Heritage Financial Corp (HFWA) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the second quarter 2004 Heritage Financial earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance during the call, please press *0. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Don Rhodes. Please go ahead, sir.

Thank you, Stacey, and this is Don Rhodes of Heritage Financial Corporation. I want to welcome those of you who are on the line now and also extend an early welcome to any who might call in when this call is available over the course of the next 10 days, so welcome, whether you're there live or whether you happen to be phoning in later on. Also with me here in our Board Room in Olympia, Washington, which is our world headquarters, is our three people who may participate in the question and answer session later on. First, Brian Vance, who is Executive Vice President of Heritage Financial Corporation and President and CEO of Heritage Bank, additionally, Ed Cameron, the Senior VP and Chief Financial Officer of both Heritage Financial and Heritage Bank, and along with us today is Mike Broadhead, who is President of Central Valley Bank.

I would just like to give a few overview comments and then open it up to your questions. I'm presuming that everyone has seen our earnings press release that went out yesterday and, if so, I would just call your attention to the obligatory words at the last paragraph of the press release on page 4, which indicates that our discussion today may include statements concerning future performance, developments or events, expectations for growth and market forecasts and other guidance on future periods. Forward-looking statements are subject to a number of risks and uncertainties that might cause actual results to differ materially from stated expectations. Specific factors include, but are not limited to, the effective interest rate changes, risks associated with the acquisition of other banks and opening new branches, the ability to control costs and expenses and general economic conditions. These factors could affect the company's financial results. Additional information on these and other factors are included in the company's filings with the Securities and Exchange Commission.

I'm sure there's no one listening who hasn't heard those words in the past, but we call those to your attention. With that, I offer these thoughts.

We now have completed 6.5 years as a public company, having started trading on the NASDAQ national market on January 9, 1998, and we continue our progress toward our goal of reaching a 15 percent ROE by the end of fiscal 2005. Actually, as noted in the press release, our ROE for the quarter ended June 30th, just last month, our ROE was 15.36, which was up from 12.46 the year earlier. We're certainly optimistic about achieving the 15 percent by the end of 2005 and we think we have a good chance to accomplish that during 2004. Year-to-date, as noted in the press release, during 2004 our ROE has been 14.73 percent.

Earnings per share, up a good solid 17 percent, compared to a year ago, 37.5 cents for the quarter just ended versus 31.9 cents for the second quarter a year ago. Actual earnings were up 3.8 percent for the quarter just ended and up over 5.5 percent for six months year-to-date, compared to a year ago. Certainly, our share repurchase program has contributed to both our earnings per share and ROE growth. Our June press release earlier indicated the completion of our seventh buy-back program, which was a 5 percent buy-back program which put us in a position of having repurchased approximately 51 percent of the shares that were originally outstanding in March, 1999, after we completed our acquisition of Washington Independent Bank shares and its Central Valley Bank subsidiary. This morning you may have noticed but, if not, we were pleased to announce the continuation of our share repurchase program. The Board authorized another 5 percent buy-back, which will be our eighth program. It will amount to approximately 295,000 shares over the next 18 months.

Asset growth during the past year was up 13 percent, compared to a year ago, a pretty decent growth overall considering a fairly soft, but now improving, Pacific Northwest economy. Of course, during that period of time, we did not open any new branches or make any acquisitions, so we thought 13 percent organic growth was a pretty solid number.

The management team continues a good strong performance in managing our net interest margin, maintaining a margin a little bit in excess of 5 percent, actually 5.15 percent, for the quarter ended June 30th and, basically, 5.15 for the first six months of the year. While that's down a little bit from this same time a year ago, certainly in reflecting the economy and certainly reflecting lower interest rates on the asset side of the balance sheet, we still feel it's a good solid number. The recent Fed increase of .25 percent right at the end of June, of course, did not impact our second quarter numbers. We think managing that margin will continue to be a challenge during the next few months due to the uncertain timing of future expected increases and amounts of those increases. More importantly, maybe because of competitive factors, both on the loan and deposit sides, but I'm confident that we will continue with an overall strong margin which certainly is very helpful to our profitability.

Our asset quality, which is characteristic of our company, I think, has been very strong asset quality that continues. On the one hand, almost not worth talking about it, it's so routine, but on the other hand, we're very pleased that non-performing assets in the entire company totaled only $651,000 at the end of the second quarter. Non-performing assets being only 10 basis points of our total assets and that's down from 11 basis points at December 31, 2003, both of which are well below the numbers for publicly traded banks on the West Coast. Asset quality remains a very important part of our management strategy.

We have continued our dividend program. We will be paying 16 cents a share, as previously announced, tomorrow, July 29th, which represents a half cent increase from the first quarter dividend and also represents the 25th consecutive quarter that we have not only paid a dividend, but the 25th consecutive quarter that we have increased that dividend by a half a cent a share. The dividend program, together with our share re-purchase activity, has really been the center of our capital management strategy and we continue to manage with that strategy in mind.

Finally, as we had earlier announced and is pointed out in the press release, we have applied to convert our Heritage Banks subsidiary from a state chartered savings bank to a state chartered commercial bank. This is largely a technical change, almost a non-event, because we have managed our company as a commercial bank from the beginning; the beginning meaning over the last 10 years or so, having converted from a mutual thrift going back in our 77 approximate year history at this point in time. We think the change, officially, to a commercial bank charter, while it won't change at all how we operate, we feel that it will contribute and enhance shareholder value over the long run.

In summary, we think that we continue to execute our strategies. They haven't a whole lot over the last few years, but we think that they've been working. Our particular objective has been to meet certain profitability objectives, namely getting our ROE to a point where we are considered to be in the upper level of performance while, at the same time, generating some asset growth, which we need to do, of course.

I'd be very pleased to respond to any questions that any of you may have and, again, just in so doing would call your attention - - but I'll save you the pain of reading the final paragraph in our press release narrative dealing with forward-looking statements. With that, Stacy, we'd be pleased to answer any questions that anyone has.

Ladies and gentlemen, if you wish to ask a question, please press *1 on the touch-tone phone. You will hear a tone indicating that you have been placed in queue. You may remove yourself from queue at any time by pressing the # key. Once again, ladies and gentlemen, if you have a question, please press *1 at this time. Your first question comes from the line of Ross Haberman with Haberman Funds. Please go ahead.

How are you, Don.

Just fine, Ross. I'm pleased that you joined in today.

I wouldn't miss it even though I'm here at the Conference for the World. It has come up in numerous meetings and conversations here about the prospect about the flattening yield curve and I was wondering, given that possibility over the next year or so, how do you see that affecting the margin and what are you doing with that prospect about positioning your balance sheet?

Thanks for the question. As noted in our press release, in my comments and in Brian Vance's comments, we think that, while not impossible, managing our margin will be challenging going forward. I'd like to call on Ed Cameron and Brian Vance, who manage our Money Market Committee at Heritage to offer their specific thoughts beyond that.

Hello, Ross. From an interest sensitivity standpoint, the company is not neutral, we're slightly asset sensitive and we think we're in pretty good shape. Two different banks with a couple of different profiles, but the combination of the two makes us asset sensitive. It'll be very good for Central Valley Bank and be closer to neutral for Heritage Bank in [inaudible] our sensitivity. I don't see a problem going forward.

Just one follow-up question, you grew about $32, $33 million net loans for the first half. Could you give us a rough breakdown of - - was there any significant changes in terms of the makeup of the portfolio and where you're seeing the best growth today?

We'll call upon Brian Vance to respond to that.

Really, the long growth has come from all sectors. I would guess - - and I'm looking at some numbers here - - it's, roughly, going to be about a third from the business loan sector in terms of first half growth, a third from the income property and, then, a third from all other areas, which includes consumer and construction and residential mortgages actually stayed about the same on the residential mortgage side. We're getting even growth from all sectors in the marketplace.

OK. Thank you.

Our next question comes from the line of James Abbott with Friedman, Billings, Ramsey & Company. Please go ahead.

Good afternoon, everyone.

Thanks for calling in. Are you getting lots of rain back there?

Well, we did, yes, a little flooding going on last night. I wanted to see if I could get a sense as to what the gain on sale of loans was for the quarter and if you could kind of characterize whether the gain on sale spreads increased? I know that, compared to the prior quarter, your non-interest income line item went fairly significantly, at least on a relative basis. I know it's off of a smaller base.

I'll call on Ed and Brian to comment on that, but, certainly, the first half of the year there was very strong re-finance and residential lending activity going on. The real estate market here, particularly in the South area of Puget Sound has been very - - I guess I could use the term - - hot, not because we've been having 80 and 90 degree temperatures, but just very, very strong activity and so we were able to benefit from that. Brian or Ed, could you respond specifically there to Jim's question.

I was just going to say, specifically, loan sale gains the first half of the year were at right at $500,000 for the corporation as it compared to just a bit over $1 million the same period last year, a lot of difference in volumes which has to do with, primarily, re-financing activities slowing considerably, especially in the second quarter. We've had some changes in our mortgage banking area as well with some changes in lending officers, some who have left the organization and moved on to other mortgage banking companies. We continue to be in the mortgage banking business. We think that we've made the appropriate adjustments on the expense side to deal with those changes and, quite frankly, we think we're pretty well positioned going forward. We probably won't see as strong a gain on sale as we have in the past, but I think we manage our expenses appropriately so that we'll still be OK there.

OK. Thanks. Maybe, if I could, just a follow-up question on that, on the non-interest expense line it was also up somewhat compared to the prior quarter. Is that sort of a function of - - I don't know if that's volume related and that will go down or if there is some of those expenses that were there for the bulk of the quarter, but now those individuals have left. I don't know, if you can give us some color on the non-interest expense line?

Are you talking about sequential quarters?

Yes. That looks like about $150,000 linked quarter increase, give or take - -

Yes. We still have substantial activity in the second quarter for the mortgage banking activities, commissions, if you will, etc., which I don't know the exact dollar amount but there were some significant dollars paid out in the second quarter for that. We continue to look for expansion activities in other markets. For instance, second quarter would reflect a new lender hired, a commercial lender hired in the Pierce County market. I think it's a combination of a variety of factors but, certainly, a resident from the mortgage lending activity did spill over into the second quarter.

OK. So is it fair to assume that expenses may remain a little bit stable going forward since mortgage banking activity may come down a little bit? The rest of it looks like it's a core expense.

I would endorse what Ed and Brian have commented, that we also hired one additional loan officer over at our Central Valley Bank subsidiary during that period of time. A couple of other significant factors that will impact us going forward, number one, as we talked about in the conference call six months ago, we are going through a process where we are converting. We are doing an upgrade of our existing data processing here at Heritage and we are in the process of converting Central Valley Bank onto the same system so that both banks will be on the same DP system. We've had some costs associated with that, some travel costs, some training costs. I don't have the specific dollar amount, but that has been an underlying expense. Certainly, going forward over the next six months, this whole Sarbanes-Oxley circumstance, I'll call it, increased accounting fees where the external auditor had to double-check the internal auditor to see if we've set up the right controls and that sort of thing. That is going to contribute some additional accounting expense during the last half of the year and, probably, going forward.

My sense is that some of the savings that we will see may be somewhat offset by these added Sarbanes-Oxley related expenses. We were just talking this morning that, company-wide, we have identified, really, about 10 positions that have either been eliminated or will be through natural attrition. Six of those, actually six in our mortgage support staff area, and we have an opportunity with a little turnover at Central Valley Bank where four positions have opened up and we think we'll only need to replace one. That will represent a savings but, again, probably, the expenses will stay about the same. As we look at the efficiency ratio, I'm hopeful we'll see that decline a bit because as loan totals grow, interest rates move up a little bit. We may see a little more revenue on the revenue expense side of that interest ratio, although that kind of gets under this category of those forward-looking statements. There's a number of moving parts to that, but I think, probably, our level of non-interest expense will, overall, end up staying about the same.

OK. Thanks very much. Actually, I think those are the basic questions that I had.

OK. We appreciate your phoning in with us today.

Once again, ladies and gentlemen, if you do have a question, please press *1 on your touch tone phone. Mr. Rhodes, there are no further questions from the phone lines at this time. Please continue.

OK. Thank you very much, Stacey, and thank you to those of you who did phone in and may still be on the line. We appreciate your interest in our company and are pleased to talk about it. We invite you to contact us at any time. We'll be pleased to respond however we can consistent with the rules of talking about what we're doing. We have, as you may be aware, had these conference calls on a semi-annual basis. The last one was in January, a year ago today, and so we would expect to have our next official conference call in late January of 2005, following the completion of our 2004 year. We appreciate your being with us. Thanks again for calling in and with that, Stacey, I think we'll conclude our conference call.

Thank you. Ladies and gentlemen, this conference will be available for replay after 3:45 P.M. today, through midnight, August 8, 2004. You may access the replay service by dialing 1-800-475-6701 and entering an access code 736530. Those numbers, again, are 1-800-475-6701, access code 736530. This concludes our conference for today and thank you for using AT&T Executive Teleconference. You may now disconnect.