Good morning, everyone, and welcome to the Horizon Bancorp Conference Call to discuss financial results for the three months ended June 30, 2020. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. Before turning the call over to management, I would like to remind everyone that today's call may contain forward-looking statements related to Horizon that may generally be identified as describing the company's future plans, objectives or goals. Such forward-looking statements are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those currently anticipated. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. For further information about the factors that could affect Horizon's future results, please see the company's most recent annual and quarterly reports filed on Forms 10-K and 10-Q. You should keep in mind that any forward-looking statements made by Horizon speak only as of the date on which they were made. New risks and uncertainties come up from time to time, and management cannot predict these events or how they may affect the company. Horizon has no duty to and does not intend to update or revise forward-looking statements after the date on which they are made. To the extent non-GAAP financial measures are discussed in this call, comparable GAAP measures and reconciliations can be found in Horizon's April 29 news release, which is available on its website at horizonbank.com. Horizon also published an investor presentation on Wednesday afternoon, and it is available on the company's website with information that will be addressed this morning. Representing Horizon today is Chairman and CEO, Craig Dwight; as well as Executive Vice President and CFO, Mark Secor; President, Jim Neff; and Executive Vice President and Chief Commercial Banking Officer, Dennis Kuhn. At this time, I would like to turn the conference over to Mr. Dwight.

Thank you, Kate, and good morning, and thank you for participating in Horizon Bancorp's earnings conference call. Our comments today will follow our investor presentation that was published after the close of trading on July 29. So starting on Slide 4. We summarize and highlight what we believe was a very solid quarter during these unprecedented times, as evidenced by a 26.9% increase over the first quarter's earnings per share. These results were supported by good loan and deposit growth of 8% and 7%, respectively, excellent expense management and record residential mortgage loan volume. In addition, during the quarter, we demonstrated our ability to effectively access the capital markets through the issuance of $60 million in subordinated debentures. This capital raise provided our holding company with a considerable cash cushion to protect the dividend to its common shareholders and provides us with the optionality on how to deploy capital in the future. Slide 5 titled Seasoned Management Team. We are very proud of our entire Horizon Bank team and what they've accomplished. Slide 6 reflects our accomplishments and excellent history of financial performance over the past 17 years. Slide 7 titled Diversified & Attractive Footprint. I'm going to spend a little more time on the next two slides so you have a better understanding of our footprint and what's taking place in the markets we do business. Horizon's focus has been consistent over a long period of time to grow four revenue streams, which diversifies risk and stabilizes earnings in varying economic cycles. For example, today, our mortgage teams are doing very well, which offset slow growth in other business lines. The map to the left reflects Horizon's 73 locations. Horizon has a great footprint with our loans distributed throughout the states of Indiana and Michigan, which represents good geographic…

Thank you, Craig. I will briefly summarize the second quarter results, which we believe continues to demonstrate the strong position we are in as we navigate the current environment. Starting with Slide 12. You will recall that in the first quarter, our results reflected a nearly 3x increase in our allowance after we implemented CECL on January 1 and built general reserves in the early days of the pandemic-driven economic emergency. We continue to provide for growing reserves in the second quarter but at a slower rate than in the first three months of the year. We believe we are appropriately reserved given the current state of our portfolio and our CECL modeling. Our profitability metrics, including pretax pre-provision earnings, also benefited from growth in net interest income supported by higher average balances of interest-earning assets resulting from the PPP program participation. Linked-quarter net interest income growth of 5% allowed us to outpace net interest margin compression of 9 basis points during the quarter. Slide 13; the 9 basis point decline in margin during the quarter was relatively modest with approximately 3 basis points attributed to lower-yielding PPP loans. In addition, as customers deposited PPP loan proceeds and other stimulus funds, we sold excess cash at very low rates, impacting the margin by approximately 4 basis points. Our ability to quickly and decisively lower funding costs since March has helped us keep pace with lower asset yields. Slide 14; loan yields were reduced during the quarter as variable rate loans repriced lower. PPP loans contributed approximately 10 basis points of this reduction. 36% of our commercial loans are variable and the vast majority repriced. 21% of our variable rate commercial loans have floors and 67% are not at their floor -- 67% are not at their floors. 74% of our…

Thank you, Mark. And looking at our $4 billion in total loans on Slide 21, you'll see a diversified portfolio with 58% in commercial loans and 42% in residential, mortgage and consumer loans. We like this loan mix as it diversifies our credit risk and provides advantages to managing net interest margin. This slide also details granularity in our commercial portfolio, which itself is well diversified. Our single largest sector is the residential multifamily loans at less than 6% of total loans, and this portfolio continues to perform well. Other key points to make; Horizon manages capital at risk by maintaining an in-house legal lending limit of $30 million and our legal limit is $76 million. Our granularity is further enhanced by the fact our average commercial loan is only $366,000. Now moving to Slide 22. Loan deferrals peaked in mid-May and have started to level off. Total deferred loans were 14.3% at quarter end, and overall, Horizon's deferral rates are in line with peer banks. Next, we are seeing a decline in mortgage deferrals, and Horizon's mortgage deferral rate continues to fall below the national average, which is well over 7.5%. Horizon's consumer loan deferrals range between 1.3% and 5.1% of total consumer loans by segment. Horizon consumer loan deferral rates compare well to Moody's Analytics report as of May 31, which reported consumer loan deferral rates running at approximately 6.5%. Consumer loan deferrals are starting to decline with the exception of the indirect auto loan portfolio. Horizon's commercial loan deferrals make up 88% of the total loans in deferral. 59% of our commercial loans on a payment deferral continue to make monthly interest payments. 74% of Horizon's commercial loans with payment deferrals were for a period of 90 days or less. We expect most of these loans to…

[Operator Instructions] The first question is from Terry McEvoy of Stephens.

Just, Craig, I want to make sure I understand your comments on the payment deferrals. A lot of them were 90 days and a lot of them occurred in the second quarter. So it really didn't show up here in the June 30 data. Were you saying that most of these deferrals will resume their normal payment schedules outside of the hotel portfolio? Was that the takeaway or the message you're getting at?

Yes, that's a fair comment. The reason for the hotel, they were extended for four to six months, and so they will not roll off until really the end of the third quarter, first part of the fourth quarter. So that would be the correct comment.

Okay. And then, Mark, maybe a question for you. On the PPP program, kind of what are you thinking about for the forgiveness period? And do you think most of those loans will go through that forgivable period by the end of this year?

Yes. We think that the ones that are going to be forgiven will be through the end of the year. Some might circle into the first quarter, just depending on how quickly the participant follows through.

The next question is from David Long of Raymond James.

I wanted to ask about the size of the balance sheet. Obviously, the PPP program helped your deposit growth pretty nicely. But even when you look in the excess of the deposit of the PPP, the deposit growth was very strong. Is that -- can you maintain that? Or what are your expectations, I guess, overall, with the deposit base here over the next couple of quarters?

During the last recession, I think other recessions, you do see the deposit balances grow as cash gets held. So reflecting back on previous history, we could expect to see deposit balances maintaining. Now they are benefiting from these funds that have been some stimulus. And you would expect those to be getting used over time also. So I guess the answer would be, just based on history, I think we will be able to maintain the deposit balances. But we're not sure what would happen and how much of that will come -- be used from the stimulus money that's been given to the customers.

Sure, got it. And being here in Chicago, I could thank you once again for your reminder about the relative attractiveness of my home market compared to your marketplace. But that said, just want to get a better sense on your expectations for loan growth outside of the -- obviously, the PPP program. And how is the sentiment amongst your commercial borrowers at this point?

Do you want to answer that, Dennis Kuhn?

Sure. The -- outside of PPP, we were down slightly year-to-date. Much of that was related to the lack of line usage -- actually paydowns and lines related to probably PPP funds for the most part. But -- so from a standpoint of loan growth, it's been obviously very modest overall. We are seeing some additional activity at this point. But with the continued restrictions, our lenders have not returned to the norm of being out in front of clients regularly. So we think it's going to be tepid, I guess, I would say, over the balance of the year. And we think that we've seen that pretty much across our peer group as well.

David, we kind of tightened our underwriting standards, somewhat requiring more downpayments on real estate, etcetera. And Fannie Mae has tightened their underwriting standards for mortgages. So just because it's tighter standards, I would not expect growth for a while.

The next question is from Nathan Race of Piper Sandler.

Just going along the lines of the last question, thinking about the core margin outlook going forward, I'm trying to isolate the impact or exclude the impact of PPP loans going forward and accretion. I think if we add back the 3 basis points, as indicated in the release, from the PPP impact, like it's maybe a core margin at 3.38%. So it sounds like excess deposit levels and liquidity levels may be somewhat elevated near term. And so just trying to think about those dynamics with ongoing funding costs, leverage. And then it sounds like you got a good chunk of loans at 4. So just trying to get what you're thinking about the core margin into 3Q at this point.

Nate, I think what we've -- what we're seeing happening with the ability to reprice the CD portfolio, the $400 million that is still coming due yet this year, that's going to have a pretty good significant impact on deposit costs. So that's going to help to offset the asset pressure. When the PPP loans come out, like you said, that's going to be able to help increase the asset yield just because they're lower yielding. The challenge is going to be to manage margins. We are going to have a lot of excess liquidity, as you indicated, that we're going to have to do something with, which most likely will be in the investment portfolio and would be at lower yields just to generate the income we need. So, I think the investment portfolio is probably what will be the challenge to being able to maintain the margin, but it will be incremental growth to net interest income.

Okay, got it. So maybe a little bit of additional near-term pressure just given the dynamic of securities' reinvestment rates relative to the portfolio yield if I'm hearing you right, Mark.

Yes.

That's probably all 2021.

Yes.

Okay, got it. And then just changing gears and thinking about the income into the third quarter. Mortgage banking, obviously really strong this quarter. The gain on sale margin came down a little bit, it would seem. So I'm just curious on kind of the puts and takes within the fee income as you guys are kind of looking out to a 3Q run rate, and then obviously, ex the MSR adjustment that we had in the quarter.

Yes. We're continuing to see very strong refinancing activity, which is benefiting both the MSR gain and -- the mortgage servicing gain but also in the warehousing line, be able to maintain those balances, continuing to be asked for larger line limits for the warehousing side as their business is continuing to see the refinance activity. So we see the refinancing driving this, especially through the third quarter and into the fourth, although it's going to depend some on what rate to do. With gain percentages, some of coming in at close to 4%, there's a lot of room as the refinance activity could slow to bring rates down yet if the treasury stays in the area where it's at. So you could continue to see volume if rates come down as we get into the fourth and the first quarter of next year.

[Operator Instructions] The next question is from Damon DelMonte of KBW.

So my first question, probably directed to Mark on the outlook for expenses. I know you had mentioned that you had some deferred comp costs related to PPP. So as we try to normalize that run rate going forward, how are you looking at the overall expense base for the back half of the year?

I think overall, it's fairly stable. Obviously, we had the deferred costs that benefited but we also had higher loan origination costs. And some of the -- or yes, loan origination cost. Some of the loan costs though, as we get into later in the year and into next year, I think you're going to see collection costs increasing as we start to determine who's coming out of this downturn and who isn't. The other area that might have some increase is if we continue to operate at the level that we are, we will need to start accruing for bonuses more than what we have in the first half of the year. So I think that would be the one area that we could see some increase.

So then on a dollar amount, would you say that's something close to like the 31, that below 31 to 31.5 range is reasonable?

I'm not sure that we can state that.

Okay. All right, fair enough. And I guess as my follow-up, it looks like nonperforming loans went up a little bit during the quarter. Can you just talk about -- a little about the migration there and what led to that uptick?

Sure. Over the first half of the year, we have seen an uptick. It was on the commercial side. And it was related to two specific credits, unrelated industries: one, as Craig mentioned earlier, the ag industry; the other, service. And so we don't believe it's an indication of the overall health of the portfolio, although we have COVID obviously impacting going forward. But again, they were two isolated instances that had been identified by the bank previously but saw some additional deterioration.

Got it. Okay, that's helpful.

David, just to add one more comment to that. In the fourth quarter, we had three large jumbo mortgages to the non-accrual, two of which properties have sold and 1 has reaffirmed payments with us. So -- and so that would show the continuation. So it's not all just commercial.

The next question is from Brian Martin of Janney Montgomery.

I joined the call a bit late, so I apologize. But Mark, could you just give any comments or just direction on how you're thinking about the core margin as you go forward here with the rate environment, so kind of most of the impact from the Fed cuts now and just kind of the core margin ex the accretion of PPP, just how you're thinking about that directionally going forward?

Yes. Brian, the core margin -- and there's going to be so much noise, as we know, in there. The core -- just our loan -- specifically, loan yields and deposit yields, we think -- we see through the next couple of quarters that the ability to reprice the CD portfolio will help offset some of the asset pressure in the loan side since we've already seen most of the variable rate loans repriced in the second quarter on the commercial side. The area that's going to have the pressure that we have to do something with the liquidity, most likely going to the investment portfolio, I think that will have more pressure on the asset yield side. And then obviously, the PPP, the income that will come in probably into the fourth quarter primarily and some may be going out into the first quarter.

There are no additional questions. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Dwight for closing remarks.

I'd like to thank all those for calling in to our second quarter conference call. And we look forward to talking to you soon in the near future without COVID-19. Thank you, and have a great day. That concludes today's conference. Bye now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.