Heritage Financial Corporation — 2022 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2022. Heritage Financial is a Washington bank holding company whose principal business is Heritage Bank, a community bank operating in Washington and Oregon. It reported one operating segment. The Bank had 50 branches at year-end and opened its first Idaho branch in January 2023.
Financial results and condition
Amounts are in U.S. dollars; financial statement amounts below are rounded to millions unless stated otherwise.
| Metric | 2022 | 2021 | Change or context |
|---|---|---|---|
| Net interest income | $219.4 million | $205.8 million | Up 6.6% |
| Net interest margin | 3.35% | 3.23% | Up 12 basis points |
| Net income | $81.9 million | $98.0 million | Down 16.5% |
| Diluted earnings per share | $2.31 | $2.73 | Down 15.4% |
| Total noninterest income | $29.6 million | $34.6 million | Down 14.5% |
| Total noninterest expense | $151.0 million | $149.3 million | Up 1.1% |
| Efficiency ratio | 60.63% | 62.09% | Improved |
| Operating cash flow | $94.5 million | $69.5 million | Provided by operations |
- Profit fell primarily because the benefit from credit-loss provision reversals was much smaller: the 2022 reversal was $1.4 million, versus $29.4 million in 2021. Higher net interest income partly offset this and other decreases.
- Interest income rose 6.9% to $227.5 million, while interest expense increased 14.6% to $8.1 million. PPP interest and fee income declined to $5.2 million from $32.1 million as guaranteed loans were forgiven and paid down.
- Noninterest income declined mainly because gains on loan sales and other asset sales were lower. The 2022 results included a $1.0 million bank-owned life insurance death benefit.
- Income before tax was $99.4 million; income tax expense was $17.6 million, for a 17.7% effective tax rate.
Balance sheet, liquidity, and capital
- Total assets were $6.98 billion, down 6.1%. Loans receivable, net, increased 6.2% to $4.01 billion.
- Deposits declined 7.3% to $5.92 billion. Non-maturity deposits were 94.8% of deposits; uninsured deposits totaled $2.37 billion. Management attributed deposit outflows principally to competitive pricing, customers moving funds to higher-yielding alternatives, and use of business funds.
- Cash and cash equivalents fell from $1.72 billion to $103.6 million, while total investment securities increased 64.2% to $2.10 billion. Management attributed the cash reduction primarily to investing excess liquidity in securities and loans.
- 2022 cash flows included $1.21 billion used in investing activities and $506.4 million used in financing activities; cash and cash equivalents declined $1.62 billion overall.
- Available-for-sale securities had fair value of $1.33 billion against $1.46 billion amortized cost. Their unrealized losses contributed to accumulated other comprehensive loss of $99.9 million, versus accumulated other comprehensive income of $9.4 million a year earlier. Management said these fair-value changes did not affect regulatory capital ratios because the Company elected to exclude AOCI from regulatory capital.
- Held-to-maturity securities had carrying value of $766.4 million and fair value of $673.4 million. The Company reported no credit-loss allowance on either available-for-sale or held-to-maturity securities.
- Available liquidity included $103.6 million in cash, $1.23 billion of FHLB borrowing availability, $46.8 million of Federal Reserve borrowing availability, and $215 million of federal funds lines. The filing’s liquidity table reports combined FHLB and Federal Reserve availability of $1.273 billion.
- Company regulatory capital ratios were 12.8% common equity Tier 1, 9.7% leverage, 13.2% Tier 1, and 14.0% total capital. The Bank was categorized as well-capitalized.
- Debt included $21.5 million of junior subordinated debentures; no FHLB advances or federal funds borrowings were outstanding at year-end. Repurchase-agreement obligations were $46.6 million.
Material changes and credit quality
- The loan portfolio grew $235.2 million. Commercial business loans were $3.22 billion, or 79.4% of loans; owner- and non-owner-occupied commercial real estate loans totaled $2.52 billion, or 62.3% of loans. Residential real estate loans more than doubled, including $139.0 million of purchased loans.
- Nonaccrual loans decreased 75.1% to $5.9 million, or 0.15% of loans, from $23.8 million, or 0.62%. The filing cites collections, transfers back to accrual status, payoffs, and loan sales.
- Loans 90 days or more past due but still accruing increased to $1.6 million from $0.3 million.
- The allowance for credit losses on loans was $43.0 million, or 1.06% of loans, compared with $42.4 million, or 1.11%, a year earlier. Net recoveries were $1.2 million in 2022, versus net charge-offs of $0.5 million in 2021.
- Total stockholders’ equity declined 6.6% to $797.9 million, primarily reflecting the $109.2 million net-of-tax other comprehensive loss, as well as dividends and share repurchases, partly offset by net income.
Outlook, risks, and unusual items
- The filing provides no specific earnings, revenue, margin, or credit-loss guidance. Management said it expected capital sources to meet reasonably foreseeable short- and intermediate-term cash requirements and expected to continue quarterly dividends, subject to Board discretion.
- The quarterly dividend was $0.21 per share during 2022; the Board declared $0.22 per share in January 2023. Future dividends are not assured and depend in part on the Bank’s ability to pay dividends to the holding company.
- Management identified interest-rate and deposit-pricing risk, deposit competition and liquidity, inflation and possible recession, and credit exposure in commercial real estate and construction lending as significant concerns. Rising rates contributed to lower securities values and may increase deposit costs; the impact on future net interest income is uncertain.
- The Bank had $389.0 million of loans tied to LIBOR at year-end and described its contract-transition measures ahead of the remaining U.S. dollar LIBOR tenors ending in June 2023.
- Other disclosed risks include cybersecurity and third-party service-provider disruptions, regulatory and compliance changes, climate-related impacts, and the possibility that economic deterioration could require higher credit-loss provisions. Management’s allowance estimates rely on forecasts and qualitative judgments; the auditor identified the qualitative allowance as a critical audit matter.
- The Bank agreed to sell its Ellensburg branch; $17.4 million of deposits were classified as held for sale. Completion was expected in the second quarter of 2023, subject to factors including regulatory approval.
- The independent auditor gave unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management and the auditor reported effective internal controls as of December 31, 2022.
Important facts for investors to verify
- Whether deposit outflows continued after year-end, and how uninsured-deposit balances and customer concentration have changed.
- How rising rates affected deposit costs, funding needs, net interest margin, and the fair value or liquidity of the securities portfolio.
- Whether commercial real estate and construction loan performance, delinquencies, criticized loans, and the allowance remain consistent with management’s assumptions.
- The status and financial impact of the Ellensburg branch sale and the January 2023 Idaho branch opening.
- Whether the $0.22 quarterly dividend remains supported by earnings, capital, liquidity, and Bank-to-parent dividend capacity.
- Progress in transitioning LIBOR-linked contracts and any changes to the disclosed liquidity sources or borrowing availability.