Horizon Bancorp, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. Horizon is an Indiana bank holding company operating a commercial bank across Indiana, Michigan and central Ohio. This unaudited filing covers the quarter and six months ended June 30, 2017; balance-sheet comparisons are to December 31, 2016. The bank converted from a national to an Indiana state charter effective June 23, 2017. Dollar amounts below are in millions unless noted.
Financial performance and condition
- Earnings: Q2 net income was $9.1 million, or $0.41 per diluted share, versus $6.3 million and $0.35 a year earlier. First-half net income was $17.3 million, or $0.77 diluted EPS, versus $11.7 million and $0.64. Management’s non-GAAP core net income was $8.6 million for Q2 and $16.1 million for the first half; core diluted EPS was $0.39 and $0.71, respectively.
- Banking income and margin: Q2 net interest income increased 30.3% to $27.2 million; first-half net interest income was $52.8 million, up $12.1 million. Net interest margin was 3.84% for Q2 versus 3.48% a year earlier, and 3.81% for the first half versus 3.47%. Excluding acquisition-related purchase-accounting adjustments, reported core margins were 3.71% and 3.67%, respectively.
- Other income and costs: Q2 non-interest income fell 11.4% to $8.2 million, chiefly reflecting lower mortgage-loan sale gains and the absence of the prior-year securities gain; service charges, interchange and fiduciary income rose. Non-interest expense was $22.5 million, up 4.3% as reported. First-half non-interest income declined 5.3% to $15.8 million and expense increased 6.6% to $44.0 million. Staff, occupancy and data-processing costs rose, partly offset by lower acquisition-related and other costs.
- Assets and lending: Total assets were $3.32 billion, up $180.0 million from year-end. Loans, net of allowance, were $2.25 billion, up $131.5 million; growth was concentrated in commercial and consumer lending. Available-for-sale securities were $505.1 million and held-to-maturity securities were $199.5 million.
- Funding, debt and liquidity: Deposits totaled $2.42 billion, down $52.4 million from year-end, partly attributed to seasonal municipal balances. Borrowings rose $217.8 million to $485.3 million, including $339.4 million of short-term borrowings. Cash and equivalents were $66.0 million, down $4.8 million; operating cash flow for the first half was $26.4 million, investing cash outflow $176.6 million and financing cash inflow $145.4 million. Unused credit lines were $181.2 million, down from $453.9 million at year-end.
- Capital and shareholder returns: Equity was $357.3 million, versus $340.9 million at year-end; book value per share was $16.11 and tangible book value per share $12.20. The bank met regulatory “well capitalized” thresholds; its total risk-based capital ratio was 13.31% and common equity Tier 1 ratio 12.69%. First-half common dividends were $0.24 per share. The board approved an 18% quarterly dividend increase, from $0.11 to $0.13 per share, payable in July 2017.
- Credit quality: The allowance for loan losses was $15.0 million, or 0.66% of loans, versus $14.8 million and 0.69% at year-end. Non-performing loans were $11.6 million, up from $10.7 million; non-performing assets included $8.8 million of non-accrual loans. Net charge-offs were $0.47 million for the first half, compared with $1.07 million in the prior-year period. Management considers the allowance appropriate but cautions that future losses could require increases.
Material changes versus comparable periods
- Reported earnings and net interest income rose substantially year over year, supported by loan growth, acquisitions and improved net interest margin. Lower funding costs also contributed to margin improvement.
- Comparability is affected by acquisitions completed in 2016, including LaPorte and Kosciusko, and CNB in November 2016; the 2017 results include acquired operations, while prior periods include them only from their respective acquisition dates. As an alternative comparison, pro forma first-half net income was $17.3 million in 2017 versus $16.7 million in 2016.
- Q2 mortgage-loan sale gains fell to $2.1 million from $3.5 million as mortgage-loan sales volume declined. The prior-year period also included a $0.8 million securities gain, versus a small loss in Q2 2017.
- Loans grew while deposits declined, increasing reliance on borrowings. First-half investing outflows rose significantly, including $128.3 million of net loan growth and securities purchases.
Outlook, commentary, risks and contingencies
- No quantified earnings or financial guidance is provided. Management cited continued loan growth, expansion in growth markets and improved margin, while identifying cost control and integration of acquired operations as important considerations.
- Horizon announced pending acquisitions of Lafayette Community Bancorp, with completion anticipated in Q3 2017, and Wolverine Bancorp, anticipated in Q4 2017. Both remain subject to shareholder and regulatory approvals and other closing conditions. Stated transaction values were approximately $32.0 million for Lafayette shares not already owned by Horizon and $91.8 million for Wolverine.
- Key disclosed risks include economic and interest-rate changes, mortgage volumes and deposit outflows, credit losses and collateral values, liquidity, competition, regulation, technology and cybersecurity, and the execution and integration risks of acquisitions. Management reported no significant change in interest-rate sensitivity from its 2016 Form 10-K.
- Management stated that ordinary-course litigation is not expected to materially affect the company. It also judged unrealized securities losses to be temporary and reported no individual security impairment considered other-than-temporary at June 30, 2017.
- The expected-credit-loss accounting standard (CECL) was still under evaluation; management expected a one-time allowance adjustment at adoption but could not estimate its size. Other accounting updates adopted in 2017 had no material impact, except stock-compensation guidance, which produced a $19,000 tax benefit.
Important facts for investors to verify
- Whether loan growth can be funded sustainably given declining deposits, higher borrowings and reduced unused credit lines.
- Trends in non-performing loans, charge-offs, consumer-credit performance and the adequacy of the loan-loss allowance as the portfolio expands.
- Whether margin and earnings growth persist after separating acquisition effects, purchase-accounting accretion and nonrecurring items; the company’s “core” measures are non-GAAP.
- Actual timing, approvals, consideration and integration costs for the Lafayette and Wolverine acquisitions, and whether anticipated benefits are realized.
- Mortgage-sale volumes and fee income, and sensitivity of mortgage servicing rights and securities values to rates and prepayments.
- The eventual CECL transition impact and the company’s ability to maintain capital and liquidity through further growth.