Horizon Bancorp, Inc. (NASDAQ:HBNC) Q4 2023 Earnings Call Transcript

Horizon Bancorp, Inc. (NASDAQ:HBNC) Q4 2023 Earnings Call Transcript January 25, 2024

Horizon Bancorp, Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, everyone, and welcome to the Horizon Bancorp, Inc. Conference Call to discuss Financial Results for the Fourth Quarter and Full Year 2023. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [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 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 Chief Commercial Banking Officer, Lynn Kerber; Executive Vice President and Senior Operations Officer, Kathie DeRuiter; Executive Vice President, Corporate Secretary, and General Counsel, Todd Etzler; 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.

Thomas Prame: Good morning, and thank you for participating in Horizon’s earnings call. We are pleased to share our fourth quarter and full year 2023 results. The fourth quarter experienced many positive trends, highlighted by strong lending results that, were led by our commercial banking team, which posted a 13% annualized growth rate in Q4. Horizon also continues to see excellent credit metrics, with low non-performing loans and charge-offs, with provision expense for the quarter primarily reflective of our positive loan growth and modest charge-offs. In Q4, we were pleased to see net interest income expand as a result of our disciplined pricing strategy and the resiliency of our core deposit base. Late in the quarter, we also executed on a balance sheet restructuring, which positioned the company exceptionally well heading into 2024, to further enhance our financial performance with significant excess cash that can be deployed into higher-yielding assets and a meaningful reduction in lower-yielding securities and liquidity ready to fund a robust loan pipeline.

Within our comments today, we will update the fourth quarter and full year results. The positive momentum in our core revenue platforms going into 2024, financial details from the balance sheet restructuring, and progress in our new leasing division. Additionally, we will provide insight to our continued disciplined operating model as well as our well-positioned capital, and liquidity levels that will continue to build throughout 2024. To offer more detail into our fourth quarter results, let me introduce Lynn Kerber, our Executive Vice President and Chief Commercial Banking Officer to shed light on our lending and credit performance. Lynn?

Lynn Kerber: Thank you, Thomas. Beginning on Slide 5, we are pleased to report commercial loans increased $85.7 million for the fourth quarter or 13.1% on an annualized basis. Net fundings were $117 million for the quarter versus $96.8 million for the third quarter. Our average commercial loan portfolio yield increased from 5.80% for the third quarter to 6.05% for the fourth quarter and new production yields increased from 7.50% to 7.87% in the fourth quarter. New loan originations continue to be very diverse across our markets and industries. In the fourth quarter, 25% of our new fundings were C&I and 11% owner-occupied commercial real estate, with the balance of 64% being diversified across the various commercial real estate categories.

As our equipment finance division ramps up in 2024, we expect C&I production to expand measurably as a proportion of both new originations and a total commercial portfolio. We’ve hired several key managers for the equipment financing division and expect balance sheet growth in Q1, with continued expansion throughout the second quarter. The overall commercial pipeline increased from $145 million at September 30 to $167 million as of December 31. Activity continues to be well diversified by industry and geography and this pipeline excludes the new equipment and finance business, which we expect to contribute over $100 million in 2024. Commercial credit quality remained strong with year-to-date net charge-offs of two basis points on an annualized basis.

On Slide 6, we have an overview of the loan portfolio as of December 31, 2023, with a mix of 61% commercial, 15% residential, and 23% consumer. Year-over-year commercial loans increased $208 million and our residential mortgage increased 4% and consumer loans increased 5%, which is a net effect of an increase in home equity loans and decrease in indirect loans. Also provided for reference is a breakdown of key sectors in our commercial portfolio, which demonstrates no significant concentration in any one sector, including office, which represents just 3.5% of our total portfolio and less than 6% of commercial loans. We believe our portfolio breakdown is well-balanced, and represents the disciplined nature of Horizon’s risk profile. Turning to Slide 7, you will see the consumer direct loan balances increased $27 million during the quarter, driven principally by the addition of transactional home equity lines of credit.

Indirect auto loans decreased by $38 million in the quarter, which is consistent with our stated strategy of reducing exposure in this lower performing loan category and redeploying capital to higher yielding product sites. The average consumer direct yield increased from 8.05% to 8.26% for the portfolio, with an average of 8.95% for new production. The average yield for consumer indirect was 3.27%, which is consistent with recent quarters. Credit remains positive and in line with expectations, with year-to-date net recoveries, consumer direct at one basis point, and consumer indirect charge-offs at 36 basis points. Slide 8 highlights our mortgage loan performance through our quarter. Our portfolio was stable and consistent with our expectations for 2023 aligning with industry trends.

Mortgages increased $5.7 million in the fourth quarter, representing a 3.4% increase on an annualized basis. The average mortgage loan yield was 4.32% for the portfolio and 7.50% for new production. With zero charge-offs for the quarter, this portfolio continues to reflect high-quality borrowers with significant payment capacity and equity in their homes. Our asset quality metrics continue to be strong as outlined on Slide 9. Past dues over 30 days were 0.38%, a slight increase which was spread across all portfolios. Non-performing loans increased slightly from $19.4 million to $19.6 million. However, they decreased one basis point as a percent of total loans. The increases were primarily in retail loans, offset by a reduction in commercial non-performing loans.

Net charge-offs for the fourth quarter were $785,000, representing two basis points of average loans. The provision of $1.1 million was primarily due to loan growth with replenishment of the reserve for charge-off loans in the fourth quarter. The allowance represents 1.13% of total gross loans, which we believe is appropriate given credit performance, and current economic forecast. Future reserve amount and related provision will be driven by loan growth and mix, economic forecasts, and credit trends. Credit quality across all of our lending classes, is performing well and reflects our history, of consistent and well balanced approach to lending. Now I’d like to turn things back to Thomas, who will provide an overview of how our earnings asset mix, and deposit franchise and flexible funding profile are contributing, to Horizon’s performance.

Thomas Prame: Thank you, Lynn, and truly appreciate the insight and detail. On Slide 10, you can see the positive impact of the team’s stewardship towards loan pricing and the strategic efforts to shift to higher-yielding assets. We feel confident in continuing this momentum in 2024, as we begin to redeploy our abundant cash position. Horizon is achieving meaningful increases in loan yields with an intentional focus on loan pricing discipline, while we continue to maintain our historical conservative credit culture. Our securities portfolio, is now strategically smaller and exhibits a slightly increased yield from Q3. And our cash position has increased significantly late in the quarter, the impact on our margin was minimal.

We will realize the full effect of this balance sheet repositioning in Q1, as we are well-positioned to fund the growth of higher-yielding assets throughout 2024. As I stated in my opening remarks, we are also very pleased with our fourth quarter deposit performance. With Slide 11 providing detail on the resiliency of the portfolio and our upbeat deal about its strength. Our core consumer and commercial relationships were slightly up in Q4, with minimal changes in total balances. The combined portfolio balances experienced a positive growth of 1.14% for the quarter with non-interest-bearing deposits relatively flat from the third quarter. Public funds balances were strategically down in the quarter aligned with the objective to reduce exposure to these higher-cost funding sources.

The leadership team will continue to be well balanced in its approach to this segment, focusing on full client relationships, and expansion of treasury management services. The quarter closed out with brokered CDs and other fixed-rate borrowings unchanged with ample capacity if needed. As mentioned previously, we ended the quarter with approximately $416 million in excess cash. Beyond the ability to reinvest into higher-yielding assets, this excess liquidity provides great flexibility and our funding strategies limits our dependency on higher-cost funding sources and provides flexibility to our go-forward deposit pricing. The consistency and discipline of our pricing strategy of loans and deposits has yielded very positive results this quarter, and the added flexibility of excess cash further advances Horizon’s revenue growth options.

On Slide 12, you’ll see that Horizon’s margin improved from the third quarter. Horizon’s yield on interest-bearing assets increased 23 basis points during the quarter, compared to the liability costs increasing 19 basis points and purchase accounting down two basis points. We believe these results is an indication that, we have hit the floor on margin compression, based on current expectations for short-term rates. The contribution of the balance sheet restructure was minimum during the quarter, due to the timing of settlement throughout December, as the lower-yielding investments were liquidated and moved into cash later in the quarter. As previously mentioned, we anticipate a portion of the cash from the restructure will be redeployed into higher-yielding assets throughout 2024, including funding the growth of our leasing platform.

Let me hand the presentation over to Executive Vice President and Chief Financial Officer, Mark Secor, who will walk through some other key financial metrics and our outlook for the beginning of 2024. Mark?

Mark Secor: Thank you, Thomas. Beginning with Slide 14, excluding the $31.6 million loss on the sale of securities in the quarter, non-interest income was down slightly from the linked quarter, primarily due to lower gain on sale of mortgages, and lower BOLI income from the balance sheet restructure. The company continues to diversify core fee income through key talent adds in treasury management and expanded private wealth capabilities to elevate non-interest income performance and expand our relationship banking model. Slide 15, non-interest expenses were 1.98% of average assets annualized for the fourth quarter, compared to 1.81% in the linked quarter. The increase reflected $705,000 of extraordinary expenses from previously announced personnel changes, the start-up of Horizon’s equipment finance and the talent adds in our treasury management division.

We also had additional employee benefit cost, due to an adjustment to variable deferred compensation costs, as we ended the year. Excluding extraordinary items, annualized non-interest expenses would have represented 1.94% of average assets in the quarter or 1.85% for all of 2023. On FDIC insurance expense, Horizon was not subject to the special assessment that recently impacted some other banks, given our relatively low level of uninsured deposit. Our regular FDIC assessment was $1.2 million in the fourth quarter, and we currently believe that it is a good baseline run rate for the full year of 2024. Overall, for the full year of 2024, we expect non-interest expenses to be slightly higher than last year. This is primarily due to annual merit increases, the addition of the equipment finance business, and 2024 investments in digital banking and technology that is designed to improve our customer acquisition capabilities and drive additional revenue.

We will provide guidance on the first quarter expenses in the upcoming slides. Moving to the investment portfolio on Slide 16. After the sale of $383 million of AFS securities in the fourth quarter, we wanted to provide details on the remaining portfolio. The portfolio totaled $2.5 billion at the end of the quarter, down $339 million from September 30 netting out the cash flows, sales, and the decrease in unrealized losses during the quarter. The portfolio had a book yield of 2.25% and an effective duration of approximately seven years at the end of the quarter. As longer-term investments were originally identified as held to maturity, the duration for that portfolio is approximately one year longer than the available-for-sale portfolio. Expected cash flows from investments, are estimated to be approximately $34 million for the first quarter of 2024, and a total of $105 million over the next 12 months.

We will continue to actively manage our portfolio, for opportunities to create shareholder value in the future. Slide 17, Horizon continues to maintain solid regulatory capital ratios after the balance sheet restructure. Capital ratios are well above the requirements to be considered well-capitalized and we believe we have sufficient capital to be opened to additional options to improve our earnings outlook in the foreseeable future. We anticipate that growth in capital will outpace the growth in total assets, during the next 12 months, providing strength and flexibility to pursue strategic growth options. As we deploy the liquidity from the balance sheet restructure, we do anticipate risk-weighted assets, to increase and there will be a slight decline, to risk-weighted capital ratios.

Looking ahead, on Slide 18, we provide you with an update on our current expectations for 2024. We expect sustainable loan growth in both our commercial and direct consumer portfolios, which should be valuable contributors to core earnings. For the first quarter of 2024, we expect 4% to 5% total loan growth annualized. Our net interest margin and net interest income trend, should continue to benefit from our balance sheet restructure and pricing management. We expect a net interest margin of greater than 2.5% for the first quarter as well as pre-provision net interest income of greater than $43.8 million. As stated, we believe Horizon’s net interest margin, has reached its floor in the third quarter of 2023 assuming the Fed funds target is at its terminal rate.

Non-interest income should continue near recent levels, with the anticipation of consistent fee income from our investments in treasury management and private wealth, coupled with seasonal softening in mortgage originations and lower BOLI income. The expected range is $10 million to $10.5 million in non-interest income in the first quarter. Non-interest 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. As discussed, we have invested in revenue generating talent in our lease build out, and our treasury management teams, which are expected to contribute to revenue growth in 2024. As a result, we expect non-interest expense to range from about $37 million to $38 million in the first quarter.

We also expect non-interest expense, to continue to remain below 2% of average assets. Now, I will turn it back over to Thomas for some final comments.

Thomas Prame: Thank you, Mark. Appreciate the insight. So, why invest in Horizon? Our investment thesis is simple. As seen on Slide 19, we are located in attractive Midwest growth markets. These markets have desirable economic environments, significant infrastructure investment, and flourishing ecosystems, for both businesses and for our communities. Horizon has made significant progress executing on its strategy of shifting its balance sheet to higher-yielding assets in 2023. We are entering 2024 with an expanding margin, an abundant cash position to further reinvest in higher-yielding assets, fund the growth of our new equipment leasing platform, and to continue the flexibility in our revenue strategies. The franchise has resilient and loyal deposit base that is actively managed by leadership to create shareholder value.

Additionally, Horizon has excess liquidity of $2.9 billion, providing nimbleness, to our operating model as needed. Horizon has a disciplined operating culture that consistently displays, a low ratio of operating expenses to average assets. We expect this to remain less than 2% even with the strategic investments in new revenue teams. Additionally, Horizon has a proven conservative credit profile displayed through its practical credit underwriting and proactive portfolio management. These efforts have consistently delivered low nonperforming loans and annual charge-offs. And lastly, even with the recent positive trends in our stock performance, we believe Horizon is still a compelling value, supported by our commitment to our dividend, with shares recently trading less than nine times 2023 adjusted EPS and offering a 4.8% dividend yield.

Horizon has a track record of 30-plus years of uninterrupted quarterly cash dividends to our shareholders. As always, we thank you for joining our presentation this morning. This concludes our prepared remarks, and I will now ask our operator, to please open up the lines for questions.

Operator: [Operator Instructions] The first question comes from Terry McEvoy with Stephens. Please go ahead.

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Q&A Session

Terry McEvoy: Maybe a couple modeling questions. Mark, could you just talk about the size of the balance sheet in 2024? Whether you think the loan growth will be kind of offset by declining cash balances?

Thomas Prame: Thanks, Terry. This is Thomas. Appreciate the question. As we look at our asset growth strategy, you’re pretty much spot on. We would see that we use a portion of our cash balances and then reinvest them into our loan growth, but still keep liquidity and our cash position for any type of fluctuations in other parts of the balance sheet.

Terry McEvoy: Thanks. And I think Lynn pointed out about $100 million of new leasing – new leases in 2024. Leases, I’m guessing, carry higher yields. There’s a fee component as well as maybe longer term higher charge-offs. So can you just help us kind of understand the growth dynamics, the profitability, and maybe some long-term charge-offs that, you’d expect out of that portfolio?

Lynn Kerber: Sure. Thanks for your question. Good morning. Relative to the lease portfolio, we are focusing on small ticket and lower-end middle market ticket. And as you have probably seen with our press releases, we’ve hired a very strong and experienced leader. As relative to originations in that portfolio, we’re looking at approximately $100 million for the year. You’re correct, the yield would be a little bit higher than our normal commercial portfolio, with an anticipated spread that’s higher than commercial C&I typically. As far as losses go, we are still modeling some of that based on the credit quality that we’re targeting. So, I will probably need to potentially get back to you on that, Terry. But I would expect that it would be a little bit higher than our core commercial experience has been over recent years.

Thomas Prame: Thank you, Lynn, for the answer. Terry, maybe just a little bit more color on that. I think if you look at the balance sheet and look at the momentum that are in different parts, adding the leasing assets at a higher yield, I completely agree with Lynn that we’ll probably see somewhere around $100 million or so this year. We’re also anticipating our continued trend in indirect auto, which is a much lower-yielding asset with higher credit losses. So as you look at the net-net, I would say from the credit exposure, it’s probably going to par out with the two. If not, we might get a slight pickup. So, I wouldn’t see the leasing part changing significantly, the overall credit profile of the organization, because the indirect auto will continue to decline.

Terry McEvoy: Right. Thank you, Thomas, and thank you, Lynn.

Operator: The next question comes from Nathan Race with Piper Sandler. Please go ahead.

Nathan Race: Yes. Hi, everyone. Good morning. Thanks for taking the questions?

Thomas Prame: Good morning.

Nathan Race: Was curious, just in terms of thinking about the size of the position of debt going forward. It looks like borrowings were kind of flat quarter-over-quarter. So just curious how you guys are maybe thinking about using some of that dry powder opposed to repositioning in 4Q to maybe pay down some wholesale sources over the next quarter or two?

Mark Secor: Thanks, Nate. Good morning. This is Mark. For the immediate future, the next period, we don’t plan on seeing any reduction in the borrowings. It is a desire to reduce the borrowings down the road. We’d like to see that, with deposit growth, but the cash that we have currently is planned to go into the lending, and to be able to keep for liquidity. So, we don’t see any additional borrowings either as we see loans grow.

Nathan Race: Got it. And I appreciate the margin guidance for the 1Q. And just kind of think about the cadence of the margin over the course of the rest of this year in terms of just the impact from Fed cuts and kind of maintaining that liability-sensitive balance sheet with the borrowings expected to remain kind of flat and using that dry powder to support loan growth. So, just trying to think about kind of, the liability sensitivity of the balance sheet and how the margin should react to some Fed rate cuts expected at some point this year?

Mark Secor: Yes. We would expect it to be positive on the borrowing – on the deposit side. The competition will drive a little bit of how quickly we can lower rates when it comes to some of the funding. But we would anticipate, trying to bring down those funding costs if there are rate cuts.

Nathan Race: Okay, great. And then just…

Thomas Prame: This is Thomas. On your question there on liability-sensitive Mark is spot on. Also from our model, we’re anticipating rate cuts in the second half of the year. We’re not anticipating – I think we have a conservative profile there, with two cuts later in the second half of the year. So, I completely agree with Mark, we’re still in a liability-sensitive position and that – we would have – probably a nice pickup if something happened a little bit earlier.

Nathan Race: Okay. So putting those pieces together, it sounds like the margin can continue to trend higher, at least in the second quarter. If there – aren’t any rate cuts in 2Q, and then maybe greater expansion in 3Q and 4Q, if we do have those cuts in Fed rates?

Mark Secor: That would be our expectation.