SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
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 6, 2001 there were outstanding 7,840,570 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, 2000 and 2001 3
Consolidated Statements of Financial Condition
As of December 31, 2000 and June 30, 2001 4
Consolidated Statements of Stockholders' Equity for the Six Months
Ended June 30, 2001 and Comprehensive Income for the Three and Six
Months Ended June 30, 2000 and 2001 5
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2000 and 2001 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
PART II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
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,
2000 2001 2000 2001
---------------------------------------------------------------
INTEREST INCOME:
Loans $10,180 $10,923 $19,763 $22,044
Investment securities and
FHLB dividends 644 370 1,303 915
Interest bearing deposits 53 152 101 193
------- ------- ------- -------
Total interest income 10,877 11,445 21,167 23,152
INTEREST EXPENSE:
Deposits 4,357 4,739 8,322 9,888
Borrowed funds 308 209 341 570
------- ------- ------- -------
Total interest expense 4,665 4,948 8,663 10,458
------- ------- ------- -------
Net interest income 6,212 6,497 12,504 12,694
PROVISION FOR LOAN LOSSES 195 240 390 518
------- ------- ------- -------
Net interest income after
provision for loan loss 6,017 6,257 12,114 12,176
NONINTEREST INCOME:
Gains on sales of loans 199 427 294 791
Commissions on sales of annuities
and securities 50 30 79 64
Service charges on deposits 398 457 754 843
Rental income 58 67 117 133
Other income 369 382 710 957
------- ------- ------- -------
Total noninterest income 1,074 1,363 1,954 2,788
NONINTEREST EXPENSE:
Salaries and employee benefits 2,625 2,696 5,238 5,411
Building occupancy 767 838 1,519 1,637
Data processing 307 260 608 522
Marketing 124 112 194 193
Goodwill Amortization 145 145 289 289
Other 941 1,562 1,874 2,740
------- ------- ------- -------
Total noninterest expense 4,909 5,613 9,722 10,792
------- ------- ------- -------
Income before federal income tax 2,182 2,007 4,346 4,172
Federal income tax 709 723 1,414 1,499
------- ------- ------- -------
Net income $ 1,473 $ 1,284 $ 2,932 $ 2,673
======= ======= ======= =======
Earnings per share:
Basic $0.158 $0.161 $0.307 $0.331
Diluted $0.156 $0.158 $0.302 $0.324
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,
2000 2001
-----------------------------------------
Assets
Cash on hand and in banks $ 20,187 $ 19,305
Interest earning deposits 1,278 9,481
Federal funds sold - 4,295
Investment securities available for sale 33,695 22,580
Investment securities held to maturity 5,076 3,967
Loans held for sale 1,931 6,790
Loans receivable 480,504 493,789
Less: Allowance for loan losses (5,063) (5,569)
-----------------------------------------
Loans, net 475,441 488,220
Real Estate Owned - 1,110
Premises and equipment, net 19,510 19,125
Federal Home Loan Bank stock 2,723 2,814
Accrued interest receivable 3,693 3,283
Prepaid expenses and other assets 2,779 2,866
Goodwill 7,217 6,929
-----------------------------------------
Total assets $573,530 $590,765
=========================================
Liabilities and Stockholders' Equity
Deposits 460,234 477,406
Advances from Federal Home Loan Bank 23,125 27,400
Other borrowings 1,000 -
Advance payments by borrowers for taxes and insurance 363 204
Accrued expenses and other liabilities 5,037 5,147
Deferred Federal income taxes 766 843
-----------------------------------------
Total liabilities 490,525 511,000
Stockholders' equity:
Common stock, no par value per share,15,000,000 shares authorized;
8,222,988 shares and 7,833,379 outstanding at December 31, 2000
and June 30, 2001, respectively 54,080 49,550
Unearned compensation ESOP and Other (1,074) (1,027)
Retained earnings, substantially restricted 30,000 31,094
Accumulated other comprehensive gain (loss) (1) 148
-----------------------------------------
Total stockholders' equity 83,005 79,765
Commitments and contingencies - -
-----------------------------------------
Total liabilities and stockholders' equity $573,530 $590,765
=========================================
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, 2001
(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, 2000 8,223 $54,080 (1,074) 30,000 (1) $83,005
Earned ESOP shares - (1) 47 - - 46
Stock repurchase (450) (4,740) - - - (4,740)
Exercise of stock options 60 211 - - - 211
Net income - - - 2,673 - 2,673
Increase in unrealized gain on
securities available for sale,
net of tax of $77 - - - - 149 149
Cash dividend declared - - - (1,579) - (1,579)
------------------------------------------------------------------------------
Balance at June 30, 2001 7,833 $49,550 (1,027) 31,094 148 $79,765
==============================================================================
Comprehensive Income Three months ended June 30, Six months ended June 30,
2000 2001 2000 2001
---------------------------------------------------------
Net income $1,473 $1,284 $2,932 $2,673
Change in unrealized gain (loss) on securities
available for sale, net of tax of $17, $17, ($20)
and $77 32 32 (38) 149
---------------------------------------------------------
Comprehensive income $1,505 $1,316 $2,894 $2,822
=========================================================
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,
-----------------------
2000 2001
Cash flows from operating activities:
Net income $ 2,932 $ 2,673
Adjustments to reconcile net income to net cash provided by (used in)
operating activities
Amortization of goodwill 289 289
Depreciation and amortization 853 844
Deferred loan fees, net of amortization (307) (2)
Provision for loan losses 390 513
Net decrease in loans held for sale (2,982) (4,859)
Federal Home Loan Bank stock dividends (72) (84)
Recognition of compensation related to ESOP 31 45
Net change in accrued interest receivable, prepaid expenses and
other assets, and accrued expenses and other liabilities (1,827) 422
-----------------------
Net cash used in operating activities (693) (159)
-----------------------
Cash flows from investing activities:
Loans originated, net of principal payments and loan sales (27,837) (14,400)
Proceeds from maturities of investment securities available for sale 671 28,851
Proceeds from maturities of investment securities held to maturity 584 1,359
Purchase of investment securities available for sale (476) (17,559)
Purchase of investment securities held to maturity - (185)
Purchase of premises and equipment, net of sales (1,424) (523)
-----------------------
Net cash used in investing activities (28,482) (2,457)
-----------------------
Cash flows from financing activities:
Net increase in deposits 25,726 17,171
Net increase in borrowed funds 11,296 3,275
Net decrease in advance payment by borrowers for taxes
and insurance (30) (159)
Cash dividends paid (1,431) (1,526)
Proceeds from exercise of stock options 104 211
Stock repurchased (9,320) (4,740)
-----------------------
Net cash provided by financing activities 26,345 14,232
-----------------------
Net increase (decrease) in cash and cash equivalents (2,830) 11,616
Cash and cash equivalents at beginning of period 20,645 21,465
-----------------------
Cash and cash equivalents at end of period $ 17,815 $ 33,081
=======================
Supplemental disclosures of cash flow information:
Cash payments for:
Interest expense $ 8,482 $ 10,621
Federal income taxes 1,764 1,772
Mortgage loans transferred to real estate owned - 1,110
See Notes to Condensed Consolidated Financial Statements.
Page 6
HERITAGE FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended June 30, 2000 and 2001
(Unaudited)
NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
(a.) Description of Business
Heritage Financial Corporation is a bank holding company incorporated in the
State of Washington in August 1997. We were 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.
We are primarily engaged in the business of planning, directing, and
coordinating the business activities of our 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.
Our business consists primarily of focusing on lending and deposit relationships
with small businesses and their owners in our 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. We also make 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 accounting principles generally accepted in the United
States of America for complete financial statements. These consolidated
financial statements should be read with our December 31, 2000 audited
consolidated financial statements and notes thereto 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, 2001 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2001. 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, (derivatives) and
Page 7
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 have adopted SFAS Statement No. 138 and it did
not have a material impact on our consolidated financial statements.
In September 2000, the Financial Accounting Standards Board issued SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," and replaced SFAS No. 125 of the same title. This statement
revises the standards for accounting for securitizations and other transfers of
financial assets and collateral and requires certain disclosures, but carries
over most of SFAS No. 125's provisions without reconsideration. This statement
is effective for transfers and servicing of financial assets and extinguishments
of liabilities occurring after March 31, 2001 and is effective for recognition
and reclassification of collateral and for disclosures relating to
securitization transactions and collateral for fiscal years ending after
December 15, 2000. We have adopted SFAS Statement No. 140 and it did not have a
material impact on our consolidated financial statements.
In July 2001 the Financial Accounting Standards Board (FASB) issued SFAS No. 141
"Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets."
SFAS No. 141 requires business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting, and broadens the criteria
for recording intangible assets separate from goodwill. Recorded goodwill and
intangibles will be evaluated against this new criteria and may result in
certain intangibles being included in goodwill. Alternatively, certain amounts
initially recorded as goodwill may be separately identified and recognized apart
from goodwill. SFAS No. 142 requires the use of a nonamortization approach to
account for purchased goodwill and certain intangibles. Under a nonamortization
approach, goodwill and certain intangibles will not be amortized into results of
operations, but instead would be reviewed for impairment and written down and
charged to results of operations only in the periods in which the recorded value
of goodwill and certain intangibles is more than its fair value. The provisions
of each statement, which apply to goodwill and intangible assets acquired prior
to June 30, 2001 will be adopted by the Company on January 1, 2002. As of the
date of adoption, the Company expects to have unamortized goodwill in the amount
of $6,640,000, which will be subject to the transition provisions of SFAS 141
and 142.
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,
2000 2001 2000 2001
-----------------------------------------------------------
Basic:
Weighted average shares outstanding 9,307,816 7,968,587 9,572,270 8,072,174
Diluted:
Basic weighted average shares outstanding 9,307,816 7,968,587 9,572,270 8,072,174
Incremental shares from unexercised stock options 134,535 166,082 133,586 162,554
-----------------------------------------------------------
Weighted average shares outstanding 9,442,351 8,134,669 9,705,856 8,234,728
===========================================================
Page 8
As of June 30, 2001 and 2000 there were anti-dilutive shares of 72,600 and
92,700 respectively, excluded from the above disclosure.
b. Cash Dividend Declared
On June 27, 2001, we announced a quarterly cash dividend of 10.0 cents per share
payable on July 25, 2001 to stockholders of record on July 16, 2001.
Page 9
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 with the unaudited
Condensed Financial Statements and its accompanying Notes, and the December 31,
2000 audited consolidated financial statements and notes 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".
Heritage Bank initiated a major effort to improve efficiency and to enhance our
revenue stream in November of 2000. We called this initiative "Vision 2001".
We engaged Alex Sheshunoff Management Services, L.P. (ASM) to assist us in this
effort. ASM completed an Opportunities Assessment with the objective of
determining ways that we can optimize our earnings performance and in March
2001, ASM began working with us to implement the opportunities identified.
Through June 30, 2001, we recognized $389,000 in after-tax expenses associated
with "Vision 2001". We incurred the majority of these expenses, which totaled
$296,000 after-tax, during the three months ended June 30, 2001. We do not
anticipate any further "Vision 2001" costs will be incurred during the remainder
of 2001, but we expect positive results to start accruing in the third and
fourth quarters. When announced, we expected the costs associated with "Vision
2001" to be $0.05 to $0.06 per share occurring primarily in the second quarter.
With the costs finalized, the impact has been to reduce earnings per share in
the second quarter by $0.036 per share and by $0.011 per share in the first
quarter. The total cost of $0.047 per share is in line with our original
projections.
Financial Condition Data
Total assets increased $17.3 million (3%) during the six months ended June 30,
2001 to $590.8 million from the December 31, 2000 balance of $573.5 million.
Total assets grew as net loans increased $17.6 million (3.7%) to $495.0 million
at June 30, 2001 from $477.4 million at December
Page 10
31, 2000. The commercial loan portfolio grew $15.3 million during the recent six
month period. The growth is consistent with management's efforts to strengthen
commercial lending. Commercial loans continue to be the largest segment of the
loan portfolio at 49.84% and 48.54% as a percentage of total loans at June 30,
2001 and December 31, 2000, respectively. Deposits increased $17.2 million
(3.7%) to $477.4 million for the six months ended June 30, 2001 from $406.2
million as of December 31, 2000.
In addition to the 100,000 shares repurchased in April 1999, the company started
the first of four 10% stock repurchase programs in October 1999. As of June 30,
2001, the Company repurchased a total of 3,223,034 shares, or 29.0% of the total
outstanding at March 1999 at an average price of $8.86 per share. During the
quarter ended June 30, 2001, 222,093 shares were repurchased at an average price
of $10.47. The Company began its fourth, and current, 10% repurchase program in
May 2001 with a target to repurchase approximately 800,000 shares over a period
of eighteen months. Through June 30, 2001, 170,743 shares were repurchased or
21.3% of the fourth program at an average price of $10.56.
Earnings Summary
Net income for the three months ended June 30, 2001 was $1,284,000 or $0.158 per
diluted share, compared to $1,473,000 or $0.156 per diluted share for the same
period last year, resulting in a decrease in net income of 12.8% and an increase
in per share earnings of 1.3%. Due to "Vision 2001", the 2nd quarter net income
was reduced by $296,000 in after-tax expenses or $0.036 per diluted share. Net
income, excluding "Vision 2001", was $1,580,000 or $0.194 per diluted share.
Net income for the six months ended June 30, 2001 was $2,673,000 or $0.324 per
diluted share, compared to $2,932,000, or $0.302 per diluted share for the same
period last year, resulting in a decrease in net income of 8.8% and an increase
in per share earnings of 7.3%. Net income for the six months ended June 30,
2001 was reduced by $389,000 after-tax or $0.048 per diluted share because of
the impact of "Vision 2001". Excluding the impact of "Vision 2001", net income
for the six months ended June 30, 2001 was $3,062,000 or $0.372 per diluted
share. The increase in the earnings per share is a result of the ongoing stock
repurchase program, which continues to be accretive to earnings per share. Cash
earnings for the quarter ended June 30, 2001 were $1,428,000, or $0.176 per
diluted share compared with $1,617,000, or $0.171 per diluted share for the
quarter ended June 30, 2000. Cash earnings for the six months ended June 30,
2001, which exclude the amortization of goodwill recorded on the acquisition of
North Pacific Bank, were $2,962,000, or $0.360 per diluted share compared with
$3,221,000, or $0.332 per diluted share for the same six month period in 2000.
Excluding "Vision 2001", cash earnings for the six months ended June 30, 2001
were $3,350,000 or $0.407 per diluted share.
Net Interest Income
Net interest income before provision for loan loss for the six months ended June
30, 2001, increased 1.5% to $12,694,000 from $12,504,000 for the six months
ended June 30, 2000. For the three months ended June 30, 2001, net interest
income before provision for loan loss increased 4.6% to $6,497,000 from
$6,212,000 for the three months ended June 30, 2000. The increase in net
interest income due to the expansion of gross loans to $500.6 million at June
30, 2001 from $448.6 million at June 30, 2000 was somewhat offset by a reduced
margin and lower levels of equity in the current period. Net interest margin
(net interest income divided by average interest earning assets)
Page 11
narrowed to 4.79% for the six months ended June 30, 2001 from 5.23% for the six
months ended June 30, 2000. For the three month period ended June 30, 2001 the
net interest margin narrowed to 4.89% from 5.10% for the same quarter last year.
The decrease in margin for the six month period is primarily attributable to the
increased use of higher costing funds, a sharply reduced prime rate, and the
reduction of capital through the stock repurchase program. The average cost of
funds for the six months ended June 30, 2001 rose 3.8% to 4.70% from 4.53% for
the same period in 2000. For the three month period ended June 30, 2001, the
average cost of funds declined 7.2% to 4.41% from 4.75% for the quarter ended
June 30, 2000. The overall decline of our cost of funds in the 2nd quarter can
be attributed to the large number of certificates of deposit that repriced in
the 1st half of the year. Average equity declined to $82.8 million for the 1st
half of 2001 from $92.8 million in the 1st half of 2000. For the 2nd quarter of
2001 average equity declined to $81.9 million from $91.3 million in the 2nd
quarter of 2000.
Provision for Loan Losses
For the six months ended June 30, 2001 the loan loss provision was $518,000
compared with $390,000 for the six months ended June 30, 2000. The quarterly
provision for loan losses was $240,000 for the current quarter up from $195,000
for the June 2000 quarter. We believe that the increases were necessary to
ensure that we maintain our allowance for loan losses at an adequate level given
the increased risk in our loan portfolio resulting from our growing emphasis on
commercial lending, and our agricultural portfolio at Central Valley Bank.
Noninterest Income
Noninterest income increased 42.7% to $2,788,000 for the six months ended June
30, 2000 compared with $1,954,000 for the same period in 2000. Noninterest
income for the quarter ended June 30, 2001 increased 26.9% to $1,363,000
compared with $1,074,000 for the same quarter in 2000. The increase is the
result of increased activity in mortgage banking; the sale of our ownership
interest in Transalliance Corporation (a debit/credit card processor), which
resulted in a pre-tax gain of $143,000 in the 1st quarter of this year; and the
sale of excess land at Central Valley Bank's Toppenish office, which resulted in
a pre-tax gain of $66,000 also in the 1st quarter of this year. Loan sale
gains were $791,000 for the six months ended June 30, 2001 compared with
$294,000 for the six months ended June 30, 2000. The improvement in the 2nd
quarter of this year over last year's 2nd quarter was primarily due to increased
mortgage banking activity and increased service charges on deposits.
Noninterest Expense
Noninterest expense increased 14.3% to $5,613,000 for the quarter ended June 30,
2001 compared to $4,909,000 for quarter ended June 30, 2000. When "Vision 2001"
after-tax expenses of $296,000 are excluded, the increase was 5.2%. Noninterest
expense increased 11.0% to $10,792,000 for the six months ended June 30, 2001
compared to $9,722,000 for the six months ended June 30, 2000. Excluding "Vision
2001" after-tax expenses of $389,000, the increase was 5.0%. For the quarter
ended June 30, 2001, the efficiency ratio increased to 71.41% from 67.37% for
the comparable quarter in 2000. The efficiency ratio for the six months ended
June 30, 2001 grew to 69.71% from 67.24% for the comparable six-month period in
2000. Excluding non-recurring items, the current six-
Page 12
month period efficiency ratio declined to 66.53%. We expect future noninterest
expenses to be contained as a result of "Vision 2001".
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 $500.6 million
at June 30, 2001 from $482.4 million at December 31, 2000.
(in thousands)
At % of At % of
December 31, 2000 Total June 30, 2001 Total
----------------------------------------------------------------------
Commercial $234,166 48.54% $249,487 49.84%
Real estate mortgages
One-to-four family residential 107,501 22.28 102,582 20.49
Five or more family and commercial
properties 109,560 22.71 107,428 21.46
---------------------------------------------------------------------
Total real estate mortgages 217,061 44.99 210,010 41.95
Real estate construction
One-to-four family residential 27,412 5.68 37,128 7.42
Consumer 5,466 1.13 5,476 1.09
---------------------------------------------------------------------
Gross loans 484,105 100.35% 502,101 100.30%
Less: deferred loan fees (1,670) (0. 35) (1,522) (0.30)
---------------------------------------------------------------------
Total loans $482,435 100.00% $500,579 100.00%
=====================================================================
Nonperforming Assets
The following table sets forth the amount of our nonperforming assets at the
dates indicated.
At At
December 31, June 30,
2000 2001
------------------------------------------
(Dollars in thousands)
Nonaccrual loans $ 1,607 $ 1,571
Restructured loans - -
-----------------------------------------
Total nonperforming loans 1,607 1,571
Real estate owned - 1,110
-----------------------------------------
Total nonperforming assets $ 1,607 $ 2,681
=========================================
Accruing loans past due 90 days or more $ 1,086 $ 357
Potential problem loans $ 2,422 $ 5,611
Allowance for loan losses $ 5,063 $ 5,569
Nonperforming loans to loans 0.33% 0.31%
Allowance for loan losses to loans 1.05% 1.11%
Allowance for loan losses to nonperforming loans 315.02% 354.39%
Nonperforming assets to total assets 0.28% 0.45%
Page 13
Nonperforming assets increased to $2,681,000, or 0.45% of total assets, at June
30, 2001 from $1,607,000, or 0.28% of total assets, at December 31, 2000. The
increase was predominately due to one credit of $977,000. The collateral
securing the credit was repossessed during the first quarter. No loss is
currently expected, because of the value of the underlying collateral.
Potential problem loans are those that display a high degree of credit risk for
a variety of reasons including adverse borrower trends. They may or may not be
performing at an acceptable level. The increase of $3.19 million in potential
problem loans from December 31, 2000 to June 30, 2001 is primarily due to one
loan on a strip mall. The loan is adequately collateralized and is, at this
time, performing at an acceptable level. However, we felt that adverse borrower
trends warranted reporting this loan as a potential problem loan.
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 in our loan portfolio based on
our assessment of various factors 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.
The following table summarizes the changes in our allowance for loan losses:
Six Months Ended June 30,
2000 2001
----------------------------------------
Allowance balance at beginning of period $4,263 $5,063
Provision for loan losses 390 518
Charge-offs
Real estate - -
Commercial (3) -
Agriculture (6) (9)
Consumer (2) (4)
----------------------------------------
Total charge-offs (11) (13)
----------------------------------------
Recoveries
Real estate 22 .5
Commercial 29 .5
Agriculture 1 -
Consumer - -
----------------------------------------
Total recoveries 52 1
----------------------------------------
Net (charge-offs) recoveries 41 (12)
----------------------------------------
Allowance balance at end of period $4,694 $5,569
========================================
Allowance for loan loss to loans 1.05% 1.11%
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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, 2001, cash and cash equivalents totaled $28.8 million (4.9% of total
assets), and investment securities classified as either available for sale or
held to maturity with maturities of one year or less amounted to $2.15 million
(0.37% of total assets). At June 30, 2001, we maintained a combined credit
facility with the FHLB of Seattle for Heritage Bank and Central Valley Bank of
$100.8 million (of which $27.4 million was outstanding at that date).
Capital
Stockholders' equity at June 30, 2001 was $79.8 million compared with $83.0
million at December 31, 2000. During the period, we repurchased $4.7 million of
Heritage Financial Corporation stock, declared two cash dividends totaling $1.6
million (9.5 cents per share to shareholders of record on April 16, 2001 and
10.0 cents per share to shareholders of record on July 16, 2001), had semi-
annual income of $2.7 million, recorded $149,000 in unrealized gains on
securities available for sale, and our employees and directors exercised stock
options totaling $211,000.
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, 2001, our leverage ratio was 12.7%, compared
with 14.0% at December 31, 2000. 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 14.7% and 15.8%, respectively, at June 30, 2001 compared with 16.0%
and 17.1%, respectively, at December 31, 2000.
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, 2001.
Page 15
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. During the first six months of this year, the Federal Reserve moved
to significantly lower short term interest rates. In our opinion, there has not
been a material change in our interest rate risk exposure since our most recent
year end at December 31, 2000.
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 16
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 April 26, 2001.
b. The following directors were elected to service for a term of three
years: James P. Senna, Peter Fluetsch, and Brian Charneski. Elected to
a service term of one year was Jeffrey Lyon.
c. For the election of directors, the number of votes cast for and
withheld for each director was as follows:
For Withheld
--------------------------------
James P. Senna 7,180,309 187,913
Peter Fluetsch 7,329,307 38,915
Brian Charneski 7,314,616 53,603
Jeffrey Lyon 7,302,828 65,394
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. There are no exhibits with this report.
b. On April 26, 2001 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.
Page 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned.
HERITAGE FINANCIAL CORPORATION
Date: August 8, 2001 by /s/ Donald V. Rhodes
-----------------------------------------------
Donald V. Rhodes
Chairman, President and Chief Executive Officer
(Authorized Officer)
by /s/ Edward D. Cameron
-----------------------------------------------
Edward D. Cameron
Vice President and Treasurer
(Principal Financial and Accounting Officer)
Page 18