Heritage Financial Corporation — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021. Heritage Financial is a bank holding company operating Heritage Bank, serving businesses and communities in Washington and the greater Portland, Oregon area.
Financial performance and position
| Metric | Q3 2021 / September 30, 2021 | Comparison |
|---|---|---|
| Net income | $20.6 million; diluted EPS $0.58 | Up from $16.6 million and $0.46 in Q3 2020 |
| Net interest income | $51.4 million | Up 3.4% year over year; net interest margin was 3.15%, down from 3.38% |
| Provision for credit losses | $3.1 million reversal | Compared with $2.7 million provision in Q3 2020 |
| Noninterest income / expense | $8.2 million / $37.2 million | Expense up 3.1%; efficiency ratio was 62.35%, versus 62.27% |
| Cash and cash equivalents | $1.63 billion | Up $891.4 million from December 31, 2020 |
| Loans receivable, net | $3.91 billion | Down $492.9 million from year-end |
| Deposits | $6.22 billion | Up $617.6 million, or 11.0%, from year-end |
| Allowance for credit losses | $48.3 million; 1.22% of loans | Down from $70.2 million and 1.57% at year-end |
| Nonperforming loans | $25.9 million; 0.65% of loans | Down from $58.1 million and 1.30% at year-end |
| Stockholders’ equity / capital | Equity $848.4 million; equity-to-assets 11.7% | Bank reported well-capitalized; total capital ratio 14.5% |
For the nine months, net income was $78.6 million, or $2.18 diluted EPS, versus $22.7 million, or $0.63, in 2020. Net interest income increased 6.3% to $157.9 million, while net interest margin declined to 3.36% from 3.67%. The $24.3 million reversal of credit-loss provisions contrasted with a $39.2 million provision in the prior-year period and was the principal driver of the year-over-year earnings increase.
Nine-month operating cash flow was $50.7 million; investing activities provided $257.7 million and financing activities provided $583.0 million. The company reported no FHLB or Federal Reserve advances outstanding at quarter-end. It had $992.3 million of FHLB facilities, $50.2 million of Federal Reserve facilities, and $215.0 million of correspondent-bank lines available. Junior subordinated debentures were $21.1 million.
Material changes and unusual items
- Loans declined 11.5% from year-end, primarily as SBA Paycheck Protection Program (PPP) loans were forgiven and the indirect auto portfolio continued to run off. PPP loans were $266.9 million at September 30, versus $715.1 million at December 31, 2020.
- Deposits rose 11.0%, primarily reflecting PPP proceeds deposited in customer accounts. Cash and cash equivalents reached 22.5% of total assets.
- The bank reclassified $244.8 million of U.S. government and agency securities from available-for-sale to held-to-maturity to reduce market-price volatility in accumulated other comprehensive income. No transfer gain or loss was recognized; the related unrealized gain remains in accumulated other comprehensive income and will be amortized over the securities’ remaining lives.
- In Q3 the company repurchased approximately 841,000 shares under its repurchase plan for an average $24.54 per share, at a cost of about $20.6 million. It declared $0.20 per share in Q3 dividends; on October 20 it declared a subsequent quarterly dividend of $0.21 per share.
- The company consolidated branches as part of a shift toward digital banking: branch count fell from 62 at September 30, 2020 to 49 after four additional closures in October 2021. Q3 results included branch-sale gains and expenses associated with the October closures.
Outlook, commentary, and risks
The filing provides no quantitative earnings or financial guidance. Management cautions that nine-month results are not necessarily indicative of full-year results. It attributed margin pressure mainly to higher interest-earning deposits earning low yields, partly offset by lower deposit costs and PPP fee recognition. Management said improved economic forecasts drove the reduction in credit-loss reserves and that nonaccrual loan balances declined, partly through payoffs and a return to accrual status.
Key risks include uncertainty from COVID-19 and economic conditions; credit deterioration, particularly in commercial and real estate lending; interest-rate and funding changes; and the possibility that reserve estimates prove inadequate. The loan portfolio is concentrated in commercial lending and in the bank’s Washington and Oregon markets. Management reported no material change in interest-rate risk from its 2020 year-end disclosure, no material pending litigation beyond ordinary routine matters, and no material changes to previously disclosed risk factors. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Key facts for investors to verify
- How much of earnings growth persists without further credit-loss reserve reversals, and whether the $48.3 million allowance remains appropriate as forecasts and borrower conditions change.
- Whether substantial deposit growth can be deployed profitably; monitor cash levels, loan demand, deposit pricing, and net interest margin.
- Credit trends in commercial and real estate portfolios, including nonaccrual loans, past-due balances, TDRs, and PPP runoff.
- The market-value and accumulated-comprehensive-income effects of the $244.8 million securities transfer, alongside the liquidity and interest-rate characteristics of the investment portfolio.
- Capital and liquidity after share repurchases, dividends, and branch consolidation costs; also verify the effect of branch closures on operating expenses and customer activity.