Heartland Financial USA, Inc.
Q4 2020 Earnings Call Transcript

Published: 25 Jan 2021

[Operator:]

Greetings, and welcome to the Heartland Financial USA, Inc. Fourth Quarter 2020 Conference Call. This afternoon, Heartland distributed its fourth quarter press release and hopefully, you have 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 Heartland’s Web site at htlf.com. With us today from management are Lynn Fuller, Executive Operating Chairman; Bruce Lee, President and CEO; and Bryan McKeag, 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.

[Lynn Fuller:]

Thank you, Valerie, and good afternoon. Welcome to Heartland’s fourth quarter 2020 earnings conference call. We appreciate everyone joining us today as we discuss the company’s performance for the fourth quarter of 2020 and for the full year. For the next few minutes, I'll touch on the highlights for the quarter. I'll then turn the call over to Heartland’s President and CEO, Bruce Lee, who will cover business performance and our COVID-19 response. Then Bryan McKeag, our EVP and CFO will provide additional color around Heartland’s results. Also joining us today is Nathan Jones, EVP and Chief Credit Officer who will be available to answer questions regarding credit. Bruce Lee and Bryan McKeag will share with you the many things we are doing to support, protect and care for our employees, customers, shareholders and communities. So now onto the financial highlights for 2020 and the fourth quarter. Well, I'm very pleased to report that based on all the challenges of 2020, the continued low interest rates, state shutdowns and the overall impact of the pandemic, we still had a very good year. Fourth quarter net income available to common shareholders was 37.8 million or $0.98 per diluted common share. Net income before our preferred dividend was 39.8 million, a 5% increase over 12/31/2019. For the full year 2020, net income available to common shareholders was 133.5 million and earnings per diluted common share was $3.57. Annualized return on average tangible common equity was 12.77% and the annualized return on average assets was 0.92%. Our tangible common equity ratio ended the quarter at 7.81% as a result of the two acquisitions totaling 2.3 billion in assets. Bryan McKeag will provide more detail on our capital ratios.

[Bruce Lee:]

Thank you, Lynn. Good afternoon. As I look at the strong results from our fourth quarter and the year as a whole, I'm once again reminded how proud I am of the teams across Heartland in each of our member banks. We have demonstrated our commitment to serving our customers and communities while prioritizing the health and safety of our employees. It's their strength and resiliency that allowed us to endure challenges and positioned us for growth in 2021 and beyond. I have said throughout the pandemic that Heartland would emerge stronger than before, and we're doing just that. We continue to drive down costs through disciplined execution of strategic initiatives, improved processes, and by leveraging scale. We completed two acquisitions that further diversified our assets and increased our presence in important growth markets of Phoenix and West Texas.

[Bryan McKeag:]

Thanks, Bruce, and good afternoon. I'll begin today with an overview of earnings per share, which was reported at $0.98 this quarter. This quarter includes three significant items. First, a provision for credit losses of 11.9 million was recorded for purchased non-credit deteriorated commonly called non-PCD loans and unfunded loan commitments acquired in the AimBank and Johnson branch transactions. Second, acquisition and integration costs of 2.2 million were incurred related to these acquisitions. And third, we recorded 4.6 million of additional fee income in conjunction with the forgiveness of approximately 20% of our PPP loan balances during the quarter. Excluding these items, Heartland’s earnings per share would have been $0.20 higher or $1.18. So again, this quarter core earnings were strong. Before I go into my detailed comments, I want to remind you that our updated fourth quarter investor presentation is available in the IR section of our Web site. So I'll start my comments with the provision for credit losses, which totaled 17.1 million this quarter and includes the previously mentioned 11.9 million provision on non-PCD loans and unfunded commitments in our two acquisitions. The remaining 5.2 million of provision related to the legacy bank and reflects the following components. First, legacy loan balances, excluding PPP, in total declined 91 million and unfunded commitments declined 65 million in the fourth quarter. Second, we continue to have some legacy loan downgrades and had a small increase in reserves for non-accrual loans. Third, consensus economic forecasts continued to show modest improvement. However, the economic outlook factors and components used to develop the allowance were not changed, as it is Heartland’s assessment that a significant level of economic uncertainty remained at year end. And lastly, net charge-offs were minimal this quarter at 216,000. Heartland also booked a $12.3 million increase directly to the allowance for loan losses for the purchase credit deteriorated or again referred to as PCD loans in our two acquisitions. In total, all the items I just mentioned resulted in a reserve build of 29.2 million for the quarter that was primarily related to acquired loans. So at quarter end, the allowance for credit losses on loans was 131.6 million or 1.31% of total loans. And the allowance for credit losses on unfunded loan commitments was 15.3 million or 16 basis points of total loans. Together, these two allowances result in a total allowance for lending related credit losses of 146.9 million or 1.47% of total loans. When the PPP loan balances are excluded, the total allowance for lending related credit losses stands at 1.62% of loans. In addition, at year end, we had amortized purchase loan valuations on our balance sheet totaling 33.2 million or 37 basis points of total loans, excluding PPP. Moving to the rest of the balance sheet. Investments grew 1.2 billion this quarter, primarily due to acquisitions and now comprise 35% of assets with a tax equivalent yield of 2.38% with a duration of just under six years and generate 65 million of average monthly cash flow. Borrowings decreased 206 million to end the quarter at 625 million or 3.5% of assets. At year end, our banking network had approximately 4.1 billion of unused borrowing capacity. The tangible common equity ratio declined 22 basis points to 7.81% at year end. Excluding the 57 basis points decline from our two acquisitions, the ratio would have increased 35 basis points and remained well over 8%. Heartland’s regulatory capital ratios also remained strong with common equity Tier 1 at just over 10.9% and total risk based at just over 14.7%. So Heartland’s growing balance sheet continues to be strong and well positioned. Moving to the income statement. Net interest income totaled 132.6 million this quarter or 10.1 million higher than the prior quarter. The net interest margin on a tax equivalent basis this quarter was 3.55% or flat compared to last quarter, as a 16 basis points decline in investment yield was offset by 20 basis points increase in loan yield and a 4 basis point drop in net interest costs. The increase in loan yield was driven by the recognition of an additional 4.6 million of fees on PPP loan forgiveness, as I previously mentioned. This quarter, the net interest margin includes 10 basis points of purchase accounting accretion, which was unchanged from the prior quarter. In addition, we exited the year with approximately 19.3 million of unamortized PPP loan fees remaining on our books. Net interest income totaled 32.6 million for the quarter, up 1.4 million from last quarter, as the gain on sale of loans declined 1.8 million on lower seasonal mortgage loan activity, while total security gains increased 1.5 million compared to last quarter. In addition, service charges were $1 million higher this quarter, primarily reflecting one month of run rate from our new acquisitions. Shifting to non-interest expense. Non-interest expenses remained well managed, totaling 99.3 million this quarter, up 8.9 million largely due to our new acquisitions. When excluding acquisition, integration, restructuring and tax credit costs and asset gains and losses, Heartland’s core expenses increased $6 million to 92.6 million compared to 86.6 million last quarter. This increase primarily reflects one month of runway costs from our new acquisitions. The one specific expense line item I would mention is losses on assets which totaled 2.6 million this quarter and primarily relate to write downs on several branches as part of Heartland’s ongoing branch optimization program. As this program continues to progress, we may have additional branch write downs over the next several quarters. So as we exit 2020 and look ahead to 2021, we believe Hartland is well positioned to deliver strong results next year and we’ll provide the following comments regarding 2021. First, loan growth rate, ex PPP, is expected to be in the mid single digits with lower first half growth and then more robust growth in the back half. A modest deposit growth rate in the low single digits is expected with higher first half growth from government stimulus, and then some run off in the second half. The remaining round of PPP forgiveness will happen largely in the first half of 2021. The new round of PPP is yet to be determined. However, we're off to a good start, as Bruce mentioned. The NIM, ex PPP, will have some modest pressure. However, with higher fee income continuing on PPP forgiveness in the first half and higher purchase accounting accretion, net interest margin is projected to be slightly under the current all-in TA rate, tax adjusted rate that is and be in the 3.5% range for next year. Provision for credit losses are not expected to exceed 35 million, assuming a firming economy in the second half of 2021. Mortgage banking income is expected to decline by 15% year-over-year. Deposits and service fees are expected to increase over 20% next year due to recent acquisitions and the recovery from a poor first half in 2020. Wealth and brokerage fees are expected to show mid single digit percentage growth. Core expenses are expected to increase to $104 million to $105 million next quarter, reflecting the full quarter of our new acquisitions. And then conversion and all cost saves realized in the second quarter will fall to the $102 million to $103 million range and then settle into the $101 million range thereafter. On a full year basis, we expect the efficiency ratio to be in the 56% to 57% range. AimBank integration and conversion costs are expected to be 2 million to 2.5 million in Q1 2021. And we believe a 22% tax rate is a reasonable full year run rate, assuming no tax law changes from the new administration in DC. Lastly, we expect our TCE ratio to climb back above 8%, as we get about 20 to 30 basis points of increase per quarter. However, the new round of PPP loans may weigh on the ratio during the first half of 2021. With that, I'll turn the call back over to Bruce.

[Bruce Lee:]

Thank you, Bryan. Valerie, let's open up the lines for questions now.

[Operator:]

Thank you. . Our first question comes from Jeff Rulis of D.A. Davidson. Your line is open.

[Jeff Rulis:]

Thanks. Good afternoon.

[Bruce Lee:]

Hi, Jeff.

[Bryan McKeag:]

Hi, Jeff.

[Jeff Rulis:]

A question just on the non-accrual, NPAs in general. If you could just kind of break out what the increase in non-accrual and OREO linked quarter what was legacy, what was acquired?

[Bruce Lee:]

Nathan, you want to answer that first and then Bryan maybe follow up.

[Nathan Jones:]

Yes, absolutely. Largely looking at the non-accruals, it was actually if we look at it from an NPL standpoint, we actually had a reduction from a legacy Heartland perspective of almost $4.5 million. So when you actually take them together, what we really saw was the overall increase that you're seeing today, which is a little bit closer to just north of 7. So really, it's a positive story overall as we continue to work with our customers, especially given some of the headwinds we’re all facing today. As Bruce said, we're very optimistic or cautiously optimistic about the credit performance and continue to remain so as we look forward. Bryan, would you like to add some additional clarity on to some of those numbers as well?

[Bryan McKeag:]

No, I think you got them pretty close. I would just say there's a table on page, at least 17 on my printout of our press release tables that can help you out, Jeff. But basically it shows that our non-performers went up about $9 million and we acquired almost 13 million in our acquisitions. So that's what Nathan was saying. Had we not had the acquisition, our non-performers would have actually gone down.

[Jeff Rulis:]

Great. Just hadn't had time to look at the table. Thanks. Maybe just an overview on capital then, saw the dividend increase. You've got these deals working. I guess and I got your comments on TCE probably looking to preserve that in the short run. But just thoughts on, I heard about the M&A pipeline, but what do we look for in '21 in all types of capital from M&A I guess you should be set on dividend, any thoughts on buyback? Thanks.

[Bruce Lee:]

Bryan, you want to kind of walk through that, explain how we plan to build the capital back up through earnings?

[Bryan McKeag:]

Yes. I think, Jeff, you had it pretty much right. We’ll grow back up, as I said, through 8.5% just with earnings projected for next year in the balance sheet growth that we have projected. Now that excludes any acquisitions. And with acquisitions, we typically -- we'll issue stock as part of that. So, I think you might see in the first half of the year, things will be a little bit tighter, especially if we do this next round of PPP. So our TCE could stay relatively flat and then really kind of move up in the last half of the year. Earnings -- our payout ratio right now at $0.22 per share is right around 20% of earnings, give or take a little bit. So, we'll see how earnings go as to whether we could increase that some more. We'll see how M&A goes to see how we need to utilize that capital. And right now, we don't see any share buybacks in the near horizon, but we'll see how things progress.

[Jeff Rulis:]

Okay. And one last one for you, Bryan, while I got you. I didn't hear a total non-interest income. I think you piecemealed it, but is there a run rate with kind of all-in acquired loans which you’re looking for in the first quarter of the non-interest income?

[Bryan McKeag:]

Yes. I think – I’ll just shuffle a piece of paper here. If you kind of look at the course, so if you back out the gains and losses, I think the core is about 30 million which really is about the same as what it was reported before. So we've been running about 30 million of non-interest income. Two more months of Aim and Johnson should add about 2 million, but probably see a little bit of seasonality. So I'd probably say -- in the first quarter, I would say probably be somewhere in that 31 million to 32 million. And then you'd probably come up with some seasonality and better mortgage fees coming through, probably up to 32 or 33 as you go across the mid quarters back down to 30 or something like that.

[Jeff Rulis:]

Okay, that’s helpful. And you said mortgage for the full year down 15% year-over-year, but just try to bake in that seasonality.

[Bryan McKeag:]

Yes. I would say kind of last year and kind of maybe drop them all above that 15, you’d probably get about the right seasonality.

[Jeff Rulis:]

Great. I’ll step back. Thank you.

[Operator:]

Thank you. Our next question comes from Andrew Liesch of Piper Sandler. Your line is open.

[Andrew Liesch:]

Hi, everyone. Good afternoon.

[Bruce Lee:]

Hi, Andrew.

[Andrew Liesch:]

I just want to touch base on the loan growth forecasts. I know in recent years growing organically has been a little bit challenging. Some of that's been by design though. What gives you confidence, what are your borrowers telling you right now that give you confidence that you will hit mid single digit growth this year?

[Bruce Lee:]

Yes, I'll take that one. This is Bruce. Our pipelines are reflecting that there's significantly increased activity. We did get organic growth in the fourth quarter in the commercial portfolio. We also are running and focusing on the consumer portfolio. So we don't think that we're going to run into those headwinds. And our applications during the first quarter would reflect organic growth in the consumer portfolio. So we think between what we have in our pipelines and quite frankly in the last six months, we've hired new commercial leaders in four of our 11 markets, and that is also boosting some of the pipeline activity. So between additions of talent for getting away from or learning to call in the COVID world, our pipelines are filling up.

[Andrew Liesch:]

Got it. That’s good to hear. Bryan, just on your margin outlook, what does that assume for I guess liquidity there? That can be such a wildcard and a driver of it. I guess what's the right average earning asset types we're using? What are you guys seeing for deposit flows? And how large of a balance sheet we should be looking at?

[Bryan McKeag:]

Yes, I think the balance sheet will go up a little bit. But remember, there's PPP in there that will be paying off and then some will come back on. So it's really, I would say, a slightly growing budget here real quick, but I think we're up for net of -- I would say we're going to probably be up 200,000, 300,000, just 100 million just on overall assets. But again, there's going to be lots of churning, right, because we've got flow coming off of the investment portfolio that we'd like to turn into loans, rather than just grow the balance sheet. So I don't know that you're going to have a hugely larger balance sheet than we have today, but hopefully a better mix of earning assets to kind of help the NIM.

[Andrew Liesch:]

Got it. Okay, that's helpful. I'll step back. Thanks.

[Operator:]

Thank you. Our next question comes from Terry McEvoy of Stephens. Your line is open.

[Terry McEvoy:]

Good evening, everyone.

[Bruce Lee:]

Hi, Terry.

[Bryan McKeag:]

Hi, Terry.

[Terry McEvoy:]

If I just look at Heartland’s stock, it's up 50% almost exactly since the end of September. And my question is, what are pricing expectations for banks that are $1 billion to $3 billion of assets that kind of fit that criteria? Have pricing expectations kind of corresponded with publicly traded bank stocks?

[Bruce Lee:]

Terry, I would say they have moved up. It was pretty tough going there when we were at our lows. But I do believe people are starting to say, if you're trading at X times earnings and X times tangible book, then can't we expect something in that range or better?

[Terry McEvoy:]

Thank you. And, Bryan, just want to clarify. The margin guidance of 350, that incorporates the remaining PPP fees from round one as well as a step up in anticipated accretion from the deals that closed in the fourth quarter?

[Bryan McKeag:]

Correct. Yes. It wouldn't have any PPP too, because I'm not sure what that is yet. So that's correct.

[Terry McEvoy:]

Okay. And then just last question here. In the press release that your charge-offs could be elevated given that they were just 1 basis point here in the fourth quarter. Any thoughts on charge-offs? I know, Bryan, you talked about the provisions, but the elevated I don't want to say it scared me, but it caught my eye as I read the release.

[Bruce Lee:]

Nathan, you want to comment on that?

[Nathan Jones:]

Yes. As we continue to work with our customers and really look at the cycle of kind of what's coming, we do realize and certainly our allowance has been elevated to account for that. We've maintained a very conservative approach. But I don't know if the word elevate is probably being used in the right term here. We're really just looking at it from a perspective of where it has been. And just looking at over the next year and thinking it's probably going to stay more in that range. I think the guidance Bryan gave earlier was really around at $35 million. So seeing it elevated from this last quarter I think again next year, I think it's appropriate to probably look as that range. Bryan, is there anything you'd like to add as far as additional color there as far as what you gave as far as guidance?

[Bryan McKeag:]

Yes. I think what I probably would say, Terry, is we had I think 32 basis points for the full year this year, but it was real choppy. I think you're going to continue to see choppiness. And hopefully, it will be better but you could see it pop up into that range again. A lot of that though I think if we've done our -- if we've done our reserving correctly under CECL, we have a lot of that already reserved for and how we've already got some economic components in there. We've been picking up the downgrades as those have been happening. So if those do end up in charge-offs, we've been increasing the reserve as we go. So we could see some elevated. I think it's hard to say that they wouldn't go up given that we're not out of the pandemic yet and we only had the 1 basis point this last quarter.

[Bruce Lee:]

And, Terry, how I would maybe frame it, it's going to be elevated from historical levels in that sort of 10 basis point range. Clearly, 1 basis point was outstanding and we're very pleased with that in the fourth quarter. But we think it's going to be elevated from historical levels, probably a lot closer to the 30 to 35 basis points for the year going forward if we had to give you specific guidance.

[Terry McEvoy:]

Great. I appreciate that. Thank you.

[Bryan McKeag:]

I think the key there, Terry, is that we've already provided for it. So even though we have the net charge-offs that are a bit elevated over historic levels, we're not going to have to be providing for it. It's already in the reserves.

[Terry McEvoy:]

Thanks.

[Operator:]

Thank you. . We have a question from Damon DelMonte of KBW. Your line is open.

[Damon DelMonte:]

Hi. Good afternoon, guys. Hope everybody's doing well these days. A lot of my questions have been asked and answered. But just maybe broadly speaking on the outlook for M&A, do you feel like the dialogue with potential targets has been increasing? And is it reasonable to expect one or maybe two deals that could be announced here in 2021?

[Bruce Lee:]

Yes, Damon, I would think that you could expect maybe two deals announced that we would only have the Aim conversion, which is going to take place mid February, and then we'd probably -- anything else would be converted in the third quarter. We might have two announcements, but we'd probably push out the next announcement into the first quarter of 2022. We have a number of Tier 1, Tier 2 projects that we need to get done. So I would expect only two conversions this year. The AimBank conversion and maybe one additional one, but you may hear about another opportunity announced. There’s still a pretty active group of prospects that we're working with right now. So, you never know if you're going to get them or not. But there are some active opportunities that we're working on right now. And some of them have advanced in time. One very nice acquisition we thought would be maybe coming around in the second half of this year, and it seems to be advancing into the first half of this year now.

[Damon DelMonte:]

Got it. And with respect to geographic focus, is one area of the footprint more attractive these days and present better opportunities than others?

[Bruce Lee:]

Well, we actually have relationships across all of our markets as well as new markets. But as I've said in the past, we really are focused on in-market transactions. They provide greater synergies and they give us more market dominance in the markets we're in. So the one we're working on right now is Midwest and the other one that I was talking about or other two would be out West.

[Damon DelMonte:]

Great. Very helpful. Thank you very much.

[Operator:]

Thank you. . I’m showing no further questions at this time. I will turn the call back over to Mr. Lee for his closing remarks.

[Bruce Lee:]

Thank you, Valerie. In closing, Hartland is well positioned for growth. It has strong momentum. We begin 2021 with a balance sheet that grew 4.7 billion in the previous year. Net interest margin is in the 3.5% range thanks to our disciplined deposit pricing. Our credit profile is stable. We've consistently lowered our credit costs to deliver our products and services. We expect ongoing benefits from Operation Customer Compass. We continue to invest in technology and improve our processes to enhance the customer experience. We continue to invest in talent that will drive growth and recently added new commercial leaders at four of our member banks. We will generate mid single digit organic loan growth in 2021. We’ll maintain an efficiency ratio below 57. We expect additional revenue and customer relationships from the second draw of PPP. We anticipate 40.5 million of net income in 2021 from the two acquisitions we closed in December. And we continue to have a deep pipeline of attractive M&A prospects with a number of active opportunities. We're moving forward in 2021. We are stronger, we're more nimble and together, we are Heartland. Thank you for joining us today. Our next quarterly conference call is scheduled for Monday, April 26. Have a great evening.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. Thank you for participating. You may now disconnect. Have a great day.