position before the recovery of the amortized cost basis. We review these investments for credit losses on an ongoing basis.

All of the Company’s debt securities held to maturity were issued by U.S. government agencies or U.S. government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss. Therefore, the Company did not record an allowance for credit losses for these securities as of December 31, 2022.

Debt securities available for sale decreased $1.32 billion from the prior year due to maturities and repayments of $770.7 million, $706.7 million in net unrealized losses, and premium amortization of $31.0 million, partially offset by purchases of $186.5 million. Debt securities held to maturity decreased by $113.5 million due to maturities and repayments of $188.4 million and premium amortization of $22.7 million, partially offset by purchases of $97.7 million.

At December 31, 2022, U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations comprised 71% of our debt securities portfolio, other asset-backed securities were 5%, state and municipal securities were 13% and government agency, government-sponsored enterprise securities were 3%, government securities were 3% and non-agency collateralized mortgage obligations were 5%. The portion of our investment portfolio that is categorized as available for sale is carried on our balance sheet at fair value and the average duration was approximately 5 years and 2 months at December 31, 2022. The portion of our investment portfolio that is categorized as held to maturity is carried on our balance sheet at amortized cost and had an average duration of approximately 5 years and 7 months at December 31, 2022. These durations take into account calls, where appropriate, and consensus prepayment speeds.

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The following table presents the contractual maturities and weighted average yield of our investment portfolio:

__________

(1)The maturities reported for mortgage-backed securities, collateralized mortgage obligations, other asset-backed securities, government agency and government-sponsored enterprise securities, government securities, and non-agency collateralized mortgage obligations are based on contractual maturities and principal amortization.

(2)Yields on fully taxable equivalent basis.

For further information on our investment portfolio, see Note 4 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

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FHLB Stock

The FHLB stock is composed of two sub-classes: membership stock and activity based stock. Membership stock is stock we are required to purchase and hold as a condition of membership in the FHLB. The Company’s membership stock purchase requirement is measured as a percentage of our year end assets, subject to a $10 million cap. Activity based stock is stock we are required to purchase and hold in order to obtain an advance or participate in FHLB mortgage programs. The Company’s activity based stock purchase requirement is measured as a percentage of our advance proceeds. At December 31, 2022, the Company held $48.2 million of FHLB Class B stock, $10.0 million of which was membership stock and the remaining $38.2 million of which was activity based. The FHLB stock is issued, transferred, redeemed, and repurchased at a par value of $100.

Loan Portfolio

Our wholly-owned banking subsidiary Columbia State Bank is a full service commercial bank, which originates a wide variety of loans, and focuses its lending efforts on originating commercial real estate and commercial business loans.

Commercial Real Estate Loans: Commercial real estate loans are secured by properties located within our primary market areas and typically, have loan-to-value ratios of 80% or lower at origination. Our underwriting standards for commercial and multifamily residential loans generally require that the loan-to-value ratio for these loans not exceed 75% of appraised value, cost, or discounted cash flow value, as appropriate, and that commercial properties maintain debt coverage ratios (net operating income divided by annual debt servicing) of 1.2 or better. However, underwriting standards can be influenced by competition and other factors. We endeavor to maintain the highest practical underwriting standards while balancing the need to remain competitive in our lending practices.

Commercial Business Loans: Our commercial business lending is directed toward meeting the credit and related deposit and treasury management needs of small to medium sized businesses. Commercial and industrial loans are primarily underwritten based on the identified cash flows of the borrower’s operations and secondarily on the underlying collateral provided by the borrower and/or the strength of the guarantor. The majority of these loans provide financing for working capital and capital expenditures. Loan terms, including, loan maturity, fixed or adjustable interest rate and collateral considerations, are based on factors such as the loan purpose, collateral type and industry and are underwritten on an individual loan basis.

Agriculture Loans: Agricultural lending includes agricultural real estate and production loans and lines of credit within our primary market area. We are committed to our communities, offering seasonal and longer-term loans and operating lines of credit by lending officers with expertise in the agricultural communities we serve. Typical loan-to-value ratios on term loans can range from 55% to 80% depending upon the type of loan. Operating lines of credit require the borrower to provide a 20% to 25% equity investment. The debt coverage ratio is generally 1.25 or better on all term loans.

Construction Loans: We originate a variety of real estate construction loans. Underwriting guidelines for these loans vary by loan type but include loan-to-value limits, term limits and loan advance limits, as applicable. Our underwriting guidelines for commercial and multifamily residential real estate construction loans generally require that the loan-to-value ratio not exceed 75% and stabilized debt coverage ratios (net operating income divided by annual debt service) of 1.2 or better. As noted above, underwriting standards can be influenced by competition and other factors. However, we endeavor to maintain the highest practical underwriting standards while balancing the need to remain competitive in our lending practices.

One-to-four Family Residential Real Estate Loans: One-to-four family residential loans, including home equity loans and lines of credit, are secured by properties located within our primary market areas and, typically, have loan-to-value ratios of 80% or lower at origination.

Other Consumer Loans: Consumer loans include automobile loans, boat and recreational vehicle financing, and other miscellaneous personal loans.

Foreign Loans: The Company has no material foreign activities. Substantially all of the Company’s loans and unfunded commitments are geographically concentrated in its service areas within the states of Washington, Oregon, Idaho and California.

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Maturities and Sensitivities of Loans to Changes in Interest Rates

The following table presents the maturity distribution of our loan portfolio and the sensitivity of these loans due after one year to changes in interest rates as of December 31, 2022:

Net unearned acquisition premium (discount): The following table provides additional details related to the net premium (discount) of acquired and purchased loans, by acquisition for the periods indicated:

For additional information on our loan portfolio, including amounts pledged as collateral on borrowings, see Note 5 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

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Allowance for Credit Losses

The ACL is an accounting estimate of expected credit losses in our loan portfolio at the balance sheet date. The provision for credit losses is the expense recognized in the Consolidated Statements of Income to adjust the ACL to the levels deemed appropriate by management, as measured by the Company’s credit loss estimation methodologies. The allowance for unfunded commitments and letters of credit is maintained at a level believed by management to be sufficient to absorb estimated expected losses related to these unfunded credit facilities at the balance sheet date.

Analysis of ACL

The table below sets forth the ratio of net charge-offs during the period to average loans outstanding during the period:

Allocation of the ACL

The table below sets forth the allocation of the ACL by loan category:

__________

(1)Represents the total of all outstanding loans in each category as a percent of total loans outstanding.

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Credit Ratios

The following table sets forth the ratios between the ACL, nonaccrual loans and total loans:

The increase in the ratio of ACL to nonaccrual loans from 2020 to 2021, as well as 2021 to 2022, was primarily due to decreases in nonaccrual loans and increases in the ACL as a result of loan growth. For additional information on our allowance for credit losses, see Note 6 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

Deposits

The following table sets forth the composition of the Company’s deposits by significant category:

__________

(1) Includes $259.4 million of noninterest-bearing deposits and $325.7 million of interest-bearing deposits classified as held for sale at December 31, 2022.

Deposits totaled $16.71 billion at December 31, 2022 compared to $18.01 billion at December 31, 2021. Noninterest-bearing deposits, interest-bearing deposits, and reciprocal money market accounts provide a stable source of low cost funding.

At December 31, 2022, broker deposits, other wholesale deposits and reciprocal money market accounts (excluding public funds) totaled $818.0 million or 4.9% of total deposits compared to $821.7 million or 4.6% of total deposits, at year end 2021. The reciprocal money market account program is similar to the CD Option of IntraFi Network Deposits program, which is a network that allows participating banks to offer extended FDIC deposit insurance coverage on time deposits. These extended deposit insurance programs are generally available only to existing customers and are not used as a means of generating additional liquidity.

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At December 31, 2022, public funds held by the Company totaled $949.0 million compared to $1.07 billion at December 31, 2021. Uninsured public funds balances decreased from $1.00 billion at December 31, 2021 to $877.7 million at December 31, 2022. The Company is required to collateralize 50% of Washington state, 40% of Oregon state and 110% of California state uninsured public funds. For additional information regarding the collateral for these deposits, see Note 4 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

The following table sets forth time deposits in excess of the FDIC insurance limit, which is currently $250,000, by time remaining until maturity:

__________

(1) Includes $4.1 million of certificates of deposit held for sale at December 31, 2022.

As of December 31, 2022, the Company had approximately $7.19 billion of uninsured deposits, which is an estimated amount based on the same methodologies and assumptions used for the Bank’s regulatory requirements.

The following table sets forth the average amount of and the average rate paid on each significant deposit category:

Borrowings

Borrowed funds provide an additional source of funding for loan growth. Our borrowed funds consist primarily of FHLB advances, FRB borrowings, securities sold under agreements to repurchase, subordinated debentures, junior subordinated debentures and a revolving line of credit. FHLB advances and FRB borrowings are secured by our loan portfolio and investment securities. Securities sold under agreements to repurchase are secured by investment securities. Subordinated debentures and junior subordinated debentures are unsecured and the revolving line of credit is available, if necessary, and requires the Company to comply with certain covenants including those related to asset quality and capital levels. For additional information on our borrowings, see Notes 12, 13, 14, 15, and 16 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

Off-Balance Sheet Arrangements

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the Consolidated Balance Sheets.

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Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company evaluates each client’s creditworthiness on a case-by-case basis.

Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The Company had off-balance sheet loan commitments aggregating $3.91 billion and $3.50 billion at December 31, 2022 and 2021, respectively. Standby letters of credit were $33.2 million at December 31, 2022, a decrease from $36.0 million at December 31, 2021.

Liquidity and Sources of Funds

In general, our primary sources of funds are net income, loan repayments, maturities and principal payments on investment securities, customer deposits, advances from the FHLB, borrowings from the FRB, securities repurchase agreements, subordinated debentures, junior subordinated debentures and a revolving line of credit available, if necessary. These funds are used to make loans, purchase investments, meet deposit withdrawals and maturing liabilities and cover operational expenses. Scheduled loan repayments and client deposits have proven to be a relatively stable source of funds while other deposit inflows and unscheduled loan prepayments are influenced by interest rate levels, competition and general economic conditions. We manage liquidity through monitoring sources and uses of funds on a daily basis and had unused credit lines with the FHLB and the FRB of $1.92 billion and $198.8 million, respectively, at December 31, 2022, that are available to us as a supplemental funding source. The holding company’s sources of funds are dividends from its banking subsidiary which are used to fund dividends to shareholders, purchase treasury shares and cover operating expenses.

In addition, we have a shelf registration statement on file with the SEC registering an unspecified amount of any combination of debt or equity securities, depository shares, purchase contracts, units and warrants in one or more offerings. From time to time, we may seek to raise additional capital in order to meet our commitments, fund our business needs and future growth, and supplement our regulatory capital. Specific information regarding the terms of the securities being offered will be provided at the time of any offering. Proceeds from any future offerings are expected to be used for general corporate purposes, including, but not limited to, the repayment of debt, repurchasing or redeeming outstanding securities, working capital, funding future acquisitions or other purposes identified at the time of any future offering.

We are party to many contractual financial obligations, including repayments of deposits and borrowings and payments for operating leases. The table below presents certain future financial obligations of the Company:

__________

(1) In the banking industry, interest-bearing obligations are principally used to fund interest-earning assets. As such, interest charges on contractual obligations were excluded from reported amounts, as the potential cash outflows would have corresponding cash inflows from interest-earning assets.

(2) Includes $585.1 million of deposits held for sale at December 31, 2022.

For additional information regarding our contractual obligations, see Notes 10, 11, 12, 13, 14 and 15 to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.

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Capital

Our shareholders’ equity decreased to $2.21 billion at December 31, 2022, from $2.59 billion at December 31, 2021. This decrease was primarily a result of market value decreases in our available for sale securities portfolio, partially offset by higher retained earnings. Shareholders’ equity was 10.92% and 12.36% of total assets at December 31, 2022 and 2021, respectively. Dividends per common share were $1.20 and $1.14, for the years ended December 31, 2022 and 2021, respectively.

Regulatory Capital. We are subject to the Capital Rules (as discussed in “Item 1. Business—Supervision and Regulation—Regulatory Capital Requirements”), which implement the Basel III capital framework and various provisions of the Dodd-Frank Act. The Company and the Bank are required to maintain a capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) total capital to risk-weighted assets of at least 10.5%. The Company and the Bank met all such capital requirements as of December 31, 2022.

In addition, FDIC regulations set forth the qualifications necessary for a bank to be classified as “well-capitalized” (as discussed in “Item 1. Business—Supervision and Regulation—Prompt Corrective Action Framework”), primarily for assignment of FDIC insurance premium rates. Failure to qualify as “well-capitalized” can negatively impact a bank’s ability to expand and to engage in certain activities. The Company and the Bank qualified as “well-capitalized” at December 31, 2022 and 2021.

As part of their response to the impact of COVID-19, the U.S. federal regulatory agencies issued an interim final rule that provided the option to temporarily delay certain effects of CECL on regulatory capital for two years, followed by a three year transition period. The interim final rule allows bank holding companies and banks to delay for two years 100% of the day one impact of adopting CECL and 25% of the cumulative change in the reported allowance for credit losses since adopting CECL. The Company elected to adopt the interim final rule. As a result, certain capital ratios and amounts as of December 31, 2022 exclude the impact of the increased allowance for credit losses related to the adoption of CECL.

The following table sets forth the Company’s and the Bank’s capital ratios at December 31, 2022 and 2021:

Dividends

The following table sets forth the dividends paid per common share and the dividend payout ratio (dividends paid per common share divided by diluted EPS):

______________

(1) Dividends paid per common share as a percentage of earnings per diluted common share

Subsequent to year end, on January 24, 2023, the Company declared a quarterly cash dividend of $0.30 per share payable on February 21, 2023, to shareholders of record at the close of business on February 6, 2023.

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Applicable federal and Washington state regulations restrict capital distributions, including dividends, by the Company’s banking subsidiary. Such restrictions are tied to the institution’s capital levels after giving effect to distributions. Our ability to pay cash dividends is substantially dependent upon receipt of dividends from the Bank. In addition, the payment of cash dividends is subject to Federal regulatory requirements for capital levels and other restrictions. In this regard, current guidance from the Federal Reserve provides, among other things, that dividends per share on the Company’s common stock generally should not exceed EPS, measured over the previous four fiscal quarters. Federal Reserve policy also provides that a bank holding company should inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period for which the dividend is being paid or that could result in a material adverse change to the bank holding company’s capital structure.

Non-GAAP Financial Measures

In addition to the capital ratios defined by banking regulators, the Company considers various measures when evaluating capital utilization and adequacy, including:

•Tangible common equity to tangible assets, and

•Tangible common equity to risk-weighted assets.

The Company believes these measures are useful because they reflect the level of capital available to withstand unexpected market conditions. Additionally, presentation of these measures allows readers to compare certain aspects of the Company’s capitalization to other organizations. These ratios differ from capital measures defined by banking regulators principally in that the numerator excludes shareholders’ equity associated with preferred securities, the nature and extent of which varies across organizations. Additionally, these measures present capital adequacy inclusive and exclusive of accumulated other comprehensive income. These calculations are intended to complement the capital ratios defined by banking regulators for both absolute and comparative purposes.

Because GAAP in the United States of America does not include capital ratio measures, the Company believes there are no comparable GAAP financial measures to these tangible common equity ratios. The following table reconciles the Company’s calculation of these measures to amounts reported under GAAP.

Despite the importance of these measures to the Company, there are no standardized definitions for them and, as a result, the Company’s calculations may not be comparable with other organizations. The Company encourages readers to consider its Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

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The Company also considers operating net interest margin (tax equivalent) to be a useful measurement as it closely reflects the ongoing operating performance of the Company. Additionally, presentation of the operating net interest margin allows readers to compare certain aspects of the Company’s net interest margin to other organizations that may not have had significant acquisitions. Despite the usefulness of the operating net interest margin to the Company, there is no standardized definition for it and, as a result, the Company’s calculations may not be comparable with other organizations. The Company encourages readers to consider its Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

The following table reconciles the Company’s calculation of the operating net interest margin (tax equivalent) to the net interest margin (tax equivalent) for the periods indicated:

__________

(1) Tax-exempt interest income has been adjusted to a tax equivalent basis. The amount of such adjustment was an addition to net interest income of $8.2 million, $7.8 million and $7.5 million for the years ended December 31, 2022, 2021 and 2020, respectively.

(2) Beginning 2021, interest reversals on nonaccrual loans is no longer a component of this non-GAAP measure.

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