Heartland Financial USA, Inc.

Greetings and welcome to the HTLF second quarter 2022 conference call. This afternoon, HTLF distributed its second quarter press release, and hopefully you've had a chance to review the results. If there is anyone on this call who did not receive a copy, you may access it at HTLF's website at htlf.com. With us today for management are Bruce Lee, President and CEO. and Brian McCaig, Executive Vice President and Chief Financial Officer. Management will provide a brief summary of the quarter, and then we will open the call up to your questions. Before we begin the presentation, I would like to remind everyone that some of the information management will be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, I must point out that 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 website or the FCC's website. At this time, I will now turn the call over to Mr. Bruce Lee at HTLF. Please go ahead, sir.

Thank you, Lateef. Good afternoon, everyone. This is Bruce Lee, President and CEO. Welcome to HTLF's 2022 Second Quarter Earnings Conference Call. We appreciate you joining us today as we detail HTLF's excellent performance for the quarter. For the next few minutes, I'll discuss our second quarter highlights and then turn the call over to Brian McKegg, our Chief Financial Officer, to provide additional information around HTLF's results. Also joining us today is Nathan Jones, our Chief Credit Officer, who can answer questions regarding credit quality, which continues to be quite strong. HTLF had an outstanding second quarter. reporting $49.9 million of net income and EPS of $1.17. Core EPS is $1.15 after both positive and negative one-time events, which clearly exceeded expectations. We are moving forward together. We have sustained our momentum as we continue to execute our strategy and drive results. with strong growth in loans, deposits, and revenue. In the second quarter, we delivered our best quarter ever for organic loan growth, increasing 552 million, or 5 percent, from the linked quarter, excluding PPP, and again, significantly exceeding our guidance of 200 million. Deposit growth of 559 million from the linked quarter Our credit quality continues to be excellent with non-performing assets holding at 34 basis points of total assets and delinquencies at historic lows. And total assets are a record $19.7 billion, an increase of $428 million or 2% from the linked quarter. Let's start with loan growth highlights. we saw continued strength across our commercial business with growth in every commercial loan portfolio. From the linked quarter, commercial and industrial increased 245 million, or 9%. Owner-occupied real estate increased 17 million, or 1%. Non-owner-occupied real estate increased 160 million, or 7%. Construction was up slightly by 3 million, and our ag portfolio increased 70 million, or 9%. In the second quarter, we added 322 new commercial relationships, representing 328 million in funded loans and 37 million of new deposits. Notably, all originations were of higher credit quality than the overall portfolio, as measured by risk ratings and credit scores. And 66 percent of these loans have variable rate structures compared to 43 percent from last year. Our investments in talent continue to deliver results. Our commercial pipeline remains strong at over $2 billion, consistent with previous quarters. And we expect to grow commercial loans by more than $250 million in the third quarter. I've had many conversations with our customers regarding the business trends they're experiencing and their outlooks. While certain headwinds, such as inflation, supply chain, and staffing persist, our customers remain optimistic for the rest of the year and cautious about 2023. In our consumer loan portfolio, we saw a strong growth of 37 million, or 9%, from the linked quarter. Residential mortgage increased 20 million, or 2%, from the linked quarter. Overall, each of our 11 banks had positive organic loan growth, with Arizona Bank and Trust and citywide banks in Colorado leading the way. we delivered another quarter of deposit growth. Non-time deposits totaled $16.1 billion, an increase of $534 million, or 3%, from the linked quarter. Total deposits grew to a record $17.2 billion, an increase of $559 million from the linked quarter and our 13th consecutive quarter of total deposit growth. We maintained our excellent deposit mix. Ninety-four percent of deposits are in non-time accounts. Thirty-five percent of total deposits are in non-interest bearing accounts, positioning us well in a rising rate environment. Our deposit strategy continues to serve us well. Total deposit costs remain low at 15 basis points. Our efficiency ratio decreased significantly to 57.7%, driven largely by both increased revenue as we executed our growth strategies and a reduction of core expenses. Competitive pressures remain for top talent, and we are executing an employee retention strategy that's been successful since implementation. This is an area we're closely monitoring as wage inflation and demands for top talent continue to be high. Turning to key credit metrics, our disciplined credit approach has delivered excellent credit quality across our portfolios. Delinquency ratio is at a historic low of six basis points. Non-performing loans represented 59 basis points of total loans at the end of the second quarter, a decrease of four basis points from the linked quarter. Non-performing assets as a percentage of total assets remained low at 34 basis points. Non-pass rated loans decreased to 5.8% from 6.3% in the linked quarter. Lastly, in the second quarter, we reported net charge-offs of $700,000 or three basis points annualized of average loans. We are delivering against our ambitious and disciplined growth strategies, which were developed by our management team and unanimously approved by HTLF's Board of Directors. We have considerable momentum in our position for continued growth and progress against our goals of organic loan growth, new customer acquisition, attracting and retaining talent, controlling expenses, branch and geographic optimization, and maintaining strong credit quality. We will also achieve growth by consolidating our 11 separate bank charters into a single HTLF bank charter in Colorado. This will create operational and cost efficiencies and unlock capacity that supports both growth both organically and through M&A. Our 11 banks will maintain their local brands, local leadership, and local decision-making. In June, we successfully executed the first of 11 bank charter consolidations with citywide banks becoming a division of HTLF Bank. We're pleased with the smooth transition and the progress on the project overall. Four other banks are slated to convert this year. We expect to finish charter consolidation by late 2023 and deliver $20 million of annual savings and capacity after the project is complete. We will also continue to optimize our branch network. In the second quarter, we sold two branches and closed seven. Over the past 18 months, we have reduced our total number of branches by 21, from 142 to 121. This represents a 15% reduction in branches. Our strategy and accomplishments continue to be recognized by local and national media. Nielsen Report ranked HTLF among the top U.S. commercial credit card issuers for the seventh year in a row. We continue to demonstrate consistent strength in the commercial payment space as HTLF saw a 48% increase in purchase volume growth in 2021. Nielsen Reports' ranking reflects HTLF's innovative approach to digital technology products in providing excellent customer education and experiences. Awards, recognition, and strong performance result from the hard work and dedication of our employees. I want to thank them for their ongoing commitment to deliver strength, insight, and growth to our customers, communities, and investors. We move forward together because together we are HTLF. I will now turn the call over to Brian McKegg, HTLF's Chief Financial Officer, for more details on our performance and financials.

Thanks, and good afternoon. As Bruce outlined, this was another solid quarter for HTLF. with earnings per share of $1.17, loan growth of $552 million, excluding PPP, strong revenue growth, improved expense levels, and continued favorable credit trends. Included in this quarter's results were the following large items. Gain on sale of two Illinois branches was $3 million. Gain on sale of a small insurance sub was $400,000. and a gain on the sale of our Visa B shares was $1.9 million. Against these gains were losses on the sales securities of $2.1 million and charter consolidation restructuring costs of $2.4 million. Altogether, these items increased pre-tax income by just under $1 million and increased earnings per share by about $0.02. I will cover these in more detail throughout my comments. I would also remind everyone that both our earnings release and second quarter investor presentation are included in the IR section of HTLF's website. So I'll start my comments as I usually do with the provision for credit losses, which totaled $3.2 million and was unchanged from last quarter. This quarter, the provisioning for loan growth was partially offset by favorable underlying credit trends. More specifically, non-performing loans were down slightly compared to last quarter, and loan delinquencies remained historically low at six basis points of total loans, and net charge-offs were minimal at $714,000 this quarter. At quarter end, the allowance for lending-related credit losses, which includes both the allowance for credit losses on loans and unfunded commitments, increased $2.5 million to $119.1 million or 1.12% of total loans. In addition, at quarter end, unamortized purchased loan valuations on the balance sheet totaled $13.2 million or 12 basis points of loans. Moving to other balance sheet items, investment balances rose just over $80 million to end the quarter at $7.3 billion representing 37% of assets with a tax equivalent yield of 2.46%, a modified duration between five and six years, and producing monthly cash flows of $65 to $70 million. During the quarter, we took the opportunity to reposition some of the portfolio by selling just over 150 million of securities that yielded 2.1%, and used the proceeds to repurchase new securities yielding 4.3%. The loss on the repositioning was largely offset by the $1.9 million gain we realized on the sale of our remaining Visa B shares. The tangible common equity ratio decreased 96 basis points to 5.56% at quarter end and reflects 115 basis points decline due to the decrease in market value of investments and some balance sheet growth. That was partially offset by a 19 basis points increase from higher retained earnings. HTLF's regulatory capital ratios remain strong with common equity tier one at just under 11.2% and total risk based at 11.1%. So the balance sheet continues to be very strong and well positioned. Moving to the income statement, starting with revenue, Net interest income totaled $142.5 million this quarter, which was $7.8 million higher than the prior quarter. The main drivers of the increase were strong loan and deposit growth, together with the impact of the Fed's short-term interest rate increases and a low level of deposit price increases. This quarter also included 2.5 million decline in PPP interest and fees to 1.8 million from 4.3 million last quarter. We exited the quarter with just under 700,000 of unamortized PPP loan fees remaining on our books. The net interest margin on a tax-equivalent basis rose 10 basis points this quarter to 3.22%. Due to the recent rate increases, investment yields improved 30 basis points and loan yields, excluding PPP, were 10 basis points higher, while interest costs also rose 10 basis points. This quarter, the net interest margin includes seven basis points of purchase accounting accretion, which is up two basis points from the prior quarter. Non-interest income was flat compared to the prior quarter at $34.5 million. However, excluding gains and losses, Core non-interest income was $36.7 million, up almost $4.8 million, and exceeded our projections. The main components were, first, a strong increase in deposit service fees of $2.8 million. That does include our usual annual visa incentives of $1.3 million. And other non-interest income was up $4 million due to a $1.8 million increase in commercial swaps and syndication fees and the previously mentioned $1.9 million gain on the sale of our remaining Visa B shares. These positives were offset somewhat by weaker wealth management fees and mortgage banking revenue due to rising interest rates. So core revenue trends were positive for both net interest income and fees, and we believe revenue can continue to trend positive through the rest of 2022. Shifting to expenses, non-interest expenses totaled $106.5 million this quarter. That's down $4.3 million from last quarter. Excluding restructuring, tax credit costs, and asset gains and losses, our core expenses decreased $3 million to $106.8 million compared to $110 million last quarter and came in a little better than projected. Almost all expense categories were flat to down this quarter, with the most significant improvement coming in salary and benefits expense, which decreased $2.1 million due primarily to a decline in FTE count of 121 for the quarter. As a result of the strong revenue growth and core expense reductions this quarter, the second quarter efficiency ratio improved significantly to 57.66%. While looking ahead, we believe second quarter results provide significant momentum that will continue into the back half of 2022. This is highlighted by First, loan pipelines, which as Bruce mentioned, remain strong and support our expected loan growth rate of 2% to 3% per quarter. Non-time deposit growth is expected to slow into the 1% range per quarter. Assuming no additional Fed changes, net interest income is projected to grow in the mid single digits on a percentage basis next quarter, reflecting continued loan growth and a full quarter impact from the June Fed rate increase with some offset from some lagging pressure on deposit pricing. The expected Fed increase of 75 basis points in July is projected to increase net interest income by $9 to $10 million on an annualized basis, assuming our normal deposit ratio of about 40. Provisions for credit losses should remain near current levels given the projected loan growth and assuming net charge-offs remain below historic levels for the rest of 2022. However, changes in economic projections could have a significant impact on future provisions should a stronger recession begin to materialize. Core non-interest income, excluding gains and losses, is expected to normalize into the range of $32 to $33 million per quarter, with higher commercial deposits, swap, and syndication fees helping to offset lower mortgage banking and wealth revenue as rates continue to rise. Core expenses are expected to decline slightly into the $105 to $106 million range over the next two quarters. However, inflationary pressures, particularly wage inflation, remain challenging. Barter consolidation restructuring costs are expected to be in the $2.5 to $3 million range next quarter. And in total, we estimate $14 to $15 million of remaining costs over the next two years. Consolidation benefits have already begun to layer in and will continue to do so over the next two years. We remain very confident that, in total, they will reach $20 million on an annualized basis when the consolidations are completed in late 2023. And finally, we believe a tax rate of 22% to 23%, excluding new tax credits, is a reasonable run rate. And with that, I will turn the call back over to Bruce for some questions.