Heritage Financial (NASDAQ:HFWA) reported fourth-quarter results that management said reflected an improving net interest margin and a favorable shift in the loan mix that helped reduce provision expense. President and CEO Bryan McDonald said adjusted diluted earnings per share rose 18% from the prior quarter and increased 29% from the fourth quarter of 2024, while adjusted return on assets improved to 1.29% compared with 0.99% in the year-ago period.
McDonald also said the company has received regulatory and shareholder approval for its pending merger with Olympic Bancorp and expects to close the transaction at the end of January. Management described the deal as an opportunity to add profitability and improve Heritage’s positioning for future growth in the Puget Sound market.
Balance sheet trends: modest loan growth, stronger deposits, and lower borrowings
Total deposits rose $63 million in the quarter, driven primarily by a $100 million increase in interest-bearing demand deposits. Hinson said the cost of interest-bearing demand deposits decreased to 1.8% from 1.89% in the prior quarter, and he expects deposit costs to continue declining as rate cuts flow through.
On the securities portfolio, investment balances declined $31 million, which Hinson attributed primarily to expected principal runoff. The investment portfolio yield declined to 3.26% from 3.35% in the third quarter, in part because a bond called in the prior quarter had added accretion income and because higher-yielding bonds rolled off without replacement at current market rates.
With cash flows from the investment portfolio and deposit growth, Heritage used liquidity to reduce borrowings. Hinson said borrowing balances fell to $20 million from $138 million at the end of the third quarter, with borrowings maturing in 2026.
Net interest margin rises as deposit costs ease
Net interest income increased $1 million, or 1.7%, from the prior quarter, driven primarily by a higher net interest margin. Hinson said the net interest margin rose to 3.70% from 3.64% in the prior quarter and from 3.36% in the fourth quarter of 2024.
During the question-and-answer session, management discussed the outlook for margin and loan yields. Hinson said that even with three rate cuts in the last four months of the year, Heritage was able to slightly increase loan yields in the fourth quarter as adjustable-rate loans repriced higher and new loans were booked at higher rates, while floating-rate loans tied to prime or SOFR repriced down. He added that in quarters without rate cuts, management would expect more improvement in loan yields, while rate cuts should help reduce deposit costs. Hinson said the company expects margin improvement to continue over the next year or two on the legacy Heritage balance sheet, even before incorporating the Olympic transaction.
Asked about a consolidated view including Olympic, Hinson cautioned that fair value work will be completed after closing, making estimates less precise. Still, he said the acquired loan portfolio could reprice into the low-6% range, and noted Olympic’s deposit costs were “over 20 basis points lower” than Heritage’s. He also said the acquired investment portfolio could reprice into the low- to mid-4% range, up from around 3% currently. Based on those assumptions, he said a combined margin could potentially approach the 4% range by the end of the year.
Credit quality: non-accrual uptick tied to three CRE loans; charge-offs remain low
Chief Credit Officer Tony Chalfant said Heritage ended the year with “strong credit quality” across the portfolio. Non-accrual loans totaled $21 million at year-end, representing 0.44% of total loans, compared with 0.37% at the end of the third quarter. Chalfant said the increase was primarily due to three non-owner-occupied commercial real estate loans moved to non-accrual because of delinquency.
Chalfant said those loans are well-secured and are expected to pay off through a sale or refinance of the underlying properties, with no anticipated loss. He added that within the non-accrual portfolio, Heritage has just over $2.4 million in government guarantees. The company reported no other real estate owned (OREO).
Criticized loans declined during the quarter to just under $188 million, down $6.6 million, but substandard loans increased 24% as some credits moved from special mention into substandard. Chalfant said the largest driver of the increase was the downgrade of two commercial and industrial relationships totaling just under $30 million, partially offset by a full payoff of a long-term problem loan workout involving a $15.6 million non-owner-occupied CRE loan. He said substandard loans remain manageable at 2.44% of total loans and in line with longer-term historical performance.
Charge-offs during the quarter totaled $640,000, primarily in the commercial loan portfolio, offset by $159,000 of recoveries for net charge-offs of $481,000. For the full year, net charge-offs were just under $1.4 million, or 0.03% of total loans, compared with just over $2.5 million, or 0.06%, in 2024.
On provisioning, Hinson said Heritage recorded a reversal of provision for credit losses of $18,000 in the fourth quarter, driven by a change in loan mix as commercial construction loans declined and permanent real estate balances increased. The allowance for credit losses decreased to 1.10% from 1.13% in the third quarter.
Production, payoffs, and expense outlook; Olympic integration takes priority
McDonald said the commercial teams closed $254 million in new loan commitments in the quarter, down from $317 million in the prior quarter and $316 million in the fourth quarter of 2024. The commercial loan pipeline ended the quarter at $468 million, down from $511 million in the third quarter but up modestly from $452 million a year earlier. Total new loan production was $271 million, which management said was largely offset by elevated payoffs and prepayments.
McDonald said 2025 prepayments and payoffs were $208 million higher than the prior year, and net advances swung from a positive $153 million in 2024 to a negative $81 million in 2025. Looking ahead, he said the company expects loan growth to return to more historical levels in 2026 as known elevated loan payoffs subside and net advances return to positive.
On deposit gathering, McDonald said deposits rose $63 million in the quarter and $236 million for the year. The deposit pipeline ended the quarter at $108 million versus $149 million in the third quarter, and average balances on new deposit accounts opened during the quarter were estimated at $43 million compared with $40 million in the third quarter. Management attributed deposit growth to relationship banking and prior investments in deposit sales teams and new locations.
Regarding pricing, McDonald said the average rate on new commercial loans was 6.56% in the fourth quarter, down 11 basis points from 6.67% in the third quarter. The average rate for all new loans was 6.43%, down 28 basis points from 6.71% in the prior quarter. Management said competitive conditions remain strong, particularly for new-to-bank relationships, though they did not describe competition as unusually intense.
On expenses, Hinson said non-interest expense declined from the prior quarter largely because of lower merger-related expenses, though compensation and benefits rose due to incentive compensation accruals rather than headcount growth. In response to an analyst question about the post-merger run rate, Hinson said the company expects approximately $20 million to $21 million of merger-related expenses. Excluding those items, he suggested that the run rate in the second and third quarters could be in the “56 range,” possibly $56 million to $57 million, due in part to operating on two systems until a conversion expected around September. He said cost savings should be more visible in the fourth quarter, with a “core” run rate potentially closer to $54 million after that.
Heritage ended the quarter with regulatory capital ratios “comfortably above” required thresholds, and tangible common equity (TCE) improved to 10.1% from 9.8% in the third quarter. Hinson said the company did not execute securities loss trades or stock buybacks in the fourth quarter. Looking ahead, he said the Olympic transaction is expected to use about 100 basis points of capital, and management will reassess additional uses of capital after closing and completion of fair value marks. He noted the company has about 800,000 shares remaining under its repurchase authorization and said buybacks could be considered depending on deal-related dilution and accretion.
McDonald also addressed the company’s path toward the $10 billion asset threshold, saying Heritage began planning in 2023 and has been executing against that plan. However, he said on an organic basis the company is “several years out” from crossing $10 billion and that management’s focus for 2026 is integrating Olympic.
About Heritage Financial (NASDAQ:HFWA)
Heritage Financial Corporation (NASDAQ:HFWA) is a bank holding company headquartered in Spokane, Washington. Through its primary subsidiary, Heritage Bank, the company provides a comprehensive range of banking and financial services to both individual and commercial clients. Heritage Bank’s offerings encompass deposit products, lending solutions, treasury and cash management services, mortgage banking, and wealth management, positioning the organization as a full-service community bank.
The company’s lending portfolio includes commercial real estate loans, agricultural loans, small business administration (SBA) loans, construction and development financing, and a variety of consumer mortgage products.
