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
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
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.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Income
Condensed Consolidated Statements of Comprehensive Income
Condensed Consolidated Statement of Stockholders’ Equity
Condensed Consolidated Statements of Cash Flows
Notes to Condensed Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
PART II. OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Signatures
Index To Exhibits
2
PART 1 — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HORIZON BANCORP AND SUBSIDIARIES
(Dollar Amounts in Thousands)
Assets
Cash and due from banks
Investment securities, available for sale
Investment securities, held to maturity (fair value of $194,294 and $193,703)
Loans held for sale
Loans, net of allowance for loan losses of $14,524 and $14,534
Premises and equipment, net
Federal Reserve and Federal Home Loan Bank stock
Goodwill
Other intangible assets
Interest receivable
Cash value of life insurance
Other assets
Total assets
Liabilities
Deposits
Non-interest bearing
Interest bearing
Total deposits
Borrowings
Subordinated debentures
Interest payable
Other liabilities
Total liabilities
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
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
Retained earnings
Accumulated other comprehensive income (loss)
Total stockholders’ equity
Total liabilities and stockholders’ equity
See notes to condensed consolidated financial statements
3
(Dollar Amounts in Thousands, Except Per Share Data)
Interest Income
Loans receivable
Investment securities
Taxable
Tax exempt
Total interest income
Interest Expense
Borrowed funds
Total interest expense
Net Interest Income
Provision for loan losses
Net Interest Income after Provision for Loan Losses
Non-interest Income
Service charges on deposit accounts
Wire transfer fees
Interchange fees
Fiduciary activities
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)
Gain on sale of mortgage loans
Mortgage servicing income net of impairment
Increase in cash value of bank owned life insurance
Death benefit on bank owned life insurance
Other income
Total non-interest income
Non-interest Expense
Salaries and employee benefits
Net occupancy expenses
Data processing
Professional fees
Outside services and consultants
Loan expense
FDIC insurance expense
Other losses
Other expense
Total non-interest expense
Income Before Income Tax
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 $43 for the nine months ended September 30, 2015, related to income tax expense from reclassification items)
Net Income
Preferred stock dividend
Net Income Available to Common Shareholders
Basic Earnings Per Share (Restated - See Note 1)
Diluted Earnings Per Share (Restated - See Note 1)
4
Other Comprehensive Income (Loss)
Change in fair value of derivative instruments:
Change in fair value of derivative instruments for the period
Income tax effect
Changes from derivative instruments
Change in securities:
Unrealized appreciation (depreciation) for the period on AFS securities
Amortization from transfer of securities from available-for-sale to held-to-maturity securities
Reclassification adjustment for securities gains realized in income
Unrealized gains (losses) on securities
Other Comprehensive Income (Loss), Net of Tax
Comprehensive Income
5
HORIZON BANCORP ANDSUBSIDIARIES
(Unaudited)
Balances, January 1, 2016
Net income
Other comprehensive income, net of tax
Redemption of preferred stock
Amortization of unearned compensation
Stock option expense
Stock issued stock plans
Stock issued in KFI acquisition
Stock issued in LPSB acquisition
Cash dividends on preferred stock (1.00%)
Cash dividends on common stock ($.30 per share)
Balances, September 30, 2016
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Operating Activities
Items not requiring (providing) cash
Depreciation and amortization
Share based compensation
Mortgage servicing rights net impairment
Premium amortization on securities available for sale, net
Gain on sale of investment securities
Proceeds from sales of loans
Loans originated for sale
Change in cash value of life insurance
Gain (Loss) on sale of other real estate owned
Net change in
Net cash provided by operating activities
Investing Activities
Purchases of securities available for sale
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale
Purchases of securities held to maturity
Proceeds from maturities of securities held to maturity
Change in FHLB stock
Net change in loans
Proceeds on the sale of OREO and repossessed assets
Change in premises and equipment, net
Acquisition of Peoples, net of cash received
Acquisition of Kosciusko, net of cash received
Acquisition of LaPorte, net of cash received
Net cash provided by (used in) investing activities
Financing Activities
Proceeds from issuance of stock
Dividends paid on common shares
Dividends paid on preferred shares
Net cash provided by (used in) financing activities
Net Change in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
Cash and Cash Equivalents, End of Period
Additional Supplemental Information
Interest paid
Income taxes paid
Transfer of loans to other real estate owned
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
Less: common stock issued
Cash paid for the capital stock
Liabilities assumed
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:
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(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.
Basic earnings per share
Less: Preferred stock dividends
Net income available to common shareholders
Weighted average common shares outstanding(1)
Diluted earnings per share
Effect of dilutive securities:
Warrants
Restricted stock
Stock options
Weighted average shares outstanding
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.
8
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
Investment securities, held to maturity
Commercial
Residential mortgage
Consumer
Total loans
FRB and FHLB stock
Core deposit intangible
Total assets purchased
Common shares issued
Cash paid
Total estimated purchase price
LIABILITIES
NOW accounts
Savings and money market
Certificates of deposits
Total liabilities assumed
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.
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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
Contractual cash flows not expected to be collected (nonaccretable differences)
Expected cash flows at acquisition
Interest component of expected cash flows (accretable discount)
Fair value of acquired loans accounted for under ASC 310-30
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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.
Summary of Operations:
Provision for Loan Losses
Non-Interest Expense
Income before Income Taxes
Income Tax Expense
Basic Earnings Per Share
Diluted Earnings Per Share
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.
Under the acquisition method of accounting, the total purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition. Based on preliminary valuations of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the Kosciusko acquisition is detailed in the following table. The final valuation numbers were received in September 2016 which changed the goodwill estimate from $6.9 million to $6.4 million.
11
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.
12
The following table details the acquired loans that are accounted for in accordance with ASC 310-30 as of June 1, 2016.
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.
13
Mortgage Warehousing
FHLB stock
Subordinated debt
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.
14
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.
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.
15
Note 3 – Securities
The fair value of securities is as follows:
Available for sale
U.S. Treasury and federal agencies
State and municipal
Federal agency collateralized mortgage obligations
Federal agency mortgage-backed pools
Corporate notes
Total available for sale investment securities
Held to maturity
Total held to maturity investment securities
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.
16
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.
Within one year
One to five years
Five to ten years
After ten years
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.
Total temporarily impaired securities
Sales of securities available for sale (Unaudited)
Proceeds
Gross gains
Gross losses
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Note 4 – Loans
Working capital and equipment
Real estate, including agriculture
Other
Total
Real estate
1–4 family
Auto
Recreation
Real estate/home improvement
Home equity
Unsecured
Mortgage warehouse
Allowance for loan losses
Loans, net
Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves larger loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets, the general economy or fluctuations in interest rates. The properties securing the Company’s commercial real estate portfolio are diverse in terms of property type, and are monitored for concentrations of credit. Management monitors and evaluates commercial real estate loans based on collateral, cash flow and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.
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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.
Horizon’s mortgage warehouse lending has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with a pledge of collateral under Horizon’s agreement with the mortgage company. Each individual mortgage and the related mortgagee are underwritten by Horizon to the end investor guidelines and is assigned to Horizon until the loan is sold to the secondary market by the mortgage company. In addition, Horizon takes possession of each original note and forwards such note to the end investor once the mortgage company has sold the loan. At the time a loan is transferred to the secondary market, the mortgage company reacquires the loan under its option within the agreement. Due to the reacquire feature contained in the agreement, the transaction does not qualify as a sale and therefore is accounted for as a secured borrowing with a pledge of collateral pursuant to the agreement with the mortgage company. When the individual loan is sold to the end investor by the mortgage company, the proceeds from the sale of the loan are received by Horizon and used to pay off the loan balance with Horizon along with any accrued interest and any related fees. The remaining balance from the sale is forwarded to the mortgage company. These individual loans typically are sold by the mortgage company within 30 days and are seldom held more than 90 days. Interest income is accrued during this period and collected at the time each loan is sold. Fee income for each loan sold is collected when the loan is sold, and no costs are deferred due to the term between each loan funding and related payoff, which is typically less than 30 days.
Based on the agreements with each mortgage company, at any time a mortgage company can reacquire from Horizon its outstanding loan balance on an individual mortgage and regain possession of the original note. Horizon also has the option to request that the mortgage company reacquire an individual mortgage. Should this occur, Horizon would return the original note and reassign the assignment of the mortgage to the mortgage company. Also, in the event that the end investor would not be able to honor the purchase commitment and the mortgage company would not be able to reacquire its loan on an individual mortgage, Horizon would be able to exercise its rights under the agreement.
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The following table shows the recorded investment of individual loan categories.
Owner occupied real estate
Non owner occupied real estate
Residential spec homes
Development & spec land loans
Commercial and industrial
Total commercial
Residential construction
Total real estate
Direct installment
Direct installment purchased
Indirect installment
Total consumer
Net loans
20
Note 5 – Accounting for Certain Loans Acquired in a Transfer
The Company acquired loans in acquisitions and the transferred loans had evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.
Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past-due and non-accrual status, borrower credit scores and recent loan-to-value percentages. Purchased credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310-30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. Management estimated the cash flows expected to be collected at acquisition using our internal risk models, which incorporate the estimate of current key assumptions, such as default rates, severity and prepayment speeds. Amounts for LaPorte were estimated as of September 30, 2016 as the final analysis of loans with deterioration was not completed.
The carrying amounts of those loans included in the balance sheet amounts of loans receivable are as follows:
Outstanding balance
Carrying amount, net of allowance of $0
Carrying amount, net of allowance of $63
Accretable yield, or income expected to be collected for the nine months ended September 30, is as follows:
Balance at January 1
Additions
Accretion
Reclassification from nonaccretable difference
Disposals
Balance at September 30
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.
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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.
Balance at beginning of the period
Loans charged-off:
Residential development
Development & Spec Land Loans
Direct Installment
Direct Installment Purchased
Indirect Installment
Home Equity
Total loans charged-off
Recoveries of loans previously charged-off:
Total loan recoveries
Net loans charged-off (recovered)
Provision charged to operating expense
Total provision charged to operating expense
Balance at the end of the period
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.
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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:
Allowance For Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment
Collectively evaluated for impairment
Loans acquired with deteriorated credit quality
Total ending allowance balance
Loans:
Total ending loans balance
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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:
Total Consumer
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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.
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The following table presents commercial loans individually evaluated for impairment by class of loan:
With no recorded allowance
With an allowance recorded
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The following table presents the payment status by class of loan:
Percentage of total loans
The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date.
Horizon Bank’s processes for determining credit quality differ slightly depending on whether a new loan or a renewed loan is being underwritten, or whether an existing loan is being re-evaluated for credit quality. The latter usually occurs upon receipt of current financial information or other pertinent data that would trigger a change in the loan grade.
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For residential real estate and consumer loans, Horizon uses a grading system based on delinquency. Loans that are 90 days or more past due, on non-accrual, or are classified as a TDR are graded “Substandard.” After being 90 to 120 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass.
Horizon Bank employs a nine-grade rating system to determine the credit quality of commercial loans. The first five grades represent acceptable quality, and the last four grades mirror the criticized and classified grades used by the bank regulatory agencies (special mention, substandard, doubtful, and loss). The loan grade definitions are detailed below.
Risk Grade 1: Excellent (Pass)
Loans secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better.
Risk Grade 2: Good (Pass)
Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by unaudited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets and unblemished credit history; or loans to publicly held companies with current long-term debt ratings of Baa or better.
Risk Grade 3: Satisfactory (Pass)
Loans supported by financial statements (audited or unaudited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.
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Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:
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:
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Risk Grade 7: Doubtful
One or more of the following characteristics may be present in loans classified Doubtful:
Risk Grade 8: Loss
Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.
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The following table presents loans by credit grades.
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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
Repurchase Agreements and repurchase-to-maturity transactions
Repurchase Agreements
Securities lending transactions
Total borrowings
Gross amount of recognized liabilities for repurchase agreements and securities lending
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.
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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:
Interest rate contracts
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments
Mortgage loan contracts
Total derivatives not designated as hedging instruments
Total derivatives
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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:
Derivative in cash flow hedging relationship
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.
Derivative in fair valuehedging relationship
Location of gain (loss)
recognized on derivative
Interest income - loans
Derivative not designated
as hedging relationship
Mortgage contracts
Other income - gain on sale of loans
Note 10 – Disclosures about Fair Value of Assets and Liabilities
The Fair Value Measurements topic of the FASB ASC defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. There are three levels of inputs that may be used to measure fair value:
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Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated financial statements, as well as the general classification of such instruments pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the period ended September 30, 2016. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.
Available for sale securities
When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U.S. Treasury and federal agency securities, state and municipal securities, federal agency collateralized mortgage obligations and mortgage-backed pools and corporate notes. Level 2 securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs. Observable inputs include dealer quotes, market spreads, cash flow analysis, the U.S. Treasury yield curve, trade execution data, market consensus prepayment spreads and available credit information and the bond’s terms and conditions. The pricing provider utilizes evaluated pricing models that vary based on asset class. These models incorporate available market information including quoted prices of securities with similar characteristics and, because many fixed-income securities do not trade on a daily basis, apply available information through processes such as benchmark curves, benchmarking of like securities, sector grouping, and matrix pricing. In addition, model processes, such as an option adjusted spread model, is used to develop prepayment and interest rate scenarios for securities with prepayment features.
Hedged loans
Certain fixed rate loans have been converted to variable rate loans by entering into interest rate swap agreements. The fair value of those fixed rate loans is based on discounting the estimated cash flows using interest rates determined by the respective interest rate swap agreement. Loans are classified within Level 2 of the valuation hierarchy based on the unobservable inputs used.
Interest rate swap agreements
The fair value of the Company’s interest rate swap agreements is estimated by a third party using inputs that are primarily unobservable including a yield curve, adjusted for liquidity and credit risk, contracted terms and discounted cash flow analysis, and therefore, are classified within Level 2 of the valuation hierarchy.
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The following table presents the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated financial statements measured at fair value on a recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at the following:
Available-for-sale securities
Total available-for-sale securities
Forward sale commitments
Commitments to originate loans
December 31, 2015
Realized gains and losses included in net income for the periods are reported in the condensed consolidated statements of income as follows:
Fair value interest rate swap agreements
Derivative loan commitments
Certain other assets are measured at fair value on a nonrecurring basis in the ordinary course of business and are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment):
Impaired loans
Mortgage servicing rights
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Impaired (collateral dependent): Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans.
If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.
Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.
Mortgage Servicing Rights (MSRs): MSRs do not trade in an active market with readily observable prices. Accordingly, the fair value of these assets is classified as Level 3. The Company determines the fair value of MSRs using an income approach model based upon the Company’s month-end interest rate curve and prepayment assumptions. The model utilizes assumptions to estimate future net servicing income cash flows, including estimates of time decay, payoffs and changes in valuation inputs and assumptions. The Company reviews the valuation assumptions against this market data for reasonableness and adjusts the assumptions if deemed appropriate. The carrying amount of the MSRs’ fair value due to impairment decreased by $193,000 during the first nine months of 2016 and decreased by $51,000 during the first nine months of 2015.
The following table presents qualitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements, other than goodwill.
Valuation
Technique
Unobservable Inputs
Note 11 – Fair Value of Financial Instruments
The estimated fair value amounts of the Company’s financial instruments were determined using available market information, current pricing information applicable to Horizon and various valuation methodologies. Where market quotations were not available, considerable management judgment was involved in the determination of estimated fair values. Therefore, the estimated fair value of financial instruments shown below may not be representative of the amounts at which they could be exchanged in a current or future transaction. Due to the inherent uncertainties of expected cash flows of financial instruments, the use of alternate valuation assumptions and methods could have a significant effect on the estimated fair value amounts.
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The estimated fair values of financial instruments, as shown below, are not intended to reflect the estimated liquidation or market value of Horizon taken as a whole. The disclosed fair value estimates are limited to Horizon’s significant financial instruments at September 30, 2016 and December 31, 2015. These include financial instruments recognized as assets and liabilities on the condensed consolidated balance sheet as well as certain off-balance sheet financial instruments. The estimated fair values shown below do not include any valuation of assets and liabilities, which are not financial instruments as defined by the FASB ASC fair value hierarchy.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
Cash and Due from Banks — The carrying amounts approximate fair value.
Held-to-Maturity Securities — For debt securities held to maturity, fair values are based on quoted market prices or dealer quotes. For those securities where a quoted market price is not available, carrying amount is a reasonable estimate of fair value based upon comparison with similar securities.
Loans Held for Sale — The carrying amounts approximate fair value.
Net Loans — The fair value of portfolio loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The carrying amounts of loans held for sale approximate fair value.
FHLB and FRB Stock — Fair value of FHLB and FRB stock is based on the price at which it may be resold to the FHLB and FRB.
Interest Receivable/Payable — The carrying amounts approximate fair value.
Deposits — The fair value of demand deposits, savings accounts, interest-bearing checking accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturity.
Borrowings — Rates currently available to Horizon for debt with similar terms and remaining maturities are used to estimate fair values of existing borrowings.
Subordinated Debentures — Rates currently available for debentures with similar terms and remaining maturities are used to estimate fair values of existing debentures.
Commitments to Extend Credit and Standby Letters of Credit — The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. Due to the short-term nature of these agreements, carrying amounts approximate fair value.
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The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall (unaudited).
Loans excluding loan level hedges, net
Stock in FHLB and FRB
Non-interest bearing deposits
Interest-bearing deposits
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Note 12 – Accumulated Other Comprehensive Income
Unrealized gain on securities available for sale
Unamortized gain on securities held to maturity, previously transferred from AFS
Unrealized loss on derivative instruments
Tax effect
Total accumulated other comprehensive income (loss)
Note 13 – Regulatory Capital
Horizon and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. Failure to meet the minimum regulatory capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators, which if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective actions, the Bank must meet specific capital guidelines involving quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined), or leverage ratio. For September 30, 2016, Basel III rules require the Bank to maintain minimum amounts and ratios of common equity Tier I capital (as defined in the regulation) to risk-weighted assets (as defined). Additionally, under Basel III rules, the decision was made to opt-out of including accumulated other comprehensive income in regulatory capital.
To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based, common equity Tier I risk-based (September 30, 2016) and Tier I leverage ratios as set forth in the table below. As of September 30, 2016 and December 31, 2015, the Bank met all capital adequacy requirements to be considered well capitalized. There have been no conditions or events since the end of the third quarter of 2016 that management believes have changed the Bank’s classification as well capitalized. There is no threshold for well-capitalized status for bank holding companies.
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Horizon and the Bank’s actual and required capital ratios as of September 30, 2016 and December 31, 2015 were as follows:
As of September 30, 2016
Total capital1 (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital1 (to risk-weighted assets)
Common equity tier 1 capital1 (to risk-weighted assets)
Tier 1 capital1 (to average assets)
As of December 31, 2015
Note 14 – Preferred Stock Redemption
On February 1, 2016, Horizon completed the redemption (the “Redemption”) of all 12,500 outstanding shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “SBLF Preferred Stock”) which were held by the U.S. Department of Treasury and issued pursuant to its Small Business Lending Fund (“SBLF”). The SBLF Preferred Stock was redeemed at its liquidation value of $1,000 per share, plus accrued dividends, for a total Redemption price of $12,510,416.67. Horizon funded the Redemption using cash on hand without borrowing and without a special dividend from the Bank. Following the Redemption, Horizon does not have any shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series B outstanding. The Redemption terminates Horizon’s participation in the SBLF.
Note 15 – Subsequent Events
On July 12, 2016, Horizon announced the acquisition of CNB Bancorp, parent company of The Central National Bank and Trust Company (“Central National Bank & Trust”). Under the terms of the Merger Agreement, stockholders of CNB Bancorp will receive cash consideration consisting of a special dividend calculated as capital in excess of 8% of CNB Bancorp’s total assets, less certain after tax transaction costs, and an amount to be paid by Horizon equal to 120% of remaining capital. These amounts will be determined as of the end of the month prior to the closing of the merger. These amounts are dependent on CNB Bancorp’s earnings and other factors, but if the cash consideration for the stockholders were calculated based on the
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March 31, 2016 financial information available at the time of signing the Merger Agreement, the stockholders would receive, in the aggregate, a $6.7 million special dividend and a $5.3 million payment from Horizon. As of September 30, 2016, CNB Bancorp had total assets of approximately $56.4 million. Horizon anticipates closing the acquisition in early November 2016.
On October 4, 2016, Horizon announced the signing of a definitive agreement to purchase certain loans and substantially all of the deposits of a single branch located at 42 S. State Road 135, Bargersville, Indiana and owned by First Farmers Bank & Trust Co., an Indiana state chartered bank (“First Farmers”) and wholly owned subsidiary of First Farmers Financial Corporation, headquartered in Converse, Indiana. Under the terms of the agreement, Horizon anticipates purchasing approximately $5.0 million dollars in loans and assuming approximately $15 million in deposits. The loans to be purchased are subject to review and acceptance by Horizon prior to closing. Horizon will not be purchasing fixed assets or assuming the underlying lease for the First Farmers branch.
Note 16 – Future Accounting Matters
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). Topic 842 establishes a right of use model that requires a lessee to record a right of use asset and a lease liability for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. A lease will be treated as a sale it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results.
The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years for public business entities. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, with certain practical expedients available. Early adoption is permitted. The Company continues to assess the impact of Topic 842 on its accounting and disclosures.
In March 2016, the FASB issued ASU 2016-07, Investments - Equity Method and Joint Ventures: Simplifying the Transition to the Equity Method of Accounting. The amendments affect all entities that have an investment that becomes qualified for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. The amendments eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required.
The amendments require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method.
The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Earlier application is permitted.
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also allows an employer to repurchase more of an employee’s shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election for forfeitures as they occur.
The guidance is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those years. Early adoption is permitted. The Company continues to assess ASU 2016-09 but does not expect a significant impact on its accounting and disclosures.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Statements. Topic 326 amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. The ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.
Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand
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significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (i.e., January 1, 2020, for calendar year entities. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230)-Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 provides cash flow statement classification guidance for certain transactions including how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows.
The guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years and should be applied retrospectively. Early adoption is permitted, including adoption in an interim period. The Company is assessing ASU 2016-15 but does not expect a significant impact on its accounting and disclosures.
Note 17 – General Litigation
The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operation and cash flows of the Company.
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Management’s Discussion and Analysis of Financial Condition
And Results of Operations
For the Three and Nine Months ended September 30, 2016
Forward–Looking Statements
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to Horizon Bancorp (“Horizon” or the “Company”) and Horizon Bank, N.A. (the “Bank”). Horizon intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for the purposes of these safe harbor provisions. Statements in this report should be considered in conjunction with the other information available about Horizon, including the information in the other filings we make with the Securities and Exchange Commission. The forward-looking statements are based on management’s expectations and are subject to a number of risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as “anticipate,” “expect,” “estimate,” “project,” “intend,” “plan,” “believe,” “could,” “will” and similar expressions in connection with any discussion of future operating or financial performance. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements.
Actual results may differ materially, adversely or positively, from the expectations of the Company that are expressed or implied by any forward-looking statement. Risks, uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statement include but are not limited to:
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The foregoing list of important factors is not exclusive, and you are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document or, in the case of documents incorporated by reference, the dates of those documents. We do not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of us. For a detailed discussion of the risks and uncertainties that may cause our actual results or performance to differ materially from the results or performance expressed or implied by forward-looking statements, see “Risk Factors” in Item 1A of Part I of our 2015 Annual Report on Form 10-K and in the subsequent reports we file with the SEC.
Overview
Horizon is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in Northern and Central Indiana and Southwestern and Central Michigan through its bank subsidiary. Horizon operates as a single segment, which is commercial banking. Horizon’s common stock is traded on the NASDAQ Global Select Market under the symbol HBNC. The Bank was chartered as a national banking association in 1873 and has operated continuously since that time. The Bank is a full-service commercial bank offering commercial and retail banking services, corporate and individual trust and agency services, and other services incident to banking.
On July 18, 2016, Horizon completed the acquisition of LaPorte Bancorp, Inc., a Maryland corporation (“LaPorte Bancorp”) and Horizon Bank’s acquisition of The LaPorte Savings Bank, a state-chartered savings bank and wholly owned subsidiary of LaPorte Bancorp, through mergers effective July 18, 2016. Under the terms of the Merger Agreement, shareholders of LaPorte Bancorp had the option to receive $17.50 per share in cash or 0.9435 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 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, the transaction has an implied valuation of approximately $98.6 million.
On June 1, 2016, Horizon completed the acquisition of Kosciusko Financial, Inc., an Indiana corporation (“Kosciusko”) and Horizon Bank’s acquisition of Farmers State Bank, a state-chartered bank and wholly owned subsidiary of Kosciusko, through mergers effective June 1, 2016. Under the terms of the Merger Agreement, shareholders of Kosciusko had the option to receive $81.75 per share in cash or 4.5183 shares of Horizon common stock, or a combination of both, for each share of Kosciusko’s common stock, subject to allocation provisions to assure that in aggregate, Kosciusko shareholders received total consideration that 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.
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On July 1, 2015, Horizon completed the acquisition of Peoples Bancorp, an Indiana corporation (“Peoples”) and Horizon Bank’s acquisition of Peoples Federal Savings Bank of DeKalb County, a federally-chartered stock savings bank and wholly owned subsidiary of Peoples, through mergers effective July 1, 2015. Under the terms of the acquisition, the exchange ratio was 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.
Following are some highlights of Horizon’s financial performance through the third quarter of 2016:
Critical Accounting Policies
The notes to the consolidated financial statements included in Item 8 of the Company’s Annual Report on Form 10-K for 2015 contain a summary of the Company’s significant accounting policies. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management has identified as critical accounting policies the allowance for loan losses, intangible assets, mortgage servicing rights, hedge accounting and valuation measurements.
Allowance for Loan Losses
An allowance for loan losses is maintained to absorb probable incurred loan losses inherent in the loan portfolio. The determination of the allowance for loan losses is a critical accounting policy that involves
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management’s ongoing quarterly assessments of the probable incurred losses inherent in the loan portfolio. The identification of loans that have probable incurred losses is subjective; therefore, a general reserve is maintained to cover all probable losses within the entire loan portfolio. Horizon utilizes a loan grading system that helps identify, monitor and address asset quality problems in an adequate and timely manner. Each quarter, various factors affecting the quality of the loan portfolio are reviewed. Large credits are reviewed on an individual basis for loss potential. Other loans are reviewed as a group based upon previous trends of loss experience. Horizon also reviews the current and anticipated economic conditions of its lending market as well as transaction risk to determine the effect they may have on the loss experience of the loan portfolio.
Goodwill and Intangible Assets
Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. FASB ASC 350-10 establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. At September 30, 2016, Horizon had core deposit intangibles of $9.6 million subject to amortization and $74.3 million of goodwill, which is not subject to amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. Horizon’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Horizon to provide quality, cost effective banking services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely affect earnings in future periods. FASB ASC 350-10 requires an annual evaluation of goodwill for impairment. The evaluation of goodwill for impairment requires the use of estimates and assumptions. Market price at the close of business on September 30, 2016 was $19.59 per share compared to a book value of $15.55 per common share.
Horizon has concluded that, based on its own internal evaluation, the recorded value of goodwill is not impaired.
Mortgage Servicing Rights
Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets on a servicing-retained basis. Capitalized servicing rights are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated regularly for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying servicing rights by predominant characteristics, such as interest rates, original loan terms and whether the loans are fixed or adjustable rate mortgages. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. When the book value of an individual stratum exceeds its fair value, an impairment reserve is recognized so that each individual stratum is carried at the lower of its amortized book value or fair value. In periods of falling market interest rates, accelerated loan prepayment can adversely affect the fair value of these mortgage-servicing rights relative to their book value. In the event that the fair value of these assets was to increase in the future, Horizon can recognize the increased fair value to the extent of the impairment allowance but cannot recognize an asset in excess of its amortized book value. Future changes in management’s assessment of the impairment of these servicing assets, as a result of changes in observable market data relating to market interest rates, loan prepayment speeds, and other factors, could impact Horizon’s financial condition and results of operations either positively or negatively.
Generally, when market interest rates decline and other factors favorable to prepayments occur, there is a corresponding increase in prepayments as customers refinance existing mortgages under more favorable interest rate terms. When a mortgage loan is prepaid, the anticipated cash flows associated with servicing that
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loan are terminated, resulting in a reduction of the fair value of the capitalized mortgage servicing rights. To the extent that actual borrower prepayments do not react as anticipated by the prepayment model (i.e., the historical data observed in the model does not correspond to actual market activity), it is possible that the prepayment model could fail to accurately predict mortgage prepayments and could result in significant earnings volatility. To estimate prepayment speeds, Horizon utilizes a third-party prepayment model, which is based upon statistically derived data linked to certain key principal indicators involving historical borrower prepayment activity associated with mortgage loans in the secondary market, current market interest rates and other factors, including Horizon’s own historical prepayment experience. For purposes of model valuation, estimates are made for each product type within the mortgage servicing rights portfolio on a monthly basis. In addition, on a quarterly basis Horizon engages a third party to independently test the value of its servicing asset.
Derivative Instruments
As part of the Company’s asset/liability management program, Horizon utilizes, from time-to-time, interest rate floors, caps or swaps to reduce the Company’s sensitivity to interest rate fluctuations. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values of derivatives are reported in the consolidated income statements or other comprehensive income (“OCI”) depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be highly effective in achieving offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedge and on an ongoing basis.
Horizon’s accounting policies related to derivatives reflect the guidance in FASB ASC 815-10. Derivatives that qualify for the hedge accounting treatment are designated as either: a hedge of the fair value of the recognized asset or liability or of an unrecognized firm commitment (a fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (a cash flow hedge). For fair value hedges, the cumulative change in fair value of both the hedge instruments and the underlying loans is recorded in non-interest income. For cash flow hedges, changes in the fair values of the derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected in the consolidated income statement in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, Horizon establishes the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of income. Horizon excludes the time value expiration of the hedge when measuring ineffectiveness.
Valuation Measurements
Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities, residential mortgage loans held for sale and derivatives are carried at fair value, as defined in FASB ASC 820, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts of goodwill, mortgage servicing rights, and pension and other post-retirement benefit obligations. To determine the values of these assets and liabilities, as well as the extent, to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment speeds and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect Horizon’s results of operations.
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Financial Condition
On September 30, 2016, Horizon’s total assets were $3.3 billion, an increase of approximately $673.2 million compared to December 31, 2015. The increase was primarily in net loans of $441.4 million, investment securities available for sale of $112.2 million, cash of $35.1 million, goodwill of $24.7 million, other assets of $23.9 million and cash value of life insurance of $19.2 million.
Investment securities were comprised of the following as of (dollars in thousands):
Total investment securities increased by approximately $111.6 million at September 30, 2016 compared to December 31, 2015, primarily due to the investing of cash from the closing of the LaPorte Bancorp acquisition.
Total loans increased $441.4 million since December 31, 2015 to $2.2 billion as of September 30, 2016. This increase was the result of an increase in commercial loans of $242.5 million, mortgage warehouse loans of $82.2 million, residential mortgage loans of $93.0 million and consumer loans of $23.7 million. The growth in total loans during the nine months ended September 30, 2016 is the direct result of increased calling efforts to increase Horizon’s market share within the Company’s footprint and market expansion as well as the loans added through the Kosciusko and LaPorte Bancorp acquisitions.
Total deposits increased $456.0 million since December 31, 2015 to $2.3 billion as of September 30, 2016. Non-interest bearing deposit accounts increased by $143.8 million, interest-bearing transaction accounts increased by $189.6 million and time deposits increased by $122.6 million during the nine months ended September 30, 2016.
The Company’s borrowings increased $120.6 million from December 31, 2015 to $569.9 million as of September 30, 2016. At September 30, 2016, the Company had $307.9 million in short-term funds borrowed compared to $206.0 million at December 31, 2015. The Company has a debt reduction plan either through cash flow or possible early redemption.
Stockholders’ equity totaled $345.7 million at September 30, 2016 compared to $266.8 million at December 31, 2015. The increase in stockholders’ equity during the period was the result of the generation of net
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income, net of dividends declared, as well as the stock issued in the Kosciusko and LaPorte Bancorp acquisitions. At September 30, 2016, the ratio of average stockholders’ equity to average assets was 10.18% compared to 10.32% at December 31, 2015. Book value per common share at September 30, 2016 increased to $15.61 compared to $14.20 at December 31, 2015.
Results of Operations
Consolidated net income for the three-month period ended September 30, 2016 was $6.6 million compared to $4.3 million for the same period in 2015. Earnings per common share for the three months ended September 30, 2016 were $0.31 basic and $0.30 diluted, compared to $0.24 basic and $0.24 diluted for the same three-month period in the previous year. The increase in net income and earnings per share from the previous year reflects an increase in net interest income and non-interest income of $4.6 million and $1.7 million, respectively, partially offset by increases in non-interest expense of $2.6 million, income tax expense of $1.2 million and the diluted shares outstanding primarily due to the stock issued in the Kosciusko and LaPorte Bancorp acquisitions. Non-interest expenses increased primarily due to an increase in salaries, employee benefits, net occupancy expenses, data processing expense, professional fees, loan expenses and other expense. Excluding acquisition-related expenses and purchase accounting adjustments, net income for the third quarter of 2016 was $8.4 million or $0.39 diluted earnings per share compared to $6.5 million or $0.36 diluted earnings per share in the same period of 2015.
Consolidated net income for the nine-month period ended September 30, 2016 was $18.3 million compared to $14.3 million for the same period in 2015. Earnings per common share for the nine months ended September 30, 2016 were $0.95 basic and $0.94 diluted, compared to $0.95 basic and $0.92 diluted for the same period of 2015. The increase in net income from the previous year reflects an increase in net interest income and non-interest income of $10.5 million and $5.1 million, respectively, and a decrease in the provision for loan losses of $1.6 million, partially offset by increases in non-interest expense of $11.2 million and income tax expense of $2.2 million and the diluted shares outstanding primarily due to the stock issued in the Kosciusko and LaPorte Bancorp acquisitions. Non-interest expenses increased primarily due to an increase in salaries, employee benefits, net occupancy expenses, data processing expense, professional fees, outside services and consultants’ expense, loan expense, FDIC deposit insurance, other losses and other expense. Excluding acquisition-related expenses and purchase accounting adjustments, gain on sale of investment securities and the death benefit on bank owned life insurance, net income for the nine months ended September 30, 2016 was $20.7 million or $1.07 diluted earnings per share compared to $15.7 million or $0.99 diluted earnings per share in the same period of 2015.
The largest component of net income is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities, and interest expense, principally on deposits and borrowings. Changes in the net interest income are the result of changes in volume and the net interest spread, which affects the net interest margin. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Net interest margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income during the three months ended September 30, 2016 was $24.4 million, an increase of $4.6 million from the $19.8 million earned during the same period in 2015. Yields on the Company’s interest-earning assets decreased by 19 basis points to 3.98% for the three months ending September 30, 2016 from 4.17% for the three months ended September 30, 2015. Interest income increased $5.4 million from $23.6 million for the three months ended September 30, 2015 to $29.0 million for the same period in 2016. This
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increase was due to an increase in interest-earning assets, partially offset by lower yields on loans and investment securities. Interest income from acquisition-related purchase accounting adjustments was $459,000 for the three months ending September 30, 2016 compared to $402,000 for the same period of 2015.
Rates paid on interest-bearing liabilities decreased by 5 basis points for the three-month period ended September 30, 2016 compared to the same period in 2015 due to the continued low interest rate environment and shift in mix on interest-bearing liabilities. Interest expense increased $750,000 compared to the three-month period ended September 30, 2015 to $4.6 million for the same period in 2016. This increase was due to higher average balances of interest-bearing deposits and borrowings, partially offset by lower rates paid on interest-bearing deposits and borrowings. The net interest margin decreased 14 basis points from 3.51% for the three-month period ended September 30, 2015 to 3.37% for the same period in 2016. The decrease in the margin for the three-month period ended September 30, 2016 compared to the same period in 2015 was due to a reduction in the yield on interest-earning assets. Excluding the interest income recognized from the acquisition-related purchase accounting adjustments, the margin would have been 3.31% for the three-month period ending September 30, 2016 compared to 3.44% for the same period in 2015.
The following are the average balance sheets for the three months ending (dollars in thousands):
Three Months Ended
September 30, 2015
Interest-earning assets
Federal funds sold
Interest-earning deposits
Investment securities - taxable
Investment securities - non-taxable (1)
Loans receivable (2)(3)
Total interest-earning assets (1)
Non-interest-earning assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities
Total interest-bearing liabilities
Non-interest-bearing liabilities
Demand deposits
Accrued interest payable and other liabilities
Stockholders’ equity
Net interest income/spread
Net interest income as a percent of average interest earning assets (1)
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Net interest income during the nine months ended September 30, 2016 was $65.1 million, an increase of $10.5 million from the $54.5 million earned during the same period in 2015. Yields on the Company’s interest-earning assets decreased by 20 basis points to 4.05% for the nine months ending September 30, 2016 compared to 4.25% for the same period of 2015. Interest income increased $12.3 million from $64.8 million for the nine months ended September 30, 2015 to $77.1 million for the same period in 2016. This increase was due to an increase in interest-earning assets, partially offset by lower yields on loans and investment securities and a decrease in interest income from acquisition-related purchase accounting adjustments from $2.3 million for the nine months ending September 30, 2015 to $1.4 million for the same period of 2016.
Rates paid on interest-bearing liabilities decreased by 5 basis points for the nine-month period ended September 30, 2016 compared to the same period in 2015 due to the continued low interest rate environment and shift in mix on interest-bearing liabilities. Interest expense increased $1.8 million compared to the nine-month period ended September 30, 2015 to $12.1 million for the same period in 2016. This increase was due to higher average balances of interest-bearing deposits and borrowings, partially offset by lower rates paid on interest-bearing deposits and borrowings. The net interest margin decreased 16 basis points from 3.59% for the nine-month period ended September 30, 2015 to 3.43% for the same period in 2016. The decrease in the margin for the nine-month period ended September 30, 2016 compared to the same period in 2015 was due to a reduction in the yield on interest-earning assets and a decrease of approximately $878,000 of interest income from acquisition-related purchase accounting adjustments. Excluding the interest income recognized from the acquisition-related purchase accounting adjustments, the margin would have been 3.36% for the nine-month period ending September 30, 2016 compared to 3.44% for the same period in 2015.
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The following are the average balance sheets for the nine months ending (dollars in thousands):
Nine Months Ended
Horizon assesses the adequacy of its Allowance for Loan and Lease Losses (“ALLL”) by regularly reviewing the performance of its loan portfolio. During the three-month period ended September 30, 2016, a provision of $455,000 was required to adequately fund the ALLL compared to $300,000 for the same period of 2015. Commercial loan net charge-offs during the three-month period ended September 30, 2016 were negative $6,000, there were no residential mortgage loan net charge-offs and consumer loan net charge-offs were $163,000. The increase in the provision for loan losses in the third quarter of 2016 compared to the same period of 2015 was due to loan growth. The ALLL balance at September 30, 2016 was $14.5 million or 0.66% of total loans. This compares to an ALLL balance of $14.5 million at December 31, 2015 or 0.83% of total loans. The decrease in the ratio at September 30, 2016 compared to December 31, 2015 was due to an increase in total loans of $441.4 million from the Kosciusko and LaPorte Bancorp mergers and improving credit trends.
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For the nine-month period ended September 30, 2016, the provision for loan losses totaled $1.2 million compared to $2.8 million in the same period of 2015. The lower provision for loan losses in the third quarter of 2016 compared to the same period of 2015 was due to the improvement of non-performing loans and the charge-off of one commercial credit of $1.3 million in the first nine months of 2015.
Horizon’s loan loss reserve ratio, excluding loans with credit-related purchase accounting adjustments, stood at 0.87% as of September 30, 2016. Loan loss reserves and credit-related loan discounts on acquired loans as a percentage of total loans was 1.40% as of September 30, 2016. The table below illustrates Horizon’s loan loss reserve ratio composition as of September 30, 2016.
Non-GAAP Allowance for Loan and Lease Loss Detail
(Dollars in Thousands, Unaudited)
Pre-discount loan balance
Allowance for loan losses (ALLL)
Loan discount
ALLL+loan discount
ALLL/ pre-discount loan balance
Loan discount/ pre-discount loan balance
ALLL+loan discount/ pre-discount loan balance
No assurance can be given that Horizon will not, in any particular period, sustain loan losses that are significant in relation to the amount reserved, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, including economic conditions and management’s ongoing quarterly assessments of the portfolio, will not require increases in the allowance for loan losses. Horizon considers the allowance for loan losses to be appropriate to cover probable incurred losses in the loan portfolio as of September 30, 2016.
Non-performing loans totaled $12.8 million as of September 30, 2016, down from $16.7 million as of December 31, 2015. Compared to December 31, 2015, non-performing commercial and real estate loans decreased by $1.5 million and $3.1 million, respectively, and non-performing consumer loans increased by $813,000.
Other Real Estate Owned (OREO) totaled $3.7 million at September 30, 2016 compared to $3.2 million on December 31, 2015 and $1.3 million on September 30, 2015.
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The following is a summary of changes in non-interest income (three and nine month table dollar amounts in thousands):
Mortgage servicing net of impairment
Increase in cash surrender value of bank owned life insurance
Total non-interest income was $1.7 million higher in the third quarter of 2016 compared to the same period of 2015. Service charges on deposit accounts increased $124,000, wire transfer fees increased $132,000, interchange fees increased by $391,000, and fiduciary activities increased $133,000 primarily due to overall company growth and increased volume. Residential mortgage loan activity during the third quarter of 2016 generated $3.5 million of income from the gain on sale of mortgage loans, up $734,000 from the same period in 2015. The increase in the gain on sale of mortgage loans was due to an increase in the percentage earned on the sale of these loans from 3.30% in the third quarter of 2015 to 3.91% in the same period of 2016. Mortgage servicing net of impairment increased by $163,000 during the third quarter of 2016 compared to the same period of 2015 primarily due to a larger portfolio of mortgage loans serviced.
Death benefit on officer life insurance
Total non-interest income was $5.1 million higher in the first nine months of 2016 compared to the same period of 2015. Service charges on deposit accounts increased $613,000, interchange fees increased by $1.0 million and fiduciary activities increased $720,000, primarily due to overall company growth and increased volume. Gain on sale of securities increased $751,000 due to gains realized in the first nine months of 2016 as the result of an analysis that determined market conditions provided the opportunity to add gains to capital without negatively impacting long-term earnings. Residential mortgage loan activity during the first nine months of 2016 generated $9.2 million of income from the gain on sale of mortgage loans, up $1.4 million from the same period in 2015. The increase in the gain on sale of mortgage loans was due to an increase in the percentage earned on the sale of these loans from 3.19% during the first nine months of 2015 to 3.81% in the same period of 2016, partially offset by a decrease in total loans sold of $2.4 million from $239.1 million
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during the first nine months of 2015 to $236.7 million in the same period of 2016. Mortgage servicing net of impairment increased by $631,000 during the first nine months of 2016 compared to the same period of 2015 primarily due to a larger portfolio of mortgage loans serviced. The cash surrender value of bank owned life insurance increased by $256,000 in the first nine months of 2016 compared to the same period in 2015 due to the addition of bank owned life insurance policies as a result of the Kosciusko and LaPorte Bancorp acquisitions. The death benefit on bank owned life insurance decreased by $145,000 compared to the previous year due to a $145,000 death benefit on officer life insurance realized during the first nine months of 2015.
The following is a summary of changes in non-interest expense (three and nine month table dollar amounts in thousands):
Non-interest expense
Salaries
Commission and bonuses
Employee benefits
FDIC deposit insurance
Total non-interest expense was $2.6 million higher in the third quarter of 2016 compared to the same period of 2015. Salaries increased by $1.5 million and employee benefits increased by $264,000 due to a larger employee base. Net occupancy expense increased $451,000 due to Horizon’s investment in growth markets and the Peoples, Kosciusko and LaPorte Bancorp acquisitions. Data processing expenses increased $335,000, professional fees increased $203,000 and loan expenses increased $131,000 primarily due to company growth. Other expenses increased by $527,000 primarily due to company growth and one-time merger-related expenses. Outside services and consultants expense decreased by $523,000 due to the one-time fees associated with the Peoples acquisition in the third quarter of 2015. One-time non-interest expense related to the Kosciusko, LaPorte Bancorp and CNB Bancorp acquisitions in the third quarter of 2016 totaled $2.9 million compared to $3.6 million in one-time fees associated with the Peoples acquisition in the same period of 2015.
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Total non-interest expenses were $11.2 million higher in the first nine months of 2016 compared to the same period of 2015. Salaries increased by $4.0 million and employee benefits increased by $1.3 million due to a larger employee base. Net occupancy expense increased $1.4 million due to Horizon’s investment in growth markets and the Peoples, Kosciusko and LaPorte Bancorp acquisitions. Data processing expenses increased $685,000, loan expense increased $111,000 and FDIC deposit insurance increased by $180,000 primarily due to company growth. Other losses increased by $159,000 primarily due to higher debit card losses and a trust settlement. Other expenses increased by $1.8 million primarily due to company growth and one-time merger-related expenses. Commission and bonuses decreased by $261,000 due to a decrease in loan volume and incentive pay. Outside services and consultants expense increased by $1.2 million due to the one-time fees associated with Kosciusko, LaPorte Bancorp and CNB Bancorp acquisitions. One-time non-interest expense related to the Kosciusko, LaPorte Bancorp and CNB Bancorp acquisitions totaled $5.5 million in the first nine months of 2016 compared to $4.4 million in one-time fees associated with the Peoples acquisition in the same period of 2015.
Liquidity
The Bank maintains a stable base of core deposits provided by long-standing relationships with individuals and local businesses. These deposits are the principal source of liquidity for Horizon. Other sources of liquidity for Horizon include earnings, loan repayment, investment security sales and maturities, proceeds from the sale of residential mortgage loans, and borrowing relationships with correspondent banks, including the FHLB. During the nine months ended September 30, 2016, cash and cash equivalents increased by approximately $35.1 million. At September 30, 2016, in addition to liquidity available from the normal operating, funding, and investing activities of Horizon, the Bank had approximately $278.2 million in unused credit lines with various money center banks, including the FHLB and the FRB Discount Window compared to $253.2 million at December 31, 2015 and $328.0 million at September 30, 2015.
Capital Resources
The capital resources of Horizon and the Bank exceeded regulatory capital ratios for “well capitalized” banks at September 30, 2016. Stockholders’ equity totaled $345.7 million as of September 30, 2016, compared to $266.8 million as of December 31, 2015. For the three months ended September 30, 2016, the ratio of average stockholders’ equity to average assets was 10.18% compared to 10.32% for the three months ended December 31, 2015. The increase in stockholders’ equity during the period was the result of the generation of net income, net of dividends declared, as well as the stock issued in the Kosciusko and LaPorte Bancorp acquisitions.
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On February 1, 2016, the Company paid off the $12.5 million in funds received through the Small Business Lending Fund with cash from the holding company, thereby ending its participation in the program, pursuant to which it issued preferred stock to the US Treasury. The funds were paid off due to an increase in the dividend cost that would have gone in effect at the end of February 2016. For the nine months ending September 30, 2016, the dividend cost was $42,000 or 1.0% annualized and included the acceleration of interest due to the payoff.
Horizon declared common stock dividends in the amount of $0.30 per share during the first nine months of 2016 compared to $0.29 per share for the same period of 2015. The dividend payout ratio (dividends as a percent of basic earnings per share) was 31.6% and 30.2% for the first nine months of 2016 and 2015, respectively. For additional information regarding dividends, see Horizon’s Annual Report on Form 10-K for 2015.
Use of Non-GAAP Financial Measures
Certain information set forth in this quarterly report on Form 10-Q refers to financial measures determined by methods other than in accordance with GAAP. Specifically, we have included non-GAAP financial measures of the net interest margin and the allowance for loan and lease losses excluding the impact of acquisition-related purchase accounting adjustments and net income and diluted earnings per share excluding the impact of one-time costs related to acquisitions, acquisition-related purchase accounting adjustments and other events that are considered to be non-recurring. Horizon believes that these non-GAAP financial measures are helpful to investors and provide a greater understanding of our business without giving effect to the purchase accounting impacts and one-time costs of acquisitions and non-core items, although these measures are not necessarily comparable to similar measures that may be presented by other companies and should not be considered in isolation or as a substitute for the related GAAP measure.
Non-GAAP Reconciliation of Net Interest Margin
Net Interest Margin As Reported
Net interest income
Average interest-earning assets
Net interest income as a percent of average interest-earning assets (“Net Interest Margin”)
Impact of Acquisitions
Interest income from acquisition-related purchase accounting adjustments
Excluding Impact of Acquisitions
Core Net Interest Margin
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Non-GAAP Reconciliation of Net Income and Diluted Earnings per Share
(Dollars in Thousands Except per Share Data, Unaudited)
Non-GAAP Reconciliation of Net Income
Net income as reported
Merger expenses
Net income excluding merger expenses
Net income excluding gain on sale of investment securities
Death benefit on bank owned life insurance (“BOLI”)
Net income excluding death benefit on BOLI
Acquisition-related purchase accounting adjustments (“PAUs”)
Net income excluding PAUs
Non-GAAP Reconciliation of Diluted Earnings per Share
Diluted earnings per share as reported
Diluted earnings per share excluding merger expenses
Death benefit on BOLI
Acquisition-related PAUs
Diluted earnings per share excluding PAUs
Non-GAAP Reconciliation of Tangible Stockholders’ Equity and Tangible Book Value per Share
(Dollars in Thousands Except per Share Data)
Less: Preferred stock
Less: Intangible assets
Total tangible stockholder’s equity
Common shares outstanding
Tangible book value per common share
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Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We refer you to Horizon’s 2015 Annual Report on Form 10-K for analysis of its interest rate sensitivity. Horizon believes there have been no significant changes in its interest rate sensitivity since it was reported in its 2015 Annual Report on Form 10-K.
Evaluation Of Disclosure Controls And Procedures
Based on an evaluation of disclosure controls and procedures as of September 30, 2016, Horizon’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of Horizon’s disclosure controls (as defined in Exchange Act Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on such evaluation, such officers have concluded that, as of the evaluation date, Horizon’s disclosure controls and procedures are effective to ensure that the information required to be disclosed by Horizon in the reports it files under the Exchange Act is recorded, processed, summarized and reported within the time specified in Securities and Exchange Commission rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to management as appropriate to allow timely decisions regarding disclosure.
Changes In Internal Control Over Financial Reporting
Horizon’s management, including its Chief Executive Officer and Chief Financial Officer, also have concluded that during the fiscal quarter ended September 30, 2016, there have been no changes in Horizon’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, Horizon’s internal control over financial reporting.
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Part II – Other Information
Horizon and its subsidiaries are involved in various legal proceedings incidental to the conduct of their business. Management does not expect that the outcome of any such proceedings will have a material adverse effect on our consolidated financial position or results of operations.
There have been no material changes from the factors previously disclosed under Item 1A of Horizon’s Annual Report on Form 10-K for 2015.
Not Applicable
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Craig M. Dwight
/s/ Mark E. Secor
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INDEX TO EXHIBITS
Exhibit No.
Description
Location
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