Heritage Financial Announces Third Quarter Results And Declares Regular Cash Dividend

OLYMPIA, Wash., Oct. 23, 2014 /PRNewswire/ -- HERITAGE FINANCIAL CORPORATION (NASDAQ GS: HFWA) Brian L. Vance, President and CEO of Heritage Financial Corporation ("the Company" or "Heritage"), today reported that the Company had net income of $7.1 million for the quarter ended September 30, 2014 compared to net income of $3.3 million for the quarter ended September 30, 2013 and $4.1 million for the linked-quarter ended June 30, 2014.  Net income for the quarter ended September 30, 2014 was $0.23 per diluted common share compared to $0.20 per diluted common share for the quarter ended September 30, 2013 and $0.16 per diluted common share for the linked-quarter ended June 30, 2014.

Net income for the nine months ended September 30, 2014 was $13.8 million, or $0.57 per diluted common share, compared to $8.9 million, or $0.57 per diluted common share, for the nine months ended September 30, 2013. 

Mr. Vance commented, "With our first full quarter following the Washington Banking Merger, we are beginning to realize the benefits of the merger through improved profitability.  For the quarter ended September 30, 2014, our earnings per share, return on average assets and return on average equity are all improved over any of the past four quarters.  As we are able to realize expected cost savings and efficiencies from the merger we expect profitability to continue to improve."

Mr. Vance added, "In order to continue to manage our capital position, a new stock repurchase program has been authorized.  We will continue to focus foremost on balance sheet growth while at the same time using tools such as dividends and stock buybacks to bring capital levels to more optimal levels."

Merger with Washington Banking Company

Effective May 1, 2014, Heritage completed the strategic merger with Washington Banking Company and its wholly owned subsidiary, Whidbey Island Bank ("Washington Banking Merger").  The merger was accounted for using the acquisition method of accounting. Accordingly, Heritage's cost to acquire Washington Banking was allocated to the assets (including identifiable intangible assets) and the liabilities of Washington Banking at their respective estimated fair values as of the merger date. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill.  The fair value on the merger date represents management's best estimates based on available information and facts and circumstances in existence on the merger date. The allocation of the purchase price is subject to adjustment within the one year re-measurement period.

During the quarter ended September 30, 2014, based on additional information obtained, certain adjustments were made to the allocation of the purchase price.  As a result of these adjustments, the amount of goodwill recognized from the merger increased to $89.5 million at September 30, 2014 from $88.8 million at June 30, 2014.

The following table provides detail of the fair value of the assets acquired and liabilities assumed:

Impact of 2013 Initiatives

In addition to the merger with Washington Banking, the following other 2013 initiatives had an impact on the current year and prior year operating results of the Company:

• On January 9, 2013, the Company acquired Northwest Commercial Bank ("NCB") and merged it into Heritage Bank, the Company's subsidiary bank (the "NCB Acquisition"). NCB was a full service commercial bank with branches in Lakewood and Auburn, Washington. In March 2013, the Company consolidated the operations of the former NCB Lakewood branch with the Lakewood branch of Heritage Bank.
• On June 19, 2013, the Company completed the merger of its subsidiary, Central Valley Bank ("CVB"), with and into Heritage Bank (the "CVB Merger"). CVB is now operated as a division of Heritage Bank.
• On July 15, 2013, the Company completed the acquisition of Valley Community Bancshares, Inc. ("Valley"), the holding company for Valley Bank, both of Puyallup, Washington (the "Valley Acquisition"). As of the acquisition date, Valley merged into Heritage and Valley Bank merged into Heritage Bank. During the quarter ended December 31, 2013, four former Valley Bank branches were consolidated into existing Heritage Bank branches.
• During the quarter ended December 31, 2013, the Company completed a core system conversion of Heritage Bank.
• Also during the quarter ended December 31, 2013, the Company consolidated three Heritage Bank branches into existing Heritage Bank branches.

Balance Sheet

The Company's total assets increased $59.6 million to $3.45 billion at September 30, 2014 from $3.39 billion at June 30, 2014.  The increase in assets was primarily due to increases of $72.1 million in interest earning deposits and $29.6 in investment securities, partially offset by a decrease of $26.2 million in total loans receivable, net.

Total loans receivable, net, decreased $26.2 million to $2.17 billion at September 30, 2014 from $2.20 billion at June 30, 2014.  This decrease was primarily due to a $18.3 million decrease in covered loans receivable, net of allowance for loan losses, to $132.7 million at September 30, 2014.  Covered loans are loans acquired through FDIC-assisted transactions which are covered by FDIC shared-loss agreements.  These balances are expected to continue to decline substantially over the next few quarters. 

Total noncovered loans, net of allowance for loan losses, decreased $7.8 million to $2.04 billion at September 30, 2014 from $2.05 billion at June 30, 2014.  Noncovered loans include loans originated by Heritage Bank as well as other noncovered loans obtained in previous mergers and acquisitions.

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented, "We did not see a significant increase in new loan closings in the past quarter and we experienced a number of large pay-offs including some completed construction projects.  The loan pipeline remains steady and we anticipate several larger transactions will close in the fourth quarter.  We are pleased to see the combined lending platform working well together to develop business across the footprint."

Total deposits increased $36.5 million to $2.90 billion at September 30, 2014 from $2.87 billion at June 30, 2014.  Non-maturity deposits as a percentage of total deposits increased to 80.1% at September 30, 2014 from 78.3% at June 30, 2014, which included noninterest bearing demand deposits that increased to 23.9% to total deposits at September 30, 2014 from 23.3% at June 30, 2014.  The increases in these ratios were primarily due to a $42.7 million decrease in certificates of deposits to $577.9 million as of September 30, 2014 from $620.7 million as of June 30, 2014. 

Total stockholders' equity increased $1.8 million to $451.7 million at September 30, 2014 from $449.8 million at June 30, 2014.  This increase was due to net income of $7.1 million partially offset by a cash dividend of $2.7 million, stock repurchases in the amount of $1.8 million and a decrease of $1.4 million in accumulated other comprehensive income, net.  The Company and Heritage Bank continue to maintain capital levels significantly in excess of the applicable regulatory requirements for them to be categorized as "well-capitalized". The Company had Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios at September 30, 2014 of 10.3%, 14.7% and 15.9%, respectively, as compared to 12.6%, 14.5%, and 15.7%, respectively, at June 30, 2014. 

Credit Quality

The allowance for loan losses on noncovered loans decreased $149,000 to $22.2 million at September 30, 2014 from $22.4 million at June 30, 2014 as a result of $716,000 in net charge-offs recognized during the quarter ended September 30, 2014 partially offset by $567,000 in provision for loan losses.  Nonperforming noncovered loans to total noncovered loans decreased to 0.57% at September 30, 2014 from 0.66% at June 30, 2014.  Nonaccrual noncovered loans decreased $1.9 million to $11.7 million ($9.8 million net of government agency guarantees) at September 30, 2014 from $13.6 million ($11.3 million net of government agency guarantees) at June 30, 2014.  The decrease was due to $1.4 million of net principal reductions, $330,000 of charge-offs and $326,000 of transfers to other real estate owned, offset partially by $100,000 of additions to nonaccrual noncovered loans.

The allowance for loan losses to nonperforming noncovered loans was 190.35% at September 30, 2014 compared to 164.62% at June 30, 2014.  Potential problem noncovered loans were $125.4 million at September 30, 2014 compared to $137.0 million at June 30, 2014. This decrease was primarily due to loan payoffs of $21.2 million, offset partially by the addition of $9.6 million of loans classified during the period.

The allowance for loan losses on noncovered loans to total noncovered loans, net was 1.08% at both September 30, 2014 and June 30, 2014.  The Company believes that its allowance for loan losses is appropriate to provide for probable incurred credit losses based on an evaluation of known and inherent risks in the loan portfolio at September 30, 2014.

Nonperforming noncovered assets were $15.8 million ($14.0 million net of government agency guarantees), or 0.48% of total noncovered assets, at September 30, 2014, compared to $18.6 million ($16.3 million net of government agency guarantees), or 0.58% of total noncovered assets, at June 30, 2014.  Other real estate owned decreased $1.2 million to $6.9 million at September 30, 2014 (of which $2.8 million was covered by FDIC shared-loss agreements) from $8.1 million at June 30, 2014 (of which $3.0 million was covered by FDIC shared-loss agreements). 

Operating Results

Net interest income increased $15.7 million to $33.3 million for the quarter ended September 30, 2014 compared to $17.6 million for the same period in 2013.  Net interest income increased $28.6 million to $78.6 million for the nine months ended September 30, 2014 compared to $50.1 million for the same period in 2013.  The increases in net interest income are primarily due to the Washington Banking Merger.

Heritage's net interest margin for the quarter ended September 30, 2014 decreased 35 basis points to 4.32% from 4.67% for the same period in 2013 and decreased 23 basis points from 4.55% in the linked-quarter ended June 30, 2014.  The decline in net interest margin from prior periods is due to a change in the earnings asset mix (lower ratio of loans to earning assets and higher ratio of investments and interest earning deposits to earning assets) as well as lower contractual loan note rates. Heritage's net interest margin for the nine months ended September 30, 2014 decreased 45 basis points to 4.43% from 4.88% for the same period in 2013. 

The following table presents the net interest margins and effects of the incremental accretion on purchased loans for the periods noted:

The net interest margin, excluding incremental accretion on purchased loans, decreased to 3.83% for the quarter ended September 30, 2014 from 4.29% for the same period in 2013 and from 4.12% from the linked-quarter ended June 30, 2014.  For the nine months ended September 30, 2014, the net interest margin, excluding incremental accretion on purchased loans, decreased to 4.01% from 4.37% for the same period in the prior year.

The provision for loan losses on noncovered loans was $567,000 for the quarter ended September 30, 2014 compared to $875,000 for the quarter ended September 30, 2013 and $370,000 for the linked-quarter ended June 30, 2014.  For the nine months ended September 30, 2014, the provision for loan losses on noncovered loans was $916,000 compared to $1.6 million for the same period in the prior year.

The provision for loan losses on covered loans totaled $27,000 for the quarter ended September 30, 2014 compared to $203,000 for the same period in the prior year and $321,000 for the linked-quarter ended June 30, 2014.  For the nine months ended September 30, 2014, the provision for loan losses on covered loans was $827,000 compared to $1.7 million for the same period in the prior year.

As of the merger dates, acquired loans were recorded at their estimated fair value, incorporating our estimate of future expected cash flows until the ultimate resolution of these credits.  As reflected in the table below, incremental accretion income from acquired loans was $3.8 million for the quarter ended September 30, 2014 compared to $1.4 million for the quarter ended September 30, 2013 and $2.7 million for the linked-quarter ended June 30, 2014.  The increase for the quarter ended September 30, 2014 was due to incremental accretion income from the Washington Banking Merger.  For the nine months ended September 30, 2014, incremental accretion income was $7.5 million compared to $5.2 million for the same period in the prior year.

For the quarter ended September 30, 2014, the Company recognized $(647,000) of change in the FDIC indemnification asset compared to $109,000 and $(350,000) for the quarters ended June 30, 2014 and September 30, 2013, respectively.

The following table illustrates the earnings impact associated with the Company's acquired loan portfolios:

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "The incremental accretion income increased from the prior quarter due to the Washington Banking Merger which had a significantly positive impact on the reported net interest margin for quarter ended September 30, 2014.  The net interest margin before incremental accretion income continues to decline due to the low rate environment.  Although the Company continues to grow earning assets, the percentage of earning assets held in loans, which are higher yielding than other earning assets, has experienced a decrease which also negatively impacts the net interest margin."

Noninterest income was $5.5 million for the quarter ended September 30, 2014 compared to $2.6 million for the same period in 2013 and $4.8 million for the linked-quarter ended June 30, 2014.  For the nine months ended September 30, 2014, noninterest income was $12.6 million compared to $7.2 million for the nine months ended September 30, 2013.  The increases were primarily due to the Washington Banking Merger.

In addition to the Washington Banking Merger, prior year initiatives had a significant impact on noninterest expense during 2013, and continue to impact 2014 expense levels. The following tables illustrate the expenses related to implementing these initiatives.  The amounts reported represent identifiable costs paid to third-party providers as well as any retention bonuses or severance payments made in conjunction with these initiatives.  The amounts do not include costs of additional staffing levels required to complete the initiatives nor do they include future expected cost savings from the Washington Banking Merger. The first table reports these expenses by initiative and the second table reports these expenses by expense category.

The types of expenses associated with the significant expense categories in the table above are summarized as follows:

• Compensation and employee benefits expense consisted substantially of retention bonus and severance packages paid to transitional employees.
• Occupancy and equipment expense consisted primarily of lease termination costs.
• Data processing expense consisted of costs relating to the Company's core system conversion as well as conversions of NCB and Valley Bank and the preparation for the conversion of Whidbey Island Bank.
• Professional services expense includes fees paid to financial advisors, attorneys, and accountants, and consultant fees related to mergers and acquisitions and to the core system conversion.

Noninterest expense was $28.4 million for the quarter ended September 30, 2014 compared to $14.3 million for the quarter ended September 30, 2013 and $27.0 million for the linked-quarter ended June 30, 2014.  Noninterest expense was $70.1 million for the nine months ended September 30, 2014 compared to $41.0 million for the nine months ended September 30, 2013.  The increases are due to the Washington Banking Merger and additional ongoing operating costs from mergers and acquisitions as well as specific costs identified in the table above.

Mr. Deuel added, "After many months of planning we successfully completed the conversion of the legacy Whidbey platform onto the Heritage core system.  Between now and the end of the year we will continue to refine our processes in order to gain the efficiencies we originally expected from the merger."

Income tax expense was $2.8 million for the quarter ended September 30, 2014 compared to $1.5 million for the comparable quarter in 2013 and for the linked-quarter ended June 30, 2014.  The increase in income tax expense for the quarter ended September 30, 2014 from the prior year periods was due to the increase in pre-tax income and was partially offset by tax credits.

Dividend

On October 23, 2014, the Company's Board of Directors declared a quarterly cash dividend of $0.09 per common share payable on November 20, 2014 to shareholders of record on November 6, 2014. 

Stock Repurchase Program

On October 23, 2014, the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares or approximately 1,513,000 shares.  The number, timing and price of shares repurchased will depend on business and market conditions, and other factors, including opportunities to deploy the Company's capital.

The new stock repurchase program supersedes the previous stock repurchase program, which was authorized in August 2012 and allowed for the buyback of approximately 757,000 shares.  Under the previous program, approximately 705,000 shares were repurchased.

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on October 24, 2014 at 9:00 a.m. Pacific time.  To access the call, please dial (800) 230-1074 a few minutes prior to 9:00 a.m. Pacific time.  The call will be available for replay through November 7, 2014, by dialing (800) 475-6701 -- access code 338164.

About Heritage Financial

Heritage Financial Corporation is an Olympia-based bank holding company with Heritage Bank, a full-service commercial bank, as its sole wholly-owned banking subsidiary. Heritage Bank has a branching network of 67 banking offices in Washington and Oregon. Heritage Bank also does business under the Central Valley Bank name in the Yakima and Kittitas counties of Washington and under the Whidbey Island Bank name on Whidbey Island. Heritage's stock is traded on the NASDAQ Global Select Market under the symbol "HFWA".  More information about Heritage Financial Corporation can be found on its website at www.hf-wa.com and more information about Heritage Bank can be found on its website at www.heritagebanknw.com.

Non-GAAP Financial Measures

This news release contains certain non-GAAP (Generally Accepted Accounting Principles) financial measures in addition to results presented in accordance with GAAP.  These measures include tangible common stockholders' equity, tangible book value per share and tangible common stockholders' equity to tangible assets.  Tangible common stockholders' equity (tangible book value) excludes goodwill and other intangible assets.  Tangible assets exclude goodwill and other intangible assets.  Management has presented these non-GAAP financial measures in this earnings release because it believes that they provide useful and comparative information to assess trends in the Company's capital reflected in the current quarter and year-to-date results and facilitate our performance with the performance of our peers.  Where applicable, the Company has also presented comparable earnings information using GAAP financial measures. Reconciliations of the GAAP and non-GAAP financial measures are presented below.

Forward-Looking Statements

This release contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements often include the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated,  including: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets,  which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to increase our allowance for loan losses; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Board of Governors of the Federal Reserve System and of our bank subsidiary by the Federal Deposit Insurance Corporation, the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementing regulations; further increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our consolidated statements of financial condition; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our expansion strategy of pursuing acquisitions and denovo branching; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired including those from the Cowlitz Bank, Pierce Commercial Bank,  Northwest Commercial Bank. Valley Community Bancshares and Washington Banking Company transactions, or may in the future acquire into our operations, and our ability to realize related revenue synergies and cost savings within expected time frames, or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and other risks detailed from time to time in our filings with the Securities and Exchange Commission including our Quarterly Reports on Form 10-Q and our Annual Reports on Form 10-K.

The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company's operating and stock price performance.

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SOURCE Heritage Financial Corporation

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