Earnings Call Transcript - HBNC Q1 2023

Operator, Operator

Good morning, everyone. Welcome to the Horizon Bancorp Conference Call to discuss Financial Results for the First 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 that this event is being recorded. Before we start, please remember that today’s call may contain forward-looking statements that are subject to risks, uncertainties, and other factors that could cause actual results to differ significantly from those presented, including factors noted in the slide presentation. More information on these potential discrepancies can be found in Horizon’s current 10-K and subsequent filings. Management may also refer to certain non-GAAP financial measures to help investors understand Horizon’s business, with reconciliations provided in the presentation. The company does not assume any obligation to update any forward-looking statements made during the call. For anyone who does not have a copy of the press release and supplemental presentation issued by Horizon yesterday, they are available on the company’s website, horizonbank.com. Joining us today are Chairman and Chief Executive Officer Craig Dwight, President Thomas Prame, EVP and Chief Executive Officer Mark Secor, EVP and Chief Commercial Banking Officer Lynn Kerber, and EVP and Senior Retail and Mortgage Lending Officer Noe Najera. At this time, I’d like to turn the call over to Mr. Craig Dwight. Please go ahead, sir.

Craig Dwight, CEO

Thank you, Nick, and good morning. And thank you for participating in Horizon Bancorp’s first quarter earnings conference call. Our comments today will follow the investor presentation and press release that we published yesterday, April 26th. We are proud to announce that Horizon Bank is celebrating its 150th anniversary in business, with our original banking charter issued in April of 1873. At the end of the first year of business, our total assets were $100,000, and 150 years later, we now exceed $7.8 billion. We like to say that we are 150 years strong. Throughout the bank’s long history, as well as our management team’s decades in banking, we have successfully leveraged our experience and operating discipline to guide Horizon through multiple economic cycles and industry challenges. As you will hear in some detail in a moment, our durable deposit relationships with end-market clients with average tenure in excess of 10 years, along with our deliberate deposit mix and pricing have served us well through the banking sector’s recent market volatility. Deposit pricing has increased within the local markets we serve, with particular price sensitivity in the public funds sector. The majority of our deposits are in stable markets, with several municipal deposit accounts in our legacy markets having banked with Horizon for most of our 150 years. In addition, we are readily able to fund 8.4% annualized loan growth and modest deposit runoff in the quarter with lower-cost borrowings and cash flows from the investment portfolio. Today, you will also learn more about how lending opportunities in our attractive Midwest markets, loan pricing discipline, ample sources of liquidity and active balance sheet management have allowed us to position Horizon well for continued success through 2023 and beyond. As you saw in our earnings release, Horizon did report a decline in quarter-over-quarter net income, driven by lower net interest margin and lower non-interest income and partially offset by good expense control and lower marginal tax rate. The end result for the quarter was a return on average assets of 0.94% and a return on tangible equity of 14.18%, which are respectable returns given the competition for deposits in volatile markets. Now to give you a quick summary of our resilient Midwest markets. We remind you that Horizon’s expansion and growth have occurred primarily in college and university towns and in state or county governmental seats. Therefore, a majority of our footprint has an economic base that is traditionally more stable than other areas of Indiana and Michigan, and our real estate values do not have the volatility of a typical large metropolitan area. In addition, Horizon’s footprint is well positioned due to considerable infrastructure investments and located in fiscally responsible states to take advantage of the outbound migration of Illinois, which continues to increase as consumers and businesses exit dense living spaces, high taxes, high cost of living and high crime rates. Our local markets have stabilized. We see the number of open positions continue to decline and unemployment rates remain relatively flat. Given the stable unemployment rates, the improved balance sheets of our commercial customers and our close relationships with these businesses, as well as our conservative underwriting culture, Horizon’s asset quality remains strong. To conclude my comments, I would like to remind listeners this will be my last earnings call, as I move into the Chairman role and Thomas Prame becomes Horizon’s next Chief Executive Officer effective June 1st. I have enjoyed working with the investment community and shareholders and have always appreciated your insights into our industry. It is now my pleasure to turn the call over to Thomas Prame, Horizon’s next Chief Executive Officer.

Thomas Prame, CEO

Thank you, Craig. Earlier this year, we provided 2023 goals to our investors and we want to take a quick Q1 update to these full year objectives. Our loan growth continues to be strong, both in the commercial and consumer sectors, which we expect to be valuable contributors to core earnings in subsequent quarters. Our net interest income and net interest margin are tracking at the lower end of our annual goals, which is not unexpected, as we see benefit from our loan growth throughout the year and recognize the elevated funding costs experienced across the industry in Q1. Expenses continue to be proactively managed across the organization, specifically in segments of our business impacted by rising rates such as mortgage and consumer lending. Our operating metrics of ROAA and ROAE in Q1 are tracking below our full year expectations, and as Craig mentioned, were impacted by elevated deposit pricing and seasonal non-interest income. We will provide more detail on these segments of our business within the presentation. Transitioning to lending, highlighting the quarter was our commercial loan balances increasing $38 million or 6.1% annualized. Net commercial funding of $109 million was strong and again well balanced across our diverse asset classes and geography. The commercial pipeline is well positioned at $130 million and continues to provide confidence in our ability to generate full year mid- to high single-digit growth. Importantly, portfolio yields continue to improve as new production replaces paydowns and payoffs. Consistent with previous quarters, our commercial loan portfolio continues to display strong credit metrics, with 1 basis point of charge-off. As we transition to slide 12, we have included a breakdown of our commercial loan portfolio to show its granularity and also its diversification across multiple asset classes. Horizon’s non-owner-occupied office represents just 7% of commercial loans, consisting of properties in Midwestern cities that have not experienced the vacancy rates found in major metropolitan markets and across the country. Horizon’s non-owner-occupied multifamily represents only 10% of commercial loans and is focused on properties in major university towns and growing local markets that are experiencing excess demand for rental properties and strong occupancy rates. We emphasize creating relationships with borrowers who are seasoned operators, with strong balance sheets and cash flows. We continue to experience positive performance in these portfolios, while remaining conservative in new project approvals and managing our exposures.

Mark Secor, CFO

Thank you, Thomas. In the current environment, we wanted to begin with the company’s liquidity position and availability. We certainly didn’t predict the events of mid-March, but at Horizon we have long subscribed to the view that liquidity availability is important. For years, many of you have heard us regularly highlight the number of quarters worth of cash we maintain at the holding company to cover fixed costs, including the dividend. Currently, that stands at eight quarters. Many of you will also remember our decision to acquire nearly $1 billion in deposits with our Michigan branch deal in 2021, when the industry was flush with liquidity, reflecting our commitment to protecting and enhancing the value of Horizon’s deposit franchise. Starting with slide 21, heading into March 2023, we were well served by our liquidity focus and balance sheet structure, including a majority of our investment portfolio unpledged. This enabled us to pledge approximately $1.5 billion of investments to provide immediate access to the liquidity if needed. At March 31st, we had available secured borrowing lines of over $1.5 billion, with access to additional liquidity through secured lines, brokered CDs and additional unpledged investments. Altogether, this totaled more than $2.7 billion of available liquidity or 47% of total deposits as of March 31st. In addition, we continue to be proactive in our balance sheet management and moved existing short-term borrowings and higher cost funding toward lower cost term borrowings at attractive rates. At the end of the quarter, $1.1 billion of our borrowings were at an average fixed rate of 3.52% with an expected duration of approximately one year.

Craig Dwight, CEO

Yeah. Terry, the banks have paid into it, but no one’s paid into it for probably over 30 years and the fund also has the capacity to borrow monies if necessary as well.

Thomas Prame, CEO

As we look at our different asset classes, again, most of our new production is going to come from commercial. That number is running closer to 7%. In our indirect auto, we are north of 8%, and if you look at our consumer lending, we are probably in the 7.5%. Mortgage, we are very deliberate on what we are putting on the balance sheet, and again, that will be reflective of what you see mostly in the marketplace at somewhere in the high 6%s, low 7%s.

Lynn Kerber, EVP and Chief Commercial Banking Officer

From a commercial perspective, we are still experiencing deal flow, although it appears to be softening slightly. The rise in interest rates means that any projects will need more equity, leading developers to reassess various factors such as rental market rates and what they are able to command, which impacts their return on investment due to the additional equity needs. Despite this, deal flow remains steady. I am closely observing certain sectors within commercial real estate. Thus far, our portfolio has been performing well and maintaining stability. There is some concern in the small business sector where they face inflation related to labor and supply costs, and they are currently navigating those challenges. As we review our customers' financials, we continue to monitor their performance for 2022, their quarterly results, and their liquidity status. Overall, while the situation has been relatively stable, demand seems to be somewhat lower than last year.

Operator, Operator

Thank you. Next question will be from Brian Martin, Janney Montgomery. Please go ahead.

Brian Martin, Analyst

Good morning, everyone, and congratulations, Craig, best wishes in retirement. It's been a pleasure working with you. I have a quick question for Mark regarding the margin. I appreciate the insights you've already provided. I'm trying to understand if there's likely to be more pressure on margins in the near term, specifically in the second and third quarters due to deposit pricing, compared to later in the year. Is this the correct way to think about the path to stabilization?

Mark Secor, CFO

I think that's reasonable, Brian, based on what we are observing. We notice the asset mix on the balance sheet and the rates associated with it, and currently, we are not experiencing significant fluctuations. The main uncertainty lies in how we will fund the balance. In terms of our outlook, there may be slight pressure in the short term. However, as rates stabilize and assets reprice, we should see movement towards the higher end of the range.

Craig Dwight, CEO

Thank you, Nick. And thank you for participating in today’s earnings call. It’s been my pleasure to speak with all the analysts and shareholders over the past 25 years and I am excited about the energy and ability of our executive team to execute our strategies, which will propel the company to new and higher levels of performance. Thank you and I will now turn the call back to the Operator to conclude today’s call. Have a good day.

Operator, Operator

Thank you. Conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.