Horizon Bancorp, Inc. (NASDAQ:HBNC) Q3 2023 Earnings Call Transcript

Horizon Bancorp, Inc. (NASDAQ:HBNC) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good morning, everyone, and welcome to the Horizon Bancorp, Inc. Conference Call to discuss Financial Results for the Third Quarter of 2023. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. 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 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 access at the company’s website, horizonbank.com. Representing Horizon today are 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.

Thomas Prame: Good morning and thank you for participating. We’re pleased to share our third quarter results that were highlighted by strong loan growth led by our commercial banking team, resilient and stable core deposit portfolio, and an increase in our non-interest income performance. Not unlike the first half of 2023, the team continues to manage expenses very well, and you’ll see in our presentation, our credit quality performance remains a positive foundation for the franchise. Within our comments today, we will update you on our fourth quarter and full-year outlook as we continue to strategically manage our balance sheet, portfolios, and pricing, and expand revenue sources, conservatively manage risk, and maintain ample capital and liquidity that we believe will position us well as we move into 2024.

To offer more detail into our third quarter results, let me introduce Lynn Kerber, our Executive Vice President and Chief Commercial Banking Officer to provide insight into our lending and credit performance. Lynn?

Lynn Kerber: Thank you, Thomas. Beginning on Slide 6, we show that commercial loans increased $83 million for the quarter, or 13.1% on an annualized basis. Net fundings were $96.8 million for the third quarter versus $128 million for the second quarter. Our average commercial loan yield was 5.80% for the portfolio and 7.5% for new production. New loan originations continue to be very diverse across our markets and industries. In the third quarter, one-third of our originations were commercial and industrial, which is a continuation of some expansion in this category. The overall commercial pipeline increased from $118 million at June 30 to $145 million as of September 30. Activity continues to be well diversified by industry and geography with 51% in Michigan and 49% in Indiana.

Commercial credit quality remains strong with low past dues of 8 basis points for quarter end. Non-performing commercial loans decreased 16% in the quarter and year-to-date net charge-offs were 1 basis point on an annualized basis. Turning to Slide 8. You will see that consumer direct loan balances increased $64 million during the quarter, which consisted primarily of increases in home equity loans. This increase was partially offset by intentional runoff in indirect auto loans. This change in mix is consistent with our strategic plan of redeploying capital to higher yielding product sites. The average consumer direct yield was 8.05% for the portfolio and 8.96% for new production. The average yield for consumer indirect was 3.25% for the portfolio and 9.51% for new production.

Consumer past dues increased in the third quarter for both consumer direct and consumer indirect reflective of the broader economic conditions. However, consumer non-performing loans remain stable. Year-to-date net charge-offs for consumer direct are a net recovery of 1 basis point and consumer indirect charge-offs were 31 basis points. Slide 9, highlights our mortgage loan performance for the quarter. Our portfolio was stable and consistent with our expectations for 2023 aligning with our industry trends. Thus far, for 2023, 67% of our year-to-date production is saleable. The average mortgage loan yield was 4.23% for the portfolio and 7.63% for new production. With zero charge-offs for the quarter, this portfolio continues to reflect high quality borrowers with significant payment capacity and equity in their homes.

Our asset quality metrics continue to be strong as outlined on Slide 10. Net charge-offs for the third quarter were $722,000, representing 2 basis points of average loans. Non-performing loans improved to 0.45%. Past dues continued to be low at 30 basis points of total loans for the quarter. Finally, our allowance for credit losses was maintained at $49.9 million representing 1.14% of total gross loans, which we believe is appropriate given the low level of past dues and non-performing and charge-offs and current economic forecasts. Credit quality across all of our lending classes is performing well and reflects our history of consistent and well-balanced approach to lending. Now, I’d like to turn things back to Thomas who will provide an overview of our deposit portfolio and trend.

Thomas Prame: Thank you, Lynn. I appreciate the insight and the detail. Transitioning to our deposit base, which is going to start on Slide number 12. As noted, Horizon has a seasoned and very granular portfolio with an average client tenure of about 10 years. A majority of these balances continue to be held in our transactional relationship accounts that know and trust to Horizon well. Additionally, in Q3, the portfolio displayed less than 20% of balances being uninsured. As I stated in my opening remarks, we’re very pleased with our third quarter deposit performance, maintaining Horizon’s core funding stability and limiting additional funding needs from brokered and/or wholesale balances. On Slide 13, provides detail on the resiliency of the portfolio, and the team continues to be very upbeat about its strength.

Our core consumer and commercial relationships were stable with minimum changes in total balances. The combined portfolio balances changed approximately 0.64% for the quarter. Public funds balances were also stable and experienced some heightened pricing pressures for excess liquid funds this quarter. However, the portfolio continues to maintain a significantly lower cost of funding when compared to alternative wholesale options. The quarter closed with brokered CDs and other fixed rate borrowings flat with ample borrowing capacity available if needed. As we saw in Q2, cash flows from our operations and securities portfolio provided a positive Fed fund sold position of $72 million at the end of Q3. This excess liquidity will continue to provide options in the fourth quarter for higher yielding asset growth or flexibility in deposit pricing.

As mentioned previously, the deposit portfolio continues to deliver strong results in terms of stability, resiliency, and flexibility in our funding. Let me hand the presentation over to our Executive Vice President and Chief Financial Officer, Mark Secor, who will walk through our current highlights and our income statement and key financial metrics for Q3. Mark?

Mark Secor: Thank you, Thomas. Our third quarter results were positive on many fronts. As Lynn stated, we had quality loan growth from the commercial team, improved non-interest income and continued a disciplined operating model in respect to expenses and credit. And our approach to new loan production spreads and strong loan growth shifted lower yielding assets into higher yielding loans. In Q3, we experienced elevated deposit pressure on commercial and public liquid funds, putting pressure on the net interest margin and net interest income in the near-term. However, we will continue to actively manage pricing and our balance sheet to begin improving the net interest margin over the longer-term. Starting with Slide 14, non-interest income improvement over the linked quarter was led by increases in gain on sale of mortgages and other income from sale of assets, while most other line items remain consistent.

The company is continuing to diversify core fee income categories that align with our relationship banking model. Going forward, we also expect our investments in treasury management and private wealth capabilities to contribute additional fee income to Horizon’s revenue mix. Slide 15, our efforts to manage our operating expenses continues to be a strength for Horizon. Non-interest expenses were 1.81% of average assets for the quarter, compared to 1.86% last quarter. Our longstanding commitment to being agile in this part of our business model and consistently reviewing opportunities to reduce expenses and streamline processes continue to be a priority, and you can expect it to remain our focus throughout 2023. Non-interest expenses improved modestly even with an elevated FDIC insurance expense that was offset by lower quarter-over-quarter expenses in several other categories.

Salary and benefits in the third quarter were slightly lower based on stable headcount and modest reductions in commissions and other variable compensation. Our loan and deposit pricing management maintains a strong spread as displayed on Slide 16. While it narrowed in the quarter, we believe a 414 basis point spread in Horizon’s loan and deposit pricing remains healthy, compares favorable its peer’s recent median, and has the ability to improve over time. Results highlight our disciplined loan pricing for new loan production and a greater focus on originating higher yielding loan products. We will continue to focus on loan spread management, product shift into higher yielding loan products, and cash flow reinvestment in — at higher rates.

Of course, these results also reflect our efforts to retain quality, durable end market relationships in a highly competitive market for deposits. Moving to the investment portfolio on Slide 17, it totaled $2.8 billion at the end of the quarter, down $26 million from June 30. The portfolio had a book yield of 2.21% and an effective duration of 6.7 years at the quarter end. As longer-term investments were originally identified as held to maturity, the duration of that portfolio is 2.2 years longer than the available for sale portfolio. Expected cash flows from investments are estimated to be $25 million for the remainder of 2023 and a total of $120 million over the next 12 months, but we continue to actively review strategic options for this portfolio.

Slide 18, Horizon continues to maintain solid regulatory capital ratios well above the required — requirements to be considered well capitalized, and we believe we have sufficient capital to be open to options to improve our earnings outlook in the foreseeable future. We anticipate that growth in capital will outpace the growth in total assets during the next 12 months providing additional strength. As shown on Slide 19, we continue to maintain a strong cash position at the holding company with adequate cash to cover eight quarters of fixed cost including shareholder dividends. The cash position helps provide additional stability in uncertain times and as mentioned previously, keeps the door open for strategies to improve our earnings. Horizon’s current focus for the use of capital is organic earnings growth, as current opportunities and market conditions make M&A less likely.

However, we remain open and receptive to discussions for profitable new revenue opportunities both in acquisition and lift-outs. We expect to continue our targeted dividend payout ratio of 30% to 40%, continuing our 30-year — plus year of uninterrupted quarterly cash dividends. Based on our current stock price, our dividend provides a higher yield relative to the sector. Looking ahead on Slide 20, we provide you with an update on our current expectations for the fourth quarter and full-year 2023. Our loan growth continues to be solid in both commercial and consumer sectors, which should be valuable contributors to core earnings in subsequent quarters. For the fourth quarter and full-year 2023, we expect 4% to 5% and 6% to 7% total loan growth, respectively.

Our net interest margin and net interest income trends should continue to benefit from our balance sheet and pricing management. We expect a net interest margin of 2.33% to 2.38% for the fourth quarter and 2.5% to 2.55% for the whole year. We expect net interest income of $40 million to $42 million for the fourth quarter and $174 million to $176 million for all of 2023. We anticipate the net interest margin to reach its floor in early 2024 assuming the Fed funds target reaches its terminal rate in the fourth quarter of 2023. Non-interest income should continue near current levels with the anticipation of consistent fee income from our investments in treasury management and wealth and a seasonal softening in Q4 of mortgage lending. The expected range of $10 million to $11 million in non-interest income in the fourth quarter and a total of $43 million to $44 million in 2023.

Non-interest expenses continue to be proactively managed across the organization, specifically in segments of our business impacted by rising rates such as mortgage and consumer lending. We also intend to invest in revenue generating talent in our treasury management and commercial lending teams to contribute to top-line in 2024. As a result, we expect non-interest expenses to range from about $35 million to $36 million in the fourth quarter. This would result in $142 million to $143 million of non-interest expense for the year. We also expect these expenses to range below 1.85% of average assets for the fourth quarter and the full-year. Our operating metrics, ROAA and ROAE are expected to be slightly lower in the next quarter. We anticipate ROAA to range from 75 basis points and 80 basis points for the fourth quarter and between 85 basis points and 90 basis points for the year.

We expect ROAE to range from 8.5% to 9% for the fourth quarter and between 9.5% and 10% for the full-year 2023. Finally, for the TCE ratio on December 31, we are expecting 6.6% to 6.8%. Now, I’ll turn it back over to Thomas for some final comments.

Thomas Prame: Thank you, Mark. So why invest in Horizon? Our investment thesis is simple. We’re located in attractive Midwest growth markets. These markets have desirable economic environments, significant infrastructure investment, and flourishing ecosystems for business and communities. Horizon continues to execute well on its strategy of shifting growth to higher yielding assets while maintaining its conservative credit risk profile. Horizon has demonstrated a track record of consistent underwriting and active portfolio management to ensure the success of our clients and our shareholders. The franchise has a stable and loyal deposit base with significant excess liquidity of $2.8 billion, providing flexibility and nimbleness to our funding strategies.

And our disciplined operating culture consistently achieves a low annual ratio of operating expense to average assets, which we expect to be less than 1.85% for 2023. This is coupled with our annualized net charge-offs of only 2 basis points and historically low non-performing loans. We are very compelling value stock support of our commitment to our dividend with a 5.9 times PE ratio and a 6% dividend yield. Horizon has a track record of 30 plus years of uninterrupted quarterly cash dividends to our shareholders. We thank you in advance for joining our presentation this morning. This concludes our prepared remarks. So now, I’ll ask the operator, please open up the line for questions.

Operator: And we will now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Terry McEvoy from Stephens. Terry, please go ahead.

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Q&A Session

Terry McEvoy: Hi, thanks. Good morning, everyone. Maybe Mark, I start with a question for you. Thanks for your thoughts on the fourth quarter net interest margin. Any thoughts on assuming the forward curve is correct where you would expect the margin or when you’d expect the margin or possibly net interest income to bottom in the future?

Mark Secor: Yes. Good morning, Terry. We think it’s close as we said, we think in the first quarter, based on what the current expectations are on rates that it will trough by our modeling, we’re seeing that and then start to tick up as we get into the second half of next year, barring any major rate change, if we start to see the rates coming down in the second half of 2024, we’ll see more benefit. What we saw coming out of this quarter were the last two months that the margin stabilized. So we have a pretty good idea of what we’re coming into going into the fourth quarter.

Terry McEvoy: Great. And then just listening to your comments about investing in treasury management and open to hiring commercial teams, any initial thoughts on how you manage expense growth in 2024?

Lynn Kerber: Good morning, Terry. It’s Lynn Kerber. Thanks for the question. Yes, we are looking at adding some additional staff in our treasury department. While there’s some additional expenses related with that staffing, the goal is to diversify our corporate deposit base better and by virtue of a lower cost of funding and that contribution, it would help offset that staffing increase. On the commercial side, there’s going to be some team members that will be adding some assets that would assist in paying for their salary and I think it’d be a fairly short payback on that.

Operator: And our next question comes from Nathan Race from Piper Sandler. Nathan, please go ahead.

Nathan Race: Great. Good morning, everyone. Thanks for taking my questions.

Thomas Prame: Good morning.

Nathan Race: Just in kind of thinking about getting to the margin guidance of 2.50% to 2.55% for the full-year. Curious kind of what that contemplates in terms of the size of the earning asset base through the fourth quarter? Are you guys seeing an opportunity just based on your deposit pipeline to wind down some wholesale funding to maybe bring down the earning asset base? Or I guess I’m just trying to think about how to get to that kind of 2.50% to 2.55% expectation, just given the lower margin expectations for 4Q.

Thomas Prame: Sure. Thanks, Nathan. This is Thomas. Appreciate the question. When we look at our asset size going in the fourth quarter, we’re going to imagine it’ll be relatively consistent. As we left the third quarter, we did have the excess cash position that we’ll use to pay down any type our cost — higher cost borrowing. When you look at our structured borrowing, it’s actually at a relatively lower cost compared to overnight borrowing. So we would say our borrowing position will be relatively consistent going in the fourth quarter. Excess funds would be used to pay down any type of higher priced borrowings, which would be most likely on the public fund side, that we saw some elevation in the third quarter, relatively consistent balance sheet going third to fourth quarter.

Mark Secor: Yes. And Nate that full-year, as you recall, if that’s not adjusted, that’s unadjusted. So it includes the swap gain that we received in the third quarter.

Nathan Race: Got you. Understood. And then, just kind of thinking about the trajectory of loan yields going forward in a higher for longer rate environment. Any color on just kind of what the new rate on production was in the third quarter and just how you’re kind of thinking about kind of the trajectory of loan yields over the next few quarters, assuming the Fed pauses and just kind of the tailwinds that you guys have with some loans re-pricing going forward.