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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015

Commission file number 0-10792

 

 

Horizon Bancorp

(Exact name of registrant as specified in its charter)

 

 

 

Indiana   35-1562417

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

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

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

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

  

Name of each exchange on which registered

Common Stock, no par value    The NASDAQ Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K  ¨

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

 

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

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

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based on the average bid price of such stock as of June 30, 2015, the last day of the registrant’s most recently completed second fiscal quarter, was approximately $208.6 million.

As of February 29, 2016, the registrant had 11,939,887 shares of common stock outstanding.

Documents Incorporated by Reference

 

Document   

Part of Form 10-K into which

portion of document is incorporated

Portions of the Registrant’s Proxy Statement to be filed for its May 5, 2016 annual meeting of shareholders    Part III

 

 

 


Table of Contents

HORIZON BANCORP

2015 Annual Report on Form 10-K

Table of Contents

 

                Page  
FORWARD-LOOKING STATEMENTS      3   
PART I   
 

Item 1

    

Business

     4   
 

Item 1A

    

Risk Factors

     19   
 

Item 1B

    

Unresolved Staff Comments

     28   
 

Item 2

    

Properties

     28   
 

Item 3

    

Legal Proceedings

     29   
 

Item 4

    

Mine Safety Disclosures

     29   
 

Special Item:

    

Executive Officers of Registrant

     29   
PART II        
 

Item 5

    

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     30   
 

Item 6

    

Selected Financial Data

     31   
 

Item 7

    

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     32   
 

Item 7A

    

Quantitative and Qualitative Disclosures about Market Risk

     53   
 

Item 8

    

Financial Statements and Supplementary Data

     54   
 

Item 9

    

Changes in and Disagreement with Accountants on Accounting and Financial Disclosure

     118   
 

Item 9A

    

Controls and Procedures

     118   
 

Item 9B

    

Other Information

     118   
PART III        
 

Item 10

    

Directors, Executive Officers and Corporate Governance

     119   
 

Item 11

    

Executive Compensation

     119   
 

Item 12

    

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     120   
 

Item 13

    

Certain Relationships and Related Transactions, and Director Independence

     120   
 

Item 14

    

Principal Accountant Fees and Services

     120   
PART IV        
 

Item 15

    

Exhibits and Financial Statement Schedules

     120   
 

SIGNATURES

     121   
 

EXHIBIT INDEX

     123   

 

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HORIZON BANCORP

2015 Annual Report on 10-K

FORWARD-LOOKING STATEMENTS

A cautionary note about forward-looking statements: In addition to historical information, information included and incorporated by reference in this Annual Report on Form 10-K contains certain “forward-looking statements” within the meaning of the federal securities laws. Horizon intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of invoking those safe-harbor provisions. Forward-looking statements can include statements about estimated cost savings, plans and objectives for future operations and expectations about Horizon’s financial and business performance as well as economic and market conditions. They often can be identified by the use of words such as “expect,” “may,” “could,” “will,” “intend,” “project,” “estimate,” “believe,” “anticipate,” “seek,” “plan” and variations of such words and similar expressions.

Horizon may include forward-looking statements in filings it makes with the Securities and Exchange Commission (“SEC”), such as this Form 10-K, in other written materials, and in oral statements made by senior management to analysts, investors, representatives of the media and others. It is intended that these forward-looking statements speak only as of the date they are made, and Horizon undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the forward-looking statement is made or to reflect the occurrence of unanticipated events.

By their nature, forward-looking statements are based on assumptions, which although believed to be reasonable, are subject to risks, uncertainties, and other factors, such as the following:

 

    economic conditions and their impact on Horizon and its customers;

 

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

 

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

 

    loss of key Horizon personnel;

 

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

 

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

 

    volatility and disruption in financial markets;

 

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

 

    sources of liquidity;

 

    potential risk of environmental liability related to lending activities;

 

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

 

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

 

    the impact of the new Basel III capital rules;

 

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

 

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

 

    rapid technological developments and changes;

 

    the risks presented by cyber terrorism and data security breaches;

 

    containing costs and expenses;

 

    the slowing or failure of economic recovery;

 

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

 

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

 

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You are cautioned that actual results may differ materially from those contained in the forward-looking statements. The “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Form 10-K lists some of the factors that could cause Horizon’s actual results to vary materially from those expressed in or implied by any forward-looking statements. Your attention is directed to this discussion.

Other risks and uncertainties that could affect Horizon’s future performance are set forth below in Item 1A, “Risk Factors.”

PART I

ITEM 1. BUSINESS

The disclosures in this Item 1 are qualified by the disclosures below in Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” and in other cautionary statements set forth elsewhere in this Annual Report on Form 10-K.

General

Horizon Bancorp (“Horizon” or the “Company”) is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in Northern and Central Indiana and Southwestern and Central Michigan through its bank subsidiary, Horizon Bank, N.A. (the “Bank”) and other affiliated entities and Horizon Risk Management, Inc. Horizon operates as a single segment, which is commercial banking. Horizon’s common stock is traded on the NASDAQ Global Select Market under the symbol HBNC. The Bank was chartered as a national banking association in 1873 and has operated continuously since that time. The Bank is a full-service commercial bank offering commercial and retail banking services, corporate and individual trust and agency services and other services incident to banking. Horizon Risk Management, Inc. is a captive insurance company incorporated in Nevada and was formed as a wholly owned subsidiary of Horizon.

On July 1, 2015, Horizon completed the acquisition of Peoples Bancorp, an Indiana corporation (“Peoples”) and the Bank’s acquisition of Peoples Federal Savings Bank of DeKalb County (“Peoples FSB”), through mergers effective July 1, 2015. Under the terms of the acquisition, the exchange ratio was 0.95 shares of Horizon common stock and $9.75 in cash for each outstanding share of Peoples common stock. Peoples shareholders owning fewer than 100 shares of common stock received $33.14 in cash for each common share. Peoples shares outstanding at the closing were 2,311,858, and the shares of Horizon common stock issued to Peoples shareholders totaled 2,192,202. Horizon’s stock price was $25.32 per share at the close of business on July 1, 2015. Based upon these numbers, the total value of the consideration for the acquisition was $78.1 million. As a result of the acquisition, the Company will have an opportunity to increase its deposit base and reduce transaction costs. The Company also expects to reduce cost through economies of scale.

On April 3, 2014 Horizon completed its acquisition of SCB Bancorp, Inc. (“Summit”) and the Bank’s acquisition of Summit Community Bank, through mergers effective as of that date. Under the final terms of the acquisition, the exchange ratio was 0.4904 shares of Horizon’s common stock and $5.15 in cash for each share of Summit common stock outstanding. Summit shares outstanding at the closing were 1,164,442, and the shares of Horizon common stock issued to Summit shareholders totaled 570,820. Horizon’s stock price was $22.23 per share at the close of business on April 3, 2014. Based upon these numbers, the total value of the consideration for the acquisition was $18.9 million (not including the retirement of Summit debt). As a result of the acquisition, the Company experienced, and expects to continue to experience, increases in its deposit base, reductions in transaction costs and reduced costs through economies of scale.

On July 17, 2012, Horizon completed its acquisition of Heartland Bancshares, Inc. (“Heartland”) and Heartland’s wholly owned subsidiary, Heartland Community Bank (“Heartland Bank”). Heartland was merged into Horizon, and Heartland Bank was merged into the Bank. The exchange ratio was 0.81 shares of Horizon’s common stock for each share of

 

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Heartland common stock outstanding. Horizon acquired the 1,442,449 outstanding shares of Heartland common stock in exchange for 1,168,383 shares of Horizon common stock, which had a market price of $16.83 per share at the close of business on July 17, 2012. Horizon also purchased and retired all shares of preferred stock that Heartland had issued pursuant to the Troubled Asset Relief Program Capital Purchase Program (“TARP”). Based upon the $16.83 market price and the TARP preferred stock purchase, the total value of the consideration for the acquisition was $26.9 million. As a result of the acquisition, the Company experienced, and expects to continue to experience, increases in its deposit base, reductions in transaction costs and reduced costs through economies of scale.

The Bank maintains 46 full service offices. At December 31, 2015, the Bank had total assets of $2.65 billion and total deposits of $1.88 billion. The Bank has wholly-owned direct and indirect subsidiaries: Horizon Investments, Inc. (“Horizon Investments”), Horizon Properties, Inc. (“Horizon Properties”), Horizon Insurance Services, Inc. (“Horizon Insurance”) and Horizon Grantor Trust. Horizon Investments manages the investment portfolio of the Bank. Horizon Properties manages the real estate investment trust. Horizon Insurance is used by the Company’s Wealth Management to sell certain insurance products. Horizon Grantor Trust holds title to certain company owned life insurance policies.

Horizon formed Horizon Bancorp Capital Trust II in 2004 (“Trust II”) and Horizon Bancorp Capital Trust III in 2006 (“Trust III”) for the purpose of participating in pooled trust preferred securities offerings. The Company assumed additional debentures as the result of the acquisition of Alliance Financial Corporation in 2005, which formed Alliance Financial Statutory Trust I (“Alliance Trust”). The Company also assumed additional debentures as the result of the acquisition of American Trust & Savings Bank (“American”) in 2010, which formed Am Tru Statutory Trust I (“Am Tru Trust”). The Company also assumed additional debentures as the result of the Heartland transaction, which formed Heartland (IN) Statutory Trust II (“Heartland Trust”). See Note 15 of the Consolidated Financial Statements included at Item 8 for further discussion regarding these previously consolidated entities that are now reported separately.

The business of Horizon is not seasonal to any material degree. No material part of Horizon’s business is dependent upon a single or small group of customers, the loss of any one or more of which would have a materially adverse effect on the business of Horizon. In 2015, revenues from loans accounted for 63.3% of the total consolidated revenue, and revenues from investment securities accounted for 11.1% of total consolidated revenue.

Available Information

The Company’s Internet address is www.horizonbank.com. The Company makes available, free of charge through the “About Us - Investor Relations – Documents - SEC Filings” section of its Internet website, copies of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after those reports are filed with or furnished to the SEC.

Employees

The Bank employed approximately 558 full and part-time employees as of December 31, 2015. Other than the Bank, neither Horizon nor any of its direct or indirect subsidiaries have employees.

Competition

Horizon faces a high degree of competition in all of its primary markets. The Bank’s primary market consists of areas throughout the northern, northwest and northeastern portions of the state of Indiana along with central Indiana defined by the counties of Lake, Porter, La Porte, St. Joseph, Elkhart, LaGrange, DeKalb, Noble, Whitley, Allen, Hamilton, Marion and Johnson Counties Indiana, along with the counties of Berrien, Cass, St. Joseph, Kalamazoo, and Ingham Counties located in southwest and southern Michigan. The Bank competes with other commercial banks as well as with savings and loan associations, consumer finance companies, credit unions and other non-bank financial service providers. To a more moderate extent, the Bank competes with Chicago money center banks, mortgage banking companies, insurance companies, brokerage houses, other institutions engaged in money market financial services and certain government agencies.

 

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Based on deposits as of June 30, 2015, Horizon was the largest of the nine bank and thrift institutions in La Porte County with a 39.05% market share and the fifth largest of the 14 institutions in Porter County with a 10.06% market share. In the counties in northeastern Indiana where Horizon just acquired Peoples FSB, Horizon holds the largest market share of 11 banks at 30.76% market share in DeKalb County; 7.04% in LaGrange County; 8.39% in Noble County; 9.84% in Whitley County and then less than 1% in Allen County where the newest branch of the former Peoples FSB is located. The branches in Michigan that were formerly with Peoples FSB are in the counties of Cass and St. Joseph with 6.01% and 5.93% market share, respectively. In Johnson County Indiana, where Horizon acquired the branches of Heartland Bank, the Bank enjoys a 12.19% market share as the third largest of the 19 institutions in that county. In Berrien County, Michigan, Horizon was the fourth largest of the 11 bank and thrift institutions with a 7.90% market share. Horizon’s market share of deposits in Lake County, Indiana was just over 1% at 1.74%, a little over 1% at 1.08% in Kalamazoo County, Michigan, and less than 1% in each of St. Joseph, Elkhart, Marion, and Hamilton Counties in Indiana. The branches of the Bank acquired in the acquisition of Summit Community Bank are located in Ingham County, Michigan and have a 2.70% market share. (Source: FDIC Summary of Deposits Market Share Reports, available at www.fdic.gov.)

Regulation and Supervision

As a bank holding company and a financial holding company, the Company is subject to extensive regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “Federal Reserve”) as its primary federal regulator. The Bank, as a nationally chartered bank, is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”) as its primary federal regulator and, as to certain matters, by the Federal Reserve Board and the Federal Deposit Insurance Corporation (“FDIC”). Both federal and state law extensively regulate various aspects of the banking business, such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Branching by the Bank is subject to the jurisdiction and requires notice to, or the prior approval of, the OCC. The Dodd-Frank Act permits the establishment of de novo branches in states where such branches could be opened by a state bank chartered by that state. The consent of the state is no longer required. The supervision, regulation and examination of Horizon and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than for Horizon’s shareholders.

Horizon also is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. Horizon’s common stock is listed on The NASDAQ Global Select Stock Market under the trading symbol “HBNC,” and Horizon is subject to the NASDAQ rules applicable to listed companies.

Included below is a brief summary of significant aspects of the laws, regulations and policies applicable to Horizon and the Bank. This summary is qualified in its entirety by reference to the full text of the statutes, regulations and policies that are referenced and is not intended to be an exhaustive description of the statutes, regulations and policies applicable to the business of Horizon and the Bank. Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to Horizon and the Bank could have a material effect on Horizon’s business, financial condition and results of operations.

The Bank Holding Company Act

The Bank Holding Company Act of 1956, as amended (“BHC Act”), generally limits the business in which a bank holding company and its subsidiaries may engage to banking or managing or controlling banks and those activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. Bank holding companies, such as Horizon, that qualify as, and elect to be, financial holding companies, however, may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board), without prior approval of the Federal Reserve Board. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments.

 

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For a bank holding company to remain qualified as a financial holding company, the company and all of its depository institution subsidiaries must be “well capitalized” and “well managed.” To commence any new activity permitted by the BHC Act or to acquire a company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the Community Reinvestment Act. The Federal Reserve Board has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal Reserve Board has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.

Federal Reserve Board policy has historically required bank holding companies to act as a source of financial and management strength for their subsidiary banks. The Dodd-Frank Act, which was signed into law on July 21, 2010, codified this policy. Under this requirement, Horizon is required to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which Horizon might not otherwise do so. For this purpose, “source of financial strength” means Horizon’s ability to provide financial assistance to the Bank in the event of the Bank’s financial distress.

The BHC Act, the Bank Merger Act and other federal and state statutes regulate acquisitions of banks and bank holding companies. The BHC Act requires the prior approval of the Federal Reserve before a bank holding company may acquire more than a 5% voting interest or substantially all assets of any bank or bank holding company. Under the Bank Merger Act, the prior approval of the OCC or another federal banking agency is required for the Bank to merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval for mergers and other acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the risks to the stability of the U.S. banking or financial system, the applicant’s performance record under the Community Reinvestment Act and the effectiveness of the subject organizations in combating money laundering activities.

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDICIA”), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” (as defined in FDICIA) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency.

Bank holding companies are required to comply with the Federal Reserve’s risk-based capital guidelines. The FDIC and the OCC also have risk-based capital ratio guidelines to which depository institutions under their respective supervision are subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk. For Horizon’s regulatory capital ratios and regulatory requirements as of December 31, 2015, see the information in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 below, which is incorporated herein by reference.

National Bank Act

As a national bank, the Bank is subject to the provisions of the National Bank Act. The Bank is supervised, regulated, and examined by the OCC, and is subject to the rules and regulations of the OCC, Federal Reserve, Consumer Financial Protection Bureau (“CFPB”) and the FDIC.

Deposit Insurance and Assessments

The Bank’s deposits are insured to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC. Generally, deposits are insured up to the statutory limit of $250,000. Banks are subject to deposit insurance premiums and assessments to maintain the DIF. A bank’s deposit insurance premium assessment rate depends on the capital category and supervisory category to which it is assigned. The FDIC has authority to raise or lower assessment rates on insured banks in order to achieve statutorily required reserve ratios in the DIF and to impose special additional assessments.

 

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The Dodd-Frank Act has resulted in significant changes to the FDIC’s deposit insurance system. Under the Dodd-Frank Act, the FDIC is authorized to set the reserve ratio for the DIF at no less than 1.35%, and must achieve the 1.35% designated reserve ratio by September 30, 2020. The FDIC must offset the effect of the increase in the minimum designated reserve ratio from 1.15% to 1.35% on insured depository institutions of less than $10 billion and may declare dividends to depository institutions when the reserve ratio at the end of a calendar quarter is at least 1.5%, although the FDIC has the authority to suspend or limit such permitted dividend declarations. In December 2010, the FDIC adopted a final rule setting the designated reserve ratio for the deposit insurance fund at 2% of estimated insured deposits.

Also as a consequence of the Dodd-Frank Act, the assessment base for deposit insurance premiums was changed, effective April 1, 2011, from adjusted domestic deposits to average consolidated total assets minus average tangible equity. Tangible equity for this purpose means Tier 1 capital. Effective April 1, 2011, the initial base assessment rates were as follows:

 

    For small Risk Category I banks, such as Horizon, the rates range from 5-9 basis points.

 

    The rates for small institutions in Risk Categories II, III and IV are 14, 23 and 35 basis points, respectively.

 

    For large institutions and large, highly complex institutions, the rate schedule ranges from 5 to 35 basis points.

Adjustments are made to the initial assessment rates based on long-term unsecured debt, depository institution debt, and brokered deposits. Horizon’s FDIC deposit insurance expense increased slightly during 2015 compared to 2014. The FDIC continued to offset the regular insurance assessments until the earlier of the exhaustion of an institution’s prepaid assessments or June 30, 2013. Any prepaid assessment remaining after collection of the amount due on June 30, 2013, was returned to the institution. The FDIC returned to the Bank $2.0 million in prepaid assessments.

The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.

FDIC-insured institutions are also subject to the requirement to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the predecessor to the Savings Association Insurance Fund (“SAIF”). These assessments will continue until the FICO bonds are repaid between 2017 and 2019. The FICO assessment rate was 0.60 basis points for each $100 of insured deposits for each quarter of 2015, except for the third quarter when it was 0.58 basis points. For the first quarter of 2016, the FICO assessment rate is 0.58 basis points for each $100 in domestic deposits maintained at an institution.

Transactions with Affiliates and Insiders

Horizon and the Bank are subject to the Federal Reserve Act, which restricts financial transactions between banks, affiliated companies and their executive officers, including limits on credit transactions between these parties. The statute prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank’s extension of credit to an affiliate.

Effective July 21, 2011, among other changes, the Dodd-Frank Act eliminated the exceptions under Section 23A of the Federal Reserve Act for transactions with financial subsidiaries and expanded the scope of transactions treated as “covered transactions” to include derivatives transactions and securities repurchase agreements. The Dodd-Frank Act also expands the types of transactions subject to insider lending limits.

Capital Regulation

The federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and account for off-balance sheet items. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to risk weighted categories consisting primarily of 0%, 20%, 50%, 100% or 150%, but also including 250% and beyond, with higher levels of capital being required for the categories perceived as representing greater risk.

 

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The capital guidelines divide a bank holding company’s or bank’s capital into two tiers. The first tier (“Tier I”) includes common equity, certain non-cumulative perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets (except mortgage servicing rights and purchased credit card relationships, subject to certain limitations). Supplementary capital (“Tier II”) includes, among other items, cumulative perpetual and long-term limited-life preferred stock, mandatory convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions. Also required by the regulations is the maintenance of a leverage ratio designed to supplement the risk-based capital guidelines. This ratio is computed by dividing Tier I capital, net of all intangibles, by the quarterly average of total assets. Pursuant to the regulations, banks must maintain capital levels commensurate with the level of risk, including the volume and severity of problem loans to which they are exposed.

In July 2013, the federal banking agencies approved final rules to be phased in from 2015 to 2019 implementing the U.S. Basel Committee on Banking Supervision’s capital framework (“Basel III”) for all U.S. banks and for bank holding companies. Under these final rules, minimum requirements have increased for both the quantity and quality of capital held by Horizon and the Bank. The rules include a new common equity Tier 1 capital ratio of 4.5%, a minimum Tier 1 capital ratio of 6.0% (increased from 4.0%), a total capital ratio of 8 % (unchanged from prior rules) and a minimum leverage ratio of 4.0%. The final rules also require a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain the required capital conservation buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of certain bonuses to senior executive management. The capital conservation buffer requirement will be phased in over three years beginning in 2016. The capital conservation buffer requirement effectively raises the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis.

The final rules also introduced other changes, including an increase in the capital required for certain categories of assets, including higher-risk construction real estate loans and certain exposures related to securitizations. The final rules allow banking organizations with less than $15 billion in assets as of December 31, 2010, to retain non-qualifying Tier 1 capital trust preferred securities issued prior to May 19, 2010, subject generally to a limit of 25% of Tier 1 capital.

These new minimum capital ratios became effective for Horizon on January 1, 2015, and will be fully phased-in on January 1, 2019. Horizon’s management believes that, as of December 31, 2015, Horizon and the Bank would meet all capital adequacy requirements under the Basel III capital rules on a fully phased-in basis, as if such requirements were currently in effect.

The following is a summary of Horizon’s and the Bank’s regulatory capital and capital requirements at December 31, 2015.

 

                  Required For Capital1     Well Capitalized Under Prompt1  
     Actual     Adequacy Purposes     Corrective Action Provisions  
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of December 31, 2015

               

Total capital1 (to risk-weighted assets)

               

Consolidated

   $ 264,452         13.99   $ 151,223         8.00     N/A         N/A   

Bank

     237,348         12.57     151,057         8.00   $ 188,821         10.00

Tier 1 capital1 (to risk-weighted assets)

               

Consolidated

     249,918         13.22     113,427         6.00     N/A         N/A   

Bank

     222,814         11.80     113,295         6.00     151,060         8.00

Common equity tier 1 capital1 (to risk-weighted assets)

               

Consolidated

     204,350         10.81     85,067         4.50     N/A         N/A   

Bank

     222,814         11.80     84,971         4.50     122,737         6.50

Tier 1 capital1 (to average assets)

               

Consolidated

     249,918         9.82     101,800         4.00     N/A         N/A   

Bank

     222,814         8.77     101,626         4.00     127,032         5.00

 

1  As defined by regulatory agencies

 

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The Dodd-Frank Act also requires the Federal Reserve to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository subsidiaries, except that bank holding companies with less than $1 billion in assets are exempt from these capital requirements.

Dividends

Dividends received from the Bank are the primary source of Horizon’s revenues. The Bank’s payment of dividends, without prior regulatory approval, is subject to regulatory limitations. The National Bank Act requires the Bank to obtain the prior approval of the OCC for the payment of dividends if the total of all dividends declared by it in one year would exceed its net profits for the current year plus its retained net profits for the two preceding years, less any required transfers to surplus. In addition, the Bank may only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed the Bank’s undivided profits after deducting statutory bad debt in excess of the Bank’s allowance for loan losses. Under the Federal Deposit Insurance Act, the Bank is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy its minimum capital requirements.

In 2011, Horizon issued 12,500 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”) to the U. S. Department of the Treasury (the “Treasury”). The issuance to the Treasury of the Series B Preferred Stock resulted in the imposition of limitations on Horizon’s ability to pay dividends. Under the terms of the Series B Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the Series B Preferred Stock, junior preferred shares, or other junior securities, including the common stock, during the current quarter and for the next three quarters following the failure to declare and pay dividends on the Series B Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach. Effective February 1, 2016, Horizon redeemed all the Series B Preferred Stock and, accordingly, the restrictions imposed on the payment of dividends by the outstanding Series B Preferred Stock will no longer have any effect.

Prompt Corrective Regulatory Action

Federal law provides the federal banking regulators with broad powers to require an undercapitalized financial institution to take prompt corrective action to resolve the institution’s problems. The extent of the regulators’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the submission of a capital restoration plan; (ii) placing limits on asset growth and restrictions on activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions with affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution. New prompt corrective action requirements became effective January 1, 2015 and increased the capital level requirements necessary to qualify as “well capitalized.” At December 31, 2015, the Bank was categorized as “well capitalized,” meaning that the Bank’s total risk-based capital ratio exceeded 10%, the Bank’s Tier I risk-based capital ratio exceeded 8%, the Bank’s common equity Tier I risk-based capital ratio exceeded 6.5%, the Bank’s leverage ratio exceeded 5%, and the Bank was not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure.

Anti-Money Laundering and the USA Patriot Act

Horizon is subject to the provisions of the USA PATRIOT Act of 2001, which contains anti-money laundering and financial transparency laws and requires financial institutions to implement additional policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering, suspicious activities and currency transaction reporting, and currency crimes.

 

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Sarbanes-Oxley Act of 2002

Horizon also is subject to the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), which revised the laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act applies to all companies with equity or debt securities registered under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act established: (i) new requirements for audit committees, including independence, expertise and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the securities laws. Management expects that significant additional efforts and expense will continue to be required to comply with the provisions of the Sarbanes-Oxley Act.

Pursuant to the final rules adopted by the SEC to implement Section 404 of the Sarbanes-Oxley Act of 2002, Horizon is required to include in each Form 10-K it files a report of management on Horizon’s internal control over financial reporting. The internal control report must include a statement of management’s responsibility for establishing and maintaining adequate control over financial reporting of Horizon, identify the framework used by management to evaluate the effectiveness of Horizon’s internal control over financial reporting and provide management’s assessment of the effectiveness of Horizon’s internal control over financial reporting. This Annual Report on Form 10-K also includes an attestation report issued by Horizon’s registered public accounting firm on Horizon’s internal control over financial reporting. For fiscal years prior to the year ended December 31, 2012, Horizon was not an “accelerated filer” and, therefore, Horizon was exempt from the attestation report requirements.

Financial System Reform – The Dodd-Frank Act and the CFPB

The Dodd-Frank Act, which was signed into law in 2010, significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that have profoundly affected how community banks, thrifts, and small bank and thrift holding companies are regulated. Among other things, these provisions eliminated the Office of Thrift Supervision and transferred its functions to the other federal banking agencies, relaxed rules regarding interstate branching, allowed financial institutions to pay interest on business checking accounts, changed the scope of federal deposit insurance coverage and imposed new capital requirements on bank and thrift holding companies.

The Dodd-Frank Act created the CFPB as an independent bureau within the Federal Reserve System with broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statutes. In July 2011, many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies transferred to the CFBP. The CFBP has a large budget and staff, and has the authority to implement regulations under federal consumer protection laws and enforce those laws against financial institutions. The CFPB has examination and primary enforcement authority over depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by the federal banking regulators for consumer compliance purposes. The CFPB also has authority to prevent unfair, deceptive or abusive practices in connection with offering consumer financial products. Additionally, the CFPB is authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities.

The CFPB has indicated that mortgage lending is an area of supervisory focus and that it will concentrate its examination and rulemaking efforts on the variety of mortgage-related topics required under the Dodd-Frank Act, including minimum standards for the origination of residential mortgages. The CFPB has published several final regulations impacting the mortgage industry, including rules related to ability-to-repay, mortgage servicing, escrow accounts, and mortgage loan originator compensation. The ability-to-repay rule makes lenders liable if they fail to assess a borrower’s ability to repay under a prescribed test, but also creates a safe harbor for so called “qualified mortgages.” Failure to comply with the ability-to-repay rule may result in possible CFPB enforcement action and special statutory damages plus actual, class action, and attorneys’ fees damages, all of which a borrower may claim in defense of a foreclosure action at any time. Horizon’s management is assessing the impact of these requirements on its mortgage lending business.

 

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The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of Horizon in substantial and unpredictable ways. Horizon has incurred higher operating costs in complying with the Dodd-Frank Act, and expects higher costs to continue for the foreseeable future. Horizon’s management continues to review rules and regulations adopted pursuant to the Dodd-Frank Act and assess their probable impact on the business, financial condition and results of operations of Horizon.

Other Regulation

In addition to the matters discussed above, the Bank is subject to additional regulation of its activities, including a variety of consumer protection regulations affecting its lending, deposit, and collection activities and regulations affecting secondary mortgage market activities.

Effect of Governmental Monetary Policies

The Bank’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

Federal Home Loan Bank (“FHLB”) System

The Bank is a member of the FHLB of Indianapolis, which is one of twelve regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned region. The FHLB is funded primarily from funds deposited by banks and savings associations and proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB. All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. The Federal Housing Finance Board (“FHFB”), an independent agency, controls the FHLB System, including the FHLB of Indianapolis.

As a member of the FHLB, the Bank is required to purchase and maintain stock in the FHLB of Indianapolis in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts, or similar obligations at the beginning of each year. At December 31, 2015, the Bank’s investment in stock of the FHLB of Indianapolis was $10.1 million. The FHLB imposes various limitations on advances such as limiting the amount of certain types of real estate related collateral to 30% of a member’s capital and limiting total advances to a member. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Indianapolis and the purpose of the borrowing.

The FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low and moderate income housing projects. For the year ended December 31, 2015, dividends paid by the FHLB of Indianapolis to the Bank totaled approximately $370,000, for an annualized rate paid in dividends of 4.2%.

Limitations on Rates Paid for Deposits; Restrictions on Brokered Deposits

FDIC regulations restrict the interest rates that less than well-capitalized insured depository institutions may pay on deposits and also restrict the ability of such institutions to accept brokered deposits. These regulations permit a “well capitalized” depository institution to accept, renew or roll over brokered deposits without restriction, and an “adequately capitalized” depository institution to accept, renew or roll over brokered deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates). The regulations prohibit an “undercapitalized” depository institution from accepting, renewing or rolling over brokered deposits. These regulations contemplate that the definitions of “well

 

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capitalized,” “adequately capitalized” and “undercapitalized” will be the same as the definitions adopted by the agencies to implement the prompt corrective action provisions of FDICIA. Management does not believe that these regulations will have a materially adverse effect on the Bank’s current operations.

Legislative Initiatives

Additional legislative and administrative actions affecting the banking industry may be considered by the United States Congress, state legislatures and various regulatory agencies, including those referred to above. It cannot be predicted with certainty whether such legislative or administrative action will be enacted or the extent to which the banking industry in general or Horizon and its affiliates will be affected.

 

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BANK HOLDING COMPANY STATISTICAL DISCLOSURES

 

I. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL

Information required by this section of Securities Act Industry Guide 3 is presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as set forth in Item 7 below, herein incorporated by reference.

 

II. INVESTMENT PORTFOLIO

 

A. The following is a schedule of the amortized cost and fair value of investment securities available for sale and held to maturity.

 

     December 31, 2015      December 31, 2014      December 31, 2013  
(dollars in thousands)    Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Available for sale

                 

U.S. Treasury and federal agencies

   $ 5,940       $ 5,926       $ 26,996       $ 26,823       $ 43,808       $ 43,134   

State and municipal

     73,829         75,095         46,535         47,952         176,670         177,898   

Federal agency collateralized mtg. obligations

     157,291         156,203         122,930         122,860         116,047         114,706   

Federal agency mortgage-backed pools

     206,970         207,704         122,583         125,395         170,006         170,894   

Private labeled mortgage-backed pools

     —           —           670         689         1,188         1,226   

Corporate notes

     32         54         32         45         708         733   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale

     444,062         444,982         319,746         323,764         508,427         508,591   

Total held to maturity

     187,629         193,703         165,767         169,904         9,910         9,910   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 631,691       $ 638,685       $ 485,513       $ 493,668       $ 518,337       $ 518,501   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

B. The following is a schedule of maturities of each category of available for sale and held-to-maturity debt securities and the related weighted-average yield of such securities as of December 31, 2015:

 

(dollars in thousands)   One Year or Less     After One Year
Through Five Years
    After Five Years
Through Ten Years
    After Ten Years  
    Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield  

Available for sale

               

U.S. Treasury and federal agencies(1)

  $  —          0.00   $ 5,468        1.17   $ 458        2.05   $  —          0.00

State and municipal

    7,232        2.45     33,425        3.22     16,694        3.60     17,744        3.73

Federal agency collateralized mtg. obligations(2)

    —          0.00     8,459        3.09     55,709        2.85     92,035        2.50

Federal agency mortgage-backed pools(2)

    3        5.97     1,229        4.52     59,847        2.70     146,625        3.00

Corporate notes

    —          0.00     —          0.00     —          0.00     54        0.00
 

 

 

     

 

 

     

 

 

     

 

 

   

Total available for sale

  $ 7,235        2.45   $ 48,581        3.00   $ 132,708        2.88   $ 256,458        2.87

Total held to maturity

  $ —          0.00   $ 18,403        2.95   $ 130,254        3.71   $ 45,046        3.60
 

 

 

     

 

 

     

 

 

     

 

 

   

Total investment securities

  $ 7,235        2.45   $ 66,984        2.99   $ 262,962        3.29   $ 301,504        2.98
 

 

 

     

 

 

     

 

 

     

 

 

   

 

(1)  Fair value is based on contractual maturity or call date where a call option exists
(2)  Maturity based upon final maturity date

The weighted-average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount. Yields are not presented on a tax-equivalent basis.

 

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Excluding those holdings of the investment portfolio in Treasury securities and other agencies and corporations of the U.S. Government, there were no investments in securities of any one issuer that exceeded 10% of the consolidated stockholders’ equity of Horizon at December 31, 2015.

 

III. LOAN PORTFOLIO

 

A. Types of Loans - Total loans on the balance sheet are comprised of the following classifications for the years indicated.

 

(dollars in thousands)    December 31
2015
    December 31
2014
    December 31
2013
    December 31
2012
    December 31
2011
 

Commercial

   $ 804,995      $ 674,314      $ 505,189      $ 460,471      $ 352,376   

Real estate

     437,144        254,625        185,958        189,714        157,141   

Mortgage warehouse

     144,692        129,156        98,156        251,448        208,299   

Consumer

     362,300        320,459        279,525        289,084        265,377   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     1,749,131        1,378,554        1,068,828        1,190,717        983,193   

Allowance for loan losses

     (14,534     (16,501     (15,992     (18,270     (18,882
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 1,734,597      $ 1,362,053      $ 1,052,836      $ 1,172,447      $ 964,311   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

B. Maturities and Sensitivities of Loans to Changes in Interest Rates - The following is a schedule of maturities and sensitivities of loans to changes in interest rates, excluding real estate mortgage, mortgage warehouse and installment loans, as of December 31, 2015:

 

(dollars in thousands)

Maturing or repricing

   One Year
or Less
     One Through
Five Years
     After Five
Years
     Total  

Commercial, financial, agricultural and commercial tax-exempt loans

   $ 515,253       $ 257,355       $ 32,387       $ 804,995   

The following is a schedule of fixed-rate and variable-rate commercial, financial, agricultural and commercial tax-exempt loans due after one year. (Variable-rate loans are those loans with floating or adjustable interest rates.)

 

(dollars in thousands)    Fixed
Rate
     Variable
Rate
 

Total commercial, financial, agricultural and commercial tax-exempt loans due after one year

   $ 209,885       $ 79,857   

 

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C. Risk Elements

Non-accrual, Past Due and Restructured Loans - The following schedule summarizes non-accrual, past due and restructured loans.

 

(dollars in thousands)    December 31
2015
     December 31
2014
     December 31
2013
     December 31
2012
     December 31
2011
 

Non-performing loans

              

Commercial

              

More than 90 days past due

   $  —         $  —         $ 45       $  —         $  —     

Non-accrual

     5,030         10,024         4,014         5,754         6,905   

Trouble debt restructuring - accruing

     60         610         1,296         1,265         —     

Trouble debt restructuring - non-accrual

     1,915         1,221         2,116         3,674         1,053   

Real estate

              

More than 90 days past due

     1         40         2         2         —     

Non-accrual

     4,354         2,297         2,459         4,565         4,694   

Trouble debt restructuring - accruing

     808         2,526         2,686         1,761         2,682   

Trouble debt restructuring - non-accrual

     1,074         1,031         999         2,827         1,120   

Mortgage warehouse

              

More than 90 days past due

     —           —           —           —           —     

Non-accrual

     —           —           —           —           —     

Trouble debt restructuring - accruing

     —           —           —           —           —     

Trouble debt restructuring - non-accrual

     —           —           —           —           —     

Consumer

              

More than 90 days past due

     27         75         2         52         37   

Non-accrual

     2,878         2,991         3,275         3,055         2,769   

Trouble debt restructuring - accruing

     350         1,236         1,072         676         858   

Trouble debt restructuring - non-accrual

     183         391         311         148         25   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-performing loans

     16,680         22,442         18,277         23,779         20,143   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other real estate owned and repossessed collateral

              

Commercial

     161         411         830         1,337         1,092   

Real estate

     3,046         636         1,277         1,228         1,708   

Mortgage warehouse

     —           —           —           —           —     

Consumer

     —           154         14         11         49   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total other real estate owned and repossessed collateral

     3,207         1,201         2,121         2,576         2,849   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-performing assets

   $ 19,887       $ 23,643       $ 20,398       $ 26,355       $ 22,992   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(dollars in thousands)              

Gross interest income that would have been recorded on non-accrual loans outstanding as of December 31, 2015, in the period if the loans had been current, in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period.

   $ 841       $ 1,143   

Interest income actually recorded on non-accrual loans outstanding as of December 31, 2015, and included in net income for the period.

     207         487   
  

 

 

    

 

 

 

Interest income not recognized during the period on non-accrual loans outstanding as of December 31, 2015.

   $ 634       $ 656   
  

 

 

    

 

 

 

Discussion of Non-Accrual Policy

 

  1. From time to time, the Bank obtains information which may lead management to believe that the collection of payments may be doubtful on a particular loan. In recognition of such, it is management’s policy to convert the loan from an “earning asset” to a non-accruing loan. Further, it is management’s policy to place a commercial loan on a non-accrual status when delinquent in excess of 90 days or it has had the accrual of interest discontinued by management. The officer responsible for the loan, the Chief Credit Officer and the senior commercial loan workout officer must review all loans placed on non-accrual status.

 

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  2. Potential Problem Loans:

Impaired and non-accrual loans for which the discounted cash flows or collateral value exceeded the carrying value of the loan totaled $16.7 million and $22.4 million at December 31, 2015 and 2014. The allowance for impaired and non-accrual loans included in the Bank’s allowance for loan losses totaled $2.5 million and $3.2 million at those respective dates. The average balance of impaired loans during 2015 and 2014 was $7.1 million and $5.3 million.

 

  3. Foreign Outstandings:

None.

 

  4. Loan Concentrations:

As of December 31, 2015, there are no significant concentrations of loans exceeding 10% of total loans. See Item III A above for a listing of the types of loans by concentration.

 

D. Other Interest-Bearing Assets

There are no other interest-bearing assets as of December 31, 2015, which would be required to be disclosed under Item III C.1 or 2 if such assets were loans.

 

IV. SUMMARY OF LOAN LOSS EXPERIENCE

 

A. The following is an analysis of the activity in the allowance for loan losses account:

 

(dollars in thousands)    December 31
2015
     December 31
2014
     December 31
2013
     December 31
2012
     December 31
2011
 

Loans outstanding at the end of the period (1)

   $ 1,749,131       $ 1,378,554       $ 1,068,828       $ 1,190,717       $ 983,193   

Average loans outstanding during the period (1)

     1,593,790         1,247,510         1,092,662         1,043,620         862,498   

 

(1)  Net of unearned income and deferred loan fees

 

(dollars in thousands)    December 31
2015
    December 31
2014
    December 31
2013
    December 31
2012
    December 31
2011
 

Balance at beginning of the period

   $ 16,501      $ 15,992      $ 18,270      $ 18,882      $ 19,064   

Loans charged-off:

          

Commercial

     3,437        1,802        2,532        2,388        967   

Real estate

     288        328        1,055        597        956   

Consumer

     2,374        1,999        2,663        2,958        4,757   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off

     6,099        4,129        6,250        5,943        6,680   

Recoveries of loans previously charged-off:

          

Commercial

     192        773        668        782        163   

Real estate

     69        21        114        77        10   

Consumer

     709        786        1,270        948        1,043   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loan recoveries

     970        1,580        2,052        1,807        1,216   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loans charged-off

     5,129        2,549        4,198        4,136        5,464   

Provision charged to operating expense

     3,162        3,058        1,920        3,524        5,282   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at the end of the period

   $ 14,534      $ 16,501      $ 15,992      $ 18,270      $ 18,882   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percent of net charge-offs to average loans outstanding for the period

     0.32     0.20     0.38     0.40     0.63

 

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B. The following schedule is a breakdown of the allowance for loan losses allocated by type of loan and the percentage of loans in each category to total loans.

 

    December 31
2015
    December 31
2014
    December 31
2013
    December 31
2012
    December 31
2011
 
(dollars in thousands)   Allowance
Amount
    % of
Loans to
Total
Loans
    Allowance
Amount
    % of
Loans to
Total
Loans
    Allowance
Amount
    % of
Loans to
Total
Loans
    Allowance
Amount
    % of
Loans to
Total
Loans
    Allowance
Amount
    % of
Loans to
Total
Loans
 

Commercial, financial and agricultural

  $ 7,195        46   $ 7,910        50   $ 6,663        48   $ 7,771        39   $ 8,017        36

Real estate

    2,476        25     2,508        18     3,462        17     3,204        16     2,472        16

Mortgage warehousing

    1,007        8     1,132        9     1,638        9     1,705        21     1,695        21

Consumer

    3,856        21     4,951        23     4,229        26     5,590        24     6,698        27

Unallocated

    —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 14,534        100   $ 16,501        100   $ 15,992        100   $ 18,270        100   $ 18,882        100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In 1999, Horizon began a mortgage warehousing program. This program is described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 below and in the Notes to the Consolidated Financial Statements in Item 8 below, which are incorporated herein by reference. The greatest risk related to these loans is transaction and fraud risk. During 2015, Horizon processed approximately $2.7 billion in mortgage warehouse loans.

 

V. DEPOSITS

Information required by this section is found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 below and in the Consolidated Financial Statements and related Notes in Item 8 below, which are incorporated herein by reference.

 

VI. RETURN ON EQUITY AND ASSETS

Information required by this section is found in Management’s Discussion and Analysis of Financial Condition and Results of Operation in Item 7 below and in the Consolidated Financial Statements and related notes in Item 8 below, which are incorporated herein by reference.

 

VII. SHORT TERM BORROWINGS

The following is a schedule of statistical information relative to securities sold under agreements to repurchase which are secured by Treasury and U.S. Government agency securities and mature within one year. There were no other categories of short-term borrowings for which the average balance outstanding during the period was 30 % or more of stockholders’ equity at the end of the period.

 

(dollars in thousands)    December 31
2015
    December 31
2014
 

Outstanding at year end

   $ 59,399      $ 44,725   

Approximate weighted-average interest rate at year-end

     0.13     0.12

Highest amount outstanding as of any month-end during the year

   $ 61,205      $ 49,325   

Approximate average outstanding during the year

   $ 54,899      $ 45,899   

Approximate weighted-average interest during the year

     0.13     0.12

 

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ITEM 1A. RISK FACTORS

An investment in Horizon’s securities is subject to risks inherent to our business. The material risks and uncertainties that management believes currently affect Horizon are described below. Before making an investment decision, you should carefully consider these risks as well as information we include or incorporate by reference in this report and other filings we make with the SEC. The risks and uncertainties we have described are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may affect our business operations.

If any of these risks or uncertainties materializes or any of these assumptions proves incorrect, our results could differ materially from the forward-looking statements. All forward-looking statements in this report are current only as of the date on which the statements were made. We do not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any statement is made or to reflect the occurrence of unanticipated events.

Risks Related to Our Business

As a financial institution, we are subject to a number of risks relating to our daily business. Although we undertake a variety of efforts to manage and control those risks, many of the risks are outside of our control. Among the risks we face are the following:

 

    Credit risk: the risk that loan customers or other parties will be unable to perform their contractual obligations;

 

    Market risk: the risk that changes in market rates and prices will adversely affect our financial condition or results of operation;

 

    Liquidity risk: the risk that Horizon or the Bank will have insufficient cash or access to cash to meet its operating needs;

 

    Operational risk: the risk of loss resulting from fraud, inadequate or failed internal processes, people and systems, or external events;

 

    Economic risk: the risk that the economy in our markets could decline further resulting in increased unemployment, decreased real estate values and increased loan charge-offs; and

 

    Compliance risk: the risk of additional action by our regulators or additional regulation could hinder our ability to do business profitably.

The current economic environment poses significant challenges for us and could adversely affect our financial condition and results of operations.

We are operating in a challenging and uncertain economic environment, including generally uncertain world, national and local conditions in our markets. The capital and credit markets have been experiencing volatility and disruption since 2008. This presents financial institutions with unprecedented circumstances and challenges that in some cases have resulted in large declines in the fair values of investments and other assets, constraints on liquidity and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans. Our financial statements have been prepared using values and information currently available to us, but given this volatility, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values and the allowance for loan losses, which could negatively impact our ability to meet regulatory capital requirements and maintain sufficient liquidity. The risks associated with our business become more acute in periods of a slowing economy or slow growth such as we began experiencing in the latter half of 2008 and which continued through 2015. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. While we continue to take steps to decrease and limit our exposure to residential construction and land development loans and home equity loans, we nonetheless retain direct exposure to the residential and commercial real estate markets, and we are affected by these events.

Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job loss, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. Further deterioration in local economic conditions in our

 

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markets could drive losses beyond that which is provided for in our allowance for loan losses and result in the following other consequences: increases in loan delinquencies, problem assets and foreclosures; demand for our products and services may decline; deposits may decrease, which would adversely impact our liquidity position; and collateral for our loans, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.

We face intense competition in all phases of our business from other banks and financial institutions.

The banking and financial services business in most of our markets is highly competitive. Our competitors include large regional banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions and other non-bank financial service providers, many of which have greater financial, marketing and technological resources than us. Many of these competitors are not subject to the same regulatory restrictions that we are and may be able to compete more effectively as a result.

Also, technology and other changes have lowered barriers to entry and made it possible for customers to complete financial transactions using non-banks that historically have involved banks at one or both ends of the transaction. Non-banks now offer products and services traditionally provided by banks. For example, consumers can maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The effects of disintermediation can also impact the lending business because of the fast growing body of financial technology companies that use software to deliver mortgage lending and other financial services. A related risk is the migration of bank personnel away from the traditional bank environments into financial technology companies and other non-banks.

Increased competition in our market may result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower. Any of these results could have a material adverse effect on our ability to maintain our earnings record, grow our loan portfolios and obtain low-cost funds. If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted. If increased competition causes us to relax our underwriting standards, we could be exposed to higher losses from lending activities. Additionally, many of our competitors are larger in total assets and capitalization, have greater access to capital markets and offer a broader range of financial services than we can offer.

Our commercial and consumer loans expose us to increased credit risks.

We have a large percentage of commercial and consumer loans. Commercial loans generally have greater credit risk than residential mortgage loans because repayment of these loans often depends on the successful business operations of the borrowers. These loans also typically have much larger loan balances than residential mortgage loans. Consumer loans generally involve greater risk than residential mortgage loans because they are unsecured or secured by assets that depreciate in value. Although we undertake a variety of underwriting, monitoring and reserving protections with respect to these types of loans, there can be no guarantee that we will not suffer unexpected losses.

Our holdings of construction, land and home equity loans may pose more credit risk than other types of mortgage loans.

Construction loans, loans secured by commercial real estate and home equity loans generally entail more risk than other types of mortgage loans. When real estate values decrease, the developers to whom we lend are likely to experience a decline in sales of new homes from their projects. Land and construction loans are more likely to become non-performing as developers are unable to build and sell homes in volumes large enough for orderly repayment of loans and as other owners of such real estate (including homeowners) are unable to keep up with their payments. We strive to establish what we believe are adequate reserves on our financial statements to cover the credit risk of these loan portfolios. However, there can be no assurance that losses will not exceed our reserves, and ultimately result in a material level of charge-offs, which could adversely impact our results of operations, liquidity and capital.

 

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The allowance for loan losses may prove inadequate or be negatively affected by credit risk exposures.

Our business depends on the creditworthiness of our customers. We periodically review the allowance for loan and lease losses for adequacy considering economic conditions and trends, collateral values, and credit quality indicators, including past charge-off experience and levels of past due loans and non-performing assets. There is no certainty that the allowance for loan losses will be adequate over time to cover credit losses in the portfolio because of unanticipated adverse changes in the economy, market conditions or events adversely affecting specific customers, industries or markets. If the credit quality of the customer base materially decreases, if the risk profile of a market, industry or group of customers changes materially, or if the allowance for loan losses is not adequate, our business, financial condition, liquidity, capital, and results of operations could be materially adversely affected.

Changes in market interest rates could adversely affect our financial condition and results of operations.

Our financial condition and results of operations are significantly affected by changes in market interest rates. We can neither predict with certainty nor control changes in interest rates. These changes can occur at any time and are affected by many factors, including international, national, regional and local economic conditions, competitive pressures and monetary policies of the Federal Reserve.

Our results of operations depend substantially on our net interest income, which is the difference between the interest income that we earn on our interest-earning assets and the interest expense that we pay on our interest-bearing liabilities. Our profitability depends on our ability to manage our assets and liabilities during periods of changing market interest rates. If rates increase rapidly as a result of an improving economy, we may have to increase the rates paid on our deposits and borrowed funds more quickly than loans and investments re-price, resulting in a negative impact on interest spreads and net interest income. The impact of rising rates could be compounded if deposit customers flow funds away from us into direct investments, such as U.S. Government bonds, corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than those offered by financial institutions such as ours. These consequences and consumer reactions may be more likely to occur during a future rise in interest rates as a result of, and in reaction to, the historically low interest rates that have persisted for an extended period of time since 2008. In other words, historical consumer behavior may not be a reliable predictor of future consumer behavior in a period of rising interest rates, resulting in a larger outflow of deposits or a higher level of loan prepayments than we would expect. In either case, our deposit costs may increase and our loan interest income may decline, either or both of which may have an adverse effect on our financial results.

Changes in interest rates also could affect loan volume. For instance, an increase in interest rates could cause a decrease in the demand for mortgage loans (and other loans), which could result in a significant decline in our revenue stream.

Conversely, should market interest rates fall below current levels, our net interest margin could also be negatively affected, as competitive pressures could keep us from further reducing rates on our deposits, and prepayments and curtailments on assets may continue. Such movements may cause a decrease in our interest rate spread and net interest margin, and therefore, decrease our profitability.

We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Increases in interest rates may decrease loan demand and/or may make it more difficult for borrowers to repay adjustable rate loans. Decreases in interest rates often result in increased prepayments of loans and mortgage-related securities, as borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments in loans or other investments that have interest rates that are comparable to the interest rates on existing loans and securities.

 

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An economic slowdown in our primary market areas could affect our business.

Our primary market area for deposits and loans consists of North and Central Indiana and Southwest and Central Michigan. An economic slowdown could hurt our business and the possible consequences of such a downturn could include the following:

 

    increases in loan delinquencies and foreclosures;

 

    declines in the value of real estate and other collateral for loans;

 

    an increase in loans charged off;

 

    an increase in the Company’s expense to fund loan loss reserves;

 

    an increase in collection costs;

 

    a decline in the demand for our products and services, and;

 

    an increase in non-accrual loans and other real estate owned.

The loss of key members of our senior management team and our lending teams could affect our ability to operate effectively.

We depend heavily on the services of our existing senior management team, particularly our CEO Craig M. Dwight, to carry out our business and investment strategies. As we continue to grow and expand our business and our locations, products and services, we will increasingly need to rely on Mr. Dwight’s experience, judgment and expertise as well as that of the other members of our senior management team. We also depend heavily on our experienced and effective lending teams and their respective special market insights, including, for example, our agricultural lending specialists. In addition to the importance of retaining our lending team, we will also need to continue to attract and retain qualified banking personnel at all levels. Competition for such personnel is intense in our geographic market areas. If we are unable to attract and retain an effective lending team and other talented people, our business could suffer. The loss of the services of any senior management personnel, particularly Mr. Dwight, or the inability to recruit and retain qualified lending and other personnel in the future, could have a material adverse effect on our consolidated results of operations, financial condition and prospects.

Potential acquisitions may disrupt our business and dilute stockholder value.

We periodically evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. We generally seek merger or acquisition partners that are culturally similar and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services. Acquiring other banks, businesses, or branches involves various risks commonly associated with acquisitions, including, among other things:

 

    potential exposure to unknown or contingent liabilities of the target company;

 

    exposure to potential asset quality issues of the target company;

 

    potential disruption to our business;

 

    potential diversion of our management’s time and attention away from day-to-day operations;

 

    the possible loss of key employees, business and customers of the target company;

 

    difficulty in estimating the value of the target company, and;

 

    potential problems in integrating the target company’s systems, customers and employees with ours.

As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving the payment of cash or the issuance of our debt or equity securities may occur at any time. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction. To the extent we were to issue additional common shares in any such transaction, our current shareholders would be diluted and such an issuance may have the effect of decreasing our stock price, perhaps significantly. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our financial condition and results of operations.

In addition, merger and acquisition costs incurred by Horizon may temporarily increase operating expenses.

 

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We may need to raise additional capital in the future, and such capital may not be available when needed or at all.

We may need to raise additional capital in the future to fund acquisitions and to provide us with sufficient capital resources and liquidity to meet our commitments, regulatory capital requirements and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Although we are currently, and have historically been, “well capitalized” for regulatory purposes, our capital levels are not far in excess of the well capitalized threshold, and in the past we have been required to maintain increased levels of capital in connection with certain acquisitions. Additionally, we periodically explore acquisition opportunities with other financial institutions, some of which are in distressed financial condition. Any future acquisition, particularly the acquisition of a significantly troubled institution or an institution of comparable size to us, may require us to raise additional capital in order to obtain regulatory approval and/or to remain well capitalized.

Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. Economic conditions and the loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital, including inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve.

We cannot guarantee that such capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, our depositors or counterparties participating in the capital markets may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Moreover, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our businesses, financial condition and results of operations and may restrict our ability to grow.

The preparation of our financial statements requires the use of estimates that may vary from actual results.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for loan losses. Due to the inherent nature of these estimates, we cannot provide absolute assurance that we will not have to increase the allowance for loan losses and/or sustain loan losses that are significantly higher than the provided allowance.

Our mortgage warehouse and indirect lending operations are subject to a higher fraud risk than our other lending operations.

We buy loans originated by mortgage bankers and automobile dealers. Because we must rely on the mortgage bankers and automobile dealers in making and documenting these loans, there is an increased risk of fraud to us on the part of the third-party originators and the underlying borrowers. In order to guard against this increased risk, we perform investigations on the mortgage companies with whom we do business, and we review the loan files and loan documents we purchase to attempt to detect any irregularities or legal noncompliance. However, there is no guarantee that our procedures will detect all cases of fraud or legal noncompliance.

Our mortgage lending profitability could be significantly reduced if we are not able to resell mortgages or experience other problems with the secondary market process or are unable to retain our mortgage loan sales force due to regulatory changes.

Currently, we sell a substantial portion of the mortgage loans we originate. The profitability of our mortgage banking operations depends in large part upon our ability to aggregate a high volume of loans and to sell them in the secondary market at a gain. Thus, we are dependent upon the existence of an active secondary market and our ability to profitably sell loans into that market.

 

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Our ability to sell mortgage loans readily is dependent upon the availability of an active secondary market for single-family mortgage loans, which in turn depends in part upon the continuation of programs currently offered by Fannie Mae, Freddie Mac and Ginnie Mae (the “Agencies”) and other institutional and non-institutional investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. Some of the largest participants in the secondary market, including the Agencies, are government-sponsored enterprises whose activities are governed by federal law. Any future changes in laws that significantly affect the activity of such government-sponsored enterprises could, in turn, adversely affect our operations.

In September 2008, Fannie Mae and Freddie Mac were placed into conservatorship by the U.S. government. Although to date, the conservatorship has not had a significant or adverse effect on our operations, and during 2010 and 2012 the Federal Housing Finance Agency indicated that the Treasury Department is committed to fund Fannie Mae and Freddie Mac to levels needed in order to sufficiently meet their funding needs, it is currently unclear whether further changes would significantly and adversely affect our operations. In addition, our ability to sell mortgage loans readily is dependent upon our ability to remain eligible for the programs offered by the Agencies and other institutional and non-institutional investors. Our ability to remain eligible may also depend on having an acceptable peer-relative delinquency ratio for the Federal Housing Administration (“FHA”) and maintaining a delinquency rate with respect to Ginnie Mae pools that are below Ginnie Mae guidelines. In the case of Ginnie Mae pools, we have repurchased delinquent loans from them in the past to maintain compliance with the minimum required delinquency ratios. Although these loans are typically insured as to principal by the FHA, such repurchases increase our capital and liquidity needs, and there can be no assurance that we will have sufficient capital or liquidity to continue to purchase such loans out of the Ginnie Mae pools if required to do so.

Any significant impairment of our eligibility with any of the Agencies could materially and adversely affect our operations. Further, the criteria for loans to be accepted under such programs may be changed from time-to-time by the sponsoring entity which could result in a lower volume of corresponding loan originations. The profitability of participating in specific programs may vary depending on a number of factors, including our administrative costs of originating and purchasing qualifying loans and our costs of meeting such criteria.

We are exposed to intangible asset risk in that our goodwill may become impaired.

As of December 31, 2015, we had $57.0 million of goodwill and other intangible assets. A significant and sustained decline in our stock price and market capitalization, a significant decline in our expected future cash flows, a significant adverse change in the business climate, or slower growth rates could result in impairment of goodwill. If we were to conclude that a future write-down of our goodwill is necessary, then we would record the appropriate charge, which could be materially adverse to our operating results and financial position. For further discussion, see Notes 1 and 11, “Nature of Operations and Summary of Significant Accounting Policies” and “Intangible Assets,” to the Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2015.

We are subject to extensive regulation and changes in laws and regulatory policies could adversely affect our business.

Our operations are subject to extensive regulation by federal agencies. See “Regulation and Supervision” in the description of our Business in Item 1 of Part I of this report for detailed information on the laws and regulations to which we are subject. Changes in applicable laws, regulations or regulator policies can materially affect our business. The likelihood of any major changes in the future and their effects are impossible to determine. As an example, the Bank could experience higher credit losses because of federal or state legislation or by regulatory or bankruptcy court action that reduces the amount the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that limits its ability to foreclose on property or other collateral or makes foreclosure less economically feasible.

Legislation enacted in recent years, together with additional actions announced by the U.S. Treasury and other regulatory agencies, continue to develop. It is not clear at this time what impact legislation and liquidity and funding initiatives of the U.S. Treasury and other bank regulatory agencies, and additional programs that may be initiated in the future, will have on the financial markets and the financial services industry.

 

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Our inability to continue to accurately process large volumes of transactions could adversely impact our business and financial results.

In the normal course of business, we process large volumes of transactions. If systems of internal control should fail to work as expected, if systems are used in an unauthorized manner, or if employees subvert the system of internal controls, significant losses could result.

We process large volumes of transactions on a daily basis and are exposed to numerous types of operational risk. Operational risk resulting from inadequate or failed internal processes, people and systems includes the risk of fraud by persons inside or outside Horizon, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes the potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.

We establish and maintain systems of internal operational controls that are designed to provide us with timely and accurate information about our level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost-effective levels. Procedures also exist that are designed to ensure that policies relating to conduct, ethics and business practices are followed. From time to time, losses from operational risk may occur, including the consequences of operational errors.

While we continually monitor and improve the system of internal controls, data processing systems and corporate-wide processes and procedures, there can be no assurance that future losses will not occur.

Our information systems may experience cyber-attacks or an interruption or breach in security.

We rely heavily on internal and outsourced technologies, communications, and information systems to conduct our business. Additionally, in the normal course of business, we collect, process and retain sensitive and confidential information regarding our customers. As our reliance on technology has increased, so have the potential risks of a technology-related operation interruption (such as disruptions in our customer relationship management, general ledger, deposit, loan, or other systems) or the occurrence of cyber-attacks (such as unauthorized access to our systems, computer viruses or other malicious code). These risks have increased for all financial institutions as new technologies, including the use of the Internet and telecommunications technologies (including mobile devices), have become commonly used to conduct financial and other business transactions, during a time of increased technological sophistication of organized crime, perpetrators of fraud, hackers, terrorists and others. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks against large financial institutions, particularly denial of service attacks, that are designed to disrupt key business services, such as customer-facing web sites. We are not able to anticipate or implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently and because attacks can originate from a wide variety of sources, both domestic and foreign. However, we have analyzed and will continue to analyze security related to device-specific considerations, user access topics, transaction-processing and network integrity.

We also face risks related to cyber-attacks and other security breaches in connection with credit card and debit card transactions that typically involve the transmission of sensitive information regarding our customers through various third parties, including merchant acquiring banks, payment processors, payment card networks and our processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments such as the point of sale that we do not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact us through no fault of our own, and in some cases we may have exposure and suffer losses for breaches or attacks relating to them. Further cyber-attacks or other breaches in the future, whether affecting us or others, could intensify consumer concern and regulatory focus and result in reduced use of payment cards and increased costs, all of which could have a material adverse effect on our business.

To the extent we are involved in any future cyber-attacks or other breaches, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any

 

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insurance we maintain. We could also suffer significant damage to our reputation. Although we are insured against many of these risks, including privacy breach response costs, notification expenses, breach support and credit monitoring expenses, cyber extortion and cyber terrorism, there can be no assurances that such insurance will be sufficient to cover all costs arising from a data or information technology breach and our exposure may exceed our coverage.

We continually encounter technological changes.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements, and we may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

We rely on other companies to provide key components of our business infrastructure.

Third-party vendors provide key components of our business infrastructure, including Internet connections, mobile and internet banking, network access and transaction and other processing services. Although we have selected these third-party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of inadequate or interrupted service or breach of customer information, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. In addition, any breach in customer information could affect our reputation and cause a loss of business. Replacing these third-party vendors also could result in significant delay and expense.

Damage to our reputation could damage our business.

Our business depends upon earning and maintaining the trust and confidence of our customers, investors and employees. Damage to our reputation could cause significant harm to our business and prospects. Harm to our reputation can arise from numerous sources, including, among others, employee misconduct, compliance failures, litigation or regulatory outcomes or governmental investigations. In addition, a failure to deliver appropriate standards of service and quality, or a failure or perceived failure to treat customers and clients fairly, can result in customer dissatisfaction, litigation, privacy breach and heightened regulatory scrutiny, all of which can lead to lost revenue, higher operating costs and harm to our reputation. Adverse publicity about Horizon, whether or not true, may result in harm to our existing business, customer relationships and prospects. Should any events or factors that can undermine our reputation occur, there is no assurance that the additional costs and expenses that we may need to incur to address the issues giving rise to the reputational harm would not adversely affect our earnings and results of operations.

The soundness of other financial institutions could adversely affect us.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.

 

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Risks Related to our Common Stock

The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell our common stock at times or at prices you find attractive.

Although our common stock is listed on the NASDAQ Global Select Market, our stock price constantly changes, and we expect our stock price to continue to fluctuate in the future. Our stock price is impacted by a variety of factors, some of which are beyond our control.

These factors include:

 

    variations in our operating results or the quality of our assets;

 

    operating results that vary from the expectations of management, securities analysts and investors;

 

    increases in loan losses, non-performing loans and other real estate owned;

 

    changes in expectations as to our future financial performance;

 

    announcements of new products, strategic developments, acquisitions and other material events by us or our competitors;

 

    the operating and securities price performance of other companies that investors believe are comparable to us;

 

    loss of our inclusion on the Russell 3000 or other indices;

 

    actual or anticipated sales of our equity or equity-related securities;

 

    our past and future dividend practice;

 

    our creditworthiness;

 

    interest rates;

 

    the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing;

 

    developments with respect to financial institutions generally; and

 

    economic, financial, geopolitical, regulatory, congressional or judicial events that affect us or the financial markets.

In addition the stock market in general has recently experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies and particularly those in the financial services and banking sector, including for reasons unrelated to their operating performance. These broad market fluctuations may adversely affect our stock price, notwithstanding our operating results.

Because our stock is thinly traded, it may be more difficult for you to sell your shares or buy additional shares when you desire to do so and the price may be volatile.

Although our common stock has been listed on the NASDAQ stock market since December 2001, our common stock is thinly traded. The prices of thinly traded stocks, such as ours, are typically more volatile than stocks traded in a large, active public market and can be more easily impacted by sales or purchases of large blocks of stock. Thinly traded stocks are also less liquid, and because of the low volume of trades, you may be unable to sell your shares when you desire to do so.

Provisions in our articles of incorporation, our by-laws, and Indiana law may delay or prevent an acquisition of us by a third party.

Our articles of incorporation and by-laws and Indiana law contain provisions that have certain anti-takeover effects. While the purpose of these provisions is to strengthen the negotiating position of the board in the event of a hostile takeover attempt, the overall effects of these provisions may be to render more difficult or discourage a merger, tender offer or proxy contest, the assumption of control by a holder of a larger block of our shares, and the removal of incumbent directors and key management.

Our articles of incorporation provide for a staggered board, which means that only one-third of our board can be replaced by shareholders at any annual meeting. Our articles also provide that our directors may only be removed without cause by shareholders owning 70% or more of our outstanding common stock. Furthermore, our articles provide that only our board of directors, and not our shareholders, may adopt, alter, amend and repeal our by-laws.

 

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Our articles also preempt Indiana law with respect to business combinations with a person who acquires 10% or more of our common stock and provide that such transactions are subject to independent and super-majority shareholder approval requirements unless certain pricing and board pre-approval requirements are satisfied.

Our by-laws do not permit cumulative voting of shareholders in the election of directors, allowing the holders of a majority of our outstanding shares to control the election of all our directors, and our directors are elected by plurality (not majority) voting. Our by-laws also establish detailed procedures that shareholders must follow if they desire to nominate directors for election or otherwise present issues for consideration at a shareholders’ meeting. We also have a mandatory retirement age for directors.

These and other provisions of our governing documents and Indiana law are intended to provide the board of directors with the negotiating leverage to achieve a more favorable outcome for our shareholders in the event of an offer for the company. However, there is no assurance that these same anti-takeover provisions could not have the effect of delaying, deferring or preventing a transaction or a change in control that might be in the best interest of our shareholders.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

The main office and full service branch of Horizon and the Bank is located at 515 Franklin Square, Michigan City, Indiana. The building located across the street from the main office of Horizon and the Bank, at 502 Franklin Square, houses the credit administration, operations, facilities and purchasing, and information technology departments of the Bank. In addition to these principal facilities, the Bank has 45 sales offices located at:

 

3631 South Franklin Street    Michigan City    Indiana   
113 West First Street    Wanatah    Indiana   
1500 West Lincolnway    LaPorte    Indiana   
423 South Roosevelt Street    Chesterton    Indiana   
4208 North Calumet Avenue    Valparaiso    Indiana   
902 East Lincolnway    Valparaiso    Indiana   
455 Morthland Drive    Valparaiso    Indiana   
2650 Willowcreek Road    Portage    Indiana   
8590 Broadway    Merrillville    Indiana   
10429 Calumet Avenue    Munster    Indiana   
17400 State Road 23    South Bend    Indiana   
1909 East Bristol Street    Elkhart    Indiana   
4574 Elkhart Road    Goshen    Indiana   
1321 119th Street    Whiting    Indiana   
1349 Calumet Avenue    Hammond    Indiana   
1300 North Main Street    Crown Point    Indiana   
420 North Morton Street    Franklin    Indiana   
151 Marlin Drive    Greenwood    Indiana   
942 South US 31    Greenwood    Indiana   
507 Three Notch Lane    Bargersville    Indiana   
302 North Alabama Steet    Indianapolis    Indiana   
1216 West Carmel Drive    Carmel    Indiana   
212 West Seventh Street    Auburn    Indiana   
105 North Main Street    Avilla    Indiana   
507 North Main Street    Columbia City    Indiana   
123-129 South Main Street    Columbia City    Indiana   
1212 South Randolph Street    Garrett    Indiana   

 

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303 Defiance Street    Howe    Indiana   
116 West Mitchell Street    Kendallville    Indiana   
114 South Detroit Street    LaGrange    Indiana   
210 West Lake Street    Topeka    Indiana   
625 South Wayne Street    Waterloo    Indiana   
22730 Main Street    Woodburn    Indiana   
811 Ship Street    St. Joseph    Michigan   
2608 Niles Road    St. Joseph    Michigan   
1041 East Napier Avenue    Benton Harbor    Michigan   
500 West Buffalo Street    New Buffalo    Michigan   
6801 West US 12    Three Oaks    Michigan   
3250 West Centre Avenue    Portage    Michigan   
1600 Abbot Road    East Lansing    Michigan   
2151 West Grand River    Okemos    Michigan   
500 North Grand Street    Schoolcraft    Michigan   
123 Portage Avenue    Three Rivers    Michigan   
1213 West Michigan Avenue    Three Rivers    Michigan   
15534 US 12    Union    Michigan   

Horizon owns all of the facilities except for the East Lansing, Michigan office located at 1600 Abbot Road, which is leased.

ITEM 3. LEGAL PROCEEDINGS

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

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

SPECIAL ITEM: EXECUTIVE OFFICERS OF REGISTRANT

 

Craig M. Dwight    59    Chairman of Horizon since July 1, 2014; Chairman and Chief Executive Officer of the Bank since January 2003; Chief Executive Officer of Horizon and the Bank since July 1, 2001; President of the Bank since 1998.
Thomas H. Edwards    63    President of the Bank since January 2003.
Mark E. Secor    49    Executive Vice President of Horizon since January 1, 2014; Chief Financial Officer and Executive Vice President of Horizon and the Bank since January 2009; Vice President, Chief Investment and Asset Liability Manager since June 2007; Chief Financial Officer of St. Joseph Capital Corp., Mishawaka, Indiana from 2004 to 2007.
James D. Neff    56    Corporate Secretary of Horizon since 2007; Executive Vice President-Mortgage Banking of the Bank since January 2004; Senior Vice President of the Bank since October 1999.
Dave G. Rose    57    Executive Vice President of Horizon since January 1, 2014; President of the Bank’s Northwest Indiana Region since January 1999.
Kathie A. DeRuiter    54    Executive Vice President of Horizon and Senior Bank Operations Officer since January 1, 2014; Senior Vice President, Senior Bank Operations Officer since January 1, 2003; Vice President, Senior Bank Operations Officer since January 1, 2000.

All officers are appointed annually by the Board of Directors of Horizon and the Bank, as applicable.

 

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Repurchases of Securities

There were no purchases by the Company of its common stock during the fourth quarter of 2015.

Performance Graph

The SEC requires Horizon to include a line graph comparing Horizon’s cumulative five-year total shareholder returns on the common shares with market and industry returns over the past five years. SNL Financial LC prepared the following graph. The return represented in the graph assumes the investment of $100 on December 31, 2010, and further assumes reinvestment of all dividends. The Company’s common stock began trading on the NASDAQ Global Market on February 1, 2007, and on the NASDAQ Global Select Market on January 2, 2014. Prior to that date, the common stock was traded on the NASDAQ Capital Market.

 

LOGO

 

     Period Ending  
Index    December 31
2010
     December 31
2011
     December 31
2012
     December 31
2013
     December 31
2014
     December 31
2015
 

Horizon Bancorp

     100.00         100.30         174.45         229.20         241.71         263.17   

Russell 2000

     100.00         95.82         111.49         154.78         162.35         155.18   

SNL Bank $1B-$5B

     100.00         91.20         112.45         163.52         170.98         191.39   

SNL Micro Cap Bank

     100.00         95.11         120.19         155.07         175.86         195.56   

Source : SNL Financial LC, Charlottesville, VA

  

           

Copyright 2015

                 www.snl.com   

 

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The following chart compares the change in market price of Horizon’s common stock since December 31, 2010 to that of publicly traded banks in Indiana and Michigan with assets greater than $500 million, excluding the reinvestment of dividends.

 

LOGO

 

     Period Ending  
Index    December 31
2010
     December 31
2011
     December 31
2012
     December 31
2013
     December 31
2014
     December 31
2015
 

Horizon Bancorp

     100.00         97.73         166.21         214.26         221.11         236.50   

Indiana Banks (1)

     100.00         102.15         109.89         150.84         157.23         162.16   

Michigan Banks (1)

     100.00         99.28         118.24         165.38         168.06         193.00   

(1)    excludes merger targets

       

              

Source : SNL Financial LC, Charlottesville, VA

  

           

Copyright 2015

                 www.snl.com   

The other information regarding Horizon’s common stock, including the approximate number of holders of the common stock, is included under the caption “Horizon’s Common Stock and Related Stockholders Matters” in Item 8 below, which is incorporated by reference.

ITEM 6. SELECTED FINANCIAL DATA

The information required under this item is incorporated by reference to the information appearing under the caption “Summary of Selected Financial Data” in Item 8 of this Form 10-K.

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Horizon is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in Northern and Central Indiana and Southwestern and Central Michigan through its bank subsidiary. Horizon operates as a single segment, which is commercial banking. Horizon’s common stock is traded on the NASDAQ Global Select Market under the symbol HBNC. The Bank was chartered as a national banking association in 1873 and has operated continuously since that time. The Bank is a full-service commercial bank offering commercial and retail banking services, corporate and individual trust and agency services, and other services incident to banking. All share data included below has been adjusted to reflect Horizon’s three-for-two stock splits paid on November 9, 2012 and December 9, 2011.

Following are some highlights of Horizon’s financial performance during 2015:

 

    Net income for the year ending December 31, 2015 was $20.5 million or $1.89 diluted earnings per share.

 

    Excluding merger expenses, gain on sale of investment securities and the death benefit on bank owned life insurance, net income for the year ending December 31, 2015 increased 29.0% compared to the year ending December 31, 2014 to $23.6 million or $2.18 diluted earnings per share.

 

    Net interest income for the year ending December 31, 2015 increased 18.7% or $11.8 million compared to the year ending December 31, 2014.

 

    Non-interest income for the year ending December 31, 2015 increased 15.7% or $4.1 million compared to the year ending December 31, 2014.

 

    Commercial loans surpassed $800.0 million during the fourth quarter of 2015 for the first time in the Company’s history, ending the year at $805.0 million.

 

    Total loans, excluding acquired loans, increased 10.7% or $148.0 million during the year ending December 31, 2015.

 

    Excluding merger expenses, gain on sale of investment securities and the death benefit on bank owned life insurance, return on average assets was 1.00% for the year ending December 31, 2015.

 

    Excluding merger expenses, gain on sale of investment securities and the death benefit on bank owned life insurance, return on average common equity was 11.36% for the year ending December 31, 2015.

 

    Non-performing loans to total loans as of December 31, 2015 were 0.95% compared to 1.62% as of December 31, 2014.

 

    Substandard loans totaled $25.1 million as of December 31, 2015, a decrease of $2.6 million from $27.7 million as of December 31, 2014.

 

    Horizon’s tangible book value per share increased to $16.53 at December 31, 2015, compared to $16.26 at December 31, 2014 and $14.97 at December 31, 2013.

 

    Horizon Bank’s capital ratios, including Tier 1 Capital to Average Assets of 8.77% and Total Capital to Risk Weighted Assets of 12.57% as of December 31, 2015, continue to be well above the regulatory standards for well-capitalized banks.

Critical Accounting Policies

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

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

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.

Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (FASB ASC 310-30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Accordingly, allowances for credit losses related to these loans are not carried over and recorded at the acquisition dates. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC 310-30, but for which a discount is attributable, at least in part to the credit quality, are also accounted for under this guidance. As a result, related discounts are recognized subsequently through accretion based on the expected cash flows of the acquired loans. For purposes of applying FASB ASC 310-30, loans acquired in business combinations are aggregated into pools of loans with common risk characteristics.

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 December 31, 2015, Horizon had core deposit intangibles of $7.4 million subject to amortization and $49.6 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 December 31, 2015 was $27.96 per share compared to a tangible book value of $16.53 per common share. Horizon’s return on average assets was 87 basis points for the year ending December 31, 2015.

Mortgage Servicing Rights

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

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

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

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

Valuation Measurements

Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities, residential mortgage loans held for sale and derivatives are carried at fair value, as defined in FASB ASC 820, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts of goodwill, mortgage servicing rights, and pension and other post-retirement benefit obligations. To determine the values of these assets and liabilities, as well as the extent, to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment speeds and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect Horizon’s results of operations.

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Analysis of Financial Condition

Horizon’s total assets were $2.7 billion as of December 31, 2015, an increase of $575.5 million from December 31, 2014.

Investment Securities

Investment securities totaled $632.6 million at December 31, 2015, and consisted of Treasury and federal agency securities of $11.8 million (1.9%); state and municipal securities of $221.4 million (35.0%); federal agency mortgage-backed pools of $234.1 million and federal agency collateralized mortgage obligations of $165.3 million (63.1%); and corporate securities of $54,000 (0.0%). Investment securities increased $143.1 million during 2015 primarily as a result of cash received from the Peoples merger.

As indicated above, 63.1% of the investment portfolio consists of mortgage-backed securities and collateralized mortgage obligations. These instruments are secured by residential mortgages of varying maturities. Principal and interest payments are received monthly as the underlying mortgages are repaid. These payments also include prepayments of mortgage balances as borrowers either sell their homes or refinance their mortgages. Therefore, mortgage-backed securities and collateralized mortgage obligations have maturities that are stated in terms of average life. The average life is the average amount of time that each dollar of principal is expected to be outstanding. As of December 31, 2015, the mortgage-backed securities and collateralized mortgage obligations in the investment portfolio had an average duration of three years. Securities that have interest rates above current market rates are purchased at a premium. Management monitors these investments periodically for other than temporary impairment by obtaining and reviewing the underlying collateral details and has concluded at December 31, 2015, any unrealized loss is temporary and that the Company has the intent and ability to hold these investments to maturity.

Available-for-sale municipal securities are priced by a third party using a pricing grid which estimates prices based on recent sales of similar securities. All municipal securities are investment grade or local non-rated issues and management does not believe there is other than temporary deterioration in market value. A credit review is performed annually on the municipal securities portfolio.

At December 31, 2015, 70.3% and at December 31, 2014, 66.1% of investment securities were classified as available for sale. Securities classified as available for sale are carried at their fair value, with both unrealized gains and losses recorded, net of tax, directly to stockholders’ equity. Net appreciation on these securities totaled $920,000, which resulted in a balance of $598,000, net of tax, included in stockholders’ equity at December 31, 2015. This compared to $2.6 million, net of tax, included in stockholders’ equity at December 31, 2014.

Fair value is defined 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. A fair value hierarchy is also established which requires an entity to maximize the use of observable and minimize the use of unobservable inputs. 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.

When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. There are no Level 1 securities. 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 Federal agency mortgage-backed pools. For Level 2 securities, Horizon uses a third party service to

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

determine fair value. In performing the valuations, the pricing service relies on models that consider security-specific details as well as relevant industry and economic factors. The most significant of these inputs are quoted market prices, interest rate spreads on relevant benchmark securities and certain prepayment assumptions. To verify the reasonableness of the fair value determination by the service, Horizon has a portion of the Level 2 securities priced by an independent securities broker-dealer.

Unrealized gains and losses on available-for-sale securities, deemed temporary, are recorded, net of income tax, in a separate component of other comprehensive income on the balance sheet. No unrealized losses were deemed to be “other-than-temporary.”

As a member of the Federal Reserve and Federal Home Loan Bank systems, Horizon is required to maintain an investment in the common stock of each entity. The investment in common stock is based on a predetermined formula. At December 31, 2015, Horizon had investments in the common stock of the Federal Reserve and Federal Home Loan Banks totaling $13.8 million and at December 31, 2014, investments totaled $11.3 million.

At December 31, 2015, Horizon did not maintain a trading account.

For more information about securities, see Note 4 — Securities to the Consolidated Financial Statements at Item 8.

Loans

Total loans, net of deferred fees/costs, the principal earning asset of the Bank, were $1.7 billion at December 31, 2015. The current level of total loans increased 26.9% from the December 31, 2014, level of $1.4 billion. The table below provides comparative detail on the loan categories.

 

     December 31
2015
     December 31
2014
     Dollar
Change
     Percent
Change
 

Commercial

           

Working capital and equipment

   $ 381,245       $ 300,940       $ 80,305         26.7

Real estate, including agriculture

     391,668         343,455         48,213         14.0

Tax exempt

     8,674         8,595         79         0.9

Other

     23,408         21,324         2,084         9.8
  

 

 

    

 

 

    

 

 

    

Total

     804,995         674,314         130,681         19.4

Real estate

           

1–4 family

     433,015         250,799         182,216         72.7

Other

     4,129         3,826         303         7.9
  

 

 

    

 

 

    

 

 

    

Total

     437,144         254,625         182,519         71.7

Consumer

           

Auto

     168,397         154,538         13,859         9.0

Recreation

     5,365         5,673         (308      -5.4

Real estate/home improvement

     47,015         38,288         8,727         22.8

Home equity

     127,113         112,426         14,687         13.1

Unsecured

     4,120         3,613         507         14.0

Other

     10,290         5,921         4,369         73.8
  

 

 

    

 

 

    

 

 

    

Total

     362,300         320,459         41,841         13.1

Mortgage warehouse

     144,692         129,156         15,536         12.0
  

 

 

    

 

 

    

 

 

    

Total loans

     1,749,131         1,378,554         370,577         26.9

Allowance for loan losses

     (14,534      (16,501      1,967      
  

 

 

    

 

 

    

 

 

    

Loans, net

   $ 1,734,597       $ 1,362,053       $ 372,544      
  

 

 

    

 

 

    

 

 

    

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

The acceptance and management of credit risk is an integral part of the Bank’s business as a financial intermediary. The Bank has established underwriting standards including a policy that monitors the lending function through strict administrative and reporting requirements as well as an internal loan review of consumer and small business loans. The Bank also uses an independent third-party loan review function that regularly reviews asset quality.

Changes in the mix of the loan portfolio averages are shown in the following table.

 

     December 31
2015
     December 31
2014
     December 31
2013
 

Commercial

   $ 743,175       $ 620,809       $ 490,137   

Real estate

     368,653         234,335         195,520   

Mortgage warehouse

     138,137         95,070         126,912   

Consumer

     343,825         297,296         280,093   
  

 

 

    

 

 

    

 

 

 

Total average loans

   $ 1,593,790       $ 1,247,510       $ 1,092,662   
  

 

 

    

 

 

    

 

 

 

Commercial Loans

Commercial loans totaled $805.0 million, or 46.0% of total loans as of December 31, 2015, compared to $674.3 million, or 48.9% as of December 31, 2014. The increase during 2015 was primarily related to the $67.4 million of commercial loans acquired in the Peoples acquisition along with organic growth of $63.2 million net of principal reductions from payments.

Commercial loans consisted of the following types of loans at December 31:

 

     December 31, 2015     December 31, 2014  
     Number      Amount      Percent of
Portfolio
    Number      Amount      Percent of
Portfolio
 

SBA guaranteed loans

     251       $ 54,549         6.8     232       $ 47,269         7.0

Municipal government

     1         447         0.1     1         548         0.1

Lines of credit

     927         153,080         19.0     714         114,779         17.0

Real estate and equipment term loans

     1,834         596,919         74.2     1,432         511,718         75.9
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

     3,013       $ 804,995         100.0     2,379       $ 674,314         100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Fixed rate term loans with a book value of $117.3 million and a fair value of $115.5 million have been swapped to a variable rate using derivative instruments. The loans are carried at fair value in the financial statements and the related swap is carried at fair value and is included with other liabilities in the balance sheet. The recognition of the loan and swap fair values are recorded in the income statement and for 2015 equally offset each other. Fair values are determined by the counter party using a proprietary model that uses live market inputs to value interest rate swaps. The model is subject to daily market tests as current and future positions are priced and valued. These are Level 3 inputs under the fair value hierarchy as described above.

At December 31, 2015, the commercial loan portfolio held $91.7 million of adjustable rate loans that had interest rate floors in the terms of the note. Of the commercial loans with interest rate floors, loans totaling $72.4 million were at their floor at December 31, 2015.

Residential Real Estate Loans

Residential real estate loans totaled $437.1 million or 25.0% of total loans as of December 31, 2015, compared to $254.6 million or 18.5% of total loans as of December 31, 2014. This category consists of home mortgages that generally require a loan to value of no more than 80%. Some special guaranteed or insured real estate loan programs do permit a higher loan to collateral value ratio. The increase during 2015 was primarily related to the $137.3 million of real estate loans acquired in the Peoples acquisition along with organic growth of $45.2 million net of principal reductions from payments.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

In addition to the customary real estate loans described above, the Bank also had outstanding on December 31, 2015, $127.1 million in home equity lines of credit compared to $112.4 million at December 31, 2014. Credit lines normally limit the loan to collateral value to no more than 89%. Home equity credit lines are primarily not combined with a first mortgage and are therefore evaluated in the allowance for loan losses as a separate pool. These loans are classified as consumer loans in the table above and in Note 5 of the Consolidated Financial Statements at Item 8.

Residential real estate lending is a highly competitive business. As of December 31, 2015, the real estate loan portfolio reflected a wide range of interest rates and repayment patterns, but could generally be categorized as follows:

 

     December 31, 2015     December 31, 2014  
(dollars in thousands)    Amount      Percent of
Portfolio
    Yield     Amount      Percent of
Portfolio
    Yield  

Fixed rate

              

Monthly payment

   $ 114,035         26.1     4.20   $ 91,605         36.0     4.50

Biweekly payment

     151         0.0     6.20     198         0.1     6.14

Adjustable rate

              

Monthly payment

     322,959         73.9     3.84     162,822         63.9     3.69

Biweekly payment

     —           0.0     0.00     —           0.0     0.00
  

 

 

    

 

 

     

 

 

    

 

 

   

Sub total

     437,145         100.0     3.93     254,625         100.0     3.98
     

 

 

        

 

 

   

Loans held for sale

     7,917             6,143        
  

 

 

        

 

 

      

Total real estate loans

   $ 445,062           $ 260,768        
  

 

 

        

 

 

      

The increase in fixed and adjustable rate residential mortgage loans during 2015 was primarily due to the real estate loans acquired in the Peoples acquisition as well as organic growth. In addition to the real estate loan portfolio, the Bank originates and sells real estate loans and retains the servicing rights. During 2015 and 2014, approximately $302.4 million and $229.2 million, respectively, of residential mortgages were sold into the secondary market. Loans serviced for others are not included in the consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled approximately $1.2 billion and $1.0 billion at December 31, 2015 and 2014.

The Bank began capitalizing mortgage servicing rights during 2000, and the aggregate fair value of capitalized mortgage servicing rights at December 31, 2015, totaled approximately $10.8 million compared to the carrying value of $8.9 million. Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value. For purposes of measuring impairment, risk characteristics including product type, investor type and interest rates, were used to stratify the originated mortgage servicing rights.

 

     December 31
2015
     December 31
2014
     December 31
2013
 

Mortgage servicing rights

        

Balances, January 1

   $ 7,980       $ 7,428       $ 6,169   

Servicing rights capitalized

     2,974         2,280         2,535   

Amortization of servicing rights

     (1,683      (1,728      (1,276
  

 

 

    

 

 

    

 

 

 

Balances, December 31

     9,271         7,980         7,428   
  

 

 

    

 

 

    

 

 

 

Impairment allowance

        

Balances, January 1

     (338      (389      (1,024

Additions

     (130      (95      (54

Reductions

     71         146         689   
  

 

 

    

 

 

    

 

 

 

Balances, December 31

     (397      (338      (389
  

 

 

    

 

 

    

 

 

 

Mortgage servicing rights, net

   $ 8,874       $ 7,642       $ 7,039   
  

 

 

    

 

 

    

 

 

 

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Mortgage Warehouse Loans

Horizon’s mortgage warehousing lending has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with pledge of collateral under Horizon’s agreement with the mortgage company. Each individual mortgage and the related mortgagee are underwritten by Horizon to the end investor guidelines and assigned to Horizon until the loan is sold to the secondary market by the mortgage company. In addition, Horizon takes possession of each original note and forwards such note to the end investor once the mortgage company has sold the loan. At the time a loan is transferred to the secondary market, the mortgage company repurchases the loan under its option within the agreement. Due to the repurchase feature contained in the agreement, the transaction does not qualify as a sale and therefore is accounted for as a secured borrowing with pledge of collateral pursuant to the agreement with the mortgage company. When the individual loan is sold to the end investor by the mortgage company the proceeds from the sale of the loan are received by Horizon and used to 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 repurchase 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 repurchase an individual mortgage. Should this occur, Horizon would return the original note and reassign the assignment of the mortgage to the mortgage company. Also, in the event that the end investor would not be able to honor the sales commitment and the mortgage company would not be able to repurchase its loan on an individual mortgage, Horizon would be able to exercise its rights under the agreement.

At December 31, 2015, the mortgage warehouse loan balance was $144.7 million compared to $129.2 million as of December 31, 2014. The increase in mortgage warehouse loans reflected a decrease in long-term interest rates during 2015 and the continued housing market recovery resulting in higher refinance volume.

Consumer Loans

Consumer loans totaled $362.3 million, or 20.7% of total loans as of December 31, 2015, compared to $320.5 million, or 23.2% as of December 31, 2014. The increase during 2015 was primarily related to the $19.6 million of consumer loans acquired in the Peoples acquisition along with organic growth of $22.2 million net of principal reductions from payments.

Allowance and Provision for Loan Losses/Critical Accounting Policy

At December 31, 2015, the allowance for loan losses was $14.5 million, or 0.83% of total loans outstanding, compared to $16.5 million, or 1.19% at December 31, 2014. The decrease in the ratio was primarily due to an increase in total loans from both organic growth and the Peoples acquisition and a decrease in the allowance for loan losses of $2.0 million. The decrease in the allowance for loan losses was the result of two commercial loans that were charged off during the fourth quarter of 2015 in the amount of $1.1 million for which $1.4 million had previously been reserved. During 2015, the expense for provision for loan losses totaled $3.2 million compared to $3.1 million in 2014. Horizon’s loan loss reserve ratio, excluding loans with credit-related purchase accounting adjustments, was .99% as of December 31, 2015.

Horizon assesses the adequacy of its Allowance for Loan and Lease Losses (ALLL) by regularly reviewing the performance of all of its loan portfolios. As a result of its quarterly reviews, a provision for loan losses is determined to bring the total ALLL to a level called for by the analysis.

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 adequate to cover losses inherent in the loan portfolio as of December 31, 2015.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Non-performing Loans

Non-performing loans are defined as loans that are greater than 90 days delinquent or have had the accrual of interest discontinued by management. Management continues to work diligently toward returning non-performing loans to an earning asset basis. Non-performing loans for the previous three years ending December 31 are as follows:

 

     December 31
2015
     December 31
2014
     December 31
2013
 

Non-performing loans

   $ 16,680       $ 22,442       $ 18,277   

Non-performing loans total 114.8%, 136.0% and 114.3% of the allowance for loan losses at December 31, 2015, 2014 and 2013, respectively. Non-performing loans at December 31, 2015 totaled $16.7 million, a decrease from a balance of $22.4 million as of December 31, 2014 and $18.3 million as of December 31, 2013. Non-performing loans as a percentage of total loans was 0.95% as of December 31, 2015, a decrease from 1.62% and 1.70% as of December 31, 2014 and December 31, 2013, respectively.

A loan becomes impaired when, based on current information, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is classified as impaired, the degree of impairment must be recognized by estimating future cash flows from the debtor. The present value of these cash flows is computed at a discount rate based on the interest rate contained in the loan agreement. However, if a particular loan has a determinable market value, the creditor may use that value. Also, if the loan is secured and considered collateral dependent, the creditor may use the fair value of the collateral. (See Note 8 of the Consolidated Financial Statements at Item 8 for further discussion of impaired loans.)

Smaller-balance, homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by 1 – 4 family residences, residential construction loans, automobile, home equity, second mortgage loans and mortgage warehouse loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of borrower operating results and financial condition indicate that underlying cash flows of a borrower’s business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 30 days or more. Loans are generally moved to non-accrual status when 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Other Real Estate Owned (OREO) net of any related allowance for OREO losses for the previous three years ending December 31 were as follows:

 

     December 31
2015
     December 31
2014
     December 31
2013
 

Other real estate owned

   $ 3,207       $ 1,047       $ 2,107   

OREO totaled $3.2 million on December 31, 2015, an increase of $2.2 million from December 31, 2014 and $1.1 million from December 31, 2013. On December 31, 2015, OREO was comprised of 7 properties. Of these properties, two totaling $161,000 were commercial real estate and 5 totaling $3.0 million were residential real estate.

No mortgage warehouse loans were non-performing or OREO as of December 31, 2015, 2014 or 2013.

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Deferred Tax

Horizon had a net deferred tax asset totaling $5.2 million and $6.0 million as of December 31, 2015 and December 31, 2014, respectively. The following table shows the major components of deferred tax:

 

     December 31
2015
     December 31
2014
 

Assets

     

Allowance for loan losses

   $ 5,329       $ 5,680   

Net operating loss (from acquisitions)

     1,679         3,509   

Director and employee benefits

     2,223         1,953   

Unrealized loss on AFS securities and fair value hedge

     711         588   

Accrued Pension

     1,725         —     

Other

     1,029         596   
  

 

 

    

 

 

 

Total assets

     12,696         12,326   
  

 

 

    

 

 

 

Liabilities

     

Depreciation

     (2,180      (1,563

Difference in expense recognition

     —           —     

State tax

     (192      (126

Federal Home Loan Bank stock dividends

     (343      (200

Difference in basis of intangible assets

     (2,938      (2,839

FHLB Penalty

     (123      (283

Other

     (1,671      (1,303
  

 

 

    

 

 

 

Total liabilities

     (7,447      (6,314
  

 

 

    

 

 

 

Net deferred tax asset

   $ 5,249       $ 6,012   
  

 

 

    

 

 

 

Horizon anticipates continued earnings and therefore determined there is no impairment to this asset.

Deposits

The primary source of funds for the Bank comes from the acceptance of demand and time deposits. However, at times the Bank will use its ability to borrow funds from the Federal Home Loan Bank and other sources when it can do so at interest rates and terms that are more favorable than those required for deposited funds or loan demand is greater than the ability to grow deposits. Total deposits were $1.9 billion at December 31, 2015, compared to $1.5 billion at December 31, 2014. Average deposits and rates by category for the three years ended December 31 are as follows:

 

     Average Balance Outstanding for the
Year Ending December 31
     Average Rate Paid for the
Year Ending December 31
 
     2015      2014      2013      2015     2014     2013  

Noninterest-bearing demand deposits

   $ 314,840       $ 258,523       $ 219,323          

Interest-bearing demand deposits

     671,493         582,916         528,738         0.12     0.12     0.13

Savings deposits

     191,593         142,420         134,242         0.05     0.05     0.08

Money market

     205,119         161,146         123,226         0.24     0.23     0.21

Time deposits

     344,464         296,349         306,590         1.21     1.39     1.50
  

 

 

    

 

 

    

 

 

        

Total deposits

   $ 1,727,509       $ 1,441,354       $ 1,312,119          
  

 

 

    

 

 

    

 

 

        

The $286.2 million increase in average deposits during 2015 was the result of an increase in the depositor base due to organic growth as well as the Peoples acquisition. The transactional accounts average balances, as the lower cost funding sources, increased $238.1 million and the average balances for higher cost time deposits increased $48.1 million. Horizon continually enhances its interest-bearing consumer and commercial demand deposit products based on local market conditions and its need for funding to support various types of assets.

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Certificates of deposit of $250,000 or more, which are considered to be rate sensitive and are not considered a part of core deposits, mature as follows as of December 31, 2015:

 

Due in three months or less

   $ 6,818   

Due after three months through six months

     13,774   

Due after six months through one year

     15,222   

Due after one year

     31,883   
  

 

 

 
   $ 67,697   
  

 

 

 

Interest expense on time certificates of $100,000 or more was approximately $2.3 million, $2.2 million, and $2.4 million for 2015, 2014 and 2013. Interest expense on time certificates of $250,000 or more was approximately $990,000 for 2015.

Off-Balance Sheet Arrangements

As of December 31, 2015, Horizon did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, change in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off-balance sheet arrangement” generally means any transaction, agreement, or other contractual arrangement to which an entity unconsolidated with the Company is a party and under which the Company has (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.

Contractual Obligations

The following tables summarize Horizon’s contractual obligations and other commitments to make payments as of December 31, 2015:

 

     Total      Within
One Year
     One to
Three Years
     Three to
Five Years
     After Five
Years
 

Certificates of Deposit

   $ 366,547       $ 167,791       $ 125,206       $ 56,878       $ 16,672   

Borrowings (1)

     449,347         298,235         77,489         68,375         5,248   

Subordinated debentures (2)

     32,798         —           —           —           32,798   

 

(1)  Includes debt obligations to the Federal Home Loan Bank and term repurchase agreements with maturities beyond one year borrowed by Horizon’s banking subsidiary. See Note 13 in Horizon’s Consolidated Financial Statements at Item 8.
(2)  Includes Trust Preferred Capital Securities issued by Horizon Statutory Trusts II and III and those assumed in the acquisitions of Alliance Bank in 2005, American Trust in 2009 and Heartland in 2012. See Note 15 in Horizon’s Consolidated Financial Statements at Item 8.

 

     Expiration by Period  
     Within One
Year
     Greater
Than

One Year
 

Letters of credit

   $ 619       $ 2,945   

Unfunded loan commitments

     91,450         377,353   

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Capital Resources

The capital resources of Horizon and the Bank exceed regulatory capital ratios for “well capitalized” banks at December 31, 2015. Stockholders’ equity totaled $266.8 million as of December 31, 2015, compared to $194.4 million as of December 31, 2014. At year-end 2015, the ratio of stockholders’ equity to assets was 10.06%, compared to 9.36% for 2014. Tangible equity to tangible assets was 7.60% at December 31, 2015, compared to 7.32% at December 31, 2014. Book value per common share at December 31, 2015 increased to $21.30, compared to $19.75 at December 31, 2014. Horizon’s capital increased during 2015 as a result of earnings and common stock issued in the Peoples acquisition, partially offset by a decrease in other comprehensive income and dividends declared.

In 2008, in connection with the issuance of preferred stock that was subsequently redeemed, Horizon issued a warrant to the Treasury to purchase shares of Horizon’s common stock. The Treasury sold the warrant to a third party, and at December 31, 2015, the warrant covered 481,510 shares with an exercise price of $7.79 per share. These warrants were exercised during 2015.

On August 25, 2011, the Company sold 12,500 shares of Series B Preferred Stock for aggregate consideration of $12.5 million, to the Treasury pursuant to the Small Business Lending Fund program. Concurrently with this transaction, Horizon redeemed all 18,750 shares of our Series A Preferred Stock that remained outstanding under the Treasury’s Capital Purchase Program. The redemption of the Series A Preferred Stock was funded by the $12.5 million in proceeds from the sale of the Series B Preferred Stock together with other available funds. On February 1, 2016 the Company redeemed all 12,500 shares of Series B Preferred Stock for $12,500,000 along with the final dividend payment of $10,416.67.

Horizon declared dividends in the amount of $.58 per share in 2015, $.51 per share in 2014, and $.42 per share in 2013. The dividend payout ratio (dividends as a percent of net income) was 29.9% for 2015, 25.7% for 2014, and 18.6% for 2013. For additional information regarding dividend conditions, see Note 1 of the Notes to the Consolidated Financial Statements at Item 8.

In October of 2004, Horizon formed Horizon Statutory Trust II (Trust II), a wholly owned statutory business trust. Trust II sold $10.3 million of Trust Preferred Capital Securities as a participant in a pooled trust preferred securities offering. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of junior subordinated debentures from Horizon. The junior subordinated debentures are the sole assets of Trust II and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 1.95% (2.56% at December 31, 2015) and mature on October 21, 2034, and securities may be called at any quarterly interest payment date at par. Costs associated with the issuance of the securities totaling $17,500 were capitalized and were amortized to the October 31, 2009, first call date of the securities.

In December of 2006, Horizon formed Horizon Bancorp Capital Trust III (Trust III), a wholly owned statutory business trust. Trust III sold $12.4 million of Trust Preferred Capital Securities as a participant in a pooled trust preferred securities offering. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of junior subordinated debentures from Horizon. The junior subordinated debentures are the sole assets of Trust III and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 1.65% (2.26% at December 31, 2015) and mature on January 30, 2037, and securities may be called at any quarterly interest payment date at par. Costs associated with the issuance of the securities totaling $12,647 were capitalized and were being amortized to the first call date of the securities.

The Company assumed additional debentures as the result of the acquisition of Alliance Bank Corporation in 2005. In June 2004, Alliance formed Alliance Financial Statutory Trust I, a wholly owned business trust (Alliance Trust) to sell $5.2 million in trust preferred securities. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of junior subordinated debentures from Alliance. The junior subordinated debentures are

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

the sole assets of Alliance Trust and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 2.65% (3.26% at December 31, 2015) and mature in June 2034, and securities may be called at any quarterly interest payment date at par.

The Company assumed additional debentures as the result of the American Trust & Savings Bank purchase and assumption in 2010. In March 2004, Am Tru Inc., the holding company for American Trust & Savings Bank, formed Am Tru Statutory Trust I a wholly owned business trust (Am Tru Trust), to sell $3.5 million in trust preferred securities. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of junior subordinated debentures from Am Tru Inc. The junior subordinated debentures are the sole assets of Am Tru Trust and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 2.85% (3.46% at December 31, 2015) and mature in March 2034, and securities may be called at any quarterly interest payment date at par. The carrying value was $3.1 million, net of the remaining purchase discount, at December 31, 2015.

The Company assumed additional debentures as the result of the Heartland merger in July 2013. In December 2006, Heartland. formed Heartland (IN) Statutory Trust II a wholly owned business trust (Heartland Trust), to sell $3.0 million in trust preferred securities. The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of junior subordinated debentures from Heartland. The junior subordinated debentures are the sole assets of Heartland Trust and are fully and unconditionally guaranteed by Horizon. The junior subordinated debentures and the trust preferred securities pay interest and dividends on a quarterly basis. The junior subordinated debentures and the securities bear interest at a rate of 90-day LIBOR plus 1.67% (2.28% at December 31, 2015) and mature in December 2036, and securities may be called at any quarterly interest payment date at par. The carrying value was $1.7 million, net of the remaining purchase discount, at December 31, 2015.

The Trust Preferred Capital Securities, subject to certain limitations, are included in Tier 1 Capital for regulatory purposes. Dividends on the Trust Preferred Capital Securities are recorded as interest expense.

Results of Operations

Net Income

Consolidated net income was $20.5 million or $1.89 per diluted share in 2015, $18.1 million or $1.90 per diluted share in 2014, and $19.9 million or $2.17 per diluted share in 2013. The increase in net income from the previous year reflects an increase in net interest income of $11.8 million and an increase in non-interest income of $4.1 million, partially offset by an increase in the provision for loan losses of $104,000, non-interest expenses of $12.2 million and income taxes of $1.1 million. The decrease in diluted earnings per share compared to the previous year reflects an increase in diluted shares due to the Peoples acquisition. Excluding acquisition-related expenses and purchase accounting adjustments, gain on sale of investment securities and the death benefit on bank owned life insurance, net income for the year ended December 31, 2015 was $21.7 million or $2.00 diluted earnings per share compared to $16.5 million or $1.74 diluted earnings per share for the year ended December 31, 2014. Diluted earnings per share were also reduced by $0.01 for the twelve months ending December 31, 2015, $0.01 for the twelve months ending December 31, 2014 and $0.04 for the twelve months ending December 31, 2013 resulting from the payment of preferred stock dividends.

Net Interest Income

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

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Net interest income during 2015 was $74.7 million, an increase of $11.8 million or 18.7% over the $63.0 million earned in 2014. Yields on the Company’s interest-earning assets decreased by 16 basis points to 4.20% during 2015 from 4.36% in 2014. Interest income increased $12.4 million to $88.6 million for 2015 from $76.2 million in 2014. This increase was due to increased volume in interest-earning assets and an increase in the recognition of interest income from the acquisition-related purchase accounting adjustments of approximately $300,000 from $2.7 million in 2014 to $3.0 million in 2015, partially offset by the lower yield on interest-earning assets.

Rates paid on interest-bearing liabilities decreased by 11 basis points during the same period due to the lower interest rate environment. Interest expense increased $632,000 from $13.2 million in 2014 to $13.9 million in 2015. This increase was due to increased volume of interest-bearing liabilities, partially offset by lower rates being paid. Due to a larger decrease in the yield on the Company’s interest-earning assets compared to the decrease in the rates paid on the Company’s interest-bearing liabilities, the net interest margin decreased 6 basis points from 3.62% for 2014 to 3.56% in 2015. Excluding the interest income recognized from the acquisition-related purchase accounting adjustments, the margin would have been 3.42% for 2015 compared to 3.47% for 2014. Management believes that the current level of interest rates is driven by external factors and therefore impacts the results of the Company’s net interest margin. Management does not expect a significant rise in interest rates in the short term, but an increase in rates is expected at some time in the future due to the current historically low interest rate environment.

 

    Twelve Months Ended     Twelve Months Ended     Twelve Months Ended  
    December 31, 2015     December 31, 2014     December 31, 2013  
    Average           Average     Average           Average     Average           Average  
    Balance     Interest     Rate     Balance     Interest     Rate     Balance     Interest     Rate  

ASSETS

                 

Interest-earning assets

                 

Federal funds sold

  $ 10,264      $ 11        0.11   $ 6,246      $ 11        0.18   $ 8,468      $ 21        0.25

Interest-earning deposits

    14,045        10        0.07     7,087        10        0.14     7,720        19        0.25

Investment securities - taxable

    394,976        8,700        2.20     387,013        9,323        2.41     371,594        8,401        2.26

Investment securities - non-taxable (1)

    152,931        4,494        4.32     146,407        4,426        4.32     136,584        4,216        4.98

Loans receivable (2)(3)(4)

    1,593,790        75,373        4.74     1,247,510        62,435        5.01     1,092,662        62,229        5.70
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-earning assets (1)

    2,166,006        88,588        4.20     1,794,263        76,205        4.36     1,617,028        74,886        4.80

Non-interest-earning assets

                 

Cash and due from banks

    31,692            27,168            24,548       

Allowance for loan losses

    (16,351         (15,945         (18,677    

Other assets

    179,138            144,803            134,220       
 

 

 

       

 

 

       

 

 

     
  $ 2,360,485          $ 1,950,289          $ 1,757,119       
 

 

 

       

 

 

       

 

 

     

LIABILITIES AND SHAREHOLDERS’ EQUITY

                 

Interest-bearing liabilities

                 

Interest-bearing deposits

  $ 1,438,026      $ 5,559        0.39   $ 1,182,831      $ 5,257        0.44   $ 1,092,796      $ 5,672        0.52

Borrowings

    336,618        6,286        1.87     281,649        5,956        2.11     234,927        5,821        2.48

Subordinated debentures

    32,717        2,009        6.14     32,561        2,009        6.17     32,406        2,010        6.20
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-bearing liabilities

    1,807,361        13,854        0.77     1,497,041        13,222        0.88     1,360,129        13,503        0.99

Non-interest-bearing liabilities

                 

Demand deposits

    317,246            258,523            219,323       

Accrued interest payable and other liabilities

    16,364            12,776            13,534       

Stockholders’ equity

    219,514            181,949            164,133       
 

 

 

       

 

 

       

 

 

     
  $ 2,360,485          $ 1,950,289          $ 1,757,119       
 

 

 

       

 

 

       

 

 

     

Net interest income/spread

    $ 74,734        3.43     $ 62,983        3.48     $ 61,383        3.81
   

 

 

       

 

 

       

 

 

   

Net interest income as a percent of average interest earning assets (1)

        3.56         3.62         3.96

 

(1)  Horizon has no foreign office and, accordingly, no assets or liabilities to foreign operations. Horizon’s subsidiary bank had no funds invested in Eurodollar Certificates of Deposit at December 31, 2015.
(2)  Yields are presented on a tax-equivalent basis.

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

(3)  Non-accruing loans for the purpose of the computations above are included in the daily average loan amounts outstanding. Loan totals are shown net of unearned income and deferred loans fees.
(4)  Loan fees and late fees included in interest on loans aggregated $4.9 million, $4.3 million, and $4.6 million in 2015, 2014 and 2013.

 

     2015-2014     2014-2013  
           Change      Change           Change     Change  
     Total     Due To      Due To     Total     Due To     Due To  
     Change     Volume      Rate     Change     Volume     Rate  

Interest Income

             

Federal funds sold

   $ —        $ 5       $ (5   $ (10   $ (5   $ (5

Interest-earning deposits

     —          7         (7     (9     (1     (8

Investment securities - taxable

     (623     189         (812     922        357        565   

Investment securities - non-taxable

     68        282         (214     210        466        (256

Loans receivable

     12,938        16,571         (3,633     206        8,254        (8,048
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     12,383        17,054         (4,671     1,319        9,071        (7,752
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Interest Expense

             

Interest-bearing deposits

     302        1,042         (740     (415     443        (858

Borrowings

     330        1,077         (747     135        1,060        (925

Subordinated debentures

     —          10         (10     (1     10        (11
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     632        2,129         (1,497     (281     1,513        (1,794
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 11,751      $ 14,925       $ (3,174   $ 1,600      $ 7,558      $ (5,958
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income during 2014 was $63.0 million, an increase of $1.6 million or 2.6% over the $61.4 million earned in 2013. Yields on the Company’s interest-earning assets decreased by 44 basis points to 4.36% during 2014 from 4.80% in 2013. Interest income increased $1.3 million to $76.2 million for 2014 from $74.9 million in 2013. This increase was due to increased volume in interest earning assets partially offset by the lower yield on interest-earning assets and a decrease in interest income from acquisition-related purchase accounting adjustments of $3.5 million from $6.3 million in 2013 to $2.7 million in 2014.

Rates paid on interest-bearing liabilities decreased by 11 basis points during the same period due to the lower interest rate environment. Interest expense decreased $281,000 from $13.5 million in 2013 to $13.2 million in 2014. This decrease was due to the lower rates being paid on the Company’s interest-bearing liabilities partially offset by the increased volume of interest-bearing liabilities. Due to a larger decrease in the yield on the Company’s interest-earning assets and the decrease in interest income from acquisition related purchase accounting adjustments compared to the decrease in the rates paid on the Company’s interest-bearing liabilities, the net interest margin decreased 34 basis points from 3.96% for 2013 to 3.62% in 2014. Excluding the interest income recognized from the acquisition-related purchase accounting adjustments, the margin would have been 3.47% for 2014 compared to 3.57% for 2013.

Provision for Loan Losses

Horizon assesses the adequacy of its Allowance for Loan and Lease Losses (ALLL) by regularly reviewing the performance of its loan portfolios. The provision for loan losses totaled $3.2 million in 2015 compared to $3.1 million in 2014. The higher provision for loan losses in 2015 compared to the previous year was due to continued loan growth. Commercial loan net charge-offs during 2015 were $3.2 million, residential mortgage loan net charge-offs were $219,000, and consumer loan net charge-offs were $1.6 million for the year ending December 31, 2015.

During 2014, the provision for loan losses totaled $3.1 million, compared to $1.9 million in 2013. The higher provision for loan losses in 2014 compared to 2013 was due to loan growth as well as $1.0 million in charge-off related to one commercial credit in the third quarter of 2014 and a specific reserve of $560,000 placed on one commercial real estate loan that was moved to non-accrual status during the fourth quarter of 2014. Commercial loan net charge-offs during 2014 were $1.0 million, residential mortgage loan net charge-offs were $307,000, and consumer loan net charge-offs were $1.2 million for the year ending December 31, 2014.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Non-interest Income

The following is a summary of changes in non-interest income:

 

     Twelve Months Ended      2014 - 2015            2013 - 2014  
     December 31
2015
     December 31
2014
     Amount
Change
    Percent
Change
    December 31
2013
     Amount
Change
    Percent
Change
 

Non-interest Income

                 

Service charges on deposit accounts

   $ 4,807       $ 4,085       $ 722        17.7   $ 3,989       $ 96        2.4

Wire transfer fees

     633         557         76        13.6     697         (140     -20.1

Interchange fees

     5,591         4,649         942        20.3     4,056         593        14.6

Fiduciary activities

     5,637         4,738         899        19.0     4,337         401        9.2

Gain on sale of investment securities

     189         988         (799     -80.9     374         614        164.2

Gain on sale of mortgage loans

     10,055         8,395         1,660        19.8     8,794         (399     -4.5

Mortgage servicing net of impairment

     993         805         188        23.4     1,521         (716     -47.1

Increase in cash surrender value of bank owned life insurance

     1,249         1,047         202        19.3     1,035         12        1.2

Death benefit on officer life insurance

     145         —           145        100.0     —           —          0.0

Other income

     1,103         1,013         90        8.9     1,103         (90     -8.2
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

   

Total non-interest income

   $ 30,402       $ 26,277       $ 4,125        15.7   $ 25,906       $ 371        1.4
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

   

 

 

 

The increase in service charges on deposit accounts and interchange fee income in 2015 compared to 2014 was the result of growth in transactional deposit accounts and volume during 2015. Fiduciary activities income increased $899,000 during 2015 as a result of an increase in assets under management. During 2015, the Company originated approximately $302.4 million of mortgage loans to be sold on the secondary market, compared to $229.2 million in 2014. This increase in volume, partially offset by a decrease in the percentage earned on the sale of mortgage loans, increased the overall gain on sale of mortgage loans by $1.7 million compared to the prior year. Mortgage servicing net of impairment increased by $188,000 during 2015 compared to 2014 due to a larger portfolio of mortgage loans serviced during 2015. The cash surrender value of bank owned life insurance increased by $202,000 in 2015 due to an increase in the number of policies outstanding as a result of the Peoples acquisition. The Death Benefit on Bank owned life insurance increase by $145,000 in 2015 due to payment realized on one of the policies. These increases were partially offset a decrease in gain on sale of investment securities of $799,000 in 2015 due to a gain on sale of securities of $988,000 during the third quarter of 2014. This gain was the result of an analysis that determined market conditions provided the opportunity to add gains to capital without negatively impacting long-term earnings. The sale of securities was also used to fund loan growth.

The increase in service charges on deposit accounts and interchange fee income in 2014 compared to 2013 was the result of growth in transactional deposit accounts and volume during 2014. Fiduciary activities income increased $401,000 during 2014 as a result of asset and market value increase. Gain on sale of securities increased $614,000 due to a gain on sale of securities of $988,000 during the third quarter of 2014. This gain was the result of an analysis that determined market conditions provided the opportunity to add gains to capital without negatively impacting long-term earnings. The sale of securities was also used to fund loan growth. These increases were partially offset by decreases compared to 2013 in wire transfer fees, gain on sale of mortgage loans and mortgage servicing net of impairment. During 2014, the Company originated approximately $229.2 million of mortgage loans to be sold on the secondary market, compared to $346.4 million in 2013. This lower volume, partially offset by an increase in the percentage earned on the sale of mortgage loans, decreased the overall gain on sale of mortgage loans by $399,000 compared to the prior year. Mortgage servicing net of impairment decreased by $716,000 during 2014 compared to 2013 due to the recovery of impairment charges totaling $635,000 in 2013, partially offset by a larger portfolio of mortgage loans serviced during 2014.

 

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HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Non-interest Expense

The following is a summary of changes in non-interest expense:

 

     Twelve Months Ended                         2013 - 2014  
     December 31
2015
     December 31
2014
    Amount
Change
     Percent
Change
    December 31
2013
     Amount
Change
    Percent
Change
 

Non-interest expense

                 

Salaries

   $ 25,284       $ 22,859      $ 2,425         10.6   $ 21,164       $ 1,695        8.0

Commission and bonuses

     6,008         4,111        1,897         46.1     4,290         (179     -4.2

Employee benefits

     6,420         5,712        708         12.4     5,578         134        2.4

Net occupancy expenses

     6,400         5,607        793         14.1     4,984         623        12.5

Data processing

     4,251         3,663        588         16.1     3,045         618        20.3

Professional fees

     2,070         1,731        339         19.6     1,668         63        3.8

Outside services and consultants

     5,735         3,250        2,485         76.5     2,412         838        34.7

Loan expense

     5,379         4,770        609         12.8     4,668         102        2.2

FDIC deposit insurance

     1,499         1,175        324         27.6     1,089         86        7.9

Other losses

     432         (70     502         -717.1     807         (877     -108.7

Other expense

     10,715         9,138        1,577         17.3     8,740         398        4.6
  

 

 

    

 

 

   

 

 

      

 

 

    

 

 

   

Total non-interest expense

   $ 74,193       $ 61,946      $ 12,247         19.8   $ 58,445       $ 3,501        6.0
  

 

 

    

 

 

   

 

 

      

 

 

    

 

 

   

Salary expense, commission and bonuses, employee benefits, net occupancy expense and other expense increased by $2.4 million, $1.9 million, $708,000, $793,000 and $1.6 million due to the Peoples merger, Horizon’s investments in growth markets and overall growth. Data processing and other expenses increased during 2015 from the cost of continued growth and expansion and the Peoples merger. Outside services and consultants increased primarily due to the fees associated with the Peoples acquisition. Loan expense increased in 2015 compared to 2014 due to company growth and collection costs. Other losses increased in 2015 compared to 2014 due to the recovery of a previously recorded loss contingency in 2014 and higher one-time losses in 2015.

Salaries increased during 2014 compared to 2013. These increases were primarily the result of changes to annual merit pay. In addition, salary expense, employee benefits, net occupancy expense and other expense was higher due to the Summit merger and Horizon’s investments in growth markets. Data processing and other expenses increased during 2014 from the cost of continued growth and expansion. Outside services and consultants increased due to $1.0 million in fees associated with the Summit acquisition. Loan expense increased in 2014 compared to 2013 due to collection costs. Commission and bonuses decreased due to lower commissions earned as a result of a decrease in mortgage loans originated. Other losses decreased in 2014 due to the recovery of a previously recorded loss contingency and higher one-time losses in 2013.

Income Taxes

Income tax expense for 2015 was $7.2 million, compared to $6.2 million of tax expense during 2014. The effective tax rate for 2015 was 26.0% compared to 25.4% in 2014 and 26.2% in 2013.

Use of Non-GAAP Financial Measures

Certain information set forth in this report on Form 10-K refers to financial measures determined by methods other than in accordance with GAAP. Specifically, we have included non-GAAP financial measures of the net interest income and net interest margin excluding the impact of acquisition-related purchase accounting adjustments and net income and diluted earnings per share excluding the impact of one-time costs related to the Summit acquisition. Horizon believes 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, although these measures are not necessarily comparable to similar measures that may be presented by other companies and should not be considered in isolation or as a substitute for the related GAAP measure.

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Non-GAAP Reconciliation of Net Interest Margin

 

     Three Months Ended     Twelve Months Ended  
     December 31     September 30     December 31     December 31  
     2015     2015     2014     2015     2014  

Net Interest Margin As Reported

          

Net interest income

   $ 20,222      $ 19,776      $ 16,523      $ 74,734      $ 62,983   

Average interest-earning assets

     2,369,301        2,304,515        1,865,750        2,166,006        1,794,263   

Net interest income as a percent of average interest- earning assets (“Net Interest Margin”)

     3.50     3.51     3.64     3.56     3.62

Impact of Acquisitions

          

Interest income from acquisition-related purchase accounting adjustments

   $ (695   $ (402   $ (719   $ (2,977   $ (2,745

Excluding Impact of Acquisitions

          

Net interest income

   $ 19,527      $ 19,374      $ 15,804      $ 71,757      $ 60,238   

Average interest-earning assets

     2,369,301        2,304,515        1,865,750        2,166,006        1,794,263   

Core Net Interest Margin

     3.38     3.44     3.49     3.42     3.47

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

 

     Twelve Months Ended  
     December 31  
     2015      2014      2013  

Non-GAAP Reconciliation of Net Income

        

Net income as reported

   $ 20,549       $ 18,101       $ 19,876   

Merger expenses

     4,889         1,335         —     

Tax effect

     (1,585      (467      —     
  

 

 

    

 

 

    

 

 

 

Net income excluding merger expenses

     23,853         18,969         19,876   

Gain on sale of investment securities

     (189      (988      (374

Tax effect

     66         346         131   
  

 

 

    

 

 

    

 

 

 

Net income excluding gain on sale of investment securities

     23,730         18,327         19,633   

Death benefit on bank owned life insurance (“BOLI”)

     (145      —           —     

Tax effect

     51         —           —     
  

 

 

    

 

 

    

 

 

 

Net income excluding death benefit on BOLI

     23,636         18,327         19,633   

Acquisition-related purchase accounting adjustments (“PAUs”)

     (2,977      (2,745      (6,294

Tax effect

     1,042         961         2,203   
  

 

 

    

 

 

    

 

 

 

Net income excluding PAUs

   $ 21,701       $ 16,542       $ 15,542   
  

 

 

    

 

 

    

 

 

 

Non-GAAP Reconciliation of Diluted Earnings per Share

        

Diluted earnings per share as reported

   $ 1.89       $ 1.90       $ 2.17   

Merger expenses

     0.45         0.14         —     

Tax effect

     (0.15      (0.05      —     
  

 

 

    

 

 

    

 

 

 

Diluted earnings per share excluding merger expenses

     2.20         1.99         2.17   

Gain on sale of investment securities

     (0.02      (0.10      (0.04

Tax effect

     0.01         0.04         0.01   
  

 

 

    

 

 

    

 

 

 

Net income excluding gain on sale of investment securities

     2.19         1.92         2.14   

Death benefit on BOLI

     (0.01      —           —     

Tax effect

     0.00         —           —     
  

 

 

    

 

 

    

 

 

 

Net income excluding death benefit on BOLI

     2.18         1.92         2.14   

Acquisition-related PAUs

     (0.28      (0.29      (0.70

Tax effect

     0.10         0.10         0.24   
  

 

 

    

 

 

    

 

 

 

Diluted earnings per share excluding PAUs

   $ 2.00       $ 1.74       $ 1.69   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

Non- GAAP Allowance for Loan and Lease Loss Detail

As of December 31, 2015

 

     Horizon                          
     Legacy     Heartland     Summit     Peoples     Total  

Pre-discount loan balance

   $ 1,461,318      $ 23,064      $ 76,120      $ 197,307      $ 1,757,809   

Allowance for loan losses (ALLL)

     14,502        32        —          —          14,534   

Loan discount

     N/A        1,386        2,942        4,350        8,678   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

ALLL+loan discount

     14,502        1,418        2,942        4,350        23,212   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans, net

   $ 1,446,816      $ 21,646      $ 73,178      $ 192,957      $ 1,734,597   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

ALLL/ pre-discount loan balance

     0.99     0.14     0.00     0.00     0.83

Loan discount/ pre-discount loan balance

     N/A        6.01     3.86     2.20     0.49

ALLL+loan discount/ pre-discount loan balance

     0.99     6.15     3.86     2.20     1.32

Liquidity and Rate Sensitivity Management

Management and the Board of Directors meet regularly to review both the liquidity and rate sensitivity position of Horizon. Effective asset and liability management ensures Horizon’s ability to monitor the cash flow requirements of depositors along with the demands of borrowers and to measure and manage interest rate risk. Horizon utilizes an interest rate risk assessment model designed to highlight sources of existing interest rate risk and consider the effect of these risks on strategic planning. Management maintains (within certain parameters) an essentially balanced ratio of interest sensitive assets to liabilities in order to protect against the effects of wide interest rate fluctuations.

Liquidity

The Bank maintains a stable base of core deposits provided by long standing relationships with consumers and local businesses. These deposits are the principal source of liquidity for Horizon. Other sources of liquidity for Horizon include earnings, loan repayments, investment security sales and maturities, sale of real estate loans and borrowing relationships with correspondent banks, including the FHLB and the Federal Reserve Bank (“FRB”). At December 31, 2015, Horizon had available approximately $253.2 million in available credit from various money center banks, including the FHLB and the FRB Discount Window. Factors which could impact Horizon’s funding needs in the future include:

 

    Horizon had outstanding borrowings of over $160.9 million with the FHLB and total borrowing capacity with the FHLB of $324.8 million. Generally, the loan terms from the FHLB are better than the terms Horizon can receive from other sources, making it less expensive to borrow money from the FHLB. Financial difficulties at the FHLB could reduce or eliminate Horizon’s additional borrowing capacity with the FHLB or FHLB could change collateral requirements, which could lower the Company’s borrowing availability.

 

    If residential mortgage loan rates remain low, Horizon’s mortgage warehouse loans could create an additional need for funding.

 

    Horizon had a total of $135.0 million of Federal Fund lines from various money center banks. These are uncommitted lines and could be withdrawn at any time by the correspondent banks.

 

    Horizon had a total of $89.2 million of available collateral at the FRB secured by municipal securities. These securities may mature, call, or be sold, which would reduce the available collateral.

 

    A downgrade in Horizon’s ability to obtain credit due to factors such as deterioration in asset quality, a large charge to earnings, a decline in profitability or other financial measures, or a significant merger or acquisition.

 

    An act of terrorism or war, natural disasters, political events, or the default or bankruptcy of a major corporation, mutual fund, hedge fund or a government agency.

 

    Market speculation or rumors about Horizon or the banking industry in general may adversely affect the cost and availability of normal funding sources.

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

If any of these events occur, they could force Horizon to borrow money from other sources including negotiable certificates of deposit. Such other monies may only be available at higher interest rates and on less advantageous terms, which will impact our net income and could impact our ability to grow. Management believes Horizon has adequate funding sources to meet short and long term needs.

Horizon maintains a liquidity contingency plan that outlines the process for addressing a liquidity crisis. The plan provides for an evaluation of funding sources under various market conditions. It also assigns specific roles and responsibilities for effectively managing liquidity through a problem period.

During 2015, cash flows were generated primarily from the sales, maturities, and prepayments of investment securities of $128.9 million and an increase in deposits and borrowings of $46.7 million and $49.4 million, respectively. Cash flows were used to purchase investments totaling $244.2 million and increase loans by $145.2 million. The net cash and cash equivalent position increased by $5.2 million during 2015.

The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2015. Interest on subordinated debentures and long-term borrowed funds is calculated based on current contractual interest rates.

 

     Total      Within
one year
     After one
but within
three years
     After three
but within
five years
     After
five
years
 

Remaining contractual maturities of time deposits

   $ 366,547       $ 167,791       $ 125,206       $ 56,878       $ 16,672   

Borrowings

     449,347         298,235         77,489         68,375         5,248   

Subordinated debentures

     32,797         —           —           —           32,797   

Loan Commitments

     468,803         91,450         377,353         —           —     

Preferred stock

     12,500         12,500         —           —           —     

Letters of credit

     3,564         619         2,945         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,333,558       $ 570,595       $ 582,993       $ 125,253       $ 54,717   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest Rate Sensitivity

The degree by which net interest income may fluctuate due to changes in interest rates is monitored by Horizon using computer simulation models, incorporating not only the current GAP position but the effect of expected repricing of specific financial assets and liabilities. When repricing opportunities are not properly aligned, net interest income may be affected when interest rates change. Forecasting results of the possible outcomes determines the exposure to interest rate risk inherent in Horizon’s balance sheet. The goal is to manage imbalanced positions that arise when the total amount of assets that reprice or mature in a given time period differs significantly from liabilities that reprice or mature in the same time period. The theory behind managing the difference between repricing assets and liabilities is to have more assets repricing in a rising rate environment and more liabilities repricing in a declining rate environment. Based on a model that assumes a lag in repricing, at December 31, 2015, the amount of assets that reprice within one year was 209% of liabilities that reprice within one year. At December 31, 2014, this same model reported that the amount of assets that reprice within one year was approximately 226% of the amount of liabilities that reprice within the same time period. The year 2015 was a stable rate environment and the yields on assets continued to reprice at lower rates due to current asset pricing and a more competitive environment. The impact of lower yields offset partially by slightly lower funding costs negatively impacted the net interest margin during 2015.

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

     Rate Sensitivity  
     3 Months
or Less
     > 3 Months
& < 6
Months
    > 6 Months
& < 1 Year
     Greater
Than 1

Year
    Total  

Loans

   $ 712,657       $ 135,568      $ 197,497       $ 711,326      $ 1,757,048   

Federal Funds Sold

     958         —          —           —          958   

Interest-Bearing balances with Banks

     14,289         —          —           —          14,289   

Investment securities and FRB and

     33,137         20,062        37,171         556,064        646,434   

FHLB stock

     —           —          —           —          —     

Other assets

     —           —          —           233,672        233,672   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total Assets

   $ 761,041       $ 155,630      $ 234,668       $ 1,501,062      $ 2,652,401   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Noninterest-bearing deposits

   $ 9,801       $ 9,801      $ 19,603       $ 296,750      $ 335,955   

Interest-bearing deposits

     72,029         74,495        124,247         1,273,427        1,544,198   

Borrowed Funds

     138,496         74,249        29,979         239,420        482,144   

Other Liabilities

     —           —          —           23,272        23,272   

Stockholders’ equity

     —           —          —           266,832        266,832   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and stockholder’s equity

   $ 220,326       $ 158,545      $ 173,829       $ 2,099,701      $ 2,652,401   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

GAP

   $ 540,715       $ (2,915   $ 60,839       $ (598,639  

Cumulative GAP

   $ 540,715       $ 537,800      $ 598,639        

Quantitative and Qualitative Disclosures about Market Risk

Horizon’s primary market risk exposure is interest rate risk. Interest rate risk (“IRR”) is the risk that Horizon’s earnings and capital will be adversely affected by changes in interest rates. The primary approach to IRR management is one that focuses on adjustments to the asset/liability mix in order to limit the magnitude of IRR.

Horizon’s exposure to interest rate risk arises from repricing or mismatch risk, embedded options risk, and yield curve risk. Repricing risk is the risk of adverse consequence from a change in interest rates that arises because of differences in the timing of when those interest rate changes affect Horizon’s assets and liabilities. Basis risk is the risk that the spread, or rate difference, between instruments of similar maturities will change. Options risk arises whenever products give the customer the right, but not the obligation, to alter the quantity or timing of cash flows. Yield curve risk is the risk that changes in prevailing interest rates will affect instruments of different maturities by different amounts. Horizon’s objective is to remain reasonably neutral with respect to IRR. Horizon utilizes a variety of strategies to maintain this position, including the sale of mortgage loans on the secondary market, hedging certain balance sheet items using derivatives, varying maturities of FHLB advances, certificates of deposit funding and investment securities.

The table which follows provides information about Horizon’s financial instruments that were sensitive to changes in interest rates as of December 31, 2015. The table incorporates Horizon’s internal system generated data related to the maturity and repayment/withdrawal of interest-earning assets and interest-bearing liabilities. For loans, securities and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities as well as the historical experience of Horizon related to the impact of interest rate fluctuations on the prepayment of residential loans and mortgage-backed securities. From a risk management perspective, Horizon believes that repricing dates are more relevant than contractual maturity dates when analyzing the value of financial instruments. For deposits with no contractual maturity dates, the table presents principal cash flows and weighted average rate, as applicable, based upon Horizon’s experience and management’s judgment concerning the most likely withdrawal behaviors.

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

 

                                               Fair Value  
                                   2021           December 31  
     2016     2017     2018     2019     2020     & Beyond     Total     2015  

Rate-sensitive assets

                

Fixed interest rate loans

   $ 380,994      $ 165,782      $ 104,552      $ 63,470      $ 34,426      $ 55,740      $ 804,964      $ 729,046   

Average interest rate

     4.53     4.62     4.57     4.55     4.55     4.46     4.55  

Variable interest rate loans

     673,135        60,297        50,855        41,836        35,430        90,531        952,084        1,097,849   

Average interest rate

     3.91     4.17     4.21     4.16     4.08     3.64     3.93  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

     1,054,129        226,079        155,407        105,306        69,856        146,271        1,757,048        1,826,895   

Average interest rate

     4.13     4.50     4.45     4.40     4.31     3.95     4.22  

Securities, including FRB and FHLB stock

     90,370        67,900        60,752        55,210        65,134        307,068        646,434        650,571   

Average interest rate

     2.80     2.90     2.97     3.00     3.58     3.88     3.44  

Other interest-bearing assets

     15,247        —          —          —          —          —          15,247        15,247   

Average interest rate

     1.32     0.00     0.00     0.00     0.00     0.00     1.32  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total earnings assets

   $ 1,159,746      $ 293,979      $ 216,159      $ 160,516      $ 134,990      $ 453,339      $ 2,418,729      $ 2,492,713   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average interest rate

     3.99     4.13     4.04     3.91     4.13     3.91     3.99  

Rate-sensitive liabilities

                

Noninterest-bearing deposits

   $ 39,206      $ 34,631      $ 30,589      $ 27,019      $ 23,866      $ 180,643      $ 335,955      $ 335,955   

NOW accounts

     32,615        30,058        27,701        25,530        23,528        276,574        416,007        388,641   

Average interest rate

     0.08     0.07     0.07     0.07     0.08     0.07     0.07  

Savings and money market accounts

     70,365        63,643        57,586        52,125        47,200        470,727        761,645        706,015   

Average interest rate

     0.17     0.17     0.17     0.17     0.17     0.16     0.16  

Certificates of deposit

     167,791        83,534        41,672        32,038        24,840        16,672        366,547        366,659   

Average interest rate

     0.91     1.44     1.51     1.70     1.58     1.62     1.25  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total deposits

     309,976        211,866        157,549        136,712        119,434        944,617        1,880,153        1,797,269   

Average interest rate

     0.54     0.63     0.47     0.48     0.41     0.13     0.32  

Fixed interest rate borrowings

     236,358        47,415        21,186        57,408        16,071        11,512        389,950        389,191   

Average interest rate

     0.56     3.83     1.18     3.12     2.15     2.61     1.49  

Variable interest rate borrowings

     92,194        —          —          —          —          —          92,194        85,352   

Average interest rate

     2.26     0.00     0.00     0.00     0.00     0.00     2.26  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total funds

   $ 638,529      $ 259,281      $ 178,734      $ 194,120      $ 135,505      $ 956,129      $ 2,362,298      $ 2,271,812   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average interest rate

     0.80     1.21     0.56     1.26     0.62     0.16     0.59  

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required under this item is incorporated by reference to the information appearing in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7.

 

53


Table of Contents

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

HORIZON BANCORP AND SUBSIDIARIES

Consolidated Financial Statements

Table of Contents

 

     Page  

Consolidated Financial Statements

  

Balance Sheets

     55   

Statements of Income

     56   

Statements of Comprehensive Income

     57   

Statements of Stockholders’ Equity

     58   

Statements of Cash Flows

     59   

Notes to Financial Statements

     60   

Reports of Independent Registered Public Accounting Firm

     112   

Other Information

  

Management’s Report on Financial Statements

     115   

Summary of Selected Financial Data

     116   

Horizon’s Common Stock and Related Stockholders’ Matters

     117   

 

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Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollar Amounts in Thousands)

 

     December 31     December 31  
     2015     2014  

Assets

    

Cash and due from banks

   $ 48,650      $ 43,476   

Investment securities, available for sale

     444,982        323,764   

Investment securities, held to maturity (fair value of $193,703 and $169,904)

     187,629        165,767   

Loans held for sale

     7,917        6,143   

Loans, net of allowance for loan losses of $14,534 and $16,501

     1,734,597        1,362,053   

Premises and equipment, net

     60,798        52,461   

Federal Reserve and Federal Home Loan Bank stock

     13,823        11,348   

Goodwill

     49,600        28,176   

Other intangible assets

     7,371        3,965   

Interest receivable

     10,535        8,246   

Cash value of life insurance

     54,504        39,382   

Other assets

     31,995        32,141   
  

 

 

   

 

 

 

Total assets

   $ 2,652,401      $ 2,076,922   
  

 

 

   

 

 

 

Liabilities

    

Deposits

    

Non-interest bearing

   $ 335,955      $ 267,667   

Interest bearing

     1,544,198        1,214,652   
  

 

 

   

 

 

 

Total deposits

     1,880,153        1,482,319   

Borrowings

     449,347        351,198   

Subordinated debentures

     32,797        32,642   

Interest payable

     507        497   

Other liabilities

     22,765        15,852   
  

 

 

   

 

 

 

Total liabilities

     2,385,569        1,882,508   
  

 

 

   

 

 

 

Commitments and contingent liabilities

    

Stockholders’ Equity

    

Preferred stock, Authorized, 1,000,000 shares Series B shares $.01 par value, $1,000 liquidation value Issued 12,500 shares

     12,500        12,500   

Common stock, no par value Authorized, 22,500,000 shares Issued, 11,995,324 and 9,278,916 shares Outstanding, 11,939,887 and 9,213,036 shares

     —          —     

Additional paid-in capital

     106,370        45,916   

Retained earnings

     148,685        134,477   

Accumulated other comprehensive income (loss)

     (723     1,521   
  

 

 

   

 

 

 

Total stockholders’ equity

     266,832        194,414   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,652,401      $ 2,076,922   
  

 

 

   

 

 

 

See notes to consolidated financial statements

 

55


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HORIZON BANCORP AND SUBSIDIARIES

Consolidated Statements of Income

(Dollar Amounts in Thousands, Except Per Share Data)

 

     Years Ended December 31  
     2015     2014     2013  

Interest Income

      

Loans receivable

   $ 75,373      $ 62,435      $ 62,229   

Investment securities

      

Taxable

     8,721        9,344        8,441   

Tax exempt

     4,494        4,426        4,216   
  

 

 

   

 

 

   

 

 

 

Total interest income

     88,588        76,205        74,886   
  

 

 

   

 

 

   

 

 

 

Interest Expense

      

Deposits

     5,559        5,257        5,672   

Borrowed funds

     6,286        5,956        5,821   

Subordinated debentures

     2,009        2,009        2,010   
  

 

 

   

 

 

   

 

 

 

Total interest expense

     13,854        13,222        13,503   
  

 

 

   

 

 

   

 

 

 

Net Interest Income

     74,734        62,983        61,383   

Provision for loan losses

     3,162        3,058        1,920   
  

 

 

   

 

 

   

 

 

 

Net Interest Income after Provision for Loan Losses

     71,572        59,925        59,463   
  

 

 

   

 

 

   

 

 

 

Non-interest Income

      

Service charges on deposit accounts

     4,807        4,085        3,989   

Wire transfer fees

     633        557        697   

Interchange fees

     5,591        4,649        4,056   

Fiduciary activities

     5,637        4,738        4,337   

Gain on sale of investment securities (includes $189, $988 and $374 for the years ended December 31, 2015, 2014 and 2013 related to accumulated other comprehensive earnings reclassifications)

     189        988        374   

Gain on sale of mortgage loans

     10,055        8,395        8,794   

Mortgage servicing income net of impairment

     993        805        1,521   

Increase in cash value of bank owned life insurance

     1,249        1,047        1,035   

Death benefit on bank owned life insurance

     145        —          —     

Other income

     1,103        1,013        1,103   
  

 

 

   

 

 

   

 

 

 

Total non-interest income

     30,402        26,277        25,906   
  

 

 

   

 

 

   

 

 

 

Non-interest Expense

      

Salaries and employee benefits

     37,712        32,682        31,032   

Net occupancy expenses

     6,400        5,607        4,984   

Data processing

     4,251        3,663        3,045   

Professional fees

     2,070        1,731        1,668   

Outside services and consultants

     5,735        3,250        2,412   

Loan expense

     5,379        4,770        4,668   

FDIC insurance expense

     1,499        1,175        1,089   

Other losses

     432        (70     807   

Other expense

     10,715        9,138        8,740   
  

 

 

   

 

 

   

 

 

 

Total non-interest expense

     74,193        61,946        58,445   
  

 

 

   

 

 

   

 

 

 

Income Before Income Tax

     27,781        24,256        26,924   

Income tax expense (includes $66, $346 and $131 for the years ended December 31, 2015, 2014 and 2013 related to income tax expense from reclassification items)

     7,232        6,155        7,048   
  

 

 

   

 

 

   

 

 

 

Net Income

     20,549        18,101        19,876   

Preferred stock dividend

     (125     (133     (370
  

 

 

   

 

 

   

 

 

 

Net Income Available to Common Shareholders

   $ 20,424      $ 17,968      $ 19,506   
  

 

 

   

 

 

   

 

 

 

Basic Earnings Per Share

   $ 1.94      $ 1.98      $ 2.26   

Diluted Earnings Per Share

     1.89        1.90        2.17   

See notes to consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)

 

     Years Ended December 31  
     2015     2014     2013  

Net Income

   $ 20,549      $ 18,101      $ 19,876   
  

 

 

   

 

 

   

 

 

 

Other Comprehensive Income (Loss)

      

Change in fair value of derivative instruments:

      

Change in fair value of derivative instruments for the period

     195        (511     2,668   

Income tax effect

     (68     179        (934
  

 

 

   

 

 

   

 

 

 

Changes from derivative instruments

     127        (332     1,734   
  

 

 

   

 

 

   

 

 

 

Change in securities:

      

Unrealized appreciation (depreciation) for the period on AFS securities

     (2,910     4,841        (18,956

Unrealized depreciation for the period on held-to-maturity securities

     (549     1,658        —     

Reclassification adjustment for securities gains realized in income

     (189     (988     (374

Income tax effect

     1,277        (1,929     6,766   
  

 

 

   

 

 

   

 

 

 

Unrealized gains (losses) on securities

     (2,371     3,582        (12,564
  

 

 

   

 

 

   

 

 

 

Other Comprehensive Income (Loss), Net of Tax

     (2,244     3,250        (10,830
  

 

 

   

 

 

   

 

 

 

Comprehensive Income

   $ 18,305      $ 21,351      $ 9,046   
  

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Dollar Amounts in Thousands, Except Per Share Data)

 

     Preferred
Stock
     Additional
Paid-in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  

Balances, January 1, 2013

   $ 12,500       $ 31,965       $ 105,402      $ 9,101      $ 158,968   

Net income

           19,876          19,876   

Other comprehensive loss, net of tax

             (10,830     (10,830

Amortization of unearned compensation

        288             288   

Exercise of stock options

        195             195   

Stock option expense

        48             48   

Cash dividends on preferred stock (2.96%)

           (370       (370

Cash dividends on common stock ($.42 per share)

           (3,655       (3,655
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances, December 31, 2013

   $ 12,500       $ 32,496       $ 121,253      $ (1,729   $ 164,520   

Net income

           18,101          18,101   

Other comprehensive income, net of tax

             3,250        3,250   

Amortization of unearned compensation

        363             363   

Exercise of stock options

        165             165   

Stock option expense

        203             203   

Stock issued from acquisition

        12,689             12,689   

Cash dividends on preferred stock (1.06%)

           (133       (133

Cash dividends on common stock ($.51 per share)

           (4,744       (4,744
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances, December 31, 2014

   $ 12,500       $ 45,916       $ 134,477      $ 1,521      $ 194,414   

Net income

           20,549          20,549   

Other comprehensive loss, net of tax

             (2,244     (2,244

Amortization of unearned compensation

        355             355   

Exercise of stock options

        403             403   

Exercise of stock warrants

        3,751             3,751   

Tax benefit related to stock options

        151             151   

Stock option expense

        288             288   

Stock issued from acquisition

        55,506             55,506   

Cash dividends on preferred stock (1.00%)

           (125       (125

Cash dividends on common stock ($.58 per share)

           (6,216       (6,216
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances, December 31, 2015

   $ 12,500       $ 106,370       $ 148,685      $ (723   $ 266,832   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements

 

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HORIZON BANCORP AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)