Heritage Financial Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. Heritage Financial is a Washington-based bank holding company focused primarily on commercial lending and deposits in Washington and the greater Portland, Oregon area.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Interest income | $16.9 | $17.4 | $34.3 | $35.4 |
| Net interest income | $15.9 | $16.2 | $32.5 | $32.9 |
| Provision for loan losses | $1.3 | $0.6 | $2.2 | $0.5 |
| Noninterest income | $2.4 | $2.1 | $4.6 | $4.0 |
| Noninterest expense | $13.0 | $12.9 | $26.7 | $25.5 |
| Net income | $2.7 | $3.2 | $5.6 | $7.4 |
| Diluted EPS | $0.18 | $0.21 | $0.37 | $0.48 |
| Net interest margin | 4.82% | 5.23% | 5.00% | 5.30% |
| Efficiency ratio | 71.1% | 70.4% | 72.0% | 69.1% |
Management attributed lower earnings mainly to increased loan-loss provisions and expenses and lower interest income. Margin pressure reflected lower contractual loan yields; reduced deposit costs partly offset that pressure. Purchased-loan discount accretion contributed $0.4 million to Q2 and $1.4 million to first-half 2013 interest income.
Financial position, cash flow and capital
- At June 30, total assets were $1.426 billion, up from $1.346 billion at year-end 2012. Net loans were $1.086 billion; deposits were $1.197 billion; stockholders’ equity was $200.5 million.
- Cash and cash equivalents were $94.1 million, down $13.0 million from year-end. First-half operating cash flow was $12.5 million, investing cash outflow was $41.5 million, and financing cash inflow was $16.0 million.
- Deposits rose $78.6 million, primarily from the NCB acquisition; a $26.8 million deposit from one customer was expected to leave by year-end. Repurchase-agreement funding was $16.4 million. No FHLB or Federal Reserve borrowings, or federal funds purchased, were outstanding at quarter-end.
- The Bank reported capital ratios above regulatory “well-capitalized” thresholds: Tier 1 leverage 11.3%, Tier 1 risk-based 14.9%, and total risk-based capital 16.2%. The Company’s consolidated Tier 1 leverage ratio was 13.1%. Company equity was 14.1% of total assets, versus 14.8% at year-end.
Changes, credit quality and unusual items
- NCB was acquired January 9, 2013. It contributed a $0.4 million bargain-purchase gain and $1.4 million of pretax operating results from acquisition through June 30. The acquisition added $60.4 million of deposits and $51.5 million of loans at acquisition-date fair value.
- Valley Community Bancshares was acquired on July 15, after the reporting date. The announced consideration included $22.0 million cash and 1,533,433 Heritage shares. Valley had $233.2 million in assets, $123.0 million in loans and $203.2 million in deposits at June 30; acquisition fair values were not finalized in the filing.
- Originated loans grew 6.6% from year-end, while total loans including purchased portfolios grew 8.6%. Growth was concentrated in commercial lending, particularly non-owner-occupied commercial real estate. Nonperforming originated assets declined to $15.2 million, or 1.06% of originated assets, from $17.9 million, or 1.39%.
- Originated nonaccrual loans were $11.7 million, down from $12.5 million. Potential problem originated loans increased to $29.2 million from $28.3 million; performing restructured loans rose to $19.4 million from $15.0 million. The originated-loan allowance was $17.8 million, 1.91% of originated loans; first-half net charge-offs were $2.1 million.
- Provision on purchased loans rose to $1.3 million for the first half, reflecting collateral-value adjustments and resolution of purchased covered impaired loans. The FDIC indemnification asset declined to $4.8 million from $7.1 million at year-end.
- First-half other comprehensive loss was $2.3 million, largely reflecting lower fair value of available-for-sale securities. First-half acquisition, merger and core-system-conversion costs totaled $1.2 million. A core system conversion was expected to be completed in Q4 2013.
Outlook, risks and contingencies
The filing provides no quantified earnings or financial guidance. Management said expenses were elevated as it pursued growth and integration, and expected them to become more consistent with revenue over time. The company declared a regular $0.08 per-share dividend and a special $0.10 per-share dividend in July, payable August 15, 2013. Management was evaluating the effect of Basel III rules, generally applicable to the company and Bank beginning in 2015.
Key disclosed risks include borrower and collateral deterioration, commercial real estate and construction lending exposure, possible inadequacy of loan-loss reserves, interest-rate and margin changes, acquisition integration and retention, regulatory actions, operating-cost control, and technology or third-party service disruptions. Management reported no material change in interest-rate-risk exposure from year-end, no material change in risk factors, and effective disclosure controls. Pending legal proceedings were not expected by management to have a material aggregate effect.
Important facts for investors to verify
- Whether loan-loss provisions and purchased-loan collateral adjustments remain elevated, and how credit grades, delinquencies, nonaccrual loans and restructurings trend.
- Whether loan growth and acquisition accretion can offset continued pressure on contractual yields and net interest margin.
- Valley acquisition accounting, integration costs, realized synergies, and the impact of the cash and share consideration on capital and per-share results.
- Deposit concentration and retention, particularly the $26.8 million single-customer balance expected to leave by year-end.
- Progress and final costs of the core-system conversion, and the company’s capital position under Basel III.