Earnings Call Transcript - HFWA Q2 2023

Operator, Operator

Hello, and welcome to the Heritage Financial Corporation Q2 2023 Earnings Conference Call. My name is Elliot, and I'll be coordinating your call today. I’d now like to hand over to Jeff Deuel, CEO. Please go ahead.

Jeffrey Deuel, CEO

Thank you, Elliot. Welcome, and good morning to everyone who called in and those who may listen later. This is Jeff Deuel, CEO of Heritage Financial. Attending with me are Don Hinson, Chief Financial Officer; Bryan McDonald, President and Chief Operating Officer; and Tony Chalfant, Chief Credit Officer. Our second quarter earnings release went out this morning premarket, and hopefully, you have had the opportunity to review it prior to the call. We have also posted an updated second 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 this presentation during the call. Please refer to the forward-looking statements in the press release. We're very pleased to report another solid quarter with EPS in line with consensus. We continue to see pressure on deposit pricing in Q2, and we expect that to continue for the balance of the year. Deposit movement in Q2 was primarily tied to normal flows, including capital purchases, with a lesser portion tied to alternative investments. FDIC insurance-related concerns have substantially subsided. We reported solid organic loan growth of 3% for the quarter as we focus on supporting our existing customers and pursuing new relationships with a primary focus on C&I. We are pleased with the positive trend of new commitments and new loan closings from our existing production teams and the newer teams added over the past year. We continue to manage expenses carefully, although we also continue to experience the impacts of inflation, mostly on compensation costs. Notably, our long-standing focus on credit quality and actively managing our loan portfolio continues to play out well for us. Staying focused on our conservative risk profile has enabled us to continue to report strong credit metrics and provides a good foundation as credit quality returns to more historical levels. We'll now move on to Don who will take a few minutes to cover our financial results.

Donald Hinson, CFO

Thank you, Jeff. I will be reviewing some of the main drivers of our performance for Q2 as I walk through our financial results. Unless otherwise noted, all of the prior period comparisons will be with the first quarter of 2023. Starting with net interest income, we experienced a decrease of $4 million or 6.7% in Q2 due mostly to an increase of $7.4 million in interest expense. This increase in interest expense resulted from a combination of an increase in our cost of interest-bearing deposits and an increased use of borrowings during the quarter. This was the main driver for the 35 basis point decrease in our net interest margin in Q2. As mentioned earlier, we had a solid loan growth of $124 million or 3% in Q2. In addition, yields on the loan portfolio were 5.19% for the quarter, which was 12 basis points higher than Q1 and contributed to an 11 basis point increase in yield on earning assets. Bryan McDonald will have an update on loan production and yields in a few minutes. Our cost of interest-bearing deposits increased 43 basis points to 0.92% for Q2. We continue to experience market pressure related to deposit rates. We are strategically increasing our deposit rates by product and working individually with our customers to maintain relationships. As a result of the current rate environment, we expect to continue to experience an increase in the cost of our core deposits, although at a slower pace than in Q2. The continued but slowing increase in this cost is illustrated by the cost of interest-bearing deposits being 1% for the month of June with a spot rate of 1.04% as of June 30. Overall, we experienced a decline in deposit balances of 3.3% for the quarter. The decline occurred primarily in April, which is a month that typically experiences decreases in deposit balances due to tax payments. Deposit balances were relatively flat during the last two months of the quarter. Bryan will discuss our deposit pipeline later in the presentation. Our insured deposits were at 67% of total deposits at June 30 compared to 65% at March 31. Also for customers seeking additional FDIC insurance, we offer deposit products that have full FDIC insurance. On balance sheet, deposit totals for these accounts were $219 million at the end of Q2. In order to supplement our funding, we borrowed $450 million from the Federal Reserve's Bank Term Funding Program or BTFP, and paid off existing FHLB advances. We utilized the BTFP due to the lower cost and fixed rate nature of the notes as well as the option to prepay borrowings at any time. The blended rate on the BTFP advances was 4.72% in Q2 compared to an average cost of 5.15% for the FHLB advances for the quarter. You can refer to Pages 38 and 39 of the investor presentation for more specifics on our borrowings and liquidity position. As I previously mentioned, we experienced a sizable decrease in NIM to 3.56% for Q2 from 3.91% in the prior quarter. We expect NIM to decrease further in Q3, although not as significantly. This can be illustrated by a NIM of 3.54% for the month of June, which is only 2 basis points lower than for the entire second 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 of deposits as well as 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. Moving on to capital. All of our regulatory capital ratios remain comfortably above well-capitalized thresholds and our TCE ratio was at 8.3%, unchanged from the prior quarter. In addition, with a loan deposit ratio of 76%, we have plenty of liquidity to continue to grow our loan portfolio. Noninterest income decreased from the prior quarter, primarily due to a $1.6 million one-time gain on the sale of Class B Visa stock, which occurred in Q1. Noninterest expense decreased $280,000 to $41.3 million in Q2. This was due mostly to a decrease in the accrual for incentive-based compensation resulting from lower expected earnings this year. Looking ahead, we expect noninterest expense to be in the low $42 million range for Q3. The effective tax rate decreased to 15.2% in Q2 from 17.1% in Q1 in order to adjust the year-to-date effective tax rate to the current estimated rate for 2023, which is now at 16.3%. And finally, moving on to the allowance, even though we continue to show strong credit quality metrics, we recognized a provision for credit losses of $1.9 million during the quarter due mostly to increases in loan balances. I will now pass the call to Tony, who will have an update on these credit quality metrics.

Anthony Chalfant, Chief Credit Officer

Thank you, Don. I'm pleased to report that credit quality remained strong and stable through the first six months of the year. As of June 30, nonaccrual loans totaled $4.6 million, and we do not hold any OREO. This represents 0.11% of total loans and 0.07% of total assets. Nonaccrual loans declined modestly during the quarter and are now down by $5.8 million or 56% over the last 12 months. We did not move any loans to nonaccrual status during the quarter. The reduction came from payments on loans that were applied to principal. Page 25 of the investor presentation highlights the positive trends in our level of nonperforming assets. Delinquent loans, which we define as those over 30 days past due and still accruing represented 0.09% of total loans or $3.9 million at quarter-end. This compares favorably to $8.4 million or 0.20% of total loans at the end of the first quarter. Criticized loans, those risk-rated special mention and substandard, totaled just over $143 million at the end of the quarter. This is a modest decrease of $2.4 million from the end of the first quarter. Criticized loans have increased by $8 million since year-end 2022. However, over the past 12 months, they've declined by $23.2 million or 14%. Notably, over the same 12-month period, loans risk-rated substandard have declined by $35.8 million or nearly 38%. Overall, our entire CRE portfolio continues to perform well and has been stable through the first six months of 2023. Total criticized CRE loans represent just 2% of our entire loan portfolio. While we continue to closely watch our portfolio of office loans, we have yet to see any material deterioration in credit quality. At quarter-end, criticized office loans totaled approximately $25 million. This represents just over 4% of our total portfolio of owner and non-owner occupied office loans. This is very consistent with what we reported at the end of the first quarter. In the second quarter, we did a detailed review of our non-owner occupied office loans that were $1.5 million or larger. This review included 52 loans that represent 65% of the outstanding balance of this portfolio. The focus was on net operating income, current occupancy levels, potential tenant rollover risk and evaluating risks around any renewal or repricing event occurring over the next 12 months. I'm pleased to report that no loans were downgraded to special mention or worse as a result of this review. While we expect to see some future deterioration of credit quality in this portfolio, the performance to date remains stable. Page 24 of the investor presentation is new this quarter and provides more detailed information about our office loan portfolio. During the second quarter, we experienced total charge-offs of $144,000. They were partially offset by recoveries of $95,000 leading to net charge-offs of just $49,000 for the quarter. Through the first six months of the year, total net charge-offs were $279,000. While trending higher than what we experienced in 2022, loan losses remained very low when compared to historical norms. As I've stated in previous earnings calls, our average annual net charge-offs for the three-year period 2018 through 2020 was approximately $2.9 million or about $700,000 a quarter. We remain disciplined in our underwriting through all business cycles and maintain a detailed approach to concentration management. This has led to a loan portfolio that is both granular and well diversified by loan type and geography. In these turbulent times, we're pleased that our credit metrics remain strong and stable. The bank remains well positioned for any potential downturn in economic conditions over the coming quarters. I'll now turn the call over to Bryan for an update on loan production.

Bryan McDonald, President and COO

Thanks, Tony. I'm going to provide detail on our second quarter loan production results, starting with our commercial lending group. For the quarter, our commercial teams closed $212 million in new loan commitments, down from $228 million last quarter and down from $283 million closed in the second quarter of 2022. Please refer to Page 19 in the second quarter investor presentation for additional detail on new originated loans over the past five quarters. The commercial loan pipeline ended the second quarter at $473 million, down from $587 million last quarter and down from $537 million at the end of the second quarter of 2022. Loan growth was $124 million for the quarter, which is above historical levels due to lower prepay volumes and increased balances on construction loans closed last year. Please see Slides 20 and 21 in the investor deck for further detail on the change in loans during the quarter. Considering current market conditions, trends in our portfolio and customer base, our quarter-end loan pipeline and the fact our new Boise team is just ramping up production, we anticipate a strong but moderately lower level of loan growth for the next couple of quarters. The deposit pipeline ended the quarter at $118 million and balances associated with new deposit customer accounts opened during the quarter totaled $46 million. Moving to interest rates. Our average second quarter interest rate for new commercial loans was 6.16%, which is 19 basis points higher than the 5.97% average for last quarter. In addition, the average second quarter rate for all new loans was 6.27%, up 26 basis points from 6.01% last quarter. The increase is due to a higher percentage of loans being closed under widened spreads implemented in 2023 versus working through the pipeline coming into the year that included pricing committed at lower levels. The market continues to be competitive, particularly for C&I relationships. The mortgage department closed $25 million of new loans in the second quarter of 2023 compared to $17 million closed in the first quarter of 2023 and $40 million in the second quarter of 2022. The mortgage loan pipeline ended the quarter at $13 million versus $25 million last quarter and $20 million at the end of the second quarter of 2022. With mortgage rates remaining at higher levels, we anticipate volumes will continue at the relatively low levels we have seen year-to-date. I'll now turn the call back to Jeff.

Jeffrey Deuel, CEO

Thank you, Bryan. As I mentioned earlier, we're pleased with our performance in the second quarter. We're confident our well-established granular deposit franchise will continue to be an area of strength for us, and we have ample liquidity sources. Our relatively low loan-to-deposit ratio positions us well to continue to support our existing customers as well as pursuing new high-quality relationships. We will continue to benefit from our historically conservative approach to credit in our strong capital position, and we operate in a footprint that is economically vibrant. We will continue to focus on expense management and improving efficiencies within the organization. Overall, we believe we are positioned to navigate the challenges ahead to take advantage of any potential dislocation in our markets that may occur. That is the conclusion of our prepared comments. So Elliot, we are ready to open up the call to any questions callers may have for us.

Operator, Operator

First question today comes from David Feaster from Raymond James.

David Feaster, Analyst

Maybe just starting on the deposit front. I was hoping you could dissect some of the trends that you saw intra-quarter. It sounds like the majority of the deposit flows and the remix was more early in the quarter, which I'd guess are related to tax payments, and I think you mentioned normal flows. But just curious what you saw there in that maybe things have stabilized later in the quarter. Is that a fair characterization? And I guess what gives you confidence that things are stabilizing and just your strategy around continued core deposit growth going forward?

Bryan McDonald, President and COO

Do you want...

Jeffrey Deuel, CEO

I think you characterized it correctly. Towards the end of the quarter, things started to settle down and became more steady. We have a deposit pipeline that we're working on. It really depends on the direction of rates because when the Fed makes a change in rates, it tends to grab everyone's attention and may restart discussions about deposits. Bryan, you might want to share some insights about the deposit pipeline and what we expect to see.

Bryan McDonald, President and COO

Yes. We are out actively meeting with our existing customers, trying to avoid outflows from those. Again, the outflows during the second quarter were excess funds just like the first quarter. But we're doing our best to retain those and then the sales force actively out calling, trying to get more deposits from existing customers as well as new. So that continues to be a focus.

David Feaster, Analyst

Could you discuss the competitive landscape? It seems that everyone is trying to retain their existing customers and grow. Has the competitive situation stayed relatively stable, or are you noticing an increase in competition? If there is an increase, where are you primarily seeing that competition?

Bryan McDonald, President and COO

Yes. The large banks have been leading with some pricing promotions on CDs and money market accounts since the beginning of the Fed rate increases, which is different from what we've observed over the past decade. Customers also have the option to easily purchase treasuries, and we have been facilitating that. This situation isn't new this quarter, but it reflects the ongoing pressure in the market. Any surplus funds can be directed towards higher rates. Ultimately, it depends on the mix of operating relationships and the details within the portfolio, and we are satisfied with our current position. We have numerous operating accounts and have never been a price leader in the market. We will need to monitor the competition and see how much excess funding remains that could potentially shift, and determine what percentage we can retain amidst the competition, particularly from the large banks.

Jeffrey Deuel, CEO

I would add that the deposit landscape is quite competitive right now, as everyone is vying for deposits. However, amidst this competition, we are also acquiring new customers along with their deposits that may be affected by the current market conditions. Thus, we have seen some successes beyond the outflows you are observing.

David Feaster, Analyst

That's helpful. Following up on that, could you discuss how much of the pipeline decrease is driven by demand versus a potential slowdown in your growth ambitions? Also, please explain the pricing dynamics you're observing in the pipeline. Additionally, are you seeing more opportunities considering your active efforts in market expansion and new hires?

Bryan McDonald, President and COO

We have noticed a decline in our loan pipeline mainly due to a rise in requests for investor real estate, of which we can only accept a limited portion. As we complete our current pipeline of these requests, we are bringing in fewer new non-owner-occupied investor real estate requests. This is the main factor behind the change. We continue to add commercial and industrial, as well as owner-occupied opportunities, but the number of investor requests is lower compared to previous quarters. Overall market demand is still present, with customers interested in borrowing and expanding, although there has been a slight slowdown this year. Regarding pricing, we are working through quotes, spreads, and commitments from the previous year, and there are a few outstanding items to finalize in the third quarter. We have noticed that new pricing has been higher than the rates we mentioned for closing rates this quarter, so we anticipate average rates to increase as we progress through the year, consistent with trends we've observed in recent quarters.

Jeffrey Deuel, CEO

David, in response to Bryan's comment about the limits of non-owner occupied real estate, we follow a concentration management process. On Page 23, you can see how we measure up against interagency guidance, where construction has increased slightly, linked to loans that closed last year and are now being funded. This has grown to 49%, compared to the 100% guidance. Additionally, we are monitoring total real estate closely, which has risen to 268%, with guidance set at 300%. This seems to be serving as a bit of a limitation. However, we are still engaged in commercial real estate; we're just being much more selective about our choices.

David Feaster, Analyst

That makes sense. Regarding the last part of your question, Jeff, I know it's a significant one. Are you seeing more opportunities for hiring and market expansion? You've had considerable success, and I'm curious about your perspective on that.

Jeffrey Deuel, CEO

Sorry, we missed that. We're currently open to opportunities to add to the team if we find high-quality individuals who fit our culture. However, things are relatively calm at the moment, and people aren't necessarily changing jobs in this environment. We have a lot to concentrate on with Boise and Eugene, as well as our operations in the Portland and Vancouver area. Any actions we take in the near future will likely involve small additions rather than larger acquisitions.

Operator, Operator

Our next question comes from Matthew Clark with Piper Sandler.

Matthew Clark, Analyst

First on just the funding mix going forward. Loan growth slowed. Let's just say you cut it in half. That would imply net loan growth of about $65 million. That's consistent with the cash flows you kind of coming off the investment portfolio in the upcoming quarter. I guess I'm trying to get a sense for, do you think deposits can stabilize here, maybe even grow? I'm trying to get a sense for should we be assuming the borrowings continue to increase here or not?

Jeffrey Deuel, CEO

That's a tough question. So I'll be happy to pass that one to Don. And I would just say, Matt, the circumstance we find ourselves in is deposits have essentially stabilized and started to trend a little bit up at the end of the quarter, but we expect that the competition for deposits will continue as the year progresses, especially with the potential for a rate hike. So I don't know if we can expect lots of deposit growth, but I think we would steer towards maybe deposit stability, and that will be dependent on what rates do during the rest of the year. Don, you probably have a couple of comments you'd like to add to that.

Donald Hinson, CFO

Sure, Matthew, you're correct about the investments. They are generating income on average. We even added a new slide in our presentation this time regarding cash flows, so I hope you can review that. It highlights the need for funding on the loan side, depending on how much we ultimately fund this quarter. At this point, I don't expect any additional borrowings. However, even if we see stabilization or growth in deposits in Q3, it's likely we won't pay down any borrowings either because we can't predict what might happen next, and we currently have some attractive rates on our borrowings. In fact, once the Fed raises rates, our borrowing costs will be in the high 4s, while we will be earning in the low 5s overnight. I'm reluctant to pay down those borrowings until everything stabilizes and we potentially see rate cuts. Therefore, I don't foresee any additional borrowing unless we encounter another significant deposit runoff, but I also think we won't be paying them off.

Matthew Clark, Analyst

Okay. And then just a couple more on the funding side. Can you quantify the pipeline of deposits? And also what was the timing of the transfer from FHLB to BTFP? Just trying to get a sense for if we saw the full quarter benefit of that.

Donald Hinson, CFO

Well, I'll start by mentioning that Bryan can provide insights into the deposit pipeline. The blended rate for these funds was 4.74%, which I believe was established in May. This rate was only slightly different from what we previously provided. Additionally, there's a slide addressing this in the slide deck. The forward-looking blended rate remains at 4.74%.

Bryan McDonald, President and COO

Matthew, the deposit pipeline was $118 million, which includes balances from new deposit customers joining the bank. This figure excludes funds from existing customers or any outflows. We also opened about $46 million in new accounts last quarter, which relates to brand-new customers. The account openings usually involve a transition period, especially for commercial clients switching banks, so we typically don't see all the funds transferred within a week or even 30 days.

Matthew Clark, Analyst

I just want to confirm that the $104 million in deposits was interest-bearing and not the total amount, correct?

Donald Hinson, CFO

Correct.

Operator, Operator

We now turn to Jeff Rulis with D.A. Davidson.

Jeffrey Rulis, Analyst

A question on the loan growth covered both the pipeline and expectations, as well as our direction. One of the uncertainties mentioned this quarter involves advances or existing lines and draws on that. Is there any seasonality related to this? Do we have any visibility on whether Q2 and Q3 tend to be stronger in this area? I'm trying to add another layer to your guidance comments.

Bryan McDonald, President and COO

Yes. Jeff, if you look at Slide 20, it has the detail on the construction commitments at the bottom, and that's really what's driving the bulk of the net advances you see on Page 21, which was really the difference quarter-over-quarter. We had really similar balances on originated loans, similar levels of prepays payoffs. So it was really the difference in those net advances that drove the higher loan growth versus last quarter. So with the level of construction commitments where they are something similar to last quarter would be pretty reasonable.

Jeffrey Rulis, Analyst

So yes, I'm looking at 20. I mean if those are kind of trending up, this may be a bigger piece in terms of maybe advances and combining that with Jeff's comments about as a percent of capital, you got some room to comfortably grow there. Is that fair to say this is a piece that we could talk incrementally more about?

Bryan McDonald, President and COO

Yes, you'll notice that the balances on those construction loans will increase to a level that is more in line with what we saw in 2020, which was significantly higher. We entered the pandemic and did not make many new construction commitments during that time. As those loans got funded, we ended up at a lower point as we came out of the pandemic, and now we are in the process of rebuilding. Many of those loans are also being refinanced into permanent options, outside of some exceptions. We finance a substantial amount of low-income housing, and most of what we fund doesn't have permanent debt or has very minimal amounts. The key question is when will we reach a peak and see prepayment activity increase again after the pandemic. However, we still have room for growth before that happens.

Jeffrey Rulis, Analyst

Yes. I guess, Bryan, if I look at 2020, I mean that's more like a 60% outstanding balance to commitments, and you're less than half of that today? Or basically saying that you would expect it to revert to historical levels?

Bryan McDonald, President and COO

Yes.

Donald Hinson, CFO

And just real quick, just to be clear, maybe not very definitive, but I'm probably thinking more in the high 3.40s kind of range for that for this next quarter.

Jeffrey Rulis, Analyst

Okay. That's helpful.

Donald Hinson, CFO

Yes. And just to be clear.

Jeffrey Deuel, CEO

Yes. Don is likely the best person to address the buyback strategy. As for mergers and acquisitions, we were close to a deal before the pandemic disrupted things, but that's no longer an option. As we have mentioned in recent quarters, we are maintaining close relationships with the banks we know and value. We are still having ongoing discussions to stay connected and keep the dialogue current, yet there is nothing urgent or imminent. I wouldn't anticipate any opportunities that would interest us for the remainder of the year at least. Don, would you like to discuss buybacks?

Donald Hinson, CFO

Sure. We were kind of picking at it a little bit this year, but we don't expect to really be heavily involved in buybacks at this point for this year.

Timothy Coffey, Analyst

I want to see if I can put some context around your comment at the beginning of the call about deposit pressures remaining through year-end. Are you talking about the expectation that deposit rates could increase materially from where they are now or that they would remain in kind of the range of where they're at right now?

Jeffrey Deuel, CEO

I think the situation is similar to what I mentioned earlier. When the Fed raises rates, it not only intensifies the existing competition for deposits but also grabs people's attention. They may read about it in the news and then come to us to see if there's anything we can offer. That's what I was referring to. I don't believe rates will increase significantly; rather, I anticipate ongoing pressure at least through the end of the year. I hope that clarifies my point.

Anthony Chalfant, Chief Credit Officer

Yes. Don, I'll probably let you take that one.

Donald Hinson, CFO

Yes. If loan growth were to slow from here, would the provision conceivably come down?

Timothy Coffey, Analyst

Yes. That all makes sense.

Jeffrey Deuel, CEO

Yes. And I didn't say that you put a timeline on it. I just missed it.

Donald Hinson, CFO

That's a combination of allowing us to grow certain aspects of our loan portfolio in addition to potential recessionaries that could be coming down the line. So we're just kind of at this point waiting and again, that's going to be very active at this point as a result.

Andrew Terrell, Analyst

Jeff, maybe if I could start. You mentioned in your opening remarks something around just the tune of credit quality returning to more normalized levels. And I understand kind of that's maybe the macro backdrop right now, but credit really seems still really strong at Heritage. I was curious if you could maybe just elaborate on what fronted that comment in the prepared remarks? And then where specifically you have concerns in the portfolio, if any, or what you're watching more closely across the book right now?

Jeffrey Deuel, CEO

Yes. Tony, you might want to contribute to this response. From our perspective, credit is in such a good state right now that it feels somewhat unusual. Historically, before the pandemic, our quarterly charge-offs were around $700,000, whereas this quarter, we're seeing just $49,000. That doesn't seem normal to us. We believe that trends will eventually revert to the norm, but we don't see any specific categories indicating that right now. As Tony mentioned, everything appears quite stable at the moment. There’s significant discussion around a potential recession, whether it will be mild or severe, and we're waiting for that situation to manifest in some form, but honestly, we don't have anything particular anticipated. Additionally, this cautious approach ties into Jeff's question regarding capital. Our nature is generally conservative, and we plan to hold onto our resources until we have a clearer picture of how things will unfold. Tony, feel free to add anything.

Anthony Chalfant, Chief Credit Officer

Thank you, Jeff. Andrew, the term "normal" is relative. We are experiencing a very gradual return to a typical credit environment. Throughout 2022, we observed net recoveries on a quarterly basis, which we don't consider normal. As we're beginning to see an increase in losses, it reflects this slow transition back to normalcy. Internally, there are companies facing management challenges that were previously masked by stimulus support; these issues are now leading to some credits being referred to our special assets team. The changes are modest and progressing very slowly, but we can sense a slight shift as we move through each quarter of 2023. Regarding our focus areas, we are closely monitoring our office loan portfolio, which has remained stable. We conducted a thorough review of the non-owner occupied segment of that office portfolio in the second quarter, and we will continue to look for potential risks and carry out special reviews in the upcoming quarters.

Andrew Terrell, Analyst

Okay. I appreciate it. And actually, if I could just follow up on the office loan portfolio review. And I guess as you look throughout that portfolio, it sounds like focused on maybe some of the loans above the average size, $1.5 million plus. I guess what did you find from just an average occupancy standpoint as you went throughout the process? Did you take a stab at reappraising or revaluing properties, just using comp-type math for any transactions that have occurred nearby? And have you seen any real changes in loan-to-value at the deep dive?

Anthony Chalfant, Chief Credit Officer

Yes, we were selectively reviewing those loans, particularly considering any significant rollover risk that might impact net operating income. We're focusing more on debt service coverage rather than loan-to-value, as the average loan-to-value in that portfolio is quite low. While we do analyze that aspect, we believe issues with debt service coverage are likely to arise before concerns with loan-to-value. In our examination of the 52 loans, we identified a few in what we classify as a caution category, but nothing serious enough to necessitate a downgrade. We'll keep monitoring those, especially regarding major leases that might have significant rollovers in the next 12 months, to ensure there are no problems with debt service coverage.

Andrew Terrell, Analyst

Understood. And do you have average occupancy across those 52?

Anthony Chalfant, Chief Credit Officer

We didn't calculate that. And we're looking kind of at a more one-off each loan on a kind of a standalone basis.

Donald Hinson, CFO

Yes, that was 16.3%.

Operator, Operator

This concludes our Q&A. I'll now hand back to Jeff Deuel, CEO, for closing remarks.

Jeffrey Deuel, CEO

Thanks, Elliot. Since there's no more questions, we'll wrap up this quarter's call. We thank you for your time, your support and your interest in our ongoing performance, and we're looking forward to seeing several of you in the coming weeks at some of the investor events. Thank you. Goodbye.

Operator, Operator

Ladies and gentlemen, today's call has now concluded. A replay of today's conference call will be available for the next seven days. You can access this by dialing 1929-458-6194 and then entering the access code 925696. We'd like to thank you for your participation. You may now disconnect your lines.