-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Im2QvEVAXWBVzdifDHYu4US3ehUU65fxUyKT5xkIaRxoU90d3OFnoe9HDfVzi6aS mRIX+6uY6SvafBu0VJBrxA== 0000939057-98-000117.txt : 19980630 0000939057-98-000117.hdr.sgml : 19980630 ACCESSION NUMBER: 0000939057-98-000117 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980629 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HORIZON FINANCIAL CORP CENTRAL INDEX KEY: 0001002682 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 911695422 STATE OF INCORPORATION: WA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-27062 FILM NUMBER: 98656549 BUSINESS ADDRESS: STREET 1: PO BOX 580 CITY: BELLINGHAM STATE: WA ZIP: 98225 BUSINESS PHONE: 3607333050 MAIL ADDRESS: STREET 1: PO BOX 580 CITY: BELLINGHAM STATE: WA ZIP: 98225 10-K405 1 HORIZON FINANCIAL CORP. FORM 10K 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, 1998 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) Chartered by the State of 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 23, 1998, was $126,359,173 (7,487,951 shares at $16.875 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 Annual Report to Stockholders for the Fiscal Year Ended March 31, 1998 (Parts I and III). 2. Portions of the Registrant's Proxy Statement for the 1998 Annual Meeting of Stockholders. (Part III). PART I Item 1. Business - ----------------- (a) General ------- Horizon Financial Corp. ("Horizon Financial" or the "Corporation") was incorporated in the State of Washington in 1995 for the purpose of becoming a bank holding company for Horizon Bank, a savings bank ("Horizon Bank" or the "Bank"). On July 25, 1995, the stockholders of the Bank approved a plan to reorganize the Bank into the holding company form of ownership. The reorganization was completed on October 13, 1995, on which date the Bank became the wholly-owned subsidiary of the Corporation, and the stockholders of the Bank became stockholders of the Corporation. Prior to completion of the reorganization, the Corporation had no material assets or liabilities and engaged in no business activities. Subsequent to the acquisition of Horizon Bank, the Corporation has engaged in no significant activity other than holding the stock of the Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank. Horizon Bank was incorporated as a Washington state-chartered mutual savings bank in 1979 as a successor to Bellingham First Federal Savings and Loan Association, whose predecessor was originally organized in 1922 as a state-chartered savings and loan association which converted to a federal savings and loan association in 1934. The Bank is a state chartered stock savings bank located in the State of Washington and is subject to regulation by the Washington Department of Financial Institutions, Division of Banks, and the Federal Deposit Insurance Corporation ("FDIC"). The Bank's deposit accounts are insured by the FDIC under the Bank Insurance Fund ("BIF"). The business of the Bank consists primarily of attracting savings deposits from the general public and originating first mortgage loans on residential properties. The Bank also makes first mortgage loans on commercial and multi-family residential properties, and, to a limited extent, loans secured by savings accounts and consumer loans. The Bank also invests in federal government and agency obligations, corporate notes and bonds, municipal bonds, common stock, preferred stock, money market instruments and mortgage-backed obligations. The Bank's principal sources of funds for lending and investment activities are savings deposits, repayment of loans, loan sales and borrowings. The Bank's principal sources of income are interest on loans and loan origination fees, commitment and servicing fees on loans, service charge income on accounts and interest and dividends on investment securities. Its principal expenses are interest paid on deposits, borrowings and general and administrative expenses. The Bank's savings and lending operations are conducted through twelve full-service office facilities located in Whatcom, Skagit and Snohomish counties in Washington State. The Bank's main office is located at 1500 Cornwall Avenue, Bellingham, Washington and its telephone number is (360) 733-3050. See "Item 2. Properties." 2 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, --------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (In thousands) Total Assets.................$547,146 $515,341 $488,968 $457,478 $424,637 Loans Outstanding............ 433,697 399,078 389,651 360,120 340,421 Cash and Investment Securities................. 101,499 104,356 87,662 83,782 71,795 Deposits..................... 450,125 424,811 402,676 377,703 351,506 Borrowings................... -- -- -- -- -- Stockholders' Equity......... 83,895 78,509 79,147 72,685 65,995 Number of Full Service Offices.................... 12 12 12 11 9 Interest Income.............. 40,901 38,710 37,082 33,989 33,619 Interest Expense............. (22,235) (20,832) (20,773) (16,948) (15,227) Net Interest Income.......... 18,666 17,878 16,309 17,041 18,392 Other Income................. 1,691 1,583 1,293 1,220 1,692 Non-interest Expense......... (7,565) (7,461) (6,685) (7,149) (7,446) Provision for Loan Losses.... (355) (200) (110) (132) (368) ------- ------- ------ ------- ------- Income (Loss) Before Taxes... 12,437 11,800 10,807 10,980 12,270 Federal Income Tax........... 4,215 3,997 3,586 3,640 4,262 Gain on Sale of Trust Department............ -- -- -- 181 -- ------- ------- ------ ------- ------- Net Income .................. $ 8,222 $ 7,803 $7,221 $ 7,521 $ 8,008 ======= ======= ====== ======= ======= 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, --------------------- 1998 1997 1996 ---- ---- ---- Return on average assets (net income divided by average total assets)................ 1.55% 1.55% 1.53% Return on average equity (net income divided by average equity)...................... 10.13 9.90 9.51 Dividend payout ratio (dividends declared per share divided by net income per share)...... 74.77 62.50 29.09 Equity to assets ratio (average equity divided by average total assets)................ 15.29 15.70 16.04 Interest rate spread (difference between average yield on interest-earning assets and average cost of interest bearing liabilities)... 2.94 2.98 2.85 Net yield on earning assets (net interest income as a percentage of average interest earning assets)................................. 3.68 3.72 3.61 3 Yields Earned and Rates Paid - ---------------------------- The Bank's pre-tax earnings depend primarily on its net interest income, the difference between the income it receives on its loan portfolio and other investments and its cost of money, consisting primarily of interest paid on savings deposits, and other borrowings. Net interest income is affected by (i) the difference between rates of interest earned on its interest-earning assets and rates paid on its interest-bearing liabilities ("interest rate spread") and (ii) the relative amounts of its interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. Thrift institutions have traditionally used interest rate spreads as a measure of net interest income. Another indicator of an institution's net interest income is its "net yield on interest-earning assets" which is net interest income divided by average interest earning assets. In an effort to make the yields on its loan portfolio and investments more interest rate sensitive, the Bank has implemented a number of measures, which are discussed herein under "-- Lending Activities." 4 The following table presents at the date and for the periods indicated, the total dollar amount of interest income and interest expense, as well as the resulting yields earned and rates paid. At March 31, Year Ended March 31, ------------- -------------------------------------------------------------------- 1998 1998 1997 1996 ------------- --------------------- ---------------------- ----------------------- Average Average Average Average Yield/ Average Yield/ Average Yield/ Average Yield/ Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost ------- ---- ------- -------- ---- ------- -------- ---- ------- -------- ---- Interest-earning assets: Loans receivable..$433,697 8.40% $416,557 $35,008 8.40% $403,056 $33,812 8.39% $375,018 $32,145 8.57% Investment securities....... 41,281 6.40 43,811 2,803 6.40 46,850 2,937 6.27 53,849 3,359 6.24 Mortgage-backed securities........ 45,589 6.55 47,158 3,090 6.55 30,834 1,962 6.36 22,895 1,578 6.89 -------- ---- -------- ------- ---- -------- ------ ---- -------- ------ ---- Total interest- earning assets... 520,567 8.06 507,526 40,901 8.06 480,740 38,711 8.05 451,762 37,082 8.21 Interest-bearing liabilities: Deposits......... 450,125 5.12 439,381 22,235 5.12 410,267 20,832 5.07 386,860 20,773 5.36 -------- ---- -------- ------- ---- -------- ------ ---- -------- ------ ---- Total interest- bearing liabilities...... 450,125 5.12 439,381 22,235 5.12 410,267 20,832 5.07 386,860 20,773 5.36 -------- ---- -------- ------- ---- -------- ------ ---- -------- ------ ---- Net interest income........... $18,666 $17,879 $16,309 ======= ======= ======= Interest rate spread............ 2.94% 2.98% 2.85% ---- ---- ---- Net yield on interest-earning assets............ 3.68% 3.72% 3.61% ---- ---- ---- Ratio of average interest-earning assets to average interest-bearing liabilities....... 115.65% 117.18% 116.78% ====== ====== ====== 5
Rate/Volume Analysis - -------------------- The table below sets forth certain information regarding changes in interest income and interest expense for the Bank for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (change in volume multiplied by old rate); (2) changes in rates (change in rate multiplied by old volume); (3) changes to rate-volume (changes in rate multiplied by the change in volume); and (4) the total changes (the sum of the prior columns). Year Ended March 31, ------------------------------------------------------------------------------------ 1998 vs. 1997 1997 vs. 1996 1996 vs. 1995 -------------------------- -------------------------- -------------------------- Increase (Decrease) Increase (Decrease) Increase (Decrease) Due to Due to Due to -------------------------- -------------------------- -------------------------- Rate/ Rate/ Rate/ Volume Rate Volume Total Volume Rate Volume Total Volume Rate Volume Total ------ ---- ------ ----- ------ ---- ------ ----- ------ ---- ------ ----- Interest income: Interest and fees on loans..........$1,154 $ 41 $ 1 $1,196 $2,388 $(671) $(50) $1,667 $1,898 $ 281 $ 18 $2,197 Investment securities and other interest- bearing securities......... 839 132 23 994 71 (108) (1) (38) 573 282 41 896 ------ ----- ----- ------ ----- ----- ---- ----- ------ ------ ---- ------ Total interest- earning assets.....$1,993 $ 173 $ 24 $2,190 $2,459 $(779) $(51) $1,629 $2,471 $ 563 $ 59 $3,093 ====== ===== ===== ====== ===== ===== ==== ===== ====== ====== ==== ====== Interest expense: Deposit accounts....$1,183 $ 208 $ 12 $1,403 $ 835 $(731) $(45) $ 59 $1,252 $2,398 $176 $3,826 ------ ----- ----- ------ ----- ----- ---- ----- ------ ------ ---- ------ Total interest- bearing liabilities........$1,183 $ 208 $ 12 $1,403 $ 835 $(731) $(45) $ 59 $1,252 $2,398 $176 $3,826 ====== ===== ===== ====== ===== ===== ==== ===== ====== ====== ==== ====== 6
Lending Activities - ------------------ General. The Bank's loan portfolio totaled $433,697,267 at March 31, 1998, representing approximately 79.27% of its total assets. On that date, 80.06% of total outstanding loans consisted of loans secured by mortgages on single family residential properties, 3.71% of the loans consisted of loans secured by two-to- four unit residential properties, 5.11% of total outstanding loans consisted of loans secured by mortgages on over four unit residential properties, and 6.52% of total outstanding loans consisted of 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, Skagit and Shohomish 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 construction loans secured by residential and income producing properties at interest rates subject to periodic adjustment based upon changes in a nationally recognized money market index and (iv) increased emphasis on originating 10 and 15 year amortizing mortgage loans. At March 31, 1998, $190,793,230 (or 43.99%) 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). This amount consists of $11,820,450 in residential ARM loans and $9,336,108 in ARM loans secured by commercial and other real estate with adjustable rates; and $169,636,672 in 15 year or less amortizing mortgage loans. 7 Loan Maturity. The following table sets forth certain information at March 31, 1998 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 After 1 Due After 3 Due After 5 Due During Through 3 Through 5 Through 15 Due Over 15 the Year Ended Years After Years After Years After Years After March 31, March 31, March 31, March 31, March 31, 1999 1998 1998 1998 1998 Total -------------- ----------- ----------- ----------- ----------- ----- (In thousands) Commercial, financial and agricultural............... $1,078 $8,191 $11,312 $28,358 $27,687 $76,626 Real estate construction..... -- -- -- -- 24,884 24,884 Real estate-mortgage, installment and other....... 1,698 5,322 10,612 125,691 188,865 332,188 ------ ------- ------- -------- -------- -------- Total................... $2,776 $13,513 $21,924 $154,049 $241,436 $433,698 ====== ======= ======= ======== ======== ========
The following table sets forth the dollar amount of all loans due one year after March 31, 1998 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....................... $1,058 $20 $1,078 Real estate construction............ -- -- -- Real estate-mortgage, installment and other.......................... 1,696 2 1,698 ------ --- ------ Total.......................... $2,754 $22 $2,776 ====== === ====== 8
Residential Loans. The primary lending activity of the Bank has 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, 1998, approximately 83.77% 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, construction 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 guidelines established by the FHLMC. For the fiscal year ended March 31, 1998, adjustable mortgage loans totalled $140,000 or.09% of total originations as compared to $11,446,235 or 10.39% of total originations for the year ended March 31, 1997. 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. The origination fees charged by the Bank on construction loans generally are from one-quarter to one percentage point higher than fees charged by the Bank for permanent financing. At March 31, 1998, the Bank had $24,883,763, or 5.74% of total loans outstanding in construction loans, as compared to $18,808,232 or 4.71% of total loans at March 31, 1997. At March 31, 1998, $4,033,984, or 16.21% 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 $50,055,247 or approximately 11.54% of Horizon Bank's loan portfolio 9 at March 31, 1998. 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 10-year loan term, with payments based upon a 15 to 30-year amortization schedule. At March 31, 1998, $9,336,108 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. 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's Certificate of Deposit, 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, 1998, the Bank held $17,842,311 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. 10 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 customers, current borrowers, walk-in customers, and referrals from 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 performed at the branch level by the branch manager or a processor working under the direction of the branch manager. 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, branch managers not having loan approval authority will forward the application with a written recommendation 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 all 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% loan 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. Loan Originations, Purchases and Sales. Currently, the Bank emphasizes the origination of intermediate and long-term fixed rate loans on terms and conditions which will permit them to be sold in the secondary market, while originating ARM loans and 10, 15 and 20 year fixed-rate loans for its own portfolio. In addition to originating loans, Horizon Bank has purchased 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 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, 11 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, 1998, the Bank was servicing loans for others aggregating approximately $112,251,375. 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. In May 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 122, "Accounting for Mortgage Servicing Rights," which is effective for years beginning after December 15, 1995. This statement requires mortgage servicers to recognize servicing rights on loans as separate assets, no matter how acquired. When the Bank sells loans and retains the servicing rights it is required to allocate the total cost of the loans between servicing rights and loans based on their relative fair values if their values can be estimated. SFAS No. 122 was effective for, and was adopted by the Bank, beginning April 1996. SFAS No. 122 was not applied retroactively. The adoption of this statement has not had a material impact on the Bank's financial condition or results of operations. Loan Commitments. Horizon Bank issues commitments to originate conventional mortgage loans on existing residential dwellings are made for periods up to 60 days from the date of loan application and are based upon the prevailing market rate at the time of application. At March 31, 1998, such commitments amounted to $23,467,932. 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, 1998 was $6,886,744. 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 has experienced a decrease in loan fee income during periods of unusually high interest rates due to the resulting lack of 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 were considering refinancing their home loans. For a 2% loan 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 1998, the Bank modified $4,515,129 of real estate loans, compared to $1,116,175 in fiscal 1997. 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 12 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, 1998, the Bank had two loans over 90 days delinquent with a net balance of $25,345. Management does not anticipate incurring material losses from these loans. Delinquent loans have been consistently low over the last three fiscal years due to a strong local economy and strong underwriting. No assurances, however, can be given as to future delinquency levels and the continued strength of the local economy. The following table sets forth information with respect to the Bank's non-performing assets at the dates indicated. At March 31, -------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Non-accrual loans........... $ -- $ -- $ -- $ -- $ -- Loans 90 days or more delinquent and accruing interest................... 25,345 38,918 -- 1,545 -- Restructured loans.......... -- -- -- -- -- Real estate acquired........ through foreclosure........ -- -- -- -- -- ------- ------- ----- ------- ------ Total..................... $25,345 $38,918 $ -- $ 1,545 $ -- ======= ======= ===== ======= ====== As a percentage of net loans ..................... .006% .010% -- .0004% -- As a percentage of total assets..................... .005 .008% -- .0003% -- Reserves for Losses. The Bank operates under a general loan loss reserve system. Any differences between the loss reserve and the amount of loss realized is charged or credited to current income. 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, 1998 in the amount of $3,611,150 and $3,406,150 for the year ended March 31, 1997. The Bank's loan loss reserve as of March 31, 1998, is approximately 83% of total loans receivable. 13 The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated. Year Ended March 31, ---------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Balance at beginning of period ........$3,406,150 $3,236,150 $3,126,150 $2,994,150 $2,626,348 Provision for loan losses .... 355,000 200,400 110,000 132,000 367,802 Adjustment to reserves ....... (150,000) (30,400) -- -- -- ---------- ---------- ---------- ---------- ---------- Balance at end of period ...........$3,611,150 $3,406,150 $3,236,150 $3,126,150 $2,994,150 ========== ========== ========== ========== ========== Ratio of net charge offs to average loans outstanding during the period............ .09% .05% .03% .04% .11% The following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated. Year Ended March 31, ---------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Commercial, financial and agricultural......$ 850,000 $ 800,000 $ 800,000 $ 858,000 $ 858,000 Real estate - construction...... -- -- -- -- -- Real estate - mortgage.......... 2,761,150 2,606,150 2,436,150 2,268,150 2,136,150 ----------- ---------- ---------- ---------- ---------- Total allowance for loan losses.. $3,611,150 $3,406,150 $3,236,150 $3,126,150 $2,994,150 ========== ========== ========== ========== ========== The Bank had no allowances for real estate acquired through foreclosure at March 31, 1998, 1997, 1996, 1995 and 1994. 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, 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, 1998 was $31,300,705 compared to a market value of $35,861,563. For further information 14 concerning the Bank's investment securities portfolio, see Note 3 of the Notes to the Consolidated Financial Statements. The Bank also invests in mortgage-backed securities. At March 31, 1998, such securities had an amortized cost of $48,588,753 and a market value of $49,096,462. 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, 1998, was approximately $84,958,025. This does not include interest-bearing deposits and cash equivalents. At March 31, ------------------------------------ 1998 1997 1996 ---- ---- ---- (In thousands) Investment securities: U.S. Government: Available for sale............... $20,258 $21,944 $31,062 Held to maturity ................ 1,485 4,970 8,346 ------- -------- ------- 21,745 26,914 39,408 Asset-backed securities(1): Available for sale............... 33,100 36,512 285 Held to maturity................. 15,489 19,691 23,079 ------- -------- ------- 48,589 56,203 23,364 Other securities(2): Available for sale............... 9,056 2,065 1,128 Held to maturity................. 500 3,412 7,734 ------- -------- ------- 9,556 5,477 8,862 ------- -------- ------- Total investments............... 79,890 88,594 71,634 Interest bearing deposits and cash equivalents................. 16,859 14,815 13,600 ------- -------- ------- $96,749 $103,409 $85,234 ======= ======== ======= - ----------------- (1) Consists of mortgage-backed securities and CMO's. (2) Consists of corporate debt securities and marketable equity securities. 15 PAGE The following table sets forth the scheduled maturities, amortized cost, market values and average yields for the Bank's investment securities at March 31, 1998. At March 31, 1998 ----------------------------------------------------------------------------------------- Total One Year One to Five Five to Ten More than Investment or Less Years Years Ten Years Securities -------------- -------------- -------------- ------------- ------------------------ Amor- Amor- Amor- Amor- Amor- tized Average tized Average tized Average tized Average tized Market Average 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... $ 7,713 5.94% $ 12,045 6.11% $ 500 6.91% $ -- --% $20,258 $20,341 6.07% Held to maturity... 998 5.90 489 6.30 -- -- -- -- 1,487 1,485 6.03 ------- ---- -------- ----- ------ ---- ------- ---- ------- ------- ----- 8,711 5.93 12,534 6.12 500 6.91 -- -- 21,745 21,826 6.06 Mortgage-backed securities: Available for sale... -- -- 9,971 6.38 2,991 6.01 20,138 6.59 33,100 33,352 6.47 Held to maturity.... -- -- 1,931 6.22 1,068 7.87 12,490 6.72 15,489 15,744 6.74 ------- ---- -------- ----- ------ ---- ------- ---- ------- ------- ----- -- -- 11,902 6.35 4,059 6.50 32,628 6.64 48,589 49,096 6.56 Other: Available for sale.... 2,921 5.96 5,583 6.33 552 6.71 -- -- 9,056 13,473 6.23 Held to maturity.... -- -- 500 11.53 -- -- -- -- 500 563 11.53 ------- ---- -------- ----- ------ ---- ------- ---- ------- ------- ----- 2,921 5.96 6,083 6.76 552 6.71 -- -- 9,556 14,036 6.51 ------- ---- -------- ----- ------ ---- ------- ---- ------- ------- ----- Total...... $11,632 5.94% $30,519 6.34% $5,111 6.56% $32,628 6.64% $79,890 $84.958 6.42% ======= ==== ======== ==== ====== ==== ======= ==== ======= ======= ==== 17
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 savings accounts, the Bank derives funds from loan repayments, loan sales, Federal Reserve borrowings, 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, 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, --------------------------------------------------------- 1998 1997 1996 ------------------ ------------------ ----------------- Weighted Weighted Weighted Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ------- ---- ------- ---- ------- ---- (Dollars in thousands) Savings............. $ 31,452 3.38% $ 30,164 3.45% $ 29,324 3.46% Drafts.............. 27,624 1.67 25,482 1.68 24,274 1.93 Money Market........ 58,256 3.81 52,334 4.15 44,181 4.48 Time Deposits....... 322,049 5.77 302,287 5.72 289,081 6.02 ------- ---- -------- ---- -------- ---- Total............... $439,381 5.08% $410,267 5.10% $386,860 5.39% ======== ==== ======== ==== ======== ==== The following table indicates the amount of the Bank's deposits by time remaining until maturity as of March 31, 1998 of $100,000 or more. Certificates Maturity Period of Deposit --------------- ---------- Three months or less....................$11,686,159 Three through six months................ 17,230,056 Six through twelve months............... 25,197,673 Over twelve months...................... 27,368,494 ----------- Total...........$81,482,382 =========== 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 Retirement Accounts (IRAs); Qualified Retirement Plans; 17 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 MMDA currently has a $1,000 minimum deposit and has a tiered pricing program, with interest rates that vary by account dollar balance -- $2,000, $10,000, $25,000 and higher. This account has no maturity requirements, no regulatory interest rate ceiling, and limited check writing privileges. The interest rate on the account is 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. This account has 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 government and corporate securities) 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 9 of the Notes to the Consolidated Financial Statements. Borrowings. Savings deposits and access to a line of credit from the discount window of the Federal Reserve Bank of San Francisco are available to the Bank. If additional borrowings are needed, the Bank may do repurchase agreements, term fed funds, or additional public funds deposits. The Bank has 18 no borrowings against any kind of credit as of March 31, 1998. Horizon Bank has had no borrowings for the last five fiscal years. 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, 1998, Horizon Bank employed 114 full-time and 20 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 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. Deposit accounts at the Bank are insured up to applicable limits by the FDIC under the BIF. As an insurer, the FDIC issues regulations, conducts examinations, requires the filing of reports and generally supervises and regulates the operations of state-chartered banks that are not members of the Federal Reserve System. FDIC approval is required prior to any merger or consolidation involving state, nonmember banks, or the establishment or relocation of an office facility thereof. FDIC supervision and regulation is intended primarily for the protection of depositors and the FDIC insurance funds. 19 Pursuant to provisions in the Federal Deposit Insurance Act ("FDI Act"), all BIF-insured banks must pay semiannual insurance assessments. These insurance premiums were substantially reduced by the FDIC effective January 1, 1996 as a result of the BIF having reached its designated reserve ratio in 1995. Insurance premiums for BIF insured institutions currently range from 0 to 27 basis points. As a well capitalized bank, Horizon Bank qualified for the minimum statutory assessment during fiscal 1998. The Bank's assessments for the year ended March 31, 1998, equalled $54,202. 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. Capital Requirements. Pursuant to FDIC regulations, a bank's qualifying total capital base consists of two types of capital elements: "Core capital" (Tier 1) and "supplementary capital" (Tier 2). To qualify as an element of Tier 1 or Tier 2 capital, a capital instrument should not contain or be subject to any conditions, covenants, terms restrictions, or provisions that are inconsistent with safe and sound banking practices. The Bank must maintain a ratio of Tier 1 capital to total assets of not less than 4 percent, as discussed below. At March 31, 1998, Horizon Bank had a ratio of Tier 1 capital to total assets of 14.83%. These capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally sound, which are well-managed and have no material or significant financial weaknesses. The FDIC capital regulations state that, where the FDIC determines that the financial history or condition, managerial resources and/or the future earnings prospects of a bank are not adequate, or where a bank has sizable off-balance sheet or funding risks, significant risks from concentrations of credit or nontraditional activities, excessive interest risk rate exposure, or a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the FDIC may determine that the minimum adequate amount of capital for that bank is greater than the minimum standards established by regulation. Core (Tier 1) capital is defined as the sum of core capital elements of common stockholders' equity (which includes common stock and related surplus, undivided profits, disclosed capital reserves that represent a segregation of undivided profits, and foreign currency translation adjustments, less net unrealized holding losses on available-for-sale equity securities with readily determinable fair values), noncumulative perpetual preferred stock including any related surplus, and minority interests in the equity capital accounts of consolidated subsidiaries, minus all intangible assets other than mortgage servicing rights and purchased credit card relationships and minus any disallowed deferred tax assets. Supplementary (Tier 2) capital includes allowances for loan and lease losses, up to a maximum of 1.25 percent of risk-weighted assets, cumulative perpetual preferred stock, long-term preferred stock (original maturity of at least 20 years) and any related surplus; perpetual preferred stock (and any related surplus) where the dividend is reset periodically based, in whole or part, on the bank's current credit standing, regardless of whether the dividends are cumulative or noncumulative; hybrid capital instruments, including mandatory convertible debt securities; and term subordinated debt and intermediated-term 20 preferred stock (original average maturity of five years or more) and any related surplus. Supplementary capital does not include revaluation reserves or hidden reserve that represent unrealized appreciation on assets such as bank premises and equity securities. Minimum Leverage Capital Requirement. Under the FDIC's capital regulations the most highly-rated institutions are required to meet a "Tier 1" leverage capital ratio of at least three percent of total assets. Tier 1 (or "core capital") consists of common equity stock minus all intangible assets other than limited amounts of purchased mortgage servicing rights. All other banks must have a Tier 1 leverage ratio of at least 100 to 200 basis points above the three percent minimum. The FDIC's capital regulations also establish a minimum leverage ratio of not less than four percent for banks that are not highly rated or are anticipating or experiencing significant growth. Based on the definitions contained in the FDIC's capital regulations, as of March 31, 1998, Horizon had Tier 1 capital of 15.30%. The FDIC's capital regulation also requires higher capital levels for banks which exhibit more than a moderate degree of risk or exhibit other characteristics which necessitate that higher than minimum levels of capital be maintained. The FDIC's capital regulations further provide that any insured bank with a Tier 1 capital to total assets ratio of less than two percent is considered to be operating in an unsafe and unsound condition pursuant to Section 8(a) of the FDI Act unless the insured bank enters into a written agreement, to which the FDIC is a party, to correct its capital deficiency. Insured banks operating with Tier 1 capital levels below two percent (and which have not entered into a written agreement) are subject to an insurance removal action. Insured banks operating with lower than the prescribed minimum capital levels, generally will not receive approval of applications submitted to the FDIC. Also, inadequately capitalized state nonmember banks will be subject to such administrative action as the FDIC deems necessary. A state nonmember bank that is below the minimum leverage requirement will be deemed to be engaging in an "unsafe or unsound practice" that could result in an FDIC enforcement action unless the bank complies with a capital plan approved by the FDIC. Risk Based Capital. The FDIC has adopted a "Statement of Policy on Risk- Based Capital" to supplement its existing capital regulations. The Federal Reserve and the Office of the Comptroller of the Currency also have adopted substantially similar risk-based capital rules. The Statement of Policy consists of: a definition of capital for risk-based capital purposes, a system for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories, and a schedule specifying a phase-in period for achieving a minimum supervisory ratio of capital-to-risk-weighted assets. According to the Statement of Policy, a bank's risk-based capital is calculated by dividing its qualifying total capital base by its risk-weighted assets. A bank's qualifying total capital base consists of "core capital" (or "Tier 1" capital) and "supplemental capital" (or "Tier 2" capital). The Statement of Policy specifies the components of each category. On March 31, 1998, Horizon Bank's risk-based capital ratio was 28.42 percent. 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 21 non-personal time deposits at a savings bank. Under Regulation D, a bank must establish reserves equal to 0% of the first $4.4 million of net transaction accounts, 3% of the next $44.9 million, and 10% plus $1.56 million of the remainder. The reserve requirement on non-personal time deposits with original maturities of less than 1.5 years is 0%. As of March 31, 1998, 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, 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. 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 22 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." 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 of 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, the Corporation's levels of consolidated regulatory capital exceed the Federal Reserve's minimum requirements, as follows: 23 Amount Percent ------ ------- (Dollars in Thousands) Tier 1 Capital $81,259 15.30% Minimum Tier 1 (leverage) requirement 21,250 4.00 ------- ----- Excess $60,009 11.30% ======= ===== Risk-based capital $83,956 28.42% Minimum risk-based capital requirement 23,601 8.00 ------- ----- Excess $60,355 20.42% ======= ===== 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 will be 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 10 of the Notes to the Consolidated Financial Statements contained in the 1998 Annual Report to Stockholders ("Annual Report") 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" 24 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, 1998. 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 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 1.60% 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. 25 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, 1998 Feet Owned ------ -------------- ---- ----- Bellingham Main Office 1971 $1,097,284 19,179 Owned 1500 Cornwall Avenue Bellingham, WA 98225 Bellingham/Meridian. 1987 800,090 4,650 Owned 4110 Meridian Bellingham, WA 98226 Ferndale Office. 1976 371,185 3,692 Owned Third and Main Ferndale, WA 98248 Lynden Office. 1981 431,651 3,702 Owned Third and Grover Lynden, WA 98264 Blaine Office. 1976 583,264 3,610 Owned Fourth & "H" Streets Blaine, WA 98230 Mount Vernon Office. 1976 241,443 3,275 Owned 1503 Riverside Dr. Mount Vernon, WA 98273 Anacortes Office 1987 879,324 3,650 Owned 1218 Commercial Avenue Anacortes, WA 98221 Snohomish Office 1987 170,907 1,388 Owned 620 2nd Street Snohomish, WA 98290 Everett Office 1991 37,587 1,972 Leased 909 S.E. Everett Mall Way #E-500 Everett, WA 98208 Burlington Office. 1994 1,236,022 3,980 Owned 1020 S. Burlington Blvd Burlington, WA 98232 Edmonds Office. 1994 54,966 1,597 Leased 315 Fifth Avenue South Suite A&B Edmonds, WA 98020 (table continued on following page) 26 Net Book Year Value as of Square Leased/ Opened March 31, 1998 Feet Owned ------ -------------- ---- ----- Mill Creek Office 1995 $91,090 1,945 Leased 13416 Bothell Everett Hwy. Suite 201 Mill Creek, WA 98012 Barkley* 1999 51,655* -- Owned - ------------- *Reflects earnest money deposit, plus architecture fees paid to date. At March 31, 1998, the aggregate book value of the Corporation's premises and equipment was $6,046,468. 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. 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 - ---------------------------------------------------------- The information contained in the section "Corporate Information -- Stock Prices and Dividend Information" in the Annual Report is incorporated herein by reference. Item 6. Selected Financial Data - -------------------------------- The information contained in "Item 1 - Business - Selected Financial Data" in this Form 10-K is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ---------------------------------------------------------- The 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 Annual Report. Item 7A. Quantitative and Qualitative Disclosures About Market Risk - ------------------------------------------------------------------- The 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" in the Annual Report. 27 Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The financial statements contained in the Annual Report 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 68 Chairman of the Board of the Corporation V. Lawrence Evans 51 Chief Executive Officer and President of the Corporation; and Chairman of the Board, Chief Executive Officer and President of the Bank Richard P. Jacobson 35 Vice President and Secretary of the Corporation and Senior Vice President and Secretary of the Bank Judy E. Boxx 56 Vice President of the Bank Jeffrey H. Jansen 40 Vice President of the Bank Karen A. LePage 57 Vice President of the Corporation and the Bank Karla C. Lewis 51 Senior Vice President of the Bank Merwyn G. Murk 59 Vice President of the Bank Donald A. Wolf 49 Vice President of the Bank Kelli J. Holz 29 Vice President of the Corporation and the Bank Sandra R. Mathewson 38 Vice President of the Bank Carla J. Williams 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: 28 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 worked for Horizon Bank from 1985 to 1992. From April 1992 to May 1994, he worked as a real estate appraiser for a local appraisal company. He re-joined the Bank in May of 1994 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. 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. 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. She has been manager of the Accounting Department since 1977. 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, Ms. Lewis was appointed Senior Vice President of 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. DONALD A. WOLF joined Horizon Bank in 1973. He has been the Bank's Operations manager since October 1984. Mr. Wolf was appointed Vice President in June 1987. 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. SANDRA R. MATHEWSON joined the Bank in 1986. She was appointed Vice President in March 1998 and is currently the Sales and Service Manager for the 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. 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. 29 PAGE 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, 1998 and 1997* Consolidated Statement of Income for the years ended March 31, 1998, 1997 and 1996* Consolidated Statement of Stockholders' Equity for the years ended March 31, 1998, 1997 and 1996* Consolidated Statement of Cash Flows for the years ended March 31, 1998 1997 and 1996* Notes to Consolidated Financial Statements* __________________ * Contained in the Annual Report filed as Exhibit 13 hereto and incorporated herein by reference. (2) All required financial statement schedules are included in the Notes to Consolidated Financial Statements. (b) The Corporation did not file any Current Reports on Form 8-K during the quarter ended March 31, 1998. 30 (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)) (13) Annual Report to Stockholders (21) Subsidiaries of the Registrant (23) Consent of Auditors (27) Financial Data Schedule 31 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the bank has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HORIZON FINANCIAL CORP. Date: June 23, 1998 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 23, 1998 Date: June 23, 1998 By: /s/V. Lawrence Evans By: /s/Fred R. Miller ---------------------------- ----------------------------- V. Lawrence Evans Fred R. Miller Principal Financial Director Officer, Chief Executive Officer and President Date: June 23, 1998 Date: June 23, 1998 By: /s/Kelli J. Holz By: /s/L.M. Strengholt ---------------------------- ----------------------------- Kelli J. Holz L. M. Strengholt Principal Accounting Officer Director Date: June 23, 1998 Date: June 23, 1998 By: /s/ Maurice D. Fox By: /s/ Frank G. Uhrig ---------------------------- ----------------------------- Maurice D. Fox Frank G. Uhrig Director Director Date: June 23, 1998 Date: June 23, 1998 By: /s/ Richard D. Haggen By: /s/Gary E. Goodman ---------------------------- ----------------------------- Richard D. Haggen Gary E. Goodman Director Director Date: June 23, 1998 Date: June 23, 1998 32 Exhibit 13 Annual Report to Stockholders HRZB HORIZON FINANCIAL CORP. FISCAL 1998 ANNUAL REPORT CORPORATE PROFILE ============================================================================== Horizon Financial Corp. is a financial services holding company based in Bellingham, Washington. The Corporation operates an FDIC-insured subsidiary, Horizon Bank, through twelve full-service offices located in Whatcom, Skagit, and Snohomish counties. Originally founded in 1922 as a savings and loan association, Horizon converted to a mutual savings bank in 1979, and then converted to a publicly traded company through an initial public offering in August 1986. The conversion to the holding company structure occurred in October 1995. Horizon's mission statement is "To be a financial leader in quality service and customer trust, while maximizing shareholder return." To this end, the Corporation's business consists of attracting checking and savings deposits and originating consumer, residential, and commercial real estate loans. Horizon has shown consistent profitability since its founding, and is noted for its strong capital base, high profitability, good control of expenses, and low rate of nonperforming loans. We invite you to review the enclosed material and we thank you for your continued support. Corporate Profile ................................................ 1 Financial Highlights ............................................. 2 Letter to Stockholders ........................................... 3 Management's Discussion & Analysis ............................... 7 Quantitative and Qualitative Disclosure About Market Risk.....11 - 12 Consolidated Financial Statements Independent Auditor's Report...................................... 14 Statements of Financial Position.................................. 15 Statements of Income ............................................. 16 Statements of Stockholders' Equity................................ 17 Statement of Cash Flows........................................... 18 Notes to Consolidated Financial Statements....................19 - 40 Directors & Officers.............................................. 41 Corporate Information ............................................ 42 Office Locations ................................................. 43 ============================================================================= 1 FINANCIAL HIGHLIGHTS ============================================================================== Thousands of dollars except common share data Years Ended March 31 98 97 96 95 94 - ------------------------------------------------------------------------------ Balance sheet data total amount of Assets $547,146 $515,341 $488,968 $457,478 $424,636 Loans outstanding 433,697 399,078 389,651 360,120 340,421 Cash and investment securities 101,499 104,356 87,662 83,782 71,795 Deposits 450,125 424,811 402,676 377,703 351,506 Stockholders' equity 83,895 78,509 79,147 72,685 65,995 - ------------------------------------------------------------------------------ Summary of Operations Interest income $40,901 $38,711 $37,082 $33,989 $33,619 Interest expense (22,235) (20,832) (20,773) (16,948) (15,227) Net interest income 18,666 17,878 16,309 17,041 18,392 Other income 1,691 1,583 1,293 1,220 1,692 Non-interest expense(1) (7,920) (7,661) (6,795) (7,281) (7,813) Income before taxes 12,437 11,800 10,807 11,255(3) 12,271 Income taxes (4,215) (3,997) (3,586) (3,734)(3) (4,263) Net income $8,222 $7,803 $7,221 $7,521 $8,008 - ------------------------------------------------------------------------------ Per Common Share(2) Basic earnings $1.11 $1.04 $0.96 $1.01 $1.08 Dividends 0.83(5) 0.75(4) 0.32 0.31 0.29 Equity 11.22 10.61 10.46 9.70 8.91 Weighted average shares outstanding 7,435,782 7,478,666 7,535,956 7,460,697 7,400,736 - ------------------------------------------------------------------------------ 1 Includes provision for loan losses. 2 Restated for 15% stock dividend declared April 22, 1997; 10% stock dividend declared June 28, 1994. 3 Includes gain on sale of Trust Department. 4 Includes special cash dividend of $0.35 declared November 21,1996. 5 Includes special cash dividend of $0.40 declared January 28,1998. Bar graphs appear below table as follows: Assets: Deposits: Loans Receivable: 1994: $424.6 1994: $351.5 1994: $340.4 1995: $457.5 1995: $377.7 1995: $360.1 1996: $489.0 1996: $402.7 1996: $389.7 1997: $515.3 1997: $424.8 1997: $399.1 1998: $547.2 1998: $450.1 1998: $433.7 ============================================================================== 2 LETTER TO STOCKHOLDERS ============================================================================== To our stockholders and customers, Horizon Financial Corp. is pleased to provide you with this report on our performance. Fiscal 1998 was a good year for the Corporation. Demand for the Bank's products and services hit record levels, Horizon's profitability increased, our stock attained an all-time high, and we moved forward with a renewed focus on creating value for our stockholders, customers, and the communities we serve. Over the years, we have made a concerted effort to build on the value our customers have come to expect at Horizon. We expanded our product offering during the year, with the introduction of our Visa check card, telephone banking, and our new internet web site. Our home equity line of credit grew in popularity, as did our home loans -- which offer free prequalification and credit approval in only five minutes. These new products serve to expand Horizon's appeal to a wider segment of the market and make it easier for more people to do their banking with Horizon. Providing exceptional customer service is an integral part of creating and maintaining value for our customers. All employees at Horizon participate in an ongoing training program that hones their customer service skills, enhances their product knowledge, and encourages employees to become a resource for their customers' financial services needs. Each year, we measure our success at providing excellent customer service through feedback received from our customers and through a mystery shopping program that is conducted by an independent research firm. Bar graphs for Return on Assets and Return on Equity appear to the right side of the above text: Return on Assets: 1994 1995 1996 1997 1998 ----------------------------------------- Horizon Financial Corp. 1.96% 1.71% 1.53% 1.55% 1.55% Washington Public Thrifts* 1.57% 0.91% 0.73% 0.36% 0.62% *Source: SNL Quarterly Thrift Digest, June 1998 Return on Equity 1994 1995 1996 1997 1998 ----------------------------------------- Horizon Financial Corp. 12.80% 10.85% 9.51% 9.90% 10.12% Washington Public Thrifts* 17.56% 14.06% 11.89% 5.61% 10.01% *Source: SNL Quarterly Thrift Digest, June 1998 ============================================================================== 3 The mystery shopping program compares Horizon's service levels to that of our local competition. We are pleased to report that Horizon continues to rank above its competition for the quality of customer service we provide. Improving our customer service is a continuous process at Horizon. Demand for Horizon's products and services have never been higher. Loan volume grew to a record $161.1 million for the year, which was an increase of over 46 percent. Relatively low interest rates helped to spur volume for residential home loans, which made up the majority of the Corporation's business. But Horizon also made progress on diversifying its loan mix by pursuing higher yield consumer loans and commercial real estate loans which, combined, represented $35.1 million, or 22 percent of Horizon's loan volume. It was also a good year for deposit growth which increased by $25.3 million. This was a solid increase for Horizon, given the competitive deposit environment and relatively flat yield curve. We are particularly pleased with the growth Horizon experienced in Snohomish County. The four Snohomish County offices collectively increased their deposit base by 27 percent, which represents over 45 percent of Horizon's deposit growth. Communities such as Edmonds and Snohomish have responded very favorably to the "hometown feel" of service at Horizon. Increasing shareholder return is one of the Corporation's long-term objectives and is one of the ways Horizon measures its success in building value for its stockholders. Bar graphs for Nonperforming Assets and Efficiency Ratio appear to the left of the above text: Nonperforming Assets: 1994 1995 1996 1997 1998 ----------------------------------------- Horizon Financial Corp. 0.00% 0.01% 0.00% 0.01% 0.01% Washington Public Thrifts* 0.86% 1.16% 1.31% 1.09% 0.81% *Source: SNL Quarterly Thrift Digest, June 1998 Efficiency Ratio: 1994 1995 1996 1997 1998 ----------------------------------------- Horizon Financial Corp. 37.1% 39.2% 38.0% 38.3% 37.2% Washington Public Thrifts* 47.2% 53.7% 58.4% 55.0% 49.9% *Source: SNL Quarterly Thrift Digest, June 1998 ============================================================================== 4 Earnings per share and return on equity are two of the key measures of shareholder value and we are pleased to report that both showed a solid increase. Basic earnings per share increased 7 percent to $1.11 and return on equity ended the year in double digits at 10.12 percent. One of the methods Horizon uses to continue to enhance shareholder return is to repurchase the Corporation's common stock. In March of this year, the Board of Directors renewed Horizon's stock repurchase plan, which allows Horizon to repurchase up to 747,000 shares, or approximately 10 percent of the Corporation's outstanding stock. As the opportunity to acquire shares at reasonable prices presents itself, we plan on continuing to do so. Horizon has also increased shareholder return by raising the dividends paid on its common stock. Over the course of the last year, Horizon increased its regular quarterly cash dividend by over 26 percent to $0.11 per share, and we paid a special cash dividend of $0.40 per share. Horizon's stock achieved an all-time high of $19-3/8 in March, and ended the fiscal year up over 54 percent. Combined with cash dividend payments totaling $0.83 per share and the effect of the 15 percent stock dividend that was paid in May 1997, the total annual return for Horizon Financial Corp.'s common stock was over 60 percent. Plans to expand are also underway. We are pleased to announce that Horizon has signed a letter of intent to purchase land for a new office located in Bellingham, near the Barkley Village shopping center. This area of Bellingham has experienced much growth over the past two years and the new office will position Horizon well to serve this growing community. We are excited about the possibilities the new office holds for improving service to our customers and for expanding our market. We believe that planning for our future is an integral part of our continued success. The Board of Directors recently approved plans to upgrade Horizon's computer system, purchase a new teller and customer service platform system, and to implement a wide-area network among its offices. Investing in these improvements will allow the Bank to better serve its customers and provide Horizon with a foundation upon which future technologies may be built. Completion of the upgrades is anticipated later in fiscal 1999. During the year, we have also diligently worked on addressing concerns regarding the "year 2000 issue." Simply put, the "year 2000 issue" is the recognition that software programs that use a two-digit expression of the year will not be able to differentiate between the year 1900 or the year 2000. For this reason, Horizon is working closely with its data processor, as well as its other vendors, suppliers, and regulators to make sure that all our systems have been tested for compliance with the year 2000. We anticipate that testing will be completed before the end of 1998 (see footnote 21 in consolidated financial statements). ============================================================================== 5 LETTER TO STOCKHOLDERS ============================================================================== Horizon is also pleased to announce the appointment of a new member to its Board of Directors. Gary E. Goodman, Refinery Manager for Tosco Refining Company, in Ferndale, Washington, became the ninth member of the Board of Directors as of May 1, 1998. He was chosen because of his familiarity with the local area, his wide range of experience, and his civic involvement. We're very happy to have Gary on our Board. Fiscal 1998 was a successful year for Horizon. We continued to enhance our efficiency and profitability, and our performance improved. We strived to provide exceptional service to our customers and we witnessed their positive response. Moving forward, we will continue to put our stockholders, customers, and the communities we serve at the forefront of our efforts. We thank our stockholders for their continued support, and we look forward to the Annual Meeting of Stockholders on July 28. /s/V. Lawrence Evans - -------------------- V. Lawrence Evans President and Chief Executive Officer /s/George W. Gust - --------------------- George W. Gust Chairman of the Board ============================================================================== 6 MANAGEMENT'S DISCUSSION & ANALYSIS ============================================================================== General Horizon Financial Corp. was formed under Washington law on May 22, 1995, and became the holding company for Horizon Bank, effective October 13, 1995. The Corporation, as a bank holding company, has a number of additional options and operating advantages over the Bank. These include, but are not limited to: expanded business diversification options; flexibility in acquisitions; and the ability to repurchase its own stock without incurring the adverse tax consequences of recapturing portions of the Bank's bad debt reserve. 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. The primary business of the Bank is to acquire funds in the form of savings deposits and to use the funds to make loans secured by residential and commercial properties in the Bank's primary market area. The Bank's operations are conducted through 12 full-service office facilities, located in Whatcom, Skagit and Snohomish counties in Northwest Washington. At its March 26, 1996 meeting, the Board of Directors authorized the repurchase of up to 10% (approximately 655,000 shares) of the Corporation's outstanding common stock over a 24 month period. This authorization ended in March of 1998. Subsequently, at its March 19, 1998 meeting, the Board of Directors authorized the repurchase of up to 10% (approximately 747,000 shares) of the Corporation's outstanding common stock over the next 24 months. During the fiscal year ended March 31, 1998, the Corporation repurchased no shares of its common stock, compared to repurchasing 249,090 shares in the prior fiscal year (restated for the 15% stock dividend declared in April 1997). The Corporation paid a special cash dividend of $0.40 per share in the fourth quarter of its fiscal year, in addition to the quarterly dividends paid throughout the year. Financial Condition Total consolidated assets for the Corporation as of fiscal year-end March 31, 1998 were $547,146,296, an increase of 6.17% from the March 31, 1997 level of $515,341,339. This increase in assets was due primarily to the growth in loans receivable, which increased 8.67% to $433,697,267 from $399,078,123. Real estate and commercial loans originated for fiscal 1998 were $148,660,761, of which 40% were refinances, compared to fiscal 1997 of $100,579,512 with 31% refinances. The increase in total real estate loan originations in fiscal 1998 was the result of lower long-term interest rates and continued strong demand for refinance mortgages, particularly in the last quarter of the Bank's fiscal year. Consumer lending originations increased as well, with annual activity increasing to $12,462,472 from $9,606,372 in fiscal 1997. The consumer loan growth was due in large part to the popularity of Horizon Prime Line, which is the Bank's home equity line of credit product. The Bank sold $29,370,377 of real estate loans in fiscal 1998, compared to $5,038,461 in fiscal 1997. The Bank sells real estate loans during periods of increased loan volume to improve the Bank's cash flow and to manage its interest rate risk profile. In addition to these cash sales, the Bank securitized $12,622,660 in long term, fixed rate mortgages during fiscal 1998, compared to $28,123,822 in fiscal 1997. These securitizations shifted loans from loans receivable into the investment portfolio, which enhanced the Bank's liquidity position and ============================================================================== 7 MANAGEMENT'S DISCUSSION & ANALYSIS ============================================================================== decreased the credit risk associated with the loans receivable. Total liabilities were $463,251,499 at March 31, 1998 an increase of 6.05% from $436,832,325 at March 31, 1997. The increase in liabilities was due primarily to the growth in savings deposits, which increased 5.96% to $450,125,058 from $424,811,286. Shareholder equity in fiscal 1998 increased 6.86% to $83,894,797 from $78,509,014 at fiscal 1997 year end. This increase is due in large part to the net unrealized gain in the Bank's available-for-sale portion of its investment portfolio. This segment of the balance sheet increased to $3,135,677 at March 31, 1998 from $624,833 at March 31, 1997, due primarily to unrealized gains in the Bank's common stock holdings. The overall growth in the total stockholder's equity is net of the $0.44 per share of regular cash dividends, and the $0.40 per share special cash dividend paid in the last quarter of the Bank's fiscal year. This special dividend was paid in an effort to enhance the total return to shareholders, improve return on equity, and to reduce the Corporation's capital-to-asset ratio. The Corporation remains strong in terms of its capital position, with a shareholder equity-to-assets ratio of 15.33% at March 31, 1998, compared to 15.23% at March 31, 1997. Net Interest Income Net interest income in fiscal 1998 was $18,665,514, a 4.40% increase from fiscal 1997 of $17,878,339, compared to $16,308,806 in fiscal 1996. Total interest income increased in fiscal 1998 to $40,900,914, a 5.66% increase from fiscal 1997 of $38,710,639, compared to $37,082,271 in fiscal 1996. Interest income on loans in fiscal 1998 was $35,008,202, a 3.54% increase from $33,812,005 in fiscal 1997, compared to $32,145,266 in fiscal 1996. The Bank's weighted average yield on loans was 8.40% in fiscal 1998, compared to 8.39% in fiscal 1997 and 8.57% in fiscal 1996. Therefore, the increase in interest income from loans was due primarily to the overall growth in loans receivable. Interest and dividends on investments and mortgage-backed securities was $5,892,712 in fiscal 1998, a 20.29% increase from $4,898,634 in fiscal 1997, compared to $4,937,005 in fiscal 1996. This increase in fiscal 1998 was due primarily to the fact that the Bank has been shifting assets from loans receivable to investments by securitizing long-term fixed rate mortgages with the Federal Home Loan Mortgage Corporation in an effort to improve its liquidity and to better manage its interest rate risk profile. The Bank's weighted average yield on investments increased in fiscal 1998 to 6.48% from 6.31% in fiscal 1997 and 6.43% in fiscal 1996. The weighted average yield on all earning assets was little changed, increasing to 8.06% in fiscal 1998 from 8.05% in fiscal 1997, compared to 8.21% in fiscal 1996. Therefore, the improvement in the Bank's total interest income is primarily attributable to the overall growth in its interest earning assets. Total interest expense in fiscal 1998 increased to $22,235,400, a 6.74% increase over fiscal 1997 of $20,832,300, compared to $20,773,465 in fiscal 1996. This increase in fiscal 1998 occurred while the Bank's deposit base increased by 5.96%. The Bank's cost of savings increased in fiscal 1998 to 5.12% from 5.07% in fiscal 1997, compared to 5.36% in fiscal 1996. The primary reason for the increase in fiscal 1998 was the increased competition for funds that the Bank faced in attracting deposits in its markets. This continues to be a challenge, as the Bank faces an increased number of bank and non-bank competitors for consumers' deposits and investments. ============================================================================== 8 MANAGEMENT'S DISCUSSION & ANALYSIS ============================================================================== Provision for Losses on Loans The provision for losses on loans increased in fiscal 1998 to $355,000 from $200,400 in fiscal 1997 and $110,000 in fiscal 1996. These figures include both specific and general reserves. As of March 31, 1998, the allowance for loan loss reserves was $3,611,150. The general and specific reserves as of March 31, 1998 represent .83% of loans receivable, compared to .85% as of March 31, 1997 and .83% at March 31, 1996. The Bank's management considers this to be an adequate level of reserves at this time. While the Bank has considered it to be a prudent practice to add to its loan loss reserve over the last several years, the ratio of loans delinquent, in foreclosure, or real estate owned to loans receivable has been less than .01% for each of the past six years. As of March 31, 1998, there were two loans in the Bank's portfolio over 90 days delinquent, with balances totaling $50,345. The Bank has allocated a reserve of $25,000 for one of these loans. This consistently low delinquency rate shows a commitment by the Bank to maintain strong underwriting requirements, along with the strength and stability of the local economy. No assurances, however, can be given as to future delinquency levels. Non-Interest Income Non-interest income in fiscal 1998 was $1,691,273, an increase of 6.84% from fiscal 1997 of $1,583,063, compared to $1,292,768 in fiscal 1996. Service fee income was $1,191,004 in fiscal 1998, a 14.82% increase from fiscal 1997 of $1,037,308, compared to $958,610 in fiscal 1996. This increase in fiscal 1998 was due in large part to increases in fee income (e.g. escrow fees) related to the increased loan origination activity for the year, along with increased servicing fee income from loans sold in the secondary market. The net gain on sale of loans and investments decreased to $83,508 in fiscal 1998, from $268,915 in fiscal 1997, compared to $7,468 in fiscal 1996. These differences were due to the varying amounts of gains recognized from the sale of loans, investments and common stocks in each of these years. Other non-interest income increased in fiscal 1998 to $416,761 from $276,840 in fiscal 1997, compared to $326,690 in fiscal 1996. One of the primary factors affecting this difference in fiscal 1998 was an adjustment of $150,000 in specific loan loss reserves due to a large principal reduction on a loan with an allocated reserve. Non-Interest Expense Non-interest expense in fiscal 1998 increased to $7,565,253, a 1.40% increase from fiscal 1997 of $7,460,889, compared to $6,684,505 in fiscal 1996. Compensation and employee benefits decreased 4.13% in fiscal 1998 to $3,993,022 from $4,164,945 in fiscal 1997, compared to $3,694,053 in fiscal 1996. This difference was due primarily to the one-time recognition of $277,525 in expenses relating to the Bank's retirement program in fiscal 1997. Without this item, compensation and employee benefits would have increased 2.72% in fiscal 1998, and the 1997 expense would have represented a 5.23% increase over fiscal 1996 figures. Building occupancy expense was $1,152,365 in fiscal 1998, a 2.84% increase from $1,120,585 in fiscal 1997, compared to $1,075,275 in fiscal 1996. FDIC insurance expenses in fiscal 1998 increased to $54,202 from $14,297 in fiscal 1997, compared to $246,686 in fiscal 1996. The primary reason for this difference is due to the fact that during the first three quarters of fiscal 1997, the Bank was only required to pay the statutory minimum of $500 per quarter for its FDIC insurance. Data processing expenses increased significantly in fiscal 1998 to $612,799 from $413,512 in fiscal 1997, compared to $388,946 in fiscal 1996. This increase is due in ============================================================================== 9 MANAGEMENT'S DISCUSSION & ANALYSIS ============================================================================== large part to the recognition of expenses relating to upgrading the technology at the Bank, including upgrading many of the Bank's personal computers, the installation of a teller platform system and the implementation of a wide-area network. The benefits of these enhancements should include: an enhanced operating platform for tellers and new accounts personnel; a faster, more powerful computer network capable of interoffice communication and file sharing; and a better foundation for future technologies and more efficient operations. Advertising expenses increased 19.48% to $416,207 in fiscal 1998 from $348,342 in fiscal 1997, compared to $322,917 in fiscal 1996. This increase is due in part to expenses relating to the Bank's web-site, which was launched during the year, and can be viewed at http://www.horizon-bank.com. Other non-interest expenses decreased 4.47% in fiscal 1998 to $1,336,658 from $1,399,208 in fiscal 1997, compared to $956,628 in fiscal 1996. Provisions for Income Tax Income tax expense increased to $4,214,657 in fiscal 1998, from $3,996,693 in fiscal 1997, and $3,585,991 in fiscal 1996. The Bank's effective tax rate was approximately 33-34% in each of the past three fiscal years. Net Income Annual earnings of $8,221,877 for fiscal 1998 represent a 5.36% increase from fiscal 1997 earnings of $7,803,420, compared to fiscal 1996 earnings of $7,221,078. Basic earnings per share for fiscal 1998 were $1.11 on weighted average shares of 7,435,782, compared to basic earnings per share of $1.04 on weighted average shares of 7,478,666 in fiscal 1997, and basic earnings per share of $0.96 on weighted average shares of 7,535,956 in fiscal 1996 (as restated for the 15% stock dividend declared in April 1997). Liquidity and Capital Resources The Bank maintains liquid assets in the form of cash and short-term investments to provide a source to fund loans, savings withdrawals, and other short-term cash requirements. At March 31, 1998, the Bank had liquid assets (cash and marketable securities with maturities of one year or less) with a book value of $19,279,948. As of March 31, 1998, the total book value of investments and mortgage-backed securities was $89,869,807 compared to a market value of $94,938,374 with an unrealized gain of $5,068,567. On March 31, 1997, the book value of investments and mortgage-backed securities was $98,991,955 compared to a market value of $99,719,336, with an unrealized gain of $727,381. The Bank foresees no factors that would impair its ability to hold debt securities to maturity. The Bank's primary sources of funds are cash flow from operations, which consist primarily of mortgage loan repayments, deposit increases, loan sales, and cash received from the maturity or sale of investment securities. The Bank's liquidity fluctuates with the supply of funds and management believes that the current level of liquidity is adequate at this time. If additional liquidity is needed, the Bank's options include, but are not necessarily limited to: 1) selling additional loans in the secondary market; 2) entering into reverse repurchase agreements; 3) accepting additional jumbo and/or public funds deposits; or 4) accessing the discount window of the Federal Reserve Bank of San Francisco. The Bank had no borrowings against any kind of credit as of March 31, 1998, other than its deposit liabilities to its customers. Shareholder's equity as of March 31, 1998 was $83,894,797 or 15.33% of assets, which exceeds the 5.0% minimum required by the FDIC in order to be considered well capitalized. ============================================================================== 10 MANAGEMENT'S DISCUSSION & ANALYSIS ============================================================================== The Bank's total risk-adjusted capital ratio as of March 31, 1998 was 28.46%, which also exceeds the well-capitalized minimum of 10% required by the FDIC. Forward Looking Statements In this document, Horizon has included certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. This statement is for the express purpose of availing Horizon of the protections of such safe harbor with respect to all "forward looking statements". Horizon has used "forward looking statements" to describe future plans and strategies, including expectations of Horizon's potential future financial results. Management's ability to predict results or the effect of future plans and strategies is inherently uncertain. Factors that could effect results include, but are not limited to: the future level of interest rates, industry trends, general economic conditions, loan delinquency rates, and changes in state and federal regulations. These factors should be considered when evaluating the "forward looking statements" and undue reliance should not be placed on such statements. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Bank's largest component of market risk continues to be interest rate risk. Currently, the Bank's assets and liabilities are not directly exposed to foreign currency or commodity price risk. At March 31, 1998, the Bank had no off-balance sheet derivative financial instruments, nor did it have a trading portfolio of investments. One method of analyzing an institution's interest rate risk position is an interest rate sensitivity GAP analysis. The interest rate GAP is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period, and the interest-bearing liabilities maturing or repricing within that same time period. A GAP is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities during the same period. A GAP is considered negative when the amount of interest sensitive liabilities exceeds the amount of interest sensitive assets. At March 31, 1998, the Bank's one year GAP position was a negative 38.67%, compared to a negative 34.53% at March 31, 1997. The Bank has historically been considered liability sensitive with its negative GAP position, due to the assumption that its liabilities (primarily comprised of certificates of deposit) would reprice more rapidly than its assets (which are primarily longer term mortgages). For example, in a rising rate environment, the Bank's cost of savings should rise more rapidly than its yield on its mortgages, as these liabilities reprice more rapidly than the Bank's assets. The result to the Bank's operation should likely be a compression of its net interest margin, which is the primary factor currently affecting the Bank's income statement. Conversely, in a falling rate environment, the Bank's liabilities should likely reprice more rapidly than its assets, resulting in an improvement in its net interest margin. Other factors, such as prepayments on mortgages and investments, the interest rate sensitivity of deposits, and general economic conditions can also have significant effects on the Bank's performance in a changing interest rate environment. In addition to changes in the directions of interest rates, the Bank's long term performance is likely to be affected significantly by the shape and magnitude of the slope of the yield curve. The yield curve is a graphical representation of the relationship between short and long term interest rates. As mentioned above, the majority of the Bank's liabilities are in the form of certificates of deposit, most of which reprice or mature within one year. As such, ============================================================================== 11 MANAGEMENT'S DISCUSSION & ANALYSIS ============================================================================== the rates paid on these liabilities are influenced primarily by rates at the short end of the yield curve. The Bank's composition of assets, however, is heavily weighted in long term fixed rate mortgages, which are generally affected more by the rates at the long end of the yield curve. Therefore, all else being equal, the Bank should generally be more profitable in the long run when there is slope in the yield curve with long term rates higher than short term rates. The current shape of the yield curve is very flat, a scenario which continues to present challenges to the Bank. The Bank's excellent asset quality, efficient operations, and healthy capital to assets ratio have allowed the Bank to continue to operate profitably, despite a very flat yield curve environment. Quantitative Disclosures About Market Risk - ------------------------------------------------------------------------------ The table below represents the balances of the Bank's financial instruments at March 31, 1998. The expected maturity categories take into consideration projected prepayment rates as well as actual amortization of principal. In preparation of the table, numerous assumptions were made regarding prepayment rates and deposit activity based on current interest rate levels. Average Within 1 Year After 2 Years Beyond 5 Yield 1 Year To 2 Years To 5 Years Years Total Fair Value --------------------------------------------------------------------------------- Dollars in thousands Interest-Sensitive Assets: Loans receivable 8.40 $66,806 $47,655 $138,424 $180,812 $433,697 $438,828 Mortgage-backed securities 6.55 4,859 7,392 12,359 23,979 48,589 49,096 Investments and other interest-earning assets 6.40 22,135 11,093 7,001 1,052 41,281 45,842 Interest-Sensitive Liabilities: Checking accounts 1.67 - 17,505 11,670 - 29,175 29,175 Money market/Ultimate accounts 3.81 27,732 13,867 13,866 - 55,465 55,465 Savings accounts 3.38 - 19,445 12,964 - 32,409 32,409 Certificates of deposit 5.77 239,741 33,086 22,258 37,991 333,076 334,751 Off-Balance Sheet Items: Commitments to extend credit 6.75 23,468 - - - 23,468 23,468 Unused lines of credit 10.00 3,904 - - - 3,904 3,904 /TABLE As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities, they may react in different degrees to changes in market interest rates. In addition, in the event of changes in interest rates, expected rates of prepayments on loans and early withdrawals from certificates of deposit might deviate significantly from those assumed in presenting the table. Therefore, the data presented in the table should not be relied upon as necessarily indicative of actual future results. ============================================================================== 12 HORIZON FINANCIAL CORP. Independent Auditor's Report and Consolidated Financial Statements March 31, 1998, 1997 and 1996 13 [Moss-Adams LLP Letterhead] INDEPENDENT AUDITOR'S REPORT To the Stockholders and Directors Horizon Financial Corp. We have audited the accompanying consolidated statement of financial position of Horizon Financial Corp. and its subsidiary as of March 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years ended March 31, 1998, 1997 and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Horizon Financial Corp. as of March 31, 1998 and 1997, and the results of its operations and cash flows for each of the years ended March 31, 1998, 1997 and 1996, in conformity with generally accepted accounting principles. /s/Moss Adams LLP Bellingham, Washington April 29, 1998 14 HORIZON FINANCIAL CORP. CONSOLIDATED STATEMENT OF FINANCIAL POSITION March 31, 1998 and 1997 ASSETS 1998 1997 ------------ ------------ Cash and cash equivalents $ 6,878,615 $ 4,416,862 Interest-bearing deposits 9,980,349 10,398,316 Investment securities Available-for-sale (amortized cost 1998: $29,314,764; 1997: $24,008,966) 33,813,752 26,238,895 Held-to-maturity (estimated fair value 1998: $2,047,811; 1997: $8,431,880) 1,985,941 8,381,775 Mortgage-backed securities Available for sale (amortized cost 1998: $33,100,230; 1997: $36,512,300) 33,352,267 35,229,087 Held-to-maturity (estimated fair value 1998: $15,744,195; 1997: $19,421,158) 15,488,523 19,690,598 Loans receivable 433,697,267 399,078,123 Accrued interest and dividends receivable 3,678,614 3,545,380 Income tax receivable - 297,192 Bank premises and equipment, net 6,046,468 6,130,683 Other assets 2,224,500 1,934,428 -------------- -------------- TOTAL ASSETS $ 547,146,296 $ 515,341,339 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 450,125,058 $ 424,811,286 Accounts payable and other liabilities 7,925,825 8,935,825 Advances by borrowers for taxes and insurance 920,995 898,950 Income tax currently payable 124,893 - Net deferred income tax liabilities 2,879,728 896,264 Deferred compensation 1,275,000 1,290,000 -------------- -------------- Total liabilities 463,251,499 436,832,325 -------------- -------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Serial preferred stock, $1 par value, 10,000,000 shares authorized; none issued or outstanding - - Common stock, $1 par value, 30,000,000 shares authorized; 7,726,762 and 6,650,340 issued and outstanding, respectively 7,726,762 6,650,340 Additional paid-in capital 53,821,396 40,063,678 Retained earnings 22,509,593 34,518,794 Debt related to ESOP (400,000) (450,000) Net unrealized gain on securities classified as available-for-sale, net of tax 3,135,677 624,833 Treasury stock, 249,090 and 216,600 shares, at cost (2,898,631) (2,898,631) -------------- -------------- Total stockholders' equity 83,894,797 78,509,014 -------------- -------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 547,146,296 $ 515,341,339 ============== ============== See accompanying notes to these financial statements. 15 HORIZON FINANCIAL CORP. CONSOLIDATED STATEMENT OF INCOME Years Ended March 31, 1998, 1997 and 1996 1998 1997 1996 ------------- ------------- ------------- INTEREST INCOME Interest on loans $ 35,008,202 $ 33,812,005 $ 32,145,266 Interest and dividends on investments and mortgage- backed securities 5,892,712 4,898,634 4,937,005 ------------- ------------- ------------- Total interest income 40,900,914 38,710,639 37,082,271 ------------- ------------- ------------- INTEREST EXPENSE Interest on deposits 22,235,400 20,832,300 20,773,465 ------------- ------------- ------------- Net interest income 18,665,514 17,878,339 16,308,806 PROVISION FOR LOAN LOSSES 355,000 200,400 110,000 ------------- ------------- ------------- Net interest income after provision for loan losses 18,310,514 17,677,939 16,198,806 ------------- ------------- ------------- NONINTEREST INCOME Service fees 1,191,004 1,037,308 958,610 Other 416,761 276,840 326,690 Net gain (loss) on sales of loans (356,668) (31,188) 2,891 Net gain on sales of investment securities 440,176 300,103 4,577 ------------- ------------- ------------- Total noninterest income 1,691,273 1,583,063 1,292,768 ------------- ------------- ------------- NONINTEREST EXPENSE Compensation and employee benefits 3,993,022 4,164,945 3,694,053 Building occupancy 1,152,365 1,120,585 1,075,275 Other expenses 1,336,658 1,399,208 956,628 FDIC insurance 54,202 14,297 246,686 Data processing 612,799 413,512 388,946 Advertising 416,207 348,342 322,917 ------------- ------------- ------------- Total noninterest expense 7,565,253 7,460,889 6,684,505 ------------- ------------- ------------- INCOME FROM CONTINUING OPERATIONS BEFORE PROVISION FOR INCOME TAX 12,436,534 11,800,113 10,807,069 ------------- ------------- ------------- PROVISION FOR INCOME TAX Current 3,524,657 3,171,693 4,062,815 Deferred 690,000 825,000 (476,824) ------------- ------------- ------------- Total provision for income tax 4,214,657 3,996,693 3,585,991 ------------- ------------- ------------- NET INCOME $ 8,221,877 $ 7,803,420 $ 7,221,078 ============= ============= ============= BASIC EARNINGS PER SHARE $ 1.11 $ 1.04 $ 0.96 ============= ============= ============= DILUTED EARNINGS PER SHARE $ 1.09 $ 1.03 $ 0.95 ============= ============= ============= See accompanying notes to these financial statements 16
HORIZON FINANCIAL CORP. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Years Ended March 31, 1998, 1997 and 1996 Net Unrealized Gains Common Stock (Losses) on -------------------- Additional Debt Securities Treasury Number of Paid-in Retained Related Available Stock Shares At Par Capital Earnings To ESOP For-Sale at Cost Total --------- ---------- ----------- ------------ --------- ---------- ---------- ----------- BALANCE, March 31, 1995 6,514,652 $6,514,652 $39,036,616 $ 26,426,840 $ (25,000) $ 731,652 $ - $72,684,760 Repayment of debt related to Employee Stock Ownership Plan - - - - 25,000 - - 25,000 Cash divi- dends on common stock at $0.32 per share - - - (2,099,206) - - - (2,099,206) Dividend reinvest- ment plan 21,202 21,202 243,112 - - - - 264,314 Stock options exercised 44,100 44,100 136,147 - - - - 180,247 Net change in unreal- ized gain/ loss on securities classified as avail- able-for- sale, net of taxes of $448,708 - - - - - 871,021 - 871,021 Net income - - - 7,221,078 - - - 7,221,078 --------- ---------- ----------- ----------- ---------- ----------- ----------- ----------- BALANCE, March 31, 1996 6,579,954 6,579,954 39,415,875 31,548,712 - 1,602,673 - 79,147,214 Employee Stock Ownership Plan debt guarantee - - - - (500,000) - - (500,000) Repayment of ESOP related debt - - - - 50,000 - - 50,000 Cash divi- dends on common stock at $0.75 per share - - - (4,833,338) - - - (4,833,338) Dividend reinvest- ment plan 23,743 23,743 304,498 - - - - 328,241 Stock options exercised 46,643 46,643 343,305 - - - - 389,948 Net change in unreal- ized gain/ loss on securities classified as avail- able-for- sale, net of taxes of $503,736 - - - - - (977,840) - (977,840) Treasury stock purchased - - - - - - (2,898,631) (2,898,631) Net income - - - 7,803,420 - - - 7,803,420 --------- ---------- ----------- ----------- ---------- ----------- ----------- ----------- BALANCE, March 31, 1997 6,650,340 6,650,340 40,063,678 34,518,794 (450,000) 624,833 (2,898,631) 78,509,014 Repayment of ESOP related debt - - - - 50,000 - - 50,000 Cash divi- dends on common stock at $0.83 per share - - - (6,188,444) - - - (6,188,444) Dividend reinvest- ment plan 26,720 26,720 413,136 - - - - 439,856 Stock options exercised 51,750 51,750 308,834 - - - - 360,584 15% stock dividend 997,952 997,952 13,035,748 (14,033,700) - - - - Cash paid for frac- tional shares in connection with stock dividend - - - (8,934) - - - (8,934) Net change in unreal- ized gain/ loss on securities classified as avail- able-for- sale, net of taxes of $1,293,465 - - - - - 2,510,844 - 2,510,844 Net income - - - 8,221,877 - - - 8,221,877 --------- ---------- ----------- ----------- ---------- ----------- ----------- ----------- BALANCE, March 31, 1998 7,726,762 $7,726,762 $53,821,396 $22,509,593 $ (400,000) $ 3,135,677 $(2,898,631)$83,894,797 ========= ========== =========== =========== ========== =========== =========== =========== See accompanying notes to these financial statements. 17
HORIZON FINANCIAL CORP. CONSOLIDATED STATEMENT OF CASH FLOWS Years Ended March 31, 1998, 1997 and 1996 Increase (Decrease) in Cash and Cash Equivalents 1998 1997 1996 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 8,221,877 $ 7,803,420 $ 7,221,078 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 449,141 443,827 441,623 Amortization and deferrals, net 51,387 (724,355) 16,729 Provision for loan losses 355,000 200,400 110,000 Provision for deferred income tax 690,000 825,000 (476,824) Changes in assets and liabilities Interest and dividends receivable (133,234) 69,557 (374,338) Interest payable (98,714) (55,520) 147,879 Federal income tax (receivable) payable 422,085 (363,307) 1,944,115 Other assets (290,072) (140,600) 202,470 Other liabilities (904,241) 4,677,457 (180,051) ------------- ------------- ------------- Net cash flows from operating activities 8,763,229 12,735,879 9,052,681 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Change in interest-bearing deposits, net 417,967 (1,642,012) 2,854,791 Purchases of investment securities - available- for-sale (19,278,206) (8,626,426) (17,526,522) Proceeds from sales and maturities of investment securities - available-for- sale 13,972,408 16,807,528 16,324,963 Purchases of investment securities - held-to-maturity - - (12,989,293) Proceeds from maturities of investment securities - held- to-maturity 6,395,834 7,698,472 8,629,679 Proceeds from maturities of mortgage-backed securities - held-to-maturity 22,544,856 3,388,227 2,565,224 Purchases of mortgage-backed securities - held-to-maturity - - (2,787,555) Purchases of mortgage-backed securities - available- for-sale (6,510,126) (8,816,864) - Proceeds from maturities of mortgage-backed securities - available-for-sale 4,202,075 712,754 264,545 Proceeds from sales of loans 29,370,377 5,038,460 10,257,604 Principal payments on loans 79,122,140 66,132,069 56,451,474 Originations and purchases of loans (156,090,708) (108,647,972) (96,291,439) Purchases of bank premises and equipment (364,926) (328,469) (226,708) ------------- ------------- ------------- Net cash flows from investing activities (26,218,309) (28,284,233) (32,473,237) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES Change in checking and savings accounts, net 2,349,945 13,055,711 4,770,671 Proceeds from issuance of time deposits 152,668,178 154,013,669 146,567,614 Payments for maturing time deposits (129,704,352) (144,934,530) (126,365,297) Common stock issued, net 800,440 718,189 444,561 Cash dividends paid (6,197,378) (4,833,338) (2,099,206) Treasury stock purchased - (2,898,631) - ------------- ------------- ------------- Net cash flows from financing activities 19,916,833 15,121,070 23,318,343 ------------- ------------- ------------- NET CHANGE IN CASH AND CASH EQUIVALENTS 2,461,753 (427,284) (102,213) CASH AND CASH EQUIVALENTS, beginning of year 4,416,862 4,844,146 4,946,359 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS, end of year $ 6,878,615 $ 4,416,862 $ 4,844,146 ============= ============= ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for interest $ 22,334,114 $ 20,887,820 $ 20,625,585 ============= ============= ============= Cash paid during the year for income tax $ 3,110,000 $ 3,535,000 $ 2,118,000 ============= ============= ============= NONCASH INVESTING AND FINANCING TRANSACTIONS Mortgage loans securitized and exchanged for FHLMC participation certificates $ 12,622,660 $ 28,123,822 $ - ============= ============= ============= See accompanying notes to these financial statements. 18 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Nature of Operations - Horizon Financial Corp. (the "Company"), through its wholly-owned subsidiary, Horizon Bank (the "Bank"), provides a full range of mortgage lending services to borrowers and a full range of customer services to depositors through twelve branches located in Whatcom, Skagit and Snohomish Counties of Washington State. The Bank is an FDIC insured, state- chartered stock savings bank. (b) Financial Statement Presentation and Use of Estimates - The financial statements have been prepared in accordance with generally accepted accounting principles and reporting practices applicable to the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of revenues and expenses for the period and assets and liabilities as of the balance sheet date. Actual results could differ from estimated amounts. (c) Principles of Consolidation - As of March 31, 1998, 1997, and 1996, and for the years then ended, the consolidated financial statements include the accounts of Horizon Financial Corp. and its wholly-owned subsidiary, Horizon Bank. Westward Financial Services, Inc. is a wholly-owned subsidiary of Horizon Bank, whose accounts are also included in the consolidation. All material intercompany balances and transactions have been eliminated. Horizon Financial Corp. was formed during 1996. (d) Cash and Cash Equivalents - Cash and cash equivalents consist of cash on hand and noninterest-bearing amounts due from banks. (e) Investments in Interest-Bearing Deposits - Investments in interest-bearing deposits consist principally of federal funds sold to a major Seattle-area bank, repurchase agreements and short-term certificates of deposit with western Washington financial institutions. (f) Investments and Mortgage-Backed Securities - The Company classifies its securities into one of three categories: (1) held-to-maturity, (2) available-for-sale, or (3) trading. Investment securities are categorized as held-to-maturity when the Bank has the positive intent and ability to hold those securities to maturity. Securities which are held-to-maturity are stated at cost, adjusted for amortization of premiums, and accretion of discounts which are recognized as adjustments to interest income. Investment securities categorized as available-for-sale are generally held for investment purposes (to maturity), although unanticipated future events may result in the sale of some securities. Available-for-sale securities are recorded at fair value, with the net unrealized gain or loss included as a separate component of stockholders' equity net of the related tax effect. Realized gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. The Company did not have any investment securities categorized as trading securities at March 31, 1998 or March 31, 1997. (g) Loans Held for Sale - Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. (h) Loans Receivable - Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. 19 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Loan origination fees, net of certain direct loan origination costs, are deferred and recognized as an adjustment of the yield on the related loans, using the interest method. (i) Impaired Loans and Related Income - A loan is considered impaired when management determines that it is probable that all contractual amounts of principal and interest will not be paid as scheduled in the loan agreement. These loans include nonaccruing loans past due 90 days or more, loans restructured in the current year, and other loans that management considers to be impaired. When a loan is placed on nonaccrual status, all interest previously accrued, but not collected, is reversed and charged against interest income. Income on nonaccrual loans is then recognized only when the loan is brought current, or when, in the opinion of management, the borrower has demonstrated the ability to resume payments of principal and interest. Interest income on restructured loans is recognized pursuant to the terms of new loan agreements. Interest income on other impaired loans is monitored and based upon the terms of the underlying loan agreement. However, the recorded net investment in impaired loans, including accrued interest, is limited to the present value of the expected cash flows of the impaired loan, or the observable fair market value of the loan, or the fair value of the loan's collateral. (j) Mortgage Servicing Rights - During fiscal year 1997, the Company began to recognize the fair value of its retained mortgage servicing rights on loans sold or securitized, in accordance with Statement of Financial Accounting Standards No. 125 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Pursuant to these requirements, the Company allocates its total cost in mortgage loans between mortgage servicing rights and loans, based upon their relative fair values. Fair values are generally obtained through quoted market prices. The allocation of cost is made when the loan is originated if the Company has a definitive plan to sell or securitize the loan at that time, or, at the date of sale or securitization if a definitive plan did not exist at the date of origination. The Company generally retains mortgage servicing rights when loans are sold, and evaluates for impairment the costs allocated to these rights on a periodic basis. To account for possible impairment, the Company has established a valuation allowance to measure impairment of its mortgage servicing rights. Impairment is measured based upon the characteristics of the individual loans, including note rate, term, underlying collateral, current market conditions and estimates of net servicing income. The Company accounts for its recorded value, and possible impairment of mortgage servicing rights, on a loan-by-loan basis. The cost allocated to mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing income. (k) Provision for Loan Losses - Management estimates the provision for loan losses by 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 allowance is based upon factors and trends identified by future market factors beyond the Company's control, which may result in losses or recoveries differing significantly from those provided for in the financial statements. (l) Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation. Major renewals or betterments are capitalized and depreciated over their estimated useful lives. Depreciation is computed on the straight-line method over the estimated useful lives of thirty-five years for buildings and three to ten years for equipment. 20 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (m) Real Estate Owned - Real estate acquired through foreclosure is recorded at the lower of cost (unpaid loan balance plus foreclosure expenses) less any reserve, or estimated market value. At March 31, 1998 and 1997, the Company did not own any real estate acquired through foreclosure. (n) Income Taxes - The Company reports income and expenses using the accrual method of accounting and files a consolidated tax return which includes its subsidiary. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred taxes result from temporary differences in the recognition of certain income and expense amounts between the Bank's financial statements and its tax returns. (o) Earnings Per Share - On January 1, 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." This Statement supersedes Accounting Principles Board (APB) No. 15 "Earnings Per Share" and establishes standards for computing and presenting earnings per share. All prior years presented have been restated to conform with the new requirements. Basic earnings per share amounts are computed based on the weighted average number of shares outstanding during the period after giving retroactive effect to stock dividends and stock splits. Diluted earnings per share amounts are computed by determining the number of additional shares that are deemed outstanding due to the stock options under the treasury stock method. (p) Financial Instruments - All financial instruments held or issued by the Bank are held or issued for purposes other than trading. In the ordinary course of business, the Bank enters into off-balance-sheet financial instruments consisting of commitments to extend credit. These commitments are recorded in the financial statements when they are funded. (q) Advertising Costs - The Company expenses advertising costs as they are incurred. (r) Stock Options - The Company recognizes the financial effects of stock options in accordance with Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees (APB 25). Generally, stock options are issued at a price equal to the fair value of the Company's stock as of the grant date. Under APB 25, options issued in this manner do not result in the recognition of employee compensation in the Company's financial statements. Disclosures required by Statement of Financial Accounting Standard No. 123 Accounting for Stock-Based Compensation are provided in Note 12. (s) Reclassifications - Certain reclassifications have been made to prior years' amounts to conform to the current year presentation. These reclassifications have no significant effect on the Bank's previously reported financial position or results of operations. 21 PAGE HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 2 - INTEREST-BEARING DEPOSITS Interest bearing deposits consisted of the following at March 31, 1998 and 1997: 1998 1997 -------------- -------------- Federal funds sold $ 9,395,000 $ 9,325,000 Certificates of deposit 585,349 548,316 Repurchase agreement - 525,000 -------------- -------------- $ 9,980,349 $ 10,398,316 ============== ============== The Company has purchased securities under an agreement to resell substantially identical securities with a major Seattle-area bank. The amounts advanced under this agreement represent short-term loans and are reflected as interest-bearing deposits in the consolidated statement of financial position. The securities underlying the agreements are comprised of shares of a mutual fund, which trades primarily in U.S. government securities. The underlying investments, which mature within 90 days, are maintained by a third party custodian in an investment pool that is comprised of securities which have been purchased by a variety of institutions under similar agreements to resell. The Company's transactions have been executed under a written custodial agreement that explicitly recognizes the Company's interest in their portion of the total investment pool. Securities purchased under this agreement to resell averaged $59,200 and 56,543 monthly during 1998 and 1997, respectively. The maximum amount outstanding during any month in 1998 and 1997 amounted to $6,254,842 and $1,753,711, respectively. NOTE 3 - INVESTMENT SECURITIES The Company's investment policy requires that the Company purchase only high-grade investment securities. Purchases of debt instruments are generally restricted to those rated A or better by a nationally recognized statistical rating organization. The amortized cost and estimated market values of investments, together with unrealized gains and losses, are as follows as of March 31, 1998 and 1997, respectively: 1998 -------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ----------- ------------- Available-For- Sale Securities State and political subdivisions and U.S. government agency securities $20,258,274 $ 97,886 $(15,206) $ 20,340,954 Marketable equity securities 339,161 4,403,537 - 4,742,698 Corporate debt securities 8,717,329 14,898 (2,127) 8,730,100 ----------- ---------- --------- ----------- Total available-for-sale securities 29,314,764 4,516,321 (17,333) 33,813,752 ----------- ---------- --------- ----------- Held-To-Maturity Securities State and political subdivisions and U.S. government agency securities 1,486,248 334 (1,739) 1,484,843 Corporate debt securities 499,693 63,275 562,968 ----------- ---------- --------- ----------- Total held-to-maturity securities 1,985,941 63,609 (1,739) 2,047,811 ----------- ---------- --------- ----------- Total investment securities $31,300,705 $4,579,930 $(19,072) $35,861,563 =========== ========== ========== =========== 22 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 3 - INVESTMENT SECURITIES (Continued) 1997 -------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ----------- ------------- Available-For-Sale Securities State and political subdivisions and U.S. government agency securities $21,943,561 $ 88,452 $ (99,483) $21,932,530 Marketable equity securities 494,580 2,245,161 - 2,739,741 Corporate debt securities 1,570,825 42 (4,243) 1,566,624 ----------- ---------- --------- ----------- Total available-for-sale securities 24,008,966 2,333,655 (103,726) 26,238,895 ----------- ---------- --------- ----------- Held-To-Maturity Securities State and political subdivisions and U.S. government agency securities 4,970,193 3,261 (21,450) 4,952,004 Corporate debt securities 3,411,582 71,564 (3,270) 3,479,876 ----------- ---------- --------- ----------- Total held-to-maturity securities 8,381,775 74,825 (24,720) 8,431,880 ----------- ---------- --------- ----------- Total investment securities $32,390,741 $2,408,480 $(128,446) $34,670,775 =========== ========== ========= =========== The amortized cost and estimated fair value of investment securities at March 31, 1998 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 1998 ------------------------------------------------------- Available-For-Sale Held-To-Maturity --------------------------- ------------------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value ----------- ----------- ---------- ---------- State and political subdivisions and U.S. government agencies One year $ 7,713,624 $ 7,723,141 $ 997,635 $ 997,968 Two to five years 12,044,650 12,098,124 488,613 486,875 Six to ten years 500,000 519,689 - - ----------- ----------- ---------- ---------- 20,258,274 20,340,954 1,486,248 1,484,843 ----------- ----------- ---------- ---------- Corporate debt securities One year 2,581,555 2,583,132 - - Two to five years 5,583,610 5,596,281 499,693 562,968 Five to ten years 552,164 550,687 - - ----------- ----------- ---------- ---------- 8,717,329 8,730,100 499,693 562,968 ----------- ----------- ---------- ---------- Marketable equity securities One year 339,161 4,742,698 - - ----------- ----------- ---------- ---------- Total investment securities $29,314,764 $33,813,752 $1,985,941 $2,047,811 =========== =========== ========== ========== 23 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 3 - INVESTMENT SECURITIES (Continued) Proceeds from sales of investments and gross realized gains and losses on investment sales were as follows for the year ended March 31: 1998 1997 1996 ---------- -------- ------- Proceeds from sales of investments $1,949,359 $374,175 $89,624 ========== ======== ======= Gross gains realized on sales of investments $ 443,766 $303,072 $ 4,577 ========== ======== ======= Gross losses realized on sales of investments $ 3,590 $ 2,969 $ - ========== ======== ======= Information about concentrations of investments in particular industries for marketable equity securities and corporate debt securities at March 31 consist of the following: 1998 1997 ----------------------- ---------------------- Market Market Cost Value Cost Value ---------- ---------- ---------- ---------- Marketable equity securities Banking $ 318,380 $1,333,136 $ 427,562 $ 973,869 FHLMC common stock 19,318 2,798,812 20,955 1,308,000 Other 1,462 610,750 46,064 457,872 ---------- ---------- ---------- ---------- $ 339,160 $4,742,698 $ 494,581 $2,739,741 ========== ========== ========== ========== Corporate debt securities Brokerage companies $ - $ - $3,573,808 $3,637,874 Finance companies 7,813,687 7,826,725 1,008,823 1,009,375 Private utilities 903,642 903,375 399,775 399,251 ---------- ---------- ---------- ---------- $8,717,329 $8,730,100 $4,982,406 $5,046,500 ========== ========== ========== ========== At March 31, 1998 and 1997, U.S. government agency and corporate debt securities of $1,000,000 were pledged as collateral for deposits of state and local government agencies and deposits for trust accounts in excess of $100,000, as required by Washington State Law. NOTE 4 - MORTGAGE-BACKED SECURITIES Mortgage-backed securities at March 31 consist of the following: 1998 --------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ----------- ----------- ----------- Available-for-sale securities $33,100,230 $ 333,595 $ (81,558) $33,352,267 Held-to-maturity securities 15,488,523 307,729 (52,057) 15,744,195 ----------- ----------- ---------- ----------- Total mortgage-backed securities $48,588,753 $ 641,324 $ (133,615) $49,096,462 =========== =========== ========== =========== 1997 --------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ----------- ------------ ----------- Available-for-sale securities $36,512,300 $ 7,542 $(1,290,755) $35,229,087 Held-to-maturity securities 19,690,598 253,046 (522,486) 19,421,158 ----------- ----------- ----------- ----------- Total mortgage-backed securities $56,202,898 $ 260,588 $(1,813,241) $54,650,245 =========== =========== =========== =========== 24 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 4 - MORTGAGE-BACKED SECURITIES (Continued) The amortized cost and estimated fair value of mortgage-backed securities at March 31, 1998 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties. 1998 -------------------------------------------------------- Available-For-Sale Held-To-Maturity -------------------------- --------------------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value ----------- ----------- ------------ ------------- Mortgage-Backed Securities One year $ - $ - $ 623,170 $ 623,324 Two to five years 9,971,335 9,935,263 1,307,649 1,311,162 Six to ten years 2,990,897 2,990,897 1,067,863 1,106,285 After ten years 20,137,998 20,430,584 12,489,841 12,703,424 ----------- ----------- ------------ ------------ Total mortgage- backed securities $33,100,230 $33,352,267 $ 15,488,523 $ 15,744,195 =========== =========== ============ ============ All of the above mortgage-backed securities are rated AAA by a nationally recognized statistical rating organization. NOTE 5 - LOANS RECEIVABLE Loans receivable (collateralized principally by properties in the Whatcom, Skagit and Snohomish Counties of Washington State) at March 31 consist of the following: 1998 1997 ------------- ------------- First mortgage loans Conventional $ 524,805,125 $ 462,416,787 Construction - conventional 24,883,763 18,808,232 FHA 11,612 15,565 VA 6,741 8,132 Real estate contracts 130,240 137,466 ------------- ------------- 549,837,481 481,386,182 Less participating interests sold (112,251,375) (83,742,111) ------------- ------------- Net of first mortgage loans 437,586,106 397,644,071 Participation loan interests 1,802,347 2,559,423 Home equity loans 11,645,867 12,296,636 Home equity LOC 1,297,603 252,834 Loans on savings deposits 1,206,550 896,824 Consumer loans 3,209,353 3,220,759 Other loans 82,938 102,180 ------------- ------------- 456,830,764 416,972,727 Less: Undisbursed loan proceeds (12,635,603) (7,653,078) Unearned discounts - (39,204) Deferred loan fees (6,886,744) (6,796,172) Allowance for loan losses (3,611,150) (3,406,150) ------------- ------------- $ 433,697,267 $ 399,078,123 ============= ============= 25 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 5 - LOANS RECEIVABLE (Continued) The Company originates both adjustable and fixed interest rate loans. Adjustable rate loans typically contain annual rate increase caps (2%) and loan lifetime rate increase caps (6 to 8%). At March 31, 1998, the Company had adjustable and fixed rate loans as follows: Fixed Rate Adjustable Rate - ---------------------------------- ------------------------------------- Term to Maturity Book Value Term to Maturity Book Value - -------------------- ------------ ----------------------- ------------ Less than one year $ 3,405,171 Less than one year $ 31,105 One to two years 4,284,912 One to two years - Two to five years 31,525,291 Two to five years 50,453 Five to ten years 78,234,111 Five to ten years 555,816 Over ten years 318,224,721 Over ten years 20,519,184 Real estate loans serviced for others are $112,251,375 and $83,742,111, respectively, as of March 31, 1998 and 1997. Impaired loans on a nonaccrual basis or restructured, and the related interest, were not material at March 31, 1998 and 1997. The allowance for loan losses at March 31 and changes during the year are as follows: 1998 1997 1996 -------------- -------------- ------------- Balance, beginning of year $ 3,406,150 $ 3,236,150 $ 3,126,150 Provision for loan losses 355,000 200,400 110,000 Adjustment to reserves (150,000) (30,400) - -------------- -------------- ------------- Balance, end of year $ 3,611,150 $ 3,406,150 $ 3,236,150 ============== ============== ============= NOTE 6 - MORTGAGE SERVICING RIGHTS Loan costs allocated to mortgage servicing rights were as follows as of March 31, 1998: 1998 1997 ------------ ----------- Beginning balance $ 336,101 $ - Additions for new loans 406,064 337,131 Amortization (43,959) (1,030) ------------ ----------- Ending balance 697,206 336,101 Valuation allowance for impairment mortgage servicing rights (370,035) (179,743) ------------ ----------- Mortgage servicing rights, net $ 327,171 $ 156,358 ============ =========== Changes in the valuation allowance for impairment of mortgage servicing was as follows: Beginning balance $ (179,743) $ - Additions (214,292) (180,307) Credited to income 24,000 564 ------------ ----------- Ending balance $ (370,035) $ (179,743) ============ =========== 26 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 7 - ACCRUED INTEREST AND DIVIDENDS RECEIVABLE Accrued interest and dividends receivable at March 31 is summarized as follows: 1998 1997 ------------ ------------ Investment securities $ 650,808 $ 614,563 Mortgage-backed securities 260,353 318,792 Loans receivable 2,759,202 2,598,621 Dividends on marketable equity securities 8,251 13,404 ------------ ------------ $ 3,678,614 $ 3,545,380 ============ ============ NOTE 8 - PREMISES AND EQUIPMENT Premises and equipment at March 31 consisted of: 1998 1997 ------------ ------------ Buildings $ 5,298,206 $ 5,296,552 Equipment 4,034,632 3,741,511 ------------ ------------ 9,332,838 9,038,063 Accumulated depreciation (4,845,137) (4,416,148) ------------ ------------ 4,487,701 4,621,915 Land 1,558,767 1,508,768 ------------ ------------ $ 6,046,468 $ 6,130,683 ============ ============ NOTE 9 - DEPOSITS A comparative summary of deposits at March 31 follows (the contractual or weighted average interest rates are indicated in parentheses): 1998 1997 ------------- ------------ Demand deposits Savings (3.38%, 3.45%) $ 32,409,140 $ 31,800,323 Checking (1.67%, 1.68%) 25,033,979 24,294,988 Checking (noninterest-bearing) 4,140,517 3,472,171 Money market (3.42%, 3.51%) 16,593,831 15,926,449 Ultimate Money Market (3.95%, 4.42%) 38,871,298 39,204,888 ------------- ------------ 117,048,765 114,698,819 ------------- ------------ Time certificates of deposit Less than 6.00% 298,913,335 265,045,389 6.00% to 7.99% 30,185,878 40,996,844 8.00% to 9.99% 3,977,080 4,070,234 ------------- ------------ 333,076,293 310,112,467 ------------- ------------ Total deposits $ 450,125,058 $424,811,286 ============= ============ Time deposit accounts of $100,000 or more amount to $81,482,382 and $72,418,954 at March 31, 1998 and 1997, respectively. 27 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 9 - DEPOSITS (Continued) Time certificate of deposit maturities at March 31 are as follows: 1998 ----------------------------------------- Variable Fixed Rate Rate Total 1997 ----------- ------------ ------------ ------------ Within one year $ 7,009,341 $232,731,197 $239,740,538 $205,528,793 One to two years 2,908,677 30,177,586 33,086,263 46,376,735 Two to three years 279,655 11,580,160 11,859,815 9,557,908 Three to four years 274,137 5,042,779 5,316,916 3,769,238 Four to five years 692,431 4,388,862 5,081,293 4,931,360 Over five years 13,658,144 24,333,324 37,991,468 39,948,433 ----------- ------------ ------------ ------------ $24,822,385 $308,253,908 $333,076,293 $310,112,467 =========== ============ ============ ============ The terms of variable rate CDs allow customers to make additional deposits to existing CDs at any time. The weighted average nominal interest rate on all deposits at March 31, 1998 and 1997 is 5.08 percent and 5.10 percent, respectively. Interest expense on deposits for the years ended March 31 is summarized as follows: 1998 1997 1996 ----------- ----------- ----------- Money market $ 2,217,726 $ 2,169,938 $ 1,979,018 Checking 461,249 427,690 468,000 Savings 1,064,260 1,039,920 1,013,374 Certificates of deposit 18,492,165 17,194,752 17,313,072 ----------- ----------- ----------- $22,235,400 $20,832,300 $20,773,464 =========== =========== =========== NOTE 10 - INCOME TAX Deferred income tax results from temporary differences in the recognition of income and expense for tax and financial statement purposes. The source of these differences and the related tax effects for the years ended March 31 are as follows: 1998 1997 1996 ---------- ---------- ---------- Deferred loan fees $ (766,610) $ (897,980) $ (758,129) Loan loss and general reserves 85,224 53,984 232,638 Deferred compensation (5,100) 70,187 24,521 Other, net (3,514) (51,191) 24,146 ---------- ---------- ---------- $ (690,000) $ (825,000) $ (476,824) ========== ========== ========== 28 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 10 - INCOME TAX (Continued) The nature and components of the Company's net deferred tax assets (liabilities), established at an estimated tax rate of 34 percent, are as follows at March 31: 1998 1997 ----------- ----------- Deferred Tax Assets Deferred loan fees in excess of amounts deferred for tax purposes $ - $ 280,000 Deferred compensation agreements 435,000 440,000 Financial reporting accrued expenses not recognized for tax purposes 275,000 275,000 ----------- ----------- Total deferred assets 710,000 995,000 ----------- ----------- Deferred Tax Liabilities Deferred loan fees for tax purposes in excess of amounts deferred for financial reporting purposes (485,000) - Tax based loan loss deductions not recognized for financial reporting (1,290,000) (1,375,000) Tax effect of unrealized gains on available-for-sale securities (1,615,348) (321,883) Other deferred tax liabilities (199,380) (194,381) ----------- ----------- Total deferred liabilities (3,589,728) (1,891,264) ----------- ----------- Net deferred tax assets (liabilities) $(2,879,728) $ (896,264) =========== =========== The Company believes, based upon the available evidence, that all deferred assets will be realized in the normal course of operations. Accordingly, these assets have not been reduced by a valuation allowance. A reconciliation of the Company's income tax provision to the statutory federal income tax rate for the years ended March 31 is as follows: 1998 1997 1996 ----------- ----------- ----------- Provision for income tax at the statutory rate of 34 percent $ 4,228,422 $ 4,012,038 $ 3,674,403 Increase (decrease) in tax resulting from Dividends received deduction (18,638) (17,891) (21,057) Other, net 4,873 2,546 (67,355) ----------- ----------- ----------- Income tax provision $ 4,214,657 $ 3,996,693 $ 3,585,991 =========== =========== =========== For fiscal years 1996 and 1995, the Company was allowed a bad debt deduction of 8 percent of taxable income, subject to certain limitations. During 1997 a tax law change eliminated this tax deduction, and, in addition, requires the Company to recapture and pay taxes on these deductions taken after fiscal year ended March 31, 1988. The Company has previously recorded deferred tax liabilities to account for this obligation. Therefore, the Company believes retroactive effects of this law change will not be significant. The cumulative tax-basis bad debt deduction as of March 31, 1998 and 1997 was approximately $13,650,000. If any portion of this amount is subsequently used for purposes other than to absorb loan losses, that portion will be subject to federal income tax at the then prevailing tax rate. 29 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 11 - BENEFIT PLANS (a) Defined Benefit Retirement Plan - The Company has a noncontributory defined benefit retirement plan which covers all full-time employees with one year of continuous service who were also eligible to participate as of December 31, 1992. Effective January 1, 1993, the Company curtailed the enrollment of new participants to the plan. Concurrent with the curtailment, the plan fiscal year end was changed to December 31. Contributions to the plan are based upon the Projected Unit Credit actuarial funding method. A new 401(k) plan (see Note 11e) has been established by the Company as an alternative to this defined benefit plan. The plan's funded status as of December 31, 1998, 1997 and 1996 was as follows: December 31 ---------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Accumulated benefit obligation Vested $ 2,485,842 $ 2,330,443 $ 2,148,381 Nonvested 51,148 51,541 50,753 ----------- ----------- ----------- $ 2,536,990 $ 2,381,984 $ 2,199,134 =========== =========== =========== Projected benefit obligation $ 3,327,085 $ 3,081,040 $ 2,883,175 Fair value of plan assets (2,667,341) (2,340,028) (2,041,493) ----------- ----------- ----------- Projected benefit obligation over (under) plan assets 659,744 741,012 841,682 Unrecognized prior service cost 103,436 116,801 130,166 Unrecognized net gain (loss) (446,484) (493,996) (559,491) Unrecognized net transition asset 70,882 89,373 107,864 ----------- ----------- ----------- Accrued pension cost $ 387,578 $ 453,190 $ 520,221 =========== =========== =========== Net annual pension cost includes the following components for the plan year ended December 31: December 31 ---------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Service costs - benefits earned during the period $ 124,996 $ 128,641 $ 158,895 Interest cost on projected benefit obligation 182,027 170,244 162,797 Actual return on plan assets (214,496) (162,872) (70,400) Net amortization and deferrals 58,458 31,460 (38,684) ----------- ----------- ----------- Net pension cost $ 150,985 $ 167,473 $ 212,608 =========== =========== =========== The weighted average assumptions used were as follows: 1998 1997 1996 ----------- ----------- ------------ Discount rate 6 % 6 % 6 % Rate of increase in compensation levels 5 % 5 % 5 % Expected long-term rate of return on plan assets 6 % 6 % 6 % 30 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 11 - BENEFIT PLANS (Continued) (b) Deferred Compensation Plan - The Company has entered into deferred compensation agreements with certain of its officers. The agreements provide for additional retirement benefits payable over a twelve to seventeen year period following retirement. In connection with these agreements, the Company has acquired life insurance policies on the individual officers covered by the deferred compensation agreements. At March 31, 1998 and 1997, the cash surrender values of these policies included in other assets aggregated $1,667,504 and $1,551,342, respectively. Deferred compensation expense amounted to $71,900, $293,521 and $32,000 in 1998, 1997 and 1996, respectively. (c) Profit Sharing Arrangement - The Company has a profit sharing arrangement with employees meeting certain service requirements. Payments made to employees pursuant to the arrangement are based upon earnings, growth in deposits and attainment of certain corporate objectives. Costs of the arrangement were $338,536, $412,829 and $437,370 for 1998, 1997 and 1996, respectively. (d) Employee Stock Ownership Plan - All employees of the Company who have completed a minimum number of years of service with the Company are eligible to participate in the Company's employee stock ownership plan ("ESOP"). Participants receive distributions from the ESOP only in the event of retirement, disability or termination of employment. The primary purpose of the ESOP is to acquire shares of the Company's common stock on behalf of ESOP participants. In April 1996, the Company issued a new loan to the ESOP in the amount of $500,000, to purchase shares of common stock in the open market. The loan is to be repaid over a period of ten years, with annual payments including interest due on March 31. For the years ending March 31, 1998, 1997 and 1996, the Company contributed $81,500, $82,442 and $26,737, including interest, to the ESOP which is included in compensation expense. The outstanding balance of the loan at March 31, 1998 and 1997 amounted to $450,000 and $400,000, respectively. (e) 401(k) Plan - Effective January 1, 1993, the Company adopted a defined contribution 401(k) retirement and savings plan (the "Plan") covering substantially all employees. The Company contributes 3 percent of participating employee's eligible salary to the Plan and a discretionary amount determined annually by the Board of Directors. Total contributions to the Plan amounted to $125,609, $118,577 and $119,737 for the years ended March 31, 1998, 1997 and 1996, respectively. NOTE 12 - STOCKHOLDERS' EQUITY (a) Capital Requirements - The Corporation and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines on the regulatory framework for prompt corrective action, the Corporation must meet specific capital adequacy guidelines that involve quantitative measures of each entity's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. 31 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 12 - STOCKHOLDERS' EQUITY (Continued) Quantitative measures established by regulation to ensure capital adequacy require maintenance of minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of March 31, 1998, that each entity meets all capital adequacy requirements to which they are subject. As of February 24, 1997, the most recent notification from the Bank's regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. To be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions -------------------- ---------------------- ------------------------ Amount Ratio Amount Ratio Amount Ratio --------- --------- ---------- ---------- ----------- ---------- As of March 31, 1998 Total Capital (to Risk Weighted Assets) Greater/less Greater/less Consolidated $ 83,956 28.4% $ 23,601 than 8.0% $ 29,501 than 10% Greater/less Greater/less Horizon Bank $ 83,848 28.4% $ 23,599 than 8.0% $ 29,499 than 10% Tier I Capital (to Risk Weighted Assets) Greater/less Greater/less Consolidated $ 81,259 27.5% $ 11,800 than 4.0% $ 17,700 than 6% Greater/less Greater/less Horizon Bank $ 81,151 27.5% $ 11,799 than 4.0% $ 17,699 than 6% Tier I Capital (to Average Assets) Greater/less Greater/less Consolidated $ 81,259 15.3% $ 21,250 than 4.0% $ 26,562 than 5% Greater/less Greater/less Horizon Bank $ 81,151 15.3% $ 21,249 than 4.0% $ 26,561 than 5%
To be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions -------------------- ---------------------- ------------------------ Amount Ratio Amount Ratio Amount Ratio --------- --------- ---------- ---------- ----------- ---------- As of March 31, 1997 Total Capital (to Risk Weighted Assets) Greater/less Greater/less Consolidated $ 80,951 30.4% $ 21,279 than 8.0% $ 26,599 than 10% Greater/less Greater/less Horizon Bank $ 80,875 30.4% $ 21,277 than 8.0% $ 26,596 than 10% Tier I Capital (to Risk Weighted Assets) Greater/less Greater/less Consolidated $ 78,384 29.5% $ 10,640 than 4.0% $ 15,960 than 6% Greater/less Greater/less Horizon Bank $ 78,309 29.4% $ 10,638 than 4.0% $ 15,958 than 6% Tier I Capital (to Average Assets) Greater/less Greater/less Consolidated $ 78,384 15.6% $ 20,086 than 4.0% $ 25,108 than 5% Greater/less Greater/less Horizon Bank $ 78,309 15.6% $ 20,085 than 4.0% $ 25,106 than 5%
(b) Holding Company Loans - Under federal regulations, the Bank is limited, unless previously approved, as to the amount it may loan to the holding company and any one affiliate to 10 percent of its capital stock and surplus, and the total of loans to the holding company and affiliates must not exceed 20 percent of capital and surplus. Further, all such loans must be fully collateralized. 32 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 12 - STOCKHOLDERS' EQUITY (Continued) (c) Dividend Reinvestment Plan - As a service to its stockholders of record, the Bank offers a Dividend Reinvestment and Stock Purchase Plan ("Reinvestment Plan"). Under the terms of the Reinvestment Plan, dividends and optional cash payments may be reinvested toward the purchase of additional shares of stock. No brokerage commission or fees are charged to acquire shares through the Reinvestment Plan. (d) Stock Repurchase Plans - During the year ended March 31, 1998, the Company announced a plan to repurchase up to 747,000 shares, or approximately 10% of the Company's outstanding common stock. The repurchase program is expected to be completed within 24 months. Pursuant to an earlier plan, the Company has repurchased 249,090 shares for a total adjusted basis of $2,898,631. (e) Stock Option and Incentive Plans - The Company may award options for a maximum of 704,087, as restated, of authorized common stock to certain officers and key employees under the 1987 Stock Option and Incentive Plan. The 1987 Incentive Plan is intended to provide for the granting of both incentive and nonincentive stock options. Options are granted at the then fair market value and vest at 20 to 35 percent per year. Options are exercisable from one to five years from date of grant, subject to certain limitations, and expire after 10 years. The Company may award options for a maximum of 414,000 as restated, of authorized common stock to certain officers and key employees under the 1995 Stock Option and Incentive Plan. Options are granted at no less than fair market value and may or may not vest immediately upon issuance based on the terms established by the Board of Directors. Options are generally exercisable within three to five years from date of grant and expire after 10 years. Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123 Accounting for Stock-Based Compensation. The pro forma information recognizes, as compensation, the value of stock options granted using an option valuation model known as the Black Scholes model. Pro forma earnings per share amounts also reflect an adjustment for an assumed purchase of treasury stock from proceeds deemed obtained from the issuance of stock options. The fair value for options issued in 1996 and 1997 is estimated at $578,890 and $12,401. The fair value of options issued in 1998 is estimated at $90,307. The following assumptions were used to estimate the fair value of the options: 1998 1997 1996 ------ ------- ------ Risk-free interest rate 5.66 % 6.71 % 6.73 % Dividend yield rate 5.117 % 5.263 % 2.535 % Price volatility .2542 .2227 .2192 Weighted average expected life of options 3.78 yr. 4.07 yr. 4.34 yr. Management believes that the assumptions used in the option pricing model are highly subjective and represent only one estimate of possible value, as there is no active market for the options granted. The fair value of the options granted in 1996, 1997 and 1998 will be allocated to pro forma earnings over the vesting period of the options. Accordingly, until the provisions for SFAS 123 are recognized for all years for which options have been granted, pro forma earnings will likely reflect an increasing amount of compensation expense resulting from the stock options. Pro forma disclosures: 1998 1997 1996 ------ ------- ------ Net income as reported $ 8,221,877 $ 7,803,420 $ 7,221,078 Additional compensation for fair value of stock options 170,399 147,823 144,723 ----------- ----------- ----------- Pro forma net income $ 8,051,478 $ 7,655,597 $ 7,076,355 =========== =========== =========== 33 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 12 - STOCKHOLDERS' EQUITY (Continued) 1998 1997 1996 ------ ------- ------ Earnings per share Basic As reported $ 1.11 $ 1.04 $ 0.96 ======= ======= ======= Proforma $ 1.08 $ 1.02 $ 0.93 ======= ======= ======= Diluted As reported $ 1.09 $ 1.03 $ 0.95 ======= ======= ======= Proforma $ 1.07 $ 1.01 $ 0.93 ======= ======= ======= Shares of Common Stock -------------------------- Weighted Average of Available for Under Exercise Price of Option/Award Plan Shares Under Plan ------------ ------------ -------------------- Balance, March 31, 1995 1,591 283,367 Authorized 414,000 - Granted (185,380) 185,380 10.635 to 10.922 Exercised - (77,896) 2.499 to 12.648 Lapsed 11,060 (11,060) 2.499 to 12.648 ------- ------- Balance, March 31, 1996 241,272 379,790 Authorized - - Granted (5,750) 5,750 11.685 Exercised - (53,731) 2.983 to 12.648 Lapsed 19,552 (19,552) 2.983 to 12.648 Expired (9,049) - ------- ------- Balance, March 31, 1997 246,025 312,257 Authorized - - Granted (25,500) 25,500 18.625 Exercised - (62,369) 6.983 - 12.648 Lapsed 11,252 (11,252) 6.983 - 12.648 Expired (7) - ------- ------- Balance, March 31, 1998 231,770 264,136 ======= ======= Options Outstanding Options Exercisable ----------------------------------- ---------------------- Weighted Average Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price ---------- ----------- ----------- -------- ----------- -------- $5 to $10 86,666 3.395 years $ 7.78 86,666 $ 7.78 $10 to $15 151,970 7.389 years 10.96 76,928 11.05 $15 to $20 25,500 10.000 years 18.63 - - At March 31, 1997, 495,905 shares of common stock were reserved for issuance pursuant to stock plans, options and conversions of preferred stock. 34 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 13 - EARNINGS PER SHARE The numerators and denominators of basic and diluted earnings per share are as follows: 1998 1997 1996 ----------- ----------- ----------- Net income (numerator) $ 8,221,877 $ 7,803,420 $ 7,221,078 Shares used in the calculation (denominators) Basic earnings per share weighted average shares outstanding 7,435,782 7,478,666 7,535,956 Effect of dilutive stock options 108,481 71,688 66,130 ----------- ----------- ----------- Diluted shares 7,544,263 7,550,354 7,602,086 =========== =========== =========== Basic earnings per share $ 1.11 $ 1.04 $ 0.96 ======= ======= ======= Diluted earnings per share $ 1.09 $ 1.03 $ 0.95 ======= ======= ======= NOTE 14 - COMMITMENTS AND CONTINGENCIES (a) Employment Agreement - The Company has entered into a four-year employment agreement with the Company's president at an amount approximating his current level of compensation. In the event of specified terminations of the president's employment following a change in control of the Company (as defined), the agreement provides the president with severance payments of up to three times his annual compensation plus continuation of certain benefits. (b) Contingency Reserve - The Company has a contingency reserve of $252,993 recorded to reflect the estimated impairment of value related to pension plan assets invested with Mutual Benefit Life Insurance Company. The Company plans to honor its pension commitments and, after reviewing all of the available information, has reserved approximately 9 percent of the plan's asset values to reflect this commitment. (c) Long-Term Lease Commitments - The Company has entered into lease agreements for three branch offices located in Snohomish County, Washington. Future noncancelable lease payments under these agreements are as follows for the years ending March 31: 1999 $ 85,020 2000 60,370 2001 18,000 ----------- $ 163,390 =========== NOTE 15 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK Most of the Bank's business activity is with customers located within Whatcom, Skagit and Snohomish Counties. Investments in state and municipal securities involve governmental entities within the state of Washington. The Bank originates commercial, real estate and consumer loans. Generally, loans are secured by deposit accounts, personal property or real estate. Rights to collateral vary and are legally documented to the extent practicable. Although the Bank has a diversified loan portfolio, local economic conditions may affect borrowers' ability to meet the stated repayment terms. 35 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 16 - FINANCIAL INSTRUMENTS The Bank is a party to financial instruments with off-balance-sheet risk (loan commitments) in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. Loan commitments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the balance sheet. The contract amounts of those commitments reflect the extent of the Bank's exposure to credit loss from these commitments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Loan commitments are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank's experience has been that substantially all loan commitments are drawn upon by customers. Collateral held usually includes single family residential property and income producing commercial properties. The Bank has not incurred any losses on its commitments in 1998, 1997 or 1996. Loan commitments outstanding were $23,467,932 in 1998, $2,523,820 in 1997 and $6,578,804 in 1996. NOTE 17 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of the following classes of financial instruments: Cash Equivalents and Federal Funds Sold - Due to the relatively short period of time between the origination of these instruments and their expected realization, the carrying amount is estimated to approximate market value. Investment and Mortgage-Backed Securities, and Loans Held-for-Sale - For securities and loans held-for-sale, fair values are based on quoted market prices or dealer quotes, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loan Receivables - For certain homogeneous categories of loans, such as those written to Federal Home Loan Mortgage Corporation ("FHLMC") standards, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Deposit Liabilities and Federal Funds Purchased - The fair value of demand deposits, savings accounts, certain money market deposits, and federal funds purchased, is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the estimated future cash flows using the rates currently offered for deposits with similar remaining maturities. Off-Balance-Sheet Instruments - The Company's off-balance-sheet instruments include unfunded commitments to extend credit. The fair value of these instruments is not considered practicable to estimate because of the lack of quoted market price and the inability to estimate fair value without incurring excessive costs. 36 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 17 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair values of the Bank's financial instruments at March 31, 1998 and 1997 are as follows: 1998 1997 -------------------------- ------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ------------- ------------ ----------- ------------ Financial Assets Cash and cash equivalents $ 6,878,615 $ 6,878,615 $ 4,416,862 $ 4,416,862 Investment securities 35,799,693 35,861,563 34,620,670 34,670,775 Mortgage-backed securities 48,840,520 49,096,462 54,919,685 54,650,245 Interest-bearing deposits 9,980,349 9,980,349 10,398,316 10,398,316 Loans 433,697,267 438,828,229 399,078,123 389,241,544 Accrued interest and dividends receivable 3,678,614 3,678,614 3,545,380 3,545,380 Financial Liabilities Demand and savings deposits 117,048,765 117,048,765 114,698,819 114,698,819 Time deposits 333,076,293 334,751,011 310,112,467 311,259,095 Accounts payable and accrued liabilities 7,774,742 7,774,742 8,686,028 8,686,028 Accrued interest payable 151,083 151,083 249,797 249,797 NOTE 18 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION In Thousands --------------------- 1998 1997 ---------- ---------- Condensed balance sheet at March 31, 1998: Cash $ 257 $ 386 Investment in bank 83,737 78,434 Other assets 723 332 -------- -------- $ 84,717 $ 79,152 ======== ======== Other liabilities $ 822 $ 643 Stockholders' equity 83,895 78,509 -------- -------- $ 84,717 $ 79,152 ======== ======== 37 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 18 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION (Continued) Condensed statement of income for the year ended March 31, 1998: In Thousands ----------------------- 1998 1997 -------- -------- Income Cash dividends from Bank subsidiary $ 5,742 $ 7,128 -------- -------- Expenses Compensation 91 89 Other 260 241 -------- -------- Total expenses 351 330 -------- -------- Income before equity in undistributed income of subsidiary and benefit equivalent to income taxes 5,391 6,798 Benefit equivalent to income taxes 89 84 -------- -------- Income before equity in undistributed income of subsidiary 5,480 6,882 Equity in undistributed income of subsidiary 2,742 921 -------- -------- Net income 8,222 $ 7,803 ======== ======== In Thousands ----------------------- 1998 1997 -------- -------- Cash flows from operating activities Net income $ 8,222 $ 7,803 Adjustments to reconcile net income to net cash flow from operating activities Equity in undistributed income of subsidiary (2,742) (921) Other operating activities (212) 352 -------- -------- Net cash flows from operating activities 5,268 7,234 -------- -------- Cash flows from financing activities Sale of common stock 800 718 Dividends paid (6,197) (4,833) Repurchase of common stock - (2,899) -------- -------- Net cash flows from financing activities (5,397) (7,014) -------- -------- Net change in cash (129) 220 Cash, beginning of year 386 166 -------- -------- Cash, end of year $ 257 $ 386 ======== ======== 38 HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Year Ended March 31, 1998 ------------------------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ------------ ------------ -------------- ------------- Interest income $ 9,942,613 $ 10,095,188 $ 10,371,826 $ 10,491,287 Interest expense 5,387,132 5,598,327 5,679,271 5,570,670 ------------ ------------ ------------- ------------- Net interest income 4,555,481 4,496,861 4,692,555 4,920,617 Provision for loan losses 30,000 150,000 0 175,000 Other income 282,002 721,811 234,509 452,951 Other expenses 1,795,176 1,972,764 1,788,079 2,009,234 ------------ ------------ ------------- ------------- Income from continuing operations before income tax 3,012,307 3,095,908 3,138,985 3,189,334 Federal income tax 1,021,259 1,047,837 1,065,245 1,080,316 ------------ ------------ ------------- ------------- Net income $ 1,991,048 $ 2,048,071 $ 2,073,740 $ 2,109,018 ============ ============ ============= ============= Basic Earnings per share (adjusted for stock splits and dividends) $ .27 $ .28 $ .28 $ .28 ======== ======== ======== ======== Diluted earnings per share (adjusted for stock splits and dividends) $ .26 $ .27 $ .28 $ .28 ======== ======== ======== ========
Year Ended March 31, 1997 ------------------------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ------------ ------------ -------------- ------------- Interest income $ 9,509,539 $ 9,596,672 $ 9,878,619 $ 9,725,809 Interest expense (5,125,258) (5,193,467) (5,267,939) (5,245,636) ------------ ------------ ------------ ------------ Net interest income 4,384,281 4,403,205 4,610,680 4,480,173 Provision for loan losses (60,000) (50,000) (60,400) (30,000) Other income 310,430 599,038 355,013 318,582 Other expenses (1,790,346) (2,152,266) (1,820,079) (1,698,198) ------------ ------------ ------------ ------------ Income from continuing operations before income tax 2,844,365 2,799,977 3,085,214 3,070,557 Federal income tax (962,206) (947,978) (1,042,909) (1,043,600) ------------ ------------ ------------ ------------ Net income $ 1,882,159 $ 1,851,999 $ 2,042,305 $ 2,026,957 ============ ============ ============ ============ Basic Earnings per share (adjusted for stock splits and dividends) $ .25 $ .24 $ .28 $ .27 ======== ======== ======== ======== Diluted earnings per share (adjusted for stock splits and dividends) $ .25 $ .24 $ .27 $ .27 ======== ======== ======== ========
NOTE 20 - NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, Reporting Comprehensive Income. This Statement establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Statement becomes effective April 1, 1998, for the Company. The Financial Accounting Standards Board also issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information" in June 1997. The Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements. Management believes that the provisions of SFAS No. 131 will not have a material effect on its financial condition or reported 39 PAGE HORIZON FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 NOTE 20 - NEW ACCOUNTING PRONOUNCEMENTS (Continued) results of operations. This Statement becomes effective April 1, 1998, for the Company. These pronouncements provide additional disclosures about the Bank's operations and are not anticipated to have material effect on financial position or results of operations. In February 1998, the Financial Accounting Standards Board issued SFAS 132, Employers' Disclosures about Pensions and Other Postretirement Benefits-an amendment of FASB Statements No. 87, 88, and 106. This Statement revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. Rather, it standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer useful. This Statement becomes effective April 1, 1998, for the Company. NOTE 21 - YEAR 2000 COMPLIANCE As year 2000 approaches, an important business issue has emerged regarding how existing application software programs and operating systems can accommodate the date value. Many software systems are designed to accommodate a two-digit year, and may read the year 2000 as the year 1900 and compute payment, interest or delinquency based on the wrong date or are not expected to be able to process the information at all. The Bank primarily utilizes a third-party service bureau for processing of the material data that could be affected by this problem. The service bureau is in the process of updating, modifying or replacing its computer applications to ensure year 2000 compliance. In addition, the Bank has instituted a year 2000 compliance program whereby the Bank is reviewing the year 2000 compliance issues that may be faced by its other third-party vendors and its own internal computer systems. In the event that the Bank's significant suppliers do not successfully and timely achieve year 2000 compliance, the Bank's business or operations could be adversely affected. However, management believes the Bank's own internal system, networks and resources would allow the Bank to effectively operate and service its customers, and the Bank intends to engage alternative vendors and suppliers. While the Bank cannot estimate the costs and expenses associated with hiring new vendors and suppliers, management believes such costs would not have a material impact on the Bank's earnings or results of operations. 40 DIRECTORS AND OFFICERS ========================================================================================================= DIRECTORS OFFICERS OF HORIZON Elizabeth E. (Beth) Sherry FINANCIAL CORP. Vice President Robert C. Diehl George W. Gust Carla J. Williams Diehl Ford, Inc., a car dealership. Chairman of the Board Vice President V. Lawrence Evans V. Lawrence Evans Donald A. Wolf President & Chief Executive Officer President & Chief Executive Officer Vice President Horizon Financial Corp. Maurice (Dennis) Fox Kelli J. Holz, CPA Theresa A. Aiello Former owner of HydroSwirl Vice President Vice President Manufacturing Corp., a hot tub and spa manufacturer. Richard P. Jacobson Tammy D. Barnett Vice President & Corporate Secretary Assistant Vice President Gary E. Goodman Tosco Refinery, Inc., an oil refinery. Karen A. LePage Marie A. Collings Vice President Assistant Vice President George W. Gust Chairman of the Board OFFICERS OF Sandra L. Hain Horizon Financial Corp. HORIZON BANK Assistant Vice President Richard R. Haggen V. Lawrence Evans Majorie K. LaValley Haggen, Inc., a grocery chain. Chairman of the Board Assistant Vice President President & Chief Executive Officer Fred R. Miller Claudia B. Jonas Former owner of Skagit Richard P. Jacobson Assistant Vice President Bonded Collectors, Inc., Senior Vice President & a collection agency. Corporate Secretary Theresa A. Ledford Assistant Vice President L.M. (Larry) Strengholt Karla C. Lewis Strengholt Construction Co., Inc., Senior Vice President Carol A. Whelchel a general building contractor. Assistant Vice President Judy E. Boxx Frank Uhrig Vice President Yeagers, Inc., a sporting goods store. Kelli J. Holz, CPA DIRECTORS EMERITUS Vice President John H. Dunkak III Jeffery Jansen Robert E. Ebright, DVM Vice President Howard E. Mitchell, PH.D. Morris Tarte Karen A. LePage A.E. (Al) Williamson Vice President Sandra R. Mathewson Vice President Merwyn G. Murk Vice President ========================================================================================================= 41
CORPORATE INFORMATION ========================================================================================================= Corporate Headquarters Stockholder Information Stock Prices and Dividend Information Bellingham & Dividend Reinvestment Horizon Financial Corp.'s common Cornwall Office David Eldred stock is traded on The NASDAQ 1500 Cornwall Avenue Investor Relations National Market under the symbol Bellingham, WA 98225 Horizon Financial Corp. HRZB. The common stock began trading (360) 733-3050 P.O. Box 580 on the NASDAQ system at the time of Bellingham, WA 98227 Horizon's conversion to stock form in Email & Website (360) 733-3050 August 1986. info@horizon-bank.com The following table presents the high www.horizon-bank.com Annual Meeting and low prices as reported by the Horizon Financial Corp.'s annual meeting NASDAQ stock market and dividends Subsidiaries of stockholders will be at 2 p.m. paid for the last two fiscal years. Horizon Bank Tuesday, July 28, 1998 at the Best These prices represent quotations by 1500 Cornwall Avenue Western Lakeway Inn, 714 Lakeway Drive, the dealers and do not necessarily Bellingham, WA 98225 Bellingham, WA 98226. represent actual transactions, and do (360) 733-3050 not include retail markups, markdowns Transfer Agent or commissions. The Corporation has Westward Financial Request for information concerning approximately 5,300 stockholders. Services Corp. transfer requirements, dividend pay- Subsidiary of Horizon ment, lost stock certificates, change 1998 Fiscal Year Bank, of address and other shareholder Qtr. High Low Dividend 1500 Cornwall Avenue matters should be directed to: ------------------------------------ Bellingham, WA 98225 4th $19.36 $16.25 $0.51 (360) 733-3050 American Stock Transfer 3rd 18.50 15.75 0.11 & Trust Company 2nd 16.75 14.50 0.11 Auditors 40 Wall Street 1st 16.63 11.74 0.10 Moss Adams LLP New York, NY 10005 ------------------------------------ 114 West Magnolia, (800) 937-5449 1997 Fiscal Year Suite 301 Qtr. High Low Dividend Bellingham, WA 98225 ------------------------------------ (360) 676-1920 Dividend Reinvestment 4th $14.57 $11.52 $0.09 As a service to its stockholders of 3rd 12.17 10.65 0.39 Special Counsel record, the Corporation offers a 2nd 12.17 10.87 0.09 John F. Breyer, Jr. Dividend Reinvestment and Stock 1st 11.52 10.22 0.09 Breyer & Aguggia LLP Purchase Plan. Under the terms of the ------------------------------------ 1300 I Street N.W., Plan, dividends and optional cash pay- Suite 470 E. ments may be reinvested toward the Dividend Policy Washington, D.C. 20005 purchase of additional shares of stock. Horizon Financial Corp. historically (202) 737-7900 No brokerage commission or fees are has paid cash dividends on its common charged to acquire shares through the stock. The Corporation must adhere General Counsel Plan. For a Plan prospectus, or to to certain regulatory requirements John S. Ludwigson enroll in the Plan, please contact the governing the distribution of divi- Ludwigson, Thompson, American Stock Transfer & Trust dends, and there can be no assurance Hayes & Bell Company Dividend Reinvestment that the Corporation will continue to 119 N. Commercial Department at the following address: declare cash dividends in the future. Bellingham, WA 98225 (360) 734-2000 American Stock Transfer & Trust Company Dividend Reinvestment Financial Information Department Richard P. Jacobson 40 Wall Street Vice President & New York, NY 10005 Corporate Secretary (800) 278-4353 Horizon Financial Corp. P.O. Box 580 Bellingham, WA 98227 (360) 733-3050 ========================================================================================================= 42
OFFICE LOCATIONS ========================================================================================================= Anacortes Everett, WA Mill Creek, WA 98012 1218 Commercial Avenue (425) 353-9410 (425) 316-6900 Anacortes, WA 98221 Terry Aiello Diane Heaslett (360) 293-4571 Assistant Vice President Loan Officer Claudia Jonas & Office Manager Mary Holmes Assistant Vice President Chris Bolyard Customer Service Manager & Office Manager Loan Officer Carol Watts Mount Vernon Loan Officer Ferndale 1503 Riverside Drive 2045 Main Street Mount Vernon, WA 98290 Bellingham/Cornwall Ferndale, WA 98248 (360) 424-7022 1500 Cornwall Avenue (360) 384-1400 Lucille Collazo Bellingham, WA 98225 Carol Whelchel Loan Officer (360) 733-3050 Assistant Vice President Bill Ketcheside & Loan Officer Loan Officer Bellingham/Meridian Diane Myers John Voth 4110 Meridian Customer Service Manager Customer Service Manager Bellingham, WA 98226 (360) 734-0181 Lynden Snohomish Debbie Harris 300 Grover Street 620 2nd Street Customer Service Manager Lynden, WA 98264 Snohomish, WA 98290 (360) 354-5678 (360) 568-1522 Blaine Jeffrey Jansen Teresa Ledford 400 H Street Vice President Assistant Vice President Blaine, WA 98230 & Office Manager & Office Manager (360) 332-8333 Pam Martin Sharon Yonally Loan Officer Visit our website Loan Officer Carol Dean Mill Creek email: info@horizon-bank.com Customer Service Manager 13416 Bothell Everett Highway 222.horizon-bank.com Suite 201 Burlington 1020 South Burlington Blvd. Burlington, WA 98233 ------------------------------------------------------------------------------ (360) 757-3200 No Postage Tammy Barnett Necessary if Assistant Vice President Mailed & Office Manager ------------------------------- In the Wendy Goodman BUSINESS REPLY CARD United States Loan Officer First Class Permit No. 34 Bellingham, WA Edmonds ------------------------------- 315 5th Avenue South Postage will be paid by Addressee Edmonds, WA 98020 (425) 744-1333 HORIZON BANK Sandra Hain INVESTOR RELATIONS Assistant Vice President PO BOX 580 & Office Manager BELLINGHAM, WA 98227-9855 Everett 909 S.E. Everett Mall Way Suite E-500 =========================== 43
Email us *** Info@horizon-bank.com *** ----------------------------------- Visit our website *** www.horizon-bank.com *** ----------------------------------- - ------------------------------------------------------------ Dividend Reinvestment Information Request - ------------------------------------------------------------ Please send me information regarding 24 Hour Telephone Horizon's Dividend Reinvestment & Stock Purchase Plan. Banking *** Mailing Address 1.888.512.BANK *** Name: ------------------------------------------------------ Address: --------------------------------------------------- City: State: Zip: --------------------- ------------ ---------- Phone: Fax: E-mail: ----------- ------------------ ------------ How are your shares held? [ ] I have physical possession of my stock certificates. [ ] My stock is held by a stock broker or other nominee. [Back cover] [Logo - Horizon Financial Corp.] Exhibit 21 Subsidiaries of the Registrant Parent - ------ Horizon Financial Corp. Jurisdiction Percentage or State of Subsidiaries (a) of Ownership Incorporation - ---------------- ------------ ------------- Horizon Bank, a savings 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 Annual Report filed as Exhibit 13 hereto and incorporated herein by reference. (b) Wholly-owned subsidiary of Horizon Bank, a savings bank. Exhibit 23 Consent of Auditors [Letterhead of Moss Adams LLP] CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-99780) of Horizon Financial Corp. of our report dated April 29, 1998 appearing in the 1998 Annual Report to Stockholders 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, 1998. /s/MOSS ADAMS LLP - ----------------- MOSS ADAMS LLP Bellingham, Washington June 25, 1998 Exhibit 27 Financial Data Schedule Exhibit 27 Financial Data Schedule This schedule contains financial information extracted from the consolidated financial statements of Horizon Financial Corp. for the year ended March 31, 1998 and is qualified in its entirety by reference to such financial statements. Financial Data as of or for the year Item Number ended March 31, 1998 Item Description - ----------- -------------------- ---------------- 9-03(1) 6,878,615 Cash and due from the Banks 9-03(2) 9,980,349 Interest-bearing deposits 9-03(3) -- Federal funds sold - purchased securities for resale 9-03(4) -- Trading account assets 9-03(6) 67,166,019 Investment and mortgage backed securities held for sale 9-03(6) 17,474,464 Investment and mortgage backed securities held to maturity - carrying value 9-03(6) 17,792,006 Investment and mortgage backed securities held to maturity - market value 9-03(7) 433,697,267 Loans 9-03(7)(2) 3,611,150 Allowance for losses 9-03(11) 547,146,296 Total assets 9-03(12) 450,125,058 Deposits 9-03(13) -- Short-term borrowings 9-03(15) 13,126,441 Other liabilities 9-03(16) -- Long-term debt 9-03(19) -- Preferred stock - mandatory redemption 9-03(20) -- Preferred stock - no mandatory redemption 9-03(21) 7,726,762 Common stocks 9-03(22) 76,168,035 Other stockholders' equity 9-03(23) 547,146,296 Total liabilities and stockholders' equity 9-04(1) 35,008,202 Interest and fees on loans 9-04(2) 5,892,712 Interest and dividends on investments 9-04(4) -- Other interest income 9-04(5) 40,900,914 Total interest income 9-04(6) 22,235,400 Interest on deposits 9-04(9) 22,235,400 Total interest expense 9-04(10) 18,665,514 Net interest income 9-04(11) 355,000 Provision for loan losses 9-04(13)(h) 83,508 Investment securities gains/(losses) 9-04(14) 7,565,253 Other expenses 9-04(15) 12,436,534 Income/loss before income tax 9-04(17) 12,436,534 Income/loss before extraordinary items 9-04(18) -- Extraordinary items, less tax 9-04(19) -- Cumulative change in accounting principles 9-04(20) 8,221,877 Net income or loss 9-04(21) 1.11 Earnings per share - basic 9-04(21) 1.09 Earnings per share - diluted I.B.5 8.06 Net yield - interest earning assets - actual III.C.1.(a) -- Loans on non-accrual III.C.1.(b) 25,345 Accruing loans past due 90 days or more III.C.2.(c) -- Troubled debt restructuring III.C.2 -- Potential problem loans IV.A.1 3,406,150 Allowance for loan loss - beginning of period IV.A.2 -- Total chargeoffs IV.A.3 -- Total recoveries IV.A.4 3,611,150 Allowance for loan loss - end of period IV.B.1 914,750 Loan loss allowance to allocated to domestic loans IV.B.2 -- Loan loss allowance to foreign loans IV.B.3 2,696,400 Loan loss allowance - unallocated EX-27 2
9 12-MOS MAR-31-1998 MAR-31-1998 6878615 9980349 0 0 67166019 17474464 17792006 433697267 3611150 547146296 450125058 0 13126441 0 0 0 7726762 76168035 547146296 35008202 5892712 0 40900914 22235400 22235400 18665514 355000 83508 7565253 12436534 12436534 0 0 8221877 1.11 1.09 8.06 0 25345 0 0 3406150 0 0 3611150 914750 0 2696400
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