Horizon Bancorp, Inc. (NASDAQ:HBNC) Q1 2024 Earnings Call Transcript

Horizon Bancorp, Inc. (NASDAQ:HBNC) Q1 2024 Earnings Call Transcript April 27, 2024

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Operator: Good morning everyone, and welcome to the Horizon Bancorp Inc. Conference Call to discuss financial results for the first quarter of 2024. All participants will be in the listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] 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 and 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, 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.

Thomas Prame: Good morning and thank you for participating in today’s call. Horizon had a solid start to the year with our second consecutive quarter of expanded net interest income both in dollars and in the margin. Net interest margin for the quarter was 2.5% with continued improvement throughout March, exiting the quarter at 2.53%. Additionally, our results showed non-interest income continues to perform well across our diversified operating model even with the seasonality of lower mortgage volumes. Expenses were well managed in the quarter with the results at the lower end of our guidance as the team continues to be diligent in capturing cost savings. Credit performance and trends remain positive with minimal charge-offs, and low nonperforming loans through continued proactive portfolio management.

As seen in the first quarter, the franchise experienced significant loan growth on several fronts, both in our core business lines and our previously communicated asset repositioning strategy. We are very proud of the results of all of our teams this quarter, displaying the diversity of our lending platforms across our footprint and the capability of our team to deploy our excess liquidity into high-quality and higher-yielding assets and improving our go-forward asset mix. Additional insight and detail into our loan growth will be shared by Lynn in the lending and credit sections later in our presentation. We are also optimistic about our deposit portfolio results that displayed very strong trends in the quarter with the continued resiliency in core balances, deposit cost increasing just 9 basis points from year-end and the modest runoff in the first quarter was primarily attributed to the company’s decision to reduce segments of its high-cost public funds portfolio.

Our first quarter results provide optimism on our go-forward financial outlook as we move into the second quarter with a positive trajectory continuing in margin and improved balance sheet positioning, well-managed expenses, and continued solid credit trends. As we move forward, a key element of our positive outlook is the strength of our core lending platforms and to provide more detail in this segment of our business model, I’ll transition the presentation to Lynn Kerber, our Executive Vice President and Chief Commercial Banking Officer, to provide details. Lynn.

Lynn Kerber: Thank you, Thomas. Beginning on Slide 5, we have an overview of the loan portfolio as of March 31, with a mix of 60% commercial, 17% residential, and 22% consumer, which remains relatively unchanged from the prior quarter. Commercial loans increased $75 million, which includes $23 million in equipment finance activity, residential mortgage loans increased to $101 million and consumer loans increased to $13 million. First quarter loan growth included $154 million in acquired loans, including approximately $59 million of consumer loans with credit protections, $95 million in residential, and the reduction of $39 million of indirect auto loans. These actions represent our planned redeployment of proceeds from December’s balance sheet restructuring into high credit quality and higher-yielding assets.

On Slide 6, we are pleased to report commercial loans increased to $74.8 million for the first quarter, representing 11.2% on an annualized basis. Net funding, including equipment finance, totaled $110 million for the first quarter compared to $117 million for the fourth quarter. We saw a meaningful increase in the average commercial loan portfolio yield in the first quarter, increasing to 6.14% from 6.05% in the fourth quarter. Also, new production yields were 7.52% in the first quarter. The core commercial pipeline increased from $167 million at December 31 to $187 million as of March 31. Activity continues to be well diversified by industry and geography. The equipment finance division contributed approximately $23 million in originations in the first quarter and will be continuing to ramp in the second quarter.

We continue to anticipate a total contribution of $100 million to $125 million for the full year 2024. Commercial credit quality remains strong with low past dues of 18 basis points for quarter end comparing to 16 basis points at December 31 and 16 basis points for March 2023. Nonperforming commercial loans decreased 27% in the quarter due to the payoff and upgrade of several non-accrual and substandard loans. Accordingly, we recorded commercial net recoveries of $57,000. Also provided for reference on Slide 7 is a breakdown of key sectors in our commercial portfolio which demonstrates no significant concentration in any one sector, and particularly multifamily non-owner occupied office and healthcare. As noted, the percent of risk-based capital is consistent with the UBPR peer group and well within regulatory guidance.

With continued focus on the interest rate environment for 2024, we have included a summary of maturing CRE loans for 2024 and 2025 on Slide 8. For the remainder of 2024, we have 277 notes with current balances of $213 million maturing representing 10.9% of our portfolio. Of this tranche, there are balances of $101 million with interest rates of less than 7% representing 5.2% of our CRE portfolio. Similarly, 2025 has 240 notes maturing with balances of $188 million maturing representing 9.6% of the portfolio. Of this tranche, there are balances of $123 million with rates of less than 7% representing 6.3% of our CRE portfolio. In all, this is another example of how Horizon benefits from our longstanding commitments to pricing discipline and 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 9. You will see that consumer direct loan balances increased $52 million during the quarter, reflective of previously mentioned acquired home improvement loans and continued reduction of auto loans by $39 million in the quarter. These actions are consistent with our stated strategy of limiting loan production that no longer meets our risk-adjusted return target and redeploying capital to higher-yielding improved credit products. The average consumer direct yield was 8.23% for the portfolio with an average of 8.92% for new production. The average yield for consumer indirect was 3.28%, which is consistent with recent quarters. Consumer direct past dues improved in the first quarter with delinquency of 0.76%, a reduction from 1.3% at December 31 and a continuation over the past six-month period.

Indirect loans recorded past dues of 1.12%, also a reduction from 1.49% at December 31 and the six-month trend. Year-to-date net charge-offs for consumer direct are 4 basis points and an annualized rate of 17 basis points and consumer indirect were 7 basis points, an annualized rate of 28 basis points, which represents an improvement from Q4 charge-offs. Slide 10 highlights our mortgage loan performance for the quarter. Our portfolio grew $101 million in the quarter, in part due to approximately $95 million of acquired high-credit quality residential mortgages. We expect residential mortgages to benefit from seasonality during the second and third quarters with both purchases and new construction. The average mortgage loan yield was 4.53% for the portfolio and 7.25% for new production.

With net recoveries for the quarter, this portfolio continues to reflect quality homeowners, the significant payment capacity and equity in their homes. Our asset quality metrics continue to be strong as outlined on Slide 11. Past dues over 30 days were 0.33%, a slight improvement from the prior quarter. As noted earlier, both direct and indirect consumer loans recorded lower past dues for this quarter, offset by an increase in residential mortgage loans. Non-performing loans decreased slightly from $20.3 million to $19.2 million, representing 41 basis points, a reduction from 46 basis points as a percentage of total loans. The decrease was driven principally by a reduction in commercial loans and nonperforming loans. Net charge-offs for the first quarter were $426,000, representing 1 basis point of average loans on an annualized rate of 4 basis points.

This was also an improvement over the third and fourth quarters of 2023. Finally, our allowance for credit losses increased $357,000 in the quarter to $50.4 million as of March 31. The increase is the net effect of loan growth reductions due to loan product mix, shifting to portfolios with lower historical loss rates, economic forecasts, and the elimination of dedicated specific reserves related to commercial loans that paid us in full during the first quarter. Provision expense of $804,000 is a combination of the allowance increase of $357,000, unfunded commitments, and replenishing the reserve for charge-off loans in the first quarter. The allowance represents 1.09% of total gross loans, which we believe is appropriate given credit performance and current economic forecasts.

Future reserve amounts and related provisions will be driven by loan growth and mix economic forecasts and credit trends. Credit quality across all of our lending classes is performing well and it reflects our history of a consistent and well-balanced approach to lending. Now I’d like to turn things back to Thomas, who will provide an overview of our net interest income trends.

Thomas Prame: Thank you, Lynn. Great insight and information. As mentioned earlier, we are pleased to see the positive momentum in our net interest margin through our strategic efforts to reposition our balance sheet to higher-yielding and higher-quality assets, also, while maintaining a disciplined approach to deposit pricing. To help illustrate the progress on our margin, we have included a waterfall graph on Page 12. As seen, the deliberate shift from lower-yielding assets to high-quality loans is making a meaningful impact on our asset yields, increasing by 19 basis points in the quarter. We expect this positive trend to continue into the second quarter as higher-yielding new production continues to replace lower-yielding amortization and cash flows from the securities portfolio.

Also within the first quarter, we experienced softer demand for swap fee income and overall commercial loan fee income was down due to the seasonal nature of payoffs and we expect this to even out over the course of the year. As I stated in my opening remarks, Horizon’s deposits and funding costs were well-managed throughout the quarter. Horizon’s core consumer and commercial balances were flat from the fourth quarter with single-digit increases in funding costs. Non-interest-bearing deposits experienced minor seasonal fluctuations, primarily due to commercial tax payments and year-end distributions, and the company elected to leverage its excess liquidity to reduce its public funds portfolio by allowing higher-priced CD maturities to flow off the balance sheet.

With this backdrop, our first quarter interest-bearing liability costs increased a modest 5 basis points for the quarter and purchase accounting adjustments were relatively flat compared to the fourth quarter. As we enter the second quarter, we have confidence in our ability to continue to improve our net interest margin even in a flat rate environment. We expect to see further expansion in the second quarter. As stated, March posted a continued advancement of 2.53% in net interest margin and the team continues to remain diligent on improving our asset mix and yields while keeping a measured approach to funding costs. Let me hand the presentation over to our Executive Vice President and Chief Financial Officer, Mark Secor, who will walk through other key financial metrics from the first quarter and our outlook as we move forward, Mark.

Mark Secor: Thank you, Thomas. Beginning with Slide 13, total non-interest income for the first quarter was in line with the first three months of 2023, with the largest segment being account service fees, up approximately 7.5% from the first quarter of 2023. Non-interest income was down from the adjusted linked quarter due to a decrease of $360,000 in BOLI income resulting from the policy surrendered at the end of last year and with lower mortgage banking income. The company continues to diversify core fee income through key talent adds in treasury management and expanded private wealth capabilities and anticipates growth in these non-interest income segments throughout the year as we expand our relationship banking model. On Slide 14, the first quarter results displayed our commitment to diligent expense management.

Non-interest expenses were 1.9% of average assets annualized for the first quarter, compared to 1.94% in the linked quarter. The decrease reflected overall proactive expense management across the franchise. We do expect expenses to be in the range of $37.5 million to $38.3 million in the second quarter, reflecting a full quarter of merit increases and new talent in the equipment finance division. Slide 15, Horizon continues to maintain solid regulatory capital ratios that are well above the requirements to be considered well capitalized. We believe we have sufficient capital to be open to options to improve our earnings outlook in the future quarters and anticipate that growth in capital will outpace the growth in total assets during the next 12 months.

As we continue to deploy additional excess liquidity and cash flows from the securities portfolio, we do anticipate risk-weighted assets will increase, resulting in a slight decline to risk-weighted capital ratios. Looking ahead on Slide 16, we’re providing you with an update on our current expectations for 2024. We expect sustainable organic loan growth in the core business line, which should be valuable contributors to core earnings. For the second quarter of 2024, we expect 5% to 6% annualized organic loan growth with the anticipation that we will replace the indirect auto runoff with an acquired pool that reflects improved yields and credit quality, resulting in total loan growth of 8% to 10% annualized for the quarter. Our net interest margin and net interest income trends should continue to benefit from our asset repositioning strategy and pricing management.

We expect a net interest margin to be in the range of 2.55% to 2.58% for the second quarter, as well as pre-provisioned net interest income in a range of $44.7 million to $45.5 million. Non-interest income should continue near recent levels with the anticipation of consistent fee income from our investments in treasury management and private wealth, coupled with seasonal increases for interchange and mortgage originations. The expected range is $10 million to $10.5 million in non-interest income in the second quarter. Non-interest expenses continue to be proactively managed across the organization, specifically in segments of our business impacted by higher rates such as mortgage and consumer lending. As discussed, we have invested in revenue-generating talent in our leasing build-out, and treasury management teams, which are expected to contribute to revenue growth in 2024.

We expect total non-interest expense to range from about $37.5 million to $38.3 million in the second quarter and remain below 2% of average assets. In our original plan and current outlook for 2024, we still anticipate only two rate cuts in the second half of 2024, which will add additional benefit to the momentum we are seeing in our net interest margin As the timing of these potential rate moves becomes more certain, we will update our outlook and forecast. Now I will turn it back over to Thomas for some final comments.

Thomas Prame: Thank you, Mark. I appreciate that. As outlined in our presentation, we see significant positive momentum for Horizon in 2024. We are located in excellent growth markets in the Midwest that are economically attractive for business and for individuals. Our loan growth is strong and aligned with our historical low credit risk profile. The commercial pipeline continues to be robust and our equipment leasing division has started to make an impact with upside potential in future quarters. The resiliency and stability of our core deposit base maintains its great value with additional opportunity to help 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 an excellent credit profile, and consistently capturing efficiencies in how we deliver our products and our services. We believe Horizon is still a very compelling value, supported by our 30-plus years of commitment to our dividend and currently offering a 5.4% dividend yield. As always, we thank you in advance for joining our presentation this morning. This concludes our prepared remarks. And now, I’ll ask our operator to please open the line for questions.

Operator: Thank you. We will now begin the question and answer session. [Operator Instructions] The first question comes from Terry McEvoy with Stephens. Please go ahead.

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Q&A Session

Terry McEvoy: Hi. Good morning, everyone.

Thomas Prame: Good morning.

Terry McEvoy: Appreciate all the details on Slide 16. I was wondering if you could share your thoughts on how you see earning asset balance is trending over the course of the year, you’ve got kind of cash at 271. You’ve got growth in certain portfolios, but then there’s the run-off of indirect. So if you could just help us put that all together, that’d be great.

Mark Secor: Thanks for the question, Terry. We would anticipate there should be some slight growth in earning assets after we deploy the remaining cash that we have that we planned from the restructure that’ll shift into higher yielding, and then we would anticipate that the runoff from indirect and from security portfolio would primarily fund the growth as we go forward this year.

Terry McEvoy: Thanks, Mark. And then as a follow up, can you maybe talk about the type of borrowers that contributed to the commercial loan growth ex-leasing last quarter? Any certain sectors, markets, customers new to the bank, any color there would be appreciated.

Lynn Kerber: Good morning. This is Lynn Kerber. I would say overall, it really represents our overall mix. We’ve been pretty consistent between CRE and C&I every quarter and in our overall portfolio. So, it really has not changed. We are proactively managing concentration limits in certain sectors and so as far as any originations in hospitality, office, multifamily, those have been more limited. And so I think most of the growth was more so owner-occupied medical and a little bit of mini storage. So overall very consistent with our traditional lending.

Terry McEvoy: Thank you, Lynn, and thanks for taking my questions.

Operator: Thank you. The next question comes from Nathan Race with Piper Sandler. Please go ahead.

Nathan Race: Hi, everyone. Good morning.

Thomas Prame: Good morning, Nathan.

Nathan Race: Was curious just to get some thoughts on just the geographic breakdown of the loans acquired in the quarter. Are these largely in footprint clients that you think you can cross-sell clients additional products going forward? And just curious kind of the appetite to continue to acquire some loans just to help redeploy the still relatively excessive cash balance coming out of the quarter.

Thomas Prame: Sure. Thanks, Nathan. The geography was across mainly outside of our geography on both coast, when the mortgages were more on the east coast, west coast, and also a little bit down in the south. As we look at these transactions that we do, as we get to acquire loans, we’re really looking at it from first, making sure we get acceptable yields and risk returns. Second is that we are looking for significantly high-quality borrowers that both have capability. And as we look at these assets, specifically in mortgage, that they have equity in their homes. So, we’re not looking to change our credit profile for the organization. In fact, these assets would probably improve credit profile and we’ll give up a little bit on geography and our ability to cross-sell to make sure that we keep our credit metrics and our movement of our earning assets up.

As far as on a go-forward basis, we do have a little bit of excess liquidity. We will most likely start continue to redeploy in the second quarter. Do not see at the same magnitude. As Mark said, we’re going to look at the runoff of the indirect auto portfolio and look at rebalancing there, and then we’ll look at the overall cash flows of the securities portfolio also. But I wouldn’t see the magnitude in Q2 that we see in Q1. And then as we look at outer quarters, Q3 and Q4 primarily will just be organic growth.

Nathan Race: Okay. Great. And perhaps looking past the second quarter guidance for loan growth, do you still feel like kind of high single digits is achievable in 3Q and 4Q of this year, just given all the hires that you’ve made across the platform over the last several quarters?

Thomas Prame: Sure. I’ll let Lynn piggyback on my commentary. Our pipelines coming out of the first quarter were strong, in most cases stronger than coming out of the fourth quarter, and our organic growth in the first quarter was at those levels. Specifically, feel very confident about what we’re seeing with the commercial team, and I’ll pass over to Lynn for some color there.

Lynn Kerber: Thanks, Thomas, and good morning. Yeah, our commercial pipeline has been running pretty steady. As we noted in our slide deck, our pipeline as of March 31 is $187 million. This does not include the equipment leasing division. And so the $187 million compares to about $167 million at 12/31, $198 million at September 30. So it’s been pretty consistent. We’ve had a nice cadence. And I’m looking at the equipment and finance division as it ramps up this quarter, start to hit its cadence in the third and fourth quarters. So that’ll really have a nice increase for us overall.

Nathan Race: Okay. Great. Very helpful. And then just on deposits, it seems like there’s some seasonality in terms of flows this quarter on the public fund side of things. Just curious how you guys are thinking about core deposit growth prospects over the course of 2024 going forward.

Thomas Prame: Thank you for the question. As we look in the second quarter, this is where we usually see some inflows from our public funds groups as we see tax money come in, it will be held in the second quarter. We’ll see some growth in the third quarter on our core deposits, usually from our consumers are building up. And then in the fourth quarter, so a little bit of seasonal decline as people start spending around the holiday season. So, we would say as we look at our outlook, we see the deposits being relatively flat for the remainder of the year, small fluctuations, but nothing material.

Nathan Race: Okay. Great. If I could just ask one last one on the margin going forward, perhaps to Mark, just curious to kind of give, get a sense for the understanding of kind of the progression in the margin over the course of 1Q and just to try to get more comfort with the continued expansion guidance for 2Q.

Mark Secor: Yeah, Nate. As we said, we exited with March being at 2.53. The purchases during the month and the growth of the loan portfolio were mid-quarter to some towards the end of the quarter. So those higher-yielding assets we’d anticipate will continue to help the margin to get us to the outlook that we gave for the second quarter. So, the trajectory is still there. And then as we reprice, you can see from some of the slides, the repricing of loans is still significantly or higher than what our portfolio rates are. So that will continue to help the margin also.