Heritage Financial Corp (HFWA) 2014 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Heritage Financial's third-quarter earnings call.

(Operator Instructions)

As a reminder, today's conference is being recorded.

I would now like to turn the conference over to our host, CEO, Mr. Brian Vance. Please go ahead.

Thanks, Tricia, appreciate it. I would like to welcome -- I would welcome to all of you who called in, and those who may listen later in recording mode.

Attending with me this morning in Olympia is Don Hinson, Chief Financial Officer, and Jeff Deuel, President and COO, and Brian McDonald, Chief Lending Officer. Our earnings press release went out yesterday afternoon in a post-market release, and hopefully you have had an opportunity to review the release prior to this call. Please refer to the forward-looking statements embedded in the press release as we go through the prepared remarks this morning, as well as later in our Q&A session.

I will first start with highlights of our third quarter. Diluted earnings per common share were $0.23 for the quarter ended September 30, compared to $0.20 for the prior year quarter-end of September 30, 2013, and $0.16 for the linked-quarter ended June 30, 2014. We declared a cash dividend of $0.09 per common share.

We successfully completed the systems conversion of the former Whidbey Island Bank into the Heritage Bank's core system on October 5. Our non-maturity deposits increased $79.3 million or 3.5% to $2.33 billion at September 30, from $2.25 billion at June 30, 2014. We also announced a new stock repurchase program which authorizes the repurchase of up to 5% of Heritage outstanding common shares.

Don Hinson will take a few minutes, and cover our balanced -- balance sheet and financial statement results. Don?

Thanks, Brian. I will start with the balance sheet.

Total assets increased $60 million during the quarter, primarily as a result of increases in total deposits, and in repurchase agreements with customers. Due to a decrease -- net decrease in loan balance during the quarter, the funds provided by these customer accounts resulted in increases in the investment portfolio, as well as overnight deposits. With these available funds, we purchased approximately $45 million of investment securities during the quarter. This was partially offset by approximately $21 million in principal paydowns and maturities on investments during the quarter.

Even with the increased investment, the overnight cash position at September 30 was approximately $146 million. We will be working to reduce that cash position by year-end through increases in loans and investments. Approximately 109,000 shares were of common stock repurchased during the quarter. Repurchases partially offset approximately 150,000 shares issued during the quarter, as a result of stock awards granted, and stock options exercised. As a result of being down to 52,000 shares remaining under the previous repurchase program, we have announced a new program which authorizes repurchases of up to 5% of outstanding shares.

I just -- briefly on credit quality metrics, we saw a nice improvement in credit quality metrics for the noncovered loan portfolio. Total nonaccrual noncovered loans decreased 14%, and total nonperforming noncovered assets decreased 15% from the prior quarter end.

Moving onto net interest margin, our net interest margin for Q3 was 4.32%, which is a 23-basis-point decrease from 4.55% in Q2. The decrease is due to a combination of a 27-basis-point decrease in pre-accretion loan yields, decrease in yields on taxable investment securities, and reduction in loans as a percentage of earning assets. The decrease in loan and investment yields was partially due to the fact that Q3 was the first full quarter subsequent to the marking-to-market as of May 1, all of the loans investments of paying the Washington banking merger.

In addition, loans originated during Q3 had a weighted average rate of 4.52%. This is a decrease from 4.71% for loans originated in Q2. Regarding noninterest income, as with other income statement items, noninterest income increased mostly due to the fact that Q3 was the first full quarter after the merger. The increase was partially offset by the negative impact of the change in FDIC indemnification assets.

The amortization of this asset is expected to be at elevated levels for next three quarters, as we approach the end of the loss sharing agreements for the commercial loan portions of the covered loan portfolios. Included in other income are recoveries from loans that were charged-off prior to the merger, and therefore not given the fair value as of the merger date. The recoveries total approximately $771,000 and $802,000 for Q3 and Q2, respectively. This income may not recur in the future.

Finally regarding noninterest expense, as in prior quarters noninterest expense was impacted by merger-related expenses. These expenses total approximately $1.3 million during Q3. The earnings per share impact of these expenses was approximately $0.03. Due to the conversion earlier this month, a large portion of the cost savings associated with the merger will not be realized until Q1 2015.

I will now pass this off to Brian McDonald, who will now have an update on the loan production.

Thanks, Don.

During the third quarter, the commercial lending teams closed $123.5 million of new loans, which is up from $120 million in the second quarter, and $100 million on a combined basis by Heritage and Whidbey commercial teams in the first quarter, when they operated as separate banks. Noncovered loan totals declined during the quarter, due to an unusually high level of large loan payoffs.

These larger loan payoffs totaled $62.5 million, and were centered in four loans that totaled $42.6 million. Two were multifamily construction take-out refinancings totaling $22.7 million, one owner-occupied loan for $10 million was a paid off -- was paid off with the sale of the underlying real estate, and the final loan was for $9.9 million on a project that the bank was looking to exit, due to credit quality concerns. Commercial team pipelines ended the third quarter and held steady at $281 million.

Moving on to the SBA 7(a) business, SBA 7(a) production remained consistent in the third quarter, with the bank closing 16 SBA 7(a) loans for $7.5 million, and ending the quarter with $14.8 million in the SBA 7(a) pipeline. This compares to second quarter, with 20 loans closed for a total of $5.4 million, and $17.2 million in the SBA pipeline. SBA lender rankings were posted at the end of September by the Seattle office. For the SBA year ended September 30, 2014, Heritage Bank ranked number five in SBA 7(a) loans, and number one in the SBA 504 loans.

Moving to our consumer business, consumer production remains strong for the third quarter with $26.7 million of new loans closed. This includes $21.6 million of indirect dealer volume, and $5.1 million of brand volume. This compares to $30.4 million of new consumer loans in the second quarter.

The mortgage department closed $27.1 million in new loans in the third quarter, compared to $26 million in the second quarter, and $16.9 million for the first quarter. The mortgage pipeline ended the third quarter at $26.6 million, up from $21 million at the end of the second quarter, and $19 million at the end of the first quarter.

I will now pass the call to Jeff for an update on conversion and the merger activities. Jeff?

Thank you, Brian.

I would just like to add that after many months of planning, we successfully completed the conversion of legacy Whidbey Island Bank's operating platform onto the legacy Heritage Bank core system the weekend of October 5, as originally planned. Many of you will recall that we moved the Heritage Bank platform from Fiserv Open Solutions to the Fiserv DNA platform about this time last year. We are pleased with the results of the core conversion, and look forward to utilizing the full capabilities of the DNA platform across the combined bank.

A significant portion of the integration process is complete at this time, with the remaining related expenses running off in the next six weeks. Now that the conversion is behind us, we will now be able to fully implemented the go-forward organizational structure we originally designed for the combined bank.

You will also recall from the original deal announcement that we did not plan for any branch closings as a result of the merger. However, we did recently announced the closure of Woodinville branch. This decision came about as a result of an expiring lease, which provided us with the opportunity to consolidate the Woodinville branch with our existing Bellevue branch, creating a larger more efficient branch location.

And now Brian will talk about capital management, and have some closing comments.

Yes. First, starting with capital management, as we previously announced, we declared a $0.09 dividend, which is in line with our previously stated payout ratio of between 35% of 40%. We continue to believe that we have flexibility and opportunity for future regular dividend increases, as our profit -- profitability continues to improve as a result of continuing efficiencies of our recent merger.

Our tangible common equity remains at a healthy 9.7%, and our strong TCE level continues to give us flexibility for a variety of growth opportunities, as well as capital management strategies. I will close with some -- a few comments about the outlook for the remainder of 2014, and some comments on 2015 as well.

The general economy in the Pacific Northwest continues to gradually strengthen. We see the greatest strength in the core Puget Sound counties of King, Snohomish and Pierce. We believe barring unusual global disruptions, the core Pacific Northwest economy will continue its current growth trajectory in 2015. Although our noncovered loan totals were down slightly, our production remains strong, and the decrease was more the result of unscheduled payoffs, then a lack of production. We are optimistic that Q4's net noncovered loan growth will strengthen.

A major strategic initiative for 2015 is to strengthen our loan production and loan balances in King, Snohomish and Pierce counties. We have already begun to implement various 2015 loan growth strategies. Additionally, we are seeing very strong nonmaturity deposit growth. During Q3, we saw nonmaturity deposits grow 7.3%. And since May 1, the merger date, nonmaturity deposits have grown 17.5% on an annualized basis.

This suggests to me, our merger activities have not derailed our overall production focus, as reflected by strong non-maturity deposit growth and new loan production. We continue to believe our various efficiency metrics, such as assets per employee, efficiency ratio, and overhead ratio will continue to improve in Q4 and throughout 2015. As Jeff has mentioned, we were pleased with the positive results from our conversion with the legacy Whidbey Island Bank customers, and we continue to be pleased with the overall integration of the two organizations.

That completes our prepared remarks this morning. Tricia and I would welcome any questions that the -- our audience may have. And once again, refer everyone to the forward-looking statements in our press release, as we answer these questions dealing with forward-looking comments. Tricia?

(Operator Instructions)

Jeff Rulis, DA Davidson.

Thanks. Good morning.

Good morning, Jeff.

On the expense front, so I guess, you had mentioned that Q1 is really going to be reflective more of core expense run rate, I guess with the conversion and all happening in Q4. Any additional color on the kind of levels that are good base? Or perhaps you could speak to any additional efficiencies or improvement on that cost base that you could offer?

Sure. No, I will start, and maybe Don or Jeff can add some comments as well.

And Jeff, just to remind everybody with the conversion that just took place, there was a staff that has been with the organization, and then programmed through conversion. But their continued employment will continue basically for the next 30 days, as we deal with just the normal issues following conversion. So that I think staff reduction is probably the primary area for expense improvement in Q4. There is other contractual agreements that can now be canceled, et cetera, which will add to improved expense structures.

As we have indicated in the last couple of quarters, there is going to be a spillover into Q1 as we continue to deal with contract cancellations. And then, even as we move through 2015, deal with consolidation of facilities. This is -- that is hard to quantify, because there is a variety of leases that we need to deal with and subleases, and our ability to consolidate -- continue to consolidate efforts of process and departments and those sorts of things. So that is hard to quantify.

But I am confident that will continue through 2015. But certainly, the bulk of expense saves should take place in Q4. Don, anything to add to that?

No. I think we are going to continue to have beginning in Q4, just some one-time expenses in addition to heightened levels, because of this -- the additional staffing and in contracts. So you are likely to see another quarter of some merger related expenses, but most of those will be flushed through the end of Q4.

Okay.

Jeff, it's Jeff Deuel. The only thing I would add to that is, that if you think of the timing, we moved Heritage to the DNA platform this time last year, and then jumped right into planning for the conversion for Whidbey Island. So in my comments I made the mention of -- we are looking forward to utilizing the full capabilities of the DNA platform.

We haven't fully done that yet for the combined banks. So I am not sure we can quantify it, but I think there are some opportunities in front of us, that we can work on to make ourselves more efficient on the new system as well.

Got you.

So if we just look at Q3's expense level, back out the merger costs, that base level, safe to say that there could be some improve -- barring the noise in Q4, but in 2015, that base level could be improved upon? Or you are expecting to?

Yes. Before --

Okay.

Or -- but for Q1 2015 it will improve on what we just experienced.

Great. Okay.

And then the second question was, was more on kind of the loan growth. And I guess on the -- first of all, do you have production levels, Q3 versus Q2? I know that Q2 there was some accounting -- it was just kind of difficult to determine, but I guess just total production, loan production or originations in Q3 versus Q2, do you have those numbers?

Yes, Jeff, this is Brian. Q1 was $100 million. That was when the banks were separate -- this is just the commercial teams. Q2 was $120 million, and then Q3 was $123.5 million. So up just a little bit from Q2. Again, that is just the commercial teams.

That's helpful. Okay.

And then I guess, then it sounds as if obviously payoffs eating the net production number. Get any sense that beyond payoffs, there is -- is it sort of also competition that is -- that maybe you are backing away from -- do you get a sense that there is any underwriting being stretched in market?

The marketplace has continued to become more and more competitive, really over the last couple years. The loan demand certainly picked up. The competitive environment has picked up as well.

My general sense, Jeff, is that we are quite active in the market, and we continue to get an increase in opportunities, and win a number of deals. The other side of this equation is really, what are our customers doing? Is the loan growth coming from our customers, or is it coming from taking business from competitors?

And we are seeing our customers engage in more expansion activities, buying equipment or buying buildings. And obviously that is the piece of the business that we really like to see. We really like to see our customers with a credit need, because we are not -- it's not as competitive. It still competitive, but not as competitive as trying to take somebody else's customer in this market.

So my sense is our customers are doing more. And with that I have a positive outlook as we finish the year, and look out into 2015. But as for the competitive environment, I expect that will remain, and continue to be challenging.

And Jeff, I would -- it's Brian -- I would also just add to Brian's comments. Each of the three quarters this year, we have seen successive growth in loan production. I think that is a very good sign. The kind of the largely uncontrollable issue here is, is the unscheduled payoffs that we have addressed.

But I -- to the competitive issue, we noticed that the loan yield for new loans has dropped, I think about 20 basis points if I recall from quarter to quarter, which I think reflects our ability and desire to be competitive, as it pertains to interest rate. We have talked a couple of different times in the past few quarters about the need to continue to leverage the balance sheet. And all of that did not take place in Q3, because of the unanticipated loan payoffs.

Production is strong, and that we will compete on the rate side. We will -- we will not compete on the credit side. That would jeopardize our historical credit quality. But we are willing, and we are competing on the rate side.

Brian, is there any sense on those payoffs that they are coming from the WBCO or HFWA side?

No. They are not, and Brian you might want to address that.

Yes. These were all predominantly from the legacy Heritage side, that really from a merger consequence standpoint, there wasn't anything out of the ordinary in terms of the payoffs, and the production teams are still highly focused with the customers. And as Jeff noted, the conversion went well, and it is a few weeks behind us.

Right. Thank you. I'll step back.

Thanks Jeff.

Jacque Chimera, KBW.

Hello, guys.

Hello, Jacque.

I missed your remarks. I heard the 4.52% rate on the -- oh, sorry. I did not have my -- sorry, technical difficulties. Can you hear me now?

That's much better. Thank you.

Okay. In the prepared remarks, I heard the 4.52% on new originations, but I missed what it was last quarter.

It was 4.71% last quarter.

Okay.

So as I look at the quarter over quarter decline, obviously new generation is having an impact on the core loan yields. Was any of the -- did any of the payoffs have particularly high rates that, given the size of what the payoff was, would have impacted the yield as well?

No. Jacque, there wasn't anything out of the ordinary other than obviously they were booked some time ago, and rates are down again now. But, no, there was nothing special about the rates on the loans that were paid off.

Okay. So it is just compression at the cost of the growth then?

Yes.

Yes, again, just what growth we had was at lower rates, than what we -- what they were on the book before.

And Jackie, this is Brian.

The other major driver in there is just beyond the new production just are pricing on the portfolio. So our -- we do focus heavily on the new rates, but all the time we have existing loans coming up to a reprice, and that rate being repriced off of FHLB index is the primary one we use. And so, as the FHLB moves down, and as rates move down. And so, that has a pretty significant impact, just the repricing activity within the portfolio.

Okay. And when you have a higher starting point, and unfortunately it creates the pressure.

Exactly.

And what did utilization rates on lines do this quarter?

Brian has got that information. He is looking for it. I think that as I recall they stayed pretty static utilization rates.

Yes. It was at the quarter end it was 42.7%, so if you look back, it has been right in that 43%, 44% range. But it wasn't materially different.

Okay. And if I am remembering correctly, you had mentioned some loans that were booked last quarter that just haven't funded yet. Am I -- did I write that down correctly?

You did. Yes, and I didn't include it in the comments. But there was four larger loans that we booked at the tail end of the second quarter, and then we booked one in the third quarter. And those -- just those four loans total a little over $35 million. And the advances on those are still in the low 30% range, so those are loans that will fund out over the next 12 months.

Those are just four particularly large loans. There is, of course, other loans, but just due to the nature and size of the projects. Some of them have no balance on them, because the customers are still funding out of their equity portion.

Okay. That's very helpful. Thank you.

And then just one last one for you, Don. Were there any cost savings? And obviously, I know that this occurs throughout the quarter, so we wouldn't have a full run rate in 3Q. But were there any cost savings that were realized throughout 3Q? Or was the most of that on hold until the conversion took place?

I would say there was not a lot in Q3 from Q2. Because of the conversion, we kept pretty much everybody on that is going to stay on through the conversion. So there wasn't a lot of personnel movement or contract cancellations. We -- the focus was on the conversion, on the backroom side of things. And so, I think that there wasn't a lot of movement there.

The majority of the cost savings then if I understand -- understood all the comments correctly, will probably take place around late November, early December of this year, and then peter out into 2015?

I would say that is correct.

Okay. Great. Thank you all very much.

Thanks, Jacque.

Tim O'Brien, Sandler O'Neill & Partners.

Good morning, guys.

Good morning, Tim.

Question for you, Don.

On the -- you mentioned three indemnification asset -- that asset, three loss share contracts coming, expiring next year. And so, over the next three quarters seeing accelerated amortization.

Well, that the -- it will be -- like it was this last quarter, it will be higher than it has been in previous quarters, over the next three quarters.

So what is the notional value of the loans, covered loans of those three contracts? What -- did they come over -- I am assuming they came over from Whidbey right, or are they yours?

No. One of them is [Talus] which is legacy Heritage's, and then there is two Whidbey, which is the North County and the Citibank. But there is the -- one of those -- it doesn't have a lot of indemnification asset relating to it through the setup of the loss share agreement. So it is mostly just two banks.

And what is the total amount of assets we are talking about, all-in with regard to these contracts?

The -- well, in total covered we report is approximately $150 million.

And then the residual indemnification asset amount. What is that?

Well, we have $5 million left.

$5 million.

$5.1 million at the end of the quarter.

So that is going over the next three quarters?

For the most part. That is on the commercial side. There is the residential side that will -- it is a10 year agreement.

Yes. That is --

But that is much less.

Okay. Got it. Thanks. That's great.

And then any staffing changes in King County during the quarter? Or Brian, you kind of alluded to focus on building that part of the business. Are you guys good to go there? Did you do any hiring up there or anything?

Yes. Tim, we are recruiting really in the metro market in Pierce, Snohomish and King County. We did add one commercial lender in the third quarter. And we continue to have kind of a number of strategies related to growing those three counties, our loans in those three counties as we look out into the fourth quarter and 2015, and one of them, of course is continuing to recruit additional talent.

Just out of curiosity, did you have any bankers leave this quarter?

We did not.

That's great to hear.

And then another question. As far as my sense was, that with the conversion we will see a jump up in kind of deal-related costs here in the fourth quarter. Third quarter was a smaller piece, but the fourth quarter you will take -- there will be another big chunk absorbed. Is that still the -- am I thinking right there still?

I don't think it is going to be bigger than it was necessarily in the third quarter. It will be -- it might be somewhat bigger, but it won't be materially bigger, because the biggest piece, which was the [process] of the system was actually that was paid earlier in the year. So we will see some in merger-related costs, but it won't be much bigger than it was in Q3.

And then, residual, clean-up, merger costs, maybe a little bit in the first quarter, and probably that it is going to be done by then?

Yes.

After that?

That's correct.

And then talking about big cost savings here in the fourth quarter, really though the full quarter impact is going to hit in the first quarter. You alluded to that in your initial comments, right?

Yes.

So your data processing cost in the third quarter was $1.7 million.

Yes.

That number is coming down pretty quickly, right?

Well, yes. That remain -- obviously, it will improve throughout the quarter, so it should come down some.

And then, a question for you, Brian. Next year, do you have many leases on branches coming due, where you guys will have more opportunities to consider consolidations?

Tim, I don't think that there is a lot that we would -- that we are focused on in terms of consolidating branches. But there are a couple that have expirations scheduled in 2016, that we might give some thought to.

Thanks, Jeff.

And then last question, Brian, did you say that pricing kind of -- did you characterize pricing on loans -- new loan production is coming down 20 basis point? Did I hear that right? What did you say there? And what is that relative to, second or first quarter pricing or?

Yes. I think, quarter to quarter -- Q2 to Q3, I think loan yields on originated new loans came down about 20 basis points. I don't have what it was from Q2 to Q3. It would have probably been a little less than that as I recall.

Rate on originations?

Yes.

In Q3, it was 5. -- sorry, 4.52%, and in Q2 it was 4.71%.

And that is just simply a reflection of the competitive nature of the -- everybody is seeing the same thing there, right? You guys are just competing for loans, and that's what it takes to get it done?-

I think Tim, it is probably two things. I think one is just the competitive nature of the marketplace, but rates are coming down again. And so, I think it probably is a combination of both.

Great. Thanks for all the color. I appreciate it.

You bet, Tim.

And I will step back.

Okay. Thanks.

(Operator Instructions)

Brett Villaume, FIG Partners.

Good morning, gentlemen.

Good morning, Brett.

I wanted to follow-up with questions about the loan yields, with a question about the securities portfolio, and the yield on what the new securities that you added this quarter were, versus the -- I think you said $21 million in securities that have run off, that were basically replaced by that addition? If you could give me some color about that -- those securities yields, that would be nice?

Sure, Brett

Yes, we put on about 40 -- again $45 million of -- the yield on the new securities was 1.7%. Of course, security yields can fluctuate, especially mortgage-backs, but at the time of purchase they were 1.7%, and that is the book yield The tax equivalent yield on those, because some of those are munis was 2.27%. So -- but the book yield was 1.87% on new ones. So that would be one -- as the yields on investments came down, so that is part of the reason.

I think we did have some, a few securities, mortgage-backs that had some increased payment fees also that also caused the yield to come down a little bit in the third quarter.

Okay. That's helpful. Thank you.

And then I missed the amount of shares that you repurchased. Do -- let me know what that is again?

About 109,000.

109,000. Okay. Thank you.

And then, do have an average price of what that occurred at?

I do. I believe it was like -- let's see. I think it was $16.65.

And I would add to that, Brett, that under our previous -- and maybe Don mentioned this, I don't recall --under the previous authorization we only had something like 50,000 shares left, which was the primary reason for renewing the new 5% authorization.

Well, my other questions have been answered. So thank you very much.

Okay. Thanks, Brett.

Jeff Rulis, DA Davidson.

Thank you.

Brian, on the revenue synergies, at this point I guess, you are through the conversion. And I know that wasn't really baked in the model of why you did the deal, but any sense of -- and you saw a nice jump in fees in Q3, mostly due to a full quarter of WBCO on the books. But from here, do you still feel optimistic that there is opportunities to grow further?

I do, Jeff. I am going to go back to a comment I made in the prepared remarks.

The fact that our loan production has increased in each of the last three quarters, our nonmaturity deposits have grown very strongly. I think when you take a -- any merger, and certainly a merger of this magnitude, where we are doubling the size of the Company, I think typically it is all too easy to become inwardly focused. And often times, organizations lose their ability or their desire to be externally focused on growth.

And I am very pleased that our entire sales force, our retail branches, our lenders, have continued to remain focused throughout the entirety of the conversion, in that production has increased as well as deposits. And we all realize that deposits are just adding to the leverage issue. But let's step back and remember, that deposit growth is asset growth in the end, and its balance sheet growth. And I think that is a very important thing to remember here.

So I think that as I look at our ability to maintain our focus on production in a very busy time frame, I am encouraged that as we move into -- excuse me -- Q4 of 2014 and into 2015, that we will continue to strengthen the production side of the organization. And I -- we are not going to go into a lot of detail for obvious reasons, as to our strategies for the metro markets that Brian alluded to. But there are a number of strategies that we are currently executing, and we feel optimistic that we can capitalize on those strategies.

So overall, yes, I think all of us remain optimistic as we move into 2015. I think we are -- it's going to take a little while to really -- to understand the rhythms of the Company, a company double the size, the volumes, our markets. There is just a variety of things.

But as I see the combined organization, the strength of the organization, footprint, the ability to go upmarket in deal size, expanded product base for both sides, there is just a number of different synergies here. That as we get our arms around it, and get our organizations put together and get -- drive our efficiencies, and continue to execute our market strategies, I think we all feel pretty positive about the balance of this year, and as we go into 2015.

Certainly, the later -- this latest round of reductions in the interest rates are a concern, I think to the banking industry in general. I think that is going continue to create challenges for all of us. But I think that we have got the leverage and the capital, and I think a management team and a sales force that has the ability to figure out these various changes and challenges and keep moving forward.

Thanks. And Don, a quick one.

The tax rate has been below historical levels the last couple of quarters. Maybe you could touch on what you think it could be for the full year 2014, and then does it normalize in 2015?

I think that we have a couple things. We have [resolved] some tax credits this year. And again, assuming that we keep the same levels, I would think that the fourth quarter will be similar to the third quarter, if you want that for your modeling.

For next year, I would say it would probably increase a little bit, because we had some acceleration, some tax credits this year. So it might go up a little bit, but I think it will still be below prior year's, because we are also adding to the muni portfolio. Some are -- so it's part of the percentage on that. Because again as the investment portfolio has become a bigger portion of the overall assets, and then we have a portion of that being muni, so then that is going to have a bigger effect on the tax rate.

Okay. Thanks, guys. Appreciate it.

Thanks, Jeff.

Eric Grubelich, Bank Investor.

Hello. Good morning.

Good morning, Eric.

A follow-up on the margins.

So that 20 basis point drop, you articulated the lower loan yields on the production this quarter. As you mentioned, rates have dropped again, much to most people's surprise. Do you think as we go into next quarter, is the same type of pressure there on your yields? Or do you think the yields are stable at this level, on that -- on those new production yields?

I think Eric, that again, a big piece of this is the repricing on existing portfolio tied to FLHB, and with rates going down, the FHLB rates go down, and the automatic repricings go down. The rates in the market, I think are at this point are relatively consistent, even with the rates down because the market has been so competitive.

But certainly as rates go down, it certainly provides more pressure on loan pricing. But is it 20 basis points? I -- that's hard to forecast, because you are talking about such a large number of loans making up that production bucket.

And I would add to that, as well Eric. And I -- just a moment ago, in my comments I alluded to just really getting an understanding of the rhythm of the Company. I think that both companies have separately had a pretty good ability to predict the rhythms of the Company, whether it be in cost structures, whether it be in loan production, yields, margins, those sorts of things. And again, I keep stressing this, but it's a reality that you double the size of the company, and it just takes us a little while to kind of dial in the feel of where these various metrics may trend.

I certainly appreciate the purpose and the reason for your question. I don't want to be evasive. But at the same time, it has just taken us -- and it will I think time to kind of get into the natural rhythms of the Company.

No, that is understandable. You are not being evasive at all.

But I had one more question. Look, I understand you don't want to dump your whole playbook open on a conference call, because you probably have a few competitors listening in. But when you talked about some of those strategies for 2015, would that include new types of lending initiatives that you have not done before?

I think that, and then Brian can add to this as well. I think that for the most part, our lending strategies are pretty well set. We have signaled earlier, and we continue to signal that the SBA strategy is a huge part of our go forward strategy. We are pleased to see this last fiscal year as Brian mentioned, we are number one in the 504, and number five in 7(a), And that is in the entire state of Washington with all lenders.

That is not just among community banks, so we remain active in that product type. I think we will continue to stress that product type.

I think probably the biggest opportunity is just the ability to go upmarket in deal size. And I think we have got the expertise to do that, and to desire to do that. And I think that probably opens up more opportunities to us than maybe any other one product type. Or so Brian, I don't know if you have additional to that?

I don't, Eric. I think Brian covered it.

Okay. Perfect. Thanks for answering my questions. Have a good afternoon.

Thank you, Eric. Appreciate it.

John Helfst, Schroders Management.

Hello. Thanks.

Good morning.

Good morning.

In terms of the paydowns, construction loans seem to make sense to me, and that is a success story that went permanent finance. What all -- is there a pipeline for that, because I mean you kind of know when these things are coming due? I mean, this quarter was it a more sizable payout? I know the sales you can't control, but just to get a feel for future quarter headwinds -- is there -- or do you guys tend to do many perms, and the takeout market has gotten stronger? Any kind of color -- in terms of construction loans are usually smaller, and this was a larger one? Or anything along those lines would be helpful? Thanks.

Yes. It was an abnormal number of large loans paying off within one quarter. Looking at the fourth quarter, I don't see this same volume of payoffs in these categories hitting, They are -- they were larger loans that we had. We don't have that many that are this size, and to have four of them pay off within the same quarter was an usual circumstance.

As I -- Jacque Chimera had a question on new larger construction loans. We had booked four larger construction loans at the end of the second, one in the third. And we have a couple more we hope to book in the fourth quarter. That is pretty customary levels. Just as the cycle went, we ended up with four paying off at one time, and the other ones are lagging somewhat in terms of their funding. So hopefully that helps answer the question.

Yes, absolutely, yes. Appreciate it. Thank you.

Don Worthington, Raymond James.

Good morning, everyone.

Hello, Don.

Just a quick question on the gain on sale in the quarter. Was that all SBA, or was there anything else in there?

That is a combination of SBA and mortgage, and actually it is probably two-thirds of mortgage.

Okay.

And then would you expect the SBA gain on sale to grow, as the SBA lending volumes grow?

Yes. We would Don. Don Hinson and I were just looking at these numbers, and confirming its included in that.

Actually, the [7.42%] -- the SBA was [2.01%] and the mortgage was [5.41%].

Okay. Great. Thanks. That's the only question I had.

Thanks, Don.

At this time, there are no other questions in queue.

Well, thank you Tricia.

Thanks everyone, to your interest today and for your questions. And myself, and the four of us on the call are always available to any of our investors for additional discussion. We appreciate your interest. We appreciate your ownership, and thanks for calling in today.

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