Q3 2019 Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the Heritage Financial third quarter earnings call. At this time all participants are in a listen only mode. And then later, we will conduct a question and answer session and instructions will be given at that time, if you should require assistance during the call.
He May press Star then zero on your telephone keypad as a reminder conference is being recorded and I would now like turn the conference over to our host President and CEO Mr., Jeff dual. Please go ahead.
Thank you Laurie a welcome to all who called in and those who May listen later this is Jeff Deuel T. O parentage attending with me are Don Hinson, our CFO and Bryan Mcdonald, our Chief operating officer.
Our earnings press release spin out this morning, Premarket and hopefully you I had an opportunity to review I'd probably the call.
Please refer to the forward looking statements in the press release.
We're pleased with our progress as we continue to build our franchise and generate attractive financial results for our shareholders. As you know we've made significant investments in Seattle, Bellevue, and Portland and were seeing the benefits of the two acquisitions, we completed in 2018 as well as the teams we've added in those markets.
Together, the Seattle, Bellevue, and Portland markets represent significant opportunities for heritage and we believe we're positioning ourselves well continue to execute in those markets. We also see good performance in our traditional markets along the I five corridor.
Despite significant loan production.
Net loan growth continued to be a challenged due to the elevated loan pay offs on the bright side. The long <unk> pipeline has grown nicely and we have strong originations had strong originations during the quarter.
We believe we have laid out a good foundation, which we will continue which will continue to produce attractive results for company in the future.
Well, we have continued to see competition for deposits in the third quarter, our loan to deposit ratio of 82% has enabled us to carefully manage pricing competition and maximize our NIM.
We continue to focus on protecting our core deposit franchise, which we view as one of our keeps track.
Don Hinson will now take a few minutes to cover our financial financial statement of results, including color on our core operating metrics.
Thank you Joe.
I'm going to start with a quick overview of earnings before heading into more detail on our balance sheet credit quality income statement and capital management.
Our diluted earnings per share for Q3 was 48 cents, which is up from 43 cents from Q2.
The increase earnings from Q2 was due mostly to a combination of an increase in non interesting color and decreases in noninterest expense and the progress for loan losses.
Moving onto the balance sheet total asset growth was strong in Q3 due to a 250 million dollar increase in total deposits.
This increase in deposits is net of $20 million brokered Cds that matured or were not renewed in Q3.
Approximately 50% of the deposit growth in the quarter was due to 109 million dollar increase in non interest bearing demand deposits.
Q3 is usually are strongest deposit growth quarter over a year.
The main firms that broke this past quarter appeared to be a combination of seasonal buildup of deposit accounts.
New commercial deposit relationships.
Some customer specific events, such as the sales of businesses, where the funds were kept for the bank at least in the short run.
<unk> gross loans grew approximately 13 million in Q3 and have increased about 77 million year to date.
The annualized year to date growth rate is 2.8%.
Bryan Mcdonald, probably discuss what production in a few minutes.
Regarding credit quality, we experienced a significant increase in nonaccrual loans in Q3, due mostly to $120 million AG relationship with primary business is tree fruit.
We put the credit on nonaccrual status incurred two or three.
Due to our concern over there or being able to meet its budget in order to pay off this year as crop line. In addition to a carryover from the 2018 crop.
The collateral coverage is currently adequate.
Adequate to satisfy the credit exposure.
With a lot of value of approximately 75%.
About 35% of its collateral what's expected proceeds from the partially harvest in 2019 crop.
We are moderate monitoring this credit carefully there will be obtaining updated collateral valuations in Q4.
Although we had lark increase in nonaccrual loans.
The combined total non accrual loans, performing tdrs and potential problem loans decreased by $13 million from Q2 levels.
In addition, net charge offs decreased three basis points in Q3, and or five basis points year to date, which is a decrease was six basis points Truecar Q3 last year.
Although we are happy about the increase in non accrual loans. We don't believe this was indicative of what's but well widespread problems in our loan portfolio.
The net interest margin decreased 12 basis points in Q3, due mostly to a similar 12 basis point decrease the loan portfolio yield.
Although a portion of the decrease the local yield was due to the rate environment line of the 12 basis points decrease was related to a combined impact the large AG credits that was put on nonaccrual status and lower discount accretion.
Because the total deposits leveled off in Q3, increasing only one basis point for Q2 levels.
The strong growth in non of spring demand deposits helped limit our cost of total deposits at 30 basis points from Q3.
Due to the shape of the yield curve.
So 2019 rates and competitive pricing pressures, we do expect continuing pressure our net interest margin in the near term.
Noninterest expense decreased 820000 from the prior quarter.
The improvement was driven mostly by lower compensation expense FDIC premiums and Oreo expenses, partially offset by higher business and use taxes.
As mentioned in the earnings release, we were able to use a credit for FDIC premiums in Q3, and we still have 883000 credits, which will be used in future quarters deposit insurance fund remains at a certain level.
It's also mentioned the release, we incurred an assessment of block or 37000 for Washington State Department revenue that was result of an audit Oh prior for your time period.
We expect this want him to decrease to normalized levels in Q4.
As a result, or overall lower costs and higher asset levels, we saw a nice improvement or overhead ratio, which moved down to 2.65% Q3 or 2.81 person you too.
And finally, moving on to capital management due to our strong capital levels. We took advantage of lower share price was in Q3 to repurchase 265000 shares.
At a weighted average price of 20 623.
I think the end of Q3, we still have 640000 shares available for repurchase under our current stock repurchase plan.
Even with these buybacks are strong asset growth in Q3 or tangible common equity ratio only decreased 10.4% from 10.5 per cent per quarter.
As a result of our strong capital position.
And earnings performance. In addition to a record dividend lighting since this quarter. The board has approved a special dividend of 10 cents for Q4.
This is the night ninth consecutive year, we have paid a special dividend in addition to our regular quarterly dividends.
We will continue to monitor quarterly dividend levels and potential share repurchases.
But also what having the flexibility if and when a potential acquisition opportunity arises.
Robert All will have an update on loan production.
Thanks, Don I'm going to provide detail on our third quarter production results by area, starting with our commercial lending group.
In the third quarter, our commercial teams close to 305 million new loan commitments very similar to the volume <unk> second quarter, 2019, and up 63% from the hundred 87 million as opposed to that third quarter 2018.
New production during the third quarter, what centered on Seattle Bellevue at 98 million Tacoma at 55 million and greater Portland at 42 million.
Commercial team loan pipelines ended the second quarter at 440 million down 8% for the second quarter, but remain up 29% compared to the beginning of the here.
Largest pipeline concentrations Orient, our Seattle, Bellevue teams, which saw their pipeline increased 9% to 162 million last quarter.
Our greater Portland teams, which ended the quarter with a pipeline of 86 million.
And our greater Tacoma teams, which ended the quarter or what the pipeline up 68 million.
Gross loans increased only 13 million during the third quarter or 1.4% analyze rate due to continued higher levels of prepayment and payoff activity.
Loan prepayments of payoffs during the quarter totaled 169 million versus 160 million in the second quarter 2019.
And the elevated hundred 53 million average we expressed in the last three quarters of 2018.
Yeah, and prepayment activity in the third quarter, what's caused by a higher level business and real estate sales.
Customers using cash to pay off debt and clients paying off loans to our active portfolio management efforts.
SPS 70 production in the third quarter included 15 loans for 4.9 billion out in the pipeline ended the quarter at 14.8 million.
This compares to last quarter, where we closed nine loans for 9 million in the pipeline ended the quarter at 13.2 million.
Sps September Thirtyth 2019 fiscal yearend, Seattle, and Portland District, Blender rankings for both 75 or four lots were just for leaves.
For the seven a program we ended up with 50 loans for 42 million, which was 150% increase over 2018.
And then the five or four long program Heritage Bank ranked number one again within the Seattle District office of 16 approvals for 24 million.
[noise] consumer production during the third quarter was 59 million up from 44 million of a second quarter and up from 41 million close to the first quarter 2019, the change in volume that's due primarily due an increase in direct lending.
Moving on to interest rates, our third quarter interest rate per new commercial loans was 50 basis points lower decreasing 4.66% from 5.16% last quarter.
In addition, the average third quarter rate for all new loans was 4.87% dropping from 5.26% last quarter.
The mortgage Department closed 47.9 billion of new long term about third quarter compared to 30.6 million caused in the second quarter, and 44 million and the third quarter 2018.
The mortgage pipeline ended the quarter at 39 million Sammis second quarter, 2019 and down moderately.
41 million in the third quarter 2018.
Just as a reminder, we reduced the size of our mortgage platform. During the second quarter I don't we only sell a portion of our mortgage loans to the secondary market.
I'll now turn the call back to cap.
Thank you, Brian I'd like to cover a few observations here in the Pacific Northwest, we continue to enjoy the economic vitality along the I five corridor.
What Asians continued to be stable for commercial real estate in single family. However competition for loans and deposits continues to be heavy.
In spite of the positive economic environment in the region, we remain cautious about our concentration levels and our operating at levels that provide us flexibility to take advantage of high quality loan opportunities, while still being able to maintain disciplined focusing on loan quality and yield.
We have strong teams in the metro markets markets, which are relatively new to us and we will continue to execute in those markets to generate future growth.
We continue to benefit from our balance sheet liquidity and the high quality granularity of our deposit base, while the cost of deposits has been trending up the overall costs are still relatively low.
We continue to manage our capital position to support our plan to organic growth as well as positioning the bank. So we can respond to future M&A opportunities when they present themselves.
Before we go to questions I would just like to add a few things about the large nonaccrual AG alone Don covered in his comments clearly we are not pleased to be taking this action, but there is some history here our AG portfolio has been around since 1999, when we acquired Central Valley Bank, which is located in the central part of this.
State in the ACA by region.
For the past couple of years, we have anticipated potential weakness in this sector and we have been actively managing our AG portfolio.
As a result, you had been seeing this credit and others working their way through our credit management process.
We have been taking action on this loan and certain other loans over the past several quarters, which is evidenced in our prior quarterly updates and comments.
Please also keep in mind that our entire AG portfolio is less than 3% of our entire well in portfolio.
We have bank. This particular customer for many years and we believe it is prudent at this time to put it on nonaccrual status, even though we believe the loan is fully collateralized and at this time, we do not anticipate a significant loss.
While this addition to the nonaccrual category is notable we believe we are monitoring it appropriately.
On another note during the Q2, we added seven loans totaling $27 million to the potential problem loan category. Again are result of our active portfolio management process. It should be noted that two of those loans have subsequently paid off.
Do you have paid down significantly and the remaining loans are showing positive progress.
Lastly, I would point out to you as you watch us actively manage the loan portfolio that you'll typically see loans, either move up or out but overtime, our actual credit costs have been pretty low.
In spite of these recent credit highlights we believe we are well positioned for the future with lots of opportunities in our newer metro markets as well as in our traditional markets along the I five corridor in Washington, and Oregon.
That is the conclusion of our prepared comments, so lauria, we're ready to open up the call now and we welcome any questions ladies and gentlemen, if he would like to ask a question. Please press Star then one on your Touchtone phone, you'll hear a telling indicating you've been placed into Q you can remove yourself from the.
Q at any time by pressing the pound Keith if you are using your speakerphone. Please pick up the handset before pressing the numbers once again for questions Press Star then one our first question from the line of Jeff Rulis with D.A. Davidson. Please go ahead.
Good morning, Jeff.
Hey, guys.
Jeff just a follow up on the on the AG credit I know that visibility or may not be there, but just kind of a workout timeline. I mean, you said is it's a long time.
Watch credit and and you know the customer well, but I guess.
Is this just do a workable situation.
And at what point does this get lifted out of the bank too early to tell.
Well you know, we're taking the action that we think as appropriate based on what we know today, Jeff and.
No we have walked through a with our credit admin teams a variety of scenarios that could play out.
Sometimes these things are correct themselves.
No no pretty short period of time, meaning you know.
Months as opposed to years, but in this case there is the potential that this could be a longer term workout.
We we just don't know at this point I think the complication here with the AG credits is they this cycle times are pretty long and wanted to.
One of the things that that were.
That's causing us to take the position. We are is a there's a there's full collateral coverage as we've outlined but a portion of that collateral is tied to the current crop which is in the process of being harvested.
And we're watching it weekly to make sure that it's progressing in a way that it should but.
The cycle would cause us to have the crop be harvested than it has to be tested for quality and pricing and it has to be package that it will be sold over a period of months, a and we're talking about a pretty significant amount of production. So that alone could take this in it.
In all likelihood this will at least go into mid to late 2020, and before I think it gets resolved.
You go into anything else in the remaining bucket, that's that's either kind of chunk year in that and P.A. balance the.
No. That's by far is the biggest one it's one that we've been watching for a long time as I said.
You know just in terms of our our AG portfolio itself.
We've already re graded I'm almost half of it over the last couple of years.
So we're we're not necessarily seeing any lingering things in that portfolio that that would present themselves and the next couple of quarters at least we don't see it right now.
Jeff while I've got you that the.
Would you hazard, a kind of Oh, gosh, I'm net loan growth for 2020.
Hey data activity and I know that you get your crystal ball, but you any caution is cautiousness out there.
But other what I mean anything that or just general thoughts on on growth for the year.
<unk> number well you can imagine how frustrated we are with the circumstances, but the payoffs and the pay downs and it's particularly frustrating I'm not just for us, but our production folks I mean, there. They you know it feels like we're we're a.
We're just churning, we're not actually what we're putting on his his new business, new laws, new relationships and a lot of.
Cases, I you know, we always talk in terms of 6% to 8% growth with normalized payoffs, we haven't had normalized payoffs and almost two years.
So maybe we should be tempering that and saying low to middle single digits.
The thing that that makes that a hard question to answer is we can see through the pipeline. What all of these teams are capable of producing if we ever get normalized you know payoffs I think we're going to really see the the balance sheet take off.
Nobody we'd just one quick last one Don you touched on that expenses that there's some puts and takes there obviously with the use of some of those credits as well as the I guess that audit assessment.
The the baseline for that and go forward. We just continue to circle back to the overhead ratio and attempts there or.
If you could talk about expense run rate Oh I'd also.
<unk> of interest.
Yeah, I think the overall I mean like I said there was some given take this last this last quarter with one benefit one kind of subtraction on that.
Overall, I think it's a it's a point decent run rate I was I won't say that we have some technology.
Initiatives going on that'll start hitting in Q4.
Then my popping up a little bit, but Oh, I think overall, it's it's probably a fairly decent run rate. Yeah. We have cease all that we're implementing oh, well take a little bit of funds and in addition to.
Treasury management.
Systems that we're implementing so like a bump it up closer to the 37 million or Mark as I mentioned before but I think it'll still be kind of between where where where you were in Q3 and 37 million dollar Mark is probably a good run rate.
Okay. Thank you and we'll go next to Gordon Maguire with Stephens. Your line is open.
Good morning Garden good morning.
Dawn I just wanted to circle back on your comment about the now continuing pressure on the now.
With the interest recovery this quarter impacting about four basis points.
I would I wouldn't I would've guessed that would kind of snapped back next quarter and be more flattish can you just kind of walk.
Me through the the NIM.
Oh I got I can do I expect the NIM to continue to have pressure downward pressure in Q4.
We had a rate cut in September that wasn't fully realized for the quarter were quite help all I have another one of <unk> next week.
I think combination those things and then what the new loans are going on with ads compared to.
The current portfolio and really the although this portfolio smaller we have a same thing going on there I do expect some contraction again.
The.
Going forward, where on the loan yields to the.
New non accrual was five basis points for the quarter, it's still going to be an impact probably of three basis points in Q4.
So again small sat back there, but I would still expect margin decreased five to 10 basis points in Q4.
Five to 10 from here.
Yeah Okay.
Uh huh.
And then just one of the CD costs I think I've missed your commentary about the broker deposits. How much are the CD costs increase was related to those.
This quarter.
Well the brokered Cds when that would actually caused CD rates come down so because they were higher.
Okay. So they were higher we didnt renew the brokered Cds, we took out earlier like I think of Q1.
Okay. So the increase was all pretty much all from the the more core book Yeah. We I think you I would say in Q2 in parts of Q3, we actually slowed it down in Q3, a mid Q3, we actually lowered our CD rates, but you know your ears only the lag effect when you put on things like Cds. So in Q2, we have higher rates be compare.
There because of some.
Competitive rates that were out there.
In our market and so we had CD rates up about 2%, but we have actually lowered those down below 2% now so I would just expect a that the CD rates will come well they could possibly still come up a little bit in in Q4 based off.
Again some of the.
Difference between what's going on and whats coming off the portfolio, but the difference will be much less.
And what was in Q3.
Then can you talk about the decision to resume SBS sales and just whether youd anticipate staying at these levels on a quarterly basis or maybe even getting back to levels a few years back.
According to spray and so we have oh formula and measure and measure against and.
The last few we've measured you know haven't hit our threshold and so we've retained so we'll just continue to look at that it's really the you know what type of gain on sale can we get a versus versus the future interest income and then of course, the prime rate changes you don't have an impact on that so.
Just generically with prime having moved up you know we've sold glass. We do it is likely as prime continues to go down you know the probability of sale will go up but we do measure those one at a time and we also do some fixed rate SP A's as well.
Alan So.
You know those obviously aren't impacted by the declining rate environments.
Right I'll step aside thank you.
Our next question from Matthew Clark with Piper Jaffray. Please go ahead [noise].
Morning, Matt Good morning, Matt.
Morning.
I Didnt see an recently.
I didn't catch it on the call, but could you quantify the the amount of payoffs and paydowns in the quarter.
Yeah, Matt.
Brian on the commercial side, the the a pay payoffs paydowns were 169 million for the quarter versus 160 last quarter.
Great Okay.
And then just on the deposit costs.
Sure.
Yeah, I heard your commentary on Cds.
A lag effect, but.
Feel like.
We Pete here in terms of interest bearing deposit costs. If you feel like yeah, one more quarter to go before they'd like to start might start turning lower.
I think overall, we probably peaked you know there's a chance it could <unk> basis point, but I don't I think we're probably peak rates out and there's a chance it could come down so since the CD portfolio isn't it isn't a huge piece of it and we are again lowering rates collectively on though various deposit accounts through them.
Rate environment, So I think we fight Pete.
Okay, and then just any.
Okay. The commentary on the M&A landscape.
Terms, it's discussions you might be having whether or not those it picked up or not.
The first Matt This is Jeff the first part of the or things were pretty quiet on the M&A front, we have started to having more conversations and the last month or so, but we're not sure what that's going to turn into a it's just a just where we are at this point.
Okay. Thank you.
Our next question from the line of Jackie Bohlen with KBW. Please go ahead.
Good morning, Jackie Hi, Hi, good morning.
Just wanted to touched on that AG portfolio again, sorry, I know you guys talked quite a bit I'm with you quantify what's taking place with that particular credit as more macro based or more micro based meaning is that indicative of the environment that that barley operating within or is it something specific to the borrower.
It's it's both if you if you add up the factors that are impacting this particular.
Customer, it's a it's whether its pricing.
It's a certain portion of it is tied to succession.
And a certain portion of it is.
A transition.
From a two or two organic product, which is a pretty big undertaking. So it's it's a little bit of both.
Okay.
That's helpful. Thank you.
And understanding you know and he said I guess less than 3% of the portfolio I do you I guess within the potential problem bucket that you have it knowing how much you scrubbed the portfolio on a regular basis, how mentioned that is.
Jackie this dog.
You know I looked at the AG portfolio and it's actually.
It's 10% of the potential Pall malls, but if you add up not impact on nonaccrual well performing tdrs.
Well, it's a default walls combined it's actually 27% of goals.
The balance.
Combined so its 54%, they're not accruals and its 49% of the T. ours.
Performing tdrs it was 10% of potential Pauls.
39% of the act portfolios either classified as your non accrual performing tdrs or potential Paul.
Oh, it's 39% you said, yes.
Okay. Thank you.
And then just.
One last one for me.
In terms of diesel and you know I know, we still have a little bit time before implementation, but just wondering if you have any update to provide.
Oh, well no updates as far as numbers are concerned we are in process and we're on pace to be able to give a number you know at the.
End of.
End of January a when we.
You know release earnings next time, so, but where we're doing things like starting around the model and side by side and and doing validations from that from doing that and making tweaks. So we're we're on pace and but we don't have any numbers to give at this point.
Okay, Great I'll, just say on the look out in the future then thank you.
Thank you. Our next question from Tim O'brien with Sandler O'neil. Please go ahead.
Good morning, guys.
Good morning.
So so dawn.
I heard you right you said that between the [laughter] interest reversal on the AG credit and a lower discount accretion that had a nine basis point impact on the name this quarter.
Correct.
[laughter] so.
[laughter] both of those items go away.
But you're still looking for five to 10 basis points across.
Impression beyond that so maybe just a bit more exacerbated pressure from the.
Right got some sanctioned the mark and I and the interest to flat curve and those sorts of things is that kind of generally how I should look at it.
Yeah. So I've worked because again, it's not the.
The AG nonaccrual loan.
You know pop back up a little bit, but not much from that and I still think that again, what new laws are going on out compared to what the coming off that and again on floating rate loans and investments.
In the we don't we didn't get a full impact of that in Q3 from a September .
Cotton, which we're probably I'm another cut coming here in October so I do think it's going to impact it and they'll be 50 basis points, if that happens within them up in the house, there, but I don't feel much impact at all in Q3, So I still think it's got some basis.
And our your thoughts on on.
And how the margin situation might play out in the fourth quarter predicated on [laughter] on October cut only or does that also take into account potential December cut obviously, that's going to be how the smaller shorter impact I guess.
Yeah, I'm not counting on December one at this point, but like you say unit. That's number one wouldn't have that much impact on Q4.
And then the AG credit that.
It was downgraded are they still making payments or has that stopped.
They are making payments, but the way the the process works as those payments or or part of the line. So it it's all one facility.
But they are essentially they are paying Tim.
Okay.
Alright, thanks for answering my questions. Thank you.
Thank you and I'll turn it back to our speakers for closing remarks.
Thank you Laurie.
There's no more questions then we're ready to wrap up this quarter's earnings call and we thank you all for your time here support and your interest in our ongoing performance as an organization. We look forward to seeing several of you over the coming weeks. We thank you for being on the call Goodbye.
Thank you ladies and gentlemen, this conference call will be made available for replay that begins today at one PM Pacific time. The replay of the conference runs through November 7th at 11, 59 PM Pacific time, you can access the ATM T. teleconference replay system by dialing one 804.
756, 701, and entering replay access code for seven to 935 again. The replay number is one 804 756 701 and the replay access code for seven to nine three fives and that will conclude the telecom.
Friends for today. Thank you for your participation and for using ATM <unk> Teleconferencing service you may now disconnect.