Heritage Financial Corporation — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. Heritage Financial is a Washington-based bank holding company operating Heritage Bank, with 50 branches across Washington, Oregon and Idaho. Figures below are in millions of dollars unless noted.
Financial performance and condition
| Metric | Q3 2023 / September 30, 2023 | Comparison |
|---|---|---|
| Net interest income | $55.6; net interest margin 3.47% | Q3 2022: $59.3 and 3.57% |
| Net income | $18.2; diluted EPS $0.51 | Q3 2022: $21.0 and $0.59 |
| Noninterest income | $6.3 | Down $1.2 year over year; included a $1.9 securities-sale loss |
| Noninterest expense | $41.0 | Up $1.8 year over year |
| Credit provision | $0.9 reversal | Q3 2022: $1.9 provision |
| Loans receivable | $4,266.9 gross; $4,219.9 net of allowance | Gross loans up 5.3% from year-end 2022 |
| Allowance for credit losses | $46.9; 1.10% of loans | $43.0 at year-end 2022 |
| Deposits | $5,635.2 | Down 4.9% from year-end 2022 |
| Borrowings | $450.0 outstanding | FRB Bank Term Funding Program borrowing; average rate 4.74% |
| Cash and cash equivalents | $220.5 | $103.6 at year-end 2022 |
| Stockholders’ equity | $813.5; equity-to-assets ratio 11.4% | Equity up 2.0% from year-end 2022; AOCI loss was $112.6 |
For the first nine months, net interest income was $171.3, up 9.6% year over year, and net interest margin was 3.64%, up 49 basis points. Net income was $55.5, down 6.4%, with diluted EPS of $1.57 versus $1.67. Interest income rose, but funding costs increased sharply: nine-month interest expense was $38.9 versus $5.2, including $12.2 of borrowing expense.
Nine-month cash flows were $78.6 provided by operating activities, $83.1 used in investing and $121.5 provided by financing. Cash and cash equivalents increased $116.9. Total available liquidity was reported as $2,720.7 after deducting outstanding borrowings; this includes borrowing capacity and unencumbered securities, not only cash.
Material changes and notable items
- Loans grew $216.0 from year-end 2022. Commercial business represented 78.1% of loans; commercial and multifamily construction loans increased 44.8% to $310.0.
- Deposits fell $289.7. Non-maturity deposits decreased $610.7, partly offset by a $321.0 increase in certificates of deposit. Brokered deposits were $107.5, or 1.91% of deposits.
- The bank sold $67.9 of available-for-sale securities and recorded a $2.2 net loss for the nine months. Available-for-sale securities had $145.0 of gross unrealized losses at quarter-end; management attributed declines to interest rates, reported no below-investment-grade rated securities, and recorded no securities credit-loss allowance.
- Other income included a one-time $1.6 gain from sale of Visa Class B shares and a $0.6 gain related to the Ellensburg branch sale. The branch sale also transferred $13.8 of deposits during Q3.
- Noninterest expense rose 12.1% for the nine months, driven particularly by compensation, branch-market expansion, technology costs and higher FDIC premiums.
- The quarterly dividend declared was $0.22 per share, up from $0.21 a year earlier. The company repurchased 330,424 shares under its program during the first nine months.
Credit, liquidity, outlook and risks
Nonaccrual loans declined to $3.1 from $5.9 at year-end 2022. Nonperforming assets were $5.2, or 0.07% of total assets. Past-due loans totaled $6.5; $2.2 of loans were 90 days or more past due and still accruing. Management cited loan growth and portfolio mix as drivers of the nine-month $3.1 loan-loss provision, partly offset by net recoveries. It also added qualitative allowance adjustments for higher-risk segments and uncertainty in the economic outlook.
Management said its deposit base was seasoned and diversified, and that 2023 banking-industry disruptions had not materially affected the company’s condition or operations. It nevertheless enhanced liquidity monitoring and contingency planning. At September 30, borrowing availability included $823.1 from the FRB and $1,202.2 from the FHLB; the bank also had $145.0 in unsecured correspondent-bank lines. Management stated that capital resources were adequate for reasonably foreseeable needs and that the company and bank met applicable capital requirements; the bank was categorized as well-capitalized. Company common equity Tier 1 and total capital ratios were 12.9% and 14.1%.
No specific earnings or margin guidance was provided. Management warned that persistent inflation, high interest rates, a possible recession, deposit competition and weaker economic activity could pressure loan growth, funding costs, credit quality, liquidity, net interest margin and securities values. CRE exposure, especially commercial lending and construction, is a key area to monitor. Interest-rate simulations showed estimated first-year net interest income increases of 1.1% for a +100-basis-point shock and 1.4% for a −100-basis-point shock; management cautioned that model assumptions are uncertain and actual results may differ. Goodwill was tested after a stock-price decline and no impairment was identified. The filing reported no material pending litigation beyond routine matters and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether deposit outflows stabilize and deposit pricing continues to pressure funding costs and margins.
- Performance and risk concentration of CRE and commercial/multifamily construction loans, alongside trends in criticized, past-due and nonaccrual balances.
- Use, maturity and cost of the $450.0 FRB borrowing, and the accessibility of reported contingent liquidity sources.
- Further changes in unrealized securities losses, AOCI and the bank’s ability to hold securities until recovery or maturity.
- Whether expense growth, including staffing, expansion, technology and FDIC costs, is matched by revenue growth.
- That Q3 includes a securities-sale loss and the nine-month comparison includes one-time Visa and branch-sale gains; assess recurring earnings separately.