KBRA Affirms Ratings for Heartland Financial USA, Inc.

KBRA affirms the senior unsecured debt rating of BBB+, the subordinated debt rating of BBB, the preferred shares rating of BBB-, and the short-term debt rating of K2 for Denver, Colorado-based Heartland Financial USA, Inc. (NASDAQ: HTLF) ("Heartland" or "the company"). In addition, KBRA affirms the deposit and senior unsecured debt ratings of A- and the short-term deposit and debt ratings of K2 for its subsidiary, HTLF Bank. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The ratings are supported by Heartland’s sound operating results historically, which have been facilitated by an experienced and knowledgeable management team. In recent years, there has been some turnover among the Board members and senior executives, which we note has been largely amicable or part of normal succession planning, though this has led the company to undergo a transformation of strategy ("HTLF 3.0"). The legacy operating strategy, which we would characterize as "M&A-centric", provided benefits as the deals were integrated effectively, including the growth to considerable scale (nearly $20 billion in assets), the reinforcement of a low-cost and granular deposit base, and the establishment of a diverse operating footprint across twelve states. However, we acknowledge that HTLF’s operations are somewhat disparate and lack meaningful market share in major MSAs. Altogether, the maintenance of a consortium of community banks and the constant state of integrations did not allow for much of a focus on organic growth initiatives over the years. With that said, the current leadership regime is emphasizing organic growth through team lift outs and talent acquisition, which is expected to be targeted in higher growth markets in footprint, including Denver, Phoenix, Minneapolis, and Kansas City. In tandem with this evolution, management has established new financial targets to reach by 2026, including top quartile returns and noninterest income levels relative to similarly sized institutions, which present execution risks amid the backdrop of the challenging and ambiguous credit and volatile interest rate environments. However, we believe that HTLF is an enviable position to achieve these targets given a less levered balance sheet, which enables stronger loan growth opportunities especially when a majority of banks are pulling back due to liquidity or regulatory uncertainties.

Other rating considerations include Heartland’s strong liquidity position, which emanates from a lower risk balance sheet, with loans to earning assets tracking well below peer levels. The conservative approach to liquidity management has historically allowed for a minimal reliance on noncore funding, with core deposits generally tracking above 90% of total funding (83% as of 4Q23). Given the higher core deposit levels, solid market share, and favorable NIB levels (28% of total), HTLF’s deposit costs have typically been below average (2.09% for 4Q23). The lower-beta deposit base has helped facilitate respectable NIM performance and solid returns in 2023. Additionally, following the balance sheet repositioning (sale of $865 million of securities used to pay down brokered deposits) in 4Q23, Heartland's NIM has rebounded and management is projecting NIM stabilization around the 3.50% level during 2024 (assuming a flat rate environment). The company’s NPA ratio increased meaningfully in 4Q23, though this was largely due to one credit, which management stated is well collateralized and has not required any specific reserves. With regard to the headwinds facing the industry, notably in the CRE space, we believe that HTLF is well positioned given its below average concentration in investor CRE (159% of total risk-based capital at YE23) and minimal exposure to office lending (<4% of loans). Capital ratios are on the lower end with respect to the rating category, though management intends to build the CET1 ratio to between 11.5%-12.0% by YE24, which we view favorably.

Rating Sensitivities

Continued solid performance through this uncertain operating environment and the accomplishment of HTLF 3.0 financial and growth targets could support positive rating momentum over time. A downgrade is unlikely, though any material deterioration among key financial ratios, most notably in credit or liquidity, could potentially pressure the ratings.

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