Q2 2019 Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the Heritage financial earnings call.
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As a reminder, today's conference is being recorded.
I'd now like to turn the conference over to President and CEO , Jeff <unk>. Please go ahead.
Thank you Ryan.
Welcome to all who called in and those who May listen to later this is Jeff do Oldfield heritage attending with me are Don Hinson, our CFO and Bryan Mcdonald, our Chief operating officer.
Our earnings press release went out this morning, Premarket, hopefully you've had an opportunity to opportunity to review it prior to the call and please refer to the forward looking statements in the press release.
We are 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 to build our franchise in Seattle and Portland.
And we are seeing the benefits of the two acquisitions, we completed in 2018 as well as the teams we've hired in those markets together, that's Seattle and Portland markets represent significant opportunities for heritage and we believe we are well positioned to continue to execute.
Despite significant loan production, our net loan growth continued to be a challenge.
Due to elevated loan pay offs on the bright side the loan pipeline has grown nicely and we have a strong had a strong origination month in June .
We believe we are laying a good foundation, which will continue to produce attractive results for our company.
While we are experiencing strong competition for deposits in the second quarter, our loan to deposit ratio of 85.5% 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 key strengths.
Don Hinson will now take a few minutes to cover our financial statement results, including color on our core operating metrics.
Thank you Jeff.
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 reported earnings per share for Q2 was 43 cents.
Which is up from 45 cents in Q2 of last year, but down from 45 cents in Q1 of this year.
The decrease in earnings for Q1 was due mostly to a combination of lower balance sheet growth.
Higher provisioning for loan losses, and higher noninterest expense.
Moving on to the balance sheet total asset growth was muted in Q2, due mostly to a 46 million dollar decrease in total deposits.
The major reason for the decrease was due to brokered Cds that matured in Q2.
To have an overall decrease in non maturity deposits.
Through the first six months of the year.
The main drivers appear to be a combination of customer seeking higher rate by migrating into higher paying Cds.
Closure of two branches earlier this year.
And customer specific events, such as using cash for real estate purchases debt payoffs and the sales of customer businesses businesses, where we ultimately lose the business account.
Loans grew approximately 22 million in Q2 and have increased about $63 million year to date.
The annualized year to date growth rate is 2.5%.
Bryan Mcdonald will further discuss loan production in few minutes.
Regarding credit quality, we experienced marginal deterioration and many of our credit quality metrics in Q2 due to increases in non accrual loans potential problem loans and charge offs.
But overall we have maintained.
Strong credit quality and do not have any significant concerns in our portfolio.
In fact, we consider that much of the changes in our ratios are due to proactively managing the portfolio.
Potential problem loans increased 20 million in Q2.
This was mostly due to six commercial relationships, which totaled 23 million that were downgraded to special mention in order to better monitor these credits.
Through the sale of properties, we have decreased Oreo down too.
Two properties totaling 1.2 million at the end of Q2.
Although charge offs increased in Q2 year to date charge offs are still at only five basis points of average outstanding loans.
In addition, the ratio of our allowance for loan losses to nonperforming loans still stands at a very healthy 188%.
Further our loan balances include $10 million of purchase accounting net fair value discounts, which may reduce the need of an allowance for loan losses on those related purchase loans.
Taken together the some of the net discounts and the allowance for loan losses of 125% sorry, 1.25% of total loans as of June 30.
The net interest margin remained fairly stable in Q2, decreasing only one basis point from Q1 levels.
Loan portfolio yield was 5.28% in Q2, which is an increase of five basis points from the prior quarter.
And the cost of total deposits was 37 basis points in Q2, which is a four basis point increase from Q1.
Due to the shape of the yield curve forecasted 2019 rates and competitive pricing pressures, we do expect continuing pressure our net interest margin in 2019.
Noninterest expense increased by $1 million from the prior quarter.
One reason for this quarter over quarter increase was a Q1 reversal of a 2018 year end accrual relating to a write off of a lease obligation of a former branch. This reversal lowered Q1 expenses by $240000.
Another reason for the increase was due to approximately $350000 paid and signing bonuses and severance payments in Q2.
Without these payments, we would have shown a decrease in compensation and benefits from Q1 levels.
Finally, we recognized.
Increase of 203000, Oreo expense related mostly to the loss taken on the sale of property properties I previously mentioned.
And finally moving on to capital management.
Our tangible common equity ratio increased to 10.5% from 10.2% at the prior quarter end.
The increase was due to a combination of unrealized gains on investment securities and continued strong levels of profitability.
As a result of our strong capital position and earnings performance, we have increased our regular dividend by a penny to 19 cents, which is a 5.6% increase in the prior quarter's dividend.
We continue to monitor quarterly dividend levels and potential share repurchases, but also like having the flexibility if and when a potential acquisition opportunity arises.
Primary goal will not have an update on loan production.
Thanks, Don I'm going to provide detail on our second quarter production results by business line, starting with our commercial lending group.
In the second quarter, our commercial teams closed a record $308 million in new loans, which is up 89% from the $163 million of new loans closed in the first quarter of 2019 and up 54% from the 200 million closed in the second quarter of 2018.
New production during the quarter was centered in King County at $111 million up from $57 million last quarter Tacoma at $60 million, which is up from $23 million last quarter.
And Portland at $56 million, which is up from $24 million last quarter.
Commercial team a loan pipelines ended the second quarter at $478 million, which is up 7% over the first quarter and up 42% since the beginning of the year.
Largest pipeline concentrations were in our King County teens, which ended the quarter with the pipeline of $149 million.
Our greater Portland teens, which saw their pipeline increased 23% to $78 million from last quarter.
And our greater Portland team saw their pipelines increased another 20% to $90 million versus last quarter.
Gross loans increased only $22 million during the second quarter or a 2.4% annualized rate due to higher prepayment and pay off activity and pipeline combined with a higher than average composition of construction loans included in the quarter's new loan production.
Loan prepayment and payoffs during the quarter totaled $116 million versus $110 million in the first quarter.
Payoffs and prepayment activity in the second quarter was elevated by a higher level of business and real estate sales.
Customers using cash to pay off debt.
And clients paying off loans due to our active portfolio management efforts.
The consumer production during the second quarter was $45 million up from 40 million closed in the first quarter of 2019 due to a moderate increase in indirect lending.
Moving on to interest rates.
Our second quarter interest rate for new commercial loans was 49 basis points lower decreasing to 5.16%.
From 5.65% last quarter.
In addition, the average second quarter rate for all new loans was 5.26% dropping from 5.68% last quarter.
And finally, the mortgage department closed $30.6 million of new loans in the second quarter of 2019 was 64% booked into portfolio and 36% sold on the secondary market.
This compares to $22.6 million of new loans closed in the first quarter of 2019 and $38.1 million close in the second quarter of 2018.
The mortgage pipeline ended the quarter at $39 million up from $29 million last quarter and down from $47 million in the second quarter of 2018.
Just a reminder, we reduced the size of our mortgage platform during the first quarter.
I'll now turn the call back to Jeff.
Thanks, Brian Some general observations, we continue to enjoy the economic vitality at the five corridor.
Valuations appear to be stable for commercial real estate and single family. However competition for loans and deposits continues to be heavy.
As a result of the strong economic environment, we see customers selling real estate and businesses. However, the silver lining in these dynamics is that we are also seeing several longer term problems getting resolved as well.
In spite of the positive economic environment in the region, we remain cautious about concentration levels, we are maintaining our non owner occupied CRT concentrations at about 250% of capital.
With construction at about 40% of capital both of these.
Levels, they are similar to last quarter.
Operating at these levels provides 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, and we will continue to execute to generate growth opportunities going forward.
We continue to benefit from our balance sheet liquidity and the high quality granularity of our deposit base, along with our strong credit culture.
While the cost of deposits has trended up the overall costs are still relatively low.
We continue to continue to manage our capital position to support our planned organic growth as well as positioning the bank. So we can respond to M&A opportunities when they present themselves. We believe we are well positioned for the future and the challenges facing our industry today.
That's the conclusion of our prepared comments, so Ryan we're ready to open up the call and now welcome any questions. Okay, Ladies and gentlemen, if you do wish to ask a question. Please press Star then one at this time.
Once again, if you have a question please press star one.
Our first question will come from the line of Jeff Rulis with da Davidson. Please go ahead, good morning, Jeff Hey, Good morning, Jeff.
So yes, I just wanted to get into the expense item it seemed.
Like there's some transitory sort of items in there.
If you could maybe talk about what kind of you think normalizes and kind of a growth rate.
Yes.
That's a good number.
Sure Jeff there were some transfer things.
In this last quarter of somewhere not as I mentioned, we have kind of have had a lower expense in Q1 due to that one reversal. So.
You know again going forward I think it's the run rate probably more in between the but the Q1 and Q2.
Be closer to to that number than it would be either one of Q1 our Q2.
And then thoughts on just.
Managing it from there.
I guess modest growth is that.
So its a or.
I think so I don't expect a lot a lot of growth to occur.
Going forward over at least the rest this year.
We've kind of added we added the team already in in Portland, the beginning of the year. So I don't expect to have a lot of a lot of growth going forward, but theres always is some with.
Pay raises and stuff like that yeah, Jeff I would add to the if you look at the quarters compared to each other we've done a pretty good job of staying on top of managing the expenses and we're going to continue to do that obviously through the rest of the year.
The only thing that could impact us would be a a maybe a surprise opportunity to.
You know to maybe enhance our operation with another team, but we don't see that on the horizon right now.
Got it and then.
On the margin.
You bet your dialogue that.
That would be given given rate cuts in the yield curve.
Kinda poised for some pressure I guess.
Relative to where you were three months ago is that an accelerated pressure are you held firm pretty well this quarter and.
And just trying to see if that's a.
You know that in a rate cut environment is is that.
To a greater extent.
Yes.
Don again, I think that if we get the rate cuts that are expected at the end of this month and possibly even another one in September I think that the merger will decrease more than it did this this last quarter.
Oh, sorry, Yeah go ahead.
Our next question comes from the line of Luke <unk> with KBW. Please go ahead.
Hello, Good morning, and congratulations Jeff.
I'm, just kind of wanted to and you've touched on a little bit just a second ago just.
On the lifting out any other teams do you see any increased to kind of.
Team grabs in some of your markets are you kind of feeling maybe de novo might be the better way to go in Portland, or or how are you feeling about that.
I think we feel really good about the platforms that we have developed over the last 18 months.
With the two acquisitions and the teams that we brought on.
And you know, we're pretty well situated in the Metro markets now with a pretty good size group in Seattle, and Bellevue as well as in Portland. So.
I think we're poised for growth with just the team that we have in place.
I think it's important to point out too that we have done some one off enhancements to some of what you might call our non metro markets and we've strengthened those production teams as well.
So that all together a as we said then they opening comments positions us well to continue to execute on our plan to grow the organization and the footprint we have.
If if a team presented itself, we obviously would would trend towards a team lift out over an acquisition to grow our organization, but right now we don't see that in the on the horizon.
And I I think that that's just fine because we still have a lot of.
Development to do with the footprint, we have and particularly in the metro markets that we just got into.
Okay. That's helpful. Thanks.
And then just back on expenses I think you guys have previously you said you were looking at the overhead ratio I'm, excluding CDIY amortization kind of decreasing on a year over year basis, just wanted to see how you are looking at that going forward.
And.
And I know you briefly touched on expenses, just kind of want to see where you see that ratio shaken out towards the end of the year.
Look as Dawn I think we'll continue to see a prudent or we'll see improvement in that part of the mitigating factors last quarter was the lack of asset growth, which is the denominator in that formula So that kind of hurt overall in that in addition to some expense hikes. This last quarter. So I expect the overall the the overhead ratio to improve as we get further into the year.
Okay. That's that's helpful. Thanks, and then just lastly wanted to kind of get the updated guidance for the loan growth through the end of the year. I think you had previously had 60% and just wanted to see if there was an update for that going forward.
You know look at its historically, we've weve guided towards a range of <unk>, 68%.
If we go back and do the math on our last two quarters.
And if we had more.
Had more normalized pay offs, we estimate that we would have come out about 7% on an annualized basis.
That seems to us to be the right place to be given the environment. We're in with regard to the economy in the cycle, where we are.
I think that we would still guide to that same range, but with the caveat that if.
You know pay offs remained at historical high levels that we it may be lower than that.
I think the overarching theme here is that that's the loan growth we'd like to have.
And it's not in our wheelhouse to try and get a exceed that unnecessarily because.
We don't feel like now is the time for us to stretch a and it's highly competitive out there right now as it is from a pricing standpoint, but also from an underwriting standpoint that we think are sticking to our knitting and going for the high single digits is probably the right sweet spot for us.
Okay. That's helpful.
And.
If you don't mind I, just got one more just kind of on capital management going forward. I know you said that you are kind of feeling comfortable and and with where you were at but just any.
Any indication for repurchases or anything going forward.
With regards to capital.
Oh, I think or hope we have a plan already in place that though we have we can.
Repurchase.
Still up 900000 shares we can repurchase within our current plan and we're always open to that depending on where our stock is trading and other opportunities that we my house and grow so were always monitoring that and there's always a possibility would be doing doing some of that.
We did repurchase just a few shares this last quarter about 28000 murder and in that case, just to kind of keep our share count. The same so but we are we do have a plan in place and we'll use it as we feel.
We can be opportunistic in that way.
Okay. That's helpful. Thank you for taking my question.
Thanks Luke.
Next question comes from the line of Gordon Mcguire with Stephens. Please go ahead. Good morning, Gordon warning. Thanks for taking the question.
Dawn I just wanted to clarify your commentary on the NIM throughout the rest of the year, what's your expectation for continuing pressure with or even without rate hikes, just based on the yield curve.
Oh, great sorry, yes, if we didnt have any.
Rate cuts.
I would say that though.
We might have just a slight bit of pressure like we did this last quarter.
ER going forward, though I think this week, if we get some deposit so let's go back if we didn't have a rate cuts and we get some deposit growth like I think we're I think deposits will start coming in and because I think the.
Or competitive pressures will subside a little bit I think that would help us maintain margin near where were at but maybe down slightly I think that's going to be with rate cuts because we're somewhat asset sensitive I think that's going to.
Increased oh, the decline I guess, you might see the pace of decline going forward over the next couple of quarters and I am I getting the markets were certainly expecting a cut at the end of the.
At the end of this month and.
And I think that will feel the impact of that Gordon another another consideration here is.
In the last quarter, we saw pretty fierce comp as competition for deposits.
From you know all the banks around us, but with the rate cuts on the horizon, we saw that tend to tended to dissipate a little bit and as you know our strategy to maintain our our deposit base was too.
Exception price as we needed to in order to keep our customers or in this case. The competition has subsided a little bit. So I don't think we're going to see as much pressure on the deposit side.
Does that reduce competition give you room to go to your coast exception customers and.
Talk them down to lower rates over time, and I guess I'm trying to figure out maybe when you see cost deposit cost peak and then maybe trend lower.
If we get a couple of months I think that the situation. We have is our cost of deposits was never very high to begin with so they had to come down.
You know, there's there's room for that to happen through what you just brought up with the exception priced customers, but I don't think that's something that we can we can do right away. That's more like a you know we put the exception in place for a period of time.
And we'll go back to it when we can.
Great respect that we might see a little bit of increase and cost deposits in Q3, but.
But then leveling out or in Q4, we just it's more of the impact of the increases we did in Q2 that Mike you know I'm kind of.
Full over into the the impact on Q3, but we're not seeing a lot of again increases going forward. So it's more that they're getting what has taken place in Q2, that's going to impact us right now.
Got it and maybe just can you provide some some color mechanics around the repricing of the loan portfolio.
Oh sure.
We have about a.
I guess it was about 25% tied to tied to prime of our.
Well I see 16% tied to prime.
Of our overall portfolio.
And another 8% tied the LIBOR, so about 25% pie that I would call floating floating rate securities are floating rate loans.
And Jeff I think I heard you earlier, saying keep making some commentary around preferring team lift outs at this point over an acquisition.
Did I hear that right and maybe you could provide just an update on where your heads at on M&A. Yeah. Yeah. Thanks for let me clarify I think that historically it has been.
Our preference to do a lift out over an acquisition because it comes without the integration risk and and you know substantially less cost.
But we are always interested in both lift outs and M&A along the I five corridor or we would be interested in.
Acquiring many of the potential targets that we see along the I pod.
Thank you Oh stuff, though.
Thanks Gordon.
Next question comes from the line of Matthew Clark with Piper Jaffray. Please go ahead.
Good morning, Matt Good morning.
Just thinking through some of the other assets on the balance sheet. This turns portfolio.
Can you remind us what the duration of that booking.
And the types of things you might.
The buying of late just trying to get a sense for that but the incremental pressure there on that thank you.
I think that if we looked at it.
About.
Yeah, the security portfolio.
But 100 billion is tied to one month LIBOR.
And another.
35 million tied to three month so.
You know we have within the a three month time frame, we have 145 million probably repricing.
That way.
So that's gives you I hope that gives you an idea that the duration itself is a under four.
So we are keeping it fairly short.
Well that portfolio grow, whereas it can continue to shrink here.
For the time being I think it really all depends on our overall balance sheet growth you know if deposits come back we make red rock song.
Well it depends on a combination of loan and deposit growth. We don't really don't have a strategy for growing it on its own it's more of a supplement to the rest of our balance sheet strategies.
Okay, Great and then just on new loan business and given what.
The five years done last few months.
Do you happen to have though the weighted average rate on new business I know, we're going to go to this repricing phenomenon with the fed cuts, but just.
I also wanted to get that other piece of it we could.
Yeah, Matt This brand so on our commercial business for new production in Q2, it was 5.16% and for all loans. It was 5.26% during the second quarter.
Great.
Okay. Thank you.
Thanks, Matt.
Next question comes the line of Tim O'brien with Sandler O'neill. Please go ahead.
Tim.
Hey, guys. Thanks.
[laughter] Don question for you on other expenses that was up about a half a million from 2.5 million to 3 million.
I don't I didn't catch if youd mentioned that or give any color on that what's behind that.
Well again 240000 of that was the reversal of a year end accrual that occurred in Q1, so that lower Q1 expenses by two Fortys. That's one reason of the.
Okay 500000, that's about half of it.
Yeah, I think the rest of it is just more overall operating expenses, whether it's travel we are we have a bigger team in Portland that we did I think there's a little more traveling going on than there was before imperious.
Various other items, but nothing big that's like that one accrual reversal.
And what was the kind of the one time incentive comp expense that you guys booked this quarter how much was that.
Well between up signing bonuses and severance payments a it was 350 this quarter.
And that was in the comp line item in the salary and benefit line item correct.
You know, we always have some but that was an unusually high worry how signing bonuses et cetera.
So that was an unusually high amount.
And then.
[laughter] surprise somebody else didn't ask this question, but it's getting asked on most calls.
Pipe Pathetically 25 basis point cut what's the.
With respect to the impact on the NIM.
Mid single digits.
Okay.
Could be I think a lot will depend on what happens on the deposit side.
I think.
I'm looking at more of if we got a cut Bolton.
And in July and in September .
You know, we're obviously the loan yields are going to probably come down.
By Q4 looks like come down.
Maybe as much as five basis points based off the current portfolio and.
And the Besson portfolio I come down.
10.
So, but a lot will although overall the overall NIM impact will depend on you know growth and.
Non interest bearing deposits and if we're able to hold those goes down.
So too.
Two cuts in Threeq, you hypothetically five bips impact potentially hypothetically on NIM in for Q.
I mean on a on loan yields and then 10 bips on investments that's kind of how you're seeing it.
Correct.
Okay. That's an estimate based on a lot of different factors, but yes, absolutely. There are a lot of moving parts to all of this I know and.
The funding side included so.
That's it from me thanks for answering my questions.
Thanks, Tim.
As a reminder, if you do have a question. Please press Star then one.
The next question comes from the line of Tim Coffey with Janney. Please go ahead.
Morning, Tim.
Hey, good morning, everybody.
You actually want to follow up on the deposit costs in the quarter. So obviously there was a lot of moving parts in that deposit book and I'm wondering of the deposit cost increases that you saw quarter over quarter, how much of that was it was related to moving you know.
Different different balances in different categories versus kind of the exception pricing.
Well, it's a good question, Tim I think that.
The migration of non maturity deposits to Cds had a had a big impact on that so a lot of those rates CD rates are up in that.
<unk> twos or due to some specials that we have going on to be competitive with it with other banks in the in the area. So a lot of those CD rates came in were probably close to one year Cds at 2% a work for the non maturity deposit rates are or a lot less so that's a big piece of it. We also you know there were some excess repricing going on and and other types of accounts, but.
I think that it's probably a combination there, but I'm not sure I could break out how much of each of those.
Oh of course, not yeah, I'm, just trying to get <unk> potential for the improvement in deposit cost could be going into Threeq you. If it could actually end up happening sooner in the quarter versus later.
If if if by chance exception pricing had intended to be a bigger driver of the deposit increases.
Again, we're not seeing much exception pricing as much as this quarter as far as trends go. So I'd right I think it's going to flatten but in Q.
In Q2, we did see a quite both Q1 and Q2, we did see quite a bit of that.
Yeah, I guess I was referred to the lack of exception pricing being a a bigger benefit.
Oh, I think it will be a benefit Oh I can't I, it's hard to put a.
Either a basis point or a dollar amount on that at this point.
Sure Okay understood. The rest of my questions have been asked thank you.
Thank you.
At this time, we have no further questions in queue.
Well, it's no more questions then we're ready to wrap up this quarter's earnings call and we thank you all for your time your support your interest in our ongoing performance as an organization. We look forward to seeing several of you over the coming weeks and thank you and goodbye.
And ladies and gentlemen, today's conference was recorded and is available for replay starting at one PM Pacific today through August 18, 2019 at Midnight you may access the Eattwenty replay system by dialing one 804, 756, 701 and entering the access code Foursix 9443.
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