Heritage Financial Announces First Quarter Results And Declares Regular Cash Dividend

OLYMPIA, Wash., April 25, 2019 /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 $16.6 million for the quarter ended March 31, 2019 compared to $9.1 million for the quarter ended March 31, 2018 and $16.6 million for the linked-quarter ended December 31, 2018. Diluted earnings per common share for the quarter ended March 31, 2019 was $0.45 compared to $0.27 for the quarter ended March 31, 2018 and $0.45 for the linked-quarter ended December 31, 2018.

Brian L. Vance, Chief Executive Officer of Heritage, commented, "The past fifteen months have been very busy with the integration and conversion of two acquisitions, and a second team lift-out in Portland as well as selective additions to our overall production platform. In addition, we have begun to build-out our technology platform to create better efficiencies in the back office which will ultimately enhance our processes and contribute to our improving overhead ratio. We believe the combined organization is well-positioned to continue to gain market share in the communities we serve while at the same time improving the customer experience."

Jeffrey J. Deuel, President and Chief Executive Officer of Heritage Bank commented, "We are pleased with our overall financial performance. We saw middle single-digit annualized loan growth during the first quarter and our loan pipelines remain strong.  While we experienced a decline in overall deposits in the quarter, it is not unusual to see seasonal deposit run-off in the first quarter.  Our relatively low 84.1% loan to deposit ratio provides us with the flexibility necessary to successfully manage through the current competitive rate environment."

Balance Sheet
The Company's total assets increased $25.2 million, or 0.5%, to $5.34 billion at March 31, 2019 from $5.32 billion at December 31, 2018.

Investment securities available for sale increased $8.9 million, or 0.9%, to $985.0 million at March 31, 2019 from $976.1 million at December 31, 2018 primarily as a result of a decrease in net unrealized losses of $10.2 million due to a decrease in interest rates during the first quarter that positively impacted the fair value of our bond portfolio.

Total loans receivable, net increased $41.2 million, or 1.1%, to $3.66 billion at March 31, 2019 from $3.62 billion at December 31, 2018. Total loans receivable, net, continued to be impacted by slightly elevated prepayments during the first quarter 2019 in addition to the seasonably low loan originations experienced during the first quarter.

Prepaid expenses and other assets increased $24.5 million, or 24.9%, to $123.0 million at March 31, 2019 from $98.5 million at December 31, 2018 primarily due to the adoption of Accounting Standards Update 2016-02, Leases, and the recognition of an operating lease right of use asset. An offsetting operating lease right of use liability was recorded in accrued expenses and other liabilities. As of March 31, 2019, the right of use asset was $28.4 million and the related liability was $29.5 million.

Total deposits decreased $38.7 million, or 0.9%, to $4.39 billion at March 31, 2019 from $4.43 billion at December 31, 2018. The decrease was due primarily to non-maturity deposits declining $92.9 million, or 2.3%, offset partially by an increase in certificates of deposit of $54.2 million, or 11.6%. The increase in certificates of deposit was due primarily to an increase in brokered certificates of deposit of $50.1 million during the quarter ended March 31, 2019 in response to the decrease in non-maturity deposits. Non-maturity deposits as a percentage of total deposits decreased to 88.1% as of March 31, 2019 from 89.5% as of December 31, 2018.

Federal Home Loan Bank advances were $25.0 million as of March 31, 2019 as compared to none at December 31, 2018.

Total stockholders' equity increased $17.5 million, or 2.3%, to $778.2 million at March 31, 2019 from $760.7 million at December 31, 2018. Changes in stockholders' equity during the three months ended March 31, 2019 were as follows:

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 11.8%, 10.7%, 12.2% and 13.0%, respectively, at March 31, 2019, compared to 11.7%, 10.5%, 12.1% and 12.9%, respectively, at December 31, 2018.

Credit Quality
The allowance for loan losses increased $1.1 million, or 3.2%, to $36.2 million at March 31, 2019 from $35.0 million at December 31, 2018. The increase was due to provision for loan losses of $920,000 recorded during the quarter ended March 31, 2019 and net recoveries of $190,000 recognized during the same period.

Nonperforming loans to loans receivable, net, increased to 0.47% at March 31, 2019 from 0.37% at December 31, 2018 due primarily to an increase in nonaccrual loans of $3.8 million, or 27.4%, to $17.5 million at March 31, 2019 from $13.7 million at December 31, 2018. The increase was primarily related to the addition of two commercial lending relationships totaling $5.1 million which showed increased signs of cash flow deterioration.  Management has allocated a specific reserve totaling $781,000 for these two credit relationships.

Changes in nonaccrual loans during the periods indicated were as follows:

The allowance for loan losses to nonperforming loans was 207.04% at March 31, 2019 compared to 255.73% at the linked-quarter ended December 31, 2018. Nonperforming assets increased to 0.36% of total assets at March 31, 2019 compared to 0.30% of total assets at December 31, 2018. The change from prior periods in both ratios is due primarily to the increase in nonaccrual loans discussed above.

Potential problem loans decreased $7.2 million, or 7.1%, to $94.1 million at March 31, 2019 compared to $101.3 million at December 31, 2018. The activity for the quarter ended March 31, 2019 includes loans paid in full of $4.9 million, and the significant pay down of two commercial lines of credit totaling $3.2 million, offset partially by the addition of a non-owner occupied commercial loan of $3.0 million.

Changes in potential problem loans during the periods indicated were as follows:

The allowance for loan losses to loans receivable, net, increased to 0.98% at March 31, 2019 from 0.96% at December 31, 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 $11.2 million at March 31, 2019 compared to $11.8 million at December 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 March 31, 2019.

Net recoveries were $190,000 for the quarter ended March 31, 2019 compared to $23,000 for the same quarter in 2018 and net charge-offs of $595,000 for the linked-quarter ended December 31, 2018. The net recoveries recorded during the quarter ended March 31, 2019 was due primarily to a recovery related to a residential construction loan of $602,000 as a result of a bankruptcy resolution, offset partially by smaller charge-off balances on a large volume of consumer loans.

Operating Results
Net interest income increased $9.0 million, or 22.0%, to $49.8 million for the quarter ended March 31, 2019 compared to $40.8 million for the same period in 2018 primarily due to an increase in the yield and average balance of total loans receivable, net as a result of our mergers with Premier Commercial Bancorp and Puget Sound Bancorp, Inc. on July 2, 2018 and January 16, 2018, respectively ("Premier and Puget Mergers"). Net interest income decreased $1.5 million, or 2.8%, from $51.3 million for the linked-quarter ended December 31, 2018 due mostly to a slight decrease in loan yield, primarily as a result of lower incremental accretion on purchased loans, and an increase in the cost of interest bearing deposits.

Net interest margin increased 22 basis points to 4.34% for the quarter ended March 31, 2019 from 4.12% for the same period in 2018 and decreased three basis points from 4.37% for the linked-quarter ended December 31, 2018 due to the same reasons as described above for net interest income.

The loan yield, excluding incremental accretion on purchased loans, increased 38 basis points to 5.08% for the quarter ended March 31, 2019 compared to 4.70% for the quarter ended March 31, 2018 and increased two basis points from 5.06% for the linked-quarter ended December 31, 2018. The increases in loan yield, excluding incremental accretion of purchased loans, from all 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 Premier and Puget Mergers as compared to legacy Heritage loans during 2018. 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 yield, also impacting net interest margin were increases in the yields on investment securities due primarily to higher interest rates on new investment purchases compared to the interest rates of maturing investments. The yields on the aggregate investment portfolio increased 40 basis points to 2.83% for the quarter ended March 31, 2019 compared to 2.43% for the quarter ended March 31, 2018 and increased 13 basis points from 2.70% for the linked-quarter ended December 31, 2018.

The total cost of deposits increased 12 basis points to 0.33% during the quarter ended March 31, 2019 compared to 0.21% during the same quarter in 2018 and increased four basis points from 0.29% during the linked-quarter ended December 31, 2018.

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "Due to a decline in incremental accretion on purchase loans, net interest margin declined from the prior quarter. Our pre-accretion net interest margin was unchanged at 4.22% as a result of a four basis point increase in the total cost of deposits offsetting yield increases in both the loan and investment portfolios. The cost of deposits increased at a higher pace than recent quarters due to a decrease in noninterest bearing deposits and the issuance of certificates of deposits to offset the decline in balances of other deposit categories during the quarter. The current shape of the yield curve will impact our ability to continue to increase the pre-accretion net interest margin as has occurred over the past several quarters."

The provision for loan losses decreased $232,000, or 20.1%, to $920,000 for the quarter ended March 31, 2019 compared to $1.2 million for the quarter ended March 31, 2018 and decreased $242,000, or 20.8%, from the linked-quarter ended December 31, 2018. 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 March 31, 2019 based on the use of a consistent methodology. The decrease in the provision for loan losses was primarily as a result of net recoveries recognized during the quarter.

Noninterest income decreased $140,000, or 1.9%, to $7.4 million for the quarter ended March 31, 2019 compared to $7.5 million for the same period in 2018 primarily due to a decrease in gain on sale of loans due to lower mortgage origination volume and the Company's decision to continue to portfolio originated Small Business Administration ("SBA") loans amidst a lower gain environment. Noninterest income decreased $1.1 million, or 12.5% from  the linked-quarter ended December 31, 2018 primarily due to a gain on sale of building of $413,000 recognized during the fourth quarter of 2018 in addition to lower service charges recognized during the first quarter 2019 primarily related to seasonal decreases.

Noninterest expense decreased $222,000, or 0.6%, to $36.5 million for the quarters ended March 31, 2019 compared to $36.7 million for the same period in 2018. Acquisition-related expenses incurred as a result of the Premier and Puget Mergers were approximately $4.8 million during the quarter ended March 31, 2018, of which $2.8 million were due to compensation and employee benefits. Acquisition-related costs of $132,000 were incurred during the quarter ended March 31, 2019 primarily related to compensation and employee benefits. Without the effects of the acquisition-related expenses the Company incurred an increase in compensation and employee benefits due to additional employees, and an increase in occupancy and equipment expense primarily due to additional rent expense.

Noninterest expense decreased $749,000, or 2.0%, from $37.3 million for the linked-quarter ended December 31, 2018. Acquisition-related expenses incurred as a result of the Premier and Puget Mergers were approximately $1.3 million during the quarter ended December 31, 2018. The decrease in acquisition-related expenses was partially offset by higher marketing expense due to the timing of contributions to community sponsorships.

The ratio of noninterest expense to average total assets (annualized) decreased to 2.79% for the quarter ended March 31, 2019 compared to 3.27% for the same period in 2018 primarily due to acquisition-related expenses recognized in 2018. The ratio increased from 2.78% for linked-quarter ended December 31, 2018 primarily due to slightly lower average total assets.

Income tax expense was $3.2 million for the quarter ended March 31, 2019 compared to $1.4 million for the quarter ended March 31, 2018 and $4.7 million for the linked-quarter ended December 31, 2018. The effective tax rate increased to 16.3% for the quarter ended March 31, 2019 compared to 13.3% for the comparable quarter in 2018 primarily due to a decrease in tax exempt securities, impacts of stock-based compensation activity, and an increased Oregon presence. The effective tax rate decreased from 22.0% for the linked-quarter ended December 31, 2018 due to a change in the estimated current tax benefits from certain low income housing tax credit projects in the amount of $898,000 recorded during the quarter ended December 31, 2018. Although long-term tax benefits from the projects are still expected to occur, the timing of some of the benefits was extended to future periods.

Dividends
On April 24, 2019, the Company's Board of Directors declared a quarterly cash dividend of $0.18 per common share. The dividend is payable on May 22, 2019 to shareholders of record as of the close of business on May 8, 2019.

Earnings Conference Call
The Company will hold a telephone conference call to discuss this earnings release on April 25, 2019 at 11:00 a.m. Pacific time. To access the call, please dial (800) 288-8961 a few minutes prior to 11:00 a.m. Pacific time. The call will be available for replay through May 9, 2019, by dialing (800) 475-6701 -- access code 466040.

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 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. 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. These non-GAAP measures have inherent limitations, are not required to be uniformly applied and are not audited. They should not be considered in isolation or as a substitute for total stockholders' equity or operating results determined in accordance with GAAP. These non-GAAP measures may not be comparable to similarly titled measures reported by other companies. 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 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 2019 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.