HORIZON BANCORP INC /IN/ 10-Q

ITEM 1. FINANCIAL STATEMENTS HORIZON BANCORP, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Dollar Amounts in Thousands) September 30, 2020 December 31, 2019 (Unaudited) Assets Cash and due from banks $ 99,126 $ 98,831 Interest-earning time deposits 9,213 8,455 Investment securities, available for sale 1,015,343 834,776 Investment securities, held to maturity (fair value of $ 191,612 and $ 215,147 ) 180,270 207,899 Loans held for sale 13,053 4,088 Loans, net of allowance for loan losses of $ 56,319 and $ 17,667 3,974,046 3,619,174 Premises and equipment, net 92,189 92,209 Federal Home Loan Bank stock 23,023 22,447 Goodwill 151,238 151,238 Other intangible assets 23,869 26,679 Interest receivable 20,456 18,828 Cash value of life insurance 96,198 95,577 Other assets 92,119 66,628 Total assets $ 5,790,143 $ 5,246,829 Liabilities Deposits Non-interest bearing $ 1,016,646 $ 709,760 Interest bearing 3,319,643 3,221,242 Total deposits 4,336,289 3,931,002 Borrowings 587,473 549,741 Subordinated debentures 58,566 — Junior subordinated debentures issued to capital trusts 56,491 56,311 Interest payable 2,481 3,062 Other liabilities 78,550 50,690 Total liabilities 5,119,850 4,590,806 Commitments and contingent liabilities Stockholders’ Equity Preferred stock, Authorized, 1,000,000 shares, Issued 0 shares — — Common stock, no par value, Authorized 99,000,000 shares Issued 43,899,422 and 45,000,840 shares, Outstanding 43,874,353 and 44,975,771 shares — — Additional paid-in capital 362,180 379,853 Retained earnings 284,835 269,738 Accumulated other comprehensive income 23,278 6,432 Total stockholders’ equity 670,293 656,023 Total liabilities and stockholders’ equity $ 5,790,143 $ 5,246,829 See notes to condensed consolidated financial statements 3 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Income (Unaudited) (Dollar Amounts in Thousands, Except Per Share Data) Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Interest Income Loans receivable $ 44,051 $ 49,455 $ 132,927 $ 136,862 Investment securities – taxable 1,704 3,157 6,923 9,552 Investment securities – tax exempt 4,391 3,099 12,294 8,520 Total interest income 50,146 55,711 152,144 154,934 Interest Expense Deposits 3,616 9,109 15,838 24,923 Borrowed funds 1,662 2,275 5,974 8,391 Subordinated notes 895 — 953 — Junior subordinated debentures issued to capital trusts 576 864 2,061 2,348 Total interest expense 6,749 12,248 24,826 35,662 Net Interest Income 43,397 43,463 127,318 119,272 Credit loss expense 2,052 376 17,709 1,636 Net Interest Income after Credit Loss Expense 41,345 43,087 109,609 117,636 Non–interest Income Service charges on deposit accounts 2,154 2,836 6,488 7,193 Wire transfer fees 298 189 699 474 Interchange fees 2,438 2,138 6,661 5,659 Fiduciary activities 2,105 1,834 6,398 5,986 Gains on sale of investment securities (includes $ 1,088 and $ — for the three months ended September 30, 2020 and 2019, respectively, and $ 1,675 and $( 85 ) for the nine months ended September 30, 2020 and 2019, respectively, related to accumulated other comprehensive earnings reclassifications) 1,088 — 1,675 ( 85 ) Gain on sale of mortgage loans 8,813 2,702 18,906 6,089 Mortgage servicing income net of impairment ( 1,308 ) 444 ( 4,043 ) 1,620 Increase in cash value of bank owned life insurance 566 556 1,677 1,624 Death benefit on bank owned life insurance 31 213 264 580 Other income 515 602 1,163 1,984 Total non–interest income 16,700 11,514 39,888 31,124 Non–interest Expense Salaries and employee benefits 18,832 16,948 51,052 48,365 Net occupancy expenses 3,107 3,131 9,549 9,051 Data processing 2,237 2,140 7,074 6,245 Professional fees 688 335 1,742 1,426 Outside services and consultants 1,561 1,552 5,235 6,737 Loan expense 2,876 2,198 7,667 6,195 FDIC insurance expense 570 ( 273 ) 955 252 Other losses 114 90 427 363 Other expense 3,422 3,939 11,287 12,748 Total non–interest expense 33,407 30,060 94,988 91,382 Income Before Income Taxes 24,638 24,541 54,509 57,378 4 Table of Contents Income tax expense (includes $ 228 and $ — for the three months ended September 30, 2020 and 2019, respectively, and $ 352 and $( 18 ) for the nine months ended September 30, 2020 and 2019, respectively, related to income tax expense from reclassification items) 4,326 4,004 7,903 9,383 Net Income $ 20,312 $ 20,537 $ 46,606 $ 47,995 Basic Earnings Per Share $ 0.46 $ 0.46 $ 1.06 $ 1.12 Diluted Earnings Per Share 0.46 0.46 1.06 1.11 See notes to condensed consolidated financial statements 5 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Comprehensive Income (Unaudited) (Dollar Amounts in Thousands) Three Months Ended Nine Months Ended September 30 September 30 2020 2019 2020 2019 Net Income $ 20,312 $ 20,537 $ 46,606 $ 47,995 Other Comprehensive Income Change in fair value of derivative instruments: Change in fair value of derivative instruments for the period ( 359 ) ( 864 ) ( 4,459 ) ( 3,871 ) Income tax effect 75 182 936 813 Changes from derivative instruments ( 284 ) ( 682 ) ( 3,523 ) ( 3,058 ) Change in securities: Unrealized appreciation for the period on AFS securities 4,019 3,963 27,518 22,591 Amortization from transfer of securities from available for sale to held to maturity securities ( 31 ) ( 15 ) ( 60 ) ( 83 ) Reclassification adjustment for securities gains realized in income ( 1,088 ) — ( 1,675 ) 85 Income tax effect ( 608 ) ( 827 ) ( 5,414 ) ( 4,745 ) Unrealized gains on securities 2,292 3,121 20,369 17,848 Other Comprehensive Income, Net of Tax 2,008 2,439 16,846 14,790 Comprehensive Income $ 22,320 $ 22,976 $ 63,452 $ 62,785 See notes to condensed consolidated financial statements 6 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Condensed Consolidated Statement of Stockholders’ Equity (Unaudited) (Dollar Amounts in Thousands, Except Per Share Data) Three Months Ended Preferred Stock Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income Total Balances, July 1, 2019 $ — $ — $ 380,735 $ 241,519 $ 4,207 $ 626,461 Net income — — — 20,537 — 20,537 Other comprehensive income, net of tax — — — — 2,439 2,439 Amortization of unearned compensation — — 202 — — 202 Exercise of stock options — — 7 — — 7 Stock option expense — — 50 — — 50 Stock issued stock plans — — 49 — — 49 Repurchase of outstanding stock — — ( 1,595 ) — — ( 1,595 ) Cash dividends on common stock ($ 0.12 per share) — — — ( 5,439 ) — ( 5,439 ) Balances, September 30, 2019 $ — $ — $ 379,448 $ 256,617 $ 6,646 $ 642,711 Balances, July 1, 2020 $ — $ — $ 361,087 $ 269,849 $ 21,270 $ 652,206 Net income — — — 20,312 — 20,312 Other comprehensive income, net of tax — — — — 2,008 2,008 Amortization of unearned compensation — — 335 — — 335 Exercise of stock options — — — — — — Stock option expense — — 28 — — 28 Stock issued stock plans — — 730 — — 730 Cash dividends on common stock ($ 0.12 per share) — — — ( 5,326 ) — ( 5,326 ) Balances, September 30, 2020 $ — $ — $ 362,180 $ 284,835 $ 23,278 $ 670,293 See notes to condensed consolidated financial statements 7 Table of Contents Nine Months Ended Preferred Stock Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Balances, January 1, 2019 $ — $ — $ 276,101 $ 224,035 $ ( 8,144 ) $ 491,992 Net income — — — 47,995 — 47,995 Other comprehensive income, net of tax — — — — 14,790 14,790 Amortization of unearned compensation — — 503 — — 503 Exercise of stock options — — 162 — — 162 Stock option expense — — 165 — — 165 Stock issued stock plans — — 1,390 — — 1,390 Stock issued in Salin acquisition — — 102,722 — — 102,722 Repurchase of outstanding stock — — ( 1,595 ) — — ( 1,595 ) Cash dividends on common stock ($ 0.34 per share) — — — ( 15,413 ) — ( 15,413 ) Balances, September 30, 2019 $ — $ — $ 379,448 $ 256,617 $ 6,646 $ 642,711 Balances, January 1, 2020 $ — $ — $ 379,853 $ 269,738 $ 6,432 $ 656,023 Net income — — — 46,606 — 46,606 Other comprehensive income, net of tax — — — — 16,846 16,846 Impact of adoption of ASU No. 2016-13 — — — ( 15,635 ) — ( 15,635 ) Amortization of unearned compensation — — 457 — — 457 Exercise of stock options — — 157 — — 157 Stock option expense — — 105 — — 105 Stock issued stock plans — — 1,244 — — 1,244 Repurchase of outstanding stock — — ( 19,636 ) — — ( 19,636 ) Cash dividends on common stock($ 0.36 per share) — — — ( 15,874 ) — ( 15,874 ) Balances, September 30, 2020 $ — $ — $ 362,180 $ 284,835 $ 23,278 $ 670,293 See notes to condensed consolidated financial statements 8 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Unaudited) (Dollar Amounts in Thousands) Nine Months Ended September 30 2020 2019 Operating Activities Net income $ 46,606 $ 47,995 Items not requiring (providing) cash Provision for credit losses 17,709 1,636 Depreciation and amortization 7,539 7,064 Share based compensation 105 165 Mortgage servicing rights income ( 630 ) ( 1,679 ) Mortgage servicing rights net impairment 4,673 59 Premium amortization on securities, net 6,649 4,119 (Gain) loss on sale of investment securities ( 1,675 ) 85 Gain on sale of mortgage loans ( 18,906 ) ( 6,089 ) Proceeds from sales of loans 436,285 192,163 Loans originated for sale ( 426,344 ) ( 186,096 ) Change in cash value life insurance ( 1,677 ) ( 1,624 ) Gain on sale of other real estate owned ( 119 ) ( 115 ) Net change in: Interest receivable ( 1,628 ) ( 1,555 ) Interest payable ( 581 ) ( 132 ) Other assets ( 7,048 ) 97,136 Other liabilities 1,873 11,413 Net cash provided by operating activities 62,831 164,545 Investing Activities Purchases of securities available for sale ( 396,133 ) ( 301,426 ) Proceeds from sales, maturities, calls and principal repayments of securities available for sale 237,645 200,067 Proceeds from maturities of securities held to maturity 26,359 6,990 Net change in interest-earning time deposits ( 758 ) 7,289 Change in FHLB stock ( 576 ) ( 803 ) Net change in loans ( 394,167 ) ( 87,905 ) Proceeds on the sale of OREO and repossessed assets 1,426 2,935 Change in premises and equipment, net ( 4,252 ) ( 3,760 ) Death benefit on bank owned life insurance 264 580 Repurchase of outstanding stock ( 19,636 ) ( 1,595 ) Net cash received in acquisition, Salin — 128,745 Net cash used in investing activities ( 549,828 ) ( 48,883 ) Financing Activities Net change in: Deposits 405,287 35,237 Borrowings 37,654 ( 104,251 ) Proceeds from issuance of stock 1,401 1,552 Net proceeds from issuance of subordinated notes 58,824 — Dividends paid on common stock ( 15,874 ) ( 15,413 ) Net cash provided by (used in) financing activities 487,292 ( 82,875 ) 9 Table of Contents Net Change in Cash and Cash Equivalents 295 32,787 Cash and Cash Equivalents, Beginning of Period 98,831 58,492 Cash and Cash Equivalents, End of Period $ 99,126 $ 91,279 Additional Supplemental Information Interest paid $ 25,407 $ 34,968 Income taxes paid 9,825 1,319 Transfer of loans to other real estate and repossessed assets 1,795 2,030 Transfer of premises to other real estate — 1,705 Right-of-use assets exchanged for lease obligations — 3,411 See notes to condensed consolidated financial statements 10 HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 1 - Accounting Policies The accompanying unaudited condensed consolidated financial statements include the accounts of Horizon Bancorp, Inc. (“Horizon” or the “Company”) and its wholly-owned subsidiaries, including Horizon Bank (“Horizon Bank” or the “Bank”). Horizon Bank (formerly known as “Horizon Bank, N.A.”) was a national association until its conversion to an Indiana commercial bank effective June 23, 2017. All inter–company balances and transactions have been eliminated. The results of operations for the periods ended September 30, 2020 and September 30, 2019 are not necessarily indicative of the operating results for the full year of 2020 or 2019. The accompanying unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of Horizon’s management, necessary to fairly present the financial position, results of operations and cash flows of Horizon for the periods presented. Those adjustments consist only of normal recurring adjustments. Certain information and note disclosures normally included in Horizon’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Horizon’s Annual Report on Form 10-K for 2019 filed with the Securities and Exchange Commission on February 28, 2020. The condensed consolidated balance sheet of Horizon as of December 31, 2019 has been derived from the audited balance sheet as of that date. On July 16, 2019, the Board of Directors of the Company authorized a stock repurchase program for up to 2,250,000 shares of Horizon’s issued and outstanding common stock, no par value. As of September 30, 2020, Horizon had repurchased a total of 373,323 shares at an average price per share of $ 15.86 . In addition to the stock repurchase program, Horizon agreed to repurchase 1,000,000 shares at a price per share of $ 15.19 from an individual shareholder on March 6, 2020. Basic earnings per share is computed by dividing net income available to common shareholders (net income less dividend requirements for preferred stock and accretion of preferred stock discount) by the weighted–average number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The following table shows computation of basic and diluted earnings per share. Three Months Ended Nine Months Ended September 30 September 30 2020 2019 2020 2019 Basic earnings per share Net income $ 20,312 $ 20,537 $ 46,606 $ 47,995 Weighted average common shares outstanding 43,862,435 45,038,021 44,099,862 42,995,082 Basic earnings per share $ 0.46 $ 0.46 $ 1.06 $ 1.12 Diluted earnings per share Net income $ 20,312 $ 20,537 $ 46,606 $ 47,995 Weighted average common shares outstanding 43,862,435 45,038,021 44,099,862 42,995,082 Effect of dilutive securities: Restricted stock 8,246 — 32,574 — Stock options 33,200 75,709 33,214 75,013 Weighted average common shares outstanding 43,903,881 45,113,730 44,165,650 43,070,095 Diluted earnings per share $ 0.46 $ 0.46 $ 1.06 $ 1.11 11 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) There were 492,273 and 273,776 shares for the three and nine months ended September 30, 2020, which were not included in the computation of diluted earnings per share because they were non–dilutive. There were 340,540 shares for the three and nine months ended September 30, 2019, which were not included in the computation of diluted earnings per share because they were non–dilutive. Horizon has share-based employee compensation plans, which are described in the notes to the financial statements included in the December 31, 2019 Annual Report on Form 10–K. Adoption of New Accounting Standards Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2016–13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments – On January 1, 2020, the Company adopted ASU No. 2016–13, “ Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“CECL”). The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held to maturity securities. It also applies to off–balance sheet (“OBS”) credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar agreements). In addition, ASC 326 made changes to the accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance, rather than as a write–down, on available for sale debt securities management does not intend to sell or believe that it is not more likely than not they will be required to sell. The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and OBS credit exposures. Results for reporting periods beginning after December 31, 2019, are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $ 15.6 million as of January 1, 2020 for the cumulative effect of adopting ASC 326. The Company adopted ASC 326 using the prospective transition approach for financial assets purchased with credit deterioration (“PCD”), previously classified as purchased credit impaired (“PCI”) and accounted for under ASC 310–30. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. On January 1, 2020, the amortized cost basis of the PCD assets was adjusted to reflect the addition of $ 2.8 million of allowance for credit losses (“ACL”) on loans. The following table illustrates the impact of ASC 326. January 1, 2020 As Reported Under ASC 326 Pre-ASC 326 Adoption Impact of ASC 326 Adoption Loans Commercial $ 25,614 $ 11,996 $ 13,618 Real estate 4,971 923 4,048 Mortgage warehouse 1,077 1,077 — Consumer 8,582 3,671 4,911 Allowance for credit losses on loans $ 40,244 $ 17,667 $ 22,577 12 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the principal balance outstanding, net of purchase premiums and discounts, and deferred loan fees and costs. Accrued interest receivable totaling $ 13.4 million at September 30, 2020 was excluded from the ACL calculation and was reported in accrued interest receivable on the consolidated balance sheets. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the effective yield method without anticipating prepayments. 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 generally 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 Commercial Banking Officer and/or the Chief Operations 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. Non–accrual 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 non–accrual loan to accrual status. Consistent with regulatory guidance, charge–offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined. For all loan portfolio segments except 1–4 family residential properties and consumer, the Company promptly charges–off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge–off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral. The Company charges–off 1–4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge–down or specific allocation of family first and junior lien mortgages to the net realizable value less costs to sell when the value is known but no later than when a loan is 180 days past due. Pursuant to such guidelines, the Company also charges–off unsecured open–end loans when the loan is contractually 90 days past due, and charges down to the net realizable value other secured loans when they are contractually 90 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well–secured and in the process of collection, such that collection in full will occur regardless of delinquency status, are not charged off. 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 13 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) 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 troubled debt restructurings, are measured for impairment. Allowable methods for determining the amount of impairment include the three methods described above. Purchased Credit Deteriorated Loans The Company has purchased loans, some of which have experienced credit deterioration since origination. PCD loans are recorded at the amount paid. An ACL on loans is determined using the same methodology as other loans held for investment. The initial ACL on loans determined on a collective basis is allocated to individual loans. The sum of the loan’s purchase price and ACL on loans becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the ACL on loans are recorded through credit loss expense. The Company adopted this ASU using the prospective transition approach for PCD loans previously accounted for under ASC 310–30. In accordance with the standard, we did not assess whether PCI loans met the criteria of PCD as of the date of adoption and all loans previously classified as PCI were updated to the PCD classification. Pools utilized for PCI accounting under ASC 310–30 were not considered since the Company did not have PCI pools at the time of adoption. PCD loans were assessed using prior specific loan reviews for the initial PCD loan ACL. At the date of adoption, no securities were determined to be PCD. Allowance for Credit Losses on Loans The ACL on loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged–off against the allowance when management believes the loan balance is confirmed to no longer be collectible. Expected recoveries do not exceed the aggregate of amounts previously charged–off and expected to be charged–off. Management estimates the allowance balance using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan–specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency level, or term as well as for changes in environmental conditions, changes in economic conditions, or other relevant factors. The Company considers the following when estimating credit losses: 1) available information relevant to assessing the collectibility of cash flows including internal information, external information or a combination of both relating to past events, current conditions and reasonable and supportable forecasts; 2) relevant qualitative and quantitative factors relating to the environment in which the Bank operates and factors specific to the borrower; 3) off–balance sheet credit exposures; and credit support. ACL on loans is measured on a collective basis and reflects impairment in groups of loans aggregated on the basis of similar risk characteristics which may include any one or a combination of the following: internal credit ratings, risk ratings or classification, financial asset type, collateral type, size, industry of the borrower, historical or expected credit loss patterns, and reasonable and supportable forecast periods. The ACL for a specific portfolio segment is computed by multiplying the loss rate by the amortized cost balance of the segment with adjustments for other qualitative factors as described above. As appropriate, newer credit products or portfolios with limited historical loss may use applicable external data for determining the ACL until experience justifies that sufficient product maturity supports the estimate of expected credit losses. 14 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Pursuant to ASC 326–20–30–9, an entity shall not rely solely on past events to estimate expected credit losses, and should consider adjustments to historical information to reflect the extent to which management expects current conditions and forecasted conditions to differ from the periods utilized for the historical loss rate calculation. Management has incorporated an adjustment of the historical loss rate calculated within the model to reflect current and forecasted condition and has applied this adjustment on a qualitative factor basis to the aggregate pool loss rate. The qualitative adjustment is based on a combination of external econometric data and internal factors such as portfolio composition, changes in management, changes in loan policy and other factors. The economic forecast is based in part on economic indexes and quantitative matrices with a six to twelve month forecast. The qualitative adjustment is calculated based on current and forecasted conditions and evaluated each quarter by management, and therefore is dynamic in nature. As a result of the forecast being applied as a qualitative factor and adjusted quarterly, no reversion to the historical loss rate is necessary, as the historical base loss rate is preserved in the calculation of “all in” loss rate. Specific reserves reflect impairment on loans identified for evaluation or individually considered non–performing, including troubled debt restructurings and receivables where the Company has determined foreclosure is probable. These loans no longer have similar risk characteristics to collectively evaluated loans due to changes in credit risk, borrower circumstances, recognition of write–offs, or cash collections that have been fully applied to principal on the basis of non–accrual policies. At a minimum, the population of loans subject to individual evaluation include individual loans and leases where it is probable we will be unable to collect all amounts due, according to the original contractual terms. These include commercial impaired loans, jumbo residential mortgages (as defined), and jumbo home equity loans with a balance exceeding $250,000, and other loans as determined by management. ACL for residential and consumer loans are, primarily, determined by meaningful pools of similar loans and are evaluated on a quarterly basis. Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not also included in the collective evaluation. When management determines that foreclosure is probable, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. The provision for credit losses on loans on individually evaluated loans is recognized on the fair value of collateral adjusted for estimated costs to sell, the basis of the present value of expected future cash flows discounted at the effective interest rate or the observable market price as of the relevant date. T he table below identifies the Company’s loan portfolio segments and classes. Portfolio Segment Class of Financing Receivable Commercial Owner occupied real estate Non-owner occupied real estate Residential spec homes Development & spec land Commercial and industrial Real estate Residential mortgage Residential construction Mortgage warehouse Mortgage warehouse Consumer Direct installment Indirect installment Home equity Portfolio segment is defined as a level at which an entity develops and documents a systematic methodology to determine its allowance for credit losses. Class of financing receivable is defined as a group of financing receivables determined on the basis of both of the following, 1) risk characteristics of the financing receivable, and 2) an entity’s method for monitoring and assessing credit risk. Generally, the Bank does not move loans from a revolving loan to a term loan other than construction loans. Construction loans are reviewed and rewritten prior to being originated as a term loan. 15 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Commercial Commercial loans are primarily based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may incorporate a personal guarantee. However, some short–term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Commercial real estate loans are viewed primarily as cash flow loans and, secondarily, as loans secured by real estate. Commercial real estate lending typically involves larger loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets, the general economy, or fluctuations in interest rates. The properties securing the Company’s commercial real estate portfolio are diverse in terms of property type, and are monitored for concentrations of credit. Management monitors and evaluates commercial real estate loans based on collateral, cash flow, and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner–occupied commercial real estate loans versus non–owner occupied loans. Real Estate and Consumer With respect to residential loans that are secured by 1–4 family residences and are generally owner occupied, the Company generally establishes a maximum loan–to–value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1–4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers. Mortgage Warehousing Horizon’s mortgage warehouse lending has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with a pledge of collateral under Horizon’s agreement with the mortgage company. Each mortgage loan funded by Horizon undergoes an underwriting review by Horizon to the end investor guidelines and is assigned to Horizon until the loan is sold to the secondary market by the mortgage company. In addition, Horizon takes possession of each original note and forwards such note to the end investor once the mortgage company has sold the loan. At the time a loan is transferred to the secondary market, the mortgage company reacquires the loan under its option within the agreement. Due to the reacquire feature contained in the agreement, the transaction does not qualify as a sale and therefore is accounted for as a secured borrowing with a pledge of collateral pursuant to the agreement with the mortgage company. When the individual loan is sold to the end investor by the mortgage company, the proceeds from the sale of the loan are received by Horizon and used to pay off the loan balance with Horizon along with any accrued interest and any related fees. The remaining balance from the sale is forwarded to the mortgage company. These individual loans typically are sold by the mortgage company within 30 days and are seldom held more than 90 days. Interest income is accrued during this period and collected at the time each loan is sold. Fee income for each loan sold is collected when the loan is sold, and no costs are deferred due to the term between each loan funding and related payoff, which is typically less than 30 days. Based on the agreements with each mortgage company, at any time a mortgage company can reacquire from Horizon its outstanding loan balance on an individual mortgage and regain possession of the original note. Horizon also has the option to request that the mortgage company reacquire an individual mortgage. Should this occur, Horizon would return the original note and reassign the assignment of the mortgage to the mortgage company. Also, in the event that the end investor would not be able to honor the purchase commitment and the mortgage company would not be able to reacquire its loan on an individual mortgage, Horizon would be able to exercise its rights under the agreement. 16 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Determining the Contractual Term Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Troubled Debt Restructurings (“TDR”) A loan for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, is considered to be a TDR. The ACL on loans on a TDR is measured using the same method as all other loans held for investment, except that the original interest rate is used to discount the expected cash flows, not the rate specified within the restructuring. The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act provides all banks with the option to elect either or both of the following from March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the termination of the national emergency: i. to suspend the requirements under GAAP for loan modifications related to the COVID–19 pandemic that would otherwise be categorized as a TDR; and/or ii. to suspend any determination of a loan modified as a result of the effects of the COVID–19 pandemic as being a TDR, including impairment for accounting purposes. If a bank elects a suspension noted above, the suspension (i) will be effective for the term of the loan modification, but solely with respect to any modification, including a forbearance arrangement, an interest rate modification, a repayment plan, and any other similar arrangement that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019; and (ii) will not apply to any adverse impact on the credit of a borrower that is not related to the COVID–19 pandemic. Allowance for Credit Losses on Off-Balance Sheet Credit Exposures The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The Company determines the estimated amount of expected credit extensions based on historical usage to calculate the amount of exposure for a loss estimate. After review of the expected credit losses on OBS, the Company determined the amount not being recorded as immaterial at this time. Allowance for Credit Losses on Available for Sale Securities For available for sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For debt securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recorded in other comprehensive income. 17 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Changes in the ACL are recorded as provision for, or reversal of, credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Allowance for Credit Losses on Held to Maturity Securities For held to maturity securities, the Company conducts an assessment of its held to maturity securities at the time of purchase and on at least an annual basis to ensure such investment securities remain within appropriate levels of risk and continue to perform satisfactorily in fulfilling its obligations. The Company considers, among other factors, the nature of the securities and credit ratings or financial condition of the issuer. If available, the Company obtains a credit rating for issuers from the Nationally Recognized Statistical Rating Organization (“NRSRO”) for consideration. If this assessment indicates that a material credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss. After completing this assessment, management determined any credit losses as of September 30, 2020 were not material to the consolidated financial statements. FASB ASU No. 2017–04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment – On January 1, 2020, the Company adopted the provision of ASU No. 2017–04, which eliminates Step 2 from the goodwill impairment test. Under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. This ASU eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative test. At each reporting date between annual goodwill impairment tests, Horizon considers potential indicators of impairment. Given the current economic uncertainty and volatility surrounding COVID–19, Horizon assessed whether the events and circumstances resulted in it being more likely than not that the fair value of any reporting unit was less than its carrying value. Impairment indicators considered comprised the condition of the economy and banking industry; government intervention and regulatory updates; the impact of recent events to financial performance and cost factors of the reporting unit; performance of the Company’s stock and other relevant events. Horizon further considered the amount by which fair value exceeded book value in the most recent quantitative analysis and sensitivities performed. At the conclusion of the assessment, the Company determined that as of September 30, 2020 it was more likely than not that the fair value exceeded its carrying values. Horizon will continue to monitor developments regarding the COVID–19 pandemic and measures implemented in response to the pandemic, market capitalization, overall economic conditions and any other triggering events or circumstances that may indicate an impairment of goodwill in the future. The adoption of this new guidance did not have a material impact on our consolidated financial statements. FASB ASU No. 2018–13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement – On January 1, 2020, the Company adopted the provision of ASU 2018–13, which modifies the disclosure requirements on fair value measurements. The amendment removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements. The update also adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, the Company may disclose other quantitative information in lieu of the weighted average if we determine that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The adoption of this new guidance did not have a material impact on our consolidated financial statements. 18 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Reclassifications Certain reclassifications have been made to the 2019 condensed consolidated financial statements to be comparable to 2020. These reclassifications had no effect on net income. Note 2 – Acquisitions Salin Bancshares, Inc. On March 26, 2019, Horizon completed the acquisition of Salin Bancshares, Inc. (“Salin”), an Indiana corporation, and Horizon Bank’s acquisition of Salin Bank and Trust Company (“Salin Bank”), an Indiana commercial bank and wholly–owned subsidiary of Salin, through mergers effective March 26, 2019. Under the terms of the Merger Agreement, shareholders of Salin received 23,907.5 shares of Horizon common stock and $ 87,417.17 in cash for each outstanding share of Salin common stock. Salin shares outstanding at the closing to be exchanged were 275 , and the shares of Horizon common stock issued to Salin shareholders totaled 6,563,697 . The Salin shareholders received cash in lieu of fractional shares. Based upon the March 25, 2019 closing price of $ 15.65 per share of Horizon common stock immediately prior to the effectiveness of the merger the transaction had an implied valuation of approximately $ 126.7 million. The Company incurred approximately $ 5.6 million in costs related to the acquisition. These expenses are classified in the non–interest expense section of the income statement and are primarily located in the data processing, professional fees, outside services and consultants and other expense line items. As a result of the acquisition, the Company was able to increase its deposit base and reduce transaction costs. The Company also expects to reduce costs through economies of scale. Under the acquisition method of accounting, the total purchase price was allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition. Assets Liabilities Cash and due from banks $ 152,745 Deposits Investment securities, available for sale 54,319 Non–interest bearing $ 188,744 Loans NOW accounts 207,567 Commercial 352,798 Savings and money market 274,504 Residential mortgage 131,008 Certificates of deposit 70,529 Consumer 85,112 Total deposits 741,344 Total loans 568,918 Borrowings 70,495 Premises and equipment, net 20,425 Subordinated debentures 18,376 FRB and FHLB stock 3,571 Interest payable 826 Goodwill 31,358 Other liabilities 8,759 Core deposit intangible 19,818 Total liabilities assumed $ 839,800 Interest receivable 2,488 Other assets 112,880 Total assets purchased $ 966,522 Common shares issued $ 102,722 Cash paid 24,000 Total purchase price $ 126,722 Of the total purchase price of $ 126.7 million, $ 19.8 million was allocated to core deposit intangible. Additionally, $ 31.4 million was allocated to goodwill and none of the purchase price is deductible. The core deposit intangible is being amortized over 10 years on a straight–line basis. The Company acquired various loans in the acquisition that had evidence of deterioration of credit quality since origination 19 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) and it was probable, at acquisition, that all contractually required payments would not be collected. Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past–due and non–accrual status, borrower credit scores and recent loan–to–value percentages. Purchased credit–impaired loans at the acquisition date, were accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310–30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans was not carried over and recorded at the acquisition date. Management estimated the cash flows expected to be collected at acquisition using our internal risk models, which incorporated the estimate of current assumptions, such as default rates, severity and prepayment speeds. The following table details the acquired loans that are accounted for in accordance with ASC 310–30 as of March 26, 2019. Contractually required principal and interest at acquisition $ 22,672 Contractual cash flows not expected to be collected (nonaccretable differences) 6,694 Expected cash flows at acquisition 15,978 Interest component of expected cash flows (accretable discount) 735 Fair value of acquired loans accounted for under ASC310-30 $ 15,243 Estimates of certain loans, those for which specific credit–related deterioration has occurred since origination, were recorded at fair value, reflecting the present value of the amounts expected to be collected. Income recognition of these loans is based on reasonable expectation about the timing and amount of cash flows to be collected. The results of operations of Salin have been included in the Company’s consolidated financial statements since the acquisition date. The following schedule includes pro–forma results for the three and nine months ended September 30, 2019 as if the Salin acquisition had occurred as of the beginning of the comparable prior reporting period. Three Months Ended Nine Months Ended September 30 September 30 2019 2019 Summary of Operations: Net Interest Income $ 43,463 $ 127,174 Provision for Loan Losses 376 1,936 Net Interest Income after Provision for Loan Losses 43,087 125,238 Non-interest Income 11,514 31,538 Non-interest Expense 30,060 103,796 Income before Income Taxes 24,541 52,980 Income Tax Expense 4,004 9,326 Net Income 20,537 43,654 Net Income Available to Common Shareholders $ 20,537 $ 43,654 Basic Earnings per Share $ 0.46 $ 0.97 Diluted Earnings per Share $ 0.46 $ 0.97 The pro–forma information includes adjustments for interest income on loans, amortization of intangibles arising from the transaction, interest expense on deposits acquired, premises expense for the banking centers acquired and the related income tax effects. 20 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The pro–forma financial information is presented for information purposes only and is not indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results. Note 3 – Securities The fair value of securities is as follows: September 30, 2020 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Available for sale U.S. Treasury and federal agencies $ 6,250 $ — $ ( 11 ) $ 6,239 State and municipal 651,256 27,978 ( 775 ) 678,459 Federal agency collateralized mortgage obligations 180,628 5,222 ( 1 ) 185,849 Federal agency mortgage-backed pools 127,802 4,670 — 132,472 Corporate notes 10,877 1,447 — 12,324 Total available for sale investment securities $ 976,813 $ 39,317 $ ( 787 ) $ 1,015,343 Held to maturity State and municipal $ 165,858 $ 10,919 $ — $ 176,777 Federal agency collateralized mortgage obligations 2,839 67 — 2,906 Federal agency mortgage-backed pools 11,573 356 — 11,929 Total held to maturity investment securities $ 180,270 $ 11,342 $ — $ 191,612 December 31, 2019 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Available for sale U.S. Treasury and federal agencies $ 1,415 $ — $ ( 2 ) $ 1,413 State and municipal 396,931 11,288 ( 2,451 ) 405,768 Federal agency collateralized mortgage obligations 267,272 2,543 ( 563 ) 269,252 Federal agency mortgage-backed pools 145,623 1,207 ( 258 ) 146,572 Corporate notes 10,848 923 — 11,771 Total available for sale investment securities $ 822,089 $ 15,961 $ ( 3,274 ) $ 834,776 Held to maturity State and municipal $ 190,767 $ 7,129 $ ( 54 ) $ 197,842 Federal agency collateralized mortgage obligations 4,560 13 ( 5 ) 4,568 Federal agency mortgage-backed pools 12,572 194 ( 29 ) 12,737 Total held to maturity investment securities $ 207,899 $ 7,336 $ ( 88 ) $ 215,147 Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information, and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary. While these securities are held in the available for sale portfolio and held to maturity, Horizon intends, and has the ability, to hold them until the earlier of a recovery in fair value or maturity. 21 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The amortized cost and fair value of securities available for sale and held to maturity at September 30, 2020 and December 31, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. September 30, 2020 December 31, 2019 Amortized Cost Fair Value Amortized Cost Fair Value Available for sale Within one year $ 49,129 $ 49,088 $ 37,386 $ 37,321 One to five years 49,766 51,201 41,230 41,293 Five to ten years 112,483 121,648 117,004 122,145 After ten years 457,005 475,085 213,574 218,193 668,383 697,022 409,194 418,952 Federal agency collateralized mortgage obligations 180,628 185,849 267,272 269,252 Federal agency mortgage–backed pools 127,802 132,472 145,623 146,572 Total available for sale investment securities $ 976,813 $ 1,015,343 $ 822,089 $ 834,776 Held to maturity Within one year $ 8,205 $ 8,245 $ 7,811 $ 7,874 One to five years 46,090 47,750 56,037 57,048 Five to ten years 85,339 91,579 94,756 98,480 After ten years 26,224 29,203 32,163 34,440 165,858 176,777 190,767 197,842 Federal agency collateralized mortgage obligations 2,839 2,906 4,560 4,568 Federal agency mortgage–backed pools 11,573 11,929 12,572 12,737 Total held to maturity investment securities $ 180,270 $ 191,612 $ 207,899 $ 215,147 The following table shows the gross unrealized losses and the fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position. September 30, 2020 Less than 12 Months 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses Investment Securities U.S. Treasury and federal agencies $ 5,239 $ ( 11 ) $ — $ — $ 5,239 $ ( 11 ) State and municipal 105,976 ( 733 ) 1,307 ( 42 ) 107,283 ( 775 ) Federal agency collateralized mortgage obligations 600 ( 1 ) — — 600 ( 1 ) Total temporarily impaired securities $ 111,815 $ ( 745 ) $ 1,307 $ ( 42 ) $ 113,122 $ ( 787 ) 22 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) December 31, 2019 Less than 12 Months 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses Investment Securities U.S. Treasury and federal agencies $ 1,413 $ ( 2 ) $ — $ — $ 1,413 $ ( 2 ) State and municipal 129,942 ( 2,374 ) 6,279 ( 131 ) 136,221 ( 2,505 ) Federal agency collateralized mortgage obligations 68,043 ( 308 ) 23,301 ( 260 ) 91,344 ( 568 ) Federal agency mortgage–backed pools 24,740 ( 104 ) 37,822 ( 183 ) 62,562 ( 287 ) Total temporarily impaired securities $ 224,138 $ ( 2,788 ) $ 67,402 $ ( 574 ) $ 291,540 $ ( 3,362 ) Information regarding security proceeds, gross gains and gross losses are presented below. Three Months Ended Nine Months Ended September 30 September 30 2020 2019 2020 2019 Sales of securities available for sale Proceeds $ 17,012 $ — $ 54,194 $ 91,635 Gross gains 1,094 — 1,731 158 Gross losses ( 6 ) — ( 56 ) ( 243 ) 23 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 4 – Loans The following table presents total loans outstanding by portfolio class, as of September 30, 2020: September 30, 2020 Commercial Owner occupied real estate $ 503,127 Non–owner occupied real estate 1,019,171 Residential spec homes 11,190 Development & spec land 26,385 Commercial and industrial 761,735 Total commercial 2,321,608 Real estate Residential mortgage 651,680 Residential construction 23,540 Mortgage warehouse 374,653 Total real estate 1,049,873 Consumer Direct installment 39,049 Indirect installment 359,299 Home equity 260,536 Total consumer 658,884 Total loans 4,030,365 Allowance for loan losses ( 56,319 ) Net loans $ 3,974,046 As of September 30, 2020, loans originated under the Federal Paycheck Protection Program (“PPP”) totaled approximately $ 310.8 million. Total loans include net deferred loan fees of $ 5.7 million at September 30, 2020. 24 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The following table presents total loans outstanding, as of December 31, 2019: December 31, 2019 Commercial Working capital and equipment $ 938,317 Real estate, including agriculture 978,891 Tax exempt 63,571 Other 65,872 Total 2,046,651 Real estate 1–4 family 762,571 Other 8,146 Total 770,717 Consumer Auto 362,729 Recreation 16,262 Real estate/home improvement 43,585 Home equity 237,979 Unsecured 7,286 Other 1,339 Total 669,180 Mortgage warehouse 150,293 Total loans 3,636,841 Allowance for loan losses ( 17,667 ) Loans, net $ 3,619,174 Note 5 – Accounting for Certain Loans Acquired in a Transfer The Company has acquired loans in acquisitions, whereby the transferred loans had evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past–due and non–accrual status, borrower credit scores and recent loan–to–value percentages prior to January 1, 2020. Purchased credit–impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310–30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. Management estimated the cash flows expected to be collected at acquisition using our internal risk models, which incorporate the estimate of current key assumptions, such as default rates, severity and prepayment speeds. 25 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The carrying amounts of those loans included in the balance sheet amounts of loans receivable as of December 31, 2019 are as follows: December 31, 2019 Commercial Real Estate Consumer Outstanding Balance Allowance for Loan Losses Carrying Amount Heartland $ 197 $ 99 $ — $ 296 $ — $ 296 Summit 88 473 — 561 — 561 Peoples 229 35 — 264 — 264 Kosciusko 244 131 — 375 — 375 LaPorte 353 793 20 1,166 — 1,166 Lafayette 1,867 — — 1,867 — 1,867 Wolverine 2,289 — — 2,289 — 2,289 Salin 4,938 1,912 962 7,812 133 7,679 Total $ 10,205 $ 3,443 $ 982 $ 14,630 $ 133 $ 14,497 Accretable yield, or income expected to be collected for the nine months ended September 30, 2019 is as follows: Nine Months Ended September 30, 2019 Beginning balance Additions Accretion Reclassification from nonaccretable difference Disposals Ending balance Heartland $ 174 $ — $ ( 24 ) $ — $ — $ 150 Summit 42 — ( 7 ) — ( 11 ) 24 Kosciusko 300 — ( 49 ) — ( 2 ) 249 LaPorte 829 — ( 85 ) — 4 748 Lafayette 609 — ( 97 ) — ( 193 ) 319 Wolverine 698 — ( 243 ) — ( 306 ) 149 Salin — 2,002 ( 375 ) — ( 30 ) 1,597 Total $ 2,652 $ 2,002 $ ( 880 ) $ — $ ( 538 ) $ 3,236 During the nine months ended September 30, 2019, the Company increased the allowance for loan losses on purchased loans by a charge to the income statement of $ 10,000 . 26 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 6 – Allowance for Credit and Loan Losses The following tables represent, by loan portfolio segment, a summary of changes in the ACL on loans for the three months ended September 30, 2020 and 2019: Three Months Ended September 30, 2020 Commercial Real Estate Mortgage Warehouse Consumer Total Balance, beginning of period $ 39,147 $ 5,832 $ 1,190 $ 8,921 $ 55,090 Provision for credit losses on loans 1,136 ( 232 ) 60 1,088 2,052 Charge–offs ( 502 ) ( 144 ) — ( 510 ) ( 1,156 ) Recoveries 14 8 — 311 333 Balance, end of period $ 39,795 $ 5,464 $ 1,250 $ 9,810 $ 56,319 Three Months Ended September 30, 2019 Commercial Real Estate Mortgage Warehouse Consumer Total Balance, beginning of period $ 11,881 $ 1,732 $ 1,040 $ 3,652 $ 18,305 Provision for credit losses on loans 393 ( 290 ) 1 272 376 Charge–offs ( 224 ) — — ( 758 ) ( 982 ) Recoveries 32 7 — 218 257 Balance, end of period $ 12,082 $ 1,449 $ 1,041 $ 3,384 $ 17,956 The following tables represent, by loan portfolio segment, a summary of changes in the ACL on loans for the nine months ended September 30, 2020 and 2019: Nine Months Ended September 30, 2020 Commercial Real Estate Mortgage Warehouse Consumer Total Balance, beginning of period $ 11,996 $ 923 $ 1,077 $ 3,671 $ 17,667 Impact of adopting ASC 326 10,832 4,048 — 4,911 19,791 Initial PCD allowance 2,786 — — — 2,786 Provision for credit losses on loans 14,655 670 173 2,211 17,709 Charge–offs ( 586 ) ( 204 ) — ( 1,654 ) ( 2,444 ) Recoveries 112 27 — 671 810 Balance, end of period $ 39,795 $ 5,464 $ 1,250 $ 9,810 $ 56,319 Nine Months Ended September 30, 2019 Commercial Real Estate Mortgage Warehouse Consumer Total Balance, beginning of period $ 10,495 $ 1,676 $ 1,006 $ 4,643 $ 17,820 Provision for credit losses on loans 2,105 ( 220 ) 35 ( 284 ) 1,636 Charge–offs ( 640 ) ( 48 ) — ( 1,669 ) ( 2,357 ) Recoveries 122 41 — 694 857 Balance, end of period $ 12,082 $ 1,449 $ 1,041 $ 3,384 $ 17,956 27 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The Company utilized the Cumulative Loss Rate method in determining expected future credit losses. The loss rate method measures the amount of loan charge–offs, net of recoveries, (“loan losses”) recognized over the life of a pool and compares those loan losses to the outstanding loan balance of that pool as of a specific point in time (“pool date”). To estimate a CECL loss rate for the pool, management first identifies the loan losses recognized between the pool date and the reporting date for the pool and determines which loan losses were related to loans outstanding at the pool date. The loss rate method then divides the loan losses recognized on loans outstanding as of the pool date by the outstanding loan balance as of the pool date. The Company’s expected loss estimate is anchored in historical credit loss experience, with an emphasis on all available portfolio data. The Company's historical look–back period includes January 2012 through the current period, on a monthly basis. When historical credit loss experience is not sufficient for a specific portfolio, the Company may supplement its own portfolio data with external models or data. Qualitative reserves reflect management’s overall estimate of the extent to which current expected credit losses on collectively evaluated loans will differ from historical loss experience. The analysis takes into consideration other analytics performed within the organization, such as enterprise and concentration management, along with other credit–related analytics as deemed appropriate. Management attempts to quantify qualitative reserves whenever possible. The Company’s CECL estimate applies to a forecast that incorporates macroeconomic trends and other environmental factors. Management utilized National, Regional and Local Leading Economic Indexes, as well as management judgment, as the basis for the forecast period. The historical loss rate was utilized as the base rate, and qualitative adjustments were utilized to reflect the forecast and other relevant factors. The Company segments the loan portfolio into pools based on the following risk characteristics: financial asset type, loan purpose, collateral type, loan characteristics, credit characteristics, outstanding loan balances, contractual terms and prepayment assumptions, industry of the borrower and concentrations, and historical or expected credit loss patterns. The $17.7 million ACL provision included special allocations related to the potential impact due to the nature and characteristics on certain loan types including, non–owner occupied retail, leisure and hospitality, and unstabilized commercial real estate while continuing allocations for hotels and restaurants, as a result of the COVID–19 business restrictions implemented by the Federal Government and the states in which Horizon operates (Indiana and Michigan). Extensive analysis and monitoring of these portfolios has been undertaken and, while no loss has been specifically identified, the risks to certain borrowers are elevated and, therefore, the special allocation was deemed prudent. 28 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The following table presents the balance in the allowance for credit loss and the recorded investment in loans, by portfolio segment, and based on impairment analysis as of December 31, 2019: December 31, 2019 Commercial Real Estate Mortgage Warehousing Consumer Total Allowance For Loan Losses Ending allowance balance attributable to loans: Individually evaluated for impairment $ 541 $ — $ — $ — $ 541 Collectively evaluated for impairment 11,455 923 1,077 3,671 17,126 Loans acquired with deteriorated credit quality — — — — — Total ending allowance balance $ 11,996 $ 923 $ 1,077 $ 3,671 $ 17,667 Loans: Individually evaluated for impairment $ 7,347 $ — $ — $ — $ 7,347 Collectively evaluated for impairment 2,040,299 770,705 150,293 665,952 3,627,249 Loans acquired with deteriorated credit quality — — — — — Total ending loans balance $ 2,047,646 $ 770,705 $ 150,293 $ 665,952 $ 3,634,596 29 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 7 – Non-performing Loans The following table presents the non–accrual, loans past due over 90 days still on accrual, and troubled debt restructured (“TDRs”) by class of loans: September 30, 2020 Non–accrual Loans Past Due Over 90 Days Still Accruing Non–performing TDRs Performing TDRs Total Non–performing Loans Non–accrual with no Allowance for Credit Losses Commercial Owner occupied real estate $ 11,105 $ — $ 629 $ 169 $ 11,903 $ 8,715 Non–owner occupied real estate 1,181 — 340 — 1,521 1,033 Residential spec homes — — — — — — Development & spec land 70 — — — 70 70 Commercial and industrial 2,152 — 523 — 2,675 1,921 Total commercial 14,508 — 1,492 169 16,169 11,739 Real estate Residential mortgage 6,606 205 988 1,410 9,209 7,594 Residential construction — — — — — — Mortgage warehouse — — — — — — Total real estate 6,606 205 988 1,410 9,209 7,594 Consumer Direct installment 23 — — — 23 23 Indirect installment 1,122 69 — — 1,191 1,122 Home equity 2,195 57 224 246 2,722 2,419 Total consumer 3,340 126 224 246 3,936 3,564 Total $ 24,454 $ 331 $ 2,704 $ 1,825 $ 29,314 $ 22,897 There was no interest income recognized on non–accrual loans during the three and nine months ended September 30, 2020 and 2019 while the loans were in non–accrual status. Included in the $ 24.5 million of non–accrual loans and the $ 2.7 million of non–performing TDRs at September 30, 2020 were $ 3.5 million and $ 993,000 , respectively, of loans acquired for which accretable yield was recognized. 30 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) December 31, 2019 Non–accrual Loans Past Due Over 90 Days Still Accruing Non–performing TDRs Performing TDRs Total Non–performing Loans Non–accrual with no Allowance for Credit Losses Commercial Owner occupied real estate $ 2,424 $ — $ 629 $ 139 $ 3,192 $ 2,563 Non–owner occupied real estate 682 — 374 — 1,056 937 Residential spec homes — — — — — — Development & spec land 73 — — — 73 73 Commercial and industrial 1,603 — 78 1,345 3,026 514 Total commercial 4,782 — 1,081 1,484 7,347 4,087 Real estate Residential mortgage 7,614 1 708 1,561 9,884 8,322 Residential construction — — — — — — Mortgage warehouse — — — — — — Total real estate 7,614 1 708 1,561 9,884 8,322 Consumer Direct installment 30 5 — — 35 30 Indirect installment 1,234 135 — — 1,369 1,234 Home equity 2,019 5 217 309 2,550 2,236 Total consumer 3,283 145 217 309 3,954 3,500 Total $ 15,679 $ 146 $ 2,006 $ 3,354 $ 21,185 $ 15,909 Troubled Debt Restructurings Loans modified as TDRs generally consist of allowing borrowers to defer scheduled principal payments and make interest only payments for a specified period of time at the stated interest rate of the original loan agreement or lower payments due to a modification of the loans’ contractual terms. TDRs that continue to accrue interest are individually monitored on a monthly basis and evaluated for impairment annually and transferred to non–accrual status when it is probable that any remaining principal and interest payments due on the loan will not be collected in accordance with the contractual terms of the loan. TDRs that subsequently default are individually evaluated for impairment at the time of default. At September 30, 2020, 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 September 30, 2020, the Company had $ 4.5 million in TDRs, $ 1.8 million were performing according to the restructured terms, and one TDR was returned to accrual status during the first nine months of 2020. There were $ 117,000 of specific reserves allocated to TDRs at September 30, 2020 based on the discounted cash flows or, when appropriate, the fair value of the collateral. These TDRs are exclusive of loans modified under the CARES Act during the first nine months of 2020. 31 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The following table presents TDRs by loan portfolio: September 30, 2020 December 31, 2019 Non–accrual Accruing Total Non–accrual Accruing Total Commercial Owner occupied real estate $ 629 $ 169 $ 798 $ 629 $ 139 $ 768 Non–owner occupied real estate 340 — 340 374 — 374 Residential spec homes — — — — — — Development & spec land — — — — — — Commercial and industrial 523 — 523 78 1,345 1,423 Total commercial 1,492 169 1,661 1,081 1,484 2,565 Real estate Residential mortgage 988 1,410 2,398 708 1,561 2,269 Residential construction — — — — — — Mortgage warehouse — — — — — — Total real estate 988 1,410 2,398 708 1,561 2,269 Consumer Direct installment — — — — — — Indirect installment — — — — — — Home equity 224 246 470 217 309 526 Total consumer 224 246 470 217 309 526 Total $ 2,704 $ 1,825 $ 4,529 $ 2,006 $ 3,354 $ 5,360 Loans Modified under the CARES Act The Bank has elected (i) to suspend the requirements under GAAP for loan modifications related to the COVID–19 pandemic that would otherwise be categorized as a TDR; and (ii) to suspend any determination of a loan modified as a result of the effects of COVID–19 pandemic as being a TDR, including impairment for accounting purposes. At September 30, 2020, the Bank modified loans totaling $ 160.1 million which qualify for treatment under the CARES Act. Collateral Dependent Financial Assets A collateral dependent financial loan relies solely on the operation or sale of the collateral for repayment. In evaluating the overall risk associated with a loan, the Company considers character, overall financial condition and resources, and payment record of the borrower; the prospects for support from any financially responsible guarantors; and the nature and degree of protection provided by the cash flow and value of any underlying collateral. However, as other sources of repayment become inadequate over time, the significance of the collateral’s value increases and the loan may become collateral dependent. 32 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The table below presents the value of collateral dependent loans by loan class as of September 30, 2020: September 30, 2020 Commercial Owner occupied real estate $ 3,018 Non–owner occupied real estate 488 Commercial and industrial 754 Total commercial 4,260 Total collateral dependent loans $ 4,260 The following table presents the payment status by class of loan, excluding non–accrual loans of $ 24.5 million and non–performing TDRs of $ 2.7 million at September 30, 2020: September 30, 2020 Current 30–59 Days Past Due 60–89 Days Past Due 90 Days or Greater Past Due Total Past Due Loans Total Loans Commercial Owner occupied real estate $ 491,393 $ — $ — $ — $ — $ 491,393 Non–owner occupied real estate 1,017,130 282 238 — 520 1,017,650 Residential spec homes 11,190 — — — — 11,190 Development & spec land 25,771 544 — — 544 26,315 Commercial and industrial 759,010 — 50 — 50 759,060 Total commercial 2,304,494 826 288 — 1,114 2,305,608 Real estate Residential mortgage 641,882 1,894 105 205 2,204 644,086 Residential construction 23,540 — — — — 23,540 Mortgage warehouse 374,653 — — — — 374,653 Total real estate 1,040,075 1,894 105 205 2,204 1,042,279 Consumer Direct installment 38,974 24 28 — 52 39,026 Indirect installment 357,060 878 170 69 1,117 358,177 Home equity 256,760 1,069 231 57 1,357 258,117 Total consumer 652,794 1,971 429 126 2,526 655,320 Total $ 3,997,363 $ 4,691 $ 822 $ 331 $ 5,844 $ 4,003,207 Percentage of total loans 99.85 % 0.12 % 0.02 % 0.01 % 0.15 % 100.00 % 33 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The following table presents the payment status by class of loan, excluding non–accrual loans of $ 15.7 million and non–performing TDRs of $ 2.0 million at December 31, 2019: December 31, 2019 Current 30–59 Days Past Due 60–89 Days Past Due 90 Days or Greater Past Due Total Past Due Loans Total Commercial Owner occupied real estate $ 515,604 $ 920 $ — $ — $ 920 $ 516,524 Non–owner occupied real estate 972,195 80 — — 80 972,275 Residential spec homes 12,925 — — — — 12,925 Development & spec land 35,881 — — — — 35,881 Commercial and industrial 503,348 819 11 — 830 504,178 Total commercial 2,039,953 1,819 11 — 1,830 2,041,783 Real estate Residential mortgage 740,712 1,984 — 1 1,985 742,697 Residential construction 19,686 — — — — 19,686 Mortgage warehouse 150,293 — — — — 150,293 Total real estate 910,691 1,984 — 1 1,985 912,676 Consumer Direct installment 40,864 175 5 5 185 41,049 Indirect installment 344,478 2,407 404 135 2,946 347,424 Home equity 273,050 904 20 5 929 273,979 Total consumer 658,392 3,486 429 145 4,060 662,452 Total $ 3,609,036 $ 7,289 $ 440 $ 146 $ 7,875 $ 3,616,911 Percentage of total loans 99.78 % 0.20 % 0.01 % 0.01 % 0.22 % 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 Credit Losses for loans. 34 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) 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). Loan grade definitions are reviewed annually via the approval of the overall loan policy. The most recent review and approval of the loan policy was in October 2020. 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 or loans to any publicly held company with a current long–term debt rating of A or better and meeting defined key financial metric ranges. 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 with required margins where there is no impediment to liquidation; loans to individuals backed by liquid personal assets and unblemished credit histories; or loans to publicly held companies with current long–term debt ratings of Baa or better and meeting defined key financial metric ranges. 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 and meeting defined key financial metric ranges. 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 rated loans and meet defined key financial metric ranges. 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 and meet defined key financial metric ranges, but with above normal risk. Borrower displays potential indicators of weakness in the primary source of repayment resulting in a 35 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) 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. Commercial construction loans are graded as 4W Management Watch until the projects are completed and stabilized. Risk Grade 5: Special Mention Loans which possess some temporary (normally less than one year) 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 and must meet defined key financial metric ranges. 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. • The borrower meets defined key financial metric ranges. 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. • The borrower meets defined key financial metric ranges. 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. 36 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The following tables present loans by credit grades and origination year. September 30, 2020 2020 2019 2018 2017 2016 Prior Revolving Loans Total Commercial Owner occupied real estate Pass $ 43,528 $ 65,996 $ 53,374 $ 50,523 $ 51,460 $ 144,099 $ 37,557 $ 446,537 Special Mention — 855 4,934 10,175 4,532 12,614 — 33,110 Substandard 1,026 1,231 4,048 2,832 2,564 7,912 3,867 23,480 Doubtful — — — — — — — — Total owner occupied real estate $ 44,554 $ 68,082 $ 62,356 $ 63,530 $ 58,556 $ 164,625 $ 41,424 $ 503,127 Non–owner occupied real estate Pass $ 97,251 $ 121,030 $ 77,110 $ 141,356 $ 105,581 $ 224,430 $ 167,632 $ 934,390 Special Mention 1,403 1,247 27,471 2,211 2,610 15,282 4,840 55,064 Substandard — 15,589 304 622 6,802 4,828 1,572 29,717 Doubtful — — — — — — — — Total non–owner occupied real estate $ 98,654 $ 137,866 $ 104,885 $ 144,189 $ 114,993 $ 244,540 $ 174,044 $ 1,019,171 Residential spec homes Pass $ 495 $ — $ — $ 1,660 $ — $ 1,237 $ 7,228 $ 10,620 Special Mention — 212 — — — — 358 570 Substandard — — — — — — — — Doubtful — — — — — — — — Total residential spec homes $ 495 $ 212 $ — $ 1,660 $ — $ 1,237 $ 7,586 $ 11,190 Development & spec land Pass $ 30 $ 885 $ 267 $ 2,232 $ 777 $ 12,224 $ 9,165 $ 25,580 Special Mention — — — — — 276 — 276 Substandard — — — — — 529 — 529 Doubtful — — — — — — — — Total development & spec land $ 30 $ 885 $ 267 $ 2,232 $ 777 $ 13,029 $ 9,165 $ 26,385 Commercial & industrial Pass $ 339,106 $ 64,658 $ 65,712 $ 87,782 $ 27,728 $ 75,580 $ 30,909 $ 691,475 Special Mention 7,650 1,852 10,922 9,880 1,953 5,684 10,641 48,582 Substandard 4,002 6,181 3,584 1,443 816 3,331 2,321 21,678 Doubtful — — — — — — — — Total commercial & industrial $ 350,758 $ 72,691 $ 80,218 $ 99,105 $ 30,497 $ 84,595 $ 43,871 $ 761,735 Total commercial $ 494,491 $ 279,736 $ 247,726 $ 310,716 $ 204,823 $ 508,026 $ 276,090 $ 2,321,608 37 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) September 30, 2020 2020 2019 2018 2017 2016 Prior Revolving Loans Total Real estate Residential mortgage Performing $ 103,964 $ 65,835 $ 102,061 $ 101,581 $ 76,188 $ 190,453 $ 2,389 $ 642,471 Non–performing — 180 639 93 605 7,692 — 9,209 Total residential mortgage $ 103,964 $ 66,015 $ 102,700 $ 101,674 $ 76,793 $ 198,145 $ 2,389 $ 651,680 Residential construction Performing $ 596 $ — $ — $ — $ — $ — $ 22,944 $ 23,540 Non–performing — — — — — — — — Total residential construction $ 596 $ — $ — $ — $ — $ — $ 22,944 $ 23,540 Mortgage warehouse Performing $ — $ — $ — $ — $ — $ — $ 374,653 $ 374,653 Non–performing — — — — — — — — Total mortgage warehouse $ — $ — $ — $ — $ — $ — $ 374,653 $ 374,653 Total real estate $ 104,560 $ 66,015 $ 102,700 $ 101,674 $ 76,793 $ 198,145 $ 399,986 $ 1,049,873 September 30, 2020 2020 2019 2018 2017 2016 Prior Revolving Loans Total Consumer Direct installment Performing $ 10,115 $ 11,016 $ 6,517 $ 6,594 $ 2,558 $ 2,191 $ 35 $ 39,026 Non–performing — — — 11 4 7 1 23 Total direct installment $ 10,115 $ 11,016 $ 6,517 $ 6,605 $ 2,562 $ 2,198 $ 36 $ 39,049 Indirect installment Performing $ 105,780 $ 108,049 $ 84,773 $ 42,883 $ 10,393 $ 6,230 $ — $ 358,108 Non–performing — 146 377 408 92 168 — 1,191 Total indirect installment $ 105,780 $ 108,195 $ 85,150 $ 43,291 $ 10,485 $ 6,398 $ — $ 359,299 Home equity Performing $ 47,991 $ 46,114 $ 38,357 $ 30,295 $ 24,204 $ 65,933 $ 4,920 $ 257,814 Non–performing — 9 61 78 50 1,100 1,424 2,722 Total home equity $ 47,991 $ 46,123 $ 38,418 $ 30,373 $ 24,254 $ 67,033 $ 6,344 $ 260,536 Total consumer $ 163,886 $ 165,334 $ 130,085 $ 80,269 $ 37,301 $ 75,629 $ 6,380 $ 658,884 38 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) December 31, 2019 Pass Special Mention Substandard Doubtful Total Commercial Owner occupied real estate $ 492,386 $ 8,328 $ 18,863 $ — $ 519,577 Non–owner occupied real estate 957,990 7,824 7,517 — 973,331 Residential spec homes 12,925 — — — 12,925 Development & spec land 35,815 — 139 — 35,954 Commercial and industrial 468,893 18,652 18,314 — 505,859 Total commercial 1,968,009 34,804 44,833 — 2,047,646 Real estate Residential mortgage 741,136 — 9,883 — 751,019 Residential construction 19,686 — — — 19,686 Mortgage warehouse 150,293 — — — 150,293 Total real estate 911,115 — 9,883 — 920,998 Consumer Direct installment 41,044 — 35 — 41,079 Indirect installment 347,289 — 1,369 — 348,658 Home equity 273,665 — 2,550 — 276,215 Total consumer 661,998 — 3,954 — 665,952 Total $ 3,541,122 $ 34,804 $ 58,670 $ — $ 3,634,596 Percentage of total loans 97.43 % 0.96 % 1.61 % 0.00 % 100.00 % Commercial loans modified due to the impact of the COVID–19 pandemic were immediately downgraded one level resulting in the increase of Special Mention commercial loans from December 31, 2019 to September 30, 2020. Note 8 – Loan Servicing Loans serviced for others are not included in the accompanying condensed consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled approximately $ 1.5 billion and $ 1.4 billion at September 30, 2020 and December 31, 2019. The aggregate fair value of capitalized mortgage servicing rights was approximately $ 11.7 million and $ 14.4 million at September 30, 2020 and December 31, 2019, compared to the carrying values of $ 11.7 million and $ 14.3 million at September 30, 2020 and December 31, 2019, respectively. Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value. For purposes of measuring impairment, risk characteristics including product type, investor type and interest rates, were used to stratify the originated mortgage servicing rights. 39 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) September 30, December 31, 2020 2019 Mortgage servicing rights Balance, beginning of period $ 15,046 $ 12,876 Servicing rights capitalized 4,107 3,547 Amortization of servicing rights ( 2,056 ) ( 1,377 ) Balance, end of period 17,097 15,046 Impairment allowance Balance, beginning of period ( 719 ) ( 527 ) Additions ( 4,673 ) ( 234 ) Reductions — 42 Balance, end of period ( 5,392 ) ( 719 ) Mortgage servicing rights, net $ 11,705 $ 14,327 The Bank recorded additional impairment of approximately $ 1.5 million and $ 4.7 million for the three and nine months ended September 30, 2020, respectively. The Bank recorded additional impairment of approximately $ 192,000 for the year ended December 31, 2019. Note 9 – Goodwill The following table presents the Company’s carrying amount of goodwill as of September 30, 2020 and December 31, 2019. September 30, December 31, 2020 2019 Balance, beginning of period $ 151,238 $ 119,880 Goodwill acquired during the period — 31,358 Balance, end of period $ 151,238 $ 151,238 In accordance with ASC 350–20, the Company conducts a goodwill impairment test at least annually, or more frequently as events occur or circumstances change that would more–likely–than–not reduce the fair value below its carrying amount. In the second quarter of 2020, the onset of the COVID–19 pandemic prompted the Company to assess qualitative and quantitative factors to determine whether it was more–likely–than–not the fair value of the Company was less than the carrying amount. The Company assessed relevant events and circumstances, including macroeconomic conditions, industry and market considerations, overall financial performance, changes in the composition or carrying amount of assets and liabilities, the market price of the Company’s common stock and other relevant facts. The Company performed both a market capitalization approach and a discounted cash flow approach to determine the fair value of the Company during the second quarter of 2020 which resulted in no goodwill impairment. The Company updated the analysis above during the third quarter of 2020 which resulted with no goodwill impairment charges for the three and nine months ended September 30, 2020. 40 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 10 – Repurchase Agreements The Company transfers various securities to customers in exchange for cash at the end of each business day and agrees to acquire the securities at the end of the next business day for the cash exchanged plus interest. The process is repeated at the end of each business day until the agreement is terminated. The securities underlying the agreement remained under the Bank’s control. The following table shows repurchase agreements accounted for as secured borrowings: September 30, 2020 Remaining Contractual Maturity of the Agreements Overnight and Continuous Up to one year One to three years Three to five years Five to ten years Beyond ten years Total Repurchase Agreements and repurchase-to-maturity transactions Repurchase Agreements $ 108,950 $ — $ — $ — $ — $ — $ 108,950 Securities pledged for Repurchase Agreements Federal agency collateralized mortgage obligations $ 55,336 $ — $ — $ — $ — $ — $ 55,336 Federal agency mortgage–backed pools 61,595 — — — — — 61,595 Total $ 116,931 $ — $ — $ — $ — $ — $ 116,931 Note 11 – Subordinated Notes On June 24, 2020, Horizon issued $ 60.0 million in aggregate principal amount of 5.625 % fixed–to–floating rate subordinated notes (the “Notes”). The Notes were offered in denominations of $1,000 and integral multiples of $1,000 in excess thereof. The Notes mature on July 1, 2030 (the “Maturity Date”). From and including the date of original issuance to, but excluding, July 1, 2025 or the date of earlier redemption (the “fixed rate period”), the Notes bear interest at an initial rate of 5.625 % per annum, payable semi–annually in arrears on January 1 and July 1 of each year, commencing on January 1, 2021. The last interest payment date for the fixed rate period will be July 1, 2025. From and including July 1, 2025 to, but excluding, the Maturity Date or the date of earlier redemption (the “floating rate period”), the Notes bear interest at a floating rate per annum equal to the Benchmark rate (which is expected to be Three–Month Term SOFR), plus 549 basis points, payable quarterly in arrears on January 1, April 1, July1, and October 1 of each year, commencing on October 1, 2025. Notwithstanding the foregoing, in the event that the Benchmark rate is less than zero, the Benchmark rate shall be deemed to be zero. Horizon may, at its option, beginning with the interest payment date of July 1, 2025 and on any interest payment date thereafter, redeem the Notes, in whole or in part. The Notes will not otherwise be redeemable by Horizon prior to maturity, unless certain events occur. The redemption price for any redemption is 100 % of the principal amount of the Notes, plus accrued and unpaid interest thereon to, but excluding, the date of redemption. Any early redemption of the Notes will be subject to the receipt of the approval of the Board of Governors of the Federal Reserve System to the extent then required under applicable laws or regulations, including capital regulations. The Notes are unsecured subordinated obligations, and rank pari passu, or equally, with all of Horizon's future unsecured subordinated debt and are junior to all existing and future senior debt. The Notes are structurally subordinated to all existing and future liabilities of Horizon's subsidiaries, including the deposit liabilities and claims of other creditors of Horizon Bank, and are effectively subordinated to Horizon’s existing and future secured indebtedness. There is no sinking fund for the Notes. The Notes are obligations of Horizon only and are not obligations of, and are not guaranteed by, any of Horizon’s subsidiaries. 41 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 12 – Derivative Financial Instruments Cash Flow Hedges – As a strategy to maintain acceptable levels of exposure to the risk of changes in future cash flow due to interest rate fluctuations, the Company entered into interest rate swap agreements for a portion of its floating rate debt. The agreements provide for the Company to receive interest from the counterparty at three months LIBOR and to pay interest to the counterparty at a fixed rate of 4.20 % on a notional amount of $ 12.0 million at September 30, 2020 and a weighted average fixed rate of 4.03 % on a notional amount of $ 15.5 million at December 31, 2019. Under the agreements, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense. The Company assumed additional interest rate swap agreements as the result of the LaPorte acquisition in July 2016. The agreements provide for the Company to receive interest from the counterparty at one month LIBOR and to pay interest to the counterparty at a fixed rate of 2.62 % on a notional amount of $ 10.0 million at September 30, 2020 and at a weighted average fixed rate of 2.31 % on a notional amount of $ 30.0 million at December 31, 2019. Under the agreements, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense. On July 20, 2018, the Company entered into an interest rate swap agreement for an additional portion of its floating rate debt. The agreement provides for the Company to receive interest from the counterparty at one month LIBOR and to pay interest to the counterparty at a rate of 2.81 % on a notional amount of $ 50.0 million at September 30, 2020 and December 31, 2019. Under the agreement, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense. Management has designated the interest rate swap agreement as a cash flow hedging instrument. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. At September 30, 2020, the Company’s cash flow hedge was effective and is not expected to have a significant impact on the Company’s net income over the next 12 months. Fair Value Hedges – Fair value hedges are intended to reduce the interest rate risk associated with the underlying hedged item. The Company enters into fixed rate loan agreements as part of its lending policy. To mitigate the risk of changes in fair value based on fluctuations in interest rates, the Company has entered into interest rate swap agreements on individual loans, converting the fixed rate loans to a variable rate. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current earnings. At September 30, 2020, the Company’s fair value hedges were effective and are not expected to have a significant impact on the Company’s net income over the next 12 months. The change in fair value of both the hedge instruments and the underlying loan agreements are recorded as gains or losses in interest income. The fair value hedges are considered to be highly effective and any hedge ineffectiveness was deemed not material. The notional amounts of the loan and security agreements being hedged were $ 425.8 million at September 30, 2020 and $ 361.0 million at December 31, 2019. Other Derivative Instruments – The Company enters into non–hedging derivatives in the form of mortgage loan forward sale commitments with investors and commitments to originate mortgage loans as part of its mortgage banking business. At September 30, 2020, the Company’s fair value of these derivatives were recorded and over the next 12 months are not expected to have a significant impact on the Company’s net income. The change in fair value of both the forward sale commitments and commitments to originate mortgage loans were recorded and the net gains or losses included in the Company’s gain on sale of loans. 42 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The following tables summarize the fair value of derivative financial instruments utilized by Horizon: Asset Derivatives Liability Derivatives September 30, 2020 September 30, 2020 Balance Sheet Location Fair Value Balance Sheet Location Fair Value Derivatives designated as hedging instruments Interest rate contracts Other assets $ 40,434 Other liabilities $ 49,331 Total derivatives designated as hedging instruments 40,434 49,331 Derivatives not designated as hedging instruments Mortgage loan contracts Other assets 1,584 Other liabilities — Total derivatives not designated as hedging instruments 1,584 — Total derivatives $ 42,018 $ 49,331 Asset Derivatives Liability Derivatives December 31, 2019 December 31, 2019 Balance Sheet Location Fair Value Balance Sheet Location Fair Value Derivatives designated as hedging instruments Interest rate contracts Other assets $ 11,422 Other liabilities $ 15,861 Total derivatives designated as hedging instruments 11,422 15,861 Derivatives not designated as hedging instruments Mortgage loan contracts Other assets 264 Other liabilities 38 Total derivatives not designated as hedging instruments 264 38 Total derivatives $ 11,686 $ 15,899 The effect of the derivative instruments on the condensed consolidated statements of income for the three–month and nine–month periods ending September 30 is as follows: Amount of Loss Recognized in Other Comprehensive Income on Derivative (Effective Portion) Three Months Ended Nine Months Ended September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019 Derivatives in cash flow hedging relationship Interest rate contracts $ ( 284 ) $ ( 682 ) $ ( 3,523 ) $ ( 3,058 ) FASB Accounting Standards Codification (“ASC”) Topic 820–10–20 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820–10–55 establishes a fair value hierarchy that emphasizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. 43 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Location of gain (loss) recognized on derivative Amount of Gain (Loss) Recognized on Derivative Three Months Ended Nine Months Ended September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019 Derivative in fair value hedging relationship Interest rate contracts Interest income - loans $ 1,944 $ ( 6,091 ) $ ( 27,548 ) $ ( 17,671 ) Interest rate contracts Interest income - loans ( 1,944 ) 6,091 27,548 17,671 Total $ — $ — $ — $ — Location of gain (loss) recognized on derivative Amount of Gain (Loss) Recognized on Derivative Three Months Ended Nine Months Ended September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019 Derivative not designated as hedging relationship Mortgage contracts Other income - gain on sale of loans $ 994 $ ( 429 ) $ 1,358 $ ( 97 ) Note 13 – Disclosures about Fair Value of Assets and Liabilities The Fair Value Measurements topic of the FASB ASC defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. There are three levels of inputs that may be used to measure fair value: Level 1 – Quoted prices in active markets for identical assets or liabilities Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated financial statements, as well as the general classification of such instruments pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the period ended September 30, 2020. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below. Available for sale securities When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U.S. Treasury and federal agency securities, state and municipal securities, federal agency collateralized mortgage obligations and mortgage–backed pools and corporate notes. Level 2 securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs. Observable inputs include dealer quotes, market spreads, cash flow analysis, the U.S. Treasury yield curve, trade execution data, market consensus prepayment spreads and available credit information and the bond’s terms and conditions. The pricing provider utilizes evaluated pricing models that vary based on asset class. These models incorporate available market information including quoted prices of securities with similar characteristics and, because many fixed–income securities do not trade on a daily basis, apply available information through processes such as benchmark 44 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) curves, benchmarking of like securities, sector grouping, and matrix pricing. In addition, model processes, such as an option adjusted spread model, is used to develop prepayment and interest rate scenarios for securities with prepayment features. Hedged loans Certain fixed rate loans have been converted to variable rate loans by entering into interest rate swap agreements. The fair value of those fixed rate loans is based on discounting the estimated cash flows using interest rates determined by the respective interest rate swap agreement. Loans are classified within Level 2 of the valuation hierarchy based on the unobservable inputs used. Interest rate swap agreements The fair value of the Company’s interest rate swap agreements is estimated by a third party using inputs that are primarily unobservable including a yield curve, adjusted for liquidity and credit risk, contracted terms and discounted cash flow analysis, and therefore, are classified within Level 2 of the valuation hierarchy. The following table presents the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated financial statements measured at fair value on a recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at the following: September 30, 2020 Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Available for sale securities U.S. Treasury and federal agencies $ 6,239 $ — $ 6,239 $ — State and municipal 678,459 — 678,459 — Federal agency collateralized mortgage obligations 185,849 — 185,849 — Federal agency mortgage–backed pools 132,472 — 132,472 — Corporate notes 12,324 — 12,324 — Total available for sale securities 1,015,343 — 1,015,343 — Interest rate swap agreements asset 40,434 — 40,434 — Forward sale commitments 1,584 — 1,584 — Interest rate swap agreements liability ( 49,331 ) — ( 49,331 ) — 45 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) December 31, 2019 Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Available for sale securities U.S. Treasury and federal agencies $ 1,413 $ — $ 1,413 $ — State and municipal 405,768 — 405,768 — Federal agency collateralized mortgage obligations 269,252 — 269,252 — Federal agency mortgage–backed pools 146,572 — 146,572 — Corporate notes 11,771 — 11,771 — Total available for sale securities 834,776 — 834,776 — Interest rate swap agreements asset 11,422 — 11,422 — Forward sale commitments 264 — 264 — Interest rate swap agreements liability ( 15,861 ) — ( 15,861 ) — Commitments to originate loans ( 38 ) — ( 38 ) — Realized gains and losses included in net income for the periods are reported in the condensed consolidated statements of income as follows: Three Months Ended Nine Months Ended September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019 Non-interest Income Total gains and losses from: Hedged loans $ 1,944 $ ( 6,091 ) $ ( 27,548 ) $ ( 17,671 ) Fair value interest rate swap agreements ( 1,944 ) 6,091 27,548 17,671 Derivative loan commitments 994 ( 429 ) 1,358 ( 97 ) $ 994 $ ( 429 ) $ 1,358 $ ( 97 ) Certain other assets are measured at fair value on a non-recurring basis in the ordinary course of business and are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment): Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) September 30, 2020 Collateral dependent loans $ 14,781 $ — $ — $ 14,781 Mortgage servicing rights 11,705 — — 11,705 December 31, 2019 Impaired loans $ 6,806 $ — $ — $ 6,806 Mortgage servicing rights 14,327 — — 14,327 46 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Collateral Dependent Loans: Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms 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. If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method. Mortgage Servicing Rights (MSRs): MSRs do not trade in an active market with readily observable prices. Accordingly, the fair value of these assets is classified as Level 3. The Company determines the fair value of MSRs using an income approach model based upon the Company’s month–end interest rate curve and prepayment assumptions. The model utilizes assumptions to estimate future net servicing income cash flows, including estimates of time decay, payoffs and changes in valuation inputs and assumptions. The Company reviews the valuation assumptions against this market data for reasonableness and adjusts the assumptions if deemed appropriate. The carrying amount of the MSRs’ fair value due to impairment decreased by $ 4.7 million during the first nine months of 2020 and increased by $ 59,000 during the first nine months of 2019. The following table presents qualitative information about unobservable inputs used in recurring and non–recurring Level 3 fair value measurements, other than goodwill. September 30, 2020 Fair Value Valuation Technique Unobservable Inputs Range (Weighted Average) Collateral dependent loans $ 14,781 Collateral based measurement Discount to reflect current market conditions and ultimate collectibility 0.0 %- 76.0 % ( 8.6 %) Mortgage servicing rights 11,705 Discounted cash flows Discount rate, Constant prepayment rate, Probability of default 7.8 %- 7.8 % ( 7.8 %), 7.1 %- 17.3 % ( 14.0 %), 0.7 %- 19.7 %( 1.9 %) December 31, 2019 Fair Value Valuation Technique Unobservable Inputs Range (Weighted Average) Impaired loans $ 6,806 Collateral based measurement Discount to reflect current market conditions and ultimate collectibility 0.0 %- 100.0 %( 7.4 %) Mortgage servicing rights 14,327 Discounted cash flows Discount rate, Constant prepayment rate, Probability of default 8.7 %- 9.0 % ( 8.7 %), 10.2 %- 19.8 %( 12.2 %), 0.1 %- 2.9 %( 0.7 %) Note 14 – Fair Value of Financial Instruments The estimated fair value amounts of the Company’s financial instruments were determined using available market information, current pricing information applicable to Horizon and various valuation methodologies. Where market quotations were not available, considerable management judgment was involved in the determination of estimated fair values. Therefore, the estimated fair value of financial instruments shown below may not be representative of the amounts at which they could be exchanged in a current or future transaction. Due to the inherent uncertainties of expected cash flows of financial instruments, the use of alternate valuation assumptions and methods could have a significant effect on the estimated fair value amounts. The estimated fair values of financial instruments, as shown below, are not intended to reflect the estimated liquidation or 47 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) market value of Horizon taken as a whole. The disclosed fair value estimates are limited to Horizon’s significant financial instruments at September 30, 2020 and December 31, 2019. These include financial instruments recognized as assets and liabilities on the condensed consolidated balance sheet as well as certain off–balance sheet financial instruments. The estimated fair values shown below do not include any valuation of assets and liabilities, which are not financial instruments as defined by the FASB ASC fair value hierarchy. The following methods and assumptions were used to estimate the fair value of each class of financial instrument: Cash and Due from Banks – The carrying amounts approximate fair value. Interest-earning time deposits – The fair values of the Company’s interest–earning time deposits are estimated using discounted cash flow analyses based on current rates for similar types of interest–earning time deposits. Held–to–Maturity Securities – For debt securities held to maturity, fair values are based on quoted market prices or dealer quotes. For those securities where a quoted market price is not available, carrying amount is a reasonable estimate of fair value based upon comparison with similar securities. Loans Held for Sale – The carrying amounts approximate fair value. Net Loans – The fair value of net loans are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors. FHLB Stock – Fair value of FHLB stock is based on the price at which it may be resold to the FHLB. Interest Receivable/Payable – The carrying amounts approximate fair value. Deposits – The fair value of demand deposits, savings accounts, interest–bearing checking accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturity. Borrowings – Rates currently available to Horizon for debt with similar terms and remaining maturities are used to estimate fair values of existing borrowings. Subordinated Notes – The fair value of subordinated notes is based on discounted cash flows based on current borrowing rates for similar types of instruments. Junior Subordinated Debentures Issued to Capital Trusts – Rates currently available for debentures with similar terms and remaining maturities are used to estimate fair values of existing debentures. Commitments to Extend Credit and Standby Letters of Credit – The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed–rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. Due to the short–term nature of these agreements, carrying amounts approximate fair value. 48 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall. September 30, 2020 Carrying Amount Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets Cash and due from banks $ 99,126 $ 99,126 $ — $ — Interest–earning time deposits 9,213 — 9,409 — Investment securities, held to maturity 180,270 — 191,612 — Loans held for sale 13,053 — — 13,053 Loans (excluding loan level hedges), net 3,974,046 — — 3,956,730 Stock in FHLB 23,023 — 23,023 — Interest receivable 20,456 — 20,456 — Liabilities Non–interest bearing deposits $ 1,016,646 $ 1,016,646 $ — $ — Interest bearing deposits 3,319,643 — 3,328,701 — Borrowings 587,473 — 601,168 — Subordinated notes 58,566 — 57,628 — Junior subordinated debentures issued to capital trusts 56,491 — 52,747 — Interest payable 2,481 — 2,481 — December 31, 2019 Carrying Amount Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets Cash and due from banks $ 98,831 $ 98,831 $ — $ — Interest–earning time deposits 8,455 — 8,537 — Investment securities, held to maturity 207,899 — 215,147 — Loans held for sale 4,088 — — 4,088 Loans (excluding loan level hedges), net 3,619,174 — — 3,554,951 Stock in FHLB 22,447 — 22,447 — Interest receivable 18,828 — 18,828 — Liabilities Non–interest bearing deposits $ 709,760 $ 709,760 $ — $ — Interest bearing deposits 3,221,242 — 3,180,768 — Borrowings 549,741 — 546,995 — Junior subordinated debentures issued to capital trusts 56,311 — 51,809 — Interest payable 3,062 — 3,062 — 49 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 15 – Accumulated Other Comprehensive Income September 30, 2020 December 31, 2019 Unrealized gain on securities available for sale $ 38,530 $ 12,687 Unamortized loss on securities held to maturity, previously transferred from AFS ( 167 ) ( 107 ) Unrealized loss on derivative instruments ( 8,899 ) ( 4,440 ) Tax effect ( 6,186 ) ( 1,708 ) Total accumulated other comprehensive income $ 23,278 $ 6,432 Note 16 – Regulatory Capital Horizon and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. These capital requirements implement changes arising from the Dodd–Frank Wall Street Reform and Consumer Protection Act and the U.S. Basel Committee on Banking Supervision’s capital framework (known as “Basel III”). Failure to meet the minimum regulatory capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators, which if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective actions, the Company and Bank must meet specific capital guidelines involving quantitative measures of the Bank’s assets, liabilities, and certain off–balance–sheet items as calculated under regulatory accounting practices. The Company’s and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. The Company and Bank are subject to minimum regulatory capital requirements as defined and calculated in accordance with the Basel III–based regulations. As allowed under Basel III rules, the Company made the decision to opt–out of including accumulated other comprehensive income in regulatory capital. The minimum regulatory capital requirements are set forth in the table below. In addition, to be categorized as well capitalized, the Company and Bank must maintain Total risk–based, Tier I risk–based, common equity Tier I risk–based and Tier I leverage ratios as set forth in the table below. As of September 30, 2020 and December 31, 2019, the Company and Bank met all capital adequacy requirements to be considered well capitalized. There have been no conditions or events since the end of the third quarter of 2020 that management believes have changed the Bank’s classification as well capitalized. There is no threshold for well capitalized status for bank holding companies. In October 2019, the federal banking agencies finalized a new rule that will simplify capital requirements for qualified community banks that opt into the new community bank leverage ratio framework. The new framework was available to use in March 31, 2020 Call Reports or Forms FRY-9C (as applicable) for depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets, among other qualifying criteria. Horizon did not elect the new community bank leverage ratio framework. As of March 31, 2020, the Company and Bank elected the transition option of the 2019 CECL Rule which allows banking organizations to phase in over a three–year period the day–one adverse effects of CECL on their regulatory capital ratios. 50 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Horizon and the Bank’s actual and required capital ratios as of September 30, 2020 and December 31, 2019 were as follows: Actual Required for Capital Adequacy Purposes (1) Required For Capital Adequacy Purposes with Capital Buffer (1) Well Capitalized Under Prompt Corrective Action Provisions (1) Amount Ratio Amount Ratio Amount Ratio Amount Ratio September 30, 2020 Total capital (to risk–weighted assets) (1) Consolidated $ 640,728 14.38 % $ 356,455 8.00 % $ 467,847 10.50 % N/A N/A Bank 514,974 11.56 % 356,383 8.00 % 467,753 10.50 % $ 445,479 10.00 % Tier 1 capital (to risk–weighted assets) (1) Consolidated 601,331 13.49 % 267,456 6.00 % 378,896 8.50 % N/A N/A Bank 475,588 10.67 % 267,435 6.00 % 378,866 8.50 % 356,580 8.00 % Common equity tier 1 capital (to risk–weighted assets) (1) Consolidated 485,235 10.89 % 200,510 4.50 % 311,905 7.00 % N/A N/A Bank 475,588 10.67 % 200,576 4.50 % 312,007 7.00 % 289,721 6.50 % Tier 1 capital (to average assets) (1) Consolidated 601,331 10.82 % 222,304 4.00 % 222,304 4.00 % N/A N/A Bank 475,588 8.57 % 221,978 4.00 % 221,978 4.00 % 277,473 5.00 % December 31, 2019 Total capital (to risk–weighted assets) (1) Consolidated $ 548,364 13.95 % $ 314,395 8.00 % $ 412,644 10.500 % N/A N/A Bank 497,227 12.65 % 314,452 8.00 % 412,718 10.500 % $ 393,065 10.00 % Tier 1 capital (to risk–weighted assets) (1) Consolidated 530,643 13.50 % 235,796 6.00 % 334,044 8.500 % N/A N/A Bank 479,506 12.20 % 235,823 6.00 % 334,082 8.500 % 314,430 8.00 % Common equity tier 1 capital (to risk–weighted assets) (1) Consolidated 473,150 12.04 % 176,846 4.50 % 275,094 7.000 % N/A N/A Bank 479,506 12.20 % 176,867 4.50 % 275,126 7.000 % 255,475 6.50 % Tier 1 capital (to average assets) (1) Consolidated 530,643 10.50 % 202,111 4.00 % 202,111 4.000 % N/A N/A Bank 479,506 9.49 % 202,110 4.00 % 202,110 4.000 % 252,638 5.00 % (1) As defined by regulatory agencies 51 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) (Table Dollar Amounts in Thousands, Except Per Share Data) Note 17 – Future Accounting Matters FASB ASU No. 2019–12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes The FASB has issued ASU No. 2019–12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The new guidance is intended to simplify the accounting for income taxes by removing certain exceptions to the general principles of ASC 740. The guidance also improves consistent application by clarifying and amending existing guidance from ASC 740. This guidance is effective for fiscal years beginning after December 15, 2020, including interim periods therein and is to be applied on a retrospective, modified retrospective or prospective approach, depending on the specific amendment. Early adoption is permitted. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact. Note 18 – General Litigation The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operation and cash flows of the Company. 52 Table of Contents HORIZON BANCORP, INC. AND SUBSIDIARIES Management’s Discussion and Analysis of Financial Condition And Results of Operations For the Three and Nine Months ended September 30, 2020 and 2019