Heritage Financial Corporation — Q2 2012 Form 10-Q
Business context and reporting period. Washington-based bank holding company operating Heritage Bank and Central Valley Bank, serving businesses and consumers primarily in Washington and the greater Portland, Oregon area. This unaudited filing covers the three and six months ended June 30, 2012; balance-sheet comparisons are with December 31, 2011. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Net interest income | $16.2 | $18.2 | $32.9 | $33.8 |
| Provision for loan losses | $0.6 | $3.5 | $0.5 | $7.9 |
| Non-interest income | $2.1 | $0.3 | $4.0 | $3.2 |
| Non-interest expense | $12.9 | $12.6 | $25.5 | $25.7 |
| Net income | $3.2 | $1.7 | $7.4 | $2.5 |
| Diluted earnings per share | $0.21 | $0.11 | $0.48 | $0.16 |
- Margins and efficiency: Net interest margin was 5.25% for Q2, down 68 basis points year over year; first-half margin was 5.30%, down 20 basis points. The efficiency ratio was 70.4% for Q2 versus 68.3%; for the first half, 69.1% versus 69.5%.
- Balance sheet at June 30: Total assets were $1.338 billion; net loans were $1.002 billion; deposits were $1.113 billion; stockholders’ equity was $200.1 million. Cash and cash equivalents totaled $83.3 million.
- Cash flow, first half: Operating activities provided $8.5 million; investing activities used $9.4 million; financing activities used $39.6 million. Cash and cash equivalents declined $40.5 million from the start of the period to $83.3 million.
- Funding and liquidity: Deposits declined $22.7 million from year-end; repurchase-agreement funding fell $9.4 million to $13.7 million. No other borrowings were outstanding. The banks reported uncommitted credit facilities of $167.5 million with the FHLB, $75.2 million with the Federal Reserve, and $52.8 million in federal-funds lines with other banks.
- Capital and shareholder returns: Equity was 15.0% of total assets, compared with 14.8% at year-end. Both banks were categorized as well capitalized; Heritage Bank’s actual Tier 1 leverage and total risk-based capital ratios were 12.8% and 19.0%, respectively, and Central Valley Bank’s were 10.4% and 14.7%. First-half dividends declared totaled $0.34 per share, including a $0.20 special dividend; the company repurchased $5.3 million of stock.
Material changes versus comparable periods
- Net income rose year over year in both Q2 and the first half, driven chiefly by substantially lower loan-loss provisions. Lower provisions more than offset reduced net interest income.
- Net interest income fell 10.7% in Q2 and 2.5% for the first half. Management attributed the decline mainly to lower loan yields; reduced deposit funding costs partly offset that pressure.
- Q2 non-interest income increased to $2.1 million from $0.3 million, largely because the reduction in the FDIC indemnification asset was much smaller than in Q2 2011. First-half non-interest income rose 25.7% to $4.0 million.
- Total assets decreased $30.8 million from year-end, mainly as interest-earning deposits declined. Originated loans increased $15.7 million, while purchased loan balances declined.
- Originated nonperforming loans fell to $16.7 million from $23.3 million at year-end, but other real estate owned increased to $8.6 million from $4.5 million. Nonperforming originated assets totaled $24.8 million, down from $27.0 million.
Outlook, commentary, risks and unusual items
- No quantitative earnings or revenue guidance is provided. Management said expenses may remain higher while growth strategies are implemented and expects expenses to become more aligned with revenue as those strategies produce longer-term results.
- Management described its capital position as strong and considered the originated-loan allowance of $20.8 million, or 2.44% of originated loans, appropriate. Total allowance for originated and purchased loans was $29.5 million at quarter-end. The filing cautions that economic deterioration, borrower or collateral changes, or regulatory review could require additional provisions.
- Key risks include credit and real-estate concentration exposure, interest-rate and net-interest-margin sensitivity, deposit and liquidity conditions, regulatory actions and capital requirements, valuation estimates, operating costs, litigation, technology and cybersecurity, and acquisition integration. Management reported no material change in the risk factors from its 2011 Form 10-K.
- Six private residential mortgage-backed securities were deemed other-than-temporarily impaired during the first half; $60,000 was charged to earnings and $38,000 recorded through other comprehensive income. The company also reported increased other real estate owned and continued FDIC loss-share accounting for certain acquired loans.
- Management reported disclosure controls were effective as of June 30, 2012, with no material change in internal control over financial reporting during the first half. Pending legal proceedings were not expected, in aggregate, to materially affect financial condition or results.
Important facts for investors to verify
- Whether improved earnings are sustainable as loan yields and net interest margin remain under pressure and much of the year-over-year profit improvement came from lower provisions.
- Trends in criticized, impaired, nonaccrual, and restructured loans; charge-offs; OREO balances and dispositions; and the adequacy of both originated and purchased-loan allowances.
- The quality and durability of non-interest income, including FDIC indemnification asset estimates and reimbursements, and the remaining exposure under acquired-loan loss-share agreements.
- Deposit trends, cash levels, contingent borrowing availability, and the effects of dividends and share repurchases on liquidity and capital. Dividend payments are subject to bank regulatory restrictions.
- The filing reports no material interest-rate-risk change from year-end, but investors should assess how further rate or yield-curve changes could affect asset yields, funding costs, and net interest margin.