Heartland Financial USA, Inc.

Greetings and welcome to HTLF's 2023 first quarter conference call. This afternoon, HTLF announced its first quarter financial results and hopefully you've had a chance to review the earnings release that's available on HTLF's website at htlf.com. With us today for management are Bruce Lee, President and CEO, Brian McKay, 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 or forward-looking statement 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 in the company's or the SEC website. I will now turn the call over to Mr. Bruce Lee. HTLF President and CEO. Please go ahead.

Thank you, Tawanda. Good afternoon, everyone. This is Bruce Lee, President and CEO. Welcome to HTLF's 2023 First Quarter Earnings Conference Call. I appreciate you joining us today as we discuss our solid performance amidst the challenging environment in detail the strength and stability our customers, communities, employees, and shareholders can depend on. For the next few minutes, I'll discuss HTLF's highlights for the first quarter, then turn the call over to Brian McKegg, Chief Financial Officer, for more details on our performance and financials. Also joining us today is Nathan Jones, Chief Credit Officer, who can answer questions regarding the stable credit quality across our portfolios. Last week, our Board of Directors approved a quarterly cash dividend of 30 cents per share on the company's common stock, payable on May 26, 2023. The Board also approved a dividend of $175 for Series E preferred stock, which results in a dividend of 43.75 cents per depository share payable on July 17, 2023. For more than 40 years, HTLF has increased or maintained our quarterly common dividend. This reflects our strength, performance, and confidence in our strategies and ongoing results. HTLF has diversified lines of business and geographies. Combined with our local leadership and talent, we are intentionally built to withstand industry and economic pressures. Challenging times are an opportunity to serve and reassure our customers. In mid-March, we proactively reached out to the top 100 customers in each of our markets more than 1,000 in total to answer their questions and reassess their banking needs. This outreach was greatly appreciated and reinforced the importance of our local leadership and local roots. It underscored the breadth of our customers we serve and the strategic diversity of our geographic footprint. I want to thank our bank presidents and relationship managers for all their great work with our customers during a very challenging time. We're deepening relationships, driving new business, and well-positioned for continued growth. In the first quarter, net income available to common stockholders was $50.8 million and earnings per share of $1.19. We strengthened our balance sheet and increased our borrowing capacity by $1.7 billion to a total of $2.8 billion, with less than $2 million outstanding. Our capital ratios, including all unrealized gains and losses as of March 31st, exceeded all well-capitalized regulatory ratio guidelines. Brian will go into more details. In spite of the challenges in the first quarter, we added more than 300 new commercial relationships and more than 8,000 new consumer accounts. Our delinquency ratio remained low at 10 basis points. Our efficiency ratio improved 749 basis points or 12% from a year ago to 57.16. and total assets remained flat at $20.2 billion. Let's start with deposits. HTLF banks have a diverse and granular deposit base. As a result of our strategic diversification, our customer deposits are diversified by both geography and industry, with no industry concentration higher than 10% across our portfolios. Overall, total deposits for the quarter grew slightly to $17.7 billion, an increase of $168 million, or 1% from the linked quarter, and 65% of total balances are insured or collateralized. From the linked quarter, total customer deposits decreased 4%, with a mixed shift into interest-bearing accounts. While we maintain a favorable deposit mix, customer demand accounts decreased from 37% to 35%. In the first quarter, we launched a successful consumer deposit campaign. We opened more than 8,000 new consumer accounts in the quarter with more than 3,000 in March alone. That's the most new consumer accounts in any quarter or month in the last five years. Positive trends have continued into April, and customer deposits are stabilizing for commercial, small business, and consumer customers. We expect total customer deposits to grow 150 million in the second quarter. Turning to loans, in the first quarter, Commercial and Ag loans grew $85 million, an increase of 1% from the linked quarter and $1.2 billion or 14% from a year ago. Commercial loans grew $195 million, an increase of 2% from the linked quarter and $1.3 billion or 13% from a year ago. As expected, growth was slower in the first quarter as up to $100 million had been pulled forward into the fourth quarter. Our ag portfolio decreased $110 million, or 12% from the linked quarter, as customers paid down credit lines and delayed utilization, primarily due to weather impacts in California. In the first quarter, we saw commercial loan growth in eight of our 11 markets. we added more than 300 new commercial relationships representing $210 million in funded loans and $51 million in new deposits. On average, new originations were of higher credit quality than the overall portfolio as measured by risk ratings and credit scores. And 75% of these loans have variable rate structures. Our commercial pipeline remains strong at over $1 billion. We expect total loan growth of $175 to $200 million in the second quarter, which we expect to substantially fund through customer deposit growth. Our consumer and residential loan portfolios decreased 18 million, or 1%, from the linked quarter. We expect consumer loans to be flat to down $10 million in the second quarter. Turning to key credit metrics, our disciplined credit approach is delivering stable credit quality across our portfolios and continues to serve us well. Delinquency ratio is at 10 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 increased slightly to 4.76% from 4.67% in the linked quarter. Lastly, in the first quarter, we had net loan recoveries of $1 million. Despite all the headwinds, we're executing our core strategies and delivering loan growth, stable credit quality, a lower efficiency ratio, and we're acquiring new customers. Bank charter consolidation continues to go smoothly. So far, we've successfully consolidated seven of our 11 banks. The project continues on schedule and on budget, and we expect to finish charter consolidation early in the fourth quarter. We enhanced the products and services offered by our retirement plan services business through our partnership with July Business Services. July specializes in technology and brings more than 25 years of experience to our clients and plan participants. By selling the record keeping and administration services, both firms will be stronger together as July's technology will enhance the customer experience. HTLF retains investment management oversight and participant education and support. This transaction is expected to be completed and record-keeping services transitioned in the second quarter. Our strategy and accomplishments continue to be recognized locally and nationally. Dubuque Bank and Trust was named one of the best places to work by the Dubuque Telegraph Herald. Michael Wamsgans, President and CEO of Citywide Banks, was named a 2023 Colorado Titan 100 for demonstrating exceptional leadership, vision, and passion. And for the seventh consecutive year, HTLF has been recognized by Forbes as one of America's best banks for 2023. The ranking is based on profitability, growth, credit quality, and efficiency. HTLF's employees have earned this recognition each year with their dedication and commitment to delivering strength, insight, and growth to our customers, communities, shareholders, and each other. Their hard work and dedication have consistently grown and strengthened our company. Together, we are HTLF. I'll now turn the call over to Brian McKegg, Chief Financial Officer, for more details on our performance and financials.

Thanks, Bruce, and good afternoon. As Bruce just described, we had another busy quarter in which HTLF reported earnings per share of $1.19, loan growth of just under $70 million, and continued stable, clean credit performance. Included in this quarter's results were three notable items. First, $1.1 million of losses on the sale or write-down of assets, which were primarily facilities-related. Second, charter consolidation restructure costs of $1.7 million. And third, security losses of $1.1 million. Together, these items decreased pre-tax income by more than $3.9 million and earnings per share by $0.07. Before I go into more detail, I want to remind everyone that our first quarter earnings release and investor presentations are both available in the IR section of our HTLF website. I'll start my comments with the provision for credit losses, which totaled $3.1 million, or $300,000 less than last quarter. This quarter, the provision reflects our continued stable, healthy credit performance, and consistent with last quarter, incorporates an economic outlook that anticipates a moderate recession developing over the next 12 months. The provision also benefited from $1 million of net loan recoveries. In addition, as Bruce mentioned, our delinquencies ticked up just slightly, but remain very low at 10 basis points of loans and non-performing loans were flat compared to last 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 $4.1 million to $133.8 million, or 1.16% of total loans, compared to 1.13% last quarter. Moving to the balance sheet, Bruce already covered loans and deposits, so I'll start with investments. Investments remain flat at $7 billion, representing 35% of assets with a tax-equivalent yield of 3.67%, and will generate cash flows exceeding $1.3 billion over the next 12 months, with approximately $240 million next quarter. The fair value mark on the Available for Sale securities portfolio continued to improve to a negative $568 million. That's a $67 million or 10% improvement over last quarter. The relatively small held to maturity portfolio of $837 or $32 million or 12% of investments has an unrecorded negative fair value mark of $16 million, which is an improvement from $53 million last quarter. We continued to actively manage the portfolio by taking several actions during the quarter. First, we utilized nearly $120 million of cash flow this quarter to fund loans and pay down borrowings. And second, we increased security pledging at the Fed by $1.5 billion, leaving $3.8 billion, or 57% of our available for sale securities, unpledged at quarter end. And lastly, we repositioned our hedges to provide protection for unrealized security losses against the impact of higher mid- to long-term rates. Moving to borrowings, total borrowings declined $284 million to $464 million, or 2.3% of total assets. The reduction was primarily in Fed and FHLB borrowings, which were reduced to just under $2 million outstanding at quarter end. Our available and unused Fed and FHLB borrowing capacity at quarter end stood at $2.8 billion. That's a $1.7 billion increase over last quarter. The increase is the result of paying down existing borrowings and pledging additional securities to the Fed. To summarize our liquidity profile at quarter end, first, we have $1.3 billion of cash flow coming off our securities portfolio over the next 12 months with $240 million next quarter. Second, we have a low level of outstanding borrowings and $2.8 billion of available capacity with the Fed and FHLB. Third, we continue to have several Fed fund borrowing lines and broker deposit sources that remain open and available. Fourth, our deposit base, as Bruce mentioned, is granular and well diversified, with over 65% of balances either insured or collateralized. Fifth, our loan-to-deposit ratio is 65%, and when removing all wholesale deposits, it remains low at 77%. Sixth, we have cash and unpledged available for sale securities totaling over $4 billion. And lastly, the holding company cash position of $284 million is 3.5 times our current annualized interest and dividend payments. In addition, our dividend payout rate is relatively low at 25% of current earnings per share. With regards to capital, regulatory capital ratios remain strong with common equity Tier 1 at just over 11.25% and total risk base of nearly 15%. Adjusted for unrealized losses on our investments, the ratios remain above well-capitalized levels at approximately 7.5% and 11.2% respectively. The tangible common equity ratio increased 51 basis points to 5.72% at quarter end. The rise in market value of investments this quarter contributed 25 basis points of the increase. Moving to the income statement, starting with revenue, net interest income totaled $152.2 million this quarter, which was $13 million lower than the prior quarter. And the net interest margin on a tax equivalent basis fell 25 basis points this quarter to 2.40%. The main drivers of the decreases were two fewer days in the quarter compared to last quarter, resulting in $3.7 million of the decrease. A decline of $1.1 million in fees and purchase accounting accretion, which also reduced net interest margin by two basis points. A shift in deposit balances from lower costing non-maturity deposits to much higher costing time deposits, primarily brokered CDs, reduced net income by nearly $5 million and decreased NIM by 12 basis points. Higher deposit betas Then loan betas, reflecting the significant increase in deposit competition that began in late 2022, accounts for the remaining decrease in net interest income and net interest margin. And finally, we exited the quarter with an adjusted NIM of running at 3.35%. Non-interest income of $30 million this quarter was unchanged from the prior quarter. excluding security losses and core non-interest income, excluding security losses, core non-interest income was 30.9 million, which exceeded our expectation of 28 to 29 million. Shifting to expenses, non-interest expenses totaled 111 million this quarter. That's down 6.2 million from last quarter. Excluding restructuring, tax credit costs, and asset gains and losses, the run rate of recurring operating expenses decreased $1.4 million to $107.7 million, coming in slightly lower than our forecast of $108 to $109 million. Looking ahead to the rest of 2023, HTLF expects to see loan growth of $150 to $200 million, or 2% per quarter, and customer deposit growth of $150 million, or 1% per quarter. Achieving these loan and deposit growth expectations should enable the bulk of the investment cash flow to be available to decrease wholesale deposits. Net interest income for Q2 is expected to increase modestly over the first quarter and the net interest margin is expected to stabilize near the March run rate in the mid-330s on a tax equivalent basis. Provision for credit losses are projected to range from 3 to 5 million per quarter and obviously declines in economic conditions or projections could impact future provisions if a worse than moderate recession develops or credit quality metrics begin to decline. Core non-interest income excluding investment gains or losses is expected to be 30 to 31 million next quarter. Recurring operating expenses are expected to be in the 108 to 109 million range next quarter. Charter consolidation Restructuring costs are forecasted to be $2.5 to $3 million next quarter. In addition, we expect the total remaining cost to complete the project will approach $8 million over the next three quarters. And finally, we believe a tax rate of 23%, excluding new tax credits, is a reasonable run rate. And with that, I'll turn the call over to Bruce for question and answer session.