SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
[X] SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
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, 1999 there were outstanding 10,901,121 common shares, with no
par value, of the registrant.
Note: This amendment is to correct a typographical error on the Registrant's
Consolidated Statements of Cash Flows on page 6.
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 3
Months and Six Months Ended June 30, 1998 and 1999
Consolidated Statements of Financial Condition 4
As of December 31, 1998 and June 30, 1999
Consolidated Statements of Stockholders' Equity and 5
Comprehensive Income for the Six Months Ended
June 30, 1999
Consolidated Statements of Cash Flows for the 6
Six Months Ended June 30, 1998 and 1999
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of 10
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II. Other Information 18
- -------- -----------------
Item 1. Legal Proceedings 18
Item 2. Changes In Securities 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters To A Vote of Security Holders 18
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
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,
-------------------- -----------------------
1998 1999 1998 1999
------ ----- ------ ------
INTEREST INCOME:
Loans $6,447 7,790 12,374 15,282
Investment securities and FHLB dividends 598 716 1,002 1,472
Interest bearing deposits 805 212 1,786 672
------ ----- ------ ------
Total interest income 7,850 8,718 15,162 17,426
INTEREST EXPENSE:
Deposits 3,067 2,997 6,010 6,236
Borrowed funds 15 9 25 19
------ ----- ------ ------
Total interest expense 3,082 3,006 6,035 6,255
------ ----- ------ ------
Net interest income 4,768 5,712 9,127 11,171
PROVISION FOR LOAN LOSSES 39 102 78 204
------ ----- ------ ------
Net interest income after provision for loan 4,729 5,610 9,049 10,967
loss
NONINTEREST INCOME:
Gains on sales of loans 587 294 1,304 725
Commissions on sales of annuities
and securities 45 50 76 132
Service charges on deposits 271 340 514 674
Rental income 52 49 104 98
Other income 140 282 265 473
------ ----- ------ ------
Total noninterest income 1,095 1,015 2,263 2,102
NONINTEREST EXPENSE:
Salaries and employee benefits 1,934 2,364 3,800 4,862
Building occupancy 572 713 1,116 1,477
Data processing 261 334 482 607
Marketing 117 142 223 278
Goodwill Amortization 3 147 6 292
Other 815 1,146 1,565 2,032
------ ----- ------ ------
Total noninterest expense 3,702 4,846 7,192 9,548
------ ----- ------ ------
Income before federal income tax 2,122 1,779 4,120 3,521
Federal income tax 744 647 1,431 1,283
------ ----- ------ ------
Net income $1,378 1,132 2,689 2,238
====== ===== ====== ======
Earnings per share:
Basic $0.13 0.11 0.26 0.21
Diluted $0.12 0.10 0.24 0.20
See Notes to Condensed Consolidated Financial Statements
3
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
December 31, June 30,
1998 1999
-------------------------------------
Assets (Unaudited)
Cash on hand and in banks $ 13,793 14,320
Interest earning deposits 36,355 5,376
Federal funds sold 20,800 1,900
Investment securities available for sale 31,625 36,612
Investment securities held to maturity 15,897 8,948
Loans held for sale 7,618 4,135
Loans receivable 319,334 357,381
Less: Allowance for loan losses (3,957) (4,199)
-------------------------------------
Loans, net 315,377 353,182
Real Estate Owned - 70
Premises and equipment, net 18,122 18,194
Federal Home Loan Bank stock 2,136 2,214
Accrued interest receivable 2,735 2,626
Prepaid expenses and other assets 3,041 2,525
Goodwill 8,372 8,219
-------------------------------------
$475,871 458,321
=====================================
Liabilities and Stockholders' Equity
Deposits 367,104 351,412
Advances from Federal Home Loan Bank 688 328
Other borrowings 17 12
Advance payments by borrowers for taxes and insurance 476 366
Accrued expenses and other liabilities 5,992 4,754
Deferred Federal income taxes 1,035 980
-------------------------------------
375,312 357,852
Stockholders' equity:
Common stock, no par value per share,15,000,000 shares authorized;
10,844,916 shares and 10,777,228 outstanding, respectively 77,476 76,714
Unearned compensation ESOP and Other (1,242) (1,217)
Retained earnings, substantially restricted 24,199 25,194
Accumulated other comprehensive income 126 (222)
-------------------------------------
Total stockholders' equity 100,559 100,469
Commitments and contingencies
-------------------------------------
$475,871 458,321
=====================================
See Notes to Condensed Consolidated Financial Statements
4
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Six Months Ended June 30, 1999
(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, 1998 10,845 $77,476 (1,242) 24,199 126 100,559
Earned ESOP shares - - 25 - - 25
Exercise of stock options 32 94 - - - 94
Stock Repurchase (100) (856) - - - (856)
Net income - - - 2,238 - 2,238
Decrease in unrealized gain on
securities available for sale, net
of tax of $179 - - - - (348) (348)
Cash dividend declared - - - (1,243) - (1,243)
------------------------------------------------------------------------------------------
Balance at June 30, 1999 10,777 $76,714 (1,217) 25,194 (222) 100,469
==========================================================================================
Six months ended
Comprehensive Income June 30,
------------------------------------------
1998 1999
------------------------------------------
Net income $2,689 $2,238
Decrease in unrealized gain on securities
available for sale, net of tax of $179 - (348)
------------------------------------------
Comprehensive income $2,689 $1,890
==========================================
See Notes to Condensed Consolidated Financial Statements
5
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Six Months
Ended
June 30,
-----------------------
1998 1999
-------- -------
Cash flows from operating activities:
Net income $ 2,689 2,238
Adjustments to reconcile net income to net cash provided by
operating activities
Amortization of goodwill 6 292
Depreciation and amortization 401 818
Deferred loan fees, net of amortization (111) (53)
Provision for loan losses 78 204
Net (increase)decrease in loans held for sale (1,369) 3,483
Federal Home Loan Bank stock dividends (69) (78)
Recognition of compensation related to ESOP (29) 25
Net change in accrued interest receivable, prepaid expenses and
other assets, and accrued expenses and other liabilities 644 (594)
-----------------------
Net cash provided by operating activities 2,240 6,335
-----------------------
Cash flows from investing activities:
Loans originated, net of principal payments and loan sales (12,892) (37,956)
Proceeds from maturities of investment securities available for sale 2,397 5,650
Proceeds from maturities of investment securities held to maturity 5,938 7,109
Purchase of investment securities available for sale (5,208) (11,158)
Purchase of investment securities held to maturity (19,010) (155)
Purchase of premises and equipment (336) (1,160)
Acquisition of North Pacific Bank, Net of cash acquired 10,573 -
-----------------------
Net cash used by investing activities (18,538) (37,670)
-----------------------
Cash flows from financing activities:
Net decrease in deposits (64,525) (15,692)
Net increase (decrease) in borrowed funds 224 (365)
Net increase in advance payment by borrowers for taxes
and insurance (55) (110)
Cash dividends paid (341) (1,088)
Proceeds from exercise of stock options 107 94
Net proceeds from stock offering (repurchase) 63,030 (856)
-----------------------
Net cash used by financing activities (1,560) (18,017)
-----------------------
Net decrease in cash and cash equivalents (17,858) (49,352)
Cash and cash equivalents at beginning of period 98,686 70,948
-----------------------
Cash and cash equivalents at end of period $ 80,828 21,596
=======================
Supplemental disclosures of cash flow information:
Cash payments for:
Interest expense $ 6,194 6,484
Federal income taxes 768 1,400
See Notes to Condensed Consolidated Financial Statements
6
HERITAGE FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended June 30, 1998 and 1999
(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
the 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). Central Valley Bank conducts business from
its main office in Toppenish, Washington and its four branch offices located in
Yakima County.
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 the Company's December 31, 1998 audited consolidated financial
statements and notes thereto included in the Company's Annual Report on Form 10-
K filed with the Securities and Exchange Commission under file number 333-35573.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the three and six months ended June 30, 1999 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1999. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the dates of the statements of
financial condition, contingent assets and liabilities and revenues and expenses
for the periods presented.
7
NOTE 2. BUSINESS COMBINATIONS
(a.) North Pacific Bank
The Company completed the acquisition of North Pacific Bank effective June 12,
1998. Effective November 20, 1998, the operations of North Pacific Bank were
merged with Heritage Bank. This acquisition was treated as a purchase for
accounting purposes. The financial statements for the six months ended June 30,
1999 include the operations of the former North Pacific Bank. The following
information presents the proforma results of operations for the six months ended
June 30, 1998 as though the acquisition had occurred on January 1, 1998. The
proforma results do not necessarily indicate the actual results that would have
been obtained.
Three Months Ended Six Months Ended
June 30, 1998 June 30, 1998
Unaudited Proforma Unaudited Proforma
------------------------------------------------------------
(in thousands except per share amounts)
Net interest income before provision for loan
losses $5,913 $11,083
Net income 1,479 2,651
Earnings per share:
Basic $ 0.14 $ 0.25
Diluted $ 0.13 $ 0.24
(b.) Washington Independent Bancshares, Inc.
Effective March 5, 1999, the Company acquired all of the outstanding common
stock of Washington Independent Bancshares, Inc. (whose wholly owned subsidiary
is Central Valley Bank, N.A., Toppenish, Washington) in exchange for 1,058,200
shares of Heritage common stock. This transaction was accounted for as a
pooling of interests and, accordingly, the Company's financial information
reported herein has been restated to include the accounts and results of
operations of Washington Independent Bancshares, Inc.
NOTE 3. STOCKHOLDERS' EQUITY
a.) Earnings per Share
The following tables illustrate the reconciliation of weighted average shares
used for earnings per share for the applicable periods.
Three months ended Six months ended
June 30, June 30,
---------------------------------- ---------------------------
1998 1999 1998 1999
------------------------------------------------------------------
Basic:
Weighted average shares outstanding 10,572,958 10,812,170 10,552,945 10,832,255
Diluted:
Basic weighted average share outstanding 10,572,958 10,812,170 10,552,945 10,832,255
Incremental shares from stock options 519,745 217,428 516,308 225,668
------------------------------------------------------------------
Weighted average shares outstanding 11,092,703 11,029,598 11,069,253 11,057,923
==================================================================
8
b. Cash Dividend Declared
On June 18, 1999, the Company announced a quarterly cash dividend of 6.0 cents
per share payable on July 27, 1999 to shareholders of record on July 15, 1999.
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 the Company. 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, 1998 audited
consolidated financial statements and notes thereto included in the Company's
recent Annual Report on Form 10-K filed with the Securities and Exchange
Commission under file number 333-35573
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 the Company's financial results are included in filings by
the Company with the Securities and Exchange Commission.
Overview
Beginning in 1994, the Company began to implement a growth strategy which is
intended to broaden its 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, the Company closed its second step
conversion and stock offering which resulted in $63 million in net proceeds.
Thereafter, the Company's common stock began to trade on the Nasdaq National
Market under the symbol "HFWA". The Company intends to continue to fund its
assets primarily with retail deposits, although FHLB advances may be used as a
supplemental source of funds, and it believes that the capital raised in the
recent stock offering will enhance its ability to continue implementing its
growth strategy.
Financial Condition Data
The Company's total assets and deposits at June 30, 1999 declined to $458.3
million and $351.4 million, respectively, from December 31, 1998 levels of
$475.9 million and $367.1 million, respectively. During the six months ended
June 30, 1999, total assets and deposits each declined 4%, primarily due to
management intentionally reducing the Company's level of dependence on higher
cost certificates of deposit in late 1998 and early 1999. While this deposit
pricing strategy suppressed deposit growth during the first half of 1999, it had
an overall favorable impact of lowering the Company's cost of deposits. During
the six months ended June 30, 1999, net loans increased $34.3 million, or 11%,
to $357.3 million from December 31, 1998. Commercial loans increased to $157.7
million at June 30, 1999, compared with $128.2 million at December 31, 1998, an
increase of 23%. At June 30, 1999 commercial loans as a percentage of total
loans increased to 44% compared with 36% and 39% at June 30, 1998 and December
31, 1998, respectively.
10
Earnings Summary
Net income for the three months ended June 30, 1999 was $1.1 million, or $0.10
per diluted share, compared to $1.4 million, or $0.12 per diluted share, for the
same period last year, a decrease of 18%. Cash earnings, which exclude the
amortization of goodwill recorded on the acquisition of North Pacific Bank, for
the quarter ended June 30, 1999 were $1.28 million, or $0.12 per diluted share
compared with $0.12 per diluted share for the same quarter last year. The
decrease in net income was attributable to noninterest expenses increasing at a
faster pace than net interest income primarily as a result of the impact of the
acquisition and integration of North Pacific Bank and increased staffing and
item processing hardware, software and facilities to further support the
Company's commercial banking efforts.
Net Interest Income
Net interest income for the three months ended June 30, 1999 increased 20% to
$5.7 million from $4.8 million for the same quarter in 1998. This increase in
net interest income was predominately due to a $42.5 million, or 12%, increase
in the average balance of earning assets for the current quarter versus the same
quarter last year. The acquisition of North Pacific Bank in June 1998 was
responsible for $48.6 million of the total increase in the average balance of
earning assets in the June 1999 quarter which was offset by the decline in
deposits from management intentionally reducing the Company's level of
dependence on higher cost certificates of deposit in late 1998 and early 1999.
Net interest margin (net interest income divided by average interest earning
assets) widened to 5.60% for the current quarter from 5.22% for the same
quarter last year. The increase in net interest margin reflects (i) the higher
margin on earning assets acquired with North Pacific Bank, (ii) a shift from
lower yielding investments and interest bearing deposits to higher yielding
loans and, (iii) lower cost of deposits. Despite the improved net interest
margin, the Company continues to experience downward pressure on lending spreads
due to increased competition and the shape of the yield curve. The impact of
downward pressure on lending yields was somewhat mitigated during the current
quarter due to the average balance of loans growing faster (27%) than average
earning assets (12%) and thereby shifting lower yielding funds in interest
earning deposits into higher yielding loans. The average yield on earning
assets declined to 8.55% for the current quarter from 8.60% for the June 1998
quarter while the Company's cost of funds improved to 3.89% for the current
quarter compared to 4.60% for the June 1998 quarter. The improvement in the
Company's cost of deposits was attributable to management's intentional pricing
posture on certificates of deposit and savings accounts coupled with falling
market interest rates in the second half of 1998 and early 1999. While this
deposit pricing strategy suppressed deposit growth during the first half of
1999, it had an overall favorable impact on lowering the cost of deposits and
continuing the structural shift in deposit mix from higher cost certificates of
deposit toward lower costing transaction accounts. The structural shift in
deposit mix is part of the Company's strategy to transform its balance sheet
toward an emphasis on commercial banking relationships and in particular, to
reduce its dependency on certificates of deposit.
11
Provision for Loan Losses
The Company increased the provision for loan losses to $102,000 for the current
quarter from $39,000 for the June 1998 quarter in order to maintain its
allowance for loan losses at an adequate level during a time of change in loan
portfolio composition and loan growth.
Noninterest Income
Noninterest income decreased 7% to $1.0 million for the three months ended June
30, 1999, compared with $1.1 million for the same quarter in 1998. This
decrease was primarily attributable to a 34% decrease in the volume of mortgage
loans sold due to lower mortgage loan originations during second quarter 1999
compared with the second quarter 1998. The Company's decline in mortgage
banking activity was comparable to the regionwide decline in activity for
mortgage lenders during the second quarter of 1999. The volume of mortgage
originations during the first half of 1998 was significantly influenced by a
refinance boom. Mortgage originations for the first half of 1999 were more in
line with the same period in 1997 as neither of these periods were influenced as
significantly by refinance activity as was the 1998 period. This decrease in
loan sale gains was partially offset by a 25% increase in service charges on
deposits in second quarter 1999 due to growth in business and personal checking
accounts.
Noninterest Expense
Noninterest expense increased 31% to $4.8 million for the second quarter 1999,
compared to $3.7 million for second quarter 1998. Of this total increase, $0.8
million was due to the impact of the acquisition and integration of the
operations of North Pacific Bank, primarily in the areas of compensation,
occupancy, amortization of goodwill and other noninterest expenses. Excluding
the impact of the acquisition and integration of the operations of North Pacific
Bank, noninterest expenses increased $0.3 million, or 9%, for the June 1999
quarter compared to the same quarter in 1998. This increase was attributable to
management increasing its investment in lending and operations staff and item
processing hardware, software and facilities to further support the Company's
commercial banking efforts. The efficiency ratio for the quarter ended June 30,
1999 increased to 72.04% from 63.14% for the comparable quarter in 1998.
Contributing to this increase, revenues were below expected levels due to a 50%
drop in gains on sale of mortgage loans (compared with the 1998 quarter) and a
decrease in the yield on earning assets which resulted from falling market
interest rates initiated by Federal Reserve rate cuts in fourth quarter 1998 as
well as the increase in noninterest expenses. The efficiency ratio for the
quarter ended March 31, 1999 was 71.83%.
12
Lending Activities
Since initiating its expansion activities in 1994, the Company has continued to
pursue a growth strategy to broaden its products and services from traditional
thrift offerings to those more closely related to commercial banking. As
indicated in the table below, total loans increased to $361.5 million at June
30, 1999 from $326.9 million at December 31, 1998. At June 30, 1999, commercial
loans increased to $157.7 million, or 43.62% of total loans, from $128.2
million, or 39.20% of total loans, at December 31, 1998.
(in thousands)
At At
December 31, % of June 30, % of
1998 Total 1999 Total
---------------------------------------------------------------------
Commercial $128,171 39.20% $157,679 43.62%
Real estate mortgages
One-to-four family residential 97,277 29.76 95,002 26.27
Five or more family and commercial
properties 70,139 21.45 79,490 21.99
---------------------------------------------------------------------
Total real estate mortgages 167,416 51.21 174,492 48.26
Real estate construction
One-to-four family residential 26,640 8.15 25,720 7.11
Five or more family and commercial
properties 2,124 0.65 1,031 0.29
---------------------------------------------------------------------
Total real estate construction 28,764 8.80 26,751 7.40
Consumer 4,000 1.22 4,032 1.12
---------------------------------------------------------------------
Gross loans 328,351 100.43% 362,954 100.40%
Less: deferred loan fees (1,399) (0.43) (1,438) (0.40)
---------------------------------------------------------------------
Total loans $326,952 100.00% $361,516 100.00%
=====================================================================
13
Nonperforming Assets
The following table sets forth the amount of the Company's nonperforming assets
at the dates indicated.
At At
December 31, June 30,
1998 1999
====================================================
(Dollars in thousands)
Nonaccrual loans $ 402 657
Restructured loans - -
----------------------------------------------------
Total nonperforming loans 402 657
Real estate owned 0 70
----------------------------------------------------
Total nonperforming assets $ 402 727
====================================================
Accruing loans past due 90 days or more $ 8 -
Potential problem loans 898 3,474
Allowance for loan losses 3,957 4,199
Nonperforming loans to loans 0.12% 0.18%
Allowance for loan losses to loans 1.21% 1.16%
Allowance for loan losses to nonperforming loans 984.70% 639.37%
Nonperforming assets to total assets 0.08% 0.16%
Nonperforming loans increased to $657,000, or 0.18% of total loans, at June 30,
1999 from $402,000, or 0.12% of total loans, at December 31, 1998.
Nonperforming assets at June 30, 1999 amounted to $727,000, or 0.16% of total
assets. At June 30, 1999, the Company's nonperforming assets consisted of
three single family mortgage loans, three loans to small businesses and a
foreclosed single family residence. For the median of 35 West Coast publicly
traded banks as monitored by Pacific Crest Securities, nonperforming assets were
0.56% of total assets at March 31, 1999 (the most recent data available).
Analysis of Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered adequate by
management to provide for reasonably foreseeable loan losses based on
management's assessment of various factors affecting the loan portfolio,
including a review of problem loans, business conditions and loss experience and
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 management believes that it uses 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.
14
The following table sets forth for the periods indicated information regarding
changes in the Company's allowance for loan losses:
Six Months Ended June 30,
----------------------------------------------------------
1998 1999
----------------------------------------------------------
Total loans outstanding at end of period (1) $314,095 361,516
Average loans outstanding during period 262,939 337,139
Allowance balance at beginning of period 3,180 3,957
Provision for loan losses 78 204
Provision acquired with North Pacific Bank 670 -
Charge-offs
Real estate - -
Commercial - (5)
Consumer - (3)
----------------------------------------------------------
Total charge-offs - (8)
----------------------------------------------------------
Recoveries
Real estate - 16
Commercial - 30
Consumer 1 -
----------------------------------------------------------
Total recoveries 1 46
----------------------------------------------------------
Net (charge-offs) recoveries 1 38
----------------------------------------------------------
Allowance balance at end of period $ 3,929 4,199
==========================================================
Ratio of net (charge-offs) recoveries during
period to average loans outstanding 0.00% (0.01%)
==========================================================
__________
(1) Includes loans held for sale
While pursuing its growth strategy, the Company will continue to employ prudent
underwriting and sound loan monitoring procedures in order to maintain asset
quality. The allowance for loan losses at June 30, 1999 increased $242,000 to
$4.2 million, or 1.16% of total loans. The Company has loans to small
businesses and farmers which are substantially guaranteed by agencies of the US
Government (i.e. Farm Service Agency and Small Business Administration). At
June 30, 1999, the government guaranteed portion of these loans amounted to
$20.1 million. Excluding the $20.1 million in government guaranteed loans, the
Company's allowance for loan losses was 1.23% of nonguaranteed loans. This
ratio of allowance for loan losses to total loans has decreased to 1.16% at June
30, 1999 from 1.24% at December 31, 1998 due to loans increasing at a faster
pace than the $204,000 provision and $38,000 in net recoveries during the first
half of 1999.
Liquidity and Source of Funds
The Company's primary sources of funds are customer 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.
15
The Company 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. The
Company generally maintains sufficient cash and short term investments to meet
short term liquidity needs. At June 30, 1999, cash and cash equivalents totaled
$21.6 million, or 4.7% 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 $5.6 million, or 1.2% of total assets. At June 30, 1999, the
Company maintained a credit facility with the FHLB of Seattle for up to 20% of
Heritage Bank's assets or $78.4 million (of which only $328,000 was outstanding
at that date).
To fund the growth of the Company, management's strategy has been to build core
deposits (which includes all deposits except public funds) through the
development of its branch office network and commercial banking relationships.
Historically, the Company has been able to retain a significant amount of its
deposits as they mature. Management anticipates that the Company will continue
to rely primarily on the same sources of funds in the future and will use those
funds primarily to make loans and purchase investment securities.
Capital
Stockholders' equity at June 30, 1999 was $100.5 million compared with $100.6
million at December 31, 1998. In addition to the Company's earnings, proceeds
from the exercise of stock options totaling $94,000 increased stockholders'
equity during the period. During the six months ended June 30, 1999, the
Company declared cash dividends in the amount of $1.2 million, or 11.5 cents
per share. The Company also paid $856,000 to repurchase 100,000 shares of its
common stock in the open market during the quarter ended June 30, 1999.
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, 1999, the Company's leverage ratio was
20.4%, compared with 21.5% at December 31, 1998. 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%. The Company's
Tier I and total capital ratios were 26.4% and 27.6%, respectively, at June 30,
1999 compared with 27.9% and 29.1%, respectively, at December 31, 1998.
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, 1999.
16
Quantitative and Qualitative Disclosures About Market Risk
The Company's results of operations are largely dependent upon its ability to
manage interest rate risk. Management considers interest rate risk to be a
significant market risk that could have a material effect on the Company's
financial condition and results of operations. Neither the Company nor its
subsidiary banks maintain a trading account for any class of financial
instrument, nor do they engage in hedging activities or purchase high risk
derivative instruments. Moreover, neither the Company nor its subsidiary banks
are subject to foreign currency exchange rate risk or commodity price risk.
In the opinion of management, there has been no material change in the Company's
interest rate risk exposure since the Company's most recent year end at December
31, 1998.
Year 2000 Issues
The Company utilizes various computer software programs to provide banking
products and services to its customers. Many existing computer programs use
only two digits to identify a year in the date field and were not designed to
consider the impact of the upcoming change in the century. If not corrected,
many computer applications could fail or create erroneous results by or at the
Year 2000. The Year 2000 issue affects virtually all companies and
organizations.
The following discussion of Year 2000 issues for the Company contains
numerous forward-looking statements based on inherently uncertain information
and management's best estimates. There can be no assurance that these estimates
will be achieved and actual results could differ. The Company places a high
degree of reliance on computer systems of third parties, such as customers and
suppliers. Although the Company is assessing the readiness of these third
parties and preparing contingency plans, there can be no guarantee that the
failure of these third parties to modify their systems in advance of December
31, 1999 would not have a material adverse affect on the Company.
Readiness Preparation
The Company has completed the identification phase in which management has
determined the extent to which all programs used in its business are Year 2000
compliant. Heritage Bank (HB) and Central Valley Bank (CVB) utilize service
bureaus to perform each bank's most mission critical data processing services
related to its loans, deposits, general ledger and other financial applications.
The service bureaus have completed the software programming for 100% of their
applications. The Company has completed the testing of all of its critical
applications and these applications are currently in use in the Company's
operations.
The Company has evaluated its major third party business relationships,
including vendors and its borrowers. The Company is also reliant on its
customers to make the necessary preparations for Year 2000 so that their
business operations will not be interrupted, thus threatening their ability to
honor their financial commitments. The Company has analyzed the extent that
Year 2000 issues could adversely impact their borrowers' business operations,
particularly its commercial borrowers. The Company has performed an initial
assessment of each major borrower and has established an ongoing assessment as
part of the Company's credit granting and loan review process.
17
Cost
Management expects Heritage Bank's costs related to Year 2000 issues to
amount to approximately $230,000. Of this total, approximately $177,000 was
incurred in prior periods. Management expects the remainder of these costs
($53,000) to be incurred in the second half of 1999. Central Valley Bank will
be upgrading computer equipment and related software for the remaining two of
its five branches in 1999 at an approximate cost of $60,000. Total costs for
the Company's Year 2000 efforts in 1999 are expected to be approximately
$125,000.
Risk and Contingency Plans
The Company has prepared a contingency plan with trigger dates to pursue
various alternatives for its critical technology and non-technology systems such
as heat, electric and telecommunication services. Some of these alternative
solutions involve the use of hot sites and cooperative agreements with other
banks for critical service bureau applications and mobile back-up services for
item processing; the use of generators to provide power in case of a disruption
in utilities service and alternative telecommunication modes as well as manual
back-up systems. Should the Company's worst case scenario, the loss of electric
power, occur, the Company will be able to continue to capture banking
transactions and process them at a remote hot site or another bank which also
uses the same service bureau and/or rely on diesel powered generators to power
the Company's item processing operations. These contingency plans are a part of
the Company's ongoing disaster recovery plan.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company or any of
its subsidiaries is a party which, if adversely decided, would have a material
adverse effect on the financial condition of the Company.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
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 27, 1999 and reconvened on May 11, 1999 due to a
lack of a quorum of votes on April 27, 1999.
18
(b) The following directors were elected to service for a term of three
years: Daryl D. Jensen, H. Edward Odegard and Donald V. Rhodes.
(c) For the election of directors, the number of votes cast for and
withheld for each director was as follows:
For Withheld
--------------------------------
Daryl D. Jensen 5,749,539 216,052
H. Edward Odegard 5,749,295 216,296
Donald V. Rhodes 5,748,434 217,157
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K
(a) Ex-27 Financial Data Schedule.
(b) On May 4, 1999, the Registrant filed a report on Form 8-K
announcing the postponement of its annual meeting of shareholders
from April 27, 1999 to May 11, 1999 due to a lack of a quorum.
(c) On May 6, 1999, the Registrant filed a report on Form 8-K
announcing the completion of its repurchase of 100,000 shares of
its outstanding common stock in the open market.
19
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
/S/ Donald V. Rhodes
Date: August 20, 1999 by _________________________________
Donald V. Rhodes
Chairman, President and Chief Executive Officer
(Duly Authorized Officer)
/S/ James Hastings
by _________________________________
James Hastings
Vice President and Treasurer
(Principal Financial and Accounting Officer)
20