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Heritage Financial Corporation (NASDAQ:HFWA)
Q1 2021 Earnings Call
Apr 22, 2021, 2:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Heritage Financial Earnings Call.

[Operator Instructions] Later, we will conduct a question-and-answer session. [Operator Instructions] And as a reminder, today's call is being recorded.

I would now like to turn the conference over to Mr. Jeff Deuel. Please go ahead.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thank you, Cynthia. Welcome and good morning to everyone who called in, and those who may listen later. This is Jeff Deuel, CEO of Heritage. Attending with me are Don Hinson, Chief Financial Officer; Bryan McDonald, Chief Operating Officer; and Tony Chalfant, Chief Credit Officer. Our earnings release went out this morning 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 website. We will reference that presentation during the call. Please refer to the forward-looking statements in the press release.

Overall, we are very pleased with our financial results for the first quarter, particularly given the pandemic environment that has been imposed on all of us. We are also very proud of our team and their strong performance during a very difficult period of time. The first quarter results have been influenced by the declining rate environment, carefully managed expenses and full participation in PPP Round 2.

Additionally, our long-standing focus on credit quality and managing loan concentrations has played out well for us so far and that discipline, together with the improving economic forecast has enabled us to report more favorable credit trends and recapture of some of our reserve build from last year. The combination of these factors has allowed us to report an EPS of $0.70 for the first quarter as well as an ROA of 1.5%. While overall loan volume continue to be muted in the first quarter, our team's focus was on portfolio management and Round 2 of PPP with notable success.

With most branch lobbies reopened together with PPP Round 1 and Round 2 moving into forgiveness phase as well as widespread vaccine deployment in our region, our teams are now focused on more traditional outreach to customers and prospects. We are already seeing results in a rapidly growing pipeline of deposits and loans, which positions us well for the balance of the year and into 2022.

I also want to add that we have continued to focus on completing important technology initiatives during the past year, which we have highlighted on page 6 of the investor deck. I'm pleased to report that our CL 360 initiative, one that will automate the loan origination process has launched internally and we will continue to enhance that platform over the balance of this year. Additionally, our new CRM platform Heritage 360 will launch in June and becomes the foundation for client service across the bank. Both of these undertakings will enable us to be more efficient, will enhance capacity on the team and allow us to provide a more seamless customer experience. It's very exciting for the team to be moving these two initiatives into production.

We'll now move to Don who will take a few minutes to cover our financial results.

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

Thank you, Jeff.

As Jeff mentioned overall profitability was very positive in Q1. I'll be reviewing some of the main drivers of this Q1 performance. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the fourth quarter of 2020.

Starting with net interest income, there was only a slight decrease in net interest income from the prior quarter and that was due more than anything to fewer days in Q1 compared to Q4. Other factors affecting this line item, were an increase of $129 million of average interest earning assets, partially offset by 2 basis point decrease in the net interest margin. The increase in average earning assets was due mainly to the strong deposit growth in Q1. The decrease in net interest margin was due mostly to a higher percentage of excess liquidity.

Interest earning deposits increased to 11.8% of average earning assets in Q1 compared to 9.5% in the prior quarter. This increase in the percentage of overnight cash was offset by a similar size decrease in the percentage of loans to average earning assets. Trends in the composition of average earning assets is shown on page 24 of the investor presentation. Removing the impacts of discount accretion and PPP loans, the yield on loans increased 2 basis points from the prior quarter. This increase was due mostly to a 3 basis point positive impact from the payoff of a non-accrual loan during Q1.

Brian will discuss loan production and balances including PPP lending in a few minutes. We continue to work down the cost of our total deposits with its bearing deposits decreasing 3 basis points in the prior quarter. Our cost of total deposits decreased to 12 basis points in Q1, which is an all time low for the Bank. More information regarding deposit growth and cost deposits can be found on page 23 of the investor presentation. As I previously mentioned, Q1 deposit growth was very strong. This growth was due to a combination of factors. The most significant of which was the deposit of PPP Round 2 loan proceeds into customer accounts. Even with the significant balance sheet growth, all of our regulatory capital ratios increased in the prior quarter and remains strongly above well capitalized thresholds.

The combination of strong liquidity and capital gives us tremendous flexibility as we continue to grow the Bank. As mentioned in the earnings release, noninterest income decreased substantially due mostly to significant gains totaling $2.8 million that were recognized in Q4. In addition, we experienced a decrease in the mortgage loan sale gains from the prior quarter. We expect that quarterly loan sale gains in 2021 will be somewhat lower than they were in the last half of 2020. We continue to see nice improvement in our overhead ratio due to the combination of expense management measures and asset growth, our overhead ratio decreased to 2.22% for Q1 compared to 2.30% in the prior quarter and 2.70% in Q1 2020.

Noninterest expense decreased from the prior quarter, due mostly to the costs in Q4, relating to the branch consolidations, which we completed in January. Since the consolidations has occurred in mid-January, we were able to realize substantially all the cost savings in Q1. Additionally, noninterest expense levels in Q1 benefited from approximately $450,000 of deferred costs related to PPP Round 2 originations. Offsetting the deferred costs in Q1 were approximately $600,000 of direct costs associated with PPP in Q1. These direct costs are expected to decrease to approximately $300,000 in Q2 and $100,000 per quarter from Q3 of this year through Q1 of next year.

The significant impact to our earnings for Q1 was the reversal of provision for credit losses in the amount of $7.2 million. Of this amount, $6.1 million was related to the allowance for loans and $1.1 million was related to the allowance for unfunded commitments. Although partly due to lower loan balances and a net recovery in Q1, the most significant factor for the provision reversal was due to an improved economic outlook. In addition, we are seeing improvements in many of our credit quality metrics.

I will now pass the call on to Tony who will have an update on these credit quality metrics.

Tony Chalfant -- Chief Credit Officer

Thank you, Don. As you stated in the first quarter, we saw the first meaningful improvement in our credit quality metrics since the start of the pandemic in early 2020.

We ended the quarter with net recoveries of $175,000, a modest level of primarily consumer loan charge-offs was more than offset by recoveries on several commercial loans. These loans had been in non-accrual status and we were successful in recovering all of the principal and accrued interest. It's important to note that these were long term workouts where the borrowers were already on non-accrual prior to the onset of the pandemic, and were not directly impacted by COVID-19.

For the quarter, non-accrual loans declined by $5.2 million or 9%. As of March 31, non-accrual loans totaled $52.9 million or 1.15% of total loans. Loan payoffs and paydowns accounted for $3.6 million of the reduction, while the remainder was the transfer of several loans back to accrual status. The loans moved back to accrual status have a long history of payment performance, and are all well secured by real estate. The addition of new loans to non-accrual status at $468,000 was much lower than we've experienced over the last three quarters.

Potential problem loans decreased by $18.5 million during the first quarter or 10.2%, a significant component of this decrease was a pay-down on a loan for a borrower in a COVID-19 impacted industry. Additions to this category during the quarter were generally offset by loans upgraded to a past reading and TDRs that were reclassified to performing status. For more information on our credit quality, I would direct you to page 21 of our investor presentation.

As we see many of our COVID-19 impacted borrowers continue to recover. We're seeing reduced levels of loan modification requests that we've been providing under the CARES Act. As of quarter end, there were 67 loans totaling $46.7 million that remained in a payment deferral modification status. This is down from 177 loans totaling $92.5 million at the end of 2021. Of these remaining modified loans, $36.7 million or approximately 79% are in the hotel and restaurant industries.

In summary, we believe with the vaccine rollout and a continued movement back to a more normalized business environment, we should continue to see improved credit metrics over the next several quarters. I'll now turn the call over to Bryan who will have an update on our loan production in our SBA PPP loan activity.

Bryan McDonald -- Executive Vice President and Chief Operating Officer

Thanks, Tony. I'm going to provide detail on our first quarter production results, starting with our commercial lending group. For the quarter, our commercial teams closed $200 million in new loan commitments, up from $140 million last quarter and up from $161 million closed in the first quarter of 2020. The commercial loan pipeline ended the first quarter at $540 million, up 31% from $413 million last quarter and up from $506 million at the end of the first quarter of 2020.

New loans increased significantly in the last two months as discussions with customers on capital projects and expansion plans continues to accelerate. Loans excluding SBA PPP balances decreased $44 million during the first quarter due in part to a 3% decline in the loan utilization rate, which reduced balances by approximately $50 million. Consumer production was $16 million for the first quarter, down from $18 million last quarter and down from $49 million in the first quarter of 2020. The decline versus 2020 was due to the discontinuation of our consumer indirect lending business during the first quarter of 2020.

Moving to interest rates. Our average first quarter interest rate for new commercial loans excluding PPP loans was 3.53%, which is up 21 basis points from 3.32% last quarter. In addition, the average first quarter rate for all new loans excluding PPP loans was 3.66%, up 24 basis points from 3.42% last quarter. The mortgage department closed $43 million of new loans in the first quarter of 2021 compared to $57 million closed in the fourth quarter of 2020 and $31 million in the first quarter of 2020. The mortgage pipeline ended the quarter at $36 million versus $33 million in Q4 and $54 million in the first quarter of 2020.

Refinances made up 71% of the pipeline at quarter end. Based on the pipeline going into the quarter and a relatively higher mix of portfolio loans, we anticipate gain on sale to be closer to $1.1 million for the second -- for the third quarter, excuse me, for the second quarter. Moving on to SBA PPP. During the quarter we provided 2,235 Round 2 SBA PPP loans for $353 million and we would direct you to page 19 of the investor deck for additional PPP loan details. We plan to continue taking applications and until close to the extended end of May expiration date for the program unless funding expires sooner. And based on the current application flow, we now anticipate total volume for Round 2 PPP will approach $375 million.

The SBA PPP forgiveness application process continues to progress smoothly for Round 1 PPP customers, and we anticipate having the bulk of Round 1 applications processed by the end of August. We are already receiving requests from Round 2 PPP customers who want to apply for forgiveness and are planning to start accepting applications for this phase by mid-May.

I will now turn the call back to Jeff.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thank you, Bryan. As I mentioned earlier, we are very pleased with our performance to date, we are also delighted to be pivoting away from the defensive position we've been in for the last year and focusing on the more positive environment ahead. We are seeing a nice upswing in our pipeline across the bank with deals coming from existing customers and new high quality prospects. The heavy lifting by our team with PPP loans will pay dividends for years to come. And we continue to see evidence of that.

Most recently, a significant new C&I relationship that was referred to us by a new customer in Portland, who we helped with PPP Round 1 last year. Additionally, our presence in the core markets of Seattle, Bellevue and Portland is still relatively new for us and continues to offer many new and exciting business opportunities, which will help further establish our position in those markets.

With the vaccine rollout, the latest stimulus package and given what we know today, we believe the risk in the loan portfolio is much improved over just a quarter ago and as things continue to open up the performance of many of our most severely impacted businesses should continue to improve. We are also happy to see some long-term problem loans get resolved this past quarter. Our capital levels and our robust liquidity provides us with a strong foundation to address any remaining challenges and to make it and take advantage of opportunities.

Our focus is on growth supported by efficient operations and the leadership team continues to identify and implement process improvements and efficiencies that will allow us to continue to deliver consistent long-term performance in all of our financial metrics. You can see evidence of this focus in the notable decline in FTE numbers and the increase in average deposits per branch and the increase in average assets per employee.

That's the conclusion of our prepared comments. Cynthia, we're ready to open up the call to any questions anyone might have.

Questions and Answers:

Operator

Certainly. [Operator Instructions] I'm showing no questions in queue at this time.

Jeffrey J. Deuel -- Chief Executive Officer and Director

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

Kaylene Lahn -- Senior Vice President of Corporate Secretary

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

Operator

Okay. And actually one moment. And I do see a few questioners here. One moment and we'll go to the first line. And we'll take the first question from Matthew Clark with Piper Sandler. And your line is open.

Matthew Clark -- Piper Sandler -- Analyst

Hey, good morning. One zero has I guess thrown everybody -- it's star one. I guess the first question I wanted to hone in on the core NII outlook and the core margin as well. Is your plan to try to grow core NII with maybe leveraging the balance sheet with securities from here, obviously loan growth sounds like it's going to be stronger going forward to with the pipeline up, but I just want to get your overall thoughts on kind of stabilizing, if not growing core NII of $42 million in that core NIM of 3.27%.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thanks, Matt for the question. Just a sidebar comment, when you don't get questions you worry, if anybody is interested, so glad that you joined in. Yeah, what we and Don probably wanted to jump in on this too, but I think the overarching project that's in front of us is to just leverage our cash just in general. And that's going to be a combination of us obviously leveraging through growing the loan portfolio, which we're feeling better about this quarter than maybe we were last quarter and also more on the investment side.

So, Don, anything you want to add to that?

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

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

Matthew Clark -- Piper Sandler -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

Bryan, you want to take that one.

Bryan McDonald -- Executive Vice President and Chief Operating Officer

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

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

And Matt, I would just for anecdotal feedback, I tend to use a measure of production based on how frequently the executive loan committee see deals and we went from very few actions to we're kind of at a point where we're seeing something at least every day, which is a great sign for us.

Matthew Clark -- Piper Sandler -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

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

Matthew Clark -- Piper Sandler -- Analyst

Okay, thank you.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thank you.

Operator

Thank you. Our next question comes from Jeff Rulis with DA Davidson. And your line is open.

Jeff Rulis -- DA Davidson -- Analyst

Thank you. Yeah Jeff, we always have question. So just [Speech Overlap] No, I guess I wanted to add a question on the branch closures and kind of the retention of which it impacted the customers and just sort of an update, as you've seen it so far. And then what that might translate on expenses kind of next question. And then just I guess looking at additional closures if thereafter. So kind of three part, how is it going, how does it impact expenses and then the rest. Thanks.

Jeffrey J. Deuel -- Chief Executive Officer and Director

I'll let Don answer the expense question, I'll do the first and the third. We have been monitoring for the last couple of months. You can imagine that the deposits are overly impacted by the liquidity that's on the balance sheet, but we're watching not just deposits in those locations but also numbers of accounts and the result has been quite good in terms of retention, even one location that was pretty distant relative to the consolidating branch is not seeing over the top run off. So we're feeling good about the actions that we took and things are still well within what we budgeted for in terms of run-off.

Additional branch closures, I would just put it to you that much like our compatriots in the industry, we are all laser-focused on expenses. And I think that we're always analyzing to determine what we can do to pare back or control expenses and will always be looking at the branch footprint. And I think you'll just see more activity in that area, in general that you would have seen any ways over time but eight branches for us was 15% of the footprint. So we're not going to rush to do eight more, we're going to wait a little bit longer and see how we've done with these eight before we step out again. I think that it's any expense in the organization is under review and we're taking the steps that we think are appropriate as we progress through 2021.

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

Yeah, Jeff I will jump in, yeah on this. As I mentioned in my comments, Jeff, that most of the cost savings were baked into Q1. So there is not much more to that you'll see in the future quarters on these. Overall the savings per branch were about 250, so it's about 2 million on an annualized basis. So I guess not much more to say about that because we've given, it's in Q1 numbers.

Jeff Rulis -- DA Davidson -- Analyst

Okay, all right. Thanks, Don. And Jeff, maybe I'll circle back to the -- you tried to recall last year at this time. Kind of mentioned it was sort of pencils down on M&A, but as you say, it maybe a quiet restart up in our region. And I guess that's more on the maybe sellers readiness. Is that what's keeping it quiet certainly your appetite, I think from a risk standpoint you're feeling better. So I just wanted to confirm that it really is the seller pace versus your readiness. Is that correct?

Jeffrey J. Deuel -- Chief Executive Officer and Director

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

Jeff Rulis -- DA Davidson -- Analyst

Okay. And then the alternative to that I guess is if we get longer the year, it gives pretty adept at capital management should M&A sort of stall I guess kind of buyback. The other capital deployment priorities obviously funding organic growth. But beyond that assume that you'd look at the other avenues if M&A doesn't play out.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Yeah, I think we would, I think our top choice would be probably to see that loan growth continue to develop in front of us. There is always the notion of potential opportunities in the form of teams, which is also something we'd be interested in. We have added a couple of new folks to our team on the production side. There are conversations going on in that area that could develop into something. So there is a lot of things that could develop, on the M&A side to just wanted to point out that we have continued the usual conversations that we have to keep us in front of people and top of mind and fortunately we're all the whole leadership team is pretty well connected with the other banks. So, I am comfortable that we are staying close enough that if someone decides to do something that they will remember to give us a call.

Jeff Rulis -- DA Davidson -- Analyst

Okay, thank you.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thank you.

Operator

Thank you. Our next question comes from the line of Jackie Bohlen with KBW. And your line is open.

Jackie Bohlen -- KBW -- Analyst

Hi, good morning.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Good morning.

Jackie Bohlen -- KBW -- Analyst

I wanted to dig into the reserve ratio a little bit, even with the quarters capture you're still really well reserved, especially if you look at where you were at on January 1, 2020 which I kind of view is the starting point before only with the next year with that will look like. With that in mind, and you've already put some of the improved economic forecast in there. What would need to happen in order to not have to do another recapture?

Jeffrey J. Deuel -- Chief Executive Officer and Director

Well, and Don may want to join in on this or Tony. But I think where we sit now is as I said earlier in our presentation material that even just a quarter ago, we're feeling better about it and feeling much more optimistic than we were in December, January, but I think where we are a fairly cautious institution, Jackie, and I think one of the things that we're waiting to see unfold is what is going to happen with that portion of the portfolio that falls into the high-risk categories.

We feel good about where we sit right now and what we can see. But things can change as you are aware from being in the region that just in the last week, we've gone backwards in the phases for a couple of the counties that we're in, one being Pierce, which is where Tacoma is, the other being Cowlitz, which is where Longview is, Cowlitz County and Pierce County. I think that we're happy that we're taking it in gradual steps. And I think if we see things portfolio quality deteriorate, obviously that would stop us from releasing in the future. And the other would be, potentially loan growth, which we are hoping for as well. I think the reality is that things probably will progress the way they are, and I think that you would expect us to continue to take -- to have continuing potentially continuing releases throughout the year.

Tony Chalfant -- Chief Credit Officer

Yeah, Jeff, I guess I'll just add on to that. Jackie, I think that losses are obviously, we still haven't start experiencing losses. So our loss history is still really low and until we start seeing some losses or have some significant growth on the loan side, this -- it will probably will continue to work itself down over the year, but we do take this on a quarter-by-quarter basis.

Jackie Bohlen -- KBW -- Analyst

Okay. Thank you. That's very helpful. And just one other one that I had. I know that we spent a lot of time talking about the loan pipeline. But one of the prepared remarks also discussed the robust deposit pipeline and so I was just curious about your expectations for growth there, particularly in light of you obviously have very strong growth from stimulus in the quarter. So how you're thinking about balance fluctuation for the rest of the year. And I don't know if I'm prompting to answer.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Don, I'll let you jump in with the deposit growth rate but Jackie, one of the things that we realize and recognize is that, well, our expectation is that a good portion of the PPP related deposits will run off as forgiveness occurs and many of the business owners who got the proceeds and haven't spent it are going to start spending it and using it for other things. And we know that deposits are precious. We feel they are even precious in this environment. And the focus on originating deposits is -- is an ability that we brought into our organization in a bigger way in the last few years and we really don't want to stop that because we're probably going to want those deposits in the future.

So, they also come with relationships and those relationships continue to grow and evolve and help us expand the base of customers too. So even though we have a preponderance of deposits, right now we have not taken our eye off the ball for developing deposits for the longer term. Don, maybe you could talk about the growth rate that's built in for us going forward.

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

Well, I think we're just in such unusual times here. I mean normally through the first quarter, mostly through April, we see very flat and sometimes even contraction of deposit balances. But even if you remove the dollar amount of the PPP originations, we did in Q1, we still saw pretty significant deposit growth. So we're in an unchartered territory here. I think that we are liable to see over time the deposit growth to flatten out and then we would expect that over time again that some of these deposits will flow out of the bank because people start reducing the amounts, which are in their accounts.

We have added quite a few accounts related as a result of the PPP origination. So, we're expecting those to stick around, at least -- at least maybe not as high balances but overall. So I think our the deposit growth overall would be somewhat muted for the rest of the year, but I think we'll still see some growth. It all depends on when people feel more comfortable about taking their deposits out.

Jackie Bohlen -- KBW -- Analyst

Okay. All right, thank you everyone.

Jeffrey J. Deuel -- Chief Executive Officer and Director

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

Jackie Bohlen -- KBW -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

Yeah that's true too.

Jackie Bohlen -- KBW -- Analyst

Thanks, Jeff.

Operator

Thank you. Next we will go to the line of David Feaster with Raymond James. And your line is open.

David Feaster -- Raymond James -- Analyst

Hey, good afternoon.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Good afternoon, David.

David Feaster -- Raymond James -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

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

Bryan, anything you want to add.

Bryan McDonald -- Executive Vice President and Chief Operating Officer

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

David Feaster -- Raymond James -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

Bryan, you want to take that one.

Bryan McDonald -- Executive Vice President and Chief Operating Officer

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

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

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

David Feaster -- Raymond James -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

Yeah, David, I think that a lot of, well I guess someone seeing this from outside may say why are you developing it yourself and not buying it off the shelf. Well, we went through that exercise and decided that we had the capacity to build more of what we wanted than what we could get off the shelf. A lot of the expense related to this is embedded in the IT expense that's been on our income statement for the last several years, it was in the form of small team of developers that we brought on, to help us develop this platform for us.

It is going, it does create an opportunity for us to flex either capacity wise to accommodate more growth or to the other direction is not the direction we want to go in, but we can, we can shrink faster if we need to with the platform that we've put in place and we think that we're, we're set up to manage through the, the growth that we believe is coming at us, a little bit more easily than we would have in the past where a lot of things before now we're manual, and if we wanted to increase capacity, we had to add expense in the form of bodies. We can pass on that at this time. So I think that that's why you would see, you can see us holding back on the FTE for example, and that you can see in the FTE numbers, but the ability to flex is one of the benefits that we're going to get out of it.

Let alone the better customer experience that's going to -- we're going to be able to put in front of our customers. The one piece of the technology that we referenced the Heritage 360 and the platform. It being the platform for serving clients in the future. It is our online platform for our customers, it's a way for us to service our customers where and when they want to interact with us, which we haven't had up till now. So if someone starts to do online account setup and they get stuck, they can go into a branch and the branch will be able to go into the system and pick it up right where they left off and keep going. That's an advantage that we haven't had, and I think will benefit us in the future and maybe hold us out there is being a little bit, a little bit different in our ability to support our customers. Don, maybe you want to make some comments about the actual expenses related to the initiatives and how they impact us.

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

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

David Feaster -- Raymond James -- Analyst

Okay, that's great color. Thank you.

Operator

Thank you. Next we will go to the line of Andrew Terrell with Stephens, and your line is open.

Andrew Terrell -- Stephens -- Analyst

Hey, good afternoon.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Good afternoon.

Andrew Terrell -- Stephens -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

Tony, you want to take that one.

Tony Chalfant -- Chief Credit Officer

Yeah, sure, Andrew. Good morning or good afternoon I guess to you. I think the, one of the things I'd probably point out with that portfolio is it's split about 50:50 between owner occupied and non-owner occupied. So we look at the owner occupied is having a bit lower risk profile because you typically have the guarantee of the occupant and you have much better visibility into the financial condition of that occupant. And then the other thing I would point out is when you take a look at that portfolio we've segmented the portfolio into core versus what do we call more suburban. And the core we've defined pretty specifically is the very close in zip codes around Seattle, Portland and Tacoma.

And if you look at that portfolio a little more than -- a little less than 5% of that is actually in those core markets, which have been a little bit less impacted by what's going on. We also do a very deep dive into our entire commercial real estate portfolio once a year and look at a very high sample of those loans. And just to give you a flavor of our office portfolio. When I look at the non-owner occupied, we have a weighted average loan to value of just under 59% and on the owner-occupied, it's just slightly over 60% and if you look at the debt service coverage on those portfolios at least this large sample of those portfolios, the weighted average debt service coverage is about 1.65% on a non-owner occupied and 2.21% on a owner occupied. So, and that's pretty stable year-to-year when we look at these samples.

So generally speaking, our office portfolio has held up really well, and we do see some pressure points on that as we move forward, but we just haven't seen anything yet.

Andrew Terrell -- Stephens -- Analyst

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

Tony Chalfant -- Chief Credit Officer

Yeah, I mean I think we're always going have an appetite for the right -- the right deals that are properly underwritten and particularly that are relationship-oriented. I would say that in the office category, we're going to be very selective as we go forward until we sort of see what's really going to happen with the trends that we're all seeing out in the marketplace. And again, it's a different -- at this point it's different from a suburban versus the core markets. So we have to take that into consideration, but also what we're finding is to a certain extent some of these opportunities are self-limiting because there is not as much from what we can see activity in the office market out there that we would really have opportunities to look at loans for, if that makes any sense.

So more of our opportunities I think we're seeing on the non-owner -- particularly on the non-owner occupied pipeline would be more on the multifamily and industrials spaces.

Andrew Terrell -- Stephens -- Analyst

Okay, great, thank you for taking my questions.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thank you.

Operator

Thank you. And we have a follow-up from Jackie Bohlen with KBW. And your line is open.

Jackie Bohlen -- KBW -- Analyst

Hi, thanks guys. Just one quick one, what was the balance of indirect auto at the end of the quarter?

Jeffrey J. Deuel -- Chief Executive Officer and Director

Don, do you have that?

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

No, but I can look it up quickly. I think it was -- I think we're down to 120, but I'm just, I thought it at the top my head I can look it up, though really quickly.

Jeffrey J. Deuel -- Chief Executive Officer and Director

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

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

And it was -- as far as -- it was $177 million. But we do pretty much expect that to kind of run off over the next two years. And so, hopefully, that won't be as much of an impact on our overall loan growth.

Jackie Bohlen -- KBW -- Analyst

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

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

Jackie Bohlen -- KBW -- Analyst

Okay. Thank you.

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thank you.

Operator

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

Jeffrey J. Deuel -- Chief Executive Officer and Director

Thank you, Cynthia. Thank you everybody. We appreciate the questions. You had me go in there for a couple of seconds when we didn't get any but happy to chat and looking forward to seeing some of you in the next couple of weeks as we start to have some investor meetings, virtual investor meetings, I should say. So thank you very much for your time, your support, your interest and we'll see you all soon. Thank you.

Operator

Thank you. And ladies and gentlemen, today's conference call will be available for replay after 9:00 PM today ending May 7. You may access the AT&T replay system by dialing 866-207-1041 and enter the access code of 6157116. International participants may dial 402-970-0847. Those numbers once again 866-207-1041 or 402-970-0847, and enter the access code of 6157116.

[Operator Closing Remarks]

Duration: 54 minutes

Call participants:

Jeffrey J. Deuel -- Chief Executive Officer and Director

Donald J. Hinson -- Executive Vice President and Chief Financial Officer

Tony Chalfant -- Chief Credit Officer

Bryan McDonald -- Executive Vice President and Chief Operating Officer

Kaylene Lahn -- Senior Vice President of Corporate Secretary

Matthew Clark -- Piper Sandler -- Analyst

Jeff Rulis -- DA Davidson -- Analyst

Jackie Bohlen -- KBW -- Analyst

David Feaster -- Raymond James -- Analyst

Andrew Terrell -- Stephens -- Analyst

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