The Company’s TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At June 30, 2019, 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 June 30, 2019, the Company had $3.8 million in TDRs and $2.2 million were performing according to the restructured terms and

TDRs were returned to accrual status during the first six months of 2019. There were $20,000 specific reserves allocated to TDRs at June 30, 2019 based on the discounted cash flows or when appropriate the fair value of the collateral.

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


	June 30, 2019
							Three Months Ended				Six Months Ended
	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	$	3,851	$	3,851	$	—	$	5,987	$	76	$	6,005	$	130
Non-owner occupied real estate		1,116		1,143		—		1,260		33		1,293		64
Residential spec homes		—		—		—		—		—		—		—
Development & spec land		140		139		—		226		2		224		2
Commercial and industrial		1,797		1,778		—		2,073		15		2,078		22

Total commercial		6,904		6,911		—		9,546		126		9,600		218
With an allowance recorded
Commercial
Owner occupied real estate		371		371		3		372		10		365		10
Non-owner occupied real estate		135		135		40		135		—		135		—
Residential spec homes		—		—		—		—		—		—		—
Development & spec land		—		—		—		—		—		—		—
Commercial and industrial		1,224		1,224		744		1,252		25		1,258		25

Total commercial		1,730		1,730		787		1,759		35		1,758		35

Total	$	8,634	$	8,641	$	787	$	11,305	$	161	$	11,358	$	253

	June 30, 2018
							Three Months Ended				Six Months Ended
	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	$	4,765	$	4,762	$	—	$	5,271	$	59	$	5,303	$	96
Non-owner occupied real estate		1,344		1,360		—		1,591		5		1,559		10
Residential spec homes		—		—		—		—		—		—		—
Development & spec land		72		70		—		71		—		73		—
Commercial and industrial		1,943		1,943		—		1,916		7		1,886		7

Total commercial		8,124		8,135		—		8,849		71		8,821		113
With an allowance recorded
Commercial
Owner occupied real estate		864		864		184		871		—		885		—
Non-owner occupied real estate		—		—		—		—		—		—		—
Residential spec homes		—		—		—		—		—		—		—
Development & spec land		—		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—		—

Total commercial		864		864		184		871		—		885		—

Total	$	8,988	$	8,999	$	184	$	9,720	$	71	$	9,706	$	113

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


	June 30, 2019
	Current			30-59 Days Past Due			60-89 Days Past Due			90 Days or Greater Past Due			Non-accrual			Total Past Due & Non-accrual Loans			Total
Commercial
Owner occupied real estate	$	705,186		$	265		$	—		$	63		$	4,083		$	4,411		$	709,597
Non-owner occupied real estate		781,012			829			—			—			1,251			2,080			783,092
Residential spec homes		14,862			—			—			—			—			—			14,862
Development & spec land		40,509			453			—			—			140			593			41,102
Commercial and industrial		513,126			2,234			499			—			3,021			5,754			518,880

Total commercial		2,054,695			3,781			499			63			8,495			12,838			2,067,533
Real estate
Residential mortgage		791,704			2,272			125			77			4,635			7,109			798,813
Residential construction		22,403			—			—			—			—			—			22,403
Mortgage warehouse		133,428			—			—			—			—			—			133,428

Total real estate		947,535			2,272			125			77			4,635			7,109			954,644
Consumer
Direct installment		46,203			180			49			—			36			265			46,468
Indirect installment		326,970			1,268			250			156			1,129			2,803			329,773
Home equity		272,047			640			569			95			2,045			3,349			275,396

Total consumer		645,220			2,088			868			251			3,210			6,417			651,637

Total	$	3,647,450		$	8,141		$	1,492		$	391		$	16,340		$	26,364		$	3,673,814

Percentage of total loans		99.28	%		0.22	%		0.04	%		0.01	%		0.44	%		0.72	%		100.00	%

	December 31, 2018
	Current			30-59 Days Past Due			60-89 Days Past Due			90 Days or Greater Past Due			Non-accrual			Total Past Due & Non-accrual Loans			Total
Commercial
Owner occupied real estate	$	556,516		$	537		$	997		$	—		$	3,413		$	4,947		$	561,463
Non-owner occupied real estate		716,574			175			19			—			1,046			1,240			717,814
Residential spec homes		4,707			492			—			—			—			492			5,199
Development & spec land		46,479			—			—			—			68			68			46,547
Commercial and industrial		390,828			515			736			208			2,059			3,518			394,346

Total commercial		1,715,104			1,719			1,752			208			6,586			10,265			1,725,369
Real estate
Residential mortgage		641,500			1,131			56			180			3,269			4,636			646,136
Residential construction		24,030			—			—			—			—			—			24,030
Mortgage warehouse		74,120			—			—			—			—			—			74,120

Total real estate		739,650			1,131			56			180			3,269			4,636			744,286
Consumer
Direct installment		38,027			93			18			—			35			146			38,173
Indirect installment		311,494			1,396			198			173			916			2,683			314,177
Home equity		192,162			761			37			7			1,799			2,604			194,766

Total consumer		541,794			2,250			253			180			2,750			5,433			547,116

Total	$	2,996,548		$	5,100		$	2,061		$	568		$	12,605		$	20,334		$	3,016,771

Percentage of total loans		99.33	%		0.17	%		0.07	%		0.02	%		0.42	%		0.67	%		100.00	%

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 that exceeds the authorities in the respective markets (ranging from $1,000,000 to $3,500,000) are validated by the Loan Committee, which is chaired by the Chief Commercial Banking Officer (CCBO).

•

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

•

The CCBO, or his designee, meets regularly 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 to 120 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 unstablized, 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.

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.


	June 30, 2019
	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	686,630		$	5,711		$	17,256		$	—		$	709,597
Non-owner occupied real estate		764,517			13,002			5,573			—			783,092
Residential spec homes		14,862			—			—			—			14,862
Development & spec land		37,847			97			3,158			—			41,102
Commercial and industrial		482,043			25,214			11,623			—			518,880

Total commercial		1,985,899			44,024			37,610			—			2,067,533
Real estate
Residential mortgage		792,446			—			6,367			—			798,813
Residential construction		22,403			—			—			—			22,403
Mortgage warehouse		133,428			—			—			—			133,428

Total real estate		948,277			—			6,367			—			954,644
Consumer
Direct installment		46,433			—			35			—			46,468
Indirect installment		328,488			—			1,285			—			329,773
Home equity		272,929			—			2,467			—			275,396

Total consumer		647,850			—			3,787			—			651,637

Total	$	3,582,026		$	44,024		$	47,764		$	—		$	3,673,814

Percentage of total loans		97.50	%		1.20	%		1.30	%		0.00	%		100.00	%

	December 31, 2018
	Pass			Special Mention			Substandard			Doubtful			Total
Commercial
Owner occupied real estate	$	538,177		$	6,618		$	16,668		$	—		$	561,463
Non-owner occupied real estate		702,269			9,682			5,863			—			717,814
Residential spec homes		5,199			—			—			—			5,199
Development & spec land		46,382			97			68			—			46,547
Commercial and industrial		379,607			6,655			8,084			—			394,346

Total commercial		1,671,634			23,052			30,683			—			1,725,369
Real estate
Residential mortgage		641,309			—			4,827			—			646,136
Residential construction		24,030			—			—			—			24,030
Mortgage warehouse		74,120			—			—			—			74,120

Total real estate		739,459			—			4,827			—			744,286
Consumer
Direct installment		38,138			—			35			—			38,173
Indirect installment		313,088			—			1,089			—			314,177
Home equity		192,625			—			2,141			—			194,766

Total consumer		543,851			—			3,265			—			547,116

Total	$	2,954,944		$	23,052		$	38,775		$	—		$	3,016,771

Percentage of total loans		97.95	%		0.76	%		1.29	%		0.00	%		100.00	%