Heartland Financial USA Inc
NASDAQ:HTLF
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Heartland Financial USA Inc
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Greetings, and welcome to HTLF 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 from management are Bruce Lee, President and CEO; and Bryan McKeag, 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 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 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, Towanda. 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 of 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 Bryan McKeag, 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 $0.30 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 $0.4375 per depositary 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 31, exceeded all well-capitalized regulatory ratio guidelines. Bryan will go into more details. In spite of the challenges in the first quarter, we added more than 300 new commercial relationships in 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 mix 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 million 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 recordkeeping 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 in record keeping, services transition in the second quarter.
Our strategy and accomplishments continue to be recognized locally and nationally. Dubuque Bank & Trust was named one of the Best Places to Work by the Dubuque Telegraph Harold. Michael Wamsganz, 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 Bryan McKeag, 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 pretax 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 remained 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 remained flat at $7 billion, representing 35% of assets with the 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 $832 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 continue 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 3.5x 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 2 basis points; a shift in deposit balances from lower costing non-maturity deposits to much higher cost and time deposits, primarily brokered CDs, reduced net income by nearly $5 million and decreased NIM by 12 basis points; higher deposit betas than loan betas, reflecting a 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 million 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 million to $109 million.
Looking ahead to the rest of 2023, HTLF expects to see loan growth of $150 million 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 million to $5 million per quarter.
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 million to $31 million next quarter.
Recurring operating expenses are expected to be in the $108 million to $109 million range next quarter. Charter consolidation, restructuring costs are forecasted to be $2.5 million 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 sessions.
Towanda, we can now open up the line for questions.
Thank you. Ladies and gentlemen, we will now conduct our question-and-answer session. [Operator Instructions] Our first question comes from the line of Damon DelMonte with KBW. Your line is open.
I just wanted to start off on the margin and the outlook for the margin. Maybe, Bryan, you could give a little perspective on kind of where you see your full cycle betas going to. I think based on the jump this quarter, you're kind of at about 28% kind of cycle to date beta. Where do you kind of see that shaking out over the remainder of this year?
Yes. I think you're looking at probably -- you're excluding DDA when you do that, right, Damon? Everybody counts it a little bit...
Yes.
Yes, yes. That's pretty close to what I've got calculated for that same piece. We tend to look at it with DDA, but I think you're in the ballpark for cycle. Our normal cycle betas are around 30% to 35% on just the -- just the non-DDA component. So, I think they could move up just a little bit. Although it feels like they're topping out, it feels like unless rates start to go back up, the Fed moves and some things happen, it feels like we're in a fairly decent spot right now that things should sort of hold where they are, but that's how it feels today.
Got it. Okay. And when you talk about the expected deposit growth in the coming quarters, this is generally going to be driven from the wholesale side? Or is this from your -- the retail side?
No. My comments, Damon, were strictly -- it excluded any wholesale growth. It was all consumer, small business or commercial or existing -- new or existing customers.
Okay. Great. And then are you able to quantify the impact of the sale of the benefit administration and recordkeeping business from -- on the fee income side?
Yes. So what I would say, Damon, is that will close here in Q2. I would say we'll see a moderate gain, not huge for us. It moves around. There's an earnout, there's some things. So, we don't have an exact number to share with everybody, but it will be modest. And then what we see going forward is that the fees will go down a little bit, but also our expenses go down.
So that should be on a run rate basis, fairly close to an offset. So I mean we didn't do this for an economic reason. We did this for the benefit of our customers to provide them a better platform, both our sponsors and the participants, better technology. And there's also some additional products that we can sell on this platform that we didn't have on our current platform.
Got it. Okay. And then I guess lastly, on the loan growth outlook, do you expect kind of a pickup in the ag portfolio. I know, Bruce, you had commented that lower line utilization and kind of delayed -- delayed need of funds because of the weather. Do you expect that to kind of ramp back up here in the second quarter?
Yes, we absolutely do. It was just really timing. We saw a significant increase in the fourth quarter. We knew we would have decreased. We didn't think it would be quite as significant as it was at $110 million because they're about three weeks behind. We were just out in California two weeks ago in the planning season there because of some of the flooding, about three weeks behind. So yes, we expect that to come back.
Thank you. Please standby for our next question. Our next question comes from the line of Jeff Rulis with D.A. Davidson. Your line is open.
Bruce, I just wanted to get back to your -- I appreciate the customer deposit growth. So is the use of wholesale deposits going to kind of swing with how successful you are in the customer growth? Or do you intend to kind of stop or install that growth or shrink? How do you approach the wholesale deposit side?
Yes, great question, Jeff. So in a perfect world, we'll grow our deposits to $150 million from customers. Loans will be $175 million to $200 million. We'll utilize the cash flow of our investment portfolio to fund that stub piece on the loan side, and then we'd use the rest of that cash flow to pay down wholesale funding.
Got it. okay. Fair enough. And then just jumping over to the -- looking at Slide 18, you're -- whatever -- trying to get to the sense of your optimized overhead ratio, whatever you're sort of depicting at just over 2%. Is that -- is that approaching the trough? I just want to kind of check in with as we finish the charter consolidation, and it's taking a little more form. What is that kind of near term and maybe as we exit the year kind of the target? And maybe there's moving pieces there, but just trying to get an orientation for how far are we on? Is there -- in other words, is there a sort of a trough optimization will you get to?
Yes. I think -- this is Bryan. I think that 2.14% that you see on Page 18, I think we'd love to see that get down to 2.10% or below as we kind of get through the charter consolidation. We've done some other things, as you know, to improve efficiency. I think, the 2.14%, if you take kind of when we started the charter consolidation, we are running at that 2.22%, maybe about 2.24%. And 2 -- $20 million on $20 billion is 10 basis points. So we should get at least to the 2.14% we're at and better with all the other things, including charter consolidation that we've been working on. That makes sense?
Okay. Yes, I follow you. Yes, I appreciate it. And just sort of a follow-up on the -- I just wanted to make sure. So the guide, Bryan, on the operating expense and fee income, that's inclusive of the RPS sale or you haven't totally quantified that. And as you said, there'll be -- when there is an adjustment, it will be offset or just trying to see if that's baked into the guide.
Yes. I think we can -- again, the two net off of each other. So if I didn't get all of it out of the non-interest income, I probably didn't get it all out of the non-interest expense. So, the two will kind of have about the same number if I missed that in my guidance, I would say I probably didn't have that all in because it won't be for a full quarter in everything. So as we go forward and get that true run rate, I can refine that for you.
Got it. But close enough, it sounds like it's...
Yes, I think so.
Again. Okay. All right, well, thank you.
Thank you. Please standby for our next question. Our next question comes from the line of Terry McEvoy with Stephens. Your line is open.
Maybe just start on deposits. Could you maybe talk about deposit activity across your footprint, particularly in March? And I'm just curious if you have any comments on California and maybe if there was outsized consumer deposit openings in that specific state of the market?
Yes, Terry, when we think about our entire footprint in all of our 11 markets, we did see in our more urban markets, higher -- kind of higher runoff of deposits. The rest of the footprint was much less. And in California, we actually grew balances during the quarter, and it was primarily on the consumer side.
And then maybe, Bryan, a question for you. Could you just talk about kind of the AOCI kind of burn down over the next couple of years just as we think about building out kind of tangible capital and book value? And just I'm curious on that topic, what was the cost in process to kind of hedge higher rates and the value of the securities portfolio that you mentioned in your prepared remarks?
Yes, I'll see if I can -- I probably don't have all of that here at the top of my head or in my notes. But if rates kind of hang where they are or what we were protecting within the hedge was for middle term rates, which is where our investment securities are kind of tied to from a duration standpoint. So, we were able to put this hedge on to actually reduce the duration effect on that portfolio by, I think, that 20 close to a year. So, we think that protects on our worst side, which is those rates go up, right?
And then we have deterioration in our TCE ratio because of that AOCI. So that was the reason for putting a hedge on. I think if rates and we can just roll out and the cash flow comes out, it will improve, Terry. I don't have the exact burn down exactly, but in terms of how the gain or loss will come out. But I think where we saw the 10%, you won't see quite that unless rates come down, but you'll see that roll off and that number should get better. Not exactly...
And...
Yes, I don't have anything better than that for you.
Okay. And then I think Nathan was on the call. A question for him, I mean we're all kind of focused on office CRE and the exposure there. From your perspective, is that where we should be focused as outsiders looking into the bank? And maybe what other parts of that kind of non-owner-occupied CRE portfolio are you monitoring a bit more closely?
Yes. Absolutely, Terry, I think office is the one that has everybody heightened. We certainly do a lot of research analysis on ourselves constantly looking at it. We feel pretty good about it. We really don't have much of construction there and have a pretty low percentage overall from a concentration.
And of course, it's strongly underwritten, and it so far has performed well. And a lot of the stuff that we're seeing today from a market perspective was accounted for in a lot of our underwriting as we kind of stress and plan for potential refinance risk. So we feel like it's in a good position. But expanding that question is kind of where you asked about what other things are we looking at and kind of really paying focus on.
We're really trying to get our hands around and also understand kind of where retail and hospitality are two others that we keep a high focus on. And then also if there's any possible contagion into other areas like a medical office space, something we continue to watch and really keep ahead of us talking with our customers, getting out there and make sure we understand where they're at and trying to understand where the potential contagion could go.
Thank you. Please standby for our next question. Our next question comes from the line of Andrew Liesch with Piper Sandler. Your line is open.
Just to go back to deposits and just like obviously, the trends here in the quarter, recognized you're expecting some growth here. Should the mix of growth be -- the trends to be similar to what we saw in the last quarter with demand accounts down and CDs up? And then, I guess, what are you guys expecting on the other interest-bearing accounts?
I think we'll see demand up a little bit because of the new relationships that we -- that are in our pipeline on the commercial side. I think on the consumer side, it will probably skew a little more toward interest-bearing accounts.
Got it. And...
There was a fair amount of seasonality in the first quarter in commercial demand accounts, as we normally have, between 1% and 2%. And so, we do expect some of that to build back up.
Got you. All right. And then so the consumer campaigns, I suspect that was largely in CDs. How many are these campaigns still ongoing? And is that where you expect most of the -- and I guess how long do you expect to run these campaigns? Or is this going to be a new part of the funding going forward?
We're going to continue to run the campaigns through the second quarter. And I think we may not be running a campaign, but we will definitely keep our advertising spend higher than it has been historically because it's been so successful.
Andrew, it is both aimed at transaction accounts as well as CDs, and we have both working those. Yes.
Got you. You've covered all my other questions. I'll step back.
Thank you. Please standby for our next question. Our next question comes from the line of David Long with Raymond James.
I wanted to ask you about non-interest-bearing deposits, and HTLF has run anywhere from 32% to 40% non-interest-bearing to total deposits for the last several years. And the events of the last several weeks, I think, are causing both businesses and consumers to review their deposit accounts, and there's definitely a trend moving towards interest-bearing accounts. And look, we've been in a zero rate environment for the last 15 years on and off or at least most of the time, absent a couple of years. Can the non-interest-bearing for HTLF drop as far as 20% or 25% of your concentration of deposits?
David, great question, and I guess the short answer is I don't think so. And let me give you some of the details about the commercial deposit decline for the quarter because, as I mentioned earlier, we normally have 1% to 2% seasonal declines.
nd we've looked at all the movement in the first quarter, and approximately 50% of the decrease on the commercial side, and most of this came out of the DDAs, were just business operations, normal business activity, another 15%, 16% were tax distributions or sub-s distributions.
And then, if you lumped people taking money out for alternative investments going somewhere for higher interest rates or safety concerns, that would be about 25%, with safety concerns being the smallest piece of that. It was only 4% of the deposit movement.
So when I say that, that's why I don't believe that we can get as low as you're referencing. And our core activity is to generate new relationships, and we've been able to do it now for, I think, seven quarters in a row on the commercial side, and all the deposits come with it.
So I feel pretty good. It may go down into the really low 30s, but I don't see it getting into the low 20s.
Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Mr. Lee for closing remarks.
Thank you, Towanda. In closing, we had a solid first quarter. March was challenging, but we stayed focused on our commitment to serving our customers, communities and each other. We continue to add new commercial, small business and consumer customers, grow loans and deposits, improve customer experience, maintain stable credit quality and drive efficiency.
The combination of HTLF's financial strength, geographic footprint, diverse customer base, local leadership and talent position us to withstand market volatility and economic headwinds. We're open for business and driving growth while continuing to serve our customers and communities.
Thank you for joining us. Our next quarterly earnings call will be in late July. Have a good evening.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.