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Heritage Financial Corporation  (NASDAQ:HFWA)
Q1 2019 Earnings Call
April 25, 2019, 2:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Heritage Financial Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Jeff Deuel, CEO. Please go ahead.

Jeff Deuel -- President and Chief Executive Officer

Thank you, Moses. Welcome to all who have called in and those who might listen later. This is Jeff Deuel, President of Heritage financial, and CEO of Heritage Bank. Attending with me are Brian Vann, CEO of Heritage Financial; Hinson, CFO; and Bryan McDonald, COO. Our earnings release -- our earnings press release went out this morning pre-market and hopefully you have had the opportunity to review it prior to this call. Please review to the -- please refer to the forward-looking statements in the press release.

It has been a solid quarter for us as we continued to integrate the combined origination teams of three banks and a new team in Portland earlier this year. It's also good to see the expanded production team working well together, and an increase in the loan origination pipeline of 33% since the first of the year. We are pleased to see the back office team refocused on several important customer focused projects, following the two conversions, as well as the implementation of several automated processes by our expanded technology team. We are also pleased to announce that our regular quarterly dividend of $0.18.

Don Hinson will now take a few minutes to cover our financial statement results, including color on our core operating metrics.

Don Hinson -- Executive Vice President and Chief Financial Officer

Thank you, Jeff. Well, I just start with the earnings overview. As we've stated in the earnings release, reported earnings per share for Q1 was $0.45, which is unchanged from Q4, 2018, and up from $0.27 in Q1, 2018.

Moving onto the balance sheet. Total asset growth was muted in Q1, due mostly to a $39 million decrease in total deposits. Deposits decreased in all maturity deposit categories. Historically the first quarter usually starts slow for deposit growth and 2019 follow that trend. To offset decreases in non-maturity deposits, we increased brokered CD balances by $50 million to a total of $78 million as of the end of Q1. The CDs purchased in Q1 will mature by the first part of Q3 and were at rates lower than current borrowing rates.

We will proactively use brokered CDs as a short-term supplement to other funding sources and as a cost of funds management tool. However, it's not our plan to use them as significant long-term funding source. Loans grew at an annualized rate of 4.6% in Q1 and Bryan McDonald will further discuss loan production in a few minutes.

Moving on to credit quality. Our non-performing asset ratio increased to 36 basis points at March 31 from 30 basis points at December 31. The increase was driven primarily by the further downgrade of two commercial lending relationships totaling $5.1 million, which were put on nonaccrual status during Q1. However, the ratio of our allowance for loan losses to non-performing loans still stands at a very 207%.

In addition, included in the carrying value of the loans are approximately $11 million of purchase accounting fair value net discounts, which may reduce the needs of allowance for loan losses on those related purchased loans. The sum of the discounts and the allowance for loan losses is 1.28% of total loans as of March 31.

We continue to have success working through problem credits as evidenced by the net recoveries in Q1 and a decline in potential problem loans. The net interest margin decreased 3 basis points in Q1, compared to Q4, 2018 due substantially to a decrease in accretion income.

Pre-accretion net interest margin remained at 4.22% in Q1, unchanged from Q4, 2018. Although, pre-accretion loan yield increased by 2 basis points and investment portfolio of yield increased by 13 basis points in Q1, this was offset by a 4 basis point increase in the cost of total deposits. The cost of total deposits increased due to a combination of an increase in the cost of interest bearing deposits and an increase in the percentage of CDs to total deposits. Due to the shape of the yield curve, forecasted 2019 rates and competitive pricing pressures, we do expect a challenging margin environment in 2019.

Net non-interest income for Q1 decreased $1.1 million from Q4 levels, due to decreases in service charges, mortgage loan sale gains and interest rate swap fees. Although, we expect mortgage loan sale gains to increase as we get further into the year, due to the current mortgage environment we have recently adjust the staffing size of the mortgage operations in order to improve the profitability of the department over future periods.

Beginning in Q3, we expect cost savings of about $200,000 per quarter related to this staff reduction. The quarter-over-quarter decrease was also due to $413,000 gain on sale of a building recognized in Q4 of 2018.

Non-interest expense for Q1 decreased $749,000 from Q4 levels, dut to a $1.2 million decrease in the acquisition related expenses. The benefit from the decrease in acquisition related expenses was partially offset by increased marketing expenses and costs related to our new commercial banking team in Portland.

Year-over-year adjusting for the combined impact of acquisition related expenses and the amortization of the intangible assets noninterest expense to average assets improved to 2.70% in Q1, 2019 from 2.77% in Q1, 2018. Our effective tax rate for Q1 was 16.3%, decreased from the 22% effective tax rate in Q4, 2018, due primarily to the $898,000 of tax expense recording Q4 related to a change in estimates for low income housing tax credit projects.

And finally on capital, our tangible common equity ratio increased to 10.2% in Q1, from 9.9% at the prior quarter end. The increase was due to a combination of reduction in the unrealized loss on investment securities and our solid earnings for the quarter.

Since December 2017, even with the slightly dilutive impact of two acquisitions, our tangible book value per common share has increased 9.6%. We continue to believe our capital position sufficiently supports our balance sheet risk, our internal growth and potential future growth, both organic and M&A. Bryan McDonald will now have an update on loan production.

Bryan McDonald -- Chief Operating Officer

Thanks, Don. I'm going to provide detail on our first quarter production results by area, starting with our commercial lending group. In the first quarter, our commercial teams closed $163 million in new loans, which is up from $149 million of new loans closed in the first quarter of 2018, and down from $187 million closed in the fourth quarter of 2018.

New production during the first quarter were centered in King County at $57 million, Portland at $24 million and Tacoma at $23 million. We were very pleased to see 65% of the quarter's new commercial loan production fall within the CNI and owner occupied CRE categories.

As we have been reporting since this time last year, our sales force has been placing a higher emphasis on these segments versus investor real estate. Commercial team deposit pipelines ended the first quarter at $59 million, down moderately from $63 million at year-end. Commercial team loan pipelines ended the first quarter at $447 million, which is up 33% from $337 million last quarter.

Each geography within the footprint saw their loan pipeline increase, with the largest concentrations and changes being in our King County teams, which saw their pipeline increase to $178 million from $157 million at year-end.

Our greater Tacoma teams, which saw their pipeline increase to $60 million from $30 million at year-end. And our greater Portland teams, which saw their pipeline increase to $72 million from $47 million at year-end. Gross loans increased by $42 million during the first quarter or 4.6% annualized rate, with loan payoffs and prepayments moderating during the quarter.

SBA 7(a) production in the first quarter included problem loans for $12.4 million and the pipeline ended the quarter at $25 million. This compares to last quarter where we closed nine loans for $7 million and the pipeline ended the quarter at $25 million.

Consumer production during the first quarter was $40 million, down from $49 million closed in the fourth quarter of 2018. The decline was due to lower indirect loan production, which was down $9 million quarter-over-quarter due to our pricing levels.

Moving on to interest rates. Our first quarter interest rate for new commercial loans was 3 basis points higher, increasing to 5.65% versus 5.62% last quarter and rates are up nearly 15% in the last year or 72 basis points, from 4.93% in the first quarter of 2018. In addition, the average first quarter rate for all new loans was 5.68%.

I'll now turn the call back to Jeff.

Jeff Deuel -- President and Chief Executive Officer

Thank you, Bryan. We continue to be comfortable with the overall Pacific Northwest economy, valuations are stable for CRE and CRE and Single family. However, competition continues to be strong. In spite of positive economic environment in the region, we continue to be cautious about all loan segments, relying on our robust concentration management process to provide guidance.

Currently our non-owner occupied CRE concentrations are at 257% of capital, which is down 1 percentage point from last quarter. Whereas construction is at 41% of capital, compared to 39% last quarter. Operating at these levels provides flexibility and allows the bank to take advantage of high quality loan opportunities, while still being able to maintain discipline, focusing on loan quality and yield.

Our overall annualized loan growth in Q1 at 4.6% was again somewhat impacted by payoffs. However, we did see that phenomenon starts moderating in Q1. I think it is important to note that, our risk profile overall tends to limit our loan growth to a certain degree also.

As Don mentioned, we saw deposit levels decline in Q1 and the strategic decision to bring on short term brokered CDs offset this outflow is a tactic we have used in the past. In prior years, we have seen deposit growth pick up in Q2, and we would expect that to occur again this year.

Also, now that we are past the distraction of two integrations and two conversions in 2018, we can see the acquired teams and our new team in Portland contributing in a more significant way, as the loan production pipeline continues to build. We are well positioned for the balance of 2019 with our largest concentrations of our production teams located in Seattle, Bellevue and Portland. The two markets in our footprint with the most opportunity for growth.

We continue to benefit from the flexibility provided by our quality deposit composition, while the cost of deposit is up slightly quarter-over-quarter, the overall costs are still relatively low, and the loan to deposit ratio is holding steady in the low 80's, which provides us with the flexibility to optimize pricing, while managing the balance sheet.

After adjusting for acquisition related expenses, we can see a positive trend in the overhead ratio year-over-year, and expect that to continue to trend down. In addition to one off branch consolidations, we continue to make good progress disposing of unused facilities, as reference by the gains on sale we have been reporting periodically, and further consolidating facilities to create back office efficiency.

As Don noted, we had two commercial loans moved to nonaccrual status in Q1. This move is a natural progression for these loans as we continue to actively manage the portfolio by either under-performing -- by either managing underperforming loans up or out. We do not anticipate significant losses from these two loans, and overall credit quality remains quite good.

We continue to manage our capital position to support risk in our balance sheet and planned organic growth as well as positioning the banks so we can respond to M&A opportunities when they present themselves.

I'll now turn it over to Brian Vance for a few closing comments.

Brian Vance -- Chief Executive Officer

Thanks, Jeff. As Jeff noted, we are comfortable with our moderate loan growth in Q1. Considering where we are in our development as a newly combined and integrated entity and we can see the combined strength of the three banks start to present itself in the growing pipeline numbers.

Additionally, we always strive to not sacrifice loan quality for loan growth, especially at this point in the cycle. While we never like to see a quarterly decline in deposits we are confident we are merely seeing historical seasonal deposit outflows as we expect to see that trend subside and improve as the rest of the year progresses as it has in the past several years.

I continue to believe that on balance sheet liquidity, a high quality of granular deposit base along with strong credit quality will separate the stronger performers from the rest of the pack as we head into more challenging interest rate and overall economic environments. I'm pleased with our historic performance in these areas.

And finally, as a reminder to everyone, this will be my last earnings call as CEO as I will retire effective July 1. I have truly appreciated the relationships I have enjoyed with all of you through the years. And I'll soon look forward to watching our management team from the sidelines as Board Chair as they take the bank to new levels of success.

Jeff, I'll turn the call back to you.

Jeff Deuel -- President and Chief Executive Officer

Thank you, Bryan. I'd like to just -- to just conclude our update with the overall comment that, we feel very good about our future prospects and expect production performance to continue to improve as the year progresses. However, with the current rate environment it will make very challenging year for everyone in the industry.

So Moses, with that said, we're ready to open up the call and move forward with questions.

Questions and Answers:

Operator

(Operator Instructions) And our first question comes from the line of Jeff Rulis with D.A. Davidson. Please go ahead.

Jeff Deuel -- President and Chief Executive Officer

Good morning, Jeff.

Jeff Rulis -- D.A. Davidson -- Analyst

Good morning. Yeah. Just one -- a couple of questions on the expense side. First, on the merger costs, you anticipate those being done, I guess, you had a small amount this quarter, but any outlook?

Don Hinson -- Executive Vice President and Chief Financial Officer

Yes. Jeff, this is Don. They're pretty much done. I don't expect much more.

Jeff Rulis -- D.A. Davidson -- Analyst

Okay. And you guys talked about the technology platform buildout, wanted to see if there is anything actively in the expense base now in the quarter or what could be coming on that front?

Jeff Deuel -- President and Chief Executive Officer

It's essentially -- this is Jeff. Embedded in the numbers you're seeing. What I was referring to is, over the last 18 months we've been adding a small team of IT oriented folks to help us strengthen our data management platform, as well as some software development capabilities, which will contribute to our efforts to create automation in the back office. All told, I think over the last year we probably feathered in about $1 million of expense related to those two things.

Jeff Rulis -- D.A. Davidson -- Analyst

I guess to wrap it up, a run rate thought. I know that maybe last years Q2 stepped down by about $1 million sequentially, I don't know if there is a lot of moving pieces, but so you anticipate any seasonal efficiencies or kind of thoughts on kind of the run rate relative to Q1 level?

Don Hinson -- Executive Vice President and Chief Financial Officer

Jeff, I don't see a lot of difference going forward. There may be some as always a few little expenses in Q1 related to things like payroll taxes and some bonuses, but we also tend to do a lot of officer (ph) increases at the beginning of Q2. So those two may offset each other. So I would say overall, there may be some slight decreased run rate, but I wouldn't -- I don't think it will be significant.

Jeff Rulis -- D.A. Davidson -- Analyst

And the question was just on the margin. Don, you mentioned in -- I think maybe Jeff also to just sort of a challenging margin environment. If we could put that in the context of kind of where that is on -- the current margin, what you saw this quarter and similar given that maybe you had some higher cost funds and if you get a inflow of core deposits where do you see the margin on -- if that occurs?

Don Hinson -- Executive Vice President and Chief Financial Officer

Well, again, like you say, some of it will be dependent on -- if you get a lot of non-spring deposit growth that obviously helps our overall margin. But I think (inaudible) challenging to grow the margin much this year, if at all. And if the cost of deposits continue to go up like it was last quarter, we may even see downward pressure as we get later in the year. So I think it's going to be a pretty flat year overall for the margin.

Jeff Deuel -- President and Chief Executive Officer

Jeff, I would add to that, that because the first quarter historically we see deposit runoff, it automatically feels more challenging to us. And as the year progresses, we tend to recover the deposits and start growing from there. What we're seeing from a competitive standpoint is pretty much what we've seen for the last year or so in terms of competition from some of the smaller banks, who may not have the same loan to deposit ratio that we do and are scrambling for deposits. But more recently, we've also started to see a couple of the larger banks in our market start to crank up their rates on money market accounts and CDs, which we can manage through, because we do have the flexibility to manage through it. It just made it a little bit more difficult to make sure that we stay on top of it and we're reacting properly when we do get confronted with one of these high rates.

One of the things we didn't have to deal with up till now was the main five banks or the biggest five banks in our market. We're not really playing with rates as much as they're starting to now. So that's a little bit different for us this quarter.

Jeff Rulis -- D.A. Davidson -- Analyst

And I guess, lastly. Brian Vance, congrats on the retirement. I guess, we will see in a couple of weeks. But congrats.

Brian Vance -- Chief Executive Officer

Yes. Thanks Jeff. And I do look forward to your conference in Denver and hope to see a lot of folks at that conference. Thank you.

Jeff Deuel -- President and Chief Executive Officer

We might bring him around for some cameo appearances over the next couple of years Jeff. So you might see him around.

Jeff Rulis -- D.A. Davidson -- Analyst

It sounds good. Appreciate it.

Operator

Next question comes from the line of Matthew Clark with Piper Jaffray. Please go ahead.

Jeff Deuel -- President and Chief Executive Officer

Good morning, Matt.

Matthew Clark -- Piper Jaffray -- Analyst

Hey, good morning. On the expense to average assets ratio, 270%, what are your updated thoughts there, Don, may be by the end of this year or for the full year?

Don Hinson -- Executive Vice President and Chief Financial Officer

Matthew, I think that, as I mentioned previously that, we continue to try to work that down throughout the year and year-over-year. So I think we ended out in the high 260's, I think at the end of last year. So I think that we'll continue to work that down year-over-year because every quarter there's some seasonality to all of this. And actually we're down in the -- in the adjusted we're down about 260 at the end of -- in Q4 last year. So we're looking to get back down there again this year by Q4. If not improve upon that.

Matthew Clark -- Piper Jaffray -- Analyst

Okay. And on the loan growth outlook, just given the step up in the pipeline and the 4.6% annualized growth this quarter. How do you -- you still feel OK with that 68% range for the year?

Jeff Deuel -- President and Chief Executive Officer

Yes. Matt, this is Jeff. We would lean toward 6% to 8% range unless we see more elevated loan payoffs as we had in the past. If we do then we would probably moderate that too more like mid single digits which is what you've seen.

Matthew Clark -- Piper Jaffray -- Analyst

Okay. And then just the swap fee line was zero this quarter. Just any color on activity there and whether or not that's something that will pick back up through the balance of the year.

Bryan McDonald -- Chief Operating Officer

Hi, Matt. This is Bryan McDonald. We didn't see any swap activity in the first quarter, some of (inaudible) flattening of the curve and some of the change in dynamics of the market. We continue to pursue it and I do see generating activity during the year, it's just hard to predict at this point.

Matthew Clark -- Piper Jaffray -- Analyst

Okay. Great. Thank you and congrats Bryan. We'll hope to see at some nice destinations over the next year or two.

Brian Vance -- Chief Executive Officer

Thanks, Matt. I appreciate it.

Operator

Next question comes from the line of Jacque Bohlen with KBW. Please go ahead.

Jeff Deuel -- President and Chief Executive Officer

Hi, Jacque.

Hi Jacque.

Jacque Bohlen -- KBW -- Analyst

Hi, good morning.

Jeff Deuel -- President and Chief Executive Officer

Good morning.

Jacque Bohlen -- KBW -- Analyst

Just wanted to talk about the gain on sale of loans, what your expectations are from a mortgage banking perspective? And then also an update on how you're thinking about SBAs? I know you've been adding those to the portfolio, but how you're thinking about that going forward?

Bryan McDonald -- Chief Operating Officer

So Jacque, at the end of the quarter the mortgage pipeline was at $29 million versus $23 million at the end of the year, we only closed $17 million in mortgage volume in Q1 versus $28 million in Q4 of last year. So we do see the volume ticking up coming into the second quarter, both seasonally and just an overall increase in demand.

We are seeing much more custom construction business, more portfolio business than secondary market business in the mix and that's kind of how we position that area for the last couple of years. So we do see gain on sale, some improvement in gain on sale in Q2 and probably throughout the year.

On the SBA side, we have an analysis that we run where we use that to determine whether or not we sell those loans. And they're just much more lucrative to keep on the balance sheet because the rates are relatively high and the gain on sale premiums have remained relatively static versus a year ago. So we just went through it and Don and I looked at a pool of them just three weeks ago just to kind of retest that thinking and it's clearly better to leave them on balance sheet versus sell them with that comparison.

So that's a long way of saying at least -- in the current gain on sale environment, we would not anticipate selling any of the SBA 7(a) loans.

Jacque Bohlen -- KBW -- Analyst

Okay, that's helpful. Thanks, Bryan. And then probably a question for you Don on taxes. And I apologize if this came up in prepared remarks, I've been on a lot of calls this morning. But I don't think that it did. I know the press release mentioned that taxes were impacted by the increased presence in Oregon, which I know is the higher tax state versus Washington. So I was just wondering what your forward guidance is? And if you expect that to continue to gradually creep up as you continue develop at Portland?

Don Hinson -- Executive Vice President and Chief Financial Officer

I think gradually, obviously, the big increase was the Premier merger last year. So I think that -- I think the guidance of mid 60 is still good for this year.

Jacque Bohlen -- KBW -- Analyst

Okay. And then just kind of gradually on a quarterly basis and into 2020 start to creep up a little bit more?

Don Hinson -- Executive Vice President and Chief Financial Officer

Correct.

Jacque Bohlen -- KBW -- Analyst

Okay. Great. Thank you. And I do echo, congratulation Brian Vance, best of luck and everything. And I look forward to some cameos from you.

Brian Vance -- Chief Executive Officer

Thanks, Jacque. I do as well.

Operator

Next we have Gordon McGuire with Stephens Inc. Please go ahead.

Jeff Deuel -- President and Chief Executive Officer

Good morning, Gordon.

Gordon McGuire -- Stephens Inc. -- Analyst

So I just wanted to start. Just trying to figure out the puts and takes on the core NIM flattening from here. And get a better sense of what you could see from an asset repricing perspective. Your new origination yields are still pretty well ahead of the book. But the core loan yields this quarter were up only 2 basis points. So I'm trying to -- how do you see the loan book and then additionally the securities book yields kind of inflecting or heading this year?

Don Hinson -- Executive Vice President and Chief Financial Officer

Hi, Gordon. This is Don. It's -- the loans were at I think -- around 5% overall of the note rate. What was happen -- actually happened to come off the books wasn't that much lower than what they came on at. Even though we again had a -- I would think overall a good quarter for new origination rates. Again, we did an analysis of what came off the books, and they were again almost that high. So what's left behind is pretty much the same rates.

We did see the loan yield book pop a little bit a couple of basis points, but that's why it didn't go up more, because it wasn't the lower stuff that was coming off, it was probably lines that have already been repriced and they were short term in nature that were coming off. So (inaudible) the loan side, on the investment side, again, I don't see that increasing much this year due to the current yield curve and what we're currently putting, new investments on at and what's coming off there either. I don't see a whole lot of it, because we're not probably going to change our--the credit quality of our investment portfolio. So without doing that I doubt we'll see much increase in the investment yields throughout rest of the year.

Gordon McGuire -- Stephens Inc. -- Analyst

In your commentary about the role off not being far from the new production. Is that what you would expect to see for the rest of the year or was it more unusual this quarter?

Don Hinson -- Executive Vice President and Chief Financial Officer

I think it's a little bit unusual. But again because of the -- we always going to see somewhat of the short term nature. Lot of the lower priced loans are maybe at a -- maybe in their commercial real estate they have five year maturities and so they don't role as quickly. So I think what's going to come off will always be a little bit higher than what's on the books.

Gordon McGuire -- Stephens Inc. -- Analyst

And then just moving to the deposit side. I think or it looks like you raised some pricing across your products recently. I'm wondering how you feel as far as your positioning standpoint, now with no more rate increases, do you feel comfortable with where your pricing is right now, just on the rate sheet.

Jeff Deuel -- President and Chief Executive Officer

I think -- in response to that, yes, we think that the strategy that we have in place is the one that we'll continue to utilize. We did feel that we needed to move some of the rack rates up a little bit, mostly to help our team in the field avoid dealing with some of the exception pricing that we were facing into. But because our loan to deposit ratio is so low, we have the ability to manage it partly on an exception basis. We -- I don't think we'll wildly change that strategy as the year goes on, but like I said earlier, we are seeing a little bit more competition than we were maybe end of last year.

Gordon McGuire -- Stephens Inc. -- Analyst

And then lastly just on the service charge decline. It looks like that was a little bit more than you've typically seen in first quarters. Was there anything unusual in there?

Don Hinson -- Executive Vice President and Chief Financial Officer

Gordon, no, that's not necessarily unusual, I'll think most of it had to do seasonality, but -- and just I think for the quarter. I think it'll be interesting to see what happens. Obviously, we did went through a conversion with Premier in the Q4 and this is the first full quarter and I think we're still kind of seeing how that plays out as we converge the service charge together.

Gordon McGuire -- Stephens Inc. -- Analyst

Okay. Thank you.

Jeff Deuel -- President and Chief Executive Officer

Thank you.

Operator

Next question comes from the line of Tim O'Brien with Sandler O'Neill & Partners.

Jeff Deuel -- President and Chief Executive Officer

Good morning, Tim.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

Good morning, guys. Hey, what was the rate that you guys are paying on the brokerage CDs you added in the quarter?

Don Hinson -- Executive Vice President and Chief Financial Officer

Good question Tim. I think it was about 2 -- I think 230 to 235.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

230 to 235 in there?

Don Hinson -- Executive Vice President and Chief Financial Officer

Right.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

Okay.

Don Hinson -- Executive Vice President and Chief Financial Officer

And again they're running off partly early this quarter and partly early next quarter, I believe.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

Okay. In 2Q and 3Q. Okay, great. And then it looks like advertising expense was up a little bit this quarter, is that some seasonal -- was that promotion related to deposit rates? Or was that a reset higher? What's going on there?

Jeff Deuel -- President and Chief Executive Officer

It's nothing specific or significant, Tim. Our marketing budget just tends to flow as the quarter go by. And we have a budget and it may be higher one quarter and lower the next. And we usually bring it in on budgeted by the end of the year.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

Out of curiosity, that budget item that gets set every year, so how much does it get? Does it increase or decrease on a year-over-year base. For marketing specifically how much do you guys tend to increase that by a 3% a year something the rate of inflation?

Jeff Deuel -- President and Chief Executive Officer

We don't necessarily increase it significantly year-over-year. We tend to try and hold it to what it was in the prior year quite frankly. Embedded in that number is not just marketing and advertising, but also contributions which is also a fairly static number.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

And then last question. I thought I caught something about some consolidation plans, office, back office something like that pending later this year. Is that right or did I misconstrue that?

Jeff Deuel -- President and Chief Executive Officer

What we were alluding to is that, we did have one branch location consolidation in the last quarter. We tend to do those onesies, twosies throughout the year as we have the opportunity to do it. But we're also focused on reducing unoccupied space in the back office we have as a results of all the transactions, we've done a lot of building that we're trying to get rid of. And we did one in the last quarter and we've got a few more on the market that may or may not sell in the next quarter.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

All right. Thanks for answering my questions.

Jeff Deuel -- President and Chief Executive Officer

Thank you.

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

Good luck, Brian.

Brian Vance -- Chief Executive Officer

Thanks, Tim.

Operator

Next question comes from the line of Tim Coffey with FIG partners. Please go ahead.

Jeff Deuel -- President and Chief Executive Officer

Good morning, Tim.

Tim Coffey -- FIG Partners -- Analyst

Hey. Good morning, gentlemen. Just a follow up on that last question. The $200,000 that you anticipated in cost saves. That was the right number right?

Don Hinson -- Executive Vice President and Chief Financial Officer

That's for the mortgage -- we've talked about the mortgage department for some staff reductions. But starting in Q3 we're expecting about $200,000 a quarter in just cost savings.

Tim Coffey -- FIG Partners -- Analyst

Okay, great. Is your expectation that, that will actually hit the expense line or will be netted away against other investments?

Don Hinson -- Executive Vice President and Chief Financial Officer

Well, I mean, we always got things going on in the bank but. But we will realize that -- those cost savings for the department.

Tim Coffey -- FIG Partners -- Analyst

Okay. All right. And then given that you've made number of investments in Portland and, of course, in Seattle and those do seem to be paying off in terms of loan growth. Do you have any other planned investments to make in other markets in the near term?

Jeff Deuel -- President and Chief Executive Officer

Not for now, Tim. As we've said during the call, we still have a focus on growing organically and through M&A activities. So M&A is always something that's interesting to us, but separate from M&A, which would likely be on the I-5 quarter to fill in what we already have in our footprint. Going further afield right now, in '19 is unlikely unless a particular team presents itself to us, because we think we have enough to work with in Seattle, Bellevue and Portland with not just the new teams there, but the opportunities to grow in those markets is something we can focus on in the meantime.

Tim Coffey -- FIG Partners -- Analyst

Okay. And then sticking with the M&A theme. I've heard from other banks this quarter that disconnects between what a seller thinks is worth and what a buyer believes that business is worth has started to reappear again. Is that any different than what you're seeing right now?

Jeff Deuel -- President and Chief Executive Officer

We're not necessarily experiencing that. We oftentimes show the slide in our investor deck that shows that 23 banks along the I-5 quarter between $2 million and $2 billion that we might be interested in. We're not necessarily facing in anything right now, but we're always having ongoing conversations throughout the year. And pricing has not been something that's been thrown out as a roadblock for us.

Unidentified Analyst -- -- Analyst

It's good time. All right. Those are my questions. Brian Vance, it's been great working with you. Good luck to you in your next chapter.

Brian Vance -- Chief Executive Officer

Thanks, Tim. I appreciate your comments.

Operator

Next question comes from the line of Matthew Clarke with Piper Jaffray. Please go ahead.

Matthew Clark -- Piper Jaffray -- Analyst

Hey. I just wanted to clarify a couple of things. Don, your commentary on the NIM, are you speaking to the reported NIM remaining relatively stable or the core?

Don Hinson -- Executive Vice President and Chief Financial Officer

Yeah. Obviously, Matthew the core NIM. Obviously this kind of accretion is -- can in someway fluctuate and unpredictable, but I was talking more to the core NIM.

Matthew Clark -- Piper Jaffray -- Analyst

Okay. And then the expense to average asset ratio. If you assume a run rate of expense -- operating expense that's comparable to 1Q and you layering your other commentary, it would suggest getting to that 260% expense to average asset ratio in the second quarter. Just wanted to make sure, showing the improvement year-over-year, you're gonna get to 260 for the full year correct?

Don Hinson -- Executive Vice President and Chief Financial Officer

No. We're trying to do is, year-over-year -- for the quarter, like for this year it was 277, the core when you take out mortgage related expenses and it was 277 in 2018, it's 270 this year, every quarter year-over-year we're looking for improvement.

Matthew Clark -- Piper Jaffray -- Analyst

Okay.

Don Hinson -- Executive Vice President and Chief Financial Officer

So it is 260 in Q4 of '18. We're looking to improve upon that. (inaudible) up in the high 250s or somewhere in the 250 by the end of the year.

Matthew Clark -- Piper Jaffray -- Analyst

Got it. Great. Thank you.

Operator

At this time there no further questions in queue.

Jeff Deuel -- President and Chief Executive Officer

Okay. Well, thank you Moses. If no more questions then we're ready to wrap up the quarter's earnings call and we thank you all for your time, your support, your interest in our ongoing performance as an organization. And we will look forward to seeing several of you over the coming weeks. So thank you and goodbye.

Operator

Ladies and gentlemen this conference will be available for replay after 1:00 P.M today through May 9th midnight. You may access the AT&T teleconference replay system at any time by darling 1800-475-6701 and entering the access code 466040. International participants dial 320-365-3844. These numbers again are 1800-475-6701 and 320-365-3844. Access code 466040. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

Duration: 41 minutes

Call participants:

Jeff Deuel -- President and Chief Executive Officer

Don Hinson -- Executive Vice President and Chief Financial Officer

Bryan McDonald -- Chief Operating Officer

Brian Vance -- Chief Executive Officer

Jeff Rulis -- D.A. Davidson -- Analyst

Matthew Clark -- Piper Jaffray -- Analyst

Jacque Bohlen -- KBW -- Analyst

Gordon McGuire -- Stephens Inc. -- Analyst

Tim O'Brien -- Sandler O'Neill & Partners -- Analyst

Tim Coffey -- FIG Partners -- Analyst

Unidentified Analyst -- -- Analyst

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