Horizon Bancorp Inc /In/ Q2 FY2023 Earnings Call

Good morning, everyone, and welcome to the Horizon Bancorp Inc. Conference Call to discuss financial results for the second quarter of 2023. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. Before turning the call over to the management, please remember that today's call may contain statements that are forward-looking in nature. These statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those discussed, including those factors noted in the slide presentation. Additional information about factors that could cause actual results to differ materially is contained in the 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. For anyone who does not already have a copy of the press release and supplemental presentation issued by Horizon yesterday, they can be accessed at the company's website, horizonbank.com. Representing Horizon today are Chief Executive Officer and President, Thomas Prame; EVP and Chief Financial Officer, Mark Secor; EVP and Chief Commercial Banking Officer, Lynn Kerber; and EVP and Senior Operations Officer, Kathie DeRuiter. At this time, I would like to turn the call over to Mr. Thomas Prame. Please go ahead, sir.

Thank you, 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 and our press release that was published yesterday on July 26. To begin with, we wanted to thank and recognize our communities, our clients and our advisors who have joined us throughout the year, celebrating our 150th anniversary. The history of our organization is based deep in community involvement, our people-first philosophy and a highly engaged and talented team of advisors. We have continually displayed a disciplined and balanced operating model that has successfully navigated economic cycles and consistently produced strong total shareholder returns to our investors over time. As the leadership team will share in our presentation, our second quarter results were positive on many fronts. Our net income improved through solid quarterly revenue, which included a thoughtful approach to new production loan spreads and daily management of our deposit funding costs. These key revenue drivers were coupled with improved non-interest income in the quarter. The team continues to manage expenses very well, and our credit quality performance remains a positive staple for the franchise. As the industry faced elevated deposit competition and client demand shifting to higher interest-bearing deposits, Horizon is navigating this environment well with a measured approach to deposit pricing and is continuing to execute on its strategy to accelerate growth in higher yielding assets. Our durable deposit relationships with tenured end market clients, which is managed through our diversified funding platform to retail, commercial and treasury management, performed well this quarter by maintaining and slightly increasing our overall deposit balances. Additionally, today, you'll learn about our forward view of our continued lending growth, the positive results of our pricing strategies, our active balance sheet management and the ample liquidity that we believe positions Horizon well for continued success through 2023 and beyond. Now to give you a quick summary of our strong core markets across Indiana and Michigan, we remind you that Horizon's expansion and growth has occurred primarily in Michigan and Indiana's college and university towns and within state and county government seats. These markets continue to provide community base that is traditionally more economically stable, which helps limit the real estate volatility of typically large metropolitan areas. Additionally, we continue to see inbound migration from high-cost states and considerable infrastructure investment in our core markets where we have distribution that has resulted in strong balance sheets of our commercial and consumer customers and aligns well with Horizon's conservative credit culture. To help communicate and provide insight in our Q2 performance on these fronts, I'm going to turn the call over to Lynn Kerber, our Executive Vice President and Chief Commercial Banking Officer, to provide detail on our loan and credit performance for the quarter.

Thank you very much, Thomas. Good morning. Commercial loans toward the second quarter had a net increase of $820,000 or 1 basis point on an annualized basis. Net fundings were $128 million for the second quarter versus $109 million for the first quarter. These results were impacted by extraordinary payoffs in the second quarter and the associated participation loan accounting. Without these adjustments, commercial loans would have increased $60 million for the quarter, aligning well with our full year growth forecast. The overall commercial pipeline remains solid with $118 million as of June 30 compared to $130 million at the end of the linked quarter. Our customers continue to evaluate new investment opportunities, and we have seen increased activity across the sector as well as public-private partnership developments. Our new loan originations continue to be very diverse across our markets and consistent with our overall portfolio sectors with roughly one-half in non-owner-occupied CRE, 21% in owner-occupied CRE and 28% in C&I. Consistent with prior periods, our commercial credit quality remains very strong with very low past dues as of June 30 and 1 basis point of net charge-offs in the second quarter of 2023. Turning to Slide 7, which highlights our overall composition of the commercial portfolio, it has remained very stable. There has been some continued focus on office and retail sectors. And with that in mind, we have highlighted our office and retail portfolios with some additional detail on Slide 8. You will note that overall, we had $162 million in office CRE, representing 6% of our overall portfolio. The office loan portfolio is well diversified across our markets and comprised of properties in Midwestern cities that have not experienced the same vacancy rates found in some major metropolitan markets. Our retail CRE portfolios also totaled roughly $160 million, representing 6% of the portfolio and is also well dispersed across our markets. Average loan size for both portfolios was $1.1 million and $777,000 respectively, with both experiencing strong credit quality metrics in both segments with no past dues or nonperforming loans as of June 30. On Slide 9, we're providing some additional insight on our maturing CRE loans and interest rate repricing risk. For 2023, the remainder of the year, we have $77 million or 4% of our CRE portfolio maturing in the second half of the year. This portfolio currently has an average rate of 6.66% and only $36 million currently has a rate under 6%, representing only 2% of our overall CRE portfolio. For 2024, there's $178 million in loans maturing, representing 10% of our overall CRE portfolio. This portfolio has an average rate of 6.02% and roughly half at a rate less than 6%, again, representing only 5% of our overall CRE portfolio. With these metrics in mind, we feel we are well positioned for rate-related credit risk at this time. On Slide 10, turning to consumer direct loan balances, you'll see that they increased $2 million through origination efforts of our branch platform. We continue to actively increase the new production yields, improving the overall portfolio performance. Indirect auto decreased $25 million for the quarter, which is consistent with our strategic plan of redeploying to higher-yielding product types and with the short duration, this provides flexibility for us in both the balance sheet and revenue goals. Our credit quality remains consistent in our consumer portfolios with higher quality borrowers with proven credit and income capacity to navigate the higher rate environment. This is reflective of the direct consumer loan portfolio despite net recoveries for the quarter and 10 basis points year-to-date charge-offs for indirect loans. Slide 11 highlights our mortgage loan performance for the quarter. Our portfolio increased $12 million, which is consistent with expectations for 2023 and reflective of high-quality jumbo loan borrowers. Thus far, for 2023, 70% of our year-to-date production is saleable. As seen with previous quarters, new production yields compare very favorably to those on payoffs and paydowns. Our team continues to adapt in the current environment and has expanded its core mortgage products and investors to provide additional flexibility and financing options for our highly competitive purchase market and new construction financing. With zero charge-offs for the quarter, our portfolio continues to reflect high-quality borrowers with significant payment capacity and also equity in their homes. Turning to asset quality metrics. They continue to be very strong, as outlined on Slide 12. Net charge-offs for the second quarter were $274,000, representing 1 basis point of average loans. Our nonperforming loans increased by $2.3 million, primarily due to non-accrual mortgage loans. However, these loans are well collateralized and no loss is expected at this time. Overall, our nonperforming loan ratio of 52 basis points is consistent with prior quarter's performance, and past dues continue to be very low at 26 basis points of our total loans for the quarter. The allowance for credit loss increased slightly to $49.9 million, representing 1.17% of total gross loans, which we believe is appropriate given the level of charge-offs and nonperforming loans, the condition of our high-quality portfolio and market and economic conditions. Credit quality across all of our lending classes is performing well and reflects our history of consistent and well-balanced approach to lending. As noted on Slide 13, our historical credit performance compares very favorably to other US commercial banks. We have had a history of outperforming the market through prior economic cycles, and we believe we will outperform the market again as we progress through 2023. Now I'd like to turn things back to Thomas, and he will provide an overview of our deposit portfolio and trends.

Thank you, Lynn, and appreciate the great insight and also the extra detail on the commercial portfolio, well done. As we transition to Slide 14 on deposits, we have a very seasoned and granular portfolio. Our key client segments consist of an average of 10 years, and balances are reflective of our strategy of helping our local businesses, our consumers, and our communities in and around our Michigan markets. Additionally, as we examine our portfolio, we continue to have over 50% of our balances in transactional checking accounts. Again, these are predominantly tenured operating accounts of our local clients. In Q2, our percentage of client balances that were collateralized or assured to the FDIC or third parties increased to 79%. As noted last quarter, in Indiana, public funds with the state, with counties and cities, towns, schools and the like are all insured through the Indiana Public Deposit Insurance Fund to the extent that they exceed federal coverage limits. As I stated in my opening comments, we're very pleased with our deposit balances, maintaining stability and slightly increasing from Q1. And Mark is going to share in subsequent slides, the cost of maintaining deposit balances was very well managed in the quarter. Slide 15 provides detail on deposit flows for the second quarter. We remain very upbeat and positive about the strength of our deposit portfolio. Our core relationships consisting of consumer and commercial shifted slightly as we saw clients spend down some excess funds, and we saw continued movement to higher-yielding deposit products. During the quarter, the combined consumer and commercial deposit portfolio was just down just over 2%. Throughout Q2, we continued our daily pricing discipline and the team was successfully able to make profitable inroads, adding to our public funds portfolio with rates and terms that align very well with our ALCO strategies. The portfolio grew approximately $120 million, balancing out the consumer and commercial portfolio. We closed the quarter with fixed-rate borrowings up slightly, and these have a positive carry to Fed funds and other funding sources. Additionally, the cash flows from our operations and securities portfolio provided additional liquidity, resulting in a positive Fed funds sold position of over $100 million at the end of the quarter. We believe this will give us additional flexibility in Q3 for asset growth and increase our ability to be nimble with deposit pricing and managing our overall funding costs. Overall, we're pleased with our Q2 deposit results. The resiliency of our core client base, the active management of our funding costs, the excess cash position will provide additional flexibility in margin management as we move forward. As always, these results are a reflection of our highly engaged team of advisors connecting our local communities and helping our clients find value in banking with Horizon. Let me hand the presentation over to Mark Secor, our EVP and Chief Financial Officer, who will walk through our current liquidity position, highlights of our income statement and the key financial metrics of Q2.

Thank you, Thomas. As Thomas shared previously, our second quarter results were positive on many fronts. Our net income improved through strong quarterly revenue, benefiting from a strategic approach to new loan production spreads and management of our deposit funding costs. These key revenue drivers were coupled with improved core fee income and a continued disciplined operating model in respect to expenses and credit. We accomplished these results while continuing to operate with significant liquidity available as outlined on Slide 16. Heading into the second quarter, Horizon was well served by our strong liquidity position, which includes the majority of our investment portfolio unpledged. At the end of the second quarter, our liquidity position had improved, including over $100 million of excess cash liquidity, which will allow flexibility in managing our funding needs. Our available secured borrowing lines had over $1.5 billion of immediately accessible liquidity, with additional liquidity through unsecured lines, brokered CDs and additional unpledged securities. Altogether, these totaled more than $2.8 billion of available liquidity or 50% of total deposits as of June 30. In addition, we continue to be proactive in our balance sheet management using lower cost term borrowings to drive shareholder value. At the end of the quarter, $1.2 billion of our borrowings were at an average fixed rate of 3.47% with an expected duration of under 1 year. Slide 17, turning to non-interest income. Improvement over the linked quarter was led by increases in interchange fees and gains on the sale of mortgages while most other line items remain consistent. The company is continuing to diversify core fee income categories that align with its relationship banking model. Going forward, we expect our investments in treasury management and private wealth capabilities to contribute additional revenues. On Slide 18, our efforts to manage our operating expenses continue to be a strength for Horizon. Non-interest expenses were 1.86% of average assets for the quarter compared to 1.79% last quarter. Our long-standing 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. As we view the second quarter's non-interest expenses, the increase from the linked period was primarily due to annual merit increases, commissions and cyclical benefit costs, along with expenses from elevated loan production and increased FDIC insurance costs. Outside of these items, in the second quarter, core non-interest expense categories have been stable over the last four quarters. We anticipate returning to more normalized run rates in subsequent quarters. Our loan and deposit pricing management is gaining traction as displayed on Slide 19. The yield on total loans increased 34 basis points in the second quarter compared to the cost of deposits increasing 31 basis points, resulting in a positive spread differential and continuing to add to our net interest income. The results highlight our disciplined loan pricing for new loan production, a greater focus on originating higher yielding loan products, adjustable loans repricing and lower-yielding loan balances being paid down as we continue to focus on loan spread management, production shift into higher-yielding loan products and cash flow reinvestments at higher rates. The increasing spread is also the result of maintaining a disciplined approach to deposit pricing in a highly competitive market, while ensuring client retention remains strong. The increase in the cost of total deposits in the second quarter was 31 basis points, notably down from the increases in the last two quarters of 43 and 33 basis points. In the current competitive deposit pricing environment, we are focused on extending the positive progress we made in the second quarter in managing our deposit costs. As for the investment portfolio, it stood at $2.9 billion at the end of the quarter, which is a decrease of $63 million from March 31. The portfolio's book yield was 2.22% with an effective duration of 6.41 years at the end of the quarter. During the quarter, we took advantage of market conditions to sell $25 million in securities for a small gain. We anticipate approximately $60 million in cash flows from investments for the rest of 2023, and we will continue to proactively explore additional options for security sales in the upcoming quarters. Slide 21. Horizon continues to maintain solid regulatory capital ratios well above the requirements to be considered well-capitalized. And we believe we have sufficient capital to continue to fund our expected growth in the foreseeable future. We anticipate the growth in capital will outpace growth in total assets during the year, providing for additional capital strength. On Slide 22. For the third consecutive quarter, our tangible common equity ratio has increased and was up 4 basis points to 6.91%. This is the result of higher retained earnings offsetting a slight increase in the unrealized losses on the AFS investments. Because we have the ability to hold all investments to maturity and pledge for secured borrowings, these unrealized losses are expected to decline over time as investments pay down and mature. As shown on Slide 23, we continue to maintain a strong cash position at the holding company with adequate cash to cover eight quarters of fixed costs, including the shareholder dividend. This cash position helps provide additional stability in uncertain times and provides flexibility in the future for managing and/or restructuring the bank's balance sheet and the ability to make opportunistic investments such as stock buybacks. Horizon's current focus for the use of capital is organic growth. As current opportunities and market conditions make M&A less likely, however, we remain open and receptive to the discussions and for profitable new revenue opportunities, both in acquisition and lift-outs. We expect to continue our target dividend payout ratio of 30% to 40%, continuing our 30-plus years 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 24, we are providing you with an update on our current expectations for the full year '23 and our progress towards meeting them through the first six months of the year. Our loan growth continues to be solid in both commercial and consumer sectors, which should be a valuable contributor to core earnings in subsequent quarters. For the year, we expect 6% to 8% total loan growth. Our net interest margin and net interest income trends should continue to benefit from our balance sheet and pricing management. And we expect NIM of 2.55% to 2.65% and net interest income of $175 million to $185 million for 2023. Non-interest income should continue at current levels with the anticipation of additional fee income from our investments in treasury management and wealth. Total 2023 non-interest income is expected to range from $42 million to $45 million. Non-interest expenses continue to be proactively managed across the organization, and specifically in segments of our business impacted by rising rates such as mortgage and consumer lending, and we expect them to remain below the 1.9% of average assets for the year. Our operating metrics with ROAA and ROAE in the second quarter look to remain consistent for the full year expectation with our TCE ratio anticipated to move upward as rates stabilize and tangible equity increases. For 2023, we expect ROAA of 93 basis points to 97 basis points, ROAE of 10.5% to 10.9% and a TCE ratio of more than 7%. Now I'll turn it back to Thomas for some final comments.

Thank you, Mark. I appreciate it very much. So why invest in Horizon? Our investment thesis is simple. We are located in very attractive Midwest growth markets. They have a desirable economic environment, significant infrastructure investment and they have flourishing ecosystems for businesses and for communities. Horizon's solid year-to-date loan growth and positive outlook is coupled with a low credit risk profile that has proven to perform favorably compared to other US commercial banks over time. We have demonstrated a track record of consistent underwriting and active portfolio management to ensure the success of our clients and also our shareholders. Horizon has a stable and loyal deposit base, which is expected to continue to deliver benefits over time. We're seeing the benefits of our active deposit pricing activities and the bank has significant excess liquidity, providing flexibility and nimbleness to our funding strategies. And we have a disciplined operating model, displayed by consistently performing at an expense to average assets of less than 1.9%. This is coupled with our annual net charge-offs of only 1 basis point and a historically low non-performing loans. And lastly, we believe we are a compelling value stock that is supported by our commitment to our dividend with a 6.7 times P/E ratio and a 6.2% dividend yield. Horizon has a track record of 30-plus years of uninterrupted quarterly cash dividends. We thank you in advance for joining our presentation this morning. This is going to conclude our prepared remarks. So I'm going to ask Marliese to please open up the line for questions. Thank you, Marliese.

Thank you. We will now begin the question-and-answer session. Our first question comes from Terry McEvoy from Stephens. Please, Terry, go ahead.

Thanks. Good morning, everyone. Maybe Mark, could you just talk about the puts and takes for hitting the high end or the low end of the margin for the year? And does the margin assume the swap benefit in Q2, which was, what, 5 basis points or 6 basis points?

For the projection we provided, it reflects the 2.69% margin from June. This is factored into our full-year expectations. On the positive side, we continue to see loan repricing at favorable rates, which allows us to increase our loan yields. The uncertainty lies in the ongoing competitive pressure on deposit funding, which seems to be stabilizing for now, but that will be a key factor as we move into the second half of the year and assess what that competition will entail.

Thanks, Mark. And Thomas, prior to your arrival at Horizon, the company had reduced branches real estate and really focused on managing expenses. My question for you is what are your thoughts on the expense run rate today? And do you see any longer-term opportunities to improve overall efficiency?

Thanks, Terry. And good morning. Appreciate the question. When we look at our expenses coming out of Q2, as Mark highlighted, we had some one-time anomalies in there, a little bit of a, I'll say, some production catch-ups from Q1 that got paid in Q2. Our biggest focus right now is really on personnel expense. That's something that we saw a little bit of a merit increase. Our branch distribution, I anticipate that we're going to continue to keep a consistent branch distribution. We hired last year a very seasoned executive, had experience at larger institutions who is working on a staffing model that's going to change our complement to more universal bankers. And we anticipate as we get into Q3 and Q4, that traction will hold us. We'll see some reduced costs there. Also as a company, we just have a very disciplined operating model being able to tighten our belts and get back within our expense line. So as we look at Q2, moving into Q3, we are anticipating going back to the run rate that you saw somewhere in the mid $35 million versus being over $36 million. Very confident we'll be there as we move into Q3 and Q4.

Thanks. I have a quick question for Lynn regarding the increase in non-accruals or non-performing loans. Can you clarify what you mentioned on the call? Were those mortgages that were adjustable rate mortgages that have now reset higher and are delinquent? I didn’t quite catch that during your prepared remarks.

Yeah. So we had a couple of mortgage loans that moved to non-accrual. These are just some customers that really needed some assistance. And so we don't see those going to foreclosure. They're well within our underwriting guidelines. So we're not concerned with that.

Great. Thanks for taking my questions.

Thanks, Terry.

And our next question comes from Damon DelMonte from KBW. Damon, go ahead.

Hey. Good morning, everyone. Hope everybody's doing well today. Just was wondering if you could provide a little bit more color on the outlook for loan growth. The first half of the year was less than 3%. Now that the full year outlook is closer to 6% to 8%. So could you talk about some of the drivers that will kind of get you to your projected range?

Thank you, Damon. I appreciate the question. I'll give a little bit of color and I'll pass it over to Lynn. As we looked at Q2, we had a little bit of muted loan growth, specifically, as Lynn talked about, again it was the last week of the month, we saw a very large pay down. And as Lynn said earlier that growth probably for commercial would have been more around the $60 million range than relatively flat. The pipeline still looks strong in that area. On the consumer side, we are entering our growth season for home equity loans and draws, and we're also experiencing positive momentum with pipeline management. We expect to see an acceleration in our consumer portfolio. On the mortgage warehouse side, we noticed a slight increase this quarter and anticipate that holiday balances will remain similar to this quarter. In terms of mortgages, we are seeing growth in pipelines. We have a strong product portfolio for well-yield borrowers in the jumbo segment, as well as other areas in commercial and consumer lending. Now, I'll pass it over to Lynn for more details on the commercial side.

Sure. As I mentioned in my prepared comments, our pipeline outlook as of July 1 is approximately $118 million. This is slightly higher than our 30-day forecast from a month ago. Over the past year, this aligns with our quarterly forecasts, although it has moderated a bit. Certainly, interest rates have made our customers evaluate their projects more closely. However, our overall production has remained steady. Our fundings for the second quarter increased to $128 million compared to the previous quarter, which was around $118 million. We did face some impacts in the second quarter due to a couple of large pay-offs. Nothing unusual there other than our customers were executing on their business model. We had one that moved a large mortgage to a HUD, and that was their plan. And we had one customer that successfully sold their building as planned. So our overall growth for the second quarter was actually very good, up $60 million on an adjusted basis. So overall, I think we're feeling good about it.

Thank you, Lynn. Damon, one other point that if you noticed in that portfolio, we're strategically declining the indirect auto portfolio, which I believe, was just under $30 million last quarter. We have the capacity and the capability talent within the house also to backfill that transactional portfolio with other assets throughout the quarter.

Got it. Okay. Appreciate all that color. Thank you. And then just to circle back on the margin. The full year guide kind of implies continued compression here in the second half. I guess two questions. One, Mark, what was the spot rate for the month of June on the margin? And two, as you look at the cadence in the back half, do you think it's equally distributed between the two quarters or do you think there's more compression here in the third quarter and then it lightens up in the fourth?

Thanks for the question, Damon. Coming out of June, we were seeing rates closer to 2.5%. Those figures shifted due to varying fee incomes and other factors, but we did observe rates in the mid to lower range of 2.5%. I believe we have managed the deposit pricing adequately, though some pressure will remain. This is reflected in our guidance indicating continued pressure into the third quarter. As we gain more clarity on rates and the possibility of halting increases, we are confident we can determine where deposit pricing will settle and manage accordingly.

Great. Okay. That's all that I had. Thank you very much.

Thanks, Damon.

And our next question is coming from David Long from Raymond James. David, please go ahead.

Good morning, everyone, and thanks for taking my question. Sticking with the deposit side, your noninterest-bearing deposit concentration is now just above 20%. In your guidance that you've given for the rest of the year, where does that noninterest-bearing concentration go? And what are the risks that you're off there?

Thanks for the question. This is Thomas. We anticipate, as we get into Q3, Q4, a slight shift down, not as the magnitude that you saw in Q2. We are seeing clients specifically on the consumer side are spending through some of their savings. We do have a little bit of seasonality that happens with our public funds deposits. I anticipate that we'll see a slight decline, again, probably about 50% of what you saw here in the second quarter.

Thank you, Thomas. My other question is about the securities portfolio. I appreciate the updated statistics this quarter regarding cash flows. It seems you sold some securities during the quarter and made a small gain. Are you considering being more aggressive with the portfolio restructuring? Would you be willing to accept a certain level of losses? I'm trying to understand if there will be further restructuring of that portfolio.

Thanks for the question, David. We've been considering if other companies are doing it and whether there's an opportunity for us to sell off, take a loss, and improve our margins. We have analyzed several models and discussed the theory with our internal Board and ALCO. This is a topic of discussion. The key issue, as you can see, is that we're monitoring the market curve. There will be opportune moments, and we frequently use that term, so we want to identify those times. If the market shifts in our favor, we aim to act quickly. This is something we are actively exploring regarding the potential use of capital.

Got it. Okay. Thanks for that color, Mark. And then just the last question I had relates to repurchase of your shares. Obviously, pretty inexpensive here. What would it take? What would you have to see to step into the market and repurchase stock?

I believe it's important to take a comprehensive approach to capital utilization. We need to identify the best opportunities for using capital in relation to current market conditions. Right now, we are focused on managing our TCE ratio to ensure it continues to grow, especially as we experience unrealized losses. However, as we notice stabilization and an increase in TCE over recent quarters, we can start evaluating various options as we gain better insights into terminal rates. Ultimately, we are considering what constitutes the most effective use of capital and the optimal mix of strategies.

Great. Thank you for taking my question. Thanks, guys.

Thanks, David.

Our next question comes from Brian Martin from Janney Montgomery. Please go ahead.

Thank you. Good morning, everyone. I have a question about the margin. Mark, if we see the margin potentially bottoming out in the next quarter or two, and with the forward curve remaining stable and potential rate declines, could you remind us how the portfolio is positioned and how the margin might perform? I'd like to get a broader perspective on this.

Thank you for the question, Brian. Some of it depends on your models for when you might see rates decrease. In a stable environment, we're observing that the margin can stabilize and improve under those circumstances. It also depends on your predictions. Our models indicate that we will likely remain at higher rates for a longer period into the first part of 2024. However, we do see the potential to continue repricing assets, manage funding costs, and see an improving margin as we move into next year.

Got you. Okay. And that's with the rate cuts probably coming mid-year later is kind of what you're suggesting there?

Yeah, right.

Yeah. Okay. And then just from a standpoint of repricing, how much in the way of loans reprice in the second half of the year and kind of what type of rate are, I guess, just kind of the portfolio rate that we see out there, just what level of opportunity is there here in the next six months on the loan repricing side?

On total asset repricing, which includes some securities, we mentioned the $60 million that would reprice alongside our liquid assets. We have approximately $1.9 billion of assets set to reprice in the next six months, which encompasses adjustable rates and the maturities and paydowns from our loan portfolio. In comparison, we have about $2.3 billion scheduled for repricing over the next 12 months, indicating that the majority of our repricing occurs within the next six months. We shared insights on this, and I'll let Thomas elaborate on loan repricing, but we've highlighted some of the spreads we are observing coming in and the significant changes in new pricing as older loans roll off.

Thank you, Mark. I think you're referencing Lynn’s slides about each sector and the potential incremental lift. We see a great opportunity for Horizon in this area. As Mark mentioned earlier, we will be repricing just over $1 billion. Over the past two quarters, we have demonstrated strong discipline in managing our loan spreads while maintaining our credit quality. This has been complemented by our disciplined deposit management observed in the second quarter. Following the second quarter, we feel very positive about the favorable spread differential between our loans and our deposit costs in a stable rate environment where the Fed is holding steady. We are seeing strength in Horizon's balance sheet. As you said before, it's really about great outlook. Our outlook is going to be, of course, the move yesterday, we're anticipating another move before the end of the year. And so for us, and as Mark talked about, we're probably looking at a little bit longer in our forecast for '24 rates being held up a little bit longer. That's what's really driving our strategy right now on when to deploy capital as you talked about before, whether it's a share buyback or perhaps restructuring the balance sheet is really being driven by our outlook on where rates are. For us right now, we're taking a little bit of a wait-and-see strategy. We believe that's best for our overall shareholder return. And as we deploy capital, we have an outlook that we like to make sure that we get the return on that capital for our shareholders back in a very reasonable time. Our objective is to make it in less than 24 months or less, and that extend out to with a rate guessing game of over three years. And so for us, a little bit of patience here in the third quarter. But as Mark said, we're actively looking at this on a daily basis, discussions with the Board already and models have been completed.

Okay. And is that kind of your suggestion on the securities portfolio, Thomas, that the two-year time period as far as payment?

We think as we look at deploying any capital that we're going to get a reasonable time frame. The securities portfolio for us, you know the dynamics well around the yield and where the duration is, and we're on the curve that we would need to see some type of movement in order to get an execution of size. But again, for us, if we're going to execute on something that deals with the securities portfolio outside of our typical opportunistic moments that we take throughout the quarter, again, somewhere between 18 and 24 months.

Got it. Okay. And then for my final question, I think someone mentioned wealth and treasury management. Is there anything significant that we should be aware of regarding changes in that area, or are you simply expecting to see some benefits? Is that what you were highlighting or explaining?

So in the wealth management area, we didn't have any prepared remarks on that today, but I shared in previous earnings calls that we did do some refocusing in our wealth management department over the course of the last year. Part of that is exiting the ESOP business, which was a significant line of business in that group. And we've had some change in leadership and retooling to really focus more on overall wealth management and financial planning and employee benefit programs. We have seen that trend improving over this course of this year as far as new pipeline and production of new closed business. So we think that will definitely help us as we continue on throughout this year and going into next year. On the treasury management side, of course, we've been managing to the interest rate environment. So that has impacted the mix of deposits, but our fee income continues to perform really well in meeting our targets.

Got you. Okay. I appreciate the color, and thank you for taking the questions.

Thanks, Brian.

A question comes now from Nathan Race from Piper Sandler. Nathan, please go ahead.

Yes, hi, everyone. Good morning. Thank you for taking the questions. Just one clarifying question. I think Thomas mentioned that deposit attrition or outflows may continue at least in the third quarter. So just curious how we should think about the level of borrowings going into the back half of the year to kind of stable level of borrowings kind of contemplating that 2.55% to 2.65% guidance on the margin?

Nathan, thanks for the question. This is Thomas. We would anticipate our borrowings will be relatively flat. Again, we're at Fed funds positive position actually in the quarter. It's going to give us a lot of flexibility around our deposit pricing and also our flows in and out. Again, I anticipate that we'll see a diminished outflows level going into Q3, stabilizing in Q4. But again, with that excess position at the end of the quarter, we feel positive about the overall balances and not really need to increase our borrowings. Also, as I mentioned earlier, a little bit more of a stable market in the public funds area, that enhanced pricing that's now probably agreeable with our outcome models, and that's a space we can step back into that we stepped out of in Q1.

Okay, great. That's helpful. And then just maybe one clarifying question on the margin guidance as well. It looked like the accretion income stepped up a little bit in 2Q versus 1Q. I guess, Mark, any thoughts on just the level of accretion that we should expect in 3Q and 4Q of this year?

Yeah. You know it bounced around depending on what we see happen with loans and recovery. But I think the best guidance is to take the first couple of quarters and average them, and that would probably be what we'd see similar to the second half of the year.

Okay, got it. And then maybe one last question for Lynn. The reserve was stable quarter over quarter at 1.17% of loans. I guess absent any CECL macro related adjustments, do you expect it to kind of remain near this level as you guys just continue to provide for the loan growth guidance that was provided in the deck?

Yeah. Thank you for the question. The CECL model for the allowance always is a combination of a variety of factors, right? And so we have the economic forecast, which is one driver. And then, of course, we have our internal loan balances and credit quality. We did have some excess, I'll call them COVID pandemic reserves that we have been releasing over the course of last year. And so at this point, the key drivers are going to be the overall economy and our overall credit trends. And so to give you a prediction, I don't know that I could do that today, of course, but it's really to be based on those drivers of the overall economy, our loan growth and our credit metrics.

Right. Got it. Sounds good. I appreciate the color. Thank you, everyone.

Thank you.

And this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Thank you, Marliese. And again, thank you for participating in today's earnings call. As we stated earlier, we're very pleased with the progress through mid-year, and the momentum headed into the second half of 2023. In our view, Horizon's markets are some of the most attractive in the Midwest, and we intend to continue to find positive momentum for our active balance sheet management, our disciplined operating culture, and create long-term shareholder value for our well-diversified loan portfolio and our valuable core deposit franchise. We appreciate your participation in today's call, and we look forward to speaking with you on our next quarterly call, which will be in October. Have a wonderful day.

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