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HBNC > SEC Filings for HBNC > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for HORIZON BANCORP /IN/


8-Nov-2012

Quarterly Report

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2012

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to Horizon Bancorp ("Horizon" or the "Company") and Horizon Bank, N.A. (the "Bank"). Horizon intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for the purposes of these safe harbor provisions. Statements in this report should be considered in conjunction with the other information available about Horizon, including the information in the other filings we make with the Securities and Exchange Commission. The forward-looking statements are based on management's expectations and are subject to a number of risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as "anticipate," "expect," "estimate," "project," "intend," "plan," "believe," "could," "will" and similar expressions in connection with any discussion of future operating or financial performance. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements.

Actual results may differ materially, and adversely or positively, from the expectations of the Company that are expressed or implied by any forward-looking statement. Risks, uncertainties, and factors that could cause the Company's actual results to vary materially from those expressed or implied by any forward-looking statement include but not limited to:

Changes to regulations governing bank capital and liquidity standards, including changes made pursuant to the Dodd-Frank Act and to the Basel III initiatives;

the use of proceeds of future offerings of securities;

the unknown future direction of interest rates and the timing and magnitude of any changes in interest rates;

changes in competitive conditions;

the introduction, withdrawal, success and timing of asset/liability management strategies or of mergers and acquisitions and other business initiatives and strategies;

changes in customer borrowing, repayment, investment and deposit practices;

changes in fiscal, monetary and tax policies;

changes in financial and capital markets;

deterioration in general economic conditions, either nationally or locally, resulting in, among other things, credit quality deterioration;

capital management activities, including possible future sales of new securities, or possible repurchases or redemptions by the Company of outstanding debt or equity securities;

risks of expansion through acquisitions and mergers, such as unexpected credit quality problems of the acquired loans or other assets, unexpected attrition of the customer base of the acquired institution or branches, and difficulties in integration of the acquired operations;

factors that may cause the Company to incur impairment charges on its investment securities;

the impact, extent and timing of technological changes

electronic, cyber and physical security breaches;

claims and litigation liabilities, including related costs, expenses, settlements and judgments, or the outcome of matters before regulatory agencies, whether pending or commencing in the future;

actions of the Federal Reserve Board;

changes in accounting principles and interpretations;


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2012

potential increases of federal deposit insurance premium expense, and possible future special assessments of FDIC premiums, either industry wide or specific to the Company's banking subsidiary;

actions of the regulatory authorities under the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Federal Deposit Insurance Act and other possible legislative and regulatory actions and reforms;

the continued availability of earnings and excess capital sufficient for the lawful and prudent declaration and payment of cash dividends; and

other factors and risks described under the caption "Risk Factors" in this report and in any of our subsequent reports that we have made or make with the Securities and Exchange Commission ("SEC").

Because such forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such statements. The foregoing list of important factors is not exclusive, and you are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document or, in the case of documents incorporated by reference, the dates of those documents. We do not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of us. For a detailed discussion of the risks and uncertainties that may cause our actual results or performance to differ materially from the results or performance expressed or implied by forward-looking statements, see "Risk Factors" in Item 1A of Part I of our 2011 Annual Report on Form 10-K and in the subsequent reports we file with the SEC.

Overview

Horizon is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in Northwestern and Central Indiana and Southwestern 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 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 continues to operate in a challenging economic and banking environment. Within the Company's primary market areas of Northwest and Central Indiana and Southwest Michigan, unemployment rates increased during 2009 and have remained elevated through the first nine months of 2012. This rise in unemployment has been driven by multiple factors including slowdowns in commercial industries as well as a continued lower activity in the housing and construction industries. The Company's higher than historical levels of non-performing loans at September 30, 2012 and over the past two years can be attributed to the continued slow economy and continued high local unemployment, which have resulted in lower business revenues and increased bankruptcies. The acquisition of Heartland on July 17, 2012, further added to the non-performing credits. Despite these economic factors and events, Horizon has continued to post record positive results through the first nine months of 2012.

On July 17, 2012 Horizon completed the acquisition of Heartland Bancshares, Inc. and its wholly owned subsidiary, Heartland Community Bank, which was merged into Horizon Bank. Under the final terms of the acquisition, the exchange ratio was 0.54 shares of Horizon's common stock for each outstanding share of Heartland common stock. Heartland shares outstanding at the closing were 1,442,449, and the shares of HBNC common stock issued to Heartland shareholders totaled 778,922. Horizon's stock price was $25.25 per share at the close of business on July 17, 2012. Based upon these numbers, the total value of the consideration for the acquisition was $19.7 million.


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2012

Following are some highlights of Horizon's financial performance through the third quarter of 2012:

Horizon's net income of $14.4 million for the first nine months of 2012 surpasses the $12.8 million earned for the entire prior year and represents the highest first nine months of net income in the Company's history.

Third quarter 2012 net income was $4.9 million or $.54 diluted earnings per share, which reflects a 50% increase in diluted earnings per share compared to the same period in 2011.

Horizon's net income for the first nine months of 2012 was $14.4 million or $1.75 diluted earnings per share, which reflects a 67% increase in diluted earnings per share compared to the same period in 2011.

On July 17, 2012 Horizon completed its acquisition of Heartland Bancshares, Inc. ("Heartland"). On that date Horizon recorded $229.5 million in assets and $218.7 million in liabilities.

Total loans increased $157.9 million during the quarter, consisting of $43.3 million in organic loan growth and $114.6 million net loans acquired from Heartland.

Total deposits increased $261.2 million during the quarter, comprising $50.0 million in organic deposit growth and $211.2 million in deposits acquired from Heartland.

Net interest income, after provisions for loan losses, for the first nine months of 2012 was $39.4 million compared with $30.1 million for the same period in the prior year.

The provision for loan losses decreased to $1.8 million for the first nine months of 2012 compared to $4.4 million for the same period in 2011.

Net charge-offs for the first nine months of 2012 were $2.1 million compared to $4.4 million for the same period in 2011.

Substandard and delinquent loans increased by $21.4 million and $4.6 million respectively over the prior quarter. The increases were primarily due to loans acquired in the Heartland merger.

Return on average assets was 1.09% for the third quarter of 2012 and 1.21% for the first nine months of 2012.

Return on average common equity was 13.96% for the third quarter of 2012 and 15.24% for the first nine months of 2012.

Horizon Bank's capital ratios 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 the Company's Annual Report on Form 10-K for 2011 contain a summary of the Company's significant accounting policies. Certain of these policies are important to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management has identified as critical accounting policies the allowance for loan losses, intangible assets, mortgage servicing rights, hedge accounting and valuation measurements.

Allowance for Loan Losses

An allowance for loan losses is maintained to absorb probable incurred loan losses inherent in the loan portfolio. The determination of the allowance for loan losses is a critical accounting policy that involves 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.


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2012

Goodwill and Intangible Assets

Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. FASB ASC 350-10 establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. At September 30, 2012, Horizon had core deposit intangibles of $4.3 million subject to amortization and $19.7 million of goodwill, which is not subject to amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. Horizon's goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Horizon to provide quality, cost effective banking services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely affect earnings in future periods. FASB ASC 350-10 requires an annual evaluation of goodwill for impairment. The evaluation of goodwill for impairment requires the use of estimates and assumptions. Market price at the close of business on September 30, 2012 was $19.05 per share compared to a book value of $16.64 per common share. Horizon reported record earnings for the twelfth consecutive year in 2011, and the first nine months of 2012 were the highest first nine months of net income in the Company's history.

Horizon has concluded that, based on its own internal evaluation the recorded, value of goodwill is not impaired.

Mortgage Servicing Rights

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

Generally, when market interest rates decline and other factors favorable to prepayments occur, there is a corresponding increase in prepayments as customers refinance existing mortgages under more favorable interest rate terms. When a mortgage loan is prepaid, the anticipated cash flows associated with servicing that 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


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2012

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.


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2012

Financial Condition

On September 30, 2012, Horizon's total assets were $1.8 billion, an increase of approximately $300.0 million compared to December 31, 2011. This increase was primarily due to the addition of $245.6 million in assets from the Heartland acquisition and $57.4 million in net organic loan growth during the first nine months of 2012.

Investment securities were comprised of the following as of:

                                                 September 30, 2012              December 31, 2011
                                              Amortized         Fair         Amortized         Fair
                                                 Cost           Value           Cost           Value
Available for sale
U.S. Treasury and federal agencies            $   46,982      $  47,376      $   12,693      $  13,022
State and municipal                              163,407        174,821         135,011        143,890
Federal agency collateralized mortgage
obligations                                       97,534         99,041          89,016         91,122
Federal agency mortgage-backed pools             166,029        174,137         173,797        179,351
Private labeled mortgage-backed pools              2,207          2,288           3,518          3,636
Corporate notes                                       32             41              32             24

Total available for sale investment
securities                                    $  476,191      $ 497,704      $  414,067      $ 431,045

Held to maturity, State and Municipal         $    6,100      $   6,100      $    7,100      $   7,134

Investment securities increased by approximately $65.6 million compared to the end of 2011. This growth was primarily the result of acquiring $63.7 million of investment securities through the Heartland acquisition.

Net loans increased $172.2 million since December 31, 2011. This increase was the result of $114.6 million in net loans acquired in the Heartland acquisition and organic increases in commercial and mortgage warehouse loans of $24.7 million and $35.9 million, respectively. These organic increases were partially offset by decreases in real estate and consumer loans of $1.4 million and $2.0 million, respectively. The increase in commercial loans is the direct result of increased calling efforts and market expansion allowing opportunities to increase Horizon's market share within the Company's footprint. Mortgage warehouse loans increased as a result of market expansion and refinancing activity.

Total deposits increased $297.1 million during the first nine months of 2012. This increase was the result of $211.2 million in deposits acquired in the Heartland acquisition and organic increases $85.9 million. Organically, non-interest bearing deposit accounts increased $21.9 million due to increased calling and marketing efforts, interest bearing deposit accounts increased $125.0 million primarily due to increased municipal deposits, and time deposits decreased $61.0 million due a decrease in brokered deposits and movement of funds from consumer certificates of deposit to interest bearing deposit accounts during the first nine months of 2012.

The Company's borrowings decreased $37.0 million from December 31, 2011. At September 30, 2012, the Company had $123.9 million in short-term funds borrowed compared to $157.0 million at December 31, 2011. The Company uses short-term borrowings to fund the increase in mortgage warehouse lending when it is determined that the loan demand may fluctuate as a result of refinancing activity. In addition, the Company's current balance sheet strategy is to utilize a reasonable level of short-term borrowing during extended low rate environments in addition to what is needed for the fluctuations in mortgage warehouse lending.

Stockholders' equity totaled $155.9 million at September 30, 2012 compared to $121.5 million at December 31, 2011. The increase in stockholders' equity during the period was the result of $19.7 million from the


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Nine Months Ended September 30, 2012

issuance of common shares in the Heartland transaction, the generation of net income and an increase in accumulated other comprehensive income, net of dividends declared. At September 30, 2012, the ratio of average stockholders' equity to average assets was 8.45% compared to 7.96% for December 31, 2011. Book value per common share at September 30, 2012 increased to $16.64 compared to $14.68 at December 31, 2011.

Results of Operations

Overview

Consolidated net income for the three-month period ended September 30, 2012 was $4.9 million, an increase of 41.9% from the $3.4 million for the same period in 2011. Earnings per common share for the three months ended September 30, 2012 increased to $0.56 basic and $0.54 diluted, compared to $0.37 basic and $0.36 diluted for the same three-month period in 2011. Dividends paid on preferred shares reduced diluted earnings per share by $0.01 and $0.09 per share for the three-month periods ended September 30, 2012 and 2011, respectively.

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