Q4 2019 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to be Heritage financial fourth quarter at year end conference call.

At this time, all participants I don't listen only mode. Later, we will conduct a question and answer session instructions will be given at that time. If you should require assistance during the call. Please press Star then zero and as a reminder, this conference is being recorded I would now like turn the conference over to host Mr. jumped all please go ahead Sir.

Thank you [laughter] a welcome to all called in and those who maybe listening later this jet fuel.

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Attending linear Don anthem, CFO and Bryan Mcdonald.

Our earnings press release.

Morning every market.

I've had an opportunity to review it prior to this call. Please refer to forward looking statements.

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As for the quarter, we're pleased with our progress as we continue to build our franchise generate attractive financial results for our shareholders. We've made good progress building on our metro strategies, and the Seattle and down here or are we.

We have seen the initial benefits.

Additionally, we completed 2018 and the team gathered in early 2019.

Together this yellow Bellevue important markets still represent significant opportunities for heritage and we believe we have positioned ourselves well.

She knew to execute in those markets.

We also see good performance in our traditional markets.

We saw strong long production in 2019 with healthy loan pipeline growth and strong originations. However, our net long growth continued to be muted I loan pay offs.

We believe we have laid down a good foundation for 2020, which will allow us to continue the positive momentum our 2019.

We believe there is additional production capacity embedded in our existing platform, which will help us overcome the higher than historical level of pay offs that we've been experiencing for the past couple of years.

While we continue to see deposit rate competition, our loan to deposit ratio of 82% allows us to carefully manage pricing competition.

We continue to focus on protecting our core deposit franchise, which provides us with a strong foundation and it's one of our keys tracks.

And some will not take a few minutes to cover our financial statement results, including color on our core operating metrics.

Thank you Joe.

I'm going to start with a quick overview earnings before heading into more detail our balance sheet credit quality income statement and capital management.

Our reported.

Earnings per share for Q4 was 47 cents, which has done a penny from 48 cents secure three.

The decrease in earnings from Q3 was due mostly to a combination of a decrease in net interest margin.

Increased the provision for loan losses, partially offset.

Like higher swap fees.

At lower non interest expense.

Our reported or away decreased nine basis points the prior quarter, our pretax pre provision early decreased 23 basis points.

Moving on the balance sheet gross loans grew 36.5 million or 3.9% on an annualized basis, Q4, and increased about 114 million or 3.1% for the year.

Bryan Mcdonald will further discuss loan production a few Matt.

Although overall deposit growth in Q4 noninterest bearing deposits increased 17 billion, which was 80 focused on the deposit growth in Q4.

The year.

To spring deposits increased 84 million or 6.2%, which was 56% to deposit growth for the year.

Regarding credit quality.

Various additional increases in nonaccrual loans in Q4, due mostly to $4.7 million relationship that was put on nonaccrual status during the quarter.

Net charge offs increased 20 basis points for Q4, due mostly to 963000 dollar charge off on a large agricultural loan relationship that was put on nonaccrual status in Q3.

Net charge offs for 2019 were nine basis points up from six basis points in 2018.

Although overall problem loans and charge offs were elevated levels with the exception.

Identified AG credits, we don't see any specific negative trend in the portfolio.

Net interest margin decreased 19 basis points in Q4, due mostly to a 16 basis points decreased in the loan portfolio yield.

Approximately four basis points the decrease in the NIM was due to a change in the mix of earning assets from the current quarter.

Although most of the decrease the loan portfolio yield was due to the rate environment. A portion of the decrease was due to nonaccrual nonaccrual loan activity, which account for two basis points and more just kinda accretion, which accounted for one basis point as well as a significant turnover in the loan portfolio in the form originations of payoffs, which probably Tony will discuss a few minutes.

The cost total deposits increased one basis point to 39 basis points in Q4.

We believe we have hit the inflection point on the cost deposits and that should start see gradual decreases in these costs in future quarters.

However, due to the spread between rates of new loans and existing loans.

We do expect continuing pressure on net interest margin in the near term.

Non interest expense decreased 722000 from the prior quarter improvement was driven mostly by lower business news taxes from the prior quarter during the assessment, we incurred in Q3.

As mentioned in the earnings release, we were again able to use a credit for FDIC premiums in Q4, and we still have $518000 and credits, which would be used in future quarters. It's a deposit insurance by remains a certain level.

As a result, our overall lower costs and higher asset levels, we saw a nice improvement in our overhead ratio, which moved down to 2.57% in Q4 from 2.69% in Q3.

We do expect higher occupancy and equipment expense in future quarters, as we occupied a new operation Center in Q4, which were one of space to grow.

The impact.

Revenue impact of a new office center, it's about 150 to $200000 per quarter from Q4 2019 levels.

These costs will be offset by lower future costs from exiting other lease basis as well as realizing expected gains on sale on buildings. We are also exiting.

And finally moving on to capital management.

Tangible common equity ratio at December 31 was 10.4% unchanged for the level at the end of Q3.

We have grown our tangible book value per share to $15 from seven cents.

<unk> percent increase from 13 54 at the end of 2018.

As result of our strong capital position and earnings performance, we increased our regular dividends 20 cents this quarter up from 19 cents last quarter.

As a reminder, although we did not buyback any stock in Q4, we have approximately 640000 shares remaining in our current stock repurchase plan.

We will continue to monitor quarterly dividend levels and potential share repurchases, but also like having the flexibility if and when a potential acquisition opportunities arise.

From a dollar will help now have an update on what production.

Thanks, Don I'm going to provide detail on our fourth quarter production results by area, starting with our commercial lending group.

In the fourth quarter, our commercial teams almost 306 million in new loan commitments very similar to the volume closed in each of the past two quarters.

New production during the fourth quarter was centered in Seattle Bellevue at 79 million.

Tacoma at 65 million at Portland at 54 million.

For the full year, new commercial loans total billion.

Five.

Which is an increase of 311 million or 42% compared to 2018.

Commercial team loan pipelines, and the fourth quarter, and 390 million down 11% compared to the third quarter.

Main up 15% compared to the fourth quarter of 2018.

The largest type plans and our Seattle Bellevue.

Which ended the quarter with a pipeline of 153 million.

Greater Portland teens ended the quarter with a pipeline of 72 million.

And our greater how much teams, which ended the quarter with pipeline 70 million.

Gross loans increased on a 36.5 million during the fourth quarter or 3.9% annualized rate due to high levels of prepayment activity.

Loan prepayments and payoffs during the quarter totaled $202 million versus 169 million third quarter, and a $160 million in the second quarter of 2019.

Pay off in prepayment activity in the fourth quarter was caused by higher level of business to real estate sales.

Customers using cash to pay off debt class pay off loans to in our active portfolio management efforts.

SPX happening production on the fourth quarter included nine months for 10.6 million pipeline ended the quarter at 5.1.

This compares to last quarter, where we closed 15 miles from 4.9 million.

Pipeline ended the quarter at 14.8 million.

Consumer production during the fourth quarter was 49 million down 61 million in the third quarter equaled 49 million, we closed in the fourth quarter of 2018.

Moving on to interest rates.

Our average fourth quarter interest rate per new commercial loans was 4.43% decrease of 23 basis points.

0.66% last quarter.

In addition, the average fourth quarter rate for all new loans was 4.4 or 5% dropping 42 basis 0.4, 0.87% last quarter.

The mortgage department close 52 million of new loans in the fourth quarter 2019, compared to 47 million closed last quarter at 28 million close in the fourth quarter 2018.

The mortgage pipeline ended the quarter at 15 million versus 39 million last quarter, and 23 million fourth quarter of 2018.

I'll now turn the call back to Jeff for some general observations.

Thank you Brian .

We continue to benefit from the positive economic environment here in the Pacific Northwest with strong stable valuations for commercial real estate single family properties.

In spite of positive economic environment in region remains we remain cautious about 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 10 yield.

We now have strong teams and all the markets, we serve and we will continue to execute in those markets to generate future growth.

While we were distracted with to M&A transactions in 2018, several internal projects were put on hold.

During 2019, the team restarted those projects and have worked diligently to update upgrade a variety of product delivery platforms that are enabling us to launch a new treasury measures platform from our for our commercial customers.

First quarter 2020.

We expect that new platform to enhance the customer experience for existing customers and also it will allow us to pursue new customers with more complex cash management team.

We continue to benefit from our balance sheet liquidity and the high quality granularity of our deposit base.

Cost of deposits have been stable in the past few quarters. The overall costs are still relatively low.

We continue to manage our capital position to support our plan organic growth as well as positioning the bank. So we can respond M&A activity.

Before we go on to questions I'd like to make a few comments while credit quality.

We continue to actively managed the loan portfolio like we have always done Unfortunately that effort is not always pretty.

However, these efforts tend to play out in a positive way into our long term credit metrics. For example in the second quarter of 2019, we reported elevated potential problem loans with the addition of seven new loans totaling $27 million two quarters later three of those seven loans totaling almost $11 million.

Have paid off and we do not expect to see significant losses from the remaining lots in that pool, the $20 million non accrual haggling, we reported last quarter continues to be closely managed and after allowing time from the harvest results, we determined to charge off was appropriate given the circumstances.

We have adequate collateral coverage based on updated valuations and we do not expect significant losses from this while the newest wanting to go on non accrual is also fully collateralized AG.

One that we have been working through the credit process for several quarters, we obviously see weakness, but we do not see substantial loss. The only specific area of concern in our portfolio right now relates to the AG segment, which you know is less than 3% of our overall portfolio and in this segment, we have been reporting on for several quarters.

Lastly, I would point out.

As you watch US actively managed portfolio you will see Arizona, either move up route, but overtime, our actual credit losses or cost continued to be pretty well.

As I said earlier, we're pleased with our performance to date, we are grateful to our team for improved production numbers and we believe we are well positioned for the future with good growth opportunities in our newer metro markets as well as in our traditional markets in Washington.

That's the conclusion of our prepared comments, so kings and how we're ready to open up to call now for and welcome any questions certainly and ladies and gentlemen, if you wish to ask a question. Please pass one then zero on your telephone keypad you may withdraw your question anytime bear repeating the one that zero confirmed.

If you are using his speakerphone, please pick up the handset before passing numbers and once again for questions or comments at this time. Please press one and then zero at this time when my first question.

Right.

And we do have something from the line of Charles Please go ahead.

Hi, Jeff.

Yeah.

Question on the just to get some color on the loan growth outlook.

In 19.

You mentioned the payoff activity.

Maybe there's some risk management there always is as you kind of alluded to Jeff but.

Looking at 20, and kind of what could play out or what.

Could change I guess your expectations for growth on a net basis.

3% in 19, but there was.

Some pieces there that the.

Payoff activity being one that was a little elevated.

Thoughts on 20.

Going go yes.

Happy that to make some comments on that and Bryan Mcdonald may want to tag onto it.

We see good momentum in our pipeline.

We also believe that Theres untapped potential in in our platform overall.

I think that the best way for us to put it is we're looking for loan and deposit growth in that mid single digit range in 2020.

And Jeff that based on two things one it assumes that we're not changing our risk profile, which is not something that we were intending to do.

And.

We based on what we're seeing in the last couple of quarters, we're not expecting the higher level of payoffs as kind of is going to necessarily trend away from us in fact based on what Brian reported you could see in the fourth quarter. It actually went up over on their quarters. So I think that mid single digit range is a good place for us to big.

Okay.

Anyway.

Okay.

I'm, sorry, if I thought Brian had something to add that you can go ahead.

Okay, sorry about that the on that and on the credit side. The AG relationships I forget what are they related or or a similar strain kind of a systemic that is.

That is that driven both to kind of.

Non accrual no no and we spent as you probably recall, Jeff we spent a lot of time talking about the the one that went on non accrual last quarter. It treats road.

And then.

Weakness is based on many factors pricing whether.

Transitional issues for wind generation to another.

Et cetera, so we still feel.

Fairly comfortable with our position with that.

Particularly long, particularly effect, particularly in light of the fact that since we last had a quarterly call. We had devaluation three done for the real estate.

And the equipment 10, and the pricing are the values are holding so.

We have this odd circumstance, where we have loan on non accrual we've taken a charge off on it but we still believe that were based on information yet now we're fully collateralized.

Everyone. The newer one is one that we've been working on for many quarters and it's been working its way through the process.

Uh huh.

Hey, producer and circumstances there is that.

There's an abundance of hey.

So there is a good amount of inventory in that relationship, but it's more things falling scenarios in the weakness.

Okay. Thanks for that and maybe last one them.

Jeff just.

M&A, obviously didnt completed the.

Whole bank deals in 18 and and.

I know the banks culture is not to force.

Activity, but I guess, if you had your.

Preferences would you be kind of lending team focused or whole bank focused in 20 if youve.

And maybe just broadly speaking overall M&A discussions that you've had.

With the pools of Thats at it.

Yes.

I think we're actually sitting in a good position.

From where we sit now with regard to M&A from the standpoint that.

Clearly past the integration.

Work that goes when around the two transactions we did in 2018.

As I mentioned in.

The prepared remarks, we.

Ben working on getting our our systems and order in upgraded and updated which is essentially done the rollout into next big step.

And that will keep us occupied.

While we wait for opportunity, but I believe that our team is ready to roll something presents itself.

We are very interested in.

Further developing our footprint along the I have corner from the Canadian border to southern part of Oregon.

Conversations were nonexistent for the first half of last year the towards the end of year.

We started having not just.

And for all casual updates, but more.

And our conversations with.

A couple of potential candidates, but as you mentioned, we don't rush. These things they have to present themselves when they're ready, but we feel comfortable.

And if M&A presents itself and then maybe year.

We're ready to pursue it.

Thanks, Jeff.

Thank you and next we will go to the line of Gordon Mcguire. Please go ahead.

Good morning Garden.

Rehash little bit your comments on the mid single digit loan growth I guess last quarter, you had mentioned low to mid single digit.

And I'm wondering if this untapped potential that you mentioned the driver from going from low to mid to mid and whether that's a new development.

Or something that gives you a little bit more ops optimists them optimism relative to three months ago, and if you could just elaborate on what that would be.

I think that.

We've had the.

Chance to watch that combine organizations operate for several quarters now so I think we have.

Better flow funny.

The ebbs and flows of deposits and loans I think we've also had time to.

Really analyze the production today across the footprint and compare that to.

Potential of the particular markets where in the teams that we have had I think we put it all together and I think that we are into maybe at a better position now to Tim move forward and mining that additional capacity I think the other thing I would add to it.

This takes a while for three organizations to come together and work like.

Chain machine then.

I'm not sure were quite fine tuning, yet, but I think we're further along the curve from that standpoint. So we're we're better organized internally.

Brian you want add to that I was just going to add Corey when you look at the difference between mid single digit and that you now.

678%.

It's a pretty moderate difference in terms of production. So if you look at the Q4 numbers.

It's it's about 102 million I'm on the new production, we did it.

For the quarter.

And to get closer to that 6% ranch with Sam I'll pay off it's more like a 108 million sell it.

Six high end differences very moderate increase relative to the total amount production obviously.

A few million anatomy drops through really drive SAP is what drives growth rate.

App, so after watching plus $100 million and production the last three quarters.

Last year.

And our team is doing to try and drive that pipeline up.

Thats really what we're shooting or as another $6 million versus all intents and important quarter.

Good.

Don I was hoping you can help us out with just the run rates on the fees on the expense levels I guess, starting with fees. The swap income was really strong. This quarter is that something you feel is sustainable.

It's higher than usual and we're not expect to see that every every quarter.

If you go back again the year. It was 1.2 million I think that.

I'd like to see that are higher than that overall from a year in 2020, but it's not going to get them on her out in the quarter ever.

Speaking that we'll see that much.

Okay.

Proved year over year, but not not from Q4 numbers.

On it so so it is tracking better than the previous run rate before for the fourth quarter.

Well, let's come earlier this year, but.

Our expectation got it and then the the expenses I guess it looked like there was an FDIC credit this quarter in marketing was a little bit unusually low relative to where that's been in the past.

Could you could you just kind of pointed to a baseline to think about for the first quarter.

Well I'm curious on directional feedback here the.

Right the FDIC premium is down.

If things work out as we think they will.

The credit again in Q1 and partly in Q2.

As you can if you look at our financials is usually the FDIC premiums using 350 400000.

A quarter and again, that's going to probably run out midway through the second quarter.

Yes, like 500000 left on that.

I will also say that Q1, we just tend to see a bump and expenses.

And then Q4 towards our lowest usually in the areas of like marketing and of course.

Things like payroll taxes always pop up the first part.

Insurance Pops up usually the first part first quarter so.

The last year and our expenses CT business went up $600000 Q4 aging the Q1 19.

In addition, as I mentioned we're.

In a new facility as far as operations go that's going to raise up.

Cost there and we have the.

As Jeff mentioned, the new Treasury management system that we are implementing this year, that's going to be about a cost about a million dollars. This year.

Over what we've.

But spending so.

I would say taken into consideration as you're looking at the expenses for this year.

And that should help you out on that.

Got it and the cost of the Treasury platform is that kind of ratably throughout the year builds or I should overtime I would say the first three quarters it'll be one is mostly implemented how much per quarter will depend on its kind of based on the number.

Customers that were.

Converting over at that time, so as I can give you.

Well, I guess ratable each quarter, but should happen over the first three quarters.

Ultimately core now will go away it's really.

Support function for us as we transition our customers from the current system to the new system.

As for clarifying that asked about the queue. Thank you.

Thank you. Thank you and next we will go to the line of Matthew Clark. Please go ahead.

Good morning, Matt.

Morning.

And then missed it but the amount of payoffs in the quarter.

Yes, Matt this is.

This is Brian and was 202 million prepayments during the quarter up from 169 third quarter and $116 million in the second quarter.

Okay.

And then just given your.

Comment on expenses.

This year any thoughts around the overhead ratio.

Relative to last year.

Our goals are.

Again continued improvement year over year and again, our love our expense our seasonal so it's not again.

From like Q4, Q1 improvement so much as.

2019 2020.

We expect improvement even with some of these other initiatives, we have going on of course with the initiatives it won't be as improvement.

We have added white from.

Implementation of the Treasury management system, obviously, that's going to slow down the improvement, but we still expect to see some.

Okay, and then the percent of the AG portfolio, that's classified at year end.

44%.

The AG portfolio.

Okay, and then just on the margin outlook it sounds like some additional pressure here in the near term.

Any aggregate guided in the past down five to 10 came in little bit more than that but.

Just curious on your thoughts on the margin outlook and when we when that might be able to stabilize if at all given the pressure on new business.

Well I expected to come out again somewhat.

Similar expectations.

Well this next quarter.

So just by looking at what's going on the loans that are going on and what's coming off I.

I think again I think our deposit costs were starting to stabilize if not start coming down that again, we don't have a lot of room to come down so, but I do think they'll start coming down either Q1 or Q2.

But I do think we're going to see pressure because of all portfolio, even without any further Rick.

The yield curve is.

Still not to great for putting on new loans.

Just a few days gotten worse so.

Thats where were the pressure is going to be.

On the loan side, given it turned out to be as I mentioned in my.

Comments on the earnings release, I think it it came down more than expected in Q4 two to also so.

The mix of earning assets played a part in that in addition to additional non accruals. So those are also factors that we it's hard to hard to predict.

Exactly will happen and how that will impact the margin, but I do expect to come down again in Q1.

Okay, and then just any update on diesel and that they want impact.

We're still working on our model would basically going over we have models set up as just making sure that were getting all of our.

Assumptions, such as prepayment speeds and.

Reversion to norms are historicals those type of things are still tweaking. So we don't really have a number right now we'll be putting an estimate in our 10-K.

At the end of February but.

It's not going to be.

Huge impact.

Obviously, we'll have some.

Okay. Thank you guys.

Thanks, Matt.

Thank you and we have no further questions in queue. Please go ahead.

Okay, well, thank you, but theres no more questions that were ready to wrap up the quarter's earnings call and we thank you up your time your support your interest in our ongoing performance as an organization.

We're seeing in several of you over the coming we have the investor events.

Thank you goodbye.

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