UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT of 1934
For the quarterly period ended September 30, 2008
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT of 1934
For the transition period from ______________ to __________________
Commission file number 0-27062
Horizon Financial Corp.
-----------------------
(Exact name of registrant as specified in its charter)
Washington
----------
(State or other jurisdiction of incorporation or organization)
91-1695422
----------
(I.R.S. Employer Identification No.)
1500 Cornwall Avenue
Bellingham, Washington
----------------------
(Address of principal executive offices)
98225
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(Zip Code)
Registrant's telephone number, including area code: (360) 733-3050
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
----- -----
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
See definition of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer Accelerated filer X
----- -----
Non-accelerated filer Smaller reporting company
----- -----
Indicate by check mark whether the registrant is a shell corporation (as
defined in Rule 12b-2 of the Exchange Act).
YES NO X
----- -----
As of November 3, 2008, 11,960,371 common shares, $1.00 par value, were
outstanding.
HORIZON FINANCIAL CORP.
INDEX PAGE
- ----- ----
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements (Unaudited)
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Financial Position 2
Consolidated Statements of Operations 3-4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Selected Notes to Consolidated Financial Statements 7-11
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-26
Item 3 Quantitative and Qualitative Disclosures About
Market Risk 26
Item 4 Controls and Procedures 26
PART II OTHER INFORMATION
Item 1 Legal Proceedings 27
Item 1A Risk Factors 27-31
Item 2 Unregistered Sales of Equity Securities and
Use of Proceeds 31
Item 3 Defaults Upon Senior Securities 31
Item 4 Submission of Matters to a Vote of Security Holders 31
Item 5 Other Information 31
Item 6 Exhibits 31-32
SIGNATURES 33
Exhibit Index 34
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
HORIZON FINANCIAL CORP.
Consolidated Statements of Financial Position (unaudited)
ASSETS
September 30, March 31,
(In thousands, except share data) 2008 2008
---------- ----------
Cash and cash equivalents $ 22,117 $ 22,412
Interest-bearing deposits 18,816 2,912
Investment securities
Available-for-sale 32,183 41,241
Mortgage-backed securities
Available-for-sale 39,503 39,100
Held-to-maturity 10 30
Federal Home Loan Bank stock 8,580 8,867
Loans held for sale 1,496 2,644
Loans receivable, net of allowance for loan
losses of $25,579 at September 30, 2008 and
$19,114 at March 31, 2008 1,239,696 1,191,478
Investment in real estate in a joint venture 17,742 17,567
Accrued interest and dividends receivable 6,942 7,916
Bank premises and equipment, net 27,142 27,778
Deferred tax benefit 7,304 6,253
Income tax receivable 4,111 -
Bank owned life insurance 19,788 19,884
Real estate owned 1,859 655
Other assets 4,010 3,441
---------- ----------
TOTAL ASSETS $1,451,299 $1,392,178
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $1,147,278 $1,038,792
Accounts payable and other liabilities 4,618 5,746
Borrowed funds 151,571 192,343
Borrowing related to investment in real
estate in a joint venture 23,404 22,448
Advances by borrowers for taxes and insurance 372 414
Income tax currently payable - 2,174
Deferred compensation 1,905 1,944
---------- ----------
Total liabilities 1,329,148 1,263,861
---------- ----------
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; 11,960,371 and
11,892,208 issued and outstanding at
September 30, 2008 and March 31, 2008,
respectively 11,960 11,892
Additional paid-in capital 51,086 50,597
Retained earnings 59,115 63,906
Accumulated other comprehensive income (loss) (10) 1,922
---------- ----------
Total stockholders' equity 122,151 128,317
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,451,299 $1,392,178
========== ==========
(See Notes to Consolidated Financial Statements)
2
HORIZON FINANCIAL CORP.
Consolidated Statements of Operations (unaudited)
Three months ended
September 30,
(In thousands, except share data) 2008 2007
---------- ----------
INTEREST INCOME
Interest on loans $ 19,808 $ 24,881
Interest on investments and mortgage-
backed securities 949 1,011
---------- ----------
Total interest income 20,757 25,892
---------- ----------
INTEREST EXPENSE
Interest on deposits 8,500 9,818
Interest on borrowed funds 1,334 2,131
---------- ----------
Total interest expense 9,834 11,949
---------- ----------
Net interest income 10,923 13,943
PROVISION FOR LOAN LOSSES 12,000 800
---------- ----------
Net interest income (loss) after provision
for loan losses (1,077) 13,143
---------- ----------
NONINTEREST INCOME
Service fees 819 918
Net gain on sales of loans - servicing released 146 173
Net gain (loss) on sales of loans - servicing
retained (2) 5
Net loss on sale of investment securities (777) -
Other 1,291 516
---------- ----------
Total noninterest income 1,477 1,612
---------- ----------
NONINTEREST EXPENSE
Compensation and employee benefits 4,337 4,296
Building occupancy 1,175 1,177
Data processing 241 238
Advertising 219 209
Other expenses 2,142 1,532
---------- ----------
Total noninterest expense 8,114 7,452
---------- ----------
NET INCOME (LOSS) BEFORE PROVISION (BENEFIT)
FOR INCOME TAX (7,714) 7,303
PROVISION (BENEFIT) FOR INCOME TAX (3,109) 2,390
---------- ----------
NET INCOME (LOSS) $ (4,605) $ 4,913
========== ==========
BASIC EARNINGS (LOSS) PER SHARE $ (0.39) $ 0.40
======= ======
DILUTED EARNINGS (LOSS) PER SHARE $ (0.39) $ 0.40
======= ======
(See Notes to Consolidated Financial Statements)
3
HORIZON FINANCIAL CORP.
Consolidated Statements of Operations (unaudited)
Six months ended
September 30,
(In thousands, except share data) 2008 2007
---------- ----------
INTEREST INCOME
Interest on loans $ 40,254 $ 48,765
Investment and mortgage-backed securities 1,910 2,026
---------- ----------
Total interest income 42,164 50,791
---------- ----------
INTEREST EXPENSE
Interest on deposits 17,087 19,285
Interest on other borrowings 2,927 4,122
---------- ----------
Total interest expense 20,014 23,407
---------- ----------
Net interest income 22,150 27,384
PROVISION FOR LOAN LOSSES 15,000 1,200
---------- ----------
Net interest income after provision for
loan losses 7,150 26,184
---------- ----------
NONINTEREST INCOME
Service fees 1,779 1,799
Net gain on sales of loans - servicing released 350 487
Net gain (loss) on sales of loans - servicing
retained (2) 17
Net loss on sale of investment securities (198) -
Other noninterest income 1,807 1,012
---------- ----------
Total noninterest income 3,736 3,315
---------- ----------
NONINTEREST EXPENSE
Compensation and employee benefits 8,840 8,427
Building occupancy 2,301 2,262
Data processing 485 479
Advertising 438 415
Other expenses 3,635 3,124
---------- ----------
Total noninterest expense 15,699 14,707
---------- ----------
NET INCOME (LOSS) BEFORE PROVISION (BENEFIT)
FOR INCOME TAX (4,813) 14,792
PROVISION (BENEFIT) FOR INCOME TAX (2,228) 4,863
---------- ----------
NET INCOME (LOSS) $ (2,585) $ 9,929
========== ==========
BASIC EARNINGS (LOSS) PER SHARE $(0.22) $ 0.81
====== ======
DILUTED EARNINGS (LOSS) PER SHARE $(0.22) $ 0.81
====== ======
(See Notes to Consolidated Financial Statements)
4
HORIZON FINANCIAL CORP.
Consolidated Statements of Stockholders' Equity
Six Months Ended September 30, 2008 and 2007
(unaudited)
Common Stock Accumulated
---------------------- Additional Other Treasury
(In thousands, Number of Paid-In Retained Comprehensive Stock
except share data) Shares At Par Capital Earnings Income (Loss) at Cost
--------- ----------- ----------- --------- ------------- -------------
<s> <c> <c> <c> <c> <c> <c>
BALANCE, March 31, 2007 12,254 $ 12,254 $ 51,489 $ 56,770 $ 3,342 $ -
Comprehensive income
Net income - - - 9,929 - -
Other comprehensive income
Change in unrealized
losses on available-for-
sale securities, net tax
benefit of $104 - - - - 193 -
Total other comprehensive
income
Comprehensive income
Cash dividends on common
stock at $.26/sh - - - (3,160) - -
Stock options exercised 11 11 54 - - -
Stock award plan 6 6 274 - - -
Tax benefit associated
with stock options - - 35 - - -
Treasury stock purchased - - - - - (3,132)
Retirement of treasury stock (147) (147) (653) (2,332) - 3,132
------ ------- ------- ------- ------ -------
BALANCE, September 30, 2007 12,124 $12,124 $51,199 $61,207 $3,535 $ -
====== ======= ======= ======= ====== =======
BALANCE, March 31, 2008 11,892 $11,892 $50,597 $63,906 $1,922 $ -
Comprehensive income
Net income (loss) - - - (2,585) - -
Other comprehensive income
Reclassification for net
losses realized in income,
net tax benefit of $69 - - - - 129 -
Change in unrealized losses
on available-for-sale
securities, net tax benefit
of $1,109 - - - - (2,061) -
Total other comprehensive income
Comprehensive income (loss)
Cash dividends on common stock
at $.185/sh - - - (2,206) - -
Dividend reinvestment plan 27 27 200 - - -
Stock options exercised 20 20 114 - - -
Stock award plan 21 21 171 - - -
Tax benefit associated with
stock options - - 4 - - -
------ ------- ------- ------- ------ -------
BALANCE, September 30, 2008 11,960 $11,960 $51,086 $59,115 $ (10) $ -
====== ======= ======= ======= ====== =======
Total
Stockholders' Comprehensive
Equity Income (Loss)
------ -------------
<s> <c> <c>
BALANCE, March 31, 2007 $ 123,855
Comprehensive income
Net income 9,929 $ 9,929
Other comprehensive income
Change in unrealized
losses on available-for-
sale securities, net tax
benefit of $104 193 193
Total other comprehensive -------
income 193
-------
Comprehensive income $10,122
Cash dividends on common =======
stock at $.26/sh (3,160)
Stock options exercised 65
Stock award plan 280
Tax benefit associated
with stock options 35
Treasury stock purchased (3,132)
Retirement of treasury stock -
--------
BALANCE, September 30, 2007 $128,065
========
BALANCE, March 31, 2008 $128,317
Comprehensive income
Net income (loss) (2,585) $(2,585)
Other comprehensive income
Reclassification for net
losses realized in income,
net tax benefit of $69 129 129
Change in unrealized losses
on available-for-sale
securities, net tax benefit
of $1,109 (2,061) (2,061)
-------
Total other comprehensive income (1,932)
-------
Comprehensive income (loss) $(4,517)
Cash dividends on common stock =======
at $.185/sh (2,206)
Dividend reinvestment plan 227
Stock options exercised 134
Stock award plan 192
Tax benefit associated with
stock options 4
--------
BALANCE, September 30, 2008 $122,151
========
(See Notes to Consolidated Financial Statements)
5
HORIZON FINANCIAL CORP.
Consolidated Statements of Cash Flows (unaudited)
Six Months Ended
(In thousands, except share data) September 30,
2008 2007
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (2,585) $ 9,929
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,670 910
Stock award plan compensation 192 280
Provision for deferred income tax 52 (54)
Provision for loan losses 15,000 1,200
Loss on sale of investment securities 198 -
Loss on sale of real estate owned 335 -
Excess tax benefits from the exercise of stock options (4) (35)
Net gain on mortgage loans held for sale (350) (487)
Proceeds from sales of mortgage loans held for sale 28,980 44,544
Origination of mortgage loans held for sale (27,482) (41,136)
Changes in assets and liabilities:
Accrued interest and dividends receivable 974 (1,065)
Interest payable 91 (900)
Federal income tax payable (6,285) (1,031)
Other assets (470) (752)
Other liabilities (292) (1,772)
--------- ---------
Net cash flows from operating activities 10,023 9,631
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in interest-bearing deposits, net (15,904) (1,457)
Purchases of investment securities - available-
for-sale (6,000) (11,245)
Proceeds from sales and maturities of
investment securities - available-for-sale 9,524 12,768
Purchases of mortgage-backed securities - available-
for-sale (1,584) (8,714)
Proceeds from maturities of mortgage-backed
securities - available-for-sale 3,483 3,070
Proceeds from maturities of mortgage-backed
securities - held-to-maturity 20 70
Redemption of Federal Home Loan Bank Stock 287 -
Net change in loans (65,873) (92,624)
Proceeds from the sale of other real estate owned 511 -
Purchases of bank premises and equipment (429) (1,949)
Net change in investment in real estate in a
joint venture (175) (237)
--------- ---------
Net cash flows from investing activities (76,140) (100,318)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 108,486 22,260
Advances from other borrowed funds 187,044 266,523
Repayments of other borrowed funds (227,816) (215,500)
Advances on borrowing related to investment in
real estate in a joint venture 956 1,176
Common stock issued, net 134 65
Tax benefit associated with stock options 4 35
Cash dividends paid (2,987) (3,116)
Treasury stock purchased - (3,132)
--------- ---------
Net cash flows from financing activities 65,821 68,311
--------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS (295) (22,376)
CASH AND CASH EQUIVALENTS, beginning of period 22,412 40,833
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 22,117 $ 18,457
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 19,924 $ 24,307
========= =========
Cash paid during the period for income tax $ 4,100 $ 5,908
========= =========
Transfer of loans to other real estate owned $ 2,413 $ -
========= =========
Bank financed sale of other real estate owned $ 364 $ -
========= =========
In-kind distribution for mutual funds $ 3,278 $ -
========= =========
(See Notes to Consolidated Financial Statements)
6
HORIZON FINANCIAL CORP.
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(unaudited)
NOTE 1 - Basis of Presentation and Significant Accounting Policies
Basis of Presentation
- ---------------------
The consolidated financial statements as of and for the three and six
months ended September 30, 2008 and 2007, include the accounts of Horizon
Financial Corp. ("Horizon Financial" or the "Corporation"), and its
wholly-owned subsidiary Horizon Bank ("Horizon Bank" or the "Bank"), and other
subsidiaries of the Bank. Significant intercompany balances and transactions
have been eliminated in consolidation. The Corporation has not engaged in any
significant activity other than holding the stock of the Bank.
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect amounts reported in
the consolidated financial statements. Changes in these estimates and
assumptions are considered reasonably possible and may have a material impact
on the financial statements and thus actual results could differ from the
amounts reported and disclosed herein.
The unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to the
Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. In the opinion of management, all adjustments (consisting only of
normal recurring accruals) necessary for a fair presentation are reflected in
the interim financial statements. The results of operations for the three and
six month periods ended September 30, 2008 and 2007 are not necessarily
indicative of the operating results for the full year. For further
information, refer to the consolidated financial statements and footnotes
thereto in the Horizon Financial Corp. Annual Report on Form 10-K for the year
ended March 31, 2008.
Consolidation of Real Estate Joint Venture
- ------------------------------------------
In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. ("FIN") 46R, Consolidation of Variable Interest
Entities. FIN 46R explains the concept of a variable interest entity and
requires consolidation by the primary beneficiary where the variable interest
entity does not have sufficient equity at risk to finance its activities
without additional subordinated financial support from other parties. This
interpretation applies to variable interest entities in which an enterprise
holds a variable interest. In October 2004, the Bank's wholly-owned
subsidiary, Westward Financial Services, Inc. ("Westward Financial"), entered
into a real estate development joint venture with Greenbriar Northwest LLC
("GBNW"), an established residential land development company headquartered in
Bellingham, Washington. The Corporation believes that GBNW is a variable
interest entity with the Corporation as the primary beneficiary. Under FIN
46R, GBNW is consolidated in the Corporation's consolidated balance sheet.
The Corporation also accounts for the portion not owned by Westward Financial,
as a minority interest, which is included in other liabilities. The
investment in real estate is recorded as an asset and the related debt is
recorded as the Corporation's liability. As of September 30, 2008, the real
estate joint venture had a carrying amount of approximately $17.7 million,
with a related borrowing of approximately $23.4 million. No income is
currently being recognized in the Corporation's financial statements; however,
in accordance with FIN 46R, the related funding expense is included in the
Corporation's interest on other borrowings expense which amounts to
approximately $69,000 and $147,000 for the three months ended September 30,
2008 and 2007, respectively, and $139,000 and $291,000 for the six months
ended September 30, 2007, respectively.
Reclassification
- ----------------
Certain reclassifications have been made to prior financial statements to
conform with the current presentation. Such reclassifications have no effect
on operations, equity, or earnings (loss) per share.
7
NOTE 2 - Stockholders' Equity
Earnings (Loss) Per Share
- -------------------------
The following table illustrates the reconciliation of weighted average
shares, as adjusted, used for earnings (loss) per share for the noted periods:
Three months ended Six months ended
September 30, September 30,
----------------------- ------------------------
2008 2007 2008 2007
---------- ---------- ---------- ----------
Basic weighted average
shares outstanding 11,940,064 12,155,532 11,917,065 12,191,256
Dilutive shares - 101,265 - 108,149
Diluted weighted ---------- ---------- ---------- ----------
average shares
outstanding 11,940,064 12,256,797 11,917,065 12,299,405
========== ========== ========== ==========
Ant-dilutive shares
outstanding related
to options to
acquire the
Corporation's
common stock 126,784 24,047 95,822 12,630
========== ========== ========== ==========
Cash Dividend Declared
- ----------------------
On September 30, 2008, the Corporation announced a quarterly cash
dividend of $0.05 cents per share payable on November 7, 2008 to shareholders
of record on October 17, 2008.
NOTE 3 - Share Based Payment and Stock Option and Restricted Stock Award Plans
Share Based Payment
- -------------------
The Corporation adopted Statement of Financial Accounting Standard
("SFAS" or "Statement") No. 123R, Share-Based Payment, on April 1, 2006 using
the "modified prospective" method. Under this method, awards that are
granted, modified, or settled after March 31, 2006 are measured and accounted
for in accordance with Statement No. 123R. Also under this method, expense is
recognized for unvested awards that were granted prior to April 1, 2006 based
upon the fair value determined at the grant date under Statement No. 123,
Accounting for Stock-based Compensation. For the three and six months ended
September 30, 2008, the Corporation recognized $85,000 and $192,000 in stock
option and restricted stock award compensation expense, net of tax, as a
component of salaries and benefits, compared to $188,000 and $275,000 for the
three and six months ended September 30, 2007. As of September 30, 2008 and
2007, there was approximately $308,000 and $870,000, respectively, of total
unrecognized compensation cost related to nonvested options and restricted
stock awards which is scheduled to amortize over the next three years. The
Corporation measures the fair value of each stock option grant at the date of
grant, using the Black Scholes option pricing model. The Corporation did not
grant any options or restricted stock awards during the three and six months
ended September 30, 2008.
The Corporation may grant options and/or awards for a maximum of 937,500
shares, as adjusted, of authorized common stock to certain officers and key
employees under the 2005 Incentive Stock Plan. Options and awards are granted
at fair market value and may or may not vest immediately upon issuance based
on the terms established by the Board of Directors. Options and awards are
generally exercisable within one to five years from the date of grant and
expire after ten years. Dividends are paid on restricted stock grants and are
not paid on incentive stock options.
8
NOTE 3 - Share Based Payment and Stock Option and Restricted Stock Award Plans
(continued)
The following table summarizes the stock option activity for the six
months ended September 30, 2008 under both the 1995 and 2005 stock plans:
Weighted
Weighted average
Out- average remaining Aggregate
standing exercise contractual intrinsic
under price term value (in
Stock Options plan per share (in years) thousands)
- ------------- ------- --------- ---------- ---------
Balance, March 31, 2008 193,076 $ 12.44
Granted - -
Exercised (20,161) 6.64
Forfeited, expired
or cancelled (4,132) 12.60
------- --------- --------- ---------
Balance, September 30, 2008 168,783 $ 13.13 5.43 $ 189
======= ========= ========= =========
Exercisable, September
30, 2008 124,130 $ 11.09 4.37 $ 189
======= ========= ========= =========
The total intrinsic value, the amount by which the fair value of the
underlying stock exceeds the exercise price of an option on the exercise date,
of options exercised for the six months ended September 30, 2008 and 2007 was
$54,000 and $143,000, respectively.
The following table summarizes the award activity for the six months
ended September 30, 2008 under the 2005 stock plan:
Weighted
Weighted average
Out- average remaining
standing exercise contractual
under price term
Restricted Stock Awards plan per share (in years)
- ----------------------- ------- --------- ----------
Balance, March 31, 2008 51,414 $ 20.66
Granted - -
Released (20,659) 21.31
Forfeited, expired or
cancelled (502) 20.34
------- --------- ----------
Balance, September 30, 2008 30,253 $ 20.22 0.98
======= ========= ==========
NOTE 4 - Fair Value Measurements
Effective April 1, 2008, the Corporation partially adopted FASB Statement
No. 157, Fair Value Measurements, for all financial instruments accounted for
at fair value on a recurring basis. The Corporation elected the deferral
reporting on non-financial instruments as permitted in FASB Staff Position
157-2 until fiscal years beginning after November 15, 2008. Statement No. 157
establishes a new framework for measuring fair value and expands related
disclosures. Statement No. 157 framework requires fair value to be determined
based on the exchange price that would be received for an asset or paid to
transfer a liability (an exit price) in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants. Statement No. 157 establishes a fair value hierarchy which
requires an entity to maximize the use of observable inputs and minimize the
use of unobservable inputs when measuring fair value. The standard describes
three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices for identical assets or liabilities in active
markets that the entity has the ability to access as of the
measurement date.
Level 2: Significant other observable inputs other than Level 1 prices,
such as quoted prices for similar assets or liabilities, quoted
prices in markets that are not active and other inputs that are
observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company's own
assumptions about the assumptions that market participants
would use in pricing an asset or liability.
9
NOTE 4 - Fair Value Measurements (continued)
The following is a description of the valuation methodologies used to
measure and disclose fair value of financial assets and liabilities on a
recurring or nonrecurring basis:
Investments in debt and equity securities: Securities available for sale
are recorded at fair value on a recurring basis. Fair value is
determined by obtaining quoted prices on nationally recognized securities
exchanges (Level 1) or through the use of alternative approaches, such
as matrix or model pricing, when market quotes are not readily available
(Level 2).
Loans held for sale: Mortgage loans originated and designated as held
for sale are carried at the lower of cost or estimated fair value, as
determined by quoted market prices, where applicable, or the prices for
other mortgage loans with similar characteristics, in aggregate, and are
measured on a nonrecurring basis. At September 30, 2008, loans held for
sale were carried at cost.
Impaired loans: A loan is considered impaired when, based upon currently
known information, it is deemed probable that the Corporation will be
unable to collect all amounts due as scheduled according to the original
terms of the agreement. Impaired loans are measured based on the present
value of expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, based on the loan's
observable market price or the fair value of the collateral, if the loan
is collateral dependent. Impaired loans, which are collateral dependent,
are included in the nonrecurring basis table below.
The following table presents the Corporation's financial assets measured
at fair value on a recurring basis at September 30, 2008 (in thousands):
Level 1 Level 2 Level 3 Total
------- ------- ------- -------
Assets
Investment securities $ 1,349 $70,337 $ - $71,686
------- ------- ------- -------
Total $ 1,349 $70,337 $ - $71,686
======= ======= ======= =======
The following table presents the Corporation's assets measured at fair
value on a nonrecurring basis at September 30, 2008 (in thousands):
Level 1 Level 2 Level 3 Total
------- ------- ------- -------
Assets
Impaired loans $ - $ - $44,766 $44,766
------- ------- ------- -------
Total $ - $ - $44,766 $44,766
======= ======= ======= =======
In accordance with FASB Statement 114, Accounting by Creditors for
Impairment of a Loan, impaired loans, with carrying amounts of $44.8 million
had specific valuation allowances totaling $7.6 million, which were included
in the allowance for loan losses. The Corporation did not recognize any
interest income on impaired loans for the three and six months ended September
30, 2008 and 2007.
NOTE 5 - Impact of New Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements. This Statement applies to other
accounting pronouncements that require or permit fair value measurements.
Accordingly, this Statement does not require any new fair value measurements.
This Statement is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. The Corporation implemented of this Statement April 1, 2008, and it did
not have a material impact on the Corporation's consolidated financial
statements.
10
In February 2007, the Financial Accounting Standards Board released
Statement No. 159, Fair Value Option for Financial Assets and Financial
Liabilities. This Statement permits entities to choose to measure many
financial instruments and certain other items at fair value. This Statement is
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those years. The Corporation
implemented of this Statement April 1, 2008, and it did not have a material
impact on the Corporation's consolidated financial statements.
In October 2008, the FASB issued FASB Staff Position No. FAS 157-3,
Determining the Fair Value of a Financial Asset When the Market for The Asset
Is Not Active ("FSP 157-3). FSP 157-3 clarifies the application of FAS 157 in
a market that is not active. The FSP is intended to address the following
application issues: (a) how the reporting entity's own assumptions (that is,
expected cash flows and appropriately risk-adjusted discount rates) should be
considered when measuring fair value; (b) how available observable inputs in a
market that is not active should be considered when measuring fair value; and
(c) how the use of market quotes (for example, broker quotes or pricing
services for the same or similar financial assets) should be considered when
assessing the relevance of observable and unobservable inputs available to
measure fair value. FSP 157-3 is effective on issuance, including prior
periods for which financial statements have not been issued. The Corporation
adopted FSP 157-3 for the quarter ended September 30, 2008 and the effect of
adoption on the consolidated financial statements was not material.
11
Item 2. 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
subsidiaries. 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 of Financial Condition and Results
of Operations and this Form 10-Q contain certain forward-looking statements
which are based on assumptions and describe future plans, strategies and
expectations of the Corporation. Management desires to take advantage of the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
and is including this statement for the express purpose of availing the
Corporation of the protections of the safe harbor with respect to all
forward-looking statements in this Form 10-Q. These forward-looking
statements are generally identified by use of the word "believe," "expect,"
"intend," "anticipate," "estimate," "project," or similar words. The
Corporation's ability to predict results of the actual effect of future plans
or strategies is uncertain. Factors which could cause actual results to
differ materially include, but are not limited to, the credit risks of lending
activities, including changes in the level and trend of loan delinquencies and
write-offs; changes in general economic conditions, either nationally or in
our market areas; changes in the levels of general interest rates, deposit
interest rates, our net interest margin and funding sources; fluctuations in
the demand for loans, the number of unsold homes and other properties and
fluctuations in real estate values in our market areas; results of
examinations of us by the Federal Reserve and our savings bank subsidiary by
the Federal Deposit Insurance Corporation, the Washington Department of
Financial Institutions or other regulatory authorities, including the
possibility that any such regulatory authority may, among other things,
require us to increase our reserve for loan losses or to write-down assets;
our ability to control operating costs and expenses; our ability to implement
our branch expansion strategy; our ability to successfully integrate any
assets, liabilities, customers, systems, and management personnel we have
acquired or may in the future acquire into our operations and our ability to
realize related revenue synergies and cost savings within expected time frames
and any goodwill charges related thereto; our ability to manage loan
delinquency rates; our ability to retain key members of our senior management
team; costs and effects of litigation, including settlements and judgments;
increased competitive pressures among financial services companies; changes in
consumer spending, borrowing and savings habits; legislative or regulatory
changes that adversely affect our business; adverse changes in the securities
markets; inability of key third-party providers to perform their obligations
to us; changes in accounting policies and practices, as may be adopted by the
financial institution regulatory agencies or the Financial Accounting
Standards Board; war or terrorist activities; other economic, competitive,
governmental, regulatory, and technological factors affecting our operations,
pricing, products and services and other risks detailed in the Corporation's
reports filed with the Securities and Exchange Commission, including the
Annual Report on Form 10-K for the fiscal year ended March 31, 2008. The
Corporation undertakes no responsibility to update or revise any
forward-looking statements. These risks and uncertainties should be
considered in evaluating forward-looking statements and you should not rely
too much on these statements.
General
- -------
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 name, "Horizon Bank". Effective August 1,
2005, the Bank converted from a state chartered savings bank to a state
chartered commercial bank.
The Corporation's results of operations depend primarily on revenue
generated as a result of its net interest income and noninterest income. Net
interest income is the difference between the interest income the Corporation
earns on its interest-earning assets (consisting primarily of loans and
investments securities) and the interest the Corporation pays on its
interest-bearing liabilities (consisting primarily of customer savings and
money market accounts, time deposits and borrowings). Noninterest income
consists primarily of service charges on deposit and loan accounts, gains on
the sale of loans and investments, and loan servicing fees. The Corporation's
results of operations are also affected by its provisions for loan losses and
other expenses. Other expenses consist primarily of noninterest expense,
including compensation and benefits, occupancy, equipment, data processing,
marketing, automated teller machine costs and, when applicable, deposit
12
insurance premiums. The Corporation's results of operations may also be
affected significantly by general and local economic and competitive
conditions, changes in market interest rates, governmental policies and
actions of regulatory authorities, as well as other factors identified under
the caption "Forward Looking Statements" above.
Business Strategy
- -----------------
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) continuing efforts towards the origination of residential
mortgage loans, focusing on loans eligible for sale in the secondary market;
(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.
Prior year's strategies included a focus on residential construction and
development lending, however growth in that area is not part of the future
strategy of the Bank, as the focus is instead on diversifying the balance
sheet by decreasing its concentration in this area.
As a result of the downturn in the economy and the net losses realized
for the three and six months ended September 30, 2008, our efforts are focused
primarily on improving asset quality, capital preservation, expense reduction
and core deposit growth. During the quarter ended September 30, 2008, we
expanded our special assets team by shifting personnel within the Corporation,
in order to focus on reducing our nonperforming assets. We will continue to
focus on core deposit growth to enhance our liquidity position. In addition,
the Bank has undergone an extensive review of potential expense reductions.
In evaluating the controllable expenses, the Bank determined the need to make
several strategic staffing reductions. As of November 4, 2008, the Bank
completed a reduction in force of 27 full-time positions, and also identified
several areas where responsibilities will be shifted to accommodate the
revised staffing levels. In the weeks leading up to the November 4, 2008
strategic staffing reduction, other positions were not filled when vacated by
the employees previously occupying these positions These reductions in
personnel, along with strategic reductions in other noninterest expense areas
are expected to result in over $3 million in expense savings on an annual
basis. In connection with the reduction in personnel, the Company expects to
incur approximately $135,000 in severance related expenses during the quarter
ended December 31, 2008.
Operating Strategy
- ------------------
The Corporation serves as a holding company for the Bank, providing
strategic oversight, management, access to capital and other resources and
activities typically performed by bank holding companies. The Bank currently
has two offices in Pierce County (south of King County), with the remaining
offices all located north of King County. Management has further indicated
that the market areas just outside King County (including, but not necessarily
limited to Snohomish, Pierce, Kitsap and Thurston counties) are logical areas
for potential future expansion, as these markets have characteristics most
similar to those in which the Bank has experienced previous success. However,
there are no specific acquisitions or new business formations planned at this
time.
The primary business of the Bank is to acquire funds in the form of
deposits and wholesale funds, and to use the funds to make commercial,
consumer, and real estate loans in its primary market area. In addition, and
to a lesser extent, 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, brokered deposits, and other wholesale borrowings, will also likely
be used as a supplemental source of funds.
The Corporation's profitability depends primarily on its net interest
income, which is the difference between the income it receives on the Bank's
loan and investment portfolio and the Bank's cost of funds, which consists of
interest paid on deposits and borrowings. The Bank reviews its opportunities
with respect to both assets and liabilities. In recent years, for example,
the Bank chose to concentrate its commercial lending efforts on growing its
Prime-based loan portfolio, at a time when many lenders were offering fixed
rate real estate loans at sub-Prime rates. In this regard, the Bank's loan
portfolio growth is heavily concentrated in the real estate development and
construction markets in the Puget Sound region. Through its relationships
with established real estate developers and builders, the Bank's loan officers
increased this portion of the Bank's portfolio, which is primarily Prime-based
business. This was beneficial in previous years, with the Federal Reserve's
Open Market Committee's ("FOMC") efforts to increase short terms interest
rates, which have in turn increased the Prime lending rate. Starting with the
FOMC's 275 basis point reduction from September 2007 through September 2008,
as well as the 50 basis point reductions on October 8, 2008 and October 29,
2008, the Corporation is experiencing a decline in its net interest margin.
This rapid pace of easing monetary policy by the FOMC will contribute to
further declines in the
13
Corporation's net interest margin. On the liability side of the balance
sheet, these changing rates also impact the Bank's earnings. Management
acknowledges that there is a lag effect in this regard, in both increasing and
decreasing rate environments as the rates on the Bank's certificate of deposit
liabilities do not adjust instantly, rather the impact occurs more gradually
than the impact on its assets, as certificates of deposit mature and reprice
in a changing interest rate environment.
Net interest income is also affected by the relative amounts of
interest-earning assets and interest-bearing liabilities. When
interest-earning assets equal or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. The
Corporation's profitability is also affected by the level of the Bank's other
income and expenses. Other noninterest income includes income associated with
the origination and sale of mortgage loans, loan servicing fees, deposit
account related fees, and net gains and losses on sales of interest-earning
assets. This portion of the Bank's income is heavily dependent on the Bank's
success at originating and selling one-to-four family mortgage loans into the
secondary market. Recently the Bank's mortgage banking activity has declined
commensurate with the slowdown in the housing industry. In addition, the
Bank's ability to generate fee income on its deposit accounts impacts this
portion of the Bank's income stream.
Other noninterest expenses include compensation and benefits, occupancy
and equipment expenses, deposit insurance premiums, data servicing expenses
and other operating costs.
Finally, the Corporation's results of operations are also significantly
affected by general economic and competitive conditions, particularly changes
in market interest rates, conditions in the financial services industry,
government legislation, regulation, and monetary and fiscal policies.
Financial Condition
- -------------------
Total consolidated assets for the Corporation at September 30, 2008,
increased to $1.45 billion or 4.3% from $1.39 billion at March 31, 2008. This
increase in assets was primarily a result of the growth in net loans
receivable, which increased $48.2 million or 4.0% to $1.24 billion at
September 30, 2008 from $1.19 billion at March 31, 2008. The growth in net
loans receivable was partially attributable to a $31.9 million increase in
commercial construction loans as prior loan commitments continue to be funded.
Commercial construction includes commercial speculative one-to-four family
(large one-to-four family developments and condominium projects), multifamily
and commercial buildings as shown in the construction and land development
table later in this section. Contributing to this increase is a slowing pace
of loan paydowns primarily in one-to-four family construction, as housing
sales activity has slowed compared to previous periods. This has resulted in
loan balances remaining on the Corporation's balance sheet longer than in more
active periods for real estate sales. Also increasing during the period is
the commercial business loan category, which increased $29.7 million as the
Bank continues to focus on increasing its commercial lines of credit balances
to diversify its loan portfolio and expand its relationships with businesses
in its markets. One-to-four family mortgage loans, net of participations
sold, decreased 1.1% to $145.2 million at September 30, 2008 from $146.9
million at March 31, 2008. The Bank sold $28.9 million of real estate loans
during the six months ended September 30, 2008, compared to $46.3 million
during the six months ended September 30, 2007 as a result of diminished
activity from the Bank's single family mortgage division.
The following is an analysis of the loan portfolio by major type of loans:
September 30, % of March 31, % of
(Dollars in thousands) 2008 Portfolio 2008 Portfolio
------------ --------- -------- ---------
One-to-four family mortgage
loans
One-to-four family $ 157,502 12.5% $ 165,824 13.7%
One-to-four family
construction 37,877 3.0 35,303 2.9
Less participations sold (50,198) (4.0) (54,269) (4.5)
---------- ----- ---------- -----
Net one-to-four family
mortgage loans 145,181 11.5 146,858 12.1
Commercial land development 177,600 14.0 178,726 14.8
Commercial Construction (1) 339,774 26.9 307,809 25.4
Multifamily residential 44,522 3.5 45,049 3.7
Commercial real estate 286,728 22.7 300,109 24.8
Commercial business loans 207,348 16.4 177,685 14.7
Home equity secured 56,047 4.4 47,351 3.9
Other consumer loans 8,075 .6 7,005 .6
---------- ----- ---------- -----
Subtotal 1,120,094 88.5 1,063,734 87.9
---------- ----- ---------- -----
Total loans receivable 1,265,275 100.0% 1,210,592 100.0%
---------- ----- ---------- -----
Less:
14
Allowance for loan losses (25,579) (19,114)
---------- ----------
Net loans receivable $1,239,696 $1,191,478
========== ==========
Net residential loans $ 143,555 11.6% $ 145,565 12.2%
Net commercial business loans 202,271 16.3 174,263 14.6
Net commercial real estate
loans (2) 831,123 67.0 818,215 68.7
Net consumer loans (3) 62,747 5.1 53,435 4.5
---------- ----- ---------- -----
$1,239,696 100.0% $1,191,478 100%
========== ===== ========== =====
(1) Includes $56.1 and $56.9 million in condominium construction projects at
September 30, 2008 and 2007, respectively.
(2) Includes construction and development, multi-family and commercial real
estate loans.
(3) Includes home equity and other consumer loans.
As reflected in the table above, approximately 67.1% of our total net
loan portfolio consists of commercial and multifamily real estate and
construction and land development loans. These types of loans afford the Bank
an opportunity to receive interest at rates higher than those generally
available from one-to-four family residential lending. These loans, however,
also typically are greater in amount, more difficult to evaluate and monitor
and, therefore, involve a greater degree of risk than single family
residential mortgage loans. Because payments on loans secured by commercial
and multifamily real estate often depend upon the successful operation and
management of the properties, repayment of such loans may be affected by
adverse conditions in the real estate market or the economy. The Bank seeks
to minimize these risks by limiting the maximum loan-to-value ratio to between
75% and 85% and carefully reviewing the financial condition of the borrower,
the quality of the collateral and the management of the property securing the
loan.
Construction and land development lending generally involves a higher
degree of risk than permanent financing for a finished residence or commercial
building, because of the inherent difficulty in estimating the cost of the
project, the property's value at completion, and the future market demand to
purchase the product upon completion. If the estimated cost of construction
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to complete the project. To address this risk,
and because of the level of construction loans in the Bank's portfolio, the
Bank has personnel dedicated specifically to monitoring the progress of its
construction projects, and making on-site inspections of the properties. The
Bank also utilizes the services of experienced inspectors to monitor the
progress and draw process in the more complex construction projects. In
addition, in an effort to monitor the available inventory in its markets, the
Bank also regularly reviews the overall building and development activity in
its markets. Also, to mitigate the risks related to construction lending, the
Bank primarily deals with experienced builders, with acceptable credit
histories, sound financial statements, and a proven track record in the
industry. The Bank also has an experienced appraisal staff, and members of
senior management with related appraisal education and experience, who
regularly review the appraisals utilized by the Bank in analyzing prospective
construction projects. Finally, members of the Bank's senior management and
loan committees also have a significant amount of experience in the areas of
construction lending, appraisals, and loan underwriting, further mitigating
the Bank's risk in this area. Changing economic conditions have had a
materially adverse impact on the Bank's borrowers and on the Bank's loan
portfolio. See the "Asset Quality" section below for details on the Bank's
non-performing assets and comments regarding identified potential weaknesses
in its loan portfolio.
The Bank actively originates construction loans through its Mortgage Loan
Division and its Commercial Loan Division. The Bank's Mortgage Loan Division
generally oversees the single family custom construction loans, and to a
lesser extent, speculative construction loans (i.e., loans for homes that do
not have a contract with a buyer for the purchase of the home upon completion
of the construction) to smaller contractors building a limited number of
speculative homes per year. These construction loans are further broken down
in the first two lines of the table below (speculative construction
one-to-four family and custom construction one-to-four family). The Bank's
Commercial Lending Division is responsible for the speculative construction
projects for the Bank's larger builders (including large one-to-four family
developments), in addition to the Bank's multi-family construction loans,
non-residential commercial construction loans, and the Bank's land development
loans.
15
The following table is provided to show additional details on the
Corporation's construction and land development loan portfolio:
September 30, 2008 March 31, 2008
------------------ ----------------
(Dollars in thousands) Amount Percent Amount Percent
------ ------- ------ -------
Speculative construction one-to-
four family $ 29,373 5.3% $ 27,206 5.2%
Custom construction one-to-four family 8,504 1.5 8,097 1.6
-------- ----- -------- -----
Total one-to-four family construction 37,877 6.8 35,303 6.8
Commercial speculative construction
one-to-four family 229,616 41.4 236,536 45.3
Commercial construction multi family 11,244 2.0 11,732 2.2
Commercial construction 98,914 17.8 59,541 11.4
Commercial residential land development 177,600 32.0 178,726 34.3
-------- ----- -------- -----
Total commercial construction and
land development 517,375 93.2 486,535 93.2
-------- ----- -------- -----
Total construction loans $555,251 100.0% $521,838 100.0%
======== ===== ======== =====
The tables below sets forth the characteristics of the available for sale
("AFS") and held-to-maturity ("HTM") investment and mortgage-backed securities
portfolios as of September 30, 2008:
Gross Gross
Unrealized Unrealized
Gross Losses Losses Estimated
Amortized Unrealized 12 Months Greater Than Fair
(In thousands) Cost Gains or Less 12 Months Value
--------- ---------- --------- ------------ ---------
AFS Securities
State and political
subdivisions and
U.S. government
agency securities $31,114 $ 251 $ - $ 531 $30,834
Marketable equity
securities 562 787 - - 1,349
Mortage-backed
securities and
Collateralized
mortgage obligations
(CMOs) 40,024 394 - (915) 39,503
------- ------ ------ ------- -------
Total available-for-
sale securities 71,700 1,432 - (1,446) 71,686
------- ------ ------ ------- -------
HTM Securities
Mortgage-backed
securities and
CMOs 10 3 - - 13
------- ------ ------ ------- -------
Total held-to-
maturity
securities 10 3 - - 13
------- ------ ------ ------- -------
Total securities $71,710 $1,435 $ - $(1,446) $71,699
======= ====== ====== ======= =======
Maturity Schedule of Securities
at September 30, 2008
-----------------------------------------------
Available-For-Sale Held-To-Maturity
---------------------- ----------------------
Amortized Estimated Amortized Estimated
(In thousands) Cost Fair Value Cost Fair Value
--------- ---------- --------- ----------
Maturities:
Less than one year $ 2,825 $ 2,839 $ 1 $ 1
One to five years 10,631 10,812 1 1
Over five to ten years 25,695 25,391 8 11
Over ten years 31,987 31,295 - -
------- ------- ------ ------
71,138 70,337 10 13
------- ------- ------ ------
Mutual funds and marketable
equity securities 562 1,349 - -
------- ------- ------ ------
Total investment securities $71,700 $71,686 $ 10 $ 13
======= ======= ====== ======
16
Total liabilities increased 5.2% to $1.33 billion at September 30, 2008,
from $1.26 billion at March 31, 2008. This increase in liabilities was
primarily the result of growth in deposits, which increased 10.4% to $1.15
billion at September 30, 2008 from $1.04 billion at March 31, 2008 as brokered
certificates of deposit were utilized to fund loan growth and repay other
borrowed funds, including FHLB advances. Many of these brokered CDs have call
options in the Bank's favor. At September 30, 2008, approximately 38% of the
Bank's brokered CDs had such a call feature. As the Bank receives funds from
other sources (i.e. its retail deposit base, loan paydowns, etc.) the Bank
will be able to exercise these options and return the Brokered CDs prior to
maturity, if it is deemed appropriate at that time.
The Bank has an agreement with Promontory Interfinancial Network that
makes it possible to offer FDIC insurance on deposits in excess of the current
deposit limits. The Certificate of Deposit Account Registry Service ("CDARS")
uses a deposit matching program to match CDARS deposits in other participating
banks, dollar for dollar. Included in the brokered CD totals were
approximately $26 million in CDARS deposits, which shifted from the Bank's
retail deposit products as certain customers sought the FDIC insurance
coverage that the CDARs product offers.
The following is an analysis of the deposit portfolio by major type of
deposit at September 30, 2008 and March 31, 2008:
September 30, March 31,
(In thousands) 2008 2008
------------ ----------
Demand deposits
Savings $ 18,135 $ 17,933
Checking 75,633 72,434
Checking (noninterest-bearing) 65,365 70,438
Money Market 179,714 183,063
---------- ----------
338,847 343,868
---------- ----------
Time certificates of deposit
Less than $100,000 289,945 286,657
Greater than or equal to $100,000 283,015 287,281
Brokered certificates of deposit 235,471 120,986
---------- ----------
808,431 694,924
---------- ----------
Total deposits $1,147,278 $1,038,792
========== ==========
The September 30, 2008 balance sheet also includes an investment in real
estate of a joint venture and the corresponding borrowing. During the fiscal
year ended March 31, 2005, Westward Financial, as a 50% partner in GBNW
(Greenbriar Northwest LLC), purchased an 85 acre parcel of land in Bellingham,
Washington for future development. GBNW intends to develop the property in
future years into a neighborhood community to be known as Fairhaven Highlands.
The $17.7 million is reflected on the Corporation's Consolidated Statements of
Financial Position as an asset at September 30, 2008 represents the current
level of the investment in real estate joint ventures, including the Fairhaven
Highlands joint venture. This amount also includes the remaining net
investment in a residential development joint venture that has since been
completed and closed. The $23.4 million shown in the liability section of the
Consolidated Statements of Financial Position represents the corresponding
wholesale borrowing used to fund the investment in the Fairhaven Highlands
joint venture. At this time, the partnership is in the process of meeting
with the appropriate public and private entities in connection with its
planning efforts relating to the future development of the property.
Presently, an Environment Impact Statement ("EIS") is being prepared utilizing
consultants hired by the City of Bellingham. According to city officials, a
preliminary draft of the EIS is expected to be available for review prior to
January 31, 2009.
Stockholders' equity at September 30, 2008 decreased 4.8% to $122.2
million from $128.3 million at March 31, 2008. This decrease was the result
of a $1.9 million decline in the unrealized gain on AFS securities and $2.2
million paid in cash dividends, as well as a $2.6 million net loss for the six
months ended September 30, 2008. Contributing to the decline in the
unrealized gain on AFS securities was the overall decline in the financial
sector, as many of the securities with unrealized gains are equities in
financial related companies. The Corporation's stockholder equity-to-assets
ratio was 8.4% at September 30, 2008, compared to 9.2% at March 31, 2008.
Asset Quality
- -------------
The Corporation manages its credit risk through diversification of its
loan portfolio and the application of prudent underwriting policies,
procedures, and monitoring practices. Delinquent and problem loans, however,
are a part of any financial institution. When a borrower fails to make
payments, the Corporation implements certain procedures, with an organized
practical approach, for the collection of delinquent loans.
17
Allowance 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 at the time financial statements are prepared.
These factors include changes in portfolio size and composition, actual loss
experience, current economic conditions, detailed analysis of individual loans
for which full collectibility may not be assured, and determination of the
existence and realizable value of the collateral and guarantees securing the
loans. The ultimate recovery of loans is susceptible to future market factors
beyond the Corporation's control, which may result in losses or recoveries
differing significantly from those provided for in the financial statements.
The following table summarizes the allowance for loan losses,
charge-offs, and loan recoveries:
For the quarter ended For the six months ended
September 30, September 30,
2008 2007 2008 2007
------ ------ ------ ------
(Dollars in thousands)
Allowance at beginning of
period $19,149 $16,262 $19,114 $15,889
Provision for loan losses 12,000 800 15,000 1,200
Charge offs (net of
recoveries) (5,570) (39) (8,535) (66)
------- ------- ------- -------
Allowance at end of period $25,579 $17,023 $25,579 $17,023
======= ======= ======= =======
Allowance for loan losses as
a percentage of gross loans
receivable at the end of the
period 2.02% 1.46% 2.02% 1.46%
Allowance for loan losses as
a percentage of net loans
receivable at the end of the
period 2.06% 1.48% 2.06% 1.48%
Net charge-offs as a percentage
of average loans outstanding
during the period 0.45% 0.00% 0.69% 0.01%
The allowance for loan losses is established as losses are estimated to
have occurred through the provision for loan losses charged to earnings. Loan
losses are charges against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The provision for loan losses was $12.0 million for the quarter ended
September 30, 2008 and $15.0 million for the six months ended September 30,
2008 compared to $800,000 and $1.2 million for the three and six months ended
September 30, 2007, respectively. These provisions reflect management's
ongoing analysis of changes in loan portfolio composition by collateral
categories, balances outstanding, overall credit quality of the portfolio,
historical industry loss experience, and current economic conditions. The
allowance for loan losses was $25.6 million, or 2.06% of net loans receivable
at September 30, 2008, compared to $19.1 million, or 1.60% of net loans
receivable at March 31, 2008 and $17.0 million, or 1.48% at September 30,
2007. The increased allowance level was a result of a combination of factors,
including a higher level of nonperforming loans at September 30, 2008 of $78.4
million compared to $11.6 million at March 31, 2008 and $6,000 at September
30, 2007 and continued loan portfolio growth in the higher-risk lending
categories of construction and land development, commercial real estate, and
commercial business loans during the period, which amounted to $1.03 billion
at September 30, 2008, compared to $992.5 million at March 31, 2008 and $952.3
million million at September 30, 2007. Also contributing the increased
provision was the increase in delinquencies on performing loans, with those 30
to 89 days past due at September 30, 2008 totaling approximately $46.0
million, compared to $13.4 million at June 30, 2008 and from $7.0 million at
September 30, 2007.
Contributing the increased provision was the increase in delinquencies on
performing loans, with those 30 to 89 days past due at September 30, 2008
totaling approximately $46.0 million, compared to $13.4 million at June 30,
2008 and from $7.0 million at September 30, 2007. In addition, at September
30, 2008 the Bank identified approximately $41.0 million of potential problem
loans, primarily single family construction and land development loans located
in Snohomish and Pierce counties. Potential problem loans are loans that do
not yet meet the criteria for placement on non-accrual status, but where known
information about the possible credit problems of the borrowers causes
management to have serious concerns as to the ability of the borrower to
comply with present loan repayment terms, and may result in the future
inclusion of such loans in the non-accrual category. If we don't see
improvement in the single family housing sector, these numbers could grow
materially.
The majority of the Corporation's loan portfolio consists of commercial
loans and single-family residential loans secured by real estate in the
Whatcom, Skagit, Snohomish, King and Pierce County areas of Washington.
Regional economic conditions are softening, particularly in Snohomish County,
where housing inventories are increasing and the
18
overall sales activity is slowing. For example, at September 30, 2008, data
indicates that the Snohomish County market has 15.6 months of available
housing inventory (using September 2008 actual sales versus available
inventory) according to RealEstats, Inc. As a comparison, housing inventory
was shown at 11.4 months at March 31, 2008 and 8.5 months at September 30,
2007. In Pierce County, housing inventory at September 30, 2008 was shown at
11.1 months, compared to 12.4 months in March 2008 and 10.0 months in
September 2007. Inventory levels in King County are also worth noting, as low
levels and the higher price of homes helped support the activity in Snohomish
and Pierce counties in recent years, as buyers migrated to the more affordable
and more available options in these counties, as compared to King County. At
September 30, 2008, housing inventory levels in King County were 8.6 months,
compared to 8.0 months at March 31, 2008 and 6.1 months at September 30, 2007.
Additional details on the geographic distribution of the Bank's non-performing
assets ("NPAs") are presented in the tables below.
The allowance for loan losses at September 30, 2008 represents management
of the Bank's best estimate of losses inherent in the loan portfolio, given
the changing portfolio mix and the current economic environment. While the
Bank believes it has established its existing allowance for loan losses in
accordance with accounting principles generally accepted in the United States,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request the Bank to significantly increase or decrease its
allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed elsewhere in this document.
Any material increase in the allowance for loan losses would adversely affect
the Bank's financial condition and results of operations.
Non-Performing Assets. As of September 30, 2008, there were three loans
in the loan portfolio over 90 days delinquent and accruing interest and 23
loan relationships on nonaccrual status. At September 30, 2008, total
non-performing loans were $78.4 million compared to $11.6 million at March 31,
2008 and $6,000 at September 30, 2007. The Bank had two properties in the
real estate owned category totaling $1.9 million at September 30, 2008. Total
non-performing assets represented $80.2 million, or 5.53% of total assets at
September 30, 2008 compared to $12.2 million or 0.88% of total assets at March
31, 2008 and $731,000 or .05% of total assets at September 30, 2007.
The following tables summarize the Bank's non-performing assets:
As of September 30,
-------------------
Non-performing assets 2008 2007
------ ------
(Dollars in thousands)
Accruing loans - 90 days past due $ 589 $ -
Non-accrual loans 77,781 6
------- -----
Total non-performing loans 78,370 6
Real estate owned 1,859 725
------- -----
Total non-performing assets $80,229 $ 731
======= =====
Total non-performing loans/gross loans 6.19% 0.00%
Total non-performing assets/total assets 5.53% 0.05%
Total non-performing assets/total capital
plus reserves 54.31% 0.50%
19
The majority of the Bank's non-performing assets are for construction
projects in Snohomish County. The following table summarizes the Bank's total
(NPAs at September 30, 2008 by county and by type of loan :
Non-performing % of
Assets by Whatcom Skagit Snohomish King Pierce Total Total
Type of Loan County County County County County NPAs NPAs
------- ------ --------- ------ ------ ----- ------
(dollars in
thousands)
One-to-four family
residential $ 26 $547 $ 1,169 $ - $ - $ 1,742 2%
One-to-four family
construction - - - - 1,417 1,417 2
------ ---- ------- ------- ------- ------- ---
Subtotal 26 547 1,169 - 1,417 3,159 4
Commercial land
development 8,862 - 6,077 - 4,540 19,479 24
Commercial
construction (1) - - 18,528 22,896 15,546 56,970 71
Multi family
residential - - - - - - -
Commercial real
estate - - - - - - -
Commercial loans - - - - 500 500 1
Home equity
secured 100 16 - - - 116 -
Other consumer
loans 5 - - - - 5 -
Subtotal 8,967 16 24,605 22,896 20,586 77,070 96
------ ---- ------- ------- ------- ------- ---
Total non-
performing
assets $8,993 $563 $25,774 $22,896 $22,003 $80,229 100%
====== ==== ======= ======= ======= ======= ===
(1) The commercial construction totals include $29.4 million in condominium
construction projects, with the majority of the remaining balance
consisting of various commercial speculative one-to-four family
construction projects.
Construction and land development, commercial real estate and
multi-family real estate loans have larger individual loan amounts, which have
a greater single impact on the total portfolio quality in the event of
delinquency or default. Further, while the Bank believes that the loss
potential for its non-performing assets is properly reserved currently, the
Bank is closely watching its construction and land development loan portfolio,
and believes there is a potential for significant additions to non-performing
loans, charge-offs, provisions for loan and lease losses, and/or real estate
owned in the future if the housing market conditions do not improve.
The Bank has added personnel and redirected the duties of certain lending
staff members to address the needs of these special credits. Our Chief Credit
Officer and Chief Lending Officer are actively managing the Bank's work-out
problem credits, with attention to marketing existing non-performing assets,
working with borrowers, and working to obtain control of properties, where
necessary. In addition, the Bank is working with certain borrowers to enhance
their marketing efforts by providing attractive financing programs to buyers
of homes currently financed by the Bank.
Other Real Estate Owned. Other real estate owned ("OREO") is carried at
the lesser of book value or market value less selling costs. The costs
related to maintenance and repair or other costs of such properties, are
generally expensed with any gains or shortfalls from the ultimate sale of OREO
being shown in other noninterest income or expense.
The following table summarizes changes in the OREO portfolio during the
three and six months ended September 30, 2008 and 2007:
For the three months ended For the six months ended
September 30, September 30,
2008 2007 2008 2007
------ ------ ------ ------
(Dollars in thousands)
Balance at beginning of
period $ 2,764 $725 $ 655 $725
Additions to OREO 304 - 2,413 -
Valuation adjustments (160) - (160) -
Disposition of OREO (1,049) - (1,049) -
------- ---- ------- ----
Balance at end of period $ 1,859 $725 $ 1,859 $725
======= ==== ======= ====
The Corporation recognized $175,000 in losses related to the disposition
of four properties during the three and six months ended September 30, 2008.
At September 30, 2008 there were two properties held in OREO, both located in
Snohomish County, totaling $1.9 million and were considered non-performing
assets.
20
Management of the Bank continually evaluates loans in nonaccrual status
for the possibility of foreclosure or deed in lieu, at which point these loans
would then become OREO. Management views this as an ordinary part of the
collection process and efforts are continually maintained to reduce and
minimize such nonperforming assets.
Comparison of Operating Results for the Three Months Ended September 30, 2008
- -----------------------------------------------------------------------------
and September 30, 2007
- ----------------------
General. The Corporation recognized a net loss of $4.6 million for the
three months ended September 30, 2008 compared to net income of $4.9 million
for the three months ended September 30, 2007. Diluted loss per share for the
three months ended September 30, 2008 was $(0.39) on weighted average diluted
shares outstanding of 11,940,064, compared to diluted earnings per share of
$0.40 on weighted average diluted shares of 12,256,797 for the three months
ended September 30, 2007.
Net Interest Income. Net interest income before provision for loan
losses for the three months ended September 30, 2008 decreased $3.0 million or
21.7% to $10.9 million from $13.9 million for the comparable period in 2007.
Interest on loans for the quarter ended September 30, 2008 decreased 20.4% to
$19.8 million, from $24.9 million for the comparable quarter a year ago. This
decrease was a result of a combination of factors, including 275 basis points
in Prime rate decreases from the prior year. The Bank's loan portfolio
includes over $500 million in Prime based loans, or approximately 40% of gross
loans outstanding, and each quarter point decrease in the Prime lending rate
equates to an annualized decrease in interest income on those types of loans
of over $1.0 million. Also contributing to the decline was the reversal of
approximately $1.6 million in interest income due to nonaccrual loans during
the quarter ended September 30, 2008 compared to no interest reversals during
the three months ended September 30, 2007.
Also included in interest income for the three months ended September 30,
2008 and 2007 were approximately $1.0 million and $1.2 million, respectively,
of deferred fee income recognition. Most of these fees were related to the
Bank's commercial real estate and land development loan portfolio. Real
estate development loans typically are shorter term in nature so the deferred
fee recognition during the effective life of the loan is greater than what
would be recognized for a comparable loan fee on a longer amortizing term
loan. However, due to current economic conditions, the effective life of
these loans has increased similar to that of longer amortizing loans,
therefore contributing to the decrease in deferred loan fee income. The table
below presents an analysis of deferred fee recognition for the three months
ended September 30, 2008 and 2007:
For the quarter
ended September 30,
2008 2007
------ ------
(In thousands)
Commercial loan deferred fees $826 $1,070
One-to-four real estate mortgage loan
deferred fees 158 162
---- ------
Total $984 $1,232
==== ======
Interest on investments and mortgage-backed securities for the three
months ended September 30, 2008 remained relatively unchanged at $1.0 million.
Total interest income decreased 19.8% to $20.8 million at September 30, 2008
from $25.9 million in the comparable period one year ago as a result of the
factors discussed above.
Total interest paid on deposits decreased 13.4% to $8.5 million for the
quarter ended September 30, 2008 from $9.8 million for the quarter ended
September 30, 2007. Contributing to the decrease was an overall lower level of
interest rates compared to the previous period. At September 30, 2008,
approximately 70% of the Bank's deposits were in the form of certificates of
deposit, including $235.5 million in brokered certificates of deposit. While
management continues its efforts to increase core deposits as a funding
source, the competitive marketplace for core deposit dollars has limited
success in this regard. The Bank's average cost of deposits decreased 92
basis points to 3.04% for the three months ended September 30, 2008 from 3.96%
for the same three months in 2007.
Interest on borrowings decreased 37.4% to $1.3 million during the quarter
ended September 30, 2008, compared to $2.1 million for the comparable period
one year ago. The decreased expense in the current year was also a result of
an overall lower level of interest rates during of the period. The Bank
continues to utilize wholesale borrowings as an alternative liquidity source
and to better manage its interest rate risk profile. The Bank's average cost
of borrowings decreased 213 basis points to 2.80% for the three months ended
September 30, 2008 from 4.93% for the same three months in 2007. The Bank's
average cost of funds decreased 110 basis points to 3.00% for the three months
ended September 30, 2008 from 4.10% for the same three months in 2007.
21
Average Balances, Interest and Average Yields/Costs. 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. For the purposes of this table, loans receivable average
balances include nonaccrual loans. The yield on investment securities is
calculated using historical cost basis.
For the three months ended September 30,
-----------------------------------------------------
2008 2007
-------------------------- --------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
(Dollars in thousands) ------- -------- ------ ------- -------- ------
Interest-earning assets:
Loans receivable $1,246,410 $19,808 6.36% $1,114,386 $24,881 8.90%
Investment securities 55,505 451 3.25 59,765 1,237 4.17
Mortgage-backed
securities 38,252 498 5.21 30,971 789 5.04
---------- ------- ---- ---------- ------- ----
Total interest-
earning assets 1,340,167 20,757 6.20 1,186,049 50,791 8.56
Interest-bearing
liabilities:
Deposits 1,118,799 8,499 3.04 981,617 19,285 3.93
Borrowings 190,443 1,334 2.80 166,779 4,122 4.94
---------- ------- ---- ---------- ------- ----
Total interest-
bearing
liabilities 1,309,242 9,833 3.00 1,148,396 23,407 4.08
------- -------
Net interest income $10,924 $27,384
======= =======
Interest rate spread 3.19% 4.49%
Net interest margin 3.26% 4.62%
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities 102.36% 103.28%
Noninterest Income. Noninterest income for the three months ended
September 30, 2008 decreased 8.3% to $1.5 million compared to $1.6 million for
the same period a year ago. Service fee income decreased 10.8% to $819,000 for
the quarter ended September 30, 2008 from $918,000 for the same quarter in the
prior period due in large part to the decrease in loan origination and related
fees. The Bank originated $72.2 million in loans during the quarter ended
September 30, 2008 compared to $173.1 million for the quarter ended September
30, 2007. The net gain on the sale of loans servicing released decreased
15.3% to $146,000 for the quarter ended September 30, 2008 from $173,000 in
the comparable period one year ago due primarily to the slowing housing market
resulting in a reduction in the Corporation's mortgage banking activity. The
Bank continued its practice of selling most of its single-family long term
fixed rate loan production into the secondary market.
There was a net loss on sales of investment securities of $777,000 for
the three months ended September 30, 2008 compared to no gain or loss for the
three months ended September 30, 2007. The loss resulted from the Bank
electing to take a redemption in-kind distribution for its $5.0 million
investment in the AMF family of mutual funds, due to the continuing decline in
the net asset value precipitated by the unprecedented disruption in the
mortgage backed securities markets. Other noninterest income for the quarter
increased 150.0% to $1.3 million for the quarter ended September 30, 2008 from
$516,000 for the three months ended September 30, 2007. During the quarter
ended September 30, 2008, the Bank realized $767,000 in death benefits from
the settlement of a bank owned life insurance policy.
Noninterest Expense. Noninterest expense for the three months ended
September 30, 2008 increased 8.9% to $8.1 million from $7.5 million for the
comparable quarter one year ago. Compensation and employee benefits remained
relatively unchanged at $4.3 million for the quarters ended September 30, 2008
and the same period last year. Building occupancy for the quarter ended
September 30, 2008 was also unchanged at $1.2 million as compared to the
quarter ended September 30, 2007. Other noninterest expense increased 39.8%
to $2.1 million for the quarter ended September 30, 2008 from $1.5 million in
the quarter ended September 30, 2007 as a result of increased FDIC insurance
premiums of approximately $185,000 over the prior period as a result of
approximately $214,000 in FDIC deposit insurance assessments in the quarter
ended September 30, 2008. The Federal Deposit insurance Reform Act of 2005
provided banks with a one-time assessment credit to be used against future
premiums. For Horizon, that amounted to a credit of approximately $649,000.
This credit was utilized beginning April 1, 2007 and was fully depleted at
June 30, 2008, accounting for the difference between these periods. Also
22
contributing to the increase over the prior period was losses realized on the
sale of OREO of $335,000 as well as additional expenses related to non-
performing assets, including legal, appraisal and related expenses.
Comparison of Operating Results for the Six Months Ended September 30, 2008
- ---------------------------------------------------------------------------
and September 30, 2007
- ----------------------
General. The Corporation realized a net loss of $2.6 million for the six
months ended September 30, 2008 compared to net income of $9.9 million for the
six months ended September 30, 2007. Diluted loss per share for the six
months ended September 30, 2008 was $(0.22) on weighted average diluted shares
outstanding of 11,917,065, compared to diluted earnings per share of $0.81 on
weighted average diluted shares of 12,299,405 for the six months ended
September 30, 2007.
Net Interest Income. Net interest income before provision for loan
losses for the six months ended September 30, 2008 decreased 19.1% to $22.2
million from $27.4 million for the comparable period in 2007. Interest on
loans for the six months ended September 30, 2008 decreased 17.5% to $40.3
million, from $48.8 million for the comparable period a year ago. This
decrease was a result of a combination of factors, including 275 basis point
reductions in the prime lending rate from September 2007 to September 2008.
Each 25 basis point decline in the rate equates to more than $1.0 million in
interest on an annual basis. Also contributing to this decline was
approximately $2.3 million in non-accrual interest related to the increase in
non-accrual loans during the six months ended September 30, 2008 compared to
no interest reversals for the six months ended September 30, 2007.
Also included in interest income for the six months ended September 30,
2008 and 2007 were $2.1 million and $2.6 million, respectively, of deferred
fee income recognition. Most of these fees were related to the Bank's
commercial real estate and land development loan portfolio for the six months
ended September 30, 2008 and 2007. These development loans typically are
shorter term in nature, so the deferred fee recognition during the life of the
loan is greater than what would be recognized for a comparable loan fee on a
longer amortizing loan. However, because of current economic conditions, the
effective life of these loans has increased similar to that of longer
amortizing loans, therefore contributing to the decrease in deferred loan fee
income. The table below presents an analysis of deferred fee recognition for
the six months ended September 30, 2008 and 2007:
For the six months
ended September 30,
2008 2007
(In thousands) ------ ------
Commercial loan deferred fees $1,796 $2,216
One-to-four real estate mortgage loan
deferred fees 336 359
------ ------
Total $2,132 $2,575
====== ======
Interest on investments and mortgage-backed securities decreased 5.7% to
$1.9 million for the six months ended September 30, 2008 from $2.0 million for
the comparable period a year ago. Total interest income decreased 17.0% to
$42.2 million at September 30, 2008 from $50.8 million in the comparable
period one year ago as a result of the factors discussed above.
Total interest paid on deposits decreased 11.4% to $17.1 million for the
six months ended September 30, 2008 from $19.3 million for the six months
ended September 30, 2007, as a result of overall lower interest rates during
the six months ended September 30, 2008 compared to the previous period. At
September 30, 2008, approximately 70% of the Bank's deposits were in the form
of certificates of deposit, including $235.5 million in brokered certificates
of deposit. While management continues its efforts to increase core deposits
as a funding source, the competitive marketplace for core deposit dollars has
resulted in only moderate success in this regard. The Bank's average cost of
deposits decreased 79 basis points to 3.14% for the six months ended September
30, 2008 from 3.93% for the same six months in 2007.
Interest on borrowings decreased 29.0% to $2.9 million during the six
months ended September 30, 2008, compared to $4.1 million for the comparable
period one year ago. The decreased expense in the current year was a result
of a declining interest rate environment during most of the period. The Bank
continues to carry wholesale borrowings as an alternative liquidity source and
to better manage its interest rate risk profile. The Bank's average cost of
borrowings decreased 210 basis points to 2.84% for the six months ended
September 30, 2008 from 4.94% for the same six months in 2007. The Bank's
average cost of funds decreased 99 basis points to 3.09% for the six months
ended September 30, 2008 from 4.08% for the same six months in 2007.
23
Average Balances, Interest and Average Yields/Costs. 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. For the purposes of this table, loans receivable average
balances include nonaccrual loans. The yield on investment securities is
calculated using historical cost basis.
For the six months ended September 30,
-----------------------------------------------------
2008 2007
-------------------------- --------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost Balance Interest Cost
------- -------- ------ ------- -------- ------
Interest-earning assets:
Loans receivable $1,239,101 $40,254 6.50% $1,095,313 $48,765 8.90%
Investment securities 52,891 916 3.46 59,765 1,237 4.14
Mortgage-backed
securities 38,497 994 5.16 30,971 789 5.10
---------- ------- ---- ---------- ------- ----
Total interest-
earning assets 1,330,489 42,164 6.34 1,186,049 50,791 8.56
Interest-bearing
liabilities:
Deposits 1,087,478 17,087 3.14 981,617 19,285 3.93
Borrowings 206,457 2,927 2.84 166,779 4,122 4.94
---------- ------- ---- ---------- ------- ----
Total interest-
bearing
liabilities 1,293,935 20,014 3.09 1,148,396 23,407 4.08
------- -------
Net interest income $22,150 $27,384
======= =======
Interest rate spread 3.24% 4.49%
Net interest margin 3.33% 4.62%
Ratio of average interest-earning
assets to average interest-
bearing liabilities 102.83% 103.28%
Noninterest Income. Noninterest income for the six months ended
September 30, 2008 increased 12.7% to $3.7 million as compared to $3.3 million
for the same period a year ago. Service fee income was relatively unchanged
at $1.8 million for the six month periods ended September 2008 and 2007. The
net gain on the sale of loans servicing released decreased 28.1% to $350,000
for the six months ended September 30, 2008 from $487,000 in the comparable
period one year ago primarily as a result of the slowing housing market
resulting in a reduction in the Corporation's mortgage banking activity.
Other noninterest income increased 78.6% to $1.8 million for the six months
ended September 30, 2008 from $1.0 million for the six months ended September
30, 2007 due primarily to the Bank realizing $767,000 in death benefits from
the settlement of a Bank owned life insurance policy.
Noninterest Expense. Noninterest expense for the six months ended
September 30, 2008 increased 6.7% to $15.7 million from $14.7 million for the
comparable six months in 2007. Compensation and employee benefits increased
4.9% for the six months ended September 30, 2008 to $8.8 million from $8.4
million for the comparable six months in 2007. Building occupancy for the six
months ended September 30, 2008 increased slightly to $2.3 million as compared
to the six months ended September 30, 2007. Increases in compensation and
employee benefits and building and occupancy expenses resulted from the
overall growth of the Bank, including the opening of a full service retail
facility and mortgage loan center in Puyallup, Washington in June 2007. Other
noninterest expense increased 16.3% to $3.6 million for the six months ended
September 30, 2008 from $3.1 million in the six months ended September 30,
2007 as a result of increased FDIC insurance premiums of approximately
$200,000 over the prior period as the one-time assessment credit for previous
payments into the system was depleted in June 2008. Also contributing to the
increase was losses realized on the sale of OREO of $335,000 and additional
expenses related to non-performing assets, including legal, appraisal and
related expenses.
24
Rate/Volume Analysis
- --------------------
The table below sets forth certain information regarding changes in
interest income and interest expense for the Corporation for the periods
indicated. For each category of interest-earning asset and interest-bearing
liability, information is provided on changes attributable to (1) changes in
volume (change in volume multiplied by old rate); (2) changes in rates (change
in rate multiplied by old volume); (3) changes to rate-volume (changes in rate
multiplied by the change in volume); and (4) the total changes (the sum of the
prior columns).
Six months ended September 30,
2008 vs. 2007
Increase (Decrease) Due to
--------------------------------------
Rate/
(In thousands) Volume Rate Volume Total
------ ------- ------ -------
Interest income:
Interest and fees on loans $6,402 $(13,182) $(1,731) $(8,511)
Investment securities and other
interest-bearing securities 14 (129) (1) (116)
------ -------- ------- -------
Total interest-earning assets $6,416 $(13,311) $(1,732) $(8,627)
====== ======== ======= =======
Interest expense:
Deposit accounts $2,080 $ (3,861) $ (417) $(2,198)
Borrowings 981 (1,758) (418) (1,195)
------ -------- ------- -------
Total interest-bearing liabilities $3,061 $ (5,619) $ (835) $(3,393)
====== ======== ======= =======
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 September 30, 2008, the Bank had liquid
assets (cash and marketable securities with maturities of one year or less) of
$44.3 million. In addition, the Bank has established lines of credit with the
FHLB and other correspondent banks. The amounts available under these lines
are in excess of $130 million at September 30, 2008.
As of September 30, 2008, the total amortized cost of investments and
mortgage-backed securities was $71.7 million compared to a market value of
$71.7 million with a net unrealized loss of $11,000. As of March 31, 2008,
the total amortized cost of investments and mortgage-backed securities was
$77.4 million, compared to a market value of $80.4 million with a net
unrealized gain of $3.0 million. The primary reasons for this change relate to
management's decision to take a redemption in-kind distribution for its $5.0
million investment in the AMF family of mutual funds, as well as declining
values in the Corporation's portfolio of equities, which are heavily
concentrated in the financial sector. The Bank does not foresee any factors
that would impair its ability and intent to hold debt securities until
recovery.
As indicated on the Corporation's Consolidated Statement of Cash Flows,
the Bank's primary sources of funds are cash flows from operations, which
consist primarily of mortgage loan repayments, deposit increases, loan sales,
borrowings and cash received from the maturity or sale of investment
securities. The Corporation's liquidity fluctuates with the supply of funds
and management believes that the current level of liquidity is adequate at
this time. If additional liquidity is needed, the Corporation's options
include, but are not necessarily limited to: (i) selling additional loans in
the secondary market; (ii) entering into reverse repurchase agreements; (iii)
borrowing from the FHLB of Seattle; (iv) accepting additional jumbo, brokered
and/or public funds deposits; or (v) accessing the discount window of the
Federal Reserve Bank of San Francisco.
Stockholders' equity as of September 30, 2008 was $122.2 million, or 8.4%
of assets, compared to $128.3 million, or 9.2% of assets at March 31, 2008.
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 September 30, 2008 was 10.4%, compared to
11.0% as of March 31, 2008. These figures remain above the well-capitalized
minimum of 10% set by the FDIC. The Corporation continues to remain
well-capitalized on all measures established under the regulatory guidelines.
To support its capital preservation efforts, the Corporation recently
reduced the cash dividend paid on its common stock. On September 30, 2008,
the Corporation's Board of Directors declared a quarterly cash dividend of
$0.05 per share, a 63% reduction from the dividend of $0.135 per share
declared in the prior quarter. This resulted in a savings of approximately
25
$1 million in capital for the Corporation. No assurances can be made regarding
the Corporation's ability to declare future dividends.
The Corporation has conducted various stock buy-back programs since
August 1996. In March 2008, the Board of Directors approved a new stock
repurchase plan that runs concurrent with the 2009 fiscal year, allowing the
Corporation to repurchase up to 2.5% of total shares outstanding, or
approximately 300,000 shares. This marked the Corporation's tenth stock
repurchase plan. During the three and six months ended September 30, 2008,
the Corporation did not repurchase any shares.
At this time, management does not intend to repurchase shares under the
current plan, due to the current housing problems in its lending markets and
the resulting focus on preserving capital. When the Corporation is
repurchasing shares, the number of shares of stock to be repurchased and the
price to be paid is the result of many factors, several of which are outside
of the control of the Corporation. The primary factors, however, are market
and economic factors such as the price at which the stock is trading in the
market, the number of shares available in the market; the attractiveness of
other investment alternatives in terms of the rate of return and risk involved
in the investment; the ability to increase the value and/or earnings per share
of the remaining outstanding shares; the Corporation's liquidity and capital
needs; and regulatory requirements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Corporation continues to be exposed to interest rate risk.
Currently, the Corporation's assets and liabilities are not materially exposed
to foreign currency or commodity price risk. At September 30, 2008, the
Corporation had no significant off-balance sheet derivative financial
instruments, nor did it have a trading portfolio of investments. At September
30, 2008, there were no material changes in the Corporation's market risk from
the information provided in the Form 10-K for the fiscal year ended March 31,
2008.
Item 4. Controls and Procedures
An evaluation of the Corporation's disclosure controls and procedures (as
defined in Rule 13(a)-15(e) of the Securities Exchange Act of 1934 (the
"Act")) was carried out under the supervision and with the participation of
the Corporation's Chief Executive Officer, Chief Financial Officer, and
several other members of the Corporation's senior management as of the end of
the period preceding the filing date of this quarterly report. Based on this
evaluation, the Corporation's Chief Executive Officer and Chief Financial
Officer concluded that, as of September 30, 2008, the Corporation's disclosure
controls and procedures were effective in ensuring that the information
required to be disclosed by the Corporation in the reports it files or submits
under the Act is (i) accumulated and communicated to the Corporation's
management (including the Chief Executive Officer and Chief Financial Officer)
in a timely manner, and (ii) recorded, processed, summarized, and reported
within the time periods specified in the SEC's rules and forms.
In the quarter ended September 30, 2008, the Corporation did not make any
changes in its internal control over financial reporting (as defined in Rule
13a-15(f) of the Exchange Act) that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting. While the Corporation believes the present designs of its
disclosure controls and procedures and internal control over financial
reporting are effective to achieve their goals, future events affecting its
business may cause the Corporation to modify its disclosure controls and
procedures and/or internal control over financial reporting.
The Corporation does not expect that its disclosure controls and
procedures and internal control over financial reporting will prevent all
error and fraud. A control procedure, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control procedure are met. Because of the inherent
limitations in all control procedures, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Corporation have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns in controls or procedures can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the control. The design of any control procedure is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, controls become inadequate because of
changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control procedure, misstatements due to error or fraud may
occur and not be detected.
26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Horizon Financial Corp. has certain litigation and/or settlement
negotiations in progress resulting from activities arising from normal
operations. In the opinion of management, none of these matters are likely to
have a materially adverse effect on the Corporation's financial position or
results of operation.
Item 1A. Risk Factors
The following risk factors inherent to our business are in addition to
the risk factors previously disclosed in the Corporation's Annual Report on
Form 10-K for the year ended March 31, 2008. You should carefully consider
the risks and uncertainties described below and in the Form 10-K for the year
ended March 31, 2008.
Difficult market conditions have adversely affected our industry.
We are particularly exposed to downturns in the U.S. housing market.
Dramatic declines in the housing market over the past year, with falling home
prices and increasing foreclosures, unemployment and under-employment, have
negatively impacted the credit performance of mortgage loans and resulted in
significant write-downs of asset values by financial institutions, including
government-sponsored entities, major commercial and investment banks, and
regional financial institutions such as our Company. Reflecting concern about
the stability of the financial markets generally and the strength of
counterparties, many lenders and institutional investors have reduced or
ceased providing funding to borrowers, including to other financial
institutions. This market turmoil and tightening of credit have led to an
increased level of commercial and consumer delinquencies, lack of consumer
confidence, increased market volatility and widespread reduction of business
activity generally. The resulting economic pressure on consumers and lack of
confidence in the financial markets have adversely affected our business,
financial condition and results of operations. We do not expect that the
difficult conditions in the financial markets are likely to improve in the
near future. A worsening of these conditions would likely exacerbate the
adverse effects of these difficult market conditions on us and others in the
financial institutions industry. In particular, we may face the following
risks in connection with these events:
* We potentially face increased regulation of our industry. Compliance
with such regulation may increase our costs and limit our ability to
pursue business opportunities.
* The process we use to estimate losses inherent in our credit exposure
requires difficult, subjective and complex judgments, including
forecasts of economic conditions and how these economic conditions
might impair the ability of our borrowers to repay their loans. The
level of uncertainty concerning economic conditions may adversely
affect the accuracy of our estimates which may, in turn, impact the
reliability of the process.
* We may be required to pay significantly higher FDIC premiums because
market developments have significantly depleted the insurance fund of
the FDIC and reduced the ratio of reserves to insured deposits.
Our business is subject to general economic risks that could adversely impact
our results of operations and financial condition.
* Changes in economic conditions, particularly a further economic slowdown in
our local markets, including Whatcom, Skagit, Snohomish, King and Pierce
Counties, could hurt our business.
Our business is directly affected by market conditions, trends in
industry and finance, legislative and regulatory changes, and changes in
governmental monetary and fiscal policies and inflation, all of which are
beyond our control. In 2007, the housing and real estate sectors experienced
an economic slowdown that has continued into 2008. Further deterioration in
economic conditions, in particular within our primary market area in the
Whatcom, Skagit, Snohomish, King and Pierce County real estate markets, could
result in the following consequences, among others, any of which could hurt
our business materially:
o loan delinquencies may increase;
o problem assets and foreclosures may increase;
o demand for our products and services may decline; and
o collateral for loans made by us, especially real estate, may
decline in value, in turn reducing a customer's borrowing power
and reducing the value of assets and collateral securing our
loans.
27
* Further downturns in the real estate markets in our primary market area
could hurt our business.
Our business activities and credit exposure are primarily concentrated in
Whatcom, Skagit, Snohomish, King and Pierce Counties. Our construction and
land loan portfolios, our commercial and multifamily loan portfolios and
certain of our other loans have been affected by the downturn in the
residential real estate market. We anticipate that further declines in the
real estate markets in our primary market area will hurt our business. As of
September 30, 2008, a significant portion of our loan portfolio consisted of
loans secured by real estate located in our local market areas. If real
estate values continue to decline the collateral for our loans will provide
less security. As a result, our ability to recover on defaulted loans by
selling the underlying real estate will be diminished, and we would be more
likely to suffer losses on defaulted loans. The events and conditions
described in this risk factor could therefore have a material adverse effect
on our business, results of operations and financial condition.
* We may suffer losses in our loan portfolio despite our underwriting
practices.
We seek to mitigate the risks inherent in our loan portfolio by adhering
to specific underwriting practices. Although we believe that our underwriting
criteria are appropriate for the various kinds of loans we make, we may incur
losses on loans that meet our underwriting criteria, and these losses may
exceed the amounts set aside as reserves in our allowance for loan losses.
Recent negative developments in the financial industry and credit markets may
continue to adversely impact our financial condition and results of
operations.
Negative developments beginning in the latter half of 2007 in the
sub-prime mortgage market and the securitization markets for such loans,
together with other factors, have resulted in uncertainty in the financial
markets in general and a related general economic downturn, which have
continued in 2008. Many lending institutions, including us, have experienced
substantial declines in the performance of their loans, including construction
and land development loans, multifamily loans, commercial loans and consumer
loans. Moreover, competition among depository institutions for deposits and
quality loans has increased significantly. In addition, the values of real
estate collateral supporting many construction and land, commercial and
multifamily and other commercial loans and home mortgages have declined and
may continue to decline. Bank and holding company stock prices have been
negatively affected, as has the ability of banks and holding companies to
raise capital or borrow in the debt markets compared to recent years. These
conditions may have a material adverse effect on our financial condition and
results of operations. In addition, as a result of the foregoing factors,
there is a potential for new federal or state laws and regulations regarding
lending and funding practices and liquidity standards, and bank regulatory
agencies are expected to be aggressive in responding to concerns and trends
identified in examinations, including the expected issuance of formal
enforcement orders. Negative developments in the financial industry and the
impact of new legislation in response to those developments could restrict our
business operations, including our ability to originate or sell loans, and
adversely impact our results of operations and financial condition.
We may be required to make further increases in our provisions for loan losses
and to charge off additional loans in the future, which could adversely affect
our results of operations.
For the quarter and six months ended September 30, 2008 we recorded a
provision for loan losses of $12.0 and $15.0 million, respectively, compared
to $800,000 and $1.2 million for the quarter and six months ended September
30, 2007, which reduced our results of operations for the second quarter and
first six months of 2008. We also recorded net loan charge-offs of $5.5 and
$8.5 million for the quarter and six months ended September 30, 2008,
respectively, compared to $39,000 and $66,000 for the quarter and six months
ended September 30, 2007. We are experiencing increasing loan delinquencies
and credit losses. Generally, our non-performing loans and assets reflect
operating difficulties of individual borrowers resulting from weakness in the
economy of the Pacific Northwest. In addition, slowing housing and developed
lot sales have been a contributing factor to the increase in non-performing
loans as well as the increase in delinquencies. At September 30, 2008 our
total non-performing loans had increased to $78.4 million compared to $6,000
at September 30, 2007. In that regard, our portfolio is concentrated in
construction and land loans and commercial and multi-family loans, all of
which have a higher risk of loss than residential mortgage loans. While
construction and land development loans represented 67% of our total loan
portfolio at September 30, 2008 they represented 95% of our non-performing
assets at that date. If current trends in the housing and real estate markets
continue, we expect that we will continue to experience increased
delinquencies and credit losses. Moreover, if a recession occurs we expect
that it would negatively impact economic conditions in our market areas and
that we could experience significantly higher delinquencies and credit losses.
An increase in our credit losses or our provision for loan losses would
adversely affect our financial condition and results of operations.
28
Liquidity risk could impair our ability to fund operations and jeopardize our
financial condition.
Liquidity is essential to our business. An inability to raise funds
through deposits, borrowings, the sale of loans and other sources could have a
substantial negative effect on our liquidity. Our access to funding sources in
amounts adequate to finance our activities or the terms of which are
acceptable to us could be impaired by factors that affect us specifically or
the financial services industry or economy in general. Factors that could
detrimentally impact our access to liquidity sources include a decrease in the
level of our business activity as a result of a downturn in the markets in
which our loans are concentrated or adverse regulatory action against us. Our
ability to borrow could also be impaired by factors that are not specific to
us, such as a disruption in the financial markets or negative views and
expectations about the prospects for the financial services industry in light
of the recent turmoil faced by banking organizations and the continued
deterioration in credit markets.
If external funds were not available, this could adversely impact our growth
and prospects.
We rely on retail deposits, brokered deposits, and advances from the
Federal Home Loan Bank ("FHLB") of Seattle and other borrowings to fund our
operations. Although we have historically been able to replace maturing
deposits and advances as necessary, we might not be able to replace such funds
in the future if, among other things, our results of operations or financial
condition or the results of operations or financial condition of the FHLB of
Seattle or market conditions were to change. In addition, if we fall below the
FDIC's thresholds to be considered "well capitalized" we will be unable to
continue with uninterrupted access to the brokered funds markets.
Although we consider these sources of funds adequate for our liquidity
needs, there can be no assurance in this regard and we may be compelled or
elect to seek additional sources of financing in the future. Likewise, we may
seek additional debt in the future to achieve our long-term business
objectives, in connection with future acquisitions or for other reasons.
There can be no assurance additional borrowings, if sought, would be available
to us or, if available, would be on favorable terms. If additional financing
sources are unavailable or not available on reasonable terms, our financial
condition, results of operations and future prospects could be materially
adversely affected.
We may elect or be compelled to seek additional capital in the future, but
that capital may not be available when it is needed.
We are required by federal and state regulatory authorities to maintain
adequate levels of capital to support our operations. In addition, we may
elect to raise additional capital to support our business or to finance
acquisitions, if any, or we may otherwise elect to raise additional capital.
In that regard, a number of financial institutions have recently raised
considerable amounts of capital as a result of a deterioration in their
results of operations and financial condition arising from the turmoil in the
mortgage loan market, deteriorating economic conditions, declines in real
estate values and other factors. Should we be required by regulatory
authorities or otherwise elect to raise additional capital, we may seek to do
so through the issuance of, among other things, our common stock or securities
convertible into our common stock, wich could dilute your ownership interest
in the Corporation.
Our ability to raise additional capital, if needed, will depend on
conditions in the capital markets, economic conditions and a number of other
factors, many of which are outside our control, and on our financial
performance. Accordingly, we cannot assure you of our ability to raise
additional capital if needed or on terms acceptable to us. If we cannot raise
additional capital when needed, it may have a material adverse effect on our
financial condition, results of operations and prospects.
There can be no assurance that recently enacted legislation and other measures
undertaken by the Treasury, the Federal Reserve and other governmental
agencies will help stabilize the U.S. financial system or improve the housing
market.
On October 3, 2008, President Bush signed into law the Emergency Economic
Stabilization Act of 2008 (the "EESA"), which, among other measures,
authorized the Treasury Secretary to establish the Troubled Asset Relief
Program ("TARP"). EESA gives broad authority to Treasury to purchase, manage,
modify, sell and insure the troubled mortgage related assets that triggered
the current economic crisis as well as other "troubled assets." EESA includes
additional provisions directed at bolstering the economy, including:
* Authority for the Federal Reserve to pay interest on depository
institution balances;
* Mortgage loss mitigation and homeowner protection;
29
* Temporary increase in Federal Deposit Insurance Corporation ("FDIC")
insurance coverage from $100,000 to $250,000 through December 31,
2009; and
* Authority to the Securities and Exchange Commission (the "SEC") to
suspend mark-to-market accounting requirements for any issuer or class
of category of transactions.
Pursuant to the TARP, the Treasury has the authority to, among other
things, purchase up to $700 billion (of which $250 billion is currently
available) of mortgages, mortgage-backed securities and certain other
financial instruments from financial institutions for the purpose of
stabilizing and providing liquidity to the U.S. financial markets. Shortly
following the enactment of EESA, the Treasury announced the creation of
specific TARP programs to purchase mortgage-backed securities and whole
mortgage loans. In addition, under the TARP, the Treasury has created a
capital purchase program, pursuant to which it proposes to provide access to
capital to financial institutions through a standardized program to acquire
preferred stock (accompanied by warrants) from eligible financial institutions
that will serve as Tier 1 capital.
EESA also contains a number of significant employee benefit and executive
compensation provisions, some of which apply to employee benefit plans
generally, and others which impose on financial institutions that participate
in the TARP program restrictions on executive compensation.
EESA followed, and has been followed by, numerous actions by the Federal
Reserve, Congress, Treasury, the SEC and others to address the currently
liquidity and credit crisis that has followed the sub-prime meltdown that
commenced in 2007. These measures include homeowner relief that encourage
loan restructuring and modification; the establishment of significant
liquidity and credit facilities for financial institutions and investment
banks; the lowering of the federal funds rate, including a 50 basis point
decrease on October 8, 2008; emergency action against short selling practices;
a temporary guaranty program for money market funds; the establishment of a
commercial paper funding facility to provide back-stop liquidity to commercial
paper issuers; coordinated international efforts to address illiquidity and
other weaknesses in the banking sector.
In addition, the Internal Revenue Service has issued an unprecedented
wave of guidance in response to the credit crisis, including a relaxation of
limits on the ability of financial institutions that undergo an "ownership
change" to utilize their pre-change net operating losses and net unrealized
built-in losses. The relaxation of these limits may make significantly more
attractive the acquisition of financial institutions whose tax basis in their
loan portfolios significantly exceeds the fair market value of those
portfolios.
On October 14, 2008, the FDIC announced the establishment of a temporary
liquidity guarantee program to provide insurance for all non-interest bearing
transaction accounts and guarantees of certain newly issued senior unsecured
debt issued by financial institutions (such as Horizon Bank), bank holding
companies and savings and loan holding companies (such as Horizon Financial).
Financial institutions are automatically covered by this program for the
30-day period commencing October 14, 2008 and will continue to be covered as
long as they do not affirmatively opt out of the program. Under the program,
newly issued senior unsecured debt issued on or before June 30, 2009 will be
insured in the event the issuing institution subsequently fails, or its
holding company files for bankruptcy. The debt includes all newly issued
unsecured senior debt (e.g., promissory notes, commercial paper and inter-bank
funding). The aggregate coverage for an institution may not exceed 125% of its
debt outstanding on September 30, 2008 that was scheduled to mature before
June 30, 2009. The guarantee will extend to June 30, 2012 even if the
maturity of the debt is after that date. Many details of the program still
remain to be worked out.
There can be no assurance as to the actual impact that EESA and such
related measures undertaken to alleviate the credit crisis will have generally
on the financial markets, including the extreme levels of volatility and
limited credit availability currently being experienced The failure of such
measures to help stabilize the financial markets and a continuation or
worsening of current financial market conditions could materially and
adversely affect our business, financial condition, results of operations,
access to credit or the trading price of our common stock.
We are subject to various regulatory requirements and may be subject to future
regulatory restrictions and enforcement actions.
In light of the current challenging operating environment, along with our
elevated level of non-performing assets, delinquencies, and adversely
classified assets, we may be subject to increased regulatory scrutiny,
regulatory restrictions, and potential enforcement actions. Such enforcement
actions could place limitations on our business and adversely affect our
ability to implement our business plans. Even though the Corporation remains
well-capitalized in terms of its capital ratios, the regulatory agencies have
the authority to restrict the Corporation's operations to those consistent
with adequately
30
capitalized institutions. For example, if the regulatory agencies were to
implement such a restriction, we would likely have limitations on our lending
activities and be limited in our ability to utilize brokered funds as a
funding source, an area that has been a source of funds for the Corporation in
recent years. In addition, the regulatory agencies have the power to limit the
rates paid by the Corporation to attract retail deposits in its local markets.
In addition, we may be required to provide notice to the FDIC regarding any
additions or changes to directors or senior executive officers and we would
not be able to pay certain severance and other forms of compensation without
regulatory approval. If any of these or similar restrictions are placed on
the Corporation, it would limit the resources currently available as a
well-capitalized institution. No assurances can be made that the regulatory
agencies will continue to consider the Corporation well-capitalized. In
addition, Horizon expects to be subject to higher regulatory assessments and
FDIC deposit insurance premiums than those prevailing in prior periods.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and
disruption for more than a year. In recent months, the volatility and
disruption has reached unprecedented levels. In some cases, the markets have
produced downward pressure on stock prices and credit availability for certain
issuers without regard to those issuers' underlying financial strength. If
current levels of market disruption and volatility continue or worsen, there
can be no assurance that we will not experience an adverse effect, which may
be material, on our ability to access capital and on our business, financial
condition and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Stock Repurchases
In March 2008, the Board of Directors approved a new stock repurchase
plan that runs concurrent with the 2009 fiscal year, allowing the Corporation
to repurchase up to 2.5% of total shares outstanding, or approximately 300,000
shares. This marked the Corporation's tenth stock repurchase plan. The
Corporation did not repurchase any shares during the three and six months
ended September 30, 2008. Management does not intend to repurchase shares
under the current plan in the near term.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
As previously announced on October 24, 2008, Greg B. Spear has
been hired to be Chief Financial Officer of the Corporation.
Mr. Spear will begin employment with the Corporation on
November 13, 2008.
Item 6. Exhibits
(a) Exhibits
--------
(3.1) Articles of Incorporation of Horizon Financial, Corp.
(incorporated by reference to Exhibit 3.1 to the
Registrant's Current Report on Form 8-K dated October 13,
1995)
(3.2) Bylaws of Horizon Financial Corp. (incorporated by
reference to Exhibit 3.2 to the Registrant's Current
Report on Form 8-K dated October 13, 1995)
(10.1) Amended and Restated Employment Agreement with V.
Lawrence Evans (incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended March 31, 1996)
(10.2) Deferred Compensation Plan (incorporated by reference to
the Registrant's Annual Report on Form 10-K for the year
ended March 31, 1996)
(10.3) Bank of Bellingham 1993 Employee Stock Option Plan
(incorporated by reference to Exhibit 99 to the
Registrant's Registration Statement on Form S-8 (File No.
33-88571)
(10.4) Severance Agreement with Dennis C. Joines (incorporated
by reference to the Registrant's Annual Report on Form
10-K for the year ended March 31, 2002)
(10.5) Severance Agreement with Richard P. Jacobson, as amended
(incorporated by reference to the Registrant's Current
Report on Form 8-K dated January 23, 2008)
31
(10.6) Severance Agreement with Steven L. Hoekstra (incorporated
by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2002)
(10.7) Stock Incentive Plan (incorporated by reference to
Exhibit 99 to the Registrant's Registration Statement on
Form S-8 (File No. 333-127178))
(10.8) Form of Incentive Stock Option Award Agreement under the
2005 Stock Incentive Plan (incorporated by reference to
Exhibit 99.1 contained in the Registrant's Current Report
on Form 8-K dated July 27, 2005)
(10.9) Form of Non-qualified Stock Option Award Agreement under
the 2005 Stock Incentive Plan (incorporated by reference
to Exhibit 99.1 contained in the Registrant's Current
Report on Form 8-K dated July 27, 2005)
(10.10) Form of Restricted Stock Award Agreement under the 2005
Stock Incentive Plan (incorporated by reference to
Exhibit 99.1 contained in the Registrant's Current Report
on Form 8-K dated July 27, 2005)
(10.11) Form of Salary Continuation Agreement between Horizon
Bank and Executive Officers Steven L. Hoekstra, Richard
P. Jacobson and Dennis C. Joines (incorporated by
reference to Exhibit 99.1 contained in the Registrant's
current Report on Form 8-K dated June 27, 2006)
(10.12) Amended Salary Continuation Agreement between Horizon
Bank and Richard P. Jacobson (incorporated by reference
to Exhibit 10.1 contained in the Registrant's Current
Report on Form 8-K dated January 23, 2008)
(10.13) Transition agreement with V. Lawrence Evans (incorporated
by reference to the registrant's Current Report on Form
8-K dated March 25, 2008)
(14) Code of Ethics (incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended March 31, 2007)
(31) Certification of Chief Executive Officer and Chief
financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act
(32) Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORIZON FINANCIAL CORP.
By: /s/ Richard P. Jacobson
------------------------------------
Richard P. Jacobson
President, Chief Executive Officer &
Chief Financial Officer (Interim)
Dated: November 7, 2008
-------------------
33
Exhibit Index
-------------
Exhibit 31.1 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Exhibit 32 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
34
Exhibit 31.1
Certification
I, Richard P. Jacobson, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Horizon Financial
Corp;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the
period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles.
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. I have disclosed, based on our most recent evaluation of internal control
over financial reporting, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing
the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 7, 2008 /s/ Richard P. Jacobson
-----------------------------------
Richard P. Jacobson
President, Chief Executive Officer &
Chief Financial Officer (Interim)
35
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF
HORIZON FINANCIAL CORP.
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
Section 1350), the undersigned hereby certifies in his capacity as an officer
of Horizon Financial Corp. (the "Company") and in connection with this
Quarterly Report on Form 10-Q ("Report"), that:
1. the report fully complies with the requirements of Sections 13(a) and
15(d) of the Securities Exchange Act of 1934, as amended, and
2. the information contained in the report fairly presents, in all
material respects, the Company's financial condition and results of
operations, as of the dates and for the periods presented in the
financial statements included in the Report.
/s/ Richard P. Jacobson
- -------------------------------------
Richard P. Jacobson
President, Chief Executive Officer &
Chief Financial Officer (Interim)
Dated: November 7, 2008
36