Heritage Financial Corp (HFWA) 2015 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. Before the conference, all participant lines are in a listen-only mode. However, 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 everyone who's called in and also to those that may listen in later in recorded mode. Attending with me this morning is Don Hinson, our CFO; Jeff Deuel, President and Chief Operator Officer; and Bryan McDonald, our Chief Lending Officer.

Our earnings press release went out this morning in a pre-market release; and hopefully, you've had an opportunity to review it prior to this call. And as we go through the presentation and as well in our Q&A period following, I would refer you to our forward-looking statements and keep that in mind if you would, please.

I'll start this morning with the highlights of our second quarter. We had what we believe is a solid quarter with respect to earnings with an EPS of $0.29 for Q2 and a return on average assets over 1% and a return on average tangible common equity of 10.5%. In addition, we had strong loan growth for the quarter with an increase in non-covered loans of $68.5 million or 3.2% for the quarter. And year-to-date non-covered loans have increased 5.4% or 10.8% on an annualized basis. Finally, we are excited about the continued development of our metro market strategy with the expanded team of bankers and downtown Seattle and we'll refer to that later in our comments.

At this point, I'd like to turn it over to Don Hinson and he will cover some financial statement results. Don?

Thanks, Brian. I'll start with the balance sheet. Total assets increased $21 million in Q2, primarily as a result of $34 million increase in total deposits during the quarter. Total net loans increased $58.5 million during the quarter. This increase was funded primarily by deposit growth as well as a $50 million decrease in the investment portfolio.

Our strong loan growth has resulted in an increase in the loan-to-deposit ratio to 78.9% at June 30 from 76.7% at the prior year-end. The decrease in the investment portfolio was partially due to sales of $33.6 million of investment securities, for a net gain of $425,000.

Also during Q2, we had additional $25 million of BOLI that was purchased, bringing the total amount of (inaudible) to $60.6 million. Non-maturity deposits continue to show growth as they increased $63.1 million during Q2. The increase in non-maturity deposits was partially offset by a decrease in CD account balances in the amount of $29 million in Q2.

As part of our stock purchase plan, in Q2, we repurchased approximately 305,000 shares at an average price of $16.88. We have 1.07 million shares remaining for repurchase under the current plan. In addition, we repurchased additional 11,000 shares in conjunction with the vesting of our restricted stock, resulting in 316,000 total shares repurchased during Q2.

Moving on to credit quality, we continued to see overall improvement in credit quality metrics for the non-covered loan portfolio. Total non-accrual non-covered assets decreased $1.5 million or 17.3% during Q2. This decrease was due mostly to sales of non-covered other real estate owned. The ratio of our allowance for loan losses on non-covered, non-performing loans stands at a very healthy 326%.

In addition, non-performing, non-covered assets to total non-covered assets improved to 0.21% as of June 30 from 0.26% as of March 31. Our net interest margin for Q2 was 4.19%. This is a 12 basis point decrease from 4.31% in Q1. The decrease is due primarily to a 9 basis point decrease in the impact of incremental discount accretion.

The carrying value of non-covered acquired portfolios decreased $58.5 million in Q2 and the carrying value of the covered acquired portfolios decreased $9.9 million in Q2 for a total decrease in acquired portfolio of $68.4 million in Q2. Pre-accretion net interest margin decreased 3.84% for Q2 from 3.87% in Q1. This decrease was due primarily to a decrease in pre-accretion loan yields of 4 basis points to 4.88% in Q2 compared to 4.92% in Q1, as new loans are being booked at rates lower than the current portfolio.

Non-interest income decreased $1.5 million from the prior quarter due primarily to the effects of the $1.65 million gain on the sale of the merchant card portfolio which occurred in Q1. The amortization of the FDIC indemnification asset increased to $304,000 for Q2. The remaining balance of the asset is $388,000 as of June 30. Therefore, we don't expect significant amount of amortization in future quarters. Of the gain on sale of loans, $948,000 related to mortgage loan sales and $334,000 related to SBA loan sales.

Finally, regarding non-interest expense, non-interest expense remained fairly steady from the prior quarter due to a combination of steady expense level and asset growth. Our overhead ratio showed improvement to 3.01% in Q2 from 3.07% in Q1.

I'll hand it off to Jeff, who will now have an update on strategic initiatives.

Thanks, Don, and good morning. We began 2015 with a specific focus on three strategic initiatives, including the integration of the two legacy banks, developing the metro markets and growing non-interest income. We're pleased to see that our focus on the integration initiatives during the first half of the year is paying off. We believe we have achieved the cost save originally identified early in the merger planning process and we continue to identify efficiencies throughout the Company. For example, we've developed and are implementing standardized processes across the footprint; and we have been renegotiating vendor contracts, which should contribute to reduced expenses over the next several quarters.

You may recall earlier this year, we identified the need to add more FTE selectively to certain back office operations where we may have been a little too surgical when we structured the new combined organization last year. We made those additions in the first and second quarters and now that capacity needs have settled down. During the second half of the year, we'll be focused on reviewing and refining FTE levels with the goal of bringing the overall number down.

Our second initiative was focused on developing metro market which has also turned out well with the opening of our new downtown Seattle location in early August and the hiring of several highly experienced lenders on the Seattle team. We will continue to selectively recruit in our high-growth markets. In addition, we have also strengthened the cash management team with a new experienced manager who joined us late last year and a reorganized sales team, which is now positioned to support planned growth in all of our markets.

Our third initiative is focused on growing non-interest income with a specific focus on referrals to mortgage, Cash Management, SBA and Wealth Management, essentially taking advantage of the ability to offer these services across the combined footprint. To support this initiative, we implemented an internal referral tracking system earlier this year. It's a system that was embedded in our new core system and it allows us to monitor referral progress, responses and completions. It's great to see that there are well over 200 active referrals in the queue at this time. Going forward, we will continue to focus on all three initiatives and we will also continue to monitor and manage our expenses, as the year progresses. Bryan McDonald will now give an update on loan production.

Thanks, Jeff. During the second quarter, the commercial lending teams closed $183.6 million of new loans, which is up from the $131.6 million closed in the first quarter and $120 million closed in the second quarter of 2014. Non-covered loan totals increased in the quarter by $68.5 million as a result of the strong level of originations. Commercial team pipeline ended the second quarter at $290.7 million or roughly even with the end of the first quarter. We continue to see increasing loan demand from our customer base and new opportunities from our calling effort and at the same time the competitive environment in the market continues to intensify. Considering all factors we are pleased with our commercial loan pipeline heading into the third quarter. Line utilization at the end of the quarter was 38.9% and this percentage has been relatively stable all of 2014 and year-to-date 2015. The average second quarter interest rate for new commercial loan was 4.23%.

SBA 7(a) production in the second quarter included 16 loans for $6.44 million and the pipeline ended the quarter at $13.7 million. This compares to the first quarter where we closed 11 SBA 7(a) loans for $6.29 million and ended the quarter with $12.6 million in the SBA 7(a) pipeline.

Consumer production grew in the second quarter to $40.1 million of new loans closed. The $40.1 million was comprised of $24.5 million in dealer volume and $15.6 million in branch volume. This compares to the first quarter of 2015 with $30.62 million of new consumer loans and this was comprised to $23.1 million in dealer volume and $7.52 million in branch volume. The mortgage department closed $46.1 million in new loans in the second quarter compared to $34.5 million in the first quarter and $30.4 million in the fourth quarter of 2014. The mortgage pipeline ended the second quarter at $46 million, up from $40.4 million at the end of the first quarter and $21.2 million at the end of 2014. The increase in the mortgage pipeline is being driven by refinance volume due to low interest rates and increases in home purchase and construction activity.

The current pipeline is comprised of 50% refinance volumes, 35% purchase loan and 15% construction loans. This compares to our 2014 average pipeline where purchased business averaged 55%, a smaller pipeline. Brian Vance will now have an update on capital management as well as some closing comments.

Thanks, Bryan. First of all, just a couple of comments on capital management. We've continued our $0.11 dividend, which represents a 37% payout ratio and is comfortably in the range of our previously stated range of 35% to 40% payout ratio.

As Don stated earlier, we repurchased 316,000 shares during the quarter. We will continue to analyze stock repurchases on an opportunistic basis, but are unlikely to purchase stock at current trading ranges. Our TCE remains at a healthy 9.9% and our strong TCE level continues to give us flexibility for a variety of growth opportunity, excuse me -- as well as other capital management strategies.

I'll close with some comments on our outlook for the balance of 2015. We continue to be optimistic about the overall economy of the Puget Sound region. Real estate values across all sectors continue to appreciate modestly and almost all economic indicators continue to show measurable improvement.

The Wall Street Journal this morning published a list of major US cities' change in airline flight additions. Adjusting for vacation destinations such as Florida and Hawaii, Seattle's flight increases were second in the nation, adding 25% more flights. By comparison, another West Coast city similar to Seattle, San Francisco, increased their flights 4%. So I'm not a bellwether economic indicator, this is just one more indication of a strong Seattle economy.

As stated earlier, we continue to be pleased with overall loan growth for the past three quarters. On an annualized basis, non-covered loans have grown 10.8% year-to-date. Prepayment levels continue at higher than normal levels. And while we have given guidance that our 2015 loan growth would be 6% to 8%, we're optimistic our net loan growth will be at the upper end of our guidance for 2015, assuming prepayment activity does not spike beyond current levels. On non-accreted yield for the last four quarters has been in a fairly tight band between 3.83% and 3.87%. However, we continue to believe our non-accretive yield will show slight decreases for the remainder of the year.

Following Q1, we indicated our Q2 efficiency ratio would increase, largely due to the lack of a one-time gain we experienced in Q1. However, we are pleased that our overhead ratio improved from 3.07% in Q1 to 3.01% in Q2. We believe our overhead ratio absent our Seattle expansion plans will continue to show slight improvement. We obviously are pleased with our recent successes in expanding our Seattle presence as a result of the recent Commercial Lending Officer hires. We believe our Seattle expansion strategies will positively affect our results later this year and more so for full-year 2016.

As Jeff has mentioned, we continue to be pleased with the positive results for our ongoing integration from a merger with Washington Banking Company, and we believe we'll continue to see synergy improvements at all levels. That completes our prepared comments for this morning and we would be happy to entertain any questions that you may have. So John, if you would like to open the line for questions.

(Operator Instructions) Jeff Rulis, D.A. Davidson.

Thanks. Good morning.

Good morning, Jeff.

Brian, in Jeff's comments on the expense side, sort of keeping expenses in check, but also some of the hiring I guess going forward. Your expectations for operating expenses from here?

Yes. Jeff, if we were to isolate the recent Seattle lender expansion, both in facility expense as well as hiring additional individuals and the potential of additional hires as we moved through the year, just on the current expenses that we have in facilities and officers that we've hired, we would anticipate an incremental increase balance of year at about $750,000.

$750,000 on the full year?

For the balance of the year.

Okay, balance of the year. Great.

Just over the last six months of the year.

Got it, okay. And then, a strong loan growth -- I guess, I was surprised within the segment on the C&I bucket was non-net flat. Is that a product of pay-downs?

Jeff, this is Bryan. Yes, we did have some paydowns during the quarter, but overall looking at the pipeline overall, we do have good activity in the C&I origination.

Bryan, do you have sequential paydown numbers last quarter in this?

I do. It's in total non C&I and what I look at is the large payoffs, the ones kind of out of the ordinary, over $1 million; and those were $23 million just on the commercial side in the quarter.

Any idea what that was last?

I can look, but I would guess that it's not an educated guess but something about half that level in the first quarter.

And then, last one for Brian. I guess, any update on sort of M&A thoughts? It sounds like a little of attention going to the Seattle expansion, but any change in the kind of conversations that you've had, the acquisition of other banks?

Sure. Jeff, I think from our perspective, we've indicated to date that we've hit the pause button as it pertains to M&A activity for obvious reasons. We really needed to normalize backroom, but we've really focused on organic growth during this period of time and I think we can see in the last several quarters, we have been getting strong organic growth and that will continue to be a focus going forward. However, as we've stated on occasion, we've had a number of smaller banks discussions, but for a variety of reasons, they really haven't worked for us and so we've declined to move forward on those, but I think that the difference might be that today, I do believe we have normalized backrooms.

While there's still some improvements in efficiencies and a variety of things that we're focused on, I think we should or were we to be presented with an opportunity, we would be prepared to move ahead with acquisition opportunities. I'm not predicting with this comment, but that's going to happen. I'm just saying that prior to previous comments, we've been pretty careful with not wanting to move forward until we have backrooms normalized from doubling the size of the Company of late last year. But we will be confident. Should we be presented an opportunity that works with us strategically and financially, we would be prepared to move forward.

Great, thanks. What was the number one city for flights added?

Yes, just a moment, I have the article right here. It was Dallas at 38% and Seattle was at 25%.

Okay, thanks.

Thanks, Jeff.

(Operator Instructions) Tim O'Brien, Sandler O'Neill.

Good morning.

Good morning, Tim.

Brian, first question. Back to expenses in the P&L, were there any -- related to Seattle expansion, was there any cost accrued this quarter that you can isolate for us?

Very negligible. It would have been less than $100,000.

And then, as far as that expansion is concerned, do you see deposit gathering being pretty important for the overall success that you would like to see come from this expansion?

I do. I'll ask Bryan to give you more color on that. I think one of the things as we go up market and looking at the middle-market lending, it's predominantly C&I focused relationships, which also has an opportunity for deposit growth. So, I think generally, we would look for deposit expansion. Bryan, any additional comments?

Yes, I would just add Tim that we've staffed the branch with both a new cash management sales officer and then the manager of our cash management area is also going to be located out of our new office in Seattle. So, as we've put the strategy together, we've been very focused on providing cash management and full-service banking; and we'll be pursuing the deposit relationships just as heavily as we will be lending.

Tim, this is Jeff. That was one of the reasons why I made the comment about cash management. We knew that we were going to be adding for the metro strategy and we knew that we needed to beef up our cash management infrastructure to keep pace with the people we're bringing in and would be gathering the deposit.

And as far as you alluded to this, Brian, deal size and potential there, what size of deal would you be comfortable with and do you see an opportunity to lean on deals that you might participate out coming through this banking team that you've added up there?

Tim, this is Brian. Our house limit is $30 million and during the last fall, we started doing some larger middle market credits and have already been participating out portions of those that exceed our comfort level with particular credit. So, we've already been active in that last year and we continue to be finding opportunities that meet that business. So yes, we're already active in it and we would anticipate we would do more.

And then, one last question. Can you guys provide a little bit of color on your rate sensitivity profile here at quarter end?

Well, I don't think it's changed a whole lot since the prior quarter. So, obviously, we're fairly neutral I would classify it as maybe slightly liability sensitive in the short run, but overall asset-sensitive in I would say year two. But even those leanings are very slight just in year one on that liability-sensitive side. I think again, it's with our flexibility on the deposit side and our loan deposit ratio, I think that we would be able to hold our NIM out in a rate dip environment.

Thanks for answering my questions.

Thanks, Tim.

Jackie Chimera with KBW.

Hi, good morning, everyone.

Good morning, Jackie.

Brian, you had mentioned that with the stock trading where it's at, you are unlikely to do repurchases. Does that change how you think about special dividends?

I think we have given guidance in the last several quarters that as we look to managing our capital, it's really three points and that's regular dividend that roughly at 35% to 40% payout, this quarter is at 37%. So we are within that range. We've talked about special dividends, we've talked about the stock repurchases as well. Special dividends, we've never signaled that this is something that we would continue, that it's just something that as the word would suggest it's special. And so it's periodic, it's something that we will evaluate on a variety of fronts, one is capital levels and our overall TCE at 9.9% was pretty steady of the 10% prior quarter.

Now, in the first two quarters of this year, we were fairly active on the stock repurchase. Should there not be stock repurchases going forward in the last half of the year because of values that maybe if they were to remain roughly in the same range that they are, certainly special dividends would be on the table, but that's something that I think that we would evaluate on a case-by-case basis, both looking at organic growth that would affect capital and as well as looking at potential M&A that would obviously affect capital. So it's highly dependent on a variety of factors, but I would say that special dividends are certainly on the table for consideration.

Okay. Thanks, Brian, that's very helpful. And then, just kind of a twofold question, looking to the new hires that you added in the quarter, you've added two senior lenders and then also somebody who is going to run a new Capital Markets Group for you, how long do you think it'll take for those individual pieces to come up and running before the new lenders, understanding it takes time obviously, can actually start to create some loan growth that we'll see at the bottom line and then how long until the Capital Markets Group creates some fee income for you?

Jackie, this is Bryan McDonald. On the capital markets side, we had already developed a swap program, which is one of the areas that we've put under the Capital Markets Group and we're already set up and out actively managing. And so it's just a question of the deal flow at this point in time, but we already had it set up ahead of time and that was running and then on some of the MultiBank business, that's also something that we already had up running and was active. So, really the individual we hired is hitting the ground running and already ramped up on both those fronts. With the other staff, it's the normal -- I would say the normal sales cycle and difficult to predict although we're optimistic that we'll have some very good opportunities looking out over the next six months.

Okay. And then, looking at the swaps and all the other programs that you have in place and that are already there for you, do you have existing customers where you may not have had these in place when you originally booked their loans that you can reach out to and perhaps increase their business?

Yes, for sure, and it's also complementary to some of the middle-market business that we're pursuing. We're just obviously wanting to have a tool set that matches up very well with the type of clients that we're pursuing in the metro market, and we feel like we really have that, both from a product service capability and a staff capability and that's just been enhanced with the recent hires.

Okay. So perhaps more of a -- to help out with sales than to drive fee income then?

For sure. We just got to the point where we really needed a dedicated person to do it. So, we were doing all of the same activities prior to the hire, but without a dedicated person that would grow into the level where really we needed a dedicated person to manage these elements for us and continue to grow it.

Okay, great, Thanks for all the color, I appreciate it.

Thanks, Jackie.

(Operator Instructions) And allow me a few moments, no further questions coming in.

Well, John, appreciate it and if there are no further questions, I appreciate everybody calling in this morning. I'll remind folks that are on the call that the four of us will be in New York City early next week for the Annual KBW Conference. I'm sure we'll be seeing many of you there on our one-on-one discussions and look forward to meeting with you and chatting with you and sharing more about what the strategies of our Company. So I appreciate everyone's call in today, thank you very much.

Ladies and gentlemen, that does conclude your conference. Thank you for your participation, you may now disconnect.