Nbt Bancorp Inc Q3 FY2021 Earnings Call

Good day, everyone. Welcome to the NBT Bancorp Third Quarter 2021 Financial Results Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC's Regulation FD. Corresponding presentation slides can be found on the company's website at nbtbancorp.com. Before the call begins, NBT's management would like to remind listeners that as note one, slide two, 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. Instructions will follow at that time. As a reminder, this call is being recorded. I would now like to turn the conference over to NBT Bancorp's President and CEO, John H. Watt Jr. for his opening remarks. Mr. Watt, please begin.

Good morning and thank you for participating in our earnings call, covering NBT Bancorp's year-to-date and third quarter 2021 results. Joining me today are NBT's Chief Financial Officer, Scott Kingsley; our Chief Accounting Officer, Annette Burns; and our Treasurer, Joe Ondesko. At NBT, we continue to experience momentum across the markets we serve and a business climate that is generally vibrant, although not without pockets of volatility, despite the ongoing impact of COVID. The headline for today is that we are pleased to report earnings per share of $0.86 for the third quarter, which is a consistent and productive result. Our team increased commercial and consumer loans with growth of 2% on a linked-quarter basis, excluding PPP, and we managed our total cost of deposits down to 10 basis points. At the end of the third quarter, the commercial pipeline and the customer acceptance and moving to closing stages was over $300 million. This pipeline covers our seven-state banking platform. Credit quality remains strong, as nonperforming and criticized assets both declined in the quarter. Our balance sheet is also strong and our ability to generate capital is robust, with tangible book value per share growing nearly 10% since the third quarter of 2020. The strength of our balance sheet continues to provide optionality to consider the opportunistic and strategic deployment of our capital. With non-interest income to total revenue at 34%, our diversified fee-based businesses had a great quarter. AUM and AUA was $9.7 billion at the end of the quarter. Across our New England footprint, we are advancing our organic growth strategy by leveraging the market disruption occurring in that region. We have hired both customer-facing bankers and team members focused on operations and support. We have also started to convert customers and believe we are at the front end of a multi-year growth strategy. In August, we welcomed Ruth Mahoney to NBT and our executive management team, as the President of Wealth Management. Ruth has more than 30 years of experience in wealth management, private banking, retail banking, and regional leadership. She joins us after many years as a senior banker at KeyCorp in New York's capital region. We're fortunate to have Ruth on our management team. To walk you through the detail on our third quarter financial performance, I will now turn the call over to Scott. And following his remarks, we'll take your questions. Scott, over to you.

Thank you, John. Turning to slide four. Our third quarter earnings per share were $0.86. These results were driven by favorable credit metrics and strong fee income. We recorded a negative provision of $3.3 million in the quarter. Charge-offs remained very low at 11 basis points. Our reserve coverage decreased to 1.28%, excluding PPP loans, from 1.38% at the end of the second quarter of 2021. Overall, we continue to be pleased with our underlying operating performance. Slide five shows trends in outstanding loans. On a core basis, excluding PPP, loans were up approximately $132 million for the quarter, or 1.8%. As John suggested earlier, commercial activity has steadily improved and we continue to have good momentum in several of our businesses. Commercial line utilization remains a headwind but new originations have been good. The lack of vehicle inventories has continued to challenge net results in our indirect auto portfolio, and we experienced a decline in outstandings for the fifth consecutive quarter. Also as a reminder, we have additional information on PPP lending on slide 13 in the appendix of today's presentation. Our total PPP balances are now around $276 million with forgiveness well underway for both the 2020 and 2021 vintage loans. We have recognized $21.1 million in total fees associated with PPP lending and we have $10.7 million in unamortized fees remaining. We expect a significant portion of these to be recognized later this year. Moving to slide six, deposits were up $410 million for the quarter as seasonally expected with our demand deposits up $165 million. Customer balances remained elevated from liquidity associated with various government support programs. Our quarterly cost of deposits declined to 10 basis points and we continue to add new accounts. Next on slide seven, you'll see the detailed changes in our net interest income and margin. Net interest income dollars decreased $1.5 million as compared to the second quarter, related entirely to lower PPP forgiveness. The net interest margin was down 12 basis points with compression in asset yields partially offset by lower funding costs. Excess liquidity net of PPP activity continued to be a drag on our margin, but we again remind ourselves that low-cost core funding should always be viewed as a long-term value driver. Looking forward as assets continue to reprice in a low rate environment, we would expect to continue to see some additional core margin pressure. As such, as we deploy liquidity into more productive earning assets over the next several quarters, we are striving to achieve stability in core net interest income results. Slide eight shows trends in non-interest income. Excluding securities gains and losses, our fee income was up linked quarter to $40.4 million or 2.6%. More broadly, non-spread revenue was 34% of our total revenue which remains a key strength for NBT and we're pleased with the trajectory of each of the nonbanking businesses we're in and continue to believe they are all investable. Retail banking fees were up linked quarter due mostly to higher card-related activities. Wealth and retirement plan administration fees had another strong quarter on new business wins and market appreciation. Turning to non-interest expense on slide nine, our total operating expenses were $72.9 million for the quarter, and we continued to demonstrate effective cost awareness. We did incur an additional $2.3 million of non-recurring costs in the quarter related to an estimated litigation settlement. We'd expect core operating expense to drift modestly upward over the next several quarters. On slide 10, we provide an overview of key asset quality metrics. Excluding the impact of PPP, net charge-offs remained lower than historical norms at 12 basis points. Both NPLs and NPAs declined this quarter. Observed credit metrics have been much better than what would have been suggested by the CECL models at this time last year. On slide 11, we provide a walk forward of our reserve. Clearly the economic outlook continues to improve, but uncertainty remains elevated. Excluding PPP, our allowance to loans ratio was 128 basis points, an appropriately conservative estimate of the credit risk in our portfolio today. We continue to believe that the path of charge-off activity will return to more historical norms and along with expected balance sheet growth will likely be the drivers of future provisioning needs. As I wrap up my prepared comments, some closing thoughts. We started 2021 on strong footing and we are pleased with the fundamental results of the first nine months of the year. Stable net interest income, good results from our recurring fee income lines, sustained expense discipline, and exceptional credit quality outcomes have been clear highlights. It's also worth mentioning that we've added over $121 million to capital over these last historically challenging seven quarters; while at the same time paying dividends to our shareholders of $82.8 million and buying back $22.1 million of our own shares. These meaningful capital accumulation results put us in an enviable position as we consider growth opportunities for 2022 and beyond. With that, we're happy to answer any questions you may have at this time.

Our first question comes from Alex Twerdahl with Piper Sandler. Your line is open.

Hey, good morning, guys.

Good morning, Alex.

Good morning, Alex.

First off I wanted to start with the loan growth outlook. John, in your prepared remarks the $300 million pipeline. That's certainly very helpful. Just wondering if you could give us a little bit more color on expectations into next year. Are you seeing in terms of that pipeline is there some backlog and some catch-up there, or is it to build which geographies are the strongest? Things like that.

Sure. I'll talk a little bit about the environment and maybe Scott will supplement after that. Across the platform, we see both on the CRE front and in C&I lots of activity. I can think of on the C&I side in Central New York and over in Massachusetts manufacturers looking to invest in their plant and equipment, expand their production lines and we're actively engaged in supporting them to do that. Multifamily still in the tertiary cities that we serve is active and the vacancy rates in those cities are very low. Demand is still high. So we're supporting our Tier 1 developers across the platform there. There's a little lumpiness maybe in some of the pipeline associated with construction loans that we will syndicate once we close. So that will lower the hold to NBT at the closing table. So I wouldn't call it a backlog or pent-up demand, Alex, I'd just call it continued momentum going into next year for the obvious reasons. In the last 30 years, it's never been an environment where you could access capital at the levels and rates that are available today, and that's a function of excess liquidity on the balance sheets of all the banks. So obviously, we're trying to manage the yield, and sometimes it's hand-to-hand combat competitively to make sure that we're achieving the return that's appropriate for us on each individual loan. But it's active in various sectors across the whole platform.

Alex, it's Scott. I'll share a few comments by line of business as you requested. On the commercial side, generally, the balances are flat. However, remember that this group of customers has substantial deposit balances and cash on hand, resulting in a very strong balance sheet. Therefore, if they have significant capital expenditure or business expansion needs, many already have that liquidity available. John mentioned commercial real estate, and it seems we're witnessing more robust activity in Southern Maine and Southern New Hampshire compared to some of the older markets of NBT. Overall, the activity is strong, with no particular areas showing weakness. The residential real estate sector should continue to perform well for us. It appears to be an excellent time for consumers to take out home equity loans, but many seem to be opting for residential real estate mortgages because of the low rates; there’s little reason to take risks when such favorable rates are available. The indirect auto sector has been interesting for us, primarily focusing on autos, as we do not deal much with recreational vehicles or snowmobiles. The dealer inventory shortage has affected our ability to achieve a consistent flow of contracts as we had hoped during this part of the cycle. I’m uncertain whether we've hit the bottom in terms of outstanding numbers, and we might need another quarter or two to see how it evolves. Generally, we’re not forecasting significant growth in that area for the upcoming quarters, but we would like to see improvement. Our dealer mix remains unchanged, and everyone we work with continues to be engaged. Specialty lending, particularly in solar lending, has been a bright spot along with other platforms we participate in, which we find promising since we control the credit parameters. Our partners are utilizing our credit strategies, so the assets we are adding to our balance sheet are ones we favor and see potential in. In summary, mid-single-digit growth rates seem appropriate at this time, and if we discover additional opportunities in our incremental markets, it may even be slightly better than that.

Great. And just I had two follow-up questions on that. First, on the specialty lending. Is there some seasonality in there? It seems like the third quarter was particularly strong there?

Yes. The third quarter was robust for specialty lending, possibly the only area where we observed some seasonality in demand. As you know, technology-enabled assisted lending is gaining traction, and our version of that is functioning more in real-time. For instance, when it comes to solar loans, we aim to persuade many customers to consider a home equity loan, which would align better with their long-term needs. However, the process for solar lending is so straightforward, and the yields are somewhat higher, so we are satisfied with this outcome. Additionally, the installer base for residential solar projects appreciates the existing platform. Therefore, we can anticipate continued growth in this area.

Great. And then I guess the other thing that we've talked about in the past is the paydowns. So obviously in this rate environment, it's been a decent headwind. Do you have any sort of line of sight into larger paydowns that could be coming up in the fourth quarter?

Yes. There are a couple and John feel free to chime in. But there are certainly a couple of larger ones that we're preparing for. It's interesting. I don't know that we've seen the borrower pay down and utilize their excess liquidity as often as we maybe would have expected in the cycle. I think generally our borrower base is sort of generally conservative in nature. So kind of much like our balance sheet they're hoarding some cash. But what we have seen is a little bit of churn in the portfolio. And we have seen the existence of certain either government-sponsored programs where the customer has been able to go to a government program and get a better outcome than they can get from us. And a couple of instances of nonbanking investors, insurance-related enterprises. More episodic than systematic at this point in time, but at the same point in time, existing.

Okay. Great. That's helpful color. And then just the other question I wanted to just kind of hone in on is, we've seen a little bit of modest pickup in merger activity within your markets. And I was just hoping that you can remind us in terms of NBT's appetite for M&A in terms of both geography size and then just the appetite from a financial standpoint?

Well, thanks for that question. And we've had this dialogue going on now for a couple of years, Alex, as you know, this company has been successful for a long time leading with its organic growth strategies and expansion markets right now. Those expansion markets are in New England. But we've always said that if we were to meet a complementary partner who would help advance and accelerate our strategic plans in those expansion markets that we'd like to form a partnership there. And it's a function of cultural alignment. It's a function of integration ease. It's a function of how on a contiguous basis we can accelerate our expansion. Scott said it earlier, we have lots of optionality right now, plenty of capital. There is activity across our markets as you suggest. I would suspect that some of those potential partners are slugging it out through their budget process right now, and thinking about what their options are and thinking about whether scale could be a solution to what is a difficult interest rate environment for the next year and also thinking about what our technology platform might be able to add to their customer base. So those dialogues continue. They are in New England contiguously in Pennsylvania perhaps and Western New York State selectively. But like I said, we win on organic growth and we're not looking to do financial engineering. We're looking for long-term strategic value for our shareholders by doing a deal that accelerates what we otherwise would be doing on our own. So we'll see what happens. But we're in a good position to field all calls and make a lot of calls and we'll see where that takes us.

And then just in terms of the size that you'd be willing to contemplate. Would it be the $0.5 billion to $5 billion in terms of assets, or how would we frame how you would even what you'd consider digestible?

That's a great floor and a great ceiling there. It's $0.5 billion up to $4 billion, $5 billion in that range. I think they're digestible depending on who the partner is, depending on what their lines of business are, how complementary they are. And how aligned we are. But I think that's a good range, Alex.

And then I guess just not to beat the dead horse here, but historically NBT has really grown organically in the wake of other M&A in some of your geographies. And then the acquisitions that you've done have really been to dive into a geography where you've got really nothing going on, or very little going on you can really accelerate that growth very quickly. Is that how we should think about a deal that if it was a new market where you didn't have much of a presence, M&A would be much more likely than in a market where you already have some existing infrastructure?

So I might choose a little different words there. But what I would say is, could we advance our strategic growth by being vertically deeper in certain of the markets where we are with loan production offices and more limited product offerings? Absolutely. And there are plenty of opportunities within those geographies where we already are to vertically go deeper and expand our presence, our brand recognition, the product offering, retail, commercial, wealth, insurance. So all of that’s quite possible. And continuously we're comfortable with the dynamics of those markets. I could see us taking a step with a manageable size, meeting all the criteria I previously laid out, to have a conversation and see whether that's possible. So that's how we think about it.

Thank you for taking my questions.

Hey, thank you. Good to talk to you.

Our next question comes from Eric Zwick with Boenning and Scattergood. Your line is open.

Thank you. Good morning, guys.

Good morning, Eric.

I wondered if I could start, maybe, John, your comments on leveraging market disruption in your northeast market. And you mentioned I think you've hired some customer-facing employees, as well as some office support. Curious, have you added any lenders, or do you have an appetite to add any commercial lenders in any of your markets? And then, what the kind of level of competition for talent is today?

Hey. I appreciate that question. And it has been very active in New England across the five-state platform. So we have hired customer-facing, primarily commercial lending officers, but also mortgage loan officers as well in Maine, New Hampshire, Vermont, Massachusetts, Connecticut. In addition, we've had the opportunity to supplement what goes on in the support units of our company by hiring folks who perceive that they may not be part of a long-term combined strategy with one of those large acquisitions that's going on. So we've invited onto our team up in Burlington, Vermont, several folks who are supporting the backroom. And skill sets there match what we otherwise were in the market for. So we're being opportunistic about it. There is a pipeline of folks that we'll continue to have dialogue with. And as I suggested in my comments, this is a multi-year strategy, and we'll be at this for months and years as we build on the opportunity that presents itself over time. As you know, in those large transactions, things happen in stages. And at each stage, the potential to meet a new partner or a new team member presents itself. And we're pretty good at knowing who's in the market and who might be willing to have those conversations, and we do that.

Thanks for that detail there. And then, Scott, you mentioned you expect expenses to drift modestly upward over the next several quarters. One, I guess, can you remind me when the annual merit increases are layered into your expense run rate? And also, just how you’d expect the outlook for higher inflation to potentially impact expense growth over the kind of near to midterm?

Sure, absolutely. Generally speaking, if you consider the third quarter as a baseline and exclude the nonrecurring charge, that's a reasonable baseline for where we are today. Merit increases for us occur in the mid-first quarter, specifically not right at the beginning of the year but certainly before March 1. We anticipate consistent mid-low single digit increases, around 3 percent, in costs related to merit, along with some need to retain our good employees if we find that we're not as effective in certain situations. While I don't see this as a major risk in many of our markets, it is a concern. Regarding other inflationary issues, our technology costs are manageable and largely determined. For most of our larger expenses, we're contractually obligated with both our core and peripheral systems. Generally, our fixed costs associated with our branching network are adequate, and we see some potential for additional opportunities, but customer traffic patterns may indicate the need for consolidation or rightsizing in the long run. Overall, I believe the third quarter serves as a strong starting point. It's reasonable to project salaries and benefits forward into 2022 at a rate of 3 to 4 percent and to anticipate slightly higher expenses in other areas because we expect increased engagement with our employees, more travel, and greater participation in outside educational meetings and customer-related activities, although nothing excessive.

That's helpful, thank you. Regarding the remaining PPP unamortized fees, I believe the balance is $10.5 million. You mentioned that a significant portion will be realized later this year. Should I think of it as potentially 50% or more in the fourth quarter, with the remainder in the early part of 2022? Is that the correct way to approach it?

It's the right way to think about it. Probably more than half in the fourth quarter. We've already had really noticeable activity on forgiveness here in the month of October. And so I think that's a good way to frame it. I also think that remembering that they won't all necessarily go away in just the first couple of quarters of the year. There are going to be those stray assets out there that will probably get into just an amortizing 1% loan. So, some of those will go a little bit longer. I don't think that will be a huge group for us but a little bit longer. But you'll probably see a little bit of PPP forgiveness and fee benefit in the first couple of quarters of the year. And then I think it would taper off to the point where it clearly will not be material to the outcome.

Great. Thank you so much for taking my questions today.

Thank you, Erik.

Thank you. And I'm showing no further questions. At this time, I would like to turn the call back to John Watt for his closing remarks.

Thank you. And in closing, I want to thank all of you for participating in our call and for your interest in NBT. And as always, Scott and I are available for any follow-up so please reach out. And as Scott suggested, in 2022, we look forward to seeing more of you in person as the ability to be out there and be safe presents itself. So, thank you everybody and have a great day.

Thank you, Mr. Watt. This concludes our program. You may now disconnect. Everyone, have a great day.