10-K405 1 k011016.txt HORIZON FINANCIAL CORP. FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-27062 Horizon Financial Corp. ------------------------------------------- (Exact name of registrant as specified in its charter) Washington 91-1695422 ----------------------------------------- ------------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 1500 Cornwall Avenue, Bellingham, Washington 98225 -------------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (360) 733-3050 ------------------- Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1.00 per share --------------------------------------- (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---- ---- Indicate by check mark whether disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or other information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. YES NO X ---- ---- The aggregate market value of the voting stock held by nonaffiliates of the registrant, based on the closing sales price of the registrant's Common Stock as quoted on the Nasdaq Stock Market under the symbol "HRZB" on June 6, 2001, was $100,687,217 (8,855,516 shares at $11.37 per share). It is assumed for purposes of this calculation that none of the registrant's officers, directors and 5% stockholders are affiliates. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Registrant's Proxy Statement for the 2001 Annual Meeting of Stockholders. (Parts II. and III). PART I Item 1. Business ----------------- (a) General ------- Horizon Financial Corp. ("Horizon Financial" or the "Corporation") was formed under Washington law on May 22, 1995, and became the holding company for Horizon Bank ("Horizon Bank" or the "Bank"), effective October 13, 1995. Effective June 19, 1999 the Corporation completed the acquisition of Bellingham Bancorporation, a $64.3 million, bank holding company for the Bank of Bellingham, which was merged with and into Horizon Bank. At March 31, 2001, the Corporation had total assets of $729.7 million, total deposits of $595.9 million and total equity of $97.9 million. The Corporation's business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to the Bank and its subsidiary. The Bank was organized in 1922 as a Washington State chartered mutual savings and loan association and converted to a federal mutual savings and loan association in 1934. In 1979, the Bank converted to a Washington State chartered mutual savings bank, the deposits of which are insured by the Federal Deposit Insurance Corporation ("FDIC"). On August 12, 1986, the Bank converted to a state chartered stock savings bank under the name "Horizon Bank, a savings bank". The Bank became a member of the Federal Home Loan Bank ("FHLB") of Seattle in December 1998. Effective March 1, 2000, the Bank changed its name to its current title, "Horizon Bank". The Bank's operations are conducted through 15 full-service office facilities, located in Whatcom, Skagit and Snohomish counties in Northwest Washington. The acquisition of Bellingham Bancorporation increased Horizon Financial's and Horizon Bank's presence in Whatcom County. During fiscal 2000, the Bank opened an additional office in Whatcom County, located in the Barkley Village area of Bellingham, in the northeast portion of the city. In addition to serving the growing population in this area, this new office (approximately 15,000 square feet) serves as an operation center to support additional growth for the Corporation. The Bank also completed construction of a new office building at Murphy's Corner near Mill Creek, which replaced the Bank's leased location in that area. During fiscal 2000, the Bank purchased a bank site in Marysville, which will provide additional growth opportunities. The Bank's management continues to research sites for future development, with emphasis on locations in the growing Snohomish County markets. At its October 24, 2000 meeting, the Board of Directors authorized a new repurchase plan for up to 10% (approximately 897,000, as restated) of the Corporation's outstanding common stock over a 24 month period. During the fiscal year ended March 31, 2001, the Corporation repurchased 683,790 shares of its Common Stock, compared to the repurchase of 420,900 shares of Common Stock during the prior year. Lending Activities ------------------ General. The Bank's loan portfolio totaled $597,382,353 at March 31, 2001, representing approximately 81.86% of its total assets. On that date, 58.66% of total outstanding loans consisted of loans secured by mortgages on single family residential properties, 4.17% of the loans consisted of loans secured by two-to- four unit residential properties, 3.80% of total outstanding loans consisted of loans secured by mortgages on over four unit residential properties, and 29.85% of total outstanding loans consisted of commercial loans and commercial real estate loans. The balance of the Bank's outstanding loans at that date consisted of secured consumer loans and loans secured by savings deposits. The Bank originates both fixed rate and adjustable rate mortgages ("ARMs") secured by residential, business, and commercial real estate, the majority of which include building improvements. The Bank has no significant concentration of credit risk other than that a substantial portion of its loan portfolio is secured by real estate located in the Bank's primary market area, which the Bank considers to be Whatcom, 1 Skagit and Snohomish Counties in Washington. This concentration of credit risk could have a material adverse effect on the Bank's financial condition and results of operations to the extent there is a material deterioration in the counties' economic and real estate values. In order to have the ability to make the yields on its loan portfolio and investments more interest rate sensitive, the Bank has implemented a number of measures. Those measures include: (i) adoption of a policy under which the Bank generally originates long-term, fixed-rate mortgage loans when such loans are written to specifications promulgated by the Federal Home Loan Mortgage Corporation ("FHLMC") and qualify for sale in the secondary market, (ii) origination of ARM loans on residential and commercial properties subject to market conditions, (iii) origination of variable rate commercial and consumer loans, and (iv) increased emphasis on originating 10 and 15 year amortizing mortgage loans. At March 31, 2001, $395,416,123 (or 66.19%) of the Bank's net mortgage loans receivable were comprised of loans that were other than long-term fixed-rate mortgage loans (i.e., loans with maturities greater than 15 years, which historically have been the industry's traditional area of lending activity). The following table provides selected data relating to the composition of the Bank's loan portfolio by type of loan on the dates indicated. At March 31, -------------------------------------------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Type of Loan: First mortgage loans: One- to-four family. . . . . . $619,394,856 $606,702,881 $564,394,944 $486,107,297 $428,045,812 One- to-four family construction. . . . . . . . . 26,715,987 25,911,941 23,817,577 15,676,088 13,902,046 Participations sold. . . . . . (246,582,822) (176,537,497) (163,526,986) (112,251,375) (83,742,111) ------------- ------------ ------------ ------------ ------------ Subtotal . . . . . . . . . . 399,528,021 456,077,325 424,685,535 389,532,010 358,205,747 Commercial construction/land development . . . . . . . . . . 30,364,368 18,716,744 2,505,484 14,381,275 8,193,186 Residential commercial real estate . . . . . . . . . . 24,186,903 21,999,357 18,158,927 17,793,806 13,572,385 Nonresidential commercial real estate. . . . . . . . . . . . . 139,232,200 88,322,611 74,120,509 46,148,886 37,198,647 Commercial loans . . . . . . . . 20,221,122 14,472,300 19,293,804 11,936,000 14,814,000 Home equity secured. . . . . . . 19,834,618 16,952,862 13,499,198 16,701,470 18,358,470 Other consumer loans . . . . . . 2,530,851 4,829,230 5,216,800 5,812,765 7,250,176 ------------- ------------ ------------ ------------ ------------ Subtotal . . . . . . . . . . 635,898,083 621,370,429 557,480,257 502,306,212 457,592,611 Less: Deferred loan fees . . . . . . (6,745,573) (7,397,782) (7,203,886) (6,924,744) (6,885,376) Loan loss reserve. . . . . . . (4,976,670) (4,757,152) (4,463,305) (4,085,203) (3,779,761) Loans in process . . . . . . . (26,793,487) (19,631,956) (12,163,897) (12,635,603) (7,653,078) ------------- ------------ ------------ ------------ ------------ $597,382,353 $589,583,539 $533,649,169 $478,660,662 $439,274,396 ============ ============ ============ ============ ============
2 Loan Maturity. The following table sets forth certain information at March 31, 2001 regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances are net of undisbursed loan proceeds, unearned discounts, unearned income and allowance for loan losses. Due Due After Within 1 Through Due Over One Year 5 Years 5 Years After After After March March March 31, 2001 31, 2001 31, 2001 Total -------- -------- -------- ----- (In thousands) Commercial, financial and agricultural . . . . $34,117 $19,432 $54,343 $107,892 Real estate construction. -- -- 26,716 26,716 Real estate-mortgage, installment and other. . 28,471 59,828 374,475 462,774 ------- ------- -------- -------- Total . . . . . . . . $62,588 $79,260 $455,534 $597,382 ======= ======= ======== ======== The following table sets forth the dollar amount of all loans due within one year after March 31, 2001 which have fixed interest rates and have floating or adjustable interest rates. Loan balances do not include undisbursed loan proceeds, unearned discounts, unearned income, and allowance for loan losses. Fixed Rates Adjustable Rates Total ------- ------------------ ------- (In thousands) Commercial, financial and agricultural . . . . . . . . . . $ 368 $33,749 $34,117 Real estate construction . . . . -- -- -- Real estate-mortgage, installment and other . . . . . . . . . . . . 8,471 -- 28,471 ------- ------- ------- Total . . . . . . . . . . . .$28,839 $33,749 $62,588 ======= ======= ======= Residential Loans. The primary lending activity of the Bank has historically been the granting of conventional loans to enable borrowers to purchase existing homes or construct new homes. The Bank's real estate loan portfolio also includes loans on two-to-four family dwellings, multi-family housing (over four units), and loans made to purchase or refinance improved buildings to be used for residential housing. At March 31, 2001, approximately 65.95% of the Bank's total loan portfolio consisted of loans secured by residential real estate. The Bank's lending practices generally limit the maximum loan-to-value ratio on one-to-four family residential mortgage loans to 97% of the appraised value as determined by an independent appraiser, with the condition that private mortgage insurance generally be required on any home loans with loan-to-value ratios in excess of 80% of the appraised value. The Bank places this insurance with carriers approved by the FHLMC. The coverage generally limits the Bank's exposure to 72% of the loan amount. If private mortgage insurance is required, the borrower pays the premium at loan closing and any recurring premiums through an escrow reserve account established with the Bank for such period of time as the Bank requires the insurance coverage to be in force. Multi-family residential and commercial real estate loans and unimproved real estate loans generally do not exceed 80% of appraised value. The Bank presently originates both fixed-rate and ARMs secured by one-to-four family properties with a loan term not exceeding 30 years. Under certain conditions, ARM borrowers are allowed to convert beginning on the first interest rate change date and ending on the fifth interest rate change date from the date of the loan note. In addition, certain consumer safeguards are built into the ARM instruments used by the Bank. These safeguards include limits on annual and lifetime interest rate adjustments. The Bank generally originates these loans in accordance with 3 guidelines established by the FHLMC. For the fiscal year ended March 31, 2001, adjustable mortgage loans totaled $515,600 or .34% of total originations as compared to $1,665,250 or 1.14% of total originations for the year ended March 31, 2000. Construction Loans. The Bank also provides construction financing for single-family dwellings and to a lesser extent makes land acquisition and development loans on properties intended for residential use. The interest rate charged by the Bank on these loans varies depending upon the type of security property and the creditworthiness of the borrower. At March 31, 2001, the Bank had $57,080,355, or 8.98% of total loans outstanding in construction loans, as compared to $44,628,685, or 7.18% of total loans at March 31, 2000. At March 31, 2001, $29,931,518 or 52.44% of the construction loan portfolio consisted of "speculative" construction loans (i.e., loans on dwellings for which there is not an underlying contract for sales). Construction lending is generally considered to involve a higher level of risk as compared to one-to-four family residential permanent lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimate of value proves to be inaccurate, the Bank may be confronted at, or prior to, the maturity of the loan, with a project whose value is insufficient to assure full repayment. Loans for the construction of speculative homes carry more risk because the payoff for the loan is dependent on the builder's ability to sell the property prior to the time that the construction loan is due. Multi-Family, Business and Commercial Loans. These types of loans constituted $183,640,225 or approximately 28.88% of Horizon Bank's loan portfolio at March 31, 2001. These loans include fixed rate and adjustable rate mortgages secured by apartment buildings (i.e., those containing five or more living units) and business and commercial properties. The Bank generally requires that such loans have a debt service coverage of 1.20 to 1 with a loan-to-value ratio not exceeding 80%. Fixed-rate loans generally have a five to 15-year loan term, with payments based upon a 15 to 30-year amortization schedule. At March 31, 2001, $32,467,547 of loans secured by income-producing properties have an interest rate which adjusts annually based upon changes in an index of United States Treasury securities published by the Board of Governors of the Federal Reserve System ("Federal Reserve"). The amount of any increase in the interest rate is generally limited to two percentage points (upward or downward) each adjustment period, with a limit of six percentage points on the amount which the interest rate can increase or decrease over the life of the loan. Multi-family residential and business and commercial real estate lending is generally considered to involve a higher degree of risk than permanent residential one-to-four family lending. Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy generally. Horizon Bank generally attempts to mitigate the risks associated with multi-family commercial and residential real estate lending by, among other things, lending on collateral located in its market area and generally to individuals who reside in its market. The merger with Bank of Bellingham included a wide range of commercial loans to small and medium sized businesses. This portfolio presently includes lines of credit with floating rates and maturities of one year or less and term loans for the purchase of equipment, real estate and other operating purposes with maturities generally not exceeding ten years. These loans are secured by a variety of business assets including equipment, real estate, accounts receivable and inventory. Under certain conditions, the Bank also offers unsecured credit to qualified borrowers. Commercial lending carries increased risks compared to residential mortgage lending due to the heavy reliance upon the future income of the customer and the uncertain liquidation value of the collateral. In the event of default, the liquidation of collateral is often insufficient to cover the outstanding debt. To mitigate these inherent risks, the Bank combines a conservative lending policy with experienced lending personnel responsible for the ongoing management of their assigned accounts. 4 Consumer Loans. The Bank makes a variety of loans for consumer purposes. Included among these are home equity loans, home equity lines of credit, loans secured by personal property, such as automobiles, boats, and other vehicles, loans secured by a Horizon Bank Certificate of Deposit, unsecured loans, and loans for mobile homes located in parks. Horizon Bank actively markets consumer loans in order to provide a wider range of financial services to its customers and to achieve shorter terms and higher interest rates normally typical of such loans. At March 31, 2001, the Bank held $22,365,469 of consumer loans. Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles, boats and other vehicles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. Consumer loans are made based on an evaluation of the borrower's creditworthiness, including income, other indebtedness, and satisfactory credit history, and the value of the collateral. Designated managers or Loan Committee members approve consumer loan requests. Secured loan amounts typically do not exceed 80% of the value of the collateral, or 80% of the appraised value of the residence in the case of home equity loans. Loan Solicitation and Processing. The primary sources for loan originations are attributable to deposit cus-tomers, current borrowers, walk-in customers, and referrals from existing customers, real estate agents, and builders. The Bank does not currently purchase loans from, or otherwise utilize, mortgage brokers in the origination of loans. The Bank accepts completed loan applications from all of its branches. Processing is substantially centralized in the main office of the Bank. Detailed information is obtained to determine the creditworthiness of the borrower and the borrower's ability to repay. The more significant items appearing on the applications and accompanying material are verified through the use of written credit reports, financial statements, and confirmations. After analysis of the loan application, supporting documents and the property to be pledged as loan security, including an appraisal of the property by either a staff appraiser or an independent fee appraiser, the application is forwarded to the Bank's Loan Committee. Loan approval requires the signatures of two members of the Loan Committee. The Loan Committee consists of officers of the Bank who are appointed by the Bank's Board of Directors. The Bank generally requires its mortgage notes to be co-signed individually by the principals on loans made to entities other than natural persons. Certain lending personnel have been given limited loan approval authority by the Board of Directors covering secondary market quality loans not exceeding 80% to value. Loan assumption requests of adjustable rate loans are handled by the Bank in a manner similar to new loan requests. FHLMC standards are generally applied to each request and full credit underwriting is required. For fixed rate loans, a sale or transfer of the secured property generally results in the Bank enforcing its due on transfer rights contained in the mortgage instrument. Residential Loan Originations, Purchases and Sales. Currently, the Bank emphasizes the origination of 15 to 30 year fixed rate loans on terms and conditions which will permit them to be sold in the secondary market, while originating ARM loans and shorter term fixed-rate loans for its own portfolio. In addition to originating loans, Horizon Bank may purchase real estate loans in the secondary market. The Bank's purchases in the secondary market depend upon the demand for mortgage credit in the local market area and 5 the inflow of funds from traditional sources. Loan purchases enable the Bank to utilize funds more quickly, particularly where sufficient loan demand is not obtainable locally. The Bank is a qualified servicer for both FHLMC and Fannie Mae. The Bank's general practice is to close its fixed-rate, one-to-four family residential loans on FHLMC loan documents in order to facilitate future sales to the mortgage corporation as well as to other institutional investors. From time to time, depending upon interest rates and economic conditions, the Bank has sold participation interests in loans in order to provide additional funds for lending, to generate servicing fee income and to decrease the dollar amount of its intermediate and long-term fixed-rate loans. The sale of loans in the secondary mortgage market reduces the Bank's interest rate risk and allows the Bank to continue to make loans during periods when savings flows decline or funds are otherwise unavailable for lending purposes. In connection with such sales, the Bank generally retains the servicing of the loans (i.e., collection of principal and interest payments), for which it generally receives a fee payable monthly of .25% to .375% per annum of the unpaid balance of each loan. As of March 31, 2001, the Bank was servicing loans for others aggregating approximately $246,582,822. In February 2001, the Bank began selling much of its current loan production on a servicing released basis, and plans to continue doing so for many of the long-term fixed rate loan originations. All sales of loan interests by the Bank are made without right of recourse to the Bank by the buyer of the loan interests in the event of default by the borrower. Loan Commitments. Horizon Bank issues commitments to originate conventional mortgage loans on existing residential dwellings. Loan commitments are made for periods up to 60 days from the date of loan application and are generally based upon the prevailing market rate at the time of application. At March 31, 2001, such commitments amounted to $6,549,275. Loan Origination and Other Fees. In addition to interest earned on loans, the Bank receives loan origination fees for originating loans. Loan origination fees are a percentage of the principal amount of the mortgage loan which are charged to the borrower at the closing of the loan. The Bank's loan origination fees are generally 0% to 2.5% on conventional residential mortgages and 1.0% to 2.0% for commercial real estate loans. The total amount of deferred loan origination fees and unearned discounts at March 31, 2001 was $6,745,573. Any unamortized loan fees are recognized as income at the time the loan is sold or paid off. Income from loan origination and commitment fees varies with the volume and type of loans and commitments made and purchased and with competitive conditions in mortgage markets, which in turn responds to the demand for and availability of money. The Bank experiences an increase in loan fee income and other fee income, such as appraisal and loan closing fees, during periods of low interest rates due to the resulting demand for mortgage loans. The Bank also receives other fees and income from charges relating to existing loans, which include late charges, and fees collected in connection with a change in terms or other loan modifications. These fees and charges have not constituted a material source of income. Loan Modifications. The Bank offers a loan modification program to assist customers who are considering refinancing their home loans. For a fee the Bank will modify customers' loans under the program. No new principal is required and only the interest rate and payment amounts are changed. All other terms and conditions remain the same. In fiscal 2001, the Bank modified $20,842,647 of real estate loans, compared to $527,643 in fiscal 2000. Delinquent Loans, Loans in Foreclosure and Foreclosed Property. Real estate loans are defined as delinquent when any payment of principal and/or interest is past due. While the Bank generally is able to work out a satisfactory repayment schedule with a delinquent borrower, the Bank will undertake foreclosure proceedings if the delinquency is not otherwise resolved within 90 days. Property acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as "real estate owned" until such time as it is sold or otherwise disposed of. At March 31, 2001, the Bank had nine loans over 90 days delinquent with a net balance of $832,299. Management does not anticipate incurring material losses from these loans. Subsequent to year end, the Bank had one borrower who had loans totaling approximately $17,000,000 become late on two regularly scheduled payments and had acknowledged 6 that it had current temporary working capital shortages. The Bank estimates that there will be no loss on these loans due to the overall financial strength of the borrower, the borrower's plan to restructure its balance sheet, and the quality of the collateral held by the Bank. The following table sets forth information with respect to the Bank's non-performing assets at the dates indicated. At March 31, ------------------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Non-accrual loans. . . . . . $ -- $455,000 $ -- $138,000 $14,000 Loans 90 days or more delinquent and accruing interest . . . . . 832,299 456,729 383,000 30,345 57,918 Restructured loans . . . . . -- -- -- -- -- Real estate acquired through foreclosure . . . . -- 323,468 -- -- -- -------- ---------- -------- -------- ------- Total. . . . . . . . . . . $832,299 $1,235,197 $383,000 $168,345 $71,918 ======== ========== ======== ======== ======= As a percentage of net loans . . . . . . . . . . . .14% .21% .07% .04% .02% As a percentage of total assets. . . . . . . . . . . .11% .17% .06% .03% .01% Reserves for Losses. The Bank operates under a general loan loss reserve system. The provision for loan losses is maintained at a level sufficient to provide for estimated loan losses based on evaluating known and inherent risks in the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. The reserve is based upon factors and trends identified by management at the time financial statements are prepared, but the ultimate recovery of loans is susceptible to future market factors beyond the Bank's control, which may result in losses or recoveries differing significantly from those provided for in the financial statements. The Bank established an allowance for losses for the year ended March 31, 2001 in the amount of $4,976,670 and $4,757,152 for the year ended March 31, 2000. The Bank's loan loss reserve as of March 31, 2001, is approximately .83% of total loans receivable. The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated. Year Ended March 31, ------------------------------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Balance at beginning of period. . . . . . $4,757,152 $4,463,305 $4,085,203 $3,779,761 $3,490,150 Provision for loan losses . . . 320,000 437,234 484,500 520,500 284,400 Adjustment to reserves . . . . (100,482) (143,387) (106,398) (215,058) (5,211) ---------- ---------- ---------- ---------- ---------- Balance at end of period . . . . $4,976,670 $4,757,152 $4,463,305 $4,085,203 $3,779,761 ========== ========== ========== ========== ========== 7 The following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated. Year Ended March 31, ------------------------------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Commercial, financial and agricultural. .$1,922,537 $1,187,327 $1,457,155 $1,324,053 $1,173,611 Residential real estate - mortgage . 3,054,133 3,569,825 3,006,150 2,761,150 2,606,150 ---------- ---------- ---------- ---------- ---------- Total allowance for loan losses. $4,976,670 $4,757,152 $4,463,305 $4,085,203 $3,779,761 ========== ========== ========== ========== ========== The Bank had no allowances for real estate acquired through foreclosure at March 31, 2001, 2000, 1999, 1998 and 1997. Investment Activities --------------------- Under Washington law, savings banks are permitted to own U.S. government and government agency obligations, commercial paper, corporate bonds, mutual fund shares, debt and equity obligations issued by creditworthy entities, whether traded on public securities exchanges or placed privately for investment purposes. The Bank holds a diverse portfolio of money market instruments, United States Treasury obligations, federal agency securities, municipal securities, common stock, preferred stock and corporate notes. The FDIC has adopted the Federal Financial Institutions Examination Council statement of policy on securities activities and accounting procedures. This policy requires that institutions establish prudent policies and strategies for securities activities, identify certain securities trading practices that are unsuitable for an investment portfolio, recommends procedures for selection of a securities dealer, and limits investment in high risk mortgage securities and disproportionately large holdings of long-term zero coupon bonds. The policy addresses concerns about speculative or other non-investment activities in the securities investment portfolios of depository institutions. Speculative securities activities can impair earnings or capital and, in some cases, may cause the failure of the institution. The policy establishes a framework for structuring securities activities and clarifies various accounting issues concerning investment accounts versus trading accounts. The amortized cost of the above investments at March 31, 2001 was $16,235,686 compared to a market value of $21,624,828. For further information concerning the Bank's investment securities portfolio, see Note 4 of the Notes to the Consolidated Financial Statements contained in the Corporation's Proxy Statement for the 2001 Annual Meeting of Stockholders ("Proxy Statement"). The Bank also invests in mortgage-backed securities. At March 31, 2001, such securities had an amortized cost of $53,507,780 and a market value of $54,354,862. 8 The following table presents the amortized cost of the Bank's investment securities portfolio and short-term investments. The market value of the Bank's investment securities portfolio at March 31, 2001 was approximately $75,979,690. This does not include interest-bearing deposits and cash equivalents. At March 31, ---------------------------------- 2001 2000 1999 ---- ---- ---- (In thousands) Investment securities: U.S. Government: Available for sale . . . . . . . . $ 4,879 $ 4,812 $ 12,312 Held to maturity . . . . . . . . . 369 369 892 ------- ------- -------- 5,248 5,181 13,204 Asset-backed securities(1): Available for sale . . . . . . . . 46,978 52,974 44,548 Held to maturity . . . . . . . . . 6,530 8,249 10,959 ------- ------- -------- 53,508 61,223 55,507 Other securities(2): Available for sale . . . . . . . . 10,988 6,124 9,807 Held to maturity . . . . . . . . . -- 500 500 ------- ------- -------- 10,988 6,624 10,307 ------- ------- -------- Total investments . . . . . . . . 69,744 73,028 79,018 Interest bearing deposits and cash equivalents . . . . . . . . . 24,508 20,004 26,462 ------- ------- -------- $94,252 $93,032 $105,480 ======= ======= ======== ---------- (1) Consists of mortgage-backed securities and CMO's. (2) Consists of corporate debt securities and marketable equity securities. 9 The following table sets forth the scheduled maturities, amortized cost, market values and average yields for the Bank's investment securities at March 31, 2001. At March 31, 2001 ------------------------------------------------------------------------------------ One Year One to Five Five to Ten More than Total Investment or Less Years Years Ten Years Securities ------------ ------------- ------------ ------------ --------------------- Amor- Aver- Amor- Aver- Amor- Aver- Amor- Aver- Amor- Aver- tized age tized age tized age tized age tized Market age Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield ---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ----- (Dollars in thousands) U.S. Government, agency securities, state and political subdivisions: Available for sale.$ -- --% $ 3,487 6.73% $ 1,392 6.59% $ -- --% $ 4,879 $ 4,970 6.69% Held to maturity. . -- -- -- -- 369 4.30 -- -- 369 373 4.30 ------ ---- ------- ---- ------- ---- ------- ---- ------- ------ ---- -- -- 3,487 6.73 1,761 6.11 -- -- 5,248 5,343 6.52 Mortgage-backed securities: Available for sale. 1,373 3.02 126 1.21 3,002 6.66 42,477 6.51 46,978 47,627 6.40 Held to maturity. . 64 6.18 36 15.12 5,941 6.43 489 9.77 6,530 6,728 6.73 ------ ---- ------- ----- ------- ---- ------- ---- ------- ------- ---- 1,437 3.16 162 4.33 8,943 6.51 42,966 6.55 53,508 54,355 6.44 Other: Available for sale. 2,806 8.97 7,192 7.02 990 6.20 -- -- 10,988 16,282 7.44 Held to maturity. . -- -- -- -- -- -- -- -- -- -- -- ------ ---- ------- ---- ------- ---- ------- ---- ------- ------- ---- 2,806 8.97 7,192 7.02 990 6.20 -- -- 10,988 16,282 7.44 ------ ---- ------- ---- ------- ---- ------- ---- ------- ------- ---- Total . . . . . . .$4,243 7.00% $10,841 6.88% $11,694 6.42% $42,966 6.55% $69,744 $75,980 6.61% ====== ==== ======= ==== ======= ==== ======= ==== ======= ======= ==== 10
Savings Activities and Other Sources of Funds --------------------------------------------- General. Savings accounts and other types of deposits have traditionally been an important source of the Bank's funds for use in lending and for other general business purposes. In addition to deposit accounts, the Bank derives funds from loan repayments, loan sales, and other borrowings and operations. The availability of funds from loan sales is influenced by general interest rates and other market conditions. Loan repayments are a relatively stable source of funds while deposit inflows and outflows vary widely and are influenced by prevailing interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in deposits or deposit inflows at less than projected levels and may be used on a longer term basis to support expanded lending activities. Deposits. Horizon Bank offers several deposit accounts, including Regular Passbook and Statement Savings Accounts, Personal and Business Checking Accounts, Money Market with and without Check Access and Certificates of Deposit Accounts with maturities ranging from 30 days up to 10 years. Certificates of Deposit account requirements vary according to minimum principal balances, the time period the funds must remain on deposit and the interest rate determined for each term and minimum balance. The following table sets forth certain information concerning the deposits at the Bank. Year Ended March 31, ---------------------------------------------------------- 2001 2000 1999 ------------------ ----------------- ------------------ Weighted Weighted Weighted Average Average Average Average Average Average Type Balance Rate Balance Rate Balance Rate ---- ------- ---- ------- ---- ------- ---- (Dollars in thousands) Savings. . . . . .$ 33,299 2.98% $ 35,503 3.05% $ 37,031 3.09% Checking . . . . . 60,360 1.20 42,267 1.27 49,466 1.17 Money Market . . . 74,696 3.87 86,322 3.72 74,160 3.96 Time Deposits. . . 407,641 6.10 367,458 5.40 355,089 5.60 -------- ---- -------- ---- -------- ---- Total. . . . . .$575,996 5.09% $531,550 4.65% $515,746 4.95% ======== ==== ======== ==== ======== ==== The following table indicates the amount of the Bank's deposits by time remaining until maturity as of March 31, 2001 of $100,000 or more. Certificates Maturity Period of Deposit --------------- ------------ (In thousands) Three months or less. . . . . . $ 26,064 Three through six months. . . . 36,821 Six through twelve months . . . 35,247 Over twelve months. . . . . . . 26,894 -------- Total . . . . . . . . . . . . $125,026 ======== The Bank has a number of different programs designed to attract both short-term and long-term savings of the general public by providing a wide assortment of accounts and rates. The program includes traditional passbook accounts; nonnegotiable time deposits with minimum deposits of $100,000 and terms of 30 days to five years called Jumbo Certificates of Deposit; nonnegotiable, nontransferable time deposits with minimum deposits of $500 and terms from 30 days to five years at fixed rates; 12-month to 10-year variable rate fixed term certificates; Individual 11 Retirement Accounts (IRAs); Qualified Retirement Plans; transaction accounts such as regular checking; MMDAs with and without limited check access. The Bank's practice on early withdrawal penalties is applicable only to time deposits. Management believes that in periods of rising interest rates this practice will discourage depositors from making premature withdrawals for the purpose of reinvesting in higher rate time deposits. The minimum amount required to open a time deposit varies from $500 to $100,000, depending on the type of time deposit. Pricing of rates on time deposits with maturities from 30 days to 10 years are determined periodically by the Bank, based upon competitive rates and local market rates, national money market rates, and yields on assets of the same maturity. The Bank's personal MMDA currently has a $1,000 minimum deposit and has a tiered pricing program, with interest rates that vary by account dollar balance -- $2,500, $10,000, $25,000, $50,000 and higher. The Bank's Business MMDA has tiers of $2,500, $10,000, $50,000, $100,000 and higher, with a $1,000 minimum deposit. These accounts have no maturity requirements, no regulatory interest rate ceilings, and limited check writing privileges. The interest rates on these accounts are adjusted by the Bank periodically, based on money market conditions. The Bank currently has a $10,000 minimum deposit (MMK) money market and has a tiered pricing program, with interest rates that vary by account dollar balance -- $10,000, $25,000, $50,000 and higher. The Bank also offers a $25,000 minimum deposit (ULT PLUS) money market and has a tiered pricing program, with interest rates that vary by account dollar balance -- $25,000, $50,000, $100,000 and higher. These accounts have no maturity requirements, no regulatory interest rate ceiling, and no check writing privileges. The interest rates on the account are adjusted by the Bank periodically or as dictated by money market conditions. The large variety of deposit accounts offered by the Bank has increased the Bank's ability to retain deposits and has allowed it to be competitive in obtaining new funds, although the threat of disintermediation (the flow of funds away from the Bank into direct investment vehicles, such as common stocks and mutual funds) still exists. The ability of the Bank to attract and retain deposits and the Bank's cost of funds have been, and will continue to be, significantly affected by capital and money market conditions. Horizon Bank attempts to control the flow of deposits by pricing its accounts to remain competitive with other financial institutions in its market area but does not necessarily seek to match the highest rates paid by competing institutions. The senior officers of the Bank meet periodically to determine the interest rates which the Bank will offer to the general public. Such officers consider the amount of funds needed by the Bank on both a short-term and long-term basis, the rates being offered by the Bank's competitors, alternative sources of funds and the projected level of interest rates in the future. The Bank's deposits are obtained primarily from residents of Northwest Washington. Horizon Bank attracts deposits by offering a wide variety of services and convenient branch locations and service hours. The Bank has not solicited brokered deposits and has no present intention to attract such deposits in the future. For further information concerning the Bank's savings deposits, reference is made to Note 10 of the Notes to the Consolidated Financial Statements contained in the Corporation's Proxy Statement. Borrowings. In December 1998, the Bank joined the Federal Home Loan Bank of Seattle providing access to a variety of wholesale funding options. Also, the Bank's security portfolio provides additional borrowing capacity in the reverse repurchase markets. At March 31, 2001, the Bank had $22.9 million in borrowings, compared to $39.9 million at March 31, 2000 and $22.7 million in borrowings during the year ended 1999. Access to these wholesale borrowings allows management to meet cyclical funding needs, and assists in interest rate risk management efforts. 12 The following tables set forth information regarding borrowings by the Bank at the end of and during the periods indicated. The tables includes both short-term and long-term borrowings unless noted otherwise. For the Year Ended March 31, ------------------------------ 2001 2000 1999 ---- ---- ---- (Dollars in thousands) Maximum amount of borrowings outstanding at any month end. . . . . . . . . . . . . . . $55,865 $39,853 $22,718 Approximate average borrowings outstanding . . 44,817 29,192 14,633 Approximate weighted average rate paid . . . . 6.73 5.64 4.92 At March 31, ------------------------------ 2001 2000 1999 ---- ---- ---- (Dollars in thousands) Balance outstanding at end of period . . . . . $22,938 $39,853 $22,718 Weighted average rate paid . . . . . . . . . . 6.73 5.64 4.92 Competition ----------- The Bank faces strong competition in its market area in originating loans and attracting deposits. Competition in originating loans is primarily from other thrift institutions, commercial banks, mortgage companies, credit unions and consumer finance companies. The Bank competes for loan originations primarily through interest rates and loan fees it charges and through the efficiency and quality of services it provides borrowers. Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions and current interest rate levels. In attracting deposits, the Bank competes primarily with other thrift institutions, commercial banks and credit unions. The Bank competes for customer deposits principally on the basis of convenience and quality of its banking services and the investment opportunities that satisfy the requirements of investors with respect to rate of return, liquidity, risk and other factors. The primary factors in competing for deposits are interest rates and the convenience of office locations. In light of the deregulation of interest rate controls on deposits, the Bank has faced increasing competition for deposits from commercial banks, other thrift institutions and non-regulated financial intermediaries. Personnel --------- At March 31, 2001, Horizon Bank employed 191 full-time and 25 part-time employees. Horizon Bank employees are not represented by any collective bargaining agreement. Management of Horizon Bank considers its relations with its employees to be good. REGULATION AND SUPERVISION The Bank -------- General. As a state-chartered, federally insured bank, Horizon Bank is subject to extensive federal and state regulation. Lending activities and other investments must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. Horizon Bank is regularly examined by the FDIC and the Washington Department of Financial Institutions, Division of Banks, and files periodic reports concerning the Bank's 13 activities and financial condition with its regulators. The Bank's relationship with depositors and borrowers also is regulated to a great extent by both federal and state law, especially in such matters as the ownership of savings accounts and the form and content of mortgage documents. The law and regulations of the State of Washington pertaining to banks and other corporations apply to the Bank. Among other things, those laws and regulations govern the Bank's investments and borrowings, loans, payment of interest and dividends, and establishment and relocation of branch offices. Deposit Insurance. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of depository institutions. The FDIC administers two separate deposit insurance funds: the BIF and the SAIF. The BIF is a deposit insurance fund for commercial banks and some state-chartered savings banks. The SAIF is a deposit insurance fund for most savings associations. The Bank is insured under the BIF fund. As an insurer of the Bank's deposits, the FDIC has examination, supervisory and enforcement authority over the Bank. The FDIC has established a risk-based system for setting deposit insurance assessments. Under the risk-based assessment system, an institution's insurance assessment varies according to the level of capital the institution holds, the balance of insured deposits during the preceding two quarters, and the degree to which it is the subject of supervisory concern. In addition, regardless of the potential risk to the insurance fund, federal law requires the ratio of reserves to insured deposits at $1.25 per $100. Both funds currently meet this reserve ratio. Since 1997, the assessment rate for both SAIF and BIF deposits has ranged from zero to 0.27% of covered deposits. As a well capitalized bank, Horizon Bank qualified for the lowest rate on its deposits for fiscal 2001. In addition to deposit insurance assessments, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation ("FICO") to service FICO debt incurred in the 1980's to help fund the thrift industry cleanup. The FICO assessment rate is adjusted quarterly. Prior to 2000, the FICO assessment rate for BIF-insured deposits was one- fifth the rate applicable to deposits insured by the SAIF. Beginning in 2000, SAIF- and BIF-insured deposits were assessed at the same rate by FICO. As a result, BIF FICO assessments will be higher than in previous periods while SAIF FICO assessments will be lower. For the first quarter of 2001, the annualized rate was 1.96 cents per $100 of insured deposits. Because the Bank is insured under the BIF fund, the FICO assessments have increased since 2000 as compared to prior years. Any insured bank which does not operate in accordance with or conform to FDIC regulations, policies and directives may be sanctioned for non-compliance. For example, proceedings may be instituted against any insured bank or any director, officer, or employee of such bank who engages in unsafe and unsound practices, including the violation of applicable laws and regulations. The FDIC has the authority to terminate deposit insurance pursuant to procedures established for that purpose. Management is not aware of any existing circumstances that could result in termination of the deposit insurance for the Bank. Capital Requirements. FDIC regulations recognize two types or tiers of capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1 capital generally includes common stockholders' equity and noncumulative perpetual preferred stock, less most intangible assets. Tier 2 capital, which is limited to 100 percent of Tier 1 capital, includes such items as qualifying general loan loss reserves, cumulative perpetual preferred stock, mandatory convertible debt, term subordinated debt and limited life preferred stock; however, the amount of term subordinated debt and intermediate term preferred stock (original maturity of at least five years but less than 20 years) that may be included in Tier 2 capital is limited to 50 percent of Tier 1 capital. The FDIC currently measures an institution's capital using a leverage limit together with certain risk-based ratios. The FDIC's minimum leverage capital requirement specifies a minimum ratio of Tier 1 capital to average total assets. Most banks are required to maintain a minimum leverage ratio of at least 4% to 5% of total assets. The FDIC retains the right to require a particular institution to maintain a higher capital level based on an institution's particular risk profile. The Bank calculated its leverage ratio to be 12.88% as of March 31, 2001. 14 FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets. Assets are placed in one of four categories and given a percentage weight -- 0%, 20%, 50% or 100% -- based on the relative risk of that category. In addition, certain off-balance-sheet items are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the four categories. Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to risk-weighted assets must be at least 4%. The Bank has calculated its total risk-based ratio to be 21.21% as of March 31, 2001, and its Tier 1 risk-based capital ratio to be 19.94%. In evaluating the adequacy of a bank's capital, the FDIC may also consider other factors that may affect a bank's financial condition. Such factors may include interest rate risk exposure, liquidity, funding and market risks, the quality and level of earnings, concentration of credit risk, risks arising from nontraditional activities, loan and investment quality, the effectiveness of loan and investment policies, and management's ability to monitor and control financial operating risks. Horizon Bank's management believes that, under the current regulations, the Bank will continue to meet its minimum capital requirements in the foreseeable future. However, events beyond the control of the Bank, such as a downturn in the economy in areas where the Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of the Bank to meet its capital requirements. Federal Deposit Insurance Improvement Act ("FDICIA"). Horizon Bank has surpassed the $500 million asset threshold, and as such, is required to be compliant with the FDICIA originally enacted in 1991 and with enhanced provisions adopted in 1993. In general, the Act required the Bank to conduct an annual independent audit of their financial statements, appoint an independent audit committee of outside directors, report on and assess management's responsibilities for preparing financial statements, and establish an internal control structure. An independent accountant must attest to and report on the assertions in management's reports concerning these internal controls with the desired outcome of efficient and effective operations; the safeguarding of assets; reliable financial reporting and compliance with applicable laws and regulations. The FDIC as the primary regulator of the Bank has outlined, in general, the requirements for compliance with FDICIA, but does not provide specific guidance on the internal control structure, documentation, or procedures to test the Bank's effectiveness. It is up to each bank to establish, document and design procedures to evaluate and test the internal control structure over financial reporting and compliance with designated laws and regulations that minimally include loans to insiders and dividend restrictions. In brief, to ensure compliance, the Bank has established and coordinated a management team that identifies and documents existing controls with consideration given to the Bank's control environment, risk assessment, control activities, information and communication systems, and monitoring activities. In addition, management establishes internal control procedures, develops and selects criteria for evaluation, tests the effectiveness of controls, and ensures that proper written documentation is in place. Under FDICIA, the Audit Committee has several responsibilities that include but are not limited to overseeing the internal audit function; conducting periodic meetings with management, the independent public accountant, and the internal auditors; review of significant accounting policies, and audit conclusions regarding significant accounting estimates; review of the assessments prepared by management and independent auditor on the adequacy of internal controls and the resolution of identified material weaknesses and reportable conditions in internal controls; and the review of compliance with laws and regulations. Federal Home Loan Bank System. The FHLB of Seattle serves as a reserve or central bank for the member institutions within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLBs. It makes loans (i.e., advances) to members in accordance with policies and procedures established by the Federal Housing Finance Board and the Board of Directors of the FHLB of Seattle. As a member, the Bank is required to purchase and hold stock in the FHLB of Seattle in an amount equal to the greater of 1% of their 15 aggregate unpaid home loan balances at the beginning of the year or an amount equal to 5% of FHLB advances outstanding. As of March 31, 2001, Horizon Bank held stock in the FHLB of Seattle in the amount of $5,832,000. See "Business "Savings Activities and Other Sources of Funds -- Borrowings." Federal Reserve System. The Federal Reserve Board requires (under "Regulation D") that all depository institutions, including savings banks, maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest bearing deposits with the regional Federal Reserve Bank. NOW accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a savings bank. Under Regulation D, a bank must maintain reserves against net transaction accounts, in the amount of 3% on amounts of $37.3 million or less, plus10% on amounts in excess of $37.3 million. In addition, a bank may designate and exempt $5.0 million of certain reservable liabilities from these reserve requirements. The amounts and percentages are subject to adjustment by the Federal Reserve. The reserve requirement on non-personal time deposits with original maturities of less than 1.5 years is 0%. As of March 31, 2001, the Bank's deposit with the Federal Reserve Bank and vault cash exceeded the Bank's reserve requirements. Prompt Corrective Action. Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution's category depends upon where its capital levels are in relation to relevant capital measure, which include a risk-based capital measure, a leverage ratio capital measure, and certain other factors. The federal banking agencies have adopted regulations that implement this statutory framework. Under these regulations, an institution is treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted assets is 6% or more, its ratio of core capital to adjusted total assets is 5% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8%, a Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of not less than 4%. Any institution which is neither well capitalized nor adequately capitalized will be considered undercapitalized. Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by the Bank to comply with applicable capital requirements would, if unremedied, result in restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements. The Corporation --------------- General. The Corporation, as the sole shareholder of the Bank, is a bank holding company and is registered as such with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and the regulations of the Federal Reserve. As a bank holding company, the Corporation is required to file with the Federal Reserve annual reports and such additional information as the Federal Reserve may require and will be subject to regular examinations by the Federal Reserve. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. New Legislation. On November 12, 1999, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 was signed into law. The Act contains federal legislation intended to modernize the financial services industry 16 by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. Generally, the Act: (a) repeals the historical restrictions and eliminates many federal and state law barriers to affiliations among banks, securities firms, insurance companies and other financial service providers; (b) provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; (c) broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies and their financial subsidiaries; (d) provides an enhanced framework for protecting the privacy of consumer information; (e) adopts a number of provisions related to the capitalization, membership, corporate governance and other measures designed to modernize the FHLB system; (f) modifies the laws governing the implementation of the Community Reinvestment Act; and (g) addresses a variety of other legal and regulatory issues affecting day-to-day operations and long-term activities of financial institutions. Acquisitions. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (1) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the Federal Reserve includes, among other things, operating a savings institution, mortgage company, finance company, credit card company or factoring company, performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers' checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers. Dividends. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company's capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve pursuant to the FDIC Improvement Act, the Federal Reserve may prohibit a bank holding company from paying any dividends if the holding company's bank subsidiary is classified as "undercapitalized." 17 Bank holding companies, except for certain "well-capitalized" bank holding companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve. Capital Requirements. The Federal Reserve has established capital requirements for bank holding companies that generally parallel the capital requirements for national banks under the Office of the Comptroller of the Currency's regulations. Under the Federal Reserve Board's capital guidelines, at March 31, 2001, the Corporation's levels of consolidated regulatory capital exceed the Federal Reserve's minimum requirements, as follows: Amount Percent ------ ------- (Dollars in Thousands) Tier 1 Capital $93,246 19.97% Minimum Tier 1 (leverage) requirement 18,678 4.00 ------- ----- Excess $74,568 15.97% ======= ===== Risk-based capital $99,189 21.24% Minimum risk-based capital requirement 37,356 8.00 ------- ----- Excess $61,833 13.24% ======= ===== Stock Repurchases. Bank holding companies, except for certain "well- capitalized" and highly rated bank holding companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve. At its January 19, 2000 meeting, the Board of Directors authorized the repurchase of up to 10% (approximately 992,450 shares) of the Corporation's outstanding common stock over a 24 month period. At its October 24, 2000 meeting, the Board of Directors authorized a new repurchase plan for up to 10% (approximately 897,000 shares) of the Corporation's outstanding common stock over a 24 month period. Shares may be purchased from time to time depending upon market conditions, price and other management considerations. During the fiscal year ended March 31, 2001, the Corporation repurchased 683,790 shares of its Common Stock, compared to the repurchase of 420,900 shares of its Common Stock during the prior year. As of June 26, 2001, the Corporation has repurchased a total of 22,200 shares under the current plan. TAXATION Federal Taxation ---------------- General. The Corporation and the Bank report their consolidated income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Corporation. Reference is made to Note 13 of the Notes to the Consolidated Financial 18 Statements contained in the Corporation's Proxy Statement for additional information concerning the income taxes payable by the Bank. Tax Bad Debt Reserves. Historically, savings institutions such as the Bank, which met certain definitional tests primarily related to their assets and the nature of their businesses, were permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions may, within specified formula limits, have been deducted in arriving at the Bank's taxable income. For purposes of computing the deductible addition to its bad debt reserve, the Bank's loans are separated into "qualifying real property loans" (i.e., generally those loans secured by interests in residential real property) and all other loans ("non-qualifying loans"). The following formulas were used to compute the bad debt deduction with respect to qualifying real property loans: (i) actual loss experience or (ii) a percentage equal to 8% of taxable income. The deduction with respect to non-qualifying loans was computed under the experience method. Reasonable additions to the reserve for losses on non-qualifying loans were based upon actual loss experience and would reduce the current year's addition to the reserve for losses on qualifying real property loans, unless that addition was also determined under the experience method. The sum of the additions to each reserve for each year was the Bank's annual bad debt deduction. The provisions repealing the current thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminate the 8% of taxable income method for deducting additions to the tax bad debt reserves for all financial institutions for tax years beginning after December 31, 1995. These rules also require that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Bank has previously recorded a deferred tax liability equal to the bad debt recapture and as such the new rules will have no effect on the net income or federal income tax expense. For taxable years beginning after December 31, 1995, the Bank's bad debt deduction will be determined under the experience method using a formula based on actual bad debt experience over a period of years or, if the Bank is a "large" association (assets in excess of $500 million) on the basis of net charge-offs during the taxable year. The new rules allow an institution to suspend bad debt reserve recapture for the 1996 and 1997 tax years if the institution's lending activity for those years is equal to or greater than the institution's average mortgage lending activity for the six taxable years preceding 1996 adjusted for inflation. For this purpose, only home purchase or home improvement loans are included and the institution can elect to have the tax years with the highest and lowest lending activity removed from the average calculation. If an institution is permitted to postpone the reserve recapture, it must begin its six year recapture no later than the 1998 tax year. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders. Horizon Bank met the residential loan requirement for the taxable year ending March 31, 2001. Distributions. If a stock institution distributes amounts to stockholders and the distribution is treated as being from its accumulated bad debt reserves, the distribution will cause the institution to have additional taxable income. A distribution to stockholder is deemed to have been made from accumulated bad debt reserves to the extent that (i) the reserves exceed the amount that would have been accumulated on the basis of actual loss experience, and (ii) the distribution is a "non-dividend distribution." A distribution in respect of stock is a non-dividend distribution to the extent that, for federal income tax purposes, (i) it is redemption of shares, (ii) it is pursuant to a liquidation or partial liquidation of the institution, or (iii) in the case of current distribution, together with all other such distributions during the taxable year, it exceeds the institution's current and post-1951 accumulated earnings and profits. The amount of additional taxable income created by a non-dividend distribution is an amount that, when reduced by tax attributable to it, is equal to the amount of the distribution. Minimum Tax. In addition to regular corporate income tax, corporations are subject to an alternative minimum tax which generally is equal to 20% of alternative minimum taxable income (taxable income, increased by tax preference items and adjusted for certain regular tax items). The preference items which are generally applicable include an amount equal to 75% of the amount by which a financial institution's adjusted current earnings (generally 19 alternative minimum taxable income computed without regard to this preference and prior to reduction for net operating losses) exceeds its alternative minimum taxable income without regard to this preference and the excess of the institution's bad debt deduction over the amount deductible under the experience method, as discussed below. Alternative minimum tax paid can be credited against regular tax due in later years. Audits. The Bank has not been audited by the IRS during the past five years. Washington Taxation ------------------- The Bank is subject to a business and occupation tax which is imposed under Washington law at the rate of 1.50% of gross receipts; however, interest received on loans secured by mortgages or deeds of trust on residential properties is not subject to such tax. The Bank's business and occupation tax returns were audited in November 1995. Item 2. Properties ------------------- The following table sets forth the location of the Bank's offices, as well as certain information relating to these offices. Net Book Year Value as of Square Leased/ Opened March 31, 2001 Feet Owned ------ -------------- ------ ------- Bellingham Main Office . . . . 1971 $1,125,184 19,179 Owned 1500 Cornwall Avenue Bellingham, WA 98225 Bellingham/Meridian. . . . . . 1987 761,191 4,650 Owned 4110 Meridian Bellingham, WA 98226 Ferndale Office. . . . . . . . 1976 368,160 3,692 Owned Third and Main Ferndale, WA 98248 Lynden Office. . . . . . . . . 1981 432,827 3,702 Owned Third and Grover Lynden, WA 98264 Blaine Office. . . . . . . . . 1976 538,039 3,610 Owned Fourth & "H" Streets Blaine, WA 98230 Mount Vernon Office. . . . . . 1976 278,092 3,275 Owned 1503 Riverside Dr. Mount Vernon, WA 98273 Anacortes Office . . . . . . . 1987 808,666 3,650 Owned 1218 Commercial Avenue Anacortes, WA 98221 (table continued on following page) 20 Net Book Year Value as of Square Leased/ Opened March 31, 2001 Feet Owned ------ -------------- ------ ------- Snohomish Office . . . . . . . 1987 $172,923 1,388 Owned 620 2nd Street Snohomish, WA 98290 Everett Office . . . . . . . . 1991 49,951 1,972 Leased 909 S.E. Everett Mall Way #E-500 Everett, WA 98208 Burlington Office. . . . . . . 1994 1,128,714 3,980 Owned 1020 S. Burlington Blvd Burlington, WA 98232 Edmonds Office . . . . . . . . 1994 2,266,286 15,265 Owned 130 Fifth Avenue South Edmonds, WA 98020 Murphy's Corner Office . . . . 2000 1,834,461 3,720 Owned 12830 Bothell Everett Hwy. Everett, WA 98208 Barkley. . . . . . . . . . . . 1999 3,432,606 14,691 Owned 2122 Barkley Blvd. Bellingham, WA 98228 Holly Street Office. . . . . . 1999 491,925 4,000 Owned 211 E. Holly Street Bellingham, WA 98227 Fountain Office (1). . . . . . 1999 137,844 4,648 Leased 2625 Meridian Street Bellingham, WA 98228 Alabama Office . . . . . . . . 1999 751,913 4,500 Owned 802 Alabama Street Bellingham, WA 98228 Marysville (land only) . . . . -- 635,737 -- Owned ---------------- 1. Fountain Office closed on July 14, 2000. At March 31, 2001, the aggregate book value of the Corporation's premises and equipment was $15,214,519. Item 3. Legal Proceedings -------------------------- Neither the Corporation nor the Bank is engaged in any legal proceedings of a material nature at the present time. From time to time it is a party to legal proceedings wherein it enforces its security interest in loans made by it. 21 Item 4. Submission of Matters to a Vote of Security-Holders ------------------------------------------------------------ Not applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ------------------------------------------------------------------------------ Horizon Financial Corp.'s common stock is traded on The Nasdaq Stock Market under the symbol HRZB. The common stock began trading on the Nasdaq Stock Market at the time of Horizon's conversion to stock form in August 1986. The following table presents the high and low prices as reported by the Nasdaq Stock Market and dividends paid for the last two fiscal years. These prices represent quotations by the dealers and do not necessarily represent actual transactions, and do not include retail markups, markdowns or commissions. The Corporation has approximately 4,274 stockholders. 2001 Fiscal Year Quarter High Low Dividend ------- ---- --- -------- Fourth $10.924 $8.913 $0.104 Third 10.381 7.826 0.104 Second 9.565 7.554 0.104 First 8.804 7.310 0.104 2000 Fiscal Year Quarter High Low Dividend ------- ---- --- -------- Fourth $9.620 $ 7.773 $0.104 Third 10.761 7.826 0.104 Second 12.174 9.348 0.104 First 12.174 10.217 0.096 Dividend Policy --------------- Horizon Financial Corp. historically has paid cash dividends on its common stock. The Corporation must adhere to certain regulatory requirements governing the distribution of dividends, and there can be no assurance that the Corporation will continue to declare cash dividends in the future. Item 6. Selected Financial Data -------------------------------- The following table sets forth certain information concerning the financial position of the Bank at and for the dates indicated. March 31, ------------------------------------------------ 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- (In thousands) Financial Condition Data: Total Assets . . . . . . $729,736 $713,914 $668,116 $605,613 $568,565 Loans Outstanding. . . . 597,382 589,584 533,649 478,661 439,274 Cash and Investment Securities. . . . . . . 106,117 99,375 115,194 112,172 114,656 Deposits . . . . . . . . 595,914 564,327 537,390 501,293 472,261 Borrowings . . . . . . . 22,938 39,853 22,718 1,180 600 Stockholders' Equity . . 97,909 95,935 96,441 86,675 83,534 22 Year Ended March 31, ------------------------------------------------- 2001 2000 1999(1) 1998(1) 1997(1) ---- ---- ---- ---- ------- (In thousands) Operating Data: Interest Income. . . $55,837 $49,947 $48,119 $45,745 $42,774 Interest Expense . . (32,239) (26,257) (25,267) (23,991) (22,372) Net Interest Income. 23,598 23,690 22,852 21,754 20,402 Other Income . . . . 2,951 2,851 3,175 2,267 1,922 Non-interest Expense . . . . . . (13,756) (13,243) (11,357) (9,934) (9,595) Provision for Loan Losses. . . . . . . (320) (437) (484) (521) (284) ------- ------- ------- ------- ------- Income (Loss) Before Taxes . . . . . . . 12,473 12,861 14,186 13,566 12,445 Federal Income Tax . (4,202) (4,180) (4,844) (4,598) (4,193) ------- ------- ------- ------- ------- Net Income . . . . . $ 8,271 $ 8,681 $ 9,342 $ 8,968 $ 8,252 ======= ======= ======= ======= ======= Per Common Share:(3) Fully-diluted earnings . . . . . $ 0.90 $0.88 $0.94 $0.91 $0.84 Dividends . . . . . 0.42 0.41 0.38(4) 0.72(2)(4) 0.65(2)(4) Equity. . . . . . . 11.05 10.08 9.88 9.22 8.68 Weighted average shares outstanding . . 9,193,661 9,875,674 9,919,413 9,860,291 9,840,603 --------------- (1) Prior year numbers are restated to reflect the merger of Bellingham Bancorporation effective June 19, 1999. (2) Includes a special cash dividend of $0.30 declared November 21, 1996, and special cash dividend of $0.35 declared January 28, 1998. (3) Restated for 15% stock dividend effective May 8, 1997 and a 15% stock dividend declared April 24, 2001. (4) Prior year numbers based on shares outstanding prior to merger for each respective year. Key Operating Ratios: --------------------- The table below sets forth certain performance ratios of the Bank for the periods indicated. These ratios are calculated based on month end balances. At and for the Year Ended March 31, ---------------------- 2001 2000 1999 ---- ---- ---- Return on average assets (net income divided by average total assets). . . . . . . . . . . . . 1.15% 1.26% 1.47% Return on average equity (net income divided by average equity). . . . . . . . . . . . . . . . 8.53 9.02 10.03 Dividend payout ratio (dividends declared per share divided by fully-diluted earnings per share). . . . . . . . . . . . . . . . . . . . 46.38 46.53 44.44 Equity to assets ratio (average equity divided by average total assets). . . . . . . . . . . . . 13.43 13.92 14.61 Interest rate spread (difference between average yield on interest-earning assets and average cost of interest bearing liabilities) . . . . . . 2.89 3.14 3.20 Net yield on earning assets (net interest income as a percentage of average interest earning assets) . . . . . . . . . . . . . . . . . 3.42 3.65 3.78 23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ------------------------------------------------------------------------ Information required by this item is incorporated herein by reference to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Corporation's Proxy Statement. Item 7A. Quantitative and Qualitative Disclosures About Market Risk ---------- --------------------------------------------------------- Information required by this item is incorporated herein by reference to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quantitative and Qualitative Disclosures About Market Risk" contained in the Corporation's Proxy Statement. Item 8. Financial Statements and Supplementary Data ---------------------------------------------------- The financial statements contained in the Proxy Statement which are listed under Item 14 herein, are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ------------------------------------------------------------------------ Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant ------------------------------------------------------------ The information contained under the section captioned "Proposal I -- Election of Directors" and "Compliance with Section 16(a) of the Exchange Act" in the Registrant's Proxy Statement is incorporated herein by reference. The executive officers of the Corporation and the Bank are as follows: Name Age Position ---- --- -------- George W. Gust 71 Chairman of the Board of the Corporation V. Lawrence Evans 54 Chief Executive Officer and President of the Corporation; and Chairman of the Board, Chief Executive Officer and President of the Bank Richard P. Jacobson 38 Vice President and Secretary of the Corporation and Executive Vice President and Secretary of the Bank A.R. (Gus) Ayala 51 Senior Vice President of the Bank Richard L. (Dick) Hovde 54 Senior Vice President of the Bank Karla C. Lewis 54 Senior Vice President of the Bank Judy E. Boxx 59 Vice President of the Bank Paul C. Eickmeyer 57 Vice President of the Bank (table continues on following page) 24 Name Age Position ---- --- -------- William (Bill) Frank 58 Vice President of the Bank Nancy A. Graham 39 Vice President of the Bank Christine C. Hagen 53 Vice President of the Bank Dale A. E. Holt 36 Vice President of the Bank Kelli J. Holz 32 Vice President of the Corporation and the Bank Jeffrey H. Jansen 43 Vice President of the Bank Karen A. LePage 60 Vice President of the Corporation and the Bank Sandra R. Mathewson 41 Vice President of the Bank Merwyn G. Murk 62 Vice President of the Bank Elizabeth (Beth) E. Sherry 49 Vice President of the Bank John K. Stewart 48 Vice President of the Bank Shawn M. Thelen 49 Vice President of the Bank Carla J. Williams 55 Vice President of the Bank Donald A. Wolf 52 Vice President of the Bank The following is a description of the principal occupation and employment of the executive officers of the Corporation and the Bank during at least the past five years: GEORGE W. GUST joined the Bank in 1975 and has served as the Chairman of the Board of Directors of the Corporation since its formation in 1995. Mr. Gust also served as Chairman of the Bank from August 1984 until July 1997. Effective May 14, 1990, Mr. Gust resigned as President. V. LAWRENCE EVANS joined the Bank in 1972 and served as the Bank's Executive Vice President/Finance from 1983 to May 14, 1990 at which time, Mr. Evans was appointed President of the Bank. On March 26, 1991, Mr. Evans was appointed Chief Executive Officer of the Bank and in July 1997, Mr. Evans was appointed Chairman of the Board of the Bank. RICHARD P. JACOBSON has worked for the Bank for 13 years and was appointed Vice President/Finance and Corporate Secretary in December 1994. In March 1998, Mr. Jacobson was appointed Senior Vice President of the Bank. In March 2000, he was appointed Executive Vice President of the Bank. A.R. (GUS) AYALA joined the Bank pursuant to the merger of Bellingham Bancorporation effective June 19, 1999. He served as Chief Financial Officer for the Bank of Bellingham from September 1997 until completion of the merger. Previously, he was Senior Vice President with a commercial bank in Lompoc, California. He is currently Senior Vice President, and Operations Manager for the Bank. 25 RICHARD L. (DICK) HOVDE joined the Bank pursuant to the merger of Bellingham Bancorporation effective June 19, 1999. He joined the Bank of Bellingham in July 1992 and served as its Senior Vice President and Senior Loan Officer until completion of the merger. He is currently Senior Vice President, Senior Commercial Lender of Horizon Bank. KARLA C. LEWIS joined Horizon Bank in 1973. From 1983 to December 1994, she was the Manager of the Loan Servicing Department. She was appointed Vice President in June 1987 and is currently the Bank's Chief Lending Officer. In March 1998, she was appointed Senior Vice President of the Bank. JUDY E. BOXX joined Horizon Bank in 1984. She has worked in the Loan Servicing/Collection Department since 1986. She was appointed Vice President and Manager of the Loan Servicing Department in December of 1994. PAUL C. EICKMEYER joined the Bank pursuant to the merger of Bellingham Bancorporation effective June 19, 1999. He served as Vice President, Commercial Loan Officer for the Bank of Bellingham from October 1994 until completion of the merger, and is currently a commercial loan officer for the Bank. WILLIAM (BILL) FRANK joined the Bank in October 1999. He is currently a Vice President, Commercial Loan Officer for the Bank. He was previously a commercial loan officer for a local commercial bank. NANCY A. GRAHAM joined the Bank in February 1997. She was appointed Vice President in March 2001 and is currently the Secondary Marketing Analyst for the Bank. CHRISTINE C. HAGEN joined the Bank pursuant to the merger of Bellingham Bancorporation effective June 19, 1999. She served as Vice President, Operations for the Bank of Bellingham from July 1992 until completion of the merger. She is currently Vice President, Human Resource Manager for the Bank. DALE A. E. HOLT joined the Bank pursuant to the merger of Bellingham Bancorporation effective June 19, 1999. He is currently Vice President, commercial loan officer for the Bank. KELLI J. HOLZ, CPA, joined the Bank in 1988. From 1991 to 1998 she was the Manager of the Internal Audit Department. In March 1998, she was appointed Vice President and is currently acting as Controller of the Bank. JEFFREY H. JANSEN joined Horizon Bank in 1985 as the manager of the Bank's Lynden Office. He was appointed Vice President in December of 1994. KAREN A. LEPAGE has been employed by the Bank since 1958. In December 1985, she was promoted to Vice President. SANDRA R. MATHEWSON joined the Bank in 1986. She was appointed Vice President in March 1998 and is currently the Employee Development Manager for the Bank. MERWYN G. MURK joined the Bank in 1969 and has been manager of the Savings Department since 1972. He was appointed Vice President in October 1977. ELIZABETH (BETH) E. SHERRY joined the Bank in 1996. She was appointed Vice President in December 1997 and is currently the Bank's Retail Sales Manager. JOHN K. STEWART joined the Bank pursuant to the merger of Bellingham Bancorporation effective June 19, 1999. He is currently a Vice President, Commercial Loan Officer for the Bank. Previously, he was Vice President of International Banking with a regional commercial bank. 26 SHAWN M. THELEN joined the Bank in February 2001 and is a commercial loan officer. She was previously a Senior Vice President Business Banking for a national bank. CARLA J. WILLIAMS joined the Bank in 1988. She was appointed Vice President in March 1998 and is currently the Bank's Loan Production Manager. DONALD A. WOLF joined Horizon Bank in 1973. Mr. Wolf was appointed Vice President in June 1987, and currently is the Bank's security officer and manager of the administrative services department. Item 11. Executive Compensation -------------------------------- Information regarding management compensation and transactions with management and others is incorporated by reference to the section captioned "Proposal I - Election of Directors" in the Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management ------------------------------------------------------------------------ (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement. (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement. (c) Changes in Control The Corporation is not aware of any arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the Corporation. Item 13. Certain Relationships and Related Transactions -------------------------------------------------------- The information contained under the sections captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement is incorporated herein by reference. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K -------------------------------------------------------------------------- (a) (1) Financial Statements. -------------------- Independent Auditor's Report* Consolidated Statement of Financial Position, March 31, 2001 and 2000* Consolidated Statement of Income for the years ended March 31, 2001, 2000 and 1999* Consolidated Statement of Stockholders' Equity for the years ended March 31, 2001, 2000 and 1999* Consolidated Statement of Cash Flows for the years ended March 31, 2001, 2000 and 1999* Notes to Consolidated Financial Statements* ------------------ * Contained in the Corporation's Proxy Statement and incorporated herein by reference. 27 (2) All required financial statement schedules are included in the Notes to Consolidated Financial Statements contained in the Corporation's Proxy Statement. (b) No current reports on Form 8-K were filed by the Corporation during the three months ended March 31, 2001. (c) Exhibits -------- (3.1) Articles of Incorporation of Horizon Financial, Corp. (incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated October 13, 1995) (3.2) Bylaws of Horizon Financial Corp. (incorporated by reference to Exhibit 3.2 to the Registrant's Current Report on Form 8-K dated October 13, 1995) (10.1) Amended and Restated Employment Agreement with V. Lawrence Evans (incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended March 31, 1996) (10.2) Deferred Compensation Plan (incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended March 31, 1996) (10.3) 1986 Stock Option and Incentive Plan (incorporated by reference to Exhibit 99.1 to the Registrant's Registration Statement on Form S-8 (File No. 33-99780)) (10.4) 1995 Stock Option Plan (incorporated by reference to Exhibit 99.2 to the Registrant's Registration Statement on Form S-8 (File No. 33-99780)) (10.5) Bank of Bellingham 1993 Employee Stock Option Plan (incorporated by reference to Exhibit 99 to the Registrant's Registration Statement on Form S-8 (File No. 33-88571)) (21) Subsidiaries of the Registrant (23) Consent of Auditors 28 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HORIZON FINANCIAL CORP. Date: June 26, 2001 By: /s/ George W. Gust ---------------------------- George W. Gust Chairman of the Board (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/George W. Gust By: /s/Robert C. Diehl ------------------------- ------------------------ George W. Gust Robert C. Diehl Director and Chairman of Director the Board Date: June 26, 2001 Date: June 26, 2001 By: /s/V. Lawrence Evans By: /s/Fred R. Miller ------------------------- ------------------------- V. Lawrence Evans Fred R. Miller Chief Executive Officer Director and President Date: June 26, 2001 Date: June 26, 2001 By: /s/ Richard P. Jacobson By: /s/ James A. Strengholt ------------------------- ------------------------- Richard P. Jacobson James A. Strengholt Principal Financial Officer Director Date: June 26, 2001 Date: June 26, 2001 By: /s/Kelli J. Holz By: /s/Frank G. Uhrig ------------------------- ------------------------- Kelli J. Holz Frank G. Uhrig Principal Accounting Officer Director Date: June 26, 2001 Date: June 26, 2001 29 By: /s/ Richard D. Haggen By: /s/Gary E. Goodman ------------------------- ------------------------- Richard D. Haggen Gary E. Goodman Director Director Date: June 26, 2001 Date: June 26, 2001 By: /s/ Robert C. Tauscher ------------------------- Robert C. Tauscher Director Date: June 26, 2001 30 Exhibit 21 Subsidiaries of the Registrant Parent ------ Horizon Financial Corp. Jurisdiction Percentage or State of Subsidiaries (a) of Ownership Incorporation ---------------- ------------ ------------- Horizon Bank 100% Washington Westward Financial Services, Inc. (b) 100% Washington -------------- (a) The operation of the Corporation's wholly owned subsidiaries are included in the Consolidated Financial Statements contained in the Item 8 of this Form 10-K. (b) Wholly-owned subsidiary of Horizon Bank. Exhibit 23 Consent of Auditors CONSENT OF INDEPENDENT ACCOUNTANTS The Board of Directors Horizon Financial Corp. We consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-99780) of Horizon Financial Corp. pertaining to the 1986 Stock Option and Incentive Plan, and the 1995 Stock Option Plan; and the Registration Statement on Form S-8 (No. 333-88571) pertaining to the Bank of Bellingham 1993 Employee Stock Option Plan; of our report dated April 24, 2001, appearing in the 2001 proxy statement of Horizon Financial Corp., which is incorporated by reference in Horizon Financial Corp.'s Annual Report on Form 10-K for the year ended March 31, 2001. /s/Moss-Adams LLP Bellingham, Washington June 26, 2001