UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10KSB
[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
- --------------------------------------------------------------------------------
(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>
PART I
Item 1. Description of Business
General
The Company. Horizon Financial Services Corporation (the "Company"), a
Delaware corporation, was formed in March 1994 to act as the holding company for
Horizon Federal Savings Bank ("Horizon Federal" or the "Bank") upon the Bank's
conversion from the mutual to the stock form (the "Conversion"), which occurred
on June 28, 1994. On that date, the Company issued 506,017 shares of common
stock at a price of $10.00 per share in the Conversion. All references to the
Company, unless otherwise indicated, at or before June 28, 1994 are to the Bank
and its subsidiary on a consolidated basis. The Company's common stock trades on
the Nasdaq SmallCap Market under the Symbol "HZFS".
At June 30, 1998, the Company had $89.9 million of assets and
stockholders' equity of $8.5 million (or 9.5% of total assets).
The executive offices of the Company are located at 301 First Avenue
East, Oskaloosa, Iowa 52577, and its telephone number at that address is (515)
673-8328.
Horizon Federal. Horizon Federal, a wholly-owned subsidiary of the
Company, is a federally chartered stock savings bank headquartered in Oskaloosa,
Iowa. Its deposits are insured up to applicable limits, by the Federal Deposit
Insurance Corporation (the "FDIC"), which is backed by the full faith and credit
of the United States. Horizon Federal's primary market area covers Mahaska
County, that portion of Marion County in and around Knoxville, Iowa and to a
lesser extent, Wapello County, Iowa. The Bank services its market area through
its three full service offices, two of which are located in Oskaloosa, Iowa and
one which is located in Knoxville, Iowa.
The principal business of the Bank consists of attracting deposits from
the general public and using such deposits, together with borrowings and other
funds, primarily to originate one- to four-family residential mortgage loans. To
a lesser extent, the Bank also originates consumer loans, commercial business
loans, multi-family and commercial real estate loans and residential
construction loans. The Bank also invests in mortgage-backed and related
securities, as well as investment securities. See "Business of the Bank -
Originations of Loans and Mortgage-Backed Securities." At June 30, 1998,
substantially all of the Bank's real estate mortgage loans (excluding
mortgage-backed securities) were secured by properties located in Iowa.
The Bank's revenues are derived principally from interest on mortgage
loans and securities, service fee income and dividends on FHLB stock. The Bank
does not originate loans to fund leveraged buyouts and has no loans to
non-United States corporations or foreign governments.
The Bank currently offers a variety of deposit accounts having a wide
range of interest rates and terms. The Bank's deposits include commercial
demand, savings, checking, money market and certificate accounts. The Bank only
solicits deposits in its primary market area and does not accept brokered
deposits.
Horizon Federal's operations are materially affected by general economic
conditions, the monetary and fiscal policies of the federal government and the
policies of the various regulatory
<PAGE>
authorities, including the Office of Thrift Supervision ("OTS") and the Board of
Governors of the Federal Reserve System ("Federal Reserve Board").
During fiscal 1995, the Company entered into a joint venture low income
apartment housing project to take advantage of certain tax benefits available
under Section 42 of the Internal Revenue Code of 1986, as amended. The apartment
housing project is composed of 62 units and is located in Des Moines, Iowa. At
June 30, 1998, the apartment complex was 96% leased. At June 30, 1998, the
Company's equity investment in the project was $190,000, representing a 16.5%
limited partnership interest in the project. The Company will receive tax
credits of approximately $42,000 per year through 2005.
For information relating to the Company's and the Bank's year 2000
preparedness, costs, risks and contingency plans, see the discussion contained
under "Management's Discussion and Analysis and Related Operations" in the
Annual Report to Stockholders attached hereto as Exhibit 13 (the "Annual
Report").
Forward-Looking Statements
When used in this Annual Report on Form 10-KSB or future filings by the
Company with the Securities and Exchange Commission, in the Company's press
releases or other public or shareholder communications, or in oral statements
made with the approval of an authorized executive officer, the words or phrases
"will likely result", "are expected to", "will continue", "is anticipated",
"estimate", "project", "believe" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors--including regional
and national economic conditions, changes in levels of market interest rates,
credit risks of lending activities, and competitive and regulatory
factors--could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake--and specifically disclaims any
obligation--to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Market Area
Horizon Federal primarily serves Mahaska County and that portion of
Marion County in and around Knoxville, Iowa. The Bank has three offices, two of
which are located in Oskaloosa, Iowa and one which is located in Knoxville,
Iowa, approximately 25 miles west of Oskaloosa. The Bank competes in loan
originations and in deposit gathering activities with the eleven financial
institutions and three credit unions serving its primary market area. See " -
Competition." The Bank estimates its share of the savings market in its primary
market area to be approximately 10%.
Oskaloosa, Iowa is located in Mahaska County, approximately 60 miles
southeast of Des Moines, Iowa. Mahaska County has a population of approximately
22,000 people. Oskaloosa, with a current population of approximately 10,500
persons, is the county seat and the largest city in Mahaska County. Oskaloosa
has a mostly agricultural economy and, to a lesser extent, light
2
<PAGE>
industrial and retail economies. Its light industrial economy, however, is
mainly agricultural support. Major employers in the area include the Clow Valve
Company, the Pella Corporation, Cargill, Vermeer Manufacturing, the V.A. Medical
Center, 3-M Company, William Penn College and the Mahaska County Hospital.
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, which is anticipated to remain in the
local economy for an extended period of time, farm prices for grain and
livestock, which are currently depressed, may continue to remain depressed and
possibly even drop further. A decrease in the prices of grain and livestock tend
to make local consumers in our market area reduce spending, which might
adversely affect the local economy. In addition, the Bank is experiencing
difficulty, as are most businesses in the area, in hiring and retaining
expericenced personnel as labor shortages in the area continue to exist.
Management believes that many of these individuals are seeking employment in the
major cities where economic conditions are stronger.
These economic conditions and strong competition may affect the
financial condition and results of operations of the Company and the Bank. 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 conditions and results of operations of the Company and the
Bank.
Lending Activities of the Bank
General. Historically, the Bank originated fixed-rate one- to
four-family mortgage loans. Since the early 1980s, however, the Bank has
emphasized, subject to market conditions, the origination and holding in
portfolio of short- and intermediate-term (one, three and seven year) loans that
convert to annual adjustable-rate mortgage ("ARM") loans after their initial
period. Management's strategy has been to increase the percentage of assets in
its portfolio with more frequent repricing characteristics or shorter
maturities. During periods of low demand for one- to four-family loans, the Bank
may seek to invest in mortgage-backed and related securities. The Bank also
originates for its loan portfolio fixed-rate, first lien mortgages with terms
generally not greater than 15 years. The Bank also originates and sells from
time to time in the secondary market 15 year and 30 year fixed-rate loans.
The Bank primarily focuses its lending activities on the origination of
loans secured by first mortgages on owner-occupied, one- to four-family
residences. To a lesser extent, the Bank also originates consumer loans,
commercial business loans, commercial and multi-family real estate loans and
residential construction loans. See "- Originations of Loans and Mortgage-Backed
Securities." At June 30, 1998, the Bank's net loan portfolio totaled $56.0
million.
Several loan officers of the Bank and all members of the Board of
Directors serve as Loan Committee members on a rotating basis. At any given
time, the approval of at least one outside director and two other members of the
Loan Committee is required to approve real estate loans of $200,000 or more.
Loan Committee approval is currently required for unsecured and secured consumer
loans of more than $80,000 and $100,000, respectively, and unsecured and secured
commercial business loans of more than $25,000 and $50,000, respectively. The
Board of Directors must approve all commercial business loans with a balance
exceeding $200,000.
3
<PAGE>
The aggregate amount of loans that the Bank is permitted to make under
applicable federal regulations to any one borrower, including related entities,
or the aggregate amount that the Bank can invest in any one real estate project
is, with certain exceptions, generally the greater of 15% of unimpaired capital
and surplus or $500,000. See "Regulation - Federal Regulation of Savings Banks."
At June 30, 1998, the maximum amount which the Bank could lend to any one
borrower and the borrower's related entities under the applicable federal
regulations was approximately $906,000, however, at June 30, 1998 the Board of
Directors of the Bank had a self-imposed $800,000 general limitation.
The Bank reserves the right to change or discontinue lending programs to
respond to regulatory or competitive factors.
4
<PAGE>
Portfolio Composition. The following table presents the composition of
the Bank's loan portfolio in dollar amounts and in percentages (before
deductions for loans in process, deferred fees and discounts and allowances for
losses) as of the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- -------------------
Amount Percent Amount Percent Amount Percent
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family ............. $34,266 60.1% $34,625 64.9% $32,511 64.7%
Commercial real estate .......... 4,472 7.8 3,944 7.4 3,801 7.5
Multi-family .................... 1,113 2.0 658 1.2 789 1.6
Residential construction ........ 2,000 3.5 829 1.6 1,335 2.7
------- ----- ------- ----- ------- -----
Total real estate loans ..... 41,851 73.4 40,056 75.1 38,436 76.5
------- ----- ------- ----- ------- -----
Other Loans:
Consumer Loans:
Automobile ..................... 3,841 6.7 4,051 7.6 3,516 7.0
Home improvement ............... 3,150 5.5 2,353 4.4 1,966 3.9
Deposit account ................ 179 .3 222 .4 175 .4
Other .......................... 2,320 4.1 1,541 2.9 1,428 2.8
------- ----- ------- ----- ------- -----
Total consumer loans ........ 9,490 16.6 8,167 15.3 7,085 14.1
Commercial business loans ....... 5,682 10.0 5,124 9.6 4,707 9.4
------- ----- ------- ----- ------- -----
Total other loans ........... 15,172 26.6 13,291 24.9 11,792 23.5
------- ----- ------- ----- ------- -----
Total loans receivable, gross 57,023 100.0% 53,347 100.0% 50,228 100.0%
===== ===== =====
Less:
Loans in process.................. 598 732 730
Deferred fees and discounts....... 81 74 76
Allowance for losses.............. 348 348 318
------- ------- -------
Total loans receivable, net....... $55,996 $52,193 $49,104
======= ======= =======
</TABLE>
5
<PAGE>
The following table shows the composition of the Bank's loan portfolio
by fixed and adjustable rate at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------------------------
1998 1997 1996
---------------------- --------------------- --------------------
Amount Percent Amount Percent Amount Percent
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed Rate Loans:
Real estate:
One- to four-family ...................... $ 5,125 9.0% $ 4,627 8.7% $ 4,865 9.7%
Commercial real estate ................... 1,246 2.2 1,015 1.9 1,171 2.3
Multi-family ............................. 573 1.0 87 .1 92 .2
Residential construction ................. 189 .3 -- -- 146 .3
------- ----- ------- ----- ------- -----
Total real estate loans ............... 7,133 12.5 5,729 10.7 6,274 12.5
Consumer ................................. 9,264 16.3 7,831 14.7 6,884 13.7
Commercial business ...................... 5,550 9.7 4,839 9.1 4,479 8.9
------- ----- ------- ----- ------- -----
Total fixed-rate loans ................ 21,947 38.5 18,399 34.5 17,637 35.1
------- ----- ------- ----- ------- -----
Adjustable Rate Loans:
Real estate:
One- to four-family ...................... 29,141 51.1 29,998 56.2 27,646 55.0
Commercial real estate ................... 3,226 5.7 2,929 5.5 2,630 5.2
Multi-family ............................. 540 .9 571 1.1 697 1.4
Residential construction ................. 1,811 3.2 829 1.6 1,189 2.4
------- ----- ------- ----- ------- -----
Total adjustable rate real estate loans 34,718 60.9 34,327 64.4 32,162 64.0
Consumer ................................. 226 .4 336 .6 201 .4
Commercial business ...................... 132 .2 285 .5 228 .5
------- ----- ------- ----- ------- -----
Total adjustable rate loans ........... 35,076 61.5 34,948 65.5 32,591 64.9
------- ----- ------- ----- ------- -----
Total loans, receivable, gross ........ 57,023 100.0% 53,347 100.0% 50,228 100.0%
===== ===== =====
Less:
Loans in process.......................... 598 732 730
Deferred fees and discounts............... 81 74 76
Allowance for loan losses................. 348 348 318
------- ------- -------
Total loans receivable, net........... $55,996 $52,193 $49,104
======= ======= =======
</TABLE>
6
<PAGE>
The following table illustrates the interest rate sensitivity of the
Bank's loan portfolio at June 30, 1998. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The table does not reflect the effects of possible prepayments
or enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
---------------------------------------
Residential Commercial
Mortgage(1) Construction Consumer Business Total
------------------- ----------------- ------------------ ---------------- -----------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ---- ------ ---- ------ ----
(Dollars in Thousands)
Due During
Years Ending
June 30,
- ------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1999(2)....................... $ 799 9.27% $2,000 7.73% $1,455 9.37% $3,240 9.59% $7,494 9.02%
2000 to 2003.................. 2,027 9.06 --- --- 5,313 9.28 1,732 8.83 9,072 9.15
2004 and following............ 37,025 8.20 --- --- 2,722 9.33 710 8.99 40,457 8.28
------- ------- ------ ------ -------
Total...................... $39,851 8.27 $2,000 7.73 $9,490 9.31 $5,682 9.28 $57,023 8.52
======= ====== ====== ====== =======
</TABLE>
(1) Includes one- to four-family, multi-family and commercial real estate
mortgage loans. (2) Includes demand loans and loans having no stated maturity.
7
<PAGE>
The total amount of loans due after June 30, 1999 which have
predetermined interest rates is $16.2 million, while the total amount of loans
due after such date which have floating or adjustable interest rates is $35.1
million.
One- to Four-Family Residential Mortgage Lending. Residential loan
originations are generated by the Bank's marketing efforts (which include radio
ads, newspaper ads and direct mail), its present and walk-in customers, and
referrals from real estate brokers and builders. The Bank focuses its lending
efforts primarily on the origination of loans secured by first mortgages on
owner-occupied, single-family residences in its market area. See "- Originations
of Loan and Mortgage-Backed Securities."
The Bank currently originates ARM loans and, to a lesser extent,
fixed-rate loans for retention in the Bank's loan portfolio. During the year
ended June 30, 1998, the Bank originated $12.8 million of adjustable-rate, one-
to four-family real estate loans (including $1.7 million of residential
construction loans) and $8.3 million of fixed-rate one- to four-family loans
(including $951,000 of residential construction loans). The Bank's one- to
four-family residential mortgage originations are primarily in its market area.
The Bank currently originates adjustable-rate, one- to four-family
residential mortgage loans with a maximum term of 30 years. Fixed-rate loans for
portfolio are generally originated up to a maximum term of 15 years. Fixed-rate
mortgage loans originated by the Bank in excess of 15 years are generally sold
in the secondary market. The Bank originated $6.5 million of fixed rate loans
for sale during fiscal 1998.
One- to four-family loan originations are generally made in amounts of
up to 95% of the appraised value or selling price of the security property,
whichever is less. For loans originated with loan-to-value ratios of greater
than 80%, the Bank typically requires private mortgage insurance to reduce the
Bank's exposure to 80% of the appraised value or selling price of the security
property.
The Bank currently offers one-year, three-year and seven-year balloon
loans that convert into ARM loans with annual adjustment after the initial term.
Rates are determined in accordance with market and competitive factors. The
Bank's ARM products generally carry interest rates which, pursuant to the terms
of the note, may be reset to a stated margin over the index utilized by the
Bank, which is currently the National Average Contract Rate for Previously Owned
Homes. The adjustable-rate loans currently originated by the Bank provide for a
maximum 2% annual cap, and a maximum 6% lifetime cap on the interest rate over
the rate in effect on the date of origination. The annual and lifetime caps on
interest rate increases reduce the extent to which these loans can help protect
the Bank against interest rate risk and may cause these loans not to be as
sensitive as the Bank's cost of funds. The Bank's ARM loans are not convertible
into fixed-rate loans. All of the Bank's one- to four-family loans are not
assumable, do not contain prepayment penalties and do not produce negative
amortization. Approximately 60.1% of the loans secured by one- to four-family
real estate originated by the Bank during fiscal 1998 were originated with
adjustable rates of interest. See "- Originations of Loans and Mortgage-Backed
Securities."
At June 30, 1998, the Bank was not servicing any loans other than loans
it originated. As of June 30, 1998, the Bank's residential ARM loan portfolio
totaled $29.1 million, or 51.1% of the Bank's gross loan portfolio as compared
to the residential fixed-rate, mortgage loan portfolio which totaled $5.1
million, or 9.0% of the Bank's gross loan portfolio. ARM loans decrease the risk
8
<PAGE>
associated with changes in interest rates but involve other risks, primarily
because as interest rates rise, the payment by the borrower may rise to the
extent permitted by the terms of the loan, thereby increasing the potential for
default. At the same time, the market value of the underlying property may be
adversely affected by higher interest rates.
In underwriting residential real estate loans, the Bank evaluates both
the borrower's ability to make monthly payments, employment history, credit
history and the value of the property securing the loan. Potential borrowers are
qualified for fixed-rate loans based upon the stated rate of the loan. Borrowers
on adjustable-rate loans are currently qualified at a rate then in effect for
seven-year loans on one- to four-family residential property. Typically, the
spread between a one-year ARM and a seven-year ARM has been 150 basis points or
more. The Bank generally requires that for mortgage loan applications an
appraisal of the security property be performed by an independent fee appraiser
approved by the Bank. In connection with origination of residential real estate
loans, the Bank generally requires an opinion from an attorney regarding the
title to the property, and fire and casualty insurance in an amount not less
than the amount of the loan.
To supplement loan demand in the Bank's primary market area the Bank
purchases mortgage-backed and related securities. The Bank purchased $20.0
million, $12.0 million and $5.0 million of mortgage-backed and related
securities during fiscal 1998, 1997 and 1996, respectively. See "Originations of
Loans and Mortgage-Backed Securities."
Residential Construction Lending. The Bank makes construction loans to
individuals for the construction of their residences and, from time to time, to
established builders and developers, for the construction of residential homes
without an underlying sales contract. At June 30, 1998, the Bank's construction
loan portfolio totaled $2.0 million, or 3.5% of its gross loan portfolio. As of
that date substantially all of these loans were in the Company's primary market
area.
Construction loans to individuals for their residences are structured
to be converted to permanent loans at the end of the construction phase which
typically runs from six months to one year. These construction loans have rates
and terms which match one- to four-family loans then offered by the Bank, except
that during the construction phase the borrower pays interest only. The maximum
loan-to-value ratio of owner occupied single family construction loans is 95%.
Residential construction loans are generally underwritten pursuant to the same
guidelines used for originating permanent one- to four-family residential loans.
The application process for construction loans includes a submission to the Bank
of the plans and costs of the project to be constructed. These items are used as
a basis to determine the appraised value of the subject property. Loans are
based on the lesser of current appraised value or the cost of construction (land
plus building).
The uncertainties inherent in estimating construction costs and the
market for a project upon completion makes it relatively difficult to evaluate
accurately the total loan funds required to complete a project, the related
loan-to-value ratios and the likelihood of ultimate success of the project.
Construction loans to borrowers other than owner-occupants also involve many of
the same risks discussed below regarding commercial real estate loans and tend
to be more sensitive to general economic conditions than many other types of
loans.
Multi-Family/Commercial Real Estate Lending. Horizon Federal also makes
real estate loans secured by multi-family and non-residential properties.
Horizon Federal's multi-family residential loans are primarily secured by
apartment buildings located within the Bank's market area.
9
<PAGE>
The commercial real estate loans originated by the Bank are primarily secured by
office buildings, churches, storage facilities, and other income-producing
properties. At June 30, 1998, $1.1 million, or 2.0%, of the Bank's gross loan
portfolio consisted of multi-family loans and $4.5 million, or 7.8%, of the
Bank's gross loan portfolio consisted of commercial real estate loans.
Commercial real estate lending entails significant additional risks as
compared with residential property lending. Commercial real estate loans
typically involve large loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans is typically dependent on the
successful operation of the real estate project and as such may be subject to a
greater extent than residential loans to adverse conditions in the economy
generally. In dealing with these risk factors, the Bank generally limits itself
to a real estate market and/or borrowers with which it has knowledge and
experience.
Appraisals on properties securing multi-family and commercial real
estate property loans originated by the Bank are performed by an independent fee
appraiser approved by the Bank at the time the loan is made. All appraisals on
multi-family and commercial real estate loans are reviewed by the Bank's
management. In addition, the Bank's underwriting procedures generally require
verification of the borrower's credit history, income and financial statements,
banking relationships and income projections for the property. In recent years,
personal guarantees have been obtained for all or most of the Bank's
multi-family and commercial real estate loans. While the Bank continues to
monitor multi-family and commercial real estate loans on a regular basis after
origination, updated appraisals are not normally obtained after closing unless
the Bank believes that there are questions regarding the status of the loan or
the value of the collateral.
At June 30, 1998, the Bank had no multi-family or commercial real
estate loans to one borrower, or group of borrowers, which had an existing
carrying value in excess of $500,000. At such date the Bank had only five
commercial and multi-family real estate loans which exceeded $300,000 at June
30, 1998, all of which were performing in accordance with their repayment terms.
Multi-family and commercial real estate lending affords the Bank an
opportunity to receive interest at rates higher than those generally available
from one- to four-family residential lending. Nevertheless, loans secured by
such properties are generally larger and involve a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties are often
dependent on the successful operation or management of the properties, repayment
of such loans may be subject to adverse conditions in the real estate market or
the economy. If the cash flow from the project is reduced (for example, if
leases are not obtained or renewed), the borrower's ability to repay the loan
may be impaired. Horizon Federal's current lending guidelines generally require,
in the case of loans secured by multi-family or commercial income-producing
property, that the property securing such loans generate net cash flow of 125%
of debt service after payment of all operating expenses, excluding depreciation,
and a loan-to-value ratio of no more than 75%.
Consumer Lending. Management believes that offering consumer loan
products helps reinforce and expand the Bank's customer base. In addition,
because consumer loans generally have shorter terms to maturity and/or
adjustable rates and carry higher rates of interest than do residential mortgage
loans, they can be useful asset/liability management tools. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Asset/Liability Management" in the Annual Report. The Bank currently originates
substantially all of its consumer loans in its
10
<PAGE>
primary market area. At June 30, 1998, the Bank's consumer loans totaled $9.5
million, or 16.6% of the Bank's gross loan portfolio.
Horizon Federal offers a variety of consumer loans for various purposes
with terms up to 15 years. The majority of lending is for automobiles, home
improvement and other personal purposes. The Bank originates consumer loans on
both a direct and an indirect basis. Direct loans are made when the Bank extends
credit directly to the borrower. Indirect loans are obtained when the Bank
purchases loan contracts from retailers of goods or services which have extended
credit to their customers. Horizon Federal began its indirect lending program in
January 1993 with selected automobile dealers located in the Bank's lending
area. At June 30, 1998, the outstanding balances on automobile loans and home
improvement totaled $3.8 million and $3.2 million, or 40.5% and 33.2% of the
Bank's gross consumer loan portfolio, respectively.
In addition, Horizon Federal commenced offering Visa and MasterCard
credit cards in April 1994. Both types of lending generally present more credit
risk to the Bank than one- to four-family residential lending. At June 30, 1998,
the Bank had $27,000 of credit card loans outstanding and $139,000 of unused
credit available under its credit card program.
The underwriting standards employed by the Bank for consumer loans
include a determination of the applicant's payment history on other debts and an
assessment of the ability to meet existing obligations and payments on the
proposed loan. Although creditworthiness of the applicant is a primary
consideration, the underwriting process also includes a comparison of the value
of the security, if any, in relation to the proposed loan amount.
Consumer loans may entail greater risk than do residential mortgage
loans, particularly in the case of consumer loans which are unsecured, or are
secured by rapidly depreciable assets such as automobiles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability and
thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
bankruptcy and insolvency laws, may limit the amount which can be recovered on
such loans. At June 30, 1998, non-performing consumer loans totaled $180,000, or
1.9% of total consumer loans and .3% of the Bank's gross loan portfolio. See
"Asset Quality - Non-Performing Assets."
Commercial Business Lending. The Bank also originates commercial
business loans. The Bank offers commercial business loans to service existing
customers, to consolidate its banking relationships with these customers, and to
further its asset/liability management goals. Most of the Bank's commercial
business loans have been extended to finance local businesses and include
short-term loans to finance machinery and equipment purchases, inventory and
accounts receivable. Commercial loans also involve the extension of revolving
credit for a combination of equipment acquisitions and working capital in
expanding companies.
The maximum term for loans extended on machinery and equipment is based
on the projected useful life of such machinery and equipment. Generally, the
maximum term on non-mortgage lines of credit is one year. The loan-to-value
ratio on such loans may not exceed 75% of the value of the collateral securing
the loan.
11
<PAGE>
The largest commercial business loan outstanding at June 30, 1998 was
an $822,000 business line of credit to a builder of one- to four-family
residential properties. At June 30, 1998, this line of credit was performing in
accordance with its repayment terms. The Bank had only two other commercial
business loans in excess of $250,000 at June 30, 1998, all of which were
performing in accordance with their repayment terms at such date.
Unlike residential mortgage loans, which generally are made on the
basis of the borrower's ability to make repayment from his or her employment and
other income, and which are secured by real property whose value tends to be
more easily ascertainable, commercial business loans are of higher risk and
typically are made on the basis of the borrower's ability to make repayment from
the cash flow of the borrower's business. As a result, the availability of funds
for the repayment of commercial business loans may be dependent upon the success
of the business itself. The Bank's commercial business loans almost always
include personal guarantees and are usually, but not always, secured by business
assets, such as accounts receivable, equipment and inventory, as well as real
estate. However, the collateral securing the loans may depreciate over time, may
be difficult to appraise and may fluctuate in value based on the success of the
business.
The Bank recognizes the generally increased credit risks associated
with commercial business lending. Horizon Federal's commercial business lending
policy emphasizes credit file documentation and analysis of the borrower's
character, management capabilities, capacity to repay the loan, the adequacy of
the borrower's capital and collateral. Analysis of the borrower's past, present
and future cash flows is also an important aspect of Horizon Federal's credit
analysis.
Originations of Loans and Mortgage-Backed Securities
The Bank originates real estate loans through marketing efforts, the
Bank's customer base, walk-in customers and referrals from real estate brokers.
The Bank originates both adjustable-rate and fixed-rate loans. Its ability to
originate loans is dependent upon the relative demand for fixed-rate or ARM
loans in the origination market, which is affected by the term structure
(short-term compared to long-term) of interest rates, as well as the current and
expected future level of interest rates and competition. During the years ended
June 30, 1998, 1997, and 1996, the Bank's dollar volume of adjustable-rate real
estate loan originations exceeded the dollar volume of the same type of
fixed-rate loan originations.
The Bank does not generally purchase loans or loan participations. In
times of low levels of loan demand, the Bank has invested its excess funds in
mortgage-backed and related securities. During fiscal 1998, 1997 and 1996 the
Bank purchased $20.2 million, $12.0 million and $5.0 million, respectively, of
mortgage-backed and related securities. The Bank funded its purchases of
mortgage-backed and related securities, specifically collateralized mortgage
obligations, during fiscal 1998, primarily with sales and repayments of mortgage
loans and mortgage-backed and related securities. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Asset/Liability
Management" in the Annual Report.
12
<PAGE>
The following table shows the loan origination, purchase and repayment
activities of the Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Originations by type:
Adjustable rate:
Real estate
- one- to four-family .............. $ 11,089 $ 5,153 $ 5,186
- multi-family ..................... 49 -- --
- commercial real estate ........... 719 664 715
- residential construction ......... 1,686 1,154 2,245
Non-real estate
- consumer ......................... 21 102 --
- commercial business .............. -- -- --
-------- -------- --------
Total adjustable-rate ........ 13,564 7,073 8,146
-------- -------- --------
Fixed rate:
Real estate
- one- to four-family .............. 7,362 1,650 1,102
- multi-family ..................... -- 23 10
- commercial real estate ........... 5,081 362 1,209
- residential construction ......... 951 212 627
Non-real estate
- consumer ......................... 10,698 5,676 4,000
- commercial business .............. 1,942 1,356 1,057
-------- -------- --------
Total fixed-rate ............. 26,034 9,279 8,005
-------- -------- --------
Total loans originated ....... 39,598 16,352 16,151
Total loan purchases .................. -- -- --
Total loan sales ...................... (6,077) (602) (1,724)
Total loan repayments ................. (29,526) (13,473) (11,048)
Increase (decrease) in other items, net (192) 812 (753)
-------- -------- --------
Net increase ................. $ 3,803 $ 3,089 $ 2,626
======== ======== ========
</TABLE>
13
<PAGE>
The following table shows the purchase, sale and repayment activities
of the Bank's mortgage-backed and related securities for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Purchases:
Mortgage-backed and related securities $ -- $ -- $ --
CMOs .................................. 20,227 12,259 5,179
-------- -------- --------
Total .......................... 20,227 $ 12,259 $ 5,179
-------- -------- --------
Sales:
Mortgage-backed and related securities (2,218) (3,191) (631)
CMOs .................................. (15,256) (971) (1,071)
-------- -------- --------
Total .......................... (17,474) (4,162) (1,702)
-------- -------- --------
Repayments:
Mortgage-backed and related securities (116) (702) (1,717)
CMOs .................................. (2,234) (683) (211)
Increase (decrease) in other items, net (3,181) (120) (110)
-------- -------- --------
Net increase (decrease) ........ $ (2,778) $ 6,592 $ 1,439
======== ======== ========
</TABLE>
Asset Quality
General. When a borrower fails to make a required payment on a loan,
the Bank attempts to cause the delinquency to be cured by contacting the
borrower. In the case of loans secured by real estate, a late notice is sent by
the 11th of the month if payment for the prior month is not received. If the
delinquency is not cured by the 15th of the month, an attempt to contact the
borrower is made by telephone. Additional written and verbal contacts are made
with the borrower to the extent necessary, and if required a personal visit by a
loan officer of the Bank is arranged. If the delinquency is not cured or a
payment plan arranged by the 61st day of delinquency or shortly thereafter, the
matter is generally referred to the Bank's collection manager and action to
foreclose on the property is initiated. After 90 days of delinquency, interest
income on loans is reduced by the full amount of accrued and uncollected
interest. If foreclosed, the property is sold at a sheriff's sale and may be
purchased by the Bank. Delinquent consumer loans are handled in a similar
manner. The Bank's procedures for repossession and sale of consumer collateral
are subject to various requirements under Iowa consumer protection laws.
Real estate acquired by Horizon Federal as a result of foreclosure or
by deed in lieu of foreclosure is classified as real estate owned until it is
sold. When property is acquired, it is recorded at the lower of cost or
estimated fair value at the date of acquisition, and any write-down resulting
therefrom is charged to the allowance for losses on loans. After acquisition,
all costs incurred in maintaining the property are expensed. However, costs
relating to the development and improvement of the property are capitalized to
the extent of net realizable value.
14
<PAGE>
The following table sets forth the Bank's loan delinquencies by type,
by amount and by percentage of category at June 30, 1998. The amounts presented
represent the total remaining principal balances of the loans, rather than the
actual payment amounts which are overdue.
<TABLE>
<CAPTION>
Loans Delinquent For:
30-59 Days 60-89 Days 90 Days and Over Total
---------------------------------- ------------------------------------ ----------------------------
Percent of Percent of Percent of Percent of
Loan Loan Loan Loan
Number Amount Category Number Amount Category Number Amount Category Number Amount Category
---------------------------------- ---------- ---------- -------------- ----------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family .. 12 $ 310 .9% 10 $ 365 1.1% 20 $ 691 2.0% 42 $1,366 4.0%
Multifamily ........... 1 410 36.8 -- -- -- -- -- -- 1 410 36.8
Commercial real estate 2 165 3.7 1 16 .3 -- -- -- 3 181 4.0
Consumer .............. 38 228 2.4 2 6 .1 25 180 1.9 65 414 4.4
Commercial business ... 5 139 2.4 -- -- -- 5 51 .9 10 190 3.3
-- ------ --- -- ------ --- -- ------ --- -- ------ ---
Total ............ 58 $1,252 2.2% 13 $ 387 .7% 50 $ 922 1.6% 121 $2,561 4.5%
== ====== === == ====== == == ====== === === ====== ===
</TABLE>
15
<PAGE>
Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in the Bank's loan portfolio. Loans are
placed on non-accrual status when the collection of principal and/or interest
become doubtful. As a matter of policy, the Bank does not generally accrue
interest on loans past due 90 days or more. For all periods presented, the Bank
has had no troubled debt restructurings (which involve forgiving a portion of
interest or principal on any loans or making loans at a rate materially less
than that of market rates). Foreclosed assets include assets acquired in
settlement of loans. There were no loans deemed to be in-substance foreclosed at
June 30, 1998.
<TABLE>
<CAPTION>
At June 30,
------------------------------
1998 1997 1996
------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C>
Non-accruing loans:
One- to four-family ...................... $ 691 $ 318 $ 504
Commercial real estate ................... -- 9 --
Consumer ................................. 180 130 151
Commercial business ...................... 51 12 43
------ ------ ------
Total ................................. 922 469 698
------ ------ ------
Accruing loans 90 days or more:
One- to four-family ...................... -- 92 --
Commercial ............................... -- 128 --
------ ------ ------
Total ................................ -- 220 --
------ ------ ------
Foreclosed assets:
One- to four-family ...................... -- 137 --
Commercial real estate ................... -- 206 205
Consumer ................................. -- 13 32
------ ------ ------
Total ................................. -- 356 237
------ ------ ------
Total non-performing assets ................ $ 922 $1,045 $ 935
====== ====== ======
Total as a percentage of total assets ..... 1.02% 1.22% 1.27%
====== ====== ======
</TABLE>
For the fiscal year ended June 30, 1998, gross interest income which
would have been recorded had the non-accruing loans been current in accordance
with their original terms amounted to $96,000, of which $48,000 was included in
interest income at such date.
At June 30, 1998, there were no non-performing loans to a single
borrower or group of related borrowers in excess of $130,000. At June 30, 1998,
there were approximately $732,000 of non-accruing loans contained in the
foregoing table which are not described in "Other Loans of Concern" or
"Classified Assets" below. These loans are not required to be classified by the
OTS and are adequately capitalized such that management does not anticipate any
losses relating to these loans.
<PAGE>
Other Loans of Concern. In addition to the non-performing assets set
forth in the table above, as of June 30, 1998, there was also an aggregate of
$217,000 in net book value of loans ($205,000 secured by single family
residences, none secured by other commercial business and $12,000 in secured
consumer loans) with respect to which known information about the possible
credit problems of the borrowers have caused management to have doubts as to the
ability of the
16
<PAGE>
borrowers to comply with present loan repayment terms and which may result in
the future inclusion of such items in the non-performing asset categories.
Classified Assets. Federal regulations provide for the classification
of loans and other assets, such as debt and equity securities considered by the
OTS to be of lesser quality, as "substandard," "doubtful" or "loss." An asset is
considered "substandard" if it is inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "doubtful" have all of the weaknesses
inherent in those classified "substandard" with the added characteristic that
the weaknesses present make "collection or liquidation in full" on the basis of
currently existing facts, conditions and values, "highly questionable and
improbable." Assets classified as "loss" are those considered "uncollectible"
and of such little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted.
When an insured institution classifies problem assets as either
substandard or doubtful, it may establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution classifies
problem assets as "loss," it is required either to establish a specific
allowance for losses equal to 100% of that portion of the asset so classified or
to charge-off such amount. An institution's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the regulatory authorities, who may order the establishment
of additional general or specific loss allowances.
In connection with the filing of its periodic reports with the OTS and
in accordance with its classification of assets policy, the Bank regularly
reviews problem loans and real estate acquired through foreclosure to determine
whether such assets require classification in accordance with applicable
regulations. On the basis of management's review of its assets, at June 30,
1998, the Bank had classified a total of $329,000 of its assets as substandard,
none as doubtful and $73,000 as loss. All portions of a loan which are
classified as loss are reserved for at a rate of 100%.
At June 30, 1998, total classified assets comprised $402,000, or 4.7%
of the Bank's capital, or .45% of the Bank's total assets.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the risk
inherent in its loan portfolio and changes in the nature and volume of its loan
activity. Such evaluation, which includes a review of all loans for which full
collectibility may not be reasonably assured, considers among other matters, the
estimated fair value of the underlying collateral, economic conditions,
historical loan loss experience and other factors that warrant recognition in
providing for an adequate loan loss allowance. Although management believes it
uses the best information available to make such determinations, future
adjustments to the allowance may be necessary, and net income could be
significantly affected, if circumstances differ substantially from the
assumptions used in making the initial determinations. At June 30, 1998, the
Bank had an allowance for loan losses of $348,000, or approximately .62% of
total loans. See "Management's Discussion and Analysis of Financial
17
<PAGE>
Condition and Results of Operations -- Results of Operations -- Provision for
Losses on Loans" in the Annual Report.
The following table sets forth an analysis of the Bank's allowance for
losses on loans.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------
1998 1997 1996
----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C>
Balance at beginning of period ...................... $ 348 $ 318 $ 291
Charge-offs:
One- to four-family ............................... (16) (15) --
Commercial real estate ............................ -- -- (29)
Commercial business ............................... (51) (150) (227)
Consumer .......................................... (30) (62) (63)
----- ----- -----
Total charge-offs ............................... (97) (227) (319)
----- ----- -----
Recoveries:
Commercial business ............................... -- -- 11
Consumer .......................................... 3 5 8
----- ----- -----
Total recoveries ................................ 3 5 18
Net charge-offs ..................................... (94) (222) (301)
Additions charged to operations ..................... 94 252 328
----- ----- -----
Balance at end of period ............................ $ 348 $ 348 $ 318
===== ===== =====
Ratio of net charge-offs during the period to average
loans outstanding during the period ................ .17% .43 % .63%
===== ===== =====
</TABLE>
During the fiscal years ended June 30, 1998, 1997 and 1996, management
recorded provisions for loan losses of $94,000, $252,000 and $328,000,
respectively. These provisions were primarily the result of charge-offs on loans
and foreclosed assets incurred during the periods, as well as a result of
management's assessment of additional credit risk associated with increased
level of the Bank's consumer and commercial business portfolios during such
periods.
18
<PAGE>
The distribution of the Bank's allowance for losses on loans at the
dates indicated is summarized as follows:
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------------------
1998 1997 1996
------------------ ------------------- ----------------------
Percent Percent Percent
of Loans of Loans of Loans
in Each in Each in Each
Category Category Category
to Total to Total to Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
One- to four-family............. $111 60.1% $116 64.9% $128 64.7%
Multi-family.................... 3 2.0 2 1.2 2 1.6
Commercial real estate.......... 13 7.8 12 7.4 11 7.5
Residential construction........ 3 3.5 2 1.6 3 2.7
Consumer........................ 111 16.6 103 15.3 80 14.1
Commercial business............. 81 10.0 95 9.6 60 9.4
Unallocated..................... 26 --- 18 --- 34 ---
---- ----- ----- ----- ----- -----
Total...................... $348 100.0% $ 348 100.0% $ 318 100.0%
==== ===== ===== ===== ===== =====
</TABLE>
Investment Activities
Horizon Federal must maintain minimum levels of investments that
qualify as liquid assets under OTS regulations. Liquidity may increase or
decrease depending upon the availability of funds and comparative yields on
investments in relation to the return on loans. Historically, the Bank has
maintained liquid assets at levels above the minimum requirements imposed by the
OTS regulations and at levels believed adequate to meet the requirements of
normal operations, including repayments of maturing debt and potential deposit
outflows. Cash flow projections are regularly reviewed and updated to assure
that adequate liquidity is maintained. At June 30, 1998, the Bank's liquidity
ratio (liquid assets as a percentage of net withdrawable savings deposits and
current borrowings) was 10.41%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Annual Report and
"Regulation - Liquidity."
Federally chartered savings institutions have the authority to invest
in various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certain certificates of deposit of
insured banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to various restrictions, federally
chartered savings institutions may also invest their assets in commercial paper,
investment grade corporate debt securities and mutual funds whose assets conform
to the investments that a federally chartered savings institution is otherwise
authorized to make directly.
<PAGE>
Generally, the investment policy of the Bank, as established by the
Board of Directors, is to invest funds among various categories of investments
and maturities based upon the Bank's liquidity needs, asset/liability management
policies, investment quality, marketability and performance objectives. Subject
to the Board's direction, the Investment Committee meets monthly to review the
Bank's investments and objectives for its investment portfolio. The Bank's
investment policy has established methods and strategies for each type of
security. It is the Bank's general policy to purchase investment securities
which are U.S. Government securities or federal agency obligations or other
issues that are rated investment grade.
19
<PAGE>
The Bank has a portfolio of mortgage-backed and related securities and
has utilized such investments to complement its mortgage lending activities. At
June 30, 1998, the Bank's mortgage-backed and related securities totaled $19.7
million, or 21.8% of total assets. For information regarding market values of
the Bank's mortgage-backed and related securities portfolio, see Note 2 of the
Notes to Consolidated Financial Statements in the Annual Report.
Historically, most of the Bank's mortgage-backed securities were
long-term, fixed-rate securities. In more recent years, the Bank has begun to
purchase other types of mortgage-backed and related securities consistent with
its asset/liability management objectives. In this regard, the Bank emphasizes
the purchase of adjustable-rate, mortgage-backed and related securities for
asset/liability management purposes and in order to supplement the Bank's
origination of ARM loans. At June 30, 1998, all of the Bank's mortgage-backed
and related securities carried adjustable rates of interest.
The Bank's portfolio of Government National Mortgage Association
("GNMA"), FNMA and Federal Home Loan Mortgage Corporation ("FHLMC") certificates
are modified pass-through mortgage-backed securities that generally represent
undivided interests in underlying pools of fixed-rate, or certain types of
adjustable rate, single-family residential mortgages issued by these
government-sponsored entities. GNMA's guarantee to the holder of timely payments
of principal and interest is backed by the full faith and credit of the U.S.
government. FNMA and FHLMC provide the certificate holder a guarantee of timely
payments of interest and scheduled principal payments, whether or not they have
been collected. Under the OTS risk-based capital requirements, GNMA
mortgage-backed securities have a zero percent risk weighting and FNMA, FHLMC
and "AA" or higher-rated mortgage-backed securities have a 20% risk weighting,
in contrast to the 50% risk weighting carried by one- to four-family performing
residential mortgage loans.
At June 30, 1998, the Bank held $11.7 million of collateralized
mortgage obligations ("CMOs") having estimated lives which ranged from less than
one year up to 11 years. CMOs are special types of pass-through debt in which
the stream of principal and interest payments on the underlying mortgages or
mortgage-backed securities is used to create classes with different maturities
and, in some cases, amortization schedules, as well as a residual interest, with
each such class possessing different risk characteristics. Management believes
these securities may represent attractive alternatives relative to other
investments due to the wide variety of maturity and repayment options available
through such investments. Management has opted to invest in CMO's, including
interest only and principal only CMOs, as opposed to straight mortgage-backed
securities, in an effort to improve or maintain spreads. The Bank has leveraged
its capital by using Federal Home Loan Bank advances to purchase many of these
securities. Management believes that the increased net income which can result
from this type of investing can, at times, provide high enough returns to
justify the increased vulnerability of sudden and unexpected interest rate
changes. See "Management's Discussion and Analysis and Results of Operations" in
the Annual Report.
OTS guidelines regarding investment portfolio policy and accounting
require insured institutions to categorize securities and certain other assets
as held for "investment," "sale," or "trading." The portion of the investment
securities portfolio which is held with the intent to hold to maturity is
accounted for on an amortized cost basis. Securities which are categorized as
available for sale are carried at fair value. At June 30, 1998, all of the
Bank's investment, mortgage-backed and related securities were classified as
available for sale.
20
<PAGE>
The following table sets forth the composition of the Bank's portfolio
of investment and mortgage-backed securities at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------------------------------------
1998 1997 1996
---------------------- --------------------- ------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
-------- ----- ------- ----- ------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Investment Securities:
U.S. government securities.......................... $ --- ---% $ 103 1.6% $ 105 2.9%
Federal agency obligations.......................... 869 9.6 849 13.3 839 22.9
Small business administration loans................. 973 10.7 971 15.3 1,021 27.8
Equity securities(1)................................ 2,428 26.8 589 9.3 247 6.7
-------- ----- ------- ------ ------ -----
Subtotal......................................... 4,270 47.1 2,512 39.5 2,212 60.3
FHLB stock............................................ 1,203 13.3 956 15.0 559 15.2
--------- ------ ------- ----- ------- -----
Total investment securities and FHLB stock....... 5,473 60.4 3,468 54.5 2,771 75.5
Other Interest-Earning Assets:
Interest-bearing deposits with banks................ 3,581 39.6 2,890 45.5 900 24.5
-------- ----- ------- ----- ------- -----
Total............................................ $ 9,054 100.0% $ 6,358 100.0% $ 3,671 100.0%
========= ===== ======= ===== ======= =====
Average remaining life or term to repricing of
investment securities and other interest-earning
assets excluding FNMA stock and FHLB stock........... 3.83 years 5.5 years 9.3 years
Mortgage-Backed and Related Securities:
CMOs................................................ $ 11,723 59.7% $18,138 80.9% $8,895 56.1%
FHLMC............................................... 667 3.4 704 3.1 1,688 10.6
FNMA................................................ --- ---- 1,399 6.2 3,413 21.6
GNMA................................................ --- ---- 924 4.1 1,834 11.6
Other(2)............................................ 7,262 36.9 1,265 5.7 8 .1
------- ------ ------- ----- -------- -----
Total mortgage-backed and related securities...... $ 19,652 100.0% $22,430 100.0% $15,838 100.0%
======== ===== ======= ===== ======= =====
</TABLE>
(1) Consists primarily of FNMA Stock, stocks of publicly traded thrift
institutions and thrift holding companies, and mutual funds.
(2) Consists of interest only and principal only stripped mortgage-backed
securities. See Footnote 2 of Notes to Consolidated Financial Statements
contained in the Annual Report.
21
<PAGE>
The composition and maturities of the debt investment securities
portfolio, excluding equity securities and FHLB stock, are indicated in the
following table.
<TABLE>
<CAPTION>
At June 30, 1998
------------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 Over 10 Total Debt Investment
1 Year Years Years Years Securities
------------------------------------------------------------------------------
Carrying Carrying Carrying Carrying Book Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. government securities....... $ --- $ --- $ --- $ --- $ --- $ ---
Federal agency obligations....... --- --- 869 --- 869 869
Small business administration
loans......................... --- --- --- 973 973 973
------ ------ ------- ----- ------ -----
Total..................... $ --- $ --- $ 869 $973 $1,842 $1,842
====== ======= ===== ==== ====== ======
Weighted average yield........... ---% ---% 3.65% 7.88% 5.88% 5.88%
</TABLE>
The following table sets forth the contractual maturities of the Bank's
mortgage-backed and related securities at June 30, 1998; however, the expected
average life to maturity of this portfolio is generally two to 10 years.
<TABLE>
<CAPTION>
At
Due in June 30,
-------------------------------------------------------- ---------
One to 5 to 10 and 1998
Less than Less than 5 Less than 10 Over Balance
One Year Years Years Years Outstanding
-------- ----- ----- ----- -----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
FHLMC.............. $ --- $ --- $ --- $ 667 $ 667
FNMA............... --- --- --- --- ---
GNMA............... --- --- --- --- ---
CMOs............... --- 153 1,132 10,438 11,723
Other.............. --- --- 2,439 4,823 7,262
------ ------ ------ --------- -------
Total............. $ --- $153 $3,571 $ 15,929 $19,652
======= ==== ====== ========= =======
</TABLE>
At June 30, 1998, the Bank's portfolio of investment and
mortgage-backed securities contained no securities of any issuer with an
aggregate book value in excess of 10% of the Bank's stockholders' equity,
excluding those issued by the United States Government or its agencies.
For additional information on the Bank's investment and mortgage-backed
securities, see Note 2 of the Notes to Consolidated Financial Statements in the
Annual Report.
22
<PAGE>
Sources of Funds
General. The Bank's primary sources of funds are deposits, amortization
and repayment of loan principal (including mortgage-backed securities), sales or
maturities of investment securities, mortgage-backed securities and short-term
investments, FHLB advances and funds provided from operations.
Borrowings, primarily FHLB advances, are used to compensate for
seasonal reductions in deposits or deposit inflows at less than projected
levels, and may be used on a longer-term basis to support lending activities. At
June 30, 1998, the Bank had total FHLB advances of $20.0 million.
Deposits. Horizon Federal offers a variety of deposit accounts having a
wide range of interest rates and terms. The Bank's deposits consist of
commercial demand, savings, checking, money market and certificate accounts. The
certificate accounts currently range in terms from 6 months to five years. The
Bank relies primarily on advertising (including radio, newspaper and direct
mail), competitive pricing policies and customer service to attract and retain
these deposits. Horizon Federal solicits deposits from its market area only and
does not use brokers to obtain deposits. The flow of deposits is influenced
significantly by general economic conditions, changes in money market and
prevailing interest rates and competition. The composition of the Bank's
deposits is set forth in Note 8 of the Notes to Consolidated Financial Statement
in the Annual Report.
The deposit accounts marketed by the Bank have allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. The Bank has become more susceptible to short-term fluctuations
in deposit flows as customers have become more interest rate conscious. The Bank
endeavors to manage the pricing of its deposits in keeping with its
asset/liability management and profitability objectives. The ability of the Bank
to attract and maintain savings accounts and certificates of deposit, and the
rates paid on these deposits, has been and will continue to be significantly
affected by market conditions.
The following table sets forth the savings flows at the Bank during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------
1998 1997 1996
(Dollars in Thousands)
<S> <C> <C> <C>
Opening balance..................... $ 57,641 $ 54,759 $ 51,330
Deposits............................ 184,512 157,275 129,814
Withdrawals......................... 184,066 156,443 128,381
Interest credited................... 2,058 2,050 1,996
--------- --------- ---------
Ending balance...................... $ 60,145 $ 57,641 $ 54,759
======== ======== ========
Net increase........................ $ 2,504 $ 2,882 $ 3,429
========= ========= ========
Percent increase.................... 4.34% 5.26 % 6.68%
==== ===== ====
</TABLE>
22
<PAGE>
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Bank for the periods
indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
Amount Percent Amount Percent Amount Percent
------- ------ ------- ------ ------- ------
(Dollars in Thousands)
Transactions and Savings Deposits:
<S> <C> <C> <C> <C> <C> <C>
Commercial Demand........................... $ 873 1.4% $ 1,964 3.4% $ 745 1.36%
Checking Accounts (0.0% to 4.8%)............ 5,580 9.3 4,788 8.3 4,581 8.36
Savings Accounts (2.3% to 4.9%)............. 18,276 30.4 16,829 29.2 14,635 26.73
Money Market Accounts (2.0% to 2.5%)........ 599 1.0 836 1.5 1,006 1.84
------- ------ ------- ------ ------- ------
Total Non-Certificates...................... 25,328 42.1% 24,417 42.4 20,967 38.29
------- ------ ------- ------ ------- ------
Certificates:
0.00 - 3.99%.............................. --- --- 52 .1 77 .14
4.00 - 4.99%.............................. 3,016 5.0 5,354 9.3 7,656 13.98
5.00 - 5.99%.............................. 24,248 40.3 18,288 31.7 18,513 33.81
6.00 - 6.99%.............................. 6,891 11.5 7,359 12.7 4,724 8.63
7.00 - 7.99%.............................. 553 .9 2,004 3.4 2,656 4.85
8.00 - 8.99%.............................. 94 .1 160 .3 154 .28
9.00% and above............................ 15 .1 7 .1 12 .02
------- ------ ------- ------ ------- ------
Total Certificates.......................... 34,817 57.9 33,224 57.6 33,792 61.71
------- ------ ------- ------ ------- ------
Total Deposits.............................. $60,145 100.00% $57,641 100.00% $54,759 100.00%
======= ====== ======= ====== ======= ======
</TABLE>
<PAGE>
The following table shows rate and maturity information for the Bank's
certificates of deposit as of June 30, 1998.
<TABLE>
<CAPTION>
0.00- 4.00- 6.00- 8.00- 9.00% Percent
3.99% 5.99% 7.99% 8.99% or more Total of Total
----- ----- ----- ----- ------- ----- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts maturing
in quarter ending:
September 30, 1998.................. --- 7,146 1,160 --- --- 8,307 23.86
December 31, 1998................... --- 3,654 449 --- --- 4,103 11.78
March 31, 1999...................... --- 3,782 803 88 8 4,681 13.44
June 30, 1999....................... --- 5,214 492 --- --- 5,706 16.39
September 30, 1999.................. --- 2,419 823 --- --- 3,242 9.31
December 31, 1999................... --- 843 744 --- --- 1,587 4.56
March 31, 2000...................... --- 667 1,094 --- 7 1,767 5.08
June 30, 2000...................... --- 628 1,048 --- --- 1,676 4.81
Thereafter.......................... --- 2,911 831 6 --- 3,748 10.77
--------- ------- ------ ------ ------ ------- ------
Total............................... $ --- $27,264 $7,444 $ 94 $ 15 $34,817 100.00%
========= ======= ====== ====== ====== ======= ======
Percent of total................. ---% 78.31% 21.38% .27% .04% 100.00%
==== ===== ===== === === ======
</TABLE>
24
<PAGE>
The following table indicates the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of June 30, 1998.
<TABLE>
<CAPTION>
Maturity
-----------------------------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
------- ------ ------ --------- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit of less
than $100,000.............................. $3,827 $3,902 $9,735 $11,359 $28,823
Certificates of deposit of
$100,000 or more........................... 367 201 652 661 1,881
Public funds(1)............................. 4,113 --- --- --- 4,113
------ ------- ------- -------- -------
Total certificates of
deposit.................................... $8,307 $4,103 $10,387 $12,020 $34,817
====== ====== ======= ======= =======
</TABLE>
- -----------
(1) Deposits from governmental and other public entities.
Borrowings. Although deposits are the Bank's primary source of funds,
the Bank's policy has been to utilize borrowings, primarily FHLB advances, when
they are a less costly source of funds or can be invested at a positive rate of
return. In addition, the Bank may rely upon borrowings for short-term liquidity
needs.
Horizon Federal may obtain advances from the FHLB of Des Moines upon
the security of its capital stock in the FHLB of Des Moines and certain of its
mortgage loans. Such advances may be made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities. At
June 30, 1998, the Bank had $20.0 million in FHLB advances.
The following table sets forth the maximum month-end balance and
average balance of FHLB advances. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Annual Report for a
discussion on the increase in the Bank's borrowings.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------
1998 1997 1996
------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C>
Maximum Balance:
FHLB advances................. $25,060 $19,107 $11,171
Average Balance:
FHLB advances................. $22,276 $13,254 $ 9,521
</TABLE>
25
<PAGE>
The following table sets forth certain information as to the Bank's
FHLB advances at the dates indicated. For additional information on the Bank's
advances, see Note 9 of the Notes to Consolidated Financial Statements in the
Annual Report.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------
1998 1997 1996
(Dollars in Thousands)
<S> <C> <C> <C>
FHLB advances ................ $ 20,038 $ 19,102 $ 9,661
========== ========== =========
Weighted average interest
rate of FHLB advances ....... 5.24% 5.71% 5.49%
</TABLE>
Subsidiary Activities
As a federally chartered savings bank, Horizon Federal is permitted by
OTS regulations to invest up to 2% of its assets, or $1.7 million at June 30,
1998, in the stock of, or loans to, service corporation subsidiaries. As of such
date, the net book value of Horizon Federal's investment in its service
corporation was approximately $40,700. Horizon Federal may invest an additional
1% of its assets in service corporations where such additional funds are used
for inner-city or community development purposes and up to 50% of its total
capital in conforming loans to service corporations in which it owns more than
10% of the capital stock. In addition to investments in service corporations,
federal associations are permitted to invest an unlimited amount in operating
subsidiaries engaged solely in activities in which a federal association may
engage.
Horizon Federal has one service corporation, Horizon Investment
Services, Inc. ("HISI"), an Iowa corporation, located in Oskaloosa, Iowa. HISI,
which changed its corporate name in August 1995 from SEI Service Corporation,
was organized by the Bank in 1983 in order to offer a variety of products to
customers of Horizon Federal. For the fiscal year ended June 30, 1998, HISI had
a net gain of $21,200.
Regulation
General. Horizon Federal is a federally chartered savings bank, the
deposits of which are federally insured and backed by the full faith and credit
of the United States Government. Accordingly, the Bank is subject to broad
federal regulation and oversight extending to all its operations. Horizon
Federal is a member of the FHLB of Des Moines and is subject to certain limited
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board"). As the savings and loan holding company of the Bank, the
Company also is subject to federal regulation and oversight. The purpose of the
regulation of the Company and other holding companies is to protect subsidiary
savings associations. The Bank is a member of the Savings Association Insurance
Fund ("SAIF"), which together with the Bank Insurance Fund (the "BIF") are the
two deposit insurance funds administered by the FDIC, and the deposits of the
Bank are insured by the FDIC. As a result, the FDIC has certain regulatory and
examination authority over the Bank.
Certain of these regulatory requirements and restrictions are discussed
below or elsewhere in this document.
26
<PAGE>
Federal Regulation of Savings Associations. The OTS has extensive
authority over the operations of savings associations. As part of this
authority, the Bank is required to file periodic reports with the OTS and is
subject to periodic examinations by the OTS and the FDIC. The last regular OTS
and FDIC examinations of the Bank were as of December 31, 1997 and December 31,
1989, respectively. Under agency scheduling guidelines, it is likely that
another examination will be initiated in the near future. When these
examinations are conducted by the OTS and the FDIC, the examiners may require
the Bank to provide for higher general or specific loan loss reserves. All
savings associations are subject to a semi-annual assessment, based upon the
savings association's total assets, to fund the operations of the OTS. The
Bank's OTS assessment for the fiscal year ended June 30, 1998, was $27,000.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Bank and the Company.
This enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
In addition, the investment, lending and branching authority of the
Bank is prescribed by federal law, and it is prohibited from engaging in any
activities not permitted by such laws. For instance, no savings institution may
invest in non-investment grade corporate debt securities. In addition, the
permissible level of investment by federal associations in loans secured by
non-residential real property may not exceed 400% of total capital, except with
approval of the OTS. Federal savings associations are also generally authorized
to branch nationwide. The Bank is in compliance with the noted restrictions.
The Bank's general permissible lending limit for loans-to-one-borrower
is equal to the greater of $500,000 or 15% of unimpaired capital and surplus
(except for loans fully secured by certain readily marketable collateral, in
which case this limit is increased to 25% of unimpaired capital and surplus). At
June 30, 1998, the Bank's lending limit under this restriction was approximately
$906,000.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, asset quality, earnings standards, internal
controls and audit systems, interest rate risk exposure and compensation and
other employee benefits. Any institution which fails to comply with these
standards must submit a compliance plan. A failure to submit a plan or to comply
with an approved plan will subject the institution to further enforcement
action.
Insurance of Accounts and Regulation by the FDIC. Horizon Federal is a
member of the SAIF, which is administered by the FDIC. Deposits are insured up
to applicable limits by the FDIC and such insurance is backed by the full faith
and credit of the United States Government. As insurer, the FDIC imposes deposit
insurance premiums and is authorized to conduct examinations of and to require
reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured
institution from engaging in any activity the FDIC determines by regulation or
order to pose a
27
<PAGE>
serious risk to the SAIF of the BIF. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action, and may terminate the deposit insurance if it
determines that the institution has engaged in unsafe or unsound practices, or
is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions will be made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.
As is the case with the SAIF, the FDIC is authorized to adjust the
insurance premium rates for banks that are insured by the BIF of the FDIC in
order to maintain the reserve ratio of the BIF at 1.25% of BIF insured deposits.
As a result of the BIF reaching its statutory reserve ratio, the FDIC revised
the premium schedule for BIF insured institutions to provide a range of .04% to
.31% of deposits. The revisions became effective in the third quarter of 1995.
In addition, the BIF rates were further revised, effective January 1996, to
provide a range of 0% to .27%. The SAIF rates, however, were not adjusted. At
the time the FDIC revised the BIF premium schedule, it noted that, absent
legislative action (as discussed below), the SAIF would not attain its
designated reserve ratio until the year 2002. As a result, SAIF insured members
would continue to be generally subject to higher deposit insurance premiums than
BIF insured institutions until, all things being equal, the SAIF attained its
required reserve ratio.
In order to eliminate this disparity and any competitive disadvantage
between BIF and SAIF member institutions with respect to deposit insurance
premiums, legislation to recapitalize the SAIF was enacted in September 1996.
The legislation provides for a one-time assessment to be imposed on all deposits
assessed at the SAIF rates, as of March 31, 1995, in order to recapitalize the
SAIF. It also provided for the merger of the BIF and the SAIF on January 1, 1999
if no savings associations then exist. The special assessment rate was
established at .657% of deposits by the FDIC and the resulting assessment of
$331,000 was paid in November 1996. This special assessment significantly
increased noninterest expense and adversely affected the Company's and the
Bank's results of operations for the year ended June 30, 1997. As a result of
the special assessment, the Bank's deposit insurance premiums was reduced to
zero based upon its current risk classification and the new assessment schedule
for SAIF insured institutions. These premiums are subject to change in future
periods.
28
<PAGE>
Prior to the enactment of the legislation, a portion of the SAIF
assessment imposed on savings associations was used to repay obligations issued
by a federally chartered corporation to provide financing ("FICO") for resolving
the thrift crisis in the 1980s. Although the FDIC has proposed that the SAIF
assessment be equalized with the BIF assessment schedule, effective October 1,
1996, SAIF-insured institutions will continue to be subject to a FICO assessment
as a result of this continuing obligation. Although the legislation also now
requires assessments to be made on BIF-assessable deposits for this purpose,
effective January 1, 1997, that assessment will be limited to 20% of the rate
imposed on SAIF assessable deposits until the earlier of December 31, 1999 or
when no savings association continues to exist, thereby imposing a greater
burden on SAIF member institutions such as the Bank. Thereafter, however,
assessments on BIF-member institutions will be made on the same basis as
SAIF-member institutions. The rates to be established by the FDIC to implement
this requirement for all FDIC-insured institutions is uncertain at this time,
but are anticipated to be about a 6.5 basis points assessment on SAIF deposits
and 1.5 basis points on BIF deposits until BIF insured institutions participate
fully in the assessment.
Regulatory Capital Requirements. Federally insured savings
associations, such as the Bank, are required to maintain a minimum level of
regulatory capital. The OTS has established capital standards, including a
tangible capital requirement, a leverage ratio (or core capital) requirement and
a risk-based capital requirement applicable to such savings associations. These
capital requirements must be generally as stringent as the comparable capital
requirements for national banks. The OTS is also authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual preferred stock and related income. In addition, all
intangible assets, other than a limited amount of purchased mortgage servicing
rights, must be deducted from tangible capital for calculating compliance with
the requirement. At June 30, 1998, the Bank did not have any intangible assets
or purchased mortgage servicing rights.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. In determining compliance with the
capital requirements, all subsidiaries engaged solely in activities permissible
for national banks or engaged in certain other activities solely as agent for
its customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the association's level of ownership. For excludable
subsidiaries the debt and equity investments in such subsidiaries are deducted
from assets and capital. All subsidiaries of the Bank are includable
subsidiaries.
At June 30, 1998, the Bank had tangible capital of $6.5 million, or
7.3% of adjusted total assets, which is approximately $5.1 million above the
minimum requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets. Core capital generally consists of tangible capital plus
certain intangible assets, including a limited amount of purchased credit card
relationships. As a result of the prompt corrective action provisions discussed
below, however, a savings association must maintain a core capital ratio of at
least 4% to
29
<PAGE>
be considered adequately capitalized unless its supervisory condition is such to
allow it to maintain a 3% ratio. At June 30, 1998, the Bank had no intangibles
which were subject to these tests.
At June 30, 1998, the Bank had core capital equal to $6.5 million, or
7.3% of adjusted total assets, which is $3.8 million above the minimum leverage
ratio requirement of 3% as in effect on that date.
The OTS risk-based requirement requires savings associations to have
total capital of at least 8% of risk-weighted assets. Total capital consists of
core capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. The
OTS is also authorized to require a savings association to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At June 30, 1998, the Bank had no
capital instruments that qualify as supplementary capital, and $275,000 of
general loss reserves, which was less than 1.25% of risk-weighted assets.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. Horizon Federal had a
$9,000 exclusion from capital and assets at June 30, 1998.
In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet items, will be multiplied by a risk weight,
ranging from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk weight of 50% for prudently underwritten
permanent one- to four-family first lien mortgage loans not more than 90 days
delinquent and having a loan to value ratio of not more than 80% at origination
unless insured to such ratio by an insurer approved by the FNMA or FHLMC.
OTS regulations also require that every savings association with more
than normal interest rate risk exposure to deduct from its total capital, for
purposes of determining compliance with such requirement, an amount equal to 50%
of its interest-rate risk exposure multiplied by the present value of its
assets. This exposure is a measure of the potential decline in the net portfolio
value of a savings association, greater than 2% of the present value of its
assets, based upon a hypothetical 200 basis point increase or decrease in
interest rates (whichever results in a greater decline). Net portfolio value is
the present value of expected cash flows from assets, liabilities and
off-balance sheet contracts. The rule 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. Any savings association with less than $300 million in assets and a
total capital ratio in excess of 12% is exempt from this requirement unless the
OTS determines otherwise.
On June 30, 1998, the Bank had total capital of $6.7 million (including
$6.5 million in core capital and $275,000 in qualifying supplementary capital)
and risk-weighted assets of $51.1 million
30
<PAGE>
(including $1.9 million in converted off-balance sheet assets); or total capital
of 13.2% of risk-weighted assets. This amount was $2.6 million above the 8%
requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally defined
to be one with less than either a 4% core capital ratio, a 4% Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is authorized to impose the additional
restrictions that are applicable to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or
is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital
ratios of less than 3% or a risk-based capital ratio of less than 6%) must be
made subject to one or more of additional specified actions and operating
restrictions, which may cover all aspects of its operations and include a forced
merger or acquisition of the association. An association that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized associations. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings association, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized association is also
subject to the general enforcement authority of the OTS and the FDIC, including
the appointment of a conservator or a receiver.
The OTS is also generally authorized to reclassify an association into
a lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the
Company or the Bank may have a substantial adverse effect on the Company's
operations and profitability. Company shareholders do not have preemptive
rights, and therefore, if the Company is directed by the OTS or the FDIC to
issue additional shares of Common Stock, such issuance may result in the
dilution in the percentage of ownership of the Company.
Limitations on Dividends and Other Capital Distributions. OTS
regulations impose various restrictions on savings associations with respect to
their ability to make distributions of capital, which include dividends, stock
redemptions or repurchases, cash-out mergers and other transactions charged to
the capital account. OTS regulations also prohibit a savings association from
declaring or paying any dividends or from repurchasing any of its stock if, as a
result, the regulatory capital of the association would be reduced below the
amount required to be maintained for the liquidation account established in
connection with its mutual to stock conversion.
31
<PAGE>
Generally, savings associations, such as the Bank, that before and
after the proposed distribution meet their capital requirements, may make
capital distributions during any calendar year equal to the greater of 100% of
net income for the year-to-date plus 50% of the amount by which the lesser of
the association's tangible, core or risk-based capital exceeds its capital
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of their net income for the most recent four quarter
period. However, an association deemed to be in need of more than normal
supervision by the OTS may have its dividend authority restricted by the OTS.
Horizon Federal may pay dividends in accordance with this general authority.
Savings associations proposing to make any capital distribution need
only submit written notice to the OTS 30 days prior to such distribution.
Savings associations that do not, or would not meet their current minimum
capital requirements following a proposed capital distribution, however, must
obtain OTS approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period based on safety and soundness concerns.
See "- Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings association may make a
capital distribution without notice to the OTS (unless it is a subsidiary of a
holding company) provided that it has a CAMEL 1 or 2 rating, is not of
supervisory concern, and would remain adequately capitalized (as defined in the
OTS prompt corrective action regulations) following the proposed distribution.
Savings associations that would remain adequately capitalized following the
proposed distribution but do not meet the other noted requirements must notify
the OTS 30 days prior to declaring a capital distribution. The OTS stated it
will generally regard as permissible that amount of capital distributions that
do not exceed 50% of the institution's excess regulatory capital plus net income
to date during the calendar year. A savings association may not make a capital
distribution without prior approval of the OTS and the FDIC if it is
undercapitalized before, or as a result of, such a distribution. As under the
current rule, the OTS may object to a capital distribution if it would
constitute an unsafe or unsound practice. No assurance may be given as to
whether or in what form the regulations may be adopted.
Liquidity. All savings associations, including the Bank, are required
to maintain an average daily balance of liquid assets equal to a certain
percentage of the sum of their average daily balance of net withdrawable deposit
accounts and borrowings payable in one year or less. For a discussion of what
the Bank includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital Resources"
in the Annual Report. This liquid asset ratio requirement may vary from time to
time (between 4% and 10%) depending upon economic conditions and savings flows
of all savings associations. At the present time, the minimum liquid asset ratio
is 4%. Penalties may be imposed upon associations for violations of the liquid
asset ratio requirement. At June 30, 1998, the Bank was in compliance with this
requirement, with an overall liquid asset ratio of 10.4%.
Accounting. An OTS policy statement applicable to all savings
associations clarifies and re-emphasizes that the investment activities of a
savings association must be in compliance with approved and documented
investment policies and strategies, and must be accounted for in accordance with
GAAP. Under the policy statement, management must support its classification of
and accounting for loans and securities (i.e., whether held for investment, sale
or trading) with appropriate documentation. The Bank is in compliance with these
amended rules.
32
<PAGE>
OTS accounting regulations, which may be made more stringent than GAAP
by the OTS, require that transactions be reported in a manner that best reflects
their underlying economic substance and inherent risk and that financial reports
must incorporate any other accounting regulations or orders prescribed by the
OTS.
Qualified Thrift Lender Test. All savings associations, including the
Bank, are required to meet a qualified thrift lender ("QTL") test to avoid
certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. As an alternative, the savings association
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code of 1986, as amended (the "Code"). Such assets
primarily consist of residential housing related loans and investments. At June
30, 1998, the Bank met the test and has always met the test since its
effectiveness.
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "- Holding Company Regulation."
Community Reinvestment Act. Under the Community Reinvestment Act
("CRA"), every FDIC insured institution has a continuing and affirmative
obligation consistent with safe and sound banking practices to help meet the
credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the OTS, in connection with the examination of the Bank, to assess the
institution's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications, such as a
merger or the establishment of a branch, by the Bank. An unsatisfactory rating
may be used as the basis for the denial of an application by the OTS.
The federal banking agencies, including the OTS, have recently revised
the CRA regulations and the methodology for determining an institution's
compliance with the CRA. Due to the heightened attention being given to the CRA
in the past few years, the Bank may be required to devote additional funds for
investment and lending in its local community. The Bank was examined for CRA
compliance in December 1997 and received a rating of "satisfactory."
33
<PAGE>
Transactions with Affiliates. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain of these transactions, such as loans to an affiliate, are
restricted to a percentage of the association's capital. Affiliates of the Bank
include the Company and any company which is under common control with the Bank.
In addition, a savings association may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of most affiliates. The Bank's subsidiaries are not deemed affiliates; however,
the OTS has the discretion to treat subsidiaries of savings associations as
affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons
are also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation. The Company is a unitary savings and loan
holding company subject to regulatory oversight by the OTS. As such, the Company
is required to register and file reports with the OTS and is subject to
regulation and examination by the OTS. In addition, the OTS has enforcement
authority over the Company and its non-savings association subsidiaries which
also permits the OTS to restrict or prohibit activities that are determined to
be a serious risk to the subsidiary savings association.
As a unitary savings and loan holding company, the Company generally is
not subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company, and the activities of the Company and any of its
subsidiaries (other than the Bank or any other SAIF-insured savings association)
would become subject to such restrictions unless such other associations each
qualify as a QTL and were acquired in a supervisory acquisition.
If the Bank fails the QTL test, the Company must obtain the approval of
the OTS prior to continuing after such failure, directly or through its other
subsidiaries, any business activity other than those approved for multiple
savings and loan holding companies or their subsidiaries. In addition, within
one year of such failure, the Company must register as, and will become subject
to, the restrictions applicable to bank holding companies. The activities
authorized for a bank holding company are more limited than are the activities
authorized for a unitary or multiple savings and loan holding company. See
"--Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control
of any other SAIF-insured association. Such acquisitions are generally
prohibited if they result in a multiple savings and loan holding company
controlling savings associations in more than one state. However, such
interstate acquisitions are permitted based on specific state authorization or
in a supervisory acquisition of a failing savings association.
Federal Securities Law. The stock of the Company is registered with the
SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
The Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the SEC under the Exchange Act.
34
<PAGE>
Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain non-interest bearing reserves at specified
levels against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts). At June 30, 1998, the Bank was in compliance with these
reserve requirements. The balances maintained to meet the reserve requirements
imposed by the Federal Reserve Board may be used to satisfy liquidity
requirements that may be imposed by the OTS. See "--Liquidity."
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Des
Moines, which is one of 12 regional FHLBs that administer the home financing
credit function of savings associations. Each FHLB serves as a reserve or
central bank for its members within its assigned region. Each is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures, established by the board of directors of the FHLB,
which are subject to the oversight of the Federal Housing Finance Board. All
advances from the FHLB are required to be fully secured by sufficient collateral
as determined by the FHLB. In addition, all long-term advances are required to
provide funds for residential home financing.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Des Moines. At June 30, 1998, the Bank had $1.2 million in FHLB stock,
which was in compliance with this requirement. In past years, the Bank has
received substantial dividends on its FHLB stock. For the year ended June 30,
1998, dividends paid by the FHLB of Des Moines to Horizon Federal totaled
$78,000, compared to $47,000 received in fiscal 1997. The $20,800 dividend
received for the quarter ended June 30, 1998 reflects an annualized rate of 6.75
%, .25% below the rate for calendar 1997. Over the past five fiscal years such
dividends have averaged 7.39%.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of the Bank's FHLB stock may result in a corresponding
reduction in the Bank's capital.
35
<PAGE>
Federal and State Taxation
Federal Taxation. For years prior to 1997, savings associations such as
the Bank that meet certain definitional tests relating to the composition of
assets and other conditions prescribed by the Code, were permitted to establish
reserves for bad debts and to make annual additions thereto which may, within
specified formula limits, be taken as a deduction in computing taxable income
for federal income tax purposes. The amount of the bad debt reserve deduction
for "non-qualifying loans" was computed under the experience method. The amount
of the bad debt reserve deduction for "qualifying real property loans"
(generally loans secured by improved real estate) was computed under either the
experience method or the percentage of taxable income method (based on an annual
election). Under the experience method, the bad debt reserve deduction is an
amount determined under a formula based generally upon the bad debts actually
sustained by the savings association over a period of years.
The percentage of specially computed taxable income that is used to
compute a savings association's bad debt reserve deduction under the percentage
of taxable income method (the "percentage bad debt deduction") is 8%. The
percentage bad debt deduction thus computed is reduced by the amount permitted
as a deduction for non-qualifying loans under the experience method. The
availability of the percentage of taxable income method permits qualifying
savings associations to be taxed at a lower effective federal income tax rate
than that applicable to corporations generally (approximately 31.3% assuming the
maximum percentage bad debt deduction).
Under the percentage of taxable income method, the percentage bad debt
deduction cannot exceed the amount necessary to increase the balance in the
reserve for "qualifying real property loans" to an amount equal to 6% of such
loans outstanding at the end of the taxable year or the greater of (i) the
amount deductible under the experience method or (ii) the amount which when
added to the bad debt deduction for "non-qualifying loans" equaled the amount by
which 12% of the amount comprising savings accounts at year-end exceeds the sum
of surplus, undivided profits and reserves at the beginning of the year.
In August 1996, legislation was enacted that repealed the reserve
method of accounting (including the percentage of taxable income method which
was used in prior years) used by many thrifts to calculate their bad debt
reserve for federal income tax purposes. Thrift institutions with $500 million
or less in assets may, however, continue to use the experience method. As a
result, the Bank must recapture that portion of the reserve that exceeds the
amount that could have been taken under the experience method for post-1987 tax
years. At June 30, 1998, the Bank's post-1987 excess reserves amounted to
approximately $223,000. The recapture will be approximately $55,000 per year and
will occur over a six-year period which began in Fiscal 1997. The legislation
also requires thrift institutions to account for bad debts for federal income
tax purposes on the same basis as commercial banks for tax years beginning after
December 31, 1995. As a result, the Company computes its bad debt deduction on
the experience method.
In addition to the regular income tax, corporations, including savings
associations such as the Bank, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any
36
<PAGE>
available exemption. The alternative minimum tax is imposed to the extent it
exceeds the corporation's regular income tax and net operating losses can offset
no more than 90% of alternative minimum taxable income. For taxable years
beginning after 1986 and before 1996, corporations, including savings
associations such as the Bank, were also subject to an environmental tax equal
to 0.12% of the excess of alternative minimum taxable income for the taxable
year (determined without regard to net operating losses and the deduction for
the environmental tax) over $2 million.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the association's supplemental reserves
for losses on loans ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of June 30, 1998, the Bank's Excess for tax purposes totaled
approximately $1.3 million.
The Company, the Bank and its subsidiary file consolidated federal
income tax returns on a fiscal year basis using the accrual method of
accounting.
The federal income tax returns of the Company for the last three years
are open to possible audit by the Internal Revenue Service (the "IRS"). No
returns are being audited by the IRS at the current time. In the opinion of
management, any examination of still open returns (including returns of
subsidiary and predecessors of, or entities merged into, the Bank) would not
result in a deficiency which could have a material adverse effect on the
financial condition of the Bank and its subsidiary.
Iowa Taxation. Iowa imposes a franchise tax on the taxable income of
both mutual and stock savings banks. The tax rate is 5%, which may effectively
be increased, in individual cases, by application of a minimum tax provision.
Taxable income under the franchise tax is generally similar to taxable income
under the federal corporate income tax, except that, under the Iowa franchise
tax, no deduction is allowed for Iowa franchise tax payments and taxable income
includes interest on state and municipal obligations. Interest on U.S.
obligations is taxable under the Iowa franchise tax and under the federal
corporate income tax. For Iowa state tax purposes, the Company and SEI file
income tax returns and the Bank files a franchise tax return.
Delaware Taxation. As a Delaware holding company, the Company is
exempted from Delaware corporate income tax but is required to file an annual
report with and pay an annual fee to the State of Delaware. The Company is also
subject to an annual franchise tax imposed by the State of Delaware.
Competition
Horizon Federal faces strong competition, both in originating real
estate loans and in attracting deposits. Competition in originating real estate
loans comes primarily from commercial and savings banks, and to a lesser extent,
credit unions located in the Bank's market area. Commercial banks, savings
banks, credit unions and finance companies provide vigorous competition in
consumer lending. The Bank competes for real estate and other loans principally
on
37
<PAGE>
the basis of the quality of services it provides to borrowers, the interest
rates it charges, loan fees it charges, and the types of loans it originates.
See "- Lending Activities."
The Bank attracts all of its deposits through its retail banking
offices, primarily from the communities in which those retail banking offices
are located. Therefore, competition for those deposits is principally from
commercial banks, savings banks, credit unions and investment banking firms
located in these communities. The Bank competes for these deposits by offering a
variety of account alternatives at competitive rates and by providing convenient
business hours, branch locations and interbranch deposit and withdrawal
privileges at each.
The Bank serves Mahaska County and that portion of Marion County in and
around Knoxville, Iowa. There are nine commercial banks, two savings banks,
other than Horizon Federal, and three credit unions which compete for deposits
and loans in Horizon Federal's primary market area. The Bank estimates its share
of the savings market in its primary market area to be approximately 10%.
Employees
At June 30, 1998, the Bank had a total of 25 full-time and four
part-time employees. The Bank's employees are not represented by any collective
bargaining group. Management considers its employee relations to be good.
The following information as to the business experience during the past
five years is supplied with respect to executive officers of the Company and the
Bank who do not serve on the Company's Board of Directors. There are no
arrangements or understandings between the persons named and any other person
pursuant to which such officers were selected.
Sharon K. McCrea - Ms. McCrea, age 56, joined Horizon Federal in 1959,
as a teller, was appointed Assistant Treasurer in 1974 and promoted to Treasurer
and Comptroller of the Bank in 1979. Ms. McCrea is in charge of the accounting
department of the Bank.
Kent R. Frankenfeld - Mr. Frankenfeld, age 42, joined the Bank in
October 1994, as Vice President in charge of Marketing and Product Development.
Mr. Frankenfeld was the Vice President of a savings bank located in Des Moines,
Iowa prior to joining the Bank.
Item 2. Description of Property
The Bank conducts its business through its three offices, two of which
are located in Oskaloosa, Iowa and one in Knoxville, Iowa. The following table
sets forth information relating to each of the Bank's offices as of June 30,
1998. The total net book value of the Bank's premises and equipment (including
land, buildings and leasehold improvements and furniture, fixtures and
equipment) at June 30, 1998 was approximately $1.1 million. See Note 6 of Notes
to Consolidated Financial Statements in the Annual Report.
38
<PAGE>
<TABLE>
<CAPTION>
Total
Approximate
Date Square Net Book Value at
Location Acquired Footage June 30, 1998
-------- -------- ------- -------------
<S> <C> <C> <C>
Main Office:
301 First Avenue East 1964 4,230 $308,000
Oskaloosa, Iowa
Branch Offices:
509 A Avenue, West 1992 3,277 $603,000
Oskaloosa, Iowa
1022 West Pleasant Street 1979 1,598 $215,000
Knoxville, Iowa
</TABLE>
Horizon Federal believes that its current facilities are adequate to
meet the present and foreseeable needs of the Bank and the Company.
The Bank maintains an on-line data base with a service bureau servicing
financial institutions. The net book value of the data processing and computer
equipment utilized by the Bank at June 30, 1998 was approximately $106,000.
Item 3. Legal Proceedings
Horizon Federal is involved, from time to time, as plaintiff or
defendant in various legal actions arising in the normal course of their
businesses. While the ultimate outcome of these proceedings cannot be predicted
with certainty, it is the opinion of management, after consultation with counsel
representing Horizon Federal in the proceedings, that the resolution of these
proceedings should not have a material effect on Horizon Federal's results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders through the
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year ended June 30, 1998.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Page 41 of the attached 1998 Annual Report to Stockholders is
incorporated herein by reference.
39
<PAGE>
Item 6. Management's Discussion and Analysis or Plan of Operation
Pages 4 through 16 of the attached 1998 Annual Report to Stockholders
are incorporated herein by reference.
Item 7. Financial Statements
The following information appearing in the Company's 1998 Annual Report
to Stockholders for the year ended June 30, 1998, is incorporated herein by
reference.
Annual Report Section Pages in Annual Report
- --------------------- ----------------------
Independent Auditors' Report 17
Consolidated Balance Sheets as of June 30, 1998 and 1997 18
Consolidated Statements of Operations for the Years Ended
June 30, 1998, 1997 and 1996 19
Consolidated Statements of Stockholders' Equity for Years
Ended June 30, 1998, 1997 and 1996 20
Consolidated Statements of Cash Flows for Years Ended
June 30, 1998, 1997 and 1996 21
Notes to Consolidated Financial Statements 22 - 40
With the exception of the aforementioned information, the Company's
Annual Report to Stockholders for the year ended June 30, 1998, is not deemed
filed as part of this Annual Report on Form 10-KSB.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There has been no Current Report on Form 8-K filed within 24 months
prior to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Directors
Information concerning Directors of the Company is incorporated herein
by reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held in October 1998, a copy of which will be filed not later
than 120 days after the close of the fiscal year.
40
<PAGE>
Executive Officers
Information regarding the business experience of the executive officers
of the Company and the Bank contained in Part I of this Form 10-KSB is
incorporated herein by reference.
Compliance with Section 16(a)
Information concerning compliance with Section 16(a) of the Securities
Exchange Act of 1934 is incorporated herein by reference from the definitive
Proxy Statement for the Annual Meeting of Stockholders to be held in October
1998, a copy of which will be filed not later than 120 days after the close of
the fiscal year.
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by
reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held in October 1998, a copy of which will be filed not later
than 120 days after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owners and Management
Information concerning security ownership of certain beneficial owners
and management is incorporated herein by reference from the definitive Proxy
Statement for the Annual Meeting of Stockholders to be held in October 1998, a
copy of which will be filed not later than 120 days after the close of the
fiscal year.
Item 12. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions
is incorporated herein by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held in October 1998, a copy of which will
be filed not later than 120 days after the close of the fiscal year.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
See Index to Exhibits.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three-month
period ended June 30, 1998.
41
<PAGE>
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
Date: September 25, 1998 By: /s/ Robert W. DeCook
------------------- ---------------------
Robert W. DeCook, President and
Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Robert W. DeCook /s/ Thomas L. Gillespie
- -------------------- -----------------------
Robert W. DeCook, Director, President and Thomas L. Gillespie, Director and
Chief Executive Officer (Principal Vice President
Executive Officer)
Date: September 25, 1998 Date: September 25, 1998
------------------ ------------------
/s/ Gary L. Rozenboom /s/ Dwight L. Groves
- --------------------- --------------------
Gary L. Rozenboom, Director Dwight L. Groves, Director
Date: September 25, 1998 Date: September 25, 1998
------------------ ------------------
/s/ Norman P. Zimmerman /s/ Sharon K. McCrea
- ----------------------- --------------------
Norman P. Zimmerman, Director Sharon K. McCrea, Treasurer and
Comptroller, (Principal Financial
and Accounting Officer)
Date: September 25, 1998 Date: September 25, 1998
------------------ -------------------
42
<PAGE>
Index to Exhibits
Exhibit
Number Document
------ --------
3 The Articles of Incorporation and Bylaws, filed on March 18,
1994 as exhibits 3.1 and 3.2, respectively, to Registrant's
Registration Statement on Form S-1 (File No.
33-76674), are incorporated herein by reference.
4 Registrant's Specimen Stock Certificate, filed on March 18,
1994 as Exhibit 4 to Registrant's Registration Statement on
Form S-1 (File No. 33-76674), is incorporated herein by
reference.
10.1 Registrant's Employee Stock Ownership Plan, filed on March 18,
1994 as Exhibit 10.3 to Registrant's Registration Statement on
Form S-1 (File No. 33-76674), is incorporated herein by
reference.
10.2 Employment Agreements between the Bank and Messrs. DeCook and
Gillespie, filed as Exhibits 10.1 and 10.2, respectively, to
Registrant's Report on Form 10-KSB for the fiscal year ended
June 30, 1994 (File No. 0-24036), are incorporated herein by
reference.
10.3 1994 Stock Option and Incentive Plan, filed as Exhibit 10.3 to
Registrant's Report on Form 10-KSB for the fiscal year ended
June 30, 1994 (File No. 0-24036), is incorporated herein by
reference.
10.4 Recognition and Retention Plan, filed as Exhibits 10.4 to
Registrant's Report on Form 10-KSB for the fiscal year ended
June 30, 1994 (File No. 0-24036), is incorporated herein by
reference.
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule (electronic filing only)
43
- --------------------------------------------------------------------------------
1998 ANNUAL REPORT
- --------------------------------------------------------------------------------
[LOGO]
HORIZON FINANCIAL SERVICES
CORPORATION
<PAGE>
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
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
- --------------
</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>
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>
42
<TABLE>
<CAPTION>
Exhibit 21
SUBSIDIARIES OF THE REGISTRANT
Percentage State of
of Incorporation
Parent Subsidiary Ownership or Organization
------ ---------- --------- ---------------
<S> <C> <C> <C>
Horizon Financial Horizon Federal Savings 100% Federal
Services Corporation Bank
Horizon Federal Savings Horizon Investment 100% Iowa
Bank Services, Inc.
</TABLE>
The financial statements of Horizon Financial Services Corporation are
consolidated with those of its subsidiaries.
Exhibit 23
Consent of KPMG Peat Marwick LLP
The Board of Directors and Stockholders
Horizon Financial Services Corporation:
We consent to incorporation by reference in the Registration Statements
(No. 33-87030 and 33-94324) on Form S-8 of Horizon Financial Services
Corporation of our report dated July 29, 1998, relating to the 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
ended June 30, 1998, which report appears in the June 30, 1998 annual report on
Form 10-KSB of Horizon Financial Services Corporation and subsidiaries.
/s/KPMG Peat Marwick LLP
------------------------
KPMG Peat Marwick LLP
Des Moines, Iowa
September 25, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 6,367
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 23,922
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 55,996
<ALLOWANCE> 348
<TOTAL-ASSETS> 89,947
<DEPOSITS> 60,145
<SHORT-TERM> 20,038
<LIABILITIES-OTHER> 1,276
<LONG-TERM> 0
0
0
<COMMON> 10
<OTHER-SE> 8,478
<TOTAL-LIABILITIES-AND-EQUITY> 89,947
<INTEREST-LOAN> 4,745
<INTEREST-INVEST> 1,699
<INTEREST-OTHER> 300
<INTEREST-TOTAL> 6,744
<INTEREST-DEPOSIT> 2,764
<INTEREST-EXPENSE> 4,021
<INTEREST-INCOME-NET> 2,723
<LOAN-LOSSES> 94
<SECURITIES-GAINS> (167)
<EXPENSE-OTHER> 2,031
<INCOME-PRETAX> 906
<INCOME-PRE-EXTRAORDINARY> 906
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 589
<EPS-PRIMARY> 0.71
<EPS-DILUTED> 0.69
<YIELD-ACTUAL> 8.00
<LOANS-NON> 922
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 217
<ALLOWANCE-OPEN> 348
<CHARGE-OFFS> 97
<RECOVERIES> 3
<ALLOWANCE-CLOSE> 348
<ALLOWANCE-DOMESTIC> 348
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 26
</TABLE>
