Heartland Financial USA, Inc.

Greetings and welcome to the HTLF third quarter 2022 conference call. This afternoon, HTLF distributed its third quarter press release and hopefully you've had the 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 from management are Bruce Lee, President and CEO, and Brian McKegg. Executive Vice President and Chief Financial Officer. Management will provide a brief 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 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 SEC's website. At this time, I will now turn the call over to Mr. Bruce Lee at HTLF. Please go ahead, sir.

Thank you, Josh. Good afternoon, everyone. This is Bruce Lee, President and CEO. Welcome to HTLF's 2022 Third Quarter Earnings Conference Call. I appreciate you joining us today as we discuss HTLF's continued strong performance. For the next few minutes, I'll discuss our third quarter highlights, then turn the call over to Brian McCaig, Chief Financial Officer, for additional information around our results. Also joining us today is Nathan Jones, Chief Credit Officer, who can answer questions regarding our disciplined credit approach that continues to deliver excellent credit quality across portfolios. HTLF had a strong, clean third quarter, with $54.6 million of net income available to common shareholders and EPS of $1.28, once again exceeding expectations. We continue to see results from the ongoing execution of our strategy. In the third quarter, organic loan growth excluding PPP totaled 255 million or 2% from the linked quarter in exceeding our guidance of 250 million. Our efficiency ratio decreased to 55.26, 512 basis points lower than a year ago. we are driving efficiency while strategically investing for growth. And our credit quality continues to be excellent with only 26,000 in quarterly net charge-offs and our delinquency remained near historic lows at 10 basis points. Let's start with loan growth highlights. We saw continued strength in commercial loan portfolios. From the linked quarter, Commercial and industrial increased 219 million, or 7%. Owner-occupied real estate increased slightly by 3 million. Construction increased significantly by 151 million, or 18%. Non-owner-occupied real estate decreased 102 million, or 4%. And our ag portfolio decreased 55 million, or 7%, as customers used seasonal harvests to pay down their credit lines. In the third quarter, we saw commercial loan growth in eight of our 11 banks. We added 353 new commercial relationships, representing $245 million in funded loans and $48 million of new deposits. On average, new originations were of higher credit quality than the overall portfolio as measured by risk ratings and credit scores. And 69% of these loans have variable rate structures compared to 66% from last quarter. We've made significant investments in specialized industry verticals and capital markets expertise, including loan syndications, interest rate derivatives, trade finance, and foreign exchange. We're driving business in fee-generating products, such as our commercial card business, which generated $6.2 million in revenue, a 6% increase from the linked quarter, and our treasury management business, where total deposit fees are up 14% year-to-date. The depth and breadth of our product and services is opening new doors. Our commercial pipeline remains strong at over $1.5 billion and we expect to grow commercial loans by $225 to $250 million in the fourth quarter. In our consumer loan portfolio, we saw solid growth of $31 million or 7% from the linked quarter and expect to grow consumer loans by $15 million in the fourth quarter. Residential mortgage increased $8 million or 1% from the linked quarter. Turning to deposits, non-time deposits were flat, while time deposits increased $44 million or 4% from the linked quarter. Overall, deposits grew to a record $17.3 billion, an increase of $42 million from the linked quarter and our 14th consecutive quarter of deposit growth. We maintain our exceptional deposit mix. 93% of deposits are in non-time accounts. 38% of total deposits are in non-interest bearing accounts, positioning us well as rates continue to rise. Our deposit pricing strategy and favorable deposit mix continues to serve us well. Core deposit costs remain low at 21 basis points, along with total deposit costs at 35 basis points. Late in the third quarter, we began to execute market specific deposit acquisition strategies. Additionally, our commercial teams are focused on attracting new relationships, including deposit only relationships. We are addressing overall price increases to maintain and grow our deposit base. As I mentioned at the top, our efficiency ratio decreased 512 basis points from a year ago to 55.26. The significant decrease demonstrates we are executing our growth strategies, increasing revenue, and reducing core expenses. Competitive pressures remain for top talent, and we're investing in our culture and our people. Wage inflation and demands for top talent continue to be high, but our employee retention strategy has been successful, and it's an area we continue to monitor closely. Turning to key credit metrics, our disciplined credit approach continues to deliver excellent credit quality across our portfolios. Delinquency ratio remains near historic lows at 10 basis points, Non-performing loans represented 60 basis points of total loans. Non-performing assets, as a percentage of total assets, remained low at 37 basis points. Non-pass-rated loans decreased to 5.3% from 5.8% in the linked quarter. Lastly, in the third quarter, we reported net charge-offs of only 26,000. which essentially rounds to zero. We'll continue to take a conservative credit approach given concerns around the current economic environment. Despite headwinds, we've sustained momentum and are well positioned 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 in maintaining strong credit quality. We will also achieve growth through charter consolidation, creating operational and cost efficiencies that unlock capacity and support growth organically and through M&A. To date, we've successfully executed four bank charter consolidations with our banks in Arizona, California, Colorado, and Minnesota becoming divisions of HTLF Bank. We're pleased to report that 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 deliver $20 million of annual savings and capacity after the project is complete. Brian will share more details in his comments. We also continue to optimize our branch network. Since the beginning of 2021, we have reduced our number of branches by 15% to 121 total locations. Our steadfast commitment to improving the customer experience has been recognized by Coalition Greenwich as six of our banks have been named 2022 customer experience leaders in the commercial small business banking or commercial middle market banking categories. To earn the recognition, our banks achieved scores that exceeded the industry benchmark by a specific margin in overall satisfaction, likelihood to recommend, and ease of doing business. Congratulations to all the teams delivering best-in-class service to our customers. HTLF's mission is to enrich lives one customer, employee, and community at a time. Our employees live this mission daily, and I specifically want to recognize Tracy Beshin, Doris Hannon, Don Oakey, Michelle Shane, and their teams for their hard work on charter consolidation and dedication to delivering strength, insight, and growth to our customers, communities, and each other. I'll now turn the call over to Brian McCagg, Chief Financial Officer, for more details on our performance and financials.

BRIAN MCCAGG. Thanks, Bruce, and good afternoon. As Bruce just outlined, this was another solid quarter for HTLF with earnings per share of $1.28 loan growth of $255 million, excluding PPP, strong revenue growth, improved core expense levels, and stable clean credit trends. Included in this quarter's results were two large items. First, a $1.1 million loss on the sales securities and charter consolidation restructure costs of $2.2 million. Together, these items decreased pre-tax income by $3.3 million, and earnings per share by $0.06. I would again remind you that both our earnings release and the third quarter investor presentation are available in the IR section of our HTLF website. I'll start my comments as I usually do with the provision for credit losses, which totaled $5.5 million. That's a $2.2 million increase over last quarter. This quarter, the provision was driven by loan growth that was heavily weighted towards C&I, elevated economic concerns, and stable, healthy credit trends. More specifically, after five quarters of decline, non-performing loans and related reserves rose just slightly this quarter, while loan delinquencies remained low at 10 basis points of total loans. Non-pass loans declined again this quarter, 5.3% of loans from 5.8 last quarter. And as Bruce already mentioned, net charge-offs were virtually zero 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 $5.5 million to $124.6 million, or 1.14% of total loans. In addition, at quarter end, unamortized purchase loan valuations on the balance sheet totaled $12 million, or 11 basis points of total loans. Moving to investments, which declined $300 million to end the quarter at $7 billion, representing 35% of assets with a tax equivalent yield of 2.92%, and will generate cash flows exceeding $1 billion over the next 12 months. We continue to actively manage the portfolio by taking several actions during the quarter. First, in August we moved $935 million of taxable munis with a market value of $748 million into the held to maturity portfolio. Second, we utilized some of our strong revenue growth to take the opportunity to sell 60 million of securities yielding 2.3% at a $1.1 million loss, and used the proceeds to purchase new AAA-rated securities yielding 5.8%. And lastly, we utilized $125 million of cash flow this quarter to fund loan growth. With regards to capital, HTLF's regulatory capital ratios remain strong, with common equity Tier 1 at just over 11% and total risk-based capital at 15%. The tangible common equity ratio decreased 62 basis points to 4.94% at quarter end and includes a 79 basis points decline due to the continuing decrease in market value investments, which was partially offset by higher retained earnings. Moving to the income statement, starting with revenue, net interest income totaled $155.9 million this quarter, which was $13.4 million higher than the prior quarter. The main drivers of the increase were strong loan growth, the Fed's short-term interest rate increases, with only modest core deposit price increases. The quarter included $400,000 of PPP interest and fees, which is $1.4 million less than last quarter. We exited the quarter with just under $400,000 of unamortized PPP loans or fees remaining on our books. Net interest margin on a tax-equivalent basis rose 23 basis points this quarter to 3.45%. Due to the recent rate increases and our asset-sensitive balance sheet, increased asset yields outpaced rising funding costs again this quarter, as investment yields improved 46 basis points and loan yields were 36 basis points higher. Total interest-bearing deposit costs were up 30 basis points. This quarter, the net interest margin includes three basis points of purchase accounting accretion, which was down four basis points from the prior quarter. Non-interest income of $29.2 million was $5.4 million lower compared to the prior quarter. Excluding security gains and losses, core non-interest income was $30.4 million, which was just short of our $31 to $32 million forecast. The main components of the reduction were a $3.1 million decrease in commercial swaps and syndication fees due to lower loan volumes this quarter compared to last quarter, weaker wealth management fees and mortgage banking revenue, which declined $500,000 and $1.1 million, respectively, due to the higher interest rate environment. And as you may recall, last quarter there was a $1.9 million gain on the sale of Visa B shares. So in total, revenue grew $8 million, or 5%, exceeding expectations and will continue to grow into 2023. Shifting to expenses, non-interest expenses totaled $108.9 million this quarter. That's up $2.4 million from last quarter. Excluding restructuring, tax credit costs, and asset gains and losses, the run rate of recurring operating expenses decreased $600,000 to $106 million compared to $106.6 million last quarter and came in within our expected range of $105 to $106 million. Most core expense categories were relatively flat or down this quarter, with the most significant improvement coming in salary and benefits expense, which decreased $1.4 million. The only category with a significant increase was other expenses, which was up just under $700,000. As a result of the strong revenue growth and core expense reductions again this quarter, the third quarter efficiency ratio continued to improve down to 55.26% from 57.66% last quarter. Looking ahead, HTLF's significant momentum will continue next quarter and into 2023. highlighted by loan pipelines, which, as Bruce noted, remain strong and support our expected loan growth rate of 2% to 3% per quarter. Non-time deposit growth is expected to remain muted in the 1% range per quarter. Assuming no additional Fed rate changes, net interest income is projected to grow low single digits on a percentage basis next quarter. reflecting continued loan growth and a full quarter impact from the September Fed rate increase, with some offset from mounting pressure on deposit pricing. The next expected Fed increase of 75 basis points is projected to increase net interest income by $8 to $9 million on an annualized basis, assuming a normal deposit beta for us of 40%. Provision for credit losses should remain in the range over the past few quarters of $3 to $5 million given projected loan growth and assuming net charge-offs and delinquencies remain near their current levels. However, further declines in economic conditions and projections could have a significant impact on future provisions should a strong recession begin to materialize. Core non-interest income, excluding investment gains and losses, is expected to be in the $29 to $30 million range per quarter, with commercial deposits, swap, and syndication fees helping to offset lower mortgage banking and wealth revenue. Recurring operating expenses are expected to remain in the $105 to $106 million range. However, inflationary pressures, including wage inflation, remain challenging. Charter consolidation restructuring costs are expected to be between $2.5 and $3 million next quarter. In total, we estimate the remaining costs to complete the project will be $12 to $13 million over the next five quarters. Consolidation and branch optimization benefits are already beginning to materialize, as evidenced by the 16 basis point reduction in our core expenses to average assets ratio since the beginning of the year. and additional benefits will continue to develop over the next 12 months. We remain confident that the total consolidated benefits will reach $20 million on an annualized basis when the consolidations are completed in early Q4 of 2023. And finally, we believe a tax rate in the 22% to 23% range, excluding tax credits, is a reasonable run rate. And with that, I'll turn the call over to Bruce for questions.