Heritage Financial Announces First Quarter 2016 Results And Declares Regular Cash Dividend

OLYMPIA, Wash., April 21, 2016 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) ("Company" or "Heritage") today reported that the Company had net income of $9.1 million for the quarter ended March 31, 2016 compared to net income of $9.8 million for the quarter ended March 31, 2015 and $9.5 million for the linked-quarter ended December 31, 2015.  Diluted earnings per common share for the quarter ended March 31, 2016 was $0.30 per diluted common share compared to $0.32 per diluted common share for both the quarter ended March 31, 2015 and the linked-quarter ended December 31, 2015.

Brian L. Vance, President and CEO, commented, "The highlight of our first quarter was our loan growth of 2.4%, or 9.6% on an annualized basis.  We continue to have confidence in the general Pacific Northwest economy.  Our core markets--Seattle, Bellevue, Everett and Tacoma--continue to show steady growth and improvement."

"We are also pleased to announce a $0.01 increase in our quarterly cash dividend to $0.12, which represents a quarter-over-quarter increase of 9.1%."

Balance Sheet

The Company's total assets increased $27.2 million, or 0.7%, to $3.68 billion at March 31, 2016 from $3.65 billion at December 31, 2015. 

Loans receivable, net of allowance for loan losses, increased $57.2 million, or 2.4%, to $2.43 billion at March 31, 2016 from $2.37 billion at December 31, 2015.  The growth in loans receivable was due primarily to increases of $33.1 million in non-owner occupied commercial real estate loans, $14.3 million in consumer loans and $12.2 million in real estate construction and land development loans.

Investment securities available for sale increased $10.3 million, or 1.3%, to $822.2 million at March 31, 2016 from $811.9 million at December 31, 2015.  The increase was due to primarily to increases in unrealized gains on the investment securities as a result of increases in market values as well as purchases of additional investment securities.

Interest earning deposits, included as a component of cash and cash equivalents, decreased $30.3 million, or 48.3%, to $32.5 million at March 31, 2016 from $62.8 million at December 31, 2015 as the Company utilized its cash to invest in higher yielding interest earning assets, including loans and investment securities.

Total deposits increased $22.6 million, or 0.7%, to $3.13 billion at March 31, 2016 from $3.11 billion at December 31, 2015.  Non-maturity deposits as a percentage of total deposits increased to 87.0% at March 31, 2016 from 86.5% at December 31, 2015.  The increase in this ratio was due to a combination of an increase of $35.1 million in non-maturity deposits and a decrease of $12.5 million in certificates of deposits.  The increase in non-maturity deposits was primarily due to a $26.2 million, or 2.9%, increase in NOW accounts to $944.1 million at March 31, 2016 from $917.9 million at December 31, 2015 and a $23.6 million, or 3.1%, increase in noninterest bearing demand deposits to $794.5 million at March 31, 2016 from $770.9 million at December 31, 2015, offset partially by a $26.3 million, or 4.8%, decrease in money market deposits to $519.1 million at March 31, 2016 from $545.3 million at December 31, 2015.  Certificates of deposit decreased $12.5 million, or 3.0%, to $407.8 million at March 31, 2016 from $420.3 million at December 31, 2015.  Deposits per branch increased $3.3 million, or 7.1%, to $49.7 million at March 31, 2016 from $46.4 million at December 31, 2015 due to a combination of deposit growth and a reduction of four branches during the quarter ended March 31, 2016.

Total stockholders' equity increased $10.2 million, or 2.2%, to $480.2 million at March 31, 2016 from $470.0 million at December 31, 2015.  The increase was primarily due to net income of $9.1 million during the quarter ended March 31, 2016 and an increase of $5.7 million in accumulated other comprehensive income, partially offset by $3.3 million in cash dividends and $1.9 million in stock repurchases.  During the quarter ended March 31, 2016, the Company repurchased 100,000 shares of common stock at a weighted average price of $17.08.  In addition, during the quarter ended March 31, 2016, the Company issued 99,373 shares of common stock in the form of restricted stock awards to employees of which the expense will be recognized over a four-year vesting period. 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  common equity Tier 1 risk-based, Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios at March 31, 2016 of 11.9%, 10.5%, 12.6% and 13.6%, respectively, compared to 12.0%, 10.4%, 12.7% and 13.7%, respectively, at December 31, 2015.

Credit Quality

The allowance for loan losses was $29.7 million at both March 31, 2016 and December 31, 2015.  This was due to a provision for loan losses of $1.1 million offset by $1.2 million in net charge-offs recognized during the quarter ended March 31, 2016.  Nonperforming loans to loans receivable, net, increased to 0.50% at March 31, 2016 from 0.40% at December 31, 2015.  Nonaccrual loans increased $2.7 million, or 27.8%, to $12.4 million ($1.4 million guaranteed by government agencies) at March 31, 2016 from $9.7 million ($1.1 million guaranteed by government agencies) at December 31, 2015.  The increase was due primarily to $4.0 million of additions to nonaccrual loans, offset partially by $1.1 million of net principal reductions and $206,000 of charge-offs.

The allowance for loan losses to nonperforming loans was 240.14% at March 31, 2016 compared to 307.67% at December 31, 2015.  Potential problem loans were $94.8 million at March 31, 2016 compared to $110.4 million at December 31, 2015. The $15.5 million decrease was primarily due to loan grade improvements of $9.8 million, net loan payments of $6.0 million, loans transferred to impaired status of $3.9 million and loan charge-offs of $1.4 million, offset partially by the addition of $6.2 million of loans graded as potential problem loans during the period.

The allowance for loan losses to loans receivable, net was 1.21% at March 31, 2016 compared to 1.24% at December 31, 2015.  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 March 31, 2016. Included in the carrying value of loans are net discounts on loans purchased in mergers and acquisitions which may reduce the need for an allowance for loan losses on these loans because they are carried at an amount below the unpaid principal balance.  The remaining net discounts on these purchased loans was $18.6 million at March 31, 2016 compared to $20.4 million at December 31, 2015.

Net charge-offs increased to $1.2 million for the quarter ended March 31, 2016 compared to $1.1 million for the same quarter in 2015 and $382,000 for the linked-quarter ended December 31, 2015.  The increase of net charge-offs in the quarter ended March 31, 2016 was due primarily to a charge-off of $925,000 from a commercial and industrial loan that defaulted during the quarter.

Nonperforming assets increased $2.5 million, or 21.3%, to $14.2 million ($1.4 million guaranteed by government agencies), or 0.39% of total assets, at March 31, 2016, compared to $11.7 million ($1.1 million guaranteed by government agencies), or 0.32% of total assets, at December 31, 2015 due primarily to the increase in nonperforming loans discussed above.  Other real estate owned decreased $193,000, or 9.6%, to $1.8 million at March 31, 2016 from $2.0 million at December 31, 2015. The decrease in other real estate owned was primarily due to the disposition of properties totaling $543,000 and valuation adjustments of $312,000 during the quarter ended March 31, 2016, offset by additions of properties totaling $652,000.

Operating Results

Net interest income increased $86,000, or 0.3%, to $32.8 million for the quarter ended March 31, 2016 compared to $32.7 million for the same period in 2015 and increased $225,000, or 0.7%, from $32.5 million for the linked-quarter ended December 31, 2015.  The increase in net interest income for the current quarter compared to same period in 2015 and the linked-quarter was primarily due to an increase in interest income on investment securities as a result of both an increase in investment yields and volumes.  The increase in net interest income was offset by a decrease in incremental accretion income (included in interest and fees on loans on the Condensed Consolidated Statements of Income).

Heritage's net interest margin for the quarter ended March 31, 2016 decreased 27 basis points to 4.04% from 4.31% for the same period in 2015 and increased seven basis points from 3.97% in the linked-quarter ended December 31, 2015.  As shown in the table below, the net interest margin, excluding incremental accretion on purchased loans, decreased to 3.82% for the quarter ended March 31, 2016 from 3.87% for the same period in 2015 and increased from 3.69% for the linked-quarter ended December 31, 2015.  The decreases in net interest margin, both including and excluding the impacts of the incremental accretion, from the same period in 2015 are due primarily to lower contractual loan note rates and a decrease in incremental accretion income as the purchased loan balances continued to decrease.  The increases in net interest margin, both including and excluding the impacts of the incremental accretion, for the three months ended March 31, 2016 compared to the linked-quarter was due to increases in the yields on investment securities and the yield on loans, excluding incremental accretion on purchased loans, as well as an increase in the percentage of average earning assets of loans and investments.

The following table presents the net interest margin and the effect of the incremental accretion on purchased loans for the periods presented below:

Yields on loans, excluding incremental accretion on purchased loans, decreased 15 basis points to 4.77% for the quarter ended March 31, 2016 from 4.92% for the same period in 2015 due primarily to lower contractual note rates, and increased seven basis points from 4.70% for the linked-quarter ended December 31, 2015 primarily as a result of the impact of an increase in variable rate indices.

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "Our pre-accretion net interest margin showed a nice increase from the linked-quarter as a result of further leveraging our overnight cash position as well as the effects of the 25 basis point prime rate increase in December.  For the quarter ended March 31, 2016, average loans receivable increased to 73.3% of average interest earning assets from 73.0% for the linked-quarter and average investments increased to 24.8% of average interest earning assets from 23.4% for the linked-quarter."

The provision for loan losses was $1.1 million for the quarter ended March 31, 2016 compared to $1.2 million for the quarter ended March 31, 2015 and $1.1 million for the linked-quarter ended December 31, 2015.

As of the dates of the completion of each of the mergers and acquisitions, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits.  As reflected in the table below, incremental accretion income from purchased loans was $1.8 million for the quarter ended March 31, 2016 compared to $3.3 million for the quarter ended March 31, 2015 and $2.3 million for the linked-quarter ended December 31, 2015. 

During the third quarter of fiscal year 2015, the Company signed a termination agreement with the Federal Deposit Insurance Corporation ("FDIC") in connection with the FDIC shared-loss agreements.  As a result, the Company recorded change in FDIC indemnification asset for only the first half of 2015.  The amount recorded for the quarter ended March 31, 2015 was $193,000.

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

Noninterest income decreased $1.4 million, or 16.2%, to $7.0 million for the quarter ended March 31, 2016 compared to $8.3 million for the same period in 2015 and decreased $508,000, or 6.8%, from $7.5 million for the linked-quarter ended December 31, 2015. The decrease from the same quarter in 2015 was due primarily to a $1.7 million gain on sale of the merchant Visa portfolio recognized during the three months ended March 31, 2015.  The decrease in noninterest income from the linked-quarter ended December 31, 2015 was due primarily to an additional $548,000 gain on sale of the merchant Visa portfolio recognized during the quarter ended December 31, 2015 and a $248,000 decrease in service charges and other fees, offset partially by a $406,000 increase in gain on sale of investments.

Noninterest expense was $26.4 million for the quarter ended March 31, 2016 compared to $26.0 million for the quarter ended March 31, 2015 and $26.8 million for the linked-quarter ended December 31, 2015. The increase from the same period in 2015 was primarily due to an increase in compensation and employee benefits expense.  The decrease in noninterest expense from the linked-quarter was due primarily to a decrease in occupancy and equipment expense as a result of consolidation and closure of certain branches during the first quarter 2016 as part of the Company's strategic initiatives.

Income tax expense was $3.2 million for the quarter ended March 31, 2016 compared to $4.0 million for the comparable quarter in 2015 and $2.6 million for the linked-quarter ended December 31, 2015.   The decrease in income tax expense from the same period in 2015 was primarily due to the decrease in pre-tax income.  The increase in income tax expense from the linked-quarter was due to a $300,000 income tax benefit recognized during the linked-quarter ended December 31, 2015, relating to the reversal of a tax liability previously recognized in conjunction with the merger with Washington Banking Company.  The effective tax rate was 25.7% for the quarter ended March 31, 2016 compared to 29.0% for the comparable quarter in 2015 and 21.8% for the linked-quarter ended December 31, 2015.  The decrease in the effective tax rate from the same period in 2015 was due to an increase in tax exempt loans and investment securities.  The increase in the effective tax rate as compared to the linked-quarter was primarily due to the above mentioned $300,000 tax benefit.

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented, "I am proud of our team's accomplishments this past quarter.  Our continued focus on process improvements, product enhancements, and expense management are contributing to the positive results.  I am also happy to see the loan growth that is coming from the concentrated efforts all our lenders and the good work done by our retail team as they continue to grow non-maturity deposits."

Dividend

On April 20, 2016, the Company's Board of Directors declared a quarterly cash dividend of $0.12 per common share.  The dividend is payable on May 19, 2016 to shareholders of record as of the close of business on May 5, 2016. 

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on April 21, 2016 at 11:00 a.m. Pacific time.  To access the call, please dial (800) 230-1074 a few minutes prior to 11:00 a.m. Pacific time.  The call will be available for replay through May 5, 2016, by dialing (800) 475-6701 -- access code 390312.

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 63 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 comparison of 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; new 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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