Heritage Financial Corporation — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; balance-sheet comparisons are to December 31, 2011. Unaudited, consolidated results. Heritage is a Washington bank holding company operating Heritage Bank and Central Valley Bank, focused primarily on commercial lending and deposits in Washington and Oregon.
Financial performance and condition
Amounts below are in millions, except per-share data and ratios.
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $15.96 | $17.30 | $48.86 | $51.05 |
| Provision for loan losses | $0.81 | $3.22 | $1.32 | $11.11 |
| Non-interest income | $1.53 | $0.24 | $5.50 | $3.40 |
| Non-interest expense | $12.50 | $11.79 | $37.97 | $37.44 |
| Net income | $2.86 | $1.84 | $10.23 | $4.29 |
| Diluted earnings per share | $0.19 | $0.12 | $0.67 | $0.27 |
| Net interest margin | 5.10% | 5.47% | 5.23% | 5.49% |
| Efficiency ratio | 71.5% | 67.2% | 69.9% | 68.8% |
- For the quarter, lower loan-loss provision and higher non-interest income more than offset lower net interest income and higher expenses. For the nine-month period, the same factors drove the increase in earnings; provision expense fell $9.8 million year over year.
- Management attributed weaker net interest income and margin primarily to lower yields on earning assets, especially loans. Lower deposit costs partly offset this pressure.
- At September 30, total assets were $1.367 billion, stockholders’ equity $202.2 million, and net loans $1.006 billion. Total assets were little changed from year-end 2011. Originated loans grew about $34 million, while purchased loans declined; total loans were approximately flat.
- Deposits were $1.134 billion, down $2.3 million from year-end. Non-maturity deposits rose $32.1 million, while certificates of deposit declined $34.5 million. Repurchase-agreement funding was $22.9 million; the filing reports no other borrowings outstanding.
- Cash and cash equivalents were $116.9 million. Nine-month operating cash flow was $18.1 million, investing cash flow was negative $10.7 million, and financing cash flow was negative $14.2 million; cash declined $6.9 million from the start of the period.
- Originated nonperforming loans were $15.7 million, down from $23.3 million at year-end; nonperforming originated assets were $22.7 million, down from $27.0 million, as higher other real estate owned partly offset loan improvement. The originated-loan allowance was $20.5 million, or 2.35% of originated loans and 149.94% of nonperforming originated loans, excluding government guarantees.
- Capital remained substantial: stockholders’ equity was 14.8% of total assets. At September 30, the subsidiary banks were reported as well capitalized; actual total risk-based capital ratios were 19.4% for Heritage Bank and 14.6% for Central Valley Bank.
Material changes, outlook, and risks
- The higher reported non-interest income largely reflected a smaller negative change in the FDIC indemnification asset, rather than a comparable increase in recurring fee income. The company reported a $0.49 million reduction in that asset for Q3 2012 versus $1.67 million in Q3 2011.
- Non-interest expense rose, including higher compensation, occupancy and professional-services costs. Professional-services costs included work on the proposed Northwest Commercial Bank acquisition. Management said expenses may remain elevated while growth strategies are being executed and expects them to become more aligned with revenue as those strategies produce longer-term results.
- On September 14, 2012, the company agreed to acquire Northwest Commercial Bank for $3.0 million cash, with up to $1.8 million additional earn-out consideration. Closing was anticipated in Q4 2012, subject to shareholder and regulatory approvals and other conditions. The company had incurred $179,000 of related costs by September 30.
- The company declared $0.42 per share of dividends during the first nine months and declared a further $0.08 per share dividend in October, payable November 21, 2012. Dividend capacity depends on earnings, capital and the banks’ ability to distribute funds; regulators may restrict bank dividends.
- No numerical earnings guidance was provided. Principal disclosed risks include credit and real-estate concentration risk, economic conditions, interest-rate and funding changes, regulator examinations and capital rules, valuation uncertainty, operating-cost control, acquisition execution, litigation, and technology or third-party service disruptions. Management noted proposed Basel III rules were not final; it expected the banks’ existing capital levels to exceed the proposed levels and did not expect significant ratio changes.
- Management reported disclosure controls were effective at September 30 and no material change in internal control over financial reporting during the nine-month period. The company said pending legal proceedings were not expected to have a material aggregate effect and reported no material changes to its prior-year risk factors.
Important facts for investors to verify
- Whether the Northwest Commercial Bank transaction closed on the expected timetable, its final consideration and earn-out terms, and its effects on capital, expenses and integration costs.
- Whether net interest margin and loan yields stabilized, and how further repricing or deposit competition affects earnings.
- Whether originated and purchased-loan credit quality, charge-offs, OREO balances and the allowance remain consistent with management’s estimates; particular attention is warranted for construction and commercial real-estate exposures.
- How much future earnings depend on FDIC indemnification-asset adjustments and acquired-loan discount accretion, versus recurring operating income.
- Deposit trends, liquidity availability, capital levels, regulatory developments and the sustainability of dividends and share repurchases.