Horizon Bancorp, Inc. (HBNC) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the Horizon Bancorp's conference call. [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 and news release published by the company yesterday. Additional information about factors that could cause actual results to differ materially is contained in Horizon's current 10-K and later filings. In addition, management may refer to certain non-GAAP financial measures that are intended to help investors understand Horizon's business. Reconciliations for those measures are contained in the presentation. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the press release and supplemental presentation published by Horizon yesterday, you can access them at the company's website. Representing Horizon today are Chairman and Chief Executive Officer, Craig Dwight; and Executive Vice President and Chief Financial Officer, Mark Secor. At this time, I'd like to turn the call over to Horizon's Chairman and CEO, Craig Dwight. Mr. Dwight, go ahead.

Thank you, Anita, and good morning, and thank you for participating in Horizon Bancorp's investor conference call to discuss the recently announced branch acquisition. Our comments today will follow the investor presentation we published yesterday, May 25. Horizon is pleased to enter into a purchase and assumption agreement with TCF National Bank to acquire 14 branches to be divested in conjunction with their merger with Huntington Bank. This transaction is still subject to Horizon Bank receiving regulatory approval and meeting other traditional closing terms and conditions. We meet -- or we expect this transaction to close by the end of third quarter. This transaction is aligned with Horizon's strategic objectives. This represents a natural market extension of our current footprint within the state of Michigan. On a pro forma basis, Horizon will be #1, 2 or 3 deposit market share in all markets acquired, except for the counties of Newaygo and Charlevoix. This will add attractive growth markets at Cadillac and Big Rapids as well as mass to our current Midland, Michigan location. This will add approximately $976 million in low cost and stable funding with the average tenure of the accounts to be acquired exceeding 10 years, and at a low total cost of acquired deposits at 8 basis points with the vast majority of the quarter accounts being retail. The average deposits per acquired branch is approximately $70 million. This transaction exceeds all of Horizon's internal financial hurdle rates. The deposit premium at 1.75% on total deposits is low compared to historical standards. The loan discount at 3.5% of total loans provides satisfactory cushion against unforeseen credit risk on a well-diversified acquired loan portfolio. This discount is in addition to our CECL and credit marks. The intro rate of return exceeds 21%. EPS accretion in the first full year exceeds 17%. This transaction will be accretive to both return on average assets and return on average equity. The tangible book value payback period is approximately 2 years. In addition, this will add mass and scale to our franchise, which will create a more efficient operation as we deploy our expenses over a greater earning asset base. This is an efficient use of Horizon's excess capital and our 2020 sub debt offering of $60 million. Finally, this transaction has considerable upside as we deploy these deposits to higher earning assets. As you just heard, we are very pleased with the strategic and financial aspects of this transaction. Slide 4 of our presentation is a map that exhibits the logical extension of our current footprint in the State of Michigan. This will add 11 new counties to Horizon's current 10 counties that we cover in the state. In addition, this transaction increased Horizon's Michigan deposits to 35% and loans to 45% of Horizon's total deposits and loans. This will be Horizon's 15th acquisition since 2002. We fully understand the importance of dedicating resources, time, planning and energy to ensure an integration is successful. And we have a very experienced team of integrators from top to bottom of our organization who are already planning for the closing and integration. This includes positioning our 3 bank-owned call centers to handle significant volume of new customer inquiries, to assign Horizon Bank mentors to their new colleagues at the 14 branches to be acquired and a detailed customer contact plan. We believe our experience and approach to acquisitions lowers the integration risk as well as improves the likelihood of retention of employees and customers. Horizon will retain all branch employees at all 14 branch locations we had acquired, plus 3 business bankers to assist in managing the acquired small business loan portfolio. Importantly, given the talent and resources we have in place, we continue to have discussions around other M&A opportunities, and we'll continue to actively evaluate potential transactions to enhance our positions within our current footprint or adjacent markets in Indiana, Michigan or Northwest Ohio. That concludes my comments. Now to discuss the financial aspects of transaction, it's my privilege to introduce Mark Secor. Mark?

Thank you, Craig. We are very pleased with what we believe are very attractively priced core deposits and a nice complement to our low-cost funding profile. Strategically, this will provide low-cost funding for future loan growth as we see signs of a recovering economy. As we show on Slide 7, based on March 31 balances, the acquired deposits would reduce the combined pro forma deposit cost to 18 basis points, a reduction from Horizon stand-alone deposit cost of 21 basis points. The growth of noninterest-bearing deposits on a pro forma basis to 27% of deposits helps in the reduction of the overall deposit costs. We understand that current deposit levels are inflated due to higher cash levels held in almost all financial institutions. For modeling purposes, we made some assumptions on deposit attritions that we believe to be conservative. First, we modeled attrition of 15% in the first 6 months post-closing. This is significantly higher than what we have historically experienced on our prior acquisitions, attempting to account for the disruption in the market, and reflects the difference between this type of premerger divestiture compared to a more typical branch or whole bank deal. Second, given current surge of deposits at most banks as customers are maintaining higher cash balances and holding stimulus dollars, over 36 months post-closing, we modeled an additional 20% of attrition. Combined, these create over 30% deposit attrition over a 3-year period. Slide 8. The loans we are acquiring are a good fit with Horizon's current mix. This does not significantly impact the first quarter's pro forma total loan yield. Extensive loan due diligence was completed to determine an adequate loan discount, purchase accounting mark and day 2 CECL allowance. As Craig mentioned, a 3.5% loan discount was applied to loans acquired. And in addition, an approximate 2.3% purchase accounting mark was applied along with an approximate 50 basis point day 2 CECL reserve. Slide 9. An attractive benefit of this transaction is the ability for us to leverage Horizon's existing infrastructure, which has been designed for growth and efficiency. For the first quarter, the combined estimated pro forma adjusted efficiency ratio would have been 55.4%, down from Horizon's stand-alone ratio of 58%, fully supporting our long-standing approach of maintaining a low-cost operating model. Slide 10. This transaction helps leverage the $60 million in sub debt issued in the second quarter of 2020, and allows the downstream of $60 million of cash at the holding company into the bank to maintain its capital levels. This also helps leverage the capital at the holding company. The pro forma tangible common equity of 7.3% is an adequate level based on the risk structure of the balance sheet and potentially inflated balances due to surge deposits. Based on expected earnings and balance sheet mix changes, we estimate by mid-2022, the TCE would be approximately 8%. Importantly, we believe we have ample capital and cash at the holding company to maintain our commitment to our quarterly cash dividend to common shareholders, which we raised by 8.3% to $0.13 per share in March. Slide 11. This chart illustrates the significant accretion upside we see from this transaction. One of the assumptions for our 17.1% EPS accretion expectation for 2022 is initial deployment of the acquired liquidity into investments at an average rate of 1.5%. If, however, the improving economy and the success of our efforts to compete in our new Northern and Central Michigan markets, along with growth in our overall footprint, would allow us to redeploy acquired liquidity into loans faster than we have modeled. The accretion upside is clearly significant. Given the deal pricing and the low-cost core deposits, we will bring onboard at closing. Now I'll turn it back over to Craig for any final comments.

Thank you, Mark. This concludes our formal comments related to the branch acquisition, and we'll turn it back over to the operator, so she can open up the lines for questions. Thank you.

[Operator Instructions] The first question today comes from Terry McEvoy with Stephens.

Can you just start on the overall [indiscernible] stand-alone bank, I think you made this [indiscernible] problems you were looking to redeploy another like $300 million here in the second quarter. And then as it relates to this transaction, could we assume or wonder whenever the deal closes, you will build out the securities portfolio along the lines that you just discussed a few minutes ago?

Yes, Terry, you were breaking up, but I think I got the question. We are and we have deployed the $350 million that we talked about in the first quarter call, and we still continue to have good cash balances. So we do plan to start building out this investment portfolio, so that we can have those assets in place, hopefully, by the time we would get to close.

And then as a follow-up, it looks like most of these are legacy commercial -- I'm sorry, chemical branches. When I just think about those employees and customers, they've gone through a lot over the last 5 years in terms of the mergers, MOEs and now today's news. So I guess, my question is, Mark, I think we ran through your assumptions on some deposit attrition and runoff. What about the bank and the employees themselves? Do you feel like you are going to be able to capture and maintain and hold those employees? Again, they have gone through a lot the last 5 years. [indiscernible].

Yes. Terry, good question. Number one, we have already acquired several chemical bankers that are familiar with these markets and some of the people in these branches. So we think that will help bridge that gap. Two, they've been working for, what I'll call, super regional banks, and what we're hearing from our current employees is that they will embrace the fact they're going to get back with the community bank or Michigan and Indiana focused banks, so that's a positive. And three, we do have an employee retention plan that we put in place. We executed right away, and it's very favorable to those employees.

The next question comes from David Long with Raymond James.

Just a couple of things here. The noninterest income, it looks like you're looking at about $800,000 or so in the quarterly noninterest income. Is that primarily service charges, interchange fees? What are the fees that are making up this portion of the deposits that you're gaining?

Yes, David, this is Mark. Yes, that would be primarily what's making it up as we anticipate continued transactions and service charges. There also is -- they do have some mortgage presence, so there is some mortgage revenue built into that also.

Got it. And then as far as future M&A transactions, it sounds like this does not take you out of the M&A games. Can you confirm that? And then If it doesn't, maybe just remind us what your priorities would be on transactions going forward.

Yes. David, this is Craig. It does not take us out of the M&A game. We still have capital to deploy. And the bank ratios are quite strong. And we have still $65 million in cash after this transaction at the holding company, which gives us still some optionality for future transactions in markets in the states of Michigan, Indiana and Northwest Ohio.

The next question comes from Nathan Race with Piper Sandler.

I was hoping to dig into some of the underlying assumptions for the 17% EPS accretion for next year. The 5% loan growth, I assume that's just on the acquired loan balances. I'm just curious, in terms of kind of what gives you guys the confidence that you can generate loan growth. Just -- it sounds like, Craig, to your earlier comment, you've added some commercial bankers in these markets. So is that kind of the main driver to get to that 5% number on the acquired loans entering 2022?

Nathan, thanks for the question. It's -- that definitely helps out with the 3 business bankers that are coming over with the transaction. The loan-to-deposit ratio in this transaction is 29%. The average loan-to-deposit ratio for the banks that are in market is over 60%. So we just plan to take some market share and get back to what the level of market expectations are. So after 5 years, we'll be at about a 50% loan-to-deposit ratio, which we think is very conservative. The other side of that, if we can't deploy the deposits in market, we plan to deploy those deposits in other Michigan growth markets where we're already over 100% loan-to-deposit ratio. So there's plenty of opportunity in the state to deploy those deposits. But you're right, the assumptions for this transaction of 5% are only on the loans that we're acquiring.

Okay, got it. And along those lines, you kind of alluded to this, but would love to get an update just in terms of kind of what you're seeing in terms of credit demand on the commercial side lately versus kind of what we last spoke in April. Are you seeing an increase in both demand and share gains, or just any more recent color on just kind of commercial loan growth dynamics across your company would be helpful?

Yes. The first quarter, we had about $70 million in payoffs in the commercial portfolio, which over half were classified credits, which we were trying to move out of the company. And the pipeline in the first quarter was over $90 million, in which we funded about 56%. The second quarter is stronger than the first quarter, as we mentioned in our conference call in April, and continues to look bright. So the numbers are picking up, the requests are coming in. Quite frankly, a lot of it is in the C&I side. The challenge has been our line of credit utilization is down to about 34% when we were in the high 40s, low 50s on a traditional look-back for both the commercial loans as well as home equity lines of credit. So we're seeing consumer spending quite -- seamless money they're going to spend through that and start using those lines again. And once businesses start to spend through that PPP money, we'll start seeing the activation of the line. So we're optimistic about the future.

The next question comes from Damon DelMonte with KBW.

So just wondering, the 14 branches that are spread over 11 counties in Michigan, do you guys feel like you're going to need to kind of build more of a presence in some of these northern counties that you're moving into?

Damon, that is a possibility. Our first objective at 12 to 18 months is to stabilize the customer base and employees, that will be our entire focus. After that 18-month period, we'll look at build-outs as we see it's needed.

Got it. Okay. And then, Mark, could you just go back over the commentary on the CECL impact, the day 1 and the day 2 impacts?

Yes. So along with the 3.5% overall discount, we did apply to the model a 2.3% purchase accounting mark as part of the transaction, and then also included a day 2 CECL mark of 50 basis points.

The next question comes from Brian Martin with Janney.

Say, maybe just one question, Craig. Just as you mentioned additional M&A, I guess, opportunities that you guys kind of look at things, I guess is that still part of the outlook here? I guess, I know you mentioned on last quarter's call that there's opportunities you expected in the second half of this year. I guess, are you still optimistic that on the whole bank acquisition side, there's still opportunities you'd expect to be active in the second half of the year following this transaction?

Brian, I think we all are hearing that discussions are taking place, the conversations are increasing. The probability of something happening in the second half year is unknown, but there's definitely a pick up in the conversations between bank CEOs and bank chairmans as well as with investment bankers. So I see that trend going on, which will -- well, possible tax law changes might encourage even a quicker pick up in the discussion. So yes, I think the probability of something could happen. However, it will depend on how those discussions play out.

Yes. Okay. All right. And then just, Mark, the assumptions, I think, if you just run back through on the deposit assumptions, the attrition, yes, I think on the slide deck, you gave the 18% deposit runoff. I think, you gave it some different numbers just as far as that goes. If you go back through that and just kind of the remarks you took because it looked like the goodwill CVI was a little bit higher than the $17 million purchase price. So just can you give a little bit of color on that? And, I guess, in conjunction with, I guess, also kind of the TCE is getting that 8% level. That would be helpful.

Yes, Brian. On the attrition aspect, what we modeled in was 15% attrition in the first 6 months just due to the potential market disruption and the type of transaction that this is. And then, over the next 3 years or 36 months, we modeled in another 20% of attrition for the surge deposits, knowing that balances are inflated currently. So all in, over the first 3 years, we have a little -- it comes up to a little over 30% attrition of the deposit base, which, again, we do think that's conservative, but we wanted to make sure that we adequately recognized what the surge deposits are right now. As far as what makes up the intangible, I think besides the purchase price and the loan marks, the other part that we also have included is the core deposit intangible. So we had a 50 basis point core deposit intangible estimate, which created another $4.2 million of intangibles.

Got you. Okay. And then just the assumptions on the 8% TCE expectation, can we get back to that, Mark? And [indiscernible] I guess, what are some general assumptions there?

I think -- and we just ran the model out with the assumptions that we're giving to see what kind of income we're going to be with the accretion of the income, along with various anticipation is with the runoff that we will see balances coming down. So that's -- that was the -- those were main assumptions to be able to see that capital build and the balance sheet strengthening.

Got you. Okay. Perfect. Congratulations, guys.

Thanks, Brian.

Thank you, Brian.

The next question is a follow-up from Nathan Race with Piper Sandler.

Just going back to the M&A discussion. Just curious, as we look at the pro forma capital levels with 7.3% TCE and all the other regulatory ratios are fairly robust as well, albeit lower from the transaction announced yesterday. Just curious as we kind of think about kind of the top end of acquired assets, what are kind of the governors on to what extent you would want to kind of leverage capital further in terms of those ratios?

Nathan, I'll start, and I'll let Mark probably get into the weeds a little bit more detail for you. What's interesting is we run the math on transactions. The bank capital actually improves, increases, which is the primary regulatory concern on the M&A we use some portion of our stock as the currency. The holding company is the issue. And the holding company to get back in 8% is a very short time period, just given the fact that we're growing earning assets faster -- sorry, or capital faster than earning assets. So we think those 2 will provide the strength to continue to look forward in acquisitions. Mark, do you want to give some detail on that?

Yes, I think you've covered pretty well, but a whole bank transaction, bank capital, we would not have the same issues you do in this transaction where it does use up the bank capital. We do feel, and I kind of made the comment that TCE is the one that we would watch, but with the structure of the balance sheet and the risk profile of the balance sheet, especially as this investment portfolio grows and we continue to maintain our credit quality and looking for investments, we're not going to take a significant amount of risk in the investment portfolio. So I think with the structure of the balance sheet, and then the balance sheet shrinking, potentially as our own deposits -- surge deposits would potentially run out as we get into the next 18 months, 24 months. So -- but the TCE would be the one that we would watch. But like I said, I think we're comfortable with where it is after this -- with this pro forma, primarily because of the risk profile.

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

Okay. Thank you for participating in today's investor conference call. We appreciate the questions and comments, and we look forward to talking to you in the near future. Have a good day. Bye now.

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