Horizon Bancorp Inc

NASDAQ:HBNC

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, everyone, and welcome to the Horizon Bancorp, Inc. conference call to discuss financial results for the Second Quarter of 2024. [Operator Instructions]

Before turning the call over to management, please remember that today's call may contain statements that are forward-looking in nature. These statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those discussed, including those factors noted in the slide presentation. Additional information about factors that could cause actual results to differ materially is contained in Horizon's most recent Form 10-K and its later filings with the Securities and Exchange Commission.

In addition, management may refer to certain non-GAAP financial measures that are intended to help investors understand Horizon's business. Reconciliations for these measures are contained in the presentation. The company assumes no obligation to update any forward-looking statements made during the call. For anyone who does not already have a copy of the press release and supplemental presentation issued by Horizon yesterday, they can be accessed at the company's website, horizonbank.com.

Representing Horizon today are Executive Vice President and Senior Operations Officer, Kathie DeRuiter; Executive Vice President, Corporate Secretary and General Counsel, Todd Etzler; Executive Vice President and Chief Commercial Banking Officer, Lynn Kerber; Executive Vice President and Chief Financial Officer, John Stewart; Executive Vice President and Chief Administration Officer, Mark Secor; and Chief Financial Officer (sic) [ Chief Executive Officer ] and President, Tom Prame.

At this time, I would like to turn the call over to Mr. Thomas Prame. Please go ahead, sir.

[Thomas Prame, executive]

Good morning, and thank you for participating in today's call. As we begin this morning, I wanted to introduce John Stewart, Horizon's new Chief Financial Officer. John is familiar to many on the call from his various leadership roles in the financial services industry over the last 2 decades. He's done a tremendous job onboarding during the quarter, and we look forward to the many positive contributions he brings to our leadership team and organization. Thank you, John. And again, welcome to Horizon.

Horizon's positive second quarter results displayed on Page 4 reflect the organization's commitment to continually enhance our financial performance. The quarter reflected sequential growth in revenue and pretax pre-provision income, driven by a third consecutive quarter of expanded net interest income and margin, fee income growth as well as prudent expense management. Loan growth in the quarter was robust, driven primarily by our relationship-based commercial lending teams. This growth was complemented by consistent positive credit trends in non-performing loans and charge-offs.

The team continues to find ample opportunities to grow in our local markets while maintaining our positive credit trends through proactive portfolio management and maintaining a diversified lending portfolio. Horizon's deposit portfolio had a solid quarter, with stability in its core consumer and commercial relationships that was balanced with a cost-effective approach to public funds balances. The granular and tender deposit base displayed very strong trends in the quarter with resiliency and core balances and overall deposit costs increasing minimally. As our first quarter results displayed, the company has positive momentum on many fronts through a more profitable balance sheet, realizing investments in our fee income businesses and our well-managed expenses.

As highlighted in my opening comments, we are very pleased with the success in the quarter. A significant part of the success was loan growth and continued excellent credit quality. To provide additional insight into this part of our business model, I'll transition the presentation to our Executive Vice President and Chief Commercial Banking Officer, Lynn Kerber.

[Lynn Kerber, executive]

Thank you, Thomas. Beginning on Slide 5, we have an overview of the loan portfolio as of June 30th with a mix of 60% commercial, 17% residential and 22% consumer, which remains relatively unchanged from our prior quarter. Loan growth was strong in the quarter with an increase in loan balances of $205 million or 17.8% annualized. The growth reflected new production predominantly in commercial loans and mortgage loans while we deemphasize lower yielding consumer originations, consistent with our ongoing balance sheet repositioning. Our improving mix resulted in an average new production coupon of 7.93% for the second quarter. Commercial loans, including equipment finance increased $155 million, residential mortgage loans increased $16 million and consumer loans increased $22 million.

Transitioning to some detail on each portfolio. We have commercial loans highlighted on Slide 6. Commercial loans increased $154.8 million for the second quarter, representing 22.6% on an annualized basis. Loan fundings were very consistent with prior quarters. However, they were influenced by 3 larger loans that closed the last week of the quarter. Additionally, we experienced modest increased utilization on lines of credit, combined with a higher volume of previously closed construction loans funding within the quarter.

The pace of unscheduled payoffs flowed within the second quarter, which also helps commercial loan balances. The core commercial pipeline continues to be strong with opportunities for continued growth with the team remaining diligent on sound credit underwriting and pricing discipline. Activity continues to be well diversified by industry and geography, and our portfolio mix continues to be roughly 73% CRE and 27% C&I. You will note that our CRE non-owner-occupied ratio at 180%, and our CRE 3-year growth rate at 20% are conservative and compared favorably to the UBPR peer group ratio of 240% and growth of 55%. Commercial credit quality remains strong with low past dues, low non-performing loan levels and net recoveries of $3,000 year-to-date 2024.

With a heightened focus on the elevated interest rate environment, we've included a summary of maturing CRE loans for '24 and '25 on Slide 7. Maturing CRE loans with interest rates below 7% represent 4% of the portfolio for the remainder of this year and 6% for 2025. We believe rates and maturities are well managed in our CRE portfolio to limit exposure to rate-related credit risk at this time.

Turning to Slide 8. Consumer loan balances increased $22 million during the quarter, reflecting [ of an ] 8.4% annualized growth. The mortgage portfolio grew $16 million, representing 8.1% annualized growth. The focus remains on high credit quality borrowers with an ability to pay a significant equity in their homes. Overall, credit quality remained satisfactory in the consumer and mortgage portfolios with delinquencies and charge-offs within targeted ranges.

Transitioning to credit quality. Our asset quality metrics continue to be strong, as outlined on Slide 9. Substandard loans of $51.2 million, represented 1.06% of loans, which is well within the range of recent period end levels. Non-performing loans remained low and were relatively unchanged for the quarter at $19.3 million, representing 0.4% of total loans. Net charge-offs for the second quarter were $584,000, representing an annualized charge-off rate of 5 basis points with charge-offs predominantly in the indirect consumer loans.

Finally, our allowance for credit losses increased in the quarter to $52.2 million, primarily attributed to growth within the quarter and was offset by small reductions of dedicated specific reserves and economic forecast. Provision expense of $2.37 million was a combination of the ACL increase of $1.8 million, represented by loan growth and recognition of the modest quarterly charge-off of $584,000. The allowance represents 1.08% of total gross loans, which we believe is appropriate given credit performance and current economic forecasts. Future reserve amounts and related provision will be driven by loan growth and mix, economic forecast and credit trends.

Now I'd like to turn things back to Thomas, who will provide an overview of our deposit portfolios.

[Thomas Prame, executive]

Thank you, Lynn. And as always, great insight and information. As we mentioned earlier, we're pleased to see the positive momentum in our net interest margin. This momentum is partially a result of the strength and resiliency of our tenured and granular deposit base that's displayed on Slides 10 and 11.

Horizon's core consumer and commercial balances were consistent from the first quarter, highlighted by stable non-interest-bearing deposit balances. Additionally, the company continues to take a practical approach to public funds, focusing on operating relationships while balancing pricing and duration in the portfolio.

Our newly added resources to our treasury management team are making an impact, gathering new relationships and expanding wallet share for their core commercial lending clients. As currently positioned, we believe the deposit portfolio will benefit the organization in a down rate environment with its granular composition and long-standing relationships in our local markets. The portfolio is very stable with approximately 50% of the balances in relationship-based checking accounts with clients that know and trust Horizon well.

Let me hand the presentation over to our Executive Vice President and Chief Financial Officer, John Stewart, who will walk through some additional balance sheet highlights and other key financial metrics.

[John Stewart, executive]

Great. Thank you, Thomas. As noted on Slide 12, there were no purchases of investment securities during the quarter, which was the primary driver of period-end balances declining by about $30 million, while the fully tax equivalent portfolio yield was unchanged when compared to the last quarter at 2.39%. Going forward, you can expect similar trends to continue for the foreseeable future as cash flows from the portfolio are profitably redeployed elsewhere on the balance sheet. At the bottom of the slide, you can see the anticipated cash flows for the next 4 quarters as well as the expected FTE roll-off yield, which is a new disclosure we hope you will find helpful.

Turning to Slide 13. The benefits of the asset repositioning strategy were again evident this quarter, driving a favorable shift in the mix of earning assets, which coupled with disciplined loan pricing and well-controlled interest-bearing funding costs drove a 14 basis point increase in the FTE net interest margin during the quarter to 2.64%. This result was better than anticipated, which drove net interest income to the higher end of the guidance range for the quarter. Looking ahead, you'll note that end-of-period loans are well above the average, which bodes well for both net interest income growth and modest further NIM expansion in Q3, even as funding costs will see a bit more lift relative to Q2 to fund that growth. Beyond Q3 into Q4, the NIM expansion likely moderates some, absent any rate cuts or meaningful changes further out on the curve.

As you can see on Slide 14, it was a relatively good quarter for the company on the fee income front, delivering $10.5 million in revenue near the upper end of the guidance range for the quarter. Seasonal increases in both interchange fees and mortgage gain on sale drove the linked quarter increase. Looking ahead to the remainder of the year, targeted hiring and treasury management, mortgage and private wealth should continue to deliver positive momentum. We would expect fee income to run rate in the $10.5 million to $11 million range per quarter for the remainder of the year.

As evident on Slide 15, it was a good expense quarter for the company, coming in at the low end of the prior guidance. Seasonal declines in occupancy expense and well-controlled outside services expense were generally offset by additional hiring and related expense in the quarter, volume-driven loan fees and elevated levels of operational loss. Looking ahead, while investments in the business will drive the quarterly expense run rate modestly higher in the second half of the year, we would remain disciplined in our approach and therefore, continue to expect annualized expenses to remain less than 2% of average total assets, even with the slowing asset growth we noted earlier.

Turning to capital on Slide 16, we saw some modest compression in risk-based ratios as strong loan growth late in the quarter helped drive risk-weighted asset growth from Q1. That said, we continue to feel good about the company's capital position. With slower growth anticipated for the back half of the year relative to the first and continued runoff in investment securities, as previously noted, we'd expect all regulatory capital ratios to increase from here over the second half of the year.

Finally, turning to the outlook on Slide 17. Now that the reinvestment activities from the securities sale in Q4 of 2023 have been completed, we are moving towards a higher level outlook methodology, which provides you with our current view for the remainder of the year. You can see the key balance sheet assumptions articulated in the first 2 sections on the slide. In short, loan and asset growth is expected to moderate from the recent pace and deposits should remain relatively stable. Excluding any impact from rate cuts, we would expect modest further NIM expansion in Q3 as the average earning asset mix will benefit from loan growth late in the second quarter.

As mentioned previously, the pace of Q4 NIM expansion will likely moderate, again, excluding any impact from rate cuts. Combined, we would anticipate net interest income to grow in the upper single-digit range for the second half of 2024 when compared with the first. Fee income should continue with some positive momentum through the second half of the year with the quarterly run rate in the $10.5 million to $11 million range. While quarterly expenses in the second half of the year will increase modestly from $37.5 million reported in Q2, they are expected to remain less than 2% annualized of average assets. Finally, the effective tax rate for the full year should be in the 9.5% to 10% range.

With that, I'll turn the call back over to Thomas.

[Thomas Prame, executive]

Thank you, John. As outlined in our presentation, we see continued positive momentum for the Horizon for the second half of 2024. We are in excellent growth markets in the Midwest that are economically attractive for businesses and individuals. Our loan growth is strong and aligned with our historical low credit risk profile. The commercial pipeline continues to be positive and the benefits of the cash flows from our securities portfolio will allow for positive reinvestment across the balance sheet.

The resiliency of our core deposit base maintains its great value with additional opportunity to help improve our financial performance as rates decline. The company also continues to have significant funding capacity if needed. Horizon has a lean and operating culture that consistently adapts to its markets and its environment to deliver long-term shareholder value. We are strategically investing in improving our revenue models, maintaining our excellent credit profile and capturing efficiencies and how we deliver our products and our services. And lastly, we believe Horizon is still a very compelling value, supported by our 30-plus years of commitment to our dividend and recently offering a 4.2% dividend yield.

As always, we thank you in advance for joining our presentation this morning. This concludes our prepared remarks, and I'll ask our operator to please open the lines for questions.

[Operator]

[Operator Instructions] The first question comes from Terry McEvoy with Stephens.

[Terence McEvoy, analyst]

Maybe just start with the margin outlook. Could you talk about the assumption for interest-bearing deposit costs? It looks like last quarter, you had a nice benefit from lower time deposits now averaging below 4%, but it looks like kind of your promo rates are 4% to 5% when I just look at your website. So it'd be helpful if you could kind of run through the underlying assumptions there.

[John Stewart, executive]

Terry, thanks for the question. It's John. Yes, so we exited the quarter, as I noted in the prepared remarks, we had some pretty strong loan growth in the end of the quarter that was corresponding with some pretty strong funding growth to the other side of the balance sheet. So as we think about the starting point for interest-bearing deposit costs, if you will, into the beginning of this quarter, they're in -- they were [ 256 ] if you kind of run through them in the second quarter. They're in the low [ 260s ] as a starting point for this quarter.

[Terence McEvoy, analyst]

And then I apologize if this is the presentation, but could you talk about any purchases of the jumbo mortgages, did that occur in the second quarter? And then it looks like there was C&I growth. How did leasing come into play in Q2 as well?

[Thomas Prame, executive]

[ Thanks again, Terry ]. As you look at our second quarter, John's comments earlier, we mentioned the fact that we're done with the redeployment strategy around the security sales in the fourth quarter. In the second quarter, if you look at our transactional portfolios, including our indirect auto, that portfolio was up about $20 million. So the aggregate growth of $200 million, about 90% of it was through our organic franchise.

I'll pass over to Lynn to talk a little bit about leasing specifically.

[Lynn Kerber, executive]

Good morning, Terry. How are you?

[Terence McEvoy, analyst]

Great. Thanks, Lynn.

[Lynn Kerber, executive]

Regarding leasing, our team is really ramping up very nicely. As you know, we had most of our funding in the first quarter kind of late in the quarter. Second quarter was really spread more throughout the quarter and really ramping up and shaping up nicely for Q3. I think I had shared previously, we were targeting $110 million, $120 million for the year. And I would say, at this time, we're on pace to achieve that.

[Terence McEvoy, analyst]

Thanks for that. And I'd just note your positive credit trends stand out this morning based on a few other things I've evaluated which has taken up my time. Thank you for taking my questions.

[Operator]

Our next question comes from Nathan Race with Piper Sandler.

[Nathan Race, analyst]

Just curious as you think about kind of the loan growth drivers for the back half of the year, I think the guidance is kind of low to mid-single digits. Just curious in terms of how you guys expect to achieve that as a continued C&I and leasing growth or any other factors that go into play there?

[Lynn Kerber, executive]

Yes. Thanks for the question. Our fundings have been -- new loan fundings have been very consistent year-over-year. And when I reviewed first and second quarter this year compared to last year, the new funding or initial funding model is very consistent. We did see a little bit of timing difference between Q1 and Q2. And I don't know that that's going to always be the same rate as Q2, right? There are some changes from quarter-to-quarter.

But as we look towards the end of the year, there are some things that we're looking at. The initial fundings, I think, will be pretty consistent. But as noted in my prepared remarks, we are having some construction funding right now on previously approved loans. So I expect that that's going to continue during the building season in Michigan and Indiana. We've also had some slowdown and unscheduled payoffs, I think, primarily with the rate environment. So I would say, generally, our outlook is good. If rates start to be reduced towards the end of the year, that could spark some additional activity.

[Nathan Race, analyst]

Okay. Great. And then just in terms of funding net loan growth in the back half of the year, I appreciate you have disclosures on Slide 12 in terms of the quarterly cash flow coming off the securities portfolio. Should that support the large amount of loan growth in the back half of the year? Do you guys see a need to maybe test some wholesale sources just given kind of the stable deposit outlook over the next couple of quarters?

[Thomas Prame, executive]

Yes. Thanks, Nathan, again, for the question. As you look at our loan growth in the mid-single digits overall in the portfolio, as we mentioned earlier, it's primarily going to be driven on the commercial side with the mix within that commercial growth, representing what the portfolio already looks like, that's going to be complemented by our continued mix change that we talked about at the top of the house, taking lower-yielding consumer assets, letting those go to cash and then being able to fund a lot of the growth in commercial. That combined with the securities run out that John outlined upfront, that's going to give us more and enough liquidity to fund any type of loan growth without really having to have significant deposit growth for the remainder of the year.

[Nathan Race, analyst]

Okay. Great. Very helpful. And if I could just ask one more on the appetite for share repurchases going forward. We had some growth in TCE, but it seems like you guys are still seeing good organic growth opportunities as well. I know the stocks went up over the last several weeks, similar to the group. But just any updated thoughts, Thomas, on perhaps reengage on repurchases going forward?

[Thomas Prame, executive]

Yes. Thank you, Nathan. We also recognize that the math could be really appealing right now for potential stock buyback and/or securities repositioning. Again, we're going to continue to evaluate the capital allocation options throughout the remainder of the year as our earnings momentum continues and we continue to grow capital levels. We're going to remain diligent and examining all potential options with our primary focus is going to be on making sure we deliver shareholder value.

[Operator]

Next question comes from Damon DelMonte with KBW.

[Damon Del Monte, analyst]

Hope everybody is doing well. And welcome aboard, John. So first question, just kind of regarding the margin outlook. I kind of took from the commentary that you're caveating it with no changes to rates, but what happens if the Fed does cut rates here in the back half of this year? And then a few times as we go through '25, how would you expect the margin to respond to that?

[John Stewart, executive]

Yes. Damon, thanks for the question. Yes. So as the outlook articulated, there's one 25 basis point cut in the middle of the year, so that doesn't have much of -- a middle of the fourth quarter, excuse me, so that doesn't have much of an impact on the outlook for this year. As we look at the balance sheet today, on a static balance sheet, a 25 basis point rate cut is marginally accretive to the NIM. That would be our expectation in the preceding 30 days. So if you just kind of work through the balance sheet, we've got about 25% of our loans that will reprice inside 30 days on the very front end of the curve, not much in securities and the cash position, you can see that there is not a meaningful contributor.

On the other side of the balance sheet, there's not a lot of contractual repricing on the liability base outside of the trust preferreds. So how much margin lift we get from 25 basis points really comes from our ability to manage down non-maturity interest-bearing deposit costs. The team around here has got a lot of experience doing that. Our expectation would be that we could do so such that rate cuts are accretive to the margin in the immediate term. Absent rate cut, you look over the course of the year over the next 4 quarters to 6 quarters, I should say, a lot of the dynamics that you saw in place this quarter will remain in place. As Thomas just mentioned, there's a positive earning asset mix shift that will take place. There's no plan to reinvest securities cash flows. So those will [ be the role ] to cash for fund loans, that's accretive on the earning asset side, absent any rate cuts.

And then while the deposit base or the funding side becomes a little harder to predict, looking out that far, again, I think all things being considered with the growth and the dynamics that we see in the balance sheet today, no rate cuts are probably marginally accretive to the NIM outlook over the foreseeable future. I might not necessarily be in a straight line as there are some timing differences between cash flows and maturities, but generally over that time frame, I think that is a reasonable expectation.

[Damon Del Monte, analyst]

Got it. That's great color. And then it's my second question. The credit trends have obviously remained very strong. As you kind of think about the provisioning here in the back half of the year, do you feel like kind of the average of the first 2 quarters is a reasonable quarterly run rate? Or do you think maybe there's some underlying trends that are starting to percolate a little bit and you think you need to kind of keep a little bit higher level?

[Lynn Kerber, executive]

Yes. In regards to the ACL, I don't know if you participated in the Q1 call that we had some rebalancing of our balance sheet and change in mix that affected the first quarter. I would say, generally speaking, both Q1 and Q2, we had the release of some dedicated specific reserves. So I don't know that I would do an average of those necessarily. But as far as factors driving it going forward, I think principally at this point is going to be driven by loan growth, as you can see for this quarter. And our credit metrics have been really solid. And so we're just going to continue to monitor those as I think it's going to be primarily driven by growth and the economic forecast.

[Damon Del Monte, analyst]

Got it. Okay. Great. That's all that I had. Everything else was asked and answered.

[Operator]

The next question comes from Brian Martin with Janney Montgomery.

[Brian Martin, analyst]

Just one question on the margin. I think Damon just asked my question. But the -- in terms of where the margin ended the month about the quarter, can you just tell us where you exited the quarter in the month of June on the margin?

[John Stewart, executive]

Brian, the margin in the month of June was pretty consistent with the quarter overall. But as Lynn noted in her prepared remarks, and you can see in the end of period balance sheet versus the average most of the growth came right at the end of the quarter. So -- but for the month of June, the margin was pretty consistent with the full quarter of 2.64%.

[Brian Martin, analyst]

Got you. Okay. Yes. And just in terms of credit, I guess, like I said, everything looks really nice. In terms of anything on the Horizon in terms of looking at the C&I portfolio, is there -- can you talk about just kind of any trends you're seeing within that C&I portfolio is still very healthy. Is there anything to be mindful of as you kind of trend forward here?

[Lynn Kerber, executive]

Yes. Well, so as you can see, our overall metrics are solid. Our commercial past dues have been extremely low in a net recovery position this year. I will tell you that third and fourth quarter of last year, we saw some impact on some of our C&I customers with the revenue run rate. Fortunately, we've got some very well-seasoned customers, and they've made some changes to their business models. So at this point, we're seeing some of them start to actually improve from what we saw in the third and fourth quarter with some other revenue rates. So I'm not seeing anything overly concerning at this point.

[Brian Martin, analyst]

Okay. And then just, I guess, one other thing was -- actually, it was already asked and answered. So I'm all good.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

[Thomas Prame, executive]

Thank you, Megan. Again, thank you for participating in today's earnings call. The team had a very productive second quarter with positive momentum in our key earning metrics heading into the second half of 2024. We appreciate your attendance today, and we look forward to our next quarterly update.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.