Horizon Bancorp Inc
NASDAQ:HBNC
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Horizon Bancorp Inc
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Good morning, everyone, and welcome to the Horizon Bancorp, Inc. conference Call To discuss financial results for the Third Quarter of 2024. [Operator Instructions] Please note this event is being recorded.
Before turning the call over to the 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 Security 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 Executive Officer and President, Thomas Prame. At this time, I would like to turn the call over to Mr. Thomas Prame. Please go ahead, sir.
Good morning, and thank you for participating in today's call. We are pleased to share our third quarter results that display another quarter of positive net income growth, highlighted by expansion of net interest income and fee income, combined with excellent credit quality. Horizon's positive third quarter results displayed on Page 4, reflect the organization's commitment to continue to enhance our financial performance. The quarter reflected continued growth in our revenue models, driven by a fourth consecutive quarter of expanded net interest income and continued fee income growth. Average loan growth for the quarter was solid at 10% annualized, coming off the strong late June production we previously reported.
It also reflects a continuation of our strategy to grow our core commercial portfolio, coupled with a planned runoff of lower yielding auto loans. The team remains very confident on its ability to find ample lending opportunities to grow in our local markets, while maintaining our positive credit trends displayed throughout 2024. Horizon's deposit portfolio displayed solid growth, with stability in its core noninterest-bearing balances and the franchise realizing the benefits of its commercial and consumer deposit gathering efforts. The granular and tenured deposit base continues to showcase very strong and sticky trends with overall deposit costs increasing slightly.
As our third quarter results displayed, the company has positive momentum on many fronts through a more productive balance sheet, revenue growth and excellent credit metrics. The quarter did reflect slightly elevated expenses that as John will discuss in his presentation, we expect to transition back to more normalized levels as we approach 2025. And Additionally, within today's presentation, John will also be sharing detail on strategic actions initiated in the fourth quarter which will further advance our efforts to create long-term shareholder value and significantly improve our operating performance in 2025. As highlighted in my opening comments, we're very pleased with the success in the quarter in average loan growth revenue expansion and continued excellent credit quality. To provide additional insight on our lending performance, I'll transition the presentation to our Executive Vice President and Chief Commercial Banking Officer, Lynn Kerber.
Thank you, Thomas. Beginning on Slide 5, we have an overview of the loan portfolio as of September 30 with a mix of 60% commercial, 17% residential and 21% consumer, reflecting our strategic shift in loan portfolio mix. Average loans increased 10% annualized from the linked quarter. However, period-end loan growth was flat with primary growth predominantly in commercial loans and mortgage loans, coupled with a continued decline in lower yielding auto loans. Transitioning to some detail on each portfolio. We have commercial loans highlighted on Slide 6. For the third quarter, commercial loans increased $9.5 million, representing 1.3% growth on an annualized basis. Initial loan fundings were generally consistent with typical activity levels. However, net total commercial loans were impacted due to the previously noted acceleration of production in the second quarter results, and a higher-than-average payoffs and line of credit pay-downs in the third quarter. The core commercial pipeline continues to be stable with opportunities for growth in traditional commercial categories. And the ramp-up of our equipment financing division.
Our equipment finance division has been well received and is meeting our expectations for new originations. We are continuing to focus our efforts on opportunistic growth and continued asset quality. Activity continues to be well diversified by industry and geography and our portfolio mix to be consistent with our overall portfolio composition. Commercial credit quality remains strong with past dues at September 30 of 3 basis points, nonperforming loan ratio of 24 basis points and net recoveries of $58,000, year-to-date 2024. Turning to Slide 7. Consumer loan balances decreased $43 million during the quarter, reflecting our planned reduction in the indirect auto. The mortgage portfolio grew $3 million, representing 2% annualized growth. Overall, credit quality remains satisfactory in the consumer and mortgage portfolios with delinquency and charge-offs within targeted ranges. Our asset quality metrics continue to be strong, as outlined on Slide 8. Substandard loans of $59.8 million represented 1.24% of loans reflecting an increase for the quarter of $8.6 million. While there is an increase for the quarter -- so several of the downgrades are viewed as temporary in nature and expected to resolve through loan payoffs and/or improving performance. Nonperforming loans increased in the quarter to $24.4 million representing 51 basis points of total loans.
This increase was principally attributable to 2 larger home equity loans totaling $1.7 million a $2.6 million single credit in the commercial portfolio and $602,000 in mortgage portfolio. While an increase one home equity loan has already been paid off and remaining loans of adequate collateral and engaged borrowers with working with our lenders. The results in the third quarter remain within historical ranges and comparable to our peer group performance. And we do not expect this moderate change to materially impact our outlook for charge-offs at this time. Net charge-offs for the third quarter were $375,000, reflecting a decrease from our most recent quarters and representing 3 basis points on an annualized basis. Charge-offs year-to-date remain predominantly in the consumer indirect auto portfolio.
Finally, our allowance for credit losses modestly increased by approximately $700,000 in the quarter to $52.9 million resulting in an allowance to loan ratio of 1.10%. The increase is primarily reflective of adjustments or economic forecast, an increase of $177,000 in specific reserves. Provision expense of $1 million is a combination of the allowance increase and replenishing the reserve for third quarter charge-offs of the $375,000. Future reserve amounts and related provision will be driven by loan growth and mix, economic forecast and credit trends. Overall, we feel our portfolios are performing well. And the reserve is adequate based on current and forecasted charge-off trends. Now I'd like to turn things back to Thomas, who will provide an overview of our deposit trends.
Thank you, Lynn. Moving on to our deposit portfolio displayed on Slide 9. Horizon's core consumer and commercial balances increased in the quarter, highlighted by continued stable noninterest-bearing deposit balances. Our diverse branch network across Indiana and Michigan, combined with the recently added resources to our treasury management team are making solid strides gathering new relationships and expanding wallet share within our core markets. Additionally, the company continues to take a practical approach to public funds, focusing on operating relationship while balancing pricing and duration in the portfolio. We anticipate this portion of the deposit portfolio to benefit the organization as rates decrease and further help improve our net interest income results going forward.
We believe the deposit portfolio will also continue to benefit the organization in a down rate environment with its granular composition and long-standing relationships in our local markets. The portfolio remains very stable with a significant portion of the balances and 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 third quarter highlights as well as the recent strategic initiatives the team has initiated in the fourth quarter. John?
Thank you, Thomas. Turning to Slide 10. As expected, the benefits of the late Q2 loan growth pulled through the averages in Q3. Which, in combination with another quarter of no purchases of investment securities led to a more favorable earning asset mix and modest expansion of the FTE net interest margin, up 2 basis points to 2.66%. This is the fourth consecutive quarter of sequential margin improvement and a trend we expect to continue for the foreseeable future. Looking ahead, excluding the Q4 actions discussed later in the presentation, our base case is anticipating NIM expansion in the range of 7 to 10 basis points in Q4 when compared with Q3. This expectation is based on the continued positive earning asset mix shift and the realized spread improvement from the September rate cut as evidenced by the reduction in our spot interest-bearing deposit costs to around 2.50% in early October from a high of 2.72% in the month of August.
We are assuming an additional 25 basis point rate cut in each of November and December which should continue to modestly benefit the net interest margin. Further in the presentation, we will provide insight into our Q4 security sales, which will be additive to these baseline assumptions. As you can see on Slide 11, it was another good quarter for the company on the fee income front, delivering $11.5 million in noninterest income, above the guidance range for the quarter. New business activity in our mortgage unit and strong momentum in our treasury management business were the primary drivers of the linked quarter increase.
Looking ahead to Q4, we continue to see positive momentum in our treasury management, mortgage and private wealth businesses. Though seasonal declines in mortgage may lead to a modest reduction in fee income relative to Q3 results. All in all, we are pleased with the progress we are seeing in our fee-generating businesses heading into 2025. And we'll continue to make strategic investments in these products. Moving to expenses on Slide 12. The reported results were above our prior expectations. The quarter was impacted by a few items that are not expected to be part of the company's long-term expense base, but are critical to achieving our strategic objectives. We anticipate Q4 results to also be impacted by a select few items as suggested in the guidance on Slide 15, but we do not expect Q4 to represent a quarterly run rate for our expenses in 2025. As the leadership team remains critically focused on generating positive operating leverage.
Turning to capital on Slide 13. As we noted last quarter, we saw some nice improvement in the company's capital ratios on the heels of improved profitability tempered period-end loan growth and continued runoff in investment securities. In consideration of similar organic trends and the Q4 actions we have announced further improvement in the company's capital ratios is expected over the coming quarters. As you can see on Slide 14, it has been a busy start to the fourth quarter, and we are pleased to announce the strategic actions you see on the left side of this slide. These include the sale of about $325 million in securities, our intent to sell the mortgage warehouse business and ongoing strategic tax planning.
In total, these actions will generate improved structural profitability on less balance sheet leverage and will simplify our business model, all with the aim of creating additional long-term sustainable value for our shareholders. Under a conservative set of assumptions, we will earn back the net after-tax loss in less than 4 years, which is well inside the weighted average life of the securities sold and will generate an incremental $0.12 of annual EPS accretion. As you can see on the right-hand side of the page, these actions will yield an immediate lift to our net interest margin, tangible book value per share our tangible common equity ratio and all profitability metrics.
Currently, the proceeds from the investment sales are being held in cash at the Fed. Which should add 8 to 10 basis points to the NIM in Q4, which is in addition to the base case NIM expansion previously discussed. Over the following few quarters, those proceeds will be reinvested in a combination of organic loan growth, selective securities purchases and to pay down wholesale borrowings. In 2025, upon the repayment of the $200 million in maturing FHLB advances, we would expect to see additional net interest margin expansion and further improvement in our tangible common equity ratio. Pro forma for all of these actions, all regulatory capital ratios will remain relatively unchanged when compared to September 30 figures.
Finally, turning to the outlook on Slide 15. While Q4 results will be noisy, as noted earlier, the intent is to give you our best view of the quarter while providing some clarity around some key line items for the coming year. In sum, we are encouraged by the financial outlook and positive momentum for the company as we look ahead. Specifically, as it relates to the balance sheet, end-of-period total loan balances are likely to be relatively unchanged from September 30, excluding warehouse balances. Core commercial growth will continue to be positive but be largely offset by the continued runoff of the indirect auto portfolio. Assuming the sale of the warehouse balances by year-end, total end-of-period loan balances are expected to be down low single digits.
Deposit balances are likely to be relatively stable as we continue to focus on core retail and commercial customers, but given our current liquidity position, we will continue to be more prescriptive around our appetite for higher-priced non-relationship balances. We are expecting total net interest margin expansion of 15 to 20 basis points in Q4 from the 2.66% reported in Q3. This would be inclusive of the contribution from the securities repositioning the balance sheet assumptions just noted and anticipated further rate reductions. This should drive an increase in net interest income in the upper single-digit percentage range for the quarter when compared with Q3. While expenses in Q4 are likely to approximate $42 million, this includes several items that are not expected to carry forward into 2025. As such, to provide some additional clarity on run rate expenses, our preliminary look at 2025 is consistent with current consensus expectations for the company.
Finally, the tax line is likely to be in a net credit position again for Q4. Driven by the realized net loss from the actions previously discussed. Therefore, we are providing an initial view of our expected effective tax rate for the full year 2025, which should be in the range of 10% to 12%.
With that, I'll turn the call back over to Thomas.
Thank you, John. I appreciate the insight in the quarter and the outlook for the fourth quarter activities. As we move into 2025 with a more productive balance sheet and a healthier core earnings engine. As the team has discussed today, we are very optimistic about the significant positive momentum for Horizon. We continue to expand our client base and brand in excellent growth markets in the Midwest, that are economically attractive for businesses and for individuals. Our core relationship-based loan growth is strong and aligned with our historical low credit risk profile. The core commercial and business portfolio continues to see ample growth options across a diverse geography and portfolio mix and will deliver positive benefits from remix out of lower-yielding consumer auto loans.
Additionally, the franchise maintained strong credit metrics, reflective of its disciplined operating model. The resiliency of our core deposit base maintained its great value with additional opportunity to improve our financial performance as rates decline. As outlined, the company intends to create further liquidity in the near term, providing optionality on balance sheet funding strategies heading into 2025. And Horizon has a lean an operating culture that consistently adapt to deliver long-term shareholder value. We see a bright future for Horizon as we prepare for 2025. Our relationship-based community banking model is strong and consistently improving in performance. The organization is taking strategic actions to create greater shareholder value through a more productive and efficient balance sheet, simplified business model and investment in core revenue models.
Additionally, we feel optimistic on the organization's go-forward direction and our ability to continually advance Horizon's financial performance. 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 Instructions] The first question comes from Brendan Nosal with Hovde Group.
Maybe just starting off here on the margin. A lot of moving pieces and can certainly do the mass on the 4Q improvement plus the FHLB piece. But just kind of curious where you see the margin kind of settling once all is said and done in 2025 -- and then how much additional benefit you're expecting across next year as the Fed continues to cut rates modestly?
Brendan, it's John. Thanks for the question. So rather than giving you a landing point for 2025, we'll just talk through some of the moving pieces. So as you noted, I think the guidance is pretty straightforward on where we generally expect Q4 to land. From there, we have a couple of things that are generally favorable to the margin outlook, so the continuation of the earning asset mix changes that you've been seeing, so core commercial loan growth, offset by lower yielding runoff in the loan portfolio, cash flow securities portfolio. Moving to higher-yielding assets, all of that will continue for the foreseeable future through '25.
So that's generally favorable rate cuts, we said in the prior quarter and continue to believe it to be true. Modestly favorable to the net interest margin. So however you assume those in your model, I think that would be our base case assumption around rate cuts. And then, of course, net of all the transactions that we see on Slide 14, we'll end up with a fairly high cash position. And so over the course of 2025, we would be looking to place those assets into higher-yielding assets as well placed the cash and higher-yielding assets as well. So I think generally, some favorable organic momentum on the margin and then, of course, you noted the benefit that we're likely to see just mathematically with the pay-down of the security of the borrowing position, excuse me, at the end of 1Q at the beginning of 2Q. So that will flow through the margin in the second quarter.
All right. Awesome. That's helpful color. One more for me before I step back. Just looking at AOCI for the quarter, certainly saw a nice improvement, which wasn't too shocking given what rates did across the third quarter. Can you happen to update us on the fair value of the HTM portfolio at [ 930 ]. Thanks.
Brendan, I don't have that number right off hand, but we can sure get back to you with that.
Our next question comes from Terry McEvoy with Stephens.
Maybe start with the number -- another NIM question for John. Just to help us kind of back into that 4Q guide. Do you have the yields on total maturities in the fourth quarter? I know CRE is 6.48 just so I can kind of compare that to the [ 6.30 ] October yield that was disclosed. And then thanks for providing the October interest-bearing deposit costs of [ 250 ], where do you see that headed in the fourth quarter, assuming the rate cuts that you discussed earlier?
Terry, thanks for the question. Are you talking about maturities in the loan portfolio? Was that what you were asking?
Yes. Yes. Thank you very much.
Yes, loans. Yes. So without assuming any material change in prepayments, the total maturities in the loan portfolio in the fourth quarter, generally around 6%. So there's some favorable roll-on roll-off effect of new production. As Lynn and her team are doing a really great job holding spreads. In terms of your question on the deposit costs, a nice realized beta you can see kind of from the peak. The peak 272 down to about a 250 range in the month of October here. We would expect a similar beta in these next kind of 25 or 50 basis points of cuts as we look forward. So depending on what you're assuming for your base case on rate cuts, I think you can apply a similar sort of roughly 40-ish 35, 40-ish beta to those incremental cuts.
Great. And then a question for Thomas. A lot of attention kind of on building capital and Slide 14, which are really important for the bank. But from your perspective, what are you seeing kind of internally and the progress internally? And what areas of the bank do you think have the most potential to call it, surprise on the upside over the next few years?
Thanks for the question. I appreciate it. As we've talked about strategically, we are really looking to simplify our business model and invest heavily in our, what I'll call our core community banking. We've made some really good strategic investments this year in treasury management, wealth and mortgage, which we're seeing the benefits there. And then also on our commercial side, the high range that we had late last year, early this year, those individuals are coming off their ability to go back and speak to some of their former clients. I would anticipate as we look at 2025, our loan growth to shift back into a growth mode that we saw in the first half of this year, probably not as strong as Q2, but on that average, and be in that mid- to high single-digit loan growth, which I think will be a breakout for us.
That includes the fact that we will have the churn of the lower yielding indirect auto on that. So just the natural churn of that portfolio would be a benefit. But, I wouldn't say we're going to see a dramatic shift in strategy. We have a really good glide path in front of us, and we'll just have more momentum behind it.
Next question comes from Nathan Race with Piper Sandler.
Just curious thinking about potential additional balance sheet actions. Obviously, your restructuring the AFS book, but just curious on thoughts around maybe restructuring the held to maturity portfolio as well and perhaps raising capital. Obviously, you've updated yourself more recently, but just be curious to hear any thoughts on that front?
Thanks, Nathan, for the question. First, on updating on our shelf, our shelf is our typical that we do. It just came at a time when some other institutions may have been talking about recent capital for different strategic actions on their balance sheet. From our standpoint, what we accomplished here in the fourth quarter really sets us up for a positive 2025. We also, as we said before, just our core organic engine and what we're going to see from an efficiency and productivity off the balance sheet. At this time, it wouldn't lead us to believe that we need to go raise capital and do something that differently with HTM. As always, we will look for opportunities to create shareholder value and if that comes into play, and we believe it's the right mix and return for our long-term value to shareholders, we would entertain that. But at this time, we're in a good position.
Okay. Great. And then just one clarifying question on expenses. There's different aggregators of consensus estimates. But John, just to clarify, we're thinking kind of high 150 range, maybe 160 for next year, on expenses?
Yes. I think the consensus number that we see is in that sort of 155 to 160 range, yes.
Okay. Great. And just be curious, just with the profitability improvement that you'll have on the balance sheet restructuring here in early 4Q and with the stock still trading kind of just north of tangible book, curious to hear your updated thoughts on share repurchases just as you continue to build capital with the repositioning and profitability improvement coming out of 4Q?
Yes, Nate, it's John. Thanks for the question. Like any other capital deployment activity, we're looking at -- we would look at that as well in a similar vein. I think you're right, we'll be in a position to evaluate capital alternatives for the foreseeable future with the improved profitability metrics we see in kind of the glide path that we see on the -- on the asset side, we should be in an excess capital position that we feel pretty comfortable with. But yes, we would just -- we'd be evaluating that with the same authorities and the same metrics that we would look at anything else.
The next question comes from Damon DelMonte with KBW.
I hope you're all doing well today. So I just wanted to circle back on the expense question. So kind of good -- good color and disclosure as to what to expect here in the fourth quarter and then also the outlook. But as we kind of think about where within the entire expense bucket, some of these expenses are coming through, is it kind of in the salary benefit line or the professional services. Could you just kind of give us a little guidance as kind of where we can assume higher run rates?
The mix will probably be evenly distributed between the 2 that you mentioned, the salary benefits and the third party.
Okay. And this is -- these are basically internal projects that you're kind of investing in today to kind of better position you guys and going forward into '25 and the expenses then leave the bank?
Exactly, how we're thinking it also.
Got it. Okay. Great. And then just with regards to credit and kind of how you're thinking about the reserve level here. I think it was 110 basis points, so up a couple from last quarter. Do you feel comfortable with this 110 level? Do you feel you need to maybe continue to add to it over the coming quarters as you continue to generate more commercial loan growth?
This is Lynn Kerber, thanks for the question. So relative to the allowance, as I've shared previous quarters, we really look at our overall portfolio mix. We've had some shifting this year as we've moved off some of our higher higher loss rate loans like indirect auto, for instance. So that's had some impact. As I mentioned in my prepared remarks, that has been a good portion of our charge-offs year-to-date. And so we have sort of that mix in the portfolio with the higher loss rates coming off. Our commercial portfolio has performed really well. As I noted, we've had year-to-date net recovery for charge-offs and the bank as a whole, 3 basis point annualized charge-offs for a year. So unless credit trend has changed or we have a significant change in economic outlook, I don't really see a significant directional change in the reserve at this point.
Got it. Okay. That's helpful. Yes, those are the only 2 questions I had. So thank you very much.
Our next question comes from Brian Martin with Janney Montgomery.
So someone might have been answered, but just on the the loan pipelines, Lynn, I guess, can you comment on just kind of where the commercial pipeline is today? And then I think you talked about the equipment finance, just kind of where the footings are on the equipment finance level today?
Sure. Our commercial pipeline has been very steady. Our initial fundings have been really close to average, plus or minus per quarter. So I'm really pleased with that, very stable on the equipment leasing division. And we had stated we are targeting roughly $100 million, $110 million this year. I believe we're just over $85 million as of September 30. So that's meeting our expectations and having really developing a nice cadence now that the team is fully assembled. So I think it's really relatively stable -- some of the noise that we had this quarter or last quarter really had to do with just some timing of some larger rather -- rather large loans.
Really at the end of the second quarter that probably wouldn't have otherwise gone in the third quarter and just the payoff and line of credit activity. Second quarter, it was in payoffs were much less -- then average. And third quarter, we saw an increase and they were higher than average. That payoff activity is really being driven by a customer's business model. So their project reach stabilization, they're either taking it to the secondary market or selling the property. So really just coming down to some movement in the portfolio based on customer activity.
Got you. Okay. That's helpful. And then in terms of the indirect portfolio, where does that portfolio land? I mean it was runoff this quarter. I guess, in terms of size, what do you expect that portfolio kind of shake out over time? Is it kind of a continued rundown here?
This is Thomas. I'll help you on that one. I'd estimate about $30 million to $35 million a quarter. Accelerated the last 2 quarters. But as we get to a smaller portfolio, the run rate will decrease a little bit.
Okay. All right. And then -- all right, yes. And then just maybe just secondly on the mortgage side, obviously, a nice lift here this quarter. I guess, given where we are with rates and seasonality, I guess, is the kind of the current level kind of a sustainable way to think about mortgage here in the near term?
I think as John put in some of his comments on the slide, we anticipate mortgage to be slightly down here in the fourth quarter with seasonality of the fourth and the first and then come back in the second quarter. So I wouldn't anticipate this to be a run rate. We've had a new leadership joined mortgage. It's increased our sales productivity and also helped us on the secondary market delivery. This quarter was a reflection of that, but we're moving a little bit more seasonality in Q4 and Q1.
This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.
Thank you. And again, thank you for participating in today's earnings call. As stated, the team is very productive in the third quarter, and we have a great start to the fourth quarter to significantly advance our financial performance as we head into 2025. I want to thank everyone again for your attendance today, and we wish you all the best in the upcoming holiday season. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.