SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
[X] SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
[ ] 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-29480
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1857900
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 Fifth Avenue SW, Olympia, WA 98501
(Address of principal executive office) (ZIP Code)
(360) 943-1500
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of August 7, 2000 there were outstanding 8,820,157 common shares, with no par
value, of the registrant.
Page 1
HERITAGE FINANCIAL CORPORATION
FORM 10-Q
INDEX
PART I. Financial Information
- ------- ---------------------
Item 1. Condensed Consolidated Financial Statements (Unaudited): Page
----
Consolidated Statements of Income for the Three
Months and Six Months Ended June 30, 1999 and 2000 3
Consolidated Statements of Financial Condition
As of December 31, 1999 and June 30, 2000 4
Consolidated Statements of Stockholders' Equity for
the Six Months Ended June 30, 2000 and Comprehensive
Income for the Three and Six Months Ended June 30,
1999 and 2000 5
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 2000 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
PART II. Other Information
- -------- -----------------
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
Page 2
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except for per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
1999 2000 1999 2000
-------------------------------- -----------------------------
INTEREST INCOME :
Loans $7,790 10,180 15,282 19,763
Investment securities and FHLB dividends 716 644 1,472 1,303
Interest bearing deposits 212 53 672 101
------ ------ ------ ------
Total interest income 8,718 10,877 17,426 21,167
INTEREST EXPENSE :
Deposits 2,997 4,357 6,236 8,322
Borrowed funds 9 308 19 341
------ ------ ------ ------
Total interest expense 3,006 4,665 6,255 8,663
------ ------ ------ ------
Net interest income 5,712 6,212 11,171 12,504
PROVISION FOR LOAN LOSSES 102 195 204 390
------ ------ ------ ------
Net interest income after provision
for loan loss 5,610 6,017 10,967 12,114
NONINTEREST INCOME :
Gains on sales of loans 294 199 725 294
Commissions on sales of annuities
and securities 50 50 132 79
Service charges on deposits 340 398 674 754
Rental income 49 58 98 117
Other income 282 369 473 710
------ ------ ------ ------
Total noninterest income 1,015 1,074 2,102 1,954
NONINTEREST EXPENSE :
Salaries and employee benefits 2,364 2,625 4,862 5,238
Building occupancy 713 767 1,477 1,519
Data processing 334 307 607 608
Marketing 142 124 278 194
Goodwill Amortization 147 145 292 289
Other 1,146 941 2,032 1,874
------ ------ ------ ------
Total noninterest expense 4,846 4,909 9,548 9,722
------ ------ ------ ------
Income before federal income tax 1,779 2,182 3,521 4,346
Federal income tax 647 709 1,283 1,414
------ ------ ------ ------
Net income $1,132 1,473 2,238 2,932
====== ====== ====== ======
Earnings per share :
Basic $0.105 0.158 0.207 0.307
Diluted $0.103 0.156 0.203 0.302
See Notes to Condensed Consolidated Financial Statements.
Page 3
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
(Unaudited)
December 31, June 30,
1999 2000
----------------------------------------
Assets
Cash on hand and in banks $ 17,596 16,197
Interest earning deposits 949 1,618
Federal funds sold 2,100 -
Investment securities available for sale 36,378 35,850
Investment securities held to maturity 6,165 5,583
Loans held for sale 589 3,571
Loans receivable 417,173 445,068
Less: Allowance for loan losses (4,264) (4,694)
----------------------------------------
Loans, net 412,909 440,374
Premises and equipment, net 18,874 19,727
Federal Home Loan Bank stock 2,218 2,565
Accrued interest receivable 2,938 3,232
Prepaid expenses and other assets 2,447 1,898
Goodwill 7,795 7,506
----------------------------------------
Total assets $510,958 538,121
========================================
Liabilities and Stockholders' Equity
Deposits 405,068 430,794
Advances from Federal Home Loan Bank 2,800 14,100
Other borrowings 8 3
Advance payments by borrowers for taxes and insurance 375 345
Accrued expenses and other liabilities 6,584 4,564
Deferred Federal income taxes 859 783
----------------------------------------
Total liabilities 415,694 450,589
Stockholders' equity:
Common stock, no par value per share,15,000,000 shares authorized;
10,025,407 shares and 8,896,157 outstanding, respectively 69,837 60,616
Unearned compensation ESOP and Other (1,154) (1,118)
Retained earnings, substantially restricted 26,926 28,417
Accumulated other comprehensive loss (345) (383)
----------------------------------------
Total stockholders' equity 95,264 87,532
Commitments and contingencies - -
----------------------------------------
Total liabilities and stockholders' equity $510,958 538,121
========================================
See Notes to Condensed Consolidated Financial Statements.
Page 4
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Six Months Ended June 30, 2000
(Amounts in Thousands)
(Unaudited)
Number Unearned Accumulated
of compensation other Total
common Common ESOP and Retained comprehensive stockholders'
shares stock other earnings income equity
-----------------------------------------------------------------------------------------
Balance at December 31, 1999 10,025 $69,837 (1,154) 26,926 (345) 95,264
Earned ESOP shares - (5) 36 - - 31
Stock repurchase (1,160) (9,320) (9,320)
Exercise of stock options 31 104 - - - 104
Net income - - - 2,932 - 2,932
Decrease in unrealized gain on
securities available for sale,
net of tax of $20 - - - - (38) (38)
Cash dividend declared - - - (1,441) - (1,441)
-----------------------------------------------------------------------------------------
Balance at June 30, 2000 8,896 $60,616 (1,118) 28,417 (383) 87,532
=========================================================================================
Comprehensive Income Three months ended June 30, Six months ended June 30,
1999 2000 1999 2000
----------------------------------------------------------
Net income $1,132 $1,473 $2,238 $2,932
Change in unrealized gain (loss) on securities
available for sale, net of tax of $165, $17, $179
and $20 (319) 32 (348) (38)
----------------------------------------------------------
Comprehensive income $ 813 $1,505 $1,890 $2,894
==========================================================
See Notes to Condensed Consolidated Financial Statements.
Page 5
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Six Months Ended
June 30,
--------------------
1999 2000
Cash flows from operating activities:
Net income $ 2,238 2,932
Adjustments to reconcile net income to net cash
provided by (used in) operating activities
Amortization of goodwill 292 289
Depreciation and amortization 818 853
Deferred loan fees, net of amortization (53) (307)
Provision for loan losses 204 390
Net (increase)decrease in loans held for sale 3,483 (2,982)
Federal Home Loan Bank stock dividends (78) (72)
Recognition of compensation related to ESOP 25 31
Net change in accrued interest receivable,
prepaid expenses and other assets, and
accrued expenses and other liabilities (594) (1,827)
---------------------
Net cash provided by (used in)
operating activities 6,335 (693)
---------------------
Cash flows from investing activities:
Loans originated, net of principal payments
and loan sales (37,956) (27,837)
Proceeds from maturities of investment
securities available for sale 5,650 671
Proceeds from maturities of investment
securities held to maturity 7,109 584
Purchase of investment securities available for sale (11,158) (476)
Purchase of investment securities held to maturity (155) -
Purchase of premises and equipment (1,160) (1,424)
---------------------
Net cash used in investing activities (37,670) (28,482)
---------------------
Cash flows from financing activities:
Net (increase) decrease in deposits (15,692) 25,726
Net (increase)decrease in borrowed funds (365) 11,296
Net decrease in advance payment by borrowers
for taxes and insurance (110) (30)
Cash dividends paid (1,088) (1,431)
Proceeds from exercise of stock options 94 104
Stock repurchased (856) (9,320)
---------------------
Net cash provided by (used in)
financing activities (18,017) 26,345
---------------------
Net decrease in cash and cash equivalents (49,352) (2,830)
Cash and cash equivalents at beginning of period 70,948 20,645
---------------------
Cash and cash equivalents at end of period $ 21,596 17,815
=====================
Supplemental disclosures of cash flow information:
Cash payments for:
Interest expense $ 6,484 8,185
Federal income taxes 1,400 1,764
See Notes to Condensed Consolidated Financial Statements.
Page 6
HERITAGE FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended June 30, 1999 and 2000
(Unaudited)
NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
(a.) Description of Business
Heritage Financial Corporation (the Company) is a bank holding company
incorporated in the State of Washington in August 1997. The Company was
organized for the purpose of acquiring all of the capital stock of Heritage Bank
upon its reorganization from a mutual holding company form of organization to a
stock holding company form of organization.
The Company is primarily engaged in the business of planning, directing and
coordinating the business activities of its wholly owned subsidiaries: Heritage
Bank (HB) and Central Valley Bank (CVB). Heritage Bank is a Washington-chartered
savings bank whose deposits are insured by the Federal Deposit Insurance
Corporation (FDIC) under the Savings Association Insurance Fund (SAIF). HB
conducts business from its main office in Olympia, Washington and its eleven
branch offices located in Thurston, Pierce and Mason Counties. Central Valley
Bank is a national bank whose deposits are insured by the FDIC under the Bank
Insurance Fund (BIF). CVB conducts business from its main office in Toppenish,
Washington and its five branch offices located in Yakima and Kittitas Counties.
The Company's business consists primarily of focusing on lending and deposit
relationships with small businesses and their owners in its market area,
attracting deposits from the general public and originating for sale or
investment purposes first mortgage loans on residential properties located in
western and central Washington. The Company also makes residential construction
loans, income property loans and consumer loans.
(b.) Basis of Presentation
The accompanying consolidated financial statements have been prepared, without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. These consolidated financial statements should be read in
conjunction with our December 31, 1999 audited consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K. In our opinion,
all adjustments (consisting of normal recurring adjustments) considered
necessary for a fair presentation have been included. Operating results for the
six months ended June 30, 2000 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2000. In preparing the
consolidated financial statements, we are required to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. Actual results could differ from those estimates.
(c). Recently Issued Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. In May 1999, the Financial Accounting
Standards Board delayed the effective date of SFAS No. 133 to fiscal years
beginning after June 15, 2000, with interim reporting required. In June 2000,
the FASB issued SFAS Statement No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities", an amendment of FASB Statement No.
133, which makes minor modifications to SFAS No. 133. We do not expect that
application of SFAS 133 or 138 will have a material effect on our financial
position or the results of operations.
Page 7
The SEC issued Staff Accounting Bulletin No. 101B (SAB 101B). SAB 101B delays
the effective date of Staff Accounting Bulletin No. 101 (SAB 101) "Revenue
Recognition in Financial Statements", to the fourth quarter for fiscal years
beginning between December 15, 1999 and March 16, 2000. SAB 101 provides
guidance for revenue recognition and the SEC staff's views on the application of
accounting principles to selected revenue recognition issues. We will adopt the
provisions of SAB 101 in the fourth quarter of 2000 and anticipate that such
adoption will not have a material impact on our consolidated financial
statements.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, "Accounting for Certain Transactions involving Stock Compensation".
Interpretation No. 44 clarifies the application of Accounting Principles Board
Opinion No. 25 (APB 25) and is effective July 1, 2000. Interpretation No. 44
clarifies the definition of "employee" for purposes of applying APB 25, the
criteria for determining whether a plan qualifies as a noncompensatory plan, the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and the accounting for an exchange of stock
compensation awards in a business combination. We do not expect the adoption of
Interpretation No. 44 will have a material impact on our consolidated financial
statements.
NOTE 2. STOCKHOLDERS' EQUITY
a.) Earnings per Share
The following table illustrates the reconciliation of weighted average shares
used for earnings per share for the applicable periods.
Three months ended June 30, Six months ended June 30,
1999 2000 1999 2000
-----------------------------------------------------------
Basic:
Weighted average shares outstanding 10,812,170 9,307,816 10,832,188 9,572,270
Diluted:
Basic weighted average shares outstanding 10,812,170 9,307,816 10,832,188 9,572,270
Incremental shares from unexercised stock options 217,428 134,535 225,668 133,586
-----------------------------------------------------------
Weighted average shares outstanding 11,029,598 9,442,351 11,057,856 9,705,856
===========================================================
As of June 30, 2000 and 1999 there were anti dilutive options of 92,700 and
96,150 respectively, which were not included in the calculation.
b. Cash Dividend Declared
On June 16, 2000, we announced a quarterly cash dividend of 8.0 cents per share
payable on July 28, 2000 to stockholders of record on July 14, 2000.
c. Shares Repurchased
As of June 30, 2000 we have repurchased 1,160,000 shares of Heritage Financial
Corporation stock at a cost of $9,320,000 during the current fiscal year. On
June 28, 2000, our Board of Directors authorized management to obtain approval
to acquire an additional 10% of our outstanding shares.
Page 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the financial
condition and results of operations of Heritage Financial Corporation. The
information contained in this section should be read in conjunction with the
Condensed Financial Statements and the accompanying Notes thereto and the
December 31, 1999 audited consolidated financial statements and notes thereto
included in our recent Annual Report on Form 10-K.
Statements concerning future performance, developments or events, concerning
expectations for growth and market forecasts, and any other guidance on future
periods, constitute forward-looking statements which are subject to a number of
risks and uncertainties which might cause actual results to differ materially
from stated expectations. Specific factors include, but are not limited to the
effect of interest rate changes, risks associated with acquisition of other
banks and opening new branches, the ability to control costs and expenses, and
general economic conditions. Additional information on these and other factors
which could affect our financial results are included in filings by the company
with the Securities and Exchange Commission.
Overview
Beginning in 1994, we began to implement a growth strategy which is intended to
broaden our products and services from traditional thrift products and services
to those more closely related to commercial banking. That strategy entails (1)
geographic and product expansion, (2) loan portfolio diversification, (3)
development of relationship banking, and (4) maintenance of asset quality.
Effective January 8, 1998, we closed our second step conversion and stock
offering which resulted in $63 million in net proceeds. Thereafter, our common
stock began to trade on the Nasdaq National Market under the symbol "HFWA".
Financial Condition Data
Total assets increased $27.1 million (5%) during the six months ended June 30,
2000 to $538.1 million from the December 31, 1999 balance of $511.0 million. The
asset growth was in lending as net loans increased $30.4 million (7%) to $443.9
million at June 30, 2000 from $413.5 million at December 31, 1999. Consistent
with management's efforts to strengthen our commercial lending, commercial loans
provided $23.9 million of growth during the recent six month period. To support
the growth in lending, deposits increased $25.7 million (6%) for the six months
ended June 30, 2000 to $430.8 million from the December 31, 1999 balance of
$405.1 million. Other borrowings increased $11.3 million to $14.1 million at
June 30, 2000 from $2.8 million at December 31, 1999. The Company also reduced
equity during the six months ended June 30, 2000 by repurchasing 1.2 million
shares of common stock, reducing equity by $9.3 million.
Earnings Summary
Net income for the six months ended June 30, 2000 was $2,932,000, or $0.302 per
diluted share, compared to $2,238,000, or $0.203 per diluted share, for the same
period last year representing an increase of 31% in actual earnings and 49% in
earnings per share. The difference in the percentage change for actual and
earnings per share is the result of the stock repurchase program. Net income for
the three months ended June 30, 2000 was $1,473,000, or $0.156 per diluted
share, compared to
Page 9
$1,132,000, or $0.103 per diluted share, for the same period last year
representing an increase of 30% in actual earnings and 51% in earnings per
share. Cash earnings, which exclude the amortization of goodwill recorded on the
acquisition of North Pacific Bank, for the six months ended June 30, 2000 were
$3,123,000, or $0.322 per diluted share compared with $2,431,000, or $0.220 per
diluted share for the same six month period in 1999. Cash earnings for the
quarter ended June 30, 2000 were $1,568,000, or $0.166 per diluted share
compared with $1,229,000, or $0.111 per diluted share for the quarter ended June
30, 1999. The increase in net income was primarily attributable to growth in the
net interest income resulting from earning assets growth.
Net Interest Income
Net interest income after provision for the six months ended June 30, 2000,
increased 10.5% to $12,114,000 from $10,967,000. For the three months ended June
30, 2000, net interest income after provision increased 7.3% to $6,017,000 from
$5,610,000 for the same quarter in 1999. This increase was due to the expansion
of gross loans to $448.6 million at June 30, 2000 from $361.5 million at June
30, 1999.
Net interest margin (net interest income divided by average interest earning
assets) narrowed to 5.23% for the six months ended June 30, 2000 from 5.43% for
the six months ended June 30, 1999. The net interest margin narrowed to 5.10%
for the current quarter from 5.60% for the same quarter last year. The decrease
in margin is attributable to our increased cost of funds. This resulted from a
greater user of public deposits and other borrowings. Public deposits averaged
$45.5 million for the six months ended June 30, 2000 compared to $0.4 million
for the six months ended June 30, 1999. Other borrowings averaged $9.9 million
for the six months ended June 30, 2000 compared to $0.7 million for the six
months ended June 30, 1999. The average cost of funds for the six months ended
June 30, 2000 rose 14% to 4.53% from 3.98% for the same period in 1999. Public
deposits averaged $45.8 million for the quarter ended June 30, 2000, compared to
$0.7 million for the quarter ended June 30, 1999. Other borrowings averaged
$17.8 million for the quarter ended June 30, 2000, compared to $0.6 million for
the quarter ended June 30, 1999. The average cost of funds for the quarter ended
June 30, 2000 rose 22% to 4.75% from 3.89% for the same period in 1999.
Provision for Loan Losses
For the six months ended June 30, 2000 the loan loss provision was $390,000
compared with $204,000 for the six months ended June 30, 1999. The quarterly
provision for loan losses was $195,000 for the current quarter up from $102,000
for the June 1999 quarter. We believe that the increase is necessary to ensure
that we maintain our allowance for loan losses at an adequate level to reflect
the inherent risk given our loan growth and the changes in our loan portfolio
mix.
Noninterest Income
Noninterest income decreased 7.0% to 1,954,000 for the six months ended June 30,
2000 compared with $2,102,000 for the same period in 1999. Noninterest income
for the quarter ended June 30, 2000 increased 5.8% to $1,074,000 compared with
$1,015,000 for the same quarter in 1999. Year to date the decrease is the result
of reduced activity in mortgage banking. Loan sale gains were $294,000 for the
six months ended June 30, 2000 compared with $725,000 for the six months ended
June 30, 1999. The year to date unfavorable impact was strongest in the first
quarter where the gains were $95,000 for the quarter ended March 31, 2000
compared to $432,000 for the quarter ended
Page 10
March 31, 1999. We have experienced an improvement in the level of activity in
the second quarter of 2000 as gain on sales were $199,000, but compared to
$294,000 for the quarter ended June 30, 1999 we are not back to levels
historically enjoyed by the Company.
Noninterest Expense
Noninterest expense increased 1.8% to $9,722,000 for the six months ended June
30, 2000 compared to $9,548,000 for the six months ended June 30, 1999.
Noninterest expense increased 1.3% to $4,909,000 for the quarter ended June 30,
2000 compared to $4,846,000 for quarter ended June 30, 1999. The efficiency
ratio for the six months ended June 30, 2000 improved to 67.24% from 71.93% for
the comparable six month period in 1999. The efficiency ratio for the quarter
ended June 30, 2000 improved to 67.37% from 72.04% for the comparable quarter in
1999. The improvement was the result of growth in net interest income along with
only modest growth in noninterest expense.
Lending Activities
Since initiating our expansion activities in 1994, we have supplemented our
traditional mortgage loan products with an increased emphasis on commercial
loans. As indicated in the table below, total loans increased to $448.6 million
at June 30, 2000 from $417.8 million at December 31, 1999.
(in thousands)
At % of At % of
December 31, 1999 Total June 30, 2000 Total
------------------------------------------------------------------------
Commercial $192,088 45.98 % 210,453 46.91 %
Real estate mortgages
One-to-four family residential 97,907 23.44 103,824 23.15
Five or more family and commercial
properties 94,242 22.56 99,796 22.24
------------------------------------------------------------------------
Total real estate mortgages 192,149 46.00 203,620 45.39
Real estate construction
One-to-four family residential 23,293 5.58 24,643 5.49
Five or more family and commercial
properties 7,537 1.80 6,406 1.43
------------------------------------------------------------------------
Total real estate construction 30,830 7.38 31,049 6.92
Consumer 4,273 1.02 5,134 1.14
------------------------------------------------------------------------
Gross loans 419,340 100.38 % 450,256 100.36 %
Less: deferred loan fees (1,578) (0.38) (1,617) (0.36)
------------------------------------------------------------------------
Total loans $417,762 100.00 % 448,639 100.00 %
========================================================================
Page 11
Nonperforming Assets
The following table sets forth the amount of our nonperforming assets at the
dates indicated.
At At
December 31, June 30,
1999 2000
-----------------------------
(Dollars in thousands)
Nonaccrual loans $ 1,804 1,554
Restructured loans - -
-----------------------------
Total nonperforming loans 1,804 1,554
Real estate owned - -
-----------------------------
Total nonperforming assets $ 1,804 1,554
=============================
Accruing loans past due 90 days or more $ - -
Potential problem loans 2,826 2,570
Allowance for loan losses 4,263 4,694
Nonperforming loans to loans 0.43% 0.35%
Allowance for loan losses to loans 1.02% 1.05%
Allowance for loan losses to nonperforming loans 236.27% 302.01%
Nonperforming assets to total assets 0.35% 0.29%
Nonperforming loans were down to $1,554,000, or 0.35% of total loans, at June
30, 2000 from $1,804,000, or 0.43% of total loans, at December 31, 1999.
Analysis of Allowance for Loan Losses
The allowance for loan losses is maintained at a level we consider adequate to
provide for reasonably foreseeable loan losses based on our assessment of
various factors affecting the loan portfolio, including a review of problem
loans, business conditions and loss experience, an overall evaluation of the
quality of the underlying collateral, holding and disposal costs, and costs of
capital. The allowance is increased by provisions for loan losses charged to
operations and reduced by loans charged off, net of recoveries.
While we believe that we use the best information available to determine the
allowance for loan losses, unforeseen market conditions could result in
adjustments to the allowance for loan losses, and net income could be
significantly affected, if circumstances differ substantially from the
assumptions used in determining the allowance.
Page 12
The following table summarizes the changes in our allowance for loan losses:
Six Months Ended June 30,
1999 2000
-------------------------------------
Total loans outstanding at end of period (1) $361,516 448,639
Average loans outstanding during period 337,139 429,349
Allowance balance at beginning of period 3,957 4,263
Provision for loan losses 204 390
Charge-offs
Real estate -
Commercial (5) (3)
Agriculture - (6)
Consumer (3) (2)
-------------------------------------
Total charge-offs (8) (11)
-------------------------------------
Recoveries
Real estate 16 22
Commercial 30 29
Agriculture - 1
Consumer - -
-------------------------------------
Total recoveries 46 52
-------------------------------------
Net (charge-offs) recoveries 38 41
-------------------------------------
Allowance balance at end of period $ 4,199 4,694
Allowance for loan loss to loans at June 30, 1999
and 2000 1.16% 1.05%
Ratio of net (charge-offs) recoveries during
period to average loans outstanding 0.011% 0.009%
=====================================
__________
(1) Includes loans held for sale
While pursuing our growth strategy, we will continue to employ prudent
underwriting and sound loan monitoring procedures in order to maintain asset
quality. The allowance for loan losses during the six months ended June 30, 2000
increased $431,000 to $4.7 million. The growth in the allowance was due to the
$390,000 provision and $41,000 in net recoveries during the quarter.
Liquidity and Source of Funds
Our primary sources of funds are customer deposits, public fund deposits, loan
repayments, loan sales, maturing investment securities and advances from the
FHLB of Seattle. These funds, together with retained earnings, equity and other
borrowed funds, are used to make loans, acquire investment securities and other
assets and to fund continuing operations. While maturities and scheduled
amortization of loans are a predictable source of funds, deposit flows and
mortgage prepayments are greatly influenced by the level of interest rates,
economic conditions and competition.
We must maintain an adequate level of liquidity to ensure the availability of
sufficient funds to fund loan originations and deposit withdrawals, to satisfy
other financial commitments and to fund operations. We generally maintain
sufficient cash and short term investments to meet short term liquidity needs.
At June 30, 2000, cash and cash equivalents totaled $17.8 million (3.3% of total
assets), and investment securities classified as either available for sale or
held to maturity with
Page 13
maturities of one year or less amounted to $37.5 million (7.0% of total assets).
At June 30, 2000, we maintained a combined credit facility with the FHLB of
Seattle for Heritage Bank and Central Valley Bank of $100.1 million (of which
$14.1 million was outstanding at that date).
Capital
Stockholders' equity at June 30, 2000 was $87.5 million compared with $95.3
million at December 31, 1999. During the period we repurchased $9.3 million of
Heritage Financial Corporation stock, declared two cash dividends totaling $1.4
million (7.5 cents per share, to shareholders of record on April 14, 2000 and
8.0 cents per share to shareholders of record on July 14, 2000), had semi-annual
income of $2.9 million, recorded $38,000 in unrealized losses on securities
available for sale, and our employees and directors exercised stock options of
$104,000.
Banking regulations require bank holding companies and banks to maintain a
minimum "leverage" ratio of core capital to adjusted quarterly average total
assets of at least 3%. At June 30, 2000, our leverage ratio was 15.3%, compared
with 18.8% at December 31, 1999. In addition, banking regulators have adopted
risk-based capital guidelines, under which risk percentages are assigned to
various categories of assets and off-balance sheet items to calculate a risk-
adjusted capital ratio. Tier I capital generally consists of common
shareholders' equity, while Tier II capital includes the allowance for loan
losses, subject to certain limitations. Regulatory minimum risk-based capital
guidelines require Tier I capital of 4% of risk-adjusted assets and total
capital (combined Tier I and Tier II) of 8%. Our Tier I and total capital ratios
were 17.8% and 18.8%, respectively, at June 30, 2000 compared with 21.1% and
22.1%, respectively, at December 31, 1999.
During 1992, the Federal Deposit Insurance Corporation (the "FDIC") published
the qualifications necessary to be classified as a "well-capitalized" bank,
primarily for assignment of FDIC insurance premium rates beginning in 1993. To
qualify as "well-capitalized", banks must have a Tier I risk-adjusted capital
ratio of at least 6%, a total risk-adjusted capital ratio of at least 10%, and a
leverage ratio of at least 5%. Heritage Bank and Central Valley Bank qualified
as "well-capitalized" at June 30, 2000.
Quantitative and Qualitative Disclosures About Market Risk
Our results of operations are highly dependent upon our ability to manage
interest rate risk. We consider interest rate risk to be a significant market
risk that could have a material effect on our financial condition and results of
operations. In our opinion, there has been no material change in our interest
rate risk exposure since our most recent year end at December 31, 1999.
We do not maintain a trading account for any class of financial instrument, nor
do we engage in hedging activities or purchase high risk derivative instruments.
Moreover, we are not subject to foreign currency exchange rate risk or commodity
price risk.
Page 14
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a. The annual meeting of shareholders of Heritage Financial Corporation
was held on May 1, 2000.
b. The following directors were elected to service for a term of three
years: Lynn M. Brunton, Melvin R. Lewis, and Philip S. Weigand. Elected
to a service term of one year was Peter Fluetsch.
c. For the election of directors, the number of votes cast for and
withheld for each director was as follows:
For Withheld
-------------------------------
Lynn M. Brunton 8,252,580 94,816
Melvin R. Lewis 8,247,330 100,066
Philip S. Weigand 8,245,704 101,692
Peter Fluetsch 8,238,431 108,965
ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K
a. See EXHIBIT 27-Financial Data Schedule.
b. On May 24, 2000, the Registrant filed a report on Form 8-K announcing
that our Board of Directors had elected Brian Charneski to the position
of director of the Corporation.
c. On June 28, 2000, the Registrant filed a report on Form 8-K announcing
that our Board of Directors had authorized management to obtain
approval to acquire an additional 10% of our outstanding shares.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HERITAGE FINANCIAL CORPORATION
Date: Aug 11, 2000 by /s/ Donald V. Rhodes
--------------------------
Donald V. Rhodes
Chairman, President and
Chief Executive Officer
(Duly Authorized Officer)
by /s/ Edward D. Cameron
--------------------------
Edward D. Cameron
Vice President and Treasurer
(Principal Financial and
Accounting Officer)
Page 16