Heritage merce p(US:HTBK)2024-08-08 20:30Part I. FINANCIAL INFORMATION This section presents the company's unaudited consolidated financial statements, including balance sheets, income statements, cash flows, and detailed notes Item 1. Consolidated Financial Statements (unaudited) The unaudited consolidated financial statements for June 30, 2024, reflect decreased net income due to higher deposit costs, despite modest asset growth and strong capital Consolidated Balance Sheets The balance sheet shows a slight increase in total assets driven by cash and loans, offset by a decrease in securities Consolidated Balance Sheet Highlights (in thousands) | Account | June 30, 2024 | December 31, 2023 | Change | | :--- | :--- | :--- | :--- | | Total Assets | $5,263,024 | $5,194,095 | +1.3% | | Total cash and cash equivalents | $648,260 | $408,129 | +58.8% | | Securities available-for-sale, at fair value | $273,043 | $442,636 | -38.3% | | Securities held-to-maturity, at amortized cost | $621,178 | $650,565 | -4.5% | | Loans, net | $3,331,839 | $3,302,420 | +0.9% | | Total Liabilities | $4,583,825 | $4,521,194 | +1.4% | | Total deposits | $4,444,610 | $4,378,458 | +1.5% | | Total Shareholders' Equity | $679,199 | $672,901 | +0.9% | Consolidated Statements of Income The income statement reveals a significant year-over-year decline in net income, primarily due to reduced net interest income and increased expenses Consolidated Income Statement Highlights (in thousands, except per share data) | Metric | Three Months Ended June 30, 2024 | Three Months Ended June 30, 2023 | YoY Change | Six Months Ended June 30, 2024 | Six Months Ended June 30, 2023 | YoY Change | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Net Interest Income | $39,455 | $46,293 | -14.8% | $79,548 | $95,551 | -16.8% | | Provision for credit losses | $471 | $260 | +81.2% | $655 | $292 | +124.3% | | Noninterest Income | $2,276 | $2,074 | +9.7% | $4,323 | $4,840 | -10.7% | | Noninterest Expense | $28,188 | $24,991 | +12.8% | $55,724 | $50,392 | +10.6% | | Net Income | $9,234 | $16,403 | -43.7% | $19,400 | $35,320 | -45.1% | | Diluted EPS | $0.15 | $0.27 | -44.4% | $0.32 | $0.58 | -44.8% | Consolidated Statements of Cash Flows The cash flow statement indicates a net increase in cash and cash equivalents, driven by investing and financing activities Cash Flow Summary for Six Months Ended June 30 (in thousands) | Cash Flow Category | 2024 | 2023 | | :--- | :--- | :--- | | Net cash provided by operating activities | $17,847 | $60,746 | | Net cash provided by investing activities | $171,610 | $47,844 | | Net cash provided by financing activities | $50,674 | $96,309 | | Net increase in cash and cash equivalents | $240,131 | $204,899 | Notes to Unaudited Consolidated Financial Statements Detailed notes provide insights into segment operations, securities portfolio losses, loan composition, credit loss allowances, capital adequacy, and recent corporate actions - The company operates primarily through its Banking segment in California's Bay Area, with a smaller Factoring segment providing working capital financing nationwide28134 Securities Portfolio Unrealized/Unrecognized Losses (June 30, 2024, in thousands) | Portfolio | Amortized Cost | Estimated Fair Value | Gross Unrealized/Unrecognized Losses | | :--- | :--- | :--- | :--- | | Available-for-Sale | $281,436 | $273,043 | ($8,393) | | U.S. Treasury & Agency MBS | $281,436 | $273,043 | ($8,393) | | Held-to-Maturity | $621,190 | $527,438 | ($93,769) | | Agency MBS & Municipals | $621,190 | $527,438 | ($93,769) | - Unrealized and unrecognized losses in the securities portfolio are due to higher interest rates, but the company does not anticipate forced sales before value recovery44197 Loan Portfolio Composition (June 30, 2024, in thousands) | Loan Category | Amount | % of Total | | :--- | :--- | :--- | | Commercial | $477,929 | 14% | | CRE - non-owner occupied | $1,283,323 | 38% | | CRE - owner occupied | $594,504 | 18% | | Residential mortgages | $484,809 | 14% | | Other Real Estate & Consumer | $540,096 | 16% | | Total Loans | $3,380,227 | 100% | - The Allowance for Credit Losses on Loans (ACLL) stood at $48.0 million, representing 1.42% of total loans and 795% coverage of nonperforming loans as of June 30, 2024154 - The company and its subsidiary bank exceeded all regulatory capital requirements to be categorized as "well-capitalized" under Basel III guidelines as of June 30, 2024109113 - The Board declared a $0.13 per share quarterly cash dividend and authorized a $15 million share repurchase program on July 25, 2024139 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management attributes the Q2 2024 net income decline to net interest margin compression from rising deposit costs and increased noninterest expenses, while maintaining strong liquidity and capital Executive Summary The executive summary highlights a significant decrease in net income and diluted EPS for Q2 2024, alongside a strong liquidity position and stable asset quality Q2 2024 Performance Overview | Metric | Q2 2024 | Q2 2023 | | :--- | :--- | :--- | | Net Income | $9.2 million | $16.4 million | | Diluted EPS | $0.15 | $0.27 | | Annualized Return on Average Assets | 0.71% | 1.25% | | Annualized Return on Average Equity | 5.50% | 10.12% | - Net interest income decreased 15% year-over-year to $39.5 million for Q2 2024, with net interest margin contracting 50 basis points to 3.26%, driven by higher deposit rates and mix shift145169 - The company maintains a strong liquidity position with $3.0 billion in available liquidity, representing 66% of total deposits and 148% of estimated uninsured deposits at June 30, 2024150259 - Loans grew 3% year-over-year to $3.38 billion, while total deposits decreased 1% to $4.44 billion, with nonperforming assets remaining low at 0.11% of total assets152153155 Results of Operations Operational results show increased deposit costs, higher provision for credit losses, a modest rise in noninterest income, and a notable increase in noninterest expenses - The average cost of total deposits increased to 1.75% in Q2 2024 from 0.97% in Q2 2023, driven by client migration to higher-yielding interest-bearing accounts145173 - A provision for credit losses on loans of $471,000 was recorded in Q2 2024, an increase from $260,000 in Q2 2023176 - Noninterest income increased 10% year-over-year to $2.3 million in Q2 2024, primarily due to a gain on company-owned life insurance proceeds offsetting lower SBA loan sales146177 - Noninterest expense rose 13% year-over-year to $28.2 million in Q2 2024, driven by increased salaries, occupancy, and IT-related costs179181 Financial Condition The financial condition reflects a reduced securities portfolio, a real estate-concentrated loan portfolio, low nonperforming assets, and a significant shift in deposit mix - The securities portfolio decreased due to maturities, with available-for-sale securities at $273.0 million and held-to-maturity at $621.2 million as of June 30, 2024186188 - The loan portfolio is heavily concentrated in real estate, with 86% of gross loans secured by real property, and CRE non-owner occupied loans growing 12% year-over-year to $1.3 billion199206 - Nonperforming assets were $6.0 million, or 0.11% of total assets, at June 30, 2024, showing a slight increase year-over-year but a decrease from year-end 2023153231 - Deposits experienced a significant mix shift, with noninterest-bearing demand deposits falling 10% year-over-year to $1.19 billion and ICS/CDARS deposits growing to $959.6 million251 Item 3. Quantitative and Qualitative Disclosures About Market Risk The company manages primary interest rate risk through GAP analysis and simulation models, indicating asset-sensitive net interest income and economic value of equity - The company's principal market risk is interest rate risk, managed through asset/liability strategies including GAP analysis and simulation modeling273274 Interest Rate Sensitivity Analysis (as of June 30, 2024) | Rate Shock (basis points) | Estimated Change in Net Interest Income (%) | Estimated Change in Economic Value of Equity (%) | | :--- | :--- | :--- | | +200 | +4.2% | +5.8% | | +100 | +2.1% | +3.3% | | -100 | (3.0)% | (5.4)% | | -200 | (6.9)% | (13.0)% | Item 4. Controls and Procedures Management, including the CEO and CFO, concluded that disclosure controls and procedures were effective as of June 30, 2024, with no material changes to internal controls - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of June 30, 2024295 - No material changes to internal controls over financial reporting occurred during the quarter296 Part II. OTHER INFORMATION This section details legal proceedings and outlines significant risk factors, including cybersecurity, economic concentration, interest rate, competition, credit, and regulatory risks Item 1. Legal Proceedings The company faces three pending employment-related lawsuits, including two class actions, which it believes are without merit and not expected to materially impact financial position - As of June 30, 2024, the company is involved in three pending employment-related legal proceedings, including two purported class actions alleging California Labor Code and PAGA violations118 - The company believes the claims are without merit and does not anticipate a material adverse effect on its financial position, results of operations, or liquidity118121297 Item 1A. Risk Factors Key risks include cybersecurity threats, economic and geographic concentration in real estate, interest rate fluctuations, intense competition, credit loss sufficiency, and extensive regulatory oversight - The company faces significant cybersecurity risks from interruptions, cyberattacks including ransomware and AI-based attacks, and security breaches that could materially harm the business298299300 - Business is sensitive to San Francisco Bay Area economic conditions, with 85% of the loan portfolio in real estate, making it vulnerable to market downturns324329335 - Interest rate fluctuations can reduce net interest income, impact loan origination volumes, and decrease the value of the fixed-rate securities portfolio383384 - Intense competition for deposits may increase funding costs, and a decline in available funding could adversely impact loan origination and obligation fulfillment332395 - Credit risk includes potential insufficiency of the allowance for credit losses, adverse effects from nonperforming assets, and exposure to small and medium-sized businesses with limited resources356357343 - Regulatory risk stems from operating in a highly regulated environment, where changes in laws, regulations, or adverse examination findings could restrict activities and increase costs399429435