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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended March 31, 2004 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-27062
Horizon Financial Corp.
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(Exact name of registrant as specified in its charter)
Washington 91-1695422
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
1500 Cornwall Avenue, Bellingham, Washington 98225
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 733-3050
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
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(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. YES X NO
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Indicate by check mark whether disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy or
other information statements incorporated by reference in Part III of this
Form 10-K or any amendments to this Form 10-K. YES NO X
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Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). YES X NO
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The aggregate market value of the voting stock held by nonaffiliates of
the registrant, based on the closing sales price of the registrant's Common
Stock as quoted on the Nasdaq Stock Market under the symbol "HRZB" on
September 30, 2003, was $169,067,630 (10,475,070 shares at $16.14 per share).
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant's Proxy Statement for the 2004 Annual
Meeting of Stockholders. (Parts II. and III).
HORIZON FINANCIAL CORP.
2004 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
PART I. ----
Item 1. Business
General. . . . . . . . . . . . . . . . . . . . . . . . . . 1
Lending Activities . . . . . . . . . . . . . . . . . . . . 1
Investment Activities. . . . . . . . . . . . . . . . . . . 10
Savings Activities and Other Sources of Funds. . . . . . . 13
Competition. . . . . . . . . . . . . . . . . . . . . . . . 15
Personnel. . . . . . . . . . . . . . . . . . . . . . . . . 15
Regulation and Supervision . . . . . . . . . . . . . . . . 15
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . 22
Available Information. . . . . . . . . . . . . . . . . . . 23
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . 24
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . 25
Item 4. Submission of Matters to a Vote of Security Holders . . . . . 25
PART II.
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities . . . . . . 26
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . 27
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . 29
Forward Looking Statements. . . . . . . . . . . . . . . . . 29
General . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Operating Strategy. . . . . . . . . . . . . . . . . . . . . 29
Critical Accounting Estimate. . . . . . . . . . . . . . . . 30
Critical Accounting Policies. . . . . . . . . . . . . . . . 31
Financial Condition . . . . . . . . . . . . . . . . . . . . 32
Results of Operations . . . . . . . . . . . . . . . . . . . 33
Yields Earned and Rates Paid . . . . . . . . . . . . . . . 36
Rate/Volume Analysis. . . . . . . . . . . . . . . . . . . . 38
Liquidity and Capital Resources . . . . . . . . . . . . . . 38
Quantitative and Qualitative Disclosures
About Market Risk . . . . . . . . . . . . . . . . . . . . 39
Effects of Interest Rate Floors . . . . . . . . . . . . . . 40
Contractual Obligations . . . . . . . . . . . . . . . . . . 41
Off-Balance Sheet Arrangements. . . . . . . . . . . . . . . 41
Impact of Inflation . . . . . . . . . . . . . . . . . . . . 42
Recent Accounting Pronouncements. . . . . . . . . . . . . . 42
Item 7A. Quantitative and Qualitative Disclosures About Market Risk . 42
Item 8. Financial Statements and Supplementary Data . . . . . . . . . 42
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure. . . . . . . . . . . . 70
Item 9A. Controls and Procedures. . . . . . . . . . . . . . . . . . . 70
PART III.
Item 10. Directors and Executive Officers of the Registrant . . . . . 70
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . 72
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters . . . . . . . 72
Item 13. Certain Relationships and Related Transactions . . . . . . . 73
Item 14. Principal Accountant Fees and Services . . . . . . . . . . . 73
PART IV.
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . 73
(i)
PART I
Item 1. Business
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(a) General
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Horizon Financial Corp. ("Horizon Financial" or the "Corporation") was
formed under Washington law on May 22, 1995, and became the holding company
for Horizon Bank ("Horizon Bank" or the "Bank"), effective October 13, 1995.
Effective June 19, 1999 the Corporation completed the acquisition of
Bellingham Bancorporation, a $64.3 million, bank holding company for the Bank
of Bellingham, which was merged with and into Horizon Bank. At March 31,
2004, the Corporation had total assets of $858.9 million, total deposits of
$670.3 million and total equity of $109.3 million. The Corporation's business
activities generally are limited to passive investment activities and
oversight of its investment in the Bank. Accordingly, the information set
forth in this report, including consolidated financial statements and related
data, relates primarily to the Bank and its subsidiary.
The Bank was organized in 1922 as a Washington State chartered mutual
savings and loan association and converted to a federal mutual savings and
loan association in 1934. In 1979, the Bank converted to a Washington State
chartered mutual savings bank, the deposits of which are insured by the
Federal Deposit Insurance Corporation ("FDIC"). On August 12, 1986, the Bank
converted to a state chartered stock savings bank under the name "Horizon
Bank, a savings bank." The Bank became a member of the Federal Home Loan
Bank ("FHLB") of Seattle in December 1998. Effective March 1, 2000, the Bank
changed its name to its current title, "Horizon Bank."
The Bank's operations are conducted through 16 full-service office
facilities, three commercial loan centers, and three real estate loan
centers, located in Whatcom, Skagit and Snohomish counties in Northwest
Washington. The acquisition of Bellingham Bancorporation increased Horizon
Financial's and Horizon Bank's presence in Whatcom County. During fiscal
2000, the Bank purchased a bank site in Marysville. In fiscal 2002, the Bank
acquired a bank site in Lynnwood, Washington, which was remodeled and opened
for business in March 2003. The Bank opened commercial banking/loan centers
in Bellingham, Snohomish, and Everett and expanded its operations in
Burlington during the first quarter of fiscal 2004. Future plans for the
Bank include the opening of a full service office in Marysville during fiscal
2005 and a full service office in Everett during fiscal 2006, which will
replace the Bank's existing Everett office.
The Corporation has been in various buy-back programs of its outstanding
common stock ("Common Stock") since August 1996. In March 2004, the Board of
Directors approved a new stock repurchase plan that runs concurrent with the
2005 fiscal year, allowing the Corporation to repurchase up to 10% of total
shares outstanding, or approximately 1.04 million shares. This marked the
Corporation's sixth stock repurchase plan. In fiscal 2004, under the previous
plans, the Corporation repurchased 314,240 shares at an average price of
$17.353. For additional information concerning the Corporation's repurchase
activities during the fourth quarter of fiscal 2004, see Item 5 hereof.
Lending Activities
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General. The Bank's loan portfolio, net totaled $658.2 million at March
31, 2004, representing approximately 76.6% of its total assets. On that
date, 33.0% of total outstanding loans consisted of loans secured by
mortgages on one-to-four family residential properties, 8.0% of total
outstanding loans consisted of loans secured by mortgages on over four unit
residential properties, and 55.0% of total outstanding loans consisted of
commercial loans and commercial real estate loans. The balance of the Bank's
outstanding loans at that date consisted of secured and unsecured consumer
loans and loans secured by savings deposits.
The Bank originates both fixed rate and adjustable rate mortgages
("ARMs") secured by residential, business, and commercial real estate, the
majority of which include building improvements.
The Bank has no significant concentration of credit risk other than that
a substantial portion of its loan portfolio is secured by real estate located
in the Bank's primary market area, which the Bank considers to be Whatcom,
Skagit and Snohomish Counties in Washington. This concentration of credit
risk could have a material adverse effect on the Bank's
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financial condition and results of operations to the extent there is a
material deterioration in the counties' economic and real estate values.
In order to have the ability to make the yields on its loan portfolio
and investments more interest rate sensitive, the Bank has implemented a
number of measures. Those measures include: (i) adoption of a policy under
which the Bank generally originates long-term, fixed-rate mortgage loans when
such loans are written to specifications promulgated by the Federal Home Loan
Mortgage Corporation ("FHLMC") and qualify for sale in the secondary market,
(ii) origination of ARM loans on residential and commercial properties
subject to market conditions, (iii) origination of variable rate commercial
and consumer loans, and (iv) increased emphasis on originating shorter term
loans for its portfolio, and selling much of its long-term mortgage loan
production into the secondary market.
The following table provides selected data relating to the composition
of the Bank's loan portfolio by type of loan on the dates indicated.
At March 31,
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2004 2003 2002 2001 2000
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Amount Percent Amount Percent Amount Percent Amount Percent Amount
Percent
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(Dollars in thousands)
Type of Loan:
First mortgage loans:
One-to-four family..$286,127 43.5% $350,488 60.2% $493,098 86.8% $619,395 103.7% $606,703
102.9%
One-to-four family
construction....... 14,165 2.1 28,036 4.8 29,958 5.3 26,716 4.5 25,912 4.4
Participations sold. (74,279) (11.3) (137,174) (23.5) (228,874) (40.3) (246,583) (41.3)
(176,538)(29.9)
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Subtotal.......... 226,013 34.3 241,350 41.5 294,182 51.8 399,528 66.9 456,077 77.4
Construction and land
development........ 36,304 5.5 66,112 11.3 55,747 9.8 30,364 5.1 18,717 3.2
Residential commer-
cial real estate... 53,344 8.1 56,930 9.8 28,604 5.0 24,187 4.0 21,999 3.7
Nonresidential
commercial real
estate............. 257,322 39.1 182,158 31.3 169,697 29.9 139,232 23.3 88,323 15.0
Commercial loans.... 78,752 11.9 54,132 9.3 37,844 6.7 20,221 3.4 14,473 2.4
Home equity secured. 26,291 4.0 22,729 3.9 18,873 3.3 19,835 3.3 16,953 2.9
Other consumer
loans.............. 6,330 1.0 6,887 1.2 5,263 0.9 2,531 0.4 4,829 0.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Subtotal.......... 684,356 103.9 630,298 108.3 610,210 107.4 635,898 106.4 621,371 105.4
Less:
Deferred loan fees.. (4,046) (0.6) (4,845) (0.8) (5,613) (1.0) (6,746) (1.1) (7,398)
(1.3)
Allowance for loan
losses............. (10,121) (1.5) (8,506) (1.5) (5,887) (1.0) (4,977) (0.8) (4,757)
(0.8)
Undisbursed loan
proceeds........... (11,963) (1.8) (34,678) (6.0) (30,407) (5.4) (26,793) (4.5) (19,632)
(3.3)
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
$658,226 100.0% $582,269 100.0% $568,303 100.0% $597,382 100.0% $589,584
100.0%
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Loan Maturity. The following table sets forth certain information at
March 31, 2004 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and
overdrafts are reported as due in one year or less. Loan balances are net of
undisbursed loan proceeds, unearned discounts, unearned income and allowance
for loan losses.
Due After
Due Within 1 Through Due Over
One Year After 5 Years After 5 Years After
March 31, 2004 March 31, 2004 March 31, 2004 Total
-------------- -------------- -------------- --------
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(In thousands)
Commercial real
estate, financial,
and agricultural..... $188,940 $146,983 $120,420
$456,343
One-to-four real
estate construction.. -- -- 14,165
14,165
Real estate-mortgage,
installment and
other................ 35,588 39,665 112,465
187,718
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Total............ $224,528 $186,648 $247,050
$658,226
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2
The following table sets forth the dollar amount of all loans due after
one year after March 31, 2004 which have fixed interest rates and have
floating or adjustable interest rates. Loan balances do not include
undisbursed loan proceeds, unearned discounts, unearned income, and allowance
for loan losses.
Adjustable
Fixed Rates Rates Total
----------- ----- -----
(In thousands)
Commercial, financial and
agricultural................ $ 96,982 $170,421 $267,403
One-to-four family real
estate construction......... 13,965 200 14,165
Real estate-mortgage,
installment and other....... 134,639 17,491 152,130
-------- -------- --------
Total.................... $245,586 $188,112 $433,698
======== ======== ========
Residential Loans. The primary lending activity of the Bank has
historically been the granting of conventional loans to enable borrowers to
purchase existing homes or construct new homes. The Bank's real estate loan
portfolio also includes loans on two-to-four family dwellings, multi-family
housing (over four units), and loans made to purchase or refinance improved
buildings to be used for residential housing. At March 31, 2004,
approximately 33.0% of the Bank's total loan portfolio consisted of loans
secured by one-to-four residential real estate.
The Bank's lending practices generally limit the maximum loan-to-value
ratio on one-to-four family residential mortgage loans to 97% of the
appraised value as determined by an independent appraiser, with the condition
that private mortgage insurance generally be required on any home loans with
loan-to-value ratios in excess of 80% of the appraised value. The Bank
places this insurance with carriers approved by the FHLMC. The coverage
generally limits the Bank's exposure to 72.0% of the loan amount. If private
mortgage insurance is required, the borrower pays the premium at loan closing
and any recurring premiums through an escrow reserve account established with
the Bank for such period of time as the Bank requires the insurance coverage
to be in force. Multi-family residential and commercial real estate loans
and unimproved real estate loans generally do not exceed 80.0% of appraised
value.
The Bank presently originates both fixed-rate and ARMs secured by
one-to-four family properties with a loan term not exceeding 30 years. Under
certain conditions, ARM borrowers are allowed to convert beginning on the
first interest rate change date and ending on the fifth interest rate change
date from the date of the loan note. In addition, certain consumer
safeguards are built into the ARM instruments used by the Bank. These
safeguards include limits on annual and lifetime interest rate adjustments.
The Bank generally originates these loans in accordance with guidelines
established by the FHLMC. For the fiscal year ended March 31, 2004,
adjustable mortgage loans totalled $6.4 million or 2.7% of total originations
as compared to $45.6 million, or 14.4%, of total originations for the year
ended March 31, 2003.
Construction Loans. The Bank also provides construction financing for
single-family dwellings and to a lesser extent makes land acquisition and
development loans on properties intended for residential use. The interest
rate charged by the Bank on these loans varies depending upon the type of
security property and the creditworthiness of the borrower. At March 31,
2004, the Bank had $50.5 million, or 7.4%, of total loans outstanding in
residential construction loans, as compared to $94.1 million, or 14.9%, of
total loans at March 31, 2003. At March 31, 2004, $36.3 million, or 71.9%,
of the construction loan portfolio consisted of "speculative" construction
loans (i.e., loans on dwellings for which there is not an underlying contract
for sales).
Construction lending is generally considered to involve a higher level
of risk as compared to one-to-four family residential permanent lending
because of the inherent difficulty in estimating both a property's value at
completion of the project and the estimated cost of the project. The nature
of these loans is such that they are generally more difficult to evaluate and
monitor. If the estimate of value proves to be inaccurate, the Bank may be
confronted at, or prior to, the maturity of the loan, with a project whose
value is insufficient to assure full repayment. Loans for the construction
of speculative homes carry more risk because the payoff for the loan is
dependent on the builder's ability to sell the property prior to the time
that the construction loan is due.
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Multi-Family, Business and Commercial Real Estate Lending. Commercial
real estate loans totaled $334.4 million, or 50.8% of total loans receivable
at March 31, 2004. The Bank originates commercial real estate loans
primarily secured by owner-occupied business facilities, apartment buildings,
warehouses, mini-storage facilities, industrial use buildings, office and
medical office buildings, hospitality facilities, commercial land development
and retail shopping centers located in its market area. Commercial real
estate loans typically range in principal amount from $500,000 to $10.0
million. At March 31, 2004, the largest commercial real estate loan on one
property had an outstanding balance of $17.0 million and is secured by a
destination resort and surrounding real estate located in the Bank's market
area. This loan was performing according to its terms at March 31, 2004.
Commercial adjustable rate mortgage loans are originated with variable
rates which generally adjust annually after an initial period ranging from
one to five years. These adjustable rate mortgage loans have generally
utilized Prime or Federal Home Loan Bank Advance Rates as indices, with
principal and interest payments fully amortizing over terms of 15 to 25
years, and are generally due in ten years. The Bank has also originated
fixed rate commercial loans due in five to 15 years, with amortization terms
of 15 to 25 years. Commercial loans originated with interest rates fixed for
the initial three, five or ten year terms generally contain prepayment
penalties during their fixed rate period ranging from 1.0% to 5.0%.
The Bank requires appraisals or evaluations on all properties securing
commercial real estate loans. The Bank considers the quality and location of
the real estate, the credit of the borrower, the cash flow of the project and
the quality of management involved with the property. The Bank generally
imposes a minimum debt coverage ratio of approximately 1.20 times for
originated loans secured by income producing commercial properties. The Bank
generally obtains loan guarantees from financially capable parties based on a
review of personal financial statements, or if the borrower is a corporation,
the Bank also generally obtains personal guarantees from corporate principals
based on a review of personal financial statements.
Commercial real estate lending affords the Bank an opportunity to
receive interest at rates higher than those generally available from one- to-
four family residential lending. However, loans secured by such properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to- four family
residential mortgage loans. Because payments on loans secured by commercial
properties often depend upon the successful operation and management of the
properties, repayment of such loans may be affected by adverse conditions in
the real estate market or the economy. The Bank seeks to minimize these
risks by limiting the maximum loan-to-value ratio to 80% and carefully
reviewing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The
continued year-over-year increase in the commercial real estate portfolio is
attributable to the Company's desire to meet the growing demand in this
sector of the lending market.
Commercial Loans. The Bank's loan portfolio also includes a wide range
of commercial loans to small and medium sized businesses. This portfolio
presently includes lines of credit with floating rates and maturities of one
year or less and term loans for the purchase of equipment, real estate and
other operating purposes with maturities generally not exceeding ten years.
These loans are secured by a variety of business assets including equipment,
real estate, accounts receivable and inventory. These types of loans
constituted $77.1 million, or approximately 11.7% of the Bank's net loan
portfolio at March 31, 2004. Under certain conditions, the Bank also offers
unsecured credit to qualified borrowers.
Commercial lending carries increased risks compared to residential
mortgage lending due to the heavy reliance upon the future income of the
customer and the uncertain liquidation value of the collateral. In the event
of default, the liquidation of collateral is often insufficient to cover the
outstanding debt. To mitigate these inherent risks, the Bank combines a
conservative lending policy with experienced lending personnel responsible
for the ongoing management of their assigned accounts.
Consumer Loans. The Bank makes a variety of loans for consumer purposes.
Included among these are home equity loans, home equity lines of credit,
loans secured by personal property, such as automobiles, boats, and other
vehicles, loans secured by deposit accounts, unsecured loans, and loans for
mobile homes located in parks.
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Horizon Bank actively markets consumer loans in order to provide a wider
range of financial services to its customers and to achieve shorter terms and
higher interest rates normally typical of such loans. At March 31, 2004, the
Bank held $32.0 million of consumer loans.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciating assets such as automobiles, boats and other vehicles.
In such cases, any repossessed collateral for a defaulted consumer loan may
not provide an adequate source of repayment of the outstanding loan balance
as a result of the greater likelihood of damage, loss or depreciation. The
remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment. In
addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness or personal bankruptcy. Furthermore,
the application of various federal and state laws, including federal and
state bankruptcy and insolvency laws, may limit the amount that can be
recovered on such loans.
Consumer loans are made based on an evaluation of the borrower's
creditworthiness, including income, other indebtedness, and satisfactory
credit history, and the value of the collateral. Designated managers or Loan
Committee members approve consumer loan requests.
Secured loan amounts typically do not exceed 90.0% of the value of the
collateral, or 90.0% of the appraised value of the residence in the case of
home equity loans.
Loan Solicitation and Processing. The primary sources for loan
originations are attributable to deposit customers, current borrowers,
walk-in customers, and referrals from existing customers, real estate agents,
and builders. The Bank does not actively utilize mortgage brokers in the
origination of loans.
The Bank accepts completed loan applications from all of its offices.
Processing is substantially centralized in the main office of the Bank.
Detailed information is obtained to determine the creditworthiness of the
borrower and the borrower's ability to repay. The more significant items
appearing on the applications and accompanying material are verified through
the use of written credit reports, financial statements, and confirmations.
After analysis of the loan application, supporting documents and the property
to be pledged as loan security, including an appraisal of the property by
either a staff appraiser or an independent fee appraiser, the application is
forwarded to the Bank's Loan Committee. Loan approval requires the
signatures of two or three members of the Loan Committee depending on the
size of the loan. The Loan Committee consists of officers of the Bank who
are appointed by the Bank's Board of Directors. The Bank generally requires
its mortgage notes to be co-signed individually by the principals on loans
made to entities other than natural persons. Certain lending personnel have
been given limited loan approval authority by the Board of Directors covering
secondary market quality loans.
Loan assumption requests of adjustable rate loans are handled by the
Bank in a manner similar to new loan requests. FHLMC standards are generally
applied to each request and full credit underwriting is required. For fixed
rate loans, a sale or transfer of the secured property generally results in
the Bank enforcing its due on transfer rights contained in the mortgage
instrument.
Residential Loan Originations, Purchases and Sales. Currently, the Bank
emphasizes the origination of 15 to 30 year fixed rate loans on terms and
conditions which will permit them to be sold in the secondary market, while
originating ARM loans and shorter term fixed-rate loans for its own
portfolio.
In addition to originating loans, Horizon Bank may purchase real estate
loans in the secondary market. The Bank's purchases in the secondary market
depend upon the demand for mortgage credit in the local market area and the
inflow of funds from traditional sources. Loan purchases enable the Bank to
utilize funds more quickly, particularly where sufficient loan demand is not
obtainable locally.
The Bank is a qualified servicer for both FHLMC and Fannie Mae. The
Bank's general practice is to close its fixed-rate, one-to-four family
residential loans on FHLMC loan documents in order to facilitate future sales
to the
5
mortgage corporation as well as to other institutional investors. From time
to time, depending upon interest rates and economic conditions, the Bank has
sold participation interests in loans in order to provide additional funds
for lending, to generate servicing fee income and to decrease the dollar
amount of its intermediate and long-term fixed-rate loans. The sale of loans
in the secondary mortgage market reduces the Bank's interest rate risk and
allows the Bank to continue to make loans during periods when savings flows
decline or funds are otherwise unavailable for lending purposes. As of March
31, 2004, the Bank was servicing loans for others aggregating approximately
$88.2 million for which it generally receives a fee payable monthly of 0.25%
to 0.375% per annum of the unpaid balance of each loan. In February 2001,
the Bank began selling much of its current loan production on a servicing
released basis, and plans to continue doing so for many of the long-term
fixed rate loan originations. All sales of loan interests by the Bank are
made without right of recourse to the Bank by the buyer of the loan interests
in the event of default by the borrower.
Loan Commitments. The Bank is a party to financial instruments with
off-balance-sheet risk (loan commitments) made in the normal course of
business to meet the financing needs of its customers and to reduce its own
exposure to fluctuations in interest rates. Loan commitments involve, to
varying degrees, elements of credit and interest-rate risk in excess of the
amount recognized in the balance sheet. The contract amounts of those
commitments reflect the extent of the Bank's exposure to credit loss from
these commitments. The Bank uses the same credit policies in making
commitments and conditional obligations 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 condition 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. The amount of collateral
obtained, if it is deemed necessary by the Bank upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant, and
equipment; and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank
to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing, and similar
transactions. Except for certain long-term guarantees, the majority of
guarantees expire in one year. The credit risk involved in issuing letters
of credit is essentially the same as that involved in extending loan
facilities to customers. Collateral supporting those commitments, for which
collateral is deemed necessary, generally amounts to one hundred percent of
the commitment amount at March 31, 2004.
The following is a summary of the off-balance-sheet financial
instruments or contracts outstanding as of the dates indicated.
As of March 31,
-------------------
2004 2003
------- -------
(In thousands)
Commitments to extend credit.... $80,275 $58,878
Credit card arrangements........ 7,991 7,385
Standby letters of credit....... 2,059 1,263
Loan Origination and Other Fees. In addition to interest earned on
loans, the Bank receives loan origination fees for originating loans. Loan
origination fees are a percentage of the principal amount of the mortgage
loan which are charged to the borrower at the closing of the loan.
The Bank's loan origination fees are generally 0% to 2.5% on
conventional residential mortgages and 1.0% to 2.0% for commercial real
estate loans. The total amount of deferred loan origination fees and
unearned discounts at March 31, 2004 was $4.0 million. Any unamortized loan
fees are recognized as income at the time the loan is sold or paid off.
6
Income from loan origination and commitment fees varies with the volume
and type of loans and commitments made and purchased and with competitive
conditions in mortgage markets, which in turn responds to the demand for and
availability of money. The Bank experiences an increase in loan fee income
and other fee income, such as appraisal and loan closing fees, during periods
of low interest rates due to the resulting demand for mortgage loans. The
Bank also receives other fees and income from charges relating to existing
loans, which include late charges, and fees collected in connection with a
change in terms or other loan modifications. These fees and charges have not
constituted a material source of income.
Loan Modifications. The Bank offers a loan modification program to
assist existing customers who are considering refinancing their home loans.
For a fee the Bank will modify customers' loans under the program. No new
principal is required and only the interest rate and payment amounts are
changed. All other terms and conditions remain the same. In fiscal 2004,
the Bank modified $46.0 million of real estate loans, compared to $66.3
million in fiscal 2003.
Delinquent Loans, Loans in Foreclosure and Foreclosed Property. Loans
are defined as delinquent when any payment of principal and/or interest is
past due. While the Bank generally is able to work out a satisfactory
repayment schedule with a delinquent borrower, the Bank will undertake
foreclosure proceedings if the delinquency is not otherwise resolved within
90 days. Property acquired by the Bank as a result of foreclosure or by deed
in lieu of foreclosure is classified as "real estate owned" until such time
as it is sold or otherwise disposed of. At March 31, 2004, the Bank had
eight loans over 90 days delinquent and no loans on nonaccrual status. At
March 31, 2004 total non-performing loans were $339,000. Real estate owned
at March 31, 2004 totaled $63,000. Total non-performing assets represented
$402,000, or 0.05%, of total assets at March 31, 2004. Management does not
anticipate incurring material losses from these loans.
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.
At March 31,
-----------------------------------------------
- -
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Non-accrual loans............ $ -- $ 242 $ -- $ -- $ 455
Loans 90 days or more
delinquent and
accruing interest.......... 339 350 618 832 457
Restructured loans........... -- -- -- -- --
Real estate acquired
through foreclosure........ 63 1,072 340 -- 323
------ ------- ------- ------- -------
Total.................... $ 402 $ 1,664 $ 958 $ 832 $ 1,235
====== ======= ======= ======= =======
As a percentage of net loans. 0.06% 0.29% 0.17% 0.14% 0.21%
As a percentage of total
assets..................... 0.05% 0.20% 0.12% 0.11% 0.17%
Additional interest income which would have been recorded had
nonaccruing loans been current in accordance with their original terms was
considered immaterial as of March 31, 2004. No interest income was recorded
on nonaccrual loans for the year ended March 31, 2004.
Reserves for Losses. The Bank operates under a general loan loss
reserve system. The provision for loan losses is maintained at a level
sufficient to provide for estimated loan losses based on evaluating known and
inherent risks in the loan portfolio. These factors include changes in the
size and composition of the loan portfolio, actual loan loss experience,
current and anticipated economic conditions, detailed analysis of individual
loans for which full collectibility may not be assured, and determination of
the existence and realizable value of the collateral and guarantees securing
the loans. The reserve is based upon factors and trends identified by
management at the time financial statements are prepared, but the ultimate
recovery of loans is susceptible to future market factors beyond the Bank's
control, which may result in losses or recoveries differing significantly
from those provided for in the financial statements.
7
The Bank maintains an allowance for credit losses sufficient to absorb
losses inherent in the loan portfolio. The Bank has established a systematic
methodology to ensure that the allowance is adequate. The Bank reviews the
following information, on a quarterly basis, to estimate the necessary
additions to its loan loss reserve:
* All loans classified during the previous analysis. Current informa-
tion as to payment history, or actions taken to correct the
deficiency are reviewed, and changes are made, as appropriate. If
conditions have not improved, the loan classification is reviewed to
ensure that the appropriate action is being taken to mitigate loss.
* All loans past due on scheduled payments. The Bank reviews all
loans that are past due 30 days or more, taking into consideration
the borrower, nature of the collateral and its value, the
circumstances that have caused the delinquency, and the likelihood
of
the borrower correcting the conditions that have resulted in the
delinquent status.
* Composition of the Bank's portfolio. The Bank also analyzes its mix
of loans when establishing appropriate allowances for loan losses.
For example, reserves for losses on the Bank's one-to-four
family mortgage portfolio (on a percentage basis) are lower than the
percentage reserve estimates for commercial or credit card loans.
Therefore, the Bank's allowance for loan losses is likely to change,
as the composition of the Bank's loan portfolio changes.
* Current economic conditions. The Bank takes into consideration
economic conditions in its market area, the state's economy, and
national economic factors that could influence the quality of the
loan portfolio in general.
* Trends in the Bank's delinquencies. Prior period statistics are
reviewed and evaluated to determine if the current conditions
warrant
changes to the Bank's loan loss allowance.
The amount that is to be added to allowance for loan losses is based
upon a variety of factors. Many financial institutions establish required
reserves based, to a great extent, upon their own experience. The Bank's
loan portfolio has traditionally consisted primarily of loans secured by
single family homes, and as a result, the loss experience has been minimal.
Each individual loan, previously classified by management, or newly
classified during the quarterly review, is evaluated for loss potential, and
a specific amount or percentage deemed to be at risk is added to the overall
required reserve amount. For the remaining portion of the portfolio, a
reserve factor is applied that is consistent with the Bank's experience in
that portfolio or with industry guidelines if management believes such
guidelines are more appropriate. The applied percentage is also influenced by
other economic factors as noted in the beginning of this section.
The calculated amount is compared to the actual amount recorded in the
allowance at the end of each quarter and a determination is made as to
whether the allowance is adequate. Management increases the amount of the
allowance for loan losses by charges to income and decreases the amount by
loans charged off (net of recoveries).
The following comments represent management's view of the risks inherent
in each portfolio category.
* One- to Four-Family Residential - Market conditions in the Bank's
primary market area have, over the long term, supported a stable or
increasing market value of real estate. Absent an overall
economic downturn in the economy, experience in this portfolio
indicates that losses are minimal provided the property is
reasonably
maintained, and marketing time to resell the property is relatively
short.
* Multi-Family Residential - While there have been minimal losses
taken
in this segment of the portfolio, the rental market is susceptible
to
the effects of an economic downturn. While the Bank monitors
loan-to-value ratios, the conditions that would create a default
would carry through to a new owner which may require that the Bank
discount the property or hold it until conditions improve.
8
* Commercial Real Estate - As with multi-family loans, the classifi-
cation of commercial real estate loans closely corresponds to
economic conditions which will limit the marketability of the
property, resulting in higher risk than a loan secured by a
single-family residence. Commercial real estate loans have
historically been assigned higher reserve levels than one-to-four
family residential loans, but lower than commercial business loans.
* Commercial Business Loans - These types of loans carry a higher
degree of risk, relying on the ongoing success of the business to
repay the loan. Collateral for commercial credits is often
difficult to secure, and even more difficult to liquidate in the
event of a default. If a commercial business loan demonstrates any
credit weakness, the reserve is increased to recognize the
additional
risk.
* Consumer Loans - The consumer loan portfolio has a wide range of
factors, determined primarily by the nature of the collateral and
the
credit history and capacity of the borrower. The loans tend to be
smaller in principal amount and secured by second deeds of trust,
automobiles, boats, and other vehicles. Loans for automobiles,
boats, and other vehicles, generally experience higher than average
wear in the environment and hold a higher degree of risk of loss in
the event of repossession.
* Unsecured Credit Cards - Due to the unsecured nature of these
accounts, these types of loans represent the highest degree of risk.
The Bank, therefore, uses a higher percentage factor than any
other loan classification, when estimating future potential loan
losses.
Management believes that the allowance for loan losses at March 31, 2004
was adequate at that date. Although management believes that it uses the
best information available to make these determinations, future adjustments
to the allowance for loan losses may be necessary and results of operations
could be significantly and adversely affected if circumstances differ
substantially from the assumptions used in making the determinations.
While the Bank believes it has established its existing allowance for
loan losses in accordance with generally accepted accounting principles,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request the Bank to increase significantly its allowance
for loan losses. In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that substantial
increases will not be necessary should the quality of any loans deteriorate
as a result of the factors discussed above. Any material increase in the
allowance for loan losses may adversely affect the Bank's financial condition
and results of operations.
The Bank established an allowance for losses for the year ended March
31, 2004 in the amount of $10.1 million and $8.5 million for the year ended
March 31, 2003. The Bank's loan loss reserve as of March 31, 2004, was
approximately 1.5% of net loans receivable.
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended March 31,
-----------------------------------------------
- -
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance at beginning of
period...................... $ 8,506 $5,887 $4,977 $4,757 $4,463
Provision for loan losses.... 1,915 2,740 1,089 320 437
Recoveries:
First mortgage loans........ -- -- -- -- --
Commercial loans............ 79 -- -- -- --
Credit card loans........... 6 8 4 1 1
Other consumer loans........ 1 -- 4 -- -
------- ------ ------ ------ ------
Total recoveries.......... 86 8 8 1 1
(table continues on following page)
9
Year Ended March 31,
-----------------------------------------------
- -
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Charge-offs:
First mortgage loans........ -- -- (28) (60)
(90)
Commercial loans............ (254) (54) (148) (21)
(10)
Credit card loans........... (124) (72) (5) (20)
(43)
Other consumer loans........ (8) (4) (6) --
(1)
------- ------ ------ ------ ------
Total charge-offs......... (386) (129) (187) (101)
(144)
Net charge-offs........... (300) (121) (179) (100)
(143)
------- ------ ------ ------ ------
Allowance at end of period... $10,121 $8,506 $5,887 $4,977 $4,757
======= ====== ====== ====== ======
Allowance for loan losses
as a percentage of total
loans outstanding at the end
of the period................ 1.48% 1.35% 0.96% 0.78%
0.77%
Net charge-offs as a percent-
of average loans outstanding
during the period............ 0.05% 0.02% 0.03% 0.02%
0.02%
Allowance for loan losses as
a percentage of nonperform-
ing assets at end of period..2,518.51% 511.09% 614.70% 597.94%
385.13%
The following table sets forth the breakdown of the allowance for loan
losses by loan category for the periods indicated.
At March 31,
---------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------------- ---------------- ---------------- ---------------- ----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Commercial,
financial and
agricultural.... $ 8,007 79.1% $6,365 74.8% $3,353 51.6% $1,923 37.4% $1,187 27.0%
Residential real
estate-mortgage. 2,114 20.9 2,141 25.2 2,534 48.4 3,054 62.6 3,570 73.0
------- ----- ------ ----- ------ ----- ------ ----- ------ -----
Total allowance
for loan
losses........ $10,121 100.0% $8,506 100.0% $5,887 100.0% $4,977 100.0% $4,757 100.0%
======= ===== ====== ===== ====== ===== ====== ===== ====== =====
The Bank had an allowance of $0, $0, $50,000, $0 and $0 for real estate
acquired through foreclosure at March 31, 2004, 2003, 2002, 2001 and 2000.
Investment Activities
- ---------------------
Under Washington law, savings banks are permitted to own U.S. government
and government agency obligations, commercial paper, corporate bonds, mutual
fund shares, debt and equity obligations issued by creditworthy entities,
whether traded on public securities exchanges or placed privately for
investment purposes. The Bank holds a diverse portfolio of money market
instruments, United States Treasury obligations, federal agency securities,
municipal securities, common stock, preferred stock and corporate notes.
10
The FDIC has adopted the Federal Financial Institutions Examination
Council statement of policy on securities activities and accounting
procedures. This policy requires that institutions establish prudent
policies and strategies for securities activities, identify certain
securities trading practices that are unsuitable for an investment portfolio,
recommends procedures for selection of a securities dealer, and limits
investment in high risk mortgage securities and disproportionately large
holdings of long-term zero coupon bonds.
The policy addresses concerns about speculative or other non-investment
activities in the securities investment portfolios of depository
institutions. Speculative securities activities can impair earnings or
capital and, in some cases, may cause the failure of the institution. The
policy establishes a framework for structuring securities activities and
clarifies various accounting issues concerning investment accounts versus
trading accounts.
The amortized cost of the above investments at March 31, 2004 was $78.0
million compared to a market value of $85.6 million. For further information
concerning the Bank's investment securities portfolio, see Notes 3 and 4 of
the Notes to the Consolidated Financial Statements contained in Item 8 of
this Form 10-K.
The Bank also invests in mortgage-backed securities. At March 31, 2004,
such securities had an amortized cost of $28.9 million and a market value of
$29.4 million.
The following table presents the amortized cost of the Bank's investment
securities portfolio and short-term investments. The market value of the
Bank's investment securities portfolio at March 31, 2004 was approximately
$115.0 million. This does not include interest-bearing deposits and cash
equivalents.
At March 31,
----------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Investment securities:
U.S. Government:
Available for sale................ $ 57,397 $ 38,821 $ 23,587
Held to maturity.................. 369 369 369
-------- -------- --------
57,766 39,190 23,956
Mortgage-backed securities(1):
Available for sale................ 27,363 37,141 29,453
Held to maturity.................. 1,544 2,793 4,410
-------- -------- --------
28,907 39,934 33,863
Other securities(2):
Available for sale................ 20,266 27,386 17,031
Held to maturity.................. -- -- --
-------- -------- --------
20,266 27,386 17,031
-------- -------- --------
Total investments................. 106,939 106,510 74,850
Interest bearing deposits and cash
equivalents......................... 39,199 75,013 83,962
-------- -------- --------
$146,138 $181,523 $158,812
======== ======== ========
- --------------
(1) Consists of mortgage-backed securities and CMO's.
(2) Consists of corporate debt securities, marketable equity securities and
mutual funds.
At March 31, 2004, the Bank did not have any investment securities
(exclusive of obligations of the U.S. Government and federal agencies) issued
by any one entity with a total book value in excess of 10% of stockholders'
equity.
11
The following table sets forth the scheduled maturities, amortized cost, market values and average
yields for the Bank's investment securities at March 31, 2004.
At March 31, 2004*
----------------------------------------------------------------------------------------
One Year One to Five Five to Ten More than Total
or Less Years Years Ten Years Investment Securities
------------- ------------- ------------- ------------- ----------------------
Amor- Aver- Amor- Aver- Amor- Aver- Amor- Aver- Amor- Aver-
tized age tized age tized age tized age tized Market age
Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
(Dollars in thousands)
U.S. Government,
agency securities,
state and politi-
cal subdivisions:
Available for
sale..........$ 8,025 4.14% $43,703 3.98% $2,868 4.37% $ 2,801 4.72% $ 57,397 $ 59,001
4.06%
Held to
maturity...... -- -- 369 4.30 -- -- -- -- 369 400 4.30
------ ---- ------- ---- ------ ---- ------- ---- ------- -------- ----
8,025 4.14 44,072 3.98 2,868 4.37 2,801 4.72 57,766 59,401 4.06
Mortgage-backed
securities:
Available for
sale......... 87 5.96 882 4.76 5,089 4.87 21,305 3.54 27,363 27,760 3.84
Held to
maturity..... 1 16.24 863 6.43 439 6.43 241 9.21 1,544 1,653 6.87
------ ---- ------- ---- ------ ---- ------- ---- ------- -------- ----
88 5.96 1,745 5.59 5,528 4.99 21,546 3.61 28,907 29,413 4.00
Other:
Available for
sale......... 13,245 5.25 7,021 4.57 -- -- -- -- 20,266 26,183 5.01
Held to
maturity..... -- -- -- -- -- -- -- -- -- -- --
------ ---- ------- ---- ------ ---- ------- ---- ------- -------- ----
13,245 5.25 7,021 4.57 -- -- -- -- 20,266 26,183 5.01
------ ---- ------- ---- ------ ---- ------- ---- ------- -------- ----
Total........ $21,358 4.83% $52,838 4.11% $8,396 4.78% $24,347 3.74% $106,939 $114,997
4.21%
======= ==== ======= ==== ====== ==== ======= ==== ======== ======== ====
- ----------------
* At March 31, 2004, yields on the Bank's tax-exempt obligations had not been computed on a tax
equivalent basis.
12
Savings Activities and Other Sources of Funds
General. Savings accounts and other types of deposits have
traditionally been an important source of the Bank's funds for use in lending
and for other general business purposes. In addition to deposit accounts,
the Bank derives funds from loan repayments, loan sales, and other borrowings
and operations. The availability of funds from loan sales is influenced by
general interest rates and other market conditions. Loan repayments are a
relatively stable source of funds while deposit inflows and outflows vary
widely and are influenced by prevailing interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in deposits or deposit inflows at less than projected levels and
may be used on a longer term basis to support expanded lending activities.
Deposits. Horizon Bank offers several deposit accounts, including
Regular Passbook and Statement Savings Accounts, Personal and Business
Checking Accounts, Money Market with and without Check Access and
Certificates of Deposit Accounts with maturities ranging from 30 days up to
10 years. Certificates of Deposit account requirements vary according to
minimum principal balances, the time period the funds must remain on deposit
and the interest rate determined for each term and minimum balance.
The following table sets forth certain information concerning the
deposits at the Bank.
Year Ended March 31,
-----------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Weighted Weighted Weighted
Average Average Average Average Average Average
Type Balance Rate Balance Rate Balance Rate
- ------------------ ------- ---- ------- ---- ------- ----
(Dollars in thousands)
Savings............. $ 39,611 0.73% $ 36,652 1.19% $ 33,676 2.06%
Checking............ 107,933 0.46 82,516 0.60 69,457 0.82
Money Market........ 122,314 1.08 126,080 1.75 95,280 2.80
Time Deposits....... 373,725 2.99 391,576 3.73 406,920 5.20
-------- ---- -------- ---- -------- ----
Total............. $643,583 2.06% $636,824 2.79% $605,333 4.14%
======== ==== ======== ==== ======== ====
The following table indicates the amount of the Bank's deposits by time
remaining until maturity as of March 31, 2004 of $100,000 or more.
Certificates
Maturity Period of Deposit
-------------------------- --------------
(In thousands)
Three months or less........... $ 22,159
Three through six months....... 16,855
Six through twelve months...... 28,360
Over twelve months............. 61,969
--------
Total....................... $129,343
========
The Bank has a number of different programs designed to attract both
short-term and long-term savings of the general public by providing a wide
assortment of accounts and rates. The program includes traditional savings
accounts; nonnegotiable time deposits with minimum deposits of $100,000 and
terms of 30 days to five years called Jumbo Certificates of Deposit;
nonnegotiable, nontransferable time deposits with minimum deposits of $500
and terms from 30 days to five years at fixed rates; 12-month to 10-year
variable rate fixed term certificates; Individual Retirement Accounts (IRAs);
Qualified Retirement Plans; transaction accounts such as regular checking;
MMDAs with and without limited check access.
13
The Bank's practice on early withdrawal penalties is applicable only to
time deposits. Management believes that in periods of rising interest rates
this practice will discourage depositors from making premature withdrawals
for the purpose of reinvesting in higher rate time deposits.
The minimum amount required to open a time deposit varies from $500 to
$100,000, depending on the type of time deposit. Pricing of rates on time
deposits with maturities from 30 days to 10 years are determined periodically
by the Bank, based upon competitive rates and local market rates, national
money market rates, and yields on assets of the same maturity.
The Bank's personal MMDA currently has a $1,000 minimum deposit and has
a tiered pricing program, with interest rates that vary by account dollar
balance -- $1,000, $10,000, $25,000, $50,000 and higher. The Bank's Business
MMDA has tiers of $1,000, $10,000, $50,000, $100,000 and higher, with a
$1,000 minimum deposit. These accounts have no maturity requirements, no
regulatory interest rate ceilings, and limited check writing privileges. The
interest rates on these accounts are adjusted by the Bank periodically, based
on money market conditions. The Bank currently has a $10,000 minimum
deposit (ULT) money market and has a tiered pricing program, with interest
rates that vary by account dollar balance -- $10,000, $25,000, $50,000 and
higher. The Bank also offers a $25,000 minimum deposit (ULT PLUS) money
market and has a tiered pricing program, with interest rates that vary by
account dollar balance -- $25,000, $50,000, $100,000 and higher. These
accounts have no maturity requirements, no regulatory interest rate ceiling,
and no check writing privileges. The interest rates on the account are
adjusted by the Bank periodically or as dictated by money market conditions.
The large variety of deposit accounts offered by the Bank has increased
the Bank's ability to retain deposits and has allowed it to be competitive in
obtaining new funds, although the threat of disintermediation (the flow of
funds away from the Bank into direct investment vehicles, such as common
stocks and mutual funds) still exists. The ability of the Bank to attract
and retain deposits and the Bank's cost of funds have been, and will continue
to be, significantly affected by capital and money market conditions.
Horizon Bank attempts to control the flow of deposits by pricing its
accounts to remain competitive with other financial institutions in its
market area but does not necessarily seek to match the highest rates paid by
competing institutions.
The senior officers of the Bank meet periodically to determine the
interest rates which the Bank will offer to the general public. Such
officers consider the amount of funds needed by the Bank on both a short-term
and long-term basis, the rates being offered by the Bank's competitors,
alternative sources of funds and the projected level of interest rates in the
future.
The Bank's deposits are obtained primarily from residents of Northwest
Washington. Horizon Bank attracts deposits by offering a wide variety of
services and convenient branch locations and service hours. Historically,
the Bank has not solicited brokered deposits.
For further information concerning the Bank's savings deposits,
reference is made to Note 9 of the Notes to the Consolidated Financial
Statements contained in Item 8 hereof.
Borrowings. In December 1998, the Bank joined the Federal Home Loan
Bank of Seattle providing access to a variety of wholesale funding options.
In addition, the Bank's security portfolio provides additional borrowing
capacity in the reverse repurchase markets. The Bank also has other borrowed
funds in the form of retail repurchase agreements. The agreements are
collateralized by securities held by a safekeeping agent not under control of
the Bank. These advances are considered overnight borrowings bearing
interest rates that fluctuate daily based on current market rates. At March
31, 2004, the Bank had $67.5 million in borrowings, compared to $53.8 million
at March 31, 2003 and $29.1 million in borrowings during the year ended March
31, 2002. Access to these wholesale borrowings allows management to meet
cyclical funding needs, and assists in interest rate risk management efforts.
See Note 11 of the Notes to the Consolidated Financial Statements
contained in Item 8 of the Form 10-K.
14
Competition
- -----------
The Bank faces strong competition in its market area in originating
loans and attracting deposits. Competition in originating loans is primarily
from other commercial banks, thrift institutions, mortgage companies, credit
unions and consumer finance companies. The Bank competes for loan
originations primarily through interest rates and loan fees it charges and
through the efficiency and quality of services it provides borrowers.
Competition is affected by, among other things, the general availability of
lendable funds, general and local economic conditions and current interest
rate levels.
In attracting deposits, the Bank competes primarily with other
commercial banks, thrift institutions, credit unions and brokerage firms.
The Bank competes for customer deposits principally on the basis of
convenience and quality of its banking services and the investment
opportunities that satisfy the requirements of investors with respect to rate
of return, liquidity, risk and other factors. The primary factors in
competing for deposits are interest rates and the convenience of office
locations. In light of the deregulation of interest rate controls on
deposits, the Bank has faced increasing competition for deposits from
commercial banks, other thrift institutions and non-regulated financial
intermediaries.
Personnel
- ---------
At March 31, 2004, Horizon Bank employed 225 full-time and 18 part-time
employees. Horizon Bank employees are not represented by any collective
bargaining agreement. Management of Horizon Bank considers its relations
with its employees to be good.
Regulation and Supervision
- --------------------------
The Bank.
General. As a state-chartered, federally insured bank, Horizon Bank is
subject to extensive federal and state regulation. Lending activities and
other investments must comply with various statutory and regulatory
requirements, including prescribed minimum capital standards. Horizon Bank
is regularly examined by the FDIC and the Washington Department of Financial
Institutions, Division of Banks, and files periodic reports concerning the
Bank's activities and financial condition with its regulators. The Bank's
relationship with depositors and borrowers also is regulated to a great
extent by both federal and state law, especially in such matters as the
ownership of deposit accounts and the form and content of loan documents.
The law and regulations of the State of Washington pertaining to banks and
other corporations apply to the Bank. Among other things, those laws and
regulations govern the Bank's investments and borrowings, loans, payment of
interest and dividends, and establishment and relocation of branch offices.
Federal and state banking laws and regulations govern all areas of the
operation of the Bank, including reserves, loans, mortgages, capital,
issuance of securities, payment of dividends and establishment of branches.
Federal and state bank regulatory agencies also have the general authority to
limit the dividends paid by insured banks and bank holding companies if such
payments should be deemed to constitute an unsafe and unsound practice. The
respective primary federal regulators of the Corporation and the Bank have
authority to impose penalties, initiate civil and administrative actions and
take other steps intended to prevent banks from engaging in unsafe or unsound
practices.
State Regulation and Supervision. As a state-chartered savings bank,
the Bank is subject to applicable provisions of Washington law and
regulations of the Washington Department of Financial Institutions. State
law and regulations govern the Bank's ability to take deposits and pay
interest, to make loans on or invest in residential and other real estate, to
make consumer loans, to invest in securities, to offer various banking
services to its customers, and to establish branch offices. Under state law,
savings banks in Washington also generally have all of the powers that
federal savings banks have under federal laws and regulations. The Bank is
subject to periodic examination and reporting requirements by and of the
Washington Department of Financial Institutions, Division of Banks.
15
Deposit Insurance. The FDIC is an independent federal agency that
insures the deposits, up to applicable limits, of depository institutions.
The FDIC currently maintains two separate deposit insurance funds: the BIF
and the SAIF. The BIF is a deposit insurance fund for commercial banks and
some state-chartered savings banks. The SAIF is a deposit insurance fund for
most savings associations. The Bank is insured under the BIF fund. As an
insurer of the Bank's deposits, the FDIC has examination, supervisory and
enforcement authority over the Bank.
The FDIC has established a risk-based system for setting deposit
insurance assessments. Under the risk-based assessment system, an
institution's insurance assessment varies according to the level of capital
the institution holds, the balance of insured deposits during the preceding
two quarters, and the degree to which it is the subject of supervisory
concern. In addition, regardless of the potential risk to the insurance
fund, federal law requires the ratio of reserves to insured deposits at $1.25
per $100. Both funds currently meet this reserve ratio. Since 1997, the
assessment rate for both SAIF and BIF deposits has ranged from zero to 0.27%
of covered deposits. As a well capitalized bank, Horizon Bank qualified for
the lowest rate on its deposits for 2004.
In addition to deposit insurance assessments, the FDIC is authorized to
collect assessments against insured deposits to be paid to the Financing
Corporation ("FICO") to service FICO debt incurred in the 1980's to help fund
the thrift industry cleanup. The FICO assessment rate is adjusted quarterly.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the
institution at the time of termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined
by the FDIC. Management is not aware of any existing circumstances that
could result in termination of the deposit insurance of Horizon Bank.
Capital Requirements. Federally insured savings institutions, such as
Horizon Bank, are required to maintain a minimum level of regulatory capital.
FDIC regulations recognize two types, or tiers, of capital: core ("Tier 1")
capital and supplementary ("Tier 2") capital. Tier 1 capital generally
includes common stockholders' equity and noncumulative perpetual preferred
stock, less most intangible assets. Tier 2 capital, which is limited to 100
percent of Tier 1 capital, includes such items as qualifying general loan
loss reserves, cumulative perpetual preferred stock, mandatory convertible
debt, term subordinated debt and limited life preferred stock; however, the
amount of term subordinated debt and intermediate term preferred stock
(original maturity of at least five years but less than 20 years) that may be
included in Tier 2 capital is limited to 50 percent of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets. Most banks are required to maintain a minimum leverage ratio
of at least 4% to 5% of total assets. The FDIC retains the right to require
a particular institution to maintain a higher capital level based on an
institution's particular risk profile. The Bank's leverage ratio was 12.58%
as of March 31, 2004. Horizon Bank has not been notified by the FDIC of any
higher capital requirements specifically applicable to it.
FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk- weighted assets. Assets are placed in
one of four categories and given a percentage weight -- 0%, 20%, 50% or 100%
- -- based on the relative risk of that category. In addition, certain
off-balance-sheet items are converted to balance-sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories.
Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2
capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1
capital to risk-weighted assets must be at least 4%. In evaluating the
adequacy of a bank's capital, the FDIC may also consider other factors that
may affect a bank's financial condition. Such factors may include interest
rate risk exposure, liquidity, funding and market risks, the quality and
level of earnings, concentration of credit risk, risks arising from
nontraditional activities, loan and investment quality, the effectiveness of
loan and investment policies, and management's
16
ability to monitor and control financial operating risks. At March 31, 2004,
the Bank's determined that its total risk-based ratio was 16.6% and its Tier
1 risk-based capital ratio was 15.0%.
The Washington Department of Financial Institutions requires that net
worth equal at least 5% of total assets. Intangible assets must be deducted
from net worth and assets when computing compliance with this requirement.
At March 31, 2004, Horizon Bank had a net worth of 12.7% of total assets.
Horizon Bank's management believes that, under the current regulations,
the Bank will continue to meet its minimum capital requirements in the
foreseeable future. However, events beyond the control of the Bank, such as
a downturn in the economy in areas where the Bank has most of its loans,
could adversely affect future earnings and, consequently, the ability of the
Bank to meet its capital requirements.
Federal Deposit Insurance Improvement Act ("FDICIA"). Horizon Bank has
surpassed the $500 million asset threshold, and as such, is required to be
compliant with the FDICIA originally enacted in 1991 and with enhanced
provisions adopted in 1993. In general, FDICIA requires the Bank to conduct
an annual independent audit of its financial statements, appoint an
independent audit committee of outside directors, report on and assess
management's responsibilities for preparing financial statements, and
establish an internal control structure.
An independent accountant must attest to and report on the assertions in
management's reports concerning these internal controls with the desired
outcome of efficient and effective operations; the safeguarding of assets;
reliable financial reporting and compliance with applicable laws and
regulations.
The FDIC as the primary regulator of the Bank has outlined, in general,
the requirements for compliance with FDICIA, but does not provide specific
guidance on the internal control structure, documentation, or procedures to
test the Bank's effectiveness. It is up to each bank to establish, document
and design procedures to evaluate and test the internal control structure
over financial reporting and compliance with designated laws and regulations
that minimally include loans to insiders and dividend restrictions.
In brief, to ensure compliance, the Bank has established and coordinated
a management team that identifies and documents existing controls with
consideration given to the Bank's control environment, risk assessment,
control activities, information and communication systems, and monitoring
activities. In addition, management establishes internal control procedures,
develops and selects criteria for evaluation, tests the effectiveness of
controls, and ensures that proper written documentation is in place.
Under FDICIA, the Audit Committee has several responsibilities that
include but are not limited to overseeing the internal audit function;
conducting periodic meetings with management, the independent public
accountant, and the internal auditors; review of significant accounting
policies, and audit conclusions regarding significant accounting estimates;
review of the assessments prepared by management and independent auditor on
the adequacy of internal controls and the resolution of identified material
weaknesses and reportable conditions in internal controls; and the review of
compliance with laws and regulations.
Federal Home Loan Bank System. The FHLB of Seattle serves as a reserve
or central bank for the member institutions within its assigned region. It is
funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLBs. It makes loans (i.e., advances) to members in
accordance with policies and procedures established by the Federal Housing
Finance Board and the Board of Directors of the FHLB of Seattle. As a
member, the Bank is required to purchase and hold stock in the FHLB of
Seattle in an amount equal to the greater of 1% of their aggregate unpaid
home loan balances at the beginning of the year or an amount equal to 5% of
FHLB advances outstanding. As of March 31, 2004, Horizon Bank held stock in
the FHLB of Seattle in the amount of $7.0 million. See "Business -- Savings
Activities and Other Sources of Funds -- Borrowings."
Federal Reserve System. The Federal Reserve Board requires (under
"Regulation D") that all depository institutions, including savings banks,
maintain reserves on transaction accounts and non-personal time deposits.
These reserves may be in the form of cash or non-interest bearing deposits
with the regional Federal Reserve Bank. NOW
17
accounts and other types of accounts that permit payments or transfers to
third parties fall within the definition of transaction accounts and are
subject to Regulation D reserve requirements, as are any non-personal time
deposits at savings bank. Under Regulation D, a bank must maintain reserves
against net transaction accounts, in the amount of 3% on amounts of $37.3
million or less, plus10% on amounts in excess of $37.3 million. In addition,
a bank may designate and exempt $5.0 million of certain reservable
liabilities from these reserve requirements. The amounts and percentages are
subject to adjustment by the Federal Reserve. The reserve requirement on
non-personal time deposits with original maturities of less than 1.5 years is
0%. As of March 31, 2004, the Bank was in compliance with the Federal
Reserve Bank's reserve requirements.
Prompt Corrective Action. Federal statutes establish a supervisory
framework based on five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measure, which include a
risk-based capital measure, a leverage ratio capital measure, and certain
other factors. The federal banking agencies have adopted regulations that
implement this statutory framework. Under these regulations, an institution
is treated as well capitalized if its ratio of total capital to risk-weighted
assets is 10% or more, its ratio of core capital to risk-weighted assets is
6% or more, its ratio of core capital to adjusted total assets is 5% or more,
and it is not subject to any federal supervisory order or directive to meet a
specific capital level. In order to be adequately capitalized, an
institution must have a total risk-based capital ratio of not less than 8%, a
Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of
not less than 4%. Any institution which is neither well capitalized nor
adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure
by the Bank to comply with applicable capital requirements would, if
unremedied, result in restrictions on its activities and lead to enforcement
actions, including, but not limited to, the issuance of a capital directive
to ensure the maintenance of required capital levels. Banking regulators
will take prompt corrective action with respect to depository institutions
that do not meet minimum capital requirements. Additionally, approval of any
regulatory application filed for their review may be dependent on compliance
with capital requirements.
The Corporation.
General. The Corporation, as the sole shareholder of the Bank, is a
bank holding company and is registered as such with the Federal Reserve.
Bank holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"),
and the regulations of the Federal Reserve. As a bank holding company, the
Corporation is required to file with the Federal Reserve annual reports and
such additional information as the Federal Reserve may require and will be
subject to regular examinations by the Federal Reserve. The Federal Reserve
also has extensive enforcement authority over bank holding companies,
including, among other things, the ability to assess civil money penalties to
issue cease and desist or removal orders and to require that a holding
company divest subsidiaries (including its bank subsidiaries). In general,
enforcement actions may be initiated for violations of law and regulations
and unsafe or unsound practices.
The Bank Holding Company Act. Under the BHCA, the Corporation is
supervised by the Federal Reserve. The Federal Reserve has a policy that a
bank holding company is required to serve as a source of financial and
managerial strength to its subsidiary banks and may not conduct its
operations in an unsafe or unsound manner. In addition, the Federal Reserve
provides that bank holding companies should serve as a source of strength to
its subsidiary banks by being prepared to use available resources to provide
adequate capital funds to its subsidiary banks during periods of financial
stress or adversity, and should maintain the financial flexibility and
capital raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligation to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking
practice or a violation of the Federal Reserve's regulations or both.
18
The Corporation is required to file quarterly and periodic reports with
the Federal Reserve and provide additional information as the Federal Reserve
may require. The Federal Reserve may examine the Corporation and any of its
subsidiaries, and charge the Corporation for the cost of the examination.
The Corporation and any subsidiaries that it may control are considered
"affiliates" within the meaning of the Federal Reserve Act, and transactions
between the Corporation's bank subsidiary and affiliates are subject to
numerous restrictions. With some exceptions, the Corporation and its
subsidiaries, are prohibited from tying the provision of various services,
such as extensions of credit, to other services offered by the Corporation,
or our affiliates.
Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the
"Act"). The Act modernized the financial services industry by establishing
a comprehensive framework to permit affiliations among commercial banks,
insurance companies, securities firms and other financial service providers.
Generally, the Act:
(a) repealed the historical restrictions and eliminated many federal
and
state law barriers to affiliations among banks, securities firms,
insurance companies and other financial service providers;
(b) provided a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding
companies;
(c) broadened the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their financial
subsidiaries;
(d) provided an enhanced framework for protecting the privacy of
consumer information; and
(e) addressed a variety of other legal and regulatory issues affecting
day-to-day operations and long-term activities of financial
institutions.
The USA Patriot Act. In response to the terrorist events of September
11, 2001, the President of the United States signed into law the Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept
and Obstruct Terrorism Act of 2001, or the USA Patriot Act, on October 26,
2001. The USA Patriot Act gives the federal government new powers to address
terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing, and broadened anti-money
laundering requirements. By way of amendments to the Bank Secrecy Act, Title
III of the USA Patriot Act takes measures intended to encourage information
sharing among bank regulatory agencies and law enforcement bodies. Further,
certain provisions of Title III impose affirmative obligations on a broad
range of financial institutions.
Among other requirements, Title III of the USA Patriot Act imposes the
following requirements with respect to financial institutions:
* Financial institutions must establish anti-money laundering
programs
that include: (i) internal policies, procedures, and controls; (ii)
specific designation of an anti-money laundering compliance
officer;
(iii) ongoing employee training programs; and (iv) an independent
audit function to test the anti-money laundering program.
* Financial institutions that establish, maintain, administer, or
manage private banking accounts or correspondent accounts in the
United States for non-United States persons or their
representatives
must establish appropriate, specific, and, where necessary, enhance
due diligence policies, procedures, and controls designed to detect
and report money laundering.
* Financial institutions are prohibited from establishing,
maintaining, administering or managing correspondent accounts for
foreign banks that do not have a physical presence in any country
and will be subject to certain recordkeeping obligations with
respect to correspondent accounts of foreign banks.
19
* Bank regulators must consider a holding company's effectiveness in
combating money laundering when ruling on Federal Reserve Act and
Bank Merger Act applications.
The Corporation's policies and procedures have been updated to reflect
the requirements of the USA Patriot Act. No significant changes in the
Corporation's business or customer practices were required as a result of the
implementation of these requirements.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley Act") was signed into law by the President of the United
States on July 30, 2002 in response to public concerns regarding corporate
accountability in connection with the recent accounting scandals. The stated
goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to
provide for enhanced penalties for accounting and auditing improprieties at
publicly traded companies and to protect investors by improving the accuracy
and reliability of corporate disclosures pursuant to the securities laws. The
Sarbanes-Oxley Act generally applies to all companies, both U.S. and
non-U.S., that file or are required to file periodic reports with the
Securities and Exchange Commission ("SEC"), under the Securities Exchange Act
of 1934 ("Exchange Act").
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and other related rules and mandates further studies of certain
issues by the SEC and the Comptroller General. The Sarbanes-Oxley Act
represents significant federal involvement in matters traditionally left to
state regulatory systems, such as the regulation of the accounting
profession, and to state corporate law, such as the relationship between a
board of directors and management and between a board of directors and its
committees.
The Sarbanes-Oxley Act addresses, among other matters:
* audit committees;
* certification of financial statements by the chief executive
officer and the chief financial officer;
* the forfeiture of bonuses or other incentive-based compensation
and
profits from the sale of an issuer's securities by directors and
senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
* a prohibition on insider trading during pension plan black out
periods;
* disclosure of off-balance sheet transactions;
* a prohibition on personal loans to directors and officers;
* expedited filing requirements for Form 4s;
* disclosure of a code of ethics and filing a Form 8-K for a change
or waiver of such code;
* "real time" filing of periodic reports;
* the formation of a public accounting oversight board;
* auditor independence; and
* various increased criminal penalties for violations of securities
laws.
Acquisitions. Under the BHCA, a bank holding company must obtain
Federal Reserve approval before: (1) acquiring, directly or indirectly,
ownership or control of any voting shares of another bank or bank holding
company if,
20
after such acquisition, it would own or control more than 5% of such shares
(unless it already owns or controls the majority of such shares); (2)
acquiring all or substantially all of the assets of another bank or bank
holding company; or (3) merging or consolidating with another bank holding
company.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company which is not a bank or bank holding company, or
from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statute or by Federal Reserve regulation or
order, have been identified as activities closely related to the business of
banking or managing or controlling banks. The list of activities permitted
by the Federal Reserve includes, among other things, operating a savings
institution, mortgage company, finance company, credit card company or
factoring company, performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing
property on a full-payout, non-operating basis; selling money orders,
travelers' checks and United States Savings Bonds; real estate and personal
property appraising; providing tax planning and preparation services; and,
subject to certain limitations, providing securities brokerage services for
customers.
Dividends. The Federal Reserve's policy statement on the payment of
cash dividends by bank holding companies expresses the Federal Reserve's view
that a bank holding company should pay cash dividends only to the extent that
the company's net income for the past year is sufficient to cover both the
cash dividends and a rate of earning retention that is consistent with the
company's capital needs, asset quality and overall financial condition. The
Federal Reserve also indicated that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.
Capital Requirements. The Federal Reserve has established capital
requirements for bank holding companies that generally parallel the capital
requirements for national banks under the Office of the Comptroller of the
Currency's regulations. Under the Federal Reserve Board's capital
guidelines, at March 31, 2004, the Corporation's levels of consolidated
regulatory capital exceed the Federal Reserve's minimum requirements, as
follows:
Amount Percent
------ -------
(Dollars in thousands)
Tier 1 Capital $103,505 14.99%
Minimum Tier 1 (leverage) requirement 32,954 4.00
-------- -----
Excess $ 70,551 10.99%
======== =====
Risk-based capital $114,607 16.60%
Minimum risk-based capital requirement 55,247 8.00
-------- -----
Excess $ 59,360 8.60%
======== =====
Stock Repurchases. Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, are required to
give the Federal Reserve prior written notice of any purchase or redemption
of its outstanding equity securities if the gross consideration for the
purchase or redemption, when combined with the net consideration paid for all
such purchases or redemptions during the preceding 12 months, is equal to 10%
or more of their consolidated net worth. The Federal Reserve may disapprove
such a purchase or redemption if it determines that the proposal would
constitute an unsafe or unsound practice or would violate any law,
regulation, Federal Reserve order, or any condition imposed by, or written
agreement with, the Federal Reserve.
The Corporation has been in various buy-back programs of its outstanding
Common Stock since August 1996. In March 2004, the Board of Directors
approved a new stock repurchase plan that runs concurrent with the 2005
fiscal year, allowing the Corporation to repurchase up to 10% of total shares
outstanding, or approximately 1.04 million shares. This marked the
Corporation's sixth stock repurchase plan. In fiscal 2004, under the previous
plans, the Corporation
21
repurchased 314,240 shares at an average price of $17.353. For additional
information concerning the Corporation's repurchase activities during the
fourth quarter of fiscal 2004, see Item 5 hereof.
Taxation
- --------
Federal Taxation.
General. The Corporation and the Bank report their consolidated income
on a fiscal year basis using the accrual method of accounting and are subject
to federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Corporation. Reference is made to Note 12 of
the Notes to the Consolidated Financial Statements contained in Item 8 of
this Form 10-K for additional information concerning the income taxes payable
by the Bank.
Tax Bad Debt Reserves. Historically, savings institutions such as the
Bank, which met certain definitional tests primarily related to their assets
and the nature of their businesses, were permitted to establish a reserve for
bad debts and to make annual additions to the reserve. These additions may,
within specified formula limits, have been deducted in arriving at the Bank's
taxable income. For purposes of computing the deductible addition to its bad
debt reserve, the Bank's loans are separated into "qualifying real property
loans" (i.e., generally those loans secured by interests in residential real
property) and all other loans ("non-qualifying loans"). The following
formulas were used to compute the bad debt deduction with respect to
qualifying real property loans: (i) actual loss experience or (ii) a
percentage equal to 8% of taxable income. The deduction with respect to
non-qualifying loans was computed under the experience method. Reasonable
additions to the reserve for losses on non-qualifying loans were based upon
actual loss experience and would reduce the current year's addition to the
reserve for losses on qualifying real property loans, unless that addition
was also determined under the experience method. The sum of the additions to
each reserve for each year was the Bank's annual bad debt deduction.
The provisions repealing the current thrift bad debt rules were passed
by Congress as part of "The Small Business Job Protection Act of 1996." The
new rules eliminate the 8% of taxable income method for deducting additions
to the tax bad debt reserves for all financial institutions for tax years
beginning after December 31, 1995. These rules also require that all
institutions recapture all or a portion of their bad debt reserves added
since the base year (last taxable year beginning before January 1, 1988).
The Bank has previously recorded a deferred tax liability equal to the bad
debt recapture and as such the new rules will have no effect on the net
income or federal income tax expense. For taxable years beginning after
December 31, 1995, the Bank's bad debt deduction will be determined under the
experience method using a formula based on actual bad debt experience over a
period of years or, if the Bank is a "large" association (assets in excess of
$500 million) on the basis of net charge-offs during the taxable year. The
new rules allow an institution to suspend bad debt reserve recapture for the
1996 and 1997 tax years if the institution's lending activity for those years
is equal to or greater than the institution's average mortgage lending
activity for the six taxable years preceding 1996 adjusted for inflation.
For this purpose, only home purchase or home improvement loans are included
and the institution can elect to have the tax years with the highest and
lowest lending activity removed from the average calculation. If an
institution is permitted to postpone the reserve recapture, it must begin its
six year recapture no later than the 1998 tax year. The unrecaptured base
year reserves will not be subject to recapture as long as the institution
continues to carry on the business of banking. In addition, the balance of
the pre-1988 bad debt reserves continue to be subject to provisions of
present law referred to below that require recapture in the case of certain
excess distributions to shareholders.
Distributions. If a stock institution distributes amounts to
stockholders and the distribution is treated as being from its accumulated
bad debt reserves, the distribution will cause the institution to have
additional taxable income. A distribution to stockholder is deemed to have
been made from accumulated bad debt reserves to the extent that (i) the
reserves exceed the amount that would have been accumulated on the basis of
actual loss experience, and (ii) the distribution is a "non-dividend
distribution." A distribution in respect of stock is a non-dividend
distribution to the extent that, for federal income tax purposes, (i) it is
redemption of shares, (ii) it is pursuant to a liquidation or partial
liquidation of the institution, or (iii) in the case of current distribution,
together with all other such distributions during the taxable
22
year, it exceeds the institution's current and post-1951 accumulated earnings
and profits. The amount of additional taxable income created by a
non-dividend distribution is an amount that, when reduced by tax attributable
to it, is equal to the amount of the distribution.
Minimum Tax. In addition to regular corporate income tax, corporations
are subject to an alternative minimum tax which generally is equal to 20% of
alternative minimum taxable income (taxable income, increased by tax
preference items and adjusted for certain regular tax items). The preference
items which are generally applicable include an amount equal to 75% of the
amount by which a financial institution's adjusted current earnings
(generally alternative minimum taxable income computed without regard to this
preference and prior to reduction for net operating losses) exceeds its
alternative minimum taxable income without regard to this preference and the
excess of the institution's bad debt deduction over the amount deductible
under the experience method, as discussed below. Alternative minimum tax
paid can be credited against regular tax due in later years.
Audits. The Bank has not been audited by the IRS during the past five
years.
Washington Taxation.
The Bank is subject to a business and occupation tax which is imposed
under Washington law at the rate of 1.50% of gross receipts; however,
interest received on loans secured by mortgages or deeds of trust on
residential properties is not subject to such tax. The Bank's business and
occupation tax returns were audited in November 1995.
Available Information
- ---------------------
The Corporation's Internet address is www.horizonbank.com. You may
access, free of charge, copies of the following documents from the
Corporation's website by using the "About Us/Investor Relations" hyperlink:
* Annual Reports on Form 10-K;
* Quarterly Reports on Form 10-Q; and
* Current Reports on Form 8-K.
The Corporation makes these reports and certain other information that
it files available on its website as soon as reasonably practicable after
filing or furnishing them electronically with the SEC. These and other SEC
filings the Corporation are also available, free of charge, from the SEC on
its website at www.sec.gov. The information contained on the Corporation's
website is not incorporated by reference into this document and should not be
considered a part of this Annual Report on Form 10-K. The Corporation's
website address is included in this document as an inactive textual reference
only.
23
Item 2. Properties
- -------------------
The following table sets forth the location of the Bank's offices, as
well as certain information relating to these offices.
Net Book
Year Value as of Square Leased/
Opened March 31, 2004 Feet Owned
------ -------------- ---- -----
(In thousands)
Bellingham Main Office............ 1971 $1,414 19,179 Owned
1500 Cornwall Avenue
Bellingham, WA 98225
Bellingham/Meridian............... 1987 696 4,650 Owned
4110 Meridian
Bellingham, WA 98226
Ferndale Office................... 1976 282 3,692 Owned
Third and Main
Ferndale, WA 98248
Lynden Office..................... 1981 493 3,702 Owned
Third and Grover
Lynden, WA 98264
Blaine Office..................... 1976 506 3,610 Owned
Fourth & "H" Streets
Blaine, WA 98230
Mount Vernon Office............... 1976 $ 266 3,275 Owned
1503 Riverside Dr.
Mount Vernon, WA 98273
Anacortes Office.................. 1987 737 3,650 Owned
1218 Commercial Avenue
Anacortes, WA 98221
Snohomish Office.................. 1987 162 1,388 Owned
620 2nd Street
Snohomish, WA 98290
Everett Office.................... 1991 29 1,972 Leased
909 S.E. Everett Mall Way, #E-500
Everett, WA 98208
Burlington Office................. 1994 1,210 3,980 Owned
1020 S. Burlington Blvd
Burlington, WA 98232
(table continues on following page)
24
Net Book
Year Value as of Square Leased/
Opened March 31, 2004 Feet Owned
------ -------------- ---- -----
(In thousands)
Edmonds Office.................... 1994 2,088 15,265 Owned
130 Fifth Avenue South
Edmonds, WA 98020
Murphy's Corner Office............ 2000 1,701 3,720 Owned
12830 Bothell Everett Hwy.
Everett, WA 98208
Barkley Office.................... 1999 3,105 14,691 Owned
2122 Barkley Blvd.
Bellingham, WA 98228
Holly Street Office............... 1999 439 4,000 Owned
211 E. Holly Street
Bellingham, WA 98227
Alabama Office.................... 1999 691 4,500 Owned
802 Alabama Street
Bellingham, WA 98228
Marysville Office (1)............. -- 676 -- Owned
3609 88th St NE
Marysville, WA 98270
Lynnwood Office................... 2003 $2,448 4,230 Owned
19405 44th Avenue W.
Lynnwood, WA 98036
Whatcom Commercial Center......... 2003 190 5,200 Leased
2211 Rimland Drive, Suite 230
Bellingham, WA 98226
Snohomish Commercial Center....... 2003 60 1,700 Leased
906 S. Everett Mall Way, Suite 140
Everett, WA 98208
- ------------
(1) To open late fiscal 2005.
At March 31, 2004, the aggregate book value of the Corporation's
premises and equipment was $17.2 million.
Item 3. Legal Proceedings
- --------------------------
Neither the Corporation nor the Bank is engaged in any legal proceedings
of a material nature at the present time. From time to time it is a party to
legal proceedings wherein it enforces its security interest in loans made by
it.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
Not applicable.
25
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
- ---------------------------------------------------------------------------
and Issuer Purchases of Equity Securities
-----------------------------------------
Horizon Financial Corp.'s Common Stock is traded on The Nasdaq Stock
Market under the symbol HRZB. The Common Stock began trading on the Nasdaq
Stock Market at the time of Horizon's conversion to stock form in August
1986. The following table presents the high and low prices as reported by
the Nasdaq Stock Market and dividends paid for the last two fiscal years.
These prices represent quotations by the dealers and do not necessarily
represent actual transactions, and do not include retail markups, markdowns
or commissions. The Corporation has approximately 4,500 shareholders.
2004 Fiscal Year
Quarter High Low Dividend
---------------- ---- --- --------
Fourth $19.39 $16.82 $0.125
Third 19.00 16.25 0.125
Second 17.73 14.98 0.120
First 18.00 14.17 0.120
2003 Fiscal Year
Quarter High Low Dividend
---------------- ---- --- --------
Fourth $15.70 $12.11 $0.115
Third 12.48 10.21 0.115
Second 12.80 10.00 0.110
First 13.28 9.88 0.110
Dividend Policy
- ---------------
Horizon Financial Corp. historically has paid cash dividends on its
Common Stock. The Corporation must adhere to certain regulatory requirements
governing the distribution of dividends, and there can be no assurance that
the Corporation will continue to declare cash dividends in the future.
Stock Repurchases
- -----------------
The Corporation has had various buy-back programs since August 1996.
Repurchases of the Corporation's outstanding Common Stock were authorized by
the Board of Directors in (i) October 2000 for the repurchase of up to 10%
(approximately 1,121,250 shares, as restated) over a 24 month period that
resulted in the repurchase of 769,058 shares at an average price of $9.88 per
share, (ii) October 2002 for the repurchase of up to 10% (approximately
1,065,000 shares) over a 12 month period that resulted in the repurchase of
358,100 shares at an average price of $15.277 per share, and (iii) September
2003 for the repurchase of up to 10% (approximately 1,050,000 shares) for a
12 month period that, as of the year ended March 31, 2004, had resulted in
the repurchase of 151,840 shares at an average price of $18.39 per share.
Repurchases in fiscal 2004 totaled 314,240 shares, at an average price of
$17.353 per share.
26
The following table sets forth the Corporation's repurchases of its
outstanding Common Stock during the fourth quarter of the year ended March
31, 2004.
Issuer Purchases of Equity Securities
-------------------------------------------------
(d)
Maximum
(c) Number (or
Total Number Approximate
of Shares Dollar
Value)
(or Units) of Shares
(or
(a) Purchased as Units that
May
Total (b) Part of Yet to Be
Number of Average Publicly Purchased
Shares (or Price Paid Announced Under the
Units) per Share Plans or Plans or
Period Purchased (or Unit) Programs Programs
- ------------------------ --------- --------- -------- --------
January 1, 2004 -
January 31, 2004........ 5,600 $18.926 89,440(1) 960,560
February 1, 2004 -
February 29, 2004....... 37,100 18.929 126,540(1) 923,460
March 1, 2004 -
March 31, 2004.......... 25,300 19.00 151,840(1) 898,160
Total..................... 68,000 18.954 151,840(1) 1,040,000(2)
- ---------------
(1) Reflects purchases made under the repurchase plan authorized by the Board
of Directors in September 2003.
(2) Reflects new repurchase plan authorized by the Board of Directors in
March
2004.
Item 6. Selected Financial Data
- --------------------------------
The following table sets forth certain information concerning the
financial position of the Corporation at and for the dates indicated.
March 31,
----------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In thousands)
Financial Condition Data:
- ------------------------
Total Assets............ $858,876 $819,872 $772,063 $729,736 $713,914
Loans Receivable, net... 658,226 582,269 568,303 597,382 589,584
Cash and Investment
Securities............ 161,071 197,296 171,346 106,117 99,375
Deposits................ 670,259 646,722 628,782 595,914 564,327
Borrowings.............. 67,469 53,763 29,121 22,938 39,853
Stockholders' Equity.... 109,307 106,244 100,600 97,909 95,935
(table continues on following page)
27
Year Ended March 31,
----------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In thousands)
Operating Data:
- --------------
Interest Income........ $48,979 $50,698 $ 53,312 $ 56,017 $50,046
Interest Expense....... (15,509) (19,461) (26,541) (32,239)
(26,257)
------- ------- -------- -------- -------
Net Interest Income.... 33,470 31,237 26,771 23,778 23,789
Other Income........... 7,881 6,939 4,393 2,771 2,752
Non-interest Expense... (20,238) (17,346) (14,891) (13,756)
(13,243)
Provision for
Loan Losses........... (1,915) (2,740) (1,089) (320)
(437)
------- ------- -------- -------- -------
Income Before Taxes.... 19,198 18,090 15,184 12,473 12,861
Provision for
Income Tax............ (6,332) (5,950) (5,130) (4,202)
(4,180)
------- ------- -------- -------- -------
Net Income............. $12,866 $12,140 $ 10,054 $ 8,271 $ 8,681
======= ======= ======== ======== =======
Per Common Share:(1)
Fully-diluted
earnings............. $1.20 $1.12 $0.91 $0.72 $0.70
Dividends............. 0.49 0.45 0.38 0.34 0.33
Equity................ 10.50 10.07 9.35 8.84 8.06
Weighted average
shares outstanding..10,480,785 10,674,506 10,921,233 11,441,342 12,228,884
- ----------
(1) Restated for 15% stock dividend effective May 11, 2001 and 25% stock
split effective July 23, 2002.
Key Operating Ratios:
- --------------------
The table below sets forth certain performance ratios of the Corporation
for the periods indicated. These ratios are calculated based on month end
balances.
At and for the
Year Ended March 31,
-----------------------
2004 2003 2002
---- ---- ----
Return on average assets (net income
divided by average total assets).............. 1.55% 1.52% 1.35%
Return on average equity (net income
divided by average equity).................... 11.94 11.69 10.14
Dividend payout ratio (dividends declared per
share divided by fully-diluted earnings
per share).................................... 40.83 40.18 42.11
Equity to assets ratio (average equity
divided by average total assets).............. 13.02 13.02 13.29
Interest rate spread (difference between
average yield on interest-earning assets and
average cost of interest bearing liabilities). 4.24 4.01 3.39
Net yield on earning assets (net interest
income as a percentage of average interest
earning assets)............................... 4.42 4.26 3.81
Efficiency ratio............................... 48.94 45.44 47.78
28
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------
Results of Operations
---------------------
The following discussion is intended to assist in understanding the
financial condition and results of operations of the Corporation and its
subsidiary. The information contained in this section should be read in
conjunction with the Consolidated Financial Statements and the accompanying
Notes contained in Item 8 herein.
Forward Looking Statements
- --------------------------
This Form 10-K contains forward-looking statements which are based on
assumptions and describe future plans, strategies and expectations of the
Corporation. These forward-looking statements are generally identified by
use of the word "believe," "expect," "intend," "anticipate," "estimate,"
"project," or similar words. The Corporation's ability to predict results of
the actual effect of future plans or strategies is uncertain. Factors which
could have a material adverse effect on the Corporation's operations include,
but are not limited to, changes in interest rates, general economic
conditions, legislative/regulatory changes, monetary and fiscal policies of
the U.S. Government, including policies of the U.S. Treasury and the Federal
Reserve Board, the quality or composition of the loan or investment
portfolios, demand for loan products, deposit flows, competition, demand for
financial services in the Corporation's market areas and accounting
principles and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements and you should not rely
too much on these statements.
General
- -------
The Corporation's results of operations depend primarily on revenue
generated as a result of its net interest income and non-interest income.
Net interest income is the difference between the interest income the
Corporation earns on its interest-earning assets (consisting primarily of
loans and investment securities) and the interest the Corporation pays on its
interest-bearing liabilities (consisting primarily of customer savings and
money market accounts, time deposits and borrowings). Non-interest income
consists primarily of service charges on deposit and loan accounts, gains on
the sale of loans and investments, and loan servicing fees. The Corporation's
results of operations are also affected by our provisions for loan losses and
other expenses. Other expenses consist primarily of non-interest expense,
including compensation and benefits, occupancy, equipment, data processing,
marketing, automated teller machine costs and, when applicable, deposit
insurance premiums. The Corporation's results of operations may also be
affected significantly by general and local economic and competitive
conditions, changes in market interest rates, governmental policies and
actions of regulatory authorities.
Operating Strategy
- ------------------
The Corporation does not presently engage in any activities outside of
serving as a shell parent company for the Bank. The operating strategy of
the Corporation has been to expand and diversify the consolidated operations
of the Corporation across a variety of companies and/or operating units that
are engaged in complementary, but different, businesses and/or operating
strategies. This diversification strategy is expected to continue as
opportunities arise, although there are no specific acquisitions or new
business formations planned at this time.
The primary business of the Bank is to acquire funds in the form of
deposits and wholesale funds, and to use the funds to make commercial,
consumer, and real estate loans in its primary market area. In addition, the
Bank invests in a variety of investment grade securities including, but not
necessarily limited to U.S. Government and federal agency obligations,
mortgage-backed securities, corporate debt, equity securities, and municipal
securities. The Bank intends to continue to fund its assets primarily with
retail and commercial deposits, although FHLB advances, and other wholesale
borrowings, may be used as a supplemental source of funds.
The Corporation's profitability depends primarily on its net interest
income, which is the difference between the income it receives on the Bank's
loan and investment portfolio and the Bank's cost of funds, which consists of
interest paid on deposits and borrowings.
29
Net interest income is also affected by the relative amounts of
interest-earning assets and interest-bearing liabilities. When
interest-earning assets equal or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. The
Corporation's profitability is also affected by the level of the Bank's other
income and expenses. Other noninterest income includes income associated
with the origination and sale of mortgage loans, loan servicing fees and net
gains and losses on sales of interest-earning assets. Other noninterest
expenses include compensation and benefits, occupancy and equipment expenses,
deposit insurance premiums, data servicing expenses and other operating
costs. The Corporation's results of operations are also significantly
affected by general economic and competitive conditions, particularly changes
in market interest rates, government legislation, regulation, and monetary
and fiscal policies.
The Bank's business strategy is to operate as a well-capitalized,
profitable and independent community bank, dedicated to commercial lending,
home mortgage lending, consumer lending, small business lending and providing
quality financial services to local personal and business customers. The
Bank has sought to implement this strategy by: (i) focusing on commercial
banking opportunities; (ii) continued efforts towards the origination of
residential mortgage loans, including one- to- four family residential
construction loans; (iii) providing high quality, personalized financial
services to individuals and business customers and communities served by its
branch network; (iv) selling many of its fixed rate mortgages to the
secondary market; (v) focusing on asset quality; (vi) containing operating
expenses; and (vii) maintaining capital in excess of regulatory requirements
combined with prudent growth.
Critical Accounting Estimate
- ----------------------------
Management recognizes that loan losses occur over the life of a loan,
and that the allowance for loan losses must be maintained at a level
sufficient to absorb probable losses inherent in the loan portfolio.
Management's determination of the allowance is based on a number of factors,
including the level of non-performing loans, loan loss experience, credit
concentrations, a review of the quality of the loan portfolio, collateral
values and uncertainties in economic conditions. The allowance is increased
by the provision for loan losses, which is charged against current period
operating results and decreased by the amount of actual loan charge-offs, net
of recoveries.
Management believes that the accounting estimate related to the
allowance for loan losses is a "critical accounting estimate" because: (1)
it is highly susceptible to change from period to period because it requires
management to make assumptions about future losses on loans; and (2) the
impact of a sudden large loss could deplete the allowance and potentially
require increased provisions to replenish the allowance, which would
negatively affect earnings.
The Corporation operates under a general loan loss reserve system. The
allowance for loan losses is maintained at a level sufficient to provide for
estimated loan losses based on evaluating known and inherent risks in the
loan portfolio. These factors include changes in the size and composition of
the loan portfolio, actual loan loss experience, current and anticipated
economic conditions, detailed analysis of individual loans for which full
collectibility may not be assured, and determination of the existence and
realizable value of the collateral and guarantees securing the loans. The
reserve is based upon factors and trends identified by management at the time
financial statements are prepared, but the ultimate recovery of loans is
susceptible to future market factors beyond the Bank's control, which may
result in losses or recoveries differing significantly from those provided
for in the financial statements. The Bank maintains an allowance for credit
losses sufficient to absorb losses inherent in the loan portfolio. The Bank
has established a systematic methodology to ensure that the allowance is
adequate.
The allowance is calculated by applying a loss percentage factor to the
various loan pool types based on past due ratios, historical loss experience,
the regulatory and internal credit grading and classification systems, and
general economic conditions that could affect the collectibility of the
portfolio. These factors may be adjusted for events that are significant in
management's judgment as of the evaluation date.
The conditions evaluated in connection with the general allowance
include loan volumes and concentrations, seasoning of the loan portfolio,
specific industry conditions within portfolio segments, governmental
regulatory actions, recent loss experience in a particular segments of the
portfolio and the duration of the current business cycle. The general
30
allowance addresses risks in the portfolio that are not specifically
associated with a pool or individual loan but exist due to changes in
economic conditions, rapid loan portfolio growth, changes in credit
underwriting, weakness in specific loan markets, unseasoned nature of loan
portfolio, and new loan products.
The Corporation's senior management reviews and analyzes the loan
portfolio, charge-offs, and allowance on a quarterly basis. Management then
discusses the development and calculation of this critical accounting
estimate with the executive committee of the Board of Directors. The audit
committee also reviews the Corporation's disclosures including this critical
accounting estimate.
Management reviewed and evaluated the loan portfolio and the adequacy of
the allowance at March 31, 2004 and believes that the allowance is adequate
for the risk inherent in the loan portfolio considering the growth,
unseasoned loans, and relatively weak economic environment. In the review,
management determined that the allowance was adequate at 1.5% of gross loans,
or $10.1 million. The allowance was 1.4% of gross loans or $8.5 million at
March 31, 2003. In fiscal 2004, the loan portfolio grew 13.0% to $658.2
million at March 31, 2004 from $582.3 million at March 31, 2003. The strong
portfolio growth in the last few years has resulted in a relatively
unseasoned loan portfolio which has the potential for increased loan losses.
The loan portfolio has experienced substantial growth especially in
multi-family and commercial real estate loans. At March 31, 2004, the
multi-family and commercial real estate portfolios totaled $310.7 million up
from the $239.1 million and $198.3 million for the years ended March 31, 2003
and 2002, respectively. The increase in the allowance is primarily
attributable to the substantial growth in the loan portfolio and the
unseasoned nature of the portfolio, all of which has occurred in a relatively
weak economic environment.
The Bank recorded net charge-offs of $300,000, $121,000, $179,000,
$100,000, and $143,000 during the years ended March 31, 2004, 2003, 2002,
2001, and 2000, respectively. Consumer loans (including home equity) totaled
$32.6 million or 4.8% of the loan portfolio at March 31, 2004. Visa card
loans and one commercial loan accounted for all of the Bank's charge-offs.
Based on historical trends, the Bank is expected to continue to charge-off
consumer loans in excess of $100,000 a year.
The provision for loan losses has fluctuated depending on the growth of
the loan portfolio and the level of charge-offs especially during weak
economic times. The provision for loan losses was $1.9 million, $2.7
million, $1.1 million, $320,000, and $437,000 for the fiscal years ended
2004, 2003, 2002, 2001, and 2000, respectively. If management's estimate of
the allowance deviated by plus or minus 10% then the $10.1 million allowance
would either decrease to $9.1 million or increase to $11.1 million. The
provision for loan losses would then subsequently decrease or increase by
$1.0 million. Accordingly, net income would increase or decrease by $668,000
after federal income taxes.
Critical Accounting Policies
- ----------------------------
The Corporation's significant accounting principles are described in
Note 1 of the Notes to Consolidated Financial Statements included in Item 8
of this report and are essential to understanding Management's Discussion and
Analysis of Financial Condition and Results of Operations. The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions which affect
the reported amounts and disclosures. Actual results may differ from these
estimates under different assumptions or conditions. The following policies
involve a higher degree of judgment than do our other significant accounting
policies detailed in Note 1 of the Notes to Consolidated Financial Statements
included in Item 8 of this report.
Allowance for Loan Losses. The Corporation reviews historical
origination and charge-off relationships, charge-off experience factors,
collection data, delinquency reports, estimates of the value of the
underlying collateral, economic conditions and trends and other information
in order to make the necessary judgments as to the appropriateness of the
provision for loan losses and the allowance for loan losses. Loans are
charged-off to the allowance for loan losses when the Corporation repossesses
and disposes of the collateral or the account is otherwise deemed
uncollectible. The Corporation believes that the allowance for loan losses
is adequate to cover probable losses inherent in its loan portfolio; however,
because the allowance for loan losses is based on estimates, there can be no
assurance that the ultimate charge-off amount will not exceed such estimates.
31
Investments. The Corporation classifies its investments as either
available-for-sale or held-to-maturity. Available-for-sale securities are
reported at their fair value, which is determined by obtaining quoted market
prices. Unrealized gains and losses on available-for-sale securities are
included in other comprehensive income and excluded from earnings. Realized
gains and losses and declines in fair value judged to be other than temporary
are included in earnings. The fair value of investments is discussed in more
detail in Notes 3 and 4 of the Notes to Consolidated Financial Statements
included in Item 8 of this report.
Long-Lived Assets and Intangibles. The Corporation periodically
assesses the impairment of its long-lived assets and intangibles using
judgment as to the effects of external factors, including market conditions.
Judgment is also required in projecting future operating results. If actual
external conditions and future operating results differ from the
Corporation's judgments, impairment charges may be necessary to reduce the
carrying value of these assets to the appropriate market value.
Accrued Taxes. The Corporation estimates tax expense based on the
amount it expects to owe various tax authorities. Taxes are discussed in
more detail in Note 12 of the Notes to Consolidated Financial Statements
included in Item 8 of this report. Accrued taxes represent the net estimated
amount due or to be received from taxing authorities. In estimating accrued
taxes, management assesses the relative merits and risks of the appropriate
tax treatment of transactions taking into account statutory, judicial and
regulatory guidance in the context of our tax position.
Financial Condition
- -------------------
Total consolidated assets for the Corporation as of March 31, 2004, were
$858.9 million, a 4.8% increase from the March 31, 2003, level of $819.9
million. This increase in assets was due primarily to the growth in loans
receivable to $658.2 million at March 31, 2004 versus $582.3 million at March
31, 2003. This growth was primarily attributable to the growth in commercial
loans during this period, as the Bank continued its practice of selling most
of its single-family fixed rate loan production into the secondary market.
The Bank sold $216.8 million of real estate loans in fiscal 2004, compared to
$216.2 million in fiscal 2003. The Bank sells real estate loans during
periods of increased loan volume to improve cash flow and to manage its
interest rate risk profile.
Also contributing to the increase in assets was the change in investment
securities, available for sale, which increased 14.3% to $85.2 million at
March 31, 2004 from $74.6 million at March 31, 2003. The tables below
display the characteristics of the available for sale ("AFS") and held to
maturity ("HTM") portfolios as of March 31, 2004:
As of March 31, 2004
----------------------------------
Amortized Net Estimated
Cost Gain/Loss Fair Value
--------- --------- ----------
(In thousands)
Available-For-Sale Securities ("AFS")
State and political subdivisions and
U.S. government agency securities.... $ 57,397 $1,604 $ 59,001
Marketable equity securities........... 1,831 5,465 7,296
Mutual funds........................... 5,000 (20) 4,980
Corporate debt securities.............. 13,434 473 13,907
Mortgage-backed securities and CMO's... 27,363 397 27,760
-------- ------ --------
Total available-for-sale securities.. $105,025 $7,919 $112,944
-------- ------ --------
Held-To-Maturity Securities ("HTM")
State and political subdivisions and
U.S. government agency securities.... $ 369 $ 31 $ 400
Mortgage-backed securities and CMO's... 1,544 109 1,653
-------- ------ --------
Total held-to-maturity securities.... 1,913 140 2,053
-------- ------ --------
Total securities..................... $106,939 $8,059 $114,997
======== ====== ========
32
Maturity Schedule of Securities
as of March 31, 2004
---------------------------------------------
- -
Available-For-Sale Held-To-Maturity
---------------------- --------------------
- -
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair
Value
-------- ---------- -------- ---------
- -
(In thousands)
Maturities:
One year.................... $ 14,525 $ 14,764 $ 1 $ 1
Two to five years........... 51,605 53,429 1,232 1,317
Five to ten years........... 7,958 8,186 439 469
Over ten years.............. 24,106 24,288 241 266
-------- -------- -------- --------
98,194 100,667 1,913 2,053
-------- -------- -------- --------
Mutual funds and marketable
equity securities (liquid)... 6,831 12,277 -- --
-------- -------- -------- --------
Total investment
securities................. $105,025 $112,944 $ 1,913 $ 2,053
======== ======== ======== ========
Total liabilities also increased 5.0% to $749.6 million at March 31,
2004, from $713.6 million at March 31, 2003. This increase in liabilities
was due in large part to the growth in deposits, which increased 3.6% to
$670.3 million at March 31, 2004 from $646.7 million at March 31, 2003. The
following is an analysis of the deposit portfolio by major type of deposit at
March 31, 2004 and March 31, 2003:
2004 2003
-------- --------
(In thousands)
Demand Deposits
Savings ............................ $ 40,527 $ 38,455
Checking............................ 78,697 66,169
Checking (noninterest-bearing)...... 44,774 28,052
Money Market........................ 131,310 125,805
-------- --------
295,308 258,481
-------- --------
Time certificates of deposit
Less than $100,000.................. 245,608 258,623
Greater than or equal to $100,000... 129,343 129,617
-------- --------
374,951 388,241
-------- --------
Total deposits ..................... $670,259 $646,722
======== ========
Also contributing to the growth was an increase in other borrowed funds
to $67.5 million at March 31, 2004, from $53.8 million at March 31, 2003.
During the year, an additional $19.0 million was borrowed from the Federal
Home Loan Bank to help control interest rate risk and support the growth in
assets.
Shareholders' equity at March 31, 2004 increased 2.9% to $109.3 million
from $106.2 million at March 31, 2003. This increase was due primarily to
the increase in net income of $12.9 million less dividends paid and shares
repurchased. The Corporation remains strong in terms of its capital
position, with a shareholder equity-to-assets ratio of 12.7% at March 31,
2004, compared to 13.0% at March 31, 2003.
Results of Operations
- ---------------------
Net Interest Income. Net interest income in fiscal 2004 was $33.5
million, a 7.2% increase from fiscal 2003 of $31.2 million, compared to $26.8
million in fiscal 2002. Total interest income decreased 3.4% in fiscal 2004
to $49.0 million from $50.7 million in fiscal 2003, compared to $53.3 million
in fiscal 2002.
33
Interest income on loans in fiscal 2004 was $43.8 million, a 1.8%
decrease from $44.6 million in fiscal 2003, compared to $47.6 million in
fiscal 2002. The decreases in fiscal 2004 and 2003 were due primarily to the
overall decline in interest rates. The decrease in fiscal 2002 was due
primarily to the decrease in loans receivable resulting from the sale of
mortgage loans in the secondary market. Included in these amounts for 2004,
2003 and 2002 are approximately $1.9 million, $1.9 million and $2.0 million,
respectively, of deferred fee income as a result of loan paydowns, payoffs,
and loans sold from the available for sale mortgage portfolio.
Interest and dividends on investments and mortgage-backed securities was
$5.1 million in fiscal 2004, a 15.4% decrease from $6.1 million in fiscal
2003, compared to $5.7 million in fiscal 2002. The decrease in fiscal 2004
was due to principal paydowns in the CMO and mortgage backed securities
portion of the Bank's investment portfolio and an overall decline in interest
rates. The increase in fiscal 2003 was due to the overall growth in the
investment portfolio compared to the prior year. The decrease in fiscal 2002
was due in part to the sale of selected long-term fixed rate mortgage-backed
securities during the year, which shifted a portion of the investment
portfolio into liquid, short-term assets with less interest rate risk.
Total interest expense in fiscal 2004 decreased 20.3% to $15.5 million
from $19.5 million in fiscal 2003, compared to $26.5 million in fiscal 2002.
Interest on deposits decreased 25.2% in fiscal 2004 to $13.2 million,
compared to $17.7 million in fiscal 2003, and $25.0 million in fiscal 2002.
The decreases in fiscal 2004, 2003 and 2002 were due to the overall decline
in interest rates.
Interest on borrowings increased to $2.3 million in fiscal 2004,
compared to $1.8 million in fiscal 2003, and $1.5 million in fiscal 2002.
The increase in fiscal 2004 was due to a higher level of borrowings
outstanding of $67.5 million at March 31, 2004 versus $53.8 million at March
31, 2003, and $29.1 million at March 31, 2002. The Bank continues to carry
wholesale borrowings in order to further leverage its balance sheet and
better manage its interest rate risk profile.
Provision for loan losses. Provisions for loan losses are charges to
earnings to bring the total allowance for loan losses to a level considered
by management as adequate to provide for known and inherent risks in the loan
portfolio, based on management's continuing analysis of factors underlying
the quality of the loan portfolio. These factors include changes in
portfolio size and composition, actual loss experience, current economic
conditions, detailed analysis of individual loans for which full
collectibility may not be assured, and determination of the existence and
realizable value of the collateral and guarantees securing the loans.
The provision for loan losses was $1.9 million for the year ended March
31, 2004 compared to $2.7 million and $1.1 million for the years ended March
31, 2003 and 2002, respectively. This change resulted from management's
ongoing analysis of changes in loan portfolio composition by collateral
categories, overall credit quality of the portfolio, peer group analysis, and
current economic conditions. The reserve for loan losses was $10.1 million,
or 1.5% of loans receivable at March 31, 2004, compared to $8.5 million, or
1.5% of loans receivable at March 31, 2003. The increased allowance level
resulted from continued loan portfolio growth in the higher-risk lending
categories of commercial and multi-family construction/permanent loans and
business loans during the period, which comprised $443.6 million, or 67.4% of
the portfolio at March 31, 2004, versus $360.5 million, or 61.9% at March 31,
2003.
In addition, commercial and multi-family loans have larger individual
loan amounts, which have a greater single impact on the total portfolio
quality in the event of delinquency or default. The Corporation considers
these increased provisions to be appropriate, due to the changing portfolio
mix and the uncertain regional economic environment. Northwest Washington's
economy has been adversely affected by a number of factors, including but not
limited to slowdowns in the aerospace, technology and telecommunications
industries.
As of March 31, 2004, there were eight loans in the loan portfolio over
90 days delinquent and no loans on non-accrual status. At March 31, 2004
total non-performing loans were $338,000. Real estate owned at March 31,
2004 totaled $63,000. Total non-performing assets represented $402,000, or
0.1% of total assets at March 31, 2004 compared to $1.7 million, or 0.2% of
total assets at March 31, 2003.
34
As of March 31,
------------------
2004 2003
-------- --------
(Dollars in thousands)
Non-Performing Assets
Accruing loans 90 days past due........... $339 $350
Non-accrual loans......................... -- 242
----- -----
Total non-performing loans................ 339 592
Total non-performing loans/net loans...... 0.05% 0.10%
Real estate owned......................... 63 1,072
----- -----
Total non-performing assets............... 402 1,664
----- -----
Total non-performing assets/total assets.. 0.05% 0.20%
Noninterest Income. Noninterest income in fiscal 2004 was $7.9 million,
an increase of 13.6% from fiscal 2003 of $7.0 million, compared to $4.4
million in fiscal 2002. Contributing to the increase in fiscal 2004 was the
increase in services fees of 26.4% to $2.9 million in fiscal 2004 from $2.3
million in fiscal 2003 and fiscal 2002. The primary reasons for this
increase was the growth in deposits and revisions to the Bank's fee schedules
during the year.
The net gain or loss on sales of investment securities increased to
$689,000 in fiscal 2004 from $62,000 in fiscal 2003 and from $249,000 in
fiscal 2002. The gains in these periods were due primarily to the sale of
selected common stocks and mortgage backed securities from the AFS investment
portfolio. Other non-interest income increased 6.0% to $1.9 million in
fiscal 2004 from $1.8 million in fiscal 2003 and $533,000 in fiscal 2002.
The primary reason for the increase in fiscal 2004 was the recognition of
approximately $422,000 in profits through March 31, 2004 compared to
approximately $206,000 in profits in the prior period from a real estate
development joint venture of the Bank's wholly owned subsidiary, Westward
Financial Services Corporation. The increase in fiscal 2003 was due to the
recognition of income related to approximately $10.0 million in bank-owned
life insurance which was acquired in late March and early April 2002.
Noninterest Expense. Noninterest expense in fiscal 2004 increased to
$20.2 million, a 16.7% increase from fiscal 2003 of $17.3 million, compared
to fiscal 2002 of $14.9 million. Compensation and employee benefits
increased 23.1% in fiscal 2004 to $11.5 million from $9.4 million in fiscal
2003, compared to $7.8 million in fiscal 2002. The increases in compensation
and employee benefits during fiscal 2004 and 2003 were primarily due to the
overall growth in employment at the Corporation, including key additions to
staff as the Corporation continues its efforts to enhance its commercial
banking expertise, along with additional staff for the Lynnwood office and
new commercial banking loan centers.
Building occupancy expense was $2.6 million in fiscal 2004, a 13.1%
increase from $2.3 million in fiscal 2003 and fiscal 2002. The increase in
fiscal 2004 was due to the opening of our Lynnwood office, three new
commercial banking/loan centers in Bellingham, Snohomish, and Everett, and
the expansion of the Burlington office/commercial center.
Other noninterest expenses increased 16.7% to $4.7 million in fiscal
2004 from $4.0 million in fiscal 2003, compared to $3.0 million in fiscal
2002. The increases in fiscal 2004 and 2003 were primarily due to the
overall growth of the Corporation and a decreasing mortgage servicing
portfolio as a result of the increased refinance activity due to the low rate
environment which results in increased amortization of the associated
mortgage servicing asset. Also contributing to the increase in fiscal 2004
was an increase in Business and Occupation (B&O) tax expense due to the shift
in the loan portfolio from one-to-four family mortgages, which are exempt
from B&O tax, to B&O taxable commercial loans.
Data processing expenses decreased in fiscal 2004 to $558,000 from
$838,000 in fiscal 2003, compared to $970,000 in fiscal 2002. The primary
reason for this decline relates to a renegotiation of the Bank's contract
with its core data processor which included substantial concessions in the
first quarter of fiscal 2004, and a reduced monthly expense thereafter.
Subsequent to year end, the Corporation entered into a five year service
agreement with a third party
35
processor for account processing services, development services and software
products. Included in this agreement are system conversion services, for
which the third party processor will bill the Corporation on a monthly basis,
as services are used and products installed.
Advertising and marketing expenses increased 3.5% to $784,000 in fiscal
2004 from $758,000 in fiscal 2003 compared to $728,000 in fiscal 2002. The
increases in fiscal 2004 and 2003 were due primarily to additional marketing.
In connection with the Bank's expanded commercial product lines and services,
the transition to a new advertising and marketing agency, and the development
of a new brand strategy for the Bank.
Provisions for Income Tax. Income tax expense increased to $6.3 million
in fiscal 2004, from $5.9 million in fiscal 2003, compared to $5.1 million
in fiscal 2002. The Corporation's effective tax rate was approximately 33.0%
in each of the past three fiscal years.
Net Income. Net income of $12.9 million for fiscal 2004 represents a
6.0% increase from net income of $12.1 million for fiscal 2003, compared to
net income of $10.0 million in fiscal 2002. Basic earnings per share for
2004 was $1.23 on weighted average shares of 10,480,785 compared to basic
earnings per share of $1.14 on weighted average shares of 10,674,506 in
fiscal 2003, and basic earnings per share of $0.92 on weighted average shares
of 10,921,233 in fiscal 2002.
Yields Earned and Rates Paid
- ----------------------------
The Corporation's pre-tax earnings depend primarily on its net interest
income, the difference between the income it receives on the loan portfolio
and other investments and its cost of money, consisting primarily of interest
paid on savings deposits, and other borrowings. Net interest income is
affected by (i) the difference between rates of interest earned on its
interest-earning assets and rates paid on its interest-bearing liabilities
("interest rate spread") and (ii) the relative amounts of its
interest-earning assets and interest-bearing liabilities. When
interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income.
Financial institutions have traditionally used interest rate spreads as a
measure of net interest income. Another indicator of an institution's net
interest income is its "Net Interest Margin" which is net interest income
divided by average interest earning assets.
36
The following table presents at the date and for the periods indicated, the total dollar amount of
interest income and interest expense, as well as the resulting yields earned and rates paid.
At March 31, Year Ended March 31,
-------------- ---------------------------------------------------------------------------
- -
2004 2004 2003 2002
-------------- ------------------------ ------------------------ -----------------------
- -
Average Average Average
Average
Yield/ Average Yield/ Average Yield/ Average
Yield/
Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- ---- ------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
Interest-
earning
assets:
Loans re-
ceivable(1)..$658,226 7.15% $613,474 $43,842 7.15% $573,814 $44,157 7.69% $576,406 $47,352
8.21%
Investment
securities(2) 106,321 3.51 107,832 3,787 3.51 122,313 4,139 3.39 87,634 3,412 3.89
Mortgage-
backed
securities... 29,304 3.67 36,780 1,350 3.67 36,115 1,933 5.35 37,970 2,327 6.13
-------- ----- -------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-
earning
assets....... 793,851 6.46 758,086 48,979 6.46 732,242 50,229 6.86 702,010 53,091 7.56
Interest-
bearing
liabilities:
Deposits...... 670,259 2.06 641,691 13,225 2.06 633,796 17,673 2.79 604,607 24,996 4.13
Borrowings.... 67,469 4.06 56,318 2,285 4.06 38,276 1,788 4.67 27,131 1,544 5.69
-------- ----- -------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-
bearing
liabilities.. 737,728 2.22 698,009 15,510 2.22 672,072 19,461 2.90 631,738 26,540 4.20
------- ------- -------
Net interest
income........ $33,470 $30,768 $26,551
======= ======= =======
Interest rate
spread........ 4.24% 3.96%
3.36%
===== ===== =====
Net interest
margin........ 4.42% 4.20%
3.78%
===== ===== =====
Ratio of aver-
age interest-
earning assets
to average
interest-
bearing lia-
bilities...... 108.61% 108.95%
111.12%
====== ====== ======
- ----------
(1) Average balances include nonaccrual loans, if any. Interest income on nonaccural loans has been
included.
(2) The yield on investment securities is calculated using historical cost basis.
37
Rate/Volume Analysis
- --------------------
The table below sets forth certain information regarding changes in
interest income and interest expense for the Corporation for the periods
indicated. For each category of interest-earning asset and interest-bearing
liability, information is provided on changes attributable to (1) changes in
volume (change in volume multiplied by old rate); (2) changes in rates
(change in rate multiplied by old volume); (3) changes to rate-volume
(changes in rate multiplied by the change in volume); and (4) the total
changes (the sum of the prior columns).
Year Ended March 31,
---------------------------------------------------------------------
2004 vs. 2003 2003 vs. 2002
--------------------------------- --------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
--------------------------------- --------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ---- ------ ----- ------ ---- ------ -----
(In thousands)
Interest income:
Interest and fees on loans..... $3,019 $(3,566) $(237) $ (784) $(212) $(2,995) $ 13 $(3,194)
Investment securities and
other interest-bearing
securities.................... (529) (444) 39 (934) 1,521 (943) (246) 332
------ ------- ----- ------- ------ ------- ----- -------
Total interest-earning assets.. $2,490 $(4,010) $(198) $(1,718) $1,309 $(3,938) $(233) $(2,862)
====== ======= ====== ======= ====== ======= ===== =======
Interest expense:
Deposit accounts............... $ 219 $(4,610) $ (57) $(4,448) $1,211 $(8,141) $(393) $(7,323)
Borrowings..................... 839 (232) (110) 497 634 (277) (113) 244
------ ------- ----- ------- ------ ------- ----- -------
Total interest-bearing
liabilities................... $1,058 $(4,842) $(167) $(3,951) $1,845 $(8,418) $(506) $(7,079)
====== ======= ====== ======= ====== ======= ===== =======
Liquidity and Capital Resources
- -------------------------------
The Bank maintains liquid assets in the form of cash and short-term
investments to provide a source to fund loans, savings withdrawals, and other
short-term cash requirements. At March 31, 2004, the Bank had liquid assets
(cash and marketable securities with maturities of one year or less) with a
book value of $74.0 million.
As of March 31, 2004, the total book value of investments and
mortgage-backed securities was $106.9 million compared to a market value of
$115.0 million with an unrealized gain of $8.0 million. As of March 31, 2003,
the total book value of investments and mortgage-backed securities was $106.5
million compared to a market value of $115.9 million with an unrealized gain
of $9.4 million. The Corporation foresees no factors that would impair its
ability to hold debt securities to maturity.
As indicated on the Corporation's Consolidated Statement of Cash Flows
contained in Item 8 hereof, the Corporation's primary sources of funds are
cash flow from operations, which consist primarily of mortgage loan
repayments, deposit increases, loan sales, borrowings, and cash received from
the maturity or sale of investment securities. The Corporation's liquidity
fluctuates with the supply of funds and management believes that the current
level of liquidity is adequate at this time. If additional liquidity is
needed, the Corporation's options include, but are not necessarily limited
to: (1) selling additional loans in the secondary market; (2) entering into
reverse repurchase agreements; (3) borrowing from the FHLB of Seattle; (4)
accepting additional jumbo and/or public funds deposits; or (5) accessing the
discount window of the Federal Reserve Bank of San Francisco.
Shareholders' equity as of March 31, 2004 was $109.3 million, or 12.7%
of assets, compared to $106.2 million, or 13.0% of assets at March 31, 2003.
The Bank continues to exceed the 5.0% minimum tier one capital required by
the FDIC in order to be considered well capitalized. The Bank's total
risk-adjusted capital ratio as of March 31, 2004
38
was 16.6%, compared to 18.7% as of March 31, 2003. These figures are well
above the well-capitalized minimum of 10% set by the FDIC.
The Corporation has been in various buy-back programs since August 1996.
In March 2004, the Board of Directors approved a new stock repurchase plan
that runs concurrent with the 2005 fiscal year, allowing the Corporation to
repurchase up to 10% of total shares outstanding, or approximately 1.04
million shares. This marked the Corporation's sixth stock repurchase plan.
In fiscal 2004, under the previous plans, the Corporation repurchased 314,240
shares at an average price of $17.353. For additional information concerning
the Corporation's repurchase activities during the fourth quarter of fiscal
2004, see Item 5 hereof.
Management intends to continue its stock buy-back programs from time to
time as long as repurchasing the stock is perceived to contribute to the
overall growth of shareholder value. The number of shares of stock that
will be repurchased and the price that will be paid is the result of many
factors, several of which are outside of the control of the Corporation. The
primary factors, however, are market and economic factors such as the price
at which the stock is trading in the market, the number of shares available
in the market; the attractiveness of other investment alternatives in terms
of the rate of return and risk involved in the investment; the ability to
increase the value and/or earnings per share of the remaining outstanding
shares, and the Corporation's liquidity and capital needs and regulatory
requirements. Presently, it is management's belief that purchases made under
the current Board approved plan will not materially affect the Corporation's
capital or liquidity position.
Quantitative and Qualitative Disclosures About Market Risk
- ----------------------------------------------------------
The Corporation continues to be exposed to interest rate risk, although
at reduced levels compared to prior years. Currently, the Corporation's
assets and liabilities are not materially exposed to foreign currency or
commodity price risk. At March 31, 2004, the Corporation had no off-balance
sheet derivative financial instruments, nor did it have a trading portfolio
of investments.
In fiscal 2004 and fiscal 2003, the Corporation continued to improve its
interest rate risk analysis efforts by outsourcing its interest rate risk
modeling to a third party provider that utilizes an IPS Sendero model@ .
This model analyzes the Corporation's major balance sheet components, and
attempts to estimate the changes to the Corporation's income statement and
economic value of equity, under a variety of interest rate change scenarios.
The figures contained in the table presented below, in the Quantitative
Disclosures About Market Risk section, were derived from this model. While
numerous assumptions go into this modeling, and undue reliance should not be
placed on the specific results, management believes that this improved
modeling will enhance its interest rate risk management efforts.
In years prior to fiscal 2002, the Corporation analyzed its interest
rate sensitivity using GAP analysis. The interest rate GAP is defined as the
difference between the amount of interest-earning assets maturing or
repricing within a specific time period, and the interest-bearing liabilities
maturing or repricing within that same time period. A GAP is considered
positive when the amount of interest rate sensitive assets exceeds the amount
of interest rate liabilities during the same period. Banks with a positive
GAP are considered "Asset Sensitive". A GAP is considered negative when the
amount of interest sensitive liabilities exceeds the amount of interest
sensitive assets. Banks with a negative GAP are considered "Liability
Sensitive."
Regardless of the method used (the more sophisticated model being used
currently, or the GAP analysis performed in prior years) the Corporation's
balance sheet has historically been considered liability sensitive, due to
the assumption that its liabilities (primarily comprised of liquid deposit
accounts and certificates of deposit) would reprice more rapidly than its
assets (which are primarily longer term loans). However, recent interest
rate risk modeling shows that the Corporation is currently moderately asset
sensitive. This is due in large part to the growth in variable rate and
shorter term commercial loans on the Corporation's Balance Sheet. Also
contributing to this change is the growth in wholesale borrowings in recent
years, most of which with maturities greater than three years at the time of
the borrowing. Other factors, such as prepayments on mortgages and
investments, the interest rate sensitivity of deposits, the overall level of
interest rates, and general economic conditions can also have significant
effects on the Corporation's performance in a changing interest rate
environment. For example, at the end of fiscal 2004, interest rates were
near historically low
39
levels. As a result, the Corporation's liability rates already reflect the
impact of a lower rate environment. Therefore, further declines in rates
would not likely result in improved profitability for the Corporation.
In the past three fiscal years, the balance sheet was further
diversified by adding variable rate loans, shorter term fixed rate loans, and
a decreased reliance on certificates of deposits for its funding needs. As a
result of the Bank's shift in focus to a community commercial bank, the
balance sheet has become slightly asset sensitive. For example, with the
level of interest rates at March 31, 2004, and the associated prepayment
assumptions in the low-rate environment, interest rate risk modeling predicts
moderate improvement in the Bank's performance in a moderately higher rate
environment. However, as interest rates increase, prepayment assumptions can
change significantly, therefore it would be inappropriate to assume that
significantly higher rates would have a sustained positive effect on the
Bank's and the Corporation's performance. Further, an increase in rates,
without a corresponding increase in certain indices (such as Prime), would
adversely affect the Corporation's performance.
For example, if it becomes necessary for the Corporation to increase the
rates it pays to attract funds in a rising rate environment, an absence of a
corresponding increase in Prime would, of course, negatively affect
performance. In addition, depending on timing differences, the magnitude of
various rates change in future quarters, and the composition of the
Corporation's balance sheet, future modeling efforts may show the
Corporation's returning to a liability sensitive position. Management
continues to monitor these areas, in its ongoing effort to manage the
Corporation's interest rate risk.
Effects of Interest Rate Floors
- -------------------------------
Periodically, the Corporation is able to establish interest rate floors
on certain loans, in order to enhance the Corporation's profitability. At
March 31, 2004, the Corporation had $212.6 in commercial loans tied to Prime.
Of these Prime based loans, approximately 63% will increase immediately when
Prime increases due to the lack of difference between the loan's current rate
and any floors in place. Approximately 12% of the Corporation's Prime Based
loans are at their floor, and require an increase of 0.50% before floating;
12% will float only after an increase of 1.0%; 11% require an increase of
1.50%; and the balance of the Prime based portfolio will float only after
Prime increases 2.0% to 3.0%. While these floors provide an overall better
return for the Corporation, the information provided in this section is
intended to provide additional information regarding the degree to which the
Corporation's earnings may be enhanced due to future increases in Prime.
Quantitative Disclosures About Market Risk. The table below represents
the balances of the Bank's financial instruments at March 31, 2004. The
expected maturity categories take into consideration projected prepayment
rates as well as actual amortization of principal. In preparation of the
table, numerous assumptions were made regarding prepayment rates and deposit
account interest sensitivity.
Amor-
tized Fair
Average Within 1 Year to 2 Years 3 Years Beyond Cost Value
Yield 1 Year 2 Years to 3 Years to 5 Years 5 Years Total Total
----- ------ ------- ---------- ---------- ------- ----- -----
(Dollars in thousands)
Interest-Sensitive Assets:
Loans receivable......... 7.15% $335,489 $131,681 $73,299 $96,347 $21,410 $658,226
$665,897
Mortgage-backed
securities............. 3.71 9,277 3,297 2,874 6,234 7,225 28,907
29,413
Investments and other
interest-earning assets. 3.51 50,734 22,688 10,411 18,726 3,255 98,799
106,352
(table continued on following page)
40
Amor-
tized Fair
Average Within 1 Year to 2 Years 3 Years Beyond Cost Value
Yield 1 Year 2 Years to 3 Years to 5 Years 5 Years Total Total
----- ------ ------- ---------- ---------- ------- ----- -----
(Dollars in thousands)
Interest-Sensitive
Liabilities:
Checking accounts........ 0.46 7,870 17,367 17,367 23,105 57,762 123,471
123,471
Money market/
ultimate accounts....... 1.08 91,918 9,848 9,848 5,628 14,069 131,311
131,311
Savings accounts......... 0.73 8,105 4,053 4,053 6,947 17,369 40,527
40,527
Certificates of deposit.. 2.99 220,406 79,520 30,505 44,520 -- 374,951
380,778
Other borrowings......... 4.06 11,969 12,000 13,500 30,000 -- 67,469
69,275
Off-Balance Sheet Items:
Commitments to
extend credit........... 5.00 33,233 -- -- -- -- 33,233
33,233
Unused lines of credit... 5.75 47,042 -- -- -- -- 47,042
47,042
Credit card arrange-
ments................... 11.88 7,991 -- -- -- -- 7,991
7,991
As with any method of measuring interest rate risk, 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,
they may react in different degrees to changes in market interest rates. In
addition, in the event of changes in interest rates, expected rates of
prepayments on loans and withdrawals from savings accounts might deviate
significantly from those assumed in presenting the table. Therefore, the
data presented in the table should not be relied upon as necessarily
indicative of actual future results.
Contractual Obligations
- -----------------------
In the normal course of business, the Corporation enters into
contractual obligations that meet various business needs. These contractual
obligations include time deposits to customers, borrowings from the FHLB of
Seattle and lease obligations for facilities. See Note 9, 11 and 16 of the
Notes to Consolidated Financial Statements included in Item 8 of this report
for additional information. The following table summarizes the Corporation's
long-term contractual obligations at March 31, 2004:
Less than One to Three to
One Three Five
Year Years Years Thereafter Total
-------- -------- ------- ---------- --------
(In thousands)
Time deposits............. $212,282 $112,933 $46,849 $2,887 $374,951
Long-term borrowings...... 11,969 25,500 30,000 -- 67,469
Operating lease
obligations.............. 205 327 171 130 833
-------- -------- ------- ------ --------
Total................. $224,456 $138,760 $77,020 $3,017 $443,253
======== ======== ======= ====== ========
Off-Balance Sheet Arrangements
- ------------------------------
In the normal course of business, the Corporation makes off-balance
sheet arrangements, including credit commitments to its customers to meet
their financial needs. These arrangements involve, to varying degrees,
elements of credit and interest rate risk not recognized in the consolidated
statement of financial condition. The Bank makes personal, commercial, and
real estate lines of credit available to customers as well as stand by
letters of credit or financial guarantees.
41
Commitments to extend credit to customers are subject to the Bank's
normal credit policies and are essentially the same as those involved in
extending loans to customers. See Note 19 of the Notes to Consolidated
Financial Statements included in Item 8 of this report for additional
information.
Impact of Inflation
- -------------------
The Consolidated Financial Statements and related financial data
presented herein have been prepared in accordance with accounting principles
generally accepted in the United States of America. These principles
generally require the measurement of financial position and operating results
in terms of historical dollars, without considering changes in the relative
purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all the assets and
liabilities of a financial institution are monetary in nature. The primary
impact of inflation is reflected in the increased cost of our operations. As
a result, interest rates generally have a more significant impact on a
financial institution's performance than do general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the prices of goods and services. In a period of rapidly rising
interest rates, the liquidity and maturities structures of our assets and
liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation on earnings, as distinct from levels
of interest rates, is in the area of non-interest expense. Expense items
such as employee compensation, employee benefits and occupancy and equipment
costs may be subject to increases as a result of inflation. An additional
effect of inflation is the possible increase in dollar value of the
collateral securing loans that we have made. Our management is unable to
determine the extent, if any, to which properties securing loans have
appreciated in dollar value due to inflation.
Recent Accounting Pronouncements
- --------------------------------
For a discussion of new accounting pronouncements and their impact on
the Corporation, see Note 1 of the Notes to Consolidated Financial Statements
contained in Item 8 of this Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------
Information required by this item is incorporated herein by reference to
the section captioned "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Quantitative and Qualitative
Disclosures About Market Risk" contained in Item 7 hereof.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
(a) (1) Financial Statements. Page
-------------------- ----
Independent Auditor's Report 43
Consolidated Statement of Financial Position,
March 31, 2004 and 2003 44
Consolidated Statement of Income for the years ended
March 31, 2004, 2003 and 2002 45
Consolidated Statement of Stockholders' Equity for
the years ended March 31, 2004, 2003 and 2002 46
Consolidated Statement of Cash Flows for the years
ended March 31, 2004, 2003 and 2002 47
Notes to Consolidated Financial Statements 48
42
Independent Auditor's Report
To the Stockholders and Directors
Horizon Financial Corp.
We have audited the accompanying consolidated statement of financial position
of Horizon Financial Corp. and Subsidiary as of March 31, 2004 and 2003, and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended March 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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 Corp. and Subsidiary as of March 31, 2004 and 2003, and the results
of their operations and cash flows for each of the three years in the period
ended March 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
/s/ Moss Adams LLP
Bellingham, Washington
April 16, 2004
43
HORIZON FINANCIAL
CORP.
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
MARCH 31, 2004 AND 2003
- -----------------------------------------------------------------------------
- -
Assets
2004 2003
------------ ------------
Cash and cash equivalents $ 18,431,964 $ 15,083,505
Interest-bearing deposits 20,767,398 59,929,418
Investment securities
Available-for-sale (amortized cost 2004:
$77,662,276; 2003: $66,206,662) 85,183,872 74,560,801
Held-to-maturity (estimated fair value 2004:
$400,299; 2003: $402,020) 369,444 369,292
Mortgage-backed securities
Available-for-sale (amortized cost 2004:
$27,362,914; 2003: $37,140,593) 27,759,813 37,921,192
Held-to-maturity (estimated fair value 2004:
$1,653,590; 2003: $2,983,743) 1,544,034 2,793,089
Federal Home Loan Bank Stock 7,014,900 6,638,500
Loans receivable, net of allowance for loan
losses of $10,121,532 in 2004 and $8,506,133
in 2003 658,226,144 582,269,145
Loans held for sale 1,333,500 2,838,300
Accrued interest and dividends receivable 4,032,007 4,620,466
Premises and equipment, net 17,193,671 15,934,254
Real estate owned 63,432 1,072,341
Net deferred income tax assets 831,123 -
Other assets 16,124,579 15,841,571
------------ ------------
TOTAL ASSETS $858,875,881 $819,871,874
============ ============
Liabilities and Stockholders' Equity
Deposits $670,259,218 $646,722,160
Accounts payable and other liabilities 8,301,761 8,048,477
Other borrowed funds 67,468,842 53,762,740
Advances by borrowers for taxes and insurance 416,899 986,702
Income tax currently payable 1,375,274 906,003
Net deferred income tax liabilities - 1,531,504
Deferred compensation 1,746,894 1,670,770
------------ ------------
Total liabilities 749,568,888 713,628,356
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Serial preferred stock, $1 par value,
10,000,000 shares authorized; none issued or
outstanding - -
Common stock, $1 par value, 30,000,000 shares
authorized; 10,405,331 and 10,550,113 issued
and outstanding, respectively 10,405,331 10,550,113
Additional paid-in capital 56,893,824 57,352,824
Retained earnings 36,925,836 32,527,963
Unearned ESOP shares (144,205) (216,309)
Accumulated other comprehensive income 5,226,207 6,028,927
------------ ------------
Total stockholders' equity 109,306,993 106,243,518
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $858,875,881 $819,871,874
============ ============
See accompanying notes to these financial statements
44
HORIZON FINANCIAL
CORP.
CONSOLIDATED STATEMENT OF INCOME
YEARS ENDED MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
2004 2003 2002
----------- ----------- -----------
INTEREST INCOME
Interest on loans $43,842,447 $44,626,384 $47,572,857
Investment and mortgage-backed
securities
Taxable interest 4,474,212 5,336,638 4,991,974
Nontaxable interest income 111,519 37,855 46,168
Dividends 551,436 696,866 700,875
----------- ----------- -----------
Total interest income 48,979,614 50,697,743 53,311,874
----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits 13,224,629 17,672,959 24,996,112
Interest on other borrowings 2,284,728 1,788,142 1,544,457
----------- ----------- -----------
Total interest expense 15,509,357 19,461,101 26,540,569
----------- ----------- -----------
Net interest income 33,470,257 31,236,642 26,771,305
PROVISION FOR LOAN LOSSES 1,915,000 2,740,000 1,089,642
----------- ----------- -----------
Net interest income after
provision for loan losses 31,555,257 28,496,642 25,681,663
----------- ----------- -----------
NONINTEREST INCOME
Service fees 2,860,089 2,262,860 2,308,411
Other 1,938,208 1,828,618 533,476
Net gain (loss) on sales of loans -
servicing retained 195,354 100,413
(252,984)
Net gain on sales of loans -
servicing released 2,198,500 2,685,251 1,554,853
Net gain on sale of investment
securities 689,350 62,258 249,393
----------- ----------- -----------
Total noninterest income 7,881,501 6,939,400 4,393,149
----------- ----------- -----------
NONINTEREST EXPENSE
Compensation and employee benefits 11,520,922 9,359,463 7,852,528
Building occupancy 2,641,378 2,335,481 2,324,248
Other expenses 4,733,971 4,055,430 3,016,851
Data processing 557,803 837,983 969,739
Advertising 784,149 757,602 727,542
----------- ----------- -----------
Total noninterest expense 20,238,223 17,345,959 14,890,908
----------- ----------- -----------
INCOME BEFORE PROVISION FOR
INCOME TAX 19,198,535 18,090,083 15,183,904
PROVISION FOR INCOME TAX
Current 8,281,271 7,457,372 5,866,947
Deferred (1,949,104) (1,507,160)
(737,000)
----------- ----------- -----------
Total provision for income tax 6,332,167 5,950,212 5,129,947
----------- ----------- -----------
NET INCOME $12,866,368 $12,139,871 $10,053,957
=========== =========== ===========
BASIC EARNINGS PER SHARE $ 1.23 $ 1.14 $ .92
=========== =========== ===========
DILUTED EARNINGS PER SHARE $ 1.20 $ 1.12 $ .91
=========== =========== ===========
See accompanying notes to these financial statements
45
HORIZON FINANCIAL CORP.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------------------------------------
- -
Common Stock Accumulated
------------------------ Additional Unearned Other
Number of At Par Paid-In Retained ESOP
Comprehensive
Shares Value Capital Earnings Shares Income
(Loss)
---------- ----------- ------------ ------------ --------- -----------
BALANCE, March 31, 2001 8,861,238 $ 8,861,238 $ 62,380,016 $ 23,046,017 $ (360,517) $3,982,603
Comprehensive income
Net income - - - 10,053,957 - -
Other comprehensive income
Change in unrealized gains
on available-for-sale
securities, net taxes
of $87,116 - - - - - 169,107
Total other comprehensive
income - - - - - -
Comprehensive income - - - - - -
Recognition of ESOP shares
released - - - - 72,104 -
Cash dividends on common
stock at $.48 per share - - - (4,172,135) - -
Dividend reinvestment plan 16,879 16,879 190,371 - - -
Stock options exercised 57,288 57,288 291,998 - - -
Stock dividend - fractional
shares adjustment (336) (336) (3,368) 3,704 - -
Treasury stock purchased - - - - - -
Retirement of treasury
stock (327,952) (327,952) (2,430,779) (1,230,604) - -
---------- ------------ ------------ ------------ ---------- ----------
BALANCE, March 31, 2002 8,607,117 8,607,117 60,428,238 27,700,939 (288,413) 4,151,710
Comprehensive income
Net income - - - 12,139,871 - -
Other comprehensive income
Change in unrealized
gains on available-for-
sale securities, net
taxes of $967,051 - - - - - 1,877,217
Total other comprehensive
income - - - - - -
Comprehensive income - - - - - -
Recognition of ESOP shares
released - - - - 72,104 -
Cash dividends on common stock
at $.45 per share - - - (4,789,101) - -
Dividend reinvestment plan 43,536 43,536 522,227 - - -
Stock options exercised 141,670 141,670 914,187 - - -
25% stock split 2,138,190 2,138,190 (2,138,190) - - -
Cash paid for fractional
shares - - - (7,425) - -
Treasury stock purchased - - - - - -
Retirement of treasury
stock (380,400) (380,400) (2,373,638) (2,516,321) - -
---------- ------------ ------------ ------------ ---------- ----------
BALANCE, March 31, 2003 10,550,113 10,550,113 57,352,824 32,527,963 (216,309) 6,028,927
Comprehensive income
Net income - - - 12,866,368 - -
Other comprehensive income
Change in unrealized
gains (losses) on
available-for-sale
securities, net tax
(benefit) of $(413,523) - - - - -
(802,720)
Total other comprehensive
income - - - - - -
Comprehensive income - - - - - -
Recognition of ESOP shares
released - - - - 72,104 -
Cash dividends on common
stock at $.49 per share - - - (5,121,345) - -
Dividend reinvestment plan 39,601 39,601 646,876 - - -
Stock options exercised 129,857 129,857 685,606 - - -
Treasury stock purchased - - - - - -
Retirement of treasury
stock (314,240) (314,240) (1,791,482) (3,347,150) - -
---------- ------------ ------------ ------------ ---------- ----------
BALANCE, March 31, 2004 10,405,331 $ 10,405,331 $ 56,893,824 $ 36,925,836 $ (144,205) $5,226,207
========== ============ ============ ============ ========== ==========
Treasury Total
Stock Stockholders' Comprehensive
at Cost Equity Income
----------- ------------- ------------
BALANCE, March 31, 2001 $ - $ 97,909,357
Comprehensive income
Net income - 10,053,957 $ 10,053,957
Other comprehensive income
Change in unrealized gains
on available-for-sale
securities, net taxes
of $87,116 - 169,107 169,107
------------
Total other comprehensive
income - - 169,107
------------
Comprehensive income - - $ 10,223,064
============
Recognition of ESOP shares
released - 72,104
Cash dividends on common
stock at $.48 per share - (4,172,135)
Dividend reinvestment plan - 207,250
Stock options exercised - 349,286
Stock dividend - fractional
shares adjustment - -
Treasury stock purchased (3,989,335) (3,989,335)
Retirement of treasury
stock 3,989,335 -
----------- -------------
BALANCE, March 31, 2002 - 100,599,591
Comprehensive income
Net income - 12,139,871 $ 12,139,871
Other comprehensive income
Change in unrealized
gains on available-for-
sale securities, net
taxes of $967,051 - 1,877,217 1,877,217
------------
Total other comprehensive
income - - 1,877,217
------------
Comprehensive income - - $ 14,017,088
============
Recognition of ESOP shares
released - 72,104
Cash dividends on common stock
at $.45 per share - (4,789,101)
Dividend reinvestment plan - 565,763
Stock options exercised - 1,055,857
25% stock split - -
Cash paid for fractional
shares - (7,425)
Treasury stock purchased (5,270,359) (5,270,359)
Retirement of treasury
stock 5,270,359 -
----------- -------------
BALANCE, March 31, 2003 - 106,243,518
Comprehensive income
Net income - 12,866,368 $ 12,866,368
Other comprehensive income
Change in unrealized
gains (losses) on
available-for-sale
securities, net tax
(benefit) of $(413,523) - (802,720) (802,720)
------------
Total other comprehensive
income - - (802,720)
------------
Comprehensive income - - $ 12,063,648
============
Recognition of ESOP shares
released - 72,104
Cash dividends on common
stock at $.49 per share - (5,121,345)
Dividend reinvestment plan - 686,477
Stock options exercised - 815,463
Treasury stock purchased (5,452,872) (5,452,872)
Retirement of treasury
stock 5,452,872 -
----------- -------------
BALANCE, March 31, 2004 $ - $ 109,306,993
=========== =============
See accompanying notes to these financial statements
46
HORIZON FINANCIAL
CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Increase (Decrease) in Cash and Cash Equivalents
2004 2003 2002
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 12,866,368 $ 12,139,871 $ 10,053,957
Adjustments to reconcile net
income to net cash provided by
operating activities
Depreciation 1,085,060 1,000,314 1,112,467
Amortization and deferrals, net 799,212 771,900 1,128,744
Stock dividends - Federal Home
Loan Bank stock (376,400) (395,200)
(411,300)
Provision for loan losses 1,915,000 2,740,000 1,089,642
Provision for deferred income
tax (1,949,104) (1,507,160)
(737,000)
Changes in assets and liabilities
Interest and dividends receivable 588,459 (125,106) 128,554
Interest payable 3,692 (27,533) 6,343
Federal income tax payable 469,271 392,494 331,947
Net change in loans held for sale 1,504,800 457,600
(913,675)
Other assets (283,008) (6,703,825)
(5,121,933)
Other liabilities (331,490) (422,065) 787,060
------------ ------------ ------------
Net cash flows from operating
activities 16,291,860 8,321,290 7,454,806
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in interest-bearing
deposits, net 39,162,020 9,845,582
(57,214,988)
Purchases of investment
securities - available-
for-sale (28,598,597) (30,941,880)
(27,723,932)
Proceeds from sales and
maturities of investment
securities - available-
for-sale 17,142,983 5,352,629 2,972,914
Purchases of mortgage-backed
securities - available-
for-sale (12,811,737) (18,285,779)
(9,812,336)
Proceeds from sales and
maturities of mortgage-backed
securities - available-
for-sale 22,589,915 10,598,409 27,336,684
Proceeds from maturities of
mortgage-backed securities -
held-to-maturity 1,248,403 1,617,115 2,120,006
Net change in loans (78,599,106) (18,857,731) 26,398,362
Purchases of bank premises
and equipment (2,344,477) (1,739,519)
(1,092,997)
Net change in other real
estate owned 1,008,909 669,359 244,799
------------ ------------ ------------
Net cash flows from investing
activities (41,201,687) (41,741,815)
(36,771,488)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 23,537,058 17,939,690 32,868,803
Repayments of securities sold
under agreements to repurchase - -
(5,938,000)
Advances from other borrowed
funds 20,706,102 24,642,011 22,120,729
Repayments of other borrowed
funds (7,000,000) -
(10,000,000)
Common stock issued, net 925,792 1,132,286 363,918
Cash dividends paid (4,457,794) (4,126,638)
(3,869,999)
Treasury stock purchased (5,452,872) (5,270,359)
(3,989,335)
------------ ------------ ------------
Net cash flows from financing
activities 28,258,286 34,316,990 31,556,116
------------ ------------ ------------
NET CHANGE IN CASH AND CASH
EQUIVALENTS 3,348,459 896,465 2,239,434
CASH AND CASH EQUIVALENTS,
beginning of year 15,083,505 14,187,040 11,947,606
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
end of year $ 18,431,964 $ 15,083,505 $ 14,187,040
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash paid during the year for
interest $ 15,505,666 $ 19,488,634 $ 26,527,133
============ ============ ============
Cash paid during the year for
income tax $ 7,812,000 $ 7,315,000 $ 5,535,000
============ ============ ============
NONCASH INVESTING AND FINANCING
TRANSACTIONS
Property taken in settlement
of loans $ 382,086 $ 1,452,271 $ 641,158
============ ============ ============
Property sold through seller
financing $ - $ - $
(106,930)
============ ============ ============
See accompanying notes to these financial statements
47
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations - Horizon Financial Corp. (the "Company"), through its
wholly-owned subsidiary, Horizon Bank (the "Bank"), provides a full range of
commercial and mortgage lending services to borrowers and a full range of
customer services to depositors through 16 full-service offices, three
commercial loan centers, and three real estate loan centers located in
Whatcom, Skagit and Snohomish Counties of Washington State. The Bank is an
FDIC insured, state-chartered stock savings bank.
Financial Statement Presentation and Use of Estimates - The financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States of America and reporting practices
applicable to the banking industry. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of revenues and expenses for the period and assets and
liabilities as of the balance sheet date. Actual results could differ from
estimated amounts.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the estimated
losses on loans and foreclosed assets held for sale, management obtains
independent appraisals for significant properties.
All per share date included in the financial statements have been restated to
reflect the stock dividend effective May 11, 2001 and the 25% stock split
effective July 23, 2002 as well as the Company's ongoing share repurchase
activities.
Principles of Consolidation - As of March 31, 2004, 2003, and 2002, and for
the years then ended, the consolidated financial statements include the
accounts of Horizon Financial Corp. and its wholly-owned subsidiary, Horizon
Bank. Westward Financial Services, Inc. a land development company, is a
wholly-owned subsidiary of Horizon Bank, whose accounts are also included in
the consolidation. All material intercompany balances and transactions have
been eliminated.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and
cash equivalents include cash on hand and noninterest-bearing amounts due
from banks.
Included in cash and cash equivalents are legally reserved amounts which are
required to be maintained on an average basis in the form of cash and
balances due from the Federal Reserve Bank and other banks. Reserve
requirements approximate $2,616,000 and $2,787,000 for the years ended March
31, 2004 and 2003, respectively.
The Company maintains cash balances at several banks. Accounts at each
institution are insured by the Federal Deposit Insurance Corporation up to
$100,000.
Investments in Interest-Bearing Deposits - Investments in interest-bearing
deposits consist principally of funds on deposit with the Federal Home Loan
Bank and short-term certificates of deposit with Western Washington financial
institutions.
Investments and Mortgage-Backed Securities - The Company classifies its
securities into one of three categories: (1) held-to-maturity, (2)
available-for-sale, or (3) trading. Investment securities are categorized as
held-to-maturity when the Bank has the positive intent and ability to hold
those securities to maturity. Securities which are held-to-maturity are
stated at cost, adjusted for amortization of premiums, and accretion of
discounts which are recognized as adjustments to interest income.
Investment securities categorized as available-for-sale are generally held
for investment purposes (to maturity), although unanticipated future events
may result in the sale of some securities. Available-for-sale securities are
recorded at fair value, with the net unrealized gain or loss included as
other comprehensive income within the statement of stockholders' equity, net
of the related tax effect. Realized gains or losses on dispositions are based
on the net proceeds and the adjusted carrying amount of securities sold,
using the specific identification method.
Declines in the fair value of individual held-to-maturity and
available-for-sale securities below their cost that are other than temporary
are recognized by write-downs of the individual securities to their fair
value. Such write-downs would be included in earnings as realized losses.
48
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
Premiums and discounts are recognized in interest income using the interest
method over the period to maturity. The Company had no trading securities at
March 31, 2004 and 2003.
Noncash Investing and Financing Transactions - Noncash investing and
financing transactions consist principally of securitizing mortgage loans and
exchanging them for FHLMC participation certificates. At the time of the
securitization, the pool of loans are reclassified from the loan portfolio
and are aggregated in a participation certificate in the available-for-sale
investment portfolio. A separate mortgage servicing right is established
using an estimate of fair market value and reorganized upon securitization.
The transaction does not result in the recognition of income or expense in
the income statement.
Federal Home Loan Bank Stock - The Bank's investment in Federal Home Loan
Bank (the "FHLB") stock is a restricted investment carried at par value ($100
per share), which reasonably approximates its fair value. As a member of the
FHLB system, the Bank is required to maintain a minimum level of investment
in FHLB stock based on specific percentages of its outstanding FHLB advances.
The Bank may request redemption at par value of any stock in excess of the
amount the Bank is required to hold. Stock redemptions are at the discretion
of the FHLB.
Loans Held for Sale - Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated market value
in the aggregate. Net unrealized losses are recognized through a valuation
allowance by charges to income.
Loans Receivable - Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off are
reported at their outstanding principal adjusted for any charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated loans
and unamortized premiums or discounts on purchased loans. Interest income is
accrued on the unpaid principal balance.
Loan origination fees, net of certain direct loan origination costs, are
deferred and recognized as an adjustment of the yield on the related loans,
using the interest method.
Impaired Loans and Related Income - A loan is considered impaired when
management determines that it is probable that all contractual amounts of
principal and interest will not be paid as scheduled in the loan agreement.
These loans include nonaccruing loans past due 90 days or more, loans
restructured in the current year, and other loans that management considers
to be impaired.
When a loan is placed on nonaccrual status, all interest previously accrued,
but not collected, is reversed and charged against interest income. Income on
nonaccrual loans is then recognized only when the loan is brought current, or
when, in the opinion of management, the borrower has demonstrated the ability
to resume payments of principal and interest. Interest income on restructured
loans is recognized pursuant to the terms of new loan agreements. Interest
income on other impaired loans is monitored and based upon the terms of the
underlying loan agreement. However, the recorded net investment in impaired
loans, including accrued interest, is limited to the present value of the
expected cash flows of the impaired loan, or the observable fair market value
of the loan, or the fair value of the loan's collateral.
Provision for Loan Losses - Management estimates the provision for loan
losses by evaluating known and inherent risks in the loan portfolio. These
factors include changes in the size and composition of the loan portfolio,
actual loan loss experience, current and anticipated economic conditions,
detailed analysis of individual loans for which full collectibility may not
be assured, and determination of the existence and realizable value of the
collateral and guarantees securing the loans. The allowance is based upon
factors and trends identified by future market factors beyond the Company's
control, which may result in losses or recoveries differing significantly
from those provided for in the financial statements.
The majority of the Company's loan portfolio consists of commercial loans and
single-family residential loans secured by real estate in the Whatcom, Skagit
and Snohomish County areas. Real estate prices in this market are stable at
this time. However, the ultimate collectibility of a substantial portion of
the Company's loan portfolio may be susceptible to changes in local market
conditions in the future.
49
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as an
integral part of their examination process periodically review the estimated
losses on loans. Such agencies may require the Company to recognize
additional losses based on their judgment about information available to them
at the time of their examination.
Mortgage Servicing Rights - The Company allocates its total cost in mortgage
loans between mortgage servicing rights and loans, based upon their relative
fair values, when loans are subsequently sold or securitized, with the
servicing rights retained. Fair values are generally obtained through quoted
market prices. The Company has established a valuation allowance to measure
impairment of its mortgage servicing rights. Impairment is measured based
upon the characteristics of the individual loans, including note rate, term,
underlying collateral, current market conditions and estimates of net
servicing income. The Company accounts for its recorded value, and possible
impairment of mortgage servicing rights, on a loan-by-loan basis.
The cost allocated to mortgage servicing rights is amortized in proportion
to, and over the period of, estimated net servicing income.
Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation. Major renewals or betterments are capitalized and
depreciated over their estimated useful lives. Depreciation is computed on
the straight-line method over the estimated useful lives of 35 years for
buildings and three to ten years for equipment.
Bank Owned Life Insurance - The carrying amount of Bank Owned Life Insurance
approximates its fair value. Fair value of Bank Owned Life Insurance is
estimated using the cash surrender value. The Bank owns approximately $11
million and $10 million in Bank Owned Life Insurance as of March 31, 2004 and
2003, respectively, and is included in Other Assets.
Goodwill - Goodwill was recognized in connection with the purchase of branch
assets and related liabilities. The Company performs periodic evaluations for
impairment. During the current year impairment testing was performed and
Goodwill was found not to be impaired. At March 31, 2004 and 2003, Goodwill
in the amount of $545,336 was included in Other Assets
Other Real Estate Owned - Other real estate owned includes properties
acquired through foreclosure. These properties are recorded at the lower of
cost or estimated fair value. Losses arising from the acquisition of
property, in full or partial satisfaction of loans, are charged to the
allowance for loan losses.
Subsequent to the transfer to other real estate owned, these assets continue
to be recorded at the lower of cost or fair value (less estimated cost to
sell), based on periodic evaluations. Generally, legal and professional fees
associated with foreclosures are expensed as incurred. Costs incurred to
improve property prior to sale are capitalized, however, in no event are
recorded costs allowed to exceed fair value. Subsequent gains, losses, or
expenses recognized on the sale of these properties are included in
noninterest income or expense.
Income Taxes - The Company reports income and expenses using the accrual
method of accounting and files a consolidated tax return which includes its
subsidiary. Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled using the
liability method. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
Deferred taxes result from temporary differences in the recognition of
certain income and expense amounts between the Bank's financial statements
and its tax returns.
Earnings Per Share - Basic earnings per share amounts are computed based on
the weighted average number of shares outstanding during the period after
giving retroactive effect to stock dividends and stock splits. Diluted
earnings per share amounts are computed by determining the number of
additional shares that are deemed outstanding due to stock options under the
treasury stock method.
50
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
Financial Instruments - All financial instruments held or issued by the Bank
are held or issued for purposes other than trading. In the ordinary course of
business, the Bank enters into off-balance-sheet financial instruments
consisting of commitments to extend credit. These commitments are recorded in
the financial statements when they are funded.
Advertising Costs - The Company expenses advertising costs as they are
incurred.
Stock Options - The Company recognizes the financial effects of stock options
under the intrinsic value method in accordance with Accounting Principles
Board Opinion No. 25 Accounting for Stock Issued to Employees (APB 25).
Generally, stock options are issued at a price equal to the fair value of the
Company's stock as of the grant date.
Under APB 25, options issued in this manner do not result in the recognition
of employee compensation in the Company's financial statements. Disclosures
required by Statement of Financial Accounting Standard No. 123 Accounting for
Stock-Based Compensation, as amended are as follows.
The pro forma information recognizes, as compensation, the value of stock
options granted using an option valuation model known as the Black Scholes
model. Pro forma earnings per share amounts also reflect an adjustment for an
assumed purchase of treasury stock from proceeds deemed obtained from the
issuance of stock options. The estimated fair value for options issued for
the years ended 2004, 2003 and 2002 is estimated at $2,317, $64,192, and
$1,093, respectively. The following assumptions were used to estimate the
fair value of the options for the year ended March 31:
2004 2003 2002
-------- -------- --------
Risk-free interest rate 1.93% 2.35% 4.438%
Dividend yield rate 3.02% 3.65% 4.130%
Price volatility 3.884% 2.457% 2.606%
Weighted average expected life
of options 3.72 yr. 3.70 yr. 3.50 yr.
Management believes that the assumptions used in the option pricing model are
highly subjective and represent only one estimate of possible value, as there
is no active market for the options granted. The fair value of the options
granted will be allocated to pro forma earnings over the vesting period of
the options.
Pro forma disclosures for the years ended March 31:
2004 2003 2002
----------- ----------- -----------
Net income as reported $12,866,368 $12,139,871 $10,053,957
Additional compensation for fair
value of stock options (78,469) (88,462)
(237,564)
----------- ----------- -----------
Pro forma net income $12,787,899 $12,051,409 $ 9,816,393
=========== =========== ===========
Earnings per share
Basic
As reported $ 1.23 $ 1.14 $ .92
=========== =========== ===========
Pro forma $ 1.22 $ 1.13 $ .90
=========== =========== ===========
Diluted
As reported $ 1.20 $ 1.12 $ .91
=========== =========== ===========
Pro forma $ 1.20 $ 1.11 $ .89
=========== =========== ===========
The remaining unrecognized compensation for fair value of stock options was
$1,738, $32,096 and $273 as of March 31, 2004, 2003, and 2002, respectively.
51
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
Recent Accounting Pronouncements - In November 2003, the Emerging Issues Task
Force (EITF) researched a consensus that certain quantitative and qualitative
disclosures should be required for debt and marketable equity securities
classified as available-for-sale or held-to-maturity under FASB Statements
No. 115 and 124, that are impaired at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. This EITF consensus
is effective for fiscal years ending after December 15, 2003. Accordingly,
the Company has adopted this statement as of March 31, 2004 and the result
did not have an impact on the Company's statement of financial position or
results of operations.
Reclassifications - Certain reclassifications have been made to prior years'
amounts to conform to the current year presentation. These reclassifications
have no significant effect on the Bank's previously reported financial
position or results of operations.
Note 2 - Interest-Bearing Deposits
Interest bearing deposits consisted of the following at March 31, 2004 and
2003:
2004 2003
----------- ----------
FHLB Demand $20,467,373 59,629,418
Certificates of deposit 300,025 300,000
----------- ----------
$20,767,398 59,929,418
=========== ==========
The Company has funds on deposit with the Federal Home Loan Bank in a Demand
account. This account acts like a savings account and earns interest based on
the daily federal funds rate. These funds are uninsured deposits held at the
Federal Home Loan Bank of Seattle. The FHLB of Seattle, a federally chartered
corporation, is one of 12 district FHLBanks, which operate under the
supervision of the Federal Housing Finance Board. The Finance Board is an
independent agency of the executive branch within the US Government which
ensures that the FHLBanks operate in a safe and sound manner, remain
adequately capitalized, and can raise funds in the capital markets.
Note 3 - Investment Securities
The Company's investment policy requires that the Company purchase only high-
grade investment securities. Purchases of debt instruments are generally
restricted to those rated A or better by a nationally recognized statistical
rating organization.
52
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 3 - Investment Securities (Continued)
The amortized cost and estimated market values of investments, together with
unrealized gains and losses, are as follows as of March 31, 2004 and 2003,
respectively:
2004
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Gross Losses Losses Estimated
Amortized Unrealized Less Than Greater Than Fair
Costs Gains 12 Months 12 Months Value
--------- ---------- --------- ------------ ----------
Available-For-Sale
Securities
State and political
subdivisions and
U.S. government
agency
securities $57,396,588 $1,666,140 $ - $(62,268)
$59,000,460
Marketable equity
securities 1,831,368 5,906,524 (441,000) -
7,296,892
Mutual funds 5,000,000 - (20,141) -
4,979,859
Corporate debt
securities 13,434,320 472,341 - -
13,906,661
----------- ---------- --------- -------- ----------
- -
Total available-
for-sale
securities 77,662,276 8,045,005 (461,141) (62,268)
85,183,872
----------- ---------- --------- -------- ----------
- -
Held-To-Maturity
Securities
State and political
subdivisions and
U.S. government
agency
securities 369,444 30,855 - -
400,299
----------- ---------- --------- -------- ----------
- -
Total held-to-
maturity
securities 369,444 30,855 - -
400,299
----------- ---------- --------- -------- ----------
- -
Total investment
securities $78,031,720 $8,075,860 $(461,141) $(62,268)
$85,584,171
=========== ========== ========= ========
===========
Certain investment securities shown above currently have fair values less
than amortized cost and therefore contain unrealized losses. At March 31,
2004, the Company has evaluated these securities and has determined that the
decline in value is temporary and is related to the change in market interest
rates since purchase. The decline in value is not related to any company or
industry specific event. At March 31, 2004, there are approximately 10
investment securities with unrealized losses. The Company anticipates full
recovery of amortized cost with respect to these securities at maturity or
sooner in the event of a more favorable market interest rate.
2003
-----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Costs Gains Losses Value
----------- ---------- ---------- -----------
Available-For-Sale Securities
State and political
subdivisions and U.S.
government agency
securities $38,820,895 $1,888,238 $ - $40,709,133
Marketable equity
securities 3,805,723 5,553,778 (130,000) 9,229,501
Mutual funds 5,000,000 10,070 - 5,010,070
Corporate debt
securities 18,580,044 1,032,053 - 19,612,097
----------- ---------- ---------- -----------
Total available-
for-sale
securities 66,206,662 8,484,139 (130,000) 74,560,801
----------- ---------- ---------- -----------
Held-To-Maturity Securities
State and political
subdivisions and
U.S. government agency
securities 369,292 32,728 - 402,020
----------- ---------- ---------- -----------
Total held-to-maturity
securities 369,292 32,728 - 402,020
----------- ---------- ---------- -----------
Total investment
securities $66,575,954 $8,516,867 $ (130,000) $74,962,821
=========== ========== ========== ===========
53
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 3 - Investment Securities (Continued)
The amortized cost and estimated fair value of investment securities at March
31, 2004, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
2004
-----------------------------------------------------
Available-For-Sale Held-To-Maturity
------------------------- --------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---------- ---------- ---------- ----------
State and political
subdivisions and
U.S. government agencies
One year $ 8,025,037 $ 8,131,630 $ - $ -
Two to five years 43,702,611 45,207,580 369,444 400,299
Five to ten years 2,868,213 2,869,326 - -
Over ten years 2,800,727 2,791,924 - -
----------- ----------- ---------- ----------
57,396,588 59,000,460 369,444 400,299
----------- ----------- ---------- ----------
Corporate debt securities
One year 6,413,622 6,545,261 - -
Two to five years 7,020,698 7,361,400 - -
Over ten years - - - -
----------- ----------- ---------- ----------
13,434,320 13,906,661 - -
----------- ----------- ---------- ----------
Mutual funds and
marketable equity
securities (liquid) 6,831,368 12,276,751 - -
----------- ----------- ---------- ----------
Total investment
securities $77,662,276 $85,183,872 $ 369,444 $ 400,299
=========== =========== ========== ==========
Proceeds from sales of investments and gross realized gains and losses on
investment sales were as follows for the year ended March 31:
2004 2003 2002
---------- -------- --------
Proceeds from sales of investments $6,839,100 $ - $64,725
========== ====== =======
Gross gains realized on sales of
investments $ 688,001 $ - $64,397
========== ====== =======
Gross losses realized on sales of
investments $ (3,000) $ - $ -
========== ====== =======
Please refer to Note 4 for information on gross gains and losses on mortgage-
backed security sales.
Information about concentrations of investments in particular industries for
marketable equity securities and corporate debt securities at March 31
consist of the following:
2003 2002
------------------------ -----------------------
- -
Market Market
Cost Value Cost Value
----------- ----------- ----------- ----------
- -
Marketable equity securities
Banking $ 315,171 $ 1,822,492 $ 318,380 $
1,636,271
Government agency stocks 1,516,197 5,474,400 3,487,343
7,593,230
----------- ----------- ----------- ----------
- -
$ 1,831,368 $ 7,296,892 $ 3,805,723 $
9,229,501
=========== =========== ===========
===========
Corporate debt securities
Finance companies $ 6,940,420 $ 7,177,139 $11,045,036
$11,650,459
Private utilities 2,710,725 2,792,817 2,705,224
2,853,869
Manufacturing companies 3,783,175 3,936,705 4,829,784
5,107,769
----------- ----------- ----------- ----------
- -
Total $13,434,320 $13,906,661 $18,580,044
$19,612,097
=========== =========== ===========
===========
54
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 3 - Investment Securities (Continued)
At March 31, 2004 and 2003, U.S. government agency and corporate debt
securities of $9,170,000 and $3,370,000 were pledged as collateral for
deposits of state and local government agencies and deposits for trust
accounts in excess of $100,000, as required by Washington State Law.
Note 4 - Mortgage-Backed Securities
Mortgage-backed securities at March 31 consist of the following:
2004
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Gross Losses Losses Estimated
Amortized Unrealized Less Than Greater Than Fair
Costs Gains 12 Months 12 Months Value
--------- ---------- --------- ------------ ----------
Available-for-sale
securities $27,362,914 $ 506,130 $ - $ (109,231)
$27,759,813
Held-to-maturity
securities 1,544,034 109,556 - -
1,653,590
----------- --------- ------ ---------- ----------
- -
Total mortgage-
backed
securities $28,906,948 $ 615,686 $ - $ (109,231)
$29,413,403
=========== ========= ====== ==========
===========
Certain investment securities shown above currently have fair values less
than amortized cost and therefore contain unrealized losses. At March 31,
2004, the Company has evaluated these securities and has determined that the
decline in value is temporary and is related to the change in market interest
rates since purchase. The decline in value is not related to any company or
industry specific event. At March 31, 2004, there are approximately 17
investment securities with unrealized losses. The Company anticipates full
recovery of amortized cost with respect to these securities at maturity or
sooner in the event of a more favorable market interest rate environment.
2003
--------------------------------------------------
- - Gross Gross
Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- --------- ----------
- -
Available-for-sale
securities $37,140,593 $ 894,448 $(113,849)
$37,921,192
Held-to-maturity securities 2,793,089 190,654 -
2,983,743
----------- ---------- --------- ----------
- -
Total mortgage-backed
securities $39,933,682 $1,085,102 $(113,849)
$40,904,935
=========== ========== =========
===========
The amortized cost and estimated fair value of mortgage-backed securities at
March 31, 2004, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right
to prepay obligations with or without prepayment penalties.
2003
---------------------------------------------------
- -
Available-For-Sale Held-To-Maturity
------------------------ ------------------------
- -
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair
Value
----------- ----------- ---------- ----------
- -
Mortgage-backed securities
One year $ 86,753 $ 87,025 $ 988 $ 1,088
Two to five years 881,648 860,482 862,792 917,418
Six to ten years 5,089,356 5,316,098 438,955 468,743
After ten years 21,305,157 21,496,208 241,299 266,341
----------- ----------- ---------- ----------
Total $27,362,914 $27,759,813 $1,544,034 $1,653,590
=========== =========== ========== ==========
All of the above mortgage-backed securities are rated AAA by a nationally
recognized statistical rating organization.
55
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 4 - Mortgage-Backed Securities (Continued)
Proceeds from sales of mortgage-backed securities and gross realized gains
and losses on mortgage-backed security sales were as follows for the year
ended March 31:
2004 2003 2002
--------- --------- --------
Proceeds from sales of mortgage-backed
securities $ - $2,403,548 $22,429,008
======== ========== ===========
Gross gains realized on sales of
mortgage-backed securities $ - $ 62,187 $ 225,104
======== ========== ===========
Gross losses realized on sales of
mortgage-backed securities $ - $ - $ (70,108)
======== ========== ===========
Note 5 - Loans Receivable
Loans receivable (collateralized principally by properties in the Whatcom,
Skagit and Snohomish Counties of Washington State) at March 31 consist of the
following:
2004 2003
------------ ------------
First mortgage loans
1-4 Family $286,126,631 $350,487,597
1-4 Family construction 14,165,219 28,035,560
Less participations (74,278,637)
(137,172,801)
------------ ------------
Net first mortgage loans 226,013,213 241,350,356
Construction and land development 36,303,953 66,111,738
Residential commercial real estate 53,343,779 56,929,901
Non-residential commercial real estate 257,321,796 182,157,758
Commercial loans 78,751,858 54,132,254
Home equity secured 26,291,270 22,729,371
Other consumer loans 6,330,294 6,886,950
------------ ------------
684,356,163 630,298,328
Less:
Undisbursed loan proceeds (11,962,770)
(34,678,121)
Deferred loan fees (4,045,717)
(4,844,929)
Allowance for loan losses (10,121,532)
(8,506,133)
------------ ------------
$658,226,144 $582,269,145
============ ============
The Company originates both adjustable and fixed interest rate loans. At
March 31, 2004, the Company had adjustable and fixed rate loans as follows:
Fixed Rate Adjustable Rate
- ----------------------------------- ------------------------------------
Term to Maturity Book Value Term to Maturity Book Value
- ------------------ ------------ ------------------ ------------
Less than one year $ 71,943,306 Less than one year $152,584,370
One to two years 15,186,248 One to two years 38,913,311
Two to five years 56,798,921 Two to five years 75,649,679
Five to ten years 91,232,992 Five to ten years 36,373,484
Over ten years 108,698,311 Over ten years 36,975,541
Loans serviced for others are $88,190,792 and $140,535,316, respectively, as
of March 31, 2004 and 2003.
The Bank generally receives a monthly fee of 0.25% to 0.375% per annum of the
unpaid balance of each loan. The sold loans are sold without right of
recourse to the Bank by the buyer of the loan interests in the event of
default by the borrower.
Impaired loans on a nonaccrual basis and the related interest are not
material as of March 31, 2004 and 2003.
56
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 5 - Loans Receivable (Continued)
The allowance for loan losses at March 31, and changes during the year are as
follows:
2004 2003 2002
----------- ----------- ----------
Balance, beginning of year $ 8,506,133 $ 5,887,482 $4,976,670
Provision for loan losses 1,915,000 2,740,000 1,089,642
Loan chargeoffs (385,335) (129,406)
(187,095)
Loan recoveries 85,734 8,057 8,265
----------- ----------- ----------
Balance, end of year $10,121,532 $ 8,506,133 $5,887,482
=========== =========== ==========
Note 6 - Mortgage Servicing Rights
Loan costs allocated to mortgage servicing rights as of March 31, were as
follows:
2004 2003
---------- -----------
Beginning balance $1,284,143 $ 2,129,964
Additions for new loans 107,798 63,850
Amortization (745,823) (909,671)
---------- -----------
Ending balance 646,118 1,284,143
Valuation allowance for impairment
of mortgage servicing rights (333,678) (668,183)
---------- -----------
Balance, end of year $ 312,440 $ 615,960
========== ===========
Changes in the valuation allowance for impairment of mortgage servicing was
as follows:
Beginning balance $ (668,183) $(1,111,016)
Additions (42,819) (29,090)
Credited to income 377,324 471,923
---------- -----------
Balance, end of year $ (333,678) $ (668,183)
========== ===========
Note 7 - Accrued Interest and Dividends Receivable
Accrued interest and dividends receivable at March 31 is summarized as
follows:
2004 2003
---------- -----------
Investment securities $1,015,346 $1,020,845
Mortgage-backed securities 147,503 191,989
Loans receivable 2,763,333 3,237,921
Dividends on marketable equity securities 105,825 169,711
---------- ----------
$4,032,007 $4,620,466
========== ==========
Note 8 - Premises and Equipment
Premises and equipment at March 31 consisted of:
2004 2003
---------- -----------
Buildings $12,728,536 $11,952,760
Equipment 8,816,230 8,072,921
----------- -----------
21,544,766 20,025,681
Accumulated depreciation (9,593,624) (9,308,956)
----------- -----------
11,951,142 10,716,725
Land 5,242,529 5,217,529
----------- -----------
Balance, end of year $17,193,671 $15,934,254
=========== ===========
57
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 9 - Deposits
A comparative summary of deposits at March 31 follows:
2004 2003
------------ ------------
Demand deposits
Savings $ 40,526,619 $ 38,455,124
Checking 78,697,106 66,169,430
Checking (noninterest-bearing) 44,773,672 28,052,250
Money market 25,264,073 26,426,247
Ultimate Money Market 106,046,597 99,378,323
------------ ------------
295,308,067 258,481,374
------------ ------------
Time certificates of deposit
Less than $100,000 245,608,118 258,623,337
Greater than or equal to $100,000 129,343,033 129,617,449
------------ ------------
374,951,151 388,240,786
------------ ------------
Total deposits $670,259,218 $646,722,160
============ ============
Time certificate of deposit maturities at March 31 are as follows:
2004
---------------------------------------
Variable Fixed
Rate Rate Total 2002
----------- ------------ ------------ ------------
Within one year $12,460,768 $199,821,284 $212,282,052 $237,979,138
One to two years 1,989,834 79,519,385 81,509,219 65,822,342
Two to three years 918,740 30,504,899 31,423,639 26,007,151
Three to four years 924,429 30,360,116 31,284,545 26,354,415
Four to five years 1,360,620 14,203,839 15,564,459 30,922,698
Over five years 2,887,237 - 2,887,237 1,155,042
----------- ------------ ------------ ------------
$20,541,628 $354,409,523 $374,951,151 $388,240,786
=========== ============ ============ ============
The terms of variable rate certificates of deposit allow customers to make
additional deposits to existing certificates of deposit at any time.
The weighted average nominal interest rate on all deposits at March 31, 2004
and 2003 was 2.06 percent and 2.79 percent, respectively.
Interest expense on deposits for the years ended March 31 is summarized as
follows:
2004 2003 2002
----------- ----------- -----------
Money market $ 1,323,697 $ 2,212,086 $ 2,664,570
Checking 500,240 491,383 572,826
Savings 288,768 437,912 694,646
Certificates of deposit 11,111,924 14,531,578 21,064,070
----------- ----------- -----------
Balance, end of year $13,224,629 $17,672,959 $24,996,112
=========== =========== ===========
58
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 10 - Securities Sold Under Agreements to Repurchase
The Bank has from time to time sold certain securities of the U.S. Government
and its agencies and other approved investments under agreements to
repurchase. A safekeeping agent not under control of the Bank held the
securities underlying the agreements. The Bank did not have any securities
sold under agreements to repurchase as of March 31, 2004 and 2003.
Note 11 - Other Borrowed Funds
The Bank is a member of the Federal Home Loan Bank ("FHLB") of Seattle. As a
member, the Bank has a committed line of credit up to 20% of total assets,
subject to the Bank pledging sufficient collateral and maintaining the
required stock investment. Committed lines of credit agreements totaling
approximately $164.1 million and $162.3 million were available to the Bank,
of which, $64.5 million and $52.5 million were outstanding at March 31, 2004
and 2003, respectively. These advances bear interest ranging from 2.67% to
5.35% and 2.67% to 5.96% per annum, respectively. Maturities for the advances
are $9,000,000 in fiscal 2005, $12,000,000 in fiscal 2006, $13,500,000 in
fiscal 2007, $29,000,000 in fiscal 2008, and $1,000,000 in fiscal 2009.
The maximum outstanding and average outstanding balances and average interest
rates on advances from the FHLB were as follows for the year ended March 31:
In Thousands
-------------------------------
2004 2003 2002
---------- -------- --------
Maximum outstanding at any month-end $ 64,500 $ 52,500 $ 28,000
Average outstanding 56,318 38,276 27,131
Weighted average interest rates:
Annual 4.06% 4.67% 5.69%
==== ==== ====
End of year 3.84% 4.33% 5.07%
==== ==== ====
The Bank also has other borrowed funds in the form of retail repurchase
agreements. These agreements are collateralized by securities held by a
safekeeping agent not under control of the Bank. These advances are
considered overnight borrowings bearing interest rates that fluctuate daily
based on current market rates. The Bank had $2,968,842 and $1,262,740
outstanding as of March 31, 2004 and 2003, respectively.
Note 12 - Income Tax
Deferred income tax results from temporary differences in the recognition of
income and expense for tax and financial statement purposes. The source of
these differences and the related tax effects for the years ended March 31
are as follows:
2004 2003 2002
---------- ---------- ---------
Deferred loan fees $ (274,000) $ (264,000) $ 219,000
Loan loss and general reserves 560,000 873,000 700,000
Deferred compensation 26,000 71,000 (3,000)
Other, net 1,637,104 827,160 (179,000)
---------- ---------- ---------
$1,949,104 $1,507,160 $ 737,000
========== ========== =========
59
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 12 - Income Tax (Continued)
The nature and components of the Company's net deferred tax assets
(liabilities), established at an estimated tax rate of 34.25%, are as follows
at March 31:
2004 2003
----------- -----------
Deferred Tax Assets
Deferred compensation agreements $ 598,000 $ 572,000
Deferred loan fees for tax purposes in
excess of amounts deferred for financial
reporting purposes 671,000 -
Financial reporting loan loss reserve not
recognized for tax purposes 3,467,000 2,541,000
Financial reporting accrued expenses not
recognized for tax purposes 183,000 222,000
Other deferred tax assets 166,000 188,000
----------- -----------
Total deferred assets 5,085,000 3,523,000
----------- -----------
Deferred Tax Liabilities
Deferred loan fees for tax purposes in
excess of amounts deferred for financial
reporting purposes - (466,000)
Tax effect of unrealized gains on
available-for-sale securities (2,692,000) (3,106,000)
FLHB stock dividends (720,000) (605,000)
Other deferred tax liabilities (841,877) (877,504)
----------- -----------
Total deferred liabilities (4,253,877) (5,054,504)
----------- -----------
Net deferred tax assets (liabilities) $ 831,123 $(1,531,504)
=========== ===========
The Company believes, based upon the available evidence, that all deferred
assets will be realized in the normal course of operations. Accordingly,
these assets have not been reduced by a valuation allowance.
A reconciliation of the Company's income tax provision to the statutory
federal income tax rate for the years ended March 31 is as follows:
2004 2003 2002
---------- ---------- ----------
Provision for income tax at the
statutory rate of 35 percent $6,721,000 $6,332,000 $5,314,366
Increase (decrease) in tax
resulting from:
Income taxed at lower brackets - (100,000) (95,000)
Dividends received deduction (53,000) (70,000) (71,166)
Other, net (335,833) (211,788) (18,253)
---------- ---------- ----------
Income tax provision $6,332,167 $5,950,212 $5,129,947
========== ========== ==========
Prior to 1997, the Company was allowed a bad debt deduction of 8 percent of
taxable income, subject to certain limitations. During 1997, a tax law change
eliminated this tax deduction and, in addition, requires the Company to
recapture and pay taxes on these deductions taken after fiscal year ended
March 31, 1988. The Company previously recorded deferred tax liabilities to
account for this obligation, thus retroactive effects of this law change have
not been significant. The cumulative tax-basis bad debt deduction as of March
31, 2004 and 2003 was approximately $-0- and $1,067,000, respectively. If any
portion of this amount is subsequently used for purposes other than to absorb
loan losses, that portion will be subject to federal income tax at the then
prevailing tax rate.
60
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 13 - Benefit Plans
Deferred Compensation Plan - The Company has entered into deferred
compensation agreements with certain of its officers. The agreements provide
for additional retirement benefits payable over a 12 to 20 year period
following retirement. In connection with these agreements, the Company has
acquired life insurance policies on the individual officers covered by the
deferred compensation agreements. At March 31, 2004 and 2003, the cash
surrender values of these policies included in Other Assets aggregated
$2,617,276 and $2,411,219, respectively.
The Company performs a present value calculation using an appropriate
discount rate on an annual basis to ensure that those obligations are
adequately estimated in the accompanying financial statements. The discount
rate was 3.50%, 4.00%, and 4.75% in 2004, 2003 and 2002, respectively.
Deferred compensation expense amounted to $150,000, $155,000 and $191,298 in
2004, 2003 and 2002, respectively.
Employee Incentive Plan - The Company has an incentive plan with employees
meeting certain service requirements. Payments made to employees pursuant to
the plan are based upon earnings, growth in deposits and loans and attainment
of certain corporate objectives. Costs of the plan were $1,657,000,
$1,403,000 and $751,488 for the years ended March 31 2004, 2003 and 2002,
respectively.
Employee Stock Ownership Plan - The Company has a noncontributory employee
stock ownership plan (ESOP) for those employees who have completed a minimum
of two years of service. The Company's contribution is determined annually by
the Board of Directors. Participants receive distributions from the ESOP only
in the event of retirement, disability or termination of employment. The
primary purpose of the ESOP is to acquire shares of the Company's common
stock on behalf of ESOP participants.
In April 1996, the Company issued a new loan to the ESOP in the amount of
$500,000, to purchase 40,000 shares of common stock in the open market. The
loan is to be repaid over a period of ten years, with annual payments
including interest due on March 31. The ESOP shares initially were pledged as
collateral for its debt. As the obligation is reduced, shares are released
from collateral and allocation to the participants' accounts at a rate of 10%
a year. In May 1997, the Company issued a 15% stock dividend which added an
additional 5,400 shares to the unallocated ESOP shares. In May 1999, the
Company made an additional loan to the ESOP in the amount of $154,725, to
purchase 12,500 shares of common stock in the open market. The loan is to be
repaid over seven years with annual payments including interest due March 31.
In April 2001, the Company issued a 15% stock dividend which added an
additional 4,789 shares to the unallocated ESOP shares. In July 2002, the
Company issued a 25% stock split which added an additional 7,342 shares to
the unallocated ESOP shares. Shares released for allocation were 9,180 for
the years ended March 31, 2004, 2003, and 2002. The ESOP shares relating to
the loans outstanding as of March 31 were as follows:
2004 2003 2002
--------- --------- ---------
Number of shares
Allocated shares 65,738 56,558 47,378
Unallocated shares 18,355 27,535 36,715
--------- --------- ---------
Total ESOP shares 84,093 84,093 84,093
========= ========= =========
Fair value
Unallocated shares $ 340,118 $ 409,996 $ 371,568
========= ========= =========
Dividends paid on unallocated shares of stock are reinvested and the new
shares purchased are allocated to the participants. Compensation expense for
the ESOP plan is based upon the fair value of shares committed to be released
each year.
401(k) Plan - Effective January 1, 1993, the Company adopted a defined
contribution 401(k) retirement and savings plan (the "Plan") covering
substantially all employees. The Company contributes three percent of
participating employee's eligible salary to the Plan and a discretionary
amount determined annually by the Board of Directors. Total contributions to
the Plan amounted to $430,000, $360,000 and $323,850 for the years ended
March 31, 2004, 2003, and 2002, respectively.
61
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 14 - Stockholders' Equity
Capital Requirements - The Company and Bank are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory - and
possibly additional discretionary - actions by regulators that, if
undertaken, could have a direct material effect on the Company's financial
statements. Under capital adequacy guidelines within the regulatory framework
for prompt corrective action, the Company must meet specific capital adequacy
guidelines that involve quantitative measures of each entity's assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. Capital classifications are also subject to
qualitative judgments by the regulators about components, risk weightings,
and other factors.
Quantitative measures are established by regulation to ensure capital
adequacy, require maintenance of minimum amounts and ratios (set forth in the
table below in thousands) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets, and of Tier 1 capital to average
assets. Management believes, as of March 31, 2004, that each entity meets all
capital adequacy requirements to which they are subject.
As of February 17, 2004, the most recent notification from the Bank's
regulator categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. There are
no conditions or events since that notification that management believes have
changed the institution's category.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- ------ -------- ------
As of March 31, 2004
Total Capital
(to Risk Weighted Assets)
Consolidated $ 114,607 16.60% $ 55,247 >8.00% $ 69,059 >10.00%
Horizon Bank $ 114,765 16.60% $ 55,299 >8.00% $ 69,124 >10.00%
Tier I Capital
(to Risk Weighted Assets)
Consolidated $ 103,505 14.99% $ 27,624 >4.00% $ 41,436 > 6.00%
Horizon Bank $ 103,655 15.00% $ 27,650 >4.00% $ 41,475 > 6.00%
Tier I Capital
(to Average Assets)
Consolidated $ 103,505 12.56% $ 32,954 >4.00% $ 41,192 > 5.00%
Horizon Bank $ 103,655 12.58% $ 32,954 >4.00% $ 41,192 > 5.00%
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- ------ -------- ------
As of March 31, 2003
Total Capital
(to Risk Weighted Assets)
Consolidated $109,357 18.75% $ 46,652 >8.00% $ 58,315 >10.00%
Horizon Bank $109,147 18.70% $ 46,684 >8.00% $ 58,355 >10.00%
Tier I Capital
(to Risk Weighted Assets)
Consolidated $ 99,608 17.08% $ 23,326 >4.00% $ 34,989 > 6.00%
Horizon Bank $ 99,393 17.03% $ 23,342 >4.00% $ 35,013 > 6.00%
Tier I Capital
(to Average Assets)
Consolidated $ 99,608 12.46% $ 31,979 >4.00% $ 39,973 > 5.00%
Horizon Bank $ 99,393 12.44% $ 31,954 >4.00% $ 39,943 > 5.00%
62
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 14 - Stockholders' Equity (Continued)
Holding Company Loans - Under federal regulations, the Bank is limited,
unless previously approved, as to the amount it may loan to the holding
company and any one affiliate, to 10 percent of its capital stock and
surplus, and the total of loans to the holding company and affiliates must
not exceed 20 percent of capital and surplus. Further, all such loans must be
fully collateralized.
Dividend Reinvestment Plan - As a service to its stockholders of record, the
Bank offers a Dividend Reinvestment and Stock Purchase Plan ("Reinvestment
Plan"). Under the terms of the Reinvestment Plan, dividends and optional cash
payments may be reinvested toward the purchase of additional shares of stock.
No brokerage commission or fees are charged to acquire shares through the
Reinvestment Plan.
Stock Repurchase Plans - In January 2000, the Company announced a plan to
repurchase up to 1,240,562 shares, as restated, or approximately 10% of the
Company's outstanding common stock. During fiscal 2001, 710,269 shares were
repurchased under this plan at a cost of $4,898,256. In October 2000, the
Company announced a plan to repurchase up to 1,121,250 shares, as restated,
or approximately 10% of the Company's outstanding common stock. During fiscal
2001, 144,468 shares were repurchased under this plan at a cost of
$1,109,850. Effective March 31, 2001, all 1,380,862 shares of treasury stock
were retired. During fiscal 2002, 409,940 shares were repurchased and
subsequently retired under this plan at a cost of $3,989,335. During fiscal
2003, 214,650 shares were repurchased and subsequently retired under this
plan at a cost of $2,498,191. In October 2002, the Company announced a plan
to repurchase up to 1,065,000 shares, or approximately 10% of the Company's
outstanding common stock. During Fiscal 2003, 195,700 shares were repurchased
and subsequently retired under this plan at a cost of $2,772,168. During
Fiscal 2004, 162,400 shares were repurchased and subsequently retired under
this plan at a cost of $2,698,586. In September 2003, the Company announced
a plan to repurchase up to 1,050,000 shares, or approximately 10% of the
Company's outstanding common stock. During Fiscal 2004, 151,840 shares were
repurchased and subsequently retired under this plan at a cost of $2,754,286.
In total, the Company repurchased 314,240 shares and subsequently retired at
a cost of $5,452,872. All share information has been restated to reflect
stock splits and dividends.
Stock Split - The Company's Board of Directors at its June 25, 2002 Board
meeting, announced a 25% stock split to be issued July 23, 2002 for
shareholders of record July 11, 2002.
Stock Dividend - The Company's Board of Directors at its April 24, 2001 Board
meeting, announced a 15% stock dividend to be issued June 4, 2001 for
shareholders of record May 11, 2001.
Stock Warrants - In 1992, certain key organizers of the Bank of Bellingham
received warrants for 24,000 shares of stock at an exercise price of $12.50
per share. In conjunction with the merger of Bellingham Bancorporation, the
outstanding warrants as of June 19, 1999 were converted at 2.74 shares of
Horizon for each share of Bellingham Bancorporation - amounting to 37,812
shares at an exercise price of $4.56 per share. The number of shares were
then adjusted to 47,365 at an exercise price of $3.17 per share due to stock
splits and stock dividends. Warrants for 7,877 and 39,387 shares of stock
were still outstanding as of March 31, 2002 and 2001, respectively. During
the fiscal year ended March 31, 2003, all remaining warrants were exercised.
Stock Option and Incentive Plans - The Company may award options for a
maximum of 595,125 as restated, of authorized common stock to certain
officers and key employees under the 1995 Stock Option and Incentive Plan.
Options are granted at no less than fair market value and may or may not vest
immediately upon issuance based on the terms established by the Board of
Directors. Options are generally exercisable within one to five years from
date of grant and expire after ten years.
63
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 14 - Stockholders' Equity (Continued)
Shares of Common Stock
------------------------ Weighted Average of
Available for Under Exercise Price of
Option/Award Plan Shares Under Plan
------------ ------- ------------------
Balance, March 31, 2002 25,638 586,982
Authorized - -
Granted (33,000) 33,000 $ 10.66 - 14.625
Exercised - (148,652) $ 4.19 - 14.625
Lapsed 15,922 (15,922) $ 4.19 - 14.625
Expired (12) -
------- --------
Balance, March 31, 2003 8,548 455,408
Authorized - -
Granted (1,000) 1,000 $ 14.485
Exercised - (146,888) $ 4.19 - 14.625
Lapsed 2,055 (2,055) $ 4.19 - 14.625
Expired (8) -
------- --------
Balance, March 31, 2004 9,595 307,465
======= ========
Options Outstanding Options Exercisable
------------------------------------ -----------------------
Weighted
Average Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
---------- ----------- ----------- -------- ----------- ---------
$ 5 to $ 10 273,465 4.842 years $ 7.75 240,945 $ 7.91
$10 to $ 15 34,000 8.068 years 11.75 8,251 $11.66
At March 31, 2004, 317,060 shares of common stock were reserved for issuance
pursuant to stock plans and options.
Note 15 - Earnings Per Share
The numerators and denominators of basic and diluted earnings per share are
as follows:
2004 2003 2002
----------- ----------- -----------
Net income (numerator) $12,866,368 $12,139,871 10,053,957
Shares used in the calculation
(denominators)
Basic earnings per weighted
average share outstanding 10,480,785 10,674,506 10,921,233
Effect of dilutive stock
options 205,260 190,463 145,822
----------- ----------- -----------
Diluted shares 10,686,045 10,864,969 11,067,055
=========== =========== ===========
Basic earnings per share $ 1.23 $ 1.14 $ .92
=========== =========== ===========
Diluted earnings per share $ 1.20 $ 1.12 $ .91
=========== =========== ===========
At March 31, 2004, 2003, and 2002, there were options to purchase 307,465,
455,408, and 586,982 shares of common stock outstanding. At March 31, 2004,
2003, and 2002, all options to purchase shares of common stock were included
in the diluted net income per share calculation.
64
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 16 - Commitments And Contingencies
Employment Agreement - The Company has entered into a four-year employment
agreement with the Company's president at an amount approximating his current
level of compensation. In the event of specified termination of the
president's employment following a change in control of the Company (as
defined), the agreement provides the president with severance payments of up
to 2.99 times his annual compensation plus continuation of certain benefits.
Purchase Commitments - As of March 31, 2004, the Bank had a purchase
commitment outstanding of approximately $1,200,000 to purchase a full service
office and regional facility in Everett, Washington, which will replace the
Company's existing Everett office.
Long-Term Lease Commitments - The Company has entered into lease agreements
for certain parcels of land and branch offices. Future noncancelable lease
payments under these agreements are as follows for the years ending March 31:
2005 $ 204,402
2006 162,090
2007 164,988
2008 136,744
2009 34,654
Thereafter 130,171
----------
$ 833,049
==========
Rent expense charged to operations was $248,661, $162,440, and $151,169 for
the years ending March 31, 2004, 2003, and 2002.
CBS Conversion Agreement - Subsequent to year end, the Company entered into a
5 year service agreement with a third party processor for account processing
services, development services, and software products. Included in this
agreement are system conversion services, for which the third party processor
will bill the Company on a monthly basis, as services are used and products
installed.
Note 17 - Related Party Transactions
Certain directors, executive officers, and principal stockholders are Bank
customers and have had banking transactions with the Bank. All loans and
commitments to loan included in such transactions were made in compliance
with applicable laws on substantially the same terms (including interest
rates and collateral) as those prevailing at the time for comparable
transactions with other persons and do not involve more than the normal risk
of collectibility or present any other unfavorable features.
The aggregate balances and activity during 2004, 2003 and 2002 are as follows
and were within regulatory limitations:
2004 2003 2002
------------ ------------ ------------
Balance, beginning of year $ 19,851,634 $ 19,846,801 $ 11,935,707
New loans or advances 7,572,429 16,750,744 13,753,750
Repayments (11,733,810) (16,745,911) (5,842,656)
------------ ------------ ------------
Balance, end of year $ 15,690,253 $ 19,851,634 $ 19,846,801
============ ============ ============
Interest earned on loans $ 1,080,891 $ 1,372,680 $ 1,095,527
============ ============ ============
Deposits from related parties totaled approximately $1,663,000 and $1,625,000
at March 31, 2004 and 2003, respectively.
65
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 18 - Significant Group Concentrations of Credit Risk
Most of the Bank's business activity is with customers located within
Whatcom, Skagit and Snohomish Counties. Investments in state and municipal
securities involve governmental entities within the state of Washington. The
Bank originates commercial, real estate and consumer loans. Generally, loans
are secured by deposit accounts, personal property or real estate. Rights to
collateral vary and are legally documented to the extent practicable.
Although the Bank has a diversified loan portfolio, local economic conditions
may affect borrowers' ability to meet the stated repayment terms.
Note 19 - Financial Instruments
The Bank is a party to financial instruments with off-balance-sheet risk
(loan commitments) in the normal course of business to meet the financing
needs of its customers and to reduce its own exposure to fluctuations in
interest rates. Loan commitments involve, to varying degrees, elements of
credit and interest-rate risk in excess of the amount recognized in the
balance sheet. The contract amounts of those commitments reflect the extent
of the Bank's exposure to credit loss from these commitments. The Bank uses
the same credit policies in making commitments and conditional obligations 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 condition 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. The amount of collateral
obtained, if it is deemed necessary by the Bank upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant, and
equipment; and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements,
including commercial paper, bond financing, and similar transactions. Except
for certain long-term guarantees, the majority of guarantees expire in one
year. The credit risk involved in issuing letters of credit is essentially
the same as that involved in extending loan facilities to customers.
Collateral supporting those commitments, for which collateral is deemed
necessary, generally amounts to one hundred percent of the commitment amount
at March 31, 2004.
The Bank has not been required to perform on any financial guarantees and has
not incurred any losses on its commitments for the years ended March 31 2004,
2003 and 2002.
The following is a summary of the off-balance-sheet financial instruments or
contracts outstanding at March 31:
2004 2003
----------- -----------
Commitments to extend credit $80,275,294 $58,878,487
Credit card arrangements 7,991,317 7,385,414
Standby letters of credit 2,058,818 1,263,217
Note 20 - Disclosures About Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
the following classes of financial instruments:
Cash Equivalents, Interest-bearing Deposits, and Loans Held-for-Sale - Due to
the relatively short period of time between the origination of these
instruments and their expected realization, the carrying amount is estimated
to approximate market value.
66
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 20 - Disclosures About Fair Value of Financial Instruments (Continued)
Investment and Mortgage-Backed Securities Fair values are based on quoted
market prices or dealer quotes, if available. If a quoted market price is not
available, fair value is estimated using quoted market prices for similar
securities.
Federal Home Loan Bank ("FHLB") Stock - FHLB Stock is carried at $100 par
value. This investment is considered restricted, as a minimum investment must
be maintained in order to obtain borrowing commitments from FHLB. The Company
may redeem its investment only at par value, which is used as the estimated
market value.
Loans Receivables - For certain homogeneous categories of loans, such as
those written to Federal Home Loan Mortgage Corporation ("FHLMC") standards,
fair value is estimated using the quoted market prices for securities backed
by similar loans, adjusted for differences in loan characteristics. For
variable rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values.
Accrued Income and Expense Accounts - Due to the short-term nature of these
amounts, recorded book value is believed to approximate fair value.
Deposit Liabilities, Repurchase Agreements and Other Borrowed Funds - The
fair value of demand deposits, savings accounts, certain money market
deposits, and federal funds purchased, is the amount payable on demand at the
reporting date. The fair value of fixed-maturity certificates of deposit,
repurchase agreements and other borrowed funds are estimated by discounting
the estimated future cash flows using the rates currently offered for these
instruments with similar remaining maturities.
Off-Balance-Sheet Instruments - The Company's off-balance-sheet instruments
include unfunded commitments to extend credit and borrowing facilities
available to the Company. The fair value of these instruments is not
considered practicable to estimate because of the lack of quoted market price
and the inability to estimate fair value without incurring excessive costs.
The carrying amounts and estimated fair values of the Bank's financial
instruments at March 31, 2004 and 2003 are as follows:
2004 2003
-------------------------- --------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
------------ ------------ ------------ ------------
Financial Assets
Cash and cash
equivalents $ 18,431,964 $ 18,431,964 $ 15,083,505 $ 15,083,505
Investment
securities 85,553,316 85,584,171 74,930,093 74,962,821
Mortgage-backed
securities 29,303,847 29,413,403 40,714,281 40,904,935
Interest-bearing
deposits 20,767,398 20,767,398 59,929,418 59,929,418
Federal Home Loan
Bank stock 7,014,900 7,014,900 6,638,500 6,638,500
Loans receivable 658,226,144 665,897,087 582,269,145 590,991,597
Loans held-for-sale 1,333,500 1,333,500 2,838,300 2,838,300
Accrued interest and
dividends receivable 4,032,007 4,032,007 4,620,466 4,620,466
Financial Liabilities
Demand and savings
deposits 295,308,067 295,308,067 258,481,374 258,481,374
Time deposits 374,951,151 380,778,241 388,240,786 396,849,780
Accounts payable and
other liabilities 8,011,206 8,011,206 7,761,614 7,761,614
Accrued interest
payable 290,555 290,555 286,863 286,863
Other borrowed funds 67,468,842 69,275,192 53,762,740 55,720,840
67
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 21 - Parent Company (Only) Financial information
In Thousands
-----------------------------
2004 2003
--------- ---------
Condensed balance sheet at March 31:
Cash $ 28 458
Investment in Bank 109,457 106,029
Other assets 1,148 1,000
--------- ---------
$ 110,633 $ 107,487
========= =========
Other liabilities $ 1,326 $ 1,243
Stockholders' equity 109,307 106,244
--------- ---------
$ 110,633 $ 107,487
========= =========
Condensed statement of income for the years ended March 31, 2004 and 2003 and
2002:
In Thousands
------------------------------------
2004 2003 2002
-------- -------- --------
Income
Cash dividends from Bank
subsidiary $ 9,028 $ 9,005 $ 7,787
Interest 5 6 8
-------- -------- --------
Total income 9,033 9,011 7,795
-------- -------- --------
Expenses
Compensation 108 105 124
Other 321 330 170
-------- -------- --------
Total expenses 429 435 294
-------- -------- --------
Income before equity in
undistributed income of
subsidiary and benefit equivalent
to income taxes 8,604 8,576 7,501
Benefit equivalent to income taxes 81 84 43
-------- -------- --------
Income before equity in
undistributed income of subsidiary 8,685 8,660 7,544
Equity in undistributed income of
subsidiary 4,181 3,480 2,510
-------- -------- --------
Net income $ 12,866 $ 12,140 $ 10,054
======== ======== ========
2004 2003 2002
-------- -------- --------
Cash flows from operating
activities
Net income $ 12,866 $ 12,140 $ 10,054
Adjustments to reconcile net
income to net cash flows from
operating activities
Equity in undistributed income
of subsidiary (4,181) (3,480) (2,510)
Other operating activities (152) 23 (65)
-------- --------- --------
Net cash flows from operating
activities (8,533) (8,683) 7,479
-------- --------- --------
Cash flows from investing activities
Other investing activities 22 22 22
-------- --------- --------
Net cash flows from investing
activities 22 22 22
-------- --------- --------
Cash flows from financing activities
Sale of common stock 926 1,132 363
Dividends paid (4,458) (4,126) (3,870)
Treasury stock purchased (5,453) (5,270) (3,989)
-------- --------- --------
Net cash flows from financing
activities (8,985) (8,264) (7,496)
-------- --------- --------
Net change in cash (430) 441 5
Cash, beginning of year 458 17 12
-------- --------- --------
Cash, end of year $ 28 $ 458 $ 17
======== ========= ========
68
HORIZON FINANCIAL
CORP.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2004, 2003, AND 2002
- -----------------------------------------------------------------------------
- -
Note 22 - Selected Quarterly Financial Data (Unaudited)
Year Ended March 31, 2004
-----------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Interest income $12,494,587 $12,210,493 $11,978,834 $12,295,700
Interest expense 4,136,452 3,932,265 3,762,912 3,677,728
----------- ----------- ----------- -----------
Net interest income 8,358,135 8,278,228 8,215,922 8,617,972
Provision for loan
losses 525,000 500,000 220,000 670,000
Noninterest income 2,031,321 2,458,097 1,440,968 1,951,115
Noninterest expense 4,915,759 5,262,744 5,125,364 4,934,356
----------- ----------- ----------- -----------
Income before provision
for income tax 4,948,697 4,973,581 4,311,526 4,964,731
Provision for income tax 1,627,357 1,632,861 1,409,485 1,662,464
----------- ----------- ----------- -----------
Net income $ 3,321,340 $ 3,340,720 $ 2,902,041 $ 3,302,267
=========== =========== =========== ===========
Basic earnings per share
(adjusted for stock
splits and dividends) $ .31 $ .32 $ .28 $ .32
=========== =========== =========== ===========
Diluted earnings per
share (adjusted for
stock splits and
dividends) $ .31 $ .31 $ .27 $ .31
=========== =========== =========== ===========
Year Ended March 31, 2003
-----------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Interest income $12,558,048 $12,625,067 $12,979,617 $12,535,010
Interest expense 5,318,384 5,011,148 4,772,948 4,358,621
----------- ----------- ----------- -----------
Net interest income 7,239,664 7,613,919 8,206,669 8,176,389
Provision for loan
losses 300,000 350,000 1,050,000 1,040,000
Noninterest income 1,479,411 1,432,947 2,059,342 1,967,701
Noninterest expense 4,163,790 4,363,950 4,281,989 4,536,230
----------- ----------- ----------- -----------
Income before provision
for income tax 4,255,285 4,332,916 4,934,022 4,567,860
Provision for income tax 1,401,031 1,421,061 1,624,108 1,504,012
----------- ----------- ----------- -----------
Net income $ 2,854,254 $ 2,911,855 $ 3,309,914 $ 3,063,848
========== =========== =========== ===========
Basic earnings per share
(adjusted for stock
splits and dividends) $ .27 $ .27 $ .31 $ .29
========== =========== =========== ===========
Diluted earnings per
share (adjusted for
stock splits and
dividends) $ .26 $ .27 $ .31 $ .28
========== =========== =========== ===========
69
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
Item 9A. Controls and Procedures
- ---------------------------------
(a) Evaluation of Disclosure Controls and Procedures: (a) Evaluation of
Disclosure Controls and Procedures: An evaluation of the Corporation's
disclosure controls and procedures (as defined in Section 13(a)-15(e) and
15d-15(e) of the Securities Exchange Act of 1934 was carried out under the
supervision and with the participation of the Corporation's Chief Executive
Officer, Chief Financial Officer and several other members of the
Corporation's senior management as of the end of the period covered by this
report. The Corporation's Chief Executive Officer and Chief Financial
Officer concluded that the Corporation's disclosure controls and procedures
as currently in effect are effective in ensuring that the information
required to be disclosed by the Corporation in the reports it files or
submits under the Securities and Exchange Act of 1934 is (i) accumulated and
communicated to the Corporation's management (including the Chief Executive
Officer and Chief Financial Officer) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms.
(b) Changes in Internal Controls: In the year ended March 31, 2004, the
Corporation did not make any significant changes in, nor take any corrective
actions regarding, its internal controls or other factors that could
significantly affect these controls.
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors" and "Compliance with Section 16(a) of the Exchange
Act" in the Registrant's Proxy Statement is incorporated herein by reference.
The executive officers of the Corporation and the Bank are as follows:
Name Age Position
- ------------------- --- --------------------------------------------------
V. Lawrence Evans 57 Chairman of the Board, Chief Executive Officer and
President of the Corporation; and Chairman of the
Board and Chief Executive Officer of the Bank (1)
Dennis C. Joines 54 President, Chief Operating Officer and Director of
the Bank; Executive Vice President and Director of
the Corporation
Richard P. Jacobson 41 Vice President and Secretary of the Corporation
and
Executive Vice President and Secretary of the Bank
Steve L. Hoekstra 53 Executive Vice President of the Bank
Karla C. Lewis 57 Senior Vice President of the Bank
Kelli J. Holz 35 Vice President of the Corporation and the Bank
A.R. (Gus) Ayala 54 Senior Vice President of the Bank
Tammy D. Barnett 44 Senior Vice President of the Bank
Jane L. VanVoorst 52 Senior Vice President of the Bank
(footnote on following page)
70
- ------------
(1) Effective April 23, 2002, Dennis C. Joines, was named President and
Chief
Operating Officer of Horizon Bank. V. Lawrence Evans, who has served as
President of Horizon Bank since 1990 continues to serve as Chairman of
the Board and Chief Executive Officer of Horizon Bank and Chairman of
the
Board, President and Chief Executive Officer of Horizon Financial Corp.
The following is a description of the principal occupation and
employment of the executive officers of the Corporation and the Bank during
at least the past five years:
V. LAWRENCE EVANS joined the Bank in 1972 and served as the Bank's
Executive Vice President from 1983 to 1990. Mr. Evans served as President of
the Bank from May 14, 1990 to April 23, 2002. He has served as Chief
Executive Officer of the Bank since March 26, 1991 and as Chairman of the
Bank's Board of Directors since July 1997. Mr. Evans also serves as Chairman
of the Board, President and Chief Executive Officer of the Corporation.
DENNIS C. JOINES became President and Chief Operating Officer of the
Bank on April 23, 2002 and a Director of the Corporation and the Bank on
April 23, 2002. He joined the Bank following an extensive career in the
Pacific Northwest banking industry for over 30 years. Most recently, Mr.
Joines was Senior Vice President/National Small Business and SBA Manager for
Washington Mutual Bank from 2001 to 2002. Prior to that time, he served in a
variety of key roles at KeyBank from 1993 to 2001.
RICHARD P. JACOBSON has worked for the Bank for 17 years and was
appointed Vice President/Finance and Corporate Secretary in December 1994.
In March 1998, Mr. Jacobson was appointed Senior Vice President of the Bank.
In March 2000, he was appointed Executive Vice President of the Bank.
STEVE L. HOEKSTRA joined the Bank in June, 2002 as Executive Vice
President, Commercial Banking. Mr. Hoekstra has 25 years of experience in
the local commercial banking industry. Most recently, he led the Bellingham
commercial and retail team for Frontier Bank. Prior to that, Mr. Hoekstra
was employed for 22 years by SeaFirst/Bank of America, where his titles
included Commercial Credit Administrator, Sales Team Leader, Equipment
Financing and Leasing Specialist and Dealer Banking.
KARLA C. LEWIS joined Horizon Bank in 1973. From 1983 to December 1994,
she was the Manager of the Loan Servicing Department. She was appointed Vice
President in June 1987 and is currently the Bank's Chief Lending Officer. In
March 1998, she was appointed Senior Vice President of the Bank.
KELLI J. HOLZ, CPA, joined the Bank in 1988. From 1991 to 1998 she was
the Manager of the Internal Audit Department. In March 1998, she was
appointed Vice President and is currently the Controller of the Bank.
A.R. (GUS) AYALA joined the Bank pursuant to the merger of Bellingham
Bancorporation effective June 19, 1999. He served as Chief Financial Officer
for the Bank of Bellingham from September 1997 until completion of the
merger. Previously, he was Senior Vice President with a commercial bank in
Lompoc, California. He is currently Senior Vice President, and Operations
Manager for the Bank.
TAMMY D. BARNETT joined the Bank in 1994. From 1994 to March 2003, she
was the Branch Manager of the Burlington office. She was appointed Vice
President in March 2002. In March 2003, she was appointed Senior Vice
President, and is currently the Bank's Mortgage Loan Operations Manager.
JANE L. VANVOORST joined Horizon Bank in May, 2002 as Vice President,
Consumer Lending Manager. In March 2004, she was appointed Senior Vice
President, Retail Sales Manager. Previously, Mrs. VanVoorst was Senior Vice
President, District Retail Leader for Key Bank from 1998 to 2002.
71
Audit Committee Financial Expert
The Audit Committee of the Corporation is composed of Directors Fred R.
Miller (Chairperson), James A. Strengholt and Robert C. Tauscher. Each
member of the Audit Committee is "independent," in accordance with the
requirements for companies quoted on The Nasdaq Stock Market. The
Corporation's Board of Directors has determined that there is no "audit
committee financial expert," as defined in the SEC regulations. The Board
believes that the current members of the Audit Committee are qualified to
serve based on their experience and background.
Code of Ethics
The Board of Directors adopted Codes of Ethics for the Corporation's
officers (including its senior financial officers), directors, and employees.
The Codes of Ethics require the Corporation's officers, directors, and
employees to maintain the highest standards of professional conduct. A copy
of the Code of Ethics applicable to the Principal Executive Officer and
Senior Financial Officer is attached hereto as Exhibit 14.
Item 11. Executive Compensation
- --------------------------------
Information regarding management compensation and transactions with
management and others is incorporated by reference to the section captioned
"Proposal I -- Election of Directors" in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
- ----------------------------------------------------------------------------
Related Stockholder Matters
---------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to
the section captioned "Voting Securities and Principal Holders Thereof"
in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to
the section captioned "Voting Securities and Principal Holders Thereof"
in the Proxy Statement.
Equity Compensation Plan Information. The following table summarizes
share and exercise price information about the Corporation's equity
compensation plans as of March 31, 2004.
(c)
Number of
securities
remaining
available for
(a) (b) future
issuance
Number of securities Weighted-average under equity
to be issued upon exercise price compensation
exercise of of outstanding plans (exclud-
outstanding options, options ing securities
Warrants warrants reflected in
Plan category and rights and rights column (a))
- ---------------------- ---------- ---------- -----------
Equity compensation plans
approved by security
holders:
Option plan............. 307,465 $ 8.19 9,595
Equity compensation plans
not approved by security
holders................... -- -- --
72
(c) Changes in Control
The Corporation is not aware of any arrangements, including any pledge
by
any person of securities of the Corporation, the operation of which may
at a subsequent date result in a change in control of the Corporation.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information contained under the section captioned "Voting Securities
and Principal Holders Thereof" in the Proxy Statement is incorporated herein
by reference.
Item 14. Principal Accountant Fees and Services
- ------------------------------------------------
The information contained under the section captioned "Independent
Auditors" is included in the Corporation's Proxy Statement and is
incorporated herein by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
--------------------------------------------------------------------------
(a) Exhibits
3.1 Articles of Incorporation of Horizon Financial, Corp.
(incorporated by reference to Exhibit 3.1 to the
Registrant's Current Report on Form 8-K dated October 13,
1995)
3.2 Bylaws of Horizon Financial Corp. (incorporated by
reference
to Exhibit 3.2 to the Registrant's Current Report on Form
8-K dated October 13, 1995)
10.1 Amended and Restated Employment Agreement with V. Lawrence
Evans (incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended March 31, 1996)
10.2 Deferred Compensation Plan (incorporated by reference to
the
Registrant's Annual Report on Form 10-K for the year ended
March 31, 1996)
10.3 1986 Stock Option and Incentive Plan (incorporated by
reference to Exhibit 99.1 to the Registrant's Registration
Statement on Form S-8 (File No. 33-99780))
10.4 1995 Stock Option Plan (incorporated by reference to
Exhibit
99.2 to the Registrant's Registration Statement on Form S-8
(File No. 33-99780))
10.5 Bank of Bellingham 1993 Employee Stock Option Plan
(incorporated by reference to Exhibit 99 to the
Registrant's
Registration Statement on Form S-8 (File No. 33-88571))
10.6 Severance Agreement with Dennis C. Joines (incorporated by
reference to the Registrant's Annual Report on Form 10-K
for
the year ended March 31, 2002)
10.7 Severance Agreement with Richard P. Jacobson (incorporated
by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002)
10.8 Severance Agreement with Steve Hoekstra (incorporated by
reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2002)
14 Code of Ethics
21 Subsidiaries of the Registrant
23 Consent of Independent Auditors
31.1 Certification of Chief Executive Officer Pursuant to
Section
302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to
Section
302 of the Sarbanes-Oxley Act
32 Certification of Chief Executive Officer and Chief
Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
(b) Reports on Form 8-K
A Current Report on Form 8-K was filed on January 26, 2004 to
report
the Corporation's earnings for the quarter ended December 31, 2003.
73
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HORIZON FINANCIAL CORP.
Date: June 11, 2004 By: /s/ V. Lawrence Evans
---------------------------------------
V. Lawrence Evans
Chairman of the Board, Chief Executive
Officer, and President
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/V. Lawrence Evans By: /s/Robert C. Diehl
---------------------------- ----------------------------
V. Lawrence Evans Robert C. Diehl
Chairman of the Board, Chief Executive Director
Officer, and President
Date: June 11, 2004 Date: June 11, 2004
By: /s/ Richard P. Jacobson By: /s/Fred R. Miller
---------------------------- ----------------------------
Richard P. Jacobson Fred R. Miller
Principal Financial Officer Director
Date: June 11, 2004 Date: June 11, 2004
By: /s/ Dennis C. Joines By: /s/ James A. Strengholt
---------------------------- ----------------------------
Dennis C. Joines James A. Strengholt
President, Chief Operating Officer Director
and Director of Horizon Bank, and
Executive Vice President and
Director of Horizon Financial Corp.
Date: June 11, 2004 Date: June 11, 2004
By: /s/Kelli J. Holz By: /s/Robert C. Tauscher
---------------------------- ----------------------------
Kelli J. Holz Robert C. Tauscher
Principal Accounting Officer Director
Date: June 11, 2004 Date: June 11, 2004
74
By: /s/ Richard R. Haggen By: /s/Gary E. Goodman
---------------------------- ----------------------------
Richard R. Haggen Gary E. Goodman
Director Director
Date: June 11, 2004 Date: June 11, 2004
75
Exhibit 14
Code of Ethics
Horizon Financial Corp.
Code of Ethics for Principal Executive Officer
And Senior Financial Officers
Introduction
The business of Horizon Financial Corp. ("Horizon") is built on trust. Our
stockholders, customers and employees depend upon our honesty and integrity.
Accordingly, the Board of Directors of Horizon has adopted this Code of
Ethics ("Code") to express a code of conduct applicable to our Chairman of
the Board, Chief Executive Officer, President, Chief Operating Officer, Chief
Financial Officer, Controller, and Investor Relations Manager (collectively,
the "Senior Financial Officers"). This Code does not constitute a new set of
requirements to which the Senior Financial Officers must adhere, but simply
reduces to writing the behavior that has always been required of the Senior
Financial Officers. The Code sets forth certain standards for the guidance of
the Senior Financial Officers.
The Code should be considered as illustrative, but not regarded as
all-inclusive. The Senior Financial Officers are also subject to Horizon's
Code of Ethics applicable to all officers and employees.
Honest and Ethical Conduct
Each Senior Financial Officer must act honestly and ethically. Senior
Financial Officers should also promote honest and ethical behavior within
Horizon.
Acting honestly and ethically includes the duty to avoid actual or apparent
conflicts of interest. A conflict of interest may arise when personal or
financial interest is adverse to, or appears adverse to, the interests of
Horizon. In those cases where personal interests do exist, or may appear to
exist, the officer or employee in question should disqualify himself or
herself and permit other members of our staff to handle the transaction.
Each Senior Financial Officer should report to the Audit Committee of the
Board of Directors any material transaction or relationship that reasonably
could be expected to result in a conflict of interest.
In addition to the duty to avoid conflicts of interest, Senior Financial
Officers must treat confidential information properly. All information
obtained by virtue of employment with Horizon should be held in strictest
confidence. Confidential information must not be disclosed to anyone except
as required for business transactions or as required by law. When
confidential information is disclosed, it must be done in a manner that does
not risk violating confidentiality.
1
Preparation of Public Documents
Each Senior Financial Officer must ensure that all public documents and
documents filed with the Securities and Exchange Commission, NASDAQ, or other
regulatory bodies, which he or she is involved in preparing or reviewing
contain full, fair, accurate, timely and understandable disclosure. In order
to ensure this, the Senior Financial Officers must maintain the skills
relevant to Horizon's needs. The Senior Financial Officers are also
responsible for establishing and maintaining appropriate disclosure controls
and procedures and internal controls.
Compliance with Laws, Rules and Regulations
Each Senior Financial Officer must comply with all local, state and federal
laws, rules and regulations. Any Senior Financial Officer engaged in
activities found to be in conflict with and against these laws, rules and
regulations will be subject to disciplinary action, up to and including
termination of employment.
Administration of the Code
Any violation or suspected violation of this Code of Ethics must be promptly
reported to the Audit Committee of the Board of Directors. Violators of the
Code may be subject to disciplinary action, up to and including termination
of employment. Questions regarding the Code and requests for a waiver from
the Code should be brought to the Audit Committee. The Audit Committee will
administer the Code and will make periodic reports to the Board of Directors,
as necessary. This Code of Ethics shall be publicly available. Changes to,
and waivers from, the Code shall also be disclosed to the public.
2
Exhibit 21
Subsidiaries of the Registrant
Parent
- ------
Horizon Financial Corp.
Jurisdiction
Percentage or State of
Subsidiaries (a) of Ownership Incorporation
- ------------------ ------------ -------------
Horizon Bank 100% Washington
Westward Financial
Services, Inc. (b) 100% Washington
- --------
(a) The operation of the Corporation's wholly owned subsidiaries are
included
in the Consolidated Financial Statements contained in the Item 8 of this
Form 10-K.
(b) Wholly-owned subsidiary of Horizon Bank.
Exhibit 23
Consent of Independent Auditors
CONSENT OF INDEPENDENT AUDITOR'S
We consent to the incorporation by reference in the Registration Statement on
Form S-8 (No. 33-99780) of Horizon Financial Corp. pertaining to the 1986
Stock Option and Incentive Plan, and the 1995 Stock Option Plan; and the
Registration Statement on Form S-8 (No. 333-88571) pertaining to the Bank of
Bellingham 1993 Employee Stock Option Plan; of our report dated April 16,
2004, appearing in the Annual Report on Form 10-K of Horizon Financial Corp.,
which is incorporated by reference in Horizon Financial Corp.'s Annual Report
on Form 10-K for the year ended March 31, 2004.
/s/Moss-Adams LLP
Bellingham, Washington
June 9, 2004
Exhibit 31.1
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, V. Lawrence Evans, certify that:
1. I have reviewed this annual report on Form 10-K of Horizon Financial
Corp.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the
statements made, in light of the circumstances under which such state-
ments were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant
and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the
period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation;
and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the design
or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: June 11, 2004
/s/V. Lawrence Evans
--------------------------------------
V. Lawrence Evans
Chief Executive Officer and President
Exhibit 31.2
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Richard P. Jacobson, certify that:
1. I have reviewed this annual report on Form 10-K of Horizon Financial
Corp.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the
statements made, in light of the circumstances under which such state-
ments were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant
and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the
period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation;
and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the design
or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: June 11, 2004
/s/Richard P. Jacobson
-------------------------------------
Richard P. Jacobson
Chief Financial Officer
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF HORIZON FINANCIAL CORP.
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form
10-K, that:
1. the report fully complies with the requirements of Sections 13(a)
and 15(d) of the Securities Exchange Act of 1934, as amended, and
2. the information contained in the report fairly presents, in all
material respects, the company's financial condition and results
of
operations.
/s/V. Lawrence Evans /s/Richard P. Jacobson
- ----------------------------------- ------------------------------
V. Lawrence Evans Richard P. Jacobson
Chief Executive Officer Chief Financial Officer
Dated: June 11, 2004