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 September 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 November 9, 1999 there were outstanding 10,852,278 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 3
Months and Nine Months Ended September 30, 1998 and 1999
Consolidated Statements of Financial Condition 4
As of December 31, 1998 and September 30, 1999
Consolidated Statements of Stockholders' Equity for Nine 5
Months and Comprehensive Income for the Three Months and
Nine Months Ended September 30, 1999
Consolidated Statements of Cash Flows for the 6
Nine Months Ended September 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 16
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 18
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
Page 2
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except for per share data)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ----------------------
1998 1999 1998 1999
---- ---- ---- ----
INTEREST INCOME:
Loans $7,601 8,519 19,975 23,801
Investment securities and FHLB dividends 695 679 1,697 2,151
Interest bearing deposits 772 63 2,559 735
------ ------ ------- -------
Total interest income 9,068 9,261 24,231 26,687
INTEREST EXPENSE:
Deposits 3,587 3,194 9,596 9,430
Borrowed funds 31 11 57 30
------ ------ ------- -------
Total interest expense 3,618 3,205 9,653 9,460
------ ------ ------- -------
Net interest income 5,450 6,056 14,578 17,227
PROVISION FOR LOAN LOSSES 100 102 178 306
------ ------ ------- -------
Net interest income after provision for loan loss 5,350 5,954 14,400 16,921
NONINTEREST INCOME:
Gains on sales of loans 588 209 1,892 935
Commissions on sales of annuities
and securities 31 23 108 155
Service charges on deposits 334 349 848 1,023
Rental income 63 54 167 152
Other income 263 383 528 855
------ ------ ------- -------
Total noninterest income 1,279 1,018 3,543 3,120
NONINTEREST EXPENSE:
Salaries and employee benefits 2,356 2,396 6,156 7,257
Building occupancy 705 716 1,822 2,194
Data processing 253 322 735 929
Marketing 141 95 364 372
Goodwill Amortization 147 147 153 439
Business and occupation tax 90 141 241 462
Office supplies and printing 66 91 222 374
Other 711 907 1,969 2,336
------ ------ ------- -------
Total noninterest expense 4,469 4,815 11,662 14,363
------ ------ ------- -------
Income before federal income taxes 2,160 2,157 6,281 5,678
Federal income taxes 799 777 2,230 2,060
------ ------ ------- -------
Net income $1,361 1,380 4,051 3,618
====== ====== ======= =======
Earnings per share:
Basic $ 0.13 0.13 0.38 0.34
Diluted $ 0.12 0.13 0.37 0.33
See Notes to Condensed Consolidated Financial Statements
Page 3
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
December 31, September 30,
1998 1999
-------------------------------------
Assets (Unaudited)
Cash on hand and in banks $ 13,793 14,671
Interest earning deposits 36,355 2,772
Federal funds sold 20,800 1,800
Investment securities available for sale 31,625 36,462
Investment securities held to maturity 15,897 7,280
Loans held for sale 7,618 1,835
Loans receivable 319,334 392,656
Less: Allowance for loan losses (3,957) (4,360)
-------------------------------------
Loans, net 315,377 388,296
Premises and equipment, net 18,122 18,385
Federal Home Loan Bank stock 2,136 2,253
Accrued interest receivable 2,735 3,164
Prepaid expenses and other assets 3,041 2,529
Goodwill 8,372 8,071
-------------------------------------
Liabilities and Stockholders' Equity $475,871 487,518
=====================================
Deposits 367,104 378,503
Advances from Federal Home Loan Bank 688 -
Other borrowings 17 10
Advance payments by borrowers for taxes and insurance 476 580
Accrued expenses and other liabilities 5,875 6,038
Deferred Federal income taxes 1,152 992
-------------------------------------
Stockholders' equity: 375,312 386,123
Common stock, no par value per share,15,000,000 shares authorized;
10,844,916 shares and 10,821,317 outstanding, respectively 77,476 76,813
Unearned compensation ESOP and Other (1,242) (1,185)
Retained earnings, substantially restricted 24,199 25,956
Accumulated other comprehensive income 126 (189)
-------------------------------------
Total stockholders' equity 100,559 101,395
Commitments and contingencies
-------------------------------------
$475,871 487,518
=====================================
See Notes to Condensed Consolidated Financial Statements
Page 4
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Nine Months Ended September 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 - (6) 57 - - 51
Exercise of stock options 77 199 - 19 - 218
Stock Repurchase (100) (856) - - - (856)
Net income - - - 3,618 - 3,618
Decrease in unrealized gain on
securities available for sale, net
of tax of $(162) - - - - (315) (315)
Cash dividend declared - - - (1,880) - (1,880)
--------------------------------------------------------------------------------------
Balance at September 30, 1999 10,822 $76,813 (1,185) 25,956 (189) 101,395
======================================================================================
Three months ended Nine months ended
Comprehensive Income September 30, September 30,
-------------------------------------------------
1998 1999 1998 1999
-------------------------------------------------
Net income $1,361 $1,380 $4,051 $3,618
Increase(Decrease) in unrealized gain on
securities available for sale, net of tax of
$21, $17, $23 and $(162), respectively 41 33 45 (315)
-------------------------------------------------
Comprehensive income $1,402 $1,413 $4,096 $3,303
=================================================
See Notes to Condensed Consolidated Financial Statements
Page 5
HERITAGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(UNAUDITED)
Nine Months Ended
September 30,
-------------------
1998 1999
---- ----
Cash flows from operating activities:
Net income $ 4,051 3,618
Adjustments to reconcile net income to net cash provided by
operating activities
Amortization of goodwill 153 439
Depreciation and amortization 899 1,199
Deferred loan fees, net of amortization (62) (129)
Provision for loan losses 178 306
Net (increase)decrease in loans held for sale (953) 5,783
Federal Home Loan Bank stock dividends (107) (117)
Recognition of compensation related to ESOP (5) 51
Net change in accrued interest receivable, prepaid expenses and
other assets, and accrued expenses and other liabilities 909 258
----------------------
Net cash provided by operating activities 5,063 11,408
----------------------
Cash flows from investing activities:
Loans originated, net of principal payments and loan sales (30,138) (73,097)
Proceeds from maturities of investment securities available for sale 4,615 7,247
Proceeds from maturities of investment securities held to maturity 14,191 8,777
Purchase of investment securities available for sale (8,832) (12,557)
Purchase of investment securities held to maturity (19,108) (155)
Purchase of premises and equipment (1,227) (1,746)
Acquisition of North Pacific Bank, Net of cash acquired 10,573 -
----------------------
Net cash used by investing activities (29,926) (71,531)
----------------------
Cash flows from financing activities:
Net increase (decrease) in deposits (58,200) 11,399
Net increase (decrease) in borrowed funds (231) (695)
Net increase in advance payment by borrowers for taxes
and insurance 203 104
Cash dividends paid (733) (1,733)
Proceeds from exercise of stock options 791 199
Net proceeds from stock offering (repurchase) 63,030 (856)
----------------------
Net cash used by financing activities 4,860 8,418
----------------------
Net decrease in cash and cash equivalents (20,003) (51,705)
Cash and cash equivalents at beginning of period 98,686 70,948
----------------------
Cash and cash equivalents at end of period $ 78,683 19,243
----------------------
Supplemental disclosures of cash flow information:
Cash payments for:
Interest expense $ 9,591 9,256
Federal income taxes 1,740 2,023
See Notes to Condensed Consolidated Financial Statements
Page 6
HERITAGE FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine Months Ended September 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 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 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.
The results of operations for the three and nine months ended September 30, 1999
are not necessarily indicative of the operating results for the full year.
Page 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. The
financial statements for the nine months ended September 30, 1999 include the
operations of the former North Pacific Bank. The following information presents
the proforma results of operations for the nine months ended September 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.
Nine Months Ended
September 30, 1998
Unaudited Proforma
---------------------
(in thousands except
per share amounts)
Net interest income before provision for loan
losses $16,534
Net income 4,012
Earnings per share:
Basic $ 0.38
Diluted $ 0.36
(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 1,058,009
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, Incorporated, for all periods
presented.
NOTE 3. STOCKHOLDERS' EQUITY
a.) Earnings per Share
The following tables reconcile the weighted average shares used for earnings per
share for the applicable periods.
Three months ended Nine months ended
September 30, September 30,
------------------------------------------------------------
1998 1999 1998 1999
Basic:
Weighted average shares outstanding 10,718,404 10,791,666 10,608,704 10,818,576
Diluted:
Basic weighted average share outstanding 10,718,404 10,791,666 10,608,704 10,818,576
Incremental shares from stock options 298,621 185,472 443,746 190,694
------------------------------------------------------------
Weighted average shares outstanding 11,017,025 10,977,138 11,052,449 11,009,270
============================================================
Page 8
At September 30, 1999, there were options to purchase 92,700 shares of common
stock outstanding which were antidilutive and therefore not included in the
computation of diluted earnings per share. There were no antidilutive
outstanding options to purchase common stock at September 30, 1998.
b. Cash Dividend Declared
On September 17, 1999, the Company announced a quarterly cash dividend of 6.5
cents per share payable on October 27, 1999 to shareholders of record on October
15, 1999.
SUBSEQUENT EVENT
On October 28, 1999, the Registrant filed a report on Form 8-K announcing the
plans to repurchase up to 10% of its outstanding common stock in the open
market or in privately negotiated transactions.
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 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 or 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".
Financial Condition Data
The Company's total assets and deposits at September 30, 1999 increased to
$487.5 million and $378.5 million, respectively, from December 31, 1998 levels
of $475.9 million and $367.1 million, respectively. During the nine months
ended September 30, 1999, total assets and deposits increased 2% and 3%,
respectively. Deposit growth included $24.3 million in public funds from the
State of Washington. During the nine months ended September 30, 1999, loans
increased $67.6 million, or 21%, to $394.5 million from December 31, 1998.
Commercial loans increased to $178.6 million at September 30, 1999, compared
with $128.2 million at December 31, 1998, an increase of 39%. At September 30,
1999 commercial loans as a percentage of total loans increased to 45% compared
with 38% and 39% at September 30, 1998 and December 31, 1998, respectively.
Earnings Summary
Net income for the nine months ended September 30, 1999 was $3.62 million, or
$0.328 per diluted share, compared to $4.05 million, or $0.366 per diluted
share, for the same period last year. Net
Page 10
income for the three months ended September 30, 1999 was $1.38 million, or
$0.126 per diluted share, compared to $1.36 million, or $0.124 per diluted
share, for the same period last year. Cash earnings, which exclude the
amortization of goodwill recorded on the acquisition of North Pacific Bank,
for the nine months ended September 30, 1999 were $3.91 million, or $0.355 per
diluted share compared with $0.363 per diluted share for the same period last
year. For the quarter ended September 30, 1999 cash earnings were $1.5 million,
or $0.135 per diluted share compared with $0.123 per diluted share for the same
quarter last year. The predominate factors in comparing 1999's results to 1998's
were: 1.) Net interest income grew $2.6 million or 18% for the year to date
period and $606,000 or 11% quarter over quarter, due to higher volumes and lower
cost of funds. 2.) Non interest income fell by $423,000 or 12% year to date and
$261,000 or 20% quarter over quarter, due to significantly lower mortgage
banking production. 3.) Non interest expense increased by $2.7 million or 23%
year to date and $346,000 or 8% quarter over quarter, due to the acquisition of
North Pacific Bank, increased staffing levels, and ongoing costs associated with
the investment in item processing hardware, software and facilities in support
of the Company's commercial banking efforts.
Net Interest Income
Net interest income after provision for the nine months ended September 30,
1998, increased 18% to $16.9 million from $14.4 million for the same period in
1998. For the three months ended September 30, 1999, net interest income
increased 11% to $6.1 million from $5.5 million for the same quarter in 1998.
For the nine month period, the increase in net interest income resulted from a
reduction in average costs of funds from 4.56% to 3.96% coupled with a 13%
increase in average earning assets during the same period while maintaining a
comparable yield on those assets. For the three month period ending September
30, 1999 the average cost of funds was 3.92% compared to 4.50% for the same
period in 1998, and average earning assets increased 2%.
Net interest margin (net interest income divided by average interest earning
assets) widened to 5.51% for the nine month period ending September 30, 1999
compared to 5.14% for the same period last year. The margin for the three months
ended September 30, 1999 was 5.65% compared to 5.18% for the same quarter in
1998. The increase in net interest margin reflects (i) a shift from lower
yielding investments and interest bearing overnight funds to higher yielding
loans and, (ii) a lower cost of funding. However, the Company is currently
experiencing downward pressure on lending spreads due to increased competition.
The change in mix resulted in the average yield on earning assets remaining
relatively constant at 8.53% for the current nine month period from 8.54% for
the same period last year, while the Company's cost of funds improved to 3.96%
compared to 4.56%. The improvement in the Company's cost of deposits is
attributable to management's strategic decision beginning in the fourth quarter
of last year to reduce our reliance on more volatile high cost certificates of
deposits coupled with falling market interest rates in the second half of 1998
and early 1999. While this deposit pricing strategy reduced deposit growth, it
achieved the intended result of lowering the cost of deposits.
Provision for Loan Losses
Page 11
For the nine months ended September 30, 1999 the loan loss provision was
$306,000 compared to $178,000 for the prior years nine month period. The
quarterly provision for loan losses was maintained at $102,000 for the third
quarter 1999 compared to $100,000 for the same quarter in 1998. The greater
provision for the nine month period is a result of the North Pacific
acquisition. Management believes that the allowance for loan losses is
maintained at an adequate level to provide for estimated losses based on an
evaluation of known and inherent risks in the loan portfolio.
Noninterest Income
Noninterest income decreased 11% to $3.1 million for the nine months ended
September 30, 1999 compared with $3.5 million for the same period in 1998. The
third quarter of 1999 noninterest income decreased 23% to $1.0 million for the
three months ended September 30, 1999, compared with $1.3 million for the same
period in 1998. This decrease was primarily attributable to a 43% decrease in
the volume of mortgage loans sold due to lower mortgage loan originations during
the nine month period 1999 compared with the same period in 1998. In the third
quarter of 1999 mortgage loan originations decreased 53% compared with the same
period in 1998. The Company's decline in mortgage banking activity was
comparable to the regionwide decline in activity for mortgage lenders during the
third quarter of 1999.
Noninterest Expense
Noninterest expense increased 23% to $14.4 million for the first nine months of
1999, compared to $11.7 million for the same period in 1998. Non interest
expense for the third quarter of 1999 increased 7% to $4.8 million compared to
$4.5 million for the third quarter of 1998. The increase was attributed to the
acquisition of North Pacific Bank in June, 1998, and additional investments 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 nine months ended September 30, 1999 increased to
70.59% from 64.36% for the same period in 1998. For the quarter ended September
30, 1999, the efficiency ratio increased to 68.06% from 66.42% for the
comparable quarter in 1998 and decreased from the quarter ended June 30, 1999 of
72.04%. Contributing to this increase, revenues were below expected levels due
to a 51% year to date and 64% quarterly drop in gains on sale of mortgage loans
(compared with the same periods in 1998) and an increase in noninterest
expenses.
Page 12
Lending Activities
Since initiating its expansion activities in 1994, the Company has continued to
pursue a growth strategy to broaden its product mix from primarily thrift
offerings to commercial banking activities. As indicated in the table below,
total loans increased to $394.5 million at September 30, 1999 from $326.9
million at December 31, 1998. At September 30, 1999, commercial loans increased
to $178.6 million, or 45% of total loans, from $128.2 million, or 39% of total
loans, at December 31, 1998.
(in thousands)
At At
December 31, % of September 30, % of
1998 Total 1999 Total
-----------------------------------------------------------------
Commercial $128,171 39.2% $178,622 45.3%
Real estate mortgages
One-to-four family residential 97,277 29.8 95,460 24.2
Five or more family and commercial
properties 70,139 21.4 86,079 21.8
-----------------------------------------------------------------
Total real estate mortgages 167,416 51.2 181,539 46.0
Real estate construction
One-to-four family residential 26,640 8.2 26,207 6.7
Five or more family and commercial
properties 2,124 0.6 5,240 1.3
-----------------------------------------------------------------
Total real estate construction 28,764 8.8 31,447 8.0
Consumer 4,000 1.2 4,411 1.1
-----------------------------------------------------------------
Gross loans 328,351 100.4% 396,019 100.4%
Less: deferred loan fees (1,399) (0.4) (1,528) (0.4)
-----------------------------------------------------------------
Total loans $326,952 100.0% $394,491 100.00%
=================================================================
Page 13
Nonperforming Assets
The following table sets forth the amount of the Company's nonperforming assets
at the dates indicated.
At At
December 31, September 30,
1998 1999
---------------------------------------
(Dollars in thousands)
Nonaccrual loans $ 402 1,053
Restructured loans - -
---------------------------------------
Total nonperforming loans 402 1,053
Real estate owned 0 70
---------------------------------------
Total nonperforming assets $ 402 1,123
=======================================
Accruing loans past due 90 days or more $ 8 -
Potential problem loans 898 3,986
Allowance for loan losses 3,957 4,360
Nonperforming loans to loans 0.12% 0.27%
Allowance for loan losses to loans 1.21% 1.11%
Allowance for loan losses to nonperforming loans 984.70% 414.15%
Nonperforming assets to total assets 0.08% 0.23%
Nonperforming loans increased to $1,053,000, or 0.27% of total loans, at
September 30, 1999 from $402,000, or 0.12% of total loans, at December 31, 1998.
Nonperforming assets at September 30, 1999 amounted to $1,123,000, or 0.23% of
total assets. For the median of 35 West Coast publicly traded banks as monitored
by Pacific Crest Securities, nonperforming assets were 0.52% of total assets at
June 30, 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 taking into account the Company's changing portfolio mix. 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.
Page 14
The following table sets forth for the periods indicated information regarding
changes in the Company's allowance for loan losses:
Nine Months Ended September 30,
-----------------------------------------
1998 1999
-----------------------------------------
Total loans outstanding at end of period (1) $ 330,576 394,491
Average loans outstanding during period 278,916 347,911
Allowance balance at beginning of period 3,180 3,957
Provision for loan losses 178 306
Provision acquired with North Pacific Bank 670 -
Charge-offs
Real estate (12) (1)
Commercial - (7)
Consumer (5) (5)
-----------------------------------------
Total charge-offs (17) (13)
-----------------------------------------
Recoveries
Real estate - 16
Commercial 6 91
Consumer 2 3
-----------------------------------------
Total recoveries 8 110
-----------------------------------------
Net (charge-offs) recoveries (9) 97
-----------------------------------------
Allowance balance at end of period $ 4,019 4,360
=========================================
Ratio of net (charge-offs) recoveries during
period to average loans outstanding 0.00% 0.03%
=========================================
__________
(1) Includes loans held for sale
While pursuing its growth strategy, the Company will continue to employ prudent
underwriting and sound loan monitoring procedures to maintain asset quality. The
allowance for loan losses at September 30, 1999 increased $160,000 from the
prior quarter to $4.4 million, or 1.11% of total loans. The Company's portfolio
includes 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 September 30, 1999, the government guaranteed
portion of these loans amounted to $19.3 million. Excluding the $19.3 million in
government guaranteed loans, the Company's allowance for loan losses was 1.17%
of nonguaranteed loans. The ratio of allowance for loan losses to total loans
decreased to 1.11% at September 30, 1999 from 1.21% at December 31, 1998. The
Company's management considers this to be an adequate level of reserves at this
time.
Liquidity and Source of Funds
The Company's 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
Page 15
mortgage prepayments are greatly influenced by the level of interest rates,
economic conditions and competition.
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 September 30, 1999, cash and cash equivalents
totaled $19.2 million, or 3.9% 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 $2.0 million, or 0.4% of total assets. At September
30, 1999, the Company maintained a credit facility with the FHLB of Seattle for
up to 20% of Heritage Bank's assets or $83.8 million (under which there were no
outstanding borrowings as of that date).
Capital
Stockholders' equity at September 30, 1999 was $101.4 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 $218,000 increased
stockholders' equity during the period. During the nine months ended September
30, 1999, the Company declared cash dividends in the amount of $1.9 million, or
18.0 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 September 30, 1999, the Company's leverage ratio was
20.2%, compared with 23.8% 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 24.0% and 25.3%, respectively, at September 30, 1999
compared with 30.5% and 31.7%, 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 September 30, 1999.
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
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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.
Cost
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Management expects Heritage Bank's costs related to Year 2000 issues to
amount to approximately $230,000. Of this total, approximately $214,000 was
incurred in prior periods. Management expects the remainder of these costs
($16,000) to be incurred in the fourth quarter of 1999. CVB has completed the
upgrading of its computer equipment and related software for the its five
branches in 1999 for $83,750. CVB does not expect to incur any additional costs
for its Year 2000 efforts.
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 mobile back-up services for item
processing, the use of a backup generator to provide power in case of a
disruption in electrical 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 and/or rely on a diesel
powered backup generator 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
None
ITEM 5. OTHER INFORMATION
None
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ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K
a. See EXHIBIT 27-Financial Data Schedule.
b. On October 28, 1999, the Registrant filed a report on Form 8-K
announcing the plans to repurchase up to 10% of its outstanding common stock in
the open market or in privately negotiated transactions.
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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: November 10, 1999 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)
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