Heritage Financial Corp (HFWA) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Heritage Financial Corporation earnings conference call. (Operator instructions) As a reminder, the conference is being recorded. I would now like to turn the conference over to our host, President and CEO Brian Vance. Mr. Vance, please go ahead.

Thank you, Reggie. And welcome to all that have called in to our semiannual conference earnings call. I would also welcome any of those that may be tuning in on an archived basis later. Attending with me here this morning is our Chairman, Don Rhodes, and also Ed Cameron, our EVP and CFO. And I may ask Ed for assistance as we go through this program.

Hopefully, you've had an opportunity to see our earnings release, our second quarter earnings release, which was released yesterday. And I'll be referring to quite a bit of information in that particular release. I also refer you to page 4 of that release, and our forward-looking statement. I will not read that statement, but ask that you keep that in mind as we work through the conference call this morning.

Those of you that have joined our conference calls in the past will recall our announced five-year strategic plan, and I'd like to just review that very quickly with you once again. Our five-year strategic plan is important to us on an ongoing basis and it's something we do intend to execute -- and that is $1 billion in total assets by year-end 2009; $14 million in net income -- all of these goals are by year-end 2009 -- focus on C&I lending. And I refer to C&I lending frequently, as most of you'll know; that's commercial and industrial lending. But our strategic focus is on C&I lending and growing DDA relationships, three new branches by the end of that five-year period, and continuing to maintain our high asset quality.

I'd like to talk a little bit about highlights of our second quarter earnings release, as announced yesterday. And just to review some of our performance, net income increased 4% over Q2 2006. Net loans increased 10% on an annualized basis. Deposits increased 12% on an annualized basis. And noninterest income increased 16% over Q2 2006. Net interest margin is stabilizing and we achieved a significant milestone towards our strategic goal of $1 billion in total assets by achieving a little over $900 million in total assets by the June 30 quarter end.

Some other financial metrics I'd like to share with you -- and I'll come back and expand on several of these here in a moment --

Diluted EPS for Q2 '07 to Q2 '06 was flat, but sequential quarterly diluted EPS was up 8.3%.

Efficiency ratio for Q2 '07 was 63.3% compared to 65.7% in Q1 of '7, and that's looking at our efficiency ratio on a sequential basis, so it was down a couple of points.

Nonperforming assets continue low at 0.18% for Q2 '07, down from 0.34% in Q2 of '06.

Net interest margin for Q2 '07 was 4.5% compared to 4.59% in Q1 of '07. So on a sequential basis, our margin declined 9 basis points, and I'll talk about that here in a moment.

When we look at earnings and EPS growth for the total company, the yield curve is a continuing challenge to all of us in the banking world. But I suspect that that yield curve is here to stay for a while, and I think all of us need to learn to successfully operate in that environment. And for us, I think that particularly means that we need to operate more efficiently.

If you annualize our first six months' performance in '07 and compare that to total '06, our earnings would not exceed that of '06. However, historically the second half of our year, on a performance basis, is typically stronger than our first half, and I would anticipate that to happen again this year.

Competitive forces continue in our local marketplace but we've been focused on increasing our loan yields on an incremental basis and have had some success in doing so just of late, and we're encouraged by those successes.

Our efficiency ratio-- while the efficiency ratio improved slightly on a quarter-to-quarter basis, we are continuing to focus on improving this particular important performance metric and we'd like to be below 60% on a run rate basis by this year end.

Nonperforming assets -- we're pleased with our overall asset quality. As mentioned earlier, we're currently at, as of June 30, 0.18%. I suspect when we see all banks reporting for our marketplace for the second quarter that that will be substantially under our peer group average.

I think this is something that, as we look at our nonperforming assets and look at the slowing housing market, that we need to be especially diligent as we manage our construction loan portfolio going forward. But we're comfortable about the overall asset quality of the organization.

Net interest margin -- I have talked about net interest margin on several occasions on a public basis. We had accurately forecasted our net interest margin erosion would decrease in Q2 and it did, just by 9 basis points. And that was, I think, fairly close to our estimates. And we think that there could be some continued net interest margin compression but we believe it will be modest on a go-forward basis.

Our net interest margin performance resulted from fewer CDs pricing as much as they have in the past as we approach a mature cycle of CD repricing. And we're also getting a little marginal improvement in asset pricing, as I mentioned earlier.

Return on equity -- this is a number that we need to improve on a go-forward basis. And when we look at improving our return on equity, I think there are three primary areas that we need to focus on -- reducing expenses in the overall company, improving our net interest margin, and continuing our quality asset growth.

Balance sheet growth -- we're especially pleased with the strong balance sheet growth that we've seen for the first six months of the year. Our primary asset growth continued, again, to be primarily in the C&I area. Deposit growth in the first six months actually exceeded asset growth, and we're pleased with this. As most of you know, deposit growth, especially in the community banking environment, is difficult and our deposit growth is exceeding our asset growth at this point. And we grew our deposits without any brokered CDs, and we have no brokered CDs on our balance sheet and we think that's an important performance metric as well.

Our growth in our transaction accounts, DDA, Now, and money market accounts, exceeded our growth in CDs for the first six months. So we're funding our strong loan growth without the expensive hot money in terms of, primarily, CDs or brokered CDs of that sort. Our branches continue to do an excellent job of overall deposit growth.

While we have not customarily given guidance on a year-by-year basis, our five-year strategic plan-- we are on a glide path for our five-year strategic plan to achieving the financial milestones of that particular plan. And as we look at the halfway point of that plan, I think the things that we have successfully done in that strategic plan are increasing the C&I lending and the DDA growth; improving interest rate sensitivity through increased C&I lending, We've been successful at new lender recruitment. Our new Sumner branch and acquisition of our Federal Way branch, or bank, in King County-- and we're well on our way to $1 billion in total assets.

As we look to the balance of 2007, I think there are several things that we need to continue to focus on for balance of year 2007. One is continuing to grow our C&I relationships, and I think we've been fairly successful at doing that. Credit quality has, and always will be, an important performance metric for us, and we need to continue our diligence in this area.

Continued commercial lending officer recruitment is important to us.

Starting construction on our new freestanding branch in Sumner should commence in the third quarter of this year. We would like to locate and option a second new branch site by the end of this year.

Continuing to improve our efficiency ratio, as we've talked about here this morning, as well as improving our return on equity.

And as always, that net interest margin is a critical performance metric to us, and we think we've made significant headway into managing our net interest margin and stabilizing the margin as we go forward.

As a reminder -- we had a press release earlier in the week -- that I am presenting at the Keefe, Bruyette, Woods Conference in New York City on August 1 at 2:00 and you could go to our website; it has specific information how you might plug into that conference on a live basis or on an archived basis as well.

That completes my comments, but I would be happy to answer any questions that you may have. And once again, I'd refer to the forward-looking statements as my responses to-- your questions may be forward looking and have you keep that in mind as well. So Reggie, if you would like to open up the questions I would be pleased to answer them.

Surely. (Operator Instructions) We do now have a question from the line of Ross Haberman with Haberman. Please go ahead.

Gentlemen, how are you?

Hi, Ross. We're doing well.

Could you give us a feel on-- I think your loans were up, for the first half, about $40 million, the net loans? Could you give us a feel on where you're seeing the best loan growth? And how big is your current development portfolio in (inaudible)?

Sure. I'll ask Ed, maybe while I'm answering the first part of your question, Ross, to get construction totals. I think on a percentage basis, they're about 10% of our overall loans. We've been ranging 9 to 10% over the last couple of years; I think it's currently at about 10%; I'll give you the exact dollar total here in a moment.

In terms of where the loan growth is coming from, we're seeing loan growth really spread across the company. And, again, it's primarily in the C&I area but we're seeing strong loan growth from both-- in the Heritage bank side from Pierce County and the Tacoma area, but also here in Thurston County, Olympia area. We've had nice, even grown from both of those markets.

With our Central Valley Bank affiliate, also have seen nice C&I lending, which is typically focused more in the agricultural markets, but they're seeing some very nice commodity prices this year and we see, across the board, commodity prices that have been stronger than several years, and we're encouraged by that. So I think we're seeing balanced growth throughout the company. Ed, do you have any specific numbers on construction?

Totals, we're at about $78 million right now. As you said, about 10% of the total loans.

Okay. And of that, is most of that spec? Spec construction?

I wouldn't say most of it; when we talk construction lending, Ross, it's broken down probably into A and B, which-- acquisition, development, financing of-- that's kind of what I call the dirt side of it -- that's getting the lots acquired and developed. And then the other half is the spec construction lending. But on the spec side, we still have a good number. I couldn't give you an exact number, but a lot of that is on a presold basis with our builders still building on a presold. So I'm sorry, Ross, I don't have a specific number as to what spec is versus A&D. But it's probably-- just off the top of my head, it's probably a little larger number, spec is, than A&D, but I--

It's probably around 25% of total construction, of everything we do.

Is it 25% of the 78?

Yeah.

Okay.

And also in that construction lending, Ross, I need to add is that we do have commercial construction where we have office buildings, owner-occupied office buildings, those sorts of things that could be under construction as well. That's included in that $78 million.

What's your inclination -- is that overall 10% construction going to grow, be about the same, or shrink? What's your inclination for that category going forward?

On a percent of total portfolio basis, I would be surprised that it would grow. I think that's-- again, for the last two or three years, we've been between that 8 and 10% number very consistently, and I would anticipate that we would stay within that 8 to 10%; I would not anticipate that it would grow much beyond where it is.

And just one last question. What is your thought-- I think you said you bought back 20-some-odd-thousand shares? Was that over the last quarter?

Yes, predominately over the last quarter, Ross.

And how much less-- what is your inclination in terms of using the excess funds for that as opposed to hitting $1 billion in assets first?

One of the things I think we need to look at is our capital ratios, and they continue strong. But I think that as we continue to focus on growing the overall balance sheet, we need to keep that capital management category in mind. I think we've stated previously that our purchases, our stock repurchases, going forward are going to be much less than they have been in the past, and I think 2006 and year-to-date 2007, if you were to look at our stock repurchases in the last 18 months, on an average I would anticipate that it would be close to that on a go-forward basis. So I don't think you're going to see a lot of change in our positioning on stock repurchases. We will still continue to do some, but probably pretty similar as we have in the last 18 months or so.

Are you currently in the market today? Not today, but recently?

We'll be back next week.

Yes.

Got it; okay. The best of luck. Appreciate the time, guys. Thank you.

Thanks, Ross.

Thank you. Our next question comes from the line of Sara Hasan with McAdams Wright and Ragen. Please go ahead.

Hi, guys.

Hi, Sara, how are you?

Hi, Sara.

Good, how are you?

We're doing well.

Good. Your expense control versus the first quarter seems very good and-- even actually versus last year. And I'm just wondering, is there anything unusual about this quarter or last quarter that wouldn't lead me to believe that's a reasonable kind of run rate, thereabouts?

I guess, Sara, as I indicated in my comments, when we look at improving our return on equity and just our overall performance, I think as a company we need to focus on more active management of expenses across the board. And as I indicated, I'd like to see our expense ratio-- excuse me, our efficiency ratio on a run-rate basis below 60 by year end.

In terms of just where that's coming from, it's really across the board. I think it's all areas. Staffing, of course, is a big piece of expenses and we're looking at staffing expense. We're looking at contractual expense, whether it's data processing-- There's just a variety of things that we're really focusing on as a company to reduce that overall expense. It's an important focus of ours right now.

Okay, thank you.

You're welcome.

All right; thank you. (Operator Instructions) And we have a question from the line of [Katherine Wood] with D.A. Davidson. Please go ahead.

Hi, everybody.

Hi, Katherine; how are you?

I'm good. I'm just here to say hi because my question's been answered. Thanks so much.

Oh. Well, thanks for tuning in. We appreciate your interest.

Thank you.

Thank you. And at this time, we have no further questions in queue; please continue.

Well, I certainly appreciate those of you that have tuned in today. We became aware, after the scheduling, that there were a number of conflicts out there with our conference call. And I apologize for that, and going forward, we'll try to anticipate that. Sometimes it's hard to know when others are scheduling their conference calls, too. But I do appreciate your interest and willingness to tune in today and happy to answer your questions. Hope to see you again in the future. Thank you very much.

Ladies and gentlemen, this conference will be available for replay after 1:30 p.m. today until August 15, 2007, at midnight. You may access the AT&T Executive Playback service at any time by dialing 1-800-475-6701 and entering access code 878993. (Operator repeats numbers) That does include our conference for today and thanks for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.