Heritage Financial Corporation — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. Comparisons are primarily with 2011. The filing also reports fourth-quarter results. Heritage is a Washington-based bank holding company operating Heritage Bank and Central Valley Bank, focused mainly on commercial lending and deposits in Washington and Oregon.
Financial performance and condition
| Metric | 2012 | 2011 |
|---|---|---|
| Interest income | $69.1 million | $74.1 million |
| Net interest income | $64.6 million | $67.5 million |
| Provision for loan losses | $2.0 million | $14.4 million |
| Noninterest income | $7.3 million | $5.7 million |
| Noninterest expense | $50.4 million | $49.7 million |
| Net income | $13.3 million | $6.5 million |
| Diluted earnings per share | $0.87 | $0.42 |
| Net interest margin | 5.17% | 5.41% |
| Efficiency ratio | 70.14% | 67.82% |
- Fourth quarter: Net income was $3.0 million, or $0.20 per diluted share. Net interest income was $15.7 million; provision for loan losses was $699,000.
- Balance sheet: Total assets were $1.346 billion, down from $1.369 billion. Net loans were $998.3 million; deposits were $1.118 billion; stockholders’ equity was $198.9 million.
- Credit and asset quality: Nonperforming originated loans fell to $12.5 million, or 1.28% of originated loans, from $23.3 million, or 2.57%. Originated-loan allowance was $19.1 million, equal to 2.19% of originated loans and 170.44% of nonperforming originated loans. Net charge-offs on originated loans were $3.9 million.
- Cash flow and liquidity: Operating cash flow was $27.9 million; investing activities used $1.3 million and financing activities used $43.3 million. Cash and cash equivalents ended the year at $107.1 million, down from $123.8 million. Available-for-sale securities totaled $144.3 million.
- Funding and capital: Non-maturity deposits were $829.0 million, or 74.2% of deposits; certificates of deposit were 25.8%, down from 29.0%. No FHLB advances were outstanding; securities sold under repurchase agreements were $16.0 million. Consolidated Tier 1 and total risk-based capital ratios were 18.7% and 19.9%; leverage ratio was 13.6%. Both banks were classified as well capitalized.
Material changes and business developments
- Net income more than doubled, largely because the loan-loss provision declined by $12.4 million and interest expense fell by $2.0 million. Lower interest income, higher noninterest expense, and higher income tax expense partly offset these benefits.
- Net interest income fell 4.4%, and net interest margin declined 24 basis points. Management attributed margin pressure to lower loan rates and reduced accretion of discounts on acquired loans.
- Originated loans grew to $874.5 million from $837.9 million, led by commercial business lending. Commercial business loans represented 83.7% of originated loans; non-owner-occupied commercial real estate represented 30.4%.
- Noninterest expense rose 1.4%, including higher compensation and professional-services costs. The efficiency ratio worsened to 70.14%.
- The company completed its acquisition of Northwest Commercial Bank on January 9, 2013, after year-end. The transaction included $3.0 million cash consideration and potential earn-out consideration of up to $1.8 million; acquired financial information had not been finalized in the filing.
Outlook, commentary, risks and unusual items
- Management’s strategy emphasizes controlled Pacific Northwest expansion, including a stated plan to acquire or build one to two branches per year, deposit growth, commercial lending and asset quality. The filing gives no specific earnings or revenue guidance.
- Management said expenses may remain elevated while growth initiatives are implemented, with expenses expected to become more aligned with revenue if the strategies produce longer-term results.
- Key risks include the concentration in commercial and commercial real-estate lending; borrower cash-flow and collateral risks; construction-loan valuations; regional economic and real-estate weakness; interest-rate and funding sensitivity; acquisition integration and FDIC shared-loss compliance; and evolving regulatory capital and compliance requirements.
- The company recorded $2.0 million of total loan-loss provision, including $1.3 million for purchased loans. The FDIC indemnification asset declined to $7.1 million from $10.4 million; FDIC loss-sharing accounting affects reported noninterest income and purchased-loan credit exposure.
- The FHLB of Seattle had improved its regulatory status, but the company held $5.5 million of FHLB stock and warned that further deterioration could cause impairment. No goodwill impairment was recorded; goodwill was $13.0 million.
- Cash dividends declared totaled $0.80 per share for 2012, including special quarterly amounts. The company repurchased $6.0 million of common stock. Dividend capacity depends partly on subsidiary-bank distributions and regulatory limits.
Important facts for investors to verify
- Whether lower nonperforming loans and provisions represent a durable credit improvement, particularly given $15.0 million of accruing restructured originated loans and $28.3 million of potential problem originated loans.
- Allowance adequacy across originated and purchased portfolios, FDIC reimbursement assumptions, and the effect of acquired-loan cash-flow estimates on earnings.
- Whether the declining net interest margin and lower loan yields can stabilize, and how interest-rate changes may affect funding costs and asset yields.
- The Northwest Commercial Bank acquisition’s finalized purchase accounting, integration costs, earn-out terms and contribution to future results.
- Deposit stability and liquidity, including the maturity of $160.6 million of certificates of deposit within one year and the availability of contingent borrowing facilities.
- Future regulatory capital rules, dividend and repurchase capacity, and any changes in the FHLB of Seattle investment’s recoverability.