Horizon Bancorp: Expansion Plans To Boost Earnings
- Plans to acquire branches and hire new lenders will likely drive loan growth in the quarters ahead.
- Deposit costs will likely decline due to the addition of low-cost deposits and the maturity of costly certificates of deposits.
- The December 2021 target price suggests a high upside from the current market price. Further, Horizon Bancorp is offering a modest dividend yield.
Expansion plans will likely drive loan growth of Horizon Bancorp, Inc. (NASDAQ: NASDAQ:HBNC) in the remainder of 2021, which will boost the bottom line. Earnings will likely also benefit from a decline in deposit costs. On the other hand, low reinvestment rates, a shift in the asset mix towards lower-yielding assets, and higher provision expenses will likely limit earnings growth. Overall, I'm expecting the company to report earnings of $0.89 per share in the second half of 2021, taking full-year earnings to $1.85 per share, up 19% year-over-year. The year-end target price suggests a high upside from the current market price. Therefore, I'm adopting a bullish rating on Horizon Bancorp.
Expansion Plans Bode Well for Loan Growth Prospects
Loans of Horizon Bancorp have declined sharply in the last three quarters. The loan portfolio will likely recover in the year ahead because of the following factors.
- Acquisition of 14 TCF National Bank branches.
- An increase in the number of commercial lenders.
- Economic recovery.
As recently announced, Horizon Bancorp plans to complete the acquisition of 14 TCF National Bank branches in Michigan in the third quarter of 2021. The acquisition will add loans totaling $278 million to Horizon Bancorp's balance sheet. As a result, the loan portfolio will increase by around 8% through this acquisition.
Further, Horizon Bancorp plans to expand organically by hiring commercial lenders. As mentioned in the second quarter’s conference call, the number of commercial lenders has already increased by 20% since the end of December 2020. According to the management, additional offers to new commercial lenders are pending.
On the other hand, the company’s plans to close branches may limit loan growth. As mentioned in the second quarter’s investor presentation, Horizon Bancorp has initiated plans to close ten branches in August 2021. Despite the widespread adoption of digital platforms by customers, Horizon Bancorp may lose some customers to other financial institutions due to the branch closures. Moreover, the company may miss out on potential borrowers in the region where the branches are closed.
Further, the upcoming forgiveness of Paycheck Protection Program (“PPP”) loans will likely constrain loan growth. As mentioned in the second quarter’s 10-Q filing, PPP loans totaled $169.4 million at the end of the last quarter, representing 4.8% of total loans. I'm expecting a majority of these loans to get forgiven in the remainder of the year.
Considering the factors mentioned above, I'm expecting the loan portfolio to increase by 10.7% in the second half of 2021, taking full-year loan growth to 0.6% year-over-year. For 2022, I'm expecting loans to grow organically at a normal rate of around 6%. I have not incorporated any potential merger and acquisition activity in the loan growth estimate for next year.
Deposit growth will most probably outpace loan growth in the remainder of 2021 because the target TCF National Bank branches have more deposits than loans. As mentioned in the press release, the branches had deposits of $976 million, as opposed to loans of $278 million. The acquisition will likely boost the deposit book by around 20%. After the acquisition in the third quarter, I'm expecting deposit growth to more or less match loan growth. The following table shows my estimates for loans, deposits, and other balance sheet items.
Loan Repricing, Asset Mix Shift to Pressure the Margin
The net interest margin will likely face downward pressure from the following factors.
- Repricing down of fixed-rate loans.
- A shift in the asset mix towards lower-yielding assets and building of excess liquidity.
Commercial loans, which make up around 60% of the total loan portfolio, are mostly based on fixed rates. According to details given in the presentation, around 62% of the commercial loan portfolio was fixed rate based. Further, around 65% of consumer loans were based on fixed rates. As a result, it is safe to assume that a large part of the total loan portfolio has still not incorporated the impact of last year's rate cuts. As loans will continue to reprice this year, the average portfolio yield will likely face downward pressure.
Further, the acquisition of TCF National Bank branches will shift the asset mix towards lower-yielding assets as the acquired loans are far less than the acquired deposits. The acquisition can also lead to a building up of excess liquidity. Excess cash was already a problem in the last few quarters. As mentioned in the 10-Q filing, Horizon Bancorp estimated that the high level of cash held on the balance sheet compressed the net interest margin by 21 basis points in the second quarter.
On the other hand, the following factors will lift the net interest margin.
- Addition of low-cost deposits through the acquisition of TCF National Bank branches.
- Maturities of costly certificates of deposits.
As mentioned in the press release, the average cost of TCF’s deposits was only 0.08%, as opposed to the average deposit cost of 0.21% for Horizon Bancorp's existing deposit book. According to my calculations, the acquisition of low-cost deposits can reduce the total deposit cost by around two basis points.
Further, the upcoming maturities of Certificates of Deposits (“CD”) will ease the pressure on the margin. CDs totaling $240 million are scheduled to mature in the remainder of 2021, as mentioned in the presentation. These CDs carried a weighted average rate of 0.72% in the last quarter. If Horizon Bancorp can replace these maturing CDs with deposit carrying rates of around 0.40%, the maturities can reduce the total deposit costs by around two basis points. The current average CD rate in the country is around 0.26%, according to FDIC. Therefore, a replacement rate of 0.40% is achievable. The following table shows the impact of different replacement rates on the average deposit costs.
Expecting Full-Year Earnings of $2 per Share
The anticipated rebound in the loan portfolio and dip in the average deposit cost will likely drive earnings in the remainder of the year. On the other hand, the provision expense will likely increase in the second half of the year relative to the first half, which will limit earnings growth. Due to the Delta variant and portfolio-specific risks, I'm expecting the provision expense to be higher in the second half of the year. Hotels made up 4% of total loans at the end of the last quarter, as mentioned in the presentation. Further, COVID-19 related deferrals still made up 1.5% of total loans at the end of the last quarter. Therefore, I believe the portfolio’s credit risk is moderately high.
Overall, I’m expecting Horizon Bancorp to report earnings of $0.89 per share in the second half of 2021, taking full-year earnings to $1.85 per share. This earnings estimate is higher than my previous estimate given in my last report. I’ve revised the earning estimate upwards due to the acquisition announcement, which was made subsequent to the release of my last report. Further, I have decreased the provision expense estimate for the full year because Horizon Bancorp surprisingly reversed some of its previous provisionings in the second quarter.
For 2022, I'm expecting earnings to increase by 2% year-over-year mostly due to loan growth. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic, especially the Delta variant.
High Total Expected Return Justifies a Bullish Rating
Horizon Bancorp is offering a dividend yield of 3.0%, assuming the company maintains its quarterly dividend at the current level of $0.13 per share. The earnings and dividend estimates suggest payout ratios of 27.5% for both 2021 and 2022, which are below the five-year average of 32.0%. Therefore, there is room for another dividend hike in the coming quarters. To remain on the safe side, I’ve incorporated no dividend increase in my investment thesis.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Horizon Bancorp. The stock has traded at an average P/TB ratio of 1.56 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $12.8 gives a target price of $19.9 for the end of 2021. This price target implies an 18.8% upside from the August 4 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 11.0x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $1.85 gives a target price of $20.5 for the end of 2021. This price target implies a 21.9% upside from the August 4 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $20.2, which implies a 20.3% upside from the current market price. Adding the forward dividend yield gives a total expected return of 23.4%. Hence, I’m adopting a bullish rating on Horizon Bancorp.
I like the company because of its organic and acquisition-based expansion plans. Further, Horizon Bancorp will have the opportunity to reduce its deposit costs in the year ahead. Additionally, the company is currently trading at an attractive level that suggests a high total expected return.
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