Heritage Financial Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
January 25, 2024

There are 7 speakers on the call.

Operator

Hello, everyone, and welcome to today's call. My name is Drew, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Heritage Financial Q4 and Year End Earnings Call. All lines have been placed on mute to prevent any background noise. To ask the speakers' remarks, there will be a question and answer session.

Operator

To if you change your mind, please press star followed by 2 to withdraw the question. I will now turn the call over to your host, Jeff Deuel, CEO. Please go ahead.

Speaker 1

To Thank you, Drew. Welcome to everybody who called in and those who may listen later. This is Jeff Duell, CEO of Heritage Financial. To Attending with me are Brian McDonald, President and Chief Operating Officer Don Hinson, Chief Financial Officer and Tony Shelvent, Chief Credit Officer. To our Q4 earnings release went out this morning pre market, and hopefully, you have had the opportunity to review it prior to the call.

Speaker 1

To we have also posted an updated 4th quarter investor presentation on the Investor Relations portion of our corporate website, to please refer to the forward looking statements in the press release. We are reporting a somewhat noisy quarter that ultimately sets us up well to turn the call over to the operator for 2020 4 and beyond that so called noise can be attributed to active balance sheet management and expense reduction measures. When we started to run the preliminary budget in 2024, 2024, to Non interest expense was running around $171,000,000 for the year. That, coupled with continued pressure on margins, to cause the management team to take a hard look at our org structure in Q4 and we were able to get that number down to a run rate to take a look at the expense reduction actions included contract rationalization, to take a moment to take a moment to take a moment to discuss the financial results. Thank you.

Speaker 1

Thank you. Thank you. Thank you. Thank you. Our next question comes from the line of John to

Speaker 2

turn the call over to Steve. All of which will be referenced in

Speaker 1

this presentation. We continue to see pressure on deposit pricing in Q4, and we to expect to see this continue for the near term. Deposit balances declined modestly in Q4, and the mix of deposits to continue to partially shift to higher rate products. Loan growth was strong in Q4 running at a 7% annualized rate. To Credit quality remains strong resulting from our long term practice of actively managing the loan portfolio.

Speaker 1

To We have ample liquidity, a low loan to deposit ratio and a solid capital base. Going forward, we will keep a sharp eye on expenses to turn the call over to Don Henson, who will take a few minutes to cover our financial results.

Speaker 3

To Thank you, Jeff. I'll be reviewing some of the main drivers of our performance for Q4. To turn the call over to Eric. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the Q3 of 2023. To I want to start by covering some actions that significantly impacted earnings for Q4 and are expected to improve earnings in future periods.

Speaker 3

To First, we repositioned a portion of our investment portfolio, which resulted in a pre tax loss of $10,000,000 during the quarter. To We sold $152,000,000 of securities with a weighted average yield of 2.41 percent and purchased $141,000,000 of securities yielding to Including the yield and cash not yet reinvested at year end, we are expecting an annualized interest income pickup of about to provide $5,000,000 from these transactions resulting in an earn back period of approximately 2 years. 2nd, we incurred certain costs related to expense to take measures in order to lower expenses in future periods. These included $1,500,000 in contract to negotiation fees, which will lower costs of the related contract over a 6 year period, dollars 320,000 due to the write off of contract to note that we will not be replacing $148,000 of severance payments to terminated employees. As mentioned in the earnings release, these costs to In addition to approximately $1,200,000 of severance payments expected to be incurred in Q1 will result in annualized cost savings of approximately $5,300,000 to turn the call over to Steve.

Speaker 3

These and other expense management measures are being taken to improve our performance in 2024 and beyond. To Please see Page 6 of the investor presentation for more information on these actions. Moving on to the balance sheet. Loan growth was strong to turn the call over to Eric. Thank you, and good morning everyone.

Speaker 3

Thank you, Eric. Thank you, Eric. Thank you, Eric. Thank you, Eric. Thank you, Eric.

Speaker 3

Thank you, Eric.

Speaker 1

Thank you, Eric.

Speaker 3

Thank you, Eric. Thank you, Eric. Good morning, everyone. Thank you, Eric. Good morning, everyone.

Speaker 3

Good morning, everyone. Good morning, everyone. To Yields in the loan portfolio were 5.35 percent for the quarter, which was 5 basis points higher than Q3. To provide an update on loan production and yields in a few minutes. Total deposits decreased $35,000,000 during the quarter.

Speaker 3

To The decrease was due to a decrease of almost $100,000,000 in non maturity deposits, partially offset by an increase of $64,000,000 in CD balances. To Customers continue to take advantage of the higher rate environment by lowering their excess balances in lower paying non maturity deposit accounts. These factors contributed to an increase of 25 basis points in our cost of interest bearing deposits to turn the call back to the operator to 1.48 percent for Q4. Due to the current market pressure related to deposit rates, we expect to continue to experience an increase to conclude the call and answer session. This is illustrated by the cost of interest bearing deposits being 1.56% for the month of December to with a spot rate of 1.59 percent as of December 31.

Speaker 3

Investment balances decreased to be in the range of $21,000,000 during Q4, partially due to the loss trade previously discussed. The security trades occurred from mid November to mid December. Therefore, the benefit of loss trade was not fully realized in Q4. Even without full realization of the loss trade benefit, the yield in the securities portfolio increased to turn the call over to the Q4 to 3.15 percent for Q4. Moving on to the income statement.

Speaker 3

To Net interest income decreased $1,700,000 from the prior quarter due to a decrease in the net interest margin and in average earning assets. To The NIM decreased to 3.41 percent for Q4 from 3.47% in the prior quarter. The decrease in NIM was primarily due to the cost of interest bearing deposits to be more rapidly than yields on earning assets. We expect NIM to decrease further in Q1 2024 since NIM for the month of December was 4 basis points lower than it was for the entire quarter Q4. The pace and duration of our decrease in margin will to be highly dependent on continued increases in our cost of interest bearing deposits as well as maintaining deposit balances.

Speaker 3

Our cost of to discuss deposits as well as deposit balances as they level off, we expect to experience margin stabilization to turn the call over to the operator to review the repricing of adjustable rate loans in addition to higher origination rates on new loans. In addition, current rates on brokered CDs are lower than those to turn the call over to our operator. We recognized a provision for credit losses in the amount of to request a reconciliation of loan growth and net charge off of 618,000 recognized during the quarter. To Removing the impact of significant Q4 expense items previously mentioned, non interest expense decreased from the prior quarter to due partly to lower FTE levels. Average FTE for was 803 for Q4 compared to to take a look at 821 for Q3.

Speaker 3

These levels will decrease further in Q1 2024 and are expected to decrease to less than to call 7.80 by Q2. All impacted employees have already been notified. Due to the previously mentioned severance costs in Q1, to. Q1 non interest expense levels are expected to be somewhat elevated from the go forward run rate. Beginning in Q2, we expect the expense run rate to be between $40,000,000 $41,000,000 to All the regulatory capital ratios remain comfortably above well capitalized thresholds and our TCE ratio increased to 8.8% to turn the call back to the operator at year end from 8.2% at the end of the prior quarter.

Speaker 3

This increase was due substantially to improvement in our AOCI as market rates improve the overall fair value to turn the call back over to Tony, who will have an update on our credit quality metrics.

Speaker 4

Thank you, Don. To Credit quality at year end remained strong and was stable throughout the year. As of year end, non accrual loans totaled just under $4,500,000 to And we do not hold any OREO. This represents 0.10% of total loans and compares to 0.07% to conclude our Q3 nonaccrual loans increased by $1,400,000 during the quarter, however, were down by 24% over the last 12 months. To Increases of just over $2,100,000 in the quarter came from moving one C and I loan to nonaccrual status.

Speaker 4

To A portion of this loan was charged off during the quarter, and the remaining balance is fully guaranteed by the SBA. We expect to be fully repaid from the guarantee during 2024. Partially offsetting this increase was to turn the call over to the operator. To Page 26 of the investor presentation reflects the significant improvement we have experienced in our non accrual loan levels since the end of 2020. Loans that are delinquent more than 30 days and still accruing stood at 0.11% of total loans at year end.

Speaker 4

To This is unchanged from the Q3 and is down from 0.17% of total loans at year end 2022. To criticize loans, those risk rated special mention or worse, totaled just under $150,000,000 at the end of the quarter. This is an increase of $15,000,000

Speaker 3

to take a look at our

Speaker 4

outlook for 11% from the end of the Q3. The largest driver of this increase was the downgrade of 2 significant C and I relationships. To During the quarter, a $7,100,000 relationship was moved to special mention and a $6,000,000 relationship was moved to substandard. To Overall, criticized loans have trended modestly higher since the end of 2022, rising by 11% to take a look at our commercial real estate portfolio continues to perform well and has shown to provide some improvement over the last 12 months. Total criticized CRE loans represent 3.4% of our total CRE portfolio to turn the call over to the operator for questions.

Speaker 4

And 2.3 percent of our entire loan portfolio. As of year end 2022, the percentages to turn the call over to the operator for questions. Thank you.

Speaker 3

Thank you.

Speaker 4

Our to turn the call over to the operator for questions. This loan segment currently represents to take a look at the financial results. $556,000,000 or 12.8 percent of total loans and is split evenly between investor CRE and owner occupied. The loans continue to be granular in size and diversified by geographic location, with little exposure in the core downtown markets. To criticized office loans are limited to just over $19,000,000 which is down modestly from the $21,500,000 to be recorded at the end of the Q3.

Speaker 4

Page 25 of the investor presentation provides more detailed information to discuss our office loan portfolio. During the Q4, we experienced total charge offs of $709,000 with the majority attributed to review our financial results for the quarter. The losses were offset by $91,000 in recoveries, leading to net charge off of $618,000 for the quarter, to Which was referenced by Don earlier. We ended 2023 in a net recovery position of $277,000 While the recovery position to turn the call over to the operator for questions. Thank you.

Speaker 4

Thank you. Our next question comes from the line of to Page 28 of our investor presentation shows that we continue to outperform the average of our peer group in this important credit metric. To While there was some modest deterioration over the last 12 months, the credit quality of our loan portfolio remains strong, to And we are well positioned heading into the New Year. The slight uptick in criticized loans during the quarter suggests a move towards a more normalized credit environment to turn the call over to Mr. President.

Speaker 4

Following a period of exceptionally high credit quality, we remain confident that our consistent and disciplined approach to credit underwriting to turn the call over to Brian for an update on loan production.

Speaker 5

To Thanks, Tony. I'm going to provide detail on our 4th quarter loan production results, starting with our commercial lending group. To For the quarter, our commercial teams closed $187,000,000 in new loan commitments, down from $217,000,000 last quarter to turn the call over to the operator for questions. And down from $329,000,000 closed in the Q4 of 2022. Please refer to Page to turn the call over

Speaker 3

to Tony in the

Speaker 5

Q4 investor presentation for additional detail on new originated loans over the past 5 quarters. To The commercial loan pipeline ended the 4th quarter at $329,000,000 up from $291,000,000 last quarter to and down from $536,000,000 at the end of the Q4 of 2022. Loan demand continues to be moderate to turn the call over to the Q4 of fiscal 2019,000,000 to turn the call back over to the operator for questions. Thank you, sir. Our first question comes from the line of John to please see Slides 21 and 23 of the investor presentation for further detail on the change in loans during the quarter.

Speaker 5

To based on our current pipeline, we anticipate our growth rate will be mid single digits over the next couple of quarters. To turn the call over to Mr. President. The deposit pipeline ended the quarter at $207,000,000 compared to $171,000,000 last quarter to And estimated average balances on new deposit accounts opened during the quarter totaled $55,000,000 This compares to $39,000,000 in actual new balance to introduce our operator to the operator to discuss our financial results. Was 6.93%, which is 48 basis points higher than the 6.45% average for last quarter.

Speaker 5

To In addition, the average 4th quarter rate for all new loans was 7.04%, up 50 basis points to turn the call over to Eric from 6.54% last quarter. The increase is due to a combination of higher underlying index rates to and widen spreads implemented in 2023. The market continues to be competitive, particularly for C and I relationships. To The mortgage department origination volume and pipeline continued to be low in the 4th quarter. To Ongoing low loan volume combined with uncertainty around when we could expect to see our mortgage business improve to lead to our decision to exit the retail component of this business line.

Speaker 5

The staff associated with the retail mortgage business to take a few minutes ago. We expect to replace to review the financial results. Thank you. Thank you. Thank you.

Speaker 5

Our next question comes from the line of Jeff. To turn the call back to Jeff.

Speaker 1

Thank you, Brian. As we mentioned earlier, we're to be pleased with our performance in the Q4, which sets us up for 2024. While we continue to experience the to take the challenges of the rate this current rate environment. We're confident that the strength of our franchise will continue to benefit us over the long term. To conclude our relatively low loan to deposit ratio positions us well to continue to support our existing customers as well as pursuing new high quality relationships.

Speaker 1

To we will continue to benefit from our solid risk management practices and our strong capital position. We will continue to focus on expense management and to extend efficiencies within the organization. Overall, we believe we are well positioned to navigate the challenges ahead and take advantage of any potential dislocation in our markets to take a look at the results that may occur. That is the conclusion of our prepared comments. So Drew, we're ready to open up the call to any questions callers may have for us.

Operator

To thank you. We will now start today's Q and A session. Our first question today comes from Jeff Rulis from D. A. Davidson.

Operator

Your line is now open. Please go ahead. To

Speaker 6

Thank you. Good morning.

Speaker 1

Good morning.

Speaker 6

Yes. Just maybe a question for Don. To On the margin side, I heard your comments about expecting further compression. I wanted to kind of to get the sense for with the security sale that's inclusive of that and kind of relative Compression is that magnitude moderating 3Q, 4Q to 1Q?

Speaker 3

To Jeff, I'll be happy to answer that for you. As I mentioned, the December to NIM drop, but like I said, it didn't include all of the loss trade, but we're still to With the cost of deposits increasing, although moderating, I do expect that we've seen NIM compression to Down again, maybe a little less so than we saw in from Q3 to Q4, but still probably into the 330s for the quarter.

Speaker 6

Okay. And if you could just remind us on kind of to No, it's if and when we get some rate cuts, I don't know about the sensitivity of each 25 basis point cut with that Initially does and maybe a little further out the impact to the margin.

Speaker 3

To I think if I'm going to start with long term, I think long term more rate cuts will be beneficial because anytime we can get away from an inverted yield curve, That's going to help us out. But in the short run, with rate cuts, we're going to there's always a lag period to And floating rate assets. I will say though, when you add up our brokered CDs, other CDs, to We have some floating rate public deposits and some and our exception price core deposits that adds up to about to $1,400,000,000 in of itself that will reprice over a year also. So I think over a year, they'll kind of to I guess reach equilibrium for over rate cuts, but in the short run, I think it's going to hurt margin more. And I don't have necessarily a specific number for you, But you can see the amount of floating rate that we have in each category.

Speaker 6

To Sure. And then just a couple of housekeeping, just on the fee income side, resumption of a normalized And it's $7,000,000 to $7,500,000 Cliff. Is that a quarterly fair run rate?

Speaker 3

I think what we did in Q4, obviously, ex The losses on the investments, and of course, we wouldn't have any gains on sale of loans. To Other than those, I think that's a pretty good run rate.

Speaker 6

Okay. And then the tax rate For 24%, should we think about 16% or 17%?

Speaker 3

Yes, I think somewhere between 16, 16.5 is probably kind of where we're going to end up.

Speaker 6

Okay. I'll step back. Thank you.

Speaker 1

To Thanks, Jeff.

Operator

Just to reiterate, if you would like to ask a question, please press star to follow by one on your telephone keypad. Our next question comes from Matt Sverdorska from KBW. Your line is now open.

Speaker 2

Hey, guys. Thanks for taking the questions. To wanted to see what you're seeing kind of what deposit balances maybe with NIBs early into to the year here, if you have any insight to where you think they might may bottom at and what the deposit flows are kind of looking like early into this year?

Speaker 1

To Don, do you want to take that?

Speaker 3

Sure. We have seen continued decrease of our to take a look at the percentage of non interest bearing. We're down to a little over 30%, I think 30.7% as of the end of the year. To Pre pandemic, we were 31.6%, I think it was. But obviously, we're in different rate environment.

Speaker 3

So to At this point, I kind of based off the trends, I kind of would expect that overall percentage to drop into the high 20s at this to point, I don't necessarily see it going below that, but the trends continue as far as over the last few quarters. So I don't see at this point where it's going to slow down until we see maybe some changes in the rate environment.

Speaker 2

To Great. And then maybe on the other side of loans, I appreciate the guidance with mid single digits. To maybe you guys could talk about where you're seeing some good opportunities this year and where you think you might see like the most growth in 2024?

Speaker 1

To Brian, you want to take that?

Speaker 5

Sure. It's Matt, it's Brian McDonald. Really, it's broad based. To our bankers have been calling with an added emphasis on C and I since last spring. We've always been a C and I to banker, but as the market conditions changed, more of an heavy emphasis on full relationship.

Speaker 5

But it's really up and down the footprint. Of course, our new teams to have more bankers with lower portfolio sizes and so they're able to get out and call more than Our bankers with large portfolios, but it's all across the network.

Speaker 2

Great. Thanks. And then one more here. To Are you guys any appetite or expecting any more restructurings this year at this time or you think that will be it?

Speaker 1

To Restructuring the balance sheet?

Speaker 3

Yes. Yes. Okay. Go ahead, Don. Okay.

Speaker 3

We're considering it. We haven't made any final decisions on that. I would say it's a less attractive trade than it was last quarter Or maybe in the quarter before that. So with potential longer earn back periods And less pickup, income pickup. I will say that we would if we did another one, we'd probably try to keep it within 3 years.

Speaker 3

As a reminder, the last one was 2 years, there and back. But we haven't made any final decisions.

Speaker 2

Yes. Awesome. Well, appreciate all the color and thanks for answering the questions.

Speaker 6

Thanks,

Operator

to We have no further questions in the queue. So I'll hand back over to Jeff for any closing remarks.

Speaker 1

Well, thank you, Drew. Since there to thank you all for your time and your support and your interest in our ongoing performance, and we'll hopefully see some of you soon.

Operator

That brings us to the end of today's call. There will be a replay available for the call. To please dial +-eight66-eight thirteen-nine four zero three three. To please use the access code of 301,843. That concludes today's Heritage Financial Q4 and Year End Earnings Call.

Operator

You may now disconnect your line.

Powered by Quartr

Key Takeaways

  • Active portfolio repositioning resulted in a $10 million pre-tax loss from selling $152 million of lower-yielding securities and buying $141 million of higher-yielding bonds, with an expected $5 million annualized interest income pickup and a two-year earn-back period.
  • The company undertook expense reduction measures—including $1.5 million in contract negotiation fees, $1.2 million of Q1 severance costs, and other contract write-offs—projected to deliver $5.3 million in annualized savings and reduce the run-rate to $40–41 million by Q2 2024.
  • Net interest margin compressed to 3.41% in Q4 (down from 3.47% in Q3) as deposit costs rose faster than asset yields; management expects further NIM pressure into early 2024 but anticipates stabilization as deposit repricing moderates and adjustable-rate loans reset.
  • Loan growth was strong at a 7% annualized rate in Q4 with $187 million in new commercial loan commitments, while total deposits declined modestly and shifted toward higher-rate products; the loan pipeline stands at $329 million and mid-single-digit growth is expected in coming quarters.
  • Credit quality remains solid, with nonaccrual loans at just 0.10% of total loans, net charge-offs of $618,000 for the quarter, no OREO holdings, and comfortably above-threshold capital ratios, although criticized loans ticked up modestly from Q3 levels.
AI Generated. May Contain Errors.
Earnings Conference Call
Heritage Financial Q4 2023
00:00 / 00:00