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Heritage Financial Announces Fourth Quarter And Annual Results And Declares Regular Cash Dividend

- Diluted earnings per common share were $0.04 for the quarter ended December 31, 2013 compared to $0.20 for the linked-quarter ended September 30, 2013 and the prior year quarter ended December 31, 2012

OLYMPIA, Wash., Jan. 29, 2014 /PRNewswire/ -- HERITAGE FINANCIAL CORPORATION (NASDAQ GS: HFWA) Brian L. Vance, President and CEO of Heritage Financial Corporation ("Company" or "Heritage"), today reported that the Company had net income of $710,000 for the quarter ended December 31, 2013 compared to net income of $3.0 million for the quarter ended December 31, 2012 and $3.3 million for the linked-quarter ended September 30, 2013.  Net income for the quarter ended December 31, 2013 was $0.04 per diluted common share compared to $0.20 per diluted common share for the quarter ended December 31, 2012 and for the linked-quarter ended September 30, 2013.

(Logo: http://photos.prnewswire.com/prnh/20110127/SF37289LOGO)

Net income for the year ended December 31, 2013 was $9.6 million, or $0.61 per diluted common share, compared to $13.3 million, or $0.87 per diluted common share, for the year ended December 31, 2012. 

Mr. Vance commented, "2013 was a transitional year for the company.  In addition to completing two acquisitions, we also completed the merger of our Central Valley Bank subsidiary into Heritage Bank and we signed a definitive agreement with Washington Banking Company to enter into a strategic alliance that will extend the reach of Heritage Bank from the Canadian border south to Portland, Oregon.  During the fourth quarter we reduced our branches from 42 to 35 and we reduced full-time equivalent employees from 415 to 373."  Mr. Vance continued, "The costs associated with these initiatives negatively impacted our fourth quarter after-tax earnings by approximately $2.4 million, or $0.15 per share. However, we expect these initiatives to have a significant positive impact on our future operating results."

Acquisition of Northwest Commercial Bank

On January 9, 2013, the Company acquired Northwest Commercial Bank ("NCB") and merged it into Heritage Bank (the "NCB Acquisition"). NCB was a full service commercial bank with branches in Lakewood and Auburn, Washington.  In March 2013, the Company consolidated the operations of the former NCB Lakewood branch with the Lakewood branch of Heritage Bank. 

The Company paid cash consideration of $3.0 million, or $5.50 per share, to the NCB shareholders. Additionally, as provided for in the merger agreement, NCB shareholders had the ability to potentially receive an additional cash payment based on an earn-out structure from the sale of an "other real estate owned" asset of NCB.  This contingent payment was included in the NCB liabilities assumed as of the January 9, 2013 acquisition date. During the quarter ended June 30, 2013 this asset was sold and the $491,000 in proceeds from the sale was paid to the former NCB shareholders during the quarter ended September 30, 2013.  This payment did not impact the recorded bargain purchase gain on bank acquisition of $399,000.

In connection with the NCB Acquisition, the Company received (at fair value) approximately $51.5 million in loans, $2.7 million of cash and cash equivalents, $2.8 million in investment securities, $2.9 million in net deferred tax assets, $2.3 million in other real estate owned, $1.0 million of other interest earning deposits and $1.9 million in other assets. The Company also assumed deposits with a fair value of approximately $60.4 million and $1.2 million of other liabilities.  The application of the acquisition method of accounting resulted in the recognition of a pre-tax bargain purchase gain on bank acquisition of $399,000.  The bargain purchase gain on bank acquisition represents the excess of the estimated fair value of the net assets acquired and the liabilities assumed over the purchase price.

Central Valley Bank Merger

On June 19, 2013, the Company completed the merger of its subsidiary, Central Valley Bank ("CVB"), with and into Heritage Bank (the "CVB Merger").  CVB is now operated as a division of Heritage Bank. 

Acquisition of Valley Community Bancshares

On July 15, 2013, the Company completed the acquisition of Valley Community Bancshares, Inc. ("Valley"), the holding company for Valley Bank, both of Puyallup, Washington (the "Valley Acquisition").  Pursuant to the terms of the merger agreement, Valley shareholders received for each share of Valley common stock $19.50 in cash and 1.3611 shares of Heritage common stock.  As of the acquisition date, Valley merged into Heritage and Valley Bank merged into Heritage Bank. 

In connection with the Valley Acquisition, the Company received (at fair value) approximately $117.1 million in  loans, $40.6 million of cash and cash equivalents, $13.9 million of other interest earning deposits, $54.4 million in investment securities, $6.6 million in premises and equipment,  $916,000 in core deposit intangible and $3.9 million in other assets. The Company also assumed deposits with a fair value of approximately $207.0 million and $342,000 of other liabilities.  The application of the acquisition method of accounting resulted in the recognition of goodwill of $16.4 million.  The goodwill represents the excess of the consideration transferred over the estimated fair value of the net assets acquired and the liabilities assumed.

Proposed Merger with Washington Banking Company

On October 23, 2013, the Company and Washington Banking Company ("Washington Banking") jointly announced the signing of a definitive agreement under which Heritage and Washington Banking will enter into a strategic merger to create one banking franchise. Washington Banking branches will adopt the Heritage Bank name in all markets, with the exception of six branches in Whidbey Island markets which will continue to operate using the Whidbey Island Bank name. The corporate headquarters of the combined company will be in Olympia, Washington.

Under the terms of the merger agreement, Washington Banking shareholders will receive 0.89000 shares of Heritage common stock and $2.75 in cash for each share of Washington Banking common stock. Upon consummation, the shareholders of Washington Banking will own approximately 46% of the combined company and the shareholders of Heritage will own approximately 54%. 

Balance Sheet

The Company's total assets decreased slightly to $1.66 billion at December 31, 2013 from $1.67 billion at September 30, 2013.   

Total originated loans receivable increased $15.4 million, or 1.6%, to $977.3 million at December 31, 2013 from $961.9 million at September 30, 2013.  The increase from the prior period was due primarily to increases in owner-occupied commercial real estate loans ($13.9 million), non-owner occupied commercial real estate loans ($7.1 million) and construction loans relating to five or more family residential and commercial properties ($6.5 million) partially offset by a decrease of $9.8 million in commercial and industrial loans.  The decrease in commercial and industrial loans was primarily due to a seasonal decline of $10.5 million in agricultural loans. Total originated loans receivable increased year-over-year by $102.8 million, or 11.8%, from $874.5 million at December 31, 2012.

Total deposits decreased $26.8 million, or 1.9%, to $1.40 billion at December 31, 2013 from $1.43 billion at September 30, 2013.  Non-maturity deposits to total deposits were 77.9% at December 31, 2013 compared to 77.6% at September 30, 2013.  In addition, noninterest demand deposits to total deposits were 25.0% at December 31, 2013 compared to 25.4% at September 30, 2013. 

Total stockholders' equity decreased to $215.8 million at December 31, 2013 from $216.6 million at September 30, 2013.  The decrease during the three months ended December 31, 2013 was primarily due to cash dividends of $1.3 million and an increase of $480,000 in accumulated other comprehensive loss, net, partially offset by $710,000 in net income and $229,000 in stock-based compensation.  The Company's ratio of tangible common equity to tangible assets was increased slightly to 11.4% at December 31, 2013 compared to 11.3% at September 30, 2013. The Company and Heritage Bank continue to maintain capital levels significantly in excess of the applicable regulatory requirements for them to be categorized as "well-capitalized". The Company had Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios at December 31, 2013 of 11.3%, 15.5% and 16.8%, respectively, compared to 11.6%, 15.5%, and 16.7%, at September 30, 2013, respectively. 

Credit Quality

The allowance for loan losses on originated loans decreased $204,000, or 1.2%, to $17.2 million at December 31, 2013 from $17.4 million at September 30, 2013 as a result of $104,000 in net charge-offs recognized during the quarter ended December 31, 2013 and a provision for loan losses of $(100,000).  Nonperforming originated loans to total originated loans decreased to 0.53% at December 31, 2013 from 0.81% at September 30, 2013.  Nonaccrual originated loans decreased $2.8 million to $6.9 million ($5.2 million net of government agency guarantees) at December 31, 2013 from $9.8 million ($7.9 million net of government agency guarantees) at September 30, 2013.  The decrease in nonaccrual originated loans was due to a $2.4 million loan restored to accrual status, $1.5 million of net principal reductions, $225,000 in transfers to other real estate owned and $58,000 of charge-offs partially offset by an addition of $1.4 million in loans to nonaccrual originated loans. 

The allowance for loan losses to nonperforming originated loans was 329.40% at December 31, 2013 compared to 221.68% at September 30, 2013.  Potential problem originated loans increased to $30.1 million at December 31, 2013 from $26.6 million at September 30, 2013 primarily as a result of a $3.3 million loan that was downgraded to special mention status during the quarter ended December 31, 2013. Restructured originated performing loans increased to $20.4 million at December 31, 2013 compared to $19.6 million at September 30, 2013.  The Company believes that its allowance for loan losses is appropriate to provide for probable incurred losses based on an evaluation of known and inherent risks in the loan portfolio at December 31, 2013.

Nonperforming originated assets were $11.3 million ($9.6 million net of government agency guarantees), or 0.68% of total originated assets, at December 31, 2013, compared to $13.6 million ($11.7 million net of government agency guarantees), or 0.83% of total originated assets, at September 30, 2013.  Other real estate owned increased $430,000, or 10.4%, to $4.6 million at December 31, 2013 ($182,000 covered by FDIC loss sharing agreements) from $4.1 million at September 30, 2013 ($317,000 covered by FDIC loss sharing agreements).  The increase was due primarily to the addition of five properties totaling $1.2 million partially offset by the disposition of five properties totaling $456,000 and valuation adjustments of $348,000.

Mr. Vance added, "We continue to see improvement in our overall credit metrics.  Our non-performing originated assets have declined to just 0.68% of total originated assets and our allowance for loan losses remains at a healthy 1.76% of total loans or 329.4% of non-performing originated loans."

Operating Results

Net interest income increased $1.9 million, or 12.3%, to $17.6 million for the quarter ended December 31, 2013 compared to $15.7 million for the same period in 2012.  Net interest income increased $3.1 million, or 4.8%, to $67.7 million for the year ended December 31, 2013 compared to $64.6 million for the same period in 2012.  The increases in net interest income are due to increases in average interest earning assets (substantially attributable to the NCB Acquisition and the Valley Acquisition) partially offset by declines in the net interest margin (substantially due to lower contractual loan note rates).

Heritage's net interest margin for the quarter ended December 31, 2013 decreased 40 basis points to 4.58% from 4.98% for the same period in 2012 and decreased nine basis points from 4.67% in the linked-quarter ended September 30, 2013.  The declines in net interest margin are due primarily to lower contractual loan note rates.  Heritage's net interest margin for the year ended December 31, 2013 decreased 37 basis points to 4.80% from 5.17% for the same period in 2012. 

The positive effect on the net interest margin of discount accretion on the acquired loan portfolios for the quarter ended December 31, 2013 was approximately 38 basis points compared to 48 basis points in the same quarter of the prior year and 38 basis points for the linked-quarter ended September 30, 2013.  Interest reversals on nonaccrual originated loans reduced the net interest margin for the quarter ended December 31, 2013 by approximately four basis points compared to six basis points for the same quarter in the prior year and four basis points for the linked-quarter ended September 30, 2013.

The positive effect on the net interest margin of discount accretion on the acquired loan portfolios was 48 basis points for the year ended December 31, 2013 compared to 50 basis points for the year ended December 31, 2012. Interest reversals on nonaccrual originated loans reduced the net interest margin for the year ended December 31, 2013 by five basis points compared to seven basis points for the prior year.

The provision for loan losses on originated loans was $(100,000) for the quarter ended December 31, 2013 compared to $280,000 for the quarter ended December 31, 2012 and $150,000 for the linked-quarter ended September 30, 2013.  For the year ended December 31, 2013, the provision for loan losses on originated loans was $890,000 compared to $695,000 for the same period in the prior year.

The Company had net charge-offs on originated loans of $104,000 for the quarter ended December 31, 2013 compared to $1.7 million for the quarter ended December 31, 2012 and $615,000 for the linked-quarter ended September 30, 2013. For the year ended December 31, 2013, the Company had net charge-offs on originated loans of $2.9 million compared to $3.9 million for the prior year.  

The provision for loan losses on purchased loans was $528,000 for the quarter ended December 31, 2013 compared to $419,000 for the same period in the prior year and $928,000 for the linked-quarter ended September 30, 2013.  For the year ended December 31, 2013, the provision for loan losses on purchased loans was $2.8 million compared to $1.3 million for the prior year.

As of the acquisition dates, purchased loans were recorded at their estimated fair values, incorporating our estimate of future expected cash flows until the ultimate resolution of these credits.  To the extent actual or projected cash flows are less than previously estimated, additional provisions for loan losses on the purchased loan portfolios are recognized immediately into earnings.  To the extent actual or projected cash flows are more than previously estimated, the increase in cash flows is recognized immediately as a recapture of provision for loan losses up to the amount of any provision previously recognized for that pool of loans, if any, then prospectively recognized in interest income as a yield adjustment.

Cash flows on pools of acquired loans are re-estimated on a quarterly basis. As reflected in the table below, incremental accretion income was $1.46 million for the quarter ended December 31, 2013 compared to $1.45 million for the linked-quarter ended September 30, 2013.  For the year ended December 31, 2013, incremental accretion income was $6.7 million compared to $6.3 million for the same period in the prior year.

For the quarter ended December 31, 2013, the Company recognized $155,000 of change in the FDIC indemnification asset compared to $(350,000) and $(346,000) for the quarters ended September 30, 2013 and December 31, 2012, respectively. The increase for the quarter ended December 31, 2013 as compared to the quarter ended September 30, 2013 was primarily due to a collateral valuation adjustment of a large purchased covered loan during the quarter ended December 31, 2013 which resulted in an addition to the FDIC indemnification asset.

The following table illustrates the significant accounting entries associated with the Company's acquired loan portfolios:












 Three Months Ended


Year Ended


December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012


(in thousands)

Incremental accretion income over stated note rate(1)

$      1,464


$      1,447


$     1,522


$     6,706


$     6,280

Change in FDIC indemnification asset

155


(350)


(346)


(181)


(1,033)

Provision for loan losses

(528)


(928)


(419)


(2,782)


(1,321)

Pre-tax earnings impact

$       1,091


$         169


$        757


$     3,743


$      3,926



(1)

The incremental accretion income represents the amount of income recorded on the acquired loans above the contractual stated interest rate in the individual loan notes.  This income is a result of the discount established at the time these loan portfolios were acquired and modified as a result of quarterly cash flow re-estimation. 

Donald J. Hinson, Executive Vice President and Chief Financial Officer, commented, "Our net interest margin was a very respectable 4.58% for the fourth quarter of 2013.  However, the net interest margin continues to experience compression due to the current low rate environment.  The net interest margin before incremental accretion income decreased nine basis points to 4.20% for the quarter ended December 31, 2013 compared to 4.29% for the linked-quarter ended September 30, 2013.  This decrease was driven primarily by lower contractual yields on the loan portfolio.  Loan yields before incremental accretion income decreased eight basis points to 5.27% for the quarter ended December 31, 2013 compared to 5.35% for the linked-quarter ended September 30, 2013.  This compression is expected to continue in the short-term as the average rates on new loans are lower than the current average yield of the loan portfolio."

Noninterest income was $2.4 million for the quarter ended December 31, 2013 compared to $1.8 million for the same period in 2012 and $2.6 million for the linked-quarter ended September 30, 2013.  The $656,000, or 37.0%, increase in the quarter ended December 31, 2013 from the same period in the prior year was primarily due to an increase of $501,000 in the change in FDIC indemnification asset and an increase of $143,000 in service charges and other fees. 

For the year ended December 31, 2013, noninterest income was $9.7 million compared to $7.3 million for the year ended December 31, 2012.  The $2.4 million, or 32.7%, increase was primarily due to a $596,000 gain on the sale of a branch building (included in "other income"), a $399,000 pre-tax bargain purchase gain on bank acquisition recognized during the first quarter of 2013 on the NCB Acquisition, an increase of $420,000 in service charges and other fees and an $852,000 improvement to income from the change in FDIC indemnification asset.  

Noninterest expense was $18.5 million for the quarter ended December 31, 2013 compared to $12.4 million for the quarter ended December 31, 2012 and $14.3 million for the linked-quarter ended September 30, 2013. Noninterest expense increased $9.1 million, or 18.1%, to $59.5 million for the year ended December 31, 2013 from $50.4 million for the year ended December 31, 2012. 

Current year initiatives had a significant impact on noninterest expense during 2013. In addition to the ongoing expenses associated with the addition of branches and personnel from the NCB Acquisition and the Valley Acquisition, there were expenses associated with implementation of these and other initiatives embarked upon during 2013. The following tables illustrate the expenses related to implementing these initiatives.  The amounts reported represent identifiable costs paid to third party providers as well as any retention bonuses or severance payments made in conjunction with these initiatives.  The amounts do not include costs of additional staffing required to be maintained in order to complete the initiatives. The first table reports these expenses by initiative and the second table reports these expenses by expense category.




Three Months Ended


Year Ended



December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012

     Initiative

(in thousands)

NCB Acquisition

$                  8


$                  5


$              446


$              794


$              616

CVB Merger

89


1


-


220


-

Valley Acquisition

1,532


232


-


2,118


-

Core system conversion

703


60


-


842


-

Consolidation of existing branches

215


23


-


238


-

Proposed Washington Banking Merger

657


234


-


890


-

Total Expense

$           3,204


$              555


$              446


$           5,102


$              616























 



Three Months Ended


Year Ended



December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012

     Expense Category

(in thousands)

Compensation and employee benefits

$              310


$                66


$                  -


$              475


$                  -

Occupancy and equipment

1,173


62


-


1,328


-

Data processing

771


4


-


1,291


-

Marketing

1


-


-


34


-

Professional services

921


412


446


1,876


610

Other expense

28


11


-


98


6

Total Expense

$           3,204


$              555


$              446


$           5,102


$              616























The types of expenses associated with the significant expense categories in the table above are summarized as follows:

  • Compensation and employee benefits expense consisted substantially of retention bonus and severances packages paid to transition employees.
  • Occupancy and equipment expense consisted primarily of lease termination costs.
  • Data processing expense consisted of costs relating to the Company's core system conversion as well as conversions of Northwest Commercial Bank and Valley Bank.
  • Professional services expense related to fees paid to: (1) financial advisors for the NCB Acquisition, the Valley Acquisition and the proposed Washington Banking Merger, (2) attorney, accountant and consultant fees related to mergers and acquisitions, and (3) consultant fees relating to the core system conversion.

Jeffrey J. Deuel, President & Chief Operating Officer of Heritage Bank, commented "We are very proud of our team and their ability to successfully complete a core system conversion of Heritage Bank as well as the conversions of CVB and Valley in addition to effectively managing the balance of our 2013 efficiency initiatives."

Income tax expense was $432,000 for the quarter ended December 31, 2013 compared to $1.3 million for the comparable quarter in 2012 and $1.5 million for the linked-quarter ended September 30, 2013.  The decrease in income tax expense for the quarter ended December 31, 2013 from the prior periods was primarily due to the decrease in pre-tax income.  The effective tax rate was 37.8% for quarter ended December 31, 2013 compared to 30.6% for the comparable quarter in 2012 and 31.5% for the linked-quarter ended September 30, 2013.  The increase in the effective tax rate was due primarily to non-deductible expenses relating to the proposed Washington Banking merger.

Dividend

On January 29, 2014, the Company's Board of Directors declared a quarterly cash dividend of $0.08 per common share payable on February 24, 2014 to shareholders of record on February 10, 2014. 

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on January 30, 2014 at 11:00 a.m. Pacific time.  To access the call, please dial (800) 230-1093 a few minutes prior to 11:00 a.m., Pacific time.  The call will be available for replay through February 13, 2014, by dialing (800) 475-6701 -- access code 315328.

About Heritage Financial

Heritage Financial Corporation is an Olympia-based bank holding company with Heritage Bank, a full-service commercial bank, as its wholly-owned banking subsidiary. Following the opening of a new branch in Vancouver, Washington, on January 13, 2014, Heritage Bank now has thirty-six banking offices in Washington and Oregon.  Heritage Bank does business under the Central Valley Bank name in the Yakima and Kittitas counties of Washington. The Company's stock is traded on the NASDAQ Global Select Market under the symbol "HFWA".  More information about Heritage Financial Corporation can be found on its website at www.hf-wa.com and more information about Heritage Bank can be found on its website at www.heritagebanknw.com.

Non-GAAP Financial Measures

This news release contains certain non-GAAP financial measures in addition to results presented in accordance with Generally Accepted Accounting Principles (GAAP).  These measures include tangible common equity, tangible book value per share and tangible common equity to tangible assets.  Tangible common equity (tangible book value) excludes goodwill and other intangible assets.  Tangible assets exclude goodwill and other intangible assets.  Management has presented these non-GAAP financial measures in this earnings release because it believes that they provide useful and comparative information to assess trends in the Company's capital reflected in the current quarter and year-to-date results.  Where applicable, the Company has also presented comparable capital information using GAAP financial measures. Reconciliations of the GAAP and non-GAAP financial measures are presented below.


December 31, 2013


September 30, 2013


December 31, 2012


(in thousands)

Stockholders' equity

$     215,762


$     216,595


$     198,938

Less: goodwill and other






intangible assets

30,980


31,137


14,098

Tangible common equity

$     184,782


$     185,458


$     184,840







Total assets

$  1,658,038


$  1,674,417


$  1,345,540

Less: goodwill and other






intangible assets

30,980


31,137


14,098

Tangible assets

$  1,627,058


$  1,643,280


$  1,331,442







Forward-Looking Statements

"Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995: This release contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Board of Governors of the Federal Reserve System and of our bank subsidiary by the Federal Deposit Insurance Corporation, the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements and restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules including changes related to Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementing of regulations; our ability to control operating costs and expenses; the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; computer systems on which we depend could fail or experience a security breach; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired including the Cowlitz Bank, Pierce Commercial Bank,  Northwest Commercial Bank and Valley Community Bancshares transactions, or may in the future acquire into our operations, and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; risks relating to acquiring assets or entering markets in which we have not previously operated and may not be familiar; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and other risks detailed from time to time in our filings with the Securities and Exchange Commission.

The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company's operating and stock price performance.

Additional Information

Heritage has filed a registration statement on Form S-4 with the SEC in connection with the proposed transaction with Washington Banking. The registration statement includes a joint proxy statement of Heritage and Washington Banking that also constitutes a prospectus of Heritage, which will be sent to the shareholders of Heritage and Washington Banking. Shareholders are advised to read the joint proxy statement/prospectus because it contains important information about Heritage, Washington Banking and the proposed transaction. This document and other documents relating to the merger filed by Heritage and Washington Banking can be obtained free of charge from the SEC's website at  www.sec.gov. These documents also can be obtained free of charge by accessing Heritage's website at http://www.hf-wa.com/docs.aspx?iid=1024198 or by accessing Washington Banking's website at http://investor.washingtonbanking.info/docs.aspx?iid=1025104. Alternatively, these documents, can be obtained free of charge from Heritage upon written request to Heritage Financial Corporation, Secretary, 201 Fifth Avenue S.W., Olympia, WA 98501 or by calling (360) 943-1500, or from Washington Banking, upon written request to Washington Banking Company, Secretary, 450 SW Bayshore Drive, Oak Harbor, Washington 98277 or by calling (360) 240-6458.

Participants in this Transaction

Heritage, Washington Banking and certain of their respective directors and executive officers may be deemed to be participants in the solicitation of proxies from shareholders in connection with the proposed transaction under the rules of the SEC. Information about these participants may be found in the definitive proxy statement of Heritage relating to its 2013 Annual Meeting of Shareholders filed with the SEC by Heritage on March 19, 2013 and the definitive proxy statement of Washington Banking relating to its 2013 Annual Meeting of Shareholders filed with the SEC on March 26, 2013. These definitive proxy statements can be obtained free of charge from the sources indicated above. Additional information regarding the interests of these participants will also be included in the joint proxy statement/prospectus regarding the proposed transaction when it becomes available.

HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollar amounts in thousands; unaudited)








December 31,


September 30,


December 31,


2013


2013


2012

Assets






Cash on hand and in banks

$           40,162


$           55,794


$           37,180

Interest earning deposits

90,238


79,329


67,088

Cash and cash equivalents

130,400


135,123


104,268

Other interest earning deposits

15,662


17,415


2,818

Investment securities available for sale

163,134


167,226


144,293

Investment securities held to maturity

36,154


35,113


10,099

Loans held for sale

-


-


1,676

Originated loans receivable, net

977,285


961,892


874,485

Less:  Allowance for loan losses

(17,153)


(17,357)


(19,125)

Originated loans receivable, net of allowance for loan losses

960,132


944,535


855,360

Purchased covered loans receivable, net of allowance for loan losses of $6,167, $5,972 and $4,352

57,587


63,484


83,978

Purchased non-covered loans receivable, net of allowance for loan losses of $5,504, $5,426 and $5,117

185,377


200,063


59,006

Total loans receivable, net

1,203,096


1,208,082


998,344

FDIC indemnification asset

4,382


4,413


7,100

Other real estate owned ($182, $317 and $260 covered by FDIC loss share, respectively)

4,559


4,129


5,666

Premises and equipment, net

34,348


34,074


24,755

Federal Home Loan Bank stock, at cost

5,741


5,795


5,495

Accrued interest receivable

5,462


5,658


4,821

Prepaid expenses and other assets

25,120


26,252


22,107

Goodwill and other intangible assets

30,980


31,137


14,098

Total assets

$      1,659,038


$      1,674,417


$      1,345,540







Liabilities and Stockholders' Equity






Deposits

$      1,399,189


$      1,425,985


$      1,117,971

Securities sold under agreement to repurchase

29,420


22,655


16,021

Accrued expenses and other liabilities

14,667


9,182


12,610

Total liabilities

1,443,276


1,457,822


1,146,602







Common stock

138,659


138,426


121,832

Retained earnings

78,265


78,851


75,362

Accumulated other comprehensive (loss) income, net

(1,162)


(682)


1,744

Total stockholders' equity

215,762


216,595


198,938

Total liabilities and stockholders' equity

$      1,659,038


$      1,674,417


$      1,345,540







Common stock, shares outstanding

16,210,747


16,210,872


15,117,980








 



HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollar amounts in thousands, except per share amounts; unaudited)












Three Months Ended


Year Ended


December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012

Interest income:










Interest and fees on loans

$       17,378


$       17,505


$       15,924


$       67,630


$       65,588

Taxable interest on investment securities

618


518


414


1,918


2,195

Nontaxable interest on investment securities

436


428


300


1,539


1,097

Interest and dividends on other interest earning assets

120


82


62


341


229

Total interest income

18,552


18,533


16,700


71,428


69,109

Interest expense:










Deposits

888


939


968


3,673


4,469

Other borrowings

18


13


16


51


65

Total interest expense

906


952


984


3,724


4,534

Net interest income

17,646


17,581


15,716


67,704


64,575

Provision for loan losses on originated loans

(100)


150


280


890


695

Provision for loan losses on purchased loans

528


928


419


2,782


1,321

Net interest income after provision for loan losses

17,218


16,503


15,017


64,032


62,559

Noninterest income:










Bargain purchase gain on bank acquisition

-


-


-


399


-

Service charges and other fees

1,542


1,609


1,399


5,936


5,516

Merchant Visa income, net

219


259


151


862


685

Change in FDIC indemnification asset

155


(350)


(346)


(181)


(1,033)

Other income

513


1,064


569


2,635


2,104

Total noninterest income

2,429


2,582


1,773


9,651


7,272

Noninterest expense:










Compensation and employee benefits

8,392


8,014


7,311


31,612


29,020

Occupancy and equipment

3,619


2,190


1,868


9,724


7,365

Data processing

1,997


953


653


4,806


2,555

Marketing

410


477


310


1,598


1,517

Professional services

1,404


862


619


3,936


2,543

State and local taxes

274


292


301


1,150


1,226

Impairment loss on investment securities, net

11


-


18


38


78

Federal deposit insurance premium

257


237


219


1,001


1,002

Other real estate owned, net

570


(162)


(171)


309


316

Other expense

1,571


1,422


1,293


5,341


4,770

Total noninterest expense

18,505


14,285


12,421


59,515


50,392

Income before income taxes

1,142


4,800


4,369


14,168


19,439

Income tax expense

432


1,510


1,335


4,593


6,178

Net income

$            710


$         3,290


$         3,034


$           9,575


$         13,261











Basic earnings per common share

$           0.04


$           0.20


$           0.20


$            0.61


$            0.87

Diluted earnings per common share

$           0.04


$           0.20


$           0.20


$            0.61


$            0.87











Average number of common shares outstanding

16,007,330


15,958,213


14,949,675


15,476,235


15,080,149

Average number of diluted common shares outstanding

16,017,109


15,969,067


14,965,475


15,487,715


15,094,789



















 

HERITAGE FINANCIAL CORPORATION

FINANCIAL STATISTICS

(Dollar amounts in thousands; unaudited)

 













Three Months Ended


Year Ended



December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012


Performance Ratios:











Efficiency ratio

92.18%


70.85%


71.02%


76.94%


70.14%


Return on average assets

0.17%


0.80%


0.89%


0.62%


0.98%


Return on average equity

1.30%


6.05%


5.99%


4.58%


6.52%













Average Balances:











Loans, including purchased loans

$    1,198,464


$    1,191,572


$      994,618


$   1,124,828


$      996,186


Taxable investment securities

127,941


126,864


116,044


117,132


121,543


Nontaxable investment securities

74,074


72,120


45,065


64,018


38,853


Interest earning deposits

122,160


96,056


93,504


98,946


86,686


Total interest earning assets

1,528,580


1,492,556


1,254,824


1,410,748


1,248,906


Total assets

1,676,801


1,635,852


1,361,678


1,540,072


1,354,072


Interest bearing deposits

1,055,556


1,057,102


876,293


992,669


886,159


Securities sold under agreement to repurchase

28,090


19,830


19,269


19,102


18,314


Total interest bearing liabilities

1,083,646


1,076,932


895,562


1,011,771


904,473


Noninterest bearing deposits

363,031


333,648


254,525


308,582


237,888


Total equity

217,606


215,707


201,541


209,176


203,401


Tangible common equity

186,528


187,232


187,383


187,153


189,082













Net Interest Spread:











Yield on loans, net

5.75%


5.83%


6.37%


6.01%


6.58%


Yield on taxable investment securities

1.90%


1.62%


1.42%


1.64%


1.81%


Yield on nontaxable investment securities

2.36%


2.35%


2.65%


2.40%


2.83%


Yield on other interest earning assets

0.35%


0.33%


0.26%


0.31%


0.26%


Yield on interest earning assets

4.82%


4.93%


5.30%


5.06%


5.53%













Cost of interest bearing deposits

0.33%


0.35%


0.44%


0.37%


0.50%


Cost of securities sold under agreement to repurchase

0.26%


0.26%


0.33%


0.26%


0.35%


Cost of interest bearing liabilities

0.33%


0.35%


0.44%


0.37%


0.50%













Net interest spread

4.49%


4.58%


4.86%


4.69%


5.03%


Net interest margin

4.58%


4.67%


4.98%


4.80%


5.17%


































 

HERITAGE FINANCIAL CORPORATION

FINANCIAL STATISTICS

(Dollar amounts in thousands; unaudited)






Three Months Ended


Year Ended


December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012

Allowance for Originated Loan Losses:










Allowance balance, beginning of period

$        17,357


$        17,822


$        20,533


$        19,125


$        22,317

Provision for loan losses

(100)


150


280


890


695

Net charge-offs:










Commercial business

(77)


(222)


(1,101)


(2,177)


(2,123)

One-to-four family residential

-


-


(179)


-


(349)

Real estate construction

-


(423)


(360)


(533)


(1,155)

Consumer

(27)


30


(48)


(152)


(260)

Total net charge-offs

(104)


(615)


(1,688)


(2,862)


(3,887)

Allowance balance, end of period

$        17,153


$        17,357


$        19,125


$        17,153


$        19,125












Three Months Ended


Year Ended


December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012

Allowance for Purchased Covered Loan Losses:











Allowance balance, beginning of period

$        5,972


$        5,769


$        4,137


$               4,352


$          3,963

Net  charge-offs

(33)


-


( 24)


(73)


(57)

Provision  for loan losses

228


203


239


1,888


446

Allowance balance, end of period

$        6,167


$        5,972


$        4,352


$               6,167


$         4,352












Three Months Ended


Year Ended


December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012

Allowance for Purchased Non-Covered Loan Losses:










Allowance balance, beginning of period

$         5,426


$         4,789


$         4,937


$               5,117


$          4,635

Net charge-offs

(222)


(88)


-


(507)


(393)

Provision for loan losses

300


725


180


894


875

Allowance balance, end of period

$         5,504


$         5,426


$         5,117


$               5,504


$           5,117






Three Months Ended


Year Ended


December 31, 2013


September 30, 2013


December 31, 2012


December 31, 2013


December 31, 2012

Other Real Estate Owned:










Balance, beginning of period

$          4,129


$          3,796


$          7,285


$          5,666


$          4,484

Additions from foreclosures

1,234


1,227


1,426


2,974


7,405

Additions from acquisition

-


-


-


2,279


-

Proceeds from dispositions

(413)


(924)


(3,292)


(6,253)


(5,987)

(Loss) gain on sales

(43)


75


588


264


588

Valuation adjustments

(348)


(45)


(341)


(371)


(824)

Balance, end of period

$           4,559


$           4,129


$          5,666


$           4,559


$          5,666












 



HERITAGE FINANCIAL CORPORATION

FINANCIAL STATISTICS

(Dollar amounts in thousands, except per share amounts; unaudited)




As of Period End


December 31,  2013


September 30,

2013


December 31,

 2012

Financial Measures:





Book value per common share

$           13.31


$           13.36


$           13.16

Tangible book value per common share

$           11.40


$           11.44


$           12.23

Stockholders' equity to total assets

13.0%


12.9%


14.8%

Tangible common equity to tangible assets

11.4%


11.3%


13.9%

Tier 1 leverage capital to average assets

11.3%


11.6%


13.6%

Tier 1 capital to risk-weighted assets

15.5%


15.5%


18.7%

Total capital to risk-weighted assets

16.8%


16.7%


19.9%

Net loans to deposits ratio

86.0%


84.7%


89.4%

Deposits per branch

$         39,977


$         33,952


$          33,878

Assets per full-time equivalent employees

$           4,448


$           4,035


$            3,707




As of Period End


December 31,  2013


September 30, 2013


December 31,

 2012

Nonperforming Originated Assets:






Nonaccrual originated loans by type:






Commercial business

$          5,524


$          5,285


$          5,492

One-to-four family residential

340


583


389

Real estate construction and land development

1,045


3,852


6,420

Consumer

38


39


157

Total nonaccrual originated loans(1)(2)

6,947


9,759


12,458

Other non-covered real estate owned

4,377


3,812


5,406

Nonperforming originated assets

$        11,324


$        13,571


$        17,864







Restructured originated performing loans(3)

$        20,439


$        19,590


$        15,039

Accruing originated loans past due 90 days or more(4)

6


-


214

Potential problem originated loans(5)

30,102


26,630


28,270

Allowance for loan losses on originated loans to:






Total originated loans

1.76%


1.80%


2.19%

Nonperforming originated loans(6)

329.40%


221.68%


170.44%

Nonperforming originated loans to total originated loans(6)

0.53%


0.81%


1.28%

Nonperforming originated assets to total originated assets(6)

0.68%


0.83%


1.39%








 

(1)

$2.5 million, $5.1 million and $8.6 million of originated nonaccrual loans were considered troubled debt restructurings at December 31, 2013, September 30, 2013 and December 31, 2012, respectively.



(2)

$1.7 million, $1.9 million and $1.2 million of originated nonaccrual loans were guaranteed by government agencies at December 31, 2013, September 30, 2013 and December 31, 2012, respectively.



(3)

$1.2 million, $1.0 million and $679,000 of originated restructured performing loans were guaranteed by government agencies at December 31, 2013, September 30, 2013 and December 31, 2012, respectively.



(4)

There were no accruing originated loans past due 90 days or more that were guaranteed by government agencies at December 31, 2013, September 30, 2013 and December 31, 2012. 



(5)

Potential problem loans are those loans that are currently accruing interest and are not considered impaired, but which are being monitored because the financial information of the borrower causes concern as to their ability to comply with their loan repayment terms. $1.8million, $1.7 million and $3.2 million of originated potential problem loans were guaranteed by government agencies at December 31, 2013, September 30, 2013 and December 31, 2012, respectively.



(6)

Excludes portions guaranteed by government agencies.

 

HERITAGE FINANCIAL CORPORATION

FINANCIAL STATISTICS

(Dollar amounts in thousands; unaudited)














December 31, 2013


September 30, 2013


December 31, 2012


Balance


% of Total


Balance


% of Total


Balance


% of Total

Loan Composition












Originated loans:












Commercial business:












    Commercial and industrial

$    283,075


29.0%


$    292,906


30.5%


$    277,240


31.7%

Owner-occupied commercial real estate

211,287


21.6%


197,421


20.5%


188,494


21.6%

Non-owner occupied commercial real estate

354,451


36.3%


347,391


36.1%


265,835


30.4%

Total commercial business

848,813


86.9%


837,718


87.1%


731,569


83.7%

One-to-four family residential

39,235


4.0%


39,902


4.2%


38,848


4.4%

Real estate construction and land development:












One-to-four family residential

18,593


1.9%


20,054


2.1%


25,175


2.9%

Five or more family residential and commercial properties

45,184


4.6%


38,704


4.0%


52,075


5.9%

Total real estate construction and land development

63,777


6.5%


58,758


6.1%


77,250


8.8%

Consumer

28,130


2.9%


28,029


2.9%


28,914


3.3%

Gross originated loans

979,955


100.3%


964,407


100.3%


876,581


100.2%

Deferred loan fees, net

(2,670)


(0.3)%


(2,515)


(0.3)%


(2,096)


(0.2)%

Originated loans, net

977,285


100.0%


961,892


100.0%


874,485


100.0%

Purchased covered loans

63,754




69,456




88,330



Purchased non-covered loans

190,881




205,489




64,123



Total loans, net of net deferred loan fees

$  1,231,920




$  1,236,837




$  1,026,938




























December 31, 2013


September 30, 2013


December 31, 2012


Balance


% of Total


Balance


% of Total


Balance


% of Total

Deposit Composition












Noninterest demand deposits

$    349,902


25.0%


$    361,743


25.4%


$    247,048


22.1%

NOW accounts

352,051


25.2%


350,361


24.6%


303,487


27.2%

Money market accounts

232,016


16.6%


233,177


16.3%


157,728


14.1%

Savings accounts

155,790


11.1%


160,586


11.3%


120,781


10.8%

Total non-maturity deposits

1,089,759


77.9%


1,105,867


77.6%


829,044


74.2%

Certificates of deposit

309,430


22.1%


320,118


22.4%


288,927


25.8%

Total deposits

$ 1,399,189


100.0%


$ 1,425,985


100.0%


$ 1,117,971


100.0%













 



 


As of Period End


December 31,  2013


September 30,

2013


December 31,

 2012

Other Data:






Total Assets

$    1,659,038


$    1,674,417


$      1,345,540

Total Deposits

$    1,399,189


$    1,425,985


$      1,117,971

Number of branches

35


42


33

Number of full-time equivalent employees

373


415


363

 

SOURCE Heritage Financial Corporation

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