Heritage Financial Corporation — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; balance-sheet comparisons are against December 31, 2021. Heritage Financial is a Washington-based bank holding company operating Heritage Bank, with 49 branches in Washington and the greater Portland, Oregon area. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q1 2022 / March 31, 2022 | Comparable period / prior year-end |
|---|---|---|
| Net income | $19.8 million; diluted EPS $0.56 | $25.3 million; diluted EPS $0.70 in Q1 2021 |
| Net interest income | $46.9 million | $52.2 million in Q1 2021 |
| Net interest margin | 2.84% | 3.51% in Q1 2021 |
| Noninterest income / expense | $8.5 million / $35.7 million | $8.3 million / $37.2 million in Q1 2021 |
| Efficiency ratio | 64.38% | 61.57% in Q1 2021 |
| Total assets | $7,483.8 million | $7,432.4 million at December 31, 2021 |
| Loans, net of allowance | $3,780.8 million | $3,773.3 million at December 31, 2021 |
| Deposits | $6,491.5 million | $6,394.3 million at December 31, 2021 |
| Cash and cash equivalents | $1,576.7 million | $1,723.3 million at December 31, 2021 |
- Credit provision and asset quality: The company recorded a $3.6 million reversal of credit-loss provision, versus a $7.2 million reversal in Q1 2021. The loan allowance was $40.3 million, or 1.06% of loans; nonaccrual loans were $16.5 million (0.43% of loans), down from $23.8 million at year-end. Net recoveries were $0.5 million.
- Cash flow: Operating activities provided $10.9 million; investing activities used $242.9 million, largely reflecting securities purchases; financing activities provided $85.4 million, including $97.2 million of net deposit inflows. Cash and equivalents fell $146.6 million during the quarter.
- Debt and capital: Junior subordinated debentures were $21.3 million and repurchase-agreement funding was $49.1 million. Stockholders’ equity was $821.4 million, or 11.0% of assets, down from 11.5% at year-end. Company and Bank regulatory capital ratios remained above minimum requirements; the Bank was categorized as well-capitalized.
Material changes and notable items
- Net income fell 22.0% year over year, primarily because interest and fees on loans declined. Net interest income decreased 10.1%; management cited lower recognized SBA Paycheck Protection Program loan fees, a slightly lower loan yield, and a larger share of lower-yielding interest-bearing deposits.
- Net interest margin contracted 0.67 percentage points year over year. Average loans were down $717.2 million, while average interest-earning deposits rose $789.4 million. The reported loan yield was 4.41%, versus 4.47% a year earlier.
- Noninterest income increased 3.5%, including a $1.0 million bank-owned life insurance death benefit. Noninterest expense declined 4.1%, mainly with lower compensation and professional-services costs.
- Investment securities increased $184.4 million from year-end. Rising market rates reduced the fair value of available-for-sale securities; the quarter’s other comprehensive loss was $43.6 million, and AOCI moved from positive $9.4 million to negative $34.2 million. Held-to-maturity securities had a reported fair value $37.4 million below amortized cost.
- Deposits rose 1.5% from year-end, with non-maturity deposits making up 94.9% of total deposits. Total loans were nearly flat quarter over quarter; residential real-estate loans increased, while SBA PPP loans declined as borrowers repaid or received forgiveness.
- The company declared a $0.21-per-share quarterly dividend in April 2022. It repurchased 105,090 shares during Q1, including shares withheld for taxes on vested awards.
Outlook, risks and contingencies
The filing provides no specific earnings, revenue, loan-growth, or margin guidance. Management said liquidity and capital resources were adequate for reasonably foreseeable needs and reported no material change in liquidity resources or interest-rate-risk exposure from the 2021 Form 10-K. This is not a guarantee of future results; management cautions that interim results are not necessarily indicative of full-year performance.
Key risks cited include interest-rate and yield-curve changes, deposit costs and funding availability, economic conditions in Washington and Oregon, commercial real-estate and other lending exposures, credit deterioration and allowance estimates, competition, regulation, technology and cybersecurity events, and the continuing effects of COVID-19. The loan book is concentrated in commercial lending, including owner-occupied and non-owner-occupied CRE. Outstanding commitments to extend credit totaled $1.10 billion. The company reported no material pending legal proceedings and no material changes to the risk factors in its 2021 Form 10-K.
Available-for-sale securities had $48.0 million of gross unrealized losses at quarter-end; management attributed the declines to interest-rate changes, reported no below-investment-grade rated securities, and recorded no securities credit-loss allowance. The company also reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether rising rates and deposit repricing further pressure net interest margin, funding costs, and the fair value of securities.
- Whether loan growth and fee income can offset the continued runoff of SBA PPP balances and lower mortgage-loan sale activity.
- Whether commercial real-estate and broader commercial-loan concentrations, nonaccrual trends, and the $40.3 million loan allowance remain appropriately managed as economic conditions change.
- How the $43.6 million quarterly other comprehensive loss and securities unrealized losses affect reported equity and capital measures; distinguish accounting marks from realized losses and regulatory capital treatment.
- Whether liquidity, regulatory capital, and dividend capacity remain resilient, including against use of the $1.10 billion in outstanding credit commitments.