Edgar Filing: HORIZON BANCORP /IN/

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Form 10-Q

HORIZON BANCORP

FORM 10-Q

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 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 ☒ 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 ☒ 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 ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 22,172,103 shares of Common Stock, no par value, at November 9, 2016.

HORIZON BANCORP

FORM 10-Q

INDEX


PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Income	4

	Condensed Consolidated Statements of Comprehensive Income	5

	Condensed Consolidated Statement of Stockholders’ Equity	6

	Condensed Consolidated Statements of Cash Flows	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	44

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	60

Item 4.	Controls and Procedures	60

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	61

Item 1A.	Risk Factors	61

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61

Item 3.	Defaults Upon Senior Securities	61

Item 4.	Mine Safety Disclosures	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 2016		December 31 2015
	(Unaudited)
Assets
Cash and due from banks	$	83,721	$	48,650
Investment securities, available for sale		557,213		444,982
Investment securities, held to maturity (fair value of $194,294 and $193,703)		187,027		187,629
Loans held for sale		7,369		7,917
Loans, net of allowance for loan losses of $14,524 and $14,534		2,175,995		1,734,597
Premises and equipment, net		67,265		60,798
Federal Reserve and Federal Home Loan Bank stock		20,877		13,823
Goodwill		74,308		49,600
Other intangible assets		9,583		7,371
Interest receivable		12,702		10,535
Cash value of life insurance		73,661		54,504
Other assets		55,929		31,995

Total assets	$	3,325,650	$	2,652,401

Liabilities
Deposits
Non-interest bearing	$	479,771	$	335,955
Interest bearing		1,856,391		1,544,198

Total deposits		2,336,162		1,880,153
Borrowings		569,908		449,347
Subordinated debentures		37,418		32,797
Interest payable		1,015		507
Other liabilities		35,411		22,765

Total liabilities		2,979,914		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, 66,000,000 shares (Restated - See Note 1) Issued, 22,172,103 and 17,992,986 shares (Restated - See Note 1) Outstanding, 22,143,228 and 17,909,831 shares (Restated - See Note 1)		—		—
Additional paid-in capital		181,901		106,370
Retained earnings		161,026		148,685
Accumulated other comprehensive income (loss)		2,809		(723	)

Total stockholders’ equity		345,736		266,832

Total liabilities and stockholders’ equity	$	3,325,650	$	2,652,401

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Dollar Amounts in Thousands, Except Per Share Data)


	Three Months Ended					Nine Months Ended
	September 30					September 30
	2016		2015			2016			2015
	(Unaudited)		(Unaudited)			(Unaudited)			(Unaudited)
Interest Income
Loans receivable	$	25,313	$	20,297		$	65,854		$	55,140
Investment securities
Taxable		2,498		2,156			7,703			6,377
Tax exempt		1,151		1,125			3,583			3,281

Total interest income		28,962		23,578			77,140			64,798

Interest Expense
Deposits		1,875		1,566			4,923			4,035
Borrowed funds		2,128		1,729			5,608			4,747
Subordinated debentures		549		507			1,556			1,504

Total interest expense		4,552		3,802			12,087			10,286

Net Interest Income		24,410		19,776			65,053			54,512
Provision for loan losses		455		300			1,219			2,820

Net Interest Income after Provision for Loan Losses		23,955		19,476			63,834			51,692

Non-interest Income
Service charges on deposit accounts		1,483		1,359			4,056			3,443
Wire transfer fees		292		160			588			493
Interchange fees		2,016		1,625			5,137			4,093
Fiduciary activities		1,653		1,520			4,753			4,033
Gain on sale of investment securities (includes $0 for the three months ended and $875 for the nine months ended September 30, 2016 and $0 for the three months ended and $124 for the nine months ended September 30, 2015, related to accumulated other comprehensive earnings reclassifications)		—		—			875			124
Gain on sale of mortgage loans		3,528		2,794			9,171			7,815
Mortgage servicing income net of impairment		409		246			1,356			725
Increase in cash value of bank owned life insurance		449		374			1,145			889
Death benefit on bank owned life insurance		—		—			—			145
Other income		226		322			708			892

Total non-interest income		10,056		8,400			27,789			22,652

Non-interest Expense
Salaries and employee benefits		12,210		10,652			32,592			27,541
Net occupancy expenses		2,174		1,723			6,011			4,649
Data processing		1,616		1,281			3,855			3,170
Professional fees		612		409			2,190			1,596
Outside services and consultants		2,686		3,209			5,983			4,753
Loan expense		1,482		1,351			4,086			3,975
FDIC insurance expense		465		423			1,279			1,099
Other losses		107		246			510			351
Other expense		3,468		2,941			9,616			7,819

Total non-interest expense		24,820		22,235			66,122			54,953

Income Before Income Tax		9,191		5,641			25,501			19,391
Income tax expense (includes $0 for the three months ended and $306 for the nine months ended September 30, 2016 and $0 for the three months ended and $43 for the nine months ended September 30, 2015, related to income tax expense from reclassification items)		2,589		1,353			7,192			5,017

Net Income		6,602		4,288			18,309			14,374
Preferred stock dividend		—		(31	)		(42	)		(94	)

Net Income Available to Common Shareholders	$	6,602	$	4,257		$	18,267		$	14,280

Basic Earnings Per Share (Restated - See Note 1)	$	0.31	$	0.24		$	0.95		$	0.95
Diluted Earnings Per Share (Restated - See Note 1)		0.30		0.24			0.94			0.92

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)


	Three Months Ended September 30						Nine Months Ended September 30
	2016			2015			2016			2015
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

Net Income	$	6,602		$	4,288		$	18,309		$	14,374

Other Comprehensive Income (Loss)
Change in fair value of derivative instruments:
Change in fair value of derivative instruments for the period		803			(516	)		158			(334	)
Income tax effect		(281	)		181			(55	)		117

Changes from derivative instruments		522			(335	)		103			(217	)

Change in securities:
Unrealized appreciation (depreciation) for the period on AFS securities		(1,927	)		1,781			6,712			1,379
Amortization from transfer of securities from available-for-sale to held-to-maturity securities		(83	)		(203	)		(560	)		(475	)
Reclassification adjustment for securities gains realized in income		—			—			(875	)		(124	)
Income tax effect		704			(552	)		(1,848	)		(273	)

Unrealized gains (losses) on securities		(1,306	)		1,026			3,429			507

Other Comprehensive Income (Loss), Net of Tax		(784	)		691			3,532			290

Comprehensive Income	$	5,818		$	4,979		$	21,841		$	14,664

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

(Dollar Amounts in Thousands, Except Per Share Data)


									Accumulated
				Additional					Other
	Preferred			Paid-in		Retained			Comprehensive
	Stock			Capital		Earnings			Income (Loss)			Total
Balances, January 1, 2016	$	12,500		$	106,370	$	148,685		$	(723	)	$	266,832
Net income							18,309						18,309
Other comprehensive income, net of tax										3,532			3,532
Redemption of preferred stock		(12,500	)										(12,500	)
Amortization of unearned compensation					222								222
Stock option expense					247								247
Stock issued stock plans					286								286
Stock issued in KFI acquisition					14,470								14,470
Stock issued in LPSB acquisition					60,306								60,306
Cash dividends on preferred stock (1.00%)							(42	)					(42	)
Cash dividends on common stock ($.30 per share)							(5,926	)					(5,926	)

Balances, September 30, 2016	$	—		$	181,901	$	161,026		$	2,809		$	345,736

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
	2016			2015
	(Unaudited)			(Unaudited)
Operating Activities
Net income	$	18,309		$	14,374
Items not requiring (providing) cash
Provision for loan losses		1,219			2,820
Depreciation and amortization		3,790			3,020
Share based compensation		247			216
Mortgage servicing rights net impairment		840			389
Premium amortization on securities available for sale, net		4,389			2,192
Gain on sale of investment securities		(875	)		(124	)
Gain on sale of mortgage loans		(9,171	)		(7,815	)
Proceeds from sales of loans		246,435			247,512
Loans originated for sale		(236,719	)		(239,137	)
Change in cash value of life insurance		(1,145	)		(868	)
Gain (Loss) on sale of other real estate owned		118			(214	)
Net change in
Interest receivable		(687	)		(1,337	)
Interest payable		275			(28	)
Other assets		(16,641	)		(61	)
Other liabilities		1,015			1,020

Net cash provided by operating activities		11,399			21,959

Investing Activities
Purchases of securities available for sale		(152,283	)		(170,391	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale		88,330			61,785
Purchases of securities held to maturity		(35,598	)		(26,128	)
Proceeds from maturities of securities held to maturity		14,654			7,155
Change in FHLB stock		(2,443	)		268
Net change in loans		(26,920	)		(123,326	)
Proceeds on the sale of OREO and repossessed assets		1,524			2,425
Change in premises and equipment, net		(1,719	)		(4,757	)
Acquisition of Peoples, net of cash received		—			182,413
Acquisition of Kosciusko, net of cash received		30,437			—
Acquisition of LaPorte, net of cash received		116,521			—

Net cash provided by (used in) investing activities		32,503			(70,556	)

Financing Activities
Net change in
Deposits		(37,495	)		79,669
Borrowings		46,846			(26,064	)
Redemption of preferred stock		(12,500	)		—
Proceeds from issuance of stock		286			4,178
Dividends paid on common shares		(5,926	)		(4,413	)
Dividends paid on preferred shares		(42	)		(94	)

Net cash provided by (used in) financing activities		(8,831	)		53,276

Net Change in Cash and Cash Equivalents		35,071			4,679
Cash and Cash Equivalents, Beginning of Period		48,650			43,476

Cash and Cash Equivalents, End of Period	$	83,721		$	48,155

Additional Supplemental Information
Interest paid	$	11,579		$	10,292
Income taxes paid		7,310			4,900
Transfer of loans to other real estate owned		3,035			2,825
The Company purchased all of the capital stock of Kosciusko for $22,983 on June 1, 2016 and Peoples for $78,147 on July 1, 2015. In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired		155,873			485,077
Less: common stock issued		14,470			22,641
Cash paid for the capital stock		8,513			55,506
Liabilities assumed		132,890			406,930

The Company purchased all of the capital stock of LaPorte Bancorp for $98,634 on July 18, 2016. In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired		546,770			—
Less: common stock issued		60,306			—
Cash paid for the capital stock		38,328			—
Liabilities assumed		448,136			—

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 1 - Accounting Policies

The accompanying unaudited condensed consolidated financial statements include the accounts of Horizon Bancorp (“Horizon” or the “Company”) and its wholly-owned subsidiaries, including Horizon Bank, N.A. (“Bank”). All inter-company balances and transactions have been eliminated. The results of operations for the periods ended September 30, 2016 and September 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.

On October 18, 2016, the Board of Directors of the Company approved a three-for-two stock split of the Company’s authorized common stock, no par value. All share and per share amounts in the condensed consolidated financial statements and notes thereto have been retroactively adjusted, where necessary, to reflect this three-for-two stock split. The effect of the three-for-two stock split on the outstanding common shares is that shareholders of record as of the close of business on October 31, 2016, the record date, will receive an additional half share of common stock held, with shareholders receiving cash in lieu of any fractional shares. The additional shares issued in the stock split are expected to be payable and issued on November 14, 2016, and that the common shares will begin trading on a split-adjusted basis on or about November 15, 2016.

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				Nine Months Ended
	September 30				September 30
	2016		2015		2016		2015
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Basic earnings per share
Net income	$	6,602	$	4,288	$	18,309	$	14,374
Less: Preferred stock dividends		—		31		42		94

Net income available to common shareholders	$	6,602	$	4,257	$	18,267	$	14,280

Weighted average common shares outstanding⁽¹⁾		21,538,752		17,408,964		19,252,295		15,044,129

Basic earnings per share	$	0.31	$	0.24	$	0.95	$	0.95


Diluted earnings per share
Net income available to common shareholders	$	6,602	$	4,257	$	18,267	$	14,280

Weighted average common shares outstanding⁽¹⁾		21,538,752		17,408,964		19,252,295		15,044,129
Effect of dilutive securities:
Warrants		—		321,888		—		436,044
Restricted stock		33,650		50,207		27,590		46,092
Stock options		79,551		58,823		66,491		54,446

Weighted average shares outstanding		21,651,953		17,839,882		19,346,376		15,580,711

Diluted earnings per share	$	0.30	$	0.24	$	0.94	$	0.92

⁽¹⁾	Adjusted for 3:2 stock split on November 14, 2016

There were no shares for both the three and nine months ended September 30, 2016, respectively, and 3,750 for both the three and nine months ended September 30, 2015 which were not included in the computation of diluted earnings per share because they were non-dilutive.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Horizon has share-based employee compensation plans, which are described in the notes to the financial statements included in the December 31, 2015 Annual Report on Form 10-K.

Note 2 – Acquisitions

On July 1, 2015, Horizon completed the acquisition of Peoples Bancorp, an Indiana corporation (“Peoples”) and Horizon Bank N.A.’s acquisition of Peoples Federal Savings Bank of DeKalb County (“Peoples FSB”), through mergers effective July 1, 2015. Under the terms of the acquisition, the exchange ratio was 1.425 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 3,288,303. Horizon’s stock price was $16.88 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 non-interest expense section of the income statement and primarily located in the salaries and employee benefits, professional services and other expense line items. As a result of the acquisition, the Company increased its deposit base and reduced transaction costs. The Company also expects to reduce cost through economies of scale.

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


ASSETS
Cash and due from banks	$	205,054
Investment securities, held to maturity		2,038

Commercial		67,435
Residential mortgage		137,331
Consumer		19,593

Total loans		224,359

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

Total assets purchased	$	485,077


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

Total estimated purchase price	$	78,147


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

Total deposits		351,087

Borrowings		48,884
Interest payable		21
Other liabilities		6,938

Total liabilities assumed	$	406,930

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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.

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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 September 30, 2016 and 2015 as if the Peoples and Peoples FSB acquisitions had occurred as of the beginning of the comparable prior reporting period.


	Three Months Ended				Nine Months Ended
	September 30		September 30		September 30		September 30
	2016		2015		2016		2015
Summary of Operations:
Net Interest Income	$	24,410	$	19,776	$	65,053	$	60,466
Provision for Loan Losses		455		300		1,219		2,880

Net Interest Income after Provision for Loan Losses		23,955		19,476		63,834		57,586
Non-interest Income		10,056		8,400		27,789		24,545
Non-Interest Expense		24,820		22,235		66,122		61,192

Income before Income Taxes		9,191		5,641		25,501		20,939
Income Tax Expense		2,589		1,353		7,192		5,164

Net Income		6,602		4,288		18,309		15,776
Net Income Available to Common Shareholders	$	6,602	$	4,257	$	18,267	$	15,682

Basic Earnings Per Share	$	0.31	$	0.24	$	0.95	$	0.91
Diluted Earnings Per Share	$	0.30	$	0.24	$	0.94	$	0.89

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 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 4.5183 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 consisted 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 873,430 shares of its common stock in the merger. Based upon the June 1, 2016 closing price of $16.57 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 non-interest expense section of the income statement and primarily located in the salaries and employee benefits, professional services and other expense line items. As a result of the acquisition, the Company will have an opportunity to increase its deposit base and reduce transaction costs. The Company also expects to reduce cost through economies of scale.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


ASSETS
Cash and due from banks	$	38,950
Investment securities, held to maturity		1,191

Commercial		70,006
Residential mortgage		26,244
Consumer		6,319

Total loans		102,569

Premises and equipment, net		1,466
FRB and FHLB stock		582
Goodwill		6,443
Core deposit intangible		526
Interest receivable		636
Cash value of life insurance		2,745
Other assets		765

Total assets purchased	$	155,873


Common shares issued	$	14,470
Cash paid		8,513

Total estimated purchase price	$	22,983


LIABILITIES
Deposits
Non-interest bearing	$	27,871
NOW accounts		35,213
Savings and money market		26,953
Certificates of deposits		32,771

Total deposits		122,808

Borrowings		9,038
Interest payable		55
Other liabilities		989

Total liabilities assumed	$	132,890

Of the total estimated purchase price of $23.0 million, $526,000 has been allocated to core deposit intangible. Additionally, $6.4 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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The following table details the acquired loans that are accounted for in accordance with ASC 310-30 as of June 1, 2016.


Contractually required principal and interest at acquisition	$	2,682
Contractual cash flows not expected to be collected (nonaccretable differences)		25

Expected cash flows at acquisition		2,657
Interest component of expected cash flows (accretable discount)		634

Fair value of acquired loans accounted for under ASC 310-30	$	2,023

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 0.9435 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 consisted of 65% stock and 35% cash. As a result of LaPorte Bancorp stockholder stock and cash elections and the related proration provisions of the Merger Agreement, Horizon issued 3,421,488 shares of its common stock in the merger. Based upon the July 18, 2016 closing price of $18.36 per share of Horizon common stock, less the consideration used to pay off LaPorte’s ESOP loan receivable, the transaction has an implied valuation of approximately $98.6 million.

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 LaPorte Bancorp acquisition is detailed in the following table. Final estimates of fair value on the date of acquisition have not been received yet. Prior to the end of the one year measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation prospectively. If any adjustments are made to the preliminary assumptions (provisional amounts), disclosures will be made in the notes to the financial statements of the amounts recorded in the current period earnings by line item that have been recorded in previous reporting periods if the adjustments to the provisional amounts had been recognized as of the acquisition date.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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


ASSETS
Cash and due from banks	$	154,849
Investment securities, held to maturity		23,779

Commercial		154,223
Residential mortgage		42,603
Consumer		16,801
Mortgage Warehousing		99,752

Total loans		313,379

Premises and equipment, net		6,022
FHLB stock		4,029
Goodwill		18,265
Core deposit intangible		2,514
Interest receivable		844
Cash value of life insurance		15,267
Other assets		7,822

Total assets purchased	$	546,770


Common shares issued	$	60,306
Cash paid		38,328

Total estimated purchase price	$	98,634


LIABILITIES
Deposits
Non-interest bearing	$	66,733
NOW accounts		99,346
Savings and money market		117,688
Certificates of deposits		86,929

Total deposits		370,696

Borrowings		64,793
Interest payable		178
Subordinated debt		4,504
Other liabilities		7,965

Total liabilities assumed	$	448,136

Of the total estimated purchase price of $98.6 million, $2.5 million has been allocated to core deposit intangible. Additionally, $18.3 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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The following table details an estimate of the acquired loans that are accounted for in accordance with ASC 310-30 as of July 18, 2016. Final valuation estimates have not yet been determined for acquired loans as of September 30, 2016. If information becomes available which would indicate adjustments to the purchase price allocation, such adjustments would be made prospectively.


Contractually required principal and interest at acquisition	$	12,551
Contractual cash flows not expected to be collected (nonaccretable differences)		3,411

Expected cash flows at acquisition		9,140
Interest component of expected cash flows (accretable discount)		1,736

Fair value of acquired loans accounted for under ASC 310-30	$	7,404

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.

The results of operations of LaPorte Bancorp and The LaPorte Savings Bank 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 September 30, 2016 and 2015 as if the LaPorte Bancorp and The LaPorte Savings Bank acquisitions had occurred as of the beginning of the comparable prior reporting periods.


	Three Months Ended				Nine Months Ended
	September 30		September 30		September 30		September 30
	2016		2015		2016		2015
Summary of Operations:
Net Interest Income	$	25,044	$	23,981	$	74,512	$	67,243
Provision for Loan Losses		455		400		1,219		3,075

Net Interest Income after Provision for Loan Losses		24,589		23,581		73,293		64,168
Non-interest Income		11,056		9,099		33,052		24,767
Non-Interest Expense		31,611		25,541		80,937		64,956

Income before Income Taxes		4,034		7,139		25,408		23,979
Income Tax Expense		1,855		1,670		8,070		5,932

Net Income		2,179		5,469		17,338		18,047
Net Income Available to Common Shareholders	$	2,179	$	5,438	$	17,296	$	17,953

Basic Earnings Per Share	$	0.10	$	0.31	$	0.90	$	1.19
Diluted Earnings Per Share	$	0.10	$	0.30	$	0.89	$	1.15

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
	Amortized		Unrealized		Unrealized			Fair
September 30, 2016	Cost		Gains		Losses			Value
Available for sale
U.S. Treasury and federal agencies	$	27,383	$	54	$	(15	)	$	27,422
State and municipal		62,825		1,321		(107	)		64,039
Federal agency collateralized mortgage obligations		188,072		1,894		(282	)		189,684
Federal agency mortgage-backed pools		272,144		4,240		(411	)		275,973
Corporate notes		32		63		—			95

Total available for sale investment securities	$	550,456	$	7,572	$	(815	)	$	557,213


Held to maturity
State and municipal	$	158,543	$	6,718	$	(761	)	$	164,500
Federal agency collateralized mortgage obligations		6,828		144		—			6,972
Federal agency mortgage-backed pools		21,656		1,166		—			22,822

Total held to maturity investment securities	$	187,027	$	8,028	$	(761	)	$	194,294


			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 September 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 September 30, 2016.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The amortized cost and fair value of securities available for sale and held to maturity at September 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.


	September 30, 2016				December 31, 2015
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Available for sale
Within one year	$	6,921	$	6,953	$	7,192	$	7,232
One to five years		52,105		52,482		38,197		38,894
Five to ten years		12,934		13,325		16,807		17,152
After ten years		18,280		18,796		17,605		17,797

		90,240		91,556		79,801		81,075
Federal agency collateralized mortgage obligations		188,072		189,684		157,291		156,203
Federal agency mortgage-backed pools		272,144		275,973		206,970		207,704

Total available for sale investment securities	$	550,456	$	557,213	$	444,062	$	444,982


Held to maturity
Within one year	$	—	$	—	$	—	$	—
One to five years		22,801		23,965		17,815		18,403
Five to ten years		88,924		93,501		106,167		110,026
After ten years		46,818		47,034		28,208		28,976

		158,543		164,500		152,190		157,405
Federal agency collateralized mortgage obligations		6,828		6,972		9,051		8,954
Federal agency mortgage-backed pools		21,656		22,822		26,388		27,344

Total held to maturity investment securities	$	187,027	$	194,294	$	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
September 30, 2016	Value		Losses			Value		Losses			Value		Losses

U.S. Treasury and federal agencies	$	6,594	$	(15	)	$	—	$	—		$	6,594	$	(15	)
State and municipal		26,360		(868	)		—		—			26,360		(868	)
Federal agency collateralized mortgage obligations		48,837		(184	)		12,304		(98	)		61,141		(282	)
Federal agency mortgage-backed pools		47,054		(365	)		6,779		(46	)		53,833		(411	)

Total temporarily impaired securities	$	128,845	$	(1,432	)	$	19,083	$	(144	)	$	147,928	$	(1,576	)


	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 September 30				Nine Months Ended September 30
	2016		2015		2016			2015
Sales of securities available for sale (Unaudited)
Proceeds	$	—	$	—	$	25,077		$	13,332
Gross gains		—		—		1,060			147
Gross losses		—		—		(185	)		(23	)

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 4 – Loans


	September 30			December 31
	2016			2015
Commercial
Working capital and equipment	$	440,599		$	381,245
Real estate, including agriculture		564,602			391,668
Tax exempt		12,621			8,674
Other		29,628			23,408

Total		1,047,450			804,995

Real estate
1–4 family		523,721			433,015
Other		6,441			4,129

Total		530,162			437,144

Consumer
Auto		167,541			168,397
Recreation		5,458			5,365
Real estate/home improvement		55,505			47,015
Home equity		140,156			127,113
Unsecured		4,230			4,120
Other		13,141			10,290

Total		386,031			362,300

Mortgage warehouse		226,876			144,692

Total loans		2,190,519			1,749,131
Allowance for loan losses		(14,524	)		(14,534	)

Loans, net	$	2,175,995		$	1,734,597

Commercial

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Real Estate and Consumer

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

Mortgage Warehousing

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


	Loan					Deferred			Recorded
September 30, 2016	Balance			Interest Due		Fees / (Costs)			Investment
Owner occupied real estate	$	321,762		$	1,151	$	1,192		$	324,105
Non owner occupied real estate		457,555			627		529			458,711
Residential spec homes		7,949			20		6			7,975
Development & spec land loans		39,798			79		74			39,951
Commercial and industrial		218,414			1,992		171			220,577

Total commercial		1,045,478			3,869		1,972			1,051,319

Residential mortgage		506,545			1,599		2,556			510,700
Residential construction		21,061			38		—			21,099
Mortgage warehouse		226,876			498		—			227,374

Total real estate		754,482			2,135		2,556			759,173

Direct installment		66,495			178		(439	)		66,234
Direct installment purchased		124			—		—			124
Indirect installment		147,829			296		—			148,125
Home equity		172,905			665		(883	)		172,687

Total consumer		387,353			1,139		(1,322	)		387,170

Total loans		2,187,313			7,143		3,206			2,197,662
Allowance for loan losses		(14,524	)		—		—			(14,524	)

Net loans	$	2,172,789		$	7,143	$	3,206		$	2,183,138


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

Total commercial		802,792			2,207		2,203			807,202

Residential mortgage		414,924			1,275		2,470			418,669
Residential construction		19,751			34		—			19,785
Mortgage warehouse		144,692			480		—			145,172

Total real estate		579,367			1,789		2,470			583,626

Direct installment		54,341			168		(359	)		54,150
Direct installment purchased		153			—		—			153
Indirect installment		151,523			323		—			151,846
Home equity		157,164			628		(522	)		157,270

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

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 5 – Accounting for Certain Loans Acquired in a Transfer

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

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


	September 30		September 30		September 30		September 30		September 30		September 30
	2016		2016		2016		2016		2016		2016
	Heartland		Summit		Peoples		Kosciusko		LaPorte		Total
Commercial	$	867	$	5,323	$	724	$	1,667	$	5,731	$	14,312
Real estate		605		989		204		492		1,673		3,963
Consumer		2		9		—		—		—		11

Outstanding balance	$	1,474	$	6,321	$	928	$	2,159	$	7,404	$	18,286

Carrying amount, net of allowance of $0											$	18,286


	December 31		December 31		December 31		December 31		December 31		December 31
	2015		2015		2015		2015		2015		2015
	Heartland		Summit		Peoples		Kosciusko		LaPorte		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 nine months ended September 30, is as follows:


	Nine Months Ended September 30, 2016
	Heartland			Summit			Peoples			Kosciusko			LaPorte		Total
Balance at January 1	$	795		$	708		$	555		$	—		$	—	$	2,058
Additions		—			—			—			634			1,736		2,370
Accretion		(127	)		(139	)		(92	)		(38	)		—		(396	)
Reclassification from nonaccretable difference		—			—			—			—			—		—
Disposals		(74	)		(35	)		(59	)		(23	)		—		(191	)

Balance at September 30	$	594		$	534		$	404		$	573		$	1,736	$	3,841


	Nine Months Ended September 30, 2015
	Heartland			Summit			Peoples			Kosciusko			LaPorte		Total
Balance at January 1	$	2,400		$	1,268		$	—		$	—		$	—	$	3,668
Additions		—			—			647			—			—		647
Accretion		(272	)		(254	)		—			—			—		(526	)
Reclassification from nonaccretable difference		—			—			—			—			—		—
Disposals		(1,210	)		(237	)		—			—			—		(1,447	)

Balance at September 30	$	918		$	777		$	647		$	—		$	—	$	2,342

During the nine months ended September 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 $87,000, respectively.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 6 – Allowance for Loan Losses

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


	Three Months Ended						Nine Months Ended
	September 30						September 30
	2016			2015			2016			2015
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Balance at beginning of the period	$	14,226		$	16,421		$	14,534		$	16,501
Loans charged-off:
Commercial
Owner occupied real estate		4			56			182			1,478
Non owner occupied real estate		(1	)		—			471			16
Residential development		—			—			—			—
Development & Spec Land Loans		—			—			—			—
Commercial and industrial		8			38			47			291

Total commercial		11			94			700			1,785
Real estate
Residential mortgage		12			101			127			287
Residential construction		—			—			—			—
Mortgage warehouse		—			—			—			—

Total real estate		12			101			127			287
Consumer
Direct Installment		55			51			159			206
Direct Installment Purchased		—			—			—			—
Indirect Installment		296			218			851			783
Home Equity		32			262			271			766

Total consumer		383			531			1,281			1,755

Total loans charged-off		406			726			2,108			3,827

Recoveries of loans previously charged-off:
Commercial
Owner occupied real estate		2			8			31			94
Non owner occupied real estate		1			1			55			1
Residential development		2			—			6			—
Development & Spec Land Loans		—			—			—			—
Commercial and industrial		12			8			107			41

Total commercial		17			17			199			136
Real estate
Residential mortgage		12			5			75			10
Residential construction		—			—			—			—
Mortgage warehouse		—			—			—			—

Total real estate		12			5			75			10
Consumer
Direct Installment		26			15			70			91
Direct Installment Purchased		—			—			—			—
Indirect Installment		160			112			400			347
Home Equity		34			24			135			90

Total consumer		220			151			605			528

Total loan recoveries		249			173			879			674

Net loans charged-off (recovered)		157			553			1,229			3,153

Provision charged to operating expense
Commercial		165			532			(471	)		2,580
Real estate		102			(955	)		(147	)		(51	)
Consumer		188			723			1,837			291

Total provision charged to operating expense		455			300			1,219			2,820

Balance at the end of the period	$	14,524		$	16,168		$	14,524		$	16,168

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.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

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

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

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


September 30, 2016	Commercial		Real Estate		Mortgage Warehousing		Consumer		Total
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—
Collectively evaluated for impairment		6,222		1,947		1,337		5,018		14,524
Loans acquired with deteriorated credit quality		—		—		—		—		—

Total ending allowance balance	$	6,222	$	1,947	$	1,337	$	5,018	$	14,524


Loans:
Individually evaluated for impairment	$	5,855	$	—	$	—	$	—	$	5,855
Collectively evaluated for impairment		1,045,464		531,799		227,374		387,170		2,191,807
Loans acquired with deteriorated credit quality		—		—		—		—		—

Total ending loans balance	$	1,051,319	$	531,799	$	227,374	$	387,170	$	2,197,662


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

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


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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 7 – Non-performing Loans and Impaired Loans

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


September 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	$	566	$	—	$	—	$	—	$	566
Non owner occupied real estate		2,734		—		240		60		3,034
Residential development		—		—		—		—		—
Development & Spec Land Loans		137		—		—		—		137
Commercial and industrial		1,740		—		—		—		1,740

Total commercial		5,177		—		240		60		5,477

Real estate
Residential mortgage		1,094		44		870		863		2,871
Residential construction		—		—		238		—		238
Mortgage warehouse		—		—		—		—		—

Total real estate		1,094		44		1,108		863		3,109

Consumer
Direct Installment		1,505		—		—		—		1,505
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		970		15		—		—		985
Home Equity		1,345		—		175		241		1,761

Total Consumer		3,820		15		175		241		4,251

Total	$	10,091	$	59	$	1,523	$	1,164	$	12,837


December 31, 2015	Non-accrual		Loans Past Due Over 90 Days Still Accruing		Non- Performing TDRs		Performing TDRs		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	1,749	$	—	$	—	$	—	$	1,749
Non owner occupied real estate		3,034		—		1,915		60		5,009
Residential development		—		—		—		—		—
Development & Spec Land Loans		71		—		—		—		71
Commercial and industrial		176		—		—		—		176

Total commercial		5,030		—		1,915		60		7,005

Real estate
Residential mortgage		4,354		1		824		808		5,987
Residential construction		—		—		250		—		250
Mortgage warehouse		—		—		—		—		—

Total real estate		4,354		1		1,074		808		6,237

Consumer
Direct Installment		541		—		—		—		541
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		601		27		—		—		628
Home Equity		1,736		—		183		350		2,269

Total Consumer		2,878		27		183		350		3,438

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Included in the $10.1 million of non-accrual loans and the $1.5 million of non-performing TDRs at September 30, 2016 were $1.2 million and $238,000, 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 September 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 September 30, 2016, the Company had $2.7 million in TDRs and $1.5 million were performing according to the restructured terms and zero TDRs were returned to accrual status during the first nine months of 2016. There was $84,000 of specific reserves allocated to TDRs at September 30, 2016 based on the discounted cash flows or when appropriate the fair value of the collateral.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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


							Three Months Ending				Nine Months Ending
September 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	$	994	$	995	$	—	$	1,029	$	—	$	1,062	$	—
Non owner occupied real estate		3,106		3,120		—		3,150		1		3,776		3
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		1,740		1,740		—		1,984		—		878		—

Total commercial		5,840		5,855		—		6,163		1		5,716		3

With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		—		—		—		—
Non owner occupied real estate		—		—		—		—		—		—		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—		—

Total commercial		—		—		—		—		—		—		—

Total	$	5,840	$	5,855	$	—	$	6,163	$	1	$	5,716	$	3


							Three Months Ending				Nine Months Ending
September 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	$	1,235	$	1,238	$	—	$	1,262	$	1	$	1,041	$	10
Non owner occupied real estate		2,798		2,801		—		2,815		1		2,846		4
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		239		239		—		583		4		415		4

Total commercial		4,272		4,278		—		4,660		6		4,302		18

With an allowance recorded
Commercial
Owner occupied real estate		2,967		2,966		598		2,968		—		2,191		55
Non owner occupied real estate		2,817		2,828		550		2,858		—		2,942		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		—		—		—		—		—		—		—
Commercial and industrial		776		776		451		776		—		836		—

Total commercial		6,560		6,570		1,599		6,602		—		5,969		55

Total	$	10,832	$	10,848	$	1,599	$	11,262	$	6	$	10,271	$	73

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:


September 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	$	282		$	17		$	—		$	299		$	321,463		$	321,762
Non owner occupied real estate		180			103			—			283			457,272			457,555
Residential development		—			—			—			—			7,949			7,949
Development & Spec Land Loans		32			—			—			32			39,766			39,798
Commercial and industrial		361			267			—			628			217,786			218,414

Total commercial		855			387			—			1,242			1,044,236			1,045,478

Real estate
Residential mortgage		982			210			43			1,235			505,310			506,545
Residential construction		—			—			—			—			21,061			21,061
Mortgage warehouse		—			—			—			—			226,876			226,876

Total real estate		982			210			43			1,235			753,247			754,482

Consumer
Direct Installment		42			30			—			72			66,423			66,495
Direct Installment Purchased		—			—			—			—			124			124
Indirect Installment		805			49			15			869			146,960			147,829
Home Equity		436			26			—			462			172,443			172,905

Total consumer		1,283			105			15			1,403			385,950			387,353

Total	$	3,120		$	702		$	58		$	3,880		$	2,183,433		$	2,187,313

Percentage of total loans		0.14	%		0.03	%		0.00	%		0.18	%		99.82	%


December 31, 2015	30 - 59 Days Past Due			60 - 89 Days Past Due			Greater than 90 Days Past Due			Total Past Due			Loans Not Past Due			Total
Commercial
Owner occupied real estate	$	481		$	18		$	—		$	499		$	267,782		$	268,281
Non owner occupied real estate		49			—			—			49			326,350			326,399
Residential development		—			—			—			—			5,018			5,018
Development & Spec Land Loans		—			—			—			—			18,183			18,183
Commercial and industrial		32			—			—			32			184,879			184,911

Total commercial		562			18			—			580			802,212			802,792

Real estate
Residential mortgage		1,121			344			1			1,466			413,458			414,924
Residential construction		—			—			—			—			19,751			19,751
Mortgage warehouse		—			—			—			—			144,692			144,692

Total real estate		1,121			344			1			1,466			577,901			579,367

Consumer
Direct Installment		106			10			—			116			54,225			54,341
Direct Installment Purchased		—			—			—			—			153			153
Indirect Installment		1,186			268			27			1,481			150,042			151,523
Home Equity		1,193			203			—			1,396			155,768			157,164

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

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

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

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

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

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

•

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

•

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

•

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

For residential real estate and consumer loans, Horizon uses a grading system based on delinquency. Loans that are 90 days or more past due, on non-accrual, or are classified as a TDR are graded “Substandard.” After being 90 to 120 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass.

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

Risk Grade 1: Excellent (Pass)

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

Risk Grade 2: Good (Pass)

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

Risk Grade 3: Satisfactory (Pass)

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

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

•

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

•

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

•

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

•

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

Risk Grade 4 Satisfactory/Monitored:

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

Risk Grade 4W Management Watch:

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

Risk Grade 5: Special Mention

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

Risk Grade 6: Substandard

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

•

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

•

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

•

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

Risk Grade 7: Doubtful

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

•

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

•

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

•

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

Risk Grade 8: Loss

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

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The following table presents loans by credit grades.


September 30, 2016	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	305,849		$	5,258		$	10,655		$	—		$	321,762
Non owner occupied real estate		450,811			344			6,400			—			457,555
Residential development		7,949			—			—			—			7,949
Development & Spec Land Loans		39,571			—			227			—			39,798
Commercial and industrial		207,998			1,419			8,997			—			218,414

Total commercial		1,012,178			7,021			26,279			—			1,045,478

Real estate
Residential mortgage		503,821			—			2,724			—			506,545
Residential construction		20,823			—			238			—			21,061
Mortgage warehouse		226,876			—			—			—			226,876

Total real estate		751,520			—			2,962			—			754,482

Consumer
Direct Installment		64,990			—			1,505			—			66,495
Direct Installment Purchased		124			—			—			—			124
Indirect Installment		146,844			—			985			—			147,829
Home Equity		171,152			—			1,753			—			172,905

Total Consumer		383,110			—			4,243			—			387,353

Total	$	2,146,808		$	7,021		$	33,484		$	—		$	2,187,313

Percentage of total loans		98.15	%		0.32	%		1.53	%		0.00	%

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

Total commercial		781,108			6,232			15,452			—			802,792

Real estate
Residential mortgage		408,937			—			5,987			—			414,924
Residential construction		19,501			—			250			—			19,751
Mortgage warehouse		144,692			—			—			—			144,692

Total real estate		573,130			—			6,237			—			579,367

Consumer
Direct Installment		53,800			—			541			—			54,341
Direct Installment Purchased		153			—			—			—			153
Indirect Installment		150,895			—			628			—			151,523
Home Equity		154,895			—			2,269			—			157,164

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

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

Percentage of total loans		98.20	%		0.36	%		1.44	%		0.00	%

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

Note 8 – Repurchase Agreements

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

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


September 30, 2016	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	$	62,703		$	35,000	$	50,000	$	10,000	$	—		$	—		$	157,703


Securities lending transactions
U.S. Treasury and federal agencies		4,025			—		—		—		—			—			4,025
Federal agency collateralized mortgage obligations		50,255			—		316		258		21,514			30,621			102,964
Federal agency mortgage-backed pools		14,501			—		89		2,146		20,778			29,388			66,902

Total		68,781			—		405		2,404		42,292			60,009			173,891

Total borrowings	$	(6,078	)	$	35,000	$	49,595	$	7,596	$	(42,292	)	$	(60,009	)	$	(16,188	)

Gross amount of recognized liabilities for repurchase agreements and securities lending																$	157,703

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 September 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 September 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 September 30, 2016, the Company’s fair value hedges were effective and are not expected to have a significant impact on the Company’s net income over the next 12 months.

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The change in fair value of both the hedge instruments and the underlying loan agreements are recorded as gains or losses in interest income. The fair value hedges are considered to be highly effective and any hedge ineffectiveness was deemed not material. The notional amounts of the loan agreements being hedged were $118.1 million at September 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 September 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
	September 30, 2016				September 30, 2016
Derivatives designated as hedging instruments (Unaudited)	Balance Sheet Location		Fair Value		Balance Sheet Location		Fair Value
Interest rate contracts		Loans	$	—		Other liabilities	$	4,563
Interest rate contracts		Other Assets		4,563		Other liabilities		3,002

Total derivatives designated as hedging instruments				4,563				7,565


Derivatives not designated as hedging instruments
Mortgage loan contracts		Other assets		787		Other liabilities		—

Total derivatives not designated as hedging instruments				787				—

Total derivatives			$	5,350			$	7,565


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

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


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

Total derivatives not designated as hedging instruments				642				—

Total derivatives			$	2,424			$	4,923

HORIZON BANCORP AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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

The effect of the derivative instruments on the condensed consolidated statements of income for the three and nine month periods ending September 30 is as follows:


	Comprehensive Income on Derivative (Effective Portion)					Comprehensive Income on Derivative (Effective Portion)
	Three Months Ended September 30					Nine Months Ended September 30
Derivative in cash flow hedging relationship	2016		2015			2016		2015
Derivative in cash flow hedging relationship	(Unaudited)		(Unaudited)			(Unaudited)		(Unaudited)
Interest rate contracts	$	522	$	(335	)	$	103	$	(217	)

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 September 30						Nine Months Ended September 30
Derivative in fair value hedging relationship	Location of gain (loss) recognized on derivative	2016			2015			2016			2015
Derivative in fair value hedging relationship	Location of gain (loss) recognized on derivative	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Interest rate contracts	Interest income - loans	$	(830	)	$	765		$	2,781		$	579
Interest rate contracts	Interest income - loans		830			(765	)		(2,781	)		(579	)

Total		$	—		$	—		$	—		$	—


		Amount of Gain (Loss) Recognized on Derivative						Amount of Gain (Loss) Recognized on Derivative
		Three Months Ended September 30						Nine Months Ended September 30

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