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, 2016

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: 14,776,952 shares of Common Stock, no par value, at August 9, 2016.

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	41

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	57

Item 4.	Controls and Procedures	57

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	58

Item 1A.	Risk Factors	58

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	58

Item 3.	Defaults Upon Senior Securities	58

Item 4.	Mine Safety Disclosures	58

Item 5.	Other Information	58

Item 6.	Exhibits	59

Signatures		60

Index To Exhibits		61

PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollar Amounts in Thousands)


	June 30		December 31
	2016		2015
	(Unaudited)
Assets
Cash and due from banks	$	109,224	$	48,650
Investment securities, available for sale		455,239		444,982
Investment securities, held to maturity (fair value of $180,059 and $193,703)		173,696		187,629
Loans held for sale		7,812		7,917
Loans, net of allowance for loan losses of $14,226 and $14,534		1,923,599		1,734,597
Premises and equipment, net		61,186		60,798
Federal Reserve and Federal Home Loan Bank stock		16,636		13,823
Goodwill		56,458		49,600
Other intangible assets		8,686		7,371
Interest receivable		11,526		10,535
Cash value of life insurance		57,944		54,504
Other assets		36,074		31,995

Total assets	$	2,918,080	$	2,652,401

Liabilities
Deposits
Non-interest bearing	$	397,412	$	335,955
Interest bearing		1,684,849		1,544,198

Total deposits		2,082,261		1,880,153
Borrowings		492,883		449,347
Subordinated debentures		32,874		32,797
Interest payable		961		507
Other liabilities		28,099		22,765

Total liabilities		2,637,078		2,385,569

Commitments and contingent liabilities
Stockholders’ Equity
Preferred stock, Authorized, 1,000,000 shares Series B shares $.01 par value, $1,000 liquidation value Issued 0 and 12,500 shares		—		12,500
Common stock, no par value Authorized, 44,000,000 shares Issued, 12,590,784 and 11,995,324 shares Outstanding, 12,571,534 and 11,939,887 shares		—		—
Additional paid-in capital		120,758		106,370
Retained earnings		156,651		148,685
Accumulated other comprehensive income (loss)		3,593		(723	)

Total stockholders’ equity		281,002		266,832

Total liabilities and stockholders’ equity	$	2,918,080	$	2,652,401

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					Six Months Ended
	June 30					June 30
	2016		2015			2016			2015
	(Unaudited)		(Unaudited)			(Unaudited)			(Unaudited)
Interest Income
Loans receivable	$	20,794	$	17,981		$	40,541		$	34,843
Investment securities
Taxable		2,661		2,067			5,205			4,221
Tax exempt		1,195		1,079			2,432			2,156

Total interest income		24,650		21,127			48,178			41,220

Interest Expense
Deposits		1,557		1,237			3,048			2,469
Borrowed funds		1,721		1,539			3,480			3,018
Subordinated debentures		503		501			1,007			997

Total interest expense		3,781		3,277			7,535			6,484

Net Interest Income		20,869		17,850			40,643			34,736
Provision for loan losses		232		1,906			764			2,520

Net Interest Income after Provision for Loan Losses		20,637		15,944			39,879			32,216

Non-interest Income
Service charges on deposit accounts		1,335		1,085			2,573			2,084
Wire transfer fees		175		182			296			333
Interchange fees		1,663		1,366			3,121			2,468
Fiduciary activities		1,465		1,216			3,100			2,513
Gain on sale of investment securities (includes $767 for the three months ended and $875 for the six months ended June 30, 2016 and $0 for the three months ended and $124 for the six months ended June 30, 2015, related to accumulated other comprehensive earnings reclassifications)		767		—			875			124
Gain on sale of mortgage loans		3,529		2,642			5,643			5,021
Mortgage servicing income net of impairment		500		300			947			479
Increase in cash value of bank owned life insurance		351		257			696			515
Death benefit on bank owned life insurance		—		—			—			145
Other income		84		138			482			570

Total non-interest income		9,869		7,186			17,733			14,252

Non-interest Expense
Salaries and employee benefits		10,317		8,385			20,382			16,889
Net occupancy expenses		1,901		1,375			3,837			2,926
Data processing		1,134		966			2,239			1,889
Professional fees		747		660			1,578			1,187
Outside services and consultants		2,198		918			3,297			1,544
Loan expense		1,409		1,367			2,604			2,624
FDIC insurance expense		409		339			814			676
Other losses		136		150			403			105
Other expense		3,304		2,490			6,148			4,878

Total non-interest expense		21,555		16,650			41,302			32,718

Income Before Income Tax		8,951		6,480			16,310			13,750
Income tax expense (includes $268 for the three months ended and $306 for the six months ended June 30, 2016 and $0 for the three months ended and $43 for the six months ended June 30, 2015, related to income tax expense from reclassification items)		2,625		1,752			4,603			3,664

Net Income		6,326		4,728			11,707			10,086
Preferred stock dividend		—		(31	)		(42	)		(63	)

Net Income Available to Common Shareholders	$	6,326	$	4,697		$	11,665		$	10,023

Basic Earnings Per Share	$	0.52	$	0.51		$	0.97		$	1.09
Diluted Earnings Per Share		0.52		0.49			0.96			1.04

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
	2016			2015			2016			2015
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net Income	$	6,326		$	4,728		$	11,707		$	10,086

Other Comprehensive Income (Loss)
Change in fair value of derivative instruments:
Change in fair value of derivative instruments for the period		(83	)		511			(645	)		182
Income tax effect		29			(179	)		226			(64	)

Changes from derivative instruments		(54	)		332			(419	)		118

Change in securities:
Unrealized appreciation (depreciation) for the period on AFS securities		2,691			(2,364	)		8,637			(402	)
Amortization from transfer of securities from available-for-sale to held-to-maturity securities		(248	)		(158	)		(477	)		(272	)
Reclassification adjustment for securities gains realized in income		(767	)		—			(875	)		(124	)
Income tax effect		(511	)		882			(2,550	)		279

Unrealized gains (losses) on securities		949			(1,640	)		4,735			(519	)

Other Comprehensive Income (Loss), Net of Tax		895			(1,308	)		4,316			(401	)

Comprehensive Income	$	7,221		$	3,420		$	16,023		$	9,685

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)


									Accumulated
				Additional					Other
	Preferred			Paid-in		Retained			Comprehensive
	Stock			Capital		Earnings			Income (Loss)			Total
Balances, January 1, 2016	$	12,500		$	106,370	$	148,685		$	(723	)	$	266,832
Net income							11,707						11,707
Other comprehensive loss, net of tax										4,316			4,316
Redemption of preferred stock		(12,500	)										(12,500	)
Amortization of unearned compensation					150								150
Stock option expense					170								170
Stock issued in acquisition					14,068								14,068
Cash dividends on preferred stock (1.00%)							(42	)					(42	)
Cash dividends on common stock ($.30 per share)							(3,699	)					(3,699	)

Balances, June 30, 2016	$	—		$	120,758	$	156,651		$	3,593		$	281,002

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
	2016			2015
	(Unaudited)			(Unaudited)
Operating Activities
Net income	$	11,707		$	10,086
Items not requiring (providing) cash
Provision for loan losses		764			2,520
Depreciation and amortization		2,463			1,883
Share based compensation		170			138
Mortgage servicing rights net impairment		840			356
Premium amortization on securities available for sale, net		2,673			1,289
Gain on sale of investment securities		(875	)		(124	)
Gain on sale of mortgage loans		(5,643	)		(5,021	)
Proceeds from sales of loans		144,197			155,746
Loans originated for sale		(138,452	)		(152,259	)
Change in cash value of life insurance		(695	)		(515	)
Gain (Loss) on sale of other real estate owned		118			(206	)
Net change in
Interest receivable		(355	)		(577	)
Interest payable		399			(36	)
Other assets		(5,624	)		4,099
Other liabilities		316			(1,511	)

Net cash provided by operating activities		12,003			15,868

Investing Activities
Purchases of securities available for sale		(50,143	)		(47,958	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale		65,523			40,359
Purchases of securities held to maturity		(17,960	)		—
Proceeds from maturities of securities held to maturity		12,934			1,535
Proceeds from the sale of FHLB stock		(2,231	)		268
Net change in loans		(88,250	)		(142,131	)
Proceeds on the sale of OREO and repossessed assets		1,253			1,793
Change in premises and equipment, net		(683	)		(3,587	)
Acquisition of Kosciusko, net of cash received		30,437			—

Net cash used in investing activities		(49,120	)		(149,721	)

Financing Activities
Net change in
Deposits		78,622			102,404
Borrowings		35,310			34,115
Redemption of preferred stock		(12,500	)		—
Proceeds from issuance of stock					389
Dividends paid on common shares		(3,699	)		(2,611	)
Dividends paid on preferred shares		(42	)		(63	)

Net cash provided by financing activities		97,691			134,234

Net Change in Cash and Cash Equivalents		60,574			381
Cash and Cash Equivalents, Beginning of Period		48,650			43,476

Cash and Cash Equivalents, End of Period	$	109,224		$	43,857

Additional Supplemental Information
Interest paid	$	7,081		$	6,519
Income taxes paid		4,750			3,700
Transfer of loans to other real estate owned		1,971			(1,384	)
The Company purchased all of the capital stock of Kosciusko for $22,581 on June 1, 2016. In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired		155,413			—
Less: common stock issued		14,068			—
Cash paid for the capital stock		8,513			—
Liabilities assumed		132,832			—

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, 2016 and June 30, 2015 are not necessarily indicative of the operating results for the full year of 2016 or 2015. 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 2015 filed with the Securities and Exchange Commission on February 29, 2016. The condensed consolidated balance sheet of Horizon as of December 31, 2015 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				Six Months Ended
	June 30				June 30
	2016		2015		2016		2015
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Basic earnings per share
Net income	$	6,326	$	4,728	$	11,707	$	10,086
Less: Preferred stock dividends		—		31		42		63

Net income available to common shareholders	$	6,326	$	4,697	$	11,665	$	10,023
Weighted average common shares outstanding		12,179,253		9,240,005		12,064,335		9,228,075
Basic earnings per share	$	0.52	$	0.51	$	0.97	$	1.09

Diluted earnings per share
Net income available to common shareholders	$	6,326	$	4,697	$	11,665	$	10,023
Weighted average common shares outstanding		12,179,253		9,240,005		12,064,335		9,228,075
Effect of dilutive securities:
Warrants		—		324,698		—		323,198
Restricted stock		20,721		34,892		21,050		30,816
Stock options		42,804		37,991		41,643		33,462

Weighted average shares outstanding		12,242,778		9,637,586		12,127,028		9,615,551
Diluted earnings per share	$	0.52	$	0.49	$	0.96	$	1.04

There were zero shares for both the three and six months ended June 30, 2016, respectively, and 2,500 and 41,444 for the three and six months ended June 30, 2015 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, 2015 Annual Report on Form 10-K.

Note 2 – Acquisitions

On July 1, 2015, Horizon completed the acquisition of Peoples Bancorp, an Indiana corporation (“Peoples”) and Horizon Bank N.A.’s acquisition of Peoples Federal Savings Bank of DeKalb County (“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. The Company had approximately $4.9 million in costs related to the acquisition as of December 31, 2015. These expenses were 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 increased its deposit base and reduced transaction costs. The Company also expects to reduce cost through economies of scale.

Under the purchase method of accounting, the total estimated purchase price is allocated to Peoples 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 final purchase price for the Peoples acquisition is allocated as follows:


ASSETS
Cash and due from banks	$	205,054
Investment securities, held to maturity		2,038
Commercial		67,435
Residential mortgage		137,331
Consumer		19,593

Total loans		224,359
Premises and equipment, net		5,524
FRB and FHLB stock		2,743
Goodwill		21,424
Core deposit intangible		4,394
Interest receivable		1,279
Cash value of life insurance		13,898
Other assets		4,364

Total assets purchased	$	485,077

Common shares issued	$	55,506
Cash paid		22,641

Total estimated purchase price	$	78,147


LIABILITIES
Deposits
Non-interest bearing	$	28,251
NOW accounts		65,771
Savings and money market		125,176
Certificates of deposits		131,889

Total deposits		351,087
Borrowings		48,884
Interest payable		21
Other liabilities		6,938

Total liabilities assumed	$	406,930

Of the total purchase price of $78.1 million, $4.4 million has been allocated to core deposit intangible. Additionally, $21.0 million has been allocated to goodwill and none of the purchase price is deductible. The core deposit intangible will be amortized over seven years on a straight line basis.

The Company acquired the $228.6 million loan portfolio at a fair value discount of $4.8 million. The performing portion of the portfolio, $223.4 million, had an estimated fair value of $220.0 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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The Company acquired certain 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.

The 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.

Loans with 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.

The following table details the acquired loans that are accounted for in accordance with ASC 310-30 as of July 1, 2015.


Contractually required principal and interest at acquisition	$	5,730
Contractual cash flows not expected to be collected (nonaccretable differences)		715

Expected cash flows at acquisition		5,015
Interest component of expected cash flows (accretable discount)		647

Fair value of acquired loans accounted for under ASC 310-30	$	4,368

The results of operations of Peoples and Peoples FSB have been included in the Company’s consolidated financial statements since the acquisition dates. The following schedule includes pro forma results for the periods ended June 30, 2016 and 2015 as if the Peoples and Peoples FSB acquisitions had occurred as of the beginning of the comparable prior reporting period.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


	Three Months Ended				Six Months Ended
	June 30		June 30		June 30		June 30
	2016		2015		2016		2015
Summary of Operations:
Net Interest Income	$	20,869	$	20,829	$	40,643	$	40,690
Provision for Loan Losses		232		1,936		764		2,580
Net Interest Income after Provision for Loan Losses		20,637		18,893		39,879		38,110
Non-interest Income		9,869		8,086		17,733		16,145
Non-Interest Expense		21,555		19,852		41,302		39,014
Income before Income Taxes		8,951		7,127		16,310		15,241
Income Tax Expense		2,625		1,779		4,603		3,791
Net Income		6,326		5,348		11,707		11,450
Net Income Available to Common Shareholders	$	6,326	$	5,317	$	11,665	$	11,387

Basic Earnings Per Share	$	0.52	$	0.46	$	0.97	$	0.99
Diluted Earnings Per Share	$	0.52	$	0.45	$	0.96	$	0.96

The pro forma information includes adjustments for interest income on loans, amortization of intangibles arising from the transaction, interest expense on deposits acquired, premises expense for the banking centers acquired and the related income tax effects. The pro forma information for the three and six months ended June 30, 2015 includes $657,000, net of tax, of operating revenue from Peoples and approximately $95,000, net of tax, of non-recurring expenses directly attributable to the Peoples acquisition.

The pro forma financial information is presented for information purposes only and is not indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

On June 1, 2016, Horizon completed the acquisition of Kosciusko Financial, Inc., an Indiana corporation (“Kosciusko”) and Horizon Bank’s acquisition of Farmers State Bank, a state-chartered bank and wholly owned subsidiary of Kosciusko, through mergers effective June 1, 2016. Under the terms of the Merger Agreement, shareholders of Kosciusko had the option to receive $81.75 per share in cash or 3.0122 shares of Horizon common stock for each share of Kosciusko’s common stock, subject to allocation provisions to assure that in aggregate, Kosciusko shareholders received total consideration that consists of 65% stock and 35% cash. Kosciusko shareholders owning fewer than 100 shares of common stock received $81.75 in cash for each common share. As a result of Kosciusko stockholder stock and cash elections and the related proration provisions of the Merger Agreement, Horizon issued 582,287 shares of its common stock in the merger. Based upon the June 1, 2016 closing price of $24.85 per share of Horizon common stock, the transaction has an implied valuation of approximately $23.0 million. The Company has had approximately $1.6 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.

Under the acquisition method of accounting, the total purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition. Based on preliminary valuations of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the Kosciusko acquisition is detailed in the following table. Prior to the end of the one year measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation prospectively. If any adjustments are made to the preliminary assumptions (provisional amounts), disclosures will be made in the notes to the financial statements of the amounts recorded in the current period earnings by line item that have been recorded in previous reporting periods if the adjustments to the provisional amounts had been recognized as of the acquisition date.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


ASSETS
Cash and due from banks	$	38,950
Investment securities, held to maturity		1,191
Commercial		67,310
Residential mortgage		26,244
Consumer		6,319

Total loans		99,873
Premises and equipment, net		1,466
FRB and FHLB stock		582
Goodwill		6,858
Core deposit intangible		1,867
Interest receivable		636
Cash value of life insurance		2,745
Other assets		1,245

Total assets purchased	$	155,413

Common shares issued	$	14,068
Cash paid		8,513

Total estimated purchase price	$	22,581


LIABILITIES
Deposits
Non-interest bearing	$	28,549
NOW accounts		35,213
Savings and money market		26,953
Certificates of deposits		32,771

Total deposits		123,486
Borrowings		8,303
Interest payable		55
Other liabilities		988

Total liabilities assumed	$	132,832

Of the total estimated purchase price of $22.6 million, $1.9 million has been allocated to core deposit intangible. Additionally, $6.9 million has been allocated to goodwill and none of the purchase price is deductible. 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.

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

On July 18, 2016, Horizon completed the acquisition of LaPorte Bancorp, Inc., a Maryland corporation (“LaPorte Bancorp”) and Horizon Bank’s acquisition of The LaPorte Savings Bank, a state-chartered savings bank and wholly owned subsidiary of LaPorte Bancorp, through mergers effective July 18, 2016. Under the terms of the Merger Agreement, shareholders of LaPorte Bancorp had the option to receive $17.50 per share in cash or 0.629 shares of Horizon common stock for each share of LaPorte Bancorp’s common stock, subject to allocation provisions to assure that in aggregate, LaPorte Bancorp shareholders received total consideration that consists of 65% stock and 35% cash. LaPorte Bancorp shareholders owning fewer than 100 shares of common stock received $17.50 in cash for each common share. As a result of LaPorte stockholder stock and cash elections and the related proration provisions of the Merger Agreement, Horizon issued 2,280,992 shares of its common stock in the merger. Based upon the July 18, 2016 closing price of $27.54 per share of Horizon common stock, the transaction has an implied valuation of approximately $101.7 million.

As of July 18, 2016, LaPorte Bancorp had total assets of approximately $536.0 million, total deposits of approximately $370.9 million and total net loans of approximately $316.8 million.

Utilizing July 15, 2016 financials for both Horizon and LaPorte Bancorp and an estimate of the fair market value adjustments associated with the merger, Horizon would have total assets of approximately $3.5 billion, total deposits of approximately $2.5 billion and total net loans of approximately $2.2 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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 3 – Securities

The fair value of securities is as follows:


			Gross		Gross
June 30, 2016	Amortized		Unrealized		Unrealized			Fair
June 30, 2016	Cost		Gains		Losses			Value
Available for sale
U.S. Treasury and federal agencies	$	18,384	$	86	$	—		$	18,470
State and municipal		60,961		1,654		(4	)		62,611
Federal agency collateralized mortgage obligations		151,736		2,596		(69	)		154,263
Federal agency mortgage-backed pools		215,445		4,654		(276	)		219,823
Corporate notes		32		40		—			72

Total available for sale investment securities	$	446,558	$	9,030	$	(349	)	$	455,239

Held to maturity
State and municipal	$	143,093	$	7,586	$	(2,606	)	$	148,073
Federal agency collateralized mortgage obligations		8,424		199		—			8,623
Federal agency mortgage-backed pools		22,179		1,184		—			23,363

Total held to maturity investment securities	$	173,696	$	8,969	$	(2,606	)	$	180,059


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
December 31, 2015	Cost		Gains		Losses			Value
Available for sale
U.S. Treasury and federal agencies	$	5,940	$	3	$	(17	)	$	5,926
State and municipal		73,829		1,299		(33	)		75,095
Federal agency collateralized mortgage obligations		157,291		567		(1,655	)		156,203
Federal agency mortgage-backed pools		206,970		2,080		(1,346	)		207,704
Corporate notes		32		22		—			54

Total available for sale investment securities	$	444,062	$	3,971	$	(3,051	)	$	444,982

Held to maturity
U.S. Treasury and federal agencies	$	5,859	$	93	$	—		$	5,952
State and municipal		146,331		5,375		(253	)		151,453
Federal agency collateralized mortgage obligations		9,051		27		(124	)		8,954
Federal agency mortgage-backed pools		26,388		1,141		(185	)		27,344

Total held to maturity investment securities	$	187,629	$	6,636	$	(562	)	$	193,703

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, 2016, 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, 2016.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The amortized cost and fair value of securities available for sale and held to maturity at June 30, 2016 and December 31, 2015, 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.


	June 30, 2016				December 31, 2015
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Available for sale
Within one year	$	7,123	$	7,153	$	7,192	$	7,232
One to five years		46,104		46,664		38,197		38,894
Five to ten years		11,351		11,804		16,807		17,152
After ten years		14,799		15,532		17,605		17,797

		79,377		81,153		79,801		81,075
Federal agency collateralized mortgage obligations		151,736		154,263		157,291		156,203
Federal agency mortgage-backed pools		215,445		219,823		206,970		207,704

Total available for sale investment securities	$	446,558	$	455,239	$	444,062	$	444,982

Held to maturity
Within one year	$	—	$	—	$	—	$	—
One to five years		20,415		20,436		17,815		18,403
Five to ten years		88,183		92,551		106,167		110,026
After ten years		34,495		35,086		28,208		28,976

		143,093		148,073		152,190		157,405
Federal agency collateralized mortgage obligations		8,424		8,623		9,051		8,954
Federal agency mortgage-backed pools		22,179		23,363		26,388		27,344

Total held to maturity investment securities	$	173,696	$	180,059	$	187,629	$	193,703

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


	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
June 30, 2016	Value		Losses			Value		Losses			Value		Losses
State and municipal	$	1,763	$	(2,609	)	$	132	$	(1	)	$	1,895	$	(2,610	)
Federal agency collateralized mortgage obligations		4,059		(23	)		9,079		(46	)		13,138		(69	)
Federal agency mortgage-backed pools		23,361		(276	)		—		—			23,361		(276	)

Total temporarily impaired securities	$	29,183	$	(2,908	)	$	9,211	$	(47	)	$	38,394	$	(2,955	)


	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2015	Value		Losses			Value		Losses			Value		Losses
U.S. Treasury and federal agencies	$	5,468	$	(17	)	$	—	$	—		$	5,468	$	(17	)
State and municipal		17,353		(280	)		446		(6	)		17,799		(286	)
Federal agency collateralized mortgage obligations		89,459		(1,124	)		25,428		(655	)		114,887		(1,779	)
Federal agency mortgage-backed pools		113,244		(1,212	)		16,506		(319	)		129,750		(1,531	)

Total temporarily impaired securities	$	225,524	$	(2,633	)	$	42,380	$	(980	)	$	267,904	$	(3,613	)


	Three Months Ended June 30					Six Months Ended June 30
	2016			2015		2016			2015
Sales of securities available for sale (Unaudited)
Proceeds	$	17,536		$	—	$	25,077		$	13,332
Gross gains		952			—		1,060			147
Gross losses		(185	)		—		(185	)		(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			December 31
	2016			2015
Commercial
Working capital and equipment	$	416,205		$	381,245
Real estate, including agriculture		424,300			391,668
Tax exempt		11,458			8,674
Other		22,617			23,408

Total		874,580			804,995
Real estate
1–4 family		489,133			433,015
Other		4,493			4,129

Total		493,626			437,144
Consumer
Auto		162,172			168,397
Recreation		5,005			5,365
Real estate/home improvement		50,121			47,015
Home equity		130,017			127,113
Unsecured		4,175			4,120
Other		12,430			10,290

Total		363,920			362,300
Mortgage warehouse		205,699			144,692

Total loans		1,937,825			1,749,131
Allowance for loan losses		(14,226	)		(14,534	)

Loans, net	$	1,923,599		$	1,734,597

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 and the related mortgagee are underwritten by Horizon to the end investor guidelines and 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 reacquires the loan under its option within the agreement. Due to the reacquire 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 reacquire 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 reacquire 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 reacquire 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.


	Loan					Deferred			Recorded
June 30, 2016	Balance			Interest Due		Fees / (Costs)			Investment
Owner occupied real estate	$	298,481		$	1,068	$	1,134		$	300,683
Non owner occupied real estate		343,360			346		566			344,272
Residential spec homes		7,660			13		13			7,686
Development & spec land loans		23,171			58		16			23,245
Commercial and industrial		199,933			1,419		246			201,598

Total commercial		872,605			2,904		1,975			877,484
Residential mortgage		473,563			1,434		2,277			477,274
Residential construction		17,786			36		—			17,822
Mortgage warehouse		205,699			480		—			206,179

Total real estate		697,048			1,950		2,277			701,275
Direct installment		59,105			164		(383	)		58,886
Direct installment purchased		131			—		—			131
Indirect installment		144,935			300		—			145,235
Home equity		160,955			621		(823	)		160,753

Total consumer		365,126			1,085		(1,206	)		365,005

Total loans		1,934,779			5,939		3,046			1,943,764
Allowance for loan losses		(14,226	)		—		—			(14,226	)

Net loans	$	1,920,553		$	5,939	$	3,046		$	1,929,538


	Loan					Deferred			Recorded
December 31, 2015	Balance			Interest Due		Fees / (Costs)			Investment
Owner occupied real estate	$	268,281		$	613	$	1,328		$	270,222
Non owner occupied real estate		326,399			306		497			327,202
Residential spec homes		5,018			9		17			5,044
Development & spec land loans		18,183			33		26			18,242
Commercial and industrial		184,911			1,246		335			186,492

Total commercial		802,792			2,207		2,203			807,202
Residential mortgage		414,924			1,275		2,470			418,669
Residential construction		19,751			34		—			19,785
Mortgage warehouse		144,692			480		—			145,172

Total real estate		579,367			1,789		2,470			583,626
Direct installment		54,341			168		(359	)		54,150
Direct installment purchased		153			—		—			153
Indirect installment		151,523			323		—			151,846
Home equity		157,164			628		(522	)		157,270

Total consumer		363,181			1,119		(881	)		363,419

Total loans		1,745,340			5,115		3,792			1,754,247
Allowance for loan losses		(14,534	)		—		—			(14,534	)

Net loans	$	1,730,806		$	5,115	$	3,792		$	1,739,713

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		June 30		June 30		June 30		June 30
	2016		2016		2016		2016		2016
	Heartland		Summit		Peoples		Kosciusko		Total
Commercial	$	1,243	$	5,409	$	750	$	7,576	$	14,978
Real estate		641		1,181		281		316		2,419
Consumer		1		9		—		22		32

Outstanding balance	$	1,885	$	6,599	$	1,031	$	7,914	$	17,429

Carrying amount, net of allowance of $0									$	17,429


	December 31		December 31		December 31		December 31		December 31
	2015		2015		2015		2015		2015
	Heartland		Summit		Peoples		Kosciusko		Total
Commercial	$	1,633	$	5,567	$	1,061	$	—	$	8,261
Real estate		693		1,216		179		—		2,088
Consumer		6		35		—		—		41

Outstanding balance	$	2,332	$	6,818	$	1,240	$	—	$	10,390

Carrying amount, net of allowance of $63									$	10,327

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


	Six Months Ended June 30, 2016
	Heartland			Summit			Peoples			Kosciusko		Total
Balance at January 1	$	795		$	708		$	555		$	—	$	2,058
Additions		—			—			—			950		950
Accretion		(89	)		(103	)		(69	)		—		(261	)
Reclassification from nonaccretable difference		—			—			—			—		—
Disposals		(24	)		(4	)		(58	)		—		(86	)

Balance at June 30	$	682		$	601		$	428		$	950	$	2,661


	Six Months Ended June 30, 2015
	Heartland			Summit			Peoples			Kosciusko		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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

During the six months ended June 30, 2016 and 2015, the Company decreased the allowance for loan losses on purchased loans by a recovery to the income statement of $0 and $76,000, respectively.

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						Six Months Ended
	June 30						June 30
	2016			2015			2016			2015
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Balance at beginning of the period	$	14,236		$	16,634		$	14,534		$	16,501
Loans charged-off:
Commercial
Owner occupied real estate		31			1,422			178			1,422
Non owner occupied real estate		173			—			472			16
Residential development		—			—			—			—
Development & Spec Land Loans		—			—			—			—
Commercial and industrial		—			253			39			253

Total commercial		204			1,675			689			1,691
Real estate
Residential mortgage		—			164			115			186
Residential construction		—			—			—			—
Mortgage warehouse		—			—			—			—

Total real estate		—			164			115			186
Consumer
Direct Installment		46			96			104			155
Direct Installment Purchased		—			—			—			—
Indirect Installment		279			196			555			565
Home Equity		64			304			239			504

Total consumer		389			596			898			1,224

Total loans charged-off		593			2,435			1,702			3,101
Recoveries of loans previously charged-off:
Commercial
Owner occupied real estate		4			78			29			86
Non owner occupied real estate		31			—			54			—
Residential development		2			—			4			—
Development & Spec Land Loans		—			—			—			—
Commercial and industrial		63			14			95			33

Total commercial		100			92			182			119
Real estate
Residential mortgage		31			3			63			5
Residential construction		—			—			—			—
Mortgage warehouse		—			—			—			—

Total real estate		31			3			63			5
Consumer
Direct Installment		28			47			44			76
Direct Installment Purchased		—			—			—			—
Indirect Installment		146			134			240			235
Home Equity		46			40			101			66

Total consumer		220			221			385			377

Total loan recoveries		351			316			630			501

Net loans charged-off (recovered)		242			2,119			1,072			2,600

Provision charged to operating expense
Commercial		(305	)		2,093			(639	)		2,048
Real estate		343			(29	)		(249	)		904
Consumer		194			(158	)		1,652			(432	)

Total provision charged to operating expense		232			1,906			764			2,520

Balance at the end of the period	$	14,226		$	16,421		$	14,226		$	16,421

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

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

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

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

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


June 30, 2016	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	500	$	—	$	—	$	—	$	500
Collectively evaluated for impairment		5,551		2,102		1,080		4,993		13,726
Loans acquired with deteriorated credit quality		—		—		—		—		—

Total ending allowance balance	$	6,051	$	2,102	$	1,080	$	4,993	$	14,226

Loans:
Individually evaluated for impairment	$	4,344	$	—	$	—	$	—	$	4,344
Collectively evaluated for impairment		873,140		495,096		206,179		365,005		1,939,420
Loans acquired with deteriorated credit quality		—		—		—		—		—

Total ending loans balance	$	877,484	$	495,096	$	206,179	$	365,005	$	1,943,764


December 31, 2015	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	202	$	—	$	—	$	—	$	202
Collectively evaluated for impairment		6,739		2,476		1,007		3,856		14,078
Loans acquired with deteriorated credit quality		254		—		—		—		254

Total ending allowance balance	$	7,195	$	2,476	$	1,007	$	3,856	$	14,534

Loans:
Individually evaluated for impairment	$	7,019	$	—	$	—	$	—	$	7,019
Collectively evaluated for impairment		798,454		438,454		145,172		363,419		1,745,499
Loans acquired with deteriorated credit quality		1,729		—		—		—		1,729

Total ending loans balance	$	807,202	$	438,454	$	145,172	$	363,419	$	1,754,247

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, 2016	Non-accrual		Loans Past Due Over 90 Days Still Accruing		Non- Performing TDRs		Performing TDRs		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	1,054	$	—	$	—	$	—	$	1,054
Non owner occupied real estate		2,901		—		243		60		3,204
Residential development		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—
Commercial and industrial		71		—		—		—		71

Total commercial		4,026		—		243		60		4,329
Real estate
Residential mortgage		3,664		1		803		950		5,418
Residential construction		—		—		242		—		242
Mortgage warehouse		—		—		—		—		—

Total real estate		3,664		1		1,045		950		5,660
Consumer
Direct Installment		345		—		—		—		345
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		837		23		—		—		860
Home Equity		1,554		—		178		246		1,978

Total Consumer		2,736		23		178		246		3,183

Total	$	10,426	$	24	$	1,466	$	1,256	$	13,172


December 31, 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	$	1,749	$	—	$	—	$	—	$	1,749
Non owner occupied real estate		3,034		—		1,915		60		5,009
Residential development		—		—		—		—		—
Development & Spec Land Loans		71		—		—		—		71
Commercial and industrial		176		—		—		—		176

Total commercial		5,030		—		1,915		60		7,005
Real estate
Residential mortgage		4,354		1		824		808		5,987
Residential construction		—		—		250		—		250
Mortgage warehouse		—		—		—		—		—

Total real estate		4,354		1		1,074		808		6,237
Consumer
Direct Installment		541		—		—		—		541
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		601		27		—		—		628
Home Equity		1,736		—		183		350		2,269

Total Consumer		2,878		27		183		350		3,438

Total	$	12,262	$	28	$	3,172	$	1,218	$	16,680

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Included in the $10.4 million of non-accrual loans and the $1.5 million of non-performing TDRs at June 30, 2016 were $2.1 million and $94,000, 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 generally 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 Operations 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. 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, 2016, 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, 2016, the Company had $2.7 million in TDRs and $1.3 million were performing according to the restructured terms and zero TDRs were returned to accrual status during the first six months of 2016. There was $107,000 of specific reserves allocated to TDRs at June 30, 2016 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)

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


							Three Months Ending				Six Months Ending
June 30, 2016	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	$	1,054	$	1,054	$	—	$	1,062	$	—	$	1,079	$	—
Non owner occupied real estate		476		480		—		600		1		1,331		2
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		71		71		—		320		—		325		—

Total commercial		1,601		1,605		—		1,982		1		2,735		2
With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		—		—		—		—
Non owner occupied real estate		2,729		2,739		500		2,747		—		2,757		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—		—

Total commercial		2,729		2,739		500		2,747		—		2,757		—

Total	$	4,330	$	4,344	$	500	$	4,729	$	1	$	5,492	$	2


							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

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, 2016	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	$	98		$	437		$	—		$	535		$	297,946		$	298,481
Non owner occupied real estate		20			—			—			20			343,340			343,360
Residential development		—			—			—			—			7,660			7,660
Development & Spec Land Loans		2			—			—			2			23,169			23,171
Commercial and industrial		—			91			—			91			199,842			199,933

Total commercial		120			528			—			648			871,957			872,605
Real estate
Residential mortgage		1,023			300			1			1,324			472,239			473,563
Residential construction		—			271			—			271			17,515			17,786
Mortgage warehouse		—			—			—			—			205,699			205,699

Total real estate		1,023			571			1			1,595			695,453			697,048
Consumer
Direct Installment		155			16			—			171			58,934			59,105
Direct Installment Purchased		—			—			—			—			131			131
Indirect Installment		493			75			23			591			144,344			144,935
Home Equity		310			134			—			444			160,511			160,955

Total consumer		958			225			23			1,206			363,920			365,126

Total	$	2,101		$	1,324		$	24		$	3,449		$	1,931,330		$	1,934,779

Percentage of total loans		0.11	%		0.07	%		0.00	%		0.18	%		99.82	%

December 31, 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	$	481		$	18		$	—		$	499		$	267,782		$	268,281
Non owner occupied real estate		49			—			—			49			326,350			326,399
Residential development		—			—			—			—			5,018			5,018
Development & Spec Land Loans		—			—			—			—			18,183			18,183
Commercial and industrial		32			—			—			32			184,879			184,911

Total commercial		562			18			—			580			802,212			802,792
Real estate
Residential mortgage		1,121			344			1			1,466			413,458			414,924
Residential construction		—			—			—			—			19,751			19,751
Mortgage warehouse		—			—			—			—			144,692			144,692

Total real estate		1,121			344			1			1,466			577,901			579,367
Consumer
Direct Installment		106			10			—			116			54,225			54,341
Direct Installment Purchased		—			—			—			—			153			153
Indirect Installment		1,186			268			27			1,481			150,042			151,523
Home Equity		1,193			203			—			1,396			155,768			157,164

Total consumer		2,485			481			27			2,993			360,188			363,181

Total	$	4,168		$	843		$	28		$	5,039		$	1,740,301		$	1,745,340

Percentage of total loans		0.24	%		0.05	%		0.00	%		0.29	%		99.71	%

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

For new and renewed commercial loans, the Bank’s Credit Department, which acts independently of the loan officer, assigns the credit quality grade to the loan. Loan grades for loans with an aggregate credit exposure 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).

•

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 to 120 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, 2016	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	282,204		$	8,716		$	7,561		$	—		$	298,481
Non owner occupied real estate		336,897			3,033			3,430			—			343,360
Residential development		7,660			—			—			—			7,660
Development & Spec Land Loans		23,171			—			—			—			23,171
Commercial and industrial		188,713			2,342			8,878			—			199,933

Total commercial		838,645			14,091			19,869			—			872,605
Real estate
Residential mortgage		468,145			—			5,418			—			473,563
Residential construction		17,544			—			242			—			17,786
Mortgage warehouse		205,699			—			—			—			205,699

Total real estate		691,388			—			5,660			—			697,048
Consumer
Direct Installment		58,760			—			345			—			59,105
Direct Installment Purchased		131			—			—			—			131
Indirect Installment		144,075			—			860			—			144,935
Home Equity		158,977			—			1,978			—			160,955

Total Consumer		361,943			—			3,183			—			365,126

Total	$	1,891,976		$	14,091		$	28,712		$	—		$	1,934,779

Percentage of total loans		97.79	%		0.73	%		1.48	%		0.00	%

December 31, 2015	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	257,181		$	4,954		$	6,146		$	—		$	268,281
Non owner occupied real estate		320,216			585			5,598			—			326,399
Residential development		5,018			—			—			—			5,018
Development & Spec Land Loans		18,112			—			71			—			18,183
Commercial and industrial		180,581			693			3,637			—			184,911

Total commercial		781,108			6,232			15,452			—			802,792
Real estate
Residential mortgage		408,937			—			5,987			—			414,924
Residential construction		19,501			—			250			—			19,751
Mortgage warehouse		144,692			—			—			—			144,692

Total real estate		573,130			—			6,237			—			579,367
Consumer
Direct Installment		53,800			—			541			—			54,341
Direct Installment Purchased		153			—			—			—			153
Indirect Installment		150,895			—			628			—			151,523
Home Equity		154,895			—			2,269			—			157,164

Total Consumer		359,743			—			3,438			—			363,181

Total	$	1,713,981		$	6,232		$	25,127		$	—		$	1,745,340

Percentage of total loans		98.20	%		0.36	%		1.44	%		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 acquire 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	$	50,348		$	25,000	$	60,000	$	10,000	$	—		$	—		$	145,348
Securities lending transactions
U.S. Treasury and federal agencies	$	4,038		$	—	$	—	$	—	$	—		$	—		$	4,038
Federal agency collateralized mortgage obligations		44,521			—		388		173		21,541			30,301			96,924
Federal agency mortgage-backed pools		15,003			—		110		2,404		21,304			28,396			67,217

Total		63,562			—		498		2,577		42,845			58,697			168,179

Total borrowings	$	(13,214	)	$	25,000	$	59,502	$	7,423	$	(42,845	)	$	(58,697	)	$	(22,831	)

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, 2016 and December 31, 2015. 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, 2016, 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, 2016, 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 $121.7 million at June 30, 2016 and $117.3 million at December 31, 2015.

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, 2016, 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 Derivatives				Liability Derivatives
	June 30, 2016				June 30, 2016
Derivatives designated as hedging instruments (Unaudited)	Balance Sheet Location		Fair Value		Balance Sheet Location		Fair Value
Interest rate contracts		Loans	$	—		Other liabilities	$	5,393
Interest rate contracts		Other Assets		5,393		Other liabilities		3,786

Total derivatives designated as hedging instruments				5,393				9,179

Derivatives not designated as hedging instruments
Mortgage loan contracts		Other assets		1,111		Other liabilities		—

Total derivatives not designated as hedging instruments				1,111				—

Total derivatives			$	6,504			$	9,179


	Asset Derivatives				Liability Derivatives
	December 31, 2015				December 31, 2015
Derivatives designated as hedging instruments (Unaudited)	Balance Sheet Location		Fair Value		Balance Sheet Location		Fair Value
Interest rate contracts		Loans	$	—		Other liabilities	$	1,782
Interest rate contracts		Other Assets		1,782		Other liabilities		3,141

Total derivatives designated as hedging instruments				1,782				4,923

Derivatives not designated as hedging instruments
Mortgage loan contracts		Other assets		642		Other liabilities		—

Total derivatives not designated as hedging instruments				642				—

Total derivatives			$	2,424			$	4,923

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 statements of income for the three and six month periods ending June 30 is as follows:


	Amount of Loss Recognized in Other Comprehensive Income on Derivative (Effective Portion)					Amount of Loss Recognized in Other Comprehensive Income on Derivative (Effective Portion)
	Three Months Ended June 30					Six Months Ended June 30
Derivative in cash flow	2016			2015		2016			2015
hedging relationship	(Unaudited)			(Unaudited)		(Unaudited)			(Unaudited)
Interest rate contracts	$	(54	)	$	332	$	(419	)	$	118

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	Location of gain (loss)	2016			2015			2016			2015
hedging relationship	recognized on derivative	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Interest rate contracts	Interest income - loans	$	1,110		$	(1,186	)	$	3,611		$	(186	)
Interest rate contracts	Interest income - loans		(1,110	)		1,186			(3,611	)		186

Total		$	—		$	—		$	—		$	—


		Amount of Gain (Loss) Recognized on Derivative Three Months Ended June 30						Amount of Gain (Loss) Recognized on Derivative Six Months Ended June 30
Derivative not designated	Location of gain (loss)	2016			2015			2016			2015
as hedging relationship	recognized on derivative	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Mortgage contracts	Other income - gain on sale of loans	$	468		$	83		$	471		$	272

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, 2016. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

Hedged loans

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

Interest rate swap agreements

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


				Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs			Significant Unobservable Inputs
	Fair Value			(Level 1)		(Level 2)			(Level 3)
June 30, 2016
Available-for-sale securities
U.S. Treasury and federal agencies	$	18,470		$	—	$	18,470		$	—
State and municipal		62,611			—		62,611			—
Federal agency collateralized mortgage obligations		154,263			—		154,263			—
Federal agency mortgage-backed pools		219,823			—		219,823			—
Corporate notes		72			—		72			—

Total available-for-sale securities		455,239			—		455,239			—
Hedged loans		116,338			—		116,338			—
Forward sale commitments		1,111			—		1,111			—
Interest rate swap agreements		(9,179	)		—		(9,179	)		—
Commitments to originate loans		—			—		—			—
December 31, 2015
Available-for-sale securities
U.S. Treasury and federal agencies	$	5,926		$	—	$	5,926		$	—
State and municipal		75,095			—		75,095			—
Federal agency collateralized mortgage obligations		156,203			—		156,203			—
Federal agency mortgage-backed pools		207,704			—		207,704			—
Corporate notes		54			—		54			—

Total available-for-sale securities		444,982			—		444,982			—
Hedged loans		115,472			—		115,472			—
Forward sale commitments		642			—		642			—
Interest rate swap agreements		(4,923	)		—		(4,923	)		—

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	2016			2015			2016			2015
Total gains and losses from:	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Hedged loans	$	1,110		$	(1,186	)	$	3,611		$	(186	)
Fair value interest rate swap agreements		(1,110	)		1,186			(3,611	)		186
Derivative loan commitments		468			83			471			272

	$	468		$	83		$	471		$	272

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):


			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2016
Impaired loans	$	3,830	$	—	$	—	$	3,830
Mortgage servicing rights		9,714		—		—		9,714
December 31, 2015
Impaired loans	$	6,803	$	—	$	—	$	6,803
Mortgage servicing rights		8,874		—		—		8,874

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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 due to impairment decreased by $46,000 during the first six months of 2016 and decreased by $18,000 during the first six months of 2015.

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		Valuation		Range (Weighted
	June 30, 2016		Technique	Unobservable Inputs	Average)
Impaired loans	$	3,830	Collateral based measurement	Discount to reflect current market conditions and ultimate collectability	10% - 15% (12%)
Mortgage servicing rights	$	9,714	Discounted cashflows	Discount rate, Constant prepayment rate, Probability of default	10% - 15% (12%), 4% - 7% (4.6%), 1% - 10% (4.5%)

	Fair Value at		Valuation		Range (Weighted
	December 31, 2015		Technique	Unobservable Inputs	Average)
Impaired loans	$	6,803	Collateral based measurement	Discount to reflect current market conditions and ultimate collectability	10% - 15% (12%)
Mortgage servicing rights	$	8,874	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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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, 2016 and December 31, 2015. 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.

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, 2016
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
	Amount		(Level 1)		(Level 2)		(Level 3)
Assets
Cash and due from banks	$	109,224	$	109,224	$	—	$	—
Investment securities, held to maturity		173,696		—		180,059		—
Loans held for sale		7,812		—		—		7,812
Loans excluding loan level hedges, net		1,807,261		—		—		1,798,943
Stock in FHLB and FRB		16,636		—		16,636		—
Interest receivable		11,526

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