Heritage Financial Corporation — FY2021 Form 10-K
Reporting period: Fiscal year ended December 31, 2021; comparisons are primarily with FY2020. This is an annual filing, not a standalone fourth-quarter results report.
Business context
Heritage Financial is a Washington bank holding company operating Heritage Bank, a commercial community bank serving Washington and the greater Portland, Oregon area through 49 branches. Lending is concentrated in commercial relationships; commercial business loans were 83.7% of loans receivable. The Bank completed its SBA Paycheck Protection Program participation when the program ended in May 2021. It had funded 7,184 PPP loans totaling $1.28 billion; $145.8 million remained outstanding at year-end, net of deferred fees.
Financial performance and condition
| Metric | FY2021 / Dec. 31, 2021 | FY2020 / Dec. 31, 2020 |
|---|---|---|
| Net income | $98.0 million | $46.6 million |
| Diluted earnings per share | $2.73 | $1.29 |
| Net interest income | $205.8 million | $201.0 million |
| Net interest margin | 3.23% | 3.63% |
| Provision for credit losses | $29.4 million reversal | $36.1 million expense |
| Noninterest income | $34.6 million | $37.2 million |
| Noninterest expense | $149.3 million | $148.9 million |
| Efficiency ratio | 62.09% | 62.52% |
| Total assets | $7.43 billion | $6.62 billion |
| Loans receivable, net | $3.77 billion | $4.40 billion |
| Deposits | $6.38 billion | $5.60 billion |
| Cash and cash equivalents | $1.72 billion | $743.3 million |
Net income rose 110.5%, chiefly because credit-loss provisions shifted from a $36.1 million expense to a $29.4 million reversal as economic forecasts improved. Net interest income increased 2.4%, but margin fell as substantial deposit inflows were held in low-yielding interest-earning deposits. Deposit costs declined, while loan yield benefited from PPP fee recognition and recoveries on previously nonaccrual loans.
Loans receivable fell 14.6% before the allowance, largely because PPP forgiveness payments exceeded new PPP originations; deposits rose 14.0%. Non-maturity deposits were 94.6% of total deposits. Nonaccrual loans declined to $23.8 million, or 0.62% of loans, from $58.1 million, or 1.30%. The allowance for credit losses on loans was $42.4 million, equal to 1.11% of loans (1.15% excluding PPP loans), versus $70.2 million and 1.57% a year earlier.
Operating cash flow was $69.5 million, compared with $70.3 million in FY2020. Investing activities provided $163.8 million, while financing activities provided $746.7 million, including $783.3 million of net deposit growth. The Company reported $21.2 million of junior subordinated debentures and $50.8 million of repurchase-agreement obligations; it had no FHLB advances outstanding. Management reported $1.06 billion of FHLB borrowing availability, $57 million of Federal Reserve borrowing availability, and $215 million of federal funds lines. Consolidated capital ratios were 13.5% CET1, 8.7% leverage, 13.9% Tier 1 risk-based, and 14.8% total risk-based; the Bank was categorized as well capitalized.
Material changes and notable items
- Net interest margin declined 0.40 percentage points year over year, despite higher net interest income.
- The Bank transferred $244.8 million of available-for-sale securities to held-to-maturity to reduce market-value volatility in accumulated other comprehensive income. Total securities increased to $1.28 billion.
- Noninterest income decreased 7.0%, partly reflecting lower mortgage loan-sale gains and the prior-year recognition of BOLI death benefits and trust-related income. FY2021 included a $2.7 million gain from the sale-and-leaseback of the Olympia headquarters.
- The Bank consolidated 12 branches during 2021, ending the year with 49 branches. Management cited increased use of digital banking and a more efficient branch footprint.
- Stockholders’ equity increased 4.1% to $854.4 million; the equity-to-assets ratio declined to 11.5% from 12.4%. The Company repurchased approximately 905,000 shares under its repurchase plans and declared $0.81 per share in dividends.
- The independent auditor issued an unqualified opinion on the financial statements and reported effective internal control over financial reporting. The audit identified the qualitative component of the loan-loss allowance as a critical audit matter.
Outlook, risks, and contingencies
The filing provides no specific earnings or revenue guidance. Management’s interest-rate simulation estimated that an instantaneous, sustained 100-basis-point increase could raise net interest income 11.8% in year one and 15.9% in year two; a 100-basis-point decrease was modeled to reduce it 3.5% and 10.2%, respectively. These are model estimates based on assumptions, not forecasts or guarantees.
Management noted continuing uncertainty from COVID-19, supply-chain disruption, worker shortages, and inflation. Key exposures include the commercial and real-estate concentration of lending, borrower cash flows and collateral values, interest-rate and securities-market movements, deposit behavior, cybersecurity and third-party service providers, and execution of acquisition or growth plans. The filing also discusses the transition away from LIBOR. The $1.13 billion of unfunded loan and letter-of-credit commitments and $41.5 million of unfunded LIHTC commitments are notable potential funding requirements. No material pending legal proceedings were reported.
Important facts for investors to verify
- How much of FY2021 earnings growth is sustainable apart from the large credit-loss reversal, PPP fees, and the headquarters sale gain.
- Whether deposit growth persists and excess cash can be deployed at yields that support net interest margin as interest rates and deposit pricing change.
- Credit performance in the commercial and CRE portfolio, including the adequacy of the allowance as economic forecasts and collateral conditions evolve.
- The liquidity and capital implications of deposit movements, unfunded commitments, securities valuation changes, and planned dividends or share repurchases.
- Progress on branch consolidation, digital investment, and the LIBOR transition, including any effects on expenses, customers, or contract terms.