Heritage Financial Announces Third Quarter 2016 Results And Declares Regular And Special Cash Dividends

OLYMPIA, Wash., Oct. 27, 2016 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) (the "Company" or "Heritage") today reported that the Company had net income of $11.0 million for the quarter ended September 30, 2016 compared to net income of $9.5 million for the quarter ended September 30, 2015 and $8.9 million for the linked-quarter ended June 30, 2016.  Diluted earnings per common share for the quarter ended September 30, 2016 was $0.37 compared to $0.32 for the quarter ended September 30, 2015 and $0.30 for the linked-quarter ended June 30, 2016.

The Company had net income of $29.0 million for the nine months ended September 30, 2016, or $0.97 per diluted common share, compared to net income of $28.0 million, or $0.93 per diluted common share, for the nine months ended September 30, 2015. 

Brian L. Vance, President and CEO, commented, "Our loan growth remains a positive for the Company.  Third quarter growth was 2.1% and year-to-date growth for the first nine months of 2016 was 9.9% on an annualized basis.  In addition, this quarter we maintained our net interest margin, excluding incremental accretion on purchased loans, constant at 3.76% versus the same quarter in 2015 and up five basis points from 3.71% during the second quarter of 2016. Overall loan growth continues to be driven by a strong Pacific Northwest economy."

Mr. Vance added, "As I have commented in the past, we are focused on managing our noninterest expense.  Our overhead expense ratio, as measured by our total noninterest expense as a percentage of average assets, continues to improve.  Our overhead expense ratio was 2.81% for the quarter ended September 30, 2016 compared to 2.87% for the linked quarter ended June 30, 2016 and 3.05% for the quarter ended September 30, 2015.  Expense control will remain a focus of ours going forward."

"And finally, I am pleased to announce that in addition to our regular quarterly cash dividend, the board has declared a special cash dividend of $0.25 payable to our shareholders in November."

Balance Sheet
The Company's total assets increased $89.5 million, or 2.4%, to $3.85 billion at September 30, 2016 from $3.76 billion at June 30, 2016. 

Loans receivable, net of allowance for loan losses, increased $52.6 million, or 2.1%, to $2.55 billion at September 30, 2016 from $2.50 billion at June 30, 2016.  The growth in loans receivable was due primarily to increases of $26.9 million in non-owner occupied commercial real estate loans, $13.9 million in commercial and industrial loans and $9.4 million in consumer loans.

Investment securities available for sale increased $3.2 million, or 0.4%, to $819.2 million at September 30, 2016 from $815.9 million at June 30, 2016.  The increase was due primarily to purchases of investment securities of $59.0 million, offset partially by maturities, calls and payments of investment securities of $33.5 million, sales of investment securities of $18.5 million and a decrease of $2.0 million in the net unrealized gains on investment securities during the quarter ended September 30, 2016.  The sales of investment securities resulted in recognized gains of $345,000 during the quarter ended September 30, 2016.

Bank owned life insurance increased $8.4 million, or 13.6%, to $70.0 million at September 30, 2016 from $61.6 million at June 30, 2016.  The increase was primarily due to purchases of additional insurance policies totaling $8.0 million during the quarter ended September 30, 2016.

Prepaid expenses and other assets increased $8.8 million, or 13.4%, to $74.8 million at September 30, 2016 from $66.0 million at June 30, 2016 primarily as a result of the Company's $9.4 million investment in a low income housing tax credit partnership during the quarter ended September 30, 2016.  This investment had a corresponding $9.4 million obligation recorded in accrued expenses and other liabilities at September 30, 2016.  This obligation will decrease as projects in the partnership are funded.

Total deposits increased $83.5 million, or 2.6%, to $3.24 billion at September 30, 2016 from $3.16 billion at June 30, 2016.  Non-maturity deposits as a percentage of total deposits increased to 88.6% at September 30, 2016 from 87.7% at June 30, 2016.  The increase in this ratio was due to both a combination of an increase of $104.1 million in non-maturity deposits and a decrease of $20.5 million in certificates of deposit.  The increase in non-maturity deposits was primarily due to a $45.6 million, or 5.6%, increase in noninterest bearing demand deposits to $865.9 million at September 30, 2016 from $820.4 million at June 30, 2016, a $35.0 million, or 3.8%, increase in NOW accounts to $963.8 million at September 30, 2016 from $928.8 million at June 30, 2016 and a $13.2 million, or 2.7%, increase in savings deposits to $508.6 million at September 30, 2016 from $495.4 million at June 30, 2016 .  Certificates of deposit decreased $20.5 million, or 5.3%, to $368.6 million at September 30, 2016 from $389.2 million at June 30, 2016.  Deposits per branch increased $1.3 million, or 2.6%, to $51.5 million at September 30, 2016 from $50.1 million at June 30, 2016.

Federal Home Loan Bank Advances decreased $15.3 million, or 46.4%, to $17.7 million at September 30, 2016 compared to $33.0 million at June 30, 2016.  There were no borrowings outstanding at December 31, 2015.

Total stockholders' equity increased $6.0 million, or 1.2%, to $496.0 million at September 30, 2016 from $490.1 million at June 30, 2016.  The increase was primarily due to net income of $11.0 million recognized during the quarter ended September 30, 2016, partially offset by $3.6 million in cash dividends, a decrease of $1.3 million in accumulated other comprehensive income and $762,000 in stock repurchases.  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 September 30, 2016 of 11.4%, 10.5%, 12.0% and 13.0%, respectively, compared to 11.5%, 10.5%, 12.1% and 13.0%, respectively, at June 30, 2016.

Credit Quality
The allowance for loan losses increased $1.8 million, or 6.3%, to $30.2 million for the quarter ended September 30, 2016 from $28.4 million for the linked-quarter ended June 30, 2016.  The increase was due to a provision for loan losses of $1.5 million during the quarter ended September 30, 2016 and $290,000 in net recoveries recorded during the same period.

Nonperforming loans to loans receivable, net, decreased to 0.45% at September 30, 2016 from 0.55% at June 30, 2016.  Nonaccrual loans decreased $2.3 million, or 16.8%, to $11.5 million ($3.0 million guaranteed by government agencies) at September 30, 2016 from $13.9 million ($2.2 million guaranteed by government agencies) at June 30, 2016.  The decrease was due primarily to $2.8 million of net principal reductions and $320,000 of charge-offs, offset partially by $625,000 of new additions to nonaccrual loans and $219,000 of additions resulting from troubled debt restructured loans being transferred to nonaccrual status.

The allowance for loan losses to nonperforming loans was 261.79% at September 30, 2016 compared to 205.05% at June 30, 2016.  Potential problem loans were $101.0 million at September 30, 2016 compared to $101.2 million at June 30, 2016. The $199,000, or 0.2%, decrease was primarily due to net loan payments of $8.0 million, loans transferred to impaired status of $1.3 million, loan grade improvements of $791,000 and loan charge-offs of $85,000, offset partially by the addition during the period of $10.0 million of loans graded as potential problem loans.

The allowance for loan losses to loans receivable, net was 1.17% at September 30, 2016 compared to 1.13% at June 30, 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 September 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 $14.7 million at September 30, 2016 compared to $17.5 million at June 30, 2016.

Net recoveries were $290,000 for the quarter ended September 30, 2016 compared to net charge-offs of $125,000 for the same quarter in 2015 and net charge-offs of $2.4 million for the linked-quarter ended June 30, 2016.  The increase in net recoveries in the quarter ended September 30, 2016 was due primarily to a recovery of $698,000 on a commercial and industrial loan that was charged-off in the amount of $925,000 during the first quarter of 2016.

Nonperforming assets decreased $3.9 million, or 25.2%, to $11.5 million ($3.0 million guaranteed by government agencies), or 0.30% of total assets, at September 30, 2016, compared to $15.4 million ($2.2 million guaranteed by government agencies), or 0.41% of total assets, at June 30, 2016 due to the decrease in nonperforming loans discussed above as well as a decrease in other real estate owned.  The Bank had no other real estate owned at September 30, 2016, a decrease from $1.6 million at June 30, 2016. The decrease in other real estate owned was due to the disposition of all remaining properties, resulting in gains on sale of other real estate owned of $131,000 during the quarter ended September 30, 2016.

Operating Results
Net interest income increased $1.7 million, or 5.2%, to $33.6 million for the quarter ended September 30, 2016 compared to $31.9 million for the same period in 2015 and increased $521,000, or 1.6%, from $33.1 million for the linked-quarter ended June 30, 2016.  Net interest income increased $2.4 million, or 2.4%, to $99.5 million for the nine months ended September 30, 2016 compared to $97.1 million for the same period in 2015.  The increase in net interest income from the prior periods was primarily due to an increase in average interest earning assets, partially offset by a decrease in the yield on average interest earning assets during the respective periods.

Heritage's net interest margin for the quarter ended September 30, 2016 decreased five basis points to 3.95% from 4.00% for both the same period in 2015 and the linked-quarter ended June 30, 2016.  The decrease in net interest margin from the prior periods was due substantially to a decrease of $339,000, or 17.5%, in incremental accretion on purchased loans to $1.6 million from the quarter ended September 30, 2016 compared to $1.9 million for the same period in 2015 and a decrease of $762,000, or 32.3%, from $2.4 million for the quarter ended June 30, 2016.  The impact on net interest margin from incremental accretion on purchased loans decreased to 0.19% for the quarter ended September 30, 2016 from 0.24% for the same period in 2015 and from 0.29% in the linked-quarter ended June 30, 2016.  The incremental accretion is highly dependent on purchased loan prepayments during the period.

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:

The net interest margin, excluding incremental accretion on purchased loans, remained constant at 3.76% for the quarter ended September 30, 2016 and for the same period in 2015 and increased five basis points from 3.71% for the linked-quarter ended June 30, 2016.  The net interest margin, excluding incremental accretion on purchased loans, has been impacted by a declining trend in contractual loan note rates.  Offsetting the decrease in contractual loan note rates are increases in the yields on investment securities during the periods as well as increases in the percentage of average loans receivable to total average earning assets.

Yields on loans, excluding incremental accretion on purchased loans, were 4.62% for the quarter ended September 30, 2016 compared to 4.75% for the same period in 2015 and 4.59% for the linked-quarter ended June 30, 2016.  Average contractual loan note rates in the loan portfolio continue to decline; however, yields on loans, excluding incremental accretion on purchase loans, increased from the linked-quarter due primarily to a $249,000 prepayment penalty recognized during the quarter ended September 30, 2016.  This prepayment penalty increased the yield on the loan portfolio by four basis points during the quarter ended September 30, 2016.

The net interest margin for the nine months ended September 30, 2016 decreased 17 basis points to 4.00% from 4.17% for the same period in 2015.  The net interest margin, excluding incremental accretion on purchased loans, decreased seven basis points to 3.76% for the nine months ended September 30, 2016 from 3.83% 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 as the purchased loan balances continued to decrease, offset partially by the increases in the average loan receivable balances during the related periods. 

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "Our pre-incremental accretion net interest margin showed an increase from the linked-quarter as a result of increases in the yield in the investment portfolio and the pre-incremental accretion yield on the loan portfolio.  Further aiding the pre-incremental accretion net interest margin is an increase in the percentage of interest earning assets which are held in the loan portfolio.  For the quarter ended September 30, 2016, average loans receivable increased to 74.7% of average interest earning assets from 74.2% for the linked-quarter ending June 30, 2016.  Although we experienced an increase in the pre-incremental accretion net interest margin during the most recent quarter, we expect the net interest margin to experience downward pressure due to the impact on the loan yields from the continued low rate environment as well as the declining impact of incremental accretion on the net interest margin."

The provision for loan losses was $1.5 million for the quarter ended September 30, 2016 compared to $851,000 for the quarter ended September 30, 2015 and $1.1 million for the linked-quarter ended June 30, 2016.  The provision for loan losses was $3.8 million for the nine months ended September 30, 2016 compared to $3.2 million for the nine months ended September 30, 2015.  The increase in the provision for loan losses was necessary to increase the allowance for loan losses to an amount that management determined to be appropriate based on the use of a consistent methodology.

Noninterest income increased $323,000, or 3.4%, to $9.9 million for the quarter ended September 30, 2016 compared to $9.5 million for the same period in 2015 and increased $3.3 million, or 50.0%, from $6.6 million for the linked-quarter ended June 30, 2016. The increase from the same quarter in 2015 and the linked-quarter was due primarily to a $2.1 million gain on sale of loans as a result of the sale of a previously classified purchased loan.  The increase in noninterest income for the quarter ended September 30, 2016 compared to the same period in 2015 was offset partially by the gain on termination of the FDIC shared-loss agreements of $1.7 million recorded during the quarter ended September 30, 2015.  Noninterest income also increased for the quarter ended September 30, 2016 from the linked-quarter ended June 30, 2016 due to an increase of $514,000 in interest rate swap contract fee income.  Noninterest income was $23.4 million for the nine months ended September 30, 2016, a decrease of $1.3 million, or 5.4%, from $24.8 million for the nine months ended September 30, 2015.  The decrease was primarily due to the above mentioned $1.7 million gain on termination of FDIC shared-loss agreements and a $1.7 million gain on sale of Merchant Visa portfolio recognized during 2015, offset partially by the above mentioned $2.1 million gain on sale of loans and an increase of $1.1 million in interest rate swap contract fee income.

Noninterest expense was $26.8 million for the quarter ended September 30, 2016 compared to $27.3 million for the quarter ended September 30, 2015 and $26.5 million for the linked-quarter ended June 30, 2016. The $504,000, or 1.8%, decrease from the same period in 2015 was primarily due to a decrease in data processing expense and federal deposit insurance expense, offset partially by an increase in compensation and employee benefits expense.  The $341,000, or 1.3%, increase in noninterest expense compared to the linked-quarter was primarily due to an increase in compensation and employee benefits expense, partially offset by the decrease in federal deposit insurance expense.  Noninterest expense increased $225,000, or 0.3%, to $79.7 million for the nine months ended September 30, 2016 compared to $79.4 million for the same period in 2015 primarily due to an increase in compensation and employee benefits expense.

Income tax expense was $4.1 million for the quarter ended September 30, 2016 compared to $3.8 million for the comparable quarter in 2015 and $3.2 million for the linked-quarter ended June 30, 2016.  Income tax expense was $10.4 million for the nine months ended September 30, 2016 compared to $11.2 million for the same period in 2015.  The increases in income tax expense from the same quarter in 2015 and the linked-quarter ended June 30, 2015 was primarily due to increases in net income.  The $730,000, or 6.5%, decrease in income tax expense for the nine months ended September 30, 2016 compared to the same period in 2015 was due primarily to a decrease in the effective tax rate.  The effective tax rate was 27.2% for the quarter ended September 30, 2016 compared to 28.7% for the comparable quarter in 2015 and 26.3% for the linked-quarter ended June 30, 2016.  The effective tax rate for the nine months ended September 30, 2016 was 26.5% compared to 28.5% for the same period in 2015.  The decreases in the effective tax rate from the same periods in 2015 were due to increases in both tax exempt loans and investment securities and increases in low income housing tax credits.

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented, "It is good to see the positive results from our collective efforts over the past two years to integrate and rationalize the larger organization. While there are still opportunities left for us to improve the operations of the bank, we are making good progress towards our goals."

Dividends
On October 26, 2016, the Company's Board of Directors declared a quarterly cash dividend of $0.12 per common share and a special cash dividend in the amount of $0.25 per common share.  The dividends are payable on November 22, 2016 to shareholders of record as of the close of business on November 8, 2016. 

Earnings Conference Call
The Company will hold a telephone conference call to discuss this earnings release on October 27, 2016 at 11:00 a.m. Pacific time.  To access the call, please dial (800) 230-1093 a few minutes prior to 11:00 a.m. Pacific time.  The call will be available for replay through November 10, 2016, by dialing (800) 475-6701 -- access code 403763.

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 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.