Heritage Financial Corporation — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011, with fourth-quarter results presented below. Heritage Financial is a Washington bank holding company operating Heritage Bank and Central Valley Bank, serving communities in Washington and the greater Portland, Oregon area. Its lending focus is commercial business and commercial real estate.
Financial performance and position
| Metric | FY 2011 / year-end | FY 2010 / prior year-end |
|---|---|---|
| Interest income | $74.1 million | $59.5 million |
| Net interest income | $67.5 million | $51.0 million |
| Net interest margin | 5.41% | 4.78% |
| Provision for loan losses | $14.4 million | $12.0 million |
| Noninterest income | $8.1 million | $21.4 million |
| Noninterest expense | $52.1 million | $40.6 million |
| Net income | $6.5 million; diluted EPS $0.42 | $13.4 million; diluted EPS $1.04 |
| Net cash from operating activities | $20.9 million | $27.1 million |
| Total assets | $1.369 billion | $1.368 billion |
| Deposits | $1.136 billion | $1.136 billion |
- Fourth-quarter 2011 net income was $2.2 million, or $0.14 per diluted share, versus $9.8 million, or $0.77 per diluted share, in fourth-quarter 2010. Fourth-quarter net interest income was $16.5 million and provision for loan losses was $3.3 million.
- At year-end, cash and cash equivalents were $123.8 million. Investment securities totaled $156.7 million. The company had $23.1 million in repurchase-agreement borrowings and no FHLB advances outstanding; it reported available but uncommitted FHLB and Federal Reserve facilities.
- Stockholders’ equity was $202.5 million, or 14.8% of assets. Detailed regulatory disclosures report consolidated Tier 1 risk-based capital of 19.0%, total risk-based capital of 20.3%, and a 13.8% leverage ratio; both subsidiary banks were classified as well-capitalized.
- Originated loans were $837.9 million before the allowance. Commercial business loans represented 82.5% of originated loans. The allowance for originated loans was $22.3 million, or 2.66% of originated loans.
Material changes versus the prior period
- Net income fell by approximately 51% from 2010. The principal factors were the absence of the $11.8 million 2010 gain on bank acquisitions, higher credit-loss provisions, and higher operating expenses. Higher net interest income partly offset these items.
- Net interest income rose 32.4%, reflecting acquired earning assets from the 2010 Cowlitz and Pierce Commercial transactions and a higher margin. Management attributed part of the margin improvement to accretion of discounts on acquired loans.
- Noninterest expense increased 28.2%, with higher salaries and benefits, occupancy and equipment costs, and other real estate owned expense; management linked much of the increase to acquisition-related growth.
- Asset-quality indicators improved in some respects: nonperforming originated loans declined to $23.3 million from $26.5 million, and potential problem originated loans declined to $29.7 million from $56.1 million. Net charge-offs on originated loans fell to $4.9 million from $16.1 million.
- Performing restructured originated loans rose to $13.8 million from $394,000. The company cited expanded identification of troubled debt restructurings under new accounting guidance and additional borrower restructurings.
- Non-maturity deposits increased to 71.0% of total deposits from 64.5%, while certificates of deposit declined to 29.0% from 35.5%. Total deposits were nearly unchanged year over year.
Outlook, commentary, and risks
- No numerical earnings or revenue guidance is provided. Management says it expects higher expenses while growth initiatives are being executed, with expenses expected to become more aligned with revenue as those initiatives produce longer-term results.
- The company plans controlled expansion, including one to two branches per year in strategic locations, and will consider acquisitions, including FDIC-assisted transactions. It emphasizes asset quality, deposit growth, and commercial lending.
- Credit risk remains material given commercial and commercial-real-estate concentration, construction lending, and continued sensitivity to Pacific Northwest economic and property-market conditions. Management warns that weaker conditions could increase delinquencies, charge-offs, and required loan-loss provisions.
- FDIC loss-sharing agreements cover specified Cowlitz acquired loans. Failure to meet detailed servicing and reporting requirements could jeopardize reimbursement. The Pierce Commercial acquired loans were not covered by an FDIC loss-sharing agreement.
- Other identified risks include interest-rate and funding sensitivity, acquisition integration and growth execution, regulatory and compliance costs under Dodd-Frank, potential impairment of FHLB of Seattle stock, and possible investment-security or goodwill impairment.
- The company repaid its remaining TARP obligations by redeeming Treasury-held preferred stock in 2010 and repurchasing the Treasury warrant for $450,000 in 2011. It paid $5.9 million in common dividends and repurchased $2.3 million of common stock during 2011.
- KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal controls. The filing says there are no material pending legal proceedings beyond ordinary routine litigation.
Important facts for investors to verify
- Reconcile the reported capital ratios: the selected financial data table appears to reverse the Tier 1 and total risk-based capital labels, while the detailed regulatory-capital table reports Tier 1 at 19.0% and total capital at 20.3%.
- Assess whether lower originated-loan problem balances are offset by growth in restructured loans and credit deterioration in acquired loan portfolios, which generated a $9.3 million purchased-loan provision in 2011.
- Review the assumptions supporting acquired-loan cash flows, FDIC indemnification-asset valuation, and future FDIC loss-sharing reimbursements.
- Evaluate whether operating expense growth and the 68.8% efficiency ratio can improve as branch and acquisition growth matures; no quantified target or timetable is given.
- Confirm the company’s capacity to sustain dividends and repurchases given earnings, bank-level dividend restrictions, and the parent company’s reliance on subsidiary-bank dividends.