Horizon Bancorp Inc (HBNC) 2021 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Horizon Bancorp Conference call to discuss financial results for the 3 months ended June 30, 2021. (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 the slide presentation. Additional information about factors that could cause actual results to differ materially is contained in Horizon's current 10-K and later filings. 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. If anyone does not already have a copy of the press release and supplemental presentation issued by Horizon yesterday, you can access it at the company's website www. horizonbank.com.

Representing Horizon today are Chairman and Chief Executive Officer, Craig Dwight; and Executive Vice President and Chief Financial Officer, Mark Secor. They will be joined by Executive Vice President and Chief Commercial Banking Officer, Dennis Kuhn, for the question-and-answer session.

At this time, I'd like to turn the call over to Horizon's Chairman and CEO, Craig Dwight.

Thank you, Kate, and good morning, and thank you for participating in Horizon Bancorp's second quarter earnings conference call. Our comments today will follow the investor presentation we published yesterday, July 27. I'm extremely proud of Horizon's team in how they position the company well for the future. As a result of this preparation, we are very optimistic about Horizon's earning power over the next 2 years. The momentum taking us into 2022 and 2023 includes welcoming new associates from the 14 branches we are in the process of acquiring in a transaction that is on track to close in September. This logical extension of our franchise includes adding approximately 50,000 new households, 2 commercial lenders, and low-cost core deposits.

We've already proven that mass and scale work to drive shareholder value, and our pending branch acquisition only contributes to that momentum. In addition, we are closing 10 branches by the end of August as we continue our effort to strive for further reductions in our consistently low non-interest expense to average asset ratio, which was just 2.18% in the second quarter. We expect to continue to achieve expense reductions even as we redeploy employees from the closing branches to fill open positions and reinvest much of the savings into technology designed to enhance sales and the customer experience. In addition, we've increased the number of commercial lenders since December 2020 by 20% with additional offers pending. We've added volume capacity to our indirect auto lending program. Horizon is positioned well to seize upon future opportunities.

Starting on Slide 4, a company highlights. Horizon completed the second quarter report reporting strong quarterly earnings at $22.1 million. Driving the quarterly results were stable net interest income, strong mortgage production, a nominal release and provision to credit loss reserve expense, and continued expense control. Horizon return on average assets of 1.45% and return on average equity of 12.59% for the quarter continued to be robust and compared favorably to peer medians. Given the size of our balance sheet, highly efficient operations, and talented workforce, we believe Horizon is well-positioned to capitalize on significant organic and strategic growth opportunities within our attractive Midwestern markets.

As you see on Slide 6, we've clearly demonstrated over the past 18.5 years that Horizon is a growth company with compounded annual average growth rates in total assets at 12.3% and net income at 16%. Year-to-date in 2021, earnings are up 64% compared to the first 6 months of last year. During this time period, we demonstrated that our strategy of mass and scale has created shareholder value through both revenue growth and disciplined expense management, resulting in strong earnings for the second quarter. Contributing to our growth is both the new and organic market expansions and 15 mergers and acquisitions, which includes our pending, Michigan branch transaction. Horizon is a company on the move, and we continue to look for new opportunities in our current and adjacent Indiana Michigan markets. With our proven track record as a successful consolidator and the pressures that other banks are facing related to succession planning, low-interest rates, and challenging operating environment, we are seeing a pickup in M&A discussions.

On Slide 8, we remind you that Horizon's expansion growth has occurred primarily in college and university towns and state or county governmental seats. Therefore, a majority of our footprint has an economic base that is traditionally more stable than other areas of Indiana and Michigan. The pending branch acquisition expands our presence into college towns and in 8 of the 11 counties where the acquired branches are located. Horizon will either be #1, #2, or #3 in deposit market share. In addition, Horizon remains positioned well to take advantage of the outbound migration from Illinois, which continues to increase as consumers and businesses exit dense living spaces, high taxes, increasing crime rates, and the high cost of living. Both Indiana and Michigan continue to show improving economies as evidenced by low unemployment rates and an increase in total workforce. As a result of the tight labor markets, we are seeing some wage inflation.

Slide 9 highlights the primary markets where we are engaged in some exciting economic events creating new business opportunities for Horizon. Moving onto digital transformation. Horizon's average monthly transactions continue to shift away from branches to our digital and virtual channels. As of last month, 73% of all transactions took place through our digital channels compared to 44% in 2018. The good news is that since that our branch network second reopening in January 2021, the online activity has stayed relatively constant. This shift, which Horizon embraced before the pandemic, which, of course, accelerated the trend is a key consideration in our annual branch performance review and consolidations, including the 10 branch closures scheduled for end of August. In addition, at the end of June 2021, 80% of all checking accounts were active online banking users, which is a 22% increase compared to 65% active online banking users in 2018. As a result of our investments made in technology over the prior years, Horizon is well prepared for future increase in digital banking activity.

Now for our financial updates, so our privilege to introduce to you, Horizon's Bank's Executive Vice President and Chief Financial Officer, Mark Secor. Mark?

Thank you, Craig. Horizon saw a record net income for the second quarter with increases in both net interest income and non-interest income over the first quarter. We're very pleased with these results and the core trends the second quarter demonstrated. Starting with Slide 12. The company's second quarter results were supported by strong and stable core trends. Compared to the first quarter of 2021, we continued to record lower PPP income from fewer loans forgiven, lower purchase accounting income, and a reduction in the average loans attributed to PPP loan forgiveness, and lower mortgage and mortgage warehouse loan balances, however, net interest income increased with a higher level of interest-earning assets with the move of assets from cash to the investment portfolio.

This is one of Horizon's key objectives to focus on increasing net interest income dollars into leverage capital. Non-interest income reflected an increase over the last quarter, primarily due to mortgage gain on sale income and interchange income. In addition, the recovery of $1.6 million of mortgage servicing right impairment contributed to the increase. The second quarter also benefited from a small release of $1.5 million from the allowance for credit losses due to continued strong credit performance, low net charge-offs, and improving econometrics. We continue to believe we are appropriately reserved given the current state of our portfolio in the recovering economy and our CECL modeling.

Slide 13. The reduction in the adjusted margin of 4 basis points during the quarter was positively impacted by 7 basis points from PPP income as net deferred fee for recognized for loan forgiveness. This compares to a positive PPP impact of 10 basis points in the first quarter, accounting for 3 of the 4 basis point decrease in the margin. In addition, high cash balances held during the quarter compressed the margin additional 21 basis points compared to 16 basis points in the first quarter. We moved $421 million into the investment portfolio, utilizing cash and liquidity from the reduction in loan balances and deposit growth, although helping to increase net interest income, this higher mix of lower yield investments puts pressure on the margin.

Slide 14. The loan yield increased in the second quarter due to the reduction in the balances of lower-yielding PPP and mortgage warehouse loans. Even with the increase in the loan yield, it absorbed the impact from PPP loan fees recognized during the quarter from only adding 3 basis points to the yield compared to the positive 6 basis points in the second quarter. As loans continue to reprice, new product is originated at lower rates in the higher-earning asset mix of investments, additional downward pressure on asset yields expected during 2021.

Slide 15. Margin compression was tempered by our continued improvement in funding costs, which reflects Horizon's valuable and growing core deposit franchise. The CD portfolio is 13 basis point decrease in prices -- in pricing reduced total funding costs, as high cost term deposits matured during the quarter, $240 million of CDs with an average cost of 72 basis points will mature during 2021 and continue to reduce our cost of funds. As total deposits continue to grow, we are also strategically pricing deposits to manage liquidity, instant inflows from transactional or transient sources. This, of course, is balanced against our commitment to stand by our long-standing customer relationships and high potential new opportunities in our growth markets in Indiana and Michigan. The 7% growth in non-interest income -- non-interest-bearing deposits also contributed lower funding costs in the second quarter.

Moving to Slide 16. Mortgage revenue from the gain on sale and mortgage-related income continued to support non-interest income as we also saw $1.6 million of recovery of non-cash impairment charges from the mortgage servicing asset in the quarter. The continued high level of mortgage production, 61% coming from purchase activity, and strong percentage gains are the primary contributors to our non-interest income for the quarter. Based on local and national refinancing activity, we expect strong top line contributions to continue from the mortgage business in 2021.

Slide 17. During the second quarter, we saw operating expenses increase from the first quarter as we recorded less deferred costs from the origination of PPP loans than in the first quarter. We saw an increase in the health insurance costs and recorded losses for the sale of some legacy bank-owned property. Core operating expenses continued to be stable as we saw non-interest expense to total average assets declined to 2.18%, and when adjusted for transaction costs to 2.16%. Craig already discussed our annual branch rationalization process that is leading us to close 10 branches next month. This disciplined process is a regular part of our normal course of operation and has been key to our long record of running an efficient and stable retail franchise while investing in Horizon's digital, mobile and remote banking as well as our communication centers.

Slide 18. The release of $1.5 million of the credit loss reserve was a result of overall continued improvement in the credit metric and the economy metrics within the CECL model. We continue to maintain allocations for sectors of loans with potentially higher risk of loss due to the nature and characteristics of these portfolios as they are monitored on a consistent basis. With the release of the reserve, the percentage of allowance to total loans increased to 1.58% at June 30 due to the decrease in total loans. A balance of $10.5 million remains for discounts on acquired loans. Overall, we are very pleased with our financial performance for the second quarter. We believe we are well-positioned from a credit, liquidity, and capital perspective and look forward to refining our operating model to further improve our results in the quarters ahead.

For some additional comments on our loan portfolio, I'll turn it back over to Craig.

Thank you, Mark. Looking at the chart on Slide 20, Horizon's $3.5 billion in total loans are well diversified with 60% in commercial and 40% in residential mortgage and consumer loans. The table on the right provides the granularity within our commercial loan portfolio, which itself is well diversified. Our single largest sector is in residential multifamily housing loans at 6% of total loans, and this segment continues to perform well. All pandemic-related distressed business sectors have seen considerable improvements over the prior year's operating results, including the hotel, restaurant, hospitality, and leisure industries.

Horizon's non-owner occupied real estate portfolio also exhibit strong cash flow from our borrowers and low delinquency rates. Horizon's consumer loan portfolio continues to reflect strong underwriting standards as evidenced by low delinquency at 0.24% of 1% and declining non-performing loans at 0.64% of 1% at quarter end. We are experiencing growth in our indirect automotive loan portfolio, which is all in market lending. To further support the increase in volume, we've added 11 new dealer relationships with another 10-plus applications pending in the new Michigan markets. In addition, we are expanding our RV and small boat lending programs. As a reminder, more than 99% of our consumer loans are secured and about 95% are prime credits. We intend to maintain the secured prime consumer lending focus even as we grow into our expanding footprint.

Horizon's commercial loan portfolio continues to reflect strong underwriting standards as evidenced by low delinquency at 0.03% of 1% and declining non-performing loans at 0.49% of 1% of total commercial loans at quarter end. Horizon is predominantly a secured lender with recourse from the business owners and continues to follow prudent underwriting standards. Horizon's commercial loan portfolio is well diversified by business sector and geographic locations throughout the states of Indiana and Michigan. As mentioned earlier, since December, we've increased our number of commercial lenders by approximately 20%, with additional job offers are waiting to be accepted. The staff additions are in growth markets of strong Kalamazoo, Michigan and South Bend, Lafayette in Indianapolis, Indiana. In addition, we will pick up 2 commercial lenders on the branches to be acquired. We are also pleased to report that the commercial pipelines are close to prepandemic levels.

Now moving to our hotel sector. Hotels represent 4% of total loans, and this segment has been -- has seen a significant pickup in occupancy and average daily room rates through the second quarter of 2021 compared with the first quarter. As of June 30, the average occupancy rate was 74%, which reflects 94% of Horizon's total hotel loan dollars reporting and is an increase from 58% in occupancy as of March '21. This compares favorably to the nationwide occupancy rates as of June 30 at 66%. Occupancy gains are primarily attributed to increase in consumer travel, along with a smaller increase in business travel.

Fortunately, Horizon's hotel portfolio is primarily located along interstate highways and resort locations frequented by the consumer traveler in that pie to convention or entertainment venues found in the larger metropolitan areas. Horizon continues to report strong asset quality metrics in the second quarter. We reported low net charge-offs over the last 5 quarters of less than 3 basis points. Our credit loss provision expense, Mark talked about, we had a slight $1.5 million in the recovery. Horizon's total non-performing loans to total loans ratio improved for the third consecutive quarter. Our allowance for credit loss remains level at 1.58% of total loans.

To summarize, Horizon Bancorp's key franchise highlights. We are positioned well for earnings growth going into 2022 and 2023 as a result of our pending 14 branch acquisition, 10 branch closures, a pickup in loan demand, an increase in commercial lenders, expansion of our consumer loan dealer network and leveraging excess capital. We are a seasoned management team who has managed through multiple economic cycles and has a history of delivering growth far exceeding banking industries average growth rates. We have robust capital position and excess cash to the holding company in excess of $125 million, with an improving outlook to deploy set capital and cash through a merger or acquisition or stock buybacks. Horizon has maintained a solid historical compounded annual earnings growth rate of 16% over the past 22 years. And the company has paid 30 years of uninterrupted cash dividends on our common shares and once again raised the dividend in the second quarter of 2021. This now concludes our prepared remarks.

And I'll turn it back to the operator for questions. Thank you.

(Operator Instructions) The first question is from Nathan Race of Piper Sandler.

So I was hoping to kind of just dig into the loan growth outlook a bit ex. PPP in the warehouse, it looks like the loans held flat in the quarter. We're chasing, it's encouraging to see. As you look forward, and I appreciate all the details with the commercial lender team up 20% since year-end. And just given some opportunities with some M&A-related disruption in your markets, how are you guys kind of thinking about loan growth at PPP in the warehouse on a percentage basis in the back half of 2021?

This is Dennis Kuhn, and thank you for the question, Nathan. Again, we think we -- during the second quarter that we did see a shift towards some growth, obviously. And from a standpoint of pipelines continuing to grow the second quarter, we saw a substantial increase in both production and funded commercial loans, in particular, over $50 million additional in each category. And as Craig said, we have returned at this point to prepandemic level of 2019 and actually eclipse that somewhat. So our pipeline going into the third quarter is solid. It's just over $100 million. And last quarter, at this time, we reported about $115 million, but we ended up eclipsing that significantly by over $30 million.

So our pipelines are growing weekly, the new -- the investments in the new lenders, they're starting to hit the ground and generate business. So again, our outlook is positive, I would say, for some commercial loan growth. We did see a continuing reduction in our revolving line usage during the second quarter, though. So if that rebounds, which we have heard from some others, it has started to rebound. But we -- again, we saw lower balances and utilization through the second quarter in revolving. So -- but again, the investments in the lenders in some growth markets where they are disrupted due to other pending mergers and acquisitions is showing some momentum.

Got it. That's a great color. Appreciate that. And then maybe changing gears and thinking about expenses. Obviously, third quarter, you mean somewhat noisy with the TCF branches about half the quarter, and then you also have the 10 locations that you'll be consolidating as well on a legacy basis. So maybe as we look to the fourth quarter or the first quarter of next year, Mark, any thoughts on just kind of where you expect the expense run rate to shape out?

Yes, Nate. There is going to be noisy next quarter. And it takes a while to get all the cost saves in for the branches. We're not letting the staff go. We're offering them employment at other locations, and we're going to absorb them through attrition over the next probably 9 to 12 months. So that won't be an initial cost save. You will also see some write-down on fixed assets as we move them into bank on property, the branches, and we do expect some write-down. But getting on into next year after the transaction and with the branch closures, as we've stated before, our target and our goal is to get to a 2% of average asset range of expenses. We're at 2.16% adjusted today. And our goal is to see that to get around that 2% and even sub 2% as we get into next year.

Okay. That's helpful. I think you can do the math in terms of the operating expense run rate from that 2% target that you guys have for the start of next year. So I appreciate all the color.

The next question is from Terry McEvoy of Stephens.

Just maybe a follow-up on the expense question. I just want to make sure I understand the message correctly. The cost savings coming from the 10 branches will be reinvested in the commercial hires and maybe the digital platform as well. Is that the message here?

Yes. I think that is our messaging, although we would anticipate some cost savings to help us continue to leverage. But with the -- and also with the branches coming on, we'll continue to leverage our operating expense.

And then maybe also a follow-up on one of Nathan's questions on just the loan outlook. Where do you kind of see the warehouse, the mortgage warehouse, what's the right level in a normal world? And then just kind of runoff of the mortgage portfolio, which we've seen really across the industry, where do you kind of see that portfolio leveling off as well? Or said another way, what type of incremental pressure in the second half of this year, do you see because of those 2 portfolios?

Our response on that question has always been that we follow directionally the Mortgage Bankers Association's outlook for refinance, et cetera, and payoffs. So where they're predicting, they predict like a 25% drop in production this year, and that's probably where our volume is going to be at as well. So if you follow that as well as the refinance index that's published, you can get a good feel for where we're headed.

And Terry, I think with the shift you saw this quarter to 61% being purchase activity, and we are seeing prepayment speed slowing, which we contributed to recovering some of the servicing asset. So there is some tapering to the refi, although with the rates are continuing to dip, you -- I don't know if that's a good predictor or not.

I appreciate it.

You asked about warehousing, Terry. We've always -- we've targeted about $125 million in a normal basis, $100 million to $125 million. And -- but as long as we're still in this kind of a higher level of mortgage volume, we should -- you could see that on the higher side of those averages.

The next question is from Damon DelMonte of KBW.

So first question, just trying to get a little bit more perspective on the margin, Mark. You have the deposits coming on board from TCF in the third quarter, and you talked already about just some core margin pressure just given some -- the different puts and takes that you discussed before. Can you kind of give a range of where you think that core margin would be in the back half of the year?

Yes. Damon, it's going to depend a lot on what we're able to buy investments at going into the transaction. We're already in the process of buying investments this quarter, so that we will have earning assets from the cash that we're getting from the transaction. Again, I think it's a hard predictor because with mix and not knowing exactly what the yield is going to be on the investment portfolio as we put those on, we targeted in the presentation of 1.5% yield, and we're able to do that and a little better. So -- and we'll give more detail on that as the transaction closes, and we have more hard facts. But I think it's encouraging that the loan yield stabilized this quarter. I think that's an encouraging sign. So to be able to pick a margin, it's hard because we also -- we don't know how much cash is coming in and going out. We continue to see cash or deposits grow. But the focus we have, and I know it's not a margin answer, but it's to grow net interest income. And that will continue to move forward with the additional investments we're putting in -- cash we're putting into the investment portfolio.

Damon, this is Craig. To add to that, and to recall, the transaction that we announced with the 14 branches. We're out -- this is really an operational leverage play as well. We were looking at a 17% accretion to earnings per share next year. The model that we used had a 1.5% investment yield. So far, we are substantially beating that yield in the investment portfolio through the last couple of months. Of the investment yield later on in the fourth quarter, so you'll see what the actual performance is once it settles down. So there'll be more color on that later on.

And then just my second question, just as it relates to the provision. Obviously, credit trends -- legacy credit trends remain extremely strong. We continue to have an improving economic outlook. Is it reasonable to expect another reversal of the provision next quarter? Or do you think it's more likely that we just have very minimal to $0 type level?

Our thought is it's going to be minimal. And the reason for that you have the possible another wave of the new variant of COVID-19, the delta variant. And a lot of the PPP money will be spent through the summer. So how -- what's our cash balances of our customers on their balance sheet going into the slow winter months. Our plan is in the third quarter to be calling on our borrowers to look at their cash balances and to reassess our credit quality going into the fourth quarter. So we're still going to be a little cautious.

(Operator Instructions) The next question is from Brian Martin of Janney.

Craig, can you talk about now that, I guess, as you get the brands transaction close, I think you talked about additional M&A opportunities and active discussions, I guess, it sounds as though you're certainly interested in doing more activity I guess. Can you just put some -- it sounds like it's what, Indiana and Michigan were the most -- I know you talked about Ohio in the past, but the greatest opportunity you can just kind of just give us some ideas on size and you guys, how big a deal you would look at doing?

Yes. Brian, we have some internal hurdle rates, and one of that to make the acquisition meaningful and with our time, we'd like to see at least 3% earnings accretion. So that's putting a deal. It has to be about $500 million or above to hit that number. The maximum size could be anything larger than that. The challenge is the larger deals, though, you have other players coming to look at them and their currency is a little richer than ours. So the math doesn't work out in our favor, typically. So we were more of the $500 million to probably $2 billion range is something we could be successful on. The state with the most discussion right now is Michigan, hearing very little activity in Indiana. I think Indiana is frail embolden with a good performance of our banks in general, so.

Got you. Okay. Perfect. And just the other one for me was just maybe 1 or 2 for Mark, just on the PPP timing, the recognition that the, I guess, it sounds like maybe most of that would be recognized in the back half of the year. And then just in addition to that, the accretion number was off quite a bit this quarter. Just kind of curious if there's -- if that kind of sets a new trend or that's just kind of bouncing around?

Yes. The PPP, I think you're right on. We're continuing to work through the forgiveness, and it will be through the back half and probably some dragging into the beginning of 2022. The purchase accounting, I think it is just bouncing around, Brian, there's still some recoveries out there potentially. But as the base is getting smaller, there is going to be less and less impact of that recovery of those marks.

The next question is a follow-up from Nathan Race with Piper Sandler.

Yes. Just a question on fee trends. It looks like the mortgage gain on sale margin bounced back pretty noticeably in the second quarter from 1Q. Just any thoughts on just that margin in the back half of the year will be helpful. And also along those lines. I was wondering if you could quantify the MSR fair value write-up that occurred in the second quarter as well?

Yes. The gain on sale percentage, it did come back. I think there's support to have that continue to be at that level or better because of the 50 basis point charge from the GSEs was going to be coming off. So I think that's going to help support that here as long as there's continued volume. We always state that if volume does start to decrease, there is room to bring rates down as the market makers would start to bring those down to drive more volume. So there could start to see that, but we're not seeing that yet. The recovery of the mortgage servicing right, we still have from the impairment we took last year, we still have about $3.5 million of that write-down.

Now we can't recover all of that. And we don't know when it will get recovered. The recovery this quarter was due to prepayment speeds. That changed in the value of the portfolio increased. So we were able to bring back some of that overall impairment. What I also saw start to swing is as the prepayments been slowed, we're able to see the amortization of the asset slow to hopefully see more actual mortgage sourcing income come through to the income statement, similar to what we probably thought prior to -- or not the amount similar to what we would see happen prior to this last refinancing boom. Our servicing portfolio is at $1.5 billion.

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

Thank you, Kate. Thank you for participating in today's earnings call, and we appreciate your investment in Horizon Bancorp, and we look forward to talking with you again soon. Have a good day.

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