Heritage Financial Announces Second Quarter 2018 Results And Declares Regular Cash Dividend

OLYMPIA, Wash., July 25, 2018 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) (the "Company" or "Heritage"), the parent company of Heritage Bank, today reported that the Company had net income of $11.9 million for the quarter ended June 30, 2018 compared to $11.8 million for the quarter ended June 30, 2017 and $9.1 million for the linked-quarter ended March 31, 2018. Diluted earnings per common share for the quarter ended June 30, 2018 was $0.35 compared to $0.40 for the quarter ended June 30, 2017 and $0.27 for the linked-quarter ended March 31, 2018.

The Company had net income of $20.9 million for the six months ended June 30, 2018, or $0.62 per diluted common share, compared to $21.1 million, or $0.71 per diluted common share, for the six months ended June 30, 2017.

Brian L. Vance, CEO of Heritage, commented, "We are pleased with our overall performance for the second quarter of 2018.  Although loan growth was muted due to unusually high prepayments, loan originations were strong and we are encouraged with a building pipeline that will help support our loan growth in future periods.  In addition, the overall asset sensitivity of our balance sheet has allowed us to improve our net interest margin in this rising rate environment.

"With the addition of the Premier Community Bancorp at the beginning of this month, our total assets exceed $5 billion.  We are excited about the impact of the addition of this quality organization will have on our future financial performance through their experienced bankers and the scale of a larger organization."

Acquisition of Premier Commercial Bancorp
On July 2, 2018, the Company completed the acquisition of Premier Commercial Bancorp ("Premier Commercial"), the holding company for Premier Community Bank, both of Hillsboro, Oregon ("Premier Merger").  As of the acquisition date, Premier Commercial was merged with and into Heritage and Premier Community Bank was merged with and into Heritage Bank. The Premier Merger will be accounted for using the acquisition method of accounting.

Pursuant to the terms of the merger agreement, Premier Commercial shareholders received 0.4863 shares of Heritage common stock in exchange for each share of Premier Commercial common stock based on the Heritage closing date per share price on June 29, 2018 of $34.85. Heritage issued an aggregate of 2,848,579 shares of its common stock and paid cash of $2,000 for fractional shares in the transaction for total consideration paid of $99.3 million. As of June 30, 2018, Premier Commercial had estimated total assets of $381.7 million, gross loans receivable of $335.3 million and total deposits of $319.3 million. Heritage is expected to complete its acquisition method of accounting during the third quarter 2018.

Acquisition of Puget Sound Bancorp, Inc.
On January 16, 2018, the Company completed the acquisition of Puget Sound Bancorp, Inc. ("Puget Sound"), the holding company for Puget Sound Bank, both of Bellevue, Washington ("Puget Sound Merger"). As of the acquisition date, Puget Sound merged into Heritage and Puget Sound Bank merged into Heritage Bank. The Puget Sound Merger was accounted for using the acquisition method of accounting. Accordingly, Heritage's cost to acquire Puget Sound was allocated to the assets (including identifiable intangible assets) and the liabilities of Puget Sound at their respective estimated fair values as of the acquisition date. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill. Fair values on the acquisition date are preliminary and represent management's best estimates based on available information and facts and circumstances in existence on the acquisition date. Fair values are subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available.

Puget Sound shareholders received 1.1688 shares of Heritage common stock in exchange for each share of Puget Sound stock. Heritage issued an aggregate of 4,112,258 shares of its common stock at the closing date per share price on January 12, 2018 of $31.80 and paid cash of $3,000 for fractional shares in the transaction for total consideration paid of $130.8 million.

The following table provides the estimated fair value of the assets acquired and liabilities assumed at January 16, 2018 (in thousands):

Balance Sheet
The Company's total assets increased $113.2 million, or 2.4%, to $4.79 billion at June 30, 2018 from $4.68 billion at March 31, 2018.

Investment securities increased $52.1 million, or 6.3%, to $873.7 million at June 30, 2018 from $821.6 million at March 31, 2018 primarily as a result of investment purchases of $78.0 million, offset partially by maturities, calls and payments of investment securities and an increase in unrealized losses due to rising interest rates that negatively impacted the fair value of our bond portfolio.

Total loans receivable, net of allowance for loan losses, increased $45.7 million, or 1.4%, to $3.29 billion at June 30, 2018 from $3.25 billion at March 31, 2018. The increase in loans receivable is primarily due to an increase in non-owner occupied commercial real estate loans of $54.2 million, offset partially by a decrease in commercial and industrial loans of $11.6 million.

Total deposits increased $64.2 million, or 1.6%, to $3.97 billion at June 30, 2018 from $3.90 billion at March 31, 2018. The increase in deposits included increases in interest bearing demand deposit accounts of $104.7 million, or 9.2%, and certificates of deposit accounts of $38.3 million, or 9.1%, offset partially by decreases in money market accounts of $57.2 million, or 8.7%. The increase in interest bearing demand deposit accounts and decrease in money market accounts was substantially due to a $48.7 million transfer between account types by one customer for the purpose of better alignment with deposit product needs. Non-maturity deposits as a percentage of total deposits decreased to 88.4% as of June 30, 2018 from 89.2% as of March 31, 2018 due to higher proportional increases of certificates of deposit accounts compared to total non-maturity deposits.

Federal Home Loan Bank advances increased $44.8 million, or 145.9%, to $75.5 million at June 30, 2018 compared to $30.7 million at March 31, 2018, to partially fund loan growth.

Total stockholders' equity increased $4.8 million, or 0.8%, to $639.5 million at June 30, 2018 from $634.7 million at March 31, 2018. Changes in stockholders' equity during the quarter and six months ended June 30, 2018 were as follows (in thousands):

The Company and Heritage Bank continue to maintain capital levels 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 of 11.2%, 10.4%, 11.7% and 12.6%, respectively, at June 30, 2018, compared to 11.3%, 10.4%, 11.8% and 12.7%, respectively, at March 31, 2018 and 11.5%, 10.5%, 12.1% and 13.1%, respectively, at June 30, 2017.

Credit Quality
The allowance for loan losses increased $711,000, or 2.1%, to $34.0 million for the quarter ended June 30, 2018 from $33.3 million for the linked-quarter ended March 31, 2018. The increase was due to provision for loan losses of $1.8 million recorded during the quarter ended June 30, 2018, offset partially by net charge-offs of $1.0 million recognized during the same period.

Nonperforming loans to loans receivable, net, increased slightly to 0.50% at June 30, 2018 from 0.48% at March 31, 2018 due primarily to an increase in nonaccrual loans of $795,000, or 5.1%, to $16.5 million at June 30, 2018 from $15.7 million at March 31, 2018. The increase was due substantially to one agricultural loan relationship in the amount of $826,000 that was classified as nonaccrual during the quarter ended June 30, 2018.

Changes in nonaccrual loans during the quarter ended June 30, 2018 were as follows (in thousands):

The allowance for loan losses to nonperforming loans was 205.60% at June 30, 2018 compared to 211.48% at the linked-quarter ended March 31, 2018. Nonperforming assets increased slightly to 0.35% of total assets at June 30, 2018 compared to 0.34% of total assets at March 31, 2018 based on the increase in nonaccrual loans discussed above as well as the addition to other real estate owned of $434,000 during the quarter ended June 30, 2018.

Potential problem loans increased $8.2 million, or 8.8%, to $101.5 million at June 30, 2018 compared to $93.3 million at March 31, 2018. The increase was due primarily to the addition of one agricultural borrowing relationship totaling $14.5 million which was downgraded. Changes in potential problem loans during the quarter ended June 30, 2018 were as follows (in thousands):

The allowance for loan losses to loans receivable, net, increased to 1.02% at June 30, 2018 from 1.01% at March 31, 2018.  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, 2018. 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 discount on purchased loans was $10.6 million at June 30, 2018 compared to $12.7 million at March 31, 2018.

Net charge-offs were $1.0 million for the quarter ended June 30, 2018 compared to net recoveries of $26,000 for the same quarter in 2017 and net recoveries of $23,000 for the linked-quarter ended March 31, 2018. The increase in net charge-offs compared to the linked-quarter was due primarily to charge-offs of two agricultural borrower relationships totaling $438,000 in addition to smaller charge-off balances on a large volume of consumer loans.

Operating Results
Net interest income increased $9.6 million, or 28.2%, to $43.7 million for the quarter ended June 30, 2018 compared to $34.1 million for the same period in 2017 and increased $2.9 million, or 7.1%, from $40.8 million for the linked-quarter ended March 31, 2018. Net interest income increased $17.3 million, or 25.7%, to $84.6 million for the six months ended June 30, 2018 compared to $67.3 million for the six months ended June 30, 2017. The increases in net interest income for all periods noted were primarily due to increases in average interest earning assets, which increased substantially in first quarter 2018 as a result of the Puget Sound Merger. In addition, the yield on total interest earning assets increased 36 basis points to 4.50% for the quarter ended June 30, 2018 compared to 4.14% for the comparable period in 2017 and increased 14 basis points from 4.36% for the linked quarter ended March 31, 2018.  Yield on total interest earning assets increased 32 basis points to 4.44% for the six months ended June 30, 2018 compared to 4.12% for the six months ended June 30, 2017.  Yields on total interest earning assets increased primarily due to higher market interest rates reflecting increases in the target federal funds rate. The increases in net interest income was offset partially by increases in the cost of total interest bearing liabilities as a result of the rising interest rates.  The cost of total interest bearing liabilities increased 10 basis points to 0.41% during the quarter ended June 30, 2018 compared to 0.31% for the quarter ended June 30, 2017 and increased six basis points from 0.35% for the linked-quarter ended March 31, 2018. The cost of total interest bearing liabilities increased nine basis points to 0.38% for the six months ended June 30, 2018 compared to 0.29% for the same period in 2017.

Net interest margin increased 30 basis points to 4.22% for the quarter ended June 30, 2018 from 3.92% for the same period in 2017 and increased 10 basis points from 4.12% for the linked-quarter ended March 31, 2018.  The net interest margin increased 26 basis points for the six months ended June 30, 2018 to 4.17% from 3.91% for the same period in 2017.  Increases in net interest margin were due primarily to the increases in net interest income as discussed above with the primary contributor being the increases in both the average loan balance and loan yield.

The loan yield, excluding incremental accretion on purchased loans, increased 28 basis points to 4.81% for the quarter ended June 30, 2018 compared to 4.53% for the quarter ended June 30, 2017 and increased 11 basis points from 4.70% for the linked-quarter ended March 31, 2018.  Loan yield, excluding incremental accretion on purchased loans, increased 22 basis points to 4.75% for the six months ended June 30, 2018 compared to 4.53% for same period in 2017. The increases in loan yields from prior periods was due to a combination of higher contractual loan rates as a result of the increasing interest rate environment as well as an increase in loan yields from the loans acquired in the Puget Sound merger as compared to legacy Heritage loans.

The impact on loan yield from incremental accretion on purchased loans increased two basis points to 0.24% for the quarter ended June 30, 2018 compared to 0.22% for the quarter ended June 30, 2017 and increased three basis points from 0.21% for the linked-quarter ended March 31, 2018. The impact on loan yield from incremental accretion on purchased loans increased three basis points to 0.23% for the six months ended June 30, 2018 from 0.20% for the same period in 2017. The increases from all prior periods was primarily a result of the loans acquired in the Puget Sound merger. The incremental accretion and the impact to loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the balance of the purchased loans decreases.

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

In addition to loan yields, also impacting net interest margin were increases in the yields on investment securities. The yields on the aggregate investment portfolio increased 28 basis points to 2.53% for the quarter ended June 30, 2018 compared to 2.25% for the quarter ended June 30, 2017 and increased 10 basis points from 2.43% for the linked-quarter ended March 31, 2018. The yields on the aggregate investment portfolio increased 25 basis points to 2.48% for the six months ended June 30, 2018 compared to 2.23% for the six months ended June 30, 2017. The increases compared to the prior periods primarily reflect the effect of the rise in interest rates on our adjustable rate investment securities.

Net interest margin has also been impacted by the cost of interest bearing liabilities which has increased primarily as a result of the rise in interest rates and secondarily by the increase in the average balance of total interest bearing liabilities.

The total cost of deposits increased five basis points to 0.23% during the quarter ended June 30, 2018 compared to 0.18% during the same quarter in 2017 and increased two basis points from 0.21% during the linked-quarter ended March 31, 2018.  The total cost of deposits increased five basis points to 0.22% during the six months ended June 30, 2018 compared to 0.17% during the same period in 2017.

The Company uses FHLB advances as a source of funding. The cost of FHLB advances increased 115 basis points to 2.04% during the quarter ended June 30, 2018 compared to 0.89% during the same quarter in 2017 and increased 34 basis points from 1.70% during the linked-quarter ended March 31, 2018. The average balance of FHLB advances decreased to $79.1 million during the quarter ended June 30, 2018 compared to an average balance of $107.1 million during the same period in 2017 and increased from an average balance of $35.7 million during the linked-quarter ended March 31, 2018.

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "We are pleased that our net interest margin performance continues to improve. This has been accomplished primarily through increases in pre-accretion loan yield and investment yield while experiencing only marginal increases in costs of deposits. The weighted average note rate on new loans originated during quarter ended June 30, 2018 increased to 5.18% from 5.00% for the quarter ended March 31, 2018 and from 4.60% for the quarter ended June 30, 2017.  As a result of these increases in new loan rates as well as past and expected future increases in the prime rate, we expect that pre-accretion loan yield will continue to have a positive impact on our net interest margin this year."

The provision for loan losses increased $619,000, or 54.7%, to $1.8 million for the quarter ended June 30, 2018 compared to $1.1 million for the quarter ended June 30, 2017 and increased $598,000, or 51.9%, from the linked-quarter ended March 31, 2018. The provision for loan losses increased $904,000, or 45.2%, to $2.9 million for the six months ended June 30, 2018 compared to $2.0 million for the six months ended June 30, 2017. The amount of provision for loan losses was necessary to increase the allowance for loan losses to an amount that management determined to be appropriate at June 30, 2018 based on the use of a consistent methodology. The increase in the provision for loan losses was primarily as a result of organic loan growth and net charge-offs.

Noninterest income decreased $3.1 million, or 29.3%, to $7.6 million for the quarter ended June 30, 2018 compared to $10.7 million for the same period in 2017 and decreased $3.0 million, or 16.3%, to $15.1 million for the six months ended June 30, 2018 compared to $18.1 million for the same period in 2017. The decreases from the prior periods were due primarily to a decrease of $3.0 million in gain on sale of loans as a result of the sale of a previously classified purchased credit impaired loan during the quarter ended June 30, 2017, offset partially by increases in service charges and other fees due primarily to changes in fee structures on business deposit accounts completed during the quarter ended June 30, 2017 in addition to increases in deposit balances.

Noninterest expense increased $7.9 million, or 28.4%, to $35.7 million for the quarter ended June 30, 2018 compared to $27.8 million for the same period in 2017. Noninterest expense increased $17.4 million, or 31.7%, to $72.5 million for the six months ended June 30, 2018 compared to $55.0 million for the same period in 2017. The increases were primarily due to expenses from the Puget Sound Merger and Premier Merger including increases related to compensation and employee benefits due to additional employees, occupancy and equipment expense primarily due to additional building and land rent expense, and additional data processing expense due to an increase in deposit balances. Noninterest expense also increased during the quarter and six months ended June 30, 2018 compared to both periods in 2017 as a result of amortization of intangible assets of $513,000 and $1.0 million recorded during the quarter and six months ended June 30, 2018, respectively, due to the amortization of core deposit intangibles acquired in the Puget Sound Merger.

Professional services increased during the quarter and six months ended June 30, 2018 compared to prior periods due substantially to the buy-out of a third party contract in the amount $1.7 million.  The third party assisted the Company in our deposit product realignment and was compensated based on success factors over three years subsequent to implementation. The Company assessed the contract and determined that it was advantageous to buy-out the contract prior to the system conversions relating to the Puget Sound Merger and Premier Merger. The Company expects the accumulated savings in future professional services expenses to fully offset the cost of the buy-out by the end of 2019. In addition, professional services costs also increased in 2018 compared to 2017 as a result of merger activities.

Noninterest expense decreased $1.0 million, or 2.8%, from $36.7 million for the linked-quarter ended March 31, 2018 primarily due to non-recurring compensation and employee benefits expense related to the Puget Sound Merger paid during the first quarter 2018, offset partially by the contract buy-out in second quarter 2018 described above.

Acquisition-related expenses incurred as a result of the Puget Sound Merger and Premier Merger were approximately $551,000 and $329,000, respectively, during the quarter ended June 30, 2018 compared to $4.5 million and $324,000, respectively, during the linked-quarter ended March 31, 2018, for a total of approximately $5.7 million during the six months ended June 30, 2018. There were no acquisition-related expenses for the same periods in 2017. Acquisition costs are primarily included in compensation and employee benefits, professional services and data processing expenses.

The ratio of noninterest expense to average assets (annualized) was 3.03% for the quarter ended June 30, 2018 compared to 2.85% for the same period in 2017 and was 3.15% for six months ended June 30, 2018 compared to 2.85% for the same period in 2017. The increase from the prior periods was due primarily to acquisition-related expenses.  The ratio of noninterest expense to average assets (annualized) decreased from 3.27% for the linked-quarter ended March 31, 2018 primarily based on the changes to the noninterest expense described above.

Income tax expense was $2.0 million for the quarter ended June 30, 2018 compared to $4.1 million for the quarter ended June 30, 2017 and $1.4 million for the linked-quarter ended March 31, 2018. The effective tax rate was 14.5% for the quarter ended June 30, 2018 compared to 25.6% for the comparable quarter in 2017 and 13.3% for the linked-quarter ended March 31, 2018. Income tax expense was $3.4 million for the six months ended June 30, 2018 compared to $7.2 million for the six months ended June 30, 2018. The effective tax rate was 14.0% for the six months ended June 30, 2018 compared to 25.3% for the six months ended June 30, 2018. The decrease in income tax expense and the effective tax rate compared to the same periods in 2017 was due primarily to the impact of the Tax Cuts and Jobs Act enacted in December 2017 which lowered the corporate income tax rate from 35% to 21%.

Jeffrey J. Deuel, President and Chief Executive Officer of Heritage Bank, commented, "It is good to see the positive momentum across the Bank as we complete the integration of Puget Sound Bank and we see the combined team begin to get traction.  It is also good to have change-of-control for Premier Community Bank behind us, and we look forward to having that team help us build out our presence in Portland in the second half of the year."

Dividends
On July 24, 2018, the Company's Board of Directors declared a quarterly cash dividend of $0.15 per common share. The dividend is payable on August 23, 2018 to shareholders of record as of the close of business on August 9, 2018.

Earnings Conference Call
The Company will hold a telephone conference call to discuss this earnings release on July 25, 2018 at 11:00 a.m. Pacific time. To access the call, please dial (800) 398-9367 a few minutes prior to 11:00 a.m. Pacific time. The call will be available for replay through August 8, 2018, by dialing (800) 475-6701 -- access code 451269.

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 65 banking offices in Washington and Oregon. Heritage Bank 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 press release includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements often include words such as "believe," "expect," "anticipate," "estimate," and "intend" or future or conditional verbs such as "will," "would," "should," "could," or "may." Forward-looking statements are not historical facts but instead represent management's current expectations and forecasts regarding future events, many of which are inherently uncertain and outside of our control. Actual results may differ, possibly materially, from those currently expected or projected in these forward-looking statements. Factors that could cause our actual results to differ materially from those described in the forward-looking statements, include the expected revenues, cost savings, synergies and other benefits from the Puget Sound Merger and the Premier Merger might not be realized within the expected time frames or at all, and costs or difficulties relating to integration matters, including but not limited to, customer and employee retention might be greater than expected; increased competitive pressures; changes in the interest rate environment; changes in general economic conditions and conditions within the securities markets; legislative and regulatory changes; and other factors described in Heritage's latest annual Report on Form 10-K and Quarterly Reports on Form 10-Q and other documents filed with or furnished to the Securities and Exchange Commission-which are available on our website at www.heritagebanknw.com and on the SEC's website at www.sec.gov. The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, any of the forward-looking statements that we make in this press release or the documents we file with or furnish to the SEC are based only on information then actually known to the Company and upon management's beliefs and assumptions at the time they are made which may turn out to be wrong because of inaccurate assumptions we might make, because of the factors described above or because of other factors that we cannot foresee. 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 2018 and beyond 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.

SOURCE Heritage Financial Corporation

Related Links

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