HERITAGE FINANCIAL ANNOUNCES FOURTH QUARTER AND ANNUAL 2023 RESULTS AND DECLARES REGULAR CASH DIVIDEND

• Net income was $6.2 million, or $0.18 per diluted share, for the fourth quarter of 2023 compared to $18.2 million, or $0.51 per diluted share, for the third quarter of 2023.
• Significant items in the fourth quarter of 2023 results include a loss on sale of securities totaling $10.0 million, or $0.22 per diluted share, and costs relating to expense management measures totaling $2.0 million, or $0.04 per diluted share.
• Book value per share increased to $24.44 at December 31, 2023, compared to $23.31 at September 30, 2023. Tangible book value per share increased to $17.40 at December 31, 2023, compared to $16.25 at September 30, 2023(1).
• Capital remains strong with a leverage ratio of 10.0% and a total capital ratio of 14.1% at December 31, 2023.
• Loans receivable increased $68.8 million, or 1.6%, during the fourth quarter of 2023 and $284.8 million, or 7.0% during the year ended December 31, 2023.
• Net interest margin was 3.41% for the fourth quarter of 2023 compared to 3.47% for the third quarter of 2023.
• Cost of total deposits was 1.01% for the fourth quarter of 2023 compared to 0.83% for the third quarter of 2023.
• Declared a regular cash dividend of $0.23 per share on January 24, 2024, an increase of 4.5% from the $0.22 regular cash dividend per share declared in the fourth quarter of 2023.

OLYMPIA, Wash., Jan. 25, 2024 /PRNewswire/ -- Heritage Financial Corporation (NASDAQ GS: HFWA) (the "Company" or "Heritage"), the parent company of Heritage Bank (the "Bank"), today reported net income of $6.2 million for the fourth quarter of 2023 compared to $18.2 million for the third quarter of 2023 and $22.5 million for the fourth quarter of 2022. Diluted earnings per share for the fourth quarter of 2023 were $0.18 compared to $0.51 for the third quarter of 2023 and $0.64 for the fourth quarter of 2022. Net income for the year ended 2023 totaled $61.8 million, or $1.75 per diluted share as compared to $81.9 million, or $2.31 per diluted share for 2022.

In the fourth quarter of 2023, the Company incurred a pre-tax loss of $10.0 million on the sale of investment securities due to the strategic repositioning of its investment portfolio, which affected diluted earnings per share by $0.22 for the quarter. The Company sold $151.8 million in investment securities with an estimated weighted average book yield of 2.41% and purchased $140.7 million of investment securities with an estimated weighted average book yield of 6.08%. The remaining proceeds from sales were invested in interest earning deposits. As a result of these actions, we anticipate an estimated annualized improvement of $5.3 million in interest income.

Further, costs relating to expense management measures totaling $2.0 million were recognized in the fourth quarter relating to contract renewal negotiations, contract cancellations and severance payments which were undertaken to improve future earnings. These noninterest expenses impacted diluted earnings per share by $0.04 for the quarter. These costs, in addition to approximately $1.2 million of severance costs incurred in the first quarter of 2024 due to staff reductions, are expected to provide annualized costs savings of approximately $5.3 million in future periods.

Jeffrey J. Deuel, President and Chief Executive Officer of Heritage, commented, "We are pleased with our accomplishments in the fourth quarter which included strong loan growth, expense management measures and repositioning of our investment portfolio. Although costs related to these activities are impacting current earnings, we expect enhanced earnings in future periods. We believe these actions, coupled with our strong balance sheet, will provide sustainable long-term returns for our shareholders.

We are also pleased to report that Heritage Bank is partnering with Community Roots Housing on the renovation of the historic Devonshire Apartments. This project will preserve 62 units of affordable housing in Seattle's Belltown Neighborhood. Heritage provided a $16.9 million construction loan and $2.6 million permanent loan to update the building, which was originally built in 1925. The renovations will provide significant seismic upgrades, make the building more energy efficient and improve living conditions for residents, all while preserving the historic brickwork façade. The project will continue to provide affordable housing, serving residents earning 50% to 60% of the Area Median Income. Heritage is proud to be a partner in preserving aging affordable housing stock in Seattle."

Financial Highlights

The following table provides financial highlights at the dates and for the periods indicated:

Balance Sheet

Total investment securities decreased $20.6 million, or 1.1%, to $1.87 billion at December 31, 2023 from $1.89 billion at September 30, 2023. As previously discussed, the Company sold $151.8 million in investment securities at a loss of $10.0 million during the fourth quarter of 2023. These funds were redeployed in investment purchases of $140.7 million and interest earning deposits.

The following table summarizes the Company's investment securities at the dates indicated:

Loans receivable increased $68.8 million, or 1.6%, to $4.34 billion at December 31, 2023 from $4.27 billion at September 30, 2023. New loans funded in the fourth quarter of 2023 and third quarter of 2023 totaled $113.4 million and $98.5 million, respectively. Loan prepayments decreased slightly during the fourth quarter of 2023 to $42.8 million, compared to $60.6 million during the third quarter of 2023.

Commercial and industrial loans increased $27.0 million, or 3.9%, due primarily to new loan production of $54.1 million during the fourth quarter of 2023 offset partially by repayments. Commercial and multifamily construction loans increased $25.8 million, or 8.3% due primarily to advances on outstanding commitments.

The following table summarizes the Company's loans receivable, net at the dates indicated:

Total deposits decreased $35.3 million, or 0.6%, to $5.60 billion at December 31, 2023 from $5.64 billion at September 30, 2023. Certificates of deposit increased $64.4 million, or 10.2%, from September 30, 2023 primarily due to transfers from non-maturity deposit accounts as customers moved balances to higher yielding accounts.

The following table summarizes the Company's total deposits at the dates indicated:

The Company discontinued offering securities sold under agreement to repurchase during the fourth quarter of 2023. Total securities sold under agreements to repurchase were $23.2 million at September 30, 2023.

Total borrowings were $500.0 million at December 31, 2023 compared to $450.0 million at September 30, 2023. Borrowings of $50.0 million at a rate 5.09% were paid off and were offset by advances of $100.0 million at a rate of 4.89% during the fourth quarter of 2023. All borrowings were from the Federal Reserve Bank ("FRB") Bank Term Funding Program ("BTFP"). The BTFP offers loans of up to one year in length to institutions pledging eligible investment securities. The advance rate on the collateral is at par value.

Total stockholders' equity increased $39.7 million, or 4.9%, to $853.3 million at December 31, 2023 compared to $813.5 million at September 30, 2023 due primarily to a decrease of $40.2 million in accumulated other comprehensive loss as a result of increasing fair values of investment securities available for sale and $6.2 million of net income recognized for the quarter offset partially by $7.7 million in dividends paid to common shareholders.

The Company and Bank continue to maintain capital levels in excess of the applicable regulatory requirements for them both to be categorized as "well-capitalized".

The following table summarizes capital ratios for the Company at the dates indicated:

Allowance for Credit Losses and Provision for Credit Losses

The allowance for credit losses ("ACL") on loans as a percentage of loans receivable was 1.11% at December 31, 2023 compared to 1.10% at September 30, 2023. During the fourth quarter of 2023, the Company recorded a $1.7 million provision for credit losses on loans, compared to a $635,000 reversal of provision for credit losses on loans during the third quarter of 2023. The provision for credit losses on loans during the fourth quarter of 2023 was primarily driven by loan growth during the quarter.

During the fourth quarter of 2023, the Company recorded a $246,000 reversal of provision for credit losses on unfunded commitments compared to a $243,000 reversal of provision for credit losses on unfunded commitments during the third quarter of 2023. The reversal of provision for credit losses on unfunded commitments during the fourth quarter of 2023 was due primarily to a $39.0 million decrease in the unfunded exposure on construction loans.

The following table provides detail on the changes in the ACL on loans and the ACL on unfunded, and the related provision for (reversal of) credit losses for the periods indicated:

Credit Quality

The percentage of classified loans to loans receivable increased slightly to 1.61% at December 31, 2023, compared to 1.47% at September 30, 2023. Classified loans include loans rated substandard or worse. Total classified loans and loans designated as special mention increased by $14.9 million to $149.7 million at December 31, 2023, compared to $134.8 million at September 30, 2023. This increase was primarily due to the transfer of a $7.1 million commercial and industrial loan to special mention and a $6.0 million commercial and industrial lending relationship to substandard offset partially by repayments and transfers of previously classified and special mention loans to a pass rating.

The following table illustrates total loans by risk rating and their respective percentage of total loans at the dates indicated:

Nonaccrual loans to loans receivable was 0.10% and 0.07% at December 31, 2023 and September 30, 2023, respectively. Nonaccrual loans increased primarily due to the addition of a $2.1 million commercial and industrial loan during the fourth quarter of 2023 which is 100% government guaranteed. Changes in nonaccrual loans during the periods indicated were as follows:

Liquidity

Total liquidity sources available at December 31, 2023 were $2.86 billion. This includes internal as well as external sources of liquidity. The Company has access to FHLB advances, the FRB Discount Window and BTFP. The Company's available liquidity sources at December 31, 2023 represented a coverage ratio of 51.1% of total deposits and 136.3% of estimated uninsured deposits.

The following table summarizes the Company's available liquidity:

Net Interest Income and Net Interest Margin

Net interest income decreased $1.7 million, or 3.1%, during the fourth quarter of 2023 compared to the third quarter of 2023 due primarily to an increase of $2.5 million in interest expense partially offset by a $795,000 increase in interest income. Net interest margin decreased six basis points to 3.41% during the fourth quarter of 2023 from 3.47% during the third quarter of 2023.

The cost of interest bearing deposits increased 25 basis points to 1.48% for the fourth quarter of 2023 from 1.23% for the third quarter of 2023.

This increase was primarily due to customers transferring balances from non-maturity deposits to higher rate certificates of deposit. The yield on interest earning assets increased 12 basis points to 4.70% for the fourth quarter of 2023 compared to 4.58% for the third quarter of 2023. The yield on loans receivable, net increased five basis points to 5.35% during the fourth quarter of 2023 compared to 5.30% during the third quarter of 2023 due to higher rates on new and renewed loans and recoveries of interest on loans classified as nonaccrual loans that paid off during the quarter which contributed three basis points to the yield on loans receivable. The yield on taxable securities increased 15 basis points to 3.15% during the fourth quarter of 2023 compared to 3.00% during the third quarter of 2023 due to sales of $151.8 million of lower yielding investments with a weighted average yield of 2.41% offset by purchases of $140.7 million of higher yielding investments with a weighted average yield of 6.08%.

Net interest income decreased $9.2 million, or 14.6%, during the fourth quarter of 2023 compared to the fourth quarter of 2022 and the net interest margin decreased 57 basis points from 3.98% during this same period. The decrease was due primarily to an increase in interest expense due to an increase in deposit rates and borrowing expense partially offset by an increase in yields earned on interest earning assets following increases in market interest rates.

The following table provides relevant net interest income information for the periods indicated:

Noninterest Income

Noninterest income decreased $9.4 million during the fourth quarter of 2023 from the third quarter of 2023 and decreased $9.7 million from the same period in 2022 due primarily to a $10.0 million pre-tax loss on the sale of investment securities available for sale. Card revenue decreased during the fourth quarter of 2023 compared to the third quarter of 2023 due to annual incentives of $250,000 recognized in the third quarter of 2023 as well as general declines in income due to lower transaction account volume. Other income decreased during the fourth quarter of 2023 compared to the third quarter of 2023 due to a $610,000 gain on sale of the Ellensburg branch which was recognized in the third quarter of 2023.

The following table presents the key components of noninterest income and the change for the periods indicated:

Noninterest Expense

Noninterest expense increased $1.8 million, or 4.3%, during the fourth quarter of 2023 from the third quarter of 2023. Compensation and employee benefits expenses decreased primarily due to a reduction in employees and included $148,000 in severance costs. Data processing expenses increased due primarily to a $320,000 accrual for the early termination of a technology-related contract. Marketing expenses increased due to an increase in marketing efforts during the fourth quarter of 2023. Professional services increased due primarily to a $1.5 million expense related to renewal of the core vendor contract during the fourth quarter of 2023.

Noninterest expense increased $2.3 million, or 5.8%, during the fourth quarter of 2023 compared to the same period in 2022. Occupancy and equipment expense increased due primarily to our expansion into Boise, Idaho and annual increases in lease expenses. Federal deposit insurance premiums increased due to the increase in the assessment rate starting in January 2023. Data processing expenses and professional services increased primarily due to the same reasons stated above.

The following table presents the key components of noninterest expense and the change for the periods indicated:

Income Tax Expense

Income tax expense decreased during the fourth quarter of 2023 compared to the third quarter of 2023, primarily due to a decrease in income before income taxes. Additionally, the effective income tax rate was lower during the fourth quarter of 2023, resulting from a decrease in annual pre-tax income for the year ended 2023 which increased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and tax credits. The effective income tax rate for the year ended December 31, 2023 was 15.3% as compared to 17.7% for the year ended December 31, 2022.

The following table presents the income tax expense and related metrics and the change for the periods indicated:

Dividends

On January 24, 2024, the Company's Board of Directors declared a quarterly cash dividend of $0.23 per share. The dividend is payable on February 22, 2024 to shareholders of record as of the close of business on February 8, 2024.

Earnings Conference Call

The Company will hold a telephone conference call to discuss this earnings release on Thursday, January 25, 2024 at 10:00 a.m. Pacific time. To access the call, please dial (833) 470-1428 -- access code 290327 a few minutes prior to 10:00 a.m. Pacific time. The call will be available for replay through February 1, 2024 by dialing (866) 813-9403 -- access code 301843.

About Heritage Financial

Heritage Financial Corporation is an Olympia-based bank holding company with Heritage Bank, a full-service commercial bank, as its sole wholly-owned banking subsidiary. Heritage Bank has a branch network of 50 banking offices in Washington, Oregon and Idaho. Heritage Bank does business under the Whidbey Island Bank name on Whidbey Island. Heritage'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.

Forward-Looking Statements

This press release includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements often include words such as "believe," "expect," "anticipate," "estimate," and "intend" or future or conditional verbs such as "will," "would," "should," "could," or "may." Forward-looking statements are not historical facts but instead represent management's current expectations and forecasts regarding future events, many of which are inherently uncertain and outside of our control. Actual results may differ, possibly materially, from those currently expected or projected in these forward-looking statements. Factors that could cause the Company's actual results to differ materially from those described in the forward-looking statements, include but are not limited to, the following: changes in general economic conditions nationally or in our local market areas, other markets where the Company has lending relationships, or other aspects of the Company's business operations or financial markets including, without limitation, as a result of employment levels, labor shortages and the effects of inflation, a potential recession or slowed economic growth, or increased political instability due to acts of war; changes in the interest rate environment, including prior increases in the Board of Governors of the Federal Reserve System (the "Federal Reserve") benchmark rate and duration at which such increased interest rate levels are maintained, which could adversely affect our revenues and expenses, the value of assets and obligations, and the availability and cost of capital and liquidity; the impact of continuing inflation and the current and future monetary policies of the Federal Reserve in response thereto; the impact of bank failures or adverse developments at other banks and related negative press about the banking industry in general on investor and depositor sentiment; the effects of any federal government shutdown; changes in the interest rate environment; the quality and composition of our securities portfolio and the impact of any adverse changes including market liquidity within the securities markets; legislative and regulatory changes, including changes in banking, securities and tax law, in regulatory policies and principles, or the interpretation of regulatory capital or other rules; credit and interest rate risks associated with the Company's businesses, customers, borrowings, repayment, investment, and deposit practices; fluctuations in deposits; liquidity issues, including our ability to borrow funds or raise additional capital, if necessary; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; effects of critical accounting policies and judgments, including the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; and other factors described in Heritage's latest Annual Report on Form 10-K and Quarterly Reports on Form 10-Q and other documents filed with or furnished to the Securities and Exchange Commission (the "SEC") which are available on our website at www.heritagebanknw.com and on the SEC's website at www.sec.gov. The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, any of the forward-looking statements that we make in this press release or the documents we file with or furnish to the SEC are based only on information then actually known to the Company and upon management's beliefs and assumptions at the time they are made which may turn out to be wrong because of inaccurate assumptions we might make, because of the factors described above or because of other factors that we cannot foresee. 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.