Heritage Financial Corporation — FY2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015; filed March 10, 2016. Heritage is a Washington bank holding company whose principal business is community banking through Heritage Bank, serving Washington and the greater Portland, Oregon area. The bank focuses on commercial lending and deposits. The filing reports 67 branches in its year-end property and financial-statement disclosures.
Financial results and position
| Metric | FY2015 / Dec. 31, 2015 | Comparable period |
|---|---|---|
| Net income | $37.5 million; diluted EPS $1.25 | FY2014: $21.0 million; $0.82 |
| Net interest income | $129.6 million | FY2014: $115.4 million |
| Net interest margin | 4.11% | FY2014: 4.53% |
| Noninterest income | $32.3 million | FY2014: $16.5 million |
| Noninterest expense | $106.2 million | FY2014: $99.4 million |
| Efficiency ratio | 65.6% | FY2014: 75.3% |
| Total assets | $3.65 billion | Dec. 31, 2014: $3.46 billion |
| Net loans | $2.37 billion | Dec. 31, 2014: $2.22 billion |
| Deposits | $3.11 billion | Dec. 31, 2014: $2.91 billion |
| Cash and cash equivalents | $126.6 million | Dec. 31, 2014: $121.6 million |
| Stockholders’ equity | $470.0 million | Dec. 31, 2014: $454.5 million |
Cash flow from operations was $51.4 million, investing activities used $216.6 million, and financing activities provided $170.2 million. Cash and cash equivalents increased $5.0 million during the year. Available-for-sale investment securities totaled $811.9 million; $565.4 million were unpledged and identified by management as a liquidity source.
Year-end borrowings included $19.4 million of junior subordinated debentures and $23.2 million of securities sold under repurchase agreements. No FHLB advances or Federal Reserve borrowings were outstanding. Available credit facilities included $626.9 million with the FHLB, $51.9 million with the Federal Reserve, and $90.0 million of federal-funds lines. Regulatory capital ratios were 12.0% CET1, 12.7% Tier 1 risk-based, 13.7% total risk-based, and 10.4% leverage; the bank met the “well-capitalized” standard.
Material changes versus prior periods
- Net income increased 78.4% from 2014. Management attributed growth chiefly to higher interest income and noninterest income, including a full year of Washington Banking merger operations.
- Net interest income rose 12.3%, but net interest margin fell 42 basis points to 4.11%. Purchased-loan discount accretion contributed $10.3 million to interest income in 2015, down from $14.3 million in 2014.
- Noninterest income nearly doubled, partly due to nonrecurring items: a $1.7 million gain on termination of FDIC shared-loss agreements and a $2.2 million gain on sale of the Merchant Visa portfolio. Mortgage-loan sale gains rose to $4.7 million.
- Loans grew 6.7% and deposits 6.9%. Non-maturity deposits reached 86.5% of deposits, up from 81.9%; certificates of deposit declined 20.0% to $420.3 million.
- Credit quality improved on several measures: nonperforming loans declined to $9.7 million, or 0.40% of net loans, from $11.6 million, or 0.51%; nonperforming assets fell to $11.7 million from $14.9 million. Net charge-offs declined to $2.4 million from $5.7 million.
- The allowance for loan losses rose to $29.7 million from $27.7 million; provision expense was $4.4 million. Potential problem loans decreased to $110.4 million from $162.9 million.
Fourth-quarter detail, outlook, risks and unusual items
- In Q4 2015, net income was $9.5 million and diluted EPS was $0.32, versus $7.3 million and $0.24 in Q4 2014. Q4 net interest income was $32.5 million, provision expense $1.1 million, noninterest income $7.5 million, and noninterest expense $26.8 million.
- The FDIC shared-loss agreements were terminated effective August 4, 2015. Heritage paid $7.1 million; the termination produced a $1.7 million pretax gain and ended FDIC sharing of future losses and recoveries on covered assets.
- All securities classified as held to maturity were transferred to available for sale in Q4. The filing says this compromised the held-to-maturity classification process, requiring careful evaluation of future classification decisions. The company also sold downgraded private mortgage securities, recording a $125,000 realized loss.
- Management described the balance sheet and liquidity as strong and intends to pursue controlled growth, deposit expansion, commercial lending, and disciplined acquisitions or branch expansion. No quantified earnings or growth guidance is provided.
- Management warned that the December 2015 increase in short-term rates, lower loan yields, and repricing differences could pressure net interest income and profitability. Other principal risks include commercial-loan and real-estate concentration, borrower and collateral deterioration, regional economic weakness, acquisition integration and goodwill impairment, regulatory changes, liquidity access, and cybersecurity and third-party systems risks.
- Three branches were closed and consolidated after year-end; additional branch-to-business-center conversions were underway, with one expected to finish in April 2016. A Washington Banking shareholder lawsuit was settled and dismissed in February 2015, with $450,000 in plaintiffs’ fees and expenses; the company denied wrongdoing. No other material pending legal proceedings were reported.
- The independent auditor gave an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective. Management reported effective disclosure controls and no significant fourth-quarter changes to financial-reporting controls.
Important facts for investors to verify
- How sustainable earnings are after separating recurring results from shared-loss termination, Merchant Visa sale, securities gains, and acquired-loan discount accretion.
- Whether margin compression continues as rates change and purchased-loan discounts run off.
- Credit performance in commercial and commercial real-estate portfolios, including potential problem loans, TDRs, and the adequacy of the allowance.
- Liquidity and funding sensitivity, including deposit stability, pledged securities, available borrowing lines, and repurchase-agreement exposure.
- Capital and dividend capacity under phased-in capital-conservation requirements; FY2015 dividends declared were $0.53 per share and stock repurchases totaled $7.7 million.
- The filing gives inconsistent branch counts: 63 in one business overview passage versus 67 in year-end property and financial-statement disclosures; confirm the applicable reporting count.