UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2013
Commission file number 0-10792
Horizon Bancorp
(Exact name of registrant as specified in its charter)
Indiana | 35-1562417 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
515 Franklin Square, Michigan City | 46360 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code: 219-879-0211
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Name of each exchange on which registered | |
Common Stock, no par value | The NASDAQ Stock Market, LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act Yes ¨ No x
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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check One)
Large Accelerated Filer | ¨ | Accelerated Filer | x | |||
Non-Accelerated Filer | ¨ (Do not check if a smaller reporting company) | Smaller Reporting Company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of the registrants common stock held by non-affiliates of the registrant, based on the average bid price of such stock as of June 30, 2013, the last day of the registrants most recently completed second fiscal quarter, was approximately $161.7 million.
As of February 28, 2014, the registrant had 8,630,966 shares of common stock outstanding.
Documents Incorporated by Reference Document |
Part of Form 10-K into which portion of document is incorporated | |
Portions of the Registrants Proxy Statement to be filed for its May 8, 2014 annual meeting of shareholders | III |
HORIZON BANCORP
2013 Annual Report on Form 10-K
Table of Contents
Page | ||||||
3 | ||||||
Item 1 |
4 | |||||
Item 1A |
18 | |||||
Item 1B |
29 | |||||
Item 2 |
29 | |||||
Item 3 |
29 | |||||
Item 4 |
29 | |||||
Special Item: |
30 | |||||
Item 5 |
31 | |||||
Item 6 |
32 | |||||
Item 7 |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
33 | ||||
Item 7A |
52 | |||||
Item 8 |
53 | |||||
Item 9 |
Changes in and Disagreement with Accountants on Accounting and Financial Disclosure |
112 | ||||
Item 9A |
112 | |||||
Item 9B |
112 | |||||
Item 10 |
113 | |||||
Item 11 |
113 | |||||
Item 12 |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
114 | ||||
Item 13 |
Certain Relationships and Related Transactions, and Director Independence |
114 | ||||
Item 14 |
114 | |||||
Item 15 |
114 | |||||
115 | ||||||
117 |
2
HORIZON BANCORP
(Table dollars in thousands except per share data)
A cautionary note about forward-looking statements: In addition to historical information, information included and incorporated by reference in this Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the federal securities laws. Horizon intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of invoking those safe-harbor provisions. Forward-looking statements can include statements about estimated cost savings, plans and objectives for future operations and expectations about Horizons financial and business performance as well as economic and market conditions. They often can be identified by the use of words such as expect, may, could, will, intend, project, estimate, believe, anticipate, seek, plan and variations of such words and similar expressions.
Horizon may include forward-looking statements in filings it makes with the Securities and Exchange Commission (SEC), such as this Form 10-K, in other written materials, and in oral statements made by senior management to analysts, investors, representatives of the media and others. It is intended that these forward-looking statements speak only as of the date they are made, and Horizon undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the forward-looking statement is made or to reflect the occurrence of unanticipated events.
By their nature, forward-looking statements are based on assumptions, which although believed to be reasonable, are subject to risks, uncertainties, and other factors, such as the following:
| 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; |
| rising interest rates and their impact on mortgage loan volumes; |
| estimates of fair value of certain of Horizons 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 Horizons 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 new Basel III capital rules; |
| 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 Horizons initial expectations, including the full realization of anticipated cost savings. |
3
HORIZON BANCORP
(Table dollars in thousands except per share data)
You are cautioned that actual results may differ materially from those contained in the forward-looking statements. The Managements Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Form 10-K lists some of the factors that could cause Horizons actual results to vary materially from those expressed in or implied by any forward-looking statements. Your attention is directed to this discussion.
Other risks and uncertainties that could affect Horizons future performance are set forth below in Item 1ARisk Factors.
The disclosures in this Item 1 are qualified by the disclosures below in Item 1A, Risk Factors, and Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operation, and in other cautionary statements set forth elsewhere in this Annual Report on Form 10-K.
General
Horizon Bancorp (Horizon or the Company) is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in Northwestern and Central Indiana and Southwestern Michigan through its bank subsidiary, Horizon Bank, N.A. (the Bank) and other affiliated entities and Horizon Risk Management, Inc. Horizon operates as a single segment, which is commercial banking. Horizons 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 Risk Management, Inc. is a captive insurance company incorporated in Nevada and was formed as a wholly owned subsidiary of the Holding Company.
On July 17, 2012, Horizon completed its acquisition of Heartland Bancshares, Inc. (Heartland) and Heartlands wholly owned subsidiary, Heartland Community Bank (Heartland Bank). Heartland was merged into Horizon, and Heartland Bank was merged into the Bank. The exchange ratio was 0.81 shares of Horizons common stock for each share of Heartland common stock outstanding. Horizon acquired the 1,442,449 outstanding shares of Heartland common stock in exchange for 1,168,383 shares of Horizon common stock, which had a market price of $16.83 per share at the close of business on July 17, 2012. Horizon also purchased and retired all shares of preferred stock that Heartland had issued pursuant to the Troubled Asset Relief Program Capital Purchase Program (TARP). Based upon the $16.83 market price and the TARP preferred stock purchase, the total value of the consideration for the acquisition was $26.9 million. As a result of the acquisition, the Company experienced, and expects to continue to experience, increases in its deposit base and reductions in transaction costs. The Company also expects to reduce cost through economies of scale.
On June 1, 2010, the Company announced the completion of the purchase of assets and the assumption of liabilities of American Trust & Savings Bank (American) in Whiting, Indiana. The transaction was consummated on May 28, 2010. The Company purchased most of the banking-related assets of American, totaling $107.8 million and assumed all the deposits, federal home loan bank advances, trust preferred securities, and accrued interest payable in the approximate amount of $110.3 million. The Company paid a deposit premium on core deposits of approximately $2.1 million and $500,000 in additional consideration. As a result of the acquisition, the Company experienced, and expects to continue to experience, increases in its deposit base and reductions in transaction costs. The Company also expects to reduce cost through economies of scale.
The Bank maintains 29 full service offices. At December 31, 2013, the Bank had total assets of $1.76 billion and total deposits of $1.29 billion. The Bank has wholly-owned subsidiaries: Horizon Investments, Inc. (Horizon Investments), Horizon Properties, Inc. (Horizon Properties), Horizon Insurance Services, Inc. (Horizon Insurance) and Horizon Grantor Trust. Horizon Investments manages the investment portfolio of the Bank. Horizon Properties manages the real estate investment trust. Horizon Insurance offered a full line of personal and corporate insurance products until March 2005, at which time the majority of its assets were sold to a third party. Horizon Insurance is no longer an operating subsidiary and is primarily used to collect residual insurance income. Horizon Grantor Trust holds title to certain company owned life insurance policies.
4
HORIZON BANCORP
(Table dollars in thousands except per share data)
Horizon formed Horizon Bancorp Capital Trust II in 2004 (Trust II) and Horizon Bancorp Capital Trust III in 2006 (Trust III) for the purpose of participating in pooled trust preferred securities offerings. The Company assumed additional debentures as the result of the acquisition of Alliance Financial Corporation in 2005, which formed Alliance Financial Statutory Trust I (Alliance Trust). The Company also assumed additional debentures as the result of the American transaction, which formed Am Tru Statutory Trust I (Am Tru Trust). The Company also assumed additional debentures as the result of the Heartland transaction, which formed Heartland (IN) Statutory Trust II (Heartland Trust). See Note 13 of the Consolidated Financial Statements for further discussion regarding these previously consolidated entities that are now reported separately. The business of Horizon is not seasonal to any material degree.
No material part of Horizons business is dependent upon a single or small group of customers, the loss of any one or more of which would have a materially adverse effect on the business of Horizon. In 2013, revenues from loans accounted for 61.7% of the total consolidated revenue, and revenues from investment securities accounted for 12.6% of total consolidated revenue.
Available Information
The Companys Internet address is www.accesshorizon.com. The Company makes available, free of charge through the Investor RelationsSEC Filings section of its Internet website, copies of the Companys Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after those reports are filed with or furnished to the SEC.
Employees
The Bank employed approximately 421 full and part-time employees as of December 31, 2013. Horizon, Horizon Insurance and Horizon Grantor Trust do not have any employees.
Competition
Horizon faces a high degree of competition in all of its primary markets. The Banks primary market consists of Porter, LaPorte, St. Joseph, Elkhart, Lake, Marion and Johnson Counties Indiana, and Berrien and Kalamazoo Counties Michigan. The Bank competes with other commercial banks as well as with savings and loan associations, consumer finance companies and credit unions. To a more moderate extent, the Bank competes with Chicago money center banks, mortgage banking companies, insurance companies, brokerage houses, other institutions engaged in money market financial services and certain government agencies.
Based on deposits as of June 30, 2013, Horizon was the largest of the nine bank and thrift institutions in LaPorte County with a 34.37% market share and the sixth largest of the 15 institutions in Porter County with an 8.97% market share. In Berrien County, Michigan, Horizon was the fourth largest of the 10 bank and thrift institutions with a 7.46% market share. Horizons market share of deposits in Lake County, Indiana was just over 1% at 1.43%, and less than 1% in each of St. Joseph and Elkhart Counties in Indiana and Kalamazoo County in Michigan. The branches of Horizon Bank acquired in the merger with Heartland Community Bank, which operate under the Heartland Community Bank a Horizon Bank Company name, are located throughout Johnson County Indiana and have a 12.66% market share, giving Horizon the second largest share of the 19 bank and thrift institutions in the Johnson County market. (Source: FDIC Summary of Deposits Market Share Reports, available at www.fdic.gov).
Regulation and Supervision
As a bank holding company and a financial holding company, the Company is subject to extensive regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (the Federal Reserve Board or FRB) as its primary federal regulator. The Bank, as a nationally chartered bank, is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency (OCC) as its primary federal regulator and, as to certain matters, by the FRB and the Federal Deposit Insurance Corporation (FDIC). Both federal and state law extensively regulate various aspects of the banking business, such as reserve requirements, truth-in-lending and truth-in-savings
5
HORIZON BANCORP
(Table dollars in thousands except per share data)
disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Branching by the Bank is subject to the jurisdiction and requires notice to, or the prior approval of, the OCC. The Dodd-Frank Act permits the establishment of de novo branches in states where such branches could be opened by a state bank chartered by that state. The consent of the state is no longer required. The supervision, regulation and examination of Horizon and the Bank by the regulatory agencies in intended primarily for the protection of depositors rather than for Horizons shareholders.
Horizon also is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the Securities and Exchange Commission (SEC). Horizons common stock is listed on The NASDAQ Stock Market under the trading symbol HBNC, and Horizon is subject to the NASDAQ rules applicable to listed companies.
Included below is a brief summary of significant aspects of the laws, regulations and policies applicable to Horizon and the Bank. This summary is qualified in its entirety by reference to the full text of the statutes, regulations and policies that are referenced and is not intended to be an exhaustive description of the statutes, regulations and policies applicable to the business of Horizon and the Bank. Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to Horizon and the Bank could have a material effect Horizons business, financial condition and results of operations.
The Bank Holding Company Act
The Bank Holding Company Act of 1956, as amended (BHC Act), in general, limits the business of bank holding companies to banking, managing or controlling the activities of banks and other subsidiaries to those activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. Bank holding companies, such as Horizon, that qualify as, and elect to be, financial holding companies, however, may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board), without prior approval of the Federal Reserve Board. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments.
For a bank holding company to remain qualified as a financial holding company, the company and all of its depository institution subsidiaries must be well capitalized and well managed. To commence any new activity permitted by the BHC Act or to acquire a company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least satisfactory in its most recent examination under the Community Reinvestment Act. The Federal Reserve Board has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal Reserve Board has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
Federal Reserve Board policy has historically required bank holding companies to act as a source of financial and management strength for their subsidiary banks. The Dodd-Frank Act, which was signed into law on July 21, 2010, codified this policy. Under this requirement, Horizon is required to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which Horizon might not otherwise do so. For this purpose, source of financial strength means Horizons ability to provide financial assistance to the Bank in the event of the Banks financial distress.
The BHC Act, the Bank Merger Act and other federal and state statutes regulate acquisitions of banks and banking companies. The BHC Act requires the prior approval of the Federal Reserve to acquire more than a 5% voting interest or substantially all assets of any bank or bank holding company. Under the Bank Merger Act, the prior approval of the OCC or other appropriate regulatory authority is required for the Bank to merge with another bank or purchase the assets or
6
HORIZON BANCORP
(Table dollars in thousands except per share data)
assume the deposits of another bank. In reviewing applications seeking approval for mergers and other acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the risks to the stability of the U.S. banking or financial system, the applicants performance record under the Community Reinvestment Act and the effectiveness of the subject organizations in combating money laundering activities.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the FDICIA), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become undercapitalized (as defined in FDICIA) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency.
Bank holding companies are required to comply with the Federal Reserves risk-based capital guidelines. The Federal Deposit Insurance Corporation (the FDIC) and the Office of the Comptroller of the Currency (the OCC) also have risk-based capital ratio guidelines to which depository institutions under their respective supervision are subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk. For Horizons regulatory capital ratios and regulatory requirements as of December 31, 2013, see the information in Managements Discussion and Analysis of Financial Condition and Results of Operation in Item 7 below, which is incorporated herein by reference.
National Bank Act
As a national bank, the Bank is subject to the provisions of the National Bank Act. The Bank is supervised, regulated, and examined by the OCC, and is subject to the rules and regulations of the OCC, Federal Reserve, and the FDIC.
Deposit Insurance and Assessments
The Banks deposits are insured to applicable limits by the Deposit Insurance Fund (DIF) of the Federal Deposit Insurance Corporation (FDIC). Banks are subject to deposit insurance premiums and assessments to maintain the DIF. A banks deposit insurance premium assessment rate depends on the capital category and supervisory category to which it is assigned. The FDIC has authority to raise or lower assessment rates on insured banks in order to achieve statutorily required reserve ratios in the DIF and to impose special additional assessments.
The Dodd-Frank Act has resulted in significant changes to the FDICs deposit insurance system. Under the Dodd-Frank Act, the FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund at no less than 1.35%, and must achieve the 1.35% designated reserve ratio by September 30, 2020. The FDIC must offset the effect of the increase in the minimum designated reserve ratio from 1.15% to 1.35% on insured depository institutions of less than $10 billion and may declare dividends to depository institutions when the reserve ratio at the end of a calendar quarter is at least 1.5%, although the FDIC has the authority to suspend or limit such permitted dividend declarations. In December 2010, the FDIC adopted a final rule setting the designated reserve ratio for the deposit insurance fund at 2% of estimated insured deposits.
Also as a consequence of the Dodd-Frank Act, the assessment base for deposit insurance premiums was changed, effective April 1, 2011, from adjusted domestic deposits to average consolidated total assets minus average tangible equity. Tangible equity for this purpose means Tier 1 capital. Effective April 1, 2011, the initial base assessment rates were as follows:
| For small Risk Category I banks, such as Horizon, the rates range from 5-9 basis points. |
| The rates for small institutions in Risk Categories II, III and IV are 14, 23 and 35 basis points, respectively. |
| For large institutions and large, highly complex institutions, the rate schedule ranges from 5 to 35 basis points. |
Adjustments are made to the initial assessment rates based on long-term unsecured debt, depository institution debt, and brokered deposits. Horizons FDIC deposit insurance expense decreased during 2012 compared to 2011 as the new assessment calculation resulted in lower expense for the Bank. In addition, the Bank used $3.7 million of the $6.0 million of the premiums prepaid on December 30, 2009 to offset the assessment paid. The FDIC continued to offset the regular
7
HORIZON BANCORP
(Table dollars in thousands except per share data)
insurance assessments until the earlier of the exhaustion of an institutions prepaid assessments or June 30, 2013. Any prepaid assessment remaining after collection of the amount due on June 30, 2013, was returned to the institution. The FDIC returned to the Bank $2.1 million in prepaid assessments.
The Dodd-Frank Act also extended unlimited insurance on noninterest bearing accounts for no additional charges through December 31, 2013. Under this program, traditional noninterest demand deposit (or checking) accounts that allowed for an unlimited number of transfers and withdrawals at any time, whether held for a business, individual, or other type of depositor, were covered. Later, Congress added Lawyers Trust Accounts (IOLTA) to this unlimited insurance protection through December 31, 2013. On December 31, 2013, as scheduled, the unlimited insurance coverage for noninterest-bearing transaction accounts provided under the Dodd-Frank Act expired. Deposits held in noninterest-bearing transaction account are now aggregated with any interest-bearing deposits the owner may hold in the same ownership category, and the combined total is insured up to at least $250,000.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.
FDIC-insured institutions are also subject to the requirement to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (FICO), an agency of the Federal government established to recapitalize the predecessor to the Savings Association Insurance Fund (SAIF). These assessments will continue until the FICO bonds are repaid between 2017 and 2019. The FICO assessment rate was 0.66 basis points for each $100 of insured deposits for each quarter of 2012. For the first quarter of 2014, the FICO assessment rate is 0.62 basis points for each $100 in domestic deposits maintained at an institution.
Transactions with Affiliates and Insiders
Horizon and the Bank are subject to the Federal Reserve Act, which restricts financial transactions between banks, affiliated companies and their executive officers, including limits on credit transactions between these parties. The statute prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a banks extension of credit to an affiliate.
Effective July 21, 2011, among other changes, the Dodd-Frank Act eliminated the exceptions under Section 23A of the Federal Reserve Act for transactions with financial subsidiaries and expanded the scope of transactions treated as covered transactions to include derivatives transactions and securities repurchase agreements. The Dodd-Frank Act also expands the types of transactions subject to insider lending limits.
Capital Regulation
The federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and account for off-balance sheet items. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk weighted categories of 0%, 20%, 50%, or 100%, with higher levels of capital being required for the categories perceived as representing greater risk.
The capital guidelines divide a bank holding companys or banks capital into two tiers. The first tier (Tier I) includes common equity, certain non-cumulative perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets (except mortgage servicing rights and purchased credit card relationships, subject to certain limitations). Supplementary capital (Tier II) includes, among other items, cumulative perpetual and long-term limited-life preferred stock, mandatory convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions. Banks and bank holding companies are required to maintain a total risk-based capital ratio of at least 8%, of which 4% must be Tier I capital. The federal banking regulators may, however, set higher capital requirements when a banks particular circumstances warrant. Banks experiencing or anticipating significant growth are expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.
8
HORIZON BANCORP
(Table dollars in thousands except per share data)
Also required by the regulations is the maintenance of a leverage ratio designed to supplement the risk-based capital guidelines. This ratio is computed by dividing Tier I capital, net of all intangibles, by the quarterly average of total assets. The minimum leverage ratio is 3% for the most highly rated institutions, and 1% to 2% higher for institutions not meeting those standards. Pursuant to the regulations, banks must maintain capital levels commensurate with the level of risk, including the volume and severity of problem loans to which they are exposed.
In June 2012, the federal banking agencies issued notices of proposed rulemakings that revise each agencys risk-based and leverage capital requirements consistent with agreements reached by the Basel Committee on Banking Supervision (Basel III), including implementation of a new common equity tier 1 minimum capital requirement and a higher minimum tier 1 capital requirement. The agencies also proposed, consistent with Basel III, to apply limits on a banking organizations capital distributions and certain discretionary bonus payments if the banking organization does not hold a specified buffer of common equity tier 1 capital in addition to the minimum risk-based capital requirements. The proposed rulemaking also would revise the agencies prompt corrective action framework by incorporating the new regulatory capital minimums and updating the definition of tangible common equity. Such proposed capital requirements were originally proposed to be phased in beginning on January 1, 2013 for all depository institution holding companies; however, in late 2012, the agencies issued guidance indicating that they did not expect the regulatory capital rules to actually become effective on such date due to the volume of comments received and the wide range of views expressed during the comment period. Basel III specified that banks should be compliant with the new capital requirements by January 2, 2015, but on January 6, 2013, the restrictions were eased to provide for annual increases that would result in full compliance in 2019.
In July 2013, the federal banking agencies approved final rules implementing the U.S. Basel Committee on Banking Supervisions capital framework for all U.S. banks and for bank holding companies with at least $500 million in assets. Under these final rules, minimum requirements will increase for both the quantity and quality of capital held by Horizon and the Bank. The rules include a new common equity Tier 1 capital ratio of 4.5%, a minimum Tier 1 capital ratio of 6.0%, a total capital ratio of 8 percent and a minimum leverage ratio of 4.0%. The final rules also require a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of certain bonuses to senior executive management. The capital buffer requirement will be phased in over three years beginning in 2016. The capital buffer requirement effectively raises the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis. The final rules also introduce other changes, including an increase in the capital required for certain categories of assets, including higher-risk construction real estate loans and certain exposures related to securitizations. These new minimum capital ratios will become effective for Horizon on January 1, 2015 and will be fully phased-in on January 1, 2019. Horizons management is currently evaluating the provisions of the final rules and their expected impact.
On August 25, 2011, Horizon issued 12,500 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the Series B Preferred Stock), for proceeds of $12.5 million and used those proceeds, together with otherwise available funds, to redeem the remaining 18,750 of the outstanding shares of Series A Preferred Stock held by the U.S. Department of the Treasury (the Treasury).
9
HORIZON BANCORP
(Table dollars in thousands except per share data)
The following is a summary of Horizons and the Banks regulatory capital and capital requirements at December 31, 2013.
Actual | For Capital1 Adequacy Purposes |
For Well1 Capitalized Purposes |
||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
As of December 31, 2013 |
||||||||||||||||||||||||
Total capital1 (to risk-weighted assets) |
||||||||||||||||||||||||
Consolidated |
$ | 192,904 | 16.33 | % | $ | 94,503 | 8.00 | % | N/A | N/A | ||||||||||||||
Bank |
173,634 | 14.67 | % | 94,688 | 8.00 | % | $ | 118,360 | 10.00 | % | ||||||||||||||
Tier 1 capital1 (to risk-weighted assets) |
||||||||||||||||||||||||
Consolidated |
178,115 | 15.08 | % | 47,245 | 4.00 | % | N/A | N/A | ||||||||||||||||
Bank |
158,827 | 13.42 | % | 47,340 | 4.00 | % | 71,011 | 6.00 | % | |||||||||||||||
Tier 1 capital1 (to average assets) |
||||||||||||||||||||||||
Consolidated |
178,115 | 10.28 | % | 69,305 | 4.00 | % | N/A | N/A | ||||||||||||||||
Bank |
158,827 | 9.18 | % | 69,206 | 4.00 | % | 86,507 | 5.00 | % |
1 | As defined by regulatory agencies |
The Dodd-Frank Act also requires the Federal Reserve to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository subsidiaries, except that bank holding companies with less than $500 million in assets are exempt from these capital requirements.
Dividends
Dividends received from the Bank are the primary source of Horizons revenues. The Banks payment of dividends, without prior regulatory approval, is subject to regulatory limitations. Under the National Bank Act, the Bank, as a national bank, is required to obtain the prior approval of the OCC for the payment of dividends if the total of all dividends declared by it in one year would exceed its net profits for the current year plus its retained net profits for the two preceding years, less any required transfers to surplus. In addition, the Bank may only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed the banks undivided profits after deducting statutory bad debt in excess of the banks allowance for loan losses. Under the Federal Deposit Insurance Act, the Bank is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy its minimum capital requirements.
The issuance to the Treasury of the Series B Preferred Stock resulted in the imposition of limitations on Horizons ability to pay dividends. Under the terms of the Series B Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the Series B Preferred Stock, junior preferred shares, or other junior securities, including the common stock, during the current quarter and for the next three quarters following the failure to declare and pay dividends on the Series B Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach. Horizon does not anticipate that these restrictions will affect its ability to pay the required dividends on the Series B Preferred Stock or its ability to continue to pay dividends on its common stock.
Prompt Corrective Regulatory Action
Federal law provides the federal banking regulators with broad powers to require the bank to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators powers depends on whether the institution in question is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized, as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators corrective powers include: (i) requiring the submission of a capital restoration plan; (ii) placing limits on asset growth and restrictions on activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions with affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution. At December 31, 2013, the Bank was
10
HORIZON BANCORP
(Table dollars in thousands except per share data)
categorized as well capitalized, meaning that the Banks total risk-based capital ratio exceeded 10%, the Banks Tier I risk-based capital ratio exceeded 6%, the Banks leverage ratio exceeded 5%, and the Bank was not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure. When the new Basel III framework, discussed under Capital Regulation, is phased in, new requirements will change the prompt corrective action framework discussed above.
Anti-Money Laundering and the USA Patriot Act
Horizon is subject to the provisions of the USA PATRIOT Act of 2001, which contains anti-money laundering and financial transparency laws and requires financial institutions to implement additional policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering, suspicious activities and currency transaction reporting, and currency crimes.
Sarbanes-Oxley Act of 2002
Horizon also is subject to the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act), which revised the laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act applies to all companies with equity or debt securities registered under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act established: (i) new requirements for audit committees, including independence, expertise and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the securities laws. Management expects that significant additional efforts and expense will continue to be required to comply with the provisions of the Sarbanes-Oxley Act.
Pursuant to the final rules adopted by the Securities and Exchange Commission to implement Section 404 of the Sarbanes-Oxley Act of 2002, Horizon is required to include in each Form 10-K it files a report of management on Horizons internal control over financial reporting. The internal control report must include a statement of managements responsibility for establishing and maintaining adequate control over financial reporting of Horizon, identify the framework used by management to evaluate the effectiveness of Horizons internal control over financial reporting and provide managements assessment of the effectiveness of Horizons internal control over financial reporting. This Annual Report on Form 10-K also includes an attestation report issued by Horizons registered public accounting firm on Horizons internal control over financial reporting. For fiscal years prior to the year ended December 31, 2013, Horizon was not an accelerated filer and, therefore, Horizon was exempt from the attestation report requirements. Significant efforts have been required to comply with Section 404, and Horizon anticipates additional efforts will be required in future years.
Recent Legislative Developments
On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that profoundly affect how community banks, thrifts, and small bank and thrift holding companies are regulated in the future. Among other things, these provisions have resulted in the abolishment of the Office of Thrift Supervision and the transfer on its functions to the other federal banking agencies, relaxed rules regarding interstate branching, allowed financial institutions to pay interest on business checking accounts, changed the scope of federal deposit insurance coverage and imposed new capital requirements on bank and thrift holding companies.
The Dodd-Frank Act also established the Bureau of Consumer Financial Protection (CFPB) as an independent entity within the Federal Reserve, which has the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Effective July 21, 2011, the CFPB assumed primary responsibility for administering substantially all of the consumer compliance regulations formerly administered by other federal agencies. The CFPB also has the authority to promulgate consumer protection regulations that will apply to all entities, including banks, that offer consumer financial services or products. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments. The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of Horizon in substantial and unpredictable ways.
11
HORIZON BANCORP
(Table dollars in thousands except per share data)
The ultimate effect of the Dodd-Frank Act on the financial services industry in general, and Horizon in particular, remains uncertain. Many aspects of the Dodd-Frank Act are subject to future rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on Horizon and the financial services industry more generally. Horizons management continues to review rules and regulations adopted pursuant to the Dodd-Frank Act and assess their probable impact on the business, financial condition and results of operations of Horizon.
Other Regulation
In addition to the matters discussed above, the Bank is subject to additional regulation of its activities, including a variety of consumer protection regulations affecting its lending, deposit, and collection activities and regulations affecting secondary mortgage market activities.
Effect of Governmental Monetary Policies
The Banks earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserves monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.
Federal Home Loan Bank System
The Bank is a member of the FHLB of Indianapolis, which is one of twelve regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned region. The FHLB is funded primarily from funds deposited by banks and savings associations and proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB. All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. The Federal Housing Finance Board (FHFB), an independent agency, controls the FHLB System, including the FHLB of Indianapolis.
As a member of the FHLB, the Bank is required to purchase and maintain stock in the FHLB of Indianapolis in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts, or similar obligations at the beginning of each year. At December 31, 2013, the Banks investment in stock of the FHLB of Indianapolis was $11.0 million. The FHLB imposes various limitations on advances such as limiting the amount of certain types of real estate related collateral to 30% of a members capital and limiting total advances to a member. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Indianapolis and the purpose of the borrowing.
The FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low and moderate income housing projects. For the year ended December 31, 2013, dividends paid by the FHLB of Indianapolis to the Bank totaled approximately $386,000, for an annualized rate of 3.50%.
Limitations on Rates Paid for Deposits
FDIC regulations place limitations on the interest rates that less than well-capitalized insured depository institutions may pay on deposits. Under these regulations, well capitalized depository institutions may accept, renew or roll such deposits over without restriction, adequately capitalized depository institutions may accept, renew or roll such deposits over with a waiver from the FDIC (subject to certain restrictions on payments of rates) and undercapitalized depository institutions may not accept, renew or roll such deposits over. The regulations contemplate that the definitions of well capitalized, adequately capitalized and undercapitalized will be the same as the definition adopted by the agencies to implement the corrective action provisions of federal law. Management does not believe that these regulations will have a materially adverse effect on the Banks current operations.
12
HORIZON BANCORP
(Table dollars in thousands except per share data)
Legislative Initiatives
Additional legislative and administrative actions affecting the banking industry may be considered by the United States Congress, state legislatures and various regulatory agencies, including those referred to above. It cannot be predicted with certainty whether such legislative or administrative action will be enacted or the extent to which the banking industry in general or Horizon and its affiliates will be affected.
BANK HOLDING COMPANY STATISTICAL DISCLOSURES
I. | DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL |
Information required by this section of Securities Act Industry Guide 3 is presented in Managements Discussion and Analysis as set forth in Item 7 below, herein incorporated by reference.
II. | INVESTMENT PORTFOLIO |
A. | The following is a schedule of the amortized cost and fair value of investment securities available for sale and held to maturity. |
December 31, 2013 | December 31, 2012 | December 31, 2011 | ||||||||||||||||||||||
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
|||||||||||||||||||
Available for sale |
||||||||||||||||||||||||
U.S. Treasury and federal agencies |
$ | 43,808 | $ | 43,134 | $ | 51,458 | $ | 51,779 | $ | 12,693 | $ | 13,022 | ||||||||||||
State and municipal |
176,670 | 177,898 | 162,147 | 172,905 | 135,011 | 143,890 | ||||||||||||||||||
Federal agency collateralized mtg. obligations |
116,047 | 114,706 | 95,337 | 96,831 | 89,016 | 91,122 | ||||||||||||||||||
Federal agency mortgage-backed pools |
170,006 | 170,894 | 152,372 | 159,204 | 173,797 | 179,351 | ||||||||||||||||||
Private labeled mortgage-backed pools |
1,188 | 1,226 | 1,960 | 2,031 | 3,518 | 3,636 | ||||||||||||||||||
Corporate notes |
708 | 733 | 32 | 51 | 32 | 24 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total available for sale |
508,427 | 508,591 | 463,306 | 482,801 | 414,067 | 431,045 | ||||||||||||||||||
Total held to maturity, state and municipal |
9,910 | 9,910 | | | 7,100 | 7,134 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total investment securities |
$ | 518,337 | $ | 518,501 | $ | 463,306 | $ | 482,801 | $ | 421,167 | $ | 438,179 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
B. | The following is a schedule of maturities of each category of available for sale and held to maturity debt securities and the related weighted-average yield of such securities as of December 31, 2013: |
One Year or Less | After One Year Through Five Years |
After Five Years Through Ten Years |
After Ten Years | |||||||||||||||||||||||||||||
Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||||||
Available for sale |
||||||||||||||||||||||||||||||||
U.S. Treasury and federal agencies(1) |
$ | | 0.00 | % | $ | 25,750 | 1.32 | % | $ | 17,385 | 1.89 | % | $ | | 0.00 | % | ||||||||||||||||
State and municipal |
3,663 | 2.98 | % | 23,876 | 3.85 | % | 90,041 | 3.81 | % | 60,318 | 4.13 | % | ||||||||||||||||||||
Federal agency collateralized mtg. obligations(2) |
| 0.00 | % | 1,688 | 3.85 | % | 7,751 | 3.50 | % | 105,267 | 2.48 | % | ||||||||||||||||||||
Federal agency mortgage-backed pools(2) |
4 | 4.23 | % | 1,385 | 4.53 | % | 41,101 | 3.15 | % | 128,404 | 2.96 | % | ||||||||||||||||||||
Private labeled mortgage-backed pools(2) |
| 0.00 | % | 435 | 4.59 | % | 791 | 5.29 | % | | 0.00 | % | ||||||||||||||||||||
Corporate notes |
| 0.00 | % | | 0.00 | % | | 0.00 | % | 733 | 0.00 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
Total available for sale |
$ | 3,667 | 2.98 | % | $ | 53,134 | 2.61 | % | $ | 157,069 | 3.39 | % | $ | 294,722 | 3.02 | % | ||||||||||||||||
Total held to maturity, state and municipal |
$ | 9,910 | 1.73 | % | $ | | 0.00 | % | $ | | 0.00 | % | $ | | 0.00 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
Total investment securities |
$ | 13,577 | 2.07 | % | $ | 53,134 | 2.61 | % | $ | 157,069 | 3.39 | % | $ | 294,722 | 3.02 | % | ||||||||||||||||
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|
|
|
|
|
|
(1) | Fair value is based on contractual maturity or call date where a call option exists |
(2) | Maturity based upon final maturity date |
The weighted-average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount. Yields are not presented on a tax-equivalent basis.
13
HORIZON BANCORP
(Table dollars in thousands except per share data)
Excluding those holdings of the investment portfolio in Treasury securities and other agencies and corporations of the U.S. Government, there were no investments in securities of any one issuer that exceeded 10% of the consolidated stockholders equity of Horizon at December 31, 2013.
III. | LOAN PORTFOLIO |
A. | Types of LoansTotal loans on the balance sheet are comprised of the following classifications for the years indicated. |
December 31 2013 |
December 32 2012 |
December 31 2011 |
December 31 2010 |
December 31 2009 |
||||||||||||||||
Commercial |
$ | 505,189 | $ | 460,471 | $ | 352,376 | $ | 330,018 | $ | 314,517 | ||||||||||
Real estate |
185,958 | 189,714 | 157,141 | 162,435 | 133,892 | |||||||||||||||
Mortgage warehouse |
98,156 | 251,448 | 208,299 | 123,743 | 166,698 | |||||||||||||||
Consumer |
279,525 | 289,084 | 265,377 | 266,681 | 271,210 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
1,068,828 | 1,190,717 | 983,193 | 882,877 | 886,317 | ||||||||||||||||
Allowance for loan losses |
(15,992 | ) | (18,270 | ) | (18,882 | ) | (19,064 | ) | (16,015 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total loans |
$ | 1,052,836 | $ | 1,172,447 | $ | 964,311 | $ | 863,813 | $ | 870,302 | ||||||||||
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|
|
B. | Maturities and Sensitivities of Loans to Changes in Interest RatesThe following is a schedule of maturities and sensitivities of loans to changes in interest rates, excluding real estate mortgage, mortgage warehousing and installment loans, as of December 31, 2013: |
Maturing or repricing | One Year or Less |
One Through Five Years |
After Five Years |
Total | ||||||||||||
Commercial, financial, agricultural and commercial tax-exempt loans |
$ | 307,814 | $ | 172,292 | $ | 25,083 | $ | 505,189 |
The following is a schedule of fixed-rate and variable-rate commercial, financial, agricultural and commercial tax-exempt loans due after one year. (Variable-rate loans are those loans with floating or adjustable interest rates.)
Fixed Rate |
Variable Rate |
|||||||
Total commercial, financial, agricultural and commercial tax-exempt loans due after one year |
$ | 141,190 | $ | 56,185 |
14
HORIZON BANCORP
(Table dollars in thousands except per share data)
C. | Risk Elements |
Non-accrual, Past Due and Restructured LoansThe following schedule summarizes non-accrual, past due and restructured loans.
December 31 2013 |
December 31 2012 |
December 31 2011 |
December 31 2010 |
December 31 2009 |
||||||||||||||||
Non-performing loans |
||||||||||||||||||||
Commercial |
||||||||||||||||||||
More than 90 days past due |
$ | 45 | $ | | $ | | $ | | $ | 1,086 | ||||||||||
Non-accrual |
4,014 | 5,754 | 6,905 | 7,508 | 8,143 | |||||||||||||||
Trouble debt restructuringaccruing |
1,296 | 1,265 | | 574 | | |||||||||||||||
Trouble debt restructuringnon-accrual |
2,116 | 3,674 | 1,053 | | | |||||||||||||||
Real estate |
||||||||||||||||||||
More than 90 days past due |
2 | 2 | | 222 | 296 | |||||||||||||||
Non-accrual |
2,459 | 4,565 | 4,694 | 5,483 | 1,257 | |||||||||||||||
Trouble debt restructuringaccruing |
2,686 | 1,761 | 2,682 | 3,380 | 3,266 | |||||||||||||||
Trouble debt restructuringnon-accrual |
999 | 2,827 | 1,120 | 241 | | |||||||||||||||
Mortgage warehouse |
||||||||||||||||||||
More than 90 days past due |
| | | | | |||||||||||||||
Non-accrual |
| | | | | |||||||||||||||
Trouble debt restructuringaccruing |
| | | | | |||||||||||||||
Trouble debt restructuringnon-accrual |
| | | | | |||||||||||||||
Consumer |
||||||||||||||||||||
More than 90 days past due |
2 | 52 | 37 | 136 | 376 | |||||||||||||||
Non-accrual |
3,275 | 3,055 | 2,769 | 3,682 | 2,515 | |||||||||||||||
Trouble debt restructuringaccruing |
1,072 | 676 | 858 | 165 | 206 | |||||||||||||||
Trouble debt restructuringnon-accrual |
311 | 148 | 25 | 37 | | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total non-performing loans |
18,277 | 23,779 | 20,143 | 21,428 | 17,145 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Other real estate owned and repossessed collateral |
||||||||||||||||||||
Commercial |
830 | 1,337 | 1,092 | 1,622 | 544 | |||||||||||||||
Real estate |
1,277 | 1,228 | 1,708 | 1,042 | 1,186 | |||||||||||||||
Mortgage warehouse |
| | | | | |||||||||||||||
Consumer |
14 | 11 | 49 | | 23 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total other real estate owned and repossessed collateral |
2,121 | 2,576 | 2,849 | 2,664 | 1,753 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total non-performing assets |
$ | 20,398 | $ | 26,355 | $ | 22,992 | $ | 24,092 | $ | 18,898 | ||||||||||
|
|
|
|
|
|
|
|
|
|
Gross interest income that would have been recorded on non- accrual loans outstanding as of December 31, 2013, in the period if the loans had been current, in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period. |
$ | 853 | ||
Interest income actually recorded on non-accrual loans outstanding as of December 31, 2013, and included in net income for the period. |
236 | |||
|
|
|||
Interest income not recognized during the period on non-accrual loans outstanding as of December 31, 2013. |
$ | 617 | ||
|
|
Discussion of Non-Accrual Policy
1. | From time to time, the Bank obtains information, which may lead management to believe that the collection of payments may be doubtful on a particular loan. In recognition of such, it is managements policy to convert the loan from an earning asset to a non-accruing loan. Further, it is managements policy to place a commercial loan on a non-accrual status when delinquent in excess of 90 days or have had the accrual of interest discontinued by management. The officer responsible for the loan, the Chief Operating Officer and the senior collection officer must review all loans placed on non-accrual status. |
15
HORIZON BANCORP
(Table dollars in thousands except per share data)
2. | Potential Problem Loans: |
Impaired and non-accrual loans for which the discounted cash flows or collateral value exceeded the carrying value of the loan totaled $18.3 million and $23.8 million at December 31, 2013 and 2012. The allowance for impaired and non-accrual loans, included in the Banks allowance for loan losses totaled $3.6 million and $5.5 million at those respective dates. The average balance of impaired loans during 2013 and 2012 was $23.6 million and $22.2 million.
3. | Foreign Outstandings: |
None
4. | Loan Concentrations: |
As of December 31, 2013, there are no significant concentrations of loans exceeding 10% of total loans. See Item III A above for a listing of the types of loans by concentration.
D. | Other Interest-Bearing Assets |
There are no other interest-bearing assets as of December 31, 2013, which would be required to be disclosed under Item III C.1 or 2 if such assets were loans.
IV. | SUMMARY OF LOAN LOSS EXPERIENCE |
A. | The following is an analysis of the activity in the allowance for loan losses account: |
December 31 2013 |
December 31 2012 |
December 31 2011 |
December 31 2010 |
December 31 2009 |
||||||||||||||||
Loans outstanding at the end of the period (1) |
$ | 1,068,828 | $ | 1,190,717 | $ | 983,193 | $ | 882,877 | $ | 886,317 | ||||||||||
Average loans outstanding during the period (1) |
1,092,662 | 1,043,620 | 862,498 | 878,181 | 892,431 |
(1) | Net of unearned income and deferred loan fees |
December 31 2013 |
December 31 2012 |
December 31 2011 |
December 31 2010 |
December 31 2009 |
||||||||||||||||
Balance at beginning of the period |
$ | 18,270 | $ | 18,882 | $ | 19,064 | $ | 16,015 | $ | 11,410 | ||||||||||
Loans charged-off: |
||||||||||||||||||||
Commercial |
2,532 | 2,388 | 967 | 3,856 | 2,461 | |||||||||||||||
Real estate |
1,055 | 597 | 956 | 811 | 432 | |||||||||||||||
Consumer |
2,663 | 2,958 | 4,757 | 5,067 | 7,354 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total loans charged-off |
6,250 | 5,943 | 6,680 | 9,734 | 10,247 | |||||||||||||||
Recoveries of loans previously charged-off: |
||||||||||||||||||||
Commercial |
668 | 782 | 163 | 233 | 66 | |||||||||||||||
Real estate |
114 | 77 | 10 | 1 | | |||||||||||||||
Consumer |
1,270 | 948 | 1,043 | 995 | 1,183 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total loan recoveries |
2,052 | 1,807 | 1,216 | 1,229 | 1,249 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Net loans charged-off |
4,198 | 4,136 | 5,464 | 8,505 | 8,998 | |||||||||||||||
Provision charged to operating expense |
1,920 | 3,524 | 5,282 | 11,554 | 13,603 | |||||||||||||||
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|
|
|
|
|
|
|
|
|
|||||||||||
Balance at the end of the period |
$ | 15,992 | $ | 18,270 | $ | 18,882 | $ | 19,064 | $ | 16,015 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Percent of net charge-offs to average loans outstanding for the period |
0.38 | % | 0.40 | % | 0.63 | % | 0.97 | % | 1.01 | % |
16
HORIZON BANCORP
(Table dollars in thousands except per share data)
B. | The following schedule is a breakdown of the allowance for loan losses allocated by type of loan and the percentage of loans in each category to total loans. |
December 31 2013 |
December 31 2012 |
December 31 2011 |
December 31 2010 |
December 31 2009 |
||||||||||||||||||||||||||||||||||||
Allowance Amount |
% of Loans to Total Loans |
Allowance Amount |
% of Loans to Total Loans |
Allowance Amount |
% of Loans to Total Loans |
Allowance Amount |
% of Loans to Total Loans |
Allowance Amount |
% of Loans to Total Loans |
|||||||||||||||||||||||||||||||
Commercial, financial and agricultural |
$ | 6,663 | 48 | % | $ | 7,771 | 39 | % | $ | 8,017 | 36 | % | $ | 7,554 | 38 | % | $ | 5,766 | 35 | % | ||||||||||||||||||||
Real estate |
3,462 | 17 | % | 3,204 | 16 | % | 2,472 | 16 | % | 2,379 | 18 | % | 1,933 | 15 | % | |||||||||||||||||||||||||
Mortgage warehousing |
1,638 | 9 | % | 1,705 | 21 | % | 1,695 | 21 | % | 1,435 | 14 | % | 1,455 | 19 | % | |||||||||||||||||||||||||
Consumer |
4,229 | 26 | % | 5,590 | 24 | % | 6,698 | 27 | % | 7,696 | 30 | % | 6,861 | 31 | % | |||||||||||||||||||||||||
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Total |
$ | 15,992 | 100 | % | $ | 18,270 | 100 | % | $ | 18,882 | 100 | % | $ | 19,064 | 100 | % | $ | 16,015 | 100 | % | ||||||||||||||||||||
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In 1999, Horizon began a mortgage warehousing program. This program is described in Managements Discussion and Analysis of Financial Condition and Results of Operation in Item 7 below and in the Notes to the Financial Statements in Item 8 below, which are incorporated herein by reference. The greatest risk related to these loans is transaction and fraud risk. During 2013, Horizon processed approximately $2.9 billion in mortgage warehouse loans.
V. DEPOSITS
Information required by this section is found in Managements Discussion and Analysis of Financial Condition and Results of Operation in Item 7 below and in the Consolidated Financial Statements and related notes in Item 8 below, which are incorporated herein by reference.
VI. RETURN ON EQUITY AND ASSETS
Information required by this section is found in Managements Discussion and Analysis of Financial Condition and Results of Operation in Item 7 below and in the Consolidated Financial Statements and related notes in Item 8 below, which are incorporated herein by reference.
VII. SHORT TERM BORROWINGS
The following is a schedule of statistical information relative to securities sold under agreements to repurchase which are secured by Treasury and U.S. Government agency securities and mature within one year. There were no other categories of short-term borrowings for which the average balance outstanding during the period was 30 percent or more of stockholders equity at the end of the period.
December 31 2013 |
December 31 2012 |
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Outstanding at year end |
$ | 45,247 | $ | 43,448 | ||||
Approximate weighted-average interest rate at year-end |
0.14 | % | 0.14 | % | ||||
Highest amount outstanding as of any month-end during the year |
$ | 46,371 | $ | 43,448 | ||||
Approximate average outstanding during the year |
$ | 42,602 | $ | 40,210 | ||||
Approximate weighted-average interest during the year |
0.14 | % | 0.14 | % |
17
HORIZON BANCORP
(Table dollars in thousands except per share data)
An investment in Horizons securities is subject to risks inherent to our business. The material risks and uncertainties that management believes currently affect Horizon are described below. Before making an investment decision, you should carefully consider these risks as well as information we include or incorporate by reference in this report and other filings we make with the SEC. The risks and uncertainties we have described are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may affect our business operations.
If any of these risks or uncertainties materializes or any of these assumptions proves incorrect, our results could differ materially from the forward-looking statements. All forward-looking statements in this report are current only as of the date on which the statements were made. We do not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any statement is made or to reflect the occurrence of unanticipated events.
Risks Related to Our Business
As a financial institution, we are subject to a number of risks relating to our daily business. Although we undertake a variety of efforts to manage and control those risks, many of the risks are outside of our control. Among the risks we face are the following:
| Credit risk: the risk that loan customers or other parties will be unable to perform their contractual obligations; |
| Market risk: the risk that changes in market rates and prices will adversely affect our financial condition or results of operation; |
| Liquidity risk: the risk that Horizon or the Bank will have insufficient cash or access to cash to meet its operating needs; |
| Operational risk: the risk of loss resulting from fraud, inadequate or failed internal processes, people and systems, or external events; |
| Economic risk: the risk that the economy in our markets could decline further resulting in increased unemployment, decreased real estate values and increased loan charge-offs; and |
| Compliance risk: the risk of additional action by our regulators or additional regulation could hinder our ability to do business profitably. |
The current economic environment poses significant challenges for us and could adversely affect our financial condition and results of operations.
We are operating in a challenging and uncertain economic environment, including generally uncertain world, national and local conditions in our markets. The capital and credit markets have been experiencing volatility and disruption since 2008. This presents financial institutions with unprecedented circumstances and challenges that in some cases have resulted in large declines in the fair values of investments and other assets, constraints on liquidity and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans. Our financial statements have been prepared using values and information currently available to us, but given this volatility, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values and the allowance for loan losses, which could negatively impact our ability to meet regulatory capital requirements and maintain sufficient liquidity. The risks associated with our business become more acute in periods of a slowing economy or slow growth such as we began experiencing in the latter half of 2008 and which continued through 2013. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. While we continue to take steps to decrease and limit our exposure to residential construction and land development loans and home equity loans, we nonetheless retain direct exposure to the residential and commercial real estate markets, and we are affected by these events.
Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job loss, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. Further deterioration in local economic conditions in our markets could drive losses beyond that which is provided for in our allowance for loan losses and result in the following
18
HORIZON BANCORP
(Table dollars in thousands except per share data)
other consequences: increases in loan delinquencies, problem assets and foreclosures; demand for our products and services may decline; deposits may decrease, which would adversely impact our liquidity position; and collateral for our loans, especially real estate, may decline in value, in turn reducing customers borrowing power, and reducing the value of assets and collateral associated with our existing loans.
Our financial performance may be adversely impacted if we are unable to continue to grow our commercial and consumer loan portfolios, obtain low-cost funds and compete with other providers of financial services.
Our ability to maintain our history of record earnings year after year will depend, in large part, on our ability to continue to grow our loan portfolios and obtain low-cost funds.
We have funded our growth with low-cost consumer deposits, and our ability to sustain our growth will depend in part on our continued success in attracting and retaining such deposits or finding other sources of low-cost funds.
Another factor in maintaining our history of record earnings will be our ability to expand our scope of available financial services to our customers in an increasingly competitive environment. In addition to other banks, our competitors include credit unions, securities brokers and dealers, mortgage brokers, mortgage bankers, investment advisors, and finance and insurance companies. Competition is intense in most of our markets. We compete on price and service with our competitors. Competition could intensify in the future as a result of industry consolidation, the increasing availability of products and services from non-banks, greater technological developments in the industry, and banking reform.
Our commercial and consumer loans expose us to increased credit risks.
We have a large percentage of commercial and consumer loans. Commercial loans generally have greater credit risk than residential mortgage loans because repayment of these loans often depends on the successful business operations of the borrowers. These loans also typically have much larger loan balances than residential mortgage loans. Consumer loans generally involve greater risk than residential mortgage loans because they are unsecured or secured by assets that depreciate in value. Although we undertake a variety of underwriting, monitoring and reserving protections with respect to these types of loans, there can be no guarantee that we will not suffer unexpected losses, and recently, we have experienced an increase in the default rates in our consumer loan portfolio, particularly relating to indirect auto loans.
Our holdings of construction, land and home equity loans may pose more credit risk than other types of mortgage loans.
Construction loans, loans secured by commercial real estate and home equity loans generally entail more risk than other types of mortgage loans. When real estate values decrease, the developers to whom we lend are likely to experience a decline in sales of new homes from their projects. Land and construction loans are more likely to become non-performing as developers are unable to build and sell homes in volumes large enough for orderly repayment of loans and as other owners of such real estate (including homeowners) are unable to keep up with their payments. We strive to establish what we believe are adequate reserves on our financial statements to cover the credit risk of these loan portfolios. However, there can be no assurance that losses will not exceed our reserves, and ultimately result in a material level of charge-offs, which could adversely impact our results of operations, liquidity and capital.
The allowance for loan losses may prove inadequate or be negatively affected by credit risk exposures.
Our business depends on the creditworthiness of our customers. We periodically review the allowance for loan and lease losses for adequacy considering economic conditions and trends, collateral values, and credit quality indicators, including past charge-off experience and levels of past due loans and non-performing assets. There is no certainty that the allowance for loan losses will be adequate over time to cover credit losses in the portfolio because of unanticipated adverse changes in the economy, market conditions or events adversely affecting specific customers, industries or markets. If the credit quality of the customer base materially decreases, if the risk profile of a market, industry or group of customers changes materially, or if the allowance for loan losses is not adequate, our business, financial condition, liquidity, capital, and results of operations could be materially adversely affected.
19
HORIZON BANCORP
(Table dollars in thousands except per share data)
Changes in market interest rates could adversely affect our financial condition and results of operations.
Our financial condition and results of operations are significantly affected by changes in market interest rates. Our results of operations depend substantially on our net interest income, which is the difference between the interest income that we earn on our interest-earning assets and the interest expense that we pay on our interest-bearing liabilities. Our profitability depends on our ability to manage our assets and liabilities during periods of changing market interest rates. If rates increase rapidly as a result of an improving economy, we may have to increase the rates paid on our deposits and borrowed funds more quickly than loans and investments re-price, resulting in a negative impact on interest spreads and net interest income. The impact of rising rates could be compounded if deposit customers move funds from savings accounts to higher rate certificate of deposit accounts. Conversely, should market interest rates fall below current levels, our net interest margin could also be negatively affected, as competitive pressures could keep us from further reducing rates on our deposits, and prepayments and curtailments on assets may continue. Such movements may cause a decrease in our interest rate spread and net interest margin, and therefore, decrease our profitability.
Changes in interest rates also could affect loan volume. For instance, an increase in interest rates could cause a decrease in the demand for mortgage loans (and other loans), which could result in a significant decline in our revenue stream.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Increases in interest rates may decrease loan demand and/or may make it more difficult for borrowers to repay adjustable rate loans. Decreases in interest rates often result in increased prepayments of loans and mortgage-related securities, as borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments in loans or other investments that have interest rates that are comparable to the interest rates on existing loans and securities.
An economic slowdown in our primary market areas could affect our business.
Our primary market area for deposits and loans consists of Northwest and Central Indiana and Southwest, Michigan. During 2013, unemployment rates have lowered, however remain at elevated levels. An economic slowdown could hurt our business and the possible consequences of such a downturn could include the following:
| increases in loan delinquencies and foreclosures; |
| declines in the value of real estate and other collateral for loans; |
| an increase in loans charged off; |
| an increase in the Companys expense to fund loan loss reserves; |
| an increase in collection costs; |
| a decline in the demand for our products and services; |
| an increase in non-accrual loans and other real estate owned. |
The loss of key members of our senior management team could affect our ability to operate effectively.
We depend heavily on the services of our existing senior management team, particularly our CEO Craig M. Dwight, to carry out our business and investment strategies. As we continue to grow and expand our business and our locations, products and services, we will increasingly need to rely on Mr. Dwights experience, judgment and expertise as well as that of the other members of our senior management team and will also need to continue to attract and retain qualified banking personnel at all levels. Competition for such personnel is intense in our geographic market areas. If we are unable to attract and retain talented people, our business could suffer. The loss of the services of any senior management personnel, particularly Mr. Dwight, or the inability to recruit and retain qualified personnel in the future, could have a material adverse effect on our consolidated results of operations, financial condition and prospects.
20
HORIZON BANCORP
(Table dollars in thousands except per share data)
Potential acquisitions may disrupt our business and dilute stockholder value.
We periodically evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. We generally seek merger or acquisition partners that are culturally similar and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services. Acquiring other banks, businesses, or branches involves various risks commonly associated with acquisitions, including, among other things:
| Potential exposure to unknown or contingent liabilities of the target company, |
| Exposure to potential asset quality issues of the target company, |
| Potential disruption to our business, |
| Potential diversion of our managements time and attention away from day-to-day operations, |
| The possible loss of key employees, business and customers of the target company, |
| Difficulty in estimating the value of the target company, and |
| Potential problems in integrating the target companys systems, customers and employees with ours. |
As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving the payment of cash or the issuance of our debt or equity securities may occur at any time. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction. To the extent we were to issue additional common shares in any such transaction, our current shareholders would be diluted and such an issuance may have the effect of decreasing our stock price, perhaps significantly. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our financial condition and results of operations.
In addition, merger and acquisition costs incurred by Horizon may temporarily increase operating expenses.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all.
We may need to raise additional capital in the future to fund acquisitions and to provide us with sufficient capital resources and liquidity to meet our commitments, regulatory capital requirements and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Although we are currently, and have historically been, well capitalized for regulatory purposes, our capital levels are not far in excess of the well capitalized threshold, and in the past we have been required to maintain increased levels of capital in connection with certain acquisitions. Additionally, we periodically explore acquisition opportunities with other financial institutions, some of which are in distressed financial condition. Any future acquisition, particularly the acquisition of a significantly troubled institution or an institution of comparable size to us, may require us to raise additional capital in order to obtain regulatory approval and/or to remain well capitalized.
Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. Economic conditions and the loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital, including inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve.
We cannot guarantee that such capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, our depositors or counterparties participating in the capital markets may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Moreover, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our businesses, financial condition and results of operations and may restrict our ability to grow.
21
HORIZON BANCORP
(Table dollars in thousands except per share data)
The preparation of our financial statements requires the use of estimates that may vary from actual results.
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for loan losses. Due to the inherent nature of these estimates, we cannot provide absolute assurance that we will not have to increase the allowance for loan losses and/or sustain loan losses that are significantly higher than the provided allowance.
Our mortgage warehouse and indirect lending operations are subject to a higher fraud risk than our other lending operations.
We buy loans originated by mortgage bankers and automobile dealers. Because we must rely on the mortgage bankers and automobile dealers in making and documenting these loans, there is an increased risk of fraud to us on the part of the third-party originators and the underlying borrowers. In order to guard against this increased risk, we perform investigations on the mortgage companies with whom we do business, and we review the loan files and loan documents we purchase to attempt to detect any irregularities or legal noncompliance. However, there is no guarantee that our procedures will detect all cases of fraud or legal noncompliance.
Our mortgage lending profitability could be significantly reduced if we are not able to resell mortgages or experience other problems with the secondary market process or are unable to retain our mortgage loan sales force due to regulatory changes.
Currently, we sell a substantial portion of the mortgage loans we originate. The profitability of our mortgage banking operations depends in large part upon our ability to aggregate a high volume of loans and to sell them in the secondary market at a gain. Thus, we are dependent upon the existence of an active secondary market and our ability to profitably sell loans into that market.
Our ability to sell mortgage loans readily is dependent upon the availability of an active secondary market for single-family mortgage loans, which in turn depends in part upon the continuation of programs currently offered by Fannie Mae, Freddie Mac and Ginnie Mae (the Agencies) and other institutional and non-institutional investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. Some of the largest participants in the secondary market, including the Agencies, are government-sponsored enterprises whose activities are governed by federal law. Any future changes in laws that significantly affect the activity of such government-sponsored enterprises could, in turn, adversely affect our operations.
In September 2008, Fannie Mae and Freddie Mac were placed into conservatorship by the U.S. government. Although to date, the conservatorship has not had a significant or adverse effect on our operations, and during 2010 and 2011 the Federal Housing Administration Agency indicated that the Treasury Department is committed to fund Fannie Mae and Freddie Mac to levels needed in order to sufficiently meet their funding needs; it is currently unclear whether further changes would significantly and adversely affect our operations. In addition, our ability to sell mortgage loans readily is dependent upon our ability to remain eligible for the programs offered by the Agencies and other institutional and non-institutional investors. Our ability to remain eligible may also depend on having an acceptable peer-relative delinquency ratio for Federal Housing Authority (FHA) and maintaining a delinquency rate with respect to Ginnie Mae pools that are below Ginnie Mae guidelines. In the case of Ginnie Mae pools, we have repurchased delinquent loans from them in the past to maintain compliance with the minimum required delinquency ratios. Although these loans are typically insured as to principal by the FHA, such repurchases increase our capital and liquidity needs, and there can be no assurance that we will have sufficient capital or liquidity to continue to purchase such loans out of the Ginnie Mae pools if required to do so.
Any significant impairment of our eligibility with any of the Agencies could materially and adversely affect our operations. Further, the criteria for loans to be accepted under such programs may be changed from time-to-time by the sponsoring entity which could result in a lower volume of corresponding loan originations. The profitability of participating in specific programs may vary depending on a number of factors, including our administrative costs of originating and purchasing qualifying loans and our costs of meeting such criteria.
22
HORIZON BANCORP
(Table dollars in thousands except per share data)
We are exposed to intangible asset risk in that our goodwill may become impaired.
As of December 31, 2013, we had $23.0 million of goodwill and other intangible assets. A significant and sustained decline in our stock price and market capitalization, a significant decline in our expected future cash flows, a significant adverse change in the business climate, or slower growth rates could result in further impairment of goodwill. If we were to conclude that a future write-down of our goodwill is necessary, then we would record the appropriate charge, which could be materially adverse to our operating results and financial position. For further discussion, see Notes 1 and 10, Nature of Operations and Summary of Significant Accounting Policies and Intangible Assets, to the Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2013.
We are subject to extensive regulation and changes in laws and regulatory policies could adversely affect our business.
Our operations are subject to extensive regulation by federal agencies. See Supervision and Regulation in the description of our Business in Item 1 of Part I of this report for detailed information on the laws and regulations to which we are subject. Changes in applicable laws, regulations or regulator policies can materially affect our business. The likelihood of any major changes in the future and their effects are impossible to determine. As an example, the Bank could experience higher credit losses because of federal or state legislation or by regulatory or bankruptcy court action that reduces the amount the Banks borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that limits its ability to foreclose on property or other collateral or makes foreclosure less economically feasible.
Legislation enacted in recent years, together with additional actions announced by the U.S. Treasury and other regulatory agencies, continue to develop. It is not clear at this time what impact the Dodd-Frank Act, other recent legislation and liquidity and funding initiatives of the U.S. Treasury and other bank regulatory agencies, and additional programs that may be initiated in the future will have on the financial markets and the financial services industry. The extreme levels of volatility and limited credit availability currently being experienced could continue to effect the U.S. banking industry and the broader U.S. and global economies, which will have an effect on all financial institutions, including Horizon.
Our inability to continue to accurately process large volumes of transactions could adversely impact our business and financial results.
In the normal course of business, we process large volumes of transactions. If systems of internal control should fail to work as expected, if systems are used in an unauthorized manner, or if employees subvert the system of internal controls, significant losses could result.
We process large volumes of transactions on a daily basis and are exposed to numerous types of operational risk. Operational risk resulting from inadequate or failed internal processes, people and systems includes the risk of fraud by persons inside or outside Horizon, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes the potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.
We establish and maintain systems of internal operational controls that are designed to provide us with timely and accurate information about our level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost-effective levels. Procedures also exist that are designed to ensure that policies relating to conduct, ethics and business practices are followed. From time to time, losses from operational risk may occur, including the consequences of operational errors.
23
HORIZON BANCORP
(Table dollars in thousands except per share data)
While we continually monitor and improve the system of internal controls, data processing systems and corporate-wide processes and procedures, there can be no assurance that future losses will not occur.
Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately or timely addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of business, loss of customer information, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We continually encounter technological changes.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements, and we may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
We rely on other companies to provide key components of our business infrastructure.
Third-party vendors provide key components of our business infrastructure, including Internet connections, mobile and internet banking, network access and transaction and other processing services. Although we have selected these third-party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of inadequate or interrupted service or breach of customer information, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. In addition, any breach in customer information could affect our reputation and cause a loss of business. Replacing these third- party vendors also could result in significant delay and expense.
Damage to our reputation could damage our business.
Our business depends upon earning and maintaining the trust and confidence of our customers, investors and employees. Damage to our reputation could cause significant harm to our business and prospects. Harm to our reputation can arise from numerous sources, including, among others, employee misconduct, compliance failures, litigation or regulatory outcomes or governmental investigations. In addition, a failure to deliver appropriate standards of service and quality, or a failure or perceived failure to treat customers and clients fairly, can result in customer dissatisfaction, litigation, privacy breach and heightened regulatory scrutiny, all of which can lead to lost revenue, higher operating costs and harm to our reputation our reputation. Adverse publicity about Horizon, whether or not true, may result in harm to our prospects. Should any events or factors that can undermine our reputation occur, there is no assurance that the additional costs and expenses that we may need to incur to address the issues giving rise to the reputational harm would not adversely affect our earnings and results of operations.
24
HORIZON BANCORP
(Table dollars in thousands except per share data)
The soundness of other financial institutions could adversely affect us.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.
Risks Related to our Common Stock
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell our common stock at times or at prices you find attractive.
Although our common stock is listed on the NASDAQ Global Market, our stock price constantly changes, and we expect our stock price to continue to fluctuate in the future. Our stock price is impacted by a variety of factors, some of which are beyond our control.
These factors include:
| variations in our operating results or the quality of our assets; |
| operating results that vary from the expectations of management, securities analysts and investors; |
| increase in loan losses, non-performing loans and other real estate owned; |
| changes in expectations as to our future financial performance; |
| announcements of new products, strategic developments, acquisitions and other material events by us or our competitors; |
| the operating and securities price performance of other companies that investors believe are comparable to us; |
| currently on the Russell 3000 index and could come off the index; |
| actual or anticipated sales of our equity or equity-related securities; |
| our past and future dividend practice; |
| our creditworthiness; |
| interest rates; |
| the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing; |
| developments with respect to financial institutions generally; and |
| economic, financial, geopolitical, regulatory, congressional or judicial events that affect us or the financial markets. |
In addition the stock market in general has recently experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies and particularly those in the financial services and banking sector, including for reasons unrelated to their operating performance. These broad market fluctuations may adversely affect our stock price, notwithstanding our operating results.
Because our stock is thinly traded, it may be more difficult for you to sell your shares or buy additional shares when you desire to do so and the price may be volatile.
Although our common stock has been listed on the NASDAQ stock market since December 2001, our common stock is thinly traded. The prices of thinly traded stocks, such as ours, are typically more volatile than stocks traded in a large, active public market and can be more easily impacted by sales or purchases of large blocks of stock. Thinly traded stocks are also less liquid, and because of the low volume of trades, you may be unable to sell your shares when you desire to do so.
25
HORIZON BANCORP
(Table dollars in thousands except per share data)
Our participation in the Small Business Lending Fund program restricts our ability to pay dividends and to repurchase our securities and could have other negative effects.
On August 25, 2011, we sold 12,500 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (Series B Preferred Stock), to the U.S. Treasury pursuant to the Small Business Lending Fund program, a $30 billion fund established under the Small Business Jobs Act of 2010 that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion. The terms of the Series B Preferred Stock impose limits on our ability to pay dividends and repurchase shares of common stock. Under the terms of the Series B Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the Series B Preferred Stock, junior preferred shares, or other junior securities (including our common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the Series B Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach. In addition, we may declare and pay a dividend on our common stock or other stock ranking junior to the Series B Preferred Stock, or repurchase shares of any such class or series of stock, only if, after payment of such dividend, the dollar amount of the Companys Tier 1 Capital would be at least 90% of the Signing Date Tier 1 Capital, which was $118,724,000, excluding any subsequent net charge-offs and any redemption of the Series B Preferred Stock. Horizon does not anticipate that these restrictions will affect its ability to pay dividends on its common stock; however, given the possibility of unforeseen developments or events, there can be no guarantee that Horizon will be able to pay dividends on its common stock.
Provisions in our articles of incorporation, our by-laws, and Indiana law may delay or prevent an acquisition of us by a third party.
Our articles of incorporation and by-laws and Indiana law contain provisions that have certain anti-takeover effects. While the purpose of these provisions is to strengthen the negotiating position of the board in the event of a hostile takeover attempt, the overall effects of these provisions may be to render more difficult or discourage a merger, tender offer or proxy contest, the assumption of control by a holder of a larger block of our shares, and the removal of incumbent directors and key management.
Our articles of incorporation provide for a staggered board, which means that only one-third of our board can be replaced by shareholders at any annual meeting. Our articles also provide that our directors may only be removed without cause by shareholders owning 70% or more of our outstanding common stock. Furthermore, our articles provide that only our board of directors, and not our shareholders, may adopt, alter, amend and repeal our by-laws.
Our articles also preempt Indiana law with respect to business combinations with a person who acquires 10% or more of our common stock and provide that such transactions are subject to independent and super-majority shareholder approval requirements unless certain pricing and board pre-approval requirements are satisfied.
Our by-laws do not permit cumulative voting of shareholders in the election of directors, allowing the holders of a majority of our outstanding shares to control the election of all our directors, and our directors are elected by plurality (not majority) voting. Our by-laws also establish detailed procedures that shareholders must follow if they desire to nominate directors for election or otherwise present issues for consideration at a shareholders meeting. We also have a mandatory retirement age for directors.
These and other provisions of our governing documents and Indiana law are intended to provide the board of directors with the negotiating leverage to achieve a more favorable outcome for our shareholders in the event of an offer for the company. However, there is no assurance that these same anti-takeover provisions could not have the effect of delaying, deferring or preventing a transaction or a change in control that might be in the best interest of our shareholders.
Risks Related to the Series B Preferred Stock
The Series B Preferred Stock is equity and is subordinate to all of our existing and future indebtedness; regulatory and contractual restrictions may limit or prevent us from paying dividends on the Series B Preferred Stock; and the Series B Preferred Stock places no limitations on the amount of indebtedness we and our subsidiaries may incur in the future.
Shares of the Series B Preferred Stock are equity interests in Horizon and do not constitute indebtedness. As such, the Series B Preferred Stock, like our common stock, ranks junior to all indebtedness and other non-equity claims against
26
HORIZON BANCORP
(Table dollars in thousands except per share data)
Horizon with respect to assets available to satisfy claims against Horizon, including in a liquidation of Horizon. Additionally, unlike indebtedness, where principal and interest would customarily be payable on specified due dates, in the case of preferred stock like the Series B Preferred Stock, dividends are payable only when, as and if authorized and declared by, our Board of Directors and depend on, among other things, our results of operations, financial condition, debt service requirements, other cash needs and any other factors our Board of Directors deems relevant. The current terms of the Series B Preferred Stock require dividends to be paid in arrears on January 1, April 1, July 1 and October 1 of each year.
Horizon is an entity separate and distinct from the Bank, our principal subsidiary, and derives a significant portion of its revenue in the form of dividends from the Bank. Accordingly, Horizon is and will be dependent upon dividends from the Bank to pay the principal of, and interest on, its indebtedness, to satisfy its other cash needs and to pay dividends on the Series B Preferred Stock. Horizons ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements while maintaining its required capital. In the event the Bank is unable to pay dividends to Horizon, Horizon may not be able to pay dividends on the Series B Preferred Stock. In addition, the Series B Preferred Stock does not limit the amount of debt or other obligations we or our subsidiaries may incur in the future. Accordingly, we and our subsidiaries may incur substantial amounts of additional debt and other obligations that will rank senior to the Series B Preferred Stock or to which the Series B Preferred Stock will be structurally subordinated.
An active trading market for the Series B Preferred Stock does not currently exist and is unlikely to develop.
The Series B Preferred Stock is not currently listed on any national securities exchange, and we do not intend to list the Series B Preferred Stock on a national securities exchange unless we are requested to do so by the U.S. Treasury. Even if requested to so do by the U.S. Treasury, it is not certain that such a listing can be achieved given the current exchange listing requirements, and even if listing is achieved, it is unlikely that an active trading market for the Series B Preferred Stock will develop, or, if developed, that an active trading market will be maintained. If an active trading market does not develop, the market value and liquidity of the Series B Preferred Stock may be adversely affected.
Dividends on the Series B Preferred Stock are non-cumulative.
Dividends on the shares of Series B Preferred Stock are non-cumulative. If our Board of Directors does not authorize and declare a dividend on the Series B Preferred Stock for any dividend period, such unpaid dividend will not accrue and will not be payable to holders of the Series B Preferred Stock even if dividends are declared for any subsequent dividend period. However, a failure to pay dividends on the Series B Preferred Stock will restrict our ability to pay dividends with respect to and repurchase shares of other classes and series of stock.
Initially the dividend rate on the Series Preferred Stock will fluctuate based on our level of Qualified Small Business Lending as compared to our Small Business Lending Baseline.
The per annum dividend rate on the shares of Series B Preferred Stock applicable to the first quarter is 5%. For the second through tenth quarters, the rate will be adjusted quarterly to reflect the percent of change in our Qualified Small Business Lending from our Small Business Lending baseline and may fluctuate between 1% and 5% per annum. The dividend rate will be a fixed rate for the eleventh quarter through the date that is four-and-a-half years from the issuance date of the shares of Series B Preferred Stock and will be based on the rate in effect for the tenth quarter. Depending on the percentage increase in our Qualified Small Business Lending over our Small Business Lending baseline, the fixed rate will be between 1% and 5% per annum. If there has been no increase (or a decrease) in our Qualified Small Business Lending over our Small Business Lending baseline, the fixed rate will be 7% per annum. For all quarters subsequent to the four-and-one-half year anniversary of issuance, the rate will be 9% per annum.
Holders of the Series B Preferred Stock have limited voting rights.
Holders of the Series B Preferred Stock only have the right to vote as a separate class on certain matters relating to the rights of holders of Series B Preferred Stock and on certain corporate transactions. Except with respect to such matters, the Series B Preferred Stock does not have voting rights. The matters on which the holders of Series B Preferred Stock would have the right to vote include amendments to Horizons Articles of Incorporation adversely affecting the Series B
27
HORIZON BANCORP
(Table dollars in thousands except per share data)
Preferred Stock or certain fundamental transactions affecting the Series B Preferred Stock, and in connection with the authorization of stock senior to the Series B Preferred Stock. If Horizon misses five dividend payments on the Series B Preferred Stock, whether or not consecutive, the holder of the Series B Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer who will attend all meetings of Horizons Board of Directors, but such observer will not have the right to vote.
28
HORIZON BANCORP
(Table dollars in thousands except per share data)
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
The main office and full service branch of Horizon and the Bank is located at 515 Franklin Square, Michigan City, Indiana. The building located across the street from the main office of Horizon and the Bank, at 502 Franklin Square, houses the credit administration, operations, facilities and purchasing, and information technology departments of the Bank. In addition to these principal facilities, the Bank has 28 sales offices located at:
3631 South Franklin Street | Michigan City | Indiana | ||
113 West First Street | Wanatah | Indiana | ||
1500 West Lincolnway | LaPorte | Indiana | ||
423 South Roosevelt Street | Chesterton | Indiana | ||
4208 North Calumet | Valparaiso | Indiana | ||
902 East Lincolnway | Valparaiso | Indiana | ||
455 Morthland Drive | Valparaiso | Indiana | ||
2650 Willowcreek Road | Portage | Indiana | ||
8590 Broadway | Merrillville | Indiana | ||
10429 Calumet Avenue | Munster | Indiana | ||
17400 State Road 23 | South Bend | Indiana | ||
1909 East Bristol Street | Elkhart | Indiana | ||
4574 Elkhart Road | Goshen | Indiana | ||
1321 119th Street | Whiting | Indiana | ||
1349 Calumet Avenue | Hammond | Indiana | ||
1300 North Main Street | Crown Point | Indiana | ||
420 North Morton Street | Franklin | Indiana | ||
151 Marlin Drive | Greenwood | Indiana | ||
800 US 31 | Greenwood | Indiana | ||
2433 East Main Street | Greenwood | Indiana | ||
507 Three Notch Lane | Bargersville | Indiana | ||
117 East Washington Street | Indianapolis | Indiana | ||
811 Ship Street | St. Joseph | Michigan | ||
2608 Niles Road | St. Joseph | Michigan | ||
1041 East Napier Avenue | Benton Harbor | Michigan | ||
500 West Buffalo Street | New Buffalo | Michigan | ||
6801 West U.S. 12 | Three Oaks | Michigan | ||
3250 West Centre Avenue | Portage | Michigan |
Horizon owns all of the facilities except for the Indiana offices located at 117 E Washington Street, Indianapolis, and 800 US 31, Greenwood, each of which is leased.
Horizon and its subsidiaries are involved in various legal proceedings incidental to the conduct of their business. Management does not expect that the outcome of any such proceedings will have a material adverse effect on our consolidated financial position or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
29
HORIZON BANCORP
(Table dollars in thousands except per share data)
SPECIAL ITEM: EXECUTIVE OFFICERS OF REGISTRANT
Craig M. Dwight | 57 | Chairman and Chief Executive Officer of the Bank since January 2003; Chairman of Horizon since July 1, 2013; Chief Executive Officer of Horizon and the Bank since July 1, 2001. | ||
Thomas H. Edwards | 61 | President of the Bank since January 2003. | ||
Mark E. Secor | 47 | Executive Vice President of Horizon since January 1, 2014; Chief Financial Officer and Executive Vice President of Horizon and the Bank since January 2009; Vice President, Chief Investment and Asset Liability Manager since June 2007; Chief Financial Officer of St. Joseph Capital Corp., Mishawaka, Indiana since January 2004. | ||
James D. Neff | 54 | Corporate Secretary of Horizon since 2007; Executive Vice President-Mortgage Banking of the Bank since January 2004; Senior Vice President of the Bank since October 1999. | ||
Dave G. Rose | 55 |
Executive Vice President of Horizon since January 1, 2014; President of the Banks Northwest Indiana Region since January 1999. | ||
Kathie A. DeRuiter | 52 | Executive Vice President of Horizon and Senior Bank Operations Officer since January 1, 2014; Senior Vice President, Senior Bank Operations Officer since January 1, 2003; Vice President, Senior Bank Operations Officer since January 1, 2000. |
30
HORIZON BANCORP
(Table dollars in thousands except per share data)
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Repurchases of Securities
There were no purchases by the Company of its common stock during the fourth quarter of 2013.
Performance Graph
The Securities and Exchange Commission requires Horizon to include a line graph comparing Horizons cumulative five-year total shareholder returns on the common shares with market and industry returns over the past five years. SNL Financial LC prepared the following graph. The return represented in the graph assumes the investment of $100 on January 1, 2008, and further assumes reinvestment of all dividends. The Companys common stock began trading on the NASDAQ Global Market on February 1, 2008. Prior to that date, the common stock was traded on the NASDAQ Capital Market.
Period Ending | ||||||||||||||||||||||||
Index | December 31 2008 |
December 31 2009 |
December 31 2010 |
December 31 2011 |
December 31 2012 |
December 31 2013 |
||||||||||||||||||
Horizon Bancorp |
100.00 | 135.85 | 229.59 | 230.27 | 400.52 | 526.20 | ||||||||||||||||||
Russell 2000 |
100.00 | 127.17 | 161.32 | 154.59 | 179.86 | 249.69 | ||||||||||||||||||
SNL Bank $1B-$5B |
100.00 | 71.68 | 81.25 | 74.10 | 91.37 | 132.87 | ||||||||||||||||||
SNL Micro Cap Bank |
100.00 | 73.74 | 75.89 | 72.18 | 91.22 | 117.71 |
Source : SNL Financial LC, Charlottesville, VA |
||
© 2013 |
www.snl.com |
31
HORIZON BANCORP
(Table dollars in thousands except per share data)
The following chart compares the change in market price of Horizons common stock since December 31, 2008 to that of publicly traded banks in Indiana and Michigan with assets greater than $500 million, excluding the reinvestment of dividends.
Period Ending | ||||||||||||||||||||||||
Index | December 31 2008 |
December 31 2009 |
December 31 2010 |
December 31 2011 |
December 31 2012 |
December 31 2013 |
||||||||||||||||||
Horizon Bancorp |
100.00 | 129.76 | 212.80 | 207.96 | 353.70 | 455.94 | ||||||||||||||||||
Indiana Banks |
100.00 | 65.41 | 75.79 | 77.33 | 83.12 | 114.29 | ||||||||||||||||||
Michigan Banks |
100.00 | 72.81 | 71.32 | 69.83 | 83.04 | 116.70 |
* | excludes merger targets |
The other information regarding Horizons common stock, including the approximate number of holders of the common stock, is included under the caption Horizons Common Stock and Related Stockholders Matters in Item 8 below, which is incorporated by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information required under this item is incorporated by reference to the information appearing under the caption Summary of Selected Financial Data in Item 8 of this Form 10-K.
32
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
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 Northwestern and Central Indiana and Southwestern Michigan through its bank subsidiary. Horizon operates as a single segment, which is commercial banking. Horizons 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. All share data included below has been adjusted to reflect Horizons three-for-two stock splits paid on November 9, 2012 and December 9, 2011.
Following are some highlights of Horizons financial performance during 2013:
| Return on average assets was 1.13% for the year ended December 31, 2013. |
| Return on average common equity was 12.86% for the year ended December 31, 2013. |
| Horizons net income of $19.9 million for 2013 surpasses the $19.5 million earned in the prior year and represented the highest annual net income in the Companys history. |
| Horizons diluted earnings per share was $2.17 in 2013, a 5.7% decrease in diluted earnings per share compared to 2012. |
| On November 12, 2013, Horizon entered into an agreement to acquire SCB Bancorp, Inc. and its wholly-owned subsidiary, Summit Community Bank, headquartered in East Lansing, Michigan. The transaction is expected to be completed in the second quarter of 2014, subject to regulatory and SCB Bancorp, Inc. shareholder approval. |
| Total assets decreased 4.9% or $90.0 million to $1.8 billion at December 31, 2013, compared with $1.8 billion at December 31, 2012. |
| Total loans decreased 11.0% or $132.4 million to $1.1 billion at December 31, 2013, compared with $1.2 billion at December 31, 2012. Mortgage warehouse loans decreased by $153.2 million, which was partially offset by an increae in commercial loans of $42.7 million. |
| Total deposits decreased 0.2% or $2.6 million to $1.3 billion at December 31, 2013, compared with $1.3 billion at December 31, 2012. |
| Core deposits consisting of non-interest bearing checking accounts, now accounts, savings and money market accounts increased by 3.3% or $32.0 million. |
| Net interest income, after provisions for loan losses, for 2013 was $59.5 million compared with $54.7 million for 2012. |
| The provision for loan losses decreased to $1.9 million for the year ended December 31, 2013 compared to $3.5 million for 2012. |
| Net charge-offs for 2013 were $4.2 million compared to $4.1 million for 2012. |
| Substandard loans in total decreased by $15.5 million during 2013 from $50.2 million at December 31, 2012 to $34.7 million at December 31, 2013. |
| Horizon Banks capital ratios continue to be well above the regulatory standards for well-capitalized banks. |
Recent Developments
On November 12, 2013, Horizon entered into an Agreement and Plan of Merger (the Merger Agreement) providing for Horizons acquisition of SCB Bancorp, Inc., a Michigan corporation (SCB). Pursuant to the Merger Agreement, SCB would merge with and into Horizon, with Horizon surviving the merger (the Merger), and Summit Community Bank, an Michigan-chartered commercial bank and wholly owned subsidiary of SCB, would merge with and into a wholly owned subsidiary of Horizon, Horizon Bank, N.A. (Horizon Bank), with Horizon Bank as the surviving bank.
33
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
The boards of directors of each of Horizon and SCB have approved the Merger and the Merger Agreement. Subject to the approval of the Merger by SCBs shareholders, regulatory approvals and other closing conditions, the parties anticipate completing the Merger in the beginning of the second quarter of 2014.
In connection with the Merger, each SCB shareholder will receive 0.4904 shares of Horizon common stock (the Exchange Ratio) and $5.15 in cash for each share of SCB common stock owned by them. Based on Horizons November 12, 2013 closing price of $21.43 per share as reported on the NASDAQ Global Market, the transaction value is estimated at $18.4 million.
Subject to certain terms and conditions, the board of directors of SCB has agreed to recommend the approval and adoption of the Merger Agreement to the SCB shareholders and will solicit proxies voting in favor of the Merger from SCBs shareholders.
The Merger Agreement also provides for certain termination rights for both Horizon and SCB, and further provides that upon termination of the Merger Agreement under certain circumstances, SCB will be obligated to pay Horizon a termination fee.
Critical Accounting Policies
The notes to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for 2012 contain a summary of the Companys significant accounting policies. Certain of these policies are important to the portrayal of the Companys financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management has identified the allowance for loan losses, goodwill and intangible asset, mortgage servicing rights, hedge accounting and valuation measurements as critical accounting policies.
Allowance for Loan Losses
An allowance for loan losses is maintained to absorb probable incurred loan losses inherent in the loan portfolio. The determination of the allowance for loan losses is a critical accounting policy that involves managements ongoing quarterly assessments of the probable incurred losses inherent in the loan portfolio. The identification of loans that have probable incurred losses is subjective; therefore, a general reserve is maintained to cover all probable losses within the entire loan portfolio. Horizon utilizes a loan grading system that helps identify, monitor and address asset quality problems in an adequate and timely manner. Each quarter, various factors affecting the quality of the loan portfolio are reviewed. Large credits are reviewed on an individual basis for loss potential. Other loans are reviewed as a group based upon previous trends of loss experience. Horizon also reviews the current and anticipated economic conditions of its lending market as well as transaction risk to determine the effect they may have on the loss experience of the loan portfolio.
Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (FASB ASC 310-30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Accordingly, allowances for credit losses related to these loans are not carried over and recorded at the acquisition dates. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC 310-30, but for which a discount is attributable, at least in part to the credit quality, are also accounted for under this guidance. As a result, related discounts are recognized subsequently through accretion based on the expected cash flows of the acquired loans. For purposes of applying FASB ASC 310-30, loans acquired in business combinations are aggregated into pools of loans with common risk characteristic.
Goodwill and Intangible Assets
Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. FASB ASC 350-10 establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. At December 31, 2013, Horizon had core deposit intangibles of $3.3 million subject to amortization and $19.7 million of goodwill, which is not subject to amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the
34
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
business acquired. Horizons goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Horizon to provide quality, cost effective banking services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely affect earnings in future periods. FASB ASC 350-10 requires an annual evaluation of goodwill for impairment. The evaluation of goodwill for impairment requires the use of estimates and assumptions. Market price at the close of business on December 31, 2013 was $25.33 per share compared to a tangible book value of $14.98 per common share. Horizon reported record earnings for the 14th consecutive year in 2013.
Mortgage Servicing Rights
Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets on a servicing-retained basis. Capitalized servicing rights are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated regularly for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying servicing rights by predominant characteristics, such as interest rates, original loan terms and whether the loans are fixed or adjustable rate mortgages. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. When the book value of an individual stratum exceeds its fair value, an impairment reserve is recognized so that each individual stratum is carried at the lower of its amortized book value or fair value. In periods of falling market interest rates, accelerated loan prepayment can adversely affect the fair value of these mortgage-servicing rights relative to their book value. In the event that the fair value of these assets was to increase in the future, Horizon can recognize the increased fair value to the extent of the impairment allowance but cannot recognize an asset in excess of its amortized book value. Future changes in managements assessment of the impairment of these servicing assets, as a result of changes in observable market data relating to market interest rates, loan prepayment speeds, and other factors, could impact Horizons financial condition and results of operations either positively or negatively.
Generally, when market interest rates decline and other factors favorable to prepayments occur, there is a corresponding increase in prepayments as customers refinance existing mortgages under more favorable interest rate terms. When a mortgage loan is prepaid, the anticipated cash flows associated with servicing that loan are terminated, resulting in a reduction of the fair value of the capitalized mortgage servicing rights. To the extent that actual borrower prepayments do not react as anticipated by the prepayment model (i.e., the historical data observed in the model does not correspond to actual market activity), it is possible that the prepayment model could fail to accurately predict mortgage prepayments and could result in significant earnings volatility. To estimate prepayment speeds, Horizon utilizes a third-party prepayment model, which is based upon statistically derived data linked to certain key principal indicators involving historical borrower prepayment activity associated with mortgage loans in the secondary market, current market interest rates and other factors, including Horizons own historical prepayment experience. For purposes of model valuation, estimates are made for each product type within the mortgage servicing rights portfolio on a monthly basis. In addition, on a quarterly basis Horizon engages a third party to independently test the value of its servicing asset.
Derivative Instruments
As part of the Companys asset/liability management program, Horizon utilizes, from time-to-time, interest rate floors, caps or swaps to reduce the Companys sensitivity to interest rate fluctuations. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values of derivatives are reported in the consolidated income statements or other comprehensive income (OCI) depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be highly effective in achieving offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedge and on an ongoing basis.
Horizons accounting policies related to derivatives reflect the guidance in FASB ASC 815-10. Derivatives that qualify for the hedge accounting treatment are designated as either: a hedge of the fair value of the recognized asset or liability or of an unrecognized firm commitment (a fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to
35
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
be received or paid related to a recognized asset or liability (a cash flow hedge). For fair value hedges, the cumulative change in fair value of both the hedge instruments and the underlying loans is recorded in non-interest income. For cash flow hedges, changes in the fair values of the derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected in the consolidated income statement in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, Horizon establishes the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of income. Horizon excludes the time value expiration of the hedge when measuring ineffectiveness.
Valuation Measurements
Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities, residential mortgage loans held for sale and derivatives are carried at fair value, as defined in FASB ASC 820, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts of goodwill, mortgage servicing rights, and pension and other post-retirement benefit obligations. To determine the values of these assets and liabilities, as well as the extent, to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment speeds and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect Horizons results of operations.
Analysis of Financial Condition
Horizons total assets were $1.8 billion as of December 31, 2013, a decrease of $90.0 million from December 31, 2012.
Investment Securities
Investment securities totaled $518.5 million at December 31, 2013, and consisted of Treasury and federal agency securities of $43.1 million (8.5%); state and municipal securities of $177.9 million (35.0%); federal agency mortgage-backed pools of $170.9 million, federal agency collateralized mortgage obligations of $114.7 million, private labeled mortgage-backed pools of $1.2 million (56.4%); and corporate securities of $733,000 (0.1%). Investment securities increased $35.7 million during 2013 primarily as a result of the decrease in mortgage warehouse balance being redeployed into investment securities.
As indicated above, 56.4% of the investment portfolio consists of mortgage-backed securities and collateralized mortgage obligations. Approximately 0.2% of the portfolio or $1.2 million are private label collateralized mortgage obligations, the remainder are issued by agencies of the Federal Government. Horizon had three private label CMOs at December 31, 2013, with an amortized cost of $1.2 million and carried at a market value of $1.2 million. The gross unrealized gain on these investments at December 31, 2013 was approximately $39,000. The private label securities generally have loan to value ratios of approximately 50% and management feels these securities are not impaired. These instruments are secured by residential mortgages of varying maturities. Principal and interest payments are received monthly as the underlying mortgages are repaid. These payments also include prepayments of mortgage balances as borrowers either sell their homes or refinance their mortgages. Therefore, mortgage-backed securities and collateralized mortgage obligations have maturities that are stated in terms of average life. The average life is the average amount of time that each dollar of principal is expected to be outstanding. As of December 31, 2013, the mortgage-backed securities and collateralized mortgage obligations in the investment portfolio had an average life of 2.0 years. Securities that have interest rates above current market rates are purchased at a premium. Management monitors these investments periodically for other than temporary impairment by obtaining and reviewing the underlying collateral details and has concluded at December 31, 2013 any unrealized loss is temporary and that the Company has the intent and ability to hold these investments to maturity.
Available-for-sale municipal securities are priced by a third party using a pricing grid which estimates prices based on recent sales of similar securities. All municipal securities are investment grade or local non-rated issues and management does not believe there is other than temporary deterioration in market value. A credit review is performed annually on the municipal securities portfolio.
36
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
At December 31, 2013, 98.1% and at December 31, 2012, 100% of investment securities were classified as available for sale. Securities classified as available for sale are carried at their fair value, with both unrealized gains and losses recorded, net of tax, directly to stockholders equity. Net appreciation on these securities totaled $165,000, which resulted in a balance of $108,000, net of tax, included in stockholders equity at December 31, 2013. This compared to $12.7 million, net of tax, included in stockholders equity at December 31, 2012.
Fair value is defined 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. A fair value hierarchy is also established which requires an entity to maximize the use of observable and minimize the use of unobservable inputs. 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. |
When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. There are no Level 1 securities. 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 collateralized mortgage obligations and Federal agency mortgage-backed pools. For level 2 securities, Horizon uses a third party service to determine fair value. In performing the valuations, the pricing service relies on models that consider security-specific details as well as relevant industry and economic factors. The most significant of these inputs are quoted market prices, interest rate spreads on relevant benchmark securities and certain prepayment assumptions. To verify the reasonableness of the fair value determination by the service, Horizon has a portion of the level 2 securities priced by an independent securities broker dealer.
Unrealized gains and losses on available-for-sale securities, deemed temporary, are recorded, net of income tax, in a separate component of other comprehensive income on the balance sheet. No unrealized losses were deemed to be other-than-temporary.
As a member of the Federal Reserve and Federal Home Loan Bank systems, Horizon is required to maintain an investment in the common stock of each entity. The investment in common stock is based on a predetermined formula. At December 31, 2013 Horizon had investments in the common stock of the Federal Reserve and Federal Home Loan Banks totaling $14.2 million and at December 31, 2012, investments totaled $13.3 million.
At December 31, 2013, Horizon did not maintain a trading account.
For more information about securities, see Note 4 (Investment Securities) to the consolidated financial statements.
Loans
Total loans, net of deferred fees/costs, the principal earning asset of the Bank, were $1.1 billion at December 31, 2013. The current level of loans is a decrease of 10.2% from the December 31, 2012, level of $1.2 billion. The table below provides comparative detail on the loan categories.
37
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
December 31 2013 |
December 31 2012 |
Dollar Change |
Percent Change |
|||||||||||||
Commercial |
||||||||||||||||
Working capital and equipment |
$ | 241,569 | $ | 198,805 | $ | 42,764 | 21.5 | % | ||||||||
Real estate, including agriculture |
245,313 | 247,108 | (1,795 | ) | -0.7 | % | ||||||||||
Tax exempt |
2,898 | 4,579 | (1,681 | ) | -36.7 | % | ||||||||||
Other |
15,409 | 9,979 | 5,430 | 54.4 | % | |||||||||||
|
|
|
|
|
|
|||||||||||
Total |
505,189 | 460,471 | 44,718 | 9.7 | % | |||||||||||
Real estate |
||||||||||||||||
14 family |
181,393 | 185,940 | (4,547 | ) | -2.4 | % | ||||||||||
Other |
4,565 | 3,774 | 791 | 21.0 | % | |||||||||||
|
|
|
|
|
|
|||||||||||
Total |
185,958 | 189,714 | (3,756 | ) | -2.0 | % | ||||||||||
Consumer |
||||||||||||||||
Auto |
139,915 | 142,149 | (2,234 | ) | -1.6 | % | ||||||||||
Recreation |
4,839 | 5,163 | (324 | ) | -6.3 | % | ||||||||||
Real estate/home improvement |
30,729 | 29,989 | 740 | 2.5 | % | |||||||||||
Home equity |
96,924 | 104,974 | (8,050 | ) | -7.7 | % | ||||||||||
Unsecured |
3,825 | 4,194 | (369 | ) | -8.8 | % | ||||||||||
Other |
3,293 | 2,615 | 678 | 25.9 | % | |||||||||||
|
|
|
|
|
|
|||||||||||
Total |
279,525 | 289,084 | (9,559 | ) | -3.3 | % | ||||||||||
Mortgage warehouse |
98,156 | 251,448 | (153,292 | ) | -61.0 | % | ||||||||||
|
|
|
|
|
|
|||||||||||
Total loans |
1,068,828 | 1,190,717 | (121,889 | ) | -10.2 | % | ||||||||||
Allowance for loan losses |
(15,992 | ) | (18,270 | ) | 2,278 | |||||||||||
|
|
|
|
|
|
|||||||||||
Loans, net |
$ | 1,052,836 | $ | 1,172,447 | $ | (119,611 | ) | |||||||||
|
|
|
|
|
|
The acceptance and management of credit risk is an integral part of the Banks business as a financial intermediary. The Bank has established underwriting standards including a policy that monitors the lending function through strict administrative and reporting requirements as well as an internal loan review of consumer and small business loans. The Bank also uses an independent third-party loan review function that regularly reviews asset quality.
Changes in the mix of the loan portfolio averages are shown in the following table.
December 31 2013 |
December 31 2012 |
December 31 2011 |
||||||||||
Commercial |
$ | 490,137 | $ | 393,580 | $ | 339,072 | ||||||
Real estate |
195,520 | 179,622 | 170,790 | |||||||||
Mortgage warehouse |
126,912 | 193,006 | 90,316 | |||||||||
Consumer |
280,093 | 277,412 | 262,320 | |||||||||
|
|
|
|
|
|
|||||||
Total average loans |
$ | 1,092,662 | $ | 1,043,620 | $ | 862,498 | ||||||
|
|
|
|
|
|
Commercial Loans
Commercial loans totaled $505.2 million, or 47.3% of total loans as of December 31, 2013, compared to $460.5 million, or 38.7% as of December 31, 2012. The increase during 2013 was primarily related to organic growth net of principal reductions from payments.
38
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Commercial loans consisted of the following types of loans at December 31:
December 31, 2013 | December 31, 2012 | |||||||||||||||||||||||
Number | Amount | Percent of Portfolio |
Number | Amount | Percent of Portfolio |
|||||||||||||||||||
SBA guaranteed loans |
184 | $ | 33,159 | 6.6 | % | 155 | $ | 26,421 | 5.7 | % | ||||||||||||||
Municipal government |
1 | 646 | 0.1 | % | 1 | 740 | 0.2 | % | ||||||||||||||||
Lines of credit |
551 | 75,172 | 14.9 | % | 522 | 58,409 | 12.7 | % | ||||||||||||||||
Real estate and equipment term loans |
1,278 | 396,212 | 78.4 | % | 1,400 | 374,901 | 81.4 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total |
2,014 | $ | 505,189 | 100.0 | % | 2,078 | $ | 460,471 | 100.0 | % | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Fixed rate term loans with a book value of $95.3 million and a fair value of $95.3 million have been swapped to a variable rate using derivative instruments. The loans are carried at fair value in the financial statements and the related swap is carried at fair value and is included with other liabilities in the balance sheet. The recognition of the loan and swap fair values are recorded in the income statement and for 2013 equally offset each other. Fair values are determined by the counter party using a proprietary model that uses live market inputs to value interest rate swaps. The model is subject to daily market tests as current and future positions are priced and valued. These are level 3 inputs under the fair value hierarchy as described above.
At December 31, 2013 the commercial loan portfolio held $44.5 million of adjustable rate loans that had interest rate floors in the terms of the note. Of the commercial loans with interest rate floors, loans totaling $41.8 million were at their floor at December 31, 2012.
Residential Real Estate Loans
Residential real estate loans totaled $186.0 million or 17.4% of total loans as of December 31, 2013, compared to $189.7 million or 16.0% of total loans as of December 31, 2012. This category consists of home mortgages that generally require a loan to value of no more than 80%. Some special guaranteed or insured real estate loan programs do permit a higher loan to collateral value ratio. The decrease during 2013 was primarily related principal reductions from payments.
In addition to the customary real estate loans described above, the Bank also has outstanding on December 31, 2013, $96.9 million in home equity lines of credit compared to $105.0 million at December 31, 2012. Credit lines normally limit the loan to collateral value to no more than 89%. Home equity credits lines are primarily not combined with a first mortgage and are therefore evaluated in the allowance for loan losses as a separate pool. These loans are classified as consumer loans in the table above and in Note 5 of the consolidated financial statements.
Residential real estate lending is a highly competitive business. As of December 31, 2013, the real estate loan portfolio reflected a wide range of interest rates and repayment patterns, but could generally be categorized as follows:
December 31, 2013 | December 31, 2012 | |||||||||||||||||||||||
Amount | Percent of Portfolio |
Yield | Amount | Percent of Portfolio |
Yield | |||||||||||||||||||
Fixed rate |
||||||||||||||||||||||||
Monthly payment |
$ | 87,367 | 47.0 | % | 4.49 | % | $ | 93,999 | 49.5 | % | 4.77 | % | ||||||||||||
Biweekly payment |
321 | 0.2 | % | 5.81 | % | 483 | 0.3 | % | 6.38 | % | ||||||||||||||
Adjustable rate |
||||||||||||||||||||||||
Monthly payment |
98,270 | 52.8 | % | 3.91 | % | 95,232 | 50.2 | % | 4.29 | % | ||||||||||||||
Biweekly payment |
| 0.0 | % | 0.00 | % | | 0.0 | % | 0.00 | % | ||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||||||
Sub total |
185,958 | 100.0 | % | 4.19 | % | 189,714 | 100.0 | % | 4.53 | % | ||||||||||||||
|
|
|
|
|||||||||||||||||||||
Loans held for sale |
3,281 | 13,744 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total real estate loans |
$ | 189,239 | $ | 203,458 | ||||||||||||||||||||
|
|
|
|
The decrease in fixed rate loans during 2013 was primarily due to principal reductions from payments. In addition to the real estate loan portfolio, the Bank originates and sells real estate loans and retains the servicing rights. During 2013 and
39
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
2012, approximately $346.4 million and $386.9 million of residential mortgages were sold into the secondary market. Loans serviced for others are not included in the consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled approximately $943.5 million and $772.1 million at December 31, 2013 and 2012.
The Bank began capitalizing mortgage servicing rights during 2000, and the aggregate fair value of capitalized mortgage servicing rights at December 31, 2013, totaled approximately $9.9 million compared to the carrying value of $7.0 million. Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value. For purposes of measuring impairment, risk characteristics including product type, investor type and interest rates, were used to stratify the originated mortgage servicing rights.
December 31 2013 |
December 31 2012 |
December 31 2011 |
||||||||||
Mortgage servicing rights |
||||||||||||
Balances, January 1 |
$ | 6,169 | $ | 5,049 | $ | 4,175 | ||||||
Servicing rights capitalized |
2,535 | 2,439 | 1,866 | |||||||||
Amortization of servicing rights |
(1,276 | ) | (1,319 | ) | (992 | ) | ||||||
|
|
|
|
|
|
|||||||
Balances, December 31 |
7,428 | 6,169 | 5,049 | |||||||||
|
|
|
|
|
|
|||||||
Impairment allowance |
||||||||||||
Balances, January 1 |
(1,024 | ) | (856 | ) | (803 | ) | ||||||
Additions |
(54 | ) | (762 | ) | (792 | ) | ||||||
Reductions |
689 | 594 | 739 | |||||||||
|
|
|
|
|
|
|||||||
Balances, December 31 |
(389 | ) | (1,024 | ) | (856 | ) | ||||||
|
|
|
|
|
|
|||||||
Mortgage servicing rights, net |
$ | 7,039 | $ | 5,145 | $ | 4,193 | ||||||
|
|
|
|
|
|
Mortgage Warehouse Loans
Horizons mortgage warehousing lending has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with pledge of collateral under Horizons agreement with the mortgage company. Each individual mortgage and the related mortgagee are underwritten by Horizon to the end investor guidelines and assigned to Horizon until the loan is sold to the secondary market by the mortgage company. In addition, Horizon takes possession of each original note and forwards such note to the end investor once the mortgage company has sold the loan. At the time a loan is transferred to the secondary market, the mortgage company repurchases the loan under its option within the agreement. Due to the repurchase feature contained in the agreement, the transaction does not qualify as a sale and therefore is accounted for as a secured borrowing with pledge of collateral pursuant to the agreement with the mortgage company. When the individual loan is sold to the end investor by the mortgage company the proceeds from the sale of the loan are received by Horizon and used to pay off the loan balance with Horizon along with any accrued interest and any related fees. The remaining balance from the sale is forwarded to the mortgage company. These individual loans typically are sold by the mortgage company within 30 days and are seldom held more than 90 days. Interest income is accrued during this period and collected at the time each loan is sold. Fee income for each loan sold is collected when the loan is sold and no costs are deferred due to the term between each loan funding and related payoff is typically less than 30 days.
Based on the agreements with each mortgage company, at any time a mortgage company can repurchase from Horizon their outstanding loan balance on an individual mortgage and regain possession of the original note. Horizon also has the option to request that the mortgage company repurchase an individual mortgage. Should this occur, Horizon would return the original note and reassign the assignment of the mortgage to the mortgage company. Also, in the event that the end investor would not be able to honor the sales commitment and the mortgage company would not be able to repurchase its loan on an individual mortgage, Horizon would be able to exercise its rights under the agreement.
At December 31, 2013, the mortgage warehouse loan balance was $98.2 million compared to $251.5 million as of December 31, 2012. The decrease in mortgage warehouse loans reflected a rise in long-term interest rates resulting in lower refinance volume.
40
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Consumer Loans
Consumer loans totaled $279.5 million, or 26.2% of total loans as of December 31, 2013, compared to $289.1 million, or 24.3% as of December 31, 2012. The decrease during 2013 was primarily related to principal reductions from payments.
Allowance and Provision for Loan Losses/Critical Accounting Policy
At December 31, 2013, the allowance for loan losses was $16.0 million, or 1.49% of total loans outstanding, compared to $18.3 million, or 1.52% at December 31, 2012. The decrease in the ratio was primarily due to loans with specific reserves charged off or released due to improved performance during the year ending December 31, 2013. During 2013, the expense for provision for loan losses totaled $1.9 million compared to $3.5 million in 2012.
Horizon assesses the adequacy of its Allowance for Loan and Lease Losses (ALLL) by regularly reviewing the performance of all of its loan portfolios. As a result of its quarterly reviews, a provision for loan losses is determined to bring the total ALLL to a level called for by the analysis. For the year 2013, the provision of $1.9 million represented a 45.5% decrease from the prior year and was primarily due to continued improvement of nonperforming and substandard loans resulting in the release of specific reserves. As the Companys non-performing and substandard loans decrease and charge-off experience improves, the assessment for the adequacy of the ALLL reduces the ALLL balance resulting in provision expense less than charge-offs.
Despite the decreased allowance, no assurance can be given that Horizon will not, in any particular period, sustain loan losses that are significant in relation to the amount reserved, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, including economic conditions and managements ongoing quarterly assessments of the portfolio, will not require increases in the allowance for loan losses. Horizon considers the allowance for loan losses to be adequate to cover losses inherent in the loan portfolio as of December 31, 2013.
Non-performing Loans
Non-performing loans are defined as loans that are greater than 90 days delinquent or have had the accrual of interest discontinued by management. Management continues to work diligently toward returning non-performing loans to an earning asset basis. Non-performing loans for the previous three years ending December 31 are as follows:
December 31 2013 |
December 31 2012 |
December 31 2011 |
||||||||||
Non-performing loans |
$ | 18,277 | $ | 23,779 | $ | 20,143 |
Non-performing loans total 114.3%, 130.2% and 106.7% of the allowance for loan losses at December 31, 2013, 2012 and 2011, respectively. Non-performing loans at December 31, 2013 totaled $18.3 million, which was 1.70% of total loans. This was a decrease from a balance of $23.8 million or 1.97% of total loans and $20.1 million or 2.02% of total loans on December 31, 2012 and December 31, 2011, respectively.
Excluding Heartland, non-performing loans would have declined to $13.7 million at December 31, 2013 compared to $16.5 million at December 31, 2012. At December 31, 2013, loans acquired in the Heartland acquisition represented $4.5 million of non-performing loans.
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, 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. (See Note 7 of the audited financial statements for further discussion of impaired loans.)
41
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
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 borrowers business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 30 days or more. Loans are generally moved to non-accrual status when 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
Other Real Estate Owned (OREO) net of any related allowance for OREO losses for the previous three years ending December 31 were as follows:
December 31 2013 |
December 31 2012 |
December 31 2011 |
||||||||||
Other real estate owned |
$ | 2,107 | $ | 2,565 | $ | 2,800 |
OREO totaled $2.1 million on December 31, 2013, a decrease from $2.6 million on December 31, 2012. On December 31, 2013, OREO was comprised of 12 properties. Of these properties, three totaling $830,000 were commercial real estate and 9 totaling $1.3 million were residential real estate.
No mortgage warehouse loans were non-performing or OREO as of December 31, 2013, 2012 or 2011.
Deferred Tax
Horizon had a net deferred tax asset totaling $5.7 million and $3.1 million as of December 31, 2013 and December 31, 2012, respectively. The following table shows the major components of deferred tax:
December 31 2013 |
December 31 2012 |
|||||||
Assets |
||||||||
Allowance for loan losses |
$ | 5,677 | $ | 6,442 | ||||
Net operating loss |
2,977 | 1,452 | ||||||
Intangible assets |
| 2,151 | ||||||
Director and employee benefits |
1,828 | 1,357 | ||||||
Unrealized loss on securities available for sale |
931 | | ||||||
Other |
537 | 581 | ||||||
|
|
|
|
|||||
Total assets |
11,950 | 11,983 | ||||||
|
|
|
|
|||||
Liabilities |
||||||||
Depreciation |
(1,424 | ) | (1,418 | ) | ||||
Difference in expense recognition |
(368 | ) | (519 | ) | ||||
State tax |
(236 | ) | (374 | ) | ||||
Federal Home Loan Bank stock dividends |
(295 | ) | (296 | ) | ||||
Difference in basis of intangible assets |
(2,189 | ) | | |||||
FHLB Penalty |
(508 | ) | (748 | ) | ||||
Unrealized gain on securities available for sale |
| (4,901 | ) | |||||
Other |
(1,188 | ) | (580 | ) | ||||
|
|
|
|
|||||
Total liabilities |
(6,208 | ) | (8,836 | ) | ||||
|
|
|
|
|||||
Net deferred tax asset |
$ | 5,742 | $ | 3,147 | ||||
|
|
|
|
Horizon anticipates continued earnings and therefore determined there is no impairment to this asset.
42
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Deposits
The primary source of funds for the Bank comes from the acceptance of demand and time deposits. However, at times the Bank will use its ability to borrow funds from the Federal Home Loan Bank and other sources when it can do so at interest rates and terms that are more favorable than those required for deposited funds or loan demand is greater than the ability to grow deposits. Total deposits were $1.3 billion at December 31, 2013, compared to $1.3 billion at December 31, 2012. Average deposits and rates by category for the three years ended December 31 are as follows:
Average Balance Outstanding for the Year Ending December 31 |
Average Rate Paid for the Year Ending December 31 |
|||||||||||||||||||||||
2013 | 2012 | 2011 | 2013 | 2012 | 2011 | |||||||||||||||||||
Noninterest-bearing demand deposits |
$ | 219,323 | $ | 165,340 | $ | 119,504 | ||||||||||||||||||
Interest-bearing demand deposits |
528,738 | 489,877 | 376,383 | 0.13 | % | 0.14 | % | 0.15 | % | |||||||||||||||
Savings deposits |
134,242 | 106,898 | 83,374 | 0.08 | % | 0.11 | % | 0.16 | % | |||||||||||||||
Money market |
123,226 | 90,339 | 83,958 | 0.21 | % | 0.13 | % | 0.12 | % | |||||||||||||||
Time deposits |
306,590 | 305,766 | 343,972 | 1.50 | % | 1.72 | % | 2.19 | % | |||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||
Total deposits |
$ | 1,312,119 | $ | 1,158,220 | $ | 1,007,191 | ||||||||||||||||||
|
|
|
|
|
|
The $153.9 million increase in average deposits during 2013 was the result of an increase in the depositor base due to organic growth as well the Heartland acquisition. The transactional accounts average balances, as the lower cost funding sources, increased $153.1 million and the average balances for higher cost time deposits increased $824,000. Horizon continually enhances its interest-bearing consumer and commercial demand deposit products based on local market conditions and its need for funding to support various types of assets.
Certificates of deposit of $100,000 or more, which are considered to be rate sensitive and are not considered a part of core deposits, mature as follows as of December 31, 2013:
Due in three months or less |
$ | 11,169 | ||
Due after three months through six months |
16,029 | |||
Due after six months through one year |
22,585 | |||
Due after one year |
84,554 | |||
|
|
|||
Total |
$ | 134,337 | ||
|
|
Interest expense on time certificates of $100,000 or more was approximately $2.4 million, $2.9 million, and $3.6 million for 2013, 2012 and 2011.
Off-Balance Sheet Arrangements
As of December 31, 2013, Horizon did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Companys financial condition, change in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term off-balance sheet arrangement generally means any transaction, agreement, or other contractual arrangement to which an entity unconsolidated with the Company is a party and under which the Company has (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.
43
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Contractual Obligations
The following tables summarize Horizons contractual obligations and other commitments to make payment as of December 31, 2013:
Total | Within One Year |
One to Three Years |
Three to Five Years |
After Five Years |
||||||||||||||||
Deposits |
$ | 280,458 | $ | 116,484 | $ | 84,955 | $ | 54,533 | $ | 24,486 | ||||||||||
Borrowings (1) |
256,296 | 106,490 | 42,872 | 46,153 | 60,781 | |||||||||||||||
Subordinated debentures (2) |
32,486 | | | | 32,486 |
(1) | Includes debt obligations to the Federal Home Loan Bank and term repurchase agreements with maturities beyond one year borrowed by Horizons banking subsidiary. See Note 12 in Horizons Consolidated Financial Statements. |
(2) | Includes Trust Preferred Capital Securities issued by Horizon Statutory Trusts II and III and those assumed in the acquisitions of Alliance Bank in 2005, American Trust in 2009 and Heartland in 2012. See Note 13 in Horizons Consolidated Financial Statements. |
Expiration by Period | ||||||||
Within One Year |
Greater Than One Year |
|||||||
Letters of credit |
$ | 1,322 | $ | 8 | ||||
Unfunded loan commitments |
178,814 | 340,844 |
Capital Resources
The capital resources of Horizon and the Bank exceed regulatory capital ratios for well capitalized banks at December 31, 2013. Stockholders equity totaled $164.6 million as of December 31, 2013, compared to $159.0 million as of December 31, 2012. At year-end 2013, the ratio of stockholders equity to assets was 9.36%, compared to 8.60% for 2012. Tangible equity to tangible assets was 7.44% at December 31, 2013, compared to 6.72% at December 31, 2012. Book value per common share at December 31, 2013 increased to $17.65, compared to $17.00 at December 31, 2012. Horizons capital increased during 2013 as a result earnings, partially offset by a decrease in other comprehensive income and by dividends declared.
In 2008, in connection with the issuance of preferred stock that was subsequently redeemed, Horizon issued a warrant to the Treasury to purchase shares of Horizons common stock. The Treasury sold the warrant to a third party, and at December 31, 2013, the warrant covered 479,172 shares with an exercise price of $7.83 per share.
On August 25, 2011, the Company sold 12,500 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (Series B Preferred Stock), for aggregate consideration of $12.5 million, to the Treasury pursuant to the Small Business Lending Fund program. Concurrently with this transaction, Horizon redeemed all 18,750 shares of our Series A Preferred Stock that remained outstanding under the Treasurys Capital Purchase Program. The redemption of the Series A Preferred stock was funded by the $12.5 million in proceeds from the sale of the Series B Preferred Stock together with other available funds.
The Company currently intends to continue its participation in the Small Business Lending Fund, pursuant to which it issued preferred stock to the Treasury, since the growth in the Companys small business lending has reduced the dividend cost. For the three months ending December 31, 2013, the dividend cost was approximately $62,500, or 2.0% annualized. For the first quarter of 2014, the dividend cost will be approximately $31,250, or 1.0% annualized, for the second quarter of 2014, the dividend cost will be approximately $31,250 or 1.0% annualized and for the third quarter of 2014, the dividend cost will be approximately $31,250 or 1.0% annualized. The Company plans to reserve cash so that it has the ability to redeem this preferred stock if and when the cost of this capital exceeds the cost of other forms of capital.
Horizon declared dividends in the amount of $.42 per share in 2013, $.38 per share in 2012, and $.31 per share in 2011. The dividend payout ratio (dividends as a percent of net income) was 18.56% for 2013, 15.9% for 2012, and 20.1% for 2011. For additional information regarding dividend conditions, see Note 1 of the Notes to the Consolidated Financial Statements.
44
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
In October of 2004, Horizon formed Horizon Statutory Trust II (Trust II), a wholly owned statutory business trust. Trust II sold $10.3 million of Trust Preferred Capital Securities as a participant in a pooled trust preferred securities offering. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of subordinated debentures from Horizon. The junior subordinated debentures are the sole assets of Trust II and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90 day LIBOR plus 1.95% (2.26% at December 31, 2013) and mature on October 21, 2034, and securities may be called at any quarterly interest payment date at par. Costs associated with the issuance of the securities totaling $17,500 were capitalized and were amortized to the October 31, 2009, first call date of the securities.
In December of 2006, Horizon formed Horizon Bancorp Capital Trust III (Trust III), a wholly owned statutory business trust. Trust III sold $12.4 million of Trust Preferred Capital Securities as a participant in a pooled trust preferred securities offering. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of subordinated debentures from Horizon. The junior subordinated debentures are the sole assets of Trust III and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90 day LIBOR plus 1.65% (1.95% at December 31, 2013) and mature on January 30, 2037, and securities may be called at any quarterly interest payment date at par. Costs associated with the issuance of the securities totaling $12,647 were capitalized and are being amortized to the first call date of the securities. The proceeds of this issue were used to redeem the securities issued by Trust I on March 26, 2007.
The Company assumed additional debentures as the result of the acquisition of Alliance Bank Corporation in 2005. In June 2004, Alliance formed Alliance Financial Statutory Trust I a wholly owned business trust (Alliance Trust) to sell $5.2 million in trust preferred securities. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of subordinated debentures from Alliance. The junior subordinated debentures are the sole assets of Alliance Trust and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 2.65% (2.96% at December 31, 2013) and mature in June 2034, and securities may be called at any quarterly interest payment date at par.
The Company assumed additional debentures as the result of the American Trust & Savings Bank purchase and assumption in 2010. In March 2004, Am Tru Inc., the holding company for American Trust & Savings Bank, formed Am Tru Statutory Trust I a wholly owned business trust (Am Tru Trust) to sell $3.5 million in trust preferred securities. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of subordinated debentures from Am Tru Inc. The junior subordinated debentures are the sole assets of Am Tru Trust and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 2.85% (3.16% at December 31, 2013) and mature in March 2034, and securities may be called at any quarterly interest payment date at par. The carrying value was $2.8 million, net of the remaining purchase discount, at December 31, 2013.
The Company assumed additional debentures as the result of the Heartland merger in July 2012. In December 2006, Heartland. formed Heartland (IN) Statutory Trust II a wholly owned business trust (Heartland Trust) to sell $3.0 million in trust preferred securities. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of subordinated debentures from Heartland. The junior subordinated debentures are the sole assets of Heartland Trust and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 1.67% (1.99% at December 31, 2013) and mature in December 2036, and securities may be called at any quarterly interest payment date at par. The carrying value was $1.5 million, net of the remaining purchase discount, at December 31, 2013.
45
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
The Trust Preferred Capital Securities, subject to certain limitations, are included in Tier 1 Capital for regulatory purposes. Dividends on the Trust Preferred Capital Securities are recorded as interest expense.
Results of Operations
Net Income
Consolidated net income was $19.9 million or $2.17 per diluted share in 2013, $19.5 million or $2.30 per diluted share in 2012, and $12.8 million or $1.51 per diluted share in 2011. Diluted earnings per share were reduced by $0.04 for the twelve months ending December 31, 2013, $0.06 for the twelve months ending December 31, 2012 and $0.17 for the twelve months ending December 31, 2011 resulting from the decrease in preferred stock dividends and the accretion of the discount on the preferred stock.
Net Interest Income
The largest component of net income is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities, and interest expense, principally on deposits and borrowings. Changes in the net interest income are the result of changes in volume and the net interest spread which affects the net interest margin. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Net interest margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income during 2013 was $61.4 million, an increase of $3.2 million or 5.5% over the $58.2 million earned in 2012. Yields on the Companys interest-earning assets decreased by 3 basis points to 4.80% during 2013 from 4.83% in 2012. Interest income increased $2.4 million to $74.9 million for 2013 from $72.5 million in 2012. This increase was due to increased volume in interest earning assets partially offset by the lower yield on interest earning assets. Interest income was also increased due to the recognition of interest income from the Heartland loan discounts of approximately $6.3 million in 2013 compared to $1.5 million in 2012.
Rates paid on interest-bearing liabilities decreased by 9 basis points during the same period due to the lower interest rate environment. Interest expense decreased $819,000 from $14.3 million for 2012 to $13.5 million in 2013. This decrease was due to the lower rates being paid on the Companys interest bearing liabilities but offset by the increased volume of interest bearing liabilities. Due to a larger decrease in the rates paid on the Companys interest-bearing liabilities compared to the decrease in the yield on the Companys interest-earning assets, along with the growth of the Companys interest earning assets and interest bearing liabilities, the net interest margin increased 7 basis points from 3.89% for 2012 to 3.96% in 2013. The increase in the margin was due to the recognition of approximately $6.3 million of interest income from the Heartland loan discounts in 2013 compared to $1.5 million in 2012. Excluding the interest income recognized from the loan discounts, the margin would have been 3.57% for 2013 compared to 3.79% for 2012. Management believes that the current level of interest rates is driven by external factors and therefore impacts the results of the Companys net interest margin. Management does not expect a significant rise in interest rates in the short term, but an increase in rates is expected at some time in the future due to the current historically low interest rate environment.
46
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Twelve Months Ended December 31, 2013 |
Twelve Months Ended December 31, 2012 |
Twelve Months Ended December 31, 2011 |
||||||||||||||||||||||||||||||||||
Average Balance |
Interest | Average Rate |
Average Balance |
Interest | Average Rate |
Average Balance |
Interest | Average Rate |
||||||||||||||||||||||||||||
ASSETS |
||||||||||||||||||||||||||||||||||||
Interest-earning assets |
||||||||||||||||||||||||||||||||||||
Federal funds sold |
$ | 8,468 | $ | 21 | 0.25 | % | $ | 5,609 | $ | 13 | 0.23 | % | $ | 20,307 | $ | 49 | 0.24 | % | ||||||||||||||||||
Interest-earning deposits |
7,720 | 19 | 0.25 | % | 2,770 | 6 | 0.22 | % | 7,262 | 2 | 0.03 | % | ||||||||||||||||||||||||
Investment securitiestaxable |
371,594 | 8,401 | 2.26 | % | 365,693 | 8,814 | 2.41 | % | 332,551 | 10,150 | 3.05 | % | ||||||||||||||||||||||||
Investment securitiesnon-taxable (1) |
136,584 | 4,216 | 4.98 | % | 115,398 | 3,968 | 4.65 | % | 111,934 | 4,073 | 5.20 | % | ||||||||||||||||||||||||
Loans receivable (2)(3)(4) |
1,092,662 | 62,229 | 5.70 | % | 1,043,620 | 59,727 | 5.73 | % | 862,498 | 50,340 | 5.84 | % | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
Total interest-earning assets (1) |
1,617,028 | 74,886 | 4.80 | % | 1,533,090 | 72,528 | 4.83 | % | 1,334,552 | 64,614 | 4.98 | % | ||||||||||||||||||||||||
Noninterest-earning assets |
||||||||||||||||||||||||||||||||||||
Cash and due from banks |
24,548 | 19,365 | 15,834 | |||||||||||||||||||||||||||||||||
Allowance for loan losses |
(18,677 | ) | (18,738 | ) | (19,047 | ) | ||||||||||||||||||||||||||||||
Other assets |
134,220 | 112,739 | 98,069 | |||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
$ | 1,757,119 | $ | 1,646,456 | $ | 1,429,408 | |||||||||||||||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||||||||||||||||||||||||||
Interest-bearing liabilities |
||||||||||||||||||||||||||||||||||||
Interest-bearing deposits |
$ | 1,092,796 | $ | 5,672 | 0.52 | % | $ | 992,880 | $ | 6,206 | 0.63 | % | $ | 887,687 | $ | 8,346 | 0.94 | % | ||||||||||||||||||
Borrowings |
234,927 | 5,821 | 2.48 | % | 297,597 | 6,166 | 2.07 | % | 261,255 | 6,334 | 2.42 | % | ||||||||||||||||||||||||
Subordinated debentures |
32,406 | 2,010 | 6.20 | % | 32,408 | 1,950 | 6.02 | % | 31,446 | 1,821 | 5.79 | % | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
Total interest-bearing liabilities |
1,360,129 | 13,503 | 0.99 | % | 1,322,885 | 14,322 | 1.08 | % | 1,180,388 | 16,501 | 1.40 | % | ||||||||||||||||||||||||
Noninterest-bearing liabilities |
||||||||||||||||||||||||||||||||||||
Demand deposits |
219,323 | 165,340 | 119,504 | |||||||||||||||||||||||||||||||||
Accrued interest payable and other liabilities |
13,534 | 16,190 | 10,841 | |||||||||||||||||||||||||||||||||
Shareholders equity |
164,133 | 142,041 | 118,675 | |||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
$ | 1,757,119 | $ | 1,646,456 | $ | 1,429,408 | |||||||||||||||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
Net interest income/spread |
$ | 61,383 | 3.81 | % | $ | 58,206 | 3.75 | % | $ | 48,113 | 3.58 | % | ||||||||||||||||||||||||
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
Net interest income as a percent of average interest earning assets (1) |
3.96 | % | 3.89 | % | 3.74 | % |
(1) | Horizon has no foreign office and, accordingly, no assets or liabilities to foreign operations. Horizons subsidiary bank had no funds invested in Eurodollar Certificates of Deposit at December 31, 2013. |
(2) | Yields are presented on a tax-equivalent basis. |
(3) | Non-accruing loans for the purpose of the computations above are included in the daily average loan amounts outstanding. Loan totals are shown net of unearned income and deferred loans fees. |
(4) | Loan fees and late fees included in interest on loans aggregated $4.6 million, $5.0 million, and $3.5 million in 2013, 2012 and 2011. |
Total Change |
2013 - 2012 Change Due To Volume |
Change Due To Rate |
Total Change |
2012 - 2011 Change Due To Volume |
Change Due To Rate |
|||||||||||||||||||
Interest Income |
||||||||||||||||||||||||
Federal funds sold |
$ | 8 | $ | 7 | $ | 1 | $ | (36 | ) | $ | (34 | ) | $ | (2 | ) | |||||||||
Interest-earning deposits |
13 | 12 | 1 | 4 | (2 | ) | 6 | |||||||||||||||||
Investment securitiestaxable |
(413 | ) | 140 | (553 | ) | (1,336 | ) | 943 | (2,279 | ) | ||||||||||||||
Investment securitiesnon-taxable |
248 | 1,035 | (787 | ) | (105 | ) | 176 | (281 | ) | |||||||||||||||
Loans receivable |
2,502 | 2,798 | (296 | ) | 9,387 | 10,391 | (1,004 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest income |
2,358 | 3,992 | (1,634 | ) | 7,914 | 11,474 | (3,560 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Interest Expense |
||||||||||||||||||||||||
Interest-bearing deposits |
(534 | ) | 585 | (1,119 | ) | (2,140 | ) | 902 | (3,042 | ) | ||||||||||||||
Borrowings |
(345 | ) | (1,430 | ) | 1,085 | (168 | ) | 817 | (985 | ) | ||||||||||||||
Subordinated debentures |
60 | | 60 | 129 | 57 | 72 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest expense |
(819 | ) | (845 | ) | 26 | (2,179 | ) | 1,776 | (3,955 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Net interest income |
$ | 3,177 | $ | 4,837 | $ | (1,660 | ) | $ | 10,093 | $ | 9,698 | $ | 395 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
47
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Net interest income during 2012 was $58.2 million, an increase of $10.1 million or 21.0% over the $48.1 million earned in 2011. Yields on the Companys interest-earning assets decreased by 15 basis points to 4.83% during 2012 from 4.98% in 2011. Interest income increased $7.9 million to $72.5 million for 2012 from $64.6 million in 2011. This increase was due to increased volume in interest earning assets partially offset by the lower yield on interest earning assets. Interest income was also increased due to the recognition of interest income from the Heartland loan discounts of approximately $1.5 million in 2012.
Rates paid on interest-bearing liabilities decreased by 32 basis points during the same period due to the lower interest rate environment. Interest expense decreased $2.2 million from $16.5 million for 2011 to $14.3 million in 2012. This decrease was due to the lower rates being paid on the Companys interest bearing liabilities but offset by the increased volume of interest bearing liabilities. Due to a larger decrease in the rates paid on the Companys interest-bearing liabilities compared to the decrease in the yield on the Companys interest-earning assets, along with the growth of the Companys interest earning assets and interest bearing liabilities, the net interest margin increased 15 basis points from 3.74% for 2011 to 3.89% in 2012. The increase in the margin in 2012 compared to 2011 was due to the recognition of approximately $1.5 million of interest income from the Heartland loan discounts. Excluding the interest income recognized from the loan discounts, the margin would have been 3.79% for 2012.
Provision for Loan Losses
Horizon assesses the adequacy of its Allowance for Loan and Lease Losses (ALLL) by regularly reviewing the performance of its loan portfolios. During 2013, the provision for loan losses totaled $1.9 million, compared to $3.5 million in the prior year. The lower provision for 2013 compared to the prior year was primarily due to continued improvement of nonperforming and substandard loans resulting in the release of specific reserves. Commercial loan net charge-offs during 2013 were $1.9 million, residential mortgage loan net charge-offs were $941,000, and installment loan net charge-offs were $1.4 million for the year ending December 31, 2013. Loan charge-offs continue to require provisions for loan losses during the year but appeared to be decreasing as the amount of charge-offs decreased during 2013 compared to 2012.
Non-interest Income
The following is a summary of changes in non-interest income:
2012 to 2013 | 2011 to 2012 | |||||||||||||||||||||||||||
December 31 2013 |
December 31 2012 |
Amount Change |
Percent Change |
December 31 2011 |
Amount Change |
Percent Change |
||||||||||||||||||||||
Non-interest Income |
||||||||||||||||||||||||||||
Service charges on deposit accounts |
$ | 3,989 | $ | 3,470 | $ | 519 | 15.0 | % | $ | 3,164 | $ | 306 | 9.7 | % | ||||||||||||||
Wire transfer fees |
697 | 892 | (195 | ) | -21.9 | % | 619 | 273 | 44.1 | % | ||||||||||||||||||
Interchange fees |
4,056 | 3,122 | 934 | 29.9 | % | 2,594 | 528 | 20.4 | % | |||||||||||||||||||
Fiduciary activities |
4,337 | 3,997 | 340 | 8.5 | % | 3,983 | 14 | 0.4 | % | |||||||||||||||||||
Gain on sale of securities |
374 | 2 | 372 | NM | 1,777 | (1,775 | ) | -99.9 | % | |||||||||||||||||||
Gain on sale of mortgage loans |
8,794 | 14,123 | (5,329 | ) | -37.7 | % | 6,449 | 7,674 | 119.0 | % | ||||||||||||||||||
Mortgage servicing net of impairment |
1,521 | 234 | 1,287 | 550.0 | % | 267 | (33 | ) | -12.4 | % | ||||||||||||||||||
Increase in cash surrender value of bank owned life insurance |
1,035 | 1,025 | 10 | 1.0 | % | 891 | 134 | 15.0 | % | |||||||||||||||||||
Other income |
1,103 | 466 | 637 | 136.7 | % | 102 | 364 | 356.9 | % | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Total non-interest income |
$ | 25,906 | $ | 27,331 | $ | (1,425 | ) | -5.2 | % | $ | 20,299 | $ | 7,032 | 34.6 | % | |||||||||||||
|
|
|
|
|
|
|
|
|
|
The increase in service charges on deposit accounts and interchange fee income has been the result of growth in transactional deposit accounts and volume during 2013. Fiduciary activities income increased during 2013 as a result of asset and market value increase. Mortgage servicing net of impairment increased by $1.3 million during 2013 compared to 2012 due to an impairment recovery of $635,000 and an increase in servicing income realized. In addition, there was a larger portfolio of mortgage loans serviced during 2013 compared to 2012. These increases were offset by decreases in gain on the sale of securities and wire transfer fees compared to 2012. During 2013, the Company originated approximately $346.4 million of mortgage loans to be sold on the secondary market, compared to $386.9 million in 2012. The decrease in the percentage earned on the sale of mortgage loans, and to a lesser extent, the lower volume, decreased the overall gain on sale of mortgage loans compared to the prior year.
48
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Non-interest Expense
The following is a summary of changes in non-interest expense:
2012 to 2013 | 2011to 2012 | |||||||||||||||||||||||||||
December 31 2013 |
December 31 2012 |
Amount Change |
Percent Change |
December 31 2011 |
Amount Change |
Percent Change |
||||||||||||||||||||||
Non-interest expense |
||||||||||||||||||||||||||||
Salaries |
$ | 21,164 | $ | 18,471 | $ | 2,693 | 14.6 | % | $ | 15,254 | $ | 3,217 | 21.1 | % | ||||||||||||||
Commission and bonuses |
4,290 | 4,878 | (588 | ) | -12.1 | % | 3,277 | 1,601 | 48.9 | % | ||||||||||||||||||
Employee benefits |
5,578 | 5,034 | 544 | 10.8 | % | 4,344 | 690 | 15.9 | % | |||||||||||||||||||
Net occupancy expenses |
4,984 | 4,529 | 455 | 10.0 | % | 4,267 | 262 | 6.1 | % | |||||||||||||||||||
Data processing |
3,045 | 2,717 | 328 | 12.1 | % | 2,006 | 711 | 35.4 | % | |||||||||||||||||||
Professional fees |
1,668 | 1,990 | (322 | ) | -16.2 | % | 1,497 | 493 | 32.9 | % | ||||||||||||||||||
Outside services and consultants |
2,412 | 2,313 | 99 | 4.3 | % | 1,741 | 572 | 32.9 | % | |||||||||||||||||||
Loan expense |
4,668 | 4,276 | 392 | 9.2 | % | 3,586 | 690 | 19.2 | % | |||||||||||||||||||
FDIC deposit insurance |
1,089 | 1,108 | (19 | ) | -1.7 | % | 1,220 | (112 | ) | -9.2 | % | |||||||||||||||||
Other losses |
807 | 619 | 188 | 30.4 | % | 2,383 | (1,764 | ) | -74.0 | % | ||||||||||||||||||
Other expense |
8,740 | 8,089 | 651 | 8.0 | % | 6,572 | 1,517 | 23.1 | % | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Total non-interest expense |
$ | 58,445 | $ | 54,024 | $ | 4,421 | 8.2 | % | $ | 46,147 | $ | 7,877 | 17.1 | % | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
Salaries and employee benefits increased during 2013 compared to 2012. These increases were primarily the result of changes to annual merit pay and increased employee benefits costs due to health insurance expense and ESOP contributions. In addition, compensation expense and net occupancy expense was higher due to Horizons expansion efforts and investment in growth markets. Data processing, outside services and consultants and other expenses increased during 2013 from the cost of continued growth and expansion. Loan expense increased in 2013 compared to 2012 due to collection costs and indirect loan dealer fees. Other losses increased in 2013 due a contingent liability related to one specific commercial loan. Professional fees decreased in 2013 as 2012 included professional costs related to the Heartland transaction.
Income Taxes
Income tax expense for 2013 was $7.0 million, compared to $8.4 million of tax expense during 2012. The effective tax rate for 2013 was 26.2% compared to 30.2% in 2012 and 24.6% in 2011. The decrease in the effective tax rate in 2013 was primarily due to tax planning strategies implemented including a captive real estate investment trust subsidiary (REIT) and a captive insurance subsidiary reducing both the federal and state tax liabilities.
Liquidity and Rate Sensitivity Management
Management and the Board of Directors meet regularly to review both the liquidity and rate sensitivity position of Horizon. Effective asset and liability management ensures Horizons ability to monitor the cash flow requirements of depositors along with the demands of borrowers and to measure and manage interest rate risk. Horizon utilizes an interest rate risk assessment model designed to highlight sources of existing interest rate risk and consider the effect of these risks on strategic planning. Management maintains (within certain parameters) an essentially balanced ratio of interest sensitive assets to liabilities in order to protect against the effects of wide interest rate fluctuations.
Liquidity
The Bank maintains a stable base of core deposits provided by long standing relationships with consumers and local businesses. These deposits are the principal source of liquidity for Horizon. Other sources of liquidity for Horizon include earnings, loan repayments, investment security sales and maturities, sale of real estate loans and borrowing relationships with correspondent banks, including the Federal Home Loan Bank (FHLB) and the Federal Reserve Bank (FRB). At December 31, 2013, Horizon had available approximately $311.8 million in available credit from various money center banks, including the FHLB and the FRB Discount Window. Factors which could impact Horizons funding needs in the future include:
| Horizon had outstanding borrowings of over $75.0 million with the FHLB and total borrowing capacity with the FHLB of $219.5 million. Generally, the loan terms from the FHLB are better than the terms Horizon can receive from other sources, making it less expensive to borrow money from the FHLB. Financial difficulties at the FHLB could reduce or eliminate Horizons additional borrowing capacity with the FHLB or FHLB could change collateral requirements, which could lower the Companys borrowing availability. |
49
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
| If residential mortgage loan rates remain low, Horizons mortgage warehouse loans could create an additional need for funding. |
| Horizon had a total of $125.0 million of Federal Fund lines from various money center banks. These are uncommitted lines and could be withdrawn at any time by the correspondent banks. |
| Horizon had a total of $89.6 million of available collateral at the Federal Reserve Bank secured by municipal securities. These securities may mature, call, or be sold, which would reduce the available collateral. |
| A downgrade in Horizons public credit rating by a rating agency due to factors such as deterioration in asset quality, a large charge to earnings, a decline in profitability or other financial measures, or a significant merger or acquisition. |
| An act of terrorism or war, natural disasters, political events, or the default or bankruptcy of a major corporation, mutual fund, hedge fund or a government agency. |
| Market speculation or rumors about Horizon or the banking industry in general may adversely affect the cost and availability of normal funding sources. |
If any of these events occur, they could force Horizon to borrow money from other sources including negotiable certificates of deposit. Such other monies may only be available at higher interest rates and on less advantageous terms, which will impact our net income and could impact our ability to grow. Management believes Horizon has adequate funding sources to meet short and long term needs.
Horizon maintains a liquidity contingency plan that outlines the process for addressing a liquidity crisis. The plan provides for an evaluation of funding sources under various market conditions. It also assigns specific roles and responsibilities for effectively managing liquidity through a problem period.
During 2013, cash flows were generated primarily from the sales, maturities, and prepayments of investment securities of $111.4 million and decrease in loans of $112.1 million. Cash flows were used to purchase investments totaling $168.9 million and decrease borrowings by $89.3 million. The net cash and cash equivalent position increased by $986,000 during 2013.
The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2013. Interest on subordinated debentures and long-term borrowed funds is calculated based on current contractual interest rates.
(dollars in thousands) | Total | Within one year |
After one but within three years |
After three but within five years |
After five years |
|||||||||||||||
Remaining contractual maturities of time deposits |
$ | 280,458 | $ | 116,484 | $ | 84,955 | $ | 54,533 | $ | 24,486 | ||||||||||
Borrowings |
256,296 | 106,490 | 42,872 | 46,153 | 60,781 | |||||||||||||||
Subordinated debentures |
32,486 | | | | 32,486 | |||||||||||||||
Loan Commitments |
519,658 | 519,658 | | | | |||||||||||||||
Preferred stock |
12,500 | | 12,500 | | | |||||||||||||||
Letters of credit |
1,330 | 1,330 | | | | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total |
$ | 1,102,728 | $ | 743,962 | $ | 140,327 | $ | 100,686 | $ | 117,753 | ||||||||||
|
|
|
|
|
|
|
|
|
|
Interest Sensitivity
The degree by which net interest income may fluctuate due to changes in interest rates is monitored by Horizon using computer simulation models, incorporating not only the current GAP position but the effect of expected repricing of specific financial assets and liabilities. When repricing opportunities are not properly aligned, net interest income may be affected when interest rates change. Forecasting results of the possible outcomes determines the exposure to interest rate risk inherent in Horizons balance sheet. The goal is to manage imbalanced positions that arise when the total amount of assets that reprice or mature in a given time period differs significantly from liabilities that reprice or mature in the same time period. The theory behind managing the difference between repricing assets and liabilities is to have more assets
50
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
repricing in a rising rate environment and more liabilities repricing in a declining rate environment. Based on one model that assumes a lag in repricing, at December 31, 2013, the amount of assets that reprice within one year was 257% of liabilities that reprice within one year. At December 31, 2012, this same model, reported that the amount of assets that reprice within one year was approximately 246% of the amount of liabilities that reprice within the same time period. The year 2013 was a stable rate environment and the yields on assets continued to reprice at lower rates due to current asset pricing and a more competitive environment. The impact of lower yields offset partially by slightly lower funding costs negatively impacted the net interest margin during 2013.
Rate Sensitivity | ||||||||||||||||||||
> 3 Months | Greater | |||||||||||||||||||
3 Months | & < 6 | > 6 Months | Than 1 | |||||||||||||||||
or Less | Months | & < 1 Year | Year | Total | ||||||||||||||||
Loans |
$ | 458,154 | $ | 79,186 | $ | 117,205 | $ | 417,564 | $ | 1,072,109 | ||||||||||
Federal Funds Sold |
2,505 | | | | 2,505 | |||||||||||||||
Interest-Bearing balances with Banks |
3,847 | | | | 3,847 | |||||||||||||||
Investment securities with FRB and FHLB stock |
37,047 | 32,285 | 45,726 | 417,627 | 532,685 | |||||||||||||||
Other assets |
| | | 147,130 | 147,130 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total Assets |
$ | 501,553 | $ | 111,471 | $ | 162,931 | $ | 982,321 | $ | 1,758,276 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Noninterest-bearing deposits |
$ | 5,269 | $ | 5,269 | $ | 10,538 | $ | 210,020 | $ | 231,096 | ||||||||||
Interest-bearing deposits |
58,705 | 56,161 | 85,774 | 859,784 | 1,060,424 | |||||||||||||||
Borrowed Funds |
54,648 | 1,896 | 24,176 | 208,062 | 288,782 | |||||||||||||||
Other Liabilities |
| | | 13,354 | 13,354 | |||||||||||||||
Stockholders equity |
| | | 164,620 | 164,620 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total liabilities and stockholders equity |
$ | 118,622 | $ | 63,326 | $ | 120,488 | $ | 1,455,840 | $ | 1,758,276 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
GAP |
$ | 382,931 | $ | 48,145 | $ | 42,443 | $ | (473,519 | ) | |||||||||||
Cumulative GAP |
$ | 382,931 | $ | 431,076 | $ | 473,519 |
Quantitative and Qualitative Disclosures about Market Risk
Horizons primary market risk exposure is interest rate risk. Interest rate risk (IRR) is the risk that Horizons earnings and capital will be adversely affected by changes in interest rates. The primary approach to IRR management is one that focuses on adjustments to the asset/liability mix in order to limit the magnitude of IRR.
Horizons exposure to interest rate risk arises from repricing or mismatch risk, embedded options risk, and yield curve risk. Repricing risk is the risk of adverse consequence from a change in interest rates that arise because of differences in the timing of when those interest rate changes affect Horizons assets and liabilities. Basis risk is the risk that the spread, or rate difference, between instruments of similar maturities will change. Options risk arises whenever products give the customer the right, but not the obligation, to alter the quantity or timing of cash flows. Yield curve risk is the risk that changes in prevailing interest rates will affect instruments of different maturities by different amounts. Horizons objective is to remain reasonably neutral with respect to IRR. Horizon utilizes a variety of strategies to maintain this position including the sale of mortgage loans on the secondary market, hedging certain balance sheet items using derivatives, varying maturities of FHLB advances, certificates of deposit funding and investment securities.
The table, which follows, provides information about Horizons financial instruments that were sensitive to changes in interest rates as of December 31, 2013. The table incorporates Horizons internal system generated data related to the maturity and repayment/withdrawal of interest-earning assets and interest-bearing liabilities. For loans, securities and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities as well as the historical experience of Horizon related to the impact of interest rate fluctuations on the prepayment of residential loans and mortgage-backed securities. From a risk management perspective, Horizon believes that repricing dates are more relevant than contractual maturity dates when analyzing the value of financial instruments. For deposits with no contractual maturity dates, the table presents principal cash flows and weighted average rate, as applicable, based upon Horizons experience and managements judgment concerning the most likely withdrawal behaviors.
51
HORIZON BANCORP AND SUBSIDIARIES
Managements Discussion and Analysis of
Financial Condition and Results of Operations
(Table dollars in thousands except per share data)
Quantitative Disclosure of Market Risk
2014 | 2015 | 2016 | 2017 | 2018 | 2019 & Beyond |
Total | Fair Value December 31 2013 |
|||||||||||||||||||||||||
Rate-sensitive assets |
||||||||||||||||||||||||||||||||
Fixed interest rate loans |
$ | 255,890 | $ | 118,955 | $ | 76,145 | $ | 46,913 | $ | 22,995 | $ | 49,857 | $ | 570,755 | $ | 523,149 | ||||||||||||||||
Average interest rate |
4.98 | % | 4.99 | % | 4.91 | % | 4.85 | % | 4.94 | % | 4.92 | % | 4.96 | % | ||||||||||||||||||
Variable interest rate loans |
395,178 | 29,035 | 24,141 | 16,062 | 20,820 | 16,118 | 501,354 | 567,406 | ||||||||||||||||||||||||
Average interest rate |
4.18 | % | 4.33 | % | 4.15 | % | 4.39 | % | 4.24 | % | 3.32 | % | 4.17 | % | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Total loans |
651,068 | 147,990 | 100,286 | 62,975 | 43,815 | 65,975 | 1,072,109 | 1,090,555 | ||||||||||||||||||||||||
Average interest rate |
4.50 | % | 4.86 | % | 4.73 | % | 4.73 | % | 4.61 | % | 4.53 | % | 4.59 | % | ||||||||||||||||||
Securities, including FRB and FHLB stock |
115,058 | 81,884 | 96,586 | 45,607 | 36,027 | 157,523 | 532,685 | 532,686 | ||||||||||||||||||||||||
Average interest rate |
2.67 | % | 2.90 | % | 2.79 | % | 2.89 | % | 3.41 | % | 3.68 | % | 3.09 | % | ||||||||||||||||||
Other interest-bearing assets |
6,352 | | | | | | 6,352 | 6,352 | ||||||||||||||||||||||||
Average interest rate |
0.30 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.30 | % | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Total earnings assets |
$ | 772,478 | $ | 229,874 | $ | 196,872 | $ | 108,582 | $ | 79,842 | $ | 223,498 | $ | 1,611,146 | $ | 1,629,593 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Average interest rate |
4.19 | % | 4.16 | % | 3.78 | % | 3.96 | % | 4.16 | % | 3.93 | % | 4.08 | % | ||||||||||||||||||
Rate-sensitive liabilities |
||||||||||||||||||||||||||||||||
Noninterest-bearing deposits |
$ | 21,076 | $ | 19,154 | $ | 17,407 | $ | 15,820 | $ | 14,377 | $ | 143,263 | $ | 231,096 | $ | 231,096 | ||||||||||||||||
NOW accounts |
48,880 | 44,227 | 40,016 | 36,207 | 32,760 | 311,356 | 513,446 | 467,224 | ||||||||||||||||||||||||
Average interest rate |
0.13 | % | 0.13 | % | 0.13 | % | 0.13 | % | 0.13 | % | 0.13 | % | 0.13 | % | ||||||||||||||||||
Savings and money market accounts |
35,275 | 25,769 | 24,287 | 20,860 | 17,976 | 142,352 | 266,520 | 252,181 | ||||||||||||||||||||||||
Average interest rate |
0.16 | % | 0.15 | % | 0.15 | % | 0.15 | % | 0.14 | % | 0.10 | % | 0.13 | % | ||||||||||||||||||
Certificates of deposit |
116,484 | 47,685 | 37,301 | 30,006 | 24,495 | 24,487 | 280,458 | 283,575 | ||||||||||||||||||||||||
Average interest rate |
0.83 | % | 1.43 | % | 2.49 | % | 2.77 | % | 2.04 | % | 1.86 | % | 1.54 | % | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Total deposits |
221,715 | 136,835 | 119,012 | 102,892 | 89,607 | 621,459 | 1,291,520 | 1,234,077 | ||||||||||||||||||||||||
Average interest rate |
0.50 | % | 0.57 | % | 0.86 | % | 0.88 | % | 0.63 | % | 0.16 | % | 0.42 | % | ||||||||||||||||||
Fixed interest rate borrowings |
72,152 | 21,027 | 22,683 | 44,825 | 130 | 50,231 | 211,050 | 211,846 | ||||||||||||||||||||||||
Average interest rate |
1.20 | % | 2.63 | % | 3.60 | % | 4.16 | % | 4.68 | % | 3.30 | % | 2.73 | % | ||||||||||||||||||
Variable interest rate borrowings |
77,732 | | | | | | 77,732 | 77,775 | ||||||||||||||||||||||||
Average interest rate |
2.44 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 2.44 | % | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Total funds |
$ | 371,599 | $ | 157,863 | $ | 141,695 | $ | 147,717 | $ | 89,738 | $ | 671,690 | $ | 1,580,302 | $ | 1,523,698 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Average interest rate |
1.04 | % | 0.84 | % | 1.29 | % | 1.88 | % | 0.64 | % | 0.40 | % | 0.83 | % |
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required under this item is incorporated by reference to the information appearing in managements discussion and analysis of financial condition and results of operation included in Item 7.
52
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HORIZON BANCORP AND SUBSIDIARIES
Consolidated Financial Statements
Table of Contents
Page | ||||
Consolidated Financial Statements |
||||
54 | ||||
55 | ||||
56 | ||||
57 | ||||
58 | ||||
59 | ||||
106 | ||||
Other Information |
||||
109 | ||||
110 | ||||
111 |
53
HORIZON BANCORP AND SUBSIDIARIES
(Dollar Amounts in Thousands)
December 31 2013 |
December 31 2012 |
|||||||
Assets |
||||||||
Cash and due from banks |
$ | 31,721 | $ | 30,735 | ||||
Investment securities, available for sale |
508,591 | 482,801 | ||||||
Investment securities, held to maturity (fair value of $9,910 and $0) |
9,910 | | ||||||
Loans held for sale |
3,281 | 13,744 | ||||||
Loans, net of allowance for loan losses of $15,992 and $18,270 |
1,052,836 | 1,172,447 | ||||||
Premises and equipment |
46,194 | 42,184 | ||||||
Federal Reserve and Federal Home Loan Bank stock |
14,184 | 13,333 | ||||||
Goodwill |
19,748 | 19,748 | ||||||
Other intangible assets |
3,288 | 4,048 | ||||||
Interest receivable |
7,501 | 7,716 | ||||||
Cash value life insurance |
36,190 | 35,192 | ||||||
Other assets |
24,832 | 26,279 | ||||||
|
|
|
|
|||||
Total assets |
$ | 1,758,276 | $ | 1,848,227 | ||||
|
|
|
|
|||||
Liabilities |
||||||||
Deposits |
||||||||
Non-interest bearing |
$ | 231,096 | $ | 209,200 | ||||
Interest bearing |
1,060,424 | 1,084,953 | ||||||
|
|
|
|
|||||
Total deposits |
1,291,520 | 1,294,153 | ||||||
Borrowings |
256,296 | 345,764 | ||||||
Subordinated debentures |
32,486 | 32,331 | ||||||
Interest payable |
506 | 560 | ||||||
Other liabilities |
12,948 | 16,451 | ||||||
|
|
|
|
|||||
Total liabilities |
1,593,756 | 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, 8,706,971 and 8,693,471 shares Outstanding, 8,630,966 and 8,617,466 shares |
| | ||||||
Additional paid-in capital |
32,496 | 31,965 | ||||||
Retained earnings |
121,253 | 105,402 | ||||||
Accumulated other comprehensive income (loss) |
(1,729 | ) | 9,101 | |||||
|
|
|
|
|||||
Total stockholders equity |
164,520 | 158,968 | ||||||
|
|
|
|
|||||
Total liabilities and stockholders equity |
$ | 1,758,276 | $ | 1,848,227 | ||||
|
|
|
|
See notes to consolidated financial statements
54
HORIZON BANCORP AND SUBSIDIARIES
Consolidated Statements of Income
(Dollar Amounts in Thousands, Except Per Share Data)
Years Ended December 31 | ||||||||||||
2013 | 2012 | 2011 | ||||||||||
Interest Income |
||||||||||||
Loans receivable |
$ | 62,229 | $ | 59,727 | $ | 50,340 | ||||||
Investment securities |
||||||||||||
Taxable |
8,441 | 8,833 | 10,201 | |||||||||
Tax exempt |
4,216 | 3,968 | 4,073 | |||||||||
|
|
|
|
|
|
|||||||
Total interest income |
74,886 | 72,528 | 64,614 | |||||||||
|
|
|
|
|
|
|||||||
Interest Expense |
||||||||||||
Deposits |
5,672 | 6,206 | 8,346 | |||||||||
Borrowed funds |
5,821 | 6,166 | 6,334 | |||||||||
Subordinated debentures |
2,010 | 1,950 | 1,821 | |||||||||
|
|
|
|
|
|
|||||||
Total interest expense |
13,503 | 14,322 | 16,501 | |||||||||
|
|
|
|
|
|
|||||||
Net Interest Income |
61,383 | 58,206 | 48,113 | |||||||||
Provision for loan losses |
1,920 | 3,524 | 5,282 | |||||||||
|
|
|
|
|
|
|||||||
Net Interest Income after Provision for Loan Losses |
59,463 | 54,682 | 42,831 | |||||||||
|
|
|
|
|
|
|||||||
Non-interest Income |
||||||||||||
Service charges on deposit accounts |
3,989 | 3,470 | 3,164 | |||||||||
Wire transfer fees |
697 | 892 | 619 | |||||||||
Interchange fees |
4,056 | 3,122 | 2,594 | |||||||||
Fiduciary activities |
4,337 | 3,997 | 3,983 | |||||||||
Gain on sale of investment securities (includes $374, $2 and $1,777 for the years ended 2013, 2012 and 2011 related to accumulated other comprehensive earnings reclassifications) |
374 | 2 | 1,777 | |||||||||
Gain on sale of mortgage loans |
8,794 | 14,123 | 6,449 | |||||||||
Mortgage servicing income net of impairment |
1,521 | 234 | 267 | |||||||||
Increase in cash value of bank owned life insurance |
1,035 | 1,025 | 891 | |||||||||
Other income |
1,103 | 466 | 102 | |||||||||
|
|
|
|
|
|
|||||||
Total non-interest income |
25,906 | 27,331 | 20,299 | |||||||||
|
|
|
|
|
|
|||||||
Non-interest Expense |
||||||||||||
Salaries and employee benefits |
31,032 | 28,383 | 22,875 | |||||||||
Net occupancy expenses |
4,984 | 4,529 | 4,267 | |||||||||
Data processing |
3,045 | 2,717 | 2,006 | |||||||||
Professional fees |
1,668 | 1,990 | 1,497 | |||||||||
Outside services and consultants |
2,412 | 2,313 | 1,741 | |||||||||
Loan expense |
4,668 | 4,276 | 3,586 | |||||||||
FDIC insurance expense |
1,089 | 1,108 | 1,220 | |||||||||
Other losses |
807 | 619 | 2,383 | |||||||||
Other expense |
8,740 | 8,089 | 6,572 | |||||||||
|
|
|
|
|
|
|||||||
Total non-interest expense |
58,445 | 54,024 | 46,147 | |||||||||
|
|
|
|
|
|
|||||||
Income Before Income Tax |
26,924 | 27,989 | 16,983 | |||||||||
Income tax expense (includes $131, $0 and $622 for the years ended 2013, 2012 and 2011 related to income tax expense from reclassification items) |
7,048 | 8,446 | 4,186 | |||||||||
|
|
|
|
|
|
|||||||
Net Income |
19,876 | 19,543 | 12,797 | |||||||||
Preferred stock dividend and discount accretion |
(370 | ) | (481 | ) | (1,325 | ) | ||||||
|
|
|
|
|
|
|||||||
Net Income Available to Common Shareholders |
$ | 19,506 | $ | 19,062 | $ | 11,472 | ||||||
|
|
|
|
|
|
|||||||
Basic Earnings Per Share |
$ | 2.26 | $ | 2.39 | $ | 1.55 | ||||||
Diluted Earnings Per Share |
2.17 | 2.30 | 1.51 |
See notes to consolidated financial statements
55
HORIZON BANCORP AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Dollar Amounts in Thousands)
Years Ended December 31 | ||||||||||||
2013 | 2012 | 2011 | ||||||||||
Net Income |
$ | 19,876 | $ | 19,543 | $ | 12,797 | ||||||
|
|
|
|
|
|
|||||||
Other Comprehensive Income (Loss) |
||||||||||||
Change in fair value of derivative instruments: |
||||||||||||
Change in fair value of derivative instruments for the period |
2,668 | (579 | ) | (3,539 | ) | |||||||
Income tax effect |
(934 | ) | 203 | 1,239 | ||||||||
|
|
|
|
|
|
|||||||
Changes from derivative instruments |
1,734 | (376 | ) | (2,300 | ) | |||||||
|
|
|
|
|
|
|||||||
Change in securities available-for-sale: |
||||||||||||
Unrealized appreciation (depreciation) for the period |
(18,956 | ) | 2,517 | 13,766 | ||||||||
Reclassification adjustment for securities gains realized in income |
(374 | ) | (2 | ) | (1,777 | ) | ||||||
Income tax effect |
6,766 | (880 | ) | (4,195 | ) | |||||||
|
|
|
|
|
|
|||||||
Unrealized gains (losses) on available-for-sale securities |
(12,564 | ) | 1,635 | 7,794 | ||||||||
|
|
|
|
|
|
|||||||
Other Comprehensive Income (Loss), Net of Tax |
(10,830 | ) | 1,259 | 5,494 | ||||||||
|
|
|
|
|
|
|||||||
Comprehensive Income |
$ | 9,046 | $ | 20,802 | $ | 18,291 | ||||||
|
|
|
|
|
|
See notes to consolidated financial statements
56
HORIZON BANCORP AND SUBSIDIARIES
Consolidated Statements of Stockholders Equity
(Dollar Amounts in Thousands, Except Per Share Data)
Preferred Stock |
Additional Paid-in Capital |
Retained Earnings |
Accumulated Other Comprehensive Income (Loss) |
Total | ||||||||||||||||
Balances, January 1, 2011 |
$ | 18,217 | $ | 11,478 | $ | 80,240 | $ | 2,348 | $ | 112,283 | ||||||||||
Net income |
12,797 | 12,797 | ||||||||||||||||||
Other comprehensive income, net of tax |
5,494 | 5,494 | ||||||||||||||||||
Redemption of preferred stock |
(18,750 | ) | (18,750 | ) | ||||||||||||||||
Issuance of preferred stock |
12,500 | 12,500 | ||||||||||||||||||
Amortization of unearned compensation |
100 | 100 | ||||||||||||||||||
Issuance of restricted shares |
60 | 60 | ||||||||||||||||||
Exercise of stock options |
63 | 63 | ||||||||||||||||||
Stock option expense |
35 | 35 | ||||||||||||||||||
Cash dividends on preferred stock (5.00%) |
(792 | ) | (792 | ) | ||||||||||||||||
Cash dividends on common stock ($ .31 per share) |
(2,325 | ) | (2,325 | ) | ||||||||||||||||
Accretion of discount on preferred stock |
533 | (533 | ) | | ||||||||||||||||
|
|
|
|
|
|
|||||||||||||||
Balances, December 31, 2011 |
$ | 12,500 | $ | 11,736 | $ | 89,387 | $ | 7,842 | $ | 121,465 | ||||||||||
Net income |
19,543 | 19,543 | ||||||||||||||||||
Other comprehensive income, net of tax |
1,259 | 1,259 | ||||||||||||||||||
Amortization of unearned compensation |
187 | 187 | ||||||||||||||||||
Issuance of restricted shares |
115 | 115 | ||||||||||||||||||
Exercise of stock options |
226 | 226 | ||||||||||||||||||
Stock option expense |
33 | 33 | ||||||||||||||||||
Stock issued from acquisition |
19,668 | 19,668 | ||||||||||||||||||
Cash dividends on preferred stock (3.85%) |
(481 | ) | (481 | ) | ||||||||||||||||
Cash dividends on common stock ($ .38 per share) |
(3,047 | ) | (3,047 | ) | ||||||||||||||||
|
|
|
|
|||||||||||||||||
Balances, December 31, 2012 |
$ | 12,500 | $ | 31,965 | $ | 105,402 | $ | 9,101 | $ | 158,968 | ||||||||||
Net income |
19,876 | 19,876 | ||||||||||||||||||
Other comprehensive loss, net of tax |
(10,830 | ) | (10,830 | ) | ||||||||||||||||
Amortization of unearned compensation |
288 | 288 | ||||||||||||||||||
Exercise of stock options |
195 | 195 | ||||||||||||||||||
Stock option expense |
48 | 48 | ||||||||||||||||||
Cash dividends on preferred stock (2.96%) |
(370 | ) | (370 | ) | ||||||||||||||||
Cash dividends on common stock ($ .42 per share) |
(3,655 | ) | (3,655 | ) | ||||||||||||||||
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Balances, December 31, 2013 |
$ | 12,500 | $ | 32,496 | $ | 121,253 | $ | (1,729 | ) | $ | 164,520 | |||||||||
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See notes to consolidated financial statements
57
HORIZON BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollar Amounts in Thousands)
Twelve Months Ended December 31 | ||||||||||||
2013 | 2012 | 2011 | ||||||||||
Operating Activities |
||||||||||||
Net income |
$ | 19,876 | $ | 19,543 | $ | 12,797 | ||||||
Items not requiring (providing) cash |
||||||||||||
Provision for loan losses |
1,920 | 3,524 | 5,282 | |||||||||
Depreciation and amortization |
3,356 | 2,875 | 2,520 | |||||||||
Share based compensation |
48 | 33 | 35 | |||||||||
Issuance of restricted stock |
| 115 | 60 | |||||||||
Mortgage servicing rights impairment (recovery) |
(635 | ) | 168 | 53 | ||||||||
Premium amortization on securities available for sale, net |
2,861 | 3,344 | 2,311 | |||||||||
Gain on sale of investment securities |
(374 | ) | (2 | ) | (1,777 | ) | ||||||
Gain on sale of mortgage loans |
(8,794 | ) | (14,123 | ) | (6,449 | ) | ||||||
Proceeds from sales of loans |
365,654 | 401,068 | 282,306 | |||||||||
Loans originated for sale |
(346,397 | ) | (386,945 | ) | (275,857 | ) | ||||||
Change in cash value of life insurance |
(998 | ) | (990 | ) | 5 | |||||||
(Gain) loss on sale of other real estate owned |
(116 | ) | 129 | 206 | ||||||||
Net change in |
||||||||||||
Interest receivable |
215 | (225 | ) | (152 | ) | |||||||
Interest payable |
(54 | ) | (126 | ) | (185 | ) | ||||||
Other assets |
9,905 | 1,030 | 286 | |||||||||
Other liabilities |
498 | (3,072 | ) | 971 | ||||||||
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Net cash provided by operating activities |
46,965 | 26,346 | 22,412 | |||||||||
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Investing Activities |
||||||||||||
Purchases of securities available for sale |
(168,886 | ) | (113,945 | ) | (193,494 | ) | ||||||
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale |
121,309 | 125,071 | 155,343 | |||||||||
Purchase of securities held to maturity |
(12,050 | ) | | (9,437 | ) | |||||||
Proceeds from maturities of securities held to maturity |
2,110 | 7,100 | 12,837 | |||||||||
Purchase of Federal Reserve Bank stock |
(851 | ) | | 1,274 | ||||||||
Net change in loans |
112,140 | (102,580 | ) | (105,678 | ) | |||||||
Proceeds on the sale of OREO and repossessed assets |
2,343 | 4,672 | 2,424 | |||||||||
Purchases of premises and equipment |
(6,318 | ) | (6,984 | ) | (2,442 | ) | ||||||
Purchases of bank owned life insurance |
| | (3,000 | ) | ||||||||
Acquisition of Heartland |
| 26,283 | | |||||||||
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|
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Net cash provided by (used in) by investing activities |
49,797 | (60,383 | ) | (142,173 | ) | |||||||
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Financing Activities |
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Net change in |
||||||||||||
Deposits |
(2,633 | ) | 73,042 | 24,367 | ||||||||
Borrowings |
(89,313 | ) | (25,415 | ) | 109,462 | |||||||
Redemption of preferred stock |
| | (18,750 | ) | ||||||||
Issuance of preferred stock |
| | 12,500 | |||||||||
Proceeds from issuance of stock |
195 | 226 | 63 | |||||||||
Dividends paid on common shares |
(3,655 | ) | (3,047 | ) | (2,325 | ) | ||||||
Dividends paid on preferred shares |
(370 | ) | (481 | ) | (792 | ) | ||||||
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Net cash provided by (used in) financing activities |
(95,776 | ) | 44,325 | 124,525 | ||||||||
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Net Change in Cash and Cash Equivalents |
986 | 10,288 | 4,764 | |||||||||
Cash and Cash Equivalents, Beginning of Period |
30,735 | 20,447 | 15,683 | |||||||||
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Cash and Cash Equivalents, End of Period |
$ | 31,721 | $ | 30,735 | $ | 20,447 | ||||||
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Additional Cash Flows Information |
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Interest paid |
$ | 13,556 | $ | 14,358 | $ | 16,686 | ||||||
Income taxes paid |
3,100 | 8,125 | 2,700 | |||||||||
Transfer of loans to other real estate owned |
3,284 | 5,899 | 4,787 |
See notes to consolidated financial statements
58
HORIZON BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Table dollars in thousands except for per share data)
Note 1Nature of Operations and Summary of Significant Accounting Policies
Nature of Business The consolidated financial statements of Horizon Bancorp (Horizon) and its wholly owned subsidiaries, Horizon Bank, N.A. (Bank) and Horizon Risk Management, Inc. together referred to as (Horizon) conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry. Horizon Risk Management, Inc. is a captive insurance company incorporated in Nevada and was formed as a wholly owned subsidiary of the Holding Company.
The Bank is a full-service commercial bank offering a broad range of commercial and retail banking and other services incident to banking along with a trust department that offers corporate and individual trust and agency services and investment management services. The Bank has three active wholly owned subsidiaries, Horizon Investments, Inc. (Investment Company), Horizon Properties, Inc. (Horizon Properties) and Horizon Grantor Trust. Investment Company manages the investment portfolio of the Bank. Horizon Properties manages the real estate investment trust. Horizon Grantor Trust holds title to certain company owned life insurance policies. The Bank maintains 29 full service facilities. The Bank also wholly owns Horizon Insurance Services, Inc. (Insurance Agency) which is inactive, but previously offered a full line of personal and corporate insurance products. The net income generated from the insurance operations was not significant to the overall operations of Horizon and the majority of the Insurance Agency assets were sold during 2005. Horizon conducts no business except that incident to its ownership of the subsidiaries.
Horizon formed Horizon Bancorp Capital Trust II in 2004 (Trust II) and Horizon Bancorp Capital Trust III in 2006 (Trust III) for the purpose of participating in pooled trust preferred securities offerings. The Company assumed additional debentures as the result of the following acquisitions: Alliance Financial Corporation in 2005, which formed Alliance Financial Statutory Trust I (Alliance Trust); American Trust, which formed Am Tru Statutory Trust I (Am Tru Trust); and Heartland, which formed Heartland (IN) Statutory Trust II (Heartland Trust). See Note 13 of the Consolidated Financial Statements for further discussion regarding these previously consolidated entities that are now reported separately. The business of Horizon is not seasonal to any material degree.
Basis of Reporting The consolidated financial statements include the accounts of Horizon and subsidiaries. All material inter-company accounts and transactions have been eliminated in consolidation.
Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of other real estate owned, goodwill and intangible assets, mortgage servicing rights, other-than-temporary impairments and fair values of financial instruments.
Fair Value Measurements Horizon uses fair value measurements to record fair value adjustments, to certain assets, and liabilities and to determine fair value disclosures. Horizon has adopted Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures for all applicable financial and nonfinancial assets and liabilities. This accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This guidance applies only when other guidance requires or permits assets or liabilities to be measured at fair value; it does not expand the use of fair value in any new circumstances.
As defined in codification, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants. It represents an exit price at the measurement date. Market participants are buyers and sellers, who are independent, knowledgeable, and willing and able to transact in the principal (or most advantageous) market for the asset or liability being measured. Current market conditions, including imbalances between supply and demand, are considered in determining fair value. Horizon values its assets and liabilities in the principal market where it sells the particular asset or transfers the liability with the greatest volume and level of activity. In the absence of a principal market, the valuation is
59
HORIZON BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Table dollars in thousands except for per share data)
based on the most advantageous market for the asset or liability (i.e., the market where the asset could be sold or the liability transferred at a price that maximizes the amount to be received for the asset or minimizes the amount to be paid to transfer the liability).
In measuring the fair value of an asset, Horizon assumes the highest and best use of the asset by a market participant to maximize the value of the asset, and does not consider the intended use of the asset.
When measuring the fair value of a liability, Horizon assumes that the nonperformance risk associated with the liability is the same before and after the transfer. Nonperformance risk is the risk that an obligation will not be satisfied and encompasses not only Horizons own credit risk (i.e., the risk that Horizon will fail to meet its obligation), but also other risks such as settlement risk. Horizon considers the effect of its own credit risk on the fair value for any period in which fair value is measured.
There are three acceptable valuation techniques that can be used to measure fair value: the market approach, the income approach and the cost approach. Selection of the appropriate technique for valuing a particular asset or liability takes into consideration the exit market, the nature of the asset or liability being valued, and how a market participant would value the same asset or liability. Ultimately, determination of the appropriate valuation method requires significant judgment, and sufficient knowledge and expertise are required to apply the valuation techniques.
Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability using one of the three valuation techniques. Inputs can be observable or unobservable. Observable inputs are those assumptions which market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from a source independent of Horizon. Unobservable inputs are assumptions based on Horizons own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date. All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy which gives the highest ranking to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest ranking to unobservable inputs (Level 3). Fair values for assets or liabilities classified as Level 2 are based on one or a combination of the following factors: (i) quoted prices for similar assets; (ii) observable inputs for the asset or liability, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation considers an input to be significant if it drives 10% or more of the total fair value of a particular asset or liability.
Assets and liabilities are considered to be fair valued on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly or quarterly). Recurring valuation occurs at a minimum on the measurement date. Assets and liabilities are considered to be fair valued on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the balance sheet. Generally, nonrecurring valuation is the result of the application of other accounting pronouncements which require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value. The fair value of assets or liabilities transferred in or out of Level 3 is measured on the transfer date, with any additional changes in fair value subsequent to the transfer considered to be realized or unrealized gains or losses.
Investment Securities Available for Sale Horizon designates the majority of its investment portfolio as available for sale based on managements plans to use such securities for asset and liability management, liquidity and not to hold such securities as long-term investments. Management repositions the portfolio to take advantage of future expected interest rate trends when Horizons long-term profitability can be enhanced. Investment securities available for sale and marketable equity securities are carried at estimated fair value and any net unrealized gains/losses (after tax) on these securities are included in accumulated other comprehensive income. Gains/losses on the disposition of securities available for sale are recognized at the time of the transaction and are determined by the specific identification method.
60
HORIZON BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Table dollars in thousands except for per share data)
Investment Securities Held to Maturity Includes any security for which Horizon has the positive intent and ability to hold until maturity. These securities are carried at amortized cost.
Loans Held for Sale Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income. Gains and losses on loan sales are recorded in noninterest income, and direct loan origination costs and fees are deferred at origination of the loan and are recognized in noninterest income upon sale of the loan.
Interest and Fees on Loans Interest on commercial, mortgage and installment loans is recognized over the term of the loans based on the principal amount outstanding. When principal or interest is past due 90 days or more, and the loan is not well secured or in the process of collection, or when serious doubt exists as to the collectability of a loan, the accrual of interest is discontinued. Loan origination fees, net of direct loan origination costs, are deferred and recognized over the life of the loan as a yield adjustment. Discounts and premiums on purchased loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments.
Concentrations of Credit Risk The Bank grants commercial, real estate, and consumer loans to customers located primarily in Northwest and Central Indiana and Southwest Michigan and provides mortgage warehouse lines to mortgage companies in the United States. Commercial loans make up approximately 47% of the loan portfolio and are secured by both real estate and business assets. These loans are expected to be repaid from cash flows from operations of the businesses. The Bank does not have a concentration in speculative commercial real estate loans. Residential real estate loans make up approximately 17% of the loan portfolio and are secured by residential real estate. Installment loans make up approximately 26% of the loan portfolio and are primarily secured by consumer assets. Mortgage warehouse loans make up approximately 9% of the loan portfolio and are secured by residential real estate.
Mortgage Warehouse Loans Horizons mortgage warehousing has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with pledge of collateral under Horizons 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 under ASC 860, Transfers and Servicing and therefore is accounted for as a secured borrowing with pledge of collateral pursuant to the agreement with the mortgage company. When the individual loan is sold to the end investor by the mortgage company the proceeds from the sale of the loan are received by Horizon and used to pay off the loan balance with Horizon along with any accrued interest and any related fees. The remaining balance from the sale is forwarded to the mortgage company. These individual loans typically are sold by the mortgage company within 30 days and are seldom held more than 90 days. Interest income is accrued during this period and collected at the time each loan is sold. Fee income for each loan sold is collected when the loan is sold and no costs are deferred due to the term between each loan funding and related payoff is typically less than 30 days.
Based on the agreements with each mortgage company, at any time a mortgage company can repurchase from Horizon their outstanding loan balance on an individual mortgage and regain possession of the original note. Horizon also has the option to request that the mortgage company repurchase an individual mortgage. Should this occur, Horizon would return the original note and reassign the assignment of the mortgage to the mortgage company. Also, in the event that the end investor would not be able to honor the sales commitment and the mortgage company would not be able to repurchase its loan on an individual mortgage, Horizon would be able to exercise its rights under the agreement.
Allowance for Loan Losses An allowance for loan losses is maintained to absorb probable incurred losses inherent in the loan portfolio. The allowance is based on ongoing quarterly assessments of the probable incurred losses inherent in the loan portfolio. The allowance is increased by the provision for credit losses, which is charged against current period
61
HORIZON BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Table dollars in thousands except for per share data)
operating results and decreased by the amount of charge offs, net of recoveries. Horizons methodology for assessing the appropriateness of the allowance consists of several key elements, which include the general allowance, specific allowances for identified problem loans and the qualitative allowance.
The general allowance is calculated by applying loss factors to pools of outstanding loans. Loss factors are based on historical loss experience and may be adjusted for significant factors that, in managements judgment, affect the collectability of the portfolio as of the evaluation date.
Specific allowances are established in cases where management has identified conditions or circumstances related to a credit that management believes indicate the probability that a loss will be incurred in excess of the amount determined by the application of the formula allowance.
The qualitative allowance is based upon managements evaluation of various conditions, the effects of which are not directly measured in the determination of the general and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific credits. The conditions evaluated in connection with the qualitative allowance may include factors such as local, regional and national economic conditions and forecasts, concentrations of credit and changes in the composition of the portfolio.
Loan Impairment When analysis determines a borrowers operating results and financial condition are not adequate to meet 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 placed on non-accrual status when 90 days or more past due. These loans are also often considered impaired. Impaired loans or portions thereof, are charged-off when deemed uncollectible. This typically occurs when the loan is 90 or more days past due.
Loans are considered impaired if the borrower does not exhibit the ability to pay or the full principal or interest payments are not expected or made in accordance with the original terms of the loan. Impaired loans are measured and carried at the lower of cost or the present value of expected future cash flows discounted at the loans effective interest rate, at the loans observable market price or at the fair value of the collateral if the loan is collateral dependent.
Smaller balance homogenous loans are evaluated for impairment in the aggregate. Such loans include residential first mortgage loans secured by one to four family residences, residential construction loans and automobile, home equity and second mortgages. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment.
Loans Acquired in Business Combinations Loans acquired in business combinations 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 purchase dates may include information such as past-due and nonaccrual status, borrower credit scores and recent loans to value percentages. Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (FASB ASC 310-30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Accordingly, allowances for credit losses related to these loans are not carried over and recorded at the acquisition dates. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC 310-30, but for which a discount is attributable, at least in part to the credit quality, are also accounted for under this guidance. As a result, related discounts are recognized subsequently through accretion based on the expected cash flows of the acquired loans. For purposes of applying FASB ASC 310-30, loans acquired in business combinations are aggregated into pools of loans with common risk characteristic.
The expected cash flows of the acquired loan pools in excess of the fair values recorded is referred to as the accretable yield and is recognized in interest income over the remaining estimated lives of the loan pools. The Company continues to evaluate the fair value of the loans including cash flows expected to be collected. Increases in the Companys cash flow expectation are recognized as increases to the accretable yield while decreases are recognized as impairments through the allowance for loan losses.
62
HORIZON BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Table dollars in thousands except for per share data)
Premises and Equipment Buildings and major improvements are capitalized and depreciated using primarily the straight-line method with useful lives ranging from 3 to 40 years. Furniture and equipment are capitalized and depreciated using primarily the straight-line method with useful lives ranging from 2 to 20 years. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on disposition are included in current operations.
Federal Reserve and Federal Home Loan Bank of Indianapolis (FHLBI) Stock The stock is a required investment for institutions that are members of the Federal Reserve Bank (FRB) and Federal Home Loan Bank (FHLBI) systems. The required investment in the common stock is based on a predetermined formula.
Mortgage Servicing Rights Mortgage servicing assets are recognized separately when rights are acquired through purchase or through sale of financial assets. Under the servicing assets and liabilities accounting guidance (ASC 860-50), servicing rights resulting from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer. Amortized mortgage servicing rights include commercial mortgage servicing rights. Under the amortization method, servicing rights are amortized in proportion to and over the period of estimated net servicing income. The amortized assets are assessed for impairment or increased obligation based on fair value at each reporting date.
Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. These variables change from quarter to quarter as market conditions and projected interest rates change, and may have an adverse impact on the value of the mortgage servicing right and may result in a reduction to noninterest income.
Each class of separately recognized servicing assets subsequently measured using the amortization method are evaluated and measured for impairment. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the carrying amount of the servicing assets for that tranche. The valuation allowance is adjusted to reflect changes in the measurement of impairment after the initial measurement of impairment. Changes in valuation allowances are reported with mortgage servicing income net of impairment on the income statement. Fair value in excess of the carrying amount of servicing assets for that stratum is not recognized.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.
Intangible Assets Goodwill is tested annually for impairment. At December 31, 2013, Horizon had core deposit intangibles of $3.3 million subject to amortization and $19.7 million of goodwill, which is not subject to amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. Horizons goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Horizon to provide quality, cost effective banking services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. Goodwill totaled $19.7 million at December 31, 2013 and $19.7 million at December 31, 2012. A large majority of the goodwill relates to the acquisition of Heartland.
63
HORIZON BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Table dollars in thousands except for per share data)
Income Taxes The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
Uncertain tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to managements judgment.
The Company recognizes interest and penalties on income taxes as a component of income tax expense.
The Company files consolidated income tax returns with its subsidiaries.
Trust Assets and Income Property, other than cash deposits, held in a fiduciary or agency capacity is not included in the consolidated balance sheets since such property is not owned by Horizon.
Earnings per Common Share 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.