Horizon Bancorp Inc (HBNC) 2020 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Horizon Bancorp conference call to discuss financial results for the third month ending December 31, 2020. (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. Please go ahead.

Thank you, Anita, and good morning, and thank you for participating in Horizon Bancorp's fourth quarter earnings conference call. Our comments today will follow the investor presentation we published yesterday, January 27.

Starting on Slide 4, you'll find highlights that summarize Horizon's excellent year as evidenced by net income for 2020 increased by 3% over the prior year. Given all the actuals that we had to confront, it was an impressive year and a true testament to the quality of our employees.

Key drivers during the year were a record 1-4 family mortgage loan production and mortgage warehouse volume, good expense control and our ability to maintain a stable net interest margin. In addition, we maintained solid asset quality as evidenced by low NPAs to total assets at 49 basis points and net charge-offs at 5 basis points of total loans.

We are also proud to state that for over 30 years, we have made uninterrupted dividend payments to our shareholders. And we have approximately 18 quarters of cash on hand at the holding company to cover fixed costs, including future dividends.

Next slide, 5, titled Seasoned Management Team, you will observe that we are a seasoned leadership team. We have managed through multiple recessions and have overseen history of strong financial performance over the past 18 years. Of special note, in December 2020, we promoted Senior Commercial Credit Administration Officer, Lynn Kerber, and our General Counsel, Todd Etzler, as our newest Executive Vice Presidents.

As you'll see on Slide 6, we've completed 11 new organic market expansions and 14 mergers and acquisitions during this time continuum. We are a company on the move, and we continue to look for new opportunities in our current and adjacent Indiana and Michigan markets. With our proven track record as a successful consolidator and the pressures that other banks are facing related to low interest rates in the challenging operating environment, we believe M&A opportunities will once again be available in 2021.

Slide 7 clearly demonstrates Horizon's track record for achieving our well-established long-term goals, which include meaningfully outpacing GDP and industry growth and achieving balanced growth of 50% organic and 50% through mergers and acquisitions. In 2020, Horizon grew the balance sheet by 8% excluding PPP loans.

On Slide 8, we highlighted our primary market area in dark brown and dark green. Horizon's markets represent diversified economies and excellent growth opportunities. Horizon's expansion and growth has occurred primarily in college and university towns and state or county government seats. Therefore, a majority of our footprint has an economic base that is traditionally more stable than other areas of Indiana and Michigan.

Horizon's footprint is 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 and a high cost of living. Both Indiana and Michigan continue to show improving economies as evidenced by a reduction in unemployment rates. As of December 31, Indiana's unemployment rate was 4.3%, which is below the U.S. national unemployment rate of 6.7%. While Michigan's overall unemployment rate was 7.5%, a slight increase from November 30.

The regions we serve in the western and central parts of the state are reporting levels ranging from 3.7% in Grand Rapids to 4.9% in Bay City, Midland area. Horizon's footprint helps to geographically disperse credit risk with 60% of our loans in Indiana and 40% in Michigan.

Slide 9 highlights the primary markets where we are engaged in some exciting economic events that are taking place that will continue to enhance our markets.

Now moving to Slide 10 titled COVID-19 Response. We continue to closely monitor the impacts of COVID-19 pandemic on the communities, customers and businesses where we operate. Indiana's numbers of daily reported positive COVID-19 cases were elevated in November and December and has started to trend downwards in January. Indiana's current restrictions are comparable to the prior quarters and are driven by county-by-county color code risk system. Michigan's positivity rates continue to trend downward, and their protocols are still more restrictive than Indiana.

The safety and well-being of our employees is our first priority, and therefore, we continue to adhere to strict safety protocols as we navigate the reopening stages in our markets. Currently, all offices are opened by appointment only. Prior to COVID-19, Horizon was well on its way to transforming its customer base to our digital platform, though the impact of the pandemic due to limited branch access has accelerated use of digital banking.

On Slide 11, looking at the chart on the right, Horizon's average monthly transactions have shifted away from taking place in branches to the majority being processed through our digital and virtual channels. In December 2020, 73% of all transactions took place through our digital channels compared to 57% 1 year ago.

As you'll see on the chart on the left, in December 2020, 75% of all checking accounts were active online banking users, an increase from 66% 1 year ago. Horizon was well prepared for this increase in digital activity. Other technology investments made in 2020 that focus on enhancing the customers' experience included adding the fourth call center location to increase service capacity and shorten wait times, expanding our interactive teller machines to allow virtual teller interactions at our over 27 locations with expanded virtual teller hours from 6 a.m. to 8 p.m., 6 days a week, the addition of chat and online account openings to improve customer experience. And as of month end, December, over 85% of Horizon's online chats are answered by bots.

Now for the financial highlights, it is my privilege to introduce to you Horizon Bank's Chief Financial Officer and Executive Vice President, Mark Secor. Mark?

Thank you, Craig. Horizon's fourth quarter results continue to demonstrate our ability to realize strong operating results and dropped record earnings to the bottom line as we navigate the current environment.

Starting with Slide 13. The company's fourth quarter results were the highest stated and adjusted net income, net interest income, pretax pre-provision income, noninterest income and earnings per share in the company's history.

Several activities during the fourth quarter impacted these record results. We incurred prepayment expense on the retirement of high-cost long-term debt, recognized PPP forgiveness fees through net interest income and recorded tax benefits from solar tax credit investments. We continue to build allowance with additional credit expense, primarily for the stressed loan sectors that we -- that have been identified. We believe we are appropriately reserved given the current state of our portfolio, additional government stimulus and our CECL modeling.

Slide 14. The 17 basis point increase in the adjusted margin during the quarter was positively impacted by 18 basis points from PPP lending as net fee income was recognized for loan forgiveness compared to 4 basis points of margin contraction in the third quarter. In addition, excess liquidity compressed the margin an additional 7 basis points compared to 3 basis points in the third quarter.

Slide 15. The loan yield was also positively impacted from PPP net loan fees recognized during the quarter, adding 15 basis points to the yield, compared to a 13 basis point reduction in the third quarter. Higher purchase accounting income recognized in the fourth quarter compared to the third also positively impacted the loan yield. As loans continue to reprice and new product is originated at lower rates, some additional downward pressure on asset yield is expected, along with a mix of additional investments resulting in some margin pressure during 2021 as the opportunity to lower funding costs are realized.

Slide 16. Our strong core deposits continue to help reduce our funding costs. The CD portfolio's 30 basis point decrease in pricing led the reduction in total funding costs as high-cost term deposits matured during the quarter. $445 million of CDs with an average cost of 93 basis points will mature during 2021 and continue to reduce our cost of funds. The 4% growth in noninterest-bearing deposit and 2 basis point drop in interest-bearing deposit costs also contributed to margin stabilization in the fourth quarter.

Slide 17. Since the first quarter of 2020, we've maintained a conservative and strong liquidity position. We also expect additional liquidity from PPP loan forgiveness and in the longer term, warehouse loan balances returning to normal levels when long-term interest rates start to escalate.

To help utilize a portion of the liquidity building up in cash, we increased the investment portfolio over $100 million during the fourth quarter. Also, we prepaid $83 million of FHLB advances with a weighted average cost of 2.61%, utilizing $62 million of cash and selling $21 million of investments. While our fourth quarter results reflected a net onetime pretax loss of $1.2 million on the prepayment, there will be less than a 1-year payback from the interest expense savings.

Looking ahead, we anticipate additional growth in the investment portfolio and are currently working on adding $200 million to the portfolio. We will continue to look for additional opportunities as we see the need to utilize our liquidity and increase earning assets.

Slide 18. Record mortgage revenue from the gain on sale and the mortgage-related income drove our record noninterest income as we saw noncash impairment charges to the mortgage servicing right asset slow in the quarter. The continued high level of mortgage production and strong percentage gains are the primary contributors to our solid noninterest income for the quarter.

We also saw all other fee-based income increase over the third quarter. Based on local and national refinancing activity, we expect strong top line contributions to continue from the mortgage business going into 2021.

Slide 19. During the fourth quarter, we saw an increase in operating expenses but improved the adjusted efficiency ratio to 56.5%. Increased salary and benefit costs were the primary driver of the increased expenses as our very strong fourth quarter and full year results merited higher performance-based compensation payments and accruals. There were also increases in other operating line items as investments were made for future efficiency efforts as are increase in customer activity and the onetime write-downs to reduce the company's bank-owned real estate assets.

As many of you know, part of Horizon's normal operating process includes a rigorous annual branch evaluation, which has led to consolidation of 25 retail locations over the last 5 years. We are currently in the process of another rigorous branch review as customer habits have changed as more digital channels are being used. Looking ahead, we intend to continue our record of maximizing the efficiency and scalability of our retail franchise while further leveraging the investments we have already made in digital, mobile, and remote banking as well as our call centers.

Slide 20. As we have discussed, we did adopt CECL on the start of 2020 and the $708,000 reserve build in the fourth quarter was primarily driven by allocations for sectors of loans with potentially higher risk of loss due to the nature and characteristics of these portfolios. The percentage of allowance to total loans was 1.47% at December 31 or 1.55% when excluding PPP loans. A balance of $11.5 million remains for discounts on acquired loans.

Slide 21. Horizon continues to maintain a strong capital position in these uncertain times, supplemented by our $60 million subordinated debt raise in June. Accordingly, at December 31, the holding company had just over $127 million in cash, representing approximately 18 quarters of fixed costs, which included interest on all debt, operating expenses at the holding company and current shareholder dividend level, which we are committed to maintaining.

Overall, we are very pleased with our financial performance for 2020 in this very challenging year. 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 portfolios, I will turn it back over to Craig.

Thank you, Mark. Looking at the chart on the left on Slide 23, Horizon's $3.8 billion in total loans are well diversified, with 50% in commercial loans and 43% in residential and consumer loans. At Horizon, we like this loan mix as it diversifies our credit risk and provides advantages to manage our net interest margin.

The chart on the right provides the granularity within our commercial loan portfolio, which itself is well diversified. Our single largest sector is in the residential multifamily housing loans at 6% of total commercial loans, and this segment continues to perform well.

Other key points to make, Horizon manages capital at risk by maintaining an in-house lending limit at $30 million, which is well below our legal lending limit of approximately $78 million. Our granularity is further enhanced by the fact that Horizon's average commercial loan is only $304,000, excluding PPP loans.

Now moving to Slide 24. As of December 31, Horizon's loan deferrals declined to 3.3%, down from its peak of 14.3% on June 30. The majority of our dollars under a loan deferment are still in the commercial loan portfolio, with the consumer and mortgage loan deferrals remaining low at less than 1%. Overall, Horizon deferral rates are in line with peer banks.

The number of commercial loans and payment deferrals as of December 31 totaled 55, down significantly from the June 30 total of 670. Horizon's commercial lending team has been diligent in meeting with our business customers to update their financial plans and to place the loans back on regularly scheduled payments.

Of the commercial loans on deferral, 95% of the dollars are making interest-only payments and only 2% or 5% of those loans deferral are making -- are deferred for principal and interest. The 2 loans on principal and interest deferrals are the same sponsor and represent 2 hotels in various stages of construction or remodeling. The borrower and guarantors have in excess of $20 million in cash on the balance sheet, so this deferral has minimal credit risk and reflects more of a retention strategy. Interest payments on these loans are scheduled to resume in April of this year.

Slide 25 reviews our diversified commercial loan portfolio. Horizon is a traditional regional bank offering a standard lineup of commercial loan products through an experienced and seasoned team of lenders and credit administration staff. We have a history and culture of prudent commercial loan underwriting, and commercial loan asset quality metrics continue to be favorable at quarter end.

Moving to Slide 26 titled Sectors with Escalated Monitoring. Horizon continues its elevated monitoring in those loan segments that exhibit the most duress as evidenced by high payment deferral rates. As of the year-end, the majority of the Horizon's payment deferrals were made to hotels, with the other nonessential businesses seeing considerable improvement in the fourth quarter.

The portfolio segments that we are continuing to monitor include hotels, restaurants, leisure and hospitality. Hotel payment modifications continue to be the highest percentage of any sector and increased from 58% of total loans outstanding as of September 30 to 72% as of December 31. This increase is due to the second COVID-19 wave starting in October and the resulting drop in occupancy rates. 19 to 20 hotel loans that are modified are making interest-only payments, and 2 are on principal and interest referrals.

The comfort we have with this portfolio is that our borrowers are longtime operators, have managed through multiple economic cycles and 71% of the total dollars in our hotel portfolio, $101 million, the sponsors have access to liquid assets in excess of $10 billion per relationship. I'll touch more on hotels in just a minute.

And next, the restaurants. This portfolio continues to perform well with only $2.7 million in deferment with all borrowers making at minimum interest payments and no loans having principal and interest payment deferrals. Our comfort in this portfolio is due to the fact that the average loan amount is low at $365,000, good current performance, long-term owner operators and good franchises.

Next, leisure and hospitality. Overall, this segment is performing well with only one loan in the amount of $130,000 being under monthly interest-only payment modification. This industry segment consists of a diverse group of borrowers, including golf courses, bowling centers, movie theaters, fitness establishments and 1 zoo. All entities are open with the exception of one Indianapolis business that went into nonaccrual during the third quarter due to the closing related to COVID-19 restrictions.

In general, we have strong, cooperative borrowers with small average loan balances of $529,000 and low loan-to-value ratios on our largest segment in this portfolio consisting of golf courses. Most golf courses actually saw an increased number of rounds played in 2020.

Slide 27 titled Hotel Sector Locations, you'll see on the map that exhibits the locations of Horizon's loans secured by hotels. And as you can see, the vast majority of the hotels that we finance are located along an interstate highway or resort communities. Hotels located along interstate highways are rebounding faster than those located in metropolitan areas, where they are dependent upon supporting their convention venues.

All hotel loans in our portfolio are open for business with occupancy rates dropping in October and November as a result of the COVID-19 second wave. The average decline from October, November was 50% to 38% for occupancy.

Even with the stress of COVID-19, Horizon continues to report strong asset quality metrics in the fourth quarter, which you can see on Slide 28. The chart in the upper-left corner exhibits low total net charge-offs over the last 5 quarters of less than 2 basis points. The chart in the upper-right corner, credit loss provision expense, was low throughout 2019. And for 2020, Horizon's provisioning expense was higher to build reserves due to the early adoption of CECL and primarily related to the kind of metrics and the general allocation for the nature and characteristics of our loan portfolios during this pandemic.

The chart on the lower left exhibits Horizon's total nonperforming loans to total loans, which is still low and manageable as of December 31 at 69 basis points. During the fourth quarter, we experienced a slight decline in nonperforming assets primarily resulting from payoffs received on distressed commercial loans.

The chart in the lower-right quarter, allowance for credit loss, exhibits [rising] at 1.4% of total loans, which is in line with other community banks that have adopted CECL. Horizon's credit loss reserve to total loans, excluding PPP loans, was at 1.51%.

On Slide 19, you'll see key franchise highlights. We are a seasoned management team who has managed through multiple economic cycles, excellent geographic diversification in good quality markets, strong credit culture, high-quality and well-diversified balance sheet, robust capital position, historical earnings run rate even during the great recession, 30 years of uninterrupted dividend payments on our common shares. Overall, good year.

This concludes today's fourth quarter earnings presentation, and operator, please open the lines now for questions. Thank you.

(Operator Instructions) The first question today comes from Terry McEvoy with Stephens.

Maybe, Mark, a question for you. How should we think about expenses in 2021? I appreciate all the data on active bank users and transaction volume. And you kind of hinted at maybe some opportunities to consolidate some branches with more news to come. So with all that said, what should expenses kind of trend and look like this year?

Well, the fourth quarter was heavily loaded on the salary benefits side. As we expected in the first part of the year, we didn't foresee where we were going to be or we thought where we were going, didn't have the accruals where they should be. So I think the year, looking at a full year of the salary benefits expense is a good picture of where we should have been for the entire year and moving into 2021.

We had some other elevated expenses here in the fourth quarter, which we alluded to and some of the onetime items that are normal operating, but in the other expense category, where we had some write-downs on bank-owned properties, we're trying to get those take -- those out of the balance sheet. And then there was higher customer activity, which that loan expense and so forth could continue through next year.

But we are looking at the branch rationalization. There will be more to come on that as we get into this year. And we are looking for way -- we also are looking to where we need to reinvest some of that as we look at that branch rationalization to invest it into future earnings.

So Terry, we never give exactly forward-looking statements, but I think the full year of expense is a pretty good basis to start with. And then we are going to do what we can to maintain the level, although there are sometimes in the inflationary or pressure to -- or needed to move up for salary benefits and so forth for increases going into 2021.

And then just as a follow-up, it sounds like over the near term, mortgage business should remain pretty healthy, though the industry is -- industry kind of folks are suggesting it declines throughout the course of 2021. What are your thoughts on kind of full year mortgage revenue as well as just the mortgage warehouse, which ended the year almost with $400 million?

Yes. I think as we look at it, we follow the mortgage banking direction that they were looking for about a 30% decline based on this year. Obviously, coming into the first quarter here, we still are at elevated levels, both refinancing and purchase. But I think following the guidance that we're seeing from the national industry is probably a pretty good look at what we're anticipating, which will also impact the warehousing as we get into the rest of the year as it slows.

Yes, Terry, this is Craig. We are directionally aligned with the refinance indexes that are published. So whatever trend they're taking is the same trend that we'll be taking. It's just been historical norms.

The next question comes from Damon DelMonte with KBW.

Great. So first question, just on the margin. Mark, could you just elaborate a little bit more on your outlook there? I think you are saying that the core margin should probably trend a little bit lower during the course of the year. And then you kind of -- you talked about some of the puts and takes around that and what could be some of those factors. Could you just kind of go back over that, please?

Yes, Damon. Our focus is since we have the liquidity and we had a lot of excess cash even as we're continuing to try to find ways to utilize it, we had excess cash again at year-end. So there is going to be some natural pressure on the loan yield just from some refinancing or the new product that comes on and rates are down. But I think the loan yields are -- we're seeing those starting to stabilize, and the repricing is working its way through.

I think the pressure is going to be more on the mix of the assets, and we're -- stated that we're looking to put $200 million more into the investment portfolio at lower yields. So I think that's going to put the pressure on the asset yield.

We have some of the benefits that of the CD portfolio rolling off on the funding side. So we'll see some pickup there. But I think the mix of the assets is probably going to have the biggest impact to the margin. So we're focused on growing net interest income. So we want to get our cash to work. We want to look for ways to increase net interest income and continue to grow that. And the margin will end up where it is depending on the mix of those assets.

Got it. Okay. That's helpful. And then, I guess, just maybe a broader question for Craig. You mentioned that you thought that M&A opportunities could be rising here in 2021, could you just give us a little refresher on your geographies and some of the characteristics you look for? And then also, could you comment on market disruption and maybe fallout opportunity from the HBAN-TCF transaction that's previously announced?

Yes. Thank you, Damon. You might -- some of you might be surprised that our primary focus is Michigan, Indiana, Northwest Ohio. We are not looking at Illinois anymore primarily because the COVID-19 pandemic has exacerbated the issues and problems in Illinois that I think will be a long-term duration. And so we're avoiding opportunities in that state.

But in Indiana, Michigan, Northwest Ohio, we are hearing discussions taking place again. People are at least talking about possible M&A. We saw some recent announcements come out that I think are encouraging. So yes, I think 2021, we'll see a resurgence of M&A in our target footprint.

Regarding the Huntington-TCF acquisition, whenever there's market disruption, we pursue it vigorously. We pursue not only talent. We pursue customers through increased advertising dollars. This will be TCF's third systems change in 3 or 4 years, I think, under the time period. That's a lot of disruption for their customers to go through. So we think there's opportunity to pick up not only talent but as well as customers going forward. Thank you for the question.

(Operator Instructions) The next question comes from Nathan Race with Piper Sandler.

I was hoping to just kind of expand on just the loan growth outlook ex PPP this year. Obviously, there's some opportunities with the M&A-related disruption in some of your geographies. So just curious if there's an update from -- I think there was kind of a flattish outlook ex PPP last quarter. Are you guys feeling kind of more, less constructive just in terms of organic loan growth for 2021?

Yes. I'll take a stab at it, and then we'll have Dennis Kuhn maybe give us some insight on the commercial side as well. Our objective is to maintain loan outstandings for the year, which will be commendable considering PPP forgiveness that's forthcoming.

That said, we don't see that taking place till third and fourth quarters. And what's interesting is our commercial line of credits have actually had a considerable decline because of the PPP proceeds and the permanent working capital that's gone into some healthy businesses. So until they burn through that cash, we don't see that line of credit usage picking up unlike what we really thought might happen where there would be a higher utilization.

But no, commercial should rebound in the third and fourth quarter. We plan to invest in commercial lenders, try to take advantage of the TCF-Huntington transaction and so how long will it take them to build that pipeline.

With that said, we had growth in some of our key markets. The Michigan market had a very good year last year. We had some payoffs in Indianapolis, so basically slowed down. The pipelines are starting to rebuild. So our growth markets, I think, will return and be promising again going forward. And we have historically taken our profits from the mortgage business during the good years and reinvested in commercial lenders for future growth. And that's what we plan to do in this year. Dennis, you want to add to that at all?

I think that was an excellent response. And again, as Craig said, the performance in our key growth markets, including the metrics you're hearing today on unemployment such bode well for those markets we're active.

Our -- and our sense at this point is that over the fourth quarter and early '21 here, we're seeing some growth in pipelines. So there are opportunities that are starting to come to the front. It is, of course, very competitive. But we will be, again, looking for opportunities with regard to the Huntington-TCF upheaval as well, so.

Got it. That's great color. And just changing gears a little bit and thinking about capital deployment. Obviously, I appreciate your comments just with M&A remain and ongoing, like consideration these days. And with the stock having bounced back a little bit, just curious on your kind of updated thoughts on going back to (inaudible) repurchases and just the overall upside there and what your remaining authorization is as well along those lines?

Nathan, as we continue to grow earning assets faster than capital -- I'm sorry, vice versa, capital is growing faster than earning assets, we do have to do something with that excess capital. So we are seriously looking at our dividend as well as stock repurchases in 2021. I'm not sure when those will start, but definitely on our table. And the third thing is the acquisitions would also take a part of that capital. Mark, do you want to add to that?

(inaudible), we have about -- in our current repurchase plan, we have about 1.8 million shares left in that plan.

Got you. And just as a follow-up, Craig, just curious with the credit picture becoming a little more clear these days, is there a payout ratio that you guys are targeting this year in terms of both buyback and common dividends relative to historical periods? I think it's been in the 30% range or so. Any updated thoughts along those lines?

Nathan, we try to keep our payout ratio in line with peers and to increase dividends directionally with earnings improvement. And we've done that historically. And so I don't see that changing. Where in the past, we were very low on payout ratios, we're at 25% or below. We're more in line with peers now, 30% to 35%. And I don't see that going backwards.

We've kind of with the -- we're a mature company versus 5, 6 years ago. We had rapid growth with all the mergers and acquisitions. We need to retain the capital. That is less of an issue today as we are a much larger company.

The next question comes from Brian Martin with Janney Montgomery.

Hey, just one follow-up, Mark, on the margin question of the dollars of net interest income. I guess if -- can you just talk about maybe what -- how you think about the dollars of net interest income, if that's more of the focus just from a growth perspective this year? I mean the PPP kind of muddies that up, but just how you're thinking about expectations for '21 versus '20 on the dollars of net interest income given the fluctuations in the size of the balance sheet here?

Yes. I think it's just general direction, Brian. I can't give you amount, obviously. But I think, as we talked about the margin, I think as we hopefully see the loan yields stabilize through the year as we continue -- as we repriced the portion, I think there's still a slight pressure, but they are stabilizing under the current scenario right now. Now we have different economic indicators. There's economic issues that could change throughout the year.

So I think the biggest impact to be able to see what would be the net interest income would be putting in the additional liquidity into the investment portfolio. And we already said we're working on $200 million, but we also have additional liquidity coming from PPP forgiveness as we get through the year and through this -- this current round. That's going to help put on more assets for a while, but those will come back.

In the last round, we picked up quite a bit of cash through that process as that money was sitting in our transaction accounts, and along with the warehousing, will create liquidity. So I think it's going to be -- it's our goal to grow net interest income, but I think there's going to be pressures because the -- getting rid of the warehousing and PPP loans and the fees, those are going to be higher-yielding than what we can put on with investments.

And part of the driving factor will also be where our deposits go. If we start to see deposit outflow, then we will be able to reduce some of the balance sheet, but really the deposit flow is driving -- the deposit levels are driving the need to put the cash into earning assets.

Got you. Okay. That's helpful. And maybe just…

Brian…

Go ahead, Craig.

This is Craig. If we just maintain the dollars of margin or have modest increase, we're going to be doing very well, given I anticipate the credit provision expense should not be anywhere near than it was in 2020 and then we built up adequate reserves. So the strategy is to bridge this year to get to 2022, where you're going to see a return of pretty good growth numbers in the stronger net interest margin that we shrink the investment portfolio and put it back into higher earning assets.

So that's our plan. We've done that before in other recessions and other mortgage boom times. I think it's worked pretty well.

Yes. Okay. And maybe just -- my next question is just on that comment, Craig, on the reserve build and just kind of where things are at. I mean the credit quality was obviously very strong here, but you guys had some build in the quarter. Just kind of how to think about the reserve kind of post-COVID here, kind of where we may trend to? Or how to think about that?

Yes. First of all, I think CECL is working as intended. We could all talk about the mechanics of it. It's different in each bank, but that's how we manage our reserves back in the '80s. We set aside earnings during great years for future losses, and that's what's taking place now. So I think CECL is working.

But what I'm encouraged about is that we are -- the number of loans are smaller. Our hotel sector was actually doing very well this summer and through October with higher occupancy rates because they are primarily hotels located along highways and reserve communities, and thanks to the Chicago influx of people coming over to the resort communities.

And then the second round of PPP is going to get them through the next summer. Will they have the occupancy rates and average daily room rates they had 2 years ago? Probably not, but they're going to cash flow have decent and modest returns to their investors, but nothing like they had with them previously. They were having, what I would consider, egregious returns to their investors given the demand. We're not in (inaudible). I feel pretty comfortable with that segment going forward from additional allocations in the stimulus money coming out. And that's true of all of our other nonessential businesses.

The PPP program has worked to bridge that gap. So from a credit quality standpoint, get us through the other side, which we're hearing in the summertime. I believe there was pent-up demand for the retail consumer sectors, probably not the business side who's sitting on all this cash, but definitely on the retail consumer side. I'm not sure about you, but I can't wait to travel again.

Yes. No, for sure. And maybe just the -- just given your comments on the hotel, the level of criticized assets, I think you guys gave the classifieds in the release. But just how does the criticized levels trend this quarter?

Yes. I'll make a broad comment and let Dennis talk about as well. Two things that I want to state. Number one, when we gave a modification, we downgraded the credit. I'm not sure all banks are doing that.

Number two, our third-party independent loan review company recommended to the Board, which we accepted, to do a deep dive into our troubled sectors. They look at a lot of loans, over 100 loans, and came back to the Board at our meeting in December and said basically that we were perhaps one of the best banks they've seen, how we address and attack the distressed sector. So that gives me a lot of confidence in how our team managed their accounts, went out, talked about their plans to cut costs, looked for capital alternatives to help them get to the other side. So very proud of what we've done. But with that, we did have an increase in substandard loans in the fourth quarter. I'll let Dennis talk about that. Dennis?

Sure. Yes, we saw an uptick of about $11 million or 12% during the fourth quarter. That's centered in commercial, of course, 7 relationships. Largest was about $8 million. That's an agribusiness, seed distributor, who's working on a recapitalization and potential payoff here during the first quarter, second quarter latest. Several other credits, a couple of manufacturers, a couple of CRE deals. So nothing really just (inaudible) type things that we see.

And as Craig said, we're actively watching our loans, of course, managing those, putting together, work out plans that have worked as you saw with the decrease in nonperforming during the fourth quarter. Two loans in particular paid off, and those were favorable results to the bank. We didn't take additional losses on those. So again, it's just repeating our history of identifying, working a plan and limiting our charge-offs.

It surprised me in quarter end, our -- it has been true all year. Our asset-based loans have primarily been in formula throughout the year, we've had a couple now that have gone out of formula, but it's because of growth. The formula -- the asset-based formula has less dependence on inventory. The inventory is building as they're -- and they haven't booked a sale yet. They're building the inventory, and we think they're going to be back in formula here in the first quarter. So even though we've downgraded the credits in the manufacturing side, they're actually performing pretty well.

Got you. And just to be clear, Dennis, the comment on the $11 million, was that the classified level? Or was that the level of criticized, including special mention? Or did you mention special mention?

That was in the substandard. So substandard category.

And how did it -- I guess, inclusive of the special mention, so the criticized number, how does it -- was that directionally the same way? Or how did that trend in the quarter?

There was significant impact. As Craig has mentioned, we -- when we modified loans, we took a 1-step downgrade. So there was certainly additional movement early in the year within the special mention. But as we've progressed and we're getting the opportunity to review those credits again, we are seeing -- again, they're stable. They're making payments, and we are starting to actually see some reversal of that. And we'll -- over time, we expect the special mention will actually reduce. So there'll be, of course, some level of migration. But again, what we're seeing at this point has been favorable.

Yes, Brian, by example, most of our hotels went into special mention. Someone is a substandard. But 71% of our hotel dollars outstanding have sponsors with $10 million plus in liquid assets, very well-heeled sponsors that can support the portfolio going forward.

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

Thank you, Anita, and thank you for participating in today's earnings call, and we look forward to speaking to you again, hopefully in person in the near future. Let's get to the other side of this pandemic. Thank you. Have a great day.

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