Nbt Bancorp Inc Q1 FY2023 Earnings Call

Good day, everyone. Welcome to the NBT Bancorp’s First Quarter 2023 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 President and CEO, John H. Watt, Jr. for his opening remarks. Mr. Watt, please begin.

Thank you, Bella. Good morning and thank you all for participating in our earnings call covering NBT Bancorp’s first quarter 2023 results. Joining me today are NBT’s Chief Financial Officer, Scott Kingsley; our Chief Accounting Officer, Annette Burns, and our Treasurer, Joe Ondesko. In a volatile macro environment, we are pleased with our operating results for the first quarter of 2023, including earnings per share of $0.88, return on average assets of 1.3%, and return on average tangible common equity of 17.2%, excluding merger expenses and securities losses. We achieved 5% annualized loan growth with our commercial banking, business banking, residential solar, and indirect auto businesses all contributing. In the markets we serve, it is clear that our customers are successfully navigating the challenging operating environment, and we are on the ground helping them every day. Looking forward, loan pipelines across the platform are active but moderating. Credit quality remains strong across our commercial and consumer businesses. Non-performing assets are at all-time lows. We’re happy to report today that both total deposits and core deposits grew in Q1, driven in part by seasonal growth of municipal deposits. Scott will speak more about this growth and about the diversity and granularity of our deposit base, which is the hallmark of our franchise. Furthermore, we enjoy access to significant and diverse liquidity sources, and our capital levels are strong. We have provided details on the accompanying slides. Our net interest margin did experience pressure in the first quarter due to re-pricing actions that positioned NBT to stay competitive in our markets. With that said, relative to our peer group and the broad market, our cycle-to-date deposit beta as of the end of March rose to a modest 12%. We continue to support our customers in connection with the multi-year ramp-up of the New York chip corridor. In Central New York, Micron is moving swiftly to complete the planning necessary to bring its fab plant out of the ground. In the Mohawk Valley, Wolfspeed has commenced work on the addition to its fab plant to support new contracts with Jaguar and Mercedes for chips in EV vehicles. The economic growth up and down the chip corridor will continue to build over the next five years and beyond, and NBT is uniquely positioned to support that growth. During the quarter, we continued to execute on our long-term growth plans, and in particular, we are making progress towards our planned acquisition of Salisbury Bancorp. On April 12th, Salisbury shareholders voted to approve the merger with NBT. This is a significant and positive milestone. As we announced in December, we expect this transaction to close late in the second quarter, subject, of course, to regulatory approval. This month NBT was named one of Forbes Best Banks for 2023. Of the U.S. banks recognized by Forbes, NBT has the highest-ranked bank based in New York State. During volatile times, our team excels, and this designation is affirmation of our efforts. Historically, our company has performed well in difficult periods in our economy. The team is positioned to do the same in 2023. Scott, I’ll turn over to you now to speak in greater detail about our financial performance in the first quarter. And following Scott’s remarks, we will take your questions.

Thank you, John, and good morning. Turning to the results overview page of our earnings presentation, our first quarter GAAP earnings per share was $0.78 and $0.88 per share excluding $0.10 per share of combined acquisition expenses and securities losses. Excluding the impact of acquisition expenses and securities losses, first-quarter results were $0.02 a share higher than the linked fourth quarter and $0.03 a share below the first quarter of last year. The 18% improvement in net interest income from the prior year’s first quarter was the result of solid organic loan growth and higher asset yields from the continued increases in the Fed funds rate. Our net interest margin in the first quarter of 2023 was 3.55%, which was up 60 basis points from the first quarter of 2022. We recorded a loan loss provision expense of $3.9 million in the first quarter compared to $600,000 of provision in the first quarter of 2022, or a $0.06 per share difference. Our reserve coverage stood at 1.21% of loans at March 31 compared to 1.24% at December 31, 2022, and 1.18% at the end of March of last year. The next page in the deck shows trends in outstanding loans. Total loans were up $114 million for the quarter or 1.4% and included growth in both our consumer and commercial portfolios. Loan yields were up 28 basis points from the fourth quarter of 2022, reflective of higher yields on our variable rate portfolios as well as higher new volume rates. Our total loan portfolio of $8.26 billion remains very well diversified and is evenly balanced between consumer and commercial outstandings. Total deposits of $9.68 billion were up $185 million from the linked fourth quarter, but were down 7.5% from the end of the first quarter of 2022, which was our high point. The decrease in deposits from last year’s first quarter was primarily concentrated in larger, more rate-sensitive customers. In many cases, those customers opted to move a portion of their excess liquidity into higher yielding off-balance sheet money market or short-term treasury instruments, many of which are managed by NBT. Our retention of core operating relationships has remained very high, and we continued to successfully add new relationships in the first quarter. Although deposit balances have declined from early 2022, they are still 23% higher than the pre-pandemic first quarter of 2020. During the fourth quarter of last year, we shifted from an excess liquidity position to a net overnight borrowing position, which continued into the first quarter of this year. Our quarterly cost of total deposits increased to 47 basis points in Q1 compared to 17 basis points in the linked fourth quarter. Our total cost of funds increased from 37 basis points in the linked fourth quarter to 75 basis points in the first quarter of this year. In addition, our total cost of deposits for the month of March was 62 basis points and total cost of funds was up to 88 basis points. We have also added a summary of our deposit mix by type, which illustrates the diversification and granularity of our customer base. Additionally, in the appendix to the presentation, we have provided a table of our available funding sources compared to estimated uninsured and uncollateralized deposits, which provides a coverage ratio of 149% at quarter end. The next slide looks at the detailed changes in our net interest income and margin. First-quarter net interest income was $4.7 million below the linked fourth quarter results, with a third of that decline related to two fewer days in the quarter and the remaining two-thirds reflective of increases in funding costs moving up faster than improvements in earning asset yields. Although we believe our granular deposit funding profile remains a core strength, we expect continued pressure on net interest margin results for at least the next couple of quarters. Our cycle-to-date deposit beta through the end of March has been 12%, with a total funding beta of 13%. Retaining and growing core deposits will continue to be a critical element of our ability to manage net interest margin results. The trends in non-interest income are summarized on the next page. Excluding securities losses, our fee income was up 6% from the linked fourth quarter to $36.4 million, and was $6 million lower than the first quarter of 2022. Our wealth management, insurance, and retirement plan administration business experienced seasonal growth in revenue generation from the fourth quarter. Card services income was consistent with the linked fourth quarter, but declined $3.9 million from the first quarter of 2022, driven by the bank being subject to the debit interchange provisions of the Durbin Amendment to the Dodd-Frank Act beginning in the third quarter of last year. Turning now to non-interest expense. Our total operating expenses were $78.7 million for the quarter, which was $6.4 million or 9.2% above the first quarter of 2022, excluding merger-related expenses in the first quarter of this year. Total operating expenses were consistent with the linked fourth quarter of last year. Salaries and employee benefit costs of $48.2 million were 1.9% higher than the linked fourth quarter due to seasonally higher payroll taxes, stock-based compensation expense, and merit pay increases, which were effective in March. We expect core operating expenses to be relatively consistent over the next several quarters as each quarter of 2023 has the same number of payroll days. We expect to fill many of our open positions in support of our customer engagement and growth objectives subsequent to the closing of our pending merger with Salisbury Bancorp. 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 19 basis points in the first quarter of 2023 compared to 18 basis points in the prior quarter. The selected financial data summary is provided within the earnings release, and we have summarized the components of quarterly net charge-offs by line of business. Consistent with the previous four quarters, first-quarter net charge-offs were concentrated in our other unsecured consumer portfolios, which are in a planned runoff status. Both NPLs and NPAs declined again this quarter. Our allowance for loan losses to total non-performing loans reached 539% at the end of the first quarter. As I wrap up the prepared remarks, I’d like to share some closing thoughts. We entered 2023 expecting to experience incremental pressure on funding costs, which started in the fourth quarter of last year. The additional market volatility and uncertainty that arose in early March accelerated those pressures and has continued. Positive results from our recurring fee income lines, stable credit quality outcomes, and diligent operating expense management allowed us to continue to report solid fundamental results in the first quarter, despite lower levels of net interest income. Our capital accumulation results over the past several quarters continued to put us in an enviable position as we consider growth opportunities for the remainder of 2023 and beyond. With that, we’re happy to answer any questions you may have at this time. Bella?

Thank you. Our first question comes from Alex Twerdahl of Piper Sandler & Co. Yes, please go ahead.

Good morning, Alex.

First off, I was just wondering if you could just give us a little commentary on what NBT's experience, in your various markets, were to some of the reaction or the reaction to some of the events in turmoil in the banking industry in the middle of March.

Happy to talk about that. As you see in the disclosures here, the customer base is broad, diverse, and granular. The focus on 250 and above for most of those customers was not all that relevant. Average deposit account size here is obviously relatively modest, which is something that is a hallmark of our franchise, I might add. The customers we did talk to were larger, rate sensitive, and concerned about ensuring they were achieving the appropriate yield on their funds. There were all, by the way, a question or two about the environment in which we were operating in the week during those two bank failures, but generally speaking, it was pretty stable. The inbound that we received was very supportive. Several of the customers I got on the Zoom with thanked me and noted that if they were customers at large money center banks, they wouldn’t be on the Zoom with the CEO of the bank. They valued that, and that’s our value proposition, right? Those relationships we have across that customer base. So things obviously have settled down. As I suggested in my comments, we’re on the offense here. We often, as you know, Alex, take advantage in periods of disruption, plenty of capital here, plenty of ability to step into a vacuum that’s created during that disruption. And we’re looking at opportunities to do that.

Great. That’s helpful. I want to ask also for your comments on thoughts around credit quality, and there’s been a lot of concern nationally about office exposure. If you could give us what your office exposure is and also talk about why some of your markets might be different from some of the areas that are maybe of more concern.

Well, I think Scott referenced a disclosure in our slides on office, so let’s just address that right off. We’re in tertiary markets. The return to the office has not been a drama in many of those cities. It occurred as soon as the vaccine was broadly introduced. So we don’t detect any concern around a very regionally diversified portfolio of office in tertiary markets. The tenants are, for the most part, suburban medical and professional tenants, with an average loan size of $2.2 million. So we think we have that well managed, and we’ve conducted stress tests there recently. We feel positive about their output. Otherwise, the portfolio is pretty diversified across many different asset classes, with multi-family being the largest, and demand for housing in these markets is still very strong. So we’re feeling pretty good about our exposure across multi-family. Residential construction is something that we consider in connection with the chip corridor. We’ll see how that plays out in the future, but we are keeping an eye on that. Finally, hospitality has been strong for us as well. So right now, the sponsors we do business with are strong and diversified. We do not detect any material deterioration, maybe around the edges, but nothing material at all.

And, Alex, it’s Scott. I’ll just add that you know our markets pretty well from Portland, Maine to Southern New Hampshire, back into Albany, Syracuse, and Binghamton. There just aren't a lot of single tenant, large downtown office-only structures in most of those cities. So, for us, I think it’s something that’s very controllable.

Great. And then just to follow up on credit, your charge-offs have been running mid-teens over the last couple of years, and that's a big reduction from where they were pre-pandemic in the 35 to 40 basis point level. Do you think that charge-offs are going to trend back towards that 35 to 40 basis point level over time? What are your thoughts on the normalization of charge-off levels given your various portfolios?

Yes, it’s a great question, Alex. To frame it this way, you’re right, our charge-offs have been concentrated in our unsecured consumer lending portfolios, our long-term relationship with Springstone Financial and LendingClub. Those portfolios are in a net runoff position. So over time, you’ll see a lower level of charge-offs as those run down over the next year or year and a half. But to your point, will other lines of business, such as indirect auto, start to return to historical numbers? Yes, I think they probably do over time, but much of that picture is closely tied to employment characteristics. We’re probably most sensitive to employment, which impacts how we reserve for these things and also how we experience losses.

Great. Thanks for taking my questions.

Thank you, Alex.

Your next question comes from the line of Steve Moss of Raymond James. Your line is now open.

Good morning.

Hi, good morning, Steve.

Good morning.

Maybe just start off on loan growth here. You still had good growth in the pace of residential solar here this quarter. Just kind of curious as to where that may level off or any updated thoughts around there. I hear you in terms of loan growth moderating. Just kind of where are you seeing pockets of strength and pockets of weakness?

Sure. Let me talk about our residential solar first. I think we mentioned in the last call that we’ve reached a concentration level on our balance sheet that has caused us to look at how to diversify our relationship with Sungage to continue to help them originate while bringing other investors into the picture and allowing us to earn servicing income as a function of that. That migration to that model is underway. There’ll be a bit more growth in the next quarter I think in that portfolio, and then it should level off. By that time, several of those investors—which have expressed interest—are currently under negotiation and could be at the table, leading to us assuming a servicing role that would add to our fee income, which is part of our long-term plan. With respect to other growth inside the chip corridor, we’ve seen activity in multi-family in Utica, New York. Over the weekend, we approved a significant multi-family project that wouldn’t even be on the drawing board without Wolfspeed and the large hospital development going on in downtown Utica. That’s promising. I would expect more of that in Central New York. In New England generally, we see a moderation of the number of opportunities to finance multi-family, and for all the obvious reasons—borrowing costs, inflation, labor costs—those factors have caused smart sponsors we work with to be thoughtful about how they want to achieve a return. So we’ve got a big focus on the C&I side right now, particularly in New England, with a targeted marketing effort moving quickly. That said, loan growth was above the median for us last year, and I think this year we should think about it more in the mid-single digits, which has been our norm in a more typical period.

And then on the margin here, Scott. I hear you in terms of the way our funding costs were for the month of March; just kind of curious how you’re thinking about that pace of decline in the margin, given the much different environment?

So Steve, I would frame it this way: needless to say, our net interest margin was higher in January than it was in March, and that differential was on the funding cost side. We are picking up a little bit of earning asset yield as we re-price new volume or replacement volume that hits the balance sheet. The Fed funds rate changes and our commercial variable rate portfolio provided a slight push in the first quarter, but not substantial. If our cost of funds for the month of March is around 88%, it's probably not unexpected that during the quarter, they could reach 1% for the second quarter. The real question is, how much of that we can offset with asset yield improvement. I think new assets are being added to the books at the right yields across all of our portfolios. We are not currently re-investing cash flows into the investment portfolio. We're taking off around $15 million to $16 million a month in cash flows from that side, using that to counterbalance short-term borrowings today. There are attractive yields in the investment portfolio, but we’ve chosen to leave our excess liquidity available for loan growth because we're still seeing mid-single-digit opportunities, which are acceptable for NBT.

Okay. That’s helpful. And maybe just in terms of also thinking about re-pricing on the loan side, with 20% to 25% of loans being variable, just kind of curious what the pace of fixed loans re-pricing is and how we should consider that dynamic going forward?

I think we’ve been using a perspective that out of the total amount of our assets that re-price over a one-year period, we consider it to be in the neighborhood of $2 billion. Most of the rest of our loan portfolios are fixed, so given that most residential mortgages and indirect auto loans are largely fixed, we think that re-pricing will have a slower effect on total portfolios compared to variable portfolios that are tied to market rates. Have cash flows slowed down in almost all of our portfolios? Yes, they have. There’s not a high number of customers looking to pay off their 3.25% mortgage. Therefore, our expectations of where cash flows have indeed slowed down. It could also lead to slightly higher growth in our loan portfolio historically, which means growth might be a bit higher than anticipated.

Okay, and then one last one in terms of just office here. Just wondering if you guys have any chance to review the LTVs or debt service coverage on the office portfolio?

Steve, we can get that to you offline. We’ve done some detailed reviews in that portfolio. We probably haven’t done a complete 100% portfolio analysis, but we can certainly provide those numbers.

All right. I appreciate that. Thank you very much.

Thanks, Steve. Appreciate the questions.

And your next question comes from the line of Chris O’Connell with KBW. Your line is now open.

Good morning.

Good morning, Chris.

I was hoping to follow-up on the securities portfolio. Appreciate the color on the cash flows upcoming for the remainder of 2023. I was hoping you guys could provide what the duration was for the AFS and HTM portfolios?

So Chris, for us across all the portfolios, the weighted average life duration is around five years.

Great. And I was wondering if you guys had good start NIM for March.

Month of March in the 3.45% range.

Okay, great. And then you guys mentioned that expenses would be flat going forward, give or take, on an organic basis for the remainder of the year. Was that just compensation expense or is that total overall expenses?

So, I think it is overall. Here’s how I’d frame this, Chris. First and foremost, as John mentioned, we’re preparing ourselves for hopefully getting regulatory approval and closing the pending Salisbury transaction. So none of my comments around that include anything relative to contribution from Salisbury and any of those line items. But on a core basis, the first quarter carried slightly larger payroll tax-related expenses, some equity compensation expense, and what I would call the first third of our merit change was processed in the first quarter. As we head into the second, third, and fourth quarters, we think about the remaining two-thirds of that merit change, a slightly lower level of payroll tax contributions, and usually the number of payroll days in every quarter in 2023 are the same. Therefore, the first quarter is a proxy of our core run rate before Salisbury.

Got it. That’s helpful. And on the Salisbury deal close, what do you now estimate again this environment the impact will be on the net interest margin and is there any other items or details around the merger close, just updated expectations given the change in environment, meaning any type of balance sheet actions or anything different that you expect with the merger close?

Yes. Our underlying assumptions used when we announced the transaction in December are still very similar to how we’re feeling about it today. Have there been modest changes in interest rate margins in certain asset classes? Yes. Has the core deposit intangible likely increased slightly compared to what we estimated back in October when we modeled? Yes. However, in general terms, proportional accretion is very similar to what we announced in December. In terms of balance sheet actions, as we work through the transition with the Salisbury team, we’ve discussed if there are certain items—such as certain lines in their securities portfolios—that we don't believe have long-term benefits. But generally speaking, we like the assets and liabilities.

Got it. Great. And one last one from me, for BOLI fees this quarter, is that a good run rate or is there anything unusual picking that up this quarter relative to the prior?

Yes. We probably had a couple of hundred thousand dollars of death-related benefits in the quarter.

Great. That’s all I had. Thanks for taking my questions.

Thanks, Chris.

Your next question comes from the line of Matt Breese of Stephens Inc. Your line is now open.

Good morning.

Hey, good morning, Matt.

Good morning, Matt.

Sorry if I missed this. Could you give us some sense for projections on overall loan growth through year-end?

Yes, I’ll take that one, and John, feel free to chime in. The 5.5% annualized growth we experienced in the first quarter had a contribution from Solar Residential, which is probably higher than we would expect for the balance of the year. That said, I believe we’re in the range of 3.5% to 5.5% for overall growth opportunities this year.

Okay. And then, on page five, you show new origination yields across commercial, consumer, and the resi categories. Can you talk a little bit about what kind of impact that’s having on loan growth? Is there a ratio of projects and deals that you say yes and no to now versus how has that changed compared to 12 to 18 months ago? As rates have moved higher, is there a change in what you’re underwriting and how often you’re saying no these days?

On the commercial side, every deal is custom. The negotiations are one-on-one and relate to the total relationship and length of that relationship. Our relationship managers have guidelines on return and yield that are appropriate under the circumstances, and we look at the overall profitability of each opportunity. What I’ll say is with respect to CRE, the sponsors are being more thoughtful right now, and like us, they’re considering how to allocate their capital to achieve appropriate returns. The volume of transactions or discussions is probably lower. On the consumer side, each week we set price parameters for each of those loan products. We’re pretty rigorous around that, sampling what's happening with the competition and understanding our cost of funds. It’s a dynamic process every week. Are we declining many deals because competitors are offering substantially lower pricing? I’d say no. We’ve seen a degree of rationalization in recent months.

Very helpful.

Matt, I would add that needless to say, in this environment where significant attention is being paid to core funding opportunities, lending that brings core funding together with it is more attractive. If that's C&I on the commercial side or residential mortgages—typically bringing a customer relationship on the funding side—that thread is just a little bit harder to achieve.

Understood. Okay. And then for your own commercial real estate loans coming up for renewal now from 2018 and 2019, how are debt service coverage ratios handling higher rates? How are LTVs reacting to higher cap rates? Have you found that rent increases and NOI increases cushioned any blow here or maybe just provide some insight into what’s coming up for renewal now? Are the underwriting characteristics as strong as they were back in 2018-2019?

So far, everything looks good. Remember, many of those loans were underwritten at rates that were not at the pandemic low rates, but some of those that were written at low rates during the pandemic do have fixed swap protections in place. Therefore, many customers are in good shape. Cap rates have been creeping up slowly, but that's not a sudden or immediate change in all our markets. The customers have had time to service their obligations under competitive rates, so from a blended standpoint, it looks quite positive. Currently, there are no customers on a watch list due to property valuations likely to trigger re-pricing activity.

Understood. Okay. Last one for me: just given capital levels and the stock, is there any increased appetite for buybacks more than historically, where it's primarily focused on trimming share counts?

We always assess our capital allocation plans. Remember, we're currently in the middle of an acquisition process and must proceed consistently with our representations to our constituents, including our regulator. In the short run, we are unlikely to change our approach. Once we complete these constructive discussions with our regulator and close the deal, we will further evaluate what’s appropriate for capital allocation moving forward.

Great. That’s all I had. I’ll leave it there. Thank you.

Thank you, Matt.

Thanks, Matt.

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

Thank you, Bella and thank you all for taking the time to hear the first quarter story at NBT Bancorp. We’re proud of it and are looking forward to being on offense for the rest of the year in a smart way, favorable for all stakeholders at NBT, including our shareholders. Again, thank you for participating. I look forward to talking to you next quarter.

Thanks everyone.

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