HBT Financial, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods unless noted. HBT is an Illinois community bank holding company operating through Heartland Bank and State Bank of Lincoln. The financial statements are unaudited.
Business context and reporting period
HBT reported total assets of $3.50 billion, loans before allowance of $2.28 billion, and deposits of $3.02 billion at June 30, 2020. It operates 63 branches across Central and Northeastern Illinois. The company participated in the SBA Paycheck Protection Program (PPP), funding $184.2 million of PPP loans to 2,245 businesses during the quarter.
Comparisons with 2019 require care: HBT changed from S corporation to C corporation taxation effective October 11, 2019. The filing provides pro forma C corporation results for the 2019 comparison periods.
Financial performance and condition
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $28.9 million | $33.9 million | $59.6 million | $68.4 million |
| Provision for loan losses | $3.6 million | $1.8 million | $7.9 million | $2.6 million |
| Noninterest income | $8.1 million | $7.3 million | $13.3 million | $14.8 million |
| Noninterest expense | $23.5 million | $24.6 million | $46.8 million | $46.8 million |
| Net income | $7.4 million | $14.6 million reported; $11.1 million C-corp equivalent | $13.6 million | $33.3 million reported; $25.2 million C-corp equivalent |
| Diluted EPS | $0.27 | $0.81 reported; $0.62 C-corp equivalent | $0.50 | $1.85 reported; $1.40 C-corp equivalent |
| Net interest margin | 3.49% | 4.36% | 3.74% | 4.40% |
Management said lower interest rates and increased loan-loss provisioning were the primary drivers of lower earnings. On a C-corp-equivalent basis, net income declined 33.3% in Q2 and 45.8% for the first half. Q2 mortgage loan-sale gains rose to $2.1 million from $0.7 million, helping offset weaker net interest income; service-charge income fell amid lower overdraft activity and customer fee relief. The 2019 comparison also included nonrecurring asset-sale gains.
Margins and costs: Q2 net interest margin fell 87 basis points year over year. Management cited lower asset yields, including the effect of excess liquidity held at the Federal Reserve while funding PPP loans; lower deposit costs provided a partial offset. The Q2 efficiency ratio was 62.74%, versus 58.59% a year earlier. Q2 return on average assets was 0.86%, versus 1.81% reported in 2019 (1.38% C-corp equivalent).
Balance sheet and liquidity: From December 31, 2019, assets rose 7.9%, deposits rose 8.6% to $3.02 billion, and loans before allowance rose 5.2% to $2.28 billion. The allowance for loan losses increased to $29.7 million, or 1.31% of loans, from $22.3 million, or 1.03%. Cash and cash equivalents were $314.4 million. The banks had no FHLB borrowings outstanding and reported $335.7 million of remaining FHLB credit availability. The loan-to-deposit ratio was 75.48%; core deposits were 99.18% of deposits.
Debt and capital: Liabilities included $51.4 million of repurchase agreements and $37.6 million of subordinated debentures; no FHLB borrowings were outstanding. At June 30, consolidated total capital to risk-weighted assets was 15.13%, Tier 1 capital was 13.92%, and common equity Tier 1 was 12.43%. Management said the company and banks met applicable capital requirements; both banks were well capitalized under prompt-corrective-action rules.
Cash flow: For the six months, operating activities used $12.6 million, compared with $38.9 million provided in 2019. Investing activities used $193.9 million, mainly reflecting securities purchases and loan growth; financing activities provided $236.9 million, primarily from $238.3 million of deposit growth. Cash and cash equivalents increased $30.4 million to $314.4 million. HBT paid $8.3 million in dividends during the half-year, including quarterly dividends of $0.15 per share.
Material changes, outlook and risks
- Credit quality: Nonperforming assets declined to $18.4 million from $24.1 million at year-end; nonperforming loans were 0.61% of loans versus 0.88%. However, pass-watch loans increased to $150.1 million from $126.6 million and substandard loans to $92.8 million from $72.4 million. Management attributed the credit-rating migration to borrowers affected by the pandemic. The first-half provision included a $7.0 million reserve build for economic weakness and a $1.3 million increase in a specific reserve, partly offset by reductions in other specific reserves.
- COVID-19 modifications and PPP: At June 30, 545 loans totaling $283.6 million had payment modifications related to COVID-19 hardship; at July 17, the reported total was 550 loans and $284.9 million. By July 17, 317 loans totaling $172.8 million had returned to regular payments, while 202 loans totaling $83.0 million remained in their original modification. PPP loans outstanding were $178.0 million net of deferred fees. HBT warned that the SBA could deny or reduce its guarantee, or seek recovery, if loan origination or servicing deficiencies are found; PPP-related litigation is also a stated risk.
- Management outlook: The filing gives no quantified earnings or loan-growth guidance. Management expects Federal Reserve rate cuts and possible pandemic-related credit deterioration to continue pressuring net interest margin and may increase credit costs. It said the duration and ultimate economic effects of COVID-19 remained uncertain. Loan-modification requests had slowed as Illinois reopened and stimulus reached customers.
- Unusual items: The supplemental executive retirement plan (SERP) was terminated and paid out in a lump sum in June 2020; no SERP liability remained at quarter-end. The liability had been $12.8 million at December 31, 2019. The plan generated expense of $0.6 million in Q2 2020 versus $3.4 million in Q2 2019; management said it would no longer affect earnings after June 30. Mortgage-servicing-rights fair-value adjustments were negative $0.5 million in Q2 and negative $2.7 million for the first half.
- Other risks and contingencies: HBT is concentrated in Illinois and faces risks from a prolonged downturn, borrower defaults and collateral declines, low interest rates, deposit competition, funding access, operational disruption, and regulatory changes. Management said routine legal claims were not expected to have a material effect. Goodwill was not impaired in the March 2020 assessment, but further evaluation could be required if circumstances worsen.
Most important facts for investors to verify
- Whether loan modifications transition back to scheduled payments and how pandemic-related borrower stress affects criticized loans, nonperforming assets, charge-offs, and the allowance.
- Whether PPP loans are forgiven or repaid as expected, and whether any SBA guarantee disputes, processing deficiencies, or litigation arise.
- Whether net interest margin stabilizes or declines further as low rates, deposit mix, and excess liquidity affect asset yields and funding costs.
- Whether deposit growth and liquidity remain durable as PPP proceeds and government stimulus are spent or withdrawn; review cash-flow trends and available borrowing capacity.
- Use C-corp-equivalent 2019 earnings for a more comparable year-over-year assessment, and distinguish GAAP results from management’s adjusted, non-GAAP measures.