Heartland Financial USA, Inc. (NASDAQ:HTLF) Q3 2023 Earnings Call Transcript

Heartland Financial USA, Inc. (NASDAQ:HTLF) Q3 2023 Earnings Call Transcript October 30, 2023

Heartland Financial USA, Inc. misses on earnings expectations. Reported EPS is $1.08 EPS, expectations were $1.11.

Operator: Greetings, and welcome to HTLF’s 2023 Third Quarter Conference Call. This afternoon, HTLF announced its third quarter financial results, and hopefully, you’ve had a chance to review the earnings release that is available on HTLF’s website @htlf.com. With us today from management are Bruce Lee, President and CEO; Bryan McKeag, Chief Financial Officer; and Nathan Jones, Chief Credit Officer. Management will provide a summary of the quarter, and then we will open the call to your questions. Before we begin the presentation, I would like to remind everyone that some of the information provided today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, any statements made during this presentation concerning the Company’s hopes, beliefs, expectations and predictions of the future are forward-looking statements, and actual results could differ materially from those projected.

Additional information on these factors is included from time to time in the Company’s 10-K and 10-Q filings, which may be obtained on the Company’s or the SEC’s websites. I would now like to turn the call over to Mr. Bruce Lee, HTLF’s President and CEO. Please go ahead, Mr. Lee.

Bruce Lee: Thank you, Latif. Good afternoon, everyone. This is Bruce Lee, President and CEO. Welcome to HTLF’s 2023 third quarter earnings conference call. I appreciate you joining us today as we discuss our ongoing solid performance. For the next few minutes, I’ll discuss HTLF’s highlights for the quarter then turn the call over to Bryan McKeag, Chief Financial Officer, for more details on our performance and financials. Also, joining us today is Nathan Jones, Chief Credit Officer, who can answer questions regarding the stable credit quality across our portfolios. The HTLF Board of Directors approved a quarterly cash dividend of $0.30 per share on the company’s common stock payable on November 29, 2023. The Board also approved a dividend of $175 for Series E preferred stock, which results in a dividend of $0.4375 per depository share, payable on January 16, 2024.

For more than 40 years, HTLF has increased or maintained our common stock dividend each quarter. This is a direct result of the strength, insight, and growth we consistently provide to our customers and shareholders. In the third quarter, HTLF delivered solid loan and deposit growth. Our credit quality remains stable. And in October, we successfully completed the final conversion of charter consolidation. For the quarter, net income available to common stockholders was $46.1 million and earnings per share of $1.08. Charter consolidation expenses reduced EPS by $0.04. We delivered on our balance sheet guidance from last quarter’s earnings call and are pleased with the results. At the end of last quarter, we said, we were going to grow loans, grow customer deposits, and pay down wholesale funding.

We accomplished all three of those things. From the linked quarter, consumer deposit growth was $152 million or 1%. Total loan growth was $154 million or 1% and was almost fully funded by our customer deposit growth, and we paid down wholesale deposits and borrowings by $367 million. While we did that, we also lowered expenses with core expenses decreasing $3.3 million or 3% from the linked quarter. Let’s start with deposits. Our deposit base is diverse and granular. Customer deposits are diversified by both geography and industry with no industry concentration higher than 10% across our portfolios. In the third quarter, customer deposits increased $152 million, 90% of the growth came from commercial and small business and 10% from consumer.

While we maintain a favorable deposit mix, customer demand accounts decreased slightly to 33% of customer balances, which reflects the ongoing, but slowing transition to interest-bearing accounts. Wholesale deposits and borrowings were reduced by $367 million from the linked quarter, which was made up of $715 million decrease in wholesale deposits and a $348 million increase in borrowings. Overall, total deposits for the quarter decreased to $17.1 billion. 64% of total balances are insured or collateralized. Turning to loans. In the third quarter, we saw a continued strength across our commercial loan portfolios with increases in each. From the linked quarter, non-owner-occupied real estate increased $126 million or 5%. Construction increased $16 million or 2%.

Commercial and industrial increased slightly while owner-occupied real estate increased $31 million or 1%, and our ag portfolio also increased slightly. In total, commercial and ag loans grew $176 million or 2% from the linked quarter in line with our guidance. In the third quarter, we added 269 new commercial relationships, representing $253 million in funded loans and $95 million of new deposits. 81% of new commercial loan originations have variable rate structures flat from the linked quarter and a 12% increase from the prior year. Yield on these new originations increased 27 basis points from the second quarter. Our commercial pipeline remains strong at over $1 billion. It’s distributed across our regions with strength in the Mountain West and Southwest.

While we added more than 2,800 consumer relationships in the quarter, our consumer loan portfolio decreased $7 million or 1% from the linked quarter, while residential mortgage decreased $15 million or 2%. We expect total loan growth of $150 million to $200 million of core loan growth in the fourth quarter, which we again expect to substantially fund through customer deposit growth. In addition, we expect seasonal ag line utilization of $100 million that would be paid down in the first half of 2024. Turning to key credit metrics. Our disciplined credit approach is delivering stable credit quality across our portfolios. Delinquency ratio remained low at 12 basis points. Non-performing loans declined $11.6 million to 44 basis points of total loans.

Non-performing assets as a percentage of total assets remained flat at 33 basis points. Non-pass-rated loans decreased $32.6 million and net charge-offs declined to $3.7 million, some of which had previously been reserved in prior quarters. This included $1.3 million from the sale of our $10 million consumer credit card portfolio. Market conditions have been applying additional pressure on the commercial real estate office market across the country. We feel good that our office exposure is low at 3.6% of our total loan portfolio. We continue to place emphasis on targeted reviews of our portfolios and recently conducted an in-depth review of each office credit over $1 million. We believe our portfolio is well constructed, granular, and generally situated outside of central business districts.

We continue to enhance our ongoing portfolio management, surveillance and refine how we screen new opportunities for underwriting. For more on our CRE office exposure, please see page 16 in the investor deck. As I mentioned at the top, earlier this month, we completed the final conversion of charter consolidation. All our local bank brands are now divisions of HTLF Bank and we are now able to serve all our customers anywhere in our footprint. The nearly two-year project was completed on schedule and on budget, driving greater internal efficiency while we continue to deliver external growth. We are now strategically and structurally positioned for our next phase HTLF 3.0 to execute on new initiatives that leverage our brand, products, technologies, and capabilities.

While we remain focused on continuing to achieve organic growth, we are also focused on reducing expenses, increasing EPS and growing TCE over the next few quarters. We continue to evaluate our balance sheet and capital structure to maximize efficiency and flexibility, and we are analyzing our expense structure, including geographies, branch footprint, management layers and span of control. We expect some one-time expenses associated with these initiatives, and Bryan will have more details in his comments. We will provide more on HTLF 3.0 during our fourth quarter earnings call in January. We are investing further in our strategy and innovation and have added to our executive leadership team. Robert Kahn is our new Chief Strategy Officer; and Zach Hamilton, our new Chief Innovation and Digital Officer.

Both Robert and Zach will help drive HTLF’s continued growth and evolution and help us further differentiate ourselves in the products and services we bring to our customers. HTLF is delivering and executing on our strategies, customer deposit growth, quality loan growth, stable credit quality, and we are driving long-term efficiency. This is all made possible by the hard work and dedication of HTLF’s employees. We are committed to delivering strength, insight and growth to our customers, communities, shareholders and each other. Together, we are HTLF. I’ll now turn the call over to Bryan for more details on our performance and financials.

Bryan McKeag: Thanks, Bruce, and good afternoon. As Bruce just described, HTLF performed well in a challenging environment this quarter, reporting earnings per share of $1.08 with loan growth of $154 million, which was fully funded by the increase of $152 million in customer deposits. Reported quarterly results included charter consolidation restructuring costs of $2.4 million, which reduced EPS by $0.04. In addition, net gains and losses on investments and other asset sales and write-downs were low at a net loss of just over $200,000. Before I go into more detail, I want to remind everyone that our third quarter earnings release and investor presentation are both available in the Investor Relations section of HTLF’s website.

So I’ll start my comments with the provision for credit losses, which was $1.5 million. The provision reflects our stable credit quality, including a reduction of nearly $12 million in non-performing loans, lower charge-offs at 12 basis points of total loans, and a continued low delinquency rate of 12 basis points of total loans. At quarter end, the total allowance for lending-related credit losses, which includes both the allowance on loans and unfunded commitments, decreased $2.1 million to $127.7 million or 1.08% of total loans. Moving to the rest of the balance sheet. Bruce has already covered loans and deposits, so I’ll start with investments. Investments declined almost $300 million during the quarter to $6.4 billion, representing 32% of assets with a tax equivalent yield of 3.79%.

Due to the increase in mid to long-term interest rates near quarter end, the unrealized loss on our available-for-sale portfolio increased $129 million to $747 million. The relatively small held-to-maturity portfolio of $835 million or 13% of investments has an unrecorded negative fair value mark of $77 million. The available-for-sale portfolio has a modified duration of just under 5.4 years. However, the hedges we have placed on $840 million of our longer-dated municipals and agency-backed secured – mortgage-backed securities reduces the effective duration to just over 4.6 years. Moving to liquidity. HTLF’s liquidity profile at quarter end is strong and stable with $1.2 billion of principal cash flow coming off our securities portfolio over the next 12 months with $240 million expected next quarter.

Second, a low level of outstanding borrowings and $3.1 billion of available capacity with the Fed and FHLB. Third, we have several Fed fund borrowing lines and broker deposit sources that remain open and available. Fourth, our customer deposit base is granular and well diversified, with over 64% of total deposits either insured or collateralized. Fifth, our loan-to-deposit ratio is 69%, and when removing all wholesale deposits, it remains low at 80%. Cash and unpledged available-for-sale securities totaled $3.9 billion. And lastly, the holding company cash position stands at over $300 million, which is over 3.5x our current annualized interest and dividend payments. In addition, our dividend payout is relatively low at 28% of current EPS. With regards to capital, regulatory capital ratios remain strong with common equity Tier 1 at just over 11.4% and total risk-based capital ratio of nearly 15%.

Adjusted for unrealized losses on our investments, these ratios remain well above capitalized levels at approximately 7.25% and 10.75%, respectively. The tangible common equity ratio decreased 13 basis points to 5.73% at quarter end. The decline in market value of investments was partially offset by an increase in fair value of swaps this quarter, resulting in a net decrease of 35 basis points that is attributable to the accumulated other comprehensive income or AOCI. Moving to the income statement, starting with revenue. Net interest income totaled $145.8 million this quarter, which was $1.4 million lower than the prior quarter. The net interest margin on a tax equivalent basis held up well, falling 5 basis points this quarter to 3.18%, which was close to our expected range of NIM in the low to mid-320s.

The decrease this quarter included a 2 basis point decline in purchase accounting accretion. Non-interest income of $28.4 million this quarter was down $4.1 million from the prior quarter. Excluding security losses, core non-interest income was down $4.4 million to $28.5 million, falling short of our expectation of $30 million to $31 million. The primary driver of the miss was capital markets fees, which were $2.2 million lower than last quarter. Shifting to expenses. Non-interest expenses totaled $111 million this quarter. That’s up $1.6 million from last quarter. However, excluding restructuring, tax credit costs and asset gains and losses, the run rate of recurring operating expenses decreased $3.4 million to $107.4 million, coming in better than our forecast of $109 million to $110 million.

The decrease was driven by $1.4 million lower advertising costs and $1.6 million decrease in professional fees. As we close out 2023 next quarter, HTLF expects loan growth of $150 million to $200 million to be primarily funded by customer deposit growth of $125 million to $175 million. In addition, we expect an additional $100 million of seasonal draws on ag lines of credit that we anticipate will be repaid in the first quarter of 2024. Achieving these loan and deposit growth expectations enables the bulk of investment cash flows to be utilized to decrease wholesale deposits and short-term borrowings. Net interest margin on a tax equivalent basis is expected to stabilize in the 3.20% range, excluding Fed, any Fed moves prior to year-end. Provision for credit losses is projected to remain in the $3 million to $5 million range.

This assumes relatively stable credit performance and a manageable level of economic contraction over the next 12 months. Core non-interest income, excluding investment gains or losses, is expected to be flat at $28 million to $29 million. We expect a reduction in consumer NSF and OD fees as we institute new policies across our now single-charter customer base, and we see a continued decline in mortgage-related revenue. Both of these will be offset by higher capital markets fees. Recurring operating expenses are expected to be $109 million to $110 million. This excludes any new FDIC assessments that maybe levied next quarter. Charter consolidation restructuring costs are forecasted to be $2 million to $3 million next quarter, which includes both the final consolidation implementation expenses as well as expenses to complete several span of control improvements next quarter as we achieve the remaining benefits of the charter consolidation project.

We also expect to have some additional restructuring costs and real estate write-downs that will be booked over the next couple of quarters as we began to execute the next phase of facilities optimization and other HTLF 3.0 initiatives. We will have more details to share next quarter regarding our views of the 2024 performance, including the impact of these new HTLF 3.0 initiatives. And finally, we believe a tax rate of 23%, excluding tax credits, is a reasonable run rate. And with that, I’ll turn the call back over to Bruce for questions.

Bruce Lee: Thanks, Bryan. Latif, we can open up the line for questions.

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Q&A Session

Operator: Thank you, sir. [Operator Instructions] Our first question comes from the line of Andrew Liesch of Piper Sandler.

Andrew Liesch: Hey, guys. Thanks for taking the questions. Good afternoon. Just on the margin guide of around 3.20%. Is it just a bit up from 3.18%? So do you think it can even rise beyond that, irrespective of what the Fed does?

Bryan McKeag: I’m always cautious to go too far on the margin. But the reason we think it’s going to go up from where we were is last quarter, right at the end, is when we saw the pay down of the wholesale borrowings and funding and deposits. So that should carry over and come down a little bit this quarter as we hopefully get the deposit growth that we’re looking for. And we also saw a slowing in the mix shift that was going from non-interest-bearing to interest-bearing accounts. So as those two things waned at the end of the third quarter and going into the fourth quarter, we think we can see the margin go up a tick or two. Beyond that, there are so many variables in there, Andrew. I hate to go too far and get ahead of ourselves.

Andrew Liesch: Got it. So I mean, at this point, do you think another 25 basis points would matter that much?

Bryan McKeag: Not at the current betas that are out there on the deposit side. If we got back to normal betas, which for us are about a 30 beta, this quarter, for example, our betas were over 100% because of the catch-up and everything. So if we get back to normal betas, there would be a little bit from a Fed move, but not a lot at this point. We’re kind of topping out on the benefit.

Andrew Liesch: Got it. And then just on your commentary on the tax rate, like 23%, this quarter, closer to 22%. So it was a 1% benefit to the tax rate from that tax credit amortization that you mentioned earlier in operating expenses?

Bryan McKeag: Yes. For this quarter, yes. For this last past quarter, yes, it’s about [indiscernible] a little bit more to me.

Andrew Liesch: Got it. I will factor that into my modeling. All right. Thanks for taking the questions here. I will step back.

Operator: Thank you. Our next question comes from the line of Damon DelMonte of KBW.

Damon DelMonte: Hey. Good evening, guys. Hope everybody is doing well today. Just wanted to ask a little bit on the credit front. Nice to see NPLs not really move at all – sorry, NPA has not really moved at all. It looks like within there, you had NPLs coming down and a little bit of a tick up here in OREO. Is that just a loan that moved into OREO status? Or were there some other moving parts there?

Nathan Jones: Correct, Damon. This is Nathan Jones. That’s a credit that we had in our non-pass, the multifamily credit. We felt after looking at it, there was some disagreement between sponsors. It was the best move quickly on this one and just drive a fast conclusion for the best overall resolution. That’s what we did. But we don’t think it’s systemic or any other issues that go with that.

Damon DelMonte: Got it. Okay. That’s good. And then with regards to the outlook for loan growth, you guys seem to be continuing to fire on all cylinders here. What areas of your footprint are you seeing like the best opportunities? Has that changed at all in the last couple of quarters? Or is it still kind of the Western side of the footprint?

Bruce Lee: Damon, this is Bruce. It’s still really the Mountain West to the West, to the Southwest. It’s a little lighter in the Midwest right now, but I would call it steady. It’s all of the calling efforts that we’ve been putting in actually for probably the last 24 months are really starting to pay dividends. And because we are open for business, we’ve been recruiting, we’ve been calling on new customer. And that’s really helped when some of the banks in some of the markets that we operate in, they’ve been sputtering a little bit, trying to decide whether they’re going to be in business or not.