Heritage Financial Corp (HFWA) 2010 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Heritage Financial earnings release 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. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, President and Chief Executive Officer, Mr. Brian Vance. Please go ahead.

Thank you, Ernie. I would like to welcome all that have attended and called in for our Q1 2010 conference call and as well to those that may be calling and listening in later. Attending with me today is Don Hinson, our CFO. Hopefully all on the call have had an opportunity to read our press release, which went out this morning prior to market opening. And I would like to read a short statement of forward-looking statements. Statements concerning future performances, developments, or events, expectations for growth and market forecasts and other guidance on future periods constitute forward-looking statements. Forward-looking statements are subject to a number of risks and uncertainties that might cause actual results to differ from, materially from stated expectations. Forward-looking statements are subject to a number of risks and uncertainties and might cause actual results-- oh, I just said that, I'm sorry.

Specific factors include but are not limited to the effective interest rate changes, risks associated with acquisition by the banks in opening new branches, the ability to control costs and expenses, credit risks of lending activities including changes in level -- in level and trend of loan delinquencies and write-offs. Changes in general economic conditions, either nationally or in our market areas. These factors could affect the Company's financial results. You should not place undue reliance on forward-looking statements and we undertake no obligation to update any such statements. The Company does not undertake and specifically disclaims any obligation to realize any potentially forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Additional information on these and other factors are included in the Company's filings with the Securities & Exchange Commission.

Would like to just start off by recapping our earnings release for Q1. We posted a Q1 net income of $696,000. The Q1 net income applicable to common shareholders including the preferred stock dividends was $365,000 or $0.03 per share, which was a slight decline from Q4 '09 net income applicable to common shareholders of $441,000 or $0.04 per share, but a significant increase from Q1 2009 net loss applicable to common shareholders of $923,000 or $0.14 per share. Even though net earnings for Q4 of '09 and Q1 were virtually the same, it is good to remember that Q4 included a $530,000 of compensation expense recaptured as management made the decision to significantly reduce incentive payments for 2009. Our total loss provision for Q1 was $3.75 million compared to a Q4 '09 provision of $4.95 million. Net charge-offs for the quarter were $5.1 million compared to $3.8 million in Q4 '09.

And due to the increased charge-offs our loan loss allowance to total loans declined slightly to 3.27% at March 31 from a 3.39% at December 31, '09. Our pretax pre-provision earnings before preferred dividends for Q1 were $4.7 million as compared to $4.2 million from the prior year quarter in 2009, a 12% increase. We believe this is a significantly strong overall pretax pre-provision year-over-year improvement. Our pretax pre-provision ROA was 1.90% for Q1. Like to talk a little bit about our balance sheet. We believe we have a strong overall balance sheet at year-end. Other than $10 million in short-term retail customer repurchase agreements, we have no debt on our balance sheet. At quarter end we held $94 million in over night interest-bearing funds primarily at the Federal Reserve Bank and our loan to deposit ratio at quarter end was 87.7%, which is a reduction from 88.9% at year-end 2009.

Focal date loans decreased approximately $15 million during the quarter. However, construction loan totals decreased by approximately $12 million, of which $2.2 million were charge-offs and $1.3 million were transfers to OREO. We have total construction exposure of 11% of total loans with only 5.5% represented in residential one to four family construction including land development. Total commercial loans including commercial real estate was basically flat during the quarter due to approximately $3 million in commercial loan charge-offs during the quarter. I believe measuring the quality and the components of your overall deposit structure is more important than measuring net overall deposit growth. We measure our deposit successes by the growth in our non-maturity deposits. As we see with almost every bank failure today, they have little or no core deposit base.

We see some banks announcing core deposit growth of double-digit rates, but I encourage to you evaluate how much of that growth is coming from CDs less than $100,000, which is considered a core deposit. We believe non-maturity deposit growth is a much better way to measure pure deposit growth. We continue to see many banks in our area offering rates in the area of 2% for CDs with maturities of twelve months. The national average rate for 12 month CDs are only 80 basis points. Our total year-to-date net deposits decreased $4.2 million. However, our non-maturity deposits, again total deposits less all CDs as of quarter end increased approximately $4 million from prior year-end. At the same time total CDs declined approximately $8 million from prior year-end. If you evaluate just our net overall deposit growth for the quarter, you would come to a different conclusion than evaluating the different components of deposit growth. Our non-maturity deposit ratio or pure deposits is a very strong 65% of total deposits.

Differently said, total CDs make up only 35% of our total deposits and our core deposits are a very strong 79% of all deposits. Our deposit strategy continues to be to grow non-maturity deposits for the following reasons. The cost structure of non-maturity deposits is much lower than CDs. In a rising interest rate environment non-maturity deposits will have more value and will drive stronger future earnings. Non-maturity deposits have a much higher customer loyalty factor and non-maturity deposits are what truly create long-term franchise value. Net costs of all deposits was a very low 1.05% for Q1. A little bit about our net interest margin. Our net interest margin for Q1 was a healthy 4.58%. This is a 13 basis points increase from 4.45% in Q4 2009. Sustained focus on non-maturity deposit growth and pricing CDs generally below area competitors continues to drive costs of funds lower, which is a primary driver to our strong net interest margin. The effect of nonaccrual loans on the margin for Q1 was 15 basis points.

Non-interest income was $2.2 million for the three months ended March 31, 2010, compared to $2.0 million for the three months ended March 31, '09. This increase was due substantially to increased service charge on deposits and merchant Visa income. Non-interest expense was $8.8. I am sorry, was $8.1 million for the quarter ended March 31, 2010 compared to $7.9 million for the quarter ended March 31, '09. The increase was due to -- increased FDIC assessment rates resulting in an increase of about $209,000; Increased salary and benefits expense in the amount of $184,000 resulting primarily from a slight increase in full time employees; and an increased professional services in the amount of $145,000 resulting from additional legal and consultant expenses.

These increases were partially offset by -- a $402,000 decline in other expense as a result of a net gain of $92,000 on a sale of other real estate owned during the quarter ended March 31, 2010, compared to a net loss of $85,000 on sale of other real estate owned during the quarter ended March of '09; an assessment during the quarter end March 31, '09, in the amount of $239,000 from the Washington Public Deposit Protection Commission due to uncollateralized public deposits of a failed bank; there was no assessment during the quarter end March 31, 2010. Non-interest expense increased $698,000 from prior quarter end December 31, due primarily to increased salaries and employee benefits. The increase in salaries and employee benefits was due primarily to a reversal of accrued incentive bonuses during the quarter end December 31.

Non-interest expense control has been a focus of ours and will continue to be. However, items such as expected increases in FDIC assessments, as well as potential future OTTI charges, will make it difficult to maintain a goal of an efficiency ratio under 60%. For the quarter ended March 31, our efficiency ratio was 62.3% compared to 65% for the quarter ended March 31, '09. Speak a little bit to overall loan quality. Nonperforming loans decreased $4.1 million. However, primarily due to a $5.1 million in net charge-offs during the quarter. As mentioned earlier, we reduced total construction loans by $12 million or 13%. Our residential construction loans as of March 31st totaled $41.6 million. This breaks down as follows -- Residential land $6.9 million; single-family homes $8 million; A&D residential $26.7 million.

Other, or excuse me, our total nonperforming loans of $28.8 million breaks down as follows -- Commercial $2.8 million; owner occupied commercial real estate $1.2 million; investor owned commercial real estate $1 million; real estate construction $23.8 million. And the real estate construction breaks down further as follows -- single-family $2.5 million; A&D lots for sale $21.2 million; and commercial construction $100,000. A breakout of all potential problem loans by categories is as follows -- Construction $24 million; C&I $9.6 million; owner occupied CRE $4.1 million; investor CRE $03 .1 million; and real estate mortgages $2.9. A breakout by county of all nonperforming and potential problem loans is as follows -- Thurston County, where Olympia is located, 17%; Pierce County or Tacoma 58%, Mason County and Shelton, a nearby county, 7%; and King County 7%; and all other counties including our central Washington -- Central Washington Bank -- Central Valley Bank affiliate located in central Washington is 11%.

Total nonperforming loans plus total potential problem loans were down $8.3 million quarter over quarter. Total delinquent loans increased approximately $17 million from the prior quarter end. This increase is due substantially to the following -- A condominium project mentioned in the earnings release; a $4.2 million on the commercial loans that are classified within potential problem loans; and then $3.4 million on a commercial loan in process of renewal. OREO, we began Q1 with three OREO properties with a total balance of $704,000. We sold those three properties and added five additional OREO properties totaling $1.6 million, which was our ending balance for the quarter. Our coverage ratio ended the quarter at a strong 86%, up slightly from Q4, which was 79%; and our allowance at quarter end was likewise a strong 3.27%. Our coverage ratio remains one of the strongest in the Pacific Northwest.

We realized our charge-offs exceeded our provision by $1.4 million this quarter. As we continue to work through this credit cycle and as we near the end of this credit cycle later this year or early next year, we expect our overall loan loss allowance to normalize at considerably lower levels than where it stands today. The process that is likely to take place over the next several quarters is gradually lower provision, coupled with losses that may modestly exceed each quarter's provision thereby normalizing allowance closer to historical levels. Liquidity, total available liquidity sources, cash and borrowing lines, is over $345 million and as mentioned earlier we have $94 million in over night cash. We realized our abnormally high liquidity was created for all the right reasons in times of high volatility. As volatility has subsided, we're beginning to focus on strategies to normalize and reduce our overall liquidity.

Strategies include -- continue to price CDs conservatively; refocus on organic growth through competitively designed loan programs. We believe most of our competitors continue to be internally focused and we believe we have the ability to become externally growth focus. And as a reminder the old adage good loans are made in bad times certainly applies. A general review of Q1 2010, I would characterize Q1 as one of continued improvement in most all operating metrics. We continue to fine tune our overall deposit structure and cost of funding. We continue to reduce our construction exposure, and our pretax, pre-provision earnings once again improved quarter over quarter and now stands at a very strong 1.9%. We have continued to focus on maintaining a strong coverage ratio and at year-end our coverage ratio improved to 86%, and as I mentioned, one of the strongest coverage ratios of public traded banks in the Pacific Northwest.

Just some comments on general outlook. Our overall view of 2010 is at follows, for the first time in 24 months I am beginning to see the other side of this recession. To be sure, we will see continued high levels of nonperforming assets, high credit losses, and isolated anomalies for the next few quarters. We continue to see stubborn pockets of economic recession in certain markets and continue to see real estate value deterioration especially in finished lot values. However, at a slower pace but overall I am beginning to be encouraged with the feel of things. Our net interest margin is likely to perform near recent historical levels for the balance of the year. Loan growth in the short run will continue to be muted by exiting construction loans, but we are hopeful we can begin so see loan growth in the last half of the year, as our externally focused loan growth programs begin to gain traction.

We will likely see an increase in non-interest expense as loan administration costs increase as well as costs for our organic growth programs, organic loan growth programs. And we are likely to see a slight reduction to overall non-interest income as future regulatory changes impact checking account fees and charges. These two factors will likely cause our efficiency ratio to show a slight increase. Most of our remaining residential lending is in developed land, which will take some time to fully work down and out. Another issue we will all need to deal with is ongoing bank failures in the Pacific Northwest, which will continue to add real estate valuation deterioration as more product comes to the market. This issue continues to be a wild card for the balance of 2010 that could mute or slow the Pacific Northwest's overall recovery. However, despite the above challenges, we see more positive operating results for the last half of 2010. I would like to close with the following points.

We are a well capitalized Company with a risk weighted capital of 21.3% and a tangible common equity to tangible assets ratio of 12.3%. We have strong liquidity and a strong net interest margin, consistently strong pretax pre-provision return on assets of 1.9% for the quarter and 1.99% for 2009, a very strong coverage ratio of 86%, and current single-family construction exposure currently is much lower than most of our peers at 5.5% of total loans. With our strong capital and liquidity positions I believe we're well positioned to strategically grow our Company. We remain optimistic that we have an opportunity to complete an [FDICS transaction before this cycle is finished. I would welcome any questions at this time and once again remind you as we answer those questions, I would refer you to the forward-looking statements I read at the beginning of the program. That completes my prepared remarks and I would be happy to answer any questions that you may have.

(Operator Instructions) We do have our first question coming from the line of Jeff Rulis with D.A. Davidson. Please go ahead, your line is open.

Good morning, Brian.

Hi, Jeff, how are you?

Doing fine, thanks. Question on the condo project problem loan that you mentioned, $10.6 million. Has that been written down any?

No, it has not.

And no reserve against that?

Yes, we do. It is a part of our overall reserve. I will remind you that loan is currently performing. It has sold units, but the units continue, the sale of units continue to slow and it is a possibility that it could become a nonaccrual loan in Q2 should certain factors not be achieved. So it is a loan that has performed for some time now, but may not continue as we go forward.

Got it. Okay. Then on the margins side on deposit costs, continue to see some benefits there. Is there any maturities on CDs or kind of what you saw in this quarter that gives you some confidence that you can continue to drive those costs lower or are you about to the bottom on funding costs?

Probably a little bit of both. We are about to the bottom of repricing opportunities in terms of repricing CDs at lower rates than existing rates. But as I indicated earlier, we continue to see still some very sticky high rates being offered by certain competitors. As I said, substantially higher than the national norm and just to maintain those, our CD base, we have to pay higher than we're comfortable in paying, but all in all I think that we'll see a little bit of repricing opportunity here in the next probably 90 days, and then I think those opportunities go away and to be candid I think some of the folks that are paying up for those deposits may go away as well.

And I guess in a related question seeing any change in competitive landscape with a couple bank failures in the region, have you seen any noticeable change versus, say, six or twelve months ago?

Well, when we looked back late last year and earlier this year we had two significant competitors fail in our immediate market area and we have seen opportunities come from those two failures, both in the way of new loan opportunities as well as new deposit opportunities. The greater opportunity certainly has been on the deposit side. The failure of a bank, and just on Friday, they don't really operate that much in our market area. There will be some impact that we'll have in a couple of branch areas where we have, where they compete directly with us, but probably not near to the extent that the other two failures had earlier in the year.

Got it. And then lastly, it is sort of a broad question, but I didn't know if you were hearing any speculation about the Port of Tacoma potentially benefiting from any diversion from traffic from the Gulf if there is some disruption from the oil spill there? I don't know if it is too early or it is rather temporary, but if you had any indication of what you think that impact might be, it would be interesting.

Jeff, I really don't. I think that's an interesting opportunity that exists. I have not seen any recent number from the Port of Tacoma, but I just did see some this morning or over the weekend from the Port of Seattle seeing some increased activities, not because of Gulf but just because of, I think, some improving economic trends, especially with exports, but that could be an opportunity for us, but probably a little early to say.

Got it. Okay, thanks. Thanks, Jeff.

Thank you. We have our next question coming from the line of Bobby Bohlen with KBW. Please go ahead, your line is open.

Hi, thank you, Brian. I was wondering if you could give us an update on your thinking, your current thinking on the TARP CPP program, where you stand with that?

Yeah. We certainly have the capability of repurchasing those securities from a variety points of view. When, I will remind everybody, when we became TARP participants we made the comment that we felt that it was a prudent move and a cautionary move at the time and that we would hold onto that until we were, felt certain that the economy has achieved a measurable improvement and a measurable sustainable, actually, not quite sure we're there. Certainly as my comments would indicate, I am feeling more positive this quarter than I have in some time. And we continue to evaluate the likely point at repurchasing those securities, so certainly a possibility.

So a little closer than we were last quarter in terms of economic outlook.

Yes, I think that's fair to say.

Okay. My next question, the Central Valley Bank seems to still be doing pretty well. Is there anything out there that worries you or that one is still doing pretty well?

Yes, I think they continue to perform well. I suppose if there were a worry, we continue to see reduction in commodity prices pretty much across the board with all commodities and I think that we will continue to experience that through this growing cycle and as we harvest and attempt to sell those crops this fall. So, yes, I think it is a concern, but it is not an overweighting concern at this point. It is just something that we continue to watch. I will remind everybody that a good portion, well over 50% of all agricultural loans we have through our Central Valley affiliate have a, have FSA guarantees, which is similar to a SBA guarantee. So our ultimate downside is protected substantially with those government guarantees.

Okay. And then final question, I know some areas of the country were actually starting to think about traditional M&A again. Do you see any opportunities for potential traditional M&A with some partners up in the Pacific Northwest or is it still way too early in the cycle to be thinking about that in your area?

It might be a little early. I still think that the best leverage for the capital dollar today is through the FDIC assisted transaction. I think that a normal M&A deal, I think the difficulties there that you don't have on the assisted side is the 141 R calculations of the loan portfolio and what truly is market in that portfolio. Your abilities to write those loans down to levels that you might be comfortable with will, I think, will be impacted by that. But again, I think the overall best opportunity still is within the FDIC assisted sale transaction. And I will remind everybody, I think this is going to be a longer than shorter process. I feel strongly that there will be banks failing well into 2011 and I think it just kind of depends on exam cycles, depends on a variety of things, but I think there are still a good number of opportunities within the Puget Sound markets.

Okay. Thank you very much for your comments.

Thanks, Bobby.

Thank you. We have our next question coming from Tim O'Brien with Sandler O'Neill. Please go ahead. Your line is open.

Good morning.

Good morning, Tim.

Question on car report data. Yes. C&I loans 30 to 89 day past due $4.4 million or just under $4.4 million.

Uh-huh.

Could you give a little color on how many loans that involves and what they're backed by and, I guess, I am assuming you haven't taken any impairments on those because they're still performing?

Yes, that's correct, Tim. It is primarily one commercial real estate loan.

And then is it tied to that relationship that you referred to, the condo development, or as far as the call report is concerned, what's -- how does that $10 million plus show up on the call report data?

First, the answer to your first question, no, it does not pertain to the condo loan and the condo loan is, I think, you're probably looking at in my comments the $17 million increase. That condo loan not all of it is past due, but a substantial portion of it is.

And, Tim, that's in the one to four family.

The condo loan is?

Yes.

Okay. As far -- .

But that's that $7.5 million in that area, that's that condo loan.

How many units are in that building and could you tell us how many are sold or at least how many units are in the building?

There were 20 units of which five have been sold.

Okay, great. Was there any other onetime events in the quarter that didn't show up in the press release?

No, I don't think so.

Okay, that's it. I will step back. Thanks.

Okay, thanks, Tim.

Thank you. We have our next question coming from the line of Tim Coffey with FIG Partners. Please go ahead, your line is open.

Thank you. Good morning, Brian.

Hi, Tim.

You guided about $35 million in non-CD deposits in the last four quarters and I am kind of curious, how much of that is from new relationships?

$35 million in non-CDs. I am not tracking with you. I am not sure --

I have got, second quarter of '09 I have you at $515 million non-interest non-CD deposits and now you are up to about 540?

Non-CD?

Yeah.

I am sorry. I thought -- okay. So non-CD. So your question is what is -- what makes up most of that growth?

How much of it is new accounts?

Well, how much of it new accounts? Okay. I can't -- I don't have that breakdown for you. We do have our checking account acquisition program that we begin now probably eighteen months ago or so is continues to be successful in bringing in new consumer accounts, both in the way of checking accounts. We find probably the two largest growth opportunities from that program is just various checking accounts plus a high yield money market account, probably makes up 80% of the growth in that area. I don't have those numbers offhand for you, Tim, as to what the breakdown is, but certainly has been a successful part of our non-CD growth program.

Okay. And then on the condo project, can you tell us where, what the risk rating was on that loan (multiple speakers).?

No. We don't comment specific grades on specific loans, Tim, condo project located in Pierce County.

Okay. Can you just remind me again what the definition is of a potential problem loans again?

Don, why don't you go ahead.

It is a classified loan. So anything that's other mention or worse would be other mention substandard or doubtful.

And I will say that the condo loan is a currently classified loan.

Okay. Those are all my only questions. Appreciate it.

You bet.

Thank you. We do have our next question coming from the line of Ross Haberman with Haberman Funds. Please go ahead, your line is open.

How are you, gentlemen?

Good, Ross, thank you.

The nonperformers, the $30 some odd million, any sense of how much you will be out of them by the year-end, calendar year-end?

No, I don't, Ross, and I probably wouldn't give that specific of guidance, but I do certainly anticipate that our, as we move into the third and fourth quarters,that our nonperformings enjoying some nice decreases. We have a number of projects that we know will be sold and moved off and taken care of, but I probably wouldn't be specific to mention a specific number.

And the potential problem loans, the $43 million you mentioned here, are those mostly in the real estate construction category?

Yes. The biggest bucket is just that, construction at $24 million. The next largest bucket is C&I at $9.6 million. Okay, guys, thanks again. Thanks, Ross.

Thank you. And ladies and gentlemen, if you have any questions, please press star 1 at this time. We do have a follow-up question coming from the line of Tim O'Brien with Sandler O'Neill. Please go ahead, sir. Your line is open.

Hi, Brian, one other question. As far as your incrementally improving kind of confidence or outlook, can you give us a little bit more color? What's driving that? Is it internal results and the profile of your balance sheet and improvement there or is it macro or is it a combination of both? Kind of give us a little color on where you're getting your confidence from.

Yes. I am not sure it is really on the macro side or the economic side, because I do see difficulties, continuing difficulties coming within the Pacific Northwest region. Having said that, I also can see the other side of the recessionary issues in the Pacific Northwest. I just think for the next few quarters we're going to see some more difficulties from economic point of view whether it is resolution of failed banks and more product going on, coming on the markets and driving down real estate values, especially in the finished lot category, I certainly expect to see that. I suppose my cautious optimism is really more focused internally just from the standpoint of being able to resolve and move out nonperforming assets as we work through this cycle. We're sitting here with a, as I said several times now, a very strong coverage ratio sitting here with strong allowance percentages and I just think that that allows us to take aggressive action in resolving some of these lending situations, and that's probably what drives most of my optimism at this point.

All right. Thank you much.

Thank you. And there are no further questions in the queue. Please continue .

Well, if there are no further questions, Ernie, appreciate your, everyone tuning in today and your continued interest and as a reminder we will be a part of the, presenting at the D.A. Davidson conference coming up next week, so may see many of you at that conference. So thanks for your attendance today.

Thank you. And ladies and gentlemen, this conference will be available for replay after 1 PM today until May 17, 2010 at midnight. You may access the AT&T Executive Playback Service at any time by dialing 1-800-475-6701, using the access code 152825. That number again is 1-800-475-6701 access code 152825. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.