Horizon Bancorp, Inc. (NASDAQ:HBNC) Q3 2022 Earnings Conference Call October 27, 2022 8:30 AM ET
Company Participants
Craig Dwight – Chairman and Chief Executive Officer
Mark Secor – Executive Vice President and Chief Executive Financial Officer
Thomas Prame – President
Lynn Kerber – Executive Vice President and Chief Commercial Banking Officer
Noe Najera – Executive Vice President and Senior Retail and Mortgage Lending Officer
Conference Call Participants
Terry McEvoy – Stephens
Nathan Race – Piper Sandler
Damon DelMonte – KBW
David Long – Raymond James
Brian Martin – Janney Montgomery
Operator
Good morning, everyone and welcome to the Horizon Bancorp Conference Call to discuss Financial Results for the Third Quarter of 2022. [Operator Instructions] Please note this event is being recorded.
Before turning the call over to management, please remember that today’s call may contain statements that are forward-looking in nature. These statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those discussed, including factors noted in the slide presentation. Additional information about the factors that could cause actual results to differ materially is contained in the Horizon’s current 10-K and later filings.
In addition, management may refer to certain non-GAAP financial measures that are intended to help investors understand the Horizon business. Reconciliations for these measures are contained in the presentation. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the press release and supplemental presentation issued by Horizon yesterday, you can access it at the company’s website, www.horizonbank.com.
Representing Horizon today are the Chairman and Chief Executive Officer, Craig Dwight; EVP and Chief Executive Financial Officer, Mark Secor; President, Thomas Prame; EVP and Chief Commercial Banking Officer, Lynn Kerber; and EVP and Senior Retail and Mortgage Lending Officer, Noe Najera.
At this time, I’d like to turn the call over to Mr. Craig Dwight, Chairman and Chief Executive Officer. Thank you. And over to you, sir.
Craig Dwight
Thank you, Matt and good morning and thank you for participating in Horizon Bancorp’s third quarter earnings conference call. Our comments today will follow the investor presentation and press release that we published yesterday, October 26. Horizon is pleased to report solid earnings for the third quarter, driven by a continuation of strong commercial and consumer loan growth, an increase in net interest income, excellent asset quality, and robust capital ratios that exceed the regulatory definition for well-capitalized banks. In addition, during the third quarter, we closed five branches with two more offices to close in the fourth quarter. The offices closings will contribute to our objective towards achieving our target of non-interest expense to average assets of less than 2% for the full year of 2022.
Starting on Slide 4 of the presentation, third quarter highlights, Horizon completed the third quarter with quarter-over-quarter loan growth at 7.8% annualized, excluding PPP loans and sold commercial participation loans. Year-to-date total loan growth was 14.5% annualized. This level of growth was achieved in part from year-to-date and annualized strong commercial consumer loan growths of 13.8% and 31.7% respectively. Thomas Prame, our President, will provide more detail on Horizon loan growth in just a few minutes.
Other notable financial metrics for the quarter end as reported include return on average assets of 1.24% and return on average equity of 13.89%. Year-to-date through September 30, Horizon’s return on average assets was reported at 1.29% and ROE of 13.97%. Given the size of our balance sheet, efficient operations, talented workforce and solid additions to our team, Horizon is well positioned to capitalize on significant organic loan growth, to shift lower earning assets to higher yielding assets, and continuation of disciplined expense control.
Why invest in Horizon? Our investment thesis is simple. Horizon continues to report solid returns with a low credit risk profile due to our diversified balance sheet, excess liquidity and low-cost core deposits. We are located in attractive Midwest growth markets where real estate values are not as volatile as in other areas of the country. Regional infrastructure improvements are attracting record inflows of private investment into Indiana and Michigan and include the commuter rail line expansion in Northwest Indiana, known as the double track and West Lake County extensions, which is forecasted to have a $3 billion positive economic impact to Northwest Indiana; the recent creation of the Regional Transportation Authority focused on promoting transportation-oriented development; the investments in quantum communication lines between Chicago, Lafayette, and South Bend; the recently enacted U.S. federal statute, known as CHIPS and Science Act, which is anticipated to provide additional economic stimulus to the states of Indiana and Michigan, including the quantum communications corridor; the American Rescue Plan Act; and dollars being invested in new roads, infrastructure support, workforce housing and capital equipment for local municipalities; Indiana, $6 billion state surplus with a plan to invest $2 billion in infrastructure the next couple of years; the continued acceleration of our outbound migration by Illinois businesses and residents as they move into our attractive markets due to quality of life, affordability, and lower taxes.
Finally, Horizon has a long history of successfully managing through varying economic cycles. To support that we are a growth company, Horizon’s compounded annual growth rate from 2002 through 2021 was 13% for total assets and 20% from net income. Horizon has historically outpaced the change in GDP, and for the past 4 years, we grew at 4.9x the change in GDP. This clearly demonstrates our ability to grow market share and attract talent.
Moving on to digital transformation, Horizon’s key advantage in technology over other community banks, include our in-house CRM core platforms, resulting in lower cost per transaction than our peers. And the ability to expedite the onboarding of new fintech partners inflects flexibility in data management. By not relying on a core service provider, Horizon is able to select technology partners based on the best-in-class and who can deliver strategic products and services at best price and optimum flexibility. Our in-house core strategy has also proven very effective for integrating acquisitions, including last fall’s 14 branch deal. In addition, our fintech partners are nimble, have considerable resources focused on improving the customer experience, and allow Horizon to be an active voice on future developments as we have representatives on most of these entities, advisory boards or user groups.
As you can see on Slide 11, Horizon has more than doubled the proportion of total tech spend devoted to strategic customer and employee-facing applications over the last 4 years. As a result of our investments in technology, Horizon has improved its productivity as measured in assets per employee from $5.4 million in 2016 to $8.7 million in 2021. Our digital transactions increased from 44% in 2018 to over 70% in 2022. We increased online consumer deposit account opening from 12% over the 12 months of 2021 to 19% year-to-date. And finally, 84% of our online chats are answered by programmed bots.
Horizon’s technology plan over the next 2 years will continue to see an increase in our annual spend to enhance the customer experience and make our model ever more scalable. As in prior years, we intend to offset these investments by continually improving efficiencies in our retail network and throughout the organization. Horizon manages and deploys capital efficiently as evidenced by our recent acquisition of 14 branches in the fall of 2021 and continuing focus on organic growth in 2022 and 2023. Rising interest rates have increased the market’s focus on accumulative other comprehensive income, and the mark-to-market adjustments occurring in the bank’s balance sheet has resulted in an increase of unrealized losses reported on the available for sale securities portfolio. As a result of the accumulated unrealized losses, Horizon’s TCE declined to 6.25% as of September 30, down from 6.48% as of June 30. This reflects a 3.5% decline in tangible capital quarter-over-quarter.
Through the third quarter end, Horizon Bank continues to report strong regulatory capital ratios which exceed the regulatory definition for well-capitalized banks. In addition, Horizon Bancorp has a consistent dividend policy as we fully expect to continue our 30-year plus of uninterrupted quarterly cash dividends. We recently increased our dividend in the second quarter of this year, reporting a 6.3% increase from $0.15 to $0.16 per common share. Horizon’s historical dividend increases are in line with earnings growth, and as of September 30, Horizon’s dividend yield was attractive at 3.6%.
Now for the financial update, it’s my privilege to introduce to you Horizon Bank’s Executive Vice President and Chief Financial Officer, Mark Secor. Mark?
Mark Secor
Thank you, Craig. Horizon reported a solid quarter for net income and loan growth as interest rates continued to increase and the competitive landscape is changing.
Starting with Slide 15, the results in the third quarter were primarily driven by strong loan growth in the rising interest rate environment, which led to the increase in net interest income. Annualized total loan growth, excluding PPP loans and sold commercial participation, was 7.7% during the quarter. The growth, along with the 34 basis point increase in average loan yields compared to the second quarter of 2022, drove the increase in net interest income, which was offset by interest-bearing deposit growth, increased borrowings and a 35 basis point increase in cost of funds.
Due to the strategy the management implemented to increase net interest income, the third quarter of 2022 absorbed the $6.1 million reduction in revenue from PPP, gain on sale and mortgages and mortgage servicing net of impairment revenues compared to the third quarter of 2021, while increasing gross revenues by $1 million. As in other rising rate cycles, home mortgage banking revenue decreased. A lag of several quarters occurs before our countercyclical revenue streams begin to offset the slowdown. But our successful strategy over the last 12 months to grow earning assets continues to provide increases in net interest income. The company’s adjusted net income was down $400,000 in the third quarter when compared to the second quarter, primarily due to lower non-interest income and higher non-interest expense. Adjusted earnings per share, was $0.55, down $0.01 per share from the second quarter of 2022 and up $0.03 per share from the year ago period.
Slide 16. As we continue to focus on balance sheet management and increasing net interest income with more rate increases expected, we want to provide more detail on our balance sheet sensitivity. As of September 30, we are modeling a slightly liability-sensitive balance sheet as we have increased our deposit betas as we expect the deposit rate environment to be more competitive. In the first half of 2022, we held operating deposit rates. However, due to the increase in loan demand and the changing competitive landscape, deposit betas are expected to increase in the fourth quarter and into the beginning of 2023. As a result, at an up 200 basis point parallel shock at September 30, we modeled decrease in net interest income of approximately $6.7 million or 3.19%.
Contributing to the decreasing results are the expected deposit betas used for rising rates, which currently range from 5% for consumer deposits, to 60% on money market and public funds with an average beta for interest-bearing deposits of approximately 31%. The actual beta for the third quarter from rising rates was 23% for interest-bearing deposits compared to 3% in the second quarter. We continue to use more conservative betas in our models as we anticipate pressure to increase deposit rates as short-term rates increase. We also utilized a non-parallel rate model to reflect the expected yield curve and when rates are projected to move. The results of this model estimate an increase to net interest income of approximately $1.3 million or 0.61% and an up 200-basis point rate move.
Slide 17. In the third quarter, Horizon increased adjusted net interest income by $700,000, although the adjusted net interest margin decreased by 4 basis points, primarily due to the increase in core funding costs, with the growth in average earning assets being the primary contributor to increase in net interest income dollars. As short-term rates have increased at a fast pace, lagging deposit rate increases has allowed a 180 basis point spread to the average Fed Funds Rate compared to the spread in 2018 of 121 basis points when Fed Rates were at similar levels. With more short-term rate increases anticipated, we believe that we can keep the margin stable by replacing asset cash flows into higher rate earning assets and continue to grow interest-earning assets to generate more growth in net interest income.
Slide 18. The investment portfolio was $3 billion at the end of the quarter, a reduction of $37 million in amortized cost from the end of the last quarter as cash flows are being redeployed into higher-yielding assets. The portfolio had a book yield of 2.28% and an effective duration of 6.95 years at quarter end. Expected cash flows in fourth quarter total approximately $48 million, again, $227 million in 2023. The unpledged investments, along with unused lines of credit, provide over $2.7 billion in potential liquidity, which is a sound liquidity position for the company.
Slide 19. The unrealized loss on available-for-sale securities in the third quarter reduced tangible common equity from 6.48% at June 30 to 6.25% as of September 30, which is a 3.55% reduction in TCE. Because we have the ability and the intent to hold these investments to maturity, these unrealized losses are expected to recover over time as investments pay down and mature. The impact of rising rates impacts certain items on the balance sheet, like unrealized losses on available for sale investments, but does not recognize the increase in the value of liabilities like core deposits. When the entire balance sheet is valued in our model, the economic value of our equity increased in the third quarter of 2022 compared to the prior year quarter. The bank’s regulatory capital is strong, exceeds regulatory definitions for well capitalized, and will continue to fund our growth and will not restrict our ability to utilize our capital to fund organic growth in the future.
Slide 20. By maintaining a disciplined approach on increasing deposit rates, the total cost of deposits only increased 20 basis points year-to-date, while deposit account retention remains strong. The actual beta for the quarter increased to 22% due to loan growth, creating a demand for funding, increasing competition from other financial institutions and from non-banking sources, all of which are putting pressure on deposit rates. We do expect that this beta will increase with additional rate increases. Our 2022 target data is around 35% for interest-bearing deposits, which we believe to be on target. However, the uncertainty in the markets and the Federal Reserve Bank’s move may adversely affect our betas in the future. We believe our valuable low-cost core deposits have provided flexibility in this rising rate environment.
Slide 21. Non-interest expenses were at 1.99% to average assets for the quarter and 1.99% year-to-date, achieving our goal of less than 2%. This quarter, increased employee health insurance costs drove the increase in salary and benefits. Professional fees and consulting fees were above our usual quarterly run rate. We expect those expenses to moderate during the course of the next year. Higher amortization of the dealer reserve assets from payoffs drove the loan expense increase, and amortization of our solar tax credit intangibles as we recognized our tax credits this quarter, increased other expenses.
As we previously announced, the closing of the seven branch consolidations, planned cost saves and cyclical business models and continued branch rationalization will provide benefits to operating expenses in future quarters. Now our President, Thomas Prame, will provide an update on our lending activities.
Thomas Prame
Thank you, Mark. And as Craig said, it was a solid quarter for our lending teams. Starting on Slide 23 with the results of our commercial lending team that generated robust loan growth in the third quarter of $41.8 million or 7.2% annualized, that’s excluding PPP and sold participations. Net commercial loan funding of $117 million was strong and it was well balanced across our business sectors and markets. The commercial loan pipeline is approximately $126 million as we enter Q4. That’s down from Q3, but several construction loans recently closed and will begin to fund in subsequent quarters. Additionally, we see future growth opportunities from highly talented new commercial loan officers who joined over the last year, increased commercial line utilization, and continued economic investment in our growing local communities.
As we look at consumer loans on Slide 24, consumer loan growth was excellent for the quarter with $149 million in fundings that elevated our balances by $52 million or 23% on an annualized basis. Loan demand for home equity and auto loans continued to be strong even while rates were adjusted to reflect the increasing rate environment. We produced positive growth, both in our indirect and consumer lending segments, with new production yields that were approximately 175 basis points higher than the payoffs and paydowns within the portfolio. Additionally, our consumer lending credit metrics remain consistent with high-quality borrowers, limited underwriting exceptions, and low delinquency and net charge-offs.
As we look at mortgage on Slide 25, mortgage loan production adjusted with the industry trends in a rapidly rising rate environment. Our year-to-date production is down about 27%, which compares very well with the Mortgage Bankers Association results showing a decrease of approximately 46% year-over-year. Linked quarter production was down 23% compared to the industry results down about 55%. The Mortgage Bankers Association is forecasting further declines in Q4 and going into 2023. As we’ve seen in our Q3 results, the revenue from mortgage gain on sales and mortgage warehouse represents approximately 3.8% of Horizon’s third quarter total revenue, which limits our exposure to further market adjustments to production expectations. The mortgage team proactively adjusted its staffing model in Q3, reflective of the shift in client demand, and anticipates further efficiency benefits in Q4. The credit quality of the mortgage loans we choose to own on our balance sheet remains very consistent and aligned with our high-quality borrowers in our consumer portfolio.
Transitioning to asset quality on Slide 26, our credit metrics remain strong as evidenced by no net charge-offs and low non-performing loans in the quarter. Additionally, we remain very well positioned in today’s fluid economic environment with a solid allowance to total loans at 1.28%. I’ll transition back to Craig now for additional highlights.
Craig Dwight
Thank you, Thomas, and we’re delighted to have you join the team. To summarize Horizon Bancorp’s key franchise highlights, Horizon is a growth company as evidenced by 20% compounded annual growth rate for net income and 13% compounded annual growth rate for total assets over the past 19 years. Our balance sheet has a diversified loan portfolio, both in product mix and geography, with ample liquidity availability and cash flows to fund future growth. The combination of Horizon’s year-to-date solid returns on average capital of 13.9% and our diversified balance sheet has proven to be a successful model in varying economic cycles.
As noted on Slide 28 and given our third quarter solid loan production results, Horizon is either beating or on plan for five of the six metric goals we announced in December of 2021 and updated our outlook in the second quarter of 2022. Year-to-date, core commercial loan growth, excluding PPP and participation sold, is an annualized growth rate of 13.8%, which is the upper range of our revised targeted range of 10% to 14%. Consumer loans year-to-date annualized growth is reported at 31.7%, which far exceeded our targeted range of 10% to 14%. Year-to-date return on average assets at 1.29% is on target to achieve 1.30%. Year-to-date return on average equity at 13.97% exceeds target of 12.5%, and our annualized expenses to average assets at 1.99%, which is on target of 2%. Overall, solid year-to-date performance for Horizon Bancorp.
This concludes our prepared remarks today, and now I’ll ask the Operator to please open the lines for questions. Thank you.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] And our first question will come from Terry McEvoy with Stephens. Please go ahead.
Terry McEvoy
Hi, good morning, everyone. Thomas, welcome to Horizon and the conference call.
Thomas Prame
Thank you.
Terry McEvoy
Maybe let’s just start with the margin. I’m hoping you can just help me understand the third quarter trends. When I think about 3 months ago, the comments I had in my notes were leveraging the company’s asset balance sheet, and it does appear betas, deposit betas of 23% were kind of below the 35% expectations, yet the margin went down. So even ex the 4 basis points of borrowings, that still was kind of flat quarter-over-quarter. 3 months ago, I thought the message was a higher margin, and maybe just help me understand what did not happen in the third quarter.
Thomas Prame
Yes, Terry, thanks for your question. What’s driving the margin lower – first, let’s start out with our net interest income actually increased about $400,000 for the quarter. But what drove the margin lower is our cash flows coming off the investment portfolio in slight decline, which was a seasonal decline of 1% in our deposit portfolios, were not sufficient to fund the loan growth. And our loan growth has far exceeded our expectations year-to-date. And therefore, the net gap in funding was through borrowed funds, which is as a beta tied to the market which is a more expensive cost. We do expect deposits to come back in play with municipalities in the fourth quarter, and beta should still be in the 35-basis point range by year-end.
Terry McEvoy
Thanks for that. And then as a follow-up, were there any branch closure-related costs in the third quarter? Or were all those taken in the second quarter? And could you just maybe talk about your expense outlook given the branch actions on top of just the increase in inflation and wage costs?
Mark Secor
Yes. We took the write-down in the second quarter for the branch fixed assets when it was approved. The branches, five of them, as Craig said earlier, five of them closed in August and two are going to be closing this month. We haven’t seen all of the cost saves yet from those. But I don’t – it continues to help and fund the inflationary costs. I don’t know that you’re going to see a significant change other than helping us to maintain our expenses going forward.
Terry McEvoy
Great. Thanks again.
Craig Dwight
Thank you, Terry.
Operator
Our next question will come from Nathan Race with Piper Sandler. Please go ahead.
Nathan Race
Yes. Hi, everyone there, good morning. And welcome, Thomas, and congrats on joining the great team at Horizon.
Thomas Prame
Thank you.
Nathan Race
Just going back maybe to Terry’s question on some of the balance sheet dynamics and around the margin going forward, I guess as you guys look out over the next quarter or two, is the cash flow that’s coming off the securities book going to be sufficient to kind of fund that still kind of mid to high single-digit loan growth outlook at least in the fourth quarter? Or do you guys see yourselves needing to test some additional wholesale funding sources if deposit growth doesn’t necessarily come through just given the increasing competitive dynamics that I believe Craig spoke to in the release?
Craig Dwight
Yes, Nathan, thanks for the question. First of all, we do expect loan growth to moderate in the fourth quarter as pipelines have diminished slightly. And then we have the investment cash flows of over $50 million coming in the fourth quarter as well as retained earnings about $15 million after costs to assist in funding the future growth. We would expect less reliance on borrowed funds in the fourth quarter and going into 2023. We may, by the way, increase deposits wholesale funding longer-term to reduce some debt though. That’s one option we will look at.
Nathan Race
Got it. And just in terms of the wholesale funding sources that you had in the quarter and may look to in the future, can you speak to just kind of the duration and cost of those sources?
Mark Secor
Yes. A good percentage is over 90 at this point and we have been funding the loan growth with it. The duration wouldn’t be over a year on all of it together.
Nathan Race
Okay, great. And then just on the security yields, they are kind of – they are flat from what I gather versus the last quarter. Is that just a function of just the structure of the securities that you guys largely put purchased in the fourth quarter last year following the branch acquisition? Or I guess how should we kind of think about the securities portfolio yield movements going forward in the context of maybe a flat to compressing margin? If I’m kind of putting all those items together.
Mark Secor
Yes, Nate, it should be fairly steady. If I look at the rates of the cash flow coming off, they are very similar rates to what the portfolio book yield is. You would expect it to be fairly stable.
Nathan Race
Okay. And if I could just ask one other question, just on kind of the outlook for loan yields going forward, some nice expansion in core loan yields from the last quarter. I believe you guys have around 30% of your portfolio that’s holding rate. Is it fair to expect loan yield expansion to accelerate in the fourth quarter just based on the rate of new loans coming on the books and just as these additional Fed Rate hikes work their way through the margin?
Craig Dwight
Yes. Nathan, we expect loan yields to continue to improve. We’re booking – commercial loans last quarter are exceeding an average over 6%. The mortgage side is slowing down, and that was probably some of the drag last quarter with yield in the 5% range. But consumer, home equity were well over 6%, so we expect – and those production results are strong in the third quarter with good pipelines going into the fourth, but they have shrunk from the second and third quarter. Expect better yields coming on to replace some of the amortizing loans that are coming off in the 3%s, quite frankly.
Nathan Race
Okay. Understood. And just – I apologize, one last one. Just trying to put all those pieces together, it sounds like with the new liability-sensitive position, you guys are expecting maybe flat to maybe a lower margin in the fourth quarter from the 3.13% recorded in 3Q?
Mark Secor
Yes, we are hoping to maintain the margin with some of the asset repricing and the moves we’re making and then – but continue to grow net interest income.
Nathan Race
Okay, great. I appreciate this on the collections and all the color. I will step back.
Operator
Our next question will come from Damon DelMonte with KBW. Please go ahead.
Damon DelMonte
Hi, good morning, guys. Welcome, Thomas. And look forward to getting to work with you more. Just to kind of follow-up on the margin questions here. Mark, your last response to Nate was that you are kind of hoping to maintain the margin in the near-term. But based on the rate shock scenario, doesn’t that imply that you’d have more pressure, especially considering that we’re going to potentially have 75 basis points in November, followed by another 50 in December?
Mark Secor
Damon, on the rate shock, where our results are more matching when I mentioned the non-parallel shock that there is a little pressure on the margin to try to maintain it. But we’re able to increase net interest income. And I think what we’re expecting is the yield curve is going to continue to be inverted as it is, and the rate shocks are going to happen here in this month and then another one, not all at once. I think that that makes that non-parallel ramp more what we’re seeing happening in our income, our net interest income.
Damon DelMonte
Okay, got it. Okay, thanks. And then with regards to the outlook for expenses, I know you called out a couple of key items that contributed to this quarter’s results. But is there a range or a growth expectation that we could kind of factor in from this quarter as we kind of look out into the end of the year and into 2023?
Mark Secor
Yes. I think we are targeting – this quarter, as you said, was high. The controllable expenses, such as the professional consulting fees as we indicated, those we anticipate to not be at those levels going into ‘23. On salary and benefits, there is obviously going to be some inflationary and some increase for – narrowing increases going into ‘23. So, I think our goal, and not to give a percentage of what we think the interest rate is going to go up, our goal is to maintain that under that 2% of average assets. So, I think that that’s the best guidance that we can provide.
Craig Dwight
We have some plans, by the way, this is Craig, to rationalize other costs during the fourth quarter and transfer some of those to more productive areas of the company. And some business lines just aren’t hitting the numbers, so we don’t expect to hit the numbers next year. So, there will be some additional rationalization taking place this quarter.
Damon DelMonte
So, that’s basically shifting expense dollars from one category to another to try to get more revenue on the back end?
Craig Dwight
Exactly. As we go into more spread business with the commercial side, we are reducing costs in other business lines.
Damon DelMonte
Okay. Also and then just I guess the last question, kind of going back to the security yields being flat on a quarter-over-quarter basis, could you just, I must have missed it, but could you just walk through the dynamics as to why those – why that yield change on the portfolio considering the notable movement in rates during the quarter?
Mark Secor
Well, we are not replacing any in the portfolio. So, that wouldn’t let us. So, we will be at the rates of what’s out there right now, and I think it’s going to be pretty steady.
Damon DelMonte
Got it. Okay. That’s all I had. Thanks a lot guys.
Craig Dwight
Thank you, David.
Operator
Our next question will come from David Long with Raymond James. Please go ahead.
David Long
Good morning, everyone and Thomas, I will welcome you as well. I am looking forward to spend some more time with you, too. With the little more challenging funding environment, does that impact your appetite to lend at all, your availability of credit to customers and prospects?
Thomas Prame
So, it’s Thomas. Thank you. Thank you for the question. It does not. I think as we have a rising rate environment, still our core mission is to help our local communities and be productive across communities. I wouldn’t say we are pulling back on lending segments. We will stick to our knitting in our local communities. We have very seasoned lenders in these markets that can help us navigate the challenges that could be coming from a slowdown in the economy. But I wouldn’t say we are taking our foot off the pedal here of continuing to lend to high-quality borrowers.
David Long
Got it. Okay. Thank you. And then if I take another angle here on the balance sheet management side of things and maybe this is directed towards Mark. But if you look back to the beginning of the year and we were thinking there would be some more asset sensitivity, more upside to the NIM in this backdrop. Is there anything that you could have done differently, had you known that the backdrop would be what it is today that may have better allowed the bank to take advantage of the higher rates?
Mark Secor
It would be nice to have a crystal ball, wouldn’t it?
David Long
Of course.
Mark Secor
Yes. I don’t think we would – I think we had – we were very asset sensitive in coming out of the branch deal and we had to change that. We had to get in within policy and manage that asset sensitivity. So, at the time, that was the right decision. I think what we didn’t expect as we came into the rising rates is how quickly the competition was going to raise deposit rates. That, I don’t think anyone in the industry thought of that, or thought that would happen as quickly as it has. And just to the loan growth that we have seen and demand. But the other thing that we didn’t mention too much about, but you also have a shifting of some of the deposits. So, you have got deposits that are lower yielding products that now are moving. Where they have not moved their money for years and years, they are actually looking for opportunities to move their money into higher yielding. So, you are getting some shift in what your deposit products are.
Craig Dwight
Yes. David, we had invested the TCF branch acquisition, net proceeds of about $620 million by October of ‘21. If you recall, in September of ‘21, the Fed was saying that the inflation was transitory, and it’s going to correct itself, and it did not happen. And now they have pivoted to their aggressive growth strategy to tame inflation. So, at that point-in-time, with the information we had, we invested the portfolio tied to cash flows, but we anticipated it was loan growth. And loan growth, quite frankly, has been exceptional this year. The teams have done their jobs. Part of it is tied up to pent-up demand. But at that point-in-time, there was I think a realistic outlook. And the other thing we had going on too, we knew would lose the PPP income going into ‘22, so we had to offset that to the investment portfolio. We announced that deal at a spread of 150 from cost of funds to our yield on the investment portfolio. We are still at a 160 spread as of end of September 30th. And our payback period in that transaction was less than 12 months. And so we have already incurred the payback and the entire cost of that capital outlay, so overall, not a bad transaction. But I appreciate the question. Thank you.
David Long
No, it was a good transaction on your part. So, appreciate the color guys. Thanks.
Operator
[Operator Instructions] Our next question will come from Brian Martin with Janney Montgomery. Please go ahead.
Brian Martin
Hey. Good morning everyone. Also welcome you, Thomas. So, for the team, just maybe a couple of follow-ups. Just, Mark, on the balance sheet, I guess as you look at the fourth quarter and next year, is the expectation with that cash flow coming off the bond book that the growth will be funded – the loan growth you are expecting will be funded by that securities portfolio? Is that the plan and there is not much growth in the balance sheet? Is that how we should think about it here?
Mark Secor
That would be the plan. That and retained earnings we think is going to be able to help fund the loan growth.
Brian Martin
Got it. Go ahead.
Mark Secor
No.
Brian Martin
Okay. Alright. And then maybe just on the mortgage outlook, can you provide any sense on – you saw the step down this quarter. Just kind of let’s say this is kind of a sustainable level? Do you think it’s still going to go lower based on kind of the MBA forecast or how you guys – trends you are seeing currently?
Noe Najera
Thank you for the question. This is Noe. Yes, we expect that the mortgage outlook will stay in line with how we have been trending to the MBA forecast. We will remain flat. The pipelines are down. But I think we still have, as we mentioned earlier, very seasoned loan officers. So, we are embedded in the communities that we serve. And I think that any opportunity that’s presented now, we will take advantage of that. But do anticipate that a significant slowdown and the entire market will slow down.
Brian Martin
Okay. So, that gain on sale, Noe, should go down as well. I mean just if the MBA forecast is lower, you would expect the gain on sale revenue to moderate here as you go the next couple of quarters?
Noe Najera
That’s expected as well. And again, it’s just – but it’s a smaller portion of our total income earned, what we delivered to the bottom line. So, I anticipate that it will fall in line.
Brian Martin
Yes. Okay. I just wanted to make sure I understood your comment. Thank you. And maybe just one last one maybe for Thomas. Just with more maybe reliance coming from the growth aspect, the loan portfolio going forward, the margins more stable, can you share – it sounds like the commercial pipeline is still healthy, a little bit down. But just kind of your outlook, I mean the level we saw year-to-date that Craig outlined is pretty significant. Just how you are thinking about the next two quarters to three quarters on loan growth on the commercial side, if you could give some outlook. And I think you also talked about utilization. I am not sure what that did linked quarter, or just how you are thinking about utilization, those two would be helpful. Thank you.
Thomas Prame
Sure. I will hit your first question on the overall loan growth. I think as Mark and Craig alluded, our loan growth will probably be in line with our cash flows coming out of securities portfolio, retained earnings, and then to maximize our benefit there. We have a very diversified loan portfolio. As you can see, quarter-over-quarter, very diverse markets and segments on the commercial side. Also, you look at our consumer side, both from mortgage and direct auto, and just in the consumer lending that we get from our branch area. So, it gives us the ability to have growth in various parts according to where we see the best opportunities for our balance sheet. I will pass it over to Lynn around utilization and perhaps more color on the commercial side.
Lynn Kerber
Thank you, Thomas. As far as utilization, our line of credit utilization has been increasing month-over-month. But it’s still below our overall average and actually lower than our pre-pandemic utilization. But we have been increasing about 1% per month, so that is a positive trend. We have been hearing from our clients with the inventory and logistics, they are expecting to have some increased line of credit utilization, so we do expect that to increase here. As far as forward-looking, as mentioned in the deck, our pipeline is moderating a bit for fourth quarter. That being said, we are still seeing opportunities with our clients. In residential one-to-four family, multifamily, senior housing, we have seen a nice uptick in industrial activity. These all continue to be active sectors for us. We are watching residential development, of course, with the impact on mortgage rates and home buyers, so we expect that to moderate. And then lastly, I will just say that this past year, we originated some strong construction lending. And that is helping to support our overall pipeline as well. So, we expect to see the benefit of that as we go into 2023.
Brian Martin
Got it. Okay. That’s helpful. And maybe the last one for me was just if I could, it’s for Craig, which is just you talked about reallocating some of the expense dollars to some areas maybe aren’t performing as well as you would like and other areas might be better. Can you just talk about where directionally, where do you plan to invest some of these dollars as you think about the next 12 months out where the benefits may come from?
Craig Dwight
Well, our non-interest income is obviously under pressure, which is part of our design of our model. And they are countercyclical business lines, mortgages and wealth management. So, those areas are going to see less investment reduction as we transfer some of that to the commercial side. As well as cost saves too, Brian.
Brian Martin
Got it. Okay. Perfect. I appreciate the color guys. Thank you.
Craig Dwight
Thank you, Brian.
Operator
Our next question is a follow-up from Nathan Race with Piper Sandler. Please go ahead.
Nathan Race
Yes. I appreciate you guys taking the follow-up questions. Just maybe on kind of the credit outlook and provisioning going forward, some stable metrics versus 2Q in terms of substandard NPAs and so forth charge-offs are obviously pretty negligible. I guess is there anything that we can’t discern from the numbers that you guys are keeping a closer eye on or you are expecting any deterioration? I guess just how has kind of commercial client segment been lately? And how are you guys just kind of thinking about where you guys want to see the reserve trend over the next few quarters kind of absent any CECL qualitative adjustments?
Lynn Kerber
Sure. This is Lynn Kerber. Relative to credit quality, as you see in the deck, our credit quality metrics have been performing really well. Our past dues for this last quarter were extremely low, and that has been a continuation of a trend that we have seen for the last year. We regularly as a lending team and management team that talk about our outlook and any concerns that we have, we also subscribe to a variety of services to help provide analysis for us. At this point, we were watching some sectors like hospitality, retail, restaurants through the pandemic very closely. And we had some special additional allocations during that timeframe. Quite frankly, all of those sectors have performed exceedingly well. And so as you look at our reserve, there has been a change in mix as we released some of those additional allocations. So, having that lead into the allowance itself, as we have unwound some of those allocations to those sectors, that’s been tempered with some additional increases just related to the overall economic conditions right now. So, at 1.28, we feel that we are appropriately reserved. If you look at our peer group, we are just slightly above that. So, I think we are well positioned. And as far as our trends going forward, at this point the credit quality looks good. But with the probability of recession, etcetera, of course that condition could change and we would have to reevaluate.
Nathan Race
Okay. Great. And then just maybe one last one for Mark, housekeeping on the tax rate. Obviously, you had some solar credits that were utilized in the quarter. Can the tax rate go back up somewhere between 14% to 15% going forward?
Mark Secor
Yes. It’s been and this was – a lot of the projects got completed this quarter, so we have recognized more. And there is a little bit in the fourth quarter, but they will go back to more normal levels.
Nathan Race
Okay. Alright. I appreciate taking the follow-up. Thanks again.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Craig Dwight for any closing remarks.
End of Q&A
Craig Dwight
Thank you, Matt and thank you for everyone who participated in today’s call. If you have other questions or comments, please feel free to contact myself or Mark Secor. We always embrace additional comments or questions from our shareholders and analysts. So, thank you and have a great day. Bye now.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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