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.
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(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
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(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
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(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).
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PART I
Item 1. Business
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(a) General
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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
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Selected Financial Data
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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
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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
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Yields Earned and Rates Paid
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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
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<TABLE>
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
------- ---- ------- -------- ---- ------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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%
====== ====== ======
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<TABLE>
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
------ ---- ------ ----- ------ ---- ------ ----- ------ ---- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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
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Lending Activities
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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
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<TABLE>
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)
<S> <C> <C> <C> <C> <C> <C>
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
====== ======= ======= ======== ======== ========
</TABLE>
<TABLE>
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)
<S> <C> <C> <C>
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
====== === ======
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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
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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
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<PAGE>
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
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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
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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.
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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
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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
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<TABLE>
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)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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
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<PAGE>
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;
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<PAGE>
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
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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
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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
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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
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<PAGE>
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
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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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<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
<PAGE>
<PAGE>
(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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
Exhibit 13
Annual Report to Stockholders
<PAGE>
<PAGE>
HRZB
HORIZON FINANCIAL CORP.
FISCAL 1998 ANNUAL REPORT
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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.
<PAGE>
<TABLE>
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
<S> <C> <C> <C> <C> <C> <C> <C>
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
<PAGE>
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
<PAGE>
<PAGE>
HORIZON FINANCIAL CORP.
Independent Auditor's Report
and
Consolidated Financial Statements
March 31, 1998, 1997 and 1996
13
<PAGE>
<PAGE>
[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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
<TABLE>
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
--------- ---------- ----------- ------------ --------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
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
</TABLE>
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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.
<PAGE>
<TABLE>
To be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------- ---------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
--------- --------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
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%
</TABLE>
<TABLE> To be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------- ---------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
--------- --------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
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%
</TABLE>
<PAGE>
(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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
HORIZON FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1998, 1997 and 1996
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<PAGE>
<TABLE>
Year Ended March 31, 1998
-------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
------------ ------------ -------------- -------------
<S> <C> <C> <C> <C>
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
======== ======== ======== ========
</TABLE>
<TABLE>
Year Ended March 31, 1997
-------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
------------ ------------ -------------- -------------
<S> <C> <C> <C> <C>
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
======== ======== ======== ========
</TABLE>
<PAGE>
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
<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
<PAGE>
<PAGE>
<TABLE>
DIRECTORS AND OFFICERS
=========================================================================================================
<S> <C> <C>
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
</TABLE>
<PAGE>
<PAGE>
<TABLE>
CORPORATE INFORMATION
=========================================================================================================
<S> <C> <C>
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.
[email protected] 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
</TABLE>
<PAGE>
<PAGE>
<TABLE>
OFFICE LOCATIONS
=========================================================================================================
<S> <C> <C>
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: [email protected]
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
</TABLE>
<PAGE>
<PAGE>
Email us
***
[email protected]
***
-----------------------------------
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.
<PAGE>
<PAGE>
[Back cover]
[Logo - Horizon Financial Corp.]
<PAGE>
<PAGE>
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.
<PAGE>
<PAGE>
Exhibit 23
Consent of Auditors
<PAGE>
<PAGE>
[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<PAGE>
Exhibit 27
Financial Data Schedule
<PAGE>
<PAGE>
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
<PAGE>
<PAGE>
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
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 6878615
<INT-BEARING-DEPOSITS> 9980349
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 67166019
<INVESTMENTS-CARRYING> 17474464
<INVESTMENTS-MARKET> 17792006
<LOANS> 433697267
<ALLOWANCE> 3611150
<TOTAL-ASSETS> 547146296
<DEPOSITS> 450125058
<SHORT-TERM> 0
<LIABILITIES-OTHER> 13126441
<LONG-TERM> 0
0
0
<COMMON> 7726762
<OTHER-SE> 76168035
<TOTAL-LIABILITIES-AND-EQUITY> 547146296
<INTEREST-LOAN> 35008202
<INTEREST-INVEST> 5892712
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 40900914
<INTEREST-DEPOSIT> 22235400
<INTEREST-EXPENSE> 22235400
<INTEREST-INCOME-NET> 18665514
<LOAN-LOSSES> 355000
<SECURITIES-GAINS> 83508
<EXPENSE-OTHER> 7565253
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