HBT Financial, Inc. (HBT) FY 2023 MD&A

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Unless the context requires otherwise, references in this report to the “Company,” “we,” “us” and “our” refer to HBT Financial, Inc. and its subsidiaries.

Management’s discussion and analysis should be read in conjunction with the following parts of this Annual Report on Form 10-K: Part I, Item 1 “Business”, Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk”, and Part II, Item 8 “Financial Statements and Supplementary Data”. Detailed discussion and analysis of the financial condition and results of operation for 2023 as compared to 2022 can be found below.

OVERVIEW

HBT Financial, Inc., headquartered in Bloomington, Illinois, is the holding company for Heartland Bank and Trust Company, and has banking roots that can be traced back to 1920. We provide a comprehensive suite of financial products and services to businesses, families, and local governments throughout Illinois and Eastern Iowa. As of December 31, 2023, the Company had total assets of $5.1 billion, loans held for investment of $3.4 billion, and total deposits of $4.4 billion.

Market Area

As of December 31, 2023, our branch network included 67 full-service branch locations throughout Illinois and Eastern Iowa. We hold a leading deposit share in many of our Central Illinois markets, which we define as a top three deposit share rank, providing the foundation for our strong deposit base. The stability provided by this low-cost funding is a key driver of our strong track record of financial performance. Below is a summary of our loan and deposit balances by geographic region:

Acquisitions

The Company incurred the following pre-tax acquisition expenses:

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(1)Includes recognition of an allowance for credit losses on non-purchase credit deteriorated ("non-PCD") loans of $5.2 million and an allowance for credit losses on unfunded commitments of $0.7 million in connection with the Town and Country merger during the first quarter of 2023 in accordance with ASC 326 which was adopted on January 1, 2023.

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Town and Country Financial Corporation

On February 1, 2023, HBT Financial completed its acquisition of Town and Country, the holding company for Town and Country Bank. The acquisition of Town and Country further enhanced HBT Financial’s footprint in Central Illinois and expanded our footprint into metro-east St. Louis. At the time of acquisition, Town and Country Bank operated ten full-service branch locations which began operating as branches of Heartland Bank. The core system conversion was successfully completed in April 2023. After considering business combination accounting adjustments, Town and Country added total assets of $937.2 million, total loans held for investment of $635.4 million, and total deposits of $720.4 million.

Total consideration consisted of 3.4 million shares of HBT Financial’s common stock and $38.0 million in cash. Based upon the closing price of HBT Financial common stock of $21.12 on February 1, 2023, the aggregate consideration was approximately $109.4 million. Goodwill of $30.5 million was recorded in the acquisition.

NXT Bancorporation, Inc.

On October 1, 2021, HBT Financial completed its acquisition of NXT Bancorporation, Inc. (“NXT”), the holding company for NXT Bank. The acquisition expanded our footprint into Eastern Iowa with four locations that began operating as branches of Heartland Bank following the merger and system conversion of NXT Bank into Heartland Bank in December 2021. After considering business combination accounting adjustments, NXT added total assets of $239.9 million, total loans of $194.6 million, and total deposits of $181.6 million.

Total consideration consisted of 1.8 million shares of HBT Financial’s common stock and $10.6 million in cash. Based upon the closing price of HBT Financial common stock of $16.27 on October 1, 2021, the aggregate consideration was approximately $39.9 million. Goodwill of $5.7 million was recorded in the acquisition.

Branch Rationalization Plan

In April 2021, the Company made plans to close or consolidate six branches. One branch was consolidated during the second quarter of 2021, and the remaining five branches were closed during the third quarter of 2021. The Company estimated annual pre-tax cost savings, net of associated revenue impacts, related to the branch rationalization plan to be approximately $1.1 million.

The Company incurred the following pre-tax branch closure costs during the year ended December 31, 2021 (dollars in thousands):

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FACTORS AFFECTING OUR RESULTS OF OPERATIONS

Economic Conditions

The Company's business and financial performance are affected by economic conditions generally in the U.S. and more directly in the Illinois and Iowa markets where we primarily operate. The significant economic factors that are most relevant to our business and our financial performance include the general economic conditions in the U.S. and in the Company's markets (including the effect of inflationary pressures and supply chain constraints), unemployment rates, real estate markets, and interest rates.

Interest Rates

Net interest income is our primary source of revenue. Net interest income is equal to the excess of interest income earned on interest earning assets (including discount accretion on purchased loans plus certain loan fees) over interest expense incurred on interest-bearing liabilities. The level of interest rates as well as the volume of interest-earning assets and interest-bearing liabilities both impact net interest income. Net interest income is also influenced by both the pricing and mix of interest-earning assets and interest-bearing liabilities which, in turn, are impacted by external factors such as local economic conditions, competition for loans and deposits, the monetary policy of the Federal Reserve Board (“FRB”) and market interest rates.

The cost of our deposits and short-term wholesale borrowings is largely based on short-term interest rates, which are primarily driven by the FRB’s actions. The yields generated by our loans and securities are typically driven by short-term and long-term interest rates, which are set by the market and, to some degree, by the FRB’s actions. Our net interest income is therefore influenced by movements in such interest rates and the pace at which such movements occur. Generally, we expect increases in market interest rates will increase our net interest income and net interest margin in future periods, while decreases in market interest rates may decrease our net interest income and net interest margin in future periods.

Credit Trends

We focus on originating loans with appropriate risk/reward profiles. We have a detailed loan policy that guides our overall loan origination philosophy and a well-established loan approval process that requires experienced credit officers to approve larger loan relationships. Although we believe our loan approval and credit review processes are strengths that allow us to maintain a high-quality loan portfolio, we recognize that credit trends in the markets in which we operate and in our loan portfolio can materially impact our financial condition and performance and that these trends are primarily driven by the economic conditions in our markets.

Competition

Our profitability and growth are affected by the highly competitive nature of the financial services industry. We compete with community banks in all our markets and, to a lesser extent, with money center banks, primarily in the Chicago MSA. Additionally, we compete with non-bank financial services companies, FinTechs and other financial institutions operating within the areas we serve. We compete by emphasizing personalized service and efficient decision-making tailored to individual needs. We do not rely on any individual, group, or entity for a material portion of our loans or our deposits. We continue to see significant competitive pressure on loan rates and terms, as well as deposit pricing, which may affect our financial results in the future.

Digital Banking

Throughout the banking industry, in-person branch traffic is expected to continue to decline as more customers turn to digital banking for routine banking transactions. The COVID-19 pandemic accelerated this transition, and in-person branch traffic is not expected to return to pre-pandemic levels. Additionally, widespread adoption of faster payment and instant payment technologies could require us to substantially increase our expenditures on technology infrastructure, increase our regulatory compliance costs, and adversely impact the stability of our deposit base. We plan to continue investing in our digital banking platforms, while maintaining an appropriately sized branch network. An inability to meet evolving customer expectations, with the appropriate level of security, for both digital and in-person banking may adversely affect our financial results in the future.

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Regulatory Environment and Trends

We are subject to federal and state regulation and supervision, which continue to evolve as the legal and regulatory framework governing our operations continues to change. The current operating environment includes extensive regulation and supervision in areas such as consumer compliance, the Bank Secrecy Act and anti-money laundering compliance, risk management and internal audit. We anticipate that this environment of extensive regulation and supervision will continue for the industry. As a result, changes in the regulatory environment may result in additional costs for additional compliance, risk management and audit personnel or professional fees associated with advisors and consultants.

FACTORS AFFECTING COMPARABILITY OF FINANCIAL RESULTS

JOBS Act Accounting Election

We qualify as an “emerging growth company” under the JOBS Act. The JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. The Company may remain an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the completion of our initial public offering, which is December 31, 2024, (2) the last day of the fiscal year in which the Company has $1.235 billion or more in annual revenues, (3) the date on which the Company is deemed to be a “large accelerated filer” under the Exchange Act or (4) the date on which the Company has, during the previous three year period, issued, publicly or privately, more than $1.0 billion in non-convertible debt securities. We have elected to use the extended transition period until we are no longer an emerging growth company or until we choose to affirmatively and irrevocably opt out of the extended transition period. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements applicable to public companies.

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RESULTS OF OPERATIONS

Overview of Recent Financial Results

The following table presents selected financial results and measures:

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(1)See "Non-GAAP Financial Information" for reconciliation of non-GAAP measures to their most closely comparable GAAP measures.

(2)On a tax-equivalent basis assuming a federal income tax rate of 21% and a state income tax rate of 9.5%.

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Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022

For the year ended December 31, 2023, net income was $65.8 million, increasing by $9.4 million, or 16.6%, when compared to net income for the year ended December 31, 2022. Notable changes include the following:

•A $45.2 million increase in net interest income, primarily attributable to the increase in average interest-earning assets following the Town and Country merger and higher yields on interest-earning assets, partially offset by higher funding costs;

•Town and Country acquisition-related expenses totaled $13.7 million during the year ended December 31, 2023, including the recognition of an allowance for credit losses on non-PCD loans of $5.2 million and an allowance for credit losses on unfunded commitments of $0.7 million through provision for credit losses, compared to $1.1 million of acquisition-related expenses during the year ended December 31, 2022;

•Net losses of $1.8 million on the sale of $185.3 million of securities were realized during the year ended December 31, 2023 with the sales proceeds used to reduce FHLB borrowings and fund loan growth; and

•Excluding Town and Country acquisition-related expenses, noninterest expense increased by $19.2 million primarily due to the addition of Town and Country’s operations.

Net Interest Income

Net interest income equals the excess of interest income on interest earning assets (including discount accretion on acquired loans plus certain loan fees) over interest expense incurred on interest-bearing liabilities. Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on interest-earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is expressed as the percentage of net interest income to average interest-earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds, principally noninterest-bearing demand deposits and stockholders’ equity, also support interest-earning assets.

The following table sets forth average balances, average yields and costs, and certain other information. Average balances are daily average balances. Nonaccrual loans are included in the computation of average balances but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees and costs, discounts and premiums, as well as purchase accounting adjustments that are accreted or amortized to interest income or expense.

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(1)Net interest margin represents net interest income divided by average total interest-earning assets.

(2)On a tax-equivalent basis assuming a federal income tax rate of 21% and a state income tax rate of 9.5%.

(3)See "Non-GAAP Financial Information" for reconciliation of non-GAAP measure to their most closely comparable GAAP measures.

(4)Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(5)Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

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The following table sets forth the components of loan interest income and their contributions to the total loan yield.

The following table sets forth the components of net interest income and their contributions to the net interest margin.

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(1)On a tax-equivalent basis assuming a federal income tax rate of 21% and a state income tax rate of 9.5%.

(2)See "Non-GAAP Financial Information" for reconciliation of non-GAAP measure to their most closely comparable GAAP measures.

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Rate/Volume Analysis

The following table sets forth the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to changes attributable to volume (i.e., changes in average balances multiplied by the prior-period average rate), and changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both volume and rate that cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022

Net interest income for the year ended December 31, 2023 was $191.1 million, increasing $45.2 million, or 31.0%, from the year ended December 31, 2022. The increase is primarily attributable to the increase in average interest-earning assets following the Town and Country merger and higher yields on interest-earning assets, partially offset by higher funding costs.

Net interest margin increased to 4.09% for the year ended December 31, 2023, compared to 3.54% for the year ended December 31, 2022. The increase was primarily attributable to higher yields on interest-earning assets which were partially offset by increased funding costs, driven by significant increases in market rates since early 2022. Additionally, the contribution of acquired loan discount accretion to net interest margin increased to 9 basis points during the year ended December 31, 2023, from 2 basis points during the year ended December 31, 2022.

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The quarterly net interest margins were as follows:

In March 2020, the Federal Open Markets Committee (“FOMC”), in response to the economic downturn caused by the COVID-19 pandemic, lowered the target range for the federal funds rate to 0% to 0.25% and announced the Federal Reserve would substantially increase its Treasury and agency mortgage-backed securities holdings. This resulted in a historically low interest rate environment which lasted through the rest of 2020 and into 2021, putting downward pressure on our net interest margin over the same period.

The FOMC began raising interest rates in March 2022 and continued raising interest rates until setting the target range for the federal funds rate at 5.25% to 5.50% in its July 2023 meeting. As a result, market interest rates have also risen since March 2022 which led to improvements in our net interest margin through the first quarter of 2023. Our net interest margin decreased modestly beginning in the second quarter of 2023 as increased competition for deposits drove an increase in our funding costs. Competition for deposits continues to be elevated relative to 2022. As a result, deposit and funding costs have increased during 2023 compared to such costs in 2022 and could continue to increase. Additionally, core deposits balances may decrease and be replaced by higher cost funding sources, such as FHLB advances and brokered deposits.

Provision for Credit Losses

The following table sets forth the components of provision for credit losses for the periods indicated:

Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022

In connection with the Town and Country merger, we recognized an allowance for credit losses on non-PCD loans of $5.2 million and an allowance for credit losses on unfunded commitments of $0.7 million. Excluding the impact of the Town and Country merger, the remaining provision for credit losses primarily reflects a $2.4 million increase in required reserves driven by growth of and changes in the loan portfolio and unfunded commitments, a $1.4 million increase in required reserves resulting from changes in economic and qualitative factors, and a $2.1 million decrease in specific reserves on individually evaluated loans.

Credit losses are highly dependent on current and forecast economic conditions. Potential deterioration of economic conditions may lead to higher credit losses and adversely impact our financial condition and results of operations. The economic forecasts utilized in estimating the allowance for credit losses on loans and lending-related unfunded commitments include the unemployment rate and changes in GDP as macroeconomic variables, although other economic metrics are considered on a qualitative basis.

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Noninterest Income

The following table sets forth the major categories of noninterest income for the periods indicated:

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NM    Not meaningful.

Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022

Total noninterest income for the year ended December 31, 2023, was $36.0 million, an increase of $1.3 million, or 3.8%, from the year ended December 31, 2022. Notable changes in noninterest income include the following:

•A $3.8 million decrease in the mortgage servicing rights fair value adjustment, primarily due to changes in prepayment assumptions utilized in the valuations;

•Net losses of $1.8 million were realized on the sale of $185.3 million of debt securities during the year ended December 31, 2023. The vast majority of the securities portfolio acquired from Town and Country was sold during the first quarter of 2023 with an additional $39.4 million of municipal debt securities sold during the third quarter of 2023;

•The addition of Town and Country's operations in the first quarter of 2023 contributed to a $2.1 million increase in mortgage servicing revenue, with the size of our existing mortgage servicing portfolio nearly doubling, a $0.8 million increase in service charges on deposit accounts, a $0.7 million increase in wealth management fees, and a $0.7 million increase in card income; and

•A $0.5 million gain on foreclosed assets was recognized during 2023, primarily related to the sale of one property, compared to a $0.3 million loss on foreclosed assets during 2022.

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Noninterest Expense

The following table sets forth the major categories of noninterest expense for the periods indicated:

Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022

Total noninterest expense for the year ended December 31, 2023, was $131.0 million, an increase of $25.9 million, or 24.6%, from the year ended December 31, 2022. Notable changes in noninterest expense include the following:

•Town and Country acquisition-related noninterest expenses totaled $7.8 million and $1.1 million for the years ended December 31, 2023 and 2022, respectively;

•Excluding Town and Country acquisition-related expenses, the $19.2 million increase in noninterest expense was mainly attributable to the addition of Town and Country’s operations, primarily related to personnel costs, occupancy of bank premises, and data processing;

•Legal accruals totaled $1.0 million during the year ended December 31, 2023 and $8.2 million during the year ended December 31, 2022 relating to legal matters disclosed in Note 22 - Commitments and Contingencies - Legal Contingencies to the consolidated financial statements; and

•A $1.8 million increase in amortization of intangible assets related to the addition of $22.3 million of intangible assets recognized through the Town and Country acquisition.

Income Taxes

During the year ended December 31, 2023 and 2022, we recorded income tax expense of $22.7 million, or an effective tax rate of 25.7%, and $19.7 million, or an effective tax rate of 25.9%, respectively. The fluctuations in effective tax rate are primarily attributable to changes in state income taxes and changes in the proportion of federally tax-exempt interest income to pre-tax income.

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FINANCIAL CONDITION

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(1)See "Non-GAAP Financial Information" for reconciliation of non-GAAP measure to their most closely comparable GAAP measures.

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Notable changes in our consolidated balance sheet include the following:

•The Town and Country merger added $937.2 million in total assets, $635.4 million in loans held for investment, and $720.4 million in deposits;

•Excluding the impact of the Town and Country merger, loan growth since December 31, 2022 was broad-based with total loans increasing $148.8 million;

•Following the Town and Country merger, the vast majority of the securities acquired from Town and Country were sold and an additional $39.4 million of municipal securities sold during the third quarter of 2023. The proceeds were used to reduce FHLB borrowings and fund loan growth;

•Additionally, paydowns, maturities and calls of debt securities generated another $102.6 million of proceeds which were also used to reduce FHLB borrowings and fund loan growth; and

•Excluding the impact of the Town and Country merger, total deposits increased $94.0 million with the addition of $144.9 million of brokered deposits and $144.0 million of wealth management customer money market deposits brought on balance sheet in December 2023. These increases were partially offset by reduced balances held in existing customer deposit accounts.

Loan Portfolio

The following table sets forth the composition of the loan portfolio, excluding loans held-for-sale, by type of loan.

Loans, before allowance for credit losses were $3.40 billion at December 31, 2023, an increase of $784.2 million, or 29.9%, from December 31, 2022. Excluding the impact of the Town and Country merger, total loans increased $148.8 million, or 5.7%, with the following notable changes:

•The relative percent decrease in construction and land development loans was generally driven by the completion of a number of sizeable projects that are now amortizing and have been moved into other real estate loan categories, including the commercial real estate - non-owner occupied and multi-family categories;

•The increase in commercial and industrial loans was driven by new loan fundings and the purchase of four pools of loans totaling $61.0 million. Three pools include equipment finance loans purchased from a bank that originated the loans through its equipment finance division. These loans are to borrowers across multiple industries and geographic regions. The remaining pool is a 50% participation in a pool of loans originated by a financial services company with a long-standing history of originating loans to healthcare and professional service borrowers. These loans are to borrowers across multiple geographic regions.

As of December 31, 2023, office commercial real estate loans totaled $169.2 million, with 2.0% rated pass-watch, less than 0.1% rated substandard, and less than 0.1% past due 30 days or more. Management regularly monitors office and other industry concentrations within the loan portfolio.

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Loan Portfolio Maturities

The following table summarizes the scheduled maturities of the loan portfolio as of December 31, 2023. Demand loans (loans having no stated repayment schedule or maturity) and overdraft loans are reported as being due in one year or less.

The following table summarizes loans maturing after one year, segregated into variable and fixed interest rates.

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Nonperforming Assets

The following table sets forth information concerning nonperforming loans and nonperforming assets as of each of the dates indicated.

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(1)Prior to 2023, excludes loans acquired with deteriorated credit quality that are past due 90 or more days and accruing. Such loans totaled $145 thousand as of December 31, 2022.

Total nonperforming assets were $8.7 million at December 31, 2023, increasing by $3.5 million since December 31, 2022. The increase was primarily attributable to the Town and Country merger, which added $3.8 million in nonaccrual loans and $0.3 million of foreclosed assets, and one commercial real estate - non-owner occupied retail credit moved to nonaccrual. These increases were partially offset by the sale of one larger foreclosed property. Additionally, of the $7.9 of nonperforming loans held as of December 31, 2023, $2.6 million are either wholly or partially guaranteed by the U.S. Government.

Risk Classification of Loans

Our risk classifications of loans were as follows:

Pass-watch loans increased $31.3 million, or 46.7%, and substandard loans decreased $9.5 million, or 12.9%, from December 31, 2022 to December 31, 2023. The increase in pass-watch loans was primarily attributable to

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pass-watch loans acquired from Town and Country. The decrease in substandard loans was primarily attributable to $12.4 million substandard relationship in the commercial real estate – non-owner occupied category which paid off during the second quarter of 2023, as well as several other smaller paydowns and payoffs, partially offset by substandard loans acquired from Town and Country.

Net Charge-offs and Recoveries

The following table summarizes net charge-offs (recoveries) to average loans, before allowance for credit losses, by loan category.

The net charge-offs (recoveries) to average total loans ratio has remained low for several years. We believe our continuous credit monitoring and collection efforts have resulted in lower levels of loan losses, while also recognizing that favorable economic conditions prior to the COVID-19 pandemic and substantial federal economic stimulus during the pandemic have also contributed to reduced loan losses.

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Securities

The Company’s investment policy emphasizes safety of the principal, liquidity needs, expected returns, cash flow targets and consistency with our interest rate risk management strategy. The composition and maturities of the debt securities portfolio as of December 31, 2023, are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. Security yields have not been adjusted to a tax-equivalent basis.