Heritage Financial Corporation — FY2019 Form 10-K
Reporting period: Year ended December 31, 2019; fourth-quarter data is also reported. Heritage is a Washington-based bank holding company operating Heritage Bank, with 62 branches in Washington and Oregon. Its business is primarily commercial lending and deposit-taking.
Financial performance and condition
| Metric | FY2019 | FY2018 |
|---|---|---|
| Interest income | $217.9 million | $199.4 million |
| Net interest income | $199.7 million | $187.0 million |
| Provision for loan losses | $4.3 million | $5.1 million |
| Noninterest income | $32.5 million | $31.6 million |
| Noninterest expense | $146.8 million | $149.2 million |
| Net income | $67.6 million | $53.1 million |
| Diluted earnings per share | $1.83 | $1.49 |
| Net interest margin | 4.22% | 4.29% |
| Efficiency ratio | 63.23% | 68.24% |
FY2019 net income rose 27.3%. Management attributed the increase principally to higher net interest income, the full-year contribution from the 2018 Premier acquisition, and lower merger-related expenses. Net interest margin narrowed seven basis points, as funding costs rose and the asset mix shifted toward lower-yielding assets. The efficiency ratio improved as 2018 acquisition-related costs subsided.
Fourth quarter: Net income was $17.1 million, versus $16.6 million in Q4 2018. Net interest income was $49.1 million versus $51.3 million; the loan-loss provision was $1.6 million versus $1.2 million.
Cash flow: Operating activities provided $87.6 million; investing activities used $120.4 million; financing activities provided $99.5 million. Cash and cash equivalents increased $66.7 million to $228.6 million.
Balance sheet and funding: Total assets were $5.55 billion, up 4.4%; net loans were $3.73 billion, up 3.1%; deposits were $4.58 billion, up 3.4%. Equity was $809.3 million, or 14.6% of assets. Non-maturity deposits were 88.6% of deposits. The bank had no FHLB advances outstanding; repurchase-agreement funding was $20.2 million and junior subordinated debentures were $20.6 million carrying value ($25.0 million par value).
Liquidity included $228.6 million in cash and cash equivalents, $719.4 million of unpledged available-for-sale securities, and unused FHLB, Federal Reserve and correspondent-bank borrowing facilities. The Bank’s regulatory capital ratios exceeded well-capitalized thresholds; its total risk-based capital ratio was 12.3% and leverage ratio was 10.2%.
Material changes and key developments
- Nonperforming loans increased to $44.5 million, or 1.18% of net loans, from $13.7 million, or 0.37%, at year-end 2018. Nonperforming assets rose to $45.4 million from $15.7 million.
- Management linked much of the deterioration to eight commercial relationships, including agricultural borrowers. Nonperforming agricultural loans were $25.9 million; commercial and industrial loans accounted for most nonperforming commercial loans.
- Net charge-offs increased to $3.2 million from $2.2 million. The allowance for loan losses was $36.2 million, 0.96% of net loans and 81.22% of nonperforming loans, versus 255.73% coverage a year earlier. Management said much of the increase in nonperforming balances was collateral-supported and carried no specific allowance.
- Deposits grew, but certificates of deposit increased to 11.4% of deposits from 10.5%; the average cost of interest-bearing deposits rose to 0.53% from 0.36%.
- There were no acquisitions in 2019. The 2018 Premier and Puget Sound mergers remain important to comparisons; they added scale and acquisition goodwill.
Outlook, risks and unusual items
- No specific earnings or growth guidance is provided. Management describes continued emphasis on commercial relationships, core deposit growth, asset quality, controlled geographic expansion and selective acquisitions.
- CECL became effective for the Company on January 1, 2020. Management estimated an increase of 10%–30% in the allowance for credit losses, including unfunded commitments, reducing opening retained earnings; the estimate was still being finalized.
- Key risks include credit deterioration—particularly in commercial, real estate and agricultural lending—regional economic weakness, interest-rate and funding-cost changes, liquidity, competition, acquisition integration, regulation, cybersecurity and dependence on third-party service providers.
- Interest-rate simulations estimated higher net interest income under +100 and +200 basis-point scenarios and lower income under a −100 basis-point scenario. These are model estimates, not guidance, and rely on uncertain assumptions.
- Other notable items: the Company recorded a $537,000 Washington business-and-occupation tax audit assessment; received $726,000 of FDIC assessment credits; and recognized $17.8 million of other comprehensive income, principally reflecting improved fair value of available-for-sale securities. Goodwill was $240.9 million and no impairment was recorded.
- The auditor issued unqualified opinions on the financial statements and internal controls. The allowance for loan losses, especially management’s environmental loss factors, was identified as a critical audit matter. The filing reports no material pending litigation beyond routine business matters.
Important facts for investors to verify
- Whether the elevated nonperforming loans—especially agricultural and commercial-and-industrial exposures—stabilize, resolve or require additional provisions and charge-offs.
- How CECL was ultimately adopted, including the actual day-one allowance and retained-earnings impact compared with the disclosed 10%–30% estimate.
- Whether deposit pricing and certificate growth continue to pressure funding costs and net interest margin.
- Whether loan growth, credit commitments of $1.21 billion and concentration in commercial lending remain consistent with underwriting standards and available liquidity.
- How acquisition-related goodwill, lease commitments and $50.7 million of unfunded LIHTC commitments affect future capital, expenses and cash needs.