Earnings Call Transcript - HFWA Q1 2021

Operator, Operator

Thank you for joining us for the Heritage Financial Earnings Call. Please note that today's call is being recorded. I will now hand the conference over to Mr. Jeff Deuel.

Jeffrey J. Deuel, CEO

Thank you, Cynthia. Welcome, and good morning to everyone who called in, and those who may listen later. This is Jeff Deuel, CEO of Heritage. Attending with me are Don Hinson, Chief Financial Officer; Bryan McDonald, Chief Operating Officer; and Tony Chalfant, Chief Credit Officer. Our earnings release went out this morning premarket, and hopefully, you've had an opportunity to review it prior to the call. We have also posted an updated first quarter investor presentation on the Investor Relations portion of our website. We will reference that presentation during the call. Please refer to the forward-looking statements in the press release. Overall, we are very pleased with our financial results for the first quarter, particularly given the pandemic environment that has been imposed on all of us. We are also very proud of our team and their strong performance during a very difficult period of time. The first quarter results have been influenced by the declining rate environment, carefully managed expenses and full participation in PPP Round 2. Additionally, our long-standing focus on credit quality and managing loan concentrations has played out well for us so far, and that discipline, together with the improving economic forecast, has enabled us to report more favorable credit trends and the recapture of some of our reserve build from last year. The combination of these factors has allowed us to report an EPS of $0.70 for the first quarter, as well as an ROA of 1.51%. While overall loan volume continued to be muted in the first quarter, our team's focus was on portfolio management and Round 2 of PPP with notable success. With most branch lobbies reopened, together with PPP Round 1 and Round 2 moving into forgiveness phase, as well as widespread vaccine deployment in our region, our teams are now focused on more traditional outreach to customers and prospects. We are already seeing results in a rapidly growing pipeline of deposits and loans, which positions us well for the balance of the year and into 2022. I also want to add that we have continued to focus on completing important technology initiatives during the past year, which we have highlighted on Page 6 of the investor deck. I'm pleased to report that our CL 360 initiative, one that will automate the loan origination process, has launched internally, and we will continue to enhance that platform over the balance of this year. Additionally, our new CRM platform, Heritage 360, will launch in June and becomes the foundation for client service across the bank. Both of these undertakings will enable us to be more efficient, enhance capacity on the team, and allow us to provide a more seamless customer experience. It's very exciting for the team to be moving these two initiatives into production.

Donald Hinson, CFO

Thank you, Jeff. As Jeff mentioned, overall profitability was very positive in Q1. I will be reviewing some of the main drivers of this Q1 performance. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the fourth quarter of 2020. Starting with net interest income, there was only a slight decrease in net interest income from the prior quarter, and that was due more than anything to fewer days in Q1 compared to Q4. Other factors affecting this line item were an increase of $129 million of average interest-earning assets, partially offset by a 2 basis point decrease in the net interest margin. The increase in average earning assets was due mainly to the strong deposit growth in Q1. The decrease in net interest margin was due mostly to a higher percentage of excess liquidity. Interest-earning deposits increased to 11.8% of average earning assets in Q1 compared to 9.5% in the prior quarter. This increase in the percentage of overhead cash was offset by a similar size decrease in the percentage of loans to average earning assets. Trends in the composition of average earning assets are shown on Page 24 of the investor presentation. Removing the impacts of discount accretion and PPP loans, the yield on loans increased 2 basis points from the prior quarter. This increase was due mostly to a 3-basis point positive impact from the payoff of a nonaccrual loan during Q1. Bryan will discuss loan production and balances, including PPP lending in a few minutes. We continue to work down the cost of our total deposits with interest-bearing deposits decreasing 3 basis points from the prior quarter. Our cost of total deposits decreased to 12 basis points in Q1, which is an all-time low for the bank. More information regarding deposit growth and cost deposits can be found on Page 23 of the investor presentation. As I previously mentioned, Q1 deposit growth was very strong. This growth was due to a combination of factors, the most significant of which was the deposit of PPP Round 2 loan proceeds into customer accounts. Even with the significant balance sheet growth, all of our regulatory capital ratios increased in the prior quarter and remained strongly above the well-capitalized thresholds. The combination of strong liquidity and capital gives us tremendous flexibility as we continue to grow the bank. As mentioned in the earnings release, non-interest income decreased substantially, due mostly to significant gains, totaling $2.8 million that were recognized in Q4. In addition, we experienced a decrease in the mortgage loan sale gains from the prior quarter. We expect that quarterly loan sale gains in 2021 will be somewhat lower than they were in the last half of 2020. We continue to see nice improvement in our overhead ratio due to the combination of expense management measures and asset growth; our overhead ratio decreased to 2.22% for Q1 compared to 2.30% in the prior quarter and 2.70% in Q1 2020. Non-interest expense decreased in the prior quarter due mostly to the costs in Q4 relating to the branch consolidations, which we completed in January. Since the consolidations occurred in mid-January, we were able to realize substantially all the cost savings in Q1. Additionally, non-interest expense levels in Q1 benefited from approximately $450,000 of deferred costs related to PPP Round 2 originations. Offsetting the deferred costs in Q1 were approximately $600,000 of direct costs associated with PPP in Q1. These direct costs are expected to decrease to approximately $300,000 in Q2 and to $100,000 per quarter from Q3 of this year through Q1 of next year. A significant impact on our earnings for Q1 was the reversal of the provision for credit losses in the amount of $7.2 million. Of this amount, $6.1 million was related to the allowance for loans and $1.1 million was related to the allowance for unfunded commitments. Although partly due to lower loan balances and a net recovery in Q1, the most significant factor for the provision reversal was due to an improved economic outlook. In addition, we are seeing improvements in many of our credit quality metrics. I will now pass the call on to Tony, who will have an update on these credit quality metrics.

Tony Chalfant, Chief Credit Officer

Thank you, Don. As you stated in the first quarter, we saw the first meaningful improvement in our credit quality metrics since the start of the pandemic in early 2020. We ended the quarter with net recoveries of $175,000. A modest level of primarily consumer loan charge-offs was more than offset by recoveries on several commercial loans. These loans had been in nonaccrual status, and we were successful in recovering all of the principal and accrued interest. It's important to note that these were long-term workouts where the borrowers were already in nonaccrual status prior to the onset of the pandemic and were not directly impacted by COVID-19. For the quarter, nonaccrual loans declined by $5.2 million or 9%. As of March 31, nonaccrual loans totaled $52.9 million or 1.15% of total loans. Loan payoffs and paydowns accounted for $3.6 million of the reduction, while the remainder was the transfer of several loans back to accrual status. The loans moved back to accrual status have a long history of payment performance and are all well secured by real estate. The addition of new loans to nonaccrual status at $468,000 was much lower than we've experienced over the last three quarters. Potential problem loans decreased by $18.5 million during the first quarter or 10.2%. A significant component of this decrease was a paydown on a loan for a borrower in a COVID-19-impacted industry. Additions to this category during the quarter were generally offset by loans upgraded to a pass rating and TDRs that were reclassified to performing status. For more information on our credit quality, I would direct you to Page 21 of our investor presentation. As we see many of our COVID-19 impacted borrowers continue to recover, we're seeing reduced levels of loan modification requests that we've been providing under the CARES Act. As of quarter end, there were 67 loans totaling $46.7 million that remained in a payment deferral modification status. This is down from 177 loans, totaling $92.5 million, at the end of 2021. Of these remaining modified loans, $36.7 million or approximately 79% are in the hotel and restaurant industries. In summary, we believe with the vaccine rollout and a continued movement back to a more normalized business environment, we should continue to see improved credit metrics over the next several quarters. I'll now turn the call over to Bryan, who will have an update on our loan production and our SBA PPP loan activity.

Bryan McDonald, Chief Operating Officer

Thanks, Tony. I'm going to provide detail on our first quarter production results, starting with our commercial lending group. For the quarter, our commercial teams closed $200 million in new loan commitments, up from $140 million last quarter and up from $161 million closed in the first quarter of 2020. The commercial loan pipeline ended the first quarter at $540 million, up 31% from $413 million last quarter and up from $506 million at the end of the first quarter of 2020. New loan demand has increased significantly in the last two months as discussions with customers on capital projects and expansion plans continue to accelerate. Loans, excluding SBA PPP balances, decreased $44 million during the first quarter, due in part to a 3% decline in the loan utilization rate, which reduced balances by approximately $50 million. Consumer production was $16 million for the first quarter, down from $18 million last quarter and down from $49 million in the first quarter of 2020. The decline versus 2020 was due to the discontinuation of our consumer indirect lending business during the first quarter of 2020. Moving to interest rates. Our average first quarter interest rate for new commercial loans, excluding PPP loans, was 3.53%, which is up 21 basis points from 3.32% last quarter. In addition, the average first quarter rate for all new loans, excluding PPP loans, was 3.66%, up 24 basis points from 3.42% last quarter. The mortgage department closed $43 million of new loans in the first quarter of 2021 compared to $57 million closed in the fourth quarter of 2020 and $31 million in the first quarter of 2020. The mortgage pipeline ended the quarter at $36 million versus $33 million in Q4 and $54 million in the first quarter of 2020. Refinances made up 71% of the pipeline at quarter end. Based on the pipeline going into the quarter and a relatively higher mix of portfolio loans, we anticipate gain on sale to be closer to $1.1 million for the second quarter. Moving on to SBA PPP. During the quarter, we provided 2,235 Round 2 SBA PPP loans for $353 million, and we would direct you to Page 19 of the investor deck for additional PPP loan details. We plan to continue taking applications until close to the extended end of May expiration date for the program unless funding expires sooner. Based on the current application flow, we now anticipate total volume for Round 2 PPP will approach $375 million. The SBA PPP forgiveness application process continues to progress smoothly for Round 1 PPP customers, and we anticipate having the bulk of Round 1 applications processed by the end of August. We are already receiving requests from Round 2 PPP customers who want to apply for forgiveness and are planning to start accepting applications for this phase by mid-May. I will now turn the call back to Jeff.

Jeffrey J. Deuel, CEO

Thank you, Bryan. As I mentioned earlier, we're very pleased with our performance to date. We are also delighted to be pivoting away from the defensive position we've been in for the last year and focusing on the more positive environment ahead. We are seeing a nice upswing in our pipeline across the bank with deals coming from existing customers and new high-quality prospects. The heavy lifting by our team with PPP loans will pay dividends for years to come, and we continue to see evidence of that. Most recently, a significant new C&I relationship that was referred to us by a new customer in Portland, who we helped with PPP Round 1 last year. Additionally, our presence in the core markets of Seattle, Bellevue, and Portland is still relatively new for us and continues to offer many new and exciting business opportunities, which will help further establish our positions in those markets. With the vaccine rollout, the latest stimulus package, and given what we know today, we believe the risk in the loan portfolio is much improved over just a quarter ago. And as things continue to open up, the performance of many of our most severely impacted businesses should continue to improve. We are also happy to see some long-term problem loans get resolved this past quarter. Our capital levels and our robust liquidity provide us with a strong foundation to address any remaining challenges and to make the most of opportunities. Our focus is on growth supported by efficient operations, and the leadership team continues to identify and implement process improvements and efficiencies that will allow us to continue to deliver consistent, long-term performance in all of our financial metrics. You can see evidence of this focus in the notable decline in FTE numbers and the increase in average deposits per branch and the increase in average assets per employee. That's the conclusion of our prepared comments. Cynthia, we're ready to open up the call to any questions anyone might have.

Operator, Operator

I'm showing no questions in queue at this time.

Jeffrey J. Deuel, CEO

Well, Cynthia, thank you. That's a little unusual, but we'll move forward, and we'll see many of these people in the coming weeks.

**Unknown Executive, **

Jeff, if I could interrupt for just one moment. We do have a few people in the queue. Cynthia, I see 4 people.

Operator, Operator

And we'll take the first question from Matthew Clark with Piper Sandler.

Matthew Clark, Analyst

I guess the first question I wanted to hone in on the core NII outlook and the core margin as well. Is your plan to try to grow core NII by maybe leveraging the balance sheet with securities from here? Obviously, loan growth sounds like it's going to be stronger going forward too, with the pipeline up. But I just want to get your overall thoughts on stabilizing, if not growing core NII of $42 million in that core NIM of 3.27%.

Jeffrey J. Deuel, CEO

Thank you, Matt, for your question. I just wanted to say that when there are no questions, it makes you wonder if anyone is engaged, so I appreciate your participation. Yes, Don may want to add to this as well. The main objective we have is to effectively utilize our cash. This will involve growing our loan portfolio, which we feel more optimistic about this quarter compared to last, as well as focusing on investments. Don, do you have anything to add?

Donald Hinson, CFO

Sure. I think we're going to continue to experience some core pressure on the margin just related to the loan yields still coming down over the next few quarters. I do think we are going to offset that some by continued leverage of our cash position, which has continued to grow. I think that cash position will subside some now that we're kind of getting through Round 2 originations on PPP. But as you know, we added quite a bit of investments of almost $100 million, I think, in Q1. We'll continue to do that in addition to, again, hoping to ramp up kind of the core loan production going forward. So a combination of the leverage of loans and investments, but we will see the margin come down some more over the next few quarters.

Matthew Clark, Analyst

Okay. And then just on the pipeline, the increase in terms of what you're seeing specifically in terms of projects and maybe by region within your footprint?

Jeffrey J. Deuel, CEO

Bryan, do you want to take that one?

Bryan McDonald, Chief Operating Officer

Sure. Sure, Matthew. So it's really across the board. Just looking at the detail quarter-over-quarter, we've seen a big jump in King County, and then in and around Seattle, Bellevue, and also down the Portland market. But also, the large counties on either side of the Seattle, Bellevue market have seen significant increases. And we are seeing a lot of requests from our customers as well as new customers, and then there is also an uptick in development going on. So we're getting an uptick in development requests. So really across the board, Matt, all categories have been heading up really in the last couple of months.

Jeffrey J. Deuel, CEO

And Matt, for some anecdotal feedback, I tend to measure production based on how often the Executive Loan Committee reviews deals. We went from very few actions to now seeing something at least every day, which is a great sign for us.

Matthew Clark, Analyst

That's great. And then last one for me just on M&A. Any updates in terms of discussions you're having and just overall activity there?

Jeffrey J. Deuel, CEO

Well, unlike the rest of the country, the Pacific Northwest seems to be pretty quiet still. I think the messaging we've been giving is that the first half would be fairly quiet. And based on where we are now, I think that's the expectation. We might start to see things move in the second half of the year. That would be ideal for us primarily because it gives us some more time to kind of launch these undertakings that we talked about a few minutes ago without distraction. So we're ready if anything presents itself, but right now, things are fairly quiet.

Operator, Operator

Our next question comes from Jeff Rulis with D.A. Davidson.

Jeff Rulis, Analyst

Jeff, we always have questions. I wanted to ask about the branch closures and their impact on customer retention. Can you provide an update on how that's progressing so far? Additionally, what impact do you anticipate on expenses? Lastly, are there plans for further closures after this? So, three parts: how is it going, how does it affect expenses, and what's next?

Jeffrey J. Deuel, CEO

I'll let Don answer the expense question. I'll do the first and the third. We have been monitoring for the last couple of months. You can imagine that the deposits are overly impacted by what the liquidity that's on the balance sheet. But we're watching not just deposits in those locations, but also numbers of accounts, and the result has been quite good in terms of retention. Even one location that was pretty distant relative to the consolidating branch is not seeing over-the-top runoff. So we're feeling good about the actions that we took, and things are still well within what we budgeted for in terms of runoff. Additional branch closures, I would just put it to you that much like our compatriots in the industry, we're all laser-focused on expenses, and I think that we're always analyzing to determine what we can do to pare back or control expenses, and we'll always be looking at the branch footprint. And I think you'll just see more activity in that area in general that you would have seen anyways overtime. But 8 branches for us was 15% of the footprint, so we're not going to rush to do 8 more. We're going to wait a little bit longer and see how we've done with these 8 before we step out again. I think that any expense in the organization is under review, and we're taking the steps that we think are appropriate as we progress through 2021.

Donald Hinson, CFO

Yes, Jeff, I’d like to add to that. As I noted earlier, most of the cost savings were accounted for in Q1, so there won't be much more to see in upcoming quarters regarding this. The savings per branch were approximately $250,000, totaling around $2 million on an annual basis. There's not much more to discuss on this since it's reflected in the Q1 figures.

Jeff Rulis, Analyst

Okay. Jeff, I want to revisit what you mentioned last year about halting M&A activities. As you've indicated, we might see a cautious restart in our region. It seems that the pace depends more on the sellers' readiness. Is that what is causing the current quietness? From a risk standpoint, it appears you're feeling more positive. Just to clarify, is it truly more about the sellers' pace rather than your own readiness? Is that correct?

Jeffrey J. Deuel, CEO

Absolutely correct. We did go pencils down this time last year, and I think that was the right move, given what we saw in front of us. And as the year progressed and we got to the end of the year, we started feeling better about things. So I think we've been ready to roll if an opportunity presents itself for the last couple of months. And I do agree with you, Jeff. I think it's that the sellers are quiet. It's not us not being ready to go because we are, if it presents.

Jeff Rulis, Analyst

Okay. And then the alternative to that, I guess, if we get longer in the year, you guys have been pretty adept at capital management. Should M&A sort of stall? I guess, kind of buyback. The other capital deployment priorities, obviously, funding organic growth, but beyond that, assume that you look at the other avenues, if M&A doesn't play out?

Jeffrey J. Deuel, CEO

Yes, I think we would. Our primary goal is to see loan growth continue to progress. We are also open to potential opportunities involving teams, which we find interesting. We have recently expanded our production team by adding a few new members. There are ongoing discussions in that area that might lead to new developments. Additionally, we are maintaining regular conversations on the M&A front to ensure we stay connected and relevant; the entire leadership team is well-connected with other banks. Therefore, I believe we are in a good position to be top of mind if any opportunities arise.

Operator, Operator

Our next question comes from the line of Jackie Bohlen with KBW.

Jacquelynne Chimera, Analyst

I just wanted to dig into the reserve ratio a little bit. Even with the quarter's recapture, you're still really well reserved, especially if you look at where you were on January 1, 2020, which I kind of view as the starting point before we all knew what the next year was going to look like. With that in mind, and you've already put some of the approved economic forecast in there, what would need to happen in order to not have to do another recapture?

Jeffrey J. Deuel, CEO

Well, Don may want to join in on this or Tony, but I think where we sit now is, as I said earlier in our presentation material that even just a quarter ago, we're feeling better about it and feeling much more optimistic than we were in December and January. But I think we are a fairly cautious institution, Jackie. And I think one of the things that we're waiting to see unfold is, what is going to happen with that portion of the portfolio that falls into the high-risk categories. We feel good about where we sit right now and what we can see, but things can change. As you are aware from being in the region, just in the last week, we've gone backwards in the phases for a couple of the counties that we're in, one being Pierce, which is where Tacoma is. The other being Cowlitz, which is where Longview is, Cowlitz County and Pierce County. I think that we're happy that we're taking it in gradual steps. And I think if we see portfolio quality deteriorate, that would obviously stop us from releasing in the future, and the other would be potentially loan growth, which we are hoping for as well. I think the reality is that things probably will progress the way they are, and I think that you would expect us to potentially have continuing releases throughout the year.

Tony Chalfant, Chief Credit Officer

Yes, Jeff, I would like to add to that. Jackie, we still have not started facing losses, so our loss history remains very low. Until we begin to see some losses or experience significant growth in loans, this will likely continue to improve throughout the year, but we will monitor it on a quarterly basis.

Jacquelynne Chimera, Analyst

Okay. I have one more question. We've discussed the loan pipeline extensively, but one of the prepared remarks also mentioned a strong deposit pipeline. I’m curious about your growth expectations in that area, especially considering the significant growth from stimulus during the quarter. How are you viewing balance fluctuations for the remainder of the year? I hope I’m not leading you too much.

Jeffrey J. Deuel, CEO

Don, I'll let you jump in with the deposit growth rate. But Jackie, one of the things that we realized and recognized is that while our expectation is that a good portion of the PPP-related deposits will run off as forgiveness occurs, and many of the business owners who got the proceeds and haven't spent it are going to start spending it and using it for other things. We know that deposits are precious. We feel they are even precious in this environment. The focus on originating deposits is an ability that we brought into our organization in a bigger way in the last few years, and we really don't want to stop that because we're probably going to want those deposits in the future. They also come with relationships, and those relationships continue to grow and evolve and help us expand the base of customers too. So even though we have a preponderance of deposits right now, we have not taken our eye off the ball for developing deposits for the longer term. Don, maybe you could talk about the growth rate that's built in for us going forward.

Donald Hinson, CFO

I think we are in very unusual times. Typically, during the first quarter and into April, we see stable or even declining deposit balances. However, even when accounting for the PPP originations in Q1, we still experienced significant deposit growth. We are navigating uncharted territory. Over time, I expect the deposit growth to stabilize, and some deposits may eventually leave the bank as people begin to withdraw money from their accounts. We have opened many new accounts due to the PPP originations, and we anticipate that those will remain, although the balances may not be as high. Overall, I believe deposit growth will be more subdued for the remainder of the year, but there should still be some growth. This will largely depend on when customers feel more at ease about withdrawing their deposits.

Jeffrey J. Deuel, CEO

Jackie, just want to go back to your question about the reserve release. I just wanted to highlight a piece of advice that someone in the industry gave us that the market likes to see gradual moves. So any release on the reserve side, you're going to see it be gradual.

Jacquelynne Chimera, Analyst

Okay. Somebody should have given that memo to us as the unseasonal.

Operator, Operator

Next, we will go to the line of David Feaster with Raymond James.

David Feaster, Analyst

Just wanted to follow-up. In light of your commentary on increasing demand, strong pipeline, new hires and entering into a seasonally stronger quarter, I guess, do you think we're at a trough here in terms of loans ex-PPP? And that we should probably see accelerating growth going forward?

Jeffrey J. Deuel, CEO

I think that based on our comments, you could see that it has been relatively quiet for us, and part of that is because we've had our people so focused on managing the existing portfolio and originating Round 2 of PPP, which was not an insignificant undertaking. And Bryan may want to join in on this, but we've started to focus on, as I said, the more traditional customers calling and prospecting. And I guess based on what we are seeing in the pipeline, we are seeing some really nice positive progress there. I think for the second half, we're probably looking at high single-digit growth on the loan side ex-PPP. That's what we're planning for. We may do better than that. I don't know. We'll have to wait and see a little bit more. Time needs to go by before we can make that statement.

Bryan McDonald, Chief Operating Officer

Yes. I was just picking up on your comments, Jeff. Q1, if you dropped out the change in the utilization rate, it would have been flat. So what happens with that utilization rate is a bit of a driver. Overall production with the pipeline is heading up in the right direction. And then the third piece, which we really didn't talk about was the prepay piece. Prepays were about $132 million for Q1, down from $176 million in Q4. And then if we go back pre-pandemic, we had some periods of $200 million or higher. But to Jeff's point, we're seeing the loan demand and pipeline going up. And at some point, we would anticipate that utilization rate to bottom out and head up. So yes, higher single digits in Q2 or Q3 and Q4 certainly appears reasonable based on what we're seeing in the pipeline right now.

David Feaster, Analyst

Okay. That's encouraging. And then just looking at the slides, it looks like loan yields ex-PPP actually increased in the quarter, and it's actually higher than it was in the third quarter as well. Just curious what's driving that? Is it a mix issue? And just generally, how is pricing trending? Has the steepening of the yield curve allowed for better pricing at all? Are there segments where you're seeing better pricing momentum or conversely, maybe even more pressure?

Jeffrey J. Deuel, CEO

Bryan, do you want to take that one?

Bryan McDonald, Chief Operating Officer

Yes. So there is a bit of a lag, David, just what you're seeing closing out in the first quarter was kind of the tail end of Q4 predominantly. So indexes are up. We've been doing our best to pass on pricing increases. We're seeing a really competitive market, more competitive right now certainly than what we saw at the end of the year or the beginning of Q1. Maybe that's related to the loan demand and others pivoting away from the PPP focus. So indexes are up. That's a real positive. I think we just have to wait and see just how competitive the market gets with all this increased liquidity. But certainly, loan repricings that are built into the book are at spreads. Those are going to convert to higher rates than they would have before the index has moved up; how much pressure do we get from other competitors looking to refinance? We're watching all of that very, very closely. But certainly, in the quarter, we were able to pass on some of the index spreads, and we're just watching it week-to-week and month-to-month in terms of what our competitors are doing.

Donald Hinson, CFO

David, this is Don. Just for a follow-up comment here. The slide deck has gone up about, I think, 6 basis points, the yield without PPP. We also have a table in the earnings release that also backs out the incremental accretion; that also had a 3-basis point positive impact quarter-over-quarter. So it really went up 2 basis points. And then, as I mentioned in my comments, about 3 basis points was just due to one non-accrual loan that we settled on, and we were able to recapture the interest on that. So I think, overall, the yield was pretty flat quarter-over-quarter, and those are some bigger impacts on that.

David Feaster, Analyst

Okay. And then I just want to touch on some of these tech initiatives. Just maybe, I guess, first, whether there are going to be any upcoming expenses that we should expect associated with this? And then the ultimate impact of these. It sounds like they can help both on the growth and the efficiency side of the equation. Just how do you think about the benefits of these initiatives? And maybe even what else might be on the docket coming up?

Jeffrey J. Deuel, CEO

Yes. David, it may seem to outsiders that we could simply purchase a solution, but we assessed our situation and concluded that we could create a more tailored solution ourselves. Much of the related expenses have been part of our IT costs over the past few years, specifically tied to a small development team we hired to build this platform. This development will allow us to adapt our capacity for growth or, although we don't wish to go this route, to reduce our size more quickly if necessary. We believe this setup will enable us to handle anticipated growth more efficiently than before when many processes were manual, and adding capacity required additional personnel. This time, we can avoid that. You may notice we are holding back on the full-time employee numbers, but our ability to adapt is a significant advantage we will gain, along with improving the experience we offer our customers.

Donald Hinson, CFO

Yes. I guess, like you said, Jeff, most of the expenses are baked in. We do have some additional expenses coming on later this year, probably about $150,000 per quarter starting in Q3 that will be adding to it, but nothing is much significant as opposed to just to continue to do what we're doing.

Operator, Operator

Next, we will go to the line of Andrew Terrell with Stephens.

Andrew Terrell, Analyst

I wanted to just ask on the office commercial real estate portfolio. It looks like the risk rating here was fairly stable this quarter. Can you just remind us of the underwriting in this portfolio for maybe a loan-to-value or debt service coverage perspectives?

Jeffrey J. Deuel, CEO

Tony, you want to take that one?

Tony Chalfant, Chief Credit Officer

Yes, Andrew. One important thing to highlight about our portfolio is that it is evenly divided between owner-occupied and non-owner-occupied properties. We consider owner-occupied properties to have a lower risk profile because they typically come with the guarantee of the occupant, and we have better visibility into their financial situation. Additionally, we have segmented our portfolio into core and suburban categories. The core areas are specifically defined as the close-in ZIP codes around Seattle, Portland, and Tacoma. A little less than 5% of our portfolio is in these core markets, which have experienced less impact from current conditions. Once a year, we conduct an in-depth analysis of our entire commercial real estate portfolio, examining a large sample of those loans. In terms of our office portfolio, the non-owner-occupied properties have a weighted average loan-to-value ratio of just under 59%, while the owner-occupied properties are slightly over 60%. Regarding debt service coverage, the weighted average for non-owner-occupied properties is about 1.65, and for owner-occupied properties, it's 2.21. Overall, our office portfolio has remained resilient, though we do anticipate some pressure points as we move forward, but we haven't observed any significant issues yet.

Andrew Terrell, Analyst

Perfect. You mentioned pressure points moving forward. Can you just maybe speak to the appetite in lending here just moving forward, maybe given some of the lingering COVID, work-from-home impacts and considering it's about 10% of the total loans?

Tony Chalfant, Chief Credit Officer

Yes, I believe we will always be interested in the right deals that are well-underwritten and focused on building relationships. In the office sector, we will be very selective moving forward as we assess the current market trends. The situation is different for suburban areas compared to core markets, and we need to factor that in. However, we're noticing that some of these opportunities are limited because there seems to be less activity in the office market, which restricts our ability to explore loan options. Therefore, we are finding more opportunities in the non-occupied sector, particularly in multifamily and industrial spaces.

Operator, Operator

And we have a follow-up from Jackie Bohlen with KBW.

Jacquelynne Chimera, Analyst

Just one quick one. What was the balance of indirect auto at the end of the quarter?

Jeffrey J. Deuel, CEO

Don, do you have that?

Donald Hinson, CFO

No. But I can check that quickly. I believe it is around $120 million, but I'm not entirely sure off the top of my head; I can verify it quickly.

Jeffrey J. Deuel, CEO

While you do, Jackie, I remember you asking about this last quarter, and that whole portfolio has performed quite well throughout the COVID environment. We did do waivers and things at the beginning, but that was fairly short-lived in the very first 90 days. We've had very few bad stories come out of that portfolio, which is nice. And I think, in retrospect, we might have expected more negative out of it than we got.

Donald Hinson, CFO

It was $177 million, and we expect that to diminish over the next two years. Hopefully, this will have a limited impact on our overall loan growth.

Jacquelynne Chimera, Analyst

Okay. And Jeff, your added comments on its performance, does that change your view on the decision to exit?

Jeffrey J. Deuel, CEO

Well, I can't say we haven't talked about it, Jackie. But because the timing of that original decision was not great, obviously, because loan growth is precious right now. But we made that decision with our eyes wide open, and it was a strategic decision. We've decided to stick with it and continue to hone the strategy of the organization to be very much focused on the commercial aspects of our organization. And that, quite frankly, just doesn't fit with it, and that's where we've come out on it.

Operator, Operator

And at this time, I'm showing no further questions. Please go ahead with any closing comments.

Jeffrey J. Deuel, CEO

Thank you, Cynthia. Thank you, everyone. We appreciate the questions. I was a bit concerned for a moment when there were no questions, but I'm glad to engage and look forward to seeing some of you in the upcoming weeks as we begin our virtual investor meetings. I appreciate your time, support, and interest, and I look forward to seeing you all soon. Thank you.

Operator, Operator

Thank you. And ladies and gentlemen, today's conference call will be available for replay after 9:00 p.m. today and ending May 7. You may access the AT&T replay system by dialing (866) 207-1041, and enter the access code of 6157116. International participants may dial (402) 970-0847. Those numbers, once again, (866) 207-1041 or (402) 970-0847, and enter the access code of 6157116. That does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.