KBRA Comments on German American Bancorp, Inc.'s Proposed Acquisition of Heartland BancCorp

Jasper, Indiana-based, German American BancCorp, Inc. (NASDAQ: GABC, or "German American") (KBRA senior unsecured debt rating: BBB+ / Stable Outlook) announced on July 29 that it had entered into a merger agreement to acquire Heartland BancCorp (OTCQX: HLAN or "Heartland'), based in Whitehall, Ohio. The transaction, valued at $330.2 million (P/TBV: 2.02x), is an all-stock deal consideration and expected to close in 1Q25 pending regulatory approval. Upon completion of the transaction, Heartland’s subsidiary bank, Heartland Bank, will be merged into German American’s subsidiary bank, German American Bank, and operate under a co-branded name within the Ohio markets. G. Scott McComb, Chairman, President and CEO of Heartland is expected to join the board of directors for GABC, while members of the Heartland executive and senior teams are expected to stay on as regional management to provide local leadership and decision making.

The proposed acquisition is in line with German American's overall growth strategy of expansion into contiguous markets through both acquisitive and organic means. The transaction allows GABC to expand into Ohio, notably the attractive Columbus and Cincinnati MSAs, offering solid opportunities to leverage GABC's business lines in new markets, notably C&I lending and wealth management business. The acquisition is expected to add approximately $1.9 billion in assets to GABC's balance sheet at close, with pro forma total assets of $8.1 billion, $5.7 billion in loans, and $7.0 billion in deposits, based on financial data as of June 30, 2024, as well as a branch network of 95 locations across Indiana, Kentucky, and Ohio. The combined company’s financial projections include strong profitability metrics following the close of the transaction, in part, due to the 30% cost-savings expected on HLAN's expense base, with 75% of the savings recognized in 2025 and the remainder achieved in the year thereafter. With cost-savings fully realized, the combined institution is expected to generate an ROA of ~1.50% in 2025, though this estimate includes a respectable amount of accretion income given the interest rate marks on the securities and loan portfolios. Excluding accretion income, ROA would be approximately 1.35%, still representing solid earnings power. The proforma loan portfolio is not expected to change materially as both institutions have complementary loan mixes, with CRE remaining the largest component at 41% of total loans, followed by residential loans at 27% and C&I at 12%. With respect to deposit mix, while HLAN maintains a higher proportion of time deposits (34% of deposits at 2Q24 vs. 16% for GABC), the proforma cost of deposits is expected to remain manageable at 1.95%, supported by a solid NIB component of 27% of total deposits, based off of 2Q24 metrics. Furthermore, GABC's liquidity position, measured by the loan-to-deposit ratio, will continue to provide flexibility with its funding profile reflected in a proforma ratio of 80% (76% as of 2Q24 for GABC).

Regarding credit quality, both institutions have had strong metrics for an extended period of time, with minimal NCO and NPA ratios for the past several years, which is a testament to disciplined underwriting and conservative management teams that have extensive knowledge of their operating markets. German American conducted a thorough review of the loan portfolio, inclusive of 74% of the total loan portfolio, and expects to record a total gross pre-tax credit mark of $28.7 million (1.85% of HLAN's loans) along with a Day 2 CECL adjustment of $13.8 million in relation to the transaction. While investor CRE relative to total risk based capital is expected to increase upon closing, CRE concentration will remain well below the 300% guidance (proforma 212%). GABC has prudently managed capital metrics with an above peer CET1 ratio of 14.5% in 2Q24, reflective of the conservative nature of the bank, though this ratio is expected to decline to ~12% at closing. Nonetheless, proforma capital metrics appear solid and, combined with the proforma earnings profile, capital rebuild should be relatively quick. Overall, we believe that the proposed acquisition complements the company’s growth strategy, and while there is an inherent level of integration risk involved with any bank M&A transaction, such risk is somewhat mitigated by GABC's demonstrated track record as an experienced acquirer.

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