UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
Commission file number 0-10792
HORIZON BANCORP, INC.
(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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol(s)
Name of each exchange
on which registered
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 every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. ☐
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: 45,052,747 shares of Common Stock, no par value, at May 8, 2019.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
PART II. OTHER INFORMATION
Item 1A.
Item 5.
Item 6.
2
PART 1 — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HORIZON BANCORP, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Dollar Amounts in Thousands)
Assets
Cash and due from banks
Interest-earning time deposits
Investment securities, available for sale
Investment securities, held to maturity (fair value of $210,106 and $208,273)
Loans held for sale
Loans, net of allowance for loan losses of $17,821 and $17,820
Premises and equipment, net
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, Issued 0 shares
Common stock, no par value, Authorized 99,000,000 shares (Restated - See Note 1)
Issued 45,077,816 and 38,400,476 shares (Restated - See Note 1),
Outstanding 45,052,747 and 38,375,407 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
Condensed Consolidated Statements of Income (Unaudited)
(Dollar Amounts in Thousands, Except Per Share Data)
March 31
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
Gains on sale of investment securities (includes $15 and $11 for the three months ended March 31, 2019 and 2018, respectively, related to accumulated other comprehensive earnings
Gain on sale of mortgage loans
Mortgage servicing income net of impairment
Increase in cash value of 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 Taxes
Income tax expense (includes $3 and $2 for the three months ended March 31, 2019 and 2018, respectively, related to income tax expense from reclassification items)
Net Income
Basic Earnings Per Share (Restated - See Note 1)
Diluted Earnings Per Share (Restated - See Note 1)
4
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
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) losses realized in income
Unrealized gains (losses) on securities
Other Comprehensive Income (Loss), Net of Tax
Comprehensive Income
5
Condensed Consolidated Statement of Stockholders’ Equity
Balances, January 1, 2018
Net income
Other comprehensive loss, net of tax
Amortization of unearned compensation
Exercise of stock options
Stock option expense
Reclassification of tax adjustment on accumulated other comprehensive loss
Cash dividends on common stock ($0.10 per share)
Balances, March 31, 2018
Balances, January 1, 2019
Other comprehensive income, net of tax
Stock issued stock plans
Stock issued in Salin acquisition
Balances, March 31, 2019
6
Condensed Consolidated Statements of Cash Flows
Operating Activities
Items not requiring (providing) cash
Depreciation and amortization
Share based compensation
Mortgage servicing rights, net impairment
Premium amortization on securities, net
Gain on sale of investment securities
Proceeds from sales of loans
Loans originated for sale
Change in cash value 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
Net change in interest-earning time deposits
Change in Federal Reserve and FHLB stock
Net change in loans
Proceeds on the sale of OREO and repossessed assets
Change in premises and equipment, net
Net cash received in acquisition, Salin
Net cash used in investing activities
Financing Activities
Proceeds from issuance of stock
Dividends paid on common stock
Net cash provided by 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
Right-of-use assets exchanged for lease obligations
7
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)
Note 1 - Accounting Policies
The accompanying unaudited condensed consolidated financial statements include the accounts of Horizon Bancorp, Inc. (“Horizon” or the “Company”) and its wholly-owned subsidiaries, including Horizon Bank (“Horizon Bank” or the “Bank”). Horizon Bank (formerly known as “Horizon Bank, N.A.”) was a national association until its conversion to an Indiana commercial bank effective June 23, 2017. All inter-company balances and transactions have been eliminated. The results of operations for the periods ended March 31, 2019 and March 31, 2018 are not necessarily indicative of the operating results for the full year of 2019 or 2018. 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 2018 filed with the Securities and Exchange Commission on February 28, 2019. The condensed consolidated balance sheet of Horizon as of December 31, 2018 has been derived from the audited balance sheet as of that date.
On May 15, 2018, 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 May 31, 2018, the record date, received an additional half share for each share of common stock held, with shareholders receiving cash in lieu of any fractional shares. The additional shares issued in the stock split were payable and issued on June 15, 2018, and the common shares began trading on a split-adjusted basis on June 19, 2018.
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.
8
Basic earnings per share
Weighted average common shares outstanding(1)
Diluted earnings per share
Net income available to common shareholders
Effect of dilutive securities:
Restricted stock
Stock options
Weighted average common shares outstanding
Adjusted for 3:2 stock split on June 15, 2018
There were 350,618 and 44,053 shares for the three months ended March 31, 2019 and 2018, respectively, which were not included in the computation of diluted earnings per share because they were non-dilutive.
Horizon has share-based employee compensation plans, which are described in the notes to the financial statements included in the December 31, 2018 Annual Report on Form 10-K.
Adoption of New Accounting Standards
9
Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities
The FASB has issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. The new guidance improves the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The amendments in this ASU also make certain targeted improvements to simplify the application of the hedge accounting guidance in current GAAP. For public entities, this new guidance became effective in fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. Early adoption was permitted in any interim period after issuance of the ASU. All transition requirements and elections should be applied to hedging relationships existing (that is, hedging relationships in which the hedging instrument has not expired, been sold, terminated, or exercised or the entity has not removed the designation of the hedging relationship) on the date of adoption. The effect of adoption should be reflected as of the beginning of the fiscal year of adoption (that is, the initial application date). The Company adopted ASU 2017-12 on January 1, 2019 and there was no material impact to the consolidated financial statements.
FASB Accounting Standards Updates No. 2016-02, Leases (Topic 842)
The FASB has issued Accounting Standards Update (ASU) No. 2016-02, Leases. Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right- of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. The Company adopted this ASU as of January 1, 2019 using the alternative transition method. In addition, the Company utilized the practical expedients allowing it to retain the classifications of existing leases, not re-assess if existing leases have initial direct costs and hindsight when determining the lease term and assessment of impairment. Upon adoption, the Company capitalized $3.5 million for right-of- use assets and lease liabilities, net of existing straight-line lease liabilities. See Note 8, “Leases”.
10
Revenue Recognition
Accounting Standards Codification 606, “Revenue from Contracts with Customers” (ASC 606) provides that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance enumerates five steps that entities should follow in achieving this core principle. Revenue generated from financial instruments, including loans and investment securities, are not included in the scope of ASC 606. The adoption of ASC 606 did not result in a change to the accounting for any of the Company’s revenue streams that are within the scope of the amendments. Revenue-generating activities that are within the scope of ASC 606 and that are presented as non-interest income in the Company’s consolidated statements of income include:
Service charges and fees on deposit accounts – these include general service fees charged for deposit account maintenance and activity and transaction-based fees charged for certain services, such as debit card, wire transfer or overdraft activities. Revenue is recognized when the performance obligation is completed, which is generally after a transaction is completed or monthly for account maintenance services.
Fiduciary activities – this includes periodic fees due from trust and wealth management customers for managing the customers’ financial assets. Fees are charged based on a standard agreement and are recognized as they are earned.
Reclassifications
Certain reclassifications have been made to the 2018 condensed consolidated financial statements to be comparable to 2019. These reclassifications had no effect on net income.
Note 2 – Acquisitions
Salin Bancshares, Inc.
On March 26, 2019, Horizon completed the acquisition of Salin Bancshares, Inc. (“Salin”), an Indiana corporation, and Horizon Bank’s acquisition of Salin Bank and Trust Company (“Salin Bank”), an Indiana commercial bank and wholly-owned subsidiary of Salin, through mergers effective March 26, 2019. Under the terms of the Merger Agreement, shareholders of Salin received 23,907.5 shares of Horizon common stock and $87,417.17 in cash for each outstanding share of Salin common stock. Salin shares outstanding at the closing to be exchanged were 275, and the shares of Horizon common stock issued to Salin shareholders totaled 6,563,697. The Salin shareholders received cash in lieu of fractional shares. Based upon the March 25, 2019 closing price of $15.65 per share of Horizon common stock immediately prior to the effectiveness of the merger the transaction has an implied valuation of approximately $126.7 million. The Company incurred approximately $4.6 million in costs related to the acquisition. These expenses are classified in thenon-interest expense section of the income statement and are primarily located in the data processing, professional fees, outside services and consultants and other expense line items. As a result of the acquisition, the Company was able to increase its deposit base and reduce transaction costs. The Company also expects to reduce costs through economies of scale.
11
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 estimates and assumptions that are subject to change, the preliminary purchase price for the Salin 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.
Loans
Commercial
Residential mortgage
Consumer
Total loans
FRB and FHLB stock
Core deposit intangible
Total assets purchased
Common shares issued
Cash paid
Total purchase price
NOW accounts
Savings and money market
Certificates of deposit
Total liabilities assumed
Of the total purchase price of $126.7 million, $21.1 million has been allocated to core deposit intangible. Additionally, $25.8 million has been allocated to goodwill and none of the purchase price is deductible. The core deposit intangible is being amortized over 10 years on a straight line basis.
The Company acquired various loans in the acquisition that 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 assumptions, such as default rates, severity and prepayment speeds.
12
The following table details an estimate of the acquired loans that are accounted for in accordance with ASC 310-30 as of March 26, 2019. Final valuation estimates have not yet been determined for acquired loans as of March 31, 2019. If information becomes available which would indicate adjustment to the purchase price allocation, such adjustments would be made prospectively.
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 ASC310-30
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.
13
The results of operations of Salin have been included in the Company’s consolidated financial statements since the acquisition date. The following schedule includes pro-forma results for the three months ended March 31, 2019 and 2018 as if the Salin acquisition had occurred as of the beginning of the comparable prior reporting periods.
Summary of Operations:
Provision for Loan Losses
Income before Income Taxes
Income Tax Expense
Net Income Available to Common Shareholders
Basic Earnings per Share
Diluted Earnings per Share
14
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.
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
15
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 andheld-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 March 31, 2019, 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 March 31, 2019.
The amortized cost and fair value of securities available for sale and held to maturity at March 31, 2019 and December 31, 2018, 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
Private labeled mortgage-backed pools
16
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.
Investment Securities
Total temporarily impaired securities
Information regarding security proceeds, gross gains and gross losses are presented below.
Sales of securities available for sale
Proceeds
Gross gains
Gross losses
17
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.
18
Real Estate and Consumer
With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.
Mortgage Warehousing
Horizon’s mortgage warehouse lending has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with a pledge of collateral under Horizon’s agreement with the mortgage company. Each mortgage loan funded by Horizon undergoes an underwriting review 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.
19
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
Commercial and industrial
Total commercial
Residential construction
Total real estate
Direct installment
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.
The carrying amounts of those loans included in the balance sheet amounts of loans receivable are as follows:
Heartland
Summit
Peoples
Kosciusko
LaPorte
Lafayette
Wolverine
Salin
21
Accretable yield, or income expected to be collected for the three months ended March 31, is as follows:
During the three months ended March 31, 2019 and 2018 the Company increased the allowance for loan losses on purchased loans by a charge to the income statement of $296,000 and $0, respectively.
22
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 using the highest of the one, two or five-year historical loss experience is an appropriate methodology 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:
Total loans charged-off
Recoveries of loans previouslycharged-off:
Total loan recoveries
Net loans charged-off
Provision charged to operating expense
Total provision charged to operating expense
Balance at the end of the period
23
Certain loans are individually evaluated for impairment, and the Company’s general practice is to proactively charge down impaired loans to the fair value of the underlying collateral, which is the appraised value less estimated selling costs.
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 contractually 90 days past due, and charges down to the net realizable value other secured loans when they are contractually 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
24
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:
25
Included in the $15.3 million of non-accrual loans and the $1.3 million of non-performing TDRs at March 31, 2019 were $3.1 million and $629,000, 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 Commercial Banking Officer and/or the Chief Operations 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.
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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 the three methods described above.
The Company’s TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At March 31, 2019, 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 March 31, 2019, the Company had $3.9 million in TDRs and $2.5 million were performing according to the restructured terms and $315,000 in TDRs were returned to accrual status during the first three months of 2019. There were $20,000 specific reserves allocated to TDRs at March 31, 2019 based on the discounted cash flows or when appropriate the fair value of the collateral.
The following table presents commercial loans individually evaluated for impairment by class of loan:
Average
Balance in
Cash/Accrual
Interest
With no recorded allowance Commercial
With an allowance recorded
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With no recorded allowance
The following table presents the payment status by class of loan:
Percentage of total loans
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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.
For new and renewed commercial loans, the Bank’s Credit Department, which acts independently of the loan officer, assigns the credit quality grade to the loan. Loan grades for loans with an aggregate credit exposure that exceeds the authorities in the respective markets (ranging from $1,000,000 to $3,500,000) are validated by the Loan Committee, which is chaired by the Chief Commercial Banking Officer (CCBO).
Commercial loan officers are responsible for reviewing their loan portfolios and reporting any adverse material change to the CCBO or Loan Committee. When circumstances warrant a change in the credit quality grade, loan officers are required to notify the CCBO and the Credit Department of the change in the loan grade. Downgrades are accepted immediately by the CCBO, however, lenders must present their factual information to either the Loan Committee or the CCBO when recommending an upgrade.
The CCBO, or his designee, meets weekly with loan officers to discuss the status of past-due loans and classified loans. These meetings are also designed to give the loan officers an opportunity to identify an existing loan that should be downgraded to a classified grade.
Monthly, senior management meets with the Watch Committee, which reviews all of the past due, classified, and impaired loans and the relative trends of these assets. This committee also reviews the actions taken by management regarding foreclosure mitigation, loan extensions, troubled debt restructures, other real estate owned and personal property repossessions. The information reviewed in this meeting acts as a precursor for developing management’s analysis of the adequacy of the Allowance for Loan and Lease Losses.
For residential real estate and consumer loans, Horizon uses a grading system based on delinquency. Loans that are 90 days or more past due, on non-accrual, or are classified as a TDR are graded “Substandard.” After being 90 to 120 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass.
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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. Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:
At inception, the loan was properly underwritten, did not possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory;
At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss.
The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.
During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.
Risk Grade 4 Satisfactory/Monitored:
Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans. Borrower displays acceptable liquidity, leverage, and earnings performance within the Bank’s minimum underwriting guidelines. The level of risk is acceptable but conditioned on the proper level of loan officer supervision. Loans that normally fall into this grade include acquisition, construction and development loans and income producing properties that have not reached stabilization.
Risk Grade 4W Management Watch:
Loans in this category are considered to be of acceptable quality, but with above normal risk. Borrower displays potential indicators of weakness in the primary source of repayment resulting in a higher reliance on secondary sources of repayment. Balance sheet may exhibit weak liquidity and/or high leverage. There is inconsistent earnings performance without the ability to sustain adverse economic conditions. Borrower may be operating in a declining industry or the property type, as for a commercial real estate loan, may be unstablized, 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.
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Risk Grade 5: Special Mention
Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered “potential,” not “defined,” impairments to the primary source of repayment. These loans may be to borrowers with adverse trends in financial performance, collateral value and/or marketability, or balance sheet strength.
Risk Grade 6: Substandard
One or more of the following characteristics may be exhibited in loans classified Substandard:
Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.
Loans are inadequately protected by the current net worth and paying capacity of the obligor.
The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.
Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.
Unusual courses of action are needed to maintain a high probability of repayment.
The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments.
The lender is forced into a subordinated or unsecured position due to flaws in documentation.
Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms.
The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.
There is a significant deterioration in market conditions to which the borrower is highly vulnerable.
Risk Grade 7: Doubtful
One or more of the following characteristics may be present in loans classified Doubtful:
Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.
The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.
The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.
Risk Grade 8: Loss
Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.
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The following table presents loans by credit grades.
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Note 8 – Leases
Operating leases are recorded as a right-of-use (“ROU”) asset and operating lease liability, included in other assets and other liabilities, respectively, on the consolidated balance sheet beginning January 1, 2019 when the Company adopted ASU 2016-02 prospectively. Operating lease ROU assets represent the right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate at the lease commencement date.
Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating liability, is recognized on a straight-line basis over the lease term, and is recorded primarily in net occupancy expense in the consolidated statements of income.
The Company adopted the guidance on January 1, 2019 by electing the optional alternative transition method permitted by ASU 2018-11 allowing for recognition of applicable leases as of January 1, 2019. Additionally, the Company elected the following accounting policies:
The practical expedient package that forgoes:
Reassessment of any expired or existing contracts for a lease
Reassessment of lease classification for expired or existing leases
Reassessment of initial direct costs for existing leases
The hindsight practical expedient to determine lease term and impairment of ROU assets
Other practical expedients regarding combination of lease and non-lease components and the exclusion of short-term leases
The practical expedient for land easements and the portfolio approach were not elected
Operating leases relate primarily to bank branches and office space with remaining average lease terms of seven years. The weighted average discount rate utilized to calculate the ROU asset and operating lease liability was approximately 2.57%, which represents the incremental borrowing rate. At inception, the Company recorded a ROU asset and operating lease liability of $3.5 million. At March 31, 2019, a ROU asset of $3.3 million is included in other assets and an operating lease liability of $3.4 million is included in other liabilities, respectively. Options to extend a lease were considered in the remaining lease term determination. The lease expense for operating leases was $148,000 for the three months ended March 31, 2019.
Future minimum operating lease payments under non-cancellable leases with initial or remaining lease terms at March 31, 2019 were as follows:
Year
2020
2021
2022
2023
2024 and thereafter
Total lease payments
Less: Interest
Present value of lease liabilities
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Note 9 – 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:
Repurchase Agreements andrepurchase-to-maturity transactions
Repurchase Agreements
Securities pledged for Repurchase Agreements
Note 10 – 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 5.81% on a notional amount of $30.5 million at March 31, 2019 and December 31, 2018. Under the agreements, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense.
The Company assumed additional interest rate swap agreements as the result of the LaPorte acquisition in July 2016. The agreements provide for the Company to receive interest from the counterparty at one month LIBOR and to pay interest to the counterparty at a weighted average fixed rate of 2.31% on a notional amount of $30.0 million at March 31, 2019 and December 31, 2018. Under the agreements, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense.
On July 20, 2018, the Company entered into an interest rate swap agreement for an additional portion of its floating rate debt. The agreement provides for the Company to receive interest from the counterparty at one month LIBOR and to pay interest to the counterparty at a rate of 2.81% on a notional amount of $50.0 million at March 31, 2019. Under the agreement, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense.
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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, 2018, 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 March 31, 2019, 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.
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 $234.3 million at March 31, 2019 and $209.2 million at December 31, 2018.
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 March 31, 2019, 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.
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The following tables summarize the fair value of derivative financial instruments utilized by Horizon:
Derivatives designated as hedging instruments
Interest rate contracts
Total derivatives desginated as hedging instruments
Derivatives not designated as hedging instruments
Mortgage loan contracts
Total derivatives not designated as hedging instruments
Total derivatives
The effect of the derivative instruments on the condensed consolidated statements of income for the three-month periods ending March 31 is as follows:
Derivatives in cash flow hedging relationship
FASB Accounting Standards Codification (“ASC”) Topic820-10-20 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.
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Derivative in fair value hedging relationship
Derivative not designated as hedging relationship
Mortgage contracts
on sale of loans
Note 11 – Disclosures about Fair Value of Assets and Liabilities
The Fair Value Measurements topic of the FASB ASC defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. There are three levels of inputs that may be used to measure fair value:
Level 1 Quoted prices in active markets for identical assets or liabilities
Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities
Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated financial statements, as well as the general classification of such instruments pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the period ended September 30, 2018. 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
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with similar characteristics and, because many fixed-income securities do not trade on a daily basis, apply available information through processes such as benchmark curves, benchmarking of like securities, sector grouping, and matrix pricing. In addition, model processes, such as an option adjusted spread model, is used to develop prepayment and interest rate scenarios for securities with prepayment features.
Hedged loans
Certain fixed rate loans have been converted to variable rate loans by entering into interest rate swap agreements. The fair value of those fixed rate loans is based on discounting the estimated cash flows using interest rates determined by the respective interest rate swap agreement. Loans are classified within Level 2 of the valuation hierarchy based on the unobservable inputs used.
Interest rate swap agreements
The fair value of the Company’s interest rate swap agreements is estimated by a third party using inputs that are primarily unobservable including a yield curve, adjusted for liquidity and credit risk, contracted terms and discounted cash flow analysis, and therefore, are classified within Level 2 of the valuation hierarchy.
The following table presents the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated financial statements measured at fair value on a recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at the following:
Quoted Prices inActive Markets
for IdenticalAssets (Level 1)
Total available for sale securities
Forward sale commitments
Commitments to originate loans
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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 non-recurring 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):
March 31, 2019
Impaired loans
Mortgage servicing rights
December 31, 2018
Impaired (collateral dependent): Loans for which it is probable that the Company will not collect all principal andinterest 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.
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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’smonth-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 increased by $14,000 during the first three months of 2019 and decreased by $6,000 during the first three months of 2018.
The following table presents qualitative information about unobservable inputs used in recurring and non-recurring Level 3 fair value measurements, other than goodwill.
Valuation
Technique
Unobservable
Inputs
Discount to reflect current market
conditions and ultimate collectability
conditions and ultimate
collectability
Discount rate,
Constant prepayment rate,
Probability of default
Note 12 – 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.
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 March 31, 2019 and December 31, 2018. 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.
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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 net loans are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors.
FHLB and FRB Stock — Fair value of FHLB and FRB stock is based on the price at which it may be resold to theFHLB 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 maturitiesare 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.
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).
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Investment securities, held to maturity
Loans (excluding loan level hedges), net
Stock in FHLB
Non-interest bearing deposits
Interest bearing deposits
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Note 13 – Accumulated Other Comprehensive Income
Unrealized gain (loss) on securities available for sale
Unamortized gain (loss) on securities held to maturity, previously transferred from AFS
Unrealized loss on derivative instruments
Tax effect
Total accumulated other comprehensive income (loss)
Note 14 – 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. 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 and Tier I leverage ratios as set forth in the table below. As of March 31, 2019 and December 31, 2018, the Bank met all capital adequacy requirements to be considered well capitalized. There have been no conditions or events since the end of the first quarter of 2019 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 March 31, 2019 and December 31, 2018 were as follows:
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)
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Note 15 – Future Accounting Matters
Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement
The FASB has issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. These amendments modify the disclosure requirements in Topic 820 as follows:
Removals: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements.
Modifications: for investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly; and the amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date.
Additions: the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements.
The guidance is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should all be applied prospectively for only the most recent interim or annual period presented in the initial year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of ASU No. 2018-13 and delay adoption of the additional disclosures until their effective date. We are currently evaluating the impact of adoption of ASU 2018-13 and the impact on our accounting and disclosures.
FASB ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350):Simplifying the Test for Goodwill Impairment
The FASB has issued ASUNo. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The new guidance is intended to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, the income tax effects of tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the qualitative impairment test is necessary. The amendments should be applied on a prospective basis. The nature of and reason for the change in accounting principle should be disclosed upon transition. The amendments in this update should be adopted for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted on testing dates after January 1, 2017. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.
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FASB ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
The FASB has issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The main objective of this amendment is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendment 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 enhance their credit loss estimates. The amendment requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, the ASU amends the accounting for credit losses onavailable-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. Early adoption will be permitted beginning after December 15, 2018. We expect a one-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. We are currently implementing third-party software that was purchased and are validating the data loaded into the solution. Our implementation team meets on a regular basis to oversee activities and monitor progress. Methodologies are still being evaluated at this time so the magnitude of any such adjustment or the overall impact of the new standard on the financial condition or results of operations cannot yet be determined.
Note 16 – 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 Months ended March 31, 2019 and 2018
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward–Looking Statements
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to Horizon Bancorp, Inc. (“Horizon” or the “Company”) and Horizon Bank (the “Bank”). Horizon intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for the purposes of these safe harbor provisions. Statements in this report should be considered in conjunction with the other information available about Horizon, including the information in the other filings we make with the Securities and Exchange Commission. The forward-looking statements are based on management’s expectations and are subject to a number of risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as “anticipate,” “expect,” “estimate,” “project,” “intend,” “plan,” “believe,” “could,” “will” and similar expressions in connection with any discussion of future operating or financial performance. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements.
Actual results may differ materially, adversely or positively, from the expectations of the Company that are expressed or implied by any forward-looking statement. Risks, uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statement include but are not limited to:
economic conditions and their impact on Horizon and its customers;
changes in the level and volatility of interest rates, spreads on earning assets and interest-bearing liabilities, and interest rate sensitivity;
rising interest rates and their impact on mortgage loan volumes and the outflow of deposits;
loss of key Horizon personnel;
increases in disintermediation, as new technologies allow consumers to complete financial transactions without the assistance of banks;
loss of fee income, including interchange fees, as new and emerging alternative payment platforms (e.g. Apple Pay or Bitcoin) take a greater market share of the payment systems;
estimates of fair value of certain of Horizon’s assets and liabilities;
volatility and disruption in financial markets;
prepayment speeds, loan originations, credit losses and market values, collateral securing loans and other assets;
sources of liquidity;
potential risk of environmental liability related to lending activities;
changes in the competitive environment in Horizon’s market areas and among other financial service providers;
legislation and/or regulation affecting the financial services industry as a whole, and Horizon and its subsidiaries in particular, including the effects resulting from the reforms enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the adoption of regulations by regulatory bodies under the Dodd-Frank Act;
the impact of whole or partial dismantling of provisions of the Dodd-Frank Act under the current federal administration, including the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act;
the impact of the Basel III capital rules;
changes in regulatory supervision and oversight, including monetary policy and capital requirements;
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changes in accounting policies or procedures as may be adopted and required by regulatory agencies;
rapid technological developments and changes;
the risks presented by cyber terrorism and data security breaches;
containing costs and expenses;
the slowing or failure of economic recovery;
the ability of the U.S. federal government to manage federal debt limits;
the potential influence on the U.S. financial markets and economy from material changes outside the U.S. or in overseas relations, including changes in the U.S. trade relations related to imposition of tariffs, Brexit and the phase out in 2021 of the London Interbank Offered Rate (“LIBOR”); and
the risks of expansion through mergers and acquisitions, including unexpected credit quality problems with acquired loans, difficulty integrating acquired operations and material differences in the actual financial results of such transactions compared with Horizon’s initial expectations, including the full realization of anticipated cost savings.
The foregoing list of important factors is not exclusive, and you are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document or, in the case of documents incorporated by reference, the dates of those documents. We do not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by us or on our behalf. 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 2018 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 regions of Indiana and the Southern, Central and Great Lakes Bay regions of 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 originally chartered as a national banking association in 1873 and has operated continuously since that time and converted to an Indiana state-chartered bank effective on June 23, 2017. 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. Upon approval of a name change by Horizon’s shareholders at the annual meeting on May 3, 2018, Horizon’s full corporate name became “Horizon Bancorp, Inc.”
On March 26, 2019, Horizon completed the acquisition of Salin Bancshares, Inc. (“Salin”), an Indiana corporation and Horizon Bank’s acquisition of Salin Bank and Trust Company (“Salin Bank”), an Indiana commercial bank and wholly-owned subsidiary of Salin, through mergers effective March 26, 2019. Under the terms of the Merger Agreement, shareholders of Salin received 23,907.5 shares of Horizon common stock and $87,417.17 in cash for each outstanding share of Salin common stock. Salin shares outstanding at the closing to be exchanged were 275, and the shares of Horizon common stock issued to Salin shareholders totaled 6,563,697. Based upon the March 25, 2019 closing price of $15.65 per share of Horizon common stock immediately prior to the effectiveness of the merger, the transaction has an implied valuation of approximately $126.7 million.
On October 17, 2017, Horizon completed the acquisition of Wolverine Bancorp, Inc., a Maryland corporation (“Wolverine”) and Horizon Bank’s acquisition of Wolverine Bank, a federally-chartered savings bank and wholly-owned subsidiary of Wolverine, through mergers effective October 17, 2017. Under the terms of the Merger Agreement, shareholders of Wolverine received 1.5228 shares of Horizon common stock and $14.00 in cash for each outstanding share of Wolverine common stock. Wolverine shares outstanding at the closing to be exchanged were 2,129,331 and the shares of Horizon common stock issued to Wolverine shareholders totaled 3,241,045. Based upon the October 16, 2017 closing price of $19.37 per share of Horizon common stock immediately prior to the effectiveness of the merger, less the consideration used to pay off Wolverine Bancorp’s ESOP loan receivable, the transaction has an implied valuation of approximately $93.8 million.
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On September 1, 2017, Horizon completed the acquisition of Lafayette Community Bancorp, an Indiana corporation (“Lafayette”) and Horizon Bank’s acquisition of Lafayette Community Bank, a state-chartered bank and wholly-owned subsidiary of Lafayette, through mergers effective September 1, 2017. Under the terms of the Merger Agreement, shareholders of Lafayette received 0.8817 shares of Horizon common stock and $1.73 in cash for each outstanding share of Lafayette common stock. Lafayette shareholders owning fewer than 100 shares of common stock received $17.25 in cash for each common share. Lafayette shares outstanding at the closing to be exchanged were 1,856,679, and the shares of Horizon common stock issued to Lafayette shareholders totaled 1,636,888. Based upon the August 31, 2017 closing price of $17.45 per share of Horizon common stock immediately prior to the effectiveness of the merger, the transaction has an implied valuation of approximately $34.5 million.
On February 3, 2017, Horizon completed the purchase and assumption of certain assets and liabilities of a single branch of First Farmers Bank & Trust Company, located in Bargersville, Indiana. Net cash of $11.0 million was received in the transaction, representing the deposit balances assumed at closing, net of amounts paid for loans acquired in the transaction and a premium on deposits assumed in the transaction.
Following is a summary of Horizon’s financial performance through the first three months of 2019:
Net income for the quarter ended March 31, 2019 decreased 15.5% to $10.8 million, or $0.28 diluted earnings per share, compared to $12.8 million, or $0.33 diluted earnings per share for the quarter ended March 31, 2018.
Core net income for the quarter ended March 31, 2019 increased 16.5% to $13.0 million, or $0.34 diluted earnings per share, compared to $11.2 million, or $0.29 diluted earnings per share, for the same period in 2018. This represents the highest quarter-to-date core net income and core diluted earnings per share in the Company’s history. (Please refer to the section captioned “Use of Non-GAAP Financial Measures” within this Item 2 for a description of the elements of core net income and a table reconciling core net income to its most closely related GAAP measures.)
Return on average assets was 1.02% for the first quarter of 2019 compared to 1.32% for the first quarter of 2018.
Core return on average assets for the first quarter of 2019 was 1.23% compared to 1.15% for the first quarter of 2018. (Please refer to the section captioned “Use of Non-GAAP Financial Measures” within this Item 2 for a description of the elements of core return on average assets and a table reconciling core return on average assets to tis most closely related GAAP measures.)
Total loans, excluding acquired loans, increased by an annualized rate of 5.0%, or $36.8 million, during the first quarter of 2019.
Net interest margin was 3.62% for the three months ended March 31, 2019 compared to 3.60% for the three months ended December 31, 2018 and 3.81% for the three months ended March 31, 2018.
Core net interest margin (defined as net interest margin excluding acquisition-related purchase accounting adjustments) was 3.46% for the three months ended March 31, 2019 compared to 3.43% for the three months ended December 31, 2018 and 3.55% for the three months ended March 31, 2018.
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Horizon’s tangible book value per share increased to $9.60 at March 31, 2019 compared to $9.43 and $8.57 at December 31, 2018 and March 31, 2018, respectively. This represents the highest tangible book value per share in the Company’s history.
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 2018 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, goodwill and 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 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 March 31, 2019, Horizon had core deposit intangibles of $31.2 million subject to amortization and $145.7 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 March 29, 2019 was $16.09 per share compared to a book value of $13.53 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-interestincome 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
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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 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, fromtime-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
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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.
Financial Condition
On March 31, 2019, Horizon’s total assets were $5.052 billion, an increase of approximately $805.0 million compared to December 31, 2018. The increase was primarily in net loans of $607.7 million, investment securities available for sale of $86.8 million, cash and due from banks of $27.6 million, goodwill of $25.8 million, other intangible assets of $20.8 million and premises and equipment of $19.5 million due to the acquisition of Salin Bancshares, Inc.
Investment securities were comprised of the following as of (dollars in thousands):
Investment securities available for sale increased $86.8 million since December 31, 2018 to $687.1 million as of March 31, 2019. This increase was primarily due to securities acquired through the acquisition of Salin which totaled approximately $54.7 million.
Total loans increased $608.7 million since December 31, 2018 to $3.623 billion as of March 31, 2019. This increase was primarily due to $571.8 million in loans through the acquisition of Salin. Total loans, excluding acquired loans, increased $36.8 million due to increases in commercial loans of $17.1 million, residential mortgage loans of $15.6 million and consumer loans of $5.4 million, offset by a decrease in mortgage warehouse loans of $2.2 million. The growth markets of Fort Wayne, Grand Rapids, Indianapolis and Kalamazoo contributed total loan growth of $77.7 million during the first three months of 2019. Management believes that this growth is due to our seasoned lending team who live and work within these expanding and robust communities.
Total deposits increased $748.6 million since December 31, 2018 to $3.888 billion as of March 31, 2019. This increase was primarily due to $741.5 million in deposits through the acquisition of Salin.
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The Company decreased total borrowings from $550.4 million as of December 31, 2018 to $457.8 million as of March 31, 2019. At March 31, 2019, the Company had $272.9 million in short-term funds borrowed compared to $402.8 million at December 31, 2018. The decrease in borrowings was primarily due to net cash received in the acquisition of Salin totaling $128.7 million.
Stockholders’ equity totaled $609.5 million at March 31, 2019 compared to $492.0 million at December 31, 2018. The increase in stockholders’ equity during the period was due to the acquisition of Salin, generation of net income, net of dividends declared, and an increase in accumulated other comprehensive income. At March 31, 2019, the ratio of average stockholders’ equity to average assets was 11.76% compared to 11.65% at December 31, 2018. Book value per common share at March 31, 2019 increased to $13.53 compared to $12.82 at December 31, 2018.
Results of Operations
Consolidated net income for the three-month period ended March 31, 2019 was $10.8 million compared to $12.8 million for the same period in 2018. Earnings per common share for the three months ended March 31, 2019 were $0.28 basic and diluted, compared to $0.33 basic and diluted for the same three- month period in the previous year. The decrease in net income and earnings per share from the previous year reflects an increase in non-interest expense of $3.9 million, primarily due to merger expenses totaling $4.1 million (before tax expense), offset by increases in net interest income of $869,000 and non- interest income of $394,000 in addition to decreases in provision for loan losses of $ 203,000 and income tax expense of $447,000. Excluding merger expenses, loss on sale of investment securities and purchase accounting adjustments, net income for the first quarter of 2019 was $13.0 million or $0.34 diluted earnings per share compared to $11.2 million or $0.29 diluted earnings per share in the same period of 2018.
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.
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The following are the average balance sheets for the three months ending (dollars in thousands):
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
Total average assets
Liabilities and Stockholders’ Equity
Interest-bearing liabilities
Interest-bearing deposits
Total interest-bearing liabilities
Non-interest-bearing liabilities
Demand deposits
Accrued interest payable and other liabilities
Stockholders’ equity
Total average liabilities and stockholders’ equity
Net interest income/spread
Net interest income as a percent of average interest-earning assets(1)
Securities balances represent daily average balances for the fair value of securities. The average rate is calculated based on the daily average balance for the amortized cost of securities. The average rate is presented on a tax equivalent basis.
Includes fees on loans. The inclusion of loan fees does not have a material effect on the average interest rate.
Non-accruing loans for the purpose of the computations above are included in the daily average loan amounts outstanding. Loan totals are shown net of unearned income and deferred loan fees. The average rate is presented on a tax equivalent basis.
Net interest income during the three months ended March 31, 2019 was $34.3 million, an increase of $869,000 from the $33.4 million earned during the same period in 2018. Yields on the Company’s interest-earning assets increased by 26 basis points to 4.76% for the three months ending March 31, 2019 from 4.50% for the three months ended March 31, 2018. Interest income increased $ 5.9 million from $39.4 million for the three months ended March 31, 2018 to $45.4 million for the same period in 2019. This was due to an increase in average interest-earning assets through organic and acquisition-related growth, in addition to an increase in yield. Interest income from acquisition-related purchase accounting adjustments was $1.5 million for the three months ending March 31, 2019 compared to $2.0 million for the same period of 2018.
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Rates paid on interest-bearing liabilities increased by 59 basis points for the three-month period ended March 31, 2019 compared to the same period in 2018. Interest expense increased $ 5.1 million compared to the three-month period ended March 31, 2018 to $11.1 million for the same period in 2019. This increase was due to higher average balances of interest-bearing deposits and borrowings in addition to the higher rates paid on both. Average balances of interest-bearing deposits increased $ 210.0 million and was due to the acquisition of Salin during the first quarter of 2019, as well as organic growth since March 31, 2018.
The net interest margin decreased 19 basis points from 3.81% for the three-month period ended March 31, 2018 to 3.62% for the same period in 2019. The decrease in the margin for the three-month period ended March 31, 2019 compared to the same period in 2018 was due to an increase in the cost of interest-bearing liabilities, offset by an increase in the yield of taxable interest-earning assets. Excluding the interest income recognized from the acquisition-related purchase accounting adjustments, the margin would have been 3.46% for the three-month period ending March 31, 2019 compared to 3.55% for the same period in 2018.
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 March 31, 2019, a provision of $364,000 was required to adequately fund the ALLL compared to $567,000 for the same period of 2018. Commercial loan net charge-offs during the three-month period ended March 31, 2019 were $61,000, residential mortgage loans had a net recovery of $27,000 and consumer loan net charge-offs were $329,000. The decrease in the provision for loan losses in the first quarter of 2019 compared to the same period of 2018 was primarily due to improving credit trends and a continued low level of charge-offs. The ALLL balance at March 31, 2019 was $17.8 million or 0.49% of total loans. This compares to an ALLL balance of $17.8 million at December 31, 2018 or 0.59% of total loans.
Horizon’s loan loss reserve ratio, excluding loans with credit-related purchase accounting adjustments, stood at 0.69% as of March 31, 2019. Loan loss reserves and credit-related loan discounts on acquired loans as a percentage of total loans was 1.10% as of March 31, 2019. The table below illustrates Horizon’s loan loss reserve ratio composition as of March 31, 2019.
Non-GAAP Allowance for Loan and Lease Loss Detail
As of March 31, 2019
(Dollars in Thousands, Unaudited)
Horizon Legacy
CNB
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 March 31, 2019.
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Non-performing loans totaled $19.4 million as of March 31, 2019, up from $ 15.2 million as of December 31, 2018. Non-performing commercial loans increased by $2.8 million, non-performing real estate loans increased by $988,000 and non-performing consumer loans increased by $376,000 at March 31, 2019 compared to December 31, 2018. The increase innon-performing loans was primarily due to non-performing loans acquired from Salin.
Other Real Estate Owned (OREO) and repossessed assets totaled $3.7 million at March 31, 2019 compared to $2.1 million on December 31, 2018. The majority of this increase was due to other real estate owned properties acquired in the Salin transaction totaling $1.6 million.
The following is a summary of changes in non-interestincome (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 $394,000 higher during the first quarter of 2019 compared to the same period of 2018. Income from mortgage servicing, net of impairment, and fiduciary activities increased $257,000 and $164,000, respectively, during the first quarter of 2019 when compared to the first quarter of 2018. Residential mortgage loan activity during the first quarter of 2019 generated $1.3 million of income from the gain on sale of mortgage loans, down from $1.4 million for the same period in 2018.
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The following is a summary of changes in non-interest expense (table dollar amounts in thousands):
FDIC deposit insurance
Other expenses
Total non-interest expense was $3.9 million higher in the first quarter of 2019 compared to the same period of 2018, primarily due to merger expenses. Outside services and consultants, other expense, loan expense and data processing increased $ 2.3 million, $974,000, $692,000 and $270,000, respectively. Offsetting these increases was a decrease in net occupancy expense of $194,000 and FDIC insurance expense of $150,000. Excluding merger expenses, total non-interest expense decreased $217,000 during the first quarter of 2019 when compared to the first quarter of 2018.
Income Taxes
Income tax expense totaled $2.1 million for the first quarter of 2019, a decrease of $447,000 when compared to the first quarter of 2018. The decrease was primarily due to a decrease in income before income tax of $2.4 million when compared to the first quarter of 2018.
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, unpledged investment securities and borrowing relationships with correspondent banks, including the FHLB. During the three months ended March 31, 2019, cash and cash equivalents increased by approximately $27.6 million. At March 31, 2019, in addition to liquidity available from the normal operating, funding, and investing activities of Horizon, the Bank had approximately $480.7 million in unused credit lines with various money center banks, including the FHLB and the FRB Discount Window compared to $340.3 million at December 31, 2018 and $161.6 million at March 31, 2018. The Bank had approximately $ 663.7 million of unpledged investment securities at March 31, 2019 compared to $648.6 million at December 31, 2018 and $518.2 million at March 31, 2018.
Capital Resources
The capital resources of Horizon and the Bank exceeded regulatory capital ratios for “well capitalized” banks at March 31, 2019. Stockholders’ equity totaled $609.5 million as of March 31, 2019, compared to $492.0 million as of December 31, 2018. For the three months ended March 31, 2019, the ratio of average stockholders’ equity to average assets was 11.76% compared to 11.65% for the twelve months ended December 31, 2018. The increase in stockholders’ equity during the period was the result of stock issued through the acquisition of Salin and the generation of net income, net of dividends declared.
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Horizon declared common stock dividends in the amount of $0.10 per share during the first three months of 2019 and 2018. The dividend payout ratio (dividends as a percent of basic earnings per share) was 35.7% and 30.0% for the first three months of 2019 and 2018, respectively. For additional information regarding dividends, see Horizon’s Annual Report on Form 10-K for 2018.
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 relating to net income, diluted earnings per share, net interest margin, the allowance for loan and lease losses, tangible stockholders’ equity, tangible book value per share, the return on average assets and the return on average common equity. In each case, we have identified special circumstances that we consider to be non-recurring and have excluded them, to show the impact of such events as acquisition-related purchase accounting adjustments and the tax reform bill, among others we have identified in our reconciliations. 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. 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. See the tables and other information below and contained elsewhere in this Report on Form 10-Q for reconciliations of the non-GAAP figures identified herein and their most comparable GAAP measures.
Non-GAAP Reconciliation of Net Interest Margin
Net interest income as reported
Average interest-earning assets
Net interest income as a percentage of average interest-earning assets (“Net Interest Margin”)
Acquisition-related purchase accounting adjustments (“PAUs”)
Core net interest income
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
Loss (gain) on sale of investment securities
Net income excluding gain on sale of investment securities
Core Net Income
Non-GAAP Reconciliation of Diluted Earnings per Share
Diluted earnings per share (“EPS”) as reported
Diluted EPS excluding merger expenses
Diluted EPS excluding gain on sale of investment securities
Acquisition-related PAUs
Core Diluted EPS
Non-GAAP Reconciliation of Tangible Stockholders’ Equity and Tangible Book Value per Share
Less: Intangible assets
Total tangible stockholders’ equity
Common shares outstanding
Tangible book value per common share
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Non-GAAP Reconciliation of Return on Average Assets and Return on Average Common Equity
Non-GAAP Reconciliation of Return on Average Assets
Average assets
Return on average assets (“ROAA”) as reported
ROAA excluding merger expenses
ROAA excluding gain on sale of investment securities
Core ROAA
Non-GAAP Reconciliation of Return on Average Common Equity
Average Common Equity
Return on average common equity (“ROACE”) as reported
ROACE excluding merger expenses
ROACE excluding gain on sale of investment securities
Core ROACE
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HORIZON BANCORP, INC. AND SUBSIDIARIES Quantitative and
Qualitative Disclosures About Market Risk
For the Three ended March 31, 2019 and 2018
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We refer you to Horizon’s 2018 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 2018 Annual Report on Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on an evaluation of disclosure controls and procedures as of March 31, 2019, Horizon’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of Horizon’s disclosure controls (as defined in Exchange Act Rule13a-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 March 31, 2019, 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
LEGAL PROCEEDINGS
Horizon and its subsidiaries are involved in various legal proceedings incidental to the conduct of their business. Management does not expect that the outcome of any such proceedings will have a material adverse effect on our consolidated financial position or results of operations.
RISK FACTORS
There have been no material changes from the factors previously disclosed under Item 1A of Horizon’s Annual Report on Form10-K for 2018.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None not previously reported on a Current Report on Form 8-K.
DEFAULTS UPON SENIOR SECURITIES
Not Applicable
MINE SAFETY DISCLOSURES
OTHER INFORMATION
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EXHIBITS
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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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