Edgar Filing: HORIZON BANCORP /IN/

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

FORM 10-Q

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

Commission file number 0-10792

HORIZON BANCORP

(Exact name of registrant as specified in its charter)


Indiana		35-1562417
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,309,512 shares of Common Stock, no par value, at November 14, 2011.

HORIZON BANCORP

FORM 10-Q

INDEX


PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Income	4

	Condensed Consolidated Statement of Stockholders’ Equity	5

	Condensed Consolidated Statements of Cash Flows	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	48

Item 4.	Controls and Procedures	48

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	49

Item 1A.	Risk Factors	49

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60

Item 3.	Defaults Upon Senior Securities	61

Item 4.	(Removed and reserved)	61

Item 5.	Other Information	61

Item 6.	Exhibits	62

Signatures		63

Index To Exhibits		64

PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollar Amounts in Thousands)


	September 30 2011 (Unaudited)		December 31 2010
Assets
Cash and due from banks	$	18,462	$	15,683
Investment securities, available for sale		430,702		382,344
Investment securities, held to maturity		10,632		9,595
Loans held for sale		12,300		18,833
Loans, net of allowance for loan losses of $19,110 and $19,064		906,730		863,813
Premises and equipment		34,289		34,194
Federal Reserve and Federal Home Loan Bank stock		12,390		13,664
Goodwill		5,910		5,910
Other intangible assets		2,403		2,741
Interest receivable		6,651		6,519
Cash value life insurance		29,959		27,195
Other assets		20,382		20,428

Total assets	$	1,490,810	$	1,400,919

Liabilities
Deposits
Non-interest bearing	$	121,483	$	107,606
Interest bearing		868,266		877,892

Total deposits		989,749		985,498
Borrowings		336,095		260,741
Subordinated debentures		30,653		30,584
Interest payable		582		781
Other liabilities		15,051		11,032

Total liabilities		1,372,130		1,288,636

Commitments and contingent liabilities
Stockholders’ Equity
Preferred stock, $.01 par value, $1,000 liquidation value Authorized, 1,000,000 Series A shares Issued 0 and 18,750 shares		—		18,217
Preferred stock, $.01 par value, $1,000 liquidation value Authorized, 1,000,000 Series B shares Issued 12,500 and 0 shares		12,500		—
Common stock, $.2222 stated value Authorized, 22,500,000 shares Issued, 3,309,512 and 3,300,659 shares		1,126		1,122
Additional paid-in capital		10,579		10,356
Retained earnings		86,524		80,240
Accumulated other comprehensive income		7,951		2,348

Total stockholders’ equity		118,680		112,283

Total liabilities and stockholders’ equity	$	1,490,810	$	1,400,919

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Dollar Amounts in Thousands, Except Per Share Data)


	Three Months Ended September 30						Nine Months Ended September 30
	2011 (Unaudited)			2010 (Unaudited)			2011 (Unaudited)			2010 (Unaudited)
Interest Income
Loans receivable	$	12,481		$	14,466		$	36,260		$	40,283
Investment securities
Taxable		2,542			2,431			7,828			7,394
Tax exempt		988			979			3,066			3,138

Total interest income		16,011			17,876			47,154			50,815

Interest Expense
Deposits		1,978			2,769			6,510			8,238
Borrowed funds		1,583			2,026			4,760			6,807
Subordinated debentures		459			461			1,363			1,229

Total interest expense		4,020			5,256			12,633			16,274

Net Interest Income		11,991			12,620			34,521			34,541
Provision for loan losses		1,564			2,657			4,444			8,890

Net Interest Income after Provision for Loan Losses		10,427			9,963			30,077			25,651

Other Income
Service charges on deposit accounts		802			921			2,422			2,750
Wire transfer fees		167			211			412			536
Interchange fees		721			649			1,905			1,663
Fiduciary activities		1,016			934			2,911			2,936
Gain on sale of securities		1,115			336			1,754			467
Gain on sale of mortgage loans		2,145			2,473			3,986			5,529
Mortgage servicing income net of impairment		(172	)		(331	)		691			(363	)
Increase in cash surrender value of bank owned life insurance		245			246			661			599
Death benefit on officer life insurance		453			—			453			—
Other income		46			209			105			828

Total other income		6,538			5,648			15,300			14,945

Other Expenses
Salaries and employee benefits		6,081			5,985			16,912			15,973
Net occupancy expenses		1,056			1,036			3,176			3,077
Data processing		549			502			1,450			1,474
Professional fees		359			417			1,039			1,418
Outside services and consultants		454			374			1,221			1,163
Loan expense		820			855			2,276			2,376
FDIC insurance expense		254			423			944			1,219
Other losses		1,088			143			1,365			180
Other expenses		1,652			1,522			4,675			4,115

Total other expenses		12,313			11,257			33,058			30,995

Income Before Income Tax		4,652			4,354			12,319			9,601
Income tax expense		1,235			1,075			3,044			2,016

Net Income		3,417			3,279			9,275			7,585
Preferred stock dividend and discount accretion		(710	)		(353	)		(1,263	)		(1,057	)

Net Income Available to Common Shareholders	$	2,707		$	2,926		$	8,012		$	6,528

Basic Earnings Per Share	$	0.82		$	0.89		$	2.44		$	1.99
Diluted Earnings Per Share		0.80			0.88			2.37			1.96

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

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


	Preferred Stock			Common Stock		Additional Paid-in Capital		Comprehensive Income			Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances, December 31, 2010	$	18,217		$	1,122	$	10,356				$	80,240		$	2,348		$	112,283
Net income								$	9,275			9,275						9,275
Redemption of preferred stock		(18,750	)															(18,750	)
Issuance of preferred stock		12,500																12,500
Other comprehensive income, net of tax:
Unrealized gain on securities									7,871						7,871			7,871
Unrealized losses on derivative instruments									(2,268	)					(2,268	)		(2,268	)

Comprehensive income								$	14,878

Amortization of unearned compensation							77											77
Issuance of restricted shares					3		57											60
Exercise of stock options					1		54											55
Tax benefit related to stock options							8											8
Stock option expense							27											27
Cash dividends on preferred stock (5.00%)												(730	)					(730	)
Cash dividends on common stock ($.52 per share)												(1,728	)					(1,728	)
Accretion of discount on preferred stock		533										(533	)					—

Balances, September 30, 2011	$	12,500		$	1,126	$	10,579				$	86,524		$	7,951		$	118,680

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)


	Nine Months Ended September 30
	2011 (Unaudited)			2010 (Unaudited)
Operating Activities
Net income	$	9,275		$	7,585
Items not requiring (providing) cash
Provision for loan losses		4,444			8,890
Depreciation and amortization		1,868			1,715
Share based compensation		27			20
Mortgage servicing rights impairment		(464	)		409
Deferred income tax		—			(923	)
Premium amortization on securities available for sale, net		1,612			1,326
Gain on sale of investment securities		(1,754	)		(467	)
Gain on sale of mortgage loans		(3,986	)		(5,529	)
Proceeds from sales of loans		178,239			188,564
Loans originated for sale		(174,253	)		(184,368	)
Change in cash surrender value of life insurance		236			(566	)
(Gain) loss on sale of other real estate owned		126			(352	)
Net change in
Interest receivable		(132	)		(195	)
Interest payable		(199	)		(369	)
Other assets		(1,590	)		5,010
Other liabilities		1,416			1,776

Net cash provided by operating activities		14,865			22,526

Investing Activities
Purchases of securities available for sale		(170,689	)		(165,749	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale		134,583			157,412
Purchase of securities held to maturity		(2,437	)		(15,332	)
Proceeds from maturities of securities held to maturity		1,400			13,500
(Purchase) proceeds from the sale of Federal Home Loan Bank stock		1,274			(78	)
Net change in loans		(44,766	)		(40,260	)
Proceeds on the sale of OREO and repossessed assets		2,008			2,982
Purchases of premises and equipment		(1,548	)		(2,020	)
Purchases of bank owned life insurance		(3,000	)		—
Purchases and assumption of ATSB		—			3,406

Net cash used in investing activities		(83,175	)		(46,139	)

Financing Activities
Net change in
Deposits		4,251			(50,242	)
Borrowings		75,423			25,774
Redemption of preferred stock		(18,750	)		—
Issuance of preferred stock		12,500			—
Proceeds from issuance of stock		115			120
Tax benefit from issuance of stock		8			77
Dividends paid on common shares		(1,728	)		(1,679	)
Dividends paid on preferred shares		(730	)		(937	)

Net cash provided by (used in) financing activities		71,089			(26,887	)

Net Change in Cash and Cash Equivalent		2,779			(50,500	)
Cash and Cash Equivalents, Beginning of Period		15,683			68,702

Cash and Cash Equivalents, End of Period	$	18,462		$	18,202

Additional Cash Flows Information
Interest paid	$	12,832		$	16,643
Income taxes paid		2,100			2,180
Transfer of loans to other real estate owned		4,273			7,937

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 1 - Accounting Policies

The accompanying condensed consolidated financial statements include the accounts of Horizon Bancorp (“Horizon” or the “Company”) and its wholly-owned subsidiaries, including Horizon Bank, N.A. (“Bank”). All inter-company balances and transactions have been eliminated. The results of operations for the periods ended September 30, 2011 and September 30, 2010 are not necessarily indicative of the operating results for the full year of 2011 or 2010. 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 2010 filed with the Securities and Exchange Commission on March 11, 2011. The consolidated condensed balance sheet of Horizon as of December 31, 2010 has been derived from the audited balance sheet of Horizon as of that date.

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


	Three months ended September 30				Nine months ended September 30
	2011		2010		2011		2010
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Basic earnings per share
Net income	$	3,417	$	3,279	$	9,275	$	7,585
Less: Preferred stock dividends and accretion of discount		710		353		1,263		1,057

Net income available to common shareholders	$	2,707	$	2,926	$	8,012	$	6,528
Weighted average common shares outstanding		3,295,130		3,279,201		3,289,911		3,275,969
Basic earnings per share	$	0.82	$	0.89	$	2.44	$	1.99

Diluted earnings per share
Net income available to common shareholders	$	2,707	$	2,926	$	8,012	$	6,528
Weighted average common shares outstanding		3,295,130		3,279,201		3,289,911		3,275,969
Effect of dilutive securities:
Warrants		72,589		42,397		74,519		31,953
Restricted stock		1,955		14,295		6,078		12,910
Stock options		6,579		741		6,803		2,998

Weighted average shares outstanding		3,376,253		3,336,634		3,377,311		3,323,830
Diluted earnings per share	$	0.80	$	0.88	$	2.37	$	1.96

At September 30, 2011 and 2010, there were 20,500 shares and 48,000 shares that were not included in the computation of diluted earnings per share because they were non-dilutive.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Horizon has share-based employee compensation plans, which are described in the notes to the financial statements included in the December 31, 2010 Annual Report on Form 10-K.

Reclassifications

Certain reclassifications have been made to the 2010 consolidated financial statements to be comparable to 2011. These reclassifications had no effect on net income.

Note 2 – Securities

The fair value of securities is as follows:


September 30, 2011 (Unaudited)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Treasury and federal agencies	$	10,818	$	358	$	—		$	11,176
State and municipal		136,147		7,648		(45	)		143,750
Federal agency collateralized mortgage obligations		87,688		2,407		—			90,095
Federal agency mortgage-backed pools		175,090		6,633		—			181,723
Private labeled mortgage-backed pools		3,817		116		—			3,933
Corporate notes		42		—		(17	)		25

Total available for sale investment securities	$	413,602	$	17,162	$	(62	)	$	430,702

Held to maturity, State and Municipal	$	10,632	$	—	$	—		$	10,632


December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Treasury and federal agencies	$	24,727	$	643	$	(119	)	$	25,251
State and municipal		132,380		1,511		(2,402	)		131,489
Federal agency collateralized mortgage obligations		100,106		1,945		(214	)		101,837
Federal agency mortgage-backed pools		114,390		3,865		(360	)		117,895
Private labeled mortgage-backed pools		5,197		126		—			5,323
Corporate notes		555		—		(6	)		549

Total available for sale investment securities	$	377,355	$	8,090	$	(3,101	)	$	382,344

Held to maturity, State and Municipal	$	9,595	$	—	$	—		$	9,595

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

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified. At September 30, 2011, 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 United States Department of the Treasury (“U.S. Treasury”) and federal agencies, securities of state and municipal governmental agencies, and federal agency mortgage-backed pools were caused by interest rate volatility and not a decline in credit quality. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. The Company expects to recover the amortized cost basis over the term of the securities. Because the Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider those investments to be other-than-temporarily impaired at September 30, 2011.

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 September 30, 2011 and December 31, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.


	September 30, 2011 (Unaudited)				December 31, 2010
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Available for sale
Within one year	$	1,070	$	1,079	$	855	$	866
One to five years		27,187		28,257		28,240		28,949
Five to ten years		51,311		54,380		44,179		44,450
After ten years		67,439		71,235		84,388		83,024

		147,007		154,951		157,662		157,289
Federal agency collateralized mortgage obligations		87,688		90,095		100,106		101,837
Federal agency mortgage-backed pools		175,090		181,723		114,390		117,895
Private labeled mortgage-backed pools		3,817		3,933		5,197		5,323

Total available for sale investment securities	$	413,602	$	430,702	$	377,355	$	382,344

Held to maturity
Within one year	$	10,532	$	10,532	$	9,495	$	9,495
One to five years		100		100		100		100

Total held to maturity investment securities	$	10,632	$	10,632	$	9,595	$	9,595

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
September 30, 2011 (Unaudited)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Treasury and federal agencies	$	—	$	—		$	—	$	—		$	—	$	—
State and municipal		2,984		(41	)		495		(4	)		3,479		(45	)
Federal agency collateralized mortgage obligations		—		—			—		—			—		—
Federal agency mortgage-backed pools		—		—			25		—			25		—
Corporate notes		26		(17	)		—		—			26		(17	)

Total temporarily impaired securities	$	3,010	$	(58	)	$	520	$	(4	)	$	3,530	$	(62	)


	Less than 12 Months					12 Months or More					Total
December 31, 2010	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Treasury and federal agencies	$	9,881	$	(119	)	$	—	$	—		$	9,881	$	(119	)
State and municipal		60,401		(2,370	)		568		(32	)		60,969		(2,402	)
Federal agency collateralized mortgage obligations		21,130		(214	)		—		—			21,130		(214	)
Federal agency mortgage-backed pools		27,033		(360	)		32		—			27,065		(360	)
Corporate notes		26		(6	)		—		—			26		(6	)

Total temporarily impaired securities	$	118,471	$	(3,069	)	$	600	$	(32	)	$	119,071	$	(3,101	)

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


	Three months ended September 30				Nine months ended September 30
	2011		2010		2011		2010
Sales of securities available for sale (Unaudited)
Proceeds	$	153,299	$	146,811	$	170,689	$	165,749
Gross gains		1,115		464		1,754		599
Gross losses		—		128		—		132

Note 3 – Loans


	September 30 2011 (Unaudited)			December 31 2010
Commercial
Working capital and equipment	$	167,387		$	151,414
Real estate, including agriculture		167,924			167,785
Tax exempt		3,474			2,925
Other		6,581			7,894

Total		345,366			330,018
Real estate
1–4 family		161,166			157,478
Other		4,263			4,957

Total		165,429			162,435
Consumer
Auto		134,718			136,014
Recreation		4,795			6,086
Real estate/home improvement		27,378			29,184
Home equity		91,125			90,580
Unsecured		3,200			3,091
Other		2,718			1,726

Total		263,934			266,681
Mortgage warehouse		151,111			123,743

Total		151,111			123,743

Total loans		925,840			882,877
Allowance for loan losses		(19,110	)		(19,064	)

Loans, net	$	906,730		$	863,813

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 higher 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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of property type, which 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, such as churches, schools, restaurants, and golf courses 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.

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


September 30, 2011 (unaudited)	Loan Balance			Interest Due		Deferred Fees / (Costs)			Recorded Investment
Owner occupied real estate	$	128,696		$	385	$	28		$	129,109
Non owner occupied real estate		141,643			377		84			142,104
Residential spec homes		2,598			2		—			2,600
Development & spec land loans		7,548			10		—			7,558
Commercial and industrial		64,765			227		4			64,996

Total commercial		345,250			1,001		116			346,367
Residential mortgage		157,870			579		64			158,513
Residential construction		7,495			13		—			7,508
Mortgage warehouse		151,111			—		—			151,111

Total real estate		316,476			592		64			317,132
Direct installment		23,994			82		(357	)		23,719
Direct installment purchased		1,100			—		—			1,100
Indirect installment		127,665			397		1			128,063
Home equity		112,272			533		(741	)		112,064

Total consumer		265,031			1,012		(1,097	)		264,946

Total loans		926,757			2,605		(917	)		928,445
Allowance for loan losses		(19,110	)		—		—			(19,110	)

Net loans	$	907,647		$	2,605	$	(917	)	$	909,335


December 31, 2010	Loan Balance			Interest Due		Deferred Fees / (Costs)			Recorded Investment
Owner occupied real estate	$	125,883		$	442	$	26		$	126,351
Non owner occupied real estate		136,986			364		87			137,437
Residential spec homes		2,257			4		(2	)		2,259
Development & spec land loans		6,439			14		—			6,453
Commercial and industrial		58,336			234		6			58,576

Total commercial		329,901			1,058		117			331,076
Residential mortgage		154,891			592		76			155,559
Residential construction		7,467			13		1			7,481
Mortgage warehouse		123,743			332		—			124,075

Total real estate		286,101			937		77			287,115
Direct installment		23,527			97		(338	)		23,286
Direct installment purchased		1,869			—		—			1,869
Indirect installment		128,122			491		7			128,620
Home equity		114,202			563		(708	)		114,057

Total consumer		267,720			1,151		(1,039	)		267,832

Total loans		883,722			3,146		(845	)		886,023
Allowance for loan losses		(19,064	)		—		—			(19,064	)

Net loans	$	864,658		$	3,146	$	(845	)	$	866,959

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 4 – 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 two-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.


	Three Months Ended				Nine Months Ended
	September 30 2011 (Unaudited)		September 30 2010 (Unaudited)		September 30 2011 (Unaudited)		September 30 2010 (Unaudited)
Balance at beginning of the period	$	18,586	$	16,543	$	19,064	$	16,015
Loans charged-off:
Commercial
Owner occupied real estate		65		350		189		1,308
Non owner occupied real estate		196		—		310		288
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		780
Commercial and industrial		17		150		227		907

Total commercial		278		500		726		3,283
Real estate
Residential mortgage		86		86		837		683
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		86		86		837		683
Consumer
Direct Installment		78		91		480		430
Direct Installment Purchased		—		—		—		—
Indirect Installment		494		460		1,280		2,189
Home Equity		359		215		1,888		1,083

Total consumer		931		766		3,648		3,702

Total loans charged-off		1,295		1,352		5,211		7,668
Recoveries of loans previously charged-off:
Commercial
Owner occupied real estate		—		5		18		5
Non owner occupied real estate		—		—		—		—
Residential development		—		—		—		66
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		9		15		14		15

Total commercial		9		20		32		86
Real estate
Residential mortgage		—		—		10		1
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		—		—		10		1
Consumer
Direct Installment		16		9		83		49
Direct Installment Purchased		—		—		—		—
Indirect Installment		179		147		568		646
Home Equity		51		6		120		11

Total consumer		246		162		771		706

Total loan recoveries		255		182		813		793

Net loans charged-off		1,040		1,170		4,398		6,875
Provision charged to operating expense		1,564		2,657		4,444		8,890

Balance at the end of the period	$	19,110	$	18,030	$	19,110	$	18,030

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

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

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

The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 90 days past due, and charge down to the net realizable value when other secured loans 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 will occur regardless of delinquency status, need not be charged off.

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


September 30, 2011 (Unaudited)	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total Allowance
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,806	$	—	$	—	$	—	$	1,806
Collectively evaluated for impairment		6,345		2,457		1,477		7,025		17,304

Total ending allowance balance	$	8,151	$	2,457	$	1,477	$	7,025	$	19,110

Loans:
Individually evaluated for impairment	$	12,562	$	—	$	—	$	—	$	12,562
Collectively evaluated for impairment		333,805		166,021		151,111		264,946		915,883

Total ending loans balance	$	346,367	$	166,021	$	151,111	$	264,946	$	928,445


December 31, 2010	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total Allowance
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,457	$	—	$	—	$	—	$	1,457
Collectively evaluated for impairment		6,097		2,379		1,435		7,696		17,607

Total ending allowance balance	$	7,554	$	2,379	$	1,435	$	7,696	$	19,064

Loans:
Individually evaluated for impairment	$	8,123	$	—	$	—	$	—	$	8,123
Collectively evaluated for impairment		322,953		163,040		124,075		267,832		877,900

Total ending loans balance	$	331,076	$	163,040	$	124,075	$	267,832	$	886,023

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 5 – Non-performing Assets and Impaired Loans

The following table presents the nonaccrual, loans past due over 90 days still on accrual, and trouble debt restructured (“TDR’s”) by class of loans:


September 30, 2011 (Unaudited)	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Non Performing TDR’s		Performing TDR’s		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	2,734	$	—	$	—	$	—	$	2,734
Non owner occupied real estate		7,685		—		217		—		7,902
Residential development		—		—		—		—		—
Development & Spec Land Loans		90		—		—		—		90
Commercial and industrial		384		—		144		841		1,369

Total commercial		10,893		—		361		841		12,095
Real estate
Residential mortgage		3,395		—		1,312		2,059		6,766
Residential construction		142		—				293		435
Mortgage warehouse		—		—		—		—		—

Total real estate		3,537		—		1,312		2,352		7,201
Consumer
Direct Installment		259		1		—		—		260
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		1,131		40		—		—		1,171
Home Equity		1,979		56		—		849		2,884

Total Consumer		3,369		97		—		849		4,315

Total	$	17,799	$	97	$	1,673	$	4,042	$	23,611


December 31, 2010	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Non Performing TDR’s		Performing TDR’s		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	1,358	$	—	$	—	$	—	$	1,358
Non owner occupied real estate		5,439		—		421		—		5,860
Residential development		16		—		—		—		16
Development & Spec Land Loans		250		—		—		—		250
Commercial and industrial		445		—		153		—		598

Total commercial		7,508		—		574		—		8,082
Real estate
Residential mortgage		5,278		222		241		3,380		9,121
Residential construction		205		—		—		—		205
Mortgage warehouse		—		—		—		—		—

Total real estate		5,483		222		241		3,380		9,326
Consumer
Direct Installment		251		23		—		—		274
Direct Installment Purchased		—		5		—		—		5
Indirect Installment		1,328		98		—		—		1,426
Home Equity		2,103		10		37		165		2,315

Total Consumer		3,682		136		37		165		4,020

Total	$	16,673	$	358	$	852	$	3,545	$	21,428

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

A loan becomes impaired when, based on current information, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is classified as impaired, the degree of impairment must be recognized by estimating future cash flows from the debtor. The present value of these cash flows is computed at a discount rate based on the interest rate contained in the loan agreement. However, if a particular loan has a determinable market value, 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 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 TDR’s, 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 TDR’s are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At September 30, 2011 the type of concessions the Company has made on restructured loans has been temporary rate reductions and/or reductions in monthly payments. 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 September 30, 2011, the Company had $5.7 million in TDR’s and $4.0 million were performing according to the restructured terms. The financial statement impact of non-perfoming TDR’s was not material for the nine months ending September 30, 2011. There was $271,000 of specific reserves for commercial TDR’s at September 30, 2011 due to the value of the collateral.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Loans classified as troubled debt restructuring during the three and nine months ended September 30, 2011, segregated by class, are shown in the table below.


	Three Months Ended September 30, 2011 (Unaudited)				Nine Months Ended September 30, 2011 (Unaudited)
(Dollars in thousands)	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		—	$	—		—	$	—
Non owner occupied real estate		—		—		—		—
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		1		841

Total commercial		—		—		1		841
Real estate
Residential mortgage		—		—		2		174
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		—		—		2		174
Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		1		76		8		724

Total Consumer		1		76		8		724

Total		1	$	76		11	$	1,739

Troubled debt restructured loans which had payment defaults during the three and nine months ended September 30, 2011, segregated by class, are shown in the table below. Default occurs when a loan is 90 days or more past due or transferred to nonaccrual.


	Three Months Ended September 30, 2011 (Unaudited)				Nine Months Ended September 30, 2011 (Unaudited)
(Dollars in thousands)	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		—	$	—		—	$	—
Non owner occupied real estate		—		—		—		—
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		2		361

Total commercial		—		—		2		361
Real estate
Residential mortgage		—		—		2		1,143
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		—		—		2		1,143
Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		1		26		2		65

Total Consumer		1		26		2		65

Total		1	$	26		6	$	1,569

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 loans:


							Nine Months Ending				Three Months Ending
September 30, 2011 (Unaudited)	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans		Interest Income Recognized		Average Balance in Impaired Loans		Interest Income Recognized
With no recorded allowance Commercial
Owner occupied real estate	$	1,315	$	1,314	$	—	$	856	$	32	$	1,224	$	31
Non owner occupied real estate		2,403		2,625		—		985		89		1,683		85
Residential development		—		—		—		9		—		—		—
Development & Spec Land Loans		—		111		—		69		—		—		—
Commercial and industrial		1,154		1,156		—		1,099		47		1,091		47

Total commercial		4,872		5,206		—		3,018		168		3,998		163
With an allowance recorded Commercial
Owner occupied real estate		1,420		1,420		460		1,234		—		1,449		—
Non owner occupied real estate		5,499		5,538		996		4,859		—		4,943		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		90		90		125		179		—		90		—
Commercial and industrial		234		308		225		393		—		284		—

Total commercial		7,243		7,356		1,806		6,665		—		6,766		—

Total	$	12,115	$	12,562	$	1,806	$	9,683	$	168	$	10,764	$	163


							Twelve Months Ending
December 31, 2010	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans		Interest Income Recognized
With no recorded allowance Commercial
Owner occupied real estate	$	720	$	721	$	—	$	2,434	$	19
Non owner occupied real estate		928		929		—		1,195		36
Residential development		—		—		—		—		—
Development & Spec Land Loans		—		—		—		770		—
Commercial and industrial		118		118		—		785		—

Total commercial		1,766		1,768		—		5,184		55
With an allowance recorded Commercial
Owner occupied real estate		639		640		385		68		15
Non owner occupied real estate		4,932		4,970		665		2,677		115
Residential development		16		16		16		7		2
Development & Spec Land Loans		250		250		126		250		—
Commercial and industrial		479		479		265		316		13

Total commercial		6,316		6,355		1,457		3,318		145

Total	$	8,082	$	8,123	$	1,457	$	8,502	$	200

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 loans:


September 30, 2011 (Unaudited)	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	$	59	$	144	$	—	$	203	$	128,493	$	128,696
Non owner occupied real estate		—		—		—		—		141,643		141,643
Residential development		—		—		—		—		2,598		2,598
Development & Spec Land Loans		—		—		—		—		7,548		7,548
Commercial and industrial		238		—		—		238		64,527		64,765

Total commercial		297		144		—		441		344,809		345,250
Real estate
Residential mortgage		1,275		—		—		1,275		156,595		157,870
Residential construction		293		—		—		293		7,202		7,495
Mortgage warehouse		—		—		—		—		151,111		151,111

Total real estate		1,568		—		—		1,568		314,908		316,476
Consumer
Direct Installment		128		35		1		164		23,830		23,994
Direct Installment Purchased		20		18		—		38		1,062		1,100
Indirect Installment		1,357		198		40		1,595		126,070		127,665
Home Equity		424		52		56		532		111,740		112,272

Total consumer		1,929		303		97		2,329		262,702		265,031

Total	$	3,794	$	447	$	97	$	4,338	$	922,419	$	926,757


December 31, 2010	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	$	229	$	—	$	—	$	229	$	125,654	$	125,883
Non owner occupied real estate		461		—		—		461		136,525		136,986
Residential development		—		—		—		—		2,257		2,257
Development & Spec Land Loans		—		—		—		—		6,439		6,439
Commercial and industrial		74		—		—		74		58,262		58,336

Total commercial		764		—		—		764		329,137		329,901
Real estate
Residential mortgage		317		91		222		630		154,261		154,891
Residential construction		293		—		—		293		7,174		7,467
Mortgage warehouse		—		—		—		—		123,743		123,743

Total real estate		610		91		222		923		285,178		286,101
Consumer
Direct Installment		294		156		23		473		23,054		23,527
Direct Installment Purchased		51		31		5		87		1,782		1,869
Indirect Installment		2,360		433		98		2,891		125,231		128,122
Home Equity		899		218		10		1,127		113,075		114,202

Total consumer		3,604		838		136		4,578		263,142		267,720

Total	$	4,978	$	929	$	358	$	6,265	$	877,457	$	883,722

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 re-evaluated for credit quality. The latter usually occurs upon receipt of current financial information or other pertinent data that would trigger a change in the loan grade.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

For new and renewed commercial loans, the Bank’s Credit Department, which acts independently of the loan officer, assigns the credit quality grade to the loan. Loan grades for loans with an aggregate credit exposure of $500,000 or greater are validated by the Loan Committee, which is chaired by the Chief Operating Officer (COO).

•

Commercial loan officers are responsible for reviewing their loan portfolios and report any adverse material change to the COO or Loan Committee. When circumstances warrant a change in the credit quality grade, loan officers are required to notify the COO and the Credit Department of the change in the loan grade. Downgrades are accepted immediately by the COO however, lenders must present their factual information to either the Loan Committee or the COO when recommending an upgrade. One of the requirements for a loan officer to meet the annual bonus criteria is that the loan officer did not have any of his/her loans downgraded by either Internal Loan Review or Bank Regulators to a classified grade; that is, substandard, doubtful or loss.

•

The COO 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 attends 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, and collateral 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 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 a troubled debt restructure are graded “Substandard.” After being 90 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass.

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

Risk Grade 1: Excellent (Pass)

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

Risk Grade 2: Good (Pass)

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

Risk Grade 3: Satisfactory (Pass)

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

•

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

•

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

•

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

•

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

Risk Grade 4: Satisfactory/Monitored (Pass)

Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans due to weak balance sheets, marginal earnings or cash flow, lack of financial information, weakening markets, insufficient or questionable collateral coverage or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision. Loans that normally fall into this grade include construction of commercial real estate buildings, land development and subdivisions, and rental properties that have not attained stabilization.

Risk Grade 5: Special Mention

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

Risk Grade 6: Substandard

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

•

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

•

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

•

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

•

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

•

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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

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

•

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

•

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

•

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

Risk Grade 7: Doubtful

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

•

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

•

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

•

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

Risk Grade 8: Loss

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


			Special
September 30, 2011 (Unaudited)	Pass		Mention		Substandard		Doubtful		Total
Commercial
Owner occupied real estate	$	104,849	$	4,438	$	19,409	$	—	$	128,696
Non owner occupied real estate		114,652		11,882		15,109		—		141,643
Residential development		597		531		1,470		—		2,598
Development & Spec Land Loans		2,351		863		4,334		—		7,548
Commercial and industrial		54,839		2,771		7,155		—		64,765

Total commercial		277,288		20,485		47,477		—		345,250
Real estate
Residential mortgage		151,104		—		6,766		—		157,870
Residential construction		7,060		—		435		—		7,495
Mortgage warehouse		151,111		—		—		—		151,111

Total real estate		309,275		—		7,201		—		316,476
Consumer
Direct Installment		23,734		—		260		—		23,994
Direct Installment Purchased		1,100		—		—		—		1,100
Indirect Installment		126,494		—		1,171		—		127,665
Home Equity		109,388		—		2,884		—		112,272

Total Consumer		260,716		—		4,315		—		265,031

Total	$	847,279	$	20,485	$	58,993	$	—	$	926,757


			Special
December 31, 2010	Pass		Mention		Substandard		Doubtful		Total
Commercial
Owner occupied real estate	$	94,722	$	13,656	$	17,506	$	—	$	125,883
Non owner occupied real estate		119,041		6,107		11,838		—		136,986
Residential development		834		537		886		—		2,257
Development & Spec Land Loans		4,378		746		1,315		—		6,439
Commercial and industrial		45,831		6,856		5,649		—		58,336

Total commercial		264,805		27,902		37,195		—		329,901
Real estate
Residential mortgage		145,770		—		9,121		—		154,891
Residential construction		7,262		—		205		—		7,467
Mortgage warehouse		123,743

Large Accelerated Filer

Accelerated Filer

Non-accelerated Filer

¨ Do not check if a smaller reporting company

Smaller Reporting Company