Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of
1934
Filed by the registrant [X]
Filed by a party other than the registrant [ ]
Check the appropriate box:
[ ] Preliminary proxy statement [ ] Confidential, for use of the
[X] Definitive proxy statement Commission only (as permitted by
[ ] Definitive additional materials Rule 14a-6(e)(2))
[ ] Soliciting material pursuant to
Rule 14a-11(c) or Rule 14a-12
Horizon Financial Corp.
- ------------------------------------------------------------------------------
(Name of Registrant as Specified in Its Charter)
Horizon Financial Corp.
- ------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement)
Payment of filing fee (Check the appropriate box):
[X] No fee required.
[ ] $500 per each party to the controversy pursuant to Exchange Act Rule
14a-6(i)(3).
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
(1) Title of each class of securities to which transaction applies:
N/A
- ------------------------------------------------------------------------------
(2) Aggregate number of securities to which transactions applies:
N/A
- ------------------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:
N/A
- ------------------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
N/A
- ------------------------------------------------------------------------------
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11 (a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the form or schedule and the date of its filing.
(1) Amount previously paid:
N/A
- ------------------------------------------------------------------------------
(2) Form, schedule or registration statement no.:
N/A
- ------------------------------------------------------------------------------
(3) Filing party:
N/A
- ------------------------------------------------------------------------------
(4) Date filed:
N/A
- ------------------------------------------------------------------------------
June 18, 2003
Dear Shareholder:
You are cordially invited to attend the Annual Meeting of Shareholders of
Horizon Financial Corp. to be held at the Fox Hall at the Hampton Inn, 1661 W.
Bakerview Road, Bellingham, Washington, on July 22, 2003 at 1:00 p.m., Pacific
Time.
The attached Notice of Annual Meeting of Shareholders and Proxy Statement
describe the formal business to be transacted at the meeting. During the
meeting, we will also report on the operations of the Corporation. Directors
and officers of the Corporation, as well as a representative of Moss Adams
LLP, will be present to respond to any questions our shareholders may have.
Please sign, date and return the enclosed proxy card. If you attend the
meeting and vote your shares at the meeting, please note the following:
1. If you are a shareholder of record and you have physical
possession of the stock certificates: You may vote in person
even if you have voted by proxy previously.
2. If your shares are held by a brokerage firm or other nominee,
and you want to vote in person at the meeting: Please contact
your broker or agent for a "Legal Proxy" from your brokerage
firm and bring the Legal Proxy to the meeting for voting.
Without the Legal Proxy, you will not be able to vote in person
at the meeting.
Your continued interest and support of the Corporation and Horizon Bank
are sincerely appreciated.
Sincerely,
/s/V. Lawrence Evans
V. Lawrence Evans
Chairman of the Board
HORIZON FINANCIAL CORP.
1500 Cornwall Avenue
Bellingham, Washington 98225
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
To Be Held on July 22, 2003
NOTICE IS HEREBY GIVEN THAT the 2003 Annual Meeting of Shareholders
("Meeting") of Horizon Financial Corp. ("Corporation") will be held at the Fox
Hall at the Hampton Inn, which is located at 1661 W. Bakerview Road,
Bellingham, Washington on July 22, 2003 at 1:00 p.m., Pacific Time.
A Proxy Card and Proxy Statement for the Meeting are enclosed herewith.
The Meeting is for the purpose of considering and acting upon:
(1) The election of three directors of the Corporation; and
(2) Such other matters as may properly come before the Meeting or any
adjournments thereof.
NOTE: The Board of Directors is not aware of any other business to
come before the Meeting.
Any action may be taken on the foregoing proposal at the Meeting on the
date specified above, or on any date or dates to which, by original or later
adjournment, the Meeting may be adjourned. Shareholders of record at the
close of business on June 6, 2003, are the shareholders entitled to notice of
and to vote at the Meeting and any adjournments thereof.
You are requested to fill in and sign the enclosed form of proxy, which
is solicited by the Board of Directors, and to mail it promptly in the
enclosed envelope. The proxy will not be used if you attend the Meeting and
vote in person.
BY ORDER OF THE BOARD OF DIRECTORS
/S/RICHARD P. JACOBSON
RICHARD P. JACOBSON
SECRETARY
Bellingham, Washington
June 18, 2003
IMPORTANT: THE PROMPT RETURN OF PROXIES WILL SAVE YOUR CORPORATION THE
EXPENSE OF FURTHER REQUESTS FOR PROXIES IN ORDER TO INSURE A QUORUM. AN
ADDRESSED ENVELOPE IS ENCLOSED FOR YOUR CONVENIENCE. NO POSTAGE IS REQUIRED
IF MAILED IN THE UNITED STATES.
PROXY STATEMENT
OF
HORIZON FINANCIAL CORP.
1500 Cornwall Avenue
Bellingham, Washington 98225
(360) 733-3050
ANNUAL MEETING OF SHAREHOLDERS
July 22, 2003
- ------------------------------------------------------------------------------
This Proxy Statement is furnished in connection with the solicitation of
proxies by the Board of Directors of Horizon Financial Corp. ("Horizon
Financial" or the "Corporation"), the holding company for Horizon Bank
("Horizon Bank" or the "Bank"), to be used at the 2003 Annual Meeting of
Shareholders of the Corporation ("Meeting") which will be held at the Fox Hall
at the Hampton Inn, 1661 W. Bakerview Road, Bellingham, Washington, on
Tuesday, July 22, 2003 at 1:00 p.m., Pacific Time. The accompanying Notice of
Annual Meeting of Shareholders and this Proxy Statement are being first mailed
to shareholders on or about June 18, 2003.
REVOCATION OF PROXIES
---------------------
Shareholders who execute proxies retain the right to revoke them at any
time. Unless so revoked, the shares represented by such proxies will be voted
at the Meeting and all adjournments thereof. Proxies may be revoked by
written notice to the Secretary of the Corporation or the filing of a later
proxy prior to a vote being taken on a particular proposal at the Meeting. An
executed proxy will not be voted if a shareholder attends the Meeting and
votes in person. Proxies solicited by the Board of Directors of the
Corporation will be voted in accordance with the directions given therein
provided they are executed. Where no instructions are indicated, executed
proxies will be voted for the nominees for directors set forth below.
VOTING AND PROXY PROCEDURE
--------------------------
Shareholders Entitled to Vote. Shareholders of record as of the close of
business on June 6, 2003 ("Voting Record Date") are entitled to one vote for
each share of common stock ("Common Stock") of the Corporation then held.
Shareholders are not permitted to cumulate their votes for the election of
directors. As of the Voting Record Date the Corporation had 10,547,331 shares
of Common Stock issued and outstanding.
If you are a beneficial owner of the Corporation's Common Stock held by a
broker, bank or other nominee (i.e., in "street name"), you will need proof of
ownership to be admitted to the Meeting. A recent brokerage statement or
letter from a bank or broker are examples of proof of ownership. If you want
to vote your shares of the Corporation's Common Stock held in street name in
person at the Meeting, you will have to get a written proxy in your name from
the broker, bank or other nominee who holds your shares.
Quorum. The presence, in person or by proxy, of at least one-third of
the total number of outstanding shares of Common Stock entitled to vote is
necessary to constitute a quorum at the Meeting. Abstentions will be counted
as shares present and entitled to vote at the Annual Meeting for purposes of
determining the existence of a quorum. Broker non-votes will be considered
shares present and will be included in determining whether a quorum is
present.
Voting. The Board of Directors solicits proxies so that each shareholder
has the opportunity to vote on the proposals to be considered at the Meeting.
When a proxy card is returned properly signed and dated, the shares
represented thereby will be voted in accordance with the instructions on the
proxy card. Where no instructions are indicated, proxies will be voted in
accordance with the recommendations of the Board of Directors. If a
shareholder of
record attends the Meeting, he or she may vote by ballot. The Board
recommends a vote FOR the election of the nominees for director.
The affirmative vote of a plurality of the votes cast at the Meeting is
required for the election of directors. Shareholders are not permitted to
cumulate their votes for the election of directors. Votes may be cast for or
withheld from each nominee. Votes that are withheld and broker non-votes will
have no effect on the outcome of the election because the nominees receiving
the greatest number of votes will be elected.
Revocation of a Proxy. Shareholders who execute proxies retain the right
to revoke them at any time before they are voted. Proxies may be revoked by
written notice delivered in person or mailed to the Secretary of the
Corporation or by filing a later proxy prior to a vote being taken on a
particular proposal at the Meeting. Attendance at the Meeting will not
automatically revoke a proxy, but a shareholder of record in attendance may
request a ballot and vote in person, thereby revoking a prior granted proxy.
If your Common Stock of the Corporation is held in street name, you will
receive instructions from your broker, bank or other nominee that you must
follow in order to have your shares voted. Your broker or bank may allow you
to deliver your voting instructions via the telephone or the Internet. Please
see the instruction form that accompanies this proxy statement. If you wish to
change your voting instructions after you have returned your voting
instruction form to your broker or bank, you must contact your broker or bank.
Participants in the ESOP. If a shareholder is a participant in the
Horizon Bank Employee Stock Ownership Plan ("ESOP"), the proxy card represents
a voting instruction to the trustees of the ESOP as to the number of shares in
the participant's plan account. Each participant in the ESOP may direct the
trustees as to the manner in which shares of Common Stock allocated to the
participant's plan account are to be voted.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
Persons and groups who beneficially own in excess of five percent of the
Corporation's Common Stock are required to file certain reports with the
Securities and Exchange Commission ("SEC"), and provide a copy to the
Corporation, disclosing such ownership pursuant to the Securities Exchange Act
of 1934, as amended ("Exchange Act"). Based on such reports, information as
to those persons who were beneficial owners of more than 5% of the outstanding
shares of Common Stock. Management knows of no persons other than those set
forth below who beneficially owned more than 5% of the outstanding shares of
Common Stock at the close of business on the Voting Record Date. The table
also sets forth, as of the close of business on the Voting Record Date,
certain information as to shares of Common Stock beneficially owned by the
Corporation's directors, "named executive officers," and all directors and
executive officers as a group.
Number of Percent of
Shares Shares
Beneficially Out-
Name Owned (1)(2) Standing
- ------------------------------------------------ ------------ --------
Beneficial Owners of More Than 5%
Dimensional Fund Advisors (3) 660,327 6.26%
1299 Ocean Avenue, 11th Floor
Santa Monica, California 90401
(table continued on following page)
2
Number of Percent of
Shares Shares
Beneficially Out-
Name Owned (1)(2) Standing
- ------------------------------------------------ ------------ --------
Directors
Robert C. Diehl 47,949 0.45%
Fred R. Miller 118,266 1.12
James A. Strengholt 9,460 0.09
Richard R. Haggen 77,354 0.73
Gary E. Goodman 5,002 0.05
Robert C. Tauscher 3,208 0.03
Named Executive Officers(4)
V. Lawrence Evans 248,614 2.36
Dennis C. Joines 5,938 0.06
Richard P. Jacobson 40,049 0.38
Karla C. Lewis 32,041 0.30
All Executive Officers and
Directors as a Group (12 persons) 609,682 5.78%
- ----------
(1) Includes all shares owned directly by the named individuals or by the
individuals indirectly through a trust or corporation, or by the
individuals' spouses and minor children, except as otherwise noted. The
named individuals effectively exercise sole or shared voting and
investment power over these shares.
(2) Includes shares of Common Stock subject to outstanding stock options
which are exercisable within 60 days after the Voting Record Date.
(3) Based on a Schedule 13G dated February 3, 2003, filed with the SEC that
discloses sole voting and dispositive power as to 660,327 shares.
(4) Under SEC regulations the term "named executive officer(s)" is defined to
include the chief executive officer, regardless of compensation level,
and the four most highly compensated executive officers, other than the
chief executive officer, whose total annual salary and bonus for the last
completed fiscal year exceeded $100,000. Mr. Evans, President, Chief
Executive Officer and Chairman of the Board of the Corporation and Chief
Executive Officer and Chairman of the Board of the Bank; Mr. Joines,
President and Chief Operating Officer of the Bank; Mr. Jacobson, Vice
President and Secretary of the Corporation and Executive Vice President
of the Bank; and Karla C. Lewis, Senior Vice President of the Bank, were
the Corporation's only "named executive officers" during the fiscal year
ended March 31, 2003.
PROPOSAL I -- ELECTION OF DIRECTORS
-----------------------------------
The Corporation's Board of Directors consists of eight directors. The
Corporation's bylaws provide that directors will be elected for three-year
staggered terms with approximately one-third of the directors elected each
year. Accordingly, at the Meeting, three directors will be elected to serve
for a three-year term,or until their respective successors have been duly
elected and qualified. The Board of Directors has nominated for election as
directors Robert C. Diehl, Fred F. Miller and Gary E. Goodman, each for
three-year terms. Messrs. Diehl, Miller and Goodman are each current members
of the Board of Directors of the Corporation and the Bank.
It is intended that the proxies solicited by the Board of Directors will
be voted for the election of the above named nominees for the terms specified
in the table below. If any nominee is unable to serve, the shares represented
by all valid proxies will be voted for the election of such substitute as the
Board of Directors may recommend or the Board may reduce the number of
directors to eliminate the vacancy. At this time the Board of Directors knows
of no reason why any nominee might be unavailable to serve.
3
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE ELECTION OF MESSRS.
DIEHL, MILLER AND GOODMAN.
The following table sets forth certain information regarding the nominees
for election at the Meeting and those directors continuing in office after the
Meeting.
Year First
Elected
or Appointed Term to
Name Age(1) Director(2) Expire
- ----------------- ------ ----------- ------
NOMINEES
--------
Robert C. Diehl 64 1976 2006(3)
Fred R. Miller 66 1984 2006(3)
Gary E. Goodman 55 1998 2006(3)
CONTINUING DIRECTORS
--------------------
Dennis C. Joines 53 2002 2004
James A. Strengholt 50 2000 2004
V. Lawrence Evans 56 1990 2005
Richard R. Haggen 58 1994 2005
Robert C. Tauscher 63 2001 2005
- ------------
(1) As of March 31, 2003.
(2) Includes prior service on the Board of Directors of the Bank.
(3) Assuming the individual is re-elected.
The principal occupation of each director nominee of the Corporation for
the last five years is set forth below. Unless otherwise stated, each
director resides in the State of Washington.
ROBERT C. DIEHL is the President and General Manager of Diehl Ford, Inc.,
an automobile dealership.
FRED R. MILLER is the retired and former owner and President of the
Skagit Bonded Collectors, Inc., Mount Vernon, Washington.
GARY E. GOODMAN is the refinery manager for the Conoco Phillips Refinery
in Ferndale, Washington.
DENNIS C. JOINES is President and Chief Operating Officer of the Bank and
a Director of the Corporation and the Bank. He joined the Bank on April 23,
2002 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.
JAMES A. STRENGHOLT is the Vice President of Strengholt Construction
Company, Inc., a general building contractor based in Lynden, Washington.
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 President
and Chief Executive Officer of the Corporation and, effective July 24, 2001,
as Chairman of the Board of the Corporation.
4
RICHARD R. HAGGEN is an owner and co-chairman of the Board of Directors
of Haggen, Inc., a retail grocery chain.
ROBERT C. TAUSCHER is the President and Chief Executive Officer of Team
Corporation, a manufacturer of vibration testing equipment, in Burlington,
Washington.
MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS
-------------------------------------------------
The Boards of Directors of the Corporation and the Bank conduct their
business through meetings of the Boards and through their committees. During
fiscal 2003, the Board of Directors of the Corporation held eight meetings.
No director of the Corporation attended fewer than 75% of the total number of
meetings of the Board of Directors and committees on which the director
served.
The full Board of Directors of the Corporation acts as a Nominating
Committee for the annual selection of its nominees for election as directors.
The Corporation's Bylaws provide that any nomination to the Board of Directors
(except one proposed by the existing Board of Directors of the Corporation)
must be in writing and delivered or mailed to the Chairman of the Board of the
Corporation at least 20 days prior to the meeting of shareholders called for
the election of directors. The Board of Directors met twice during the 2003
fiscal year in its capacity as the Nominating Committee.
The Executive Committee of the Corporation is composed of Directors
Diehl, Evans, Goodman, Joines and Miller. This Committee meets at least
monthly to advise management of the Corporation between meetings of the Board
of Directors. The Executive Committee met 12 times during the 2003 fiscal
year.
The Audit Committee of the Corporation is composed of Directors Miller,
Strengholt and Tauscher. The Audit Committee is responsible for examining and
evaluating the activities of the Corporation and reporting its findings to the
Board. This examination determines the reliability of information produced on
behalf of the Corporation and the effectiveness of internal practices and
procedures and the efficiency of operations. The Audit Committee also assists
the Board in the selection of independent accountants. The Audit Committee
met six times during the 2003 fiscal year.
The Compensation and Retirement Committee is composed of Directors Diehl,
Goodman and Miller. This Committee makes recommendations to the Board of
Directors concerning corporation compensation packages and retirement plans.
The Compensation and Retirement Committee met twice during the 2003 fiscal
year.
DIRECTORS' COMPENSATION
-----------------------
Each director of the Corporation is also a director of the Bank.
Directors of the Corporation received no additional compensation for
attendance at any meeting of the Corporation's Board of Directors during the
2003 fiscal year. Members of the Bank's Board of Directors receive an annual
retainer of $9,000 and $500 for attendance at each Board meeting. The
Chairman of the Board receives an additional $500 per month. Directors also
receive $400 for each committee meeting attended held on the day of a regular
meeting or a special board meeting held by telephone conference call, and $400
for attendance at a special board meeting or a committee meeting held on a day
other than the day of a regular board meeting. Members of the Executive
Committee receive $500 per month. Employees of the Bank who are also
directors do not receive compensation for their attendance at any board or
committee meetings.
5
EXECUTIVE COMPENSATION
----------------------
Summary Compensation Table. The following information is furnished for
the Chief Executive Officer of the Corporation and the Bank, and three
executive officers who received salary and bonus in excess of $100,000 during
the fiscal year ended March 31, 2003. No other executive officer's total
annual salary and bonus for the last completed fiscal year exceeded $100,000.
Long-Term
Compensation
Annual Compensation* Awards
------------------------------------------- ------------
Securities
Name and Other Annual Underlying All Other
Position Year Salary($) Bonus($) Compensation($)(1) Options(#)(2) Compensation($)(3)
- ------------------ ---- --------- -------- ------------------ ------------ ------------------
<s> <c> <c> <c> <c> <c> <c>
V. Lawrence Evans 2003 $200,004 $34,974 $ 99,653 -- $27,331
President, Chief 2002 182,700 18,441 115,257 -- 24,573
Executive Officer 2001 182,700 17,351 97,117 10,781 23,772
and Chairman of the
Board of the Corpor-
ation and Chief
Executive Officer
and Chairman of the
Board of the Bank
Dennis C. Joines (4) 2003 167,222 15,759 -- 18,750 11,317
President and Chief
Operating Officer
of the Bank and a
Director of the
Corporation and
the Bank
Richard P. Jacobson 2003 111,297 18,254 -- -- 17,676
Vice President and 2002 91,800 9,090 -- -- 13,463
Secretary of the 2001 88,200 8,376 -- 5,462 10,934
Corporation and
Executive Vice
President and
Secretary of the
Bank
Karla C. Lewis 2003 95,820 16,931 -- -- 12,602
Senior Vice 2002 89,520 8,898 -- -- 11,719
President of 2001 86,700 8,304 -- 4,312 11,152
the Bank
- ------------
* All compensation is paid by the Bank.
(1) Amounts reflect: for Mr Evans, deferred compensation under the Bank's
deferred compensation plan.
(2) Pursuant to the 1995 Stock Option Plan, Mr. Joines was granted 18,750
options on April 23, 2002, which vest at a rate of 25% per year over a
four year period.
(3) Amounts for fiscal 2003 reflect: for Mr. Evans, contributions of $4,039
to the Bank's ESOP, $19,327 to the Bank's Retirement Savings and
Investment Plan, $1,032 for life insurance premiums; and $2,933 for an
automobile and other allowance; for Mr. Joines, $368 for life insurance
premiums, and $10,949 for automobile and other allowance; for Mr.
Jacobson, contributions of $2,248 to the Bank's ESOP, $10,724 to the
Bank's Retirement Savings and Investment Plan, $268 for life insurance
premiums; and $4,436 for an automobile and other allowance; and for Ms.
Lewis, contributions of $1,935 to the Bank's ESOP, $9,472 to the Bank's
Retirement Savings and Investment Plan, and $1,195 for life insurance
premiums.
(4) Effective April 23, 2002, Mr. Dennis C. Joines was appointed President
and Chief Operating Officer of the Bank. Mr. Evans, who formerly served
as President of the Bank, has continued to serve as Chief Executive
Officer and Chairman of the Bank and President, Chief Executive Officer
and Chairman of the Corporation.
6
Option Grants in Last Fiscal Year. The following table sets forth
information concerning the grant of stock options to Mr. Joines during the
year ended March 31 2003. No other named executive officer was granted
options during the year ended March 31, 2003.
Individual Grants
---------------------------------------------
Percent Potential Realizable Value
Number of Of Total at Assumed Annual Rate
Securities Options of Stock Price Appreciation
Underlying Granted to Exercise Expira- For Option Term (2)
Options Employees in Price tion ----------------------------
Name Granted(1) Fiscal Year ($/sh) Date 0%($) 5%($) 10%($)
- -------------------- ---------- ----------- ------ ---- ------ ------- -------
<s> <c> <c> <c> <c> <c> <c> <c>
Dennis C. Joines 18,750 57.0% $10.66 4/23/12 $79,313 $93,188 $107,250
- ----------
(1) Each option grant reported in the table vests at the rate of 25% per annum. Options will become
immediately exercisable in the event of a change in control of the Corporation.
(2) The dollar gains under these columns result from calculations required by the SEC's rules and are not
intended to forecast future price appreciation of the Corporation Common Stock. It is important to note
that options have value only if the stock price increases above the exercise price shown in the table
during the effective option period. At March 31, 2003, the price was $14.89, which represents the
value in the 0% appreciation column. In order for the executive to realize the potential values set
forth in the 5% and 10% columns in the table, the price per share of the Corporation's Common Stock
would be approximately $15.63 and $16.38, respectively, as of the expiration date of the
options.
Option Exercise/Value Table. The following information with respect to options exercised during the
fiscal year ended March 31, 2003, and remaining unexercised at the end of the fiscal year, is presented for
Messrs. Evans, Joines and Jacobson, and Ms. Lewis.
Number of
Securities Underlying Value of Unexercised
Unexercised Options In-the-Money Options
Shares at Fiscal Year End(#) at Fiscal Year End($)(1)
Acquired on Value --------------------------- ----------------------------
Name Exercise (#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
- --------------- ------------ ----------- ----------- ------------- ----------- -------------
<s> <c> <c> <c> <c> <c> <c>
V. Lawrence Evans 42,912 $220,938 58,220 7,186 $422,274 $60,472
Dennis C. Joines -- -- -- 18,750 -- 79,313
Richard P. Jacobson -- -- 33,553 4,526 238,542 38,049
Karla C. Lewis 14,919 84,211 15,847 2,155 101,405 18,167
(1) Value of unexercised in-the-money stock options equals the market value of shares covered by
in-the-money options on March 31, 2003 less the option exercise price. Options are in-the-money if the
market value of shares covered by the options is greater than the exercise price.
Employment and Severance Agreements. The Corporation and the Bank are
parties to an employment contract with Mr. Evans. The agreement renews
automatically for an additional one year term until either of the parties
notifies the other in writing of its intent not to renew the contract. Under
the agreement, Mr. Evans' current annual base compensation is $206,000. In
addition, Mr. Evans is entitled to participate in and to receive all benefits
which are applicable to the Corporation's executive employees. The agreement
also provides for compensation to be paid to Mr. Evans in the event of his
disability, termination without cause or in the event of a change in control
of the Corporation. In the event of a change in control (as defined in the
agreement), Mr. Evans would be entitled to receive an amount equal to 2.99
times the average annual base compensation received prior to the date of
change of control for the most recent five taxable years. Assuming that a
change in control had occurred during fiscal 2003, Mr. Evans would have been
entitled to a cash payment equal to approximately $546,216.
7
On June 11, 2002, the Bank entered into a severance agreement with Mr.
Joines, a director of the Corporation and President, Chief Operating Officer
and a director of the Bank, in connection with his employment on April 23,
2002. The agreement is for an initial term of 36 months, and may be extended
annually unless either party elects not to extend the agreement. The
agreement provides that if a "change in control" of the Corporation or the
Bank occurs, and within 12 months thereafter the executive's employment is
involuntarily terminated without just cause, or the executive voluntarily
terminates his employment for good reason, as defined in the agreement, he
will be entitled to receive a severance payment equal to 2.99 times his annual
compensation. Assuming that a change in control had occurred during fiscal
2003, Mr. Joines would be entitled to a severance payment of approximately
$554,573.
The Bank entered into a change of control severance agreement with Mr.
Jacobson, Vice President and Secretary of the Corporation and Executive Vice
President and Secretary of the Bank, on July 16, 2002. The agreement is for
an initial term of 36 months, and may be extended annually unless either party
elects not to extend the agreement. The agreement provides that if a "change
in control" of the Corporation or the Bank occurs, and within 12 months
thereafter the executive's employment is involuntarily terminated without just
cause, or the executive voluntarily terminates his employment for good reason,
as defined in the agreement, he will be entitled to receive a severance
payment equal to 1.99 times his annual compensation. Assuming that a change
in control had occurred during fiscal 2003, Mr. Jacobson would be entitled to
a severance payment of approximately $257,806.
Deferred Compensation Plan. The Bank has established a deferred
compensation plan for certain of its officers, including Mr. Evans. The plan
provides for additional retirement benefits payable over a 12 to 20 year
period following retirement. In connection with the funding of the Bank's
obligation under the plan, the Bank has acquired life insurance policies on
the lives of plan participants. Deferred compensation expense for Mr. Evans
amounted to $99,653, $115,257 and $97,117 in 2003, 2002 and 2001,
respectively.
AUDIT COMMITTEE MATTERS
-----------------------
Audit Committee Charter. The Audit Committee operates pursuant to a
Charter approved by the Corporation's Board of Directors. The Audit Committee
reports to the Board of Directors and is responsible for overseeing and
monitoring financial accounting and reporting, the system of internal controls
established by management and the audit process of the Corporation. The Audit
Committee Charter, which was adopted by the Corporation's Executive Committee
in June 2000 and ratified and approved by the Audit Committee in July 2000,
sets out the responsibilities, authority and specific duties of the Audit
Committee. The Charter specifies, among other things, the structure and
membership requirements of the Audit Committee, as well as the relationship of
the Audit Committee to the independent accountants, the internal audit
department, and management of the Corporation. A copy of the Charter was
attached as Exhibit A to the 2001 annual meeting proxy statement.
Report of the Audit Committee. The Audit Committee reports as follows
with respect to the Corporation's audited financial statements for the year
ended March 31, 2003:
. The Audit Committee has completed its initial review and discussion
of the Corporation's 2003 audited financial statements with
management;
. The Audit Committee has discussed with the independent auditors
(Moss Adams LLP) the matters required to be discussed by Statement
on Auditing Standards ("SAS") No. 61, Communication with Audit
Committees, as amended by SAS No. 90, Audit Committee
Communications, including matters related to the conduct of the
audit of the Corporation's financial statements;
. The Audit Committee has received written disclosures, as required by
Independence Standards Board Standard No. 1, Independence
Discussions with Audit Committee, indicating all relationships, if
any, between the independent auditor and its related entities and
the Corporation and its related entities which, in the auditors'
professional judgment, reasonably may be thought to bear on the
auditors' independence, and the letter from the independent auditors
confirming that, in its professional
8
judgment, it is independent from the Corporation and its related
entities, and has discussed with the auditors the auditors'
independence from the Corporation; and
. The Audit Committee has, based on its initial review and discussions
with management of the Corporation's 2003 audited financial
statements and discussions with the independent auditors,
recommended to the Board of Directors that the Corporation's audited
financial statements for the year ended March 31, 2003 be included
in the Corporation's 2003 Annual Meeting Proxy Solicitation
Materials.
Audit Committee: Fred R. Miller, Chairman
James A. Strengholt
Robert C. Tauscher
Independence and Other Matters. Each member of the Audit Committee is
"independent," as defined, in the case of the Corporation, under The Nasdaq
Stock Market Rules. The Audit Committee members do not have any relationship
to the Corporation that may interfere with the exercise of their independence
from management and the Corporation. None of the Audit Committee members are
current officers or employees of the Corporation or its affiliates.
COMPENSATION COMMITTEE MATTERS
------------------------------
Notwithstanding anything to the contrary set forth in any of the
Corporation's previous filings under the Securities Act of 1933, as amended,
or the Exchange Act that might incorporate future filings, including this
Proxy Statement, in whole or in part, the following Report of the Compensation
Committee and Performance Graph shall not be incorporated by reference into
any such filings.
Report of the Compensation Committee. The Compensation Committee's
duties are to recommend and administer policies that govern executive
compensation for the Corporation and the Bank. The Compensation Committee
evaluates executive performances, compensation policies and salaries. The
Compensation Committee recommends salaries to be paid to each executive
officer. The entire Board of Directors reviews the Compensation Committee's
recommendations as to executive compensation, including the Chief Executive
Officer, and sets these salaries.
The executive compensation policy of the Corporation and the Bank is
designed to establish an appropriate relationship between executive pay and
the Corporation's and the Bank's annual and long-term performance, long-term
growth objectives, and their ability to attract and retain qualified executive
officers. The principles underlying the program are:
. To attract and retain key executives who are vital to the long-term
success of the Corporation and the Bank and are of the highest
caliber;
. To provide levels of compensation competitive with those offered
throughout the financial industry; and
. To motivate executives to enhance long-term shareholder value by
building their ownership in the Corporation.
The Committee also considered a variety of subjective and objective
factors in determining the compensation package for individual executives
including (1) the performance of the Corporation and the Bank as a whole with
an emphasis on annual and long-term performance, (2) the responsibilities
assigned to each executive, and (3) the performance of each executive of
assigned responsibilities as measured by the progress of the Corporation and
the Bank during the year.
9
Another factor the Compensation Committee (and the Board of Directors)
considered when making their decisions was the overall profitability of the
Corporation and Bank, rather than establishing compensation levels on the
basis of whether specific financial goals had been achieved by the Corporation
and the Bank.
The annual salary for V. Lawrence Evans was $200,004 for fiscal 2003.
The bonus paid to Mr. Evans is based on the profitability of the Bank, using
the same formula that applies to all employees vested in the Bank's cash
profit sharing program. The Compensation Committee believes that Mr. Evans'
compensation, and management compensation levels as a whole, appropriately
reflect the application of the Corporation's and the Bank's executive
compensation policy and the progress of the Corporation and the Bank.
Compensation Committee
/s/Robert C. Diehl
/s/Gary E. Goodman
/s/Fred R. Miller
Compensation Committee Interlocks and Insider Participation. The
Compensation Committee of the Board of Directors consists of Directors Robert
C. Diehl, Fred R. Miller and Gary E. Goodman. During fiscal 2003, there were
no compensation committee interlocks between the Corporation and any other
entity.
10
Performance Graph. The following graph compares the cumulative total
shareholder return on the Corporation's Common Stock with the cumulative total
return on the Nasdaq Index and the SNL Western Thrift Index, which encompasses
ten western states. Total return assumes reinvestment of all dividends.
[GRAPH APPEARS HERE]
Period Ending
----------------------------------------------------------
Index 03/31/98 03/31/99 03/31/00 03/31/01 03/31/02 03/31/03
- ------------------ -------- -------- -------- -------- -------- --------
Horizon Financial
Corp. 100.00 73.51 51.85 66.79 91.54 140.08
Nasdaq - Total US* 100.00 135.08 250.99 100.60 101.32 74.37
SNL Western Thrift
Index 100.00 83.23 62.01 124.27 120.51 134.39
SNL Western Bank
Index 100.00 83.29 98.94 119.60 131.16 123.91
*Source: CRSP, Center for Research in Security Prices, Graduate School of
Business, The University of Chicago, 2000. Used with permission. All rights
reserved. crsp.com.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
-------------------------------------------------
Section 16(a) of the Exchange Act requires the Corporation's executive
officers and directors, and persons who own more than 10% of any registered
class of the Corporation's equity securities, to file reports of ownership and
changes
11
in ownership with the SEC within prescribed time periods. Executive officers,
directors and greater than 10% shareholders are required by regulation to
furnish the Corporation with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms it has received
and written representations provided to the Corporation by the above
referenced persons, the Corporation believes that all filing requirements
applicable to its reporting officers, directors and greater than 10%
shareholders were properly and timely complied with during the fiscal year
ended March 31, 2003, except for the filing of a Form 4, Statement of Change
in Beneficial Ownership of Securities, by Director Tauscher. Director
Tauscher inadvertently failed to file a Form 4, Statement of Change in
Beneficial Ownership of Securities, on July 26, 2002 for a transaction on July
26, 2002. The transaction was subsequently reported on a Form 5, Annual
Statement of Changes in Beneficial Ownership, which was filed on May 13, 2003.
TRANSACTIONS WITH MANAGEMENT
----------------------------
Under federal law, officers and directors of the Bank are generally
prohibited from receiving any loan or extension of credit at other than market
rates and terms.
AUDITORS
--------
Moss Adams LLP served as the Corporation's auditors for the 2003 fiscal
year. The Board of Directors currently anticipates appointing Moss Adams LLP
to be its auditors for the 2004 fiscal year. A representative of Moss Adams
LLP will be present at the Meeting to respond to questions from shareholders
and will have the opportunity to make a statement if he or she so desires.
Audit Fees
The aggregate fees billed to the Corporation by Moss Adams LLP for
professional services rendered for the audit of the Corporation's financial
statements and the reviews of the financial statements included in the
Corporation Forms 10-Q were $63,000.
Financial Information Systems Design and Implementation Fees
Moss Adams LLP performed no financial information system design or
implementation work for the Corporation during the fiscal year ended March 31,
2003.
All Other Fees
Other than audit fees, the aggregate fees billed to the Corporation by
Moss Adams LLP for fiscal 2003, none of which were financial information
systems design and implementation fees, were $45,331, which consisted of tax,
consulting and other services. The Audit Committee of the Board of Directors
determined that the services performed by Moss Adams LLP other than audit
services are not incompatible with Moss Adams LLP maintaining its
independence.
OTHER MATTERS
-------------
The Board of Directors is not aware of any business to come before the
Meeting other than the matter described above in this Proxy Statement.
However, if any other matters should properly come before the Meeting, it is
intended that proxies in the accompanying form will be voted in respect
thereof in accordance with the judgment of the person or persons voting the
proxies.
12
The cost of solicitation of proxies will be borne by the Corporation. In
addition to solicitations by mail, directors, officers, and regular employees
of the Corporation may solicit proxies personally or by telephone at their
regular salary or hourly compensation.
The Corporation's 2003 Annual Report to Shareholders has been mailed to
all shareholders of record as of the Voting Record Date. Any shareholder who
has not received a copy of such annual report may obtain a copy without charge
by writing the Corporation. Such annual report is not to be treated as part
of the proxy solicitation material nor having been incorporated herein by
reference.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the
financial condition and results of operations of the Corporation and its
subsidiary. The information contained in this section should be read in
conjunction with the Consolidated Financial Statements and the accompanying
Notes contained herein.
Forward Looking Statements
- --------------------------
Management's Discussion and Analysis and other portions of this report
contain certain "forward looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. This statement is for the express
purpose of availing Horizon Financial Corp. to the protections of such safe
harbor provisions of said Act with respect to all "forward looking
statements." Horizon Financial Corp. has used "forward looking statements" to
describe future plans and strategies, including expectations of Horizon
Financial Corp.'s potential future financial results. Management's ability to
predict results or the effect of future plans and strategies is inherently
uncertain. Factors that could affect results include, but are not limited to:
the future level of interest rates, industry trends, general economic
conditions, loan delinquency rates, and changes in state and federal
regulations. These factors should be considered when evaluating the "forward
looking statements" and undue reliance should not be placed on such
statements.
General
- -------
Horizon Financial Corp. ("Corporation") was formed under Washington law
on May 22, 1995, and became the holding company for Horizon Bank, effective
October 13, 1995. Effective June 19, 1999 the Corporation completed the
acquisition of Bellingham Bancorporation, whose wholly-owned subsidiary, Bank
of Bellingham, was merged with and into Horizon Bank. At March 31, 2003, the
Corporation had total assets of $819.9 million, total deposits of $646.7
million and total equity of $106.2 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 herein, including the consolidated financial statements and related
data, relates primarily to the Bank and its subsidiary.
The Bank was organized in 1922 as a Washington State chartered mutual
savings and loan association and converted to a federal mutual savings and
loan association in 1934. In 1979, the Bank converted to a Washington State
chartered mutual savings bank, the deposits of which are insured by the
Federal Deposit Insurance Corporation ("FDIC"). On August 12, 1986, the Bank
converted to a state chartered stock savings bank under the name "Horizon
Bank, a savings bank". The Bank became a member of the Federal Home Loan Bank
("FHLB") of Seattle in December 1998. Effective March 1, 2000, the Bank
changed its name to its current title, "Horizon Bank".
The Bank's operations are conducted through 16 full-service office
facilities, located in Whatcom, Skagit and Snohomish counties in Northwest
Washington. The acquisition of Bellingham Bancorporation increased Horizon
Financial's and Horizon Bank's presence in Whatcom County. During fiscal
2000, the Bank purchased a bank site in Marysville, which will provide
potential additional growth opportunities. In Fiscal 2002, the Bank acquired
a bank site in Lynnwood, Washington, which was remodeled and opened for
business in March 2003. Future plans for the Bank include the opening of
commercial banking centers in Bellingham, Snohomish, and Everett during the
first quarter of fiscal 2004.
13
Operating Strategy
- ------------------
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 the Bank's 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 Bank's profitability depends primarily on its net interest income,
which is the difference between the income it receives on its loan and
investment portfolio and its 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 Bank's
profitability is also affected by the level of 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 Bank'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.
Financial Condition
- -------------------
Total consolidated assets for the Corporation as of March 31, 2003, were
$819,871,874, a 6.19% increase from the March 31, 2002, level of $772,062,906.
This increase in assets was due primarily to the growth in available for sale
investment securities, which increased 60.78% to $74,560,801 from $46,373,554
at March 31, 2002. The tables below display the characteristics of the
available for sale ("AFS") and held to maturity ("HTM") portfolios as of March
31, 2003:
As of March 31, 2003
-------------------------------------
Amortized Net Estimated
Cost Gain/Loss Fair Value
---- --------- ----------
Available-For-Sale Securities
State and politicial subdivisions
and U.S. government agency
securities......................... $38,820,895 $1,888,238 $ 40,709,133
Marketable equity securities........ 3,805,723 5,423,778 9,229,501
Mutual funds........................ 5,000,000 10,070 5,010,070
Corporate debt securities........... 18,580,044 1,032,053 19,612,097
Mortgage-backed securities
and CMO's......................... 37,140,593 780,599 37,921,192
------------ ---------- ------------
Total available-for-
sale securities................. 103,347,255 9,134,738 112,481,993
------------ ---------- ------------
(table continues on following page)
14
As of March 31, 2003
-------------------------------------
Amortized Net Estimated
Cost Gain/Loss Fair Value
---- --------- ----------
Held-To-Maturity Securities
State and political subdivisions
and U.S. government agency
securities......................... 369,292 32,728 402,020
Mortgage-backed securities
and CMO's.......................... 2,793,089 190,654 2,983,743
------------ ---------- ------------
Total held-to-
maturity securities............ 3,162,381 223,382 3,385,763
------------ ---------- ------------
Total securities.................$106,509,636 $9,358,120 $115,867,756
============ ========== ============
Maturity Schedule of Securities
-----------------------------------------------------------------
Available-For-Sale Held-To-Maturity
------------------------------ -----------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
------------ ------------ ------------ ------------
<s> <c> <c> <c> <c>
Maturities:
One year............... $ 5,504,827 $ 5,618,886 $ 2,657 $ 2,810
Two to five years...... 60,427,304 63,214,583 557,136 602,989
Five to ten years...... 3,231,630 3,284,793 2,240,867 2,380,374
Over ten years......... 25,377,771 26,124,160 361,721 399,590
------------ ------------ ------------ ------------
94,541,532 98,242,422 3,162,381 3,385,763
------------ ------------ ------------ ------------
Mutual funds and
marketable equity
securities (liquid).... 8,805,723 14,239,571 -- --
------------ ------------ ------------ ------------
Total investment
securities.......... $103,347,256 $112,481,993 $ 3,162,381 $ 3,385,763
============ ============ ============ ============
Also contributing to the asset growth was an increase in loans receivable
to $582,269,145 from $568,303,481 at March 31, 2002. This growth was
primarily attributable to the growth in commercial loans during this period,
as the Bank continued its practice of selling most of its single-family fixed
rate loan production into the secondary market. The Bank sold $216,236,638 of
real estate loans in fiscal 2003, compared to $187,505,676 in fiscal 2002.
The Bank sells real estate loans during periods of increased loan volume to
improve the Bank's cash flow and to manage its interest rate risk profile.
Total liabilities also increased 6.28% to $713,628,356 at March 31, 2003,
from $671,463,315 at March 31, 2002. This increase in liabilities was due in
large part to the growth in deposits, which increased 2.85% to $646,722,160 at
March 31, 2003 from $628,782,470 at March 31, 2002. The following is an
analysis of the deposit portfolio by major type of deposit:
A comparative summary of deposits at March 31, 2003 and March 31, 2002
follows:
2003 2002
------------ ------------
Demand Deposits
Savings............................... $ 38,455,124 $ 35,262,865
Checking.............................. 66,169,430 52,336,378
Checking (noninterest-bearing)........ 28,052,250 22,915,124
Money Market/Ultimate................. 125,804,570 121,666,173
------------ ------------
258,481,374 232,180,540
------------ ------------
Time certificates of deposit
Less than $100,000.................... 258,623,337 272,739,558
Greater than or equal to $100,000..... 129,617,449 123,862,372
------------ ------------
388,240,786 396,601,930
------------ ------------
Total deposits........................ $646,722,160 $628,782,470
============ ============
15
Also contributing to the growth was an increase in other borrowed funds
to $53,762,740 at March 31, 2003, from $29,120,729 at March 31, 2002. During
the year, the Bank took out an additional $24,500,000 in borrowings from the
Federal Home Loan Bank to help control interest rate risk and support the
growth in assets.
Shareholders' equity at March 31, 2003 increased 5.61% to $106,243,518
from $100,599,591 at March 31, 2002. This increase was due primarily to the
increase in net income of $12,139,871 less dividends paid and shares
repurchased. Also contributing to this increase was the change accumulated
other comprehensive income to $6,028,927 at March 31, 2003 from $4,151,710 at
March 31, 2002. The decline in interest rates throughout fiscal 2003 resulted
in an increased value of the Bank's AFS security portfolio as shown in the
table above. The Corporation remains strong in terms of its capital position,
with a shareholder equity-to-assets ratio of 12.96% at March 31, 2003,
compared to 13.03% at March 31, 2002.
Results of Operations
- ---------------------
Net Interest Income. Net interest income in fiscal 2003 was $30,767,678,
a 15.88% increase from fiscal 2002 of $26,550,259, compared to $23,597,920 in
fiscal 2001. Total interest income decreased 5.39% in fiscal 2003 to
$50,228,779 from $53,090,828 in fiscal 2002, compared to $55,837,145 in fiscal
2001.
Interest income on loans in fiscal 2003 was $44,157,420, a 6.75% decrease
from $47,351,811 in fiscal 2002, compared to $49,361,792 in fiscal 2001. The
decrease in fiscal 2003 was due primarily to the overall decline in interest
rates. The decrease in fiscal 2002 was due primarily to the decrease in loans
receivable resulting from the sale of mortgage loans in the secondary market.
The increase in fiscal 2001 was due primarily to an overall growth in loans
receivable. Included in these amounts are approximately $1,871,000,
$1,990,000, and $1,833,000, respectively, of deferred fee income as a result
of loan paydowns, payoffs, and loans sold from the portfolio.
Interest and dividends on investments and mortgage-backed securities was
$6,071,359 in fiscal 2003, a 5.79% increase from $5,739,017 in fiscal 2002,
compared to $6,475,353 in fiscal 2001. The increase in fiscal 2003 was due to
the overall growth in the investment portfolio compared to the prior year.
The decrease in fiscal 2002 was due in part to the sale of selected long-term
fixed rate mortgage-backed securities during the year, which shifted a portion
of the investment portfolio into liquid, short-term assets with less interest
rate risk. Also contributing to this decrease was the decline in short term
interest rates.
Total interest expense in fiscal 2003 decreased 26.67% to $19,461,101
from $26,540,569 in fiscal 2002, compared to $32,239,225 in fiscal 2001.
Interest on deposits decreased 29.30% in fiscal 2003 to $17,672,959, compared
to $24,996,112 in fiscal 2002, and $29,221,019 in fiscal 2001. The decreases
in fiscal 2003 and 2002 were due to the overall decline in interest rates.
The increased level in fiscal 2001 was due to a higher interest rate
environment for short term obligations, which greatly affects the rates paid
by the Bank to attract and retain deposits.
Interest on borrowings increased to $1,788,142 in fiscal 2003, compared
to $1,544,457 in fiscal 2002, and $3,018,206 in fiscal 2001. The increase in
fiscal 2003 was due to a higher level of borrowings outstanding. The decrease
in fiscal 2002 was due to lower outstanding balances and a declining interest
rate environment. The expense in fiscal 2001 was due to a higher level of
borrowings outstanding and a higher level of interest rates. The Bank
continues to carry wholesale borrowings in order to further leverage its
balance sheet and better manage its interest rate risk profile.
Provision for loan losses. Provisions for loan losses are charges to
earnings to bring the total allowance for loan losses to a level considered by
management as adequate to provide for known and inherent risks in the loan
portfolio, based on management's continuing analysis of factors underlying the
quality of the loan portfolio. These factors include changes in portfolio
size and composition, actual loss experience, current economic conditions,
detailed analysis of individual loans for which full collectibility may not be
assured, and determination of the existence and realizable value of the
collateral and guarantees securing the loans.
16
The provision for loan losses was $2,740,000 for the year ended March 31,
2003 compared to $1,089,642 and $320,000 for the years ended March 31, 2002
and 2001, respectively. This increase resulted from management's ongoing
analysis of changes in loan portfolio composition by collateral categories,
overall credit quality of the portfolio, peer group analysis, and current
economic conditions. The reserve for loan losses was $8.5 million, or 1.46%
of loans receivable at March 31, 2003, compared to $5.9 million, or 1.04% of
loans receivable at March 31, 2002. The increased allowance level resulted
from continued loan portfolio growth in the higher-risk lending categories of
commercial and multi-family construction/permanent loans and business loans
during the period, which comprised $360.5 million, or 61.9% of the portfolio
at March 31, 2003, versus $269.6 million, or 47.5% at March 31, 2002. The
following is an analysis of the loan portfolio by major type of loans:
At March 31,
----------------------------
2003 2002
------------ ------------
First mortgage loans
1-4 family............................. $ 350,487,597 $ 493,097,739
1-4 family construction................ 28,035,560 29,958,286
Less participations.................... (137,172,801) (228,874,332)
------------ ------------
Net first mortgage loans............ 241,350,356 294,181,693
Construction and land development....... 66,111,738 55,746,760
Residential commercial real estate...... 56,929,901 28,603,971
Non-residential commercial real estate.. 182,157,758 169,696,803
Commercial loans........................ 54,132,254 37,844,119
Home equity secured..................... 22,729,371 18,873,309
Other consumer loans.................... 6,886,950 5,263,284
------------ ------------
Subtotal............................... 388,947,972 316,028,246
------------ ------------
Subtotal............................... 630,298,328 610,209,939
------------ ------------
Less:
Undisbursed loan proceeds.............. (34,678,121) (30,406,272)
Deferred loan fees..................... (4,844,929) (5,612,704)
Allowance for loan losses.............. (8,506,133) (5,887,482)
------------ ------------
$582,269,145 $568,303,481
============ ============
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 Bank considers these
increased provisions to be appropriate, due to the changing portfolio mix and
the uncertain regional economic environment. Northwest Washington's economy
has been adversely affected by a number of factors, including but not limited
to slowdowns in the aerospace, technology, and telecommunications industries.
As of March 31, 2003, there were nine loans in the Bank's portfolio over
90 days delinquent and two loans on non accrual status. At March 31, 2003
total non-performing loans were $591,966. Real estate owned at March 31, 2003
totaled $1,072,341. Total non-performing assets represented $1,664,380, or
..20% of total assets at March 31, 2003 compared to $957,774 or .12% of total
assets at March 31, 2002.
17
As of March 31,
----------------------------
2003 2002
------------ ------------
Non-Performing Assets
Accruing loans 90 days past due.......... $ 349,515 $ 618,345
Non-accrual loans........................ 242,451 --
------------ ------------
Total non-performing loans............... 591,966 618,345
Total non-performing loans/net loans..... 0.10% 0.11%
Real estate owned........................ 1,072,341 339,429
------------ ------------
Total non-performing assets.............. 1,664,307 957,774
------------ ------------
Total non-performing assets/total assets. 0.20% 0.12%
Noninterest Income. Noninterest income in fiscal 2003 was $7,408,364, an
increase of 60.56% from fiscal 2002 of $4,614,195, compared to $2,950,714 in
fiscal 2001. The primary reason for the increase in fiscal 2003 was due to
the increase in the net gain/(loss) on the sales of loans servicing released
to $2,685,251 from $1,554,853 in fiscal 2002. The recent low mortgage rate
environment was the primary reason for this increase over the prior year. In
February 2001, the Bank began selling many of its new long-term fixed rate
mortgages into the secondary market on a servicing released basis.
Separately, the net gain/loss on the sale of loans on a servicing retained
basis (loans sold from the Bank's portfolio) showed a gain of $100,413 during
the year, compared to a loss of $252,984 in the comparable period one year
ago. When the Bank sells loans, the gains or losses related to the loan
balances and the prices received in the secondary market are reflected as
noninterest income.
The net gain or loss on sales of investment securities decreased 75.04%
to $62,258 in fiscal 2003 from $249,393 in fiscal 2002 and from $379,017 in
fiscal 2001. The gains in these periods were due primarily to the sale of
selected common stocks and mortgage backed securities from the Bank's AFS
investment portfolio. Other non-interest income increased 242.77% to
$1,828,618 in fiscal 2003 from $533,476 in fiscal 2002 and $746,964 in fiscal
2001. The primary reason for the increase in fiscal 2003 was the recognition
of income related to approximately $10.0 million in bank-owned life insurance
which was acquired in late March and early April 2002. Also contributing to
the increase in fiscal 2003 was the recognition of approximately $469,000 in
commercial loan origination fees.
Noninterest Expense. Noninterest expense in fiscal 2003 increased to
$17,345,959, a 16.49% increase from fiscal 2002 of $14,890,908, compared to
fiscal 2001 of $13,756,271. Compensation and employee benefits increased
19.19% in fiscal 2003 to $9,359,463 from $7,852,528 in fiscal 2002, compared
to $7,303,373 in fiscal 2001. The increase in compensation and employee
benefits during fiscal 2003 was 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, along with additional
staff for the Lynnwood office. The increase in compensation and employee
benefits during fiscal 2002 was primarily due, to the overall growth in
employment at the Bank.
Building occupancy expense was $2,335,481 in fiscal 2003, a slight
increase from $2,324,248 in fiscal 2002, compared to $2,300,210 in fiscal
2001.
Other noninterest expenses increased 34.42% to $4,055,430 in fiscal 2003
from $3,016,851 in fiscal 002, compared to $2,658,918 in fiscal 2001. The
increases in fiscal 2003 and 2002 were primarily due to the overall growth of
the Bank and a decreasing mortgage servicing portfolio as a result of the
increased refinance activity due to the low rate environment which results in
increased amortization of the associated mortgage servicing asset. Also
contributing the increase in fiscal 2003 was the recognition of approximately
$165,000 in Other Real Estate Owned expenses/losses.
Data processing expenses decreased in fiscal 2003 to $837,983 from
$969,739, compared to $914,467 in fiscal 2001. The decline in fiscal 2003 was
primarily due to improved pricing from the Bank's data processor. The
increase in fiscal 2002 was primarily due to the overall growth of the Bank.
18
Advertising and marketing expenses increased 4.13% to $757,602 in fiscal
2003 from $727,542 in fiscal 2002 compared to $579,303 in fiscal 2001. The
increases in fiscal 2003 and 2002 were due primarily to the Bank's additional
marketing efforts to communicate its expanded commercial product lines and
services, the transition to a new advertising and marketing agency, and the
development of a new brand strategy for the Bank.
Provisions for Income Tax. Income tax expense increased to $5,950,212 in
fiscal 2003, from $5,129,947 in fiscal 2002, compared to $4,201,964 in fiscal
2001. The Bank's effective tax rate was approximately 34% in each of the past
three fiscal years.
Net Income. Net income of $12,139,871 for fiscal 2003 represents a
20.75% increase from net income of $10,053,957 for fiscal 2002, compared to
net income of $8,270,399 in fiscal 2001. Basic earnings per share for 2003 is
$1.14 on weighted average shares of 10,674,506 compared to basic earnings per
share of $.92 on weighted average shares of 10,921,233 in fiscal 2002, and
basic earnings per share of $.72 on weighted average shares of 11,441,342 in
fiscal 2001.
Yields Earned and Rates Paid
- ----------------------------
The Bank's pre-tax earnings depend primarily on its net interest income,
the difference between the income it receives on its 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.
19
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,
------------ ---------------------------------------------------------------------------
2003 2003 2002 2001
------------ ------------------------ ------------------------- ------------------------
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)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Interest-
earning assets:
Loans re-
ceivable (1). $582,269 7.69% $573,814 $44,157 7.69% $576,406 $47,352 8.21% $594,181 $49,362 8.31%
Investment
securi-
ties (2)..... 133,144 3.39 122,313 4,139 3.39 87,634 3,412 3.89 30,642 2,208 7.20
Mortgage-
backed
securities... 39,934 5.35 36,115 1,933 5.35 37,970 2,327 6.13 64,235 4,267 6.64
-------- ---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest-
earning
assets....... 755,347 6.86 732,242 50,229 6.86 702,010 53,091 7.56 689,058 55,837 8.10
Interest-bearing
liabilities:
Deposits...... 646,722 2.79 633,796 17,673 2.79 604,607 24,996 4.13 573,509 29,221 5.10
Borrowings.... 53,763 4.67 38,276 1,788 4.67 27,131 1,544 5.69 44,817 3,018 6.73
-------- ---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest-
bearing
liabilities.. 700,485 2.90 672,072 19,461 2.90 631,738 26,540 4.20 618,326 33,239 5.21
------- ------- --------
Net interest
income........ $30,768 $26,551 $23,598
======= ======= =======
Interest rate
spread........ 3.96% 3.36% 2.89%
==== ==== ====
Net interest
margin........ 4.20% 3.78% 3.42%
==== ==== ====
Ratio of
average inter-
est-earning
assets to
average inter-
est-bearing
liabilities... 108.95% 111.12% 111.44%
====== ====== ======
- -------------
(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.
20
Rate/Volume Analysis
- --------------------
The table below sets forth certain information regarding changes in interest income and interest
expense for the Bank 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,
---------------------------------------------------------------------------
2003 vs. 2002 2002 vs. 2001
------------------------------------ ----------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------------------ ----------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ---- ------ ----- ------ ---- ------ -----
(In thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c>
Interest income:
Interest and fees on loans.. $ (212) $(2,995) $ 13 $(3,194) $(1,446) $ (581) $ 17 $(2,010)
Investment securities and
other interest-bearing
securities................ 1,521 (943) (246) 332 2,088 (2,133) (691) (736)
------ ------- ----- ------- ------ ------- ------ -------
Total interest-earning
assets.................... $1,309 $(3,938) $(233) $(2,862) $ 642 $(2,714) $ (674) (2,746)
====== ======= ===== ======= ====== ======= ====== =======
Interest expense:
Deposit accounts............ $1,211 $(8,141) $(393) $(7,323) $1,566 $(5,493) $ (298) $(4,225)
Borrowings.................. 634 (277) (113) 244 (1,191) (467) 184 (1,474)
------ ------- ----- ------- ------ ------- ------ -------
Total interest-bearing
liabilities............... $1,845 $(8,418) $(506) $(7,079) $ 375 $(5,960) $ (114) $(5,699)
====== ======= ===== ======= ====== ======= ====== =======
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, 2003, the Bank had liquid assets
(cash and marketable securities with maturities of one year or less) with a
book value of $96,689,205.
As of March 31, 2003, the total book value of investments and
mortgage-backed securities was $106,509,636 compared to a market value of
$115,867,756 with an unrealized gain of $9,358,120. As of March 31, 2002 the
total book value of investments and mortgage-backed securities was
$74,850,129, compared to a market value of $81,336,830 with an unrealized gain
of $6,486,701. The Bank 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,
the Bank'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 Bank'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 Bank's options include, but are
not necessarily limited to: 1) selling additional loans in the secondary
market; 2) entering into reverse repurchase agreements; 3) borrowing from the
FHLB of Seattle; 4) accepting additional jumbo and/or public funds deposits;
or 5) accessing the discount window of the Federal Reserve Bank of San
Francisco.
Shareholders' equity as of March 31, 2003 was $106,243,518, or 12.96% of
assets, compared to $100,599,591, or 13.03% of assets at March 31, 2002. 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, 2003
21
was 18.70%, compared to 20.26% as of March 31, 2002. These figures are well
above the well-capitalized minimum of 10% set by the FDIC.
The Corporation has been in various buy-back programs since August 1996.
At its October 24, 2000 meeting, the Board of Directors authorized the
repurchase of up to 10% (approximately 1,121,250 shares, as restated) of the
Corporation's outstanding Common Stock over a 24 month period. In total, the
Corporation repurchased 769,059 shares under this plan at an average price of
$9.88.
At its October 22, 2002 meeting, the Board of Directors authorized it's
fourth repurchase plan, allowing the repurchase of up to 10% (approximately
1,065,000 shares) of the Corporation's outstanding Common Stock over a 12
month period. During the year ended March 31, 2003, the Corporation
repurchased 195,700 shares of its Common Stock under this plan, at an average
price of $14.16. Repurchases in fiscal 2003, under both plans, totaled
410,350 shares, at an average price of $12.84 per share.
Management intends to continue its stock buy-back programs from time to
time as long as repurchasing the stock is perceived to contribute to the
overall growth of shareholder value. The number of shares of stock that will
be repurchased and the price that will be paid is the result of many factors,
several of which are outside of the control of the Corporation. The primary
factors, however, are market and economic factors such as the price at which
the stock is trading in the market, the number of shares available in the
market; the attractiveness of other investment alternatives in terms of the
rate of return and risk involved in the investment; the ability to increase
the value and/or earnings per share of the remaining outstanding shares, and
the Bank's 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 Bank's capital
or liquidity position.
Quantitative and Qualitative Disclosures About Market Risk
- ----------------------------------------------------------
The Bank continues to be exposed to interest rate risk. Currently, the
Bank's assets and liabilities are not materially exposed to foreign currency
or commodity price risk. At March 31, 2003, the Bank had no off-balance sheet
derivative financial instruments, nor did it have a trading portfolio of
investments.
In fiscal 2003, the Bank 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
Bank's major balance sheet components, and attempts to estimate the changes to
the Bank's income statement and economic value of equity, under a variety of
interest rate change scenarios. The figures contained in the table presented
below, in the Quantitative Disclosures About Market Risk section, were derived
from this model. While numerous assumptions go into this modeling, and undue
reliance should not be placed on the specific results, management believes
that this improved modeling will enhance its interest rate risk management
efforts.
In years prior to fiscal 2002, the Bank analyzed its interest rate
sensitivity using GAP analysis. The interest rate GAP is defined as the
difference between the amount of interest-earning assets maturing or repricing
within a specific time period, and the interest-bearing liabilities maturing
or repricing within that same time period. A GAP is considered positive when
the amount of interest rate sensitive assets exceeds the amount of interest
rate liabilities during the same period. Banks with a positive GAP are
considered "Asset Sensitive". A GAP is considered negative when the amount of
interest sensitive liabilities exceeds the amount of interest sensitive
assets. Banks with a negative GAP are considered "Liability Sensitive".
Regardless of the method used (the more sophisticated model being used
currently, or the GAP analysis performed in prior years) the Bank's balance
sheet has historically been considered liability sensitive, due to the
assumption that its liabilities (primarily comprised of liquid deposit
accounts and certificates of deposit) would reprice more rapidly than its
assets (which are primarily longer term loans). For example, in a rising rate
environment, the Bank's cost of deposits should rise more rapidly than its
yield on its loans, as these liabilities reprice more rapidly than the Bank's
assets. The result to the Bank's operation in a rising rate environment
should be a compression of its net
22
interest margin. Conversely, in a falling rate environment (which was the
case for fiscal 2003), the Bank's liabilities should re-price more rapidly
than its assets, resulting in an improvement in its net interest margin.
Other factors, such as prepayments on mortgages and investments, the interest
rate sensitivity of deposits, the overall level of interest rates, and general
economic conditions can also have significant effects on the Bank's
performance in a changing interest rate environment. For example, at the end
of fiscal 2003, interest rates were at historically low levels. As a result,
the Bank's liability rates already reflect the lower rate environment.
Therefore, further declines in rates would not necessarily result in improved
profitability for the Bank.
In addition to changes in the directions of interest rates, the Bank's
long term performance is likely to be affected significantly by the shape and
magnitude of the slope of the yield curve. The yield curve is a graphical
representation of the relationship between short and long term interest rates.
As mentioned above, the majority of the Bank's liabilities are in the form of
liquid deposit accounts and certificates of deposit, most of which reprice or
mature within one year. As such, the rates paid on these liabilities are
influenced primarily by rates at the short end of the yield curve. The Bank's
composition of assets, however, is more heavily weighted in longer term loans,
which are generally affected more by the rates further out on the yield curve.
Therefore, all else being equal, the Bank should generally be more profitable
in the long run when there is a positive slope in the yield curve. The Bank's
excellent asset quality, low efficiency ratio, and healthy capital to assets
ratio have allowed the Bank to continue to operate profitably, despite a
variety of yield curve environments.
In fiscal 2003, the Bank succeeded in further diversifying its balance
sheet by adding variable rate loans, shorter term fixed rate loans, and relied
less on certificates of deposits for its funding needs. As a result of the
Bank's shift in focus to a community commercial bank, the Bank's balance sheet
has become significantly less liability sensitive. For example, with the
level of interest rates at March 31, 2003, and the associated prepayment
assumptions in the low-rate environment, interest rate risk modeling predicts
moderate improvement in the Bank's performance in a slightly 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 positive long-term effect on the
Bank's performance.
Quantitative Disclosures About Market Risk. The table below represents
the balances of the Bank's financial instruments at March 31, 2003. 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.
Average Within 1 Year to 2 Years 3 Years Beyond Fair Value
Yield 1 Year 2 Years to 3 Years to 5 Years 5 Years Total Total
----- ------ ------- ---------- ---------- ------- ----- -----
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c>
Interest-Sensitive Assets:
Loans receivable......... 7.69% $291,371 $129,495 $75,601 $62,069 $23,733 $582,269 $590,992
Mortgage-backed
securities............. 5.35 23,133 7,717 5,481 1,734 1,869 39,934 40,905
Investments and other
interest-earning assets. 3.39 79,416 15,531 21,185 14,455 2,557 133,144 141,531
Interest-Sensitive
Liabilities:
Checking accounts........ 0.60 6,616 11,724 11,724 18,330 45,827 94,221 94,221
Money market/
ultimate accounts....... 1.75 75,484 6,290 6,290 10,783 26,958 125,805 125,805
Savings accounts......... 1.19 7,691 3,846 3,846 6,592 16,480 38,455 38,455
Certificates of deposit.. 3.73 246,358 60,826 25,292 55,765 -- 388,241 396,850
Other borrowings......... 4.67 8,263 9,000 12,000 24,500 -- 53,763 55,721
(table continued on following page)
23
Average Within 1 Year to 2 Years 3 Years Beyond Fair Value
Yield 1 Year 2 Years to 3 Years to 5 Years 5 Years Total Total
----- ------ ------- ---------- ---------- ------- ----- -----
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c>
Off-Balance Sheet Items:
Commitments to
extend credit.......... 5.44 6,822 -- -- -- -- 6,822 6,822
Unused lines of credit... 6.14 52,056 -- -- -- -- 52,056 52,056
Credit card arrangements. 11.66 7,385 -- -- -- -- 7,385 7,385
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.
SHAREHOLDER PROPOSALS
---------------------
In order to be eligible for inclusion in the proxy solicitation materials
of the Corporation for next year's Annual Meeting of Shareholders, any
shareholder proposal to take action at such meeting must be received at the
Corporation's main office at 1500 Cornwall Avenue, Bellingham, Washington, no
later than February 19, 2004. Any such proposals shall be subject to the
requirements of the proxy solicitation rules adopted under the Exchange Act.
BY ORDER OF THE BOARD OF DIRECTORS
/s/RICHARD P. JACOBSON
RICHARD P. JACOBSON
SECRETARY
Bellingham, Washington
June 18, 2003
A COPY OF THE ANNUAL REPORT ON FORM 10-K AS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION WILL BE FURNISHED WITHOUT CHARGE TO SHAREHOLDERS OF RECORD
AS OF JUNE 6, 2003, UPON WRITTEN REQUEST TO RICHARD P. JACOBSON, SECRETARY,
HORIZON FINANCIAL CORP., 1500 CORNWALL AVENUE, BELLINGHAM, WASHINGTON 98225.
24
Horizon Financial Corp.
Independent Auditor's Report
and
Consolidated Financial Statements
March 31, 2003, 2002 and 2001
MOSS-ADAMS LLP
HORIZON FINANCIAL CORP.
Table of Contents
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Page
Independent Auditor's Report........................................... 1
Consolidated Financial Statements
Statement of Financial Position................................... 2
Statement of Income............................................... 3
Statement of Stockholders' Equity................................. 4
Statement of Cash Flows........................................... 5
Notes to Financial Statements..................................... 6-27
MOSS-ADAMS LLP
- -----------------------------------------------------------------------------
CERTIFIED PUBLIC ACCOUNTANTS
Independent Auditor's Report
To the Stockholders and Directors
Horizon Financial Corp.
We have audited the accompanying consolidated statement of financial position
of Horizon Financial Corp. and Subsidiary as of March 31, 2003 and 2002, and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended March 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Horizon
Financial Corp. and Subsidiary as of March 31, 2003 and 2002, and the results
of their operations and cash flows for each of the three years in the period
ended March 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
/s/Moss Adams LLP
Bellingham, Washington
April 25, 2003
1
HORIZON FINANCIAL CORP.
Consolidated Statement of Financial Position
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Assets
2003 2002
------------- -------------
Cash and cash equivalents $ 15,083,505 $ 14,187,040
Interest-bearing deposits 59,929,418 69,775,000
Investment securities
Available-for-sale (amortized cost 2003:
$66,206,662; 2002: $40,617,563) 74,560,801 46,373,554
Held-to-maturity (estimated fair value 2003:
$402,020; 2002: $373,792) 369,292 369,140
Mortgage-backed securities
Available-for-sale (amortized cost 2003:
$37,140,593; 2002: $29,453,222) 37,921,192 29,987,703
Held-to-maturity (estimated fair value 2003:
$2,983,743; 2002: $4,601,781) 2,793,089 4,410,204
Federal Home Loan Bank Stock 6,638,500 6,243,300
Loans receivable, net of allowance for loan
losses of $8,506,133 in 2003 and $5,887,482
in 2002 582,269,145 568,303,481
Loans held for sale 2,838,300 3,295,900
Accrued interest and dividends receivable 4,620,466 4,495,360
Bank premises and equipment, net 15,934,254 15,195,049
Real estate owned 1,072,341 289,429
Other assets 15,841,571 9,137,746
------------- -------------
TOTAL ASSETS $ 819,871,874 $ 772,062,906
============= =============
Liabilities and Stockholders' Equity
Deposits $ 646,722,160 $ 628,782,470
Accounts payable and other liabilities 8,048,477 7,955,100
Other borrowed funds 53,762,740 29,120,729
Advances by borrowers for taxes and insurance 986,702 1,439,124
Income tax currently payable 906,003 513,509
Net deferred income tax liabilities 1,531,504 2,071,613
Deferred compensation 1,670,770 1,580,770
------------- -------------
Total liabilities 713,628,356 671,463,315
------------- -------------
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; 10,550,113 and 8,607,117
issued and outstanding, respectively 10,550,113 8,607,117
Additional paid-in capital 57,352,824 60,428,238
Retained earnings 32,527,963 27,700,939
Unearned ESOP shares (216,309) (288,413)
Accumulated other comprehensive income 6,028,927 4,151,710
------------- -------------
Total stockholders' equity 106,243,518 100,599,591
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 819,871,874 $ 772,062,906
============= =============
See accompanying notes to these financial statements. 2
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Consolidated Statement of Income
Years Ended March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
2003 2002 2001
------------ ------------ ------------
INTEREST INCOME
Interest on loans $ 44,157,420 $ 47,351,811 $ 49,361,792
Investment and mortgage-backed
securities
Taxable interest 5,336,638 4,991,974 5,855,320
Nontaxable interest income 37,855 46,168 54,416
Dividends 696,866 700,875 565,617
------------ ------------ ------------
Total interest income 50,228,779 53,090,828 55,837,145
------------ ------------ ------------
INTEREST EXPENSE
Interest on deposits 17,672,959 24,996,112 29,221,019
Interest on other borrowings 1,788,142 1,544,457 3,018,206
------------ ------------ ------------
Total interest expense 19,461,101 26,540,569 32,239,225
------------ ------------ ------------
Net interest income 30,767,678 26,550,259 23,597,920
PROVISION FOR LOAN LOSSES 2,740,000 1,089,642 320,000
------------ ------------ ------------
Net interest income after
provision for loan losses 28,027,678 25,460,617 23,277,920
------------ ------------ ------------
NONINTEREST INCOME
Service fees 2,731,824 2,529,457 2,076,421
Other 1,828,618 533,476 746,964
Net gain (loss) on sales of
loans - servicing retained 100,413 (252,984) (251,688)
Net gain (loss) on sales of
loans - servicing released 2,685,251 1,554,853 -
Net gain on sale of investment
securities 62,258 249,393 379,017
------------ ------------ ------------
Total noninterest income 7,408,364 4,614,195 2,950,714
------------ ------------ ------------
NONINTEREST EXPENSE
Compensation and employee
benefits 9,359,463 7,852,528 7,303,373
Building occupancy 2,335,481 2,324,248 2,300,210
Other expenses 4,055,430 3,016,851 2,658,918
Data processing 837,983 969,739 914,467
Advertising 757,602 727,542 579,303
------------ ------------ ------------
Total noninterest expense 17,345,959 14,890,908 13,756,271
------------ ------------ ------------
INCOME BEFORE PROVISION FOR
INCOME TAX 18,090,083 15,183,904 12,472,363
PROVISION FOR INCOME TAX
Current 7,458,212 5,866,947 4,526,964
Deferred (1,508,000) (737,000) (325,000)
------------ ------------ ------------
Total provision for
income tax 5,950,212 5,129,947 4,201,964
------------ ------------ ------------
NET INCOME $ 12,139,871 $ 10,053,957 $ 8,270,399
============ ============ ============
BASIC EARNINGS PER SHARE $ 1.14 $ .92 $ .72
====== ====== ======
DILUTED EARNINGS PER SHARE $ 1.12 $ .91 $ .72
====== ====== ======
See accompanying notes to these financial statements. 3
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Consolidated Statement of Stockholders' Equity
Years Ended March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------------------------------------
Common Stock Accumulated
------------------------ Additional Unearned Other
Number of At Par Paid-In Retained ESOP Comprehensive
Shares Value Capital Earnings Shares Income (Loss)
---------- ----------- ------------ ------------ --------- -----------
<s> <c> <c> <c> <c> <c> <c>
BALANCE, March 31, 2000 8,642,571 $ 8,642,571 $ 57,372,024 $ 33,325,068 $ (432,621) $ 718,759
Comprehensive income
Net income - - - 8,270,399 - -
Other comprehensive income
Change in unrealized
gains on available-for-
sale securities, net
taxes of $1,681,374 - - - - - 3,263,844
Total other comprehensive
income - - - - - -
Comprehensive income - - - - - -
Recognition of ESOP shares
released - - - - 72,104 -
Cash dividends on common
stock at $.48 per share - - - (3,785,761) - -
Stock options exercised 23,453 23,453 138,433 - - -
15% stock dividend 1,155,814 1,155,814 11,587,035 (12,742,849) - -
Treasury stock purchased - - - - - -
Retirement of treasury
stock (960,600) (960,600) (6,717,476) (2,020,840) - -
---------- ------------ ----------- ------------ ---------- ----------
BALANCE, March 31, 2001 8,861,238 8,861,238 62,380,016 23,046,017 (360,517) 3,982,603
Comprehensive income
Net income - - - 10,053,957 - -
Other comprehensive income
Change in unrealized gains
on available-for-sale
securities, net taxes of
$87,116 - - - - - 169,107
Total other comprehensive
income - - - - - -
Comprehensive income - - - - - -
Recognition of ESOP shares
released - - - - 72,104 -
Cash dividends on common
stock at $.48 per share - - - (4,172,135) - -
Dividend reinvestment plan 16,879 16,879 190,371 - - -
Stock options exercised 57,288 57,288 291,998 - - -
Stock dividend - fractional
shares adjustment (336) (336) (3,368) 3,704 - -
Treasury stock purchased - - - - - -
Retirement of treasury
stock (327,952) (327,952) (2,430,779) (1,230,604) - -
---------- ------------ ----------- ------------ ---------- ----------
BALANCE, March 31, 2002 8,607,117 8,607,117 60,428,238 27,700,939 (288,413) 4,151,710
Comprehensive income
Net income - - - 12,139,871 - -
Other comprehensive income
Change in unrealized gains
on available-for-sale
securities, net taxes
of $967,051 - - - - - 1,877,217
Total other comprehensive
income - - - - - -
Comprehensive income - - - - - -
Recognition of ESOP shares
released - - - - 72,104 -
Cash dividends on common
stock at $.45 per share - - - (4,789,101) - -
Dividend reinvestment plan 43,536 43,536 522,227 - - -
Stock options exercised 141,670 141,670 914,187 - - -
25% stock split 2,138,190 2,138,190 (2,138,190) - - -
Cash paid for fractional
shares - - - (7,425) - -
Treasury stock purchased - - - - - -
Retirement of treasury
stock (380,400) (380,400) (2,373,638) (2,516,321) - -
---------- ------------ ----------- ------------ ---------- ----------
BALANCE, March 31, 2003 10,550,113 $ 10,550,113 $57,352,824 $ 32,527,963 $ (216,309) $6,028,927
========== ============ =========== ============ ========== ==========
Treasury Total
Stock Stockholders' Comprehensive
at Cost Equity Income
----------- ------------- ------------
<s> <c> <c> <c>
BALANCE, March 31, 2000 $(3,690,810) $ 95,934,991
Comprehensive income
Net income - 8,270,399 $ 8,270,399
Other comprehensive income
Change in unrealized
gains on available-for-
sale securities, net
taxes of $1,681,374 - 3,263,844 3,263,844
------------
Total other comprehensive
income - - 3,263,844
------------
Comprehensive income - - $ 11,534,243
============
Recognition of ESOP shares
released - 72,104
Cash dividends on common
stock at $.48 per share - (3,785,761)
Stock options exercised - 161,886
15% stock dividend - -
Treasury stock purchased (6,008,106) (6,008,106)
Retirement of treasury stock 9,698,916 -
----------- ------------
BALANCE, March 31, 2001 - 97,909,357
Comprehensive income
Net income - 10,053,957 $ 10,053,957
Other comprehensive income
Change in unrealized gains
on available-for-sale
securities, net taxes of
$87,116 - 169,107 169,107
------------
Total other comprehensive
income - - 169,107
------------
Comprehensive income - - $ 10,223,064
============
Recognition of ESOP shares
released - 72,104
Cash dividends on common
stock at $.48 per share - (4,172,135)
Dividend reinvestment plan - 207,250
Stock options exercised - 349,286
Stock dividend - fractional
shares adjustment - -
Treasury stock purchased (3,989,335) (3,989,335)
Retirement of treasury
stock 3,989,335 -
----------- ------------
BALANCE, March 31, 2002 - 100,599,591
Comprehensive income
Net income - 12,139,871 $ 12,139,871
Other comprehensive income
Change in unrealized gains
on available-for-sale
securities, net taxes
of $967,051 - 1,877,217 1,877,217
------------
Total other comprehensive
income - - 1,877,217
------------
Comprehensive income - - $ 14,017,088
============
Recognition of ESOP shares
released -
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
=========== ============
See accompanying notes to these financial statements. 4
- -----------------------------------------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Consolidated Statement of Cash Flows
Years Ended March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents
2003 2002 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 12,139,871 $ 10,053,957 $ 8,270,399
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation 1,000,314 1,112,467 1,201,520
Amortization and deferrals, net 771,900 1,128,744 652,209
Stock dividends - Federal Home Loan
Bank stock (395,200) (411,300) (359,900)
Provision for loan losses 2,740,000 1,089,642 320,000
Provision for deferred income tax (1,507,160) (737,000) (325,000)
Changes in assets and liabilities
Interest and dividends receivable (125,106) 128,554 (231,953)
Interest payable (27,533) 6,343 (19,778)
Federal income tax (receivable)
payable 392,494 331,947 497,890
Net change in loans held for sale 457,600 (913,675) (2,382,225)
Other assets (6,703,825) (5,121,933) (284,152)
Other liabilities (422,065) 787,060 (2,273,337)
------------ ------------ ------------
Net cash flows from operating
activities 8,321,290 7,454,806 5,065,673
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in interest-bearing
deposits, net 9,845,582 (57,214,988) (8,599,490)
Purchases of investment securities -
available-for-sale (30,941,880) (27,723,932) (15,369,787)
Proceeds from sales and maturities
of investment securities -
available-for-sale 5,352,629 2,972,914 10,438,917
Proceeds from maturities of
investment securities - held-to-
maturity - - 499,776
Purchases of mortgage-backed
securities - available-for-sale (18,285,779) (9,812,336) (2,095,614)
Proceeds from sales and maturities
of mortgage-backed securities -
available-for-sale 10,598,409 27,336,684 29,796,026
Proceeds from maturities of
mortgage-backed securities -
held-to-maturity 1,617,115 2,120,006 1,718,917
Purchase of Federal Home Loan
Bank stock - - (217,900)
Net change in loans (18,857,731) (26,398,362) (30,492,023)
Purchases of bank premises
and equipment (1,739,519) (1,092,997) (223,885)
Net change in other real
estate owned 669,359 244,799 412,996
------------ ------------ ------------
Net cash flows from
investing activities (41,741,815) (36,771,488) (14,132,067)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 17,939,690 32,868,803 31,586,582
Advances from securities sold under
agreements to repurchase - - 30,071,000
Repayments of securities sold under
agreements to repurchase - (5,938,000) (41,986,000)
Advances from other borrowed funds 24,642,011 22,120,729 81,000,000
Repayments of other borrowed funds - (10,000,000) (86,000,000)
Common stock issued, net 1,132,286 363,918 161,886
Cash dividends paid (4,126,638) (3,869,999) (3,854,417)
Treasury stock purchased (5,270,359) (3,989,335) (6,008,106)
------------ ------------ ------------
Net cash flows from financing
activities 34,316,990 31,556,116 4,970,945
------------ ------------ ------------
NET CHANGE IN CASH AND CASH
EQUIVALENTS 896,465 2,239,434 (4,095,449)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 14,187,040 11,947,606 16,043,055
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 15,083,505 $ 14,187,040 $ 11,947,606
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash paid during the year for
interest $ 19,488,634 $ 26,527,133 $ 32,259,004
============ ============ ============
Cash paid during the year for
income tax $ 7,315,000 $ 5,535,000 $ 4,130,000
============ ============ ============
Noncash Investing And Financing
Transactions
Mortgage loans securitized and
exchanged for FHLMC participation
certificates $ - $ - $ 21,703,576
============ ============ ============
Property taken in settlement of
loans $ 1,452,271 $ 641,158 $ 89,528
============ ============ ============
Property sold through seller
financing $ - $ (106,930) $ -
============ ============ ============
See accompanying notes to these financial statements. 5
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations - Horizon Financial Corp. (the "Company"), through its
wholly-owned subsidiary, Horizon Bank (the "Bank"), provides a full range of
commercial and mortgage lending services to borrowers and a full range of
customer services to depositors through 15 branches 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.
A material estimate that is particularly susceptible to significant change
relates to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the estimated
losses on loans and foreclosed assets held for sale, management obtains
independent appraisals for significant properties.
All per share date included in the financial statements have been restated to
reflect the stock dividend effective May 11, 2001 and the 25% stock split
effective July 23, 2002 as well as the Company's ongoing share repurchase
activities.
Principles of Consolidation - As of March 31, 2003, 2002 and 2001, 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. is a wholly-owned subsidiary of Horizon
Bank, whose accounts are also included in the consolidation. All material
intercompany balances and transactions have been eliminated.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and
cash equivalents include cash on hand and noninterest-bearing amounts due from
banks.
Included in cash and cash equivalents are legally reserved amounts which are
required to be maintained on an average basis in the form of cash and balances
due from the Federal Reserve Bank and other banks. Reserve requirements
approximate $2,787,000 and $1,646,000 for the years ended March 31, 2003 and
2002, respectively.
The Company maintains cash balances at several banks. Accounts at each
institution are insured by the Federal Deposit Insurance Corporation up to
$100,000.
Investments in Interest-Bearing Deposits - Investments in interest-bearing
deposits consist principally of funds on deposit with the Federal Home Loan
Bank and short-term certificates of deposit with Western Washington financial
institutions.
Investments and Mortgage-Backed Securities - The Company classifies its
securities into one of three categories: (1) held-to-maturity, (2)
available-for-sale, or (3) trading. Investment securities are categorized as
held-to-maturity when the Bank has the positive intent and ability to hold
those securities to maturity. Securities which are held-to-maturity are stated
at cost, adjusted for amortization of premiums, and accretion of discounts
which are recognized as adjustments to interest income.
Investment securities categorized as available-for-sale are generally held for
investment purposes (to maturity), although unanticipated future events may
result in the sale of some securities. Available-for- sale securities are
recorded at fair value, with the net unrealized gain or loss included as other
comprehensive income within the statement of stockholders' equity, net of the
related tax effect. Realized gains or losses on dispositions are based on the
net proceeds and the adjusted carrying amount of securities sold, using the
specific identification method.
Declines in the fair value of individual held-to-maturity and
available-for-sale securities below their cost that are other than temporary
are recognized by write-downs of the individual securities to their fair
value. Such write-downs would be included in earnings as realized losses.
6
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes TO Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
Premiums and discounts are recognized in interest income using the interest
method over the period to maturity. The Company had no trading securities at
March 31, 2003 and 2002.
Noncash Investing and Financing Transactions - Noncash investing and financing
transactions consist principally of securitizing mortgage loans and exchanging
them for FHLMC participation certificates. At the time of the securitization,
the pool of loans are reclassified from the loan portfolio and are aggregated
in a participation certificate in the available-for-sale investment portfolio.
A separate mortgage servicing right is established using an estimate of fair
market value and reorganized upon securitization. The transaction does not
result in the recognition of income or expense in the income statement.
Federal Home Loan Bank Stock - The Bank's investment in Federal Home Loan Bank
(the "FHLB") stock is a restricted investment carried at par value ($100 per
share), which reasonably approximates its fair value. As a member of the FHLB
system, the Bank is required to maintain a minimum level of investment in FHLB
stock based on specific percentages of its outstanding FHLB advances. The Bank
may request redemption at par value of any stock in excess of the amount the
Bank is required to hold. Stock redemptions are at the discretion of the FHLB.
Loans Held for Sale - Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated market value in
the aggregate. Net unrealized losses are recognized through a valuation
allowance by charges to income.
Loans Receivable - Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off are
reported at their outstanding principal adjusted for any charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated loans
and unamortized premiums or discounts on purchased loans. Interest income is
accrued on the unpaid principal balance.
Loan origination fees, net of certain direct loan origination costs, are
deferred and recognized as an adjustment of the yield on the related loans,
using the interest method.
Impaired Loans and Related Income - A loan is considered impaired when
management determines that it is probable that all contractual amounts of
principal and interest will not be paid as scheduled in the loan agreement.
These loans include nonaccruing loans past due 90 days or more, loans
restructured in the current year, and other loans that management considers to
be impaired.
When a loan is placed on nonaccrual status, all interest previously accrued,
but not collected, is reversed and charged against interest income. Income on
nonaccrual loans is then recognized only when the loan is brought current, or
when, in the opinion of management, the borrower has demonstrated the ability
to resume payments of principal and interest. Interest income on restructured
loans is recognized pursuant to the terms of new loan agreements. Interest
income on other impaired loans is monitored and based upon the terms of the
underlying loan agreement. However, the recorded net investment in impaired
loans, including accrued interest, is limited to the present value of the
expected cash flows of the impaired loan, or the observable fair market value
of the loan, or the fair value of the loan's collateral.
Provision for Loan Losses - Management estimates the provision for loan losses
by evaluating known and inherent risks in the loan portfolio. These factors
include changes in the size and composition of the loan portfolio, actual loan
loss experience, current and anticipated economic conditions, detailed
analysis of individual loans for which full collectibility may not be assured,
and determination of the existence and realizable value of the collateral and
guarantees securing the loans. The allowance is based upon factors and trends
identified by future market factors beyond the Company's control, which may
result in losses or recoveries differing significantly from those provided for
in the financial statements.
The majority of the Company's loan portfolio consists of commercial loans and
single-family residential loans secured by real estate in the Whatcom, Skagit
and Snohomish County areas. Real estate prices in this market are stable at
this time. However, the ultimate collectibility of a substantial portion of
the Company's loan portfolio may be susceptible to changes in local market
conditions in the future.
7
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as an
integral part of their examination process periodically review the estimated
losses on loans. Such agencies may require the Company to recognize additional
losses based on their judgment about information available to them at the time
of their examination.
Mortgage Servicing Rights - The Company allocates its total cost in mortgage
loans between mortgage servicing rights and loans, based upon their relative
fair values, when loans are subsequently sold or securitized, with the
servicing rights retained. Fair values are generally obtained through quoted
market prices. The Company has established a valuation allowance to measure
impairment of its mortgage servicing rights. Impairment is measured based upon
the characteristics of the individual loans, including note rate, term,
underlying collateral, current market conditions and estimates of net
servicing income. The Company accounts for its recorded value, and possible
impairment of mortgage servicing rights, on a loan-by-loan basis.
The cost allocated to mortgage servicing rights is amortized in proportion to,
and over the period of, estimated net servicing income.
Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation. Major renewals or betterments are capitalized and
depreciated over their estimated useful lives. Depreciation is computed on the
straight-line method over the estimated useful lives of 35 years for buildings
and three to ten years for equipment.
Bank Owned Life Insurance - The carrying amount of Bank Owned Life Insurance
approximates its fair value. Fair value of Bank Owned Life Insurance is
estimated using the cash surrender value. The Bank owns approximately $10
million and $5 million in Bank Owned Life Insurance as of March 31, 2003 and
2002, respectively, and is included in Other Assets.
Goodwill - Goodwill was recognized in connection with the purchase of branch
assets and related liabilities. The Company performs periodic evaluations for
impairment. During the current year impairment testing was performed and
Goodwill was found not to be impaired. At March 31, 2003 and 2002, Goodwill in
the amount of $545,336 and $574,038 was included in Other Assets.
Other Real Estate Owned - Other real estate owned includes properties acquired
through foreclosure. These properties are recorded at the lower of cost or
estimated fair value. Losses arising from the acquisition of property, in full
or partial satisfaction of loans, are charged to the allowance for loan
losses.
Subsequent to the transfer to other real estate owned, these assets continue
to be recorded at the lower of cost or fair value (less estimated cost to
sell), based on periodic evaluations. Generally, legal and professional fees
associated with foreclosures are expensed as incurred. Costs incurred to
improve property prior to sale are capitalized, however, in no event are
recorded costs allowed to exceed fair value. Subsequent gains, losses, or
expenses recognized on the sale of these properties are included in
noninterest income or expense.
Income Taxes - The Company reports income and expenses using the accrual
method of accounting and files a consolidated tax return which includes its
subsidiary. Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. 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.
8
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
Financial Instruments - All financial instruments held or issued by the Bank
are held or issued for purposes other than trading. In the ordinary course of
business, the Bank enters into off-balance-sheet financial instruments
consisting of commitments to extend credit. These commitments are recorded in
the financial statements when they are funded.
Advertising Costs - The Company expenses advertising costs as they are
incurred.
Stock Options - The Company recognizes the financial effects of stock options
under the intrinsic value method in accordance with Accounting Principles
Board Opinion No. 25 Accounting for Stock Issued to Employees (APB 25).
Generally, stock options are issued at a price equal to the fair value of the
Company's stock as of the grant date.
Under APB 25, options issued in this manner do not result in the recognition
of employee compensation in the Company's financial statements. Disclosures
required by Statement of Financial Accounting Standard No. 123 Accounting for
Stock- Based Compensation, as amended are as follows.
The pro forma information recognizes, as compensation, the value of stock
options granted using an option valuation model known as the Black Scholes
model. Pro forma earnings per share amounts also reflect an adjustment for an
assumed purchase of treasury stock from proceeds deemed obtained from the
issuance of stock options. The estimated fair value for options issued in
2003, 2002 and 2001 is estimated at $64,192, $1,093, and $246,272,
respectively. The following assumptions were used to estimate the fair value
of the options:
2003 2002 2001
----- ------ ------
Risk-free interest rate 2.35% 4.438% 4.54%
Dividend yield rate 3.65% 4.130% 4.728%
Price volatility 2.457% 2.606% 3.018%
Weighted average expected life of options 3.70 yr. 3.50 yr. 3.20 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:
2003 2002 2001
----------- ----------- ----------
Net income as reported $12,139,871 $10,053,957 $8,270,399
Additional compensation for fair
value of stock options (88,462) (237,564) (282,400)
----------- ----------- ----------
Pro forma net income $12,051,409 $ 9,816,393 $7,987,999
=========== =========== ==========
Earnings per share
Basic
As reported $1.14 $ .92 $ .72
===== ===== =====
Pro forma $1.13 $ .90 $ .70
===== ===== =====
Diluted
As reported $1.12 $ .91 $ .72
===== ===== =====
Pro forma $1.11 $ .89 $ .70
===== ===== =====
The remaining unrecognized compensation for fair value of stock options was
$48,144, $547 and $61,568 as of March 31, 2003, 2002 and 2001, respectively.
9
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued)
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.
New Accounting Pronouncements - In November 2002, the FASB issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. The
Interpretation elaborates on the disclosures to be made by sellers or
guarantors of products and services, as well as those entities guaranteeing
the financial performance of others. The Interpretation further clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the obligations it has undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of the Interpretation
are effective on a prospective basis to guarantees issued or modified after
December 31, 2002, and the disclosure requirements are effective for financial
statements of periods ending after December 15, 2002. The Company believes
that its disclosures with regards to these matters are adequate as of March
31, 2003.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. The interpretation explains how to identify
variable interest entities and how an enterprise assesses its interest in a
variable interest entity to decide whether to consolidate that entity. This
interpretation requires existing unconsolidated variable interest entities to
be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. Variable interest entities
that effectively disperse risks will not be consolidated unless a single party
holds an interest or combination of interest that effectively recombines risks
that were previously dispersed. This interpretation applies immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date.
It applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. Implementation of this
statement did not result in a material impact on its financial position or
results of operations.
In April of 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB No. 133, Accounting for Derivative Instruments
and Hedging Activities. The statement is effective for certain contracts
entered into or modified after June 30, 2003, and for certain hedging
relationships designated after June 30, 2003. Implementation of this statement
is not expected to have an impact on the Company's financial condition or
results of operations.
Note 2 - Interest-Bearing Deposits
Interest bearing deposits consisted of the following at March 31, 2003 and
2002:
2003 2002
----------- -----------
FHLB Demand $59,629,418 $69,475,000
Certificates of deposit 300,000 300,000
----------- -----------
$59,929,418 $69,775,000
=========== ===========
The Company has funds on deposit with the Federal Home Loan Bank in Demand
account. This account acts like a savings account and earns interest based on
the daily federal funds rate. These funds are uninsured deposits held at the
Federal Home Loan Bank of Seattle. The FHLB of Seattle, a federally chartered
corporation, is one of 12 district FHLBanks, which operate under the
supervision of the Federal Housing Finance Board. The Finance Board is an
independent agency of the executive branch within the US Government which
ensures that the FHLBanks operate in a safe and sound manner, remain
adequately capitalized, and can raise funds in the capital markets.
10
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
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, 2003 and 2002,
respectively:
2003
-----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Costs Gains Losses Value
----------- ---------- ---------- -----------
Available-For-Sale Securities
State and political
subdivisions and U.S.
government agency
securities $38,820,895 $1,888,238 $ - $40,709,133
Marketable equity
securities 3,805,723 5,553,778 (130,000) 9,229,501
Mutual funds 5,000,000 10,070 - 5,010,070
Corporate debt
securities 18,580,044 1,032,053 - 19,612,097
----------- ---------- ---------- -----------
Total available-
for-sale
securities 66,206,662 8,484,139 (130,000) 74,560,801
----------- ---------- ---------- -----------
Held-To-Maturity Securities
State and political
subdivisions and
U.S. government agency
securities 369,292 32,728 - 402,020
----------- ---------- ---------- -----------
Total held-to-maturity
securities 369,292 32,728 - 402,020
----------- ---------- ---------- -----------
Total investment
securities $66,575,954 $8,516,867 $ (130,000) $74,962,821
=========== ========== ========== ===========
2002
-----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Costs Gains Losses Value
----------- ---------- ---------- -----------
Available-For-Sale Securities
State and political
subdivisions and
U.S. government agency
securities $23,586,937 $ 87,443 $ (112,234) $23,562,146
Marketable equity
securities 3,805,723 5,597,600 (105,000) 9,298,323
Mutual funds 5,000,000 - - 5,000,000
Corporate debt
securities 8,224,903 288,182 - 8,513,085
----------- ---------- ---------- -----------
Total available-for-
sale securities 40,617,563 5,973,225 (217,234) 46,373,554
----------- ---------- ---------- -----------
Held-To-Maturity Securities
State and political
subdivisions and U.S.
government agency
securities 369,140 4,652 - 373,792
----------- ---------- ---------- -----------
Total held-to-maturity
securities 369,140 4,652 - 373,792
----------- ---------- ---------- -----------
Total investment
securities $40,986,703 $5,977,877 $ (217,234) $46,747,346
=========== ========== ========== ===========
11
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 3 - Investment Securities (Continued)
The amortized cost and estimated fair value of investment securities at March
31, 2003, 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.
2003
-----------------------------------------------------
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 $ 2,091,099 $ 2,120,697 $ - $ -
Two to five years 33,880,802 35,700,197 369,292 402,020
Five to ten years 2,198,284 2,228,865 - -
Over ten years 650,710 659,374 - -
----------- ----------- -------- --------
38,820,895 40,709,133 369,292 402,020
----------- ----------- -------- --------
Corporate debt securities
One year 3,016,527 3,098,921 - -
Two to five years 14,572,942 15,413,594 - -
Over ten years 990,575 1,099,582 - -
----------- ----------- -------- --------
18,580,044 19,612,097 - -
----------- ----------- -------- --------
Mutual funds and
marketable equity
securities (liquid) 8,805,723 14,239,571 - -
----------- ----------- -------- --------
Total investment
securities $66,206,662 $74,560,801 $369,292 $402,020
=========== =========== ======== ========
Proceeds from sales of investments and gross realized gains and losses on
investment sales were as follows for the year ended March 31:
2003 2002 2001
------- ------- --------
Proceeds from sales of investments $ - $64,725 $143,675
======= ======= ========
Gross gains realized on sales of
investments $ - $64,397 $142,856
======= ======= ========
Please refer to Note 4 for information on gross gains and losses on
mortgage-backed security sales.
Information about concentrations of investments in particular industries for
marketable equity securities and corporate debt securities at March 31 consist
of the following:
2003 2002
------------------------ ------------------------
Market Market
Cost Value Cost Value
----------- ----------- ----------- -----------
Marketable equity securities
Banking $ 318,380 $ 1,636,271 $ 318,380 $ 1,410,678
Government agency stocks 3,487,343 7,593,230 3,487,343 7,887,645
----------- ----------- ----------- -----------
$ 3,805,723 $ 9,229,501 $ 3,805,723 $ 9,298,323
=========== =========== =========== ===========
Corporate debt securities
Finance companies $11,045,036 $11,650,459 $ 5,573,514 $ 5,786,569
Private utilities 2,705,224 2,853,869 1,661,196 1,714,098
Manufacturing companies 4,829,784 5,107,769 990,193 1,012,418
----------- ----------- ----------- -----------
Total investment securities $18,580,044 $19,612,097 $ 8,224,903 $ 8,513,085
=========== =========== =========== ===========
At March 31, 2003 and 2002, U.S. government agency and corporate debt
securities of $3,370,000 and $3,125,000 were pledged as collateral for
deposits of state and local government agencies and deposits for trust
accounts in excess of $100,000, as required by Washington State Law.
12
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 4 - Mortgage-Backed Securities
Mortgage-backed securities at March 31 consist of the following:
2003
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- --------- -----------
Available-for-sale
securities $37,140,593 $ 894,448 $(113,849) $37,921,192
Held-to-maturity securities 2,793,089 190,654 - 2,983,743
----------- ---------- --------- -----------
Total mortgage-backed
securities $39,933,682 $1,085,102 $(113,849) $40,904,935
=========== ========== ========= ===========
2002
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- --------- -----------
Available-for-sale
securities $29,453,222 $ 592,751 $ (58,270) $29,987,703
Held-to-maturity securities 4,410,204 191,577 - 4,601,781
----------- ---------- --------- -----------
Total mortgage-backed
securities $33,863,426 $ 784,328 $ (58,270) $34,589,484
=========== ========== ========= ===========
The amortized cost and estimated fair value of mortgage-backed securities at
March 31, 2003, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right
to prepay obligations with or without prepayment penalties.
2003
----------------------------------------------------
Available-For-Sale Held-To-Maturity
------------------------ -------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
----------- ----------- ---------- -----------
Mortgage-backed securities
One year $ 397,201 $ 399,268 $ 2,657 $ 2,810
Two to five years 11,973,560 12,100,792 187,844 200,969
Six to ten years 1,033,346 1,055,928 2,240,867 2,380,374
After ten years 23,736,486 24,365,204 361,721 399,590
----------- ----------- ---------- ----------
Total investment
securities $37,140,593 $37,921,192 $2,793,089 $2,983,743
=========== =========== ========== ==========
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 year ended
March 31:
2003 2002 2001
---------- ----------- -----------
Proceeds from sales of mortgage-backed
securities $2,403,548 $22,429,008 $28,030,581
========== =========== ===========
Gross gains realized on sales of
mortgage-backed securities $ 62,187 $ 225,104 $ 236,161
========== =========== ===========
Gross losses realized on sales of
investments $ - $ (70,108) $ -
========== =========== ===========
13
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 5 - Loans Receivable
Loans receivable (collateralized principally by properties in the Whatcom,
Skagit and Snohomish Counties of Washington State) at March 31 consist of the
following:
2003 2002
------------ ------------
First mortgage loans
1-4 Family $350,487,597 $493,097,739
1-4 Family construction 28,035,560 29,958,286
Less participating (137,172,801) (228,874,332)
------------ ------------
Net first mortgage loans 241,350,356 294,181,693
Construction and land development 66,111,738 55,746,760
Residential commercial real estate 56,929,901 28,603,971
Non-residential commercial real estate 182,157,758 169,696,803
Commercial loans 54,132,254 37,844,119
Home equity secured 22,729,371 18,873,309
Other consumer loans 6,886,950 5,263,284
------------ ------------
630,298,328 610,209,939
Less:
Undisbursed loan proceeds (34,678,121) (30,406,272)
Deferred loan fees (4,844,929) (5,612,704)
Allowance for loan losses (8,506,133) (5,887,482)
------------ ------------
$582,269,145 $568,303,481
============ ============
The Company originates both adjustable and fixed interest rate loans. At March
31, 2003, 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 $ 28,631,331 Less than one year $102,412,904
One to two years 13,321,322 One to two years 30,067,390
Two to five years 53,757,127 Two to five years 41,188,130
Five to ten years 108,384,162 Five to ten years 23,351,853
Over ten years 208,361,149 Over ten years 20,822,960
Loans serviced for others are $140,535,316 and $228,874,332, respectively, as
of March 31, 2003 and 2002.
The Bank generally receives a monthly fee of 0.25% to 0.375% per annum of the
unpaid balance of each loan. The sold loans are sold without right of recourse
to the Bank by the buyer of the loan interests in the event of default by the
borrower.
Impaired loans on a nonaccrual basis and the related interest are not material
as of March 31, 2003 and 2002.
The allowance for loan losses at March 31, and changes during the year are as
follows:
2003 2002 2001
---------- ---------- ----------
Balance, beginning of year $5,887,482 $4,976,670 $4,757,152
Provision for loan losses 2,740,000 1,089,642 320,000
Loan chargeoffs (129,406) (187,095) (101,628)
Loan recoveries 8,057 8,265 1,146
---------- ---------- ----------
Balance, end of year $8,506,133 $5,887,482 $4,976,670
========== ========== ==========
14
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 6 - Mortgage Servicing Rights
Loan costs allocated to mortgage servicing rights as of March 31, were as
follows:
2003 2002
----------- -----------
Beginning balance $ 2,129,964 $ 2,244,895
Additions for new loans 63,850 492,201
Amortization (909,671) (607,132)
----------- -----------
Ending balance 1,284,143 2,129,964
Valuation allowance for impairment
of mortgage servicing rights (668,183) (1,111,016)
----------- -----------
Balance, end of year $ 615,960 $ 1,018,948
=========== ===========
Changes in the valuation allowance for impairment of mortgage servicing was as
follows:
Beginning balance $(1,111,016) $(1,184,842)
Additions (29,090) (239,801)
Credited to income 471,923 313,627
----------- -----------
Balance, end of year $ (668,183) $(1,111,016)
=========== ===========
Note 7 - Accrued Interest and Dividends Receivable
Accrued interest and dividends receivable at March 31 is summarized as
follows:
2003 2002
----------- -----------
Investment securities $ 1,020,845 $ 588,110
Mortgage-backed securities 191,989 217,979
Loans receivable 3,237,921 3,531,629
Dividends on marketable equity securities 169,711 157,642
----------- -----------
$ 4,620,466 $ 4,495,360
=========== ===========
Note 8 - Premises and Equipment
Premises and equipment at March 31 consisted of:
2003 2002
----------- -----------
Buildings $11,952,760 $11,085,239
Equipment 8,072,921 7,077,819
----------- -----------
20,025,681 18,163,058
Accumulated depreciation (9,308,956) (8,389,657)
----------- -----------
10,716,725 9,773,401
Land 5,217,529 5,421,648
----------- -----------
Balance, end of year $15,934,254 $15,195,049
=========== ===========
15
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 9 - Deposits
A comparative summary of deposits at March 31 follows:
2003 2002
------------ ------------
Demand deposits
Savings $ 38,455,124 $ 35,262,865
Checking 66,169,430 52,336,378
Checking (noninterest-bearing) 28,052,250 22,915,124
Money market 26,426,247 26,349,597
Ultimate Money Market 99,378,323 95,316,576
------------ ------------
258,481,374 232,180,540
------------ ------------
Time certificates of deposit
Less than $100,000 258,623,337 272,739,558
Greater than or equal to $100,000 129,617,449 123,862,372
------------ ------------
388,240,786 396,601,930
------------ ------------
Total deposits $646,722,160 $628,782,470
============ ============
Time certificate of deposit maturities at March 31 are as follows:
2003
---------------------------------------
Variable Fixed
Rate Rate Total 2002
----------- ------------ ------------ ------------
Within one year $15,772,139 $222,206,999 $237,979,138 $283,934,285
One to two years 4,996,096 60,826,246 65,822,342 46,313,655
Two to three years 714,719 25,292,432 26,007,151 19,333,578
Three to four years 613,433 25,740,982 26,354,415 19,890,177
Four to five years 898,814 30,023,884 30,922,698 24,612,336
Over five years 1,155,042 - 1,155,042 2,517,899
----------- ------------ ------------ ------------
$24,150,243 $364,090,543 $388,240,786 $396,601,930
=========== ============ ============ ============
The terms of variable rate CDs allow customers to make additional deposits to
existing CDs at any time.
The weighted average nominal interest rate on all deposits at March 31, 2003
and 2002 is 2.79 percent and 4.14 percent, respectively.
Interest expense on deposits for the years ended March 31 is summarized as
follows:
2003 2002 2001
----------- ----------- -----------
Money market $ 2,212,086 $ 2,664,570 $ 2,888,813
Checking 491,383 572,826 573,139
Savings 437,912 694,646 991,817
Certificates of deposit 14,531,578 21,064,070 24,767,250
----------- ----------- -----------
Balance, end of year $17,672,959 $24,996,112 $29,221,019
=========== =========== ===========
Note 10 - Securities Sold Under Agreements to Repurchase
The Bank has from time to time sold certain securities of the U.S. Government
and its agencies and other approved investments under agreements to
repurchase. A safekeeping agent not under control of the Bank held the
securities underlying the agreements. Securities sold under agreements to
repurchase were $-0- and $-0- as of March 31, 2003 and 2002, respectively.
16
- ------------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 11 - Other Borrowed Funds
The Bank is a member of the Federal Home Loan Bank ("FHLB") of Seattle. As a
member, the Bank has a committed line of credit up to 20% of total assets,
subject to the Bank pledging sufficient collateral and maintaining the
required stock investment. Committed lines of credit agreements totaling
approximately $162.3 million and $121.2 million were available to the Bank, of
which, $52.5 million and $28 million were outstanding at March 31, 2003 and
2002, respectively. These advances bear interest ranging from 2.67% to 5.96%
and 4.26% to 5.96% per annum, respectively. Maturities for the advances are
$7,000,000 in fiscal 2004, $9,000,000 in fiscal 2005, $12,000,000 in fiscal
2006, $13,500,000 in fiscal 2007, and $11,000,000 in fiscal 2008.
The maximum outstanding and average outstanding balances and average interest
rates on advances from the FHLB were as follows for the year ended March 31:
In Thousands
------------------------------
2003 2002 2001
------- ------- -------
Maximum outstanding at any month-end $52,500 $28,000 $55,865
Average outstanding 38,276 27,131 44,817
Weighted average interest rates:
Annual 4.67% 5.69% 6.73%
==== ==== ====
End of year 4.33% 5.07% 6.14%
==== ==== ====
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 $1,262,740 and $1,120,729 outstanding as of
March 31, 2003 and 2002, respectively.
Note 12 - Income Tax
Deferred income tax results from temporary differences in the recognition of
income and expense for tax and financial statement purposes. The source of
these differences and the related tax effects for the years ended March 31 are
as follows:
2003 2002 2001
---------- --------- ---------
Deferred loan fees $ (264,000) $ 219,000 $ 64,000
Loan loss and general reserves 873,000 700,000 428,000
Deferred compensation 71,000 (3,000) 36,000
Other, net 828,000 (179,000) (203,000)
---------- --------- ---------
$1,508,000 $ 737,000 $ 325,000
========== ========= =========
17
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 12 - Income Tax (Continued)
The nature and components of the Company's net deferred tax assets
(liabilities), established at an estimated tax rate of 34.25%, are as follows
at March 31:
2003 2002
----------- -----------
Deferred Tax Assets
Deferred compensation agreements $ 572,000 $ 501,000
Financial reporting loan loss reserve not
recognized for tax purposes 2,541,000 956,000
Financial reporting accrued expenses not
recognized for tax purposes 222,000 296,000
Other deferred tax assets 188,000 -
----------- -----------
Total deferred assets 3,523,000 1,753,000
----------- -----------
Deferred Tax Liabilities
Deferred loan fees for tax purposes in excess
of amounts deferred for financial reporting
purposes (466,000) (842,000)
Tax effect of unrealized gains on available-
for-sale securities (3,106,000) (2,138,760)
FLHB stock dividends (605,000) (463,000)
Other deferred tax liabilities (877,504) (380,853)
----------- -----------
Total deferred liabilities (5,054,504) (3,824,613)
----------- -----------
Net deferred tax assets (liabilities) $(1,531,504) $(2,071,613)
=========== ===========
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:
2003 2002 2001
---------- ---------- ----------
Provision for income tax at the
statutory rate of 35 percent $6,332,000 $5,314,366 $4,365,327
Increase (decrease) in tax
resulting from:
Income taxed at lower brackets (100,000) (95,000) (100,000)
Dividends received deduction (70,000) (71,166) (48,290)
Other, net (211,788) (18,253) (15,073)
---------- ---------- ----------
Income tax provision $5,950,212 $5,129,947 $4,201,964
========== ========== ==========
Prior to 1997, the Company was allowed a bad debt deduction of 8 percent of
taxable income, subject to certain limitations. During 1997, a tax law change
eliminated this tax deduction and, in addition, requires the Company to
recapture and pay taxes on these deductions taken after fiscal year ended
March 31, 1988. The Company previously recorded deferred tax liabilities to
account for this obligation, thus retroactive effects of this law change have
not been significant. The cumulative tax-basis bad debt deduction as of March
31, 2003 and 2002 was approximately $1,067,000 and $2,135,000, respectively.
If any portion of this amount is subsequently used for purposes other than to
absorb loan losses, that portion will be subject to federal income tax at the
then prevailing tax rate.
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, 2003 and 2002, the cash
surrender values of these policies included in Other Assets aggregated
$2,411,219 and $2,241,901, respectively.
18
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 13 - Benefit Plans (Continued)
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
4.00%, 4.75%, and 5.00% in 2003, 2002 and 2001, respectively. Deferred
compensation expense amounted to $155,000, $191,298 and $172,776 in 2003, 2002
and 2001, respectively.
Profit Sharing Arrangement - The Company has a profit sharing arrangement with
employees meeting certain service requirements. Payments made to employees
pursuant to the arrangement are based upon earnings, growth in deposits and
attainment of certain corporate objectives. Costs of the arrangement were
$1,403,000, $751,488 and $483,413 for 2003, 2002 and 2001, 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 May 1999, the Company issued 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, 2003, 2002 and 2001. The ESOP shares relating to the
loans outstanding as of March 31 were as follows:
2003 2002 2001
-------- -------- --------
Number of shares
Allocated shares 56,558 47,378 38,197
Unallocated shares 27,535 36,715 45,896
-------- -------- --------
Total ESOP shares 84,093 84,093 84,093
======== ======== ========
Fair value
Unallocated shares $409,996 $371,568 $355,053
======== ======== ========
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 $360,000, $323,850 and $312,122 for the years ended March
31, 2003, 2002 and 2001, respectively.
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.
19
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 14 - Stockholders' Equity (Continued)
Quantitative measures are established by regulation to ensure capital
adequacy, require maintenance of minimum amounts and ratios (set forth in the
table below in thousands) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets, and of Tier 1 capital to average assets.
Management believes, as of March 31, 2003, that each entity meets all capital
adequacy requirements to which they are subject.
As of February 3, 2003, the most recent notification from the Bank's regulator
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- ------ -------- ------
<s> <c> <c> <c> <c> <c> <c>
As of March 31, 2003
Total Capital
(to Risk Weighted Assets)
Consolidated $109,357 18.75% $ 46,652 >8.00% $ 58,315 >10.00%
Horizon Bank $109,147 18.70% $ 46,684 >8.00% $ 58,355 >10.00%
Tier I Capital
(to Risk Weighted Assets)
Consolidated $ 99,608 17.08% $ 23,326 >4.00% $ 34,989 > 6.00%
Horizon Bank $ 99,393 17.03% $ 23,342 >4.00% $ 35,013 > 6.00%
Tier I Capital
(to Average Assets)
Consolidated $ 99,608 12.46% $ 31,979 >4.00% $ 39,973 > 5.00%
Horizon Bank $ 99,393 12.44% $ 31,954 >4.00% $ 39,943 > 5.00%
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- ------ -------- ------
<s> <c> <c> <c> <c> <c> <c>
As of March 31, 2002
Total Capital
(to Risk Weighted Assets)
Consolidated $102,508 20.27% $ 40,464 >8.00% $ 50,580 >10.00%
Horizon Bank $102,530 20.26% $ 40,478 >8.00% $ 50,598 >10.00%
Tier I Capital
(to Risk Weighted Assets)
Consolidated $ 95,772 18.93% $ 20,232 >4.00% $ 30,348 > 6.00%
Horizon Bank $ 95,794 18.93% $ 20,239 >4.00% $ 30,359 > 6.00%
Tier I Capital
(to Average Assets)
Consolidated $ 95,772 12.67% $ 30,237 >4.00% $ 37,796 > 5.00%
Horizon Bank $ 95,794 12.67% $ 30,237 >4.00% $ 37,796 > 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 percent of its capital stock and surplus, and the
total of loans to the holding company and affiliates must not exceed 20
percent of capital and surplus. Further, all such loans must be fully
collateralized.
Dividend Reinvestment Plan - As a service to its stockholders of record, the
Bank offers a Dividend Reinvestment and Stock Purchase Plan ("Reinvestment
Plan"). Under the terms of the Reinvestment Plan, dividends and optional cash
payments may be reinvested toward the purchase of additional shares of stock.
No brokerage commission or fees are charged to acquire shares through the
Reinvestment Plan.
20
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 14 - Stockholders' Equity (Continued)
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.
Stock Split - The Company's Board of Directors at its June 25, 2002 Board
meeting, announced a 25% stock split to be issued July 23, 2002 for
shareholders of record July 11, 2002.
Stock Dividend - The Company's Board of Directors at its April 24, 2001 Board
meeting, announced a 15% stock dividend to be issued June 4, 2001 for
shareholders of record May 11, 2001.
Stock Warrants - In 1992, certain key organizers of the Bank of Bellingham
received warrants for 24,000 shares of stock at an exercise price of $12.50
per share. In conjunction with the merger of Bellingham Bancorporation, the
outstanding warrants as of June 19, 1999 were converted at 2.74 shares of
Horizon for each share of Bellingham Bancorporation amounting to 37,812
shares at an exercise price of $4.56 per share. The number of shares were then
adjusted to 47,365 at an exercise price of $3.17 per share due to stock splits
and stock dividends. Warrants for 7,877 and 39,387 shares of stock were still
outstanding as of March 31, 2002 and 2001, respectively. During the fiscal
year ended March 31, 2003, 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.
Stock options outstanding also include shares issued under the 1986 Stock
Option and Incentive Plan. Options under this plan were granted at fair
market value, vest at 20 to 35 percent per year, are exercisable from one to
five years and expire after ten years. There are no additional options to be
granted under this plan.
Shares of Common Stock
------------------------ Weighted Average of
Available for Under Exercise Price of
Option/Award Plan Shares Under Plan
------------ ------- ------------------
Balance, March 31, 2001 989 661,711
Authorized - -
Granted (719) 719 $ 7.67
Exercised - (49,712) $ 3.17 - 9.22
Lapsed 25,736 (25,736) $ 3.17 - 9.22
Expired (368) -
------- -------
Balance, March 31, 2002 25,638 586,982
Authorized - -
Granted (33,000) 33,000 $ 10.66 - 14.625
Exercised - (148,652) $ 4.19 - 14.625
Lapsed 15,922 (15,922) $ 4.19 - 14.625
Expired (12) -
------- -------
Balance, March 31, 2003 8,548 455,408
======= =======
21
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 14 - Stockholders' Equity (Continued)
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 $10 422,408 5.108 years $ 7.71 348,257 $ 7.96
$10 to $15 33,000 9.372 years 11.66 - N/A
At March 31, 2003, 463,956 shares of common stock were reserved for issuance
pursuant to stock plans, options and conversions of preferred stock.
Note 15 - Earnings Per Share
The numerators and denominators of basic and diluted earnings per share are as
follows:
2003 2002 2001
----------- ----------- -----------
Net income (numerator) $12,139,871 $10,053,957 $ 8,270,399
Shares used in the calculation
(denominators)
Basic earnings per weighted
average share outstanding 10,674,506 10,921,233 11,441,342
Effect of dilutive stock options 190,463 145,822 50,723
----------- ----------- -----------
Diluted shares 10,864,969 11,067,055 11,492,065
=========== =========== ===========
Basic earnings per share $ 1.14 $ .92 $ .72
====== ===== =====
Diluted earnings per share $ 1.12 $ .91 $ .72
====== ===== =====
At March 31, 2003, 2002 and 2001, there were options to purchase 455,408,
586,982, and 661,711 shares of common stock outstanding. As of March 31, 2001,
options of 376,747 were antidilutive and therefore not included in the
computation of diluted net income per share. At March 31, 2003 and March 31,
2002, all options to purchase shares of common stock were included in the
diluted net income per share calculation.
Note 16 - Commitments And Contingencies
Employment Agreement - The Company has entered into a four-year employment
agreement with the Company's president at an amount approximating his current
level of compensation. In the event of specified termination of the
president's employment following a change in control of the Company (as
defined), the agreement provides the president with severance payments of up
to three 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 are as follows for the years ending March 31:
2004 $ 234,060
2005 201,511
2006 157,181
2007 127,209
2008 124,432
Thereafter 157,370
----------
$1,001,763
==========
22
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
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 2003, 2002 and 2001 are as follows
and were within regulatory limitations:
2003 2002 2001
------------ ----------- -----------
Balance, beginning of year $ 19,846,791 $11,935,697 $ 7,000,849
New loans or advances 16,750,744 13,753,750 10,612,418
Repayments (16,745,911) (5,842,656) (5,677,570)
------------ ----------- -----------
Balance, end of year $ 19,851,634 $19,846,791 $11,935,697
============ =========== ===========
Interest earned on loans $ 1,372,680 $ 1,095,527 $ 948,342
============ =========== ===========
Deposits from related parties totaled approximately $1,625,000 and $2,725,000
at March 31, 2003 and 2002, 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.
Note 19 - Financial Instruments
The Bank is a party to financial instruments with off-balance-sheet risk (loan
commitments) in the normal course of business to meet the financing needs of
its customers and to reduce its own exposure to fluctuations in interest
rates. Loan commitments involve, to varying degrees, elements of credit and
interest-rate risk in excess of the amount recognized in the balance sheet.
The contract amounts of those commitments reflect the extent of the Bank's
exposure to credit loss from these commitments. The Bank uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The amount of collateral
obtained, if it is deemed necessary by the Bank upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant, and
equipment; and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements,
including commercial paper, bond financing, and similar transactions. Except
for certain long-term guarantees, the majority of guarantees expire in one
year. The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers. Collateral
supporting those commitments, for which collateral is deemed necessary,
generally amounts to one hundred percent of the commitment amount at March 31,
2003.
23
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 19 - Financial Instruments (Continued)
The Bank has not been required to perform on any financial guarantees and has
not incurred any losses on its commitments in 2003, 2002 and 2001.
The following is a summary of the off-balance-sheet financial instruments or
contracts outstanding:
2003 2002
----------- -----------
Commitments to extend credit $58,878,487 $36,331,803
Credit card arrangements 7,385,414 6,896,030
Standby letters of credit 1,263,217 348,463
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.
Federal Home Loan Bank ("FHLB") Stock - FHLB Stock is carried at $100 par
value. This investment is considered restricted, as a minimum investment must
be maintained in order to obtain borrowing commitments from FHLB. The Company
may redeem its investment only at par value, which is used as the estimated
market value.
Loans Receivables - For certain homogeneous categories of loans, such as those
written to Federal Home Loan Mortgage Corporation ("FHLMC") standards, fair
value is estimated using the quoted market prices for securities backed by
similar loans, adjusted for differences in loan characteristics. For variable
rate loans that reprice frequently and with no significant change in credit
risk, fair values are based on carrying values.
Accrued Income and Expense Accounts - Due to the short-term nature of these
amounts, recorded book value is believed to approximate fair value.
Deposit Liabilities, Repurchase Agreements and Other Borrowed Funds - The fair
value of demand deposits, savings accounts, certain money market deposits, and
federal funds purchased, is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit, repurchase
agreements and other borrowed funds are estimated by discounting the estimated
future cash flows using the rates currently offered for these instruments with
similar remaining maturities.
Off-Balance-Sheet Instruments - The Company's off-balance-sheet instruments
include unfunded commitments to extend credit and borrowing facilities
available to the Company. The fair value of these instruments is not
considered practicable to estimate because of the lack of quoted market price
and the inability to estimate fair value without incurring excessive costs.
24
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 20 - Disclosures About Fair Value of Financial Instruments (Continued)
The carrying amounts and estimated fair values of the Bank's financial
instruments at March 31, 2003 and 2002 are as follows:
2003 2002
-------------------------- --------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
------------ ------------ ------------ ------------
Financial Assets
Cash and cash
equivalents $ 15,083,505 $ 15,083,505 $ 14,187,040 $ 14,187,040
Investment
securities 74,930,093 74,962,821 46,742,694 46,747,346
Mortgage-backed
securities 40,714,281 40,904,935 34,397,907 34,589,484
Interest-bearing
deposits 59,929,418 59,929,418 69,775,000 69,775,000
Federal Home Loan
Bank stock 6,638,500 6,638,500 6,243,300 6,243,300
Loans receivable 582,269,145 590,991,597 568,303,481 572,112,150
Loans held-for-sale 2,838,300 2,838,300 3,295,900 3,295,900
Accrued interest and
dividends receivable 4,620,466 4,620,466 4,495,360 4,495,360
Financial Liabilities
Demand and savings
deposits 258,481,374 258,481,374 232,180,540 232,180,540
Time deposits 388,240,786 396,849,780 396,601,930 401,745,275
Accounts payable and
other liabilities 7,761,614 7,761,614 7,640,704 7,640,704
Accrued interest
payable 286,863 286,863 314,396 314,396
Other borrowed funds 53,762,740 55,720,840 29,120,729 29,719,929
Note 21 - Parent Company (Only) Financial Information
In Thousands
------------------------------
2003 2002
--------- ---------
Condensed balance sheet at March 31:
Cash $ 458 $ 17
Investment in bank 106,029 100,622
Other assets 1,000 944
--------- ---------
$ 107,487 $ 101,583
========= =========
Other liabilities $ 1,243 $ 983
Stockholders' equity 106,244 100,600
--------- ---------
$ 107,487 $ 101,583
========= =========
25
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes to Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 21 - Parent Company (Only) Financial Information (Continued)
Condensed statement of income for the years ended March 31, 2003 and 2002:
In Thousands
-----------------------------
2003 2002 2001
------- ------- -------
Income
Cash dividends from Bank subsidiary $ 9,005 $ 7,787 $ 9,775
Interest 6 8 9
------- ------- -------
Total income 9,011 7,795 9,784
------- ------- -------
Expenses
Compensation 105 124 116
Other 330 170 268
------- ------- -------
Total expenses 435 294 384
------- ------- -------
Income before equity in undistributed
income of subsidiary and benefit
equivalent to income taxes 8,576 7,501 9,400
Benefit equivalent to income taxes 84 43 68
------- ------- -------
Income before equity in undistributed
income of subsidiary 8,660 7,544 9,468
Equity in undistributed income of subsidiary 3,480 2,510 (1,198)
------- ------- -------
Net income $12,140 $10,054 $ 8,270
======= ======= =======
2003 2002 2001
------- ------- -------
Cash flows from operating activities
Net income $12,140 $10,054 $ 8,270
Adjustments to reconcile net income to
net cash flows from operating activities
Equity in undistributed income of
subsidiary (3,480) (2,510) 1,198
Other operating activities (23) (65) (63)
------- ------- -------
Net cash flows from operating activities (3,457) 7,479 9,405
------- ------- -------
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 1,132 363 161
Dividends paid (5,271) (3,870) (3,854)
Treasury stock purchased (4,125) (3,989) (6,008)
------- ------- -------
Net cash flows from financing activities (8,264) (7,496) (9,701)
------- ------- -------
Net change in cash 441 5 (274)
Cash, beginning of year 17 12 (286)
------- ------- -------
Cash, end of year $ 458 $ 17 $ 12
======= ======= =======
26
- -----------------------------------------------------------------------------
HORIZON FINANCIAL CORP.
Notes To Financial Statements
March 31, 2003, 2002 and 2001
- -----------------------------------------------------------------------------
Note 22 - Selected Quarterly Financial Data (Unaudited)
Year Ended March 31, 2003
-----------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Interest income $12,518,449 $12,546,020 $12,787,426 $12,376,884
Interest expense 5,318,384 5,011,148 4,772,948 4,358,621
----------- ----------- ----------- -----------
Net interest income 7,200,065 7,534,872 8,014,478 8,018,263
Provision for loan
losses 300,000 350,000 1,050,000 1,040,000
Noninterest income 1,519,010 1,511,994 2,251,533 2,125,827
Noninterest expense 4,163,790 4,363,950 4,281,989 4,536,230
----------- ----------- ----------- -----------
Income before provision
for income tax 4,255,285 4,332,916 4,934,022 4,567,860
Provision for income tax 1,401,031 1,421,061 1,624,108 1,504,012
----------- ----------- ----------- -----------
Net income $ 2,854,254 $ 2,911,855 $ 3,309,914 $ 3,063,848
=========== =========== =========== ===========
Basic earnings per share
(adjusted for stock
splits and dividends) $ .27 $ .27 $ .31 $ .29
===== ===== ===== =====
Diluted earnings per share
(adjusted for stock
splits and dividends) $ .26 $ .27 $ .31 $ .28
===== ===== ===== =====
Year Ended March 31, 2002
-----------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Interest income $ 4,026,405 $13,478,400 $12,933,200 $12,652,823
Interest expense 7,752,882 7,070,286 6,021,833 5,695,568
----------- ----------- ----------- -----------
Net interest income 6,273,523 6,408,114 6,911,367 6,957,255
Provision for loan
losses 160,000 285,000 459,642 185,000
Noninterest income 859,594 1,134,932 1,411,141 1,208,528
Noninterest expense 3,527,956 3,648,770 3,806,198 3,907,984
----------- ----------- ----------- -----------
Income before provision
for income tax 3,445,161 3,609,276 4,056,668 4,072,799
Provision for income tax 1,166,076 1,218,833 1,371,204 1,373,834
----------- ----------- ----------- -----------
Net income $ 2,279,085 $ 2,390,443 $ 2,685,464 $ 2,698,965
=========== =========== =========== ===========
Basic earnings per share
(adjusted for stock
splits and dividends) $ .21 $ .21 $ .25 $ .25
===== ===== ===== =====
Diluted earnings per share
(adjusted for stock
splits and dividends) $ .20 $ .21 $ .24 $ .25
===== ===== ===== =====
27
- -----------------------------------------------------------------------------
REVOCABLE PROXY
HORIZON FINANCIAL CORP.
ANNUAL MEETING OF SHAREHOLDERS
July 22, 2003
The undersigned hereby appoints the Executive/Proxy Committee of the
Board of Directors of Horizon Financial Corp. ("Corporation") with full powers
of substitution to act as attorneys and proxies for the undersigned, to vote
all shares of Common Stock of the Corporation which the undersigned is
entitled to vote at the Annual Meeting of Shareholders ("Meeting"), to be held
at the Fox Hall at the Hampton Inn, 1661 W. Bakerview Road, Bellingham,
Washington, on July 22, 2003 at 1:00 p.m., Pacific Time, and at any and all
adjournments thereof, as follows:
VOTE
FOR WITHHELD
---- --------
I. The election as directors of the
nominees listed below [ ] [ ]
(except as marked to the contrary below).
Robert C. Diehl
Fred R. Miller
Gary E. Goodman
INSTRUCTIONS: To withhold your vote for
any individual nominees, write the nominee's
name on the line below.
-------------------------------------------
-------------------------------------------
The Board of Directors recommends a vote "FOR" the adoption of the proposal
listed above.
THIS PROXY WILL BE VOTED AS DIRECTED, BUT IF NO INSTRUCTIONS ARE SPECIFIED,
THIS PROXY WILL BE VOTED FOR THE PROPOSITION STATED. IF ANY OTHER BUSINESS IS
PRESENTED AT SUCH MEETING, THIS PROXY WILL BE VOTED BY THE BOARD OF DIRECTORS
IN ITS BEST JUDGMENT. AT THE PRESENT TIME, THE BOARD OF DIRECTORS KNOWS OF NO
OTHER BUSINESS TO BE PRESENTED AT THE MEETING. THIS PROXY ALSO CONFERS
DISCRETIONARY AUTHORITY ON THE BOARD OF DIRECTORS TO VOTE WITH RESPECT TO
APPROVAL OF THE MINUTES OF THE PRIOR MEETING OF SHAREHOLDERS, THE ELECTION OF
ANY PERSON AS DIRECTOR WHERE THE NOMINEE IS UNABLE TO SERVE OR FOR GOOD CAUSE
WILL NOT SERVE, AND MATTERS INCIDENT TO THE CONDUCT OF THE 2003 ANNUAL
MEETING.
THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS
Should the undersigned be present and elect to vote at the Meeting or at
any adjournment thereof and after notification to the Secretary of the
Corporation at the Meeting of the shareholder's decision to terminate this
proxy, then the power of said attorneys and proxies shall be deemed terminated
and of no further force and effect.
The undersigned acknowledges receipt from the Corporation, prior to the
execution of this proxy, of Notice of the Annual Meeting, a proxy statement
for the Annual Meeting and an Annual Report to Shareholders.
Dated: , 2003
--------------------
------------------------------- ------------------------------
PRINT NAME OF SHAREHOLDER PRINT NAME OF SHAREHOLDER
------------------------------- ------------------------------
PRINT NAME OF SHAREHOLDER PRINT NAME OF SHAREHOLDER
Please sign exactly as your name appears on the enclosed card. When signing
as attorney, executor, administrator, trustee or guardian, please give your
full title. If shares are held jointly, only one signature is required, but
each holder should sign, if possible.
PLEASE COMPLETE, DATE, SIGN AND MAIL THIS PROXY PROMPTLY IN THE ENCLOSED
POSTAGE-PREPAID ENVELOPE.