HFWA Heritage Financial Corporation

• Net income was $16.8 million, or $0.48 per diluted share, for the second quarter of 2023 compared to $20.5 million, or $0.58 per diluted share, for the first quarter of 2023.
• Loans receivable increased $123.9 million, or 3.0% in the second quarter of 2023.
• Capital remains strong with a leverage ratio of 9.9% and a total capital ratio of 14.1% at June 30, 2023.
• The ratio of nonperforming assets to total assets at June 30, 2023 and March 31, 2023 was 0.07%.
• Net interest margin was 3.56% for the second quarter of 2023 compared to 3.91% for the first quarter of 2023.
• Cost of total deposits was 0.61% for the second quarter of 2023 compared to 0.31% for the first quarter of 2023.
• Total deposits decreased $193.5 million or 3.3% in the second quarter of 2023.
• Declared a regular cash dividend of $0.22 per share on July 19, 2023.

OLYMPIA, Wash., July 20, 2023 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) (the "Company" or "Heritage"), the parent company of Heritage Bank (the "Bank"), today reported net income of $16.8 million for the second quarter of 2023 compared to $20.5 million for the first quarter of 2023 and $18.6 million for the second quarter of 2022. Diluted earnings per share for the second quarter of 2023 were $0.48 compared to $0.58 for the first quarter of 2023 and $0.52 for the second quarter of 2022.

Jeffrey J. Deuel, President and Chief Executive Officer of Heritage, commented, "Results for the second quarter continue to demonstrate the strength of our business model. We have a balance sheet with a legacy of strong core deposits and ample liquidity which allows us to maintain loan production. Although we are experiencing the industry-wide pressure on funding costs, we are encouraged with the ongoing development of customer relationships, particularly in the markets where we've hired banking teams over the past year, such as the Portland, Eugene and Boise MSAs. We believe our continued focus on prudent risk management, coupled with strategic and measured growth, will benefit our long-term returns for shareholders.

We are proud to report that Heritage Bank has partnered with Francis + Clare Place to provide financing for 61 affordable housing units in Portland, Oregon. These units will house individuals who have been living on the street and will provide substantial social safety-net services to help them reintegrate into the community. This Catholic Charities of Oregon sponsored transaction is the second of two complexes located in an area that has been especially hurt by homelessness."

Financial Highlights

The following table provides financial highlights at the dates and for the periods indicated:

Balance Sheet

Cash and cash equivalents decreased $193.1 million, or 64.1%, to $108.4 million at June 30, 2023 from $301.5 million at March 31, 2023 due primarily to an increase in loans receivable and a decrease in deposits, partially offset by an increase in borrowings.

Total investment securities decreased $47.4 million, or 2.3%, to $2.03 billion at June 30, 2023 from $2.08 billion at March 31, 2023 due primarily to maturities and prepayments. There were no investment securities purchased in the second quarter of 2023. The total of net unrealized losses in available for sale and net unrecognized losses in held to maturity investments increased $32.6 million due primarily to a decline in fair values of investment securities available for sale and held to maturity since March 31, 2023 due to changes in market rates.

The following table summarizes the Company's investment securities at the dates indicated including change in net unrealized loss and net unrecognized loss:

Loans receivable increased $123.9 million, or 3.0% in the second quarter of 2023, due to a combination of loan originations and net advances on loans outstanding.  New loans funded in the second quarter of 2023 and first quarter of 2023 were $133.6 million and $138.1 million, respectively. Net advances on loans outstanding increased $47.8 million to $60.9 million during the second quarter of 2023 as compared to $13.1 million in the first quarter of 2023.  Loan prepayments increased slightly during the second quarter of 2023 to $52.3 million, compared to $41.5 million during the first quarter of 2023.

Non-owner occupied CRE loans increased by $42.7 million, or 2.7%, during the second quarter of 2023 due to new loan originations of $46.2 million offset partially by loan repayments. Commercial and multifamily construction loans increased by $36.5 million, or 13.5%, due primarily to advances on outstanding loans during the second quarter of 2023. Total new commitments for commercial and multifamily construction loans were $58.5 million in the second quarter of 2023. In addition, commercial and industrial loans increased $23.0 million, or 3.4%, due to new loan originations of $34.4 million offset partially by loan repayments.

The following table summarizes the Company's loans receivable, net at the dates indicated:

Total deposits decreased $193.5 million, or 3.3%, from March 31, 2023. The decrease was due to competitive pricing pressures and customers moving excess funds to alternative higher yielding investments as well as general decreases in individual customer balances which included large capital expenditures and tax payments.

Certificates of deposit increased $44.8 million, or 11.3%, from March 31, 2023. The increase in certificates of deposits included transfers from non-maturity deposit accounts. Brokered deposits decreased $7.6 million, or 14.5%, to $44.7 million at June 30, 2023 from $52.3 million at March 31, 2023.

The following table summarizes the Company's total deposits at the dates indicated:

Total borrowings increased $66.9 million, or 17.5%, to $450.0 million at June 30, 2023 compared to $383.1 million at March 31, 2023. All borrowings at March 31, 2023 were advances from the Federal Home Loan Bank ("FHLB"). During the second quarter of 2023, the Company transferred all borrowings to the Federal Reserve Bank ("FRB") Bank Term Funding Program ("BTFP") due to advantageous terms and conditions. The BTFP offers loans of up to one year in length to institutions pledging eligible investment securities. The advance rate on the collateral is at par value. The average rate on borrowings from the BTFP was 4.72% as compared to an average rate of 5.15% for FHLB borrowings during the second quarter of 2023.

Total stockholders' equity decreased $6.3 million, or 0.8%, to $819.7 million  at June 30, 2023 compared to $826.1 million at March 31, 2023 due primarily to an increase of $14.7 million in accumulated other comprehensive loss as a result of declining fair values of available for sale investment securities and $7.8 million in dividends paid offset partially by $16.8 million of net income recognized for the quarter.

The Company and Bank continue to maintain capital levels in excess of the applicable regulatory requirements for them both to be categorized as "well-capitalized".

The following table summarizes capital ratios for the Company at the dates indicated:

Allowance for Credit Losses and Provision for Credit Losses

The ACL as a percentage of loans was 1.09% at June 30, 2023 compared to 1.08% at March 31, 2023. During the second quarter of 2023, the Company recorded a $1.9 million provision for credit losses, compared to a $1.8 million provision for credit losses during the first quarter of 2023 and a $1.2 million reversal of the provision for credit losses during second quarter of 2022. The increase in the provision for credit losses during the second quarter of 2023 was primarily driven by growth in loans receivable, net and changes in loan mix primarily due to the increases in non-owner occupied CRE, commercial and multifamily construction, and commercial and industrial loans.

The ACL on unfunded commitments ("unfunded") decreased during the second quarter of 2023 compared to the first quarter of 2023 due primarily to an increase in loan utilization rates.

The following table provides detail on the changes in the ACL on loans and the ACL on unfunded and the related provision for (reversal of) credit losses for the periods indicated:

Credit Quality

The ratio of classified loans increased slightly to 1.38% at June 30, 2023 as compared to 1.18% at March 31, 2023. Classified loans include loans rated substandard or worse.

The following table illustrates total loans by risk rating and their respective percentage of total loans at the dates indicated:

Nonperforming assets to total assets was 0.07% at both June 30, 2023 and March 31, 2023 compared to 0.14% at June 30, 2022. Nonperforming assets at June 30, 2023, March 31, 2023 and June 30, 2022 consisted only of nonaccrual loans.

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

Liquidity

Total liquidity sources available at June 30, 2023 were 2.75 billion. This includes internal as well as external sources of liquidity. The Company has access to FHLB advances, the FRB Discount Window and BTFP. The Company's available liquidity sources  at June 30, 2023 represented a coverage ratio of 49.2% of total deposits and 150.6% of estimated uninsured deposits.

The following table summarizes the Company's available liquidity:

Net Interest Income and Net Interest Margin

Net interest income decreased $4.0 million, or 6.7%, during the second quarter of 2023 compared to the first quarter of 2023. In addition, net interest margin decreased 35 basis points to 3.56% from 3.91% as compared to the prior quarter. The decrease in net interest income was due primarily to a $4.1 million increase in interest expense on deposits and $3.3 million increase in interest expense on borrowings. The increase in interest expense on deposits was due to a 43 basis point increase in average rates due to competitive rate pressures. The average cost of interest bearing deposits increased from 0.49% to 0.92%. The increase in interest expense on borrowings was due to an increase in average balances. The average cost of borrowings declined 5 basis points from 4.92% to 4.87% as the Company transferred borrowings from the FHLB to the FRB's BTFP during the second quarter of 2023 due to a lower borrowing rate. The increase in interest expense was partially offset by a $3.4 million increase in interest income, primarily due to a $3.2 million increase in interest income on loans receivable, net. The average balance of loans receivable, net increased by $106.2 million and the average yield on loans receivable, net increased 12 basis points to 5.19% during the second quarter of 2023. 

Net interest income increased $5.8 million, or 11.5%, during the second quarter of 2023 compared to the second quarter of 2022 and the net interest margin increased 52 basis points during this same period.  The increase was due primarily to an increase in yields earned on interest earning assets following increases in market interest rates and a shift into higher yielding interest earning assets.  This was partially offset by an increase in interest expense due to an increase in deposit rates and borrowing expense.  

The following table provides relevant net interest income information for the periods indicated:

Noninterest Income

Noninterest income decreased during the second quarter of 2023 from the first quarter of 2023 due primarily to a $1.7 million decrease in other income as a result of a $1.6 million gain from the sale of Visa Inc. Class B common stock during the first quarter of 2023.

Noninterest income increased during the second quarter of 2023 compared to the same period in 2022 due primarily to higher deposit service charges and an increase in FHLB dividend income included in other income. The following table presents the key components of noninterest income and the change for the periods indicated:

Noninterest Expense

Noninterest expense decreased $0.3 million or 0.7% during the second quarter of 2023 from the first quarter of 2023 due primarily to a decrease in compensation and employee benefits resulting from a decrease in the accrual for incentive-based compensation  and decrease in payroll taxes offset partially by an increase in salary expense due to annual merit increases in base pay. Occupancy and equipment expense decreased due to a decrease in maintenance costs related to winter weather conditions experienced in the first quarter of 2023. Other expense increased due to an increase in customer account loss expense in the second quarter of 2023.

Noninterest expense increased $5.6 million or 15.7% during the second quarter of 2023 compared to the same period in 2022 due primarily to an increase in compensation and employee benefits resulting from an increase in the number of full-time equivalent employees including the addition of commercial and relationship banking teams in 2023 and an increase in salaries and wages due to upward market pressure. Occupancy and equipment expense increased due to the expansion into Eugene, Oregon and Boise, Idaho. Data processing costs increased due primarily to the expansion of digital services including the addition of the ability to open accounts online. Federal deposit insurance premiums increased due to the increase in the assessment rate starting in January 2023. Other expense increased due to an increase in customer account loss expense, employee related expenses which included additional expenses related to calling efforts for the newly added teams, as well as a general increase in operating costs in the second quarter of 2023 as compared to the same period in 2022.

The following table presents the key components of noninterest expense and the change for the periods indicated:

Income Tax Expense

Income tax expense decreased during the second quarter of 2023 compared to the first quarter of 2023 and the same period in 2022 due primarily to a lower effective income tax rate during the second quarter of 2023 following a decrease in pre-tax income which increased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and low-income housing tax credits. The following table presents the income tax expense and related metrics and the change for the periods indicated:

Dividends

On July 19, 2023, the Company's Board of Directors declared a quarterly cash dividend of $0.22 per share. The dividend is payable on August 16, 2023 to shareholders of record as of the close of business on August 2, 2023.

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on Thursday, July 20, 2023 at 10:00 a.m. Pacific time. To access the call, please dial (833) 470-1428 -- access code 536813 a few minutes prior to 10:00 a.m. Pacific time. The call will be available for replay through July 27, 2023 by dialing (866) 813-9403 -- access code 925696.

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 branch network of 51 banking offices in Washington, Oregon and Idaho. 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.

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 the Company's actual results to differ materially from those described in the forward-looking statements, include but are not limited to, the following: changes in general economic conditions, either nationally or in our market areas, including as a result of employment levels, labor shortages and the effects of inflation, a potential recession or slowed economic growth caused by increasing political instability from acts of war including Russia's invasion of Ukraine, as well as supply chain disruptions; higher inflation and the current and future monetary policies of the Federal Reserve in response thereto; the impact of bank failures or adverse developments at other banks and related negative press about the banking industry in general on investor and depositor sentiment; changes in the interest rate environment; the quality and composition of our securities portfolio and the impact of any adverse changes including market liquidity within the securities markets; legislative and regulatory changes, including changes in banking, securities and tax law, in regulatory policies and principles, or the interpretation of regulatory capital or other rules; credit and interest rate risks associated with the Company's businesses, customers, borrowings, repayment, investment, and deposit practices; fluctuations in deposits; liquidity issues, including our ability to borrow funds or raise additional capital, if necessary; 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 2023 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.