Good morning, everyone, and welcome to the Horizon Bancorp conference call to discuss financial results for the 3 months ended September 30, 2020. [Operator Instructions] Please note that this event is being recorded. Before turning the call over to the 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 Litigations 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 Form 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 or does not intend to update or revise forward-looking statements after the date on which they were made. To the extent non-GAAP financial measures are discussed in this call, comparable GAAP measures and reconciliations can be found in Horizon’s October 28 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 today from Horizon are Chairman and CEO, Craig Dwight; as well as Executive Vice President and CFO, Mark Secor. They are joined by President, Jim Neff; and Executive Vice President and Chief Commercial Banking Officer, Dennis Kuhn, for the question-and-answer session. At this time, I would like to turn the conference over to Mr. Dwight. Thank you. And over to you, sir.

Good morning, and thank you for participating in Horizon Bancorp's Third Quarter Earnings Conference Call. Our comments today will follow the investor presentation we published yesterday, October 28. So starting on Slide 4, you'll find the highlights that summarize Horizon's excellent third quarter results, as evidenced by a 39% increase over the second quarter's earnings per share. Continued improvement in Horizon's efficiency ratio to 55.6%, record gain on sale of mortgage loans at $8.8 million, growth in earning assets for the quarter at 2.7%, growth in deposits for the quarter at 2.5% and continued strong credit metrics. On the next slide, we exhibit Verizon's seasoned leadership team that has managed through multiple recessions and overseeing the history of strong financial performance and growth over the past 17 years. As you’ll see on Slide 6, we've completed 11 new or organic market expansions and 14 mergers and acquisitions during this 17 time year period. Horizon Bancorp is a company on the move and we continue to look for new opportunities. Slide 7 clearly demonstrates Horizon's ability to achieve meaningful growth. Horizon's objective is to attain a balanced growth strategy with 50% organic and 50% through mergers and acquisitions. From 2009 to 2019, Horizon achieved 14% annual growth on assets, which was 4.7x the change in gross domestic product during the same time period and 3.3x the average growth rate for the banking industry. For the last 5 years from 2014 to 2019, Horizon's results are even more impressive, exhibit by 20% annual growth rate over -- growth rate on average assets, which was 5.2x change in gross domestic product and 5.2x the average growth rate for the banking industry. On Slide 8, we highlight our primary market area in dark brown and dark green. Horizon's markets represent diversified economies and excellent…

Thank you, Craig. I will briefly summarize our third quarter results, which demonstrated the ability to realize our strong operating results drop to the bottom line as we navigate this current environment. Starting with Slide 13. The third quarter's results were just shy of matching the company's record high earnings with pretax, preprovision income being the highest in the company's history. We continue to build allowance, but with a lower credit expense in the previous 2 quarters, as we believe we are appropriately reserved given the current state of our portfolio and our CECL modeling. Our profitability metrics, including pretax, preprovision earnings, benefited from growth with net interest income supported by higher average balances in interest-earning assets. Linked quarter, net interest income growth allowed us to outpace net interest margin compression of 8 basis points during the quarter. On Slide 14, the 8 basis point decline in margin during the quarter was expected with 10 basis points coming from the full 3 months of interest expense following our June subordinated debt issuance. In addition, compared to the second quarter impact of the lower-yielding PPP loans, the margin was impacted an additional 1 basis point. Based on these impacts, the margin performed well as a reduction to deposit costs continue to outpace or continue to keep pace with the reduction in asset yields. On Slide 15, loan yields were reduced during the quarter as new production and adjustable rate loans have repriced lower. PPP loans contribute approximately 3 more basis points to the reduction than they did in the last quarter. As loans continue to reprice and new product is originated at lower rates, additional down pressure on asset yield is expected resulting in additional margin pressure as we enter into 2021 as the opportunities to lower funding costs are realized.…

Thank you, Mark. Looking at Horizon's $4 billion in total loans on Slide 24. You'll see a diversified portfolio with 58% in commercial loans and 42% in residential mortgage and consumer loans. At Horizon, we like this loan mix. It diversifies our credit risk and provide advantages to managing our net interest margin. This slide also details granularity in our commercial portfolio, which itself is well diversified. Our single largest sector is in residential multifamily housing loans at less than 6% of total loans, which continues to perform well. Other key points to make, Horizon manages capital at risk by maintaining an in-house lending limit at $30 million, which is well below our legal lending limit of approximately $76 million. Our granularity is further enhanced by the fact that Horizon's average commercial loan is only $366,000. Now moving to Slide 25. Loan deferrals peaked in May and continue to rapidly decline through September 30. Deferred loans as of September 30 declined by 70% over the prior quarter to 4.1% of total loans. The majority of our dollars under a loan deferment are still in the commercial loan portfolio with consumer and mortgage loan deferral remaining low at less than 1%. Overall, Horizon referral rates are in line with peer banks. The number of commercial loans on payment deferral totaled 61, down from the prior quarter's total of 670 loans. Horizon’s commercial lending team has been diligent in meeting with our business customers to update their financial plans and to place their loans back on a regularly scheduled payment routine. Approximately half the commercial loans and deferral continue to make interest payments and the other half are still on full payment deferrals. Those loans on full payment deferral are primarily hotels and are expected to come off full deferral in the…

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

Maybe let's start with a question on expenses. I understand the step-up in the third quarter due to the -- just the strong performance of the company in the second half of the year. But was wondering what your thoughts were on the third quarter, whether it will move down to a more normal level? And then looking out into 2021, I know you talked about evaluating branches, which, in theory, should generate some cost savings. But what are your thoughts on expense growth in 2021 just incorporating inflation and other investments that you foresee across the company?

Yes. What you saw -- this is Mark. What you saw in the third quarter was what you explained was a catch-up from the first half of the year, just based on the performance through that point and needed to start to build these accruals. And with -- obviously, you can't predict what we're going to exactly see in the fourth quarter. We will need to continue to maintain bonus accruals we expect through the fourth quarter. Going into '21, we're committed to continue to look for these cost saves through -- branch rationalization is going to be key to that as we want to continue to leverage the network that we have and the technology that we have. And we know that we need to maintain the level of expenses to be able to help drive the bottom line. Just based on what we see coming on the interest rate side into '21 and the net interest margin.

Yes, if I can add to that. What's driving our strategy for '21, '22 and beyond is the fact that shrinking net interest margin. So there's not a single line item on our expense side that's not being considered for reduction. In addition to that, we engaged a third-party consulting firm to review all 73 of our locations, to look at where should we invest for future growth and where should we reduce our cost for -- because the market isn't supporting growth. So we do have a plan in place for 2021 and more will be coming out probably in the first quarter. Thank you for the question.

And then just as my follow-up, not to be too technical, but Slide 20 on the CECL, the third quarter reserve building in consumer stands out versus some of the other banks that I've looked at this quarter. Could you just talk about what was behind that reserve build in consumer in Q3?

Yes. That's all Econometrics driven. The fact that we are running out of seamless monies and so forth, the delinquency still remains low. So we were basing it on the Econometrics trends in the consumer side. Bankruptcies are starting to increase again in our markets. So it's not tied to the portfolio performance. Jim, do you want to add anything to that all? You cover that.

We went through our portfolio and look at them by loan to value, debt to income ratio, credit score and put them in different categories. And the most risk at the top, we took those loans in the most risk and applied a percentage to those to put as an overall allowance to that just to be on a conservative basis. But as Craig said, the delinquencies are holding up very well, and we don't see any specific issues.

Yes, that percentage that we have tied that portfolio, higher risk credits was due to the Econometrics. So good point. To Jim's comment, we have an excellent data bank of information on our loans that can slice and dice multiple ways, which we've exhausted, I think, in the last 2, 3 quarters. Thank you for the question.

The next question is from the line of Nathan Race from Piper Sandler.

Mark, I was hoping to -- or Craig, get your guys as kind of outlooking commentary on the core margin going forward, obviously, PPP dynamics will impact the reported NIM. But I guess, away from that, curious to know what the balance sheet [ you ever dreamed ] that was alluded to earlier? How should kind of think about the core NIM kind of trajecting into this fourth quarter and into early '21 as well at this point?

Yes, Nate. In the fourth quarter, the deleverage and -- or the reduction in those interest costs should benefit the margin as we have been able to see even through the third quarter that we were able -- taking out the additional costs of that sub debt, we were able to maintain the margin on the remaining of the asset side and savings on the liability side. So I think that will be a benefit. Going into next year, we still have anticipated. We still have some additional saving coming from the CD portfolio. But as I stated, as that starts to -- those benefits start to run out, we do see some pressure as we get into '21 and through '21 on the margin.

Okay. Got it. I'm just curious now as we kind of think about those dynamics, how we should think about loan growth. Obviously, the warehouse showed some nice growth in the quarter. Just curious if you guys have continued to work through some price on the commercial side, if we should expect some attrition within the commercial portfolio going forward and maybe we can expect a bottoming in loans overall, ex the warehouse in the [ fourth build ] modestly into '21? Or just any thoughts on the overall loan growth outlook from here ex warehouse?

Nate, this is Craig. Thank you for the question. Based on historical performance we are coming out of recession, we have about 2 quarters where we have to make up the loan loss -- not loss, but loan shrinkage in the warehouse business, and we would expect that again going into 2021. So 2021 from a growth standpoint, we don't expect much growth because we have to offset the decline in warehouse loans. Pipelines for commercial lending are picking up. Dennis, do you want to add anything to the pipelines in commercial at all?

No, that's really -- we have seen an increase in activity across -- really across our footprint. Our growth markets are performing well, getting new opportunities with some new clients to Horizon, but well-known to our officers.

The next question is from the line of Damon DelMonte from KBW.

Hope everybody's doing well today. So my first question is related to the outlook for provision expense. Mark, just kind of wondering what your thoughts are, pretty meaningful decline this quarter from the first 2 quarters of the year. And just kind of -- you kind of assess your CECL model when you look out for the remainder of this year and into 2021. Do you feel that reserve levels are adequate? Or do you feel that ongoing uncertainties in the global economies would require you to continue to build reserve?

Yes. Thank you, Damon. I think you said it. The uncertainties are unknown to us now even. And as we stood at the end of the third quarter, we're very comfortable with what our allowance balance is based on what we know to date. I think the driving factors and the uncertainty is what direction does the economy go going into next year, if we continue to see where we are right now, and we don't see additional deterioration, I think, we would feel like we're in line. We would have to continue to look when there's charge-offs to replace. But it's just too hard to know what's going to happen. We've got an election coming up. We have the COVID spike. So I think it's kind of hard to -- even for us to be able to say until we start seeing the kind of metric. Obviously, they've been improving, but that could change.

We've been pleasantly surprised by the dynamic management of our borrowers of their business lines. And a lot of the feedback we're getting from our commercial portfolio is they are able to manage through this COVID-19 except some of the essential -- nonessential businesses and those markets have been more restrictive. So I think the question is going to be after the election, what's going to happen to the business segment, I think, shut it down again. And then two, I have a high degree of confidence, there will be another stimulus package coming out shortly after election, maybe after January 20, but that should help soften any blow in 2021.

Got you. Okay. And then with respect to the fee income, you guys had a loss this quarter in the mortgage servicing income net of MSR. Kind of normalizing that, Mark, what's the reasonable expectation for fee income, taking into account the pipeline strength from mortgage banking.

Yes. I think we commented that the mortgage banking looking into the fourth quarter still is strong as we continue to see purchase and refinancing activity strong. Going into next year, I think, sometimes the first quarter is typically a slower quarter in the Midwest. However, depending on what happens with interest rates and the continued ability to potentially lower the mortgage rate could continue to drive refinancing and maintain a strong gain. But yes, I think if you look -- when you look at the estimates from the mortgage banking experts, they are predicting around a 30% decline next year in volume. So that's kind of what we're looking at right now until we start to see what actually is happening.

Yes. The real question is really would that stop their monetary policy, stop buying long-term debt. Once they get out of the market, you'll see that business turn downward.

The next question is from the line of Brian Martin from Janney Montgomery.

I wonder could you just comment -- it sounds like the credit performance, obviously, very strong. Were there any changes of note in the -- in your criticized or classified portfolio this quarter?

Brian, we downgraded our credits as we modified loans one downgrade. And Dennis, can you give more color on that for Brian?

Yes. The -- so as Craig mentioned, whenever we were touching a file for modification, we were downgrading by one step. So very few loans went into classified status in that exercise, so to speak. Now we did see some increase in classified as we did move a one -- excuse me, 2 relationships related to the hotel portfolio into that classified category substandard during the quarter. They are continuing to make payments as agreed. But again, recognizing some weaknesses, obviously, in that portfolio, but some of the metrics for these 2 borrowers, in particular, we felt that was prudent. So -- but beyond that, we have not seen significant movement in the portfolio.

Okay. So pretty stable or slightly higher for the criticizing classified when we see the Q come out.

Yes. And Brian, we haven't even, at this point, been able to allocate specific reserves either for these credits, they still are in a general pool allocation within our modeling just because specific losses have not been identified yet.

Got you. Okay. And then could you just, Mark, just any thoughts on just the remaining unearned loan fees for the PPP and how you're thinking about that?

Yes. We're starting to -- we're taking applications. We're starting -- we had just a handful of it forgiven at this point. So they are starting to come through. But only about a little less than 1/4 of our customers have applied for PPP forgiveness at this point. So we expect to see some come in through the fourth quarter. And then again, depending on how quickly the FDA approves them, which right now looks like they're approving some of them fairly quickly, we would expect to see the larger portion come into the first quarter.

Okay. And then the remaining unearned fees you expect to collect?

Yes. That would be the same as when those are forgiven. The unearned fees are just under $8 million, around $8 million. They're amortizing at a rate of about $450,000 a month when they're not being forgiven. So -- but those fees would be kind of what I was saying. We should see some in the fourth quarter and then the more -- the majority of them coming into next year.

$8 million net of expenses.

Yes, yes. That's the net remaining.

The next question is from the line of David Long from Raymond James.

As it relates to the $100 million in the securities or cash that you've been investing in the security portfolio, what are you adding and what type of yields are you getting on those right now?

Primarily because, as Craig mentioned, the fed is buying about everything there is in the mortgage side. We're trying to mix in some of that product, but primarily looking at non -- taxable and nontaxable munis and where there's value in those. So the muni portfolio we’ll see the biggest percentage of the increase. And the mix of that, we would hope to be able to maintain over a 2% return on a cash equivalent basis as we're purchasing those.

[Operator Instructions] And there are no further questions, I now hand the conference over to the management for closing remarks. Over to you.

Okay. Thank you for participating in today's earnings conference call with Horizon Bancorp. We look forward to meeting you in person someday in the near future. Have a good week. Thank you now. Bye now.

Thank you very much, members of management. Ladies and gentlemen, the conference call has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.