Heritage Financial Q1 2023 Earnings Call Transcript

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Provided by Quartr
April 20, 2023

There are 9 speakers on the call.

Operator

You for attending today's Heritage Financial Corporation Q1 2023 Earnings Call. My name is Sierra, and I will be your moderator today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to our host, Jeff Buell, CEO of Heritage Financial Corporation. Please proceed.

Speaker 1

Thank you, Sierra. Welcome and good morning to everyone who called in and those may listen later. This is Jeff Duell, CEO of Heritage Financial. Attending with me are Don Hinson, Chief Financial Officer Brian McDonald, President and Chief Operating Officer and Tony Shelfand, Chief Credit Officer. Our first quarter earnings release went out this morning pre market, and hopefully, you've had the to review it prior to the call.

Speaker 1

We have also posted an updated Q1 investor presentation on the Investor Relations portion of our corporate website, which includes more detail on our deposits, liquidity and credit quality. We will reference this presentation during the call. Please refer to forward looking statements in the press release. We're very pleased to report another solid quarter. In spite of the unfortunate industry turmoil we all faced in March, We were happy to see the destabilizing factors around us calm down quickly with the majority of deposit movement in Q1 Tied to normal deposit flows.

Speaker 1

As you know, deposit pricing started to get more competitive late in Q3 of 'twenty 2 And that theme continued through Q4 'twenty two and into Q1 'twenty three. We continue to focus on exception pricing for relationships With good success, the majority of deposit movement in Q1 was tied to normal flows, including Capital purchases with a lesser portion tied to alternative investments and general FDIC insurance related concerns, Which in most cases resulted in retention of deposits, but at a higher Deposits to stabilize as the year progresses, aided by our $150,000,000 deposit pipeline. We reported solid organic loan growth of 7.7 percent annualized, and we're pleased with the positive trend we have seen in the number of new commitments And new loan closings from our existing production teams and the newer members of that team. We continue to manage carefully, although we also continue to experience the impacts of inflation. Notably, our long standing focus on credit quality And actively managing our loan portfolio continues to play out well for us.

Speaker 1

Staying focused on our conservative risk profile Has enabled us to continue to report improving credit trends and provides a good foundation facing into a potential recession. We'll now move to Don Henson, who will take a few minutes to cover our financial results.

Speaker 2

Thank you, Jeff. As Jeff mentioned, overall financial performance was positive in Q1, and I'll be reviewing some of the main drivers of our performance. As I walk through our financial results, unless otherwise noted, all the prior period comparisons will be with the Q4 of 2022. Starting with net interest income, we experienced a decrease of $3,300,000 or 5.2 percent in Q1, due mostly to an increase in interest expense. This resulted from an increase in our cost of interest bearing deposits as well as an increased use of short term borrowings during the quarter.

Speaker 2

This was the main driver for the 7 basis point decrease in our net interest margin for Q1. We expect to continue to experience downward pressure On NIM in Q2. As mentioned earlier, we started 2023 with solid loan growth In Q1 of $77,000,000 or 7.7 percent annualized. In addition, yields in the loan portfolio were 5.07% in Q1, Which was 21 basis points higher than Q4. Brian McDonald will have an update on loan production and yields in a few minutes.

Speaker 2

Our cost of interest bearing deposits increased 24 basis points to 0.49 percent for Q1. We continue to experience Market pressure related to deposit rates. However, we are strategically increasing our deposit rates by product and working individually with our customers to maintain relationships. As a result of the current rate environment, we expect to continue to experience an increase in the cost of our core deposits. Overall, we experienced decline in total deposit balances in Q1 of 2.3%.

Speaker 2

The decline occurred throughout the quarter. We closely monitored our deposit balances during the Q1, including the days subsequent to the bank failures in mid March. As Jeff mentioned, our large deposit outflows in Q1 were primarily due to either capital purchases or normal outflows. We did not see significant runoff From the recent bank failures, historically, the Q1 is also a quarter of minimal to no deposit growth. Brian will Also discuss our deposit pipeline later in the presentation.

Speaker 2

Our insured deposits were at 65% of total deposits at the end of Q1. Also for customers seeking additional FDIC insurance, we offer product deposit products, which have full FDIC insurance coverage. On balance sheet deposit totals for these accounts were $162,000,000 at the end of Q1. In order to supplement core deposits in Q1, added $52,000,000 in broker deposits and $100,000,000 in higher costing floating rate public funds This quarter, which contributed to the increased cost deposits. In addition, we added $383,000,000 of overnight FHLB borrowings in Q1.

Speaker 2

The decision to add these non core deposits and borrowings was made to enhance our liquidity position And when offset by the earnings on overnight Federal Reserve Bank balances did not significantly impact our net interest income. We are also set up to participate in the bank term funding program offered by the Federal Reserve Bank. However, we have not yet utilized this facility. You can refer to Page 36 of the investor presentation for more specifics on our borrowings and liquidity position. All of our regulatory capital ratios remain well above well capitalized thresholds.

Speaker 2

Our TCE ratio is at 8.3%, Up from 8.2% at the end of Q4. In addition, with a loan deposit ratio of 71%, we have plenty of liquidity to continue to grow our loan portfolio. We saw improvement this quarter in the market value of our investments from the previous quarter. Our unrealized loss on available for sale securities declined by 17%, which also had a positive impact on equity through the change in AOCI. The credit quality of our investment portfolio is strong with 89% of available for sale and all of held to maturity securities guaranteed by The U.

Speaker 2

S. Government or government agencies. The duration of our investment portfolio is under 5 years and new purchases over the last two quarters were under 3 years. We have provided additional detail in our investment presentation regarding our investment portfolios on Pages 29 through 31. Non interest income increased $1,700,000 primarily due to a one time gain on sale of Class B Visa stock, which we have held since 2,008.

Speaker 2

Non interest expense increased $1,200,000 to $41,600,000 in Q1. This increase was due to an increase in benefit costs and higher payroll taxes Paid during the Q1 of each year. Looking ahead, due to April 1 offshore increases and additional expenses related to our new Boise production we expect non interest expense to be in the low $42,000,000 range for Q2. And finally, moving on to the allowance. Even though we continue to show strong credit quality metrics, we recognized provision for credit losses of $1,800,000 during Q1 due mostly to increases in loan balances unfunded commitments as well as a change in mix of loans in the portfolio, which impacts the balance calculation.

Speaker 2

I will now pass the call to Tony, who will have an update on these credit quality metrics.

Speaker 3

Thank you, Don. I'm pleased to report that credit quality was stable in the Q1 when compared to the strong results that we reported at the end of 2022. As of March 31, non accrual loans totaled $4,800,000 and we do not hold any OREO. This represents 0.12% of total loans and 0.07 percent of total assets. Non accrual loans declined by $1,100,000 during the quarter And are now down by $11,700,000 or 71 percent from the Q1 of 2022.

Speaker 3

We moved 3 C and I relationships to non accrual in the Q1 in the aggregate amount of $468,000 This was more than offset by $1,600,000 in loans that were either paid in full or made payments that were applied to principal. Our delinquent loans, which we define as those over 30 days past due and still accruing, is stable from year end at 8,400,000 or 0.20 percent of total loans. Page 24 of the investor presentation highlights the positive trends in our level of non performing assets. Criticized loans, those risk rated special mentioned in the substandard totaled just under $146,000,000 at the end of the quarter. This is a modest increase of $10,400,000 or approximately 8% since year end 2022.

Speaker 3

This still compares very favorably to the Q1 of 2022 where criticized loans totaled 174,600,000 Notably, over the same 12 month period, loans risk rated substandard have declined by $62,000,000 or 56%. While criticized loans in the hotel portion of the portfolio are still high at just under $30,000,000 we see continuing improvement. Two loans represent $24,600,000 of this total and both are now rated special mention and show improving trends. For comparative purposes, I'll highlight that criticized hotel loans totaled just over $67,000,000 at the end of 2021. We continue to closely watch our portfolio of office loans.

Speaker 3

We have yet to see any material deterioration in the credit quality of this portfolio. At quarter end, criticized office loans totaled approximately $22,000,000 or just under 4% of our total portfolio of owner And non owner occupied office loans. This is very close to the level that we reported at the end of 2022. At $582,000,000 this is the largest category of CRE loans in the bank. Some key characteristics of this portfolio include 48% The portfolio is owner occupied properties.

Speaker 3

These have a lower risk profile as there's less tenant rollover risk and we typically have the from the company occupying the space as well as the owners of that company. We have very little exposure in the core downtown markets within our footprint. Outstanding office loans in Downtown Seattle, Portland and Tacoma totaled just over $50,000,000 with 29 loans For an average loan size of $1,700,000 On Page 23 of the investor presentation, we added a page Our commercial real estate concentration levels. The bank has a long history of robust management of loan portfolio concentrations. You'll see that we maintain our CRE concentration levels well below the regulatory threshold at 2 59% of capital for total CRE And 44% for the subset of construction, land development and land loans.

Speaker 3

During the Q1, we experienced charge offs of $314,000 split evenly between our commercial and consumer portfolios. They were partially offset by recoveries of $84,000 leading to net charge offs of $230,000 for the quarter That represents 0.02% of our average total loans. This compares to a net recovery of $208,000 For the Q4 of 2022 and a net recovery of $494,000 in the Q1 of 2022. The loss for the quarter is relatively small and compares favorably to historical norms. By comparison, our average annual net charge offs For the 3 year period 2018 through 2020 was approximately $2,900,000 or about $700,000 a quarter.

Speaker 3

While we recognize that 2023 may represent a more challenging economic environment in 2022, We saw very little deterioration in our credit quality during the Q1. With our disciplined underwriting and diversified loan portfolio, We remain well positioned to deal with the economic challenges we may encounter in the coming quarters. I'll now turn the call over to Brian for an update on production in Q1.

Speaker 4

Thanks, Tony. I'm going to provide detail on our Q1 projection results starting with our commercial lending group. For the quarter, our commercial teams closed $228,000,000 in new loan commitments, down from $329,000,000 last quarter And roughly equivalent to the $222,000,000 closed in the Q1 of 2022. Please refer to Page 19 in the Q1 investor presentation for additional detail on new originated loans over the past 5 quarters. The commercial loan pipeline ended the Q1 at $587,000,000 up from $536,000,000 last quarter And up from $527,000,000 at the end of the Q1 of 2022.

Speaker 4

New commercial teams hired during 2022 have been adding to our loan Pipeline and the Poisey team is just starting to ramp up with the majority of the sales team not joining until later in the Q1 And into April. We currently have a team of 8 with 2 additional bankers scheduled to start before the end of the month. Our Boise office is fully staffed at this point and we are moving into our permanent space on May 22nd. As Jeff and Don mentioned, loan growth was $77,000,000 for the quarter or a 7.7% annualized rate. Although loan production and fundings on production during the quarter were both down versus 2022 averages, We benefited from lower prepaid levels and increased balances on construction loans.

Speaker 4

Please see Slides 20 21 of the investor deck for full detail on the change in loans during the quarter. Considering current economic conditions, market conditions, trends in our portfolio and customer base and the quarter end loan pipeline, plus the fact our new Boise team is just ramping up its production, We anticipate a similar level of loan growth for the next couple of quarters. Balances associated with new deposit accounts opened during the quarter Totaled $114,000,000 and the deposit pipeline ended the quarter at over $150,000,000 New deposit teams hired during 2022 and our existing deposit officers have been producing strong results As reflected on Slide 10 of the investor presentation, deposit balances in Oregon and the Portland MSA increased at a 28 Moving to interest rates. Our average first quarter interest rate for new commercial loans was 5.97%, which is 25 basis points higher than the 5.72% average for last quarter. In addition, the average first quarter rate for all new loans was 6.01%, Up 50 basis points from 5.51 percent last quarter.

Speaker 4

Although the marketplace continues to be competitive and the fixed rate indexes have been volatile, We're seeing loan spreads improve, which is translating into higher quoted interest rates on new loans. The mortgage department closed $17,000,000 of new loans in the Q1 of 2023 compared to $18,000,000 closed in the Q4 of 2022 And $37,000,000 in the Q1 of 2022. The mortgage pipeline ended the quarter at $25,000,000 versus $8,000,000 at year end 2020 $27,000,000 at the end of the Q1 of 2022. With mortgage rates remaining at higher levels, we anticipate volumes will continue the relatively low levels we saw in the second half of twenty twenty two. I'll now turn the call back to Jeff.

Speaker 1

Thank you, Brian. As I mentioned earlier, we're pleased with our performance in the Q1. While the general dialogue around the recent liquidity crisis is still a broader topic of discussion. We're confident our long established granular deposit franchise will continue to be an area of strength for us, And we have ample liquidity sources should we need them. Our relatively low loan to deposit ratio positions us well to continue our To support our existing customers as well as pursuing new high quality relationships, we will continue to benefit from our historically conservative approach credit in our strong capital position as we face the possibility of recession, and we operate in a footprint that has historically been economically vibrant.

Speaker 1

We will continue to focus on expense management, and we're making good progress with our in house tech build with version 1 wrapping up in 2023, Which will position us well-to-do more with the same people as we continue to grow. Overall, we believe we are positioned to navigate the challenging economic conditions And to take advantage of any potential dislocation in our markets that may occur. That is the conclusion of our prepared comments, Sierra, so we're ready to open up the call to any questions the callers may have for us.

Operator

Absolutely. And as a reminder, if you're using a speakerphone today, please remember to pick up your handset before asking your question. Our first question comes from Jeff Rulis with D. A. Davidson.

Operator

Please proceed.

Speaker 5

Thanks. Good morning. Good morning, Jeff. Just a question on just on the deposit side. Don and Jeff, you alluded The ongoing sort of challenges there and expect rate pressure to continue.

Speaker 5

But on a relative sense, I guess, It didn't sound like balances were all that impacted by the March news more so just some seasonal trends In addition to rate pressure, but just trying to get a sense for if you think that those rate requests Have slowed to a degree. Do you think you're kind of what you've seen so far in April? I mean, Don, you mentioned additional pressure expected, but Do you feel like you're getting through any of that? And then maybe just comment on balances as well in terms of stabilization quarter to date?

Speaker 6

Yes. I can start, Don, and

Speaker 1

maybe you want to join in. Jeff, I think maybe we're making it sound Completely benign. I'm not sure that that's exactly what we experienced. I think like everybody else, mid March, We were pretty anxious about the environment around us. And I think that what we did see Was a lot of conversations going on between our bankers and our customers, helping them understand the circumstances around us and what was going on with the banks that weren't doing very well.

Speaker 1

And I think that dialogue that occurred was, Quite frankly, much more meaningful than I thought it would be given the circumstances. It reminded me how closely tied to our customer base, our bankers are and, they're trusted advisors. And I think that did us a lot of good during That period of time. I think what did happen and maybe something that we benefited from in The Q4 was that up until that point, I don't think everybody's attention was really focused on rates in general As they related to deposits, and I think the conversations went well in terms of heritage is fine. But I think step 2 was, and let's talk about rates.

Speaker 1

So I think rates did move Maybe faster in a shorter period of time than we had anticipated given the circumstances. We as the month of March Went on. And as Don said, we watched daily, hourly for many days. As things started to calm down, What we normally see in this time of year is deposit flows tend to trend down anyways because There's a lot of tax activity for other there's other reasons too, but that's a big one. That's I think we're seeing stabilization or we saw stabilization towards the end of March, and now we're starting to see a little bit of activity That we believe is tied to tax payments, but none of it's outsized.

Speaker 1

And I think that as we said in the script, We think that things will start to stabilize as we get further into the end of April, And we think we'll benefit from some of the activity that's going on in the footprint around new relationship development, which I think will help stabilize and also maybe help us grow the deposits through the end of the year, which would be one of our focuses. We have a lot folks on our team now that are deposit focused, and I think all that energy is going to bear fruit as we get towards the end of the year. Don, maybe you want to comment on rates going forward?

Speaker 2

Sure. As far as just the rates themselves, The cost of interest bearing deposits for the quarter was 49 basis points. I'll just give you an update. For March, it was 64 basis points And the spot rate is 78 basis points. Now 8 basis points to that 78 basis points is the $100,000,000 of public deposits we brought in Kind of higher rates, which is basically paying fed funds minus 15.

Speaker 2

So it's a little cheaper than borrowings, but It's still kind of a floating rate higher cost deposit. So just to give you kind of a flavor of kind of what the cost and therefore for next quarter, right, With a spot rate of 78 basis points, this is going to be higher than the 49 that we experienced in Q1. As far as rate exceptions, I'm going to actually see if Brian MacDonald can speak to that real quickly. I think he's got his finger on the pulse a little bit more on that than I do.

Speaker 4

Yes, sure, Don. We are I would say the volume has declined a bit over the last Couple of weeks, as Jeff described, all those conversations with the customers did end up leading to a higher level of rate request. I think this is going to be largely dependent on what happens with our competitors. Although I would say that These are all excess non operating deposits, where we're feeling the rate pressure and a lot of those dollars are going to alternative outside the banks similar to what we've seen reported by other companies, including our own wealth management area. So That's the primary competition for short term rates competing with The money market funds that are available out there, where customers can get higher rates.

Speaker 4

So I still anticipate some pressure. We're seeing it moderate somewhat, but it's just a little bit early to say that we're not going to have Some higher level of activity, at least through the Q2. As both Don and Jeff mentioned, We're following this really closely and our teams are following that really closely. And we want to maintain competitive pricing to Keep as much of that on balance sheet as that reasonably makes sense to do.

Speaker 5

Very helpful. And if I were just circle back then to the Don, your expectation on margin being down in the second quarter relative to Q1, there's a thread there that You've built up some broker deposits. You added FHLB. You're addressing some Customer request now. I guess, in your further out, I guess, the balance of 23, Any expectations on margin as you digest things that carried forward from Q1 into Q2, but the back half of the year, Perhaps you could update us on kind of your rate sensitivity and how you see the margin sort of navigate in the back half, if that's Doable.

Speaker 2

Well, as I just look at trends and I think the decline is going To slow down, we didn't the overall margin did come down much in Q1. But again, Our March NIM was 373, just to give you some color on that. And therefore, I'm expecting it to fall probably into the somewhere into the 360s somewhere in there, probably next quarter. And And depending on what happens, right, with rates, it could get down to the 350s, although I don't really think it's going to get really I would be surprised, I guess, a couple of that, so based off the current rate environment. So but it could fall a bit more Throughout the year.

Speaker 5

Okay. Don, just so I get you right there, you had Not a single digit margin compression, but if you're pointing to 3.70 or lower, so we could see Sequentially higher margin compression in the 2nd quarter relative to the Q1? Yes. I'm expecting that. Okay.

Speaker 6

Okay.

Speaker 5

I'll step back. I appreciate it. Thank you.

Speaker 1

Thanks, Jeff.

Operator

Thank you for your question. Our next question comes from Andrew Terrell with Stephens. Please proceed.

Speaker 6

Hey, good morning.

Speaker 1

Good morning, Andrew.

Speaker 6

I wanted to start on The deposit side, I heard your commentary around the deposit pipeline. I think you said it stands around $150,000,000 or so. I'd be curious to hear how much of that is non interest bearing? And then how does the aggregate level of that pipeline, the $150,000,000 compared to The deposit pipeline coming into the year.

Speaker 1

Just trying to get a sense of

Speaker 6

how sequentially it's up.

Speaker 1

Brian, you may be closer to the details. Can you take that one?

Speaker 4

Yes, sure. It's up Significantly over Q4, meaning kind of in that 30% to 40% range. And then in terms of the mix, these are predominantly operating accounts, although there is Some with excess balances in there, but that's what we're going after and where we're finding the most success is Operating relationships. So I don't have a breakout by account in terms of the mix On that portfolio, although, I have reviewed the names and some familiarity with the accounts And there is some excess balances associated with these with the new relationships, but they're operating account based.

Speaker 1

Yes. Andrew, I could add to that, that we get a monthly production report, which we just got one For March, and Brian and I both go through that in pretty good detail and remind you that we not only have a lot more deposit gatherers than we had at the beginning Last year because of the lift outs that we did. But for several years now, all of our Loan production people have had deposit goals and we can see in the March report that there's a lot of activity in spite of what's been going on for the So it's going to come from 2 different directions, the deposit gathers well, 3 actually, the branch folks And the folks on the loan side.

Speaker 6

Okay. Very good. Thanks for the added color there. And then Maybe just trying to understand some of the puts and takes on just balance sheet size and some of the funding going into the second quarter. It looks like you built cash going into the end of the quarter here with some FHLBs.

Speaker 6

I know Brokered was mentioned. But I guess just when I piece together the commentary on the loan growth, as well as it sounds like some level of optimism on the deposit Moving forward, does it feel like you will incrementally need to build FHLBs or brokered Deposits as we go into the Q2, does some of that kind of, I guess, prefunding, if you will, in March, kind of keep that Keep that at bay.

Speaker 1

Well, and Don, you may want to add to this, but really what we did do was Bulk up given the circumstances to make sure we were prepared for anything that was coming at us. But if you look at our balance sheet, There's still a considerable amount of invested cash that serves to offset some of the FHLB borrowings, which were mostly defensive. And then you've got The other borrowings were done, more to just bolster Our position, and the broker deposits run off over 3, 6, 9 months, which It's part of the design of what we did. So I think that we're feeling like And I think, Don, if I correct me if I'm wrong, but I think we've been lowering the FHLB borrowing since the end of the quarter because we think that things have settled down and that the deposits have started to be a little more stable in our minds. You want to add to that?

Speaker 2

Sure. Well, we did kind of increase our kind of cash position overnight deposit balances as Quarter end, just to be just to have a little bit more there because what was going on in the last half of March within the whole environment. But if you look at it, really we've got almost $200,000,000 of, you might say, excess cash than we had the quarter before. We could if you look at it one way, we can fund that much in loans without having to take out any more borrowings. So because I think it's saying settle down, We'll be fine with working that cash position down.

Speaker 6

Yes. Okay. And then I guess last question for me just With rates pulling back a little bit versus where they've peaked out in kind of early March timeframe, are there any areas within the bond book You could look to trim up either for our repositioning trade or for incremental liquidity purposes to also help fund loan growth?

Speaker 2

Yes. We have an oversized investment portfolio right now. It's compared to our total assets. We are certainly willing to do that when it makes sense. It didn't make sense last quarter, Especially in March, we did a little bit.

Speaker 2

You saw we took a little bit of loss, but it wasn't a huge amount of dollars. But the Prices, the market got kind of wonky as far as there was not a lot of people looking to buy ponds. They were more looking to sell and we I just didn't want to sell in Environment. So we held off. There's a chance that if prices stabilize and are Looking better that we might be doing some of that.

Speaker 2

Okay.

Speaker 1

Quite frankly, Andrew, it would have been nice to offset Some losses on repositioning with that Visa shares, but it just didn't make sense, as Don said.

Speaker 6

Yes. No, makes total sense. Okay, I'll step back. Thank you for taking the questions.

Speaker 1

Thank you.

Operator

Our next question is from Adam Butler with Piper Sandler. Please proceed. Adam?

Speaker 7

Sorry, I was muted. Good morning, everybody. This is Adam on for Matthew Clark. Sorry about that. Just to add on another question to The deposit commentary, I appreciate that Slide 10 separating the growth that you've seen in The Oregon and Portland area and Seattle, with your commentary about the $150,000,000 deposit pipeline, I was just curious, Is that all kind of in one of the MSAs or is it kind of spread out between both of them?

Speaker 1

Brian, do you want to take that? Yes.

Speaker 4

The deposit pipeline that's bank wide versus just Reflective of what will flow into Slide 10. So that's the bank pipeline versus the pipeline For just that region, that's reflected on the bottom part of Slide 10.

Speaker 7

Okay, understood. I was just trying to get An idea of what the recent team lift outs could possibly be doing and maybe you will see an even larger deposit pipeline in the future quarters. Any comments on that?

Speaker 4

Yes. We're obviously watching it really closely. Deposits are coming from A number of different sources is the first thing I would say. Having a sales team without a customer base, They're out calling as well as Jeff mentioned, our existing deposit officers and Fully kind of relationship, bankers are all actively out calling. And So a lot of it's going to depend on just what sort of disruption we see in the market.

Speaker 4

I mean, we're viewing the loan opportunities the same way. Our bankers Call for years and oftentimes it's during a period of market disruption like this where they're maybe not able to get all their needs met at another institution and That's our opportunity to convert them. So this is the type of environment we look at. Again, we're seeking those relationship Clients, whether it be on the loan or deposit side. So that wasn't a direct answer, but we remain optimistic and Hopeful that we'll be able to put up some good numbers in that market down there because of the staff that we've added.

Speaker 7

Okay, great. I appreciate that color. And then just one question switching over to the credit. I appreciate The commentary on the call about the office portfolio, I was just wondering if you could provide some further detail on The office portfolio, some of the loan to values you're seeing and occupancy rates in the downtown area, Anything would be appreciated. Thanks.

Speaker 3

Sure, Adam. I'll go ahead and take that one. Yes. Yes, this is Tony. Yes, just a little bit more color on the portfolio.

Speaker 3

We at the end of Q4 of last year, we wrapped up a pretty deep dive into our commercial real estate that we do on an annual basis. And that portfolio, we looked at about 60% of the office loans, For example, and that particular portfolio had a, I think, an average Loan to value, and this would be focused on the larger deals in our portfolio, probably those over $1,500,000 And our average loan to value was weighted average loan to value is about 59% and our debt service coverage was about 2 point Three times. So, felt pretty good about those numbers. I mean, clearly, the downtown core markets are experiencing some significant distress already, If you do look at the core market, I was looking at the top 10 we have in those core markets and I think 9 of them are owner occupied properties, which again makes us feel pretty good about that mix. One other, I guess, I'll point out about of our office portfolio in the $580,000,000 range, about $95,000,000 of that is medical office, which we look at as a much lower risk profile and that market continues to perform Pretty well, really across our footprint.

Speaker 3

So I'll stop there and see if you had anything more specific you might be looking for.

Speaker 7

No, that was great. I appreciate it. And I'll step back. Thank you guys very much.

Speaker 1

Thank you, Adam.

Operator

Thank you for your question. Our next question comes from David Feaster with Raymond James. Please proceed.

Speaker 8

Hi. Good morning, everybody.

Speaker 1

Good morning, David.

Speaker 8

I wanted to touch on the loan growth side. Just Just here in your prepared remarks, it sounds like growth you're expecting it to remain relatively stable. I'm just curious how is demand trending across your footprint? Where are you seeing good opportunities for growth at this point? Are the new hires Really allowing you to gain share and sustain good pace of growth.

Speaker 8

And just to your commentary on spreads widening, I'm curious where new loan yields are at Today.

Speaker 1

Brian, you want to take that?

Speaker 4

Sure. Well, maybe I'll start with just A broad comment. It is those projects that were maybe rate sensitive. So we've seen some of those fall off really over the last year or related to that construction cost Increases over the last year. So that's continued.

Speaker 4

We've got a number of other customers that have been working on Projects for the last few years and those are the ones that we're seeing continuing ahead. And if the underlying business has a real Strong backlog and they still feel confident and they're moving ahead with those sort of projects. And Specific geography, I will say our new teams and new bankers without a lot of portfolio, the ones that are out, Obviously, calling, they're contributing to that overall pipeline. We have more salespeople Now than we did a year ago at this time. So that's also a factor.

Speaker 4

In terms of new loan yields, if We quoted the numbers for the full quarter. I can give you the numbers for March. We'll give you a sense of that On commercial business for March, the rate was 6.32 Versus I mentioned $5.97 for the full quarter and then for all new loans. Let's see if I have that number here. Yes, 625 for March versus 601 average for the full quarter.

Speaker 4

So we have seen spreads widen. Our challenge, David, obviously not prime based loans because prime's You know at a reasonable level, but the fixed rate index is if you look at the 5 year FHLB, It's at 4.17 when I looked earlier this week. And so even with a couple of 100 basis point spread, that puts it in the low 6s. That spread is higher than what we were Seeing a year ago, again, that was because everybody's deposit costs were so low. So it isn't we haven't seen spreads come back to What we think would be a reasonable a more reasonable level, but we have seen them come up from the really low spreads that we're seeing over the last few years.

Speaker 4

So we're hoping those spreads keep continuing up. We're again looking at this if we've been particularly existing core relationships And new customer opportunities if they fit that relationship profile, maybe we've been calling on them for years and their current bank Is pricing much higher or not able or not as interested in doing lending? We see this as a great opportunity to pick up Those core long term relationship clients and want to stay in the market and support the markets and support our bankers and Better our customer base through this volatility, if those opportunities come about.

Speaker 1

Hey, David, this is Jeff. It might be a little anecdotal in In terms of response to your question, but I see only the deals that hit a certain level based on relationship size, not necessarily loan size. And We've seen a steady flow of deals over the last several months. And interestingly enough, There's several of them that when I see the report out on what is being requested for approval, It's often saying you saw this deal in October, when it first started coming together and this is the deal actually happening. So It feels like from my vantage point, the deals are there.

Speaker 1

They're just moving a little bit slower.

Speaker 8

Okay. Okay. That's encouraging. And then maybe just touching on, we've talked several times about the recruiting that you guys have done and there's obviously a lot of disruption around you. I'm just curious, your appetite for more hires, as these guys are starting to Hit the ground running.

Speaker 8

Do you have an appetite for more? Are you seeing more opportunities? How are conversations going? And maybe what markets or geographies or segments Would you be looking to potentially add to?

Speaker 1

I would start by saying that you know that we're Always positioned to take advantage of opportunities on the M and A side, but obviously that is probably on the sidelines for a while. But we've always had a bias For teams and we've actually illustrated that in our deck. There's a slide in there that shows M and A versus teams. I guess I would leave it with you, David and Brian may want to add to this that we're always interested in teams, particularly if they augment What we already have or enhance a team that already exists, but would probably focus Only on the three state area that we're in now. And I think that a team right now would have to be really compelling for us to take action because While the team down south has been with us surprisingly almost a year now because they all came across in May, They're making good headway.

Speaker 1

Still, we're trying to give them as much support as we can due to their newness and their In Eugene, for example, newness in that market. And Boise is just getting their legs under them. So we want to make sure we don't get Spread so thin we can't support them too. So like I said, it would have to be pretty compelling, probably more so interested in one offs and There's a couple of spots in the footprint that we would like to flesh out a little bit Due to maybe some of the retirements that have been going on and repositioning of some people. So we're always looking, but to do a whole team would have to be pretty compelling.

Speaker 1

Brian, anything you want to add to that?

Speaker 4

No, I agree. Totally, we've taken on a lot and it's going well. And we just filled the entire team in Boise Here, over the last few months. And so we have some, as Jeff said, onesie, twosies, we've got some retirements. So we're always out recruiting and then We're always willing to meet and listen.

Speaker 4

And if it was really compelling situation, we'd certainly take a hard look. But I agree with Jeff. We've done a lot and we'd like to continue to support these groups well, to have a really Favorable onboarding experience for them and help them any way we can. So

Speaker 1

David, we also need to be cognizant of our Spend space, too. That's why it has to be really compelling because we really need to keep an eye on that now that we've added the teams that we have.

Speaker 8

Yes. Yes, understood. And just maybe switching gears to capital. You already touched on the M and A side a bit, but just You guys managed your cash really well positioned. You don't have the same AOCI issues that a lot of other banks have, very well capitalized balance Just curious your thoughts on capital at this point and your willingness to return capital.

Speaker 8

Looking at the buybacks, I mean, you look back, I mean, the stocks where it's trading up, it's cheaper than where we bought stock back in the past Several years. I'm just curious your appetite for that or given the uncertainty, are we kind of more in a capital preservation mode?

Speaker 1

Don, you want to take that?

Speaker 6

Yes, I'll take that.

Speaker 2

Yes, we have done buybacks before and right at even Levels higher in this. I think that our regulatory capital ratios are strong. TC ratio is A little low still because the AOCI, although improving every quarter, it's a little uncertain whether we could be heading into a recession. So We may get involved some. We also may wait depending on just the economic environment, but we are watching that carefully.

Speaker 2

I don't have Really any guidance to give you in that area at this point, but we are considering it.

Speaker 8

Do you have an authorization in place? And how much do you have left? I don't remember off the top of my head.

Speaker 2

Yes. We have slightly over 500,000 left, 500 shares 100,000 shares left in our current repurchase plan. And we usually do and when we do do new It's usually about 1,500,000 shares at a time.

Speaker 8

Okay, terrific. Thanks everybody.

Speaker 1

Thank you.

Operator

Thank you for your question. There are no questions waiting at this time. So I'll pass the conference back over to management team for any further remarks.

Speaker 1

Thank you, Sierra. If there's no more questions, we'll wrap up the call. We thank you all for your time and your support and your interest in our ongoing

Operator

That concludes the Heritage Financial Corporation Q1 2023 earnings call. The replay for today's call will be available until Thursday, April 27. To access the replay, please dial 1-eight sixty six-eight thirteen-nine thousand four hundred and three and enter access code 8,6,2416. Again, dial 1-eight sixty six-eight thirteen-nine thousand four hundred and three and enter access code 8,6,200 and

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Earnings Conference Call
Heritage Financial Q1 2023
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