Horizon Bancorp Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Dollar amounts below are in millions unless stated otherwise. Comparisons are with Q3 or the first nine months of 2012, or with December 31, 2012 for balance-sheet measures.
Business context and financial performance
Horizon is an Indiana-based bank holding company operating through Horizon Bank in Indiana and southwestern Michigan. It provides commercial and retail banking, trust and agency services, and mortgage lending. The company completed its Heartland acquisition in July 2012; 2013 results include acquired operations and loan-discount accretion.
| Metric | Q3 2013 | Nine months 2013 | Comparison |
|---|---|---|---|
| Net income | $4.8 | $15.8 | Q3 down 1.3%; nine months up 9.7% |
| Net income available to common shareholders | $4.7 | $15.5 | — |
| Diluted EPS | $0.52 | $1.72 | $0.54 and $1.75, respectively, in 2012 |
| Net interest income | $14.7 | $47.3 | Q3 down $0.3; nine months up $6.1 |
| Non-interest income | $5.9 | $20.2 | Q3 down 23.3%; nine months up 4.2% |
| Non-interest expense | $14.1 | $42.8 | Q3 down 5.2%; nine months up 12.2% |
| Provision for loan losses | $0.1 | $2.9 | $1.0 and $1.8, respectively, in 2012 |
Q3 net interest margin was 3.78%, versus 3.79% a year earlier. Nine-month margin was 4.06%, versus 3.80%; management said it would have been 3.61% excluding accretion of acquired-loan discounts and loans paid off before maturity. The effective tax rate was 25.4% for Q3 and 27.4% for the nine months, lower than the comparable 2012 rates of 29.0% and 30.3%.
Net cash from operating activities was $40.0 for the nine months, compared with $17.5 in 2012. Investing activities provided $41.8, while financing activities used $71.9; cash and cash equivalents rose $9.8 to $40.5.
Financial condition, liquidity and capital
- Total assets were $1,781.0 at September 30, down $67.2 from year-end 2012. Net loans were $1,063.6, down $108.9; gross loans fell $109.3, largely because mortgage warehouse loans declined $137.9 to $113.6. Commercial loans increased $39.1.
- Investment securities totaled $524.1, including $514.1 available for sale and $9.9 held to maturity; total securities increased $41.3 from year-end. Deposits rose $34.2 to $1,328.3, including $223.4 in non-interest-bearing deposits.
- Borrowings decreased $103.3 to $242.5, reflecting lower warehouse funding needs and deposit growth. Subordinated debentures were $32.4. The filing reports $328.9 of unused credit lines at September 30.
- Stockholders’ equity was $163.5, versus $159.0 at year-end. Bank capital ratios included Tier 1 capital to average assets of 9.13% and total capital to risk-weighted assets of 14.09%; management said these exceeded well-capitalized regulatory standards.
- The allowance for loan losses was $17.8, or 1.64% of total loans. Net charge-offs were $3.3 for the first nine months, versus $2.1 in 2012. Non-performing loans were $22.5, or 2.07% of loans, compared with $23.8 and 1.97% at year-end.
Material changes and management commentary
- Q3 earnings were pressured by lower mortgage refinancing and warehouse activity: mortgage-loan sale gains fell $2.8 to $1.7, and warehouse balances were $113.6 versus $244.2 a year earlier. Management cited slower refinancing demand and higher long-term rates.
- Nine-month net interest income benefited from commercial loan growth and approximately $5.4 of acquired Heartland loan-discount accretion and early loan payoffs. The company reported its highest first-nine-month net income to date, but diluted EPS declined year over year, partly due to additional shares and dilutive securities.
- Nine-month non-interest income growth reflected higher deposit service charges, interchange and fiduciary fees, partly offset by lower mortgage-sale gains. Expense growth reflected Heartland and investment in growth markets, as well as compensation, occupancy, loan and other costs.
- Credit indicators were mixed: non-performing loans declined in dollars from year-end, but their share of loans rose as the loan portfolio contracted. Substandard loans were $44.4, or 4.11% of loans, versus $50.2 at year-end. Management attributed the lower Q3 provision to improved non-performing and substandard loans; the higher year-to-date provision included $1.6 related to Heartland acquired-loan credit losses exceeding acquisition discounts.
Outlook, risks and unusual items
- The filing gives no specific earnings, revenue or margin guidance. Management described continued challenging local economic conditions, elevated unemployment, and ongoing pressure in housing and construction markets.
- Key stated risks include economic and interest-rate changes, credit losses and collateral values, liquidity sources, regulation and Basel III, competition, cost control, technology, and acquisition integration and realization of expected savings. Horizon said it was evaluating Basel III requirements, with its phase-in beginning in 2015.
- Available-for-sale securities had $6.7 of gross unrealized losses at September 30, contributing to a $8.5 nine-month other-comprehensive loss after tax; accumulated other comprehensive income fell from $9.1 to $0.6. Management considered the securities declines temporary and reported no other-than-temporary impairment.
- Heartland acquired loans included $6.2 of non-performing credits and $12.2 of substandard loans at September 30. The filing also reports $9.5 of troubled debt restructurings, of which $3.5 were performing.
- Management said disclosure controls were effective and there were no material changes in internal control over financial reporting. It did not expect pending legal proceedings to materially adversely affect consolidated financial position or results.
Important facts for investors to verify
- How much future net interest income and margin depend on finite Heartland loan-discount accretion and early payoffs, and what the underlying earning-asset yields are without these items.
- Whether the mortgage business stabilizes as refinancing demand and warehouse balances change, and the effect on mortgage-sale gains, servicing rights and earnings.
- Credit migration, charge-offs and reserve adequacy, particularly for acquired Heartland loans, commercial real estate, home equity and troubled debt restructurings.
- The sensitivity of securities values, capital and earnings to interest-rate movements, alongside liquidity availability and the company’s reduced borrowing balance.
- The sustainability of year-to-date earnings growth given higher operating expenses, share dilution, tax-planning benefits and the absence of formal forward guidance.