Heritage Financial Corporation

Hello, everyone. Thank you for attending today's Heritage Financial Corporation Q1 2023 earnings call. My name is Ciara 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. If you would like to ask a question, press star one on your telephone keypad. I would now like to pass the conference over to our host, Jeff Buell, CEO of Heritage Financial Corporation. Please proceed.

Thank you, Ciara. Welcome and good morning to everyone who called in and those who may listen later. This is Jeff Duhl, CEO of Heritage Financial. Attending with me are Don Hinson, Chief Financial Officer, Brian McDonald, President and Chief Operating Officer, and Tony Chalfant, Chief Credit Officer. Our first quarter earnings release went out this morning pre-market and hopefully you've had the opportunity to review it prior to the call. We have also posted an updated first quarter 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. As you know, deposit pricing started to get more competitive late in the third quarter of 22, and that theme continued through Q4 22 and into Q1 23. 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 cost. We expect deposits to stabilize as the year progresses, aided by our $150 million deposit pipelines. We reported solid organic loan growth of 7.7% 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 expenses carefully, although we also continue to experience the impacts of inflation. 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 provides a good foundation facing into a potential recession. We'll now move to Don Hinson, who will take a few minutes to cover our financial results.

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 fourth quarter of 2022. Starting with net interest income, we experienced a decrease of 3.3 million or 5.2% 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. This was the main driver for the seven basis point decrease in our net interest margin for Q1. We expect to continue to experience downward pressure on NEM in Q2. As mentioned earlier, we started 2023 with solid loan growth in Q1 of 77 million or 7.7% 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. Our cost of interest-bearing deposits increased 24 basis points to 0.49% 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 a decline in total deposit balances in Q1 of 2.3%. The decline occurred throughout the quarter. We closely monitored our deposit balances during the first quarter, including the days subsequent to the bank failures in mid-March. As Jeff mentioned, our large deposit outflows in Q1 are primarily due to either capital purchases or normal outflows. We did not see significant runoff from the recent bank failures. Historically, the first quarter is also a quarter of minimal to no deposit growth. Brian will also discuss our deposit pipeline later in the presentation. Our insured deposits were at 65% of total deposits at the end of Q1. Also, for customers seeking additional FDIC insurance, we offer deposit products which have full FDIC insurance coverage. On balance sheet deposit totals for these accounts were $162 million at the end of Q1. In order to supplement core deposits in Q1, we added $52 million in broker deposits and $100 million in higher costing floating rate public funds this quarter, which contributed to the increased cost deposits. In addition, we added $383 million of overnight FHLB borrowings in Q1. 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. 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 US government or government agencies. The duration of our investment portfolio is under five years and new purchases over the last two quarters were under three years. We have provided additional detail in our investment presentation regarding our investment portfolios on pages 29 through 31. Non-interest income increased $1.7 million primarily due to a one-time gain on sale of Class B Visa stock which we have held since 2008. Non-interest expense increased $1.2 million to $41.6 million in Q1. This increase was due to an increase in benefit costs and higher payroll taxes paid during the first quarter of each year. Looking ahead, due to April 1 officer increases and additional expenses related to our new Boise production office, we expect non-interest expense to be in the low $42 million 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 $1.8 million during Q1 due mostly to increases in loan balances and unfunded commitments. as well as a change in mix of loans in the portfolio, which impacts allowance calculation. I will now pass the call to Tony, who will have an update on these credit quality metrics.