Edgar Filing: HORIZON BANCORP /IN/

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10-Q

HORIZON BANCORP

FORM 10-Q

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

Commission file number 0-10792

HORIZON BANCORP

(Exact name of registrant as specified in its charter)

Indiana

35-1562417

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)


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

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

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

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

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 9,256,026 shares of Common Stock, no par value, at August 10, 2015.

HORIZON BANCORP

FORM 10-Q

INDEX


PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Income	4

	Condensed Consolidated Statements of Comprehensive Income	5

	Condensed Consolidated Statement of Stockholders’ Equity	6

	Condensed Consolidated Statements of Cash Flows	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	56

Item 4.	Controls and Procedures	56

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	57

Item 1A.	Risk Factors	57

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57

Item 3.	Defaults Upon Senior Securities	57

Item 4.	Mine Safety Disclosures	57

Item 5.	Other Information	57

Item 6.	Exhibits	58

Signatures		59

Index To Exhibits		60

PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollar Amounts in Thousands)


	June 30 2015		December 31 2014
	(Unaudited)
Assets
Cash and due from banks	$	43,857	$	43,476
Investment securities, available for sale		330,970		323,764
Investment securities, held to maturity (fair value of $167,581 and $169,904)		162,661		165,767
Loans held for sale		7,677		6,143
Loans, net of allowance for loan losses of $16,421 and $16,501		1,502,862		1,362,053
Premises and equipment, net		54,778		52,461
Federal Reserve and Federal Home Loan Bank stock		11,080		11,348
Goodwill		28,176		28,176
Other intangible assets		3,531		3,965
Interest receivable		8,823		8,246
Cash value of life insurance		39,897		39,382
Other assets		24,995		32,141

Total assets	$	2,219,307	$	2,076,922

Liabilities
Deposits
Non-interest bearing	$	307,215	$	267,667
Interest bearing		1,277,508		1,214,652

Total deposits		1,584,723		1,482,319
Borrowings		385,236		351,198
Subordinated debentures		32,719		32,642
Interest payable		461		497
Other liabilities		14,037		15,852

Total liabilities		2,017,176		1,882,508

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, 9,313,779 and 9,278,916 shares Outstanding, 9,256,026 and 9,213,036 shares		—		—
Additional paid-in capital		46,622		45,916
Retained earnings		141,889		134,477
Accumulated other comprehensive income		1,120		1,521

Total stockholders’ equity		202,131		194,414

Total liabilities and stockholders’ equity	$	2,219,307	$	2,076,922

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Dollar Amounts in Thousands, Except Per Share Data)


	Three Months Ended June 30						Six Months Ended June 30
	2015			2014			2015			2014
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Interest Income
Loans receivable	$	17,981		$	16,631		$	34,843		$	29,585
Investment securities
Taxable		2,067			2,395			4,221			4,785
Tax exempt		1,079			1,096			2,156			2,219

Total interest income		21,127			20,122			41,220			36,589

Interest Expense
Deposits		1,237			1,355			2,469			2,632
Borrowed funds		1,539			1,478			3,018			2,900
Subordinated debentures		501			501			997			997

Total interest expense		3,277			3,334			6,484			6,529

Net Interest Income		17,850			16,788			34,736			30,060
Provision for loan losses		1,906			339			2,520			339

Net Interest Income after Provision for Loan Losses		15,944			16,449			32,216			29,721

Non-interest Income
Service charges on deposit accounts		1,085			1,038			2,084			1,961
Wire transfer fees		182			145			333			257
Interchange fees		1,366			1,254			2,468			2,213
Fiduciary activities		1,216			1,199			2,513			2,247
Gain on sale of investment securities (includes $0 for the three months ended and $124 for the six months ended June 30, 2015 and $0 for the three and six months ended June 30, 2014, related to accumulated other comprehensive earnings reclassifications)		—			—			124			—
Gain on sale of mortgage loans		2,642			2,537			5,021			3,948
Mortgage servicing income net of impairment		300			233			479			440
Increase in cash value of bank owned life insurance		257			252			515			485
Death benefit on bank owned life insurance		—			—			145			—
Other income		138			(31	)		570			598

Total non-interest income		7,186			6,627			14,252			12,149

Non-interest Expense
Salaries and employee benefits		8,385			8,293			16,889			15,776
Net occupancy expenses		1,375			1,360			2,926			2,784
Data processing		966			937			1,889			1,807
Professional fees		660			419			1,187			1,027
Outside services and consultants		918			1,298			1,544			1,959
Loan expense		1,367			1,272			2,624			2,287
FDIC insurance expense		339			285			676			541
Other losses		150			95			105			133
Other expense		2,490			2,449			4,878			4,608

Total non-interest expense		16,650			16,408			32,718			30,922

Income Before Income Tax		6,480			6,668			13,750			10,948
Income tax expense (includes $0 for the three months ended and $43 for the six months ended June 30, 2015 and $0 for the three and six months ended June 30, 2014, related to income tax expense from reclassification items)		1,752			1,890			3,664			2,753

Net Income		4,728			4,778			10,086			8,195
Preferred stock dividend		(31	)		(32	)		(63	)		(63	)

Net Income Available to Common Shareholders	$	4,697		$	4,746		$	10,023		$	8,132

Basic Earnings Per Share	$	0.51		$	0.52		$	1.09		$	0.91
Diluted Earnings Per Share		0.49			0.50			1.04			0.88

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)


	Three Months Ended June 30						Six Months Ended June 30
	2015			2014			2015			2014
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

Net Income	$	4,728		$	4,778		$	10,086		$	8,195

Other Comprehensive Income
Change in fair value of derivative instruments:
Change in fair value of derivative instruments for the period		511			(317	)		182			(542	)
Income tax effect		(179	)		111			(64	)		190

Changes from derivative instruments		332			(206	)		118			(352	)

Change in securities available-for-sale:
Unrealized appreciation (depreciation) for the period on AFS securities		(2,364	)		2,336			(650	)		6,762
Unrealized depreciation for the period on held-to-maturity		(158	)		(108	)		(272	)		(108	)
Reclassification adjustment for securities gains realized in income		—			—			124			—
Income tax effect		882			(779	)		279			(2,329	)

Unrealized gains (losses) on available-for-sale securities		(1,640	)		1,449			(519	)		4,325

Other Comprehensive Income (Loss), Net of Tax		(1,308	)		1,243			(401	)		3,973

Comprehensive Income	$	3,420		$	6,021		$	9,685		$	12,168

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

(Dollar Amounts in Thousands, Except Per Share Data)


	Preferred Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances, January 1, 2015	$	12,500	$	45,916	$	134,477		$	1,521		$	194,414
Net income						10,086						10,086
Other comprehensive income, net of tax									(401	)		(401	)
Amortization of unearned compensation				179								179
Exercise of stock options				290								290
Tax benefit related to stock options				99								99
Stock option expense				138								138
Cash dividends on preferred stock (1.00%)						(63	)					(63	)
Cash dividends on common stock ($.28 per share)						(2,611	)					(2,611	)

Balances, June 30, 2015	$	12,500	$	46,622	$	141,889		$	1,120		$	202,131

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)


	Six Months Ended June 30
	2015			2014
	(Unaudited)			(Unaudited)
Operating Activities
Net income	$	10,086		$	8,195
Items not requiring (providing) cash
Provision for loan losses		2,520			339
Depreciation and amortization		1,883			1,805
Share based compensation		138			87
Mortgage servicing rights net (recovery) impairment		356			(38	)
Premium amortization on securities available for sale, net		1,289			1,132
Gain on sale of investment securities		(124	)		—
Gain on sale of mortgage loans		(5,021	)		(3,948	)
Proceeds from sales of loans		155,746			93,991
Loans originated for sale		(152,259	)		(94,048	)
Change in cash value of life insurance		(515	)		(485	)
Gain on sale of other real estate owned		(206	)		(173	)
Net change in
Interest receivable		(577	)		(432	)
Interest payable		(36	)		(50	)
Other assets		4,099			702
Other liabilities		(1,511	)		(1,190	)

Net cash provided by operating activities		15,868			5,887

Investing Activities
Purchases of securities available for sale		(47,958	)		(52,484	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale		40,359			35,828
Purchases of securities held to maturity		—			(4,839	)
Proceeds from maturities of securities held to maturity		1,535			7,900
Purchase of Federal Reserve Bank stock		—			(6	)
Proceeds from the sale of FHLB stock		268			—
Net change in loans		(142,131	)		(130,424	)
Proceeds on the sale of OREO and repossessed assets		1,793			2,095
Purchases of premises and equipment		(3,587	)		(3,326	)
Acquisition of SCB		—			7,925
Purchase of Mortgage Company		—			(736	)

Net cash used in investing activities		(149,721	)		(138,067	)

Financing Activities
Net change in
Deposits		102,404			86,564
Borrowings		34,115			66,993
Proceeds from issuance of stock		389			—
Dividends paid on common shares		(2,611	)		(2,231	)
Dividends paid on preferred shares		(63	)		(63	)

Net cash provided by financing activities		134,234			151,263

Net Change in Cash and Cash Equivalents		381			19,083
Cash and Cash Equivalents, Beginning of Period		43,476			31,721

Cash and Cash Equivalents, End of Period	$	43,857		$	50,804

Additional Supplemental Information
Interest paid	$	6,519		$	6,527
Income taxes paid		3,700			600
Transfer of loans to other real estate owned		(1,384	)		1,999
Transfer of available-for-sale securities to held-to-maturity		—			167,047
The Company purchased all of the capital stock of Summit for $18,896. In conjunction with the acquisition, liabilities were assumed as follows:		—			158,585
Fair value of assets acquired		—			6,207
Cash paid to retire Summit debt		—			1,029
Cash paid for the capital stock		—			138,660

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 1 - Accounting Policies

The accompanying unaudited condensed consolidated financial statements include the accounts of Horizon Bancorp (“Horizon” or the “Company”) and its wholly-owned subsidiaries, including Horizon Bank, N.A. (“Bank”). All inter-company balances and transactions have been eliminated. The results of operations for the periods ended June 30, 2015 and June 30, 2014 are not necessarily indicative of the operating results for the full year of 2015 or 2014. The accompanying unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of Horizon’s management, necessary to fairly present the financial position, results of operations and cash flows of Horizon for the periods presented. Those adjustments consist only of normal recurring adjustments.

Certain information and note disclosures normally included in Horizon’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Horizon’s Annual Report on Form 10-K for 2014 filed with the Securities and Exchange Commission on March 13, 2015. The condensed consolidated balance sheet of Horizon as of December 31, 2014 has been derived from the audited balance sheet as of that date.

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


	Three Months Ended June 30				Six Months Ended June 30
	2015		2014		2015		2014
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Basic earnings per share
Net income	$	4,728	$	4,778	$	10,086	$	8,195
Less: Preferred stock dividends		31		32		63		63

Net income available to common shareholders	$	4,697	$	4,746	$	10,023	$	8,132

Weighted average common shares outstanding		9,240,005		9,182,986		9,228,075		8,908,492

Basic earnings per share	$	0.51	$	0.52	$	1.09	$	0.91


Diluted earnings per share
Net income available to common shareholders	$	4,697	$	4,746	$	10,023	$	8,132

Weighted average common shares outstanding		9,240,005		9,182,986		9,228,075		8,908,492
Effect of dilutive securities:
Warrants		324,698		303,399		323,198		308,060
Restricted stock		34,892		38,003		30,816		38,717
Stock options		37,991		36,551		33,462		38,154

Weighted average shares outstanding		9,637,586		9,560,939		9,615,551		9,293,423

Diluted earnings per share	$	0.49	$	0.50	$	1.04	$	0.88

There were 2,500 and 41,444 shares for the three and six months ended June 30, 2015, respectively, and 45,766 shares for both the three and six months ended June 30, 2014 which were not included in the computation of diluted earnings per share because they were non-dilutive.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Horizon has share-based employee compensation plans, which are described in the notes to the financial statements included in the December 31, 2014 Annual Report on Form 10-K.

Reclassifications

Certain reclassifications have been made to the 2014 condensed consolidated financial statements to be comparable to 2015. These reclassifications had no effect on net income.

Note 2 – Acquisitions

On February 18, 2015, Horizon entered into an Agreement and Plan of Merger (the “Merger Agreement”) providing for Horizon’s acquisition of Peoples Bancorp, Inc., an Indiana corporation (“Peoples”). Pursuant to the Merger Agreement, Peoples would merge with and into Horizon, with Horizon surviving the merger (the “Merger”), and Peoples Federal Savings Bank of DeKalb County (“Peoples FSB”), a federally chartered stock savings bank and wholly owned subsidiary of Peoples, would merge with and into a wholly owned subsidiary of Horizon, Horizon Bank, N.A. (“Horizon Bank”), with Horizon Bank as the surviving bank.

On July 1, 2015 Horizon completed the acquisition of Peoples and Horizon Bank N.A.’s acquisition of Peoples FSB, through mergers effective July 1, 2015. Under the terms of the acquisition, the exchange ratio was 0.95 shares of Horizon common stock (the “Exchange Ratio”) and $9.75 in cash for each outstanding share of Peoples common stock. Peoples shareholders owning fewer than 100 shares of common stock received $33.14 in cash for each common share. Peoples shares outstanding at the closing were 2,311,858, and the shares of Horizon common stock issued to Peoples shareholders totaled 2,192,202. Horizon’s stock price was $25.32 per share at the close of business on July 1, 2015. Based upon these numbers, the total value of the consideration for the acquisition was $78.1 million.

As of July 1, 2015, Peoples had total assets of approximately $462.7 million, total deposits of approximately $350.6 million and total net loans of approximately $226.6 million.

Utilizing June 30, 2015 financials for both Horizon and Peoples and an estimate of the fair market value adjustments associated with the merger, Horizon would have total assets of approximately $2.7 billion, total deposits of approximately $1.9 billion and total net loans of approximately $1.7 billion on a pro forma basis. The accounting for the business combination is not yet complete and therefore all required disclosures for a business combination have not been provided.

On April 3, 2014 Horizon closed its acquisition of SCB Bancorp, Inc. (“Summit”) and Horizon Bank N.A.’s acquisition of Summit Community Bank, through mergers effective as of that date. Under the final terms of the acquisition, the exchange ratio was 0.4904 shares of Horizon’s common stock and $5.15 in cash for each share of Summit common stock outstanding. Summit shares outstanding at the closing were 1,164,442, and the shares of Horizon common stock issued to Summit shareholders totaled 570,820. Horizon’s stock price was $22.23 per share at the close of business on April 3, 2014. Based upon these numbers, the total value of the consideration for the acquisition was $18.9 million (not including the retirement of Summit debt). The Company had approximately $1.3 million in costs related to the acquisition. These expenses are classified in the other expense section of the income statement and primarily located in the salaries and employee benefits, professional services and other expense line items. As a result of the acquisition, the Company will have an opportunity to increase its deposit base and reduce transaction costs. The Company also expects to reduce cost through economies of scale.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


ASSETS			LIABILITIES
Cash and due from banks	$	15,161	Deposits
			Non-interest bearing	$	27,274
Commercial		70,441	NOW accounts		16,332
Residential mortgage		43,448	Savings and money market		35,045
Consumer		10,192	Certificates of deposits		42,368

Total loans		124,081	Total deposits		121,019

Premises and equipment, net		2,548	Borrowings		16,990
FRB and FHLB stock		2,136	Interest payable		52
Goodwill		8,428	Other liabilities		599
Core deposit intangible		822
Interest receivable		347
Cash value of life insurance		2,185
Other assets		2,877

Total assets purchased	$	158,585	Total liabilities assumed	$	138,660


Common shares issued	$	12,689
Cash paid		6,207
Retirement of Holding Company Debt		1,029

Total estimated purchase price	$	19,925

Of the total estimated purchase price of $19.9 million, $822,000 has been allocated to core deposit intangible. Additionally, $8.4 million has been allocated to goodwill and $4.4 million of the purchase price is deductible and was assigned to the business assets. The core deposit intangible will be amortized over seven years on a straight line basis.

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

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

The Company acquired the $130.5 million loan portfolio at a fair value discount of $6.4 million. The performing portion of the portfolio, $106.2 million, had an estimated fair value of $104.6 million. The excess of expected cash flows above the fair value of the performing portion of loans will be accreted to interest income over the remaining lives of the loans in accordance with ASC 310-20.

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The following table details the acquired loans that are accounted for in accordance with ASC 310-30 as of April 3, 2014.


Contractually required principal and interest at acquisition	$	14,460
Contractual cash flows not expected to be collected (nonaccretable differences)		3,146

Expected cash flows at acquisition		11,314
Interest component of expected cash flows (accretable discount)		1,688

Fair value of acquired loans accounted for under ASC 310-30	$	9,626

Pro-forma statements were not presented due to the materiality of the transaction.

Note 3 – Securities

The fair value of securities is as follows:


June 30, 2015	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Treasury and federal agencies	$	28,308	$	35	$	(104	)	$	28,239
State and municipal		49,739		1,212		(168	)		50,783
Federal agency collateralized mortgage obligations		116,674		973		(705	)		116,942
Federal agency mortgage-backed pools		132,762		2,661		(473	)		134,950
Corporate notes		32		24		—			56

Total available for sale investment securities	$	327,515	$	4,905	$	(1,450	)	$	330,970


Held to maturity
U.S. Treasury and federal agencies	$	9,845	$	102	$	—		$	9,947
State and municipal		127,452		4,416		(511	)		131,357
Federal agency collateralized mortgage obligations		3,670		33		(22	)		3,681
Federal agency mortgage-backed pools		21,694		1,064		(162	)		22,596

Total held to maturity investment securities	$	162,661	$	5,615	$	(695	)	$	167,581


December 31, 2014	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Treasury and federal agencies	$	26,996	$	56	$	(229	)	$	26,823
State and municipal		46,535		1,462		(45	)		47,952
Federal agency collateralized mortgage obligations		122,930		975		(1,045	)		122,860
Federal agency mortgage-backed pools		122,583		3,172		(360	)		125,395
Private labeled mortgage-backed pools		670		19		—			689
Corporate notes		32		13		—			45

Total available for sale investment securities	$	319,746	$	5,697	$	(1,679	)	$	323,764


Held to maturity
U.S. Treasury and federal agencies	$	9,804	$	82	$	—		$	9,886
State and municipal		129,595		3,398		(106	)		132,887
Federal agency collateralized mortgage obligations		4,039		35		(1	)		4,073
Federal agency mortgage-backed pools		22,329		729		—			23,058

Total held to maturity investment securities	$	165,767	$	4,244	$	(107	)	$	169,904

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified. At June 30, 2015, no individual investment security had an unrealized loss that was determined to be other-than-temporary.

The unrealized losses on the Company’s investments in securities of state and municipal governmental agencies, U.S. Treasury and federal agencies, federal agency collateralized mortgage obligations, and federal agency mortgage-backed pools were caused by interest rate volatility and not a decline in credit quality. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. The Company expects to recover the amortized cost basis over the term of the securities. Because the Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider those investments to be other-than-temporarily impaired at June 30, 2015.

The Company elected to transfer 319 available-for-sale (“AFS”) securities with an aggregate fair value of $167.1 million to a classification of held-to-maturity (“HTM”) on April 1, 2014. In accordance with FASB ASC 320-10-55-24, the transfer from AFS to HTM must be recorded at the fair value of the AFS securities at the time of transfer. The net unrealized holding gain of $1.3 million, net of tax, at the date of transfer was retained in accumulated other comprehensive income, with the associated pre-tax amount retained in the carrying value of the HTM securities. Such amounts will be amortized to comprehensive income over the remaining life of the securities. The fair value of the transferred AFS securities became the book value of the HTM securities at April 1, 2014, with no unrealized gain or loss at this date. Future reporting periods, with potential changes in market value for these securities, would likely record an unrealized gain or loss for disclosure purposes.

The amortized cost and fair value of securities available for sale and held to maturity at June 30, 2015 and December 31, 2014, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


	June 30, 2015				December 31, 2014
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Available for sale
Within one year	$	6,436	$	6,477	$	6,098	$	6,169
One to five years		50,332		51,057		44,720		45,093
Five to ten years		15,380		15,571		16,147		16,768
After ten years		5,931		5,973		6,598		6,790

		78,079		79,078		73,563		74,820
Federal agency collateralized mortgage obligations		116,674		116,942		122,930		122,860
Federal agency mortgage-backed pools		132,762		134,950		122,583		125,395
Private labeled mortgage-backed pools		—		—		670		689

Total available for sale investment securities	$	327,515	$	330,970	$	319,746	$	323,764


Held to maturity
Within one year	$	—	$	—	$	—	$	—
One to five years		8,184		8,319		592		593
Five to ten years		101,504		105,071		99,225		101,323
After ten years		27,609		27,914		39,582		40,857

		137,297		141,304		139,399		142,773
Federal agency collateralized mortgage obligations		3,670		3,681		4,039		4,073
Federal agency mortgage-backed pools		21,694		22,596		22,329		23,058

Total held to maturity investment securities	$	162,661	$	167,581	$	165,767	$	169,904

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


	Less than 12 Months					12 Months or More					Total
June 30, 2015	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

U.S. Treasury and federal agencies	$	4,469	$	(14	)	$	13,897	$	(90	)	$	18,366	$	(104	)
State and municipal		38,471		(667	)		1,249		(12	)		39,720		(679	)
Federal agency collateralized mortgage obligations		24,435		(170	)		28,098		(557	)		52,533		(727	)
Federal agency mortgage-backed pools		23,044		(208	)		26,017		(427	)		49,061		(635	)

Total temporarily impaired securities	$	90,419	$	(1,059	)	$	69,261	$	(1,086	)	$	159,680	$	(2,145	)


	Less than 12 Months					12 Months or More					Total
December 31, 2014	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

U.S. Treasury and federal agencies	$	2,993	$	(7	)	$	20,762	$	(222	)	$	23,755	$	(229	)
State and municipal		10,287		(121	)		2,050		(30	)		12,337		(151	)
Federal agency collateralized mortgage obligations		15,013		(88	)		39,801		(957	)		54,814		(1,045	)
Federal agency mortgage-backed pools		5,993		(9	)		28,044		(351	)		34,037		(360	)

Total temporarily impaired securities	$	34,286	$	(225	)	$	90,657	$	(1,560	)	$	124,943	$	(1,785	)

Three Months Ended June 30

Six Months Ended June 30

2015

2014

2015

2014

Sales of securities available for sale (Unaudited)

Proceeds

—

13,332

—

Gross gains

—

147

—

Gross losses

—

(23

)

—

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 4 – Loans


	June 30 2015			December 31 2014
Commercial
Working capital and equipment	$	323,709		$	300,940
Real estate, including agriculture		353,859			343,455
Tax exempt		8,665			8,595
Other		23,713			21,324

Total		709,946			674,314

Real estate
1–4 family		273,753			250,799
Other		3,654			3,826

Total		277,407			254,625

Consumer
Auto		166,501			154,538
Recreation		5,676			5,673
Real estate/home improvement		41,309			38,288
Home equity		112,095			112,426
Unsecured		3,711			3,613
Other		6,714			5,921

Total		336,006			320,459

Mortgage warehouse		195,924			129,156

Total loans		1,519,283			1,378,554
Allowance for loan losses		(16,421	)		(16,501	)

Loans, net	$	1,502,862		$	1,362,053

Commercial

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

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves larger loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets, the general economy or fluctuations in interest rates. The properties securing the Company’s commercial real estate portfolio are diverse in terms of property type, and are monitored for concentrations of credit. Management monitors and evaluates commercial real estate loans based on collateral, cash flow and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Real Estate and Consumer

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

Mortgage Warehousing

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


June 30, 2015	Loan Balance			Interest Due		Deferred Fees / (Costs)			Recorded Investment
Owner occupied real estate	$	238,883		$	471	$	611		$	239,965
Non owner occupied real estate		313,871			326		488			314,685
Residential spec homes		2,606			2		18			2,626
Development & spec land loans		13,593			32		27			13,652
Commercial and industrial		139,823			802		26			140,651

Total commercial		708,776			1,633		1,170			711,579

Residential mortgage		257,795			816		525			259,136
Residential construction		19,087			34		—			19,121
Mortgage warehouse		195,924			480		—			196,404

Total real estate		472,806			1,330		525			474,661

Direct installment		44,119			138		(398	)		43,859
Direct installment purchased		179			—		—			179
Indirect installment		152,268			313		—			152,581
Home equity		140,316			555		(478	)		140,393

Total consumer		336,882			1,006		(876	)		337,012

Total loans		1,518,464			3,969		819			1,523,252
Allowance for loan losses		(16,421	)		—		—			(16,421	)

Net loans	$	1,502,043		$	3,969	$	819		$	1,506,831


December 31, 2014	Loan Balance			Interest Due		Deferred Fees / (Costs)			Recorded Investment
Owner occupied real estate	$	228,380		$	385	$	680		$	229,445
Non owner occupied real estate		297,299			309		506			298,114
Residential spec homes		2,027			2		—			2,029
Development & spec land loans		12,097			28		30			12,155
Commercial and industrial		133,256			859		39			134,154

Total commercial		673,059			1,583		1,255			675,897

Residential mortgage		242,521			737		599			243,857
Residential construction		11,505			21		—			11,526
Mortgage warehouse		129,156			480		—			129,636

Total real estate		383,182			1,238		599			385,019

Direct installment		40,137			129		(375	)		39,891
Direct installment purchased		219			—		—			219
Indirect installment		141,868			314		(163	)		142,019
Home equity		139,007			568		(234	)		139,341

Total consumer		321,231			1,011		(772	)		321,470

Total loans		1,377,472			3,832		1,082			1,382,386
Allowance for loan losses		(16,501	)		—		—			(16,501	)

Net loans	$	1,360,971		$	3,832	$	1,082		$	1,365,885

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 5 – Accounting for Certain Loans Acquired in a Transfer

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

The carrying amounts of those loans included in the balance sheet amounts of loans receivable are as follows:


	June 30 2015 Heartland		June 30 2015 Summit		June 30 2015 Total
Commercial		14,586		55,822	$	70,408
Real estate		8,284		20,617		28,901
Consumer		6,243		7,009		13,252

Outstanding balance	$	29,113	$	83,448	$	112,561

Carrying amount, net of allowance of $283					$	112,278


	December 31 2014 Heartland		December 31 2014 Summit		December 31 2014 Total
Commercial	$	18,307	$	66,371	$	84,678
Real estate		9,734		24,653		34,387
Consumer		8,447		8,975		17,422

Outstanding balance	$	36,488	$	99,999	$	136,487

Carrying amount, net of allowance of $359					$	136,128

Accretable yield, or income expected to be collected for the six months ended June 30, is as follows:


	Six Months Ended June 30, 2015
	Heartland			Summit			Total
Balance at January 1	$	2,400		$	1,268		$	3,668
Additions		—			—			—
Accretion		(205	)		(180	)		(385	)
Reclassification from nonaccretable difference		—			—			—
Disposals		(117	)		(49	)		(166	)

Balance at June 30	$	2,078		$	1,039		$	3,117


	Six Months Ended June 30, 2014
	Heartland			Summit		Total
Balance at January 1	$	3,185		$	—	$	3,185
Additions		—			1,758		1,758
Accretion		(288	)		—		(288	)
Reclassification from nonaccretable difference		—			—		—
Disposals		(95	)		—		(95	)

Balance at June 30	$	2,802		$	1,758	$	4,560

During the six months ended June 30, 2015 and 2014, the Company decreased the allowance for loan losses on purchased loans by a recovery to the income statement of $76,000 and $0, respectively.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 6 – Allowance for Loan Losses

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


	Three Months Ended June 30						Six Months Ended June 30
	2015			2014			2015			2014
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Balance at beginning of the period	$	16,634		$	16,102		$	16,501		$	15,992
Loans charged-off:
Commercial
Owner occupied real estate		1,422			—			1,422			—
Non owner occupied real estate		—			—			16			22
Residential development		—			—			—			—
Development & Spec Land Loans		—			166			—			173
Commercial and industrial		253			127			253			127

Total commercial		1,675			293			1,691			322
Real estate
Residential mortgage		164			172			186			194
Residential construction		—			—			—			—
Mortgage warehouse		—			—			—			—

Total real estate		164			172			186			194
Consumer
Direct Installment		96			44			155			77
Direct Installment Purchased		—			—			—			—
Indirect Installment		196			341			565			568
Home Equity		304			247			504			431

Total consumer		596			632			1,224			1,076

Total loans charged-off		2,435			1,097			3,101			1,592

Recoveries of loans previously charged-off:
Commercial
Owner occupied real estate		78			2			86			6
Non owner occupied real estate		—			74			—			75
Residential development		—			—			—			—
Development & Spec Land Loans		—			—			—			—
Commercial and industrial		14			32			33			417

Total commercial		92			108			119			498
Real estate
Residential mortgage		3			3			5			7
Residential construction		—			—			—			—
Mortgage warehouse		—			—			—			—

Total real estate		3			3			5			7
Consumer
Direct Installment		47			21			76			39
Direct Installment Purchased		—			—			—			—
Indirect Installment		134			147			235			266
Home Equity		40			37			66			111

Total consumer		221			205			377			416

Total loan recoveries		316			316			501			921

Net loans charged-off (recovered)		2,119			781			2,600			671

Provision charged to operating expense
Commercial		2,093			(93	)		2,048			119
Real estate		(29	)		(383	)		904			(987	)
Consumer		(158	)		815			(432	)		1,207

Total provision charged to operating expense		1,906			339			2,520			339

Balance at the end of the period	$	16,421		$	15,660		$	16,421		$	15,660

Certain loans are individually evaluated for impairment, and the Company’s general practice is to proactively charge down impaired loans to the fair value of the underlying collateral.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

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

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

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


June 30, 2015	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,291	$	—	$	—	$	—	$	1,291
Collectively evaluated for impairment		6,841		3,044		1,319		3,672		14,876
Loans acquired with deteriorated credit quality		254		—		—		—		254

Total ending allowance balance	$	8,386	$	3,044	$	1,319	$	3,672	$	16,421


Loans:
Individually evaluated for impairment	$	10,274	$	—	$	—	$	—	$	10,274
Collectively evaluated for impairment		699,576		278,257		196,404		337,012		1,511,249
Loans acquired with deteriorated credit quality		1,729		—		—		—		1,729

Total ending loans balance	$	711,579	$	278,257	$	196,404	$	337,012	$	1,523,252


December 31, 2014	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,589	$	—	$	—	$	—	$	1,589
Collectively evaluated for impairment		5,827		2,508		1,132		4,951		14,418
Loans acquired with deteriorated credit quality		494		—		—		—		494

Total ending allowance balance	$	7,910	$	2,508	$	1,132	$	4,951	$	16,501


Loans:
Individually evaluated for impairment	$	11,055	$	—	$	—	$	—	$	11,055
Collectively evaluated for impairment		664,251		255,383		129,636		321,470		1,370,740
Loans acquired with deteriorated credit quality		591		—		—		—		591

Total ending loans balance	$	675,897	$	255,383	$	129,636	$	321,470	$	1,382,386

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 7 – Non-performing Loans and Impaired Loans

The following table presents the non-accrual, loans past due over 90 days still on accrual, and troubled debt restructured (“TDRs”) by class of loans:


June 30, 2015	Non-accrual		Loans Past Due Over 90 Days Still Accruing		Non- Performing TDRs		Performing TDRs		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	4,447	$	—	$	—	$	150	$	4,597
Non owner occupied real estate		4,898		207		2,352		68		7,525
Residential development		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—
Commercial and industrial		477		—		785		—		1,262

Total commercial		9,822		207		3,137		218		13,384

Real estate
Residential mortgage		2,319		—		760		2,482		5,561
Residential construction		—		—		258		—		258
Mortgage warehouse		—		—		—		—		—

Total real estate		2,319		—		1,018		2,482		5,819

Consumer
Direct Installment		447		—		—		—		447
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		405		—		—		—		405
Home Equity		2,057		—		368		571		2,996

Total Consumer		2,909		—		368		571		3,848

Total	$	15,050	$	207	$	4,523	$	3,271	$	23,051


December 31, 2014	Non-accrual		Loans Past Due Over 90 Days Still Accruing		Non- Performing TDRs		Performing TDRs		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	1,773	$	—	$	—	$	44	$	1,817
Non owner occupied real estate		7,439		—		217		566		8,222
Residential development		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—
Commercial and industrial		812		—		1,004		—		1,816

Total commercial		10,024		—		1,221		610		11,855

Real estate
Residential mortgage		2,297		40		765		2,526		5,628
Residential construction		—		—		266		—		266
Mortgage warehouse		—		—		—		—		—

Total real estate		2,297		40		1,031		2,526		5,894

Consumer
Direct Installment		227		10		—		—		237
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		557		47		—		—		604
Home Equity		2,207		18		391		1,236		3,852

Total Consumer		2,991		75		391		1,236		4,693

Total	$	15,312	$	115	$	2,643	$	4,372	$	22,442

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Included in the $15.1 million of non-accrual loans and the $4.5 million of non-performing TDRs at June 30, 2015 were $679,000 and $302,000, respectively, of loans acquired for which accretable yield was recognized.

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

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

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

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

The Company’s TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At June 30, 2015, the type of concessions the Company has made on restructured loans has been temporary rate reductions and/or reductions in monthly payments and there have been no restructured loans with modified recorded balances. Any modification to a loan that is a concession and is not in the normal course of lending is considered a restructured loan. A restructured loan is returned to accruing status after six consecutive payments but is still reported as TDR unless the loan bears interest at a market rate. As of June 30, 2015, the Company had $7.8 million in TDRs and $3.3 million were performing according to the restructured terms and four TDR were returned to accrual status during the first six months of 2015. There was $792,000 of specific reserves allocated to TDRs at June 30, 2015 based on the discounted cash flows or when appropriate the fair value of the collateral.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Loans transferred and classified as troubled debt restructuring during the three and six months ended June 30, 2015 and 2014, segregated by class, are shown in the table below.


	Three Months Ending June 30, 2015				Three Months Ending June 30, 2014				Six Months Ending June 30, 2015				Six Months Ending June 30, 2014
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		2	$	111		—	$	—		3	$	2,462		—	$	—
Non owner occupied real estate		—		—		—		—		—		—		—		—
Residential development		—		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—		2		371

Total commercial		2		111		—		—		3		2,462		2		371

Real estate
Residential mortgage		1		81		1		226		1		81		1		226
Residential construction		—		—		—		—		—		—		—		—
Mortgage warehouse		—		—		—		—		—		—		—		—

Total real estate		1		81		1		226		1		81		1		226

Consumer
Direct Installment		—		—		—		—		—		—		—		—
Direct Installment Purchased		—		—		—		—		—		—		—		—
Indirect Installment		—		—		—		—		—		—		—		—
Home Equity		—		—		1		51		1		32		2		196

Total Consumer		—		—		1		51		1		32		2		196
		—		—						—		—

Total		3	$	192		2	$	277		5	$	2,575		5	$	793

Troubled debt restructured loans which had payment defaults during the three and six months ended June 30, 2015 and 2014, segregated by class, are shown in the table below. Default occurs when a loan is 90 days or more past due or has been transferred to non-accrual.


	Three Months Ending June 30, 2015				Three Months Ending June 30, 2014				Six Months Ending June 30, 2015				Six Months Ending June 30, 2014
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		—	$	—		—	$	—		1	$	2,352		—	$	—
Non owner occupied real estate		—		—		—		—		—		—		—		—
Residential development		—		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—		2		371

Total commercial		—		—		—		—		1		2,352		2		371

Real estate
Residential mortgage		1		81		1		223		1		81		2		377
Residential construction		—		—		—		—		—		—		—		—
Mortgage warehouse		—		—		—		—		—		—		—		—

Total real estate		1		81		1		223		1		81		2		377

Consumer
Direct Installment		—		—		—		—		—		—		—		—
Direct Installment Purchased		—		—		—		—		—		—		—		—
Indirect Installment		—		—		—		—		—		—		—		—
Home Equity		1		32		1		51		1		32		2		196

Total Consumer		1		32		1		51		1		32		2		196
		—		—						—		—

Total		2	$	113		2	$	274		3	$	2,465		6	$	944

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


							Three Months Ending				Six Months Ending
June 30, 2015	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans		Cash/Accrual Interest Income Recognized		Average Balance in Impaired Loans		Cash/Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	1,605	$	1,606	$	—	$	1,350	$	17	$	1,118	$	17
Non owner occupied real estate		2,820		2,824		—		3,168		7		3,270		14
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		379		379		—		639		—		599		—

Total commercial		4,804		4,809		—		5,157		24		4,987		31

With an allowance recorded
Commercial
Owner occupied real estate		2,991		2,991		593		4,366		54		1,992		54
Non owner occupied real estate		1,590		1,590		200		1,590		—		1,590		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		884		884		498		1,008		—		974		—

Total commercial		5,465		5,465		1,291		6,964		54		4,556		54

Total	$	10,269	$	10,274	$	1,291	$	12,121	$	78	$	9,543	$	85


							Three Months Ending				Six Months Ending
June 30, 2014	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans		Cash/Accrual Interest Income Recognized		Average Balance in Impaired Loans		Cash/Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	2,121	$	2,124	$	—	$	1,885	$	40	$	1,432	$	51
Non owner occupied real estate		3,244		3,246		—		3,270		93		3,283		98
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		283		283		—		441		—		466		—

Total commercial		5,648		5,653		—		5,596		133		5,181		149

With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		—		—		—		—
Non owner occupied real estate		340		340		170		342		—		347		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		1,722		1,722		965		1,710		—		1,570		2

Total commercial		2,062		2,062		1,135		2,052		—		1,917		2

Total	$	7,710	$	7,715	$	1,135	$	7,648	$	133	$	7,098	$	151

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


June 30, 2015	30 - 59 Days Past Due			60 - 89 Days Past Due			Greater than 90 Days Past Due			Total Past Due			Loans Not Past Due			Total
Commercial
Owner occupied real estate	$	157		$	21		$	—		$	178		$	238,705		$	238,883
Non owner occupied real estate		82			—			207			289			313,582			313,871
Residential development		—			—			—			—			2,606			2,606
Development & Spec Land Loans		—			—			—			—			13,593			13,593
Commercial and industrial		591			46			—			637			139,186			139,823

Total commercial		830			67			207			1,104			707,672			708,776

Real estate
Residential mortgage		308			147			—			455			257,340			257,795
Residential construction		—			—			—			—			19,087			19,087
Mortgage warehouse		—			—			—			—			195,924			195,924

Total real estate		308			147			—			455			472,351			472,806

Consumer
Direct Installment		138			41			—			179			43,940			44,119
Direct Installment Purchased		—			—			—			—			179			179
Indirect Installment		721			130			—			851			151,417			152,268
Home Equity		699			245			—			944			139,372			140,316

Total consumer		1,558			416			—			1,974			334,908			336,882

Total	$	2,696		$	630		$	207		$	3,533		$	1,514,931		$	1,518,464

Percentage of total loans		0.18	%		0.04	%		0.01	%		0.23	%		99.77	%


December 31, 2014	30 - 59 Days Past Due			60 - 89 Days Past Due			Greater than 90 Days Past Due			Total Past Due			Loans Not Past Due			Total
Commercial
Owner occupied real estate	$	103		$	645		$	—		$	748		$	227,632		$	228,380
Non owner occupied real estate		413			—			—			413			296,886			297,299
Residential development		—			—			—			—			2,027			2,027
Development & Spec Land Loans		—			—			—			—			12,097			12,097
Commercial and industrial		19			1			—			20			133,236			133,256

Total commercial		535			646			—			1,181			671,878			673,059

Real estate
Residential mortgage		1,033			193			40			1,266			241,255			242,521
Residential construction		—			—			—			—			11,505			11,505
Mortgage warehouse		—			—			—			—			129,156			129,156

Total real estate		1,033			193			40			1,266			381,916			383,182

Consumer
Direct Installment		113			4			10			127			40,010			40,137
Direct Installment Purchased		—			—			—			—			219			219
Indirect Installment		1,042			243			47			1,332			140,536			141,868
Home Equity		1,084			189			18			1,291			137,716			139,007

Total consumer		2,239			436			75			2,750			318,481			321,231

Total	$	3,807		$	1,275		$	115		$	5,197		$	1,372,275		$	1,377,472

Percentage of total loans		0.28	%		0.09	%		0.01	%		0.38	%		99.62	%

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

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

•

For new and renewed commercial loans, the Bank’s Credit Department, which acts independently of the loan officer, assigns the credit quality grade to the loan. Loan grades for loans with an aggregate credit exposure that exceeds the authorities in the respective markets (ranging from $1,000,000 to $2,500,000) are validated by the Loan Committee, which is chaired by the Chief Credit Officer (CCO).

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

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

•

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

•

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

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

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

Risk Grade 1: Excellent (Pass)

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

Risk Grade 2: Good (Pass)

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

Risk Grade 3: Satisfactory (Pass)

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

•

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

•

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

•

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

•

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

Risk Grade 4 Satisfactory/Monitored:

Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans. Borrower displays acceptable liquidity, leverage, and earnings performance within the Bank’s minimum underwriting guidelines. The level of risk is acceptable but conditioned on the proper level of loan officer supervision. Loans that normally fall into this grade include acquisition, construction and development loans and income producing properties that have not reached stabilization.

Risk Grade 4W Management Watch:

Loans in this category are considered to be of acceptable quality, but with above normal risk. Borrower displays potential indicators of weakness in the primary source of repayment resulting in a higher reliance on secondary sources of repayment. Balance sheet may exhibit weak liquidity and/or high leverage. There is inconsistent earnings performance without the ability to sustain adverse economic conditions. Borrower may be operating in a declining industry or the property type, as for a commercial real estate loan, may be high risk or in decline. These loans require an increased level of loan officer supervision and monitoring to assure that any deterioration is addressed in a timely fashion.

Risk Grade 5: Special Mention

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

Risk Grade 6: Substandard

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

•

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

•

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

•

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

Risk Grade 7: Doubtful

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

•

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

•

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

•

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

Risk Grade 8: Loss

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The following table presents loans by credit grades.


June 30, 2015	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	224,414		$	6,299		$	8,170		$	—		$	238,883
Non owner occupied real estate		303,292			2,442			8,137			—			313,871
Residential development		2,606			—			—			—			2,606
Development & Spec Land Loans		13,520			73			—			—			13,593
Commercial and industrial		136,586			991			2,246			—			139,823

Total commercial		680,416			9,805			18,553			—			708,776

Real estate
Residential mortgage		252,234			—			5,561			—			257,795
Residential construction		18,829			—			258			—			19,087
Mortgage warehouse		195,924			—			—			—			195,924

Total real estate		466,987			—			5,819			—			472,806

Consumer
Direct Installment		43,672			—			447			—			44,119
Direct Installment Purchased		179			—			—			—			179
Indirect Installment		151,863			—			405			—			152,268
Home Equity		137,320			—			2,996			—			140,316

Total Consumer		333,034			—			3,848			—			336,882

Total	$	1,480,437		$	9,805		$	28,220		$	—		$	1,518,464

Percentage of total loans		97.50	%		0.65	%		1.86	%		0.00	%


December 31, 2014	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	215,875		$	7,623		$	4,883		$	—		$	228,381
Non owner occupied real estate		283,518			4,458			9,323			—			297,299
Residential development		2,027			—			—			—			2,027
Development & Spec Land Loans		12,018			79			—			—			12,097
Commercial and industrial		128,589			1,799			2,868			—			133,256

Total commercial		642,027			13,959			17,074			—			673,060

Real estate
Residential mortgage		236,893			—			5,628			—			242,521
Residential construction		11,239			—			266			—			11,505
Mortgage warehouse		129,156			—			—			—			129,156

Total real estate		377,288			—			5,894			—			383,182

Consumer
Direct Installment		39,900			—			237			—			40,137
Direct Installment Purchased		219			—			—			—			219
Indirect Installment		141,264			—			604			—			141,868
Home Equity		135,155			—			3,852			—			139,007

Total Consumer		316,538			—			4,693			—			321,231

Total	$	1,335,854		$	13,959		$	27,661		$	—		$	1,377,473

Percentage of total loans		96.98	%		1.01	%		2.01	%		0.00	%

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 8 – Repurchase Agreements

The Company transfers various securities to customers in exchange for cash at the end of each business day and agrees to reaquire the securities at the end of the next business day for the cash exchanged plus interest. The process is repeated at the end of each business day until the agreement is terminated. The securities underlying the agreement remained under the Bank’s control.

The following table shows repurchase agreements accounted for as secured borrowings (in thousands):


	Remaining Contractual Maturity of the Agreements
	Overnight and Continuous			Up to one year		One to three years		Three to five years		Five to ten years			Beyond ten years			Total
Repurchase Agreements and repurchase-to-maturity transactions
Repurchase Agreements - Long-term	$	57,731		$	—	$	35,000	$	50,000	$	10,000		$	—		$	152,731

Securities lending transactions
U.S. Treasury and federal agencies	$	8,468		$	—	$	—	$	—	$	—		$	—		$	8,468
Federal agency collateralized mortgage obligations		41,140			—		87		1,020		7,413			46,412			96,071
Federal agency mortgage-backed pools		10,560			—		—		541		8,574			41,476			61,151

Total		60,168			—		87		1,561		15,987			87,888			165,691

Total borrowings	$	(2,437	)	$	—	$	34,913	$	48,439	$	(5,987	)	$	(87,888	)	$	(12,960	)

Gross amount of recognized liabilities for repurchase agreements and securities lending																$	152,731

Note 9 – Derivative Financial Instruments

Cash Flow Hedges

As a strategy to maintain acceptable levels of exposure to the risk of changes in future cash flow due to interest rate fluctuations, the Company entered into interest rate swap agreements for a portion of its floating rate debt. The agreements provide for the Company to receive interest from the counterparty at three month LIBOR and to pay interest to the counterparty at a weighted average fixed rate of 6.14% on a notional amount of $30.5 million at June 30, 2015 and December 31, 2014. Under the agreements, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense.

Management has designated the interest rate swap agreement as a cash flow hedging instrument. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. At June 30, 2015, the Company’s cash flow hedge was effective and is not expected to have a significant impact on the Company’s net income over the next 12 months.

Fair Value Hedges

Fair value hedges are intended to reduce the interest rate risk associated with the underlying hedged item. The Company enters into fixed rate loan agreements as part of its lending policy. To mitigate the risk of changes in fair value based on fluctuations in interest rates, the Company has entered into interest rate swap agreements on individual loans, converting the fixed rate loans to a variable rate. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current earnings. At June 30, 2015, the Company’s fair value hedges were effective and are not expected to have a significant impact on the Company’s net income over the next 12 months.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The change in fair value of both the hedge instruments and the underlying loan agreements are recorded as gains or losses in interest income. The fair value hedges are considered to be highly effective and any hedge ineffectiveness was deemed not material. The notional amounts of the loan agreements being hedged were $111.7 million at June 30, 2015 and $102.7 million at December 31, 2014.

Other Derivative Instruments

The Company enters into non-hedging derivatives in the form of mortgage loan forward sale commitments with investors and commitments to originate mortgage loans as part of its mortgage banking business. At June 30, 2015, the Company’s fair value of these derivatives were recorded and over the next 12 months are not expected to have a significant impact on the Company’s net income.

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

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


	Asset Derivative June 30, 2015			Liability Derivatives June 30, 2015
Derivatives designated as hedging instruments (Unaudited)	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Interest rate contracts	Loans	$	—	Other liabilities	$	1,022
Interest rate contracts	Other Assets		1,022	Other liabilities		3,155

Total derivatives designated as hedging instruments			1,022			4,177


Derivatives not designated as hedging instruments
Mortgage loan contracts	Other assets		751	Other liabilities		32

Total derivatives not designated as hedging instruments			751			32

Total derivatives		$	1,773		$	4,209


	Asset Derivative December 31, 2014			Liability Derivatives December 31, 2014
Derivatives designated as hedging instruments (Unaudited)	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Interest rate contracts	Loans	$	—	Other liabilities	$	1,208
Interest rate contracts	Other Assets		1,208	Other liabilities		3,339

Total derivatives designated as hedging instruments			1,208			4,547


Derivatives not designated as hedging instruments
Mortgage loan contracts	Other assets		447	Other liabilities		—

Total derivatives not designated as hedging instruments			447			—

Total derivatives		$	1,655		$	4,547

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The effect of the derivative instruments on the condensed consolidated statement of income for the three and six-month periods ending June 30 is as follows:


	Comprehensive Income on Derivative (Effective Portion)					Comprehensive Income on Derivative (Effective Portion)
	Three Months Ended June 30					Six Months Ended June 30
Derivative in cash flow hedging relationship	2015 (Unaudited)		2014 (Unaudited)			2015 (Unaudited)		2014 (Unaudited)
Interest rate contracts	$	332	$	(206	)	$	118	$	(352	)

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


		Amount of Gain (Loss) Recognized on Derivative						Amount of Gain (Loss) Recognized on Derivative
		Three Months Ended June 30						Six Months Ended June 30
Derivative in fair value hedging relationship	Location of gain (loss) recognized on derivative	2015 (Unaudited)			2014 (Unaudited)			2015 (Unaudited)			2014 (Unaudited)
Interest rate contracts	Interest income - loans	$	(1,186	)	$	544		$	(186	)	$	751
Interest rate contracts	Interest income - loans		1,186			(544	)		186			(751	)

Total		$	—		$	—		$	—		$	—


		Amount of Gain (Loss) Recognized on Derivative				Amount of Gain (Loss) Recognized on Derivative
		Three Months Ended June 30				Six Months Ended June 30
Derivative not designated as hedging relationship	Location of gain (loss) recognized on derivative	2015 (Unaudited)		2014 (Unaudited)		2015 (Unaudited)		2014 (Unaudited)
Mortgage contracts	Other income - gain on sale of loans	$	83	$	210	$	272	$	450

Note 10 – Disclosures about Fair Value of Assets and Liabilities

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


Level 1		Quoted prices in active markets for identical assets or liabilities

Level 2		Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated financial statements, as well as the general classification of such instruments pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the period ended June 30, 2015. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Available for sale securities

When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U.S. Treasury and federal agency securities, state and municipal securities, federal agency mortgage

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

Hedged loans

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

Interest rate swap agreements

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

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


	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
June 30, 2015
Available-for-sale securities
U.S. Treasury and federal agencies	$	28,239		$	—	$	28,239		$	—
State and municipal		50,783			—		50,783			—
Federal agency collateralized mortgage obligations		116,942			—		116,942			—
Federal agency mortgage-backed pools		134,950			—		134,950			—
Corporate notes		56			—		56			—

Total available-for-sale securities		330,970			—		330,970			—

Hedged loans		109,448			—		109,448			—
Forward sale commitments		751			—		751			—
Interest rate swap agreements		(4,177	)		—		(4,177	)		—
Commitments to originate loans		(32	)		—		(32	)		—

December 31, 2014
Available-for-sale securities
U.S. Treasury and federal agencies	$	26,823		$	—	$	26,823		$	—
State and municipal		47,952			—		47,952			—
Federal agency collateralized mortgage obligations		122,860			—		122,860			—
Federal agency mortgage-backed pools		125,395			—		125,395			—
Private labeled mortgage-backed pools		689			—		689			—
Corporate notes		45			—		45			—

Total available-for-sale securities		323,764			—		323,764			—

Hedged loans		101,445			—		101,445			—
Forward sale commitments		447			—		447			—
Interest rate swap agreements		(4,546	)		—		(4,546	)		—

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


	Three Months Ended June 30						Six Months Ended June 30
Non Interest Income Total gains and losses from:	2015 (Unaudited)			2014 (Unaudited)			2015 (Unaudited)			2014 (Unaudited)
Hedged loans	$	(1,186	)	$	544		$	(186	)	$	751
Fair value interest rate swap agreements		1,186			(544	)		186			(751	)
Derivative loan commitments		83			210			272			450

	$	83		$	210		$	272		$	450

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


	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2015
Impaired loans	$	8,978	$	—	$	—	$	8,978
Mortgage servicing rights		8,279		—		—		8,279

December 31, 2014
Impaired loans	$	9,464	$	—	$	—	$	9,464
Mortgage servicing rights		7,642		—		—		7,642

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

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

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Mortgage Servicing Rights (MSRs): MSRs do not trade in an active market with readily observable prices. Accordingly, the fair value of these assets is classified as Level 3. The Company determines the fair value of MSRs using an income approach model based upon the Company’s month-end interest rate curve and prepayment assumptions. The model utilizes assumptions to estimate future net servicing income cash flows, including estimates of time decay, payoffs and changes in valuation inputs and assumptions. The Company reviews the valuation assumptions against this market data for reasonableness and adjusts the assumptions if deemed appropriate. The carrying amount of the MSRs’ fair value decreased by $18,000 during the first six months of 2015 and increased by $38,000 during the first six months of 2014.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


	Fair Value at June 30, 2015		Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans	$	8,978	Collateral based measurement	Discount to reflect current market conditions and ultimate collectability	10% - 15% (12%)

Mortgage servicing rights	$	8,279	Discounted cashflows	Discount rate, Constant prepayment rate, Probability of default	10% - 15% (12%), 4% - 7% (4.6%), 1% - 10% (4.5%)

	Fair Value at December 31, 2014		Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans	$	9,464	Collateral based measurement	Discount to reflect current market conditions and ultimate collectability	10% - 15% (12%)

Mortgage servicing rights	$	7,642	Discounted cashflows	Discount rate, Constant prepayment rate, Probability of default	10% - 15% (12%), 4% - 7% (4.6%), 1% - 10% (4.5%)

Note 11 – Fair Value of Financial Instruments

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

The estimated fair values of financial instruments, as shown below, are not intended to reflect the estimated liquidation or market value of Horizon taken as a whole. The disclosed fair value estimates are limited to Horizon’s significant financial instruments at June 30, 2015 and December 31, 2014. These include financial instruments recognized as assets and liabilities on the condensed consolidated balance sheet as well as certain off-balance sheet financial instruments. The estimated fair values shown below do not include any valuation of assets and liabilities, which are not financial instruments as defined by the FASB ASC fair value hierarchy.

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

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

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

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

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

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

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

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


	June 30, 2015
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and due from banks	$	43,857	$	43,857	$	—	$	—
Investment securities, held to maturity		162,661		—		167,581		—
Loans held for sale		7,677		—		—		7,677
Loans excluding loan level hedges, net		1,393,414		—		—		1,426,252
Stock in FHLB and FRB		11,080		—		11,080		—
Interest receivable		8,823		—		8,823		—

Liabilities
Non-interest bearing deposits	$	307,215	$	307,215	$	—	$	—
Interest-bearing deposits		1,277,508		—		1,204,516		—
Borrowings		385,236		—		381,302		—
Subordinated debentures		32,719		—		32,698		—
Interest payable		461		—		461		—

	December 31, 2014
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and due from banks	$	43,476	$	43,476	$	—	$	—
Investment securities, held to maturity		165,767		—		169,904		—
Loans held for sale		6,143		—		—		6,143
Loans excluding loan level hedges, net		1,260,608		—		—		1,295,133
Stock in FHLB and FRB		11,348		—		11,348		—
Interest receivable		8,246		—		8,246		—

Liabilities
Non-interest bearing deposits	$	267,667	$	267,667	$	—	$	—
Interest-bearing deposits		1,214,652		—		1,158,912		—
Borrowings		351,198		—		348,597		—
Subordinated debentures		32,642		—		32,669		—
Interest payable		497		—		497		—

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 12 – Accumulated Other Comprehensive Income


	June 30 2015			December 31 2014
Unrealized gain on securities available for sale	$	3,455		$	4,018
Unamortized gain on securities held to maturity, previously transferred from AFS		1,423			1,658
Unrealized loss on derivative instruments		(3,155	)		(3,337	)
Tax effect		(603	)		(818	)

Total accumulated other comprehensive income	$	1,120		$	1,521

Note 13 – Regulatory Capital

Horizon and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. Failure to meet the minimum regulatory capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators, which if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective actions, the Bank must meet specific capital guidelines involving quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined), or leverage ratio. For June 30, 2015, Interim Final Basel III rules require the Bank to maintain minimum amounts and ratios of common equity Tier I capital (as defined in the regulation) to risk-weighted assets (as defined). Additionally, under Basel III rules, the decision was made to opt-out of including accumulated other comprehensive income in regulatory capital. For December 31, 2014, regulatory capital ratios were calculated under Basel I rules.

To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based, common equity Tier I risk-based (June 30, 2015) and Tier I leverage ratios as set forth in the table below. As of June 30, 2015 and December 31, 2014, the Bank met all capital adequacy requirements to be considered well capitalized. There have been no conditions or events since the end of the second quarter of 2015 that management believes have changed the Bank’s classification as well capitalized. There is no threshold for well-capitalized status for bank holding companies.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Horizon and the Bank’s actual and required capital ratios as of June 30, 2015 and December 31, 2014 were as follows:

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