HERITAGE FINANCIAL CORP /WA/ Q4 FY2024 earnings call

Management Statement and Operational Highlights

• CEO Transition: Jeff Deuel will retire May 5, 2025, with Bryan McDonald to assume CEO of the holding company. Jeff will become a non-executive advisor.
• Financial Results: Strong Q4 operating results with loan growth, margin expansion, and expense management. Net interest income increased $805,000, and net interest margin rose to 3.39% from 3.33% in prior quarter.
• Loan Production: Commercial lending group closed $316 million in new loan commitments in Q4, up 25% from prior quarter. Average interest rate on new commercial loans was 6.63%, up 10 bps from prior quarter.
• Credit Quality: Non-accrual loans were 0.08% of total loans, net charge-offs were $27,000 in Q4, and $2.5 million full-year. Criticized loans increased, but substandard loans decreased.
• Deposit and Investment Activity: Deposits relatively flat in Q4; investments repositioned for higher-yielding loans; BOLI portfolio restructured for better yield.

Segment Performance

• Loans: Loan balances increased $123 million in Q4. Yields on the loan portfolio were 5.53%, down 7 basis points from Q3 due to Fed rate cuts. Loan growth for the quarter was $123 million, or just over 10%, with annual loan growth at 10.8%.
• Deposits: Total deposits decreased $24 million in Q4 due to a $25 million reduction in brokered CDs. Core CD balances grew, and the cost of interest-bearing deposits decreased to 1.98% in Q4 from 2.02% in the prior quarter. Average deposit balances in Q4 were $30 million higher than the ending focal date balance.
• Investments: Decreased $104.5 million, with a pre-tax loss of $3.9 million from selling $36 million of securities. Estimated annualized pre-tax income improvement from the loss trade is $1.4 million, with an earn-back period of about 3 years.
• BOLI Portfolio: Surrendered $34 million of policies, incurring ~$2.4 million in tax expense. Redeployed $19 million into new policies with higher yield, initiated tax-free exchanges on ~$10 million of policies, and incurred ~$500k in transaction costs.

Guidance

• Margin: Expect continued NIM expansion, with Q1 likely seeing improvement, highly dependent on interest rates. December core margin was 3.44%.
• Capital Management: Consider moderate stock buybacks, active in M&A discussions, aim to maintain FTE levels with initiatives like Builder Banking Business expansion increasing costs.
• Expenses: Target $41M-$42M per quarter, with FTE levels maintained but offset by merit increases and vendor costs.
• Tax Rate: Expected 15%-16% in 2025, excluding one-time BOLI restructure costs.

Risks

• Credit Environment: Continued movement to a normalized credit environment could bring isolated credit issues.
• Market Dependence: Dependence on market conditions for deposit cost reductions and loan to deposit ratio management, including CD maturities and money market account rate adjustments.

Question and Answer

• Q: Jeff Rulis on margin and restructuring expectations A: Jennifer Nino said December margin was 3.44%, expecting NIM expansion, with restructuring impact seen in Q1. Borrowing costs expected to decrease.
• Q: Jeff Rulis on capital priorities and M&A A: Bryan McDonald said M&A discussions ongoing, confident in adding teams. Jennifer Nino on stock buybacks: moderate levels dependent on stock price, and investment activity: consider additional loss trades if beneficial.
• Q: Liam Coohill on loan commitments and expenses A: Bryan McDonald on loan commitments breakdown (C&I vs CRE), Jennifer Nino on expense targets ($41M-$42M per quarter) and tax rate expectation (15%-16% in 2025).
• Q: Kelly Motta on deposits and loan to deposit ratio A: Bryan McDonald and Jennifer Nino on deposit repricing (CDs maturing in Q1/Q2, money market rates lagging Fed cuts), and balance sheet management to increase loan to deposit ratio.