Business context and reporting period
Heritage Financial Corporation is a Washington-based bank holding company operating Heritage Bank, with 50 branches across Washington, the greater Portland and Eugene areas of Oregon, and Boise, Idaho. Its business focuses on commercial lending and deposits, alongside construction, residential real estate, and consumer lending. This unaudited Form 10-Q covers the three months ended March 31, 2024; comparisons are primarily with Q1 2023 for earnings and December 31, 2023 for balance-sheet items.
Financial results and position
- Earnings: Net income was $5.7 million, down 71.9% from $20.5 million; diluted EPS was $0.16 versus $0.58. The quarter included a $10.0 million pretax loss on investment securities sales.
- Revenue and margin: Interest income rose to $74.4 million from $66.7 million, but interest expense increased to $22.8 million from $6.8 million. Net interest income fell 13.9% to $51.5 million, and net interest margin declined to 3.32% from 3.91%. Net interest spread was 2.70% versus 3.66%.
- Credit provision and expenses: Provision for credit losses was $1.4 million, down from $1.8 million. Noninterest expense fell 3.0% to $40.4 million; compensation included $1.1 million of severance costs.
- Cash flow: Operating activities provided $12.9 million and investing activities provided $33.5 million; financing activities used $81.7 million. Cash and cash equivalents declined $35.3 million during the quarter to $189.6 million.
- Balance sheet: Total assets were $7.09 billion, down 1.2% from year-end. Net loans increased 2.1% to $4.38 billion. Deposits decreased 1.2% to $5.53 billion; noninterest-bearing deposits fell $78.7 million, while certificates of deposit increased $86.7 million.
- Credit quality: The allowance for credit losses on loans was $49.7 million, or 1.12% of loans, versus $48.0 million, or 1.11%, at year-end. Nonperforming loans were $7.4 million, up from $5.8 million; nonperforming assets were 0.10% of total assets. Net charge-offs were low, with $33,000 in net recoveries.
- Debt and liquidity: Borrowings were $500 million, consisting of Bank Term Funding Program borrowings; $400 million mature in May 2024 and $100 million in January 2025. Junior subordinated debentures were $21.8 million. Reported available liquidity totaled $2.50 billion, including $1.38 billion of FHLB availability, $708.4 million of unencumbered available-for-sale securities, and $189.6 million of cash. Brokered deposits were $115 million, or 2.08% of deposits.
- Capital and shareholder returns: Stockholders’ equity was $847.6 million, or 12.0% of assets. The Bank’s common equity Tier 1 ratio was 12.9% and it remained categorized as well-capitalized. The company declared a $0.23 per-share dividend for Q1 and repurchased 303,880 shares under its prior program.
Material changes versus comparable periods
- Management attributed the sharp year-over-year earnings decline mainly to the $10.0 million securities-sale loss and an $8.3 million decrease in net interest income, as higher deposit and borrowing costs outweighed increased asset yields.
- The company sold securities with $144.0 million of amortized cost as part of a balance-sheet repositioning. It purchased $33.1 million of securities at an estimated 6.05% weighted-average book yield, compared with a 2.37% estimated yield on securities sold; remaining proceeds supported loan growth and interest-earning deposits.
- Loans grew $92.5 million from year-end, led by commercial and multifamily construction lending and commercial and industrial loans. Total investment securities declined $143.3 million, and deposits declined $67.5 million.
- Interest-bearing deposit costs rose to 1.70% from 0.49% year over year. Average certificates of deposit increased by $383.6 million year over year, while average noninterest-bearing demand deposits decreased by $411.6 million.
Outlook, commentary, risks, and unusual items
- The filing provides no specific earnings or financial guidance. Management said it believes liquidity and capital sources are adequate for reasonably foreseeable needs; it cautions that Q1 results are not necessarily indicative of full-year results.
- Management describes interest-rate sensitivity as somewhat neutral over 12 months, but less asset-sensitive than at year-end. Its model estimates net interest income changes of -0.5% under an immediate +200-basis-point shock and +1.4% under a -200-basis-point shock. The estimates rely on assumptions and are not forecasts of actual results.
- Key stated risks include economic weakness and inflation, changing interest rates and funding costs, deposit competition or outflows, credit deterioration—particularly in commercial real estate—regulatory actions, liquidity access, and operational, technology, and third-party risks. Management said there were no material changes to the risk factors in the 2023 Form 10-K.
- Available-for-sale securities had $92.6 million of gross unrealized losses at quarter-end, primarily attributed by management to interest-rate changes; the company recorded no securities credit-loss allowance and said it did not intend or expect to be required to sell the securities before recovery.
- Unfunded commitments to extend credit totaled $1.19 billion. LIHTC investments had $98.4 million of unfunded contingent commitments, with $19.3 million expected to be funded in 2024 and $63.0 million in 2025.
- The board authorized a new repurchase program on April 24, 2024, for up to approximately 1.7 million shares, and declared a $0.23 dividend payable in May. These actions are subsequent to quarter-end and future repurchases and dividends remain subject to business, market, capital, and other considerations.
Important facts for investors to verify
- Whether the securities repositioning produces the expected improvement in recurring earnings, and how future securities sales or valuation changes may affect results and capital.
- Plans and funding capacity for the $400 million BTFP maturity in May 2024, and the effect of repayment or refinancing on liquidity and interest expense.
- Trends in deposit balances, mix, and pricing, especially migration into higher-cost certificates of deposit and the sustainability of funding costs.
- Commercial real estate and construction loan performance, nonperforming and past-due loan trends, and the adequacy of the allowance under changing economic conditions.
- Execution and timing of loan growth, the large outstanding credit commitments, and scheduled funding of LIHTC obligations.
- Capital levels and constraints on dividends or repurchases, including the terms and actual use of the new repurchase authorization.