UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10KSB/A
(Amendment No. 1)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission file number 0-24036
HORIZON FINANCIAL SERVICES CORPORATION
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(Name of small business issuer in its charter)
Delaware 42-1419757
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
301 First Avenue East, Oskaloosa, Iowa 52577-0008
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (515) 673-8328
---------------------------
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 $0.01 per share
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained herein, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
State the issuer's revenues for its most recent fiscal year:
$7,052,163.
<PAGE>
The aggregate market value of the voting stock held by non-affiliates
of the registrant, computed by reference to the average of the closing bid and
asked price of such stock as reported on the Nasdaq System as of September 15,
1998, was $10.4 million. (The exclusion from such amount of the market value of
the shares owned by any person shall not be deemed an admission by the
registrant that such person is an affiliate of the registrant.)
As of September 15, 1998, there were issued and outstanding 879,942
shares of the Registrant's Common Stock
DOCUMENTS INCORPORATED BY REFERENCE
Part II of Form 10-KSB - Annual Report to Stockholders for the fiscal
year ended June 30, 1998.
Part III of Form 10-KSB - Proxy Statement for the Annual Meeting of
Stockholders held in October 1998.
Transitional Small Business Disclosure Format: YES [ ]; NO [X].
<PAGE>
Registrant is filing this Amendment No. 1 to its Form 10-KSB for the
fiscal year ended June 30, 1998, to correct the inadvertent text omission from
its electronic filing of certain pages of its Annual Report to Stockholders
filed as Exhibit 13 hereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 SERVICES
CORPORATION
By: /s/ Sharon K. McCrea
---------------------
Sharon K. McCrea, Treasurer and
Comptroller
(Duly Authorized Representative)
Date: October 26, 1998
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1998 ANNUAL REPORT
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[LOGO]
HORIZON FINANCIAL SERVICES
CORPORATION
<PAGE>
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TABLE OF CONTENTS
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President's Letter to Shareholders............................ 1
Selected Consolidated Financial Information................... 2
Management's Discussion and Analysis of Financial
Condition and Results of Operation.......................... 4
Consolidated Financial Statements.............................17
Stockholder Information.......................................41
Corporate Information.........................................42
Annual Report on Form 10-KSB
A copy of Horizon Financial Services Corporation's Annual Report on Form 10-KSB
for the year ended June 30, 1998, as filed with the Securities and Exchange
Commission, may be obtained without charge by contacting Robert W. DeCook,
President and Chief Executive Officer, Horizon Financial Services Corporation,
301 First Avenue East, Oskaloosa, Iowa, (515) 673-8328.
<PAGE>
[HORIZON FINANCIAL LETTERHEAD]
September 25, 1998
Dear Stockholder:
I am very pleased to report to you that the Company's fiscal year ended June 30,
1998, was again one of increased profitability from recurring operations. Net
interest income after provision for losses on loans was $2.63 million, an
increase of $388,000 or 17.3 percent.
Net income increased to $589,000 in fiscal 1998, which represents a .67 percent
return on average assets. This represents an increase of $311,000 over the
previous year's net income, an increase substantially in excess of 100 percent.
Included in current year net income was a write down of $475,000 on an interest
only mortgage-backed security resulting from a decline in fair market value that
was judged to be other than temporary. Fiscal 1997 net income was affected by a
$331,000 special assessment by the Federal Deposit Insurance Corporation to
recapitalize the Savings Association Insurance Fund.
Loans receivable increased by $3.8 million as residential real estate, consumer
and commercial business loans increased. Total assets increased by $4.0 million,
an increase of 4.7 percent. During fiscal 1998, the Company's average interest
rate spread (the difference between the yields earned on interest-earning assets
and the rates paid on interest-bearing liabilities) was a healthy 2.96 percent
and its net interest margin was 3.23 percent, compared to 3.12 percent and 3.41
percent, respectively, for fiscal 1997.
Your Board and management are committed to continue building value in Horizon
Financial and are gratified that the Company's share price has risen
impressively over last years value, even with the recent market downturn. We
will also continue to be an organization which builds family financial
relationships and demonstrates commitment to our customers and to the
communities we serve.
On behalf of all us at Horizon Financial and Horizon Federal, we thank you for
your support of and your investment in Horizon Financial.
Yours very truly,
Robert W. DeCook
President and Chief Executive Officer
<PAGE>
<TABLE>
<CAPTION>
SELECTED CONSOLIDATED FINANCIAL INFORMATION(1)
At June 30,
--------------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(In Thousands)
Selected Financial Condition Data:
<S> <C> <C> <C> <C> <C>
Total assets..................................... $89,947 $85,969 $73,464 $69,624 $60,589
Cash and cash equivalents........................ 6,367 5,621 3,471 3,812 5,081
Securities available for sale.................... 23,922 24,942 18,049 5,170 2,079
Loans receivable, net............................ 55,996 52,193 49,104 46,478 40,409
Deposits......................................... 60,145 57,641 54,759 51,330 49,969
Advances from FHLB............................... 20,038 19,102 9,661 8,718 1,447
Stockholders' equity............................. 8,488 8,412 8,390 8,786 8,584
<CAPTION>
Year Ended June 30,
----------------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(In Thousands, Except Per Share Data)
Selected Operations Data:
<S> <C> <C> <C> <C> <C>
Total interest income.............................. $6,744 $5,895 $5,454 $4,752 $4,147
Total interest expense............................. 4,021 3,402 3,144 2,443 2,160
------ ------ ------ ------ ------
Net interest income.............................. 2,723 2,493 2,310 2,309 1,987
Provision for losses on loans...................... 94 252 328 2 ---
------ ------ ------ ------ ------
Net interest income after
provision for losses on loans..................... 2,629 2,241 1,982 2,307 1,987
Noninterest income
Fees, commissions and service charges............ 448 338 345 238 230
Gain (loss) on sale of securities, net........... (167) 81 39 --- (273)
Other noninterest income......................... 27 19 94 23 21
------ ------ ------ ------ ------
Total noninterest income........................... 308 438 478 261 (22)
Total noninterest expense.......................... 2,031 2,255(2) 1,886 1,904 1,526
------ ------ ------ ------ ------
Earnings before taxes on income.................... 906 424 573 664 439
Taxes on income ................................... 317 146 197 245 166
------ ------ ------ ------ ------
Net earnings before change in accounting
principle........................................ 589 278 376 419 273
Cumulative effect from change in accounting
principle, net of taxes on income................ --- --- --- --- 160
------ ------ ------ ------ ------
Net earnings ...................................... $ 589 $ 278 $ 376 $ 419 $ 433
======= ====== ====== ====== ======
Basic earnings per common share.................... $ 0.71 $ 0.34 $ 0.43 $ 0.44 N\A
Diluted earnings per common share.................. $ 0.69 $ 0.33 $ 0.42 $ 0.44 N\A
Dividends per share................................ $ 0.18 $ 0.16 $ 0.16 $ 0.08 N\A
</TABLE>
<PAGE>
(1) All per share information has been restated for the 2-for-1 stock split
paid by the Company on November 10, 1997 in the form of a 100% stock
dividend.
(2) Includes the special assessment of $331,000 paid by the Company to the
Federal Deposit Insurance Fund (the"FDIC") to recapitalize the Savings
Association Insurance Fund (the "SAIF").
2
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets (ratio of net earnings to average
total assets)......................................... .67% .35(1) .53% .64% .74%
Interest rate spread information:
Average during year..................................... 2.96 3.12 3.09 3.42 3.59
End of year............................................. 3.05 3.07 3.06 2.59 3.41
Net interest margin(2)................................... 3.23 3.41 3.44 3.82 3.70
Ratio of operating expense to average total
assets................................................. 2.31 2.83(1) 2.64 2.92 2.61
Return on stockholders' equity (ratio of net
earnings to average equity)............................ 6.97 3.31(1) 4.38 4.82 9.84
Efficiency ratio(3)....................................... 63.51 67.51 68.61 74.09 68.19
Asset Quality Ratios:
Non-performing assets to total assets at end of
year(4)................................................. 1.02 1.22 1.27 1.06 1.21
Allowance for losses on loans to non-performing
loans(4)............................................... 37.74 50.51 34.01 39.27 51.85
Allowance for losses on loans to total loans............. .61 .65 .63 .62 .91
Other Ratios:
Stockholders' equity to total assets at end of
year.................................................... 9.44 9.78 11.42 12.62 14.17
Average stockholders' equity to average assets............ 9.61 10.54 12.00 13.34 7.54
Average interest-earning assets to average
interest-bearing liabilities........................... 105.65% 106.13% 107.31% 109.88% 102.58%
Number of full-service offices............................. 3 3 3 3 3
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</TABLE>
(1) Includes one-time SAIF assessment paid in fiscal 1997 of $331,000
($207,000, net of taxes). Excluding the SAIF assessment, return on
assets, operating expenses to total assets and return on stockholder's
equity was .61%, 2.41% and 5.77%, respectively, for fiscal 1997.
(2) Net interest income divided by average interest-earning assets.
(3) Noninterest expense (not including one-time SAIF assessment paid in
fiscal 1997) divided by net interest income and other income,
(excluding gain (loss) on sale of securities, net).
(4) Nonperforming assets consist of nonaccruing loans, accruing loans
past-due 90 or more days and real estate owned. Nonperforming loans are
nonperforming assets less real estate owned.
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Horizon Financial Services Corporation (the "Company") is a savings and
loan holding company the primary asset of which is Horizon Federal Savings Bank
(the "Bank"). The Company was incorporated in March 1994 and sold 506,017 shares
of common stock on June 28, 1994 for the purpose of acquiring all of the capital
stock of the Bank in connection with the Bank's conversion from mutual to stock
form of ownership (the "Conversion"). On November 10, 1997, the Company effected
a 2-for-1 stock split paid in the form of a 100% stock dividend ("1997 Stock
Split"). All information presented herein, except as otherwise indicated, has
been adjusted to reflect the 1997 Stock Split. All references to the Company
prior to June 28, 1994, except where otherwise indicated, are to the Bank and
its subsidiary on a consolidated basis.
The principal business of the Company has historically consisted of
attracting deposits from the general public and making loans secured by
residential and, to a lesser extent, other properties. The Company's results of
operations are primarily dependent on net interest rate spread, which is the
difference between the average yield on loans, mortgage-backed securities and
investments and the average rate paid on deposits and other borrowings. The
interest rate spread is affected by regulatory, economic and competitive factors
that influence interest rates, loan demand and deposit flows. In addition, the
Company, like other non-diversified savings institution holding companies, is
subject to interest rate risk to the degree that its interest-earning assets
mature or reprice at different times, or on a different basis, than its
interest-bearing liabilities.
The Company's results of operations are also affected by, among other
things, fee income received, loss or profit on securities available for sale,
the establishment of provisions for possible losses on loans, income derived
from subsidiary activities, the level of operating expenses and income taxes.
The Company's operating expenses principally consist of employee compensation
and benefits, occupancy expenses, federal deposit insurance premiums, data
processing expenses and other general and administrative expenses.
The Company is significantly affected by prevailing economic conditions
including federal monetary and fiscal policies and federal regulation of
financial institutions. Deposit balances are influenced by a number of factors
including interest rates paid on competing personal investments and the level of
personal income and savings within the institution's market area. Lending
activities are influenced by the demand for housing as well as competition from
other lending institutions. The primary sources of funds for lending activities
include deposits, loan repayments, borrowings and funds provided from
operations.
Some local economic conditions in the Bank's market are weakening. The
farm economy has been strong for over five years but is now beginning to soften.
As a result of an over-supply of grain, farm prices for grain and livestock,
which are currently depressed, may continue to remain depressed and possibly
even drop further. In addition, the Bank is experiencing difficulty, as are most
businesses in the area, in hiring and retaining experienced personnel as labor
shortages in the area continue to exist. In the event current economic and
market conditions persist or worsen, loan demand and existing loans may be
affected. No assurances can be given that the Bank will be able to maintain or
increase its loan portfolio, which could adversely affect the financial
condition and results of operations of the Company and the Bank.
<PAGE>
Certain statements in this report that relate to the Corporation's
plans, objectives or future performance may be deemed to be forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Such statements are based on Management's current expectations. Actual
strategies and results in future periods may differ materially from those
currently expected because of various risks and uncertainties. Additional
discussion of factors affecting the Corporation's business and prospects is
contained in the Corporation's periodic filings with the Securities and Exchange
Commission.
4
<PAGE>
Financial Condition
June 30, 1998 Compared to June 30, 1997. Total assets increased $4.0
million, or 4.7%, to $89.9 million at June 30, 1998 from $85.9 million at June
30, 1998. The increase was reflected in a $3.8 million increase net loans
receivable, a $700,000 increase in cash and cash equivalents, and a $400,000
increase in deferred income tax. The increase was partially offset by a $1.0
million decrease in securities available for sale. The increases were funded
primarily through a $2.5 million increase in deposits and additional advances of
$900,000 from the Federal Home Loan Bank (the "FHLB") of Des Moines. The Company
continued to leverage its capital through FHLB advances to increase the
Company's earnings. See "Asset\Liability Management."
Total liabilities increased $3.9 million, or 5.0%, to $81.5 million at
June 30, 1998 from $77.6 million at June 30, 1997, primarily as a result of a
$2.5 million increase in deposits and a $900,000 increase in FHLB advances. The
increase in deposits was due to the deposit of short-term public funds with the
Company, of which approximately $2.0 million were withdrawn subsequent to June
30, 1998.
Stockholder's equity increased $75,000, or .89%, during fiscal 1998,
primarily through the retention of net income, net proceeds received in
connection with the exercise of Company stock options and the amortization for
the allocated portion of shares held by the ESOP, offset by a negative
adjustment of net unrealized losses on securities available for sale and the
payment of cash dividends by the Company. The Company paid cash dividends
totaling approximately $145,000 or $.175 per share.
June 30, 1997 Compared to June 30, 1996. Total assets increased $12.5
million, or 17.0%, to $85.9 million at June 30, 1997 from $73.4 million at June
30, 1996. The increase was reflected in a $6.9 million increase in securities
available for sale, a $3.1 million increase in net loans receivable, a $2.1
million increase in cash and cash equivalents, and a $400,000 increase in
Federal Home Loan Bank stock. The increases were funded primarily through
additional advances of $9.4 million from the FHLB of Des Moines and a $2.9
million increase in deposits. During fiscal 1997, the Company leveraged its
capital through FHLB advances in an effort to increase earnings.
Total liabilities increased $12.5 million, or 19.2%, to $77.6 million
at June 30, 1997 from $65.1 million at June 30, 1996, primarily as a result of
the $9.4 million increase in FHLB advances and a $2.9 million increase in
deposits.
Stockholders' equity increased $22,000, or .27%, during fiscal 1997,
primarily through the retention of net income and a positive adjustment of net
unrealized losses on securities available for sale, offset by the repurchase of
the Company's common stock and the payment of dividends declared on common
stock. The Company paid cash dividends totaling approximately $130,000 or $.16
per share. The Company repurchased five percent of its common stock, 22,397
shares, under a stock repurchase program completed during fiscal 1997. Common
stock was repurchased during 1997 at a cost of $337,354, or $7.53 per share.
Results of Operations
Comparison of Years Ended June 30, 1998 and June 30, 1997
General. Net earnings for the year ended June 30, 1998 increased
$311,000 to $589,000 from $278,000 for the year ended June 30, 1997. This
increase was primarily due to an increase of $388,000 in net interest income
after provision for loan losses, a decrease in FDIC premiums, primarily due to
the absence of the one-time SAIF assessment paid in fiscal 1997,of $331,000, and
an increase of $110,000 in fee income. Net earnings, without the SAIF
assessment, for the year ended June 30, 1997 would have been
5
<PAGE>
$485,000 as compared to $589,000 for the same period ended June 30, 1998,
resulting in an increase of $104,000 or 21% for the year ended June 30, 1998.
During fiscal 1998, the Company's return on average assets ("ROAA") and
return on average stockholder's equity ("ROAA") was .67% and 6.97%,
respectively, compared to .35% and 2.83% for fiscal 1997. ROAA and ROAE for
fiscal 1997 were affected by the one-time SAIF assessment of $207,000 (net of
taxes) paid by the Company. The Company's ROAA and ROAE for fiscal 1997 without
the SAIF assessment, was .61% and 5.77%, respectively. Average stockholders'
equity to average assets was 9.61% during fiscal 1998 compared to 10.54% during
fiscal 1997. The Company's dividend payout ratio was 26% during fiscal 1998
compared to 48% during fiscal 1997.
Interest Income. Interest income increased $849,000 to $6.7 million for
the year ended June 30, 1998 compared to $5.9 million for the year ended June
30, 1997. The increase was attributable primarily to interest earned on loans
receivable and securities available for sale as a result of an increase in the
average outstanding balance of these assets. The average outstanding balance of
loans receivable increased $3.8 million to $55.0 million and the securities
increased $5.9 million to $25.4 million during fiscal 1998. An increase of
$900,000 in the average outstanding balance of the Company's other interest
earning assets also contributed to the increase in interest income. These
increases were funded with customer deposits and FHLB advances. The yield on all
average interest-earning assets decreased slightly during fiscal 1998 to 8.00%
from 8.06% during fiscal 1997.
Interest Expense. Interest expense increased $619,000 to $4.0 million
for the year ended June 30, 1998 compared to $3.4 million for the ended June 30,
1997. The increase in interest expense was primarily attributable to increases
in the average outstanding balance of FHLB advances and deposits, combined with
increased rates paid on FHLB advances. The average rate paid on advances
increased by 15 basis points to 5.69% during fiscal 1998 from 5.54% during
fiscal 1997. The average rate paid on all interest-bearing liabilities increased
ten basis points to 5.04% during fiscal 1998 from 4.94% during fiscal 1997.
Net Interest Income. Net interest income increased $230,000 to $2.7
million in fiscal 1998 from $2.5 million in fiscal 1997. The ratio of the
Company's average interest-bearing assets to average interest-bearing
liabilities decreased to 105.65% during fiscal 1998 from 106.13% during fiscal
1997. During this same period the Company's interest rate spread decreased
slightly to 2.96% from 3.12%.
Provision for Losses on Loans. The provision for losses on loans is a
result of management's periodic analysis of the adequacy of the Company's
allowances for losses on loans. During the year ended June 30, 1998, the Company
had a $94,000 addition to its allowance for losses on loans compared to a
$252,000 provision in fiscal 1997. The Company continues to monitor and adjust
its allowances for losses on loans as management's analysis of its loan
portfolio and economic conditions dictate. The Company believes it has taken an
appropriate approach toward reserve levels, consistent with the Company's loss
experiences and considering, among other factors, the composition of the
Company's loan portfolio, the level of the Company's classified and
non-performing assets and their estimated values. However, future additions to
the Company's allowances for losses on loans and any changes in the related
ratio of the allowances for losses to non-performing loans are dependent upon
the economy, changes in real estate values and interest rates, and might be
necessary in the event conditions deteriorate. In addition, federal regulators
may require additional reserves as a result of their examination of the Company.
The allowances for losses on loans reflects what the Company currently believes
is an adequate level of reserves. There can be no assurances, however, that
future losses will not occur, thereby adversely affecting future results of
operations. As of June 30, 1998 and June 30, 1997 the Company's allowances for
losses on loans was $348,000.
6
<PAGE>
As of June 30, 1998, the Company's non-performing assets, consisting of
nonaccruing loans, accruing loans 90 days or more delinquent, real estate owned
and repossessed consumer property, totaled $922,000, or 1.02% of total assets,
compared to $1,045,000, or 1.22% of total assets, as of June 30, 1997.
Noninterest Income. Noninterest income decreased $130,000 to $308,000
for the year ended June 30, 1998 from $438,000 for the year ended June 30, 1997.
The decrease was primarily attributable to a $167,000 loss realized on the sales
of securities in fiscal 1998 compared to an $81,000 gain realized on the sale of
securities in fiscal 1997. The loss realized on the sale of securities during
fiscal 1998 primarily was the result of a $475,000 write down on an interest
only mortgage-backed security resulting from a decline in fair value that was
judged to be other than temporary. This decline in fair value resulted from a
sustained increase in the prepayment speeds of the underlying mortgage loans.
The decrease in noninterest income was partially offset by a $110,000
increase in fees, service charges and commission, resulting from increased fees
charged on checking accounts and increased commission income on the sales of
insurance, annuity and mutual fund products through the wholly-owned financial
services subsidiary of the Bank.
Noninterest Expense. Noninterest expense decreased $224,000, or 9.9%,
to $2.0 million for the year ended June 30, 1998 from $2.3 million for the year
ended June 30, 1997. The decrease was primarily the result of the absence in
fiscal 1998 of the one time special assessment of $331,000 paid by the Company
to recapitalize the SAIF in fiscal 1997. This decrease was partially offset by a
$186,000 increase in compensation costs generally associated with the Company's
stock-based compensation plans as a result of an increase in the Company's stock
price.
The Company also anticipates incurring costs in connection with testing
and documenting the readiness of its electronic systems, programs and processes
to recognize properly the year 2000. While the Company does not believe that the
process of making its systems, programs and processes ready for the year 2000
will result in material cost, it is expected that a substantial amount of
management and staff time will be required on the year 2000 project. The Company
currently expects to spend approximately $10,000 in connection with its year
2000 readiness efforts. It is impossible to predict the exact expenses associate
with year 2000 preparedness, as additional funds may be needed for unknown
expenses related to year 2000 testing, potential charges by third party software
vendors for product enhancements, and, if necessary, for developing and
implementing any contingency plans in the event such enhancements cannot be
made. Furthermore, the readiness of our service provider, as well as certain
vendors and customers, may affect our preparedness. No assurance can be given,
that the Company's third party service providers' or other outside parties year
2000 readiness efforts will proceed as anticipated, or that the results of
operations of the Company will not be adversely affected by difficulties or
delays in the Company's or third parties' year 2000 readiness efforts. See
"-Year 2000 Issues."
Income Tax Expense. Income taxes increased $171,000 to $317,000 for the
year ended June 30, 1998 from $146,000 for the same period in 1997. The increase
was primarily due to an increase in earnings prior to taxes on income. Income
tax expense was reduced by low income housing credits of approximately $42,000,
which will continue annually through 2005.
Comparison of Years Ended June 30, 1997 and June 30, 1996
General. Net earnings for the year ended June 30, 1997 decreased
$98,000 to $278,000 from $376,000 for the year ended June 30, 1996. This
decrease was primarily due to the one time special assessment of $207,000, net
of taxes, by the FDIC to recapitalize the SAIF. Net earnings, without the SAIF
assessment, for the year ended June 30, 1997 would have been $485,000 as
compared to $376,000 for the same period ended June 30, 1996, resulting in an
increase of $109,000 or 29.0%.
7
<PAGE>
During fiscal 1997, the Company's return on average assets and return
on average stockholders' equity was .35% (.61% without the SAIF assessment) and
3.31% (5.77% without the SAIF assessment), respectively, compared to .53% and
4.38% during fiscal 1996. Average stockholders' equity to average assets was
10.54% during fiscal 1997 compared to 12.00% during fiscal 1996. The Company's
dividend payout ratio was 48% during fiscal 1997 compared to 38% during fiscal
1996.
Interest Income. Interest income increased $441,000 to $5.9 million for
the year ended June 30, 1997 compared to $5.5 million for the year ended June
30, 1996. The increase was attributable primarily to interest earned on loans
receivable as a result of an increase in the average outstanding balance of
loans, and to a lesser extent, the yield earned on such loans. The average
outstanding balance of loans receivable increased $3.2 million to $51.2 million
during fiscal 1997, while the yield earned on such loans increased 8 basis
points to 8.62%. An increase of $2.7 million in the average outstanding balance
of the Company's securities available for sale also contributed to the increase
in interest income. These increases were funded with FHLB advances and customer
deposits. The yield on all average interest-earning assets decreased slightly
during fiscal 1997 to 8.06% from 8.11% during fiscal 1996.
Interest Expense. Interest expense increased $258,000 to $3.4 million
for the year ended June 30, 1997 compared to $3.1 million for the year ended
June 30, 1996. The increase in interest expense was primarily attributable to
increases in the average outstanding balance of FHLB advances and deposits,
combined with increased rates paid on savings deposits. The average rate paid on
savings deposits increased by 60 basis points to 4.43% during fiscal 1997 from
3.83% during fiscal 1996. The average rate paid on all interest-bearing
liabilities decreased 8 basis points to 4.94% during fiscal 1997 from 5.02%
during fiscal 1996.
Net Interest Income. Net interest income increased $183,000 to $2.5
million in fiscal 1997 from $2.3 million in fiscal 1996. The ratio of the
Company's average interest-earning assets to average interest-bearing
liabilities decreased to 106.14% during fiscal 1997 from 107.31% during fiscal
1996. During this same period the Company's interest rate spread increased
slightly to 3.12% from 3.09%.
Provision for Losses on Loans. During the year ended June 30, 1997, the
Company had a $252,000 addition to its allowance for losses on loans compared to
a $328,000 provision in fiscal 1996. As of June 30, 1997 the Company's allowance
for losses on loans was $348,000 compared to $318,000 at June 30, 1996.
As of June 30, 1997, the Company's non-performing assets, consisting of
nonaccruing loans, accruing loans 90 days or more delinquent, real estate owned
and repossessed consumer property, totaled $1,045,000, or 1.22% of total assets,
compared to $935,000, or 1.27% of total assets, as of June 30, 1996. The
increase in non-performing assets related primarily to a $119,000 increase to
foreclosed assets and a $220,000 increase in accruing loans past-due 90 or more
days. The increase was partially offset by a $229,000 decrease in non-accruing
loans.
Noninterest Income. Noninterest income decreased $40,000 to $438,000
for the year ended June 30, 1997 from $478,000 for the year ended June 30, 1996.
The decrease was primarily attributable to the $37,000 nonrecurring special
patronage dividend received by the Company from its data processing servicer and
a $33,000 gain on the sale of the data processing center during fiscal 1996
while no similar noninterest income was received for fiscal 1997. This decrease
was partially offset by a $42,000 increase in the gain on sale of securities to
$81,000 for fiscal 1997 as compared to $39,000 for the year ended June 30, 1996.
8
<PAGE>
Noninterest Expense. Noninterest expense increased $369,000, or 19.6%,
to $2.3 million for the year ended June 30, 1997 from $1.9 million for the year
ended June 30, 1996. The increase was primarily the result of the one time
special assessment of $331,000 by the FDIC to recapitalize the SAIF. Also
contributing to the increase in noninterest expense was a $121,000 increase in
compensation costs generally associated with the Company's stock-based
compensation plans as a result of an increase in the Company's stock price,
partially offset by a $51,000 decrease in other general expense.
Income Tax Expense. Income taxes decreased $52,000 to $145,000 for the
year ended June 30, 1997 from $197,000 for the same period in 1996. The decrease
was primarily due to a decrease in earnings prior to taxes on income. Income tax
expense was reduced by low income housing credits of approximately $42,000.
Year 2000 Issues
A great deal of information has been disseminated about the widespread
computer problems that may arise in the year 2000. Computer programs that can
only distinguish the final two digits of the year entered (a common programming
practice in earlier years) are expected to read entries for the year 2000 as the
year 1900 and compute payment, interest or delinquency based on the wrong date,
or are expected to be unable to compute payment, interest or delinquency. Rapid
and accurate data processing is essential to the operation of the Company and
the Bank. Data processing is also essential to most other financial institutions
and many other companies. An internal committee of the Company, comprised of six
officers and one outside director, has been formed to address the potential risk
that year 2000 poses for the Company and the Bank.
Accurate data processing is essential to the operations of the Company
and the Bank, and a lack of accurate processing by its vendors (or by the
Company or the Bank) could have a significant adverse impact on the Company's
financial condition and results of operations. The Bank is currently undergoing
a data processing service bureau conversion. The conversion will be completed on
October 26, 1998. The Bank has been assured by its current and newly selected
data processing service bureaus that their computer services will function
properly on and after January 1, 2000. The Bank's newly selected data processing
service bureau has advised Management that it, in fact, is currently year 2000
compliant with no programming corrections needed, and will commence testing in
December 1998. If by the end of this year it appears that the Bank's primary
data processing service bureau in not year 2000 compliant or will be unable to
resolve this problem in a timely manner, then the Bank will identify a secondary
data processing service provider to complete the task. If the Bank is unable to
do this, it will identify those steps necessary to minimize the negative impact
the computer problems could have on the Bank. Notwithstanding the foregoing, if
the Company and the Bank are unable to resolve this potential problem in time,
the Bank will likely experience significant data processing delays, mistakes or
failures. These delays, mistakes or failures could have a significant adverse
impact on the financial condition and results of operations of the Company.
The Company has also received year 2000 updates from most of its
material non-information system providers, including but not limited to security
cameras, credit card and ATM card processors, the vault alarm, check printers,
telephone systems, participation loan servicers, and institutions the Company or
the Bank invests through or with, and based on these updates do not anticipate
any significant year 2000 issues.
In addition to expenses related to our own systems, the Company could
incur losses if loan payments are delayed due to year 2000 problems affecting
any of our significant borrowers or impairing the payroll systems of large
employers in the Company's market area. We have been communicating with the
Bank's vendors to assess their progress in evaluating their systems and
implementing any corrective
9
<PAGE>
measures required by them to be prepared for the year 2000. Year 2000 readiness
request letters have also been sent to certain borrowers of the Bank. These
borrowers were selected based on the aggregate amounts owed to the Bank, the
type of loans outstanding, and the perceived Year 2000 risk based on
management's knowledge of the loan customers and their operations. To date, the
Bank has not been advised by such parties that they do not have plans in place
to address and correct the issues associated with the year 2000 problem;
however, no assurance can be given as to the adequacy of such plans or to the
timeliness of their implementation.
Average Balances, Interest Rates and Yields
The following table presents for the periods indicated the total dollar
amount of interest income earned on average interest-earning assets and total
dollar amount of interest expense paid on average interest-bearing liabilities,
as well as their resultant yields and rates, respectively. No tax equivalent
adjustments were made. All average balances are monthly average balances.
Non-accruing loans have been included in the table as loans carrying a zero
yield.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------------------------------------------------------
1998 1997 1996
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate(2)
------- ---- ---- ------- ---- ---- ------- ---- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Loans receivable(1)............... $55,015 $4,745 8.62% $51,166 $4,408 8.62% $47,993 $4,101 8.54%
Securities available for sale..... 25,394 1,699 6.69 19,445 1,332 6.85 16,779 1,159 6.91
Other interest-earning assets..... 2,786 222 7.98 1,814 108 5.96 1,954 158 8.09
FHLB stock........................ 1,143 78 6.85 666 47 7.03 507 36 7.10
Total interest-earning assets(1). 84,338 6,744 8.00 73,091 5,895 8.06 67,233 5,454 8.11
Interest-Bearing Liabilities:
Savings deposits.................. 17,118 743 4.34 15,829 701 4.43 11,577 443 3.83
Money market deposits............. 747 18 2.50 935 22 2.42 1,163 28 2.41
Demand and NOW deposits........... 5,863 104 1.71 5,371 93 1.66 4,590 83 1.81
Certificates of deposit........... 33,989 1,899 5.59 33,759 1,866 5.53 35,820 2,040 5.70
FHLB Advances..................... 22,109 1,257 5.69 12,978 720 5.54 9,502 550 5.79
Total interest-bearing liabilities $ 79,826 4,021 5.04 $68,872 3,402 4.94 $62,652 3,144 5.02
Net interest income................ $2,723 $2,493 $2,310
Net interest rate spread........... 2.96% 3.12% 3.09%
Net interest-earning assets........ $ 4,512 $ 4,219 $ 4,581
Net interest margin(2)............. 3.23% 3.41% 3.44%
Average interest-earning assets to 105.65%
average interest-bearing liabilities 106.13% 107.31%
</TABLE>
-------------------------------
(1) Calculated net of deferred loan fees, loan discounts, loans in process
and loss reserves
(2) Net interest income divided by average interest-earning assets.
10
<PAGE>
Rate/Volume Analysis of the Net Interest Income
The following table presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old volume). For purposes
of this table, changes attributable to both rate and volume which cannot be
segregated have been allocated proportionately to the change due to volume and
the change due to rate.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
--------------------------------- ------------------------------------
Increase Increase
(Decrease) (Decrease)
Due to Total Due to Total
------------------- Increase ------------------ Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable...................... $ 408 $ (71) $ 337 $ 217 $ 90 $ 307
Securities available for sale......... 355 12 367 153 20 173
Other interest-earning assets......... 107 7 114 (49) (1) (50)
FHLB Stock............................ 32 (1) 31 11 --- 11
------- -------- ------- ------- -------- --------
Total interest-earning assets....... $ 902 $ (53) $ 849 $ 332 $ 109 $ 441
======= ======== ======= ======= ====== =======
Interest-bearing liabilities:
Savings deposits...................... 28 14 42 199 59 258
Money market deposits................. (3) (1) (4) (5) --- (5)
Demand and NOW deposits............... (2) 13 11 60 (50) 10
Certificates of deposits.............. 40 (7) 33 (1,248) 1,074 (174)
FHLB advances......................... 507 30 537 162 7 169
------- -------- ------- ------- -------- --------
Total interest-bearing liabilities.. $ 570 $ 49 $ 619 $ (832) $ 1,090 $ 258
====== ===== ======= ======= ======= =======
Net interest income..................... $ 230 $ 183
======= =======
</TABLE>
11
<PAGE>
Interest Rate Spread
The following table sets forth the weighted average yields on
interest-earning assets, the weighted average rates on interest-bearing
liabilities and the interest rate spread between weighted average yields and
rates at the end of each of the years presented. Non-accruing loans have been
included in the table as carrying a zero yield.
<TABLE>
<CAPTION>
At June 30,
----------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C> <C>
Weighted average yield on:
Loans receivable, net(1) .................. 8.54% 8.65% 8.43%
Securities available for sale ............. 6.98 6.99 6.66
Other interest-earning assets ............. 5.54 5.45 5.15
FHLB stock ................................ 6.92 7.00 7.00
Combined weighted average yield on
interest-earning assets ................. 7.95 8.00 7.90
Weighted average rate paid on:
Savings deposits .......................... 4.42 4.24 4.06
Money market deposits ..................... 2.37 2.43 2.41
Demand and NOW deposits ................... 1.87 1.39 1.79
Certificates of Deposit ................... 5.57 5.62 5.54
FHLB advances ............................. 5.24 5.71 5.49
Combined weighted average rate paid
on interest-bearing liabilities ......... 4.90 4.93 4.84
Spread .................................... 3.05% 3.07% 3.06%
</TABLE>
(1) Calculated net of deferred loan fees, loan discounts, loans in
process and loan loss reserves.
Asset/Liability Management
The Company currently focuses lending efforts toward originating
competitively priced adjustable-rate loan products and fixed-rate loan products
with relatively short terms to maturity, generally fifteen years or less. This
allows the Company to maintain a portfolio of loans which will be sensitive to
changes in the level of interest rates while providing a reasonable spread to
the cost of liabilities used to fund the loans. The Company, however, also makes
long-term, fixed-rate mortgage loans which are sold in the secondary market.
The Company's primary objective for its investment portfolio is to
provide the liquidity necessary to meet loan funding needs. This portfolio is
used in the ongoing management of changes to the Company's assets/liability mix,
while contributing to profitability through earnings flow. The investment policy
generally calls for funds to be invested among various categories of security
types and maturities based upon the Company's need for liquidity, desire to
achieve a proper balance between minimizing risk while maximizing yield, the
need to provide collateral for borrowings, and to fulfill the Company's
asset/liability management goals.
12
<PAGE>
The Company's cost of funds are typically responsive to changes in
interest rates due to the relatively short-term nature of its deposit portfolio.
Consequently, the results of operations are influenced by the levels of
short-term interest rates. The Company offers a range of maturities on its
deposit products at competitive rates and monitors the maturities on an ongoing
basis.
The Company emphasizes and promotes its savings, money market, demand
and NOW accounts and, subject to market conditions, certificates of deposit with
maturities of six months through five years, principally within its primary
market area. The savings and NOW accounts tend to be less susceptible to rapid
changes in interest rates.
In managing its asset/liability mix, the Company, at times, depending
on the relationship between long- and short-term interest rates, market
conditions and consumer preference, may place somewhat greater emphasis on
maximizing its net interest margin than on strictly matching the interest rate
sensitivity of its assets and liabilities. In this regard, the Company has
borrowed and may continue to borrow from the FHLB to purchase securities when
advantageous interest rate spreads can be obtained. Management believes that the
increased net income which may result from an acceptable mismatch in the actual
maturity or repricing of its asset and liability portfolios can, during periods
of declining or stable interest rates, provide sufficient returns to justify the
increased exposure to sudden and unexpected increases in interest rates which
may result from such a mismatch. The Company has established limits, which may
change from time to time, on the level of acceptable interest rate risk. There
can be no assurance, however, that in the event of an adverse change in interest
rates the Company's efforts to limit interest rate risk will be successful.
Net Portfolio Value. The OTS provides a Net Portfolio Value ("NPV")
approach to the quantification of interest rate risk. This approach calculates
the difference between the present value of expected cash flows from assets and
the present value of expected cash flows from liabilities, as well as cash flows
from off-balance sheet contracts. Management of the Bank's assets and
liabilities is done within the context of the marketplace, but also within
limits established by the Board of Directors on the amount of change in NPV
which is acceptable given certain interest rate changes.
The OTS issued a regulation which uses a net market value methodology
to measure the interest rate risk exposure of thrift institutions. Under OTS
regulations, an institution's "normal" level of interest rate risk in the event
of an assumed change in interest rates is a decrease in the institution's NPV in
an amount not exceeding 2% of the present value of its assets. Thrift
institutions with greater than "normal" interest rate exposure must take a
deduction from their total capital available to meet their risk based capital
requirement. The amount of that deduction is one-half of the difference between
(a) the institution's actual calculated exposure to a 200 basis point interest
rate increase or decrease (whichever results in the greater pro forma decrease
in NPV) and (b) its "normal" level of exposure which is 2% of the present value
of its assets. The regulation, however, will not become effective until the OTS
evaluates the process by which savings associations may appeal an interest rate
risk deduction determination. It is uncertain as to when this evaluation may be
completed. Notwithstanding the foregoing and the fact that the Bank, due to its
asset size and level of risk-based capital, is exempt from this requirement,
utilizing this measuring concept, a deduction to risk-based capital would have
been required as of June 30, 1998 if the regulation applied to the Bank.
However, even if such deduction was applied, the Bank would still meet their
risk-based capital requirement under current regulatory guidelines.
Presented below, as of June 30, 1998, is an analysis of the Bank's
interest rate risk as measured by changes in NPV for instantaneous and sustained
parallel shifts in the yield curve, in 100 basis point increments, up and down
400 basis points and compared to Board policy limits and in accordance with OTS
regulations. Such limits have been established with consideration of the dollar
impact of various rate
13
<PAGE>
changes and the Bank's strong capital position. As illustrated in the table, NPV
is more sensitive to declining rates than rising rates.
<TABLE>
<CAPTION>
Change in At June 30, 1998
Interest Rate Board Limit ---------------------------
(Basis Points) % Change $ Change % Change
-------------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
+400 (75)% $(3,769) (45)%
+300 (60) (3,259) (39)
+200 (45) (1,030) (12)
+100 (25) (200) (2)
0 --- --- ---
-100 (25) (3,706) (44)
-200 (45) (5,278) (63)
-300 (60) (5,843) (69)
-400 (75) (6,403) (76)
</TABLE>
Management reviews the OTS measurements on a quarterly basis. In a
declining interest rate environment, at June 30, 1998, the Bank's interest rate
risk was in excess of the Board's prescribed guidelines. The Bank, in an effort
to reduce its present interest rate risk exposure and in order to bring its NPV
within Board policy limits, has eliminated and is continuing to eliminate
certain investments which have proven to be more interest rate sensitive than is
currently acceptable to the Bank. In addition, the Bank has purchased new
software to assist management in its efforts to monitor and control the Bank's
exposure to interest rate risk in the future.
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable-rate mortgage
loans, have features which restrict changes in interest rates on a short-term
basis and over the life of the asset. Further, in the event of a change in
interest rates, prepayments and early withdrawal levels would likely deviate
significantly from those assumed in calculating the tables. Finally, the ability
of many borrowers to service their debt may decrease in the event of an interest
rate increase.
Liquidity and Capital Resources
The OTS requires minimum levels of liquid assets. OTS regulations
presently require the Bank to maintain an average daily balance of liquid assets
(United States Treasury and federal agency securities and other investments
having maturities of five years or less) equal to at least 4.0% of the sum of
its average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. Such requirements may be changed from time to time
by the OTS to reflect changing economic conditions. Such investments are
intended to provide a source of relatively liquid funds upon which the Bank may
rely, if necessary, to fund deposit withdrawals and other short-term funding
needs. The Bank has historically maintained its liquidity ratio in excess of
that required. The Bank's liquidity ratios were 10.4%, 7.1% and 6.1% at June 30,
1998, 1997 and 1996, respectively.
Liquidity management is both a daily and long-term responsibility of
management. The Bank adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand,
14
<PAGE>
(ii) expected deposit flows, (iii) yields available on interest-bearing
investments and (iv) the objectives of its asset/liability management program.
Excess liquidity generally is invested in interest-bearing overnight deposits
and other short-term government and agency obligations. If the Bank requires
additional funds beyond its internal ability to generate such funds it has
additional borrowing capacity with the FHLB of Des Moines and collateral
eligible for repurchase agreements.
The Company principally uses its liquidity resources to meet ongoing
commitments, to fund maturing certificates of deposit and deposit withdrawals,
to invest, to fund existing and future loan commitments, to maintain liquidity,
and to meet other operating needs. At June 30, 1998, the Company had $690,000 of
loan commitments. The Company anticipates that it will have sufficient funds
available to meet outstanding loan commitments. Management believes that loan
repayments and other sources of funds will be adequate to meet and exceed the
Bank's foreseeable short- and long-term liquidity needs.
Certificates of deposit scheduled to mature in a year or less at June
30, 1998 totaled $22.8 million or 65.5% of the Company's total certificates of
deposit. Based on historical experience, management believes that a significant
portion of such deposits will remain with the Company. There can be no
assurance, however, that the Company can retain all such deposits. At June 30,
1998, the Company had outstanding borrowings of $20.0 million from the FHLB of
Des Moines and had the capacity to borrow up to approximately $23.6 million.
The primary investing activities of the Company include the origination
of loans and the purchase of mortgage-backed securities. At June 30, 1998, these
assets accounted for over 84.1% of the Company's total assets. Such origination
and purchases are funded primarily from loan repayments, repayments of
mortgage-backed and investment securities, FHLB advances, net income and, to a
lesser extent, increases in deposits.
At June 30, 1998, the Bank had tangible and core capital of $6.5
million, or 7.3% of adjusted total assets, which was approximately $5.1 million
and $2.9 million above the minimum requirements of 1.5% and 4.0%, respectively,
of the adjusted total assets in effect on that date. At June 30, 1998, the Bank
had total risk-based capital of $6.7 million (including $6.5 million in core
capital), or 13.2% of risk-weighted assets of $51.1 million. This amount was
$2.6 million above the 8% requirement in effect on that date. The Bank is
presently in compliance with its regulatory capital requirements.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with generally accepted accounting
principles which require the measurement of financial position and results of
operations in terms of historical dollars without considering changes in the
relative purchasing power of money over time because of inflation. The impact of
inflation is reflected in the increased cost of the Company's operations. Unlike
most industrial companies, virtually all of the assets and liabilities of the
Company are monetary in nature. As a result, interest rates have a more
significant impact on the Company's performance than the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the prices of goods and services.
15
<PAGE>
Effect of New Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income, will be effective for the Company for the year beginning
July 1, 1998, and establishes the standards for the reporting and display of
comprehensive income in the financial statements. Comprehensive income
represents net earnings and certain amounts reported directly in stockholders'
equity, such as the net unrealized gain or loss on available-for-sale
securities. The Company expects to adopt SFAS No. 130 when required.
SFAS No. 131, Disclosure About Segments of an Enterprise and Related
Information, will be effective for the Company for the year beginning July 1,
1998 and establishes disclosure requirements for segment operation disclosures.
The Company expects to adopt SFAS No. 131 when required.
SFAS No. 132, Employers' Disclosures about Pensions and Other
Postretirement Benefits, will be effective for the Company for the year
beginning July 1, 1998, and revises the disclosure requirements for pension and
other post-retirement benefits plans. The Company expects to adopt SFAS No. 132
when required.
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, will be effective for the Company beginning July 1, 1999. Management
is evaluating the impact the adoption of SFAS No. 133 will have on the Company's
consolidated financial statements and expects to adopt SFAS 133 when required.
16
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Consolidated Financial Statements
June 30, 1998 and 1997
(With Independent Auditors' Report Thereon)
- --------------------------------------------------------------------------------
<PAGE>
Independent Auditors' Report
The Board of Directors
Horizon Financial Services Corporation
Oskaloosa, Iowa:
We have audited the accompanying consolidated balance sheets of Horizon
Financial Services Corporation and subsidiaries as of June 30, 1998 and 1997
and the related consolidated statements of operations, stockholders' equity
and cash flows for each of the years in the three-year period ended June 30,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Horizon
Financial Services Corporation and subsidiaries as of June 30, 1998 and 1997
and the results of their operations and their cash flows for each of the
years in the three-year period ended June 30, 1998, in conformity with
generally accepted accounting principles.
/s/KPMG Peat Marwick LLP
------------------------
KPMG Peat Marwick LLP
Des Moines, Iowa
July 29, 1998
17
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, 1998 and 1997
- ---------------------------------------------------------------------------------------------------------------------------
Assets 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents $ 6,366,619 5,621,242
Securities available-for-sale (note 2) 23,921,718 24,942,234
Loans receivable, net (notes 3 and 4) 55,996,418 52,193,285
Real estate (note 5) 190,402 550,690
Stock in Federal Home Loan Bank, at cost 1,202,500 955,600
Office property and equipment, net (note 6) 1,126,516 1,082,013
Accrued interest receivable (note 7) 683,120 554,239
Deferred tax asset (note 10) 405,541 -
Prepaid expenses and other assets 53,911 70,160
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $ 89,946,745 85,969,463
===========================================================================================================================
Liabilities and Stockholders' Equity
- ---------------------------------------------------------------------------------------------------------------------------
Deposits (note 8) $ 60,144,866 57,641,372
Advances from Federal Home Loan Bank (note 9) 20,038,174 19,101,533
Advance payments by borrowers for taxes and insurance 407,050 400,663
Accrued taxes on income (note 10):
Current 291,492 39,923
Deferred - 51,000
Accrued expenses and other liabilities 577,343 322,311
- ---------------------------------------------------------------------------------------------------------------------------
Total liabilities 81,458,925 77,556,802
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Stockholders' equity:
Preferred stock, $.01 par value; authorized 250,000 shares; none issued -
Common stock, $.01 par value; 1,500,000 shares authorized;
issued and outstanding 1,046,198 and 523,099 shares
at 1998 and 1997, respectively 10,462 5,231
Additional paid-in capital 4,894,744 4,795,400
Retained earnings, substantially restricted (note 12) 5,730,257 5,305,946
Treasury stock, at cost (166,256 and 97,559 shares in 1998
and 1997, respectively) (1,185,924) (1,360,275)
Unearned employee stock ownership plan shares (note 11) (129,205) (193,798)
Unearned recognition and retention plan shares (note 11) (11,439) (47,655)
Unrealized losses on securities available-for-sale (821,075) (92,188)
- ---------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 8,487,820 8,412,661
Commitments and contingencies (notes 3 and 15)
- ---------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 89,946,745 85,969,463
===========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended June 30, 1998, 1997 and 1996
- ---------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $ 4,744,988 4,408,308 4,100,960
Investment securities available-for-sale 1,699,038 1,331,322 1,159,091
Other investment income 300,494 154,960 193,756
- ---------------------------------------------------------------------------------------------------------------------------
Total interest income 6,744,520 5,894,590 5,453,807
- ---------------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits (note 8) 2,763,850 2,682,335 2,593,419
Advance from Federal Home Loan Bank 1,257,447 719,415 550,293
- ---------------------------------------------------------------------------------------------------------------------------
Total interest expense 4,021,297 3,401,750 3,143,712
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income 2,723,223 2,492,840 2,310,095
Provision for losses on loans (note 4) 94,000 252,110 328,192
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for losses on loans 2,629,223 2,240,730 1,981,903
- ---------------------------------------------------------------------------------------------------------------------------
Noninterest income:
Fees, service charges and commissions 447,871 338,107 345,241
(Loss) gain on sale of securities, net (166,959) 81,403 39,198
Other 26,731 18,629 93,295
- ---------------------------------------------------------------------------------------------------------------------------
Total noninterest income 307,643 438,139 477,734
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Noninterest expense:
Compensation, payroll taxes and employee benefits (note 11) 1,237,633 1,051,597 931,089
Advertising 66,850 60,447 65,448
Office property and equipment 317,385 319,765 312,592
Federal insurance premiums and special assessments (note 13) 35,816 404,489 118,908
Data processing services 117,090 108,337 97,938
Other real estate expense 44,777 52,701 50,996
Other 211,231 257,741 309,205
- ---------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 2,030,782 2,255,077 1,886,176
- ---------------------------------------------------------------------------------------------------------------------------
Earnings before taxes on income 906,084 423,792 573,461
Taxes on income (note 10) 316,700 145,300 197,000
- ---------------------------------------------------------------------------------------------------------------------------
Net earnings $ 589,384 278,492 376,461
===========================================================================================================================
Basic earnings per common share $ .71 .34 .43
===========================================================================================================================
Diluted earnings per common share $ .69 .33 .42
===========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended June 30, 1998, 1997 and 1996
Additional
Preferred Common paid-in Retained
stock stock capital earnings
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at June 30, 1995 ..................... $-- 5,231 4,736,089 4,919,191
Net earnings ................................. -- -- -- 376,461
Dividends declared ($.16 per share)(1) ....... -- -- -- (138,166)
Treasury stock acquired ...................... -- -- -- --
ESOP shares allocated ........................ -- -- -- --
Stock appreciation of allocated ESOP shares .. -- -- 16,841 --
Amortization of recognition and retention plan -- -- -- --
Adjust valuation allowance on securities
available-for-sale ..................... -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996 ..................... -- 5,231 4,752,930 5,157,486
Net earnings ................................. -- -- -- 278,492
Dividends declared ($.16 per share)(1) ....... -- -- -- (130,032)
Treasury stock acquired ...................... -- -- -- --
ESOP shares allocated ........................ -- -- -- --
Stock appreciation of allocated ESOP shares .. -- -- 42,470 --
Amortization of recognition and retention plan -- -- -- --
Adjust valuation allowance on securities
available-for-sale ..................... -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 ..................... -- 5,231 4,795,400 5,305,946
Net earnings ................................. -- -- -- 589,384
Dividends declared ($.18 per share) .......... -- -- -- (144,982)
Treasury stock acquired ...................... -- -- -- --
Two-for-one stock dividend ................... -- 5,231 -- (5,231)
Stock options exercised ...................... -- -- 94 (14,860)
ESOP shares allocated ........................ -- -- -- --
Stock appreciation of allocated ESOP shares .. -- -- 99,250 --
Amortization of recognition and retention plan -- -- -- --
Adjust valuation allowance on securities
available-for-sale ..................... -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 ..................... $-- 10,462 4,894,744 5,730,257
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Recognition Net unrealized
Unearned and gain (loss) on
Treasury ESOP retention securities available
stock shares plan for sale Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at June 30, 1995 ..................... (323,490) (332,523) (120,093) (98,140) 8,786,265
Net earnings ................................. -- -- -- -- 376,461
Dividends declared ($.16 per share)(1) ....... -- -- -- -- (138,166)
Treasury stock acquired ...................... (699,431) -- -- -- (699,431)
ESOP shares allocated ........................ -- 72,220 -- -- 72,220
Stock appreciation of allocated ESOP shares .. -- -- -- -- 16,841
Amortization of recognition and retention plan -- -- 36,222 -- 36,222
Adjust valuation allowance on securities
available-for-sale ..................... -- -- -- (60,186) (60,186)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996 ..................... (1,022,921) (260,303) (83,871) (158,326) 8,390,226
Net earnings ................................. -- -- -- -- 278,492
Dividends declared ($.16 per share)(1) ....... -- -- -- -- (130,032)
Treasury stock acquired ...................... (337,354) -- -- -- (337,354)
ESOP shares allocated ........................ -- 66,505 -- -- 66,505
Stock appreciation of allocated ESOP shares .. -- -- -- -- 42,470
Amortization of recognition and retention plan -- -- 36,216 -- 36,216
Adjust valuation allowance on securities
available-for-sale ..................... -- -- -- 66,138 66,138
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 ..................... (1,360,275) (193,798) (47,655) (92,188) 8,412,661
Net earnings ................................. -- -- -- -- 589,384
Dividends declared ($.18 per share) .......... -- -- -- -- (144,982)
Treasury stock acquired ...................... -- -- -- -- --
Two-for-one stock dividend ................... -- -- -- -- --
Stock options exercised ...................... 174,351 -- -- -- 159,585
ESOP shares allocated ........................ -- 64,593 -- -- 64,593
Stock appreciation of allocated ESOP shares .. -- -- -- -- 99,250
Amortization of recognition and retention plan -- -- 36,216 -- 36,216
Adjust valuation allowance on securities
available-for-sale ..................... -- -- -- (728,887) (728,887)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 ..................... (1,185,924) (129,205) (11,439) (821,075) 8,487,820
====================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
(1) Restated to reflect the two-for-one stock split effected in the form of a
stock dividend on November 10, 1997.
20
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended June 30, 1998, 1997 and 1996
- ----------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 589,384 278,492 376,461
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 147,585 163,658 166,803
Amortization of fees, premiums and accretion of discounts, net (179,225) 23,807 63,035
Federal Home Loan Bank stock dividend - - (9,500)
Provision for losses on loans 94,000 252,111 328,192
Loans originated for sale (6,478,320) (486,300) -
Proceeds on sales of loans 6,076,820 349,500 -
Amortization of stock compensation plans 200,059 145,191 119,283
(Loss) gain on sale of securities 166,959 (81,403) (39,198)
Increase in accrued interest receivable (128,881) (40,610) (45,073)
(Decrease) increase in accrued taxes payable 178,216 43,576 (39,102)
Other, net 271,281 115,687 (12,657)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 937,878 763,709 908,244
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Securities available-for-sale:
Purchases (23,698,089) (12,835,616) (5,429,589)
Proceeds from sale 18,838,215 4,434,596 1,701,971
Proceeds from maturity and principal collected 4,780,581 1,672,003 1,273,989
Held-to-maturity securities -
proceeds from maturity and principal collected - - 866,251
Loans to customers, net (3,495,633) (3,309,738) (3,219,704)
Proceeds from sale of real estate 360,288 65,233 260,000
Purchase of investment real estate - - (65,000)
Purchase of Federal Home Loan Bank stock (246,900) (396,800) (68,996)
Proceeds from sale of fixed assets - - 17,900
Purchase of office property and equipment, net (192,088) (112,356) (78,600)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (3,653,626) (10,482,678) (4,741,778)
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Cash flows from financing activities:
Increase in customer deposit accounts, net 2,503,494 2,882,405 3,429,309
Increase (decrease) in advance payments by borrowers for taxes and insurance 6,387 14,391 (42,981)
Proceeds from advances from Federal Home Loan Bank 27,000,000 15,000,000 7,500,000
Principal payments on advances from Federal Home Loan Bank (26,063,359) (5,559,738) (6,556,324)
Payment of dividends (144,982) (130,031) (138,166)
Excercise of stock options 159,585 - -
Treasury stock acquired - (337,354) (699,431)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 3,461,125 11,869,673 3,492,407
- ----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 745,377 2,150,704 (341,127)
Cash and cash equivalents at beginning of year 5,621,242 3,470,538 3,811,665
- ----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 6,366,619 5,621,242 3,470,538
============================================================================================================================
Supplemental disclosures of cash flow information:
Cash paid for interest $ 3,794,411 3,336,641 3,144,844
Cash paid for taxes 91,102 134,941 205,000
Transfers of loans to real estate acquired through foreclosures - 105,330 265,060
Transfer of investment and mortgage-backed securities to
securities available-for-sale - - 10,725,869
============================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies
Description of the Business and Concentration of Credit
Horizon Financial Services Corporation and subsidiaries (the Company or
the Parent Company) is a thrift holding company headquartered in
Oskaloosa, Iowa. The Company was organized for the purpose of owning the
outstanding stock of Horizon Federal Savings Bank, FSB, (the Bank).
The Bank serves Mahaska County, Marion County, and to a lesser extent
Wapello County through its three retail offices, two of which are
located in Oskaloosa, Iowa, and one located in Knoxville, Iowa. The Bank
is primarily engaged in attracting retail deposits from the general
public and investing those funds in residential and commercial real
estate loans and other consumer and commercial loans in its central Iowa
market area. Although the Bank has a diversified loan portfolio, a
substantial portion of its borrowers ability to repay their loans is
dependent upon the economic conditions in the Company's market area.
Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of Horizon
Financial Services Corporation and its wholly owned subsidiary, the Bank
and its wholly owned subsidiary, Horizon Investment Services, Inc.
Horizon Investment Services, Inc. provides investment products and sells
credit life insurance to customers of the Bank. All material
intercompany accounts and transactions have been eliminated.
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the consolidated financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Material estimates that are
particularly susceptible to significant changes relate to the
determination of the allowance for losses on loans.
Regulatory Capital
The Bank is required by the Office of Thrift Supervision (OTS) to
maintain prescribed levels of regulatory capital. At June 30, 1998, the
requirements were met, and management anticipates meeting the
requirements at June 30, 1999.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
short-term investments with a maturity of three months or less at date
of purchase to be cash equivalents. Cash and cash equivalents include
interest earning deposits of $3,581,000 and $2,890,000 at June 30, 1998
and 1997, respectively.
<PAGE>
Earnings Per Share
Basic earnings per share, pursuant to Statement of Financial Accounting
Standards (SFAS) No. 128, Earnings Per Share, is determined using net
income and weighted average common shares outstanding, decreased by
unearned employee stock ownership plan (ESOP) shares. Diluted earnings
per share, as defined by SFAS No. 128 is computed by dividing net income
by the weighted average common shares, decreased by unearned ESOP shares
and increased by assumed incremental common shares issued. All earnings
per share data has been restated to reflect the two-for-one stock split
effected in the form of a stock dividend on November 10, 1997. Amounts
used in the determination of basic and diluted earnings per share for
the years ended June 30, 1998, 1997 and 1996 are shown in table on the
following page.
(Continued)
22
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
--------- ------- -------
<S> <C> <C> <C>
Net income ........................ $ 589,384 278,492 376,461
--------- ------- -------
Weighted average common shares outstanding 862,720 863,442 936,718
Less - unearned ESOP shares ....... (31,279) (44,502) (59,002)
--------- ------- -------
Weighted average common shares - basic 831,441 818,940 877,716
Assumed incremental common shares issued
upon exercise of stock options 29,425 24,410 16,004
--------- ------- -------
Weighted average common shares - diluted 860,866 843,350 893,720
========= ======= =======
</TABLE>
Securities Available-for-sale
The Company classifies investment securities based on the Company's
intended holding period. Securities which may be sold prior to maturity
to meet liquidity needs, to respond to market changes or to adjust the
Company's asset-liability position are classified as available-for-sale.
Securities which the Company intends to hold to maturity are classified
as held-to-maturity.
Securities available-for-sale are recorded at fair value. The aggregate
unrealized gains or losses, net of the effect of taxes on income, are
recorded as a component of stockholders' equity. Discounts and premiums
are accreted and amortized, respectively, over the term of the security
except for mortgage-backed and related securities and stripped
mortgage-backed securities which are accreted and amortized over the
period of estimated cash flows using the interest method. Actual
prepayment experience on mortgage-backed and related securities and
stripped mortgage-backed securities is periodically reviewed, and the
timing of accretion or amortization is adjusted accordingly.
Gain or loss on sale is recognized in the statements of operations using
the specific identification method.
Allowance for Losses on Loans
The allowance for losses on loans and real estate are maintained at
amounts considered adequate to provide for such losses. The allowance
for losses on loans is based on management's periodic evaluation of the
loan portfolio and reflects an amount that, in management's opinion, is
adequate to absorb losses in the existing portfolio. In evaluating the
portfolio, management takes into consideration numerous factors,
including current economic conditions, prior loan loss experience, the
composition of the loan portfolio and management's estimates of
anticipated credit losses.
<PAGE>
Accrued interest receivable on loans which become more than ninety days
in arrears is charged to income. Subsequently, interest income is not
recognized on such loans until collected or until determined by
management to be collectable.
Loans Receivable
Under the Company's credit policies, all loans with interest more than
ninety days in arrears and restructured loans are considered to meet the
definition of impaired loans. Loan impairment is measured based on the
present value of expected future cash flows discounted at the loan's
effective interest rate except, where more practical, at the observable
market price of the loan or the fair value of the collateral if the loan
is collateral dependent.
Loans held for sale are stated at the lower of individual cost or
estimated fair value. Loans are sold on a nonrecourse basis with
servicing released and gains and losses are recognized based on the
difference between sales proceeds and the carrying value of the loan.
(Continued)
23
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Loan Origination Fees and Related Costs
Mortgage loan origination fees and certain direct loan origination
costs, if material, are deferred and the net fee or cost is recognized
in operations using the interest method. Direct loan origination costs
for other loans are expensed, as such costs are not material in amount.
Real Estate
Investment real estate represents a limited partnership interest in a
low income housing apartment complex. The investment in the low income
housing complex is carried at cost, adjusted for earnings and losses of
the limited partnership.
Real estate acquired in settlement of loans is carried at the lower of
cost or fair value. When property is acquired through foreclosure or a
loan is considered impaired, any excess of the related loan balance over
fair value is charged to the allowance for losses on loans. An allowance
for real estate is provided as circumstances indicate additional loss on
the property and is charged to noninterest expense.
Financial Instruments with Off Balance Sheet Risk
In the normal course of business to meet the financing needs of its
customers, the Bank is a party to financial instruments with off balance
sheet risk, which include commitments to extend credit. The Bank's
exposure to credit loss in the event of nonperformance by the other
party to the commitments to extend credit is represented by the
contractual amount of those instruments. The Bank uses the same credit
policies in making commitments as it does for on balance sheet
instruments.
Commitments to extend credit are agreements to lend to a customer, as
long as there is no violation of any conditions established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements
(see note 3). Each customer's creditworthiness is evaluated on a
case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Bank, upon extension of credit is based on management's
credit evaluation of the counterparty.
Office Property and Equipment
Office property and equipment are recorded at cost, and depreciation is
accumulated on a straight-line basis over the estimated useful lives of
the related assets. Estimated lives are forty years for office buildings
and five to ten years for furniture, fixtures, and equipment.
Maintenance and repairs are charged against income. Betterments are
capitalized and subsequently depreciated. The cost and accumulated
depreciation of properties retired or otherwise disposed of are
eliminated from the asset and accumulated depreciation accounts. Related
profit or loss from such transactions is credited or charged to income.
<PAGE>
Treasury Stock
Treasury stock is accounted for by the cost method, whereby shares of
common stock reacquired are recorded at their purchase price.
(Continued)
24
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Taxes on Income
The Company files a consolidated federal income tax return. For
financial statement purposes, taxes on income are also presented on a
consolidated basis. For state purposes, the Company and Horizon
Investment Services, Inc.
file income tax returns and the Bank files a franchise tax return.
Generally accepted accounting principles require use of the asset and
liability method of accounting for income taxes, and deferred tax assets
and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
basis. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
Stock Option Plan
The Company has adopted the provisions of Statement of Financial
Accounting Standards (SFAS) 123, "Accounting for Stock-Based
Compensation," which permits entities to recognize as expense over the
vesting period the fair value of all stock-based awards on the date of
grant. Alternatively, SFAS 123 also allows entities to continue to apply
the provisions of Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations
and provide pro forma net earnings and pro forma net earnings per common
share disclosures for employee stock option grants made subsequent to
the adoption date as if the fair-value-based method defined in SFAS 123
had been applied. APB Opinion No. 25 requires compensation expense to be
recorded only if on the date of grant the current market price of the
underlying stock exceeded the exercise price. The Company has made no
option grants since the adoption of SFAS 123.
Fair Value of Financial Instruments
The Company's fair value estimates, methods and assumptions for its
financial instruments are set forth below:
o Cash and Cash Equivalents and Accrued Interest Receivable and
Payable - The carrying amount approximates the estimated fair value
due to the short-term nature of those instruments.
o Securities Available-for-sale - The fair value of securities
available-for-sale is estimated based on bid prices published in
financial newspapers, bid quotations received from securities
dealers or quoted market prices of similar instruments, adjusted
for differences between the quoted instruments and the instruments
being valued.
<PAGE>
o Loans - Fair values are estimated for portfolios of loans with
similar financial characteristics. Loans are segregated by type,
such as commercial, real estate and installment.
The fair value of loans is calculated by discounting scheduled cash
flows through the estimated maturity using the current rates at
which similar loans would be made to borrowers with similar credit
ratings. The estimate of maturity is based on the historical
experience, with repayments for each loan classification, modified
as required by an estimate of the effect of current economic and
lending conditions. The effect of nonperforming loans is considered
in assessing the credit risk inherent in the fair value estimate.
o Federal Home Loan Bank (FHLB) Stock - The value of the FHLB stock
is equivalent to its carrying value because the stock is redeemable
at par value.
(Continued)
25
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
o Deposits - The fair value of deposits with no stated maturity, such
as checking, savings and money market accounts, is equal to the
amount payable on demand. The fair value of certificates of deposit
is based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered for
deposits of similar remaining maturities. The fair value estimates
do not include the benefit that results from the low-cost funding
provided by the deposit liabilities compared to the cost of
borrowing funds in the market.
o Advances from the FHLB - The fair value of advances from the FHLB
is calculated by discounting the scheduled payments through
maturity. The discount rate is estimated using the rates currently
offered for similar instruments.
o Off Balance Sheet Instruments - The fair value of commitments to
extend credit and unused lines of credit is estimated using the
difference between current levels of interest rates and committed
rates.
o Limitations - Fair value estimates are made at a specific point in
time, based on relevant market information and information about
the financial instrument. Because no market exists for a
significant portion of the Company's financial instruments, fair
value estimates are based on judgments regarding future expected
loss experience, current economic conditions, risk characteristics
of various financial instruments and other factors. These estimates
are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with
precision. Changes in assumptions could significantly affect the
estimates.
Effect of New Accounting Standards
SFAS No. 130, Reporting Comprehensive Income, will be effective for the
Company for the year beginning July 1, 1998, and establishes the
standards for the reporting and display of comprehensive income in the
financial statements. Comprehensive income represents net earnings and
certain amounts reported directly in stockholders' equity, such as the
net unrealized gain or loss on available-for-sale securities. The
Company expects to adopt SFAS No 130 when required.
SFAS No. 131, Disclosure About Segments of an Enterprise and Related
Information, will be effective for the Company for the year beginning
July 1, 1998 and establishes disclosure requirements for segment
operation disclosures. The Company expects to adopt SFAS No. 131 when
required.
SFAS No 132, Employers' Disclosures about Pensions and Other
Postretirement Benefits, will be effective for the Company for the year
beginning July 1, 1998, and revises the disclosure requirements for
pension and other postretirement benefits plans. The Company expects to
adopt SFAS 132 when required.
<PAGE>
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, will be effective for the Company beginning July 1, 1999.
Management is evaluating the impact the adoption of SFAS No. 133 will
have on the Company's consolidated financial statements and expects to
adopt SFAS 133 when required.
(Continued)
26
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(2) Securities Available-for-sale
Securities available-for-sale at June 30, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Fair
Description cost gains losses value
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998:
FHLB bonds - due beyond five years,
but within ten years $ 1,000,000 - 131,250 868,750
Small Business Administration guaranteed
loan participation certificates 955,787 16,679 - 972,466
Mortgage-backed and related securities:
Mortgage-backed securities 672,987 - 5,920 667,067
Collateralized mortgage obligations 11,624,160 101,948 3,089 11,723,019
Mutual funds 1,000,000 - - 1,000,000
Equity securities 1,430,056 82,300 83,969 1,428,387
- ----------------------------------------------------------------------------------------------------------------------------
16,682,990 200,927 224,228 16,659,689
Stripped mortgage-backed securities:
Principal only 10,823 - 4,754 6,069
Interest only 8,537,520 13,807 1,295,367 7,255,960
- ----------------------------------------------------------------------------------------------------------------------------
$ 25,231,333 214,734 1,524,349 23,921,718
- ----------------------------------------------------------------------------------------------------------------------------
1997:
U. S. treasury note, due within one year $ 99,925 2,861 - 102,786
FHLB bonds - due beyond five years,
but within ten years 1,000,000 - 150,946 849,054
Small Business Administration guaranteed
loan participation certificates 983,898 - 12,303 971,595
Mortgage-backed and related securities:
Mortgage-backed securities 3,021,148 29,546 24,018 3,026,676
Collateralized mortgage obligations 18,131,580 88,307 82,043 18,137,844
Equity securities 579,775 9,800 625 588,950
- ----------------------------------------------------------------------------------------------------------------------------
23,816,326 130,514 269,935 23,676,905
Stripped mortgage-backed securities:
Principal only 13,862 - 6,089 7,773
Interest only 1,259,083 2,587 4,114 1,257,556
- ----------------------------------------------------------------------------------------------------------------------------
$ 25,089,271 133,101 280,138 24,942,234
============================================================================================================================
</TABLE>
<PAGE>
Sales of securities available-for-sale resulted in the following for the
three years ended June 30:
<TABLE>
<CAPTION>
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Proceeds $ 18,838,215 4,434,596 1,701,971
Gross realized gains 330,031 87,499 41,442
Gross realized losses 21,990 6,096 2,244
=============================================================================================================================
</TABLE>
(Continued)
27
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
During 1998, the Company recognized a write down of $475,000 on a
interest only stripped mortgage-backed security resulting from a decline
in fair value that was judged to be other than temporary.
The Company has investments in certain securities which are classified
as high risk and are found within the caption Interest Only Stripped
Mortgage-backed Securities. Such securities have a weighted average
yield of 9.54% which will be used to accrue income in future periods.
At June 30, 1998, certain securities available-for-sale with a fair
value of approximately $6,100,000 were pledged as collateral for public
funds deposits.
(3) Loans Receivable
At June 30, 1998 and 1997, loans receivable consisted of the following:
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Residential real estate loans:
One-to-four-family $ 33,728,158 34,488,297
One-to four-family held for sale 538,300 136,800
Multifamily 1,112,894 657,818
Construction 1,999,818 829,266
- -------------------------------------------------------------------------------------------
37,379,170 36,112,181
Commercial real estate loans 4,471,829 3,944,435
Total real estate 41,850,999 40,056,616
- -------------------------------------------------------------------------------------------
Consumer loans:
Automobile 3,840,944 4,051,259
Home improvement 3,150,311 2,352,928
Deposit accounts 178,883 221,613
Other 2,319,831 1,541,457
- -------------------------------------------------------------------------------------------
Total consumer 9,489,969 8,167,257
- -------------------------------------------------------------------------------------------
Commercial business loans 5,682,429 5,123,735
- -------------------------------------------------------------------------------------------
57,023,397 53,347,608
Less:
Loans in process 597,825 732,186
Deferred fees and discounts 80,681 74,109
Allowance for losses on loans 348,473 348,028
- -------------------------------------------------------------------------------------------
$ 55,996,418 52,193,285
===========================================================================================
</TABLE>
(Continued)
28
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
At June 30, 1998, the Bank had committed to originate $690,000 of fixed
rate loans. In addition, the Bank had customers with unused lines of
credit totaling $870,000 at June 30, 1998.
At June 30, 1998 and 1997, the Bank had nonaccrual loans of $922,000 and
$469,000, respectively. The allowance for losses on loans related to
these impaired loans was approximately $90,000 and $17,000,
respectively. The average balances of such loans for the years ended
June 30, 1998, 1997 and 1996, were $745,000, $523,000 and $875,000,
respectively. For the years ended June 30, 1998, 1997 and 1996, interest
income which would have been recorded under the original terms of such
loans was approximately $96,000, $57,000 and $82,000, respectively, and
interest income actually recorded amounted to approximately $48,000,
$37,000 and $43,000, respectively.
Loan customers of the Bank include certain executive officers and
directors and their related interests and associates. All loans to this
group were made in the ordinary course of business at prevailing terms
and conditions. Changes in loans outstanding to executive officers and
directors for the years ended June 30, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 192,106 25,440
Advances 111,000 175,000
Repayments (18,032) (8,334)
- -------------------------------------------------------------------------------
Balance at end of year $ 285,074 192,106
===============================================================================
</TABLE>
(4) Allowance for Losses on Loans
Following is a summary of the allowance for losses on loans for the
three years ending June 30, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $ 348,028 317,645 291,005
Provision for losses 94,000 252,111 328,192
Charge-offs (96,388) (226,701) (319,155)
Recoveries 2,834 4,973 17,603
- -----------------------------------------------------------------------------------------------
Balance at end of year $ 348,474 348,028 317,645
===============================================================================================
</TABLE>
(Continued)
29
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(5) Real Estate
Following is a summary of real estate as of June 30, 1998 and 1997:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Real estate acquired through foreclosure $ - 342,816
Real estate acquired for investment 190,402 207,874
- --------------------------------------------------------------------------------
$ 190,402 550,690
================================================================================
</TABLE>
There were no allowances for losses on real estate for the years ended
June 30, 1998, 1997 and 1996, respectively.
(6) Office Property and Equipment
At June 30, 1998 and 1997, the cost and accumulated depreciation of
office property and equipment were as follows:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------------
<S> <C> <C>
Land $ 216,595 142,595
Office buildings 1,106,698 1,091,698
Furniture, fixtures and equipment 1,098,418 994,183
Automobile 20,363 17,380
- -----------------------------------------------------------------------------------
2,442,074 2,245,856
Less accumulated depreciation 1,315,558 1,163,843
- -----------------------------------------------------------------------------------
$ 1,126,516 1,082,013
===================================================================================
</TABLE>
<PAGE>
(7) Accrued Interest Receivable
At June 30, 1998 and 1997, accrued interest receivable consisted of the
following:
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------
<S> <C> <C>
Loans receivable $ 498,063 449,104
Securities available-for-sale 185,057 105,135
- ------------------------------------------------------------------------
$ 683,120 554,239
========================================================================
</TABLE>
(Continued)
30
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(8) Deposits
Deposit account balances at June 30, 1998 and 1997 are summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------------------
<S> <C> <C>
Balance by account type:
Savings $ 18,275,661 16,828,605
Money market 598,734 835,832
Demand and NOW 6,453,159 6,752,306
Certificates of deposit 34,817,312 33,224,629
- ------------------------------------------------------------------------------------
$ 60,144,866 57,641,372
====================================================================================
</TABLE>
The aggregate amount of certificates of deposit with a minimum
denomination of $100,000 was approximately $5,994,000 and $3,241,000 at
June 30, 1998 and 1997, respectively.
At June 30, 1998, scheduled maturities of certificates of deposit were
as follows:
1999 $ 22,796,838
2000 8,272,644
2001 2,864,707
2002 501,337
2003 and thereafter 381,786
----------------
$ 34,817,312
================
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
Years ended June 30,
------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Savings $ 742,894 701,023 442,927
Money market 17,843 22,275 28,029
Demand and NOW 104,480 93,254 82,600
Certificates of deposit 1,898,633 1,865,783 2,039,863
- ------------------------------------------------------------------------------------
$ 2,763,850 2,682,335 2,593,419
====================================================================================
</TABLE>
At June 30, 1998 and 1997, accrued interest payable on deposits totaled
$355,860 and $102,501, respectively.
(Continued)
31
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(9) Advances from FHLB
Advances from FHLB at June 30, 1998 and 1997, were as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------- --------------------------
Weighted- Weighted-
average average
Amount rates Amount rates
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Advance maturity:
Within one year:
Variable $ 6,000,000 various 16,000,000 various
Fixed 937,912 5.90% 2,063,358 6.20%
Beyond one year, but within five years -
Fixed 100,262 5.80 1,038,175 5.89
Beyond five years but within ten years -
Fixed 13,000,000 5.03 - -
--------------- ----------
$ 20,038,174 19,101,533
=============== ==========
</TABLE>
Advances from FHLB are secured by stock in FHLB. In addition, the Bank
has agreed to maintain unencumbered additional security in the form of
certain residential mortgage loans aggregating no less than 130% of
outstanding advances. Variable rate advances are based on LIBOR.
<PAGE>
(10) Taxes on Income
Taxes on income for the years ended June 30, 1998, 1997 and 1996, were
as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------------------------------ -----------------------------------------------
Federal State Total Federal State Total
------- ----- ----- ------- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Current $ 229,700 65,000 294,700 121,300 24,000 145,300
Deferred 19,000 3,000 22,000 - - -
--------- ------- -----------
$ 248,700 68,000 316,700 121,300 24,000 145,300
========= ======= ===========
<CAPTION>
1996
--------------------------------------------------
Federal State Total
<S> <C> <C> <C>
Current 169,000 28,000 197,000
Deferred - - -
----------- --------- ----------
169,000 28,000 197,000
=========== ========= ===========
</TABLE>
(Continued)
32
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Taxes on income differ from the amounts computed by applying the federal
income tax rate of 34% to earnings before taxes on income for the
following reasons, expressed in percentages:
<TABLE>
<CAPTION>
Years ended June 30,
1998 1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal income tax rate 34.0% 34.0 34.0
Items affecting federal income tax rate:
State tax, net of federal benefit 4.9 3.7 3.2
Low income housing tax credits (4.6) (9.9) (5.3)
Other, net .7 6.5 2.5
- -----------------------------------------------------------------------------------------------
35.0% 34.3 34.4
==============================================================================================
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at June
30, 1998 and 1997 are presented below:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Accrued expenses not deducted $ 37,000 44,000
Unrealized losses on securities available-for-sale 489,000 54,000
State net operating loss 6,000 -
Loan loss allowance 1,000 -
Other, net 9,000 3,000
- --------------------------------------------------------------------------------------------------
Total gross deferred tax assets 542,000 101,000
- --------------------------------------------------------------------------------------------------
Deferred tax liabilities:
FHLB stock dividends 57,000 62,000
Accrued interest receivable not taxed 8,000 7,000
Deferred loan fees 71,000 60,000
Loan loss allowance - 23,000
- --------------------------------------------------------------------------------------------------
Total gross deferred tax liabilities 136,000 152,000
- --------------------------------------------------------------------------------------------------
Net deferred tax assets (liabilities) $ 406,000 (51,000)
=================================================================================================
</TABLE>
<PAGE>
There was no valuation allowance for deferred tax assets during the
years ended June 30, 1998, 1997 and 1996.
Based upon the Company's level of historical taxable income and
anticipated future taxable income over the periods in which the deferred
tax assets are deductible, management believes it is more likely than
not the Bank will realize the benefits of these deductible differences.
(Continued)
33
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(11) Employee Benefits
Pension Plan
The Bank has a noncontributory, nontrusteed pension plan for all
eligible employees. The plan's assets include bonds, stocks, commercial
and residential mortgages and cash. The Bank's policy is to fund pension
cost accrued.
The following table sets forth the plan's funded status and amounts
recognized in the consolidated financial statements at June 30, 1998 and
1997:
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Actuarial present value of benefit obligations -
Accumulated benefit obligations, including vested
benefits of $554,132 and $507,481 at June 30,
1998 and 1997, respectively $ 617,355 558,929
- -----------------------------------------------------------------------------------------------------------
Projected benefit obligation for services rendered to date (1,044,684) (981,480)
Plan assets at fair value 1,048,560 829,431
- ------------------------------------------------------------------------------------------------------------
Projected benefit obligation in (excess of) less than plan assets 3,876 (152,049)
Unrecognized net (gain) loss from past experience different
from that assumed and effects of changes in assumptions (84,836) 53,604
Unrecognized net assets at transition date being recognized
over eighteen years (16,586) (18,347)
- ------------------------------------------------------------------------------------------------------------
Accrued pension liability $ (97,546) (116,792)
===========================================================================================================
</TABLE>
<PAGE>
The weighted-average discount rate and rate of increase in future
compensation levels used in determining the actuarial present value of
the projected benefit obligation at June 30, 1998 and 1997, were each
6.25%. The expected long-term rate of return on assets was 7.75%.
<TABLE>
<CAPTION>
Years ended June 30,
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net pension expense included the following components:
Service cost - benefits earned during the period $ 61,554 55,038 44,511
Interest cost on projected benefit obligation 59,256 54,529 46,894
Actual return on plan assets (179,902) (80,873) (103,298)
Net amortization and deferral 114,392 28,880 60,280
- --------------------------------------------------------------------------------------------------------------------------
Net periodic pension expense $ 55,300 57,574 48,387
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
34
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
ESOP Plan
All employees meeting age and service requirements are eligible to
participate in an ESOP established in June 1994. Contributions made by
the Bank to the ESOP are allocated to participants by a formula based on
compensation. Participant benefits become 100% vested after five years
of service. The ESOP purchased 80,962 shares (restated for two-for-one
stock dividend) in the Bank's conversion and is accounted for under
Employers' Accounting for Employee Stock Ownership Plans (SOP 93-6). At
June 30, 1998 and 1997, 56,197 and 43,668 shares, respectively, were
committed to be released, and the fair value of the 23,251 and 35,780
unearned shares was approximately $360,000 and $347,000. ESOP expense
was $163,843, $108,973 and $79,085 for the years ended June 30, 1998,
1997 and 1996, respectively.
Employment Agreements
The Company has entered into employment agreements, which expire in July
2000, with two of its executive officers. The agreements provide, among
other things, for payment to the officers of up to 299% of the officers'
then current annual compensation in the event there is a change of
control of the Company where employment terminates involuntarily in
connection with such change of control.
Stock Options
Certain officers and directors of the Company have been granted options
to purchase up to 89,222 shares of the Company's $.01 par common stock.
The exercise price is equal to the fair market value of the shares at
the date the options are granted. The options are subject to certain
vesting requirements and, if unused, the options will expire October
2004.
<PAGE>
Changes in options outstanding and exercisable during 1998 and 1997,
were as follows:
<TABLE>
<CAPTION>
Exercisable Outstanding Option price
options options per share
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
June 30, 1995 14,808 74,042 $ 5.50 - 6.06
Vested 14,808 - 5.50 - 6.06
- ----------------------------------------------------------------------------------------
June 30, 1996 29,616 74,042 5.50 - 6.06
Vested 14,809 - 5.50 - 6.06
- ----------------------------------------------------------------------------------------
June 30, 1997 44,425 74,042 5.50 - 6.06
Vested 14,809 - 5.50 - 6.06
Exercised (28,862) (28,862) 5.50 - 6.06
- ----------------------------------------------------------------------------------------
June 30, 1998 30,372 45,180 $ 5.50 - 6.06
========================================================================================
</TABLE>
(Continued)
35
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Recognition and Retention Plan
In 1995, the Company established a recognition and retention plan (RRP)
for certain executive officers and directors. The Company authorized the
RRP to award shares equal to approximately 4% of the shares of common
stock of the Company. The employees become vested in the shares of stock
over a five-year period. RRP expense for the years ended June 30, 1998,
1997 and 1996, was $36,216, $36,216 and $36,222, respectively.
(12) Stockholders' Equity
Stock Conversion
In order to grant priority to eligible account holders in the event of
future liquidation, the Bank, at the time of conversion to a stock
savings bank, established a liquidation account in the amount equal to
the regulatory capital as of March 31, 1993. In the event of the future
liquidation of the Bank, eligible account holders who continue to
maintain their deposit accounts shall be entitled to receive a
distribution from the liquidation account. The total amount of the
liquidation account will be decreased as the balance of the eligible
account holders is reduced subsequent to the conversion, based on an
annual determination of such balances.
Regulatory Capital Requirements
The Financial Institution Reform, Recovery and Enforcement Act of 1989
(FIRREA) and the capital regulations of the OTS promulgated thereunder
require institutions to have a minimum regulatory tangible capital equal
to 1.5% of total assets, a minimum 3% leverage capital ratio and a
minimum 8% risk-based capital ratio. These capital standards set forth
in the capital regulations must generally be no less stringent than the
capital standards applicable to national banks. FIRREA also specifies
the required ratio of housing-related assets in order to qualify as a
savings institution.
The Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA) established additional capital requirements which require
regulatory action against depository institutions in one of the
undercapitalized categories defined in implementing regulations. FDICIA
requires depository institutions to maintain a tangible equity ratio of
2%. Institutions such as the Bank, which are defined as well
capitalized, must generally have a leverage capital (core) ratio of at
least 5%, a tier I risk-based capital ratio of at least 6% and a total
risk-based capital ratio of at least 10%. FDICIA also provides for
increased supervision by federal regulatory agencies, increased
reporting requirements for insured depository institutions and other
changes in the legal and regulatory environment for such institutions.
The Bank met the regulatory capital requirements at June 30, 1998 and
1997.
The Bank met all regulatory capital requirements at June 30, 1998 and
1997.
(Continued)
36
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Bank's actual and required capital amounts and ratios as of June 30,
1998 were as follows:
<TABLE>
<CAPTION>
To be well
For capital capitalized under
adequacy prompt corrective
Actual purposes action provisions
Amount Ratio Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Tangible capital (to tangible assets) $ 6,456,000 7.3% $ 1,773,000 2.0% $ - - %
Leverage/equity (core) capital
(to adjusted tangible assets) 6,456,000 7.3 3,547,000 4.0 4,434,000 5.0
Tier I risk-based capital
(to risk-weighted assets) 6,456,000 12.7 2,042,000 4.0 3,063,000 6.0
Risk-based (total) capital
(to risk-weighted assets) 6,722,000 13.2 4,084,000 8.0 5,106,000 10.0
=========================================================================================================================
</TABLE>
At June 30, 1998 and 1997, the Bank had federal income tax bad debt
reserves of approximately $1,263,000 which constitute allocations to bad
debt reserves for federal income tax purposes for which no provision for
taxes on income had been made. If such allocations are charged for other
than bad debt losses, taxable income is created to the extent of the
charges. The Bank's retained earnings at June 30, 1998 and 1997 were
substantially restricted because of the effect of these income tax bad
debt reserves.
Dividend Restrictions
Federal regulations impose certain limitations on the payment of
dividends and other capital distributions by the Bank. Under the
regulations, a savings institution, such as the Bank, that will meet the
fully phased-in capital requirements (as defined by the OTS regulations)
subsequent to a capital distribution is generally permitted to make such
capital distribution without OTS approval, subject to certain
limitations and restrictions as described in the regulations. A savings
institution with total capital in excess of current minimum capital
requirements but not in excess of the fully phased-in requirements is
permitted by the new regulations to make, without OTS approval, capital
distributions of between 25% and 75% of its net earnings for the
previous four quarters less dividends already paid for such period. A
savings institution that fails to meet current minimum capital
requirements is prohibited from making any capital distributions without
prior approval from the OTS.
<PAGE>
(13) Special Deposit Insurance Assessment
On September 30, 1996, the Deposit Insurance Funds Act of 1996 (the Act)
was signed into law. The Act imposed a one-time special assessment of
65.7 basis points on deposits held as of March 31, 1995, to capitalize
the Savings Association Insurance Fund (SAIF). All of the deposits of
the Bank are SAIF insured. The special assessment of $330,875 was paid
by the Bank on November 27, 1996. Subsequent to the special assessment,
the premium for SAIF-insured deposits was reduced from 23 basis points
to 6.4 basis points, thus reducing deposit insurance expense for the
Bank.
(Continued)
37
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(14) Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments as of
June 30, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
June 30, 1998 June 30, 1997
--------------------------------- -----------------------------
Recorded Fair Recorded Fair
amount value amount value
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 6,366,619 6,366,619 5,621,242 5,621,242
Securities available-for-sale 23,921,718 23,921,718 24,942,234 24,942,234
Loans 55,996,418 56,560,330 52,193,285 51,465,206
FHLB stock 1,202,500 1,202,500 955,600 955,600
Accrued interest receivable 683,120 683,120 554,240 554,240
Financial liabilities:
Deposits 60,144,866 60,486,010 57,641,372 57,884,295
FHLB advances 20,038,174 20,142,145 19,101,534 19,101,534
Advance payments by borrowers
for taxes and insurance 407,050 407,050 400,663 400,663
Accrued interest payable 355,860 355,860 131,917 131,917
==========================================================================================================================
<CAPTION>
Notional Unrealized Notional Unrealized
value gains (losses) value gains (losses)
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Off balance sheet assets:
Commitments to extend credit $ 690,000 - 238,000 -
Unused lines of credit 870,000 - 422,000 -
==========================================================================================================================
</TABLE>
(15) Contingency
The Bank is involved in various legal actions and proceedings arising
from the normal course of operations. Management believes that
liability, if any, arising from such legal actions and proceedings will
not have a material adverse effect upon the consolidated financial
statements of the Company.
(Continued)
38
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(16) Horizon Financial Services Corporation (Parent Company Only) Financial
Information
The Parent Company's principal asset is its 100% ownership of the Bank
and the Bank's subsidiary. The following are the condensed financial
statements for the Parent Company:
<TABLE>
<CAPTION>
Condensed Balance Sheets
1998 1997
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents $ 375,000 189,692
Securities available-for-sale 1,395,421 1,561,950
Loans receivable, net 439,207 92,165
Loans receivable from subsidiary 129,205 193,798
Investment in subsidiary 5,765,898 6,150,951
Real estate 190,402 207,874
Interest receivable 18,185 20,834
Income taxes receivable 175,375 -
- ------------------------------------------------------------------------------------------------
Total assets $ 8,488,693 8,417,264
- ------------------------------------------------------------------------------------------------
Accrued expenses and other liabilities $ 873 4,603
Common stock 10,462 5,231
Additional paid-in capital 4,894,744 4,795,400
Retained earnings 5,730,257 5,305,946
Treasury stock, at cost (1,185,924) (1,360,275)
Unearned ESOP shares (129,205) (193,798)
Unearned RRP shares (11,439) (47,655)
Unrealized losses on securities available-for-sale (821,075) (92,188)
- ------------------------------------------------------------------------------------------------
Total liabilities and equity $ 8,488,693 8,417,264
- ------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
39
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Condensed Statements of Operations
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income $ 123,091 177,996 178,035
Equity in earnings of subsidiaries 814,876 230,579 301,785
Other income (expense) (334,958) 27,053 29,598
Other expenses (187,314) (150,136) (118,957)
- -------------------------------------------------------------------------------------------------------------------
Net earnings before tax 415,695 285,492 390,461
Income tax (benefit) expense (173,689) 7,000 14,000
- -------------------------------------------------------------------------------------------------------------------
Net earnings $ 589,384 278,492 376,461
===================================================================================================================
<CAPTION>
Condensed Statements of Cash Flows
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net earnings $ 589,384 278,492 376,461
Equity in earnings of subsidiary (814,876) (230,579) (301,785)
Other, net 288,588 29,809 (8,380)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 63,096 77,722 66,296
- --------------------------------------------------------------------------------------------------------------------
Investing activities:
Proceeds from sale of securities available-for-sale 2,647,147 272,962 1,071,422
Purchase of securities available-for-sale (3,445,162) (577,106) (1,221,867)
Principal collected on AFS securities 599,306 - -
Purchase of real estate - - (65,000)
Proceeds from the sale of real estate - 65,233 -
Loans receivable, net (282,449) 60,505 738,030
- --------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (481,158) (178,406) 522,585
- --------------------------------------------------------------------------------------------------------------------
Financing activities:
Dividends from subsidiary 588,767 750,000 204,440
Treasury stock acquired - (337,354) (699,431)
Exercise of stock options 159,585 - -
Dividends paid (144,982) (130,032) (148,580)
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Net cash provided by (used in) financing activities 603,370 282,614 (643,571)
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 185,308 181,930 (54,690)
Cash and cash equivalents at beginning of year 189,692 7,762 62,452
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 375,000 189,692 7,762
====================================================================================================================
</TABLE>
(Continued)
40
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
ANNUAL MEETING
The Annual Meeting of Stockholders will be held at 3:00 p.m. local time, on
October 22, 1998, at the main office of Horizon Federal Savings Bank, 301 First
Avenue East, Oskaloosa, Iowa.
STOCK LISTING
Horizon Financial Services Corporation common stock is traded on the Nasdaq
SmallCap Market under the symbol "HZFS."
PRICE RANGE OF COMMON STOCK
The high and low bid quotations for the common stock as reported on the Nasdaq
Stock Market, as well as dividends declared per share, is reflected in the table
below. The information set forth in the table below was provided by the Nasdaq
Stock Market. Such information reflects interdealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
<TABLE>
<CAPTION>
FISCAL 1998 (1) FISCAL 1997 (1)
----------------------------------------- ---------------------------------
HIGH LOW DIVIDENDS HIGH LOW DIVIDENDS
---------- -------- --------- ------- ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
First Quarter $ 10.00 $ 9.25 $ .04 First Quarter $ 7.50 $ 7.00 $ .04
Second Quarter 14.50 10.375 .045 Second Quarter 7.625 7.25 .04
Third Quarter 16.75 12.125 .045 Third Quarter 9.125 7.50 .04
Fourth Quarter 16.875 15.50 .045 Fourth Quarter 9.875 8.50 .04
</TABLE>
- ----------------------------
(1) Restated to reflect the 2-for-1 stock split paid in the form of a 100% stock
dividend by the Company on November 10, 1997.
Cash dividend payout is continually reviewed by management and the Board of
Directors. The Company intends to continue its policy of paying quarterly
dividends; however, the payment will depend upon a number of factors, including
capital requirements, regulatory limitations, the Company's financial condition,
results of operations and the Bank's ability to pay dividends to the Company.
The Company relies significantly upon such dividends originating from the Bank
to accumulate earnings for payment of cash dividends to its stockholders. See
Note 12 to the Notes to Consolidated Financial Statements for a discussion of
restrictions on the Bank's ability to pay dividends.
At September 11, 1998, there were 879,942 shares of Horizon Financial Services
Corporation common stock issued and outstanding and approximately 300
stockholders of record.
STOCKHOLDERS AND GENERAL INQUIRIES TRANSFER AGENT
Robert W. DeCook, President and CEO First Bankers Trust Company, N.A.
Horizon Financial Services Corporation 1201 Broadway
301 First Avenue East Quincy, IL 62301
Oskaloosa, Iowa 52577 (217) 228-8000
41
<PAGE>
HORIZON FINANCIAL SERVICES CORPORATION
CORPORATE INFORMATION
- --------------------------------------------------------------------------------
COMPANY AND BANK ADDRESS
301 First Avenue East Telephone:(515) 673-8328
Oskaloosa, IA 52577 Fax: (515) 673-0074
DIRECTORS OF THE BOARD
Robert W. DeCook
Chairman of the Board, President and
Chief Executive Officer of Horizon
Financial Services Corporation and
Horizon Federal Savings Bank
Gary L. Rozenboom
Self-Employed Flooring Business
Oskaloosa, Iowa
Dwight L. Groves
Property Manager and Retired Restaurateur
Oskaloosa, Iowa
Thomas L. Gillespie
Vice President of Horizon Financial
Services Corporation and Horizon
Federal Savings Bank
Norman P. Zimmerman
Retired Dentist and Former Mayor of the City
of Oskaloosa
Oskaloosa, Iowa
HORIZON FINANCIAL SERVICES CORPORATION EXECUTIVE OFFICERS
Robert W. DeCook
President and Chief Executive Officer
Thomas L. Gillespie
Vice President
Sharon K. McCrea
Treasurer and Chief Financial Officer
<TABLE>
<CAPTION>
INDEPENDENT AUDITORS CORPORATE COUNSEL SPECIAL COUNSEL
<S> <C> <C>
KPMG Peat Marwick LLP McCoy, Faulkner & Broerman Silver, Freedman & Taff, L.L.P.
2500 Ruan Center 216 South First Street 1100 New York Avenue, N.W.
Des Moines, Iowa 50309 Oskaloosa, Iowa 52577 Seventh Floor
Washington, D.C. 20005
</TABLE>
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