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

OLYMPIA, Wash., July 21, 2016 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) (the "Company" or "Heritage") today reported that the Company had net income of $8.9 million for the quarter ended June 30, 2016 compared to net income of $8.7 million for the quarter ended June 30, 2015 and $9.1 million for the linked-quarter ended March 31, 2016.  Diluted earnings per common share for the quarter ended June 30, 2016 was $0.30 per diluted common share compared to $0.29 per diluted common share for the quarter ended June 30, 2015 and $0.30 for the linked-quarter ended March 31, 2016.

The Company had net income of $18.0 million for the six months ended June 30, 2016, or $0.60 per diluted common share, compared to net income of $18.5 million, or $0.61 per diluted common share, for the six months ended June 30, 2015. 

Brian L. Vance, President and CEO, commented, "We continue to be pleased with our loan growth.  Second quarter growth was 2.7% and year-to-date growth for the first six months of 2016 was 10.5% on an annualized basis.  Additionally, year-over-year loan growth was 7.6%.  Our loan growth continues to be driven by our strong Pacific Northwest economy."

"We are also pleased with our continuing efforts and results in managing our noninterest expense.  Our overhead expense, as measured by our total noninterest expense as a percentage of average assets, has consistently improved over the past two years.  Our overhead ratio was 2.87% for the quarter ended June 30, 2016 compared to 3.01% for the quarter ended June 30, 2015 and 3.85% for the quarter ended June 30, 2014.  We still have room to improve, but I am pleased with our steady improvement of this important metric."

Balance Sheet

The Company's total assets increased $78.8 million, or 2.1%, to $3.76 billion at June 30, 2016 from $3.68 billion at March 31, 2016. 

Loans receivable, net of allowance for loan losses, increased $66.7 million, or 2.7%, to $2.50 billion at June 30, 2016 from $2.43 billion at March 31, 2016.  The growth in loans receivable was due primarily to increases of $31.9 million in commercial and industrial loans and $29.6 million in real estate construction and land development loans, offset by a reduction of $11.0 million in non-owner occupied commercial real estate loans.

Investment securities available for sale decreased $6.3 million, or 0.8%, to $815.9 million at June 30, 2016 from $822.2 million at March 31, 2016.  The decrease was due primarily to maturities, calls and payments of investment securities of $37.8 million and sales of investment securities of $25.4 million during the quarter ended June 30, 2016.  The decrease was partially offset by purchases of investment securities of $52.6 million and increases in unrealized gains on the investment securities of $6.3 million as a result of increases in market values.

Prepaid expenses and other assets increased $13.2 million, or 25.1%, to $66.0 million at June 30, 2016 from $52.8 million at March 31, 2016 primarily as a result of the Company's investment in a $10.2 million low income tax housing credit partnership during the quarter ended June 30, 2016.  This investment had a corresponding $8.6 million obligation recorded in accrued expenses and other liabilities at June 30, 2016.  These obligations will decrease as projects in the partnership are funded.

Total deposits increased $28.0 million, or 0.9%, to $3.16 billion at June 30, 2016 from $3.13 billion at March 31, 2016.  Non-maturity deposits as a percentage of total deposits increased to 87.7% at June 30, 2016 from 87.0% at March 31, 2016.  The increase in this ratio was due to a combination of an increase of $46.6 million in non-maturity deposits and a decrease of $18.7 million in certificates of deposit.  The increase in non-maturity deposits was primarily due to a $30.0 million, or 6.4%, increase in savings deposits to $495.4 million at June 30, 2016 from $465.4 million at March 31, 2016 and a $25.9 million, or 3.3%, increase in noninterest bearing demand deposits to $820.4 million at June 30, 2016 from $794.5 million at March 31, 2016, offset partially by a $15.3 million, or 1.6%, decrease in NOW accounts to $928.8 million at June 30, 2016 from $944.1 million at March 31, 2016.  Certificates of deposit decreased $18.7 million, or 4.6%, to $389.2 million at June 30, 2016 from $407.8 million at March 31, 2016.  Deposits per branch increased $444,000, or 0.9%, to $50.1 million at June 30, 2016 from $49.7 million at March 31, 2016.

Federal Home Loan Bank Advances increased to $33.0 million at June 30, 2016 compared to no borrowings at March 31, 2016 or December 31, 2015.  The increase in advances was necessary to fund the Company's significant increase in loans receivable during the quarter ended June 30, 2016.

Total stockholders' equity increased $9.9 million, or 2.1%, to $490.1 million at June 30, 2016 from $480.2 million at March 31, 2016.  The increase was primarily due to net income of $8.9 million recognized during the quarter ended June 30, 2016 and an increase of $4.1 million in accumulated other comprehensive income, partially offset by $3.6 million in cash dividends and $505,000 in stock compensation related expenses.  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 June 30, 2016 of 11.2%, 10.5%, 11.8% and 12.7%, respectively, compared to 11.9%, 10.5%, 12.6% and 13.6%, respectively, at March 31, 2016.

Credit Quality

The allowance for loan losses decreased $1.2 million, or 4.4%, to $28.4 million at June 30, 2016 from $29.7 million March 31, 2016.  The decrease was due to $2.4 million in net charge-offs recognized during the quarter ended June 30, 2016, offset partially by a provision for loan losses of $1.1 million recorded during the same period.  Of the $2.4 million in net charge-offs during the quarter ended June 30, 2016, $1.0 million related to the closure of a purchased credit impaired ("PCI") pool during the period.  This accounting entry represents past residual losses estimated and provided for in the pool's allocated allowance for loan loss.  As the last loan in the PCI pool was resolved during the quarter ended June 30, 2016, the Company recognized these past losses as a charge-off to the allowance for loan losses. 

Nonperforming loans to loans receivable, net, increased to 0.55% at June 30, 2016 from 0.50% at March 31, 2016.  Nonaccrual loans increased $1.5 million, or 12.2%, to $13.9 million ($2.2 million guaranteed by government agencies) at June 30, 2016 from $12.4 million ($1.4 million guaranteed by government agencies) at March 31, 2016.  The increase was due primarily to $2.3 million of new additions to nonaccrual loans and $854,000 of additions resulting from TDR loans being transferred to nonaccrual status, offset partially by $1.6 million of net principal reductions and $43,000 of charge-offs.

The allowance for loan losses to nonperforming loans was 205.05% at June 30, 2016 compared to 240.14% at March 31, 2016.  Potential problem loans were $101.2 million at June 30, 2016 compared to $94.8 million at March 31, 2016. The $6.4 million, or 6.7%, increase was primarily due to the addition of $16.0 million of loans graded as potential problem loans during the period, offset by net loan payments of $6.9 million, loan grade improvements of $2.3 million, loan charge-offs of $302,000 and loans transferred to impaired status of $161,000.

The allowance for loan losses to loans receivable, net was 1.13% at June 30, 2016 compared to 1.21% at March 31, 2016.  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 June 30, 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 outstanding principal balance.  The remaining net discounts on these purchased loans was $17.5 million at June 30, 2016 compared to $18.6 million at March 31, 2016.

Net charge-offs increased to $2.4 million for the quarter ended June 30, 2016 compared to $727,000 for the same quarter in 2015 and $1.2 million for the linked-quarter ended March 31, 2016.  The increase of net charge-offs in the quarter ended June 30, 2016 was due primarily to the $1.0 million PCI pool closure discussed above and a charge-off of $868,000 from a commercial and industrial loan that defaulted during the quarter.

Nonperforming assets increased $1.2 million, or 8.8%, to $15.4 million ($2.2 million guaranteed by government agencies), or 0.41% of total assets, at June 30, 2016, compared to $14.2 million ($1.4 million guaranteed by government agencies), or 0.39% of total assets, at March 31, 2016 due primarily to the increase in nonperforming loans discussed above.  Other real estate owned decreased $266,000, or 14.6%, to $1.6 million at June 30, 2016 from $1.8 million at March 31, 2016. The decrease in other real estate owned was primarily due to the disposition of properties totaling $227,000 and valuation adjustments of $71,000 during the quarter ended June 30, 2016.

Operating Results

Net interest income increased $615,000, or 1.9%, to $33.1 million for the quarter ended June 30, 2016 compared to $32.5 million for the same period in 2015 and increased $325,000, or 1.0%, from $32.8 million for the linked-quarter ended March 31, 2016.  Net interest income increased $701,000, or 1.1%, to $65.8 million for the six months ended June 30, 2016 compared to $65.1 million for the same period in 2015.  The increase in net interest income for the periods in 2016 compared to same periods in 2015 was primarily due to an increase in interest income on investment securities as a result of both an increase in investment yields and average balances.  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).  The increase in net interest income for the quarter ended June 30, 2016 compared to the linked-quarter ended March 31, 2016 was primarily due to an increase in incremental accretion income due primarily to the resolution of certain purchased Washington Banking Company loans during the quarter.

Heritage's net interest margin for the quarter ended June 30, 2016 decreased 19 basis points to 4.00% from 4.19% for the same period in 2015 and decreased four basis points from 4.04% in the linked-quarter ended March 31, 2016.  The net interest margin for the six months ended June 30, 2016 decreased 23 basis points to 4.02% from 4.25% for the same period in 2015.  As shown in the table below, the net interest margin, excluding incremental accretion on purchased loans, decreased to 3.71% for the quarter ended June 30, 2016 from 3.84% for the same period in 2015 and decreased from 3.82% for the linked-quarter ended March 31, 2016.  The net interest margin, excluding incremental accretion on purchased loans, decreased nine basis points to 3.77% for the six months ended June 30, 2016 from 3.86% for the same period in 2015.  The decreases in net interest margin, both including and excluding the impacts of the incremental accretion, for the periods in 2016 compared to the same periods in 2015 are due to a combination of lower contractual loan note rates and decreases in incremental accretion income as the purchased loan balances continued to decrease.  These decreases in loan yields were offset partially by increases in the average loan balances during 2016 compared to the same periods in 2015.  The decrease in net interest margin for the quarter ended June 30, 2016 compared to the linked-quarter ended March 31, 2016 was also due to the decrease in contractual note rates, offset partially by an increase in incremental accretion for the quarter ended June 30, 2016 due primarily to the resolution of certain purchased Washington Banking Company loans in excess of their estimated expected cash flows.

The decreases in net interest margin for the three and six months ended June 30, 2016 compared to the same periods in 2015 described above were partially offset by increases in both the yields on investment securities and the average investment securities during the periods.

As of the dates of the completion of each of the merger and acquisition transactions, 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 $2.4 million for the quarter ended June 30, 2016 compared to $2.7 million for the quarter ended June 30, 2015 and $1.8 million for the linked-quarter ended March 31, 2016.

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 29 basis points to 4.59% for the quarter ended June 30, 2016 from 4.88% for the same period in 2015  and decreased 18 basis points from 4.77% for the linked-quarter ended March 31, 2016 due primarily to lower contractual note rates. For the six months ended June 30, 2016, the yields on loans, excluding incremental accretion on purchased loans, decreased 21 basis points to 4.68% from 4.89% for the same period in 2015.

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "Our pre-accretion net interest margin continues to experience downward pressure as a result of the continued low rate environment.   The decrease in loan yields was partially offset by the increase in incremental accretion income to $2.4 million during the quarter ended June 30, 2016 from $1.8 million for the linked-quarter ended March 31, 2016, primarily as a result of purchased loan resolutions.  The Company will continue to focus on growth of earnings assets in order to mitigate the lower loan yields."

The provision for loan losses was $1.1 million for the quarter ended June 30, 2016 compared to $1.2 million for the quarter ended June 30, 2015 and $1.1 million for the linked-quarter ended March 31, 2016.  The provision for loan losses was $2.3 million for the six months ended June 30, 2016 compared to $2.4 million for the six months ended June 30, 2015.

Noninterest income decreased $305,000, or 4.4%, to $6.6 million for the quarter ended June 30, 2016 compared to $6.9 million for the same period in 2015 and decreased $414,000, or 5.9%, from $7.0 million for the linked-quarter ended March 31, 2016. The decrease from the same quarter in 2015 was due primarily to decreases in gains on sale of investments and decreases in service charges and other fees recognized during the quarter ended June 30, 2015.  The decrease in noninterest income from the linked-quarter ended March 31, 2016 was due primarily to a $485,000 decrease in recoveries on zero balance purchased loan notes which were charged-off prior to the consummation of the related merger or acquisition. Noninterest income was $13.6 million for the six months ended June 30, 2016, a  $1.7 million, or 10.9%, decrease from $15.2 million for the six months ended June 30, 2015.  The decrease was primarily due to a $1.7 million gain on sale of Merchant Visa portfolio recognized during the first quarter of 2015.

Noninterest expense was $26.5 million for the quarter ended June 30, 2016 compared to $26.1 million for the quarter ended June 30, 2015 and $26.4 million for the linked-quarter ended March 31, 2016. The $398,000, or 1.5%, increase from the same period in 2015 was primarily due to an increase in compensation and employee benefits expense.  Noninterest expense increased $729,000, or 1.4%, to $52.8 million for the six months ended June 30, 2016 compared to $52.1 million for the same period in 2015 primarily due to an increase in compensation and employee benefits.

Income tax expense was $3.2 million for the quarter ended June 30, 2016 compared to $3.4 million for the comparable quarter in 2015 and $3.2 million for the linked-quarter ended March 31, 2016.   Income tax expense was $6.3 million for the six months ended June 30, 2016 compared to $7.4 million for the same period in 2015.  The decreases in income tax expense from the same periods in 2015 was primarily due to a decrease in the effective tax rate.  The effective tax rate was 26.3% for the quarter ended June 30, 2016 compared to 27.8% for the comparable quarter in 2015 and 25.7% for the linked-quarter ended March 31, 2016.   The effective tax rate for the six months ended June 30, 2016 was 26.0% compared to 28.4% for the same period in 2015.  The decreases in the effective tax rate from the same periods in 2015 were due to increases in tax exempt loans and investment securities.

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented, "I am very pleased with our overall progress as we focus on a variety of projects that will enable us to remain competitive and strong in the current low interest rate environment; an environment which appears to here for the foreseeable future."

Dividend

On July 20, 2016, the Company's Board of Directors declared a quarterly cash dividend of $0.12 per common share.  The dividend is payable on August 18, 2016 to shareholders of record as of the close of business on August 4, 2016. 

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on July 21, 2016 at 11:00 a.m. Pacific time.  To access the call, please dial (800) 230-1059 a few minutes prior to 11:00 a.m. Pacific time.  The call will be available for replay through August 4, 2016, by dialing (800) 475-6701 -- access code 397250.

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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SOURCE Heritage Financial Corporation

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