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, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission file number 0-24036
HORIZON FINANCIAL SERVICES CORPORATION
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(Name of small business issuer in its charter)
Delaware 42-1419757
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
301 First Avenue East, Oskaloosa, Iowa 52577-0008
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (515) 673-8328
---------------------------
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. YES [X] NO [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained herein, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
State the issuer's revenues for its most recent fiscal year:
$4,659,289.
<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,
1999, was $5.6 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, 1999, there were issued and outstanding 875,062
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, 1999.
Part III of Form 10-KSB - Proxy Statement for the Annual Meeting of
Stockholders held in October 1999.
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, 1999, the Company had $85.0 million of assets and
stockholders' equity of $8.1 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 "-- Originations of Loans and
Mortgage-Backed Securities." At June 30, 1999, 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 Federal Home Loan Bank
("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.
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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 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, 1999, the apartment complex was 100% leased. At June 30, 1999, the
Company's equity investment in the project was $173,000, 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
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a current population of approximately 10,500 persons, is the county seat and the
largest city in Mahaska County. Oskaloosa has primarily an agricultural economy
and, to a lesser extent, light 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
experienced personnel as labor shortages in the area continue to exist.
Management believes that many of these individuals are seeking employment in
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 condition 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 five 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 for certain
budgeted amounts. 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, 1999, the Bank's net loan portfolio totaled $56.1
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
3
<PAGE>
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.
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, 1999, 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 $915,000, however, at June 30, 1999 the Board of
Directors of the Bank had a self-imposed $800,000 general limitation.
At June 30, 1999, the Bank had one group of loans to related borrowers
with outstanding balances in excess of the Board's self imposed limit but not in
excess of regulatory limits. The lending relationships totaled $892,000 and
consisted of a $748,000 commercial line of credit, four loans totaling $79,000
on commercial real estate, $43,000 on a single family residence and a $22,000
commercial loan. At June 30, 1999 all of the foregoing loans were performing in
accordance with their terms.
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,
---------------------------------------------------------------------------------------
1999 1998 1997
---------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
---------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family....................... $35,397 62.6% $34,266 60.1% $34,625 64.9%
Commercial real estate.................... 5,428 9.6 4,472 7.8 3,944 7.4
Multi-family.............................. 1,339 2.4 1,113 2.0 658 1.2
Residential construction ................. 152 .3 2,000 3.5 829 1.6
------- ----- ------- ----- -------- -----
Total real estate loans............... 42,316 74.9 41,851 73.4 40,056 75.1
------- ----- ------- ----- ------- -----
Other Loans:
Consumer Loans:
Automobile............................... 3,990 7.1 3,841 6.7 4,051 7.6
Home improvement......................... 1,047 1.8 3,150 5.5 2,353 4.4
Deposit account.......................... 149 .3 179 .3 222 .4
Other.................................... 2,099 3.7 2,320 4.1 1,541 2.9
------- ----- -------- ----- -------- -----
Total consumer loans.................. 7,285 12.9 9,490 16.6 8,167 15.3
Commercial business loans................. 6,872 12.2 5,682 10.0 5,124 9.6
------- ----- -------- ----- -------- -----
Total other loans..................... 14,157 25.1 15,172 26.6 13,291 24.9
------- ----- ------- ----- ------- -----
Total loans receivable, gross......... 56,473 100.0% 57,023 100.0% 53,347 100.0%
===== ===== =====
Less:
Loans in process.......................... --- 598 732
Deferred fees and discounts............... 64 81 74
Allowance for losses...................... 343 348 348
------- ------- -------
Total loans receivable, net............... $56,066 $55,996 $52,193
======= ======= =======
</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,
-----------------------------------------------------------------------------
1999 1998 1997
-----------------------------------------------------------------------------
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 ............................... $ 6,875 12.1% $ 5,125 9.0% $ 4,627 8.7%
Commercial real estate ............................ 1,058 1.9 1,246 2.2 1,015 1.9
Multi-family ...................................... 680 1.2 573 1.0 87 .1
Residential construction .......................... 152 .3 189 .3 -- --
------ ----- ------ ----- ------ -----
Total real estate loans ........................ 8,765 15.5 7,133 12.5 5,729 10.7
Consumer .......................................... 7,201 12.7 9,264 16.3 7,831 14.7
Commercial business ............................... 6,536 11.6 5,550 9.7 4,839 9.1
------ ----- ------ ----- ------ -----
Total fixed-rate loans ......................... 22,502 39.8 21,947 38.5 18,399 34.5
------ ----- ------ ----- ------ -----
Adjustable Rate Loans:
Real estate:
One- to four-family ............................... 28,522 50.5 29,141 51.1 29,998 56.2
Commercial real estate ............................ 4,370 7.7 3,226 5.7 2,929 5.5
Multi-family ...................................... 659 1.2 540 .9 571 1.1
Residential construction .......................... -- -- 1,811 3.2 829 1.6
------ ----- ------ ----- ------ -----
Total adjustable rate real estate loans......... 33,551 59.4 34,718 60.9 34,327 64.4
Consumer .......................................... 84 .2 226 .4 336 .6
Commercial business ............................... 336 .6 132 .2 285 .5
------ ----- ------ ----- ------ -----
Total adjustable rate loans .................... 33,971 60.2 35,076 61.5 34,948 65.5
------ ----- ------ ----- ------ -----
Total loans, receivable, gross ................. 56,473 100.0% 57,023 100.0% 53,347 100.0%
===== ===== =====
Less:
Loans in process.................................... --- 598 732
Deferred fees and discounts......................... 64 81 74
Allowance for loan losses........................... 343 348 348
------- ------- -------
Total loans receivable, net..................... $56,066 $55,996 $52,193
======= ======= =======
</TABLE>
6
<PAGE>
The following table illustrates the interest rate sensitivity of the
Bank's loan portfolio at June 30, 1999. 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>
2000(2).................... $10,735 7.72% $152 7.36% $1,322 9.13% $2,873 9.65% $15,082 8.21%
2001 to 2004............... 20,021 7.57 --- --- 4,760 9.37 3,288 8.45 28,069 7.98
2005 and following......... 11,408 8.19 --- --- 1,203 9.21 711 9.10 13,322 8.33
------- ---- ------ ------ -------
Total................... $42,164 7.78 $152 7.36% $7,285 9.30% $6,872 9.02% $56,473 8.12%
======= ==== ====== ====== =======
</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, 2000 which have
predetermined interest rates is $18.0 million, while the total amount of loans
due after such date which have floating or adjustable interest rates is $23.4
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, 1999, the Bank originated $6.6 million of adjustable-rate, one-
to four-family real estate loans and $7.4 million of fixed-rate one- to
four-family loans (including $220,000 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 30 years. Fixed-rate
mortgage loans originated by the Bank in excess of 15 years are generally sold
in the secondary market. The Bank originated $9.0 million of fixed rate loans
for sale during fiscal 1999.
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 five-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 48.1% of the loans secured by one- to four-family
real estate originated by the Bank during fiscal 1999 were originated with
adjustable rates of interest. See "--Originations of Loans and Mortgage-Backed
Securities."
At June 30, 1999, the Bank was not servicing any loans other than loans
it originated. As of June 30, 1999, the Bank's residential ARM loan portfolio
totaled $28.5 million, or 50.5% of the Bank's gross loan portfolio as compared
to the residential fixed-rate, mortgage loan portfolio which totaled $6.9
million, or 12.1% of the Bank's gross loan portfolio. ARM loans decrease the
risk 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
8
<PAGE>
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
five-year loans on one- to four-family residential property. Typically, the
spread between a one-year ARM and a five-year ARM has been 100 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 $4.8
million, $20.0 million and $12.0 million of mortgage-backed and related
securities during fiscal 1999, 1998 and 1997, 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, 1999, the Bank's construction
loan portfolio totaled $152,000, or .3% 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. 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,
1999, $1.3 million,
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<PAGE>
or 2.4%, of the Bank's gross loan portfolio consisted of multi-family loans and
$5.4 million, or 9.6%, 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, 1999, 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 $600,000. At such date the Bank had only five
commercial and multi-family real estate loans which exceeded $300,000 at June
30, 1999, 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
to 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 primary market area. At June 30,
1999, the Bank's consumer loans totaled $7.3 million, or 12.9% of the Bank's
gross loan portfolio.
10
<PAGE>
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, 1999, the outstanding balances on automobile loans and home
improvement totaled $4.0 million and $1.0 million, or 54.8% and 14.4% 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, 1999,
the Bank had $23,000 of credit card loans outstanding and $178,000 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, 1999, non-performing consumer loans totaled $186,000, or
2.6% 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.
The two largest commercial business loans outstanding at June 30, 1999
were a $753,000 business line of credit to a builder of one- to four-family
residential properties and a $748,000 business line of credit to a local
trucking firm. At June 30, 1999, these lines of credit were performing in
accordance with their repayment terms. The Bank had only four other commercial
11
<PAGE>
business loans in excess of $250,000 at June 30, 1999, 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, 1999 and 1998, the Bank's dollar volume of adjustable-rate real estate
loan originations and the dollar volume of the same type of fixed-rate loan
originations were approximately the same and for the year ended June 30, 1997
adjustable-rate real estate loans exceeded the dollar volume 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 1999, 1998 and 1997 the
Bank purchased $4.8, $20.2 million and $12.0 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 1999, 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. The Bank decreased its holdings of
collaterized mortgage obligations ("CMOs") during the fiscal year by primarily
selling CMOs that would increase the Bank's interest rate risk. This decrease of
the CMO portfolio resulted in placing interest rate risk within the Board's
policy guidelines by June 30, 1999. Pursuant to an agreement with the OTS, the
Bank intends to maintain a moderate interest rate risk position for its total
portfolio. See "Regulation -- Supervisory Agreement."
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,
--------------------------------------
1999 1998 1997
-------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
Originations by type:
Adjustable rate:
Real estate
- one- to four-family .............. $ 6,637 $ 11,089 $ 5,153
- multi-family ..................... 140 49 --
- commercial real estate ........... 1,415 719 664
- residential construction ......... -- 1,686 1,154
Non-real estate
- consumer ......................... 35 21 102
- commercial business .............. 125 -- --
-------- -------- --------
Total adjustable-rate ........ 8,352 13,564 7,073
-------- -------- --------
Fixed rate:
Real estate
- one- to four-family .............. 7,148 7,362 1,650
- multi-family ..................... 596 -- 23
- commercial real estate ........... 265 5,081 362
- residential construction ......... 220 951 212
Non-real estate
- consumer ......................... 6,099 10,698 5,676
- commercial business .............. 2,714 1,942 1,356
-------- -------- --------
Total fixed-rate ............. 17,042 26,034 9,279
-------- -------- --------
Total loans originated ....... 25,394 39,598 16,352
Total loan purchases .................. 60 -- --
Total loan sales ...................... (8,613) (6,077) (602)
Total loan repayments ................. (21,118) (29,526) (13,473)
Increase (decrease) in other items, net 4,347 (192) 812
-------- -------- --------
Net increase ................. $ 70 $ 3,803 $ 3,089
======== ======== ========
</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,
--------------------------------------
1999 1998 1997
-------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
Purchases:
Mortgage-backed and related securities $ 1,213 $ -- $ --
CMOs .................................. 3,565 20,236 12,259
-------- -------- --------
Total .......................... 4,778 20,236 $ 12,259
-------- -------- --------
Sales:
Mortgage-backed and related securities -- (2,209) (3,148)
CMOs .................................. (4,894) (15,617) (979)
-------- -------- --------
Total .......................... (4,894) (17,826) (4,127)
-------- -------- --------
Repayments:
Mortgage-backed and related securities (110) (126) (744)
CMOs .................................. (5,262) (3,806) (837)
Net Amortization MBS and CMOs ......... 18 421 (12)
Decrease in other items, net .......... (795) (1,676) (55)
-------- -------- --------
Net increase (decrease) ........ $ (6,265) $ (2,777) $ 6,592
======== ======== ========
</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, 1999. 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
----------------------------------------------------------------------------------------------------
Percent of Percent of Percent of
Loan Loan Amount Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ---------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family............ 14 $ 680 1.9% 6 $127 .4% 22 $ 755 2.1%
Multi-family................... -- -- -- -- -- -- -- -- --
Commercial real estate......... 3 149 2.8 1 20 .4 1 116 2.1
Consumer....................... 24 237 3.3 10 46 .6 29 186 2.5
Commercial business............ 2 7 .1 1 72 1.0 4 103 1.5
--- ------ --- ---- --- ------
Total..................... 43 $1,073 1.9% 18 $265 .5% 56 $1,160 2.1%
=== ====== === ==== === ======
<CAPTION>
Loans Delinquent For:
---------------------------------
Total
---------------------------------
Percent of
Loan
Number Amount Category
---------- ------ ----------
(Dollars in Thousands)
<S> <C> <C> <C>
Real Estate:
One- to four-family............ 42 $1,562 4.4%
Multi-family................... -- -- --
Commercial real estate......... 5 285 5.3
Consumer....................... 63 469 6.4
Commercial business............ 7 182 2.6
--- ------
Total..................... 117 $2,498 4.4%
=== ======
</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
becomes 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, 1999.
<TABLE>
<CAPTION>
At June 30,
--------------------------------
1999 1998 1997
------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C>
Non-accruing loans:
One- to four-family ................... $ 755 $ 691 $ 318
Commercial real estate ................ 116 -- 9
Consumer .............................. 186 180 130
Commercial business ................... 103 51 12
------ ------ ------
Total .............................. 1,160 922 469
------ ------ ------
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
Consumer .............................. -- -- 13
------ ------ ------
Total .............................. -- -- 356
------ ------ ------
Total non-performing assets ............. $1,160 $ 922 $1,045
====== ====== ======
Total as a percentage of total assets .. 1.36% 1.02% 1.22%
====== ====== ======
</TABLE>
For the fiscal year ended June 30, 1999, gross interest income which
would have been recorded had the non-accruing loans been current in accordance
with their original terms amounted to $134,000, of which $72,000 was included in
interest income at such date.
At June 30, 1999, there were no non-performing loans to a single
borrower or group of related borrowers in excess of $116,000. At June 30, 1999,
there were approximately $658,000 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.
Other Loans of Concern. In addition to the non-performing assets set
forth in the table above, as of June 30, 1999, there was also an aggregate of
$481,000 in net book value of loans ($80,000 secured by single family
residences, $401,000 secured by other commercial business and none 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 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.
16
<PAGE>
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,
1999, the Bank had classified a total of $950,000 of its assets as substandard,
none as doubtful and $18,000 as loss. All portions of a loan which are
classified as loss are reserved for at a rate of 100%.
At June 30, 1999, total classified assets comprised $968,000, or 12.0%
of the Bank's capital, or 1.14% 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, 1999, the
Bank had an allowance for loan losses of $343,000, or approximately .61% of
total loans. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Results of Operations -- Provision for Losses on
Loans" in the Annual Report.
17
<PAGE>
The following table sets forth an analysis of the Bank's allowance for
losses on loans.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------
1999 1998 1997
----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C>
Balance at beginning of period ...................... $ 348 $ 348 $ 318
Charge-offs:
One- to four-family ............................... (84) (16) (15)
Commercial real estate ............................ -- -- --
Commercial business ............................... (24) (51) (150)
Consumer .......................................... (60) (30) (62)
----- ----- -----
Total charge-offs ............................... (168) (97) (227)
----- ----- -----
Recoveries:
Commercial business ............................... 19 -- --
Consumer .......................................... 5 3 5
----- ----- -----
Total recoveries ................................ 24 3 5
----- ----- -----
Net charge-offs ..................................... (144) (94) (222)
Additions charged to operations ..................... 139 94 252
----- ----- -----
Balance at end of period ............................ $ 343 $ 348 $ 348
===== ===== =====
Ratio of net charge-offs during the period to average
loans outstanding during the period ................ .26% .17% .43%
===== ===== =====
</TABLE>
During the fiscal years ended June 30, 1999, 1998 and 1997, management
recorded provisions for loan losses of $139,000, $94,000 and $252,000,
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 the 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,
------------------------------------------------------------------
1999 1998 1997
------------------------------------------------------------------
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............. $ 69 62.6% $111 60.1% $116 64.9%
Multi-family.................... 3 2.4 3 2.0 2 1.2
Commercial real estate.......... 27 9.6 13 7.8 12 7.4
Residential construction........ 1 .3 3 3.5 2 1.6
Consumer........................ 91 12.9 111 16.6 103 15.3
Commercial business............. 138 12.2 81 10.0 95 9.6
Unallocated..................... 14 --- 26 --- 18 ---
---- ----- ---- ----- ---- -----
Total...................... $343 100.0% $348 100.0% $348 100.0%
==== ===== ==== ===== ==== =====
</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 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, 1999, the Bank's liquidity
ratio (liquid assets as a percentage of net withdrawable savings deposits and
current borrowings) was 11.5%. 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 U.S. 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.
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, 1999, the Bank's mortgage-backed and related securities totaled $13.4
million, or 15.7% 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, 1999 primarily 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, 1999 the Bank held $10.6 million of collateralized mortgage
obligations ("CMOs") having estimated lives which ranged from less than one year
up to 8 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 FHLB 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, 1999, 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,
---------------------------------------------------------------------
1999 1998 1997
---------------------------------------------------------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
---------------------------------------------------------------------
(Dollars in Thousands)
Investment Securities:
<S> <C> <C> <C> <C> <C> <C>
U.S. government securities.......................... $ --- ---% $ --- ---% $ 103 1.6%
Federal agency obligations.......................... 844 8.5 869 9.6 849 13.3
Small business administration loans................. 739 7.4 973 10.7 971 15.3
Equity securities(1)................................ 2,127 21.5 2,428 26.8 589 9.3
------- ----- ------- ----- ------- -----
Subtotal......................................... 3,710 37.4 4,270 47.1 2,512 39.5
FHLB stock............................................ 1,203 12.2 1,203 13.3 956 15.0
------- ----- ------- ----- ------- -----
Total investment securities and FHLB stock....... 4,913 49.6 5,473 60.4 3,468 54.5
Other Interest-Earning Assets:
Interest-bearing deposits with banks................ 5,000 50.4 3,581 39.6 2,890 45.5
------- ----- ------- ----- ------- -----
Total............................................ $ 9,913 100.0% $ 9,054 100.0% $ 6,358 100.0%
======= ===== ======= ===== ======= =====
Average remaining life or term to repricing of
investment securities and other interest-earning
assets excluding FNMA stock and FHLB stock........... 2.46 years 3.83 years 5.5 years
Mortgage-Backed and Related Securities:
CMOs................................................ $10,701 80.0% $11,723 59.7% $18,138 80.9%
FHLMC............................................... 606 4.5 667 3.4 704 3.1
FNMA................................................ --- --- --- --- 1,399 6.2
GNMA................................................ 1,126 8.4 --- --- 924 4.1
Other(2)............................................ 954 7.1 7,262 36.9 1,265 5.7
------- ----- ------- ----- ------- -----
Total mortgage-backed and related securities...... $13,387 100.0% $19,652 100.0% $22,430 100.0%
======= ===== ======= ===== ======= =====
</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, 1999
-------------------------------------------------------------------------------
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....... --- 444 400 --- 844 844
Small business administration
loans......................... --- --- --- 739 739 739
----- ----- ----- ------ ------ ------
Total..................... $ --- $444 $400 $739 $1,583 $1,583
===== ==== ==== ==== ====== ======
Weighted average yield........... ---% 3.52% 2.71% 7.88% 5.35% 5.35%
</TABLE>
The following table sets forth the contractual maturities of the Bank's
mortgage-backed and related securities at June 30, 1999; 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 1999
Less than Less than 5 Less than 10 Over Balance
One Year Years Years Years Outstanding
---------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
FHLMC............................... $ --- $ --- $ --- $ 606 $ 606
FNMA................................ --- --- --- --- ---
GNMA................................ --- --- --- 1,126 1,126
CMOs................................ --- 38 3,107 7,556 10,701
Other............................... --- --- 950 4 954
----- ----- ------ ------ -------
Total.............................. $ --- $ 38 $4,057 $9,292 $13,387
===== ===== ====== ====== =======
</TABLE>
At June 30, 1999, 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 U.S. 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
including CMO purchases. At June 30, 1999, the Bank had total FHLB advances of
$16.6 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.
23
<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,
--------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
--------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Transactions and Savings Deposits:
Commercial Demand........................... $ 1,061 1.8% $ 873 1.4% $ 1,964 3.4%
Checking Accounts (0.0% to 4.8%)............ 6,305 10.6 5,580 9.3 4,788 8.3
Savings Accounts (2.3% to 4.9%)............. 23,443 39.3 18,276 30.4 16,829 29.2
Money Market Accounts (2.0% to 2.5%)........ 463 .8 599 1.0 836 1.5
------- ------ ------- ------ ------- -----
Total Non-Certificates...................... 31,272 52.5 25,328 42.1% 24,417 42.4
------- ----- ------- ----- ------- -----
Certificates:
0.00 - 3.99%.............................. 11 .1 --- --- 52 .1
4.00 - 4.99%.............................. 10,251 17.1 3,016 5.0 5,354 9.3
5.00 - 5.99%.............................. 13,505 22.7 24,248 40.3 18,288 31.7
6.00 - 6.99%.............................. 4,360 7.2 6,891 11.5 7,359 12.7
7.00 - 7.99%.............................. 163 .2 553 .9 2,004 3.4
8.00 - 8.99%.............................. 6 .1 94 .1 160 .3
9.00% and above............................ 8 .1 15 .1 7 .1
-------- ----- ------- ------ -------- -----
Total Certificates.......................... 28,304 47.5 34,817 57.9 33,224 57.6
------- ----- ------- ----- ------- -----
Total Deposits.............................. $59,576 100.0% $60,145 100.0% $57,641 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
24
<PAGE>
The following table shows rate and maturity information for the Bank's
certificates of deposit as of June 30, 1999.
<TABLE>
<CAPTION>
0.00- 4.00- 5.00- 6.00- 7.00% Percent
3.99% 4.99% 5.99% 6.99% or more Total of Total
----- ----- ----- ----- ------- ----- --------
(Dollars in Thousands)
Certificate accounts maturing
in quarter ending:
- -----------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1999.................. --- 2,080 3,239 796 --- 6,115 21.60%
December 31, 1999................... --- 2,201 1,602 747 --- 4,550 16.08
March 31, 2000...................... --- 1,406 727 985 134 3,252 11.49
June 30, 2000....................... --- 1,378 2,024 1,001 30 4,433 15.66
September 30, 2000.................. 11 1,148 1,314 417 5 2,884 10.19
December 31, 2000................... --- 461 626 240 --- 1,338 4.73
March 31, 2001...................... --- 207 1,314 101 --- 1,622 5.73
June 30, 2001...................... --- 186 762 --- 8 956 3.38
Thereafter.......................... --- 1,184 1,897 73 --- 3,154 11.14
---- ------- ------- ------ ---- ------- ------
Total............................... $11 $10,251 $13,505 $4,360 $177 $28,304 100.0%
=== ======= ======= ====== ==== ======= =====
Percent of total................. .04% 36.22% 47.71% 15.40% .63% 100.0%
=== ===== ===== ===== === =====
</TABLE>
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, 1999.
<TABLE>
<CAPTION>
Maturity
-------------------------------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
-------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit of less
than $100,000.............................. $5,581 $3,651 $7,464 $ 9,420 $26,116
Certificates of deposit of
$100,000 or more........................... 234 749 221 534 1,738
Public funds(1)............................. 300 150 --- --- 450
------ ------ ------ ------- -------
Total certificates of
deposit.................................... $6,115 $4,550 $7,685 $ 9,954 $28,304
====== ====== ====== ======= =======
</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.
25
<PAGE>
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, 1999, the Bank had $16.6 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,
---------------------------------------------
1999 1998 1997
---------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C>
Maximum Balance:
FHLB advances........................................ $20,636 $25,060 $19,107
Average Balance:
FHLB advances........................................ $19,038 $22,276 $13,254
</TABLE>
26
<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,
----------------------------------------
1999 1998 1997
----------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C>
FHLB advances........................................ $16,606 $20,038 $19,102
======= ======= =======
Weighted average interest
rate of FHLB advances............................... 5.07% 5.24% 5.71%
</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,
1999, 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 $49,000. 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, 1999, HISI had
a net gain of $8,300.
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 U.S. government. Accordingly, the Bank is subject to broad federal
regulation and oversight extending to all of 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.
27
<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 April 19, 1999 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, 1999 was $32,000.
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, 1999, the Bank's lending limit under this restriction was approximately
$915,000.
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 U.S. 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 serious risk to the SAIF of the BIF. The FDIC also has the
authority to initiate enforcement actions against savings
28
<PAGE>
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 semi-annual
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 U.S. 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.
29
<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.
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, 1999, 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, 1999, the Bank had tangible capital of $5.8 million, or
6.9% of adjusted total assets, which is approximately $4.5 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 be considered adequately capitalized unless its supervisory
condition is such to allow it to maintain a 3% ratio. At June 30, 1999, the Bank
had no intangibles which were subject to these tests.
30
<PAGE>
At June 30, 1999, the Bank had core capital equal to $5.8 million, or
6.9% of adjusted total assets, which is $3.3 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, 1999, the Bank had no
capital instruments that qualify as supplementary capital, and $325,000 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, 1999.
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, 1999, the Bank had total capital of $6.1 million (including
$5.8 million in core capital and $325,000 in qualifying supplementary capital)
and risk-weighted assets of $48.4 million (including $794,000 in converted
off-balance sheet assets); or total capital of 12.6% of risk-weighted assets.
This amount was $2.2 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
31
<PAGE>
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.
Supervisory Agreement. The Bank was required to enter into a
Supervisory Agreement with the OTS on August 27, 1999. The Supervisory Agreement
generally required the Bank to (i) comply with specified federal laws and
regulations regarding management and financial policies, the establishment and
maintenance of records and interest-risk management policies and procedures and
to (ii) take certain corrective actions regarding the disposal of certain of the
Bank's securities classified as high-risk, the maintenance of at least a
moderate level of interest rate risk, the prior receipt of a "no objection" from
the OTS before the Bank buys, exchanges or otherwise changes positions with any
security it owns, and the development of loan underwriting policies and
procedures. In addition, the Bank is required to obtain prior written approval
of the OTS before it may pay any dividends to the holding company.
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
32
<PAGE>
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.
Generally, savings associations, such as the Bank, that before and
after the proposed distribution remain well-capitalized, may make capital
distributions during any calendar year equal to the greater of 100% of net
income for the year-to-date plus retained net income for the two preceding
years. However, an institution deemed to be in need of more than normal
supervision by the OTS may have its dividend authority restricted by the OTS.
The Bank 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 "Regulation -- Supervisory Agreement."
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, 1999, the Bank was in compliance with this
requirement, with an overall liquid asset ratio of 11.5%.
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.
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").
33
<PAGE>
Such assets primarily consist of residential housing related loans and
investments. At June 30, 1999, 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
impermissible 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 March 1998 and received a rating of "satisfactory."
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
34
<PAGE>
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.
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, 1999, 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."
35
<PAGE>
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, 1999, 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 years ended June 30,
1999 and 1998, dividends paid by the FHLB of Des Moines to Horizon Federal
totaled $77,000, and $78,000, respectively. The $18,700 dividend received for
the quarter ended June 30, 1999 reflects an annualized rate of 6.25%, .38% below
the rate for calendar 1998. Over the past five fiscal years such dividends have
averaged 7.05%.
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.
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
36
<PAGE>
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, 1999, the Bank's post-1987 excess reserves amounted to
approximately $167,000. The recapture will be approximately $56,000 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 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, 1999, 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.
37
<PAGE>
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 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, one savings bank, 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, 1999, the Bank had a total of 26 full-time and five
part-time employees. The Bank's employees are not represented by any collective
bargaining group. Management considers its employee relations to be good.
38
<PAGE>
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 57, 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 43, 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,
1999. 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, 1999 was approximately $1.1 million. See Note 6 of Notes
to Consolidated Financial Statements in the Annual Report.
<TABLE>
<CAPTION>
Total
Approximate
Date Square Net Book Value at
Location Acquired Footage June 30, 1999
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Main Office:
301 First Avenue East 1964 4,230 $307,000
Oskaloosa, Iowa
Branch Offices:
509 A Avenue, West 1992 3,277 575,000
Oskaloosa, Iowa
1022 West Pleasant Street 1979 1,598 207,000
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 in Oskaloosa,
Iowa, but some expansion of our Knoxville facility is being considered.
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, 1999 was approximately $140,000.
39
<PAGE>
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, 1999.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Page 44 of the attached 1999 Annual Report to Stockholders is
incorporated herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
Pages 4 through 16 of the attached 1999 Annual Report to Stockholders
are incorporated herein by reference.
Item 7. Financial Statements
The following information appearing in the Company's 1999 Annual Report
to Stockholders for the year ended June 30, 1999, is incorporated herein by
reference.
Annual Report Section Pages in Annual Report
- --------------------- ----------------------
Independent Auditors' Report 17
Consolidated Balance Sheets as of June 30, 1999 and 1998 18
Consolidated Statements of Operations for the Years Ended 19
June 30, 1999, 1998 and 1997
Consolidated Statements of Changes in Stockholders' Equity and 20
Comprehensive Income for Years Ended June 30, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for Years Ended 21
June 30, 1999, 1998 and 1997
Notes to Consolidated Financial Statements 22
40
<PAGE>
With the exception of the aforementioned information, the Company's
Annual Report to Stockholders for the year ended June 30, 1999, 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 1999, a copy of which will be filed not later
than 120 days after the close of the fiscal year.
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
1999, 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 1999, 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 1999, a
copy of which will be filed not later than 120 days after the close of the
fiscal year.
41
<PAGE>
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 1999, 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, 1999.
42
<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 28, 1999 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 Thomas L. Gillespie, Director and
and Chief Executive Officer Vice President
(Principal Executive Officer)
Date: September 28, 1999 Date: September 28, 1999
------------------ ------------------
/s/ Gary L. Rozenboom /s/ Dwight L. Groves
- --------------------------- ---------------------------
Gary L. Rozenboom, Director Dwight L. Groves, Director
Date: September 28, 1999 Date: September 28, 1999
------------------ ------------------
/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 28, 1999 Date: September 28, 1999
------------------ ------------------
43
<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 Annual 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 Annual 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 Annual 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
27 Financial Data Schedule (electronic filing only)
44
- --------------------------------------------------------------------------------
1999 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..............................................44
Corporate Information................................................45
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, 1999, 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 24, 1999
Dear Stockholder:
For many financial institutions, fiscal 1999 was a year of mixed results, some
good, some bad. Horizon Financial was no exception to this development, which
saw the stock prices of the financial institutions trend down as investors
concentrated their investing efforts on other segments of the economy, notably
high tech.
For Horizon Financial, and its principal operating subsidiary Horizon Federal
Savings Bank, the good news is that its core operations produced the second
highest net income after provision for loan losses in the last five fiscal
years, second only to the record-breaking results of fiscal 1998. Unfortunately,
Horizon Financial took a loss on its portfolio of securities available-for-sale.
The decline in value of these securities resulted from a sustained increase in
the prepayment speeds of the underlying mortgage loans. Most of these securities
held by the Company were sold during the fiscal year ending June 30, 1999.
Core earnings for the Company remained strong enough that the net worth only
decreased $427,000 from June 30, 1998 to June 30, 1999, approximately five
percent of the Company's net worth. Horizon Federal Savings Bank remains in full
compliance with regulatory capital requirements. At June 30, 1999, Horizon
Financial Services Corporation had assets of $85.0 million and stockholders
equity of $8.1 million or $9.21 per share of common stock.
We are further encouraged that future losses on the remaining portion of our
securities held for sale portfolio appear at this writing to be abating, and
that the Company expects to return to its historic profitability in the second
quarter of this fiscal year.
On behalf of all of us at Horizon Financial and Horizon Federal, we thank you
for your support of and your investment in Horizon Financial.
Yours very truly,
/s/Robert W. DeCook
Robert W. DeCook
President and Chief Executive Officer
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------------------
1999 1998(1) 1997(1) 1996(1) 1995(1)
-------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Selected Financial Condition Data:
Total assets..................................... $85,023 $89,947 $85,969 $73,464 $69,624
Cash and cash equivalents........................ 7,917 6,367 5,621 3,471 3,812
Securities available-for-sale.................... 17,097 23,922 24,942 18,049 5,170
Loans receivable, net............................ 56,066 55,996 52,193 49,104 46,478
Deposits......................................... 59,576 60,145 57,641 54,759 51,330
Advances from FHLB............................... 16,606 20,038 19,102 9,661 8,718
Stockholders' equity............................. 8,060 8,488 8,412 8,390 8,786
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------------
1999 1998(1) 1997(1) 1996(1) 1995(1)
-----------------------------------------------------------------
(In Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Selected Operations Data:
Total interest income.............................. $6,192 $6,744 $5,895 $5,454 $4,752
Total interest expense............................. 3,642 4,021 3,402 3,144 2,443
------- ------ ------ ------ ------
Net interest income.............................. 2,550 2,723 2,493 2,310 2,309
Provision for losses on loans...................... 139 94 252 328 2
------- ------ ------- ------- ------
Net interest income after
provision for losses on loans..................... 2,411 2,629 2,241 1,982 2,307
Noninterest income
Fees, commissions and service charges............ 497 448 338 345 238
Gain (loss) on sale of securities, net........... (2,038) (167) 81 39 ---
Other noninterest income......................... 8 27 19 94 23
------- ------ ------- ------- ------
Total noninterest income........................... (1,533) 308 438 478 261
Total noninterest expense.......................... 2,116 2,031 2,255(2) 1,886 1,904
------ ------ ------ ------ ------
(Loss), earnings before taxes on income............ (1,238) 906 424 573 664
Taxes on income (benefits)......................... (466) 317 146 197 245
------- ------ ------ ------ ------
Net (loss) earnings................................ $(772) $589 $278 $376 $419
====== ==== ==== ==== ====
Basic (loss) earnings per common share............. ($0.90) $ 0.71 $ 0.34 $ 0.43 $ 0.44
Diluted (loss) earnings per common share........... ($0.90) $ 0.69 $ 0.33 $ 0.42 $ 0.44
Dividends per share................................ $0.18 $ 0.18 $ 0.16 $ 0.16 $ 0.08
</TABLE>
- -------------------
(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,
-------------------------------------------------------
1999 1998 1997 1996 1995
-------------------------------------------------------
<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)......................................... (.88%) .67% .35(1) .53% .64%
Interest rate spread information:
Average during year..................................... 3.00 2.96 3.12 3.09 3.42
End of year............................................. 3.03 3.05 3.07 3.06 2.59
Net interest margin(2)................................... 3.17 3.23 3.41 3.44 3.82
Ratio of operating expense to average total
assets................................................. 2.42 2.31 2.83(1) 2.64 2.92
Return on stockholders' equity (ratio of net
earnings to average equity)............................ (9.33) 6.97 3.31(1) 4.38 4.82
Efficiency ratio(3)....................................... 69.26 63.51 67.51 68.61 74.09
Asset Quality Ratios:
Non-performing assets to total assets at end of
year(4)................................................. 1.36 1.02 1.22 1.27 1.06
Allowance for losses on loans to non-performing
loans(4)............................................... 29.57 37.74 50.51 34.01 39.27
Allowance for losses on loans to total loans............. .61 .61 .65 .63 .62
Other Ratios:
Stockholders' equity to total assets at end of
year.................................................... 9.48 9.44 9.78 11.42 12.62
Average stockholders' equity to average assets............ 9.46 9.61 10.54 12.00 13.34
Average interest-earning assets to average
interest-bearing liabilities........................... 103.79% 105.65% 106.13% 107.31% 109.88%
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 whose primary asset 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"). 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
business 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.
Forward-Looking Statement
When used in this Annual Report 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
4
<PAGE>
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
obligations, to revise any forward- looking statements to reflect the occurrence
of anticipated or unanticipated events or circumstances after the date of such
statements.
Financial Condition
June 30, 1999 Compared to June 30, 1998. Total assets decreased $4.9
million, or 5.5%, to $85.0 million at June 30, 1999 from $89.9 million at June
30, 1998. The decrease was reflected primarily in a $6.8 million decrease in
securities available-for-sale. This decrease was partially offset by a $1.5
million increase in cash and cash equivalents and a $500,000 increase in income
tax receivable. The decrease was used primarily to pay off $3.4 million in
advances from the Federal Home Loan Bank (the "FHLB") of Des Moines and a
decrease in deposits of $600,000.
Total liabilities decreased $4.5 million, or 5.5%, to $77.0 million at
June 30, 1999 from $81.5 million at June 30, 1998, primarily as a result of a
$3.4 million decrease in FHLB advances and a $600,000 decrease in deposits.
Stockholder's equity decreased $427,000, or 5.03%, during fiscal 1999,
primarily due to the net loss, the payment of cash dividends by the Company and
the repurchase of the Company's common stock. During fiscal 1999, the Company
paid cash dividends totaling approximately $154,000 or $.18 per share. Common
stock was repurchased during 1999 at a cost of $44,375, or $8.88 per share under
a repurchase program. The decrease in stockholder's equity was partially offset
by a positive adjustment of net unrealized losses on securities
available-for-sale and the amortization for the allocated portion of shares held
by the Employee Stock Ownership Plan (the "ESOP").
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, 1997. 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 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.
5
<PAGE>
Results of Operations
Comparison of Years Ended June 30, 1999 and June 30, 1998
General. Net earnings for the year ended June 30, 1999 decreased
$1,361,000 to a net loss of ($772,000) from $589,000 for the year ended June 30,
1998. This decrease was primarily attributable to substantial write-downs on
interest only mortgage-backed securities, as further described below, and losses
on the sale of available-for-sale assets.
During fiscal 1999, the Company's return on average assets ("ROAA") and
return on average stockholder's equity ("ROAE") was (.88%) and (9.33%),
respectively, compared to .67% and 6.97% for fiscal 1998. Average stockholders'
equity to average assets was 9.46% during fiscal year 1999 compared to 9.61%
during fiscal 1998. The Company paid cash dividends of $0.18 per share for
fiscals 1999 and 1998.
Interest Income. Interest income decreased $552,000 to $6.2 million for
the year ended June 30, 1999 compared to $6.7 million for the year ended June
30, 1998. The decrease was attributable primarily to a decrease in interest
earned on securities available-for-sale as a result of a decrease in the average
outstanding balance of these assets and to a lesser degree due to a decrease in
interest rates. Also contributing to the decrease was the reduction of interest
earned on loans receivable as a result of reduced interest rates for the period.
The average outstanding balance of securities available-for-sale decreased $4.4
million to $21.0 million during fiscal 1999. The yield on all average
interest-earning assets decreased during fiscal 1999 to 7.70% from 8.00% during
fiscal 1998.
Interest Expense. Interest expense decreased $379,000 to $3.6 million
for the year ended June 30, 1999 compared to $4.0 million for the year ended
June 30, 1998. The decrease in interest expense was primarily attributable to a
decrease in the average outstanding balance of FHLB advances, combined with
decreased rates paid on FHLB advances. The average rate paid on advances
decreased by 43 basis points to 5.26% during fiscal 1999 from 5.69% during
fiscal 1998. The average rate paid on all interest-bearing liabilities decreased
34 basis points to 4.70% during fiscal 1999 from 5.04% during fiscal 1998.
Net Interest Income. Net interest income decreased $173,000 to $2.5
million in fiscal 1999 from $2.7 million in fiscal 1998. The ratio of the
Company's average interest-earning assets to average interest-bearing
liabilities decreased to 103.79% during fiscal 1999 from 105.65% during fiscal
1998. During this same period the Company's interest rate spread increased
slightly to 3.00% from 2.96%.
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
allowance for losses on loans. During the year ended June 30, 1999, the Company
had a $139,000 addition to its allowance for losses on loans compared to a
$94,000 provision in fiscal 1998. The Company continues to monitor and adjust
its allowance 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 value. Future additions to the
Company's allowance for losses on loans and any change in the related ratio of
the allowance for losses on loan to non-performing loans are dependent upon the
economy, changes in real estate values and interest rates. In addition, federal
regulators may require additional reserves as a result of their examination of
the Company. The allowance for losses on loans reflects what the Company
currently believes is an adequate level of reserves, although there can be no
assurance that future losses will not exceed the estimated amounts, thereby
adversely affecting future results of operations. As of June 30, 1999 and June
30, 1998 the Company's allowance for losses on loans was $343,000 and $348,000,
respectively.
6
<PAGE>
As of June 30, 1999, the Company's non-performing assets, consisting of
nonaccuring loans, accruing loans 90 days or more delinquent, real estate owned
and repossessed consumer property, totaled $1,160,000 or 1.36% of total assets
compared to $922,000 or 1.02% of total assets at June 30, 1998. The increase in
non-performing assets related primarily to a $238,000 increase in non-accruing
loans past-due 90 or more days.
Noninterest Income. Noninterest income decreased $1.8 million to
$(1,533,000) for the year ended June 30, 1999 from $308,000 for the year ended
June 30, 1998. The decrease was primarily attributable to a $2.0 million loss on
securities available-for-sale (including a $1.5 million loss recognized on
interest only mortgage-backed securities). The write-downs on interest-only
mortgage-backed securities resulted 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, due to refinancing, of the underlying
mortgage loans as a result of the low interest rate environment. The Bank cannot
predict interest rates or prepayment speeds.
This decrease was slightly offset by a $49,000 increase in fees,
service charges and commission, due to increased fees received on checking
accounts and increased loan fees, primarily attributable to loans originated for
sale in the secondary market.
Noninterest Expense. Noninterest expense increased $86,000 to $2.1
million for the year ended June 30, 1999 from $2.0 million for the year ended
June 30, 1998. The increase was primarily due to a $38,000 increase in data
processing services and a $55,000 increase in other noninterest expense
primarily due to costs associated with the conversion to a new data center. The
conversion has permitted us to offer new services to our customers including
telephone banking.
The Company has incurred costs in connection with the assessment of,
and the documenting and remediation 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 procedures year
2000 ready ("Y2K") will result in material cost, it is expected that a
substantial amount of management and staff time will be required. The Company
currently expects to spend approximately $25,000 in connection with its year
2000 readiness efforts. It is impossible to predict the exact expenses
associated 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.
Income Tax Expense. Income taxes decreased $783,000 to ($467,000) for
the year ended June 30, 1999 from $317,000 for the same period in 1998. The
decrease was primarily due to a decrease in earnings before taxes on income.
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 $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.
7
<PAGE>
During fiscal 1998, the Company's ROAA and ROAE 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
available-for-sale 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. 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. As of June 30, 1998 and June 30, 1997 the
Company's allowances for losses on loans was $348,000.
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
8
<PAGE>
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.
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.
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 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. Like other financial institutions, the Company is
heavily dependent on their computer systems. Many of the information technology
and non-information technology systems of the Company are already Y2K ready, or
have been scheduled for replacement in on-going system plans. Attaining Y2K
readiness is an on-going process for the Company and the Bank. Management and
the Board of Directors are committed to achieving the goal of Y2K readiness.
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 has been assured by its
current 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. The Company and the Bank believes that they are taking
reasonable steps to address and remediate Y2K issues, especially with respect to
mission critical systems. The Company has received Y2K updates from most of its
material non-information system providers, including but not limited to security
cameras, credit/debit 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 Y2K issues.
While the Company and the Bank have undertaken significant efforts to
assess, remediate and test their technical systems to address Y2K processing
issues, they are also developing contingency plans. These contingency plans are
intended to provide alternative processes and actions in the event of systems
malfunction or failures. The Bank is required to follow Federal Financial
Institutions Examination Council guidance advising two levels of contingency
planning - remediation and business-resumption. Remediation contingency plans
address the actions to be taken if remediation efforts fall behind schedule or
appear in jeopardy of not delivering a Y2K ready system when required.
Business-resumption contingency plans address the actions that would be taken if
key business processes could not be performed in the normal manner upon entering
the Y2K due to system or third party failures. We have been communicating with
the Bank's vendors to assess their progress in evaluating their systems and
implementing any corrective 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
9
<PAGE>
implementation. The Company will continue to monitor the Y2K continuity progress
of such customers and third parties through 1999 and into 2000 and work
appropriately to address any problems which may arise.
The Company and the Bank have defined remediation contingency plan
requirements that are intended to provide alternative processes and actions to
address failed or unsuccessful remediation efforts. The first priority of the
Company and the Bank is their core processes and mission-critical systems.
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. The Company is aware there is a
potential for heavy currency demand by our customers which may occur in late
1999 and early 2000. The Company has addressed this issue in its contingency
plans.
10
<PAGE>
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,
-----------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------- ----------------------------- -----------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------- ---- --- ------- ---- ---- ------- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Loans receivable(1)................. $55,243 $4,597 8.32% $55,015 $4,745 8.63% $51,166 $4,408 8.62%
Securities available-for-sale....... 21,020 1,340 6.38 25,394 1,699 6.69 19,445 1,332 6.85
Other interest-earning assets....... 3,002 178 5.93 2,786 222 7.97 1,814 108 5.96
FHLB stock.......................... 1,203 77 6.40 1,143 78 6.82 666 47 7.03
-------- ------ ------- ------- ------- ------
Total interest-earning assets(1)... 80,468 6,192 7.70 84,338 6,744 8.00 73,091 5,895 8.06
------- ------ ------- ----- ------ -----
Interest-Bearing Liabilities:
Savings deposits.................... 19,938 857 4.30 17,118 743 4.34 15,829 701 4.43
Money market deposits............... 540 13 2.41 747 18 2.41 935 22 2.42
Demand and NOW deposits............. 6,905 132 1.91 5,863 104 1.77 5,371 93 1.66
Certificates of deposit............. 31,031 1,635 5.27 33,989 1,899 5.59 33,759 1,866 5.53
FHLB Advances....................... 19,115 1,005 5.26 22,109 1,257 5.69 12,978 720 5.54
-------- ------ -------- -------- ------- -------
Total interest-bearing liabilities $77,529 3,642 4.70 $ 79,826 4,021 5.04 $68,872 3,402 4.94
------- ------ -------- ------- ------- -------
Net interest income.................. $2,550 $2,723 $2,493
====== ====== ======
Net interest rate spread............. 3.00% 2.96% 3.12%
==== ====
Net interest-earning assets.......... $2,939 $ 4,512 $ 4,219
====== ======== =======
Net interest margin(2)............... 3.17% 3.23% 3.41%
==== ==== ====
Average interest-earning assets to
average interest-bearing liabilities 103.79% 105.65% 106.13%
====== ====== ======
</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.
11
<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,
------------------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
------------------------------------------------------------------------
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 ................................... $ 4 $(152) $(148) $ 408 $ (71) $ 337
Securities available-for-sale ...................... (275) (84) (359) 355 12 367
Other interest-earning assets ...................... (64) 20 (44) 107 7 114
FHLB Stock ......................................... -- (1) (1) 32 (1) 31
----- ----- ----- ----- ----- -----
Total interest-earning assets .................... $(335) $(217) $(552) $ 902 $ (53) $ 849
===== ===== ===== ===== -----
Interest-bearing liabilities:
Savings deposits ................................... 142 (28) 114 28 14 42
Money market deposits .............................. (5) -- (5) (3) (1) (4)
Demand and NOW deposits ............................ 36 (8) 28 (2) 13 11
Certificates of deposits ........................... (184) (80) (264) 40 (7) 33
FHLB advances ...................................... (212) (40) (252) 507 30 537
----- ----- ----- ----- ----- -----
Total interest-bearing liabilities ............... $(223) $(156) $(379) $ 570 $ 49 $ 619
===== ===== ----- ===== ===== -----
Net interest income..................... $(173) $ 230
===== =====
</TABLE>
12
<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,
-------------------------------------
1999 1998 1997
-------------------------------------
<S> <C> <C> <C>
Weighted average yield on:
Loans receivable, net(1) .................. 8.14% 8.54% 8.65%
Securities available-for-sale ............. 6.37 6.98 6.99
Other interest-earning assets ............. 4.85 5.54 5.45
FHLB stock ................................ 6.25 6.92 7.00
Combined weighted average yield on
interest-earning assets ................. 7.52 7.95 8.00
Weighted average rate paid on:
Savings deposits .......................... 4.17 4.42 4.24
Money market deposits ..................... 2.37 2.37 2.43
Demand and NOW deposits ................... 1.81 1.87 1.39
Certificates of Deposit ................... 5.12 5.57 5.62
FHLB advances ............................. 5.07 5.24 5.71
Combined weighted average rate paid
on interest-bearing liabilities ......... 4.49 4.90 4.93
Spread .................................... 3.03% 3.05% 3.07%
</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. The
Company also makes a small amount of longer term fixed rate mortgages for its
portfolio from time to time. 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.
13
<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, 1999 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.
14
<PAGE>
Presented below, as of June 30, 1999, 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
300 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 changes and the Bank's strong capital position.
Change in Board Limit At June 30,
Interest Rate (min NPV ratios) 1999
(Basis Points) % Change %Change
-------------- -------- -------
+300 5.00% 7.78%
+200 6.00 8.81
+100 6.75 9.62
0 6.75 10.11
-100 6.75 9.31
-200 6.00 8.23
-300 5.00 7.50
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. At June 30, 1999, the Bank's interest rate
risk was within the Board's prescribed guidelines.
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 requirement. The Bank's liquidity ratios were 11.5%, 10.4% and 7.1% at June
30, 1999, 1998 and 1997, 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, (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
15
<PAGE>
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, 1999, the Company had $1.4
million 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, 1999 totaled $18.3 million or 64.8% 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,
1999, the Company had outstanding borrowings of $16.6 million from the FHLB of
Des Moines and had the capacity to borrow up to approximately $21.7 million.
The primary investing activities of the Company include the origination
of loans and the purchase of mortgage-backed securities. At June 30, 1999, these
assets accounted for over 81.7% 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, 1999, the Bank had tangible and core capital of $5.8
million, or 6.9% of adjusted total assets, which was approximately $4.5 million
and $2.4 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, 1999, the Bank
had total risk-based capital of $6.1 million (including $5.8 million in core
capital), or 12.6% of risk-weighted assets of $48.4 million. This amount was
$2.2 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.
Effect of New Accounting Standards
Effective July 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income, SFAS No. 130 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.
Effective July 1, 1998, the Company adopted SFAS No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits. SFAS No. 132
revises the disclosure requirements for pension and other post-retirement
benefits plans.
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and SFAS No. 137, an amendment to SFAS No. 133 will be effective for
the Company beginning July 1, 2001. Management is evaluating the impact the
adoption of SFAS No. 133 and SFAS No. 137 will have on the Company's
consolidated financial statements and expects to adopt SFAS No. 133 and SFAS No.
137 when required.
16
<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, 1999 and
1998 and the related consolidated statements of operations, changes in
stockholders' equity and comprehensive income and cash flows for each of
the years in the three-year period ended June 30, 1999. 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, 1999 and
1998 and the results of their operations and their cash flows for each of
the years in the three-year period ended June 30, 1999, izzn conformity
with generally accepted accounting principles.
/s/KPMG LLP
Des Moines, Iowa
July 28, 1999, except for
note 17, which is as
of August 23, 1999
17
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, 1999 and 1998
Assets 1999 1998
------------ ------------
<S> <C> <C>
Cash and cash equivalents .................................... $ 7,917,020 6,366,619
Securities available-for-sale (note 2) ....................... 17,096,985 23,921,718
Loans receivable, net (notes 3 and 4) ........................ 56,066,399 55,996,418
Real estate (note 5) ......................................... 270,779 190,402
Stock in Federal Home Loan Bank, at cost ..................... 1,202,500 1,202,500
Office property and equipment, net (note 6) .................. 1,089,053 1,126,516
Accrued interest receivable (note 7) ......................... 522,121 683,120
Deferred tax asset (note 10) ................................. 254,000 405,541
Income tax receivable (note 10) .............................. 522,699 --
Prepaid expenses and other assets ............................ 81,646 53,911
------------ ------------
Total assets .................................... $ 85,023,202 89,946,745
============ ============
Liabilities and Stockholders' Equity
Deposits (note 8) ............................................ $ 59,576,232 60,144,866
Advances from Federal Home Loan Bank (note 9) ................ 16,606,176 20,038,174
Advance payments by borrowers for taxes and insurance ........ 399,830 407,050
Accrued income taxes ......................................... -- 291,492
Accrued expenses and other liabilities ....................... 380,617 577,343
------------ ------------
Total liabilities ............................... 76,962,855 81,458,925
------------ ------------
<PAGE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Stockholders' equity:
Preferred stock, $.01 par value; authorized 250,000 shares;
none issued ............................................ -- --
Common stock, $.01 par value; 1,500,000 shares authorized;
issued and outstanding 1,046,198 shares at 1999 and 1998 10,462 10,462
Additional paid-in capital ................................ 4,996,761 4,894,744
Retained earnings, substantially restricted (note 12) ..... 4,804,455 5,730,257
Treasury stock, at cost (171,136 and 166,256 shares in 1999
and 1998, respectively) ................................ (1,229,571) (1,185,924)
Unearned employee stock ownership plan shares (note 11) ... (65,503) (129,205)
Unearned recognition and retention plan shares (note 11) .. -- (11,439)
Accumulated other comprehensive income - net unrealized
loss on securities available for sale .................. (456,257) (821,075)
------------ ------------
Total stockholders' equity ...................... 8,060,347 8,487,820
Commitments and contingencies (notes 3 and 15)
------------ ------------
Total liabilities and stockholders' equity ...... $ 85,023,202 89,946,745
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended June 30, 1999, 1998, and 1997
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Interest income:
Loans ........................................................... $ 4,597,470 4,744,988 4,408,308
Investment securities available-for-sale ........................ 1,339,629 1,699,038 1,331,322
Other investment income ......................................... 255,272 300,494 154,960
----------- ----------- -----------
Total interest income ................................. 6,192,371 6,744,520 5,894,590
----------- ----------- -----------
Interest expense:
Deposits (note 8) ............................................... 2,636,943 2,763,850 2,682,335
Advance from Federal Home Loan Bank ............................. 1,005,569 1,257,447 719,415
----------- ----------- -----------
Total interest expense ................................ 3,642,512 4,021,297 3,401,750
----------- ----------- -----------
Net interest income ................................... 2,549,859 2,723,223 2,492,840
Provision for losses on loans (note 4) ............................. 138,540 94,000 252,110
----------- ----------- -----------
Net interest income after provision for losses on loans 2,411,319 2,629,223 2,240,730
----------- ----------- -----------
Noninterest income:
Fees, service charges and commissions ........................... 497,012 447,871 338,107
(Loss) gain on sale of securities, net .......................... (2,038,667) (166,959) 81,403
Other ........................................................... 8,573 26,731 18,629
----------- ----------- -----------
Total noninterest income (loss) ....................... (1,533,082) 307,643 438,139
----------- ----------- -----------
<PAGE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Noninterest expense:
Compensation, payroll taxes and employee benefits (note 11) ..... 1,210,041 1,237,633 1,051,597
Advertising ..................................................... 71,750 66,850 60,447
Office property and equipment ................................... 333,336 317,385 319,765
Federal insurance premiums and special assessments (note 13) .... 44,197 35,816 404,489
Data processing services ........................................ 155,169 117,090 108,337
Other real estate expense ....................................... 35,317 44,777 52,701
Other ........................................................... 266,798 211,231 257,741
----------- ----------- -----------
Total noninterest expense ............................. 2,116,608 2,030,782 2,255,077
----------- ----------- -----------
(Loss) earnings before taxes on income (benefit) ...... (1,238,371) 906,084 423,792
Taxes on income (benefit) (note 10) ................................ (466,600) 316,700 145,300
----------- ----------- -----------
Net (loss) earnings ................................... $ (771,771) 589,384 278,492
=========== =========== ===========
Basic (loss) earnings per common share ............................. $ (0.90) 0.71 0.34
=========== =========== ===========
Diluted (loss) earnings per common share ........................... $ (0.90) 0.69 0.33
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income
Years ended June 30, 1999, 1998, and 1997
Additional Unearned
Preferred Common paid-in Retained Treasury ESOP
stock stock capital earnings stock shares
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1996 ....................... $ -- 5,231 4,752,930 5,157,486 (1,022,921) (260,303)
Comprehensive income:
Net earnings .............................. -- -- -- 278,492 -- --
Unrealized gains (losses) on securities
available-for-sale .................... -- -- -- -- -- --
Less: reclassification adjustment for net
realized (gains) losses included in net
income, net of tax .................... -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Total comprehensive income ............ -- -- -- 278,492 -- --
---------- ---------- ---------- ---------- ---------- ----------
Dividends declared ($.16 per share)(1) ......... -- -- -- (130,032) -- --
Treasury stock acquired ........................ -- -- -- -- (337,354) --
ESOP shares allocated .......................... -- -- -- -- -- 66,505
Stock appreciation of allocated ESOP shares .... -- -- 42,470 -- -- --
Amortization of recognition and retention plan . -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Balance at June 30, 1997 ....................... -- 5,231 4,795,400 5,305,946 (1,360,275) (193,798)
Comprehensive income:
Net earnings .............................. -- -- -- 589,384 -- --
Unrealized gains (losses) on securities ...
available-for-sale .................... -- -- -- -- -- --
Less: reclassification adjustment for net
realized (gains) losses included in net
income, net of tax .................... -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Total comprehensive income ............ -- -- -- 589,384 -- --
---------- ---------- ---------- ---------- ---------- ----------
Dividends declared ($.18 per share) ............ -- -- -- (144,982) -- --
Two-for-one stock dividend ..................... -- 5,231 -- (5,231) -- --
Stock options exercised ........................ -- -- 94 (14,860) 174,351 --
ESOP shares allocated .......................... -- -- -- -- -- 64,593
Stock appreciation of allocated ESOP shares .... -- -- 99,250 -- -- --
Amortization of recognition and retention plan . -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Balance at June 30, 1998 ....................... -- 10,462 4,894,744 5,730,257 (1,185,924) (129,205)
Comprehensive income:
Net loss .................................. -- -- -- (771,771) -- --
Unrealized gains (losses) on securities ...
available-for-sale .................... -- -- -- -- -- --
Less: reclassification adjustment for net
realized (gains) losses included in net
income, net of tax .................... -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Total comprehensive income ............ -- -- -- (771,771) -- --
---------- ---------- ---------- ---------- ---------- ----------
Dividends declared ($.18 per share) ............ -- -- -- (153,963) -- --
Treasury stock acquired ........................ -- -- -- -- (44,375) --
Stock options exercised ........................ -- -- -- (68) 728 --
ESOP shares allocated .......................... -- -- -- -- -- 63,702
Stock appreciation of allocated ESOP shares .... -- -- 89,450 -- -- --
Tax benefit related
to non-qualified recognition and
retention plan ............................ -- -- 12,567 -- -- --
Amortization of recognition and retention plan . -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Balance at June 30, 1999 ....................... $ -- 10,462 4,996,761 4,804,455 (1,229,571) (65,503)
========== ========== ========== ========== ========== ==========
<PAGE>
<CAPTION>
Recognition Net unrealized
and gain (loss) on
retention securities available
plan for sale Total
---------- -------------------- ----------
<S> <C> <C> <C>
Balance at June 30, 1996 ....................... (83,871) (158,326) 8,390,226
Comprehensive income:
Net earnings .............................. -- -- 278,492
Unrealized gains (losses) on securities
available-for-sale .................... -- 96,175 96,175
Less: reclassification adjustment for net
realized (gains) losses included in net
income, net of tax .................... -- (30,037) (30,037)
---------- ---------- ----------
Total comprehensive income ............ -- 66,138 344,630
---------- ---------- ----------
Dividends declared ($.16 per share)(1) ......... -- -- (130,032)
Treasury stock acquired ........................ -- -- (337,354)
ESOP shares allocated .......................... -- -- 66,505
Stock appreciation of allocated ESOP shares .... -- -- 42,470
Amortization of recognition and retention plan . 36,216 -- 36,216
---------- ---------- ----------
Balance at June 30, 1997 ....................... (47,655) (92,188) 8,412,661
Comprehensive income:
Net earnings .............................. -- -- 589,384
Unrealized gains (losses) on securities ... --
available-for-sale .................... -- (969,183) (969,183)
Less: reclassification adjustment for net
realized (gains) losses included in net
income, net of tax .................... -- 240,296 240,296
---------- ---------- ----------
Total comprehensive income ............ -- (728,887) (139,503)
---------- ---------- ----------
Dividends declared ($.18 per share) ............ -- -- (144,982)
Two-for-one stock dividend ..................... -- -- --
Stock options exercised ........................ -- -- 159,585
ESOP shares allocated .......................... -- -- 64,593
Stock appreciation of allocated ESOP shares .... -- -- 99,250
Amortization of recognition and retention plan . 36,216 -- 36,216
---------- ---------- ----------
Balance at June 30, 1998 ....................... (11,439) (821,075) 8,487,820
Comprehensive income:
Net loss .................................. -- -- (771,771)
Unrealized gains (losses) on securities ... --
available-for-sale .................... -- (1,061,478) (1,061,478)
Less: reclassification adjustment for net
realized (gains) losses included in net
income, net of tax .................... -- 1,426,296 1,426,296
---------- ---------- ----------
Total comprehensive income ............ -- 364,818 (406,953)
---------- ---------- ----------
Dividends declared ($.18 per share) ............ -- -- (153,963)
Treasury stock acquired ........................ -- -- (44,375)
Stock options exercised ........................ -- -- 660
ESOP shares allocated .......................... -- -- 63,702
Stock appreciation of allocated ESOP shares .... -- -- 89,450
Tax benefit related
to non-qualified recognition and
retention plan ............................ -- -- 12,567
Amortization of recognition and retention plan . 11,439 -- 11,439
---------- ---------- ----------
Balance at June 30, 1999 ....................... -- (456,257) 8,060,347
========== ========== ==========
</TABLE>
(1) Restated to reflect the two-for-one stock split effected in the form of a
stock dividend on November 10, 1997.
See accompanying notes to consolidated financial statements.
20
<PAGE>
<TABLE>
<CAPTION>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended June 30, 1999, 1998, and 1997
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) earnings ........................................................ $ (771,771) 589,384 278,492
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation .......................................................... 147,461 147,585 163,658
Amortization of fees, premiums, and accretion of discounts, net ....... (7,636) (179,225) 23,807
Provision for losses on loans ......................................... 138,540 94,000 252,111
Loans originated for sale ............................................. (9,047,665) (6,478,320) (486,300)
Proceeds on sales of loans ............................................ 8,616,722 6,076,820 349,500
Amortization of stock compensation plans .............................. 177,158 200,059 145,191
Loss (gain) on sale of securities ..................................... 547,667 (308,041) (81,403)
Impairment losses on securities ....................................... 1,491,000 475,000 --
Gain on sale of fixed assets .......................................... (8,573) -- --
Decrease (increase) in accrued interest receivable .................... 160,999 (128,881) (40,610)
(Decrease) increase in accrued taxes payable and deferred taxes ....... (877,419) 178,216 43,576
Other, net ............................................................ (209,838) 271,281 115,687
------------ ------------ ------------
Net cash provided by operating activities ......................... 356,645 937,878 763,709
------------ ------------ ------------
Cash flows from investing activities:
Securities available-for-sale:
Purchases ............................................................... (6,413,852) (23,698,089) (12,835,616)
Proceeds from sale ...................................................... 6,739,179 18,838,215 4,434,596
Proceeds from maturity and principal collected .......................... 5,047,962 4,780,581 1,672,003
Loans to customers, net .................................................... 222,422 (3,495,633) (3,309,738)
Proceeds from sale of real estate .......................................... 5,000 360,288 65,233
Purchase of investment real estate ......................................... (100,000) -- --
Purchase of Federal Home Loan Bank stock ................................... -- (246,900) (396,800)
Proceeds from sale of fixed assets ......................................... 13,582 -- --
Purchase of office property and equipment, net ............................. (115,007) (192,088) (112,356)
------------ ------------ ------------
Net cash provided by (used in) investing activities ............... 5,399,286 (3,653,626) (10,482,678)
------------ ------------ ------------
Cash flows from financing activities:
Increase in customer deposit accounts, net ................................. (568,634) 2,503,494 2,882,405
(Decrease) increase in advance payments by borrowers for taxes and insurance (7,220) 6,387 14,391
Proceeds from advances from Federal Home Loan Bank ......................... 6,650,000 27,000,000 15,000,000
Principal payments on advances from Federal Home Loan Bank ................. (10,081,998) (26,063,359) (5,559,738)
Payment of dividends ....................................................... (153,963) (144,982) (130,031)
Exercise of stock options .................................................. 660 159,585 --
Treasury stock acquired .................................................... (44,375) -- (337,354)
------------ ------------ ------------
Net cash (used in) provided by financing activities ............... (4,205,530) 3,461,125 11,869,673
------------ ------------ ------------
Net increase in cash and cash equivalents ......................... 1,550,401 745,377 2,150,704
Cash and cash equivalents at beginning of year ................................ 6,366,619 5,621,242 3,470,538
------------ ------------ ------------
Cash and cash equivalents at end of year ...................................... $ 7,917,020 6,366,619 5,621,242
============ ============ ============
Supplemental disclosures of cash flow information:
Cash paid for interest ..................................................... $ 3,752,446 3,794,411 3,336,641
Cash paid for taxes ........................................................ 415,750 91,102 134,941
Transfers of loans to real estate acquired through foreclosures ............ -- -- 105,330
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
(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, 1999, the
requirements were met, and management anticipates meeting the
requirements at June 30, 2000.
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 $5,000,000 and $3,581,000 at June 30, 1999
and 1998, respectively.
22
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
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, 1999, 1998, and 1997 are shown in table below.
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Net (loss) earnings ...................... $(771,771) 589,384 278,492
========= ========= =========
Weighted average common shares outstanding 879,151 862,720 863,442
Less - unearned ESOP shares .............. (18,768) (31,279) (44,502)
--------- --------- ---------
Weighted average common
shares - basic ............ 860,383 831,441 818,940
Assumed incremental common shares issued
upon exercise of stock options ........ -- 29,425 24,410
--------- --------- ---------
Weighted average common
shares - diluted .......... 860,383 860,866 843,350
========= ========= =========
</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 separate component of other comprehensive income until
realized. 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.
23
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
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.
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.
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 in real estate represents a limited partnership interest in a
low income housing apartment complex, and a 50% partnership interest in
a retail mall. The investments are carried at cost, adjusted for
earnings and losses of the limited partnerships.
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.
24
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
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.
Treasury Stock
Treasury stock is accounted for by the cost method, whereby shares of
common stock reacquired are recorded at their purchase price.
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.
25
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
Stock Option Plan
The Company has adopted the provisions of Statement of Financial
Accounting Standards (SFAS) No. 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 No. 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 No. 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
No. 123.
Fair Value of Financial Instruments
The Company's fair value estimates, methods and assumptions for its
financial instruments are set forth below:
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.
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.
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.
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.
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.
26
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
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.
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.
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
Effective July 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. SFAS No. 130 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.
Effective July 1, 1998, the Company adopted SFAS No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits. SFAS No.
132 revises the disclosure requirements for pension and other
postretirement benefit plans.
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and SFAS No. 137, an amendment to SFAS No. 133 will be
effective for the Company beginning July 1, 2001. Management is
evaluating the impact the adoption of SFAS No. 133 and SFAS No. 137 will
have on the Company's consolidated financial statements and expects to
adopt SFAS No. 133 and SFAS No. 137 when required.
27
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
(2) Securities Available-for-sale
Securities available-for-sale at June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Fair
Description cost gains losses value
- ------------------------------------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1999:
FHLB bonds - due beyond one year,
but within ten years ................................. $ 500,000 -- 56,250 443,750
FHLB bonds - due beyond five years,
but within ten years ................................. 500,000 -- 100,000 400,000
Small Business Administration guaranteed
loan participation certificates ...................... 731,356 7,336 -- 738,692
Mortgage-backed and related securities:
Mortgage-backed securities ........................... 1,774,515 -- 42,370 1,732,145
Collateralized mortgage obligations .................. 10,807,364 87,223 193,564 10,701,023
Mutual funds ............................................ 1,127,365 -- 2,216 1,125,149
Equity securities ....................................... 1,133,606 6,550 138,103 1,002,053
----------- ----------- ----------- -----------
16,574,206 101,109 532,503 16,142,812
Stripped mortgage-backed securities:
Principal only ....................................... 8,478 -- 4,041 4,437
Interest only ........................................ 1,246,544 -- 296,808 949,736
----------- ----------- ----------- -----------
$17,829,228 101,109 833,352 17,096,985
=========== =========== =========== ===========
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
=========== =========== =========== ===========
</TABLE>
28
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
Sales of securities available-for-sale resulted in the following for the
three years ended June 30:
1999 1998 1997
---------- ---------- ----------
Proceeds ....................... $6,739,179 18,838,215 4,434,596
Gross realized gains ........... 166,347 330,031 87,499
Gross realized losses .......... 714,014 21,990 6,096
========== ========== ==========
During 1999 and 1998, the Company recognized write downs of $1,491,000
and $475,000, respectively, on interest only strip mortgage-backed
securities 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 and Collateralized Mortgage Obligations.
At June 30, 1999, certain securities available-for-sale with a fair
value of approximately $8,349,000 were pledged as collateral for public
funds deposits.
29
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
(3) Loans Receivable
At June 30, 1999 and 1998, loans receivable consisted of the following:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Residential real estate loans:
One-to-four-family ........................ $34,428,507 33,728,158
One-to four-family held for sale .......... 969,243 538,300
Multifamily ............................... 1,338,804 1,112,894
Construction .............................. 151,809 1,999,818
----------- -----------
36,888,363 37,379,170
Commercial real estate loans ................. 5,427,615 4,471,829
----------- -----------
Total real estate ............... 42,315,978 41,850,999
----------- -----------
Consumer loans:
Automobile ................................ 3,990,454 3,840,944
Home improvement .......................... 1,047,558 3,150,311
Deposit accounts .......................... 148,990 178,883
Other ..................................... 2,098,553 2,319,831
----------- -----------
Total consumer .................. 7,285,555 9,489,969
----------- -----------
Commercial business loans .................... 6,871,944 5,682,429
----------- -----------
56,473,477 57,023,397
Less:
Loans in process .......................... -- 597,825
Deferred fees and discounts ............... 64,088 80,681
Allowance for losses on loans ............. 342,990 348,473
----------- -----------
$56,066,399 55,996,418
=========== ===========
</TABLE>
At June 30, 1999, the Bank had committed to originate $1,440,460 of
fixed and variable rate loans. In addition, the Bank had customers with
unused lines of credit totaling $1,510,000 at June 30, 1999.
At June 30, 1999 and 1998, the Bank had nonaccrual loans of $1,161,000
and $922,000, respectively. The allowance for losses on loans related to
these impaired loans was approximately $97,000 and $90,000,
respectively. The average balances of such loans for the years ended
June 30, 1999, 1998, and 1997, were $1,192,000, $745,000, and $523,000,
respectively. For the years ended June 30, 1999, 1998, and 1997,
interest income which would have been recorded under the original terms
of such loans was approximately $133,853, $96,000, and $57,000,
respectively, and interest income actually recorded amounted to
approximately $72,000, $48,000, and $37,000, respectively.
30
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
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, 1999 and 1998 were as follows:
1999 1998
--------- ---------
Balance at beginning of year ............... $ 285,074 192,106
Advances ................................... -- 111,000
Repayments ................................. (211,176) (18,032)
--------- ---------
Balance at end of year ..................... $ 73,898 285,074
========= =========
(4) Allowance for Losses on Loans
Following is a summary of the allowance for losses on loans for the
three years ending June 30, 1999:
1999 1998 1997
--------- --------- ---------
Balance at beginning of year ...... $ 348,474 348,028 317,645
Provision for losses .............. 138,540 94,000 252,111
Charge-offs ....................... (168,549) (96,388) (226,701)
Recoveries ........................ 24,525 2,834 4,973
--------- --------- ---------
Balance at end of year ............ $ 342,990 348,474 348,028
========= ========= =========
(5) Real Estate
Following is a summary of real estate as of June 30, 1999 and 1998:
1999 1998
-------- --------
Real estate acquired through foreclosure ......... $ -- --
Real estate acquired for investment .............. 270,779 190,402
-------- --------
$270,779 190,402
======== ========
There were no allowances for losses on real estate for the years ended
June 30, 1999, 1998, and 1997, respectively.
31
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
(6) Office Property and Equipment
At June 30, 1999 and 1998, the cost and accumulated depreciation of
office property and equipment were as follows:
1999 1998
---------- ----------
Land ......................................... $ 216,595 216,595
Office buildings ............................. 1,092,164 1,106,698
Furniture, fixtures and equipment ............ 1,154,698 1,098,418
Automobile ................................... 18,883 20,363
---------- ----------
2,482,340 2,442,074
Less accumulated depreciation ................ 1,393,287 1,315,558
---------- ----------
$1,089,053 1,126,516
========== ==========
(7) Accrued Interest Receivable
At June 30, 1999 and 1998, accrued interest receivable consisted of the
following:
1999 1998
-------- --------
Loans receivable ............................. $433,651 498,063
Securities available-for-sale ................ 88,470 185,057
-------- --------
$522,121 683,120
======== ========
(8) Deposits
Deposit account balances at June 30, 1999 and 1998 are summarized as
follows:
1999 1998
----------- -----------
Balance by account type:
Savings ............................... $23,442,674 18,275,661
Money market .......................... 462,859 598,734
Demand and NOW ........................ 7,366,239 6,453,159
Certificates of deposit ............... 28,304,460 34,817,312
----------- -----------
$59,576,232 60,144,866
=========== ===========
The aggregate amount of certificates of deposit with a minimum
denomination of $100,000 was approximately $2,188,000 and $5,994,000 at
June 30, 1999 and 1998, respectively.
32
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
At June 30, 1999, scheduled maturities of certificates of deposit were
as follows:
2000 $18,349,723
2001 6,799,876
2002 2,080,352
2003 570,277
2004 and thereafter 504,232
-----------
$28,304,460
===========
Interest expense on deposits is summarized as follows:
Years ended June 30,
------------------------------------------
1999 1998 1997
---------- ---------- ----------
Savings ........................ $ 950,097 742,894 701,023
Money market ................... 12,745 17,843 22,275
Demand and NOW ................. 131,810 104,480 93,254
Certificates of deposit ........ 1,542,291 1,898,633 1,865,783
---------- ---------- ----------
$2,636,943 2,763,850 2,682,335
========== ========== ==========
At June 30, 1999 and 1998, accrued interest payable on deposits totaled
$248,686 and $355,860, respectively.
(9) Advances from FHLB
Advances from FHLB at June 30, 1999 and 1998, were as follows:
<TABLE>
<CAPTION>
1999 1998
---------------------------------- -------------------------------
Weighted- Weighted-
average average
Amount rates Amount rates
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Advance maturity:
Within one year:
Variable $ -- -- $ 6,000,000 various
Fixed 870,712 5.50% 937,912 5.90%
Beyond one year, but within
five years - Fixed 1,100,263 4.93 100,262 5.80
Beyond five years, but within
ten years - Fixed 14,200,000 5.02 13,000,000 5.03
Beyond ten years, but within
fifteen years - Fixed 435,201 5.50 -- --
------------ ------------
$16,606,176 $20,038,174
============ ============
</TABLE>
33
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
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.
(10) Taxes on Income
Taxes on income for the years ended June 30, 1999, 1998, and 1997, were
as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------------- ------------------------------- -------------------------------
Federal State Total Federal State Total Federal State Total
---------- --------- ----------- --------- --------- ---------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Current $(437,600) (92,000) (529,600) 229,700 65,000 294,700 121,300 24,000 145,300
Deferred 49,000 14,000 63,000 19,000 3,000 22,000 -- -- --
---------- --------- ----------- --------- --------- ---------- --------- --------- ----------
$(388,600) (78,000) (466,600) 248,700 68,000 316,700 121,300 24,000 145,300
========== ========= =========== ========= ========= ========== ========= ========= ==========
</TABLE>
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:
Years ended June 30,
------------------------------
1999 1998 1997
-------- -------- --------
Federal income tax rate .................... (34.0%) 34.0 34.0
Items affecting federal income tax rate:
State tax, net of federal benefit ....... (4.2) 4.9 3.7
Low income housing tax credits .......... (3.4) (4.6) (9.9)
Other, net .............................. 3.9 0.7 6.5
-------- -------- --------
(37.7%) 35.0 34.3
======== ======== ========
34
<PAGE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at June
30, 1999 and 1998 are presented below:
1999 1998
-------- --------
Deferred tax assets:
Accrued expenses not deducted ..................... $ 30,000 37,000
Unrealized losses on securities
available-for-sale ............................. 274,000 489,000
State net operating loss .......................... 13,000 6,000
Loan loss allowance ............................... 66,000 1,000
Other, net ........................................ -- 9,000
-------- --------
Total gross deferred tax assets ......... 383,000 542,000
-------- --------
Deferred tax liabilities:
FHLB stock dividends .............................. 57,000 57,000
Accrued interest receivable not taxed ............. 3,000 8,000
Deferred loan fees ................................ 69,000 71,000
Loan loss allowance ............................... -- --
-------- --------
Total gross deferred tax liabilities .... 129,000 136,000
-------- --------
Net deferred tax assets ................. $254,000 406,000
======== ========
There was no valuation allowance for deferred tax assets during the
years ended June 30, 1999, 1998, and 1997.
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.
(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 benefit
cost accrued.
35
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
The following table sets forth the plan's funded status and amounts
recognized in the consolidated financial statements at June 30, 1999 and
1998:
1999 1998
----------- -----------
Change in Benefit Obligaiton:
Benefit Obligation at Beginning of Year ....... $ 1,044,684 981,480
Service Cost .................................. 67,394 61,554
Interest Cost ................................. 65,293 59,256
Actuarial (Gain)/Loss ......................... 211,129 (22,287)
Benefits Paid ................................. -- (35,319)
----------- -----------
Benefit Obligation at End of Year ............. $ 1,388,500 1,044,684
=========== ===========
Change in Plan Assets:
Fair Value of Plan Assets at Beginning of Year $ 1,048,560 829,431
Actual Return on Plan Assets .................. 49,309 179,902
Employer Contributions ........................ 91,409 74,546
Benefits Paid ................................. -- (35,319)
----------- -----------
Fair Value of Plan Assets and End of Year ..... $ 1,189,278 1,048,560
=========== ===========
Reconciliation of Funded Status:
Funded Status (Underfunded)/Overfunded ........ $ (199,222) 3,876
Unrecognized Net Actuarial (Gain)/Loss ........ 161,153 (84,836)
Unrecognized Transition (Asset)/Obligation .... (14,825) (16,586)
----------- -----------
Accrued Benefit Cost .......................... $ (52,894) (97,546)
=========== ===========
36
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
The Net Periodic Benefit Cost for the years ending June 30, 1999, 1998,
and 1997 includes the following components:
<TABLE>
<CAPTION>
Years ended June 30,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Components of Net Periodic Benefit Cost:
Service Cost ................................ $ 67,394 61,554 55,038
Interest Cost ............................... 65,293 59,256 54,529
Expected Return on Plan Assets .............. (84,169) (63,749) (50,232)
Amortization of Transition (Asset)/Obligation (1,761) (1,761) (1,761)
-------- -------- --------
Net Periodic Benefit Cost ......... $ 46,757 55,300 57,574
======== ======== ========
</TABLE>
1999 1998
---- ----
Discount Rate 5.75% 6.25%
Expected Long Term Rate of Return 8.25% 7.75%
Weighted Average Rate of Compensation Increase 5.09% 5.13%
Amortization Method Straight-Line Straight-Line
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, 1999 and 1998, 66,168 and 56,197 shares, respectively, were
committed to be released, and the fair value of the 11,498 and 23,251
unearned shares was approximately $96,000 and $360,000. ESOP expense was
$153,154, $163,843, and $108,973 for the years ended June 30, 1999,
1998, and 1997, 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.
37
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
Changes in options outstanding and exercisable during 1999 and 1998,
were as follows:
Exercisable Outstanding Option price
options options per share
----------------- ----------------- -----------------
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
Vested ........... 14,808 -- 5.50-6.06
Exercised ........ (120) (120) 5.50
----------------- ----------------- -----------------
June 30, 1999 .... 45,060 45,060 $ 5.50-6.06
================= ================= =================
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, 1999,
1998, and 1997, was $11,439, $36,216, and $36,216, 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.
38
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
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, 1999 and
1998.
The Bank met all regulatory capital requirements at June 30, 1999 and
1998.
The Bank's actual and required capital amounts and ratios as of June 30,
1999 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) $ 5,773,000 6.9% $ 1,664,000 2.0% $ -- 0.0%
Leverage/equity (core) capital
(to adjusted tangible assets) 5,773,000 7.0 3,329,000 4.0 4,161,000 5.0
Tier I risk-based capital
(to risk-weighted assets) 5,773,000 11.9 1,934,000 4.0 2,901,000 6.0
Risk-based (total) capital
(to risk-weighted assets) 6,089,000 12.6 3,868,000 8.0 4,835,000 10.0
=========== ===== =========== ======= ============ ========
</TABLE>
At June 30, 1999 and 1998, 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, 1999 and 1998 were
substantially restricted because of the effect of these income tax bad
debt reserves.
<PAGE>
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.
39
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
(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.
(14) Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments as of
June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
June 30, 1999 June 30, 1998
------------------------------- --------------------------------
Recorded Fair Recorded Fair
amount value amount value
-------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 7,917,020 7,917,020 6,366,619 6,366,619
Securities available-for-sale 17,096,985 17,096,985 23,921,718 23,921,718
Loans 56,066,399 56,361,401 55,996,418 56,560,330
FHLB stock 1,202,500 1,202,500 1,202,500 1,202,500
Accrued interest receivable 522,121 522,121 683,120 683,120
Financial liabilities:
Deposits 59,576,232 59,673,754 60,144,866 60,486,010
FHLB advances 16,606,176 15,350,823 20,038,174 20,142,145
Advance payments by borrowers
for taxes and insurance 399,830 399,830 407,050 407,050
Accrued interest payable 380,617 380,617 355,860 355,860
============== =============== =============== ===============
<CAPTION>
Unrealized Unrealized
Notional gains Notional gains
value (losses) value (losses)
-------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Off balance sheet assets:
Commitments to extend credit $ 1,440,460 -- 690,000 --
Unused lines of credit 1,510,000 -- 870,000 --
============== =============== =============== ===============
</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.
40
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
(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
1999 1998
----------- -----------
<S> <C> <C>
Cash and cash equivalents .................... $ 409,472 375,000
Securities available-for-sale ................ 745,803 1,395,421
Loans receivable, net ........................ 1,052,717 439,207
Loans receivable from subsidiary ............. 65,503 129,205
Investment in subsidiary ..................... 5,417,889 5,765,898
Real estate .................................. 270,779 190,402
Interest receivable .......................... 19,623 18,185
Deferred taxes ............................... 64,100 21,375
Income tax receivable ........................ 14,461 154,000
----------- -----------
Total assets .................... $ 8,060,347 8,488,693
=========== ===========
Accrued expenses and other liabilities ....... $ -- 873
Common stock ................................. 10,462 10,462
Additional paid-in capital ................... 4,996,761 4,894,744
Retained earnings ............................ 4,804,455 5,730,257
Treasury stock, at cost ...................... (1,229,571) (1,185,924)
Unearned ESOP shares ......................... (65,503) (129,205)
Unearned RRP shares .......................... -- (11,439)
Accumulated other comprehensive
income - net unrealized loss
on securities available for sale .......... (456,257) (821,075)
----------- -----------
Total liabilities and equity .... $ 8,060,347 8,488,693
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
Condensed Statements of Operations
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Interest income ........................... $ 79,472 123,091 177,996
Equity in (losses) earnings of subsidiaries (634,347) 814,876 230,579
Other income (expense) .................... (131,105) (334,958) 27,053
Other expenses ............................ (180,091) (187,314) (150,136)
--------- --------- ---------
Net earnings before tax ...... (866,071) 415,695 285,492
Income tax (benefit) expense .............. (94,300) (173,689) 7,000
--------- --------- ---------
Net (loss) earnings .......... $(771,771) 589,384 278,492
========= ========= =========
</TABLE>
41
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
<TABLE>
<CAPTION>
Condensed Statements of Cash Flows
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Operating activities:
Net (loss) earnings ................................ $ (771,771) 589,384 278,492
Equity in losses (earnings) of subsidiary .......... 634,347 (814,876) (230,579)
Other, net ......................................... 370,614 288,588 29,809
----------- ----------- -----------
Net cash provided by operating activities 233,190 63,096 77,722
----------- ----------- -----------
Investing activities:
Proceeds from sale of securities available-for-sale 1,844,763 2,647,147 272,962
Purchase of securities available-for-sale .......... (1,510,444) (3,445,162) (577,106)
Principal collected on securities available-for-sale 88,340 599,306 --
Purchase of real estate ............................ (100,000) -- --
Proceeds from the sale of real estate .............. -- -- 65,233
Loans receivable, net .............................. (549,808) (282,449) 60,505
----------- ----------- -----------
Net cash used in investing activities ... (227,149) (481,158) (178,406)
----------- ----------- -----------
Financing activities:
Dividends from subsidiary .......................... 226,109 588,767 750,000
Treasury stock acquired ............................ (44,375) -- (337,354)
Exercise of stock options .......................... 660 159,585 --
Dividends paid ..................................... (153,963) (144,982) (130,032)
----------- ----------- -----------
Net cash provided by
financing activities ................... 28,431 603,370 282,614
----------- ----------- -----------
Net increase in cash and
cash equivalents ....................... 34,472 185,308 181,930
Cash and cash equivalents at beginning of year ........ 375,000 189,692 7,762
----------- ----------- -----------
Cash and cash equivalents at end of year .............. $ 409,472 375,000 189,692
=========== =========== ===========
</TABLE>
42
<PAGE>
HORIZON FINANCIAL SERVICES
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
(17) Subsequent Event
On August 23, 1999, the Bank entered into a supervisory agreement with
the Office of Thrift Supervision (OTS) which requires certain actions by
the Bank including
o Implementing procedures to improve credit administration and
documentation;
o Disposal of the Bank's investments classified by the OTS as high risk
and reducing the level of the Bank's interest rate risk;
o Obtaining prior approval of the OTS for payment of dividends.
Management is proceeding with the required actions and does not believe
these actions will have a material effect on the financial position or
results of operations of the company.
43
<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 28, 1999, 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 inter-dealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
FISCAL 1999
-------------------------------------
HIGH LOW DIVIDENDS
First Quarter $16.750 $14.875 $.045
Second Quarter 15.750 12.500 .045
Third Quarter 12.750 10.000 .045
Fourth Quarter 10.250 7.000 .045
FISCAL 1998 (1)
-------------------------------------
HIGH LOW DIVIDENDS
First Quarter $10.000 $ 9.250 $ .040
Second Quarter 14.500 10.375 .045
Third Quarter 16.750 12.125 .045
Fourth Quarter 16.875 15.500 .045
- ----------------------------
(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
Notes 12 and 17 to the Notes to Consolidated Financial Statements for a
discussion of restrictions on the Bank's ability to pay dividends.
At September 15, 1999, there were 875,062 shares of Horizon Financial Services
Corporation common stock issued and outstanding and approximately 160
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
44
<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
INDEPENDENT AUDITORS
KPMG LLP
2500 Ruan Center
Des Moines, Iowa 50309
CORPORATE COUNSEL
McCoy, Faulkner & Broerman
216 South First Street
Oskaloosa, Iowa 52577
SPECIAL COUNSEL
Silver, Freedman & Taff, L.L.P.
1100 New York Avenue, N.W.
Seventh Floor
Washington, D.C. 20005
Exhibit 21
<TABLE>
<CAPTION>
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.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ANNUAL
REPORT ON FORM 10-KSB FOR THE YEAR ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 7,917
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 17,097
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 56,066
<ALLOWANCE> 343
<TOTAL-ASSETS> 85,023
<DEPOSITS> 59,576
<SHORT-TERM> 16,606
<LIABILITIES-OTHER> 780
<LONG-TERM> 0
10
0
<COMMON> 0
<OTHER-SE> 8,050
<TOTAL-LIABILITIES-AND-EQUITY> 85,023
<INTEREST-LOAN> 4,597
<INTEREST-INVEST> 1,340
<INTEREST-OTHER> 255
<INTEREST-TOTAL> 6,192
<INTEREST-DEPOSIT> 2,637
<INTEREST-EXPENSE> 3,642
<INTEREST-INCOME-NET> 2,550
<LOAN-LOSSES> 139
<SECURITIES-GAINS> (2,038)
<EXPENSE-OTHER> 2,116
<INCOME-PRETAX> (1,238)
<INCOME-PRE-EXTRAORDINARY> (1,238)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (772)
<EPS-BASIC> (0.90)
<EPS-DILUTED> (0.90)
<YIELD-ACTUAL> 7.70
<LOANS-NON> 1,160
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 481
<ALLOWANCE-OPEN> 348
<CHARGE-OFFS> 168
<RECOVERIES> 24
<ALLOWANCE-CLOSE> 343
<ALLOWANCE-DOMESTIC> 343
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 14
</TABLE>
