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Item 1A. Risk Factors

2023-03-15 compared with 2022-03-09 · 120 added, 97 removed, 260 unchanged (45% of the section changed)

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This report is qualified in its entirety by these risk factors.

If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected.

If any of the following risks actually occur, our business, financial condition and results

HORIZON BANCORP, INC.

2022 Annual Report on Form 10–K

of operations could be materially and adversely affected.

If this were to happen, the value of our securities could decline significantly, and you could lose all or part of your investment.

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Risks Related to Our Business

The COVID–19 pandemic has and may continue to impact our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The COVID–19 pandemic has created and continues to create disruptions to the global economy and to the lives of individuals throughout the world.

Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID–19 and to mitigate its effects, including quarantines, travel bans, shelter–in–place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief.

While the scope, duration, and full effects of COVID–19 are still rapidly evolving and not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains.

If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in this Annual Report could be exacerbated and such effects could have a material adverse impact on us in a number of ways related to credit, collateral, customer demand, funding operations, interest rate risk, human capital, self–insurance and financial results, as described in more detail below.

• Credit Risk – Our risks of timely loan repayment and the value of collateral supporting the loans are affected by the strength of our borrowers' businesses.

Concern about the spread of COVID–19 has caused and is likely to continue to cause business shutdowns, limitations on commercial activity and financial transactions, labor shortages, change in consumer and business spending and travel behaviors, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability, inability of property owners to make mortgage payments, and overall economic and financial market instability, all of which have already caused some of our customers to be unable to make scheduled loan payments.

If the continuing effects of COVID–19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is insufficient to cover our exposure.

The future effects of COVID–19 on economic activity could negatively affect the collateral values associated with our existing loans, our ability to liquidate the real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for or profitability of our lending services, and the financial condition and credit risk profiles of our customers.

HORIZON BANCORP, INC.

2021 Annual Report on Form 10–K

Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making our business decisions or may result in a delay in our taking certain remediation actions, such as foreclosure.

In addition, we have unfunded commitments to extend credit to customers.

During a challenging economic environment like now, our customers are more dependent on our credit commitments and increased borrowings under these commitments could adversely impact our liquidity.

Furthermore, in an effort to support our communities during the pandemic, we participated in the Paycheck Protection Program (“PPP”) under the CARES Act whereby loans to small businesses were made and those loans are subject to regulatory requirements that require forbearance of loan payments for a specified time and that limit our ability to pursue all available remedies in the event of a loan default.

If a borrower under a PPP loan fails to qualify for loan forgiveness, we are at the heightened risk of holding these loans at unfavorable interest rates as compared to loans to customers that we would have otherwise extended credit to.

• Strategic Risk – Our success in effectively implementing our short–term and long–term strategic objectives and business plans may be negatively affected by the continuing impacts of the COVID–19 pandemic, including changes in the pricing marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to deteriorating economic conditions and the various responses of governmental and nongovernmental authorities.

In many of our markets, local governments have acted to temporarily close or restrict the operations of most businesses from time to time during the COVID–19 pandemic.

• Operational Risk – Current and future restrictions on our workforce's access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations and financial results.

We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties.

In response to COVID–19, we have modified our business practices with a portion of our employees working remotely from other locations and their homes to have our operations uninterrupted as much as possible.

Further, technology in employees' homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices.

The continuation of these work–from–home measures also introduces additional operational risk, including increased cybersecurity risk.

These cyber risks include greater phishing, malware, and other cybersecurity attacks, vulnerability to disruptions of our information technology infrastructure and telecommunications systems for remote operations, increased risk of unauthorized dissemination of confidential information, limited ability to restore the systems in the event of a systems failure or interruption, greater risk of a security breach resulting in destruction or misuse of valuable information, and potential impairment of our ability to perform critical functions, including wiring funds, all of which could expose us to risks of data or financial loss, litigation and liability and could seriously disrupt our operations and the operations of any impacted customers.

Moreover, we rely on many third parties in our business operations, including appraisers of real estate collateral, vendors that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses.

In light of the developing measures responding to the pandemic, many of these entities may limit the availability of, and access to, their services and facilities.

For example, loan origination could be delayed due to the limited availability of real estate appraisers for the collateral.

Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses in certain counties, which slows the process for title work, mortgage and UCC filings in those counties.

If the third–party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations and financial results.

• Interest Rate Risk – Our net interest income, lending activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID–19.

A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect our market risk mitigation strategies.

Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets.

Fluctuations in interest rates will also impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest earning assets and

As a financial institution, we are subject to a number of risks relating to our daily business.

Although we undertake a variety of efforts to manage and control those risks, many of the risks are outside of our control.

Among the risks we face are the following:

• Credit Risk – the risk that loan customers or other parties will be unable to perform their contractual obligations;

• Market Risk – the risk that changes in market rates and prices will adversely affect our financial condition or results of operation;

• Liquidity Risk – the risk that Horizon or the Bank will have insufficient cash or access to cash to meet its operating needs;

• Operational Risk – the risk of financial and reputational loss resulting from fraud, inadequate or failed internal processes, cyber–security breaches, people and systems, or external events;

• Economic Risk – the risk that the economy in our markets could decline resulting in increased unemployment, decreased real estate values and increased loan charge–offs;

• Compliance Risk – the risk of additional action by our regulators or additional regulation that could hinder our ability to do business profitably;

• Regulatory Risk – the risk presented by the need to comply with all laws, rules and regulations from multiple regulatory agencies, including but not limited to the FDIC, CFPB, Indiana Department of Financial Institutions, Federal Reserve Bank and the Board of Governors of the Federal Reserve, and the Department of Labor;

• Fiduciary Risk – the risk of failing to act in our fiduciary capacity in the best interests of the grantors and beneficiaries of trust accounts and benefit plans.

We recently identified material weaknesses in our internal controls over financial reporting and determined that our disclosure controls and procedures were not effective.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, adequate disclosure controls and procedures, and evaluating and reporting on those systems of internal control and disclosure controls and procedures.

Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Our disclosure controls and procedures are processes designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms.

Based on management’s assessment, we concluded that our disclosure controls and procedures were not effective as of December 31, 2022 and that we had, as of such date, material weaknesses in our internal control over financial reporting.

The specific factors leading to this conclusion are described in Part II - Item 9A.

“Controls and Procedures” of this Annual Report on Form 10–K.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements would not be prevented or detected on a timely basis.

HORIZON BANCORP, INC.

2022 Annual Report on Form 10–K

interest bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or overall financial condition.

In addition, the United States Government and its related entities are incurring unprecedented debt levels in support of the United States economy.

This level of debt may not be sustainable, may cause further inflationary pressures and poses increased risks to the United States economy if international investors elect to no longer purchase United States Treasuries.

Because there have been no recent global pandemics that resulted in similar global impact, we do not yet know the full extent of COVID–19's effects on our business, operations, and customers, or the global economy as a whole.

Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work from home arrangements, third party providers' ability to support our operations, and any actions taken by governmental authorities and other third parties in response to the pandemic.

The uncertain future development of this crisis could materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.

Management identified material weaknesses with respect to insufficient controls over the reporting, classification, and disclosure of loans, investments and individual cash flow line items, and lack of sufficient controls around the financial reporting process that allows for the timely release of financial statements.

These material weaknesses in the Company’s internal controls over financial reporting resulted in

• accounting revisions of previously issued financial statements with respect to the classification of sold commercial loan participation balances, the reporting of indirect loan dealer reserve asset balances and related amortization expense and the classification of certain available for sale and held to maturity securities from private labeled mortgage-backed pools to federal agency mortgage pool, which revisions were previously disclosed in the press release in the Company’s Form 8–K filed January 25, 2023 (the “Earnings Release”) and the Company’s Form 10–Q filings during 2022, in addition to errors in previously issued financial statement disclosures relating to the transfer of available for sale to held to maturity securities and the cash flow classification of repurchases of outstanding stock from an investing activity to a financing activity, which are being disclosed for the first time in this Annual Report on Form 10–K, and

• a calculation error in the Company's public float which resulted in the late filing of this Annual Report on Form 10–K.

During the first quarter of 2023, we began (and are continuing) to implement a remediation plan to update the design and implementation of controls to remediate these deficiencies and enhance the Company's internal control environment.

If our remedial measures are insufficient, or if additional material weaknesses or significant deficiencies in our internal control over financial reporting or in our disclosure controls occur in the future, our future consolidated financial statements or other information filed with the SEC may contain material misstatements and could require a restatement of our consolidated financial statements, cause us to fail to meet our reporting obligations or cause investors to lose confidence in our reported financial information, leading to a decline in the market value of our securities.

However, after giving full consideration to the material weaknesses described herein, and based on a number of other factors, as further described in Part II – Item 9A.

“Controls and Procedures” of this Annual Report on Form 10–K, Horizon has concluded that the consolidated financial statements included in this Annual Report on Form 10–K present fairly, in all material respects, Horizon’s financial position, the results of its operations and its cash flows for each of the periods presented in conformity with U.S.

generally accepted accounting principles.

Instability in global economic conditions and geopolitical matters, as well as volatility in financial markets, could have a material adverse effect on our results of operations and financial condition.

The macroeconomic environment in the United States is susceptible to global events and volatility in financial markets.

For example, global demand for products continues to exceed supply during the economic recovery from the COVID–19 pandemic, creating significant inflationary pressures which, in turn, may adversely impact consumer and business confidence and regional and global economic conditions, as well as our financial condition and results of operations.

In addition, trade negotiations between the U.S.

and other nations remain uncertain and could adversely impact economic and market conditions for Horizon and its clients and counterparties.

An economic slowdown in our primary market areas could affect our business.

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• an increase in non–accrual loans and other real estate owned.

We face intense competition in all phases of our business from other banks, financial institutions and non–banks.

The banking and financial services business in most of our markets is highly competitive.

Our competitors include large banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions, neo–banks (a digital or mobile–only bank that exists without any physical bank branches), and other non–bank financial and digital service providers, many of which have greater financial, marketing and technological resources than we do.

Many of these competitors are not subject to the same regulatory restrictions that we are and may be able to compete more effectively as a result.

Also, technology and other changes have lowered barriers to entry and made it possible for customers to complete financial transactions using neo–banks, non–banks and financial technology (“FinTech”) companies that historically have involved banks at one or both ends of the transaction.

These entities now offer products and services traditionally provided by banks and often at lower costs.

The wide acceptance of Internet–based commerce has resulted in a number of alternative payment processing systems, and deposit and lending platforms in which banks play only minor roles.

For example, consumers can maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds.

Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks.

Use of emerging alternative payment platforms, such as Apple Pay or Bitcoin or other cryptocurrencies, can alter consumer credit card behavior and consequently impact our interchange fee income.

The continuing process of eliminating banks as intermediaries, known as “disintermediation,” will likely result in the loss of additional fee income, as well as the loss of customer deposits and the related income generated from those deposits.

The effects of disintermediation are also likely to continue to negatively impact the lending activities of traditional banks because of the fast growing number of FinTech companies that use software and technology to deliver mortgage lending and other financial services with fewer employees.

A related risk is the migration of bank personnel away from the traditional bank environments into neo–banks, FinTech companies and other non–banks.

HORIZON BANCORP, INC.

2022 Annual Report on Form 10–K

Increased competition in our markets may result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower.

Any of these results could have a material adverse effect on our ability to maintain our earnings record, grow our loan portfolios and obtain low–cost funds.

If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted.

If increased competition causes us to change our underwriting standards, we could be exposed to higher losses from lending activities.

Additionally, many of our competitors are larger in total assets and capitalization and have greater access to capital markets.

Horizon is also experiencing an increase in competition to acquire other banks, due to the overall strength of financial institutions and their high capital levels.

In addition, credit unions, private equity groups, and FinTech companies are now actively pursuing small bank acquisitions.

Increased competition for bank acquisitions may slow Horizon’s ability to grow earning assets at comparable historical growth rates.

Changes in interest rates could adversely affect our financial condition and results of operations.

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At the same time, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense.

HORIZON BANCORP, INC.

2021 Annual Report on Form 10–K

Decreases in interest rates often result in increased prepayments of loans and mortgage–related securities, as borrowers refinance their loans to reduce borrowing costs.

Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments in loans or other investments that have interest rates that are comparable to the interest rates on existing loans and securities.

We are subject to liquidity risk in our operations, which could adversely affect the ability to fund various obligations.

Liquidity risk is the possibility of being unable to meet obligations as they come due, pay deposits when withdrawn, capitalized on growth opportunities as they arise, or pay dividends because of an inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances.

Liquidity is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operations, and access to other funding sources.

Liquidity is essential to our business.

We must maintain sufficient funds to respond to the needs of depositors and borrowers.

An inability to

HORIZON BANCORP, INC.

2022 Annual Report on Form 10–K

raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a material adverse effect on our liquidity.

Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general.

Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn, failures of other financial institutions which reduces overall market confidence in the banking and financial services industry, or regulatory action that limits or eliminates our access to alternate funding sources.

Our ability to borrow could also be impaired by factors that are nonspecific to us, such as severe disruption of the financial markets or negative expectations about the prospects for the financial services industry as a whole, as evidenced by the recent failures of certain depository institutions and the resulting market turmoil and volatility stemming from such failures.

Unrealized losses in our investment portfolio could adversely affect liquidity.

As market interest rates increased during 2022 and continued into the early months of 2023, we have experienced increased unrealized losses within our investment portfolio.

Our investment portfolio consists of obligations of the U.S.

Treasury and federal agencies, obligations of state and local municipalities, federal agency mortgage obligations, private labeled mortgage–backed pools and corporate notes.

Many of these instruments are particularly sensitive to interest rate fluctuations, especially long–term fixed–income securities.

From December 31, 2021, to December 31, 2022, the available for sale investment portfolio experienced unrealized losses of approximately $147.3 million and our held to maturity of approximately $349.0 million, which coincided with an increase by the Federal Reserve in the federal funds target rate from 0.25% as of December 31, 2021 to 4.50% as of December 31, 2022.

See Note 4 in the 2022 Annual Report for more details on the securities.

As of the date of this report, the current federal funds target rate is 4.75%.

The increase in unrealized losses for available for sale investments is reflected in Accumulated Other Comprehensive Income (AOCI) on our balance sheet and reduces our book capital and tangible common equity ratio.

However, unrealized losses do not affect our regulatory capital ratios.

Management continues to actively monitor the investment portfolio and does not currently anticipate the need to realize material losses from the investment portfolio, and we believe it is unlikely we would be required to sell the securities before recovery of their amortized cost bases, which may be at maturity.

However, our access to liquidity sources could be affected by unrealized losses if securities within the investment portfolio must be sold at a loss or tangible capital ratios decline from an increase in unrealized losses or realized credit losses.