Heritage Financial Corporation — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Heritage Financial is a bank holding company operating Heritage Bank, with 50 branches in Washington and Oregon and a focus on commercial lending and deposits. Financial amounts below are in U.S. dollars; “$ million” means millions.
Financial performance and condition
| Metric | Q3 2022 / Sep. 30, 2022 | Comparable period / Dec. 31, 2021 |
|---|---|---|
| Net income | $21.0 million; diluted EPS $0.59 | Q3 2021: $20.6 million; $0.58 |
| Nine-month net income | $59.3 million; diluted EPS $1.67 | Nine months 2021: $78.6 million; $2.18 |
| Net interest income | Q3: $59.3 million; nine months: $156.3 million | Q3 2021: $51.4 million; nine months 2021: $157.9 million |
| Net interest margin | Q3: 3.57%; nine months: 3.15% | Q3 2021: 3.15%; nine months 2021: 3.36% |
| Loans, net of allowance | $3,959 million | $3,773 million |
| Total deposits | $6,238 million | $6,394 million |
| Cash and cash equivalents | $407 million | $1,723 million |
| Total assets | $7,200 million | $7,432 million |
| Stockholders’ equity | $777 million; 10.8% of assets | $854 million; 11.5% of assets |
- Q3 provision for credit losses was $1.9 million, versus a $3.1 million reversal in Q3 2021. For the nine months, the company recorded a $2.8 million reversal, compared with a $24.3 million reversal in 2021.
- Q3 noninterest income was $7.5 million, down 9.4%; noninterest expense was $39.1 million, up 5.3%. The Q3 efficiency ratio was 58.66%, versus 62.35%.
- For the first nine months, operating cash flow was $62.4 million; investing cash outflow was $1,186.2 million; financing cash outflow was $192.2 million. Cash declined $1,316.0 million, principally as liquidity was deployed into securities and loans.
- Interest-bearing debt included $21.4 million of junior subordinated debentures and $40.4 million of repurchase-agreement liabilities; no FHLB advances were outstanding at quarter-end.
- Regulatory capital ratios remained above minimum requirements. At September 30, the company’s CET1, leverage, Tier 1 and total capital ratios were 12.8%, 9.2%, 13.3% and 14.0%; Heritage Bank’s were 13.0%, 9.0%, 13.0% and 13.8%. Management said the Bank remained well-capitalized.
Material changes and management commentary
- Q3 net income rose 1.9% year over year as higher interest earned on assets outweighed the credit provision and higher expenses. Nine-month net income fell 24.6%, primarily because credit-loss reversals were much smaller than in 2021.
- Q3 net interest margin improved year over year, reflecting higher asset yields and a shift toward loans and taxable securities. Nine-month margin declined as a larger share of earning assets was held in lower-yielding securities and deposits, and PPP loan-fee income fell.
- Loans grew 4.9% from year-end, led by commercial and industrial and residential real estate lending. Nonaccrual loans fell to $6.2 million from $23.8 million; the nonaccrual-to-loans ratio was 0.16%.
- Deposits decreased 2.4%, which management attributed mainly to competitive pricing and customers moving excess funds into higher-yielding alternatives. Total investment securities increased 66.7% as excess liquidity was invested in higher-yielding, longer-duration assets.
- Higher market rates reduced the fair value of available-for-sale securities: the portfolio had $135.4 million of gross unrealized losses at September 30, and AOCI declined $114.4 million from year-end to a $105.0 million loss. Management stated AOCI was excluded from regulatory capital calculations under the company’s election.
- The Bank agreed to sell its Ellensburg branch and transfer related assets, $22.7 million of deposits and other liabilities. Closing was expected by March 31, 2023, subject to factors including regulatory approval.
- The board declared a quarterly dividend of $0.21 per share in October 2022. No formal earnings or financial guidance is provided in the supplied filing text.
Outlook, risks and contingencies
Management said liquidity and capital resources were adequate for reasonably foreseeable needs and reported no material change in liquidity and capital resources from the 2021 annual report. Key uncertainties include inflation, potential recession or slower growth, interest-rate changes and deposit pricing competition, credit deterioration (particularly in commercial real estate), securities valuation changes, loan demand, regulation, and technology or third-party disruptions. The filing cautions that actual results may differ materially from forward-looking statements.
The Bank had $1.149 billion of outstanding commitments to extend credit, including letters of credit. The filing reports no material pending litigation beyond ordinary routine matters. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether deposit outflows and funding costs accelerate as customers seek higher yields, and the effect on net interest margin.
- Whether the $135.4 million of available-for-sale unrealized losses, the broader held-to-maturity fair-value discount, or further rate moves affect capital, liquidity or securities-sale decisions.
- Whether loan growth is accompanied by deterioration in commercial real estate or other credit quality, and whether the allowance remains adequate.
- Whether the Ellensburg branch sale closes on schedule and on the disclosed terms, subject to regulatory approval.
- How earnings develop as PPP-related fees diminish, compensation and technology costs evolve, and the credit-loss provision normalizes.