Item 1. Business - -----------------
(a) General -------
Horizon Financial Corp. ("Horizon Financial" or the "Corporation") was formed under Washington law on May 22, 1995, and became the holding company for Horizon Bank ("Horizon Bank" or the "Bank"), effective October 13, 1995. Effective June 19, 1999 the Corporation completed the acquisition of Bellingham Bancorporation, a $64.3 million, bank holding company for the Bank of Bellingham, which was merged with and into Horizon Bank. At March 31, 2002, the Corporation had total assets of $772.1 million, total deposits of $628.8 million and total equity of $100.6 million. The Corporation's business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to the Bank and its subsidiary.
The Bank was organized in 1922 as a Washington State chartered mutual savings and loan association and converted to a federal mutual savings and loan association in 1934. In 1979, the Bank converted to a Washington State chartered mutual savings bank, the deposits of which are insured by the Federal Deposit Insurance Corporation ("FDIC"). On August 12, 1986, the Bank converted to a state chartered stock savings bank under the name "Horizon Bank, a savings bank". The Bank became a member of the Federal Home Loan Bank ("FHLB") of Seattle in December 1998. Effective March 1, 2000, the Bank changed its name to its current title, "Horizon Bank".
The Bank's operations are conducted through 15 full-service office facilities, located in Whatcom, Skagit and Snohomish counties in Northwest Washington. The acquisition of Bellingham Bancorporation increased Horizon Financial's and Horizon Bank's presence in Whatcom County. During fiscal 2000, the Bank opened an additional office in Whatcom County, located in the Barkley Village area of Bellingham, in the northeast portion of the city. In addition to serving the growing population in this area, this office serves as an operation center to support additional growth for the Corporation. The Bank also completed construction of a new office building at Murphy's Corner near Mill Creek, which replaced the Bank's leased location in that area. During fiscal 2000, the Bank purchased a bank site in Marysville, which will provide additional growth opportunities. In fiscal 2002, the Bank acquired a bank site in Lynnwood, Washington. The Bank is currently working on remodeling and upgrading this building, and anticipates opening for business in the fall of 2002.
At its October 24, 2000 meeting, the Board of Directors authorized a new repurchase plan for up to 10% (approximately 897,000, as restated) of the Corporation's outstanding common stock over a 24 month period. During the fiscal year ended March 31, 2002, the Corporation repurchased 327,952 shares of its Common Stock, compared to the repurchase of 683,790 shares of Common Stock during the prior year. The Corporation had repurchased an aggregate of 443,527 shares under this plan as of March 31, 2002.
Recent Developments - -------------------
Management. On April 23, 2002, Dennis C. Joines, was named President and Chief Operating Officer of Horizon Bank. V. Lawrence Evans, who has served as President of Horizon Bank since 1990 will continue to serve as Chairman of the Board and Chief Executive Officer of Horizon Bank and President and Chief Executive Officer of Horizon Financial. For additional information regarding Mr. Joines, see Part III, Item 10, Directors and Executive Officers of the Registrant, contained in this Form 10-K.
Recently Issued Accounting Standards. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141 entitled Business Combinations and SFAS No. 142 entitled Goodwill and Other Intangible Assets. These statements address how intangible assets that are acquired individually, with a group of other assets or in connection with a business combination, should be accounted for in financial statements upon and subsequent to their acquisition. These standards apply to all business combinations
initiated after June 30, 2001 and are effective for fiscal years beginning after December 15, 2001. The Corporation has evaluated the impact that these statements might have on its financial position and results of operations, and does not expect such impact to be material.
In June 2001, the FASB issued SFAS No. 143 entitled Accounting for Asset Retirement Obligations. This statement establishes the accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This standard is effective for fiscal years beginning after June 15, 2002. The Corporation is currently evaluating the impact that this statement will have on their financial position and results of operations, however they do not expect such impact to be material.
In August 2001, the FASB issued SFAS No. 144 entitled Accounting for the Impairment or Disposal of Long-Lived Assets. This statement supercedes SFAS No. 121 and establishes financial accounting and reporting requirements for the impairment and disposal of long-lived assets. This standard is effective for fiscal years beginning after December 15, 2001. The Corporation is currently evaluating the impact that this statement will have on their financial position and results of operations, however they do not expect such impact to be material.
Lending Activities - ------------------
General. The Bank's loan portfolio totaled $568,303,481 at March 31, 2002, representing approximately 73.61% of its total assets. On that date, 42.45% of total outstanding loans consisted of loans secured by mortgages on single family residential properties, 5.76% of the loans consisted of loans secured by two-to- four unit residential properties, 4.69% of total outstanding loans consisted of loans secured by mortgages on over four unit residential properties, and 43.15% of total outstanding loans consisted of commercial loans and commercial real estate loans. The balance of the Bank's outstanding loans at that date consisted of secured consumer loans and loans secured by savings deposits.
The Bank originates both fixed rate and adjustable rate mortgages ("ARMs") secured by residential, business, and commercial real estate, the majority of which include building improvements.
The Bank has no significant concentration of credit risk other than that a substantial portion of its loan portfolio is secured by real estate located in the Bank's primary market area, which the Bank considers to be Whatcom, Skagit and Snohomish Counties in Washington. This concentration of credit risk could have a material adverse effect on the Bank's financial condition and results of operations to the extent there is a material deterioration in the counties' economic and real estate values.
In order to have the ability to make the yields on its loan portfolio and investments more interest rate sensitive, the Bank has implemented a number of measures. Those measures include: (i) adoption of a policy under which the Bank generally originates long-term, fixed-rate mortgage loans when such loans are written to specifications promulgated by the Federal Home Loan Mortgage Corporation ("FHLMC") and qualify for sale in the secondary market, (ii) origination of ARM loans on residential and commercial properties subject to market conditions, (iii) origination of variable rate commercial and consumer loans, and (iv) increased emphasis on originating shorter term loans for its portfolio, and selling much of its long-term mortgage loan production into the secondary market.
Loan Maturity. The following table sets forth certain information at March 31, 2002 regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances are net of undisbursed loan proceeds, unearned discounts, unearned income and allowance for loan losses.
Due After Due Within 1 Through Due Over One Year After 5 Years After 5 Years After March 31, 2002 March 31, 2002 March 31, 2002 Total -------------- -------------- -------------- ----- (In thousands)
Commercial, financial and agricultural... $ 57,805 $ 23,281 $ 80,041 $161,127 Real estate construction....... -- -- 29,958 29,958 Real estate-mortgage, installment and other.............. 42,146 68,621 266,451 377,218 -------- -------- -------- -------- Total........... $ 99,951 $ 91,902 $376,450 $568,303 ======== ======== ======== ========
The following table sets forth the dollar amount of all loans due within one year after March 31, 2002 which have fixed interest rates and have floating or adjustable interest rates. Loan balances do not include undisbursed loan proceeds, unearned discounts, unearned income, and allowance for loan losses.
Adjustable Fixed Rates Rates Total ----------- ---------- ----- (In thousands)
Commercial, financial and agricultural.................... $13,141 $44,664 $57,805 Real estate construction........... -- -- -- Real estate-mortgage, installment and other....................... 32,744 9,402 42,146 ------- ------- ------- Total......................... $45,885 $54,066 $99,951 ======= ======= =======
Residential Loans. The primary lending activity of the Bank has historically been the granting of conventional loans to enable borrowers to purchase existing homes or construct new homes. The Bank's real estate loan portfolio also includes loans on two-to-four family dwellings, multi-family housing (over four units), and loans made to purchase or refinance improved buildings to be used for residential housing. At March 31, 2002, approximately 52.9% of the Bank's total loan portfolio consisted of loans secured by residential real estate.
The Bank's lending practices generally limit the maximum loan-to-value ratio on one-to-four family residential mortgage loans to 97% of the appraised value as determined by an independent appraiser, with the condition that private mortgage insurance generally be required on any home loans with loan-to-value ratios in excess of 80% of the appraised value. The Bank places this insurance with carriers approved by the FHLMC. The coverage generally limits the Bank's exposure to 72% of the loan amount. If private mortgage insurance is required, the borrower pays the premium at loan closing and any recurring premiums through an escrow reserve account established with the Bank for such period of time as the Bank requires the insurance coverage to be in force. Multi-family residential and commercial real estate loans and unimproved real estate loans generally do not exceed 80% of appraised value.
The Bank presently originates both fixed-rate and ARMs secured by one-to-four family properties with a loan term not exceeding 30 years. Under certain conditions, ARM borrowers are allowed to convert beginning on the first interest rate change date and ending on the fifth interest rate change date from the date of the loan note. In addition, certain consumer safeguards are built into the ARM instruments used by the Bank. These safeguards include limits on annual and lifetime interest rate adjustments. The Bank generally originates these loans in accordance with guidelines established by the FHLMC. For the fiscal year ended March 31, 2002, adjustable mortgage loans totalled $14,386,260 or 5.75% of total originations as compared to $515,600 or .34% of total originations for the year ended March 31, 2001.
Construction Loans. The Bank also provides construction financing for single-family dwellings and to a lesser extent makes land acquisition and development loans on properties intended for residential use. The interest rate charged by the Bank on these loans varies depending upon the type of security property and the creditworthiness of the borrower. At March 31, 2002, the Bank had $85,705,046, or 14.05% of total loans outstanding in construction loans, as compared to $57,080,355, or 8.98% of total loans at March 31, 2001. At March 31, 2002, $55,746,760 or 65.04% of the construction loan portfolio consisted of "speculative" construction loans (i.e., loans on dwellings for which there is not an underlying contract for sales).
Construction lending is generally considered to involve a higher level of risk as compared to one-to-four family residential permanent lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimate of value proves to be inaccurate, the Bank may be confronted at, or prior to, the maturity of the loan, with a project whose value is insufficient to assure full repayment. Loans for the construction of speculative homes carry more risk because the payoff for the loan is dependent on the builder's ability to sell the property prior to the time that the construction loan is due.
Multi-Family, Business and Commercial Loans. These types of loans constituted $236,144,893 or approximately 38.70% of Horizon Bank's loan portfolio at March 31, 2002. These loans include fixed rate and adjustable rate mortgages secured by apartment buildings (i.e., those containing five or more living units) and business and commercial properties. The Bank generally requires that such loans have a debt service coverage of 1.20 to 1 with a loan-to-value ratio not exceeding 80%. Fixed-rate loans generally have a three to 15-year loan term, with payments based upon a 15 to 30-year amortization schedule.
At March 31, 2002, $44,664,042 of loans secured by income-producing properties have an interest rate which adjusts based upon changes in an index of United States Treasury securities published by the Board of Governors of the Federal Reserve System ("Federal Reserve") or other widely recognized indices.
Multi-family residential and business and commercial real estate lending is generally considered to involve a higher degree of risk than permanent residential one-to-four family lending. Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy generally. Horizon Bank generally attempts to mitigate the risks associated with multi-family commercial and residential real estate lending by, among other things, lending on collateral located in its market area and generally to individuals who reside in its market.
The Bank's loan portfolio also includes a wide range of commercial loans to small and medium sized businesses. This portfolio presently includes lines of credit with floating rates and maturities of one year or less and term loans for the purchase of equipment, real estate and other operating purposes with maturities generally not exceeding ten years. These loans are secured by a variety of business assets including equipment, real estate, accounts receivable and inventory. Under certain conditions, the Bank also offers unsecured credit to qualified borrowers.
Commercial lending carries increased risks compared to residential mortgage lending due to the heavy reliance upon the future income of the customer and the uncertain liquidation value of the collateral. In the event of default, the liquidation of collateral is often insufficient to cover the outstanding debt. To mitigate these inherent risks, the Bank combines a conservative lending policy with experienced lending personnel responsible for the ongoing management of their assigned accounts.
Consumer Loans. The Bank makes a variety of loans for consumer purposes. Included among these are home equity loans, home equity lines of credit, loans secured by personal property, such as automobiles, boats, and other vehicles, loans secured by deposit accounts, unsecured loans, and loans for mobile homes located in parks.
Horizon Bank actively markets consumer loans in order to provide a wider range of financial services to its customers and to achieve shorter terms and higher interest rates normally typical of such loans. At March 31, 2002, the Bank held $24,136,593 of consumer loans.
Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles, boats and other vehicles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Consumer loans are made based on an evaluation of the borrower's creditworthiness, including income, other indebtedness, and satisfactory credit history, and the value of the collateral. Designated managers or Loan Committee members approve consumer loan requests.
Secured loan amounts typically do not exceed 80% of the value of the collateral, or 80% of the appraised value of the residence in the case of home equity loans.
Loan Solicitation and Processing. The primary sources for loan originations are attributable to deposit customers, current borrowers, walk-in customers, and referrals from existing customers, real estate agents, and builders. The Bank does not actively utilize mortgage brokers in the origination of loans.
The Bank accepts completed loan applications from all of its branches. Processing is substantially centralized in the main office of the Bank. Detailed information is obtained to determine the creditworthiness of the borrower and the borrower's ability to repay. The more significant items appearing on the applications and accompanying material are verified through the use of written credit reports, financial statements, and confirmations. After analysis of the loan application, supporting documents and the property to be pledged as loan security, including an appraisal of the property by either a staff appraiser or an independent fee appraiser, the application is forwarded to the Bank's Loan Committee. Loan approval requires the signatures of two members of the Loan Committee. The Loan Committee consists of officers of the Bank who are appointed by the Bank's Board of Directors. The Bank generally requires its mortgage notes to be co-signed individually by the principals on loans made to entities other than natural persons. Certain lending personnel have been given limited loan approval authority by the Board of Directors covering secondary market quality loans not exceeding 80% to value.
Loan assumption requests of adjustable rate loans are handled by the Bank in a manner similar to new loan requests. FHLMC standards are generally applied to each request and full credit underwriting is required. For fixed rate loans, a sale or transfer of the secured property generally results in the Bank enforcing its due on transfer rights contained in the mortgage instrument.
Residential Loan Originations, Purchases and Sales. Currently, the Bank emphasizes the origination of 15 to 30 year fixed rate loans on terms and conditions which will permit them to be sold in the secondary market, while originating ARM loans and shorter term fixed-rate loans for its own portfolio.
In addition to originating loans, Horizon Bank may purchase real estate loans in the secondary market. The Bank's purchases in the secondary market depend upon the demand for mortgage credit in the local market area and the inflow of funds from traditional sources. Loan purchases enable the Bank to utilize funds more quickly, particularly where sufficient loan demand is not obtainable locally.
The Bank is a qualified servicer for both FHLMC and Fannie Mae. The Bank's general practice is to close its fixed-rate, one-to-four family residential loans on FHLMC loan documents in order to facilitate future sales to the mortgage corporation as well as to other institutional investors. From time to time, depending upon interest rates and economic conditions, the Bank has sold participation interests in loans in order to provide additional funds for lending, to generate servicing fee income and to decrease the dollar amount of its intermediate and long-term fixed-rate loans. The sale of loans in the secondary mortgage market reduces the Bank's interest rate risk and allows the Bank to continue to make loans during periods when savings flows decline or funds are otherwise unavailable for lending purposes. As of March 31, 2002, the Bank was servicing loans for others aggregating approximately $228,874,332 for which it generally receives a fee payable monthly of .25% to ...375% per annum of the unpaid balance of each loan. In February 2001, the Bank began selling much of its current loan production on a servicing released basis, and plans to continue doing so for many of the long-term fixed rate loan originations. All sales of loan interests by the Bank are made without right of recourse to the Bank by the buyer of the loan interests in the event of default by the borrower.
Loan Commitments. Horizon Bank issues commitments to originate conventional mortgage loans on existing residential dwellings. Loan commitments are made for periods up to 60 days from the date of loan application and are
generally based upon the prevailing market rate at the time of application. At March 31, 2002, such commitments amounted to $6,046,650.
Loan Origination and Other Fees. In addition to interest earned on loans, the Bank receives loan origination fees for originating loans. Loan origination fees are a percentage of the principal amount of the mortgage loan which are charged to the borrower at the closing of the loan.
The Bank's loan origination fees are generally 0% to 2.5% on conventional residential mortgages and 1.0% to 2.0% for commercial real estate loans. The total amount of deferred loan origination fees and unearned discounts at March 31, 2002 was $5,612,704. Any unamortized loan fees are recognized as income at the time the loan is sold or paid off.
Income from loan origination and commitment fees varies with the volume and type of loans and commitments made and purchased and with competitive conditions in mortgage markets, which in turn responds to the demand for and availability of money. The Bank experiences an increase in loan fee income and other fee income, such as appraisal and loan closing fees, during periods of low interest rates due to the resulting demand for mortgage loans. The Bank also receives other fees and income from charges relating to existing loans, which include late charges, and fees collected in connection with a change in terms or other loan modifications. These fees and charges have not constituted a material source of income.
Loan Modifications. The Bank offers a loan modification program to assist customers who are considering refinancing their home loans. For a fee the Bank will modify customers' loans under the program. No new principal is required and only the interest rate and payment amounts are changed. All other terms and conditions remain the same. In fiscal 2002, the Bank modified $14,968,652 of real estate loans, compared to $20,842,647 in fiscal 2001.
Delinquent Loans, Loans in Foreclosure and Foreclosed Property. Real estate loans are defined as delinquent when any payment of principal and/or interest is past due. While the Bank generally is able to work out a satisfactory repayment schedule with a delinquent borrower, the Bank will undertake foreclosure proceedings if the delinquency is not otherwise resolved within 90 days. Property acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as "real estate owned" until such time as it is sold or otherwise disposed of. At March 31, 2002, the Bank had 11 loans over 90 days delinquent and one real estate owned with a balance of $957,775. Management does not anticipate incurring material losses from these loans. As of March 31, 2001, the Bank had one borrower who had loans totaling approximately $17,000,000. Subsequent to the prior year end the borrower had become late on two regularly scheduled payments and had acknowledged that it had current temporary working capital shortages. As of March 31, 2002, conditions have improved sufficiently that the loan is no longer considered impaired.
The following table sets forth information with respect to the Bank's non-performing assets at the dates indicated.
At March 31, ------------------------------------------------------ 2002 2001 2000 1999 1998 --------- --------- ---------- --------- ---------
Non-accrual loans..... $ -- $ -- $ 455,000 $ -- $ 138,000 Loans 90 days or more delinquent and accruing interest.... 618,346 832,299 456,729 383,000 30,345 Restructured loans.... -- -- -- -- -- Real estate acquired through foreclosure.. 339,429 -- 323,468 -- -- --------- --------- ---------- --------- --------- Total............... $ 957,775 $ 832,299 $1,235,197 $ 383,000 $ 168,345 ========= ========= ========== ========= =========
As a percentage of net loans............ 0.17% 0.14% 0.21% 0.07% 0.04% As a percentage of total assets......... 0.12% 0.11% 0.17% 0.06% 0.03%
The Bank had no non-accrual loans for the year ended March 31, 2002 and, therefore, no interest income was recorded on nonaccrual loans for the year ended March 31, 2002.
Reserves for Losses. The Bank operates under a general loan loss reserve system. The provision for loan losses is maintained at a level sufficient to provide for estimated loan losses based on evaluating known and inherent risks in the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. The reserve is based upon factors and trends identified by management at the time financial statements are prepared, but the ultimate recovery of loans is susceptible to future market factors beyond the Bank's control, which may result in losses or recoveries differing significantly from those provided for in the financial statements.
The Bank maintains an allowance for credit losses sufficient to absorb losses inherent in the loan portfolio. The Bank has established a systematic methodology to ensure that the allowance is adequate. The Bank reviews the following information, on a quarterly basis, to estimate the necessary additions to its loan loss reserve:
- All loans classified during the previous analysis. Current informa- tion as to payment history, or actions taken to correct the deficiency are reviewed, and changes are made, as appropriate. If conditions have not improved, the loan classification is reviewed to ensure that the appropriate action is being taken to mitigate loss.
- All loans past due on scheduled payments. The Bank reviews all loans that are past due 30 days or more, taking into consideration the borrower, nature of the collateral and its value, the circumstances that have caused the delinquency, and the likelihood of the borrower correcting the conditions that have resulted in the delinquent status.
- Composition of the Bank's portfolio. The Bank also analyzes its mix of loans when establishing appropriate allowances for loan losses. For example, reserves for losses on the Bank's one-to-four family mortgage portfolio (on a percentage basis) are lower than the percentage reserve estimates for commercial or credit card loans. Therefore, the Bank's allowance for loan losses is likely to change, as the composition of the Bank's loan portfolio changes.
- Current economic conditions. The Bank takes into consideration economic condition in its market area, the state's economy, and national economic factors that could influence the quality of the loan portfolio in general.
- Trends in the Bank's delinquencies. Prior period statistics are reviewed and evaluated to determine if the current conditions warrant changes to the Bank's loan loss allowance.
The amount that is to be added to allowance for loan losses is based upon a variety of factors. Many financial institutions establish required reserves based, to a great extent, upon their own experience. The Bank's loan portfolio has traditionally consisted primarily of loans secured by single family homes, and as a result, the loss experience has been minimal.
Each individual loan, previously classified by management, or newly classified during the quarterly review, is evaluated for loss potential, and a specific amount or percentage deemed to be at risk is added to the overall required reserve amount. For the remaining portion of the portfolio, a reserve factor is applied that is consistent with the Bank's experience in that portfolio or with industry guidelines if management believes such guidelines are more appropriate. The applied percentage is also influenced by other economic factors as noted in the beginning of this section.
The calculated amount is compared to the actual amount recorded in the allowance at the end of each quarter and a determination is made as to whether the allowance is adequate. Management increases the amount of the allowance for loan losses by charges to income and decreases the amount by loans charged off (net of recoveries).
The following comments represent management's view of the risks inherent in each portfolio category.
- One- to Four-Family Residential - Market conditions in the Bank's primary market area have, over the long term, supported a stable or increasing market value of real estate. Absent an overall economic downturn in the economy, experience in this portfolio indicates that losses are minimal provided the property is reasonably maintained, and marketing time to resell the property is relatively short.
- Multi-Family Residential - While there have been minimal losses taken in this segment of the portfolio, the rental market is susceptible to the effects of an economic downturn. While the Bank monitors loan-to-value ratios, the conditions that would create a default would carry through to a new owner which may require that the Bank discount the property or hold it until conditions improve.
- Commercial Real Estate - As with multi-family loans, the classifi- cation of commercial real estate loans closely corresponds to economic conditions which will limit the marketability of the property, resulting in higher risk than a loan secured by a single-family residence. Commercial real estate loans have historically been assigned higher reserve levels than one-to-four family residential loans, but lower than commercial business loans.
- Commercial Business Loans - These types of loans carry a higher degree of risk, relying on the ongoing success of the business to repay the loan. Collateral for commercial credits is often difficult to secure, and even more difficult to liquidate in the event of a default. If a commercial business loan demonstrates any credit weakness, the reserve is increased to recognize the additional risk.
- Consumer Loans - The consumer loan portfolio has a wide range of factors, determined primarily by the nature of the collateral and the credit history and capacity of the borrower. The loans tend to be smaller in principal amount and secured by second deeds of trust, automobiles, boats, and other vehicles. Loans for automobiles, boats, and other vehicles, generally experience higher than average wear in the environment and hold a higher degree of risk of loss in the event of repossession.
- Unsecured Credit Cards - Due to the unsecured nature of these accounts, these types of loans represent the highest degree of risk. The Bank, therefore, uses a higher percentage factor than any other loan classification, when estimating future potential loan losses.
Management believes that the allowance for loan losses at March 31, 2002 was adequate at that date. Although management believes that it uses the best information available to make these determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations.
While the Bank believes it has established its existing allowance for loan losses in accordance with generally accepted accounting principles, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase significantly its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect the Bank's financial condition and results of operations.
The Bank established an allowance for losses for the year ended March 31, 2002 in the amount of $5,887,482 and $4,976,670 for the year ended March 31, 2001. The Bank's loan loss reserve as of March 31, 2002, is approximately 1.04% of net loans receivable.
The Bank had an allowance of $50,000, $0, $0, $0 and $0 for real estate acquired through foreclosure at March 31, 2002, 2001, 2000, 1999 and 1998.
Investment Activities - ---------------------
Under Washington law, savings banks are permitted to own U.S. government and government agency obligations, commercial paper, corporate bonds, mutual fund shares, debt and equity obligations issued by creditworthy entities, whether traded on public securities exchanges or placed privately for investment purposes. The Bank holds a diverse portfolio of money market instruments, United States Treasury obligations, federal agency securities, municipal securities, common stock, preferred stock and corporate notes.
The FDIC has adopted the Federal Financial Institutions Examination Council statement of policy on securities activities and accounting procedures. This policy requires that institutions establish prudent policies and strategies for securities activities, identify certain securities trading practices that are unsuitable for an investment portfolio, recommends procedures for selection of a securities dealer, and limits investment in high risk mortgage securities and disproportionately large holdings of long-term zero coupon bonds.
The policy addresses concerns about speculative or other non-investment activities in the securities investment portfolios of depository institutions. Speculative securities activities can impair earnings or capital and, in some cases, may cause the failure of the institution. The policy establishes a framework for structuring securities activities and clarifies various accounting issues concerning investment accounts versus trading accounts.
The amortized cost of the above investments at March 31, 2002 was $40,986,703 compared to a market value of $46,747,346. For further information concerning the Bank's investment securities portfolio, see Note 3 of the Notes to the Consolidated Financial Statements contained in the Corporation's Proxy Statement for the 2002 Annual Meeting of Stockholders ("Proxy Statement").
The Bank also invests in mortgage-backed securities. At March 31, 2002, such securities had an amortized cost of $33,863,426 and a market value of $34,589,484.
The following table presents the amortized cost of the Bank's investment securities portfolio and short-term investments. The market value of the Bank's investment securities portfolio at March 31, 2002 was approximately $81,336,830. This does not include interest-bearing deposits and cash equivalents.
At March 31, ------------------------------------ 2002 2001 2000 -------- -------- -------- (In thousands) Investment securities: U.S. Government: Available for sale.............. $ 23,587 $ 4,879 $ 4,812 Held to maturity................ 369 369 369 -------- -------- -------- 23,956 5,248 5,181
Asset-backed securities(1): Available for sale.............. 29,453 46,978 52,974 Held to maturity................ 4,410 6,530 8,249 -------- -------- -------- 33,863 53,508 61,223
Other securities(2): Available for sale.............. 17,031 10,988 6,124 Held to maturity................ -- -- 500 -------- -------- -------- 17,031 10,988 6,624 -------- -------- -------- Total investments.............. 74,850 69,744 73,028
Interest bearing deposits and cash equivalents................ 83,962 24,508 20,004 -------- -------- -------- $158,812 $ 94,252 $ 93,032 ======== ======== ========
- ----------------- (1) Consists of mortgage-backed securities and CMO's. (2) Consists of corporate debt securities and marketable equity securities.
At March 31, 2002, the Bank did not have any investment securities (exclusive of obligations of the U.S. Government and federal agencies) issued by any one entity with a total book value in excess of 10% of stockholders' equity.
Savings Activities and Other Sources of Funds
General. Savings accounts and other types of deposits have traditionally been an important source of the Bank's funds for use in lending and for other general business purposes. In addition to deposit accounts, the Bank derives funds from loan repayments, loan sales, and other borrowings and operations. The availability of funds from loan sales is influenced by general interest rates and other market conditions. Loan repayments are a relatively stable source of funds while deposit inflows and outflows vary widely and are influenced by prevailing interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in deposits or deposit inflows at less than projected levels and may be used on a longer term basis to support expanded lending activities.
Deposits. Horizon Bank offers several deposit accounts, including Regular Passbook and Statement Savings Accounts, Personal and Business Checking Accounts, Money Market with and without Check Access and Certificates of Deposit Accounts with maturities ranging from 30 days up to 10 years. Certificates of Deposit account requirements vary according to minimum principal balances, the time period the funds must remain on deposit and the interest rate determined for each term and minimum balance.
The following table sets forth certain information concerning the deposits at the Bank.
The following table indicates the amount of the Bank's deposits by time remaining until maturity as of March 31, 2002 of $100,000 or more.
Certificates Maturity Period of Deposit ------------------------------------ ---------- (In thousands)
Three months or less................ $ 31,668 Three through six months............ 29,363 Six through twelve months........... 28,661 Over twelve months.................. 34,170 -------- Total............................. $123,862 ========
The Bank has a number of different programs designed to attract both short-term and long-term savings of the general public by providing a wide assortment of accounts and rates. The program includes traditional passbook accounts; nonnegotiable time deposits with minimum deposits of $100,000 and terms of 30 days to five years called Jumbo Certificates of Deposit; nonnegotiable, nontransferable time deposits with minimum deposits of $500 and terms from 30 days to five years at fixed rates; 12-month to 10-year variable rate fixed term certificates; Individual Retirement Accounts (IRAs); Qualified Retirement Plans; transaction accounts such as regular checking; MMDAs with and without limited check access.
The Bank's practice on early withdrawal penalties is applicable only to time deposits. Management believes that in periods of rising interest rates this practice will discourage depositors from making premature withdrawals for the purpose of reinvesting in higher rate time deposits.
The minimum amount required to open a time deposit varies from $500 to $100,000, depending on the type of time deposit. Pricing of rates on time deposits with maturities from 30 days to 10 years are determined periodically by the Bank, based upon competitive rates and local market rates, national money market rates, and yields on assets of the same maturity.
The Bank's personal MMDA currently has a $1,000 minimum deposit and has a tiered pricing program, with interest rates that vary by account dollar balance -- $2,500, $10,000, $25,000, $50,000 and higher. The Bank's Business MMDA has tiers of $2,500, $10,000, $50,000, $100,000 and higher, with a $1,000 minimum deposit. These accounts have no maturity requirements, no regulatory interest rate ceilings, and limited check writing privileges. The interest rates on these accounts are adjusted by the Bank periodically, based on money market conditions. The Bank currently has a $10,000 minimum deposit (MMK) money market and has a tiered pricing program, with interest rates that vary by account dollar balance -- $10,000, $25,000, $50,000 and higher. The Bank also offers a $25,000 minimum deposit (ULT PLUS) money market and has a tiered pricing program, with interest rates that vary by account dollar balance -- $25,000, $50,000, $100,000 and higher. These accounts have no maturity requirements, no regulatory interest rate ceiling, and no check writing privileges. The interest rates on the account are adjusted by the Bank periodically or as dictated by money market conditions.
The large variety of deposit accounts offered by the Bank has increased the Bank's ability to retain deposits and has allowed it to be competitive in obtaining new funds, although the threat of disintermediation (the flow of funds away from the Bank into direct investment vehicles, such as common stocks and mutual funds) still exists. The ability of the Bank to attract and retain deposits and the Bank's cost of funds have been, and will continue to be, significantly affected by capital and money market conditions.
Horizon Bank attempts to control the flow of deposits by pricing its accounts to remain competitive with other financial institutions in its market area but does not necessarily seek to match the highest rates paid by competing institutions.
The senior officers of the Bank meet periodically to determine the interest rates which the Bank will offer to the general public. Such officers consider the amount of funds needed by the Bank on both a short-term and long-term basis, the rates being offered by the Bank's competitors, alternative sources of funds and the projected level of interest rates in the future.
The Bank's deposits are obtained primarily from residents of Northwest Washington. Horizon Bank attracts deposits by offering a wide variety of services and convenient branch locations and service hours. The Bank has not solicited brokered deposits and has no present intention to attract such deposits in the future.
For further information concerning the Bank's savings deposits, reference is made to Note 9 of the Notes to the Consolidated Financial Statements contained in the Corporation's Proxy Statement.
Borrowings. In December 1998, the Bank joined the Federal Home Loan Bank of Seattle providing access to a variety of wholesale funding options. In addition, the Bank's security portfolio provides additional borrowing capacity in the reverse repurchase markets. The Bank also has other borrowed funds in the form of retail repurchase agreements. The agreements are collateralized by securities held by a safekeeping agent not under control of the Bank. These advances are considered overnight borrowings bearing interest rates that fluctuate daily based on current market rates. At March 31, 2002, the Bank had $29.1 million in borrowings, compared to $22.9 million at March 31, 2001 and $39.9 million in borrowings during the year ended 2000. Access to these wholesale borrowings allows management to meet cyclical funding needs, and assists in interest rate risk management efforts.
The following tables set forth information regarding borrowings by the Bank at the end of and during the periods indicated. The tables includes both short-term and long-term borrowings unless noted otherwise.
For the Year Ended March 31, ------------------------------------ 2002 2001 2000 ------- ------- ------- (Dollars in thousands) Maximum amount of borrowings outstanding at any month end......$35,857 $55,865 $39,853 Approximate average borrowings outstanding....................... 27,131 44,817 29,192 Approximate weighted average rate paid......................... 5.69 6.73 5.64
At March 31, ------------------------------------ 2002 2001 2000 ------- ------- ------- (Dollars in thousands) Balance outstanding at end of period.........................$29,121 $22,938 $39,853 Weighted average rate paid.......... 5.69 6.73 5.64
Competition - -----------
The Bank faces strong competition in its market area in originating loans and attracting deposits. Competition in originating loans is primarily from other thrift institutions, commercial banks, mortgage companies, credit unions and consumer finance companies. The Bank competes for loan originations primarily through interest rates and loan fees it charges and through the efficiency and quality of services it provides borrowers. Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions and current interest rate levels.
In attracting deposits, the Bank competes primarily with other thrift institutions, commercial banks and credit unions. The Bank competes for customer deposits principally on the basis of convenience and quality of its banking services and the investment opportunities that satisfy the requirements of investors with respect to rate of return, liquidity, risk and other factors. The primary factors in competing for deposits are interest rates and the convenience of office locations. In light of the deregulation of interest rate controls on deposits, the Bank has faced increasing competition for deposits from commercial banks, other thrift institutions and non-regulated financial intermediaries.
Personnel - ---------
At March 31, 2002, Horizon Bank employed 187 full-time and 29 part-time employees. Horizon Bank employees are not represented by any collective bargaining agreement. Management of Horizon Bank considers its relations with its employees to be good.
REGULATION AND SUPERVISION
The Bank - --------
General. As a state-chartered, federally insured bank, Horizon Bank is subject to extensive federal and state regulation. Lending activities and other investments must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. Horizon Bank is regularly examined by the FDIC and the Washington Department of Financial Institutions, Division of Banks, and files periodic reports concerning the Bank's activities and financial condition with its regulators. The Bank's relationship with depositors and borrowers also is regulated to a great extent by both federal and state law, especially in such matters as the ownership of savings accounts and the form and content of mortgage documents. The law and regulations of the State of Washington pertaining to banks and other
corporations apply to the Bank. Among other things, those laws and regulations govern the Bank's investments and borrowings, loans, payment of interest and dividends, and establishment and relocation of branch offices.
Deposit Insurance. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of depository institutions. The FDIC administers two separate deposit insurance funds: the BIF and the SAIF. The BIF is a deposit insurance fund for commercial banks and some state-chartered savings banks. The SAIF is a deposit insurance fund for most savings associations. The Bank is insured under the BIF fund. As an insurer of the Bank's deposits, the FDIC has examination, supervisory and enforcement authority over the Bank.
The FDIC has established a risk-based system for setting deposit insurance assessments. Under the risk-based assessment system, an institution's insurance assessment varies according to the level of capital the institution holds, the balance of insured deposits during the preceding two quarters, and the degree to which it is the subject of supervisory concern. In addition, regardless of the potential risk to the insurance fund, federal law requires the ratio of reserves to insured deposits at $1.25 per $100. Both funds currently meet this reserve ratio. Since 1997, the assessment rate for both SAIF and BIF deposits has ranged from zero to 0.27% of covered deposits. As a well capitalized bank, Horizon Bank qualified for the lowest rate on its deposits for fiscal 2002.
In addition to deposit insurance assessments, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation ("FICO") to service FICO debt incurred in the 1980's to help fund the thrift industry cleanup. The FICO assessment rate is adjusted quarterly.
Prior to 2000, the FICO assessment rate for BIF-insured deposits was one-fifth the rate applicable to deposits insured by the SAIF. Beginning in 2000, SAIF- and BIF-insured deposits were assessed at the same rate by FICO. As a result, BIF FICO assessments will be higher than in previous periods while SAIF FICO assessments will be lower. For the first quarter of 2002, the annualized rate was 1.76 cents per $100 of insured deposits. Because the Bank is insured under the BIF fund, the FICO assessments have increased since 2000 as compared to prior years.
Any insured bank which does not operate in accordance with or conform to FDIC regulations, policies and directives may be sanctioned for non-compliance. For example, proceedings may be instituted against any insured bank or any director, officer, or employee of such bank who engages in unsafe and unsound practices, including the violation of applicable laws and regulations. The FDIC has the authority to terminate deposit insurance pursuant to procedures established for that purpose. Management is not aware of any existing circumstances that could result in termination of the deposit insurance for the Bank.
Capital Requirements. FDIC regulations recognize two types or tiers of capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1 capital generally includes common stockholders' equity and noncumulative perpetual preferred stock, less most intangible assets. Tier 2 capital, which is limited to 100 percent of Tier 1 capital, includes such items as qualifying general loan loss reserves, cumulative perpetual preferred stock, mandatory convertible debt, term subordinated debt and limited life preferred stock; however, the amount of term subordinated debt and intermediate term preferred stock (original maturity of at least five years but less than 20 years) that may be included in Tier 2 capital is limited to 50 percent of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit together with certain risk-based ratios. The FDIC's minimum leverage capital requirement specifies a minimum ratio of Tier 1 capital to average total assets. Most banks are required to maintain a minimum leverage ratio of at least 4% to 5% of total assets. The FDIC retains the right to require a particular institution to maintain a higher capital level based on an institution's particular risk profile. The Bank calculated its leverage ratio to be 12.67% as of March 31, 2002.
FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets. Assets are placed in one of four categories and given a percentage weight -- 0%, 20%, 50% or 100% - -- based on the relative risk of that category. In addition, certain off-balance-sheet items are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the four categories. Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1
capital to risk-weighted assets must be at least 4%. The Bank has calculated its total risk-based ratio to be 20.26% as of March 31, 2002, and its Tier 1 risk-based capital ratio to be 18.93%. In evaluating the adequacy of a bank's capital, the FDIC may also consider other factors that may affect a bank's financial condition. Such factors may include interest rate risk exposure, liquidity, funding and market risks, the quality and level of earnings, concentration of credit risk, risks arising from nontraditional activities, loan and investment quality, the effectiveness of loan and investment policies, and management's ability to monitor and control financial operating risks.
Horizon Bank's management believes that, under the current regulations, the Bank will continue to meet its minimum capital requirements in the foreseeable future. However, events beyond the control of the Bank, such as a downturn in the economy in areas where the Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of the Bank to meet its capital requirements.
Federal Deposit Insurance Improvement Act ("FDICIA"). Horizon Bank has surpassed the $500 million asset threshold, and as such, is required to be compliant with the FDICIA originally enacted in 1991 and with enhanced provisions adopted in 1993. In general, FDICIA required the Bank to conduct an annual independent audit of its financial statements, appoint an independent audit committee of outside directors, report on and assess management's responsibilities for preparing financial statements, and establish an internal control structure.
An independent accountant must attest to and report on the assertions in management's reports concerning these internal controls with the desired outcome of efficient and effective operations; the safeguarding of assets; reliable financial reporting and compliance with applicable laws and regulations.
The FDIC as the primary regulator of the Bank has outlined, in general, the requirements for compliance with FDICIA, but does not provide specific guidance on the internal control structure, documentation, or procedures to test the Bank's effectiveness. It is up to each bank to establish, document and design procedures to evaluate and test the internal control structure over financial reporting and compliance with designated laws and regulations that minimally include loans to insiders and dividend restrictions.
In brief, to ensure compliance, the Bank has established and coordinated a management team that identifies and documents existing controls with consideration given to the Bank's control environment, risk assessment, control activities, information and communication systems, and monitoring activities. In addition, management establishes internal control procedures, develops and selects criteria for evaluation, tests the effectiveness of controls, and ensures that proper written documentation is in place.
Under FDICIA, the Audit Committee has several responsibilities that include but are not limited to overseeing the internal audit function; conducting periodic meetings with management, the independent public accountant, and the internal auditors; review of significant accounting policies, and audit conclusions regarding significant accounting estimates; review of the assessments prepared by management and independent auditor on the adequacy of internal controls and the resolution of identified material weaknesses and reportable conditions in internal controls; and the review of compliance with laws and regulations.
Federal Home Loan Bank System. The FHLB of Seattle serves as a reserve or central bank for the member institutions within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLBs. It makes loans (i.e., advances) to members in accordance with policies and procedures established by the Federal Housing Finance Board and the Board of Directors of the FHLB of Seattle. As a member, the Bank is required to purchase and hold stock in the FHLB of Seattle in an amount equal to the greater of 1% of their aggregate unpaid home loan balances at the beginning of the year or an amount equal to 5% of FHLB advances outstanding. As of March 31, 2002, Horizon Bank held stock in the FHLB of Seattle in the amount of $6,243,300. See "Business -- Savings Activities and Other Sources of Funds -- Borrowings."
Federal Reserve System. The Federal Reserve Board requires (under "Regulation D") that all depository institutions, including savings banks, maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest bearing deposits with the regional Federal Reserve Bank. NOW
accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a savings bank. Under Regulation D, a bank must maintain reserves against net transaction accounts, in the amount of 3% on amounts of $37.3 million or less, plus10% on amounts in excess of $37.3 million. In addition, a bank may designate and exempt $5.0 million of certain reservable liabilities from these reserve requirements. The amounts and percentages are subject to adjustment by the Federal Reserve. The reserve requirement on non-personal time deposits with original maturities of less than 1.5 years is 0%. As of March 31, 2002, the Bank was in compliance with the Federal Reserve Bank's reserve requirements.
Prompt Corrective Action. Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution's category depends upon where its capital levels are in relation to relevant capital measure, which include a risk-based capital measure, a leverage ratio capital measure, and certain other factors. The federal banking agencies have adopted regulations that implement this statutory framework. Under these regulations, an institution is treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted assets is 6% or more, its ratio of core capital to adjusted total assets is 5% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8%, a Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of not less than 4%. Any institution which is neither well capitalized nor adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by the Bank to comply with applicable capital requirements would, if unremedied, result in restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.
The Corporation - ---------------
General. The Corporation, as the sole shareholder of the Bank, is a bank holding company and is registered as such with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and the regulations of the Federal Reserve. As a bank holding company, the Corporation is required to file with the Federal Reserve annual reports and such additional information as the Federal Reserve may require and will be subject to regular examinations by the Federal Reserve. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the "Act"). The Act modernized the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. Generally, the Act:
(a) repealed the historical restrictions and eliminated many federal and state law barriers to affiliations among banks, securities firms, insurance companies and other financial service providers;
(b) provided a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies;
(c) broadened the activities that may be conducted by national banks, banking subsidiaries of bank holding companies and their financial subsidiaries;
(d) provided an enhanced framework for protecting the privacy of consumer information;
(e) adopted a number of provisions related to the capitalization, membership, corporate governance and other measures designed to modernize the FHLB system;
(f) modified the laws governing the implementation of the Community Reinvestment Act; and
(g) addressed a variety of other legal and regulatory issues affecting day-to-day operations and long-term activities of financial institutions.
Acquisitions. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (1) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the Federal Reserve includes, among other things, operating a savings institution, mortgage company, finance company, credit card company or factoring company, performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers' checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.
Dividends. The Federal Reserve's policy statement on the payment of cash dividends by bank holding companies expresses the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company's capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends.
Capital Requirements. The Federal Reserve has established capital requirements for bank holding companies that generally parallel the capital requirements for national banks under the Office of the Comptroller of the Currency's regulations. Under the Federal Reserve Board's capital guidelines, at March 31, 2002, the Corporation's levels of consolidated regulatory capital exceed the Federal Reserve's minimum requirements, as follows:
Amount Percent -------- --------- (Dollars in thousands)
Tier 1 Capital $95,772 12.67% Minimum Tier 1 (leverage) requirement 30,237 4.00 ------- ----- Excess $65,535 8.67% ======= ======
Risk-based capital $102,508 20.27% Minimum risk-based capital requirement 40,464 8.00 ------- ----- Excess $ 62,044 12.27% ======= ======
Stock Repurchases. Bank holding companies, except for certain "well-capitalized" and highly rated bank holding companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve.
At its January 19, 2000 meeting, the Board of Directors authorized the repurchase of up to 10% (approximately 992,450 shares) of the Corporation's outstanding common stock over a 24 month period. At its October 24, 2000 meeting, the Board of Directors authorized a new repurchase plan for up to 10% (approximately 897,000 shares) of the Corporation's outstanding common stock over a 24 month period. Shares may be purchased from time to time depending upon market conditions, price and other management considerations. During the fiscal year ended March 31, 2002, the Corporation repurchased 327,952 shares of its Common Stock, compared to the repurchase of 683,790 shares of its Common Stock during the prior year. As of June 5, 2002, the Corporation has repurchased a total of 543,327 shares under the current plan.
TAXATION
Federal Taxation - ----------------
General. The Corporation and the Bank report their consolidated income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Corporation. Reference is made to Note 12 of the Notes to the Consolidated Financial Statements contained in the Corporation's Proxy Statement for additional information concerning the income taxes payable by the Bank.
Tax Bad Debt Reserves. Historically, savings institutions such as the Bank, which met certain definitional tests primarily related to their assets and the nature of their businesses, were permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions may, within specified formula limits, have been deducted in arriving at the Bank's taxable income. For purposes of computing the deductible addition to its bad debt reserve, the Bank's loans are separated into "qualifying real property loans" (i.e., generally those loans secured by interests in residential real property) and all other loans ("non-qualifying loans"). The following formulas were used to compute the bad debt deduction with respect to qualifying real property loans: (i) actual loss experience or (ii) a percentage equal to 8% of taxable income. The deduction with respect to non-qualifying loans was computed under the experience method. Reasonable additions to the reserve for losses on non-qualifying loans were based upon actual loss experience and would reduce the current year's addition to the reserve for losses on qualifying real property loans, unless that addition was also determined under the experience method. The sum of the additions to each reserve for each year was the Bank's annual bad debt deduction.
The provisions repealing the current thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminate the 8% of taxable income method for deducting additions to the tax bad debt reserves for all financial institutions for tax years beginning after December 31, 1995. These rules also require that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Bank has previously recorded a deferred tax liability equal to the bad debt recapture and as such the new rules will have no effect on the net income or federal income tax expense. For taxable years beginning after December 31, 1995, the Bank's bad debt deduction will be determined under the experience method using a formula based on actual bad debt experience over a period of years or, if the Bank is a "large" association (assets in excess of $500 million) on the basis of net charge-offs during the taxable year. The new rules allow an institution to suspend bad debt reserve recapture for the 1996 and 1997 tax years if the institution's lending activity for those years is equal to or greater than the institution's average mortgage lending activity for the six taxable years preceding 1996
adjusted for inflation. For this purpose, only home purchase or home improvement loans are included and the institution can elect to have the tax years with the highest and lowest lending activity removed from the average calculation. If an institution is permitted to postpone the reserve recapture, it must begin its six year recapture no later than the 1998 tax year. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders.
Distributions. If a stock institution distributes amounts to stockholders and the distribution is treated as being from its accumulated bad debt reserves, the distribution will cause the institution to have additional taxable income. A distribution to stockholder is deemed to have been made from accumulated bad debt reserves to the extent that (i) the reserves exceed the amount that would have been accumulated on the basis of actual loss experience, and (ii) the distribution is a "non-dividend distribution." A distribution in respect of stock is a non-dividend distribution to the extent that, for federal income tax purposes, (i) it is redemption of shares, (ii) it is pursuant to a liquidation or partial liquidation of the institution, or (iii) in the case of current distribution, together with all other such distributions during the taxable year, it exceeds the institution's current and post-1951 accumulated earnings and profits. The amount of additional taxable income created by a non-dividend distribution is an amount that, when reduced by tax attributable to it, is equal to the amount of the distribution.
Minimum Tax. In addition to regular corporate income tax, corporations are subject to an alternative minimum tax which generally is equal to 20% of alternative minimum taxable income (taxable income, increased by tax preference items and adjusted for certain regular tax items). The preference items which are generally applicable include an amount equal to 75% of the amount by which a financial institution's adjusted current earnings (generally alternative minimum taxable income computed without regard to this preference and prior to reduction for net operating losses) exceeds its alternative minimum taxable income without regard to this preference and the excess of the institution's bad debt deduction over the amount deductible under the experience method, as discussed below. Alternative minimum tax paid can be credited against regular tax due in later years.
Audits. The Bank has not been audited by the IRS during the past five years.
Washington Taxation - -------------------
The Bank is subject to a business and occupation tax which is imposed under Washington law at the rate of 1.50% of gross receipts; however, interest received on loans secured by mortgages or deeds of trust on residential properties is not subject to such tax. The Bank's business and occupation tax returns were audited in November 1995.
Item 2.
Item 2. Properties - -------------------
The following table sets forth the location of the Bank's offices, as well as certain information relating to these offices.
Net Book Year Value as of Square Leased/ Opened March 31, 2002 Feet Owned ------ -------------- ---- -----
Bellingham Main Office............ 1971 $1,092,281 19,179 Owned 1500 Cornwall Avenue Bellingham, WA 98225
Bellingham/Meridian............... 1987 720,958 4,650 Owned 4110 Meridian Bellingham, WA 98226
Ferndale Office................... 1976 318,049 3,692 Owned Third and Main Ferndale, WA 98248
Lynden Office..................... 1981 408,780 3,702 Owned Third and Grover Lynden, WA 98264
Blaine Office..................... 1976 501,726 3,610 Owned Fourth & "H" Streets Blaine, WA 98230
Mount Vernon Office............... 1976 261,861 3,275 Owned 1503 Riverside Dr. Mount Vernon, WA 98273
Anacortes Office.................. 1987 762,349 3,650 Owned 1218 Commercial Avenue Anacortes, WA 98221
Snohomish Office.................. 1987 140,265 1,388 Owned 620 2nd Street Snohomish, WA 98290
Everett Office.................... 1991 43,059 1,972 Leased 909 S.E. Everett Mall Way #E-500 Everett, WA 98208
Burlington Office................. 1994 1,082,131 3,980 Owned 1020 S. Burlington Blvd Burlington, WA 98232
(table continued on following page)
Net Book Year Value as of Square Leased/ Opened March 31, 2002 Feet Owned ------ -------------- ---- -----
Edmonds Office................... 1994 $2,187,486 15,265 Owned 130 Fifth Avenue South Edmonds, WA 98020
Murphy's Corner Office........... 2000 1,770,011 3,720 Owned 12830 Bothell Everett Hwy. Everett, WA 98208
Barkley.......................... 1999 3,276,785 14,691 Owned 2122 Barkley Blvd. Bellingham, WA 98228
Holly Street Office.............. 1999 478,569 4,000 Owned 211 E. Holly Street Bellingham, WA 98227
Alabama Office................... 1999 715,883 4,500 Owned 802 Alabama Street Bellingham, WA 98228
Marysville (land only)........... -- 635,737 -- Owned
Lynnwood Office (1).............. 2002 799,119 3,345 Owned 19405 44th Avenue W. Lynnwood, WA 98036
- ------------ (1) Projected to open in September 2002.
At March 31, 2002, the aggregate book value of the Corporation's premises and equipment was $15,195,049.
Item 3.
Item 3. Legal Proceedings - --------------------------
Neither the Corporation nor the Bank is engaged in any legal proceedings of a material nature at the present time. From time to time it is a party to legal proceedings wherein it enforces its security interest in loans made by it.
Item 4.
Item 4. Submission of Matters to a Vote of Security-Holders - ------------------------------------------------------------
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters - ------------------------------------------------------------------------------
Horizon Financial Corp.'s common stock is traded on The Nasdaq Stock Market under the symbol HRZB. The common stock began trading on the Nasdaq Stock Market at the time of Horizon's conversion to stock form in August 1986. The following table presents the high and low prices as reported by the Nasdaq Stock Market and dividends paid for the last two fiscal years. These prices represent quotations by the dealers and do not necessarily represent actual transactions, and do not include retail markups, markdowns or commissions. The Corporation has approximately 4,251 stockholders.
2002 Fiscal Year Quarter High Low Dividend -------------------- ------- ------ --------
Fourth $13.00 $10.95 $0.12 Third 13.00 10.88 0.12 Second 12.50 9.50 0.12 First 11.75 8.913 0.12
2001 Fiscal Year Quarter High Low Dividend -------------------- ------- ------ --------
Fourth $10.924 $8.913 $0.104 Third 10.381 7.826 0.104 Second 9.565 7.554 0.104 First 8.804 7.310 0.104
Dividend Policy - --------------- Horizon Financial Corp. historically has paid cash dividends on its common stock. The Corporation must adhere to certain regulatory requirements governing the distribution of dividends, and there can be no assurance that the Corporation will continue to declare cash dividends in the future.
Item 6.
Item 6. Selected Financial Data - --------------------------------
The following table sets forth certain information concerning the financial position of the Bank at and for the dates indicated.
March 31, ----------------------------------------------------- 2002 2001 2000 1999 1998 -------- --------- -------- -------- --------- (In thousands) Financial Condition Data: - ------------------------
Total Assets............ $772,063 $729,736 $713,914 $668,116 $605,613 Loans Outstanding....... 568,303 597,382 589,584 533,649 478,661 Cash and Investment Securities............. 171,346 106,117 99,375 115,194 112,172 Deposits................ 628,782 595,914 564,327 537,390 501,293 Borrowings.............. 29,121 22,938 39,853 22,718 1,180 Stockholders' Equity.... 100,600 97,909 95,935 96,441 86,675
Year Ended March 31, ------------------------------------------------- 2002 2001 2000 1999(1) 1998(1) -------- -------- ------- -------- -------- (In thousands) Operating Data: - --------------
Interest Income....... $ 53,091 $ 55,837 $ 49,947 $ 48,119 $45,745 Interest Expense...... (26,541) (32,239) (26,257) (25,267) (23,991) Net Interest Income... 26,550 23,598 23,690 22,852 21,754 Other Income.......... 4,614 2,951 2,851 3,175 2,267 Non-interest Expense.. (14,891) (13,756) (13,243) (11,357) (9,934) Provision for Loan Losses.............. (1,089) (320) (437) (484) (521) -------- -------- -------- -------- ------- Income (Loss) Before Taxes............... 15,184 12,473 12,861 14,186 13,566 Federal Income Tax.... (5,130) (4,202) (4,180) (4,844) (4,598) -------- -------- -------- -------- ------- Net Income............ $ 10,054 $ 8,271 $ 8,681 $ 9,342 $ 8,968 ======== ======== ======== ======== =======
Per Common Share:(3) Fully-diluted earnings.......... $1.14 $0.90 $0.88 $0.94 $0.91 Dividends........... 0.48 0.42 0.41 0.38(4) 0.72(2)(4) Equity.............. 11.69 11.05 10.08 9.88 9.22 Weighted average shares outstanding.......8,853,652 9,193,661 9,875,705 9,919,413 9,860,291 - ------------- (1) Prior year numbers are restated to reflect the merger of Bellingham Bancorporation effective June 19, 1999. (2) Includes a special cash dividend of $0.35 declared January 28, 1998. (3) Restated for 15% stock dividend effective May 11, 2001. (4) Prior year numbers based on shares outstanding prior to merger for each respective year.
Key Operating Ratios: - -------------------- The table below sets forth certain performance ratios of the Bank for the periods indicated. These ratios are calculated based on month end balances.
At and for the Year Ended March 31, --------------------- 2002 2001 2000 ---- ---- ----
Return on average assets (net income divided by average total assets)............................ 1.35% 1.14% 1.26%
Return on average equity (net income divided by average equity).................................. 10.14 8.58 9.02
Dividend payout ratio (dividends declared per share divided by fully-diluted earnings per share)..... 42.11 46.38 46.53
Equity to assets ratio (average equity divided by average total assets)............................ 13.29 13.43 13.92
Interest rate spread (difference between average yield on interest-earning assets and average cost of interest bearing liabilities)............ 3.36 2.89 3.14
Net yield on earning assets (net interest income as a percentage of average interest earning assets). 3.78 3.42 3.65
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ------------------------------------------------------------------------
Information required by this item is incorporated herein by reference to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Corporation's Proxy Statement.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk - -------------------------------------------------------------------
Information required by this item is incorporated herein by reference to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quantitative and Qualitative Disclosures About Market Risk" contained in the Corporation's Proxy Statement.
Item 8.
Item 8. Financial Statements and Supplementary Data - ----------------------------------------------------
The financial statements contained in the Proxy Statement which are listed under Item 14 herein, are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure - ------------------------------------------------------------------------
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------
The information contained under the section captioned "Proposal I -- Election of Directors" and "Compliance with Section 16(a) of the Exchange Act" in the Registrant's Proxy Statement is incorporated herein by reference.
The executive officers of the Corporation and the Bank are as follows:
Name Age Position - ------------------- --- ---------------------------------------------------
V. Lawrence Evans 55 Chairman of the Board, Chief Executive Officer and President of the Corporation; and Chairman of the Board and Chief Executive Officer of the Bank (1)
Dennis C. Joines 52 President, Chief Operating Officer and director of the Bank; Executive Vice President and director of the Corporation
Richard P. Jacobson 39 Vice President and Secretary of the Corporation and Executive Vice President and Secretary of the Bank
A.R. (Gus) Ayala 52 Senior Vice President of the Bank
Karla C. Lewis 55 Senior Vice President of the Bank
Kelli J. Holz 33 Vice President of the Corporation and the Bank
Karen A. LePage 61 Vice President of the Corporation and the Bank
(footnotes on following page)
- ------------- (1) Effective April 23, 2002, Dennis C. Joines, was named President and Chief Operating Officer of Horizon Bank. V. Lawrence Evans, who has served as President of Horizon Bank since 1990 will continue to serve as Chairman of the Board and Chief Executive Officer of Horizon Bank and Chairman of the Board, President and Chief Executive Officer of Horizon Financial Corp.
The following is a description of the principal occupation and employment of the executive officers of the Corporation and the Bank during at least the past five years:
V. LAWRENCE EVANS joined the Bank in 1972 and served as the Bank's Executive Vice President from 1983 to 1990. Mr. Evans served as President of the Bank from May 14, 1990 to April 23, 2002. He has served as Chief Executive Officer of the Bank since March 26, 1991 and as Chairman of the Bank's Board of Directors since July 1997. Mr. Evans also serves as Chairman of the Board, President and Chief Executive Officer of the Corporation.
DENNIS C. JOINES became President and Chief Operating Officer of the Bank on April 23, 2002 and a director of the Corporation and the Bank on April 23, 2002. He joined the Bank following an extensive career in the Pacific Northwest banking industry for over 30 years. Most recently, Mr. Joines was Senior Vice President/National Small Business and SBA Manager for Washington Mutual Bank from 2001 to 2002. Prior to that time, he served in a variety of key roles at KeyBank from 1993 to 2001.
RICHARD P. JACOBSON has worked for the Bank for 15 years and was appointed Vice President/Finance and Corporate Secretary in December 1994. In March 1998, Mr. Jacobson was appointed Senior Vice President of the Bank. In March 2000, he was appointed Executive Vice President of the Bank.
A.R. (GUS) AYALA joined the Bank pursuant to the merger of Bellingham Bancorporation effective June 19, 1999. He served as Chief Financial Officer for the Bank of Bellingham from September 1997 until completion of the merger. Previously, he was Senior Vice President with a commercial bank in Lompoc, California. He is currently Senior Vice President, and Operations Manager for the Bank.
KARLA C. LEWIS joined Horizon Bank in 1973. From 1983 to December 1994, she was the Manager of the Loan Servicing Department. She was appointed Vice President in June 1987 and is currently the Bank's Chief Lending Officer. In March 1998, she was appointed Senior Vice President of the Bank.
KELLI J. HOLZ, CPA, joined the Bank in 1988. From 1991 to 1998 she was the Manager of the Internal Audit Department. In March 1998, she was appointed Vice President and is currently the Controller of the Bank.
KAREN A. LEPAGE has been employed by the Bank since 1958. In December 1985, she was promoted to Vice President.
Item 11.
Item 11. Executive Compensation - --------------------------------
Information regarding management compensation and transactions with management and others is incorporated by reference to the section captioned "Proposal I -- Election of Directors" in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement.
Equity Compensation Plan Information. The following table summarizes share and exercise price information about the Corporation's equity compensation plans as of March 31, 2002.
(c) Changes in Control
The Corporation is not aware of any arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the Corporation.
Item 13.
Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------
The information contained under the sections captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - --------------------------------------------------------------------------
(a) (1) Financial Statements. --------------------
Independent Auditor's Report* Consolidated Statement of Financial Position, March 31, 2002 and 2001* Consolidated Statement of Income for the years ended March 31, 2002, 2001 and 2000* Consolidated Statement of Stockholders' Equity for the years ended March 31,2002, 2001 and 2000* Consolidated Statement of Cash Flows for the years ended March 31,2002, 2001 and 2000*
Notes to Consolidated Financial Statements*
----------- * Contained in the Corporation's Proxy Statement and incorporated herein by reference.
(2) All required financial statement schedules are included in the Notes to Consolidated Financial Statements contained in the Corporation's Proxy Statement.
(b) No current reports on Form 8-K were filed by the Corporation during the three months ended March 31, 2002.
(c) Exhibits (3.1) Articles of Incorporation of Horizon Financial, Corp. (incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated October 13, 1995) (3.2) Bylaws of Horizon Financial Corp. (incorporated by reference to Exhibit 3.2 to the Registrant's Current Report on Form 8-K dated October 13, 1995) (10.1) Amended and Restated Employment Agreement with V. Lawrence Evans (incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended March 31, 1996) (10.2) Deferred Compensation Plan (incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended March 31, 1996) (10.3) 1986 Stock Option and Incentive Plan (incorporated by reference to Exhibit 99.1 to the Registrant's Registration Statement on Form S-8 (File No. 33-99780)) (10.4) 1995 Stock Option Plan (incorporated by reference to Exhibit 99.2 to the Registrant's Registration Statement on Form S-8 (File No. 33-99780)) (10.5) Bank of Bellingham 1993 Employee Stock Option Plan (incorporated by reference to Exhibit 99 to the Registrant's Registration Statement on Form S-8 (File No. 33-88571)) (10.6) Severance Agreement with Dennis C. Joines (21) Subsidiaries of the Registrant (23) Consent of Auditors
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HORIZON FINANCIAL CORP.
Date: June 21, 2002 By: /s/ V. Lawrence Evans ---------------------------- V. Lawrence Evans Chairman of the Board, Chief Executive Officer, and President (Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By: /s/V. Lawrence Evans By: /s/Robert C. Diehl --------------------------------- ----------------------------- V. Lawrence Evans Robert C. Diehl Chairman of the Board, Chief Director Executive Officer, and President
Date: June 21, 2002 Date: June 21, 2002
By: /s/Richard P. Jacobson By: /s/Fred R. Miller -------------------------------- ----------------------------- Richard P. Jacobson Fred R. Miller Principal Financial Officer Director
Date: June 21, 2002 Date: June 21, 2002
By: /s/Dennis C. Joines By: /s/ James A. Strengholt -------------------------------- ----------------------------- Dennis C. Joines James A. Strengholt President, Chief Operating Director Officer and Director of Horizon Bank, and Executive Vice President and Director of Horizon Financial Corp.
Date: June 21, 2002 Date: June 21, 2002
By: /s/Kelli J. Holz By: /s/Frank G. Uhrig -------------------------------- ----------------------------- Kelli J. Holz Frank G. Uhrig Principal Accounting Officer Director
Date: June 21, 2002 Date: June 21, 2002
By: /s/ Richard R. Haggen By: /s/Gary E. Goodman ------------------------- ------------------------- Richard R. Haggen Gary E. Goodman Director Director
Date: June 21, 2002 Date: June 21, 2002
By: /s/ Robert C. Tauscher ------------------------- Robert C. Tauscher Director
Date: June 21, 2002
Exhibit 10.6
Severance Agreement with Dennis C. Joines
CHANGE OF CONTROL /SEVERANCE AGREEMENT --------------------------------------
THIS CHANGE OF CONTROL/ SEVERANCE AGREEMENT (the "Agreement") is made and entered into as of this 23rd day of April, 2002 (the "Commencement Date"), by and between HORIZON BANK, a savings bank chartered under the laws of the State of Washington (the "Bank"), and Dennis C. Joines (the "Executive").
WHEREAS, the Executive is currently serving as President and Chief Operating Officer; and has agreed to continue to serve in the employ of the Bank; and
WHEREAS, the Board of Directors of the Bank recognizes the substantial contribution the Executive has made to the Bank and wishes to provide Executive with certain benefits for the period provided in this Agreement in the event of a change of control (as defined herein) of the Bank or of its holding company, Horizon Financial Corp. (the "Holding Company");
NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements of the parties herein, the parties hereto agree as follows:
1. Certain Definitions. -------------------
(a) The term "Change of Control" means: (i) an event of a nature that would be required to be reported in response to Item 1(a) of the current report on Form 8-K, as in effect on the date hereof, pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"); (ii) any "person," as such term is used in Sections 13(d) and 14(d) of the Exchange Act, other than the Holding Company, any Consolidated Subsidiaries (as hereinafter defined), is or becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act) directly or indirectly of securities of the Bank or the Holding Company representing 25% or more of the combined voting power of the Bank's or Holding Company's outstanding securities; (iii) individuals who are members of the Board of Directors of the Holding Company (the "Board") on the Commencement Date (the "Incumbent Board") cease for any reason to constitute at least a majority thereof, provided that any person becoming a director subsequent to the Commencement Date whose election was approved by a vote of at least three-quarters of the directors comprising the Incumbent Board or whose nomination for election by the Holding Company's stockholders was approved by the nominating committee serving under an Incumbent Board or who was appointed as a result of a change at the direction of the Federal Reserve Board or the Federal Deposit Insurance Corporation ("FDIC"), shall be considered a member of the Incumbent Board; (iv) the stockholders of the Holding Company approve a merger, consolidation or acquisition of the Holding Company or the Bank, with or by any other corporation or entity, other than (1) a merger, consolidation or acquisition which would result in the voting securities of the Holding Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than 50% of the combined voting power of the voting securities of the Holding Company or such surviving entity outstanding immediately after such merger or consolidation or (2) a merger or consolidation effected to implement a recapitalization of the Holding Company or the Bank (or similar transaction) in which no person (as hereinabove defined) acquires more than 25% of the combined voting power of the Holding Company's then outstanding securities; or (v) the stockholders of the Holding Company approve a plan of complete liquidation of the Holding Company or the Bank or an agreement for the sale or disposition by the Holding Company of all or substantially all of the Holding Company's or the
Bank's assets (or any transaction having a similar effect); provided that the term "Change of Control" shall not include an acquisition of securities by an employee benefit plan of the Bank or the Holding Company or a change in the composition of the Board at the direction of the Federal Reserve Board or the FDIC. Upon a Change of Control, the provisions hereof shall become immediately operative.
(b) The term "Consolidated Subsidiaries" means any subsidiary or subsidiaries of the Holding Company that are part of the affiliated group (as defined in Section 1504 of the Internal Revenue Code of 1986, as amended (the "Code"), without regard to subsection (b) thereof) that includes the Bank.
(c) The term "Good Reason" means the occurrence, without the Executive's express written consent, of a material diminution of or interference with the Executive's duties, responsibilities or benefits, including (without limitation) any of the following circumstances:
(i) a requirement that the Executive be based at any location not within 30 miles of the Executive's then existing job location, providing that such new location is not closer to Executive's home; (ii) a material demotion, or loss of title or loss of significant authority of the Executive; (iii) a reduction in the Executive's salary or a material adverse change in the Executive's perquisites, benefits or vacation, other than as part of an overall program applied uniformly and with equitable effect to all members of the senior management of the Bank; (iv) a successor bank or company fails or refuses to assume the Bank's obligations under this Agreement, as required in Section 4(a) hereof; or (v) any purported termination of the Executive's employment, except for Termination for Cause that is not effected pursuant to a Notice of Termination satisfying the requirements of Section 6 hereof (and, if applicable, the requirements of Section 1(d) hereof), which termination shall not be effective for purposes of this Agreement.
(d) The term "Termination for Cause" means termination of the employment of the Executive because of the Executive's personal dishonesty, incompetence, willful misconduct, breach of a fiduciary duty involving personal profit, intentional failure to perform stated duties, insubordination, willful violation of any law, rule, or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement or any other agreement between Executive and the Bank or the Holding Company. The Executive shall not be entitled to any payment or benefit hereunder in the event a termination occurs by reason of a voluntary retirement, voluntary termination other than for reasons specified in Section 1(c) hereof, disability, or Termination for Cause.
2. Term of the Agreement. ---------------------
(a) The term of this Agreement shall be a period of thirty-six calendar months beginning on the Commencement Date. Commencing on the first anniversary date of this Agreement and continuing on each anniversary thereafter, the term of the Agreement shall be extended for a period of one year in addition to the remaining term, unless either party elects not to extend this Agreement further by giving written notice thereof to the other party, subject to earlier termination, as provided herein.
(b) Nothing in this Agreement shall be deemed to prohibit the Bank at any time from terminating the Executive's employment during the term of this Agreement with or without notice for any reason; provided, however, that the relative rights and obligations of the Bank and the Executive in the event of any such termination shall be determined under this Agreement.
3. Severance Benefits. ------------------
(a) If after a Change of Control, the Bank shall terminate the Executive's employment other than Termination for Cause, or the Executive shall terminate employment with the Bank for Good Reason within twelve (12) months following a Change of Control, the Bank shall: (i) pay the Executive (or in the event of Executive's subsequent death, Executive's beneficiary or estate, as the case may be), as severance pay, a sum equal to 2.99 times Executive's annual compensation. For purposes of this Agreement, "annual compensation" shall mean all wages, salary, bonus, and other compensation, if any, paid by the Bank as consideration for the Executive's services during the twelve (12) month period ending on the last day of the month preceding the effective date of a Change of Control which is or would be includable in the gross income of the Executive receiving the same for federal income tax purposes. Such amount shall be paid to Executive in a lump sum no later than sixty (60) days after the date of Executive's termination; and (ii) cause to be continued for twelve (12) months after the effective date of a Change of Control, life, medical, dental, and disability coverage substantially identical to the coverage maintained by the Bank or the Holding Company for the Executive prior to the effective date of a Change of Control, except to the extent such coverage may be changed in its application to all Bank or Holding Company employees on a nondiscriminatory basis.
(b) Notwithstanding the provisions of Section 3(a) above, if a payment to the Executive who is a "disqualified individual" shall be in an amount which includes an "excess parachute payment," the payment hereunder to the Executive shall be reduced to the maximum amount which does not include an "excess parachute payment." The terms "disqualified individual" and "excess parachute payment" shall have the meaning defined in Section 280G of the Code.
(c) The Executive shall not be required to mitigate the amount of any payment or benefit provided for in Section 3(a) of this Agreement by seeking other employment or otherwise, nor shall the amount of any payment or benefit provided for in Section 3(a) of this Agreement be reduced by any compensation earned or benefit received by the Executive as the result of employment by another employer. This Agreement shall not be construed as a contract of employment or as providing the Executive any right to be retained in the employ of the Holding Company or the Bank or any affiliate thereof.
4. Assignment. ----------
(a) This Agreement is personal to each of the parties hereto, and neither party may assign or delegate any of its rights or obligations hereunder without first obtaining the written consent of the other party; provided, however, that the Bank shall require any successor or assignee of (whether direct or indirect, by purchase, merger, consolidation, operation of law or otherwise) to all or substantially all of the business and/or assets of the Bank, to expressly assume and agree to perform the Bank's obligations under this Agreement.
(b) This Agreement shall be binding upon and inure to the benefit of the Executive, Bank, and Holding Company, and their respective successors and assigns.
5. Required Regulatory Provisions. ------------------------------
Any payments made to Executive pursuant to this agreement, or otherwise, are subject to and conditioned upon compliance with 12 U.S.C. Section 1828(k) and any rules and regulations promulgated thereunder, including 12 C.F.R. Part 359.
6. Delivery of Notices. -------------------
For the purposes of this Agreement, all notices and other communications to any party hereto shall be in writing and shall be deemed to have been duly given when delivered or sent by certified mail, return receipt requested, postage prepaid, to the party's address identified herein. Any purported termination by the Bank or the Executive in connection with a Change of Control shall be communicated by a Notice of Termination to the other party. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which indicates the specific termination provision in this Agreement and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for the termination of Executive's employment under the provision so indicated.
7. Amendments. ----------
No amendments or additions to this Agreement shall be binding unless in writing and signed by both parties, except as herein otherwise provided.
8. Headings. --------
The headings used in this Agreement are included solely for convenience and shall not affect, or be used in connection with, the interpretation of this Agreement.
9. Severability. ------------
The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof.
10. Governing Law. -------------
This Agreement shall be governed by the laws of the State of Washington.
11. Arbitration. -----------
Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by binding arbitration, conducted before a panel of three arbitrators in a location selected by the Executive within 50 miles of the location of the Bank, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrators' award in any court having jurisdiction.
12. Reimbursement of Fees. ---------------------
All reasonable legal fees and expenses paid or incurred by Executive pursuant to any dispute or question of interpretation relating to this Agreement shall be paid or reimbursed by the Bank if Executive is successful on the merits pursuant to an arbitration award or legal judgment.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written.
THIS AGREEMENT CONTAINS A BINDING ARBITRATION PROVISION WHICH MAY BE ENFORCED BY THE PARTIES.
Attest: HORIZON BANK
/s/Barbara Brown /s/V. Lawrence Evans - ------------------------------- ------------------------------------
By: V. Lawrence Evans ---------------------------------
Its: Chairman --------------------------------
Address: 1500 Cornwall Avenue ---------------------------- Bellingham, WA 98225 ----------------------------
EXECUTIVE
/s/Dennis C. Joines ------------------------------------
Address: 1500 Cornwall Avenue ---------------------------- Bellingham, WA 98225 ----------------------------
Exhibit 21
Subsidiaries of the Registrant
Parent - ------
Horizon Financial Corp. Jurisdiction Percentage or State of Subsidiaries (a) of Ownership Incorporation - ---------------- ------------ -------------
Horizon Bank 100% Washington
Westward Financial Services, Inc. (b) 100% Washington
- -------------- (a) The operation of the Corporation's wholly owned subsidiaries are included in the Consolidated Financial Statements contained in the Item 8 of this Form 10-K.
(b) Wholly-owned subsidiary of Horizon Bank.
Exhibit 23
Consent of Auditors
CONSENT OF INDEPENDENT ACCOUNTANTS
The Board of Directors Horizon Financial Corp.
We consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-99780) of Horizon Financial Corp. pertaining to the 1986 Stock Option and Incentive Plan, and the 1995 Stock Option Plan; and the Registration Statement on Form S-8 (No. 333-88571) pertaining to the Bank of Bellingham 1993 Employee Stock Option Plan; of our report dated April 22, 2002, appearing in the 2002 proxy statement of Horizon Financial Corp., which is incorporated by reference in Horizon Financial Corp.'s Annual Report on Form 10-K for the year ended March 31, 2002.
/s/Moss-Adams LLP
Bellingham, Washington June 21, 2002