HBNC

Horizon Bancorp Inc. - 10-Q Summary (Period Ended Sept 30, 2006)

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2006, and the nine-month period ended on the same date. Horizon Bancorp Inc. is a financial holding company headquartered in Michigan City, Indiana, operating primarily through its subsidiary, Horizon Bank, N.A. The company is a non-accelerated filer. As of November 8, 2006, there were 3,238,682 shares of common stock outstanding.

Key Financial Metrics

(Dollar amounts in thousands, except per share data)

Material Changes vs. Prior Period

• Net Income: For the nine months ended Sept 30, 2006, net income increased to $5.251 million from $5.011 million in the prior year. For the quarter, net income decreased slightly to $1.968 million from $2.028 million.
• Net Interest Income: Increased by 3.9% ($878k) for the nine-month period due to a 11.9% increase in average earning assets, largely driven by the 2005 acquisition of Alliance Bank. However, the Net Interest Margin (NIM) declined from 3.28% to 3.08% due to competitive pressure on deposit rates.
• Non-Interest Income: Increased by 14.3% in the quarter, driven by a $656k gain on the sale of mortgage servicing rights. This was partially offset by a $515k loss on the sale of investment securities.
• Asset Composition: Loans increased by approximately $96.5 million since year-end 2005, while investment securities decreased by $35.3 million. The company sold lower-yielding securities to fund loan growth and reduce short-term debt.
• Deposits: Total deposits declined from $855.6 million at year-end 2005 to $815.2 million, primarily due to the withdrawal of a large municipal deposit in early 2006.

Guidance, Outlook, and Risks

• Portfolio Restructuring: Management sold $91.5 million of lower-yielding securities, recognizing a loss of $764k. This is expected to negatively impact 2006 net income by approximately $258k (after-tax) but will positively impact 2007 by approximately $301k due to reinvestment in higher-yielding assets.
• Capital Resources: Stockholders' equity increased to $59.49 million. The company maintains regulatory capital ratios 100 basis points above "well capitalized" minimums as required by the OCC following the Alliance Bank acquisition.
• Regulatory Uncertainty: Regulators have questioned the classification of mortgage warehouse loans. If reclassified as "other loans" rather than home mortgages, risk-based capital ratios would decrease, though the bank would likely remain "well capitalized."
• Accounting Changes: The company adopted SFAS 123(R) effective Jan 1, 2006, resulting in the recognition of share-based compensation expense ($29k for the nine months).
• Risks: Key risks include credit risk, market risk (interest rate changes), liquidity risk, and operational risk. Management believes the allowance for loan losses of $8.81 million is adequate.

Investor Verification Checklist

• Verify the impact of the $764k loss on securities sales on full-year 2006 earnings guidance.
• Monitor the regulatory status of the mortgage warehouse loan classification and its potential effect on capital ratios.
• Assess the sustainability of loan growth given the decline in core deposits and reliance on short-term borrowings (which increased to $120.6 million).
• Review the composition of the loan portfolio, specifically the shift toward adjustable-rate mortgages and installment loans.
• Confirm the timeline for the positive yield impact from the reinvested securities in 2007.