HORIZON FINANCIAL CORP, 10-K405, 2000-06-28

HORIZON FINANCIAL CORP
10-K405, 2000-06-28
SAVINGS INSTITUTION, FEDERALLY CHARTERED

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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, 2000 OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

Commission File Number: 0-27062

Horizon Financial Corp.
--------------------------------
(Exact name of registrant as specified in its charter)

Chartered by the State of Washington 91-1695422
--------------------------------------------- ----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)

1500 Cornwall Avenue, Bellingham, Washington 98225
--------------------------------------------- -----------------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code (360) 733-3050
-----------------
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $1.00 per share
---------------------------------------
(Title of Class)

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
------ ------
Indicate by check mark whether disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy or
other information statements incorporated by reference in Part III of this
Form 10-K or any amendments to this Form 10-K. YES NO X
------ ------
The aggregate market value of the voting stock held by nonaffiliates of
the registrant, based on the closing sales price of the registrant's Common
Stock as quoted on the Nasdaq Stock Market under the symbol "HRZB" on June 7,
2000, was $80,750,387 (8,282,091 shares at $9.75 per share). It is assumed
for purposes of this calculation that none of the registrant's officers,
directors and 5% stockholders are affiliates.

DOCUMENTS INCORPORATED BY REFERENCE

1. Portions of the Registrant's Proxy Statement for the 2000 Annual Meeting
of Stockholders. (Parts II. and III).

<PAGE>

PART I

Item 1. Business
-----------------
(a) General
-------
Horizon Financial Corp. ("Horizon Financial" or the "Corporation") was
formed under Washington law on May 22, 1995, and became the holding company
for Horizon Bank ("Horizon Bank" or the "Bank"), effective October 13, 1995.
Effective June 19, 1999 the Corporation completed the acquisition of
Bellingham Bancorporation, whose wholly-owned subsidiary, Bank of Bellingham,
was merged with and into Horizon Bank. At March 31, 2000, the Corporation had
total assets of $713.9 million, total deposits of $564.3 million and total
equity of $95.9 million. The Corporation's business activities generally are
limited to passive investment activities and oversight of its investment in
the Bank. Accordingly, the information set forth in this report, including
consolidated financial statements and related data, relates primarily to the
Bank and its subsidiary.

The Bank was organized in 1922 as a Washington State chartered mutual
savings and loan association and converted to a federal mutual savings and
loan association in 1934. In 1979, the Bank converted to a Washington State
chartered mutual savings bank, the deposits of which are insured by the
Federal Deposit Insurance Corporation ("FDIC"). On August 12, 1986, the Bank
converted to a state chartered stock savings bank under the name "Horizon
Bank, a savings bank". The Bank became a member of the Federal Home Loan Bank
("FHLB") of Seattle in December 1998. Effective March 1, 2000, the Bank
changed its name to its current title, "Horizon Bank".

The Bank's operations are conducted through 16 full-service office
facilities, located in Whatcom, Skagit and Snohomish counties in Northwest
Washington. The acquisition of Bellingham Bancorporation increased Horizon
Financial's and Horizon Bank's presence in Whatcom County. During fiscal
2000, the Bank opened an additional office in Whatcom County, located in the
Barkley Village area of Bellingham, in the northeast portion of the city. In
addition to serving the growing population in this area, this new office
(approximately 15,000 square feet) serves as an operation center to support
additional growth for the Corporation. The Bank also completed construction
of a new office building at Murphy's Corner near Mill Creek, which replaced
the Bank's leased location in that area. During fiscal 2000, the Bank
purchased a bank site in Marysville, which will provide additional growth
opportunities. The Bank's management continues to research sites for future
development, with emphasis on locations in the growing Snohomish County
markets.

At its January 19, 2000 meeting, the Board of Directors authorized the
repurchase of up to 10% (approximately 863,000 shares) of the Corporation's
outstanding Common Stock over a 24 month period. During the fiscal year ended
March 31, 2000, the Corporation repurchased 366,000 shares of its Common
Stock, compared to the repurchase of 13,900 shares of Common Stock during the
prior year. The Corporation had authorized a repurchase plan in March 1998,
which plan was rescinded by the Board of Directors effective January 18, 1999,
with the signing of the definitive agreement to merge with Bellingham
Bancorporation, as discussed below.

Acquisition
-----------
On June 19, 1999, the Corporation completed the acquisition of Bellingham
Bancorporation, a Washington corporation, headquartered in Bellingham,
Washington. The acquisition was accomplished in an all stock transaction
valued at approximately $15.5 million, including the assumption of outstanding
Bellingham Bancorporation stock options and warrants. The Corporation
exchanged 2.74 shares of its Common Stock for each Bellingham Bancorporation
share. In this regard, Horizon Financial issued approximately 1,129,264
shares of its Common Stock in the transaction. The acquisition was accounted
for as a pooling of interests.

Prior to the acquisition, Bellingham Bancorporation was a $64.3 million,
bank holding company for the Bank of Bellingham, its primary subsidiary. The
Bank of Bellingham was founded in 1992 by a group of local business people for
the purpose of providing commercial banking services to the local community,
and operated three full-service banking facilities in Bellingham.

Lending Activities
------------------
General. The Bank's loan portfolio totaled $589,583,539 at March 31,
2000, representing approximately 82.58% of its total assets. On that date,
69.58% of total outstanding loans consisted of loans secured by mortgages on
single family residential properties, 3.82% of the loans consisted of loans
secured by two-to- four unit residential

<PAGE>

properties, 3.54% of total outstanding loans consisted of loans secured by
mortgages on over four unit residential properties, and 19.56% of total
outstanding loans consisted of commercial loans and commercial real estate
loans. The balance of the Bank's outstanding loans at that date consisted of
secured consumer loans and loans secured by savings deposits.

The Bank originates both fixed rate and adjustable rate mortgages
("ARMs") secured by residential, business, and commercial real estate, the
majority of which include building improvements.

The Bank has no significant concentration of credit risk other than that
a substantial portion of its loan portfolio is secured by real estate located
in the Bank's primary market area, which the Bank considers to be Whatcom,
Skagit and Snohomish Counties in Washington. This concentration of credit
risk could have a material adverse effect on the Bank's financial condition
and results of operations to the extent there is a material deterioration in
the counties' economic and real estate values.

In order to have the ability to make the yields on its loan portfolio and
investments more interest rate sensitive, the Bank has implemented a number of
measures. Those measures include: (i) adoption of a policy under which the
Bank generally originates long-term, fixed-rate mortgage loans when such loans
are written to specifications promulgated by the Federal Home Loan Mortgage
Corporation ("FHLMC") and qualify for sale in the secondary market, (ii)
origination of ARM loans on residential and commercial properties subject to
market conditions, (iii) origination of variable rate commercial and consumer
loans, and (iv) increased emphasis on originating 10 and 15 year amortizing
mortgage loans. At March 31, 2000, $312,132,877 (or 52.9%) of the Bank's net
mortgage loans receivable were comprised of loans that were other than
long-term fixed-rate mortgage loans (i.e., loans with maturities greater than
15 years, which historically have been the industry's traditional area of
lending activity).

The following table provides selected data relating to the composition of
the Bank's loan portfolio by type of loan on the dates indicated.

<TABLE>
At March 31,
--------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Type of Loan:
First mortgage loans:
One- to-four family. . . . . . .$ 606,702,881 $ 564,394,944 $ 486,107,297 $ 428,045,812 $ 388,962,279
One- to-four family
construction . . . . . . . . . 25,911,941 23,817,577 15,676,088 13,902,046 13,921,353
Participations sold. . . . . . . (176,537,497) (163,526,986) (112,251,375) (83,742,111) (57,668,222)
------------- ------------- ------------- ------------- ------------
Subtotal. . . . . . . . . 456,077,325 424,685,535 389,532,010 358,205,747 345,215,410

Commercial construction/land
development . . . . . . . . . 18,716,744 2,505,484 14,381,275 8,193,186 5,243,040
Residential commercial
real estate . . . . . . . . . 21,999,357 18,158,927 17,793,806 13,572,385 13,870,686
Nonresidential commercial
real estate . . . . . . . . . 88,322,611 74,120,509 46,148,886 37,198,647 40,760,363
Commercial loans . . . . . . . . 14,472,300 19,293,804 11,936,000 14,814,000 10,776,000
Home equity secured. . . . . . . 16,952,862 13,499,198 16,701,470 18,358,470 13,632,690
Other consumer loans . . . . . . 4,829,230 5,216,800 5,812,765 7,250,176 4,043,386
------------- ------------- ------------- ------------- -------------
Subtotal . . . . . . . . . 621,370,429 557,480,257 502,306,212 457,592,611 433,541,575

Less:
Deferred loan fees . . . . . . . (7,397,782) (7,203,886) (6,924,744) (6,885,376) (7,596,712)
Loan loss reserve. . . . . . . . (4,757,152) (4,463,305) (4,085,203) (3,779,761) (3,490,150)
Loans in process . . . . . . . . (19,631,956) (12,163,897) (12,635,603) (7,653,078) (5,665,166)
------------- ------------- ------------- ------------- -------------
$589,583,539 $ 533,649,169 $ 478,660,662 $ 439,274,396 $ 416,789,547
============= ============= ============= ============= =============
</TABLE>
2

<PAGE>

Loan Maturity. The following table sets forth certain information at
March 31, 2000 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less. Loan balances are net of undisbursed
loan proceeds, unearned discounts, unearned income and allowance for loan
losses.

Due Due After
Within 1 Through Due Over
One Year 5 Years 5 Years
After After After
March March March
31, 2000 31, 2000 31, 2000 Total
-------- -------- -------- -----
(In thousands)

Commercial, financial
and agricultural . . . . $19,877 $12,739 $ 38,688 $ 71,304
Real estate construction. -- -- 25,912 25,912
Real estate-mortgage,
installment and other . . 21,043 58,669 412,656 492,368
------- ------- --------- ----------
Total. . . . . . . . $40,920 $71,408 $477,256 $ 589,584
======= ======= ========= ==========

The following table sets forth the dollar amount of all loans due one
year after March 31, 2000 which have fixed interest rates and have floating or
adjustable interest rates. Loan balances do not include undisbursed loan
proceeds, unearned discounts, unearned income, and allowance for loan losses.

Fixed
Rates Adjustable Rates Total
------ ---------------- -----
(In thousands)

Commercial, financial and
agricultural . . . . . . . . $ 1,026 $18,851 $19,877
Real estate construction . . -- -- --
Real estate-mortgage,
installment and other. . . 21,043 -- 21,043
-------- ------- -------
Total . . . . . . . . . $ 22,069 $18,851 $40,920
======== ======= =======

Residential Loans. The primary lending activity of the Bank has
historically been the granting of conventional loans to enable borrowers to
purchase existing homes or construct new homes. The Bank's real estate loan
portfolio also includes loans on two-to-four family dwellings, multi-family
housing (over four units), and loans made to purchase or refinance improved
buildings to be used for residential housing. At March 31, 2000,
approximately 76.94% of the Bank's total loan portfolio consisted of loans
secured by residential real estate.

The Bank's lending practices generally limit the maximum loan-to-value
ratio on one-to-four family residential mortgage loans to 97% of the appraised
value as determined by an independent appraiser, with the condition that
private mortgage insurance generally be required on any home loans with
loan-to-value ratios in excess of 80% of the appraised value. The Bank places
this insurance with carriers approved by the FHLMC. The coverage generally
limits the Bank's exposure to 72% of the loan amount. If private mortgage
insurance is required, the borrower pays the premium at loan closing and any
recurring premiums through an escrow reserve account established with the Bank
for such period of time as the Bank requires the insurance coverage to be in
force. Multi-family residential and commercial real estate loans and
unimproved real estate loans generally do not exceed 80% of appraised value.

The Bank presently originates both fixed-rate and ARMs secured by
one-to-four family properties with a loan term not exceeding 30 years. Under
certain conditions, ARM borrowers are allowed to convert beginning on the
first interest rate change date and ending on the fifth interest rate change
date from the date of the loan note. In addition, certain consumer safeguards
are built into the ARM instruments used by the Bank. These safeguards include
limits on annual and lifetime interest rate adjustments. The Bank generally
originates these loans in accordance with guidelines established by the FHLMC.
For the fiscal year ended March 31, 2000, adjustable mortgage loans totalled
$1,665,250 or 1.53% of total originations as compared to $196,000 or .08% of
total originations for the year ended March 31, 1999.

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

<PAGE>

rate charged by the Bank on these loans varies depending upon the type of
security property and the creditworthiness of the borrower. At March 31,
2000, the Bank had $44,628,685, or 7.18% of total loans outstanding in
construction loans, as compared to $26,323,061, or 4.72% of total loans at
March 31, 1999. At March 31, 2000, $19,520,805 or 43.74% 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 $124,794,268 or approximately 20.08% of Horizon Bank's loan
portfolio at March 31, 2000. These loans include fixed rate and adjustable
rate mortgages secured by apartment buildings (i.e., those containing five or
more living units) and business and commercial properties. The Bank generally
requires that such loans have a debt service coverage of 1.20 to 1 with a
loan-to-value ratio not exceeding 80%. Fixed-rate loans generally have a five
to 15-year loan term, with payments based upon a 15 to 30-year amortization
schedule.

At March 31, 2000, $16,983,543 of loans secured by income-producing
properties have an interest rate which adjusts annually based upon changes in
an index of United States Treasury securities published by the Board of
Governors of the Federal Reserve System ("Federal Reserve"). The amount of
any increase in the interest rate is generally limited to two percentage
points (upward or downward) each adjustment period, with a limit of six
percentage points on the amount which the interest rate can increase or
decrease over the life of the loan.

Multi-family residential and business and commercial real estate lending
is generally considered to involve a higher degree of risk than permanent
residential one-to-four family lending. Such lending typically involves large
loan balances concentrated in a single borrower or groups of related
borrowers. In addition, the payment experience on loans secured by
income-producing properties is typically dependent on the successful operation
of the related real estate project and thus may be subject to a greater extent
to adverse conditions in the real estate market or in the economy generally.
Horizon Bank generally attempts to mitigate the risks associated with
multi-family commercial and residential real estate lending by, among other
things, lending on collateral located in its market area and generally to
individuals who reside in its market.

The merger with Bank of Bellingham included a wide range of commercial
loans to small and medium sized businesses. This portfolio presently includes
lines of credit with floating rates and maturities of one year or less and
term loans for the purchase of equipment, real estate and other operating
purposes with maturities generally not exceeding five years. These loans are
secured by a variety of business assets including equipment, real estate,
accounts receivable and inventory. Under certain conditions, the Bank also
offers unsecured credit to qualified borrowers.

Commercial lending carries increased risks compared to residential
mortgage lending due to the heavy reliance upon the future income of the
customer and the uncertain liquidation value of the collateral. In the event
of default, the liquidation of collateral is often insufficient to cover the
outstanding debt. To mitigate these inherent risks, the Bank combines a
conservative lending policy with experienced lending personnel responsible for
the ongoing management of their assigned accounts.

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, unsecured loans, and
loans for mobile homes located in parks.

Horizon Bank actively markets consumer loans in order to provide a wider
range of financial services to its customers and to achieve shorter terms and
higher interest rates normally typical of such loans. At March 31, 2000, the
Bank held $21,782,092 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

<PAGE>

such cases, any repossessed collateral for a defaulted consumer loan may not
provide an adequate source of repayment of the outstanding loan balance as a
result of the greater likelihood of damage, loss or depreciation. The
remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Furthermore, the application
of various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount that can be recovered on such loans.

Consumer loans are made based on an evaluation of the borrower's
creditworthiness, including income, other indebtedness, and satisfactory
credit history, and the value of the collateral. Designated managers or Loan
Committee members approve consumer loan requests.

Secured loan amounts typically do not exceed 80% of the value of the
collateral, or 80% of the appraised value of the residence in the case of home
equity loans.

Loan Solicitation and Processing. The primary sources for loan
originations are attributable to deposit cus-tomers, current borrowers,
walk-in customers, and referrals from existing customers, real estate agents,
and builders. The Bank does not currently purchase loans from, or otherwise
utilize, mortgage brokers in the origination of loans.

The Bank accepts completed loan applications from all of its branches.
Processing is substantially centralized in the main office of the Bank.
Detailed information is obtained to determine the creditworthiness of the
borrower and the borrower's ability to repay. The more significant items
appearing on the applications and accompanying material are verified through
the use of written credit reports, financial statements, and confirmations.
After analysis of the loan application, supporting documents and the property
to be pledged as loan security, including an appraisal of the property by
either a staff appraiser or an independent fee appraiser, the application is
forwarded to the Bank's Loan Committee. Loan approval requires the signatures
of two members of the Loan Committee. The Loan Committee consists of officers
of the Bank who are appointed by the Bank's Board of Directors. The Bank
generally requires its mortgage notes to be co-signed individually by the
principals on loans made to entities other than natural persons. Certain
lending personnel have been given limited loan approval authority by the Board
of Directors covering secondary market quality loans not exceeding 80% to
value.

Loan assumption requests of adjustable rate loans are handled by the Bank
in a manner similar to new loan requests. FHLMC standards are generally
applied to each request and full credit underwriting is required. For fixed
rate loans, a sale or transfer of the secured property generally results in
the Bank enforcing its due on transfer rights contained in the mortgage
instrument.

Residential Loan Originations, Purchases and Sales. Currently, the Bank
emphasizes the origination of 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 may purchase real estate
loans in the secondary market. The Bank's purchases in the secondary market
depend upon the demand for mortgage credit in the local market area and the
inflow of funds from traditional sources. Loan purchases enable the Bank to
utilize funds more quickly, particularly where sufficient loan demand is not
obtainable locally.

The Bank is a qualified servicer for both FHLMC and Fannie Mae. The
Bank's general practice is to close its fixed-rate, one-to-four family
residential loans on FHLMC loan documents in order to facilitate future sales
to the mortgage corporation as well as to other institutional investors. From
time to time, depending upon interest rates and economic conditions, the Bank
has sold participation interests in loans in order to provide additional funds
for lending, to generate servicing fee income and to decrease the dollar
amount of its intermediate and long-term fixed-rate loans. The sale of loans
in the secondary mortgage market reduces the Bank's interest rate risk and
allows the Bank to continue to make loans during periods when savings flows
decline or funds are otherwise unavailable for lending purposes. In
connection with such sales, the Bank generally retains the servicing of the
loans (i.e., collection of principal and interest payments), for which it
generally receives a fee payable monthly of .25% to .375% per annum of the
unpaid balance of each loan. As of March 31, 2000, the Bank was servicing
loans for others aggregating approximately $176,537,497. 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.

<PAGE>

Loan Commitments. Horizon Bank issues commitments to originate
conventional mortgage loans on existing residential dwellings. Loan
commitments are made for periods up to 45 days from the date of loan
application and are based upon the prevailing market rate at the time of
application. At March 31, 2000, such commitments amounted to $3,653,690.

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, 2000 was $7,397,782. Any unamortized loan fees are recognized as income
at the time the loan is sold or paid off.

Income from loan origination and commitment fees varies with the volume
and type of loans and commitments made and purchased and with competitive
conditions in mortgage markets, which in turn responds to the demand for and
availability of money. The Bank experiences an increase in loan fee income
and other fee income, such as appraisal and loan closing fees, during periods
of low interest rates due to the resulting demand for mortgage loans. The
Bank also receives other fees and income from charges relating to existing
loans, which include late charges, and fees collected in connection with a
change in terms or other loan modifications. These fees and charges have not
constituted a material source of income.

Loan Modifications. The Bank offers a loan modification program to
assist customers who were considering refinancing their home loans. For a fee
the Bank will modify customers' loans under the program. No new principal is
required and only the interest rate and payment amounts are changed. All
other terms and conditions remain the same. In fiscal 2000, the Bank modified
$527,643 of real estate loans, compared to $17,148,381 in fiscal 1999.

Delinquent Loans, Loans in Foreclosure and Foreclosed Property. Real
estate loans are defined as delinquent when any payment of principal and/or
interest is past due. While the Bank generally is able to work out a
satisfactory repayment schedule with a delinquent borrower, the Bank will
undertake foreclosure proceedings if the delinquency is not otherwise resolved
within 90 days. Property acquired by the Bank as a result of foreclosure or
by deed in lieu of foreclosure is classified as "real estate owned" until such
time as it is sold or otherwise disposed of. At March 31, 2000, the Bank had
eight loans over 90 days delinquent with a net balance of $911,729.
Management does not anticipate incurring material losses from these loans.

The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.

<TABLE>
At March 31,
-----------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Non-accrual loans. . . . . . . . . $ 455,000 $ -- $138,000 $14,000 $ --
Loans 90 days or more delinquent
and accruing interest . . . . . . 456,729 383,000 30,345 57,918 --
Restructured loans . . . . . . . . -- -- -- -- --
Real estate acquired
through foreclosure . . . . . . . 323,468 -- -- -- --
---------- --------- -------- ------- -------
Total. . . . . . . . . . . . . . $1,235,197 $ 383,000 $168,345 $71,918 $ --
========== ========= ======== ======= =======
As a percentage of net loans . . . .21% .07% .04% .02% --
As a percentage of total assets. . .17% .06% .03% .01% --
</TABLE>

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

<PAGE>

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,
2000 in the amount of $4,757,152 and $4,463,305 for the year ended March 31,
1999. The Bank's loan loss reserve as of March 31, 2000, is approximately
.81% of total loans receivable.

The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.

<TABLE>
Year Ended March 31,
-------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance at beginning
of period. . . . . . . . . . . . $4,463,305 $4,085,203 $3,779,761 $3,490,150 $3,304,150

Provision for loan losses. . . . 437,234 484,500 520,500 284,400 207,000

Adjustment to reserves . . . . . (143,387) (106,398) (215,058) (5,211) (21,000)
---------- ---------- ---------- ---------- ----------
Balance at end of period . . . . . $4,757,152 $4,463,305 $4,085,203 $3,779,761 $3,490,150
========== ========== ========== ========== ==========
</TABLE>

<TABLE>
The following table sets forth the breakdown of the allowance for loan losses by loan category for the
periods indicated.

Year Ended March 31,
-------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial, financial and
agricultural. . . . . . . . . . . $1,187,327 $1,457,155 $1,324,053 $1,173,611 $1,054,000
Residential real estate -
mortgage. . . . . . . . . . . . . 3,569,825 3,006,150 2,761,150 2,606,150 2,436,150
---------- ---------- ---------- ---------- ----------
Total allowance for loan
losses . . . . . . . . . . . . $4,757,152 $4,463,305 $4,085,203 $3,779,761 $3,490,150
========== ========== ========== ========== ==========
</TABLE>

The Bank had no allowances for real estate acquired through foreclosure
at March 31, 2000, 1999, 1998, 1997 and 1996.

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, 2000 was
$11,804,592 compared to a market value of $15,067,065. For further
information concerning the Bank's investment securities portfolio, see Note 4
of the Notes

<PAGE>

to the Consolidated Financial Statements contained in the Corporation's Proxy
Statement for the 2000 Annual Meeting of Stockholders ("Proxy Statement") .

The Bank also invests in mortgage-backed securities. At March 31, 2000,
such securities had an amortized cost of $61,223,533 and a market value of
$58,923,944.

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, 2000 was approximately
$73,991,009. This does not include interest-bearing deposits and cash
equivalents.

At March 31,
-----------------------------------
2000 1999 1998
---- ---- ----
(In thousands)
Investment securities:
U.S. Government:
Available for sale . . . . . . . . . . $ 4,812 $ 12,312 $ 25,748
Held to maturity . . . . . . . . . . . 369 892 1,889
-------- --------- ---------
5,181 13,204 27,637
Asset-backed securities(1):
Available for sale . . . . . . . . . . 52,974 44,548 33,100
Held to maturity . . . . . . . . . . . 8,249 10,959 15,489
-------- --------- ---------
61,223 55,507 48,589
Other securities(2):
Available for sale . . . . . . . . . . 6,124 9,807 9,056
Held to maturity . . . . . . . . . . . 500 500 500
-------- --------- ---------
6,624 10,307 9,556
-------- --------- ---------
Total investments . . . . . . . . . . 73,028 79,018 85,782

Interest bearing deposits and cash
equivalents . . . . . . . . . . . . . 20,004 26,462 21,456
-------- --------- ---------
$93,032 $105,480 $107,238
======== ========= =========

------------------
(1) Consists of mortgage-backed securities and CMO's.
(2) Consists of corporate debt securities and marketable equity securities.

<PAGE>

<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, 2000.

At March 31, 2000
------------------------------------------------------------------------------
One Year One to Five Five to Ten More than
or Less Years Years Ten Years Investment Securities
------------- ------------- ------------- ------------ --------------------------
Amor- Aver- Amor- Aver- Amor- Aver- Amor- Aver- Amor- Aver-
tized age tized age tized age tized age tized Market age
Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield
----- ----- ------ ------ ----- ----- ----- ----- ---- ----- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government,
agency securities,
state and political
subdivisions:
Available for sale. $2,155 5.65% $2,181 6.30% $ 476 6.97% $ -- --% $ 4,812 $ 4,775 6.08%
Held to maturity. . -- -- -- -- 369 4.30 -- -- 369 350 4.30
------ ---- ------ ---- ------ ---- ------ ---- -------- ------- -----
2,155 5.65 2,181 6.30 845 5.80 -- -- 5,181 5,125 5.95
Mortgage-backed
securities:
Available for sale. 1,215 3.72 1,659 5.07 1,467 6.52 48,633 6.60 52,975 50,797 6.49
Held to maturity. . 175 6.40 476 6.94 6,961 6.41 637 9.70 8,249 8,128 6.70
------ ---- ------ ---- ------ ---- ------- ---- ------- ------- -----
1,390 4.06 2,135 5.49 8,428 6.43 49,270 6.64 61,224 58,925 6.52
Other:
Available for sale. 3,736 6.52 2,387 6.99 -- -- -- -- 6,123 9,428 6.71
Held to maturity. . 500 11.52 -- -- -- -- -- -- 500 513 11.52
------ ---- ------ ---- ------ ---- ------- ---- ------- ------- -----
4,236 7.11 2,387 6.99 -- -- -- -- 6,623 9,941 7.07
------ ---- ------ ---- ------ ---- ------- ---- ------- ------- -----
Total . . . . . . . $7,781 6.16% $6,703 6.29% $9,273 6.37% $49,270 6.64% $73,028 $73,991 6.53%
====== ==== ====== ==== ====== ==== ======= ==== ======= ======= =====
</TABLE>

<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, and other borrowings and operations.
The availability of funds from loan sales is influenced by general interest
rates and other market conditions. Loan repayments are a relatively stable
source of funds while deposit inflows and outflows vary widely and are
influenced by prevailing interest rates and money market conditions.
Borrowings may be used on a short-term basis to compensate for reductions in
deposits or deposit inflows at less than projected levels and may be used on a
longer term basis to support expanded lending activities.

Deposits. Horizon Bank offers several deposit accounts, including
Regular Passbook and Statement Savings Accounts, Personal and Business
Checking Accounts, Money Market with and without Check Access and Certificates
of Deposit Accounts with maturities ranging from 30 days up to 10 years.
Certificates of Deposit account requirements vary according to minimum
principal balances, the time period the funds must remain on deposit and the
interest rate determined for each term and minimum balance.

The following table sets forth certain information concerning the
deposits at the Bank.

Year Ended March 31,
-------------------------------------------------------
2000 1999 1998
----------------- ----------------- -----------------
Weighted Weighted Weighted
Average Average Average Average Average Average
Type Balance Rate Balance Rate Balance Rate
---- ------- -------- ------- -------- ------- --------
Savings. . . . . . . $ 35,503 3.05% $ 37,031 3.09% $ 35,831 3.38%
Checking . . . . . . 42,267 1.27 49,466 1.17 38,530 1.46
Money Market . . . . 86,322 3.72 74,160 3.96 72,761 3.91
Time Deposits. . . . 367,458 5.40 355,089 5.60 336,569 5.74
-------- ---- -------- ---- -------- ----
Total. . . . . . . $531,550 4.65% $515,746 4.95% $483,691 4.95%
======== ==== ======== ==== ======== ====

The following table indicates the amount of the Bank's deposits by time
remaining until maturity as of March 31, 2000 of $100,000 or more.

Certificates
Maturity Period of Deposit
--------------- ------------
Three months or less. . . . . . . . . $ 20,235
Three through six months. . . . . . . 29,735
Six through twelve months . . . . . . 27,378
Over twelve months. . . . . . . . . . 24,140
---------
Total. . . . . . . . . . . . . . $ 101,488
=========

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; 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

<PAGE>

by the Bank, based upon competitive rates and local market rates, national
money market rates, and yields on assets of the same maturity.

The Bank's personal MMDA currently has a $1,000 minimum deposit and has a
tiered pricing program, with interest rates that vary by account dollar
balance -- $2,000, $10,000, $25,000, $50,000 and higher. The Bank's Business
MMDA has tiers of $10,000, $50,000, $100,000 and higher, with a $1,000 minimum
deposit. These accounts have no maturity requirements, no regulatory interest
rate ceilings, and limited check writing privileges. The interest rates on
these accounts are adjusted by the Bank periodically, based on money market
conditions. The Bank currently has a $10,000 minimum deposit (MMK) money
market and has a tiered pricing program, with interest rates that vary by
account dollar balance -- $10,000, $25,000, $50,000 and higher. 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 common
stocks and mutual funds) still exists. The ability of the Bank to attract and
retain deposits and the Bank's cost of funds have been, and will continue to
be, significantly affected by capital and money market conditions.

Horizon Bank attempts to control the flow of deposits by pricing its
accounts to remain competitive with other financial institutions in its market
area but does not necessarily seek to match the highest rates paid by
competing institutions.

The senior officers of the Bank meet periodically to determine the
interest rates which the Bank will offer to the general public. Such officers
consider the amount of funds needed by the Bank on both a short-term and
long-term basis, the rates being offered by the Bank's competitors,
alternative sources of funds and the projected level of interest rates in the
future.

The Bank's deposits are obtained primarily from residents of Northwest
Washington. Horizon Bank attracts deposits by offering a wide variety of
services and convenient branch locations and service hours. The Bank has not
solicited brokered deposits and has no present intention to attract such
deposits in the future.

For further information concerning the Bank's savings deposits, reference
is made to Note 10 of the Notes to the Consolidated Financial Statements
contained in the Corporation's Proxy Statement.

Borrowings. In December 1998, the Bank joined the Federal Home Loan Bank
of Seattle providing access to a variety of wholesale funding options. Also,
the Bank's security portfolio provides additional borrowing capacity in the
reverse repurchase markets. At March 31, 2000, the Bank had $39.9 million in
borrowings, compared to $22.7 million at March 31, 1999 and no borrowings
during the year ended 1998. Access to these wholesale borrowings allows
management to meet cyclical funding needs, and assists in interest rate risk
management efforts.

The following table sets forth information regarding borrowings by the
Bank at the end of and during the periods indicated. The table includes both
short-term and long-term borrowings unless noted otherwise.

For the Year Ended March 31,
----------------------------
2000 1999 1998
---- ---- ----
(Dollars in thousands)

Maximum amount of borrowings outstanding
at any month end. . . . . . . . . . . . . . . $39,943 $22,718 $1,180
Approximate average borrowings outstanding . . 29,192 14,633 690
Approximate weighted average rate paid . . . . 5.64 4.92 6.97

<PAGE>

At March 31,
-------------------------------
2000 1999 1998
---- ---- ----
(Dollars in thousands)

Balance outstanding at end of period. . . . $39,943 $22,718 $1,180
Weighted average rate paid. . . . . . . . . 5.64 4.92 6.97

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, 2000, Horizon Bank employed 177 full-time and 21 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. The FDIC is an independent federal agency that insures
the deposits, up to prescribed statutory limits, of depository institutions.
The FDIC administers two separate deposit insurance funds: the BIF and the
SAIF. The BIF is a deposit insurance fund for commercial banks and some
state-chartered savings banks. The SAIF is a deposit insurance fund for most
savings associations. The Bank is insured under the BIF fund. As an insurer
of the Bank's deposits, the FDIC has examination, supervisory and enforcement
authority over the Bank.

The FDIC has established a risk-based system for setting deposit
insurance assessments. Under the risk-based assessment system, an
institution's insurance assessment varies according to the level of capital
the institution holds and the degree to which it is the subject of supervisory
concern. In addition, regardless of the potential risk to the insurance fund,
federal law requires the ratio of reserves to insured deposits at $1.25 per
$100. Both funds currently meet this reserve ratio. During 1999, the
assessment rate for both SAIF and BIF deposits ranged from zero to 0.27% of
covered deposits. As a well capitalized bank, Horizon Bank qualified for the
lowest rate on its deposits for fiscal 2000.

<PAGE>

In addition to deposit insurance assessments, the FDIC is authorized to
collect assessments against insured deposits to be paid to the Finance
Corporation ("FICO") to service FICO debt incurred in the 1980's to help fund
the thrift industry cleanup. The FICO assessment rate is adjusted quarterly.

Prior to 2000, the FICO assessment rate for BIF-insured deposits was
one-fifth the rate applicable to deposits insured by the SAIF. Beginning in
2000, SAIF- and BIF-insured deposits will be assessed at the same rate by
FICO. As a result, BIF FICO assessments will be higher than in previous
periods while SAIF FICO assessments will be lower. For the first quarter of
2000, the annualized rate will be 2.1 cents per $100 of insured deposits. Due
to the fact that the Bank is insured under the BIF fund, the FICO assessment
will increase for 2000 as compared to prior years.

Any insured bank which does not operate in accordance with or conform to
FDIC regulations, policies and directives may be sanctioned for
non-compliance. For example, proceedings may be instituted against any
insured bank or any director, officer, or employee of such bank who engages in
unsafe and unsound practices, including the violation of applicable laws and
regulations. The FDIC has the authority to terminate deposit insurance
pursuant to procedures established for that purpose. Management is not aware
of any existing circumstances that could result in termination of the deposit
insurance for the Bank.

Capital Requirements. FDIC regulations recognize two types or tiers of
capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1
capital generally includes common stockholders' equity and noncumulative
perpetual preferred stock, less most intangible assets. Tier 2 capital, which
is limited to 100 percent of Tier 1 capital, includes such items as qualifying
general loan loss reserves, cumulative perpetual preferred stock, mandatory
convertible debt, term subordinated debt and limited life preferred stock;
however, the amount of term subordinated debt and intermediate term preferred
stock (original maturity of at least five years but less than 20 years) that
may be included in Tier 2 capital is limited to 50 percent of Tier 1 capital.

The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets. Most banks are required to maintain a minimum leverage ratio of
at least 4% to 5% of total assets. The FDIC retains the right to require a
particular institution to maintain a higher capital level based on an
institution's particular risk profile. The Bank calculated its leverage ratio
to be 13.58% as of March 31, 2000.

FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in
one of four categories and given a percentage weight -- 0%, 20%, 50% or 100% -
- based on the relative risk of that category. In addition, certain
off-balance-sheet items are converted to balance-sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories.
Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2
capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1
capital to risk-weighted assets must be at least 4%. The Bank has calculated
its total risk-based ratio to be 22.93% as of March 31, 2000, and its Tier 1
risk-based capital ratio to be 21.77%. In evaluating the adequacy of a bank's
capital, the FDIC may also consider other factors that may affect a bank's
financial condition. Such factors may include interest rate risk exposure,
liquidity, funding and market risks, the quality and level of earnings,
concentration of credit risk, risks arising from nontraditional activities,
loan and investment quality, the effectiveness of loan and investment
policies, and management's ability to monitor and control financial operating
risks.

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.

<PAGE>

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.

Horizon Bank's management believes that, under the current regulations,
the Bank will continue to meet its minimum capital requirements in the
foreseeable future. However, events beyond the control of the Bank, such as a
downturn in the economy in areas where the Bank has most of its loans, could
adversely affect future earnings and, consequently, the ability of the Bank to
meet its capital requirements.

Federal Deposit Insurance Improvement Act ("FDICIA"). Horizon Bank has
surpassed the $500 million asset threshold, and as such, is required to be
compliant with the FDICIA originally enacted in 1991 and with enhanced
provisions adopted in 1993. In general, the Act required the Bank to conduct
an annual independent audit of their financial statements, appoint an
independent audit committee of outside directors, report on and assess
management's responsibilities for preparing financial statements, and
establish an internal control structure.

An independent accountant must attest to and report on the assertions in
management's reports concerning these internal controls with the desired
outcome of efficient and effective operations; the safeguarding of assets;
reliable financial reporting and compliance with applicable laws and
regulations.

The FDIC as the primary regulator of the Bank has outlined, in general,
the requirements for compliance with FDICIA, but does not provide specific
guidance on the internal control structure, documentation, or procedures to
test the Bank's effectiveness. It is up to each bank to establish document
and design procedures to evaluate and test the internal control structure over
financial reporting and compliance with designated laws and regulations that
minimally include loans to insiders and dividend restrictions.

In brief, to ensure compliance, the Bank has established and coordinated
a management team that identifies and documents existing controls with
consideration given to the Bank's control environment, risk assessment,
control activities, information and communication systems, and monitoring
activities. In addition, management establishes internal control procedures,
develops and selects criteria for evaluation, tests the effectiveness of
controls, and ensures that proper written documentation is in place.

Under FDICIA, the Audit Committee has several responsibilities that
include but are not limited to overseeing the internal audit function;
conducting periodic meetings with management, the independent public
accountant, and the internal auditors; review of significant accounting
policies, and audit conclusions regarding significant accounting estimates;
review of the assessments prepared by management and independent auditor on
the adequacy of internal controls and the resolution of identified material
weaknesses and reportable conditions in internal controls; and the review of
compliance with laws and regulations.

Federal Home Loan Bank System. The FHLB of Seattle serves as a reserve
or central bank for the member institutions within its assigned region. It is
funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLBs. It makes loans (i.e., advances) to members in
accordance with policies and procedures established by the Federal Housing
Finance Board and the Board of Directors of the FHLB of Seattle. As a member,
the Bank is required to purchase and hold stock in the FHLB of Seattle in an
amount equal to the greater of 1% of their aggregate unpaid home loan balances
at the beginning of the year or an amount equal to 5% of FHLB advances
outstanding. As of March 31, 2000, Horizon Bank held stock in the FHLB of
Seattle in the amount of $5,254,200. See "Business -- Savings Activities and
Other Sources of Funds -- Borrowings."

Federal Reserve System. The Federal Reserve Board requires (under
"Regulation D") that all depository institutions, including savings banks,
maintain reserves on transaction accounts or non-personal time deposits.
These reserves may be in the form of cash or non-interest bearing deposits
with the regional Federal Reserve Bank. NOW accounts and other types of
accounts that permit payments or transfers to third parties fall within the
definition of transaction accounts and are subject to Regulation D reserve
requirements, as are any non-personal time deposits at a savings bank. Under
Regulation D, a bank must establish reserves equal to 0% of the first $4.9
million of net transaction accounts, 3% of the next $41.6 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, 2000, 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

<PAGE>

undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measure, which include a risk-based
capital measure, a leverage ratio capital measure, and certain other factors.
The federal banking agencies have adopted regulations that implement this
statutory framework. Under these regulations, an institution is treated as
well capitalized if its ratio of total capital to risk-weighted assets is 10%
or more, its ratio of core capital to risk-weighted assets is 6% or more, its
ratio of core capital to adjusted total assets is 5% or more, and it is not
subject to any federal supervisory order or directive to meet a specific
capital level. In order to be adequately capitalized, an institution must
have a total risk-based capital ratio of not less than 8%, a Tier 1 risk-based
capital ratio of not less than 4%, and a leverage ratio of not less than 4%.
Any institution which is neither well capitalized nor adequately capitalized
will be considered undercapitalized.

Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure
by the Bank to comply with applicable capital requirements would, if
unremedied, result in restrictions on its activities and lead to enforcement
actions, including, but not limited to, the issuance of a capital directive to
ensure the maintenance of required capital levels. Banking regulators will
take prompt corrective action with respect to depository institutions that do
not meet minimum capital requirements. Additionally, approval of any
regulatory application filed for their review may be dependent on compliance
with capital requirements.

The Corporation
---------------
General. The Corporation, as the sole shareholder of the Bank, is a bank
holding company and is registered as such with the Federal Reserve. Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"),
and the regulations of the Federal Reserve. As a bank holding company, the
Corporation is required to file with the Federal Reserve annual reports and
such additional information as the Federal Reserve may require and will be
subject to regular examinations by the Federal Reserve. The Federal Reserve
also has extensive enforcement authority over bank holding companies,
including, among other things, the ability to assess civil money penalties to
issue cease and desist or removal orders and to require that a holding company
divest subsidiaries (including its bank subsidiaries). In general,
enforcement actions may be initiated for violations of law and regulations and
unsafe or unsound practices.

New Legislation. On November 12, 1999, President Clinton signed into law
the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, federal
legislation intended to modernize the financial services industry by
establishing a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers. Generally, the Act:

(a) repeals the historical restrictions and eliminates many federal
and state law barriers to affiliations among banks, securities
firms, insurance companies and other financial service providers;

(b) provides a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding
companies;

(c) broadens the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their financial
subsidiaries;

(d) provides an enhanced framework for protecting the privacy of
consumer information;

(e) adopts a number of provisions related to the capitalization,
membership, corporate governance and other measures designed to
modernize the FHLB system;

(f) modifies the laws governing the implementation of the Community
Reinvestment Act; and

(g) addresses a variety of other legal and regulatory issues affecting
day-to-day operations and long-term activities of financial
institutions.

Acquisitions. Under the BHCA, a bank holding company must obtain
Federal Reserve approval before: (1) acquiring, directly or indirectly,
ownership or control of any voting shares of another bank or bank holding
company if, after such acquisition, it would own or control more than 5% of
such shares (unless it already owns or controls the majority of such shares);
(2) acquiring all or substantially all of the assets of another bank or bank
holding company; or (3) merging or consolidating with another bank holding
company.

<PAGE>

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,
at March 31, 2000, the Corporation's levels of consolidated regulatory capital
exceed the Federal Reserve's minimum requirements, as follows:

Amount Percent
------ ------
(Dollars in Thousands)

Tier 1 Capital $94,514 13.24%
Minimum Tier 1 (leverage) requirement 28,557 4.00
------- -----
Excess $65,957 9.24%
======= =====

Risk-based capital $99,530 22.73%
Minimum risk-based capital requirement 35,025 8.00
------- -----
Excess $64,505 14.73%
======= =====

Stock Repurchases. Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, are required to
give the Federal Reserve prior written notice of any purchase or redemption of
its outstanding equity securities if the gross consideration for the purchase
or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding 12 months, is equal to 10% or
more of their consolidated net worth. The Federal Reserve may disapprove such
a purchase or redemption if it determines that the proposal would constitute
an unsafe or unsound practice or would violate any law, regulation, Federal
Reserve order, or any condition imposed by, or written agreement with, the
Federal Reserve.

At its January 19, 2000 meeting, the Board of Directors authorized the
repurchase of up to 10% (approximately 863,000 shares) of the Corporation's
outstanding common stock over a 24 month period. Shares may be purchased from
time to time depending upon market conditions, price and other management
considerations. During the fiscal year ended March 31, 2000, the Corporation
repurchased 366,000 shares of its common stock,

<PAGE>

compared to the repurchase of 13,900 shares of common stock under the prior
plan during the prior year. As of June 27, 2000, the Corporation has
repurchased a total of 379,600 shares.

TAXATION

Federal Taxation
----------------
General. The Corporation and the Bank report their consolidated income
on a fiscal year basis using the accrual method of accounting and are subject
to federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Corporation. Reference is made to Note 13 of
the Notes to the Consolidated Financial Statements contained in the
Corporation's Proxy Statement for additional information concerning the income
taxes payable by the Bank.

Tax Bad Debt Reserves. Historically, savings institutions such as the
Bank, which met certain definitional tests primarily related to their assets
and the nature of their businesses, were permitted to establish a reserve for
bad debts and to make annual additions to the reserve. These additions may,
within specified formula limits, have been deducted in arriving at the Bank's
taxable income. For purposes of computing the deductible addition to its bad
debt reserve, the Bank's loans are separated into "qualifying real property
loans" (i.e., generally those loans secured by interests in residential real
property) and all other loans ("non-qualifying loans"). The following
formulas were used to compute the bad debt deduction with respect to
qualifying real property loans: (i) actual loss experience or (ii) a
percentage equal to 8% of taxable income. The deduction with respect to
non-qualifying loans was computed under the experience method. Reasonable
additions to the reserve for losses on non-qualifying loans were based upon
actual loss experience and would reduce the current year's addition to the
reserve for losses on qualifying real property loans, unless that addition was
also determined under the experience method. The sum of the additions to each
reserve for each year was the Bank's annual bad debt deduction.

The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The new
rules eliminate the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all financial institutions for tax years beginning
after December 31, 1995. These rules also require that all institutions
recapture all or a portion of their bad debt reserves added since the base
year (last taxable year beginning before January 1, 1988). The Bank has
previously recorded a deferred tax liability equal to the bad debt recapture
and as such the new rules will have no effect on the net income or federal
income tax expense. For taxable years beginning after December 31, 1995, the
Bank's bad debt deduction will be determined under the experience method using
a formula based on actual bad debt experience over a period of years or, if
the Bank is a "large" association (assets in excess of $500 million) on the
basis of net charge-offs during the taxable year. The new rules allow an
institution to suspend bad debt reserve recapture for the 1996 and 1997 tax
years if the institution's lending activity for those years is equal to or
greater than the institution's average mortgage lending activity for the six
taxable years preceding 1996 adjusted for inflation. For this purpose, only
home purchase or home improvement loans are included and the institution can
elect to have the tax years with the highest and lowest lending activity
removed from the average calculation. If an institution is permitted to
postpone the reserve recapture, it must begin its six year recapture no later
than the 1998 tax year. The unrecaptured base year reserves will not be
subject to recapture as long as the institution continues to carry on the
business of banking. In addition, the balance of the pre-1988 bad debt
reserves continue to be subject to provisions of present law referred to below
that require recapture in the case of certain excess distributions to
shareholders. Horizon Bank met the residential loan requirement for the
taxable year ending March 31, 2000.

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.

<PAGE>

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 1.50% of gross receipts; however, interest
received on loans secured by mortgages or deeds of trust on residential
properties is not subject to such tax. The Bank's business and occupation
tax returns were audited in November 1995.

Item 2. Properties
-------------------
The following table sets forth the location of the Bank's offices, as
well as certain information relating to these offices.

Net Book
Year Value as of Square Leased/
Opened March 31, 2000 Feet Owned
------ -------------- ------ -------

Bellingham Main Office . 1971 $1,296,793 19,179 Owned
1500 Cornwall Avenue
Bellingham, WA 98225

Bellingham/Meridian. . . 1987 798,308 4,650 Owned
4110 Meridian
Bellingham, WA 98226

Ferndale Office. . . . . 1976 413,080 3,692 Owned
Third and Main
Ferndale, WA 98248

Lynden Office. . . . . . 1981 482,087 3,702 Owned
Third and Grover
Lynden, WA 98264

Blaine Office. . . . . . 1976 578,829 3,610 Owned
Fourth & "H" Streets
Blaine, WA 98230

Mount Vernon Office. . . 1976 304,738 3,275 Owned
1503 Riverside Dr.
Mount Vernon, WA 98273

Anacortes Office . . . . 1987 862,821 3,650 Owned
1218 Commercial Avenue
Anacortes, WA 98221

Snohomish Office . . . . 1987 209,384 1,388 Owned
620 2nd Street
Snohomish, WA 98290

(table continued on following page)

<PAGE>

Net Book
Year Value as of Square Leased/
Opened March 31, 2000 Feet Owned
------ -------------- ------ -------

Everett Office . . . . . 1991 $ 46,585 1,972 Leased
909 S.E. Everett
Mall Way #E-500
Everett, WA 98208

Burlington Office. . . . 1994 1,184,432 3,980 Owned
1020 S. Burlington Blvd
Burlington, WA 98232

Edmonds Office . . . . . 1994 2,351,651 15,265 Owned
130 Fifth Avenue South
Edmonds, WA 98020

Murphy's Corner Office . 2000 1,846,012 3,720 Owned
12830 Bothell Everett Hwy.
Everett, WA 98208

Barkley. . . . . . . . . 1999 3,524,004 14,691 Owned
2122 Barkley Blvd.
Bellingham, WA 98228

Holly Street Office. . . 1999 565,133 4,000 Owned
211 E. Holly Street
Bellingham, WA 98227

Fountain Office(1) . . . 1999 286,678 4,648 Leased
2625 Meridian Street
Bellingham, WA 98228

Alabama Office . . . . . 1999 805,882 4,500 Owned
802 Alabama Street
Bellingham, WA 98228

Marysville (land only) . -- 635,737 -- Owned

-----------
1. Fountain Office schedule to be closed on July 14, 2000.

At March 31, 2000, the aggregate book value of the Corporation's premises
and equipment was $16,192,154.

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.

19
<PAGE>

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
------------------------------------------------------------------------------
Horizon Financial Corp.'s common stock is traded on The Nasdaq Stock
Market under the symbol HRZB. The common stock began trading on the Nasdaq
Stock Market at the time of Horizon's conversion to stock form in August 1986.
The following table presents the high and low prices as reported by the Nasdaq
Stock Market and dividends paid for the last two fiscal years. These prices
represent quotations by the dealers and do not necessarily represent actual
transactions, and do not include retail markups, markdowns or commissions.
The Corporation has approximately 4,625 stockholders.

2000 Fiscal Year
Quarter High Low Dividend
------- ---- --- --------

Fourth $11.06 $ 8.94 $0.12
Third 12.38 9.00 0.12
Second 14.00 10.75 0.12
First 14.00 11.75 0.11

1999 Fiscal Year
Quarter High Low Dividend
------- ---- --- --------

Fourth $15.25 $12.56 $0.11
Third 14.25 12.00 0.11
Second 16.50 12.38 0.11
First 18.88 15.25 0.11

Dividend Policy
---------------
Horizon Financial Corp. historically has paid cash dividends on its
common stock. The Corporation must adhere to certain regulatory requirements
governing the distribution of dividends, and there can be no assurance that
the Corporation will continue to declare cash dividends in the future.

Item 6. Selected Financial Data
--------------------------------
The following table sets forth certain information concerning the
financial position of the Bank at and for the dates indicated.

March 31,
---------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(In thousands)
Financial Condition Data:

Total Assets . . . . . . $713,914 $668,116 $605,613 $568,565 $525,279
Loans Outstanding. . . . 589,584 533,649 478,661 439,274 416,790
Cash and Investment
Securities . . . . . . . 99,375 115,194 112,172 114,656 95,631
Deposits . . . . . . . . 564,327 537,390 501,293 472,261 433,482
Borrowings . . . . . . . 39,853 22,718 1,180 600 600
Stockholders' Equity . . 95,935 96,441 86,675 83,534 83,919

(table continued on following page)

<PAGE>

Year Ended March 31,
--------------------------------------------------
2000 1999(1) 1998(1) 1997(1) 1996(1)
---- ---- ---- ---- ----
(In thousands)
Operating Data:
---------------
Interest Income. . $49,947 $48,119 $45,745 $42,774 $39,765
Interest Expense . (26,257) (25,267) (23,991) (22,372) (21,891)
Net Interest
Income. . . . . . 23,690 22,852 21,754 20,402 17,874
Other Income . . . 2,851 3,175 2,267 1,922 1,417
Non-interest
Expense . . . . . (13,243) (11,357) (9,934) (9,595) (7,837)
Provision for
Loan Losses . . . (437) (485) (521) (284) (207)
------- ------- ------- ------- -------
Income (Loss)
Before Taxes. . . 12,861 14,186 13,566 12,445 11,247
Federal Income
Tax . . . . . . . (4,180) (4,844) (4,598) (4,193) (3,665)
------- ------- ------- ------- -------
Net Income . . . . $ 8,681 $ 9,342 $ 8,968 $ 8,252 $ 7,582
======= ======= ======= ======= =======
Per Common Share:
Fully-diluted
earnings. . . . $ 1.01 $ 1.08 $ 1.05 $ 0.96(3) $0.88(3)
Dividends . . . 0.47 0.44(4) 0.83(2)(4) 0.75(2)(4) 0.32(4)
Equity. . . . . 11.59 11.36 10.62 9.99(3) 9.81(3)
Weighted average
shares
outstanding . . 8,587,543 8,625,391 8,573,940 8,455,637(3) 8,520,411(3)
----------
(1) Prior year numbers are restated to reflect the merger of Bellingham
Bancorporation effective June 19, 1999.
(2) Includes special cash dividend of $0.35 declared November 21, 1996, and
special cash dividend of $0.40 declared January 28, 1998.
(3) Restated for 15% stock dividend effective May 8, 1997.
(4) Prior year numbers based on shares outstanding prior to merger for
each respective year.

Key Operating Ratios:
---------------------
The table below sets forth certain performance ratios of the Bank for the
periods indicated. These ratios are calculated based on month end balances.

At and for the
Year Ended March 31,
---------------------------
2000 1999 1998
---- ---- ----
Return on average assets (net income divided
by average total assets). . . . . . . . . . 1.26% 1.47% 1.53%

Return on average equity (net income divided
by average equity). . . . . . . . . . . . . 9.02 10.03 10.36

Dividend payout ratio (dividends declared
per share divided by fully-diluted earnings
per share). . . . . . . . . . . . . . . . . 46.53 44.44 79.05

Equity to assets ratio (average equity
divided by average total assets). . . . . . 13.92 14.61 14.75

Interest rate spread (difference between
average yield on interest-earning assets
and average cost of interest bearing
liabilities). . . . . . . . . . . . . . . . 3.14 3.20 3.26

Net yield on earning assets (net interest
income as a percentage of average interest
earning assets) . . . . . . . . . . . . . . 3.65 3.78 3.91

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
-----------------------------------------------------------------------------
Information required by this item is incorporated herein by reference to
the section captioned "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Corporation's Proxy Statement.

<PAGE>

Item 7A. Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------
Information required by this item is incorporated herein by reference to
the section captioned "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Quantitative and Qualitative
Disclosures About Market Risk" contained in the Corporation's Proxy Statement.

Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
The financial statements contained in the Proxy Statement which are
listed under Item 14 herein, are incorporated herein by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
-----------------------------------------------------------------------------
Not applicable.

PART III

Item 10. Directors and Executive Officers of the Registrant
------------------------------------------------------------
The information contained under the section captioned "Proposal I -
Election of Directors" and "Compliance with Section 16(a) of the Exchange Act"
in the Registrant's Proxy Statement is incorporated herein by reference.

The executive officers of the Corporation and the Bank are as follows:

Name Age Position
---- --- --------
George W. Gust 70 Chairman of the Board of the Corporation

V. Lawrence Evans 53 Chief Executive Officer and President of the
Corporation; and Chairman of the Board,
Chief Executive Officer and President of the
Bank

John M. (Jack) Daughters 58 Executive Vice President and Board member of
the Bank

Richard P. Jacobson 37 Vice President and Secretary of the
Corporation and Executive Vice President and
Secretary of the Bank

A.R. (Gus) Ayala 50 Senior Vice President of the Bank

Richard L. (Dick) Hovde 53 Senior Vice President of the Bank

Karla C. Lewis 53 Senior Vice President of the Bank

Judy E. Boxx 58 Vice President of the Bank

Paul C. Eickmeyer 56 Vice President of the Bank

William (Bill) Frank 57 Vice President of the Bank

Ronald Funk 42 Vice President of the Bank

Christine C. Hagen 52 Vice President of the Bank

Kelli J. Holz 31 Vice President of the Corporation and the
Bank

Jeffrey H. Jansen 42 Vice President of the Bank

Karen A. LePage 59 Vice President of the Corporation and the
Bank

<PAGE>

Sandra R. Mathewson 40 Vice President of the Bank

Merwyn G. Murk 61 Vice President of the Bank

Elizabeth (Beth) E. Sherry 48 Vice President of the Bank

John K. Stewart 47 Vice President of the Bank

Carla J. Williams 54 Vice President of the Bank

Donald A. Wolf 51 Vice President of the Bank

The following is a description of the principal occupation and employment
of the executive officers of the Corporation and the Bank during at least the
past five years:

GEORGE W. GUST joined the Bank in 1975 and has served as the Chairman of
the Board of Directors of the Corporation since its formation in 1995. Mr.
Gust also served as Chairman of the Bank from August 1984 until July 1997.
Effective May 14, 1990, Mr. Gust resigned as President.

V. LAWRENCE EVANS joined the Bank in 1972 and served as the Bank's
Executive Vice President/Finance from 1983 to May 14, 1990 at which time, Mr.
Evans was appointed President of the Bank. On March 26, 1991, Mr. Evans was
appointed Chief Executive Officer of the Bank and in July 1997, Mr. Evans was
appointed Chairman of the Board of the Bank.

JOHN M. (JACK) DAUGHTERS joined the Bank pursuant to the merger of
Bellingham Bancorporation effective June 19, 1999. He joined the Bank of
Bellingham in July 1992 and served as its President and Chief Executive
Officer until completion of the merger. He is currently the Executive Vice
President, Commercial Department Manager, and Board member of Horizon Bank.

RICHARD P. JACOBSON has worked for the Bank for 13 years and was
appointed Vice President/Finance and Corporate Secretary in December 1994. In
March 1998, Mr. Jacobson was appointed Senior Vice President of the Bank. In
March 2000, he was appointed Executive Vice President of the Bank.

A.R. (GUS) AYALA joined the Bank pursuant to the merger of Bellingham
Bancorporation effective June 19, 1999. He served as Chief Financial Officer
for the Bank of Bellingham from September 1997 until completion of the merger.
Previously, he was Senior Vice President with a commercial bank in Lompoc,
California. He is currently Senior Vice President and Operations Manager for
the Bank.

RICHARD L. (DICK) HOVDE joined the Bank pursuant to the merger of
Bellingham Bancorporation effective June 19, 1999. He joined the Bank of
Bellingham in July 1992 and served as its Senior Vice President and Senior
Loan Officer until completion of the merger. He is currently Senior Vice
President, Senior Commercial Lender of Horizon Bank.

KARLA C. LEWIS joined Horizon Bank in 1973. From 1983 to December 1994,
she was the Manager of the Loan Servicing Department. She was appointed Vice
President in June 1987 and is currently the Bank's Chief Lending Officer. In
March 1998, she was appointed Senior Vice President of the Bank.

JUDY E. BOXX joined Horizon Bank in 1984. She has worked in the Loan
Servicing/Collection Department since 1986. She was appointed Vice President
and Manager of the Loan Servicing Department in December of 1994.

PAUL C. EICKMEYER joined the Bank pursuant to the merger of Bellingham
Bancorporation effective June 19, 1999. He served as Vice President,
Commercial Loan Officer for the Bank of Bellingham from October 1994 until
completion of the merger, and is currently a commercial loan officer for the
Bank.

WILLIAM (BILL) FRANK joined the Bank in October 1999. He is currently a
Vice President, Commercial Loan Officer for the Bank. He was previously a
commercial loan officer for a local commercial bank.

<PAGE>

RONALD FUNK joined the Bank in July 1999. He is currently a Vice
President, Commercial Loan Officer for the Bank. He was previously a
commercial loan officer at two northwest commercial banks.

CHRISTINE C. HAGEN joined the Bank pursuant to the merger of Bellingham
Bancorporation effective June 19, 1999. She served as Vice President,
Operations for the Bank of Bellingham from July 1992 until completion of the
merger. She is currently Vice President, Human Resource Manager for the Bank.

KELLI J. HOLZ, CPA, joined the Bank in 1988. From 1991 to 1998 she was
the Manager of the Internal Audit Department. In March 1998, she was
appointed Vice President and is currently acting as Controller of the Bank.

JEFFREY H. JANSEN joined Horizon Bank in 1985 as the manager of the
Bank's Lynden Office. He was appointed Vice President in December of 1994.

KAREN A. LEPAGE has been employed by the Bank since 1958. In December
1985, she was promoted to Vice President.

SANDRA R. MATHEWSON joined the Bank in 1986. She was appointed Vice
President in March 1998 and is currently the Employee Development Manager for
the Bank.

MERWYN G. MURK joined the Bank in 1969 and has been manager of the
Savings Department since 1972. He was appointed Vice President in October
1977.

ELIZABETH (BETH) E. SHERRY joined the Bank in 1996. She was appointed
Vice President in December 1997 and is currently the Bank's Retail Sales
Manager.

JOHN K. STEWART joined the Bank pursuant to the merger of Bellingham
Bancorporation effective June 19, 1999. He is currently a Vice President,
Commercial Loan Officer for the Bank. Previously, he was Vice President of
International Banking with a regional commercial bank.

CARLA J. WILLIAMS joined the Bank in 1988. She was appointed Vice
President in March 1998 and is currently the Bank's Loan Production Manager.

DONALD A. WOLF joined Horizon Bank in 1973. Mr. Wolf was appointed Vice
President in June 1987, and currently is the Bank's security officer and
manager of the administrative services department.

Item 11. Executive Compensation
--------------------------------
Information regarding management compensation and transactions with
management and others is incorporated by reference to the section captioned
"Proposal I - Election of Directors" in the Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management
------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners

Information required by this item is incorporated herein by reference to
the section captioned "Voting Securities and Principal Holders Thereof"
in the Proxy Statement.

(b) Security Ownership of Management

Information required by this item is incorporated herein by reference to
the section captioned "Voting Securities and Principal Holders Thereof"
in the Proxy Statement.

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.

<PAGE>

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,
2000 and 1999*
Consolidated Statement of Income for the years ended
March 31, 2000, 1999 and 1998*
Consolidated Statement of Stockholders' Equity
for the years ended March 31, 2000, 1999 and 1998*
Consolidated Statement of Cash Flows for the years
ended March 31, 2000, 1999 and 1998*

Notes to Consolidated Financial Statements*

------------------
* Contained in the Corporation's Proxy Statement and incorporated
herein by reference.

(2) All required financial statement schedules are included in the Notes
to Consolidated Financial Statements contained in the Corporation's
Proxy Statement.

(b) No current reports on Form 8-K were filed by the Corporation during
the three months ended March 31, 2000.

(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))
(21) Subsidiaries of the Registrant
(23) Consent of Auditors
(27) Financial Data Schedule

<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.

HORIZON FINANCIAL CORP.

Date: June 27, 2000 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 27, 2000 Date: June 27, 1999

By: /s/V. Lawrence Evans By: /s/Fred R. Miller
------------------------ -----------------------------
V. Lawrence Evans Fred R. Miller
Chief Executive Officer Director
and President

Date: June 27, 2000 Date: June 27, 2000

By: /s/ Richard P. Jacobson By: /s/ L.M. Strengholt
------------------------ -----------------------------
Richard P. Jacobson L. M. Strengholt
Principal Financial Officer Director

Date: June 27, 2000 Date: June 27, 2000

By: /s/Kelli J. Holz By: /s/Frank G. Uhrig
------------------------ -----------------------------
Kelli J. Holz Frank G. Uhrig
Principal Accounting Officer Director

Date: June 27, 2000 Date: June 27, 2000

By: /s/ Richard D. Haggen By: /s/Gary E. Goodman
------------------------ -----------------------------
Richard D. Haggen Gary E. Goodman
Director Director

Date: June 27, 2000 Date: June 27, 2000

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Exhibit 21

Subsidiaries of the Registrant

Parent
------
Horizon Financial Corp.

Jurisdiction
Percentage or State of
Subsidiaries (a) of Ownership Incorporation
---------------- ------------ -------------

Horizon Bank 100% Washington

Westward Financial
Services, Inc. (b) 100% Washington

----------------
(a) The operation of the Corporation's wholly owned subsidiaries are
included in the Consolidated Financial Statements contained in the Item
8 of this Form 10-K.

(b) Wholly-owned subsidiary of Horizon Bank.

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Exhibit 23

Consent of Auditors

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[Moss-Adams LLP Letterhead]

CONSENT OF INDEPENDENT ACCOUNTANTS

The Board of Directors
Horizon Financial Corp.

We consent to the incorporation by reference in the Registration Statement on
Form S-8 (No. 33-99780) of Horizon Financial Corp. pertaining to the 1986
Stock Option and Incentive Plan, and the 1995 Stock Option Plan; and the
Registration Statement on Form S-8 (No. 333-88571) pertaining to the Bank of
Bellingham 1993 Employee Stock Option Plan; of our report dated April 25,
2000, appearing in the 2000 proxy statement of Horizon Financial Corp., which
is incorporated by reference in Horizon Financial Corp.'s Annual Report on
Form 10-K for the year ended March 31, 2000.

/s/Moss-Adams LLP

Bellingham, Washington
June 27, 2000

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Exhibit 27

Financial Data Schedule

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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,
2000 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, 2000 Item Description
----------- --------------------- ----------------
9-03(1) 16,043,055 Cash and due from the Banks
9-03(2) 3,960,522 Interest-bearing deposits
9-03(3) -- Federal funds sold - purchased
securities for resale
9-03(4) -- Trading account assets
9-03(6) 64,999,763 Investment and mortgage backed
securities held for sale
9-03(6) 9,117,391 Investment and mortgage backed
securities held to maturity
- carrying value
9-03(6) 8,991,246 Investment and mortgage backed
securities held to maturity
- market value
9-03(7) 589,583,539 Loans
9-03(7)(2) 4,757,152 Allowance for losses
9-03(11) 713,914,043 Total assets
9-03(12) 564,327,085 Deposits
9-03(13) 37,853,000 Short-term borrowings
9-03(15) 13,798,967 Other liabilities
9-03(16) 2,000,000 Long-term debt
9-03(19) -- Preferred stock - mandatory
redemption
9-03(20) -- Preferred stock - no mandatory
redemption
9-03(21) 8,642,571 Common stocks
9-03(22) 87,292,420 Other stockholders' equity
9-03(23) 713,914,043 Total liabilities and
stockholders' equity
9-04(1) 43,881,883 Interest and fees on loans
9-04(2) 6,065,394 Interest and dividends on
investments
9-04(4) -- Other interest income
9-04(5) 49,947,277 Total interest income
9-04(6) 24,611,084 Interest on deposits
9-04(9) 26,256,892 Total interest expense
9-04(10) 23,690,385 Net interest income
9-04(11) 437,234 Provision for loan losses
9-04(13)(h) 185,018 Investment securities
gains/(losses)
9-04(14) 13,243,789 Other expenses
9-04(15) 12,860,551 Income/loss before income tax
9-04(17) 12,860,551 Income/loss before extraordinary
items
9-04(18) -- Extraordinary items, less tax
9-04(19) -- Cumulative change in accounting
principles
9-04(20) 8,680,511 Net income or loss
9-04(21) 1.02 Earnings per share - basic
9-04(21) 1.01 Earnings per share - diluted
I.B.5 7.73 Net yield - interest earning
assets - actual
III.C.1.(a) 455,000 Loans on non-accrual
III.C.1.(b) 456,729 Accruing loans past due 90 days
or more
III.C.2.(c) -- Troubled debt restructuring
III.C.2 -- Potential problem loans
IV.A.1 4,463,305 Allowance for loan loss -
beginning of period
IV.A.2 (143,387) Total chargeoffs
IV.A.3 -- Total recoveries
IV.A.4 4,757,152 Allowance for loan loss - end of
period
IV.B.1 1,238,883 Loan loss allowance to allocated
to domestic loans
IV.B.2 -- Loan loss allowance to foreign
loans
IV.B.3 3,518,269 Loan loss allowance - unallocated

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