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: March 31, 2016 Non-accrual Loans Past Due Over 90 Days Still Accruing Non- Performing TDRs Performing TDRs Total Non- Performing Loans Commercial Owner occupied real estate $ 1,089 $ — $ — $ — $ 1,089 Non owner occupied real estate 2,934 — 1,615 60 4,609 Residential development — — — — — Development & Spec Land Loans — — — — — Commercial and industrial 76 — — — 76 Total commercial 4,099 — 1,615 60 5,774 Real estate Residential mortgage 3,950 1 815 962 5,728 Residential construction — — 246 — 246 Mortgage warehouse — — — — — Total real estate 3,950 1 1,061 962 5,974 Consumer Direct Installment 496 — — — 496 Direct Installment Purchased — — — — — Indirect Installment 739 — — — 739 Home Equity 1,611 — 181 209 2,001 Total Consumer 2,846 — 181 209 3,236 Total $ 10,895 $ 1 $ 2,857 $ 1,231 $ 14,984 December 31, 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 $ 1,749 $ — $ — $ — $ 1,749 Non owner occupied real estate 3,034 — 1,915 60 5,009 Residential development — — — — — Development & Spec Land Loans 71 — — — 71 Commercial and industrial 176 — — — 176 Total commercial 5,030 — 1,915 60 7,005 Real estate Residential mortgage 4,354 1 824 808 5,987 Residential construction — — 250 — 250 Mortgage warehouse — — — — — Total real estate 4,354 1 1,074 808 6,237 Consumer Direct Installment 541 — — — 541 Direct Installment Purchased — — — — — Indirect Installment 601 27 — — 628 Home Equity 1,736 — 183 350 2,269 Total Consumer 2,878 27 183 350 3,438 Total $ 12,262 $ 28 $ 3,172 $ 1,218 $ 16,680 Included in the $10.9 million of non-accrual loans and the $2.9 million of non-performing TDRs at March 31, 2016 were $2.4 million and $95,000, 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 Operations 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. Interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made. Smaller-balance, homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by 1–4 family residences, residential construction loans, automobile, home equity, second mortgage loans and mortgage warehouse loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of borrower operating results and financial condition indicate that underlying cash flows of a borrower’s business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 30 days or more. Loans are generally moved to non-accrual status when they are 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible. Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms, including TDRs, are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans. The Company’s TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At March 31, 2016, 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 three consecutive payments but is still reported as TDR unless the loan bears interest at a market rate. As of March 31, 2016, the Company had $4.1 million in TDRs and $1.2 million were performing according to the restructured terms and zero TDRs were returned to accrual status during the first three months of 2016. There was $140,000 of specific reserves allocated to TDRs at March 31, 2016 based on the discounted cash flows or when appropriate the fair value of the collateral. The following table presents commercial loans individually evaluated for impairment by class of loan: Three Months Ending March 31, 2016 Unpaid Principal Balance Recorded Investment Allowance For Loan Loss Average Balance in Impaired Loans Cash/Accrual Interest Income Recognized With no recorded allowance Commercial Owner occupied real estate $ 1,089 $ 1,089 $ — $ 1,106 $ — Non owner occupied real estate 1,851 1,856 — 2,063 1 Residential development — — — — — Development & Spec Land Loans — — — — — Commercial and industrial 76 76 — 330 — Total commercial 3,016 3,021 — 3,499 1 With an allowance recorded Commercial Owner occupied real estate — — — — — Non owner occupied real estate 2,757 2,767 900 2,767 — Residential development — — — — — Development & Spec Land Loans — — — — — Commercial and industrial — — — — — Total commercial 2,757 2,767 900 2,767 — Total $ 5,773 $ 5,788 $ 900 $ 6,266 $ 1 Three Months Ending March 31, 2015 Unpaid Principal Balance Recorded Investment Allowance For Loan Loss Allocated Average Balance in Impaired Loans Cash/Accrual Interest Income Recognized With no recorded allowance Commercial Owner occupied real estate $ 1,076 $ 1,077 $ — $ 1,329 $ 2 Non owner occupied real estate 3,907 3,912 — 4,534 6 Residential development — — — — — Development & Spec Land Loans — — — — — Commercial and industrial 609 609 — 649 — Total commercial 5,592 5,598 — 6,512 8 With an allowance recorded Commercial Owner occupied real estate 417 417 165 419 — Non owner occupied real estate 1,590 1,590 184 1,590 — Residential development — — — — — Development & Spec Land Loans — — — — — Commercial and industrial 942 942 680 949 — Total commercial 2,949 2,949 1,029 2,958 — Total $ 8,541 $ 8,547 $ 1,029 $ 9,470 $ 8 The following table presents the payment status by class of loan: March 31, 2016 30 - 59 Days Past Due 60 - 89 Days Past Due Greater than 90 Days Past Due Total Past Due Loans Not Past Due Total Commercial Owner occupied real estate $ 161 $ 158 $ — $ 319 $ 264,580 $ 264,899 Non owner occupied real estate — — — — 324,824 324,824 Residential development — — — — 7,011 7,011 Development & Spec Land Loans — — — — 19,961 19,961 Commercial and industrial — 20 — 20 178,986 179,006 Total commercial 161 178 — 339 795,362 795,701 Real estate Residential mortgage 498 — 1 499 420,923 421,422 Residential construction — — — — 19,020 19,020 Mortgage warehouse — — — — 119,876 119,876 Total real estate 498 — 1 499 559,819 560,318 Consumer Direct Installment 51 9 — 60 56,707 56,767 Direct Installment Purchased — — — — 140 140 Indirect Installment 412 150 — 562 147,012 147,574 Home Equity 672 17 — 689 155,471 156,160 Total consumer 1,135 176 — 1,311 359,330 360,641 Total $ 1,794 $ 354 $ 1 $ 2,149 $ 1,714,511 $ 1,716,660 Percentage of total loans 0.10 % 0.02 % 0.00 % 0.13 % 99.87 % December 31, 2015 30 - 59 Days Past Due 60 - 89 Days Past Due Greater than 90 Days Past Due Total Past Due Loans Not Past Due Total Commercial Owner occupied real estate $ 481 $ 18 $ — $ 499 $ 267,782 $ 268,281 Non owner occupied real estate 49 — — 49 326,350 326,399 Residential development — — — — 5,018 5,018 Development & Spec Land Loans — — — — 18,183 18,183 Commercial and industrial 32 — — 32 184,879 184,911 Total commercial 562 18 — 580 802,212 802,792 Real estate Residential mortgage 1,121 344 1 1,466 413,458 414,924 Residential construction — — — — 19,751 19,751 Mortgage warehouse — — — — 144,692 144,692 Total real estate 1,121 344 1 1,466 577,901 579,367 Consumer Direct Installment 106 10 — 116 54,225 54,341 Direct Installment Purchased — — — — 153 153 Indirect Installment 1,186 268 27 1,481 150,042 151,523 Home Equity 1,193 203 — 1,396 155,768 157,164 Total consumer 2,485 481 27 2,993 360,188 363,181 Total $ 4,168 $ 843 $ 28 $ 5,039 $ 1,740,301 $ 1,745,340 Percentage of total loans 0.24 % 0.05 % 0.00 % 0.29 % 99.71 % 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. March 31, 2016 Pass Special Substandard Doubtful Total Commercial Owner occupied real estate $ 253,513 $ 6,118 $ 5,268 $ — $ 264,899 Non owner occupied real estate 317,121 2,709 4,994 — 324,824 Residential development 7,011 — — — 7,011 Development & Spec Land Loans 19,961 — — — 19,961 Commercial and industrial 172,960 1,997 4,049 — 179,006 Total commercial 770,566 10,824 14,311 — 795,701 Real estate Residential mortgage 415,694 — 5,728 — 421,422 Residential construction 18,774 — 246 — 19,020 Mortgage warehouse 119,876 — — — 119,876 Total real estate 554,344 — 5,974 — 560,318 Consumer Direct Installment 56,271 — 496 — 56,767 Direct Installment Purchased 140 — — — 140 Indirect Installment 146,835 — 739 — 147,574 Home Equity 154,159 — 2,001 — 156,160 Total Consumer 357,405 — 3,236 — 360,641 Total $ 1,682,315 $ 10,824 $ 23,521 $ — $ 1,716,660 Percentage of total loans 98.00 % 0.63 % 1.37 % 0.00 % December 31, 2015 Pass Special Substandard Doubtful Total Commercial Owner occupied real estate $ 257,181 $ 4,954 $ 6,146 $ — $ 268,281 Non owner occupied real estate 320,216 585 5,598 — 326,399 Residential development 5,018 — — — 5,018 Development & Spec Land Loans 18,112 — 71 — 18,183 Commercial and industrial 180,581 693 3,637 — 184,911 Total commercial 781,108 6,232 15,452 — 802,792 Real estate Residential mortgage 408,937 — 5,987 — 414,924 Residential construction 19,501 — 250 — 19,751 Mortgage warehouse 144,692 — — — 144,692 Total real estate 573,130 — 6,237 — 579,367 Consumer Direct Installment 53,800 — 541 — 54,341 Direct Installment Purchased 153 — — — 153 Indirect Installment 150,895 — 628 — 151,523 Home Equity 154,895 — 2,269 — 157,164 Total Consumer 359,743 — 3,438 — 363,181 Total $ 1,713,981 $ 6,232 $ 25,127 $ — $ 1,745,340 Percentage of total loans 98.20 % 0.36 % 1.44 % 0.00 % |