HBNC

Horizon Bancorp Inc. - 10-Q Summary (Period Ended September 30, 2008)

Business Context and Reporting Period

Horizon Bancorp Inc. (Horizon) is a smaller reporting company headquartered in Michigan City, Indiana, operating primarily through its subsidiary, Horizon Bank, N.A. The company serves Northwestern Indiana and Southwestern Michigan. This filing covers the quarterly period ended September 30, 2008, and the nine-month period ended on that date. The financial statements are unaudited.

Key Financial Metrics

Note: Dollar amounts in thousands unless otherwise noted. Q3 2008 Net Interest Margin improved 44 basis points year-over-year.

Material Changes vs. Prior Period

• Profitability Decline in Q3: Net income for the third quarter of 2008 decreased by $938,000 (41%) compared to the same period in 2007. This decline was driven primarily by a significant increase in the provision for loan losses ($3.137 million vs. $0.550 million), attributed to the deterioration of three commercial loans and increased charge-offs in the indirect auto loan portfolio.
• Year-to-Date Growth: Despite the Q3 decline, net income for the nine months ended September 30, 2008, increased by $720,000 (11.7%) compared to the prior year, supported by a 34 basis point improvement in net interest margin and a $36 million increase in average earning assets.
• Asset Quality Deterioration: Non-performing loans increased to $6.634 million (0.77% of total loans) from $2.3 million in the prior year. Net charge-offs for the quarter were $2.423 million, compared to $392,000 in Q3 2007. Other real estate owned (OREO) increased to $1.357 million.
• Liquidity and Funding: Total deposits declined by approximately $144 million year-to-date, driven by the maturity of high-cost consumer and negotiable certificates of deposit. To offset this, borrowings increased by $69.6 million, and cash and cash equivalents decreased by $34.5 million.

Guidance, Outlook, and Risks

Capital Purchase Program (TARP/CPP): On November 3, 2008, Horizon filed an application to sell $25 million in preferred stock to the U.S. Treasury under the Capital Purchase Program. Management views this as a strategic move to provide a capital cushion and expand credit flow, not as an indication of financial distress. The company currently exceeds regulatory requirements to be classified as "well capitalized."

Outlook and Risks:

• Economic Environment: Management highlights significant challenges due to the global financial crisis, housing market declines, and credit market volatility. These factors increase the risk of loan delinquencies and collateral value declines.
• Interest Rate Risk: The company is asset-sensitive, with assets repricing within one year at 130% of liabilities. Rising rates could benefit net interest income, while falling rates could compress margins.
• Legal Proceedings: A putative class action lawsuit was filed in August 2008 regarding post-repossession notices for vehicle repossessions. The bank is vigorously defending the action.
• Regulatory Changes: Potential legislative changes regarding foreclosure processes or borrower payment obligations could increase credit losses.

Investor Verification Checklist

• Loan Portfolio Quality: Verify the specific status of the three commercial loans cited as the primary driver for the increased provision for loan losses.
• TARP Participation Terms: Confirm the final approval and specific terms of the $25 million preferred stock issuance, including dividend obligations (5% for 5 years, then 9%) and restrictions on common stock dividends and buybacks.
• Non-Performing Assets Trend: Monitor the trajectory of non-performing loans and OREO, which have more than doubled year-over-year.
• Deposit Stability: Assess the sustainability of the deposit base given the $144 million outflow in the first nine months of 2008 and the reliance on higher-cost borrowings.
• Legal Exposure: Track the progress of the class action lawsuit regarding vehicle repossession notices.