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HBNC > SEC Filings for HBNC > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for HORIZON BANCORP /IN/

Form 10-Q for HORIZON BANCORP /IN/


8-Aug-2013

Quarterly Report

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months Ended June 30, 2013

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:

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;

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 Basel III capital rules as adopted by the federal banking agencies;

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;

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


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months Ended June 30, 2013

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.

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 2012 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 six months of 2013. 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 June 30, 2013 and over the past three years can be attributed to the continued slow economy worldwide and continued high local unemployment, which have resulted in lower business revenues. 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 results through the first six months of 2013.

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 0.81 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 Horizon common stock issued to Heartland shareholders totaled 1,168,383. Horizon's stock price was $16.83 per share at the close of business on July 17, 2012. Based upon these numbers, the total value of the consideration, including the retirement of TARP, for the acquisition was $26.9 million.

Following are some highlights of Horizon's financial performance through the second quarter of 2013:

Second quarter 2013 net income rose 15.4% compared to the same period in 2012 to $5.7 million or $.62 diluted earnings per share, the highest quarterly net income in the Company's history.

Net income for the first six months of 2013 rose 15.3% compared to the same period in 2012 to $11.0 million or $1.20 diluted earnings per share, the highest first half net income in the Company's history.


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months Ended June 30, 2013

Net interest income, before provisions for loan losses, for the first six months of 2013 was $32.6 million compared with $26.2 million for the same period of 2012.

Non-interest income rose 22.3% to $14.3 million for the first six months of 2013 compared with $11.7 million for the same period of 2012.

Return on average assets was 1.29% for the second quarter of 2013 and 1.25% for the first six months of 2013.

Return on average common equity was 14.67% for the second quarter of 2013 and 14.31% for the first six months of 2013.

Total loans increased $27.9 million during the quarter and $120.5 million compared to June 30, 2012 to $1.1 billion at June 30, 2013.

Commercial loans increased $29.1 million during the quarter and $145.7 million compared to June 30, 2012 to $502.2 million at June 30, 2013, marking the first time in Horizon's history that commercial loans surpassed the $500 million milestone.

Tangible book value per share decreased to $14.42 at June 30, 2013, compared to $14.64 and $14.81 at March 31, 2013 and June 30, 2012, respectively, reflecting the decrease in accumulated other comprehensive income and the increase in outstanding shares as a result of the Heartland acquisition.

Horizon Bank's capital ratios, including Tier 1 Capital to Average Assets of 8.84% and Total Capital to Risk Weighted Assets of 13.22% as of June 30, 2013, 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 2012 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.

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 June 30, 2013, Horizon had core deposit intangibles of $3.7 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


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months Ended June 30, 2013

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 June 30, 2013 was $20.41 per share compared to a book value of $17.14 per common share. Horizon reported record earnings for the thirteenth consecutive year in 2012, and the first six months of 2013 were the highest six 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 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


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months Ended June 30, 2013

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 Six Months Ended June 30, 2013

Financial Condition

On June 30, 2013, Horizon's total assets were $1.8 billion, a decrease of approximately $62.3 million compared to December 31, 2012. This decrease was primarily due to the reduction of $96.5 million in mortgage warehouse loans, partially offset by an increase in commercial loans of $41.8 million.

Investment securities were comprised of the following as of:

                                                    June 30, 2013                December 31, 2012
                                              Amortized         Fair         Amortized         Fair
                                                 Cost           Value           Cost           Value
Available for sale
U.S. Treasury and federal agencies            $   39,071      $  38,607      $   51,458      $  51,779
State and municipal                              176,838        180,367         162,147        172,905
Federal agency collateralized mortgage
obligations                                      108,607        108,803          95,337         96,831
Federal agency mortgage-backed pools             151,146        153,077         152,372        159,204
Private labeled mortgage-backed pools              1,502          1,554           1,960          2,031
Corporate notes                                       32             45              32             51

Total available for sale investment
securities                                    $  477,196      $ 482,453      $  463,306      $ 482,801

Held to maturity, State and Municipal         $    9,910      $   9,910      $       -       $      -

Total investment securities increased by approximately $9.6 million at June 30, 2013 compared to December 31, 2012.

Net loans decreased $73.7 million since December 31, 2012. This decrease was the result of a reduction in mortgage warehouse loans of $96.5 million, consumer loans of $11.2 million and residential mortgage loans of $7.1 million, partially offset by an increase in commercial loans of $41.8 million. The decrease in the Company's mortgage warehousing business reflects lower demand from increased long-term interest rate movements, seasonality and the decline in the demand for mortgage refinance business. The decrease in consumer and residential mortgage loans resulted from loan payments and payoffs outpacing origination volume. The increase in commercial loans is the direct result of increased calling efforts to increase Horizon's market share within the Company's footprint and market expansion.

Total deposits increased $3.1 million during the first six months of 2013. This increase was the result of non-interest bearing deposit accounts increasing by $4.5 million due to increased calling and marketing efforts and interest bearing deposit accounts increasing by $3.0 million primarily due to increased consumer deposits, partially offset by a decrease in time deposits of $4.4 million during the first six months of 2013.

The Company's borrowings decreased $62.9 million from December 31, 2012 as the short-term funding needed for mortgage warehouse loans declined and deposits increased. At June 30, 2013, the Company had $75 million of short-term funds borrowed compared to $157.0 million at December 31, 2012. The Company reduces short-term borrowings to offset decreases in mortgage warehouse lending when it is determined that the loan demand will decrease as a result of refinancing activity. In addition, the Company's current balance sheet strategy is to utilize a reasonable level of short-term borrowings during extended low rate environments in addition to what is needed for the fluctuations in mortgage warehouse lending.

Stockholders' equity totaled $160.2 million at June 30, 2013 compared to $159.0 million at December 31, 2012. The increase in stockholders' equity during the period was the result of the generation of net income partially offset by a decrease in accumulated other comprehensive income and dividends declared. At June 30, 2013, the ratio of average stockholders' equity to average assets was 9.34% compared to 8.71% for December 31, 2012. Book value per common share at June 30, 2013 increased to $17.14 compared to $17.00 at December 31, 2012.


Table of Contents

HORIZON BANCORP AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition

And Results of Operations

For the Three and Six Months Ended June 30, 2013

Results of Operations

Overview

Consolidated net income for the three-month period ended June 30, 2013 was $5.7 million, an increase of 15.4% from the $4.9 million for the same period in 2012. Earnings per common share for the three months ended June 30, 2013 were $0.65 basic and $0.62 diluted, compared to $0.65 basic and $0.62 diluted for the same three-month period in 2012. Additional income from the growth in commercial loans and the realization of synergies from the Heartland transaction contributed to the record earnings in the second quarter of 2013 as mortgage warehousing balances declined.

Consolidated net income for the six-month period ended June 30, 2013 was $11.0 million, an increase of 15.3% from the $9.5 million for the same period in 2012. Earnings per common share for the six months ended June 30, 2013 were $1.25 basic and $1.20 diluted, compared to $1.25 basic and $1.21 diluted for the same six-month period in 2012. Diluted earnings per share decreased by $.01 compared with the same six-month period in 2012 due to an increase in dilutive shares and additional shares issued in the Heartland acquisition. Growth in commercial loans and realizing the synergies from the Heartland transaction contributed to the record earnings in the first half of 2013 as mortgage warehousing balances decreased.

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 . . .

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