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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, 2005 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
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
---- ----
Indicate by check mark whether the registrant is an accelerated filer
(as defined in 12b-2 of the Act). 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, 2004, was $195,327,933 (10,168,034 shares at $19.21 per share).
As of May 31, 2005, the registrant had 9,978,313 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the registrant's Proxy Statement for the 2005 Annual
Meeting of Stockholders. (Parts II. and III).
HORIZON FINANCIAL CORP.
2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
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PART I.
Item 1. Business
General.............................................. 1
Recent Developments.................................. 1
Lending Activities................................... 1
Investment Activities................................ 11
Real Estate Development Subsidiary................... 14
Bank Owned Life Insurance............................ 14
Deposit Activities and Other Sources of Funds........ 14
Competition.......................................... 16
Personnel............................................ 17
Regulation and Supervision........................... 18
Taxation............................................. 24
Available Information................................ 26
Item 2. Properties............................................. 27
Item 3. Legal Proceedings...................................... 29
Item 4. Submission of Matters to a Vote of Security Holders.... 29
PART II.
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities............................................. 29
Item 6. Selected Financial Data................................ 31
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 32
Forward Looking Statements............................ 32
General............................................... 33
Operating Strategy.................................... 33
Critical Accounting Estimate.......................... 34
Critical Accounting Policies.......................... 35
Financial Condition................................... 36
Results of Operations................................. 38
Yields Earned and Rates Paid.......................... 41
Rate/Volume Analysis ................................. 43
Liquidity and Capital Resources....................... 43
Quantitative and Qualitative Disclosures About
Market Risk......................................... 44
Effects of Interest Rate Floors....................... 45
Contractual Obligations............................... 45
Off-Balance Sheet Arrangements........................ 45
Impact of Inflation................................... 45
Recent Accounting Pronouncements...................... 46
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk........................................... 46
Item 8. Financial Statements and Supplementary Data........... 47
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................... 79
Item 9A. Controls and Procedures............................... 79
Item 9B. Other Information..................................... 79
PART III.
Item 10. Directors and Executive Officers of the Registrant.... 79
Item 11. Executive Compensation................................ 80
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters........ 80
Item 13. Certain Relationships and Related Transactions........ 80
Item 14. Principal Accounting Fees and Services................ 80
PART IV.
Item 15. Exhibits and Financial Statement Schedules............ 80
(i)
PART I
Item 1. Business
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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, the $64.3 million, bank holding company for the
Bank of Bellingham, which was merged with and into Horizon Bank. At March 31,
2005, the Corporation had total assets of $997.6 million, total deposits of
$746.8 million and total equity of $107.0 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 Washington 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 name, "Horizon Bank."
The Bank's operations are conducted through 18 full-service office
facilities, three commercial loan centers, and three real estate loan centers,
located in Whatcom, Skagit, Snohomish, and Pierce 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, which was remodeled and opened for business
in March 2003. The Bank opened commercial banking/loan centers in Bellingham,
and Everett and expanded its operations in Burlington during the first quarter
of fiscal 2004. In November 2004, the Bank opened a full service office in
Marysville. In April 2005, the Bank opened a full service office in Lakewood,
located in Pierce County, just south of Tacoma. Future plans for the Bank
include the opening of a full service regional facility in the first quarter
of calendar 2006, which will replace the Bank's existing Everett office.
Recent Developments
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On March 28, 2005, the Corporation announced that the Bank's Board of
Directors had determined to convert the Bank from a Washington chartered
savings bank organized under Title 32 of the Revised Code of Washington
("RCW") to a Washington chartered commercial bank organized under Title 30 of
the RCW. The conversion of the Bank's charter requires the approval of the
Washington Department of Financial Institutions ("Department"), the Bank's
primary regulator. The Bank is in the process of preparing an application for
filing with the Department and anticipates that the charter conversion will be
completed in the second quarter of fiscal 2006.
Lending Activities
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General. The Bank's loan portfolio, net totaled $805.0 million at March
31, 2005, representing approximately 80.7% of its total assets. On that date,
15.6% of net loans receivable consisted of loans secured by mortgages on
one-to-four family residential properties, 9.1% consisted of loans secured by
mortgages on over four unit residential properties, and 71.5% 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.
1
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, Snohomish and Pierce Counties in Washington. This concentration of
credit risk could have a material adverse effect on the Bank's financial
condition and results of operations to the extent there is a material
deterioration in the counties' economic and real estate values.
In order to enable it 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 ("Freddie Mac") 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,
-----------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
-------------- --------------- -------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------ ------ ------- ------ ------ ------ ------- ------ -------
(Dollars in thousands)
Type of Loan:
First mortgage
loans:
One-to-four
family
residential..$174,458 21.7% $179,324 27.2% $309,283 56.6% $502,094 88.3% $625,242 104.6%
One-to-four
family con-
struction.... 16,464 2.0 14,165 2.2 22,394 4.1 20,231 3.6 11,685 2.0
Participations
sold......... (65,125) (8.1) (74,279) (11.3) (137,173) (31.7) (228,874) (40.3) (246,583) (41.3)
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Subtotal... 125,797 15.6 119,210 18.1 194,504 29.0 293,451 51.6 390,344 65.3
Construction
and land
development.. 161,006 20.0 129,153 19.6 74,576 13.7 61,238 10.8 20,329 3.4
Multi-family
residential.. 73,397 9.1 53,344 8.1 55,869 10.2 26,971 4.8 23,697 4.0
Commercial
real estate.. 323,464 40.2 255,273 38.8 182,158 33.3 125,173 22.0 112,072 18.8
Commercial
loans........ 91,210 11.4 78,721 12.0 54,052 9.9 38,177 6.7 28,226 4.7
Home equity
secured...... 35,913 4.5 26,985 4.1 22,716 4.2 23,887 4.2 22,763 3.8
Other consumer
loans........ 5,961 0.7 5,662 0.8 6,900 1.3 5,293 0.9 4,928 0.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Subtotal... 690,951 85.9 549,138 83.4 396,271 72.6 280,739 49.4 212,015 35.5
-------- ----- -------- ----- -------- ----- -------- ----- ------- -----
Total loans
outstand-
ing....... 816,748 101.5 668,348 101.5 590,775 101.6 574,190 101.0 602,359 100.8
Less:
Loan loss
reserve...... (11,767) (1.5) (10,122) (1.5) (8,506) (1.6) (5,887) (1.0) (4,977) (0.8)
-------- ---- -------- ----- -------- ----- -------- ----- -------- -----
Net loans
receiv-
able..... $804,981 100.0% $658,226 100.0% $582,269 100.0% $568,303 100.0% $597,382 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
2
Loan Maturity. The following table sets forth certain information at
March 31, 2005 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
1 Year 5 Years 5 Years
After March After March After March
31, 2005 31, 2005 31, 2005 Total
---------- -------- -------- -----
(In thousands)
Commercial, commercial
real estate, multi-
family, construction
and land development...... $406,801 $162,740 $69,507 $639,048
One-to-four family
construction.............. -- -- 16,464 16,464
One-to-four family
residential, home
equity, and other
consumer loans............ 53,417 66,802 29,250 149,469
-------- -------- ------- --------
Total...................... $460,218 $229,542 115,221 $804,981
======== ======== ======= ========
The following table sets forth the dollar amount of all loans due after
one year after March 31, 2005 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, commercial real estate,
multi-family construction and land
development......................... $ 79,092 $ 153,155 $ 232,247
One-to-four family construction...... 16,464 -- 16,464
One-to-four family residential, home
equity, and other consumer loans.... 51,109 44,943 96,052
-------- -------- --------
Total $146,665 $198,098 $344,763
======== ======== ========
Multi-Family, and Commercial Real Estate Lending. Commercial real
estate loans, including multi-family, totaled $396.9 million, or 49.3% of net
loans receivable at March 31, 2005. 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, 2005, 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, 2005.
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 FHLB 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 10 years, (with amortization terms of 10 to 25 years), along with 15 year
fully amortizing loans. Commercial loans originated with interest rates fixed
for the initial three, five year terms generally contain prepayment penalties
during their fixed rate period ranging from 1.0% to 5.0% of the loan's
outstanding balance.
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
3
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 the principals 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 Bank'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 $91.2 million, or approximately 11.4% of the Bank's net loan
portfolio at March 31, 2005. 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
borrower 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 and monitoring their assigned accounts.
Construction Loans. The Bank 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,
2005, the Bank had $16.5 million, or 2.0% of net loans receivable in
residential construction loans, as compared to $14.2 million, or 2.2%, of net
loans receivable at March 31, 2004. At March 31, 2005, $54.1 million, or
33.6%, of the construction and land development portfolio consisted of
"speculative" construction loans (i.e., loans on dwellings for which there is
not an underlying contract for sales), as compared to $76.4 million, or 59.2%
at March 31, 2004.
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. To mitigate these risks, the Bank primarily deals
with experienced builders, with acceptable credit histories, sound financial
statements, and a proven track record in the industry. In addition, the Bank
utilizes the services of experienced inspectors to monitor the progress and
draw process of the more complex construction projects. The Bank also has an
appraisal staff, who review each appraisal utilized by the Bank in analyzing
prospective projects. Finally, members of the Bank's senior management and
loan committees also have a significant amount of experience in the areas of
construction lending, appraisals, and loan underwriting, further mitigating
the Bank's risk in this area.
4
One-to-Four Family Residential Loans. A significant 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, and
loans made to purchase or refinance improved buildings to be used for
residential housing. At March 31, 2005, approximately 13.6% of the Bank's net
loans receivable 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 Freddie Mac. 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.
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 to a fixed rate loan
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 Freddie Mac.
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 mobile home parks.
Horizon Bank actively markets consumer loans in order to provide a wider
range of financial services to its customers and to achieve shorter terms and
higher interest rates normally typical of such loans. At March 31, 2005, the
Bank held $41.9 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 officers of the
Bank or members of the Bank's Loan Committee 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 and
processing is substantially centralized. Detailed information is obtained to
determine the creditworthiness of the borrower and the borrower's ability to
repay. Significant items appearing on the loan applications and accompanying
material are verified through the use of written
5
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 loans that would
qualify for sale in the secondary market.
Loan assumption requests of adjustable rate loans are handled by the
Bank in a manner similar to new loan requests. Freddie Mac 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 Freddie Mac and Federal
National Mortgage Association ("Fannie Mae"). The Bank's general practice is
to close its fixed-rate, one-to-four family residential loans on Freddie Mac
loan documents in order to facilitate future sales to Freddie Mac 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 deposit flows decline or funds are otherwise unavailable
for lending purposes. As of March 31, 2005, the Bank was servicing loans for
others aggregating approximately $103.2 million for which it generally
receives a fee payable monthly of .25% to .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. Because 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.
6
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 100% of the commitment amount at March 31,
2005.
The following is a summary of the off-balance-sheet financial
instruments or contracts outstanding as of the dates indicated.
At March 31,
-------------------------
2005 2004
---------- ---------
(In thousands)
Commitments to extend credit..... $219,647(1) $80,275
Credit card arrangements......... 9,087 7,991
Standby letters of credit........ 1,824 2,059
- ---------
(1)The increase in commitments to extend credit at March 31, 2005 was the
result of significant growth in the Bank's construction and land development
loan portfolio.
Loan Origination and Other Fees. In addition to interest earned on
loans, the Bank receives 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 0% to 2.0% for commercial real estate
loans. The total amount of deferred loan origination fees and unearned
discounts at March 31, 2005 was $4.8 million. Any unamortized loan fees are
recognized as income at the time the loan is sold or paid off.
Income from loan origination and commitment fees varies with the volume
and type of loans and commitments made and purchased and with competitive
conditions in mortgage markets, which in turn responds to the demand for and
availability of money. The Bank experiences an increase in loan fee income
and other fee income, such as appraisal and loan closing fees, during periods
of low interest rates because of 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 2005, the
Bank modified $7.8 million of real estate loans, compared to $46.0 million
during fiscal 2004 when interest rates were lower and as a result there was
greater refinance activity.
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. As of March 31, 2005 there were no loans in
the loan portfolio over 90 days delinquent and 16 loans on non-accrual status.
The Bank had no real estate owned at March 31, 2005. Total non-performing
assets represented $1.5 million or 0.15% of total assets
7
at March 31, 2005 compared to $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,
------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in thousands)
Non-accrual loans.......... $ 1,481 $ -- $ 242 $ -- $ --
Loans 90 days or more
delinquent and accruing
interest.................. -- 339 350 618 832
Restructured loans......... -- -- -- -- --
Real estate acquired
through foreclosure....... -- 63 1,072 340 --
------- ----- ------- ----- -----
Total.................... $ 1,481 $ 402 $ 1,664 $ 958 $ 832
======= ===== ======= ===== =====
As a percentage of
net loans................. 0.18% 0.06% 0.29% 0.17% 0.14%
As a percentage of
total assets.............. 0.15% 0.05% 0.20% 0.12% 0.11%
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, 2005. No interest income was recorded
on nonaccrual loans for the year ended March 31, 2005.
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.
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
information 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.
8
* 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, if any, 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 above.
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 in
this segment of the portfolio, the rental market is susceptible to
the effects of an economic downturn. Although 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.
* Commercial Real Estate - As with multi-family loans, the
classification 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.
9
Management believes that the allowance for loan losses at March 31, 2005
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.
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, 2005 in the amount of $ 11.8 million and $10.1 million for the year ended
March 31, 2004. The Bank's loan loss reserve as of March 31, 2005, was 1.46%
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,
-------------------------------------------------
2005 2004 2003 2002 2001
------- ------- ------ ------ ------
(Dollars in thousands)
Allowance at beginning
of period................ $10,122 $ 8,506 $5,887 $4,977 $4,757
Provision for loan losses. 1,700 1,915 2,740 1,089 320
Recoveries:
First mortgage loans..... -- -- -- -- --
Commercial loans......... 168 79 -- -- --
Credit card loans........ 5 6 8 4 1
Other consumer loans..... 1 1 -- 4 --
------- ------- ------ ------ ------
Total recoveries......... 174 86 8 8 1
Charge-offs:
First mortgage loans..... -- -- -- (28) (60)
Commercial loans....... (105) (253) (54) (148) (21)
Credit card loans...... (104) (124) (71) (5) (20)
Other consumer loans... (20) (8) (4) (6) --
Total charge-offs...... (229) (385) (129) (187) (101)
Net charge-offs........ (55) (299) (121) (179) (100)
------- ------- ------ ------ ------
Allowance at end of
period................... $11,767 $10,122 $8,506 $5,887 $4,977
======= ======= ====== ====== ======
Allowance for loan losses
as a percentage of net
loans receivable at the
end of the period........ 1.46% 1.48% 1.35% 0.96% 0.78%
Net charge-offs as a
percentage of average
loans outstanding
during the period........ 0.01% 0.05% 0.02% 0.03% 0.02%
Allowance for loan losses
as a percentage of non-
performing assets
at end of period......... 794.53% 2,518.51% 511.09% 614.70% 597.94%
10
The following table sets forth the breakdown of the allowance for loan losses by loan category for the
periods indicated.
At March 31,
---------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---------------- ---------------- ---------------- ---------------- ---------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
One-to-four family
residential, home
equity, and other
consumer loans.....$ 1,052 8.9% $ 1,574 15.6% $1,780 20.9% $2,105 35.8% $2,468 49.6%
Commercial,
commercial real
estate, multi-
family, and
construction
and land
development........ 10,715 91.1 8,547 84.4 6,726 79.1 3,782 64.2 2,509 50.4
------- ----- ------- ----- ------ ----- ------ ----- ------ -----
Total allowance
for loan
losses............$11,767 100.0% $10,121 100.0% $8,506 100.0% $5,887 100.0% $4,977 100.0%
======= ===== ======= ===== ====== ===== ====== ===== ====== =====
The Bank had an allowance of $0, $0, $0, $50,000 and $0 for real estate
acquired through foreclosure at March 31, 2005, 2004, 2003, 2002 and 2001,
respectively.
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, and 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, U.S. Treasury obligations, federal agency securities, municipal
securities, common stock, preferred stock and corporate notes.
The FDIC has adopted the Federal Financial Institutions Examination
Council statement of policy on securities activities and accounting
procedures. This policy requires that institutions establish prudent policies
and strategies for securities activities, identify certain securities trading
practices that are unsuitable for an investment portfolio, recommends
procedures for selection of a securities dealer, and limits investment in high
risk mortgage securities and disproportionately large holdings of long-term
zero coupon bonds.
The policy addresses concerns about speculative or other non-investment
activities in the securities investment portfolios of depository institutions.
Speculative securities activities can impair earnings or capital and, in some
cases, may cause the failure of the institution. The policy establishes a
framework for structuring securities activities and clarifies various
accounting issues concerning investment accounts versus trading accounts.
The amortized cost of the Bank's investment securities of the type
described above at March 31, 2005 was $67.2 million with a market value of
$72.2 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, 2005,
these securities had an amortized cost of $19.2 million and a market value of
$19.4 million.
11
The following table presents the amortized cost of the Bank's investment
securities portfolio. The market value of the Bank's investment securities
portfolio at March 31, 2005 was approximately $91.6 million. This table also
includes interest-bearing deposits and cash equivalents.
At March 31,
-------------------------------
2005 2004 2003
-------- -------- ---------
(In thousands)
Investment securities:
U.S. Government:
Available for sale.......... $ 54,034 $ 57,397 $ 38,821
Held to maturity............ 370 369 369
-------- -------- --------
54,404 57,766 39,190
Mortgage-backed securities(1):
Available for sale.......... 18,353 27,363 37,141
Held to maturity............ 885 1,544 2,793
-------- -------- --------
19,238 28,907 39,934
Other securities(2):
Available for sale.......... 12,762 20,266 27,386
Held to maturity............ -- -- --
-------- -------- --------
12,762 20,266 27,386
-------- -------- --------
Total investments.......... 86,404 106,939 106,510
Interest bearing deposits
and cash equivalents......... 27,158 39,199 75,013
-------- -------- --------
$113,562 $146,138 $181,523
======== ======== ========
- ----------
(1) Consists of mortgage-backed securities and collateralized mortgage
obligations ("CMOs").
(2) Consists of corporate debt securities, marketable equity securities and
mutual funds.
At March 31, 2005, 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.
12
The following table sets forth the scheduled maturities, amortized cost, market values and average
yields for the Bank's investment securities at March 31, 2005.
At March 31, 2005*
----------------------------------------------------------------------------------------
More than More than
1 Year 1 to 5 5 to 10 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 securi-
ties, state
and political
subdivisions:
Available for
sale.......... $14,101 4.46% $35,296 3.60% $2,981 4.43% $1,656 4.78% $54,034 $53,391 3.90%
Held to
maturity...... -- -- 370 4.30 -- -- -- -- 370 383 4.30
------- ---- ------- ---- ------ ---- ------- ---- ------- ------- ----
14,101 4.46 35,666 3.61 2,981 4.43 1,656 4.78 54,404 53,774 3.90
Mortgage-backed
securities:
Available for
sale.......... 56 5.96 -- -- 3,335 5.57 14,962 4.22 18,353 18,510 4.45
Held to
maturity...... -- -- 771 6.39 11 9.21 103 9.37 885 926 6.77
------- ---- ------- ---- ------ ---- ------- ---- ------- ------- ----
56 5.96 771 6.39 3,346 5.58 15,065 4.25 19,238 19,436 4.56
Other:
Available for
sale.......... 9,080 4.06 3,682 4.75 -- -- -- -- 12,762 18,435 4.26
Held to
maturity...... -- -- -- -- -- -- -- -- -- -- --
9,080 4.06 3,682 4.75 -- -- -- -- 12,762 18,435 4.26
------- ---- ------- ---- ------ ---- ------- ---- ------- ------- ----
Total.......... $23,237 4.31% $40,119 3.77% $6,327 5.04% $16,721 4.30% $86,404 $91,645 4.10%
======= ==== ======= ==== ====== ==== ======= ==== ======= ======= ====
- ----------
* At March 31, 2005, yields on the Bank's tax-exempt obligations had not been computed on a tax
equivalent basis.
13
Real Estate Development Subsidiary
- ----------------------------------
Westward Financial Services, Inc ("Westward"), a land development
company, is a wholly owned subsidiary of the Bank. Westward has been in the
real estate development business since the 1970s, primarily focused on
residential land development. Westward recently completed a 110 lot
residential development in north Bellingham ("Stoneybrook"), with the final 11
lots scheduled to close in the first quarter of fiscal 2006. Income
attributable to Westward totaled $491,143, $522,429, and $291,650 for fiscal
years 2005, 2004, and 2003, respectively. The majority of the lot sales for
the "Stoneybrook" development occurred in fiscal years 2005 and 2004, which
accounts for the differing income amounts in these periods.
In October 2004, Westward entered into a real estate development joint
venture in Greenbriar Northwest LLC ("GBNW"), an established residential land
development company headquartered in Bellingham,Washington (50% owned by
Westward and 50% by Greenbriar Construction, a Bellingham based real estate
development company). This joint venture involves approximately 85 acres of
land in south Bellingham, and current plans include developing the property
into 739 residential units, in a new neighborhood to be known as "Fairhaven
Highlands." The investment in real estate is recorded as an asset on the
Corporation's balance sheet, and the related debt is recorded as a liability.
The real estate joint venture has a carrying amount of approximately $17.2
million, with a related borrowing of approximately $16.7 million. One-half of
the borrowing expense related to the joint venture is recognized as an expense
on the Corporation's financial statements as incurred, with the remainder
being capitalized. The Corporation is presently not recognizing any income
related to this joint venture, as it is in the early stages of development.
For additional details on this joint venture, please see Note 1 - Nature of
Operations and Summary of Significant Accounting Policies, of the Notes to the
Consolidated Financial Statements, contained in Item 8 of this Form 10-K.
Bank Owned Life Insurance
- -------------------------
At March 31, 2005, the Bank held $13.6 million in bank owned life
insurance ("BOLI"), compared to $13.8 million at March 31, 2004. The majority
of the Bank's BOLI assets are concentrated in two policies, each in the
approximate amount of $5.5 million. These two policies were purchased in
March and April 2002, for approximately $5.0 million per policy. These
policies are with Mass Mutual and New York Life, two of the highest rated BOLI
providers. Both of these firms continue to receive high ratings from AM Best,
Fitch, Standard & Poors and Moodys.
Deposit Activities and Other Sources of Funds
- ---------------------------------------------
General. Savings accounts and other types of deposits have
traditionally been important sources 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 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 ten 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.
14
The following table sets forth certain information concerning the
deposits at the Bank.
Year Ended March 31,
-----------------------------------------------------
2005 2004 2003
----------------- ----------------- -----------------
Weighted Weighted Weighted
Average Average Average Average Average Average
Type Balance Rate Balance Rate Balance Rate
- ------------------ ------- ---- ------- ---- ------- ----
Savings........... $ 40,956 0.53% $ 39,611 0.73% $36,652 1.19%
Checking.......... 131,440 0.33 107,933 0.46 82,516 0.60
Money Market...... 134,144 1.26 122,314 1.08 126,080 1.75
Time Deposits..... 383,161 2.86 373,725 2.99 391,576 3.73
-------- ---- -------- ---- -------- ----
Total.......... $689,701 1.92% $643,583 2.06% $636,824 2.79%
======== ==== ======== ==== ======== ====
The following table indicates the amount of the Bank's deposits by time
remaining until maturity as of March 31, 2005 of $100,000 or more.
Certificates
Maturity Period of Deposit
-------------------------- --------------
(In thousands)
Three months or less........... $24,429
Over three through six months.. 27,853
Over six through twelve months. 48,922
Over twelve months............. 83,072
--------
Total......................... $184,276
========
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. These include 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, and money
market deposit accounts ("MMDAs") with and without limited check access.
The Bank's practice on early withdrawal penalties is applicable only to
time deposits. Management believes that in periods of rising interest rates
this practice will discourage depositors from making premature withdrawals for
the purpose of reinvesting in higher rate time deposits.
The minimum amount required to open a time deposit varies from $500 to
$100,000, depending on the type of time deposit. Pricing of rates on time
deposits with maturities from 30 days to ten 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 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 money market
15
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
its 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 Bank's ability to attract and
retain deposits and its 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. These 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.
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 of this Form 10-K.
Brokered Deposits. The Bank also utilizes brokered deposits as a
supplemental source of funding, when appropriate. During fiscal 2005, the
Bank increased its balances in brokered deposits from $0 at March 31, 2004 to
$27.5 million at March 31, 2005. The rates paid on these deposits are
comparable to the rates on similar term from the Bank's alternative sources of
funding (such as wholesale borrowings, discussed below). The Bank intends to
continue utilizing brokered deposits to support its funding needs.
Borrowings. In December 1998, the Bank joined the FHLB of Seattle which
provides it with access to a variety of wholesale funding options. In
addition, the Bank's securities portfolio provides additional borrowing
capacity in the reverse repurchase markets. 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 funds are considered overnight borrowings and bear interest
at rates that fluctuate daily based on current market rates. At March 31,
2005, the Bank had $119.1 in borrowings, compared to $67.5 million at March
31, 2004. Access to these wholesale borrowings allows management to meet
cyclical funding needs, and assists in interest rate risk management efforts.
For additional information on borrowings, see Note 11 of the Notes to
the Consolidated Financial Statements contained in Item 8 of the Form 10-K.
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.
16
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, 2005, Horizon Bank employed 244 full-time and 22 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.
Executive Officers of the Registrant
The executive officers of the Corporation and the Bank are as follows:
Age at
Name March 31, 2005 Position
- ---------------- -------------- -------------------------------------
V. Lawrence Evans 58 Chairman of the Board, Chief Executive
Officer and President of the
Corporation; and Chairman of the Board
and Chief Executive Officer of the Bank
Dennis C. Joines 55 President, Chief Operating Officer and
Director of the Bank; Executive Vice
President and Director of the
Corporation
Richard P. Jacobson 42 Vice President and Secretary of the
Corporation and Executive Vice President
and Secretary of the Bank
Steve L. Hoekstra 54 Executive Vice President of the Bank
Kelli J. Holz 36 Vice President of the Corporation and
the Bank
A.R. (Gus) Ayala 55 Senior Vice President of the Bank
Tammy D. Barnett 41 Senior Vice President of the Bank
Frank Jeretzky 57 Senior Vice President of the Bank
Jane L. VanVoorst 53 Senior Vice President of the Bank
The following is a description of the principal occupation and
employment of the executive officers of the Corporation and the Bank during at
least the past five years:
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.
17
DENNIS C. JOINES became President and Chief Operating Officer of the
Bank 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 joined the Bank in 1987 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 and is currently the
Chief Financial Officer.
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.
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 in connection with 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.
FRANK JERETZKY joined the Bank in 2004 as Senior Vice President, Senior
Commercial Real Estate Lending Executive. Previously, Mr. Jeretzky was a
Commercial Real Estate Specialist for First Mutual Bank from 1996 until 2004.
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.
Regulation and Supervision
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The Bank.
General. As a state-chartered, federally insured bank, Horizon Bank is
subject to extensive 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 its state regulators, and files quarterly and 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.
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 are 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.
18
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, Washington
savings banks 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.
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 Bank
Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF").
The BIF is for commercial banks and some state-chartered savings banks and the
SAIF is 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 this 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 2005, and therefore, paid no deposit insurance assessments.
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 1980s to help fund
the thrift industry cleanup. The FICO assessment rate is adjusted quarterly.
For the first quarter of 2005, the annualized rate was 1.44 cents per $100 of
insured deposits.
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%
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% 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. At March 31, 2005, the Bank had Tier 1
leverage capital of 10.8%. 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 based on the relative
risk of
19
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 the bank's financial condition. Such
factors may include interest rate risk exposure, liquidity, funding and market
risks, the quality and level of earnings, concentration of credit risk, risks
arising from nontraditional activities, loan and investment quality, the
effectiveness of loan and investment policies, and management's ability to
monitor and control financial operating risks. At March 31, 2005, the Bank's
determined that its total risk-based ratio was 13.7% and its Tier 1 risk-based
capital ratio was 12.1%.
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, 2005, Horizon Bank had a net worth of 10.7% 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. For additional information concerning the
Bank's capital, see Note 14 of the Notes to the Consolidated Financial
Statements.
Federal Deposit Insurance Improvement Act ("FDICIA"). Horizon Bank has
more than $500 million in assets and therefore, is required to comply with the
provisions of FDICIA. 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 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,
20
the Bank is required to purchase and hold stock in the FHLB of Seattle in an
amount equal to .75% of home mortgage loans and pass through securities plus
3.5% of the advances outstanding. As of March 31, 2005, Horizon Bank held
stock in the FHLB of Seattle in the amount of $7.2 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 nonpersonal time deposits.
These reserves may be in the form of cash or non-interest bearing deposits
with the regional Federal Reserve Bank. NOW accounts and other types of
accounts that permit payments or transfers to third parties fall within the
definition of transaction accounts and are subject to Regulation D reserve
requirements, as are any non-personal time deposits at a savings bank. Under
Regulation D, a bank must establish reserves equal to 3% of the first $47.6
million of transactions accounts, of which the first $7.0 million is exempt,
and 10% of the remainder. Currently, there is no reserve requirement on
nonpersonal time deposits with original maturities of less than 1.5 years. As
of March 31, 2005, the Bank was in compliance with the Federal Reserve Bank's
reserve requirements.
Prompt Corrective Action. The FDIC is required to take certain
supervisory actions against undercapitalized savings institutions, the
severity of which depends upon the institution's degree of
undercapitalization. Generally, an institution that has a ratio of total
capital to risk-weighted assets of less than 8%, a ratio of Tier 1 (core)
capital to risk-weighted assets of less than 4%, or a ratio of core capital to
total assets of less than 4% (3% or less for institutions with the highest
examination rating) is considered to be undercapitalized. An institution that
has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of
less than 3% or a leverage ratio that is less than 3% is considered to be
significantly undercapitalized and an institution that has a tangible capital
to assets ratio equal to or less than 2% is deemed to be critically
undercapitalized. In most instances, the FDIC is required to appoint a
receiver or conservator for a savings institution that is critically
undercapitalized. FDIC regulations also require that a capital restoration
plan be filed with the FDIC within 45 days of the date a savings institution
receives notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. Compliance with the plan must be guaranteed by
any parent holding company in an amount of up to the lesser of 5% of the
institution's assets or the amount which would bring the institution into
compliance with all capital standards. In addition, numerous mandatory
supervisory actions become immediately applicable to an undercapitalized
institution, including, but not limited to, increased monitoring by regulators
and restrictions on growth, capital distributions and expansion. The FDIC
also could take any one of a number of discretionary supervisory actions,
including the issuance of a capital directive and the replacement of senior
executive officers and directors.
At March 31, 2005, the Bank was categorized as "well capitalized" under
the prompt corrective action regulations of the FDIC.
The Corporation.
General. The Corporation, as the sole stockholder 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
21
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.
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.
Financial Services Modernization Act. On November 12, 1999, the
Gramm-Leach-Bliley Financial Services Modernization Act of 1999 was signed
into law. 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 Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001, or the USA Patriot
Act, was signed into law 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. 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 must implement a risk-based customer
identification program in connection with opening new accounts. The
program must contain requirements for identity verification,
record-keeping, comparison of information to government-maintained
lists and notice to customers.
22
* Financial institutions that establish, maintain, administer, or manage
private banking accounts or correspondent accounts in the United
States for non-U.S. 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.
* 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 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 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;
23
* the formation of a public accounting oversight board;
* auditor independence; and
* various increased criminal penalties for violations of securities
laws.
Acquisitions. The BHCA prohibits a bank holding company, with certain
exceptions, from acquiring ownership or control of more than 5% of the voting
shares of any company that is not a bank or bank holding company and from
engaging in activities other than those of banking, managing or controlling
banks, or providing services for its subsidiaries. Under the BHCA, the
Federal Reserve may approve the ownership of shares by a bank holding company
in any company, the activities of which the Federal Reserve has determined to
be so closely related to the business of banking or managing or controlling
banks as to be a proper incident thereto. These activities include: 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 U.S. 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
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for banks. The Federal Reserve regulations
provide that capital standards will be applied on a consolidated basis in the
case of a bank holding company with $150 million or more in total consolidated
assets. The Corporation's total risk based capital must equal 8% of
risk-weighted assets and one- half of the 8%, or 4%, must consist of Tier 1
(core) capital. At March 31, 2005, the Corporation's capital position was in
excess of these requirements with total risk based capital of 13.7% of
risk-weighted assets and Tier 1 (core) capital of 12.1% of risk-weighted
assets.
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.
Taxation
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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.
24
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 were 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 eliminated 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 required 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 is 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 rules allowed an
institution to suspend bad debt reserve recapture for the 1996 and 1997 tax
years if the institution's lending activity for those years was 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 were included and the institution
could have elected to have the tax years with the highest and lowest lending
activity removed from the average calculation. If an institution was
permitted to postpone the reserve recapture, it must have begun its six year
recapture no later than the 1998 tax year. The unrecaptured base year
reserves would 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 stockholders.
Distributions. If a stock institution distributes amounts to
stockholders and the distribution is treated as being from its accumulated bad
debt reserves, the distribution will cause the institution to have additional
taxable income. A distribution to stockholder is deemed to have been made
from accumulated bad debt reserves to the extent that (i) the reserves exceed
the amount that would have been accumulated on the basis of actual loss
experience, and (ii) the distribution is a "non-dividend distribution." A
distribution in respect of stock is a non-dividend distribution to the extent
that, for federal income tax purposes, (i) it is redemption of shares, (ii) it
is pursuant to a liquidation or partial liquidation of the institution, or
(iii) in the case of current distribution, together with all other such
distributions during the taxable year, it exceeds the institution's current
and post-1951 accumulated earnings and profits. The amount of additional
taxable income created by a non-dividend distribution is an amount that, when
reduced by tax attributable to it, is equal to the amount of the distribution.
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 Internal Revenue Service
during the past five years.
25
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
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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.
26
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, 2005 Feet Owned
-------- --------------- ------ ---------
(In thousands)
Bellingham Main
Office 1971 $1,837 19,179 Owned
1500 Cornwall Avenue
Bellingham, WA 98225
Bellingham/Meridian 1987 813 4,650 Owned
4110 Meridian Street
Bellingham, WA 98226
Ferndale Office 1976 288 3,692 Owned
Third and Main
Ferndale, WA 98248
Lynden Office 1981 544 3,702 Owned
Third and Grover Streets
Lynden, WA 98264
Blaine Office 1976 644 3,610 Owned
Fourth & "H" Streets
Blaine, WA 98230
Mount Vernon Office 1976 261 3,275 Owned
1503 Riverside Dr.
Mount Vernon, WA 98273
Anacortes Office 1987 748 3,650 Owned
1218 Commercial Avenue
Anacortes, WA 98221
Snohomish Office 1987 151 1,388 Owned
620 2nd Street
Snohomish, WA 98290
Everett Office 1991 31 1,972 Leased
909 S.E. Everett Mall
Way, #E-500
Everett, WA 98208
Burlington Office 1994 1,164 3,980 Owned
1020 S. Burlington Blvd
Burlington, WA 98232
(table continues on following page)
27
Net Book
Year Value as of Square Leased/
Opened March 31, 2005 Feet Owned
-------- --------------- ------ ---------
(In thousands)
Edmonds Office 1994 $2,064 15,265 Owned
130 Fifth Avenue South
Edmonds, WA 98020
Murphy's Corner Office 2000 1,670 3,720 Owned
12830 Bothell Everett Hwy.
Everett, WA 98208
Barkley Office 1999 3,009 14,691 Owned
2122 Barkley Blvd.
Bellingham, WA 98228
Holly Street Office 1999 418 4,000 Owned
211 E. Holly Street
Bellingham, WA 98227
Alabama Office 1999 722 4,500 Owned
802 Alabama Street
Bellingham, WA 98228
Marysville Office (1) 2004 2,403 4126 Owned
3617 88th St NE
Marysville, WA 98270
Lynnwood Office 2003 2,352 4,230 Owned
19405 44th Avenue W.
Lynnwood, WA 98036
Lakewood Office(2) 2005 2,019 4,773 Owned
10318 Gravelly Lake
Dr. SW
Lakewood, WA 98499
Everett Office (new) 1,382 -- Owned
9929 Evergreen Way
Everett, WA 98204
Whatcom Commercial Center 2003 213 5,200 Leased
2211 Rimland Drive,
Suite 230
Bellingham, WA 98226
Snohomish Commercial
Center 2003 49 1,700 Leased
906 S. Everett Mall
Way, Suite 140
Everett, WA 98208
- -------------
(1) Opened in November 2004.
(2) Opened in April 2005.
28
At March 31, 2005, the aggregate book value of the Corporation's
premises and equipment was $22,782 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 the Bank 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.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
- ---------------------------------------------------------------------------
and Issuer Purchases of Equity Securities
-----------------------------------------
Horizon Financial'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 Bank'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 stockholders.
2005 Fiscal Year
Quarter High Low Dividend
------------- ---------- ----------- -------------
Fourth $22.02 $17.55 $0.135
Third 22.00 18.59 0.135
Second 20.42 17.37 0.130
First 20.07 16.73 0.130
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
Dividend Policy
- --------------
Horizon Financial 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
29
1,065,000 shares) over a 12 month period that resulted in the repurchase of
358,100 shares at an average price of $15.28 per share, (iii) September 2003
for the repurchase of up to 10% (approximately 1,050,000 shares) for a 12
month period which resulted in the repurchase of 151,840 shares at an average
price of $18.14 per share, (iv) March 2004 for the repurchase of up to 10%
(approximately 1,040,000 shares) for a 12 month period that, as of the year
ended March 31, 2005, had resulted in the repurchase of 450,880 shares at an
average price of $19.23 per share, and (v) March 2005 for the repurchase of up
to 10% (approximately 1,000,000 shares) for a 12 month period.
The following table sets forth the Corporation's repurchases of its
outstanding Common Stock during the fourth quarter of the year ended March 31,
2005.
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 (1) Purchased (or Unit) Programs Programs
- -------------- ----------- ----------- -------------- ---------------
January 1, 2005
- January 31,
2005......... 8,860 $19.057 352,962(1) 687,038
February 1, 2005
- February 28,
2005......... 51,618 20.429 404,580(1) 635,420
March 1, 2005
- March 31,
2005......... 46,300 20.705 450,880(1) 589,120
-------- -------- ---------- -----------
Total......... 106,778 20.435 450,880(1) 1,000,000(2)
======== ======== ========== ===========
- -------------
(1) Reflects purchases made under the repurchase plan authorized by the
Board of Directors in March 2004.
(2) Reflects new repurchase plan authorized by the Board of Directors in
March 2005.
30
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.
At March 31,
-------------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(In thousands)
Financial Condition Data:
- ------------------------
Total Assets............ $997,570 $858,876 $819,872 $772,063 $729,736
Loans Receivable, net... 804,981 658,226 582,269 568,303 597,382
Cash and Investment
Securities............. 125,965 161,071 197,296 171,346 106,117
Deposits................ 746,849 670,259 646,722 628,782 595,914
Borrowings.............. 135,787 67,469 53,763 29,121 22,938
Stockholders' Equity.... 107,024 109,307 106,244 100,600 97,909
Year Ended March 31,
-------------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(In thousands)
Operating Data:
- ---------------
Interest Income........ $52,182 $48,979 $50,698 $ 53,312 $ 56,017
Interest Expense....... (16,144) (15,509) (19,461) (26,541) (32,239)
------- ------- ------- -------- --------
Net Interest Income.... 36,038 33,470 31,237 26,771 23,778
Provision for Loan
Losses................ (1,700) (1,915) (2,740) (1,089) (320)
------- ------- ------- -------- --------
Noninterest Income..... 6,517 7,881 6,939 4,393 2,771
Noninterest Expense.... (22,423) (20,238) (17,346) (14,891) (13,756)
Income before Provision
for Income Taxes...... 18,432 19,198 18,090 15,184 12,473
Provision for Income
Tax................... (5,369) (6,332) (5,950) (5,130) (4,202)
------- ------- ------- -------- --------
Net Income............. $13,063 $12,866 $12,140 $ 10,054 $ 8,271
======= ======= ======= ======== ========
Per Common Share:(1)
Fully-diluted
earnings............. $1.26 $1.20 $1.12 $0.91 $0.72
Dividends............. 0.53 0.49 0.45 0.38 0.34
Book Value............ 10.66 10.50 10.07 9.35 8.84
Weighted average
shares outstanding...10,212,190 10,480,785 10,674,506 10,921,233 11,441,342
- ---------
(1) Restated for 15% stock dividend effective May 11, 2001 and 25% stock
split effective July 23, 2002.
31
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,
-----------------------------
2005 2004 2003
------- -------- --------
Return on average assets
(net income divided by
average total assets)............ 1.43% 1.55% 1.52%
Return on average equity
(net income divided by
average equity).................. 12.11 11.94 11.69
Dividend payout ratio
(dividends declared per share
divided by fully-diluted
earnings per share).............. 42.06 40.83 40.18
Equity to assets ratio
(average equity divided by
average total assets)............ 11.84 13.02 13.02
Interest rate spread
(difference between average
yield on interest-earning
assets and average cost of
interest bearing liabilities).... 4.21 4.24 4.01
Net yield on earning assets
(net interest income as a
percentage of average interest
earning assets).................. 4.34 4.42 4.26
Efficiency ratio (noninterest
expense divided by the sum of
net interest income and non-
interest income)................. 52.69 48.94 45.44
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 the Bank.
The information contained in this section should be read in conjunction with
the Consolidated Financial Statements and the accompanying Notes contained in
Item 8 of this Form 10-K.
Forward Looking Statements
- --------------------------
Management's Discussion and Analysis at Financial Condition and Results
of Operations and this Form 10-K contain certain forward-looking statements
which are based on assumptions and describe future plans, strategies and
expectations of the Corporation. Management desires to take advantage of the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
and is including this statement for the express purpose of availing the
Corporation of the protections of the safe harbor with respect to all
forward-looking statement in this Form 10-K. 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.
32
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 the provisions for loan losses and
other expenses. Other expenses consist primarily of noninterest 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.
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.
33
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: (i) it
is highly susceptible to change from period to period because it requires
management to make assumptions about future losses on loans; and (ii) 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
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. Horizon's 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, 2005 and believes that the allowance is adequate
for the risk inherent in the loan portfolio and the current economic
environment. In the review, management determined that the allowance was
adequate at 1.46% of net loans, or $11.8 million. The allowance was 1.5% of
net loans or $10.1 million at March 31, 2004. In fiscal 2005, the loan
portfolio grew 22.3% to $805.0 million at March 31, 2005 from $658.2 million
at March 31, 2004. The loan portfolio has experienced substantial growth
especially in multi-family and commercial real estate loans. At March 31,
2005, the multi-family and commercial real estate portfolios totaled $396.9
million up from the $308.6 million and $238.0 million for the years ended
March 31, 2004 and 2003, respectively. The increase in the allowance is
primarily attributable to the substantial growth in the loan portfolio. Fiscal
2005 was a period that showed improvement in the economic environment in the
Bank's markets, which provided management with additional comfort regarding
these reserve levels.
34
The Bank recorded net charge-offs of $55,000, $300,000, $121,000,
$179,000 and $100,000 during the years ended March 31, 2005, 2004, 2003, 2002
and 2001, respectively. Consumer loans (including home equity) totaled $41.9
million or 5.2% of the net loan portfolio at March 31, 2005. Visa card loans
and unsecured consumer loans 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 $50,000 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 $1.7 million, $1.9 million,
$2.7 million, $1.1 million and $320,000 for the fiscal years ended 2005, 2004,
2003, 2002 and 2001, respectively. If management's estimate of the allowance
deviated by plus or minus 10% then the $11.8 million allowance would either
decrease to $10.6 million or increase to $13.0 million. The provision for
loan losses would then subsequently decrease or increase by $1.2 million.
Accordingly, net income would increase or decrease by $790,000 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 Form 10-K 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.
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.
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 Form 10-K.
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 Form 10-K. 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 the Corporation's tax position.
35
Financial Condition
- -------------------
Total consolidated assets for the Corporation as of March 31, 2005, were
$997.6 million, a 16.1% increase from the March 31, 2004 level of $858.9
million. This increase in assets was primarily attributable to the growth in
loans receivable to $805.0 million at March 31, 2005 from $658.2 million at
March 31, 2004. 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 $106.4 million of real estate loans in fiscal
2005, compared to $216.8 million in fiscal 2004. The Bank sells real estate
loans during periods of increased loan volume to improve cash flow and to
manage its interest rate risk profile. The following is an analysis of the
loan portfolio by major type of loan as of March 31, 2005 and March 31, 2004.
At March 31,
------------------------
2005 2004
-------- ---------
(Dollars in thousands)
First mortgage loans:
One-to-four family................... $174,457 $179,324
One-to-four family construction...... 16,464 14,165
Participations sold.................. (65,125) (74,279)
-------- -------
Subtotal.......................... 125,796 119,210
Construction and land
development......................... 161,006 129,153
Residential commercial
real estate......................... 73,397 53,344
Nonresidential commercial
real estate......................... 323,464 255,273
Commercial loans..................... 91,210 78,721
Home equity secured.................. 35,913 26,985
Other consumer loans................. 5,962 5,662
-------- --------
Subtotal.......................... 690,952 549,138
-------- --------
Subtotal.......................... 816,748 668,348
Less:
Allowance for loan
losses.............................. (11,767) (10,122)
-------- --------
Total loans receivable............ 804,981 (658,226)
Net residential loans................. 124,745 16% 118,158 18%
Net commercial loans.................. 89,542 11 77,199 12
Net commercial real estate loans...... 549,506 68 430,814 65
Net consumer loans.................... 41,188 5 32,055 5
-------- --- -------- ---
$804,981 100% $658,226 100%
======== === ======== ===
36
Also contributing to the change in assets was the decline in investment
and mortgage-backed securities, available for sale, which, combined, decreased
20.0% to $90.3 million at March 31, 2005 from $112.9 million at March 31,
2004. The tables below display the characteristics of the available for sale
and held to maturity portfolios as of March 31, 2005:
As of March 31, 2005
--------------------------------------------
Amortized Gain/ Estimated
Cost (Loss) Fair Value
------------ ---------- -------------
(In thousands)
Available For Sale
Securities
State and political
subdivisions and U.S.
government agency
securities............. $54,034 $ (643) $ 53,391
Marketable equity
securities............. 1,824 5,692 7,516
Mutual funds............ 5,000 (70) 4,930
Corporate debt
securities............. 5,938 50 5,988
Mortgage-backed
securities and CMOs.... 18,353 157 18,510
------- ------ -------
Total available-for-
sale securities...... 85,149 5,186 90,335
------- ------ -------
Held To Maturity Securities
State and political
subdivisions and U.S.
government agency
securities............. 370 13 383
Mortgage-backed
securities and CMOs.... 885 41 926
------- ------ -------
Total held to
maturity securities.. 1,255 54 1,309
------- ------ -------
Total securities...... $86,404 $5,240 $91,644
======= ====== =======
Maturity Schedule of Securities
as of March 31, 2005
-----------------------------------------------
Available For Sale Held To Maturity
----------------------- ----------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---------- ----------- ---------- ----------
(In thousands)
Maturities:
Less than one year..... $ 16,413 $ 16,476 $ -- $ --
Over one year
to five years......... 38,979 38,461 1,141 1,177
Over five to
ten years............. 6,316 6,322 11 12
Over ten years......... 16,617 16,630 103 120
-------- -------- ------- -------
78,325 77,889 1,255 1,309
-------- -------- ------- -------
Mutual funds and
marketable equity
securities............. 6,824 12,446 -- --
-------- -------- ------- -------
Total investment
securities......... $ 85,149 $ 90,335 $ 1,255 $ 1,309
======== ======== ======= =======
37
Total liabilities also increased 18.8% to $890.5 million at March 31,
2005, from $749.6 million at March 31, 2004. This increase was the result, in
large part, of growth in deposits, which increased 11.4% to $746.8 million at
March 31, 2005 from $670.3 million at March 31, 2004. The following is an
analysis of the deposit portfolio by major type of deposit at March 31, 2005
and 2004:
At March 31,
----------------------
2005 2004
-------- -------
(In thousands)
Demand Deposits
Savings............................$ 40,863 $ 40,527
Checking........................... 83,268 78,697
Checking (non-interest-bearing).... 63,503 44,774
Money Market....................... 134,761 131,310
-------- --------
322,395 295,308
-------- --------
Time certificates of deposit
Less than $100,000................. 240,178 245,608
Greater than or
equal to $100,000................. 184,276 129,343
-------- --------
424,454 374,951
-------- --------
Total deposits.....................$746,849 $670,259
======== ========
Also contributing to the growth was an increase in other borrowed funds
to $119.1 million at March 31, 2005, from $67.5 million at March 31, 2004.
During the year, the Bank borrowed an additional $52.0 million from the FHLB
to help control interest rate risk and support the growth in assets.
Also included in the March 31, 2005 balance sheet is an investment in
real estate for a joint and venture and the corresponding borrowing. During
the year ended March 31, 2005, the Bank's subsidiary (Westward Financial
Services), as a 50% partner in the Greenbriar NW LLP, purchased an 85 acre
parcel of land in Bellingham, Washington for future development. The
partnership intends to develop the property in future years, into a
neighborhood community to be known as Fairhaven Highlands. The $17.2 million
shown on the Corporation's balance sheet as an asset at March 31, 2005
represents the current level of the investment in real estate joint ventures,
including the Fairhaven Highlands joint venture. The $16.7 million shown in
the liability section of the balance sheet represents the corresponding
wholesale borrowing used to fund the investment in the Fairhaven Highlands
joint venture. At this time, the partnership is in the process of meeting
with the appropriate public and private entities, in its preliminary planning
efforts relating to the future development of the property.
Stockholders' equity at March 31, 2005 decreased 2.1% to $107.0 million
from $109.3 million at March 31, 2004. This decrease was due primarily to the
decrease in accumulated other comprehensive income to $3.4 million at March
31, 2005 from $5.2 million at March 31, 2004. The primary reason for the
decline was the decrease in fair market value of various securities in the
Bank's portfolio as a result of rising interest rates. Also contributing to
the decrease was the share repurchase program totaling $8.7 million for the
year ended March 31, 2005 compared to $5.5 million for the year ended March
31, 2004. The Corporation remains strong in terms of its capital position,
with a stockholder equity-to-assets ratio of 10.7% at March 31, 2005, compared
to 12.7% at March 31, 2004.
Results of Operations
- ---------------------
Net Interest Income. Net interest income in fiscal 2005 was $36.0
million, a 7.7% increase from fiscal 2004 net interest income of $33.5
million, compared to $31.2 million in fiscal 2003. Total interest income
increased 6.5% in fiscal 2005 to $52.2 million from $49.0 million in fiscal
2004, compared to $50.7 million in fiscal 2003.
Interest income on loans in fiscal 2005 was $48.1 million, a 9.8%
increase from $43.8 million in fiscal 2004, compared to $44.6 million in
fiscal 2003. The increase in fiscal 2005 was due primarily to the growth in
loans receivable, as the Bank experienced significant loan growth during the
year, increasing to $805.0 million at March 31,
38
2005, compared to $658.2 million at March 31, 2004, and $582.3 million at
March 31, 2003. The decrease in fiscal 2004 compared to 2003 was due primarily
to the overall decline in interest rates. Included in these amounts for 2005,
2004 and 2003 were approximately $1.5 million, $3.0 million and $3.0 million,
respectively, of deferred fee income recognition.
Interest and dividends on investments and mortgage-backed securities was
$4.1 million in fiscal 2005, a 21.1% decrease from $5.1 million in fiscal
2004, compared to $6.1 million in fiscal 2003. These decreases were due to
lower levels of investments and mortgage backed securities outstanding during
the respective periods, as total investments decreased 28.0% to $102.7 million
at March 31, 2005 as compared to $142.6 million at March 31, 2004 and 182.2
million at March 31, 2003. The decline in the investment portfolio balances in
these years was due primarily to assist in funding the Bank's lending
activities. Also contributing to the decline in fiscal 2005 was a reduction
in dividend income on the Bank's FHLB stock. At March 31, 2005, Horizon held
$7.2 million in FHLB of Seattle stock and received dividends in the amounts of
$162,800 in fiscal 2005, $335,700 in fiscal 2004, and $413,300 in fiscal 2003.
On May 18, 2005, the FHLB of Seattle announced a three-year dividend
suspension; therefore, the Bank's investment income will be reduced
accordingly over the next three years.
Total interest expense in fiscal 2005 increased 4.1% to $16.1 million
from $15.5 million in fiscal 2004, compared to $19.5 million in fiscal 2003.
Interest on deposits decreased slightly in fiscal 2005 to $13.2 million,
compared to $13.2 million in fiscal 2004, and $17.7 million in fiscal 2003.
The decreases in fiscal 2005, 2004 and 2003 were due to the overall decline in
interest rates.
Interest on borrowings increased to $2.9 million in fiscal 2005,
compared to $2.3 million in fiscal 2004, and $1.8 million in fiscal 2003. The
increase in fiscal 2005 was due to a higher level of borrowings outstanding of
$119.1 million at March 31, 2005 compared to $67.5 million at March 31, 2004,
and $53.8 million at March 31, 2003. The significant increase in fiscal 2005
was related to funding the Bank's significant loan growth during the year.
The Bank continues to utilize 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 $1.7 million for the year ended March
31, 2005 compared to $1.9 million and $2.7 million for the years ended March
31, 2004 and 2003, 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 allowance for loan losses was $11.8 million,
or 1.46% of net loans receivable at March 31, 2005, compared to $10.1
million, or 1.48% of net loans receivable at March 31, 2004. 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 commercial business loans during the period,
which comprised $639.0 million, or 79.4% of net loans receivable at March 31,
2005, versus $453.0 million, or 68.8% at March 31, 2004.
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 the
allowance level to be appropriate, due to the changing portfolio mix and the
current economic environment.
39
As of March 31, 2005, there were no loans in the loan portfolio over 90
days delinquent and 16 loans on non- accrual status. The Bank had no real
estate owned at March 31, 2005. Total non-performing assets were $1.5
million, or 0.15% of total assets at March 31, 2005 compared to $402,000, or
0.05% of total assets at March 31, 2004.
At March 31,
-----------------------
2005 2004
------- ------
(Dollars in thousands)
Non-Performing Assets
Accruing loans-90 days past due.... $ -- $ 339
Non-accrual loans................. 1,481 --
Restructured loans................ -- --
------ ------
Total non-performing loans....... 1,481 339
Total non-performing
loans/net loans................. 0.18% 0.05%
Real estate owned................. -- 63
------ ------
Total non-performing assets...... 1,481 402
------ ------
Total non-performing
assets/total assets............. 0.15% 0.05%
Noninterest Income. Noninterest income in fiscal 2005 was $6.5 million,
a decrease of 17.3% from fiscal 2004 of $7.9 million, compared to $6.9 million
in fiscal 2003. Contributing to the decrease in fiscal 2005 was the decrease
in the net gain on the sale of loans (servicing released) of 55.3% to $983,000
from $2.2 million in fiscal 2004 and $2.7 million in fiscal 2003. The primary
reason for the decline was due to a lower amount of loans sold in the current
year of $90.3 million versus $201.9 million in fiscal 2004 and $209.6 million
in fiscal 2003 with both 2004 and 2003 being more active residential refinance
markets than fiscal 2005. Also contributing to the change in fiscal 2005 was
the increase in service fees of 10.7% to $3.2 million from $2.9 million in
fiscal 2004 and $2.3 million in fiscal 2003. The primary reasons for these
increases were the growth in deposits and revisions to the Bank's fee
schedules during the year.
The net gain on sales of investment securities decreased to $476,000 in
fiscal 2005 from $689,000 in fiscal 2004 and from $62,000 in fiscal 2003. The
gains in these periods were primarily attributable to the sale of selected
securities from the Bank's investment portfolio. Other non-interest income
decreased slightly to $1.8 million in fiscal 2005 from $1.9 million in fiscal
2004 and $1.8 million in fiscal 2003.
Noninterest Expense. Noninterest expense in fiscal 2005 increased to
$22.4 million, a 10.8% increase from fiscal 2004 of $20.2 million, compared to
fiscal 2003 of $17.3 million. Compensation and employee benefits increased
9.7% in fiscal 2005 to $12.6 million from $11.5 million in fiscal 2004,
compared to $9.4 million in fiscal 2003. The increases in compensation and
employee benefits in each year were primarily due to the overall growth in
employment at the Bank, including key additions to staff as the Bank continues
its efforts to enhance its commercial banking expertise, and staffing for the
Bank's Lynnwood office in fiscal 2004, and the Marysville and Lakewood offices
in fiscal 2005.
Building occupancy expense was $3.0 million in fiscal 2005, a 12.3%
increase from $2.6 million in fiscal 2004 compared to $2.3 million in fiscal
2003. The increase in fiscal 2005 was due to the opening of a full service
retail office in Marysville, Washington.
Other noninterest expenses increased 10.5% to $5.2 million in fiscal
2005 from $4.7 million in fiscal 2004, compared to $4.1 million in fiscal
2003. The increase in fiscal 2005 was primarily due to increased expenses
related to accounting services for compliance with the internal control
provisions of the Sarbanes-Oxley Act, and expenses related to opening the
Marysville office in November 2004. 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.
Data processing expenses increased in fiscal 2005 to $901,000 from
$558,000 in fiscal 2004, compared to $838,000 in fiscal 2003. The primary
reason for this increase relates to the core data processor conversion
effective
40
November 4, 2004. This core data processor conversion will allow the Bank to
better serve its growing commercial customer base, compared to its previous
data processor which targeted traditional thrift institutions. The other
significant contributing factor to this difference relates to an abnormally
low level of expenses in fiscal 2004, as a result of a renegotiation of the
Bank's contract with it core data processor at the time, which included
substantial concessions in the first quarter of fiscal 2004, and a reduced
monthly expense thereafter.
Advertising and marketing expenses decreased 12.3% to $688,000 in fiscal
2005 from $784,000 in fiscal 2004 compared to $758,000 in fiscal 2003. The
decreases in fiscal 2005 were primarily due to management's decision to reduce
this expense. The increases in fiscal 2004 and 2003 were related to market
research and brand positioning of the Bank in its various markets.
Provisions for Income Tax. Income tax expense decreased to $5.4 million
in fiscal 2005, from $6.3 million in fiscal 2004, compared to $5.9 million in
fiscal 2003. The Corporation's effective tax rate was approximately 30.0% in
fiscal 2005 and 33.0% in fiscal 2004 and 2003. During fiscal 2005 the Bank's
tax rate decline was primarily attributable to cost segregation studies
completed on several Bank properties, which provides more favorable
depreciation treatment on certain elements of the Bank's facilities for income
tax purposes.
Net Income. Net income of $13.1 million for fiscal 2005 represents a
1.5% increase from net income of $12.9 million for fiscal 2004, compared to
net income of $12.1 million in fiscal 2003. Basic earnings per share for 2005
was $1.28 on weighted average shares outstanding of 10,212,190 compared to
basic earnings per share of $1.23 on weighted average shares of 10,480,785 in
fiscal 2004, and basic earnings per share of $1.14 on weighted average shares
outstanding of 10,674,506 in fiscal 2003.
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.
41
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,
-------------- ----------------------------------------------------------------------------
2005 2005 2004 2003
-------------- ------------------------ ------------------------ ------------------------
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)...$804,980 6.69% $718,918 $48,131 6.69% $613,474 $43,842 7.15% $573,814 $44,157 7.69%
Investment
securities(2). 83,319 3.62 89,052 3,227 3.62 107,832 3,787 3.51 122,313 4,139 3.39
Mortgage-
backed
securities.... 19,396 3.62 22,751 824 3.62 36,780 1,350 3.67 36,115 1,933 5.35
-------- ---- ------- ------- ----- -------- ------- ---- -------- ------- ----
Total interest-
earning
assets....... 907,695 6.28 830,721 52,182 6.28 758,086 48,979 6.46 732,242 50,229 6.86
Interest-bearing
liabilities:
Deposits....... 746,849 1.92 689,425 13,219 1.92 641,691 13,225 2.06 633,796 17,673 2.79
Borrowings..... 119,066 3.26 89,820 2,925 3.26 56,318 2,285 4.06 38,276 1,788 4.67
-------- ---- ------- ------- ----- -------- ------- ---- -------- ------- ----
Total interest-
bearing
liabilities.. 865,915 2.07 779,245 16,144 2.07 698,009 15,510 2.22 672,072 19,461 2.90
-------- ------- ------- -------
Net interest
income......... $36,038 $33,470 $30,768
======= ======= =======
Interest rate
spread......... 4.21% 4.24% 3.96%
==== ==== ====
Net interest
margin......... 4.34% 4.42% 4.20%
==== ==== ====
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities.... 106.61% 108.61% 108.95%
====== ====== ======
- ----------------
(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.
42
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,
---------------------------------------------------------------------
2005 vs. 2004 2004 vs. 2003
--------------------------------- --------------------------------
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.... $7,640 $(2,860) $(491) $4,289 $3,019 $(3,566) $(237) $ (784)
Investment securities and
other interest-bearing
securities .................. (1,164) 101 (23) (1,086) (529) (444) 39 (934)
------ ------- ----- ------ ------ ------- ----- -------
Total interest-earning assets. $6,476 $(2,759) $(514) $3,203 $2,490 $(4,010) $(198) $(1,718)
====== ======= ===== ====== ====== ======= ===== =======
Interest expense:
Deposit accounts.............. $ 947 $ (887) $ (66) $(6) $ 219 $(4,610) $ (57) $(4,448)
Borrowings.................... 1,359 (451) (268) 640 839 (232) (110) 497
------ ------- ----- ------ ------ ------- ----- -------
Total interest-bearing
liabilities.................. $2,306 $(1,338) $(334) $ 634 $1,058 $(4,842) $(167) $(3,951)
====== ======= ===== ====== ====== ======= ===== =======
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, 2005, the Bank had liquid assets
(cash and marketable securities with maturities of one year or less) with a
book value of $ 63.1 million.
As of March 31, 2005, the total book value of investments and
mortgage-backed securities was $86.4 million compared to a market value of
$91.6 million with an unrealized gain of $5.2 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 $8.1 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 of this Form 10-K, 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:
(i) selling additional loans in the secondary market; (ii) entering into
reverse repurchase agreements; (iii) borrowing from the FHLB of Seattle; (iv)
accepting additional jumbo and/or public funds deposits; or (v) accessing the
discount window of the Federal Reserve Bank of San Francisco.
Stockholders' equity as of March 31, 2005 was $107.0 million, or 10.7%
of assets, compared to $109.3 million, or 12.7% of assets at March 31, 2004.
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, 2005
43
was 13.7%, compared to 16.6% as of March 31, 2004. These figures are well
above the well-capitalized minimum of 10% set by the FDIC.
The Corporation has conducted various buy-back programs since August
1996. In March 2005, the Board of Directors approved a new stock repurchase
plan that runs concurrent with the 2006 fiscal year, allowing the Corporation
to repurchase up to 10% of total shares outstanding, or approximately 1.0
million shares. This marked the Corporation's seventh stock repurchase plan.
In fiscal 2005, under the previous plans, the Corporation repurchased 450,880
shares at an average price of $19.23. For additional information concerning
the Corporation's repurchase activities during the fourth quarter of fiscal
2005, see Item 5 of this Form 10-K.
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 stockholder value. The number of shares of stock to be
repurchased and the price to 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, 2005, the Corporation had no off-balance
sheet derivative financial instruments, nor did it have a trading portfolio of
investments.
In fiscal 2005 and fiscal 2004, 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.
Similar to the analysis performed one year ago, the current interest
rate risk modeling continues to show the Bank's balance sheet as moderately
asset sensitive. The Bank's continued focus on shorter term, variable rate
assets has contributed to the Bank's performance in this regard. This
strategy has allowed the Bank to utilize wholesale borrowing and brokered
deposits as a supplemental source of funds to its retail and commercial
deposit gathering efforts, without significantly impacting the Bank's interest
rate risk profile. In addition, the Bank has been successful at increasing
its demand deposit based in the past three fiscal years, further enhancing the
Bank's interest rate risk profile. Accordingly, the interest rate risk
modeling performed each quarter during fiscal 2005 shows that the Bank
continues to operate within the interest rate risk tolerance limits set by its
Board of Directors.
With the current level of interest rates at March 31, 2005 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
45
addition, depending on timing differences, the magnitude of various rates
change in future periods, 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 profitability. At March 31, 2005, the
Corporation had $339.9 million in commercial loans tied to Prime. Of these
Prime based loans, approximately 98% will increase immediately when Prime
increases due to the lack of difference between the loan's current rate and
any floors in place. Approximately 1% of the Corporation's Prime based loans
are at their floor, and require an increase of 0.25% before adjusting; and the
balance of the Prime based portfolio will adjust only after Prime increases
0.75% to 1.5%. 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.
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 Notes 9, 11 and 16 of the
Notes to Consolidated Financial Statements included in Item 8 of this Form
10-K for additional information. The following table summarizes the
Corporation's long-term contractual obligations at March 31, 2005:
Less than One to Three to
One Three Five
Year Years Years Thereafter Total
---------- --------- ------- ---------- --------
(In thousands)
Time deposits........... $251,677 $130,170 $37,833 $4,775 $424,455
Long-term borrowings.... 72,787 52,500 10,500 - 135,787
Operating lease
obligations............ 244 333 64 109 750
-------- -------- ------- ------ --------
Total............... $324,708 $183,003 $48,397 $4,884 $560,992
======== ======== ======= ====== ========
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.
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 Form 10-K 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.
45
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 noninterest 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
- -------------------------------------------------------------------
Quantitative Disclosures About Market Risk. The table below represents
the balances of the Bank's financial instruments at March 31, 2005. 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-
Over 1 Over 2 Over 3 tized Fair
Average Within Year to Years 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......... 6.69% $438,306 $105,493 $122,384 $110,398 $28,399 $804,980 $803,378
Mortgage-backed
securities.............. 3.62 6,631 3,258 2,717 3,903 2,887 19,396 19,437
Investments and other
interest-earning assets. 3.62 39,044 10,307 14,617 16,104 3,248 83,320 83,333
----- ------- ------- -------- ------- ------ ------ ------
Total Interest
Sensitive Assets........ 6.28 483,981 119,058 139,718 130,405 34,534 907,696 906,148
Cumulative Totals........ -- 483,981 603,039 742,757 873,162 907,696 -- --
Interest-Sensitive Liabilities:
Checking accounts........ 0.33 8,327 23,214 23,214 26,291 65,725 146,771 146,771
Money market ultimate
accounts................ 1.26 94,333 10,107 10,107 5,775 14,439 134,761 134,761
Savings accounts......... 0.53 8,172 4,086 4,086 7,005 17,514 40,863 40,863
Certificates of deposit.. 2.86 256,086 71,322 67,203 29,843 -- 424,454 414,263
Other borrowings(1)...... 3.26 72,787 23,500 29,000 10,500 -- 135,787 134,502
----- ------- ------- -------- ------- ------ ------ ------
Total Interest Sensitive
Liabilities............. 2.07 439,705 132,229 133,610 79,414 97,678 882,636 871,160
Cumulative Totals........ -- 439,705 571,934 705,544 784,958 882,636 -- --
(table continues on following page)
46
Amor-
Over 1 Over 2 Over 3 tized Fair
Average Within Year to Years Years Beyond Cost Value
Yield 1 Year 2 Years to 3 Years to 5 Years 5 Years Total Total
----- ------ ------- ---------- ---------- ------- ----- -----
(Dollars in thousands)
Off-Balance Sheet Items:
Commitments to
extend credit............ 6.51 128,780 -- -- -- -- 128,780 128,780
Unused lines of credit.... 6.53 90,867 -- -- -- -- 90,867 90,867
Stand by letters
of credit................ -- 1,824 1,824 1,824
Credit card arrangements.. 12.01 9,087 - - - - 9,087 9,087
------- ------- -------- ------- ------ ------ ------
Total Off Balance
Sheet Items.............. 6.74 230,558 -- -- -- -- 230,558 230,558
- -----------
(1) Includes borrowing related to investment in real estate for a joint
venture.
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.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
(a) (1) Financial Statements. Page
-------------------- ----
Management's Annual Report on Internal Control Over
Financial Reporting 48
Report of Independent Registered Public Accounting
Firm 49
Consolidated Statement of Financial Position as of
March 31, 2005 and 2004 51
Consolidated Statement of Income for the Years Ended
March 31, 2005, 2004 and 2003 52
Consolidated Statement of Stockholders' Equity for
the Years Ended March 31, 2005, 2004 and 2003 53
Consolidated Statement of Cash Flows for the Years
Ended March 31, 2005, 2004 and 2003 54
Notes to Consolidated Financial Statements 55
47
Management's Annual Report on Internal Control Over Financial Reporting:
- ------------------------------------------------------------------------
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Horizon Financial Corp. and its subsidiaries ("the Company") is
responsible for establishing and maintaining adequate internal control over
financial reporting, and for performing an assessment of the effectiveness of
internal control over financial reporting as of March 31, 2005. The Company's
internal control over financial reporting is a process designed under the
supervision of the Company's management, including the Chief Executive Officer
and Chief Financial Officer, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States of America.
The Company's system of internal control over financial reporting includes
policies and procedures that (i) pertain to the maintenance of records that,
in reasonable detail, accurately and fairly reflect transactions and
dispositions of assets of the Company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the
United States, and that receipts and expenditures of the Company are being
made only in accordance with authorizations of Management and Directors of the
Company; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the Company's
assets that could have a material effect on the financial statements.
Management recognizes that there are inherent limitations in the effectiveness
of any system of internal control, and accordingly, even effective internal
control can provide only reasonable assurance with respect to financial
statements preparation and fair presentation. Further, because of changes in
condition, the effectiveness of internal control may vary over time.
Under the supervision and with the participation of the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer,
the Company performed an assessment of the effectiveness of the Company's
internal control over financial reporting as of March 31, 2005 based upon
criteria in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO"). Based on this
assessment, Management determined that the Company's internal control over
financial reporting was effective as of March 31, 2005.
The Company's independent registered public accounting firm, Moss Adams LLP
who audits the Company's consolidated financial statements, have issued an
attestation report on Management's assessment and on the effectiveness of the
Company's internal control over financial reporting. This report follows.
Dated May 26, 2005
48
[Moss Adams LLP Letterhead]
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Horizon Financial Corp. and Subsidiary
We have audited the accompanying consolidated statement of financial position
of Horizon Financial Corp. and Subsidiary as of March 31, 2005 and 2004, and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended March 31, 2005. We also
have audited management's assessment included in the accompanying Management
Report on Internal Control over Financial Reporting that Horizon Financial
Corp. maintained effective internal control over financial reporting as of
March 31, 2005, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Horizon Financial Corp. and Subsidiary's management is
responsible for these financial statements, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility is to express
an opinion on these financial statements, an opinion on management's
assessment, and an opinion on the effectiveness of the Horizon Financial Corp.
and Subsidiary's internal control over financial reporting based on our
audits.
We conducted our audits in accordance with auditing 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 in all
material respects. Our audits of financial statements included examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we considered necessary in the circumstances. We believe that
our audits provide a reasonable basis for our opinion.
The Company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A Company's internal
control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of the Company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts
and expenditures of the Company are being made only in accordance with
authorizations of management and Directors of the Company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
49
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Horizon Financial Corp. and Subsidiary as of March 31, 2005 and 2004, and
the results of their operations and cash flows for each of the three years in
the period ended March 31, 2005, in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion,
management's assessment that Horizon Financial Corp. and Subsidiary maintained
effective internal control over financial reporting as of March 31, 2005, is
fairly stated, in all material respects, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Furthermore, in our opinion, Horizon
Financial Corp. and Subsidiary maintained, in all material respects, effective
internal control over financial reporting as of March 31, 2005, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
/s/Moss Adams LLP
Bellingham, Washington
May 26, 2005
50
HORIZON FINANCIAL CORP.
Consolidated Statement of Financial Position
March 31, 2005 and 2004
==============================================================================
Assets
2005 2004
------------ ------------
Cash and cash equivalents $ 23,250,411 $ 18,431,964
Interest-bearing deposits 3,907,349 20,767,398
Investment securities
Available-for-sale (amortized cost 2005:
$66,796,424; 2004: $77,662,276) 71,824,994 85,183,872
Held-to-maturity (estimated fair value
2005: $382,909; 2004: $400,299) 369,596 369,444
Mortgage-backed securities
Available-for-sale (amortized cost 2005:
$18,353,299; 2004: $27,362,914) 18,510,439 27,759,813
Held-to-maturity (estimated fair value
2005: $926,329; 2004: $1,653,590) 885,137 1,544,034
Federal Home Loan Bank Stock 7,217,900 7,014,900
Loans receivable, net of allowance for loan
losses of $11,767,029 in 2005 and
$10,121,532 in 2004 804,980,578 658,226,144
Loans held for sale 4,068,859 1,333,500
Investment in real estate in a joint venture 17,204,265 -
Accrued interest and dividends receivable 4,498,756 4,032,007
Premises and equipment, net 22,781,657 17,193,671
Real estate owned - 63,432
Net deferred income tax assets 2,299,225 831,123
Income tax currently receivable 330,862 -
Other assets 15,440,447 16,124,579
------------ ------------
TOTAL ASSETS $997,570,475 $858,875,881
============ ============
Liabilities and Stockholders' Equity
Deposits $746,849,411 $670,259,218
Accounts payable and other liabilities 5,570,071 8,301,761
Other borrowed funds 119,066,193 67,468,842
Borrowing related to investment in real
estate in a joint venture 16,720,745 -
Advances by borrowers for taxes and insurance 518,774 416,899
Income tax currently payable - 1,375,274
Deferred compensation 1,821,094 1,746,894
------------ ------------
Total liabilities 890,546,288 749,568,888
------------ ------------
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; 10,037,903 and 10,405,331 issued
and outstanding, respectively 10,037,903 10,405,331
Additional paid-in capital 54,737,070 56,893,824
Retained earnings 38,939,268 36,925,836
Unearned ESOP shares (72,101) (144,205)
Accumulated other comprehensive income 3,382,047 5,226,207
------------ ------------
Total stockholders' equity 107,024,187 109,306,993
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $997,570,475 $858,875,881
============ ============
See accompanying notes to these financial statements 51
==============================================================================
HORIZON FINANCIAL CORP.
Consolidated Statement of Income
Years Ended March 31, 2005, 2004, and 2003
==============================================================================
2005 2004 2003
----------- ----------- -----------
INTEREST INCOME
Interest on loans $48,131,012 $43,842,447 $44,626,384
Investment and mortgage-backed
securities
Taxable interest 3,598,339 4,474,212 5,336,638
Nontaxable interest income 148,884 111,519 37,855
Dividends 303,661 551,436 696,866
----------- ----------- -----------
Total interest income 52,181,896 48,979,614 50,697,743
----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits 13,218,857 13,224,629 17,672,959
Interest on other borrowings 2,924,988 2,284,728 1,788,142
----------- ----------- -----------
Total interest expense 16,143,845 15,509,357 19,461,101
----------- ----------- -----------
Net interest income 36,038,051 33,470,257 31,236,642
PROVISION FOR LOAN LOSSES 1,700,000 1,915,000 2,740,000
----------- ----------- -----------
Net interest income after
provision for loan losses 34,338,051 31,555,257 28,496,642
----------- ----------- -----------
NONINTEREST INCOME
Service fees 3,167,678 2,860,089 2,262,860
Other 1,824,286 1,938,208 1,828,618
Net gain (loss) on sales of
loans - servicing retained 65,669 195,354 100,413
Net gain on sales of loans -
servicing released 982,788 2,198,500 2,685,251
Net gain on sale of investment
securities 476,327 689,350 62,258
----------- ----------- -----------
Total noninterest income 6,516,748 7,881,501 6,939,400
----------- ----------- -----------
NONINTEREST EXPENSE
Compensation and employee
benefits 12,635,243 11,520,922 9,359,463
Building occupancy 2,967,481 2,641,378 2,335,481
Other expenses 5,231,541 4,733,971 4,055,430
Data processing 901,042 557,803 837,983
Advertising 687,503 784,149 757,602
----------- ----------- -----------
Total noninterest expense 22,422,810 20,238,223 17,345,959
----------- ----------- -----------
INCOME BEFORE PROVISION FOR
INCOME TAX 18,431,989 19,198,535 18,090,083
PROVISION FOR INCOME TAX
Current 5,948,892 8,281,271 7,457,372
Deferred (579,477) (1,949,104) (1,507,160)
----------- ----------- -----------
Total provision for income
tax 5,369,415 6,332,167 5,950,212
----------- ----------- -----------
NET INCOME $13,062,574 $12,866,368 $12,139,871
=========== =========== ===========
BASIC EARNINGS PER SHARE $ 1.28 $ 1.23 $ 1.14
====== ====== ======
DILUTED EARNINGS PER SHARE $ 1.26 $ 1.20 $ 1.12
====== ====== ======
See accompanying notes to these financial statements 52
==============================================================================
HORIZON FINANCIAL CORP.
Consolidated Statement of Stockholders' Equity
Years Ended March 31, 2005, 2004, and 2003
============================================================================================================
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, 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
Comprehensive income
Net income - - - 13,062,574 - -
Other comprehensive income
Change in unrealized
gains (losses) on
available-for-sale
securities, net tax
(benefit) of $(950,022) - - - - - (1,844,160)
Total other comprehensive
income - - - - - -
Comprehensive income - - - - - -
Recognition of ESOP shares
released - - - - 72,104 -
Cash dividends on common
stock at $.53 per share - - - (5,382,724) - -
Stock options exercised 83,452 83,452 413,713 - - -
Treasury stock purchased - - - - - -
Retirement of treasury
stock (450,880) (450,880) (2,570,467) (5,666,418) - -
---------- ------------ ------------ ----------- ---------- ----------
BALANCE, March 31, 2005 10,037,903 $ 10,037,903 $ 54,737,070 $38,939,268 $ (72,101) $3,382,047
========== ============ ============ =========== ========== ==========
Treasury Total
Stock Stockholders' Comprehensive
At Cost Equity Income
------- ------------ ------
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
Comprehensive income
Net income - 13,062,574 $13,062,574
Other comprehensive income
Change in unrealized
gains (losses) on
available-for-sale
securities, net tax
(benefit) of $(950,022) - (1,844,160) (1,844,160)
-----------
Total other comprehensive
income - - (1,844,160)
-----------
Comprehensive income - - $11,218,414
Recognition of ESOP shares ===========
released - 72,104
Cash dividends on common
stock at $.53 per share - (5,382,724)
Stock options exercised - 497,165
Treasury stock purchased (8,687,765) (8,687,765)
Retirement of treasury
stock 8,687,765 -
------------ ------------
BALANCE, March 31, 2005 $ - $107,024,187
============ ============
See accompanying notes to these financial statements 53
======================================================================
HORIZON FINANCIAL CORP.
Consolidated Statement of Cash Flows
Years Ended March 31, 2005, 2004, and 2003
==============================================================================
Increase (Decrease) in Cash and Cash Equivalents
2005 2004 2003
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 13,062,574 $ 12,866,368 $ 12,139,871
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation 1,249,181 1,085,060 1,000,314
Amortization and deferrals, net (773,550) 799,212 771,900
Stock dividends - Federal Home
Loan Bank stock (203,000) (376,400) (395,200)
Provision for loan losses 1,700,000 1,915,000 2,740,000
Provision for deferred income tax (579,477) (1,949,104) (1,507,160)
Changes in assets and liabilities
Interest and dividends receivable (466,749) 588,459 (125,106)
Interest payable 595,593 3,692 (27,533)
Federal income tax payable (1,706,135) 469,271 392,494
Net change in loans held for sale (2,735,359) 1,504,800 457,600
Other assets 684,132 (283,008) (6,703,825)
Other liabilities (3,205,660) (331,490) (422,065)
------------- ------------- -------------
Net cash flows from operating
activities 7,621,550 16,291,860 8,321,290
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in interest-bearing
deposits, net 16,860,049 39,162,020 9,845,582
Purchases of investment securities
- available-for-sale (11,465,000) (28,598,597) (30,941,880)
Proceeds from sales and maturities
of investment securities -
available-for-sale 22,330,851 17,142,983 5,352,629
Purchases of mortgage-backed
securities - available-for-sale - (12,811,737) (18,285,779)
Proceeds from sales and maturities
of mortgage-backed - securities
- available-for-sale 9,009,616 22,589,915 10,598,409
Proceeds from maturities of
mortgage-backed securities -
held-to-maturity 658,745 1,248,403 1,617,115
Net change in loans (147,608,780) (78,599,106) (18,857,731)
Purchases of bank premises and
equipment (6,837,167) (2,344,477) (1,739,519)
Net change in investment in joint
venture (17,204,265) - -
Net change in other real estate
owned 63,432 1,008,909 669,359
------------- ------------- -------------
Net cash flows from investing
activities (134,192,519) (41,201,687) (41,741,815)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 76,590,193 23,537,058 17,939,690
Advances from other borrowed
funds 142,297,351 20,706,102 24,642,011
Repayments of other borrowed
funds (90,700,000) (7,000,000) -
Net change in borrowing related
to inv. in real estate in a
joint venture 16,720,745 - -
Common stock issued, net 497,165 925,792 1,132,286
Cash dividends paid (5,328,273) (4,457,794) (4,126,638)
Treasury stock purchased (8,687,765) (5,452,872) (5,270,359)
------------- ------------- -------------
Net cash flows from
financing activities 131,389,416 28,258,286 34,316,990
------------- ------------- -------------
NET CHANGE IN CASH AND CASH
EQUIVALENTS 4,818,447 3,348,459 896,465
CASH AND CASH EQUIVALENTS,
beginning of year 18,431,964 15,083,505 14,187,040
------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
end of year $ 23,250,411 $ 18,431,964 $ 15,083,505
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash paid during the year for
interest $ 15,548,251 $ 15,505,666 $ 19,488,634
============= ============= =============
Cash paid during the year for
income tax $ 7,661,000 $ 7,812,000 $ 7,315,000
============= ============= =============
NONCASH INVESTING AND FINANCING
TRANSACTIONS
Property taken in settlement
of loans $ - $ 382,086 $ 1,452,271
============= ============= =============
Property sold through seller
financing $ - $ - $ -
============= ============= =============
See accompanying notes to these financial statements 54
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations - Horizon Financial Corp. (the "Company" or the
"Corporation"), 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 18
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 data 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, 2005, 2004, and 2003, 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. ("Westward") 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.
In October 2004, the Bank's wholly owned subsidiary, Westward Financial
Services, Inc., entered into a real estate development joint venture in
Greenbriar Northwest LLC ("GBNW"), an established residential land development
company headquartered in Bellingham, Washington. The Company believes that
GBNW is a variable interest entity. Under Financial Interpretation Number 46
GBNW is consolidated in our consolidated balance sheet. The Company also
accounts for the unowned portion as a minority interest. The investment in
real estate is recorded as an asset and the related debt is recorded as a
liability. The real estate joint venture has a carrying amount of
approximately $17.2 million, comprised mainly of land and land improvements,
with a related borrowing of approximately $16.7 million. As of March 31, 2005,
the project is in early development.
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 with maturities of three months or less.
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 were
approximately $5.0 million and $2.6 million for the years ended March 31, 2005
and 2004, 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 ("FHLB") of Seattle and short-term certificates of deposit with Western
Washington financial institutions. They mature within one year and are
carried at cost.
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.
55
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
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. In estimating
other-then-temporary impairment losses, management considers (1) the length of
time and the extent to which the fair value has been less than cost, (2) the
financial condition and near-term prospects of the issuer, and (3) the intent
and ability of the Company to retain its investment in the issuer for a period
of time sufficient to allow for any anticipated recovery in fair value. Gains
and losses on the sale of securities are recorded on the trade date and are
determined using the specific identification method.
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, 2005 and 2004.
Noncash Investing and Financing Transactions - Noncash investing and financing
transactions consist principally of securitizing mortgage loans and exchanging
them for Federal Home Loan Mortgage Corporation ("Freddie Mac") participation
certificates. At the time of the securitization, the pool of loans is
reclassified from the loan portfolio and is 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 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. At
this time, the FHLB has ceased paying dividends on FHLB stock.
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.
Mortgage loans held for sale can be sold with the mortgage servicing rights
retained by the Company. The carrying value of mortgage loans sold is reduced
by the cost allocated to the associated mortgage servicing rights. Gains or
losses on sales of mortgage loans are recognized based on the difference
between the selling price and the carrying value of the related mortgage loans
sold.
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.
56
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
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.
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charges against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
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 - Servicing assets are recognized as separate assets
when rights are acquired through sale of financial assets. Generally, for
sales of mortgage loans, a portion of the cost of originating the loan is
allocated to the servicing right based on relative fair value. Fair value is
based on market prices for comparable mortgage servicing contracts, when
available, or alternatively, is based on a valuation model that calculates the
present value of estimated future net servicing income. The valuation model
incorporates assumptions that market participants would use in estimating
future net servicing income, such as the cost to service, the discount rate,
the custodial earnings rate, an inflation rate, ancillary income, prepayment
speeds and default rates and losses. Capitalized servicing rights are reported
in other assets and are amortized into non-interest income in proportion to,
and over the period of, the estimated future net servicing income of the
underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost. Impairment is determined by stratifying
rights into tranches based on predominant risk characteristics, such as
interest rate, loan type and investor type. Impairment is recognized through a
valuation allowance for an individual tranche, to the extent that fair value
is less than the capitalized amount for the tranche. If the Company later
determines that all or a portion of the impairment no longer exists for a
particular tranche, a reduction of the allowance may be recorded as an
increase to income.
Servicing fee income is recorded for fees earned for servicing loans. The fees
are based on a contractual percentage of the outstanding principal; or a fixed
amount per loan and are recorded as income when earned. The amortization of
mortgage servicing rights is netted against loan servicing fee income.
57
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
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
("BOLI") approximates its fair value. Fair value of BOLI is estimated using
the cash surrender value. The Bank owns approximately $11 million in Bank
Owned Life Insurance as of March 31, 2005 and 2004, which 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, 2005 and 2004, 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 the
Bank. 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.
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.
58
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
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 2005, 2004, and 2003 is estimated at $51,032, $2,317, and $64,192,
respectively. The following assumptions were used to estimate the fair value
of the options for the year ended March 31:
2005 2004 2003
---------- ---------- ----------
Risk-free interest rate 4.26% 1.93% 2.35%
Dividend yield rate 2.875% 3.02% 3.65%
Price volatility 25.47% 38.84% 24.57%
Weighted average expected life
of options 6.20 yr. 3.72 yr. 3.70 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:
2005 2004 2003
---------- ---------- ----------
Net income as reported $13,062,574 $12,866,368 $12,139,871
Additional compensation for fair
value of stock options, net
of tax (19,501) (51,593) (58,164)
----------- ----------- -----------
Pro forma net income $13,043,073 $12,814,775 $12,081,707
=========== =========== ===========
Earnings per share
Basic
As reported $1.28 $1.23 $1.14
===== ===== =====
Pro forma $1.28 $1.22 $1.13
===== ===== =====
Diluted
As reported $1.26 $1.20 $1.12
===== ===== =====
Pro forma $1.26 $1.20 $1.11
===== ===== =====
The remaining unrecognized compensation for fair value of stock options was
$38,274, $1,159, and $16,048 as of March 31, 2005, 2004, and 2003,
respectively.
Transfers of Financial Assets - Transfers of financial assets are accounted
for as sales, when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been
isolated from the Corporation, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain
effective control over the transferred assets through an agreement to
repurchase them before their maturity.
Comprehensive Income - Accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income. Although
certain changes in assets and liabilities, such as unrealized gains and losses
on available-for-sale securities, are reported as a separate component of the
equity section of the balance sheet, such items, along with net income, are
components of comprehensive income.
59
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
The components of other comprehensive income and related tax effects are as
follows for the years ended March 31:
2005 2004 2003
----------- ----------- -----------
Change in unrealized holding
gains on available-for-sale
securities $(2,317,855) $ (531,242) $ 2,844,268
Reclassification adjustment for
losses (gains) realized
in income (476,327) (685,001) -
----------- ----------- -----------
Net change in unrealized holding
gains (2,794,182) (1,216,243) 2,844,268
Tax effect 950,022 413,523 (967,051)
----------- ----------- -----------
Change in unrealized holding
gains, net of tax amount $(1,844,160) $ (802,720) $ 1,877,217
=========== =========== ===========
Recent Accounting Pronouncements - In December 2004, the FASB issued Statement
of Financial Accounting Standard No. 123(R), Share-Based Payment, which is a
revision of FASB Statement No. 123, Accounting for Stock-Based Compensation.
Statement 123(R) supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows. Generally, the approach in Statement 123(R) is
similar to the approach described in Statement 123. However, Statement 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair
values. Pro forma disclosure is no longer an alternative. The SEC's new rule
allows public companies to implement Statement 123(R) at the beginning of
their next fiscal year, instead of the next reporting period, after June 15 or
December 15, 2005, as applicable. The SEC's new rule does not change the
accounting required by Statement 123(R); only the compliance deadlines have
been altered. With the recent extension, the Company expects to adopt
Statement 123(R) on April 1, 2006.
As permitted by Statement 123, the Company currently accounts for share-based
payments to employees using Opinion 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have a
significant impact on our results of operations, although it will have no
impact on our overall financial position. The impact of adoption of Statement
123(R) cannot be predicted at this time because it will depend on levels of
share-based payments granted in the future. However, had we adopted Statement
123(R) in prior periods, the impact of that standard would have approximated
the impact of Statement 123 as described in the disclosure of pro forma net
income and earnings per share in Note 1 to our consolidated financial
statements. Statement 123(R) also requires the benefits of tax deductions in
excess of recognized compensation cost to be reported as a financing cash
flow, rather than as an operating cash flow as required under current
literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after adoption.
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:
2005 2004
----------- ------------
FHLB Demand $ 3,607,324 $ 20,467,373
Certificates of deposit 300,025 300,025
----------- ------------
$ 3,907,349 $ 20,767,398
=========== ============
60
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 2 - Interest Bearing Deposits (Continued)
The Company has funds on deposit with the FHLB 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 FHLBs, which operate under the supervision
of the Federal Housing Finance Board. The Finance Board is an independent
agency of the executive branch within the U.S. government which ensures that
the FHLBs 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.
The amortized cost and estimated market values of investments, together with
unrealized gains and losses, are as follows as of March 31, 2005,
respectively:
2005
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Gross Losses Losses Estimated
Amortized Unrealized 12 Months Greater Than Fair
Costs Gains or Less 12 Months Value
--------- ---------- --------- ------------ ----------
Available-For-Sale
Securities
State and political
subdivisions and U.S.
government agency
securities $54,034,115 $ 203,765 $ (10,170) $(836,288) $53,391,422
Marketable equity
securities 1,824,224 6,027,209 (335,000) - 7,516,433
Mutual funds 5,000,000 - (70,493) - 4,929,507
Corporate debt
securities 5,938,085 49,547 - - 5,987,632
----------- ---------- --------- --------- -----------
Total available-
for- sale
securities 66,796,424 6,280,521 (415,663) (836,288) 71,824,994
----------- ---------- --------- --------- -----------
Held-To-Maturity
Securities
State and political
subdivisions and
U.S. government
agency securities 369,596 13,313 - - 382,909
----------- ---------- --------- --------- -----------
Total held-to-
maturity
securities 369,596 13,313 - - 382,909
----------- ---------- --------- --------- -----------
Total investment
securities $67,166,020 $6,293,834 $(415,663) $(836,288) $72,207,903
=========== ========== ========= ========= ===========
Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2005, 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, 2005, there were approximately 36 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.
61
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 3 - Investment Securities (Continued)
2004
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Gross Losses Losses Estimated
Amortized Unrealized 12 Months Greater Than Fair
Costs Gains or Less 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
=========== ========== ========= ======== ===========
The amortized cost and estimated fair value of investment securities at March
31, 2005, 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.
2005
----------------------------------------------------
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 $14,101,242 $14,159,687 $ - $ -
Two to five years 35,296,191 34,733,548 369,596 382,909
Five to ten years 2,981,220 2,858,737 - -
Over ten years 1,655,462 1,639,450 - -
----------- ----------- ----------- ------------
54,034,115 53,391,422 369,596 382,909
----------- ----------- ----------- ------------
Corporate debt securities
One year 2,255,452 2,260,271 - -
Two to five years 3,682,633 3,727,361 - -
Over ten years - - - -
----------- ----------- ----------- ------------
5,938,085 5,987,632 - -
----------- ----------- ----------- ------------
Mutual funds and
marketable equity
securities (liquid) 6,824,224 12,445,940 - -
----------- ----------- ----------- ------------
Total investment
securities $66,796,424 $71,824,994 $ 369,596 $ 382,909
=========== =========== =========== ============
62
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 3 - Investment Securities (Continued)
Proceeds from sales of investments and gross realized gains and losses on
investment sales were as follows for the years ended March 31:
2005 2004 2003
---------- ---------- -----------
Proceeds from sales of investments $9,576,300 $6,839,100 $ -
========== ========== ===========
Gross gains realized on sales of
investments $ 484,877 $ 688,001 $ -
========== ========== ===========
Gross losses realized on sales of
investments $ (8,550) $ (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
consists of the following:
2005 2004
------------------------ ------------------------
Market Market
Cost Value Cost Value
----------- ----------- ----------- -----------
Marketable equity securities
Banking $ 309,009 $ 1,603,753 $ 315,171 $ 1,822,492
Government agency stocks 1,515,215 5,912,680 1,516,197 5,474,400
----------- ----------- ----------- -----------
$ 1,824,224 $ 7,516,433 $ 1,831,368 $ 7,296,892
=========== =========== =========== ===========
Corporate debt securities
Finance companies $ 2,255,452 $ 2,260,271 $ 6,940,420 $ 7,177,139
Private utilities 1,016,324 1,037,265 2,710,725 2,792,817
Manufacturing companies 2,666,309 2,690,096 3,783,175 3,936,705
----------- ----------- ----------- -----------
Total $ 5,938,085 $ 5,987,632 $13,434,320 $13,906,661
=========== =========== =========== ===========
At March 31, 2005 and 2004, U.S. government agency and corporate debt
securities of $3,370,000 and $3,870,000, respectively, 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 law.
Note 4 - Mortgage-Backed Securities
Mortgage-backed securities at March 31 consisted of the following:
2005
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Gross Losses Losses Estimated
Amortized Unrealized 12 Months Greater Than Fair
Costs Gains or Less 12 Months Value
--------- ---------- --------- ------------ ----------
Available-for-sale
securities $18,353,299 $ 275,108 $(8,644) $ (109,324) $18,510,439
Held-to-maturity
securities 885,137 41,192 - - 926,329
----------- --------- ------- ---------- -----------
Total mortgage-
backed
securities $19,238,436 $ 316,300 $(8,644) $ (109,324) $19,436,768
=========== ========= ======= ========== ===========
63
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 4 - Mortgage-Backed Securities (Continued)
Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2005, the
Company has evaluated these securities and 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, 2005, there were approximately 22 mortgage-backed
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.
2004
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Gross Losses Losses Estimated
Amortized Unrealized 12 Months Greater Than Fair
Costs Gains or Less 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
=========== ========= ======= ========== ===========
The amortized cost and estimated fair value of mortgage-backed securities at
March 31, 2005, 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.
2005
-----------------------------------------------------
Available-For-Sale Held-To-Maturity
------------------------- -------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---------- ---------- ---------- ----------
Mortgage-backed
securities
One year $ 56,252 $ 56,324 $ - $ -
Two to five years - - 771,412 794,193
Six to ten years 3,334,873 3,463,089 11,067 12,040
After ten years 14,962,174 14,991,026 102,658 120,096
----------- ----------- ---------- -----------
Total $18,353,299 $18,510,439 $ 885,137 $ 926,329
=========== =========== ========== ===========
All of the above mortgage-backed securities are rated AAA by a nationally
recognized statistical rating organization.
Proceeds from sales of mortgage-backed securities and gross realized gains and
losses on mortgage-backed security sales were as follows for the years ended
March 31:
2005 2004 2003
-------- -------- ----------
Proceeds from sales of mortgage-
backed securities $ - $ - $2,403,548
======== ======== ==========
Gross gains realized on sales of
mortgage-backed securities $ - $ - $ 62,187
======== ======== ==========
Gross losses realized on sales of
mortgage-backed securities $ - $ - $ -
======== ======== ==========
64
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 5 - Loans Receivable
Loans receivable (collateralized principally by properties in the Whatcom,
Skagit and Snohomish Counties of Washington State) at March 31 consisted of
the following:
2005 2004
------------- -------------
First mortgage loans
1-4 Family $ 174,457,469 $ 179,324,244
1-4 Family construction 16,464,259 14,165,219
Less participations (65,124,970) (74,278,637)
------------- -------------
Net first mortgage loans 125,796,758 119,210,826
Construction and land development 161,005,886 129,152,131
Residential commercial real estate 73,396,638 53,343,779
Non-residential commercial real estate 323,463,682 255,273,566
Commercial loans 91,209,920 78,720,811
Home equity secured 35,913,110 26,984,619
Other consumer loans 5,961,613 5,661,944
------------- -------------
816,747,607 668,347,676
Less:
Allowance for loan losses (11,767,029) (10,121,532)
------------- -------------
$ 804,980,578 $ 658,226,144
============= =============
The Company originates both adjustable and fixed interest rate loans. At March
31, 2005, 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 $ 5,552,625 Less than one year $ 466,432,592
One to three years 22,104,053 One to three years 120,898,519
Three to five years 10,331,590 Three to five years 76,207,601
Five to fifteen years 58,544,509 Five to fifteen years 991,389
Over fifteen years 55,684,729 Over fifteen years -
Loans serviced for others were $103,174,983 and $88,190,792, respectively, as
of March 31, 2005 and 2004.
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.
The allowance for loan losses at March 31, and changes during the year were as
follows:
2005 2004 2003
----------- ----------- -----------
Balance, beginning of year $10,121,532 $ 8,506,133 $ 5,887,482
Provision for loan losses 1,700,000 1,915,000 2,740,000
Loan chargeoffs (228,805) (385,335) (129,406)
Loan recoveries 174,302 85,734 8,057
----------- ----------- -----------
Balance, end of year $11,767,029 $10,121,532 $ 8,506,133
=========== =========== ===========
65
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 5 - Loans Receivable (Continued)
The following is a summary of information pertaining to impaired and
non-accrual loans:
March 31,
------------------
2005 2004
------- -------
(in thousands)
Impaired loans without a valuation allowance $ - $ -
Impaired loans with a valuation allowance 1,481
------- -------
Total impaired loans $ 1,481 $ -
======= =======
Valuation allowance related to impaired loans $ 300 $ -
Total non-accrual loans $ 1,481 $ -
Total loans past-due 90 days or more and
still accruing $ - $ 238
Years Ended March 31,
-----------------------------
2005 2004 2003
------- ------- -------
(in thousands)
Average investment in impaired loans $ 964 $ - $ 121
======= ======= =======
Interest income recognized on impaired loans $ - $ - $ -
======= ======= =======
Interest income recognized on a cash basis
on impaired loans $ - $ - $ -
======= ======= =======
No additional funds are committed to be advanced in connection with impaired
loans.
Note 6 - Mortgage Servicing Rights
Loan costs allocated to mortgage servicing rights as of March 31, were as
follows:
2005 2004
---------- ----------
Beginning balance $ 646,118 $1,284,143
Additions for new loans 156,286 107,798
Amortization (223,332) (745,823)
---------- ----------
Ending balance 579,072 646,118
Valuation allowance for impairment
of mortgage servicing rights (295,620) (333,678)
---------- ----------
Balance, end of year $ 283,452 $ 312,440
========== ==========
Changes in the valuation allowance for impairment of mortgage servicing was as
follows:
Beginning balance $ (333,678) $ (668,183)
Additions (59,605) (42,819)
Credited to income 97,663 377,324
---------- ----------
Balance, end of year $ (295,620) $ (333,678)
========== ==========
Note 7 - Accrued Interest and Dividends Receivable
Accrued interest and dividends receivable at March 31 is summarized as
follows:
2005 2004
---------- ----------
Investment securities $ 810,762 $1,015,346
Mortgage-backed securities 117,578 147,503
Loans receivable 3,545,045 2,763,333
Dividends on marketable equity securities 25,371 105,825
---------- ----------
$4,498,756 $4,032,007
========== ==========
66
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 8 - Premises and Equipment
Premises and equipment at March 31 consisted of:
2005 2004
----------- ------------
Buildings $ 14,983,220 $ 12,728,536
Equipment 10,988,914 8,816,230
----------- ------------
25,972,134 21,544,766
Accumulated depreciation (10,182,899) (9,593,624)
----------- ------------
15,789,235 11,951,142
Land 6,992,422 5,242,529
----------- ------------
Balance, end of year $ 22,781,657 $ 17,193,671
============ ============
Note 9 - Deposits
A comparative summary of deposits at March 31 follows:
2005 2004
----------- ------------
Demand deposits
Savings $ 40,862,597 $ 40,526,619
Checking 83,268,122 78,697,106
Checking (noninterest-bearing) 63,503,350 44,773,672
Money Market 134,760,821 131,310,670
----------- ------------
322,394,890 295,308,067
----------- ------------
Time certificates of deposit
Less than $100,000 240,178,675 245,608,118
Greater than or equal to $100,000 184,275,846 129,343,033
----------- ------------
424,454,521 374,951,151
----------- ------------
Total deposits $746,849,411 $670,259,218
============ ============
Time certificate of deposit maturities at March 31 are as follows:
2005
---------------------------------------
Variable Fixed
Rate Rate Total 2004
----------- ------------ ------------ ------------
Within one year $12,853,190 $238,823,847 $251,677,037 $212,282,052
One to two years 4,201,291 72,680,258 76,881,549 81,509,219
Two to three years 2,412,692 50,875,766 53,288,458 31,423,639
Three to four years 1,600,482 12,697,646 14,298,128 31,284,545
Four to five years 6,725,463 16,808,848 23,534,311 15,564,459
Over five years 4,775,038 - 4,775,038 2,887,237
----------- ------------ ------------ ------------
$32,568,156 $391,886,365 $424,454,521 $374,951,151
=========== ============ ============ ============
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, 2005
and 2004, was 1.92% and 2.0%, respectively.
67
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 9 - Deposits (Continued)
Interest expense on deposits for the years ended March 31 is summarized as
follows:
2005 2004 2003
----------- ----------- -----------
Money market $ 1,685,321 $ 1,323,697 $ 2,212,086
Checking 427,990 500,240 491,383
Savings 215,997 288,768 437,912
Certificates of deposit 10,889,549 11,111,924 14,531,578
----------- ----------- -----------
Balance, end of year $13,218,857 $13,224,629 $17,672,959
=========== =========== ===========
Note 10 - Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase, which are classified as other
borrowed funds, generally mature within one to four days from the transaction
date. Securities sold under agreements to repurchase are reflected at the
amount of cash received in connection with the transaction. The Company may be
required to provide additional collateral based on the fair value of the
underlying securities (see Note 11).
Note 11 - Other Borrowed Funds
The Bank is a member of the 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 $186.2 million and
$164.1 million were available to the Bank, of which, $129 million (including
$16.7 million related to the investment in the real estate joint venture) and
$64.5 million were outstanding at March 31, 2005 and 2004, respectively. These
advances bear interest ranging from 2.06% to 5.27% and 2.67% to 5.35% per
annum, respectively. Maturities for the advances are $71,000,000 in fiscal
2006, $18,500,000 in fiscal 2007, $29,000,000 in fiscal 2008, $4,500,000 in
fiscal 2009, and $6,000,000 in fiscal 2010.
The maximum outstanding and average outstanding balances and average interest
rates on FHLB advances were as follows for the years ended March 31:
In Thousands
---------------------------------------
2005 2004 2003
----------- ----------- -----------
Maximum outstanding at any month-end $ 129,500 $ 64,500 $ 52,500
Average outstanding 89,820 56,318 38,276
Weighted average interest rates:
Annual 3.26% 4.06% 4.67%
===== ===== =====
End of year 3.28% 3.84% 4.33%
===== ===== =====
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 $5,773,338 and $2,968,842 outstanding as
March 31, 2005 and 2004, respectively.
At March 31, 2005 and 2004, respectively, U.S. government agency and corporate
debt securities of $9,383,333 and $4,000,000 were pledged as collateral for
retail repurchase agreements.
68
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
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 sources of
these differences and the related tax effects for the years ended March 31
were as follows:
2005 2004 2003
----------- ----------- -----------
Increase (decrease) in deferred
loan fees $ 265,000 $ (274,000) $ (264,000)
Loan loss and general reserves 461,000 560,000 873,000
Deferred compensation 25,000 26,000 71,000
Other, net (171,523) 1,637,104 827,160
----------- ----------- ----------
$ 579,477 $ 1,949,104 $1,507,160
=========== =========== ==========
The nature and components of the Company's net deferred tax assets
(liabilities), established at an estimated tax rate of 34.25%, were as follows
at March 31:
2005 2004
----------- ------------
Deferred Tax Assets
Deferred compensation agreements $ 624,000 $ 598,000
Deferred loan fees for tax purposes in excess
of amounts deferred for financial reporting
purposes 1,225,000 671,000
Financial reporting loan loss reserve not
recognized for tax purposes 3,927,000 3,467,000
Financial reporting accrued expenses not
recognized for tax purposes 234,000 183,000
Other deferred tax assets 215,000 166,000
----------- ------------
Total deferred assets 6,225,000 5,085,000
----------- ------------
Deferred Tax Liabilities
Tax effect of unrealized gains on available-for-
sale securities (1,803,663) (2,692,288)
FHLB stock dividends (776,000) (720,000)
Other deferred tax liabilities (1,346,112) (841,589)
----------- ------------
Total deferred liabilities (3,925,775) (4,253,877)
----------- ------------
Net deferred tax assets (liabilities) $ 2,299,225 $ 831,123
=========== ===========
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:
2005 2004 2003
----------- ----------- -----------
Provision for income tax at the
statutory rate of 35 percent $ 6,556,196 $ 6,721,000 $ 6,332,000
Increase (decrease) in tax resulting
from:
Nontaxable income (639,726) (354,380) (260,976)
Nondeductible expense 12,759 6,041 4,555
Income taxed at lower brackets - - (100,000)
Dividends received deduction (34,469) (53,000) (70,000)
Adjustment to deferred tax items:
Deferred loan fees (74,616) - -
Property, plant, and equipment (314,514) - -
Investment in joint venture (37,472) - -
Other, net 6,258 12,506 44,633
----------- ----------- -----------
Income tax provision $ 5,369,415 $ 6,332,167 $ 5,950,212
=========== =========== ===========
69
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
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, 2005 and 2004, the cash
surrender values of these policies included in Other Assets aggregated
$2,389,722 and $2,617,276, 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
3.00%, 3.50%, and 4.00% in 2005, 2004 and 2003, respectively. Deferred
compensation expense amounted to $150,000, $150,000 and $155,000 in 2005, 2004
and 2003, 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 $1,347,000,
$1,657,000, and $1,403,000 for the years ended March 31, 2005, 2004 and 2003,
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, 2005, 2004, and 2003. The ESOP shares relating to the
loans outstanding as of March 31 were as follows:
2005 2004 2003
----------- ----------- -----------
Number of shares
Allocated shares 74,918 65,738 56,558
Unallocated shares 9,175 18,355 27,535
----------- ----------- -----------
Total ESOP shares 84,093 84,093 84,093
=========== =========== ===========
Fair value
Unallocated shares $ 342,504 $ 340,118 $ 409,996
=========== =========== ===========
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 $450,000, $430,000, and $360,000 for the years ended
March 31, 2005, 2004, and 2003, respectively.
70
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
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 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, 2005, that
each entity meets all capital adequacy requirements to which they are subject.
As of March 31, 2005, the Bank was categorized 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 Bank's categorization.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- ------ -------- ------
As of March 31, 2005 (in thousands)
Total Capital
(to Risk Weighted Assets)
Consolidated $ 116,231 13.68% $ 67,978 >8.00% $ 84,972 >10.00%
Horizon Bank $ 116,211 13.68% $ 67,978 >8.00% $ 84,972 >10.00%
Tier I Capital
(to Risk Weighted Assets)
Consolidated $ 103,069 12.13% $ 33,989 >4.00% $ 50,983 > 6.00%
Horizon Bank $ 103,049 12.13% $ 33,989 >4.00% $ 50,983 > 6.00%
Tier I Capital
(to Average Assets)
Consolidated $ 103,069 10.83% $ 38,080 >4.00% $ 47,601 > 5.00%
Horizon Bank $ 103,049 10.82% $ 38,080 >4.00% $ 47,601 > 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, 2004 (in thousands)
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%
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% of its capital stock and surplus, and
the total of loans to the holding company and affiliates must not exceed 20%
of capital and surplus. Further, all such loans must be fully collateralized.
In addition, dividends paid by the Bank to the Company would be prohibited if
the effect thereof would cause the Bank's capital to be reduced below
applicable minimum capital requirements.
71
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 14 - Stockholders' Equity (Continued)
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.
In March 2004, the Company announced a plan to repurchase up to 1,040,000
shares, or approximately 10% of the Company's outstanding common stock.
During fiscal 2005, 450,880 shares were repurchased and subsequently retired
at a cost of $8,687,765. 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
stockholders of record July 11, 2002.
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.
72
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
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, 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
Authorized - -
Granted (12,500) 12,500 $17.96 - 21.430
Exercised - (97,117) $ 4.19 - 14.625
Lapsed 2,945 (2,945) $ 4.19 - 14.625
Expired (40) -
------------ ----------
Balance, March 31, 2005 - 219,903
============ ==========
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 $ 10 174,403 3.987 years $ 7.60 174,224 $ 7.60
$ 10 to $ 15 43,500 8.196 years $ 13.36 16,752 $ 11.71
$ 20 to $ 25 2,000 9.750 years $ 21.42 - $ -
At March 31, 2005, 219,903 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:
2005 2004 2003
----------- ----------- -----------
Net income (numerator) $13,062,574 $12,866,368 $12,139,871
Shares used in the calculation
(denominators)
Basic earnings per weighted
average share outstanding 10,212,190 10,480,785 10,674,506
Effect of dilutive stock options 149,843 205,260 190,463
----------- ----------- -----------
Diluted shares 10,362,033 10,686,045 10,864,969
=========== =========== ===========
Basic earnings per share $1.28 $1.23 $1.14
===== ===== =====
Diluted earnings per share $1.26 $1.20 $1.12
===== ===== =====
At March 31, 2005, 2004, and 2003, there were options to purchase 219,903,
307,465, and 455,408 shares of common stock outstanding. As of March 31,
2005, 2004, and 2003, all options to purchase shares of common stock were
included in the diluted net income per share calculation.
73
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
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 in the agreement), the agreement provides the president with severance
payments of up to 2.99 times his annual compensation plus continuation of
certain benefits.
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 were as follows for the years ending March 31:
2006 $ 244,349
2007 179,695
2008 152,895
2009 42,956
2010 21,398
Thereafter 108,773
---------
$ 750,066
=========
Rent expense charged to operations was $266,606, $248,661, and $162,440 for
the years ending March 31, 2005, 2004, and 2003.
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 2005, 2004 and 2003 were as follows
and were within regulatory limitations:
2005 2004 2003
------------ ------------ ------------
Balance, beginning of year $ 15,690,253 $ 19,851,634 $ 19,846,801
New loans or advances 4,880,489 7,572,429 16,750,744
Repayments (6,023,951) (11,733,810) (16,745,911)
------------ ------------ ------------
Balance, end of year $ 14,546,791 $ 15,690,253 $ 19,851,634
============ ============ ============
Interest earned on loans $ 1,050,208 $ 1,080,891 $ 1,372,680
============ ============ ============
Deposits from related parties totaled approximately $3,674,000 and $1,663,000
at March 31, 2005 and 2004, respectively.
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.
74
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
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. Because 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.
Unfunded commitments under commercial lines-of-credit, revolving credit lines
and overdraft protection agreements are commitments for possible future
extensions of credit to existing customers. These lines-of-credit are
uncollateralized and usually do not contain a specified maturity date and may
not be drawn upon to the total extent to which the Bank is committed.
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,
2005.
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, 2005,
2004, and 2003.
The following is a summary of the off-balance-sheet financial instruments or
contracts outstanding at March 31:
2005 2004
------------- -------------
Commitments to extend credit $ 219,646,651 $ 80,275,294
Credit card arrangements 9,087,129 7,991,317
Standby letters of credit 1,824,000 2,058,818
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.
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.
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 the FHLB. The Company may redeem its
investment only at par value, which is used as the estimated market value.
75
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 20 - Disclosures About Fair Value of Financial Instruments (Continued)
Loan Receivables and Investment in Real Estate in a Joint Venture For
certain homogeneous categories of loans, such as those written to Freddie Mac
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.
The carrying amount of the investment in the real estate joint venture is
estimated to approximate its fair value based on the nature of the asset.
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, Other Borrowed Funds, and
Borrowing Related to Investment in Real Estate in a Joint Venture - 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, 2005 and 2004 were as follows:
2005 2004
--------------------------- ---------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
Financial Assets
Cash and cash
equivalents $ 23,250,411 $ 23,250,411 $ 18,431,964 $ 18,431,964
Investment
securities 72,194,590 72,207,903 85,553,316 85,584,171
Mortgage-backed
securities 19,395,576 19,436,768 29,303,847 29,413,403
Interest-bearing
deposits 3,907,349 3,907,349 20,767,398 20,767,398
Federal Home Loan
Bank stock 7,217,900 7,217,900 7,014,900 7,014,900
Loans receivable 804,980,578 803,378,000 658,226,144 665,897,087
Loans held-for-sale 4,068,859 4,068,859 1,333,500 1,333,500
Investment in real
estate in a joint
venture 17,204,265 17,204,265 - -
Accrued interest and
dividends receivable 4,498,756 4,498,756 4,032,007 4,032,007
Financial Liabilities
Demand and savings
deposits 322,394,890 322,394,890 295,308,067 295,308,067
Time deposits 424,454,521 414,263,468 374,951,151 380,778,241
Accounts payable and
other liabilities 4,683,923 4,683,923 8,011,206 8,011,206
Accrued interest
payable 886,148 886,148 290,555 290,555
Other borrowed funds 119,066,193 117,781,243 67,468,842 69,275,192
Borrowing related to
investment in real
estate in a joint
venture 16,720,745 16,720,745 - -
76
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 21 - Parent Company (Only) Financial Information
In Thousands
-----------------------
2005 2004
---------- ----------
Condensed balance sheet at March 31:
Cash $ 30 $ 28
Investment in Bank 107,004 109,457
Other assets 1,355 1,148
---------- ----------
$ 108,389 $ 110,633
========== ==========
Other liabilities $ 1,365 $ 1,326
Stockholders' equity 107,024 109,307
---------- ----------
$ 108,389 $ 110,633
========== ==========
Condensed statement of income for the years ended March 31, 2005, 2004, and
2003:
In Thousands
------------------------------------
2005 2004 2003
---------- ---------- ----------
Income
Cash dividends from Bank subsidiary $ 14,081 $ 9,028 $ 9,005
Interest 3 5 6
---------- ---------- ----------
Total income 14,084 9,033 9,011
---------- ---------- ----------
Expenses
Compensation 126 108 105
Other 237 239 246
---------- ---------- ----------
Total expenses 363 347 351
---------- ---------- ----------
Income before equity in undistributed
income of subsidiary and benefit
equivalent to income taxes 13,721 8,686 8,660
Benefit equivalent to income taxes 123 118 119
---------- ---------- ----------
Income before equity in undistributed
income of subsidiary 13,598 8,568 8,541
Equity in undistributed income of
subsidiary (535) 4,298 3,599
---------- ---------- ----------
Net income $ 13,063 $ 12,866 $ 12,140
========== ========== ==========
2005 2004 2003
---------- ---------- ----------
Cash flows from operating activities
Net income $ 13,063 $ 12,866 $ 12,140
Adjustments to reconcile net income
to net cash flows from operating
activities
Equity in undistributed income
of subsidiary 659 (4,181) (3,480)
Other operating activities (223) (152) 23
---------- ---------- ----------
Net cash flows from operating
activities 13,499 (8,533) (8,683)
---------- ---------- ----------
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 497 926 1,132
Dividends paid (5,328) (4,458) (4,126)
Treasury stock purchased (8,688) (5,453) (5,270)
---------- ---------- ----------
Net cash flows from financing
activities (13,519) (8,985) (8,264)
---------- ---------- ----------
Net change in cash 2 (430) 441
Cash, beginning of year 28 458 17
---------- ---------- ----------
Cash, end of year $ 30 $ 28 $ 458
========== ========== ==========
77
==============================================================================
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2005, 2004, and 2003
==============================================================================
Note 22 - Selected Quarterly Financial Data (Unaudited)
Year Ended March 31, 2005
--------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Interest income $12,178,210 $12,890,130 $13,294,160 $13,819,396
Interest expense 3,731,222 3,880,823 4,085,740 4,446,060
----------- ----------- ----------- -----------
Net interest income 8,446,988 9,009,307 9,208,420 9,373,336
Provision for loan losses 300,000 325,000 350,000 725,000
Noninterest income 1,768,978 1,775,049 1,579,601 1,393,120
Noninterest expense 5,213,821 5,713,308 5,814,704 5,680,977
----------- ----------- ----------- -----------
Income before provision for
income tax 4,702,145 4,746,048 4,623,317 4,360,479
Provision for income tax 1,427,787 1,439,174 1,399,403 1,103,051
----------- ----------- ----------- -----------
Net income $ 3,274,358 $ 3,306,874 $ 3,223,914 $ 3,257,428
=========== =========== =========== ===========
Basic earnings per share
(adjusted for stock splits
and dividends) $ 0.32 $ 0.32 $ 0.32 $ 0.32
====== ====== ====== ======
Diluted earnings per share
(adjusted for stock splits
and dividends) $ 0.31 $ 0.32 $ 0.31 $ 0.32
====== ====== ====== ======
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
===== ===== ===== =====
During fiscal 2005, the Bank charged off loans totaling $229,000 and received
recoveries of $174,000. At March 31, 2005, the allowance for loan losses was
$11,767,029, or 1.46% of total loans, compared to $10,121,532, or 1.48% of
total loans at March 31, 2004. A large portion of the increase in the
allowance for loan losses occurred in the fourth quarter of 2005 in the amount
of $725,000 due in large part to the significant commercial loan growth in the
quarter. Management believes the current balance of the allowance for loan
losses is adequate given the mix of our current loan portfolio and existing
economic conditions.
During the fourth quarter of fiscal 2005, the Bank's provision for income tax
decreased to $1,103,051. The Bank made return to accrual adjustments related
to the result of cost segregation studies completed on several Bank
properties.
78
==============================================================================
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: An evaluation of
the Corporation's disclosure controls and procedures (as defined in Rule
13(a)-15(e) of the Exchange Act 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 Exchange Act
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, 2005, 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.
(c) Management's Annual Report on Internal Control over Financial
Reporting. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, a
report of management's assessment of the design and effectiveness of its
internal controls is included in herein. The Corporation's independent
registered public accounting firm, Moss Adams, LLP, also attested to, and
reported on, management's assessment of the effectiveness of internal control
over financial reporting. Management's report and the independent registered
public accounting firm's attestation report are included in Item 8 of this
Annual Report on Form 10-K for the year ended March 31, 2005 under the
captions entitled "Management's Annual Report on Internal Control over
Financial Reporting" and "Report of Independent Registered Public Accounting
Firm."
The Corporation intends to continually review and evaluate the design
and effectiveness of its disclosure controls and procedures and to improve its
controls and procedures over time and to correct any deficiencies that it may
discover in the future. The goal is to ensure that senior management has
timely access to all material financial and non-financial information
concerning the Corporation's business. While the Corporation believes the
present design of its disclosure controls and procedures is effective to
achieve its goal, future events affecting its business may cause the
Corporation to modify its disclosure controls and procedures.
Item 9B. Other Information
- ---------------------------
There was no information to be disclosed by the Corporation in a current
report on Form 8-K during the fourth quarter of fiscal 2005 that was not so
disclosed.
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors" is included in the Company's Definitive Proxy Statement
for the 2005 Annual Meeting of Stockholders ("Proxy Statement") and is
incorporated herein by reference.
For information regarding the executive officers of the Corporation and
the Bank, see the information contained herein under the section captioned
"Item 1. Business - Personnel - Executive Officers of the Registrant."
79
Item 11. Executive Compensation
- --------------------------------
Information regarding management and director compensation and
transactions with management and others is incorporated by reference to the
section captioned "Executive Compensation" and "Director's Compensation" in
the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
- ----------------------------------------------------------------------------
Related Stockholder Matters
---------------------------
Information regarding security ownership of certain beneficial owners
and management is incorporated herein by reference to the section captioned
"Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement. The Corporation is not aware of any arrangements, including any
pledge by any person of securities of the Corporation, the operation of which
may at a subsequent date result in a change in control of the Corporation.
Information regarding the Corporation's equity compensation plans as of
March 31, 2005 is incorporated herein by reference to the section captioned
"Executive Compensation" in the Proxy Statement.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information contained under the section captioned "Transactions with
Management" in the Proxy Statement is incorporated herein by reference.
Item 14. Principal Accounting 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 and Financial Statement Schedules
- ----------------------------------------------------
(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)
(continued on following page)
80
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 (incorporated by reference to the Registrant's
Annual Report on Form 10-K for the year ended March 31, 2004)
21 Subsidiaries of the Registrant
23 Consent of Moss Adams LLP, Independent Registered Public
Accounting Firm
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) Financial Statement Schedules
The Consolidated Financial Statements and Notes thereto are included
in Item 8 of this Form 10-K.
81
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 9, 2005 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, Director
Chief Executive Officer,
and President
Date: June 9, 2005 Date: June 9, 2005
By: /s/Richard P. Jacobson By: /s/Fred R. Miller
------------------------- ---------------------------
Richard P. Jacobson Fred R. Miller
Principal Financial Officer Director
Date: June 9, 2005 Date: June 9, 2005
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 9, 2005 Date: June 9, 2005
By: /s/Kelli J. Holz By: /s/Robert C. Tauscher
------------------------- ---------------------------
Kelli J. Holz Robert C. Tauscher
Principal Accounting Officer Director
Date: June 9, 2005 Date: June 9, 2005
82
By: /s/Richard R. Haggen By: /s/Gary E. Goodman
------------------------- ---------------------------
Richard R. Haggen Gary E. Goodman
Director Director
Date: June 9, 2005 Date: June 9, 2005
83
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 Registered Public Accounting Firm
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Horizon Financial Corp.
We consent to the incorporation by reference in the Registration Statement on
Form S-8 (No. 33-99780) of Horizon Financial Corp. pertaining to the 1986
Stock Option and Incentive Plan, and the 1995 Stock Option Plan; and the
Registration Statement on Form S-8 (No. 333-88571) pertaining to the Bank of
Bellingham 1993 Employee Stock Option Plan; of our report dated May 26, 2005
relating to the consolidated statement of financial condition of Horizon
Financial Corp. as of March 31, 2005 and 2004, the related consolidated
statements of income, stockholders' equity, and cash flows for each of the
years in the three year period ended March 31, 2005, and our report dated May
26, 2005, with respect to Horizon Financial Corp. management's assessment of
the effectiveness of internal control over financial reporting and the
effectiveness of internal control over financial reporting, appearing in this
Annual Report on Form 10-K of Horizon Financial Corp., for the year ended
March 31, 2005.
/s/Moss Adams LLP
Bellingham, Washington
June 9, 2005
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 statements
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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) 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) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
c) 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
d) 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 9, 2005
/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 statements
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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) 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) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
c) 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
d) 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 9, 2005
/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 9, 2005