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As filed with the Securities and Exchange Commission on December 20, 2013

Registration No. 333-          

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-4

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

HERITAGE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Washington		6021		91-1857900
(State or other jurisdiction of incorporation or organization)		(Primary Standard Industrial Classification Code Number)		(I.R.S. Employer Identification No.)

201 Fifth Avenue SW

Olympia, WA 98501

(360) 943-1500

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Kaylene M. Lahn

Senior Vice President and Corporate Secretary

Heritage Financial Corporation

201 Fifth Avenue SW

Olympia, WA 98501

(360) 943-1500

 

 

With copies to:

 

John F. Breyer, Jr. Breyer & Associates PC 8180 Greensboro Drive, Suite 785 McLean, Virginia 22102 Telephone: (703) 883-1100 Facsimile: (703) 883-2511		Andrew H. Ognall Lane Powell PC 601 SW Second Avenue, Suite 2100 Portland, Oregon 97204-3158 Telephone: (503) 778-2169 Facsimile: (503) 778-2200

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 

 

Approximate date of commencement of proposed sale of the securities to the public: As soon as practicable following the effectiveness of this Registration Statement, satisfaction or waiver of the other conditions to closing of the merger described herein, and consummation of the merger.

If the securities being registered on this Form are being offered in connection with formation of a holding company and there is compliance with General Instruction G, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

If applicable, place an X in the box to designate the appropriate rule provision relied upon in conducting this transaction:

Exchange Act Rule 13e-4(i) (Cross-Border Issuer Tender Offer)  ¨

Exchange Act Rule 14d-1(d) (Cross-Border Third-Party Tender Offer  ¨

 

 

Calculation of Registration Fee

 

Title of each class of securities to be registered		Amount to be registered(1)		Proposed maximum offering price per share		Proposed maximum aggregate offering price(2)		Amount of registration fee
Common Stock, no par value		14,349,349 shares		N/A		$240,714,360		$31,005.00

 

(1)

Represents the maximum number of shares of common stock of Heritage Financial Corporation (“Heritage”) estimated to be issuable upon completion of the merger described herein in exchange for shares of the common stock of Washington Banking Company (“Washington Banking”) that are currently outstanding or underlying outstanding stock options. Pursuant to Rule 416, this registration statement also covers additional securities that may be issued as a result of stock splits, stock dividends or similar transactions.

 

(2)

Calculated in accordance with 457(f)(1), 457(f)(3) and 457(c) under the Securities Act, the proposed maximum aggregate offering price of Heritage’s common stock was calculated based upon the market value of shares of Washington Banking common stock as follows: (A) the product of (1) $17.68, which is the average of the high and low prices per share of Washington Banking common stock on December 16, 2013, as reported on the NASDAQ Global Select Market, multiplied by (2) 16,122,864, which is the estimated maximum number of shares of Washington Banking common stock that may be exchanged in the merger, including shares issuable upon the exercise of outstanding options or other securities to acquire Washington Banking common stock, less (B) the estimated maximum amount of cash consideration to be paid in the merger by Heritage in exchange for shares of Washington Banking common stock (which equals $240,714,360.00).

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 

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The information contained in this joint proxy statement/prospectus is not complete and may be changed. A registration statement relating to the shares of Heritage stock to be issued in the merger has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This joint proxy statement/prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any jurisdiction in which such offer, solicitation or sale is not permitted or would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction.

 

PRELIMINARY JOINT PROXY STATEMENT/PROSPECTUS

DATED DECEMBER 20, 2013, SUBJECT TO COMPLETION

 

MERGER PROPOSED—YOUR VOTE IS VERY IMPORTANT

Dear Shareholder:

We are pleased to report that the boards of directors of Heritage Financial Corporation, or Heritage, and Washington Banking Company, or Washington Banking, have each approved a merger of our two companies. We believe that this combination will create one of the premier community banking franchises in Western Washington and the Pacific Northwest. Under the merger agreement, Washington Banking will merge with and into Heritage, with Heritage as the surviving corporation. Each outstanding share of Washington Banking common stock, other than dissenting shares, will be converted into the right to receive, promptly following the completion of the merger, 0.89000 of a share of Heritage common stock and $2.75 in cash.

Although the number of shares of Heritage common stock that holders of Washington Banking common stock will receive for the stock portion of the merger consideration is fixed, the market value of those shares will fluctuate with the market price of Heritage common stock and will not be known at the time Washington Banking shareholders vote on the merger agreement. Based on the closing price of Heritage’s common stock of $15.89 on the NASDAQ Global Select Market, or NASDAQ, on October 23, 2013, immediately prior to the public announcement of the merger agreement, the value of the per share merger consideration payable to Washington Banking shareholders was $16.89. Based on the closing price of Heritage’s common stock of $        .        on NASDAQ on                 , 2013, the last trading day before the date of this joint proxy statement/prospectus, the value of the per share merger consideration payable to Washington Banking shareholders was $        . We urge you to obtain current market quotations for Heritage common stock (NASDAQ: trading symbol “HFWA”) and Washington Banking common stock (NASDAQ: trading symbol “WBCO”). Based on the number of shares of Washington Banking common stock currently outstanding and reserved for issuance under various equity plans, the maximum number of shares of Heritage common stock issuable in the merger is expected to be 14,349,349.

Heritage and Washington Banking will each hold a special meeting of their respective shareholders in connection with the merger. Heritage and Washington Banking shareholders will be asked to vote to approve the merger agreement and related matters as described in the attached joint proxy statement/prospectus. Approval of the merger agreement by Heritage and Washington Banking shareholders requires the affirmative vote of the holders of two-thirds of the votes entitled to be cast.

The special meeting of Heritage shareholders will be held on                 , 2014. The special meeting of Washington Banking shareholders will be held on                 , 2014.

Heritage’s board of directors unanimously recommends that Heritage shareholders vote “FOR” approval of the Heritage merger proposal and “FOR” each of the other items to be considered at the Heritage special meeting.

Washington Banking’s board of directors unanimously recommends that Washington Banking shareholders vote “FOR” approval of the Washington Banking merger proposal and “FOR” each of the other items to be considered at the Washington Banking special meeting.

This joint proxy statement/prospectus describes the special meetings of Heritage and Washington Banking, the documents related to the merger and other related matters. Please carefully read this entire joint proxy statement/prospectus, including “Risk Factors,” beginning on page 19, for a discussion of the risks relating to the proposed merger. You also can obtain information about Heritage and Washington Banking from documents that each has filed with the Securities and Exchange Commission.

 

Brian L. Vance				John L. Wagner
President and Chief Executive Officer Heritage Financial Corporation				President and Chief Executive Officer Washington Banking Company

Neither the Securities and Exchange Commission nor any state securities commission or any bank regulatory agency has approved or disapproved the shares of Heritage stock to be issued in the merger or passed upon the adequacy or accuracy of this joint proxy statement/prospectus. Any representation to the contrary is a criminal offense.

The securities to be issued in the merger are not savings or deposit accounts or other obligations of any bank or nonbank subsidiary of Heritage or Washington Banking, and they are not insured by the Federal Deposit Insurance Corporation or any other governmental agency.

The date of this joint proxy statement/prospectus is                 , 2013, and is first being mailed or otherwise delivered to the shareholders of Heritage and Washington Banking on or about                 , 2013.

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Heritage Financial Corporation

201 Fifth Avenue SW

Olympia, Washington 98501

(360) 943-1500

Notice of Special Meeting of Heritage Financial Corporation Shareholders

 

•		Date:		, 2014
•		Time:		:        a.m., local time
•		Place:		The DoubleTree Hotel,
				417 Capitol Way N., Olympia, Washington

To Heritage Financial Corporation Shareholders:

We are pleased to notify you of and invite you to a special meeting of shareholders (which we refer to as the “Heritage special meeting”). At the Heritage special meeting, you will be asked to vote on the following matters:

 

•

the approval of the Agreement and Plan of Merger, dated as of October 23, 2013, by and between Heritage and Washington Banking Company, pursuant to which Washington Banking will merge with and into Heritage, and the approval of the issuance of Heritage common stock to Washington Banking shareholders in connection with the merger (which we refer to as the “Heritage merger proposal”); and

 

•

a proposal to adjourn the Heritage special meeting, if necessary or appropriate, to solicit additional proxies in favor of the Heritage merger proposal (which we refer to as the “Heritage adjournment proposal”).

Only holders of record of Heritage common stock as of the close of business on                 , 2013 are entitled to notice of, and to vote at, the Heritage special meeting and any adjournments or postponements of the Heritage special meeting. Approval of the Heritage merger proposal requires the affirmative vote of holders of at least two-thirds of the outstanding shares of Heritage common stock. The Heritage adjournment proposal will be approved if a majority of the votes cast on those proposals at the Heritage special meeting are voted in favor of those proposals.

Heritage’s board of directors has unanimously approved the merger agreement, has determined that the merger agreement and the transactions contemplated thereby, including the merger, are advisable and in the best interests of Heritage and its shareholders, and unanimously recommends that Heritage shareholders vote “FOR” the Heritage merger proposal, and “FOR” the Heritage adjournment proposal.

Your vote is very important. We cannot complete the merger unless Heritage’s shareholders approve the Heritage merger proposal.

To ensure your representation at the Heritage special meeting, please complete and return the enclosed proxy card or submit your proxy by telephone or via the Internet. Whether or not you expect to attend the Heritage special meeting in person, please vote promptly. If you hold your shares in street name through a bank, broker or other nominee and wish to vote your shares in person at the Heritage special meeting, then you must obtain a legal proxy from the holder of record authorizing you to do so by contacting your bank, broker or other nominee.

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The enclosed joint proxy statement/prospectus provides a detailed description of the Heritage special meeting, the Heritage merger proposal, the documents related to the Heritage merger proposal and other related matters. We urge you to read the joint proxy statement/prospectus, including the documents incorporated in the joint proxy statement/prospectus by reference, and its appendices carefully and in their entirety.

By Order of the Board of Directors

Kaylene M. Lahn

Senior Vice President and Corporate Secretary

                , 2013

Olympia, Washington

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Washington Banking Company

450 SW Bayshore Drive

Oak Harbor, Washington 98277

(360) 240-6458

Notice of Special Meeting of Washington Banking Company Shareholders

 

•

Date:             , 2014

•

Time:      :      .m., local time

•

Place: Best Western Harbor Plaza,

33175 State Route 20, Oak Harbor, Washington

To Washington Banking Company Shareholders:

We are pleased to notify you of and invite you to a special meeting of shareholders (which we refer to as the “Washington Banking special meeting”). At the Washington Banking special meeting, you will be asked to vote on the following matters:

 

•

the approval of the Agreement and Plan of Merger, dated as of October 23, 2013, by and between Heritage Financial Corporation and Washington Banking, pursuant to which Washington Banking will merge with and into Heritage (which we refer to as the “Washington Banking merger proposal”);

 

•

a proposal to adjourn the Washington Banking special meeting, if necessary or appropriate, to solicit additional proxies in favor of the Washington Banking merger proposal (which we refer to as the “Washington Banking adjournment proposal”); and

 

•

the approval, on an advisory (non-binding) basis, of compensation that may become payable to certain executive officers of Washington Banking in connection with the merger (which we refer to as the “Washington Banking compensation proposal”).

Only holders of record of Washington Banking common stock as of the close of business on             , 2013 are entitled to vote at the Washington Banking special meeting and any adjournments or postponements of the Washington Banking special meeting. Approval of the Washington Banking merger proposal requires the affirmative vote of holders of at least two-thirds of the outstanding shares of Washington Banking common stock. The Washington Banking adjournment proposal and Washington Banking compensation proposal will be approved if a majority of the votes cast on those proposals at the Washington Banking special meeting are voted in favor of those proposals.

Washington Banking’s board of directors has unanimously approved the merger agreement, has determined that the merger agreement and the transactions contemplated thereby, including the merger, are advisable and in the best interests of Washington Banking and its shareholders, and unanimously recommends that Washington Banking shareholders vote “FOR” the Washington Banking merger proposal, “FOR” the Washington Banking adjournment proposal and “FOR” the Washington Banking compensation proposal.

Your vote is very important. We cannot complete the merger unless Washington Banking’s shareholders approve the Washington Banking merger proposal.

To ensure your representation at the Washington Banking special meeting, please complete and return the enclosed proxy card or submit your proxy by telephone or via the Internet. Whether or not you expect to attend the Washington Banking special meeting in person, please vote promptly. If you hold your shares in street name through a bank, broker or other nominee and wish to vote your shares in person at the Washington Banking special meeting, then you must obtain a legal proxy from the holder of record authorizing you to do so by contacting your bank, broker or other nominee.

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The enclosed joint proxy statement/prospectus provides a detailed description of the Washington Banking special meeting, the Washington Banking merger proposal, the documents related to the Washington Banking merger proposal and other related matters. We urge you to read the joint proxy statement/prospectus, including the documents incorporated in the joint proxy statement/prospectus by reference, and its appendices carefully and in their entirety.

In connection with the merger, Washington Banking shareholders will have the opportunity to exercise dissenters’ rights in accordance with the procedures specified in the Washington Business Corporation Act (Chapter 23B.13 of the Revised Code of Washington (“RCW” and “RCW Chapter 23B.13”)). RCW Chapter 23B.13 is included in the accompanying joint proxy statement/prospectus as Appendix D. A dissenting shareholder who follows the required procedures may receive cash in an amount equal to the fair value of his or her shares of Washington Banking common stock in lieu of the merger consideration provided for under the merger agreement. A shareholder who chooses to dissent pursuant to RCW Chapter 23B.13 may provide the required notice specified therein to Washington Banking’s principal executive offices at 450 SW Bayshore Drive, Oak Harbor, Washington 98277. For additional details about dissenters’ rights, please refer to the section entitled “The Merger—Washington Banking Shareholder Dissenters’ Rights” and Appendix D in the accompanying joint proxy statement/prospectus.

By Order of the Board of Directors

Shelly L. Angus

Senior Vice President and Corporate Secretary

                , 2013

Oak Harbor, Washington

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REFERENCES TO ADDITIONAL INFORMATION

This joint proxy statement/prospectus incorporates important business and financial information about Heritage and Washington Banking from documents filed with the Securities and Exchange Commission, or the SEC, that are not included in or delivered with this joint proxy statement/prospectus. You can obtain any of the documents filed with or furnished to the SEC by Heritage and/or Washington Banking at no cost from the SEC’s website at http://www.sec.gov. You may also request copies of these documents, including documents incorporated by reference in this joint proxy statement/prospectus, at no cost by contacting the appropriate company:

 

Heritage Financial Corporation		Washington Banking Company
201 Fifth Avenue SW		450 SW Bayshore Drive
Olympia, Washington 98501		Oak Harbor, Washington 98277
Attention: Kaylene M. Lahn,                  Senior Vice President and                  Corporate Secretary                  (360) 943-1500		Attention: Shelly L. Angus,                  Senior Vice President and                  Corporate Secretary                  (360) 240-6458

You will not be charged for any of these documents that you request. To obtain timely delivery of these documents, you must request them no later than five business days before the date of your company’s special meeting. This means that Heritage shareholders requesting documents must do so by             , 2014, in order to receive them before the Heritage special meeting, and Washington Banking shareholders requesting documents must do so by             , 2014, in order to receive them before the Washington Banking special meeting.

You should rely only on the information contained in, or incorporated by reference into, this document. No one has been authorized to provide you with information that is different from that contained in, or incorporated by reference into, this document. This document is dated             , 2013, and you should assume that the information in this document is accurate only as of such date. You should assume that the information incorporated by reference into this document is accurate as of the date of the document that includes such information. Neither the mailing of this document to Heritage shareholders or Washington Banking shareholders nor the issuance by Heritage of shares of Heritage stock in connection with the merger will create any implication to the contrary.

Information on the websites of Heritage or Washington Banking, or any subsidiary of Heritage or Washington Banking, is not part of this document or incorporated by reference herein. You should not rely on that information in deciding how to vote.

This document does not constitute an offer to sell, or a solicitation of an offer to buy, any securities, or the solicitation of a proxy, in any jurisdiction to or from any person to whom it is unlawful to make any such offer or solicitation in such jurisdiction. Except where the context otherwise indicates, information contained in this document regarding Heritage has been provided by Heritage and information contained in this document regarding Washington Banking has been provided by Washington Banking.

See “Where You Can Find More Information” for more details.

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TABLE OF CONTENTS

 

		Page
QUESTIONS AND ANSWERS ABOUT THE MERGER AND THE SPECIAL MEETINGS			1
SUMMARY			9
RISK FACTORS			19
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS			24
SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION			26
Selected Historical Financial Data of Heritage and Washington Banking			26
Selected Historical Financial Data of Heritage			27
Selected Historical Financial Data of Washington Banking			29
Reconciliation of Non-GAAP Historical Financial Data of Washington Banking			31
Selected Unaudited Consolidated Pro Forma Financial Data of Heritage and Washington Banking			32
Comparative Unaudited Pro Forma Per Share Data			33
THE HERITAGE SPECIAL MEETING			34
Date, Time and Place of Meeting			34
Matters to Be Considered			34
Recommendation of Heritage’s Board of Directors			34
Record Date and Quorum			34
Vote Required; Treatment of Abstentions and Failure to Vote			35
Shares Held by Directors and Executive Officers; Voting and Support Agreements			35
Voting of Proxies; Incomplete Proxies			35
Shares Held in Street Name; Broker Non-Votes			36
Revocability of Proxies and Changes to a Heritage Shareholder’s Vote			36
Solicitation of Proxies			36
Attending the Heritage Special Meeting			37
HERITAGE PROPOSALS			38
Heritage Merger Proposal			38
Heritage Adjournment Proposal			38
THE WASHINGTON BANKING SPECIAL MEETING			39
Date, Time and Place of Meeting			39
Matters to Be Considered			39
Recommendation of Washington Banking’s Board of Directors			39
Record Date and Quorum			39
Vote Required; Treatment of Abstentions and Failure to Vote			40
Shares Held by Directors and Executive Officers; Voting and Support Agreements			40
Voting of Proxies; Incomplete Proxies			40
Shares Held in Street Name; Broker Non-Votes			41
Revocability of Proxies and Changes to a Washington Banking Shareholder’s Vote			41
Solicitation of Proxies			42
Attending the Washington Banking Special Meeting			42
WASHINGTON BANKING PROPOSALS			42
Washington Banking Merger Proposal			42
Washington Banking Adjournment Proposal			43
Washington Banking Compensation Proposal			43
THE MERGER			44
Terms of the Merger			44
Background of the Merger			44
Heritage’s Reasons for the Merger; Recommendation of Heritage’s Board of Directors			50

 

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Washington Banking’s Reasons for the Merger; Recommendation of Washington Banking’s Board of Directors			53
Opinion of D.A. Davidson & Co.—Financial Advisor to Heritage			56
Opinion of Sandler O’Neill & Partners, L.P.—Financial Advisor to Washington Banking			66
Combined Company Board of Directors Following Completion of the Merger			76
Amendment to Heritage’s Bylaws			76
Interests of Washington Banking’s Directors and Executive Officers in the Merger			76
Merger-Related Compensation for Washington Banking’s Named Executive Officers			81
Regulatory Approvals			83
Accounting Treatment			83
Washington Banking Shareholder Dissenters’ Rights			84
Heritage’s Dividend Policy			85
Public Trading Markets			86
Litigation Relating to the Merger			86
THE MERGER AGREEMENT			87
Structure of the Merger			87
Merger Consideration			87
Treatment of Washington Banking Stock Options and Restricted Stock Unit Awards			87
Closing and Effective Time of the Merger			88
Conversion of Shares; Exchange Procedures			88
Representations and Warranties			89
Covenants and Agreements			91
Shareholder Meetings and Recommendation of Heritage’s and Washington Banking’s Boards of Directors			96
Agreement Not to Solicit Other Offers			97
Conditions to Complete the Merger			97
Termination of the Merger Agreement			98
Effect of Termination			99
Termination Fee			99
Expenses and Fees			100
Amendment, Waiver and Extension of the Merger Agreement			100
Voting and Support Agreements			100
UNAUDITED PRO FORMA COMBINED CONDENSED CONSOLIDATED FINANCIAL INFORMATION			102
MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER			113
INFORMATION ABOUT HERITAGE AND WASHINGTON BANKING			117
Heritage			117
Washington Banking			117
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF HERITAGE			118
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF WASHINGTON BANKING			120
COMPARATIVE MARKET PRICES AND DIVIDENDS ON COMMON STOCK			122
DESCRIPTION OF HERITAGE’S CAPITAL STOCK			123
General			123
Common Stock			123
Preferred Stock			123
Other Anti-Takeover Provisions			123
COMPARISON OF SHAREHOLDER RIGHTS			124
LEGAL MATTERS			128

 

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EXPERTS			128
FUTURE SHAREHOLDER PROPOSALS			128
Heritage			128
Washington Banking			129
WHERE YOU CAN FIND MORE INFORMATION			129

APPENDICES

A      Agreement and Plan of Merger, dated as of October  23, 2013, by and between Heritage Financial Corporation and Washington Banking Company
B      Opinion of D.A. Davidson & Co.
C      Opinion of Sandler O’Neill & Partners, L.P.
D      RCW Chapter 23B.13 of the Washington Business Corporation Act

 

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QUESTIONS AND ANSWERS ABOUT THE MERGER AND THE SPECIAL MEETINGS

The following are some questions that you may have about the merger and the special meetings, and brief answers to those questions. We urge you to read carefully the entire joint proxy statement/prospectus because the information in this section does not provide all of the information that might be important to you with respect to the merger and the special meetings. Additional important information is contained in the documents incorporated by reference into this joint proxy statement/prospectus. See “Where You Can Find More Information.”

Unless the context otherwise requires, throughout this document, “Heritage” refers to Heritage Financial Corporation, “Washington Banking” refers to Washington Banking Company and “we,” “us” and “our” refers collectively to Heritage and Washington Banking.

 

Q:	What is the merger?

 

A:

Heritage and Washington Banking have entered into an Agreement and Plan of Merger, dated as of October 23, 2013 (which we refer to as the “merger agreement”), pursuant to which Washington Banking will be merged with and into Heritage, with Heritage continuing as the surviving corporation (we refer to this transaction as the “merger”). Immediately following the merger, Washington Banking’s wholly owned subsidiary bank, Whidbey Island Bank, will merge with Heritage’s wholly owned subsidiary bank, Heritage Bank (we refer to this transaction as the “bank merger”). A copy of the merger agreement is attached to this joint proxy statement/prospectus as Appendix A.

 

Q:	Why am I receiving this joint proxy statement/prospectus?

 

A:

We are delivering this document to you because you are a shareholder of either Heritage or Washington Banking and this document is a joint proxy statement being used by both the Heritage and Washington Banking boards of directors to solicit proxies of their respective shareholders in connection with approval of the merger and related matters. This document is also a prospectus that is being delivered to Washington Banking shareholders because Heritage is offering shares of its stock to Washington Banking shareholders in connection with the merger.

The merger cannot be completed unless the shareholders of Heritage approve the merger agreement and the issuance of Heritage stock in the merger (which we refer to as the “Heritage merger proposal”) and the shareholders of Washington Banking adopt the merger agreement (which we refer to as the “Washington Banking merger proposal”).

 

Q:	In addition to the Heritage merger proposal, what else are Heritage shareholders being asked to vote on?

 

A:	Heritage is soliciting proxies from its shareholders with respect to one additional proposal; completion of the merger is not conditioned upon approval of this additional proposal:

 

•

a proposal to adjourn the Heritage special meeting, if necessary or appropriate, to solicit additional proxies in favor of the Heritage merger proposal (which we refer to as the “Heritage adjournment proposal”).

 

Q:	In addition to the Washington Banking merger proposal, what else are Washington Banking shareholders being asked to vote on?

 

A:	Washington Banking is soliciting proxies from holders of its common stock with respect to two additional proposals; completion of the merger is not conditioned upon approval of either of these additional proposals:

 

•

a proposal to adjourn the Washington Banking special meeting, if necessary or appropriate, to solicit additional proxies in favor of the Washington Banking merger proposal (which we refer to as the “Washington Banking adjournment proposal”); and

 

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•

a proposal to approve, on an advisory (non-binding) basis, the compensation that certain executive officers of Washington Banking may receive that is based on or otherwise relates to the merger (which we refer to as the “Washington Banking compensation proposal”).

 

Q:	What will Washington Banking shareholders receive in the merger?

 

A:

Each outstanding share of Washington Banking common stock (except for dissenting shares) will be converted into the right to receive, promptly following the completion of the merger, 0.89000 of a share of Heritage common stock and $2.75 in cash (which we refer to as the “merger consideration”). Heritage will not issue any fractional shares of Heritage common stock in the merger. Washington Banking shareholders who would otherwise be entitled to a fractional share of Heritage common stock upon completion of the merger will instead receive an amount in cash equal to the fractional share interest multiplied by the average of the volume weighted price (rounded to the nearest one ten thousandth) of Heritage common stock on NASDAQ for the ten trading days ending on the trading day immediately preceding the trading day the merger is completed (which we refer to as the “average Heritage common stock price”).

Because the number of shares of Heritage common stock that holders of Washington Banking common stock will receive is fixed, the market value of the stock portion of the merger consideration will fluctuate with the market price of Heritage common stock and will not be known at the time Washington Banking shareholders vote on the merger agreement.

 

Q:	What will Heritage shareholders receive in the merger?

 

A:

Heritage shareholders will retain their shares, they will not receive any consideration for their shares in the merger. If you are a Heritage shareholder, each share of Heritage common stock that you hold before the merger will continue to represent one share of Heritage common stock after the merger.

 

Q:	How will the merger affect outstanding Washington Banking stock options and restricted stock unit awards?

 

A:	The outstanding Washington Banking stock options and restricted stock unit awards will be affected as follows:

Stock Options. Each option granted by Washington Banking to purchase shares of Washington Banking common stock will be converted into an option to purchase Heritage common stock on the same terms and conditions as were applicable prior to the merger, subject to adjustment of the exercise price and the number of shares of Heritage common stock issuable upon exercise of such option based on the per share value of the merger consideration. All outstanding options granted by Washington Banking are fully vested.

Restricted Stock Unit Awards. Each restricted stock unit award in respect of a share of Washington Banking common stock will fully vest at the effective time of the merger and will be converted into a restricted stock unit award in respect of the number of shares of Heritage common stock on the same terms and conditions as were applicable prior to the merger, adjusted based on the per share value of the merger consideration.

 

Q:	How does Heritage’s board of directors recommend that I vote at the Heritage special meeting?

 

A:	After careful consideration, Heritage’s board of directors unanimously recommends that you vote “FOR” the Heritage merger proposal, and “FOR” the Heritage adjournment proposal.

Each of the directors and executive officers of Heritage has entered into a voting agreement with Washington Banking, pursuant to which they have agreed to vote “FOR” the Heritage merger proposal, and “FOR” any other matter required to be approved by the shareholders of Heritage to facilitate the transactions contemplated by the merger agreement. For more information regarding the voting agreements, please see the section entitled “The Merger Agreement—Voting and Support Agreements” beginning on page     .

 

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For a more complete description of Heritage’s reasons for the merger and the recommendations of the Heritage board of directors, please see the section entitled “The Merger—Heritage’s Reasons for the Merger; Recommendation of Heritage’s Board of Directors” beginning on page     .

 

Q:	How does Washington Banking’s board of directors recommend that I vote at the Washington Banking special meeting?

 

A:	After careful consideration, Washington Banking’s board of directors unanimously recommends that you vote “FOR” the Washington Banking merger proposal, “FOR” the Washington Banking adjournment proposal and “FOR” the Washington Banking compensation proposal.

Each of the directors and executive officers of Washington Banking has entered into a voting agreement with Heritage, pursuant to which they have agreed to vote “FOR” the Washington Banking merger proposal, and “FOR” any other matter required to be approved by the shareholders of Washington Banking to facilitate the transactions contemplated by the merger agreement. For more information regarding the voting agreements, please see the section entitled “The Merger Agreement—Voting and Support Agreements” beginning on page     .

For a more complete description of Washington Banking’s reasons for the merger and the recommendations of the Washington Banking board of directors, please see the section entitled “The Merger—Washington Banking’s Reasons for the Merger; Recommendation of Washington Banking’s Board of Directors” beginning on page     .

 

Q:	When and where are the special meetings?

A: The Heritage special meeting will be held at The DoubleTree Hotel, 417 Capitol Way N., Olympia, Washington on             , 2014, at     :            .m. local time.

The Washington Banking special meeting will be held at the Best Western Harbor Plaza, 33175 State Route 20, Oak Harbor, Washington on             , 2014, at     :            .m. local time.

 

Q:	What do I need to do now?

 

A:

After you have carefully read this joint proxy statement/prospectus and have decided how you wish your shares to be voted, please promptly take the steps identified in the following sentences so that your shares are represented and voted at your company’s special meeting, as applicable. If you hold your shares in your name as a shareholder of record, you must complete, sign, date and mail your proxy card in the enclosed postage-paid return envelope as soon as possible. Alternatively, you can provide your proxy directing how you want your shares voted through the internet or by telephone. Information and applicable deadlines for providing your proxy through the internet or by telephone are set forth in the enclosed proxy card instructions. If you hold your shares in “street name” through a bank or broker, you must direct your bank or broker how to vote in accordance with the instructions you have received from your bank or broker.

 

Q:	Who is entitled to vote?

 

A:	Heritage Special Meeting. Holders of record of Heritage common stock at the close of business on [            ], 2014 which is the date that the Heritage board of directors has fixed as the record date for the Heritage special meeting, are entitled to vote at the Heritage special meeting.

Washington Banking Special Meeting. Holders of record of Washington Banking common stock at the close of business on [            ], 2014, which is the date that the Washington Banking board of directors has fixed as the record date for the Washington Banking special meeting, are entitled to vote at the Washington Banking special meeting.

 

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Q:	What constitutes a quorum?

 

A:

Heritage Special Meeting. The presence at the Heritage special meeting, in person or by proxy, of holders of a majority of the outstanding shares of Heritage common stock entitled to vote at the special meeting will constitute a quorum for the transaction of business. Abstentions and broker-nonvotes will be treated as shares that are present at the meeting for the purpose of determining the presence of a quorum.

 

A:

Washington Banking Special Meeting. The presence at the Washington Banking special meeting, in person or by proxy, of holders of at least a majority of the outstanding shares of Washington Banking common stock entitled to vote at the special meeting will constitute a quorum for the transaction of business. Abstentions and broker-nonvotes will be treated as shares that are present at the meeting for the purpose of determining the presence of a quorum.

 

Q:	If my shares are held in “street name” through a bank, broker or other nominee, will my bank, broker or other nominee vote my shares for me?

 

A:

No. Your bank, broker or other nominee cannot vote your shares without instructions from you. Please follow the voting instruction form provided by your bank, broker or other nominee. The effects of failing to instruct your bank, broker or other nominee how to vote your shares of Heritage or Washington Banking common stock on each of the proposals to be considered at the Heritage or Washington Banking special meetings are described below.

 

Q:	What is the vote required to approve each proposal at the Heritage special meeting?

 

A:

Heritage merger proposal: To approve the Heritage merger proposal, at least two-thirds of the Heritage common stock outstanding and entitled to vote thereon must be voted in favor of such proposal. If you mark “ABSTAIN” on your proxy, fail to submit a proxy or fail to vote in person at the Heritage special meeting or fail to instruct your bank or broker how to vote with respect to the Heritage merger proposal, it will have the same effect as a vote “AGAINST” the proposal.

Heritage adjournment proposal: The Heritage adjournment proposal will be approved if the votes cast in favor of such proposal at the Heritage special meeting exceed the votes cast in opposition. If you mark “ABSTAIN” on your proxy, fail to submit a proxy or fail to vote in person at the Heritage special meeting or fail to instruct your bank or broker how to vote with respect to the Heritage adjournment proposal, it will have no effect on the proposal.

 

Q:	What is the vote required to approve each proposal at the Washington Banking special meeting?

 

A:

Washington Banking merger proposal: To approve the Washington Banking merger proposal, at least two-thirds of the Washington Banking common stock outstanding and entitled to vote thereon must be voted in favor of such proposal. If you mark “ABSTAIN” on your proxy, fail to submit a proxy or fail to vote in person at the Washington Banking special meeting or fail to instruct your bank or broker how to vote with respect to the Washington Banking merger proposal, it will have the same effect as a vote “AGAINST” the proposal.

Washington Banking adjournment proposal: The Washington Banking adjournment proposal will be approved if the votes cast in favor of such proposal at the Washington Banking special meeting exceed the votes cast in opposition. If you mark “ABSTAIN” on your proxy, fail to submit a proxy or fail to vote in person at the Washington Banking special meeting or fail to instruct your bank or broker how to vote with respect to the Washington Banking adjournment proposal, it will have no effect on such proposal.

Washington Banking compensation proposal: The Washington Banking compensation proposal will be approved if the votes cast in favor of such proposal at the Washington Banking special meeting exceed the votes cast in opposition. If you mark “ABSTAIN” on your proxy, fail to submit a proxy or fail to vote in

 

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person at the Washington Banking special meeting or fail to instruct your bank or broker how to vote with respect to the Washington Banking compensation proposal, it will have no effect on such proposal.

 

Q:	What will happen if Washington Banking’s shareholders do not approve the Washington Banking advisory (non-binding) proposal on compensation?

 

A:

The vote on the Washington Banking compensation proposal is a vote separate and apart from the vote to approve the Washington Banking merger proposal and other related proposals. You may vote for this proposal and against the Washington Banking merger proposal and other related proposals, or vice versa. Because the vote on this proposal is advisory only, it will not be binding on Heritage or Washington Banking and will have no impact on whether the merger is consummated or on whether any contractually obligated payments are made to Washington Banking’s named executive officers. Washington Banking is seeking your approval of these payments, on an advisory (non-binding) basis, in order to comply with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and related SEC rules.

 

Q:	Why is my vote important?

 

A:

If you do not vote by proxy or in person at your company’s special meeting, it will be more difficult for your company to obtain the necessary quorum to hold its special meeting. In addition, your failure to submit a proxy or vote in person, or failure to instruct your bank or broker how to vote, or abstention will have the same effect as a vote “AGAINST” the merger proposal at your company’s special meeting. The merger agreement must be approved by the affirmative vote of the holders of at least two-thirds of the outstanding shares of Heritage common stock entitled to vote at the Heritage special meeting and approved by the affirmative vote of the holders of at least two-thirds of the outstanding shares of Washington Banking common stock entitled to vote at the Washington Banking special meeting.

 

Q:	Can I attend my company’s special meeting and vote my shares in person?

 

A:

Yes. All shareholders of Heritage and all shareholders of Washington Banking, including shareholders of record and shareholders who hold their shares through banks, brokers, nominees or any other holder of record, are invited to attend their respective meetings. Holders of record of Heritage and Washington Banking common stock can vote in person at the Heritage special meeting and Washington Banking special meeting, respectively. If you wish to vote in person at your company’s special meeting and if you are a shareholder of record, you should bring the enclosed proxy card and proof of identity. If you hold your shares in street name through a broker, or beneficially own your shares through another holder of record, you will need to bring with you and provide to the inspectors of election proof of identity and a letter from your bank, broker, nominee or other holder of record confirming your beneficial ownership of common stock as of the record date and authorization for you to vote such shares at your company’s special meeting (a “legal proxy” from your holder of record). At the appropriate time during your company’s special meeting, the shareholders present will be asked whether anyone wishes to vote in person. You should raise your hand at this time to receive a ballot to record your vote. Everyone who attends the special meeting must abide by the rules for the conduct of the meeting distributed at the meeting by your company.

 

Q:	Can I change my proxy or voting instructions?

 

A:

Heritage shareholders: Yes. If you are a holder of record of Heritage common stock, you may revoke your proxy at any time before it is voted by (1) signing and returning a proxy card with a later date, (2) delivering a written revocation to Heritage’s corporate secretary, (3) attending the Heritage special meeting in person and voting by ballot at the special meeting, or (4) voting by telephone or the internet at a later time. Attendance at the Heritage special meeting will not automatically revoke your proxy. A revocation or later-dated proxy received by Heritage after the vote is taken at the Heritage special meeting will not affect your previously submitted proxy. Heritage’s corporate secretary’s mailing address is: Corporate Secretary, Heritage Financial Corporation, 201 Fifth Avenue SW, Olympia, Washington 98501. If you hold your shares in “street name” through a bank or broker, you should contact your bank or broker to change your voting instructions.

 

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Washington Banking shareholders: Yes. If you are a holder of record of Washington Banking common stock, you may revoke your proxy at any time before it is voted by (1) signing and returning a proxy card with a later date, (2) delivering a written revocation to Washington Banking’s corporate secretary, (3) attending the Washington Banking special meeting in person and voting by ballot at the special meeting, or (4) voting by telephone or the internet at a later time. Attendance at the Washington Banking special meeting by itself will not automatically revoke your proxy. A revocation or later-dated proxy received by Washington Banking after the vote is taken at the Washington Banking special meeting will not affect your previously submitted proxy. Washington Banking’s corporate secretary’s mailing address is: Corporate Secretary, Washington Banking Company, 450 SW Bayshore Drive, Oak Harbor, Washington 98277. If you hold your shares in “street name” through a bank or broker, you should contact your bank or broker to change your voting instructions.

 

Q:	Will Heritage be required to submit the proposal to approve the merger agreement to its shareholders even if Heritage’s board of directors has withdrawn, modified or qualified its recommendation?

 

A:	Yes. Unless the merger agreement is terminated before the Heritage special meeting, Heritage is required to submit the proposal to approve the merger agreement to its shareholders even if Heritage’s board of directors has withdrawn or modified its recommendation.

 

Q:	Will Washington Banking be required to submit the proposal to approve the merger agreement to its shareholders even if Washington Banking’s board of directors has withdrawn, modified or qualified its recommendation?

 

A:	Yes. Unless the merger agreement is terminated before the Washington Banking special meeting, Washington Banking is required to submit the proposal to approve the merger agreement to its shareholders even if Washington Banking’s board of directors has withdrawn or modified its recommendation.

 

Q:	What are the U.S. federal income tax consequences of the merger to Washington Banking shareholders?

 

A:

The merger is intended to qualify as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code, or Code. Assuming the merger qualifies as a reorganization, a U.S. holder of Washington Banking common stock generally will not recognize any gain or loss upon receipt of Heritage common stock in exchange for Washington Banking common stock in the merger, and will recognize gain (but not loss) in an amount not to exceed any cash received as part of the merger consideration (except with respect to any cash received upon exercise of dissenters’ rights under Washington law and in lieu of a fractional share of Heritage common stock, as discussed below under “Material U.S. Federal Income Tax Consequences of the Merger—Receipt of Only Cash Consideration Upon Exercise of Dissenters’ Rights and Cash Received Instead of a Fractional Share of Heritage Common Stock”). It is a condition to the completion of the merger that Heritage and Washington Banking receive written opinions from their respective counsel to the effect that the merger will qualify as a reorganization within the meaning of Section 368(a) of the Code.

 

Q:	Are Washington Banking shareholders entitled to dissenter’s rights?

 

A:

Yes. If you want to exercise dissenters’ rights, you must deliver to Washington Banking, before the vote is taken by Washington Banking shareholders on the approval of the merger agreement, written notice of your intent to exercise your dissenters’ rights if the merger is completed. Also, you must vote against, or abstain from voting on, the approval of the merger agreement and follow other procedures, both before and after the Washington Banking special meeting, as described in Appendix D. Note that if you return a signed proxy card without voting instructions or with instructions to vote “FOR” the merger agreement, your shares will be automatically voted in favor of the merger agreement and you will lose all dissenters’ rights available under Washington law For further information, see “The Merger—Washington Banking Shareholder Dissenters’ Rights.”

 

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Q:	Are Heritage shareholders entitled to dissenter’s rights?

 

A:	No. Under Washington law Heritage shareholders do not have dissenters’ rights.

 

Q:	If I am a holder of Washington Banking common stock in certificated form, should I send in my Washington Banking stock certificates now?

 

A:

No. Please do not send in your Washington Banking stock certificates with your proxy. After the merger, an exchange agent will send you instructions for exchanging Washington Banking stock certificates for the merger consideration. See “The Merger Agreement—Conversion of Shares; Exchange Procedures.”

 

Q:	What should I do if I hold my shares of Washington Banking common stock in book-entry form?

 

A:

You are not required to take any special additional actions if your shares of Washington Banking common stock are held in book-entry form. After the completion of the merger, an exchange agent will send you instructions for exchanging your shares for the merger consideration. See “The Merger Agreement—Conversion of Shares; Exchange Procedures.”

 

Q:	Whom may I contact if I cannot locate my Washington Banking stock certificate(s)?

 

A:	If you are unable to locate your original Washington Banking stock certificate(s), you should contact Computershare, Washington Banking’s transfer agent, at (800) 962-4284.

 

Q:	Should Heritage shareholders do anything with their stock certificates?

 

A:	No. Heritage stock certificates will not be exchanged and will remain outstanding after the merger without any action required by Heritage shareholders.

 

Q:	What should I do if I receive more than one set of voting materials?

 

A:

Heritage shareholders and Washington Banking shareholders may receive more than one set of voting materials, including multiple copies of this joint proxy statement/prospectus and multiple proxy cards or voting instruction cards. For example, if you hold shares of Heritage and/or Washington Banking common stock in more than one brokerage account, you will receive a separate voting instruction card for each brokerage account in which you hold such shares. If you are a holder of record of Heritage common stock or Washington Banking common stock and your shares are registered in more than one name, you will receive more than one proxy card. In addition, if you are a holder of both Heritage common stock and Washington Banking common stock, you will receive one or more separate proxy cards or voting instruction cards for each company. Please complete, sign, date and return each proxy card and voting instruction card that you receive or otherwise follow the voting instructions set forth in this joint proxy statement/prospectus to ensure that you vote every share of Heritage common stock and/or Washington Banking common stock that you own.

 

Q:	When do you expect to complete the merger?

 

A:

Heritage and Washington Banking expect to complete the merger in the first half of 2014. However, neither Heritage nor Washington Banking can assure you of when or if the merger will be completed. Heritage and Washington Banking must first obtain the approval of Heritage shareholders and Washington Banking shareholders for the merger, as well as obtain necessary regulatory approvals and satisfy certain other closing conditions.

 

Q:	What happens if the merger is not completed?

 

A:

If the merger is not completed, holders of Washington Banking common stock will not receive any consideration for their shares in connection with the merger. Instead, Washington Banking will remain an independent public company and its common stock will continue to be listed and traded on NASDAQ. In addition, if the merger agreement is terminated in certain circumstances, a termination fee may be required to be paid by either Heritage or Washington Banking. See “The Merger Agreement—Termination Fee”

 

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beginning on page     for a complete discussion of the circumstances under which termination fees will be required to be paid.

 

Q:	Whom should I call with questions?

 

A:

Heritage shareholders: If you have any questions concerning the merger or this joint proxy statement/prospectus, would like additional copies of this joint proxy statement/prospectus or need help voting your shares of Heritage common stock, please contact Kaylene M. Lahn, Senior Vice President and Corporate Secretary (360) 943-1500, or Heritage’s proxy solicitor, Karen Smith of Advantage Proxy, toll-free at (877) 870-8565, or at ksmith@advantageproxy.com.

Washington Banking shareholders: If you have any questions concerning the merger or this joint proxy statement/prospectus, would like additional copies of this joint proxy statement/prospectus or need help voting your shares of Washington Banking common stock, please contact Shelly L. Angus, Senior Vice President and Corporate Secretary, (360) 240-6458, or Washington Banking’s proxy solicitor, Karen Smith of Advantage Proxy, toll-free at (877) 870-8565, or at ksmith@advantageproxy.com.

 

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RISK FACTORS

In addition to general investment risks and the other information contained in or incorporated by reference into this joint proxy statement/prospectus, including the matters addressed under the section “Cautionary Statement Regarding Forward-Looking Statements,” you should carefully consider the following risk factors in deciding how to vote for the proposals presented in this joint proxy statement/prospectus. You should also consider the other documents incorporated by reference into this joint proxy statement/prospectus. See “Where You Can Find More Information.”

Because the market price of Heritage common stock will fluctuate, holders of Washington Banking common stock cannot be certain of the market value of the stock portion of the merger consideration they will receive.

Upon completion of the merger, each outstanding share of Washington Banking common stock will be converted into the right to receive 0.89000 of a share of Heritage common stock and $2.75 in cash. The market value of the stock portion of the merger consideration will vary from the closing price of Heritage common stock on the date Heritage and Washington Banking announced the merger, on the date that this joint proxy statement/prospectus is mailed to Washington Banking shareholders, on the date of the special meeting of the Washington Banking shareholders and on the date the merger is completed and thereafter. Any change in the market price of Heritage common stock prior to the completion of the merger will affect the market value of the stock portion of the merger consideration that holders of Washington Banking common stock will receive upon completion of the merger, and there will be no adjustment to the merger consideration for changes in the market price of either shares of Heritage common stock or shares of Washington Banking common stock. Stock price changes may result from a variety of factors that are beyond the control of Heritage and Washington Banking, including, but not limited to, general market and economic conditions, changes in our respective businesses, operations and prospects and regulatory considerations. Therefore, if you are a holder of Washington Banking common stock, you will not know at the time of the Washington Banking special meeting the precise market value of the merger consideration you will receive at the effective time of the merger. You should obtain current market quotations for shares of Heritage common stock and for shares of Washington Banking common stock.

The market price of Heritage common stock after the merger may be affected by factors different from those affecting the shares of Washington Banking or Heritage currently.

Upon completion of the merger, holders of Washington Banking common stock will become holders of Heritage common stock. Heritage’s business differs in important respects from that of Washington Banking, and, accordingly, the results of operations of the combined company and the market price of Heritage common stock after the completion of the merger may be affected by factors different from those currently affecting the independent results of operations of each of Heritage and Washington Banking. For a discussion of the businesses of Heritage and Washington Banking and of some important factors to consider in connection with those businesses, see the documents incorporated by reference in this joint proxy statement/prospectus and referred to under “Where You Can Find More Information.”

Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following the merger.

Before the merger and the bank merger may be completed, Heritage and Washington Banking must obtain approvals from the Federal Reserve Board (or a waiver), the FDIC and the DFI. Other approvals, waivers or consents from regulators may also be required. An adverse development in either party’s regulatory standing or other factors could result in an inability to obtain approvals or delay their receipt. These regulators may impose conditions on the completion of the merger or the bank merger or require changes to the terms of the merger or the bank merger. Such conditions or changes could have the effect of delaying or preventing completion of the merger or the bank merger or imposing additional costs on or limiting the revenues of the combined company

 

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following the merger and the bank merger, any of which might have an adverse effect on the combined company following the merger. See “The Merger—Regulatory Approvals.”

Combining the two companies may be more difficult, costly or time consuming than expected and the anticipated benefits and cost savings of the merger may not be realized.

Heritage and Washington Banking have operated and, until the completion of the merger, will continue to operate, independently. The success of the merger, including anticipated benefits and cost savings, will depend, in part, on our ability to successfully combine the businesses of Heritage and Washington Banking. To realize these anticipated benefits and cost savings, after the completion of the merger, Heritage expects to integrate Washington Banking’s business into its own. It is possible that the integration process could result in the loss of key employees, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company’s ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the merger. The loss of key employees could adversely affect Heritage’s ability to successfully conduct its business, which could have an adverse effect on Heritage’s financial results and the value of its common stock. If the combined company experiences difficulties with the integration process, the anticipated benefits of the merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause Heritage and/or Washington Banking to lose customers or cause customers to remove their accounts from Heritage and/or Washington Banking and move their business to competing financial institutions. Integration efforts between the two companies will also divert management attention and resources. These integration matters could have an adverse effect on each of Washington Banking and Heritage during this transition period and for an undetermined period after completion of the merger on the combined company. In addition, the actual cost savings of the merger could be less than anticipated.

The fairness opinions obtained by Heritage and Washington Banking from their respective financial advisors will not reflect changes in circumstances between signing the merger agreement and the completion of the merger.

Heritage has not obtained an updated opinion as of the date of this joint proxy statement/prospectus from Davidson, Heritage’s financial advisor. Changes in the operations and prospects of Heritage or Washington Banking, general market and economic conditions and other factors which may be beyond the control of Heritage and Washington Banking, and on which the fairness opinions were based, may alter the value of Heritage or Washington Banking or the prices of shares of Heritage common stock or Washington Banking common stock by the time the merger is completed. The opinions do not speak as of the time the merger will be completed or as of any date other than the dates of such opinions. Because Heritage and Washington Banking currently do not anticipate asking their respective financial advisors to update their opinions, the October 23, 2013 opinions, and the                 , 2013 Sandler update, do not address the fairness of the merger consideration, from a financial point of view, at the time the merger is completed. For a description of the opinions that Heritage and Washington Banking received from their respective financial advisors, please refer to “The Merger—Opinion of D.A. Davidson & Co.–Financial Advisor to Heritage” and “The Merger—Opinion of Sandler O’Neill & Partners, L.P. –Financial Advisor to Washington Banking.” For a description of the other factors considered by the boards of directors of Heritage and Washington Banking in determining to approve the merger agreement, please refer to “The Merger—Heritage’s Reasons for the Merger; Recommendation of Heritage’s Board of Directors” and “The Merger—Washington Banking’s Reasons for the Merger; Recommendation of Washington Banking’s Board of Directors.”

Certain of Washington Banking’s directors and executive officers have interests in the merger that may differ from the interests of Washington Banking’s shareholders.

Washington Banking’s shareholders should be aware that some of Washington Banking’s directors and executive officers have interests in the merger and have arrangements that are different from, or in addition to, those of Washington Banking’s shareholders generally. These interests and arrangements may create potential

 

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conflicts of interest. Washington Banking’s board of directors was aware of these interests and considered these interests, among other matters, when making its decision to approve the merger agreement, and in recommending that Washington Banking’s shareholders vote in favor of approving the merger agreement.

These interests include the following:

 

•

Certain executive officers of Washington Banking may be eligible for severance benefits under existing agreements with, and benefit plans offered by, Washington Banking.

 

•

Accelerated vesting of all of the unvested restricted stock unit awards held by Washington Banking directors and executive officers.

 

•

Bryan McDonald, President and Chief Executive Officer of Whidbey Island Bank, will become Executive Vice President and Chief Lending Officer of Heritage Bank following the bank merger and has entered into an employment agreement with Heritage Bank, to become effective at the effective time of the merger.

 

•

Edward Eng, Executive Vice President and Chief Administrative Officer of Whidbey Island Bank, will become Executive Vice President and Chief Administrative Officer of Heritage Bank following the bank merger and has entered into an employment agreement with Heritage Bank, to become effective at the effective time of the merger.

 

•

John L. Wagner, President and Chief Executive Officer of Washington Banking, will serve as a special advisor to Heritage following the merger and has entered into a consulting agreement with Heritage, to become effective at the effective time of the merger.

 

•

Seven current Washington Banking directors, including Anthony B. Pickering, who will serve as chairman of the board of Heritage upon completion of the merger, and Rhoda L. Altom, Mark D. Crawford, Deborah J. Gavin, Jay T. Lien, Gragg E. Miller and Robert T. Severns will be appointed to the board of directors of Heritage.

For a more complete description of these interests, see “The Merger—Interests of Washington Banking’s Directors and Executive Officers in the Merger”.

Termination of the merger agreement could negatively impact Washington Banking or Heritage.

If the merger agreement is terminated, there may be various consequences. For example, Washington Banking’s or Heritage’s businesses may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger. Additionally, if the merger agreement is terminated, the market price of Washington Banking’s or Heritage’s common stock could decline to the extent that the current market prices reflect a market assumption that the merger will be completed. If the merger agreement is terminated under certain circumstances, Washington Banking or Heritage may be required to pay to the other party a termination fee of $7.9 million.

Washington Banking and Heritage will be subject to business uncertainties and contractual restrictions while the merger is pending.

Uncertainty about the effect of the merger on employees and customers may have an adverse effect on Washington Banking, Heritage and the combined company. These uncertainties may impair Washington Banking’s or Heritage’s ability to attract, retain and motivate key personnel until the merger is completed, and could cause customers and others that deal with Washington Banking or Heritage to seek to change existing business relationships with Washington Banking or Heritage. Retention of certain employees by Washington Banking or Heritage may be challenging while the merger is pending, as certain employees may experience uncertainty about their future roles with Washington Banking, Heritage or the combined company. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to

 

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remain with Washington Banking, Heritage or the combined company, Washington Banking’s or Heritage’s business or the business of the combined company following the merger could be harmed. In addition, both companies have agreed to operate their businesses in the ordinary course prior to closing and are subject to other agreed upon contractual operating restrictions prior to closing. See “The Merger Agreement—Covenants and Agreements-Conduct of Business Prior to Completion of the Merger.”

If the merger is not completed, Heritage and Washington Banking will have incurred substantial expenses without realizing the expected benefits of the merger.

Each of Heritage and Washington Banking has incurred and will incur substantial expenses in connection with the due diligence, negotiation and completion of the transactions contemplated by the merger agreement, as well as the costs and expenses of preparing, filing, printing and mailing this joint proxy statement/prospectus and all filing fees paid to the SEC in connection with the merger. If the merger is not completed, Heritage and Washington Banking would have to recognize these expenses without realizing the expected benefits of the merger.

The merger agreement limits Heritage’s and Washington Banking’s ability to pursue acquisition proposals and requires each company to pay a termination fee of $7.9 million under certain circumstances, including circumstances relating to acquisition proposals.

The merger agreement prohibits Heritage and Washington Banking from initiating, soliciting, knowingly encouraging or knowingly facilitating certain third-party acquisition proposals. See “The Merger Agreement—Agreement Not to Solicit Other Offers.” The merger agreement also provides that Heritage or Washington Banking must pay a termination fee in the amount of $7.9 million in the event that the merger agreement is terminated under certain circumstances, including involving such party’s failure to abide by certain obligations not to solicit acquisition proposals. See “The Merger Agreement—Termination Fee.” These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of Washington Banking or Heritage from considering or proposing such an acquisition.

The shares of Heritage common stock to be received by holders of Washington Banking common stock for the stock portion of the merger consideration will have different rights from the shares of Washington Banking common stock.

Upon completion of the merger, Washington Banking shareholders will become Heritage shareholders and their rights as shareholders will continue to be governed by the Washington Business Corporation Act and will also be governed by Heritage’s articles of incorporation and bylaws. The rights associated with Washington Banking common stock are different from the rights associated with Heritage common stock. See “Comparison of Shareholders’ Rights” for a discussion of the different rights associated with Heritage common stock.

Pending litigation against Washington Banking and Heritage could result in an injunction preventing the completion of the merger or a judgment resulting in the payment of damages.

In connection with the merger, certain purported Washington Banking shareholders have filed putative shareholder class action lawsuits against Washington Banking, the members of the Washington Banking board of directors and Heritage. Among other remedies, the plaintiffs seek to enjoin the merger. The outcome of any such litigation is uncertain. If the cases are not resolved, these lawsuits could prevent or delay completion of the merger and result in substantial costs to Heritage and Washington Banking, including any costs associated with the indemnification of directors and officers. Additional lawsuits may be filed against Heritage, Washington Banking and/or the directors and officers of either company in connection with the merger. The defense or settlement of any lawsuit or claim that remains unresolved at the time the merger is completed may adversely affect the combined company’s business, financial condition, results of operations and cash flows following the merger. See “The Merger—Litigation Relating to the Merger.”

 

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Sales of substantial amounts of Heritage’s common stock in the open market by former Washington Banking shareholders could depress Heritage’s stock price.

Shares of Heritage common stock that are issued to shareholders of Washington Banking in the merger will be freely tradable without restrictions or further registration under the Securities Act of 1933. As of the record date, Heritage had approximately [            ] shares of common stock outstanding, and [            ] shares of Heritage common stock were reserved for issuance under Heritage equity plans. Based on the shares of Washington Banking common stock, the in-the-money Washington Banking options, and the Washington Banking restricted stock units outstanding as of the record date, the maximum number of shares of common stock Heritage will issue in the merger is approximately [            ] shares.

If the merger is completed and if Washington Banking’s former shareholders sell substantial amounts of Heritage common stock in the public market following completion of the merger, the market price of Heritage common stock may decrease. These sales might also make it more difficult for Heritage to sell equity or equity-related securities at a time and price that it otherwise would deem appropriate.

The unaudited pro forma combined condensed consolidated financial information included in this document is illustrative only and the actual financial condition and results of operations after the merger may differ materially.

The unaudited pro forma combined condensed consolidated financial information in this document is presented for illustrative purposes only and is not necessarily indicative of what Heritage’s actual financial condition or results of operations would have been had the merger been completed on the dates indicated. The unaudited pro forma combined condensed consolidated financial information reflects adjustments, which are based upon preliminary estimates, to record the Washington Banking identifiable tangible and intangible assets to be acquired and liabilities to be assumed at fair value and the resulting goodwill to be recognized. The purchase price allocation reflected in this document is preliminary and final allocation of the purchase price will be based upon the actual purchase price and the fair value of the consolidated assets and liabilities of Washington Banking as of the date of the completion of the merger. Accordingly, the final acquisition accounting adjustments may differ materially from the pro forma adjustments reflected in this document. For more information, please see the section entitled “Unaudited Pro Forma Combined Condensed Consolidated Financial Information” beginning on page     .

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements contained or incorporated by reference in this joint proxy statement/prospectus are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 giving Heritage’s or Washington Banking’s expectations or predictions of future financial or business performance or conditions. Forward-looking statements are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “target,” “estimate,” “continue,” “positions,” “prospects” or “potential,” by future conditional verbs such as “will,” “would,” “should,” “could” or “may,” or by variations of such words or by similar expressions. Such forward-looking statements include, but are not limited to, statements about the benefits of the business combination transaction involving Washington Banking and Heritage, including future financial and operating results, the combined company’s plans, objectives, expectations and intentions and other statements that are not historical facts. These forward-looking statements are subject to numerous assumptions, risks and uncertainties which change over time. In addition to the risk factors set forth above and those previously disclosed in Heritage’s and Washington Banking’s reports filed with the Securities and Exchange Commission, the following factors, among others, could cause actual results to differ materially from forward-looking statements:

 

•

expected revenues, cost savings, synergies and other benefits from the merger and Heritage’s recent acquisitions of Northwest Commercial Bank and Valley Community Bancshares, Inc. and it’s subsidiary Valley Bank, might not be realized within the expected time frames or at all and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected;

 

•

the requisite shareholder and regulatory approvals for the merger might not be obtained;

 

•

the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses, which could necessitate additional provisions for loan losses, resulting both from loans originated and loans acquired from other financial institutions;

 

•

results of examinations by regulatory authorities, including the possibility that any such regulatory authority may, among other things, require increases in the allowance for loan losses or writing down of assets;

 

•

competitive pressures among depository institutions;

 

•

interest rate movements and their impact on customer behavior and net interest margin;

 

•

the impact of repricing and competitors’ pricing initiatives on loan and deposit products;

 

•

fluctuations in real estate values;

 

•

changes in both companies’ businesses during the period between now and the completion of the merger may have adverse impacts on the combined company;

 

•

the ability to adapt successfully to technological changes to meet customers’ needs and developments in the market place;

 

•

the ability to access cost-effective funding;

 

•

changes in financial markets;

 

•

changes in economic conditions in general and in Western Washington and the Pacific Northwest in particular;

 

•

the costs, effects and outcomes of litigation;

 

•

new legislation or regulatory changes, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and regulations adopted thereunder, changes in capital requirements pursuant to the Dodd-Frank Act and the implementation of the

 

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Basel III capital standards, other governmental initiatives affecting the financial services industry and changes in federal and/or state tax laws or interpretations thereof by taxing authorities;

 

•

changes in accounting principles, policies or guidelines;

 

•

future acquisitions by Heritage of other depository institutions or lines of business; and

 

•

future goodwill impairment due to changes in Heritage’s business, changes in market conditions, or other factors.

For any forward-looking statements made in this joint proxy statement/prospectus or in any documents incorporated by reference into this joint proxy statement/prospectus, Heritage and Washington Banking claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You are cautioned not to place undue reliance on these statements, which speak only as of the date of this joint proxy statement/prospectus or the date of the applicable document incorporated by reference in this joint proxy statement/prospectus. Heritage and Washington Banking do not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made. All subsequent written and oral forward-looking statements concerning the merger or other matters addressed in this joint proxy statement/prospectus and attributable to Heritage, Washington Banking or any person acting on their behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this joint proxy statement/prospectus.

 

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SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION

Selected Historical Financial Data of Heritage and Washington Banking

The following tables set forth selected historical financial and other data of Heritage and Washington Banking for the periods and at the dates indicated. The information at December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010 is derived in part from and should be read together with the audited consolidated financial statements and notes thereto of Heritage and Washington Banking incorporated by reference in this joint proxy statement/prospectus from their Annual Reports on Form 10-K for the year ended December 31, 2012. The information as of December 31, 2010, 2009 and 2008 and for the years ended December 31, 2009 and 2008 is derived in part from audited consolidated financial statements and notes thereto of Heritage and Washington Banking that are not incorporated by reference in this joint proxy statement/prospectus. The information at and for the nine months ended September 30, 2013 and 2012 is derived in part from and should be read together with Heritage’s and Washington Banking’s unaudited consolidated financial statements and notes thereto incorporated by reference in this document from their Quarterly Reports on Form 10-Q for the quarters ended September 30, 2013 and 2012. In the opinion of management of each of Heritage and Washington Banking, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results of operations of the respective companies for the unaudited periods have been made. The selected data presented below for the nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for future periods.

Certain of the selected financial data of Washington Banking in the tables below contain information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (referred to as “GAAP”). This information consists of tangible book value per common share, the efficiency ratio on a fully tax equivalent basis and net interest margin on a fully tax equivalent basis. Washington Banking management believes that it is standard practice in the banking industry to present these values as stated herein, and accordingly believes that providing these measures may be useful for peer comparison purposes. These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. See “Reconciliation of Non-GAAP Historical Financial Data of Washington Banking” for reconciliations of non-GAAP measures to GAAP measures immediately following Washington Banking’s selected financial data table.

 

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Selected Historical Financial Data of Heritage

 

		As of or for the Nine Months Ended September 30,								As of or for the Year Ended December 31,
		2013				2012				2012				2011				2010				2009				2008
		(Dollars in thousands, except per share data)
Operations Data:
Interest income		$	52,876			$	52,409			$	69,109			$	74,120			$	59,522			$	53,341			$	56,948
Interest expense			2,818				3,550				4,534				6,582				8,511				11,645				18,606
Net interest income			50,058				48,859				64,575				67,538				51,011				41,696				38,342
Provision for loan losses			3,244				1,317				2,016				14,430				11,990				19,390				7,420
Noninterest income			7,222				5,499				7,272				5,746				18,779				5,988				6,358
Noninterest expense			41,010				37,971				50,392				49,703				38,011				28,216				27,953
Income tax expense (benefit)			4,161				4,843				6,178				2,633				6,435				(503	)			2,976
Net income			8,865				10,227				13,261				6,518				13,354				581				6,351
Net income (loss) available to common shareholders			8,865				10,227				13,261				6,518				11,668				(739	)			6,208
Common Share Data:
Earnings (loss) per common share(1)
Basic		$	0.57			$	0.67			$	0.87			$	0.42			$	1.05			$	(0.10	)		$	0.93
Diluted			0.57				0.67				0.87				0.42				1.04				(0.10	)			0.93
Dividend payout ratio to common shareholders(2)			59.6	%			62.7	%			92.0	%			90.5	%			—	%			(100.0	)%			60.2	%
Cash dividends per common share		$	0.34			$	0.42			$	0.80			$	0.38			$	0.00			$	0.10			$	0.56
Selected Performance Ratios:
Net interest spread(3)(4)			4.77	%			5.09	%			5.03	%			5.23	%			4.56	%			4.25	%			4.11	%
Net interest margin(3)(5)			4.88				5.23				5.17				5.41				4.78				4.57				4.59
Efficiency ratio(6)			71.60				69.85				70.14				67.82				54.46				59.17				62.53
Return on average assets(3)			0.79				1.01				0.98				0.48				1.16				0.06				0.71
Return on average common equity(3)			5.74				6.70				6.52				3.17				8.15				(0.72	)			6.98
Balance Sheet Data:
Total assets		$	1,674,417			$	1,366,582			$	1,345,540			$	1,368,985			$	1,367,684			$	1,014,859			$	946,145
Originated loans receivable, net			944,535				851,426				855,360				815,607				719,957				746,083				793,303
Purchased covered loans receivable, net			63,484				89,005				83,978				105,394				128,715				—				—
Purchased noncovered loans receivable, net			200,063				65,592				59,006				83,479				131,049				—				—
Loans receivable, net			1,208,082				1,006,023				998,344				1,004,480				979,721				746,083				793,303
Loans held for sale			—				1,411				1,676				1,828				764				825				304
FDIC indemnification asset			4,413				7,480				7,100				10,350				16,071				—				—
Deposits			1,425,985				1,133,700				1,117,971				1,136,044				1,136,276				840,128				824,480
Securities sold under agreement to repurchase			22,655				22,889				16,021				23,091				19,027				10,440				—
Shareholders’ equity			216,595				202,244				198,938				202,520				202,279				158,498				113,147
Book value per common share			13.36				13.34				13.16				13.10				12.99				12.21				13.40
Equity to assets ratio			12.9	%			14.8	%			14.8	%			14.8	%			14.8	%			15.6	%			12.0	%

 

(1)	Effective January 1, 2009, Heritage adopted FASB ASC 03-6-1. Earnings per share data for the prior periods have been revised to reflect the retrospective adoption of the FASB ASC.

(2)	Dividend payout ratio is declared dividends per common share divided by basic earnings (loss) per common share.

(3)	Ratios for the nine months ended September 30, 2013 and 2012 are annualized.

(4)	Net interest spread is the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities.

(5)	Net interest margin is net interest income divided by average interest earning assets.

(6)	The efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.

 

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Selected Historical Financial Data of Heritage (continued)

 

		As of or for the Nine Months Ended September 30,								As of or for the Year Ended December 31,
		2013				2012				2012				2011				2010				2009				2008(1)
		(Dollars in thousands)
Capital Ratios:
Total risk-based capital ratio			16.7	%			20.4	%			19.9	%			20.3	%			21.5	%			20.7	%			13.7	%
Tier 1 risk-based capital ratio			15.5				19.1				18.7				19.0				20.2				19.4				12.5
Leverage ratio			11.6				14.0				13.6				13.8				13.9				14.6				11.0
Asset Quality Ratios:
Nonperforming originated loans to total originated loans(7)			0.81	%			1.57	%			1.28	%			2.57	%			3.14	%			4.21	%			0.42	%
Allowance for loan losses on originated loans to total originated loans(7)			1.80				2.35				2.19				2.66				2.97				3.38				1.91
Allowance for loan losses on originated loans to nonperforming originated loans(7)			221.68				149.94				170.44				103.52				94.73				79.34				454.02
Nonperforming originated assets to total originated assets(7)			0.83				1.72				1.39				2.14				2.38				3.32				0.57
Other Data:
Number of banking offices			42				33				33				33				31				20				20
Number of full-time equivalent employees			415				368				363				354				321				222				217

 

(7)

Nonperforming originated loan balances exclude portions guaranteed by governmental agencies of $2.9 million and $2.0 million as of September 30, 2013 and 2012, respectively, and $1.2 million, $1.8 million, $3.2 million and $2.3 million as of December 31, 2012, 2011, 2010 and 2009, respectively. There were no governmental guarantees on nonperforming originated loans as of December 31, 2008.

 

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Selected Historical Financial Data of Washington Banking

 

		As of or for the Nine Months Ended September 30,								As of or for the Year Ended December 31,
		2013				2012				2012				2011				2010				2009				2008
		(Dollars in thousands, except per share data)
Operations data:
Interest income		$	56,805			$	68,271			$	89,710			$	89,707			$	75,949			$	54,392			$	58,782
Interest expense			4,119				5,528				7,113				9,981				11,830				14,019				20,834
Net interest income			52,686				62,743				82,597				79,726				64,119				40,373				37,948
Provision for loan losses			14,239				5,998				9,744				10,050				13,486				10,200				5,050
Noninterest income			19,180				3,643				8,246				9,212				33,531				7,661				6,886
Noninterest expense			39,865				42,427				56,399				55,825				46,797				28,734				27,523
Income tax expense			5,768				5,703				7,856				7,111				11,797				2,886				3,929
Net income before preferred dividends			11,994				12,258				16,844				15,952				25,570				6,214				8,332
Preferred dividends			—				—				—				1,084				1,659				1,600				—
Net income available to common shareholders			11,994				12,258				16,844				14,868				23,911				4,614				8,332
Common per share data:
Earnings per common share
Basic		$	0.77			$	0.80			$	1.09			$	0.97			$	1.56			$	0.46			$	0.88
Diluted			0.77				0.79				1.09				0.97				1.55				0.46				0.88
Dividend payout ratio to common shareholders(1)			50.41	%			44.04	%			45.81	%			20.63	%			8.64	%			37.23	%			29.01	%
Cash dividends per common share		$	0.39			$	0.35			$	0.50			$	0.20			$	0.14			$	0.18			$	0.26
Selected performance ratios:
Net interest spread(2)(3)			4.61	%			5.55	%			5.45	%			5.39	%			4.76	%			4.28	%			4.18	%
Net interest margin (fully tax-equivalent)(2)(4)(6)			4.71				5.65				5.54				5.47				4.90				4.63				4.60
Efficiency ratio (fully tax-equivalent)(5)(6)			54.98				63.11				61.31				62.06				47.48				59.01				60.63
Return on average assets(2)			0.97				0.98				1.01				0.95				1.72				0.66				0.94
Return on average common equity(2)			8.84				9.38				9.56				9.17				16.87				7.11				10.82
Balance sheet data:
Total assets		$	1,648,154			$	1,680,126			$	1,687,677			$	1,670,682			$	1,704,939			$	1,045,871			$	899,631
Non-covered loans			872,636				824,610				853,134				812,830				834,293				813,852				823,068
Covered loans			171,416				232,524				217,339				269,081				366,153				—				—
Allowance for loan losses, non-covered loans			16,942				16,570				17,147				18,032				18,812				16,212				12,250
Allowance for loan losses, covered loans			15,026				1,007				3,252				870				1,336				—				—
Non-covered OREO			4,747				4,080				3,023				1,976				4,122				4,549				2,226
Covered OREO			4,109				18,811				13,460				26,622				29,766				—				—
Deposits			1,429,279				1,458,230				1,462,973				1,466,344				1,492,220				846,671				747,159
Overnight borrowings			—				—				—				—				—				—				11,640
Other borrowed funds			—				—				—				—				—				10,000				30,000
Junior subordinated debentures			25,774				25,774				25,774				25,774				25,774				25,774				25,774
Preferred securities			—				—				—				—				25,334				24,995				—
Shareholders’ equity			181,798				180,967				182,624				170,820				182,098				159,521				80,560
Tangible book value per common share(7)			11.34				11.31				11.41				10.67				9.76				8.79				8.47
Average equity to average assets			11.01	%			10.45	%			10.54	%			9.64	%			11.26	%			11.86	%			8.65	%

 

(1)	Dividend payout ratio is total dividends paid on common stock divided by net income available to common shareholders.

(2)	Ratios for the nine months ended September 30, 2013 and 2012 are annualized.

(3)	Net interest spread is the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities.

(4)	Net interest margin is net interest income divided by average interest earning assets.

(5)	The efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.

(6)

A non-GAAP performance measure. The calculation involves grossing up the interest income on tax-exempt loans and investments by an amount that makes it comparable to taxable income. See “Reconciliation of Non-GAAP Historical Financial Data of Washington Banking” for reconciliations of non-GAAP measures to GAAP measures immediately following Washington Banking’s selected financial data table.

(7)	Tangible book value is a non-GAAP performance measure. See “Reconciliation of Non-GAAP Historical Financial Data of Washington Banking” for reconciliations of non-GAAP measures to GAAP measures immediately following Washington Banking’s selected financial data table.

 

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Selected Historical Financial Data of Washington Banking (continued)

 

		As of or for the Nine Months Ended September 30,								As of or for the Year Ended December 31,
		2013				2012				2012				2011				2010				2009				2008
		(Dollars in thousands)
Capital ratios:
Total risk-based capital			19.82	%			19.59	%			19.39	%			19.73	%			20.96	%			22.15	%			13.23	%
Tier 1 risk-based capital			18.55				18.34				18.13				18.47				19.70				20.89				11.98
Leverage ratio			12.56				11.65				11.78				11.16				11.42				18.73				11.68
Asset quality ratios:
Non-covered nonperforming loans to total gross non-covered loans			1.14	%			2.14	%			1.82	%			2.72	%			3.10	%			0.42	%			0.23	%
Allowance for loan losses to total gross non-covered loans			1.94				2.01				2.01				2.22				2.25				1.99				1.49
Allowance for loan losses to total non-covered nonperforming loans			171.00				93.92				110.26				81.59				72.79				477.53				638.69
Non-covered nonperforming assets to total assets			0.89				1.29				1.10				1.44				1.76				0.76				0.46
Net loan charge-offs to average non-covered loans outstanding(2)			0.32				1.16				0.97				1.37				1.15				0.76				0.48
Other data:
Number of banking offices			31				30				31				30				30				18				19
Number of full time equivalent employees			464				463				467				450				448				281				258

 

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Reconciliation of Non-GAAP Historical Financial Data of Washington Banking

 

		As of or for the Nine Months Ended September 30,								As of or for the Year Ended December 31,
		2013				2012				2012				2011				2010				2009				2008
		(Dollars in thousands)
Net interest margin (fully tax- equivalent):
GAAP net interest income		$	52,686			$	62,743			$	82,597			$	79,726			$	64,119			$	40,373			$	37,948
Tax-equivalent adjustment(1)			644				837				1,144				1,021				918				658				559
Tax-equivalent net interest income		$	53,330			$	63,580			$	83,741			$	80,747			$	65,037			$	41,031			$	38,507
Average interest earning assets		$	1,515,424			$	1,502,903			$	1,510,471			$	1,475,834			$	1,327,871			$	887,070			$	837,456
Net interest margin			4.65	%			5.58	%			5.47	%			5.40	%			4.83	%			4.55	%			4.53	%
Net interest margin (fully tax-equivalent)			4.71				5.65				5.54				5.47				4.90				4.63				4.60
Efficiency Ratio:
GAAP net interest income		$	52,686			$	62,743			$	82,597			$	79,726			$	64,119			$	40,373			$	37,948
Tax equivalent adjustment(1)			644				837				1,144				1,021				918				658				559
Tax equivalent net interest income		$	53,330			$	63,580			$	83,741			$	80,747			$	65,037			$	41,031			$	38,507
Efficiency ratio			55.47	%			63.91	%			62.08	%			62.77	%			47.92	%			59.82	%			61.39	%
Efficiency ratio (fully tax-equivalent)			54.98				63.11				61.31				62.06				47.48				59.01				60.63
Tangible Common Equity:
Total shareholders’ equity		$	181,798			$	180,967			$	182,624			$	170,820			$	182,098			$	159,521			$	80,560
Less:
Goodwill and other intangible assets, net			(5,698	)			(6,156	)			(6,027	)			(6,539	)			(7,161	)			—				—
Less:
Preferred stock			—				—				—				—				(25,334	)			(24,995	)			—
Tangible common equity		$	176,100			$	174,811			$	176,597			$	164,281			$	149,603			$	134,526			$	80,560
Common shares outstanding at end of period			15,532,349				15,451,307				15,483,598				15,398,197				15,321,227				15,297,801				9,510,007
Book value per common share		$	11.70			$	11.71			$	11.79			$	11.09			$	11.89			$	10.43			$	8.47
Tangible book value per common share			11.34				11.31				11.41				10.67				9.76				8.79				8.47

 

(1)	Tax-equivalent adjustment relates to non-taxable investment interest income. Interest and rates are presented on a fully taxable–equivalent basis using a tax rate of 34%.

 

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Selected Unaudited Consolidated Pro Forma Financial Data of Heritage and Washington Banking

The following table shows selected unaudited consolidated pro forma financial data reflecting the merger of Washington Banking with Heritage, assuming the companies had been combined at the dates and for the periods shown. The pro forma amounts reflect certain purchase accounting adjustments, which are based on estimates that are subject to change depending on fair values as of the merger completion date. These adjustments are described in the notes to unaudited pro forma combined condensed consolidated financial information contained elsewhere in this document under the heading “Unaudited Pro Forma Combined Condensed Consolidated Financial Information,” beginning on page     . The pro forma financial data in the table below does not include any projected cost savings, revenue enhancements or other possible financial benefits of the merger to the combined company and does not attempt to suggest or predict future results. This information also does not necessarily reflect what the historical financial condition or results of operations of the combined company would have been had Heritage and Washington Banking been combined as of the dates and for the periods shown.

 

		At or for the Nine Months Ended September 30, 2013				For the Year Ended December 31, 2012
		(In thousands)
Statement of Operations Data:
Interest income		$	109,933			$	159,483
Interest expense			7,043				11,694
Net interest income			102,890				147,789
Provision for loan losses, excluding covered loans			3,409				8,670
Provision for loan losses on covered loans			14,074				3,090
Net interest income after provision for loan losses			85,407				136,029
Noninterest income			26,774				15,772
Noninterest expense			81,490				108,306
Income before income taxes			30,691				43,495
Income tax expense			9,895				13,809
Net income		$	20,796			$	29,686
		At September 30, 2013
		(In thousands)
Financial Condition Data:
Total assets		$	3,354,172
Investment securities available for sale and held to maturity			602,615
Loans, excluding covered loans, net of allowance of $22,783			1,987,714
Covered loans, net of allowance of $5,972			205,985
Total loans receivable, net of allowance of $28,755			2,193,699
Total deposits			2,855,264
Securities sold under agreement to repurchase			22,655
Junior subordinated debentures			17,578
Accrued expenses and other liabilities			19,663
Total shareholders’ equity			439,012

 

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Comparative Unaudited Pro Forma Per Share Data

The table below sets forth the book value per common share, cash dividends per common share, and basic and diluted earnings per common share data for each of Heritage and Washington Banking on a historical basis, for Heritage on a pro forma combined basis and on a pro forma combined basis per Washington Banking equivalent share. The pro forma combined and pro forma combined per equivalent share information gives effect to the merger as if the merger occurred on September 30, 2013 or December 31, 2012, in the case of the book value data, and as if the merger occurred on January 1, 2012, in the case of the cash dividends and earnings per common share data. The Pro Forma Combined Amounts for Heritage data reflect certain purchase accounting adjustments, which are based on estimates that are subject to change depending on fair values as of the merger completion date. These adjustments are described in the notes to unaudited pro forma combined condensed consolidated financial information contained elsewhere in this document under the heading “Unaudited Pro Forma Combined Condensed Consolidated Financial Information,” beginning on page     . The Pro Forma Combined Per Washington Banking Equivalent Share data shows the effect of the merger from the perspective of an owner of Washington Banking common stock. The pro forma financial data in the table below is provided for illustrative purposes, does not include any projected cost savings, revenue enhancements or other possible financial benefits of the merger to the combined company and does not attempt to suggest or predict future results. This information also does not necessarily reflect what the historical financial condition or results of operations of the combined company would have been had Heritage and Washington Banking been combined as of the dates and for the periods shown.

 

		Heritage Historical				Washington Banking Historical				Pro Forma Combined Amounts for Heritage				Pro Forma Combined Per Washington Banking Equivalent Share(1)
Book value per common share at September 30, 2013		$	13.36			$	11.70			$	14.53			$	15.68
Book value per common share at December 31, 2012			13.16				11.79				14.50				15.66
Cash dividends per common share for the nine months ended September 30, 2013(2)			0.34				0.39				0.34				0.30
Cash dividends per common share for the year ended December 31, 2012(2)			0.80				0.50				0.80				0.71
Basic earnings per common share for the nine months ended September 30, 2013			0.57				0.77				0.71				0.63
Basic earnings per common share for the year ended December 31, 2012			0.87				1.09				1.02				0.90
Diluted earnings per common share for the nine months ended September 30, 2013			0.57				0.77				0.71				0.63
Diluted earnings per common share for the year ended December 31, 2012			0.87				1.09				1.01				0.90

 

(1)

Calculated by multiplying the Pro Forma Combined Amounts for Heritage by 0.89000, which is the exchange ratio for the stock portion of the merger consideration payable to the holders of Washington Banking common stock, and, solely in the case of the book value per common share at September 30, 2013, and December 31, 2012, adding to that result, $2.75, which is the per share cash merger consideration payable to holders of Washington Banking common stock. See “The Merger Agreement—Merger Consideration.”

(2)	The pro forma combined cash dividends per common share for the nine months ended September 30, 2013 and the year ended December 31, 2012 represent the actual cash dividends per share declared by Heritage for those periods.

 

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THE HERITAGE SPECIAL MEETING

This section contains information for Heritage shareholders about the special meeting that Heritage has called to allow its shareholders to consider and vote on the merger agreement and other related matters. Heritage commenced the mailing of this joint proxy statement/prospectus to its shareholders on or about                 , 2013. This joint proxy statement/prospectus is accompanied by a notice of the special meeting of Heritage shareholders and a form of proxy card that Heritage’s board of directors is soliciting for use at the Heritage special meeting and at any adjournments or postponements of the Heritage special meeting.

Date, Time and Place of Meeting

The Heritage special meeting will be held on                 , 2014 at     :        .m., local time, at The DoubleTree Hotel, 417 Capitol Way N., Olympia, Washington.

Matters to Be Considered

At the Heritage special meeting, Heritage shareholders will be asked to consider and vote on the following matters:

 

•

a proposal to approve the merger agreement and the issuance of Heritage common stock in connection with the merger (which is referred to as the “Heritage merger proposal”); and

 

•

a proposal to adjourn the Heritage special meeting, if necessary or appropriate, to solicit additional proxies in favor of the Heritage merger proposal (which is referred to as the “Heritage adjournment proposal”).

Recommendation of Heritage’s Board of Directors

Heritage’s board of directors has determined that the merger agreement and the transactions contemplated thereby, including the merger, are advisable and in the best interests of Heritage and its shareholders, has unanimously approved the merger agreement and unanimously recommends that Heritage shareholders vote “FOR” the Heritage merger proposal, and “FOR” the Heritage adjournment proposal. See “The Merger—Heritage’s Reasons for the Merger; Recommendation of Heritage’s Board of Directors” for a more detailed discussion of Heritage’s board of directors’ recommendation.

Record Date and Quorum

The Heritage board of directors has fixed the close of business on                 , 2013 as the record date for determining the holders of shares of Heritage common stock entitled to receive notice of and to vote at the Heritage special meeting. Only holders of record of shares of Heritage common stock as of the close of business on that date will be entitled to vote at the Heritage special meeting and at any adjournment or postponement of that meeting. At the close of business on the record date, there were                 shares of Heritage common stock outstanding, held by approximately                 holders of record.

Each holder of shares of Heritage common stock outstanding as of the close of business on the record date will be entitled to one vote for each share held of record upon each matter properly submitted at the Heritage special meeting and at any adjournment or postponement of that meeting; provided, however, that pursuant to Heritage’s articles of incorporation, no person who beneficially owns more than 10.0% of the shares of Heritage common stock outstanding as of the record date may vote shares in excess of this limit. The presence at the Heritage special meeting, in person or by proxy, of holders of a majority of the outstanding shares of Heritage common stock entitled to vote at the special meeting will constitute a quorum for the transaction of business. All shares of Heritage common stock present in person or represented by proxy, including abstentions and broker non-votes, will be treated as present for purposes of determining the presence or absence of a quorum for all matters voted on at the Heritage special meeting.

 

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Vote Required; Treatment of Abstentions and Failure to Vote

To approve the Heritage merger proposal, two-thirds of the shares of Heritage common stock outstanding and entitled to vote thereon must be voted in favor of such proposal. The Heritage adjournment proposal will be approved if a majority of the votes cast at the Heritage special meeting are voted in favor of such proposal. If you mark “ABSTAIN” on your proxy or fail to submit a proxy or vote in person at the Heritage special meeting with respect to the Heritage merger proposal, it will have the same effect as a vote “AGAINST” the proposal. If you mark “ABSTAIN” on your proxy or fail to submit a proxy or vote in person at the Heritage special meeting with respect to the Heritage adjournment proposal, it will have no effect on the proposal.

Shares Held by Directors and Executive Officers; Voting and Support Agreements

As of the record date for the Heritage special meeting, Heritage directors and executive officers and their affiliates owned and were entitled to vote, and have agreed to vote in favor of the merger proposal pursuant to the voting and support agreements described below, approximately                 shares of Heritage common stock, representing approximately     % of the outstanding shares of Heritage common stock, and Washington Banking directors and executive officers and their affiliates owned and were entitled to vote approximately                 shares of Heritage common stock, representing approximately     % of the outstanding shares of Heritage common stock. Washington Banking owns no shares of Heritage common stock.

Concurrent with the execution of the merger agreement, each of the directors and executive officers of Heritage entered into a voting and support agreement with Washington Banking under which he or she generally has agreed (1) to vote or cause to be voted in favor of the Heritage merger proposal and any other matter required to be approved by the shareholders of Heritage to facilitate the transactions contemplated by the merger agreement, all shares of Heritage common stock over which he or she or a member of his or her immediate family has, directly or indirectly, sole or shared voting power as of the record date for the Heritage special meeting and (2) subject to limited exceptions, not to sell or otherwise dispose of shares of Heritage common stock he or she beneficially owned as of the date of such voting and support agreement until after the approval of the Heritage merger proposal by the shareholders of Heritage.

Voting of Proxies; Incomplete Proxies

Each copy of this joint proxy statement/prospectus mailed to holders of Heritage common stock is accompanied by a form of proxy card with instructions for voting. If you hold shares of Heritage common stock in your name as a shareholder of record, you should complete and return the proxy card accompanying this joint proxy statement/prospectus, regardless of whether you plan to attend the special meeting. You may also vote your shares through the Internet or by telephone. Information and applicable deadlines for voting through the Internet or by telephone are set forth in the enclosed proxy card instructions.

If you hold shares of Heritage common stock in “street name” through a bank, broker or other nominee, you must direct your bank, broker or other nominee how to vote in accordance with the instructions you have received from your bank, broker or other nominee. See “—Shares Held in Street Name; Broker Non-Votes.”

All shares represented by valid proxies that Heritage receives through this solicitation, and that are not revoked, will be voted at the Heritage special meeting in accordance with your instructions on the proxy card. If you make no specification on your proxy card as to how you want your shares voted before signing and returning it, your proxy will be voted “FOR” the Heritage merger proposal and “FOR” the Heritage adjournment proposal. No matters other than the matters described in this joint proxy statement/prospectus are anticipated to be presented for action at the Heritage special meeting or at any adjournment or postponement of the Heritage special meeting. However, if other business properly comes before the Heritage special meeting, the proxy agents will, in their discretion, vote upon such matters in their best judgment.

 

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Shares Held in Street Name; Broker Non-Votes

If you are a Heritage shareholder and your shares are held in “street name” through a bank, broker or other nominee, you must provide the record holder of your shares with instructions on how to vote the shares. Please follow the voting instructions provided by the bank, broker or other nominee. You may not vote shares held in street name by returning a proxy card directly to Heritage or by voting in person at the Heritage special meeting unless you provide a “legal proxy,” which you must obtain from your bank, broker or other nominee. Further, because each of the proposals to be considered at the Heritage special meeting is a “non-routine” matter, under stock exchange rules, banks, brokers or other nominees who hold shares of Heritage common stock on behalf of their customers may not give a proxy to Heritage to vote those shares with respect to any of these proposals without specific voting instructions from their customers. Therefore, if you are a Heritage shareholder and you do not instruct your bank, broker or other nominee on how to vote your shares:

 

•

your bank, broker or other nominee may not vote your shares on the Heritage merger proposal, which will have the same effect as a vote “AGAINST” this proposal; and

 

•

your bank, broker or other nominee may not vote your shares on the Heritage adjournment proposal, which will have no effect on the vote count for this proposal.

Broker non-votes are shares held by a broker, bank or other nominee that are represented at the Heritage special meeting, but with respect to which the broker or nominee is not instructed by the beneficial owner of such shares to vote on the particular proposal and the broker does not have discretionary voting power on such proposal.

Revocability of Proxies and Changes to a Heritage Shareholder’s Vote

If you hold shares of Heritage common stock in your name as a shareholder of record, you may revoke any proxy at any time before it is voted at the Heritage special meeting by (1) signing and returning a proxy card with a later date, (2) delivering a written revocation to Heritage’s Corporate Secretary, (3) attending the Heritage special meeting in person, notifying the Corporate Secretary and voting by ballot at the Heritage special meeting or (4) voting by telephone or the Internet at a later time.

Any shareholder entitled to vote in person at the Heritage special meeting may vote in person regardless of whether a proxy has been previously given, but the mere presence (without notifying Heritage’s Corporate Secretary of revocation) of a shareholder at the Heritage special meeting will not constitute revocation of a previously given proxy.

Written notices of revocation and other communications about revoking your proxy card should be addressed to: Heritage Financial Corporation, Attn: Corporate Secretary, 201 Fifth Avenue SW, Olympia, Washington 98501.

If your shares are held in “street name” by a bank, broker or other nominee, you must follow the instructions of your bank, broker or other nominee regarding changes in voting instructions.

Solicitation of Proxies

Heritage will bear the entire cost of soliciting proxies from Heritage shareholders. In addition to solicitation of proxies by mail, Heritage will request that banks, brokers and other record holders send proxy materials to the beneficial owners of Heritage common stock and secure their voting instructions. Heritage will reimburse the record holders for their reasonable expenses in taking those actions. If necessary, Heritage may use its directors and several of its regular employees, who will not be specially compensated, to solicit proxies from the Heritage shareholders, either personally or by telephone, facsimile, letter or electronic means. Heritage has also made arrangements with Advantage Proxy to assist it in soliciting proxies and has agreed to pay Advantage Proxy approximately $7,500 plus reasonable expenses for these services.

 

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Attending the Heritage Special Meeting

All holders of Heritage common stock, including shareholders of record and shareholders who hold their shares through banks, brokers, nominees or any other holder of record, are invited to attend the Heritage special meeting. If you hold your Heritage shares in an account at a brokerage firm or bank, your name will not appear on Heritage’s shareholder list. Please bring an account statement or a letter from your broker showing your holdings of Heritage common stock. You may be asked to provide this documentation and picture identification at the meeting registration desk to attend the Heritage special meeting.

 

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HERITAGE PROPOSALS

Heritage Merger Proposal

As discussed elsewhere in this joint proxy statement/prospectus, Heritage is asking its shareholders to approve the Heritage merger proposal. Holders of Heritage common stock should read carefully this joint proxy statement/prospectus in its entirety, including the appendices, for more detailed information concerning the merger agreement and the merger. In particular, holders of Heritage common stock are directed to the merger agreement, a copy of which is attached as Appendix A to this joint proxy statement/prospectus.

The affirmative vote of the holders of at least two-thirds of the outstanding shares of Heritage common stock entitled to vote is required to approve the Heritage merger proposal.

The Heritage board of directors unanimously recommends that Heritage shareholders vote “FOR” the Heritage merger proposal.

Each of the directors and executive officers of Heritage has entered into a voting and support agreement with Washington Banking, pursuant to which each has agreed to vote “FOR” the Heritage merger proposal. For more information regarding the voting and support agreements, see “The Merger Agreement—Voting and Support Agreements.”

Heritage Adjournment Proposal

The Heritage special meeting may be adjourned to another time or place, if necessary or appropriate, to permit, among other things, further solicitation of proxies if necessary to obtain additional votes in favor of the Heritage merger proposal.

If, at the Heritage special meeting, the number of shares of Heritage common stock present or represented and voting in favor of the Heritage merger proposal is insufficient to approve the Heritage merger proposal, Heritage intends to move to adjourn the Heritage special meeting in order to enable the Heritage board of directors to solicit additional proxies for approval of the Heritage merger proposal.

In this proposal, Heritage is asking its shareholders to authorize the holder of any proxy solicited by the Heritage board of directors on a discretionary basis to vote in favor of adjourning the Heritage special meeting to another time and place for the purpose of soliciting additional proxies, including the solicitation of proxies from Heritage shareholders who have previously voted.

The affirmative vote of the holders of a majority of the votes cast on the Heritage adjournment proposal is required to approve the Heritage adjournment proposal.

The Heritage board of directors unanimously recommends that Heritage shareholders vote “FOR” the Heritage adjournment proposal.

 

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THE WASHINGTON BANKING SPECIAL MEETING

This section contains information for Washington Banking shareholders about the special meeting that Washington Banking has called to allow its shareholders to consider and vote on the merger agreement and other related matters. Washington Banking commenced the mailing of this joint proxy statement/prospectus to holders of Washington Banking common stock on or about                 , 2013. This joint proxy statement/prospectus is accompanied by a notice of the special meeting of Washington Banking shareholders and a form of proxy card that Washington Banking’s board of directors is soliciting for use at the Washington Banking special meeting and at any adjournments or postponements of the Washington Banking special meeting.

Date, Time and Place of Meeting

The Washington Banking special meeting will be held on                 , 2014 at     :        .m., local time, at the Best Western Harbor Plaza, 33175 State Route 20, Oak Harbor, Washington.

Matters to Be Considered

At the Washington Banking special meeting, holders of Washington Banking common stock will be asked to consider and vote on the following matters:

 

•

a proposal to approve the merger agreement (which is referred to as the “Washington Banking merger proposal”);

 

•

a proposal to adjourn the Washington Banking special meeting, if necessary or appropriate, to solicit additional proxies in favor of the Washington Banking merger proposal (which is referred to as the “Washington Banking adjournment proposal”); and

 

•

a proposal to approve, on an advisory (non-binding) basis, the compensation that certain executive officers of Washington Banking may receive that is based on or otherwise relates to the merger (which is referred to as the “Washington Banking compensation proposal”).

Recommendation of Washington Banking’s Board of Directors

After careful consideration, Washington Banking’s board of directors has determined that the merger agreement and the transactions contemplated thereby, including the merger, are advisable and in the best interests of Washington Banking and its shareholders, has unanimously approved the merger agreement and unanimously recommends that Washington Banking shareholders vote “FOR” the Washington Banking merger proposal, “FOR” the Washington Banking adjournment proposal and “FOR” the Washington Banking compensation proposal. See “The Merger—Washington Banking’s Reasons for the Merger; Recommendation of Washington Banking’s Board of Directors” for a more detailed discussion of Washington Banking’s board of directors’ recommendation.

Record Date and Quorum

The Washington Banking board of directors has fixed the close of business on                 , 2013 as the record date for determining the holders of shares of Washington Banking common stock entitled to receive notice of and to vote at the Washington Banking special meeting. Only holders of record of shares of Washington Banking common stock as of the close of business on that date will be entitled to vote at the Washington Banking special meeting and at any adjournment or postponement of that meeting. At the close of business on the record date, there were                 shares of Washington Banking common stock outstanding, held by approximately                 holders of record.

Each holder of shares of Washington Banking common stock outstanding as of the close of business on the record date will be entitled to one vote for each share held of record upon each matter properly submitted at the

 

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Washington Banking special meeting and at any adjournment or postponement of that meeting. The presence at the Washington Banking special meeting, in person or by proxy, of holders of a majority of the outstanding shares of Washington Banking common stock entitled to vote at the special meeting will constitute a quorum for the transaction of business. All shares of Washington Banking common stock present in person or represented by proxy, including abstentions and broker non-votes, will be treated as present for purposes of determining the presence or absence of a quorum for all matters voted on at the Washington Banking special meeting.

Vote Required; Treatment of Abstentions and Failure to Vote

To approve the Washington Banking merger proposal, the affirmative vote of two-thirds of the shares of Washington Banking common stock outstanding and entitled to vote thereon must be voted in favor of such proposal. The Washington Banking adjournment proposal and the Washington Banking compensation proposal will each be approved if a majority of the votes cast at the Washington Banking special meeting are voted in favor of such proposal. If you mark “ABSTAIN” on your proxy or fail to submit a proxy or vote in person at the Washington Banking special meeting with respect to the Washington Banking merger proposal, it will have the same effect as a vote “AGAINST” the proposal. If you mark “ABSTAIN” on your proxy or fail to submit a proxy or vote in person at the Washington Banking special meeting with respect to the Washington Banking adjournment proposal or the Washington Banking compensation plan proposal, it will have no effect on the proposal.

Shares Held by Directors and Executive Officers; Voting and Support Agreements

As of the record date for the Washington Banking special meeting, Washington Banking directors and executive officers and their affiliates owned and were entitled to vote, and have agreed to vote in favor of the merger proposal pursuant to the voting and support agreements described below, approximately                 shares of Washington Banking common stock, representing approximately     % of the outstanding shares of Washington Banking common stock, and Heritage directors and executive officers and their affiliates owned and were entitled to vote approximately 5,000 shares of Washington Banking common stock, representing less than one percent of the outstanding shares of Washington Banking common stock. Heritage owns no shares of Washington Banking common stock.

Concurrent with the execution of the merger agreement, each of the directors and executive officers of Washington Banking entered into a voting and support agreement with Heritage under which he or she generally has agreed (1) to vote or cause to be voted in favor of the Washington Banking merger proposal and any other matter required to be approved by the shareholders of Washington Banking to facilitate the transactions contemplated by the merger agreement, all shares of Washington Banking common stock over which he or she or a member of his or her immediate family has, directly or indirectly, sole or shared voting power as of the record date for the Washington Banking special meeting and (2) subject to limited exceptions, not to sell or otherwise dispose of shares of Washington Banking common stock he or she beneficially owned as of the date of such voting and support agreement until after the approval of the Washington Banking merger proposal by the shareholders of Washington Banking. For additional information regarding the voting and support agreements, see “The Merger Agreement—Voting and Support Agreements.”

Voting of Proxies; Incomplete Proxies

Each copy of this joint proxy statement/prospectus mailed to holders of Washington Banking common stock is accompanied by a form of proxy card with instructions for voting. If you hold shares of Washington Banking common stock in your name as a shareholder of record, you should complete and return the proxy card accompanying this joint proxy statement/prospectus, regardless of whether you plan to attend the special meeting. You may also vote your shares through the Internet or by telephone. Information and applicable deadlines for voting through the Internet or by telephone are set forth in the enclosed proxy card instructions.

 

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If you hold shares of Washington Banking common stock in “street name” through a bank, broker or other nominee, you must direct your bank, broker or other nominee how to vote in accordance with the instructions you have received from your bank, broker or other nominee. See “—Shares Held in Street Name; Broker Non-Votes.”

All shares represented by valid proxies that Washington Banking receives through this solicitation, and that are not revoked, will be voted at the Washington Banking special meeting in accordance with your instructions on the proxy card. If you make no specification on your proxy card as to how you want your shares voted before signing and returning it, your proxy will be voted “FOR” the Washington Banking merger proposal, “FOR” the Washington Banking adjournment proposal and “FOR” the Washington Banking compensation proposal. No matters other than the matters described in this joint proxy statement/ prospectus are anticipated to be presented for action at the Washington Banking special meeting or at any adjournment or postponement of the Washington Banking special meeting. However, if other business properly comes before the Washington Banking special meeting, the proxy agents will, in their discretion, vote upon such matters in their best judgment.

Shares Held in Street Name; Broker Non-Votes

If you are a Washington Banking shareholder and your shares are held in “street name” through a bank, broker or other nominee, you must provide the record holder of your shares with instructions on how to vote the shares. Please follow the voting instructions provided by the bank, broker or other nominee. You may not vote shares held in street name by returning a proxy card directly to Washington Banking or by voting in person at the Washington Banking special meeting unless you provide a “legal proxy,” which you must obtain from your bank, broker or other nominee. Further, because each of the proposals to be considered at the Washington Banking special meeting is a “non-routine” matter, under stock exchange rules, banks, brokers or other nominees who hold shares of Washington Banking common stock on behalf of their customers may not give a proxy to Washington Banking to vote those shares with respect to any of these proposals without specific voting instructions from their customers. Therefore, if you are a holder of Washington Banking common stock and you do not instruct your bank, broker or other nominee on how to vote your shares:

 

•

your bank, broker or other nominee may not vote your shares on the Washington Banking merger proposal, which will have the same effect as a vote “AGAINST” this proposal; and

 

•

your bank, broker or other nominee may not vote your shares on the Washington Banking adjournment proposal or the Washington Banking compensation proposal, which will have no effect on the vote counts for these proposals.

Broker non-votes are shares held by a broker, bank or other nominee that are represented at the Washington Banking special meeting, but with respect to which the broker or nominee is not instructed by the beneficial owner of such shares to vote on the particular proposal and the broker does not have discretionary voting power on such proposal.

Revocability of Proxies and Changes to a Washington Banking Shareholder’s Vote

If you hold shares of Washington Banking common stock in your name as a shareholder of record, you may revoke any proxy at any time before it is voted at the Washington Banking special meeting by (1) signing and returning a proxy card with a later date, (2) delivering a written revocation to Washington Banking’s Corporate Secretary, (3) attending the Washington Banking special meeting in person, notifying the Corporate Secretary and voting by ballot at the Washington Banking special meeting or (4) voting by telephone or the Internet at a later time.

Any shareholder entitled to vote in person at the Washington Banking special meeting may vote in person regardless of whether a proxy has been previously given, but the mere presence (without notifying Washington Banking’s Corporate Secretary of revocation) of a shareholder at the Washington Banking special meeting will not constitute revocation of a previously given proxy.

 

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Written notices of revocation and other communications about revoking your proxy card should be addressed to: Washington Banking Company, Attn: Corporate Secretary, 450 SW Bayshore Drive, Oak Harbor, Washington 98277.

If your shares are held in “street name” by a bank, broker or other nominee, you must follow the instructions of your bank, broker or other nominee regarding changes in voting instructions.

Solicitation of Proxies

Washington Banking will bear the entire cost of soliciting proxies from Washington Banking shareholders. In addition to solicitation of proxies by mail, Washington Banking will request that banks, brokers and other record holders send proxies and proxy material to the beneficial owners of Washington Banking common stock and secure their voting instructions. Washington Banking will reimburse the record holders for their reasonable expenses in taking those actions. If necessary, Washington Banking may use its directors and several of its regular employees, who will not be specially compensated, to solicit proxies from the Washington Banking shareholders, either personally or by telephone, facsimile, letter or electronic means. Washington Banking has also made arrangements with Advantage Proxy to assist it in soliciting proxies and has agreed to pay Advantage Proxy approximately $7,500 plus reasonable expenses for these services.

Attending the Washington Banking Special Meeting

All holders of Washington Banking common stock, including shareholders of record and shareholders who hold their shares through banks, brokers, nominees or any other holder of record, are invited to attend the Washington Banking special meeting. If you hold your Washington Banking shares in an account at a brokerage firm or bank, your name will not appear on Washington Banking’s shareholder list. Please bring an account statement or a letter from your broker showing your holdings of Washington Banking common stock. You may be asked to provide this documentation and picture identification at the meeting registration desk to attend the Washington Banking special meeting.

WASHINGTON BANKING PROPOSALS

Washington Banking Merger Proposal

As discussed elsewhere in this joint proxy statement/prospectus, Washington Banking is asking its shareholders to approve the Washington Banking merger proposal. Holders of Washington Banking common stock should read carefully this joint proxy statement/prospectus in its entirety, including the appendices, for more detailed information concerning the merger agreement and the merger. In particular, holders of Washington Banking common stock are directed to the merger agreement, a copy of which is attached as Appendix A to this joint proxy statement/prospectus.

The affirmative vote of the holders of two-thirds of the outstanding shares of Washington Banking common stock entitled to vote is required to approve the Washington Banking merger proposal.

The Washington Banking board of directors unanimously recommends that Washington Banking shareholders vote “FOR” the Washington Banking merger proposal.

Each of the directors and executive officers of Washington Banking has entered into a voting and support agreement with Heritage, pursuant to which each has agreed to vote “FOR” the Washington Banking merger proposal. For more information regarding the voting and support agreements, see “The Merger Agreement—Voting and Support Agreements.”

Under Washington law, shareholders are not entitled to bring any other proposals before the Washington Banking special meeting.

 

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Washington Banking Adjournment Proposal

The Washington Banking special meeting may be adjourned to another time or place, if necessary or appropriate, to permit, among other things, further solicitation of proxies if necessary to obtain additional votes in favor of the Washington Banking merger proposal.

If, at the Washington Banking special meeting, the number of shares of Washington Banking common stock present or represented and voting in favor of the Washington Banking merger proposal is insufficient to approve the Washington Banking merger proposal, Washington Banking intends to move to adjourn the Washington Banking special meeting in order to enable the Washington Banking board of directors to solicit additional proxies for approval of the Washington Banking merger proposal.

In this proposal, Washington Banking is asking its shareholders to authorize the holder of any proxy solicited by the Washington Banking board of directors on a discretionary basis to vote in favor of adjourning the Washington Banking special meeting to another time and place for the purpose of soliciting additional proxies, including the solicitation of proxies from Washington Banking shareholders who have previously voted.

The affirmative vote of the holders of a majority of the votes cast on the Washington Banking adjournment proposal is required to approve the Washington Banking adjournment proposal.

The Washington Banking board of directors unanimously recommends that Washington Banking shareholders vote “FOR” the Washington Banking adjournment proposal.

Washington Banking Compensation Proposal

In accordance with Section 14A of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) Washington Banking is providing its shareholders with the opportunity to cast an advisory (non-binding) vote on certain compensation that may become payable to its named executive officers that is based on or otherwise relates to the merger, the value of which is set forth in the table included in the section of this joint proxy statement/prospectus entitled “The Merger—Merger-Related Compensation for Washington Banking’s Named Executive Officers”. As required by Section 14A of the Exchange Act, and the applicable SEC rules issued thereunder, Washington Banking is asking its shareholders to vote on the adoption of the following resolution:

“RESOLVED, that the compensation that may be paid or become payable to Washington Banking’s named executive officers that is based on or otherwise relates to the merger, as disclosed in the table and associated narrative discussion in the section of the joint proxy statement/prospectus statement entitled “The Merger—Merger-Related Compensation for Washington Banking’s Named Executive Officers,” is hereby APPROVED.”

The affirmative vote of the holders of a majority of the votes cast on the Washington Banking compensation proposal is required to approve the Washington Banking compensation proposal. The vote on named executive officer merger-related compensation is a vote separate and apart from the vote on the Washington Banking merger proposal. Accordingly, a Washington Banking shareholder may vote to approve the Washington Banking merger proposal and vote not to approve the Washington Banking compensation proposal and vice versa.

Because the vote on named executive officer merger-related compensation is advisory in nature only, it will not be binding on either Washington Banking or Heritage. Accordingly, because Washington Banking is contractually obligated to pay the compensation described in the section of this joint proxy statement/prospectus entitled “The Merger—Merger-Related Compensation for Washington Banking’s Named Executive Officers”, such compensation will be payable, subject only to the conditions applicable thereto, if the merger is approved and the merger is completed, regardless of the outcome of the advisory vote.

The Washington Banking board of directors unanimously recommends that Washington Banking shareholders vote “FOR” the Washington Banking compensation proposal.

 

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THE MERGER

The following discussion contains certain information about the merger. The discussion is subject, and qualified in its entirety by reference, to the merger agreement attached as Appendix A to this joint proxy statement/prospectus and incorporated herein by reference. We urge you to read carefully this entire joint proxy statement/prospectus, including the merger agreement attached as Appendix A, for a more complete understanding of the merger.

Terms of the Merger

Each of Heritage’s and Washington Banking’s respective boards of directors has approved the merger agreement. The merger agreement provides for the merger of Washington Banking with and into Heritage, with Heritage continuing as the surviving corporation. Immediately following the completion of the merger, Washington Banking’s wholly owned bank subsidiary, Whidbey Island Bank, will merge with and into Heritage Bank, with Heritage Bank continuing as the resulting institution in the bank merger.

In the merger, each share of Washington Banking common stock, no par value per share, issued and outstanding immediately prior to the completion of the merger, except for specified shares of Washington Banking common stock held by Washington Banking or Heritage and dissenting shares, will be converted into the right to receive 0.8900 shares of Heritage common stock, no par value per share, and $2.75 in cash per share. No fractional shares of Heritage common stock will be issued in connection with the merger, and holders of Washington Banking common stock will be entitled to receive cash in lieu thereof.

Washington Banking shareholders and Heritage shareholders are being asked to approve the merger agreement. See “The Merger Agreement” for additional and more detailed information regarding the legal documents that govern the merger, including information about the conditions to the completion of the merger and the provisions for terminating or amending the merger agreement.

Background of the Merger

As part of their ongoing consideration and evaluation of their respective long-term prospects and strategies, each of Washington Banking’s and Heritage’s board of directors and senior management have regularly reviewed and assessed their respective business strategies and objectives, including strategic opportunities and challenges, and have considered various strategic options potentially available to them, all with the goal of enhancing value for their respective shareholders. The strategic discussions have focused on, among other things, the business and regulatory environment facing financial institutions generally and Washington Banking and Heritage, respectively, in particular, as well as conditions and ongoing consolidation in the financial services industry.

Heritage continually seeks potential merger and acquisition candidates to enhance the value of its franchise. Heritage’s most recent acquisitions consisted of two FDIC-assisted transactions during 2010 involving failed banking institutions in its primary market area; the acquisition of Northwest Commercial Bank, a Washington chartered commercial bank headquartered in Lakewood, Washington on January 9, 2013; and the acquisition of Valley Community Bancshares, Inc. and its subsidiary financial institution, Valley Bank on July 15, 2013. Following these acquisitions, Heritage was particularly interested in a transformative strategic transaction of significant size that would both enhance Heritage’s competitive position in the commercial banking business and further diversify its loan portfolio and revenue stream. Washington Banking was well-known to Heritage, and the strength of its business lines, similar customer base and market area appeared to make it a good strategic fit with Heritage.

Over the past four years, Washington Banking, consistent with the strategic plan adopted by its board of directors, has actively sought potential merger and acquisition and other growth opportunities to enhance shareholder value. Washington Banking’s recent acquisitions consisted of two FDIC-assisted transactions in

 

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2010 involving failed banking institutions. The FDIC-assisted acquisition of City Bank expanded Washington Banking’s footprint into King County, Washington. During 2013, Washington Banking continued to review and pursue acquisition opportunities, including during the summer of 2013 an acquisition of a smaller financial institution. In connection with Washington Banking’s strategic planning, the board of directors and management stressed the importance of enhancing shareholder value through mergers or acquisitions in order to remain competitive in the challenging economic, regulatory and interest rate climate, and to address potentially increased operating costs and declining revenues with the projected runoff of covered loans from FDIC-assisted transactions. The board of directors focused on identifying strong complementary franchises that shared Washington Banking’s values and approach to community banking.

Over the years, Brian L. Vance, President and Chief Executive Officer of Heritage, and John L. Wagner, President and Chief Executive Officer of Washington Banking, have engaged in informal discussions regarding general industry and business matters. In the course of these conversations and discussions, Mr. Vance and Mr. Wagner discussed a potential strategic business combination between the two companies; however, subsequent discussions had not occurred.

In early August 2013, Mr. Vance telephoned Mr. Wagner to suggest that they have an informal meeting, and they agreed to meet in Seattle on August 27, 2013. At the meeting, Mr. Vance informed Mr. Wagner that he had arranged the meeting with a view towards initiating an informal dialogue about a possible strategic combination of Heritage and Washington Banking.

Between August 13, 2013 and August 22, 2013, representatives of Heritage met with its financial advisor, Davidson, to discuss the structure, terms and pricing of a proposed transaction between Heritage and Washington Banking.

On August 13, 2013 through August 23, 2013, Washington Banking’s management, along with Sandler, participated in discussions regarding the upcoming meeting between Messrs. Wagner and Vance. Management and Sandler discussed the various items that would need to be negotiated. Mr. Wagner informed board members of the pending meeting.

At the August 27, 2013 meeting, Messrs. Vance and Wagner initially engaged in a broad-ranging conversation, including discussion of general business and financial services industry matters and an exchange of their respective business philosophy. Mr. Vance then introduced the topic of a possible strategic business combination of Heritage and Washington Banking, and inquired as to whether Washington Banking would be interested in engaging in a discussion about a possible transaction. Mr. Wagner confirmed that under the right terms he believed Washington Banking would be interested in further discussions with Heritage about a possible strategic business combination. Messrs. Vance and Wagner acknowledged that this strategic business combination would require careful consideration of numerous structural and financial issues in order to be acceptable to both Washington Banking and Heritage. Following the meeting, Mr. Wagner informed Washington Banking board members and senior management of his initial discussions with Mr. Vance.

On August 28, 2013, Mr. Wagner contacted Washington Banking’s legal counsel, Lane Powell PC (which we refer to as “Lane Powell”), to discuss the proposed transaction. Lane Powell reviewed with Mr. Wagner the various items that would need to be addressed in connection with the proposed transaction.

On August 29, 2013, at Washington Banking’s regularly scheduled board meeting, Mr. Wagner gave a report of his meeting with Mr. Vance and Heritage’s desire to have further discussions regarding a potential strategic business combination with Washington Banking. Sandler participated in the meeting. After discussion and at the conclusion of the meeting, Washington Banking’s board authorized management to have further discussions with Heritage about a possible strategic business combination.

 

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On August 30, 2013, Heritage’s management, Heritage’s legal counsel, Breyer & Associates PC and Silver Freedman & Taff L.L.P. (together, referred to as “Heritage’s legal counsel”), and Davidson participated in initial discussions of the proposed strategic business combination by telephone.

On September 3, 2013, Heritage’s management and its board of directors, along with Davidson and Heritage’s legal counsel participated in a special board meeting to discuss the proposed transaction. Management and Heritage’s legal counsel responded to questions from the board regarding the proposed transaction. In addition, Heritage’s legal counsel reviewed with the board of directors the various items that would need to be addressed in connection with the proposed transaction. Davidson presented detailed financial analysis concerning Washington Banking and information concerning the combined company. During that meeting, the board of directors authorized management to send an initial draft of the nondisclosure agreement to Washington Banking. That same day, Heritage management provided an initial draft of the nondisclosure agreement to Washington Banking.

On September 3, 2013, Heritage’s legal counsel, Lane Powell, Davidson and Sandler participated in a telephone call to discuss the structure of the proposed strategic business combination. In addition, a special meeting of the Heritage board of directors was held to discuss the proposed strategic business combination.

On September 4, 2013, Messrs. Wagner and Vance met in Seattle along with Sandler and Davidson to discuss the proposed strategic business combination. This was the initial discussion between Heritage and Washington Banking and their respective financial advisors regarding the structure and pricing of the proposed transaction. At that meeting, Mr. Vance distributed a list of discussion items regarding the structure of the strategic business transaction and the potential combined company, including deal structure, pricing, governance and operational issues including participation in the combined company by board members of Heritage and Washington Banking and management team roles for individuals from both institutions, and logistical issues including the combined company’s name and location of its headquarters. During the meeting, the group reached consensus on some of the items. At the meeting, Mr. Wagner executed the nondisclosure agreement. Following the meeting Mr. Vance provided Mr. Wagner with an updated list of discussion items reflecting the matters discussed at the meeting.

On September 6, 2013, Heritage’s board of directors held a special meeting to discuss the status of the proposed strategic business combination, and management informed the board of additional developments regarding preliminary discussions with Washington Banking.

On September 6, 2013, Washington Banking’s board of directors held a special meeting to discuss the status of the proposed strategic business combination and management informed the board of additional development regarding preliminary discussions with Heritage. Washington Banking’s management and Sandler responded to questions about the status of discussions and possible next steps. Based on the information from the September 4, 2013, meeting, Sandler presented detailed financial analysis concerning the strategic business combination. Washington Banking’s board of directors determined that in order to proceed with discussions with Heritage, the proposed merger consideration to Washington Banking’s shareholders would need to be increased and additional governance and operational changes would need to be made to the proposed merger terms in order to reflect Washington Banking’s contribution to the combined company. Washington Banking’s board of directors instructed Mr. Wagner to provide this feedback to Mr. Vance. Following the special board meeting, Mr. Wagner contacted Mr. Vance to share the board’s feedback.

On September 9, 2013, Mr. Vance communicated to Mr. Wagner an updated approach to the proposed strategic business combination, including a revised approach to certain social and operational issues and reflecting greater involvement from Washington Banking in the potential combined company. Mr. Vance told Mr. Wagner that Heritage would consider revised merger consideration, but needed more definitive direction from Washington Banking. Mr. Vance also indicated to Mr. Wagner that in order for Heritage to move forward with due diligence and drafting a merger agreement, Heritage and Washington Banking would need to enter into a period of mutual exclusivity for purposes of their negotiations.

 

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On September 12, 2013, at a special meeting of the Heritage board, the Heritage board received an update on the proposed strategic business combination.

On September 13, 2013, at a special meeting of the Washington Banking board, directors discussed the proposed strategic business combination, including the proposed consideration and social issues, such as the board composition and executive management team of the combined company. During that discussion, the Washington Banking board noted the importance of ensuring an appropriate balance of directors and executives of Washington Banking in the oversight, strategic direction and management of the combined company whose familiarity with Washington Banking’s business, customers and employees would help minimize integration risk, which in turn would maximize the opportunity for Washington Banking’s shareholders to participate in the synergies of the strategic business combination as continuing shareholders of the potential combined company. The Washington Banking board also discussed the opportunities and risks associated with a strategic business combination with Heritage. Sandler and Lane Powell participated in the meeting. Sandler presented certain financial analysis and data regarding Washington Banking and Heritage. Lane Powell reviewed with the Washington Banking board the fiduciary duties of Washington Banking directors applicable to their consideration of the proposed strategic business combination. Washington Banking’s board directed Mr. Wagner and Sandler to inform Mr. Vance and Davidson that Washington Banking would proceed with due diligence and a reasonable period of exclusivity to complete due diligence and prepare a merger agreement if the cash consideration to be received by Washington Banking shareholders was increased. The Washington Banking board approved the 0.89000 exchange ratio and directed Mr. Wagner and Sandler to negotiate for additional cash consideration in the range of $2.75 to $3.00 per share.

On September 14, 2013, Heritage presented to Washington Banking a revised proposal with an exchange ratio of 0.89000 per share and cash consideration of $2.50 per share and an exclusivity period until the end of October 2013.

On September 14 and 15, 2013, Davidson and Sandler had a series of discussions regarding the terms of the proposed strategic business combination, primarily the merger consideration.

On September 15, 2013, after further discussion between Heritage and Washington Banking and their respective financial advisors, Heritage and Washington Banking agreed to proceed with negotiations of a definitive merger agreement with cash consideration of $2.75 per share and an exchange ratio of 0.89000, subject to completion of satisfactory due diligence and a period of mutual exclusivity through October 24, 2013.

On September 16, 2013, Heritage’s board of directors held a special meeting to discuss the status of the negotiations. At that board meeting, the board also approved the engagement letter with Davidson, which was then executed. On that same day, Heritage provided the exclusivity agreement to Washington Banking.

On September 16, 2013, Mr. Wagner informed the Washington Banking directors and senior management of the status of discussions.

On September 17, 2013, Heritage provided Washington Banking access to Heritage due diligence information. On that same day, Washington Banking entered into an engagement letter with Sandler.

On September 19, 2013, Mr. Vance and Jeff Deuel, Executive Vice President of Heritage, had a meeting with the Washington Banking management team in Burlington, Washington. Introductions of the parties in attendance were made and a discussion of the general operating processes of Heritage and Washington Banking followed. On that same day, the exclusivity agreement was signed by Washington Banking.

From September 21, 2013 through September 30, 2013, Heritage’s legal counsel prepared the merger agreement and the related transaction documents, with the assistance of Heritage’s management and Davidson.

 

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On September 23, 2013, the Heritage management team met in Seattle, Washington with the Washington Banking management team, Davidson and Sandler also attended the meeting. Introductions of the parties in attendance were made and a discussion followed regarding the general operating processes of the potential combined company.

On September 24, 2013 Washington Banking provided Heritage with access to Washington Banking due diligence information.

From September 25, 2013 through September 27, 2013 Heritage and an outside third party conducted credit due diligence of Washington Banking.

On September 26, 2013, at Washington Banking’s regularly scheduled board meeting, Mr. Wagner, Sandler and Lane Powell provided updates on the status of the proposed strategic business combination. Lane Powell presented an overview of the timeline for the potential business combination and the key approvals required.

On September 30, 2013, management of Heritage had a call with management of Washington Banking to discuss credit trends, and from September 30, 2013 through October 2, 2013, Washington Banking and an outside third party conducted credit due diligence of Heritage.

On October 1, 2013, Heritage’s legal counsel provided the initial draft of the merger agreement and related transaction documents to Washington Banking, Lane Powell and Sandler.

On October 2, 2013, the management teams from Heritage and Washington Banking, along with Davidson and Sandler, met in Seattle to discuss process, procedures, human resources and other general topics concerning the potential combined company. Lane Powell participated in due diligence discussions and reviewed documents. Mr. Vance met individually with members of Washington Banking’s senior management team. Later that day, the Washington Banking board traveled to Seattle to meet with Mr. Vance.

On October 8, 2013, Heritage received comments on the merger agreement and related transaction documents from Lane Powell.

On October 11, 2013, Heritage’s board of directors held a special meeting to discuss the comments on the merger agreement and related transaction documents received from Lane Powell with Heritage’s legal counsel. Following that discussion, Heritage’s legal counsel provided Lane Powell with a revised draft of the merger agreement.

On October 14, 2013, Messrs. Vance and Wagner met to discuss Mr. Wagner’s role in the potential combined company.

On October 15, 2013, the Washington Banking board of directors held a special meeting in order to receive an update on the status of the negotiation of the merger agreement and potential strategic business combination with Heritage. Sandler reviewed with the board the key business terms of the transaction as then currently proposed. The discussion included a review of possible strategic alternatives. Sandler and Lane Powell reviewed with the board additional information regarding the proposed transaction and certain of the key terms and open issues in the current draft of the merger agreement. Further, management reported on the status of Washington Banking’s due diligence of Heritage. In addition, Lane Powell reviewed with the board the legal standards and duties applicable to the board’s process, decisions and actions with respect to the proposed transaction. Following questions from and discussions among those in attendance, Washington Banking’s board authorized management to continue their negotiations with Heritage regarding the possible transaction.

On October 16, 2013, Messrs. Vance and Wagner further discussed by telephone personnel issues and responsibilities in the potential combined company.

 

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On October 17, 2013, Lane Powell provided comments on the merger agreement to Heritage’s legal counsel.

On October 18, 2013, Washington Banking’s board of directors held a special meeting to review the merger agreement and related open items. Lane Powell reviewed in detail the merger agreement and open items. Following a discussion, the board authorized management to continue discussions with Heritage management concerning the resolution of these open items.

Also on October 18, 2013, Heritage provided Washington Banking with a revised draft of the merger agreement and related documents.

On October 20, 2013, Heritage’s board of directors held a special meeting to discuss the open items with respect to the merger agreement. On that same date, Heritage management discussed with Washington Banking management the proposed bylaw amendments concerning the composition of the combined company’s board of directors, including the procedures for the appointment of replacement directors, the term of the directors of the combined company, the appointment of the chairman and vice-chairman of the combined company, and the amendment of the proposed bylaw amendment.

As a result of continuing discussions and negotiations, the parties agreed to recommend to their respective boards of directors a transaction in which Washington Banking would merge with and into Heritage in a stock and cash transaction, with Washington Banking shareholders receiving 0.89000 shares of Heritage common stock and $2.75 in cash in exchange for each share of Washington Banking common stock. The transaction would provide that Mr. Vance would serve as President and Chief Executive Officer of the combined company and Chief Executive Officer of Heritage Bank, Mr. Deuel would serve as Executive Vice President of the combined company and President and Chief Operating Officer of Heritage Bank, Mr. Hinson would serve as Executive Vice President and Chief Financial Officer of the combined company and Heritage Bank, Mr. David A. Spurling would serve as Senior Vice President and Chief Credit Officer of Heritage Bank; Mr. Bryan McDonald would serve as Executive Vice President and Chief Lending Officer of Heritage Bank, and Mr. Edward Eng would serve as Executive Vice President and Chief Administrative Officer of Heritage Bank. The boards of directors of the combined company and the combined banks would each consist of 15 directors, eight of which would be ongoing Heritage directors (including Mr. Vance and Mr. Brian S. Charneski, the current Vice Chairman of Heritage, who would serve as Vice-Chairman of the Board of Heritage and Heritage Bank) and seven of which would be former Washington Banking directors, including Mr. Anthony B. Pickering, the current Washington Banking Chairman of the Board, who would serve as Chairman of the Board of Heritage and Heritage Bank.

On October 21, 2013, Messrs. Wagner and Vance spoke by telephone with the FDIC Western Regional Director about the proposed transaction. Heritage legal counsel provided to Lane Powell the Heritage disclosure schedules. Mr. Wagner telephoned Mr. Vance to inform him that, although he was enthusiastic about the proposed transaction, he had determined that he did not want to serve on the board of the combined company. During their discussion, Mr. Wagner agreed to enter into a consulting agreement with the potential combined company, which would provide that Mr. Wagner assist in the maintenance and retention of important customer and employee relationships with Washington Banking and Heritage.

Also on October 21, 2013, Heritage’s legal counsel provided a revised draft of the merger agreement and plan of bank merger to Lane Powell.

On October 21 and 22, 2013, Mr. McDonald, President and Chief Executive Officer of Whidbey Island Bank, entered into an employment agreement with Heritage Bank to serve as Executive Vice President and Chief Lending Officer of Heritage Bank; and Mr. Eng, Chief Administrative Officer of Whidbey Island Bank entered into an employment agreement with Heritage Bank to serve as Executive Vice President and Chief Administrative Officer of Heritage Bank. Each agreement was entered into subject to Heritage and Washington Banking entering into the merger agreement, and each such agreement would be effective only if the merger is completed.

 

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On October 22, 2013, Davidson distributed to all parties drafts of a joint press release announcing the transaction and investor presentation. Heritage’s board of directors convened a special meeting to review the merger agreement, voting agreements, the proposed bylaw amendment and plan of merger. At the meeting, Davidson presented its financial analysis, oral fairness opinion and information on the public announcements for the proposed merger. Following these discussions, and review and discussion among the members of the Heritage board of directors, including consideration of the factors described under “—Heritage’s Reasons for the Merger; Recommendation of Heritage’s Board of Directors,” the Heritage board of directors determined that the merger agreement and the transactions contemplated thereby, including the merger, are advisable and in the best interests of Heritage and its shareholders, and the directors voted unanimously to approve the merger agreement and the transactions contemplated thereby and recommended that Heritage’s shareholders approve the merger agreement. On that same day, Lane Powell provided Heritage legal counsel and Heritage with drafts of the Washington Banking disclosure schedules to the merger agreement. Following the Heritage board meeting, Messrs. Vance and Wagner contacted the Federal Reserve Bank of San Francisco and the Washington State Department of Financial Institutions, Division of Banks to notify them of the announcement of a strategic business combination between Washington Banking and Heritage.

On October 23, 2013, Heritage provided its final disclosure schedules to Washington Banking. On that same day, the Washington Banking board of directors held a special meeting to consider the proposed merger in accordance with the terms of the draft merger agreement. At the meeting, the board of directors received an update from Washington Banking’s management on the status of negotiations with Heritage and received due diligence reports on aspects of Heritage’s operations and financial condition. Also at this meeting Sandler reviewed with Washington Banking’s board of directors its financial analysis of the proposed merger consideration and delivered to Washington Banking’s board of directors an oral opinion, which was confirmed by delivery of a written opinion dated October 23, 2013, to the effect that, as of such date and based on and subject to various factors, assumptions and limitations set forth in its opinion, the proposed merger consideration was fair, from a financial point of view, to the holders of Washington Banking common stock. A representative of Lane Powell again reviewed with the board the legal standards applicable to the board’s process, decisions and actions on the proposed merger. In addition, representatives of Lane Powell reviewed the most recent draft of the proposed merger agreement and related agreements. Washington Banking’s senior management and outside legal and financial advisors responded to questions from the directors throughout the meeting and there were discussions among the directors and management.

Following these discussions, and review and discussion among the members of Washington Banking’s board of directors, including consideration of the factors described under “—Washington Banking’s Reasons for the Merger; Recommendation of Washington Banking’s Board of Directors,” the Washington Banking board of directors determined that the merger agreement and the transactions contemplated thereby, including the merger, were advisable and in the best interests of Washington Banking and its shareholders, and the directors voted unanimously to approve the merger agreement and the transactions contemplated thereby and recommended that Washington Banking’s shareholders approve the merger agreement.

Following the completion of the October 23, 2013 Washington Banking board meeting, the parties and their respective legal and financial advisors completed final negotiations covering the remaining open items in the merger agreement. Following these final negotiations, Mr. Wagner executed a consulting agreement with Heritage to serve as a special advisor to Heritage following the merger. The consulting agreement for Mr. Wagner, and the employment agreements for Messrs. McDonald and Eng become effective as of the closing of the merger and the bank merger. The merger agreement and the related agreements were then finalized, executed and delivered, and the proposed transaction was announced in the afternoon of October 23, 2013, in a press release issued jointly by Heritage and Washington Banking.

Heritage’s Reasons for the Merger; Recommendation of Heritage’s Board of Directors

After careful consideration, at a meeting held on October 22, 2013, Heritage’s board of directors unanimously determined that the merger agreement, including the merger and the other transactions

 

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contemplated thereby, is in the best interests of Heritage and its shareholders. Accordingly, Heritage’s board of directors unanimously approved the merger agreement and recommends that Heritage’s shareholders vote “FOR” the Heritage merger proposal and “FOR” the Heritage adjournment proposal.

In reaching its decision to approve the merger agreement, the merger and the other transactions contemplated by the merger agreement and recommend that its shareholders vote “FOR” the Heritage merger proposal, the Heritage board of directors consulted with Heritage management, as well as its independent financial and legal advisors, and considered a number of factors, including the following material factors:

 

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its knowledge of Heritage’s business, operations, financial condition, earnings and prospects and of Washington Banking’s business, operations, financial condition, earnings and prospects, taking into account the results of Heritage’s due diligence review of Washington Banking, including Heritage’s assessments of Washington Banking’s credit policies, asset quality, adequacy of loan loss reserves, interest rate risk and litigation;

 

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its understanding of the current and prospective environment in which Heritage and Washington Banking operate, including national and local economic conditions, the interest rate environment, increasing operating costs resulting from regulatory initiatives and compliance mandates, the competitive environment for financial institutions generally, and the likely effect of these factors on Heritage both with and without the proposed transaction;

 

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the broader product offering for its customer base and the additional cross-selling opportunities in certain segments, including consumer lending, auto lending, mortgages and small business administration;

 

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the enhancement of the combined company’s competitive position expected to result from the merger, including the fact that the combined company is expected to have the 11th largest deposit market share in Washington and third in deposit market share among Washington-based institutions, with corporate headquarters in the state of Washington, in the combined footprint (based on data as of June 30, 2013 provided by SNL Financial);

 

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the locations of Washington Banking’s branch offices and the potential opportunity to double the branch footprint of the combined company along the I-5 corridor;

 

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the strength of Washington Banking’s management team;

 

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the anticipated pro forma impact of the merger on the combined company, including potential synergies, and the expected impact on financial metrics such as earnings and tangible equity per share, as well as on regulatory capital levels;

 

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the expanded possibilities, including organic growth and future acquisitions, expected to be available to the combined company, given its larger size, asset base and capital position;

 

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the likelihood of a successful integration of Washington Banking’s business, operations and workforce with those of Heritage and of successful operation of the combined company despite the challenges of such integration, and the belief that customer disruption in the transition phase would not be significant due to the complementary nature of the markets served by Heritage and Washington Banking;

 

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the financial and other terms of the merger agreement, including the fixed exchange ratio for the stock portion of the merger consideration and the fixed per share amount for the cash portion of the merger consideration, tax treatment and mutual deal protection and termination fee provisions, which the Heritage board reviewed with its outside financial and legal advisors;

 

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the written opinion of Davidson, Heritage’s financial advisor, dated as of October 23, 2013, delivered to the Heritage board of directors to the effect that, as of that date, and subject to and based on the various assumptions, considerations, qualifications and limitations set forth in the opinion, the merger consideration payable to holders of Washington Banking common stock was fair, from a financial point of view, to Heritage; and

 

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•

the interests of Washington Banking’s directors and executive officers in the merger, in addition to their interests generally as shareholders, as described under “—Interests of Washington Banking’s Directors and Executive Officers in the Merger.”

The Heritage board of directors also considered a number of potential risks and uncertainties associated with the merger in connection with its deliberation of the proposed transaction, including, without limitation, the following:

 

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the potential risk of diverting management attention and resources from the operation of Heritage’s business towards the completion of the merger;

 

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the restrictions on the conduct of Heritage’s business prior to the completion of the merger, which are customary for public company merger agreements involving financial institutions, but which, subject to specific exceptions, could delay or prevent Heritage from undertaking business opportunities that may arise or any other action it would otherwise take with respect to the operations of Heritage absent the pending merger;

 

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the potential risks associated with achieving anticipated cost synergies and savings and successfully integrating Washington Banking’s business, operations and workforce with those of Heritage;

 

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the fact that, because the stock portion of the merger consideration consists of a fixed exchange ratio of shares of Heritage common stock, there will be no reduction in the number of shares of Heritage common stock to be issued in connection with the merger even if the price of Heritage common stock increases prior to completion of the merger;

 

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the fact that, while Heritage expects that the merger will be consummated, there can be no assurance that all conditions to the parties’ obligations to complete the merger agreement will be satisfied, including the risk that necessary regulatory or shareholder approvals might not be obtained and, as a result, the merger may not be consummated;

 

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the risk of potential employee attrition and/or adverse effects on business and customer relationships as a result of the pending merger;

 

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the outcome of litigation in connection with the merger;

 

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the fact that: (i) the merger agreement includes a “force the vote” provision that would obligate Heritage to hold a shareholders’ meeting to consider the merger agreement even if the Heritage board of directors withdraws its favorable recommendation of the merger agreement after determining in good faith that it would be inconsistent with its fiduciary duties to continue to recommend the merger agreement; (ii) Heritage would be prohibited from affirmatively soliciting acquisition proposals after execution of the merger agreement; and (iii) Heritage would be obligated to pay to Washington Banking a termination fee of $7.9 million if the merger agreement is terminated under certain circumstances, all of which may discourage other parties potentially interested in a strategic transaction with Heritage from pursuing such a transaction; and

 

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the other risks described under the heading “Risk Factors.”

The foregoing discussion of the information and factors considered by the Heritage board of directors is not intended to be exhaustive, but includes the material factors considered by the Heritage board of directors. In reaching its decision to approve the merger agreement, the merger and the other transactions contemplated by the merger agreement, the Heritage board of directors did not quantify or assign any relative weights to the factors considered, and individual directors may have given different weights to different factors. The Heritage board of directors considered all these factors as a whole, including discussions with, and questioning of, Heritage’s management and Heritage’s independent financial and legal advisors, and overall considered the factors to be favorable to, and to support, its determination.

 

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Heritage’s board of directors unanimously approved the merger agreement and recommends that Heritage’s shareholders vote “FOR” the approval of the Heritage merger proposal and “FOR” the Heritage adjournment proposal.

This summary of the reasoning of Heritage’s board of directors and other information presented in this section is forward-looking in nature and, therefore, should be read in light of the factors discussed under the heading “Cautionary Statement Regarding Forward-Looking Statements.”

Washington Banking’s Reasons for the Merger; Recommendation of Washington Banking’s Board of Directors

After careful consideration, at a meeting held on October 23, 2013, Washington Banking’s board of directors unanimously determined that the merger agreement, including the merger and the other transactions contemplated thereby, is in the best interests of Washington Banking and its shareholders. Accordingly, Washington Banking’s board of directors unanimously approved the merger agreement and recommends that Washington Banking’s shareholders vote “FOR” the Washington Banking merger proposal, “FOR” the Washington Banking adjournment proposal and “FOR” the Washington Banking compensation proposal.

In reaching its decision to approve the merger agreement, the merger and the other transactions contemplated by the merger agreement and recommend that its shareholders vote “FOR” the Washington Banking merger proposal, the Washington Banking board of directors consulted with Washington Banking management, as well as its independent financial and legal advisors, and considered a number of factors, including the following material factors:

 

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its knowledge of Washington Banking’s business, operations, financial condition, asset quality, earnings, covered loan portfolio, capital and prospects both as an independent organization, as an acquirer executing its strategic plan and as a part of a combined company with Heritage, as well as under various other alternative scenarios;

 

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its understanding of Heritage’s business, operations, regulatory and financial condition, asset quality, earnings, capital and prospects taking into account presentations by senior management of the results of due diligence review and information from Sandler and Lane Powell;

 

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its belief that the merger will result in a premier, locally-operated commercial banking franchise with a diversified revenue stream, strong capital ratios, a well-balanced loan portfolio and an attractive funding base that has the potential to deliver a higher value to Washington Banking’s shareholders than the alternatives to the merger;

 

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the complementary nature of the cultures and product mix of Washington Banking and Heritage, including with respect to strategic focus, target markets and client service, which management believes should facilitate integration and implementation of the transaction;

 

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the expanded possibilities, including organic growth and future acquisitions, that would be available to the combined company, given its larger size, asset base, capital, market capitalization and trading liquidity and footprint;

 

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the anticipated pro forma impact of the merger on the combined company, including potential synergies, and the expected impact on financial metrics such as earnings and tangible equity per share, as well as on regulatory capital levels;

 

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the fact that the value of the merger consideration for holders of Washington Banking common stock at $16.89 per share, represents a premium of approximately 18.5% over the $14.25 closing price of Washington Banking common stock on NASDAQ on October 23, 2013 (the last trading day prior to the execution and announcement of the merger agreement), and the board’s review of similar transactions and belief that the transaction is likely to provide substantial future value to Washington Banking’s shareholders;

 

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the financial analyses of Sandler and the written opinion of Sandler, Washington Banking’s independent financial advisor, dated as of October 23, 2013, delivered to the Washington Banking board of directors to the effect that, as of that date, and subject to and based on the various assumptions, considerations, qualifications and limitations set forth in the opinion, the merger consideration was fair, from a financial point of view, to Washington Banking’s shareholders;

 

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the familiarity of Washington Banking’s management team with Heritage’s management team and the belief of Washington Banking’s management that the management and employees of Washington Banking and Heritage possess complementary skills and expertise;

 

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the anticipated continued participation of certain members of Washington Banking’s board of directors and management team in the combined company, which enhances the likelihood that the strategic benefits that Washington Banking expects to achieve as a result of the merger will be realized and that the benefits and talents that Washington Banking brings to the combined institution will be appropriately valued and effectively utilized—including the appointment of seven current Washington Banking directors to the board of directors of Heritage with Washington Banking’s current Chairman of the Board, Anthony B. Pickering, to serve as Chairman of the Board of Heritage and Heritage Bank, the appointment of Whidbey Island Bank’s President and Chief Executive Officer, Bryan McDonald, as Executive Vice President and Chief Lending Officer of Heritage Bank, the appointment of Whidbey Island Bank’s Executive Vice President and Chief Administrative Officer, Edward Eng, as Executive Vice President and Chief Administrative Officer of Heritage Bank, and the continuing leadership of Washington Banking’s President and Chief Executive Officer, John L. Wagner, as a special advisor to Heritage following the merger, and the expected participation of other Washington Banking officers in management positions of the combined company;

 

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the effects of the merger on other Washington Banking employees, including the prospects for continued employment and various benefits agreed to be provided to Washington Banking employees;

 

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the board’s understanding of the current and prospective environment in which Washington Banking and Heritage operate, including national and local economic conditions, the interest rate environment, increasing operating costs resulting from regulatory initiatives and compliance mandates, the competitive environment for financial institutions generally, and the likely effect of these factors on Washington Banking both with and without the proposed transaction;

 

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the limited availability of FDIC-assisted and traditional acquisition opportunities that met, or would meet going forward, the strategic goals of Washington Banking, including growth in the current environment;

 

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the effects of the run-off of the covered loan portfolio, including declining revenue and lower net interest margin, and the prospects, and impact on financial performance, of a prolonged low interest rate environment, which emphasized the importance of seeking merger and acquisition opportunities with community banks that share similar business models;

 

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the merger is consistent with Washington Banking’s strategic plan, including achieving strong earnings growth, providing the opportunity to replace the covered loan portfolio, improving customer attraction and retention and focusing on expense control;

 

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the complementary fit of Washington Banking and Heritage because of the nature of the markets served and the products offered by the two institutions;

 

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the enhancement of the combined company’s competitive position expected to result from the merger, including that the combined company is expected to have the 11th largest deposit market share in Washington and third in deposit market share among Washington-based institutions, with corporate headquarters in the state of Washington, in the combined footprint (based on data as of June 30, 2013 provided by SNL Financial);

 

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the ability of Heritage to complete the merger from a financial and regulatory perspective;

 

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the structure of the transaction as a strategic business combination in which, among other things, Washington Banking’s board and management would have substantial participation in the combined company;

 

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the equity interest in the combined company that Washington Banking’s existing shareholders will receive in the merger, which allows such shareholders to continue to participate in the future success of the combined company;

 

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the greater market capitalization and trading liquidity of Heritage common stock in the event that Washington Banking shareholders desired to sell the shares of Heritage common stock to be received by them following completion of the merger;

 

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the proximity of Mr. Wagner to retirement and the effect of his retirement on the management team and Washington Banking’s prospects;

 

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the board’s understanding that the merger will qualify as a “reorganization” under Section 368(a) of the Code, providing favorable tax consequences to Washington Banking’s shareholders in the merger on the stock portion of the merger consideration; and

 

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the board’s review with its independent legal advisor, Lane Powell, of the material terms of the merger agreement, including the board’s ability, under certain circumstances, to withhold, withdraw, qualify or modify its recommendation to Washington Banking’s shareholders and to consider an acquisition proposal in certain circumstances, subject to the potential payment by Washington Banking of a termination fee of $7.9 million to Heritage, which the board of directors concluded was reasonable in the context of termination fees in comparable transactions and in light of the overall terms of the merger agreement, as well as the reciprocal nature of the covenants, representations and warranties and termination provisions in the merger agreement.

The Washington Banking board of directors also considered a number of potential risks and uncertainties associated with the merger in connection with its deliberation of the proposed transaction, including, without limitation, the following:

 

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the potential risk of diverting management attention and resources from the operation of Washington Banking’s business and towards the completion of the merger;

 

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the restrictions on the conduct of Washington Banking’s business prior to the completion of the merger, which are customary for public company merger agreements involving financial institutions, but which, subject to specific exceptions, could delay or prevent Washington Banking from undertaking business opportunities that may arise or any other action it would otherwise take with respect to the operations of Washington Banking absent the pending merger;

 

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the potential risks associated with achieving anticipated cost synergies and savings and successfully integrating Washington Banking’s business, operations and workforce with those of Heritage;

 

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the merger-related costs;

 

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the fact that the interests of certain of Washington Banking’s directors and executive officers may be different from, or in addition to, the interests of Washington Banking’s other shareholders as described under the heading “—Interests of Washington Banking’s Directors and Executive Officers in the Merger”;

 

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the fact that, because the stock portion of the merger consideration consists of a fixed exchange ratio of shares of Heritage common stock, Washington Banking shareholders could be adversely affected by a decrease in the trading price of Heritage common stock during the pendency of the merger;

 

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the fact that, while Washington Banking expects that the merger will be consummated, there can be no assurance that all conditions to the parties’ obligations to complete the merger agreement will be satisfied, including the risk that necessary regulatory or shareholder approvals might not be obtained and, as a result, the merger may not be consummated;

 

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the risk of potential employee attrition and/or adverse effects on business and customer relationships as a result of the pending merger;

 

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the outcome of litigation in connection with the merger;

 

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the dividend history of Heritage and possible dividend amounts following the merger;

 

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the fact that: (i) the merger agreement includes a “force the vote” provision that would obligate Washington Banking to hold a shareholders’ meeting to consider the merger agreement even if the Washington Banking board of directors withdraws its favorable recommendation of the merger agreement after determining in good faith that it would be inconsistent with its fiduciary interests to recommend the merger agreement; (ii) Washington Banking would be prohibited from affirmatively soliciting acquisition proposals after execution of the merger agreement; and (iii) Washington Banking would be obligated to pay to Heritage a termination fee of $7.9 million if the merger agreement is terminated under certain circumstances, all of which may discourage other parties potentially interested in a strategic transaction with Washington Banking from pursuing such a transaction; and

 

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the other risks described under the heading “Risk Factors.”

The foregoing discussion of the information and factors considered by the Washington Banking board of directors is not intended to be exhaustive, but includes the material factors considered by the Washington Banking board of directors. In reaching its decision to approve the merger agreement, the merger and the other transactions contemplated by the merger agreement, the Washington Banking board of directors did not quantify or assign any relative weights to the factors considered, and individual directors may have given different weights to different factors. The Washington Banking board of directors considered all these factors as a whole, including discussions with, and questioning of Washington Banking’s management and Washington Banking’s independent financial and legal advisors, and overall considered the factors to be favorable to, and to support, its determination.

Washington Banking’s board of directors unanimously approved the merger agreement and recommends that Washington Banking’s shareholders vote “FOR” the approval of the Washington Banking merger proposal, “FOR” the Washington Banking adjournment proposal and “FOR” the Washington Banking compensation proposal. Washington Banking shareholders should be aware that Washington Banking’s directors and executive officers have interests in the merger that are different from, or in addition to, those of other Washington Banking shareholders. The board of directors was aware of and considered these interests, among other matters, in evaluating and negotiating the merger agreement, and in recommending that the merger agreement be approved by the shareholders of Washington Banking. See “—Interests of Washington Banking’s Directors and Executive Officers in the Merger.”

This summary of the reasoning of Washington Banking’s board of directors and other information presented in this section is forward-looking in nature and, therefore, should be read in light of the factors discussed under the heading “Cautionary Statement Regarding Forward-Looking Statements.”

Opinion of D.A. Davidson & Co.—Financial Advisor to Heritage

On September 16, 2013, Heritage entered into an engagement agreement with Davidson to render financial advisory and investment banking services to Heritage. As part of its engagement, Davidson agreed to assist Heritage in analyzing, structuring, negotiating and, if appropriate, effecting a transaction between Heritage and Washington Banking. Davidson also agreed to provide Heritage’s board of directors with an opinion as to the fairness, from a financial point of view, to Heritage of the merger consideration in the proposed strategic business combination. Heritage engaged Davidson because Davidson is a nationally recognized investment banking firm with substantial experience in transactions similar to the merger and is familiar with Heritage and its business. As part of its investment banking business, Davidson is continually engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions.

 

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On October 22, 2013, the Heritage board of directors held a meeting to evaluate the proposed strategic business combination. At this meeting, Davidson reviewed the financial aspects of the proposed strategic business combination and rendered an opinion to the Heritage board that, as of such date and based upon and subject to factors and assumptions set forth therein, the merger consideration was fair, from a financial point of view, to Heritage.

The full text of Davidson’s written opinion, dated October 22, 2013, which sets forth the assumptions made, procedures followed, matters considered and limitations on the review undertaken in connection with the opinion, is attached as Appendix B to this joint proxy statement/prospectus and is incorporated herein by reference. The description of the opinion set forth herein is qualified in its entirety by reference to the full text of such opinion. Heritage’s shareholders are urged to read the opinion in its entirety.

Davidson’s opinion speaks only as of the date of the opinion and Davidson undertakes no obligation to revise or update its opinion. The opinion does not address, and Davidson expresses no view or opinion with respect to, (i) the underlying business decision of Heritage to engage in or proceed with the merger, (ii) the relative merits or effect of the merger as compared to any strategic alternatives or business strategies or combinations that may be or may have been available to or contemplated by Heritage or Heritage’s board of directors, or (iii) any legal, regulatory, accounting, tax or similar matters relating to Heritage, its shareholders or relating to or arising out of the merger. The opinion expresses no view or opinion as to any terms or other aspects of the merger. Heritage and Washington Banking determined the merger consideration through the negotiation process. The opinion does not constitute a recommendation to any Heritage shareholder as to how such shareholder should vote with respect to the merger or with respect to any other matter. The opinion does not express any view as to the fairness of the amount or nature of the compensation to any of Heritage’s or Washington Banking’s officers, directors or employees, or any class of such persons, relative to the merger consideration. The opinion has been reviewed and approved by Davidson’s Fairness Opinion Committee in conformity with its policies and procedures established under the requirements of Rule 5150 of the Financial Industry Regulatory Authority.

Davidson has reviewed the registration statement on Form S-4 of which this joint proxy statement/prospectus is a part and consented to the inclusion of its opinion to the Heritage board of directors as Appendix B to this joint proxy statement/prospectus and to the references to Davidson and its opinion contained herein. A copy of the consent of Davidson is attached as Exhibit 99.3 to the registration statement on Form S-4.

In connection with rendering its opinion, Davidson reviewed, analyzed and relied upon material bearing upon the merger and the financial and operating condition of Heritage and Washington Banking, including among other things, the following:

 

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a draft of the merger agreement dated October 22, 2013;

 

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certain financial statements and other historical financial and business information about Heritage and Washington Banking made available to Davidson from published sources and/or from the internal records of Heritage and Washington Banking that Davidson deemed relevant;

 

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certain publicly available analyst earnings estimates for Heritage for the years ending December 31, 2013 and December 31, 2014 and estimated long-term growth rate for the years thereafter, in each case as discussed with, and confirmed by, senior management of Heritage;

 

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certain publicly available analyst earnings estimates for Washington Banking for the years ending December 31, 2013 and December 31, 2014 and estimated long-term growth rate for the years thereafter, in each case as discussed with, and confirmed by, senior management of Heritage;

 

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the current market environment generally and the banking environment in particular;

 

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the financial terms of certain other transactions in the financial institutions industry, to the extent publicly available;

 

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the market and trading characteristics of public companies, and bank holding companies and/or savings and loan holding companies in particular;

 

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the relative contributions of Heritage and Washington Banking to the combined company;

 

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the pro forma financial impact of the merger, taking into consideration the amounts and timing of the transaction costs and cost savings;

 

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the net present value of Washington Banking with consideration of projected financial results;

 

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the net present value of Heritage with consideration of projected financial results;

 

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the net present value of Heritage, on a pro forma basis with the pro forma financial impact of the merger, with consideration of projected financial results; and

 

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such other financial studies, analyses and investigations and financial, economic and market criteria and other information as Davidson considered relevant including discussions with management and other representatives and advisors of Heritage and Washington Banking concerning the business, financial condition, results of operations and prospects of Heritage and Washington Banking.

In arriving at its opinion, Davidson has assumed and relied upon the accuracy and completeness of all information supplied or otherwise made available to Davidson, discussed with or reviewed by or for Davidson, or publicly available, and Davidson has not assumed responsibility for independently verifying such information or undertaken an independent evaluation or appraisal of any of the assets or liabilities (contingent or otherwise) of Heritage or Washington Banking, nor did Davidson make an independent appraisal or analysis on Heritage or Washington Banking with respect to the merger. In addition, Davidson has not assumed any obligation to conduct, nor has Davidson conducted any physical inspection of the properties or facilities of Heritage or Washington Banking. Davidson has further relied on the assurances of management of Heritage and Washington Banking that they are not aware of any facts or circumstances that would make any of such information inaccurate or misleading. Davidson did not make an independent evaluation or appraisal of the specific assets or liabilities including the amount of any fair value adjustments per FASB Accounting Standards Codification No. 805, Business Combinations. Davidson did not make an independent evaluation of the adequacy of the allowance for loan losses of Heritage or Washington Banking nor has Davidson reviewed any individual credit files relating to Heritage or Washington Banking. Davidson has assumed that the respective allowances for loan losses for both Heritage and Washington Banking are adequate to cover such losses and will be adequate on a pro forma basis for the combined entity. Davidson has assumed that there has been no material adverse change in Heritage’s or Washington Banking’s assets, financial condition, results of operations, business or prospects since the date of the most recent financial statements provided. Davidson has assumed in all respects material to its analysis that Heritage and Washington Banking will remain as going concerns for all periods relevant to its analysis. Davidson has also assumed in all respects material to its analysis that all of the representations and warranties contained in the merger agreement and all related agreements are true and correct, that each party to such agreements will perform all of the covenants required to be performed by such party under such agreements and that the conditions precedent in the merger agreement are not waived. Davidson has assumed that in the course of obtaining necessary regulatory or other consents or approvals (contractual or otherwise) for the merger, no restrictions, including any divestiture requirements or amendment or modifications, will be imposed that will have a material adverse effect on the contemplated benefits of the merger. Davidson’s opinion is necessarily based upon information available to Davidson and economic, market, financial and other conditions as they exist and can be evaluated on the date the fairness opinion letter was delivered to Heritage’s board of directors.

Set forth below is a summary of the material financial analyses performed by Davidson in connection with rendering its opinion. The summary of the analyses of Davidson set forth below is not a complete description of the analysis underlying its opinion, and the order in which these analyses are described below is not indicative of any relative weight or importance given to those analyses by Davidson. The following summaries of financial analyses include information presented in tabular format. You should read these tables together with the full text of the summary financial analyses, as the tables alone are not a complete description of the analyses.

 

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Unless otherwise indicated, the following quantitative information, to the extent it is based on market data, is based on market data as of October 18, 2013 and is not necessarily indicative of market conditions after such date.

Summary of Proposal

Davidson reviewed the financial terms of the proposed transaction. As described in the merger agreement, each share of the common stock, no par value per share, of Washington Banking issued and outstanding immediately prior to the effective time, except for cancelled shares and dissenting shares, shall be converted into the right to receive a fraction of a share of Heritage’s common stock equal to 0.89000 and $2.75 in cash. The terms and conditions of the merger are more fully described in the merger agreement.

Based upon financial information as of or for the twelve month period ended September 30, 2013, Davidson calculated the following transaction ratios:

 

Transaction Ratios
Transaction Price / Last Twelve Months Earnings Per Share			15.8	x
Transaction Price / Book Value Per Share			144.3	%
Transaction Price / Tangible Book Value Per Share			149.0	%
Transaction Price / Book Value (Aggregate)			145.8	%
Transaction Price / Tangible Book Value (Aggregate)			150.5	%
Tangible Book Premium / Core Deposits(1)			7.1	%
Transaction Price / Washington Banking’s Closing Price as of 10/18/2013(2)			17.0	%
Transaction Price / Washington Banking’s 20-Day Average Price as of 10/18/2013(3)			19.4	%

 

(1)	Core deposits exclude time deposits with account balances greater than $100,000. Tangible book premium / core deposits calculated by dividing the excess or deficit of the aggregate transaction value over tangible book value by core deposits

(2)	Based on Washington Banking’s Closing Price price as of 10/18/2013 of $14.44

(3)	Based on Washington Banking’s 20-Day Average Price price as of 10/18/2013 of $14.14

Stock Trading History of Heritage and Washington Banking

Davidson reviewed the history of the reported trading prices and volume of Heritage and Washington Banking common stock and the relationship between the movements in the prices of Heritage and Washington Banking common stock to movements in certain stock indices, including the Standard & Poor’s 500 Index and the SNL Bank Index.

 

One Year Stock Performance
		Beginning Index Value on October 18, 2012				Ending Index Value on October 18, 2013
Washington Banking			100.0	%			106.0	%
Heritage			100.0	%			113.6	%
Standard & Poor’s 500 Index			100.0	%			119.7	%
SNL Bank Index			100.0	%			129.7	%

 

Three Year Stock Performance
		Beginning Index Value on October 18, 2010				Ending Index Value on October 18, 2013
Washington Banking			100.0	%			103.0	%
Heritage			100.0	%			106.0	%
Standard & Poor’s 500 Index			100.0	%			147.3	%
SNL Bank Index			100.0	%			144.5	%

 

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Comparable Companies Analysis for Heritage and Washington Banking

Davidson used publicly available information to compare selected financial and market trading information for Heritage, Washington Banking and two separate groups of financial institutions selected by Davidson. The two groups of comparable companies consisted of (1) “Pacific Northwest Companies” which included eight bank holding companies and/or savings and loan holding companies headquartered in Washington or Oregon with common stock listed on NASDAQ and market capitalization greater than $100.0 million; and (2) “Western U.S. Companies” which consisted of 17 bank holding companies and/or savings and loan holding companies headquartered in Arizona, California, Colorado, Montana, Oregon, and Washington with total assets between $1.0 billion and $10.0 billion as set forth below:

 

Pacific Northwest Companies
Banner Corporation Cascade Bancorp Columbia Banking System, Inc. First Financial Northwest, Inc.		HomeStreet, Inc. Pacific Continental Corporation Umpqua Holdings Corporation Washington Federal, Inc.

 

Western U.S. Companies
Banc of California, Inc. Bank of Marin Bancorp Banner Corporation Cascade Bancorp CoBiz Financial Inc. Columbia Banking System, Inc. CU Bancorp CVB Financial Corp. First Interstate BancSystem, Inc.		Glacier Bancorp, Inc. Guaranty Bancorp Heritage Commerce Corp Heritage Oaks Bancorp Pacific Continental Corporation TriCo Bancshares Westamerica Bancorporation Western Alliance Bancorporation

The analysis compared publicly available financial and market trading information for Heritage, Washington Banking and the median data for the comparable companies as of and for the most recently reported three month period available. The table below compares the data for Heritage, Washington Banking and the median data for the comparable companies, with pricing data as of October 18, 2013. The 2013 and 2014 Earnings Per Share estimates used in the table below were based on FactSet Research Systems, Inc. mean estimates for Heritage, Washington Banking and the comparable companies.

 

Financial Condition and Performance
		Heritage				Washington Banking				Comparable Group Median Result
										Pacific NW				Western U.S.
Total Assets (in millions)		$	1,674.4			$	1,648.2			$	3,506.2			$	2,587.9
Non-Performing Assets / Total Assets			0.81	%			0.89	%			2.67	%			1.89	%
Texas Ratio(1)			16.4	%			21.4	%			18.2	%			14.3	%
Tangible Common Equity Ratio			11.29	%			10.72	%			11.56	%			9.75	%
Net Interest Margin			4.67	%			4.59	%			3.98	%			4.01	%
Cost of Deposits			0.27	%			0.34	%			0.29	%			0.21	%
Efficiency Ratio			70.9	%			63.8	%			66.5	%			64.3	%
Return on Average Equity			6.05	%			10.03	%			8.93	%			8.98	%
Return on Average Assets			0.80	%			1.10	%			1.21	%			1.03	%

 

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Market Performance Multiples
		Heritage				Washington Banking				Comparable Group Median Result
										Pacific NW				Western U.S.
Market Capitalization (in millions)		$	266.0			$	224.3			$	515.8			$	382.3
Price / Tangible Book Value Per Share			138.9	%			127.4	%			147.5	%			171.5	%
Price / LTM Earnings Per Share			20.9	x			13.2	x			15.8	x			16.2	x
Price / 2013 Est. Earnings Per Share(2)			20.2	x			14.4	x			16.5	x			16.6	x
Price / 2014 Est. Earnings Per Share(2)			15.7	x			14.0	x			15.1	x			15.6	x

 

(1)	Texas ratio is calculated as the sum of non-performing assets and loans 90 days or more past due divided by the sum of tangible common equity and loan loss reserves

(2)	Earnings per share estimates based on FactSet Research Systems, Inc. mean estimates

Precedent Transactions Analysis

Davidson reviewed two sets of comparable merger and acquisition transactions. The sets of mergers and acquisitions included: (1) “Nationwide Transactions” which included 14 transactions announced from January 1, 2011 through October 18, 2013 involving bank holding companies and/or savings and loan holding companies headquartered nationwide where the merger transaction value was between $100.0 million and $500.0 million, the merger transaction value included stock consideration, and the target company’s total assets were between $500.0 million and $4.0 billion, non-performing assets to total assets ratio was less than 3.00%, and return on average assets over the preceding twelve months was greater than 0.70%; and (2) “Western U.S. Transactions” which included five transactions announced from January 1, 2011 through October 18, 2013 involving bank holding companies and/or savings and loan holding companies headquartered in California, Idaho, Oregon and Washington where the target company’s total assets were between $1.0 billion and $10.0 billion, non-performing assets to total assets ratio was less than 4.00% and return on average assets over the preceding twelve months was greater than 0.00%, as set forth below:

Nationwide Transactions

 

Announcement Date		Acquirer		Target
9/18/2013* 9/10/2013* 8/15/2013*		East West Bancorp, Inc. Old National Bancorp Mercantile Bank Corporation		MetroCorp Bancshares, Inc. Tower Financial Corporation Firstbank Corporation
8/13/2013* 7/01/2013* 7/01/2013* 6/28/2013* 6/10/2013* 4/04/2013* 2/20/2013 12/10/2012 10/08/2012 4/28/2011 3/11/2011		Cullen/Frost Bankers, Inc. Prosperity Bancshares, Inc. First Federal Bancshares of Arkansas, Inc. Peoples Financial Services Corp. Union First Market Bankshares Corporation Provident New York Bancorp SCBT Financial Corporation Prosperity Bancshares, Inc. NBT Bancorp Inc. Valley National Bancorp IBERIABANK Corporation		WNB Bancshares, Inc. FVNB Corp. First National Security Company Penseco Financial Services Corporation StellarOne Corporation Sterling Bancorp First Financial Holdings, Inc. Coppermark Bancshares, Inc. Alliance Financial Corporation State Bancorp, Inc. Cameron Bancshares, Inc.

*Indicates the transaction was pending as of October 18, 2013

 

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Western U.S. Transactions

 

Announcement Date		Acquirer		Target
9/24/2013* 9/11/2013* 11/06/2012 9/26/2012 3/12/2012		Banner Corporation Umpqua Holdings Corporation PacWest Bancorp Columbia Banking System, Inc. Mitsubishi UFJ Financial Group, Inc.		Home Federal Bancorp, Inc. Sterling Financial Corporation First California Financial Group, Inc. West Coast Bancorp Pacific Capital Bancorp

*Indicates the transaction was pending as of October 18, 2013

Davidson reviewed the following multiples for both sets of comparable mergers and acquisitions: transaction price to last twelve months earnings per share, transaction price to tangible book value per share, and tangible book premium to core deposits. As illustrated in the following table, Davidson compared the proposed merger multiples to the median multiples of the comparable transaction groups and other operating financial data where relevant. The table below sets forth the median data for the comparable transaction groups as of the last twelve months ended prior to the transaction announcement and Washington Banking data for the last twelve months ended September 30, 2013.

 

Financial Condition and Performance
		Washington Banking				Comparable Group Median Results
						Nationwide Transactions				Western U.S. Transactions
Total Assets (in millions)		$	1,648.2			$	1,439.9			$	2,408.4
Return on Average Assets (Last Twelve Months)			1.00	%			0.89	%			1.08	%
Return on Average Equity (Last Twelve Months)			9.14	%			8.71	%			8.23	%
Tangible Common Equity Ratio			10.72	%			8.44	%			11.71	%
Efficiency Ratio (Last Twelve Months)			63.8	%			64.8	%			70.7	%
Non-Performing Assets / Total Assets			0.89	%			1.44	%			1.70	%
Loan Loss Reserves / Non-Performing Loans			39.3	%			120.1	%			77.4	%

 

Transaction Multiples
		Washington Banking				Comparable Group Median Results
						Nationwide Transactions				Western U.S. Transactions
Transaction Price / Last Twelve Months Earnings Per Share			15.8	x			15.3	x			19.5	x
Transaction Price / Tangible Book Value Per Share			149.0	%			167.6	%			167.1	%
Tangible Book Premium / Core Deposits(1)			7.1	%			8.5	%			11.0	%

 

(1)	Core deposits exclude time deposits with account balances greater than $100,000. Tangible book premium / core deposits calculated by dividing the excess or deficit of the aggregate transaction value over tangible book value by core deposits.

Net Present Value Analysis—Washington Banking

Davidson performed an analysis that estimated the net present value per share of Washington Banking common stock under various circumstances. The analysis assumed Washington Banking performed in accordance with publicly available analyst earnings estimates for the years ending December 31, 2013 and December 31, 2014 and an estimated long-term growth rate for the years thereafter and the dividend payout ratio, as discussed with and confirmed by Heritage senior management. To approximate the terminal value of Washington Banking common stock at December 31, 2018, Davidson applied price to forward earnings multiples of 12.0x to 22.0x and multiples of tangible book value ranging from 120.0% to 190.0%. The terminal values

 

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were then discounted to present values using different discount rates ranging from 9.00% to 15.00% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Washington Banking’s common stock. In evaluating the discount rate, Davidson used the industry standard methods of adding the current risk-free rate, which is based on the 10-year Treasury yield, plus the published Ibbotson Equity Risk Premium, plus the published Ibbotson Size Premium, plus the published Ibbotson Industry Premium.

At the October 22, 2013 Heritage board of directors meeting, Davidson noted that the net present value analysis is a widely used valuation methodology, but the results of such methodology are highly dependent upon the numerous assumptions that must be made, and the results thereof are not necessarily indicative of actual values or future results.

As illustrated in the following tables, the analysis indicates an imputed range of values per share of Washington Banking common stock of $7.83 to $18.97 when applying the price to earnings multiples to the financial forecasts and $8.25 to $17.28 when applying the multiples of tangible book value to the financial forecasts.

Earnings Per Share Multiples

 

Discount Rate		12.0x				14.0x				16.0x				18.0x				20.0x				22.0x
9.00%		$	10.38			$	12.10			$	13.81			$	15.53			$	17.25			$	18.97
10.00%		$	9.89			$	11.53			$	13.17			$	14.80			$	16.44			$	18.07
11.00%		$	9.43			$	10.99			$	12.55			$	14.11			$	15.67			$	17.23
12.00%		$	9.00			$	10.49			$	11.97			$	13.46			$	14.95			$	16.43
13.00%		$	8.59			$	10.01			$	11.43			$	12.84			$	14.26			$	15.68
14.00%		$	8.20			$	9.55			$	10.91			$	12.26			$	13.62			$	14.97
15.00%		$	7.83			$	9.12			$	10.42			$	11.71			$	13.00			$	14.30

Tangible Book Value Multiples

 

Discount Rate		120.0%				130.0%				140.0%				150.0%				160.0%				170.0%				180.0%				190.0%
9.00%		$	10.94			$	11.85			$	12.75			$	13.66			$	14.56			$	15.47			$	16.38			$	17.28
10.00%		$	10.43			$	11.29			$	12.15			$	13.02			$	13.88			$	14.74			$	15.61			$	16.47
11.00%		$	9.94			$	10.77			$	11.59			$	12.41			$	13.23			$	14.06			$	14.88			$	15.70
12.00%		$	9.49			$	10.27			$	11.05			$	11.84			$	12.62			$	13.41			$	14.19			$	14.97
13.00%		$	9.05			$	9.80			$	10.55			$	11.30			$	12.04			$	12.79			$	13.54			$	14.29
14.00%		$	8.64			$	9.36			$	10.07			$	10.78			$	11.50			$	12.21			$	12.93			$	13.64
15.00%		$	8.25			$	8.94			$	9.62			$	10.30			$	10.98			$	11.66			$	12.35			$	13.03

Net Present Value Analysis—Heritage

Davidson performed an analysis that estimated the net present value per share of Heritage common stock under various circumstances. The analysis assumed Heritage performed in accordance with publicly available analyst earnings estimates for the years ending December 31, 2013 and December 31, 2014 and an estimated long-term growth rate for the years thereafter and the dividend payout ratio, as discussed with and confirmed by Heritage senior management. To approximate the terminal value of Heritage common stock at December 31, 2018, Davidson applied price to forward earnings multiples of 12.0x to 22.0x and multiples of tangible book value ranging from 120.0% to 190.0%. The terminal values were then discounted to present values using different discount rates ranging from 9.00% to 15.00% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Heritage’s common stock. In evaluating the discount rate, Davidson used the industry standard methods of adding the current risk-free rate, which is based on the 10-year Treasury yield, plus the published Ibbotson Equity Risk Premium, plus the published Ibbotson Size Premium, plus the published Ibbotson Industry Premium.

 

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At the October 22, 2013 Heritage board of directors meeting, Davidson noted that the net present value analysis is a widely used valuation methodology, but the results of such methodology are highly dependent upon the numerous assumptions that must be made, and the results thereof are not necessarily indicative of actual values or future results.

As illustrated in the following tables, the analysis indicates an imputed range of values per share of Heritage common stock of $7.72 to $18.76 when applying the price to earnings multiples to the financial forecasts and $8.74 to $18.18 when applying the multiples of tangible book value to the financial forecasts.

Earnings Per Share Multiples

 

Discount Rate		12.0x				14.0x				16.0x				18.0x				20.0x				22.0x
9.00%		$	10.25			$	11.96			$	13.67			$	15.38			$	17.07			$	18.76
10.00%		$	9.77			$	11.39			$	13.02			$	14.65			$	16.27			$	17.88
11.00%		$	9.31			$	10.86			$	12.41			$	13.96			$	15.52			$	17.05
12.00%		$	8.88			$	10.36			$	11.84			$	13.32			$	14.80			$	16.27
13.00%		$	8.47			$	9.88			$	11.29			$	12.70			$	14.11			$	15.53
14.00%		$	8.08			$	9.43			$	10.78			$	12.12			$	13.47			$	14.82
15.00%		$	7.72			$	9.00			$	10.29			$	11.58			$	12.86			$	14.15

Tangible Book Value Multiples

 

Discount Rate		120.0%				130.0%				140.0%				150.0%				160.0%				170.0%				180.0%				190.0%
9.00%		$	11.55			$	12.50			$	13.45			$	14.39			$	15.34			$	16.29			$	17.23			$	18.18
10.00%		$	11.02			$	11.92			$	12.82			$	13.72			$	14.62			$	15.53			$	16.43			$	17.33
11.00%		$	10.51			$	11.37			$	12.23			$	13.09			$	13.95			$	14.81			$	15.67			$	16.53
12.00%		$	10.03			$	10.85			$	11.67			$	12.49			$	13.31			$	14.13			$	14.95			$	15.77
13.00%		$	9.58			$	10.36			$	11.14			$	11.92			$	12.71			$	13.49			$	14.27			$	15.05
14.00%		$	9.15			$	9.90			$	10.64			$	11.39			$	12.13			$	12.88			$	13.63			$	14.37
15.00%		$	8.74			$	9.46			$	10.17			$	10.88			$	11.59			$	12.31			$	13.02			$	13.73

Net Present Value Analysis—Pro Forma Heritage

Davidson performed an analysis that estimated the net present value per share of Heritage common stock on a pro forma basis, including the pro forma impact with the merger transaction, under various circumstances. In performing this analysis, Davidson assumed Heritage and Washington Banking performed in accordance with publicly available analyst earnings estimates for the years ending December 31, 2013 and December 31, 2014 and an estimated long-term growth rate for the years thereafter and pro forma financial impact of cost savings estimates, purchase accounting adjustments, transaction expenses and the dividend payout ratio, as discussed with and confirmed by Heritage senior management. To approximate the terminal value of Heritage common stock at December 31, 2018, Davidson applied price to forward earnings multiples of 12.0x to 22.0x and multiples of tangible book value ranging from 120.0% to 190.0%. The terminal values were then discounted to present values using different discount rates ranging from 9.00% to 15.00% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Heritage’s common stock. In evaluating the discount rate, Davidson used the industry standard methods of adding the current risk-free rate, which is based on the 10-year Treasury yield, plus the published Ibbotson Equity Risk Premium, plus the published Ibbotson Size Premium, plus the published Ibbotson Industry Premium.

At the October 22, 2013 Heritage board of directors meeting, Davidson noted that the net present value analysis is a widely used valuation methodology, but the results of such methodology are highly dependent upon the numerous assumptions that must be made, and the results thereof are not necessarily indicative of actual values or future results.

 

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As illustrated in the following tables, the analysis indicates an imputed range of values per share of Heritage common stock of $9.51 to $23.01 when applying the price to earnings multiples to the financial forecasts and $8.45 to $17.67 when applying the multiples of tangible book value to the financial forecasts.

Earnings Per Share Multiples

 

Discount Rate		12.0x				14.0x				16.0x				18.0x				20.0x				22.0x
9.00%		$	12.60			$	14.68			$	16.77			$	18.85			$	20.93			$	23.01
10.00%		$	12.01			$	13.99			$	15.98			$	17.96			$	19.95			$	21.93
11.00%		$	11.45			$	13.34			$	15.23			$	17.13			$	19.02			$	20.91
12.00%		$	10.93			$	12.73			$	14.53			$	16.34			$	18.14			$	19.94
13.00%		$	10.43			$	12.15			$	13.87			$	15.59			$	17.31			$	19.03
14.00%		$	9.96			$	11.60			$	13.24			$	14.88			$	16.52			$	18.17
15.00%		$	9.51			$	11.08			$	12.65			$	14.21			$	15.78			$	17.35

Tangible Book Value Multiples

 

Discount Rate		120.0%				130.0%				140.0%				150.0%				160.0%				170.0%				180.0%				190.0%
9.00%		$	11.20			$	12.12			$	13.05			$	13.97			$	14.89			$	15.82			$	16.74			$	17.67
10.00%		$	10.67			$	11.55			$	12.43			$	13.31			$	14.20			$	15.08			$	15.96			$	16.84
11.00%		$	10.18			$	11.02			$	11.86			$	12.70			$	13.54			$	14.37			$	15.21			$	16.05
12.00%		$	9.71			$	10.51			$	11.31			$	12.11			$	12.91			$	13.71			$	14.51			$	15.31
13.00%		$	9.27			$	10.03			$	10.80			$	11.56			$	12.32			$	13.09			$	13.85			$	14.61
14.00%		$	8.85			$	9.58			$	10.31			$	11.04			$	11.76			$	12.49			$	13.22			$	13.95
15.00%		$	8.45			$	9.15			$	9.85			$	10.54			$	11.24			$	11.93			$	12.63			$	13.32

Financial Impact Analysis

Davidson performed pro forma merger analyses that combined projected income statement and balance sheet information of Heritage and Washington Banking. Assumptions regarding the accounting treatment, purchase accounting adjustments and cost savings were used to calculate the financial impact that the merger would have on certain projected financial results of Heritage. In the course of this analysis, Davidson used the FactSet Research Systems, Inc. mean consensus earnings estimates for Heritage and Washington Banking for years ending December 31, 2013 and December 31, 2014 and an estimated long-term growth rate for the years thereafter, as discussed with and confirmed by Heritage senior management. This analysis indicated that the merger is expected to be accretive to Heritage’s estimated earnings per share for the years ending December 31, 2014 and December 31, 2015, excluding the impact of transaction expenses. The analysis also indicated that the merger is expected to be dilutive to tangible book value per share for Heritage and that Heritage would maintain capital ratios in excess of those required for Heritage to be considered well-capitalized under existing regulations. For all of the above analyses, the actual results achieved by Heritage and Washington Banking following the merger will vary from the projected results, and the variations may be material.

Davidson prepared its analyses for purposes of providing its opinion to Heritage’s board of directors as to the fairness, from a financial point of view to Heritage, of the merger consideration and to assist Heritage’s board of directors in analyzing the proposed merger. The analyses do not purport to be appraisals or necessarily reflect the prices at which businesses or securities actually may be sold. Analyses based upon forecasts of future results are not necessarily indicative of actual future results, which may be significantly more or less favorable than those suggested by these analyses. Because these analyses are inherently subject to uncertainty, being based upon numerous factors or events beyond the control of the parties and their respective advisors, none of Heritage, Washington Banking or Davidson or any other person assumes responsibility if future results are materially different from those forecasted.

 

 

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Davidson’s opinion was one of many factors considered by Heritage’s board of directors in its evaluation of the merger and should not be viewed as determinative of the views of the board of directors of Heritage or management with respect to the merger or the merger consideration.

Davidson and its affiliates, as part of their investment banking business, are continually engaged in performing financial analyses with respect to businesses and their securities in connection with mergers and acquisitions, negotiated underwritings, competitive biddings, secondary distributions of listed and unlisted securities, private placements and other transactions. Davidson acted as financial advisor to Heritage in connection with, and participated in certain of the negotiations leading to the merger. Davidson is a full service securities firm engaged, either directly or through its affiliates, in securities trading, investment management, financial planning and benefits counseling, financing and brokerage activities for both companies and individuals. In the ordinary course of these activities, Davidson and its affiliates may provide such services to Heritage, Washington Banking and their respective affiliates, may actively trade the debt and equity securities (or related derivative securities) of Heritage and Washington Banking for their own account and for the accounts of their customers and may at any time hold long and short positions of such securities. Heritage selected Davidson as its financial advisor because it is a recognized investment banking firm that has substantial experience in transactions similar to the merger. Pursuant to a letter agreement dated September 16, 2013, Heritage engaged Davidson as its financial advisor in connection with the contemplated transaction. Pursuant to the terms of the engagement letter, Heritage agreed to pay Davidson a cash fee of $250,000 concurrently with the rendering of its opinion. Heritage will pay to Davidson at the time of closing of the merger a contingent cash fee equal to 0.65% of the aggregate consideration payable in the merger (which consideration shall be calculated in part based on the average price of Heritage’s stock for the ten days up to and including the closing date; and which fee would be approximately $1.8 million if the merger had closed on the date of this joint proxy statement/prospectus). Heritage has also agreed to reimburse Davidson for all reasonable out-of-pocket expenses, including fees of counsel, and to indemnify Davidson and certain related persons against specified liabilities, including liabilities under the federal securities laws, relating to or arising out of its engagement.

Davidson has, in the past, provided certain investment banking services to Heritage and its affiliates, has had a material relationship with Heritage and its affiliates and has received compensation and reimbursement of out-of-pocket expenses for such services. During the two years preceding the date of the opinion, Davidson received $150,000 in connection with Heritage’s acquisition of Northwest Commercial Bank in January 2013. Additionally, Davidson served as an underwriter for Heritage’s follow-on offering of equity securities in 2009 and 2010. Davidson may provide investment banking services to the combined company in the future and may receive future compensation. In the two years prior to the execution of the merger agreement, Davidson has not provided investment banking services to, or received fees for such services from, Washington Banking.

Opinion of Sandler O’Neill & Partners, L.P.—Financial Advisor to Washington Banking

By letter dated September 17, 2013, Washington Banking retained Sandler to act as financial advisor to Washington Banking’s board of directors in connection with a possible business combination with Heritage. Sandler is a nationally recognized investment banking firm whose principal business specialty is financial institutions. In the ordinary course of its investment banking business, Sandler is regularly engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions.

Sandler acted as financial advisor to Washington Banking’s board of directors in connection with the proposed transaction and participated in certain of the negotiations leading to the execution of the merger agreement. At the October 23, 2013 meeting at which Washington Banking’s board of directors considered and approved the merger agreement, Sandler delivered to the board its oral opinion, which was subsequently followed up in writing, that, as of such date, the merger consideration was fair to the holders of Washington Banking’s common stock from a financial point of view. The full text of Sandler’s opinion is attached as Appendix C to this proxy statement/prospectus. The opinion outlines the procedures followed, assumptions

 

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made, matters considered and qualifications and limitations on the review undertaken by Sandler in rendering its opinion. The description of the opinion set forth below is qualified in its entirety by reference to the full text of the opinion. Holders of Washington Banking common stock are urged to read the entire opinion carefully in connection with their consideration of the proposed merger.

Sandler’s opinion speaks only as of the date of the opinion. The opinion was directed to Washington Banking’s board and is directed only to the fairness of the merger consideration to the holders of Washington Banking’s common stock from a financial point of view. It does not address the underlying business decision of Washington Banking to engage in the merger or any other aspect of the merger and is not a recommendation to any holder of Washington Banking common stock as to how such holder of Washington Banking common stock should vote at the special meeting with respect to the merger or any other matter.

In connection with rendering its opinion on October 23, 2013, Sandler reviewed and considered, among other things:

 

•

the merger agreement;

 

•

certain financial statements and other historical financial information of Washington Banking that Sandler deemed relevant;

 

•

certain financial statements and other historical financial information of Heritage that Sandler deemed relevant;

 

•

publicly available earnings estimates for the years ending December 31, 2013 and December 31, 2014 and an estimated long term growth rate for the years thereafter in each instance as discussed with the senior management of Washington Banking;

 

•

publicly available earnings estimates for the years ending December 31, 2013 and December 31, 2014 and an estimated long term growth rate for the years thereafter in each instance as discussed with the senior management of Heritage;

 

•

the pro forma financial impact of the merger on Heritage based on assumptions relating to transaction expenses, purchase accounting adjustments, cost savings and other synergies as provided by Heritage;

 

•

comparison of certain financial and other information for Washington Banking and Heritage, including relevant stock trading information, with similar publicly available information for certain other commercial banks, the securities of which are publicly traded and the relative contributions of certain assets, liabilities, equity and earnings of Washington Banking and Heritage to the combined institution;

 

•

the terms and structures of other recent mergers and acquisition transactions in the commercial banking sector;

 

•

the current market environment generally and in the commercial banking sector in particular; and

 

•

such other information, financial studies, analyses and investigations and financial, economic and market criteria as Sandler considered relevant.

Sandler also discussed with certain members of the senior management of Washington Banking the business, financial condition, results of operations and prospects of Washington Banking and held similar discussions with the senior management of Heritage regarding the business, financial condition, results of operations and prospects of Heritage.

In performing its reviews and analyses and in rendering its opinion, Sandler relied upon the accuracy and completeness of all of the financial and other information that was available to Sandler from public sources, that was provided to Sandler by Washington Banking or Heritage or their respective representatives or that was otherwise reviewed by Sandler and Sandler assumed such accuracy and completeness for purposes of rendering

 

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its opinion. Sandler further relied on the assurances of the senior management of each of Washington Banking and Heritage that they were not aware of any facts or circumstances that would make any of such information inaccurate or misleading in a material respect. Sandler did not make an independent evaluation or appraisal of the specific assets, the collateral securing assets or the liabilities (contingent or otherwise) of Washington Banking or Heritage or any of their respective subsidiaries. Sandler did not make an independent evaluation of the adequacy of the allowance for loan losses of Washington Banking and Heritage and Sandler did not review any individual credit files relating to Washington Banking and Heritage. Sandler assumed that the respective allowances for loan losses for Washington Banking and Heritage are adequate to cover such losses.

Sandler used publicly available earnings estimates for Washington Banking and Heritage and an estimated long-term growth rate as discussed with the respective senior managements of Washington Banking and Heritage. Sandler also received and used in its analyses certain projections of transaction costs, purchase accounting adjustments, expected cost savings and other synergies which were provided by Heritage. Sandler expresses no opinion as to such estimates or the assumptions on which they are based. Sandler has assumed that there has been no material adverse change in the respective assets, financial condition, results of operations, business or prospects of Washington Banking and Heritage since the date of the most recent financial data made available to Sandler. Sandler has also assumed in all respects material to its analysis that Washington Banking and Heritage would remain as a going concern for all the periods relevant to its analyses. Sandler expresses no opinion as to any of the legal, accounting and tax matters relating to the merger and any other transaction contemplated in connection therewith.

Sandler’s opinion was necessarily based on financial, economic, regulatory, market and other conditions as in effect on, and the information made available to Sandler as of, the date of its opinion. Events occurring after the date thereof could materially affect its opinion. Sandler has not undertaken to update, revise, reaffirm or withdraw its opinion or otherwise comment upon events occurring after the date of its opinion. Sandler expressed no opinion as to the trading values at which the common stock of Washington Banking or Heritage may trade at any time or what the value of Heritage common stock will be once it is actually received by the holders of Washington Banking common stock. Sandler’s opinion was approved by Sandler’s fairness opinion committee. Sandler did not express any opinion as to the fairness of the amount or nature of the compensation to be received in the merger by Washington Banking’s officers, directors, or employees, or class of such persons, relative to the merger consideration to be received by Washington Banking’s shareholders.

In rendering its October 23, 2013 opinion, Sandler performed a variety of financial analyses. The following is a summary of the material analyses performed by Sandler, but is not a complete description of all the analyses underlying Sandler’s opinion. The summary includes information presented in tabular format. In order to fully understand the financial analyses, these tables must be read together with the accompanying text. The tables alone do not constitute a complete description of the financial analyses. The preparation of a fairness opinion is a complex process involving subjective judgments as to the most appropriate and relevant methods of financial analysis and the application of those methods to the particular circumstances. The process, therefore, is not necessarily susceptible to a partial analysis or summary description. Sandler believes that its analyses must be considered as a whole and that selecting portions of the factors and analyses to be considered without considering all factors and analyses, or attempting to ascribe relative weights to some or all such factors and analyses, could create an incomplete view of the evaluation process underlying its opinion. Also, no company included in Sandler’s comparative analyses described below is identical to Washington Banking or Heritage and no transaction is identical to the merger. Accordingly, an analysis of comparable companies or transactions involves complex considerations and judgments concerning differences in financial and operating characteristics of the companies and other factors that could affect the public trading values or merger transaction values, as the case may be, of Washington Banking and Heritage and the companies to which they are being compared.

In performing its analyses, Sandler also made numerous assumptions with respect to industry performance, business and economic conditions and various other matters, many of which cannot be predicted and are beyond the control of Washington Banking, Heritage and Sandler. The analysis performed by Sandler is not necessarily

 

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indicative of actual values or future results, both of which may be significantly more or less favorable than suggested by such analyses. Sandler prepared its analyses solely for purposes of rendering its opinion and provided such analyses to the Washington Banking board of directors at the board of directors’ October 23, 2013 meeting. Estimates on the values of companies do not purport to be appraisals or necessarily reflect the prices at which companies or their securities may actually be sold. Such estimates are inherently subject to uncertainty and actual values may be materially different. Accordingly, Sandler’s analyses do not necessarily reflect the value of Washington Banking’s common stock or the prices at which Washington Banking’s common stock may be sold at any time. The analyses of Sandler and its opinion were among a number of factors taken into consideration by Washington Banking’s board of directors in making its determination to approve of Washington Banking’s entry into the merger agreement and the analyses described below should not be viewed as determinative of the decision made by Washington Banking’s board of directors with respect to the fairness of the merger.

In arriving at its opinion Sandler did not attribute any particular weight to any analysis or factor that it considered. Rather it made qualitative judgments as to the significance and relevance of each analysis and factor. Sandler did not form an opinion as to whether any individual analysis or factor (positive or negative) considered in isolation supported or failed to support its opinions; rather Sandler made its determination as to the fairness of the merger consideration on the basis of its experience and professional judgment after considering the results of all its analyses taken as a whole.

Summary of Proposal. Sandler reviewed the financial terms of the proposed transaction. As described in the merger agreement, Washington Banking shareholders will receive consideration consisting of 0.8900 shares of Heritage common stock and $2.75 in cash in exchange for each share of Washington Banking’s common stock. Based upon Heritage’s closing price of $15.85 as of October 22, 2013, Sandler calculated merger consideration value of $16.86 per Washington Banking share. Based upon 15,533,186 common shares outstanding, 128,575 restricted stock units outstanding, 100,650 in-the-money options outstanding with a weighted-average strike price of $11.57 and using Heritage’s closing price of $15.85 as of October 22, 2013, Sandler calculated aggregate consideration value of $265 million. Based upon financial information as or for the twelve month period ended September 30, 2013, Sandler calculated the following transaction ratios:

 

		Washington Banking/ Heritage
Transaction Value / Book Value Per Share			144	%
Transaction Value / Tangible Book Value Per Share			149	%
Transaction Value / Last Twelve Months’ Earnings Per Share			15.6	x
Transaction Value / Mean Estimated 2013 Earnings Per Share			16.9	x
Transaction Value / Mean Estimated 2014 Earnings Per Share			16.4	x
Tangible Book Premium to Core Deposits			6.8	%
Premium to Washington Banking Stock Price (Oct. 22, 2013)			18.1	%
Premium to Washington Banking 52 Week High Price			7.7	%
Premium to Washington Banking 52 Week Low Price			28.9	%
Premium to Washington Banking 30 Day Average Closing Price			18.7	%

Comparable Company Analysis. Sandler used publicly available information to compare selected financial information for Washington Banking and Heritage and a group of financial institutions as selected by Sandler. The peer group consisted of publicly traded commercial banks headquartered in the Western Region of the United States with total assets as of the most recently reported period between $1 billion and $3 billion and nonperforming assets / total assets less than 4%. The group excluded thrifts, merger targets and ethnic-focused banks.

 

Bank of Marin Bancorp		Northrim BanCorp, Inc.
Cascade Bancorp		Pacific Continental Corporation
CU Bancorp		Pacific Premier Bancorp, Inc.
Heritage Commerce Corp		TriCo Bancshares
Heritage Oaks Bancorp

 

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The analysis compared publicly available financial information for Washington Banking, Heritage and the financial and market trading data for the peer group. The peer group data is as of or for the period ended June 30, 2013, with the exception of Pacific Continental Corporation, Bank of Marin, Washington Banking and Heritage whose data is as of or for the period ending September 30, 2013. Pricing data for all companies is as of October 22, 2013. The table below sets forth the data for Washington Banking, Heritage and the mean and median data for the peer group.

 

		Washington Banking				Heritage				Comparable Group Median				Comparable Group Mean
Total Assets (in millions)		$	1,648			$	1,674			$	1,400			$	1,488
Last Twelve Months Return on Average Assets1			1.0	%			0.8	%			1.0	%			0.9	%
Last Twelve Months Return on Average Tangible Equity1			9.4	%			6.4	%			9.6	%			9.0	%
Non-Performing Assets / Total Assets			2.4	%			2.0	%			1.2	%			1.8	%
Tangible Equity / Tangible Assets1			10.7	%			11.3	%			10.9	%			10.9	%
Stock Price		$	14.28			$	15.85				—				—
Market Capitalization (in millions)		$	222			$	257			$	241			$	246
Price / Tangible Book Value			126	%			139	%			153	%			153	%
Price / Last Twelve Months’ Earnings Per Share1			13.2	x			20.6	x			16.9	x			18.5	x
Price / Estimated 2013 Earnings Per Share			14.3	x			20.1	x			15.7	x			17.2	x
Price / Estimated 2014 Earnings Per Share			13.9	x			15.7	x			14.7	x			15.3	x
Dividend Yield			2.5	%			2.0	%			1.6	%			1.2	%
3 Months Total Return			-7.8	%			0.3	%			1.9	%			0.2	%
1 Year Total Return			11.1	%			19.6	%			22.9	%			30.6	%

Notes:

¹LTM profitability for Pacific Premier Bancorp, Inc., Pacific Continental Corporation, CU Bancorp and Heritage Oaks Bancorp adjusted for one-time items

Stock Price Performance. Sandler reviewed the history of the publicly reported trading prices of Washington Banking and Heritage’s common stock for the one-year and three-year periods ended October 22, 2013. Sandler then compared the relationship between the movements in the price of Washington Banking and Heritage’s common stock against the movements in the prices of the peer group, S&P 500 Index and NASDAQ Bank Index.

 

One-Year Comparative Stock Performance
		Beginning Index Value		Ending Index Value
		October 19, 2012		October 22, 2013
Washington Banking		100%		107%
Heritage		100%		114%
Peer Group		100%		128%
S&P 500		100%		122%
NASDAQ Bank		100%		131%
Three-Year Comparative Stock Performance
		Beginning Index Value		Ending Index Value
		October 22, 2010		October 22, 2013
Washington Banking		100%		104%
Heritage		100%		111%
Peer Group		100%		146%
S&P 500		100%		148%
NASDAQ Bank		100%		146%

 

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Washington Banking—Net Present Value Analysis. Sandler performed an analysis that estimated the net present value per share of Washington Banking common stock under various circumstances. The analysis assumed that Washington Banking performed in accordance with the publicly available analyst estimated earnings for the years ending December 31, 2013 and December 31, 2014 and an estimated long-term growth rate for the years thereafter, in each case as discussed with, and confirmed by, senior management of Washington Banking. To approximate the terminal value of Washington Banking common stock at December 31, 2018, Sandler applied price to earnings multiples ranging from 12.0x to 22.0x and multiples of tangible book value ranging from 115% to 190%. The terminal values were then discounted to present values using different discount rates ranging from 9.5% to 15.5% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Washington Banking’s common stock.

As illustrated in the following tables, the analysis indicates an imputed range of values per share of Washington Banking common stock of $9.77 to $21.19 when applying multiples of earnings to the applicable amounts indicated in the Washington Banking projections and $9.86 to $19.52 when applying multiples of tangible book value to the applicable amounts indicated in the Washington Banking projections.

 

Discount     Rate		Earnings Per Share Multiples
		12.0x				14.0x				16.0x				18.0x				20.0x				22.0x
9.50%		$	12.62			$	14.34			$	16.05			$	17.76			$	19.47			$	21.19
10.50%		$	12.08			$	13.71			$	15.35			$	16.98			$	18.61			$	20.24
11.50%		$	11.57			$	13.12			$	14.68			$	16.24			$	17.80			$	19.35
12.50%		$	11.08			$	12.57			$	14.05			$	15.54			$	17.02			$	18.51
13.50%		$	10.62			$	12.04			$	13.46			$	14.87			$	16.29			$	17.71
14.50%		$	10.18			$	11.54			$	12.89			$	14.25			$	15.60			$	16.95
15.50%		$	9.77			$	11.06			$	12.36			$	13.65			$	14.94			$	16.24
Discount     Rate		Tangible Book Value Multiples
		115%				130%				145%				160%				175%				190%
9.50%		$	12.75			$	14.10			$	15.46			$	16.81			$	18.17			$	19.52
10.50%		$	12.20			$	13.49			$	14.78			$	16.07			$	17.37			$	18.66
11.50%		$	11.68			$	12.91			$	14.14			$	15.37			$	16.61			$	17.84
12.50%		$	11.19			$	12.36			$	13.54			$	14.71			$	15.89			$	17.07
13.50%		$	10.72			$	11.84			$	12.97			$	14.09			$	15.21			$	16.33
14.50%		$	10.28			$	11.35			$	12.42			$	13.49			$	14.57			$	15.64
15.50%		$	9.86			$	10.88			$	11.91			$	12.93			$	13.96			$	14.98

Sandler also considered and discussed with the Washington Banking board of directors how this analysis would be affected by changes in the underlying assumptions, including variations with respect to net income. To illustrate this impact, Sandler performed a similar analysis assuming Washington Banking net income varied from 25% above projections to 25% below projections. This analysis resulted in the following range of per share

 

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values for Washington Banking common stock, using the same price to earnings multiples of 12.0x to 22.0x and a discount rate of 12.5% (which represents the midpoint of the range of discount rates used).

 

Annual Budget Variance		Earnings Per Share Multiples
		12.0x				14.0x				16.0x				18.0x				20.0x				22.0x
-25.0%		$	8.85			$	9.97			$	11.08			$	12.19			$	13.31			$	14.42
-20.0%		$	9.30			$	10.49			$	11.67			$	12.86			$	14.05			$	15.24
-15.0%		$	9.74			$	11.01			$	12.27			$	13.53			$	14.79			$	16.06
-10.0%		$	10.19			$	11.53			$	12.86			$	14.20			$	15.54			$	16.87
-5.0%		$	10.63			$	12.05			$	13.46			$	14.87			$	16.28			$	17.69
0.0%		$	11.08			$	12.57			$	14.05			$	15.54			$	17.02			$	18.51
5.0%		$	11.53			$	13.09			$	14.65			$	16.21			$	17.77			$	19.33
10.0%		$	11.97			$	13.61			$	15.24			$	16.87			$	18.51			$	20.14
15.0%		$	12.42			$	14.13			$	15.83			$	17.54			$	19.25			$	20.96
20.0%		$	12.86			$	14.65			$	16.43			$	18.21			$	20.00			$	21.78
25.0%		$	13.31			$	15.17			$	17.02			$	18.88			$	20.74			$	22.60

During the Washington Banking board of directors’ meeting on October 23, 2013, Sandler noted that the terminal value analysis is a widely used valuation methodology, but the results of such methodology are highly dependent upon the numerous assumptions that must be made, and the results thereof are not necessarily indicative of actual values or future results.

Heritage—Net Present Value Analysis. Sandler also performed an analysis that estimated the net present value per share of Heritage common stock under various circumstances. The analysis assumed that Heritage performed in accordance with publicly available analyst earnings estimates for the years ending December 31, 2013 and December 31, 2014 and an estimated long-term earnings growth rate for the years thereafter, in each case as discussed with, and confirmed by, senior management of Heritage.

To approximate the terminal value of Heritage common stock at December 31, 2018, Sandler applied price to earnings multiples ranging from 12.0x to 22.0x and multiples of tangible book value ranging from 115% to 190%. The terminal values were then discounted to present values using different discount rates ranging from 9.5% to 15.5% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Heritage’s common stock.

As illustrated in the following tables, the analysis indicates an imputed range of values per share of Heritage common stock of $9.13 to $20.23 when applying multiples of earnings to the applicable amounts indicated in the Heritage projections and $9.69 to $19.62 when applying multiples of tangible book value to the applicable amounts indicated in the Heritage projections.

 

Discount     Rate		Earnings Per Share Multiples
		12.0x				14.0x				16.0x				18.0x				20.0x				22.0x
9.50%		$	11.86			$	13.53			$	15.20			$	16.88			$	18.55			$	20.23
10.50%		$	11.34			$	12.93			$	14.53			$	16.13			$	17.72			$	19.32
11.50%		$	10.85			$	12.37			$	13.89			$	15.41			$	16.94			$	18.46
12.50%		$	10.38			$	11.84			$	13.29			$	14.74			$	16.19			$	17.65
13.50%		$	9.94			$	11.33			$	12.72			$	14.10			$	15.49			$	16.88
14.50%		$	9.53			$	10.85			$	12.18			$	13.50			$	14.82			$	16.15
15.50%		$	9.13			$	10.40			$	11.66			$	12.93			$	14.19			$	15.46

 

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Discount     Rate		Tangible Book Value Multiples
		115%				130%				145%				160%				175%				190%
9.50%		$	12.59			$	14.00			$	15.40			$	16.81			$	18.21			$	19.62
10.50%		$	12.04			$	13.38			$	14.72			$	16.06			$	17.40			$	18.74
11.50%		$	11.52			$	12.80			$	14.07			$	15.35			$	16.63			$	17.91
12.50%		$	11.02			$	12.24			$	13.46			$	14.68			$	15.90			$	17.12
13.50%		$	10.55			$	11.72			$	12.88			$	14.05			$	15.21			$	16.37
14.50%		$	10.11			$	11.22			$	12.33			$	13.45			$	14.56			$	15.67
15.50%		$	9.69			$	10.75			$	11.81			$	12.88			$	13.94			$	15.00

Sandler also considered and discussed with the Washington Banking board of directors how this analysis would be affected by changes in the underlying assumptions, including variations with respect to net income. To illustrate this impact, Sandler performed a similar analysis assuming Heritage net income varied from 25% above projections to 25% below projections. This analysis resulted in the following range of per share values for Heritage common stock, using the same price to earnings multiples of 12.0x to 22.0x and a discount rate of 12.5% (which represents the midpoint of the range of discount rates used).

 

Annual Budget Variance		Earnings Per Share Multiples
		12.0x				14.0x				16.0x				18.0x				20.0x				22.0x
-25.0%		$	8.21			$	9.29			$	10.38			$	11.47			$	12.56			$	13.65
-20.0%		$	8.64			$	9.80			$	10.97			$	12.13			$	13.29			$	14.45
-15.0%		$	9.08			$	10.31			$	11.55			$	12.78			$	14.02			$	15.25
-10.0%		$	9.51			$	10.82			$	12.13			$	13.43			$	14.74			$	16.05
-5.0%		$	9.95			$	11.33			$	12.71			$	14.09			$	15.47			$	16.85
0.0%		$	10.38			$	11.84			$	13.29			$	14.74			$	16.19			$	17.65
5.0%		$	10.82			$	12.34			$	13.87			$	15.39			$	16.92			$	18.44
10.0%		$	11.26			$	12.85			$	14.45			$	16.05			$	17.65			$	19.24
15.0%		$	11.69			$	13.36			$	15.03			$	16.70			$	18.37			$	20.04
20.0%		$	12.13			$	13.87			$	15.61			$	17.36			$	19.10			$	20.84
25.0%		$	12.56			$	14.38			$	16.19			$	18.01			$	19.82			$	21.64

At the October 23, 2013 Washington Banking board of directors meeting, Sandler noted that the net present value analysis is a widely used valuation methodology, but the results of such methodology are highly dependent upon the numerous assumptions that must be made, and the results thereof are not necessarily indicative of actual values or future results.

Analysis of Selected Merger Transactions. Sandler reviewed two groups of comparable mergers and acquisitions. The first group of mergers and acquisitions included: 12 transactions announced during the last twelve month period as of October 22, 2013 involving nationwide commercial banks with total assets between

 

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$500 million and $4 billion with nonperforming assets / total assets less than 4% and tangible equity / equity greater than 8%. Group one was composed of the following transactions:

 

Buyer/Seller

Banner Corporation/ Home Federal Bancorp, Inc.

East West Bancorp, Inc./ MetroCorp Bancshares, Inc.

Old National Bancorp/ Tower Financial Corporation

CenterState Banks, Inc./ Gulfstream Bancshares, Inc.

Wilshire Bancorp, Inc./ Saehan Bancorp

First Fed. Bancshares of AR, Inc./ First National Security Co.

F.N.B. Corporation/ BCSB Bancorp, Inc.

Union First Market Bankshares Corporation/ StellarOne Corp.

Home BancShares, Inc./ Liberty Bancshares, Inc.

SCBT Financial Corporation/ First Financial Holdings, Inc.

United Bankshares, Inc./ Virginia Commerce Bancorp, Inc.

PacWest Bancorp/ First California Financial Group, Inc.

The second group of mergers and acquisitions included: six transactions announced during the last twelve month period as of October 22, 2013 involving nationwide commercial banks with total assets greater than $500 million and target ownership greater than 40% in the combined company. Group two was composed of the following transactions:

 

Buyer/Seller

Umpqua Holdings Corp./ Sterling Financial Corp.

Mercantile Bank Corp./ Firstbank Corp.

PacWest Bancorp/ CapitalSource Inc.

Union First Market Bankshares Corp./ StellarOne Corp.

Peoples Financial Services Corp./ Penseco Financial Services Corp.

Provident New York Bancorp/ Sterling Bancorp

Sandler then reviewed the following multiples for each of the transactions: transaction price to book value, transaction price to tangible book value, transaction price to last twelve months’ earnings per share, transaction price to estimated current year earnings per share, tangible book premium to core deposits and transaction price to seller’s stock price one day before transaction announcement. As illustrated in the following table, Sandler compared the proposed merger multiples to the multiples of the comparable transactions.

 

		Washington Banking / Heritage				Group One								Group Two
						Median				Mean				Median				Mean
Transaction Value / Book Value Per Share			144	%			131	%			134	%			134	%			133	%
Transaction Value / Tangible Book Value Per Share			149	%			153	%			153	%			163	%			159	%
Transaction Value / Last Twelve Months’ Earnings Per Share1			15.6	x			15.9	x			18.4	x			17.5	x			17.6	x
Transaction Value / Estimated 2013 Earnings Per Share			16.9	x			17.8	x			18.5	x			18.8	x			17.2	x
Tangible Book Premium to Core Deposits			6.8	%			6.3	%			7.4	%			7.8	%			12.8	%
Premium to Stock Price:			18.1	%			17.6	%			20.7	%			17.0	%			16.6	%

Notes:

¹LTM EPS for Gulfstream Bancshares, Inc., First Financial Holdings, Inc., Virginia Commerce Bancorp, Inc., First California Financial Group, Inc., Sterling Financial Corp. and CapitalSources, Inc. adjusted for one-time items.

 

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Relative Contribution. Sandler performed a contribution analysis comparing the September 30, 2013 financial information of Heritage and Washington Banking and each company’s relative financial contribution to the pro forma entity, prior to any purchase accounting or other transaction related adjustments. Heritage will own 54% and Washington Banking will own 46% of the pro forma entity. The results of Sandler’s analysis are set forth in the following table:

 

(Dollars in thousands)		Washington Banking								Pro Forma				Heritage
Total Net Loans		$	1,208,082				54.4	%		$	2,220,166				45.6	%		$	1,012,084
Total Net Portfolio Loans (ex FDIC covered)		$	1,144,598				57.2	%		$	2,000,292				42.8	%		$	855,694
Assets		$	1,674,417				50.4	%		$	3,322,571				49.6	%		$	1,648,154
Core Deposits (excluding CDs)		$	1,105,867				51.3	%		$	2,154,129				48.7	%		$	1,048,262
Noninterest Bearing Deposits		$	361,743				57.3	%		$	630,954				42.7	%		$	269,211
Tangible Common Equity		$	185,458				51.3	%		$	361,558				48.7	%		$	176,100
Mean Analyst Est. 2014 Net Income		$	16,419				50.7	%		$	32,366				49.3	%		$	15,947
Market Cap (10/22/13)		$	256,942				53.7	%		$	478,742				46.3	%		$	221,800
							57.3	%			High				49.6	%
							50.4	%			Low				42.7	%
							53.3	%			Mean				46.7	%
							52.5	%			Median				47.5	%

Pro Forma Results and Capital Ratios. Sandler analyzed certain potential pro forma effects of the merger, assuming the following: (i) the merger closes March 31, 2014; (ii) per share merger consideration value of $16.86, based on Heritage’s closing stock price on October 22, 2013 of $15.85; (iii) Heritage would be able to achieve cost savings of approximately 20% of Washington Banking projected operating expense and such savings would be 50% realized in 2014 and fully realized in 2015; (iv) pretax transaction costs and expenses would total approximately $14.9 million, with 50% of the expenses phased-in at closing and the remaining 50% recognized post-closing; (v) a core deposit intangible of approximately $14.5 million (10 year, sum-of-years-digits amortization method); (vi) Washington Banking’s performance was calculated in accordance with publicly available analyst estimated earnings per share for the years ending December 31, 2013 and December 31, 2014, and an estimated long-term growth rate for the years thereafter; (vii) Heritage’s performance was calculated in accordance publicly available analyst earnings estimates for the years ending December 31, 2013 and December 31, 2014 and an estimated long-term growth rate for the years thereafter; and (viii) various purchase accounting adjustments, including credit and interest rate mark-to-market adjustments and other accounting adjustments on Washington Banking’s loan portfolio, other real estate owned, borrowings and other liabilities. The analyses indicated that for the year ending December 31, 2014, the merger (excluding transaction expenses) would be accretive to Heritage’s projected earnings per share and, as of March 31, 2014 the merger would be dilutive to Heritage’s tangible book value per share. The actual results achieved by the combined company, however, may vary from projected results and the variations may be material.

Sandler’s Relationship. Sandler acted as the financial advisor to Washington Banking’s board of directors in connection with the merger. Pursuant to the terms of the letter agreement with Sandler, Washington Banking has agreed to pay Sandler a cash fee equal to 1.20% of the aggregate consideration payable in the merger (which shall be calculated in part based on the average last sales prices of Heritage’s common stock on the five trading days ending five calendar days prior to the effective date of the merger; and which fee would be approximately $3.4 million if the merger had closed on the date of this joint proxy statement/prospectus), payable at, and contingent upon, the closing of the merger. Washington Banking paid $250,000 to Sandler, which will be credited towards any fee payable at the closing the merger, in connection with Sandler’s opinion. Washington Banking has also agreed to reimburse Sandler for reasonable out-of-pocket expenses incurred in connection with its engagement and to indemnify Sandler and its affiliates and their respective partners, directors, officers, employee and agents against certain expenses and liabilities, including liabilities under the securities laws.

 

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Sandler has, in the past, provided certain investment banking services to Washington Banking and its affiliates, has had a material relationship with Washington Banking and its affiliates and has received compensation and reimbursement of out-of-pocket expenses for such services. During the two years preceding the date of the Sandler opinion, Sandler did not receive any fees from Washington Banking. Sandler may provide investment banking services to the combined company in the future and may receive future compensation. In the two years prior to the execution of the merger agreement, Sandler has not provided investment banking services to, or received fees for such services from, Heritage.

In the ordinary course of its respective broker and dealer businesses, Sandler may purchase securities from and sell securities to Washington Banking and Heritage and their respective affiliates. Sandler may also actively trade the debt and/or equity securities of Washington Banking or Heritage or their respective affiliates for their own accounts and for the accounts of their customers and, accordingly may at any time hold a long or short position in such securities.

Combined Company Board of Directors Following Completion of the Merger

In accordance with the merger agreement, upon completion of the merger, the number of directors constituting the board of directors of the combined company will be increased by four to 15 members, and it is seven current Washington Banking directors, including Anthony B. Pickering, who will serve as chairman of the board of the combined company upon completion of the merger, and Rhoda L. Altom, Mark D. Crawford, Deborah J. Gavin, Jay T. Lien, Gragg E. Miller and Robert T. Severns who are expected to be appointed to the board of directors of the combined company. Eight current Heritage directors, including Mr. Brian S. Charneski, the current Vice Chairman of Heritage, who will serve as vice-chairman of the board of the combined company upon completion of the merger, and Brian L. Vance, David H. Brown, Gary B. Christensen, John A. Clees, Kimberly T. Ellwanger, Jeffrey S. Lyon and Ann Watson will continue to serve on the board of directors of the combined company upon completion of the merger.

Amendment to Heritage’s Bylaws

At or prior to the closing of the merger, the Bylaws of Heritage will be amended, which we refer to as the “bylaw amendment”, to provide for the addition of new provisions to the Bylaws addressing certain governance matters in connection with the merger. The bylaw amendment will apply for two years after the completion of the merger and has the following terms:

 

•

the combined company’s board of directors will be comprised of eight members from Heritage and seven from Washington Banking;

 

•

procedures for the appointment of replacement directors by the continuing directors of each company;

 

•

reduction in the size of the board in a manner that the proportion of directors from each company remains approximately the same;

 

•

Anthony B. Pickering of Washington Banking will serve as chairman of the board of directors and Brian S. Charneski of Heritage will serve as the vice chairman of the board of directors; and

 

•

during the two year period these bylaw provisions are in effect they may only be amended by a vote of two thirds of the directors and a majority of the continuing directors from Heritage and the continuing directors from Washington Banking, respectively.

Interests of Washington Banking’s Directors and Executive Officers in the Merger

Washington Banking shareholders should be aware that some of Washington Banking’s directors and executive officers have interests in the merger and have arrangements that are different from, or in addition to, those of Washington Banking shareholders generally. Washington Banking’s board of directors was aware of these interests and considered these interests, among other matters, when making its decision to approve the merger agreement, and in recommending that Washington Banking shareholders vote in favor of adopting the merger agreement.

 

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These interests include the following:

 

•

Certain executive officers of Washington Banking may be eligible for severance benefits under existing agreements with, and benefit plans offered by, Washington Banking.

 

•

Accelerated vesting of all of the unvested restricted stock unit awards held by Washington Banking directors and executive officers.

 

•

Bryan McDonald, President and Chief Executive Officer of Whidbey Island Bank, will become Executive Vice President and Chief Lending Officer of Heritage Bank following the bank merger and has entered into an employment agreement with Heritage Bank, to become effective at the effective time of the merger.

 

•

Edward Eng, Executive Vice President and Chief Administrative Officer of Whidbey Island Bank, will become Executive Vice President and Chief Administrative Officer of Heritage Bank following the bank merger and has entered into an employment agreement with Heritage Bank, to become effective at the effective time of the merger.

 

•

John L. Wagner, President and Chief Executive Officer of Washington Banking, will serve as a special advisor to Heritage following the merger and has entered into a consulting agreement with Heritage, to become effective at the effective time of the merger.

 

•

Seven current Washington Banking directors, including Anthony B. Pickering, who will serve as chairman of the board of the combined company upon completion of the merger, and Rhoda L. Altom, Mark D. Crawford, Deborah J. Gavin, Jay T. Lien, Gragg E. Miller, Robert T. Severns and Edward J. Wallgren will be appointed to the board of directors of the combined company.

Equity Interests of Directors and Executive Officers

Stock Options. Each Washington Banking stock option issued under the Washington Banking 1998 Stock Option and Restricted Stock Award Plan and the Washington Banking 2005 Stock Incentive Plan (together, the “Washington Banking Stock Plans”) that is outstanding immediately prior to the merger will automatically be converted into an option to purchase the number of whole shares of Heritage common stock that is equal to the number of shares of Washington Banking common stock subject to such Washington Banking stock option immediately prior to the merger multiplied by a fraction having a numerator equal to the sum of (i) $2.75 plus (ii) the product of 0.89000 multiplied by the average of the Heritage common stock price and a denominator equal to the average Heritage common stock price (we refer to this fraction as the “option exchange ratio”), rounded down to the nearest whole share, at an exercise price per share of Heritage common stock (rounded to the nearest penny) equal to the exercise price for each option immediately prior to the merger divided by the option exchange ratio. Each outstanding stock option held by Washington Banking directors and executive officers is fully vested.

Restricted Stock Unit Awards. Each Washington Banking restricted stock unit award granted under the Washington Banking Stock Plans that is outstanding and subject to vesting, repurchase or other lapse restriction immediately prior to the merger will fully vest upon the effective time of the merger and will be converted automatically into a restricted stock unit award in respect of the number of shares of Heritage common stock, rounded to the nearest whole share, equal to the product of the number of shares of Washington Banking common stock subject to the Washington Banking restricted stock unit award and the option exchange ratio, with such converted restricted stock unit award to continue to be subject to the same terms and conditions as were applicable to the restricted stock unit award under the Washington Banking Stock Plan and the applicable award agreement thereunder.

The following table sets forth the number of Washington Banking stock options and restricted stock units held by each director and executive officer of Washington Banking as of December __, 2013. The following table assumes that Washington Banking’s directors and executive officers will not sell, acquire or forfeit any shares of Washington Banking common stock or equity awards following such date. As described below,

 

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directors and executive officers of Washington Banking may be eligible to receive new equity awards prior to the effective time of the merger.

 

Name		Stock Options(1)				Restricted Stock Units(1)
John L. Wagner			15,123	(2)			13,167	(7)
Richard A. Shields			17,623	(3)			6,834	(8)
Bryan McDonald			6,194	(4)			8,500	(9)
George W. Bowen			0				6,334	(10)
Edward Eng			0				6,100	(11)
Daniel E. Kuenzi			3,717	(5)			6,334	(10)
Rhoda L. Altom			0				0
Mark D. Crawford			0				3,833	(12)
Deborah J. Gavin			0				0
Jay T. Lien			2,925	(6)			4,500	(13)
Gragg E. Miller			0				4,500	(13)
Anthony B. Pickering			2,925	(6)			4,500	(13)
Robert T. Severns			0				4,500	(13)

 

(1)	All stock options are fully vested and all restricted stock units (RSUs) vest upon completion of the merger.

(2)	Option exercise prices equal $14.60 (496 shares), $15.98 (2,627 shares) and $9.11 (12,000 shares).

(3)	Option exercise prices equal $14.60 (496 shares), $15.98 (2,627 shares) and $9.11 (14,500 shares).

(4)	Option exercise prices equal $15.98 (1,194 shares) and $9.11 (5,000 shares).

(5)	Option exercise prices equal $15.77 (1,000 shares), $15.98 (717 shares) and $9.11 (2,000 shares).

(6)	Option exercise prices equal $14.60 (1,162 shares) and $15.98 (1,763 shares).

(7)	1,667 RSUs scheduled to vest on 6/23/14; 2,000 RSUs scheduled to vest on 2/23/14; 2,000 RSUs scheduled to vest on 2/23/15; 2,500 RSUs scheduled to vest on 1/24/14; 2,500 RSUs scheduled to vest on 1/24/15; and 2,500 RSUs scheduled to vest on 1/24/16.

(8)	834 RSUs scheduled to vest on 6/23/14; 1,000 RSUs scheduled to vest on 2/23/14; 1,000 RSUs scheduled to vest on 2/23/15; 1,334 RSUs scheduled to vest on 1/24/14; 1,333 RSUs scheduled to vest on 1/24/15; and 1,333 RSUs scheduled to vest on 1/24/16.

(9)	834 RSUs scheduled to vest on 6/23/14; 1,333 RSUs scheduled to vest on 2/23/14; 1,333 RSUs scheduled to vest on 2/23/15; 1,667 RSUs scheduled to vest on 1/24/14; 1,666 RSUs scheduled to vest on 1/24/15; and 1,667 RSUs scheduled to vest on 1/24/16.

(10)	334 RSUs scheduled to vest on 6/23/14; 1,000 RSUs scheduled to vest on 2/23/14; 1,000 RSUs scheduled to vest on 2/23/15; 1,334 RSUs scheduled to vest on 1/24/14; 1,333 RSUs scheduled to vest on 1/24/15; and 1,333 RSUs scheduled to vest on 1/24/16.

(11)	100 RSUs scheduled to vest on 6/23/14; 1,000 RSUs scheduled to vest on 2/23/14; 1,000 RSUs scheduled to vest on 2/23/15; 1,334 RSUs scheduled to vest on 1/24/14; 1,333 RSUs scheduled to vest on 1/24/15; and 1,333 RSUs scheduled to vest on 1/24/16.

(12)	666 RSUs scheduled to vest on 2/23/14; 667 RSUs scheduled to vest on 2/23/15; 834 RSUs scheduled to vest on 1/24/14; 834 RSUs scheduled to vest on 1/24/15; and 833 RSUs scheduled to vest on 1/24/16.

(13)	667 RSUs scheduled to vest on 6/23/14; 666 RSUs scheduled to vest on 2/23/14; 667 RSUs scheduled to vest on 2/23/15; 834 RSUs scheduled to vest on 1/24/14; 834 RSUs scheduled to vest on 1/24/15; and 833 RSUs scheduled to vest on 1/24/16.

New Equity Awards. Prior to the effective time of the merger, Washington Banking’s board of directors may grant up to 92,400 restricted stock units under the Washington Banking 2005 Stock Incentive Plan to directors, officers and employees.

 

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New Consulting and Employment Agreements

In connection with the execution of the merger agreement, Heritage entered into a consulting agreement with Mr. Wagner and employment agreements with Messrs. Eng and McDonald, executive officers of Washington Banking. As described below, these agreements set forth the terms and conditions of each such individual’s employment or consulting relationship with Heritage following the effective time of the merger and will be effective upon and subject to the completion of the merger. When effective, the employment agreements will also supersede and replace any prior employment, retention, pre-existing change of control or other similar agreement with Messrs. Eng and McDonald, including their Washington Banking employment agreements. Mr. Wagner’s consulting agreement sets forth the terms and conditions of his consulting relationship with Heritage commencing at the effective time of the merger.

Consulting Agreement with Mr. Wagner. Mr. Wagner’s consulting agreement, which expires as of the third anniversary of the effective date of the merger, provides that he will assist in the maintenance and retention of important customer and employee relationships with Washington Banking and Heritage and assist in advising on Heritage’s merger and acquisition activities following the effective time of the merger. Under the consulting agreement, Mr. Wagner will receive a fee of $500,000, payable in three installments in the amount of $250,000 immediately following the effective time of the merger, $150,000 as of the first anniversary of the effective time of the merger and $100,000 as of the second anniversary of the effective time of merger, in each case provided that Mr. Wagner has not violated confidentiality, non-competition and non-solicitation covenants in the consulting agreement.

If Mr. Wagner terminates the consulting agreement, Heritage has no further obligation to make payments. If Heritage terminates the consulting agreement or Mr. Wagner dies during the term of the consulting agreement, Heritage must pay the balance of the consulting fees that would have been paid through the end of the term of the consulting agreement.

Employment Agreements with Other Executive Officers. The employment agreements with Messrs. Eng and McDonald have initial terms from effective time of the merger through June 30, 2016. The terms of the employment agreements will be automatically extended for an additional year beginning on July 1, 2015, and on each July 1 thereafter, unless either party gives at least 90 days prior notice of non-renewal. Mr. Eng will serve as Heritage Bank’s Executive Vice President and Chief Administrative Officer and Mr. McDonald will serve as Heritage Bank’s Executive Vice President and Chief Lending Officer.

The employment agreements provide for annual base salaries of $250,000 for Mr. McDonald and $202,000 for Mr. Eng. The base salaries will be reviewed annually and may be increased at the discretion of the board of directors of Heritage Bank. The agreements provide that the executives will be eligible to receive performance-based annual incentive bonuses, in accordance with Heritage Bank’s annual incentive plan with initial target bonuses of 30% of annual base salary, and also to receive employee benefits on as favorable a basis as other similarly situated and performing senior executives of Heritage Bank, provided that each executive will have an initial target equity compensation plan award of 25% of annual base salary. Mr. McDonald will also be entitled to a special bonus of $250,000 to be paid in equal installments over 24 months commencing following the effective time of the merger (which payments cease upon termination of Mr. McDonald’s employment for any reason), the use of an automobile provided by Heritage Bank and a one-time restricted stock grant with a grant date fair value of $50,000, subject to Heritage’s standard award agreement and terms. Mr. Eng will be entitled to receive, as of the 14-month anniversary of the effective time of the merger, provided he has been continuously employed by Heritage Bank through such date, a one-time grant of restricted stock with a grant date fair value of $75,000, subject to Heritage’s standard award agreement and terms, with vesting over two years. Messrs. Eng and McDonald will be entitled to reimbursement for up to $50,000 and $75,000, respectively, of relocation expenses incurred associated with relocating to the Olympia, Washington area and, for Mr. McDonald, such amounts will be grossed-up for Federal, Washington State and employment taxes via a single iteration calculation. Mr. McDonald will also be provided a housing allowance of $2,000 per month following executive’s leasing of an apartment in Olympia, Washington, for a maximum of two years from the effective date of the merger.

 

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The employment agreements provide for severance benefits in the event the executive’s employment is terminated by Heritage Bank (other than for cause or as a result of the executive’s death or disability) or if the employment is terminated by the executive for good reason (referred to as a Termination). For a Termination during the first 12 months of the term of the employment agreement, or during the six months before or within 24 months after a change in control of Heritage (such period referred to as the Covered Period), Messrs. Eng and McDonald would be entitled to receive a lump sum payment equal to 200% of the sum of: (i) his then-current annual base salary or, if greater, his annual base salary one day prior to the applicable change in control, plus (ii) the average of his annual performance-based bonuses for the immediately preceding three completed fiscal year performance periods (or, if the Termination occurs during the 12-month period beginning on the effective date of the merger, the highest bonus paid by Washington Banking for 2011, 2012 or 2013 will be used) (collectively referred to as Base Compensation). Mr. Eng would also be entitled to receive such amount for a voluntary resignation during the 30-day period beginning on the 13-month anniversary of the effective time of the merger. Except as noted in the previous sentence, for a Termination that occurs other than during a Covered Period and other than during the 12-month period beginning at the effective time of the merger, Messrs. Eng and McDonald would be entitled to receive a payment equal to 100% of Base Compensation, paid in 24 monthly installments. The executives and their eligible dependents would also be entitled to continued coverage under the medical and dental plans of Heritage (12 months’ coverage for Termination that does not occur during a Covered Period and 18 months’ coverage for Termination during a Covered Period). The employment agreements also provide that any equity awards granted to the executive and subject to vesting, performance or target requirements will be treated as having satisfied the applicable requirements in the case of any Termination other than a Termination during the 12-month period beginning at the effective time of the merger.

All severance benefits under the employment agreements for Messrs. Eng and McDonald are contingent upon the executive’s execution and non-revocation of a general release and waiver of claims. The agreements are subject to certain banking regulatory provisions and include a clawback provision should any severance payment require recapture under any applicable statute, law, regulation or regulatory interpretation or guidance. Further, the agreements provide for an automatic reduction of severance payments if the reduction would result in a better net-after-tax result for the respective executive after taking into account the impact of the golden parachute payment restrictions of Section 280G of the Internal Revenue Code.

The employment agreements for the executives contain restrictive covenants prohibiting the unauthorized disclosure of confidential information of Heritage by the executives during and after their employment, prohibiting Mr. McDonald from competing with Heritage and prohibiting the executives from soliciting Heritage’s employees or customers during employment and, in certain circumstances, after termination of employment. The non-solicitation provisions, and for Mr. McDonald the non-competition provisions, apply for a period of 18 months following any termination not during a Covered Period or within the 12 months of the effective date of the merger, and apply for a period of 12 months following any termination that occurs during a Covered Period or within 12 months of the effective date of the merger. For Mr. McDonald, in the event of delivery of a notice of non-renewal of his employment agreement by Heritage Bank, the restricted period, in all cases, ends as of the expiration of the employment agreement pursuant to such non-renewal notice; and in the event of delivery of a notice of non-renewal of the employment agreement by Mr. McDonald, if delivered to Heritage Bank after the second anniversary of the effective date of the merger and he continues to be employed through the expiration of the employment agreement pursuant to such notice, the restricted period, in all cases, ends as of the expiration of the employment agreement.

Washington Banking Employment Agreements

Washington Banking is party to employment agreements with Messrs. Bowen, Eng, Kuenzi, McDonald, Shields and Wagner, the terms of which are substantially the same, except as described below. The employment agreements with Messrs. Eng and McDonald will be superseded at the effective time of the merger by their Heritage employment agreements described immediately above.

 

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Mr. Wagner’s employment agreement provides that, following termination of his employment by Washington Banking without cause or by Mr. Wagner for good reason, he is entitled to employer-paid health and dental insurance benefits for a maximum period of 18 months or, if earlier, until such time that he becomes eligible for comparable group insurance coverage in connection with new employment. Mr. Wagner is subject to a provision prohibiting him from soliciting the customers or employees of Washington Banking for a period of 18 months following his employment termination.

Messrs. Bowen, Kuenzi and Shields are eligible for certain payments and benefits under their respective employment agreements if the executive officer’s employment is terminated without cause or the executive officer terminates employment for good reason. The termination benefits under the employment agreements are calculated based on an amount equal to two times the executive officer’s highest annual base salary over the prior three years, plus an amount equal to two times the greater of the annual bonus last paid to the executive under the employment or two times the average bonus paid over the prior three years. Payment of the benefits commences on the 60th day following the executive officer’s termination of employment, provided that the executive officer has executed a release of claims, and continues with regular equal payments on the employer’s payroll schedule until two years after termination of employment. In addition, the employment agreements provide that, following termination of employment by Washington Banking without cause or by the executive for good reason, the executive officer is entitled to health and dental insurance benefits until such time that the executive officer becomes eligible for comparable group insurance coverage in connection with new employment for a maximum period of 18 months except that, with respect to Mr. Bowen, such benefits are not payable for a termination of employment within two years following a change in control. The employment agreements contain a covenant not to compete with Washington Banking’s business for a period of 18 months (or 12 months in the event of a termination within 12 months following a change in control, which the merger constitutes for purposes of the agreements) following employment termination, and not to solicit Washington Banking’s employees or customers for a period of 18 months following employment termination. Each of the agreements provides for reduction of the executive officer’s payments and benefits to the maximum amount that does not trigger the Internal Revenue Code Section 280G excise tax unless the executive would be better off (on an after-tax basis) receiving all payments and benefits due and paying all excise and income taxes.

Washington Banking Retirement Agreements for Mr. Wagner

Washington Banking and Whidbey Island Bank are each party to a Salary Continuation Agreement with Mr. Wagner dated December 10, 2010 (we refer to these collectively as the “SCAs” and individually as the “Bank SCA” and the “Washington Banking SCA”). The SCAs provide for a fixed schedule of retirement benefits to be paid to Mr. Wagner. Benefits under the Bank SCA commenced on August 24, 2012, when Mr. Wagner reached age 69. Benefits under the Washington Banking SCA commence upon his retirement on or after August 24, 2015, when Mr. Wagner reaches age 72. The Bank SCA normal retirement benefit is an initial lump sum payment of $100,000 plus $50,000 per year for five years from age 69, and the Washington Banking SCA normal retirement benefit provides an additional $25,000 per year for five years from age 72. If Mr. Wagner terminates employment prior to age 72 and prior to a change in control, the Washington Banking SCA generally provides for a lump sum payment of the vested, GAAP-accrued amount under the Washington Banking SCA, in addition to the normal retirement payments under the Bank SCA. For a termination following a change in control (which the merger constitutes for purposes of the SCAs), the Washington Banking SCA provides for a lump sum payment of $125,000 and the Bank SCP provides for a lump sum payment of the vested, GAAP-accrued amount. If Mr. Wagner dies while receiving payments, his estate will receive the remainder of the scheduled payments under both the Bank SCA and the Washington Banking SCA.

Merger-Related Compensation for Washington Banking’s Named Executive Officers

This section sets forth the information required by Item 402(t) of Regulation S-K regarding the compensation that will or may become payable to Washington Banking’s “named executive officers” (as defined under SEC rules) that is based on or otherwise relates to the merger. Washington Banking shareholders are being

 

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asked to approve, on a non-binding, advisory basis, such compensation for these executive officers (see “Washington Banking Proposals—Washington Banking Compensation Proposal” beginning on page [    ]). Because the vote to approve such compensation is advisory only, it will not be binding on either Heritage or Washington Banking. Accordingly, if the merger is completed, the compensation will be paid (or payable) regardless of the outcome of the vote to approve such compensation, subject only to the conditions applicable thereto, which are described below. Except as noted in the footnotes to the table, the amounts indicated below are estimates of amounts that would be payable if the merger were consummated on March 31, 2014 and assuming that the employment of the named executive officers were terminated immediately thereafter on a basis entitling them to severance payments. Some of these assumptions are based on information not currently available and, as a result, the actual amounts, if any, to be received by the named executive officers may differ in material respects from the amounts set forth below. See the footnotes to the table for additional information.

 

Name		Cash(1)				Equity(2)				Pension/ NQDC(3)				Perquisites / benefits(4)				Tax reimbursement(5)				Other(6)				Total
John Wagner		$	500,000			$	148,223			$	33,347				—				—				—			$	681,570
Richard Shields			—			$	76,959				—				—				—				—			$	76,959
Bryan McDonald			—			$	144,061				—			$	131,125			$	22,500			$	250,000			$	547,686
George Bowen			—			$	68,408				—				—				—				—			$	68,408
Daniel Kuenzi			—			$	68,408				—				—				—				—			$	68,408

 

(1)

As further described under “The Merger—Interests of Washington Banking’s Directors and Executive Officers in the Merger—New Employment and Consulting Agreements,” in the event Mr. Wagner’s consulting agreement is terminated by Heritage during the term of the agreement, he would be entitled to receive the unpaid amounts due under the Consulting Agreement in a lump sum payment equal to a maximum of $500,000, and in the event Mr. McDonald is terminated without cause or resigns for good reason following the merger and during the term of his employment agreement with Heritage, subject to the execution of a release of claims and compliance with certain restrictive covenants, he would be entitled to severance benefits up to 200% of the sum of: (i) his then-current annual base salary or, if greater, his annual base salary one day prior to the effective time of the merger, plus (ii) the highest bonus paid by Washington Banking for 2011, 2012 or 2013. However, the amount reflected in this column for Mr. McDonald does not reflect any payments he would have been owed under his current employment agreement with Washington Banking as a result of a similar termination of employment irrespective of the occurrence of the merger, because these payments are not considered based on or otherwise related to the merger. As further described under “The Merger—Interests of Washington Banking’s Directors and Executive Officers in the Merger—Washington Banking Employment Agreements,” if Messrs. Bowen, Kuenzi or Shields, is involuntarily terminated by Heritage without cause or resigns for good reason within 24 months following the merger, subject to the execution of a release of claims and compliance with certain restrictive covenants, he would receive an amount equal to two times his highest annual base salary over the prior three years, plus an amount equal to the greater of two times the most recent annual bonus or two times the average bonus paid over the prior three years. This payment would be made in equal monthly installments commencing on the 60th day following termination of employment and continuing until two years after termination of employment. However, the amounts reflected in this column for Messrs. Bowen, Kuenzi and Shields do not reflect any payments they would have been owed under their current employment agreements as a result of a similar termination of employment irrespective of the occurrence of the merger, because these payments are not considered based on or otherwise related to the merger.

(2)

Pursuant to the terms of Washington Banking’s equity plans and award agreements, Washington Banking stock options and restricted stock units fully vest at the effective time of the merger. The value above reflects the value of restricted stock units for which vesting would be accelerated as a result of the merger, based on a price per share of Washington Banking common stock of $17.10 (the average closing market price of Washington Banking common stock over the first five business days following the first public announcement of the merger). All stock options held by the named executive officers are fully vested. For Mr. McDonald, the amount also reflects the vesting of the $50,000 grant date fair value restricted stock award granted pursuant to his employment agreement with Heritage, which vesting would occur if

 

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Mr. McDonald is terminated without cause or resigns for good reason following the merger and during the term of the employment agreement.

(3)	Represents the additional benefit payable to Mr. Wagner under his salary continuation agreement with Washington Banking as a result of termination following a change in control as compared to termination prior to age 72.

(4)

For Mr. McDonald, reflects the following benefits pursuant to the terms of his employment agreement with Heritage (which benefits are not conditioned upon Mr. McDonald’s termination of employment): (a) $75,000 for relocation expenses; (b) $48,000 for a housing allowance ($2,000 per month payable for up to two years); (c) $2,500 in legal fees incurred in connection with the negotiation of the employment agreement; and (d) $5,625 for the cost of a company-provided automobile ($2,500 per year) through June 30, 2016 (the end of the initial term of the employment agreement).

(5)	For Mr. McDonald, reflects a tax gross up for the relocation expenses he is entitled to pursuant to the terms of his employment agreement with Heritage (which gross up is not conditioned upon Mr. McDonald’s termination of employment).

(6)	For Mr. McDonald, reflects a special bonus pursuant to the terms of his employment agreement with Heritage, to be paid in equal installments over 24 months commencing following the effective time of the merger (which payments cease upon termination of Mr. McDonald’s employment for any reason).

Regulatory Approvals

Under applicable law, the merger must be approved by the Federal Reserve Board, and the bank merger must be approved by the FDIC and the DFI. The U.S. Department of Justice may review the impact of the merger and the bank merger on competition.

We have requested a waiver from the Federal Reserve Board of its application requirements that would apply to this merger. Assuming this waiver is granted by the Federal Reserve Board and the FDIC and DFI approve the bank merger, we must wait for up to 30 days before we can complete the merger. If, however, there are no adverse comments from the U.S. Department of Justice and we receive permission from the FDIC and DFI to do so, the merger may be completed on or after the 15th day after approval from the FDIC and DFI.

As of the date of this joint proxy statement/prospectus, all of the required applications have been filed. There can be no assurance as to whether all regulatory approvals will be obtained or as to the dates of the approvals. There also can be no assurance that the regulatory approvals received will not contain a condition or requirement that results in a failure to satisfy the conditions to closing set forth in the merger agreement. See “The Merger Agreement—Conditions to Complete the Merger.”

Accounting Treatment

In accordance with current accounting guidance, the merger will be accounted for using the acquisition method. The result of this is that the recorded assets and liabilities of Heritage will be carried forward at their recorded amounts, the historical operating results will be unchanged for the prior periods being reported on and that the assets and liabilities of Washington Banking will be adjusted to fair value at the date of the merger. In addition, all identified intangibles will be recorded at fair value and included as part of the net assets acquired. To the extent that the purchase price, consisting of cash plus the number of shares of Heritage common stock to be issued to former Washington Banking shareholders, at fair value, exceeds the fair value of the net assets including identifiable intangibles of Washington Banking at the merger date, that amount will be reported as goodwill. In accordance with current accounting guidance, goodwill will not be amortized but will be evaluated for impairment annually. Identified intangibles will be amortized over their estimated lives. Further, the acquisition method of accounting results in the operating results of Washington Banking being included in the operating results of Heritage beginning from the date of completion of the merger.

 

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Washington Banking Shareholder Dissenters’ Rights

In connection with the merger, record holders of Washington Banking common stock who comply with the requirements of the Washington Business Corporation Act, as set forth in Chapter 23B.13 of the Revised Code of Washington (which we will refer to as “RCW Chapter 23B.13”), which is summarized below, will be entitled to dissenters’ rights if the merger is completed.

Washington Banking shareholders electing to exercise dissenters’ rights must comply with the provisions of RCW Chapter 23B.13 in order to perfect their rights. The following is intended as a brief summary of the material provisions of the Washington statutory procedures required to be followed by a Washington Banking shareholder in order to dissent from the merger and perfect the shareholder’s dissenters’ rights. This summary, however, is not a complete statement of all applicable requirements and is qualified in its entirety by reference to RCW Chapter 23B.13, the applicable text of which is set forth in Appendix D.

A shareholder who wishes to assert dissenters’ rights must (i) deliver to Washington Banking, before the vote is taken by Washington Banking shareholders, notice of the shareholder’s intent to demand payment for the shareholder’s shares