Heartland Financial USA, Inc. (NASDAQ:HTLF) Q4 2022 Earnings Call Transcript

Heartland Financial USA, Inc. (NASDAQ:HTLF) Q4 2022 Earnings Call Transcript January 30, 2023

Operator: Greetings, and welcome to HTLF 2022 Fourth Quarter Conference Call. This afternoon, HTLF announced its fourth quarter earnings, and hopefully, you had a chance to review those results. The earnings release is available on HTLF’ website at htlf.com. With us today from management are Bruce Lee, President and CEO; Bryan McKeag, Executive Vice President and Chief Financial Officer; and Nathan Jones, Executive Vice President and 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 website. I will now turn the call over to Mr. Bruce Lee, HTLF’S President and CEO. Sir, you may begin.

Bruce Lee: Thank you, Twanda. Good afternoon, everyone. This is Bruce Lee, President and CEO. Welcome to HTLF’s 2022 fourth quarter earnings conference call. I appreciate you joining us today, as we discuss our continued strong performance and ongoing momentum. For the next few minutes, I’ll discuss HTLF’s highlights for the fourth quarter and year, then turn the call over to Bryan McKeag, Chief Financial Officer, for more on our results. Also joining us today is Nathan Jones, Chief Credit Officer, who can answer questions regarding the excellent credit quality across our portfolios. HTLF had tremendous success and significant growth in 2022. We are driving momentum, executing our strategy and delivering strong results that exceed expectations.

This month, our Board of Directors approved a record quarterly cash dividend of $0.30 per share on the company’s common stock, a 7% increase from the previous quarter. The dividend is payable on February 28, 2023. This increase reflects our strong performance for the quarter and year and our confidence in our strategies and ongoing results. In 2022, revenue was a record $726 million, an increase of $37 million, or 5% for the year. Total revenue increased $10 million, or 5% from the linked quarter. For the year, we delivered net income available to common stockholders of $204.1 million and EPS of $4.79. For the quarter, net income available to common stockholders was $58.6 million and EPS of $1.37. For the quarter, we saw notable expansion of our net interest margin on a tax equivalent basis, rising 20 basis points to 3.65%.

Our efficiency ratio decreased 15% from a year ago to 54.33. For the year, we reduced our number of employees by 11%. We’re driving efficiency while investing for growth. And total assets grew to a record $20.2 billion, up $970 million, or 5% from a year ago. Assets increased $561 million or 3% from the linked quarter. Asset growth was driven by strong momentum in commercial and consumer loans, and we continue to see growth in deposits and service fees. Let’s start with loan growth highlights. In 2022, we saw tremendous loan growth of $1.6 billion, or 17%, excluding PPP across our portfolios. In the fourth quarter, loans grew $505 million, an increase of 5% from the linked quarter and greatly exceeding our guidance for the quarter. This includes approximately $105 million in increased credit line utilization, primarily in Agribusiness and approximately $100 million of loan growth which we previously expected to close in the first quarter.

This was an exceptional quarter, and our commercial loan pipeline remains strong at over $1 billion. We expect total loan growth of $150 million to $200 million in the first quarter. In the fourth quarter, we saw significant strength across our commercial portfolios. From the linked quarter, commercial and industrial increased $185 million or 6%. Owner-occupied real estate decreased $20 million or 1%. Non-owner occupied real estate increased $111 million, or 5%. Construction increased $80 million, or 8%, and our Ag portfolio increased $139 million, or 18%. Seasonal line utilizations were up, and we expect this to normalize in the first quarter. For more on line utilization, please see Page 24 in the investor deck. In the fourth quarter, we saw commercial loan growth in eight of our 11 bank markets.

We added 303 new commercial relationships, representing $296 million in funded loans and $229 million of new deposits. On average, new originations were higher credit quality than the overall portfolio as measured by risk ratings and credit scores. And 79% and of these loans have variable rate structures compared to 69% last quarter. The depth and breadth of our products and services is expanding relationships and developing new ones. We have made strategic investments in specialized industry verticals and capital markets expertise, including loan syndications, interest rate derivatives, trade finance and foreign exchange and we’re driving business in fee-generating products. Service charges and fees increased $2.1 million, or 14% for the year and 1% for the quarter, driven primarily by our growing credit card business.

In 2022, HTLF reached a significant milestone surpassing $1 billion in purchase volume as a commercial card issuer. HTLF continues to be one of the fastest-growing Visa commercial card issuers. For more on the growth of our commercial non-interest income, please see Page 20 in the investor deck. Our consumer loan portfolio saw significant growth in 2022, increasing $87 million or 21%. Consumer loans grew $11 million, or 2% from the linked quarter. Residential mortgage increased $24 million, or 3% for the year and was flat from the linked quarter. Turning to deposits. Non-time deposits increased $302 million, or 2% for the year. Non-time deposits decreased $448 million, or 3% from the linked quarter, mostly due to balanced declines that occurred in our commercial operational accounts for seasonal needs and year-end distribution and not as a result of account attrition.

We expect these account balances to rebuild over time. Time deposits increased $793 million, or 77% for the year and $694 million, or 62% from the linked quarter. The increase in time deposits for both the year and the quarter was primarily driven by an increase in wholesale time deposits. Overall, total deposits grew to a record $17.5 billion, an increase of $1.1 billion, or 7% for the year and $245 million from the linked quarter. We maintain our favorable deposit, 90% of deposits are in non-time accounts, 36% of total deposits are in non-interest-bearing accounts and our deposit pricing strategy continues to serve us well. In the fourth quarter, core deposit costs were 44 basis points and total deposit costs 74 basis points. For detail on our deposit beta, please see Page 23 of the investor deck.

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Turning to key credit metrics. Our disciplined credit approach is delivering excellent credit quality across our portfolios. Delinquency ratio is at a historic low of 4 basis points. Non-performing loans represented 51 basis points of total loans. Non-performing assets as a percentage of total assets remained low at 33 basis points. Non-pass rated loans decreased to 4.7% from 5.3% in the linked quarter. Lastly, in the fourth quarter, we had net loan recoveries of $1.7 million. We continue to take a conservative credit approach given concerns around the current economic environment. Despite some headwinds, we’ve sustained momentum, we’re executing our strategies, and we’re delivering record revenue, record organic loan growth, record customer acquisition, improved credit quality, expanded net interest margin and a lower efficiency ratio.

We’re doing all this while consolidating our bank charters. In 2022, we successfully executed five bank charter consolidations with our banks in Arizona, California, Colorado, Illinois and Minnesota becoming divisions of HTLF Bank. Transitions have been smooth, and the project continues on schedule and on budget. We expect to finish charter consolidation early in the fourth quarter of 2023 and delivered $20 million of annual savings and capacity after the project is complete. Bryan will share more details in his comments. We also continue to optimize our branch network. In 2022, we reduced our number of total branches by 8% to 119 total locations. In alignment with HTLF Banks Colorado Charter, as of January 1, HTLFs corporate headquarters is now in Denver.

Geographic diversity is a strength of HTLF. We have 11 markets in 12 states with Denver as our largest market. HTLF’s corporate headquarters in Denver reinforces our presence and commitment to global markets. We are committed to our strong and sizable presence in Dubuque, Iowa, where 17% of our employees are located. HTLF operational and administrative functions will continue to be largely staffed and run from Dubuque. As I look back on 2022, it was a year of significant growth and tremendous accomplishment for HTLF. We continue to execute our strategies, grow our business operate more efficiently, deliver strong results, and most importantly, serve our customers and communities. This is all the result of the hard work and dedication of HTLF’s employees.

I want to recognize and thank them for their continued commitment to delivering strength, insight and growth to our customers, communities, investors and each other. We move forward together because together, we are HTLF. I’ll now turn the call over to Bryan McKeag, Chief Financial Officer for more details on our performance and financials.

Bryan McKeag: Thanks, Bruce, and good afternoon. As Bruce just outlined, this was another strong quarter for HTLF with earnings per share of $1.37, loan growth of just over $500 million, revenue growth this quarter of over $10 million and stable clean credit performance. Included in this quarter’s results were three large notable items. First, $2.4 million of losses on the sale or write-down of assets related. Second, charter consolidation restructure costs of $2.4 million; and third, shareholder dispute resolution costs of over $1 million. Together, these items decreased pretax net income by more than $5.8 million and earnings per share by $0.11. Before I go into more detail, I want to remind everyone that our fourth quarter earnings release and investor presentation are both available in the IR section of HTLF’s website.

So I’ll start my comments with the provision for credit losses, which totaled $3.4 million, that’s up — that’s a $2.1 million decrease over last quarter. This quarter, the provision reflects our strong loan growth, continued stable, healthy credit performance and an economic outlook that anticipates a moderate recession developing over the next 12 months. In addition, the provision benefited from $1.7 million of net loan loss risk (ph) recoveries. At quarter end, the allowance for related for lending-related credit losses, which includes both the allowance for credit losses on loans and unfunded commitments increased $5.1 million to $129.7 million or 1.13% of total loans. In addition, at quarter end, unamortized purchase loan valuations on the balance sheet totaled just over $10 million or 9 basis points of loans.

Moving to investments. Investments remained flat at $7 billion, representing 35% of assets with a tax equivalent yield of 3.45% and will generate cash flows exceeding $1 billion over the next 12 months. We continued to actively manage the portfolio by taking several actions during the quarter. First, we utilized nearly $65 million of cash flow this quarter to fund loan growth. And second, we took advantage of some mid-quarter market disruption and reinvested $115 million cash flow into a AAA rated security with a purchase yield of nearly 9% and a duration of less than a year. With regards to capital, regulatory capital ratios remained strong with common equity Tier 1 at just over 11% and total risk-based just over 14.75%. The tangible common equity ratio reversed a several quarter decline, increasing 27 basis points to 5.21% at quarter end.

The rise in market value of investments this quarter contributed 15 basis points of the increase. Moving to the income statement, starting with revenue. Net interest income totaled $165.2 million this quarter which was $9.3 million higher than the prior quarter. And the net interest margin on a tax equivalent basis rose 20 basis points this quarter to 3.65%. The main drivers of the increase were our strong loan growth and asset-sensitive balance sheet and the Fed’s short-term interest rate increases. This quarter, the net interest margin includes 3 basis points of purchase accounting accretion, which is unchanged from the prior quarter. Non-interest income of $30 million this quarter was $800,000 higher than the prior quarter. Excluding security losses, core non-interest income was $30.1 million, which was at the high end of our 28 — $29 million to $30 million forecast.

So in total, quarterly revenue grew $10 million or 5% and exceeded patients. Shifting to expenses. Non-interest expense totaled $117.2 million this quarter, that’s up $8.3 million from last quarter. Excluding restructuring, tax credit costs and asset gains and losses, the run rate of recurring operating expenses increased $3.1 million to $109.1 million compared to $106 million last quarter, and exceeded our forecast of $105 million to $106 million. Operating expenses were higher than anticipated in Q4, primarily due to legal and other cost reimbursements related to the resolution of a shareholder group dispute and higher incentive compensation accruals due to stronger than expected revenue — quarterly revenue and loan growth. As a result of the strong revenue growth this quarter, the fourth quarter efficiency ratio improved to 54.33% from 55.26% last quarter.

Now looking ahead to 2023. HTLF expects to see continued success and improvement, highlighted by expected loan growth of 6% to 8% next year with $150 million to $200 million expected next quarter. Deposit growth is expected to be 3% to 5% next year, with Q1 expected to show nominal growth. Investment cash flow will be utilized to fund the gap between loan growth and deposit growth. Net interest income for Q1 will be down versus Q4 due to two fewer days in the quarter. Full year net interest income will be much higher than 2022, that reflects our higher net interest margin and larger balance sheet. However, magnitude of the increase will be dependent upon future Fed rate moves and deposit pricing, which are difficult to predict at this time.

Provision for credit losses are projected to range from $4 million to $6 million per quarter, given projected loan growth and assuming credit trends began to normalize from their current levels. However, declines in economic conditions and projections could significantly impact future provisions, if a worse than moderate recession develops. Core non-interest income, that is excluding investment gains and losses is expected to be $28 million to $29 million next quarter, and is projected to raise 4% to 5% on a full year basis, as persistently weaker mortgage revenue is offset by growth in other income categories, primarily commercial fees. Recurring operating expenses are expected to be $108 million to $109 million next quarter, and show a 2% to 3% increase on a full year basis.

This includes the impact of an increase in FDIC costs of $3 million to $4 million for the full year. Charter consolidation and restructuring costs are expected to be $2 million to $2.5 million next quarter. In total, we estimate the remaining costs to complete the project will approach $10 million over the next four quarters. And finally, we believe a tax rate of 22% to 23%, excluding new tax credits, is a reasonable run rate. So with that, I’ll turn the call back over to Bruce for questions-and-answers.

Bruce Lee: Thank you, Bryan. We want to open up the call to Tawanda.

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Q&A Session

Operator: Thank you. We will now conduct a Q&A session. Our first question comes from the line of Terry McEvoy with Stephens. Your line is open.

Terry McEvoy: Hi. Good afternoon, everybody.

Bruce Lee: Hi, Terry.

Terry McEvoy: Hi, Bryan. Thanks for the all the financial outlook. Maybe if I could just ask a question, the $20 million of benefits from the charter consolidation, could you remind me, is that all on the expense side? And then maybe if we just take a step back, could you give us a few real world examples of the benefit to the charter consolidation outside the numbers? And maybe just to finish the thought or has there been any impact on local decision-making or even the perception that things have changed there? Thank you.

Bruce Lee: Yeah, Bryan, let me maybe answer — give some comments on Terry’s last question. There is absolutely no impact on local decision-making, not only the perception, but there’s actually no impact. The decisions that our local CEOs and leadership teams were able to make pre-charter consolidation and post-charter consolidation are exactly the same. So there’s absolutely no change there, and it’s actually gone very, very, very smoothly. Bryan, why don’t you talk a little bit about the real world, examples of not just the expense side, but the actual changes because your area has a lot of that benefit?

Bryan McKeag: Yeah. I think there’s certainly internal efficiencies that we’ll gain Terry, for example, not doing as many call reports. That’s a simple one, right? But we also manage multiple investment portfolios will eventually only need to manage one. Same with liquidity, maintaining liquidity at 11 banks versus one. So there’s a lot in finance. There’s — throughout the operations side, Rego (ph) doesn’t have to be reported as much. There’s some compliance things that help as well. So there’s lots of those things. I think for traditionally, for customers, it will be easier for them to bank at any one of our locations across the footprint, easier than it is today and so there are customer benefits as well. In terms of the $20 million efficiency gain in terms of dollars, it’s really in a couple, maybe two or three places.

The predominant place is expense savings. As you can probably see, our FTE count is down already. Whether we have to replace some of that, but we certainly won’t have to replace it, I don’t think, all back to the levels that we were before because it will become more efficient. So there’s some cost takeouts for not having to do certain things, but there’s going to be efficiency gains as well, where we won’t have to add back people even if we continue to grow. And maybe the third, and this is probably the smaller one, is there’s probably some efficiencies in the treasury area just with when we do exercise some of our trades, they’re probably bigger blocks and we can maybe get a little bit better execution. So one other thing that — one big benefit that we get internally is, we don’t have to participate loans back and forth between banks.

And we spent a lot of time in the operations area and in the finance area kind of sorting that out and we put it all together, but then keeping the bank separate. Bruce, anything else to add?