SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the quarterly period ended June 30, 1999
-------------
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the transition period from March 31, 1999 to June 30, 1999
Commission file number 0-27062
Horizon Financial Corp.
-----------------------
(Exact name of registrant as specified in its charter)
Chartered by the State of Washington
------------------------------------
(State or other jurisdiction of incorporation or organization)
91-1695422
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(IRS Employer Identification No.)
1500 Cornwall Avenue
Bellingham, Washington
----------------------
(Address of principal executive offices)
98225
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(Zip Code)
Registrant's telephone number including area code: (360) 733-3050
--------------
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
----- -----
As of August 6, 1999, 8,529,869 common shares, $1.00 par value, were
outstanding.
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HORIZON FINANCIAL CORP.
INDEX PAGE
- ----- ----
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Statements of Financial Condition 3
Consolidated Statements of Operations 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flow 6-7
Notes to Consolidated Financial Statements 8-9
Item 2 Management's discussion and Analysis of Financial
Condition and Results of Operations 9-14
PART II OTHER INFORMATION
Item 1 Legal Proceedings 15
Item 2 Changes in Securities 15
Item 3 Defaults Upon Senior Securities 15
Item 4 Submission of Matters to a Vote of Security Holders 15
Item 5 Other Information 15
Item 6 Exhibits and Reports on Form 8-K 15
SIGNATURES
2
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HORIZON FINANCIAL CORP.
Consolidated Statements of Financial Condition
June 30, March 31,
1999 1999*
---- ----
(Unaudited) (Unaudited)
ASSETS:
- ------
Cash and Due from Banks $ 11,904,662 $ 10,889,530
Interest-Bearing Deposits 8,909,050 15,572,363
Investment Securities - Available for Sale 25,295,797 27,631,904
Investment Securities-Held to Maturity 1,364,383 1,391,873
Mortgage-Backed Securities - Available for Sale 51,527,520 43,886,859
Mortgage-Backed Securities - Held to Maturity 9,889,458 10,959,539
Federal Home Loan Bank stock 4,879,600 4,861,700
Loans Receivable 533,664,035 533,649,169
Accrued Interest and Dividends Receivable 3,899,654 3,739,470
Property and Equipment, Net 12,248,075 11,609,414
Goodwill 674,495 688,846
Other Assets 2,950,731 3,235,435
------------ ------------
Total Assets $667,207,460 $668,116,102
============ ============
LIABILITIES:
- -----------
Deposits $537,079,130 $537,389,845
Securities sold under agreements to repurchase 14,700,000 14,800,000
Borrowings 7,000,000 7,918,151
Accounts payable and other liabilities 6,556,482 6,034,947
Advances by Borrowers for Taxes and Insurance 472,920 928,618
Deferred Compensation 1,275,875 1,260,100
Net Deferred Income Tax Liabilities 2,046,289 2,572,474
Income Tax Payable 1,334,592 770,986
------------ ------------
Total Liabilities $570,465,288 $571,675,121
============ ============
STOCKHOLDERS' EQUITY:
- --------------------
Serial Preferred Stock, $1.00 Par Value,
10,000,000 Shares Authorized;
None Issued or Outstanding - -
Common Stock, $1.00 Par Value,
30,000,000 shares Authorized;
8,517,539 and 8,491,523 Shares Issued
and Outstanding $ 8,517,539 $ 8,491,523
Paid-in Capital 56,670,363 56,459,066
Retained Earnings 29,785,032 28,638,576
Net unrealized gain/(loss) on investments
available for sale 2,273,963 3,201,816
Debt Related to ESOP <350,000> <350,000>
------------ ------------
Total Stockholders' Equity $ 96,742,172 $ 96,440,981
============ ============
Total Liabilities and Stockholders' Equity $667,207,460 $668,116,102
============ ============
* All prior year numbers have been restated to reflect the merger of
Bellingham Bancorporation effective June 19, 1999.
(See Notes to Financial Statements)
3
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HORIZON FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
3 Months Ended
June 30
1999 1998*
---- ----
INTEREST INCOME:
- ---------------
Interest on Loans $10,533,781 $10,141,493
Interest and Dividends on Investment and
Mortgage-Backed Securities 1,566,627 1,531,751
----------- -----------
Total Interest Income 12,100,408 11,673,244
INTEREST EXPENSE:
- ----------------
Interest on Deposits 5,988,484 6,144,642
Interest on Borrowings 311,402 81,636
----------- -----------
Total Interest Expense 6,299,886 6,226,278
----------- -----------
Net Interest Income 5,800,522 5,446,966
----------- -----------
Provision for Loan Losses 44,000 344,500
----------- -----------
Net Interest Income After Provision
For Loan Losses 5,756,522 5,102,466
----------- -----------
NON-INTEREST INCOME:
- -------------------
Service Fees 482,646 455,764
Net Gain (Loss) on Sale of Loans < 44,641> <114,712>
Net Gain (Loss) on Sale of Investments 185,018 301,836
Other 174,913 359,753
----------- -----------
Total Non-Interest Income 797,936 1,002,641
----------- -----------
NON-INTEREST EXPENSE:
- --------------------
Compensation and Employee Benefits 1,654,038 1,282,485
Building Occupancy 532,567 381,538
Other Expenses 1,278,245 938,923
----------- -----------
Total Non-Interest Expense 3,464,850 2,602,946
----------- -----------
Income Before Provision for
Income Taxes 3,089,608 3,502,161
Provision for Income Taxes 1,006,222 1,189,391
----------- -----------
Net Income $2,083,386 $2,312,770
=========== ===========
Earnings Per Share:
Basic Earnings Per Share $.25 $.27
Diluted Earnings Per Share $.23 $.27
* All prior year numbers have been restated to reflect the merger
of Bellingham Bancorporation effective June 19, 1999.
(See Notes to Financial Statements)
4
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<TABLE>
HORIZON FINANCIAL CORP.
Consolidated Statements of Changes in Stockholder's Equity
3 Months Ended June 30, 1999 and 1998 *
(unaudited)
Common Stock
------------ Additional Accum Other Debt
Number Paid-In Retained Comprehensive Related
Of Shares At Par Capital Earnings Income to ESOP Total
--------- ------- ------- -------- ------ ------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at 3/31/98 8,460,858 $8,460,858 $55,688,886 $22,993,399 $3,135,677 $<400,000> $ 89,878,820
Cash div on common
stock at $.11 per
share <823,734> <823,734>
Stock opts.
exercised 2,923 2,923 25,696 28,619
DRIP 7,356 7,356 124,588 131,944
Net change in other
Comprehensive income <1,660> <1,660>
Net income 2,312,770 2,312,770
--------- ---------- ----------- ----------- ---------- --------- ------------
Balance at 6/30/98 8,471,137 $8,471,137 $55,839,170 $24,482,435 $3,134,017 $<400,000> $ 91,526,759
========= ========== =========== =========== ========== ========= ============
Balance at 3/31/99 8,491,523 $8,491,523 $56,459,066 $28,638,576 $3,201,816 $<350,000> $ 96,440,981
Cash div on common <936,930> <936,930>
stock at $.11 per share
Stock opts
exercised 16,638 16,638 106,390 123,028
DRIP 9,378 9,378 104,907 114,285
Net change in other
comprehensive income <$927,853> <927,853>
Loan to ESOP <154,725> <154,725>
Net income 2,083,386 2,083,386
--------- ---------- ----------- ----------- ---------- --------- ------------
Balance at 6/30/99 8,517,539 $8,517,539 $56,670,363 $29,785,032 $2,273,963 $<504,725> $96,742,172
========= ========== =========== =========== ========== ========= ============
* All prior year numbers have been restated to reflect the merger of Bellingham
Bancorporation effective June 19, 1999.
(See Notes to Financial Statements)
</TABLE>
5
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HORIZON FINANCIAL CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
3 Months Ended
June 30,
1999 1998 *
---- ----
Cash Flows From Operating Activities:
Net Income $ 2,083,386 $2,312,770
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Depreciation 234,735 121,520
Provision for loan losses 44,000 344,500
Changes in Assets and Liabilities:
Interest & Dividends Receivable <160,184> 211,672
Interest Payable 68,126 20,362
Federal Income Tax (rec) Payable 563,606 1,189,391
Other Assets 284,704 <82,331>
Other Liabilities <41,558> <3,108,727>
Goodwill 14,351 23,918
---------- ----------
Net Cash Flows from Operating Activities 3,091,166 1,033,075
---------- ----------
Cash Flows From Investing Activities:
Inv in Interest-Bearing Deposits, Net 6,663,313 7,858,065
FHLB Stock <17,900> <3,500>
Purchases of Investment securities-AFS <5,280,000> <500,000>
Proceeds from Sales and Mat of 7,466,427 4,829,936
Purchases of Investment Securities-HTM - -
Proceeds from Sales & Mat of HTM 27,490 1,002,049
Purchases of Mtge Backed Securities - AFS - -
Sales from Mat of Mtge Backed Sec - AFS 1,635,273 7,415,266
Purch Mtg. Backed - HTM - -
Mat Mtge Back - HTM 1,070,081 1,106,518
Net Change in Loans <10,738,840> <29,883,848>
Purchases of Bank Premises and Equipment <873,396> <761,069>
---------- ----------
Net Cash Flows From Investing Activities <47,552> <8,936,583>
---------- ----------
* All prior year numbers have been restated to reflect the merger of
Bellingham Bancorporation effective June 19, 1999.
(See Notes to Financial Statements)
6
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HORIZON FINANCIAL CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
3 Months Ended
June 30,
1999 1998 *
---- ----
Cash Flows From Financing Activities:
Change in Deposits <310,715> 508,918
Borrowings <1,018,151> 7,710,353
Common Stock Issued, Net 237,313 160,563
Cash Dividends Paid <936,929> <823,734>
---------- ---------
Net Cash Flows from Financing Activities <2,028,482> 7,556,100
---------- ---------
Net change in Cash and Cash Equivalents 1,015,132 <347,408>
Cash and Cash Equivalents,
Beginning of Year 10,889,530 9,841,417
Cash and Cash Equivalents,
End of Year 11,904,662 9,494,009
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
Cash Paid During the Period for:
Interest Expense $5,988,484 6,145,873
Income Taxes $ 425,000 -
* All prior year numbers have been restated to reflect the merger of
Bellingham Bancorporation effective June 19, 1999.
(See Notes to Financial Statements)
7
<PAGE>
HORIZON FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 1999
(unaudited)
NOTE A - Basis of Presentation
- ------------------------------
The unaudited consolidated financial statements have been prepared in
accordance with general accepted accounting principles for interim financial
information and with the instructions to the Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting only of normal recurring accruals) necessary for a fair
presentation are reflected in the interim financial statements. The results
of operations for the periods ended June 30, 1999 and 1998 are not necessarily
indicative of the operating results for the full year. The March 31, 1999,
consolidated statement of financial condition presented with the interim
financial statements has been restated to reflect the merger of Bellingham
Bancorporation effective June 19, 1999. For audited financial results, refer
to the consolidated financial statements and footnotes thereto included in the
Bank's annual report for the year ended March 31, 1999.
On October 13, 1995, Horizon Bank, a savings bank, ("Bank") reorganized into
the holding company form of ownership ("Reorganization"), resulting in the
Registrant becoming the sole stockholder of the Bank. Each outstanding share
of common stock of the Bank and options to acquire shares of common stock of
the Bank, became outstanding shares of common stock of the Registrant and
options to acquire shares of common stock of the Registrant, respectively, as
a result of the Reorganization. The consolidated financial statements for the
three months ended June 30, 1999, include the accounts of Horizon Financial
Corp., the Bank and other subsidiaries of the Bank. Significant intercompany
balances and transactions have been eliminated in consolidation.
Prior to Reorganization, Horizon Financial Corp. had no material assets or
liabilities and engaged in no business activity. Subsequent to the
acquisition of the bank, Horizon Financial Corp. has engaged in no significant
activity other than holding the stock of the Bank.
On June 19, 1999 Bellingham Bancorporation merged into Horizon Financial Corp.
This transaction was accounted for as a pooling of interests. As such, all
prior year numbers have been restated to reflect the merger.
NOTE B - Net Income Per Share
- -----------------------------
Basic earnings per share for the three months ended June 30, 1999 and 1998 are
calculated on the basis of 8,500,329 and 8,461,843 weighted average shares
outstanding. Diluted earnings per share for the three months ended June 30,
1999 and 1998 are calculated on the basis of 8,632,551 and 8,640,979 weighted
average share outstanding, respectively. Diluted EPS figures are computed by
determining the number of additional shares that are deemed outstanding due to
stock options under the treasury stock method.
8
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NOTE C - Reclassification
- -------------------------
Certain reclassifications have been made to prior financial statements to
conform with current presentation. Such reclassifications have no effect on
net income. All prior year numbers have been restated to reflect the merger
with Bellingham Bancorporation.
HORIZON FINANCIAL CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS
General
- -------
The Corporation was formed under Washington law on May 22, 1995, and became
the holding company of the Bank, effective October 13, 1995. As a bank holding
company, the Corporation 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 then 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 15 full-service office facilities,
located in Whatcom, Skagit and Snohomish counties in northwest Washington. The
Bank is currently building an additional office in Whatcom County, located in
the Barkley Village area of Bellingham, in the northeast portion of the city.
In addition to serving the growing population in this area, this office
(approximately 15,000 square feet) will serve as an operation center to
support additional growth for the Corporation. Completion of construction is
scheduled for the fourth quarter of 1999. The Bank is also currently working
on plans to build an office at Murphy's Corner near Mill Creek, which will
replace the Bank's current leased location in that area. During the fiscal
year ended March 31, 1999, the Bank relocated its Edmonds office by purchasing
the Dayton Place building at the corner of 5th and Dayton in downtown Edmonds.
During the quarter ended June 30, 1999, the Bank purchased a bank site in
Marysville, which will provide additional growth opportunities. The Bank's
management continues to research sites for future development, with emphasis
on locations in the growing Snohomish County markets.
At its 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 subsequent 24 month period. This repurchase
plan was rescinded by the Board of Directors effective January 18, 1999 with
the signing of the definitive agreement to merge with Bellingham
Bancorporation.
In December 1998, the Bank became a member of the Federal Home Loan Bank of
Seattle. One of the significant benefits of membership include the ability to
supplement the Bank's balance sheet with
9
<PAGE>
wholesale funds in order to meet cyclical funding needs and to assist
management in its interest rate risk management efforts.
On January 18, 1999, the Corporation announced a definitive agreement to merge
with Bellingham Bancorporation. The merger of Bellingham Bancorporation into
Horizon Financial Corp. was completed on June 19, 1999 and was accounted for
as a pooling of interests. The historical numbers presented herein for
Horizon Financial Corp. have been restated to include Bellingham
Bancorporation's numbers.
Financial Condition
- -------------------
The balance sheet for the Corporation was little changed at June 30, 1999,
compared to March 31, 1999. Total consolidated assets for the Corporation as
of June 30,1999, were $667,207,460, a slight decrease from the March 31, 1999,
level of $668,116,102. Total liabilities also decreased slightly to
$570,465,288 at June 30,1999, from $571,675,121 at March 31, 1999.
Stockholders' equity showed a small increase to $96,742,172 at June 30, 1999,
from $96,440,981 at March 31, 1999.
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 June 30, 1999, the Bank had liquid assets
(cash and marketable securities with maturities of one year or less) with a
book value of $43,197,136.
As of June 30, 1999, the total book value of investments and mortgage-backed
securities was $89,511,358 compared to a market value of $93,022,297,
resulting in an unrealized gain of $3,510,939. On March 31, 1999, the book
value of investments and mortgage-backed securities was $83,582,540 compared
to a market value of $88,721,979 resulting in an unrealized gain of
$5,139,439. The primary reason for this difference at June 30, 1999 compared
to March 31, 1999 was the overall higher level of interest rates, which
decreased the valuation of the bank's investment portfolio.
The Bank's primary sources of funds are cash flow from operations, which
consist mainly of mortgage loan repayments; deposit increases; loan sales;
borrowings; and cash received from the maturity or sale of investment
securities. These funds are primarily used to originate real estate secured
mortgage loans and commercial loans.
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) Borrowing from the Federal
Home Loan Bank of Seattle; 4) Accepting additional jumbo and/or public funds
deposits; or 5) Accessing the discount window of the Federal Reserve Bank of
San Francisco.
Stockholders' equity to total assets was 14.52% as of June 30, 1999, well in
excess of the 5.0% minimum required by the FDIC in order to be considered well
capitalized.
10
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Comparative Results of Operations
For the Three Months Ended
June 30, 1999 and 1998
Net Interest Income
Net interest income for the three months ended June 30, 1999, increased 6.49%
to $5,800,522 from $5,446,966 in the same time period of the previous year.
Interest on loans for the quarter ended June 30, 1999, increased 3.87% to
$10,533,781, from $10,141,493. This increase was due primarily to an overall
growth in loans receivable. Interest and dividends on investments and
mortgage-backed securities increased 2.28% to $1,566,627, from $1,531,751 for
the comparable quarter a year ago. Total interest income increased 3.66% to
$12,100,408 from $11,673,244. This increase is primarily attributable to an
overall increase in interest earning assets over the prior period.
Total interest paid on deposits decreased 2.54% to $5,988,484 from $6,144,642.
This decrease in interest expense is due to a lower level of interest rates
being paid on certificates of deposit, along with a shift in the overall
deposit mix, specifically the growth in non-interest bearing checking
accounts. Interest on borrowings increased to $311,402 during the quarter,
compared to $81,636 for the comparable period one year ago, due to a higher
level of borrowings outstanding. During the quarter, the bank continued to
carry wholesale borrowings in order to further leverage its balance sheet and
better manage its interest rate risk profile.
Provision for losses on loans
- -----------------------------
The provision for losses on loans for the three months ended June 30, 1999,
decreased 87.23% to $44,000 from $344,500 in the same time period of the
previous year. The provision made in the quarter ended June 30, 1998,
represented 87% of the loan loss provisions for the entire fiscal year. At
June 30, 1999, the loan loss reserve balance was $4,502,287. This represents
.84% of loans receivable, compared to .90% as of June 30, 1998. The Bank's
management considers this to be an adequate level of reserves at this time.
As of June 30, 1999, the Bank had $714,641 in loans over 90 days delinquent
compared to $267,145 at June 30, 1998. This is due in part to the changing
mix of loans on the Bank's balance sheet, which now includes more commercial,
consumer, VISA and other unsecured loans.
Non Interest Income
- -------------------
Non interest income for the three months ended June 30, 1999, decreased 20.42%
to $797,936 from $1,002,641 for the same time period a year ago. Service fee
income increased 5.90% to $482,646 from $455,764. The net gain/loss on the
sale of loans showed a loss of $44,641 during the quarter, compared to a loss
of $114,712 in the comparable period one year ago. These losses in the prior
year were due primarily to the sale of approximately $11 million in long-term
fixed rate mortgage loans during the quarter. When the Bank sells loans, the
remaining outstanding fees associated with these mortgages flow to the income
statement as interest income. The proceeds directly related to the loan
balances, however, are reflected as non-interest income. Therefore, even when
the sale of loans generate an overall profit to the Bank (including the
recognition of the fee income), the non-interest portion of the
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<PAGE>
sale reflects a loss, due to the pricing of the loans at the time of the sale.
The net gain/loss on sales of investment securities decreased to $185,018 for
the quarter ended June 30, 1999 from $301,836 for the comparable period one
year ago. These gains were due primarily to the sale of selected common
stocks and mortgage backed securities from the Bank's investment portfolio
during the quarters. Other non-interest income for the quarter decreased
51.38% to $174,913 from $359,753. One significant reason for this difference
relates to the sale of mortgage servicing rights. Prior to the merger with
Horizon, the Bank of Bellingham's mortgage division sold its mortgage
servicing rights at the time it sold loans in the secondary market. Horizon,
however, retains the servicing rights on the loans it sells, which defers
income into future quarters as servicing fee income. The quarter ended June
30, 1998 was an active quarter of servicing released loan sales, therefore the
non-interest income for that period was higher than the quarter ended June 30,
1999.
Non Interest Expense
- --------------------
Non interest expense for the three months ended June 30, 1999, increased
33.11% to $3,464,850 from $2,602,946. Compensation and employee benefits
increased 28.97% for the quarter ended June 30, 1999, to $1,654,038 from
$1,282,485. This is due primarily the overall growth in employment at the
Bank from the prior year period. Building occupancy for the quarter ended
June 30, 1999 increased 39.58% to $532,567 from $381,538. Factors
contributing to this increase include: a new office in Edmonds, opened in
March 1999; a new office in Bellingham, opened by the Bank of Bellingham in
November 1998; and considerable technology upgrades implemented over the past
year, including the replacement of most of the personal computers at the Bank,
and the installation of a wide area network. Other non-interest expenses
increased 36.14% to $1,278,245 from $938,923. The primary reason for this
increase relates to approximately $275,000 in merger related recognized during
the period, including legal and accounting fees, investment banking expenses,
and computer conversion charges.
Year 2000 Discussion
- --------------------
General. The year 2000 ("Y2K") issue centers on the potential inability of
computer systems and programs to recognize the year 2000. Many existing
computer programs and systems originally were programmed to allow only two
digits to identify the calendar year in the date field. If left unchanged,
these programs and systems might interpret "00" as the year 1900, rather than
as the year 2000.
Regulation. Financial institution regulators have increased their focus upon
Year 2000 issues and have issued guidance concerning the responsibilities of
senior management and directors. The sole subsidiary of Horizon Financial
Corp., Horizon Bank ("Bank") has been examined by the FDIC and the State of
Washington's Department of Financial Institutions on several occasions,
including both on-site and off-site exams. The Bank's most recent exam was
conducted by the State of Washington in February of 1999. In addition, the
Bank has been notified of an additional Year 2000 exam to be conducted in
August 1999. Regulations do not allow the Bank to make public the results of
the State or FDIC examinations. However, the Bank's Board of Directors
reviews each report, and the Board is satisfied with management's progress to
date regarding Year 2000 issues.
The Federal Financial Institution Examination Council ("FFIEC") has issued
several interagency statements on Year 2000 issues. These statements require
financial institutions to proceed through five phases of year 2000
preparedness. The following sections summarize these phases, and the Bank's
progress to date in each phase:
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<PAGE>
Awareness Phase. The Bank has established a formal Year 2000 plan and created
an internal Year 2000 committee, which has been meeting on this issue since
1997. This phase focused on identifying those systems and programs that had
the potential of being affected by Year 2000 risks. This phase also included
educating the Bank's employees about Year 2000 issues and resulted in a bank
wide effort to identify potential problems related to the Year 2000. This
phase was substantially completed early in 1998.
Assessment Phase. This phase focused on completing assessments of hardware,
software and other computer applications in order to identify risks and
monitor Year 2000 progress. Further, this phase included a prioritization of
Year 2000 risks, to identify which systems were mission critical systems for
the Bank's business, and which were considered less important in terms of
potential adverse impact to the Bank. This assessment was substantially
completed in mid 1998.
Renovation Phase. Following the Assessment Phase, the Bank moved into the
renovation phase, which focused on identifying solutions to potential Year
2000 problems with its systems and programs. During the fourth quarter of
1998, the Bank completed a major personal computer renovation, which included
new machines at all teller stations, and numerous other network upgrades.
While the primary purpose for this renovation was not related to the Year 2000
issue, compliance efforts were enhanced by this project, since computers with
older BIOS chips are more likely to be susceptible to Year 2000 problems than
newer computers. The Bank decided, however, that even these new machines
would be tested for Year 2000 readiness. The renovation phase is
substantially completed at this time.
Validation Phase. This phase was designed to test the ability of hardware and
software to accurately process date sensitive data. The Bank is working with
its data processor, Fiserv, as well as other vendors, to make sure that their
computers and software programs have been tested for Year 2000 readiness. As
an example, the Bank conducted extensive testing of the Fiserv system in
December 1998, with additional testing performed in April of 1999. Based on
the analysis of these test results, along with the extensive amount of data
received on the Year 2000 issue from Fiserv over the past two years, the Bank
is satisfied with the progress made by its service provider in its Year 2000
efforts. In addition, the Bank is satisfied with the results of the testing
of the Bank's other vendors and internal computer systems, along with the
renovations that have been completed to date. Year 2000 testing expenses are
anticipated to total less than $50,000, the majority of which have already
been paid by the Bank. Future expenses relating to Year 2000 issues are not
anticipated to have a material impact on the Bank's financial statements. The
Validation phase is substantially complete at this time.
Implementation Phase. The Bank has completed the implementation phase for all
systems currently being utilized. Any new systems deployed prior to year-end
will also be reviewed for Year 2000 compliance.
Early in 1999, the Bank's Year 2000 focus shifted from the five phases
presented above, to the development of business resumption and contingency
plans. Guidelines provided by the FFIEC set forth four phases in this
contingency planning process, and the paragraphs below set forth the Bank's
progress to date in these phases.
Organizational Planning Guidelines. This phase focused on establishing
organizational planning guidelines that define the business continuity
planning strategy for the Bank, and the FDIC required institutions to complete
this phase prior to March 31, 1999. The Bank completed this phase of the
Contingency Planning process prior to March 31, 1999.
13
<PAGE>
Business Impact Analysis. Irrespective of best efforts towards Year 2000
compliance, the possibility exists that there may be an interruption of
business around the turn of the century. Therefore, the Bank has completed a
Business Impact Analysis, which assesses the effects of potential system
failures in each core business process, such as deposit taking, check cashing,
cash withdrawals and lending services. This analysis sets forth Year 2000
event scenarios and considers the risks of both internal and external
infrastructure failures on each core business process and determines the
minimum acceptable level of outputs and services for each process. While this
analysis will be an ongoing process during the remainder of 1999, the Business
Impact Analysis was substantially completed prior to March 31, 1999.
Business Resumption Contingency Plan. Upon completion of the Business Impact
Analysis, the Bank's management began developing a Business Resumption
Contingency Plan. This plan provides the framework to operate the Bank in the
event that any of the Bank's core business processes experience Year 2000
related problems. Specifically, the plan sets forth logistical guidelines and
time frames to assist the Bank's personnel in its business resumption
contingency planning efforts. This plan is considered a supplement to the
Bank's Disaster Recovery Plan, already in place. The Business Resumption
Contingency Plan was completed prior to June 30, 1999.
Validation of Business Resumption Contingency Plan. Finally, the Bank's
Internal Audit Department has designed methods to validate the Business
Resumption Contingency Plan to ensure that the plan will be effective, if
needed. The Validation methods were substantially completed prior to June 30,
1999. The Bank is now in the process of implementing these validation
procedures, along with communicating its Year 2000 efforts with its customers.
While there can be no guarantee of total Year 2000 compliance, be assured that
Horizon Bank is taking this issue very seriously and is working diligently to
minimize potential impacts to its customers and shareholders as a result of
the turn of the century.
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 to the
protections of the safe harbor provisions of said Act 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.
14
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Horizon Financial Corporation has certain litigation and/or
negotiations in progress resulting from activities arising from
normal operations. In the opinion of management, none of these
matters is likely to have a materially adverse effect on the
Corporation's financial position or results of operation.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
A report on Form 8-K was filed on July 15, 1999, to report the
completion of the merger of Bellingham Bancorporation and Bank of
Bellingham with and into Horizon Financial Corp. and Horizon Bank.
The merger was effective as of June 19, 1999.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORIZON FINANCIAL CORP.
By: V. Lawrence Evans
----------------------------------
V. Lawrence Evans
President and Chief Executive Officer
By: Richard P. Jacobson
----------------------------------
Richard P. Jacobson
Chief Financial Officer
Dated: August 13, 1999
-----------------
16
<PAGE>
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