Earnings Call Transcript
HERITAGE FINANCIAL CORP /WA/ (HFWA)
Earnings Call Transcript - HFWA Q4 2021
Jeff Deuel, CEO
Hello, everybody. Sorry for the late start. We had a little confusion in some cases around the access code. Hopefully, you didn't have too much trouble getting on the call. I'd like to welcome you all to our fourth quarter and full year 2021 performance update. Attending with me are Don Hinson, our CFO; Bryan McDonald, our President and Chief Operating Officer; and Tony Chalfant, our Chief Credit Officer. Our earnings release went out this morning pre-market. And hopefully, you have had an opportunity to review it prior to the call. We also posted an updated fourth quarter investor presentation on the Investor Relations portion of our website, which can be found at heritagebanknw.com. We will reference the presentation during this call. Please refer to the forward-looking statements in the press release. We're pleased with our financial performance for the fourth quarter. While loan growth excluding PPP was muted this quarter by payoffs, pre-pays, and lower line utilization, we're pleased with the very positive trend we see in the number of new commitments. We are getting our fair share of new deals. A good portion of the new transactions are coming from proactive outbound calling efforts, customer referrals, and PPP recipients. We continue to see deposits growing for the same reasons with very limited runoff from our branch consolidations in 2021. The pipeline is strong, and we expect it to continue to grow throughout the year. We maintained our focus on carefully managing expenses with good success as evidenced in the non-interest expense number. Non-interest expenses are essentially flat year-over-year, and we expect non-interest expenses to stay relatively flat at about $37 million to $38 million per quarter through 2022. Additionally, we have continued our focus on reducing our real estate footprint, and we wrapped up the year by completing the sale-leaseback of our headquarters campus in Olympia, which closed at the end of the year. Notably, our long-standing focus on credit quality and actively managing our loan portfolio continues to play out well for us as the pandemic recedes. Staying focused on our moderate risk profile has enabled us to continue to report improving credit trends throughout 2021 and also recapture a significant portion of the reserve build from 2020. It's very exciting at this point to be facing a much more positive business environment for organic growth opportunities and potential M&A as we move through the new year. We will now move to Don who will take a few minutes to cover our financial results.
Don Hinson, CFO
Thank you, Jeff. As Jeff mentioned, overall financial performance was very positive in Q4, and I'll be reviewing some of the main drivers of our performance. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the third quarter of 2021. Starting with net interest income, there is a decrease of $3.5 million, due mostly to a decrease of $3.1 million in income from PPP loans. Partially offsetting this was an increase in income from investment securities. This increase was due mostly to an increase in average investment balances of $119 million or 11% from the prior quarter. We have been and expect to continue to be very active in investment purchases due to our large overnight cash position. The net interest margin decreased, due mostly to the declining impact of PPP, as well as lower core loan yields. In addition, overnight interest-earning deposits increased to 25% of average earning assets compared to 22% in the prior quarter. These overnight deposits, in addition to floating rate loans and investments, result in a balance sheet position to take advantage of a rising rate environment. Trends in the composition of average earning assets as well as asset re-pricing information are shown on page 30 of the investor presentation. Removing the impact of discount accretion and PPP loans, the yield on loans decreased by 11 basis points as new loans in Q4 were being originated at rates lower than the current portfolio. Bryan will discuss loan production and balances in a few minutes. We had another strong quarter in deposit growth. Deposits grew $166 million or 2.7% in Q4, and grew $783 million or 14% for the year. When adding the growth for 2020, deposits have grown $1.8 billion or 39% over the last two years. During the same time, we have decreased our cost of deposits to nine basis points as shown on page 27 of the investor presentation. All of our regulatory capital ratios remain strongly above well-capitalized thresholds, and our liquidity position continues to increase. The combination of strong liquidity and capital gives us tremendous flexibility as we continue to grow the bank. You can refer to page 32 of the investor presentation for more specifics on capital and liquidity. Non-interest income increased $1.6 million from the prior quarter, due primarily to an increase in the gain on sale of other assets. As Jeff mentioned, we completed the sale-leaseback of our headquarters building in Olympia, and we recognized a $2.7 million gain as a result. We continue to see nice improvement in our overhead ratio due to a combination of expense management measures and asset growth. Our overhead ratio decreased to 2.06% compared to 2.30% in Q4 of 2020. Non-interest expense increased from the prior quarter due mostly to elevated costs related to severance payments and a quarter-over-quarter increase in incentive compensation accruals. These two expense items accounted for approximately $1.2 million in Q4, $500,000 due to severance payments and about $700,000 due to increased incentive compensation accruals. Even with these elevated Q4 expenses, total non-interest expense for the year 2021 increased only 0.2% over 2020 levels. In addition, through our initiatives over the past two years, we have decreased FTE by 12% from Q4 2019 levels. Our efficiency initiatives will continue to benefit us in 2022 and beyond. As occurred throughout 2021, a significant impact to our earnings for Q4 was a reversal of provision for credit losses in the amount of $5 million. Factors for the provision reversal included: a decrease in nonaccrual loans; a continued improved economic outlook; changes in the loan mix, most notably decreases in C&I and construction loan balances; and improvement in overall credit quality metrics. I will now pass the call to Tony, who will have an update on these credit quality metrics.
Tony Chalfant, Chief Credit Officer
Thank you, Don. Consistent with what we experienced last quarter, we're pleased to report continued improvement in our credit quality for the fourth quarter. At year-end, our key credit quality metrics reflected significant improvement over year-end 2020. For the fourth quarter, nonaccrual loans declined by $2.1 million or 8% from the prior quarter. Nonaccrual loans are now down 59% from our December 31, 2020 levels. As of year-end, nonaccrual loans totaled $23.8 million or 0.62% of total loans. The significant year-over-year improvement was due to three primary factors. First, we had a number of significant pay-downs or payoffs on loans that were the result of successful long-term workout strategies. Generally, these loans were not impacted by COVID, with issues that began well before the start of the pandemic. Second, there were very few loans placed on nonaccrual status during the year, totaling just $1.5 million. The average yearly additions to nonaccrual status in 2018 and 2019 were just over $25 million. The third factor was one significant and a few smaller COVID-impacted borrowers that were placed on nonaccrual status in 2020. Their improved performance in 2021 allowed us to move them back to accrual status during the year. Criticized loans, which are risk-weighted special mentions and substandard, declined by approximately 16% or $34 million since the end of the third quarter. Over the last 12 months, criticized loans have dropped by $107 million or almost 37%. We're getting close to a level we consider normal in a good economy. As of year-end, criticized loans were $41 million higher than December 31, 2019, which we consider to be at a pre-pandemic level. The lingering COVID impact on our hotel portfolio is the largest contributor to this remaining elevated level. Within this portfolio, we have approximately $66 million of criticized loans. While the underlying properties continue to demonstrate improving cash flow, they're not yet at a level of performance that warrants a return to a pass rating. With the expected continued improvement in the travel industry in 2022, we should be able to upgrade many of these loans in the second half of the year. There's a new slide in our investor presentation that shows the trends in our criticized loan levels, and that slide is on Page 25. During the fourth quarter, we experienced net charge-offs of $466,000. Total charge-offs were $679,000 and were partially offset by $213,000 in recoveries spread between our commercial and consumer portfolios. For the year, we experienced $526,000 in net charge-offs, representing a very low 0.01% of average loans. As a comparison, average annual net charge-offs for the three-year period from 2018 through 2020 were approximately $2.9 million. Despite some remaining COVID headwinds including related supply chain and labor shortage issues, the economies of both Washington and Oregon performed very well in 2021. With our strong credit culture, we expect our loan quality to outperform in a challenging economy. We were very pleased to see this reflected in our strong credit quality metrics at year-end. Heritage Bank is very well positioned as we move into 2022. I'll now turn the call over to Bryan, who will give us an update on loan production.
Bryan McDonald, President and COO
Thanks, Tony. I'm going to provide detail on our fourth quarter loan production results starting with our commercial lending group. For the quarter, our commercial teams closed $329 million in new loan commitments, up from $271 million last quarter and significantly up from $164 million closed in the fourth quarter of 2020. Please refer to page 18 in the Q4 investor presentation for additional detail on newly originated loans over the past five quarters. The commercial loan pipeline ended the fourth quarter at $462 million, down from $547 million last quarter but up from $413 million at the end of the fourth quarter of 2020. We have been seeing an increase in new loan requests from customers and prospects since July of 2021 when the governors of Washington and Oregon lifted many of the pandemic restrictions. We are seeing this trend continue into the first quarter of 2022. Loans, excluding SBA PPP, declined $17 million during the fourth quarter. The decline was due to the higher loan production during the quarter being offset by increased prepayments and payoffs, as well as a higher percentage of the new loan volume during the quarter being unfunded construction commitments. Specifically, outstanding construction loan balances decreased by $69 million, while unfunded construction loan commitments increased by $98 million during the fourth quarter. Please refer to slide 19 in the investor presentation for additional details on the utilization rate of construction loans, which shows a decline from the high 50% range down to 42% at the end of the fourth quarter. As these new construction loans begin to fund in 2022, we will see the utilization rate approach historical averages and recapture the balance declines that occurred in the fourth quarter. Consumer loan production, the majority of which are home equity lines of credit, was $23 million for the fourth quarter, down from $30 million last quarter and up from $18 million in the fourth quarter of 2020. As a reminder, we discontinued our indirect consumer lending business in the fourth quarter of 2020. The balances continue to run off, including an $18 million decline in the fourth quarter. Moving to interest rates, our average fourth quarter interest rate for new commercial loans was 3.71%, which is up 20 basis points from 3.51% last quarter. In addition, the average fourth quarter rate for all new loans was 3.48%, up six basis points from 3.42% last quarter. The mortgage department closed $45 million of new loans in the fourth quarter of 2021 compared to $44 million closed in the third quarter of 2021 and $57 million in the fourth quarter of 2020. The mortgage pipeline ended the quarter at $29 million versus $55 million in the third quarter and $33 million in the fourth quarter of 2020. Refinances made up 80% of the pipeline at quarter end. With interest rates rising, we anticipate refinance volumes will decrease and overall mortgage volume will be lower in 2022. Moving on to SBA PPP forgiveness, the process continues to progress smoothly. As shown on slide 22 of the Q4 investor presentation, of the original $1.3 billion in PPP loans originated, we had only 11% of the original PPP balances still outstanding at $146 million at quarter end. Additionally, to the limited extent we have filed claims with the SBA, these have been processed and paid very quickly. I will now turn the call back to Jeff.
Jeff Deuel, CEO
Thank you, Bryan. As mentioned earlier, we're pleased with our performance as we emerge from the pandemic. We're seeing a nice upswing in organic production across the bank with deals coming from existing customers and new high-quality prospects. We are prepared for high single-digit growth, and we're optimistic we will get back to that level of historical loan production as the year progresses. We believe that there are opportunities to add talent to the team and new customers to the book as a result of dislocation in our markets. However, we don't expect to see that dislocation begin to materialize until later in the year. We rationalized our expense base last year, and we will continue to focus on expense control in '22. We have also continued to focus on our technology strategy, which is designed to support more efficient operations, a more consistent customer experience and position us well to pivot as bank technology continues to evolve and we continue to grow. For reference, on Page 7 of the investor deck, we have included a new overview slide of our technology strategy. You will see that several segments of that strategy went into production last year with more segments coming online in '22 and beyond. We are prepared to pursue acquisitions in the three-state area when we see the right deals for us. As Don mentioned earlier, our capital levels and our robust liquidity provide us with a strong foundation to address challenges and take advantage of opportunities. That's the conclusion of our prepared comments. So, we're ready to open up the call to any questions that folks on the call might have.
Operator, Operator
We've had our first question in from Jeff Rulis. Jeff Rulis from D.A. Davidson. Your line is now open. Please go ahead.
Jeff Rulis, Analyst
Thank you. Good morning, everyone. I have a question, possibly for Jeff. You explained the loan trends quite well. As we move into 2022, with less auto runoff, it seems that your construction line of credit will likely increase. There is also growing demand in originations, and you mentioned an expectation of high single-digit loan growth. The main concern is the payoffs, which you've hinted at being positive on the credit side. Could you elaborate on that, Jeff? Do you believe the payoffs are somewhat unpredictable and that higher rates might affect that? What are your thoughts on net growth for 2022?
Jeff Deuel, CEO
I'm sure Bryan has some comments that he'd probably like to add. But Jeff, it actually has been pretty lumpy, and it's a little bit hard for us to forecast. Part of it ties back to the robust environment we're in with the customers being able to sell properties and businesses at rather high prices. It's hard to turn that down when it presents itself. The one thing I will tell you though is when we see the payoffs occurring, we're also seeing that money or those loans coming back to us in another form as they reinvest in another business or another building. So, I think we're probably going to be facing prepayments as we have for the past couple of years. It's just hard to know what quarter they're going to be up in and what quarter they may be down. I think the more important thing for us is to keep the origination team focused on developing all of those new prospects to help offset the net impact of those payoffs. Bryan, anything you want to add?
Bryan McDonald, President and COO
Just Jeff, just picking up on your last point Q3, Q4, if you look at Page 18 in the investor deck, we did $600 million of new production after the governors eased the restrictions and $100 million a month or a little bit more Jeff with the prepays. We're seeing now is really the target. So, we'd love to get the pipeline up a little higher than where it ended the quarter. But the deal flow that we're seeing right now is strong. We've seen good deal flow since July, and that's continuing. So, getting that $100 million or maybe $110 million a month in new production with maybe a bit more normalized funding mix in there we're pretty close at least looking at the results for the second half of the year and what we're seeing so far this quarter. The prepays and payoffs as Jeff said, we're in a strong market and customers are selling businesses and selling real estate. We would expect that that's going to continue based on how strong the economy is here in the Northwest. But we're not far off on the gross production numbers at least looking at the last couple of quarters. We'd like to get the pipeline up a little higher based on that elevated payoff volume we saw as we went through the year last year.
Jeff Deuel, CEO
Jeff, I would add, and you're familiar with the region we're in, but we've been pretty much buttoned down here in our two-state area longer than a lot of other parts of the country. None of us are experienced in predicting how we come out of a pandemic in any form. But what we are facing too, which makes it hard to predict is we still have customers and prospects that are essentially locked down where they're not making contact in person with anybody. We still got a little bit of that factor to deal with and sort out. And that also makes it difficult to predict.
Jeff Rulis, Analyst
Yes, thank you. I wanted to check on the expense line. Don, you mentioned around $1.2 million for severance and increased incentives. Some of that may recur, although not the severance, but possibly the incentives. If you exclude that, we're looking at a figure in the low $37 million range. I wanted to confirm if you're estimating a run rate of $37 million to $38 million for 2022. Is my understanding correct? If the rate decreases, do you plan to maintain expenses from that point?
Don Hinson, CFO
I believe it generally increases slightly throughout the year. There is likely to be some wage pressure this year. However, overall, if you exclude the $1.2 million from Q4, you would return to a reasonable run rate starting in Q1. This is why we are projecting between $37 million and $38 million for the year, as there could be some rise in expenses during the year. But for Q1, that should be our expected run rate.
Jeff Deuel, CEO
Jeff, we've got a little bit of an interesting dynamic with that incentive piece in the standpoint that the programs benefiting from the recapture of the reserve, which is earnings we created in 2020, but really didn't see it present until 2021. So, there's a bit of a timing difference there, and there's also a bit of a timing difference with regard to how those new commitments play out. Incentives get paid on commitments when they close, and we're going to see the funding probably in the first part of the year. So, there's a little timing difference there. I think that that's just the impact of how we're coming back as an economy and timing. I think that will also contribute to settling down a bit as Don said.
Jeff Rulis, Analyst
Got it. That's helpful. Maybe a little bit of a lag and some leverage in the model. I'll step back.
Jeff Deuel, CEO
Thank you.
Operator, Operator
Our next question comes in from David Feaster of Raymond James. David, your line is open, please go ahead with your question.
David Feaster, Analyst
Hey, good morning everybody.
Jeff Deuel, CEO
Good morning.
David Feaster, Analyst
I just want to follow back up on the growth outlook. I guess kind of thinking about the high single-digit growth run rate, I guess we have two avenues to get there, right? We either see accelerating originations or see a slowdown in payoffs and paydowns. I guess could you just maybe walk through some of the puts and takes with both of those? What kind of things that you guys are doing to accelerate originations and productivity? And then on the payoffs and paydown side, I mean, just what are you seeing there? It sounds like it's more asset sales and deleveraging. But do you find that you're passing on more deals from pricing or structural reasons?
Jeff Deuel, CEO
I think Bryan will tackle this, but one of the things that I would say is we have not changed our approach from a credit standpoint. We talk in terms of a moderate risk profile. I think to a certain degree, David, that's kind of self-limiting. That’s why you hear us typically say that our loan production that we're striving for is maybe something less than double-digit because we think part of the impact is the parameters with which we operate cause a certain limit. But no, I don't think that we're overextending or going beyond our normal parameters. Bryan, maybe you could give some color around expectations with regard to volume and maybe some anecdotal stories about what we're seeing with the prepays.
Bryan McDonald, President and COO
Yes. I think David, Page 20 of the investor presentation provides a good overview of what's happening within the portfolio. In Q4, we originated $329 million, with $222 million outstanding, meaning $107 million was unfunded. In Q3, the figures were $271 million originated and $195 million outstanding, which resulted in about $76 million unfunded. During Q3, we experienced $185 million in prepays and payoffs, averaging just over $60 million monthly. However, there was a slight increase in net utilization by $21 million in Q3. In Q4, payoffs increased further to $204 million, while we experienced a drop in utilization and payments of $38 million. The shifts from payoffs, prepays, and changes in utilization represented significant quarterly swings. In Q3, the negative impact was $164 million, and in Q4, it rose to $242 million, indicating a notable variation in prepaid payoffs and utilization. Much of this fluctuation is expected to stabilize, particularly with the increased construction commitments. Therefore, I believe Q3 serves as a better indicator, and we hope we've reached the lowest point for utilization declines. Our lines decreased by about $11 million in Q4, and we expect to stabilize there. At least, we hope not to see a significant uptick in 2022, while also avoiding continued declines. In terms of our client mix, we're seeing more new customers with substantial deposit balances, some taking on term debt, usually with a zero balance on their lines. Many new opportunities in the market relate to construction, whether owner or non-owner occupied, which contributed to the dollar amounts in the quarter. Predicting when utilization rates will increase or seeing more core C&I requests is challenging but we are receiving them more consistently than last year. Overall, when considering total production of $600 million for the last half of the year, averaging $100 million a month, that’s a solid figure and slightly above that. As the funding mix normalizes, this is a favorable number. The market is competitive, and everyone is actively pursuing loans like we are, but we are successfully securing our share of the market.
David Feaster, Analyst
Okay. That's helpful color. And then just maybe switching gears to the margin. Could you maybe just give us some thoughts on how you think about deploying excess liquidity? We're sitting at north of 23% of total assets are cash. I mean, is there an increased appetite to start deploying that into securities? Obviously, loan growth is a top priority. And then just kind of as we see the loan growth accelerate in the earning asset mix, do you think we've troughed here? Any color on your rate sensitivity and how you'd expect the margin to react in the first couple of hikes?
Don Hinson, CFO
Okay. Well you have a strong position.
David Feaster, Analyst
It's a lot.
Don Hinson, CFO
Yes, let's start with the investments. We purchased about $268 million in Q4, which is higher than usual. We'll continue this trend, possibly increasing our investment levels, at least until we see some cash balances. When rates are higher, it will be more beneficial for us. We need to ensure that if we don’t see loan growth, which we are planning for, we will still use our $1.6 billion in cash for more investments. Regarding the net interest margin, I believe we will likely reach the bottom in Q1. Due to the Paycheck Protection Program, we will experience a decline in balances, which will materially affect our margin. However, I think we will begin to see margins increase later in the year, especially if there are rate increases. Having 38% of our interest-earning assets in floating rates will have a significant impact. A 25 basis point shift could contribute about nine basis points to our net interest margin, which would be substantial and should benefit us significantly.
David Feaster, Analyst
Okay. That's helpful color.
Don Hinson, CFO
Do you have a follow-up on that?
David Feaster, Analyst
You covered everything thoroughly. It was quite comprehensive. I also appreciate the technology slide. Could you explain your tech strategy a bit more and outline your investment priorities? Additionally, we have several initiatives that were launched this year. Could you share the benefits in terms of efficiency or productivity that have come from these technology initiatives?
Jeff Deuel, CEO
Sure. I think it's important to outline that the overarching premise of the plan is to integrate process and technologies to create that omnichannel customer experience. We think that's what our customers want and what they'll expect from us in the future. As we continue to grow the bank, we also wanted to ensure we can maintain the community bank identity that we have because we believe that's what differentiates us from the big bank competition and the fintechs. The notion of preserving the community bank feel of Heritage is something we refer to as community banking at scale, which you see under the line on that slide. Now, some people have asked us why we are building instead of buying. We did look at several brand-name vendors for a solution but we couldn't find exactly what we thought we needed to be successful. We also wanted a certain amount of control over what we built. So we also didn't want a platform that just monitored production and was a place to put information. We wanted a platform to be a place to go for information and a place to get things done, essentially a fulfillment engine. We call it a hub for relationship management and also for service delivery. We developed this tech platform which we hope and believe will become a primary resource for everybody on the team, whether you're on the production side or the support side. Our goal or our expectation is that it becomes the second place employees go to in the morning after they sign on to Outlook. So if you look at the slide, it's all centered. You can see in that one box, Heritage360 is essentially the center point for everything. That's where you go to get information first and foremost and to service accounts. It's a place that no matter where you come to us, you can see over on the left side those are the methods that our customers come in contact with us, but we're going to end up using that Heritage 360 platform to service them, whether they start with online banking, get confused on setting up an account, and they need to talk to somebody, or whether they come to their relationship manager. We've developed a technology ecosystem with HeritageONE, which is what we call that ecosystem. It allows us, from a proprietary standpoint, to create our own platform where we can develop processes internally but also tie ourselves through APIs to the vendors we decide to use. So as you look at this diagram, Heritage360 has the service engine, which is up in the right-hand corner. That's how we get things done. There's the sales pipeline where we've tied our online account opening to that, for example. The Treasury Management 360, which is in the process of being launched now, is as much about service as it is about helping new customers get set up on treasury management products in a seamless fashion. Over on the right side is the progression that we've gone through with getting that customer service engine up first, which we've also referred to as a CRM. The commercial loan origination system is in place now and being used across the bank and treasury management is being launched. David, to get back to the other part of your question, eventually as we implement all of these things, the savings will come in the form of how many times we have to touch a loan to originate it, how many people have to be involved in the closing process, allowing our service folks on the front line to not have to go to seven different locations to get enough information to answer customer questions. It's all in one place. We believe that tying that streamlined experience from a digital standpoint to the people who are interacting with our customers and prospects is a winning combination that will allow us to continue to present ourselves as a community bank regardless of how big we get. Hopefully that wasn't too much information and hopefully it was clear enough.
David Feaster, Analyst
Great color. Yes. No, that was great color. Thank you very much.
Operator, Operator
Thank you. And our next question comes in from Kelly Motta of KBW. Kelly, please go ahead with your question.
Kelly Motta, Analyst
Hi. Thank you for the question and for the insights on the tech spending. The data processing line saw an increase of about $700,000. Is that a sustainable rate for that line item? Did it actually increase, or should we expect it to revert to the previous rate of around $4 million that it was running before the fourth quarter?
Jeff Deuel, CEO
I'm going to let Don answer that specific question. Kelly, good morning. But wanted to…
Kelly Motta, Analyst
Good morning.
Jeff Deuel, CEO
To also make a point that we started this build three years ago. So, a lot of the cost of it has been in our expense base for a while now. Don, I don't know if there's some specific color on that increase that you could share to answer Kelly's question.
Don Hinson, CFO
Sure. Part of that was due to some implementation fees, and the other part was just due to increased costs because of our investments in technology. I would say it's probably about half and half.
Kelly Motta, Analyst
Got it. That’s helpful. Did something happen?
Don Hinson, CFO
But some of it is going to be in the.
Kelly Motta, Analyst
Understood. And then with the buyback, yes.
Jeff Deuel, CEO
And Kelly, I would expect I'm sorry to interrupt you. I just wanted to add that…
Kelly Motta, Analyst
Sorry. We need to carry you off. Go ahead.
Jeff Deuel, CEO
No, I just wanted to add to what Don said that we're in the process of doing some analysis around a look back at what it would have cost us to use a third party and what it has cost us to do this on our own. Early-stage feedback is that it's kind of about the same. If that proves to be true when we do the final analysis, I think we're going to be happy we took the path we did because we have complete control, and we're getting exactly what we want.
Kelly Motta, Analyst
Got it, understood. I did want to switch to the buyback. It looks like your repurchases came down quarter-on-quarter. Just where your stock is and also given on the flip side that it seems like you're pretty confident about production volumes. How are you viewing the buyback as we enter 2022 and the relative attractiveness of the stock at these levels versus other avenues of capital returns?
Don Hinson, CFO
Yes, we are hoping to again grow our loan portfolio quite a bit this year. So we're not anxious to buy back a lot of it. The price dropped to a level where it was very attractive. We've mentioned that our earn-back on buybacks is probably within five years. So when it hit that level, we did dabble a little bit last quarter, but it wasn't a lot. If that happens again we may if the price gets down that low. But it's not really our first choice of capital deployment. We are just hoping to grow into it over time.
Kelly Motta, Analyst
Got it. I just have one last question about loan sales. They decreased significantly, and I understand that refinancing volume is declining. Mortgage contributions are expected to be substantial. Is the $0.5 million a reasonable estimate for future performance, considering potential seasonality? I'm trying to finalize my model on these. Thanks.
Bryan McDonald, President and COO
Jeff, you want me to take that one?
Jeff Deuel, CEO
Yes, that would be great, Bryan. Thanks.
Bryan McDonald, President and COO
Yes, Kelly, the volumes were actually really strong in the quarter, but we ended up with a significantly higher percentage of portfolio just volume into the portfolio either construction or jumbos. I think we'll see that in Q1. A little hard to tell the rest of the year if it maybe doesn't normalize to a more even mix with secondary market sales. It was really different in the fourth quarter than what we normally see, but again a little hard to predict going into next year. Also, just volumes in general right will the Q4 volumes in general hold up. So my guess is we'll end up with a higher ratio of secondary market sales than what we saw in Q4, but overall volume is down somewhat from 2021.
Kelly Motta, Analyst
Got it. Thank you so much. I’ll step back. Appreciate it.
Jeff Deuel, CEO
Thanks, Kelly.
Operator, Operator
The next question on the line comes from Andrew Terrell of Stephens Inc. Andrew, please go ahead with your question. Thank you.
Andrew Terrell, Analyst
Hey, good morning.
Jeff Deuel, CEO
Good morning.
Andrew Terrell, Analyst
Jeff, maybe just to start. I think last quarter you mentioned that some of the recent M&A announcements in your footprint could potentially be a catalyst for more conversations for Heritage moving into 2022. I guess, a question, have you seen that kind of materialize yet? And then just more broadly can you just talk to us about your expectations for M&A potential in 2022?
Jeff Deuel, CEO
We continue to engage with the banks that interest us in the region. While I don’t expect anything to happen immediately, I wouldn’t be surprised if opportunities arise this year. We are prepared to act when the right chances come along, aiming to pursue those that align with our strategy as we have in the past. Given the current disruptions, it's too early for us to see any tangible benefits. Several banks are merging in our area, including Columbia and Umpqua, which is significant for us. If there are disruptions affecting talent or customers, I believe they will become more apparent towards the end of the year, likely as we approach a conversion scheduled for the first quarter of next year. This situation typically involves many months of customer communication, so any opportunities may emerge during the summer and late in the year.
Andrew Terrell, Analyst
Okay. That's very helpful. I appreciate it. And then maybe Don, can you help us out with kind of tax rate heading into 2022? And should it follow kind of a similar trajectory as it did kind of walking throughout 2021?
Don Hinson, CFO
Sure. It increased a little bit in Q4 as a result of some reversal of provisioning. So that impacted that quite a bit. I think it's going to be probably more in the 17% to 18% range heading into next year.
Andrew Terrell, Analyst
Okay. Great. All of my questions asked and answered. So thanks for taking my questions.
Don Hinson, CFO
Thank you, Andrew.
Operator, Operator
Matthew Clark of Piper Sandler, you have the next question. Please go ahead.
Matthew Clark, Analyst
Thanks. Good morning, guys. How are you?
Don Hinson, CFO
Good morning.
Matthew Clark, Analyst
Maybe starting with the rate sensitivity, Don, you mentioned that for every 25 basis points, there is a nine basis point benefit to the net interest margin. Were you using the 30-plus percent that reprices within three months for that estimate, or is there more to it? I'm trying to understand if you were factoring in some sort of deposit beta with that estimate or not.
Don Hinson, CFO
No, I don't think that the first couple of rate increases will have much impact on deposit rates. They are low, and some CDs are still slightly repricing down, though this isn't significantly affecting the cost of deposits. Considering that 38% of our interest-earning assets are floating, almost everything is above the floors. We only have about $45 million in loans that fall below these floors and about $25 million in liabilities that are priced based on indices. This is the point I am trying to convey.
Matthew Clark, Analyst
Okay. Thanks. And then just on the reserve at 1.15% excluding PPP, I think your day one was 1.01%. I think pre-pandemic or pre-CECL you guys were back in 2018 in the mid-to-high 90s. What's your sense for where that coverage ratio could stabilize? I know you still have some marks left, but kind of ex-marks.
Jeff Deuel, CEO
Don, you want to take that?
Don Hinson, CFO
I think the allowance percentage?
Matthew Clark, Analyst
Yes. That makes sense.
Don Hinson, CFO
I'm sorry. Yes, I think if we don't experience any losses and we navigate through the rest of this with fewer uncertainties, we could potentially lower the allowance percentage, possibly even below our previous levels. The models we use are based on historical losses, so if we continue to have periods without losses, the model suggests we shouldn't expect to maintain a higher percentage. I can definitely see that happening. The time it takes to reach that level will depend on any losses we might incur, economic growth, and the uncertainties in the market.
Matthew Clark, Analyst
Got it. Okay. That’s great. Thanks, guys.
Don Hinson, CFO
Thanks, Matt.
Operator, Operator
Our final question on the line comes from Tim Coffey of Janney Montgomery Scott. Please go ahead. Thank you, Tim.
Tim Coffey, Analyst
Great. Thanks. Good morning, everybody.
Don Hinson, CFO
Good morning, Tim.
Tim Coffey, Analyst
The overhead expense ratio has been trending down positively. What is the likelihood or timing of getting it under 2% on assets? Will that happen in 2023, or is it uncertain due to the current wage inflation?
Jeff Deuel, CEO
I'm going to ask Don to grab that.
Don Hinson, CFO
I think we kind of talked about the expense levels themselves. For the overhead ratio to get below 2%, we're going to need to see probably continued strong asset growth. That's a little uncertain right now because we've seen such strong deposit growth over the last couple of years. We keep expecting to see some outflow of deposits, and we may see some of that this year. If that happens, of course, that impacts assets, which impacts the overhead ratio. I'm still thinking we're going to be around 2%, maybe a little above over the next year or two. That's my best forecast right now because of what I mentioned about the asset growth not being as strong.
Tim Coffey, Analyst
Sure. Some of the loan production in the last two quarters was good. Yes, I apologize.
Don Hinson, CFO
So again, it's the deposit growth that really drives the asset growth. Your loan growth is simply taking cash and putting it into loans. That's why I'm saying it really depends on our deposit growth, as that's what will drive that.
Tim Coffey, Analyst
Okay. Understood. And that has I guess been slowing last couple of quarters. It wasn't as big as 1Q. And then Bryan, I mean, forecasting pre-payments is always a bit challenging. But given that we're about to go into a higher rate cycle, do you think there could be a rush of prepayments ahead of that?
Bryan McDonald, President and COO
No, it is primarily being driven by asset sales, and values are still related to either business sales or the sale of the underlying collateral. The market remains strong. Looking at the entire year of 2021, we observed an upward trend each quarter. We have returned to levels similar to those before the pandemic when the market was also robust. A couple of hundred million in pay-offs and pre-pays per quarter would not be surprising, even with rising rates, unless there is some weakness in the economy. Currently, there is significant interest in the Northwest, whether in real estate or companies. Another aspect has been the utilization rate; last quarter, net advances and payments decreased by $38 million. If that were to stabilize at zero or increase slightly, it would greatly benefit us. I feel that we have reached a relatively low level, and hopefully, we are at the bottom, with no negative impact in future quarters.
Tim Coffey, Analyst
Okay. Those are my questions. Thank you.
Jeff Deuel, CEO
Thanks, Tim.
Operator, Operator
We have no further questions on the line, so I'll hand back to the team.
Jeff Deuel, CEO
Thanks, Gemma. If there's no more questions, then we'll wrap up the quarter's call. We thank you for your time, your support, and your interest in the ongoing performance of Heritage Financial. We look forward to seeing and talking with many of you in the coming weeks. We'll sign off now. Thank you.