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 September 30, 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: 8,695,721 shares of Common Stock, no par value, at November 7, 2013.

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	38

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	53

Item 4.	Controls and Procedures	53

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	54

Item 1A.	Risk Factors	54

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	54

Item 3.	Defaults Upon Senior Securities	54

Item 4.	Mine Safety Disclosures	54

Item 5.	Other Information	54

Item 6.	Exhibits	55

Signatures

Index To Exhibits

PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollar Amounts in Thousands)


	September 30 2013		December 31 2012
	(Unaudited)
Assets
Cash and due from banks	$	40,500	$	30,735
Investment securities, available for sale		514,144		482,801
Investment securities, held to maturity		9,910		—
Loans held for sale		4,594		13,744
Loans, net of allowance for loan losses of $17,848 and $18,270		1,063,571		1,172,447
Premises and equipment		43,473		42,184
Federal Reserve and Federal Home Loan Bank stock		14,184		13,333
Goodwill		19,748		19,748
Other intangible assets		3,477		4,048
Interest receivable		7,506		7,716
Cash value life insurance		35,945		35,192
Other assets		23,972		26,279

Total assets	$	1,781,024	$	1,848,227

Liabilities
Deposits
Non-interest bearing	$	223,354	$	209,200
Interest bearing		1,104,966		1,084,953

Total deposits		1,328,320		1,294,153
Borrowings		242,505		345,764
Subordinated debentures		32,448		32,331
Interest payable		488		560
Other liabilities		13,804		16,451

Total liabilities		1,617,565		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, 8,695,721 and 8,693,471 shares Outstanding, 8,619,716 and 8,617,466 shares		—		—
Additional paid-in capital		32,237		31,965
Retained earnings		118,157		105,402
Accumulated other comprehensive income		565		9,101

Total stockholders’ equity		163,459		158,968

Total liabilities and stockholders’ equity	$	1,781,024	$	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 September 30						Nine Months Ended September 30
	2013			2012			2013			2012
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Interest Income
Loans receivable	$	14,843		$	15,527		$	48,189		$	42,386
Investment securities
Taxable		2,084			2,178			6,153			6,738
Tax exempt		1,114			1,014			3,105			2,944

Total interest income		18,041			18,719			57,447			52,068

Interest Expense
Deposits		1,395			1,638			4,320			4,803
Borrowed funds		1,465			1,597			4,369			4,635
Subordinated debentures		512			485			1,504			1,427

Total interest expense		3,372			3,720			10,193			10,865

Net Interest Income		14,669			14,999			47,254			41,203
Provision for loan losses		104			1,041			2,917			1,809

Net Interest Income after Provision for Loan Losses		14,565			13,958			44,337			39,394

Non-interest Income
Service charges on deposit accounts		1,083			1,002			2,984			2,477
Wire transfer fees		169			248			562			643
Interchange fees		1,123			885			3,049			2,227
Fiduciary activities		953			971			3,140			2,928
Gain on sale of investment securities (includes $6 and $374 for the three and nine months ended 2013 and $2 for the three and nine months ended 2012, respectively, related to accumulated other comprehensive earnings reclasifications)		6			2			374			2
Gain on sale of mortgage loans		1,667			4,436			7,580			10,121
Mortgage servicing income net of impairment		348			(355	)		813			(95	)
Increase in cash value of bank owned life insurance		278			300			787			760
Other income		283			221			930			344

Total non-interest income		5,910			7,710			20,219			19,407

Non-interest Expense
Salaries and employee benefits		7,694			7,905			22,919			20,407
Net occupancy expenses		1,172			1,186			3,778			3,216
Data processing		766			754			2,184			1,883
Professional fees		357			366			1,310			1,483
Outside services and consultants		436			624			1,634			1,621
Loan expense		1,040			1,311			3,556			2,879
FDIC insurance expense		270			291			821			798
Other losses		55			309			146			501
Other expense		2,271			2,094			6,487			5,392

Total non-interest expense		14,061			14,840			42,835			38,180

Income Before Income Tax		6,414			6,828			21,721			20,621
Income tax expense (includes $2 and $131 for the three and nine months ended 2013 and $0 for the three and nine months ended 2012, respectively, related to income tax expense from reclassification items)		1,629			1,978			5,960			6,248

Net Income		4,785			4,850			15,761			14,373
Preferred stock dividend and discount accretion		(66	)		(63	)		(308	)		(325	)

Net Income Available to Common Shareholders	$	4,719		$	4,787		$	15,453		$	14,048

Basic Earnings Per Share	$	0.55		$	0.56		$	1.79		$	1.81
Diluted Earnings Per Share		0.52			0.54			1.72			1.75

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)


	Three Months Ended September 30						Nine Months Ended September 30
	2013			2012			2013			2012
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

Net Income	$	4,785		$	4,850		$	15,761		$	14,373

Other Comprehensive Income (Loss)
Change in fair value of derivative instruments:
Change in fair value of derivative instruments for the period		38			(259	)		2,058			(904	)
Income tax effect		(13	)		90			(720	)		316

Changes from derivative instruments		25			(169	)		1,338			(588	)

Change in securities available-for-sale:
Unrealized appreciation (depreciation) for the period		(959	)		2,453			(15,566	)		4,533
Reclassification adjustment for securities gains realized in income		6			2			374			2
Income tax effect		334			(860	)		5,318			(1,588	)

Unrealized gains (losses) on available-for-sale securities		(619	)		1,595			(9,874	)		2,947

Other Comprehensive Income (Loss), Net of Tax		(594	)		1,426			(8,536	)		2,359

Comprehensive Income	$	4,191		$	6,276		$	7,225		$	16,732

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						15,761						15,761
Other comprehensive income (loss), net of tax									(8,536	)		(8,536	)
Amortization of unearned compensation				207								207
Exercise of stock options				34								34
Stock option expense				31								31
Cash dividends on preferred stock (3.29%)						(308	)					(308	)
Cash dividends on common stock ($.31 per share)						(2,698	)					(2,698	)

Balances, September 30, 2013	$	12,500	$	32,237	$	118,157		$	565		$	163,459

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)


	Nine Months Ended September 30
	2013			2012
	(Unaudited)			(Unaudited)
Operating Activities
Net income	$	15,761		$	14,373
Items not requiring (providing) cash
Provision for loan losses		2,917			1,809
Depreciation and amortization		2,522			1,988
Share based compensation		31			25
Mortgage servicing rights impairment (recovery)		(208	)		369
Premium amortization on securities available for sale, net		2,221			2,387
Gain on sale of investment securities		(374	)		(2	)
Gain on sale of mortgage loans		(7,580	)		(10,121	)
Proceeds from sales of loans		306,505			293,909
Loans originated for sale		(289,775	)		(283,788	)
Change in cash value of life insurance		(753	)		(727	)
(Gain) loss on sale of other real estate owned		(270	)		(5	)
Net change in
Interest receivable		210			(757	)
Interest payable		(72	)		(107	)
Other assets		8,493			217
Other liabilities		326			(2,112	)

Net cash provided by operating activities		39,954			17,458

Investing Activities
Purchases of securities available for sale		(152,275	)		(96,713	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale		103,893			92,734
Purchase of securities held to maturity		(9,910	)		—
Proceeds from maturities of securities held to maturity		—			4,177
Purchase of Federal Reserve Bank stock		(851	)		—
Net change in loans		101,796			(66,596	)
Proceeds on the sale of OREO and repossessed assets		2,138			2,661
Purchases of premises and equipment		(3,033	)		(4,520	)
Acquisition of Heartland		—			26,283

Net cash provided by (used in) by investing activities		41,758			(41,974	)

Financing Activities
Net change in
Deposits		34,167			85,861
Borrowings		(103,142	)		(38,078	)
Proceeds from issuance of stock		34			341
Dividends paid on common shares		(2,698	)		(2,168	)
Dividends paid on preferred shares		(308	)		(325	)

Net cash provided by (used in) financing activities		(71,947	)		45,631

Net Change in Cash and Cash Equivalent		9,765			21,115
Cash and Cash Equivalents, Beginning of Period		30,735			20,447

Cash and Cash Equivalents, End of Period	$	40,500		$	41,562

Additional Cash Flows Information
Interest paid	$	10,265		$	10,882
Income taxes paid		3,100			3,925
Transfer of loans to other real estate owned		2,528			3,486

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 September 30, 2013 and September 30, 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 September 30				Nine months ended September 30
	2013		2012		2013		2012
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Basic earnings per share
Net income	$	4,785	$	4,850	$	15,761	$	14,373
Less: Preferred stock dividends and accretion of discount		66		63		308		325

Net income available to common shareholders	$	4,719	$	4,787	$	15,453	$	14,048

Weighted average common shares outstanding⁽¹⁾⁽²⁾		8,618,969		8,503,475		8,617,972		7,758,537

Basic earnings per share	$	0.55	$	0.56	$	1.79	$	1.81


Diluted earnings per share
Net income available to common shareholders	$	4,719	$	4,787	$	15,453	$	14,048

Weighted average common shares outstanding⁽¹⁾⁽²⁾		8,618,969		8,503,475		8,617,972		7,758,537
Effect of dilutive securities:
Warrants		314,353		269,431		299,704		231,037
Restricted stock		40,833		30,971		39,883		19,317
Stock options		45,056		34,782		41,069		26,105

Weighted average shares outstanding		9,019,211		8,838,659		8,998,628		8,034,996

Diluted earnings per share	$	0.52	$	0.54	$	1.72	$	1.75

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

⁽²⁾	Includes average shares issued for the Heartland acquisition for the three and nine months ending September 30, 2012

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

For the nine months ended September 30, 2013 and 2012, there were no shares and 12,750 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 non-interest 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 has the opportunity to increase its deposit base and reduce transaction costs. The Company also expects to continue reducing costs 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 September 30, 2013. The amounts of loans at September 30, 2013, are as follows:


Commercial	$	44,717
Real estate		13,146
Consumer		12,612

Outstanding balance	$	70,475

Carrying amount, net of allowance of $488	$	69,987

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		(1,016	)
Reclassification from nonaccreatable difference		—
Disposals		(1,629	)

Balance at September 30, 2013	$	3,466

During the nine months ended September 30, 2013, the Company increased the allowance for loan losses by a charge to the income statement of $1.6 million. No allowances for loan losses were reversed for the nine months ended 2013.

Note 3 – Securities

The fair value of securities is as follows:


September 30, 2013	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Treasury and federal agencies	$	43,161	$	243	$	(647	)	$	42,757
State and municipal		176,711		5,505		(2,699	)		179,517
Federal agency collateralized mortgage obligations		111,266		1,293		(1,777	)		110,782
Federal agency mortgage-backed pools		176,880		3,907		(1,593	)		179,194
Private labeled mortgage-backed pools		1,290		44		—			1,334
Corporate notes		532		28		—			560

Total available for sale investment securities	$	509,840	$	11,020	$	(6,716	)	$	514,144

Held to maturity, State and Municipal	$	9,910	$	—	$	—		$	9,910


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 September 30, 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 September 30, 2013.

The amortized cost and fair value of securities available for sale and held to maturity at September 30, 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.


	September 30, 2013				December 31, 2012
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Available for sale
Within one year	$	3,968	$	3,987	$	4,358	$	4,368
One to five years		49,167		49,763		49,415		50,673
Five to ten years		99,931		102,194		98,551		104,258
After ten years		67,338		66,890		61,313		65,436

		220,404		222,834		213,637		224,735
Federal agency collateralized mortgage obligations		111,266		110,782		95,337		96,831
Federal agency mortgage-backed pools		176,880		179,194		152,372		159,204
Private labeled mortgage-backed pools		1,290		1,334		1,960		2,031

Total available for sale investment securities	$	509,840	$	514,144	$	463,306	$	482,801


Held to maturity
Within one year	$	9,910	$	9,910	$	—	$	—
One to five years		—		—		—		—

Total held to maturity investment securities	$	9,910	$	9,910	$	—	$	—

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
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
September 30, 2013	Value		Losses			Value		Losses			Value		Losses

U.S. Treasury and federal agencies	$	27,836	$	(647	)	$	—	$	—		$	27,836	$	(647	)
State and municipal		53,822		(2,686	)		1,033		(13	)		54,855		(2,699	)
Federal agency collateralized mortgage obligations		56,488		(1,645	)		4,499		(132	)		60,987		(1,777	)
Federal agency mortgage-backed pools		52,517		(1,593	)		—		—			52,517		(1,593	)

Total temporarily impaired securities	$	190,663	$	(6,571	)	$	5,532	$	(145	)	$	196,195	$	(6,716	)


	Less than 12 Months					12 Months or More				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
December 31, 2012	Value		Losses			Value		Losses		Value		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	)


	Three months ended September 30				Nine months ended September 30
	2013		2012		2013			2012
Sales of securities available for sale (Unaudited)
Proceeds	$	648	$	—	$	23,853		$	—
Gross gains		6		—		382			—
Gross losses		—		—		(8	)		—

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 4 – Loans


	September 30 2013			December 31 2012
Commercial
Working capital and equipment	$	239,305		$	198,805
Real estate, including agriculture		243,262			247,108
Tax exempt		3,093			4,579
Other		13,924			9,979

Total		499,584			460,471

Real estate
1-4 family		184,928			185,940
Other		4,326			3,774

Total		189,254			189,714

Consumer
Auto		137,991			142,149
Recreation		4,955			5,163
Real estate/home improvement		31,045			29,989
Home equity		98,657			104,974
Unsecured		3,785			4,194
Other		2,557			2,615

Total		278,990			289,084

Mortgage warehouse		113,591			251,448

Total loans		1,081,419			1,190,717
Allowance for loan losses		(17,848	)		(18,270	)

Loans, net	$	1,063,571		$	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 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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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.


September 30, 2013	Loan Balance			Interest Due		Deferred Fees / (Costs)			Recorded Investment
Owner occupied real estate	$	153,113		$	226	$	212		$	153,551
Non owner occupied real estate		229,654			175		430			230,259
Residential spec homes		242			—		—			242
Development & spec land loans		15,621			39		43			15,703
Commercial and industrial		100,194			732		75			101,001

Total commercial		498,824			1,172		760			500,756

Residential mortgage		179,964			567		409			180,940
Residential construction		8,881			17		—			8,898
Mortgage warehouse		113,591			480		—			114,071

Total real estate		302,436			1,064		409			303,909

Direct installment		28,968			92		(278	)		28,782
Direct installment purchased		331			—		—			331
Indirect installment		129,450			306		—			129,756
Home equity		120,222			517		297			121,036

Total consumer		278,971			915		19			279,905

Total loans		1,080,231			3,151		1,188			1,084,570
Allowance for loan losses		(17,848	)		—		—			(17,848	)

Net loans	$	1,062,383		$	3,151	$	1,188		$	1,066,722


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					Nine Months Ended
	September 30					September 30
	2013			2012		2013		2012
	(Unaudited)			(Unaudited)		(Unaudited)		(Unaudited)
Balance at beginning of the period	$	18,880		$	18,374	$	18,270	$	18,882
Loans charged-off:
Commercial
Owner occupied real estate		—			92		138		95
Non owner occupied real estate		539			81		730		109
Residential development		—			—		—		—
Development & Spec Land Loans		182			—		182		—
Commercial and industrial		35			221		948		548

Total commercial		756			394		1,998		752
Real estate
Residential mortgage		43			247		602		451
Residential construction		—			—		—		—
Mortgage warehouse		—			—		—		—

Total real estate		43			247		602		451
Consumer
Direct Installment		87			90		282		261
Direct Installment Purchased		—			—		—		—
Indirect Installment		329			313		953		922
Home Equity		306			123		945		1,010

Total consumer		722			526		2,180		2,193

Total loans charged-off		1,520			1,167		4,780		3,396

Recoveries of loans previously charged-off:
Commercial
Owner occupied real estate		15			—		61		352
Non owner occupied real estate		35			—		38		7
Residential development		—			—		—		—
Development & Spec Land Loans		—			—		—		—
Commercial and industrial		101			61		248		114

Total commercial		151			61		347		473
Real estate
Residential mortgage		3			42		11		74
Residential construction		—			—		—		—
Mortgage warehouse		—			—		—		—

Total real estate		3			42		11		74
Consumer
Direct Installment		10			28		458		63
Direct Installment Purchased		—			—		—		—
Indirect Installment		157			173		529		563
Home Equity		63			16		95		100

Total consumer		230			217		1,082		726

Total loan recoveries		384			320		1,440		1,273

Net loans charged-off		1,136			847		3,340		2,123

Provision charged to operating expense
Commercial		741			625		1,543		320
Real estate		(381	)		254		606		900
Consumer		(256	)		162		769		589

Total provision charged to operating expense		104			1,041		2,917		1,809

Balance at the end of the period	$	17,848		$	18,568	$	17,848	$	18,568

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:


September 30, 2013	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,316	$	—	$	—	$	—	$	1,316
Collectively evaluated for impairment		6,347		3,238		1,686		5,261		16,532

Total ending allowance balance	$	7,663	$	3,238	$	1,686	$	5,261	$	17,848


Loans:
Individually evaluated for impairment	$	7,919	$	—	$	—	$	—	$	7,919
Collectively evaluated for impairment		492,837		189,838		114,071		279,905		1,076,651

Total ending loans balance	$	500,756	$	189,838	$	114,071	$	279,905	$	1,084,570


December 31, 2012	Commercial		Real Estate		Mortgage 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:


September 30, 2013	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Non Performing TDR’s		Performing TDR’s		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	464	$	—	$	82	$	783	$	1,329
Non owner occupied real estate		2,829		—		825		—		3,654
Residential development		—		—		—		—		—
Development & Spec Land Loans		170		—		—		—		170
Commercial and industrial		1,953		—		781		—		2,734

Total commercial		5,416		—		1,688		783		7,887

Real estate
Residential mortgage		3,436		2		2,693		1,678		7,809
Residential construction		—		—		284		—		284
Mortgage warehouse		—		—		—		—		—

Total real estate		3,436		2		2,977		1,678		8,093

Consumer
Direct Installment		249		—		—		—		249
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		657		—		—		—		657
Home Equity		3,228		—		1,321		1,046		5,595

Total Consumer		4,134		—		1,321		1,046		6,501

Total	$	12,986	$	2	$	5,986	$	3,507	$	22,481


December 31, 2012	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Non Performing TDR’s		Performing TDR’s		Total Non- Performing 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 $13.0 million of non-accrual loans and the $6.0 million of non-performing TDR’s at September 30, 2013 were $1.6 million and $857,000, 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 Vice President of Operations 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 nine 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 September 30, 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 nine consecutive payments but is still reported as TDR unless the loan bears interest at a market rate. As of September 30, 2013, the Company had $9.5 million in TDRs and $3.5 million were performing according to the restructured terms and no TDR’s were returned to accrual status in the first nine months of 2013. There was $440,000 million of specific reserves allocated to TDRs at September 30, 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 restructured loans during the nine months ended September 30, 2013 and 2012, segregated by class, are shown in the table below.


	September 30, 2013				September 30, 2012
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		2	$	81		3	$	1,472
Non owner occupied real estate		1		68		3		637
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		—		—

Total commercial		3		149		6		2,109

Real estate
Residential mortgage		8		1,132		1		582
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		8		1,132		1		582

Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		7		1,882		—		—

Total Consumer		7		1,882		—		—

Total		18	$	3,163		7	$	2,691

Troubled debt restructured loans which had payment defaults during the nine months ended September 30, 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.


	September 30, 2013				September 30, 2012
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		2	$	81		3	$	1,473
Non owner occupied real estate		1		68		2		261
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		—		—

Total commercial		3		149		5		1,734

Real estate
Residential mortgage		4		400		2		677
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		4		400		2		677

Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		4		1,175		—		—

Total Consumer		4		1,175		—		—

Total		11	$	1,724		7	$	2,411

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					Nine Months Ending
September 30, 2013	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans			Cash/ Accrual Interest Income Recognized		Average Balance in Impaired Loans		Cash/ Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	1,329	$	1,331	$	—	$	1,959			16	$	2,685	$	43
Non owner occupied real estate		3,167		3,170		—		3,814			8		3,298		21
Residential development		—		—		—		—			—		—		—
Development & Spec Land Loans		21		21		—		24			—		25		—
Commercial and industrial		546		561		—		1,297			—		1,311		—

Total commercial		5,063		5,083		—		7,094			24		7,319		64

With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		(1	)		—		—		—
Non owner occupied real estate		487		487		302		491			—		502		—
Residential development		—		—		—		—			—		—		—
Development & Spec Land Loans		149		149		48		173			—		165		—
Commercial and industrial		2,188		2,200		966		2,379			—		1,808		23

Total commercial		2,824		2,836		1,316		3,042			—		2,475		23

Total	$	7,887	$	7,919	$	1,316	$	10,136		$	24	$	9,794	$	87


							Three Months Ending				Nine Months Ending
September 30, 2012	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans		Cash/ Accrual Interest Income Recognized		Average Balance in Impaired Loans		Cash/ Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	4,457	$	4,460	$	—	$	3,810	$	—	$	1,978	$	3
Non owner occupied real estate		2,521		2,542		—		2,429		70		1,920		72
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		131		131		—		109		—		37		—
Commercial and industrial		456		471		—		382		—		129		—

Total commercial		7,565		7,604		—		6,730		70		4,064		75

With an allowance recorded
Commercial
Owner occupied real estate		903		903		450		910		—		1,109		1
Non owner occupied real estate		2,938		2,938		1,065		2,943		—		2,843		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		658		658		615		660		—		523		6
Commercial and industrial		801		801		273		801		—		807		—

Total commercial		5,300		5,300		2,403		5,314		—		5,282		7

Total	$	12,865	$	12,904	$	2,403	$	12,044	$	70	$	9,346	$	82

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:


September 30, 2013	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	$	99		$	—		$	—		$	99		$	153,014		$	153,113
Non owner occupied real estate		45			—			—			45			229,609			229,654
Residential development		—			—			—			—			242			242
Development & Spec Land Loans		—			—			—			—			15,621			15,621
Commercial and industrial		13			—			—			13			100,181			100,194

Total commercial		157			—			—			157			498,667			498,824

Real estate
Residential mortgage		695			351			2			1,048			178,916			179,964
Residential construction		—			—			—			—			8,881			8,881
Mortgage warehouse		—			—			—			—			113,591			113,591

Total real estate		695			351			2			1,048			301,388			302,436

Consumer
Direct Installment		122			13			—			135			28,833			28,968
Direct Installment Purchased		—			—			—			—			331			331
Indirect Installment		894			60			—			954			128,496			129,450
Home Equity		173			227			—			400			119,822			120,222

Total consumer		1,189			300			—			1,489			277,482			278,971

Total	$	2,041		$	651		$	2		$	2,694		$	1,077,537		$	1,080,231

Percentage of total loans		0.19	%		0.06	%		0.00	%		0.25	%		99.75	%


December 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	$	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	%

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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.

•

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 or his designee 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 with respect to 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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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.

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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

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.

•

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.


September 30, 2013	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	142,836		$	2,600		$	7,677		$	—		$	153,113
Non owner occupied real estate		210,632			3,119			15,903			—			229,654
Residential development		242			—			—			—			242
Development & Spec Land Loans		13,844			94			1,683			—			15,621
Commercial and industrial		90,221			5,410			4,563			—			100,194

Total commercial		457,775			11,223			29,826			—			498,824

Real estate
Residential mortgage		172,155			—			7,809			—			179,964
Residential construction		8,597			—			284			—			8,881
Mortgage warehouse		113,591			—			—			—			113,591

Total real estate		294,343			—			8,093			—			302,436

Consumer
Direct Installment		28,719			—			249			—			28,968
Direct Installment Purchased		331			—			—			—			331
Indirect Installment		128,793			—			657			—			129,450
Home Equity		114,627			—			5,595			—			120,222

Total Consumer		272,470			—			6,501			—			278,971

Total	$	1,024,587		$	11,223		$	44,420		$	—		$	1,080,231

Percentage of total loans		94.85	%		1.04	%		4.11	%		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 September 30, 2013 and 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 September 30, 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 September 30, 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 $90.3 million at September 30, 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 September 30, 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			Liability Derivatives
	September 30, 2013			September 30, 2013
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments (Unaudited)
Interest rate contracts	Loans	$	23	Other liabilities	$	579
Interest rate contracts	Other Assets		556	Other liabilities		3,435

Total derivatives designated as hedging instruments			579			4,014


Derivatives not designated as hedging instruments
Mortgage loan contracts	Other assets		619	Other liabilities		—

Total derivatives not designated as hedging instruments			619			—

Total derivatives		$	1,198		$	4,014


	Asset Derivative			Liability Derivatives
	December 31, 2012			December 31, 2012
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments (Unaudited)
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			—

Total derivatives		$	3,072		$	7,707

The effect of the derivative instruments on the condensed consolidated statement of income for the three and nine month periods ending 2013 and 2012 is as follows:


	Comprehensive Income on Derivative (Effective Portion)					Comprehensive Income on Derivative (Effective Portion)
	Three Months Ended September 30					Nine Months Ended September 30
Derivative in cash flow hedging relationship	2013 (Unaudited)		2012 (Unaudited)			2013 (Unaudited)		2012 (Unaudited)
Interest rate contracts	$	25	$	(169	)	$	1,338	$	(588	)

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.

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						Amount of Gain (Loss) Recognized on Derivative
		Three Months Ended September 30						Nine Months Ended September 30
Derivative in fair value hedging relationship	Location of gain (loss) recognized on derivative	2013 (Unaudited)			2012 (Unaudited)			2013 (Unaudited)			2012 (Unaudited)
Interest rate contracts	Interest income - loans	$	211		$	112		$	(1,635	)	$	336
Interest rate contracts	Interest income - loans		(211	)		(112	)		1,635			(336	)

Total		$	—		$	—		$	—		$	—


		Amount of Gain (Loss) Recognized on Derivative				Amount of Gain (Loss) Recognized on Derivative
		Three Months Ended September 30				Nine Months Ended September 30
Derivative not designated as hedging relationship	Location of gain (loss) recognized on derivative	2013 (Unaudited)		2012 (Unaudited)		2013 (Unaudited)			2012 (Unaudited)
Mortgage contracts	Other income - gain on sale of loans	$	169	$	320	$	(239	)	$	600

Note 8 – 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 condensed consolidated 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 September 30, 2013. 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, private-label 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.

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)
September 30, 2013
Available-for-sale securities
U.S. Treasury and federal agencies	$	42,757		$	—	$	42,757		$	—
State and municipal		179,517			—		179,517			—
Federal agency collateralized mortgage obligations		110,782			—		110,782			—
Federal agency mortgage-backed pools		179,194			—		179,194			—
Private labeled mortgage-backed pools		1,334			—		1,334			—
Corporate notes		560			—		560			—

Total available-for-sale securities		514,144			—		514,144			—

Hedged loans		89,718			—		89,718			—
Forward sale commitments		619			—		619			—
Interest rate swap agreements		(4,014	)		—		(4,014	)		—
Commitments to originate loans		—			—		—			—

December 31, 2012
Available-for-sale securities
U.S. Treasury and federal agencies	$	51,779		$	—	$	51,779		$	—
State and municipal		172,905			—		172,905			—
Federal agency collateralized mortgage obligations		96,831			—		96,831			—
Federal agency mortgage-backed pools		159,204			—		159,204			—
Private labeled mortgage-backed pools		2,031			—		2,031			—
Corporate notes		51			—		51			—

Total available-for-sale securities		482,801			—		482,801			—

Hedged loans		81,018			—		81,018			—
Forward sale commitments		858			—		858			—
Interest rate swap agreements		(7,707	)		—		(7,707	)		—
Commitments to originate loans		—			—		—			—

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Transfers between levels

Transfers between Levels 1, 2 and 3 and the reasons for those transfers are as follows:


December 31, 2012	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Reason for Transfer
Transfers to level:

Hedged loans	$	—	$	59,911		$	—		(a)
Forward sale commitments		—		510			—		(b)
Interest rate swap agreements		—		(6,464	)		—		(a)
Commitments to originate loans		—		(71	)		—		(b)


Total transfers to level	$	—	$	53,886		$	—


(a)	-	Valuation determined by widely accepted techniques including discounted cash flow analysis on expected cash flows of each derivative and observable market rate inputs such as yield curves and contractual terms on each instrument.
(b)	-	Valuation determined by quoted prices for similar loans in the secondary market with an expected fallout rate (interest rate locked pipeline loans not expected to close). Fallout rate is not considered a significant input to the fair value in its entirety.

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated balance sheet using significant unobservable (Level 3) inputs:


	Hedged Loans			Forward Sale Commitments			Interest Rate Swaps			Commitments to Originate Loans
Beginning balance December 31, 2011	$	54,362		$	662		$	(7,101	)	$	—
Total realized and unrealized gains and losses
Included in net income		(74	)		(152	)		74			(71	)
Included in other comprehensive income, gross		—			—			563			—
Purchases, issuances, and settlements		6,114			—			—			—
Principal payments		(491	)		—			—			—
Transfers out to Level 2		(59,911	)		(510	)		6,464			71

Ending balance December 31, 2012	$	—		$	—		$	—		$	—

Realized gains and losses included in net income for the periods are reported in the condensed consolidated statements of income as follows:


	Three Months Ended September 30						Nine Months Ended September 30
	2013			2012			2013			2012
Non Interest Income	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Total gains and losses from:
Hedged loans	$	211		$	112		$	(1,635	)	$	336
Fair value interest rate swap agreements		(211	)		(112	)		1,635			(336	)
Derivative loan commitments		169			320			(239	)		600

	$	169		$	320		$	(239	)	$	600

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Certain other assets are measured at fair value on a nonrecurring basis in the ordinary course of business and are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment):


	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2013
Impaired loans	$	6,571	$	—	$	—	$	6,571
Mortgage servicing rights		6,302		—		—		6,302

December 31, 2012
Impaired loans	$	8,652	$	—	$	—	$	8,652
Mortgage servicing rights		5,145		—		—		5,145

Impaired (collateral dependent): Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms 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.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method. Fair value adjustments on impaired loans were $1.3 million at September 30, 2013 and $1.9 million at December 31, 2012.

Mortgage Servicing Rights (MSRs): MSRs do not trade in an active market with readily observable prices. Accordingly, the fair value of these assets is classified as Level 3. The Company determines the fair value of MSRs using an income approach model based upon the Company’s month-end interest rate curve and prepayment assumptions. The model utilizes assumptions to estimate future net servicing income cash flows, including estimates of time decay, payoffs and changes in valuation inputs and assumptions. The Company reviews the valuation assumptions against this market data for reasonableness and adjusts the assumptions if deemed appropriate. The carrying amount of the MSR’s fair value increased by $208,000 during the first nine months of 2013 and decreased by $369,000 during the first nine months of 2012.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The following table presents qualitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements, other than goodwill.


	Fair Value at September 30, 2013		Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans	$	6,571	Collateral based measurement	Discount to reflect current market conditions and ultimate collectability	10% - 15%(12%)
Mortgage servicing rights	$	6,302	Discounted cashflows	Discount rate, Constant prepayment rate, Probably of default	10% - 15%(12%), 4% - 7%(4.6%), 1% - 10%(4.5%)


	Fair Value at December 31, 2012		Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans	$	8,652	Collateral based measurement	Discount to reflect current market conditions and ultimate collectability	10% - 15%(12%)
Mortgage servicing rights	$	5,145	Discounted cashflows	Discount rate, Constant prepayment rate, Probably of default	10% - 15%(12%), 4% - 7%(4.6%), 1% - 10%(4.5%)

Note 9 – Fair Value of Financial Instruments

The estimated fair value amounts of the Company’s financial instruments were determined using available market information, current pricing information applicable to Horizon and various valuation methodologies. Where market quotations were not available, considerable management judgment was involved in the determination of estimated fair values. Therefore, the estimated fair value of financial instruments shown below may not be representative of the amounts at which they could be exchanged in a current or future transaction. Due to the inherent uncertainties of expected cash flows of financial instruments, the use of alternate valuation assumptions and methods could have a significant effect on the estimated fair value amounts.

The estimated fair values of financial instruments, as shown below, are not intended to reflect the estimated liquidation or market value of Horizon taken as a whole. The disclosed fair value estimates are limited to Horizon’s significant financial instruments at September 30, 2013 and December 31, 2012. These include financial instruments recognized as assets and liabilities on the consolidated balance sheet as well as certain off-balance sheet financial instruments. The estimated fair values shown below do not include any valuation of assets and liabilities, which are not financial instruments as defined by the FASB ASC fair value hierarchy.

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash and Due from Banks — The carrying amounts approximate fair value.

Held-to-Maturity Securities — For debt securities held to maturity, fair values are based on quoted market prices or dealer quotes. For those securities where a quoted market price is not available, carrying amount is a reasonable estimate of fair value based upon comparison with similar securities.

Loans Held for Sale — The carrying amounts approximate fair value.

Net Loans — The fair value of portfolio loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The carrying amounts of loans held for sale approximate fair value.

FHLB and FRB Stock — Fair value of FHLB and FRB stock is based on the price at which it may be resold to the FHLB and FRB.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Interest Receivable/Payable — The carrying amounts approximate fair value.

Deposits — The fair value of demand deposits, savings accounts, interest-bearing checking accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturity.

Borrowings — Rates currently available to Horizon for debt with similar terms and remaining maturities are used to estimate fair values of existing borrowings.

Subordinated Debentures — Rates currently available for debentures with similar terms and remaining maturities are used to estimate fair values of existing debentures.

Commitments to Extend Credit and Standby Letter of Credit — The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. Due to the short-term nature of these agreements, carrying amounts approximate fair value.

The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall (unaudited).


	September 30, 2013
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and due from banks	$	40,500	$	40,500	$	—	$	—
Investment securities, held to maturity		9,910		—		—		9,910
Loans held for sale		4,594		—		—		4,594
Loans excluding loan level hedges, net		973,300		—		—		996,408
Stock in FHLB and FRB		14,184		—		14,184		—
Interest receivable		7,506		—		7,506		—

Liabilities
Non-interest bearing deposits	$	223,354	$	223,354	$	—	$	—
Interest-bearing deposits		1,104,966		—		1,060,853		—
Borrowings		242,505		—		245,043		—
Subordinated debentures		32,448		—		32,483		—
Interest payable		488		—		488		—

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


	December 31, 2012
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and due from banks	$	30,735	$	30,735	$	—	$	—
Loans held for sale		13,744		—		—		13,744
Loans excluding loan level hedges, net		1,089,215		—		—		1,118,255
Stock in FHLB and FRB		13,333		—		13,333		—
Interest receivable		7,716		—		7,716		—

Liabilities
Non-interest bearing deposits	$	209,200	$	209,200	$	—	$	—
Interest-bearing deposits		1,084,953		—		1,092,184		—
Borrowings		345,764		—		352,891		—
Subordinated debentures		32,331		—		32,268		—
Interest payable		560		—		560		—

Note 10 – Other Comprehensive Income


	Accumulated Other Comprehensive Income⁽¹⁾
Unaudited	Unrealized Gains (Losses) on Securities Available-for-Sale			Unrealized Gains (Losses) on Derivative Instruments			Total
Balance at December 31, 2012	$	12,671		$	(3,570	)	$	9,101

Other comprehensive income (loss) before reclassifications		(9,631	)		1,338			(8,293	)
Amounts reclassified from other comprehensive income		(243	)		—			(243	)

Period change		(9,874	)		1,338			(8,536	)

Balance at September 30, 2013	$	2,797		$	(2,232	)	$	565



Balance at December 31, 2011	$	11,036		$	(3,194	)	$	7,842

Other comprehensive income (loss) before reclassifications		2,947			(588	)		2,359
Amounts reclassified from other comprehensive income		—			—			—

Period change		2,947			(588	)		2,359

Balance at September 30, 2012	$	13,983		$	(3,782	)	$	10,201

⁽¹⁾	All amounts are net of tax. Related income tax expense or benefit is calculated using a combined Federal and State income tax rate approximating 35%.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


	Amount Reclassified from
Details About Accumulated Other Comprehensive Income Components	Accumulated Other Comprehensive Income For the Three Months Ended September 30,					Affected Line Items in the Statement of Net Income
Unaudited	2013			2012
Securities available-for-sale ⁽¹⁾
Net securities gains reclassified into earnings	$	6		$	—	Gain on sale of investment securities
Related income tax expense		(2	)		—	Income tax expense

Net effect on accumulated other comprehensive income for the period		4			—	Net of tax

Total reclassifications for the period	$	4		$	—	Net of tax

⁽¹⁾	For additional detail related to unrealized gains on securities and related amounts reclassified from accumulated other comprehensive income see Note 3, “Securities”


Details About Accumulated Other Comprehensive Income Components	Amount Reclassified from Accumulated Other Comprehensive Income For the Nine Months Ended September 30,					Affected Line Items in the Statement of Net Income
Unaudited	2013			2012
Securities available-for-sale ⁽¹⁾
Net securities gains reclassified into earnings	$	374		$	—	Gain on sale of investment securities
Related income tax expense		(131	)		—	Income tax expense

Net effect on accumulated other comprehensive income for the period		243			—	Net of tax

Total reclassifications for the period	$	243		$	—	Net of tax

⁽¹⁾	For additional detail related to unrealized gains on securities and related amounts reclassified from accumulated other comprehensive income see Note 3, “Securities”

Note 11 – Future accounting matters

Accounting Standards Update No. 2013-04 — Liabilities (Topic 405) — On February 28, 2013, FASB issued ASU 2013-04. The amendments in this Update provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this Update is fixed at the reporting date, except for obligations addressed within existing guidance in U.S. GAAP. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors.

The guidance in this Update also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. This Accounting Standards Update is the final version of Proposed Accounting Standards Update EITF12D — Liabilities (Topic 405) which has been deleted.

The amendments in this Update are effective for fiscal years beginning after December 31, 2013. Early adoption is permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

Accounting Standards Update No. 2013-07 — Presentation of Financial Statements (Topic 205) — On April 22, 2013, FASB issued ASU 2013-07. The objective of this Update is to clarify when an entity should apply the liquidation basis of accounting and to provide principles for the measurement of assets and liabilities under the liquidation basis of accounting, as well as any required disclosures. This Accounting Standards Update is the final version of Proposed Accounting Standards Update 2012-210 — Presentation of Financial Statements (Topic 205), which has been deleted.

The amendments are effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein. Entities should apply the requirements prospectively from the day that liquidation becomes imminent. Early adoption is permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Accounting Standards Update No. 2013-10 — Derivatives and Hedging (Topic 815) — In July 2013, FASB issued ASU 2013-10. The objective of this Update is to provide for the inclusion of the Fed Funds Effective Swap Rate — Overnight Index Swap Rate (OIS) as a U.S. benchmark interest rate for hedge accounting purposes, in addition to U.S. Treasury (UST) or London Interbank Offered Rate (LIBOR) indices. The Update also removes a restriction stating that entities must use the same rates for similar hedges, offering greater flexibility in hedge accounting.

The amendments in this Update are effective prospectively for qualifying new or re-designated hedging relationships entered into on or after July 17, 2013. The Company has adopted the applicable methodologies prescribed by this ASU and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

Accounting Standards Update No. 2013-11 — Income Taxes (Topic 740) — In July 2013, FASB issued ASU 2013-11. This update pertains to the unrecognized tax benefit when a net operating loss carry forward, a similar tax loss or a tax credit carry forward exists. The ASU is intended to end the varying ways that entities present these situations since GAAP is non-specific and leads to diversity in practice. The new standard deems that any unrecognized tax benefit or portion of an unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carry forward, a similar tax loss, or a tax credit carry forward except for certain defined situations.

The amendments in this Update are effective for fiscal years beginning after December 15, 2013. Early adoption is permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2013

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward–Looking Statements

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to Horizon Bancorp (“Horizon” or the “Company”) and Horizon Bank, N.A. (the “Bank”). Horizon intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for the purposes of these safe harbor provisions. Statements in this report should be considered in conjunction with the other information available about Horizon, including the information in the other filings we make with the Securities and Exchange Commission. The forward-looking statements are based on management’s expectations and are subject to a number of risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as “anticipate,” “expect,” “estimate,” “project,” “intend,” “plan,” “believe,” “could,” “will” and similar expressions in connection with any discussion of future operating or financial performance. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements.

Actual results may differ materially, adversely or positively, from the expectations of the Company that are expressed or implied by any forward-looking statement. Risks, uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statement include but are not limited to:

•

economic conditions and their impact on Horizon and its customers;

•

changes in the level and volatility of interest rates, spreads on earning assets and interest-bearing liabilities, and interest rate sensitivity;

•

estimates of fair value of certain of Horizon’s assets and liabilities;

•

volatility and disruption in financial markets;

•

prepayment speeds, loan originations, credit losses and market values, collateral securing loans and other assets;

•

sources of liquidity;

•

potential risk of environmental liability related to lending activities;

•

changes in the competitive environment in Horizon’s market areas and among other financial service providers;

•

legislation and/or regulation affecting the financial services industry as a whole, and Horizon and its subsidiaries in particular, including the effects resulting from the reforms enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the adoption of regulations by regulatory bodies under the Dodd-Frank Act;

•

the impact of the Basel III capital rules as adopted by the federal banking agencies;

•

changes in regulatory supervision and oversight, including monetary policy and capital requirements;

•

changes in accounting policies or procedures as may be adopted and required by regulatory agencies;

•

rapid technological developments and changes;

•

containing costs and expenses;

•

the slowing or failure of economic recovery;

•

the ability of the U.S. federal government to manage federal debt limits; and

•

the risks of expansion through mergers and acquisitions, including unexpected credit quality problems with acquired loans, difficulty integrating acquired operations and material differences in the actual financial results of such transactions compared with Horizon’s initial expectations, including the full realization of anticipated cost savings.

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2013

Because such forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such statements. The foregoing list of important factors is not exclusive, and you are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document or, in the case of documents incorporated by reference, the dates of those documents. We do not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of us. For a detailed discussion of the risks and uncertainties that may cause our actual results or performance to differ materially from the results or performance expressed or implied by forward-looking statements, see “Risk Factors” in Item 1A of Part I of our 2012 Annual Report on Form 10-K and in the subsequent reports we file with the SEC.

Overview

Horizon is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in Northwest and Central Indiana and Southwestern Michigan through its bank subsidiary. Horizon operates as a single segment, which is commercial banking. Horizon’s common stock is traded on the NASDAQ Global Market under the symbol HBNC. The Bank was chartered as a national banking association in 1873 and has operated continuously since that time. The Bank is a full-service commercial bank offering commercial and retail banking services, corporate and individual trust and agency services, and other services incident to banking.

Horizon continues to operate in a challenging economic and banking environment. Within the Company’s primary market areas of North

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