Nbt Bancorp Inc Q2 FY2020 Earnings Call

Good day everyone. Welcome to the NBT Bancorp Second Quarter 2020 Financial Results Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC’s Regulation FB. Corresponding presentation slides can be found on the company's website at nbtbancorp. Before the call begins, NBT’s management would like to remind listeners that as noted on Slide 2, today's presentation may contain forward-looking statements as defined by the Securities and Exchange Commission. Actual results may differ from those projected. In addition, certain non-GAAP measures will be discussed. Reconciliations for these numbers are contained within the appendix of today's presentation. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this call is being recorded. I would now like to turn the conference over to NBT Bancorp President and CEO, John H. Watt, Jr. for his opening remarks. Mr. Watt, please begin.

John Moran and our Chief Risk and Credit Officer, Amy Wiles, will join me to review the highlights for the quarter, after which we will take your questions. The second quarter was exceptional for NBT, our employees, customers, and communities. We focused on long-term strategies, ensuring that we remain operational and continue lending, supported by our strong balance sheet. Despite the challenges posed by the pandemic at the start of the quarter, NBT performed admirably as markets started to reopen, particularly those that are less densely populated, allowing us to resume activities in early May. During the quarter, we actively participated in the SBA’s Paycheck Protection Program, funding 3,000 loans to various customers, which helped preserve over 60,000 jobs. As a result of our involvement in the PPP, we surpassed the $10 billion threshold early in the quarter, something John Moran will discuss later. We cautiously reopened our branch lobbies in mid-June, maintaining an optimistic yet realistic approach as our team members prepare to return to our facilities, and we are confident in our IT infrastructure's resilience to support remote work. Additionally, on April 1, we completed the acquisition of Peoria-based ABG in our Retirement Plan Services Administration line to bolster that platform. Now, let me highlight some financial metrics for the quarter. Net income reached $24.7 million, or $0.56 per share, after accounting for a CECL provision and charge-offs. Our asset quality remains strong, and we will hear more details on that from Amy shortly. We also took advantage of market conditions to raise $100 million in subordinated debt in June, which has been largely transferred to the bank, providing us with maximum flexibility to pursue our strategies and capitalize on new opportunities. Our current capital ratios are available in the earnings report. Lastly, our board approved a $0.27 dividend, which will be payable on September 15, and they reaffirmed our dividend strategy for the remainder of the year, contingent on the economic impact of the virus in the upcoming months. With that, I will now turn it over to our Chief Financial Officer, John Moran, for more detailed insights on our second-quarter financial performance. John, the floor is yours.

Yeah, thanks, John. So following along, turning to Slide 4, as John highlighted, our second quarter GAAP earnings per share were $0.56. Gains were offset by $650,000 of real estate repositioning charges recognized down in the other line. Together, those items netted to about a $0.01 for the quarter putting core operating EPS at $0.57 per share. As you can see, the provision for loan losses, while down from first quarter level, did remain elevated as compared to 2019. Similar to the first quarter, our underlying operating performance continued to hold in very well. Pre-provision net revenue of nearly $51 million was 13% higher linked quarter, 8% higher year-over-year, and our PPNR return on average assets held fairly steady at just over 190 basis points. The results were driven by lower expenses and higher spread revenue on a larger balance sheet. We generated over 400 basis points of positive operating leverage year-over-year, and we demonstrated good expense flexibility during the quarter. Tangible book value per share was up 2.6% and our CET1 ratio improved 44 basis points as compared to the first quarter, underscoring that our strong PPNR generation provides a buffer for future provisioning needs. Turning to Slide 5, you can see trends in outstanding loans. End of period loans were up just over $380 million, that was driven by $510 million of net PPP loans. Excluding PPP, our core loans decreased $130 million or 2%, mostly on managed runoff in our indirect auto book. We also saw a decrease in commercial line utilization driven by excess client cash, as well as a handful of larger pay downs. Commercial activity has reset lower as compared to the robust levels that we experienced in last year’s fourth quarter and the first two months of this year. And you can see that slowdown reflected in our quarterly commercial originations, which decreased $20 million from the first quarter’s levels, excluding PPP. That said, we are continuing to see some early signs of increased activity and substantially all parts of our footprint continue to reopen more fully. As John pointed out, we do operate in markets that are less dense and relatively less COVID impacted compared to downstate Metro New York, and we're cautiously optimistic around the return to a new business as usual in the coming weeks and months. Shifting to loan yields, the full impact from the change in short-term rates can be seen in the relatively sharp decline in portfolio yields during the quarter and the gradual rollover of fixed-rate assets, which is obviously more sensitive to the belly of the curve would be expected to continue to pressure asset yields in the back half of the year. Moving to Slide 6, deposits stood at $8.8 billion, which was up nearly $1 billion point-to-point for the quarter. This increase came despite $135 million of run-off in the CD book. Non-interest bearing deposit growth was especially robust, up approximately $685 million from the prior quarter. Deposits were boosted by the increased liquidity associated with funding PPP loans, and various other government support programs. We have continued to actively manage our deposit costs, both in our exception price book and in standard rates. Those actions combined with the higher levels of demand deposits are evident in the decline in total deposit costs to a low 23 basis points. Looking only at the cost of interest-bearing deposits, we were able to drive a 50% decrease from first-quarter levels to 34 basis points. We continue to evaluate additional pricing adjustments and have some opportunities remaining in the back book around special pricing and CDs. Core deposit funding has obviously long been a hallmark of the NBT franchise, and we're really pleased with the results of our active repricing strategy, which has driven a meaningful reduction in deposit costs in a short period of time, while maintaining our client base. Next, on Slide 7, you'll see the detailed changes in our net interest income and margin. Earning assets increased during the quarter, driven by PPP loans and a meaningfully higher overnight cash position. As you'd expect, the net impact of these assets was margin diluted. Net interest income dollars were up despite 14 basis points of margin compression, and the net drag from excess cash and PPP was responsible for approximately half of that decrease with core underlying margin compression at approximately 7 basis points. The decline in asset yields was partially offset by lower funding costs. As you look to the third quarter, in addition to the asset yield dynamics previously discussed, we will remind you that our recent sub-debt issuance is expected to negatively impact quarterly margin by approximately 5 basis points over the near term. Slide 8 shows trends in non-interest income. Excluding modest securities gains and losses, our fee income decreased $1.4 million from last quarter and was stable from last year. More broadly, non-spread revenue remained 30% of our total revenue and continues to be another key strength for NBT as compared to peers. On retail banking fees, a slowdown in transactional velocity and higher cash balances resulted in notably lower service charges, although ATM and debit card fees demonstrated better resilience than we would have expected. The RPA line benefited from the first quarter of our recent ABG acquisition and new business pipelines for EPIC remain robust. Wealth was soft on market volatility and limited retail cross-sell via the in-store channel and insurance demonstrated typical second-quarter seasonality. Swap fees remained a strong contributor to the quarter. Turning to non-interest expense on Slide 9, excluding the $650,000 of real estate repositioning charges and other, our total operating expenses were just under $65 million for the quarter, down more than $5 million. As a reminder, last quarter was somewhat elevated due to the normal seasonality of the compensation line and we did have a $2 million increase in first quarter's other expense for unfunded commitments under CECL that was not repeated this quarter. Our net overhead ratio improved to a low 111 basis points, and while we're very pleased with that outcome, we continue to think through the appropriate level of operating expense as we adjust to the new economic reality of a COVID world. Over the last five years, we've consolidated 12 branches and realized several million dollars in cost savings while continuing to show growth in retail deposits. As client and associate behavior continues to evolve, we remain focused on opportunities to optimize both our retail and our corporate real estate portfolios. Consolidation of a handful of branches later this year is expected to result in slightly over $1 million in annual savings next year. On Slide 10, we provide an overview of key asset quality metrics. As you can see, we remained in very good shape this quarter. Excluding the impact of PPP, net charge-offs were 30 basis points, down from 32 basis points linked quarter. Favorable migration trends and non-performing loans were driven by the resolution of a single larger $4.2 million commercial credit that we had referenced last quarter. Both non-performing loans and non-performing assets have returned to year-end 2019 levels in dollar terms, and there continues to be only one relationship in the bank above a million dollars in non-performing status. We believe that the diversity and the granularity of our loan portfolios, our long-established track record of conservative underwriting, and the less dense nature of our upstate New York and New England footprint should help us weather the current environment better than most. On Slide 11, we provide a walk forward of our second-quarter reserve build and the reserve allocation by loan category. A full reconciliation of our allowance from year-end 2019 is provided in the appendix of today's presentation. Loan loss provision was $19 million for the quarter, which took reserves to just under 150 basis points of period and non-PPP loans. That's an increase of 21 basis points linked quarter, and it's up 57 basis points from the end of the year. A quick word on the CECL models themselves; the key macroeconomic variables used were derived from the Moody's June baseline forecast. I think everybody on the line is probably familiar with what's in that forecast at this point. I would just kind of point out there is still a great deal of uncertainty around the path of the economy, the ultimate path of the pandemic, and future government actions, but the model assumptions are now fairly well-aligned with the observed economic reality. If the current outlook more or less holds, we would expect that the path of charge-off activity and our balance sheet growth will be the heavier factors in future provisioning needs versus model-driven reserve build, per se. Lastly, before we turn it over to Amy on the credit side, I'll just provide some quick updated thoughts around the $10 billion cross. Obviously, total assets finished the quarter closer to $11 billion than they did to $10 billion. And while we continue to maintain significant liquidity and flexibility on the asset side of the balance sheet, our optionality on the right-hand side has become more constrained, given unprecedented levels of deposit inflows. We now expect to remain above $10 billion at year-end. Because we've prepared for this over the course of many years, we would not expect any material increase in operating expense as a result. However, as a reminder, we will absorb a 50% reduction in Durban-related revenue, which works out to approximately $5 million pre-tax in the back half of next year and approximately $10 million on a full-year basis beginning in 2022. PPP lending fees are clearly going to be a meaningful offset and are expected to accelerate later this year, and into next. Additionally, natural growth in transactions and the shift from cash could reasonably be expected to provide a partial offset. Finally, we intend to deploy excess cash into more productive earning assets over the next year. We will continue to evaluate fee-based acquisition opportunities, and as the dust settles around credit, will look to re-engage more actively in selective whole bank M&A. With that, I'll turn it over to Amy Wiles, our Chief Credit and Risk Officer for some additional details on the credit fund. Amy?

Thank you, John. In terms of deferrals, we've been working very hard on these and we've seen significant progress. Our deferrals across all lines of business peaked in May, where we flattened the curve and rolled forward to today, we have seen over $475 million in customers returning to payment, or over a 40% reduction from peak. As of July 22, total deferrals stand at $622 million, or 8.8% of total loans, down from close to 15%. The reductions continue to trend downward and currently we're down to $608 million. We have reached 56% of initial loan deferral maturities, and we're seeing strong results with an average 74% returning to pay bank wide, which demonstrates strong resiliency. As you can see on the slide, we're seeing similar returns of paying all lines of business. This was a name by name effort with robust outreach from each of our lenders to their customers. We also worked to strengthen our positions where we could, and we were able to shift principal and interest deferrals from 55% of total deferrals to 39%, meaning 61% were principal only deferrals and have returned to paying interest. In our commercial businesses, those industries that did not return to pay requiring an additional 90-day deferral are centered in high-risk industries that are shown on the next slide. As we know, certain segments have been impacted to a greater degree than others, specifically hotels, restaurants, entertainment, healthcare, general retailers, and auto dealers. These industries have experienced a disproportionate impact. For us, the overall exposure to these industries remains low, overall at 9.6% of total loans. In terms of total deferrals, these industries represent $191 million or 31% of total deferrals and only 2.6% of total loans. Hotels are our largest exposure, with $88 million on deferral, representing 48% of our exposure to this industry on deferral, down from 69% at peak. We have seen improvement as the number of customers in our footprint have vacationed and driven to destination and are seeing high bookings closer to pre-COVID levels. Also, most of these sit in legacy markets with strong sponsors, season properties, low loan-to-value ratios, and strong debt service coverage. So while some will take longer to normalize operations, we have solid loan structures and strong performers pre-COVID. We've always had a conservative posture in underwriting these high-risk industries. Similarly, as you can see on the slide, we've seen progress in all of our higher risk sectors as things open up in the economy; the impact of PPP money and other fiscal stimulus have taken effect. Just a final thought, the nature of our footprint, our conservative lending policies, and our diversified portfolios help us with resiliency.

Thank you, John. Thank you, Amy. As we begin to take your questions, I want to make you aware that our Chief Accounting Officer, Annette Burns joins us; as does our Corporate Treasurer, Mark Mershon; and our Financial Planning and Analysis Manager, Bill Whitaker. Operator, I'll turn it back to you for questions.

Thank you. Our first question comes from Alex Twerdahl with Piper Sandler.

Good morning.

Good morning, Alex.

First question, appreciate your comments around the $10 billion threshold and crossing it and tending to stay above it, but correct me if I'm wrong, over the last couple of years, you guys have had some strategies in place to focus more on sort of more profitable lending areas, including things like the planned run-off of the auto portfolio, which is cited in the press release. Now that you're above $10 billion, did some of those strategies shift and potentially will allow for loan growth to pick-up a little bit more, obviously, once the environment normalizes?

So thanks, Alex. And you know, you're absolutely right. As you know, we were optimizing our performance last year and the prior year, knowing that we were in the $9 billion to $10 billion range, and growth in certain of our businesses was probably more muted than it needed to be as a function of making sure that we were prepared to cross. Now that we have crossed, as you know, we have a very diverse portfolio of businesses with opportunity to grow. That's a function of—in this rate environment—an analysis of what kind of yields we can squeeze out of those businesses and also the risk environment we're in, but I think you can expect to see that on the consumer side, in our mortgage business, and in our indirect auto business that will continue to allocate capital and grow. On the commercial side, you'll also see that we'll continue our growth in New England. We have opportunity in Connecticut. As you know, we've hired a team of bankers there that are ready to go and are coming out of the COVID crisis in Connecticut ready. We've also hired bankers in western Massachusetts, and we're seeing in our core markets, C&I opportunities presenting themselves as well. So, we feel pretty good about our ability to continue to organically grow. John talked about the capital raise and our ability to deploy that capital and pursue whole bank acquisition, as well as fee-based businesses. Anyone who's followed us knows that we're very disciplined about that, but when we determine to execute, we do execute. We think that there is opportunity there for us as well. So, I set it upfront, we plan for the long-term, we have a long-term strategy, we pull different levers at different times, and will continue to execute on that strategy and drive growth in an appropriate way for the environment we're in. So, thank you.

I appreciate that answer. Just as a quick follow-up, when you said M&A opportunities, and you guys have been good acquirers in the past, do you feel like you can do due diligence in this environment or do you have to wait for the next six months to sort of play out and see how the economy reopens or what happens with the pandemic, etc., before you can actually go into a bank and get really comfortable with its loan book?

So again, I think you're absolutely right. It's a little early to suggest that we have the opportunity to understand a potential partner deeply enough to come to a valuation that makes sense and understand all the risk, but that doesn't mean we can't be relationship building in the short term, and then after the storm passes, be in a position to execute and that's probably what will happen here. As we said in the past, we're more interested in smaller bite-sized opportunities. This is not an environment, nor do we have an interest in doing something transformational. Those smaller opportunities exist, and relationship building continues virtually as it is, and once the rain stops and it clears a little bit, we'll be able to get in and have more meaningful opportunities to understand the potential partner more deeply.

Perfect. Thank you for taking my questions.

Sure.

Thanks. Good morning, guys.

Good morning, Collyn.

Maybe if we could start, John Moran, on the OpEx discussion. Obviously, you know some improvement there this quarter. Kind of, how do you and you sort of alluded to it in your opening remarks, the potential there to always be looking at that. You guys have obviously consolidated branches in the past, but just trying to get a sense of maybe what you see as kind of the near-term OpEx trends and then longer-term maybe what—where you see potential levers to pull there?

Sure, yeah. Good morning, Collyn. Thanks for the question. So yeah, if you look at 2Q levels, obviously we benefited a little bit from two things; one is, there's some seasonality in 1Q, where 1Q tends to run a little bit high for us both on the compensation line and on the occupancy line because it gets cold and snows where we operate. So, we had a little bit of a tailwind coming into 2Q to begin with, and then, you know, shelter-in-place and some of the changes in operating model that we ran through, during a good chunk of May, you see some of those lines down more than they might otherwise have been. I think that will kind of normalize a little bit. So, I don't view 2Q in the very near term as a sustainable run rate. I think we'll have a little bit of lift as we get the branches more fully open and things return a little bit more to business as usual. We did say, you know, real estate repositioning charges—we've identified a handful of branches that we'll take a look at, and that should drive some savings into next year. I think longer-term; there could be an opportunity to address some of that. We operate with a somewhat greater branch density than peers. I think we've done a good job over time. It's sort of business as usual to continue to look at that network and figure out with changes in customer behavior, how many branches do we need, and where do we need them? And then I think the longer-term, sort of interesting, compelling opportunity on the corporate real estate side could materialize. We've sent 90% of the bank home, and things have gone pretty well. I think we've learned a lot from that experience. We'll revisit corporate real estate over time; that's probably a more three to five-year opportunity for us though.

Okay, okay. That's very helpful. And then just in terms of the liquidity situation here, as you had indicated, I mean, you guys dropped your funding costs to the floor. You know, you mentioned some maybe exception pricing you can do, but overall, it doesn't seem like there's nearly as much to do there, so managing that asset side is going to be key. How do you sort of see the liquidity deployment evolving? And again, sort of near-term and then longer-term there, which then ties into I guess, the question of where you see, you know, maybe organic loan growth going in the back half of the year, and then maybe if it normalizes next year?

Sure, yeah. So, on liquidity, you know, $1.2 billion of deposits have come into the bank from the end of last year. Certainly, when we drew up 2020, we wouldn't have imagined that. I think the interesting thing is that it shows no real sign of leaving, and so some portion of that will be really careful around because as PPP kind of winds down and those funds get spent. I think it's reasonable to expect that a portion of that ultimately leaves the bank, particularly in parts of the footprint where we don't have dominant market share. But in terms of redeployment opportunity, you know, securities are certainly an option, and that’d be 90 basis points to 100 basis points of yield pickup versus 10 basis points in cash. John did a good job alluding to some of the opportunities we see in front of us on the loan side. I’d agree that there are some levers left on the funding side, but there's not a ton of juice there. We've got $250 million in higher-cost CDs that'll roll off in the balance of this year. Those are 150 basis points or so today. I think the highest CD rate we pay in the bank is some 50 basis points today. We'll certainly pick up something there, but you know, the funding side, not as much juice there. As you think through asset yield, I think securities are every bit of 150 basis points lower, and then depending on the loans that we're putting on, those are kind of coming in with spreads that are a little bit below book yield today.

Okay. Okay, that's helpful. And then just also sort of tied to that, I know it's hard to project, but just for you, as you guys are looking at it internally for modeling and for us on this side, how should we think about the forgiveness schedule on the PPP loans, you think?

Yeah, you know, I think that'll start to—the SBA is opening up the portal here in a couple of weeks, early August. I think that'll start to clean up in Q3. I think we'll start to get more of that in Q4, but initially, we were thinking that most of that would be gone by the end of the year. I think under the way that the program has shifted a little bit, our expectations are that this drives larger amounts of total forgiveness, but it's going to stretch out a little longer than what we anticipated. We would think that, you know, a portion of that program stays with us over year-end, and then cleans up in Q1 and Q2.

Okay, that's great. And then my last question is for Amy, perhaps the hardest, but just to tie into your point, John is, you know, kind of your—as we think about the reserve, right, so future provisioning is going to be more about loan growth and charge-offs. So, Amy, what do you see today, right, and the deferral trends that you're seeing, which was great detail on those slides, thank you, any sense of where you think that, you know, net charge-offs could go in the next few quarters? I know there's so many uncertainties, but I guess just based on what you see in your book today, and kind of what you know about your borrowers, and maybe the stress testing you've done and kind of collateral test you've done, any range you could offer us there on that?

I'll speak to that a little bit. You know, maybe speak a little about how I think things are going to cycle through. You know, we will expect some increase in charge-offs in the second half of the year relative to the first half of the year. It'll cycle through first with our consumer businesses, and because of deferrals, our delinquencies and charge-offs were lower in the second quarter than normal. We expect an increase at the end of the deferral periods, which is largely by the end of Q3 and Q4. You know, we've been very encouraged by the high return-to-pay we've seen on the deferrals, particularly in the consumer book when you see where those are running in the 3% range overall. As the economy reopens and the stimulus money has had an effect, you know, that's kind of how we see it cycling on the consumer side, but the exact levels, you know, in terms of getting you a range are still so uncertain depending on employment levels and the conditions in the economy in Q3 and Q4. You know, on the commercial side, we see credit losses, similarly, higher, and you know, 2020 and 2019, which were, as you know, at various historical lows, but we see any potential losses there really cycling in late Q4 and into 2021. We do feel that we've identified what is most vulnerable so far, but it's really too early to determine a specific forecast so far. However, we are further ahead than we thought considering the deferrals.

Okay. That is helpful. I will leave it there. Thanks, everyone.

Our next question comes from Matthew Breese with Stephens Inc. Your line is open.

Good morning.

Good morning, Matt.

Hey, I thought it was notable on Page 11 that the commercial real estate reserve, you know next to other consumer is now the highest of all the buckets. I was hoping you could talk about the portfolio a little bit in terms of loan-to-values and debt service coverage ratios, and then especially within that the higher-risk categories, maybe provide the same metrics for hospitality and retail.

Sure, Matt. You know, in terms of the hotels, generally speaking, as I mentioned, we've got long-standing relationships. These are seasonable properties. So, the loan-to-values are low, typically having amortized down in the 50% range on average; of course, that varies across the portfolio. So, pre-COVID debt service coverage was very strong on these properties. Generally, within there, as I mentioned, it's really a mix of different property types. Some are seeing good performance and are within state that are drive-to and vacation properties. It's really the business side that are near the airports and support those customers. Coming in typically, we had guarantees where we could not in every case, but we had strong underwriting. We feel we're reasonably well-positioned there. On the commercial real estate retail side, that’s not a large component. You can see, I think, in the appendix that's 16% of non-owner-occupied commercial real estate, and we do track large tenants. Typically, what we see, as I mentioned, is that there are strip centers with essential businesses, home centers, gas stations, and convenience stores as the other area in terms of general retail on the C&I side where we have exposure. We’re in good shape. Typically, on the commercial real estate retail side, we have guarantees from strong sponsors, and we have essential businesses as anchors, such as pharmacies and grocery stores, which are showing good collection performance.

And then I just wanted to confirm, did you say that, you know, of the loans coming off deferral or reaching the end of their 90 days, 74% of those are returning to pay? Was that accurate?

Yes, that's an average across bank-wide, and what I said prior to that is that we're a little more than halfway through the first deferral period, at 56%. We're seeing an average of 74% returning to pay.

And just thinking about that 74%, as you look at the loans and the customers that require an additional 90 days, do you think that 74% is a good cure rate for the second batch as we get into the fall? Can you provide some of the puts and takes around that?

So, we're still working through the first deferral phase, and that will take us through, you know, August or so. I’m encouraged by what we've seen so far. We'll continue to monitor that. I don't want to forecast that, but we’d like to think things will continue in a similar vein. However, we’ll just see how that comes forward. Most of those sit in the high-risk or sensitive industries, and it really is a function of the reopening and the performance overall. Most are trending better than they were, but we'll have to see where we are at that time, and we’ll be able to come back and speak to that.

I appreciate that. That's all I had. Thank you.

Thanks, Matt.

I'm not showing any further questions. I will now turn the call back to John Watt for closing remarks.

Thank you operator. So, thank you all for participating in this reformatted earnings call. A little bit of life in the age of Corona here with our technology, but we’re used to that. I want to just finally state that 2020 obviously is going to be a very different year than we expected, but it's all about our team. It's risen to the challenge. It's there to support our customers, our communities, and importantly, to position NBT to take advantage of new opportunities as we discussed here. So we again appreciate your participation, and if there's any follow-up, you all know to reach out to John, one-on-one. Thanks, everybody. Be safe.

Thank you to everyone who participated in this conference call for your interest in NBT Bancorp. This concludes today's program. You may disconnect. Have a great day.