Notes to Financial Statements
December 31, 2022 and 2021
(1) Description of Plan
The following description of the Heritage Financial Corporation 401(k) Profit Sharing Plan and Trust (the "Plan") provides only general information. Participants should refer to the Plan agreement for a more complete description of the Plan’s provisions.
(a ) General
Heritage Financial Corporation (the "Company") is a bank-holding company headquartered in Olympia, Washington, and is considered the Plan Sponsor. The Plan is administered by the Advisory Committee, which consists of certain officers and employees of the Company.
The Plan is a qualified defined contribution plan established by the Company under the provisions of Section 401(a) and Section 401(k) of the Internal Revenue Code ("IRC") with salary reduction and employee stock ownership features for the benefit of eligible employees of the Company. The Plan is subject to the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA"), as amended.
(b) Eligibility
Employees are eligible to participate in the Plan on the first of the month coincident with or following employment.
(c) Contributions
Subject to certain Internal Revenue Service ("IRS") limitations discussed below, participants may make elective pre-tax 401(k) and after-tax Roth 401(k) contributions up to 100% of their eligible compensation. The IRS limitations include a dollar limitation of $20,500 for 2022 and certain discrimination testing limitations. Additionally, participants over the age of 50 at Plan year end may make catch-up contributions up to the applicable dollar limitation of $6,500 for 2022.
Participants may also contribute elective after-tax contributions to the Plan, subject to discrimination testing limitations.
Participants may also contribute rollovers into the Plan, which represent distributions from other qualified plans, if certain conditions are met. The Plan permits participants to convert amounts within the Plan to Roth accounts either as in-plan Roth rollovers or in-plan Roth transfers.
The Company makes a matching contribution to participant accounts equal to 50% of the participant’s contribution, up to 6% of the participant’s eligible compensation. Matching contributions are considered part of the employer contributions and are subject to discrimination limitations.
The Company's profit sharing contribution is discretionary. The Company did not make a discretionary contribution for the plan year 2022. Discretionary profit sharing contributions are considered part of the employer contributions.
The following provisions apply to employer contributions:
•Participants are eligible for matching contributions upon participation in the Plan.
•Matching and discretionary profit sharing contributions to the Plan are invested as directed by the employee.
•Participants, who are not credited with at least 1,000 hours of service during the Plan year or are not employed on the last working day of a Plan year, are not eligible for an allocation of discretionary profit sharing contributions for that year except in the event of the participant’s death, disability or retirement.
(d) Participants' Accounts
Each participant’s account is valued daily and credited with the participant's contribution and allocations of (a) the Company's contributions, (b) Plan earnings (losses), (c) forfeitures of employer profit sharing contributions, (d) participant withdrawals and (e) allocation of administrative expenses as determined by the Plan document.
Allocations are based on participant contributions, eligible compensation, participant account balances, or specific participant transactions, as defined. The benefit to which a participant is entitled is the benefit that can be provided from the participant’s vested account. Each participant directs the investment of his or her account to any of the investment options available under the Plan.
(e) Vesting
Participants are always 100% vested in all contributions and earnings thereon.
(f) Investment Options
Participants direct the investment of their contributions and the Company's matching contributions in 1% increments into various investment options offered by the Plan. The Plan currently offers investments in mutual funds, a stable value collective trust fund, and the Company's stock fund. Participants also have the option to invest in four different managed portfolio strategies or twelve different Target Retirement Date Funds. When a new participant is added to the Plan, any contribution will be allocated to the default investment option if the participant has inadvertently failed to provide investment election options.
The Company's stock fund is tracked on a unitized basis, which allows for daily trades, and consists of Company common stock and cash and cash equivalents (to meet daily cash needs).
Participants may change their investment elections and reallocate their investments on a daily basis. Contributions may be temporarily held as cash balances pending the execution of the investment according to the participant’s direction.
(g) Payment of Benefits
Generally, no distributions from the Plan may be made until a participant retires, dies (in which case, payment shall be made to his or her beneficiary or, if none, to his or her legal representatives), becomes disabled or otherwise terminates employment with the Company. However, the participant has the right to defer receipt of their Plan accounts until minimum distributions are required.
Distributions are made in cash, Company stock, or both (if eligible), at the election of the participant, subject to the terms of the Plan; are based on the participant’s vested account balance; and may be distributed in a lump sum. If a participant’s vested account balances exceed $5,000, a participant may elect to have the vested accounts distributed in a lump sum, a partial distribution or installments over a period of not more than the participant’s life expectancy.
Under certain conditions, participants, while still employed by the Company, are permitted to withdraw in a single sum, the employee deferral contribution portion of their account balance on account of hardship as defined in IRS regulations. In addition, participants, while still employed by the Company, are permitted to withdraw all or a portion of their account balances after age 59 1/2. Rollover accounts may be withdrawn, all or part, once during each Plan year regardless of the participant’s age.
The Plan provides for automatic rollovers for terminated participants with balances not exceeding $5,000 into an Individual Retirement Account (“IRA”) with Millennium Trust. Affected participants are notified of the change and provided an opportunity to distribute or move their funds. Participants are charged an annual $40 fee to maintain a balance.
(h) Voting and Dividend Rights
No participant shall have any voting or dividend rights or other rights of a stockholder prior to the time that shares are allocated to the participant.
Each participant is entitled to exercise voting rights attributable to the shares of Company common stock allocated to his or her account and is notified by the trustee prior to the time that such rights are to be exercised.
(i) Forfeitures
Forfeitures may be used to pay reasonable and permitted administrative expenses or to reduce the Company’s employer contribution obligation. There were no forfeitures used during 2022. There were no forfeitures available to be used at December 31, 2022 and December 31, 2021.
(j) Notes Receivable from Participants
Participants may borrow any amount provided that the aggregate amount of all outstanding notes from the participant to the Plan, taking into account notes payable to any other qualified plan maintained by the employer, shall not exceed the lesser of $50,000 or 50% of the participant’s vested account balance. Participants can request loans for any purpose. Note terms shall not exceed five years, except for the purchase of a primary residence. The notes are collateralized by the balance in the participant’s account and bear interest at a rate equal to the then current prime rate. Loans which were transferred into the Plan retain the repayment terms and interest rates in effect at the time of transfer. Principal and interest is paid ratably through semi-monthly payroll deductions.
(k) Administrative Expenses
Administrative expenses including trust, recordkeeping and investment advisor fees are paid by the Plan. Certain administrative expenses incurred by the Plan, including audit expenses, are paid directly by the Company and are excluded from these financial statements. Investment-related expenses are included in the net depreciation of fair value of investments.
(2) Summary of Significant Accounting Policies
(a) Basis of Accounting
The accompanying financial statements have been prepared under the accrual method of accounting. Investments held by a defined contribution plan are required to be reported at fair value.
(b) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and changes therein, and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
(c) Risks and Uncertainties
The Plan allows participants to direct contributions into various mutual funds, a stable value collective trust fund and Company stock. The mutual funds are all registered investment companies. The underlying investment securities of the mutual funds, stable value collective trust fund, and the Company stock are exposed to various risks, including but not limited to interest rate risk, market risk, liquidity risk, credit risk, and global events such as the Coronavirus Disease of 2019 pandemic. Due to the level of risk associated with certain underlying investment securities, the sensitivity of certain fair value estimates to changes in
valuation assumptions, and the level of uncertainty related to changes in the value of the funds, it is likely that changes in the value of investment securities will occur in the near term and that such changes could materially affect participants’ account balances and the amounts reported in the statement of net assets available for benefits and the statement of changes in net assets available for benefits.
Participants should refer to Heritage Financial Corporation’s annual and quarterly financial statements filed with the Securities and Exchange Commission (Form 10K and 10Q) regarding risks associated with Company stock.
(d) Investment Valuation and Income Recognition
The Plan’s investments are reported at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Plan Trustees determine the Plan’s valuation policies utilizing information provided by the investment advisers, custodians, and insurance company. See Note (3) Fair Value Measurements for discussion of fair value measurements.
Purchases and sales of securities are recorded on a trade-date basis. Dividend income is accrued on the ex-dividend date. Interest income is recorded on the accrual basis. Realized gains and losses from security transactions are reported on the moving average method. Net appreciation (depreciation) in fair value of investments represents the change in fair value from one period to the next and realized gains and losses.
(e) Payment of Benefits
Benefits are recorded when paid. There were no allocations to withdrawing participants at December 31, 2022 and $15,640 was allocated to withdrawing participants at December 31, 2021.
(f) Notes and Receivable from Participants
Notes receivable from participants are stated at the outstanding balance of the loan plus accrued interest. Interest income is recorded on the accrual basis. Related fees are recorded as administrative expenses and are expensed when they are incurred. All notes were current and the Plan recorded no allowance for credit losses on loans related to the outstanding notes receivable from participants as of December 31, 2022 and 2021.
(g) Excess Contributions Payable
Amounts payable to participants for contributions in excess of amounts allowed by the IRS are recorded as a liability with a corresponding reduction to contributions. The Plan distributes the excess contributions to the applicable participants before March 15th of the subsequent year. There were no excess contributions payable as of December 31, 2022 and December 31, 2021.
(h) Recently Issued Pronouncements
Secure 2.0 Act of 2022, In December 2022, Securing a Strong Retirement Act (SECURE 2.0) was passed into law. This package of laws builds on the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. SECURE Act 2.0 covers numerous changes to retirement provisions designed to increase retirement savings, facilitate access to retirement savings, encourage employees to save for retirement, and lower employers’ cost of offering and funding retirement savings plans. The majority of the SECURE 2.0 provisions will become effective in 2024. The provisions include both required and optional elements and the Plan Administrator will determine the optional provisions to elect. There was no impact to the Plan for the year ended December 31, 2022.
(3) Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2: Observable inputs other than Level 1 quoted prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs other than quoted prices that are observable or corroborated by observable market data. Level 2 quoted prices are obtained from independent third-party brokers or dealers, including prices derived from model-based valuation techniques for which the significant assumptions are observable in the market or corroborated by observable market data.
Level 3: Unobservable inputs that are supported by little or no market activity. These inputs require significant management judgment and reflect the Plan’s estimation of assumptions that market participants would use in pricing the asset or liability.
The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used maximize the use of observable inputs and minimize the use of unobservable inputs.
The following descriptions of the valuation methods and assumptions used by the Plan to estimate the fair values of investments apply to investments held directly by the Plan. There have been no changes in the methodologies used at December 31, 2022 and 2021.
Heritage Financial Corporation common stock: Valued based on its closing price as quoted on the NASDAQ National Market System. The Plan Sponsor common stock is determined to be a Level 1 investment.
Mutual funds: Valued at the daily closing price as reported by the fund. Mutual funds held by the Plan are open-end mutual funds that are registered with the United States Securities and Exchange Commission. These funds are required to publish their daily net asset value (“NAV”) and to transact at that price. The mutual funds held by the Plan are deemed to be actively traded. These are determined to be Level 1 investments.
Money market account: Valued based on quoted prices in active markets and determined to be a Level 1 investment.
Collective trust fund: The stable value collective trust fund is valued at the NAV of units of the bank collective trust. The NAV is used as a practical expedient to estimate fair value. This practical expedient would not be used if it is determined to be probable that the fund will sell the investment for an amount different from the reported net asset value. Participant transactions (purchases and sales) may occur daily. If the Plan initiates a full redemption of the collective trust, the issuer reserves the right to require 12 months’ notification in order to ensure that securities liquidations will be carried out in an orderly business manner. The stable value collective trust fund seeks to provide investors with a moderate level of stable income without principal volatility.
The fair value of other financial instruments such as employer contributions receivable approximate their carrying value.
The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Plan believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
The following tables sets forth by level, within the fair value hierarchy, the Plan’s assets at fair value on a recurring basis as of December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
| Investments at Fair Value as of December 31, 2022 |
| Level 1 | | Level 2 | | Level 3 | | Total |
| Mutual funds | $ | 71,824,620 | | | $ | — | | | $ | — | | | $ | 71,824,620 | |
| Heritage Financial Corporation common stock | 7,484,341 | | | — | | | — | | | 7,484,341 | |
| Money market account | 342,730 | | | — | | | — | | | 342,730 | |
| Total investments in the fair value hierarchy | 79,651,691 | | | — | | | — | | | 79,651,691 | |
Collective trust fund (1) | — | | | — | | | — | | | 7,408,008 | |
| Total investments at fair value | $ | 79,651,691 | | | $ | — | | | $ | — | | | $ | 87,059,699 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Investments at Fair Value as of December 31, 2021 |
| Level 1 | | Level 2 | | Level 3 | | Total |
| Mutual funds | $ | 88,853,875 | | | $ | — | | | $ | — | | | $ | 88,853,875 | |
| Heritage Financial Corporation common stock | 6,493,952 | | | — | | | — | | | 6,493,952 | |
| Money market account | 268,646 | | | — | | | — | | | 268,646 | |
| Total investments in the fair value hierarchy | 95,616,473 | | | — | | | — | | | 95,616,473 | |
Collective trust fund (1) | — | | | — | | | — | | | 6,850,709 | |
| Total investments at fair value | $ | 95,616,473 | | | $ | — | | | $ | — | | | $ | 102,467,182 | |
(1) In accordance with FASB Accounting Codification Standards ("ASC") 820-10, certain investments that were measured at net asset value per share (or its equivalent) have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the line items presented in the statement of net assets available for benefits.
(4) Plan Termination
Although it has not expressed any intent to do so, the Company reserves the right to terminate the Plan at any time, subject to Plan provisions. Upon termination of the Plan, participant accounts will be distributed to the participant or his or her beneficiary as prescribed by the Plan document and the IRC.
(5) Tax Status
The Plan obtained its latest favorable determination letter on May 22, 2018, in which the IRS ruled that the Plan, as amended through December 30, 2015, was in compliance with the applicable requirements of the IRC. Although the Plan has been amended since the as-amended date in the favorable determination letter, the Plan administrator believes that the Plan is designed and is currently being operated in compliance with the applicable requirements of the IRC. Accordingly, no provision for income taxes has been included in the Plan’s financial statements as of December 31, 2022.
Accounting principles generally accepted in the United States of America require Plan management to evaluate tax positions taken by the Plan and recognize a tax liability (or asset) if the Plan has taken an uncertain position that more likely than not would not be sustained upon examination by the IRS. The Plan administrator has analyzed the tax positions taken by the Plan and has concluded that as of December 31, 2022 and 2021, there were no uncertain positions taken or expected to be taken that would require recognition of a liability (or asset) or disclosure in the financial statements. The Plan is subject to routine audits by taxing jurisdictions; however, there are currently no audits for any tax periods in progress. The Plan administrator believes it is no longer subject to income tax examinations for years prior to 2019.
(6) Party-in-Interest Transactions
A party-in-interest is defined under Department of Labor and ERISA regulations as any fiduciary of the Plan, any party rendering service to the Plan, the employer, and certain others. The following qualify as a party-in-interest or party-in-interest transactions:
•Certain officers of the Company serve as Trustees of the Plan and certain officers or employees of the Company may perform administrative functions for the Plan. No officer or employee receives compensation from the Plan.
•The Plan’s assets are held by Matrix Trust Company, a Broadridge Financial Solutions, Inc. company, as the custodian of the Plan assets. The Plan assets are managed by the custodian, at the direction of the Trustees, which invests cash received, interest and dividend income, and makes distributions to participants.
•Northwest Plan Services, Inc. serves as the recordkeeper of the Plan. The recordkeeper maintains participant account detail and administers the payment of interest and principal on the participant loans.
•RBC Wealth Management serves as the investment advisor to the Plan.
•Administrative expenses including trust, recordkeeping and investment advisor fees paid to all parties-in-interest are considered parties-in-interest transactions. Total administrative expenses paid to parties-in-interest was $189,122 during the year ended December 31, 2022.
•The Plan issues loans to participants, which are secured by the balance in the participant’s accounts.
•The Plan’s investment in Heritage Financial Corporation common stock constitutes a party-in-interest transaction as the Company is a related party. The value of the Company common stock held by the Plan as of December 31, 2022 and 2021 is disclosed in Note (3) Fair Value Measurements. During the year ended December 31, 2022, the Plan made no additional purchases of Heritage Financial Corporation common stock and received $569,570 in proceeds from the sale of 21,443 shares. Total dividend income recognized by the Plan from the investment in Heritage Financial Corporation common stock was $213,473 during the year ended December 31, 2022.
•The Plan earns revenue sharing credits from certain mutual funds based on the invested balances. The credits may be used to pay reasonable and permitted administrative expenses. Credits used to pay Plan expenses during 2022 were $74,958.
(7) Reconciliation of Financial statements to Form 5500
The following is a reconciliation of net assets available for benefits per the financial statements to the Form 5500 at the following dates:
| | | | | | | | | | | |
| December 31, 2022 | | December 31, 2021 |
| Net assets available for benefits per the financial statements | $ | 88,020,598 | | | $ | 103,119,366 | |
| Amounts allocated to withdrawing participants at current year end | — | | | (15,640) | |
| Net assets available for benefits per the Form 5500 | $ | 88,020,598 | | | $ | 103,103,726 | |
The following is a reconciliation of the change in net assets available for benefits per the financial statements to the Form 5500:
| | | | | |
| Year Ended December 31, 2022 |
| Net decrease in net assets available for benefit per the financial statements | $ | (15,098,768) | |
| Amounts allocated to withdrawing participants at current year end | — | |
| Amounts allocated to withdrawing participants at prior year end | 15,640 | |
| Net loss per the Form 5500 | $ | (15,083,128) | |
(8) Subsequent Events
The Plan’s management evaluated subsequent events from December 31, 2022 through June 23, 2023, the date these financial statements were issued. There have been no significant subsequent events during this period that require adjustments to or disclosure in the financial statements as of December 31, 2022 and for the year then ended.