Table of Contents

 

 

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

Commission file number 0-10792

 

 

 

HORIZON BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

Indiana				35-1562417
(State or other jurisdiction of incorporation or organization)				(I.R.S. Employer Identification No.)

 

515 Franklin Square, Michigan City, Indiana				46360
(Address of principal executive offices)				(Zip Code)

(219) 879-0211

Registrant’s telephone number, including area code:

N/A

Former name, former address and former fiscal year, if changed since last report:

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large Accelerated Filer		¨		Accelerated Filer		x
Non-accelerated Filer		¨  (Do not check if smaller reporting company)		Smaller Reporting Company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 4,997,017 shares of Common Stock, no par value, at May 10, 2012.

 

 

 

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HORIZON BANCORP

FORM 10-Q

INDEX

 

PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets			3
		Condensed Consolidated Statements of Income			4
		Condensed Consolidated Statements of Comprehensive Income			5
		Condensed Consolidated Statement of Stockholders’ Equity			6
		Condensed Consolidated Statements of Cash Flows			7
		Notes to Condensed Consolidated Financial Statements			8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			36
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			47
Item 4.		Controls and Procedures			47
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings			48
Item 1A.		Risk Factors			48
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			48
Item 3.		Defaults Upon Senior Securities			48
Item 4.		Mine Safety Disclosures			48
Item 5.		Other Information			48
Item 6.		Exhibits			49
Signatures
Index To Exhibits

 

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PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollar Amounts in Thousands)

 

		March 31				December 31
		2012 (Unaudited)				2011
Assets
Cash and due from banks		$	19,049			$	20,447
Investment securities, available for sale			433,501				431,045
Investment securities, held to maturity			7,100				7,100
Loans held for sale			10,202				14,090
Loans, net of allowance for loan losses of $19,412 and $18,882			969,141				964,311
Premises and equipment			35,775				34,665
Federal Reserve and Federal Home Loan Bank stock			12,390				12,390
Goodwill			5,910				5,910
Other intangible assets			2,182				2,292
Interest receivable			6,798				6,671
Cash value life insurance			30,415				30,190
Other assets			14,368				18,051
Total assets		$	1,546,831			$	1,547,162
Liabilities
Deposits
Non-interest bearing		$	138,618			$	130,673
Interest bearing			926,003				879,192
Total deposits			1,064,621				1,009,865
Borrowings			310,889				370,111
Subordinated debentures			30,699				30,676
Interest payable			555				596
Other liabilities			13,829				14,449
Total liabilities			1,420,593				1,425,697
Commitments and contingent liabilities
Stockholders’ Equity
Preferred stock, $.01 par value, $1,000 liquidation value
Authorized, 1,000,000 Series B shares
Issued 12,500 and 12,500 shares			12,500				12,500
Common stock, $.3333 stated value
Authorized, 22,500,000 shares
Issued, 4,994,017 and 4,967,196 shares
Outstanding, 4,954,347 and 4,947,696 shares			1,126				1,126
Additional paid-in capital			10,641				10,610
Retained earnings			93,198				89,387
Accumulated other comprehensive income			8,773				7,842
Total stockholders’ equity			126,238				121,465
Total liabilities and stockholders’ equity		$	1,546,831			$	1,547,162

See notes to condensed consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Dollar Amounts in Thousands, Except Per Share Data)

 

		Three Months Ended March 31
		2012				2011
		(Unaudited)				(Unaudited)
Interest Income
Loans receivable		$	13,532			$	11,888
Investment securities
Taxable			2,314				2,500
Tax exempt			980				1,043
Total interest income			16,826				15,431
Interest Expense
Deposits			1,639				2,337
Borrowed funds			1,519				1,577
Subordinated debentures			470				450
Total interest expense			3,628				4,364
Net Interest Income			13,198				11,067
Provision for loan losses			559				1,548
Net Interest Income after Provision for Loan Losses			12,639				9,519
Other Income
Service charges on deposit accounts			712				795
Wire transfer fees			182				108
Interchange fees			628				545
Fiduciary activities			975				963
Gain on sale of securities			—				274
Gain on sale of mortgage loans			2,274				533
Mortgage servicing income net of impairment			90				764
Increase in cash surrender value of bank owned life insurance			225				205
Other income			56				127
Total other income			5,142				4,314
Other Expenses
Salaries and employee benefits			5,963				5,361
Net occupancy expenses			1,054				1,081
Data processing			526				407
Professional fees			534				349
Outside services and consultants			471				381
Loan expense			702				762
FDIC insurance expense			257				387
Other losses			30				31
Other expenses			1,623				1,499
Total other expenses			11,160				10,258
Income Before Income Tax			6,621				3,575
Income tax expense			2,008				810
Net Income			4,613				2,765
Preferred stock dividend and discount accretion			(156	)			(276	)
Net Income Available to Common Shareholders		$	4,457			$	2,489
Basic Earnings Per Share		$	0.90			$	0.51
Diluted Earnings Per Share			0.88				0.49

See notes to condensed consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)

 

		Three Months Ended March 31
		2012				2011
		(Unaudited)				(Unaudited)
Net Income		$	4,613			$	2,765
Other Comprehensive Income
Change in fair value of derivative instruments, net of taxes of $198 and $670, for 2012 and 2011, respectively			367				1,245
Unrealized appreciation on available-for-sale securities, net of taxes of $303 and $158, for 2012 and 2011, respectively			564				293
Less: reclassification adjustment for realized gains included in net income, net of taxes of $0 and $96, for 2012 and 2011, respectively			—				178
			931				1,716
Comprehensive Income		$	5,544			$	4,481

See notes to condensed consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

		Preferred Stock				Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income				Total
Balances, January 1, 2012		$	12,500			$	1,126			$	10,610			$	89,387			$	7,842			$	121,465
Net income															4,613								4,613
Other comprehensive income, net of tax																			931				—
Amortization of unearned compensation											23												23
Stock option expense											8												8
Cash dividends on preferred stock (5.00%)															(156	)							(156	)
Cash dividends on common stock ($.13 per share)															(646	)							(646	)
Balances, March 31, 2012		$	12,500			$	1,126			$	10,641			$	93,198			$	8,773			$	126,238

See notes to condensed consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)

 

		Three Months Ended March 31
		2012				2011
		(Unaudited)				(Unaudited)
Operating Activities
Net income		$	4,613			$	2,765
Items not requiring (providing) cash
Provision for loan losses			559				1,548
Depreciation and amortization			646				604
Share based compensation			8				10
Mortgage servicing rights impairment (recovery)			7				(701	)
Premium amortization on securities available for sale, net			700				522
Gain on sale of investment securities			—				(274	)
Gain on sale of mortgage loans			(2,274	)			(533	)
Proceeds from sales of loans			82,619				64,764
Loans originated for sale			(80,345	)			(64,231	)
Change in cash surrender value of life insurance			(225	)			(205	)
(Gain) loss on sale of other real estate owned			21				(30	)
Net change in
Interest receivable			(127	)			(114	)
Interest payable			(41	)			5
Other assets			1,415				1,401
Other liabilities			(179	)			(1,159	)
Net cash provided by operating activities			7,397				4,372
Investing Activities
Purchases of securities available for sale			(22,581	)			(76,429	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale			20,294				25,358
Purchase of securities held to maturity			—				(2,437	)
Proceeds from maturities of securities held to maturity			—				1,400
Net change in loans			(2,102	)			84,163
Proceeds on the sale of OREO and repossessed assets			2,461				1,469
Purchases of premises and equipment			(1,622	)			(990	)
Net cash provided (used in) by investing activities			(3,550	)			32,534
Financing Activities
Net change in
Deposits			54,756				15,911
Borrowings			(59,199	)			(36,360	)
Proceeds from issuance of stock			—				56
Tax benefit from issuance of stock			—				8
Dividends paid on common shares			(646	)			(560	)
Dividends paid on preferred shares			(156	)			(235	)
Net cash used in financing activities			(5,245	)			(21,180	)
Net Change in Cash and Cash Equivalent			(1,398	)			15,726
Cash and Cash Equivalents, Beginning of Period			20,447				15,683
Cash and Cash Equivalents, End of Period		$	19,049			$	31,409
Additional Cash Flows Information
Interest paid		$	3,669			$	4,358
Income taxes paid			900				—
Transfer of loans to other real estate owned			527				1,095

See notes to condensed consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

Note 1 – Accounting Policies

The accompanying condensed consolidated financial statements include the accounts of Horizon Bancorp (“Horizon” or the “Company”) and its wholly-owned subsidiaries, including Horizon Bank, N.A. (“Bank”). All inter-company balances and transactions have been eliminated. The results of operations for the periods ended March 31, 2012 and March 31, 2011 are not necessarily indicative of the operating results for the full year of 2012 or 2011. The accompanying unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of Horizon's management, necessary to fairly present the financial position, results of operations and cash flows of Horizon for the periods presented. Those adjustments consist only of normal recurring adjustments.

Certain information and note disclosures normally included in Horizon's annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Horizon's Annual Report on Form 10-K for 2011 filed with the Securities and Exchange Commission on March 12, 2012. The consolidated condensed balance sheet of Horizon as of December 31, 2011 has been derived from the audited balance sheet of Horizon as of that date.

Basic earnings per share is computed by dividing net income available to common shareholders (net income less dividend requirements for preferred stock and accretion of preferred stock discount) by the weighted-average number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The following table shows computation of basic and diluted earnings per share.

 

		Three months ended March 31
		2012 (Unaudited)				2011 (Unaudited)
Basic earnings per share
Net income		$	4,613			$	2,765
Less: Preferred stock dividends and accretion of discount			156				276
Net income available to common shareholders		$	4,457			$	2,489
Weighted average common shares outstanding(1)			4,948,573				4,924,715
Basic earnings per share		$	0.90			$	0.51
Diluted earnings per share
Net income available to common shareholders		$	4,457			$	2,489
Weighted average common shares outstanding(1)			4,948,573				4,924,715
Effect of dilutive securities:
Warrants			106,438				115,887
Restricted stock			971				22,217
Stock options			9,678				11,945
Weighted average shares outstanding			5,065,660				5,074,763
Diluted earnings per share		$	0.88			$	0.49

 

(1)	Adjusted for 3:2 stock split on December 9, 2011

 

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

At March 31, 2012 and 2011, there were 31,500 shares and 39,176 shares that were not included in the computation of diluted earnings per share because they were non-dilutive.

Horizon has share-based employee compensation plans, which are described in the notes to the financial statements included in the December 31, 2011 Annual Report on Form 10-K.

Reclassifications

Certain reclassifications have been made to the 2011 consolidated financial statements to be comparable to 2012. These reclassifications had no effect on net income.

Note 2 – Securities

The fair value of securities is as follows:

 

						Gross				Gross
March 31, 2012		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
Available for sale
U.S. Treasury and federal agencies		$	18,365			$	293			$	(1	)		$	18,657
State and municipal			134,661				9,195				(82	)			143,774
Federal agency collateralized mortgage obligations			84,458				2,233				(1	)			86,690
Federal agency mortgage-backed pools			174,909				6,095				(21	)			180,983
Private labeled mortgage-backed pools			3,247				113				—				3,360
Corporate notes			32				5				—				37
Total available for sale investment securities		$	415,672			$	17,934			$	(105	)		$	433,501
Held to maturity, State and Municipal		$	7,100			$	—			$	—			$	7,100

 

						Gross				Gross
December 31, 2011		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
Available for sale
U.S. Treasury and federal agencies		$	12,693			$	329			$	—			$	13,022
State and municipal			135,011				8,950				(71	)			143,890
Federal agency collateralized mortgage obligations			89,016				2,106				—				91,122
Federal agency mortgage-backed pools			173,797				5,669				(115	)			179,351
Private labeled mortgage-backed pools			3,518				118				—				3,636
Corporate notes			32				—				(8	)			24
Total available for sale investment securities		$	414,067			$	17,172			$	(194	)		$	431,045
Held to maturity, State and Municipal		$	7,100			$	34			$	—			$	7,134

Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information, and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary. While these securities are held in the available for sale portfolio, Horizon intends, and has the ability, to hold them until the earlier of a recovery in fair value or maturity.

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified. At March 31, 2012, no individual investment security had an unrealized loss that was determined to be other-than-temporary.

The unrealized losses on the Company’s investments in United States Department of the Treasury (“U.S. Treasury”) and federal agencies, securities of state and municipal governmental agencies, and federal agency mortgage-backed pools were caused by interest rate volatility and not a decline in credit quality. The

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. The Company expects to recover the amortized cost basis over the term of the securities. Because the Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider those investments to be other-than-temporarily impaired at March 31, 2012.

The amortized cost and fair value of securities available for sale and held to maturity at March 31, 2012 and December 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		March 31, 2012								December 31, 2011
		Amortized Cost				Fair Value				Amortized Cost				Fair Value
Available for sale
Within one year		$	936			$	941			$	931			$	940
One to five years			32,713				33,847				30,796				31,910
Five to ten years			59,524				63,509				51,476				55,053
After ten years			59,885				64,171				64,533				69,033
			153,058				162,468				147,736				156,936
Federal agency collateralized mortgage obligations			84,458				86,690				89,016				91,122
Federal agency mortgage-backed pools			174,909				180,983				173,797				179,351
Private labeled mortgage-backed pools			3,247				3,360				3,518				3,636
Total available for sale investment securities		$	415,672			$	433,501			$	414,067			$	431,045
Held to maturity
Within one year		$	7,100			$	7,100			$	7,100			$	7,134
One to five years			—				—				—				—
Total held to maturity investment securities		$	7,100			$	7,100			$	7,100			$	7,134

The following table shows the gross unrealized losses and the fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

 

		Less than 12 Months								12 Months or More								Total
March 31, 2012		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
U.S. Treasury and federal agencies		$	2,984			$	(1	)		$	—			$	—			$	2,984			$	(1	)
State and municipal			2,323				(82	)			—				—				2,323				(82	)
Federal agency collateralized mortgage obligations			2,595				(1	)			—				—				2,595				(1	)
Federal agency mortgage-backed pools			7,248				(21	)			20				—				7,268				(21	)
Total temporarily impaired securities		$	15,150			$	(105	)		$	20			$	—			$	15,170			$	(105	)
		Less than 12 Months								12 Months or More								Total
December 31, 2011		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
State and municipal		$	1,550			$	(44	)		$	1,948			$	(27	)		$	3,498			$	(71	)
Federal agency mortgage-backed pools			23,442				(115	)			23				—				23,465				(115	)
Corporate notes			24				(8	)			—				—				24				(8	)
Total temporarily impaired securities		$	25,016			$	(167	)		$	1,971			$	(27	)		$	26,987			$	(194	)

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

		Three months ended March 31
		2012				2011
Sales of securities available for sale (Unaudited)
Proceeds		$	—			$	9,274
Gross gains			—				274
Gross losses			—				—

Note 3 — Loans

 

		March 31				December 31
		2012				2011
Commercial
Working capital and equipment		$	164,199			$	170,325
Real estate, including agriculture			176,889				172,910
Tax exempt			3,539				3,818
Other			5,836				5,323
Total			350,463				352,376
Real estate
1–4 family			151,497				153,039
Other			4,053				4,102
Total			155,550				157,141
Consumer
Auto			138,682				134,686
Recreation			4,808				4,737
Real estate/home improvement			27,865				27,729
Home equity			92,495				92,249
Unsecured			3,039				3,183
Other			2,499				2,793
Total			269,388				265,377
Mortgage warehouse			213,152				208,299
Total			213,152				208,299
Total loans			988,553				983,193
Allowance for loan losses			(19,412	)			(18,882	)
Loans, net		$	969,141			$	964,311

Commercial

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of property type, which are monitored for concentrations of credit. Management monitors and evaluates commercial real estate loans based on collateral, cash flow and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Real Estate and Consumer

With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Mortgage Warehousing

Horizon’s mortgage warehouse lending has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with pledge of collateral under Horizon’s agreement with the mortgage company. Each individual mortgage is assigned to Horizon until the loan is sold to the secondary market by the mortgage company. In addition, Horizon takes possession of each original note and forwards such note to the end investor once the mortgage company has sold the loan. At the time a loan is transferred to the secondary market, the mortgage company repurchases the loan under its option within the agreement. Due to the repurchase feature contained in the agreement, the transaction does not qualify as a sale and therefore is accounted for as a secured borrowing with pledge of collateral pursuant to the agreement with the mortgage company. When the individual loan is sold to the end investor by the mortgage company the proceeds from the sale of the loan are received by Horizon and used to pay off the loan balance with Horizon along with any accrued interest and any related fees. The remaining balance from the sale is forwarded to the mortgage company. These individual loans typically are sold by the mortgage company within 30 days and are seldom held more than 90 days. Interest income is accrued during this period and collected at the time each loan is sold. Fee income for each loan sold is collected when the loan is sold and no costs are deferred due to the term between each loan funding and related payoff is typically less than 30 days.

Based on the agreements with each mortgage company, at any time a mortgage company can repurchase from Horizon their outstanding loan balance on an individual mortgage and regain possession of the original note. Horizon also has the option to request that the mortgage company repurchase an individual mortgage. Should this occur, Horizon would return the original note and reassign the assignment of the mortgage to the mortgage company. Also, in the event that the end investor would not be able to honor the sales commitment and the mortgage company would not be able to repurchase its loan on an individual mortgage, Horizon would be able to exercise its rights under the agreement.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

The following table shows the recorded investment of individual loan categories.

 

March 31, 2012		Loan Balance				Interest Due				Deferred Fees/(Costs)				Recorded Investment
Owner occupied real estate		$	129,530			$	409			$	26			$	129,965
Non owner occupied real estate			150,861				395				99				151,355
Residential spec homes			2,834				7				—				2,841
Development & spec land loans			7,366				15				—				7,381
Commercial and industrial			59,744				198				3				59,945
Total commercial			350,335				1,024				128				351,487
Residential mortgage			148,073				569				68				148,710
Residential construction			7,409				11				—				7,420
Mortgage warehouse			213,152				427				—				213,579
Total real estate			368,634				1,007				68				369,709
Direct installment			24,735				86				(346	)			24,475
Direct installment purchased			863				—				—				863
Indirect installment			131,461				403				—				131,864
Home equity			113,420				524				(745	)			113,199
Total consumer			270,479				1,013				(1,091	)			270,401
Total loans			989,448				3,044				(895	)			991,597
Allowance for loan losses			(19,412	)			—				—				(19,412	)
Net loans		$	970,036			$	3,044			$	(895	)		$	972,185

 

December 31, 2011		Loan Balance				Interest Due				Deferred Fees/(Costs)				Recorded Investment
Owner occupied real estate		$	131,893			$	383			$	30			$	132,306
Non owner occupied real estate			142,269				360				94				142,723
Residential spec homes			3,574				6				—				3,580
Development & spec land loans			8,739				16				—				8,755
Commercial and industrial			65,774				169				3				65,946
Total commercial			352,249				934				127				353,310
Residential mortgage			150,893				513				68				151,474
Residential construction			6,181				8				—				6,189
Mortgage warehouse			208,299				427				—				208,726
Total real estate			365,373				948				68				366,389
Direct installment			24,252				94				(360	)			23,986
Direct installment purchased			981				—				—				981
Indirect installment			127,751				420				(56	)			128,115
Home equity			113,561				559				(752	)			113,368
Total consumer			266,545				1,073				(1,168	)			266,450
Total loans			984,167				2,955				(973	)			986,149
Allowance for loan losses			(18,882	)			—				—				(18,882	)
Net loans		$	965,285			$	2,955			$	(973	)		$	967,267

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

Note 4 – Allowance for Loan Losses

The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior one to five years. Management believes the two-year historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

 

		Three Months Ended
		March 31				March 31
		2012				2011
		(Unaudited)				(Unaudited)
Balance at beginning of the period		$	18,882			$	19,064
Loans charged-off:
Commercial
Owner occupied real estate			—				11
Non owner occupied real estate			—				—
Residential development			—				—
Development & Spec Land Loans			—				—
Commercial and industrial			—				50
Total commercial			—				61
Real estate
Residential mortgage			89				82
Residential construction			—				—
Mortgage warehouse			—				—
Total real estate			89				82
Consumer
Direct Installment			113				185
Direct Installment Purchased			—				—
Indirect Installment			338				455
Home Equity			133				977
Total consumer			584				1,617
Total loans charged-off			673				1,760
Recoveries of loans previously charged-off:
Commercial
Owner occupied real estate			300				—
Non owner occupied real estate			7				—
Residential development			—				—
Development & Spec Land Loans			—				—
Commercial and industrial			25				2
Total commercial			332				2
Real estate
Residential mortgage			30				—
Residential construction			—				—
Mortgage warehouse			—				—
Total real estate			30				—
Consumer
Direct Installment			15				48
Direct Installment Purchased			—				—
Indirect Installment			201				169
Home Equity			66				19
Total consumer			282				236
Total loan recoveries			644				238
Net loans charged-off			29				1,522
Provision charged to operating expense
Commercial			86				1,114
Real estate			611				47
Consumer			(138	)			387
Total provision charged to operating expense			559				1,548
Balance at the end of the period		$	19,412			$	19,090

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

For all loan portfolio segments except 1-4 family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down or specific allocation of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the value is known but no later than when a loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 90 days past due, and charge down to the net realizable value when other secured loans are 90 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment analysis:

 

March 31, 2012		Commercial				Real Estate				Mortgage Warehousing				Consumer				Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	2,833			$	—			$	—			$	—			$	2,833
Collectively evaluated for impairment			5,602				3,025				1,694				6,258				16,579
Total ending allowance balance		$	8,435			$	3,025			$	1,694			$	6,258			$	19,412
Loans:
Individually evaluated for impairment		$	9,035			$	—			$	—			$	—			$	9,035
Collectively evaluated for impairment			342,452				156,130				213,579				270,401				982,562
Total ending loans balance		$	351,487			$	156,130			$	213,579			$	270,401			$	991,597
December 31, 2011		Commercial				Real Estate				Mortgage Warehousing				Consumer				Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	2,136			$	—			$	—			$	—			$	2,136
Collectively evaluated for impairment			5,881				2,472				1,695				6,698				16,746
Total ending allowance balance		$	8,017			$	2,472			$	1,695			$	6,698			$	18,882
Loans:
Individually evaluated for impairment		$	7,960			$	—			$	—			$	—			$	7,960
Collectively evaluated for impairment			345,350				157,663				208,726				266,450				978,189
Total ending loans balance		$	353,310			$	157,663			$	208,726			$	266,450			$	986,149

 

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Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

Note 5 – Non-performing Loans and Impaired Loans

The following table presents the nonaccrual, loans past due over 90 days still on accrual, and troubled debt restructured (“TDR’s”) by class of loans:

 

						Loans Past
						Due Over 90				Non								Total Non-
						Days Still				Performing				Performing				Performing
March 31, 2012		Nonaccrual				Accruing				TDR’s				TDR’s				Loans
Commercial
Owner occupied real estate		$	2,359			$	—				—			$	—			$	2,359
Non owner occupied real estate			4,033				—				152				(0	)			4,185
Residential development			—				—				—				—				—
Development & Spec Land Loans			805				—				—				—				805
Commercial and industrial			808				—				878				0				1,686
Total commercial			8,005				—				1,030				0				9,035
Real estate
Residential mortgage			4,853				—				1,331				2,047				8,231
Residential construction			144				—				—				292				436
Mortgage warehouse			—				—				—				—				—
Total real estate			4,997				—				1,331				2,339				8,667
Consumer
Direct Installment			157				—				24				0				181
Direct Installment Purchased			—				9				—				—				9
Indirect Installment			755				19				—				—				774
Home Equity			1,536				—				53				849				2,438
Total Consumer			2,448				28				78				849				3,402
Total		$	15,450			$	28			$	2,439			$	3,188			$	21,104

 

						Loans Past
						Due Over 90				Non								Total Non-
						Days Still				Performing				Performing				Performing
December 31, 2011		Nonaccrual				Accruing				TDR’s				TDR’s				Loans
Commercial
Owner occupied real estate		$	2,515			$	—			$	—			$	—			$	2,515
Non owner occupied real estate			3,970				—				152				—				4,122
Residential development			—				—				—				—				—
Development & Spec Land Loans			90				—				—				—				90
Commercial and industrial			330				—				901				—				1,231
Total commercial			6,905				—				1,053				—				7,958
Real estate
Residential mortgage			4,550				—				1,120				2,389				8,059
Residential construction			144				—				—				293				437
Mortgage warehouse			—				—				—				—				—
Total real estate			4,694				—				1,120				2,682				8,496
Consumer
Direct Installment			256				1				—				—				257
Direct Installment Purchased			—				4				—				—				4
Indirect Installment			926				29				—				—				955
Home Equity			1,587				3				25				858				2,473
Total Consumer			2,769				37				25				858				3,689
Total		$	14,368			$	37			$	2,198			$	3,540			$	20,143

From time to time, the Bank obtains information that may lead management to believe that the collection of payments may be doubtful on a particular loan. In recognition of this, it is management’s policy to convert

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

the loan from an “earning asset” to a non-accruing loan. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Further, it is management’s policy to place a loan on a non-accrual status when delinquent in excess of 90 days or have had the accrual of interest discontinued by management. The officer responsible for the loan and the Chief Operating Officer or the senior collection officer must review all loans placed on non-accrual status. Subsequent payments on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

A loan becomes impaired when, based on current information, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is classified as impaired, the degree of impairment must be recognized by estimating future cash flows from the debtor. The present value of these cash flows is computed at a discount rate based on the interest rate contained in the loan agreement. However, if a particular loan has a determinable market value for its collateral, the creditor may use that value. Also, if the loan is secured and considered collateral dependent, the creditor may use the fair value of the collateral. Interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

Smaller-balance, homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by 1 – 4 family residences, residential construction loans, automobile, home equity, second mortgage loans and mortgage warehouse loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of borrower operating results and financial condition indicate that underlying cash flows of a borrower’s business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 30 days or more. Loans are generally moved to non-accrual status when 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms, including TDR’s, are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans.

The Company’s TDR’s are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At March 31, 2012, the type of concessions the Company has made on restructured loans has been temporary rate reductions and/or reductions in monthly payments. Any modification to a loan that is a concession and is not in the normal course of lending is considered a restructured loan. A restructured loan is returned to accruing status after six consecutive payments but is still reported as TDR unless the loan bears interest at a market rate. As of March 31, 2012, the Company had $5.6 million in TDR’s and $3.4 million were performing according to the restructured terms. The financial statement impact of non-perfoming TDR’s was not material for the three months ending March 31, 2012. There was $840,000 of specific reserves allocated to TDR’s at March 31, 2012 based on the collateral deficiencies.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

Loans classified as troubled debt restructuring during the three months ended March 31, 2012 and 2011, segregated by class, are shown in the table below.

 

		March 31, 2012								March 31, 2011
		Number of Defaults				Unpaid Principal Balance				Number of Defaults				Unpaid Principal Balance
Commercial
Owner occupied real estate			—			$	—				—			$	—
Non owner occupied real estate			—				—				—				—
Residential development			—				—				—				—
Development & Spec Land Loans			—				—				—				—
Commercial and industrial			—				—				—				—
Total commercial			—				—				—				—
Real estate
Residential mortgage			1				121				2				342
Residential construction			—				—				—				—
Mortgage warehouse			—				—				—				—
Total real estate			1				121				2				342
Consumer
Direct Installment			—				—				—				—
Direct Installment Purchased			—				—				—				—
Indirect Installment			—				—				—				—
Home Equity			1				53				1				9
Total Consumer			1				53				1				9
Total			2			$	174				3			$	351

Troubled debt restructured loans which had payment defaults during the three months ended March 31, 2012 and 2011, segregated by class, are shown in the table below. Default occurs when a loan is 90 days or more past due or transferred to nonaccrual.

 

		March 31, 2012								March 31, 2011
		Number				Unpaid				Number				Unpaid
		of				Principal				of				Principal
		Defaults				Balance				Defaults				Balance
Commercial
Owner occupied real estate			—			$	—				—			$	—
Non owner occupied real estate			—				—				—				—
Residential development			—				—				—				—
Development & Spec Land Loans			—				—				—				—
Commercial and industrial			—				—				—				—
Total commercial			—				—				—				—
Real estate
Residential mortgage			2				232				1				459
Residential construction			—				—				1				293
Mortgage warehouse			—				—				—				—
Total real estate			2				232				2				752
Consumer
Direct Installment			—				—				—				—
Direct Installment Purchased			—				—				—				—
Indirect Installment			—				—				—				—
Home Equity			1				53				—				—
Total Consumer			1				53				—				—
Total			3			$	285				2			$	752

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

The following table presents commercial loans individually evaluated for impairment by class of loans:

 

														Three Months Ending
														Average				Cash/Accrual
		Unpaid								Allowance For				Balance in				Interest
		Principal				Recorded				Loan Loss				Impaired				Income
March 31, 2012		Balance				Investment				Allocated				Loans				Recognized
With no recorded allowance
Commercial
Owner occupied real estate		$	723			$	723			$	—			$	503			$	3
Non owner occupied real estate			972				974				—				973				—
Residential development			—				—				—				—				—
Development & Spec Land Loans			90				90				—				90				—
Commercial and industrial			338				338				—				240				1
Total commercial			2,123				2,125				—				1,806				4
With an allowance recorded
Commercial
Owner occupied real estate			1,636				1,636				595				1,783				1
Non owner occupied real estate			3,213				3,213				1,105				3,186				2
Residential development			—				—				—				—				—
Development & Spec Land Loans			715				715				470				237				6
Commercial and industrial			1,348				1,348				663				1,130				4
Total commercial			6,912				6,912				2,833				6,336				13
Total		$	9,035			$	9,037			$	2,833			$	8,142			$	17

 

														Three Months Ending
														Average				Cash/Accrual
		Unpaid								Allowance For				Balance in				Interest
		Principal				Recorded				Loan Loss				Impaired				Income
March 31, 2011		Balance				Investment				Allocated				Loans				Recognized
With no recorded allowance
Commercial
Owner occupied real estate		$	1,003			$	1,006			$	—			$	818			$	1
Non owner occupied real estate			1,254				1,254				—				1,037				4
Residential development			16				16				—				16				—
Development & Spec Land Loans			124				124				—				83				—
Commercial and industrial			191				191				—				154				—
Total commercial			2,588				2,591				—				2,107				5
With an allowance recorded
Commercial
Owner occupied real estate			1,538				1,537				585				1,141				—
Non owner occupied real estate			4,849				4,888				665				4,884				—
Residential development			—				—				—				—				—
Development & Spec Land Loans			250				250				125				250				—
Commercial and industrial			251				251				115				251				1
Total commercial			6,888				6,926				1,490				6,526				1
Total		$	9,476			$	9,517			$	1,490			$	8,633			$	6

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

The following table presents the payment status by class of loans:

 

March 31, 2012		30 - 59 Days Past Due				60 - 89 Days Past Due				Greater than 90 Days Past Due				Total Past Due				Loans Not Past Due				Total
Commercial
Owner occupied real estate		$	285			$	30			$	—			$	315			$	129,215			$	129,530
Non owner occupied real estate			—				97				—				97				150,764				150,861
Residential development			—				—				—				—				2,834				2,834
Development & Spec Land Loans			—				—				—				—				7,366				7,366
Commercial and industrial			1				—				—				1				59,743				59,744
Total commercial			286				127				—				413				349,922				350,335
Real estate
Residential mortgage			213				254				—				467				147,606				148,073
Residential construction			292				—				—				292				7,117				7,409
Mortgage warehouse			—				—				—				—				213,152				213,152
Total real estate			505				254				—				759				367,875				368,634
Consumer
Direct Installment			137				17				—				154				24,581				24,735
Direct Installment Purchased			4				8				9				21				842				863
Indirect Installment			816				87				19				922				130,539				131,461
Home Equity			655				36				—				691				112,729				113,420
Total consumer			1,612				148				28				1,788				268,691				270,479
Total		$	2,403			$	529			$	28			$	2,960			$	986,488			$	989,448

 

December 31, 2011		30 - 59 Days Past Due				60 - 89 Days Past Due				Greater than 90 Days Past Due				Total Past Due				Loans Not Past Due				Total
Commercial
Owner occupied real estate		$	89			$	168			$	—			$	257			$	131,636			$	131,893
Non owner occupied real estate			228				—				—				228				142,041				142,269
Residential development			—				—				—				—				3,574				3,574
Development & Spec Land Loans			—				—				—				—				8,739				8,739
Commercial and industrial			34				22				—				56				65,718				65,774
Total commercial			351				190				—				541				351,708				352,249
Real estate
Residential mortgage			411				—				—				411				150,482				150,893
Residential construction			—				—				—				—				6,181				6,181
Mortgage warehouse			—				—				—				—				208,299				208,299
Total real estate			411				—				—				411				364,962				365,373
Consumer
Direct Installment			164				22				1				187				24,065				24,252
Direct Installment Purchased			7				14				4				25				956				981
Indirect Installment			1,333				335				29				1,697				126,054				127,751
Home Equity			363				92				3				458				113,103				113,561
Total consumer			1,867				463				37				2,367				264,178				266,545
Total		$	2,629			$	653			$	37			$	3,319			$	980,848			$	984,167

The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date.

Horizon Bank’s processes for determining credit quality differ slightly depending on whether a new loan or a renewed loan is being underwritten, or whether an existing loan is re-evaluated for credit quality. The latter usually occurs upon receipt of current financial information or other pertinent data that would trigger a change in the loan grade.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

•

For new and renewed commercial loans, the Bank’s Credit Department, which acts independently of the loan officer, assigns the credit quality grade to the loan. Loan grades for loans with an aggregate credit exposure of $500,000 or greater are validated by the Loan Committee, which is chaired by the Chief Operating Officer (COO).

 

•

Commercial loan officers are responsible for reviewing their loan portfolios and report any adverse material change to the COO or Loan Committee. When circumstances warrant a change in the credit quality grade, loan officers are required to notify the COO and the Credit Department of the change in the loan grade. Downgrades are accepted immediately by the COO however, lenders must present their factual information to either the Loan Committee or the COO when recommending an upgrade.

 

•

The COO meets weekly with loan officers to discuss the status of past-due loans and classified loans. These meetings are also designed to give the loan officers an opportunity to identify an existing loan that should be downgraded to a classified grade.

 

•

Monthly, Senior Management attends the Watch Committee, which reviews all of the past due, classified, and impaired loans and the relative trends of these assets. This committee also reviews the actions taken by management regarding foreclosure mitigation, loan extensions, troubled debt restructures, and collateral repossessions. The information reviewed in this meeting acts as a precursor for developing Management’s analysis of the adequacy of the Allowance for Loan and Lease Losses.

For real estate and consumer loans, Horizon uses a grading system based on delinquency. Loans that are 90 days or more past due, on non-accrual, or a troubled debt restructure are graded “Substandard.” After being 90 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass.

Horizon Bank employs an eight-grade rating system to determine the credit quality of commercial loans. The first four grades represent acceptable quality, and the last four grades mirror the criticized and classified grades used by the bank regulatory agencies (special mention, substandard, doubtful, and loss). The loan grade definitions are detailed below.

Risk Grade 1: Excellent (Pass)

Loans secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better.

Risk Grade 2: Good (Pass)

Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by unaudited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets and unblemished credit history; or loans to publicly held companies with current long-term debt ratings of Baa or better.

Risk Grade 3: Satisfactory (Pass)

Loans supported by financial statements (audited or unaudited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:

 

•

At inception, the loan was properly underwritten, did not possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory;

 

•

At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss.

 

•

The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.

 

•

During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.

Risk Grade 4: Satisfactory/Monitored (Pass)

Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans due to weak balance sheets, marginal earnings or cash flow, lack of financial information, weakening markets, insufficient or questionable collateral coverage or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision. Loans that normally fall into this grade include construction of commercial real estate buildings, land development and subdivisions, and rental properties that have not attained stabilization.

Risk Grade 5: Special Mention

Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered “potential,” not “defined,” impairments to the primary source of repayment. These loans may be to borrowers with adverse trends in financial performance, collateral value and/or marketability, or balance sheet strength.

Risk Grade 6: Substandard

One or more of the following characteristics may be exhibited in loans classified Substandard:

 

•

Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.

 

•

Loans are inadequately protected by the current net worth and paying capacity of the obligor.

 

•

The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.

 

•

Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

 

•

Unusual courses of action are needed to maintain a high probability of repayment.

 

•

The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments.

 

•

The lender is forced into a subordinated or unsecured position due to flaws in documentation.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

•

Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms.

 

•

The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

 

•

There is a significant deterioration in market conditions to which the borrower is highly vulnerable.

Risk Grade 7: Doubtful

One or more of the following characteristics may be present in loans classified Doubtful:

 

•

Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.

 

•

The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

 

•

The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.

Risk Grade 8: Loss

Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

March 31, 2012		Pass				Special Mention				Substandard				Doubtful				Total
Commercial
Owner occupied real estate		$	111,070			$	5,936			$	12,524			$	—			$	129,530
Non owner occupied real estate			125,077				12,740				13,044				—				150,861
Residential development			974				527				1,333				—				2,834
Development & Spec Land Loans			3,624				939				2,803				—				7,366
Commercial and industrial			52,043				2,831				4,870				—				59,744
Total commercial			292,788				22,973				34,574				—				350,335
Real estate
Residential mortgage			139,842				—				8,231				—				148,073
Residential construction			6,973				—				436				—				7,409
Mortgage warehouse			213,152				—				—				—				213,152
Total real estate			359,967				—				8,667				—				368,634
Consumer
Direct Installment			24,554				—				181				—				24,735
Direct Installment Purchased			854				—				9				—				863
Indirect Installment			130,687				—				774				—				131,461
Home Equity			110,982				—				2,438				—				113,420
Total Consumer			267,077				—				3,402				—				270,479
Total		$	919,832			$	22,973			$	46,643			$	—			$	989,448

 

December 31, 2011		Pass				Special Mention				Substandard				Doubtful				Total
Commercial
Owner occupied real estate		$	107,155			$	4,101			$	20,637			$	—			$	131,893
Non owner occupied real estate			118,446				11,423				12,400				—				142,269
Residential development			1,677				529				1,368				—				3,574
Development & Spec Land Loans			3,778				860				4,101				—				8,739
Commercial and industrial			55,964				3,012				6,798				—				65,774
Total commercial			287,020				19,925				45,304				—				352,249
Real estate
Residential mortgage			142,834				—				8,059				—				150,893
Residential construction			5,744				—				437				—				6,181
Mortgage warehouse			208,299				—				—				—				208,299
Total real estate			356,877				—				8,496				—				365,373
Consumer
Direct Installment			23,995				—				257				—				24,252
Direct Installment Purchased			977				—				4				—				981
Indirect Installment			126,796				—				955				—				127,751
Home Equity			111,088				—				2,473				—				113,561
Total Consumer			262,856				—				3,689				—				266,545
Total		$	906,753			$	19,925			$	57,489			$	—			$	984,167

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

Note 6 – Derivative financial instruments

Cash Flow Hedges

As a strategy to maintain acceptable levels of exposure to the risk of changes in future cash flow due to interest rate fluctuations, the Company entered into interest rate swap agreements for a portion of its floating rate debt. The agreements provide for the Company to receive interest from the counterparty at three month LIBOR and to pay interest to the counterparty at a weighted average fixed rate of 5.63% on a notional amount of $30.5 million at March 31, 2012. Under these agreements, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense.

Management has designated the interest rate swap agreement as a cash flow hedging instrument. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of the other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. At March 31, 2012, the Company’s cash flow hedge was effective and is not expected to have a significant impact the Company’s net income over the next 12 months.

Fair Value Hedges

Fair value hedges are intended to reduce the interest rate risk associated with the underlying hedged item. The Company enters into fixed rate loan agreements as part of its lending activities. To mitigate the risk of changes in fair value based on fluctuations in interest rates, the Company has entered into interest rate swap agreements on individual loans, converting the fixed rate loans to a variable rate. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current earnings. At March 31, 2012, the Company’s fair value hedges were effective and are not expected to have a significant impact on the Company’s net income over the next 12 months.

The change in fair value of both the hedge instruments and the underlying loan agreements are recorded as gains or losses in interest income. The fair value hedges are considered to be highly effective, and any hedge ineffectiveness was deemed not material. The notional amounts of the loan agreements being hedged were $47.6 million at March 31, 2012.

Other Derivative Instruments

The Company enters into non-hedging derivatives in the form of mortgage loan forward sale commitments with investors and commitments to originate mortgage loans as part of its mortgage banking business. At March 31, 2012, the Company’s fair value of these derivatives was recorded and over the next 12 months is not expected to have a significant impact on the Company’s net income.

The change in fair value of both the forward sale commitments and commitments to originate mortgage loans were recorded and the net gains or losses included in the Company’s gain on sale of loans.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

The following tables summarize the fair value of derivative financial instruments utilized by Horizon Bancorp:

 

		Asset Derivative March 31, 2012						Liability Derivatives March 31, 2012
Derivatives designated as hedging instruments (Unaudited)		Balance Sheet Location		Fair Value				Balance Sheet Location				Fair Value
Interest rate contracts		Loans		$	643				Other liabilities			$	2,113
Interest rate contracts		Other Assets			1,470				Other liabilities				4,351
Total derivatives designated as hedging instruments					2,113								6,464
Derivatives not designated as hedging instruments
Mortgage loan contracts		Other assets			510				Other liabilities				71
Total derivatives not designated as hedging instruments					510								71
Total derivatives				$	2,623							$	6,535

 

		Asset Derivative December 31, 2011						Liability Derivatives December 31, 2011
Derivatives designated as hedging instruments (Unaudited)		Balance Sheet Location		Fair Value				Balance Sheet Location				Fair Value
Interest rate contracts		Loans		$	754				Other liabilities			$	2,187
Interest rate contracts		Other Assets			1,433				Other liabilities				4,914
Total derivatives designated as hedging instruments					2,187								7,101
Derivatives not designated as hedging instruments
Mortgage loan contracts		Other assets			662				Other liabilities				—
Total derivatives not designated as hedging instruments					662								—
Total derivatives				$	2,849							$	7,101

The effect of the derivative instruments on the consolidated statement of income for the three-month periods ending is as follows:

 

		Comprehensive Income on Derivative (Effective Portion)
		Three Months Ended March 31
Derivative in cash flow hedging relationship		2012 (Unaudited)				2011 (Unaudited)
Interest rate contracts		$	367			$	293

FASB Accounting Standards Codification (“ASC”) Topic 820-10-20 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820-10-55 establishes a fair value hierarchy that emphasizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

`				Amount of Gain (Loss) Recognized on Derivative
Derivative in fair value hedging relationship		Location of gain (loss) recognized on derivative		Three Months Ended March 31
				2012 (Unaudited)				2011 (Unaudited)
Interest rate contracts		Interest income - loans		$	(74	)		$	(410	)
Interest rate contracts		Interest income - loans		$	74				410
Total				$	—			$	—
				Amount of Gain (Loss) Recognized on Derivative
Derivative not designated as hedging relationship		Location of gain (loss) recognized on derivative		Three Months Ended March 31
				2012 (Unaudited)				2011 (Unaudited)
Mortgage contracts		Other income - gain on sale of loans		$	(223	)		$	634

Note 7 – Disclosures about fair value of assets and liabilities

The Fair Value Measurements topic of the FASB ASC defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. There are three levels of inputs that may be used to measure fair value:

 

Level 1		Quoted prices in active markets for identical assets or liabilities
Level 2		Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying financial statements, as well as the general classification of such instruments pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the period ended March 31, 2012. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Available for sale securities

When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U.S. Treasury and federal agency securities, state and municipal securities, federal agency mortgage obligations and mortgage-backed pools, and corporate notes. Level 2 securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs. Observable inputs include dealer quotes, market spreads, cash flow analysis, the U.S. Treasury yield curve, trade execution data, market consensus prepayment spreads and available credit information and the bond’s terms and conditions. The pricing provider utilizes evaluated pricing models that vary based on asset class. These models incorporate available market information including quoted prices of securities with similar characteristics and, because many fixed-income securities do not trade on a daily basis, apply available information through processes such as benchmark curves, benchmarking of like securities, sector grouping, and matrix pricing. In addition, model processes, such as an option adjusted spread model is used to develop prepayment and interest rate scenarios for securities with prepayment features.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Table Dollar Amounts in Thousands, Except Per Share Data)

 

Hedged loans

Certain fixed rate loans have been converted to variable rate loans by entering into interest rate swap agreements. The fair value of those fixed rate loans is based on discounting the estimated cash flows using interest rates determined by the respective interest rate swap agreement. Loans are classified within Level 2 of the valuation hierarchy based on the unobservable inputs used.

Interest rate swap agreements

The fair value of the Company’s interest rate swap agreements is estimated by a third party using inputs that are primarily unobservable including a yield curve, adjusted for liquidity and credit risk, contracted terms and discounted cash flow analysis, therefore, are classified within Level 2 of the valuation hierarchy.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying financial statements measured at fair value on a recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at the following:

 

		Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
March 31, 2012
Available-for-sale securities
U.S. Treasury and federal agencies		$	18,657			$	—			$	18,657			$	—
State and municipal			143,774				—				143,774				—
Federal agency collateralized mortgage obligations			86,690				—  </