Table of Contents

 

 

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):

 

Large Accelerated Filer		¨		Accelerated Filer		x
Non-accelerated Filer		¨  Do not check if smaller reporting company		Smaller Reporting Company		¨

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

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.

 

 

 

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Table of Contents

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

 

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Table of Contents

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

 

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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

 

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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

 

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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

 

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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

 

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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.

 

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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:

 

 

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.

 

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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.

 

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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.

 

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HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

 

 

Of the total estimated purchase price of $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.

 

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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
		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.

 

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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	)

 

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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.

 

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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.

 

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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

 

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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.

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. Amounts for Kosciusko were estimated as of June 30, 2016 as the final analysis of loans with deterioration was not completed.

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

 

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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

 

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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

 

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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

 

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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.

 

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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

 

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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.

 

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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.

 

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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.

 

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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.

 

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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	%

 

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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.

 

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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

 

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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.

 

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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:

 

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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

 

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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.

 

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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.

 

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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				—				11,526				—
Liabilities
Non-interest bearing deposits		$	397,412			$	397,412			$	—			$	—
Interest-bearing deposits			1,684,849				—				1,656,009				—
Borrowings			492,883				—				491,538				—
Subordinated debentures			32,874				—				33,000				—
Interest payable			961				—				961				—
		December 31, 2015
						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		$	48,650			$	48,650			$	—			$	—
Investment securities, held to maturity			187,629				—				193,703				—
Loans held for sale			7,917				—				—				7,917
Loans excluding loan level hedges, net			1,619,125				—				—				1,703,506
Stock in FHLB and FRB			13,823				—				13,823				—
Interest receivable			10,535				—				10,535				—
Liabilities
Non-interest bearing deposits		$	335,955			$	335,955			$	—			$	—
Interest-bearing deposits			1,544,198				—				1,461,314				—
Borrowings			449,347				—				441,547				—
Subordinated debentures			32,797				—				32,996				—
Interest payable			507				—				507				—

 

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Notes to Condensed Consolidated Financial Statements

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

 

Note 12 – Accumulated Other Comprehensive Income

 

		June 30 2016				December 31 2015
Unrealized gain on securities available for sale		$	8,681			$	920
Unamortized gain on securities held to maturity, previously transferred from AFS			632				1,109
Unrealized loss on derivative instruments			(3,786	)			(3,141	)
Tax effect			(1,934	)			389
Total accumulated other comprehensive income (loss)		$	3,593			$	(723	)

Note 13 – Regulatory Capital

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

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined), or leverage ratio. For June 30, 2016, Basel III rules require the Bank to maintain minimum amounts and ratios of common equity Tier I capital (as defined in the regulation) to risk-weighted assets (as defined). Additionally, under Basel III rules, the decision was made to opt-out of including accumulated other comprehensive income in regulatory capital.

To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based, common equity Tier I risk-based (June 30, 2016) and Tier I leverage ratios as set forth in the table below. As of June 30, 2016 and December 31, 2015, the Bank met all capital adequacy requirements to be considered well capitalized. There have been no conditions or events since the end of the second quarter of 2016 that management believes have changed the Bank’s classification as well capitalized. There is no threshold for well-capitalized status for bank holding companies.

Horizon and the Bank’s actual and required capital ratios as of June 30, 2016 and December 31, 2015 were as follows:

 

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Notes to Condensed Consolidated Financial Statements

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

 

										Required For Capital1								Well Capitalized Under Prompt1
		Actual								Adequacy Purposes								Corrective Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of June 30, 2016
Total capital1 (to risk-weighted assets)
Consolidated		$	267,414				12.56	%		$	183,703				8.63	%			N/A				N/A
Bank			257,203				12.45	%			178,286				8.63	%		$	206,589				10.00	%
Tier 1 capital1 (to risk-weighted assets)
Consolidated			253,188				11.89	%			141,130				6.63	%			N/A				N/A
Bank			242,977				11.77	%			136,868				6.63	%			165,150				8.00	%
Common equity tier 1 capital1 (to risk-weighted assets) Consolidated			220,120				10.34	%			109,200				5.13	%			N/A				N/A
Bank			242,977				11.77	%			105,902				5.13	%			134,184				6.50	%
Tier 1 capital1 (to average assets)
Consolidated			253,188				9.55	%			106,069				4.00	%			N/A				N/A
Bank			242,977				9.18	%			105,872				4.00	%			132,340				5.00	%
As of December 31, 2015
Total capital1 (to risk-weighted assets)
Consolidated		$	264,452				13.99	%		$	151,223				8.00	%			N/A				N/A
Bank			237,348				12.57	%			151,057				8.00	%		$	188,821				10.00	%
Tier 1 capital1 (to risk-weighted assets)
Consolidated			249,918				13.22	%			113,427				6.00	%			N/A				N/A
Bank			222,814				11.80	%			113,295				6.00	%			151,060				8.00	%
Common equity tier 1 capital1 (to risk-weighted assets) Consolidated			204,350				10.81	%			85,067				4.50	%			N/A				N/A
Bank			222,814				11.80	%			84,971				4.50	%			122,737				6.50	%
Tier 1 capital1 (to average assets)
Consolidated			249,918				9.82	%			101,800				4.00	%			N/A				N/A
Bank			222,814				8.77	%			101,626				4.00	%			127,032				5.00	%

 

1	As defined by regulatory agencies

Note 14 – Preferred Stock Redemption

On February 1, 2016, Horizon completed the redemption (the “Redemption”) of all 12,500 outstanding shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “SBLF Preferred Stock”) which were held by the U.S. Department of Treasury and issued pursuant to its Small Business Lending Fund (“SBLF”). The SBLF Preferred Stock was redeemed at its liquidation value of $1,000 per share, plus accrued dividends, for a total Redemption price of $12,510,416.67. Horizon funded the Redemption using cash on hand without borrowing and without a special dividend from the Bank. Following the Redemption, Horizon does not have any shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series B outstanding. The Redemption terminates Horizon’s participation in the SBLF.

Note 15 – Business Combinations

On July 12, 2016, Horizon announced the acquisition of CNB Bancorp, parent company of The Central National Bank and Trust Company (“Central National Bank & Trust”). Under the terms of the Merger Agreement, stockholders of CNB Bancorp will receive cash consideration consisting of a special dividend calculated as capital in excess of 8% of CNB Bancorp’s total assets, less certain after tax transaction costs and an amount to be paid by Horizon equal to 120% of remaining capital. These amounts will be determined as of the end of the month prior to the closing of the merger. These amounts are dependent on CNB Bancorp’s earnings and other factors, but if the cash consideration for the stockholders were calculated as of March 31, 2016, the stockholders would receive, in the aggregate, a $6.7 million special dividend and a $5.3 million payment from Horizon. As of June 30, 2016, CNB Bancorp had total assets of approximately $56.4 million.

 

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Notes to Condensed Consolidated Financial Statements

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

 

Note 16 – Future Accounting Matters

In March 2016, the FASB issued ASU 2016-07, Investments - Equity Method and Joint Ventures: Simplifying the Transition to the Equity Method of Accounting. The amendments affect all entities that have an investment that becomes qualified for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. The amendments eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required.

The amendments require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method.

The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Earlier application is permitted.

In June 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Statements. Topic 326 amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. The ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.

Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.

The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (i.e., January 1, 2020, for calendar year entities. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.

 

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Notes to Condensed Consolidated Financial Statements

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

 

Note 17 – General Litigation

The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operation and cash flows of the Company.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

ITEM 2.

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

Forward–Looking Statements

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

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

 

•

economic conditions and their impact on Horizon and its customers;

 

•

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

 

•

rising interest rates and their impact on mortgage loan volumes and the outflow of deposits;

 

•

loss of key Horizon personnel;

 

•

increases in disintermediation, as new technologies allow consumers to complete financial transactions without the assistance of banks;

 

•

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

 

•

volatility and disruption in financial markets;

 

•

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

 

•

sources of liquidity;

 

•

potential risk of environmental liability related to lending activities;

 

•

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

 

•

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

 

•

the impact of the new Basel III capital rules;

 

•

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

 

•

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

 

•

rapid technological developments and changes;

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

•

the risks presented by cyber terrorism and data security breaches;

 

•

containing costs and expenses;

 

•

the slowing or failure of economic recovery;

 

•

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

 

•

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

The foregoing list of important factors is not exclusive, and you are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document or, in the case of documents incorporated by reference, the dates of those documents. We do not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of us. For a detailed discussion of the risks and uncertainties that may cause our actual results or performance to differ materially from the results or performance expressed or implied by forward-looking statements, see “Risk Factors” in Item 1A of Part I of our 2015 Annual Report on Form 10-K and in the subsequent reports we file with the SEC.

Overview

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

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.

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, or a combination of both, 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.

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

On July 1, 2015, Horizon completed the acquisition of Peoples Bancorp, an Indiana corporation (“Peoples”) and Horizon Bank’s acquisition of Peoples Federal Savings Bank of DeKalb County, a federally-chartered stock savings bank and wholly owned subsidiary of Peoples, 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.

Following are some highlights of Horizon’s financial performance through the second quarter of 2016:

 

•

Net income for the second quarter of 2016 was $6.3 million or $.52 diluted earnings per share.

 

•

Excluding acquisition-related expenses and gain on sale of investment securities, net income for the second quarter of 2016 increased 38.9% compared to the same period of 2015 to $7.2 million or $.59 diluted earnings per share.

 

•

Net income for the first six months of 2016 was $11.7 million or $.96 diluted earnings per share.

 

•

Excluding acquisition-related expenses, gain on sale of investment securities and the death benefit on bank owned life insurance, net income for the first six months of 2016 increased 24.1% compared to the same period of 2015 to $13.0 million or $1.07 diluted earnings per share.

 

•

Total loans, excluding mortgage warehouse loans, increased 8.1% on an annualized basis during the second quarter of 2016.

 

•

Net interest income for the first six months of 2016 increased 17.0% or $5.9 million compared to the same period in 2015.

 

•

Net interest margin, excluding the impact of acquisitions (“core net interest margin”), was 3.42% for the second quarter of 2016 compared to 3.36% for the prior quarter and 3.51% for the same period in 2015.

 

•

Non-interest income for the first six months of 2016 increased 24.4% or $3.5 million compared to the same period in 2015.

 

•

Horizon’s tangible book value per share rose to $17.17 at June 30, 2016, compared to $16.53 at December 31, 2015 and $17.06 at June 30, 2015.

 

•

Horizon entered Fort Wayne, Indiana in the second quarter of 2016 by establishing a loan production team that will focus on commercial lending in Indiana’s second largest city.

 

•

On June 1, 2016, Horizon closed the acquisition of Kosciusko Financial, Inc. (“Kosciusko”) and its wholly-owned subsidiary, Farmers State Bank, headquartered in Mentone, Indiana.

 

•

On July 18, 2016, Horizon closed the acquisition of LaPorte Bancorp, Inc. (“LaPorte Bancorp”) and its wholly-owned subsidiary, The LaPorte Savings Bank, headquartered in La Porte, Indiana. LaPorte Bancorp’s results are not included in Horizon’s June 30, 2016 financial results.

 

•

On July 12, 2016, Horizon announced the pending acquisition of CNB Bancorp and its wholly-owned subsidiary, The Central National Bank and Trust Company, headquartered in Attica, Indiana.

Critical Accounting Policies

The notes to the consolidated financial statements included in Item 8 of the Company’s Annual Report on Form 10-K for 2015 contain a summary of the Company’s significant accounting policies. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management has identified as critical accounting policies the allowance for loan losses, intangible assets, mortgage servicing rights, hedge accounting and valuation measurements.

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Allowance for Loan Losses

An allowance for loan losses is maintained to absorb probable incurred loan losses inherent in the loan portfolio. The determination of the allowance for loan losses is a critical accounting policy that involves management’s ongoing quarterly assessments of the probable incurred losses inherent in the loan portfolio. The identification of loans that have probable incurred losses is subjective; therefore, a general reserve is maintained to cover all probable losses within the entire loan portfolio. Horizon utilizes a loan grading system that helps identify, monitor and address asset quality problems in an adequate and timely manner. Each quarter, various factors affecting the quality of the loan portfolio are reviewed. Large credits are reviewed on an individual basis for loss potential. Other loans are reviewed as a group based upon previous trends of loss experience. Horizon also reviews the current and anticipated economic conditions of its lending market as well as transaction risk to determine the effect they may have on the loss experience of the loan portfolio.

Goodwill and Intangible Assets

Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. FASB ASC 350-10 establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. At June 30, 2016, Horizon had core deposit intangibles of $8.7 million subject to amortization and $56.5 million of goodwill, which is not subject to amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. Horizon’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Horizon to provide quality, cost effective banking services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely affect earnings in future periods. FASB ASC 350-10 requires an annual evaluation of goodwill for impairment. The evaluation of goodwill for impairment requires the use of estimates and assumptions. Market price at the close of business on June 30, 2016 was $25.14 per share compared to a book value of $22.35 per common share.

Horizon has concluded that, based on its own internal evaluation, the recorded value of goodwill is not impaired.

Mortgage Servicing Rights

Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets on a servicing-retained basis. Capitalized servicing rights are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated regularly for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying servicing rights by predominant characteristics, such as interest rates, original loan terms and whether the loans are fixed or adjustable rate mortgages. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. When the book value of an individual stratum exceeds its fair value, an impairment reserve is recognized so that each individual stratum is carried at the lower of its amortized book value or fair value. In periods of falling market interest rates, accelerated loan prepayment can adversely affect the fair value of these mortgage-servicing rights relative to their book value. In the event that the fair value of these assets was to increase in the future, Horizon can recognize the increased fair value to the extent of the impairment allowance but cannot recognize an asset in excess of its amortized book value. Future changes in management’s assessment of the impairment of these servicing assets, as a result of changes in observable market data relating to market interest rates, loan prepayment speeds, and other factors, could impact Horizon’s financial condition and results of operations either positively or negatively.

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Generally, when market interest rates decline and other factors favorable to prepayments occur, there is a corresponding increase in prepayments as customers refinance existing mortgages under more favorable interest rate terms. When a mortgage loan is prepaid, the anticipated cash flows associated with servicing that loan are terminated, resulting in a reduction of the fair value of the capitalized mortgage servicing rights. To the extent that actual borrower prepayments do not react as anticipated by the prepayment model (i.e., the historical data observed in the model does not correspond to actual market activity), it is possible that the prepayment model could fail to accurately predict mortgage prepayments and could result in significant earnings volatility. To estimate prepayment speeds, Horizon utilizes a third-party prepayment model, which is based upon statistically derived data linked to certain key principal indicators involving historical borrower prepayment activity associated with mortgage loans in the secondary market, current market interest rates and other factors, including Horizon’s own historical prepayment experience. For purposes of model valuation, estimates are made for each product type within the mortgage servicing rights portfolio on a monthly basis. In addition, on a quarterly basis Horizon engages a third party to independently test the value of its servicing asset.

Derivative Instruments

As part of the Company’s asset/liability management program, Horizon utilizes, from time-to-time, interest rate floors, caps or swaps to reduce the Company’s sensitivity to interest rate fluctuations. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values of derivatives are reported in the consolidated income statements or other comprehensive income (“OCI”) depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be highly effective in achieving offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedge and on an ongoing basis.

Horizon’s accounting policies related to derivatives reflect the guidance in FASB ASC 815-10. Derivatives that qualify for the hedge accounting treatment are designated as either: a hedge of the fair value of the recognized asset or liability or of an unrecognized firm commitment (a fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (a cash flow hedge). For fair value hedges, the cumulative change in fair value of both the hedge instruments and the underlying loans is recorded in non-interest income. For cash flow hedges, changes in the fair values of the derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected in the consolidated income statement in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, Horizon establishes the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of income. Horizon excludes the time value expiration of the hedge when measuring ineffectiveness.

Valuation Measurements

Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities, residential mortgage loans held for sale and derivatives are carried at fair value, as defined in FASB ASC 820, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts of goodwill, mortgage servicing rights, and pension and other post-retirement benefit obligations. To determine the values of these assets and liabilities, as well as

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

the extent, to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment speeds and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect Horizon’s results of operations.

Financial Condition

On June 30, 2016, Horizon’s total assets were $2.9 billion, an increase of approximately $265.7 million compared to December 31, 2015. The increase was primarily in net loans of $189.0 million and cash of $60.6 million offset partially by a decrease in investment securities of $3.7 million.

Investment securities were comprised of the following as of (dollars in thousands):

 

		June 30, 2016								December 31, 2015
		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
Available for sale
U.S. Treasury and federal agencies		$	18,384			$	18,470			$	5,940			$	5,926
State and municipal			60,961				62,611				73,829				75,095
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
Corporate notes			32				72				32				54
Total available for sale investment securities		$	446,558			$	455,239			$	444,062			$	444,982
Held to maturity
U.S. Treasury and federal agencies		$	—			$	—			$	5,859			$	5,952
State and municipal			143,093				148,073				146,331				151,453
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

Total investment securities decreased by approximately $3.7 million at June 30, 2016 compared to December 31, 2015, primarily due to the cash in-flows from investment securities used to fund loan growth.

Total loans increased $188.7 million since December 31, 2015 to $1.9 billion as of June 30, 2016. This increase was the result of an increase in commercial loans of $69.6 million, mortgage warehouse loans of $61.0 million, residential mortgage loans of $56.5 million and consumer loans of $1.6 million. The growth in total loans during the six months ended June 30, 2015 is the direct result of increased calling efforts to increase Horizon’s market share within the Company’s footprint and market expansion as well as the loans added through the Kosciusko acquisition.

Total deposits increased $202.1 million since December 31, 2015 to $2.1 billion as of June 30, 2016. Non-interest bearing deposit accounts increased by $61.5 million, interest-bearing transaction accounts decreased by $36.0 million and time deposits increased by $104.6 million during the six months ended June 30, 2016.

The Company’s borrowings increased $43.5 million from December 31, 2015 to $492.9 million as of June 30, 2016. At June 30, 2016, the Company had $192.0 million in short-term funds borrowed compared to $206.0 million at December 31, 2015. The Company’s current balance sheet strategy is to utilize a reasonable level of short-term borrowings during extended low rate environments along with seasonal increases in municipal deposits to fund an increase in mortgage warehouse loans.

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Stockholders’ equity totaled $281.0 million at June 30, 2016 compared to $266.8 million at December 31, 2015. The increase in stockholders’ equity during the period was the result of the generation of net income, net of dividends declared, as well as the stock issued in the Kosciusko acquisition. At June 30, 2016, the ratio of average stockholders’ equity to average assets was 9.94% compared to 10.32% at December 31, 2015 due to the growth in earning assets. Book value per common share at June 30, 2016 increased to $22.35 compared to $21.30 at December 31, 2015.

Results of Operations

Overview

Consolidated net income for the three-month period ended June 30, 2016 was $6.3 million compared to $4.7 million for the same period in 2015. Earnings per common share for the three months ended June 30, 2016 were $0.52 basic and $0.52 diluted, compared to $0.51 basic and $0.49 diluted for the same three-month period in the previous year. The increase in net income and earnings per share from the previous year reflects an increase in net interest income and non-interest income of $3.0 million and $2.7 million, respectively, and a decrease in the provision for loan losses of $1.7 million, partially offset by increases in non-interest expense of $4.9 million, income tax expense of $873,000 and the diluted shares outstanding primarily due to the stock issued in the Peoples and Kosciusko acquisitions. Non-interest expenses increased primarily due to an increase in salaries and employee benefits and expenses related to outside services and consultants. Excluding acquisition-related expenses and purchase accounting adjustments, gain on sale of investment securities, net income for the second quarter of 2016 was $6.9 million or $.57 diluted earnings per share compared to $4.6 million or $.49 diluted earnings per share in the same period of 2015.

Consolidated net income for the six-month period ended June 30, 2016 was $11.7 million compared to $10.1 million for the same period in 2015. Earnings per common share for the six months ended June 30, 2016 were $.97 basic and $.96 diluted, compared to $1.09 basic and $1.04 diluted for the same period of 2015. The increase in net income from the previous year reflects an increase in net interest income and non-interest income of $5.9 million and $3.5 million, respectively, and a decrease in the provision for loan losses of $1.8 million, partially offset by increases in non-interest expense of $8.6 million and income tax expense of $939,000. The decrease in diluted earnings per share compared to the same period of 2015 was due to an increase in the diluted shares outstanding primarily due to the stock issued in the Peoples and Kosciusko acquisitions. Non-interest expenses increased primarily due to an increase in salaries and employee benefits and expenses related to outside services and consultants. Excluding acquisition-related expenses and purchase accounting adjustments, and gain on sale of investment securities and the death benefit on bank owned life insurance, net income for the six months ended June 30, 2016 was $12.3 million or $1.01 diluted earnings per share compared to $9.2 million or $.95 diluted earnings per share in the same period of 2015.

Net Interest Income

The largest component of net income is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities, and interest expense, principally on deposits and borrowings. Changes in the net interest income are the result of changes in volume and the net interest spread, which affects the net interest margin. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Net interest margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

Net interest income during the three months ended June 30, 2016 was $20.9 million, an increase of $3.0 million from the $17.9 million earned during the same period in 2015. Yields on the Company’s interest-earning assets decreased by 23 basis points to 4.10% for the three months ending June 30, 2016 from 4.33% for the three months ended June 30, 2015. Interest income increased $3.5 million from $21.1 million for the

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

three months ended June 30, 2015 to $24.7 million for the same period in 2016. This increase was due to an increase in interest-earning assets, a $415,000 prepayment penalty received on an investment security during the second quarter, partially offset by lower yields on loans and investment securities and a decrease in interest income from acquisition-related purchase accounting adjustments from $797,000 for the three months ending June 30, 2015 to $397,000 for the same period of 2016.

Rates paid on interest-bearing liabilities decreased by 5 basis points for the three-month period ended June 30, 2016 compared to the same period in 2015 due to the continued low interest rate environment and shift in mix on interest-bearing liabilities. Interest expense increased $504,000 compared to the three-month period ended June 30, 2015 to $3.8 million for the same period in 2016. This increase was due to higher average balances of interest-bearing deposits and borrowings and higher rates on borrowings, partially offset by lower rates paid on interest-bearing deposits. The net interest margin decreased 19 basis points from 3.67% for the three-month period ended June 30, 2015 to 3.48% for the same period in 2016. The decrease in the margin for the three-month period ended June 30, 2016 compared to the same period in 2015 was due to a reduction in the yield on interest-earning assets and a decrease of approximately $400,000 of interest income from acquisition-related purchase accounting adjustments. Excluding the interest income recognized from the acquisition-related purchase accounting adjustments, the margin would have been 3.42% for the three-month period ending June 30, 2016 compared to 3.51% for the same period in 2015.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

The following are the average balance sheets for the three months ending (dollars in thousands):

 

		Three Months Ended												Three Months Ended
		June 30, 2016												June 30, 2015
		Average								Average				Average								Average
		Balance				Interest				Rate				Balance				Interest				Rate
ASSETS
Interest-earning assets
Federal funds sold		$	3,309			$	4				0.49	%		$	3,597			$	2				0.22	%
Interest-earning deposits			28,045				59				0.85	%			8,608				5				0.23	%
Investment securities - taxable			469,925				2,598				2.22	%			363,919				2,060				2.27	%
Investment securities - non-taxable (1)			182,886				1,195				3.70	%			141,784				1,079				4.24	%
Loans receivable (2)(3)			1,787,189				20,794				4.69	%			1,490,283				17,981				4.87	%
Total interest-earning assets (1)			2,471,354				24,650				4.10	%			2,008,191				21,127				4.33	%
Non-interest-earning assets
Cash and due from banks			35,435												31,783
Allowance for loan losses			(14,350	)											(16,756	)
Other assets			223,258												157,795
		$	2,715,697											$	2,181,013
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities
Interest-bearing deposits		$	1,625,024			$	1,557				0.39	%		$	1,255,123			$	1,237				0.40	%
Borrowings			400,585				1,721				1.73	%			381,782				1,539				1.62	%
Subordinated debentures			32,854				503				6.16	%			32,699				501				6.15	%
Total interest-bearing liabilities			2,058,463				3,781				0.74	%			1,669,604				3,277				0.79	%
Non-interest-bearing liabilities
Demand deposits			364,822												294,425
Accrued interest payable and other liabilities			22,574												13,770
Stockholders’ equity			269,838												203,214
		$	2,715,697											$	2,181,013
Net interest income/spread						$	20,869				3.36	%						$	17,850				3.54	%
Net interest income as a percent of average interest earning assets (1)											3.48	%											3.67	%

 

(1)	Securities balances represent daily average balances for the fair value of securities. The average rate is calculated based on the daily average balance for the amortized cost of securities. Interest rate is presented on a tax equivalent basis.

(2)	Includes loan fees and late fees. The inclusion of these fees does not have a material effect on the average interest rate.

(3)	Non-accruing loans for the purpose of the computations above are included in the daily average loan amounts outstanding. Loan totals are shown net of unearned income and deferred loans fees.

Net interest income during the six months ended June 30, 2016 was $40.6 million, an increase of $5.9 million from the $34.7 million earned during the same period in 2015. Yields on the Company’s interest-earning assets decreased by 25 basis points to 4.10% for the six months ending June 30, 2016 from 4.35% for the six months ended June 30, 2015. Interest income increased $7.0 million from $41.2 million for the six months ended June 30, 2015 to $48.2 million for the same period in 2016. This increase was due to an increase in interest-earning assets, a $415,000 prepayment penalty received on an investment security during the second quarter, partially offset by lower yields on loans and investment securities and a decrease in interest income from acquisition-related purchase accounting adjustments from $1.9 million for the six months ending June 30, 2015 to $944,000 for the same period of 2016.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Rates paid on interest-bearing liabilities decreased by 4 basis points for the six-month period ended June 30, 2016 compared to the same period in 2015 due to the continued low interest rate environment and shift in mix on interest-bearing liabilities. Interest expense increased $1.1 million compared to the six-month period ended June 30, 2015 to $7.5 million for the same period in 2016. This increase was due to higher average balances of interest-bearing deposits and borrowings and higher rates on borrowings, partially offset by lower rates paid on interest-bearing deposits. The net interest margin decreased 21 basis points from 3.68% for the six-month period ended June 30, 2015 to 3.47% for the same period in 2016. The decrease in the margin for the six-month period ended June 30, 2016 compared to the same period in 2015 was due to a reduction in the yield on interest-earning assets and a decrease of approximately $936,000 of interest income from acquisition-related purchase accounting adjustments. Excluding the interest income recognized from the acquisition-related purchase accounting adjustments, the margin would have been 3.40% for the six-month period ending June 30, 2016 compared to 3.49% for the same period in 2015.

The following are the average balance sheets for the six months ending (dollars in thousands):

 

		Six Months Ended												Six Months Ended
		June 30, 2016												June 30, 2015
		Average								Average				Average								Average
		Balance				Interest				Rate				Balance				Interest				Rate
ASSETS
Interest-earning assets
Federal funds sold		$	2,853			$	4				0.28	%		$	4,198			$	11				0.53	%
Interest-earning deposits			24,300				109				0.90	%			9,684				10				0.21	%
Investment securities - taxable			464,209				5,092				2.21	%			362,250				4,200				2.34	%
Investment securities - non-taxable (1)			181,660				2,432				3.64	%			141,269				2,156				4.27	%
Loans receivable (2)(3)			1,733,446				40,541				4.71	%			1,436,886				34,843				4.90	%
Total interest-earning assets (1)			2,406,468				48,178				4.10	%			1,954,287				41,220				4.35	%
Non-interest-earning assets
Cash and due from banks			34,246												30,396
Allowance for loan losses			(14,350	)											(16,623	)
Other assets			217,797												157,669
		$	2,644,161											$	2,125,729
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities
Interest-bearing deposits		$	1,571,579			$	3,048				0.39	%		$	1,235,601			$	2,469				0.40	%
Borrowings			401,594				3,480				1.74	%			359,436				3,018				1.69	%
Subordinated debentures			32,653				1,007				6.20	%			32,678				997				6.15	%
Total interest-bearing liabilities			2,005,826				7,535				0.76	%			1,627,715				6,484				0.80	%
Non-interest-bearing liabilities
Demand deposits			350,157												282,796
Accrued interest payable and other liabilities			22,465												14,374
Stockholders’ equity			265,713												200,844
		$	2,644,161											$	2,125,729
Net interest income/spread						$	40,643				3.34	%						$	34,736				3.55	%
Net interest income as a percent of average interest earning assets (1)											3.47	%											3.68	%

 

(1)	Securities balances represent daily average balances for the fair value of securities. The average rate is calculated based on the daily average balance for the amortized cost of securities. Interest rate is presented on a tax equivalent basis.

(2)	Includes loan fees and late fees. The inclusion of these fees does not have a material effect on the average interest rate.

(3)	Non-accruing loans for the purpose of the computations above are included in the daily average loan amounts outstanding. Loan totals are shown net of unearned income and deferred loans fees.

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Provision for Loan Losses

Horizon assesses the adequacy of its Allowance for Loan and Lease Losses (“ALLL”) by regularly reviewing the performance of its loan portfolio. During the three-month period ended June 30, 2016, a provision of $232,000 was required to adequately fund the ALLL compared to $1.9 million for the same period of 2015. Commercial loan net charge-offs during the three-month period ended June 30, 2016 were $104,000, residential mortgage loan net charge-offs were negative $31,000 and consumer loan net charge-offs were $169,000. The lower provision for loan losses in the second quarter of 2016 compared to the same period of 2015 was due to the improvement of non-performing loans. The ALLL balance at June 30, 2016 was $14.2 million or 0.73% of total loans. This compares to an ALLL balance of $14.5 million at December 31, 2015 or 0.83% of total loans. The decrease in the ratio at June 30, 2016 compared to December 31, 2015 was due to an increase in total loans of $188.7 million, the increase in loans from the Kosciusko merger and improving credit trends.

For the six-month period ended June 30, 2016, the provision for loan losses totaled $764,000 compared to $2.5 million in the same period of 2015. The lower provision for loan losses in the second quarter of 2016 compared to the same period of 2015 was due to the improvement of non-performing loans and the charge-off of one commercial credit of $1.3 million in the first six months of 2015.

Horizon’s loan loss reserve ratio, excluding loans with credit-related purchase accounting adjustments, stood at 0.89% as of June 30, 2016. Loan loss reserves and credit-related loan discounts on acquired loans as a percentage of total loans was 1.32% as of June 30, 2016. The table below illustrates Horizon’s loan loss reserve ratio composition as of June 30, 2016.

Non- GAAP Allowance for Loan and Lease Loss Detail

As of June 30, 2016

(Dollars in Thousands, Unaudited)

 

		Horizon
		Legacy				Heartland				Summit				Peoples				Kosciusko				Total
Pre-discount loan balance		$	1,591,788			$	19,346			$	69,137			$	169,224			$	99,873			$	1,949,368
Allowance for loan losses (ALLL)			14,226				—				—				—				—				14,226
Loan discount			N/A				1,222				2,801				3,694				3,826				11,543
ALLL+loan discount			14,226				1,222				2,801				3,694				3,826				25,769
Loans, net		$	1,577,562			$	18,124			$	66,336			$	165,530			$	96,047			$	1,923,599
ALLL/ pre-discount loan balance			0.89	%			0.00	%			0.00	%			0.00	%			0.00	%			0.73	%
Loan discount/ pre-discount loan balance			N/A				6.32	%			4.05	%			2.18	%			3.83	%			0.59	%
ALLL+loan discount/ pre-discount loan balance			0.89	%			6.32	%			4.05	%			2.18	%			3.83	%			1.32	%

No assurance can be given that Horizon will not, in any particular period, sustain loan losses that are significant in relation to the amount reserved, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, including economic conditions and management’s ongoing quarterly assessments of the portfolio, will not require increases in the allowance for loan losses. Horizon considers the allowance for loan losses to be appropriate to cover probable incurred losses in the loan portfolio as of June 30, 2016.

Non-performing loans totaled $13.2 million as of June 30, 2016, down from $16.7 million on December 31, 2015. Compared to December 31, 2015, non-performing commercial, real estate and consumer loans decreased by $2.7 million, $577,000 and $255,000, respectively.

Other Real Estate Owned (OREO) totaled $3.5 million at June 30, 2016 compared to $3.2 million on December 31, 2015 and $471,000 on June 30, 2015.

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Non-interest Income

The following is a summary of changes in non-interest income (three and six month table dollar amounts in thousands):

 

		Three Months Ended
		June 30				June 30				Amount				Percent
		2016				2015				Change				Change
Non-interest Income
Service charges on deposit accounts		$	1,335			$	1,085			$	250				23.0	%
Wire transfer fees			175				182				(7	)			-3.8	%
Interchange fees			1,663				1,366				297				21.7	%
Fiduciary activities			1,465				1,216				249				20.5	%
Gain on sale of securities			767				—				767				NM
Gain on sale of mortgage loans			3,529				2,642				887				33.6	%
Mortgage servicing net of impairment			500				300				200				66.7	%
Increase in cash surrender value of bank owned life insurance			351				257				94				36.6	%
Other income			84				138				(54	)			-39.1	%
Total non-interest income		$	9,869			$	7,186			$	2,683				37.3	%

Total non-interest income was $2.7 million higher in the second quarter of 2016 compared to the same period of 2015. Service charges on deposit accounts increased $250,000, interchange fees increased by $297,000 and fiduciary activities increased $249,000, primarily due to overall company growth and increased volume. Gain on sale of securities increased $767,000 due to gains realized in the second quarter of 2016 as the result of an analysis that determined market conditions provided the opportunity to add gains to capital without negatively impacting long-term earnings. Residential mortgage loan activity during the second quarter of 2016 generated $3.5 million of income from the gain on sale of mortgage loans, up $887,000 from the same period in 2015. The increase in the gain on sale of mortgage loans was due to an increase in the percentage earned on the sale of these loans from 3.07% in the second quarter of 2015 to 3.68% in the same period of 2016. Mortgage servicing net of impairment increased by $200,000 during the second quarter of 2016 compared to the same period of 2015 primarily due to a larger portfolio of mortgage loans serviced.

 

		Six Months Ended
		June 30				June 30				Amount				Percent
		2016				2015				Change				Change
Non-interest Income
Service charges on deposit accounts		$	2,573			$	2,084			$	489				23.5	%
Wire transfer fees			296				333				(37	)			-11.1	%
Interchange fees			3,121				2,468				653				26.5	%
Fiduciary activities			3,100				2,513				587				23.4	%
Gain on sale of investment securities			875				124				751				605.6	%
Gain on sale of mortgage loans			5,643				5,021				622				12.4	%
Mortgage servicing net of impairment			947				479				468				97.7	%
Increase in cash surrender value of bank owned life insurance			696				515				181				35.1	%
Death benefit on officer life insurance			—				145				(145	)			100.0	%
Other income			482				570				(88	)			-15.4	%
Total non-interest income		$	17,733			$	14,252			$	3,481				24.4	%

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Total non-interest income was $3.5 million higher in the first six months of 2016 compared to the same period of 2015. Service charges on deposit accounts increased $489,000, interchange fees increased by $653,000 and fiduciary activities increased $587,000, primarily due to overall company growth and increased volume. Gain on sale of securities increased $751,000 due to gains realized in the first six months of 2016 as the result of an analysis that determined market conditions provided the opportunity to add gains to capital without negatively impacting long-term earnings. Residential mortgage loan activity during the first six months of 2016 generated $5.6 million of income from the gain on sale of mortgage loans, up $622,000 from the same period in 2015. The increase in the gain on sale of mortgage loans was due to an increase in the percentage earned on the sale of these loans from 3.12% in the first half of 2015 to 3.74% in the same period of 2016, partially offset by a decrease in total loans sold of $13.8 million from $152.3 million in the first half of 2015 to $138.5 million in the same period of 2016. Mortgage servicing net of impairment increased by $468,000 during the first six months of 2016 compared to the same period of 2015 primarily due to a larger portfolio of mortgage loans serviced. The cash surrender value of bank owned life insurance increased by $181,000 in the first six months of 2016 compared to the same period in 2015 due to the addition of bank owned life insurance policies as a result of the Peoples acquisition. The death benefit on bank owned life insurance decreased by $145,000 compared to the previous year due to a $145,000 death benefit on officer life insurance realized during the first six months of 2015.

Non-interest Expense

The following is a summary of changes in non-interest expense (three and six month table dollar amounts in thousands):

 

		Three Months Ended
		June 30				June 30				Amount				Percent
		2016				2015				Change				Change
Non-interest expense
Salaries		$	7,250			$	5,993			$	1,257				21.0	%
Commission and bonuses			1,190				1,200				(10	)			-0.8	%
Employee benefits			1,877				1,192				685				57.5	%
Net occupancy expenses			1,901				1,375				526				38.3	%
Data processing			1,134				966				168				17.4	%
Professional fees			747				660				87				13.2	%
Outside services and consultants			2,198				918				1,280				139.4	%
Loan expense			1,409				1,367				42				3.1	%
FDIC deposit insurance			409				339				70				20.6	%
Other losses			136				150				(14	)			-9.3	%
Other expense			3,304				2,490				814				32.7	%
Total non-interest expense		$	21,555			$	16,650			$	4,905				29.5	%

Total non-interest expenses were $4.9 million higher in the first three months of 2016 compared to the same period of 2015. Salaries increased by $1.3 million and employee benefits increased by $685,000 due to a larger employee base. Net occupancy expense increased $526,000 due to Horizon’s investment in growth markets and the Peoples and Kosciusko acquisitions. Data processing expenses increased $168,000 primarily due to company growth. Other expenses increased by $814,000 primarily due to company growth and one-time merger-related expenses. Outside services and consultants expense increased by $1.3 million due to the one-time fees associated with Kosciusko and LaPorte Bancorp acquisitions. One-time non-interest expense related to the Kosciusko and LaPorte Bancorp acquisitions totaled $1.9 million in the second quarter of 2016 compared to $570,000 in one-time fees associated with the Peoples acquisition in the same period of 2015.

 

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Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

		Six Months Ended
		June 30				June 30				Amount				Percent
		2016				2015				Change				Change
Non-interest expense
Salaries		$	14,136			$	11,626			$	2,510				21.6	%
Commission and bonuses			2,265				2,367				(102	)			-4.3	%
Employee benefits			3,981				2,896				1,085				37.5	%
Net occupancy expenses			3,837				2,926				911				31.1	%
Data processing			2,239				1,889				350				18.5	%
Professional fees			1,578				1,187				391				32.9	%
Outside services and consultants			3,297				1,544				1,753				113.5	%
Loan expense			2,604				2,624				(20	)			-0.8	%
FDIC deposit insurance			814				676				138				20.4	%
Other losses			403				105				298				283.8	%
Other expense			6,148				4,878				1,270				26.0	%
Total non-interest expense		$	41,302			$	32,718			$	8,584				26.2	%

Total non-interest expenses were $8.6 million higher in the first six months of 2016 compared to the same period of 2015. Salaries increased by $2.5 million and employee benefits increased by $1.1 million due to a larger employee base. Net occupancy expense increased $911,000 due to Horizon’s investment in growth markets and the Peoples and Koscisuko acquisitions. Data processing expenses increased $350,000 and FDIC deposit insurance increase by $138,000 primarily due to company growth. Other losses increased by $298,000 primarily due to higher debit card losses and a trust settlement. Other expenses increased by $1.3 million primarily due to company growth and one-time merger-related expenses. Commission and bonuses decreased by $102,000 due to a decrease in loan volume and incentive pay. Outside services and consultants expense increased by $1.8 million due to the one-time fees associated with Kosciusko and LaPorte Bancorp acquisitions. One-time non-interest expense related to the Kosciusko and LaPorte Bancorp acquisitions totaled $2.5 million in the first six months of 2016 compared to $716,000 in one-time fees associated with the Peoples acquisition in the same period of 2015.

Liquidity

The Bank maintains a stable base of core deposits provided by long-standing relationships with individuals and local businesses. These deposits are the principal source of liquidity for Horizon. Other sources of liquidity for Horizon include earnings, loan repayment, investment security sales and maturities, proceeds from the sale of residential mortgage loans, and borrowing relationships with correspondent banks, including the FHLB. During the six months ended June 30, 2016, cash and cash equivalents increased by approximately $60.6 million. At June 30, 2016, in addition to liquidity available from the normal operating, funding, and investing activities of Horizon, the Bank had approximately $300.6 million in unused credit lines with various money center banks, including the FHLB and the FRB Discount Window compared to $253.2 million at December 31, 2015 and $361.7 million at June 30, 2015.

Capital Resources

The capital resources of Horizon and the Bank exceeded regulatory capital ratios for “well capitalized” banks at June 30, 2016. Stockholders’ equity totaled $281.0 million as of June 30, 2016, compared to $266.8 million as of December 31, 2015. For the six months ended June 30, 2016, the ratio of average stockholders’ equity to average assets was 9.94% compared to 10.32% for the twelve months ended December 31, 2015. The increase in stockholders’ equity during the period was the result of the generation of net income, net of dividends declared, as well as the stock issued in the Kosciusko acquisition.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

On February 1, 2016, the Company paid off the $12.5 million in funds received through the Small Business Lending Fund with cash from the holding company, thereby ending its participation in the program, pursuant to which it issued preferred stock to the US Treasury. The funds were paid off due to an increase in the dividend cost that would have gone in effect at the end of February 2016. For the six months ending June 30, 2016, the dividend cost was $42,000 or 1.0% annualized and included the acceleration of interest due to the payoff.

Horizon declared common stock dividends in the amount of $0.30 per share during the first six months of 2016 compared to $0.28 per share for the same period of 2015. The dividend payout ratio (dividends as a percent of basic earnings per share) was 31.0% and 25.8% for the first six months of 2016 and 2015, respectively. For additional information regarding dividends, see Horizon’s Annual Report on Form 10-K for 2015.

Use of Non-GAAP Financial Measures

Certain information set forth in this quarterly report on Form 10-Q refers to financial measures determined by methods other than in accordance with GAAP. Specifically, we have included non-GAAP financial measures of the net interest margin and the allowance for loan and lease losses excluding the impact of acquisition-related purchase accounting adjustments and net income and diluted earnings per share excluding the impact of one-time costs related to acquisitions, acquisition-related purchase accounting adjustments and other events that are considered to be non-recurring. Horizon believes that these non-GAAP financial measures are helpful to investors and provide a greater understanding of our business without giving effect to the purchase accounting impacts and one-time costs of acquisitions and non-core items, although these measures are not necessarily comparable to similar measures that may be presented by other companies and should not be considered in isolation or as a substitute for the related GAAP measure.

Non-GAAP Reconciliation of Net Interest Margin

(dollar in thousands)

 

		Three Months Ended												Six Months Ended
		June 30				March 31				June 30				June 30
		2016				2016				2015				2016				2015
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Net Interest Margin As Reported
Net interest income		$	20,869			$	19,774			$	17,850			$	40,643			$	34,736
Average interest-earning assets			2,471,354				2,367,250				2,008,191				2,406,468				1,954,287
Net interest income as a percent of average interest-earning assets (“Net Interest Margin”)			3.48	%			3.45	%			3.67	%			3.47	%			3.68	%
Impact of Acquisitions
Interest income from acquisition-related purchase accounting adjustments		$	(397	)		$	(547	)		$	(797	)		$	(944	)		$	(1,880	)
Excluding Impact of Acquisitions
Net interest income		$	20,472			$	19,227			$	17,053			$	39,699			$	32,856
Average interest-earning assets			2,471,354				2,367,250				2,008,191				2,406,468				1,954,287
Core Net Interest Margin			3.42	%			3.36	%			3.51	%			3.40	%			3.49	%

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months ended June 30, 2016

 

Non-GAAP Reconciliation of Net Income and Diluted Earnings per Share

(Dollars in Thousands Except per Share Data, Unaudited)

 

		Three Months Ended								Six Months Ended
		June 30								June 30
		2016				2015				2016				2015
Non-GAAP Reconciliation of Net Income
Net income as reported		$	6,326			$	4,728			$	11,707			$	10,086
Merger expenses			1,881				570				2,520				716
Tax effect			(531	)			(132	)			(696	)			(183	)
Net income excluding merger expenses			7,676				5,166				13,531				10,619
Gain on sale of investment securities			(767	)			—				(875	)			(124	)
Tax effect			268				—				306				43
Net income excluding gain on sale of investment securities			7,177				5,166				12,962				10,538
Death benefit on bank owned life insurance (“BOLI”)			—				—				—				(145	)
Tax effect			—				—				—				51
Net income excluding death benefit on BOLI			7,177				5,166				12,962				10,444
Acquisition-related purchase accounting adjustments (“PAUs”)			(397	)			(797	)			(944	)			(1,880	)
Tax effect			139				279				330				658
Net income excluding PAUs		$	6,919			$	4,648			$	12,348			$	9,222
Non-GAAP Reconciliation of Diluted Earnings per Share
Diluted earnings per share as reported		$	0.52			$	0.49			$	0.96			$	1.04
Merger expenses			0.15				0.06				0.21				0.07
Tax effect			(0.04	)			(0.01	)			(0.06	)			(0.02	)
Diluted earnings per share excluding merger expenses			0.63				0.54				1.11				1.09
Gain on sale of investment securities			(0.06	)			—				(0.07	)			(0.01	)
Tax effect			0.02				—				0.03				0.00
Net income excluding gain on sale of investment securities			0.59				0.54				1.07				1.09
Death benefit on BOLI			—				—				—				(0.02	)
Tax effect			—				—				—				0.01
Net income excluding death benefit on BOLI			0.59				0.54				1.07				1.08
Acquisition-related PAUs			(0.03	)			(0.08	)			(0.09	)			(0.20	)
Tax effect			0.01				0.03				0.03				0.07
Diluted earnings per share excluding PAUs		$	0.57			$	0.49			$	1.01			$	0.95

 

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HORIZON BANCORP AND SUBSIDIARIES

Quantitative and Qualitative Disclosures About Market Risk

For the Three and Six Months ended June 30, 2016

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We refer you to Horizon’s 2015 Annual Report on Form 10-K for analysis of its interest rate sensitivity. Horizon believes there have been no significant changes in its interest rate sensitivity since it was reported in its 2015 Annual Report on Form 10-K.

 

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation Of Disclosure Controls And Procedures

Based on an evaluation of disclosure controls and procedures as of June 30, 2016, Horizon’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of Horizon’s disclosure controls (as defined in Exchange Act Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on such evaluation, such officers have concluded that, as of the evaluation date, Horizon’s disclosure controls and procedures are effective to ensure that the information required to be disclosed by Horizon in the reports it files under the Exchange Act is recorded, processed, summarized and reported within the time specified in Securities and Exchange Commission rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to management as appropriate to allow timely decisions regarding disclosure.

Changes In Internal Control Over Financial Reporting

Horizon’s management, including its Chief Executive Officer and Chief Financial Officer, also have concluded that during the fiscal quarter ended June 30, 2016, there have been no changes in Horizon’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, Horizon’s internal control over financial reporting.

 

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HORIZON BANCORP AND SUBSIDIARIES

Part II – Other Information

For the Three and Six Months ended June 30, 2016

 

ITEM 1.

LEGAL PROCEEDINGS

Horizon and its subsidiaries are involved in various legal proceedings incidental to the conduct of their business. Management does not expect that the outcome of any such proceedings will have a material adverse effect on our consolidated financial position or results of operations.

 

ITEM 1A.

RISK FACTORS

There have been no material changes from the factors previously disclosed under Item 1A of Horizon’s Annual Report on Form 10-K for 2015.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not Applicable

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not Applicable

 

ITEM 4.

MINE SAFETY DISCLOSURES

Not Applicable

 

ITEM 5.

OTHER INFORMATION

Not Applicable

 

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HORIZON BANCORP AND SUBSIDIARIES

Part II – Other Information

For the Three and Six Months ended June 30, 2016

 

ITEM 6.

EXHIBITS

(a) Exhibits

 

Exhibit No.		Description
3.1		Amended and Restated Articles of Incorporation of Horizon Bancorp (incorporated by reference to Exhibit 3.1 to Registrant’s Form 8-K filed May 10, 2016)
3.2		Amended and Restated Bylaws of Horizon Bancorp (incorporated by reference to Exhibit 3.1 to Registrant’s Form 8-K filed April 18, 2013)
31.1		Certification of Craig M. Dwight
31.2		Certification of Mark E. Secor
32		Certification of Chief Executive and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		Interactive Data Files

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

						HORIZON BANCORP
Dated: August 9, 2016						/s/ Craig M. Dwight
						Craig M. Dwight
						Chief Executive Officer
Dated: August 9, 2016						/s/ Mark E. Secor
						Mark E. Secor
						Chief Financial Officer

 

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INDEX TO EXHIBITS

 

Exhibit No.		Description		Location
Exhibit 3.1		Amended and Restated Articles of Incorporation of Horizon Bancorp		Incorporated by reference to Exhibit 3.1 to Registrant’s Form 8-K filed May 10, 2016
Exhibit 3.2		Amended and Restated Bylaws of Horizon Bancorp		Incorporated by reference to Exhibit 3.1 to Registrant’s Form 8-K filed April 18, 2013
Exhibit 31.1		Certification of Craig M. Dwight		Attached
Exhibit 31.2		Certification of Mark E. Secor		Attached
Exhibit 32		Certification of Chief Executive and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		Attached
Exhibit 101		Interactive Data Files		Attached

 

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