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| HFWA > SEC Filings for HFWA > Form 10-Q on 29-Oct-2009 | All Recent SEC Filings |
29-Oct-2009
Quarterly Report
The following discussion is intended to assist in understanding the financial condition and results of the Company as of and for the nine months ended September 30, 2009. The information contained in this section should be read with the unaudited condensed consolidated financial statements and its accompanying notes, and the December 31, 2008 audited consolidated financial statements and its accompanying notes included in our Annual Report on Form 10-K/A for the year ended December 31, 2008.
Overview
Heritage Financial Corporation is a bank holding company, which primarily engages in the business activities of our wholly owned subsidiaries: Heritage Bank and Central Valley Bank. We provide financial services to our local communities with an ongoing strategic focus in expanding our commercial lending relationships, market expansion and a continual focus on asset quality. Effective January 8, 1998, our common stock began to trade on the NASDAQ Global Select Market under the symbol "HFWA".
The following table provides relevant net interest income information for selected time periods. The average loan balances presented in the table are net of allowances for loan losses. Nonaccrual loans have been included in the tables as loans carrying a zero yield. Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis.
For the Three Months Ended September 30,
2009 2008
Interest Interest
Average Earned/ Average Average Earned/ Average
Balance Paid Rate Balance Paid Rate
(Dollars in thousands)
Interest Earning Assets:
Loans $ 761,475 $ 12,583 6.56 % $ 795,093 $ 13,692 6.85 %
Taxable securities 59,027 598 4.02 31,550 425 5.36
Nontaxable securities 7,609 63 3.31 5,638 51 3.54
Interest earning deposits 80,333 60 0.30 2,944 14 1.98
Federal Home Loan Bank stock 3,566 - 0.00 3,392 11 1.33
Total interest earning assets $ 912,010 $ 13,304 5.79 % $ 838,617 $ 14,193 6.73 %
Non-interest earning assets 63,490 59,626
Total assets $ 975,500 $ 898,243
Interest Bearing Liabilities:
Certificates of deposit $ 318,146 $ 1,904 2.37 % $ 335,209 $ 2,762 3.28 %
Savings accounts 80,131 176 0.87 96,363 428 1.77
Interest bearing demand and money
market accounts 321,438 673 0.83 250,682 1,062 1.69
Total interest bearing deposits 719,715 2,753 1.52 682,254 4,252 2.48
FHLB advances and other borrowings 3 - 1.73 10,768 85 3.15
Securities sold under agreement to
repurchase 11,675 22 0.75 - - -
Total interest bearing liabilities $ 731,393 $ 2,775 1.51 % $ 693,022 $ 4,337 2.49 %
Demand and other non-interest
bearing deposits 121,854 105,598
Other non-interest bearing
liabilities 4,618 5,382
Stockholders' equity 117,635 89,241
Total liabilities and stockholders'
equity $ 975,500 $ 893,243
Net interest income $ 10,529 $ 9,856
Net interest spread 4.28 % 4.24 %
Net interest margin 4.58 % 4.66 %
Average interest earning assets to
average interest bearing liabilities 124.69 % 121.01 %
For the Nine Months Ended September 30,
2009 2008
Interest Interest
Average Earned/ Average Average Earned/ Average
Balance Paid Rate Balance Paid Rate
(Dollars in thousands)
Interest Earning Assets:
Loans $ 770,689 $ 38,115 6.61 % $ 779,546 $ 41,366 7.09 %
Taxable securities 50,175 1,603 4.27 33,555 1,194 4.75
Nontaxable securities 6,924 176 3.39 5,404 145 3.58
Interest earning deposits 64,833 161 0.33 7,046 134 2.55
Federal Home Loan Bank stock 3,566 - 0.00 3,284 31 1.25
Total interest earning assets $ 896,187 $ 40,055 5.98 % $ 828,835 $ 42,870 6.91 %
Non-interest earning assets 67,061 57,773
Total assets $ 963,248 $ 886,608
Interest Bearing Liabilities:
Certificates of deposit $ 325,840 $ 6,211 2.55 % $ 346,397 $ 9,827 3.79 %
Savings accounts 87,614 692 1.06 89,537 1,155 1.72
Interest bearing demand and money
market accounts 307,579 2,181 0.95 239,601 3,318 1.85
Total interest bearing deposits 721,033 9,084 1.68 675,535 14,300 2.83
FHLB advances and other borrowings 1 - 1.73 8,844 261 3.95
Securities sold under agreement to
repurchase 4,930 28 0.75 - - -
Total interest bearing liabilities $ 725,964 $ 9,112 1.68 % $ 684,379 $ 14,561 2.84 %
Demand and other non-interest
bearing deposits 117,351 107,290
Other non-interest bearing
liabilities 4,927 6,526
Stockholders' equity 115,006 88,413
Total liabilities and stockholders'
equity $ 963,248 $ 886,608
Net interest income $ 30,943 $ 28,309
Net interest spread 4.30 % 4.07 %
Net interest margin 4.62 % 4.56 %
Average interest earning assets to
average interest bearing liabilities 123.45 % 121.11 %
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Earnings Summary
Including preferred stock dividends, a net loss applicable to common shareholders of $0.003 per diluted common share was recorded for the three months ended September 30, 2009 compared to net income of $0.31 per diluted common share for the three months ended September 30, 2008. Net income for the three months ended September 30, 2009 was $312,000 compared to net income of $2.1 million for the same period in 2008. Including preferred stock dividends, a net loss applicable to common shareholders of $0.17 per diluted common share was recorded for the nine months ended September 30, 2009 compared to net income of $0.98 per diluted common share for the nine months ended September 30, 2008. The net loss for the nine months ended September 30, 2009 was $191,000 compared to net income of $6.5 million for the same period in 2008. Operations for the three and nine months ended September 30, 2009 were significantly affected by increased provisioning for loan losses as described below.
Net Interest Income
Net interest income before provision for loan losses for the three months ended September 30, 2009 increased $673,000 or 6.8% to $10.5 million from $9.9 million for the same quarter in 2008. Net interest income before provision for loan losses for the nine months ended September 30, 2009 increased $2.6 million or 9.3% to $30.9 million from $28.3 million for the same quarter in 2008. This increase resulted primarily from by growth in earning assets and reductions in rates paid on deposits. The net interest margin (net interest income divided by average earning assets) decreased to 4.58% for the quarter ended September 30, 2009 compared to 4.66% for the quarter ended September 30, 2008. The net interest margin increased to 4.62% for the nine months ended September 30, 2009 compared to 4.56% for the nine months ended September 30, 2008.
Interest income decreased $889,000 or 6.3%, for the three months ended September 30, 2009 as compared to the third quarter last year and interest expense decreased $1.6 million or 36.0%, during this same period. Interest income decreased $2.8 million or 6.6%, for the nine months ended September 30, 2009 as compared to the nine months ended last year and interest expense decreased $5.4 million or 37.4%, during this same period.
The decline in interest income during both the three and nine month periods ended September 30, 2009 primarily was the result of a decline in the average balance of loans outstanding and the yield earned on these loans, partially offset by the increase in the average balance of investment securities outstanding during these periods. Net loans averaged $761.5 million with an average yield of 6.56% for the three months ended September 30, 2009 compared to average net loans of $795.1 million with an average yield of 6.85% for the same period in 2008. Net loans averaged $770.7 million with an average yield of 6.61% for the nine months ended September 30, 2009 compared to average net loans of $779.5 million with an average yield of 7.09% for the same period in 2008. Net loans declined during these periods primarily due to real estate construction loan payoffs and charge offs exceeding new loan originations
The decline in interest expense during the 2009 period was due to the lower average balance of and lower rates paid on certificates of deposit, as well as the lower rates paid on interest bearing demand and money market accounts. Certificates of deposit averaged $318.1 million with an average cost of 2.37% for the three months ended September 30, 2009 compared to $335.2 million with an average cost of 3.28% for the same period in 2008. Certificates of deposit averaged $325.8 million with an average cost of 2.55% for the nine months ended September 30, 2009 compared to $346.4 million with an average cost of 3.79% for the same period in 2008.
Provision for Loan Losses
The provision for loan losses was $4.7 million for the three months ended September 30, 2009, an increase of $2.9 million over the provision for loan losses during the third quarter of 2008 of $1.8 million. The provision for loan losses was $14.4 million for the nine months ended September 30, 2009, an increase of $11.6 million over the provision for loan losses during the nine months ended September 30, 2008 of $2.8 million. The increase in the provision was a result of management's continuing assessment of the increased risk in the loan portfolio due to the current economic environment which has led to increases in potential problem loans and loan losses. Management continues to see weakness specifically within its residential construction portfolio, as well as developing weaknesses in its commercial and industrial portfolio. See "Analysis of Allowance for Loan Losses" below for further information on the factors we consider when estimating credit losses.
Non-Interest Income
Non-interest income decreased $146,000 or 6.5% to $2.1 million for the three months ended September 30, 2009 compared with $2.3 million for the same quarter in 2008. Non-interest income decreased $357,000 or 5.3% to $6.4 million for the nine months ended September 30, 2009 compared with $6.8 million for the same period in 2008. The decrease for the nine months ended was due substantially to a decrease in income from mortgage banking operations, decreased gains on Small Business Administration loan sales due to decreased market demand and a decrease in rental income due to vacancies.
Non-Interest Expense
Non-interest expense increased $352,000 or 4.8% to $7.6 million during the three months ended September 30, 2009 compared to $7.3 million for the same period during 2008. Non-interest expense increased $1.0 million or 4.5% to $23.5 million during the nine months ended September 30, 2009 compared to $22.5 million for the same period during 2008. The increase for the three months ended was due primarily to 2009 increases in FDIC assessment rates and increased marketing expenses resulting primarily from costs associated with a checking account acquisition program. The increase for the nine months ended September 30, 2009 was due substantially to an assessment from the Washington Public Deposit Protection Commission ("WPDPC") in the amount of $239,000 due to uncollateralized public deposits of a failed bank, increased FDIC assessment rates and a special assessment resulting in an increase in FDIC assessments in the amount of $979,000, and increased marketing expense in the amount of $309,000 resulting primarily from costs associated with a checking account acquisition program. The increase for the nine months ended September 30, 2009 also included $263,000 in other-than-temporary impairment losses recognized during the period, a $996,000 reduction from the amount recognized in the same period last year.
The efficiency ratio for the quarter ended September 30, 2009 was 60.3% compared to 60.0% for the comparable quarter in 2008. The efficiency ratio for the nine months ended September 30, 2009 was 63.0% compared to 64.2% for the same period last year. The efficiency ratio consists of non-interest expense divided by the sum of net interest income before provision for loan losses plus non-interest income.
Effective June 30, 2009, the Company adopted FASB ASC 320-10-65, Recognition and Presentation of Other-Than-Temporary Impairments, which provides for the bifurcation of other-than-temporary impairments into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. As a result of adopting FASB ASC 320-10-65, the Company recorded $414,000 in other-than-temporary impairments not related to credit losses through other comprehensive income rather than through non-interest expense and as discussed above, recorded $263,000 in other-than-temporary impairments related to credit losses to non-interest expense during the nine months ended September 30, 2009.
Financial Condition Data
Total assets increased $71.8 million or 7.6%, to $1.02 billion as of September 30, 2009 from the December 31, 2008 balance of $946.1 million. Deposits increased $20.7 million or 2.5%, to $845.1 million as of September 30, 2009 from the December 31, 2008 balance of $824.5 million. For the same period, net loans, which exclude loans held for sale but are net of the allowance for loan losses, decreased $35.2 million or (4.4%), to $758.1 million as of September 30, 2009 from the December 31, 2008 balance of $793.3 million. Commercial loans continue to be the largest segment of loans at 56.6% and 54.9% as a percentage of total loans as of September 30, 2009 and December 31, 2008, respectively.
Total stockholders' equity increased by $45.4 million or 40.1%, to $158.6 million as of September 30, 2009 from the December 31, 2008 balance of $113.1 million. In September 2009, the Company completed the sale of 4.3 million shares of common stock in a public offering. The stock was issued at $11.50 per share and net proceeds from the offering was approximately $46.7 million. The Company's capital position remains strong at 15.58% of total assets as of September 30, 2009, an increase from 11.96% at December 31, 2008.
Lending Activities
As indicated in the table below, total loans (including loans held for sale) decreased to $783.2 million at September 30, 2009 from $809.0 million at December 31, 2008. The largest declines in our loan portfolio occurred in the real estate construction portfolio as a result of a combination of construction loan payoffs and charge offs. As a result of ongoing weakness in the local real estate markets and continuing stagnation of the economic recovery, management continues to see weakness specifically within its residential construction portfolio, as well as developing weaknesses in its commercial and industrial portfolio.
At At
September 30, % of December 31, % of
2009 Total 2008 Total
(Dollars in thousands)
Commercial $ 443,553 56.6 % $ 443,821 54.9 %
Real estate mortgages
One-to-four family residential 53,686 6.9 57,535 7.1
Five or more family residential and
commercial properties 158,670 20.2 157,542 19.5
Total real estate mortgages 212,356 27.1 215,077 26.6
Real estate construction
One-to-four family residential 54,863 7.0 71,159 8.8
Five or more family residential and
commercial properties 52,057 6.7 59,572 7.3
Total real estate construction 106,920 13.7 130,731 16.1
Consumer 21,973 2.8 21,255 2.6
Gross loans 784,802 100.2 810,884 100.2
Less: deferred loan fees (1,627 ) (0.2 ) (1,854 ) (0.2 )
Total loans $ 783,175 100.0 % $ 809,030 100.0 %
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Nonperforming Assets
The following table describes our nonperforming assets for the dates indicated.
At At
September 30, December 31,
2009 2008
(Dollars in thousands)
Nonaccrual loans:
Commercial $ 4,362 $ 1,176
Real estate mortgages 676 -
Real estate construction 30,644 2,221
Total nonaccrual loans (1) 35,682 3,397
Total nonperforming loans 35,682 3,397
Other real estate owned 151 2,031
Total nonperforming assets $ 35,833 $ 5,428
Accruing loans past due 90 days or more $ 710 $ 664
Potential problem loans 37,346 43,061
Allowance for loan losses 25,052 15,423
Nonperforming loans to total loans 4.56 % 0.42 %
Allowance for loan losses to total loans 3.20 % 1.91 %
Allowance for loan losses to nonperforming loans 70.21 % 454.02 %
Nonperforming assets to total assets 3.52 % 0.57 %
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(1) $17.1 million of nonaccrual loans were considered troubled debt restructures at September 30, 2009. There were no troubled debt restructures at December 31, 2008.
Nonperforming assets increased to $35.8 million, or 3.52% of total assets, at September 30, 2009 from $5.4 million, or 0.57% of total assets, at December 31, 2008 due to increases in nonperforming loans. The increase in nonperforming loans was primarily attributable to six residential construction borrower relationships totaling approximately $28.6 million and one commercial relationship totaling approximately $2.4 million being placed on non-accrual status. Of the six residential construction borrower relationships one was the Company's largest lending relationship to one borrower. The loans are to a builder/developer of single-family homes/lots in Pierce County, Washington and are secured by several homes under construction as well as single-family lots ready for sale. Pierce County has had a significant slowdown in homes sales and this slowdown has affected the borrower's ability to sell lots and repay the loans as originally planned. At September 30, 2009, these loans had an approximate balance of $13.9 million.
Given the increases in nonperforming loans and current economic conditions we increased our allowance for loan losses to total loans to 3.20% at September 30, 2009 from 1.91% at December 31, 2008. We also had $37.3 million of potential problem loans at September 30, 2009, which are those loans that are currently accruing interest and are not considered impaired, but which we are monitoring because the financial information of the borrower causes us concerns as to their ability to comply with their loan repayment terms. The decrease in other real estate owned from $2.0 million or $151,000 is due to the sale of real estate construction property.
Analysis of Allowance for Loan Losses
Management maintains an allowance for loan losses to absorb estimated credit losses associated with the loan portfolio. We determine an adequate allowance through our ongoing quarterly loan quality assessments.
We assess the estimated credit losses inherent in our non-classified and classified loan portfolio by considering a number of elements including:
• Historical loss experience in the portfolio;
• Levels of and trends in delinquencies and impaired loans;
• Levels and trends in charge offs and recoveries;
• Effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices;
• Experience, ability, and depth of lending management and other relevant staff;
• External factors such as competition, legal, and regulatory; and
• Effects of changes in credit concentrations.
We calculate an adequate allowance for the non-classified and classified portion of our loan portfolio based on an appropriate percentage loss factor that is calculated based on the above-noted elements and trends. We may record specific provisions for each impaired loan after a careful analysis of that loan's credit and collateral factors. Our analysis of an adequate allowance combines the provisions made for our non-classified loans, classified loans, and the specific provisions made for each impaired loan.
While we believe we use the best information available to determine the allowance for loan losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A further decline in local and national economic conditions, or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company's financial conditions and results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
The following table summarizes the changes in our allowance for loan losses:
Nine Months Ended September 30,
2009 2008
(Dollars in thousands)
Total loans outstanding at end of period (1) $ 783,175 $ 811,964
Average total loans outstanding during period
(1) 790,523 790,035
Allowance balance at beginning of period 15,423 10,374
Provision for loan losses 14,440 2,830
Charge offs:
Commercial (2,599 ) (133 )
Real estate mortgages - (280 )
Real estate construction (2,160 ) (75 )
Consumer (158 ) (113 )
Total charge offs (4,917 ) (601 )
Recoveries:
Commercial 1 -
Real estate mortgages 1 -
Real estate construction - -
Consumer 104 25
Total recoveries 106 25
Net charge offs (4,811 ) (576 )
Allowance balance at end of period $ 25,052 $ 12,628
Allowance for loan losses to total loans 3.20 % 1.56 %
Ratio of net charge offs during period to
average total loans outstanding (0.61 )% (0.07 )%
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