HORIZON BANCORP

FORM 10-Q

United States
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934

HORIZON BANCORP

(Exact name of registrant as specified in its charter)

Indiana		35-1562417
(State or other jurisdiction of incorporation or organization)		(I.R. S. Employer Identification No.)
515 Franklin Square, Michigan City, Indiana		46360
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (219) 879-0211

Former name, former address and former fiscal year, if changed since last report: N/A

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

     

Large Accelerated Filer o

Accelerated Filer o

Non-accelerated Filer o (Do not check if smaller reporting company)

Smaller Reporting Company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,273,562 at May 14, 2009.

 

 

HORIZON BANCORP
FORM 10-Q
INDEX

PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets			3
		Condensed Consolidated Statements of Income			4
		Condensed Consolidated Statements of Stockholders’ Equity			5
		Condensed Consolidated Statements of Cash Flows			6
		Notes to Condensed Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			25
Item 4T.		Controls and Procedures			25
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings			26
Item 1A.		Risk Factors			26
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			26
Item 3.		Defaults Upon Senior Securities			26
Item 4.		Submission of Matters to a Vote of Security Holders			26
Item 5.		Other Information			26
Item 6.		Exhibits			27
Signatures					28
Index To Exhibits					29
EX-31.1
EX-31.2
EX-32

PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HORIZON BANCORP AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Dollar Amounts in Thousands)

		March 31, 2009				December 31,
		(Unaudited)				2008
Assets
Cash and due from banks		$	13,311			$	36,001
Federal Reserve and fed funds sold			75,568				—
Cash and cash equivalents			88,879				36,001
Interest-bearing deposits			6,444				2,679
Investment securities, available for sale			325,219				301,638
Investment securities, held to maturity			2,070				1,630
Loans held for sale			7,752				5,955
Loans, net of allowance for loan losses of $11,589 and $11,410			922,515				870,557
Premises and equipment			29,548				28,280
Federal Reserve and Federal Home Loan Bank stock			12,625				12,625
Goodwill			5,787				5,787
Other intangible assets			1,674				1,751
Interest receivable			6,038				5,708
Cash value life insurance			22,607				22,451
Deferred tax asset			1,727				2,580
Other assets			9,966				9,215
Total assets		$	1,442,851			$	1,306,857
Liabilities
Deposits
Non-interest bearing		$	81,000			$	83,642
Interest bearing			896,489				757,527
Total deposits			977,489				841,169
Borrowings			320,956				324,383
Subordinated debentures			27,837				27,837
Interest payable			1,849				1,910
Other liabilities			8,293				8,208
Total liabilities			1,336,424				1,203,507
Commitments and Contingent Liabilities
Stockholders’ Equity
Preferred stock, no par value, $1,000 liquidation value Authorized, 1,000,000 shares Issued 25,000 shares			24,191				24,154
Common stock, $.2222 stated value Authorized, 22,500,000 shares Issued, 5,013,906 shares			1,114				1,114
Additional paid-in capital			26,869				26,802
Retained earnings			69,654				67,804
Accumulated other comprehensive income			1,751				628
Less treasury stock, at cost, 1,759,424 shares			(17,152	)			(17,152	)
Total stockholders’ equity			106,427				103,350
Total liabilities and stockholders’ equity		$	1,442,851			$	1,306,857

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(Dollar Amounts in Thousands, Except Per Share Data)

		Three Months Ended March 31
		2009				2008
		(Unaudited)				(Unaudited)
Interest Income
Loans receivable		$	14,905			$	15,367
Investment securities:
Taxable			2,849				2,548
Tax exempt			920				837
Total interest income			18,674				18,752
Interest Expense
Deposits			3,996				6,594
Borrowed funds			2,892				2,828
Subordinated debentures			370				407
Total interest expense			7,258				9,829
Net Interest Income			11,416				8,923
Provision for loan losses			3,197				778
Net Interest Income after Provision for Loan Losses			8,219				8,145
Other Income
Service charges on deposit accounts			934				921
Wire transfer fees			247				105
Interchange fees			388				188
Fiduciary activities			917				885
Gain on sale of loans			1,913				804
Mortgage servicing net of impairment			(134	)			(24	)
Increase in cash surrender value of bank owned life insurance			156				228
Other income			73				106
Total other income			4,494				3,213
Other Expenses
Salaries and employee benefits			4,831				4,275
Net occupancy expenses			1,032				972
Data processing			379				332
Professional fees			395				249
Outside services and consultants			326				304
Loan expense			566				458
FDIC deposit insurance			292				116
Other losses			385				101
Other expenses			1,191				1,220
Total other expenses			9,397				8,027
Income Before Income Tax			3,316				3,331
Income tax expense			681				803
Net Income			2,635				2,528
Preferred stock dividends and discount accretion			(350	)			—
Net Income Available to Common Shareholders		$	2,285			$	2,528
Basic Earnings Per Share		$	.71			$	.79
Diluted Earnings Per Share		$	.70			$	.78

See notes to condensed consolidated financial statements

HORIZON BANCORP AND SUBSIDIARIES
Condensed Consolidated Statement of Stockholders’ Equity
(Unaudited)
(Table Dollar Amounts in Thousands, Except Per Share Data)

																						Accumulated
										Additional												Other
		Preferred				Common				Paid-in				Comprehensive				Retained				Comprehensive				Treasury
		Stock				Stock				Capital				Income				Earnings				Loss				Stock				Total
Balances, December 31, 2008		$	24,154			$	1,114			$	26,802							$	67,804			$	628			$	(17,152	)		$	103,350
Net income														$	2,635				2,635												2,635
Amortization of discount on preferred stock			37																(37	)											—
Other comprehensive income (loss), net of tax, unrealized gain on securities															1,170								1,170								1,170
Unrealized loss on derivative instruments															(47	)							(47	)							(47	)
Comprehensive income														$	3,758
Amortization of unearned compensation											58																				58
Stock option expense											9																				9
Cash dividends on preferred stock (5.00%)																			(195	)											(195	)
Cash dividends on common stock ($.17 per share)																			(553	)											(553	)
Balances, March 31, 2009		$	24,191			$	1,114			$	26,869							$	69,654			$	1,751			$	(17,152	)		$	106,427

See notes to condensed consolidated financial statements.

HORIZON BANCORP AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Dollar Amounts in Thousands)

		Three Months Ended
		March 31
		2009				2008
		(Unaudited)				(Unaudited)
Operating Activities
Net income		$	2,635			$	2,528
Items not requiring (providing) cash
Provision for loan losses			3,197				778
Depreciation and amortization			580				583
Share based compensation			9				9
Mortgage servicing rights impairment			129				4
Deferred income tax			249				1,803
Premium amortization on securities available for sale, net			91				39
Gain on sale of loans			(1,913	)			(611	)
Proceeds from sales of loans			99,449				37,061
Loans originated for sale			(100,369	)			(35,682	)
Loss on sale of premises and equipment			—				1
Increase in cash surrender value of life insurance			(156	)			(228	)
Loss on sale of other real estate owned			27				—
Net change in
Interest receivable			(330	)			193
Interest payable			(61	)			384
Other assets			30				(1,534	)
Other liabilities			(270	)			204
Net cash provided by operating activities			3,297				5,532
Investing Activities
Net change in interest-bearing deposits			(3,765	)			(2,981	)
Purchases of securities available for sale			(37,929	)			(7,548	)
Proceeds from sales, maturities, calls, and principal repayments of securities available for sale			16,057				6,727
Purchases of securities held to maturity			(440	)			—
Net change in loans			(55,064	)			1,817
Proceeds from sale of other real estate owned			290				—
Recoveries on loans previously charged-off			—				211
Purchases of premises and equipment			(1,713	)			(892	)
Proceeds from sale of loans transferred to held for sale			—				37,695
Gain on sale of loans transferred to held for sale			—				(193	)
Net cash provided (used) by investing activities			(82,564	)			34,836
Financing Activities
Net change in
Deposits			136,320				(10,934	)
Borrowings			(3,427	)			(2,878	)
Dividends paid on preferred shares			(195	)			—
Dividends paid on common shares			(553	)			(487	)
Net cash provided (used) by financing activities			132,145				(14,299	)
Net Change in Cash and Cash Equivalent			52,878				26,069
Cash and Cash Equivalents, Beginning of Period			36,001				55,029
Cash and Cash Equivalents, End of Period		$	88,879			$	81,098
Additional Cash Flows Information
Interest paid		$	7,319			$	9,445
Income taxes paid			125				30

See notes to condensed consolidated financial statements.

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

Note 1 — Accounting Policies

The accompanying consolidated financial statements include the accounts of Horizon Bancorp (Horizon) and its wholly-owned subsidiaries, Horizon Bank, N.A. (“Bank”). All inter-company balances and transactions have been eliminated. The results of operations for the periods ended March 31, 2009 and March 31, 2008 are not necessarily indicative of the operating results for the full year of 2009 or 2008. The accompanying unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of Horizon’s management, necessary to fairly present the financial position, results of operations and cash flows of Horizon for the periods presented. Those adjustments consist only of normal recurring adjustments.

Certain information and note disclosures normally included in Horizon’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Horizon’s Annual Report on Form 10-K for 2008 filed with the Securities and Exchange Commission. The consolidated balance sheet of Horizon as of December 31, 2008 has been derived from the audited balance sheet of Horizon as of that date.

Basic earnings per share is computed by dividing net income available to common shareholders (net income less dividend requirements for preferred stock and accretion of preferred stock discount) by the weighted-average number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. In August 2002, substantially all of the participants in Horizon’s Stock Option and Stock Appreciation Rights Plans voluntarily entered into an agreement with Horizon to cap the value of their stock appreciation rights (SARS) at $14.67 per share and cease any future vesting of the SARS. These agreements with option holders make it more advantageous to exercise an option rather than a SAR whenever Horizon’s stock price exceeds $14.67 per share, therefore the option becomes potentially dilutive at $14.67 per share or higher. The following table shows computation of basic and diluted earnings per share.

		Three months ended March 31
		2009				2008
		(Unaudited)				(Unaudited)
Basic earnings per share
Net income		$	2,635			$	2,528
Less: Preferred stock dividends and accretion of discount			350				—
Net income available to common shareholders		$	2,285			$	2,528
Weighted average common shares outstanding			3,209,482				3,207,232
Basic earnings per share		$	.71			$	.79
Diluted earnings per share
Net income available to common shareholders		$	2,285			$	2,528
Weighted average common shares outstanding			3,209,482				3,207,232
Effect of dilutive securities:
Restricted stock			35,216				27,451
Stock options			5,726				7,788
Weighted average shares outstanding			3,250,424				3,242,471
Diluted earnings per share		$	.70			$	.78

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

At March 31, 2009 and 2008 there were 30,800 shares and 29,000 shares that were not included in the computation of diluted earnings per share because they were anti-dilutive. Warrants to purchase 212,104 shares at March 31, 2009 were not included in the computation of diluted earnings per share because the effect would be anti-dilutive.

Horizon has share-based employee compensation plans, which are described in the notes to the financial statements included in the December 31, 2008 Annual Report on Form 10-K.

Reclassifications

Certain reclassifications have been made to the 2008 consolidated financial statements to be comparable to 2009. These reclassifications had no effect on net income.

Note 2 — Loans

		March 31, 2009				December 31,
		(Unaudited)				2008
Commercial		$	313,840			$	310,842
Real estate			160,478				167,766
Mortgage warehouse			186,058				123,287
Installment			273,728				280,072
			934,104				881,967
Allowance for loan losses			(11,589	)			(11,410	)
Total loans		$	922,515			$	870,557

Note 3 — Allowance for Loan Losses

		Three months ended March 31
		2009				2008
		(Unaudited)				(Unauditied)
Balances, beginning of period		$	11,410			$	9,791
Provision for losses			3,197				778
Recoveries on loans			258				211
Loans charged off			(3,276	)			(1,099	)
Balances, end of period		$	11,589			$	9,681

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

Note 4 — Non-performing Assets

		March 31, 2009				December 31,
		(Unaudited)				2008
Non-performing loans
Commercial		$	6,474			$	5,167
Real estate			2,446				1,904
Mortgage warehouse			—				—
Installment			1,549				792
Total non-performing loans			10,469				7,863
Other real estate owned and repossessed collateral
Commercial			—				—
Real estate			2,492				2,874
Mortgage warehouse			—				—
Installment			204				207
Total other real estate owned and repossessed collateral			2,696				3,081
Total non-performing assets		$	13,165			$	10,944

Note 5 — Derivative financial instruments

The Company adopted SFAS No. 161 as of January 1, 2009, which expands the disclosure requirements of SFAS No. 133 as follows.

Cash Flow Hedges

As a strategy to maintain acceptable levels of exposure to the risk of changes in future cash flow due to interest rate fluctuations, the Company entered into interest rate swap agreements for a portion of its floating rate debt. The agreements provide for the Company to receive interest from the counterparty at three month LIBOR and to pay interest to the counterparty at a weighted average fixed rate of 5.54% on a notional amount of $27.0 million at March 31, 2009. Under the agreements, the Company pays or receives the net interest amount monthly, with the monthly settlements included in interest expense.

Management has designated the interest rate swap agreement as a cash flow hedging instrument. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of the other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. At March 31, 2009 the Company’s cash flow hedge was effective and is not expected to have a significant impact the Company’s net income over the next 12 months.

Fair Value Hedges

Fair value hedges are intended to reduce the interest rate risk associated with the underlying hedged item. The Company enters into fixed rate loan agreements as part of its lending policy. To mitigate the risk of changes in fair value based on fluctuations in interest rates, the Company has entered into interest rate swap agreements on individual loans, converting the fixed rate loans to a variable rate. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current earnings. At March 31, 2009 the Company’s fair value hedges were effective and are not expected to have a significant impact the Company’s net income over the next 12 months.

The change in fair value of both the hedge instruments and the underlying loan agreements are recorded as gains or losses in interest income. The fair value hedges are considered to be highly effective and any hedge ineffectiveness was deemed not material. The notional amounts of the loan agreements being hedged were $26.1 million at March 31, 2009.

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

Other Derivative Instruments

The Company enters into non-hedging derivative in the form of mortgage loan forward sale commitments with investors and commitments to originate mortgage loans as part of its mortgage banking business. At March 31, 2009 the Company’s fair value of these derivatives were recorded and over the next 12 months are not expected to have a significant impact the Company’s net income.

The change in fair value of both the forward sale commitments and commitments to originate mortgage loans were recorded and the net gains or losses included in the Company’s gain on sale of loans.

The following tables summarize the fair value of derivative financial instruments utilized by Horizon Bancorp:

Asset Derivative

Liability Derivatives

Derivative designated as

March 31, 2009 (Unaudited)

March 31, 2009 (Unaudited)

hedging instruments

Balance Sheet

Balance Sheet

under Statement 133

Location

Fair Value

Location

Fair Value

Interest rate contracts

Loans

$

1,730

Other liabilities

$

1,730

Interest rate contracts

—

Other liabilities

924

Total derivatives designated as hedging instruments under Statement 133

1,730

2,654

Derivative not designated as

hedging instruments

under Statement 133

Mortgage loan contracts

Other assets

444

Other liabilities

180

Total derivatives not designated as hedging instruments under Statement 133

444

180

Total derivatives

$

2,174

$

2,834

The effect of the derivative instruments on the consolidated statement of income for the three-month period ended is as follows:

		Amount of Loss Recognized in Other Comprehensive Income on
		Derivative (Effective Portion)
Derivative in Statement 133		Three Months Ended March 31,
cash flow hedging		(Unaudited)
relationships		2009
Interest rate contracts		$	(47	)
Total		$	(47	)

						Amount of Gain (Loss)
						Recognized on Derivative
Derivative in Statement 133						Three Months Ended March 31,
fair value hedging		Location of Gain (Loss)				(Unaudited)
relationships		Recognized on Derivative				2009
Interest rate contracts		Interest income — loans				$	24
Interest rate contracts		Interest income — loans					(24	)
Total						$	—

						Amount of Gain (Loss)
						Recognized on Derivative
Derivative not designated as						Three Months Ended March 31,
hedging instruments		Location of Gain (Loss)				(Unaudited)
under Statement 133		Recognized on Derivative				2009
Mortgage contracts		Other income — gain on sale of loans				$	32
Total						$	32

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

Note 6 — Disclosures about fair value of assets and liabilities

Effective January 1, 2008 Horizon adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The standard describes three levels of inputs that may be used to measure fair value:

Level 1		Quoted prices in active markets for identical assets or liabilities
Level 2		Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying financial statements, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available for sale securities

When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include corporate notes. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include, U.S. Treasury and federal agency securities, State and municipal securities, Federal agency collateralized mortgage obligations and Federal agency mortgage-backed pools.

Hedged loans

Certain fixed rate loans have been converted to variable rate loans through entering into interest rate swap agreements. Fair value of those fixed rate loans is based on discounting estimated cash flows using interest rates determined by a respective interest rate swap agreement. Loans are classified within Level 3 of the valuation hierarchy based on the unobservable inputs used.

Interest rate swap agreements

The fair value is estimated by a third party using inputs that are primarily unobservable and cannot be corroborated by observable market data and, therefore, are classified within Level 3 of the valuation hierarchy.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying financial statements measured at fair value on a recurring basis and the level within the FAS 157 fair value hierarchy in which the fair value measurements fall at the following:

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

						Quoted Prices in Active
						Markets for Identical				Significant Other				Significant
						Assets				Observable Inputs				Unobservable Inputs
		Fair Value				(Level 1)				(Level 2)				(Level 3)
March 31, 2009 (Unaudited)
Available-for-sale securities		$	325,219			$	—			$	325,219			$	—
Hedged loans			27,791				—				—				27,791
Forward sale commitments			444				—				—				444
Interest rate swap agreements			(2,654	)			—				—				(2,654	)
Commitments to originate loans			(180	)			—				—				(180	)
December 31, 2008
Available-for-sale securities		$	301,638			$	—			$	301,638			$	—
Hedged loans			25,033				—				—				25,033
Forward sale commitments			670				—				—				670
Interest rate swap agreements			(2,557	)			—				—				(2,557	)
Commitments to originate loans			(438	)			—				—				(438	)

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated balance sheet using significant unobservable (level 3) inputs (unaudited):

						Forward Sale				Interest Rate				Commitments to
		Hedged Loans				Commitments				Swaps				Originate Loans
Beginning balance December 31, 2008		$	25,033			$	670			$	(2,557	)		$	(438	)
Total realized and unrealized gains and losses Included in net income			24				(226	)			(24	)			258
Included in other comprehensive income			—				—				(73	)			—
Purchases, issuances, and settlements			2,901				—				—				—
Principal payments			(167	)			—				—				—
Ending balance March 31, 2009		$	27,791			$	444			$	(2,654	)		$	(180	)

Realized gains and losses included in net income for the period from January 1, 2009 to March 31, 2009, are reported in the condensed consolidated statements of income as follows (Unaudited):

		Non interest
		Income
Total gains and losses from:
Hedged loans		$	24
Fair value interest rate swap agreements			(24	)
Derivative loan commitments			32
		$	32

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

Certain other assets and liabilities are measured at fair value on a nonrecurring basis in the course of business and are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment):

						Quoted Prices in Active
						Markets for Identical				Significant Other				Significant
						Assets				Observable Inputs				Unobservable Inputs
		Fair Value				(Level 1)				(Level 2)				(Level 3)
March 31, 2009 (Unaudited)
Impaired and non-accrual loans		$	5,802			$	—			$	—			$	5,802
Other real estate owned			2,492				—				—				2,492
December 31, 2008
Impaired and non-accrual loans		$	4,685			$	—			$	—			$	4,685
Other real estate owned			2,874				—				—				2,874

Impaired, non-accrual loans, and other real estate owned: Fair value adjustments for impaired and non-accrual loans typically occur when there is evidence of impairment. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. The Company measures fair value based on the value of the collateral securing the loans. Collateral may be in the form of real estate or personal property including equipment and inventory. The value of the collateral is determined based on internal estimates as well as third party appraisals or non-binding broker quotes. These measurements were classified as Level 3. The fair value of the Company’s other real estate owned is determined using Level 3 inputs, which include current and prior appraisals and estimated costs to sell.

Note 7 — Future accounting matters

Financial Accounting Standards Board (FASB)

SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—An Amendment of Accounting Research Bulletin (ARB) No. 51

This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Before this statement was issued, limited guidance existed for reporting noncontrolling interests. As a result, considerable diversity in practice existed. So-called minority interests were reported in the consolidated statement of financial position as liabilities or in the mezzanine section between liabilities and equity. This statement improves comparability by eliminating that diversity. Management does not anticipate that this Statement will have a material impact on the Company’s consolidated financial condition or results of operations.

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—An Amendment FASB Statement No. 133

This Statement was issued in March 2008 and amends and expands the disclosure requirements of SFAS No. 133 to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS No. 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. Management does not anticipate that this Statement will have a material impact on the Company’s consolidated financial condition or results of operations. Effective for interim reporting periods ending after January 1, 2009.

FASB Staff Position (FSP) FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies

This FSP amends and clarifies FAS 141(R), Business Combinations, regarding the initial recognition and measurement, subsequent measurement and accounting and disclosure of assets and liabilities arising from contingencies in a business combination. This FSP eliminates the distinction between contractual and noncontractual contingencies discussed in FAS 141(R), specifies whether contingencies should be measured at fair value or in accordance with FAS 5, provides application guidance on subsequent accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies and establishes new disclosure requirements. This FSP is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Management does not anticipate that this Position will have a material impact on the Company’s consolidated financial condition or results of operations.

FSP FAS 157-4—Determining Fair Value when the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly

This FSP, issued on April 9, 2009, provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. Even if there has been a significant decrease in the volume and level of activity regardless of valuation technique, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This FSP is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009 only if FSP FAS 115-2 and FAS 124-2 and FSP FAS 107-1 and APG 28-1 are adopted concurrently. This FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. Management does not anticipate that this Position will have a material impact on the Company’s consolidated financial condition or results of operations.

FSP No. 115-2 and FAS 124-2—Recognition and Presentation of Other-Than-Temporary Impairments

Issued on April 9, 2009, this FSP amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments and APB Opinion No. 28, Interim Financial Reporting, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009 only if FSP FAS 157-4 and FSP FAS 107-1 and

HORIZON BANCORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Table Dollar Amounts in Thousands, Except Per Share Data)

APG 28-1 are adopted concurrently. This FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. Management does not anticipate that this Position will have a material impact on the Company’s consolidated financial condition or results of operations.

FSP No. 107-1 and APG 28-1—Interim Disclosures about Fair Value of Financial Instruments

This FSP issued on April 9, 2009 amends the other-than-temporary guidance in U.S. generally accepted accounting principles for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities and does not require disclosures for earlier periods presented for comparative purposes at initial adoption. Effective for interim reporting periods ending after June 15, 2009, early adoption is permitted for periods ending after March 15, 2009 only if FSP FAS 157-4 and FSP FAS 115-2 and FAS 124-2 are adopted concurrently. Management does not anticipate that this Position will have a material impact on the Company’s consolidated financial condition or results of operations.

Public Company Accounting Oversight Board (PCAOB)

Auditing Standard No. 6, Evaluating Consistency of Financial Statements

This standard establishes requirements and provides direction for the auditor’s evaluation of the consistency of the financial statements, including changes to previously issued financial statements, and the effect of that evaluation on the auditor’s report on the financial statements.

Proposed Auditing Standards Related to the Auditor’s Assessment of and Response to Risk

The Board is proposing a suite of seven new auditing standards related to the auditor’s assessment of and response to risk, and related conforming amendments. The proposed standards would supersede the Board’s interim auditing standards related to audit risk and materiality, audit planning and supervision, consideration of internal control in an audit of financial statements, audit evidence and performing tests of accounts and disclosures before year end. The proposed standards would apply to all audits performed in accordance with the standards of the PCAOB.

HORIZON BANCORP AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
For the Three Months Ended March 31, 2009

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward—Looking Statements

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to Horizon Bancorp (“Horizon” or “Company”) and Horizon Bank, N.A. (Bank). Horizon intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for the purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of Horizon, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. Horizon’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on Horizon’s future activities and operating results include, but are not limited to:

	•		credit risk: the risk that loan customers or other parties will be unable to perform their contractual obligations;
	•		market risk: the risk that changes in market rates and prices will adversely affect the Company’s financial condition or results of operation;
	•		liquidity risk: the risk that Horizon or the Bank will have insufficient cash or access to cash to meet its operating needs;
	•		operational risk: the risk of loss resulting from inadequate or failed internal processes, people and systems, or external events;
	•		economic risk: the risk that the economy in the Company’s markets could decline further resulting in increased unemployment, decreased real estate values and increased loan charge-offs; and
	•		compliance risk: the risk of additional action by Horizon’s regulators or additional regulation could hinder the Company’s ability to do business profitably.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

Overview

Horizon Bancorp (“Horizon” or the “Company”) is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in Northwestern Indiana and Southwestern Michigan through its bank subsidiary, Horizon Bank, N.A. (the “Bank”) and other affiliated entities. Horizon operates as a single segment, which is commercial banking. Horizon’s Common Stock is traded on the Nasdaq Global Market under the symbol HBNC. The Bank was chartered as a national banking association in 1873 and has operated continuously since that time. The Bank is a full-service commercial bank offering commercial and retail banking services, corporate and individual trust and agency services, and other services incident to banking.

Horizon continues to operate in a challenging and uncertain economic environment. Within the Company’s primary market areas of Northwest Indiana and Southwest Michigan unemployment rates have increased over the last year. This rise in unemployment has been driven by factors including slowdowns in the steel and recreational vehicle industries as well as a continued slowdown in the housing industry. Like numerous other parts of the country, Northwest Indiana and Southwest Michigan are experiencing a rise in mortgage delinquencies and bankruptcy filings as a result of increased unemployment rates. Despite these economic factors, Horizon reported net income growth for the first quarter of 2009 compared to the same period in 2008.

HORIZON BANCORP AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
For the Three Months Ended March 31, 2009

Following are some of the major factors that impacted Horizons financial performance for the first quarter:

	•		The net interest margin increased 68 basis points from the same three-month period in 2008 and 21 basis points from the three months ending December 31, 2008.
	•		The cost of interest bearing liabilities decreased 101 basis points from the same three-month period in 2008 and 32 basis point from the three months ending December 31, 2008.
	•		Average earning assets increased $80.6 million from the same three-month period in 2008 and $157.6 million from the three months ending December 31, 2008.
	•		Provision for loan losses were $3.2 million for the first quarter of 2009 attributed to losses primarily in the commercial and installment loan portfolios due to current economic pressures.
	•		Mortgage loan refinancing activity during the quarter contributed $1.9 million to gain on sale of loans.
	•		Diluted earnings per share decreased $.08 per share for the first quarter of 2009 compared to the first quarter of 2008 due to $.11 per share paid in dividends on the preferred stock. The preferred stock dividends reduce the net income available to common shareholders.

Critical Accounting Policies

The notes to the consolidated financial statements included in Item 8 of the Company’s Annual Report on Form 10-K for 2008 contain a summary of the Company’s significant accounting policies. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management has identified the allowance for loan losses, intangible assets and hedge accounting as critical accounting policies.

Allowance for Loan Losses

An allowance for loan losses is maintained to absorb probable incurred loan losses inherent in the loan portfolio. The determination of the allowance for loan losses is a critical accounting policy that involves management’s ongoing quarterly assessments of the probable incurred losses inherent in the loan portfolio. The identification of loans that have probable incurred losses is subjective, therefore, a general reserve is maintained to cover all probable losses within the entire loan portfolio. Horizon utilizes a loan grading system that helps identify, monitor and address asset quality problems in an adequate and timely manner. Each quarter, various factors affecting the quality of the loan portfolio are reviewed. Large credits are reviewed on an individual basis for loss potential. Other loans are reviewed as a group based upon previous trends of loss experience. Horizon also reviews the current and anticipated economic conditions of its lending market as well as transaction risk to determine the effect they may have on the loss experience of the loan portfolio.

Goodwill and Intangible Assets

Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. Statement of Financial Accounting Standard (SFAS) No. 142, “Accounting for Goodwill and Other Intangible Assets” establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. At March 31, 2009, Horizon had core deposit intangibles of $1.7 million subject to amortization and $5.8 million of goodwill, which is not subject to amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. Horizon’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Horizon to provide quality, cost effective banking services in a competitive marketplace. The goodwill value is supported by revenue that

HORIZON BANCORP AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
For the Three Months Ended March 31, 2009

is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely affect earnings in future periods. SFAS No. 142 requires an annual evaluation of goodwill for impairment. The evaluation of goodwill for impairment requires the use of estimates and assumptions. For the first time in Horizon’s history, the market value for Horizon’s stock dropped below the book value during the fourth quarter of 2008. Market price at the close of business on March 31, 2009 was $11.10 per share compared to a book value of $25.62 per common share. Horizon reported record earnings for the ninth consecutive year in 2008 and increased earnings in the first quarter of 2009 compared to the same period in 2008 and believes the decline in market price relates to an overall decline in the financial industry sector and are not specific to Horizon. Horizon engaged a third party to perform an impairment test of its goodwill in 2008. The evaluation included three approaches: 1) income approach using a discounted cash flow based on earnings capacity, 2) price to earnings multiples and 3) price to book value ratios. Approaches two and three use median results from 17 bank sale transactions that occurred during 2007 and 2008. The selling banks ranged in size from $763.0 million to $2.1 billion. The impairment test was performed as of November 30, 2008 and provided support that no impairment to the Company’s goodwill was required based on its results.

Financial results for December 2008 (and for the full year of 2008) were as anticipated by the analysis. An additional $20 million of capital was injected into Horizon Bank by the holding company but the calculated fair value of Horizon Bank was still well above its book value. There were no significant changes in the Company’s stock price, book value, or earnings as of March 31, 2009 that would change the results of the evaluation completed at the end of 2008. Horizon has concluded that, based on its own internal evaluation and the independent impairment test conducted by a third party, the recorded value of goodwill is not impaired.

Mortgage Servicing Rights

Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets on a servicing-retained basis. Capitalized servicing rights are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated regularly for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying servicing rights by predominant characteristics, such as interest rates, original loan terms and whether the loans are fixed or adjustable rate mortgages. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. When the book value of an individual stratum exceeds its fair value, an impairment reserve is recognized so that each individual stratum is carried at the lower of its amortized book value or fair value. In periods of falling market interest rates, accelerated loan prepayment speeds can adversely affect the fair value of these mortgage-servicing rights relative to their book value. In the event that the fair value of these assets was to increase in the future, Horizon can recognize the increased fair value to the extent of the impairment allowance but cannot recognize an asset in excess of its amortized book value. Future changes in management’s assessment of the impairment of these servicing assets, as a result of changes in observable market data relating to market interest rates, loan prepayment speeds, and other factors, could impact Horizon’s financial condition and results of operations either positively or adversely.

Generally, when market interest rates decline and other factors favorable to prepayments occur, there is a corresponding increase in prepayments as customers refinance existing mortgages under more favorable interest rate terms. When a mortgage loan is prepaid, the anticipated cash flows associated with servicing that loan are terminated, resulting in a reduction of the fair value of the capitalized mortgage servicing rights. To the extent that actual borrower prepayments do not react as anticipated by the prepayment model (i.e., the historical data observed in the model does not correspond to actual market activity), it is possible that the prepayment model could fail to accurately predict mortgage prepayments and could result in significant

HORIZON BANCORP AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
For the Three Months Ended March 31, 2009

earnings volatility. To estimate prepayment speeds, Horizon utilizes a third-party prepayment model, which is based upon statistically derived data linked to certain key principal indicators involving historical borrower prepayment activity associated with mortgage loans in the secondary market, current market interest rates and other factors, including Horizon’s own historical prepayment experience. For purposes of model valuation, estimates are made for each product type within the mortgage servicing rights portfolio on a monthly basis.

Derivative Instruments

As part of the Company’s asset/liability management program, Horizon utilizes, from time-to-time, interest rate floors, caps or swaps to reduce the Company’s sensitivity to interest rate fluctuations. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values of derivatives are reported in the consolidated income statements or other comprehensive income (OCI) depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be highly effective in achieving offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedge and on an ongoing basis.

Horizon’s accounting policies related to derivatives reflect the guidance in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as revised and further interpreted by SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” (“SFAS 133”) and other related accounting guidance. Derivatives that qualify for the hedge accounting treatment are designated as either: a hedge of the fair value of the recognized asset or liability or of an unrecognized firm commitment (a fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (a cash flow hedge). For fair value hedges, the cumulative change in fair value of both the hedge instruments and the underlying loans is recorded in non-interest income. For cash flow hedges, changes in the fair values of the derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected in the consolidated income statement in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, Horizon establishes the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of income. Horizon excludes the time value expiration of the hedge when measuring ineffectiveness.

Valuation Measurements

Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities, residential mortgage loans held for sale and derivatives are carried at fair value, as defined in SFAS No. 157 “Fair Value Measurement” (“SFAS 157”), which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts of goodwill, mortgage servicing rights, and pension and other post-retirement benefit obligations. To determine the values of these assets and liabilities, as well as the extent, to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment rates and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect Horizon’s results of operations.

HORIZON BANCORP AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
For the Three Months Ended March 31, 2009

Financial Condition

On March 31, 2009, Horizon’s total assets were $1.4 billion, compared to $1.3 billion on December 31, 2008. Cash and cash equivalents increased $52.9 million since year end primarily due to a $50.0 million fixed rate long term corporate repurchase agreement entered into on March 31, 2009 as part of the Company’s strategy to extend the duration of its liabilities in this low interest rate environment.

Investment securities increased by approximately $24.0 million compared to the end of 2008. This growth was continued from the fourth quarter as additional investment securities were purchased to leverage the capital raised through the U.S. Department of Treasury’s Capital Purchase Program which is part of the Economic Emergency Stabilization Act approved by Congress during the fourth quarter of 2008. The intent was to purchase a total of approximately $125.0 million of investment securities and using the cash flows from the repayment of mortgage backed securities to fund new loan growth. Approximately $105.0 million in investment securities were purchased and $20.0 million of the remaining leverage strategy was used to fund loan growth during the first quarter.

Investment securities were comprised of the following as of:

		March 31, 2009								December 31, 2008
		Amortized				Fair				Amortized				Fair
Investment securities		Cost				Value				Cost				Value
Available for sale
U.S. Treasury and federal agencies		$	20,069			$	20,650			$	23,661			$	24,914
State and municipal			95,794				95,057				88,282				86,985
Federal agency collateralized mtg. obligations			18,792				18,466				13,063				12,951
Federal agency mortgage-backed pools			186,358				190,793				174,227				176,389
Corporate notes			587				253				587				399
Total available for sale			321,600				325,219				299,820				301,638
Total held to maturity, state and municipal			2,070				2,079				1,630				1,634
Total investment securities		$	323,670			$	327,298			$	301,450			$	303,272

Net loans increased $52.0 million since December 31, 2008. This increase is almost entirely related to the growth in the Company’s mortgage warehouse business line as its customers utilized their warehouse lines. Commercial loans increased slightly and both real estate and consumer loans decreased.

Total deposits increased $136.3 million during the first quarter. Growth came in both interest-bearing transaction accounts totaling $60.7 million and time deposits totaling $78.2 million. The Company’s borrowings decreased slightly during the first quarter. These results were from two major funding initiatives that were implemented during the quarter. The first initiative was to reduce short-term borrowings, which would increase short-term daily liquidity, and the second initiative was to continue to take steps to extend the duration of liabilities in a low interest rate environment. The short-term borrowings of $52.2 million at year-end were replaced with a $50.0 million fixed rate long-term corporate repurchase agreement leaving the balance of borrowings steady and extending their duration. The Company also added $33.6 million of long-term brokered certificates of deposit to help in extending the duration of deposits. The remaining growth in total deposits was primarily from municipal money market accounts and short-term certificates of deposit. This short-term funding was designed to match the growth of short-term assets in the mortgage warehouse business line and provide additional liquidity without utilizing asset based collateral borrowings or federal fund lines. The Company will continue to look for opportunities to extend the duration of liabilities as long-term rates remain low.

HORIZON BANCORP AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
For the Three Months Ended March 31, 2009

Stockholders’ equity totaled $106.4 million at March 31, 2009 compared to $103.4 million at December 31, 2008. The increase in stockholders’ equity during the quarter was the result of net income and an increase in the market value of investment securities available for sale, reduced by dividends declared. At March 31, 2009, the ratio of average stockholders’ equity to average assets was 7.94% compared to 6.65% at December 31, 2008. Book value per common share at March 31, 2009 increased to $25.62 compared to $24.68 at December 31, 2008.

Results of Operations

Overview

Consolidated net income for the three-month period ended March 31, 2009 was $2.6 million, an increase of 4.2% compared to $2.5 million for the same period in 2008. Earnings per common share for the three months ended March 31, 2009 decreased to $0.71 basic and $0.70 fully-diluted, compared to $0.79 basic and $0.78 fully-diluted for the same three month period in 2008. Earnings per share were reduced by $0.11 per share resulting from the accrual of the preferred stock dividends and the accretion of the discount on preferred stock, which is not available to common stockholders. The preferred stock was issued in the fourth quarter of 2008 and therefore did not affect the first quarter of 2008. This decrease was offset by an increase in net income of $107,000 or $0.03 per share.

Net Interest Income

The largest component of net income is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities, and interest expense, principally on deposits and borrowings. Changes in the net interest income are the result of changes in volume, net interest spread, and net interest margin. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Net interest margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

The reduction in short-term interest rates over the last six months has influenced the cost of the Company’s interest bearing liabilities more significantly then the reduction in yields received on the Company’s interest earning assets, resulting in an increase of the net interest margin. Management believes that the current level of interest rates is significantly driven by external factors and therefore impacts the results of the Company’s net interest margin. Management does not expect a significant rise in interest rates in the short term, but an increase in rates is expected at some time in the future due to the currently low interest rate environment.

Net interest income during the three months ended March 31, 2009 was $11.4 million, an increase of $2.5 million or 27.9% over the $8.9 million earned during the same period in 2008 and an increase of $1.7 million or 17.8% earned during the three months ended December 31, 2008. Yields on the Company’s interest-earning assets decreased by 34 basis points to 6.11% for the three months ended March 31, 2009, from 6.45% for the same period in 2008. Interest income decreased $78,000 from $18.8 million for the three months ended March 31, 2008 to $18.7 million for the same period in 2009. This decrease was due to the lower yields received on an increased volume in interest earning assets. However, asset yields have not declined at the same pace as some market indices partially due to interest rate floors that are in place on approximately $368.2 million out of $532.8 million of the Company’s adjustable rate loans.

Rates paid on interest-bearing liabilities decreased by 101 basis points during the same period due to the lower interest rate environment. Interest expense decreased $2.6 million from $9.8 million for the three-months ended March 31, 2008 to $7.3 million for the same period in 2009. This decrease was due to the lower rates being paid on the Company’s interest bearing liabilities but also due to the increased volume of

HORIZON BANCORP AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
For the Three Months Ended March 31, 2009

lower cost interest bearing liabilities. Due to a more significant decrease in the rates paid on the Company’s interest-bearing liabilities compared to the decrease in the yield on the Company’s interest-earning assets, offset with the growth of the Company’s interest earning assets and interest bearing liabilities, the net interest margin increased 68 basis points from 3.10% for the three months ended March 31, 2008 to 3.78% for the same period in 2009.

The following are the average balance sheets for the three months ending:

		March 31, 2009												December 31, 2008												March 31, 2008
		Average								Average				Average								Average				Average								Average
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
		(Dollars in thousands)
ASSETS
Interest-earning assets
Federal funds sold		$	3,119			$	2				0.22	%		$	5,058			$	9				0.69	%		$	45,890			$	366				3.21	%
Interest-earning deposits			4,550				5				0.46				6,687				9				0.56				14,885				119				3.23
Investment securities — taxable (1)			245,134				2,842				4.70				177,453				2,184				4.89				166,740				2,063				4.98
Investment securities — non taxable (1)			89,508				920				5.35				75,562				808				5.25				82,428				837				4.86
Loans receivable (2)			917,566				14,905				6.59				837,542				14,038				6.67				869,367				15,367				7.11
Total interest- earning assets (1)			1,259,877				18,674				6.11	%			1,102,302				17,048				6.22	%			1,179,310				18,752				6.45	%
Non interest-earning assets
Cash and due from banks			23,119												19,253												21,859
Allowance for loan losses			(11,387	)											(10,578	)											(9,722	)
Other assets			76,270												72,279												67,269
		$	1,347,879											$	1,183,256											$	1,258,716
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities
NOW		$	232,169			$	422				0.74	%		$	238,123			$	574				0.96	%		$	253,915			$	1,220				1.93	%
Savings			34,220				24				0.28				32,451				25				0.31				29,373				20				0.28
Money market			144,922				421				1.18				83,905				274				1.30				105,203				521				1.99
Certificates of deposit			373,480				3,129				3.40				339,769				3,111				3.64				429,253				4,833				4.53
Borrowings			339,417				2,892				3.46				294,574				2,990				4.04				260,300				2,828				4.37
Subordinated debentures			27,837				370				5.39				27,837				385				5.50				27,837				407				5.88
Total interest- bearing liabilities			1,152,045				7,258				2.56	%			1,016,659				7,359				2.88	%			1,105,881				9,829				3.57	%
Non interest-bearing liabilities
Demand deposits			79,785												79,567												73,214
Other liabilities			8,991												7,425												6,026
Shareholders’ equity			107,058												79,605												73,595
		$	1,347,879											$	1,183,256											$	1,258,716
Net interest income/spread						$	11,416				3.56	%						$	9,689				3.34	%						$	8,923				2.88	%
Net interest income as a percent of average interest earning assets (1)											3.78	%											3.57	%											3.10	%