Heritage Financial Announces Second Quarter 2017 Results And Declares Regular Cash Dividend

OLYMPIA, Wash., July 26, 2017 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) (the "Company" or "Heritage") today reported that the Company had net income of $11.8 million for the quarter ended June 30, 2017 compared to $8.9 million for the quarter ended June 30, 2016 and $9.3 million for the linked-quarter ended March 31, 2017. Diluted earnings per common share for the quarter ended June 30, 2017 was $0.39 compared to $0.30 for the quarter ended June 30, 2016 and $0.31 for the linked-quarter ended March 31, 2017.

The Company had net income of $21.1 million for the six months ended June 30, 2017, or $0.70 per diluted common share, compared to $18.0 million, or $0.60 per diluted common share, for the six months ended June 30, 2016.

Brian L. Vance, President and CEO, commented, "We are pleased with our overall financial performance for the second quarter of 2017.  Our loan growth rebounded from a traditionally cyclical slow first quarter by posting an annualized net loan growth of 8.3% for the first six months of this year and a year-over-year net loan growth of 8.8%."

"In addition, this quarter we maintained our net interest margin, excluding incremental accretion on purchased loans, constant at 3.75% versus the linked quarter March 31, 2017 at 3.75% and up four basis points from 3.71% during the second quarter of 2016."

Balance Sheet

The Company's total assets increased $105.3 million, or 2.7%, to $3.99 billion at June 30, 2017 from $3.89 billion at March 31, 2017.

Total loans receivable, net of allowance for loan losses, increased $84.6 million, or 3.2%, to $2.72 billion at June 30, 2017 from $2.63 billion at March 31, 2017. The growth in loans receivable was due primarily to increases in commercial business loans of $70.2 million, real estate construction and land development loans of $7.5 million and consumer loans of $5.4 million.

Total deposits increased $47.8 million, or 1.5%, to $3.29 billion at June 30, 2017 from $3.24 billion at March 31, 2017. Non-maturity deposits as a percentage of total deposits decreased to 88.1% at June 30, 2017 from 89.4% at March 31, 2017. The decrease in this ratio was due primarily to an increase in certificates of deposit of $46.1 million, or 13.4%, to $390.3 million at June 30, 2017 from $344.1 million at March 31, 2017. Noninterest bearing demand deposits increased $38.6 million, or 4.4%, to $919.6 million at June 30, 2017 from $881.0 million at March 31, 2017. The $41.3 million increase in NOW accounts during the quarter ended June 30, 2017 was due primarily to a transfer of money market sweep account balances into NOW sweep accounts, which was also the primary reason for the decrease in money market accounts during the quarter.

Federal Home Loan Bank advances increased $44.2 million, or 66.1%, to $110.9 million at June 30, 2017 compared to $66.8 million at March 31, 2017, to partially fund loan growth.

Total stockholders' equity increased $10.9 million, or 2.2%, to $500.0 million at June 30, 2017 from $489.2 million at March 31, 2017. The increase was primarily due to net income of $11.8 million and a $2.7 million increase in accumulated other comprehensive income, offset partially by cash dividends declared and paid of $3.9 million. 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 11.5%, 10.5%, 12.1%, and 13.1%, respectively at June 30, 2017, compared to 11.6%, 10.3%, 12.2%, and 13.2%, respectively, at March 31, 2017, and 11.5%, 10.5%, 12.1% and 13.0%, respectively, at June 30, 2016.

Credit Quality

The allowance for loan losses increased $1.2 million, or 3.7%, to $32.8 million for the quarter ended June 30, 2017 from $31.6 million for the linked-quarter ended March 31, 2017. The increase was due primarily to a provision for loan losses of $1.1 million during the quarter ended June 30, 2017 driven primarily by loan growth.

Nonperforming loans to loans receivable, net, decreased slightly to 0.40% at June 30, 2017 from 0.41% at March 31, 2017. Nonaccrual loans increased $96,000, or 0.9%, to $11.0 million ($1.6 million guaranteed by government agencies) at June 30, 2017 from $10.9 million ($1.7 million guaranteed by government agencies) at March 31, 2017. The increase from the linked-quarter was due primarily to new additions to nonaccrual loans of $614,000 of which $427,000 reflects loans previously graded as potentially problem loans, offset partially by net principal reductions of $486,000 and charge-offs of $32,000.

The allowance for loan losses to nonperforming loans was 298.47% at June 30, 2017 compared to 290.47% at the linked-quarter ended March 31, 2017.

Potential problem loans were $84.1 million at June 30, 2017 compared to $82.8 million at March 31, 2017. The $1.3 million, or 1.5%, increase from the linked-quarter was primarily due to additions of loans graded as potential problem loans of $10.8 million, offset partially by net loan payments of $7.6 million, loan grade improvements of $1.4 million, loans transferred to impaired status of $427,000 and charge-offs of $97,000 during the quarter ended June 30, 2017.

The allowance for loan losses to loans receivable, net was 1.19% at both June 30, 2017 and March 31, 2017. The Company believes that its allowance for loan losses is appropriate to provide for probable incurred credit losses based on an evaluation of known and inherent risks in the loan portfolio at June 30, 2017. 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 $11.2 million at June 30, 2017 compared to $12.6 million at March 31, 2017.

Net recoveries were $26,000 for the quarter ended June 30, 2017 compared to net charge-offs of $2.4 million for the same quarter in 2016 and net charge-offs of $356,000 for the linked-quarter ended March 31, 2017. The net recoveries for the quarter ended June 30, 2017 were due primarily to commercial and industrial loan net recoveries of $313,000, primarily due to recoveries on two large loans, offset partially by $288,000 in consumer net charge-offs. Consumer net charge-offs were due primarily to small charge-off balances on a large volume of consumer loans.

Nonperforming assets increased $96,000, or 0.8%, to $11.8 million, ($1.6 million guaranteed by government agencies) or 0.29% of total assets, at June 30, 2017, compared to $11.7 million and March 31, 2017 ($1.7 million guaranteed by government agencies) or 0.30% of total assets, at March 31, 2017 reflecting a slight increase in nonperforming loans discussed above. The Bank had $786,000 of other real estate owned at June 30, 2017 and March 31, 2017 as a result of no activity in the other real estate owned portfolio during the quarter ended June 30, 2017.

Operating Results

Net interest income increased $1.1 million, or 3.3%, to $34.2 million for the quarter ended June 30, 2017 compared to $33.1 million for the same period in 2016 and increased $1.0 million, or 3.1%, from $33.1 million for the linked-quarter ended March 31, 2017. Net interest income increased $1.5 million, or 2.2%, to $67.3 million for the six months ended June 30, 2017 compared to $65.8 million for the same period in 2016. The increase in net interest income from the three and six month periods ended June 30, 2016 was primarily due to an increase in average interest earning assets, partially offset by a decrease in the yield on average interest earning assets as average contractual note rates in the loan portfolio declined despite recent increases in interest rates.

The increase in net interest income from the linked-quarter ended March 31, 2017 was due to an increase in average interest earning assets and an increase in the yield on average interest earning assets, partially offset by an increase in the cost of interest bearing liabilities. The increase in the yield on average interest earning assets from the linked-quarter was primarily due to increases in average loan yields and investment yields as a result of increases in market rates, including prime and LIBOR rates from prior periods.

Heritage's net interest margin for the quarter ended June 30, 2017 decreased eight basis points to 3.92% from 4.00% for the same period in 2016 and increased three basis points from 3.89% for the linked-quarter ended March 31, 2017. The net interest margin for the six months ended June 30, 2017 decreased 11 basis points to 3.91% from 4.02% for the same period in 2016. The changes in net interest margin are primarily impacted by loan yields, including incremental accretion on purchased loans, which is included in the table below.

The loan yield, excluding incremental accretion on purchased loans, was 4.53% for the quarter ended June 30, 2017 compared to 4.59% for the same period in 2016 and 4.52% for the linked-quarter ended March 31, 2017. Loan yield, excluding incremental accretion on purchased loans, was 4.53% for the six months ended June 30, 2017 compared to 4.68% for the same period in 2016. The loan yield for the periods in 2017 as compared to the same periods in 2016 are lowering due to the higher average contractual note rates in the loan portfolio in 2016.

The decreases in net interest margin and loan yields during the three and six month periods ended June 30, 2017 as compared to the same periods in 2016 was also due to decreases in incremental accretion on purchased loans. Incremental accretion decreased $880,000, or 37.3%, to $1.5 million for the quarter ended June 30, 2017 from $2.4 million for the same period in 2016 and decreased $1.5 million, or 36.0%, to $2.7 million for the six months ended June 30, 2017 from $4.1 million for the same period in 2016. The incremental accretion is expected to continue to decrease as the balance of the purchased loans continues to decrease.

As mentioned above, loan yield, excluding incremental accretion on purchased loans, was greater for the quarter ended June 30, 2017 as compared to the linked-quarter ended March 31, 2017 as variable rate loans that use indexes such as the prime and LIBOR rates as a percentage of the loan portfolio increased. The magnitude of the change will depend on the mix of fixed and variable rate loans in the portfolio. At June 30, 2017, gross loan balances totaling $509.7 million, or 18.6% of the total gross loan balances, repriced during the six months ended 2017. The increase in net interest margin from the linked-quarter was also due to an increase in incremental accretion on purchased loans of $311,000, or 26.6%, to $1.5 million for the quarter ended June 30, 2017 from $1.2 million for the quarter ended March 31, 2017 as a result of 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:

Also impacting net interest margin, excluding incremental accretion on purchased loans, were increases in the yields on investment securities in 2017 as compared to the 2016 periods. The yield on the aggregate investment portfolio increased to 2.25% for the quarter ended June 30, 2017 compared to 1.98% for the quarter ended June 30, 2016 and 2.22% for the linked-quarter ended March 31, 2017 reflecting the effect of the recent rise in interest rates on our adjustable rate investment securities.

To a lesser extent, the cost of interest bearing liabilities has impacted net interest margin, both including and excluding incremental accretion on purchased loans. The cost of interest bearing liabilities increased to 0.31% during the quarter ended June 30, 2017 compared to 0.25% for the quarter ended June 30, 2016 and 0.28% for the linked-quarter ended March 31, 2017. The cost of interest bearing liabilities increased to 0.29% for the six months ended June 30, 2017 compared to 0.25% for the same period in 2016. The increase in costs is a result of increases in market interest rates and an increase in time deposits as a percentage of total deposits.

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "We continue to be encouraged by the trending increase in yields on interest earning assets as well as the growth in earning assets.  The impact of these increases was somewhat muted by a decrease in the percentage of average loans to average interest earning assets from the prior quarter as well as an increase in the cost of interest bearing liabilities during the quarter.  Although we had strong overall loan growth for the quarter, over two-thirds of the growth occurred in the last month of the quarter. This growth will benefit us as we move into the remainder of the year."

The provision for loan losses was $1.1 million for both the quarters ended June 30, 2017 and June 30, 2016 and $867,000 for the linked-quarter ended March 31, 2017. 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 based on the use of a consistent methodology. The increase in the allowance for loan losses for the quarter ended June 30, 2017 was necessary primarily as a result of loan growth during the period.

Noninterest income increased $4.1 million, or 62.2%, to $10.7 million for the quarter ended June 30, 2017 compared to $6.6 million for the same period in 2016 and increased $3.3 million, or 45.1%, from $7.3 million for the linked-quarter ended March 31, 2017. Noninterest income increased $4.4 million, or 32.8%, to $18.0 million for the six months ended June 30, 2017 compared to $13.6 million for the same period in 2016. The increases from the prior periods were due primarily to a $3.0 million gain on sale of loans as a result of the sale during the current quarter of a previously classified purchased credit impaired loan. In addition, service charges and other fees increased $950,000, or 27.3%, to $4.4 million for quarter ended June 30, 2017 from $3.5 million for the same period in 2016 and increased $1.8 million, or 26.5%, to $8.6 million for the six months ended June 30, 2017 from $6.8 million for the same period in 2016 as a result of product changes implemented at the end of 2016. Service charges and other fees increased $213,000, or 5.1%, from $4.2 million for the linked-quarter ended March 31, 2017. The increase in noninterest income for the six months ended June 30, 2017 as compared to the six months ended was offset partially by a $644,000, or 84.6%, decrease in gain on sale of investments as a result of fewer sales during 2017.

Noninterest expense increased $1.3 million, or 5.0%, to $27.8 million for the quarter ended June 30, 2017 compared to $26.5 million for the same period in 2016 and increased $586,000, or 2.2%, from $27.2 million for the linked-quarter ended March 31, 2017. Noninterest expense increased $2.2 million, or 4.1%, to $55.0 million for the six months ended June 30, 2017 compared to $52.8 million for the same period in 2016. The increases from the same periods in 2016 were primarily due to compensation and employee benefits and professional services expenses, partially offset by lower occupancy and equipment and federal deposit insurance premium expenses. The increase from the linked-quarter ended March 31, 2017 was due primarily to increases in compensation and employee benefits. The ratio of noninterest expense to average assets (annualized) was 2.85% for the quarter ended June 30, 2017 compared to 2.87% for the same period in 2016 and 2.85% for the linked-quarter ended March 31, 2017. The ratio of noninterest expense to average assets (annualized) was 2.85% for the six months ended June 30, 2017 compared to 2.89% for the same period in 2016.

Income tax expense was $4.1 million for the quarter ended June 30, 2017 compared to $3.2 million for the comparable quarter in 2016 and $3.1 million for the linked-quarter ended March 31, 2017. Income tax expense was $7.2 million for the six months ended June 30, 2017 compared to $6.3 million for the comparable quarter in 2016. The effective tax rate was 25.6% for the quarter ended June 30, 2017 compared to 26.3% for the comparable quarter in 2016 and 24.9% for the linked-quarter ended March 31, 2017. The effective tax rate was 25.3% for the six months ended June 30, 2017 compared to 26.0% for the comparable period in 2016. The decrease in the effective tax rates during the three and six month periods ended June 30, 2017 from the prior year periods was due primarily to the implementation of ASU 2016-09 on January 1, 2017 whereby the excess tax benefits on option exercises and restricted stock vesting were recognized during the periods. The increase in the effective tax rate from the linked-quarter was due to a lessened impact from the vesting of restricted stock.

Dividends

On July 25, 2017, the Company's Board of Directors declared a quarterly cash dividend of $0.13 per common share. The dividend is payable on August 24, 2017 to shareholders of record as of the close of business on August 10, 2017.

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on July 26, 2017 at 11:00 a.m. Pacific time. To access the call, please dial (800) 230-1074 a few minutes prior to 11:00 a.m. Pacific time. The call will be available for replay through August 9, 2017, by dialing (800) 475-6701 -- access code 426408.

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 59 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 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 increased competitive pressures; 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 2017 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.