Heritage Oaks Bancorp Announces Results for the Third Quarter 2012

• Third quarter net income was $6.4 million, $4.5 million more than the second quarter of 2012 and $4.3 million higher than the third quarter of 2011. Included in third quarter earnings is the reversal of the Company's remaining deferred tax asset valuation reserve of $4.1 million.
• Total deposits grew $21.1 million from the second quarter, of which $17.5 million was growth in non-interest bearing demand deposits. Total deposits grew $68.8 million or 11.6% from the fourth quarter of 2011.
• Gross loans increased $14.7 million from the second quarter, marking the second consecutive quarter of loan growth for the Company.
• Provision for loan losses was $1.3 million in the third quarter, down $1.8 million from the second quarter. The allowance for loan losses was 2.65% of total loans at September 30, 2012.
• On September 27, 2012, the Company announced it entered into a definitive agreement to acquire the Morro Bay branch of Coast National Bank and approximately $30 million of related branch deposits. This transaction is expected to close by year-end 2012, pending regulatory approval.
• In early October, a $5.0 million pay-off was received against a loan that was included in classified and non-accrual loans as of September 30, 2012. This transaction will be reflected as a $3.9 million reduction in classified and non-accrual loans and a $1.1 million recovery to the allowance for loan losses in the fourth quarter of 2012.

PASO ROBLES, Calif., Oct. 25, 2012 (GLOBE NEWSWIRE) -- Heritage Oaks Bancorp (the "Company") HEOP, the holding company of Heritage Oaks Bank (the "Bank"), today reported net income of $6.4 million for the third quarter 2012, $4.5 million higher than reported in the second quarter and $4.3 million higher than that reported in the third quarter 2011. The increase in net income from the prior quarter was primarily attributable to a $2.7 million increase in the tax benefit largely due to the reversal of the Company's remaining deferred tax asset (DTA) valuation allowance of $4.1 million as compared to a $0.7 million partial reversal in the second quarter, a $1.8 million reduction in the provision for loan losses, a $0.3 million reduction in non-interest expenses and a $0.2 million increase in net interest income. After incorporating accrued dividends and accretion on preferred stock of $0.4 million, net income available to common shareholders for the third quarter was $6.1 million. Net income per basic common share was $0.24 and net income per diluted common share was $0.23 in the third quarter, $0.18 and $0.17 higher than the basic and diluted income per share, respectively, reported in the second quarter of 2012.

Pre-income tax earnings for the third quarter were $3.5 million, $1.8 million higher than the prior quarter. The third quarter earnings before income taxes and the provision for loan loss expense were $4.8 million, substantially unchanged from the second quarter of 2012 and $0.4 million higher than the third quarter of 2011.

"I am delighted by the progress we are making in achieving the strategic goals we outlined at the start of this year, which included: continuing to improve credit quality; increasing efficiency; providing outstanding service and value to our customers; and growing our earning asset base, which is mitigating the impacts of rate compression and should ultimately lead to top line growth," said Simone Lagomarsino, CEO and President of Heritage Oaks Bancorp. "This is the second consecutive quarter of loan portfolio growth for the Company, the fourth consecutive quarter of core deposit growth and our classified assets to tier 1 capital plus allowance for loan loss ratio declined to 41.6%, marking the lowest level the Bank has achieved in the last two years. Further, our efficiency ratio improved to 65.5% as compared to 66.5% a year ago and efforts to improve upon this are continuing," said Ms. Lagomarsino.

"From a business growth perspective, last quarter we announced several front line sales and account relationship officer hires who are already making a difference and contributing to the growing commercial, agri-business and consumer mortgage loan pipelines. In the third quarter, we opened our Ventura County loan production office (LPO) and we expect to open our next loan production office in the city of Goleta in Santa Barbara County by year-end 2012. Both of these LPOs will provide additional fuel for growth and have the potential to be converted to full service branches in the future. Further, we recently announced that we have entered into a definitive agreement to acquire Coast National Bank's Morro Bay branch. The addition of the $30 million in deposits acquired in this transaction with our existing customer deposits in Morro Bay will place us in second position in terms of market share in Morro Bay and enable us to efficiently serve these customers. In addition, the branch location and amenities are far superior to our previous branch location, which will allow us to better serve our customers in Morro Bay," said Ms. Lagomarsino.

Third Quarter Operating Results

Net interest income was $10.6 million in the third quarter, $0.2 million higher than the prior quarter. The primary reason for the increase was a $17.0 million increase in average earning assets, primarily driven by loan portfolio growth and, to a lesser extent, an increase in the investment security portfolio. Partly offsetting the increase in the earning asset volume was a decrease of 5 basis points in net interest margin from 4.41% in second quarter to 4.36% in the third quarter. The net interest margin compression in the third quarter largely resulted from a decrease in the loan portfolio yield which dropped 15 basis points in the third quarter to 5.70% and led to a 9 basis point drop in the overall earning asset yield to 4.75%. The security portfolio yield was largely flat in third quarter, increasing 3 basis points to 2.66%. Partly offsetting the decline in the earning asset yield was a 4 basis point decrease in the overall cost of funds which declined to 0.42% in the third quarter largely due to growth in our non-interest bearing demand deposits and additional pricing actions to reduce the overall cost of interest bearing deposit products in line with current market conditions.

We continue to anticipate net interest margin pressure due to the very low interest rate environment, a competitive environment for quality loan relationships, some refinancing activity of existing loans at lower rates, and a change in the mix of our loan portfolio. We expect to minimize the impact of the pressure on our net interest margin over the short term by growing the loan portfolio in place of lower yielding security portfolio investments, through reductions in non-accrual loan balances and through modest reductions in the cost of deposits and borrowings.

Non-interest income was $3.0 million in the third quarter, $0.5 million less than in the second quarter. The decrease in non-interest income was primarily due to a $0.7 million decrease in gain on sale of investment securities, partly offset by a $0.2 million increase in mortgage revenues driven by higher mortgage origination volumes which are sold to investors. Mortgage origination volume in the third quarter was $56.9 million as compared to $53.9 million in the second quarter of 2012. On a year-to-date basis, mortgage revenues were $3.1 million, up 75% from a year ago, reflecting increased focus on originations, investments made in staffing and infrastructure and more favorable market conditions.

In the third quarter 2012, non-interest expense decreased $0.3 million from the prior quarter. Contributing to lower non-interest expense quarter over quarter was a $0.6 million reduction in the provision for mortgage repurchases, which was partially offset by $0.2 million higher outside service costs, mainly consisting of consulting expenses and a $0.2 million increase in other general operating expenses.

The Company recorded a $1.2 million provision for income taxes in the third quarter of 2012 and an adjustment of the remaining $4.1 million of DTA valuation allowance as a credit to income tax expense, resulting in a net income tax benefit of $2.9 million in the third quarter of 2012. The effective tax rate of the underlying $1.2 million in income tax provision was approximately 33.3%, which should be representative of the effective rate for the remainder of 2012.

Asset Quality: In the third quarter of 2012, non-accrual loans decreased $0.4 million to $20.5 million of which $15.8 million were still paying as agreed at the end of the quarter. In early October, we received a $5.0 million pay-off on a loan that was reported as classified and was included in the portion of non-accrual loans that were paying as agreed at September 30, 2012. This payment will be reflected as a $3.9 million reduction in both classified and non-accrual loans and a $1.1 million recovery to the allowance for loan losses in the fourth quarter of 2012. Total non-performing assets, inclusive of non-accrual loans, decreased $0.9 million to $21.1 million in the third quarter. Non-performing loans to gross loans decreased to 3.02% as of the end of the third quarter. The percentage of non-performing assets to total assets was 1.99% at the end of the third quarter.

Classified loans totaled $57.6 million at the end of the third quarter 2012, down $3.4 million from the prior quarter. Classified assets, inclusive of classified loans, were $58.5 million at the end of the third quarter, down $3.8 million from $62.3 million at the end of the second quarter. Other real estate owned (OREO) at September 30, 2012 was $0.6 million, $0.5 million less than at the end of the second quarter due to property sales during the third quarter, which resulted in a gain on sale of $0.1 million. The overall classified assets to tier 1 capital plus allowance for loan loss ratio was 41.6% at the end of the third quarter, improved from the 45.9% at the end of the prior quarter. On a pro-forma basis, adjusting for the non-accrual loan that paid off subsequent to quarter-end, this ratio would have been 38.8%. During the third quarter 2012, loans delinquent 30-89 days were $1.3 million or 0.19% of total loans, which is consistent with the levels experienced over the last year. Troubled debt restructurings ("TDRs") were $11.5 million at the end of third quarter, up from $10.8 million at the end of the second quarter mainly due to the extension of terms on problem loans during the third quarter.

At September 30, 2012, the allowance for loan and lease losses (ALLL) was $18.0 million, or 2.65% of total loans, compared to $18.1 million, or 2.73% of total loans at the end of the prior quarter. The decrease in the ALLL to total loans ratio is due to continued decreases in the historical loss experience of the loan portfolio and from decreases in loans risk-graded substandard which declined $3.4 million in the third quarter. Special mention loans at the end of the third quarter were substantially unchanged from the prior quarter. Net loan charge-offs were $1.4 million in the third quarter, as compared to $4.7 million in the second quarter and $2.4 million in the third quarter of 2011. Of the $1.4 million of net charge-offs in the quarter, 86% relates to a single credit relationship, for which the borrower is under investigation for fraud.

A summary of key metrics related to asset quality follows (dollars in millions):

Balance Sheet: Total assets as of September 30, 2012 were $1,058.7 million, $34.9 million higher than reported in the prior quarter. The primary reason for the increase in total assets was the investment of funds received as a result of improving deposit levels. The primary areas of asset growth were the $14.7 million growth in the gross loan portfolio, the $3.3 million increase in mortgage loans held for sale and the $11.6 million increase in cash and cash equivalents as several large deposits arrived at quarter-end. Also contributing to asset growth was the reversal of the remaining DTA valuation allowance of $4.1 million, which is the primary cause for the increase in the DTA. The growth in the loan portfolio was primarily due to a $25.9 million increase in real estate secured loans, mainly farmland and commercial real estate loans due in large part to production from the new lending team hires completed in the first part of the year. The increase in real estate secured loans was partially offset by a $12.5 million reduction in commercial loans, largely commercial and industrial (C & I) loans. In the third quarter of 2012, $36.5 million of loans paid-off as a combination of loan pay-downs, normal amortization and charge-offs. This decrease was more than offset by advances against new loan portfolio production of $53.9 million. At September 30, 2012, the loan pipeline remains robust with opportunities for continued loan growth, as investments in lending staff and customer relationship managers in the first half of 2012 continue to yield new lending opportunities across all loan portfolio segments but most notably commercial real estate and agriculture.     

At September 30, 2012, the investment security portfolio totaled $261.5 million, up $0.7 million from the prior quarter-end. Actions continued during the third quarter to sell faster paying, lower yielding collateralized mortgage obligation securities (CMOs) and mortgage backed securities (MBSs), which were exposed to prepayment and reinvestment risk. The sustained low interest rate environment, government asset purchases and strong investor demand for liquid investments has kept mortgage rates near all-time lows and is driving fast prepayment speeds resulting in faster amortization of premium expense and reinvestment risk for fixed income investors. In the third quarter, $0.3 million in securities gains were recognized through the sale of $41.9 million of securities. This gain was $0.7 million less than the gain recognized in the second quarter due to the type and volume of securities sold. During the second quarter of 2012, longer maturity taxable municipals were sold with much larger embedded gains as compared to the MBS and CMOs that were sold during the third quarter. The net unrealized gain/(loss) in the investment security portfolio at September 30, 2012 was $6.3 million. Year to date, the Company has recognized $1.7 million in investment securities gains, $0.5 million more than the same period last year.

The following are the major components of the investment portfolio: 

MBS comprise 59% of the investment securities portfolio (including 42% agency issued), while state and municipal bonds comprise 24%, corporate bonds comprise 12% and other securities comprise the remaining 5%. At September 30, 2012, the investment securities portfolio had a weighted average effective duration of 3.06 years and a weighted average credit rating of AA.

Mortgage originations were $56.9 million in the third quarter, $3.0 million more than second quarter originations of $53.9 million. The Bank primarily originates conforming residential mortgage loans, which are almost all sold to investors shortly following origination. However, in the third quarter of 2012, the Company originated and placed $4.6 million of non-conforming, adjustable rate mortgages into its portfolio. Low interest rates, an increased sales force, expansion into Ventura County and greater marketing efforts have all contributed to mortgage growth this year. Gain on sale of consumer mortgages and related fees contributed $1.2 million to non-interest income in the third quarter, $0.1 million higher than the prior quarter.

Total liabilities grew $27.3 million during the third quarter to $916.4 million as compared to $889.1 million at the end of the second quarter of 2012. The growth in total liabilities was primarily due to growth in total deposits which increased $21.1 million in third quarter to $855.0 million, due to a combination of enhanced deposit gathering efforts across all branches and new customer relationships brought to the Bank as a result of the new lending and customer relationship manager hires completed in the first part of the year. Non-interest bearing demand deposits grew $17.5 million and savings, NOW and money market account balances grew $11.2 million during the third quarter of 2012. These increases in deposit balances were partially offset by a $7.5 million decline in time deposits as depositors appear to prefer liquidity over the relatively small additional interest that can be earned in time deposits. Non-interest bearing DDA deposits comprised 31% of total deposits, while core deposits (defined as deposits exclusive of certificates of deposit greater than $100 thousand and any brokered deposits) were 90% of total deposits, each as of September 30, 2012.

Federal Home Loan Bank (FHLB) borrowings increased $6.0 million to $46.0 million at the end of the third quarter, of which $9.5 million were in over-night borrowings and were subsequently paid off at the beginning of October. 

Deferred Tax Assets: The Company's deferred tax asset at September 30, 2012 was $22.9 million, up $3.5 million from the prior quarter due primarily to the reversal of the remaining $4.1 million of the DTA valuation allowance in the third quarter. In 2010, the Company established a partial DTA valuation allowance of $7.1 million against a gross deferred tax asset of $28.2 million due to uncertainty as to whether the Company would have sufficient future profitability to utilize all of its deferred tax assets. This partial valuation allowance was determined based on the results of the Company's ongoing assessment of the expected realization of DTA utilization over a forecast period. In 2011, the Company's pre-tax earnings increased by $28.9 million over 2010 pre-tax losses and as part of management's quarterly analysis of the DTA valuation allowance, it reduced the valuation allowance $1.5 million in the fourth quarter of 2011. Since that time, management has continued to model its DTA valuation allowance quarterly and further released portions of the valuation allowance by $0.8 million in the first quarter and $0.7 million in the second quarter of 2012 as the Company demonstrated continued profitability and overall credit quality indicators in the loan portfolio improved.

Management reassesses the need for the valuation allowance quarterly by updating earnings forecasts and assessing both positive and negative evidence related to the realizability of the Company's DTA. Based on its assessment as of September 30, 2012, management concluded that it was now more likely than not that such DTA will be fully realized. Management's assessment was influenced by the quality and amount of earnings in 2012, coupled with those of 2011 and near-term projections for the fourth quarter of 2012 and the full year 2013. Management further considered improving asset quality metrics and capital levels.

Capital Position:  As of September 30, 2012, the Company and the Bank continued to maintain their strong capital positions and both entities remain above the minimums generally required to be considered a "well-capitalized" institution for regulatory purposes. Both the Company and the Bank are committed to maintaining strong capital levels and deploy active capital management to hedge against risk, support balance sheet growth and to provide an adequate return to our shareholders. The Company remains current with regard to the interest it pays on its junior subordinated debentures and is current with regard to the dividends it pays on its TARP preferred stock.

Liquidity:  Our liquidity ratio (total cash and cash equivalents plus unpledged marketable securities divided by the sum of total deposits and short-term liabilities less pledged securities) remained at 35.1% at the end of the third quarter. At quarter-end, the Bank had remaining borrowing capacity with the FHLB of approximately $173.6 million. The Bank also has a collateralized borrowing facility with the Federal Reserve Bank of $7.4 million and has the ability to purchase federal funds under correspondent bank lines of credit in the aggregate amount of $37.0 million as of September 30, 2012. Additionally, $254.2 million of the Company's $261.5 million investment securities portfolio was unpledged and available as on-balance sheet liquidity as of third quarter-end.

Conference Call

The Company will host a conference call to discuss these third quarter results at 8:00 a.m. PDT on October 26, 2012. Media representatives, analysts and the public are invited to listen to this discussion by calling (877) 363-5052 and entering the conference ID 42223936, or via on-demand webcast. A link to the webcast will be available on Heritage Oaks Bancorp's website at www.heritageoaksbancorp.com. A replay of the call will be available on Heritage Oaks Bancorp's website later that day and will remain on its site for up to 14 calendar days. By including the foregoing website address, Heritage Oaks Bancorp does not intend to and shall not be deemed to incorporate by reference any material contained therein.

About the Company

Heritage Oaks Bancorp is the holding company for Heritage Oaks Bank which operates as Heritage Oaks Bank and Business First, a division of Heritage Oaks Bank. Heritage Oaks Bank has its headquarters and two branch offices in Paso Robles, two branch offices in San Luis Obispo, single branch offices in Cambria, Arroyo Grande, Atascadero, Templeton, and two branch offices in Santa Maria, as well as a loan production office in Oxnard. Heritage Oaks Bank conducts commercial banking business in the counties of San Luis Obispo, Santa Barbara, and Ventura. The Business First division has one branch office in Santa Barbara. Visit Heritage Oaks Bancorp on the Web at www.heritageoaksbancorp.com. By including the foregoing website address, Heritage Oaks Bancorp does not intend to and shall not be deemed to incorporate by reference any material contained therein.

The Heritage Oaks Bancorp logo is available at http://www.globenewswire.com/newsroom/prs/?pkgid=7045

Forward Looking Statements

Certain matters discussed in this earnings release may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements concerning future performance, developments or events, including expectations for growth, income forecasts, sales activity for collateral, credit quality and any other guidance on future periods may constitute forward-looking statements. These statements are based upon our management's current expectations and speak only as of the date hereof. Forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially and adversely from stated expectations. Specific factors include, but are not limited to the continued weak economic recovery in the United States and the markets in which the Company operates, and the response of the federal and state government and our regulators thereto, the effects on our operations of the memoranda of understanding we are subject to, continued growth, the Bank's beliefs as to the adequacy of its existing and anticipated allowances for loan losses, beliefs and expectations regarding actions that may be taken by regulatory authorities having oversight of the Bank's operations, interest rates and financial policies of the United States government, continued weakness in the real estate markets within which we operate and general economic conditions in both the United States and abroad. Additional information on these and other factors that could affect financial results are included in Heritage Oaks Bancorp's Securities and Exchange Commission filings. If any of these risks or uncertainties materialize or if any of the assumptions underlying such forward-looking statements proves to be incorrect, Heritage Oaks Bancorp's results could differ materially from those expressed in, implied or projected by such forward-looking statements. Accordingly, investors should use caution in relying on forward-looking statements to anticipate future results or trends. Heritage Oaks Bancorp assumes no obligation, and specifically disclaims any obligation to revise or update such forward-looking statements for any reason.

Use of Non-GAAP Financial Information

Heritage Oaks Bancorp provides all information required in accordance with generally accepted accounting principles (GAAP), but it believes that evaluating its ongoing operating results and in particular, making comparisons to similar companies, may be enhanced by providing additional measures used by management to assess operating results. Earnings before income taxes and provision for loan losses, a non-GAAP financial measure, is presented because the Company believes adjusting its results to exclude tax and loan loss provisions provides stockholders with a useful metric for evaluating the core profitability of the Company. A schedule reconciling our GAAP net income to earnings before income taxes and provision for loan losses is provided at the end of the tables below.