Heritage Financial Corp (HFWA) 2016 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Heritage Financial earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would like to now turn the conference over to our host, CEO Brian Vance. Please go ahead.

Thank you, Celina.

I would like to welcome all who called in for our first-quarter earnings conference call and those who may call in later on a recorded mode. Attending with me is Don Hinson, our CFO, Jeff Deuel, who is President and COO, and Bryan McDonald, who is our Chief Lending Officer, and he is attending remotely with us today.

Our earnings press release went out this morning, our pre-market release. Hopefully you've had an opportunity to review the release prior to this call. I would remind everyone to refer to our forward-looking statements contained in that recent press release. I will start with the highlights of our first-quarter results.

Diluted earnings per common share $0.30 for the quarter ended March 31, 2016; compared to $0.32 for the quarter ended March 31, 2015 and $0.32 for the linked quarter ended 12/31/15. Heritage declared a regular cash dividend of $0.12 per common share on April 20, 2016, an increase of 9.1% from $0.11 for the cash dividend paid in the quarter ended March 31, 2016.

Return on average assets was 1% and return on average tangible common equity was 10.48% for the quarter ended March 31. Total loan receivables net increase $57.2 million, or 2.4%, to $2.43 billion at March 31, 2016, from $2.37 billion at December 31, 2015.

Don Hinson will take a few minutes and cover our financial statement results.

Thanks, Brian.

I will start with the balance sheet. As Brian mentioned, net loans grew $57 million during Q1. Much of this growth occurred late in the quarter. Therefore, we will experience a nice benefit from this in Q2.

As a result of loan growth our loan deposit ratio increased to 77.8% from 76.6% at year end. Investment balances increased $10 million to $822 million at March 31, due mostly to an increase in unrealized gain on the portfolio.

During the quarter, the percentage of demand deposits to total deposits increased to 25.4% from 24.8% in the prior quarter-end and total non-maturity deposits to total deposits increased to 87.0% from 86.5% from the prior quarter-end. We continue to see experience a runoff in CD balances due to the low rate environment.

Moving on to some credit quality metrics, we continue to see overall improvement in the levels of potential problem loans. Potential problem loans decreased $15.5 million, or 14% during Q1. Nonperforming total assets increased to 0.39%, as of March 31, from 0.32% as of December 31.

Much of the increase was a result of three problem loans totaling $2.5 million that we placed on non accrual during the quarter. All these loans are secured with commercial real estate and are properly reserved for. The borrowers operate in different industries and we do not see the increase in nonperforming loans as a trend. The ratio of our allowance for loan losses to nonperforming loans still stands at a very healthy 240%.

In addition, included in the carrying value of the loans, is $18.6 million of purchased accounting net discounts, which may reduce the need from allowance for loan losses on those related purchase loans. Our net interest margin for Q1 was 4.04%.

This is a seven-basis point increase from 3.97% in Q4. Pre accretion net interest margin increased 13 basis points to 3.82% for Q1 from 3.69% in Q4. This increase was due to a combination of increased yields in the loan and investment portfolios, as well as additional leveraging of the overnight cash position during the quarter.

Noninterest income decreased by $108,000 from the prior quarter, due mostly to the final gain recognized in Q4 on the sale of the merchant Visa portfolio. Of the gain on sale of loans in Q1, $598,000 related to mortgage loan sales and $131,000 related to SBA loan sales. Noninterest expense for Q1 decreased $400,000 from the prior quarter.

The decrease was due mostly to a decrease of $450,000 in occupancy and equipment expense. This was due primarily to effects of branch consolidations. Much of this decrease is due to approximately $300,000 of costs, which were incurred in Q4 of 2015 related to the branch consolidation process.

I will now pass it off to Bryan McDonald, who will now have an update on loan production.

Thanks Don. Good morning everyone.

I'm going to cover the production activity during the quarter for each of our primary lending areas starting with commercial banking. During the first-quarter the commercial teams closed $151 million of new loans, which is up from the $149 million closed in the fourth-quarter of 2015, and $131.6 million closed in the first-quarter of 2015.

Gross loan totaled increase in the quarter by $57 million as a result of the strong level of originations. More loans funding at closing, and lower payoff activity than we encountered in the fourth-quarter of 2015. Commercial team pipelines ended the fourth-quarter at $310.3 million, down from $336 million at the end of 2015.

Loan demand has remained consistent from our customer base, and our calling efforts continue to provide the banks a number of new opportunities. Line utilization at the end of the quarter was 34.6%. This equates to $139 million of outstandings on $403 million of commitments and compares to 35.7% for the fourth-quarter of 2015.

The utilization percentage, the last two quarters is down from the 38% to 39% range, which has been more typical the last two years. The average first-quarter interest rate for new commercial loans was 4.15%.

Moving on to SBA, we had 10 loans close in the first-quarter for $2.4 million, and the pipeline ended the quarter at $12.8 million. This compares to the fourth-quarter of 2015 when we closed four loans for $2.6 million and the pipeline of 7(a) loans ended at $9 million.

Consumer production during the quarter was $42.8 million. This is in line with the prior quarter with branch consumer lending making up a larger portion of the volume as a result of the consumer platform being rolled out across the Heritage Bank footprint after the Whidbey Island bank merger.

Branch consumer volume has averaged $14.2 million per quarter in the past three-quarters as compared to $7.8 million per quarter in the same period after the merger. This is an 82% increase in branch consumer loan volume and the proportion of branch volume to total consumer loan volume has also increased from 26% to 35% over the same period.

The mortgage department closed $29.6 million in new loans during the first-quarter compared to $29.4 million in the fourth-quarter of 2015. The mortgage pipeline ended the first-quarter at $41.1 million, up from $29.4 million at the end of 2015. Current pipeline is comprised of 50% refinance loans, 37% purchase loans, and 13% construction loans. This compares to last quarter's pipeline, where refinance business averaged 56%.

I will now turn the call to Jeff Deuel who will have an update on our retail strategy.

Thank you, Brian.

On the last earnings call I highlighted our continued focus on transforming our retail presence and outlined the six-branch consolidations scheduled for the first-quarter of 2016. We're beginning to see evidence of these efforts in the form of reduced expenses, as well as improved deposits per branch. As a result of our efforts to implement process improvements and identify efficiencies, we're also seeing a positive effect on noninterest expense in general.

We have also been working on system improvements and product enhancements to provide a better experience for our customers. We introduced the following enhancements. The first is Card Valet, which is a mobile app that enables card holders to manage their debit cards with the ability to turn a card on, off, set general spending limits, and create activity alerts. And also a person-to-person service that allows on-line banking users to send secure electronic payments to anyone with a US bank account.

Payments can be sent to a bank account, a mobile phone number, or an e-mail address. We can also accommodate external transfers between owned accounts of other financial institutions.

In the next few months we will activate several other product enhancements, including consumer on-line banking entitlements; which allows the customer to create sub-users on their account for a variety of purposes; EMV for debit cards for greater security; business mobile banking, which will allow our business customers to use our business on-line banking product to view balances, transfers, ACH and wires; and instant issue debit cards which will enable new or replacement cards to be generated on the spot in the branches. All of these enhancements will make it easier for our customers to manage their accounts, but it also provides the bank with more options for creating retail efficiencies and reducing expenses across our footprint.

I'll now pass it on to Brian for an update on capital strategies and closing comments.

Thanks Jeff and I'll start with capital management.

As mentioned previously we have increased our regular cash dividend to $0.12 from $0.11. Our tangible common equity increased to 9.9% from 9.7% at the end of Q4.

Our strong tangible common equity levels continue to give us flexibility for a variety of growth opportunities, as well as other capital management strategies. Additionally during Q1 we bought back 100,000 shares under our repurchase plan at an average price of $17.08, which was roughly 1.5 times tangible book value.

Some comments now on the outlook for the balance of 2016, we continue to be optimistic about the overall economy of the Puget Sound region. Real estate values across all sectors continue to appreciate and most all economic indicators continue to show measurable improvement. Commercial real estate construction growth is robust in the region and construction activity seems to match demand at this point, but we are being careful to constantly monitor and limit loan concentration in high activity sectors.

Managing our concentration levels may cause us to turn away certain loan origination opportunities, consistent with establishing and maintaining discipline over our loan concentrations. As I had previously stated, loan growth is not always perfectly linear. As stated earlier, annualized loan growth for Q1 was 9.6%.

Previous quarters having ranged from flat to double digits annualized growth. Our year-over-year loan growth was 7.5%, which is on the higher side of our guided 6% to 8% growth. We continue to be optimistic our net loan growth for 2016 will be in the 6% to 8% guidance that we have been giving. While overall loan quality remains strong, we continue to improve it.

On a linked quarter basis, our loan quality as measured by the sum of: total nonperforming assets, restructured performing loans and potential problem loans improved 8.7%; Q1's annualized performance is even an improvement to the same loan quality measurement for the years 2016 over 2015, which was 22%. While total deposit growth was modest in Q1, our noninterest deposit growth was 3% or 12% annualized.

We have guided our annual noninterest deposit growth at 8% to 10% and are pleased that this important category continues to improve nicely. I am pleased that we continue to improve our overhead ratio as we have guided for the past several quarters. Our overhead ratio for 2015 was 3.01%, a significant improvement over 2014's overhead ratio of 3.49%.

Our overhead ratio for Q1 improved to 2.91%, substantially better than Q1 of 2015 at 3.07% and also an improvement from Q4 overhead ratio of 2.92%. Additionally it is important to remember this noninterest expense improvement has been accomplished while adding significant new expense for our Seattle office.

We continue to guide to an overhead ratio of approximately 2.85% on a run-rate basis by the end of this year. That concludes our prepared remarks and I welcome any questions you may have. And, once again would refer to our forward-looking statements in our press release as we answer any of these questions that you may have.

Celina, that completes our prepared remarks, and we would open up for any questions that they may have.

(Operator Instructions)

Our first question comes from the line of Matthew Clark with Piper Jaffray.

Good morning, guys. Maybe first one just on new loan pricing. Just wanted to get an update on what the weighted average rate was on the new loans this quarter.

I think it was 4.15% for new loans that were added during the quarter.

Okay. Great. And tax rate bouncing around a little bit here the last couple of few quarters. Just curious what your expectations are for the balance of the year.

I think it will stay lower. I'm thinking more in the 26% range by quarter.

Okay. And then on your noninterest expense run-rate, I know you gave guidance of 2.85% for the overhead ratio by the end of this year but knowing that you've got some branches consolidated here this quarter, is there some potential that we can see further relief in the run-rate from that 26.4% this quarter?

Yes, I think we're -- we talked about this last quarter where we're not going to see a lot of the benefits from the use -- we're still consolidating having some consolidation costs even in Q2. We'll see more of the impact starting in Q3, but we will expect to see occupancy and equipment expense to decrease some as a result on overall noninterest expense as a result.

Okay. And then just on fees, gain on sale has been down for the last couple of quarters. Just curious what your thoughts are on production there and gain on sale income.

Sure, Matt. The pipeline at the end of the quarter was up to over $41 million versus $29 million at the end of the fourth-quarter so we are seeing the pipeline ramp up on the mortgage side.

On the SBA, the gain on the SBA volume, we're just seeing more competitive pressure in that market, and we have a formula we use to determine whether we want to sell those loans or not. So to the extent we're offering fixed rates or lower variable rates, we may sell a little less of that product than we have previously.

Okay. It sounds like with the pipelines building, and even with the competitive pressures on SBA, you should see some improvement here going forward.

Yes, the pipeline is definitely up from where it was at the end of the year.

Okay. Thank you.

Okay. And our next question comes from the line of Tim O'Brien with Sandler O'Neill.

Good morning. Quick question for you, Don. The provision reversal expense for loan losses, that $639,000 number this quarter; in the table, little table in the narration, what was that?

That's related to the cash flow estimations on purchase loans. So in total we had an expense, Tim. Because the reversal is a positive number in Q4 of last year. It is actually expense.

Okay, and that's related to purchase loans.

Yes.

And I guess that's self-explanatory in the table above. I didn't see that purchase loan session. And then the other question is, I think you alluded to this, the three loans that were downgraded this quarter to nonaccrual, those were purchase loans?

I don't believe they were, but maybe Brian -- I don't know if Brian has that information.

It looks like maybe one of three were.

Were any -- can you give a little color, Brian, on the C&I loans? I think one of those at least was a C&I loan.

We're talking about the nonaccrual loans?

Yes.

I think the C&I loan was the charge off that I mentioned in the earnings release, Tim. So I think these are CRE loans that are related to the additional nonaccrual balances.

And the C&I loan that was charged off, that was identified and charged off in the quarter?

Yes.

Yes, it was. Just a little further, color on that, it was fully charged off, so that there's no balance left. There is the potential for some recovery on that loan, but a little additional information.

Where was that -- the borrower based where that loan was tied to?

The borrower was based in, I'll say, north of Seattle.

North Seattle? And was it -- how old was the loan?

It had seasoned. It was a -- and not that this makes any difference, but it was a legacy Whidbey Island originated bank loan, and it had been originated, I'm going to say probably four years ago, three or four years ago.

And then sticking with credit, can you give a little bit of color on that $14 million reduction in problem loans? What was -- that was nice improvement; and how did that come about this quarter?

I think, Tim, if you -- in my comments, I talked about the improvement on overall credit quality, and as we measure it by the combination of -- let me find my remarks here. The combination of nonperforming assets, restructured performing loans, and potential problem loans.

And that improvement rate has been going on for some time. And we had a very nice improvement rate in 2015 and it continues in Q1 of 2016. And it's really just the ongoing management of the problem assets.

As I said, it's a variety of different assets, variety of different types of loans and buckets of loans. I think our credit administration area is doing a nice job of managing problem loans out of the bank.

If there's -- there's an opportunity to do that, and we're taking advantage of it. So it's just a continuation of our strategy.

Thanks for answering my questions.

Okay. And our next question comes from the line of Riley Stormont with D.A. Davidson.

Good morning, guys. I was just wondering, I know previously you talked about being a bit more selective in hiring for 2016. I was wondering if there were any certain markets you've identified or you're feeling opportunistic in.

Sure, Riley. We continue to actively recruit in King, Pierce, and Snohomish County, primarily to replace for retirees or other people that have departed the bank. And then really in all our markets, if we have -- again, if we have a situation where somebody is retiring or we need to fill a position.

So we continue to be very active in recruiting, primarily because the talent is pretty limited, and we just always want to be out in front and be aware of who is available or may become available, and be in that all the time. So we were pretty well staffed at the end of 2015, and continue to be out, just active, if we have a need.

And I would add to that as well as Brian Vance. We were chatting about this the other day, our net lender base really hasn't changed over the last few quarters. But we're adding lenders all the time.

We've had a good deal of retirement activity. I think this is something that most community banks worry about as our lender base may age. They're retiring out, and we're certainly experiencing that.

But the important thing is we've been able to replace these lenders either with folks coming up through the credit administration area, loan analysis, as well as hiring folks from the outside. So our net lender base hasn't changed, but we have hired several lenders which have been replacing some retiring lenders. So I wanted to add that additional color.

Thanks. And on core margin tail winds, obviously you guys saw a pretty big jump in core margin this quarter. Expecting any additions from investing excess cash moving forward?

I think we're down to -- there might be a little bit of that, but we used a lot of that in Q1. Our average balance for the cash, overnight cash, dropped from $114 million in Q4 to $60 million in Q1. There's a chance we could drop that a little bit further maybe to $40 million or something in Q2, but obviously not as big of a jump this next quarter as it was the previously.

Thanks, guys.

Thank you. And our next question comes from the line of Jackie Chimera with KBW.

Hi, good morning, everyone. I just want to make sure that I understand the costs that are associated with the four branch closures in the quarter, and sorry if I missed in this your prepared remarks. I hopped on a little bit late. You previously discussed around $400,000 related to those. Is that what happened in the quarter, and if not, can you provide an update on that?

Okay. Jackie, you're talking about the costs being for this quarter on that?

Yes. At least I thought they were going to be incurred in the quarter. Maybe I misunderstood?

We've incurred some this quarter. Actually, we incurred some in the Q1. We also incurred, again, like I said, $300,000 in Q4.

I would say somewhat that the benefit we got off the branch consolidations may have offset somewhat the additional costs. I think we ended up with a couple hundred thousand of costs in Q1. I think we're going to probably have that also maybe in Q2.

And, once again, not get the benefits from this totally until Q3. So I think we talked initially that there was going to be about $800,000 potentially of a -- we started this process of overall costs. We're probably going to be in that area when we get all done.

Okay. That must be my notes where I got the $400,000 from with the $300,000 that were taken issue for and then the roughly $800,000 for all in. That's helpful. Thank you. Did you notice any change in depositor behavior following the rate increase that we saw in December?

No, we really didn't. We always have -- the first-quarter is always a little slow compared to -- as a quarters and deposit growth, but I think it behaved like it normally does in Q1.

So we really didn't notice that. And we didn't really need to raise our rates, either. So a situation where it really ended up benefiting us overall.

Okay. Great. And I'm guessing that from a competitive standpoint, you're not noticing anybody coming in and saying, well so-and-so is raising rates, so I think you should do the same, it's just kind of business as usual?

Yes, the competitive environment stayed pretty stable over the last few months.

Okay. Great. Thank you. That's very helpful. Everything else that I had was already asked.

Okay. And at this time there are no further questions.

Well, if there are no further questions, I appreciate those that listened in, those that may -- those that joined us today and those that may listen in later on recorded mode. Appreciate your interest in our company. That concludes our call today.

Ladies and gentlemen, this conference will be available for replay after 1.00pm today through May 5, 2016. (Operator Instructions) That does conclude your conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.