Heritage Financial Corporation — Q1 2019 Form 10-Q
Business context and period: Washington-based bank holding company focused on commercial banking, with 63 branches in Washington and the greater Portland, Oregon area. This unaudited report covers the three months ended March 31, 2019; balance-sheet comparisons are against December 31, 2018. Results versus Q1 2018 reflect the 2018 Puget Sound and Premier acquisitions.
Financial performance and position
Amounts below are in millions except per-share data and ratios.
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior year-end |
|---|---|---|
| Net income; diluted EPS | $16.6; $0.45 | Q1 2018: $9.1; $0.27 |
| Net interest income | $49.8 | Q1 2018: $40.8 |
| Net interest margin | 4.34% | Q1 2018: 4.12% |
| Noninterest income / expense | $7.4 / $36.5 | Q1 2018: $7.5 / $36.7 |
| Efficiency ratio | 63.84% | Q1 2018: 75.95% |
| Total assets | $5,342.1 | December 31, 2018: $5,316.9 |
| Loans, net of allowance | $3,660.3 | December 31, 2018: $3,619.1 |
| Deposits | $4,393.7 | December 31, 2018: $4,432.4 |
| Cash and cash equivalents | $111.2 | December 31, 2018: $161.9 |
| Stockholders’ equity | $778.2 | December 31, 2018: $760.7 |
| Allowance for loan losses | $36.2; 0.98% of loans | December 31, 2018: $35.0; 0.96% |
- Earnings and margins: Net income rose 82.2% year over year, primarily as net interest income increased 22.0%. Average interest-earning assets grew 15.7%; asset yields rose, while deposit costs also increased. Excluding acquired-loan discount accretion, management reported a 4.22% net interest margin versus 3.96% a year earlier.
- Credit: Provision for loan losses was $0.9 million, down from $1.2 million. Net recoveries were $0.2 million. Nonaccrual loans increased to $17.5 million from $13.7 million at year-end; nonperforming assets rose to $19.4 million, or 0.36% of assets. The allowance covered 207% of nonperforming loans, versus 256% at year-end.
- Cash flow: Operating activities provided $21.3 million; investing activities used $44.4 million, mainly for net loan originations; financing activities used $27.7 million, mainly reflecting deposit runoff and dividends, partly offset by net FHLB advances. Cash and cash equivalents fell $50.7 million during the quarter.
- Funding and debt: Deposits declined $38.7 million. Non-maturity deposits fell $92.9 million while certificates of deposit increased $54.2 million, including a $50.1 million increase in brokered CDs. The company had $25.0 million of short-term FHLB advances outstanding, $24.9 million in repurchase agreements, and $20.4 million in junior subordinated debentures. Available FHLB and Federal Reserve borrowing capacity was $889.8 million and $38.4 million, respectively.
- Capital and liquidity: Equity was 14.6% of assets. The Bank’s actual capital ratios included 11.9% common equity Tier 1 and 12.7% total capital to risk-weighted assets; management reported the Bank as well capitalized. Available-for-sale securities were $985.0 million, of which $719.5 million were unpledged.
Material changes, outlook, and risks
- Year-over-year earnings benefited from a larger earning-asset base following the 2018 mergers and higher market rates. Acquisition-related expenses fell to $0.1 million from $4.8 million, supporting the improved efficiency ratio. The company completed no acquisitions in Q1 2019.
- Management said the commercial loan pipeline increased 39% from year-end, while loan growth remained modest amid elevated prepayments and seasonally low originations. No formal earnings or financial guidance was provided.
- Management considered the allowance appropriate but cautioned that deterioration in economic conditions, borrowers, or collateral could require additional provisions. Two commercial relationships totaling $5.1 million moved to nonaccrual; a specific reserve of $0.8 million was assigned to those relationships.
- Interest-rate risk is identified as significant; management reported no material change in exposure since the 2018 annual report. Rising funding costs, deposit competition, credit quality, regulatory actions, and operational or technology disruptions are among the disclosed risks.
- The company adopted lease accounting in January 2019, recognizing $28.4 million of right-of-use assets and $29.5 million of lease liabilities. It expects to adopt CECL on January 1, 2020; management said the allowance may increase but had not determined the magnitude.
- The board declared a regular $0.18-per-share dividend on April 24, payable May 22, 2019. Management reported disclosure controls as effective and no material change in internal control over financial reporting. No material pending legal proceedings were reported beyond routine litigation.
Important facts for investors to verify
- Whether the increase in nonaccrual loans and nonperforming assets persists, and whether reserves remain adequate.
- Deposit trends, especially non-maturity deposit runoff and reliance on brokered CDs, alongside changes in borrowing needs and cash balances.
- How loan growth and net interest margin develop as asset yields, deposit costs, and acquired-loan accretion change.
- The eventual CECL impact, including effects on the allowance and related credit-loss processes.
- Capital adequacy and dividend capacity, including the Bank’s ability to upstream dividends to the holding company.