Edgar Filing: HORIZON BANCORP /IN/

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10-Q

HORIZON BANCORP

FORM 10-Q

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

¨	QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

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)

Registrant’s telephone number, including area code: (219) 879-0211

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

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):

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: 8,693,741 shares of Common Stock, no par value, at May 8, 2013.

HORIZON BANCORP

FORM 10-Q

INDEX


PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements	3

	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	37

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	48

Item 4.	Controls and Procedures	48

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	49

Item 1A.	Risk Factors	49

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 3.	Defaults Upon Senior Securities	49

Item 4.	Mine Safety Disclosures	49

Item 5.	Other Information	49

Item 6.	Exhibits	50

Signatures		51

Index To Exhibits		52

PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollar Amounts in Thousands)


	March 31 2013		December 31 2012
	(Unaudited)
Assets
Cash and due from banks	$	27,053	$	30,735
Investment securities, available for sale		479,976		482,801
Investment securities, held to maturity		2,110		—
Loans held for sale		9,105		13,744
Loans, net of allowance for loan losses of $19,565 and $18,270		1,070,203		1,172,447
Premises and equipment		42,431		42,184
Federal Reserve and Federal Home Loan Bank stock		13,333		13,333
Goodwill		19,748		19,748
Other intangible assets		3,857		4,048
Interest receivable		7,549		7,716
Cash value life insurance		35,444		35,192
Other assets		23,441		26,279

Total assets	$	1,734,250	$	1,848,227

Liabilities
Deposits
Non-interest bearing	$	217,197	$	209,200
Interest bearing		1,097,866		1,084,953

Total deposits		1,315,063		1,294,153
Borrowings		208,899		345,764
Subordinated debentures		32,370		32,331
Interest payable		552		560
Other liabilities		15,089		16,451

Total liabilities		1,571,973		1,689,259

Commitments and contingent liabilities
Stockholders’ Equity
Preferred stock, Authorized, 1,000,000 shares Series B shares $.01 par value, $1,000 liquidation value Issued 12,500 shares		12,500		12,500
Common stock, no par value Authorized, 22,500,000 shares Issued, 8,693,471 shares Outstanding, 8,617,466 shares		—		—
Additional paid-in capital		32,037		31,965
Retained earnings		109,700		105,402
Accumulated other comprehensive income		8,040		9,101

Total stockholders’ equity		162,277		158,968

Total liabilities and stockholders’ equity	$	1,734,250	$	1,848,227

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Dollar Amounts in Thousands, Except Per Share Data)


	Three Months Ended March 31
	2013 (Unaudited)			2012 (Unaudited)
Interest Income
Loans receivable	$	16,440		$	13,532
Investment securities
Taxable		2,022			2,314
Tax exempt		967			980

Total interest income		19,429			16,826

Interest Expense
Deposits		1,480			1,639
Borrowed funds		1,448			1,519
Subordinated debentures		491			470

Total interest expense		3,419			3,628

Net Interest Income		16,010			13,198
Provision for loan losses		2,084			559

Net Interest Income after Provision for Loan Losses		13,926			12,639

Other Income
Service charges on deposit accounts		913			712
Wire transfer fees		190			182
Interchange fees		866			628
Fiduciary activities		1,140			975
Gain on sale of investment securities (includes $368 and $0 for the three months ended March 31, 2013 and 2012, respectively, related to accumulated other comprehensive earnings reclasifications)		368			—
Gain on sale of mortgage loans		3,106			2,274
Mortgage servicing income net of impairment		163			90
Increase in cash value of bank owned life insurance		252			225
Other income		462			56

Total other income		7,460			5,142

Other Expenses
Salaries and employee benefits		7,504			5,963
Net occupancy expenses		1,311			1,054
Data processing		600			526
Professional fees		499			534
Outside services and consultants		712			471
Loan expense		1,114			702
FDIC insurance expense		283			257
Other losses		(72	)		30
Other expenses		2,028			1,623

Total other expenses		13,979			11,160

Income Before Income Tax		7,407			6,621
Income tax expense (includes $129 and $0 for the three months ended March 31, 2013 and 2012, respectively, related to income tax expense from reclassification items)		2,096			2,008

Net Income		5,311			4,613
Preferred stock dividend and discount accretion		(146	)		(156	)

Net Income Available to Common Shareholders	$	5,165		$	4,457

Basic Earnings Per Share	$	0.60		$	0.60
Diluted Earnings Per Share		0.58			0.59

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)


	Three Months Ended March 31
	2013 (Unaudited)			2012 (Unaudited)
Net Income	$	5,311		$	4,613

Other Comprehensive Income (Loss)
Change in fair value of derivative instruments, net of taxes of $154 and $198, for the three months ended March 31, 2013 and 2012, respectively		285			367
Unrealized appreciation (depreciation) on available-for-sale securities, net of taxes of $(597) and $303, for the three months ended March 31, 2013 and 2012, respectively		(1,107	)		564
Less: reclassification adjustment for realized gains included in net income, net of taxes of $129 and $0, for the three months ended March 31, 2013 and 2012, respectively		239			—

		(1,061	)		931

Comprehensive Income	$	4,250		$	5,544

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

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


	Preferred Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances, January 1, 2013	$	12,500	$	31,965	$	105,402		$	9,101		$	158,968
Net income						5,311						5,311
Other comprehensive income (loss), net of tax									(1,061	)		(1,061	)

Amortization of unearned compensation				64								64
Stock option expense				8								8
Cash dividends on preferred stock (4.67%)						(146	)					(146	)
Cash dividends on common stock ($.10 per share)						(867	)					(867	)

Balances, March 31, 2013	$	12,500	$	32,037	$	109,700		$	8,040		$	162,277

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)


	Three Months Ended March 31
	2013			2012
	(Unaudited)			(Unaudited)
Operating Activities
Net income	$	5,311		$	4,613
Items not requiring (providing) cash
Provision for loan losses		2,084			559
Depreciation and amortization		849			646
Share based compensation		8			8
Mortgage servicing rights impairment (recovery)		(33	)		7
Premium amortization on securities available for sale, net		808			700
Gain on sale of investment securities		(368	)		—
Gain on sale of mortgage loans		(3,106	)		(2,274	)
Proceeds from sales of loans		102,762			82,619
Loans originated for sale		(95,017	)		(80,345	)
Change in cash value of life insurance		(252	)		(225	)
(Gain) loss on sale of other real estate owned		(238	)		21
Net change in
Interest receivable		167			(127	)
Interest payable		(8	)		(41	)
Other assets		3,346			1,415
Other liabilities		(676	)		(179	)

Net cash provided by operating activities		15,637			7,397

Investing Activities
Purchases of securities available for sale		(51,581	)		(22,581	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale		51,894			20,294
Purchase of securities held to maturity		(2,110	)		—
Net change in loans		99,089			(2,102	)
Proceeds on the sale of OREO and repossessed assets		1,159			2,461
Purchases of premises and equipment		(841	)		(1,622	)

Net cash provided by (used in) by investing activities		97,610			(3,550	)

Financing Activities
Net change in
Deposits		20,910			54,756
Borrowings		(136,826	)		(59,199	)
Dividends paid on common shares		(867	)		(646	)
Dividends paid on preferred shares		(146	)		(156	)

Net cash used in financing activities		(116,929	)		(5,245	)

Net Change in Cash and Cash Equivalent		(3,682	)		(1,398	)
Cash and Cash Equivalents, Beginning of Period		30,735			20,447

Cash and Cash Equivalents, End of Period	$	27,053		$	19,049

Additional Cash Flows Information
Interest paid	$	3,427		$	3,669
Income taxes paid		400			900
Transfer of loans to other real estate owned		670			527

See notes to condensed consolidated financial statements

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, 2013 and March 31, 2012 are not necessarily indicative of the operating results for the full year of 2013 or 2012. 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 2012 filed with the Securities and Exchange Commission on March 12, 2013. The consolidated condensed balance sheet of Horizon as of December 31, 2012 has been derived from the audited balance sheet 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
	2013		2012
	(Unaudited)		(Unaudited)
Basic earnings per share
Net income	$	5,311	$	4,613
Less: Preferred stock dividends and accretion of discount		146		156

Net income available to common shareholders	$	5,165	$	4,457

Weighted average common shares outstanding⁽¹⁾⁽²⁾		8,617,466		7,422,860

Basic earnings per share	$	0.60	$	0.60

Diluted earnings per share
Net income available to common shareholders	$	5,165	$	4,457

Weighted average common shares outstanding⁽¹⁾⁽²⁾		8,617,466		7,422,860
Effect of dilutive securities:
Warrants		293,237		159,657
Restricted stock		35,557		1,457
Stock options		34,395		14,517

Weighted average shares outstanding		8,980,655		7,598,490

Diluted earnings per share	$	0.58	$	0.59

⁽¹⁾	Adjusted for 3:2 stock split on November 9, 2012

⁽²⁾	Includes average shares issued for the Heartland acquisition for the three months ending March 31, 2013

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

At March 31, 2013 and 2012, there were no shares and 47,250 shares, respectively, which 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, 2012 Annual Report on Form 10-K.

Reclassifications

Certain reclassifications have been made to the 2012 consolidated financial statements to be comparable to 2013. These reclassifications had no effect on net income.

Note 2 – Acquisition

On July 17, 2012 Horizon closed its acquisition of Heartland Bancshares, Inc. and Horizon Bank N.A.’s acquisition of Heartland Community Bank, through mergers effective as of that date. Under the final terms of the acquisition, the exchange ratio was 0.81 shares of Horizon’s common stock for each share of Heartland common stock outstanding. Heartland shares outstanding at the closing were 1,442,449, and the shares of Horizon common stock issued to Heartland shareholders totaled 1,168,383. Horizon’s stock price was $16.83 per share at the close of business on July 17, 2012. Based upon these numbers, the total value of the consideration, including the retirement of TARP, for the acquisition was $26.9 million. For the year ended December 31, 2012, the Company had approximately $1.5 million in costs related to the acquisition. These expenses are classified in the other expense section of the income statement primarily located in the salaries and employee benefits, professional services and other expense line items. As a result of the acquisition, the Company will have an opportunity to increase its deposit base and reduce transaction costs. The Company also expects to reduce cost through economies of scale.

Under the purchase method of accounting, the total estimated purchase price is allocated to Heartland’s net tangible and intangible assets based on their current estimated fair values on the date of the acquisition. Based on management’s preliminary valuation of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on estimates and assumptions that are subject to change, the preliminary purchase price for the Heartland acquisition is allocated as follows (in thousands):


ASSETS
Cash and due from banks	$	33,531
Investment securities, available for sale		63,707

Commercial		70,343
Residential mortgage		20,838
Consumer		23,423

Total loans		114,604

Premises and equipment		2,647
FRB and FHLB stock		943
Goodwill		13,838
Core deposit intangible		2,332
Interest receivable		820
Cash value life insurance		4,012
Other assets		9,210

Total assets purchased	$	245,644

Common shares issued	$	19,668
Retirement of TARP preferred shares		7,248

Total estimated purchase price	$	26,916


LIABILITIES
Deposits
Non-interest bearing	$	59,350
NOW accounts		42,681
Savings and money market		61,465
Certificates of deposits		47,749

Total deposits		211,245

Borrowings		1,186
Subordinated debentures		1,537
Interest payable		90
Other liabilities		4,670

Total liabilities assumed	$	218,728

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Of the total estimated purchase price of $26.9 million, $2.3 million has been allocated to core deposit intangible. Additionally, $13.8 million has been allocated to goodwill and $10.8 million of the purchase price is deductible and was assigned to the business assets. The core deposit intangible will be amortized over seven years on a straight line basis.

The Company acquired loans in the acquisition and the transferred loans had evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past-due and nonaccrual status, borrower credit scores and recent loan-to-value percentages. Purchased credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310-30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. Management estimated the cash flows expected to be collected at acquisition using our internal risk models, which incorporate the estimate of current key assumptions, such as default rates, severity and prepayment speeds.

The Company acquired the $131.1 million loan portfolio at a fair value discount of $16.5 million. The performing portion of the portfolio, $95.4 million, had an estimated fair value of $91.6 million. The excess of expected cash flows above the fair value of the performing portion of loans will be accreted to interest income over the remaining lives of the loans in accordance with ASC 310-20.

Preliminary estimates of certain loans, those for which specific credit-related deterioration, since origination, was identified are recorded at fair value, reflecting the present value of the amounts expected to be collected. Income recognition of these loans is based on reasonable expectation about the timing and amount of cash flows to be collected.

The following table details the acquired loans that are accounted for in accordance with ASC 310-30 (formerly Statement of Position “SOP” 03-3) as of July 17, 2012.


Contractually required principal and interest at acquisition	$	35,574
Contractual cash flows not expected to be collected (nonaccretable differences)		5,264

Expected cash flows at acquisition		30,310
Interest component of expected cash flows (accretable discount)		7,494

Fair value of acquired loans accounted for under ASC 310-30	$	22,816

Pro-forma statements were determined to be impracticable due to the materiality of the transaction.

The carrying amount of those loans is included in the balance sheet amounts of loans receivable at March 31, 2013. The amounts of loans at March 31, 2013, are as follows:


Commercial	$	55,081
Real estate		16,011
Consumer		15,504

Outstanding balance	$	86,596

Carrying amount, net of allowance of $1,418	$	85,178

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Accretable yield, or income expected to be collected, is as follows:


Balance at December 31, 2012	$	6,111
Additions		—
Accretion		(451	)
Reclassification from nonaccreatable difference		—
Disposals		(696	)

Balance at March 31, 2013	$	4,964

During the three months ended March 31, 2013, the Company increased the allowance for loan losses by a charge to the income statement by $1.4 million. No allowances for loan losses were reversed for the three months ended 2013.

Note 3 – Securities

The fair value of securities is as follows:


March 31, 2013	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Treasury and federal agencies	$	45,974	$	281	$	(38	)	$	46,217
State and municipal		160,824		9,864		(199	)		170,489
Federal agency collateralized mortgage obligations		109,727		1,591		(83	)		111,235
Federal agency mortgage-backed pools		144,300		5,956		(26	)		150,230
Private labeled mortgage-backed pools		1,695		61		—			1,756
Corporate notes		32		17		—			49

Total available for sale investment securities	$	462,552	$	17,770	$	(346	)	$	479,976

Held to maturity, State and Municipal	$	2,110	$	—	$	—		$	2,110


December 31, 2012	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Treasury and federal agencies	$	51,458	$	351	$	(30	)	$	51,779
State and municipal		162,147		10,842		(84	)		172,905
Federal agency collateralized mortgage obligations		95,337		1,533		(39	)		96,831
Federal agency mortgage-backed pools		152,372		6,847		(15	)		159,204
Private labeled mortgage-backed pools		1,960		71		—			2,031
Corporate notes		32		19		—			51

Total available for sale investment securities	$	463,306	$	19,663	$	(168	)	$	482,801

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, 2013, 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 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 contractual terms of those investments do not permit the issuer to settle the securities at a

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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, 2013.

The amortized cost and fair value of securities available for sale and held to maturity at March 31, 2013 and December 31, 2012, 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, 2013				December 31, 2012
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Available for sale
Within one year	$	4,102	$	4,116	$	4,358	$	4,368
One to five years		53,522		54,656		49,415		50,673
Five to ten years		91,240		96,738		98,551		104,258
After ten years		57,966		61,245		61,313		65,436

		206,830		216,755		213,637		224,735
Federal agency collateralized mortgage obligations		109,727		111,235		95,337		96,831
Federal agency mortgage-backed pools		144,300		150,230		152,372		159,204
Private labeled mortgage-backed pools		1,695		1,756		1,960		2,031

Total available for sale investment securities	$	462,552	$	479,976	$	463,306	$	482,801

Held to maturity
Within one year	$	2,110	$	2,110	$	—	$	—
One to five years		—		—		—		—

Total held to maturity investment securities	$	2,110	$	2,110	$	—	$	—

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, 2013	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasury and federal agencies	$	15,552	$	(38	)	$	—	$	—	$	15,552	$	(38	)
State and municipal		16,027		(199	)		—		—		16,027		(199	)
Federal agency collateralized mortgage obligations		31,845		(83	)		—		—		31,845		(83	)
Federal agency mortgage-backed pools		15,241		(26	)		—		—		15,241		(26	)

Total temporarily impaired securities	$	78,665	$	(346	)	$	—	$	—	$	78,665	$	(346	)


	Less than 12 Months					12 Months or More				Total
December 31, 2012	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasury and federal agencies	$	13,064	$	(30	)	$	—	$	—	$	13,064	$	(30	)
State and municipal		11,928		(84	)		—		—		11,928		(84	)
Federal agency collateralized mortgage obligations		12,719		(39	)		—		—		12,719		(39	)
Federal agency mortgage-backed pools		4,126		(15	)		—		—		4,126		(15	)

Total temporarily impaired securities	$	41,837	$	(168	)	$	—	$	—	$	41,837	$	(168	)

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


	Three months ended March 31
	2013			2012
Sales of securities available for sale (Unaudited)
Proceeds	$	23,485		$	—
Gross gains		376			—
Gross losses		(8	)		—

Note 4 – Loans


	March 31			December 31
	2013			2012
Commercial
Working capital and equipment	$	207,901		$	198,805
Real estate, including agriculture		251,470			247,108
Tax exempt		4,467			4,579
Other		9,264			9,979

Total		473,102			460,471

Real estate
1–4 family		187,692			185,940
Other		3,655			3,774

Total		191,347			189,714

Consumer
Auto		139,785			142,149
Recreation		4,908			5,163
Real estate/home improvement		29,599			29,989
Home equity		101,261			104,974
Unsecured		3,759			4,194
Other		2,398			2,615

Total		281,710			289,084

Mortgage warehouse		143,609			251,448

Total loans		1,089,768			1,190,717
Allowance for loan losses		(19,565	)		(18,270	)

Loans, net	$	1,070,203		$	1,172,447

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 larger loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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, and 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 a 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 a 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, which 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 purchase 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.

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, 2013	Loan Balance			Interest Due		Deferred Fees / (Costs)			Recorded Investment
Owner occupied real estate	$	157,076		$	287	$	363		$	157,726
Non owner occupied real estate		217,220			197		349			217,766
Residential spec homes		248			—		—			248
Development & spec land loans		10,975			22		21			11,018
Commercial and industrial		86,729			815		121			87,665

Total commercial		472,248			1,321		854			474,423

Residential mortgage		184,589			599		506			185,694
Residential construction		6,252			8		—			6,260
Mortgage warehouse		143,609			480		—			144,089

Total real estate		334,450			1,087		506			336,043

Direct installment		27,396			108		(208	)		27,296
Direct installment purchased		382			—		—			382
Indirect installment		131,293			361		(71	)		131,583
Home equity		122,176			585		742			123,503

Total consumer		281,247			1,054		463			282,764

Total loans		1,087,945			3,462		1,823			1,093,230
Allowance for loan losses		(19,565	)		—		—			(19,565	)

Net loans	$	1,068,380		$	3,462	$	1,823		$	1,073,665


December 31, 2012	Loan Balance			Interest Due		Deferred Fees / (Costs)			Recorded Investment
Owner occupied real estate	$	162,694		$	503	$	485		$	163,682
Non owner occupied real estate		201,763			467		276			202,506
Residential spec homes		1,056			8		—			1,064
Development & spec land loans		6,963			11		—			6,974
Commercial and industrial		87,082			380		152			87,614

Total commercial		459,558			1,369		913			461,840

Residential mortgage		181,450			565		583			182,598
Residential construction		7,681			13		—			7,694
Mortgage warehouse		251,448			480		—			251,928

Total real estate		440,579			1,058		583			442,220

Direct installment		27,831			115		(204	)		27,742
Direct installment purchased		429			—		—			429
Indirect installment		133,481			370		—			133,851
Home equity		126,588			605		959			128,152

Total consumer		288,329			1,090		755			290,174

Total loans		1,188,466			3,517		2,251			1,194,234
Allowance for loan losses		(18,270	)		—		—			(18,270	)

Net loans	$	1,170,196		$	3,517	$	2,251		$	1,175,964

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 5 – 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 five-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. The actual allowance for loan loss activity is provided below.


	Three Months Ended
	March 31
	2013		2012
Balance at beginning of the period	$	18,270	$	18,882
Loans charged-off:
Commercial
Owner occupied real estate		132		—
Non owner occupied real estate		146		—
Residential development		—		—
Development & Spec Land Loans		—		—
Commercial and industrial		139		—

Total commercial		417		—
Real estate
Residential mortgage		143		89
Residential construction		—		—
Mortgage warehouse		—		—

Total real estate		143		89
Consumer
Direct Installment		107		113
Direct Installment Purchased		—		—
Indirect Installment		353		338
Home Equity		438		133

Total consumer		898		584

Total loans charged-off		1,458		673

Recoveries of loans previously charged-off:
Commercial
Owner occupied real estate		32		300
Non owner occupied real estate		2		7
Residential development		—		—
Development & Spec Land Loans		—		—
Commercial and industrial		36		25

Total commercial		70		332
Real estate
Residential mortgage		3		30
Residential construction		—		—
Mortgage warehouse		—		—

Total real estate		3		30
Consumer
Direct Installment		394		15
Direct Installment Purchased		—		—
Indirect Installment		170		201
Home Equity		32		66

Total consumer		596		282

Total loan recoveries		669		644

Net loans charged-off		789		29

Provision charged to operating expense
Commercial		1,738		86
Real estate		312		611
Consumer		34		(138	)

Total provision charged to operating expense		2,084		559

Balance at the end of the period	$	19,565	$	19,412

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Certain loans are individually evaluated for impairment, and the Company’s general practice is to proactively charge down impaired loans 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. Pursuant to such guidelines, the Company also charges-off unsecured open-end loans when the loan is 90 days past due, and charges down to the net realizable value other secured loans when they 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 in full will occur regardless of delinquency status, are not 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:


					Mortgage
March 31, 2013	Commercial		Real Estate		Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,945	$	—	$	—	$	—	$	1,945
Collectively evaluated for impairment		7,221		3,477		1,603		5,319		17,620

Total ending allowance balance	$	9,166	$	3,477	$	1,603	$	5,319	$	19,565

Loans:
Individually evaluated for impairment	$	10,054	$	—	$	—	$	—	$	10,054
Collectively evaluated for impairment		464,369		191,954		144,089		282,764		1,083,176

Total ending loans balance	$	474,423	$	191,954	$	144,089	$	282,764	$	1,093,230


					Mortgage
December 31, 2012	Commercial		Real Estate		Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,945	$	—	$	—	$	—	$	1,945
Collectively evaluated for impairment		5,826		3,204		1,705		5,590		16,325

Total ending allowance balance	$	7,771	$	3,204	$	1,705	$	5,590	$	18,270

Loans:
Individually evaluated for impairment	$	10,597	$	—	$	—	$	—	$	10,597
Collectively evaluated for impairment		451,243		190,292		251,928		290,174		1,183,637

Total ending loans balance	$	461,840	$	190,292	$	251,928	$	290,174	$	1,194,234

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 6 – 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 (“TDRs”) by class of loans:


			Loans Past
			Due Over 90						Total Non-
			Days Still		Non Performing		Performing		Performing
March 31, 2013	Nonaccrual		Accruing		TDR’s		TDR’s		Loans
Commercial
Owner occupied real estate	$	1,299	$	—	$	1,190	$	823	$	3,312
Non owner occupied real estate		2,219		—		1,674		447		4,340
Residential development		—		—		—		—		—
Development & Spec Land Loans		699		—		—		—		699
Commercial and industrial		912		—		792		—		1,704

Total commercial		5,129		—		3,656		1,270		10,055

Real estate
Residential mortgage		4,057		2		2,691		1,907		8,657
Residential construction		—		—		290		—		290
Mortgage warehouse		—		—		—		—		—

Total real estate		4,057		2		2,981		1,907		8,947

Consumer
Direct Installment		273		—		—		—		273
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		930		—		—		—		930
Home Equity		1,904		—		147		1,460		3,511

Total Consumer		3,107		—		147		1,460		4,714

Total	$	12,293	$	2	$	6,784	$	4,637	$	23,716


			Loans Past
			Due Over 90						Total Non-
			Days Still		Non Performing		Performing		Performing
December 31, 2012	Nonaccrual		Accruing		TDR’s		TDR’s		Loans
Commercial
Owner occupied real estate	$	2,800	$	—	$	1,272	$	819	$	4,891
Non owner occupied real estate		1,705		—		1,605		446		3,756
Residential development		—		—		—		—		—
Development & Spec Land Loans		705		—		—		—		705
Commercial and industrial		544		—		797		—		1,341

Total commercial		5,754		—		3,674		1,265		10,693

Real estate
Residential mortgage		4,565		2		2,536		1,761		8,864
Residential construction		—		—		291		—		291
Mortgage warehouse		—		—		—		—		—

Total real estate		4,565		2		2,827		1,761		9,155

Consumer
Direct Installment		138		26		—		—		164
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		866		26		—		—		892
Home Equity		2,051		—		148		676		2,875

Total Consumer		3,055		52		148		676		3,931

Total	$	13,374	$	54	$	6,649	$	3,702	$	23,779

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Included in the $12.3 million of non-accrual loans and the $6.8 million of non-performing TDR’s at March 31, 2013 were $3.0 million and $3.5 million, respectively, of loans acquired for which accretable yield was recognized.

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 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 the payment is delinquent in excess of 90 days or the loan has 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 in accordance with the loan terms. 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 they are 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 TDRs, 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 TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At March 31, 2013, the type of concessions the Company has made on restructured loans has been temporary rate reductions and/or reductions in monthly payments and there have been no restructured loans with modified recorded balances. 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, 2013, the Company had $11.4 million in TDRs and $4.6 million were performing according to the restructured terms and no TDR’s were returned to accrual status in the first three months of 2013. There was $1.7 million of specific reserves allocated to TDRs at March 31, 2013 based on the collateral deficiencies.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Loans transferred and classified as troubled debt restructuring during the three months ended March 31, 2013 and 2012, segregated by class, are shown in the table below.


	March 31, 2013				March 31, 2012
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		2	$	76		—	$	—
Non owner occupied real estate		1		70		—		—
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		—		—

Total commercial		3		146		—		—

Real estate
Residential mortgage		3		390		1		121
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		3		390		1		121

Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		2		791		1		53

Total Consumer		2		791		1		53

Total		8	$	1,327		2	$	174

Troubled debt restructured loans which had payment defaults during the three months ended March 31, 2013 and 2012, segregated by class, are shown in the table below. Default occurs when a loan is 90 days or more past due or has been transferred to nonaccrual.


	March 31, 2013				March 31, 2012
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		2	$	76		—	$	—
Non owner occupied real estate		1		70		—		—
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		—		—

Total commercial		3		146		—		—

Real estate
Residential mortgage		1		234		2		232
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		1		234		2		232

Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		—		—		1		53

Total Consumer		—		—		1		53

Total		4	$	380		3	$	285

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 loan:


							Three Months Ending
							Average		Cash/Accrual
	Unpaid				Allowance For		Balance in		Interest
	Principal		Recorded		Loan Loss		Impaired		Income
March 31, 2013	Balance		Investment		Allocated		Loans		Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	3,310	$	3,317	$	—	$	4,906		14
Non owner occupied real estate		2,578		2,579		—		3,793		11
Residential development		—		—		—		—		—
Development & Spec Land Loans		135		135		—		166		—
Commercial and industrial		912		928		—		1,877		—

Total commercial		6,935		6,959		—		10,742		25

With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		—		—
Non owner occupied real estate		1,763		1,763		1,080		1,774		—
Residential development		—		—		—		—		—
Development & Spec Land Loans		564		564		600		569		—
Commercial and industrial		792		792		265		794		—

Total commercial		3,119		3,119		1,945		3,137		—

Total	$	10,054	$	10,078	$	1,945	$	13,879	$	25


							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

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 loan:


	30 -59 Days			60 -89 Days			Greater than 90						Loans Not Past
March 31, 2013	Past Due			Past Due			Days Past Due			Total Past Due			Due			Total
Commercial
Owner occupied real estate	$	568		$	17		$	—		$	585		$	156,491		$	157,076
Non owner occupied real estate		636			183			—			819			216,401			217,220
Residential development		—			—			—			—			248			248
Development & Spec Land Loans		—			39			—			39			10,936			10,975
Commercial and industrial		203			99			—			302			86,427			86,729

Total commercial		1,407			338			—			1,745			470,503			472,248

Real estate
Residential mortgage		44			84			2			130			184,459			184,589
Residential construction		—			—			—			—			6,252			6,252
Mortgage warehouse		—			—			—			—			143,609			143,609

Total real estate		44			84			2			130			334,320			334,450

Consumer
Direct Installment		80			200			—			280			27,116			27,396
Direct Installment Purchased		—			—			—			—			382			382
Indirect Installment		949			96			—			1,045			130,248			131,293
Home Equity		1,428			1,091			—			2,519			119,657			122,176

Total consumer		2,457			1,387			—			3,844			277,403			281,247

Total	$	3,908		$	1,809		$	2		$	5,719		$	1,082,226		$	1,087,945

Percentage of total loans		0.36	%		0.17	%		0.00	%		0.53	%		99.47	%

	30 -59 Days			60 -89 Days			Greater than 90						Loans Not Past
December 31, 2012	Past Due			Past Due			Days Past Due			Total Past Due			Due			Total
Commercial
Owner occupied real estate	$	2,207		$	19		$	—		$	2,226		$	160,468 $			162,694
Non owner occupied real estate		669			147			—			816			200,947			201,763
Residential development		—			—			—			—			1,056			1,056
Development & Spec Land Loans		—			—			—			—			6,963			6,963
Commercial and industrial		538			16			—			554			86,528			87,082

Total commercial		3,414			182			—			3,596			455,962			459,558

Real estate
Residential mortgage		167			—			2			169			181,281			181,450
Residential construction		—			—			—			—			7,681			7,681
Mortgage warehouse		—			—			—			—			251,448			251,448

Total real estate		167			—			2			169			440,410			440,579

Consumer
Direct Installment		240			64			26			330			27,501			27,831
Direct Installment Purchased		—			—			—			—			429			429
Indirect Installment		1,105			177			26			1,308			132,173			133,481
Home Equity		1,072			321			—			1,393			125,195			126,588

Total consumer		2,417			562			52			3,031			285,298			288,329

Total	$	5,998		$	744		$	54		$	6,796		$	1,181,670		$	1,188,466

Percentage of total loans		0.50	%		0.06	%		0.00	%		0.57	%		99.43	%

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 being 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.

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 meets with 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 act 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 are classified as a TDR 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.

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.

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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The following table presents loans by credit grades.


March 31, 2013	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	139,631		$	4,062		$	13,383		$	—		$	157,076
Non owner occupied real estate		189,876			10,806			16,538			—			217,220
Residential development		248			—			—			—			248
Development & Spec Land Loans		7,108			99			3,768			—			10,975
Commercial and industrial		78,882			1,993			5,854			—			86,729

Total commercial		415,745			16,960			39,543			—			472,248

Real estate
Residential mortgage		175,933			—			8,656			—			184,589
Residential construction		5,962			—			290			—			6,252
Mortgage warehouse		143,609			—			—			—			143,609

Total real estate		325,504			—			8,946			—			334,450

Consumer
Direct Installment		27,123			—			273			—			27,396
Direct Installment Purchased		382			—			—			—			382
Indirect Installment		130,363			—			930			—			131,293
Home Equity		118,665			—			3,511			—			122,176

Total Consumer		276,533			—			4,714			—			281,247

Total	$	1,017,782		$	16,960		$	53,203		$	—		$	1,087,945

Percentage of total loans		93.55	%		1.56	%		4.89	%		0.00	%

December 31, 2012	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	137,664		$	6,407		$	17,029		$	1,594		$	162,694
Non owner occupied real estate		171,319			19,440			10,717			287			201,763
Residential development		405			—			651			—			1,056
Development & Spec Land Loans		3,171			178			3,614			—			6,963
Commercial and industrial		78,810			3,136			5,136			—			87,082

Total commercial		391,369			29,161			37,147			1,881			459,558

Real estate
Residential mortgage		172,586			—			8,864			—			181,450
Residential construction		7,390			—			291			—			7,681
Mortgage warehouse		251,448			—			—			—			251,448

Total real estate		431,424			—			9,155			—			440,579

Consumer
Direct Installment		27,667			—			164			—			27,831
Direct Installment Purchased		429			—			—			—			429
Indirect Installment		132,589			—			892			—			133,481
Home Equity		123,713			—			2,875			—			126,588

Total Consumer		284,398			—			3,931			—			288,329

Total	$	1,107,191		$	29,161		$	50,233		$	1,881		$	1,188,466

Percentage of total loans		93.16	%		2.45	%		4.23	%		0.16	%

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 7 – 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 6.14% on a notional amount of $30.5 million at March 31, 2013 and $30.5 million at December 31, 2012. Under the 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 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, 2013 the Company’s cash flow hedge was effective and is not expected to have a significant impact on 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 policy. 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, 2013 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 $75.6 million at March 31, 2013 and $81.0 million at December 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, 2013, the Company’s fair value of these derivatives were recorded and over the next 12 months are 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.

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, 2013			Liability Derivatives March 31, 2013
Derivatives designated as hedging instruments (Unaudited)	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Interest rate contracts	Loans	$	89	Other liabilities	$	1,813
Interest rate contracts	Other Assets		1,724	Other liabilities		5,055

Total derivatives designated as hedging instruments			1,813			6,868

Derivatives not designated as hedging instruments
Mortgage loan contracts	Other assets		846	Other liabilities		—

Total derivatives not designated as hedging instruments			846			—

Total derivatives		$	2,659		$	6,868


	Asset Derivative December 31, 2012			Liability Derivatives December 31, 2012
Derivatives designated as hedging instruments (Unaudited)	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Interest rate contracts	Loans	$	279	Other liabilities	$	2,214
Interest rate contracts	Other Assets		1,935	Other liabilities		5,493

Total derivatives designated as hedging instruments			2,214			7,707

Derivatives not designated as hedging instruments
Mortgage loan contracts	Other assets		858	Other liabilities		—

Total derivatives not designated as hedging instruments			858			—

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