Heritage Financial Corporation — Q3 2013 Form 10-Q
Business context and period. Unaudited results cover the three and nine months ended September 30, 2013; balance-sheet comparisons are with December 31, 2012. Heritage is a Washington bank holding company operating Heritage Bank, with 42 branches in Washington and the greater Portland, Oregon area, focused principally on commercial lending and deposits. Results include Northwest Commercial Bank from January 9 and Valley Community Bancshares from July 15, 2013.
Key financial metrics
| Metric | Q3 2013 / September 30, 2013 | Comparable period / prior balance |
|---|---|---|
| Net interest income | $17.6 million | $16.0 million in Q3 2012 |
| Net income | $3.29 million; diluted EPS $0.20 | $2.86 million; diluted EPS $0.19 in Q3 2012 |
| Net income, nine months | $8.87 million; diluted EPS $0.57 | $10.23 million; diluted EPS $0.67 in 2012 |
| Net interest margin | 4.67% for Q3; 4.88% for nine months | 5.09% and 5.23%, respectively, in 2012 |
| Efficiency ratio | 70.9% for Q3; 71.6% for nine months | 71.5% and 69.9%, respectively, in 2012 |
| Assets / stockholders’ equity | $1.674 billion / $216.6 million | $1.346 billion / $198.9 million at December 31, 2012 |
| Loans receivable, net | $1.208 billion | $998.3 million at December 31, 2012 |
| Deposits | $1.426 billion | $1.118 billion at December 31, 2012 |
| Cash and cash equivalents | $135.1 million | $104.3 million at December 31, 2012 |
| Cash flows, nine months | Operating +$20.2 million; investing −$22.6 million; financing +$33.2 million | Cash increased $30.9 million to $135.1 million |
| Funding and capital | Repurchase agreements $22.7 million; consolidated Tier 1 leverage 11.6%, total risk-based capital 16.7% | No FHLB or Federal Reserve advances outstanding at September 30 |
The Q3 provision for loan losses was $1.08 million, including $928,000 on purchased loans; nine-month provision was $3.24 million. Originated-loan allowance was $17.4 million, or 1.80% of originated loans. Dividends declared were $0.18 per share in Q3, including a $0.10 special dividend; $0.08 per share was declared in October for payment in November.
Material changes versus comparable periods
- Q3 net income rose $427,000 year over year, supported by higher interest and noninterest income, partly offset by higher expenses and loan-loss provision. Nine-month net income fell $1.36 million, primarily because expenses and provisions increased.
- Net interest income rose 10.2% in Q3 and 2.5% for nine months, largely reflecting acquired assets. However, margin declined 42 basis points in Q3 and 35 basis points year to date, primarily from lower contractual loan yields; deposit costs also fell.
- Noninterest income increased 69.1% in Q3 and 31.3% for nine months. Q3 included a $596,000 gain on sale of a branch building; nine-month results also included a $399,000 NCB bargain-purchase gain.
- Noninterest expense increased 14.3% in Q3 and 8.0% year to date, reflecting acquisitions, staffing and operating costs, and the core-system conversion completed in October. Year-to-date efficiency weakened despite modest Q3 improvement.
- Assets grew $328.9 million and deposits $308.0 million, principally due to the NCB and Valley acquisitions. Originated loans increased $87.4 million net; total loans grew about 20% from year-end.
- Nonperforming originated assets declined to $13.6 million, or 0.83% of originated assets, from $17.9 million, or 1.39%, at year-end. Originated nonaccrual loans fell to $9.8 million from $12.5 million. Potential problem originated loans were $26.6 million, down from $28.3 million.
Outlook, commentary, risks and unusual items
- No quantified earnings or margin guidance is provided. Management said acquisition and conversion-related expenses had raised costs during implementation of growth strategies, and expected expenses to become more consistent with revenue in the future.
- On October 23, 2013, Heritage and Washington Banking Company announced a strategic merger agreement. Washington Banking shareholders are to receive 0.89 Heritage shares plus $2.75 cash per share; the announced aggregate value was approximately $265.1 million. Closing was expected in the first half of 2014, subject to regulatory and shareholder approvals and other conditions. Washington Banking reported approximately $1.6 billion in assets at September 30.
- Liquidity included $135.1 million cash and cash equivalents and $17.4 million of other interest-earning deposits. The Bank also had $261.5 million of FHLB facilities, $37.6 million of Federal Reserve facilities, and $50.0 million of federal-funds lines; none was drawn at quarter-end. A customer’s $10.6 million of non-maturity deposits was expected to be withdrawn by year-end.
- The Bank was reported as well capitalized under prompt-corrective-action rules. Basel III requirements were scheduled to apply beginning January 1, 2015, with certain provisions phased in through 2019; management was evaluating the impact.
- Key risks include credit deterioration, loan-loss allowance estimation, commercial real estate and construction exposures, interest-rate and funding changes, acquisition integration and cost synergies, regulatory capital changes, competition, and operational or technology disruption. Management noted regulatory review could require additional loan-loss reserves. The filing reported no material change in previously disclosed risk factors.
- Other notable items: 2013 acquisitions increased goodwill by $16.4 million through Valley; no goodwill impairment was recorded. The company repurchased $8.8 million of stock in the first nine months. Legal proceedings were described as ordinary-course matters not expected in aggregate to materially affect financial condition or results.
Investor verification priorities
- Track the announced Washington Banking merger’s approvals, closing timetable, consideration, integration costs and expected synergies.
- Assess whether margin pressure continues and separate recurring earnings from purchased-loan accretion, the branch-building gain and the NCB bargain-purchase gain.
- Review purchased-loan credit performance and provision requirements, originated-loan charge-offs, restructured credits, and the adequacy of the allowance.
- Monitor deposit stability, including the expected withdrawal of the $10.6 million customer balance, and liquidity and capital after acquisitions.
- Verify expense normalization following the core-system conversion and acquisition integration, alongside the reported efficiency ratio and capital ratios.