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| HRZB > SEC Filings for HRZB > Form 10-K on 15-Jun-2009 | All Recent SEC Filings |
15-Jun-2009
Annual Report
The following discussion is intended to assist in understanding the financial condition and results of operations of the Corporation and the Bank. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes contained in Item 8 of this Form 10-K.
Financial Overview
Horizon Financial Corp. is the bank holding company for Horizon Bank and reported some of the following highlights for the fiscal year ended March 31, 2009:
* The net loss for the fiscal year ended March 31, 2009 was $33.4
million or $2.79 per diluted share compared to net income of $18.4
million or $1.51 per diluted share for the year ended March 31,
2008.
* During the 2009 fiscal year, we charged off $309,000 associated
with our measurement for other than temporary impairment ("OTTI") of
our private label mortgage-backed securities.
* The interim measurement of our goodwill asset resulting from a
qualifying event gave rise to the complete write-off of the $545,000
goodwill asset during the fiscal year 2009.
* A gain in the amount of $767,000 was recognized during the fiscal
year 2009 resulting from the life insurance benefit paid on the
death of a retired executive officer.
* A loss of $777,000 was recognized during fiscal year 2009 from the
permanent loss in value associated with the in-kind distribution of
securities from redemption of our investment in the Shay AMF Ultra
Short-Term Bond Mutual Fund.
* A one-time gain of $579,000 was recognized during fiscal year 2009
from the sale of equity securities.
* An $800,000 unfunded loan commitment liability expense was
recognized during fiscal year 2009.
* The loan loss provision for the fiscal year ended March 31, 2009
was $65.0 million as compared to $4.1 million for the prior year.
* The total noninterest expense for the fiscal year ended March 31,
2009 was $33.6 million as compared to $29.2 million for the prior
period ended March 31, 2008.
* Total non-performing assets increased from $12.3 million as of
March 31, 2008 to $104.7 million as of March 31, 2009.
* Total assets were $1.47 billion as of March 31, 2009 as compared to
$1.39 billion as of March 31, 2008.
* Gross loans were $1.2 billion as of March 31, 2009 as compared to
$1.2 billion as of March 31, 2008.
* Total deposits were $1.2 billion as of March 31, 2009 as compared
to $1.0 billion as of March 31, 2008.
* The net interest margin was 2.86% for the year ended March 31, 2009
as compared to 4.37% for the same period in 2008.
* The regulatory Tier 1 capital ratio of March 31, 2009 was 6.2% as
compared to 9.1% at March 31, 2008.
Business Strategy
The Corporation's business strategy is to return the Bank to a well-capitalized and profitable community bank, dedicated to a diversified base of commercial lending, home mortgage lending, consumer lending, small business lending and providing competitive deposit and cash-management services to our personal and business customers. The Corporation has sought to implement this strategy by: (i) focusing on commercial banking opportunities; (ii) providing competitive, personalized financial services to individuals and business customers and communities served by its branch network; (iii) selling many of its fixed rate mortgages to the secondary market; (iv) focusing on asset quality; (v) prudently managing our operating expenses; and (vi) meeting the capital requirements set forth in the Order.
As a result of the U.S. recession and the impact from a downturn in the housing market, the Bank has focused its efforts on improving asset quality, deleveraging the balance sheet, raising capital, managing liquidity and growing
core deposits. Beginning with the quarter ended September 30, 2008, the Bank expanded its special assets team, which is responsible for working out problem assets that have grown substantially over the six months ended March 31, 2009, by shifting personnel within the Bank. The Bank has continued to focus on core deposit growth to enhance its liquidity position. At March 31, 2009, the Bank's core deposits increased $34.5 million, or 5.5% to $665.0 million from $630.5 million at March 31, 2008. See "Business Deposit Activities and Other Sources of Funds Deposits" for an analysis of the deposit portfolio by major type of deposit. In addition, the Bank has performed an extensive review of potential expense reductions. In evaluating the controllable expenses, the Bank determined the need to make several strategic staffing reductions. As of November 4, 2008, the Bank completed a reduction in force of 27 full-time positions and identified several areas where responsibilities will be shifted to accommodate the revised staffing levels. In the weeks leading up to the November 4, 2008 strategic staffing reduction, other positions were not filled when vacated by the employees previously occupying these positions. These reductions in personnel, along with strategic reductions in other noninterest expense areas have resulted in savings of over $3.0 million on an annual basis. In connection with the reduction in personnel, the Corporation incurred approximately $135,000 in severance related expenses during the year ended March 31, 2009.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions which affect the reported amounts and disclosures. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed.
Our financial statements are based on the selection and application of significant accounting policies which require management to make significant estimates and assumptions as detailed in Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K. We believe the following policies and estimates involve a higher degree of judgment:
Allowance for Loan and Lease Losses and Reserve for the Unfunded Loan Loss Commitments. The allowance for loan and lease losses ("ALLL") represents management's estimate of the measured accounting loss. The foundation of the ALLL is based on the loan grading system, which rates our loans from low risk to high risk. Those loans that are considered high risk undergo more careful evaluation when estimating the contingent loss. The ALLL is divided into two separate categories. The first group is comprised of individual impaired loans. An impaired loan exists when it is probable that the Bank will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement. When a loan is determined to be impaired, we then measure the impairment using either the discounted cash flows or the current fair value, less selling costs when the source of repayment is the liquidation of collateral. The second group of the ALLL is comprised of all other loans that are pooled into homogenous categories and a historical loss rate is applied for measuring the estimated accounting loss.
For additional information regarding the allowance for loan losses, see the Asset Quality section in this Management's Discussion and Analysis and Provision for Loan Losses in Note 1 in the Notes to the Consolidated Financial Statements included in Item 8 of this Form 10-K.
The reserve for unfunded loan loss commitments is established to absorb inherent losses associated with our commitments to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and the reserve for unfunded loan loss commitment are monitored on a regular basis and are based on management's evaluation of numerous factors, which include the quality of the current loan portfolio, the trend in the loan portfolio's risk ratings, current economic conditions, loan concentrations, past-due and non-performing trends, evaluation of specific loss estimates for all significant problem loans and charge-offs and recoveries.
Management believes that the ALLL and the reserve for unfunded loan loss commitments were adequate as of March 31, 2009. However, there is no assurance that future loan losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and leases losses. In addition, the Bank's
regulatory agencies as part of their periodic examination may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.
Investments. The Corporation classifies its investments as either available-for-sale or held-to-maturity. Available for sale securities are reported at their fair value, which is determined by obtaining quoted market prices. Unrealized gains and losses on available for sale securities are included in other comprehensive income and excluded from earnings. Realized gains and losses and declines in fair value determined to be other than temporary are included in earnings. During the year ended March 31, 2009, the Corporation recorded a $309,000 other than temporary impairment related to 15 non-agency collateralized mortgage obligations. These collateralized mortgage obligations are included in investments available for sale where the default rates, declines in investment ratings and loss severities of the underlying collateral indicate credit losses are expected to occur. These securities were valued by third party pricing services using readily available market quotes. There were no similar charges recorded during the year ended March 31, 2008. The fair value of investments is discussed in more detail in Notes 3 and 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Long-Lived Assets and Intangibles. The Corporation periodically measures for impairment of its long-lived assets and intangibles using a methodology that takes into account external factors, including market conditions, changes in competition, a significant change in expectations and an adverse change. If actual external conditions and operating results differ from the Corporation's expectations, then impairment charges may be necessary to reduce the carrying value of the asset(s) to the appropriate market value.
Management measures the goodwill for impairment on an annual basis at the fiscal year-end on a broad basis at the consolidated level since it is not identifiable to a "reporting unit." During most of fiscal 2009, volatility in the stock market and particularly financial institutions and their holding companies, were a significant contributing factor causing fluctuations in the Corporation's common stock during the interim reporting periods. Management considered this as well as other factors ("the business climate") in evaluating whether or not goodwill was impaired. As part of the process, management considered the "business climate" as a potential trigger for an interim measurement under SFAS 142, but deemed the economic environment to be abnormally volatile and irrational to conclude that an interim assessment of goodwill was required based on stock volatility alone.
During the third quarter of fiscal 2009, the Corporation recorded a non-cash charge of $545,000 related to the impairment of goodwill. The interim test for impairment was performed as of December 31, 2008 rather than an earlier period as a result of two events: (1) Horizon Bank was informed in December 2008 by the Federal Deposit Insurance Corporation and the State of Washington Department of Financial Institutions that a Cease and Desist Order would be issued and forthcoming, and (2) Horizon Bank's decision to close a branch office that was directly associated with the creation of the original goodwill asset signaled potential impairment. This impairment charge had no effect on the Company's or the Bank's cash balances, liquidity or regulatory ratios. At March 31, 2008, the $545,000 balance of goodwill was included in other assets. For additional information regarding goodwill, see "Goodwill" below and Note 1 in the Notes to the Consolidated Financial Statements included in Item 8 of this Form 10-K.
Valuation of Deferred Tax Assets. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled using the asset liability method. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred taxes result from temporary differences in the recognition of certain income and expense amounts between the Corporation's financial statements and its tax returns. The Corporation evaluates the deferred tax assets and liabilities at least annually and at March 31, 2009 believes, based upon the available evidence, that all deferred tax assets will be realized in the normal course of operations. Accordingly, these assets have not been reduced by a valuation allowance.
Accrued Taxes. The Corporation estimates tax expense based on the amount it expects to owe various tax authorities. Taxes are discussed in more detail in Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax
treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of the Corporation's tax position.
Comparison of Financial Condition at March 31, 2009 and March 31, 2008
Overview. Total consolidated assets for the Corporation as of March 31, 2009, were $1.5 billion, a 5.4% increase from the March 31, 2008 level of $1.4 billion. This increase in assets was primarily attributable to the growth in interest bearing deposits to $126.2 million at March 31, 2009 from $2.9 million at March 31, 2008. The growth in interest bearing deposits was a result of the strategy to enhance the Bank's liquidity position, accomplished in part by utilizing brokered deposits and by paying above average retail deposit rates in our local markets. Net loans receivable decreased 5.7% to $1.1 billion at March 31, 2009 compared to $1.2 billion at March 31, 2008. The decrease in net loans receivable was attributable to a combination of factors, including a $80.5 million decrease in commercial construction loans as the Bank worked to decrease its balances in this business line. Commercial construction includes commercial speculative one-to-four family (large one-to-four family developments and condominium projects), multi-family and commercial buildings. During the period ended March 31, 2009, the commercial business loan category increased $24.3 million, or 13.7% as the Bank continues to focus on increasing its commercial lines of credit balances in order to diversify its loan portfolio and expand its relationships with businesses in its markets.
Loans. One-to-four family mortgage loans, net of participations sold, increased 3.8% to $152.5 million at March 31, 2009 from $146.9 million at March 31, 2008. The Bank implemented a key lending program to help the Bank's commercial builder/developers sell inventory, which focused on offering special mortgages to prospective home buyers. The Bank had net sales of $68.5 million of one-to-four family real estate loans during the twelve months ended March 31, 2009, compared to $86.7 million during the twelve months ended March 31, 2008 as a result of a slowdown in the real estate market.
The following is an analysis of the loan portfolio by major type of loan at March 31, 2009 and 2008.
At March 31,
-----------------------------------
2009 2008
--------- ---------
(Dollars in thousands)
First mortgage loans:
One-to-four family.................... $167,048 14.4% $165,824 13.7%
One-to-four family construction....... 28,290 2.4 35,303 2.9
Less participations sold.............. (42,853) (3.7) (54,269) (4.5)
---------- ----- ---------- -----
Subtotal........................... 152,485 13.1 146,858 12.1
Commercial land development........... 186,580 16.0 183,827 15.2
Commercial construction............... 222,207 19.1 302,708 25.0
Multi-family residential.............. 51,970 4.5 45,049 3.7
Nonresidential commercial real
estate.............................. 281,481 24.2 300,109 24.8
Commercial loans...................... 201,973 17.4 177,685 14.7
Home equity secured................... 58,228 5.0 47,351 3.9
Other consumer loans.................. 7,717 0.7 7,005 0.6
---------- ----- ---------- -----
Subtotal........................... 1,010,156 86.9 1,063,734 87.9
---------- ----- ---------- -----
Total loans receivable............. 1,162,641 100.0% 1,210,592 100.0%
---------- ----- ---------- -----
Less:
Allowance for loan losses............. (38,981) (19,114)
---------- ----------
Total loans receivable, net........$1,123,660 $1,191,478
========== ==========
Net residential loans...................$ 149,625 13.3% $ 145,565 12.2%
Net commercial loans.................... 193,687 17.2 174,263 14.6
Net commercial real estate loans (1).... 716,743 63.8 818,215 68.7
Net consumer loans (2).................. 63,605 5.7 53,435 4.5
---------- ----- ---------- -----
$1,123,660 100.0% $1,191,478 100.0%
========== ===== ========== =====
(footnotes on following page)
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(1) Includes construction and development, multi-family and commercial real
estate loans.
(2) Includes home equity and other consumer loans.
As reflected in the table above, approximately 63.8% of our total net loan portfolio consists of commercial and multifamily real estate and construction and land development loans. Management has made the strategic decision to reduce the level of exposure to these types of loans during the economic slowdown and has dramatically reduced its lending to this type of borrower. Management intends to continue these efforts to reduce its concentration in construction and land development loans.
The following table is provided to show additional details on the Corporation's construction and land development loan portfolio:
At March 31, 2009 At March 31, 2008
------------------- --------------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
Speculative construction
one-to-four family........... $ 19,280 4.4% $ 27,206 5.2%
Custom construction one-
to-four family............... 9,010 2.1 8,097 1.6
-------- ----- -------- -----
Total one-to-four family... 28,290 6.5 35,303 6.8
Commercial speculative
construction one-to-
four family.................. 142,315 32.6 236,536 45.3
Commercial construction
multi-family................. 8,439 1.9 11,732 2.2
Commercial construction
non-residential.............. 71,453 16.3 59,541 11.4
Land development............... 186,580 42.7 178,726 34.3
-------- ----- -------- -----
Total construction and
land development.......... 408,787 93.5 486,535 93.2
-------- ----- -------- -----
Total construction loans.... $437,077 100.0% $521,838 100.0%
======== ===== ======== =====
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Investment Securities. The investment portfolio is comprised of the following securities; government agencies, municipal bonds, mortgage-backed securities, collateralized mortgage obligations ("CMOs") and common stock. The total carrying amount of these securities was $66.9 million as of March 31, 2009 as compared to $80.4 million as of March 31, 2008, which represents a decrease of $13.5 million or 16.8%. During the fiscal year ended March 31, 2009, we elected not to renew maturing securities or replace pre-payments to principal.
The table below presents the available for sale and held-to-maturity amortized cost, fair value and unrealized gain or loss as of March 31, 2009:
At March 31, 2009
---------------------------------------
Unrealized
Amortized Gain/ Estimated
Cost (Loss) Fair Value
--------- ---------- ----------
(In thousands)
Available For Sale Securities
State and political subdivisions
and U.S. government agency
securities...................... $26,565 $ 608 $27,173
Marketable equity securities...... 562 348 910
Mortgage-backed securities
and CMOs........................ 37,563 1,219 38,782
------- ------ -------
Total available-for-
sale securities.............. 64,690 2,175 66,865
Held To Maturity Securities
State and political subdivisions
and U.S. government agency
securities...................... -- -- --
Mortgage-backed securities
and CMOs........................ 8 3 11
------- ------ -------
Total held to maturity
securities................... 8 3 11
------- ------ -------
Total securities.............. $64,698 $2,178 $66,876
======= ====== =======
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The table below presents the available for sale and held-to-maturity maturity schedule of the securities as of March 31, 2009:
Maturity Schedule of Securities
at March 31, 2009
------------------------------------------------
Available For Sale Held To Maturity
----------------------- -----------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
--------- ---------- --------- ----------
(In thousands)
Maturities:
Less than one year........ $ 1,718 $ 1,734 $-- $--
Over one year to five
years.................... 12,976 13,668 -- --
Over five to ten years.... 21,260 21,685 8 11
Over ten years............ 28,174 28,868 -- --
------- ------- --- ---
64,128 65,955 8 11
Marketable equity
securities................. 562 910 -- --
------- ------- --- ---
Total investment
securities.............. $64,690 $66,865 $ 8 $11
======= ======= === ===
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Federal Home Loan Bank ("FHLB") Stock. The investment in the FHLB of Seattle stock totaled $7.25 million as of March 31, 2009. The investment in the FHLB stock is a restricted investment carried at par value ($100 per share), which approximates its fair value.
Management has evaluated the FHLB stock for impairment by giving consideration to the length of time the situation persists with the FHLB, commitments by the FHLB to make payments, the impact of regulatory changes and the liquidity position. We have reviewed the most recent unaudited financial statements included in the Form 10-Q filing. Their most recent Form 10-Q filing noted that the FHLB did not meet one of the three statutory capital requirements. The three capital requirements are 1) risk-based capital, 2) capital-to-asset ratio, and 3) leverage capital ratio. The FHLB did not meet the risk-based capital requirements as of March 31, 2009, but was in compliance with the other two statutory capital ratios. It was further noted in their Form 10-Q that a recovery in the market value of the private-label securities occurred in January and February 2009, which allowed the FHLB to redeem $669,000 of Class B capital stock. On February 28, 2009, stock redemptions were once again halted when the private-label securities were downgraded by a rating agency. The FHLB of Seattle Board of Directors have taken steps to restore the risk-based capital by suspending the issuance of Class A stock, issuing only Class B stock (considered permanent capital) and suspended the redemption and repurchase of Class A and Class B stock and the payment of dividends until such time the deficiency of the risk-based capital ratio is corrected.
The FHLB of Seattle reported a $16.3 million loss for the quarter ended March 31, 2009. The FHLB of Seattle attributes its first quarter 2009 net loss primarily to $71.7 million of OTTI charges on certain of its private-label mortgage-backed securities that are classified as held-to-maturity. As a result of its net loss for the first quarter 2009, the FHLB of Seattle also reported a $1.1 billion accumulated other comprehensive loss and total capital of $961 million as of March 31, 2009, as compared with total capital of $1.8 billion as of December 31, 2008. The OTTI recognized in accumulated other comprehensive loss is accreted to the carrying value of each security on a prospective basis, based on the amount and timing of future cash flows, over the remaining life of each security. The accretion increases the carrying value of each security and does not affect earnings unless the security is subsequently sold or has an additional OTTI charge that is recognized in earnings. The FHLB of Seattle's first quarter 2009 OTTI charge reflects the effects of isolating the portion of the loss that is directly associated with the other than temporary impairment of the private-label mortgage-backed securities. As a result of our review and intent to hold the security to maturity, the Corporation has not recorded an "other than temporary impairment" on its investment in FHLB of Seattle stock.
Asset Quality and Non-Performing Assets. The Corporation manages its credit risk exposure through managing the loan concentrations, and the application of its underwriting policies, procedures, and monitoring practices.
Delinquent and problem loans, however, are a part of any financial . . .
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