Horizon Bancorp, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Horizon is an Indiana bank holding company serving northern and central Indiana and southern and central Michigan. Dollar amounts below are in U.S. dollars; financial statement amounts are generally shown in millions.
Financial performance and condition
| Metric | Q2 2020 | Comparable period |
|---|---|---|
| Net interest income | $43.0 million | $41.5 million in Q2 2019 |
| Credit loss expense | $7.1 million | $0.9 million in Q2 2019 |
| Non-interest income | $11.1 million | $10.9 million in Q2 2019 |
| Non-interest expense | $30.4 million | $31.6 million in Q2 2019 |
| Net income / diluted EPS | $14.6 million / $0.33 | $16.6 million / $0.37 in Q2 2019 |
| Net interest margin | 3.47% | 3.73% in Q2 2019; 3.56% in Q1 2020 |
- First-half results: Net interest income was $83.9 million versus $75.8 million in the first half of 2019; credit loss expense was $15.7 million versus $1.3 million. Net income was $26.3 million, or $0.59 diluted EPS, compared with $27.5 million, or $0.65.
- Balance sheet at June 30: Total assets were $5.74 billion; gross loans were approximately $4.0 billion, including $308.1 million of PPP loans; deposits were $4.31 billion; stockholders’ equity was $652.2 million. Since year-end 2019, loans increased about $353 million and deposits about $377 million.
- Credit quality: The allowance for credit losses was $55.1 million, or 1.38% of total loans, versus $17.7 million and 0.49% at year-end. Non-performing loans were $28.1 million, or 0.70% of loans, versus $21.2 million and 0.52% at year-end. Q2 net charge-offs were reported at 0.01% of average loans.
- Cash flow and liquidity: First-half operating cash flow was $40.8 million, compared with $134.3 million in 2019; investing used $428.5 million, while financing provided $459.0 million. Cash and due from banks rose to $170.1 million. Management reported approximately $1.3 billion of cash and investment securities and $910.7 million of unused credit lines.
- Funding and capital: Borrowings were $583.1 million, compared with $549.7 million at year-end. Horizon issued $60 million principal amount of subordinated notes in June, bearing 5.625% fixed interest through June 2025 before converting to floating rate. The company and bank met applicable capital adequacy requirements; the bank was classified as well capitalized.
Material changes and notable items
- Q2 net income declined about 12% year over year. Higher credit loss expense was the principal headwind; lower interest expense, higher net interest income, mortgage-loan sale gains, and lower reported operating expenses partly offset it.
- Lower market rates reduced asset yields and weighed on margin. The Q2 net interest margin fell 9 basis points from Q1 2020; management estimated PPP lending reduced it by approximately 3 basis points.
- Mortgage banking was unusually strong: Q2 mortgage originations reached a reported record $252.8 million and gains on mortgage-loan sales were $6.6 million, versus $2.1 million a year earlier. Mortgage servicing income included impairment; the filing reports $3.2 million of MSR impairment for the first half.
- Horizon adopted CECL on January 1, 2020, recording a $15.6 million reduction to retained earnings and increasing the opening allowance. The company also reported substantial additional credit-loss provisions during the first half, including COVID-related qualitative and portfolio-specific reserves.
- Horizon repurchased shares during the first half, including a separately agreed repurchase of 1 million shares at $15.19 per share. The filing reports $19.6 million of stock repurchases in first-half cash flows.
- First-half 2019 comparisons include Salin Bancshares only from its March 26, 2019 acquisition date; therefore, the six-month year-over-year comparison is not on a fully equivalent acquired-business basis.
Outlook, risks, and contingencies
- The filing provides no numerical earnings or loan-growth guidance. Management describes pandemic effects as uncertain and says actual results may differ materially from forward-looking expectations.
- COVID-19-related risk is central: borrower repayment capacity, collateral values, business activity, interest rates, funding, and operations could deteriorate if economic stress persists. Management had modified $533.9 million of loans under CARES Act relief provisions, equal to 14.3% of the portfolio; these modifications were excluded from TDR treatment under the elected relief provisions.
- The $15.7 million first-half credit loss provision included special allocations for non-owner-occupied retail, leisure and hospitality, and unstabilized commercial real estate exposures. Management said no loss had been specifically identified in those portfolios but considered borrower risks elevated.
- Horizon noted remote-work, cybersecurity, third-party service, and operational risks. It also identified sensitivity to rates, mortgage prepayments and servicing-rights valuations, economic conditions, and credit losses. No goodwill impairment was recorded after COVID-related impairment assessments.
- Management stated ordinary-course litigation was not expected to have a material adverse effect. No material legal contingency amount is specified in the provided filing text.
Important facts for investors to verify
- How the $533.9 million of modified loans performs as deferral periods end, and whether further modifications or delinquencies emerge.
- Whether the $55.1 million allowance adequately reflects credit risk, particularly in commercial real estate, hospitality, retail, and other COVID-sensitive borrowers; distinguish CECL adoption effects from subsequent provision expense.
- Whether PPP fee income, loan forgiveness, and PPP funding effects change reported interest income and margins in subsequent periods.
- Whether the strong mortgage origination and sale activity is sustainable, and how prepayments affect MSR valuations and impairment.
- The terms, future floating-rate exposure, and regulatory treatment of the new subordinated notes, along with trends in borrowings and available liquidity.
- Compare reported results with adjusted non-GAAP measures carefully; adjusted measures exclude specified items and are not substitutes for GAAP results.