Heritage Financial Corporation

Hello and welcome to the Heritage Financial Corporation Q2 2023 Earnings Conference Call. My name is Elliot and I'll be coordinating your call today. If you'd like to register a question during today's event, please press star followed by one on your telephone keypad. And I'd like to hand over to Jeff Duhl, CEO. The floor is yours. Please go ahead.

Thank you, Elliot. 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 Henson, Chief Financial Officer, Brian McDonald, President and Chief Operating Officer, and Tony Chalfant, Chief Credit Officer. Our second quarter earnings release went out this morning pre-market, and hopefully you have had the opportunity to review it prior to the call. We have also posted an updated second quarter investor presentation on the investor relations portion of our corporate website, which includes more detail on our deposits, loan portfolios, liquidity and credit quality. We will reference this presentation during the call. Please refer to the forward-looking statements in the press release. We're very pleased to report another solid quarter with EPS in line with consensus. We continue to see pressure on deposit pricing in Q2, and we expect that to continue for the balance of the year. Deposit movement in Q2 was primarily tied to normal flows, including capital purchases, with a lesser portion tied to alternative investments. FDIC insurance-related concerns have substantially subsided. We reported solid organic loan growth of 3% for the quarter as we focus on supporting our existing customers and pursuing new relationships with a primary focus on C&I. We are pleased with the positive trend of new commitments and new loan closings from our existing production teams and the newer teams added over the past year. We continue to manage expenses carefully, although we also continue to experience the impacts of inflation, mostly on compensation costs. 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 strong credit metrics and provides a good foundation as credit quality returns to more historical levels. We'll now move on to Don, who will take a few minutes to cover our financial results.

Thank you, Jeff. I will be reviewing some of the main drivers of our performance for Q2 as I walk through our financial results, unless otherwise noted, all the prior period comparisons will be with the first quarter of 2023. Starting with net interest income, we experienced a decrease of $4 million or 6.7% in Q2, due mostly to an increase of $7.4 million in interest expense. This increase in interest expense resulted from a combination of an increase in our cost of interest-bearing deposits and an increased use of borrowings during the quarter. This was the main driver for the 35 basis point decrease in our net interest margin in Q2. As mentioned earlier, we had a solid loan growth of $124 million, or 3% in Q2, In addition, yields on the loan portfolio were 5.19% for the quarter, which was 12 basis points higher than Q1 and contributed to an 11 basis points increase in yield on earning assets. Brian McDonald will have an update on loan production and yields in a few minutes. Our cost of interest-bearing deposits increased 43 basis points to 0.92% for Q2. We continue to experience market pressure related to deposit rates. 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, although at a slower pace than in Q2. The continued but slowing increase in this cost is illustrated by the cost of end-spring deposits being 1% for the month of June with a spot rate of 1.04% as of June 30. Overall, we experienced a decline in deposit balances of 3.3% for the quarter. The decline occurred primarily in April, which is a month that typically experiences decreases in deposit balances due to tax payments. Deposit balances were relatively flat during the last two months of the quarter. Brian will discuss our deposit pipeline later in the presentation. Our insured deposits were at 67% of total deposits at June 30 compared to 65% at March 31. Also, for customers seeking additional FDIC insurance, we offer deposit products, which have full FDIC insurance. On balance sheet, deposit totals for these accounts were $219 million at the end of Q2. In order to supplement our funding, we borrowed $450 million from the Federal Reserve's Bank Term Funding Program, or BTFP, and paid off existing FHLV advances. We utilize the BTFP due to the lower cost and fixed rate nature of the notes, as well as the option to prepay barrings at any time. The blended rate on the BTFP advances was 4.72% in Q2 compared to an average cost of 5.15% for the FHV advances for the quarter. You can refer to pages 38 and 39 of the investor presentation for more specifics on our barrings and liquidity position. As I previously mentioned, we experienced a sizable decrease in NIM to 3.56% for Q2 from 3.91% in the prior quarter. We expect NIM to decrease further in Q3, although not as significantly. This can be illustrated by a NIM of 3.54% for the month of June, which is only two basis points lower than for the entire second quarter. The pace and duration of our decrease in margin will be highly dependent on continued increases in our cost of spring deposits, as well as maintaining deposit balances. As our cost deposits as well as deposit balances level off, we expect to experience margin stabilization due to the repricing of adjustable rate loans in addition to high origination rates on new loans. Moving on to capital, all of our regulatory capital ratios remain comfortably above well-capitalized thresholds, and our TCE ratio is at 8.3% unchanged from the prior quarter. In addition, with a loan deposit ratio of 76%, we have plenty of liquidity to continue to grow our loan portfolio. Non-interest income decreased from the prior quarter, primarily due to a $1.6 million one-time gain on the sale of Class B Visa stock, which occurred in Q1. Non-interest expense decreased $280,000 to $41.3 million in Q2. This was due mostly to a decrease in the accrual for incentive-based compensation resulting from lower expected earnings this year. Looking ahead, we expect non-interest expense to be in the low $42 million range for Q3. The effective tax rate decreased to 15.2% in Q2 from 17.1% in Q1 in order to adjust the year-to-date effective tax rate to the current estimated rate for 2023, which is now at 16.3%. And finally, moving on to the allowance, even though we continue to show strong credit quality metrics, We recognize provision for credit losses of 1.9 million during the quarter, due mostly to increases in loan balances. I will now pass the call to Tony, who will have an update on these credit quality metrics.