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:


March 31, 2014	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	$	294	$	—	$	81	$	769	$	1,144
Non owner occupied real estate		2,192		—		1,084		514		3,790
Residential development		—		—		—		—		—
Development & Spec Land Loans		162		—		—		—		162
Commercial and industrial		1,043		—		1,173		—		2,216

Total commercial		3,691		—		2,338		1,283		7,312
Real estate
Residential mortgage		2,709		3		858		2,510		6,080
Residential construction		—		—		278		—		278
Mortgage warehouse		—		—		—		—		—

Total real estate		2,709		3		1,136		2,510		6,358
Consumer
Direct Installment		289		20		—		—		309
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		536		103		—		—		639
Home Equity		1,548		77		187		1,206		3,018

Total Consumer		2,373		200		187		1,206		3,966

Total	$	8,773	$	203	$	3,661	$	4,999	$	17,636


December 31, 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	$	293	$	—	$	222	$	778	$	1,293
Non owner occupied real estate		2,289		45		1,117		518		3,969
Residential development		—		—		—		—		—
Development & Spec Land Loans		182		—		—		—		182
Commercial and industrial		1,250		—		777		—		2,027

Total commercial		4,014		45		2,116		1,296		7,471
Real estate
Residential mortgage		2,459		2		719		2,686		5,866
Residential construction		—		—		280		—		280
Mortgage warehouse		—		—		—		—		—

Total real estate		2,459		2		999		2,686		6,146
Consumer
Direct Installment		202		—		—		—		202
Direct Installment Purchased		—		—		—		—		—
Indirect Installment		531		2		—		—		533
Home Equity		2,542		—		311		1,072		3,925

Total Consumer		3,275		2		311		1,072		4,660

Total	$	9,748	$	49	$	3,426	$	5,054	$	18,277

Included in the $8.8 million of non-accrual loans and the $3.7 million of non-performing TDR’s at March 31, 2014 were $2.6 million and $436,000, 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 Credit Officer or the senior collection officer must review all loans placed on non-accrual status. Subsequent payments on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. 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 six 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 March 31, 2014, the type of concessions the Company has made on restructured loans has been temporary rate reductions and/or reductions in monthly payments and there have been no restructured loans with modified recorded balances. Any modification to a loan that is a concession and is not in the normal course of lending is considered a restructured loan. A restructured loan is returned to accruing status after six consecutive payments but is still reported as TDR unless the loan bears interest at a market rate. As of March 31, 2014, the Company had $8.7 million in TDRs and $5.0 million were performing according to the restructured terms and no TDR’s were returned to accrual status during the first three months of 2014. There was $1.5 million of specific reserves allocated to TDRs at March 31, 2014 based on the discounted cash flows.

Loans transferred and classified as troubled debt restructuring during the three months ended March 31, 2014 and 2013, segregated by class, are shown in the table below.


	March 31, 2014				March 31, 2013
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		—	$	—		2	$	76
Non owner occupied real estate		—		—		1		70
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		2		398		—		—

Total commercial		2		398		3		146
Real estate
Residential mortgage		—		—		3		390
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		—		—		3		390
Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		1		146		2		791

Total Consumer		1		146		2		791

Total		3	$	544		8	$	1,327

Troubled debt restructured loans which had payment defaults during the three months ended March 31, 2014 and 2013, 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.


	March 31, 2014				March 31, 2013
	Number of Defaults		Unpaid Principal Balance		Number of Defaults		Unpaid Principal Balance
Commercial
Owner occupied real estate		—	$	—		2	$	76
Non owner occupied real estate		—		—		1		70
Residential development		—		—		—		—
Development & Spec Land Loans		—		—		—		—
Commercial and industrial		2		398		—		—

Total commercial		2		398		3		146
Real estate
Residential mortgage		1		154		1		234
Residential construction		—		—		—		—
Mortgage warehouse		—		—		—		—

Total real estate		1		154		1		234
Consumer
Direct Installment		—		—		—		—
Direct Installment Purchased		—		—		—		—
Indirect Installment		—		—		—		—
Home Equity		1		146		—		—

Total Consumer		1		146		—		—

Total		4	$	698		4	$	380

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


							Three Months Ending
March 31, 2014	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans			Cash/ Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	1,145	$	1,148	$	—	$	1,759		$	12
Non owner occupied real estate		3,443		3,446		—		3,514			5
Residential development		—		—		—		—			—
Development & Spec Land Loans		24		24		—		24			—
Commercial and industrial		333		349		—		608			—

Total commercial		4,945		4,967		—		5,905			17
With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		(1	)		—
Non owner occupied real estate		347		347		170		353			—
Residential development		—		—		—		—			—
Development & Spec Land Loans		138		138		40		142			—
Commercial and industrial		1,883		1,883		1,080		1,727			2

Total commercial		2,368		2,368		1,290		2,221			2

Total	$	7,313	$	7,335	$	1,290	$	8,126		$	19


							Three Months Ending
March 31, 2013	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Loss Allocated		Average Balance in Impaired Loans			Cash/ Accrual Interest Income Recognized
With no recorded allowance
Commercial
Owner occupied real estate	$	3,310	$	3,317	$	—	$	4,906		$	14
Non owner occupied real estate		2,578		2,579		—		3,793			11
Residential development		—		—		—		—			—
Development & Spec Land Loans		135		135		—		166			—
Commercial and industrial		912		928		—		1,877			—

Total commercial		6,935		6,959		—		10,742			25
With an allowance recorded
Commercial
Owner occupied real estate		—		—		—		—			—
Non owner occupied real estate		1,763		1,763		1,080		1,774			—
Residential development		—		—		—		—			—
Development & Spec Land Loans		564		564		600		569			—
Commercial and industrial		792		792		265		794			—

Total commercial		3,119		3,119		1,945		3,137			—

Total	$	10,054	$	10,078	$	1,945	$	13,879		$	25

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


March 31, 2014	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	$	218		$	127		$	—		$	345		$	173,169		$	173,514
Non owner occupied real estate		122			—			—			122			230,103			230,225
Residential development		—			—			—			—			833			833
Development & Spec Land Loans		—			—			—			—			21,347			21,347
Commercial and industrial		110			—			—			110			102,002			102,112

Total commercial		450			127			—			577			527,454			528,031
Real estate
Residential mortgage		313			—			3			316			180,533			180,849
Residential construction		—			—			—			—			8,692			8,692
Mortgage warehouse		—			—			—			—			102,146			102,146

Total real estate		313			—			3			316			291,371			291,687
Consumer
Direct Installment		67			10			20			97			30,459			30,556
Direct Installment Purchased		—			—			—			—			270			270
Indirect Installment		771			41			103			915			130,479			131,394
Home Equity		555			278			77			910			117,222			118,132

Total consumer		1,393			329			200			1,922			278,430			280,352

Total	$	2,156		$	456		$	203		$	2,815		$	1,097,255		$	1,100,070

Percentage of total loans		0.20	%		0.04	%		0.02	%		0.26	%		99.74	%

December 31, 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	$	341		$	—		$	—		$	341		$	155,921		$	156,262
Non owner occupied real estate		424			—			45			469			224,244			224,713
Residential development		—			—			—			—			400			400
Development & Spec Land Loans		—			—			—			—			21,289			21,289
Commercial and industrial		—			—			—			—			101,920			101,920

Total commercial		765			—			45			810			503,774			504,584
Real estate
Residential mortgage		445			87			2			534			175,534			176,068
Residential construction		—			—			—			—			9,508			9,508
Mortgage warehouse		—			—			—			—			98,156			98,156

Total real estate		445			87			2			534			283,198			283,732
Consumer
Direct Installment		120			24			—			144			29,839			29,983
Direct Installment Purchased		—			—			—			—			294			294
Indirect Installment		1,011			175			2			1,188			130,196			131,384
Home Equity		767			58			—			825			117,133			117,958

Total consumer		1,898			257			2			2,157			277,462			279,619

Total	$	3,108		$	344		$	49		$	3,501		$	1,064,434		$	1,067,935

Percentage of total loans		0.29	%		0.03	%		0.00	%		0.33	%		99.67	%

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 Credit Officer (CCO).

•

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

•

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

•

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

For residential real estate and consumer loans, Horizon uses a grading system based on delinquency. Loans that are 90 days or more past due, on non-accrual, or are classified as a TDR are graded “Substandard.” After being 90 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 a nine-grade rating system to determine the credit quality of commercial loans. The first five grades represent acceptable quality, and the last four grades mirror the criticized and classified grades used by the bank regulatory agencies (special mention, substandard, doubtful, and loss). The loan grade definitions are detailed below.

Risk Grade 1: Excellent (Pass)

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

Risk Grade 2: Good (Pass)

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

Risk Grade 3: Satisfactory (Pass)

Loans supported by financial statements (audited or unaudited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered. Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:

•

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

•

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

•

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

•

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

Risk Grade 4 Satisfactory/Monitored:

Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans. Borrower displays acceptable liquidity, leverage, and earnings performance within the Bank’s minimum underwriting guidelines. The level of risk is acceptable but conditioned on the proper level of loan officer supervision. Loans that normally fall into this grade include acquisition, construction and development loans and income producing properties that have not reached stabilization.

Risk Grade 4W Management Watch:

Loans in this category are considered to be of acceptable quality, but with above normal risk. Borrower displays potential indicators of weakness in the primary source of repayment resulting in a higher reliance on secondary sources of repayment. Balance sheet may exhibit weak liquidity and/or high leverage. There is inconsistent earnings performance without the ability to sustain adverse economic conditions. Borrower may be operating in a declining industry or the property type, as for a commercial real estate loan, may be high risk or in decline. These loans require an increased level of loan officer supervision and monitoring to assure that any deterioration is addressed in a timely fashion.

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.


March 31, 2014	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	163,274		$	2,667		$	7,573		$	—		$	173,514
Non owner occupied real estate		213,918			6,211			10,096			—			230,225
Residential development		738			95			—			—			833
Development & Spec Land Loans		19,984			88			1,275			—			21,347
Commercial and industrial		92,357			6,045			3,710			—			102,112

Total commercial		490,271			15,106			22,654			—			528,031
Real estate
Residential mortgage		174,769			—			6,080			—			180,849
Residential construction		8,414			—			278			—			8,692
Mortgage warehouse		102,146			—			—			—			102,146

Total real estate		285,329			—			6,358			—			291,687
Consumer
Direct Installment		30,247			—			309			—			30,556
Direct Installment Purchased		270			—			—			—			270
Indirect Installment		130,755			—			639			—			131,394
Home Equity		115,114			—			3,018			—			118,132

Total Consumer		276,386			—			3,966			—			280,352

Total	$	1,051,985		$	15,106		$	32,978		$	—		$	1,100,070

Percentage of total loans		95.63	%		1.37	%		3.00	%		0.00	%

December 31, 2013	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	146,085		$	2,231		$	7,946		$	—		$	156,262
Non owner occupied real estate		208,625			5,047			11,041			—			224,713
Residential development		400			—			—			—			400
Development & Spec Land Loans		19,858			91			1,340			—			21,289
Commercial and industrial		91,852			6,492			3,576			—			101,920

Total commercial		466,820			13,861			23,903			—			504,584
Real estate
Residential mortgage		170,202			—			5,866			—			176,068
Residential construction		9,228			—			280			—			9,508
Mortgage warehouse		98,156			—			—			—			98,156

Total real estate		277,586			—			6,146			—			283,732
Consumer
Direct Installment		29,781			—			202			—			29,983
Direct Installment Purchased		294			—			—			—			294
Indirect Installment		130,851			—			533			—			131,384
Home Equity		114,033			—			3,925			—			117,958

Total Consumer		274,959			—			4,660			—			279,619

Total	$	1,019,365		$	13,861		$	34,709		$	—		$	1,067,935

Percentage of total loans		95.45	%		1.30	%		3.25	%		0.00	%