Heritage Financial Announces Second Quarter Results And Declares Regular Cash Dividend

OLYMPIA, Wash., July 24, 2014 /PRNewswire/ -- HERITAGE FINANCIAL CORPORATION (NASDAQ GS: HFWA) Brian L. Vance, President and CEO of Heritage Financial Corporation ("the Company" or "Heritage"), today reported that the Company had net income of $4.1 million for the quarter ended June 30, 2014 compared to net income of $2.7 million for the quarter ended June 30, 2013 and $2.5 million for the linked-quarter ended March 31, 2014.  Net income for the quarter ended June 30, 2014 was $0.16 per diluted common share compared to $0.18 per diluted common share for the quarter ended June 30, 2013 and $0.16 per diluted common share for the linked-quarter ended March 31, 2014.

Net income for the six months ended June 30, 2014 was $6.7 million, or $0.32 per diluted common share, compared to $5.6 million, or $0.37 per diluted common share, for the six months ended June 30, 2013. 

Mr. Vance commented, "Taking into consideration the effects of Washington Banking merger-related expenses, I am pleased with the financial results for the quarter.  Merger-related expenses lowered earnings per share by $0.15 for the second quarter of 2014.  Excluding these merger-related expenses, earnings per share were $0.31 for the quarter.  Since the merger closed on May 1, 2014, only two of the three reporting months for the quarter included the effects of the Washington Banking merger."

"Linked-quarter and year-over-year comparisons reflect a substantially and positively different company as a result of the merger, and we are beginning to see a balance sheet and operating metrics that are reflecting what we believed were the values of this strategic merger.  Specifically, two merger adjusted metrics, earnings per share and efficiency ratio, are beginning to reflect the accretion, scale and efficiencies of this combination. We are also pleased with our resulting tangible common equity to tangible assets ratio which while substantially reduced still gives us the ability to take advantage of future growth opportunities as well as a continuation of our capital management strategies." 

"There are considerable integration activities and opportunities to improve efficiencies yet remaining for the balance of this year, and we are positive about the outcome of our efforts."

Merger with Washington Banking Company

Effective May 1, 2014, Heritage completed the strategic merger with Washington Banking Company and its wholly owned subsidiary, Whidbey Island Bank ("Washington Banking Merger").  The merger was accounted for using the acquisition method of accounting. Accordingly, Heritage's cost to acquire Washington Banking was allocated to the assets (including identifiable intangible assets) and the liabilities of Washington Banking at their respective estimated fair values as of the merger date. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill.  The fair value on the merger date represents management's best estimates based on available information and facts and circumstances in existence on the merger date. The allocation of the purchase price is subject to adjustment within the one year re-measurement period.

The following table provides detail of the fair value of the assets acquired and liabilities assumed:

Impact of 2013 Initiatives

In addition to the merger with Washington Banking, the following other 2013 initiatives had an impact on the current and historical operating results of the Company:

• On January 9, 2013, the Company acquired Northwest Commercial Bank ("NCB") and merged it into Heritage Bank (the "NCB Acquisition"). NCB was a full service commercial bank with branches in Lakewood and Auburn, Washington.  In March 2013, the Company consolidated the operations of the former NCB Lakewood branch with the Lakewood branch of Heritage Bank. 
• On June 19, 2013, the Company completed the merger of its subsidiary, Central Valley Bank ("CVB"), with and into Heritage Bank (the "CVB Merger").  CVB is now operated as a division of Heritage Bank. 
• On July 15, 2013, the Company completed the acquisition of Valley Community Bancshares, Inc. ("Valley"), the holding company for Valley Bank, both of Puyallup, Washington (the "Valley Acquisition").  As of the acquisition date, Valley merged into Heritage and Valley Bank merged into Heritage Bank.  During the quarter ended December 31, 2013, four former Valley Bank branches were consolidated into other Heritage Bank branches.
• During the quarter ended December 31, 2013, the Company completed a core system conversion of Heritage Bank.
• Also during the quarter ended December 31, 2013, the Company consolidated three Heritage Bank branches into other Heritage Bank branches.

Balance Sheet

The Company's total assets increased $1.73 billion to $3.39 billion at June 30, 2014 from $1.66 billion at March 31, 2014 as a result of the Washington Banking Merger.  Excluding the total assets acquired as a result of the Washington Banking Merger, total assets decreased $17.4 million during the quarter ended June 30, 2014.

Total noncovered loans, net of net deferred fees (not including loans held for sale) increased $894.0 million to $2.07 billion at June 30, 2014 from $1.18 billion at March 31, 2014 primarily due an increase of $893.8 million of noncovered loans as a result of the Washington Banking Merger.  Noncovered loans include loans originated by Heritage Bank as well as other noncovered loans obtained in previous mergers and acquisitions.

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented, "We continue to see steady loan growth across the combined lending platform and a continuing upward trend in our loan pipeline.  The size and breadth of the post-merger organization will provide additional lending opportunities."

Total deposits increased $1.46 billion to $2.87 billion at June 30, 2014 from $1.40 billion at March 31, 2014 primarily due to the Washington Banking Merger.  Excluding the deposits assumed as a result of the Washington Banking Merger, total deposits increased $28.4 million, or 2.0%, during the quarter ended June 30, 2014.  Non-maturity deposits as a percentage of total deposits decreased to 78.3% at June 30, 2014 from 78.8% at March 31, 2014.  In addition, noninterest bearing demand deposits to total deposits decreased to 23.3% at June 30, 2014 from 25.1% at March 31, 2014.  The decreases in these ratios were primarily due to the Washington Banking Merger. 

Total stockholders' equity increased $233.4 million to $449.8 million at June 30, 2014 from $216.4 million at March 31, 2014.  This increase was mostly due to $226.8 million of stock issued in the Washington Banking Merger, $4.1 million of net income, and an increase of $2.0 million in accumulated other comprehensive income, net.  The Company and Heritage Bank, its subsidiary 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 June 30, 2014 of 11.9%, 13.7% and 14.9%, respectively, as compared to 11.5%, 15.3%, and 16.6%, at March 31, 2014, respectively. 

Credit Quality

The allowance for loan losses on noncovered loans decreased $451,000 to $22.4 million at June 30, 2014 from $22.8 million at March 31, 2014 as a result of $821,000 in net charge-offs recognized during the quarter ended June 30, 2014 partially offset by $370,000 in provision for loan losses.  Nonperforming noncovered loans to total noncovered loans decreased to 0.66% at June 30, 2014 from 0.98% at March 31, 2014.  Nonaccrual noncovered loans increased $2.0 million to $13.6 million ($11.3 million net of government agency guarantees) at June 30, 2014 from $11.5 million ($9.7 million net of government agency guarantees) at March 31, 2014.  The increase was due to $3.9 million of additions to nonaccrual noncovered loans partially offset by $1.3 million of net principal reductions and $623,000 of charge-offs.  Of the $3.9 million of additions to nonaccrual noncovered loans, approximately $3.3 million were previously reported as potential problem loans and $418,000 were previously reported as performing troubled debt restructurings.

The allowance for loan losses to nonperforming noncovered loans was 164.62% at June 30, 2014 compared to 197.75% at March 31, 2014.  Potential problem noncovered loans were $137.0 million at June 30, 2014 compared to $58.4 million at March 31, 2014. The $78.6 million increase in noncovered potential problem loans from the prior quarter-end was due to noncovered potential problem loans acquired in the Washington Banking Merger. Excluding the effects of the Washington Banking Merger, noncovered potential problem loans decreased $4.4 million during the quarter ended June 30, 2014.  This decrease was due to $3.3 million of noncovered potential problem loans transferring to nonaccrual status and $1.0 million being classified as noncovered performing troubled debt restructurings.

The allowance for loan losses on noncovered loans to total noncovered loans, net was 1.08% at June 30, 2014 compared to 1.94% as March 31, 2014.  The decrease in the allowance percentage resulted from the noncovered loans acquired in the Washington Banking Merger, for which no allowance was estimated at quarter-end giving management's judgment that net acquisition accounting adjustments adequately address the estimated losses in the acquired loans. 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, 2014.

Nonperforming noncovered assets were $18.6 million ($16.3 million net of government agency guarantees), or 0.58% of total noncovered assets, at June 30, 2014, compared to $15.6 million ($13.8 million net of government agency guarantees), or 0.97% of total noncovered assets, at March 31, 2014.  Other real estate owned increased $3.8 million to $8.1 million at June 30, 2014 (of which $3.0 million was covered by FDIC shared-loss agreements) from $4.3 million at March 31, 2014 (of which $182,000 was covered by FDIC loss sharing agreements).  The increase was primarily due to the Washington Banking Merger partially offset by $3.3 million in proceeds from the disposition of seven properties.

Operating Results

Net interest income increased $12.7 million to $28.6 million for the quarter ended June 30, 2014 compared to $15.9 million for the same period in 2013.  Net interest income increased $12.9 million to $45.3 million for the six months ended June 30, 2014 compared to $32.5 million for the same period in 2013.  The increases in net interest income are primarily due to the Washington Banking Merger.

Heritage's net interest margin for the quarter ended June 30, 2014 decreased 27 basis points to 4.55% from 4.82% for the same period in 2013 and increased seven basis points from 4.48% in the linked-quarter ended March 31, 2014.  The decline in net interest margin from the same period in 2013 is due to a change in the earnings asset mix (lower ratio of loans to earning assets and higher ratio of investments to earning assets) as well as lower contractual loan note rates.  The increase in the net interest margin from the linked-quarter ended March 31, 2014 is primarily due to the increase in the impact from discount accretion as a result of the Washington Banking Merger. Heritage's net interest margin for the six months ended June 30, 2014 decreased 48 basis points to 4.52% from 5.00% for the same period in 2013. 

The positive effect on the net interest margin of discount accretion on the acquired loan portfolios for the quarter ended June 30, 2014 was approximately 43 basis points compared to 45 basis points in the same quarter of the prior year and 25 basis points for the linked-quarter ended March 31, 2014.  The positive effect on the net interest margin of discount accretion on the acquired loan portfolios for the six months ended June 30, 2014 was approximately 37 basis points compared to 58 basis points for the same period of the prior year. 

The provision for loan losses on noncovered loans was $370,000 for the quarter ended June 30, 2014 compared to $345,000 for the quarter ended June 30, 2013 and $(21,000) for the linked-quarter ended March 31, 2014.  For the six months ended June 30, 2014, the provision for loan losses on noncovered loans was $349,000 compared to $709,000 for the same period in the prior year.

The provision for loan losses on covered loans totaled $321,000 for the quarter ended June 30, 2014 compared to $1.1 million for the same period in the prior year and $479,000 for the linked-quarter ended March 31, 2014.  For the six months ended June 30, 2014, the provision for loan losses on covered loans was $800,000 compared to $1.5 million for the same period in the prior year.

As of the merger dates, acquired loans were recorded at their estimated fair value, incorporating 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 $2.7 million for the quarter ended June 30, 2014 compared to $1.5 million for the quarter ended June 30, 2013 and $935,000 for the linked-quarter ended March 31, 2014.  The increase for the quarter ended June 30, 2014 was due to incremental accretion income from the Washington Banking Merger.  For the six months ended June 30, 2014, incremental accretion income was $3.7 million compared to $3.8 million for the same period in the prior year.

For the quarter ended June 30, 2014, the Company recognized $109,000 of change in the FDIC indemnification asset compared to $(37,000) and $281,000 for the quarters ended March 31, 2014 and June 30, 2013, respectively.

The following table illustrates the significant accounting entries associated with the Company's acquired loan portfolios:

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "The net interest margin before incremental accretion income decreased 11 basis points to 4.12% for the quarter ended June 30, 2014 compared to 4.23% for the linked-quarter ended March 31, 2014.  This core net interest margin reflected the decrease of the loan to deposit ratio in connection with the Washington Banking Merger. Loan yields before incremental accretion income increased six basis points to 5.28% for the quarter ended June 30, 2014 compared to 5.22% for the linked-quarter ended March 31, 2014."

Noninterest income was $4.8 million for the quarter ended June 30, 2014 compared to $2.4 million for the same period in 2013 and $2.3 million for the linked-quarter ended March 31, 2014.  For the six months ended June 30, 2014, noninterest income was $7.1 million compared to $4.6 million for the six months ended June 30, 2013.  The increases were primarily due to the Washington Banking Merger.

In addition to the Washington Banking Merger, prior year initiatives had a significant impact on noninterest expense during 2013, and continue to impact 2014 expense levels. The following tables illustrate the expenses related to implementing these initiatives.  The amounts reported represent identifiable costs paid to third-party providers as well as any retention bonuses or severance payments made in conjunction with these initiatives.  The amounts do not include costs of additional staffing levels required to complete the initiatives nor do they include future expected cost savings from the Washington Banking Merger. The first table reports these expenses by initiative and the second table reports these expenses by expense category.

The types of expenses associated with the significant expense categories in the table above are summarized as follows:

• Compensation and employee benefits expense consisted substantially of retention bonus and severance packages paid to transition employees.
• Occupancy and equipment expense consisted primarily of lease termination costs.
• Data processing expense consisted of costs relating to the Company's core system conversion as well as conversions of NCB and Valley Bank and the preparation for the future conversion of Whidbey Island Bank.
• Professional services expense includes fees paid to financial advisors, attorneys, and accountants, and consultant fees related to mergers and acquisitions and to the core system conversion.

Noninterest expense was $27.0 million for the quarter ended June 30, 2014 compared to $13.0 million for the quarter ended June 30, 2013 and $14.8 million for the linked-quarter ended March 31, 2014.  Noninterest expense was $41.8 million for the six months ended June 30, 2014, an increase of $15.0 million from $26.7 million for the six months ended June 30, 2013.  The increases are due to the Washington Banking Merger and additional ongoing operating costs from mergers and acquisitions as well as specific costs identified in the table above.

Mr. Hinson added, "The costs associated with the Washington Banking Merger had a significant impact on operating ratios.  Excluding merger costs, the efficiency ratio improved to 65% from a reported 81% for the quarter ended June 30, 2014.  We expect to continue to see improvement in operating ratios as we realize the cost savings expected from the Washington Banking Merger."

Mr. Deuel added, "We have made very good progress with the integration of the two banks.  We are fully functioning with the new, combined organizational structure while we continue to work on process refinements. We are also positioned for a positive system conversion in early October when we will bring the legacy Whidbey business onto the Heritage operating platform.  After the conversion we will truly be functioning as one bank."

Income tax expense was $1.5 million for the quarter ended June 30, 2014 compared to $1.3 million for the comparable quarter in 2013 and for the linked-quarter ended March 31, 2014.  The increase in income tax expense for the quarter ended June 30, 2014 from the prior year periods was due to the increase in pre-tax income and was partially offset by tax credits.

Dividend

On July 24, 2014, the Company's Board of Directors declared a quarterly cash dividend of $0.09 per common share payable on August 21, 2014 to shareholders of record on August 7, 2014. 

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on July 25, 2014 at 9:00 a.m. Pacific time.  To access the call, please dial (800) 230-1074 a few minutes prior to 9:00 a.m. Pacific time.  The call will be available for replay through August 8, 2014, by dialing (800) 475-6701 -- access code 330527.

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 67 banking offices in Washington and Oregon including the 31 Whidbey Island Bank branches. The Whidbey Island Bank branches will continue to operate under the Whidbey Island Bank name until the system conversion which is scheduled for completion during the fourth quarter of 2014. Following the system conversion, the six branch offices located on Whidbey Island will continue to operate under the Whidbey Island Bank name and the remainder of the branches will operate under the Heritage Bank name. Heritage Bank also does business under the Central Valley Bank name in the Yakima and Kittitas counties of Washington. 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 financial measures in addition to results presented in accordance with Generally Accepted Accounting Principles (GAAP).  These measures include tangible common equity, tangible book value per share and tangible common equity to tangible assets.  Tangible common 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.  Where applicable, the Company has also presented comparable capital 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