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Edited Transcript of HFWA earnings conference call or presentation 26-Apr-17 5:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Heritage Financial Corp Earnings Call

Olympia Apr 27, 2017 (Thomson StreetEvents) -- Edited Transcript of Heritage Financial Corp earnings conference call or presentation Wednesday, April 26, 2017 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian L. Vance

Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank

* Bryan D. McDonald

Washington Banking Co. - CEO of Whidbey Island Bank and President of Whidbey Island Bank

* Donald J. Hinson

Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank

* Jeffrey J. Deuel

Heritage Financial Corporation - EVP, President of Heritage Bank and COO - Heritage Bank

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Conference Call Participants

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* Jacquelynne Chimera Bohlen

Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research

* Jeffrey Allen Rulis

D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst

* Matthew Timothy Clark

Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst

* Timothy Norton Coffey

FIG Partners, LLC, Research Division - VP and Research Analyst

* Timothy O'Brien

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the Heritage Financial First Quarter Earnings Call. (Operator Instructions) Also as a reminder, today's teleconference is being recorded.

And at this time, I'll turn the conference over to your host, CEO, Mr. Brian Vance. Please go ahead, sir.

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [2]

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Thank you, Tony, appreciate it. I'd like to welcome everybody to our first quarter earnings conference call this morning and also to those that may listen in later in recorded mode. Attending with me this morning is: Don Hinson, our CFO; Jeff Deuel, our President and COO; and Bryan McDonald, our Chief Lending Officer.

Our earnings press release went out earlier this morning in a premarket release. And hopefully, you had an opportunity to review the release prior to this call. And as always, I would refer all of you to our forward-looking statements in the press release and also would refer you to the forward-looking statements as we enter into a Q&A period later on this call.

I'd like to just highlight our first quarter results. Diluted earnings per common share were $0.31 for Q1 compared to $0.30 for Q1 of '16 and $0.33 for linked-quarter Q4 of '16. We declared a regular cash dividend of 13% per common -- $0.13 per common share, an increase of 8.3% from $0.12 for the cash dividend paid in Q1 of 2017. Return on average assets was 0.97% and return on average tangible common equity was 10.51% for Q1 of '17. Net interest margin, excluding incremental accretion on purchased loans, increased to 3.75% for Q1 from 3.68% for Q1 of '16.

At this point, I'd like to turn the call over to Don Hinson to take a few minutes and cover some of the highlights of our financial statements. Don?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [3]

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Thanks, Brian. I'll start on the balance sheet. We had muted balance sheet growth in Q1, which is not uncommon for the first quarter of the year. Loans grew $22.4 million or at an annualized rate of 3.5% in Q1. However, over the trailing 12 months, loans have grown 8.3%. Total deposits grew $13.7 million or 1.7% annualized in Q1. Non-maturity deposits grew $27.1 million or 3.8% annualized. During Q1, the percentage of non-maturity deposits to total deposits increased to 89.4% from 88.9% at the prior quarter-end due partly to a decrease in CD balances.

Moving on to credit quality. We saw a continued overall improvement in credit quality of the loan portfolio. Potential problem loans decreased $4.9 million or 5.6% during Q1. Nonperforming loans remained relatively unchanged to $10.9 million or 0.41% of total loans. The ratio of our allowance for loan losses to nonperforming loans stands at a very healthy 290%. In addition, included in the carrying value of the loans are $12.6 million of purchase accounting net discounts, which may reduce the needs of an allowance for loan losses on those related purchased loans. Net charge-offs for the quarter were 0.05%, which is unchanged from Q4 2016 and 15 basis points better than 0.20% in Q1 of 2016.

Our net interest margin for Q1 was 3.89%. This is a 4 basis point increase from 3.85% in Q4 2016. Pre-accretion net interest margin increased 7 basis points to 3.75% for Q1 from 3.68% in Q4 of '16. The increase in pre-accretion net interest margin was mostly due to increases in pre-accretion loan yields as well as increases in yields on the investment portfolio. Pre-accretion loan yields increased due to the repricing of our floating rate loans and higher rates on newly originated loans due to the increase in market rates from the prior quarter.

New loans for Q1 were originated at a weighted average rate of 4.40%, a significant increase from 4.08% in Q4 2016. This is the highest quarterly average rate of originated loans since Q3 of 2014. Noninterest income decreased 835 -- $837,000 from the prior quarter due to lower gains on sale of loans and investments as well as lower interest rate swap fees. Of the $1.2 million in loan sale gains recognized in Q1, $909,000 related to mortgage loan sales and $286,000 related to SBA loan sales. Service charges increased $341,000 or 8.3% from Q4 2016 and increased $857,000 or 25.5% from Q1 2016. These increases were due mostly to the recent impacts of the deposit account consolidation process we have previously discussed.

Noninterest expense for Q1 was $27.2 million, an increase of $414,000 from Q4 2016. The increase was due mostly to an increase of $271,000 in compensation benefits. This increase was due primarily to increases in payroll taxes and insurance from the prior quarter. Although total noninterest expense to average assets increased to 2.85% in Q1 from 2.78% in Q4 2016, it has decreased from 2.91% in Q1 2016, which is a 6 basis point improvement year-over-year.

Bryan McDonald will now have an update on loan production.

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Bryan D. McDonald, Washington Banking Co. - CEO of Whidbey Island Bank and President of Whidbey Island Bank [4]

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Thanks, Don. I'm going to provide detail on our first quarter lending results by production area, starting with our commercial lending group. In the first quarter, commercial teams closed $121 million of new loans, which is down from $153 million closed in the fourth quarter of 2016 and $151 million closed in the first quarter of 2016. Commercial team pipelines ended the first quarter at $362.6 million, which was up from $296.5 million at the end of 2016 and $310.3 million at the end of the first quarter of 2016.

The lower first quarter new commercial loan closings were the result of 2 primary factors. First, we had a number of loans that have been delayed in closing, which can be seen in the loan pipeline increasing $66 million during the quarter. In addition, we continue to see an elevated number of investor real estate permanent and construction loan opportunities, but with increasing concentration levels in these categories are passing on more of these opportunities than last year. Line utilization was 36.4% at the end of the first quarter and is relatively unchanged from 35.6% at the end of 2016.

Moving on to interest rates. Average first quarter interest rate for new commercial loans was 4.35% as compared to 4.01% during the fourth quarter. And as Don mentioned, the average fourth quarter rate for total loans was 4.4%. SBA 7(a) production in the first quarter totaled 11 loans for $5.4 million and the pipeline ended the quarter at $14.8 million. This compares to the fourth quarter of 2016, when we closed 17 loans for $14.8 million and the pipeline ended at $14 million.

Consumer production during the quarter was $35.5 million, which is down from $43.7 million in the fourth quarter of 2016. Branch retail loan volume comprised $10.7 million of the quarter's volume, which was down $3.3 million from the 2016 quarterly average. And indirect loan volume was $24.8 million during the quarter, which was down $4 million from the 2016 quarterly average. The decline in retail branch volume was due to a 6% decline in applications at a lower average loan size. The decline in indirect loan volumes was the result of the bank taking measures to slow production to manage the loan concentration limits.

The mortgage department closed $33.3 million of new loans during the first quarter compared to $53.9 million in new loans during the fourth quarter of 2016 and $29.6 million in the first quarter of 2016. The mortgage pipeline ended the third quarter at $22.6 million, down from $34.3 million at the end of 2016 and $41.1 million at the end of the first quarter of 2016. Current pipeline is comprised of 42% refinanced loans, 37% purchased loans and 21% construction loans. This compares to last quarter's pipeline where refinanced business averaged 59%.

I'll now turn the call back to Brian for an update on capital management as well as some closing comments.

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [5]

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Thanks, Bryan. I'll start with capital management. As noted earlier, we have increased our regular quarterly dividend of $0.12 to $0.13. And this is our fourth consecutive year in which we have increased our regular quarterly dividend. We continue to believe our capital position sufficiently supports our balance sheet risk, our internal growth and potential future growth, both organic and M&A.

Just some comments on the outlook for the balance of 2017. We continue to be optimistic about the overall economy of the Puget Sound region for the balance of '17 and for our continuing growth. Commercial real estate construction continues to be robust in the area and we remain disciplined in monitoring our commercial real estate loan production concentration risk. In Bryan McDonald's comments earlier, he indicated concentration issues were at least a partial reason for a slower growth in Q1. You will recall in our discussions in our last earnings conference call that we mentioned potential downside risk to our 2017 loan growth could possibly be related to managing our concentration guidelines.

While we remain comfortably under regulatory CRE concentration guidelines at approximately 250% of capital, we are mindful that a higher percentage of our growth this past year has come from CRE lending, so loan concentration risk management continues to be an important risk management tool for us going forward. While loan growth in Q1 was slower than we would have liked, we are encouraged by a stronger-than-normal loan pipeline at this point. We remain optimistic about loan growth potential for 2017.

We have announced the consolidation -- previously announced the consolidation of 4 branches, which will be completed April 28. This brings our total branch consolidations to 17 since January of 2010. While we were pleased to note the increase in our non-accretive net interest margin and 1 quarter does not necessarily create a trend, we are encouraged with increasing note rates in general while our total cost of interest-bearing deposits remains the same on a year-over-year comparison. As I indicated last call, we expect our M&A activity in the smaller, less than $1 billion range to increase this year. And we expect to be active in that arena.

That concludes our prepared remarks. And I'll turn the call back to Tony to open up for a Q&A period. And I would also again remind you to keep in mind our forward-looking statements as we respond to any questions you may have. Tony?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question we'll take will come from Jeff Rulis with D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [2]

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Just following up on the margin, I get the sense that the loan yield increases are more a product of new production rather than maybe repricing in the portfolio. Is that safe to say?

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [3]

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I would invite Don and Bryan to comment on this as well. I think it's probably both. Production is -- rates on new production is up as a result of just rates being up in general. But we're also getting some benefit of reprices in the portfolio. I would caution folks -- and we're optimistic about the NIM increase in Q1, but we also see interest rates moving. They dropped, and now they're coming back again, whether you'd be looking on the low end or the 5-year, I think that rates are going to continue to move as they always do. But we are cautiously optimistic in terms of rates in general. Don, Bryan, any additional comments?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [4]

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Yes, I would say it's a combination. We saw the rates increase on the -- or prime increased both at the end of last year and, of course, we had one in March, which probably did not have that much of an impact on the quarter. But in addition, we continue to see LIBOR increase -- have increased over the last quarter. But as you see, we're also again making loans at higher rates. But again, the dollar amount of loans we make are going to move the needle a little bit on the overall portfolio but not significantly. I think it is encouraging when we look at our -- when I looked at our note rates, kind of overall contractual rates on the portfolio, over the last few quarters. And this is the first quarter -- if you look at the contractual rates actually ticked up just slightly as opposed to going down quarter-over-quarter. And it's not the yield on them but actually the contractual rates, current contractual rates at quarter-end. So that was encouraging to see. And of course, whether this will continue depend on the overall rate environment. And if the rate environment stays where it was in Q1, then that can be encouraging going forward.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [5]

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Sure, lots of variables, I guess. Put in another way, I guess, is there a potential for the core margin strength to keep pace with any kind of decline in incremental accretion, I guess, in the reported margin? Then does that -- is there a potential that exists that, that sort of maintains at these levels?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [6]

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Well, I think our accretion won't fluctuate tremendously unless we have some really unexpected large payouts. So I think you have that number in there. I think that the nice thing is that hopefully the growth will be more than offsetting that. But again, I think that if we stay in this rate environment, then there's lots of variables there, we can hold that margin.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [7]

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Got it, okay. And then just on the expenses and the outlook, obviously a little seasonal bump. But for the balance of the year, anything coming online? You've had the branch consolidations. And I don't know if the impact is fully embedded or if there's actually a near-term bump. But maybe just expectation of kind of $27.2 million this quarter, I think you kind of tried to maintain that through the balance of last year. Anything different maybe through '17 that would be changing versus what we've seen?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [8]

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Well, I don't believe there's going to be a lot of change. I think that there's a kind of offsetting. In the first quarter, we tend to have higher payroll taxes because the bonuses are paid in the first quarter. At the same time, because we tend to give a lot of increases at the end of the first quarter, a lot of those impacts won't be seen until it's Q2. So I think there's some offsetting there. I think overall, we're going to see pretty steady. Again with the full branch consolidations, I think that we're going to see some benefit in Q3 and 4 this year. I think Q2 will kind of the exit costs of the branches will offset any savings in Q2.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [9]

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Fair enough. And then Don, just a last one on the tax rate. Maybe a little lower in Q1. And well, I guess what would you expect for the last 3 quarters?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [10]

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Well, I think the overall, I would say, core tax rate is still going to be around 26%. I don't know if how much you're aware of the new accounting pronouncement on stock that impacted our effective tax rate this quarter. But that could happen possibly, to a lesser extent, in Q2 but not as much as it was in Q1. I think overall, when you start getting in Q3 and 4, it will probably be back more to 26%.

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Operator [11]

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(Operator Instructions) Next in queue is Matthew Clark with Piper Jaffray.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [12]

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On the expense front, it sounds like maintaining that run rate still gets you to about a 2% growth rate in expenses, I think, that you had guided to last quarter. Is that still fair for the year?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [13]

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Yes, that's still what we're looking at.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [14]

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Okay. And then on the loan growth side of things, Brian, you sound optimistic. Pipeline is up, but yet being a little bit more selective on the commercial real estate side. Is that 6% to 8% still seem doable for the year?

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [15]

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I think so, Matthew. The variables that we talk about, and you mentioned loan concentration risk that I'll just reiterate for everyone's benefit, that we're serious about that. And if we go back to the last turndown in the economy, it was the concentration risk that caused everybody a lot of problems, not so much us because we had the discipline and we'll continue to have that discipline. I think the other piece that I've talked about and remains a variable is the prepayment activity, and I'll ask Bryan to comment to that. That's always an unknown and a variable. We tend to be a little light on first quarter, just seasonality. Our pipeline is up. So yes, I feel fairly optimistic. And Bryan, other additional thoughts?

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Bryan D. McDonald, Washington Banking Co. - CEO of Whidbey Island Bank and President of Whidbey Island Bank [16]

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The pipeline is strong going into the second quarter. Really, anything over that $300 million number is -- we consider quite strong. The prepays in Q1 were -- in total were about $60 million, which is not -- we see a lot of variety, as Brian Vance just commented. But that's been anywhere from $55 million to $75 million the last 4 quarters, so it's kind of the right in the middle. We also have decreased our indirect volume. Last year, we had about a 27% growth rate and (inaudible) about a 7.5% growth rate. Year-to-date, again just moderating the portfolio growth related to our concentration limits, we are working very hard on the direct side of the consumer business and increasing our focus on that. We see lots of opportunity there to make up that volume. So Brian Vance also commented just on the economic environment of the Northwest and that continues to be quite strong. We continue to get some nice new opportunities in our existing customer base, continues to look for growth opportunities and putting expansion on equipment. So we haven't seen a change in our customer sentiment of, yes, that was the pipeline. It's just a matter of keeping the mix and balance.

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [17]

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And I would add to that, just to clarify for everyone's benefit. Our decision to back off on the indirect volume was totally and exclusively focused on concentration, had nothing to do with quality. Quality of that portfolio continues to perform very well. And I would even say exceeding our expectations. So that would -- that did not factor into our decision to ratchet back the growth rates in that category.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [18]

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Okay, great. And then just getting back to the margin and thinking about a couple items that may have impacted it. I mean, could you maybe quantify the prepayment fees this quarter and last? And also without premium amortization as well, what it was this quarter versus last?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [19]

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Premium amortization. Yes, I don't have those off the top of my head. I think -- are you talking about the investment portfolio on premium amortization?

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [20]

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Yes.

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [21]

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Okay. Last quarter, I did mention that we did have some unusually high premium amortizations in Q4 of last year. And so that's one reason it increased so much. If you can go back to maybe Q3 of last year, you would see we were moving up, and then all of a sudden, it dropped in Q4 on the investment portfolio. I would say where we're at now is more in line with what I would expect going forward on the investment portfolio. On the prepayments, I don't think we had any unusual prepayments in any quarter, the last couple of quarters related to loans.

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Operator [22]

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Our next question will come from Tim Coffey with FIG Partners.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP and Research Analyst [23]

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Brian, I was wondering if you could give me a little color on the $2 million increase in non-accruals.

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [24]

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Yes, I don't have that right at my fingertips. Don, Jeff, do you have that? Obviously, there's a lot of in and outs to the non-accruals. And do we have the addition and subtraction data? While Don is looking that up, we'll come back to you on that. Did you have a second question?

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP and Research Analyst [25]

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Sure. Kind of along the same lines, as rates start moving up and you look at some of the borrowers in your footprint, do you think -- how much do you think they're going to be susceptible to higher rates in terms of the quality, their ability to service their debt?

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [26]

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I don't see that as an issue in the short run. Obviously, increasing rates change debt service coverage ratios, those sorts of things. We do an annual stress analysis to our CRE portfolio. And that's typically done in the fourth quarter. We did not see any deterioration, any concerns over that. I think that if rates were to rise sharply, that's something we'd probably have a bit more concern and analyze it more. I don't believe that will happen. The Fed had said there will 3 increases this year. I don't believe we'll see 3 increases. That's just a personal opinion. So it's something that we monitor very closely, not only on existing portfolio but new portfolio. But we're not seeing any weaknesses within existing portfolio.

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [27]

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Yes. Tim, I guess, I'm looking at the earnings -- you caught me offguard there. Our non-accruals actually went down slightly quarter-over-quarter.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP and Research Analyst [28]

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Okay. I'll have to go back and read the press release. I thought it said there was an increase in -- there was a $2 million new non-accruals.

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [29]

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Well, yes, we have non-accruals come in and out. But overall, the overall balances did not increase. So that's just -- again, they came in about -- again, a little over $2 million probably came in. Again, nothing unusual there. I think there are about 6 different loans, so it's nothing big on that. But that's kind of standard quarter-over-quarter that we'll see some come out and some come back in.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP and Research Analyst [30]

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Great. Yes, and that was really what I was looking for, that kind of commentary right there. And then as you look at kind of the construction loans in the quarter, were those kind of -- did those come from existing clients? Or have you made a big push to market to new clients in that product area?

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Bryan D. McDonald, Washington Banking Co. - CEO of Whidbey Island Bank and President of Whidbey Island Bank [31]

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Tim, this is Bryan. It's a mix. We've got some new clients and many existing clients in that mix. And if you look at the -- just the balance detail quarter-over-quarter and looking back to Q1 of '16, many of these projects are multiyear projects. We're also doing more low-income housing projects. And those in particular have a pretty long construction period. So the balance fluctuation is more a result of the increase in bookings over the last couple of years. Last year, in particular, but just growing commitments as the activity has gone up.

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Operator [32]

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Our next question will come from Tim O'Brien with Sandler O'Neill.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [33]

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Great. $4.2 million in service charges on deposit accounts. So is that a good baseline here going forward with what you've got, a reflection on the consolidation that you described that took place? And was there anything one-time in that also, some sort of catch-up or I don't know, whatever? Or is that kind of -- because typically, first quarters are -- that number is down a little bit. And obviously, that's not the case this quarter.

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Jeffrey J. Deuel, Heritage Financial Corporation - EVP, President of Heritage Bank and COO - Heritage Bank [34]

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Tim, this is Jeff. Last time, we talked about the deposit rationalization project that we started last fall. And we believe we're seeing the benefits of that undertaking now. I think it will continue to come across over the next month or so. We're still working through the notifications to customers, which is triggering them to take action one way or the other it. And the ultimate -- the other thing that's going on is we're not only generating probably more service charges on the lower balance, less active accounts, but we're also going to get kind of an ancillary benefit from the standpoint that if we have accounts runoff because they are inactive, it's less costly for us from a systems standpoint to maintain them. And what the rationalization process did, too, was it steered customers to paperless statements, which doesn't sound significant. But when you look at industry metrics, a paper statement mailed costs us close to $4 and paperless is like $0.19. So there's a huge benefit behind the scenes, too.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [35]

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$4, that's remarkable. So carrying that -- this process, this rationalization and consolidation, what-have-you process in that part of your business, did that also affect loan balance -- I mean, deposit balances this quarter?

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Jeffrey J. Deuel, Heritage Financial Corporation - EVP, President of Heritage Bank and COO - Heritage Bank [36]

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Not necessarily. What we project -- we always project loan runoff when we -- deposit runoff when we take an action like that. But in our case, we saw a larger trend on the number of accounts closed but not a very significant trend in the deposits related to the balances that were impacted.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [37]

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So as a line item, as a fee item, there's a little bit -- it's a little bit in a state of flux still as far as how your depositors react and adjust, I guess. Is that fair to say here in the second and third quarter?

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Jeffrey J. Deuel, Heritage Financial Corporation - EVP, President of Heritage Bank and COO - Heritage Bank [38]

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It is. And what makes it complicated is people don't oftentimes read their mail. So when we send mail, the first time, they might have missed it, some people got it, and then we send -- then we start the actual changing of the fees, and then they start seeing the fee or the charge for the statement show up on subsequent -- they see it in their account. And it triggers activity over a period of time as customers realize what we're doing and are making decisions about what they actually want.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [39]

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I'll admit I'm guilty of walking in those shoes in the past, but...

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Jeffrey J. Deuel, Heritage Financial Corporation - EVP, President of Heritage Bank and COO - Heritage Bank [40]

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Yes, that's why we're trying to get more connected online with our customers, so we can communicate that way more so than through the mail.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [41]

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Great. Most of my other questions were answered. One other question I have for you is what did [AG] balances do? I mean, typically there's some seasonal payoff to that effect, your net growth numbers for the quarter.

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Bryan D. McDonald, Washington Banking Co. - CEO of Whidbey Island Bank and President of Whidbey Island Bank [42]

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Tim, this is Bryan. I don't have those in front of me. But it really starts kind of in the -- during the late third quarter through the fourth quarter, and then we do see runoff through the first quarter. And that was a portion of that payoff activity during the quarter, which was really pretty consistent with the range of prior quarters. So there definitely was an impact in both the fourth quarter and the first quarter. But I don't have that number in front of me here.

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Operator [43]

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(Operator Instructions) Next in queue is Jackie Bohlen with KBW.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [44]

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Brian, were there any repurchases in the quarter?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [45]

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No, there were not. I guess, Jackie, let me -- there were only repurchases related to restricted stock award vestings that are for tax purposes but no on-the-market repurchases.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [46]

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Okay. And I mean, obviously shares have all come up since the election and everything. How are you thinking about that now versus how you were thinking about it in January? Has there been any change at all?

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [47]

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In terms of repurchase, potential repurchase activity?

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [48]

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Yes.

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [49]

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Yes, I don't think our position has changed. At these levels, it's not likely that we would be in the repurchase market.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [50]

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Okay, makes sense. And Brian, you mentioned in your prepared remarks your continued optimism in terms of M&A. Can you just provide us with an update maybe on how conversations are going, just your thoughts on it and any other color you have?

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [51]

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Sure. Well, as consistent with maybe comments that I made in the last call, last conference call and this one, we're seeing increased activity in that, I'll say, the smaller banks, the less than $1 billion or even I would say -- go as far as to say less than $500 million. And I think in our case that if there is an opportunity of less than $500 million, it's something that we would be certainly interested in from the standpoint that you do a couple of deals less than $500 million and that changes the needle one by itself, will have an impact. But we do a couple of them and it begins to have a more meaningful impact. So I think that we're going to see some activity in that less than $500 million area. I think that these smaller banks are seeing what the general bank environment is enjoying those of us that are publicly traded is that we've seen a substantial lift in valuations over -- since the election. And I think the smaller banks are looking at that. But they're not seeing their ability to pass on increased regulatory costs in the scale, et cetera. And I think there is a willingness maybe to have some discussions. So we're seeing an increased level of discussion. Increased levels of discussion don't always equate into deals being done. I will tell you that we have looked at and have been active on a lot of different opportunities over the last, I'll say, 12 to 18 months. And for a variety of reasons, some of those opportunities have not worked for us. I think that we remain very disciplined on cultural mesh. In other words, similarities in culture are important to us. Geographic opportunities are important to us. And so we'll remain disciplined. But at the same time, I'm probably more optimistic today than I have been for sometime in terms of opportunities in that smaller bank acquisition opportunity.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [52]

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Okay. So those that you're talking to are more interested in their evaluations coming up than they are in the potential that we've seen 2 rate increases now recently in those having a positive benefit on their operating abilities?

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [53]

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No, that probably varies from organization-to-organization as to what their motivations are, what they're looking at, what they're strategies are. That's a pretty wide range. It's hard to characterize it as whether it's a rate opportunity, whether it's aging CEOs, boards. There's just a variety of things there that I think that lead them to a conclusion that they would like to seek a partner in. So it's -- I guess the short answer is it varies.

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Operator [54]

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We do have a follow-up in queue from Tim O'Brien.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [55]

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Guys, one other question, following up on Jeff's branch consolidation question, just drilling down. Don, you said -- can you give us an update or characterize or have a ballpark of what the total exit cost is going to be for this initiative and what the kind of dollar amount of run rate savings could be coming out of it on a quarterly basis or on an annual basis for that matter?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [56]

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Sure, Tim. I think that depending on -- we always try to -- as we close branches, we always try to find places for people. So some will depend on severance pay and on whether they -- we can find spots for the employees that are in the branches that we're consolidating. And so I think the cost will probably be between $300,000 and $400,000, depending on that. And then going forward, I would expect the savings to be around $300,000 a quarter going forward.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [57]

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And the cost will hit again mostly in the second quarter or third quarter, split?

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Donald J. Hinson, Heritage Financial Corporation - CFO, EVP, CFO of Heritage Bank and EVP of Heritage Bank [58]

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Should hit almost all in the second quarter.

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Jeffrey J. Deuel, Heritage Financial Corporation - EVP, President of Heritage Bank and COO - Heritage Bank [59]

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Tim, it's Jeff. I misspoke earlier when I was talking about the paperless statements. I got mixed up with the cost of doing a transaction in the branch versus online. Just to qualify, the savings on a paperless statement is about $1.75. So it's not quite as significant, but it's still pretty significant.

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Operator [60]

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At this time, there are no additional questions in the queue. Please continue.

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Brian L. Vance, Heritage Financial Corporation - CEO, President, Executive Director, Vice Chairman of Central Valley Bank, CEO of Heritage Bank and CEO of Central Valley Bank [61]

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Thank you, Tony. Appreciate hosting the call. Appreciate everyone calling in. I know we'll be involved in a couple of investor conferences over the next couple of weeks, and we'll see many of you in maybe one or both of those conferences. So appreciate your continued interest in our company. Thanks for joining us today.

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Operator [62]

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Thank you. And ladies and gentlemen, this conference will be available for replay after 1:00 p.m. Pacific Time today, running through May 10 at midnight. You may access the AT&T executive playback service at any time by dialing (800) 475-6701 and entering the access code of 421543. That does conclude your conference call for today. We do thank you for your participation and for using the AT&T Executive TeleConference. You may now disconnect.