Heritage Financial Corp (HFWA) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Heritage Financial Corporation earning call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Brian Vance. Please go ahead.

Thank you, Robert, and thanks to all out there that have tuned in. There are several on the call and I appreciate your interest in our Company and would also welcome any of those that may tune in later on our recording in our recorded version. With me today is our Chairman of the Board, Don Rhodes, and then our Senior Vice President CFO, Don Hinson. Hopefully you have all had the opportunity to see the press releases that went out yesterday. There were two of them. There was the press release on our earnings and also a separate press release on our dividend, stock -- cash dividend announcement as well. And in those earnings we have the obligatory forward-looking statement that I will not read, but I will certainly refer you to that statement through the duration of this particular call.

I would like to start out by just talking about some highlights of our performance for the fourth quarter and for the year as well and then I will expand on each of these a bit as we go through our discussion this morning and certainly be willing to open it later for question and answers. Net interest margin increased to 4.67, I'm sorry, 4.67% for the quarter ended and 4.39% for the previous year quarter end. The fourth quarter was our fourth consecutive improvement in our net interest margin and we are pleased with that. Core efficiency ratio improved to 59.8% for the quarter ending and 61.24% for the prior year quarter ending. Many of you will remember that it has been our goal to have a core efficiency ratio below 60% and we were able to average that for the fourth quarter. Our core deposits grew 15% year to year. And our nonperforming assets decreased to 0.57% at year-end from 0.93% the previous quarter.

Our risk-weighted assets increased, our capital ratio increased to 13.73% from 10.55% at quarter end September. And then our year-to-date 2008 net income was $6.4 million versus $10.7 million for 2007. Talk just a little bit about earnings. As you saw in the earnings release we posted a quarterly loss for Q4 of $194,000. That's our first ever quarterly loss as a public Company. But I certainly would like to draw your attention to the fact that we posted a respectable $6.4 million in net profit for the year. Our total loan loss provisions for 2008 was $7.4 million, which compared to a 2007 total provision of $810,000, a significant increase. Even though our nonperforming assets went down for the quarter, we felt the substantially increased provision was necessary in view of increasing problem loans.

But this also allowed us to increase our loan loss allowance to 1.91%. Early in 2008 we recorded a total of $1.260 million in impairment charges, which were -- which we elected to take as a redemption in kind from the Shay fund. But additionally during the fourth quarter we took an additional impairment charge on those same assets of approximately $668,000. Despite these earnings challenges this past year, as I indicated before, we were able to post a respectable profit and a core return on equity of 8.39%, which we believe when all of the earnings releases are in the Pacific Northwest is going to be a, one of the stronger overall earnings performances in our peer group. I would like to talk just a little bit about our balance sheet. We believe we have one of the strongest overall balance sheet strengths among our peers in the Pacific Northwest. And at year-end we have no debt on our balance sheet, no FHLB borrowings, no trust preferred, no short-term debt, no long-term debt, simply no debt.

With the exception of $556,000 in reciprocated Cedar CDs, we have no brokerage CDs on our balance sheet. We don't own any trust preferred securities. We have a loan to deposit ratio at year-end of 94.9%. We have a pure deposit ratio, that's all deposits less all CDs, of 58%. During this past year we decreased our total CDs by approximately $13.4 million. And during this past year we grew transaction accounts, DDA savings, money markets by 14.8%, very strong growth in transaction account deposits. Despite allowing our, allowing about $13.4 million run off in CDs, we grew total deposits 6.2%. And I would add that it was a conscious effort on our part in terms of pricing efforts on and not matching high rate CDs in our market is why we are able to reduce the CDs by that total, but yet still grow total deposits by a respectable amount.

As of year-end we held $29 million in overnight interest bearing funds at the Fed and FHLB and we have total construction exposure of 16.2% with only 8.8% represented in residential one to four family construction and that includes land development loans. Talk just a little bit about -- and incidentally, we grew, net loans grew at 3.2% last year as well. Speak to net interest margin for just a moment. As indicated earlier we were able to improve our net interest margin each in the, of the last four quarters. As of September 30, our net interest margin was the sixth best margin among 38 western banks covered by the DA Davidson Company. We suspect that our net interest margin position, once Q4 data is in, will even improve over what it was for Q3. We were able to improve our net interest margin over the past four quarters as a result of a variety of things, one rate floors in most of our floating rate C&I loans protected us on the down side with some very strong prime rate reductions during this, during this past quarter.

And our overall liquidity allowed us to selectively and conservatively price our deposits as opposed to being out in the market with the highest rates in town. We believe that our depositors are aware that higher rates mean higher risk and are willing to trade risk for a bit less yield. Noninterest expense, speak to that for a moment. Our impairment adjusted total noninterest expense for the total Company for last year was $28.5 million compared to $28.3 million for the prior year, an increase of total noninterest expense of only 0.7%. We think that's an achievement that is particularly noteworthy. Overall salaries and benefit expenses for 2008 were $75,000 less than that of 2007. Noninterest expense control has been a focus of ours and this attention to expense control has allowed us to post a core efficiency ratio of 59.9% for Q4, which as I have stated has been our long stated goal.

I would like to speak to loan quality for a bit. First of all, we had a FDIC exam in December and an annual internal credit exam just prior to our FDIC exam. And at year-end our NPA levels were only 5.4 million, which were represented primarily by three single family construction projects. More specifically, our other real estate owned category was approximately $2 million and our nonperforming loans were approximately $3.4 million, which comprises the total of $5.4 million in nonperforming assets. Using those same DA Davidson statistics for average nonperforming asset ratios for west coast banks for Q3 was 3.96% and I would suspect that it will go over 4% for Q4. And again ours was, was a very low level at 0.57%. In addition to that, our loan loss allowance is 1.91% of total loans.

Our allowance to nonperforming average, or excuse me, our allowance to nonperforming assets coverage is 454%. Our 2008 net to loan losses totaled $2.4 million. Our year-end total loan past due percentages were less than 1%. Our total construction exposure was 16% and single, and of that 16% single family construction exposure was only 8.8%. The total construction exposure was flat quarter to quarter, due to, primarily due to continuing commitments that we have to fund existing commitments that are in place. But our single family commitments were down from 9.6% in Q3 to the 8.8% in Q4. Our problem loans, which are identified as accruing loans, other mention or worse, increased to $43 million at year-end. But I think it is important to note that the nonperforming assets, even with the recent exam, were at $5.4 million.

Liquidity, this is something that I have talked a lot about in the last year or 18 months at a variety of investors conferences and we have worked hard to, to improve what I believe was an already strong liquidity position. We have total available liquidity sources of about $280 million. We improved our loan to deposit ratio to a very respectable 94.9%. The liquidity sources I cited earlier includes approximately $30 million in overnight cash invested at the Fed and FHLB. And again, we have no brokerage CDs in those liquidity numbers except for the $500,000 which were reciprocal Cedar CDs. Our capital, we have total risk based, our total risk based capital as of year-end is 13.73%. Our tangible equity is $76.3 million or 8.2% of tangible assets. In addition, we made a decision to reduce our cash dividend from $0.14 in the prior quarter to $0.10 this quarter to preserve and grow our capital.

Our core earnings, when we take a look at core earnings and adjust them for the impairment charges our -- adjust them -- excuse me, adjust them for impairment charges and for provision, our core earnings grew 11% year to year. We think that is a very noteworthy accomplishment. And I have been talking a lot, and again these same investor conferences, about the strength of our core earnings and I realize that in some cases when we speak to core earnings one might argue that provision is part of core. But what I want to do is what this number, this 11% improvement shows is the ability to show core earnings improvement year to year, except -- allowing for asset quality issues.

And I have said many times that the level of which we participated in the construction lending over the last several years has been considerably less than our peers here in the northwest and many of the margins and many of the core earnings that have been generated out of the Pacific Northwest have been construction fueled earnings, whereas our reliance on that sector has been much less than our peers and I felt that our core earnings as a result would be much stronger than our peers. And I think this is being proven out. Just some comments on general market outlook that I see for 2009. I see our net interest margin flat to perhaps a slight reduction. I see we will continue to focus on growing our liquidity, even above its strong, current strong position. I see loan growth modest at best. I see continuing strong provision. I see increasing weakness in construction and we are just beginning to see some weaknesses develop in certain C&I sectors.

I think due to the increase in FDIC premiums that everybody is experiencing in 2009, it will be difficult to maintain our current level of core efficiency ratios. I would like to speak just briefly to the TARP program. As many of you will recall, we participated in Treasury's capital purchase program in November, which was, as we all know, intended to invest at the Treasury's intentions, which were to invest in healthy, viable banks. We sold $24 million in preferred securities to the Treasury in November. Much attention is being given to what banks are doing with this capital injection. And during the months of November and December, we made $33 million in new loans and we renewed $57 million in existing loans and will continue to focus on making capital investments in our communities by way of loans, new loans as well as renewing existing loans, in addition to providing what we believe is a safe harbor for deposit growth as we work through the difficult economic times ahead.

I would like to close with the following points and some of these points will just be a reiteration of my points to date this morning. But, I think some of the things that we have really focused on the last couple of years and we will continue to focus on as we move forward the next year or so and that's strong liquidity. We have got approximately $280 million available to us to draw on if needed and that is certainly aided by the fact that we have no debt on our balance sheet. We are a well capitalized Company with risk-weighted capital of 13.73%. We have strong stable core earnings. We have good expense control. We have a stable net interest margin. Our current single family residential construction exposure stands at, currently stands at a very low peer comparison of 8.8%. We have strong allowance levels, good credit quality, low past dues and low nonperforming assets.

I believe we have built one of the most fundamentally sound balance sheets in the Pacific Northwest. We will continue to build a strong balance sheet to create safety for our customers and investors, as well as taking advantage of future opportunities. We believe we will emerge with a stronger Pacific Northwest presence and believe we will have opportunities as we move through this economic cycle. And finally, I would like to announce that we will be presenting at the Sandler O'Neill Investor conference in San Francisco on March 3rd of this year. So at that point, Robert, that concludes my prepared remarks and I would be happy to answer any questions that folks may have.

(Operator Instructions). Our first question will come from the line of Ross Haberman from Haberman Fund, please go ahead.

Good morning, Brian, how are you.

I'm doing well, Ross, how are you.

You sweated out a tough year. I congratulate you. Don and the board should be pretty proud and I am not stroking you here at all.

Thank you, I appreciate that.

Could you talk about the 16% you said you have in construction? You said 8.8%, I guess, was in single family.

Yes.

And the other 8% is in land?

No. No, the 8.8% includes single family construction. When I talk about the 8.8%, I will just clarify that a bit more, that is, let's say, single family spec construction, single family development acquisition and single family land acquisition. So it is all inclusive, anything having to do with single family.

Okay. And I guess the other roughly 7.5% or 8% is in, in what other type of constructions?

Primarily in commercial construction, as well as there's a bit of multifamily construction as well.

And are you as concerned on the commercial side as the, as the residential side of that construction business?

No. Our greatest concern lies still with the single family buckets.

And have they all run through, I guess, their interest rate reserves or is there, or is there still some flexibility there in the residential side?

Now, I am just going guess, Ross, that most of them have utilized their interest rate reserves. There may be a few left out there, but most of them are servicing interest costs out of pocket and I think that speaks to the relative strength of that portfolio and another reason why we do not have a high nonperforming asset level is these are viable builders/developers that have at this point fairly strong carrying power. We think that's significant. But again, the question is is that how deep and long with this cycle is. At some point everybody will, will run out of gas if this goes on long enough, but currently they're performing.

Just two follow up questions. Just a question on noninterest income, I guess, Visa income or Visa fees.

Yes.

I am hearing that slowed down significantly the last pre-christmas, Christmas and so forth. Did you experience that as well?

Yes, we experienced a little bit of slow down there, Ross. But I think year-over-year growth was up and our merchants probably saw a little bit. We don't have a lot of what you would call national, probably no national merchants in those totals. Those are just are really represent our retail C&I folks. It was down, but year-over-year we were up.

And finally, I know it is an insignificant number, but did you figure out how big your, your exposure was on Clark County's municipal deposit hit.

Yes, we are still calculating that. We got a letter from the State earlier this week and they, although they have not given us our assessment numbers, we are guessing that number to be around $200,000 exposure. But we are not certain to that. Of course every, almost every bank in the State of Washington will have some piece of that pie.

How big is your municipal deposits in total or as a percentage of the total deposits?

Yes, we have all, we have a -- let me, before I answer that question, we have a very strong relationship with a number of municipalities, ports, PUDs that is represented in cash management accounts, transaction accounts, a variety of -- that's been a fairly strong strategy of ours and it has worked well. I think that year-end we had exposure, all public entities, about $120 million in deposits.

Okay. Again guys, the best of luck. Thank you.

Thanks, Ross, appreciate it.

(Operator Instructions). We do have a question from the line of Luke Kautzer from DA Davidson Company. Please go ahead.

Morning.

Hi, Luke. How are you.

Good. How are you doing? Jeff just wanted me to fill in and ask a few questions.

Sure.

The first one, I don't know if you guys classify or separate out a 30 to 89 day bucket, some do, some don't.

In terms of past dues?

Past dues, yes.

The past due number I gave you that was less than 1% is all past dues over 30 days.

Okay. Perfect. And then, congrats again on the net interest margin. That was real strong. There weren't any recoveries or anything included in that, were there.

Recoveries in terms of loan loss recoveries in Q4.

Exactly, yes.

If there were they would have been very minimal.

All right. As far as like loan growth opportunities, what are you guys kind of seeing in the market right now as -- if loans are, you said you already mentioned that loan growth is going be kind of flattish. Where are you seeing opportunities right now?

Well , yes. I think that's as we contemplate what probably is still some rough road ahead of us from an economic point of view, we are being selective in that regard. I think there are still, on a selective basis, we are finding that customers want to align with a bank that they know that their credit line is going be available at a later date. So I think we are seeing some C&I opportunities. I think there is some owner occupied real estate opportunities out there that we are looking at. It probably goes without saying, that we are not seeking out construction lending. We are not seeking out income property, commercial real estate, but I think we are going to focus on the bread and butter, the C&I and owner occupied real estate. And we are seeing some opportunity there, but I think the, certainly, the demand has dropped. I think that the normal borrower out there, the normal business owner is not anxious to take on increased debt in this cycle as well, but there are a few opportunities that we are seeing.

Great. That's all I had. Thanks, guys.

You bet. Thanks, Luke.

Thank you. We have a follow up from Ross Haberman. Please go ahead.

Sorry, Brian, I couldn't resist. ReFi's, what are you seeing there? And what are you doing with, I guess, ReFi's which are yours, are you renegotiating them or just selling them.

Good question, Ross. We are seeing a marked increase of refinancing activities because, as we all know, the low interest rates out there, but we are also seeing that pipeline that we have there is a fairly high dropout rate as folks go through the process, appraisals and I think when you are looking at doing a ReFi, I think the homeowner is finding out that they have got a second some times and the bank that owns the second isn't willing to subordinate and there's loan to value issues. So we are seeing a fairly high dropout rate. But, having said that, we are seeing a marked increase of applications and actual loans that we are able to refinance and we are continuing to sell them into the secondary market. We are not really seeing much on our single family, on our portfolio loans. That is a very well seasoned portfolio and those borrowers aren't typically the ones that churn the portfolio every time there's a tick down in the rate. So most of our activity is really just a refinance availability in the general market. And that has, that has increased substantially.

Will that -- I guess because they are not yours it is not going to hurt your margin. Because, again, you are saying most of those loans are not yours but others. So it will only help you on the fee side, you are saying.

That's exactly right, Ross, yes.

Could you give us some color on, on any sort of M&A activity and would you expect to see the zero premium deals like we saw in Bank of Clark County or do you think you and anyone else left standing will end up having to pay some type of premium for some, for any upcoming negotiated deals?

Yes, I think you could argue that the Bank of Clark County deal might have been a negative premium and that the FDIC chose to pay 90 days of expenses. But in any event -- .

True, true.

In any event, I -- the zero premium or negative premium, I think that there are going to be some opportunities that because of franchise location, there's some attractive franchise locations that a small premium might be still a good transaction. And I think there will be some opportunities and we would certainly be interested in looking at those opportunities as they do come around.

Would you focus on contiguous, any sort of contiguous or given the opportunity go outside your existing market area.

We had an opportunity at the Bank of Clark County and we passed because that was not a contiguous market for us. I think we would prefer to stay contiguous. I think that there is -- we just get much bigger bang for our buck when we are talking about advertising dollars and ability to manage locations that are close to us and really focus in on the core operations. I see no reason to jump counties and go a long distance away. So, now having said that, there could be an opportunity that just screams at us that makes a lot of sense, but my preference would be contiguous markets.

Again, the best of luck. Thank you very much. Thanks, Ross, you bet.

We have a question now from the line of [Allen Laudermelch], private investor. Please go ahead.

Yes. I had a question about the AMF mortgage backed securities.

Yes.

What is the current fair value of those on your books?

Well, I will ask Don Hinson, our CFO, to respond to that. You will probably realize that when we took the redemption in kind we brought in a number of different securities and so I just can't say that we can't go down through security by security and make that comment, but and as you will also note.

I was just interesting, have you written off 30%, 20%?

And again that varies by security, but also when we took the redemption in kind, we brought them in not at par value but at a discounted book value and then took a write down from there. And Don, maybe you can just speak to it in general.

Sure. We have currently after the fourth quarter impairment, probably of about $6.8 million of book value and the investments that we received when we did the redemption in kind on the AMF Fund. Of that about $4.2 million is remaining in book value of the private label, which is really the concern. The other $3 million or so, $3.2 million is agencies, so we are obviously a lot less concerned about those. So, that is kind of where we are at. Obviously it is, the risk is in the private label portfolio. But even those are -- a lot of those are still well rated and there was only, again, 11 securities that we wrote down and those are the first write downs since we have done the redemption in kind.

Okay. The other ones are still paying?

All of, even the ones that we wrote down are still paying, but according to the impairment rules for accounting, we had to write those 11 down to market value.

Right. I understand. I'd also a question, I understand the Seattle Home Loan Bank Board has stopped paying dividends on stock. I was just wondering what kind of impact that might have on your bottom-line.

Well, it was -- the dividends were very minimal to begin with. It will have a minimal effect to our bottom-line. I'm assuming you are representing or you are talking about the stock ownership that we own in Seattle.

Right.

Yes, very minimal.

All right. Thank you.

You bet. Thank you for your questions.

We have no further questions in queue.

Well, if there are no further questions I certainly appreciate everybody's interest and thank you for joining our conference call and again it will be available for recording should you want to refer back to it. Thanks again.

Thank you. And ladies and gentlemen, this conference will be available for replay after 1:00 p.m. today Pacific time until February 10th at midnight. You may access the AT&T replay system by dialing 1-800-475-6701 or 320-365-3844 and entering the access code 980944. Once again those numbers are 800-475-6701 or 320-365-3844, access code 980944. That does conclude our conference for today. Thank you for your participation and thank you for using AT&T Executive Teleconference Service. You may now disconnect.