Heritage Financial Corp (HFWA) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Heritage Financial Corporation earnings conference call.

[OPERATOR INSTRUCTIONS]

I would like to turn the conference over to our host, Mr. Don Rhodes. Please go ahead.

Thank you, Julie. This is Don Rhodes speaking, Chairman and CEO of Heritage Financial Corporation. Good morning to you, or good afternoon, depending on what time zone you happen to be located in. Also, I want to give a welcome to those who may be not on the line today but who may phone in over the next week to 10 days to listen to this particular program.

Also present with me is Brian Vance, who is President of Heritage Financial Corporation and President and CEO of Heritage Bank, along with Edward Cameron, who is Senior Vice President and Chief Financial Officer of both Heritage Financial and Heritage Bank. Brian and Ed will be available later when we get to the question and answer part of it.

I would like to just make some overview comments, and then we will be pleased to respond to your questions. My overview comments will be somewhat brief. But also note, I am assuming that everyone has seen the press release so I will not cover every detail that is in that press release. But just call your attention, also, as shown in the press release that we were in New York yesterday for an investor conference sponsored by Keefe Bruyette Woods.

Our full presentation was webcast, along with the other presenters and is available for your review or review by interested parties on the KBW website, which is accessed at www.kbw.com. Click on "Investor Conference," and if all goes well you will be able to dial-up our particular webcast, or program we presented. I would also like to call your attention on the bottom of page 4 of the press release, the statement concerning forward-looking statements. There's a reason I particularly want to read this to you today.

This presentation today will include statements concerning future performance, developments or advance 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 may cause actual results to differ materially from stated expectations. We hope that doesn't happen, but it could happen. Specific factors include, but are not limited to, the effect of interest-rate changes, risks associated with 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. With those weasel words behind us, which I know all of you have heard on many occasions, I would just offer these comments. I want to start the comments today primarily looking at the future and then we will come back and look at the first six months.

As noted in our January 27, 2005 conference call, we achieved some important milestones during 2004m which included the conversion of Heritage Bank to a commercial bank charter, which then converts us totally to a commercial banking organization. And most importantly, we achieved a financial goal that we have been talking about for the last four years, which was to reach a target of 15% return on average equity by the end of 2005. As you heard at our January call, we actually achieved a 15.8 ROE by the end of 2004, a year ahead of schedule.

As a result of that, a new strategic planning effort was undertaken under the effective leadership of Heritage Bank President Brian Vance, who met with a number of our officers, got other input, and last November, we took our recommendations to our Board of Directors, which was approved for our targets for the next five years to be achieved by fiscal year-end 2009. Key among those targets, looking forward, were the following.

First, to continue our quality earnings growth. Our specific net profit target is $14 million by fiscal year end 12/31/09, while at the same time maintaining a 15% ROE. Secondly, we wanted to put a little more emphasis on growth. Our target is to reach $1 billion in assets. We think that is an important threshold to have on the radar screen.

As you may recall, over the last three or four years, we have not opened any new branches. We have hired some new loan officers who have added asset totals to our company, but we have not opened any new branches because we wanted to put the primary emphasis on profitability and reaching our ROE goal. But as we look ahead over the next five years, we would expect that we could open two or three new branches to put a little more emphasis on growth as long as we continue to meet our 15% ROE number.

We would also consider looking at acquisitions if they made sense and were the right situation, and were contiguous to our current markets and in the growth patterns that we're looking at in the Pierce County, primarily, and the South King County area north of us, here in the South Sound area. Third, part of our plan will be to continue our capital management strategy through stock repurchases and dividends. Of course, I call your attention to the forward-looking statement. These decisions are decisions our Board makes on a regular basis, and we take a look at those at least on a quarterly basis.

But at this point in time, we would expect to continue our capital management strategies, recognizing as noted in the press release, that our stock repurchases have slowed considerably over the last year. For one reason, although we think share repurchases at this particular level are still accretive to earnings, they're just have not been that many shares that shareholders have put out there on the market place for us to buy. So that certainly has been a factor. Fourth, in our overall objectives going forward, is to maintain our historical high asset quality standards, which certainly, as you note, in the first six months of this year we have done.

We have now completed our first six months with these goals in mind. And as noted in the press release, I think the following highlights suggest that we're moving along nicely toward those objectives that I outlined. First of all, our earnings per diluted share increased 15.3% versus the same period a year ago. And our actual net income was up about 12% over the first six months of last year. Our ROE in the first six months of 2005 reached 15.91%, which was compared to 1473 for the first six months of last year and compared to 15.8 for the entire 2004 year. So we saw continued growth in our ROE number.

We have, as I mentioned, some ambitious goals to grow up to that $1 billion size range. And during the first six months of this year, our assets grew 3.7% just during the first six months and were up 8.5% compared to a year ago, June 30th in 2004.

Asset quality remains very strong, with a very low level of non-performing assets. We expect to continue to manage conservatively and aggressively to maintain that particular standard. More importantly, although we are seeing a challenge, nevertheless our net interest margin remains above 5%. And Brian Vance and Ed Cameron are doing a great job of managing our pricing committee and taking the steps to manage both sides of the balance sheet to keep that very important margin at that 5% level.

In summary, I think we had a good solid first six months, a good start very early in our five-year plan toward meeting the objectives we have to reach at the outside by 2009.

I think with that, I will stop any comments that I have here and would be pleased to respond to specific questions that any of you who are on the line might have. And again, I invite you to keep in mind as we try to answer your questions as candidly as we can, that you keep in mind the statement regarding future performance that you find on the bottom of page 4 of your press release.

With that, Julie, we'd be pleased to respond to any questions that anyone might have.

Certainly, thank you.

[OPERATOR INSTRUCTIONS]

With that being said, we will go to the line of Jim Bradshaw from DA Davidson. Please go ahead.

Good morning.

Good morning, Jim.

I have a couple questions. First was on the operating expense line or non-interest expense line, it was a little higher than we assumed and jumped up a little bit from Q1. Can you talk about what were the drivers of the increase in the quarter?

Certainly. I'm going to ask Ed Cameron to address that or Brian, if you will please. While they are giving that some thought, what was the second question that you had?

The second question was, I hear your caution about margin given the flat-yield curve and the slower buyback activity. It looks like those two things will dampen the rate of EPS growth in the second half. You had a really strong first half relative to first half last year. But the comparisons from the second half of last year are tougher. So, just your overall thoughts on the rate of growth might decelerate in the second half?

I'll -- certainly Ed and Brian can comment on that. But I think you're right. Certainly with us having repurchased over 50% of the shares outstanding in March of '99, our pretty aggressive share repurchase program has been a very important factor in our EPS growth. But that -- continuing to grow our earnings per share is still a very, very important objective to us. We're just going to have to -- while I would expect that growth may not be as rapid over the next couple, three years as it has been because our share repurchases will have slowed, we hope to continue with good, solid profitability and see good, acceptable earnings per share growth going forward. Ed, do you have any thicker additional comment there?

Not on that, no. I will talk about the expense number. Jim, on our non-interest expense, one of the categories that we have that is most difficult for us to project are the deferred loan fees. And a good hunk of our loan growth, particularly in the second quarter, has been in the construction area, like it has everywhere else. And the loan fees there, the deferrals there, are much lower than say, for term real estate deals, which our focus is actually more on C&I rather than term deals these days. So, we are not deferring the same level of loan fees and therefore deferring the same level of expenses that we have been experiencing. So one of the - actually, probably the main reason for the expansion increase in the second quarter is just that. Lower deferred expenses-- excuse me, lower deferred expenses.

Got it. So if you see the shift in the loan mix or an acceleration in production volume in the second half, that would start to level back off then, I guess?

Yes, it would. Another issue that -- actually Mr. Rhodes just flashed in front of me, is we do not have the Sox 404 expenses in the second quarter that we did have. That should help us going forward, as well.

Jim Bradshaw Yes, it will. Thank you. I appreciate it. Thanks very much guys.

Jim, this is Brian. An additional comment to one of your questions as to EPS growth going forward. I think it is probably contingent on two things. One is asset growth and two is maintaining margin. And maintaining margin in the flat yield curve we are experiencing is increasingly difficult. But I think we have done a pretty good job. And it will certainly require focus going forward.

To the asset growth side, you may recall that we have brought on an additional lender in Pierce County. And we think there are some opportunities for asset growth that he may bring the organization, which -- let's look -- sometimes that does not happen day one. But he has a very strong presence in our Pierce County market. We believe his contacts will begin to bring in some significant business. May not a little bit in the third quarter, but may not starting to gain steam until the fourth quarter or maybe, first quarter next year. But I think there's an opportunity for asset growth there.

Thanks Brian.

Brian Vance. Thank you, Jim.

Thank you. We will go to the line of David Rochester with FER. Please go ahead.

Morning guys. Just a couple of questions, going back to your comments on the margin in the press release. It sounds like you're looking for something below five. I was just wondering if you could give a little color or quantify what is going on the funding side in terms of CD costs, what the average was during the quarter, and where you guys are pricing these things at this point in time. And on the flip side of that, on the asset side, what kind of upward re-pricing did you see in your loan portfolio?

It's Brian responding to that question. David, one of the real key pieces to our strategic plan going forward is certainly asset and liability management, specifically as it pertains to liabilities or deposits. We have implemented, late first quarter or early second quarter this year, a fairly significant strategy shift in our asset liability management in both loans and deposits. This strategy is with a fairly sophisticated pricing model that we are pricing all of the - on a -- product by product on the liability side and loan by loan on the asset side.

Those strategies that we are employing, especially as it pertains to CDs, focus being in the lower third from the market competition basis for all of our CD families but then offering specials in certain categories that we want and need to achieve CD growth. By doing that, those deposits that are not interest sensitive, and many of them are not for a variety of reasons from our depositors, aren't re-priced at that typically high rate we have to have to go out and acquire new dollars. We're seeing the fruits of that strategy really start to play true in our margin. That will be important part going forward. On the flip side of that, being able to have a little better insight into pricing each and every loan that come across our desks. And doing so with a little bit of creativity so that we can be a little different in the market place I think will help us with margin on the asset side going forward.

Okay. Thank you for that, by the way. Just going back to loan growth. Going forward, you mentioned a lot of the strength this quarter was in construction. Are there other areas of strength for the past quarter? What do you see going forward for construction and the other categories?

This is Brian again. The construction activity in this particular market area continues strong, as it does in most areas of the country. We're monitoring the risk aspects of that. We do not see a lot of speculation, especially in the residential side yet in this market. I'm sure there is some out there but not to the degree that apparently is present in some of the other areas in the United States. But I think that construction activity will continue. We look at that risk issue pretty close and I think choosing the markets that we're doing business in and the borrowers we're doing business with is critical to that aspect. Additionally, our strategic plan going forward has been much more of a C&I commercial industry focus. And I think that we have been successful there. What we have focused on that in the past, I think we continue to focus away from income real estate properties or commercial real-estate concentrations to more of a C&I variety. We're beginning to see some fruits of that focus, as well.

Great. Thank you very much.

This is Ed Cameron. I just wanted to add one comment. One of the things that we're working hard at to mitigate our margin squeeze is increasing our non-interest bearing demand. That goes hand-in-hand of course with the C&I push. We've had some success at that. It is very difficult to actually grow your DDA as a percentage of total deposits because we're growing everything. We have increased it from 12% on average in the first six months of last year to 13% on average in the first six months of this year. We have some pretty aggressive goals that continue to increase that as a percent of our total deposits. We look to that to mitigate the margin squeeze.

David, any other questions?

No, that is it. I appreciate the color on that.

We appreciate your listening in.

Thank you. We have no further questions on the phone lines.

All right. We want to again thank you, Julie, for coordinating for us here. And thanks to all of you who phoned in. Jim and David, we appreciate your questions. We'll look forward to your reviewing our ongoing progress here as we try to work toward these goals we set for ourselves. We appreciate very much your participation. We will talk with you next time. Thank you.

Thank you. Ladies and gentlemen, this conference will be available for replay after 2:30 p.m. Pacific time today through midnight August 5, 2005. You may access the AT&T Teleconference Replay System at any time by dialing (800) 475-6701 and entering the access code 786762. International participants dial (320) 365-3844. Those numbers again are (800) 475-6701 and (320) 365-3844 and enter the access code 786762. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.