Heritage Financial (NASDAQ:HFWA) executives said the company’s second-quarter results reflected higher net interest margin, stable credit quality and continued merger-related expenses as it moves toward a late-September systems conversion.
President and CEO Bryan McDonald said the integration with Kitsap Bank is “progressing as planned,” adding that the company expects to carry higher expenses until after the conversion. Chief Financial Officer Don Hinson said second-quarter results included the first full quarter of combined operations following the Olympic Bancorp merger, which affected comparisons with the prior quarter.
Net Interest Margin Moves Higher
Hinson said the margin improvement was driven primarily by higher yields on the investment portfolio and a lower cost of deposits. The cost of interest-bearing deposits fell to 1.67% from 1.71% in the prior quarter, which Hinson attributed largely to having a full-quarter impact from the Olympic merger compared with two months in the first quarter.
However, Hinson told analysts that deposit costs may have reached their low point. He said the spot rate for interest-bearing deposits was 1.64% at quarter-end, but added that competition for deposits has intensified and CD rates are beginning to rise.
“I think we’ve hit the bottom,” Hinson said. “I think that we will see some gradual increases in cost of interest-bearing deposits from here on.”
Management said additional margin expansion is expected, though at a more moderate pace. McDonald said the company continues to benefit from asset repricing, with new commercial loans originated at higher rates than the existing portfolio average.
Loan Production Rises, But Payoffs Limit Balance Growth
Total loan balances increased by $26 million during the quarter. Hinson said loan originations rose, but elevated prepayments offset much of the higher production.
McDonald said Heritage’s commercial teams closed $339 million in new loan commitments during the quarter, up from $166 million in the first quarter and $248 million in the second quarter of 2025. The commercial loan pipeline ended the period at $628 million, nearly flat with $631 million at the end of the prior quarter and above $473 million a year earlier.
Loan balance growth was limited by $152 million in loan prepayments and payoffs, up from $119 million in the first quarter. McDonald said the quarter also included a higher level of construction loans, where balances are expected to increase over time.
Based on the current pipeline, McDonald said the company expects annualized loan growth in the mid-single-digit range over the next couple of quarters. In response to analyst questions, he said that outlook assumes prepayments remain elevated.
The average second-quarter interest rate for new commercial loans was 6.44%, up 36 basis points from the first quarter. The rate for all new loans was 6.40%, compared with 6.16% in the prior quarter. McDonald said the increase was driven by higher underlying indexes, including the five-year Federal Home Loan Bank rate used to price much of the company’s term debt.
Deposits Decline Seasonally
Total deposits decreased by $210 million in the quarter. Hinson said the decline reflected seasonal tax-payment outflows in April, a $67 million decrease from a single deposit relationship that had placed funds on a short-term basis in the first quarter, and a $48.5 million decline in brokered certificates of deposit.
McDonald said that, excluding the single relationship and brokered CD decline, deposits were down 1.3% in the quarter, compared with a 1% decline in the second quarter of 2025. He said average deposit balances on new accounts opened during the quarter were estimated at $62 million, up from $33 million in the first quarter. The deposit pipeline ended the quarter at $78 million, down from $102 million at the end of the first quarter.
During the question-and-answer session, Hinson said the second half of the year is typically stronger for deposit growth and that he expects mid-single-digit annualized deposit growth, with the third quarter generally the strongest period.
Credit Metrics Remain Stable
Chief Credit Officer Tony Chalfant said credit quality remained “strong and stable” through the first half of the year. Non-accrual loans totaled $15.5 million at quarter-end, up $500,000 during the quarter. That represented 0.27% of total loans, compared with 0.26% at the end of the first quarter and 0.44% at the end of 2025.
Chalfant said two related commercial and industrial loans were downgraded to non-accrual during the quarter due to delinquency, but both were fully repaid before quarter-end. The company’s non-accrual loan portfolio included $4.2 million in government guarantees.
Non-performing assets totaled 0.19% of total assets, unchanged from the prior quarter. Chalfant said the company continues to hold one single-family residence as other real estate owned, with a book balance of $755,000. The property is listed for sale, and the company expects it to close during the third quarter.
Criticized loans rose by $5.5 million, but remained stable at 4% of total loans. Substandard loans improved to 1.8% of total loans from 2.1% at the end of the first quarter and 2.4% at year-end 2025. Total charge-offs were $269,000, partially offset by $35,000 in recoveries, resulting in net charge-offs of $234,000 for the quarter.
Expenses Expected to Fall After Conversion
Hinson said non-interest expense increased due to the first full quarter of combined operations and merger-related costs of $7.5 million, compared with $5.2 million in the first quarter. He said expenses are expected to remain elevated until the fourth quarter because the systems conversion is scheduled for late in the third quarter.
Management reiterated guidance for quarterly non-interest expense of $64 million to $65 million in the third quarter, declining to $56 million to $57 million in the fourth quarter. In response to analyst questions, Hinson said the fourth-quarter range represents the expected run rate going forward, with most merger-related expenses completed in the third quarter.
Capital ratios remained above well-capitalized thresholds, and the tangible common equity ratio was 9.7% at quarter-end, up from 9.6% in the prior quarter. Heritage repurchased 372,000 shares of common stock for $10 million during the quarter and had 424,000 shares remaining under its current repurchase plan at quarter-end. Hinson said the company will continue to consider buybacks depending on market conditions and other capital priorities.
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.
