NBT Bancorp Inc. (NASDAQ:NBTB) Q3 2023 Earnings Call Transcript

NBT Bancorp Inc. (NASDAQ:NBTB) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Good day, everyone. Welcome to the NBT Bancorp’s Third Quarter 2023 Financial Results Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC Regulation FD. Corresponding presentation slides can be found on the Company’s website @nbtbancorp.com. Before the call begins, NBT’s management would like to remind listeners that, as noted on Slide 2, today’s presentation may contain forward-looking statements as defined by the Securities and Exchange Commission. Actual results may differ from those projected. In addition, certain non-GAAP measures will be discussed. Reconciliations for these numbers as contained within the appendix of today’s presentation. At this time, all participants are on a listen-only mode.

Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call is being recorded. I would now like to turn the conference over to NBT Bancorp President and CEO, John H. Watt, Jr. for his opening remarks. Mr. Watt, please begin.

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John Watt: Thank you, Michelle, and good morning, and thank you all for participating in this earnings call covering NBT Bancorp’s third quarter 2023 results. Joining me today are NBT’s Chief Financial Officer, Scott Kingsley, our Chief Accounting Officer, Annette Burns, our Treasurer, Joe Ondesko, and our Chief Information Officer and President of Retail Banking, Joe Stagliano. It was a very active quarter at NBT. We continued to successfully navigate the volatile interest rate environment and its impact on our company and our customers. We closed on the acquisition of Salisbury Bancorp on August 11. The simultaneous core systems conversion was successful, and the integration is substantially complete. We welcomed over 40,000 new customers, 141 new colleagues, and we brought 13 additional branches onto our platform, allowing us to add scale in Connecticut and to expand south into the Hudson Valley.

We also welcome Salisbury CEO, Rick Cantelli, to our Executive Management Team and our Board of Directors. The successful closing of this acquisition positions NBT well for future strategic growth. Let me take a moment to highlight 3Q activity across our businesses. First, we are very pleased with our operating results, including EPS at $0.84 and return on tangible equity of 16.25%. We’ve achieved commercial and consumer loan growth at an annualized growth rate of 6.1% in the third quarter. That growth was diverse with our commercial lending and indirect auto businesses leading the way. Through nine months, we continue to observe a resilient consumer and small business owner. As stated, our indirect auto business had a strong quarter with originations of over $148 million.

Our residential mortgage business experienced a seasonal lift despite the interest rate environment. Credit quality at NBT is strong and each of the core credit portfolios continue to perform at levels better than those we experienced prior to the pandemic. Like the rest of our industry, our cost of funds has risen as customers seek out higher yielding deposit products. With that said, total deposits grew during the third quarter, including the seasonal municipal inflow we experienced. Our full cycle deposit beta is at 24%, including acquired deposits. We continue to enjoy high account retention levels. Our funding sources are robust and we have the headroom we need to execute on our organic growth plans. Our fee-based businesses continued their solid performance in Q3.

Our Epic Retirement Services administration business experienced organic account growth and was additionally upported by the acquisition of Retirement Direct in early July. Total non-interest income was 30% of total revenue in the third quarter. In August, we announced that Mike O’Reilly joined the NBT team in Portland as our main regional president. In addition, he will oversee the execution of our strategy across our markets in Northern New England. Mike’s focus on the diversification of our approach in those markets is the next phase of our long-term organic expansion plans. During the quarter, activity associated with the upstate New York chip corridor was notable. In Central New York, Micron filed its application with the Commerce Department for multimillion dollar grants and other support under the Chips Act.

The international semiconductor company Advanced Micro Devices announced that it opened research and development facilities in Fishkill and Rochester. The Albany Nanotech Complex was designated by the federal government as a center for workforce training and received significant federal funding commitments. At the end of the quarter, the U.S. Department of Defense awarded a new 10-year contract to Global Foundries in the Capital District to produce semiconductors for defense and aerospace applications. Total spend under this contract will be over $3 billion. As we have discussed in prior calls, the economic activity generated along the chip corridor will drive long-term transformational economic growth across our core markets. That growth will promote long-term success at NBT as our platform is uniquely positioned along the corridor.

As we head into the final months of the year, NBT continues to be on offense, enhanced by the successful integration of Salisbury into our model, the continued focus on growth in New England, and the organic growth occurring along the chip corridor. We are well-positioned with strong liquidity and capital levels, a diversified business mix, highly effective risk management practices, and an experienced team of professionals. I will turn the call over to Scott and Annette now to talk in greater detail about the outcomes associated with the Salisbury merger and our financial performance in the third quarter. Following their remarks, we will take your questions. So Scott, I’ll turn it over to you.

Scott Kingsley: Thank you, John, and good morning, everyone. Before we get started with some additional color on quarterly results, I would like to ask Annette to summarize some of the specific outcomes related to the Salisbury acquisition. Annette?

Annette Burns: Thank you, Scott, and good morning. As John mentioned, we closed the merger on August 11 and successfully converted all Salisbury customer accounts to the NBT core operating system simultaneously with the closing. We acquired approximately $1.2 billion of loans, $1.3 billion of deposits, and issued 4.3 million additional shares as consideration, with a value of $162 million as of the closing date. Thus far, we have achieved the greater part of our estimated 30% in cost synergies, with the remaining expected to be realized by the end of 2023. As outlined on page four of our earnings presentation, we recorded fair value marks on loans of $78.7 million, net of a $5.8 million reclassification to loan loss reserves for PCD loans.

In the third quarter, we recognized $1.6 million of accretion income. Based on current prepayment feeds, this fair value mark will be accreted over the estimated remaining life of the loans, which we’ve assumed at just over seven years. We also recorded a fair value discount of $3 million on Salisbury’s $25 million of subordinated debt obligations, which will amortize over the next three and a half years. We also recorded a $31.2 million core deposit intangible related to Salisbury’s core funding base. We are expecting to amortize that intangible over the next 10 years on an accelerated basis. Lastly, we added $4.7 million wealth management customer list intangible, which would amortize over the next 12 years, again, on an accelerated basis.

Together, the amortization of these two Salisbury-related intangibles added $1 million of expense in the third quarter. The net of these four items added approximately $400,000 to our third quarter pre-tax income and is roughly a half a quarter’s impact. In addition, we recorded $1.8 million in amortizing intangibles related to the retirement direct acquisition during the quarter. Scott?

Scott Kingsley: Thank you, Annette. Turning to page five of our earnings presentation, our third quarter reported earnings per share were $0.54 while third quarter operating earnings per share were $0.84, compared to $0.80 per share in the linked second quarter and $0.91 in the third quarter of last year. Tangible book value per share of $20.39 at September 30 was down $1.16 per share from the end of the second quarter, influenced by the Salisbury acquisition as well as an additional $0.37 per share of unfavorable AOCI impacts. Our quarter end tangible equity ratio of 7.15% was very close to our projected capital levels at the announcement of the merger last December, despite the higher level of AOCI-related dilution. The next page shows trends in outstanding loans.

New origination yields have continued to move productively higher. Our now larger loan, total loan portfolio of $9.67 billion remains very well diversified and is roughly 52% commercial and 48% consumer outstandings. Total deposits of $11.4 billion were up $1.9 billion in 2023, which included $1.3 billion of deposits acquired from Salisbury. The company continues to experience remixing from its no interest and low interest checking and savings accounts into higher yielding money market and time deposit instruments. Our quarterly cost of total deposits increased to 118 basis points compared to 85 basis points in the linked second quarter and total cost of funds increased 28 basis points from the prior quarter and included the impact of the acquired Salisbury deposits, which did carry generally higher interest rates than the legacy NBT portfolios.

In addition, our total cost of deposits for the month of September was 131 basis points, which is 13 basis points above the reported quarterly level. We have also again included a summary of our deposit mix by type, which illustrates the diversification and deep granularity of our customer base. Page eight looks at the detailed changes in our net interest income and margin. Third quarter net interest income was $6 million above the linked second quarter results, primarily from the Salisbury acquisition, as well as one additional calendar day in the third quarter. We believe our granular deposit funding profile remains a core strength. However, we do continue to expect funding pressures to persist for the next couple of quarters. The trends in non-interest income are summarized on the next page.

Excluding securities losses, our fee income was up $3.7 million from the linked second quarter to $40.4 million and up 8.3% from the third quarter of 2022. Consistent with historical results, the third quarter of the year continues to be our most robust quarter of revenue generation for our fee-based businesses. As such, we’d expect some seasonal declines in the fourth quarter. Third quarter revenues in our wealth management business included approximately $650,000 from Salisbury, and our retirement plan administration business added $700,000 of revenues from the retirement direct acquisition completed on July 1. The diversification of our revenue generation sources continues to be a core strength of the company. Turning to non-interest expense, our total operating expenses were $82.9 million for the quarter, which was 6.8% above the linked second quarter, excluding merger-related expenses.

Quarter-over-quarter increases in salaries and employee benefits, technology services, occupancy, advertising, and FDIC assessment costs also related to the half-quarter impact from Salisbury. On the next slide, we provide an overview of key asset quality metrics. A walk-forward of our loan loss reserve changes is also available in the appendix to the presentation. Net charge-offs were 18 basis points of loans in the third quarter of 2023 compared to 17 basis points in the prior quarter. The increase in quarter-end loss reserves reflected an allowance for acquired Salisbury loans, which included an $8.8 million day one provision expense and the $5.8 million of PCD allowance. We continue to believe that the path of charge-off activity will return to more historical norms and along with expected balance sheet growth will likely be the drivers of future provisioning needs.

As I wrap up prepared remarks, some closing thoughts. The additional market volatility and uncertainty that arose in early March accelerated our funding cost pressures, which has resulted in lower net interest margins. However, well-balanced organic loan growth, constructive results from our recurring fee income level stable credit quality outcomes and diligent operating expense management have allowed us to generate solid quarterly results. Lastly, our post acquisition capital levels continue to put us in an enviable position as we consider future growth opportunities. With that, we’re happy to answer any questions you may have at this time. Michelle?

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question is going to come from the line of Alex Riddall with Piper Sandler. Your line is open. Please go ahead.

Alexander Twerdahl: Morning. Hey, yeah, first off, I wanted to start, John, you talked about the next phase of your organic expansion. I know that you know the main market very well. I believe you ran that for a little bit before taking the current role that you have now. I’m just, wondering if you can elaborate a little bit on sort of what you mean by that, if that is going to require some further investment into next year or if it’s going to be sort of what you’ve been doing just maybe with a couple of additional people?

John Watt: Thanks for that question. And yes, I did spend time in Portland, as you know. I think the investment here is in people and the supporting systems we need to deliver high-quality products and services. As we got off to a really strong start in Maine, focused primarily on CRE. It’s time now, and it always has been our plan, to diversify that approach in the market. And we think Mike O’Reilly and the team there, thinking about expanding our small business offering, our C&I offerings, putting the treasury management platform we have front and center on the deposit side, are all sort of basic block and tackling things that we are now ready to do in Maine and New Hampshire. We’ve done that in Burlington and Northern Vermont, and I think we’ve demonstrated it’s possible and achievable, and that’s where we’re headed.I don’t see us investing in brick and mortar in the short run, so it’ll be people and systems.

Alexander Twerdahl: Great, thanks for that additional color. And then, Scott, I’m just wondering if you can walk through sort of the funding strategies you have. I think you said cash flows from the securities gets you to roughly around 2% of your loan growth, or I guess would get you the first 2% of loan growth based on the cash flows from securities that you disclosed in the presentation. Assuming that you do a little bit better than that, which is kind of how you’ve been running, how do you weigh the different options for funding that? Would you consider additional securities restructurings, things like that?

Scott Kingsley: Thanks, Alex. And obviously an important question for us going forward. You’re right in your expectations relative to the investment portfolio. I think we’re expecting another $45 million in cash-flows in the fourth quarter, somewhere between $180 million to $200 million going into next year. Remember, our investment portfolio is generally amortizing mortgage-backed securities, which of course have slowed down as prepayment speeds have virtually reached zero. So our expectation of cash flows have been pulled down a little bit relative to that, but still productive. Given that’s the outcome of our investment portfolio, Alex, the ability to launch some kind of a restructuring of our securities portfolio would require us to estimate interest rates beyond the one or one and a half year horizon.

And we’re just not so sure that that’s the appropriate thing to do today in the market. So back to your point of, geez, how do you fund mid-single digit loan growth? I think it’s the organic strategies that we’ve proven we’re pretty good at over time. Do we expect some continued remixing into CDs and money market accounts from savings and checking, non-interest checking or low-interest checking? For sure. A piece of our customer portfolio started to get some repricing of their deposit instruments about a year ago, the fourth quarter of last year, or even maybe into the early first quarter. And remember, that was at a time when the Federal Reserve was moving rates in 50 to 75 basis point buckets at each meeting. So I think it was a little more top of mind.

Have we seen some sort of levelling out of that here in the third quarter? A little bit. Does that mean there’s some customers that still think they deserve a better yield on their depository or their excess liquidity? For sure, those people are still out there. I think the other thing, I think we pointed this out a quarter ago or maybe two quarters ago, that generally the Salisbury cost of funds were higher than ours on a blended basis. And so you’re seeing those numbers in the third quarter. And remember, you only got half of that in the third quarter so you’ll see a little bit more of that in the fourth quarter but generally, Alex, I think if you’re targeting now how to come up with funding sources for a $300 million or $350 million organic growth rate, I think we’re in good shape relative to figuring that out.

Alexander Twerdahl: Okay, so first line of defense is cash flows from security. The second line of defense is the organic growth that we all hope for. And then third, to have some borrowing options should they come to rise. But sale of securities is currently not one of the considerations?

Scott Kingsley: It is not, so you’re spot on with that. And I also think that in terms of what if the Salisbury transaction allows to expand our geography relative to thinking about other spots within our geography that we have never been represented in. Upper and lower Hudson Valley, as an example, we’ve really never had significant exposure there. Are there some additional spots between where the Salisbury franchise was in the Hudson Valley and where we’ve been sort of in the Southern Catskills and the Capital District of Albany? There’s probably some places in there where rationally we should link up. Same thing in Northwest Connecticut. Do we have immediate plans for that? No. Are we spending a lot of time trying to identify productive markets for that kind of expansion? For sure.

Alexander Twerdahl: Got it. And then just final question for me, when I look at the quarterly loan yields on slide six and the new origination yields, some of them seem still just a little bit light just given rates and what we’re hearing from other people. Is that kind of indicative of where the pipeline is as well, the new origination, or is the pipeline a bit higher than the new origination yields on slide six?

Scott Kingsley: Yeah, a couple of things there, Alex. I would say the pipeline is a little bit higher, remembering that the third quarter also includes months that were July, August, and September. And here we stand at the end of October. So the pipeline is probably a little bit higher than that. I think in terms of how those things are blending, residential loan production is obviously not at an all-time high. It’s at a fairly modest point. And so the mix of residential loans that may be ending up in a lower duration portfolio, 15 years, or in an adjustable rate, or a product that has an adjustable rate attached to it, that really explains why that number probably looks a little bit lower. Your point is well taken. Today, given where incremental funding costs are, do new yield expectations need to be north of 750 or 775 or even eight?