HERITAGE FINANCIAL CORP WA

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.

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

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

(2) Average loans receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of $938,000 and $940,000 for the three months ended September 30, 2024 and 2023, 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 September 30, 2024 compared to the same period in 2023, 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:

Net interest income decreased $2.7 million, or 4.8%, to $53.0 million for the three months ended September 30, 2024, compared to $55.6 million for the same period in 2023 due primarily to a $9.0 million increase in total interest expense, offset partially by a $6.4 million increase in total interest income.

Total interest income increased to $79.8 million for the three months ended September 30, 2024, compared to $73.5 million for the same period in 2023. The increase was primarily due to a $8.0 million increase in interest income on loans receivable, net, offset partially by a $1.4 million decrease in interest income on investment securities during the three months ended September 30, 2024 as compared to the same period in 2023. Interest income on loans receivable, net, increased due to increases in both the average yield earned on and the average outstanding balance of those assets. The yield earned on loans receivable, net, increased 30 basis points to 5.60% and the average balance of loans receivable, net, increased $353.5 million to $4.56 billion during the three months ended September 30, 2024, as compared to the same period in 2023.

Interest income on investment securities decreased $1.4 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 34 basis points to 3.34% and average balances decreased $327.1 million to $1.60 billion during the three months ended September 30, 2024 compared to 3.00% and average balances of $1.93 billion during the same period in 2023.

Total interest expense increased to $26.9 million during the three months ended September 30, 2024 compared to $17.8 million for the same period in 2023. The increase was due primarily to a $8.4 million increase in interest expense on interest bearing deposits and a $0.7 million increase in interest expense on borrowings during the three months ended September 30, 2024, as compared to the same period in 2023. The increase in interest expense on interest bearing deposits was due primarily to a 79 basis point increase in the average rate to 2.02% for the three months ended September 30, 2024, as compared to 1.23% for the same period in 2023 due to competitive rate pressures, and to a lesser extent, a $353.7 million increase in the average balance of certificates of deposit which are generally at higher rates than other deposit products.

Net interest margin decreased 14 basis points to 3.33% for the three months ended September 30, 2024 compared to 3.47% for the same period in 2023.

Comparison of nine months ended September 30, 2024 to the comparable period in the prior year

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

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

(2) Average loans receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of $2.7 million and $2.4 million for the nine months ended September 30, 2024 and 2023, 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 nine months ended September 30, 2024 compared to the same period in 2023, 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:

Net interest income decreased $15.7 million, or 9.2%, to $155.6 million for the nine months ended September 30, 2024, as compared to $171.3 million for the same period in 2023, due primarily to an increase in total interest expense offset partially by an increase in total interest income.

Total interest income increased $20.5 million, or 9.8%, to $230.8 million for the nine months ended September 30, 2024, compared to $210.2 million for the same period in 2023. The increase was primarily due to a $22.4 million increase in interest income on loans receivable, net, and a $0.7 million increase in interest income on interest earning deposits, offset partially by a $2.6 million decrease in interest income on investment securities during the nine months ended September 30, 2024 as compared to the same period in 2023. Interest income on loans receivable, net, and interest earning deposits increased due to increases in both the average yield earned on and the average outstanding balance of those assets. The yield earned on loans receivable, net increased 32 basis points to 5.51% and the average balance of loans receivable, net, increased $295.8 million to $4.43 billion during the nine months ended September 30, 2024, as compared to the same period in 2023. Similarly, the yield earned on interest earning deposits increased 28 basis points to 5.45% and the average balance of those deposits increased $12.2 million to $127.0 million during nine months ended September 30, 2024, as compared to the same period in 2023.

Interest income on investment securities decreased $2.6 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 36 basis points to 3.34% and average balances decreased $275.8 million to $1.70 billion during the nine months ended September 30, 2024 compared to 2.98% and average balances of $1.98 billion during the same period in 2023.

Total interest expense increased $36.2 million, or 93.1%, to $75.2 million during the nine months ended September 30, 2024, compared to $38.9 million for the same period in 2023. The increase was due primarily to a $30.1 million increase in interest expense on interest bearing deposits and a $6.2 million increase in interest expense on borrowings during the nine months ended September 30, 2024, as compared to the same period in 2023. The increase in interest expense on deposits was due primarily to a 99 basis point increase in the average rate of interest bearing deposits to 1.87% for the nine months ended September 30, 2024, as compared to 0.88% for the same period in 2023, due to competitive rate pressures, and to a lesser extent, a $384.3 million increase in the average balance of certificates of deposit which are generally at higher rates than other deposit products. The increase of interest expense on borrowings was due primarily to a $145.0 million increase in average balances.

Net interest margin decreased 33 basis points to 3.31% for the nine months ended September 30, 2024, compared to 3.64% for the same period in 2023.