Heritage Financial Corporation — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021. Heritage Financial is a Washington-based bank holding company operating Heritage Bank, with 53 branches in Washington and the greater Portland, Oregon area at period-end.
Financial results and position
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Net interest income | $54.3 million | $50.3 million | $106.5 million | $98.9 million |
| Net income (loss) | $32.7 million | ($6.1 million) | $58.0 million | $6.1 million |
| Diluted EPS | $0.90 | ($0.17) | $1.60 | $0.17 |
| Net interest margin | 3.44% | 3.64% | 3.47% | 3.84% |
| Efficiency ratio | 58.18% | 63.31% | 59.84% | 63.75% |
Q2 pretax income was $40.2 million, versus a $7.1 million loss a year earlier. The improvement primarily reflected a $14.0 million reversal of credit-loss provision in Q2 2021, compared with a $28.6 million provision in Q2 2020. For the six-month period, the provision reversal was $21.2 million, versus a $36.5 million provision in 2020. Q2 noninterest income was $8.3 million and noninterest expense was $36.4 million; six-month amounts were $16.5 million and $73.6 million, respectively.
- Balance sheet at June 30: Assets were $7.11 billion, up 7.4% from year-end 2020. Deposits were $6.06 billion, up 8.3%. Net loans were $4.16 billion, down 5.5%, while available-for-sale securities were $1.05 billion, up 30.8%.
- Credit and allowance: Allowance for credit losses on loans was $51.6 million, or 1.23% of loans (1.41% excluding PPP loans), compared with $70.2 million and 1.57% at year-end. Nonaccrual loans were $35.3 million, down from $58.1 million; nonperforming loans were 0.84% of loans versus 1.30% at year-end. Net recoveries for the first half were $0.3 million.
- Cash flow and liquidity: First-half operating, investing, and financing cash flows were positive $29.8 million, $32.5 million, and $459.3 million, respectively. Cash and cash equivalents ended at $1.26 billion, or 17.8% of assets. The Bank reported $1.84 billion in established credit facilities and lines, none of which were drawn at quarter-end.
- Debt and capital: Junior subordinated debentures were $21.0 million; there were no FHLB or Federal Reserve advances outstanding. The Bank was categorized as well-capitalized, with actual CET1, Tier 1 leverage, Tier 1 risk-based, and total risk-based capital ratios of 13.8%, 8.9%, 13.8%, and 14.8%. Company stockholders’ equity was $856.0 million.
- Shareholder returns: Dividends declared were $0.20 per share for Q2 and $0.40 for the first half. No shares were repurchased under the company’s repurchase plans during the first half; share repurchases were limited to withholding taxes on vested awards.
Material changes versus comparable periods
- Profit rebounded from a Q2 2020 loss, largely because credit-loss provisioning shifted from a substantial expense to a reversal. The first-half earnings increase had the same primary driver.
- Net interest income rose 7.9% in Q2 and 7.7% for the first half, but net interest margin fell year over year. The filing attributes margin pressure to excess interest-earning deposits and lower asset yields; lower deposit costs provided a partial offset.
- Loans declined $261.1 million from December 2020, mainly due to PPP forgiveness payments exceeding new PPP originations, lower commercial and industrial demand, and runoff of indirect auto loans. Deposits rose $463.7 million, partly from PPP proceeds deposited in customer accounts.
- First-half noninterest expense declined 0.9%, while noninterest income declined 6.7%, mainly due to fewer investment-security sales and fewer interest-rate swap transactions.
Outlook, commentary, and risks
- The filing provides no quantitative earnings or financial guidance. Management cautions that first-half results are not necessarily indicative of full-year results.
- Management linked the allowance reduction to improved economic forecasts and lower loan balances; the allowance is sensitive to forecast assumptions and estimates. PPP loans are fully SBA-guaranteed and excluded from the loan allowance.
- At June 30, 57 loans totaling $40.9 million remained in payment-deferral modification status, down from 177 loans totaling $92.5 million at year-end. Three travel and accommodations relationships accounted for $31.7 million, or 77.5%, of the remaining modified balances and were expected to remain deferred through December 31, 2021.
- Credit exposure is concentrated in commercial lending and the Washington–Oregon market area. Management cites COVID-19 and economic conditions, credit quality, interest rates, funding, competition, regulatory changes, technology and third-party disruptions, and execution of growth strategies among risks.
- The company announced plans in July 2021 to consolidate four branches in October, reducing its branch count from 53 to 49. It also declared a $0.20-per-share quarterly dividend in July. Management reported no material change in interest-rate risk exposure, no material pending litigation beyond ordinary business matters, and no material changes to the risk factors in its 2020 Form 10-K.
Important facts for investors to verify
- How much earnings improvement is recurring versus attributable to the credit-loss reversal, PPP fee recognition, and recovery of $2.0 million of interest and fees on nonaccrual loans in Q2?
- Whether economic forecasts, borrower performance, and commercial real estate conditions support the reduced allowance, particularly given geographic and commercial-loan concentrations.
- Repayment performance of the remaining COVID-modified loans, especially the three travel and accommodations relationships, and whether any deferrals extend or lead to renewed credit deterioration.
- Whether deposit growth and elevated cash balances persist, and how the resulting asset mix affects net interest margin as PPP balances are forgiven and liquidity is redeployed.
- Progress and costs associated with the planned branch consolidations and ongoing technology investment.