Non-performing Loans and Impaired Loans | Note 7 – Non-performing Loans and Impaired 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: June 30, 2015 Non-accrual Loans Past Due Over 90 Days Still Accruing Non- Performing TDRs Performing TDRs Total Non- Performing Loans Commercial Owner occupied real estate $ 4,447 $ — $ — $ 150 $ 4,597 Non owner occupied real estate 4,898 207 2,352 68 7,525 Residential development — — — — — Development & Spec Land Loans — — — — — Commercial and industrial 477 — 785 — 1,262 Total commercial 9,822 207 3,137 218 13,384 Real estate Residential mortgage 2,319 — 760 2,482 5,561 Residential construction — — 258 — 258 Mortgage warehouse — — — — — Total real estate 2,319 — 1,018 2,482 5,819 Consumer Direct Installment 447 — — — 447 Direct Installment Purchased — — — — — Indirect Installment 405 — — — 405 Home Equity 2,057 — 368 571 2,996 Total Consumer 2,909 — 368 571 3,848 Total $ 15,050 $ 207 $ 4,523 $ 3,271 $ 23,051 December 31, 2014 Non-accrual Loans Past Due Over 90 Days Still Accruing Non- Performing TDRs Performing TDRs Total Non- Performing Loans Commercial Owner occupied real estate $ 1,773 $ — $ — $ 44 $ 1,817 Non owner occupied real estate 7,439 — 217 566 8,222 Residential development — — — — — Development & Spec Land Loans — — — — — Commercial and industrial 812 — 1,004 — 1,816 Total commercial 10,024 — 1,221 610 11,855 Real estate Residential mortgage 2,297 40 765 2,526 5,628 Residential construction — — 266 — 266 Mortgage warehouse — — — — — Total real estate 2,297 40 1,031 2,526 5,894 Consumer Direct Installment 227 10 — — 237 Direct Installment Purchased — — — — — Indirect Installment 557 47 — — 604 Home Equity 2,207 18 391 1,236 3,852 Total Consumer 2,991 75 391 1,236 4,693 Total $ 15,312 $ 115 $ 2,643 $ 4,372 $ 22,442 Included in the $15.1 million of non-accrual loans and the $4.5 million of non-performing TDRs at June 30, 2015 were $679,000 and $302,000, respectively, of loans acquired for which accretable yield was recognized. From time to time, the Bank obtains information that may lead management to believe that the collection of payments may be doubtful on a particular loan. In recognition of this, it is management’s policy to convert the loan from an “earning asset” to a non-accruing loan. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Further, it is management’s policy to place a loan on a non-accrual status when the payment is delinquent in excess of 90 days or the loan has had the accrual of interest discontinued by management. The officer responsible for the loan and the Chief Credit Officer or the senior collection officer must review all loans placed on non-accrual status. Subsequent payments on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. 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. 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, which is the appraised value less estimated selling costs. Interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made. Smaller-balance, homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by 1–4 family residences, residential construction loans, automobile, home equity, second mortgage loans and mortgage warehouse loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of borrower operating results and financial condition indicate that underlying cash flows of a borrower’s business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 30 days or more. Loans are generally moved to non-accrual status when they are 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible. Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms, including TDRs, are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans. The Company’s TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At June 30, 2015, the type of concessions the Company has made on restructured loans has been temporary rate reductions and/or reductions in monthly payments and there have been no restructured loans with modified recorded balances. Any modification to a loan that is a concession and is not in the normal course of lending is considered a restructured loan. A restructured loan is returned to accruing status after six consecutive payments but is still reported as TDR unless the loan bears interest at a market rate. As of June 30, 2015, the Company had $7.8 million in TDRs and $3.3 million were performing according to the restructured terms and four TDR were returned to accrual status during the first six months of 2015. There was $792,000 of specific reserves allocated to TDRs at June 30, 2015 based on the discounted cash flows or when appropriate the fair value of the collateral. Loans transferred and classified as troubled debt restructuring during the three and six months ended June 30, 2015 and 2014, segregated by class, are shown in the table below. Three Months Ending Three Months Ending Six Months Ending Six Months Ending Number of Unpaid Number of Unpaid Number of Unpaid Number of Unpaid Commercial Owner occupied real estate 2 $ 111 — $ — 3 $ 2,462 — $ — Non owner occupied real estate — — — — — — — — Residential development — — — — — — — — Development & Spec Land Loans — — — — — — — — Commercial and industrial — — — — — — 2 371 Total commercial 2 111 — — 3 2,462 2 371 Real estate Residential mortgage 1 81 1 226 1 81 1 226 Residential construction — — — — — — — — Mortgage warehouse — — — — — — — — Total real estate 1 81 1 226 1 81 1 226 Consumer Direct Installment — — — — — — — — Direct Installment Purchased — — — — — — — — Indirect Installment — — — — — — — — Home Equity — — 1 51 1 32 2 196 Total Consumer — — 1 51 1 32 2 196 — — — — Total 3 $ 192 2 $ 277 5 $ 2,575 5 $ 793 Troubled debt restructured loans which had payment defaults during the three and six months ended June 30, 2015 and 2014, segregated by class, are shown in the table below. Default occurs when a loan is 90 days or more past due or has been transferred to non-accrual. Three Months Ending Three Months Ending Six Months Ending Six Months Ending Number of Unpaid Number of Unpaid Number of Unpaid Number of Unpaid Commercial Owner occupied real estate — $ — — $ — 1 $ 2,352 — $ — Non owner occupied real estate — — — — — — — — Residential development — — — — — — — — Development & Spec Land Loans — — — — — — — — Commercial and industrial — — — — — — 2 371 Total commercial — — — — 1 2,352 2 371 Real estate Residential mortgage 1 81 1 223 1 81 2 377 Residential construction — — — — — — — — Mortgage warehouse — — — — — — — — Total real estate 1 81 1 223 1 81 2 377 Consumer Direct Installment — — — — — — — — Direct Installment Purchased — — — — — — — — Indirect Installment — — — — — — — — Home Equity 1 32 1 51 1 32 2 196 Total Consumer 1 32 1 51 1 32 2 196 — — — — Total 2 $ 113 2 $ 274 3 $ 2,465 6 $ 944 The following table presents commercial loans individually evaluated for impairment by class of loan: Three Months Ending Six Months Ending June 30, 2015 Unpaid Recorded Allowance For Average Cash/Accrual Average Cash/Accrual With no recorded allowance Commercial Owner occupied real estate $ 1,605 $ 1,606 $ — $ 1,350 $ 17 $ 1,118 $ 17 Non owner occupied real estate 2,820 2,824 — 3,168 7 3,270 14 Residential development — — — — — — — Development & Spec Land Loans — — — — — — — Commercial and industrial 379 379 — 639 — 599 — Total commercial 4,804 4,809 — 5,157 24 4,987 31 With an allowance recorded Commercial Owner occupied real estate 2,991 2,991 593 4,366 54 1,992 54 Non owner occupied real estate 1,590 1,590 200 1,590 — 1,590 — Residential development — — — — — — — Development & Spec Land Loans — — — — — — — Commercial and industrial 884 884 498 1,008 — 974 — Total commercial 5,465 5,465 1,291 6,964 54 4,556 54 Total $ 10,269 $ 10,274 $ 1,291 $ 12,121 $ 78 $ 9,543 $ 85 Three Months Ending Six Months Ending June 30, 2014 Unpaid Recorded Allowance For Average Cash/Accrual Average Cash/Accrual With no recorded allowance Commercial Owner occupied real estate $ 2,121 $ 2,124 $ — $ 1,885 $ 40 $ 1,432 $ 51 Non owner occupied real estate 3,244 3,246 — 3,270 93 3,283 98 Residential development — — — — — — — Development & Spec Land Loans — — — — — — — Commercial and industrial 283 283 — 441 — 466 — Total commercial 5,648 5,653 — 5,596 133 5,181 149 With an allowance recorded Commercial Owner occupied real estate — — — — — — — Non owner occupied real estate 340 340 170 342 — 347 — Residential development — — — — — — — Development & Spec Land Loans — — — — — — — Commercial and industrial 1,722 1,722 965 1,710 — 1,570 2 Total commercial 2,062 2,062 1,135 2,052 — 1,917 2 Total $ 7,710 $ 7,715 $ 1,135 $ 7,648 $ 133 $ 7,098 $ 151 The following table presents the payment status by class of loan: June 30, 2015 30 - 59 Days 60 - 89 Days Greater than 90 Total Past Due Loans Not Past Total Commercial Owner occupied real estate $ 157 $ 21 $ — $ 178 $ 238,705 $ 238,883 Non owner occupied real estate 82 — 207 289 313,582 313,871 Residential development — — — — 2,606 2,606 Development & Spec Land Loans — — — — 13,593 13,593 Commercial and industrial 591 46 — 637 139,186 139,823 Total commercial 830 67 207 1,104 707,672 708,776 Real estate Residential mortgage 308 147 — 455 257,340 257,795 Residential construction — — — — 19,087 19,087 Mortgage warehouse — — — — 195,924 195,924 Total real estate 308 147 — 455 472,351 472,806 Consumer Direct Installment 138 41 — 179 43,940 44,119 Direct Installment Purchased — — — — 179 179 Indirect Installment 721 130 — 851 151,417 152,268 Home Equity 699 245 — 944 139,372 140,316 Total consumer 1,558 416 — 1,974 334,908 336,882 Total $ 2,696 $ 630 $ 207 $ 3,533 $ 1,514,931 $ 1,518,464 Percentage of total loans 0.18 % 0.04 % 0.01 % 0.23 % 99.77 % December 31, 2014 30 - 59 Days 60 - 89 Days Greater than 90 Total Past Due Loans Not Past Total Commercial Owner occupied real estate $ 103 $ 645 $ — $ 748 $ 227,632 $ 228,380 Non owner occupied real estate 413 — — 413 296,886 297,299 Residential development — — — — 2,027 2,027 Development & Spec Land Loans — — — — 12,097 12,097 Commercial and industrial 19 1 — 20 133,236 133,256 Total commercial 535 646 — 1,181 671,878 673,059 Real estate Residential mortgage 1,033 193 40 1,266 241,255 242,521 Residential construction — — — — 11,505 11,505 Mortgage warehouse — — — — 129,156 129,156 Total real estate 1,033 193 40 1,266 381,916 383,182 Consumer Direct Installment 113 4 10 127 40,010 40,137 Direct Installment Purchased — — — — 219 219 Indirect Installment 1,042 243 47 1,332 140,536 141,868 Home Equity 1,084 189 18 1,291 137,716 139,007 Total consumer 2,239 436 75 2,750 318,481 321,231 Total $ 3,807 $ 1,275 $ 115 $ 5,197 $ 1,372,275 $ 1,377,472 Percentage of total loans 0.28 % 0.09 % 0.01 % 0.38 % 99.62 % 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 $2,500,000) are validated by the Loan Committee, which is chaired by the Chief Credit Officer (CCO). • Commercial loan officers are responsible for reviewing their loan portfolios and report any adverse material change to the CCO or Loan Committee. When circumstances warrant a change in the credit quality grade, loan officers are required to notify the CCO and the Credit Department of the change in the loan grade. Downgrades are accepted immediately by the CCO however, lenders must present their factual information to either the Loan Committee or the CCO when recommending an upgrade. • The CCO, or his designee, meets weekly with loan officers to discuss the status of past-due loans and classified loans. These meetings are also designed to give the loan officers an opportunity to identify an existing loan that should be downgraded to a classified grade. • Monthly, senior management meets with the Watch Committee, which reviews all of the past due, classified, and impaired loans and the relative trends of these assets. This committee also reviews the actions taken by management regarding foreclosure mitigation, loan extensions, troubled debt restructures, other real estate owned and personal property repossessions. The information reviewed in this meeting acts as a precursor for developing management’s analysis of the adequacy of the Allowance for Loan and Lease Losses. For residential real estate and consumer loans, Horizon uses a grading system based on delinquency. Loans that are 90 days or more past due, on non-accrual, or are classified as a TDR are graded “Substandard.” After being 90 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass. Horizon Bank employs a nine-grade rating system to determine the credit quality of commercial loans. The first five grades represent acceptable quality, and the last four grades mirror the criticized and classified grades used by the bank regulatory agencies (special mention, substandard, doubtful, and loss). The loan grade definitions are detailed below. Risk Grade 1: Excellent (Pass) Loans secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better. Risk Grade 2: Good (Pass) Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by unaudited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets and unblemished credit history; or loans to publicly held companies with current long-term debt ratings of Baa or better. Risk Grade 3: Satisfactory (Pass) Loans supported by financial statements (audited or unaudited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered. Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply: • At inception, the loan was properly underwritten, did not • At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss. • The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance. • During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted. Risk Grade 4 Satisfactory/Monitored: Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans. Borrower displays acceptable liquidity, leverage, and earnings performance within the Bank’s minimum underwriting guidelines. The level of risk is acceptable but conditioned on the proper level of loan officer supervision. Loans that normally fall into this grade include acquisition, construction and development loans and income producing properties that have not reached stabilization. Risk Grade 4W Management Watch: Loans in this category are considered to be of acceptable quality, but with above normal risk. Borrower displays potential indicators of weakness in the primary source of repayment resulting in a higher reliance on secondary sources of repayment. Balance sheet may exhibit weak liquidity and/or high leverage. There is inconsistent earnings performance without the ability to sustain adverse economic conditions. Borrower may be operating in a declining industry or the property type, as for a commercial real estate loan, may be high risk or in decline. These loans require an increased level of loan officer supervision and monitoring to assure that any deterioration is addressed in a timely fashion. Risk Grade 5: Special Mention Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted Risk Grade 6: Substandard One or more of the following characteristics may be exhibited in loans classified Substandard: • Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss. • Loans are inadequately protected by the current net worth and paying capacity of the obligor. • The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees. • Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected. • Unusual courses of action are needed to maintain a high probability of repayment. • The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments. • The lender is forced into a subordinated or unsecured position due to flaws in documentation. • Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms. • The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan. • There is a significant deterioration in market conditions to which the borrower is highly vulnerable. Risk Grade 7: Doubtful One or more of the following characteristics may be present in loans classified Doubtful: • Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable. • The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment. • The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known. Risk Grade 8: Loss Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future. The following table presents loans by credit grades. June 30, 2015 Pass Special Substandard Doubtful Total Commercial Owner occupied real estate $ 224,414 $ 6,299 $ 8,170 $ — $ 238,883 Non owner occupied real estate 303,292 2,442 8,137 — 313,871 Residential development 2,606 — — — 2,606 Development & Spec Land Loans 13,520 73 — — 13,593 Commercial and industrial 136,586 991 2,246 — 139,823 Total commercial 680,416 9,805 18,553 — 708,776 Real estate Residential mortgage 252,234 — 5,561 — 257,795 Residential construction 18,829 — 258 — 19,087 Mortgage warehouse 195,924 — — — 195,924 Total real estate 466,987 — 5,819 — 472,806 Consumer Direct Installment 43,672 — 447 — 44,119 Direct Installment Purchased 179 — — — 179 Indirect Installment 151,863 — 405 — 152,268 Home Equity 137,320 — 2,996 — 140,316 Total Consumer 333,034 — 3,848 — 336,882 Total $ 1,480,437 $ 9,805 $ 28,220 $ — $ 1,518,464 Percentage of total loans 97.50 % 0.65 % 1.86 % 0.00 % December 31, 2014 Pass Special Substandard Doubtful Total Commercial Owner occupied real estate $ 215,875 $ 7,623 $ 4,883 $ — $ 228,381 Non owner occupied real estate 283,518 4,458 9,323 — 297,299 Residential development 2,027 — — — 2,027 Development & Spec Land Loans 12,018 79 — — 12,097 Commercial and industrial 128,589 1,799 2,868 — 133,256 Total commercial 642,027 13,959 17,074 — 673,060 Real estate Residential mortgage 236,893 — 5,628 — 242,521 Residential construction 11,239 — 266 — 11,505 Mortgage warehouse 129,156 — — — 129,156 Total real estate 377,288 — 5,894 — 383,182 Consumer Direct Installment 39,900 — 237 — 40,137 Direct Installment Purchased 219 — — — 219 Indirect Installment 141,264 — 604 — 141,868 Home Equity 135,155 — 3,852 — 139,007 Total Consumer 316,538 — 4,693 — 321,231 Total $ 1,335,854 $ 13,959 $ 27,661 $ — $ 1,377,473 Percentage of total loans 96.98 % 1.01 % 2.01 % 0.00 % |