Non-performing Assets and Impaired Loans | Note 8 – Non-performing Assets and Impaired Loans The following table presents the nonaccrual, loans past due over 90 days still on accrual, and troubled debt restructured (“TDRs”) by class of loans: December 31, 2018 Non-accrual Loans Past Due Over 90 Days Still Accruing Non-peforming TDRs Performing TDRs Total Non-performing Loans Commercial Owner occupied real estate $ 3,413 $ — $ — $ 109 $ 3,522 Non-owner occupied real estate 554 — 492 — 1,046 Residential spec homes — — — — — Development & spec land 68 — — — 68 Commercial and industrial 2,059 208 — — 2,267 Total commercial 6,094 208 492 109 6,903 Real estate Residential mortgage 2,846 180 423 1,558 5,007 Residential construction — — — — — Mortgage warehouse — — — — — Total real estate 2,846 180 423 1,558 5,007 Consumer Direct installment 35 — — — 35 Indirect installment 916 173 — — 1,089 Home equity 1,657 7 142 335 2,141 Total consumer 2,608 180 142 335 3,265 Total $ 11,548 $ 568 $ 1,057 $ 2,002 $ 15,175 December 31, 2017 Non-accrual Loans Past Due Over 90 Days Still Accruing Non-peforming TDRs Performing TDRs Total Non-performing Loans Commercial Owner occupied real estate $ 4,877 $ — $ 11 $ 1 $ 4,889 Non-owner occupied real estate 115 — 440 — 555 Residential spec homes — — — — — Development & spec land 176 — — — 176 Commercial and industrial 1,734 — — — 1,734 Total commercial 6,902 — 451 1 7,354 Real estate Residential mortgage 3,693 — 351 1,450 5,494 Residential construction — — — 222 222 Mortgage warehouse — — — — — Total real estate 3,693 — 351 1,672 5,716 Consumer Direct installment 160 — — — 160 Direct installment purchased — — — — — Indirect installment 1,041 167 — — 1,208 Home equity 1,480 — 211 285 1,976 Total consumer 2,681 167 211 285 3,344 Total $ 13,276 $ 167 $ 1,013 $ 1,958 $ 16,414 Included in the $11.5 million of non-accrual loans and the $1.1 million of non-performing TDRs at December 31, 2018 were $3.6 million and $0, respectively, of loans acquired for which there were accretable yields 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 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 Credit 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. 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 the three methods described above. The Company’s TDRs are considered impaired loans and included in the allowance methodology using the guidance for impaired loans. At December 31, 2018, 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 December 31, 2018, the Company had $3.1 million in TDRs and $2.0 million were performing according to the restructured terms and one TDR was returned to accrual status during 2018. There was $20,000 of specific reserves allocated to TDRs at December 31, 2018 based on the collateral deficiencies. The following table presents commercial loans individually evaluated for impairment by class of loans: December 31, 2018 Twelve Months Ended 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 $ 2,696 $ 2,689 $ — $ 3,048 $ 71 Non-owner occupied real estate 860 888 — 1,096 12 Residential spec homes — — — — — Development & spec land 68 66 — 71 — Commercial and industrial 1,344 1,337 — 1,239 27 Total commercial 4,968 4,980 — 5,454 110 With an allowance recorded Commercial Owner occupied real estate 827 828 145 864 — Non-owner occupied real estate 186 186 30 180 4 Residential spec homes — — — — — Development & spec land — — — — — Commercial and industrial 715 714 860 870 14 Total commercial 1,728 1,728 1,035 1,914 18 Total $ 6,696 $ 6,708 $ 1,035 $ 7,368 $ 128 December 31, 2017 Twelve Months Ended 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 $ 3,824 $ 3,849 $ — $ 1,673 $ 11 Non-owner occupied real estate 554 570 — 345 — Residential spec homes — — — — — Development & spec land 176 174 — 233 4 Commercial and industrial 1,656 1,663 — 1,445 25 Total commercial 6,210 6,256 — 3,696 40 With an allowance recorded Commercial Owner occupied real estate 931 931 184 78 46 Non-owner occupied real estate — — — — — Residential spec homes — — — — — Development & spec land — — — — — Commercial and industrial — — — — — Total commercial 931 931 184 78 46 Total $ 7,141 $ 7,187 $ 184 $ 3,774 $ 86 December 31, 2016 Twelve Months Ended 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 $ 1,533 $ 1,533 $ — $ 1,619 $ 58 Non-owner occupied real estate 440 440 — 871 18 Residential spec homes — — — — — Development & spec land 118 118 — 61 16 Commercial and industrial 128 127 — 349 1 Total commercial 2,219 2,218 — 2,900 93 With an allowance recorded Commercial Owner occupied real estate — — — — — Non-owner occupied real estate — — — — — Residential spec homes — — — — — Development & spec land — — — — — Commercial and industrial 31 32 4 5 2 Total commercial 31 32 4 5 2 Total $ 2,250 $ 2,250 $ 4 $ 2,905 $ 95 The following table presents the payment status by class of loans: December 31, 2018 Current 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due Total Past Due Total Past Due & Non-accrual Loans Total Commercial Owner occupied real estate $ 556,516 $ 537 $ 997 $ — $ 3,413 $ 4,947 $ 561,463 Non-owner occupied real estate 716,574 175 19 — 1,046 1,240 717,814 Residential spec homes 4,707 492 — — — 492 5,199 Development & spec land 46,479 — — — 68 68 46,547 Commercial and industrial 390,828 515 736 208 2,059 3,518 394,346 Total commercial 1,715,104 1,719 1,752 208 6,586 10,265 1,725,369 Real estate Residential mortgage 641,500 1,131 56 180 3,269 4,636 646,136 Residential construction 24,030 — — — — — 24,030 Mortgage warehouse 74,120 — — — — — 74,120 Total real estate 739,650 1,131 56 180 3,269 4,636 744,286 Consumer Direct installment 38,138 93 18 — 35 35 38,173 Indirect installment 313,088 1,396 198 173 916 1,089 314,177 Home equity 192,960 761 37 7 1,799 1,806 194,766 Total consumer 544,186 2,250 253 180 2,750 2,930 547,116 Total $ 2,998,940 $ 5,100 $ 2,061 $ 568 $ 12,605 $ 17,831 $ 3,016,771 Percentage of total loans 99.41 % 0.17 % 0.07 % 0.02 % 0.42 % 0.59 % December 31, 2017 Current 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due Total Past Due Total Past Due & Non-accrual Loans Total Commercial Owner occupied real estate $ 567,571 $ 1,613 $ 1,950 $ — $ 4,888 $ 8,451 $ 576,022 Non-owner occupied real estate 682,712 512 122 — 555 1,189 683,901 Residential spec homes 16,591 — — — — — 16,591 Development & spec land 49,789 31 — — 176 207 49,996 Commercial and industrial 346,830 520 1 — 1,734 2,255 349,085 Total commercial 1,663,493 2,676 2,073 — 7,353 12,102 1,675,595 Real estate Residential mortgage 590,746 1,248 49 — 4,044 5,341 596,087 Residential construction 15,964 63 — — — 63 16,027 Mortgage warehouse 94,508 — — — — — 94,508 Total real estate 701,218 1,311 49 — 4,044 5,404 706,622 Consumer Direct installment 36,489 78 10 — 160 248 36,737 Indirect installment 224,348 1,859 244 167 1,041 3,311 227,659 Home equity 192,140 502 527 — 1,691 2,720 194,860 Total consumer 452,977 2,439 781 167 2,892 6,279 459,256 Total $ 2,817,688 $ 6,426 $ 2,903 $ 167 $ 14,289 $ 23,785 $ 2,841,473 Percentage of total loans 99.16 % 0.23 % 0.10 % 0.01 % 0.50 % 0.84 % 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) • Commercial loan officers are responsible for reviewing their loan portfolios and report 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 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 to 120 days delinquent a loan is charged off unless it is well secured and in the process of collection. If the latter case exists, the loan is placed on non-accrual. Occasionally a mortgage loan may be graded as “Special Mention.” When this situation arises, it is because the characteristics of the loan and the borrower fit the definition of a Risk Grade 5 described below, which is normally used for grading commercial loans. Loans not graded Substandard are considered Pass. Horizon Bank employs a nine-grade rating system to determine the credit quality of commercial loans. The first five grades represent acceptable quality, and the last four grades mirror the criticized and classified grades used by the bank regulatory agencies (special mention, substandard, doubtful, and loss). The loan grade definitions are detailed below. Risk Grade 1: Excellent (Pass) Loans secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better. Risk Grade 2: Good (Pass) Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by unaudited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets and unblemished credit history; or loans to publicly held companies with current long-term debt ratings of Baa or better. Risk Grade 3: Satisfactory (Pass) Loans supported by financial statements (audited or unaudited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered. Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply: • At inception, the loan was properly underwritten, did not • 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 level of risk and (2) weaknesses are considered “potential,” not “defined,” impairments to the primary source of repayment. These loans may be to borrowers with adverse trends in financial performance, collateral value and/or marketability, or balance sheet strength. Risk Grade 6: Substandard One or more of the following characteristics may be exhibited in loans classified Substandard: • Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss. • Loans are inadequately protected by the current net worth and paying capacity of the obligor. • The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees. • Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected. • Unusual courses of action are needed to maintain a high probability of repayment. • The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments. • The lender is forced into a subordinated or unsecured position due to flaws in documentation. • Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms. • 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. December 31, 2018 Pass Special Mention Substandard Doubtful Total Commercial Owner occupied real estate $ 538,177 $ 6,618 $ 16,668 $ — $ 561,463 Non-owner occupied real estate 702,269 9,682 5,863 — 717,814 Residential spec homes 5,199 — — — 5,199 Development & spec land 46,382 97 68 — 46,547 Commercial and industrial 379,607 6,655 8,084 — 394,346 Total commercial 1,671,634 23,052 30,683 — 1,725,369 Real estate Residential mortgage 641,309 — 4,827 — 646,136 Residential construction 24,030 — — — 24,030 Mortgage warehouse 74,120 — — — 74,120 Total real estate 739,459 — 4,827 — 744,286 Consumer Direct installment 38,138 — 35 — 38,173 Indirect installment 313,088 — 1,089 — 314,177 Home equity 192,625 — 2,141 — 194,766 Total consumer 543,851 — 3,265 — 547,116 Total $ 2,954,944 $ 23,052 $ 38,775 $ — $ 3,016,771 Percentage of total loans 97.95 % 0.76 % 1.29 % 0.00 % December 31, 2017 Pass Special Mention Substandard Doubtful Total Commercial Owner occupied real estate $ 549,198 $ 8,622 $ 18,202 $ — $ 576,022 Non-owner occupied real estate 675,030 3,864 5,007 — 683,901 Residential spec homes 16,591 — — — 16,591 Development & spec land 48,884 886 226 — 49,996 Commercial and industrial 327,970 7,448 13,667 — 349,085 Total commercial 1,617,673 20,820 37,102 — 1,675,595 Real estate Residential mortgage 590,593 — 5,494 — 596,087 Residential construction 15,805 — 222 — 16,027 Mortgage warehouse 94,508 — — — 94,508 Total real estate 700,906 — 5,716 — 706,622 Consumer Direct installment 36,577 — 160 — 36,737 Indirect installment 226,451 — 1,208 — 227,659 Home equity 192,884 — 1,976 — 194,860 Total consumer 455,912 — 3,344 — 459,256 Total $ 2,774,491 $ 20,820 $ 46,162 $ — $ 2,841,473 Percentage of total loans 97.64 % 0.73 % 1.62 % 0.00 % |