Earnings Call Transcript - HFWA Q1 2023

Operator, Operator

Hello everyone. Thank you for joining today's Heritage Financial Corporation Q1 2023 Earnings Call. My name is Sierra, and I will be your moderator. I would now like to turn the conference over to our host Jeff Deuel, CEO of Heritage Financial Corporation. Please proceed.

Jeffrey Deuel, CEO

Thank you, Sierra. 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 first quarter earnings release went out this morning pre-market, and hopefully, you have 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 corporate website which includes more detail on our deposits, liquidity and credit quality. We will reference this presentation during the call. Please refer to forward-looking statements in the press release. We're very pleased to report another solid quarter. In spite of the unfortunate industry turmoil we all faced in March, we were happy to see the destabilizing factors around us calm down quickly with the majority of deposit movement tied to normal deposit flows. As you know, deposit pricing started to get more competitive late in the third quarter of '22 and that theme continued through Q4 '22 and into Q1 '23. We continue to focus on exception pricing for relationships with good success. The majority of deposit movement in Q1 was tied to normal flows, including capital purchases with a lesser portion tied to alternative investments and general FDIC insurance-related concerns, which, in most cases, resulted in retention of deposits, but at a higher cost. We expect deposits to stabilize as the year progresses aided by our $150 million deposit pipeline. We reported solid organic loan growth of 7.7% annualized, and we're pleased with the positive trend we have seen in the number of new commitments and new loan closings from our existing production teams and the newer members of that team. We continue to manage expenses carefully, although we also continue to experience the impacts of inflation. Notably, our long-standing focus on credit quality and 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 improving credit trends and provides a good foundation facing into a potential recession. We'll now move to Don Hinson, who will take a few minutes to cover our financial results.

Donald Hinson, CFO

Thank you, Jeff. As Jeff mentioned, overall financial performance was positive in Q1 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 fourth quarter of 2022. Starting with net interest income, we experienced a decrease of $3.3 million or 5.2% in Q1 due mostly to an increase in interest expense. This resulted from an increase in our cost of interest-bearing deposits as well as an increased use of short-term borrowings during the quarter. This was the main driver for the 7 basis point decrease in our net interest margin for Q1. We expect to continue to experience downward pressure on NIM in Q2. As mentioned earlier, we started 2023 with solid loan growth in Q1 of $77 million or 7.7% annualized. In addition, yields on the loan portfolio were 5.07% in Q1, which was 21 basis points higher than Q4. Bryan McDonald will have an update on loan production and yields in a few minutes. Our cost of interest-bearing deposits increased 24 basis points to 0.49% for Q1. We continue to experience market pressure related to deposit rates. However, 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. Overall, we experienced a decline in total deposit balances in Q1 of 2.3%. The decline occurred throughout the quarter. We closely monitored our deposit balances during the first quarter, including the days subsequent to the bank failures in mid-March. As Jeff mentioned, our large deposit outflows in Q1 were primarily due to either capital purchases or normal outflows. We did not see significant runoff from the recent bank failures. Historically, the first quarter is also a quarter of minimal to no deposit growth. Brian will also discuss our deposit pipeline later in the presentation. Our insured deposits were 65% of total deposits at the end of Q1. Also for customers seeking additional FDIC insurance, we offer deposit products, which have full FDIC insurance coverage. On balance sheet deposit totals for these accounts were $162 million at the end of Q1. In order to supplement core deposits in Q1, we added $52 million in broker deposits and $100 million in higher costing floating rate public funds this quarter, which contributed to the increased cost of deposits. In addition, we added $383 million of overnight FHLB borrowings in Q1. The decision to add these non-core deposits and borrowings was made to enhance our liquidity position and when offset by the earnings on overnight Federal Reserve Bank balances did not significantly impact our net interest income. We are also set up to participate in the bank term funding program offered by the Federal Reserve Bank. However, we have not yet utilized this facility. You can refer to Page 36 of the investor presentation for more specifics on our borrowings and liquidity position. All of our regulatory capital ratios remain well above well-capitalized thresholds. Our TCE ratio is at 8.3%, up from 8.2% at the end of Q4. In addition, with a loan-to-deposit ratio of 71%, we have plenty of liquidity to continue to grow our loan portfolio. We saw improvement this quarter in the market value of our investments from the previous quarter. Our unrealized loss on available for sale securities declined by 17% and which also had a positive impact on equity through the change in AOCI. The credit quality of our investment portfolio is strong with 89% of available for sale and all held-to-maturity securities guaranteed by the U.S. government or government agencies. The duration of our investment portfolio is under five years, and new purchases over the last two quarters were under three years. We have provided additional detail on our investment portfolios on Pages 29 through 31 of our investment presentation. Noninterest income increased $1.7 million primarily due to a one-time gain on sale of Class B Visa stock, which we have held since 2008. Noninterest expense increased $1.2 million to $41.6 million in Q1. This increase was due to an increase in benefit costs and higher payable taxes paid during the first quarter of each year. Looking ahead, due to April 1 offer increases and additional expenses related to our new Boise production office, we expect noninterest expense to be in the low $2 million range for Q2. 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 $1.8 million during Q1 due mostly to increases in loan balances and unfunded commitments as well as a change in the mix of loans in the portfolio, which impacted the allowance calculation. 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 was stable in the first quarter when compared to the strong results that we reported at the end of 2022. As of March 31, nonaccrual loans totaled $4.8 million, and we do not hold any OREO. This represents 0.12% of total loans and 0.07% of total assets. Nonaccrual loans declined by $1.1 million during the quarter and are now down by $11.7 million or 71% from the first quarter of 2022. We moved three C&I relationships to nonaccrual in the first quarter in the aggregate amount of $468,000. This was more than offset by $1.6 million in loans that were either paid in full or maintenance that were applied to principal. Our delinquent loans, which we define as those over 30 days past due and still accruing, is stable from year-end at $8.4 million or 0.20% of total loans. Page 24 of the investor presentation highlights the positive trends in our level of nonperforming assets. Criticized loans, those risk-rated special mention and substandard totaled just under $146 million at the end of the quarter. This is a modest increase of $10.4 million or approximately 8% since year-end 2022. This still compares very favorably to the first quarter of 2022, where criticized loans totaled $174.6 million. Notably, over the same 12-month period, loans risk-rated substandard have declined by $62 million or 56%. While criticized loans in the hotel portion of the portfolio are still high, at just under $30 million, we see continuing improvement. Two loans represent $24.6 million of this total, and both are now rated special mention and show improving trends. For comparative purposes, I'll highlight that criticized hotel loans totaled just over $67 million at the end of 2021. We continue to closely watch our portfolio of office loans. We have yet to see any material deterioration in the credit quality of this portfolio. At quarter end, criticized office loans totaled approximately $22 million or just under 4% of our total portfolio of owner and nonowner-occupied office loans. This is very close to the level that we reported at the end of 2022. At $582 million, this is the largest category of CRE loans in the bank. Some key characteristics of this portfolio include 40% of the portfolio is owner-occupied properties. These have a lower risk profile as there's less tenant rollover risk, and we typically have guarantees from the company occupying the space as well as the owners of that company. We have very little exposure in the core downtown markets within our footprint. Outstanding office loans in downtown Seattle, Portland and Tacoma totaled just over $50 million with 29 loans for an average loan size of $1.7 million. On Page 23 of the investor presentation, we added a page showing our commercial real estate concentration levels. The bank has a long history of robust management of loan portfolio concentrations. You'll see that we maintain our CRE concentration levels well below the regulatory threshold at 259% of capital for total CRE and 44% for the subset of construction, land development and land loans. During the first quarter, we experienced charge-offs of $314,000 split evenly between our commercial and consumer portfolios. They were partially offset by recoveries of $84,000 leading to net charge-offs of $230,000 for the quarter that represents 0.02% of our average total loans. This compares to a net recovery of $208,000 for the fourth quarter of 2022 and a net recovery of $494,000 in the first quarter of 2022. The loss for the quarter is relatively small and compares favorably to historical norms. By comparison, 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. While we recognize that 2023 may represent a more challenging economic environment than 2022, we saw very little deterioration in our credit quality during the first quarter. With our disciplined underwriting and diversified loan portfolio, we remain well positioned to deal with the economic challenges we may encounter in the coming quarters. I'll now turn the call over to Bryan for an update on production in Q1.

Bryan McDonald, President and COO

Thanks, Tony. I'm going to provide detail on our first quarter projection results, starting with our commercial lending group. For the quarter, our commercial teams closed $228 million in new loan commitments, down from $329 million last quarter and roughly equivalent to the $222 million closed in the first quarter of 2022. Please refer to Page 19 in the first quarter investor presentation for additional detail on new originated loans over the past five quarters. The commercial loan pipeline ended the first quarter at $587 million, up from $536 million last quarter and up from $527 million at the end of the first quarter of 2022. New commercial teams hired during 2022 have been adding to our loan pipeline and the Boise team is just starting to ramp up with the majority of the sales team not joining until later in the first quarter and into April. We currently have a team of eight with two additional bankers scheduled to start before the end of the month. Our Boise office is fully staffed at this point, and we are moving into our permanent space on May 22. As Jeff and Don mentioned, loan growth was $77 million for the quarter, or a 7.7% annualized rate. Although loan production and fundings on production during the quarter were both down versus 2022 averages, we benefited from lower prepaid levels and increased balances on construction loans. Please see Slides 20 and 21 of the investor deck for full detail on the change in loans during the quarter. Considering current economic conditions, market conditions, trends in our portfolio and customer base, and the quarter-end loan pipeline, plus the fact our new Boise team is just ramping up its production, we anticipate a similar level of loan growth for the next couple of quarters. Balances associated with new deposit accounts opened during the quarter totaled $114 million, and the deposit pipeline ended the quarter at over $150 million. New deposit teams hired during 2022 and our existing deposit officers have been producing strong results as reflected on Slide 10 of the investor presentation. Deposit balances in Oregon and the Portland MSA increased at a 28% annualized rate during the first quarter, which is particularly significant given we saw a deposit balance decline in other regions. Moving to interest rates. Our average first quarter interest rate for new commercial loans was 5.97%, which is 25 basis points higher than the 5.72% average for last quarter. In addition, the average first quarter rate for all new loans was 6.01%, up 50 basis points from 5.51% last quarter. Although the marketplace continues to be competitive and the fixed rate indexes have been volatile, we're seeing loan spreads improve, which is translating into higher quarter interest rates on new loans. The mortgage department closed $17 million of new loans in the first quarter of 2023 compared to $18 million closed in the fourth quarter of 2022 and $37 million in the first quarter of 2022. The mortgage pipeline ended the quarter at $25 million versus $8 million at year-end '22 and $27 million at the end of the first quarter of 2022. With mortgage rates remaining at higher levels, we anticipate volumes will continue at the relatively low levels we saw in the second half of '22. 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 first quarter. While the general dialogue around the recent liquidity crisis is still a broader topic of discussion, we're confident our long-established granular deposit franchise will continue to be an area of strength for us, and we have ample liquidity sources should we need them. Our relatively low loan-to-deposit ratio positions us well to continue to support our existing customers as well as pursue new high-quality relationships. We will continue to benefit from our historically conservative approach to credit and our strong capital position as we face the possibility of a recession, and we operate in a footprint that has historically been economically vibrant. We will continue to focus on expense management, and we're making good progress with our in-house tech build with version 1 wrapping up in 2023, which will position us well to do more with the same people as we continue to grow. Overall, we believe we are positioned to navigate the challenging economic conditions and to take advantage of any potential dislocation in our markets that may occur. That is the conclusion of our prepared comments. So we're ready to open up the call to any questions that callers may have for us.

Operator, Operator

Our first question comes from Jeff Rulis with D.A. Davidson. Please proceed.

Jeff Rulis, Analyst

Thanks. Good morning. Just a question on the deposit side. Don and Jeff, you alluded to the ongoing sort of challenges there and expect rate pressure to continue but on a relative sense, I guess it didn't sound like balances were all that impacted by the March news, more so just the seasonal trends in addition to rate pressure. But just trying to get a sense for if you think that those rate requests have slowed to a degree? Do you think you're kind of what you've seen so far in April? I mean, Don, you mentioned additional pressure expected. But do you feel like you're getting through any of that? And then maybe just comment on balances as well in terms of stabilization quarter-to-date.

Jeffrey Deuel, CEO

I can begin, Don, and perhaps you want to add your thoughts. I think we might be making the situation seem less concerning than it was. Like everyone else, we were quite anxious about the environment in mid-March. We observed a significant amount of dialogue between our bankers and customers, helping them navigate the surrounding circumstances and the issues faced by struggling banks. This dialogue turned out to be more impactful than I anticipated, highlighting the strong relationship our bankers have with their clients as trusted advisers, which proved beneficial during that time. As we moved towards the fourth quarter, I believe we gained an advantage since not everyone was initially focused on deposit rates. The conversations confirmed that Heritage was doing well, but the next step was addressing rates. Rates seemed to shift more quickly than we had expected given the conditions. Throughout March, as Don mentioned, we monitored the situation closely to see if it would stabilize. We typically see deposit flows decline this time of year due to various factors, mainly tax activities. We noticed stabilization towards the end of March and are starting to observe some activity related to tax payments, although it's not significant. As mentioned earlier, we expect stabilization as we approach the end of April and are optimistic about the new relationship development in our area, which should help stabilize and potentially grow our deposits as we head into the year-end, a key focus for us. Our team now has a strong deposit focus, and I believe this effort will yield positive results as we near the end of the year. Don, would you like to share your thoughts on rates moving forward?

Donald Hinson, CFO

Sure. The cost of interest-bearing deposits for the quarter was 49 basis points. In March, it was 64 basis points, and the current spot rate is 70 basis points. The additional 8 basis points on the 78 basis points refers to the $100 million in public deposits we secured at higher rates, which are effectively paying Fed funds minus 15. This is slightly cheaper than borrowings, but it's still higher-cost, floating rate deposits. For the next quarter, with a spot rate of 78 basis points, we expect it to be higher than the 49 basis points from this quarter. Regarding rate expectations, I'll let Steve Bryan Donald provide some insights since he has a better grasp on that than I do.

Bryan McDonald, President and COO

Yes, the volume has declined over the past couple of weeks, leading to a rise in rate requests as described by Jeff. This situation will largely depend on our competitors, but it’s important to note that these are primarily excess nonoperating deposits where we are experiencing rate pressure. Many of these funds are moving to alternative investments outside of banks, similar to trends reported by other companies, including our wealth management segment. This creates competition with money market funds that offer higher rates to customers. I expect there will still be some pressure on rates. While we are seeing some moderation, it's too early to conclude that we won’t experience a higher level of activity, at least through the second quarter. As both Don and Jeff noted, we are monitoring this situation closely, and our teams are actively engaged in managing it. We aim to maintain competitive pricing to retain as much of that on our balance sheet as is reasonably feasible.

Jeff Rulis, Analyst

Very helpful. I'd like to revisit your expectations regarding margins declining in the second quarter compared to Q1. You've mentioned building up broker deposits and adding FHLB, and you're currently addressing customer requests. Looking ahead to the remainder of 2023, what are your expectations for margins as you continue to process what we've carried over from Q1 into Q2? Additionally, could you provide an update on your rate sensitivity and how you foresee margins evolving in the latter half of the year?

Donald Hinson, CFO

As I observe the trends, I believe the decline in margin will slow down. Although our overall margin decreased in the first quarter, it stood at 3.73%. I anticipate it will drop to around the 3.60s next quarter, and depending on interest rates, it might reach the 3.50s, though I doubt it will go significantly lower given the current rate environment. However, it could decline further throughout the year.

Jeff Rulis, Analyst

Okay. Don, just so I get you right there, you had not a single-digit margin compression, but if you're pointing to 3.70 or lower. So we could see sequentially higher margin compression in the second quarter relative to the first quarter.

Donald Hinson, CFO

I'm expecting that, yes.

Jeff Rulis, Analyst

Okay. Okay. I'll step back. I appreciate. Thank you.

Operator, Operator

Thank you for your question. Our next question comes from Andrew Terrell with Stephens. Please proceed.

Andrew Terrell, Analyst

Hi, good morning.

Jeffrey Deuel, CEO

Good morning, Andrew.

Andrew Terrell, Analyst

I wanted to start on the deposit side. I heard your commentary around the deposit pipeline. I think you said it stands around $150 million or so. I'd be curious here how much of that is noninterest-bearing. And then how does the aggregate level of that pipeline in the $150 million compare to the deposit pipeline coming into the year? Just trying to get a sense of the -

Jeffrey Deuel, CEO

Bryan, you may be closer to the details. Can you take that one?

Bryan McDonald, President and COO

Yes, it's significantly increased compared to Q4, in the range of 30% to 40%. Regarding the mix, these accounts are mainly operating accounts, although there are some excess balances included. Our main focus and where we've seen the most success is in operating relationships. I don't have a detailed breakdown of the accounts in that portfolio, but I have reviewed the names and am somewhat familiar with them. There are some excess balances tied to these new relationships, but they are primarily operating accounts.

Jeffrey Deuel, CEO

I could add that we receive a monthly production report, and we just reviewed the one for March in detail. It's important to note that we have significantly more deposit gatherers now compared to the start of last year due to our recent efforts. For several years, all our loan production staff have had deposit goals, and the March report shows a lot of activity despite recent events. The contributions will come from various sources, including the deposit gatherers, branch staff, and the loan team.

Andrew Terrell, Analyst

Okay. Very good. Thanks for a lot of color there. And then maybe just trying to understand some of the puts and takes on just balance sheet size and some of the funding going into the second quarter. It looks like you built cash going into the end of the quarter here with some FHLBs, I know brokered was mentioned. But I guess just when I piece together the commentary on the loan growth, as well as it sounds like some level of optimism on deposit growth front moving forward. Does it feel like you will incrementally need to build FHLBs or brokered deposits as we go into the second quarter? Does some of that kind of, I guess, prefunding, if you will, in March, kind of keep that at bay?

Jeffrey Deuel, CEO

We took steps to strengthen our position given the circumstances to ensure we were ready for any challenges ahead. Our balance sheet still shows a significant amount of invested cash, which helps counterbalance some of the FHLB borrowings, primarily made for defensive reasons. The other borrowings were intended to further enhance our position. The brokered deposits will expire over the next three, six, and nine months, which aligns with our strategy. Overall, we're feeling optimistic, and I believe we've been reducing the FHLB borrowings since the end of the quarter because we think the situation has stabilized and deposits have started to become more consistent. Would you like to add anything to that?

Donald Hinson, CFO

Sure. We increased our cash position or overnight deposit balances at the end of the quarter to ensure we had more liquidity due to the events in the last half of March. In fact, we have nearly $200 million in excess cash compared to the previous quarter. This essentially allows us to fund that amount in loans without needing additional borrowings. As conditions stabilize, we believe we will effectively manage that cash position.

Andrew Terrell, Analyst

Yes. Okay. And then I guess last question for me, just with rates pulling back a little bit versus where they peaked out in kind of the early March timeframe, are there any areas within the bond book that you could look to trim up either for our positioning trade or for incremental liquidity purposes to also help fund loan growth?

Donald Hinson, CFO

Yes. We have an oversized investment portfolio right now compared to our total assets. We are certainly willing to do that when it makes sense. It didn't make sense last quarter, especially in March; we did a little bit. We took a little bit of loss, but it wasn't a huge amount of dollars. The prices, the market got kind of wonky as far as there was not a lot of people looking to buy par. They were more looking to sell, and we just didn't want to sell in that environment. So we held off. There's a chance that if the prices stabilize or looking better, then we might be doing some of that.

Andrew Terrell, Analyst

Okay.

Jeffrey Deuel, CEO

Quite frankly, Andrew, it would have been nice to offset some losses on repositioning with that Visa shares, but it just didn't make sense, as Don said.

Andrew Terrell, Analyst

Yes. No, makes total sense. Okay. I'll step back. Thank you for taking the questions.

Jeffrey Deuel, CEO

Thank you.

Operator, Operator

Thank you for your question. Our next question is from Adam Butler with Piper Sandler. Please proceed. Adam?

Adam Butler, Analyst

Sorry, I was muted. Good morning, everybody. This is Adam for Matthew Clark. Sorry about that. Just to add on another question to the deposit commentary. I appreciate that Slide 10, separating the growth that you've seen in the Oregon and Portland area and Seattle. With your commentary about the $150 million deposit pipeline, I was just curious, is that all kind of in one of the MSAs? Or is it kind of spread out between both of them?

Jeffrey Deuel, CEO

Bryan, do you want to take that?

Bryan McDonald, President and COO

Yes. The deposit pipeline refers to the entire bank rather than just what is shown on the slide. It's the overall bank pipeline compared to the specific pipeline for the region illustrated in the lower section of Slide 10.

Adam Butler, Analyst

Okay, understood. I was just trying to get an idea of what the recent team lift-outs could possibly be doing? And maybe you will see an even larger deposit pipeline in the future quarters? Any comments on that?

Bryan McDonald, President and COO

Yes. We're obviously watching it really closely. The deposits are coming from a number of different sources is the first thing I would say, having the sales team without a customer base, they're out calling as well as Jeff mentioned, our existing deposit officers and fully kind of relationship bankers are all actively out calling. A lot of it is going to depend on just what sort of disruption we see in the market. And we're viewing the loan opportunities the same way our bankers call for years and oftentimes, it's during a period of market disruption like this where they're maybe not able to get all their needs met at another institution, and that's our opportunity to convert them. So this is the type of environment we look at again, we're seeking those relationship clients, whether it be on the loan or deposit side. So that wasn't a direct answer, but we remain optimistic and hopeful that we'll be able to put up some good numbers in that market down there because of the staff that we've added.

Adam Butler, Analyst

Okay. Great. I appreciate that color. And then just one question, switching over to the credit. I appreciate the commentary on the call of the office portfolio. I was just wondering if you could provide some further detail on the office portfolio, some of the loan-to-values you're seeing and occupancy rates in the downtown area? Anything would be appreciated. Thanks.

Anthony Chalfant, Chief Credit Officer

Sure, Adam, I’ll take that one. Yes, this is Tony. Just to provide a bit more detail on the portfolio, at the end of the fourth quarter of last year, we conducted a thorough review of our commercial real estate portfolio, which we do annually. In this review, we analyzed about 60% of our office loans, particularly focusing on the larger deals in our portfolio, which are primarily over $1.5 million. Our average loan-to-value was around 59%, and our debt service coverage was approximately 2.3 times. We feel pretty positive about those figures. However, it’s important to note that downtown core markets like Seattle and Portland are facing significant distress. We’re fortunate to have minimal exposure in those areas. Looking at the core markets, I noticed that out of the top 10 we have, 9 are owner-occupied properties, which reassures us about our portfolio's mix. Additionally, within our office portfolio, which is valued at around $580 million, about $95 million is allocated to medical offices, which we consider to have a lower risk profile, and that sector continues to perform well across our footprint. I’ll stop there and see if you have any more specific questions.

Adam Butler, Analyst

That was great. I appreciate it. And pass that back. Thank you, guys, very much.

Jeffrey Deuel, CEO

Thank you, Adam.

Operator, Operator

Thank you for your question. Our next question comes from David Feaster with Raymond James. Please proceed.

David Feaster, Analyst

Hi, good morning, everybody.

Jeffrey Deuel, CEO

Good morning, David.

David Feaster, Analyst

I wanted to touch on the loan growth side. Just here in your prepared remarks, it sounds like growth you're expecting it to remain relatively stable. I'm just curious, how is demand trending across your footprint? Where are you seeing good opportunities for growth at this point? Are the new hires really allowing you to gain share and sustain a good pace of growth? And just to your commentary on spreads widening, I'm curious where new loan yields are at today.

Jeffrey Deuel, CEO

Bryan, do you want to take that?

Bryan McDonald, President and COO

Sure. I'll start with a general observation. We've seen some rate-sensitive projects decline over the past year due to construction cost increases. However, we have several customers who have been working on projects for a few years, and they feel confident moving forward, supported by a strong backlog in the underlying business. There's no specific geographic area driving this, but our new teams and bankers are actively contributing to our overall pipeline, and we have more salespeople than we did a year ago. Regarding new loan yields, for March, the commercial business rate was 6.32%, compared to 5.97% for the entire quarter. For all new loans, March showed 6.25%, up from an average of 6.01% for the full quarter. We have noticed spreads widening, although our challenge lies with non-prime-based loans since prime remains at a reasonable level. The fixed rate indexes, such as the 5-year FHLB, were at 4.17% earlier this week. Even with a couple hundred basis points spread, that's in the low sixes, higher than the spreads we saw last year when deposit costs were very low. We've not yet returned to what we consider a more reasonable spread level, but we have seen a rise from the very low spreads of the past few years, and we hope they continue to improve.

Jeffrey Deuel, CEO

Again, we're looking at this if we've been particularly existing core relationships and new customer opportunities if they fit that relationship profile, maybe we've been calling on them for years, and their current bank is pricing much higher or not able or not as interested in doing lending. We see this as a great opportunity to pick up those core long-term relationship clients and want to stay in the market and support our bankers and better our customer base through this volatility if those opportunities come about.

David Feaster, Analyst

That's encouraging. I'm curious about your appetite for more hires as your team starts to gain momentum. Are you seeing more opportunities? How are conversations progressing? Which markets, geographies, or segments are you considering for potential growth?

Jeffrey Deuel, CEO

I would start by saying that you know that we're always positioned to take advantage of opportunities on the M&A side. But obviously, that is probably on the sidelines for a while. But we've always had a bias for teams, and we've actually illustrated that in our deck. There's a slide in there that shows M&A versus teams. I guess I would leave it with David and Bryan may want to add to this, that we're always interested in teams, particularly if they augment what we already have or enhance a team that already exists but would probably focus only on the three-state area that we're in now. And I think that a team right now would have to be really compelling for us to take action because while the team down south has been with us surprisingly almost a year now because they all came across in May. They're making good headway. Still, we're trying to give them as much support as we can due to their newness and their in Eugene, for example, newness in that market. and Boise is just getting their legs under them. So we want to make sure we don't get spread out, then we can't support them too. So like I said, it would have to be pretty compelling, probably more so interested in one-offs, and there's a couple of spots in the footprint that we would like to flesh out a little bit due to maybe some of the retirements that have been going on and repositioning of some people. So we're always looking, but to do a whole team would have to be pretty compelling. Bryan, anything you want to add to that?

Bryan McDonald, President and COO

No, I agree. Totally we've taken on a lot and it's going well. And we just filled the entire team in Boise here over the last few months. And so we have some as Jeff said, onesie, two-sies, we've got some retirements. So we're always out recruiting and then we're always willing to meet and listen, and if it was a really compelling situation, we'd certainly take a hard look. But I agree with Jeff, we've done a lot, and we'd like to continue to support these groups well to have a really favorable onboarding experience for them and help them in any way we can. So.

Jeffrey Deuel, CEO

David, we also need to be cognizant of our expense base too. That's why it has to be really compelling because we really need to keep an eye on that now that we've added the teams that we have.

David Feaster, Analyst

Yes. Understood. And just maybe switching gears to capital. You already touched on the M&A side a bit. But just you guys manage your cash really well positioned. You don't have the same AOCI issues that a lot of other banks have very well-capitalized balance sheet. Just curious your thoughts on capital at this point and your willingness to return capital? Looking at the buybacks, I mean, you look back, I mean, the stocks, where it's trading out cheaper than where we bought stock back in the past several years. I'm just curious your appetite for that or given the uncertainty, are we kind of more in a capital preservation mode?

Donald Hinson, CFO

Yes, I'll take that. Yes, we have done buybacks before and right at even levels higher than this. I think that our regulatory capital ratios are strong. TCE ratio is a little low still because of the AOCI, although improving every quarter. It’s a little uncertain whether we could be heading into a recession. So we may get involved some, we also may wait depending on just the economic environment. But we are watching that carefully. I don't have really any guidance to give you in that area at this point, but we are considering it.

David Feaster, Analyst

Do you have an authorization in place? And how much do you have left at I don't remember...

Donald Hinson, CFO

We have slightly over 500,000 shares remaining in our current repurchase plan. When we initiate new plans, it typically involves around 1.5 million shares at a time.

David Feaster, Analyst

Got it. Terrific. Thanks everybody.

Jeffrey Deuel, CEO

Thank you.

Operator, Operator

Thank you for your question. There are no questions waiting at this time. So I'll pass the conference back over to management for any further remarks.

Jeffrey Deuel, CEO

Thank you, Sierra. If there's no more questions, we'll wrap up the call. We thank you all for your time and your support and your interest in our ongoing performance, and we look forward to seeing many of you in the coming weeks. Thank you, and goodbye.

Operator, Operator

That concludes the Heritage Financial Corporation's Q1 2023 earnings call. The replay for today's call will be available until Thursday, April 27. To access the replay, please dial 1-866-813-9403 and enter access code 862416, again dial 1-866-813-9403 and enter access code 862416. Thank you all for your participation. You may now disconnect your lines.