# HORIZON BANCORP INC /IN/ (HBNC) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from HORIZON BANCORP INC /IN/'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/706129/000070612923000034/hbnc-20221231.htm
Accession: 0000706129-23-000034
Filing date: 2023-03-15
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/HBNC/
All MD&A years: /company/HBNC/mda/
Previous year: /company/HBNC/mda/fy2021/ (FY 2021)
Next year: /company/HBNC/mda/fy2023/ (FY 2023)

ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Horizon is a registered bank holding company incorporated in Indiana and headquartered in Michigan City, Indiana. Horizon provides a broad range of banking services in northern and central Indiana and southern and central Michigan through its bank subsidiary, Horizon Bank. Horizon operates as a single segment, which is commercial banking. Horizon’s common stock is traded on the NASDAQ Global Select Market under the symbol HBNC. The Bank was founded in 1873 as a national association, and it remained a national association until its conversion to an Indiana commercial bank effective June 23, 2017. 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.

Fourth Quarter and Full Year 2022 Highlights

•Return on average assets (“ROAA”) was 1.24% for the year ended 2022.

•Return on average tangible equity was 18.33% for the year ended 2022.

•Total loans grew 13.4% year–to–date and 12.8% annualized during the fourth quarter.

•Commercial loans grew to a record $2.42 billion, up 13.4% year–to–date and 10.8% annualized during the fourth quarter.

•Consumer loans grew to a record $967.8 million, up 30.6% year–to–date and 21.0% annualized during the fourth quarter.

•Asset quality remained solid with total loan delinquency at 0.26% of total loans, net charge–offs to average loans of 0.02% and non–performing loans to total loans at 0.52%.

•Total deposits remained strong increasing $26.9 million during the quarter at an average cost of 71 basis points and $54.8 million year–to–date at an average cost of 30 basis points.

•An accounting revision was made to amounts reported in previously issued financial statements covering the years ended December 31, 2021 and 2020 related to immaterial errors discovered in the fourth quarter of 2022. The errors relate to the inclusion of the dealer reserve amortization expense in loan expense in non–interest expenses for the years ended December 31, 2021 and 2020 rather than loan interest income. The previously issued financial statements for the years ended December 31, 2021 and 2020 have been revised to correct this error, which resulted in lowering both interest income and non–interest expense by $5.9 million and $5.4 million, respectively. In addition, net interest margin was lowered by ten basis points and eleven basis points for the years ended December 31, 2021 and 2020, respectively. All periods presented reflect this adjustment, and there was no impact to net income. See Note 1 of Horizon's Consolidated Financial Statements for further details.

•Non-interest expense was $35.7 million in the quarter, or 1.84% of average assets on an annualized basis, compared to $36.8 million, or 1.91%, in the third quarter of 2022. Year–to–date non–interest expense continued to be well managed at $139.5 million, or 1.85% of average assets.

•The Bank’s capital position continues to be robust with leverage and risk based capital ratios of 8.89% and 13.59%, respectively. The annualized dividend yield was 4.24% as of December 31, 2022.

Critical Accounting Policies

The Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10–K for 2022 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, goodwill and intangible assets, mortgage servicing rights, derivative instruments and valuation measurements as critical accounting policies.

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Allowance for Credit Losses

The allowance for credit losses on loans and leases (“ACL”) replaces the allowance for loan and lease losses as a credit accounting estimate, as of January 1, 2020 with the adoption of ASU 2016–13, Financial Instruments–Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.

The allowance for credit losses represents management’s best estimate of current expected credit losses over the life of the portfolio of loans and leases. Estimating credit losses requires judgment in determining loan specific attributes impacting the borrower’s ability to repay contractual obligations. Other factors such as economic forecasts used to determine a reasonable and supportable forecast, prepayment assumptions, the value of underlying collateral, and changes in size composition and risks within the portfolio are also considered.

The allowance for credit losses is assessed at each balance sheet date and adjustments are recorded in the provision for credit losses. The allowance is estimated based on loan level characteristics using historical loss rates, a reasonable and supportable economic forecast. Loan losses are estimated using the fair value of collateral for collateral–dependent loans, or when the borrower is experiencing financial difficulty such that repayment of the loan is expected to be made through the operation or sale of the collateral. Loan balances considered uncollectible are charged–off against the ACL. Assets purchased with credit deterioration (“PCD”) represent assets that are acquired with evidence of more than insignificant credit quality deterioration since origination at the acquisition date. At acquisition, the allowance for credit losses on PCD assets is booked directly to the ACL. Any subsequent changes in the ACL on PCD assets is recorded through the provision for credit losses. Management believes that the ACL is adequate to absorb the expected life of loan credit losses on the portfolio of loans and leases as of the balance sheet date. Actual losses incurred may differ materially from our estimates.

Allowance for Credit Losses on Off–Balance Sheet Credit Exposures

The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The Company determines the estimated amount of expected credit extensions based on historical usage to calculate the amount of exposure for a loss estimate and has recorded an allowance.

Allowance for Credit Losses on Available for Sale Securities

For available for sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security's amortized cost basis is written down to fair value through income. For debt securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recorded in other comprehensive income.

Changes in the ACL are recorded as provision for, or reversal of, credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Allowance for Credit Losses on Held to Maturity Securities

For held to maturity securities, the Company conducts an assessment of its held to maturity securities at the time of purchase and on at least an annual basis to ensure such investment securities remain within appropriate levels of risk and continue to perform satisfactorily in fulfilling its obligations. The Company considers, among other factors, the nature of the securities and credit ratings or financial condition of the issuer. If available, the Company obtains a credit rating for issuers from the Nationally Recognized Statistical Rating Organization (“NRSRO”) for consideration. If this assessment indicates that a material credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss.

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. FASB ASC 350–10 establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. At December 31, 2022, Horizon had core deposit intangibles of $17.2 million subject to amortization and $155.2 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 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. FASB ASC 350–10 requires an annual evaluation of goodwill for impairment.

At each reporting date between annual goodwill impairment tests, Horizon considers potential indicators of impairment. Impairment indicators considered comprised the condition of the economy and banking industry; government intervention and regulatory updates; the impact of recent events to financial performance and cost factors of the reporting unit; performance of the Company's stock and other relevant events. Horizon further considered the amount by which fair value exceeded book value in the most recent quantitative analysis and stress testing performed. At the conclusion of the assessment, the Company determined that as of December 31, 2022, it was more likely than not that the fair value exceeded its carrying value. Horizon will continue to monitor overall economic conditions and any other triggering events or circumstances that may indicate an impairment of goodwill in the future.

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 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 negatively.

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

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 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. In addition, on a quarterly basis Horizon engages a third party to independently test the value of its servicing asset.

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 FASB ASC 815–10. 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 FASB ASC 820, 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 speeds 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.

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Analysis of Financial Condition

Horizon’s total assets were $7.9 billion as of December 31, 2022, an increase of $460.6 million from December 31, 2021. The increase was primarily in net loans of $503.3 million, investment securities of $307.1 million, and other assets of $72.4 million, offset by a decrease in cash and due from banks of $470.0 million.

Investment Securities

Investment securities carrying values totaled $3.0 billion at December 31, 2022, and consisted of Treasury and federal agency securities of $562.4 million (18.6%); state and municipal securities of $1.6 billion (51.7%); federal agency mortgage–backed pools of $534.6 million and federal agency collateralized mortgage obligations of $87.8 million (20.6%); private labeled mortgage–backed pools of $35.5 million (1.2%); and corporate securities of $238.8 million (7.9%).

As indicated above, 20.6% of the investment portfolio consists of mortgage–backed securities and collateralized mortgage obligations. These instruments are secured by residential mortgages of varying maturities. Principal and interest payments are received monthly as the underlying mortgages are repaid. These payments also include prepayments of mortgage balances as borrowers either sell their homes or refinance their mortgages. Therefore, mortgage–backed securities and collateralized mortgage obligations have maturities that are stated in terms of average life. The average life is the average amount of time that each dollar of principal is expected to be outstanding. As of December 31, 2022, the mortgage–backed securities and collateralized mortgage obligations in the investment portfolio had an average duration of 5 years. Securities that have interest rates above current market rates are purchased at a premium.

Available for sale municipal securities are priced by a third party using a pricing grid which estimates prices based on recent sales of similar securities. All municipal securities are investment grade or local non–rated issues. A credit review is performed annually on the municipal securities portfolio.

At December 31, 2022 and 2021, 33.0% and 42.8%, respectively, of investment securities were classified as available for sale. Securities classified as available for sale are carried at their fair value, with both unrealized gains and losses recorded, net of tax, directly to stockholders’ equity. Net depreciation on these securities totaled $140.1 million, which resulted in a balance of $110.7 million, net of tax, included in stockholders’ equity at December 31, 2022. This compared to net appreciation on securities which totaled $5.7 million, net of tax, included in stockholders’ equity at December 31, 2021.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy is also established which requires an entity to maximize the use of observable and minimize the use of unobservable inputs. There are 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.

When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. There are no Level 1 securities. 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, Federal agency mortgage-backed pools and corporate notes. For Level 2 securities, Horizon uses a third party service to determine fair value. In performing the valuations, the pricing service relies on models that consider security–specific details as well as relevant industry and economic factors. The most significant of these inputs are quoted market prices, interest rate spreads on relevant benchmark securities and

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

certain prepayment assumptions. To verify the reasonableness of the fair value determination by the service, Horizon has a portion of the Level 2 securities priced by an independent securities broker–dealer.

Unrealized gains and losses on available for sale securities, deemed temporary, are recorded, net of income tax, in a separate component of accumulated other comprehensive income on the balance sheet.

The following is a schedule of maturities of each categories of available for sale and held to maturity debt securities and the related weighted–average yield of such securities as of December 31, 2022:

[[GREPCENT_TABLE]]
[["","One Year or Less","","After One Year Through Five Years","","After Five Years Through Ten Years","","After Ten Years"],["(dollars in thousands)","Amount","","Yield","","Amount","","Yield","","Amount","","Yield","","Amount","","Yield"],["Available for sale"],["U.S. Treasury and federal agencies(1)","$","1,513","","","0.62","%","","$","216,819","","","1.77","%","","$","47,024","","","1.91","%","","$","1,823","","","1.85","%"],["State and municipal","\u2014","","","\u2014","%","","38,559","","","2.67","%","","139,990","","","2.92","%","","254,995","","","3.33","%"],["Federal agency collateralized mortgage obligations(2)","\u2014","","","\u2014","%","","3,260","","","2.86","%","","4,388","","","3.04","%","","23,567","","","3.48","%"],["Federal agency mortgage-backed pools(2)","\u2014","","","\u2014","%","","13,358","","","3.24","%","","43,120","","","3.08","%","","134,178","","","2.12","%"],["Private labeled mortgage-backed pools(2)","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%"],["Corporate notes","\u2014","","","\u2014","%","","56,760","","","2.96","%","","17,267","","","4.10","%","","937","","","\u2014","%"],["Total available for sale","1,513","","","0.62","%","","328,756","","","2.15","%","","251,789","","","2.84","%","","415,500","","","2.94","%"],["Held to maturity"],["U.S. Treasury and federal agencies(1)","7,407","","","0.75","%","","100,288","","","1.77","%","","46,191","","","2.50","%","","92,127","","","2.85","%"],["State and municipal","24,975","","","2.46","%","","109,566","","","3.23","%","","99,627","","","3.55","%","","701,417","","","3.23","%"],["Federal agency collateralized mortgage obligations(2)","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","47,699","","","2.41","%"],["Federal agency mortgage-backed pools(2)","\u2014","","","\u2014","%","","2,213","","","3.58","%","","122,870","","","2.42","%","","162,156","","","2.23","%"],["Private labeled mortgage-backed pools(2)","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","29,973","","","2.96","%"],["Corporate notes","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","134,800","","","4.53","%","","\u2014","","","\u2014","%"],["Total held to maturity","32,382","","","2.07","%","","212,067","","","2.54","%","","403,488","","","3.41","%","","1,033,372","","","3.00","%"],["Total investment securities","$","33,895","","","2.00","%","","$","540,823","","","2.30","%","","$","655,277","","","3.19","%","","$","1,448,872","","","2.98","%"],["(1) Fair value is based on contractual maturity or call date where a call option exists"],["(2) Maturity based upon final maturity date"]]
[[/GREPCENT_TABLE]]

The weighted–average interest rates are based on coupon rates for securities purchased at par value an on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount. Yields are not presented on a tax–equivalent basis.

As a member of the Federal Home Loan Bank system, Horizon is required to maintain an investment in the common stock of the Federal Home Loan Bank. The investment in common stock is based on a predetermined formula. At December 31, 2022 and 2021, Horizon had investments in the common stock of the Federal Home Loan Bank totaling $26.7 million and $24.4 million, respectively.

At December 31, 2022, Horizon did not maintain a trading account.

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

For more information about securities, see Note 4 – Securities to the Consolidated Financial Statements at Item 8.

Total Loans

Total loans, net of deferred fees/costs, the principal earning asset of the Bank, were $4.1 billion at December 31, 2022. The current level of total loans increased 14.0% from the December 31, 2021, level of $3.6 billion primarily due to an increase in commercial, consumer, residential mortgage and residential construction loans, offset by a decrease in mortgage warehouse loans during the year. The table below provides comparative detail on the loan categories.

[[GREPCENT_TABLE]]
[["","December 31,","","December 31,","","Dollar","","Percent"],["","2022","","2021","","Change","","Change"],["Commercial"],["Owner occupied real estate","$","594,562","","","$","560,887","","","$","33,675","","","6.0","%"],["Non\u2013owner occupied real estate","1,187,077","","","1,088,470","","","98,607","","","9.1","%"],["Residential spec homes","10,838","","","9,907","","","931","","","9.4","%"],["Development & spec land","27,358","","","24,473","","","2,885","","","11.8","%"],["Commercial and industrial","647,587","","","530,208","","","117,379","","","22.1","%"],["Total commercial","2,467,422","","","2,213,945","","","253,477","","","11.4","%"],["Real estate"],["Residential mortgage","612,551","","","563,811","","","48,740","","","8.6","%"],["Residential construction","40,741","","","30,571","","","10,170","","","33.3","%"],["Mortgage warehouse","69,529","","","109,031","","","(39,502)","","","(36.2)","%"],["Total real estate","722,821","","","703,413","","","19,408","","","2.8","%"],["Consumer"],["Direct installment","56,614","","","63,714","","","(7,100)","","","(11.1)","%"],["Indirect installment","500,549","","","386,492","","","114,057","","","29.5","%"],["Home equity","410,592","","","290,970","","","119,622","","","41.1","%"],["Total consumer","967,755","","","741,176","","","226,579","","","30.6","%"],["Total loans","4,157,998","","","3,658,534","","","499,464","","","13.7","%"],["Allowance for loan losses","(50,464)","","","(54,286)","","","3,822","","","(7.0)","%"],["Loans, net","$","4,107,534","","","$","3,604,248","","","$","503,286","","","14.0","%"]]
[[/GREPCENT_TABLE]]

The acceptance and management of credit risk is an integral part of the Bank’s business as a financial intermediary. The Bank has established underwriting standards including a policy that monitors the lending function through strict administrative and reporting requirements as well as an internal loan review of consumer and small business loans. The Bank also uses an independent third-party loan review function that regularly reviews asset quality.

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Management’s Discussion and Analysis of

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(Table dollars in thousands except per share data)

Changes in the mix of the loan portfolio averages are shown in the following table.

[[GREPCENT_TABLE]]
[["","December 31,","","December 31,","","December 31,"],["","2022","","2021","","2020"],["Commercial","$","2,280,553","","","$","2,155,018","","","$","2,218,812"],["Real estate","621,163","","","591,395","","","725,168"],["Mortgage warehouse","89,409","","","206,932","","","259,727"],["Consumer","850,667","","","679,712","","","676,849"],["Total average loans","$","3,841,792","","","$","3,633,057","","","$","3,880,556"]]
[[/GREPCENT_TABLE]]

Maturities and Sensitivities of Loans to Changes in Interest Rates

The following table presents the maturity distribution of our loan portfolio as December 31, 2022. The table also presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index.

[[GREPCENT_TABLE]]
[["","Due in One Year or Less","","After One, but Within Five Years","","After Five, but Within Fifteen Years","","After Fifteen Years","","Total"],["Commercial","$","284,888","","","$","959,545","","","$","1,116,706","","","$","106,283","","","$","2,467,422"],["Real estate","1,161","","","9,317","","","64,360","","","578,454","","","653,292"],["Mortgage warehouse","69,529","","","\u2014","","","\u2014","","","\u2014","","","69,529"],["Consumer","11,818","","","268,460","","","362,135","","","325,342","","","967,755"],["Total","$","367,396","","","$","1,237,322","","","$","1,543,201","","","$","1,010,079","","","$","4,157,998"],["Loans with fixed interest rates:"],["Commercial","$","87,192","","","$","582,557","","","$","409,281","","","$","43,412","","","$","1,122,442"],["Real estate","1,131","","","8,383","","","41,015","","","325,286","","","375,815"],["Mortgage warehouse","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Consumer","6,772","","","250,016","","","337,073","","","14,164","","","608,025"],["Total","$","95,095","","","$","840,956","","","$","787,369","","","$","382,862","","","$","2,106,282"],["Loans with variable interest rates:"],["Commercial","$","197,696","","","$","376,988","","","$","707,425","","","$","62,871","","","$","1,344,980"],["Real estate","30","","","934","","","23,345","","","253,168","","","277,477"],["Mortgage warehouse","69,529","","","\u2014","","","\u2014","","","\u2014","","","69,529"],["Consumer","5,046","","","18,444","","","25,062","","","311,178","","","359,730"],["Total","$","272,301","","","$","396,366","","","$","755,832","","","$","627,217","","","$","2,051,716"]]
[[/GREPCENT_TABLE]]

Commercial Loans

Commercial loans totaled $2.47 billion, or 59.3% of total loans as of December 31, 2022, compared to $2.21 billion, or 60.5% as of December 31, 2021. The increase during 2022 was due to growth in all types of commercial loans offset by a decrease in PPP loans of $25.6 million to $217,000 at December 31, 2022 compared to $25.8 million at December 31, 2021.

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Commercial loans consisted of the following types of loans at December 31:

[[GREPCENT_TABLE]]
[["","December 31, 2022","","December 31, 2021"],["","Number","","Amount","","Percent of Portfolio","","Number","","Amount","","Percent of Portfolio"],["SBA guaranteed","268","","","$","56,650","","","2.3","%","","491","","","$","82,060","","","3.7","%"],["Municipal government","73","","","85,520","","","3.5","%","","75","","","67,029","","","3.0","%"],["Lines of credit","1,507","","","561,995","","","22.8","%","","1,494","","","448,685","","","20.3","%"],["Real estate and equipment","5,261","","","1,763,257","","","71.6","%","","4,896","","","1,616,171","","","73.0","%"],["Total","7,109","","","$","2,467,422","","","100.2","%","","6,956","","","$","2,213,945","","","100.0","%"]]
[[/GREPCENT_TABLE]]

At December 31, 2022, the commercial loan portfolio held $279.9 million of adjustable rate loans that had interest rate floors in the terms of the note. Of the commercial loans with interest rate floors, loans totaling $48.9 million were at their floor at December 31, 2022.

Residential Real Estate Loans

Residential real estate loans totaled $653.3 million, or 15.7% of total loans as of December 31, 2022, compared to $594.4 million, or 16.3% of total loans as of December 31, 2021. This category consists of home mortgages that generally require a loan to value of no more than 80%. Some special guaranteed or insured real estate loan programs do permit a higher loan to collateral value ratio. The increase during 2022 was primarily due to borrowers selecting adjustable rate loans, which are held on the balance sheet, as fixed rates increased during the year.

In addition to the customary real estate loans described above, the Bank also had outstanding on December 31, 2022, $355.2 million in home equity lines of credit compared to $252.4 million at December 31, 2021. Credit lines normally limit the loan to collateral value to no more than 89%. Home equity credit lines are primarily not combined with a first mortgage and are therefore evaluated in the allowance for loan losses as a separate pool. These loans are classified as consumer loans in the Loans table above and in Note 5 of the Consolidated Financial Statements at Item 8.

Residential real estate lending is a highly competitive business. As of December 31, 2022, the real estate loan portfolio reflected a wide range of interest rates and repayment patterns, but could generally be categorized as follows:

[[GREPCENT_TABLE]]
[["","December 31, 2022","","December 31, 2021"],["","Amount","","Percent of Portfolio","","Yield","","Amount","","Percent of Portfolio","","Yield"],["Fixed rate"],["Monthly payment","$","375,185","","","57.4","%","","3.76","%","","$","283,145","","","47.6","%","","3.63","%"],["Biweekly payment","\u2014","","","\u2014","%","","\u2014","%","","\u2014","","","\u2014","%","","\u2014","%"],["Adjustable rate"],["Monthly payment","278,107","","","42.6","%","","4.21","%","","311,237","","","52.4","%","","3.73","%"],["Biweekly payment","\u2014","","","\u2014","%","","\u2014","%","","\u2014","","","\u2014","%","","\u2014","%"],["Subtotal","653,292","","","100.0","%","","3.95","%","","594,382","","","100.0","%","","3.67","%"],["Loans held for sale","5,807","","","","","","","12,579"],["Total real estate loans","$","659,099","","","","","","","$","606,961"]]
[[/GREPCENT_TABLE]]

The decrease in adjustable rate residential mortgage loans and increase in fixed rate residential mortgage loans was primarily due to customers moving to fixed rate products during the first half of 2022 as a result of the low interest rate environment. In addition to the real estate loan portfolio, the Bank originates and sells real estate loans and retains the servicing rights. During 2022 and 2021, approximately $221.9 million and $438.1 million,

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

respectively, of residential mortgages were sold into the secondary market. Loans serviced for others are not included in the consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled approximately $1.5 billion and $1.5 billion at December 31, 2022 and 2021.

The aggregate fair value of capitalized mortgage servicing rights at December 31, 2022, totaled approximately $20.0 million compared to the carrying value of $18.6 million. Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value. For purposes of measuring impairment, risk characteristics including product type, investor type and interest rates, were used to stratify the originated mortgage servicing rights.

[[GREPCENT_TABLE]]
[["","December 31,","","December 31,","","December 31,"],["","2022","","2021","","2020"],["Mortgage servicing rights"],["Balances, January 1","$","17,780","","","$","17,644","","","$","15,046"],["Servicing rights capitalized","3,184","","","4,209","","","5,530"],["Amortization of servicing rights","(2,345)","","","(4,073)","","","(2,932)"],["Balances, December 31","18,619","","","17,780","","","17,644"],["Impairment allowance"],["Balances, January 1","(2,594)","","","(5,172)","","","(719)"],["Additions","\u2014","","","\u2014","","","(5,106)"],["Reductions","2,594","","","2,578","","","653"],["Balances, December 31","\u2014","","","(2,594)","","","(5,172)"],["Mortgage servicing rights, net","$","18,619","","","$","15,186","","","$","12,472"]]
[[/GREPCENT_TABLE]]

Mortgage Warehouse Loans

Horizon’s mortgage warehousing lending has specific mortgage companies as customers of Horizon Bank. Individual mortgage loans originated by these mortgage companies are funded as a secured borrowing with a pledge of collateral under Horizon’s agreement with the mortgage company. Each mortgage loan funded by Horizon undergoes an underwriting review by Horizon to the end investor guidelines and is assigned to Horizon until the loan is sold to the secondary market by the mortgage company. In addition, Horizon takes possession of each original note and forwards such note to the end investor once the mortgage company has sold the loan. At the time a loan is transferred to the secondary market, the mortgage company reacquires the loan under its option within the agreement. Due to the reacquire feature contained in the agreement, the transaction does not qualify as a sale and therefore is accounted for as a secured borrowing with a pledge of collateral pursuant to the agreement with the mortgage company. When the individual loan is sold to the end investor by the mortgage company, the proceeds from the sale of the loan are received by Horizon and used to pay off the loan balance with Horizon along with any accrued interest and any related fees. The remaining balance from the sale is forwarded to the mortgage company. These individual loans typically are sold by the mortgage company within 30 days and are seldom held more than 90 days. Interest income is accrued during this period and collected at the time each loan is sold. Fee income for each loan sold is collected when the loan is sold and no costs are deferred due to the term between each loan funding and related payoff, which is typically less than 30 days.

Based on the agreements with each mortgage company, at any time a mortgage company can reacquire from Horizon its outstanding loan balance on an individual mortgage and regain possession of the original note. Horizon also has the option to request that the mortgage company reacquire an individual mortgage. Should this occur, Horizon would return the original note and reassign the assignment of the mortgage to the mortgage company. Also, in the event that the end investor would not be able to honor the purchase commitment and the mortgage company would not be able to reacquire its loan on an individual mortgage, Horizon would be able to exercise its rights under the agreement. The greatest risk related to these loans is transaction and fraud risk. During 2022, Horizon processed approximately $2.6 billion in mortgage warehouse loans.

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

At December 31, 2022, the mortgage warehouse loan balance was $69.5 million compared to $109.0 million as of December 31, 2021.

Consumer Loans

Consumer loans totaled $967.8 million, or 23.3% of total loans as of December 31, 2022, compared to $741.2 million, or 20.3% as of December 31, 2021. The increase during 2022 was due to strong indirect lending during the first half of 2022 and home equity lines of credit production during the second half of 2022, in addition to approximately $52.4 million of purchased home equity lines of credit in the fourth quarter of 2022.

Allowance and Provision for Credit Losses

The table below provides an allocation of the year–end allowance for credit losses on loans by loan portfolio segment; however, allocation of a portion of the allowance to one segment does not preclude its availability to absorb losses in other segments.

[[GREPCENT_TABLE]]
[["","Amount of Allowance Allocated","","Percent of Loans in Each Category to Total Loans","","Total Loans","","Ratio of Allowance Allocated to Loans in Each Category"],["December 31, 2022"],["Commercial","$","32,445","","","59.3","%","","$","2,467,422","","","1.31","%"],["Real estate","5,577","","","15.7","%","","653,292","","","0.85","%"],["Mortgage warehouse","1,020","","","1.7","%","","69,529","","","1.47","%"],["Consumer","11,422","","","23.3","%","","967,755","","","1.18","%"],["Total","$","50,464","","","100.0","%","","$","4,157,998","","","1.21","%"],["Excluding PPP loans","$","50,464","","","","","$","4,157,781","","","1.21","%"],["December 31, 2021"],["Commercial","$","40,775","","","60.6","%","","$","2,213,945","","","1.84","%"],["Real estate","3,856","","","16.2","%","","594,382","","","0.65","%"],["Mortgage warehouse","1,059","","","3.0","%","","109,031","","","0.97","%"],["Consumer","8,596","","","20.3","%","","741,176","","","1.16","%"],["Total","$","54,286","","","100.1","%","","$","3,658,534","","","1.48","%"],["Excluding PPP loans","$","54,286","","","","","$","3,632,690","","","1.49","%"]]
[[/GREPCENT_TABLE]]

At December 31, 2022, the allowance for credit losses was $50.5 million, or 1.21% of total loans outstanding, compared to $54.3 million, or 1.48%, at December 31, 2021. During 2022, a release of provision for credit losses was recorded totaling $1.8 million compared to a release of provision for credit losses totaling $2.1 million in 2021.

Horizon assesses the adequacy of its Allowance for Credit Losses (“ACL”) by regularly reviewing the performance of all of its loan portfolios. As a result of its quarterly reviews, a provision for credit losses is determined to bring the total ACL to a level called for by the analysis. Horizon's reserve includes allocations for potential future loan losses related to economic factors and the nature and characteristics of its loan portfolios, primarily related to the impact on non–essential businesses caused by COVID–19 closures and the slow pace of reopening and economic recovery. Through December 31, 2022, Horizon has not recorded any material specific loan losses attributed to COVID–19 closures. As a result, the allocations related to the impact of COVID–19 were reduced during 2022 and partially reallocated to current economic factors and also released from the ACL.

No assurance can be given that Horizon will not, in any particular period, sustain loan losses that are significant in relation to the amount reserved, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, including economic conditions and management’s ongoing quarterly assessments of the portfolio, will not require increases in the allowance for credit losses. Horizon considers the allowance for credit losses to be adequate to cover losses inherent in the loan portfolio as of December 31, 2022.

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Non–performing Loans

Non–performing loans are defined as loans that are greater than 90 days delinquent or have had the accrual of interest discontinued by management. From time to time, the Bank obtains information which may lead management to believe that the collection of payments may be doubtful on a particular loan. In recognition of such, it is management's policy to convert the loan from an “earning asset” to a non–accruing loan. Further, it is management's policy to place a commercial loan on non–accrual status when delinquent in excess of 90 days or management has determined that the borrower's ability to continue to make payments is in doubt. The officer responsible for the loan, Executive Vice President and Chief Commercial Banking Officer and the senior commercial loan workout officer must review all loans placed on non–accrual status. Management continues to work diligently toward returning non–performing loans to an earning asset basis. 

Non–performing loans for the previous three years ending December 31 are as follows:

[[GREPCENT_TABLE]]
[["","December 31,","","December 31,","","December 31,"],["(dollars in thousands)","2022","","2021","","2020"],["Non\u2013performing loans"],["Commercial"],["More than 90 days past due","$","\u2014","","","$","\u2014","","","$","\u2014"],["Non\u2013accrual","8,493","","","6,621","","","12,714"],["Trouble debt restructuring \u2013 accruing","837","","","603","","","168"],["Trouble debt restructuring \u2013 non\u2013accrual","\u2014","","","285","","","1,466"],["Real estate"],["More than 90 days past due","43","","","66","","","17"],["Non\u2013accrual","5,479","","","5,626","","","5,674"],["Trouble debt restructuring \u2013 accruing","1,391","","","1,421","","","1,381"],["Trouble debt restructuring \u2013 non\u2013accrual","1,210","","","892","","","922"],["Mortgage warehouse"],["More than 90 days past due","\u2014","","","\u2014","","","\u2014"],["Non\u2013accrual","\u2014","","","\u2014","","","\u2014"],["Trouble debt restructuring \u2013 accruing","\u2014","","","\u2014","","","\u2014"],["Trouble debt restructuring \u2013 non\u2013accrual","\u2014","","","\u2014","","","\u2014"],["Consumer"],["More than 90 days past due","49","","","79","","","245"],["Non\u2013accrual","3,658","","","2,715","","","3,754"],["Trouble debt restructuring \u2013 accruing","342","","","367","","","244"],["Trouble debt restructuring \u2013 non\u2013accrual","338","","","344","","","222"],["Total non\u2013performing loans","21,840","","","19,019","","","26,807"],["Other real estate owned and repossessed collateral"],["Commercial","1,881","","","2,861","","","1,908"],["Real estate","107","","","695","","","\u2014"],["Mortgage warehouse","\u2014","","","\u2014","","","\u2014"],["Consumer","152","","","5","","","\u2014"],["Total other real estate owned and repossessed collateral","2,140","","","3,561","","","1,908"],["Total non\u2013performing assets","$","23,980","","","$","22,580","","","$","28,715"]]
[[/GREPCENT_TABLE]]

Non–performing loans totaled 43.3%, 35.0% and 47.0% of the allowance for credit losses at December 31, 2022, 2021 and 2020, respectively. Non–performing loans at December 31, 2022 totaled $21.8 million, an increase from a balance of $19.0 million as of December 31, 2021 and a decrease from a balance of $26.8 million as of

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

December 31, 2020. The increase in non–performing loans in 2022 was primarily due to the downgrade of one previously performing commercial relationship to non–performing status during the year. Non–performing loans as a percentage of total loans was 0.52% as of December 31, 2022, which was the same percentage as of December 31, 2021 and a decrease from 0.58% from December 31, 2020.

[[GREPCENT_TABLE]]
[["","Non\u2013Performing Loans","","Percent of Non\u2013Performing Loans in Each Category to Total Loans","","Total Loans"],["December 31, 2022"],["Commercial","$","9,330","","","0.38","%","","$","2,467,422"],["Real estate","8,123","","","1.24","%","","653,292"],["Mortgage warehouse","\u2014","","","0.00","%","","69,529"],["Consumer","4,387","","","0.45","%","","967,755"],["Total","$","21,840","","","0.53","%","","$","4,157,998"],["Excluding PPP loans","$","21,840","","","0.53","%","","$","4,157,781"],["Allowance for credit losses on loans","$","50,464"],["Ratio of allowance for credit losses on loans to non\u2013performing loans","231.06","%"],["December 31, 2021"],["Commercial","$","7,509","","","0.34","%","","$","2,213,945"],["Real estate","8,005","","","1.35","%","","594,382"],["Mortgage warehouse","\u2014","","","0.00","%","","109,031"],["Consumer","3,505","","","0.47","%","","741,176"],["Total","$","19,019","","","0.52","%","","$","3,658,534"],["Excluding PPP loans","$","19,019","","","0.52","%","","$","3,632,690"],["Allowance for credit losses on loans","$","54,286"],["Ratio of allowance for credit losses on loans to non\u2013performing loans","285.43","%"]]
[[/GREPCENT_TABLE]]

There were no COVID–19 related loan deferrals at December 31, 2022, a decrease from $10.8 million, or 0.3% of total loans at December 31, 2021, and $126.7 million, or 3.3% of total loans at December 31, 2020.

Other Real Estate Owned (“OREO”) totaled $1.9 million on December 31, 2022, a decrease of $1.6 million from December 31, 2021 and an increase of $211,000 from December 31, 2020. On December 31, 2022, OREO was comprised of eight properties, six of these properties were bank owned properties from branch closures and two properties were residential.

No mortgage warehouse loans were non–performing or OREO as of December 31, 2022, 2021 or 2020.

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Management’s Discussion and Analysis of

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(Table dollars in thousands except per share data)

Other Assets

As of December 31, 2022, other assets totaled $139.3 million, an increase of $72.4 million, or 108.4%, from $66.8 million as of December 31, 2021. The increase in other assets was primarily due to an increase in the deferred tax asset related to unrealized gains (losses) on investment securities of $31.4 million, an increase in the fair value of hedging activities of $28.5 million and an increase in mortgage servicing rights, net of impairment, of $3.4 million.

Deferred Tax

Horizon had a net deferred tax asset totaling $40.3 million as of December 31, 2022 and a net deferred tax asset of $3.3 million as of December 31, 2021. The following table shows the major components of deferred tax:

[[GREPCENT_TABLE]]
[["","December 31,","","December 31,"],["","2022","","2021"],["Assets"],["Allowance for loan losses","$","12,762","","","$","13,707"],["Net operating loss and tax credits","9,313","","","\u2014"],["Director and employee benefits","2,019","","","2,094"],["Unrealized loss on AFS securities and cash flow hedge","28,230","","","\u2014"],["Other","555","","","1,785"],["Total assets","52,879","","","17,586"],["Liabilities"],["Depreciation","(4,599)","","","(4,540)"],["State tax","(262)","","","(261)"],["Federal Home Loan Bank stock dividends","(368)","","","(371)"],["Difference in basis of intangible assets","(4,440)","","","(3,476)"],["Fair value adjustment on acquisitions","(2,807)","","","(3,435)"],["Unrealized gain on AFS securities and cash flow hedge","\u2014","","","(1,953)"],["Other","(68)","","","(222)"],["Total liabilities","(12,544)","","","(14,258)"],["Net deferred tax asset/(liability)","$","40,335","","","$","3,328"]]
[[/GREPCENT_TABLE]]

Deposits

The primary source of funds for the Bank comes from the acceptance of demand and time deposits. However, at times the Bank will use its ability to borrow funds from the Federal Home Loan Bank and other sources when it can do so at interest rates and terms that are more favorable than those required for deposited funds or loan demand is greater than the ability to grow deposits. Total deposits were $5.9 billion at December 31, 2022, compared to $5.8 billion at December 31, 2021.

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Average deposits and rates by category for the three years ended December 31 are as follows:

[[GREPCENT_TABLE]]
[["","Average Balance Outstanding for the","","Average Rate Paid for the"],["","Years Ended December 31","","Years Ended December 31"],["","2022","","2021","","2020","","2022","","2021","","2020"],["Non\u2013interest bearing demand deposits","$","1,332,937","","","$","1,188,275","","","$","919,449"],["Interest bearing demand deposits","1,971,567","","","1,651,060","","","1,267,617","","","0.28","%","","0.09","%","","0.19","%"],["Savings deposits","940,499","","","779,325","","","625,842","","","0.13","%","","0.05","%","","0.12","%"],["Money market","810,083","","","815,081","","","615,722","","","0.45","%","","0.15","%","","0.38","%"],["Time deposits","791,519","","","652,284","","","818,736","","","0.95","%","","0.75","%","","1.60","%"],["Total deposits","$","5,846,605","","","$","5,086,025","","","$","4,247,366"]]
[[/GREPCENT_TABLE]]

The $760.6 million increase in average deposits during 2022 was primarily due to the acquisition of 14 branches on September 17, 2021. The transactional accounts average balances, as the lower cost funding sources, increased $621.3 million and the average balances for higher cost time deposits increased $139.2 million. Horizon continually enhances its interest bearing consumer and commercial demand deposit products based on local market conditions and its need for funding to support various types of assets.

As of December 31, 2022 and 2021, approximately $2.4 billion and $2.4 billion, respectively, or our deposit portfolio was uninsured. The uninsured amounts are estimates based on the methodologies and assumptions used for Horizon Bank's regulatory reporting requirements.

Certificates of deposit of $250,000 or more, which are considered to be rate sensitive and are not considered a part of core deposits, mature as follows as of December 31, 2022:

[[GREPCENT_TABLE]]
[["Due in three months or less","$","103,578"],["Due after three months through six months","108,806"],["Due after six months through one year","141,471"],["Due after one year","197,510"],["","$","551,365"]]
[[/GREPCENT_TABLE]]

Interest expense on time certificates of $250,000 or more was approximately $4.2 million, $1.4 million and $2.9 million for 2022, 2021 and 2020.

Off–Balance Sheet Arrangements

As of December 31, 2022, Horizon did not have any off–balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, change in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off–balance sheet arrangement” generally means any transaction, agreement, or other contractual arrangement to which an entity unconsolidated with the Company is a party and under which the Company has (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.

Capital Resources

Horizon has no material commitments for capital expenditures as of December 31, 2022. Horizon’s sources of funds and liquidity are discussed below in the section captioned “Liquidity” in this Item 7.

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Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Results of Operations

Net Income

Consolidated net income was $93.4 million, or $2.14 per diluted share, in 2022, $87.1 million or $1.98 per diluted share in 2021, and $68.5 million or $1.55 per diluted share in 2020. The increase in net income from the previous year reflects an increase in net interest income of $23.7 million and a decrease in income tax expense of $3.2 million, offset by an increase in non–interest expense of $9.8 million and a decrease in non–interest income of $10.5 million. The increase in diluted earnings per share compared to the previous year reflects an increase in net income and a decrease in diluted shares. Adjusted net income for the year ended December 31, 2022 was $92.8 million, or $2.13 diluted earnings per share, compared to $88.6 million, or $2.00 diluted earnings per share, for the year ended December 31, 2021. (See the “Non–GAAP Reconciliation of Net Income and Diluted Earnings per Share” table under the heading “Use of Non–GAAP Financial Measures” below for the definition of adjusted net income.)

Net Interest Income

The largest component of 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 and the net interest spread which affects the 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.

Net interest income during 2022 was $199.5 million, an increase of $23.7 million, or 13.5%, over the $175.8 million earned in 2021. Yields on the Company’s interest earning assets increased by 17 basis points to 3.50% during 2022 from 3.33% in 2021. Interest income increased $41.9 million to $236.0 million for 2022 from $194.1 million in 2021. This increase was due to the overall increase in interest rates during 2022 and the increase in the average balance of interest earning assets of $942.2 million.

Interest expense increased $18.2 million from $18.3 million in 2021 to $36.5 million in 2022. This increase was due to the overall increase in interest rates during 2022 and the increase in average balance of interest bearing liabilities of $905.1 million. The increase in rates paid on interest bearing liabilities of 27 basis points was greater than the increase in the yield of interest earning assets of 17 basis points that resulted in a decrease in the net interest margin of 5 basis points from 3.03% for 2021 to 2.98% in 2022. Excluding interest income recognized from acquisition–related purchase accounting adjustments and prepayment penalties on borrowings, the margin would have been 2.93% for 2022 compared to 2.96% for 2021. Management believes that the current level of interest rates is driven by external factors and therefore impacts the results of the Company’s net interest margin.

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

The following table presents the average balances of our assets, liabilities, and stockholders' equity, and the related weighted average yields and rates on our interest earning assets and interest bearing liabilities for the periods indicated.

[[GREPCENT_TABLE]]
[["","Twelve Months Ended","","Twelve Months Ended","","Twelve Months Ended"],["","December 31, 2022","","December 31, 2021","","December 31, 2020"],["","Average Balance","","Interest","","Average Rate","","Average Balance","","Interest","","Average Rate","","Average Balance","","Interest","","Average Rate"],["Assets"],["Interest earning assets"],["Federal funds sold","$","62,211","","","$","165","","","0.27","%","","$","398,528","","","$","535","","","0.13","%","","$","61,408","","","$","154","","","0.25","%"],["Interest earning deposits","13,596","","","141","","","1.04","%","","25,993","","","160","","","0.62","%","","25,943","","","268","","","1.03","%"],["Investment securities \u2013 taxable","1,700,418","","","33,202","","","1.95","%","","884,244","","","14,437","","","1.63","%","","459,551","","","8,071","","","1.76","%"],["Investment securities \u2013 non\u2013taxable(1)","1,356,045","","","29,025","","","2.71","%","","1,086,942","","","23,246","","","2.71","%","","706,092","","","17,213","","","3.09","%"],["Loans receivable(2)(3)(4)","3,845,137","","","173,500","","","4.53","%","","3,639,454","","","155,732","","","4.30","%","","3,880,556","","","174,262","","","4.51","%"],["Total interest earning assets(1)","6,977,407","","","236,033","","","3.50","%","","6,035,161","","","194,110","","","3.33","%","","5,133,550","","","199,968","","","4.00","%"],["Non\u2013interest earning assets"],["Cash and due from banks","99,885","","","","","","","89,993","","","","","","","84,065"],["Allowance for loan losses","(52,606)","","","","","","","(56,798)","","","","","","","(46,329)"],["Other assets","509,229","","","","","","","445,895","","","","","","","457,497"],["Total average assets","$","7,533,915","","","","","","","$","6,514,251","","","","","","","$","5,628,783"],["Liabilities and Stockholders\u2019 Equity"],["Interest bearing liabilities"],["Interest bearing deposits","$","4,513,668","","","$","17,809","","","0.39","%","","$","3,897,750","","","$","7,867","","","0.20","%","","$","3,327,917","","","$","18,556","","","0.56","%"],["Borrowings","696,584","","","11,938","","","1.71","%","","425,214","","","4,546","","","1.07","%","","459,752","","","11,160","","","2.43","%"],["Repurchase agreements","141,048","","","527","","","0.37","%","","123,675","","","155","","","0.13","%","","100,201","","","270","","","0.27","%"],["Subordinated notes","58,819","","","3,522","","","5.99","%","","58,672","","","3,522","","","6.00","%","","30,610","","","1,824","","","5.96","%"],["Junior subordinated debentures issued to capital trusts","56,899","","","2,719","","","4.78","%","","56,657","","","2,215","","","3.91","%","","56,427","","","2,628","","","4.66","%"],["Total interest bearing liabilities","5,467,018","","","36,515","","","0.67","%","","4,561,968","","","18,305","","","0.40","%","","3,974,907","","","34,438","","","0.87","%"],["Non\u2013interest bearing liabilities"],["Demand deposits","1,332,937","","","","","","","1,188,275","","","","","","","919,449"],["Accrued interest payable and other liabilities","50,330","","","","","","","51,886","","","","","","","68,961"],["Stockholders\u2019 equity","683,630","","","","","","","712,122","","","","","","","665,466"],["Total average liabilities and stockholders\u2019 equity","$","7,533,915","","","","","","","$","6,514,251","","","","","","","$","5,628,783"],["Net interest income/spread","","","$","199,518","","","2.83","%","","","","$","175,805","","","2.93","%","","","","$","165,530","","","3.13","%"],["Net interest income as a percent of average interest earning assets(1)","","","","","2.98","%","","","","","","3.03","%","","","","","","3.33","%"],["(1) Horizon has no foreign office and, accordingly, no assets or liabilities to foreign operations. Horizon's subsidiary bank had no funds invested in Eurodollar Certificates of Deposit at December 31, 2022."],["(2) Yields are presented on a tax\u2013equivalent basis."],["(3) Non\u2013accruing loans for the purpose of the computations above are included in the daily average loan amounts outstanding. Loan totals are shown net of unearned income and deferred loan fees."],["(4) Net loan fees included in interest on loans aggregated $5.2 million, $13.9 million and $11.2 million in 2022, 2021 and 2020, respectively."]]
[[/GREPCENT_TABLE]]

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Net interest income during 2021 was $175.8 million, an increase of $10.3 million, or 6.2%, over the $165.5 million earned in 2020. Yields on the Company’s interest earning assets decreased by 67 basis points to 3.33% during 2021 from 4.00% in 2020. Interest income decreased $5.9 million to $194.1 million for 2021 from $200.0 million in 2020. This decrease was due to the overall decrease in interest rates during 2021 and a decrease in the recognition of interest income from acquisition–related purchase accounting adjustments of approximately $2.4 million from $6.9 million in 2020 to $4.5 million in 2021, offset by an increase in the average balance of interest earning assets of $901.6 million.

Interest expense decreased $16.1 million from $34.4 million in 2020 to $18.3 million in 2021. This decrease was due to the overall decrease in interest rates during 2021 and $3.8 million in prepayment penalties on borrowings paid in 2020. The prepayment penalties on borrowings were incurred as part of a deleverage strategy in which $83.0 million in FHLB advances with an average cost of 2.61% were paid off during the 4th quarter of 2020. The decrease in rates paid on interest bearing liabilities in addition to the decrease in the yield on the Company's interest earning assets resulted in a decrease in the net interest margin of 30 basis points from 3.33% for 2020 to 3.03% in 2021. Excluding interest income recognized from acquisition–related purchase accounting adjustments and prepayment penalties on borrowings, the margin would have been 2.96% for 2021 compared to 3.27% for 2020.

[[GREPCENT_TABLE]]
[["","2022 - 2021","","2021 - 2020"],["","Total Change","","Change Due To Volume","","Change Due To Rate","","Total Change","","Change Due To Volume","","Change Due To Rate"],["Interest Income"],["Federal funds sold","$","(370)","","","$","(655)","","","$","285","","","$","381","","","$","483","","","$","(102)"],["Interest earning deposits","(19)","","","(97)","","","78","","","(108)","","","1","","","(109)"],["Investment securities \u2013 taxable","18,765","","","15,480","","","3,285","","","6,366","","","6,973","","","(607)"],["Investment securities \u2013 non\u2013taxable","5,779","","","7,291","","","(1,512)","","","6,033","","","10,582","","","(4,549)"],["Loans receivable","17,768","","","9,087","","","8,681","","","(18,530)","","","(10,585)","","","(7,945)"],["Total interest income","41,923","","","31,106","","","10,817","","","(5,858)","","","7,454","","","(13,312)"],["Interest Expense"],["Interest bearing deposits","9,942","","","1,412","","","8,530","","","(10,689)","","","2,760","","","(13,449)"],["Borrowings","7,392","","","3,800","","","3,592","","","(6,614)","","","(783)","","","(5,831)"],["Repurchase agreements","372","","","25","","","347","","","(115)","","","53","","","(168)"],["Subordinated notes","\u2014","","","9","","","(9)","","","1,698","","","1,684","","","14"],["Junior subordinated debentures issued to capital trusts","504","","","9","","","495","","","(413)","","","11","","","(424)"],["Total interest expense","18,210","","","5,255","","","12,955","","","(16,133)","","","3,725","","","(19,858)"],["Net interest income","$","23,713","","","$","25,851","","","$","(2,138)","","","$","10,275","","","$","3,729","","","$","6,546"]]
[[/GREPCENT_TABLE]]

Credit Loss Expense

Horizon assesses the adequacy of its ACL by regularly reviewing the performance of its loan portfolios. Credit loss expense totaled a recovery of $1.8 million in 2022 compared to a recovery of $2.1 million in 2021. Total loan net charge–offs were $843,000, which included commercial loan net recoveries of $80,000, residential mortgage loan net recoveries of $53,000 and consumer loan net charge–offs of $976,000 for the year ending December 31, 2022. The recovery of the ACL in 2022 was the result of allocations related to the impact of COVID–19 being reduced during the year and partially reallocated to current economic factors and also required some release from the ACL.

52

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Credit loss expense totaled a recovery of $2.1 million in 2021 compared to an expense of $20.8 million in 2020. Total loan net charge–offs were $1.6 million, which included commercial loan net charge–offs of $1.1 million, residential mortgage loan net charge–offs of $9,000 and consumer loan net charge–offs of $533,000 for the year ending December 31, 2021. The higher level of credit loss expense for 2020 was due to the adoption of CECL at the beginning of 2020 increasing credit loss expense for economic factors due to the economic shutdown and exposures to loans with nature and characteristics that have greater loss exposure due to economic uncertainty brought on by COVID–19.

Additional information related to credit loss expense (recovery) and net charge–offs (recoveries) is presented in the table below. Also see Note 6 – Allowance for Credit and Loan Losses in the accompanying notes to consolidated financial statements included elsewhere in this report.

[[GREPCENT_TABLE]]
[["","Credit Loss Expense (Recovery)","","Net (Charge\u2013Offs) Recoveries","","Average Loans","","Ratio of Annualized Net (Charge\u2013Offs) Recoveries to Average Loans"],["Twelve Months Ended December 31, 2022"],["Commercial","$","(7,650)","","","$","80","","","$","2,280,553","","","0.00","%"],["Real estate","1,668","","","53","","","621,163","","","0.01","%"],["Mortgage warehouse","(39)","","","\u2014","","","89,409","","","0.00","%"],["Consumer","3,802","","","(976)","","","850,667","","","(0.11)","%"],["Total","(2,219)","","","(843)","","","3,841,792","","","(0.02)","%"],["Excluding PPP loans","$","(2,219)","","","$","(843)","","","$","3,836,682","","","(0.02)","%"],["Twelve Months Ended December 31, 2021"],["Commercial","$","(1,320)","","","$","(1,099)","","","$","2,155,018","","","(0.05)","%"],["Real estate","(755)","","","(9)","","","591,395","","","0.00","%"],["Mortgage warehouse","(208)","","","\u2014","","","206,932","","","0.00","%"],["Consumer","199","","","(533)","","","679,712","","","(0.08)","%"],["Total","(2,084)","","","(1,641)","","","3,633,057","","","(0.05)","%"],["Excluding PPP loans","$","(2,084)","","","$","(1,641)","","","$","3,466,912","","","(0.05)","%"],["Twelve Months Ended December 31, 2020"],["Commercial","$","19,198","","","$","(497)","","","$","2,218,812","","","(0.02)","%"],["Real estate","(184)","","","(167)","","","725,168","","","(0.02)","%"],["Mortgage warehouse","190","","","\u2014","","","259,727","","","0.00","%"],["Consumer","1,547","","","(1,199)","","","676,849","","","(0.18)","%"],["Total","20,751","","","(1,863)","","","3,880,556","","","(0.05)","%"],["Excluding PPP loans","$","20,751","","","$","(1,863)","","","$","3,682,173","","","(0.05)","%"]]
[[/GREPCENT_TABLE]]

53

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Non–interest Income

The following is a summary of changes in non–interest income:

[[GREPCENT_TABLE]]
[["","Twelve Months Ended December 31","","2021 - 2022","","Twelve Months Ended December 31","","2020 - 2021"],["Non\u2013interest Income","2022","","2021","","Amount Change","","Percent Change","","2021","","2020","","Amount Change","","Percent Change"],["Service charges on deposit accounts","$","11,598","","","$","9,192","","","$","2,406","","","26.2","%","","$","9,192","","","$","8,848","","","$","344","","","3.9","%"],["Wire transfer fees","595","","","892","","","(297)","","","(33.3)","%","","892","","","1,000","","","(108)","","","(10.8)","%"],["Interchange fees","12,402","","","10,901","","","1,501","","","13.8","%","","10,901","","","9,306","","","1,595","","","17.1","%"],["Fiduciary activities","5,381","","","7,419","","","(2,038)","","","(27.5)","%","","7,419","","","9,145","","","(1,726)","","","(18.9)","%"],["Gain (loss) on sale of investment securities","\u2014","","","914","","","(914)","","","(100.0)","%","","914","","","4,297","","","(3,383)","","","(78.7)","%"],["Gain on sale of mortgage loans","7,165","","","19,163","","","(11,998)","","","(62.6)","%","","19,163","","","26,721","","","(7,558)","","","(28.3)","%"],["Mortgage servicing net of impairment","4,800","","","2,352","","","2,448","","","104.1","%","","2,352","","","(3,716)","","","6,068","","","(163.3)","%"],["Increase in cash surrender value of bank owned life insurance","2,594","","","2,094","","","500","","","23.9","%","","2,094","","","2,243","","","(149)","","","(6.6)","%"],["Death benefit on officer life insurance","644","","","783","","","(139)","","","(17.8)","%","","783","","","264","","","519","","","196.6","%"],["Other income","2,272","","","4,242","","","(1,970)","","","(46.4)","%","","4,242","","","1,513","","","2,729","","","180.4","%"],["Total non\u2013interest income","$","47,451","","","$","57,952","","","$","(10,501)","","","(18.1)","%","","$","57,952","","","$","59,621","","","$","(1,669)","","","(2.8)","%"]]
[[/GREPCENT_TABLE]]

During 2022, the Company originated approximately $221.9 million of mortgage loans to be sold on the secondary market, compared to $438.1 million in 2021 as long–term interest rates began to increase during 2022. This decrease in volume, in addition to a decrease in the percentage earned on the sale of mortgage loans, resulted in a decrease in the overall gain on sale of mortgage loans of $12.0 million compared to the prior year. Gain on the sale of investment securities decreased $914,000 in 2022 as there were no sales in 2022. Fiduciary activities income decreased $2.0 million during 2022 primarily due to the sale of ESOP trustee accounts which was completed during the third quarter 2021. Mortgage servicing net of impairment increased by $2.4 million during 2022 compared to 2021 primarily due to the recovery net impairment charges of $2.6 million recorded during 2022. Other income decreased $2.0 million during 2022 primarily due to the gain on sale of ESOP trustee accounts of $2.3 million recorded in 2021. The increase in interchange fee income in 2022 compared to 2021 was the result of the branch acquisition in September 2021 and organic growth in transactional deposit accounts and volume during 2022.

During 2021, the Company originated approximately $438.1 million of mortgage loans to be sold on the secondary market, compared to $584.1 million in 2020 as long–term interest rates began to increase during 2021. This decrease in volume, in addition to a slight decrease in the percentage earned on the sale of mortgage loans, resulted in a decrease in the overall gain on sale of mortgage loans of $7.6 million compared to the prior year. Gain on the sale of investment securities decreased $3.4 million in 2021 due to the deleverage strategy executed in 2020. Fiduciary activities income decreased $1.7 million during 2021 primarily due to the sale of ESOP trustee accounts which was completed during the third quarter. Mortgage servicing net of impairment increased by $6.1 million during 2021 compared to 2020 primarily due to the recovery net impairment charges of $2.6 million recorded during 2021. Other income increased $2.7 million during 2021 primarily due to the gain on sale of ESOP trustee accounts of $2.3 million. The increase in interchange fee income in 2021 compared to 2020 was the result of organic growth in transactional deposit accounts and volume during 2021.

54

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Non–interest Expense

The following is a summary of changes in non–interest expense:

[[GREPCENT_TABLE]]
[["","Twelve Months Ended December 31","","2021 - 2022","","Twelve Months Ended December 31","","2020 - 2021"],["Non\u2013interest Expense","2022","","2021","","Amount Change","","Percent Change","","2021","","2020","","Amount Change","","Percent Change"],["Salaries","$","55,422","","","$","49,463","","","$","5,959","","","12.0","%","","$","49,463","","","$","44,671","","","$","4,792","","","10.7","%"],["Commission and bonuses","8,442","","","11,089","","","(2,647)","","","(23.9)","%","","11,089","","","6,861","","","4,228","","","61.6","%"],["Employee benefits","16,419","","","13,499","","","2,920","","","21.6","%","","13,499","","","13,673","","","(174)","","","(1.3)","%"],["Net occupancy expenses","13,323","","","12,541","","","782","","","6.2","%","","12,541","","","12,811","","","(270)","","","(2.1)","%"],["Data processing","10,567","","","9,962","","","605","","","6.1","%","","9,962","","","9,200","","","762","","","8.3","%"],["Professional fees","1,843","","","2,216","","","(373)","","","(16.8)","%","","2,216","","","2,433","","","(217)","","","-8.9","%"],["Outside services and consultants","10,850","","","8,449","","","2,401","","","28.4","%","","8,449","","","7,318","","","1,131","","","15.5","%"],["Loan expense","5,411","","","5,492","","","(81)","","","(1.5)","%","","5,492","","","5,218","","","274","","","5.3","%"],["FDIC deposit insurance","2,558","","","2,377","","","181","","","7.6","%","","2,377","","","1,855","","","522","","","28.1","%"],["Core deposit intangible amortization","3,702","","","3,644","","","58","","","1.6","%","","3,644","","","3,723","","","(79)","","","(2.1)","%"],["Other losses","1,046","","","2,283","","","(1,237)","","","(54.2)","%","","2,283","","","1,162","","","1,121","","","96.5","%"],["Other expenses","13,618","","","12,379","","","1,239","","","10.0","%","","12,379","","","11,229","","","1,150","","","10.2","%"],["Total non\u2013interest expense","$","143,201","","","$","133,394","","","$","9,807","","","7.4","%","","$","133,394","","","$","120,154","","","$","13,240","","","11.0","%"]]
[[/GREPCENT_TABLE]]

For the twelve months ended December 31, 2022, salaries increased $6.0 million reflecting annual merit increases and the additional employees from the branch acquisition completed during the third quarter of 2021. Outside services and consultants increased $2.4 million from additional consulting services performed during the year. Other losses decreased $1.2 million primarily due to $1.9 million in ESOP settlement expenses recorded during the fourth quarter of 2021.

For the twelve months ended December 31, 2021, salaries increased $2.4 million reflecting annual merit increases and the additional employees from the branch acquisition completed during the third quarter. Outside services and consultants and other expenses each increased by $1.1 million during 2021. This was partially due to acquisition–related expenses of $671,000 in outside services and consultants and $674,000 in other expenses. Other losses increased $1.1 million primarily due to $1.9 million in ESOP settlement expenses recorded during the fourth quarter of 2021.

Income Taxes

Income tax expense totaled $12.2 million for the year ended December 31, 2022, a decrease of $3.2 million when compared to the year ended December 31, 2021. The decrease was primarily due to the additional benefit related to investments that generate tax credits, an increase in tax exempt investments, offset slightly by an increase in income before income taxes of $3.1 million in 2022.

Income tax expense totaled $15.4 million for the year ended December 31, 2021, an increase of $5.5 million when compared to the year ended December 31, 2020. The increase was primarily due to an increase in income before income taxes of $24.1 million in 2021 and fewer tax credits recognized due to delays in projects the Company has invested in offset by an increase in tax exempt municipal investments.

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Replacement of London Interbank Offered Rate

In 2017, the United Kingdom's Financial Conduct Authority (the authority that regulates LIBOR) (the “FCA”) announced that after 2021 it would no longer compel banks to submit the rates required to calculate LIBOR. Subsequently, on March 5, 2021, the FCA announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after December 31, 2021, in the case of 1–week and 2–month LIBOR, and immediately after June 30, 2023, in the case of the remaining LIBOR settings. On March 15, 2022, the President of the United States signed into law the Adjustable Interest Rate (LIBOR) Act (the “LIBOR Act”). This legislation establishes a uniform benchmark replacement process for certain contracts that do not contain clearly defined or practicable fall–back provisions. Under the LIBOR Act, such contracts will automatically transition as a matter of law to a Secured Overnight Financing Rate (“SOFR”) based replacement rate identified by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The legislation also creates a safe harbor that shields lenders from litigation if they choose to utilize a replacement rate recommended by the Federal Reserve.

We have loans, borrowings and other financial instruments with attributes that are directly or indirectly dependent on LIBOR and do not provide a replacement rate or include other fall–back provisions that would apply after June 30, 2023. Thus, Horizon has elected to allow the LIBOR under these contracts to automatically convert into the CME Term SOFR after June 30, 2023 pursuant to an in accordance with the LIBOR Act.

Use of Non–GAAP Financial Measures

Certain information set forth in this report on Form 10–K refers to financial measures determined by methods other than in accordance with GAAP. Specifically, we have included non–GAAP financial measures relating to net income, diluted earnings per share, net interest margin, the allowance for credit losses, tangible stockholders’ equity, tangible book value per share, the return on average assets, the return on average common equity and pre–tax pre–provision net income. In each case, we have identified special circumstances that we consider to be adjustments and have excluded them, in order to show the impact of such events as acquisition–related purchase accounting adjustments, prepayment penalties on borrowings and the Tax Cuts and Jobs Act, among other matters we have identified in our reconciliations. Horizon believes these non–GAAP financial measures are helpful to investors and provide a greater understanding of our business without giving effect to the purchase accounting impacts and other adjustments. These measures are not necessarily comparable to similar measures that may be presented by other companies and should not be considered in isolation or as a substitute for the related GAAP measure. See the following tables for reconciliations of the non–GAAP measures identified in this Form 10–K to their most comparable GAAP measures.

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Reconciliation of Net Income"],["(Dollars in Thousands, Unaudited)"],["","Years Ended December 31"],["","2022","","2021","","2020"],["Net income as reported","$","93,408","","","$","87,091","","","$","68,499"],["Acquisition expenses","\u2014","","","1,925","","","\u2014"],["Tax effect","\u2014","","","(401)","","","\u2014"],["Net income excluding acquisition expenses","93,408","","","88,615","","","68,499"],["Credit loss expense on acquired loans","\u2014","","","2,034","","","\u2014"],["Tax effect","\u2014","","","(427)","","","\u2014"],["Net income excluding credit loss expense on acquired loans","93,408","","","90,222","","","68,499"],["Gain on sale of ESOP trustee accounts","\u2014","","","(2,329)","","","\u2014"],["Tax effect","\u2014","","","489","","","\u2014"],["Net income excluding gain on sale of ESOP trustee accounts","93,408","","","88,382","","","68,499"],["ESOP settlement expenses","\u2014","","","1,900","","","\u2014"],["Tax effect","\u2014","","","(315)","","","\u2014"],["Net income excluding ESOP settlement expenses","93,408","","","89,967","","","68,499"],["(Gain) / loss on sale of investment securities","\u2014","","","(914)","","","(4,297)"],["Tax effect","\u2014","","","192","","","902"],["Net income excluding (gain) / loss on sale of investment securities","93,408","","","89,245","","","65,104"],["Death benefit on bank owned life insurance (\u201cBOLI\u201d)","(644)","","","(783)","","","(264)"],["Net income excluding death benefit on BOLI","92,764","","","88,462","","","64,840"],["Prepayment penalties on borrowings","\u2014","","","125","","","3,804"],["Tax effect","\u2014","","","(26)","","","(799)"],["Net income excluding prepayment penalties on borrowings","92,764","","","88,561","","","67,845"],["Adjusted net income","$","92,764","","","$","88,561","","","$","67,845"]]
[[/GREPCENT_TABLE]]

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Reconciliation of Diluted Earnings per Share"],["(Dollars in Thousands, Unaudited)"],["","Years Ended December 31"],["","2022","","2021","","2020"],["Diluted earnings per share (\u201cEPS\u201d) as reported","$","2.14","","","$","1.98","","","$","1.55"],["Acquisition expenses","\u2014","","","0.04","","","\u2014"],["Tax effect","\u2014","","","\u2014","","","\u2014"],["Diluted EPS excluding acquisition expenses","2.14","","","2.02","","","1.55"],["Credit loss expense on acquired loans","\u2014","","","0.05","","","\u2014"],["Tax effect","\u2014","","","(0.01)","","","\u2014"],["Diluted EPS excluding credit loss expense on acquired loans","2.14","","","2.06","","","1.55"],["Gain on sale of ESOP trustee accounts","\u2014","","","(0.05)","","","\u2014"],["Tax effect","\u2014","","","0.01","","","\u2014"],["Diluted EPS excluding gain on sale of ESOP trustee accounts","2.14","","","2.02","","","1.55"],["ESOP settlement expenses","\u2014","","","0.04","","","\u2014"],["Tax effect","\u2014","","","(0.01)","","","\u2014"],["Diluted EPS excluding ESOP settlement expenses","2.14","","","2.05","","","1.55"],["(Gain) / loss on sale of investment securities","\u2014","","","(0.02)","","","(0.10)"],["Tax effect","\u2014","","","\u2014","","","0.02"],["Diluted EPS excluding (gain) / loss on sale of investment securities","2.14","","","2.03","","","1.47"],["Death benefit on bank owned life insurance (\u201cBOLI\u201d)","(0.01)","","","(0.03)","","","(0.01)"],["Diluted EPS excluding death benefit on BOLI","2.13","","","2.00","","","1.46"],["Prepayment penalties on borrowings","\u2014","","","\u2014","","","0.09"],["Tax effect","\u2014","","","\u2014","","","(0.02)"],["Diluted EPS excluding prepayment penalties on borrowings","2.13","","","2.00","","","1.53"],["Adjusted diluted EPS","$","2.13","","","$","2.00","","","$","1.53"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Reconciliation of Pre\u2013Tax, Pre\u2013Provision Income"],["(Dollars in Thousands, Unaudited)"],["","Years Ended December 31"],["","2022","","2021","","2020"],["Pre\u2013tax income","$","105,584","","","$","102,447","","","$","78,369"],["Credit loss expense","(1,816)","","","(2,084)","","","20,751"],["Pre\u2013tax, pre\u2013provision income","$","103,768","","","$","100,363","","","$","99,120"],["Pre\u2013tax, pre\u2013provision income","$","103,768","","","$","100,363","","","$","99,120"],["Acquisition expenses","\u2014","","","1,925","","","\u2014"],["Gain on sale of ESOP trustee accounts","\u2014","","","(2,329)","","","\u2014"],["ESOP settlement expenses","\u2014","","","1,900","","","\u2014"],["(Gain) / loss on sale of investment securities","\u2014","","","(914)","","","(4,297)"],["Death benefit on bank owned life insurance","(644)","","","(783)","","","(264)"],["Prepayment penalties on borrowings","\u2014","","","125","","","3,804"],["Adjusted pre\u2013tax, pre\u2013provision income","$","103,124","","","$","100,287","","","$","98,363"]]
[[/GREPCENT_TABLE]]

58

Table of Contents

HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Reconciliation of Net Interest Margin"],["(Dollars in Thousands, Unaudited)"],["","Years Ended December 31"],["","2022","","2021","","2020"],["Net interest income as reported","$","199,518","","","$","175,805","","","$","165,530"],["Average interest earning assets","6,977,407","","","6,035,161","","","5,133,550"],["Net interest income as a percentage of average interest earning assets (\u201cNet Interest Margin\u201d)","2.98","%","","3.03","%","","3.33","%"],["Net interest income as reported","$","199,518","","","$","175,805","","","$","165,530"],["Acquisition\u2013related purchase accounting adjustments (\u201cPAUs\u201d)","(3,476)","","","(4,503)","","","(6,936)"],["Prepayment penalties on borrowings","\u2014","","","125","","","3,804"],["Adjusted net interest income","$","196,042","","","$","171,427","","","$","162,398"],["Adjusted net interest margin","2.93","%","","2.96","%","","3.27","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Reconciliation of Return on Average Assets"],["(Dollars in Thousands, Unaudited)"],["","Years Ended December 31"],["","2022","","2021","","2020"],["Average assets","$","7,533,915","","","$","6,514,251","","","$","5,628,783"],["Return on average assets (\u201cROAA\u201d) as reported","1.24","%","","1.34","%","","1.22","%"],["Acquisition expenses","\u2014","%","","0.03","%","","\u2014","%"],["Tax effect","\u2014","%","","(0.01)","%","","\u2014","%"],["ROAA excluding acquisition expenses","1.24","%","","1.36","%","","1.22","%"],["Credit loss expense on acquired loans","\u2014","%","","0.03","%","","\u2014","%"],["Tax effect","\u2014","%","","(0.01)","%","","\u2014","%"],["ROAA excluding credit loss expense on acquired loans","1.24","%","","1.38","%","","1.22","%"],["Gain on sale of ESOP trustee accounts","\u2014","%","","(0.04)","%","","\u2014","%"],["Tax effect","\u2014","%","","0.01","%","","\u2014","%"],["ROAA excluding gain on sale of ESOP trustee accounts","1.24","%","","1.35","%","","1.22","%"],["ESOP settlement expenses","\u2014","%","","0.03","%","","\u2014","%"],["Tax effect","\u2014","%","","\u2014","%","","\u2014","%"],["ROAA excluding ESOP settlement expenses","1.24","%","","1.38","%","","1.22","%"],["(Gain) / loss on sale of investment securities","\u2014","%","","(0.01)","%","","(0.08)","%"],["Tax effect","\u2014","%","","\u2014","%","","0.02","%"],["ROAA excluding (gain) / loss on sale of investment securities","1.24","%","","1.37","%","","1.16","%"],["Death benefit on bank owned life insurance","(0.01)","%","","(0.01)","%","","\u2014","%"],["ROAA excluding death benefit on bank owned life insurance","1.23","%","","1.36","%","","1.16","%"],["Prepayment penalties on borrowings","\u2014","%","","\u2014","%","","0.07","%"],["Tax effect","\u2014","%","","\u2014","%","","(0.01)","%"],["ROAA excluding prepayment penalties on borrowings","1.23","%","","1.36","%","","1.22","%"],["Adjusted ROAA","1.23","%","","1.36","%","","1.22","%"]]
[[/GREPCENT_TABLE]]

59

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Reconciliation of Return on Average Common Equity"],["(Dollars in Thousands, Unaudited)"],["","Years Ended December 31"],["","2022","","2021","","2020"],["Average common equity","$","683,630","","","$","712,122","","","$","665,466"],["Return on average common equity (\u201cROACE\u201d) as reported","13.66","%","","12.23","%","","10.29","%"],["Acquisition expenses","\u2014","%","","0.27","%","","\u2014","%"],["Tax effect","\u2014","%","","(0.06)","%","","\u2014","%"],["ROACE excluding acquisition expenses","13.66","%","","12.44","%","","10.29","%"],["Credit loss expense on acquired loans","\u2014","%","","0.29","%","","\u2014","%"],["Tax effect","\u2014","%","","(0.06)","%","","\u2014","%"],["ROACE excluding credit loss expense on acquired loans","13.66","%","","12.67","%","","10.29","%"],["Gain on sale of ESOP trustee accounts","\u2014","%","","(0.33)","%","","\u2014","%"],["Tax effect","\u2014","%","","0.07","%","","\u2014","%"],["ROACE excluding gain on sale of ESOP trustee accounts","13.66","%","","12.41","%","","10.29","%"],["ESOP settlement expenses","\u2014","%","","0.27","%","","\u2014","%"],["Tax effect","\u2014","%","","(0.04)","%","","\u2014","%"],["ROACE excluding ESOP settlement expenses","13.66","%","","12.64","%","","10.29","%"],["(Gain) / loss on sale of investment securities","\u2014","%","","(0.13)","%","","(0.65)","%"],["Tax effect","\u2014","%","","0.03","%","","0.14","%"],["ROACE excluding (gain) / loss on sale of investment securities","13.66","%","","12.54","%","","9.78","%"],["Death benefit on bank owned life insurance","(0.09)","%","","(0.11)","%","","(0.04)","%"],["ROACE excluding death benefit on bank owned life insurance","13.57","%","","12.43","%","","9.74","%"],["Prepayment penalties on borrowings","\u2014","%","","0.02","%","","0.57","%"],["Tax effect","\u2014","%","","\u2014","%","","(0.12)","%"],["ROACE excluding prepayment penalties on borrowings","13.57","%","","12.45","%","","10.19","%"],["Adjusted ROACE","13.57","%","","12.45","%","","10.19","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Reconciliation of Tangible Stockholders\u2019 Equity and Tangible Book Value per Share"],["(Dollars in Thousands Except per Share Data, Unaudited)"],["","December 31,","","September 30,","","June 30,","","March 31,","","December 31,"],["","2022","","2022","","2022","","2022","","2021"],["Total stockholders\u2019 equity","$","677,375","","","$","644,993","","","$","657,865","","","$","677,450","","","$","723,209"],["Less: Intangible assets","172,450","","","173,375","","","173,662","","","174,588","","","175,513"],["Total tangible stockholders\u2019 equity","$","504,925","","","$","471,618","","","$","484,203","","","$","502,862","","","$","547,696"],["Common shares outstanding","43,574,151","","","43,574,151","","","43,572,796","","","43,572,796","","","43,547,942"],["Book value per common share","$","15.55","","","$","14.80","","","$","15.10","","","$","15.55","","","$","16.61"],["Tangible book value per common share","$","11.59","","","$","10.82","","","$","11.11","","","$","11.54","","","$","12.58"]]
[[/GREPCENT_TABLE]]

60

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HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

[[GREPCENT_TABLE]]
[["Non\u2013GAAP Calculation and Reconciliation of Efficiency Ratio and Adjusted Efficiency Ratio"],["(Dollars in Thousands, Unaudited)"],["","Years Ended December 31"],["","2022","","2021","","2020"],["Non\u2013interest expense as reported","$","143,201","","","$","133,394","","","$","126,031"],["Net interest income as reported","199,518","","","175,805","","","165,530"],["Non\u2013interest income as reported","$","47,451","","","$","57,952","","","$","59,621"],["Non\u2013interest expense / (Net interest income + Non\u2013interest income) (\u201cEfficiency Ratio\u201d)","57.98","%","","57.07","%","","55.98","%"],["Non\u2013interest expense as reported","$","143,201","","","$","133,394","","","$","126,031"],["Acquisition expenses","\u2014","","","(1,925)","","","\u2014"],["ESOP settlement expenses","\u2014","","","(1,900)","","","\u2014"],["Non\u2013interest expense excluding acquisition expenses and ESOP settlement expenses","143,201","","","129,569","","","126,031"],["Net interest income as reported","199,518","","","175,805","","","165,530"],["Prepayment penalties on borrowings","\u2014","","","125","","","3,804"],["Net interest income excluding prepayment penalties on borrowings","199,518","","","175,930","","","169,334"],["Non\u2013interest income as reported","47,451","","","57,952","","","59,621"],["Gain on sale of ESOP trustee accounts","\u2014","","","(2,329)","","","\u2014"],["(Gain) / loss on sale of investment securities","\u2014","","","(914)","","","(4,297)"],["Death benefit on bank owned life insurance","(644)","","","(783)","","","(264)"],["Non\u2013interest income excluding gain on sale of ESOP trustee accounts, (gain) / loss on sale of investment securities and death benefit on bank owned life insurance","$","46,807","","","$","53,926","","","$","55,060"],["Adjusted efficiency ratio","58.13","%","","56.37","%","","56.17","%"]]
[[/GREPCENT_TABLE]]

61

Table of Contents

HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

Liquidity and Rate Sensitivity Management

Management and the Board of Directors meet regularly to review both the liquidity and rate sensitivity position of Horizon. Effective asset and liability management ensures Horizon’s ability to monitor the cash flow requirements of depositors along with the demands of borrowers and to measure and manage interest rate risk. Horizon utilizes an interest rate risk assessment model designed to highlight sources of existing interest rate risk and consider the effect of these risks on strategic planning. Management maintains (within certain parameters) an essentially balanced ratio of interest sensitive assets to liabilities in order to protect against the effects of wide interest rate fluctuations.

Liquidity

The Bank maintains a stable base of core deposits provided by long standing relationships with consumers and local businesses. These deposits are the principal source of liquidity for Horizon. Other sources of liquidity for Horizon include earnings, loan repayments, investment security sales, cashflows and maturities, sale of real estate loans and borrowing relationships with correspondent banks, including the FHLB and the Federal Reserve Bank (“FRB”). At December 31, 2022, Horizon had available approximately $672.0 million in available credit from various money center banks, including the FHLB and the FRB Discount Window. The following factors could impact Horizon’s funding needs in the future:

◦Horizon had outstanding borrowings of approximately $575.4 million with the FHLB and total borrowing capacity with the FHLB of $816.5 million. Generally, the loan terms from the FHLB are better than the terms Horizon can receive from other sources, making it less expensive to borrow money from the FHLB. Financial difficulties at the FHLB could reduce or eliminate Horizon’s additional borrowing capacity with the FHLB or the FHLB could change collateral requirements, which could lower the Company’s borrowing availability.

◦If residential mortgage loan rates remain low, Horizon’s mortgage warehouse loans could create an additional need for funding.

◦Horizon had a total of $45.0 million of unused Federal Fund lines from various money center banks. These are uncommitted lines and could be withdrawn at any time by the correspondent banks.

◦Horizon had a total of $385.9 million of available collateral at the FRB secured by municipal securities. These securities may mature, call, or be sold, which would reduce the available collateral.

◦Horizon had approximately $1.9 billion of unpledged investment securities at December 31, 2022.

◦A downgrade in Horizon’s ability to obtain credit due to factors such as deterioration in asset quality, a large charge to earnings, a decline in profitability or other financial measures, or a significant merger or acquisition could impact the availability of funding sources.

◦An act of terrorism or war, natural disasters, political events, or the default or bankruptcy of a major corporation, mutual fund, hedge fund or a government agency could affect the cost and availability of funding sources.

◦Market speculation or rumors about Horizon or the banking industry in general may adversely affect the cost and availability of normal funding sources.

If any of these events occur, they could force Horizon to borrow money from other sources including negotiable certificates of deposit. Such other monies may only be available at higher interest rates and on less advantageous terms, which will impact our net income and could impact our ability to grow. Management believes Horizon has adequate funding sources to meet short and long term needs.

Horizon maintains a liquidity contingency plan that outlines the process for addressing a liquidity crisis. The plan provides for an evaluation of funding sources under various market conditions. It also assigns specific roles and responsibilities for effectively managing liquidity through a problem period.

62

Table of Contents

HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

During 2022, cash flows were generated primarily from the proceeds from borrowings totaling $675.0 million, the sales, maturities, and prepayments of investment securities of $142.1 million and an increase in deposits of $54.8 million. Cash flows were primarily used to purchase investments totaling $610.7 million, an increase in net loans of $448.3 million and the repayment of borrowings totaling $755.6 million. The net cash and cash equivalent position decreased by $470.0 million during 2022.

At December 31, 2022, the Bank had $1.5 billion in commitments to extend credit outstanding, excluding interest rate lock commitments for residential mortgage loans intended for sale in the secondary market that meet the definition of a derivative. Time deposits due within one year of December 31, 2022 totaled $697.6 million, or 70.0% of time deposits. We believe the large percentage of time deposits that mature within one year reflects customers' hesitancy to invest their funds for long periods due to the recent low interest rate environment and local competitive pressure. The balance also includes $18.6 million in brokered time deposits at December 31, 2022. If these maturing time deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the time deposits due on or before December 31, 2023. We believe, however, based on past experience that a significant portion of our time deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

Interest Rate Sensitivity

The degree by which net interest income may fluctuate due to changes in interest rates is monitored by Horizon using computer simulation models, incorporating not only the current GAP position but the effect of expected repricing of specific financial assets and liabilities. When repricing opportunities are not properly aligned, net interest income may be affected when interest rates change. Forecasting results of the possible outcomes determines the exposure to interest rate risk inherent in Horizon’s balance sheet. The goal is to manage imbalanced positions that arise when the total amount of assets that reprice or mature in a given time period differs significantly from liabilities that reprice or mature in the same time period. The theory behind managing the difference between repricing assets and liabilities is to have more assets repricing in a rising rate environment and more liabilities repricing in a declining rate environment.

Based on a model that assumes a lag in repricing, at December 31, 2022, the amount of assets that reprice within one year was 95% of liabilities that reprice within one year. At December 31, 2021, this same model reported that the amount of assets that reprice within one year was approximately 257% of the amount of liabilities that reprice within the same time period. During the year 2022, the decrease in the yield of interest–earning assets outpaced the decrease in the cost of funding resulting in a decrease in net interest margin.

63

Table of Contents

HORIZON BANCORP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Table dollars in thousands except per share data)

[[GREPCENT_TABLE]]
[["","3 Months or Less",""," 3 Months & /= 6 Months",""," 6 Months & /= 1 Year","","Greater Than 1 Year","","Total"],["Loans","$","1,540,109","","","$","183,370","","","$","339,817","","","$","2,100,509","","","$","4,163,805"],["Federal funds sold","3,581","","","\u2014","","","\u2014","","","\u2014","","","3,581"],["Interest earning balances with banks","11,464","","","\u2014","","","\u2014","","","\u2014","","","11,464"],["Investment securities and FHLB stock","84,547","","","36,474","","","48,602","","","2,877,360","","","3,046,983"],["Other assets","\u2014","","","\u2014","","","\u2014","","","646,685","","","646,685"],["Total assets","$","1,639,701","","","$","219,844","","","$","388,419","","","$","5,624,554","","","$","7,872,518"],["Non\u2013interest bearing deposits","$","33,217","","","$","32,354","","","$","62,206","","","$","1,149,991","","","$","1,277,768"],["Interest bearing deposits","287,557","","","268,952","","","542,015","","","3,481,482","","","4,580,006"],["Borrowed funds","1,092,601","","","57,057","","","61","","","109,153","","","1,258,872"],["Other liabilities","\u2014","","","\u2014","","","\u2014","","","78,497","","","78,497"],["Stockholders\u2019 equity","\u2014","","","\u2014","","","\u2014","","","677,375","","","677,375"],["Total liabilities and stockholders\u2019 equity","$","1,413,375","","","$","358,363","","","$","604,282","","","$","5,496,498","","","$","7,872,518"],["GAP","$","226,326","","","$","(138,519)","","","$","(215,863)","","","$","128,056"],["Cumulative GAP","$","226,326","","","$","87,807","","","$","(128,056)"]]
[[/GREPCENT_TABLE]]

The Company was liability sensitive as of December 31, 2022, resulting from longer term fixed rate assets on the balance sheet not repricing as quickly as deposits pricing based on expected deposit repricing betas. Based on parallel rate shocks to the balance sheet, at a 100 basis point shock and 200 basis point shock up, net interest income decreases approximately $5.1 million and $10.5 million, respectively. At a 100 basis point shock and 200 basis point shock down, net interest income increases approximately $5.1 million and $6.8 million, respectively.