Note 6 – Non-performing Loans and Impaired Loans

The following table presents the nonaccrual, loans past due over 90 days still on accrual, and troubled debt restructured (“TDRs”) by class of loans:


September 30, 2013	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Non Performing TDR’s		Performing TDR’s		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	464	$	—	$	82	$	783	$	1,329
Non owner occupied real estate		2,829		—		825		—		3,654
Residential development		—		—		—		—		—
Development & Spec Land Loans		170		—		—		—		170
Commercial and industrial		1,953		—		781		—		2,734

Total commercial		5,416		—		1,688		783		7,887

Real estate
Residential mortgage		3,436		2		2,693		1,678		7,809
Residential construction		—		—		284		—		284
Mortgage warehouse		—		—		—		—		—

Total real estate		3,436		2		2,977		1,678		8,093

Consumer
Direct Installment		249		—		—		—		249
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		657		—		—		—		657
Home Equity		3,228		—		1,321		1,046		5,595

Total Consumer		4,134		—		1,321		1,046		6,501

Total	$	12,986	$	2	$	5,986	$	3,507	$	22,481


December 31, 2012	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Non Performing TDR’s		Performing TDR’s		Total Non- Performing Loans
Commercial
Owner occupied real estate	$	2,800	$	—	$	1,272	$	819	$	4,891
Non owner occupied real estate		1,705		—		1,605		446		3,756
Residential development		—		—		—		—		—
Development & Spec Land Loans		705		—		—		—		705
Commercial and industrial		544		—		797		—		1,341

Total commercial		5,754		—		3,674		1,265		10,693

Real estate
Residential mortgage		4,565		2		2,536		1,761		8,864
Residential construction		—		—		291		—		291
Mortgage warehouse		—		—		—		—		—

Total real estate		4,565		2		2,827		1,761		9,155

Consumer
Direct Installment		138		26		—		—		164
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		866		26		—		—		892
Home Equity		2,051		—		148		676		2,875

Total Consumer		3,055		52		148		676		3,931

Total	$	13,374	$	54	$	6,649	$	3,702	$	23,779

Included in the $13.0 million of non-accrual loans and the $6.0 million of non-performing TDR’s at September 30, 2013 were $1.6 million and $857,000, respectively, of loans acquired for which accretable yield was recognized.

From time to time, the Bank obtains information that may lead management to believe that the collection of payments may be doubtful on a particular loan. In recognition of this, it is management’s policy to convert the loan from an “earning asset” to a non-accruing loan. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Further, it is management’s policy to place a loan on a non-accrual status when the payment is delinquent in excess of 90 days or the loan has had the accrual of interest discontinued by management. The officer responsible for the loan and the Chief Operating Officer or the Senior Vice President of Operations must review all loans placed on non-accrual status. Subsequent payments on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal in accordance with the loan terms. The Company requires a period of satisfactory performance of not less than nine months before returning a nonaccrual loan to accrual status.

A loan becomes impaired when, based on current information, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is classified as impaired, the degree of impairment must be recognized by estimating future cash flows from the debtor. The present value of these cash flows is computed at a discount rate based on the interest rate contained in the loan agreement. However, if a particular loan has a determinable market value for its collateral, the creditor may use that value. Also, if the loan is secured and considered collateral dependent, the creditor may use the fair value of the collateral. Interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

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

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms, including TDRs, are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans.

The Company’s TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At September 30, 2013, the type of concessions the Company has made on restructured loans has been temporary rate reductions and/or reductions in monthly payments and there have been no restructured loans with modified recorded balances. Any modification to a loan that is a concession and is not in the normal course of lending is considered a restructured loan. A restructured loan is returned to accruing status after nine consecutive payments but is still reported as TDR unless the loan bears interest at a market rate. As of September 30, 2013, the Company had $9.5 million in TDRs and $3.5 million were performing according to the restructured terms and no TDR’s were returned to accrual status in the first nine months of 2013. There was $440,000 million of specific reserves allocated to TDRs at September 30, 2013 based on the collateral deficiencies.

Loans transferred and classified as troubled debt restructured loans during the nine months ended September 30, 2013 and 2012, segregated by class, are shown in the table below.


	September 30, 2013				September 30, 2012
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		2	$	81		3	$	1,472
Non owner occupied real estate		1		68		3		637
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		—		—

Total commercial		3		149		6		2,109

Real estate
Residential mortgage		8		1,132		1		582
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		8		1,132		1		582

Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		7		1,882		—		—

Total Consumer		7		1,882		—		—

Total		18	$	3,163		7	$	2,691

Troubled debt restructured loans which had payment defaults during the nine months ended September 30, 2013 and 2012, segregated by class, are shown in the table below. Default occurs when a loan is 90 days or more past due or has been transferred to nonaccrual.


	September 30, 2013				September 30, 2012
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		2	$	81		3	$	1,473
Non owner occupied real estate		1		68		2		261
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		—		—		—		—

Total commercial		3		149		5		1,734

Real estate
Residential mortgage		4		400		2		677
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		4		400		2		677

Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		4		1,175		—		—

Total Consumer		4		1,175		—		—

Total		11	$	1,724		7	$	2,411

The following table presents commercial loans individually evaluated for impairment by class of loan:


							Three Months Ending					Nine Months Ending
September 30, 2013	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans			Cash/ Accrual Interest Income Recognized		Average Balance in Impaired Loans		Cash/ Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	1,329	$	1,331	$	—	$	1,959			16	$	2,685	$	43
Non owner occupied real estate		3,167		3,170		—		3,814			8		3,298		21
Residential development		—		—		—		—			—		—		—
Development & Spec Land Loans		21		21		—		24			—		25		—
Commercial and industrial		546		561		—		1,297			—		1,311		—

Total commercial		5,063		5,083		—		7,094			24		7,319		64

With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		(1	)		—		—		—
Non owner occupied real estate		487		487		302		491			—		502		—
Residential development		—		—		—		—			—		—		—
Development & Spec Land Loans		149		149		48		173			—		165		—
Commercial and industrial		2,188		2,200		966		2,379			—		1,808		23

Total commercial		2,824		2,836		1,316		3,042			—		2,475		23

Total	$	7,887	$	7,919	$	1,316	$	10,136		$	24	$	9,794	$	87


							Three Months Ending				Nine Months Ending
September 30, 2012	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans		Cash/ Accrual Interest Income Recognized		Average Balance in Impaired Loans		Cash/ Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	4,457	$	4,460	$	—	$	3,810	$	—	$	1,978	$	3
Non owner occupied real estate		2,521		2,542		—		2,429		70		1,920		72
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		131		131		—		109		—		37		—
Commercial and industrial		456		471		—		382		—		129		—

Total commercial		7,565		7,604		—		6,730		70		4,064		75

With an allowance recorded
Commercial
Owner occupied real estate		903		903		450		910		—		1,109		1
Non owner occupied real estate		2,938		2,938		1,065		2,943		—		2,843		—
Residential development		—		—		—		—		—		—		—
Development & Spec Land Loans		658		658		615		660		—		523		6
Commercial and industrial		801		801		273		801		—		807		—

Total commercial		5,300		5,300		2,403		5,314		—		5,282		7

Total	$	12,865	$	12,904	$	2,403	$	12,044	$	70	$	9,346	$	82

The following table presents the payment status by class of loan:


September 30, 2013	30 - 59 Days Past Due			60 - 89 Days Past Due			Greater than 90 Days Past Due			Total Past Due			Loans Not Past Due			Total
Commercial
Owner occupied real estate	$	99		$	—		$	—		$	99		$	153,014		$	153,113
Non owner occupied real estate		45			—			—			45			229,609			229,654
Residential development		—			—			—			—			242			242
Development & Spec Land Loans		—			—			—			—			15,621			15,621
Commercial and industrial		13			—			—			13			100,181			100,194

Total commercial		157			—			—			157			498,667			498,824

Real estate
Residential mortgage		695			351			2			1,048			178,916			179,964
Residential construction		—			—			—			—			8,881			8,881
Mortgage warehouse		—			—			—			—			113,591			113,591

Total real estate		695			351			2			1,048			301,388			302,436

Consumer
Direct Installment		122			13			—			135			28,833			28,968
Direct Installment Purchased		—			—			—			—			331			331
Indirect Installment		894			60			—			954			128,496			129,450
Home Equity		173			227			—			400			119,822			120,222

Total consumer		1,189			300			—			1,489			277,482			278,971

Total	$	2,041		$	651		$	2		$	2,694		$	1,077,537		$	1,080,231

Percentage of total loans		0.19	%		0.06	%		0.00	%		0.25	%		99.75	%


December 31, 2012	30 - 59 Days Past Due			60 - 89 Days Past Due			Greater than 90 Days Past Due			Total Past Due			Loans Not Past Due			Total
Commercial
Owner occupied real estate	$	2,207		$	19		$	—		$	2,226		$	160,468		$	162,694
Non owner occupied real estate		669			147			—			816			200,947			201,763
Residential development		—			—			—			—			1,056			1,056
Development & Spec Land Loans		—			—			—			—			6,963			6,963
Commercial and industrial		538			16			—			554			86,528			87,082

Total commercial		3,414			182			—			3,596			455,962			459,558

Real estate
Residential mortgage		167			—			2			169			181,281			181,450
Residential construction		—			—			—			—			7,681			7,681
Mortgage warehouse		—			—			—			—			251,448			251,448

Total real estate		167			—			2			169			440,410			440,579

Consumer
Direct Installment		240			64			26			330			27,501			27,831
Direct Installment Purchased		—			—			—			—			429			429
Indirect Installment		1,105			177			26			1,308			132,173			133,481
Home Equity		1,072			321			—			1,393			125,195			126,588

Total consumer		2,417			562			52			3,031			285,298			288,329

Total	$	5,998		$	744		$	54		$	6,796		$	1,181,670		$	1,188,466

Percentage of total loans		0.50	%		0.06	%		0.00	%		0.57	%		99.43	%

The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date.

Horizon Bank’s processes for determining credit quality differ slightly depending on whether a new loan or a renewed loan is being underwritten, or whether an existing loan is being re-evaluated for credit quality. The latter usually occurs upon receipt of current financial information or other pertinent data that would trigger a change in the loan grade.

•

For new and renewed commercial loans, the Bank’s Credit Department, which acts independently of the loan officer, assigns the credit quality grade to the loan. Loan grades for loans with an aggregate credit exposure of $500,000 or greater are validated by the Loan Committee, which is chaired by the Chief Operating Officer (COO).

•

Commercial loan officers are responsible for reviewing their loan portfolios and report any adverse material change to the COO or Loan Committee. When circumstances warrant a change in the credit quality grade, loan officers are required to notify the COO and the Credit Department of the change in the loan grade. Downgrades are accepted immediately by the COO however, lenders must present their factual information to either the Loan Committee or the COO when recommending an upgrade.

•

The COO or his designee meets weekly with loan officers to discuss the status of past-due loans and classified loans. These meetings are also designed to give the loan officers an opportunity to identify an existing loan that should be downgraded to a classified grade.

•

Monthly, senior management meets with the Watch Committee, which reviews all of the past due, classified, and impaired loans and the relative trends of these assets. This committee also reviews the actions taken with respect to foreclosure mitigation, loan extensions, troubled debt restructures, and collateral repossessions. The information reviewed in this meeting act as a precursor for developing management’s analysis of the adequacy of the Allowance for Loan and Lease Losses.

For real estate and consumer loans, Horizon uses a grading system based on delinquency. Loans that are 90 days or more past due, on non-accrual, or are classified as a TDR are graded “Substandard.” After being 90 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass.

Horizon Bank employs an eight-grade rating system to determine the credit quality of commercial loans. The first four grades represent acceptable quality, and the last four grades mirror the criticized and classified grades used by the bank regulatory agencies (special mention, substandard, doubtful, and loss). The loan grade definitions are detailed below.

Risk Grade 1: Excellent (Pass)

Loans secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better.

Risk Grade 2: Good (Pass)

Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by unaudited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets and unblemished credit history; or loans to publicly held companies with current long-term debt ratings of Baa or better.

Risk Grade 3: Satisfactory (Pass)

Loans supported by financial statements (audited or unaudited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.

Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:

•

At inception, the loan was properly underwritten, did not possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory;

•

At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss.

•

The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.

•

During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.

Risk Grade 4: Satisfactory/Monitored (Pass)

Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans due to weak balance sheets, marginal earnings or cash flow, lack of financial information, weakening markets, insufficient or questionable collateral coverage or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision. Loans that normally fall into this grade include construction of commercial real estate buildings, land development and subdivisions, and rental properties that have not attained stabilization.

Risk Grade 5: Special Mention

Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered “potential,” not “defined,” impairments to the primary source of repayment. These loans may be to borrowers with adverse trends in financial performance, collateral value and/or marketability, or balance sheet strength.

Risk Grade 6: Substandard

One or more of the following characteristics may be exhibited in loans classified Substandard:

•

Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.

•

Loans are inadequately protected by the current net worth and paying capacity of the obligor.

•

The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.

•

Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

•

Unusual courses of action are needed to maintain a high probability of repayment.

•

The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments.

•

The lender is forced into a subordinated or unsecured position due to flaws in documentation.

•

Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms.

•

The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

•

There is a significant deterioration in market conditions to which the borrower is highly vulnerable.

Risk Grade 7: Doubtful

One or more of the following characteristics may be present in loans classified Doubtful:

•

Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.

•

The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

•

The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.

Risk Grade 8: Loss

Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The following table presents loans by credit grades.


September 30, 2013	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	142,836		$	2,600		$	7,677		$	—		$	153,113
Non owner occupied real estate		210,632			3,119			15,903			—			229,654
Residential development		242			—			—			—			242
Development & Spec Land Loans		13,844			94			1,683			—			15,621
Commercial and industrial		90,221			5,410			4,563			—			100,194

Total commercial		457,775			11,223			29,826			—			498,824

Real estate
Residential mortgage		172,155			—			7,809			—			179,964
Residential construction		8,597			—			284			—			8,881
Mortgage warehouse		113,591			—			—			—			113,591

Total real estate		294,343			—			8,093			—			302,436

Consumer
Direct Installment		28,719			—			249			—			28,968
Direct Installment Purchased		331			—			—			—			331
Indirect Installment		128,793			—			657			—			129,450
Home Equity		114,627			—			5,595			—			120,222

Total Consumer		272,470			—			6,501			—			278,971

Total	$	1,024,587		$	11,223		$	44,420		$	—		$	1,080,231

Percentage of total loans		94.85	%		1.04	%		4.11	%		0.00	%


December 31, 2012	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	137,664		$	6,407		$	17,029		$	1,594		$	162,694
Non owner occupied real estate		171,319			19,440			10,717			287			201,763
Residential development		405			—			651			—			1,056
Development & Spec Land Loans		3,171			178			3,614			—			6,963
Commercial and industrial		78,810			3,136			5,136			—			87,082

Total commercial		391,369			29,161			37,147			1,881			459,558

Real estate
Residential mortgage		172,586			—			8,864			—			181,450
Residential construction		7,390			—			291			—			7,681
Mortgage warehouse		251,448			—			—			—			251,448

Total real estate		431,424			—			9,155			—			440,579

Consumer
Direct Installment		27,667			—			164			—			27,831
Direct Installment Purchased		429			—			—			—			429
Indirect Installment		132,589			—			892			—			133,481
Home Equity		123,713			—			2,875			—			126,588

Total Consumer		284,398			—			3,931			—			288,329

Total	$	1,107,191		$	29,161		$	50,233		$	1,881		$	1,188,466

Percentage of total loans		93.16	%		2.45	%		4.23	%		0.16	%