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

Heartland Financial USA, Inc. (NASDAQ:HTLF) Q4 2023 Earnings Call Transcript January 29, 2024

Heartland Financial USA, Inc. misses on earnings expectations. Reported EPS is $1.06 EPS, expectations were $1.07. HTLF isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to HTLF’s 2023 Fourth Quarter Conference Call. This afternoon, HTLF announced its annual earnings and fourth quarter financial results, and hopefully, you’ve had a chance to review the earnings release that is available on HTLF’s website at htlf.com. With us today from management are Bruce Lee, President and CEO; Kevin Thompson, Chief Financial Officer; Bryan McKeag; 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 guideline of forward-looking statements as defined by Securities and Exchange Commission.

As part of these guidelines and statements made during this presentation concerning the company’s hopes, beliefs, expectations and predictions of the future and forward-looking statements and actual results could differ materially from those projected. Additional information on those 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 website. I will now turn the call over to Mr. Bruce Lee, HTLF President and CEO. Please go ahead, Mr. Lee.

Bruce Lee: Thank you, Valerie. Good afternoon, everyone. This is Bruce Lee, President and CEO. Welcome to HTLF’s 2023 fourth quarter earnings conference call. I appreciate you joining us as we discuss our results and the strategic initiatives we’ve undertaken to drive performance and position HTLF as a top-performing bank. For the next few minutes, I’ll discuss our highlights for the fourth quarter and year. I’ll then turn the call over to Kevin Thompson, our new CFO for more on our results. Also joining us today is Nathan Jones, Chief Credit Officer, who can answer questions regarding the stable credit quality across our portfolios. Bryan McKeag, our retiring CFO is also on the call. I want to personally thank Bryan for his numerous contributions to HTLF over the past decade.

His expertise and stewardship have helped guide our significant growth during his tenure, and we wish him well during his retirement. The HTLF Board of Directors has approved a quarterly cash dividend of $0.30 per share on the company’s common stock payable on February 27, 2024. 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 April 15, 2024. For more than 40 years HTLF has increased or maintained our common stock dividend every quarter. This reflects our strength, stability and confidence in our strategies and performance. Stockholders also benefited from a significant increase in tangible book value per common share, ending the year at $28.77, a 19% increase from 2022.

2023 was a year of significant progress and successful execution of our strategic plans. We completed charter consolidation, strategically and structurally positioning the company to focus on our next phase, HTLF 3.0, our connected set of initiatives that will drive efficiency, enhance EPS growth, deliver higher return on assets and more efficient use of capital. One component of HTLF 3.0 was repositioning our balance sheet. In the fourth quarter, HTLF sold investment securities with proceeds totaling $865 million in a pre-tax loss of $140 million. The proceeds of the sale were used to repay high-cost wholesale deposits and short-term borrowings. By selling low-yielding investments and reducing high-cost wholesale funding, we increased our net interest margin, improved our balance sheet efficiency and flexibility, and significantly strengthened our capital position.

This, in part, resulted in a $72.4 million loss for the quarter to common stockholders, and EPS of negative $1.69. For the year, net income available to common stockholders was $71.9 million, and EPS of $1.68. Adjusted earnings for the quarter were $45.6 million available to common stockholders and EPS of $1.06, which excludes losses related to the balance sheet repositioning, losses on sale or write-down of assets, FDIC special assessment expense and restructuring costs. Adjusted earnings for the year were $193.9 million available to common stockholders and EPS of $4.53. We’re already seeing benefits from our balance sheet repositioning. In the fourth quarter, net interest income was $156 million, an increase of $10 million, or 7% from the linked quarter.

For the year, net interest income was $601 million, an increase of $3 million, or 1% from the previous year. We saw a notable expansion of our net interest margin on a tax-equivalent basis, rising 34 basis points from the linked quarter to 3.52%. And total assets were $19.4 billion, a decrease of $718 million, or 4% from the linked quarter. The decrease was largely due to the securities sold to repay wholesale funding and short-term borrowings. HTLF maintained strong momentum in commercial loans, and we continue to see growth in customer deposits. Let’s start with loan growth highlights. In the fourth quarter, we saw strength in our commercial and ag portfolios. In total, commercial and ag loans grew $224 million, or 2% from the linked quarter, in-line with our guidance.

For the year, commercial and ag loans grew $719 million, or 7%. In the fourth quarter, we added 234 new commercial relationships, representing $196 million in funded loans and $54 million of new deposits. 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 2,200 consumer relationships in the quarter, our consumer loan portfolio decreased $12 million, or 2%, from the linked quarter, and residential mortgage loans decreased $16 million, or 2%. For the year, consumer loans decreased $14 million, or 3%; residential mortgage loans decreased $56 million, or 7%. Turning to deposits, wholesale deposits decreased $958 million from the linked quarter as the proceeds from the balance sheet repositioning were used to pay down high-cost wholesale funding.

Our deposit base continues to be diverse and granular. Customer deposits are diversified by geography and industry with no industry concentration higher than 10% across our portfolios. Customer deposits increased $59 million from the linked quarter, the second consecutive quarter of customer deposit growth. Average customer deposits were up substantially from the linked quarter, increasing $271 million, or 2%. While we maintain a favorable deposit mix, customer demand accounts decreased to 30% of customer balances, reflecting the ongoing transition to interest-bearing accounts. Total deposits for the quarter decreased to $16.2 billion, largely due to the paydown of wholesale deposits. 61% of total balances are insured or collateralized. Total deposits for the year decreased $1.3 billion, with customer deposits declining only $367 million, or 2%.

Importantly, we saw momentum in the second half of the year, with customer deposits increasing $295 million combined in the third and fourth quarters for 4% annualized growth. Turning to key credit metrics, our disciplined approach continues to enable strong credit performance. Delinquency ratio increased — decreased, I’m sorry, to 9 basis points of total loans, and our lowest ratio of 2023. Net charge-offs declined to $392,000, or 1 basis point of total average loans. Nonperforming assets increased to 57 basis points, primarily driven by the downgrade of a well-collateralized long-term Midwest manufacturing customer, who is experiencing cash flow challenges due to a recent acquisition. NPAs have already improved in the first quarter of 2024, with the sale of a real estate-owned property decreasing the amount by $10 million with no additional loss associated.

Market conditions continue applying additional pressure on commercial real estate across the country, in the office market specifically. Our office exposure is low at 3.2% of our total loan portfolio. We are conducting targeted reviews of our portfolios, where we see stress or additional potential weakness. We continue to enhance our ongoing portfolio management and surveillance, and refine how we screen new opportunities for underwriting. In 2023, HTLF continued executing our strategies despite industry challenges. We completed charter consolidation and introduced HTLF 3.0, the next phase of our strategic plan, which includes repositioning the balance sheet, reducing our retail delivery cost by centralizing our retail structure, decreasing the number of retail leaders and increasing their span of control, and reducing real estate expenses through branch rationalization, size and location.

Our current footprint is also under review as we look to maximize our return on capital. We’re investing in growth by expanding middle market banking and adding talent in California’s Central Valley, Denver, Kansas City, Milwaukee, Minneapolis and Phoenix; expanding treasury management products and capabilities; and creating a digital platform to serve consumers and small business. Each of these components are underway and at various stages, but all will help us better serve our customers and drive efficiency, enhance EPS growth, deliver a higher return on assets and more efficient use of capital. More on HTLF 3.0, please refer to Pages 5 through 12 in the investor deck. HTLF is moving forward together in 2024. We’re executing our 3.0 strategies, investing in quality revenue growth, reducing our operating costs, improving EPS growth, return on assets and efficient use of capital, and most importantly, serving our customers and communities.

This is all due to 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. I will now turn the call over to Kevin Thompson, Chief Financial Officer, for more details on our performance and financials.

Kevin Thompson: Thank you, Bruce. I first want to say how thrilled I am to be part of the HTLF team. I’ve long admired HTLF from positions in peer banks, and I’m very excited to be part of a talented team that’s just in the beginning of the HTLF 3.0 strategic transformation. The unusual items in the quarter that Bruce described are detailed in our earnings release and on Page 13 of our earnings presentation. Most of these items are related to actions that will improve the profitability of the bank going forward. We had a pre-tax loss of $140 million related to sell securities. The proceeds from this repositioning were used to pay down high-cost wholesale deposits and borrowings. This both improves our liquidity profile and will result in approximately $6 million in improved net interest income per quarter going forward.

We had $4.4 million of restructuring expenses, $2.1 million related to sells and valuations of facilities, and $1.3 million of expenses as we consolidated our final bank charter in the quarter. We executed on projects to centralize our retail management and to consolidate our footprint. These are just the beginning of the plans under HTLF 3.0 to increase our operational leverage, optimize our efficiency, and to serve our customers more effectively. Refer to our earnings deck for more details on our strategic transformation. Finally, we had an FDIC insurance special assessment as many banks did this quarter of $8.1 million. We continue to see good economic trends in our business. Loan growth totaled $196 million and customer deposits grew $59 million, with average customer deposits increasing $271 million compared to the prior quarter.

Loans to deposits increased to 74%, as we decreased our wholesale deposits. Investments decreased $832 million due to bond sales of $865 million and normal amortization, offset by improvements in fair value with the decline in interest rates. We are very pleased that our revenue growth exceeded analysts and even our own expectations in the quarter. Net revenues increased 6%, or $10 million, when adjusting for the securities loss. This is driven mostly by our expanding net interest margin, which increased to 3.52%. Loan yields increased 28 basis points to 6.49%, while interest-bearing liabilities only increased 10 basis points to 3.11%. The total cost of deposits decreased 1 basis point to 2.09%. Noninterest expense was up in the quarter, and adjusting for the $15 million of unusual items, expenses were up $4.8 million.

Professional fees were higher than usual and we expect them to normalize going forward. Also, we made additional investments in tax credit projects, which were offset with benefits in tax expense. These two items account for $6 million of additional expenses in the quarter, and excluding them, expenses would have been down around $1 million. The adjusted efficiency ratio was 59% for both the quarter and full year. Noninterest income when adjusting for securities losses was flat to the prior quarter. This included a decrease of $600,000 in consumer NSF and overdraft fees in the month of December, as we instituted new fee policies across our single charter customer base. This is a permanent change to our consumer fee structure that will impact our fee income going forward, but we expect to offset this with growth in treasury management, card fees and other strategic fee initiatives.

The provision for loan losses was $11.7 million in the quarter with an allowance for lending-related credit losses of 1.15% of total loans. The provision was driven by loan growth and one credit that moved to non-accrual status that required a specific reserve. Net loan charge-offs remain low at 1 basis point for the quarter and 11 basis points for the full year, and delinquencies were also low at 9 basis points to total loans. Capital ratios are strong with the CET1 ratio of 11%, even after the securities loss and other restructuring expenses that will improve our profitability going forward. The tangible common equity ratio increased 80 basis points to 6.53%, which benefited from the increase in market value of our investments and the reduction in assets as part of our balance sheet repositioning.

If you refer to Page 28 of our earnings deck, we provided our management outlook for 2024, compared to our 2023 results assuming no change in the economic environment. We expect loan growth of 6% to 8%, principally in our commercial portfolio in the year. We anticipate a 5% to 7% increase in deposits to fund loan growth with strong commercial and some consumer growth. We plan to let our securities portfolio amortized down with the cash flows used to pay off wholesale funding. We expect a stable net interest margin of around 3.5% assuming a stable interest rate environment. We expect our full year provision for credit losses to increase modestly. We expect core noninterest income to be flat with growth in treasury management and card fees, offset by lower consumer and small business, NSF and overdraft fees, as well as lower mortgage fees with our exit of the mortgage business in 2023.

Core expenses should be down around 2% with lower occupancy, marketing, legal and operational expenses, offset by performance compensation and technology investments. Our effective tax rate should be around 24%, excluding discrete items such as new tax credits. And finally, earnings accretion and securities amortization are expected to increase all capital ratios with CET1 approaching 11.5% to 12% by year-end. I will now turn the time back over to Bruce.

Bruce Lee: Thanks, Kevin. 2023 was a year of significant progress and successful execution of our strategic plans. We completed charter consolidation on time, under budget and exceeded estimated net savings. We then initiated HTLF 3.0. We’ve repositioned the balance sheet, centralized our retail structure, and increased retail leadership span of control. We’re reviewing our current footprint to maximize return on capital, reducing real estate expenses through branch rationalization, size and location, investing in middle market banking and adding talent in key growth markets, expanding treasury management, products and capabilities, and creating a digital platform to serve consumers and small business customers. We remain focused on continuing to achieve organic growth, while reducing expenses, enhancing EPS growth, delivering a higher return on assets and efficiently using our capital. So, I think now we can turn it over to Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Jeff Rulis of D.A. Davidson. Your line is open.

Bruce Lee: Hi, Jeff.

Jeff Rulis: Hi. Good afternoon. Just a couple of questions I guess on the outlook. The first on the margin, stable here, I guess in-line with kind of Q4. I wanted to kind of check in on sensitivity with rate cuts in the second half if there were to be some, generally speaking. First question is, surprise maybe no tail of benefit from the restructuring. Maybe that’s chewed up by deposit costs in the first part of the year. But then, if you could just kind of position us for where the balance sheet is? Should you see some rate cuts in the second half?

Kevin Thompson: I’ll respond to it. It really depends on how the yield curve plays out this year. We’re inverted now. We do hope that the yield curve normalizes over time, and that’s — that really will impact banks across the country. I’ll say that we are asset-sensitive. So, on a raw basis unadjusted, any 25 basis point decrease to rates impacts us about 5 basis points to 7 basis points in our NIM. That’s on a raw basis. We do have the opportunity to react and strategically create some opportunities to buoy that up. Among many other things that we’re talking about right now, we can put some hedging floors in place with our loans. We have some opportunities to reposition some of our wholesale funding. We have a lot of deposit programs going on that should benefit us, and we have some hedges in place that make us more asset sensitive, but those roll off over time.

And so, this is the topic of the year obviously, and we are all over it and have some strategic initiatives right now to be able to be prepared for a write-down scenario.

Bruce Lee: Jeff, this is Bruce. I might add a couple of things. It’s really very dependent upon what the deposit betas are and if we’re able to overachieve what we’ve modeled, that helps the margin. Also, if, as we expect, we’re able to grow deposits to fund loan and use the cash flow of the investment portfolio to repay wholesale funding, I mean that in essence shrinks our balance sheet but that is an accretive trade to our margin and to our revenue. So, it really depends on our ability to execute on those couple of things on whether or not we’ll be able to improve on the decrease in margin that Kevin discussed with each 0.25% move.

Jeff Rulis: Okay. Thank you for that. And a quick one on the expense guide. What would you put the base of the core expense in ’23 to kind of base off of the down 2%?

Kevin Thompson: I think the easiest way to look at it is the fourth quarter. So, expenses came in at about $130 million. You take out $15 million of those unusual items, and then I also called out another $6 million of run rate that was higher than normal. So, that puts you at about $109 million, $110 million quarterly. That seems like our run rate going forward. And that includes merit increases, performance increases. So, underlying there are a lot of benefits we’re seeing from the initiatives we’ve been doing over the past few years.

Jeff Rulis: So, Kevin, if I take that $109 million, $110 million again, and then you kind of hope to improve expenses by 2% over the course of the year of that quarterly run rate?

Kevin Thompson: I should be a little more clear. That would be our run rate, $109 million, $110 million a quarter on average.

Jeff Rulis: Okay, for the balance of the year?

Kevin Thompson: That’s right.

Jeff Rulis: Okay. One last one if I could. Wanted to kind of — Bruce, you’ve laid out a pretty good plan here with 3.0. First question would be kind of the timeline of that. I haven’t had a chance to look through all the slides of the — I guess in ’24, the tangible, what do you think you complete this year? And then, the second part of that question is, I guess, if M&A were to present itself in terms of bankers or markets that you’ve targeted that you want to grow into, do you have not abandoned the plan, but you pivot to say, well, we can acquire this for a cheaper? I guess to clarifying that question, what part does M&A come up if it did and it were attractive and it accelerated kind of what you’re doing with 3.0 in terms of some of the growth in talent acquisition?

Bruce Lee: Yeah. Thank you. Thanks, Jeff. So, let me maybe first talk about what we’ll achieve in 2024 and beyond. If you look on Page 12 of the earnings deck, it kind of lays out what our targets are for three years. And we would expect to make progress in every single area during 2024, but it really starts to ramp up in 2025 and 2026 because a lot of the investments, particularly in people and in our treasury management investments are really being made in 2024. So, I think that’s probably at the moment the best I can do, but we would expect again to make progress, but the significant progress happens in 2025 and 2026. And we feel very confident to be able to achieve these targets over that period of time. And if we look at M&A, so first, we’re very far along in the talent acquisition in those specific markets, and we would look at M&A, if it was the right culture, provided the right accretion, they were focused as a commercial bank and they were in market, particularly in those growth markets that I mentioned.