Heritage Financial Corp (HFWA) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Heritage Financial earnings call. [OPERATOR INSTRUCTIONS]. I would now like to turn the conference over to your host, Mr. Brian Vance. Please go ahead.

Thank you, Lisa. I'm Brian Vance, President and Chief Executive Officer of Heritage Financial. I would like to welcome all of you that have joined into our earnings conference call this morning and to those of you that may also call in at a later date and listen to the recorded version. Attending here with me this morning is Don Rhodes, Chairman of Heritage Financial and Ed Cameron, Executive Vice President and Chief Financial Officer. Hopefully all of you have had an opportunity to see our press release that did go out yesterday. In that press release, you will see the normal forward-looking statement that is part of the disclaimer and I would refer you, I won't read that forward-looking statement, but I'll refer that statement to you as we will be making forward-looking statements this morning, and as we go into the question-and-answer period later, I would also refer you to the forward-looking statement.

Those of you that have joined in on previous earnings conference calls with us over the past several years, you will remember that we quite often talk about a strategic plan that we have implemented, and we are currently operating under a strategic plan that is through year 2009. We are now in the second year of that strategic plan. And I'll remind you, just a couple of particular milestones to that plan was that we hoped to have in excess of $1 billion of total assets by 2009. We had strived to maintain an ROE of 15%. We would like to focus on commercial and industrial lending, commonly referred to as C&I lending and growing our DDA relationships as a strategic focus of the Company. We hope to build three new de novo branches during this five-year period, and we certainly want to maintain high asset quality throughout the time frame of the strategic plan.

We have now completed the second year of this current strategic plan initiative, and I would like to highlight just a few things of what we believe are significant accomplishments that are consistent with our strategic plan. Last year, we had net loan increases of about 15%. We had DDA increases of demand deposits or low-interest or no-interest checking accounts, and those increased about 22 2% over previous year. We're quite pleased with that execution of our strategic plan. Our C&I loan production was up about 53% 2006 over 2005. Again, I think evidence that we are executing the strategic plan. Non-interest income had an increase of about 20% over previous year. And our loan loss allowance increased from 1.3% to about 1.35% of total loans.

Other notable financial metrics, and I will list several of these, and come back and talk about each one of them in just a bit of detail, and all of these numbers are annual numbers. Net earnings, as you saw perhaps in our earnings release was $10.547 million, essentially flat over 2005. Diluted EPS was $1.60 in 2006 compared to $1.65 in '05. Efficiency ratio increased to 61.9 over 59.7. We had a slight nonperforming asset increase from 0.16% to 0.36%. Net interest margins declined from 5.08 to 4.83, and likewise ROE declined from about 16.1% to about 14.1.

While all of these numbers I have just mentioned reflect some decline in trends, we believe there are mitigating factors to each one of these items and likewise, though, they're fairly consistent with our strategic plan. I would like to talk about each one of those briefly. Earnings and EPS growth, first. Flat earnings this past year were caused by a flat yield curve. We realized that all banks today are dealing with the flat yield curve. But within our portfolio, as you may know, we have a relatively large portfolio of commercial real estate loans, which tend to be fixed rate loans. And the flat yield curve causes our deposits to reprice and move up. And as a result, margin has slipped a little bit. And because of the larger commercial real estate portfolio, we continue to be subject to conduit refinancing activities that has, while we had a net loan growth this past year, the conduit refinancing has really affected that overall portfolio. The net growth of our portfolio, which, of course, has affected earnings as a result.

Certainly growth initiatives that are consistent with our strategic plan have impacted earnings and EPS growth. Those growth initiatives, such as our new Sumner branch, four new lenders hired within the past 12 to 13 months, and some of these lenders and certainly our Sumner branch are not yet accretive to net income, but we believe they will be in the near term. This past year in 2006, we had increased ISO expense as a result of new accounting changes that amounted to about $335,000 of additional ISO expense this past year. And certainly competitive pressures in our marketplace in terms of acquiring asset growth has caused our margins to narrow as we have not been able to achieve the loan yields that we have historically, and likewise we have not been able to achieve many some cases loan fees that we have historically enjoyed with the loan growth. And also this year, earnings and EPS growth was affected by a lower than originally planned stock repurchase program.

Our efficiency ratio, while we believe the Federal Way acquisition added somewhere between $0.03 and $0.04 to our EPS and was accretive in the calendar year '06, our growth initiatives did impact our efficiency ratio and that was expected and certainly was strategically planned. Nonperforming assets, I indicated a moment ago, they increased to 0.36% during the year, up from about 0.16. That 0.36, we believe, is still very comparable to our peers in our marketplace, but within the last couple of weeks, we have managed that nonperforming assets down by about $1 million which is back in-line with our numbers. In addition, many of you realize and know that the Federal Way acquisition was a troubled bank and those loans were integrated into our portfolio this past year and added to our nonperforming assets slightly. But at the same time, we've been managing through that portfolio and we believe the portfolio is well under control from an overall quality point of view.

Net interest margin compressions during the year certainly were impacted by the continuing yield curve, the competitive pressures that I mentioned earlier, and I think as well a strategic focus on C&I lending. As we focus on C&I lending, quality C&I loans typically sometimes are prime plus zero and some cases a prime minus to acquire quality loans and that has the affect of compression in the near term to margin. Our ROE was also impacted this last year, our return on equity, it declined a bit as I indicated earlier. Certainly the narrowing margins, the conduit refinancing, flat profitability had an affect on our overall ROE. Our increased equity position, our equity position, equity assets introduced from about 8.8% to about 9.2%, and that, coupled with lower than planned stock repurchases certainly had affect on our overall EPS as did the growth initiatives that I've talked about several times already.

While we have not in the past given guidance on a year by year basis as it pertains to our strategic plan, on a retrospective basis and looking at 2006, I can share with you that we have met many of the strategic and financial plans that we had in place with our original strategic plan as it pertained to the 2006 numbers. A couple of highlights there, I've talked to earlier about the increased C&I and DDA growth was certainly consistent with our strategic plan and was on course in terms of our growth there. The C&I lending has had the effect of improved interest rate sensitivity, but the flat yield curve has masked that improved interest rate sensitivity and was part of the reason for compression on our net interest margin, but certainly is consistent with our strategic plans. New lender recruitment has been consistent and on schedule with our 2006 goals, as was the new Sumner branch and the acquisition of the Federal Way bank. And we've achieved our net profit milestone in '06 as it compared to our original strategic plan for '06.

As we look to 2007, we will continue to focus on executing our strategic plan. We will continue to build on the strong foundation of credit quality and fundamental business relationship lending. We fully realize that we have not been as active in the construction lending in the past few years as many of our peers in this particular marketplace, and as you know, construction lending typically has prime plus one and in many cases prime plus two pricing, with at least a 1% fee. And we believe that has had the effect of assisting some of our peers with margin stabilization, or in some cases, margin growth as well as loan growth.

Our construction lending portfolio remains at less than 10% of our total portfolio. And while we realize that we may have left some opportunities without participating in the construction lending activities to the degree that some of our peers have, we believe it was a conscious and strategic decision that has been consistent with our overall strategic plan, where while we focused on more fundamentally sound and more predictable C&I lending activities. We will continue our expansion in South King County at the location of our Federal Way branch with more lending capacity, improved marketing, and more community involvement. We will continue our business lending recruitment efforts in 2007. We hope to start construction on our free standing branch in Sumner. While our branch is operational in Sumner and is exceeding our strategic goals, it is in a leased facility in a walkup facility without a drive-in and we believe when we build our free stranding branch with a drive-in, we'll have the increased visibility and increased performance from that particular site. Hopefully or possibly locating and optioning a second branch site during 2007. One of our focus will be continue to improve our efficiency ratio as our new lender's portfolio and our Sumner branch becomes accretive to income.

Our growth initiatives may not allow us to maintain a 15% ROE in the short run, but we believe those growth initiatives will create more acceptable EPS growth going forward. Our net interest margin, while it's been a challenge, we see that as continuing to be a challenge for at least the first six months of this year due to the flat yield curve and some of the competitive pressures that I've mentioned earlier. That concludes my overview remarks.

I would be happy to answer any questions that you may have. I would once again refer you to the forward-looking statement comment and likely some of my answers to your questions may be forward-looking in their nature and would point out that disclaimer. So thanks for listening. I would welcome your questions. Lisa, we'll take questions from the audience.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from the line of Jim Bradshaw with D.A. Davidson. Please go ahead.

Good morning. A couple questions. First off, Ed, tax rate in the fourth quarter was a little higher than I was expecting. Is that the normal run rate now, or was there anything unusual in the number this quarter?

No, we chewed up for the fourth quarter, we got ourselves into that 38% tax bracket.

And Ed, in '07, is that what you think the likely tax rate is for the full year in '07?

Well, it's just moved up to 35 for the full year in '07.

That's what I thought.

And we probably should have provided it a little more earlier in the year, so we had to chew it up in the fourth quarter.

Perfect. And second, Brian, could you give me a little bit of color on how you think loan production is trending and especially in light of also maybe you could give me an idea of whether you think you're starting to see conduit refinance activity tapering or decelerating or accelerating from here. So just from a net loan growth perspective, if you could give me a little color on when your outlook might be for a while.

Sure, be glad to, Jim. First of all, we had some strong loan growth very late in the month of December. That shows in focal date numbers, but obviously didn't add to our averages, our monthly or 12-month average. I think that gives us a pretty decent start for January. As we look at our pipeline for the first quarter in terms of active deals that we believe will result in loan bookings, we are fairly comfortable that that pipeline remains strong and perhaps a little stronger than it has been in the last couple of quarters. Certainly, Jim, our challenges has been as I've indicated in the conduit financing, we have seen that begin to slow down a little bit, but we also have seen ten-year fixed rate conduit financing out there in the low 6s and sometimes even in the high 5%. That's been a number heretofore that we haven't been willing to compete with. So I won't say and I don't believe it is over, but I'm hoping that it has slowed.

Perfect. Thanks very much. Appreciate it.

You bet you, Jim. Thank you.

Thank you, our next question comes from the line of Ross Haberman with Haberman Fund. Please go ahead.

Good morning, gentleman. How are you?

Doing fine, Ross. How are you?

Okay. Could you tell us what you're doing or what you're planning to do -- you're doing a good job growing the core deposits, what are your plans to further enhance that growth? And could you just touch upon Federal Way, what kind of runoff have you seen there and sort of the local competition in that specific market?

Sure. Just a comment on core deposits first. As I indicated earlier, Ross, I think the most important core deposit we have is that DDA account. We got that at a 23% rate last year. We're pleased with that. That will continue to be a focus of ours going forward. In terms of just core deposits in general, I think from an overall competitive point of view, we do a pretty good job of overall deposit growth in where it is. We do not have any so-called hot money, brokerage CD, with the exception of Federal Way, and I'll come back to that. But we have a nice mix of DDA growth as well as other interest-bearing transaction accounts and CD growth. When I look at that growth historically, it's been pretty balanced and I think coming from the right areas as opposed to just not all CD growth. So I'm pleased with that and I think that will continue as we move into '07.

Federal Way, we knew when we acquired Federal Way that there were some brokerage CDs and a few of those, there are a variety of maturities up to a couple years out there, and a few of those are beginning to run off as expected, and we're choosing not to replace those with brokerage CDs, so I think we'll likely see a little bit of run off this in that particular branch, but that was planned for and known from the beginning. Local competition in Federal Way, I think we've put and assembled a good lending team there. We just augmented it with an individual recently and I think that with some increased community presence in advertising, I think we'll continue to grow that particular franchise.

Ed, do you have any comments on core deposits, anything additional?

I don't have anything to add to that, no. Those deposits in Federal Way were primary credit union deposits they relied on heavily, and we're letting them run off, Ross.

The brokered ones?

Right.

Would you say that that operation is profitable at a branch level?

Absolutely. Really, almost from day one, it exceeded our expectations from a profitability point of view. As I indicated earlier in my comments, we believe it was accretive to calendar year EPS by $0.03 to $0.04 roughly.

Thank you.

Thanks, Ross.

Thank you. [OPERATOR INSTRUCTIONS] We have a question from Rob Longnecker with Barrington. Please go ahead.

Could you give a little bit of color in terms of what happened with the nonperforming asset, and then it sounds like there was a bit of a recovery there as well?

Certainly. Nonperforming assets, as I indicated earlier, increased from about 1.6% [sic -- see press release] of total loans in '05 to about 0.36%. I think even at the 0.36%, we're well within norms of our local peers in this marketplace. A portion of that NPA increase came from the Federal Way acquisition, as I indicated, that was commonly known as a troubled bank. A portion of those NPAs came from that source. And as I indicated recently, we were able to manage out of through payoffs about $1 million of NPAs, which now has lowered that back down to a very acceptable level of 0.15, 0.17, somewhere in that area. And we do not see any loss in those existing NPAs. So we feel very comfortable about overall credit quality of total organization.

Of the increase in the $1.2 million, how much of that came from Federal Way, roughly?

Roughly about half of it, maybe a bit less, but about half.

Okay. Just as a comment, you guys were saying that your competitors have been into construction and you have been away from that, I don't view that as a negative. I think that's probably a nice conservative thing to do.

Well, thank you for your comment. Not meaning to parse words, I don't think we have necessarily stayed away from it, we have been active in that market, but not nearly to the extent of our peers and I think that was the point of your comment.

Yes, exactly.

Thank you.

Thank you.

We have no further questions at this time. Please continue.

I have no additional comments, and so if there aren't any additional questions, I thank all of you for calling in and attending today. I appreciate your interest in our company and your continued support with your investments in our company. So thank you very much, and we'll talk to you next time.

Thank you. Ladies and gentlemen, this conference will be available for replay after 12:45 p.m. today through February 12th. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 857278. International participants, dial 320-365-3844. Those numbers again are 1-800-475-6701 with the access code 857278. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.