Heritage Financial Corp (HFWA) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Heritage Financial second quarter earnings release. For the conference, all the participant lines are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time.

(Operator Instructions)

As a reminder, today's call is being recorded. I'll turn the conference now over to the Chief Executive Officer, Mr. Brian Vance. Please go ahead, Sir.

Thank you, John. Appreciate it. I'd like to welcome all who called in and those who may listen later in our recorded mode. Attending with me here in Olympia this morning is Don Hinson, our Chief Financial Officer; Jeff Deuel, President and Chief Operating Officer; Bryan McDonald, Chief Lending Officer. Our earnings press release now yesterday morning in a pre-market release and hopefully you've had an opportunity to review the release prior to this call. I apologize for a Friday conference call, but yesterday was our annual meeting which was delayed as a result of the special meeting earlier in the year to approve the Washington Banking Company merger and we just did not have time to hold a conference call yesterday. Please refer to the forward-looking statements in a press release and as we go through our presentation and then as well as we entertain questions and answers following our formal presentation.

I'll begin our discussion this morning with highlights of our second quarter. Heritage completed the merger with Washington Banking Company on May 1, 2014. Diluted earnings per common share were $0.16 for the quarter ended June 30 and compared to $0.18 per the prior-year ended June 30, 2013 and unchanged from the linked-quarter ended March 31. Excluding merger-related expenses incurred as a result of Washington Banking Company merger, earnings per share were $0.31 for the quarter ending June 30. Heritage declared a cash dividend of $0.09 per common share, an increase of 12.5% from a prior cash dividend.

I'll turn the call over to Don Hinson now who will take a few minutes to cover our balance sheet and income statement changes. Don.

Thanks, Brian. Starting with the balance sheet. Balance sheets saw significant increases due to the Washington Banking merger. As a result of the merger, the investment portfolio has become a more significant portion of the balance sheet. Total investment securities increased $513 million to $691 million as of June 30, $458 million of which was due to the merger. The Company used the merger event to restructure the portfolio obtained in the merger. Approximately $110 million of investments were sold during the quarter for a net gain of $87,000.

In addition, approximately $176 million of investments were purchased during the quarter. These purchase were primarily mortgage-backed securities and municipal bonds. Plan to continue to focus on these segments for future purchases. The overnight cash position at June 30 was approximately $70 million. This balance will fluctuate some depending on loan deposit activity, but we are seeking to be near that cash level in the short term.

Moving on to some credit quality metrics. Non-accrual, non-covered loans increased $2 million from the prior quarter. The increase was due to $3.9 million of additions to non-accrual, non-covered loans partially offset by $1.3 million of net principal reductions and $623,000 of charge-offs. Potential problems non-covered loans increased to $137 million at June 30 from $58 million on March 31. Again, the increase was due to the Washington Banking merger.

We consider potential problem loans, those loans that are graded special mention or worse and are not classified as impaired loans. The reason for the significant increase in the purchase of problem loans and a corresponding lack of increase in impaired loans from the merger is due to accounting for purchased credit impaired loans. Loans previously considered impaired by Washington Banking are accruing income based on the accretion of the fair value discount calculated as of merger date. For example, if a substandard loan was reported as an impaired loan by Washington Banking, that loan will now be considered potential problem loan by Heritage.

The ratio of allowance per loan loss non-performing, non-covered loans decreased 164% from 198% at the prior quarter end. In addition, the ratio of allowance loan loss to non-covered loans decreased 1.08% at June 30 compared to 1.94% at March 31. The decreases in the allowance percentages resulted from the non-covered loans acquired in the Washington Banking merger for which no allowance was estimated at quarter end given Management's judgement that the purchase discounts [adequately address the estimated losses in the acquired loans. However, as the purchase discounts decrease over time, an allowance for loan losses will need to be provided for in order to address the estimated losses in the portfolio.] (corrected by company after the call)

Moving on to net interest margin. Net interest margin for Q2 is 4.55%, This is a 7 basis point increase from 4.48% in Q1. The increase is mostly due to an increase from discount accretion as a result of the Washington Banking Merger. The effect on the net interest margin of incremental discount accretion on the acquired loan portfolios was 47 basis points for Q2 compared to 25 basis points for Q1. Without the effects of the loan discounted accretion the net interest margin decreased 15 basis points to 4.08% in Q2 compared to 4.23% in Q1. Contributing to the decrease of pre-accretion of net interest margin was a change in the mix of earning assets. Compared to Q1, there was a lower ratio of loans and higher ratio of investments to earning assets. It is expected that discount accretion will provide a nice boost to net interest margin in the short run but it will taper off over time. However, as previously mentioned, it is expected that this boost will be partially offset by recquired loan loss provisioning as the discount [balances related to the acquired loans] (corrected by company after the call) decrease.

And, finally, I'd like to touch on non-interest expense which also increased significantly due to the merger. Contributing to the increase of merger-related expenses, during Q2 there were approximately $5.3 million in merger accounts compared to $793,000 in the prior quarter. The after-tax Q2 earnings impact of these initiative costs were $3.77 million or $0.15 per share. Removing the effects of the merger-related costs, efficiency metrics increased significantly. Excluding merger-related expenses incurred in both Q1 and Q2, efficiency ratio improved to 64.9% percent in Q2 from 73.4% in Q1 and the ratio of non-interest expense to average assets improved to 3.08% in Q2 from 3.38% in Q1. Bryan McDonald will now have an update on loan production.

Thanks, Don. With the purchase accounting treatment of bringing the Whidbey Island Bank loans onto the Heritage balance sheet, we wanted to provide some additional detail on organic loan growth and production. Some of my comments cover the pre-merger performance and in these cases I am using the independent results of each Heritage Bank and Whidbey Island Bank.

For the first quarter Heritage Bank and Whidbey Island Bank independently had 6.8% and 10.7% originated annualized loan growth respectively. On a combined basis, originated loans increased to $40.391 million or a 8.66% annualized rate. The primary difference between the growth rates was consumer lending platform at legacy Whidbey Island Bank. The second quarter, including Whidbey Island Bank's April originated loan growth, the combined company had $18.2 million of growth which results in an 3.82% annualized rate and combined with the growth in the first quarter a 6.28% annualized rate for the first six months of the year.

During the second quarter, the commercial lending team closed $120 million of new loans which resulted in $100 million of new loans closed [on a combined basis by Heritage and Whidbey commercial teams in the first quarter when they operated as separate banks.] (corrected by company after the call). There were several larger construction loans closed during the second quarter which will be funding out over the next year. The unfunded commitments associated with these new loans is the primary reason [why the loan growth moderated] (corrected by company after the call) from the first quarter even with $20 million more in new loan that closed. Commercial team pipelines ended the second quarter at $295 million -- (multiple speakers).

Excuse me, this is the AT&T operator. My apologies for the interruption. We're getting some distortion from the speaker lines. Is it possible for the speakers that are not talking to have their on mute, perhaps?

Yes, they are on mute. The other lines are. This is Brian. Is distortion still coming through?

Mr. Vance, your line is coming across good. Please continue. We'll see how it sounds.

Commercial team pipelines ended the second quarter at $295 million up from $285 million at the end of the first quarter. For the second quarter, the bank closed 20 SBA 7(a) loans totaling $5.4 million and ended the quarter with $17.2 million in the SBA 7(a) pipeline. This compares to first quarter with 13 loans closed for a total of $5.1 million and a pipeline of $14 million at the end of March. Consumer production remained strong for the second quarter with $30.4 million of new loans closed. This compares to $26.5 million of new consumer loans in the first quarter.

During late June, the legacy Whidbey Island Bank consumer platform was rolled out to the legacy Heritage retail branches and we are already seeing an increase in application activity in our direct business. The mortgage department closed $26 million in new loans in the second quarter compared to $16.9 million for the first quarter and $26.8 million in the fourth quarter of 2013. The increase during the second quarter is primarily attributable to new volume generated the legacy Heritage customer base which did not previously have access to an internal mortgage platform. The mortgage pipeline ended the second quarter at $21 million up from $19 million at the end of the first quarter. Brian will now have an update on capital management as well as some closing comments. Brian.

Thank you, Bryan. I apologize to folks out there for some sound quality issues we apparently have. We have a new system we are working on and we apparently need to work out some bugs to it. So, John, I would appreciate if any time during the call we're getting distortion, please chime in and let us know.

As Bryan indicated, I'll talk a little bit about capital management first. We have increase our quarterly cash dividend 12.5% to $0.09 per share. While $0.09 exceeds our normal guidance of 35% to 40% payout ratio of stated earnings, it is well within this guidance after adjusted earnings per merger-related expenses. In fact, $0.09 represents a 29% payout ratio of our adjusted earnings. We believe we have flexibility and opportunity for future regular dividend increases.

When we announced the Washington Banking merger in October 2013, we suggested pro forma TCE, or tangible common equity, above 9% and close this quarter TCE at 9.8%. The higher TCE level gives us sufficient capital for future organic growth, but also more flexibility for various capital management strategies including, but not committing to: M&A our opportunities, increased regular dividends, special dividends, and stock repurchases.

I'd like to speak for just a moment on adjusted performance metrics. In addition to the adjusted performance metrics Don had mentioned earlier of EPS at $0.31 and an efficiency ratio at 65%, it is important to also note our Q2 adjusted overhead ratio was 3.08% and our adjusted ROA was 1.13% and adjusted our ROE was 8.54%. We believe as we continue to optimize our capital position and our operating efficiencies we can achieve double-digit ROE. While we're optimistic about our Q2 adjusted performance, it is important to note we are very early in a significantly transformational merger and it will take several quarters to develop and optimize all of our performance methods including -- (technical difficulty).

I'd like to spend a few moments on [comments as the outlook --](technical difficulty) for 2014.

Excuse me, Mr. Vance, you're coming across distorted again.

Okay. We'll make a couple of other adjustments. I apologize. Again, remind me if you get any further problems, John.

We continue to see general economic improvement across the Pacific Northwest region and we continue to believe 2014 will show improvement over 2013. Washington state's unemployment currently stands at 5.8% compared to a national average of 6.1%. Seattle, Bellevue, and Everett's unemployment rate stands at 4.8% for June.

We have previously given loan growth guidance for legacy Heritage originated loan growth. Continuing to give guidance on originated loan growth no longer has any relevance as a legacy Heritage originated portfolio is less than 50% of the total portfolio because of legacy with the loan portfolio is now technically an acquired portfolio.

As Bryan mentioned earlier we are still working through all the various loan portfolios as we now have roughly 50% of our current loan portfolios accounted for via purchased accounting rules on a discounted basis and for FDIC assisted transactions which are still running off. As a result, we are not yet comfortable in giving loan growth guidance until we fully analyze the most advisable methodology of reporting loan growth going forward. However, we remain optimistic we can continue to achieve strong loan growth as a result of the merger with Whidbey Island Bank along with increasing confidence in our local economies.

The efficiency improvement initiatives undertaken in 2013 along with the projected scale and efficiencies of the combined company are beginning to generate expected results. As stated earlier, primary efficiency metrics such as efficiency ratio and overhead ratio, improved substantially on an adjusted basis and we believe additional improvements in the various efficiency metrics of efficiency ratio, overhead ratio, and assets for employee are likely to improve in the next several quarters.

Future improvement to these ratios are likely to come from additional FTE reduction following conversion in -- which is planned for the fourth quarter. Elimination, consolidation of duplicated technology platforms; elimination, consolidation of duplicated vendor contracts; elimination, consolidation of non-branch facilities. We believe we will achieve the previously stated 20% cost reductions and our optimistic we can achieve previously stated EPS accretion of 24% for 2015. And, finally, we are pleased with our ongoing integration processes. The teams are working well together to create new procedures, processes, and synergies. I continue to be quite optimistic about the synergies of our new combined footprints and Company. John, that completes our formal remarks and we would like to open it up for questions and answers for any that may be out there.

(Operator Instructions)

Jeff Rulis, D.A. Davidson

Good morning. I guess the margin discussion came in a little choppy. If you could sort of recap or discuss the core margin trends, kind of what -- it's a decline this quarter with the combination, I guess, kind of near and medium term how do you see that core margin sort of playing out especially as you maybe deploy some of that excess funding?

Okay, Jeff. This is Don. As I said, again, it sounds like it was coming through and I don't know if I'm coming through okay now? Okay, great. That the core margin was down about 15 basis points quarter over quarter to 4.08% from 4.23%. I think that again there's two factors. I think again we're still in a low-rate environment and so that core margin of 4.08% is still going to be somewhat challenging.

At the same time, I think we're hoping to -- our loan-deposit ratio right now is down to about 77%. We had hoped to actually get that up and start increasing that back up so that will offset any kind of a note rate situation it may have on the low rate environment. So, I think it will be obviously challenging to keep that core margin up, but I think again as we put more earning assets to work in loans, I think that will also help that out.

So if I read you right, you're sort of suggesting that still pressure but perhaps mitigating not at the size of the drop this quarter?

Correct.

Okay. And then I can't -- on the loan growth. Could you review sort of the origination numbers in organic loan growth and I don't know if it's possible to kind of break it out by Whidbey versus Heritage legacy?

I think Bryan has those numbers and I think we did break that out by legacy, Heritage and legacy, Whidbey originated. Bryan, maybe you could go over those numbers again.

Sure. Jeff, in terms of -- and you're just looking at Q2 or also Q1 because obviously we had a merger event on May 1, so really my numbers were under kind of the old originated basis and on a combined basis the Company had $40 million in loan growth in the first quarter had they been combined, and then the originated loans increased $18 million in the second quarter.

Again, if they'd been combined for the full second quarter obviously when you look at the balance sheet the legacy Whidbey loans were brought across with a covered loan accounting so the reserve went away and then we had that other discount and other purchase accounting.

And then on a production basis, the commercial teams had $120 million worth of production in Q2. Again, that's the full Q2, not just the two months the companies were combined. And that compares to $100 million again just looking at commercial teams had they been combined in Q1. So, production was up in the second quarter.

In the pipeline is at $295 million at the end of the second quarter and that compares with $285 million at the end of the first quarter. So, the production in the quarter was good. The loan growth moderated from the first quarter because there was a significant number of larger construction loans included in the Q2 production numbers that will be funding out here over the rest of the year.

So, we do have some catch up on the loan growth -- originated loan growth percentage at the same time as Brian Vance mentioned, we'll be re-evaluating how to report on this metric going forward since much of the balance sheet is not an originated loan and tying it back to pre-merger analysis is quite cumbersome at this point.

That is helpful. I appreciate it and I'll step back. Thank you.

[Jackie Tamara] with KBW.

As I look out, I just want to make sure that I'm thinking about this properly. So, what's in the non-covered portfolio is legacy Heritage, legacy originated Heritage, the non-covered FDIC deal, and legacy Whidbey, and then the other acquisitions that have happened recently. And then what's in the covered portfolio is the two covered portfolios that came over from Whidbey plus the one covered Heritage portfolio. Is that correct?

You are correct, Jackie.

Okay. So, as I'm looking at the covered portfolio, if I strip out what came out on the date of acquisition, it looked like it was down more substantially than it has been in past quarters. Is that on any sort of accelerated runoff mode as we near the expiration of loss share or was it just quarterly fluctuations?

I think it's just quarterly fluctuations. Sometimes there is more runoff than others, but I know that we are -- on the covered side the FDIC indemnification asset is only about another year on the commercial side. So, we're obviously working through -- anything that is a problem we're trying to get through within the next year.

Bryan has some color on that as well.

Yes, Jackie, we just covered this earlier in the week and I do know the -- just the Citibank and North County Bank, now this is customer balances, they were down about 33% from year-end through the end of June and, yes, the team continues to work those down, but that has certainly been the case since the acquisition.

Okay. And then, Brian, can you remind me if the hospitality loans that had had some problems in the past, were those worked through or is there still some of that that you're trying to manage through the end of the loss share?

Yes, there has been good success on working out of those. There are still a few that remain, but a number of them have been worked out since last spring which was really when we had a number of larger hospitality loans on the legacy website that we had increased concerns. So, a number of those have been worked through. We have a few left and really much of the reduction here since year end has been in that portfolio of past hospitality loans.

Okay. Great. And then, Don, just one quick margin question for you. Looking to the amortization on the trust-preferred securities, is that a pretty good run rate in 2Q or will that increase as we have a full quarter in 3Q?

There's only two months of that. Yes, it will go up. The rate will stay about the same.

Okay.

But it is an adjustable rate instrument, so if rates do go up, that will also change but, again, as far the cost of the -- cost of funds for that should stay about the same in the near term.

Okay. So it has the two months of the amortization and then next quarter will have the three months?

Correct.

Okay. Great. Thank you. I'll step back now.

Tim O'Brien, Sandler O'Neill.

Can you guys hear me? Am I echoing?

No, you're fine, Tim.

Okay. Great. Just a followup question on comments that Brian made about construction commitments. What was the dollar amount of construction commitments you guys made in the second quarter, Brian, that are going to fund out?

Tim, I didn't bring that detail but there were three large projects in excess of $10 million each. One was a low income housing project and then there was a couple of owner-occupied commercial real estate projects and those were kind of the outliers. We had a number of what I'd call normal construction loans closed in the quarter as well, but those were the three that were different than what we might have in a normal quarter.

And then I lost something on the call. My understanding is that originated loans, loan growth this quarter, net growth was nominal at best, was very small relative to the portfolio that brought over most of the growth in non-covered loans this quarter came as a result of the acquisition. Is that right or am I missing something?

Well, it's a little bit of an apples and oranges comparison really. We'll have to compare non-covered loan growth going forward because as you brought the legacy Whidbey portfolio over, we lost the allowance and then had an additional discount.

Yes.

So, that's why you're not seeing the growth. There was also the write-off on all of the fees which are normally amortized going forward.

So, I guess let's leave that out. So, I guess maybe a different way to approach it that might be helpful is this. What was combined for the quarter net originated production -- is there a way to look at that and ex pay downs and payoffs from the existing books? Is there a way to exclude the discount aspect of it and just look at net production -- net growth on a dollar basis?

Yes, if we look at it and assume the merger accounting had not occurred, that was the $18 million number of originated loan growth, so that's looking at it on an independent basis essentially, adding back the fair value discount that was carried at the end of the quarter. That's the closest proxy in terms of what would have been originated loan growth. Again, I think as we look into future quarters we'll need to come up with a different metric to measure loan growth because the originated portfolios are going to include such a large segment of purchased loans which will run off, so --

And that was $18 million in net growth on $120 million in production?

That's true.

And so what -- can you account for, again, what the payoffs and paydowns were? Do you have any color on what was behind that?

We had normal paydowns. We did have some additional larger payoffs in the quarter, but the primary driver behind the drop in the growth rate was really those unfunded commitments on those few larger construction loans for the quarter. Although the payoffs were a little beyond what we might have in a typical quarter, they weren't well outside the range. So, the majority of the variance I would attribute to these three larger construction loans on top of a normal production. We're estimating the replacement production at somewhere around $32 million per quarter to replenish normal runoff. So that would get you to $90 million and we got $120 million and $18 million in growth.

Again, it's early on in the process with just combing the two companies and just having two months, so we're looking at it every month and trying to refine exactly what you're looking for here with your question. This is the closest we can get at this point.

What's that, Bryan?

I just wanted to offer some apologies to you and the other analysts on the call in terms of trying to get your arms wrapped around loan growth. I fully understand what your issues are, but hopefully folks will understand that we closed the transaction May 1, the quarter ended June 30. We needed to go through a massive process of reevaluating the acquired portfolio from Whidbey market into market which takes several weeks to do that.

We still are operating under two systems, so we're pulling data from two systems. We have, through the (inaudible) because of acquisitions from both organizations, both covered and uncovered and open bank and the complexity and the fact that we doubled the size of the Company with this particular merger, hopefully you're going to appreciate all the moving pieces to this in terms of us trying to get our arms around the loan growth. You've got the discount issues and all these other things. So, I do understand the difficulty you're having and we will have much better color on this and data for the third quarter.

Thanks, Bryan. I appreciate that. I think all the analysts appreciate what you guys are undertaking right now and no apology necessary at all. I apologize on my end for my asking the questions, but just trying to get some clarity so that we can talk about your bank in the marketplace.

Here's another question for you that might be worth asking. Do you have -- happen to have at June 30 the utilization rate on your CNI book where it stood at that point kind of as a baseline going forward?

I think we could probably give you some estimations of that. Again, we're pulling information from two separate systems and I think, Bryan, you might have some comments on that?

Yes, I do. It was just under 47% which has been fairly consistent the last several months. We did look back at principal companies independently and combined and we've had it pretty stable at that level.

And then my last question is it looks like other fee income saw a pretty noticeable -- like a $1.1 million jump sequentially from $484,000, if I'm reading this right, in the first quarter to $1.6 million in the second quarter. Do you have any color on what that was?

Tim, it's Don. A variety of things having to do with -- can you hear me okay?

Yes.

Having to do with combined organization now. Again, Heritage legacy was not doing [SB] loan sales or mortgage loan sales but that's part of it. About $276,000 of that and then approximately $100,000 of [bully] income which was brought over in the merger also. There were also some annuity sales that were brought over, but a big chunk of that, about half of that, was due to some recoveries of previously acquired charge-off loans and this is kind of a situation where these were older loans that came across. There's no allowance associated with them.

It's kind of almost like a gain on disposition, so these were some acquired loans that basically because we bring them over everything comes over new. There's no allowance, there's nothing to charge off an allowance against, so it comes almost across as a again. (multiple speakers)

That was $600,000 of the -- $500,000, you said?

Yes. A little -- over $500,000 of that. Can you hear me okay?

Non-recurring, right?

This could happen.

Atypical.

Yes. This will happen periodically, but the amounts will fluctuate, yes. It's not a consistent amount, no.

Thanks a lot, guys.

(Operator Instructions)

Brett Villaume, FIG Partners.

I wanted to ask if you guys have a target or a minimum reserve ratio going forward now with the combined companies versus non-covered loans?

Don will take it.

Before the allowance for loan losses?

Yes, relative to the balance of originated loans and non-covered loans whether or not there is sort of some guidance you can give us on what level that might be going forward.

As we kind of build up -- right now it's at 1.08% of non-covered. You're talking about what kind of --just want to make sure I clarify your question here. You're talking about what reserve level we might see going forward on that?

Yes. Exactly. Thank you.

Again, purchasing accounting issues here are rather difficult to work through the process. As Don just mentioned, we have a little over 1% of allowance on the non-covered. You've got the discount sitting out there from the -- now the biggest portion of that discount, of course, would be from the legacy Whitbey portfolio. Now, that discount is going to bring with it accretion as we accrete that discount over the life of the loans. The difficulty is, is that were going to need to create a process, again it's 50% of the Company as we move forward.

We need to create a process that some of that discount would be to be allocated to future provision so that at such time that the totality of the loans acquired are -- that the discount is fully accreted and we're at the point that we need an allowance for that portfolio, we'll probably need to come in somewhere, I'm going to say, at 1.5% to 1.7 5% and of course that particular number is highly dependent on the economy, the performance of the loan portfolio, and any variety of things. But it's going to be over a period of two, three years to normalize that allowance to the then total portfolio. So, there is going to be some adjustment as we work through that process.

Okay. Thanks, Brian. As complicated as that subject was, that was a pretty good explanation, so thank you.

It is complicated and I know that purchase accounting continues to create issues for all of us. And the significance of that here is that in previous mergers or acquisitions that either Company did, it was a fairly smaller -- a much smaller portion of the total Company. This is complicated by the fact, as I said it several times now, we doubled the size of the Company and so it's a very material process.

One final question was about M&A opportunities. Would you give us an update, if you could, about just -- if anything has change regarding the size of potential acquisitions, geographic location, and what kind of banks you still have an appetite for in your markets or outside of your markets?

Sure. As I've said several times since we've announced the Washington Banking Company merger is that our primary focus is the integration of this particular merger and it is going well. I'm very pleased with the results from Q2. I'm very pleased with the process of bringing the companies together. Everything is working well, but we need to continue to focus on that because that is a very critical process.

And during this time period we have folks approach us with smaller bank opportunities that either didn't fit with our footprint, didn't fit with culture, or would have been too much of a distraction for us as we are integrating these two companies, so we took a pass on them. I think going forward we're in a position now that we would entertain M&A possibilities. We will continue with the discipline and the focus that we've employed on all previous M&A activity. We will continue to look within our footprint; our footprint has expanded from Bellingham to Portland. We'll continue to focus on the I-5 corridor.

Obviously smaller transactions don't necessarily move the needle for us at a nearly $3.5 billion company today, so I think we need to look maybe up market a little bit from a size and an impact point of view. However, if we see smaller acquisitions, and I'll say the smaller acquisitions might be something below $300 million in total size, asset size, if we have an opportunity to do smaller strategic acquisitions, then we would certainly take a look at those.

Those smaller strategic ones may be in areas where we -- they could be in areas where we need to increase our visibility and our scale. For instance, Seattle, Bellevue; Vancouver, Portland. As I've said several times, too, there may be some possibilities down the road to extend the footprint further south in Oregon along the I-5 corridor, but just in a general sense I think that's where we stand on M&A activity at this point.

Perfect. Thank you very much.

[Peter Lewer with Post Street Capital].

Quick question on capital levels, what you think mid-target capital level would be TCE to TA and when you think you would start to work to sort of reach that target through stock buyback or sort of some other means?

Sure. Well, as I mentioned in my comments I think that we love the flexibility that we have to manage our capital through the potential of increasing dividends, the potential of special dividends, and the potential of those stock buybacks, not to mention organic growth and to -- potential M&A obviously would have an impact on capital levels. So I appreciate the fact that we have the flexibility to manage capital. I also appreciate the fact that at 9.8% tangible common equity, that's still a very strong number. I think we will continue to evaluate that as growth opportunities may present themselves.

I think from a stock repurchase point of view, we have been active in stock repurchases in 2013 when we felt that the valuations were at a point that it was an advantageous opportunity for us. We have not done any of that in 2014, but we will continue to analyze that. I think generally speaking, 9.8% is a strong capital position and we would look to work that down through organic growth, M&A, and various capital management strategies over the next couple of years.

I think when we look back on capital management, we've done -- even though we had a lot of capital and I realize that, we've been pretty active with stock repurchases, special dividends and those sorts of things and will continue to analyze all of that as we go forward. So, hopefully those general comments help a bit.

Is there like a floor level where you're comfortable managing the business?

Well, I think that there's opposing forces. There's the regulatory side of things, there's Basel III that is looming that we need to fully analyze and appreciate the effects of the potential of that. I think that from an investor point of view all of us would probably rather see higher levels of return on equity. I fully understand that. So, without naming a number I would say that we're certainly comfortable in working that 9.8% down to lower levels but another thing is just generally economic conditions.

And while we see general economic conditions improving in our footprint and across the nation, recently we've been reminded that there is geopolitical risk out there and there's any variety of things that can upset the status quo. So, I think that we need to keep an eye on all those factors going forward, but generally I think that working that capital level down as we have been doing is our strategy.

Thanks a lot.

We do have followup from Tim O'Brien.

Hey, one followup. In the deck you guys indicated or initial outlook was for about a $30 million, a little less than $30 million discount on loans you're going to be acquiring. Do you happen to have kind of the final discount mark that you pegged the deal at at close?

I'll maybe have Don address that. Don.

Hi, Tim. For the non-covered piece, which I think is what you were probably referring to --

Non-covered, exactly.

Yes, it was -- ended up at $26.7 million.

Okay. Thanks.

Thanks, Tim.

And to the presenters, (technical difficulty).

Well, John, I appreciate everyone's call in today and once again I will apologize for sound quality issues. We'll get those corrected for our next call. I appreciate everybody's interest in the Company and your continued ownership.

I'll just close by saying and repeating a comment that I made just a moment ago, we continue to be very positive about the scale and efficiencies that we're beginning to create as a result of the merger of these two companies. And I will also say that the efficiency has been improved by a number of initiatives that we put in place last year under the legacy Heritage system. So, that's not to be lost on, I think, what we're seeing now and improved efficiencies across the balance sheet, but I continue to be very encouraged by the prospects of bringing these two companies together.

And just as a reminder, we'll be meeting with many of our institutional investors next week at the KBW conference in New York City. I look forward to meeting and chatting with you and talking again some more about the Company that we've created. I appreciate all of your interest today. Thank you for calling.

Ladies and gentlemen, this conference is available for replay. It starts today at 11:00 AM Pacific time. It will last until August 8 at midnight. You may access the replay at any time by dialing 800-475-6701 and the access code 330527. That number again, 800-475-6701 and the access code 330527. That does conclude your conference for today. Thank you for your participation. You may now disconnect.