Heritage Financial Announces First Quarter Results And Declares Regular Cash Dividend

OLYMPIA, Wash., April 23, 2015 /PRNewswire/ -- HERITAGE FINANCIAL CORPORATION (NASDAQ GS: HFWA) Brian L. Vance, President and CEO of Heritage Financial Corporation ("Company" or "Heritage"), today reported that the Company had net income of $9.8 million for the quarter ended March 31, 2015 compared to net income of $2.5 million for the quarter ended March 31, 2014 and $7.3 million for the linked-quarter ended December 31, 2014.  Net income for the quarter ended March 31, 2015 was $0.32 per diluted common share compared to $0.16 per diluted common share for the quarter ended March 31, 2014 and $0.24 per diluted common share for the linked-quarter ended December 31, 2014.

Mr. Vance commented, "The first quarter of 2015 represents our first quarterly performance largely absent of the merger-related expenses that we have had for the last several quarters, and we are pleased with the overall results. We are seeing the results we anticipated when we announced our merger with Washington Banking Company.  We see these results in critical performance metrics such as return on average assets, return on average tangible common equity, and earnings per share.  In addition, the benefits from the synergies of the merger are evidenced by an efficiency ratio which decreased to 63.5% in the first quarter."

"We were pleased with noncovered loan growth of 2.2% during the quarter while at the same time improving overall credit quality which was achieved largely by managing some poorer quality loans out of our portfolio.  We remain positive about continuing positive performance metrics of the combined company and the economic environment in which we operate."

"Finally, we are also pleased to announce another increase in our regular dividend to $0.11 which is an increase of 10% from the dividend in the first quarter of this year."

Balance Sheet

The Company's total assets increased $1.6 million to $3.459 billion at March 31, 2015 from $3.458 billion at December 31, 2014.  Although total assets increased only slightly, there was a change in the mix of interest earning assets and interest bearing liabilities during the quarter ended March 31, 2015.  As a percentage of total assets, total loans receivable, net of allowance for loan losses, increased to 65.3% at March 31, 2015 from 64.3% at December 31, 2014 while interest earning deposits decreased to 0.6% of total assets at March 31, 2015 from 1.4% at December 31, 2014.

Total loans receivable, net of allowance for loan losses, increased $37.2 million, or 1.7%, to $2.26 billion at March 31, 2015 from $2.22 billion at December 31, 2014.  The increase was due to an increase of $45.7 million in noncovered loans receivable, net of allowance for loan losses, to $2.15 billion at March 31, 2015 from $2.10 billion at December 31, 2014.  Noncovered loans include loans originated by Heritage Bank as well as other noncovered loans obtained in mergers and acquisitions.  This increase was partially offset by a decrease of $8.5 million, or 7.0%, in covered loans receivable, net of allowance for loan losses, to $112.1 million at March 31, 2015 from $120.6 million at December 31, 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. 

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented, "We continue to make positive progress with the integration process and all conversion-related projects are essentially complete at this point. We are now focused on refining processes, strengthening the cross-selling framework between the various business lines, and further developing our position in the Seattle metro market as well as working on expense improvements throughout the organization."

"The 8.8% annualized noncovered loan growth in the first quarter continues to highlight the potential of the combined footprint.  The loan pipeline is quite strong and we can feel the momentum building in the whole organization as we look forward to the balance of 2015.  It is gratifying to see the growth in loans and deposits which is a direct result of a lot of hard work by everyone on the team."

Total deposits increased $6.1 million to $2.912 billion at March 31, 2015 from $2.906 billion at December 31, 2014.  Non-maturity deposits as a percentage of total deposits increased to 83.2% at March 31, 2015 from 81.9% at December 31, 2014.  The increase in this ratio was primarily due to a $43.4 million, or 5.5%, increase in NOW accounts to $836.8 million at March 31, 2015 from $793.4 million at December 31, 2014 and a $35.2 million, or 6.7%, decrease in certificates of deposit to $490.2 million as of March 31, 2015 from $525.4 million as of December 31, 2014. 

Total stockholders' equity increased $8.0 million, or 1.8%, to $462.5 million at March 31, 2015 from $454.5 million at December 31, 2014.  This increase was primarily due to net income of $9.8 million and an increase of $2.8 million in accumulated other comprehensive income, net for the quarter ended March 31, 2015, partially offset by cash dividends of $3.0 million.  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 March 31, 2015 of 10.6%, 13.4% and 14.4%, respectively, as compared to 10.2%, 13.9%, and 15.1%, respectively, at December 31, 2014.  Effective during the first quarter of 2015, the Company is required to present its common equity Tier 1 risk-based capital ratio in accordance with Basel III, which was 12.6% at March 31, 2015.

Credit Quality

The allowance for loan losses on noncovered loans increased $164,000 to $22.3 million at March 31, 2015 from $22.2 million at December 31, 2014 reflecting provision for loan losses of $1.3 million partially offset by $1.1 million in net charge-offs recognized during the quarter ended March 31, 2015.  Nonperforming noncovered loans to total noncovered loans decreased to 0.34% at March 31, 2015 from 0.35% at December 31, 2014.  Nonaccrual noncovered loans decreased $58,000 to $7.45 million ($1.7 million guaranteed by government agencies) at March 31, 2015 from $7.51 million ($1.6 million guaranteed by government agencies) at December 31, 2014.  The slight decrease was due to $618,000 of net principal reductions, $249,000 of charge-offs and $149,000 of transfers to accrual status, offset partially by $958,000 of additions to nonaccrual noncovered loans.

The allowance for loan losses to nonperforming noncovered loans was 299.48% at March 31, 2015 compared to 294.98% at December 31, 2014.  Potential problem noncovered loans were $100.4 million at March 31, 2015 compared to $117.3 million at December 31, 2014. The $16.8 million decrease was primarily due to loan grade improvements of $15.1 million, net loan payments of $7.1 million and net transfers of $331,000 to nonaccrual status, offset partially by the addition of $5.9 million of loans graded as potential problem loans during the period.

The allowance for loan losses on noncovered loans to total noncovered loans, net was 1.03% at March 31, 2015 and 1.04% at December 31, 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 March 31, 2015. Included in the carrying value of noncovered loans are net discounts from mergers and acquisitions which would be utilized if any principal losses were experienced on the related loans.  The remaining net discounts on noncovered loans at March 31, 2015 were $21.5 million.

Nonperforming noncovered assets were $8.8 million ($1.7 million guaranteed by government agencies), or 0.26% of total noncovered assets, at March 31, 2015, compared to $9.7 million ($1.6 million guaranteed by government agencies), or 0.29% of total noncovered assets, at December 31, 2014.  Other real estate owned increased $739,000 to $4.1 million at March 31, 2015 (of which $2.8 million was covered by FDIC shared-loss agreements) from $3.4 million at December 31, 2014 (of which $1.2 million was covered by FDIC shared-loss agreements).  During the quarter ended March 31, 2015, three covered loans were transferred to other real estate owned resulting in additions of $1.7 million.  The Company also sold two noncovered properties and one covered property resulting in proceeds of $589,000 and losses of $70,000 and recorded $330,000 of valuation adjustments to noncovered other real estate owned during the three months ended March 31, 2015.

Operating Results

Net interest income increased $15.9 million, or 95.2%, to $32.7 million for the quarter ended March 31, 2015 compared to $16.7 million for the same period in 2014 and decreased $4.1 million, or 11.2%, from $36.8 million for the linked-quarter ended December 31, 2014. The increase in net interest income for the first quarter of fiscal 2015 compared to the same period in fiscal 2014 was primarily due to Heritage's merger with Washington Banking Company ("Washington Banking Merger") which was completed on May 1, 2014.  The decrease in net interest income for the current quarter compared to the linked-quarter was primarily due to a decrease in interest income on loans as a result of a decrease in incremental accretion income.

Heritage's net interest margin for the quarter ended March 31, 2015 decreased 17 basis points to 4.31% from 4.48% for the same period in 2014 and decreased 43 basis points from 4.74% in the linked-quarter ended December 31, 2014.  The decrease in net interest margin from the comparable period in the prior year is primarily due to the lower contractual loan note rates.  The decrease in net interest margin from the linked-quarter is primarily the result of lower incremental accretion income recorded during the quarter ended March 31, 2015.

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

The net interest margin, excluding incremental accretion on purchased loans, decreased to 3.87% for the quarter ended March 31, 2015 from 4.23% for the same period in 2014 and increased slightly from 3.86% for the linked-quarter ended December 31, 2014.  The increase from the linked-quarter is due to the change in the earnings asset mix (higher ratio of loans and investments to interest earning assets and a lower ratio of interest earning deposits to interest earning assets) partially offset by lower contractual loan note rates. Yields on loans, excluding incremental accretion on purchased loans, decreased to 4.92% for the quarter ended March 31, 2015 from 5.22% for the same period in 2014 and decreased from 5.04% for the linked-quarter ended December 31, 2014.

The provision for loan losses on noncovered loans was $1.3 million for the quarter ended March 31, 2015 compared to $(21,000) for the quarter ended March 31, 2014 and $1.3 million for the linked-quarter ended December 31, 2014.

The provision for loan losses on covered loans was $(77,000) for the quarter ended March 31, 2015 compared to $479,000 for the same period in the prior year and $1.5 million for the linked-quarter ended December 31, 2014.

As of the dates of the completion of each of the mergers and acquisitions, acquired 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 acquired loans was $3.3 million for the quarter ended March 31, 2015 compared to $935,000 for the quarter ended March 31, 2014 and $6.8 million for the linked-quarter ended December 31, 2014.  The increase for the quarter ended March 31, 2015 compared to the same period in 2014 was due to the increase in incremental accretion income from the Washington Banking Merger. The decrease in incremental accretion income from the linked-quarter was the result of the recognition of an increased amount of incremental accretion during the quarter ended December 31, 2014 as a result of significant amounts of payoffs and workouts as well as some adjustments to prior accretion estimates relating to the loans obtained in the Washington Banking Merger.

For the quarter ended March 31, 2015, the Company recognized $(193,000) of change in the FDIC indemnification asset compared to $(37,000) and $(2.0) million for the quarters ended March 31, 2014 and December 31, 2014, 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, "Incremental accretion income continues to be at elevated levels due to the amounts of loan prepayments in the acquired portfolios.  The income for the first quarter was slightly higher than the expected range of $2 million to $3 million, which is still the range we expect over the next few quarters."

"The net interest margin before incremental accretion income increased slightly from the prior quarter.  This was achieved through the leveraging of the balance sheet.  However, loan yields continue to experience downward pressure as a result of the continued low rate environment.  The Company will continue to focus on growth of earnings assets in order to mitigate the lower loan yields."

Noninterest income was $8.3 million for the quarter ended March 31, 2015 compared to $2.3 million for the same period in 2014 and $3.9 million for the linked-quarter ended December 31, 2014.  The increase in the quarter ended March 31, 2015 compared to prior periods was due to a $1.7 million gain on the sale of the merchant Visa portfolio (included in the "other income" category), an increase in gain on sale of loans, net and an increase in gain on sale of investment securities, net.  The increase in noninterest income for the quarter ended March 31, 2015 from the same period in 2014 was also the result of the Washington Banking Merger, which generated an increase in service charges and other fees of $1.9 million.  The $4.4 million increase from the linked-quarter was also due to an increase from the change in FDIC indemnification asset of $1.8 million.

The FDIC indemnification asset decreased $424,000 to $692,000 at March 31, 2015 from $1.1 million at December 31, 2014.  Of this decrease, $231,000 was related to claims made for losses under the shared-loss agreements and $124,000 was related to amortization.  For the linked-quarter ended December 31, 2014, the Company recorded a $1.6 million valuation adjustment.  The shared-loss agreements on non-single family loans covering $104.2 million of covered loans at March 31, 2015 will expire in the second and third quarters of 2015.  Therefore, a valuation adjustment was recognized in the prior period for previously estimated losses for which claims are not expected to be made prior to the expiration of the shared-loss agreements.

Noninterest expense was $26.0 million for the quarter ended March 31, 2015 compared to $14.8 million for the quarter ended March 31, 2014 and $29.2 million for the linked-quarter ended December 31, 2014. The $11.3 million increase for the quarter ended March 31, 2015 from the same period in 2014 was primarily due to the Washington Banking Merger.  The decrease of $3.2 million in noninterest expense from the linked-quarter was due primarily to decreases in expenses related to post-conversion cost savings realized in the Washington Banking Merger partially offset by an increase of $935,000 in expenses related to other real estate owned.

Income tax expense was $4.0 million for the quarter ended March 31, 2015 compared to $1.3 million for the comparable quarter in 2014 and $1.3 million for the linked-quarter ended December 31, 2014.  The increases in income tax expense was primarily due to the increase in pre-tax income.   For the linked-quarter ended December 31, 2014, the $2.7 million increase was partially due to a $728,000 income tax benefit realized during the linked quarter related to the resolution of a tax position previously taken by Washington Banking Company. 

Dividend

On April 22, 2015, the Company's Board of Directors declared a quarterly cash dividend of $0.11 per common share payable on May 21, 2015 to shareholders of record on May 7, 2015. 

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on April 23, 2015 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 7, 2015, by dialing (800) 475-6701 -- access code 357073.

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 66 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; 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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