Heritage Financial Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited consolidated results. Heritage Financial is a Washington bank holding company serving small businesses and consumers in Washington and Oregon. Comparisons below are with Q1 2012 for income and cash flow, and December 31, 2012 for balance-sheet measures.
Key financial results
- Earnings: Net income was $2.9 million, down from $4.2 million; diluted EPS was $0.19 versus $0.27. Income before taxes was $4.2 million, compared with $6.1 million.
- Interest and other income: Net interest income was $16.5 million, down 0.9%. Total noninterest income rose to $2.3 million from $1.9 million, including a $399,000 bargain-purchase gain from the Northwest Commercial Bank (NCB) acquisition. Net interest income plus noninterest income was $18.8 million, versus $18.6 million; this measure includes the acquisition gain.
- Margins and expenses: Net interest margin declined to 5.19% from 5.35%; excluding incremental purchased-loan accretion, it was 4.47% versus 4.86%. Noninterest expense increased 8.9% to $13.7 million. The efficiency ratio rose to 72.9% from 67.7%.
- Cash flow: Operating activities provided $4.3 million, investing activities used $6.6 million, and financing activities provided $41.4 million. Cash and cash equivalents increased $39.1 million to $146.2 million.
- Balance sheet and liquidity: Total assets were $1.447 billion, up from $1.346 billion; total loans, net, were $1.055 billion, versus $998.3 million. Deposits increased to $1.225 billion from $1.118 billion. Stockholders’ equity was $200.5 million, compared with $198.9 million. Repurchase-agreement balances declined to $12.0 million from $16.0 million. No borrowings were outstanding under the disclosed FHLB or Federal Reserve credit facilities at quarter-end.
- Capital: Consolidated Tier 1 leverage, Tier 1 risk-based, and total risk-based capital ratios were 13.3%, 17.8%, and 19.1%, respectively. The Company reported its subsidiary banks were “well capitalized.”
- Credit quality: Nonperforming originated assets were $18.5 million, up from $17.9 million; nonperforming originated loans were 1.34% of originated loans, versus 1.28%. The originated-loan allowance was $17.9 million, or 2.02% of originated loans, compared with $19.1 million, or 2.19%. Net charge-offs on originated loans were $1.7 million, including $1.6 million related to one borrower. Potential problem originated loans declined to $25.1 million from $28.3 million.
Material changes and notable items
- Q1 net income fell by $1.3 million year over year. Management attributed the decline mainly to a $967,000 increase in loan-loss provisions, a $1.1 million increase in noninterest expense, and a $156,000 decrease in net interest income, partly offset by higher noninterest income.
- NCB was acquired on January 9, 2013 and merged into Heritage Bank. The acquisition added $60.4 million of deposits and loans initially measured at $51.5 million, and produced a $399,000 bargain-purchase gain. Reported Q1 results include NCB operations from January 10 through March 31.
- NCB-related acquisition and conversion costs were approximately $665,000 in Q1. Management said the higher expenses reflected the acquisition and growth initiatives, and expected expenses to become more in line with revenue as those initiatives produce results.
- Management disclosed that a single customer added approximately $26.8 million in money-market deposits during the quarter; those funds were expected to be withdrawn by the end of 2013.
- On March 11, 2013, the Company announced a proposed acquisition of Valley Community Bancshares, valued initially at approximately $44.2 million, with consideration split between cash and Company stock. Closing was expected in Q3 2013, subject to approvals and other conditions. The Company had incurred $148,000 of related costs by March 31. A merger of Central Valley Bank into Heritage Bank was announced April 8 and was expected in Q2, subject to regulatory approval.
- The quarterly dividend was $0.08 per share, up from $0.06 in Q1 2012. A further $0.08 dividend was declared after quarter-end.
Outlook, risks, and contingencies
- The filing provides no specific earnings or revenue forecast. Results for the quarter are not necessarily indicative of full-year 2013 results.
- Management identified credit quality, real-estate values, economic conditions, interest rates and net interest margin, deposit flows, acquisition integration, regulatory actions, and expense control as material risks. Regulators could require higher loan-loss reserves, asset write-downs, or changes affecting capital or liquidity.
- The Company stated that its interest-rate-risk exposure had not materially changed since year-end 2012. It did not maintain a trading account or engage in hedging activities.
- Management believed the allowance for loan losses was appropriate, while cautioning that economic deterioration, future borrower or collateral developments, or regulatory review could require additional provisions. The filing reported no material changes to previously disclosed risk factors.
- Management said pending legal proceedings, in aggregate, were not expected to materially affect consolidated financial condition or results. Disclosure controls were judged effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether NCB integration costs subside and purchased-loan accretion remains sustainable; Q1 net interest margin was 4.47% excluding incremental purchased-loan accretion.
- Whether the approximately $26.8 million customer deposit balance is withdrawn as expected and how deposit growth and funding costs develop.
- Trends in nonaccrual loans, charge-offs, impaired and restructured loans, and allowance coverage, particularly following the significant borrower default.
- Whether the Valley acquisition closes on the expected terms and schedule, and the resulting integration costs, capital impact, and performance.
- Capital, liquidity, and dividend capacity under changing regulatory requirements and market conditions.