Heritage Financial Corporation — Q1 2016 Form 10-Q
Business context and reporting period
Unaudited results for the three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. Heritage is a Washington bank holding company operating Heritage Bank, with 63 branches in Washington and the greater Portland, Oregon area. Its business focuses primarily on commercial lending and deposits.
Key financial metrics
| Metric | Q1 2016 / March 31, 2016 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $32.8 million | $32.7 million in Q1 2015 |
| Net interest margin | 4.04% | 4.31% in Q1 2015 |
| Noninterest income | $7.0 million | $8.3 million in Q1 2015 |
| Noninterest expense | $26.4 million | $26.0 million in Q1 2015 |
| Net income / diluted EPS | $9.1 million / $0.30 | $9.8 million / $0.32 in Q1 2015 |
| Operating cash flow | $13.1 million | $0.2 million in Q1 2015 |
| Total assets | $3.68 billion | $3.65 billion at December 31, 2015 |
| Net loans / deposits | $2.43 billion / $3.13 billion | $2.37 billion / $3.11 billion at December 31, 2015 |
| Cash and cash equivalents | $94.0 million | $126.6 million at December 31, 2015 |
| Stockholders’ equity | $480.2 million; 13.1% of assets | $470.0 million; 12.9% at December 31, 2015 |
Cash and cash equivalents decreased $32.6 million during the quarter. Investing activities used $60.4 million, principally reflecting net loan originations and securities purchases; financing activities provided $14.7 million, mainly from deposit growth. The allowance for loan losses was $29.7 million, or 1.21% of net loans. Junior subordinated debentures were $19.5 million and repurchase-agreement funding was $20.3 million. The Bank reported regulatory capital ratios of 12.4% common equity Tier 1, 10.3% Tier 1 leverage, 12.4% Tier 1 risk-based, and 13.4% total capital, and was categorized as well capitalized.
Material changes versus comparable periods
- Net income declined $688,000, or 7.0%, year over year. Q1 2015 included a $1.65 million gain on sale of the Merchant Visa portfolio; that gain did not recur.
- Net interest income edged up 0.3%, but the margin fell 27 basis points to 4.04%. Management attributed pressure to lower loan yields and reduced accretion income on purchased loans; the margin excluding incremental purchased-loan accretion was 3.82%, versus 3.87% a year earlier.
- Noninterest income declined 16.2%, mainly due to the nonrecurring Merchant Visa gain and lower loan-sale gains. Noninterest expense increased 1.3%; higher compensation and data-processing costs were partly offset by lower other expense, OREO expense, and intangible amortization.
- Loans grew 2.4% from year-end, with increases in non-owner-occupied commercial real estate, commercial-property construction, and consumer loans. Deposits grew 0.7%; non-maturity deposits rose to 87.0% of deposits.
- Credit indicators weakened in some respects: nonperforming assets increased to $14.2 million (0.39% of assets) from $11.7 million (0.32%); nonaccrual loans rose to $12.4 million from $9.7 million. Potential problem loans declined to $94.8 million from $110.4 million.
Outlook, commentary, risks, and unusual items
- Management expects continued downward pressure on net interest margin because of the low-rate environment and projected reduction in higher-yielding purchased loans. The filing provides no quantitative earnings or revenue guidance.
- Management considered the $29.7 million loan-loss allowance appropriate, while noting that deterioration in borrower or collateral conditions, economic weakness, or regulatory review could require additional provisions and adversely affect earnings.
- Key disclosed risks include credit and real-estate exposure, interest-rate and yield-curve changes, deposit competition and liquidity, regulatory requirements, acquisition integration, expense control, cybersecurity and third-party service disruptions, and litigation. Management reported no material change to the risk factors in its 2015 Form 10-K.
- The company reported $312,000 of OREO valuation adjustments in Q1 and said available-for-sale securities’ unrealized losses were primarily rate-related and considered temporary. A $5.7 million increase in other comprehensive income reflected securities valuation changes.
- The FDIC shared-loss agreements covering acquired loans had terminated in August 2015. The filing states that there were no material pending legal proceedings beyond ordinary routine litigation. Disclosure controls were deemed effective; no material change in internal control over financial reporting was reported.
- After quarter-end, the board declared a regular $0.12-per-share dividend, payable May 19, 2016. The quarter’s declared dividend was $0.11 per share.
Important facts for investors to verify
- Whether subsequent filings confirm the expected margin pressure and show how purchased-loan accretion and loan yields evolve.
- Whether the rise in nonaccrual loans and nonperforming assets persists, and whether charge-offs or provisions increase; review commercial real-estate and construction exposure.
- Whether deposit growth and liquidity remain sufficient as loans expand and cash balances decline; verify available borrowing capacity and funding costs.
- Whether reported capital levels and dividend payments remain supported by bank earnings, regulatory requirements, and the Bank’s ability to distribute dividends to the holding company.
- How much Q1 profitability depended on recurring operations versus the comparison-period Merchant Visa gain and other variable income items.