Heritage Financial Corporation — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021; unaudited consolidated results. Heritage Financial is a bank holding company operating Heritage Bank, with 53 branches in Washington and the greater Portland, Oregon area. Its business focuses on commercial lending and deposits, alongside residential, construction and consumer lending.
Financial results and condition
| Metric | Q1 2021 | Prior comparable period / balance |
|---|---|---|
| Net interest income | $52.2 million | $48.6 million in Q1 2020; up 7.6% |
| Net interest margin | 3.51% | 4.06% in Q1 2020 |
| Net income; diluted EPS | $25.3 million; $0.70 | $12.2 million; $0.34 in Q1 2020 |
| Provision for credit losses | $7.2 million reversal | $7.9 million provision in Q1 2020 |
| Noninterest income / expense | $8.3 million / $37.2 million | $9.5 million / $37.3 million in Q1 2020 |
| Total assets | $7.03 billion | $6.62 billion at Dec. 31, 2020 |
| Loans receivable, net | $4.53 billion | $4.40 billion at Dec. 31, 2020 |
| Deposits | $6.02 billion | $5.60 billion at Dec. 31, 2020 |
| Cash and cash equivalents | $934.3 million | $743.3 million at Dec. 31, 2020 |
| Stockholders’ equity | $827.2 million | $820.4 million at Dec. 31, 2020 |
Q1 operating cash flow was $9.1 million; investing activities used $232.7 million and financing activities provided $414.7 million. Cash rose by $191.0 million, largely reflecting deposit growth. The quarter-end allowance for credit losses on loans was $64.2 million, or 1.40% of loans (1.73% excluding SBA PPP loans). Nonperforming loans were $52.9 million, 1.15% of loans, and the allowance equaled 121.48% of nonperforming loans.
Liquidity included $934.3 million of cash and $694.3 million of unpledged available-for-sale securities. The Bank reported no FHLB, Federal Reserve, federal funds purchased or PPPLF borrowings outstanding; it had $926.3 million of FHLB capacity, $48.9 million of Federal Reserve capacity, $215.0 million of correspondent-bank lines and $909.7 million of PPPLF capacity. The Bank was categorized as well-capitalized; its actual common equity Tier 1 ratio was 13.0%, and the Company’s was 12.8%.
Changes and drivers
- Net income more than doubled year over year, primarily because the credit-loss provision changed from a $7.9 million expense to a $7.2 million reversal. Management attributed the reversal mainly to an improved economic forecast.
- Net interest income increased, but margin fell 55 basis points. Lower yields on adjustable-rate assets and a higher share of low-yielding interest-bearing deposits were partly offset by lower deposit costs.
- Loans grew 2.8% from year-end, mainly due to PPP lending. PPP loans totaled $886.8 million at amortized cost, and $174.3 million of principal payments, including SBA forgiveness, were received during the quarter. Deposits rose 7.5%, primarily as PPP proceeds were deposited in customer accounts.
- The allowance declined $6.0 million from year-end. Nonaccrual loans declined $5.2 million; potential problem loans fell to $163.8 million from $182.3 million. Payment-deferral COVID modifications declined to 67 loans totaling $46.7 million from 177 loans totaling $92.5 million.
- Available-for-sale securities increased to $893.6 million. Other comprehensive loss was $11.6 million, reflecting a decline in securities’ fair value; management attributed unrealized losses to interest-rate movements and reported no below-investment-grade holdings.
Outlook, commentary and risks
The filing provides no quantitative earnings or margin guidance. Management cautioned that Q1 results are not necessarily indicative of full-year results. It said the continuing COVID-19 pandemic and its economic effects remain uncertain. Material sensitivities include borrower credit quality, commercial real estate and regional economic conditions, interest rates and deposit pricing, the adequacy of credit-loss estimates, and regulatory actions.
The loan portfolio is concentrated in commercial lending and in Washington and Oregon. Management noted that estimates for loan and unfunded-commitment credit losses, goodwill and fair values could change as pandemic effects and economic conditions evolve. The company also cited operational, technology/vendor, competitive, regulatory and litigation risks. It completed consolidation of nine branches, including eight in January 2021, as part of a shift balancing physical branches and digital banking. The board declared a regular $0.20-per-share dividend in April, payable May 19, 2021.
Unusual comparison items include a $1.0 million tax benefit recorded in Q1 2020 under the CARES Act that did not recur, contributing to the higher 2021 effective tax rate of 16.8% versus 5.0%. The filing reported no material pending legal proceedings beyond routine litigation, no material changes to previously disclosed risk factors, and effective disclosure controls as of quarter-end.
Important facts for investors to verify
- Whether improved economic assumptions supporting the $7.2 million credit-loss reversal remain appropriate, and how loan quality and the $163.8 million of potential problem loans develop.
- How PPP forgiveness, deferred-fee recognition and eventual runoff affect loan balances, net interest income and reported margin.
- Whether deposit growth and the unusually high cash balance persist, and how management deploys excess liquidity amid low yields.
- Changes in commercial real estate and commercial borrower performance, COVID-related modifications and the allowance for unfunded commitments ($3.6 million).
- Interest-rate sensitivity, securities valuation/accumulated other comprehensive income, and the company’s capacity to maintain dividends and capital ratios.