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, 2019 Non-accrual Loans Past Due Over 90 Days Still Accruing Non-peforming TDRs Performing TDRs Total Non-performing Loans Commercial Owner occupied real estate $ 3,372 $ — $ 389 $ 139 $ 3,900 Non-owner occupied real estate 3,041 — 404 314 3,759 Residential spec homes 261 — — — 261 Development & spec land 177 — — — 177 Commercial and industrial 1,653 — — — 1,653 Total commercial 8,504 — 793 453 9,750 Real estate Residential mortgage 3,691 140 416 1,748 5,995 Residential construction — — — — — Mortgage warehouse — — — — — Total real estate 3,691 140 416 1,748 5,995 Consumer Direct installment 55 17 — — 72 Indirect installment 986 30 — — 1,016 Home equity 2,077 5 140 331 2,553 Total consumer 3,118 52 140 331 3,641 Total $ 15,313 $ 192 $ 1,349 $ 2,532 $ 19,386 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 Included in the $19.4 million of non-accrual loans and the $1.3 million of non-performing TDRs at March 31, 2019 were $3.1 million and $629,000, 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 generally place a loan on a non-accrual status when the payment is delinquent in excess of 90 days or the loan has had the accrual of interest discontinued by management. The officer responsible for the loan and the Chief Commercial Banking Officer and/or the Chief Operations Officer must review all loans placed on non-accrual status. Subsequent payments on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Non-accrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal in accordance with the loan terms. The Company requires a period of satisfactory performance of not less than six months before returning a non-accrual loan to accrual status. 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 March 31, 2019, 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 March 31, 2019, the Company had $3.9 million in TDRs and $2.5 million were performing according to the restructured terms and $ in TDRs were returned to accrual status during the first three months of 2019. There were $20,000 specific reserves allocated to TDRs at March 31, 2019 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: March 31, 2019 Three 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 $ 3,275 $ 3,269 $ — $ 3,650 $ 60 Non-owner occupied real estate 840 869 — 875 32 Residential spec homes 261 261 — 261 3 Development & spec land 66 64 — 65 — Commercial and industrial 656 648 — 668 7 Total commercial 5,098 5,111 — 5,519 102 With an allowance recorded Commercial Owner occupied real estate 355 355 25 358 — Non-owner occupied real estate 135 135 40 135 — Residential spec homes — — — — — Development & spec land — — — — — Commercial and industrial 632 632 850 632 — Total commercial 1,122 1,122 915 1,125 — Total $ 6,220 $ 6,233 $ 915 $ 6,644 $ 102 March 31, 2018 Three 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 $ 4,038 $ 4,063 $ — $ 4,590 $ 37 Non-owner occupied real estate 1,033 1,049 — 975 5 Residential spec homes — — — — — Development & spec land 76 74 — 75 — Commercial and industrial 737 745 — 1,447 — Total commercial 5,884 5,931 — 7,087 42 With an allowance recorded Commercial Owner occupied real estate 893 893 184 900 — Non-owner occupied real estate — — — — — Residential spec homes — — — — — Development & spec land — — — — — Commercial and industrial — — — — — Total commercial 893 893 184 900 — Total $ 6,777 $ 6,824 $ 184 $ 7,987 $ 42 The following table presents the payment status by class of loan: March 31, 2019 Current 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due Non-accrual Total Past Due & Non-accrual Loans Total Commercial Owner occupied real estate $ 672,729 $ 27 $ — $ — $ 3,761 $ 3,788 $ 676,517 Non-owner occupied real estate 827,610 2,386 362 — 3,445 6,193 833,803 Residential spec homes 9,469 491 — — 261 752 10,221 Development & spec land 74,885 17 — — 177 194 75,079 Commercial and industrial 493,723 1,616 632 — 1,653 3,901 497,624 Total commercial 2,078,416 4,537 994 — 9,297 14,828 2,093,244 Real estate Residential mortgage 790,848 1,910 169 140 4,107 6,326 797,174 Residential construction 24,593 — — — — — 24,593 Mortgage warehouse 71,944 — — — — — 71,944 Total real estate 887,385 1,910 169 140 4,107 6,326 893,711 Consumer Direct installment 37,345 67 48 17 55 72 37,417 Indirect installment 316,613 906 129 30 986 1,016 317,629 Home equity 279,938 956 264 5 2,217 2,222 282,160 Total consumer 633,896 1,929 441 52 3,258 3,310 637,206 Total $ 3,599,697 $ 8,376 $ 1,604 $ 192 $ 16,662 $ 24,464 $ 3,624,161 Percentage of total loans 99.32 % 0.23 % 0.04 % 0.01 % 0.46 % 0.68 % December 31, 2018 Current 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due Non-accrual 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 — 35 146 38,284 Indirect installment 313,088 1,396 198 173 916 2,683 315,771 Home equity 192,960 761 37 7 1,799 2,604 195,564 Total consumer 544,186 2,250 253 180 2,750 5,433 549,619 Total $ 2,998,940 $ 5,100 $ 2,061 $ 568 $ 12,605 $ 20,334 $ 3,019,274 Percentage of total loans 99.33 % 0.17 % 0.07 % 0.02 % 0.42 % 0.67 % 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 3,500,000 • Commercial loan officers are responsible for reviewing their loan portfolios and reporting any adverse material change to the CCBO or Loan Committee. When circumstances warrant a change in the credit quality grade, loan officers are required to notify the CCBO and the Credit Department of the change in the loan grade. Downgrades are accepted immediately by the CCBO, however, lenders must present their factual information to either the Loan Committee or the CCBO when recommending an upgrade. • The CCBO, or his designee, meets 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 possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory; • At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss. • The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance. • During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted. Risk Grade 4 Satisfactory/Monitored: Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory 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 unstablized, 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. March 31, 2019 Pass Special Mention Substandard Doubtful Total Commercial Owner occupied real estate $ 656,354 $ 5,046 $ 15,117 $ — $ 676,517 Non-owner occupied real estate 815,974 9,048 8,781 — 833,803 Residential spec homes 9,960 — 261 — 10,221 Development & spec land 74,805 97 177 — 75,079 Commercial and industrial 482,091 7,074 8,459 — 497,624 Total commercial 2,039,184 21,265 32,795 — 2,093,244 Real estate Residential mortgage 791,663 — 5,511 — 797,174 Residential construction 24,593 — — — 24,593 Mortgage warehouse 71,944 — — — 71,944 Total real estate 888,200 — 5,511 — 893,711 Consumer Direct installment 37,345 — 72 — 37,417 Indirect installment 316,613 — 1,016 — 317,629 Home equity 279,826 — 2,334 — 282,160 Total consumer 633,784 — 3,422 — 637,206 Total $ 3,561,168 $ 21,265 $ 41,728 $ — $ 3,624,161 Percentage of total loans 98.26 % 0.59 % 1.15 % 0.00 % 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 % |