KBRA Affirms Ratings for Heritage Financial Corporation

24 May 2024   |   New York


KBRA affirms the senior unsecured debt rating of BBB+, the subordinated debt rating of BBB, and the short-term debt rating of K2 for Olympia, WA-based Heritage Financial Corporation (NASDAQ: HFWA or “the company”). Additionally, KBRA affirms the deposit and senior unsecured debt ratings of A-, the subordinated debt rating of BBB+, and the short-term deposit and debt ratings of K2 for HFWA's subsidiary, Heritage Bank. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

Management’s consistent and diligent balance sheet stewardship, anchored by its capital and liquidity management practices, has served the bank well in recent periods and continues to buttress the ratings. Consolidated regulatory capital ratios remain above peer averages, while loans represent a smaller percentage of deposits than at similarly rated banks.

Underpinning the bank’s relatively solid and stable earnings performance is the low cost of deposits (1.20% as of 1Q24), which is buoyed by the historically sizeable base of noninterest-bearing deposits (30% of total deposits as of 1Q24). Notably, the bank’s NIM has outperformed rated peers since 4Q21 – a period predominated by rising interest rates.

The bank’s rich deposit base – intrinsically correlated to the economic dynamism of the local economy – has afforded management with the ability to strategically fund loans with relatively lower yields, which portends lower credit risk ceteris paribus.

Financial flexibility – sturdy capital and funding, together with higher quality earnings – contributed to management’s decision to restructure a sizeable portion of the bank’s AFS investment portfolio in 4Q23 and 1Q24, in KBRA’s view. The negative impact to consolidated ROAA in both periods was equivalent to about 0.45% annualized. Management estimates the earn-back period at about 2 years for each of the quarterly securities transactions.

The hallmark of liquidity management remains the relatively low level of loans in relation to deposits, which favorably positions the bank to manage funding in the current environment. Contingent sources of funding (e.g., FHLB unused lines of credit) have been ample historically but may not always be available, in KBRA’s judgment. Currently, on-balance sheet asset liquidity and contingent sources of funding are sufficient to cover net uninsured deposits (32% of total deposits, net of assets pledged).

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Further information on key credit considerations, sensitivity analyses that consider what factors can affect these credit ratings and how they could lead to an upgrade or a downgrade, and ESG factors (where they are a key driver behind the change to the credit rating or rating outlook) can be found in the full rating report referenced above.

A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider.

Doc ID: 1004408

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