Heritage Financial Corporation

Hello all and welcome to Heritage Financial Corporation's first quarter 2024 earnings call. My name is Lydia and I'll be your operator today. If you'd like to ask a question after the prepared remarks, you can do so by pressing star followed by one on your telephone keypad. I'll now hand you over to Jeff Duhl to begin. Please go ahead.

Thank you, Lydia. 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 Brian McDonald, President and Chief Operating Officer, Don Henson, Chief Financial Officer, and Tony Chalfant, Chief Credit Officer. Our first 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 first quarter investor presentation on the investor relations portion of our corporate website, which includes more detail on deposits, loan portfolio, liquidity, and credit quality. We will reference this presentation during the call. Please refer to the forward-looking statements in the press release. Although there was some noise in the quarter, we're pleased to report solid core performance, including active balance sheet management and expense management activities to reduce non-interest expense. We continue to see pressure on deposit pricing in Q1, and we expect to see that continue for the near term. Deposit balances declined modestly in Q1, and the mix of deposits continues to partially shift to higher rate products. Loan growth was strong in Q1, running at an 8.4% annualized rate. Credit quality remains strong, resulting from our long-term practice of actively managing the loan portfolio. 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 while we focus on growing loans and deposits. We'll now move to Don Hinson, who will take a few minutes to cover our financial results.

Don Hinson Thank you, Jeff. I will be reviewing some of the main drivers of our performance for Q1. As I walk through our financial results, unless otherwise noted, all the prior period comparisons will be with the fourth quarter of 2023. I want to start by covering some actions that significantly impacted earnings for Q1 and are expected to help protect future earnings. First, we repositioned a portion of our investment portfolio, which resulted in a pre-tax loss of $10 million during Q1, which is similar to the loss recognized in Q4. We sold 144 million of securities with a weighted average yield of 2.37% and purchased 33 million of securities yielding 6.05%. Including the yield on cash not reinvested at quarter end, we are expecting an annualized net interest income pickup of about $4.6 million from these transactions, resulting in an earn-back period of approximately two and a half years. Unlike the trading Q4, where we reinvested substantially all of the proceeds, we intend to use a portion of this quarter's proceeds for other cash needs, such as the BTFP debt that matures in early May. Second, we incurred certain costs related to expense management measures in order to lower expenses in future periods. For Q1, these primarily included severance costs of $1.1 million due to reduction in staffing levels, which we mentioned during our previous earnings call in January. These costs in aggregate with expense management costs occurred in Q4 are expected to improve the annualized expense run rate by $5.3 million. Please see page six of the investor presentation for more information on these actions. Moving on to the balance sheet, loan growth was strong in Q1, as mentioned by Jeff, increasing $92.5 million for the quarter. Most of this growth occurred in the latter portion of the quarter, and the benefits won't be fully realized until Q2. Yields in the loan portfolio were 5.41% for the quarter, which was six basis points higher than Q4. Brian McDonald will have an update on loan production and yields in a few minutes. Total deposits decreased 67.5 million during the quarter. This was due to a decrease of 154 million in non-maturity deposits, approximately half of which was due to declines in non-interest-bearing deposits, partially offset by an increase of 87 million in CD balances. Customers continued to take advantage of the higher-rate environment by lowering their excess balances and lower-paying non-maturity deposit accounts. These factors contributed to an increase of 22 basis points in our cost-of-interest-bearing deposits to 1.70 percent for Q1. Due to the current market pressure-related deposit rates, we expect to continue to experience an increase in the cost of our core deposits. This is illustrated by the cost of interest-bearing deposits being 1.78 percent for the month of March, with a spot rate of 1.80 percent as of March 31. Investment balances decreased 143 million during Q1, mostly due to the lost trade previously discussed, The security trades occurred in March, therefore the benefits of the lost trade was not fully realized in Q1. Even without full realization of the lost trade benefit, the yield on the securities portfolio increased 15 basis points from the prior quarter to 3.30% for Q1. Moving on to the income statement, net interest income decreased 2.3 million from the prior quarter due to a decrease in both the net interest margin and average earning assets. The net interest margin decreased to 3.32% for Q1 from 3.41% in the prior quarter. This decrease was primarily due to the cost of interest-bearing deposits increasing more rapidly than yields on earning assets. Although the impact of the loss trade will partially mitigate other factors, 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 of deposits as well as the deposit balances level off, we expect to experience margin stabilization due to the repricing of adjustable rate loans in addition to higher origination rates on new loans. We recognized provision for credit losses in the amount of 1.4 million during Q1, which is similar to the provision expense in Q4. The provision expense was due substantially to loan growth experience during the quarter. Non-interest expense decreased in the prior quarter due to lower FTE levels and lower costs related to contract renegotiations, partially offset by higher severance costs. Average FTE was 765 in Q1, compared to 803 in Q4, a reduction of 38 FTE. As was communicated in the last earnings call, we expect the expense run rate to be between 40 and 41 million for the remainder of the year. All of our regulatory capital ratios remain comfortably above well-capitalized thresholds, and our TCA ratio remained at 8.8%. Our strong capital ratios have allowed us to be active in lost trades, on investments, and in stock buybacks. During Q1, we repurchased approximately 330,000 shares at a weighted average cost of $18.56, or 107% of March 31 tangible book value per share. As we announced in the earnings release, the Board has approved a new share repurchase plan in the amount of 5% of outstanding stock, which equates to 1.7 million shares. As we have done in the past, we will use the share repurchase plan to manage our capital levels. I will now pass the call to Tony, who will have an update on our credit quality metrics.