Nbt Bancorp Inc Q3 FY2022 Earnings Call

Good day, everyone and welcome to the NBT Bancorp Third Quarter 2022 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 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. 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.

Thank you, Tanya, and good morning and thank you for participating in this earnings call covering NBT Bancorp's third quarter 2022 results. Joining me this morning are NBT's Chief Financial Officer, Scott Kingsley, and our Chief Accounting Officer, Annette Burns. In an interest rate environment that is volatile and where economic and macroeconomic conditions are constantly changing, we are extremely pleased with our results for the third quarter of 2022, including earnings per share of $0.90, return on average assets at 1.3% and return on average tangible common equity landing at 17.1%. Let me take a moment to highlight activity in our business and in the markets we serve. We are excited to be in a position to support the commercial, retail banking and other financial service needs of the Central New York market as Micron Technology makes a transformational investment in this region. The announcement earlier this month that Micron will invest as much as $100 billion over the next 20 years to boost production of memory chips represents the largest private investment in New York state history. The new Upstate factory will create tens of thousands of jobs. Our franchise is uniquely positioned to play a role in the growth that is being created in the Upstate New York chip corridor running through our core markets from greater Syracuse to the Mohawk Valley in the capital district. Global foundries will speed and now Micron, all engaged in chip fabrication, have and will continue to generate growth. We're working hard to support our customers and the communities we serve, who will be the beneficiaries of that anticipated growth. As you will hear from Scott later this morning, we are actively and favorably managing our costs and deposits and cost of funds generally, while maintaining high levels of liquidity to fund further loan growth. We continue to enjoy success in our lending businesses with annualized loan growth of 9% through Q3. It's clear to us that our commercial and small business customers continue to successfully navigate the challenging operating environment in the face of supply chain issues, tight labor markets, and inflation. Our residential solar lending business had a strong quarter driven in part by the extension and increase in federal tax credits through the Inflation Reduction Act passed in early August. Our fee-based businesses reported solid results despite headwinds in the fixed income and equity markets. Although we are very mindful that the forward environment is likely to be volatile, we continue to observe a strong consumer. Balances in personal checking accounts have held steady in the quarter, and credit quality in the consumer loan portfolios is very healthy. Delinquency across all consumer loan categories is well below pre-pandemic levels. As we head into the last quarter of 2022, we are well-positioned with strong liquidity and capital levels, a diversified business mix, highly effective risk management practices, and a team of experienced professionals. So Scott, I'll turn to you for more detail on our performance in the third quarter. And after Scott's remarks, we'll take your questions.

Thank you, John, and good morning, everyone. Turning to the results overview on Page 4 of our earnings presentation. Our third quarter earnings per share were $0.90, which was up $0.04 from the $0.86 a share reported in the third quarter of 2021, and $0.02 a share higher than the linked second quarter of 2022. These results were achieved despite a $2.5 million decline in PPP income recognition compared to the third quarter of last year or $0.05, and a $1.0 million decline in PPP income from the second quarter of 2022, or $0.02 a share. The improvement in net interest income over the two comparative quarters was the result of solid organic loan growth, incremental deployment of a portion of our liquidity into investment securities, the continuation of historically low funding costs, and continued increases in the Federal Reserve's targeted Fed funds rate. We recorded a loan loss provision expense of $4.5 million in the third quarter, compared to a provision benefit of $3.3 million in the third quarter of 2021, or a $0.14 per share swing. Net charge-offs in the third quarter were $1.3 million or 7 basis points of loans, compared to 11 basis points of loans in the third quarter of 2021 and 4 basis points of net charge-offs in the linked second quarter. Our reserve coverage increased slightly to 1.22% of loans from 1.20% at the end of June, which provided for loan growth and some deterioration in economic forecasts. The next slide, Page 5, shows trends and outstanding loans. On a core basis, excluding PPP, loans were up $141 million for the quarter and included growth in both our consumer and commercial portfolios. Loan yields were up 25 basis points from the second quarter of 2022 reflective of higher yields on our variable rate portfolios as well as new higher volume rates. Our total loan portfolio of nearly $8 billion remains very well diversified and it's evenly balanced between consumer and commercial outstanding loans. Moving to the slide on deposits, we were down $110 million, or 1.1% from the end of the second quarter. During the quarter, we also introduced a short-term treasury product designed specifically for certain customers' excess liquidity that resulted in nearly $100 million of deposits moving off the balance sheet. Our quarterly cost of total deposits increased to 9 basis points compared to 7 basis points in the linked second quarter. Interest-bearing deposits moved up from 11 basis points to 14. The next slide looks at detailed changes in our net interest income and margin. Net interest income increased $16.8 million as compared to the third quarter of last year and was up $6.9 million from the second quarter of 2022, reflective of higher yields on earning assets. Reported third quarter net interest margin was 3.51%, up 30 basis points from the linked second quarter and 63 basis points higher than the third quarter of 2021. Looking forward with interest rates expected to continue to rise, the yields on our variable rate earning assets are expected to continue to move higher. We also expect to reinvest our loan and securities portfolio cash flows at levels above our current blended portfolio yields. Although we believe our deposit funding profile is best-in-class, we would expect increased levels of deposit beta in the fourth quarter and going forward. Our balance sheet still continues to be asset sensitive, and as such, we would expect to see incremental opportunities for additional core margin improvement for at least the next couple of quarters. The trends in noninterest income are summarized on Page 8. Excluding securities gains and losses, our fee income was down 8% from the third quarter of 2021 to $37.3 million and lower by $4.9 million from the linked second quarter. More broadly, non-spread revenue was 28% of our total revenue in the third quarter of 2022 and remains a key strength and value driver for NBT. Our retirement plan administration, wealth management and insurance agency businesses reported year-over-year revenue increases driven by productive organic growth and higher activity-based fees. Comparisons to the linked second quarter were net lower, principally reflective of the inherent headwinds of declining equity market valuations. Card services income decreased $3.4 million from the third quarter of last year and $4.1 million from the linked second quarter, driven by the bank being subject to the provisions of the Durbin Amendment to the Dodd-Frank Act beginning in the third quarter, which caps our per transaction compensatory opportunity for debit card interchange activities. Turning now to noninterest expense. Our total operating expenses were $76.7 million for the quarter, which was $3.8 million, or 5.2% above the third quarter of 2021. Salaries and employee benefit costs of $48.4 million were up 9.5% over the prior year, and included merit-related salary increases as well as higher performance-based incentive compensation accruals. Total operating expenses were also $575,000 higher than the linked second quarter of 2022, reflective of one additional day of payroll. We'd expect core operating expenses to drift modestly upward over the next several quarters as we continue our efforts to fill a higher-than-historical level of open positions in support of our customer engagement and growth objectives. We would also anticipate somewhat higher than historical levels of merit-based compensation increases in early 2023. In addition to investing in our people, we expect to continue to invest in technology-related applications and tools in order to advance our customer-facing and processing infrastructure. On the next slide, we provide an overview of key asset quality metrics. A walk forward of our loan loss reserve changes is also available in the appendix to the presentation. As I previously mentioned, net charge-offs were 7 basis points of loans in the third quarter of 2022, compared to 4 basis points in the prior quarter. Both NPLs and NPAs declined again this quarter. We are continuing to benefit from our conservative underwriting and have continued to experience higher than historical levels of recoveries. As I wrap up prepared remarks, a couple of closing thoughts. We started 2022 on strong footing, and we are pleased with the fundamental results achieved. Improving net interest income, solid results from our recurring fee income lines and exceptional credit quality outcomes have more than offset higher levels of noninterest expense, which has allowed for productive gains and operating leverage. Our capital accumulation results over the past several quarters continue to put us in an enviable position as we consider growth opportunities for the balance of 2022 and beyond. With that, we're happy to answer any questions you may have at this time. Tanya?

Our first question will come from Alex Twerdahl of Piper Sandler. One moment. Alex, your line is open.

Good morning, guys.

Good morning, Alex.

Good morning, Alex.

I would like to start by discussing your comments on the Micron investment, which I noticed a couple of weeks ago and found interesting. I'm pleased you mentioned it. It appears that a $100 billion investment in the Syracuse area is quite significant. Could you elaborate on how this might unfold regarding initial projects? Additionally, what kind of infrastructure might be necessary in terms of housing and other requirements? Could you also provide insights on the jobs you mentioned and relate it back to your positioning in that market? I'm interested in how you believe you are poised to benefit from this situation.

So thanks for that question, and we are excited about it as is the whole geography. It's a transformational announcement. It's a transformational commitment. Those of you who follow NBT know that we are at our best when we're playing our long game and this is a long game that we intend to be involved in for a long time. A couple of facts around what is going to happen here. A $100 billion investment in four facilities on a campus in the town of Clay, north of Syracuse. We have a branch network that is ideally positioned in and around Syracuse and particularly north Syracuse up to Oswego County, that will be there to serve the additional workforce and the additional population that is projected to grow there. Initially, 9,000 jobs are likely to be created on the site over the next 20 years. Along with that is a projected 40,000 indirect jobs to support the supply chain construction and other support necessary to have in our region a large and sophisticated manufacturing operation like that one. We understand New York plans to spend $200 million on road and infrastructure improvements. That's our sweet spot we have in our portfolio. Contractors who do that work all day long, every day, road works, sewer work, who also are involved in setting up the electric network. So we intend to be there to support them. It looks like we'll see airport expansion, Micron and New York State will also make a $500 million community benefit investment over time, up at Syracuse University, another $10 million investment in its semiconductor program, all of that very significant and material. You hit on one of the areas where I think we can participate and place to our strength. The residential mortgage product in a geography where the acceleration of homebuilding both multifamily and individual homes is likely to take off immediately, we're already aware of land speculation around the site here that we know developers are positioning themselves for that growth. We think that on the business banking side, there are lots of opportunities for support businesses here as this project takes off. We're also committed to the community. We have a team looking at how we can help to develop the workforce that's going to be necessary to populate this plant and related businesses. And we have senior executives who are plugged in at the economic development level, not only in Central New York but in the Mohawk Valley and down in the capital district who also give us visibility into what the needs are. So lots of layers there, lots of opportunity, lots of positive momentum for a geography that has experienced sluggish growth over the last 25 or 30 years.

Thanks. That's a great comprehensive answer there. We look forward to tracking that progress and seeing how it plays out. Next question, Scott, I was hoping that one of the questions that a lot of banks are getting is just in terms of liquidity, and you kind of touched on a little bit. But with your securities portfolio and your cash position, can you just talk a little bit about cash flows that are coming off the securities portfolio over the next several quarters into, I guess, early '23, and '24 that will help to support the loan growth that you may be seeing?

Sure, Alex, I'm happy to help. To remind you, a significant portion of our investment portfolio consists of cash-flowing instruments, such as mortgage-backed securities and CMOs, which provide monthly payments. We anticipate monthly cash flows from the investment portfolio to be around $20 million. Given the current underlying yields and the nature of these instruments, we don't expect much prepayment activity or anything slower than historical patterns. We're quite comfortable with the $20 million estimate. Over a 12-month period, that translates to a cash flow opportunity of $250,000. Regarding liquidity, at the close of the third quarter, we were still a modest seller of funds to the Federal Reserve. We had some days where we borrowed funds and have continued to do so in October. We're managing that strategically. We recognize that some areas of our deposit portfolio may require slightly higher yields for our customers, especially after experiencing a 300 basis points increase. If predictions point to a 375 basis points increase by next week, everything is progressing rapidly. In just seven months, we reached the 375 mark, which is unprecedented. We believe that in the next phase, our deposit beta will exceed what we've reported so far. The pace of this change is important, as we have a diverse deposit base. We're reassured by our noninterest-bearing deposits, which account for 35% to 37%, and we prefer our interest-bearing checking and savings accounts that are currently priced below 5 basis points. They may need to adjust upward, but they shouldn’t have to reach wholesale borrowing rates. That's how we're viewing this situation, Alex. We anticipate some margin improvement in the fourth quarter, which might carry into the first quarter of next year, although it's too soon to predict what will happen with funding beyond that.

Great. Thanks. That's my questions for now.

Thank you, Alex.

One moment. And our next question will come from Chris O'Connell of KBW. Chris, your line is open.

Good morning.

Good morning, Chris.

I think I missed it in the opening comments. But did you give just the exact breakdown of what the PPP and excess liquidity impact was versus last quarter?

Yes. So, Chris, the PPP for the quarter was just $0.05 per share. We are essentially finished with that. This is compared to approximately $1 million of PPP income in the second quarter and about $2.5 million in the third quarter of '21. We are effectively at 99% forgiveness or extinguishment of our instruments, with less than $10 million of PPP loans remaining on the balance sheet. In response to your question, we had significantly lower levels of cash equivalents or overnight short-term investments, mostly held at the Fed, than we did in the second quarter. This likely accounted for a 6 to 8 basis point change in the margin. However, as the Fed was raising rates, the funds we had at the Fed benefited from a higher yield compared to the no yield activity we experienced earlier in the year. Practically speaking, as I mentioned to Alex, we view our balance sheets as fairly neutral today regarding excess liquidity. We believe that natural cash flows from the loan portfolio and the investment portfolio will keep us in that neutral position for at least a quarter or two. Chris, did I cover that? Or do you have a follow-up?

Yes. No, that's great. And then just some of the deposit flows this quarter, and kind of looking ahead at the overall size of the balance sheet going forward, you mentioned the treasury linked product. And then I think there's supposed to be some muni inflows seasonal coming in this quarter. Just what's the outlook, I guess, on what you're seeing from your customers there? And how much deposit growth would be your target going forward? And I guess, like what are you willing to pay up on that?

There's a lot to unpack in that question. I'll address it step by step. Our deposit base is around $10 billion as of the end of September, with about $7 billion in noninterest checking, low interest checking, and low interest savings. We're actively managing the remaining $3 billion, which consists of institutional or larger commercial customers who typically respond more to interest rate changes than our retail customers. In regard to retail and small business banking money market funds, we believe we need to increase those to reflect the benefits we've gained on the asset side, which should yield between 300 and 400 basis points soon. We also have just over $1 billion in municipal portfolio, and while the third quarter is usually strong for municipal inflows, we were more neutral this year. This is likely because many municipalities have found alternative money market options that provide yields over 2%, which our current offerings do not match. It’s essential for us to retain our core checking and operating accounts, even if customers move some of their excess liquidity off our balance sheet temporarily. We learned from previous experiences with our commercial customers, where we provided short-term treasury instruments to offer them higher yields. While we may not currently bring such instruments back at existing short-term treasury yields, we’re keeping an eye on potential opportunities for future yields. Overall, we're looking to maintain optionality in our strategies. We have seen minimal negative outcomes with customers, although some have moved excess balances away from us. Additionally, some customers are realizing that they can use their existing liquidity to reduce debt, which we noted in several significant cases this quarter. There’s a recognition among customers of the potential to earn more by leveraging their liquidity. It’s a complex situation with many moving parts, but we're fully engaged in managing it on all fronts.

Got you. Yes, that's really helpful. Appreciate the color there. And then last one for me, just on the fee items. I was surprised that wealth management held up really well this quarter given the broader market declines. And then a little bit of pressure on the retirement plan, and I'm sure from similar items. And it looks like there have been kind of came in line with expectations here. But maybe just given all the moving parts, if you could provide a little bit of an update on those items.

Before addressing your kind comments about wealth management holding steady, I want to note that our third quarter included some activity-based billing. We bill for certain services once a year, which amounts to about $300,000 to $400,000 for this quarter. Consequently, we are likely closer to a neutral position, and considering the challenges in the equity markets, that's a positive result. It indicates we generated some new assets and accounts that helped mitigate those challenges. In the retirement plan administration area, we did see some activity-based income this year due to plan document changes and similar events that occur every five to six years. Since 2022 falls into that cycle, our decline in the third quarter can be attributed to a stronger performance in the second quarter. Approximately 40% to 45% of our revenue in this sector is influenced by market conditions. The remaining 50% to 55% derives from billing based on participant census in the plans, with the other portion depending on market yields. We are bringing in more participants and accruing basis points on assets. Typically, our billing cycle lags by a quarter, so our fourth quarter billing will reflect the broader S&P results from the third quarter, which may introduce additional pressure. Nonetheless, we are seeing reasonable growth as new accounts are being added. Regarding banking fees, we've mentioned previously that we tweaked our overdraft and nonsufficient funds programs, which likely impacted us by about $0.01 per share each quarter. We felt some of that in the third quarter. Our estimates for debit interchange revenue were relatively accurate, in the range of $15 million to $15.5 million. The number of transactions has actually increased, but our potential revenue has been significantly reduced.

Really helpful. Appreciate it. Thanks for taking my questions.

Thanks, Chris.

I would now like to turn the call back to Mr. Watt for his closing remarks.

Thank you, Tanya, and thank you all for participating in our call and for all of your great questions. We look forward next quarter to bringing you up to speed on our full year-end results. And with that said thank you and have a great day.

Thanks, everyone.

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