Heritage Financial Announces Third Quarter 2010 Earnings

OLYMPIA, Wash., Nov. 1, 2010 /PRNewswire-FirstCall/ -- HERITAGE FINANCIAL CORPORATION (Nasdaq: HFWA) Brian L. Vance, President and CEO of Heritage Financial Corporation ("Company" or "Heritage"), today reported net income for the quarter ended September 30, 2010 of $2.0 million compared to net income of $312,000 for the quarter ended September 30, 2009 and $855,000 for the linked-quarter ended June 30, 2010.  Including preferred stock dividends, the net income applicable to common shareholders for the quarter ended September 30, 2010 was $1.7 million, or $0.15 per diluted common share, compared with a net loss applicable to common shareholders of $18,000, or $0.003 per diluted common share for the quarter ended September 30, 2009 and net income applicable to common shareholders of $523,000, or $0.05 per diluted common share for the linked-quarter ended June 30, 2010.  The increase in earnings from the prior year quarter ended September 30, 2009 and the linked-quarter ended June 30, 2010 was substantially attributable to the decrease in provision for loan losses and the increase in net interest income.  

Net income applicable to common shareholders for the nine months ended September 30, 2010 was $2.6 million, or $0.23 per diluted common share, compared to a net loss applicable to common shareholders of $1.2 million, or $0.17 per diluted common share, for the nine months ended September 30, 2009.

Mr. Vance commented, "We are very pleased to report positive net income applicable to common shareholders for the fourth consecutive quarter, despite an ongoing difficult economic cycle for financial institutions.  We are continuing to execute our strategies while maintaining strong liquidity and capital levels."

"We had two significant positive events this quarter.  We successfully acquired Cowlitz Bank and its division Bay Bank through an FDIC-assisted transaction effective July 30, 2010.  The acquisition added nine branches, ranging from Portland to Seattle.  In addition to adding 4 branches in Washington's Cowlitz County (thereby giving us the number one market share among commercial banks in that county), we added important new markets for us in Seattle, Bellevue, Vancouver (Washington) and Portland (Oregon).  We believe these new markets will allow us significant future growth opportunities as we build out and strengthen our presence in these markets."  

"We also opened a new full service branch in Puyallup, Washington further expanding our presence in the Pierce County market.  These two events have now expanded our branch network to a total of 30 branches.  The synergy that has been generated from integrating these new markets into our company is exciting.  We will continue to pursue growth opportunities to further leverage our capital and grow our franchise."

FDIC-Assisted Acquisition of Cowlitz Bank

On July 30, 2010, Heritage Bank ("Bank") acquired certain assets and assumed certain liabilities of Cowlitz Bank from the FDIC in an FDIC-assisted transaction (the "Cowlitz Acquisition").  As part of the Purchase and Assumption Agreement, the Bank and the FDIC entered into shared-loss agreements, whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded loan commitments) and accrued interest on loans for up to 90 days.  We refer to the acquired loans subject to the shared-loss agreements as "covered loans" (loans not subject to the shared-loss agreements are referred to as "noncovered loans").  Under the terms of the shared-loss agreements, the FDIC will absorb 80% of losses and share in 80% of recoveries.  The shared-loss agreement for commercial and single family residential mortgage loans is in effect for five years and ten years, respectively, from the July 30, 2010 acquisition date and the recovery provisions for such loans are in effect for eight years and ten years, respectively, from the acquisition date.  All of the loans acquired in the Cowlitz Acquisition are covered loans other than unpaid principal of approximately $2.3 million in consumer loans for which the FDIC has no reimbursement obligation.

The Bank purchased certain assets of Cowlitz Bank from the FDIC including (at fair value) approximately $145.3 million in loans, $74.1 million of cash and cash equivalents, $33.7 million in investment securities, $1.2 million in FHLB stock and $1.2 million in other assets. The Bank also assumed liabilities with fair value of approximately $343.9 million in deposits and $0.4 million of other liabilities of Cowlitz Bank from the FDIC.   Cowlitz Bank was a full service commercial bank headquartered in Longview, Washington that operated nine branch locations, including seven in the state of Washington and two in the state of Oregon.  We made this acquisition primarily to expand our geographic footprint.

Under the terms of the Purchase and Assumption Agreement, the Bank was permitted to re-price and repay deposits assumed, including time deposits, which it did promptly after the acquisition.  The Bank re-priced approximately $168.2 million of internet certificates of deposit. As a result, the accounts have decreased approximately $133.4 million since July 30, 2010 to September 30, 2010. The Bank also coordinated a withdrawal of approximately $27.2 million in NOW accounts held by the State of Washington and approximately $10.0 million of brokered certificates of deposits subsequent to the acquisition date.

The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting (formerly the purchase method).  The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the July 30, 2010 acquisition date.  The application of the acquisition method of accounting resulted in the recognition of a pre-tax gain on bank acquisition of $438,000 and a core deposit intangible of $1.7 million.  In addition, the Company recorded a $16.1 million FDIC indemnification asset, which is the present value of cash flows the Company expects to collect from the FDIC under the loss-sharing agreements. 

The gain on bank acquisition represents the excess of the estimated fair value of the assets acquired over the estimated fair value of the liabilities assumed and is influenced significantly by the FDIC-assisted transaction process.  Under the FDIC-assisted transaction process, only certain assets and liabilities are transferred to the acquirer and, depending on the nature and amount of the acquirer's bid, the FDIC may be required to make a cash payment to the acquirer.  In the Cowlitz Acquisition, we received a cash payment from the FDIC of $70.8 million.

Balance Sheet

The Company's total assets increased $244.8 million to $1.25 billion at September 30, 2010 from $1.01 billion at June 30, 2010 and increased $236.6 million from $1.02 billion at September 30, 2009 due substantially to the acquisition of the assets of Cowlitz Bank.  Total noncovered loans (including loans held for sale) decreased $3.9 million to $757.3 million at September 30, 2010 from $761.2 million at June 30, 2010. This decrease was due substantially to charge-offs recognized during the quarter ended September 30, 2010. A $21.0 million decrease in commercial loans is largely attributable to the reclassification of certain commercial business loans to multi-family and commercial real estate loans in order to be more consistent with federal interagency reporting guidelines. The decline in the real estate construction portfolio was the result of a combination of $1.8 million in charge offs, $591,000 of transfers to other real estate owned, and loan payoffs.  At September 30, 2010, real estate construction loan balances accounted for $62.9 million, or 8.3% of total loans, of which $29.9 million were single-family residential construction loans.  

Deposits increased $239.0 million to $1.07 billion at September 30, 2010 from $829.0 million at June 30, 2010 due primarily to the assumption of Cowlitz Bank deposits.  As a result of the acquisition, non-interest demand deposits to total deposits increased to 16.8% at September 30, 2010 from 14.9% at June 30, 2010.

At September 30, 2010, the Company's stockholders' equity to total assets decreased to 13.0% compared to 15.9% at June 30, 2010 as a result of the acquisition of Cowlitz Bank assets.  The Company and its subsidiary banks continue to maintain capital levels significantly in excess of the requirements to be categorized as "well-capitalized" under applicable regulatory standards. The Company had Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios at September 30, 2010 of 12.2%, 18.4% and 19.7%, respectively, as compared to 14.8%, 20.2% and 21.4% at June 30, 2010, respectively.  

Credit Quality

The allowance for loan losses at September 30, 2010 decreased by $1.1 million to $25.2 million from $26.3 million at June 30, 2010.  Nonperforming noncovered assets were $28.3 million, or 2.53% of total noncovered assets, at September 30, 2010, a decrease from $31.3 million, or 3.10% of total noncovered assets, at June 30, 2010.  Potential problem loans increased $10.0 million to $46.1 million at September 30, 2010 from $36.1 million at June 30, 2010.  The increase in potential problem loans was primarily due to two credit relationships totaling $10.6 million that were downgraded during the quarter ended September 30, 2010. The Company believes that its allowance for loan losses is adequate to provide for probable losses based on an evaluation of known and inherent risk in the loan portfolio at September 30, 2010.

Nonperforming noncovered loans to total noncovered loans was 3.49% at September 30, 2010, a decrease from 3.91% and 4.56% at June 30, 2010 and September 30, 2009, respectively.  The allowance for loan losses to nonperforming noncovered loans increased to 95.6% at September 30, 2010 from 88.4% and 70.2% at June 30, 2010 and September 30, 2009, respectively.  The decrease in nonperforming noncovered loans from June 30, 2010 was due substantially to net charge-offs of $3.3 million during the quarter ended September 30, 2010. Of these charge-offs, $1.4 million related to nonperforming commercial loans and $1.8 million related to nonperforming construction loans.

Mr. Vance added, "We are pleased with the continuing improvement of our non-performing loan levels as well as our strong coverage ratio.  While we believe we will continue to see overall improvement in non-performing loans, we may also experience additional potential problem loans as we continue through this difficult and likely lengthy recovery period."

"Overall loan demand remains soft, but with the new lending teams from the Cowlitz Acquisition as well as the addition of experienced commercial lenders in the Pierce County market, we are confident we will see increased loan levels as we begin a new year.  It is important to note that excluding the decrease of $44 million in real estate construction loans from September 30, 2009 to September 30, 2010, the remaining portfolio of noncovered loans increased approximately 3% year over year."  

Operating Results

Net interest income increased $2.2 million or 20.4%, to $12.7 million for the quarter ended September 30, 2010 compared with $10.5 million during the same period in 2009 as a result of the increased earning assets acquired in the Cowlitz Acquisition. Heritage's net interest margin for the quarter ended September 30, 2010 decreased to 4.42% from 4.58% for the same period in 2009 and from 4.60% for the prior quarter ended June 30, 2010.  The decrease in net interest margin was due to large balances in low interest earning overnight cash deposits acquired in the Cowlitz Acquisition.

The provision for loan losses decreased $2.5 million or 52.8% to $2.2 million for the quarter ended September 30, 2010 from $4.7 million for the quarter ended September 30, 2009 and decreased $955,000 or 30.3% from $3.2 million for the quarter ended June 30, 2010. The decrease in the provision for loan losses was due to the improving trends in the ratios of nonperforming noncovered loans to total noncovered loans and of the allowance for loan losses to nonperforming noncovered loans. The Company had net charge-offs of $3.3 million for both the quarters ended September 30, 2010 and September 30, 2009 and $1.7 million for the quarter ended June 30, 2010.

Non-interest income increased $808,000, or 38.4%, to $2.9 million for the quarter ended September 30, 2010 compared to $2.1 million for the same period in 2009. The increase was due substantially to a $438,000 pre-tax gain on the Cowlitz Acquisition and an increase of $126,000 in service charges on deposits due to increased deposit balances as a result of the Cowlitz Acquisition.

Non-interest expense increased $2.7 million or 35.7% to $10.3 million during the quarter ended September 30, 2010 compared to $7.6 million for the quarter ended September 30, 2009. The increase for the three months was due to increased salaries and benefits expense in the amount of $1.5 million, increased professional services of $368,000, increased occupancy and equipment expense of $298,000, and increased data processing of $116,000.  These increases were substantially due to the Cowlitz Acquisition.  

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on November 1, 2010, at 11:00 a.m. Pacific time.  To access the call, please dial (800) 230-1085 a few minutes prior to 11:00 a.m. Pacific time.  The call will be available for replay through November 15, 2010, by dialing (800) 475-6701 -- access code 173483.

About Heritage Financial

Heritage Financial Corporation is a bank holding company headquartered in Olympia, Washington.  The Company operates two community banks, Heritage Bank and Central Valley Bank.  With the FDIC-assisted acquisition of Cowlitz Bank, Heritage Bank now serves western Washington and the greater Portland, Oregon area through its twenty-four full-service banking offices and its Online Banking Website www.HeritageBankWA.com.  Central Valley Bank serves Yakima and Kittitas Counties in central Washington through its six full-service banking offices and its Online Banking Website www.CVBankWA.com.  Additional information about Heritage Financial Corporation is available on its Internet Website www.HF-WA.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 average tangible common equity, tangible book value per share and tangible common equity to tangible assets.  Tangible common equity (tangible book value) excludes preferred stock, 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. Reconciliation of the GAAP and non-GAAP financial measures are presented below.

Forward-Looking Statements

"Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995: This release contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to: 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; 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; 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 (the "Federal Reserve Board") and of our bank subsidiaries by the Federal Deposit Insurance Corporation (the "FDIC"), the Washington State Department of Financial Institutions, Division of Banks (the "Washington DFI") or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve 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, including the interpretation of regulatory capital or other rules; our ability to control operating costs and expenses; the use of estimates in determining 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 balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; computer systems on which we depend could fail or experience a security breach; 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; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; 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; future legislative changes in the United States Department of Treasury Troubled Asset Relief Program Capital Purchase Program; and other risks detailed from time to time in our filings with the Securities and Exchange Commission.

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 2010 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

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