Horizon Bancorp Inc /In/ Q1 FY2024 Earnings Call

Good morning, everyone, and welcome to the Horizon Bancorp, Inc. Conference Call to discuss financial results for the first quarter of 2024. Before turning the call over to the management, please remember that today's call may contain statements that are forward-looking in nature. These statements are subject to risks and uncertainties and other factors that could cause actual results to differ materially from those discussed, including those factors noted in the slide presentation. Additional information about factors that could cause actual results to differ materially is contained in Horizon's most recent Form 10-K and its later filings with the Securities and Exchange Commission. In addition, management may refer to certain non-GAAP financial measures that are intended to help investors understand Horizon's business. Reconciliations for these measures are contained in the presentation. The company assumes no obligation to update any forward-looking statements made during the call. For anyone who does not already have a copy of the press release and supplemental presentation issued by Horizon yesterday, they can be accessed at the company's website, horizonbank.com. Representing Horizon today are Executive Vice President and Senior Operations Officer, Kathie DeRuiter; Executive Vice President, Corporate Secretary and General Counsel, Todd Etzler; Executive Vice President and Chief Commercial Banking Officer, Lynn Kerber; Executive Vice President and Chief Financial Officer, Mark Secor; and Chief Executive Officer and President, Thomas Prame. At this time, I would like to turn the call over to Mr. Thomas Prame. Please go ahead, sir.

Good morning, and thank you for participating in today's call. Horizon had a solid start to the year with our second consecutive quarter of expanded net interest income, both in dollars and in margin. Net interest margin for the quarter was 2.5%, with continued improvement throughout March, exiting the quarter at 2.53%. Additionally, our results showed noninterest income continues to perform well across our diversified operating model even with seasonality of lower mortgage volumes. Expenses were well managed in the quarter, with the results at the lower end of our guidance, as the team continues to be diligent in capturing cost savings. Credit performance and trends remain positive, with minimal charge-offs and low nonperforming loans, through continued proactive portfolio management. As seen in the first quarter, the franchise experienced significant loan growth on several fronts, both in our core business lines and our previously communicated asset repositioning strategy. We are very proud of the results of all of our teams this quarter, displaying the diversity of our lending platforms across our footprint and the capability of our team to deploy our excess liquidity into high-quality and higher-yielding assets and improving our go-forward asset mix. Additional insight and detail into our loan growth will be shared by Lynn in the lending and credit sections later in our presentation. We are also optimistic about our deposit portfolio results that displayed very strong trends in the quarter with the continued resiliency in core balances, deposit costs increasing just 9 basis points from year-end and the modest runoff in the first quarter was primarily attributed to the company's decision to reduce segments of its high-cost public funds portfolio. Our first quarter results provide optimism on our go-forward financial outlook as we move into the second quarter with a positive trajectory continuing in margin and improved balance sheet positioning, well-managed expenses and continued solid credit trends. As we move forward, a key element of our positive outlook is the strength of our core lending platforms and to provide more detail on this segment of our business model. I'll transition the presentation to Lynn Kerber, our Executive Vice President and Chief Commercial Banking Officer, to provide details. Lynn?

Thank you, Thomas. Beginning on Slide 5, we have an overview of the loan portfolio as of March 31 with a mix of 60% commercial, 17% residential and 22% consumer, which remains relatively unchanged from the prior quarter. Commercial loans increased $75 million, which includes $23 million in equipment finance activity, residential mortgage loans increased $101 million and consumer loans increased $13 million. First quarter loan growth included $154 million in acquired loans, including approximately $59 million of consumer loans with credit protections, $95 million in residential and a reduction of $39 million of indirect auto loans. These actions represent our planned redeployment of proceeds from December's balance sheet restructuring into high credit quality and higher-yielding assets. On Slide 6, we are pleased to report commercial loans increased $74.8 million for the first quarter, representing 11.2% on an annualized basis. Net fundings, including equipment finance, totaled $110 million for the first quarter compared to $117 million for the fourth quarter. We saw a meaningful increase in the average commercial loan portfolio yield in the first quarter, increasing to 6.14% from 6.05% in the fourth quarter. Also, new production yields were 7.52% in the first quarter. The core commercial pipeline increased from $167 million at December 31 to $187 million as of March 31. Activity continues to be well diversified by industry and geography. The Equipment Finance Division contributed approximately $23 million in originations in the first quarter and will be continuing to ramp in the second quarter. We continue to anticipate a total contribution of $100 million to $125 million for the full year 2024. Commercial credit quality remained strong with low past dues of 18 basis points for quarter end compared to 16 basis points at December 31 and 16 basis points for March 2023. Nonperforming commercial loans decreased 27% in the quarter due to the payoff and upgrade of several nonaccrual and substandard loans. Accordingly, we recorded commercial net recoveries of $57,000. Also provided for reference on Slide 7 is a breakdown of key sectors in our commercial portfolio, which demonstrates no significant concentration in any one sector and particularly multifamily, nonowner-occupied office and health care. As noted, the percent of risk-based capital is consistent with the UBPR peer group and well within regulatory guidance. With continued focus on the interest rate environment for 2024, we have included a summary of maturing CRE loans for 2024 and 2025 on Slide 8. For the remainder of 2024, we have 277 notes with current balances of $213 million maturing, representing 10.9% of our portfolio. Of this tranche, there are balances of $101 million with interest rates of less than 7%, representing 5.2% of our CRE portfolio. Similarly, 2025 has 240 notes, maturing with balances of $188 million maturing, representing 9.6% of the portfolio. Of this tranche, there are balances of $123 million, with rates of less than 7%, representing 6.3% of our CRE portfolio. In all, this is another example of how Horizon benefits from our long-standing commitment to pricing discipline, and we believe rates and maturities are well managed in our CRE portfolio to limit exposure to rate-related credit risk at this time.

Thank you, Lynn. Great insight and information. As mentioned earlier, we are pleased to see the positive momentum in our net interest margin through our strategic efforts to reposition our balance sheet to higher yielding and higher quality assets, while also maintaining a disciplined approach to deposit pricing. To help illustrate the progress on our margin, we have included a waterfall graph on Page 12. As seen, the deliberate shift from lower-yielding assets to high-quality loans is making a meaningful impact on our asset yields, increasing by 19 basis points in the quarter. We expect this positive trend to continue into the second quarter as higher yielding new production continues to replace lower-yielding amortization and cash flows from the securities portfolio. Also, within the first quarter, we experienced softer demand for swap fee income, and overall commercial loan fee income was down due to the seasonal nature of payoffs, and we expect this to even out over the course of the year. As I stated in my opening remarks, Horizon's deposits and funding costs were well managed throughout the quarter. Horizon's core consumer and commercial balances were flat from the fourth quarter with single-digit increases in funding costs. Noninterest-bearing deposits experienced minor seasonal fluctuations, primarily due to commercial tax payments and year-end distributions. The company elected to leverage its excess liquidity to reduce its public funds portfolio by allowing higher-priced CD maturities to flow off the balance sheet. With this backdrop, our first quarter interest-bearing liability costs increased a modest 5 basis points for the quarter and purchase accounting adjustments were relatively flat compared to the fourth quarter. As we enter the second quarter, we have confidence in our ability to continue to improve our net interest margin even in a flat rate environment. We expect to see further expansion in the second quarter. As stated, March posted a continued advancement of 2.53% in net interest margin, and the team continues to remain diligent on improving our asset mix and yields while keeping a measured approach to funding costs. Let me hand the presentation over to our Executive Vice President and Chief Financial Officer, Mark Secor, who will walk through other key financial metrics from the first quarter and our outlook as we move forward. Mark?

Thank you, Thomas. Beginning with Slide 13. Total noninterest income for the first quarter was in line with the first 3 months of 2023, with the largest segment being account service fees up approximately 7.5% from the first quarter of 2023. Noninterest income was down from the adjusted linked quarter due to a decrease of $360,000 in BOLI income resulting from the policy surrendered at the end of last year and with lower mortgage banking income. The company continues to diversify core fee income through key talent adds in treasury management and expanded private wealth capabilities and anticipates growth in these noninterest income segments throughout the year as we expand our relationship banking model. On Slide 14, first quarter results displayed our commitment to diligent expense management. Noninterest expenses were 1.9% of average assets annualized for the first quarter compared to 1.94% in the linked quarter. The decrease reflected overall proactive expense management across the franchise. We do expect expenses to be in the range of $37.5 million to $38.3 million in the second quarter, reflecting a full quarter of merit increases and new talent in the Equipment Finance Division. Slide 15. Horizon continues to maintain solid regulatory capital ratios that are well above the requirements to be considered well capitalized. We believe we have sufficient capital to be open to options to improve our earnings outlook in the future quarters and anticipate that growth in capital will outpace the growth in total assets during the next 12 months. As we continue to deploy additional excess liquidity and cash flows from the securities portfolio, we do anticipate risk-weighted assets will increase resulting in a slight decline to risk-weighted capital ratios. Looking ahead on Slide 16, we're providing you with an update on our current expectations for 2024. We expect sustainable organic loan growth in the core business lines, which should be valuable contributors to core earnings. For the second quarter of 2024, we expect 5% to 6% annualized organic loan growth with the anticipation that we will replace the indirect auto runoff with an acquired pool that reflects improved yield and credit quality, resulting in total loan growth of 8% to 10% annualized for the quarter. Our net interest margin and net interest income trends should continue to benefit from our asset repositioning strategy and pricing management. We expect a net interest margin to be in a range of 2.55% to 2.58% for the second quarter as well as pre-provision net interest income in a range of $44.7 million to $45.5 million. Noninterest income should continue near recent level with the anticipation of consistent fee income from our investments in treasury management and private wealth, coupled with seasonal increases for interchange and mortgage originations. The expected range is $10 million to $10.5 million in noninterest income in the second quarter. Noninterest expenses continue to be proactively managed across the organization, specifically in segments of our business impacted by higher rates such as mortgage and consumer lending. As discussed, we have invested in revenue-generating talent in our leasing build-out and treasury management teams, which are expected to contribute to revenue growth in 2024. We expect total noninterest expense to range from about $37.5 million to $38.3 million in the second quarter and remain below 2% of average assets. In our original plan and current outlook for 2024, we still anticipate only 2 rate cuts in the second half of 2024, which will add additional benefit to the momentum we are seeing in our net interest margin. As the timing of these potential rate moves becomes more certain, we will update our outlook and forecast. Now I will turn it back over to Thomas for some final comments.

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

The first question comes from Terry McEvoy with Stephens.

Appreciate all the details on Slide 16. I was wondering if you could share your thoughts on how you see earning asset balances trending over the course of the year, you've got kind of cash at $271 million, you've got growth in certain portfolios, but then there's the runoff of indirect. So if you could just help us put that all together, that would be great.

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

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

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

The next question comes from Nathan Race with Piper Sandler.

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

Thanks, Nathan. The activity was mainly outside our usual areas, particularly along both coasts, with more focus on the East Coast, West Coast, and southern regions. When examining our transactions, especially for acquired loans, our priority is to ensure we achieve acceptable yields and risk returns. We seek high-quality borrowers who are capable and have equity in their homes. We intend to maintain our existing credit profile, and these assets may enhance it while accepting some limitations on geography and cross-selling to uphold our credit metrics and increase our earning assets. Looking ahead, we have some excess liquidity, which we expect to start redeploying in the second quarter, though not to the same degree as we did in the first quarter. As Mark mentioned, we will evaluate the decline of the indirect auto portfolio and adjust accordingly, along with assessing the cash flows of our securities portfolio. However, I do not anticipate seeing the same level of activity in the second quarter as in the first. For the next quarters, specifically Q3 and Q4, we expect to focus primarily on organic growth.

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

Sure. I'll let Lynn expand on my comments here. Our pipeline coming out of the first quarter is strong, in most instances, stronger than what we saw coming out of the fourth quarter, and our organic growth in the first quarter was at those levels. I feel very confident about what we're observing with the commercial team. Now, I'll turn it over to Lynn for further details.

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

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

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

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

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

The next question comes from Damon DelMonte with KBW.

Hope everybody is doing well today. Credit has been exceptionally strong for you guys. And as you guys continue to grow the loan portfolio, just kind of curious as to your thoughts on the provision level and the reserve level. I think loan loss reserve came down by 4 basis points this quarter to like 1.09%. So kind of wondering how you're thinking about that. Do you feel you need to increase that going forward because of the nature of the types of loans that you're putting on the books?

Thanks for the question. Relative to the allowance, first of all, I'll just say that we had a couple of factors that affected it this quarter as far as its reduction, as far as the percent of total loans. First of all, we had a larger nonperforming loan that paid off and had a specific reserve. So that was eliminated and that allowed us to decrease the reserve just under $500,000. So that was sort of extraordinary for this quarter. That's not always a repeating event. We also had a change in mix in our portfolio. As we've stated, we have been intentionally reducing our indirect auto paper that has traditionally had higher credit losses. And so with that reduction, it's decreased the allowance that's needed. And with some of the loan purchases this quarter, those have a lower loss experience. And one of the portfolios has full coverage of credit enhancement. And so it was really a combination of the specific reserve being eliminated and the overall loan mix. As far as going forward, our provision is really being driven by a couple of factors. First, loan growth and loan mix. Of course, the economic forecast and our charge-off experience. We are very pleased with charge-offs this quarter. They were roughly half of fourth quarter and third quarter charge-offs. So that's been very positive. So I expect the reserve really to be pretty stable as we move forward.

Great. I appreciate that color. And then with regards to the upcoming CRE maturities, that was a great slide you guys included in the deck. Can you just talk a little bit about the approach that you take with your borrowers as they get close to the maturity date? Like are you guys reaching out to them and double-checking financials and making sure they're comfortable with a higher rate in order to best position you guys to respond to any potential headwinds that you could be facing?

Sure. We actually have several activities that are part of our overall credit risk management and account relationship management that are not new. This is just part of the fabric of monitoring our portfolio and working with our customers. Firstly, we're doing annual reviews on these clients, collecting financials on schedule, depending on the type of credit it is. And so on a flow basis, we're continually monitoring those as part of our underwriting and the annual review process. We do stress testing for interest rates, loan-to-value compression and some other factors. So that's an ongoing activity. And we have the opportunity to see how our customers are positioned to absorb the interest rate changes upon maturity. We also do a deep dive on certain CRE sectors, including hospitality, office, multifamily, nursing home, CRE that may have a term loan and are going to be approaching that maturity. We do a deep dive on those throughout the year. And so again, we have a pretty good idea of how they're performing and what their capacity is going to be to absorb any interest rate increase. As part of that stress testing, we go up to 300 basis points. And as you can see from our charts, we took a look at those that are under 7%. I didn't provide the color here. But by and large, most of the increases in these two tranches are about 200 basis points. So it's well within our stress testing metrics.

We have the next question from Brian Martin with Janney Montgomery.

I have a follow-up question regarding the credit side. The performance has been strong this quarter. Regarding the special mention credits or criticized assets, it seems like there hasn't been much change, considering what we heard about the provision in Lynn's comments. Is that correct? Can you provide some insight on that?

Yes. There really wasn't a significant change in the first quarter. As noted in our fourth quarter 10-K, we did see some increases on a handful of credits in the fourth quarter. There were some unusual circumstances there. We had one multifamily property that had a fire, water damage. It was under construction. So we felt it was prudent to move into that category. We also had a couple of C&I credits that had some interim financial results, so that warranted additional monitoring, I'll say. Those companies are all strong. We have strong sponsors. In the first quarter, we saw improvement with stabilization and recovery from the fire from the one property. And for the C&I credits, we're seeing improvement in their interim numbers. So we remain very comfortable with those that there's not going to be further migration. And then certainly, as you saw in our substandard and nonaccruals, those improved this quarter. So we're very pleased with that performance.

Yes. Okay. No, perfect. That's helpful. I appreciate the added color. And then maybe just for Mark. Mark, you talked about the loans that are repricing and that that's still going to kind of continue. Can you just give us an idea of the magnitude of those loans that are repricing and then just how much of a rate pickup you're getting on those?

Yes, Brian, I don't have the exact details. This quarter, we're seeing $39 million come out of indirect, which has one of the lowest yields. These will lead to an increase of 3 to 4 basis points in overall yield or 300 to 400 basis points on those loans. From Lynn's slides, we observe that what's coming off of CRE is about a 200 basis point pickup on some of those loans that are maturing. That's essentially what we're observing as they roll off.

Got you. Okay. And then just one last one, Mark. Just on the rate, regarding the margin, my last question is about your outlook. I think you mentioned there might be a couple of cuts over the remainder of the year. Can you discuss how your overall outlook would change if we don't see those cuts, or if they occur later than expected? I understand that you'll provide updates as more details on the rate become available, but if the cuts don't happen as anticipated, how would that affect the guidance you've already discussed?

Yes, Brian. For the second quarter, we do not expect any rate cuts, so our guidance is based on that assumption. In our modeling, we considered a rate cut in July and towards the end of the year, which would have some slight impact. Overall, if there are no cuts, we anticipate continued margin increases due to the repricing of assets, particularly with indirect investments. Additionally, as we see higher rates for maturing loans, we expect margin growth as we move into the third and fourth quarters. If a rate cut occurs and we remain slightly sensitive to liabilities, we would see a bit more benefit.

Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Thomas Prame for any closing remarks.

Thank you. And again, I appreciate all the questions today. And also thank you for participating in today's earnings call. The team had a very solid first quarter with positive momentum in our key earnings metrics also heading into Q2. As stated, we're very optimistic in the near term about our ability to continue to improve our financial performance and remain well positioned for potential lowering rates that will be additive to our positive financial trajectory. Thank you again for your attendance today, and we look forward to our next update in July.

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