Heartland Financial USA, Inc.

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 for management are Bruce Lee, President and CEO, Kevin Thompson, Chief Financial Officer, Brian McKay, 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 our 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. Additionally, 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.

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. Brian McKegg, our retiring CFO, is also on the call. I want to personally thank Brian 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 30 cents 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 43.75 cents 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 maintains 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 pay down 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 decreased to nine basis points of total loans and our lowest ratio of 2023. Net charge-offs declined to $392,000 or one basis point of total average loans. Non-performing 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, and the office market specifically. Our office exposure is low at 3.2% of our total loan portfolio. We're 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 costs 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, in 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. For 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'll now turn the call over to Kevin Thompson, Chief Financial Officer, for more details on our performance and financials. 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 a cell of 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 cells 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 a 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 one basis point to 2.09%. Non-interest 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 are 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. Non-interest 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 loan. 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 one basis point for the quarter and 11 basis points for the full year, and delinquencies were also low at nine 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 provide our management outlook for 2024 compared to our 2023 results, assuming no change in the economic environment. We expect loan growth of 68%, 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 amortize 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 non-interest 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.