Ladies and gentlemen, thank you for standing by. Welcome to the Heritage Financial First Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] Also as a reminder, today's teleconference is being recorded. And at this time, I'll turn the conference over to your host, CEO, Mr. Brian Vance. Please go ahead, Sir.

Thank you, Tony. Appreciate it. I'd like to welcome everybody to our first quarter earnings conference call this morning and also to those that may listen in later in recorded mode. Attending with me this morning in Don Hinson, our CFO; Jeff Deuel, our President and COO; and Bryan McDonald, our Chief Lending Officer. Our earnings press release went out earlier this morning in a pre-market release and hopefully you've had an opportunity to review the release prior to the call. And as always, I would refer all of you to our forward-looking statements in the press release and also would refer you to the forward-looking statements as we enter into a Q&A period later on this call. I would like to just highlight our first quarter, results diluted earnings per common share were $0.31 for Q1, compared to $0.30 for Q1 of '16 and $0.33 for a linked quarter Q4 of '16. We declared a regular cash dividend of 13% per common -- I'm sorry $0.13 per common share, an increase of 8.3% from $0.12 for the cash dividend paid in Q1 of 2017. Return on average assets was 0.97% and return on average tangible common equity was 10.51% for Q1 of '17. Net interest margin excluding incremental accretion on purchased loans increased to 3.75% for Q1 from 3.68% for Q1 of '16. At this point, I like to turn the call over to Don Hinson to take a few minutes and cover some of the highlights of our financial statement, Don?

Thanks Brian. I'll start on the balance sheet. We had muted balance sheet growth in Q1, which is not uncommon for the first quarter of the year. Loans grew $22.4 million or at an annualized rate of 3.5% in Q1. However, over the trailing 12 months, loans have grown 8.3%. Total deposits grew $13.7 million or 1.7% annualized in Q1. Non-maturity deposits grew $27.1 million or 3.8% annualized. During Q1, the percentage of non-maturity deposits to total deposits increased to 89.4% from 88.9% at the prior quarter end due partly to a decrease in CD balances. Moving on to credit quality, we saw continued overall improvement in credit quality of the loan portfolio. Potential problem loans decreased $4.9 million or 5.6% during Q1. Nonperforming loans remained relatively unchanged at $10.9 million or 0.41% of total loans. The ratio of our allowance for loan losses to nonperforming loans stands at a very healthy 290%. In addition, included in the carrying value of the loans are $12.6 million of purchase accounting, net discounts, which may reduce the needs of an allowance loan losses on those related purchased loans. Net charge offs for the quarter were at 0.05%, which is unchanged from Q4 2016 and 15 basis points better than 0.20% in Q1 of 2016. Our net interest margin for Q1 was 3.89% and this is a four basis point increase from 3.85% in Q4 2016. Pre-accretion net interest margin increased seven basis points to 3.75% for Q1 from 3.68% in Q4 of '16. The increase in pre-accretion net interest margin was mostly due to increases in pre-accretion loan yields as well as increases in deals on the investment portfolio. Pre-accretion loan yields increased due to the repricing of our floating rate loans and higher rates on newly originated loans, due to the…

Thanks Don. I am going to provide detail on our first quarter lending results by production areas, starting with our lending group. In the first quarter, commercial teams closed $121 million of new loans, which is down from $153 million closed in the fourth quarter of 2016 and $151 million closed in the first quarter of 2016. Commercial team pipelines ended the first quarter at $362.6 million, which was up from $296.5 million at the end of 2016 and $310.3 million at the end of the first quarter of 2016. The lower first quarter new commercial loan closing were the results of two primary factors. First, we had a number of loans that have been delayed in closing, which can be seen in the loan pipeline increasing $66 million during the quarter. In addition, we continue to see an elevated number of investor real estate permanent and construction loan opportunities, but with increasing concentration levels in these categories are passing on more of these opportunities from the last year. Line utilization was 36.4% at the end of the first quarter and has relatively unchanged from 35.6% at the end of 2016. Moving on to interest rates, average first quarter interest rate for our new commercial loans was 4.35% as compared to 4.01% during the fourth quarter and as Don mentioned, the average fourth quarter rate for total loans was 4.4%. SBA 7(a) production in the first quarter totaled 11 loans for $5.4 million and the pipeline ended the quarter at $14.8 million. This compares to the fourth quarter of 2016 when we closed 17 loans for $14.8 million and the pipeline ended at $14 million. Consumer production during the quarter was $35.5 million, which was down from $43.7 million in the fourth quarter of 2016. Branch retail loan volume comprised $10.7 million of the quarter's volume, which was down $3.3 million from the 2016 quarterly average and indirect loan volume was $24.8 million during the quarter, which was down $4 million from the 2016 quarterly average. The decline in the retail brand volume was due to a 6% decline in applications and a lower average loan size. The decline in indirect loan volumes was the result of the bank taking measures to slow production to manage the loan concentration limits. The mortgage department closed $33.3 million of new loans during the first quarter compared to $53.9 million in new loans during the fourth quarter of 2016 and $29.6 million in the first quarter of 2016. The mortgage pipeline ended the third quarter at $22.6 million down from $34.3 million at the end of 2016 and $41.1 million at the end of the first quarter of 2016. Current pipeline is comprised of 42% refinanced loans, 37% purchased loans and 21% construction loans. This compares to last quarter's pipeline where refinanced business averaged 59%. I'll now turn the call back to Brian for an update on capital management as well as some closing comments.

Thanks Bryan. I'll start with capital management. As noted earlier, we have increased our regular quarterly dividend of $0.12 to $0.13 and this is our fourth consecutive year in which we have increased our regular quarterly dividend. We continue to believe our capital position sufficiently supports our balance sheet risk, our internal growth and potential for future growth, both organic and M&A. Just for some -- just comments on the outlook for the balance of 2017, we continue to be optimistic about the overall economy, the Puget Sound region for the balance of '17 and for our continuing growth. Commercial real estate construction continues be robust in the area and we remain disciplined in monitoring our commercial real estate loan production concentration risk. In Brian McDonald's comments earlier, he indicated concentration issues were at least a partial reason for a slower growth in Q1. You will recall in our discussions in our last earnings conference call that we mentioned potential downside risk to our 2017 loan growth could possibly be related to managing our concentration guidelines, while we remain comfortably under regulatory CRE concentration guidelines at approximately 250% of capital. We are mindful that a higher percentage of our growth this past year has come from CRE lending. So, loan concentration risk management continues to be important risk management tool for us going forward. While loan growth in Q1 was slower than we would have liked, we are encouraged by a stronger than normal loan pipeline at this point. We remain optimistic about loan growth potential for 2017. We've announced the consolidation -- we had previously announced the consolidation of four branches, which will be completed April 28. This brings our total branch consolidations to 17 since January of 2010. While we were pleased to note the increase in our non-accretive net interest margin and one quarter does not necessarily create a trend, we are encouraged with increasing note rates in general while our total cost of interest-bearing deposits remains the same on a year-over-year comparison. As indicated in last call, we expect our M&A activity in the smaller less than $1 billion range to increase this year and we expect to be active in that arena. That concludes our prepared remarks, and I'll turn the call back to Tony to open up for Q&A period and also again remind you to keep in mind our forward-looking statements as we respond to any questions you may have, Tony?

Thank you very much. [Operator instructions] And our first question we take will come from Jeff Rulis with D.A. Davidson. Please go ahead.

Thanks. Good morning.

Good morning, Jeff.

Just following up on the margin, I get a sense that the loan yield increases are more a product of new production rather than may be repricing in the portfolio, is that safe to say?

I'll let Don and Bryan to comment on this as well. I think it's probably both. Production is -- rates on new production is up as a result of just rates being up in general, but we're also getting some benefit of rate prices in the portfolio. I would caution folks and we're optimistic about the NIM increase in Q1. But we also see interest rates moving, they’ve dropped and now they're coming back again whether you're looking on the lower end or the five-year, I think that rates are going to continue to move as they always do, but were cautiously optimistic in terms of rates in general. Don or Bryan any additional comments?

Yeah, I would say it's a combination. We saw the rates increase on the -- prime increased both at the end of last year and of course we got one in March, which probably didn't have that much impact on the quarter, but in addition, we've continued to see LIBOR increase -- have increased over the last quarter. But as you see we're again making loans at higher rates, but again the dollar amount of loans we make are going to move the needle a little bit on the overall portfolio, but not significantly. I think it is encouraging when we look at our note rates, overall contractual rates on the portfolio, over the last few quarters and this is the first quarter or actually when you look at the contractual rates actually ticked up just slightly as opposed to going down quarter-over-quarter and is not the yields on them, but actually the contractual rates -- current contractual rates at quarter end. So that was encouraging to see and of course whether this continue will depend on the overall rate environment and the rate environment stays where it was in Q1 then that can be encouraging going forward.

Sure. Lots of variables I guess. Put another way, I guess is there a potential for the core margin strength to keep pace with any decline in incremental accretion I guess in the reported margin then -- is there a potential that exists that maintains at these levels?

I think our accretion will fluctuate tremendously unless we have really unexpected large payoffs. So, I think you have that number in there. I think the nice thing is that hopefully the accruals will be more than offsetting that, but again I think that if we stay in this rate environment, there's a lot of variables there that we can hold that margin.

Got it. Okay and then just on the expenses and the outlook obviously, a little seasonal bump, but for the balance of the year, anything coming online? You've the branch consolidations and I don't know the impact is fully embedded or if there's actually a near-term bump, but maybe just the expectation of 27.2 this quarter I think you kind of try to maintain that through the balance of last year. Anything different maybe through '17 that would be changing versus what we've seen?

I don't believe there is going to be a lot of change. I think that there is kind of offsetting -- in the first quarter, we tend to have higher payroll taxes because the bonuses are paid in the first quarter. At the same time because we tend to give a lot of increases at the end of the first quarter. A lot of those impacts won't be seen until it's Q2. So, I think there is some offsetting there. Overall, we're going to see pretty steady again with the branch consolidations, I think that we're going to see some benefit in Q3 and Q4 of this year. I think Q2 will cover the cost of the branches we're offsetting these savings in Q2.

And Don just a last one on the tax rate, maybe a little lower in Q1 and while I guess what would you expect for the last three quarters?

Well I think the overall I would say core tax rate is still going to be around 26%. I don't know if you're -- how much you're aware of the new accounting pronouncement on stock that impacted our effective tax rate this quarter, but that could happen possibly to a lesser extent in Q2, but not as much as it was in Q1. I think the overall when you start getting in Q3 and Q4, it will be back of the 26%.

Okay. Thank you.

Thanks Jeff.

Thank you. [Operator instructions] Next in queue is Matthew Clark with Piper Jaffray. Please go ahead.

Hey. Good morning, guys.

Hi Matthew.

On the expense front, it sounds like maintaining that run rate still gets you to about a 2% growth rate in expenses I think that you had guided to last quarter. Is that still fair for the year?

Yes, that's still we're looking at.

Okay. And then on the loan growth side of things, Bryan you sound optimistic, pipeline is up but yet a little bit more selective on the commercial real estate side. Is that 6% to 8% still seem doable for the year?

I think so Matthew. The variables that we talk about and you mentioned loan concentration risk that I'll just reiterate for everyone's benefit. We're serious about that and if we got back to the last turn down in the economy, it was the concentration risk, the cost made a lot of problems. Not so much us because we had the discipline and we'll continue that discipline. I think that the other piece that I talked about and it remains a variable is the prepayment activity in our brand to comment to that, that's always a unknown and a variable. We tend to be a little light on first quarter just seasonality. Our pipeline is up. So, I feel fairly optimistic and Brian are there other additional thoughts?

Yeah, the pipeline is strong going into the second quarter, really anything over that $300 million number, we consider quite strong. The prepays in Q1 were -- in total were about $60 million, which is not -- we see a lot of variety as Brian Vance just commented, but that's been anywhere from $55 million to $75 million the last four quarters. So, it's right in the middle. We also have decreased our indirect volume. Last year we had about a 27% growth rate and recorded about a 7.5% growth rate. Year-to-date, again just moderating the portfolio grow related to our concentration limits, we are working very hard on the direct side of the consumer business and increasing our focus on that and we see lots of opportunity there to make up that volume. So, Brian Vance also commented just on the economic environment in the Northwest and that continues to be quite strong. We continue to get some nice new opportunities in our existing customer base, continues to look for growth opportunities including expansion and equipment. So, we haven't seen a change in our customer sentiment of yet that with the pipeline. It's just a matter of keeping the mix and balance.

And I would add to that, just to clarify for everyone's benefit, our decision to back up on the indirect volume was totally and exclusively focused on concentration. Had nothing to do with quality. Quality of that portfolio continues to perform very well and I would even say exceeding our expectations. So that did not factor into our decision to ratchet back the growth rates in that category.

Okay. Great. And just getting back to the margin and thinking about a couple items that may have impacted it, could you maybe quantify the prepayment fees this quarter and last and also with that premium amortization as well what it was this quarter versus last?

Premium amortization, I don't have that off the top of my head. I think you talked about the investment portfolio on premium amortization?

Yes.

Okay. Last quarter I did mention that we did have some unusually high premium amortizations in Q4 of last year and so that's what we've increased so much. If you go back to maybe Q3 of last year, you'll see we were moving up and then alternate drop in Q4 on the investment portfolio. I would say we're right now is a more in line with what I would expect going forward on the investment portfolio. On the prepayments, I don't think we had any unusual prepayments in any quarter over the last couple quarters related to loans.

Okay. Great. And that will do it for me for now. Thanks.

Okay. Thanks Matthew.

Thank you. Our next question will come from Tim Coffee with FIG Partners. Please go ahead.

Thanks. Good morning, gentlemen.

Good morning, Tim.

Bryan, I was wondering if you could give a little color on the $2 million increase in non-accruals.

Look I don't have that right at my fingertips. Don or Jeff, do you have that?

Obviously, there's a lot of in and outs to the nonaccruals and do we have the addition and subtraction data?

While Don is looking that up we'll come back to you on that. Did you have a second question?

Again, on the same lines, as rates start moving up and you look at some of the borrowers, the borrowers in your footprint, do you think, how much do you think they're going to be susceptible to higher rates in terms of the quality -- the ability to service their debt?

I don't see that as an issue in the short run. Obviously increasing rates changed that service coverage ratio such things. We do any annual stress analysis to our CRE portfolio and that's typically done in the fourth quarter. We did not see any deterioration, any concerns over that. I think that is if rates were to rise sharply, that's something we would probably have a bit more concern and analyze it more. I don't believe that will happen. The fed has said there will be three increases this year. I don't believe we'll see three increase. That's just a personal opinion. So, it's something that we monitor very closely, not only on existing portfolio, but new portfolio, but we're not seeing any weaknesses within existing portfolio. Tim, so what's -- I guess I am looking at the earnings release, you caught me off guard there. Nonaccruals actually went down slightly quarter-over-quarter.

I asked you I thought there was an increase in those $2 million new nonaccruals.

Well, yes, we have nonaccruals coming in and out, but overall, the overall balances did not increase. So that's just -- again they came in about again little over $2 million probably came in again nothing unusual. I think they're about six different loans, so it's nothing big on that, but that's kind of standard quarter-over-quarter that we'll see some come out and some come back in.

Great and that was really what I was look for, that kind of commentary. And then as you look at kind of the construction loans in the quarter, will those come from existing clients or have you made a big push to markets and new clients in that product area.

Tim, it's Bryan. It's a mix. We've got some new clients and many existing clients in that mix and if you look at just the balance detail quarter-over-quarter and looking back to Q1 of '16 you may of these projects are multiyear projects. We're also doing more low-income housing projects and those in particular have a pretty really long construction period. So, the balance fluctuation is more a result of the increase in bookings over the last couple years -- last year in particular but just growing commitments as the activity has gone up.

Great. Thanks Brian. Well gentlemen those are my questions, appreciate your time.

Okay. Thanks Tim.

Thank you. Our next question will come from Tim O’Brien with Sandler O’Neill. Please go ahead. Tim O’Brien: Good morning.

Hi Tim. How are you doing? Tim O’Brien: Fine thanks Brian and you?

Good thanks. Tim O’Brien: Great. Hey $4.2 million in service charges on deposit accounts, so was that a good baseline here going forward with what you've done -- a reflection of the consolidation that you described that took place and was there anything one time and that also comes sort of catch up or I don't know whatever, but or is that kind of as typically first quarter is your, that number is down a little bit and obviously, that's not the case this quarter?

Tim, this is Jeff. Last time we talked about the deposit rationalization project that we started last fall and we believe we're seeing the benefits of that undertaking now. I think it will continue to come across over the next month or so. We're still working through the notifications to customers, which is triggering them to take action one way or the other. And the other thing that's going on is we're not only generating probably more service charges on lower balance less active accounts, but we're also going to get kind of an ancillary benefit from the standpoint that if we have accounts run off because they are inactive, it's less costly for us from a system standpoint to maintain them and with the rationalization process did to, was it's geared to customers to paperless statements, which doesn't sound significant. But when you look at industry metrics, a paper statement mailed has cost us close to $4 and paperless is like $0.19. So, there's a huge benefit behind the scenes too. Tim O’Brien: $4 that's remarkable. So, carrying that, this process, this rationalization and consolidation what have you process in that part of your business, did that also affect loan balances, excuse me, deposit balances this quarter?

Not necessarily. What we project -- we always project loan run off when we excuse me, deposit run off when we take an action like that, but in our case, we saw a larger trend on the number of accounts closed, but not a very significant trend in the deposits related to the balances that will impact it. Tim O’Brien: So, as a line item as a fee item, there's a little bit, it's a little bit in a state of flux still as far as how your depositors react and adjust I guess, is that fair to say here in the second and third quarter?

It is and what makes it complicated is people don't often times read their mail. So, when we send mail, the first time they might have missed it, some people got it and then we send, then we start the actual changing of the fees and then they start seeing the fee or the charge for the statement show up on subsequent -- they see it in their account and it triggers activity over a period of time as customers realize what we're doing and are making decisions about what they actually want. Tim O’Brien: I'm guilty of walking in those shoes in the past, but…

That's why we're trying to get more connected online with our customers so we can communicate that way more so than through the mail. Tim O’Brien: Great. Most of my other questions were answered. One other question I have for you is what did Ag balances do? Typically, there's some seasonal payoff to that affect your net growth numbers for the quarter?

Tim it's Bryan. I don't have those in front of me, but it really starts during the late third quarter through the fourth quarter and then we do see run offs through the first quarter and that was a portion of that payoff activity during the quarter, which was really pretty consistent with the range of prior quarters. So there definitely was an impact in both the fourth quarter and the first quarter, but I don't have that number in front of me here. Tim O’Brien: All right. Thanks guys. Thanks for answering my questions.

Thanks Tim.

Thank you. [Operator instructions] Next is queue is Jacque Bohlen with KBW. Please go ahead.

Hi. Good morning, everyone.

Good morning, Jacque.

Were there any repurchases in the quarter?

No there were not. I guess let me -- there were only purchases related to the restricted stock award testings that are for tax purposes, but no -- on the market are repurchases.

Okay. And obviously, shares have all come up since the election and everything. How are you thinking about that now versus how everything you might in the January? Has there been any change at all?

In terms of potential purchase -- potential repurchase activity? Yeah, I don't our position has changed. At these levels, it's not likely that we would be in the repurchase market.

Okay. All right, it makes sense and then Brian, you mentioned in your prepared remarks, your continued optimism in terms of M&A, can you just provide us with an update maybe on how conversations are going, just your thoughts on it and any other color you have?

Sure. That's consistent with maybe comments that I made in the last call -- last conference call and this one. We’re seeing increased activity in I'll say the smaller banks, the less than billion or even I would say go as far as to say less than $500 million and I think in our case, that if there is an opportunity less than $500 million, it's something that we would be certainly interested in from the standpoint that you do a couple of deals less than $500 million and that changes the needle one by itself, will have an impact, but we do a couple of them and it begins to have a more meaningful impact. So, I think that we're going to see some activity in that less than $500 million area. I think that these smaller banks are seeing what the general bank environment is enjoying those of us that are publicly traded is that we've seen a substantial lift in valuations since the election. And I think the smaller banks are looking at that, but they're not seeing their ability to pass on increased regulatory cost and the scale etcetera and I think there's a willingness maybe to have some discussions. So, we're seeing an increased level of discussion. Increased levels of discussion don't always equate into deals being done. I will tell you that we have looked at and have been active on a lot of different opportunities over the last -- I'll say 12 to 18 months and for a variety of reasons. Some of those opportunities have not worked for us. I think that we remain very disciplined on cultural mash. In other words, similarities and culture are important to us. Geographic opportunities are important to us and so we'll remain disciplined, but at the same time, I'm probably more optimistic today than I have been for some time in terms of opportunities in that smaller bank acquisition opportunity.

So, the other thing you're talking to are more interested in their valuations come up than they are in the potential that we're seeing queue rate increases now recently in those having a positive benefit on their operating abilities?

No. That probably varies from organization to organization as to what their motivations are and what they're looking at, what their strategies are. That's a pretty wide range. It's hard to characterize it as whether it's a rate opportunity, whether it's aging CEOs or there is just a variety of things there that I think that lead them to a conclusion that they would like to seek a partner. And so, I guess the short answer is it varies.

Okay. Fair enough. Thank you for all the added information.

Yeah. Thank you, Jacque, appreciate it.

Thank you. We do have a follow-up in queue from Tim O'Brien. Please go ahead.

Guys one other question following up on Jeff's branch consolidation question, just drilling down, Don Hinson you said -- can you give us an update or characterize or have a ballpark of what the total exit cost is going to be for this initiative and what the kind of dollar amount of run worried savings could be coming out of it on a quarterly basis or on an annual basis for that matter?

Sure Tim. I think that depending on we will try to as we close branches, we always try to find places for people. So, some will depend on severance paid on whether we can find spot for the employees that are in the branches that we're consolidating. And so, I think the cost will probably be between $300,000 and $400,000 depending on that and then going forward I would expect the savings to be around $300,000 a quarter going forward.

And the cost will hit again mostly in the second quarter, third quarter.

Should hit almost all in the second quarter.

Great. Thanks a lot guys. That's helpful appreciate it.

Tim, it's Jeff, I may spoke earlier when I was talking about the paperless statements, I got mixed up with the cost of doing a transaction in the branch versus online. Just to qualify, the savings on a paperless statement is about a $1.75.

Okay. Fantastic.

Yeah, so it's not quite as significant, but it's still pretty significant.

Alright. Thank you.

Thanks Tim.

Thank you very much. At this time, there are no additional questions in the queue. Please continue.

Thank you, Tony. Appreciate hosting the call. Appreciate everyone calling in. I know we'll be involved in a couple of investor conferences over the next couple weeks and we'll see many of you in maybe one or both of those conferences. So, appreciate your continued interest in our company. Thanks for joining us today.

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