Heritage Financial Corporation

Good morning. Thank you for attending today's Heritage Financial Corporation Q3 2022 Earnings Call. My name is Bethany. I will be the moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I would now like to pass the conference over to our host, Jeff Duell, CEO of Heritage Financial. Please go ahead.

Thank you, Bethany. Welcome and good morning to everyone who called in. For those who may listen later, this is Jeff Duell, CEO of Heritage Financial. Attending with me are Don Henson, Chief Financial Officer, Brian McDonald, President and Chief Operating Officer, and Tony Chalfant, Chief Credit Officer. Our earnings release went out this morning pre-market and hopefully you've had an opportunity to review it prior to the call. We have also posted an updated third quarter investor presentation on the investor relations portion of our corporate website. We will reference the presentation during the call. Please refer to the forward looking statements in the press release. We're very pleased to report a strong third quarter, we reported good organic loan growth, which was aided by lower payoffs, higher line utilization, and a pool of purchase residential mortgage loans. We're pleased with the positive trend we have seen in the number of new commitments and new loan closings across the footprint in spite of strong competition. NIM is improving with the deployment of cash into loans, higher rates of the Fed, and growing the investment portfolio. Don and our treasurer have done a nice job of carefully managing our investment portfolio over the past couple of years, which has limited the negative impacts of AOCI. We continue to carefully manage expenses, although we are experiencing the impacts of inflation. You may recall we guided to a range of 38 to 39 for the quarter, and we finished slightly above that range. Notably, our longstanding focus on credit quality and actively managing our loan portfolio continues to play out well for us. Staying focused on our conservative risk profile has enabled us to continue to report improving credit trends and provide a good foundation facing into a potential recession. We'll now move to Don, who will take a few minutes to cover our financial results.

Thank you, Jeff. As Jeff mentioned, overall financial performance was very positive in Q3, 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 the second quarter of 2022. Starting with net interest income, there was an increase of $9.2 million or 18.5% due mostly to higher net interest margin. The net interest margin increased 53 basis points to 3.57% for Q3. This was due mostly to improved yields on earning assets, the leveraging of cash into loans and investments, and continued low cost deposits. We had another strong quarter of loan growth with balances increasing 127 million or 3.3%. In addition, yields on the loan portfolio were 4.51% in Q3, which was 21 basis points higher than Q2. Brian McDonald will have an update on loan production in a few minutes. In addition, investments increased 326 million due to the additional purchases of securities in Q3 to take advantage of improved market yields. Due to these purchases and the overall rate environment, the yield on the investment portfolio increased at 2.63% compared to 2.15% in the prior quarter. We experienced a decrease of 92 million of deposits during Q3. Most of this decrease occurred late in the quarter as shown by the fact that the average balance was down only 17 million from the prior quarter. Much of this decrease was due to rate sensitive customers seeking higher yielding investments. We have increased our deposit rates, and we are working with our customers on rates to maintain relationships. As a result, we expect to experience an increase in the cost of deposits over the next few quarters. All of our regulatory capital ratios are made strongly above real capital life thresholds, and we continue to have a very strong liquidity position. Our TCE ratio is at 7.6%, down from 7.9% at the end of Q2. This decrease was due to the continued decline in the fair value marks on the investment portfolio, which impacts the AOCI portion of equity. As of the end of Q3, AOCI had a 140 basis point impact on the TCE ratio. You can refer to page 30 of the investor presentation for more specifics on capital and liquidity. Non-interest expense increased 3.4 million to 39.1 million in Q3. This increase was due mostly to an increase in compensation expense. and this was due to a combination of inflationary pressures on internal pay scales, a full quarter impact of the new teams hired in Q2, an increase in FTE due to improved success in filling open positions, and increased incentive compensation accruals. Even though we continue to show strong credit quality metrics, including reduction in non-accrual loans and realizing net recoveries for the quarter, we recognize the provision for credit losses of $1.9 million during Q3 due mostly to increases in loan balances, as well as the lengthening of the duration of certain loan segments, which impacts the allowance calculation. I will now pass the call to Tony, who will go into detail on these credit quality metrics.