Heritage Financial Corporation Q3 FY2025 earnings call

• Improving net interest margin and tight controls on noninterest expense drove earnings higher in Q3. Adjusted earnings per share was up 5.7% vs last quarter and 24.4% vs Q3 2024. ROAA improved to 1.11% vs 0.87% in Q3 2024.
• Pending merger with Olympic Bancorp will add to profitability and position the company for growth in the Puget Sound market.
• Total loan balances were flat in Q3 with loan originations up but payoffs/prepayments also up. Deposits increased $73 million, with noninterest-bearing deposits up $33.7 million. Investment balances decreased $33 million.
• Net interest income increased due to higher net interest margin. Provision for credit losses up. Noninterest expense increased due to comp/benefits and professional services, including $635k merger-related expenses.
• Credit quality remains strong with nonaccrual loans at $17.6 million, nonperforming loans at low levels, and net charge-offs low.
• Commercial lending group closed $317 million in new loan commitments in Q3, with the pipeline at $511 million. Expecting $320 million in Q4 commitments. Deposits increased $73 million in Q3, up $173 million YTD.

Loan Portfolio: Total loan balances were relatively flat in Q3, decreasing by $5.7 million. Yields in the loan portfolio were 5.53%, 3 basis points higher than Q2 due to new loans at higher rates and adjustable rate loans repricing higher. Deposits: Total deposits increased $73 million in Q3, with noninterest-bearing deposits up $33.7 million. The cost of interest-bearing deposits decreased to 1.89% from 1.94% in the prior quarter. Net Interest Income: Increased $2.4 million or 4.3% from the prior quarter due to a higher net interest margin, which rose to 3.64% from 3.51% in the prior quarter. Provision for Credit Losses: $1.8 million, up from $956,000 in the prior quarter due to an increase in the weighted average life of the construction loan portfolio. Credit Quality: Nonaccrual loans totaled $17.6 million (0.37% of total loans), nonperforming loans increased to 0.44% of total loans, criticized loans decreased, net charge-offs were low at $118,000 for the quarter.

• Expect continued decreases in the cost of deposits due to the September rate cut.
• Anticipate loan balances to remain flat in Q4 then resume growth in 2026 as payoffs moderate.
• Expect Q4 commercial loan commitments of $320 million, similar to Q3 levels.
• Pending merger with Olympic Bancorp is on track for closing in early Q1 2026 and will add to profitability.

• Economic volatility could materially impact credit quality.
• Competition in deposit pricing in certain local geographies.
• Uncertainty in loan demand beyond the next 90 days, though loan demand trends are moving positively.

Q: What was the spot cost of deposits at September 30 and the NIM for September?

A: The interest-bearing spot cost of deposits was 1.87%, and the NIM for September was 3.66% compared to 3.64% for the quarter.

Q: How much opportunity is there to reduce rates on nonmaturity deposits?

A: There is approximately $1 billion in exception-priced deposits costing ~3%, and they will be worked down over time as rates cut, though new accounts may have higher rates initially.

Q: How is organic loan growth expected in 2026 and when payoffs might normalize?

A: Expecting mid- to high single-digit organic loan growth in 2026. Payoffs are affected by cycling construction loans reaching perm and paying off, with positive net advances expected in 2026 as payoffs moderate.

Q: Any managed or encouraged balance reductions for credit-related reasons in payoffs?

A: Some larger payoffs in Q4 are for adversely classified credits where customers are selling assets and paying off.

Q: Is deposit success in Q3 due to seasonal factors, execution, or both?

A: A bit of both; Q3 is traditionally the strongest deposit growth quarter, and there have been good additions from new account activity.

Q: How is the margin trending ahead, considering rate cuts and loss trades?

A: Expect continued help on the deposit side, but loan yields likely flat this quarter. Margin improvement will be muted compared to last quarter due to recent rate cuts.

Q: How is progress on the Olympic acquisition trending and priorities post-approval?

A: Progress is right on track for a Q1 2026 closing. Priorities include coordinating closely with the Olympic team for smooth integration.

Q: What are you watching more closely for asset quality moving forward?

A: No particular systemic trends, just normal ins and outs of classified/criticized buckets, with some positive momentum in the substandard category expected in Q4.

Q: Adjusting for merger costs, are expenses on a good run rate going forward?

A: Expenses are expected to be in the low 41s core, with a $300k per quarter impact from a state revenue tax rate increase, and some acquisition-related costs to be considered.

Q: How is M&A thought about post-Olympic deal close?

A: Focus is on closing the Olympic deal first, but open to considering opportunities if the right one comes up next year.

Q: Thoughts on capital priorities post-Olympic deal integration?

A: Hard to comment specifically yet, but expect to preserve capital due to transaction costs and upfront dilution, with plans to earn back capital over time.

Q: How is the loan-to-deposit ratio managed moving forward?

A: Goal is to get the loan-to-deposit ratio back up to 85% and be comfortable above that, looking for loan opportunities to deploy assets.