Heritage Financial (HFWA) - 2022 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION Financial Statements This section presents the unaudited condensed consolidated financial statements for Heritage Financial Corporation as of September 30, 2022, and for the three and nine months then ended Condensed Consolidated Statements of Financial Condition (Unaudited) Total assets decreased to $7.20 billion by September 30, 2022, due to cash redeployment and equity decline from AOCI losses Condensed Consolidated Statements of Financial Condition (in thousands) | Account | Sep 30, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | Assets | | | | Cash and cash equivalents | $407,324 | $1,723,292 | | Total investment securities | $2,129,461 | $1,277,728 | | Loans receivable, net | $3,959,206 | $3,773,301 | | Total assets | $7,200,312 | $7,432,412 | | Liabilities & Equity | | | | Total deposits | $6,237,735 | $6,394,290 | | Total liabilities | $6,423,610 | $6,577,980 | | Accumulated other comprehensive (loss) income, net | ($105,001) | $9,396 | | Total stockholders' equity | $776,702 | $854,432 | Condensed Consolidated Statements of Income (Unaudited) Q3 2022 net income slightly increased to $21.0 million, while YTD net income decreased to $59.3 million due to credit loss provisions Financial Performance Summary (in thousands, except per share data) | Metric | Q3 2022 | Q3 2021 | YTD 2022 | YTD 2021 | | :--- | :--- | :--- | :--- | :--- | | Net interest income | $59,286 | $51,378 | $156,278 | $157,881 | | Provision for (reversal of) credit losses | $1,945 | ($3,149) | ($2,836) | ($24,335) | | Noninterest income | $7,453 | $8,228 | $23,007 | $24,776 | | Noninterest expense | $39,147 | $37,166 | $110,574 | $110,804 | | Net income | $20,990 | $20,592 | $59,331 | $78,638 | | Diluted EPS | $0.59 | $0.58 | $1.67 | $2.18 | Notes to Condensed Consolidated Financial Statements (Unaudited) Notes detail financial statement components, including loan portfolios, credit quality, and fair value measurements, and the company's core business - The company's business consists primarily of commercial lending and deposit relationships with small and medium-sized businesses in Washington and Oregon[30] - Material estimates susceptible to significant change relate to the Allowance for Credit Losses (ACL) on securities and loans, goodwill impairment, and the fair value of financial instruments[32] - The company is transitioning away from LIBOR as a reference rate, with no new LIBOR-indexed loans initiated or renewed after January 1, 2022[36] Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) Management discusses financial performance, highlighting Q3 2022 net income growth, YTD decline, balance sheet shifts, and equity changes Results of Operations Q3 2022 net income rose to $21.0 million due to higher net interest income, while YTD net income decreased to $59.3 million - Q3 2022 net income increased to $21.0 million from $20.6 million in Q3 2021, primarily due to higher interest income from rising market rates, offset by a provision for credit losses versus a reversal in the prior year[117] - YTD 2022 net income decreased to $59.3 million from $78.6 million in YTD 2021, mainly due to a significantly lower reversal of provision for credit losses[118] - Net interest income for Q3 2022 increased by $7.9 million (15.4%) YoY, driven by higher yields on assets, despite a $7.8 million decrease in SBA PPP loan fee income[123][124] - Noninterest expense for Q3 2022 increased by 5.3% YoY, primarily due to a $2.2 million (10.2%) increase in compensation and employee benefits from market pressure on wages and incentive accruals[138] Financial Condition Overview Total assets decreased to $7.2 billion due to cash redeployment, while deposits and stockholders' equity also declined - Total assets decreased by 3.1% since year-end 2021, driven by a $1.3 billion (76.4%) decrease in cash and cash equivalents[143][144] - The company deployed excess liquidity, increasing total investment securities by $851.7 million (66.7%) and net loans receivable by $185.9 million (4.9%)[143][144] - Total deposits decreased by $156.6 million (2.4%), attributed to competitive pricing pressures and customers seeking higher-yielding investments[144][152] - Stockholders' equity decreased by 9.1%, primarily due to AOCI becoming a loss of $105.0 million from a gain of $9.4 million, a negative swing of $114.4 million, due to rising interest rates impacting the fair value of AFS securities[144][154] Loan Portfolio Overview Total loans grew to $4.0 billion, driven by C&I and residential real estate, while asset quality improved with fewer nonaccrual loans Loan Portfolio Composition (in thousands) | Loan Type | Sep 30, 2022 | Dec 31, 2021 | % Change | | :--- | :--- | :--- | :--- | | Commercial and industrial | $735,028 | $621,567 | 18.3% | | SBA PPP | $3,593 | $145,840 | -97.5% | | Owner-occupied CRE | $959,486 | $931,150 | 3.0% | | Non-owner occupied CRE | $1,547,114 | $1,493,099 | 3.6% | | Residential real estate | $296,019 | $164,582 | 79.9% | | Total Loans | $4,001,295 | $3,815,662 | 4.9% | - Nonaccrual loans decreased significantly by $17.5 million (73.8%) to $6.2 million at September 30, 2022, from $23.8 million at year-end 2021, due to collection efforts, payoffs, and transfers to accruing status[147][148] Allowance for Credit Losses (ACL) on Loans Overview The ACL on loans decreased to $42.1 million (1.05% of total loans) by September 30, 2022, reflecting improved economic forecasts ACL Ratios | Metric | Sep 30, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | ACL on loans | $42,089 thousand | $42,361 thousand | | ACL on loans to loans receivable | 1.05% | 1.11% | | ACL on loans to loans receivable (ex-PPP) | 1.05% | 1.15% | - The ACL decreased during the first nine months of 2022 due to a reduction in reserves for individually evaluated loans and improvements in the economic forecast compared to the prior year[149] Regulatory Requirements Overview As of September 30, 2022, the Company and Heritage Bank met all capital adequacy requirements, maintaining well-capitalized status Capital Ratios as of September 30, 2022 | Ratio | Company | Heritage Bank | | :--- | :--- | :--- | | Common equity Tier 1 capital ratio | 12.8% | 13.0% | | Tier 1 capital ratio | 13.3% | 13.0% | | Total capital ratio | 14.0% | 13.8% | | Leverage ratio | 9.2% | 9.0% | - Management believes that as of September 30, 2022, the Company and the Bank met all capital adequacy requirements to which they are subject[157] Quantitative and Qualitative Disclosures About Market Risk No material change in interest rate risk exposure since 2021, with no trading accounts, hedging, or high-risk derivatives - There has not been a material change in the company's interest rate risk exposure since the 2021 Annual Form 10-K[166] Controls and Procedures Disclosure controls and procedures were effective as of September 30, 2022, with no material changes in internal financial reporting controls - The CEO and CFO concluded that the Company's disclosure controls and procedures were effective as of September 30, 2022[167] - No material changes occurred in the Company's internal control over financial reporting during the third quarter of 2022[168] PART II. OTHER INFORMATION Legal Proceedings Neither the Company nor Heritage Bank is a party to any material pending legal proceedings beyond routine litigation - The Company is not a party to any material pending legal proceedings outside of ordinary routine litigation[170] Risk Factors No material changes to the risk factors previously disclosed in the Company's 2021 Annual Form 10-K - There have been no material changes to the risk factors set forth in the Company's 2021 Annual Form 10-K[171] Unregistered Sales of Equity Securities and Use of Proceeds In Q3 2022, the company repurchased 100 shares for tax withholding, with 638,214 shares remaining under the repurchase plan - In Q3 2022, the company repurchased 100 shares at an average price of $26.94 to pay withholding taxes on vested restricted stock[172] - As of September 30, 2022, 638,214 shares may yet be purchased under the current stock repurchase plan[172] Exhibits Exhibits filed with Form 10-Q include executive agreements, deferred compensation plan addendums, and required CEO/CFO certifications - Key exhibits filed include a Transitional Retirement Agreement for Cindy M. Hirman and Deferred Compensation Plan addendums for several key executives[174] - Certifications by the Principal Executive Officer and Principal Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act were filed[174]