Heritage Financial Corporation

Thank you all for joining. I would like to welcome you all to the Heritage Financial Corporation Q3 2023 Earnings Conference Call. My name is Brica and I'll be your moderator for today's call. All lines are on mute for the presentation portion of the call, with an opportunity for questions and answers at the end. If you would like to ask a question at this time, please press star followed by the number one on your touch phone keypad. I would now like to pass the conference over to your host, Jeff Jewell, CEO of Heritage Financial, to begin. So, Jeff, please go ahead.

Thank you, Brika. Welcome and good morning to everyone who called in. And for those who may listen later, this is Jeff Jewell, CEO of Heritage Financial. Attending with me are Brian McDonald, President and Chief Operating Officer, Don Henson, Chief Financial Officer, and Tony Chalfant, Chief Credit Officer. Our third 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 third quarter investor presentation on the investor relations portion of our corporate website, which includes more detail on our deposits, loan portfolio, liquidity, and credit quality. We will reference the presentation during the call. Please refer to the forward-looking statements in the press release. We're pleased to report another solid quarter with earnings per share exceeding consensus. This quarter's performance was enhanced by loan recoveries. These recoveries are further evidence of our strong risk management practices and how they continue to benefit us. We continue to see pressure on deposit pricing in Q3, which is impacting our net interest margin. Deposit balance is stabilized in Q3, although the mix of deposits continue to partially shift into higher rate products. As expected, due mostly to the rate environment, loan growth slowed in Q3 compared to the first two quarters of the year. Although year-to-date, we are still reporting low single-digit loan growth. Overall, we continue to focus on growing a strong balance sheet with ample liquidity and capital that will serve us well present and in the future. We will now move to Don, who will take a few minutes to cover our financial results.

Thank you, Jeff. I'll be reviewing some of the main drivers of our performance for Q3. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the second quarter of 2023. Starting with the balance sheet, loan growth slowed in Q3, increasing 15.5 million for the quarter. Year-to-date loan growth through Q3 is at 5.3%. Yields on the loan portfolio were 5.30 for the quarter, which was 11 basis points higher than Q2 and contributed to a 12 basis point increase in yield on earning assets. Brian McDonald will have an update on loan production and yields in a few minutes. Unlike the declines over the past few quarters, total deposits increased $39.6 million during the quarter. The increase is due substantially to higher CD balances as customers continue to take advantage of the higher rate environment by lowering their excess balances and lower paying non-maturity deposits. accounts. These factors contributed to an increase of 31 basis points in our cost of interest bearing deposits to 1.23% for Q3. Also impacting total deposit balances in Q3 was the sale of our Ellensburg branch, along with its 14.7 million of deposits, as well as an increase of 62.8 million in brokered CDs during the quarter. Due to the current market pressure related to deposit rates, we expect to continue to experience an increase in the cost of our core deposits, although at a slower pace. This is illustrated by the cost of our interest-bearing deposits being 1.35% for the month of September with a spot rate of 1.38% as of September 30th. Investment balances decreased $136 million during Q3 due to higher-than-normal maturities and prepayments during the quarter, as well as the sale of 47 million of securities. These sales, in combination with the purchase of 23 million of higher-earning securities, was done to partially restructure the portfolio while also increasing our cash position. A loss of 1.9 million was recognized on these sales in Q3, most of which occurred in September. It is estimated that the annualized income improvement from these transactions will be 1.4 million, resulting in an earn-back period of 1.4 years. we will consider additional loss trades in order to continue to defend our margin from downward pressures. Moving on to the income statement, net interest income decreased $206,000 due to a decrease in the net interest margin partially offset by an increase in average earning assets. The NIM decreased to 3.47% for Q3 from 3.56% in the prior quarter. The decrease in NIM was primarily due to the cost of interest-bearing deposits increasing more rapidly than the yields on earning assets. We expect NEM to decrease further in Q4 since the NEM for the month of September was five basis points lower than it was for the quarter. The pace and duration of our decrease in margin will be highly dependent on continued increases in our cost of interest-bearing deposits as well as maintaining deposit balances. As our cost deposits as well as deposit balances level off, we expect to experience margin stabilization through the repricing of adjustable rate loans in addition to higher origination rates on new loans. We recognize a reversal of provision for credit losses in the amount of $878,000 during Q3 versus a provision expense of $1.9 million in Q2. The reversal of provision expense was due to net recoveries of $1.2 million recognized during the quarter. Tony will provide more information on these recoveries in a few minutes. Noninterest income decreased $1 million from the prior quarter, primarily due to the loss on the sale of securities previously mentioned, partially offset by a gain of $610,000 on the sale of our Ellensburg branch that I discussed earlier. Noninterest expense decreased $355,000 to approximately $41 million in Q3. This was due to decreases in numerous categories, partially offset by an increase in compensation and benefits. Compensation and expense was higher compared to Q2 due to the adjustments we made to the accrual for incentive-based compensation in Q2. All of our regulatory capital ratios remain comfortably above well-capitalized thresholds, and our TCE ratio is at 8.2%, down slightly from the prior quarter due primarily to AOCI. In addition, with a loan deposit ratio of approximately 76%, and cash balances over $200 million, we have plenty of liquidity to continue to grow our loan portfolio. I will now pass the call to Tony, who will have an update on our credit quality metrics.