2023-11-07 16:23:46 ET
Summary
- Robust pipelines bode well for loan growth in the near term. However, the regional unemployment trend signals a slowdown.
- The declining margin trend is likely to turn around because the up-rate cycle has likely ended. Further, new loan production will help the margin.
- HBNC is currently offering a dividend yield of 6.1%. The dividend appears secure as my estimated payout ratio is only slightly above management’s guidance.
- The year-end target price suggests a high upside from the current market price.
Earnings of Horizon Bancorp, Inc. (HBNC) will most probably dip in upcoming quarters because expense growth will undermine the effect of loan and margin growth. Overall, I’m expecting the company to report earnings of $1.57 per share for 2023 and $1.36 per share for 2024. Next year’s target price suggests a high upside from the current market price. Further, Horizon is offering a high dividend yield of 6.1%. Therefore, I’m maintaining a buy rating on Horizon Bancorp.
Pipeline Bodes Well for Loan Growth but Risks are Emanating from the Regional Economies
Horizon Bancorp’s loan portfolio grew by a strong 2.2% during the third quarter, taking the first nine-month growth rate to 4.9%, or 6.5% annualized. Management mentioned in the earnings presentation that the impressive loan growth was attributable to strong commercial lending performance. This growth momentum is likely to continue in the fourth quarter of the year because of robust pipelines. As mentioned in the presentation, the commercial pipeline stood at $145 million at the end of September 2023 as opposed to $118 million at the end of June 2023.
However, the current regional economic factors present a less rosy picture for loan growth. Horizon Bancorp operates mostly in Michigan and Indiana. The unemployment rates of both states have been trending upward since the middle of this year. This trend indicates a slowdown in regional economic activity, which is bad for loan growth.
Overall, I believe that loan growth should slow down to 1% (4% annualized) every quarter till the end of 2024. The following table shows my balance sheet estimates.
Financial Position | FY19 | FY20 | FY21 | FY22 | FY23E | FY24E |
Net Loans | 3,619 | 3,810 | 3,553 | 4,108 | 4,352 | 4,529 |
Growth of Net Loans | 20.8% | 5.3% | (6.7)% | 15.6% | 6.0% | 4.1% |
Other Earning Assets | 1,078 | 1,325 | 2,731 | 3,029 | 2,865 | 2,981 |
Deposits | 3,931 | 4,531 | 5,803 | 5,858 | 5,757 | 5,991 |
Borrowings and Sub-Debt | 606 | 590 | 791 | 1,259 | 1,487 | 1,517 |
Common equity | 656 | 692 | 723 | 677 | 702 | 713 |
Book Value Per Share ($) | 15.1 | 15.7 | 16.5 | 15.5 | 16.0 | 16.3 |
Tangible BVPS ($) | 11.0 | 11.7 | 12.5 | 11.6 | 12.1 | 12.4 |
Source: SEC Filings, Author's Estimates(In USD million unless otherwise specified) |
The Margin’s Declining Trend is Likely to Turn Around
After dipping by 16 basis points in the first half of this year, the net interest margin declined by 28 basis points in the third quarter. This dip was expected because the balance sheet is positioned in a manner such that the margin declines in a rising-rate environment. This is because more liabilities (i.e. deposits and borrowings) than assets (i.e. loans and securities) are scheduled to mature this year. The gap between liabilities and assets re-pricing this year is $128 million, or 2% of total assets, as mentioned in the 10-K filing for 2022. (This information hasn’t been updated for the quarters of 2023).
Management believes that the margin was at the bottom of the trough for the third quarter, as mentioned on the conference call . I agree with the management that there is now a good chance the declining trend can turn around. This is because, firstly, I believe the up-rate cycle has ended. The stable interest rate environment will ensure that fast liability re-pricing is no longer problematic.
Moreover, the production of new loans at higher rates will lift the average portfolio yield, and consequently the margin. The average new production yield on commercial loans was 7.50% during the last quarter, which is much higher than the average portfolio yield of 5.80% in the quarter, as mentioned in the presentation.
Considering these factors, I’m expecting the margin to increase by two basis points in each quarter till the end of 2024.
Expense Growth to Keep Earnings on a Downtrend
The anticipated loan growth and slight margin expansion will likely support earnings in upcoming quarters. However, expense growth will most probably undermine the benefit of loan and margin growth. I’m expecting both provisions expenses and operating expenses to be higher in 2024 compared to this year.
I’m expecting the provision expense for loan losses to return to a normal level in 2024 after remaining unusually subdued during the first nine months of this year.
Further, I’m expecting inflation to drive up operating expenses, especially salary expenses. However, there is hope that management will be successful in restricting expense growth. This is because the company’s expense discipline was quite impressive during the third quarter of this year. Management also mentioned on the conference call that “our longstanding commitment to being agile in this part of our business model and consistently reviewing opportunities to reduce expenses and streamline processes continue to be a priority, and you can expect it to remain our focus throughout 2023.” As a result, I’m expecting the expense growth to be only moderate. I’m expecting the efficiency ratio (calculated as non-interest expenses divided by total revenue) to drop to 66.7% in the fourth quarter of 2023 from 67.1% in the third quarter. For 2024, I’m expecting an efficiency ratio of 67.2%.
Overall, I’m expecting Horizon Bancorp to report earnings of $1.57 per share for 2023 and $1.36 per share for 2024. The following table shows my income statement estimates.
Income Statement | FY19 | FY20 | FY21 | FY22 | FY23E | FY24E |
Net interest income | 161 | 171 | 182 | 200 | 176 | 180 |
Provision for loan losses | 2 | 21 | (2) | (2) | 2 | 4 |
Non-interest income | 43 | 60 | 58 | 47 | 44 | 46 |
Non-interest expense | 122 | 131 | 139 | 143 | 143 | 151 |
Net income - Common Sh. | 67 | 68 | 87 | 93 | 69 | 59 |
EPS - Diluted ($) | 1.53 | 1.55 | 1.98 | 2.14 | 1.57 | 1.36 |
Source: SEC Filings, Author's Estimates(In USD million unless otherwise specified) |
Compared to my last report on the company, which was issued before the second quarter results, I haven’t changed my earnings estimate much because the earnings releases so far have been mostly in line with my expectations. This is the first time I’m giving estimates for 2024.
Risks are Low
Horizon Bancorp’s risk level appears subdued, as discussed below.
- As mentioned in the presentation, uninsured deposits make up less than 20% of the total deposit book, which seems manageable.
- Net unrealized losses on the available-for-sale securities portfolio amounted to $2.83 per common share at the end of September 2023, as mentioned in the earnings release . In my opinion, this value isn’t problematic. I’m expecting most of these unrealized losses to reverse in the second half of 2024 when interest rates start declining.
Horizon Offers an Attractive Dividend Yield of 6.1%
Horizon Bancorp is offering a dividend yield of 6.1% at the current quarterly dividend rate of $0.16 per share. The earnings and dividend estimates suggest a payout ratio of 47% for 2024, which is above the five-year average of 29%.
Management mentioned on the conference call, “We expect to continue our targeted dividend payout ratio of 30% to 40%, continuing our 30-year -- plus year of uninterrupted quarterly cash dividends.” Although my estimated payout ratio is higher, I’m not worried because it’s only slightly higher than management’s guidance. I think it’s highly unlikely that management will cut its dividend for a margin so small.
Maintaining a Buy Rating
I'm using the peer average price-to-tangible book ("P/TB") and price-to-earnings ("P/E") multiples to value Horizon Bancorp. Peers are trading at an average P/TB ratio of 1.16 and an average P/E ratio of 8.4, as shown below.
HBNC | FMNB | CAC | PGC | CPF | Peer Average | |
P/E ("ttm") | 6.23 | 9.17 | 9.39 | 7.63 | 7.40 | 8.40 |
P/E ("fwd") | 6.93 | 9.40 | 10.15 | 9.59 | 8.33 | 9.37 |
P/B ("ttm") | 0.67 | 1.44 | 1.01 | 0.82 | 1.01 | 1.07 |
P/TB ("ttm") | 0.87 | 1.43 | 1.29 | 0.90 | 1.00 | 1.16 |
Source: Seeking Alpha |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $12.40 gives a target price of $14.30 for the end of 2024. This price target implies a 37.4% upside from the November 6 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 0.96x | 1.06x | 1.16x | 1.26x | 1.36x |
TBVPS - Dec 2024 ($) | 12.4 | 12.4 | 12.4 | 12.4 | 12.4 |
Target Price ($) | 11.9 | 13.1 | 14.3 | 15.6 | 16.8 |
Market Price ($) | 10.4 | 10.4 | 10.4 | 10.4 | 10.4 |
Upside/(Downside) | 13.6% | 25.5% | 37.4% | 49.3% | 61.2% |
Source: Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $1.36 gives a target price of $11.40 for the end of 2024. This price target implies a 9.3% upside from the November 6 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 6.4x | 7.4x | 8.4x | 9.4x | 10.4x |
EPS 2024 ($) | 1.36 | 1.36 | 1.36 | 1.36 | 1.36 |
Target Price ($) | 8.7 | 10.0 | 11.4 | 12.8 | 14.1 |
Market Price ($) | 10.4 | 10.4 | 10.4 | 10.4 | 10.4 |
Upside/(Downside) | (16.7)% | (3.7)% | 9.3% | 22.3% | 35.4% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $12.90 , which implies a 23.4% upside from the current market price. Adding the forward dividend yield gives a total expected return of 29.5%.
In my last report, I gave a target price of $13.10 per share for the end of 2023, which is quite close to my new target price for the end of 2024. The market price has increased since my last report was issued. Nevertheless, there is still plenty of expected upside left. The dividend yield is also very attractive. Therefore, I’ve decided to maintain a buy rating on Horizon Bancorp.
For further details see:
Horizon Bancorp: Negative Earnings Outlook Doesn't Dampen The Appeal Of A 6% Dividend Yield