Heritage Financial Announces Fourth Quarter And Annual 2015 Results And Declares Regular Cash Dividend

OLYMPIA, Wash., Jan. 28, 2016 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) ("Company" or "Heritage") today reported that the Company had net income of $9.5 million for the quarter ended December 31, 2015 compared to net income of $7.3 million for the quarter ended December 31, 2014 and $9.5 million for the linked-quarter ended September 30, 2015.  Net income for the quarter ended December 31, 2015 was $0.32 per diluted common share compared to $0.24 per diluted common share for the quarter ended December 31, 2014 and $0.32 per diluted common share for the linked-quarter ended September 30, 2015.

Net income for the year ended December 31, 2015 was $37.5 million, or $1.25 per diluted common share, compared to $21.0 million, or $0.82 per diluted common share, for the year ended December 31, 2014.

Brian L. Vance, President and CEO, commented, "As we conclude the year 2015, we continue to be encouraged with the performance of our core operating metrics.  For instance, our return on average assets improved to 1.04% in the fourth quarter of 2015 from 0.83% for the same period of 2014.  We also improved our expense management as measured by total noninterest expense to average assets to 2.92% in the fourth quarter of 2015 from 3.36% for the same period in 2014."

"We continue to be encouraged by the economic growth that is occurring in our core markets of Seattle, Bellevue, Everett and Tacoma, and we believe the growth of these markets coupled with the growth of our lender base in these markets will provide for strong growth in both loans and deposits in 2016."

"Credit quality remains a very important discipline for us in both originating new loans and managing our existing portfolios.  We continue to proactively manage weaker credits out of the bank as evidenced by reducing our potential problem loans and nonaccrual loans by an aggregate total of $54.5 million, or 31.2%, year over year.  Additionally, our net charge-offs for the fiscal year 2015 were 0.10% of average loans while our nonperforming assets to total assets improved to 0.32%."

Balance Sheet

The Company's total assets increased $55.4 million, or 1.5%, to $3.65 billion at December 31, 2015 from $3.60 billion at September 30, 2015. 

Investment securities available for sale increased $108.8 million to $811.9 million at December 31, 2015 from $703.1 million at September 30, 2015.  The 15.5% increase was due to investment purchases and the transfer of all investment securities previously classified as held to maturity to the available for sale classification.  Management elected this change during the quarter ended December 31, 2015 in an effort to manage more effectively the investment portfolio, including subsequently selling securities that were formerly classified as held to maturity.  The amortized cost of the securities that were transferred to available for sale totaled $29.4 million and the net unrealized pre-tax gain related to these securities totaled $952,000 on the date of the transfer.

Loans receivable, net of allowance for loan losses, decreased $2.7 million, or 0.1%, to $2.37 billion at December 31, 2015 from $2.38 billion at September 30, 2015 and increased $148.9 million, or 6.7%, from $2.22 billion at December 31, 2014. The decrease from September 30, 2015 was due to loan payoffs in excess of loan originations during the quarter.  Loans receivable includes loans originated by Heritage Bank as well as loans acquired in mergers and acquisitions, including the Cowlitz Bank, Pierce Commercial Bank, Northwest Commercial Bank, and Valley Community Bancshares transactions, and most recently, Heritage's merger with Washington Banking Company completed on May 1, 2014 (the "Washington Banking Merger").

Total deposits increased $54.1 million, or 1.8%, to $3.11 billion at December 31, 2015 from $3.05 billion at September 30, 2015.  Non-maturity deposits as a percentage of total deposits increased to 86.5% at December 31, 2015 from 85.7% at September 30, 2015 and from 81.9% at December 31, 2014.  The increase in this ratio was primarily due to a $31.5 million, or 6.1%, increase in money market accounts to $545.3 million at December 31, 2015 from $513.9 million at September 30, 2015 and a $24.8 million, or 2.8%, increase in NOW accounts to $917.9 million at December 31, 2015 from $893.0 million at September 30, 2015, offset partially by a $17.2 million, or 3.9%, decrease in certificates of deposit to $420.3 million at December 31, 2015 from $437.5 million at September 30, 2015.  Total deposits increased $202.0 million, or 6.9%, from $2.91 billion at December 31, 2014. 

Total stockholders' equity increased $1.3 million, or 0.3%, to $470.0 million at December 31, 2015 from $468.7 million at September 30, 2015.  This increase was primarily due to net income of $9.5 million, partially offset by cash dividends in the amount of $6.3 million and a decrease in accumulated other comprehensive income of $2.4 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  common equity Tier 1 risk-based, Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios at December 31, 2015 of 11.9%, 10.4%, 12.5% and 13.6%, respectively, compared to 11.8%, 10.5%, 12.4% and 13.4%, respectively, at September 30, 2015.

Credit Quality

The allowance for loan losses increased $742,000, or 2.6%, to $29.7 million at December 31, 2015 from $29.0 million at September 30, 2015 reflecting a provision for loan losses of $1.1 million partially offset by $382,000 in net charge-offs recognized during the quarter ended December 31, 2015.  Nonperforming loans to loans receivable, net decreased to 0.40% at December 31, 2015 from 0.41% at September 30, 2015.  Nonaccrual loans decreased $239,000, or 2.4%, to $9.7 million ($1.1 million guaranteed by government agencies) at December 31, 2015 from $9.9 million ($1.4 million guaranteed by government agencies) at September 30, 2015.  The decrease was due primarily to $2.4 million of net principal reductions and $50,000 of charge-offs, offset partially by $2.2 million of additions to nonaccrual loans.

The allowance for loan losses to nonperforming loans was 307.67% at December 31, 2015 compared to 292.76% at September 30, 2015.  Potential problem loans were $110.4 million at December 31, 2015 compared to $113.3 million at September 30, 2015. The $2.9 million decrease was primarily due to net loan payments of $10.5 million, loan grade improvements of $7.8 million, and $133,000 of loan charge-offs, offset partially by the addition of $15.9 million of loans graded as potential problem loans during the period.

The allowance for loan losses to loans receivable, net was 1.24% at December 31, 2015 compared to 1.21% at September 30, 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 December 31, 2015. 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 unaccreted net discounts on these purchased loans was $20.4 million at December 31, 2015 compared to $21.6 million at September 30, 2015.

Nonperforming assets decreased $291,000, or 2.4%, to $11.7 million ($1.1 million guaranteed by government agencies), or 0.32% of total assets, at December 31, 2015, compared to $12.0 million ($1.4 million guaranteed by government agencies), or 0.33% of total assets, at September 30, 2015.  Other real estate owned decreased $52,000 to $2.0 million at December 31, 2015 from $2.1 million at September 30, 2015. The decrease in other real estate owned was primarily due to the disposition of properties totaling $356,000 and valuation adjustments of $114,000 during the quarter ended December 31, 2015, offset by additions of properties totaling $421,000.

Operating Results

Net interest income decreased $4.2 million, or 11.5%, to $32.5 million for the quarter ended December 31, 2015 compared to $36.8 million for the same period in 2014 and increased $595,000, or 1.9%, from $31.9 million for the linked-quarter ended September 30, 2015. Net interest income increased $14.2 million, or 12.3%, to $129.6 million for the year ended December 31, 2015 from $115.4 million for the same period in the prior year.  The decrease in net interest income for the current quarter compared to same period in 2014 was primarily due to a decrease in incremental accretion income (included in interest and fees on loans on the Consolidated Statements of Income) as well as a decrease in the loan interest income as a result of lower loan yields. The increase in net interest income for the current quarter compared to the linked-quarter ended September 30, 2015 was primarily the result of an increase in incremental accretion income from loan settlements in excess of recorded investment balances. The increase in net interest income for the year ended December 31, 2015 compared to the same period in 2014 was primarily due to the Washington Banking Merger.

Heritage's net interest margin for the quarter ended December 31, 2015 decreased 77 basis points to 3.97% from 4.74% for the same period in 2014 and decreased three basis points from 4.00% in the linked-quarter ended September 30, 2015.  The decrease in net interest margin from the prior periods is due to lower contractual loan note rates.  The decrease from the same period in 2014 also is attributable due to lower incremental accretion income.   The net interest margin for the year ended December 31, 2015 decreased 42 basis points to 4.11% from 4.53% for the same period in 2014 due to lower contractual loan note rates and lower incremental accretion income as the purchased loan balances continued to decrease.

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 3.69% for the quarter ended December 31, 2015 from 3.86% for the same period in 2014 and from 3.76% for the linked-quarter ended September 30, 2015.  For the year ended December 31, 2015, the net interest margin, excluding incremental accretion on purchased loans, decreased to 3.78% from 3.97% for the same period in the prior year.

Yields on loans, excluding incremental accretion on purchased loans, decreased to 4.70% for the quarter ended December 31, 2015 from 5.03% for the same period in 2014 and from 4.75% for the linked-quarter ended September 30, 2015.  For the year ended December 31, 2015, the yields on loans, excluding incremental accretion on purchased loans, decreased to 4.81% from 5.14% for the same period in the prior year.

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "Our pre-accretion net interest margin continues to experience downward pressure due to the low rate environment.  Yields on new originated loans remain lower than the yield of the current portfolio.  The Company will continue to focus on balance sheet growth and leverage in order to mitigate the effects of the current rate environment."

The provision for loan losses was $1.1 million for the quarter ended December 31, 2015 compared to $2.9 million for the quarter ended December 31, 2014 and $851,000 for the linked-quarter ended September 30, 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 $2.3 million for the quarter ended December 31, 2015 compared to $6.8 million for the quarter ended December 31, 2014 and $1.9 million for the linked-quarter ended September 30, 2015. 

During the quarter ended September 30, 2015, the Company signed a termination agreement with the Federal Deposit Insurance Corporation ("FDIC") in connection with the FDIC shared-loss agreements, resulting in $1.7 million of other income, and the elimination of the FDIC indemnification asset.  The change in FDIC indemnification asset was $497,000 and $2.5 million for the years ended December 31, 2015 and 2014, respectively.

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

Noninterest income increased $3.6 million, or 92.4%, to $7.5 million for the quarter ended December 31, 2015 compared to $3.9 million for the same period in 2014 and decreased $2.0 million, or 21.4%, from $9.5 million for the linked-quarter ended September 30, 2015. The increase from the prior year quarter was due to a $548,000 additional gain on sale of merchant Visa portfolio (in addition to the $1.7 million gain recognized at the time of the sale in January 2015), the change in FDIC indemnification asset in the amount of $(2.0) million recognized during the quarter ended December 31, 2014 and increases in the gain on sale of loans and income from bank owned life insurance.  The decrease from the linked-quarter ended September 30, 2015 was due primarily to the $1.7 million gain relating to the termination of FDIC shared-loss agreements which was recognized during the quarter ended September 30, 2015.  For the year ended December 31, 2015, noninterest income increased $15.8 million, or 96.0%, to $32.3 million compared to $16.5 million for the year ended December 31, 2014 primarily due to the Washington Banking Merger, the gain from the termination of the FDIC shared-loss agreements, the gain on sale of loans and the gain on sale of the merchant Visa portfolio.

Noninterest expense was $26.8 million for the quarter ended December 31, 2015 compared to $29.2 million for the quarter ended December 31, 2014 and $27.3 million for the linked-quarter ended September 30, 2015. The decreases from the quarterly periods are primarily due to efficiencies gained by the Washington Banking Merger, including the reduction of duplicate contracts and decreases in staffing levels.  Noninterest expense increased $6.8 million, or 6.9%, to $106.2 million for the year ended December 31, 2015 compared to $99.4 million for the same period in the prior year.  The increases from the prior year periods are primarily due to the Washington Banking Merger, offset by the above mentioned efficiencies from the merger. 

Income tax expense was $2.6 million for the quarter ended December 31, 2015 compared to $1.3 million for the comparable quarter in 2014 and $3.8 million for the linked-quarter ended September 30, 2015.  Income tax expense was $13.8 million for the year ended December 31, 2015 compared to $6.9 million for the same period in the prior year. The increases in income tax expense from the prior year periods were primarily due to the increase in pre-tax income.  The decrease in income tax expense from the linked-quarter was due to a higher percentage of tax exempt income and a $300,000 income tax benefit related to the reversal of a tax liability previously recognized in conjunction with the Washington Banking Merger.  The effective tax rate was 21.8% for the quarter ended December 31, 2015 compared to 28.7% for the linked-quarter ended September 30, 2015 and 15.5% for the comparable quarter in 2014. 

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented, "We remained focused on our strategic initiatives throughout 2015 with very positive results. In 2016, we will continue to refine our operating model, we will continue to leverage the larger organization by concentrating on additional efficiencies, and at the same time, continue developing our new team in Seattle as well as our existing teams along the I-5 corridor."

Dividend

On January 27, 2016, the Company's Board of Directors declared a quarterly cash dividend of $0.11 per common share.  The dividend is payable on February 24, 2016 to shareholders of record as of the close of business on February 10, 2016. 

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on January 28, 2016 at 10:00 a.m. Pacific time.  To access the call, please dial (800) 230-1074 a few minutes prior to 10:00 a.m. Pacific time.  The call will be available for replay through February 11, 2016, by dialing (800) 475-6701 -- access code 383144.

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; 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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