HBNC - NASDAQ

Good morning, everyone, and welcome to the Horizon Bancorp Inc. conference call to discuss financial results for the second quarter of 2025. [Operator Instructions] Now I will turn the call over to Todd Etzler, Executive Vice President, Corporate Secretary and General Counsel for the opening introduction.

Good morning, and welcome to our second quarter conference call. 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 may 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, John Stewart; Executive Vice President and Chief Administration Officer, Mark Secor; and Chief Executive Officer and President, Thomas Prame. At this time, I will turn the call over to Thomas Prame. Thomas?

Thank you, Todd. Good morning, and we appreciate you joining us. Horizon's second quarter earnings reflect the strength of the organization's exceptional core community banking franchise, strong loan growth, stable and granular core funding, excellent credit quality and prudent management of expenses, fuel the quarter's positive results and expanded on management's commitment to improve the financial performance of the company. The quarter was highlighted by a seventh consecutive quarter of significant net interest margin expansion, low net charge-offs of 2 basis points annualized and enhanced momentum in key performance metrics of ROAA and ROATCE. We continue to show the strength across our core community banking platform that is being driven by a disciplined approach to creating a more efficient balance sheet and effective deployment of capital. We are pleased with our results for the first 6 months of 2025 with reported earnings per share growing by 58% versus the comparable period a year ago. Page 3 provides insight into the quarter's results. The quarter displayed positive growth in our revenue model with the margin continuing to expand through solid loan growth of approximately 6% and disciplined pricing both on loans and deposits. Noninterest income continued to deliver good results and the consistency in our expense management efforts further provided momentum to our improving operating metrics. Overall, a solid quarter on many fronts, and we feel well positioned heading into the second half of 2025. As mentioned earlier, the second quarter was highlighted by strong loan growth and asset quality that has been a consistent theme of our excellent community banking model. I'll transition the presentation to our Executive Vice President and Chief Commercial Banking Officer, Lynn Kerber, who will share highlights for the second quarter in this part of our business model.

Thank you, Thomas. We are very pleased with loan growth for the second quarter, which closely aligned with our forecast for volume, mix and yield. Net loans held for investment grew $75.5 million representing 1.5% growth in the quarter and 6.2% on an annualized basis. Primary drivers of loan growth included commercial loans of $117 million and consumer loans of $8 million, offset by the sale of residential loans and the planned contraction of indirect loans. Commercial loan growth of $117 million represents growth of 14.8% in the quarter driven by growth in our core Commercial Banking segment. Growth for the quarter is consistent with our overall portfolio composition with expansion of our C&I portfolio. We continue to actively manage a diverse portfolio, both from a geographic and segment basis with the largest segment at 6% of total loans and our CRE ratios below our peer group. Loan demand and pipelines remained stable at this time, and we continue to focus on quality origination and pricing discipline. Despite volatility related to federal policies and our associated impact on interest rates, our lenders have done an excellent job managing rates and maintaining spread. In the second quarter, we piloted equipment finance indication sales and expect this will be an additional tool to support balance sheet management and a generation of additional noninterest income. Turning to Slide 6. Consumer loan balances decreased $41 million during the quarter, reflective of the continued strategic shift to run down the indirect auto portfolio and reinvest this liquidity in the higher-yielding and franchise value commercial lending relationships. Residential mortgage lending modestly grew during the quarter, reflecting our organizational strategy to sell a majority of its production and leverage its balance sheet for higher quality client relationships in our local market. Credit quality remains satisfactory and consistent with credit performance over the past year. Substandard loans and nonperforming loans represent 1.29% and 54 basis points, respectively, a slight reduction in both metrics this quarter. Net charge-offs were near $254,000 or 2 basis points in the quarter which compares favorably to performance over the past year. Year-to-date charge-offs totaled $1.1 million, representing an annualized charge-off rate of 5 basis points. Finally, our allowance for credit losses increased to $54 million, representing an increase from 1.07% to 1.09% of loans held for investment. Provision expense of $2.4 million represents an increase from recent quarters, which is primarily driven by loan growth and economic forecast, the most recent quarters having benefited from the release of special reserve allocation. We continue to monitor economic conditions and future provision expense will be driven by anticipated loan growth and mix, economic factors and credit quality trends. Now I'd like to turn things back to Thomas, who will provide an overview of our deposit trends.

Thank you, Lynn. Moving on to our deposit portfolio displayed on Slide 8. Horizon's core relationship balances continue to show the strength of the franchise's community banking model. Balances for the quarter were relatively flat from Q1 and the team extended its disciplined approach to deposit pricing while continuing to take advantage of Horizon's diversified funding sources. These efforts helped our funding costs remain relatively flat from the first quarter. We continue to believe the deposit portfolio is positioned well to benefit the organization moving forward with its granular composition and long-standing relationships in our local markets. The team has displayed its ability to be agile in leveraging multiple funding options and creating optionality within the portfolio to continue to create shareholder value. Let me hand the presentation over to our Executive Vice President and Chief Financial Officer, John Stewart, who will walk through additional second quarter financial highlights and our outlook as we look to the remainder of 2025.

Thank you, Thomas. Turning to Slide 9. The Q2 net interest margin increased by another 19 basis points to 3.23%, which was above expectations. Included in the margin this quarter is approximately 7 basis points of outsized interest recoveries on commercial and residential loans. Excluding that recovery income, the margin expanded nicely in Q2, driven by the continued execution of our core balance sheet strategies, which resulted in an improved mix of both earning assets and liabilities. Additionally, and importantly, excluding the interest recoveries just noted, loan yields expanded in the second quarter, which is a result of the purposeful mix shift, favorable roll-off roll-on yield dynamics and disciplined pricing. The combination of these factors resulted in a widening of our net spread in the quarter as earning asset yields expanded with and without the recoveries, while interest-bearing funding costs declined by 2 basis points versus the prior quarter. Looking ahead, many of these same balance sheet dynamics are expected to persist for the balance of the year, such that we would still expect additional net interest margin expansion as the year progresses, albeit at a more modest pace. While our current outlook assumes 2 cuts in September and December, neither will have a material impact on the net interest income outlook or margin outlook for the remainder of the year. which remains for full year net interest income growth to be in the mid-teens. Slide 10 provides a profile of the remaining investment securities and the projected cash flows and yield roll off for the coming year. It continues to be the case that we do not intend to reinvest cash flows in 2025. As we have done in the past several quarters, we will continue to use those proceeds to fund organic relationship-based commercial loan growth. As you can see on Slide 11, reported noninterest income was straightforward this quarter, interchange fees and mortgage gain on sale experienced some seasonal strength in the quarter, while most other categories were relatively stable. Additionally, mortgage continues to benefit from the prior period investment in the business and the efforts of new leadership. Our outlook for 2025 remains unchanged for growth in the low-single digits. This comparable excludes the securities losses in both 2024 and 2025 and the $7 million gain in the first quarter. On Slide 12, at $39.4 million, you can see it was another well-managed expense quarter for the company as we remain focused on delivering sustainable positive operating leverage. While we are pleased with the expense results through the first half of the year, we understand the need to remain diligent. Therefore, we are modestly reducing our outlook for full year reported expenses to now be approximately flat when compared to the $158.8 million reported for the full year 2024. Turning to capital on Slide 13. The positive momentum over the last few quarters continued again this quarter with linked quarter increases in all capital ratios as well as tangible book value per share. The increases were driven by improved profitability and the strategic repositioning of the balance sheet, which continues to restrict growth in risk-weighted and total assets. We would generally expect these capital trends to continue for the balance of the year as profitability improves and total balance sheet growth remains relatively muted. Finally, turning to Slide 14 and our updated outlook for the full year. In short, we are pleased with the progress through the first 6 months of the year and are optimistic for a strong finish. Net interest income and margin are trending nicely, while our expense outlook is modestly more favorable. As we have said for several quarters now, the objective remains to drive improvement in recurring and predictable operating profitability and are trending in the right direction. There are a few items I would like to highlight. While expectations for loan growth in loans held for investment are unchanged in the mid-single-digit range for the year, we are anticipating a bit more runoff in the indirect auto book versus prior expectations, which would now total about $125 million for the year, up from about $100 million previously. Deposit growth expectations remain unchanged in the low-single digits. Under our base set of assumptions, which now includes two 25 basis point Fed fund cuts in September and December, our net interest income growth expectations for the full year 2025 remain unchanged in the mid-teens. Total reported expenses for 2025 are now expected to be approximately flat relative to the reported full year 2024. Finally, the full year effective tax rate for 2025 is still expected to be in the mid-teens. With that, I'll turn the call back over to Thomas.

Thank you, John, and appreciate the summary of the second quarter and our outlook for 2025. As you can see from our financial results and momentum entering the second half of the year, we continue to see a bright future for Horizon, and we are delighted with the positive strides in our financial performance metrics for the quarter and year-over-year comparison. A very good performance for the team on many fronts, and we look forward to continuing to deliver incremental shareholder value in the second half of 2025. This is the end of our prepared remarks, and I welcome the operator to open the line up for questions for our management team.

[Operator Instructions] The first question today comes from Brendan Nosal with Hovde Group.

Well, first of all, congrats on the quarter and the progress you've been making. Maybe just to start off here on capital. You folks continue to build ratios this quarter. Just kind of curious if you have any updated thoughts on how you're viewing the capital build from here, potential uses as we move through the next few quarters and just the ultimate thought process on kind of resolution of HTM and borrowings?

Sure, Brendan. Thanks for the question, and I appreciate the acknowledgment of the performance and capital build over the last year. if you look at -- specifically look at our CET1, we're up about 90 basis points over the last 12 months, that includes some capital actions that we've taken internally. So there's been really nice momentum. As we look at the second half of the year and the capital levels we have and the generation coming off from a more profitable balance sheet. I would say that's going to give us some more optionality of what we'd like to do. As John mentioned in our opening comments, our focus over the last year is really about making sure we have a balance sheet and income statement that can have predictable returns, improved predictable operating income. I think the team has done really nice strides on that. So as we look forward, optionality of items may be discussion around potential buybacks, other uses of capital. I said the table has gotten a little bit broader for us. The second part of your question, I imagine, deals with some of the transactions that we've seen over the last year around individuals perhaps raising equity and/or using capital to restructure their balance sheet. In most of these cases, what we've seen out in the marketplace that these organizations have done that to achieve where Horizon has achieved success over the last year on our own. We're really proud of that track record. And if you look over time, we've executed on several capital actions that are very friendly to our shareholders. A couple of them have the investment restructures. We ran off the indirect auto. We sold the mortgage warehouse business and took back capital and added to our stack. And additionally, we also are making different choices around capital and around tax investments. I think you can expect the same approach going forward as we continue to improve the performance of the organization and look for capital optionality.

Okay. All right. Maybe kind of turning to lending and the competitive environment. Just can we get an update on how the competitive environment has evolved for both lending and funding? Heard from several that larger regionals are stepping back into certain asset classes like commercial real estate and then also hearing that funding competition is back a little bit as more banks seek to grow loans. So I would love your thoughts there.

This is Lynn. Regarding commercial, I think generally, I would describe the environment as fairly competitive, specifically on pricing. We've seen some compression on spreads in the commercial area with our competition. As I commented in my earlier remarks, I think our team has done an excellent job of navigating the rate environment and negotiating yield. But it does remain very competitive. We've seen some reduction in that spread over the indexes over the last, I would say, 4 months, probably more than I actually maybe anticipated with the volatility in the rate indexes. As far as underwriting classes, it really depends on the competitor. Everybody is managing to their concentrations. I've been asked in the past about our office exposure, multifamily. I mean those segments have performed extremely well for us. So we just continue to be very focused on our basic underwriting, the fundamentals. And also opportunistic. There have been some office loans that we've done over the last year, strong sponsors, low loan-to-value, strong underwriting metrics. So I would say it's more situational.

The next question comes from Terry McEvoy with Stephens.

Maybe just start the small one, the interchange revenue down quite a bit year-over-year. I know there's seasonality you talked about in the second quarter, but any color there on the decline in 2Q and your thoughts going forward?

Appreciate the question. As far as interchange, we keep a pretty close eye on that. We've seen 2 aspects of interchange this year compared to last year. One, the overall swipes are slightly down and the spend per swipe is down. Mainly, we're just seeing a little bit more conservative spend from the consumer base and also where they're spending that. As you know, not every swipe is equal at the terminal. And so as we see higher interchange volumes such as like lower interchange volumes and things like groceries and gas that's going to impact it. But again, what I think where we're seeing right now, these levels will probably be our go-forward look.

Maybe as a follow-up, could you just discuss market competition for deposits in your markets and where you see deposit costs trending in the back half of the year?

I'd say for -- I'll split it out by segment. And first, I'll start with the consumer segment. I'd say that's relatively been consistent quarter- over-quarter. We're seeing promotional rates come down and also we're seeing the term of those promotional rates pulled back into the 3- to 5-month territory. So for us, as we've been disciplined about around that, we're making sure that we're not taking on extension risk and pricing for us in that portfolio is about 4%. So it's in a good spot. And we anticipate, as we start seeing further Fed moves that they'll probably move -- that market will move towards us. As we get into the larger institution -- institutional funds and then also in the public funds area, that can still be a pretty wide bid-ask as you saw in the second quarter for us, we let some strategic -- we let some higher-priced CDs go off the balance sheet, simply because it just didn't make incremental sense from our margin management and overall flexibility on the balance sheet. So I would say the competitive in the public space is still pretty competitive. There are some banks out there in our marketplace and also some credit unions that perhaps have a little bit higher loan-to-deposit ratios. But I wouldn't say that's changed -- like impairing our operating model. We're just being conscious of it, being diligent in our pricing going forward. And I think as you saw from our quarterly results, we were able to hold our overall funding costs slightly down from Q1.

Perfect. Appreciate that. And Thomas also appreciate the comments on the HTM securities and definitely acknowledge the actions taken and how they've resulted in improved earnings and overall profitability.

The next question comes from Damon DelMonte with KBW.

I appreciate all the color and disclosure in the slides. Just kind of curious, from the loan growth perspective, you guys continue to feel pretty optimistic it sounds like on the back half of the year on the commercial side. Are you finding that the growth is being driven more by new customers coming to the bank? Or do you have some amount of increased line utilization from some of your current customers?

Relative to the commercial customers, I would say a good majority of our business has been with existing customers. Regarding the line of credit utilization it's remained actually pretty stable. In fact, it actually reduced a little bit the last couple of months. So it's being driven by expansion of business with our customers and referrals by our customers. C&I is probably a little bit more new customer acquisition. So it's a mix, but it's really truly our core markets and expanding those existing relationships that we have.

Got it. Okay. Appreciate that. And then with regards to the margin and the outlook there. John, can you just remind us, do you have any sizable CDs that are repricing in the back half of the year?

No. The CD book is fairly homogenous. The duration is relatively short, it's been sitting at about 5 or 6 months kind of all year long. So those dynamics all still stay in place.

Got it. Okay. And then just lastly, is there anything specific you guys are doing on the expense front to be able to manage them so successfully and kind of keep the total amount flat year-over-year. I don't know if there's any initiatives or anything kind of that's going on that's giving you the leverage there?

No, I appreciate the acknowledgment there. Nothing in particular. I mean it's just really diligent expense management across the organization, both corporate out in the markets. We understand where the bogeys are, and we're working hard to meet them. There's nothing -- no big named expense plan or anything else out there. It's just business as usual. But we've got a pretty tight budget and the folks are doing a really good job managing to it.

The next question comes from Nathan Race with Piper Sandler.

You guys have obviously done a great job building a more kind of core funded balance sheet over the last several quarters. So just curious how you're thinking about the target for wholesale funding on the balance sheet going forward relative to kind of where we came out at the end of this quarter and maybe what your targets are over the next 12 to 18 months as deposit growth is expected to pick up.

Yes. Thanks for the question. I wouldn't say there's any specific targets out there. The general objectives at the top of the house remain the same, which is the balance sheet has been more heavily dependent on wholesale funding than in the past than maybe we would want to see going forward, really nothing to the borrowings picking up here in the second quarter. I mean we just took advantage of -- as Tom has mentioned before, we just swapped some expensive deposit funding out and had a nice opportunity to do so at the very beginning of the quarter with the rally in rates, pretty sharp rally that backed right off. But longer term, the objectives remain the same, which is to reduce the reliance on wholesale funding. From here, if we have some good success on the deposit side, maybe they'll give us a chance to modestly reduce that going forward, I wouldn't anticipate any step function changes though At the moment.

Okay. Great. So John, I imagine that implies some modest earning asset growth in the back half of this year.

That's correct.

Okay. Great. And then, John, if I heard you correctly, it sounds like the way the balance sheet is positioned today, you guys are pretty neutral in terms of the margin impact to any Fed cuts on the short end.

Sorry, that's also correct.

Okay. Great. All right. And then just generally, from a margin perspective, is there still kind of an upward bias over the back half of this year, just given the neutral sensitivity and some of the repricing tailwinds that we talked about on the earning asset side and with maybe kind of flat deposit cost as long as the Fed remains on pause?

Yes, I think that's correct as well. So I think if you look at the margin in the second quarter, the 3.23%, we called out the 7 basis points, so back that off to about 3.16% on an operating basis. From there, we would anticipate there's some modest expansion, albeit less than what we've seen in the past, most of the step function mix changes on the asset side and the liability side as we just talked about are largely behind us. So it really becomes about the churn on the asset side and the management of funding costs on the liability side. So I think it's correct that you would expect some modest improvement off that 3.16% back half of the year and probably into the beginning parts of next year as well. I still feel pretty good about that landing spot in Q4 for 3.15% to 3.20% on the operating margin.

Just to clarify, that's not tax equivalent adjustment on the margin you're referring to?

So the FTE reported margin was the 3.23% in the quarter, about 7 basis points of that is what we've called out as outsized recoveries. So if you back that down to the 3.16%, that's what I'm talking off of that number.

The next question comes from David Long with Raymond James.

Just big picture, and I don't want to put words in your mouth here, but overall, I think there's a general positive sentiment on the Northern Indiana and Indiana as a whole economy. Can you just talk about maybe your outlook for the economy within your footprint?

Sure, David. And I appreciate the acknowledgment. We are very pleased to be in the markets that we're in. Northern Indiana is still seeing some significant infrastructure investment, data centers, the 2 track here locally. We are still experiencing the outflow of talent, people and businesses in Indiana from Illinois. So I would say we're very fortunate to have some good tailwinds here in the marketplace. Also, I want to acknowledge Indiana's just a great state to have your banking franchise in. It's a bank-friendly state. It's a friendly business state. And so with that, our distribution, specifically in Northern Indiana, going all the way down to Indianapolis has been a benefit for us. And I do want to not discount the fact that Michigan is a great state also. We've seen just some great growth on the Western side of Michigan where we just have some very positive distribution there and great leadership and talent on our commercial team and retail team. And we're seeing even in the CCF transaction that was done several years ago, the deposits that we received from that have been stable and sticky and modestly growing, those are just really good communities that our advisers are very intertwined in the DNA of helping make sure the communities are successful. So I would say Lynn talked a little bit earlier about the commercial growth. I do believe it's -- we've got a really good client base there, but also we're very fortunate that we have the right talent in growing markets. And so as you said earlier, I think we're in the right spot to continue to be successful.

Excellent. Appreciate that color.

[Operator Instructions] The next question comes from Brian Martin with Janney.

Congrats on all the success here. Just a couple for me. Just in terms of the expense number, and I guess the efforts you guys have had on that front, I guess, the expectation would be -- I know you're not giving guidance on that, but we should start to see some pickup as you go into '26 on the expense numbers.

Yes. Thanks for the question. I think you should anticipate us approaching expenses in a similar fashion as we did this year, and that is to say a pretty disciplined approach around budgeting. That's -- it's an important consideration for us to drop some positive operating leverage next year as well. But yes, I mean, normal merit increases, you would anticipate there being some uplift to expenses in '26 versus the guidance that we've given for full year 2025.

Yes. Okay. Okay. Just making sure there's no initiatives that could keep it kind of at bay again, like we're seeing this year with all the efforts you guys have done. So -- and then just maybe 1 additional 1 on the asset side. Just -- you talk about the mix is continuing to get better on the average earning assets in the funding side. Can you just talk about maybe what the target of those mixes are as you kind of go forward here? Is there something you're targeting in terms of where those mixes go to over time?

Yes, sure. So I think on an organic balance sheet basis, we've still got near 30% of earning assets in the securities portfolio. I mean, can that be over time something that looks more like 20%, absolutely. However, the cash flows of the portfolio are fairly locked in at this point. We give you the forward 4 quarters if you extrapolate that out 4 to 6 or 8 quarters beyond that, it doesn't look too terribly different. So the way point may be something close to what I just mentioned, but it's going to be a pretty ratable path forward to get there. There's no large chunky cash flows coming off in the next couple of years. So only so much of that is in our control, unless you really, really yes, peddle the loan growth, and that's just not the objective at the moment.

Got you. Okay. And on the asset side, anything you're targeting on that side other than just -- I mean, you talked about the remix here with the indirect.

No, the indirect portfolio will continue to run off over the next, call it, 18 to 24 months beyond that and then the securities remix that I just mentioned, I don't think there's any specific targets to note.

Yes. Okay. All right. And then maybe just last 2, just on the provision. I know you talked about it being up a bit this quarter for a couple of items. Just how we think about that going forward just in terms of the pickup we saw this quarter with credit quality still being very, very strong.

Yes. Regarding the reserve, it did increase this quarter. It was driven predominantly by loan growth and mix and then just economic forecast. That was a predominant of $1.7 million, roughly $1 million, a little over $1 million of it was economic forecast and the balance was loan growth. When you get to the provision, as you know, our credit quality has been really strong. We had very low charge-offs for the quarter, but we did have an increase in the unfunded commitments. And so that's the other piece there. As we move forward, I don't expect any significant change. It's really going to be moderated by loan growth levels and the economic forecast.

Got you. Okay. I appreciate that, Lynn. And then just -- the last 1 for me. Just -- I know you talked about broadening out the capital initiatives. Can you just talk about your appetite for M&A here? And just if you are -- are discussions up? Or is it -- are there something you're targeting, certain markets, geographies? Just kind of what your approach to M&A is here as things possibly broaden out?

I think as you look across the Horizon's decades of success here, a lot of it has come from the successful M&A and we would look to continue that for good targets. As we talked about before, we're very excited about the marketplace here in Indiana and also in Michigan for the right doings would be great. There as you probably see, also in the marketplace, there's an increasing dialogue going on, and we're glad to be part of those dialogues. We'll be very disciplined about the approach to M&A to make sure that it's as we've talked about earlier, very shareholder friendly discussions on that, make sure we got positive earns back and that it makes logical sense to our investment base of why we involved M&A and also the returns that come along with that.

And in terms of geography or size, I mean, are you looking for something larger, smaller, multiple deals? Any more commentary on that?

Yes. I think every CEO out there has a specific market size exactly who they would want to be. For us, I would say we'd like to be continuous within our footprint. We have some marketplaces I feel like we can definitely expand our brand and also expand our distribution in the Grand Rapids area, I've called it also in Eastern Michigan. There'll be some great opportunities for us there. We have great platforms, great leaders, just need more distribution. From a size standpoint, we've been successful historically in that $500 million to $1 billion space. I think with our skill set and leadership here that we can even go a little bit bigger than that, but I'd probably say that's about the size we'd be looking at.

Got you. Okay. Perfect. Well, again, congrats on all the success.

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

Thank you. And again, thanks for participating in today's earnings call. We appreciate your time and interest in Horizon, and we look forward to sharing our third quarter results in October. Have a wonderful day.