UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                              __________________

                                  FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

    For the Fiscal Year Ended March 31, 2008               OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

                      Commission File Number: 0-27062

                          Horizon Financial Corp.
------------------------------------------------------------------------------
           (Exact name of registrant as specified in its charter)

          Washington                                       91-1695422
--------------------------------------------      ---------------------------
(State or other jurisdiction of                  (I.R.S. Employer I.D. Number)
incorporation or organization)

1500 Cornwall Avenue, Bellingham, Washington                98225
--------------------------------------------      ---------------------------
(Address of principal executive offices)                  (Zip Code)


Registrant's telephone number, including area code:    (360) 733-3050
                                                  ---------------------------

Securities registered pursuant to Section 12(b)
 of the Act:

Common Stock, par value $1.00 per share           The NASDAQ Stock Market LLC
--------------------------------------------      ---------------------------
          (Title of Each Class)                   (Name of Each Exchange on
                                                       Which Registered)

Securities registered pursuant to Section 12(g)
 of the Act:                                                  None
                                                  ---------------------------


    Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES ___  NO  X

    Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.  YES ___  NO  X

    Indicate by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES  X   NO ___

    Indicate by check mark whether disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or other
information statements incorporated by reference in Part III of this Form 10-K
or any amendments to this Form 10-K.  YES X   NO ___

    Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definitions of "large accelerated filer," "accelerated filer"
and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer ___  Accelerated filer  X   Non-accelerated filer ___
Smaller reporting company ____

     Indicate by check mark whether the  registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES ___  NO  X

     The aggregate market value of the voting stock held by nonaffiliates of
the  registrant, based on the closing sales price of the registrant's common
stock as quoted on the NASDAQ Stock Market under the symbol "HRZB" on
September 30, 2007, was $245,866,507 (12,133,595 shares at $20.28 per share).
As of June 3, 2008, the registrant had 11,895,801 shares of common
stock outstanding.

                     DOCUMENTS INCORPORATED BY REFERENCE

     1.   Portions of the registrant's Proxy Statement for the 2008 Annual
Meeting of Stockholders. (Part III).

<PAGE>



                            HORIZON FINANCIAL CORP.
                       2008 ANNUAL REPORT ON FORM 10-K
                             TABLE OF CONTENTS
                                                                     Page
PART I.
  Item 1. Business
            General..................................................  1
            Lending Activities.......................................  1
            Investment Activities.................................... 13
            Real Estate Development Subsidiary....................... 16
            Bank Owned Life Insurance................................ 16
            Deposit Activities and Other Sources of Funds............ 16
            Competition.............................................. 19
            Personnel................................................ 19
            Regulation and Supervision............................... 21
            Taxation................................................. 25
            Available Information.................................... 27
  Item 1A. Risk Factors.............................................. 27
  Item 1B. Unresolved Staff Comments................................. 32
  Item 2. Properties................................................. 33
  Item 3. Legal Proceedings.......................................... 35
  Item 4. Submission of Matters to a Vote of Security Holders........ 35
PART II.
  Item 5. Market for Registrant's Common Equity, Related Stockholder
          Matters and Issuer Purchases of Equity Securities.......... 35
  Item 6. Selected Financial Data.................................... 38
  Item 7. Management's Discussion and Analysis of Financial
          Condition and Results of Operations........................ 39
            Forward Looking Statements............................... 39
            General.................................................. 40
            Business Strategy........................................ 40
            Operating Strategy....................................... 40
            Critical Accounting Estimates............................ 41
            Critical Accounting Policies............................. 43
            Comparison of Financial Condition at March 31, 2008
             and March 31, 2007...................................... 44
            Comparison of Operating Results for the Years Ended
             March 31, 2008 and March 31, 2007....................... 48
            Comparison of Operating Results for the Years Ended
             March 31, 2007 and March 31, 2006....................... 51
            Average Balances, Interest and Yields/Costs.............. 54
            Rate/Volume Analysis..................................... 55
            Liquidity and Capital Resources.......................... 55
            Quantitative and Qualitative Disclosures About Market
             Risk.................................................... 56
            Contractual Obligations.................................. 57
            Off-Balance Sheet Arrangements........................... 57
            Impact of Inflation...................................... 57
            Recent Accounting Pronouncements......................... 58
  Item 7A. Quantitative and Qualitative Disclosures About Market
             Risk.................................................... 58
  Item 8. Financial Statements and Supplementary Data................ 59

                          (continued on following page)


                                       (i)

<PAGE>


<PAGE>
  Item 9. Changes in and Disagreements with Accountants on
          Accounting and Financial Disclosure........................ 91
  Item 9A. Controls and Procedures................................... 91
  Item 9B. Other Information......................................... 91
PART III.
  Item 10. Directors, Executive Officers and Corporate Governance.... 92
  Item 11. Executive Compensation.................................... 92
  Item 12. Security Ownership of Certain Beneficial Owners and
           Management and Related Stockholder Matters................ 92
  Item 13. Certain Relationships and Related Transactions, and
           Director Independence..................................... 93
  Item 14. Principal Accounting Fees and Services.................... 93
PART IV.
Item 15. Exhibits and Financial Statement Schedules.................. 93


                                      (ii)

<PAGE>



                              PART I

Item 1.  Business
-----------------

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. At
March 31, 2008, the Corporation had total assets of $1.4 billion, total
deposits of $1.0 billion and total equity of $128.3 million. The Corporation's
business activities generally are limited to passive investment activities and
oversight of its investment in the Bank.  Accordingly, the information set
forth in this report, including consolidated financial statements and related
data, relates primarily to the Bank and its subsidiary.

     The Bank was organized in 1922 as a Washington State chartered mutual
savings and loan association and converted to a federal mutual savings and
loan association in 1934.  In 1979, the Bank converted to a Washington State
chartered mutual savings bank, the deposits of which are insured by the
Federal Deposit Insurance Corporation ("FDIC"). On August 12, 1986, the Bank
converted to a Washington state chartered stock savings bank under the name
"Horizon Bank, a savings bank." Effective March 1, 2000, the Bank changed its
name to its current name, "Horizon Bank."  The Bank became a member of the
Federal Home Loan Bank ("FHLB") of Seattle in December 1998. Effective August
1, 2005, the Bank converted from a Washington chartered savings bank organized
under Title 32 of the Revised Code of Washington ("RCW") to a Washington
chartered commercial bank organized under Title 30 of the RCW.

     The Bank's operations are conducted through 19 full-service office
facilities, four commercial loan centers, and four real estate loan centers,
located in Whatcom, Skagit, Snohomish, and Pierce counties in Northwest
Washington.  The Bank opened commercial banking/loan centers in Bellingham and
Everett, Washington, and expanded its operations in Burlington, Washington
during the first quarter of fiscal 2004.  In November 2004, the Bank opened a
full service office in Marysville, Washington.  In April 2005, the Bank opened
a full service office in Lakewood, Washington, located in Pierce County, just
south of Tacoma.  The Bank opened a full service regional facility in June
2006, which replaced the Bank's existing office and commercial banking center
in south Everett.  During the third quarter of fiscal 2007, the Bank entered
into a lease agreement to open a branch in Puyallup, Washington, which opened
in June of 2007, to expand its presence in Pierce County.

Lending Activities
------------------

     General.  The Bank's loan portfolio, net totaled $1.2 billion at March
31, 2008, representing approximately 86% of its total assets.  On that date,
12.3% of net loans receivable consisted of loans secured by mortgages on
one-to-four family residential properties, 3.8% consisted of loans secured by
mortgages on multi-family residential properties, and 80.9% consisted of
construction and land development loans, commercial loans and commercial real
estate loans.  The balance of the Bank's outstanding loans at that date
consisted of secured and unsecured consumer loans and loans secured by savings
deposits.

     The Bank originates both fixed rate and adjustable rate mortgages
("ARMs") secured by residential and commercial real estate.

     A substantial portion of the Bank's loan portfolio is secured by real
estate located in the Bank's primary market area, which the Bank considers to
be Whatcom, Skagit, Snohomish and Pierce counties in Washington.  In addition,
the Bank's portfolio contains a large amount of construction and land
development loans, which are being adversely impacted by the slow housing
market.  This concentration of credit risk could have a material adverse
effect on the Bank's financial condition and results of operations to the
extent there is a material deterioration in the counties' economic and real
estate values.

    In order to enable it to make the yields on its loan portfolio and
investments more interest rate sensitive, the Bank has implemented a number of
measures.  Those measures include the: (i) origination of long-term,
fixed-rate

                                        1

<PAGE>



mortgage loans when such loans are written to specifications promulgated by
the Federal Home Loan Mortgage Corporation ("Freddie Mac") and qualify for
sale in the secondary market, (ii) origination of ARM loans on residential and
commercial properties subject to market conditions, (iii) origination of
variable rate commercial and consumer loans, and (iv) increased emphasis on
originating shorter term loans for its portfolio, and selling much of its
long-term mortgage loan production into the secondary market.

     The following table provides selected data relating to the composition of
the Bank's loan portfolio by type of loan at the dates indicated.  The changes
represented in the table below reflect the changes in the Bank's lending
strategies, which began in 1999 when the Bank shifted its focus from a
traditional thrift institution to that of a community commercial bank.  As
part of this shift in strategy, the Bank began selling much of its one-to-four
family loan production into the secondary market on a servicing released
basis.  In addition, as repayments were received on its one-to-four family
loan portfolio, the funds were used to support the growth in the commercial
loan categories, as shown in the table below.


<PAGE>
<TABLE>
                                                         At March 31,
                    ----------------------------------------------------------------------------------------
                          2008             2007              2006               2005               2004
                    ---------------   ---------------   ---------------    ---------------   ---------------
                    Amount  Percent   Amount  Percent   Amount  Percent    Amount  Percent   Amount  Percent
                    ------  -------   ------  -------   ------  -------    ------  -------   ------  -------
                                                      (Dollars in thousands)

                <c>        <c>    <c>        <c>    <c>        <c>     <c>        <c>    <c>       <c>
Type of Loan:
First mortgage loans:
 One-to-four family
  residential..... $165,824   13.9%  $149,885   14.2 %  $148,515   16.2%   $167,454   20.8%  $173,908  26.4%
 One-to-four family
  construction....   35,303    3.0     28,576    2.7      20,971    2.3      16,464    2.1     14,165   2.2
 Participations
  sold............  (54,269)  (4.6)   (54,592)  (5.2)    (56,546)  (6.2)    (65,125)  (8.1)   (74,279)(11.3)
                 ----------  ------ ---------- ------   --------  ------   --------  ------  -------- -----
    Subtotal......  146,858   12.3    123,869   11.7     112,940   12.3     118,793   14.8    113,794  17.3
 Construction
  and land
  development.....  486,535   40.8    405,348   38.4     262,358   28.6     162,726   20.2    132,436  20.1
 Multi-family
  residential.....   45,049    3.8     52,727    5.0      70,080    7.6      73,397    9.1     53,344   8.1
 Commercial real
  estate..........  300,109   25.2    292,212   27.7     314,299   34.2     312,722   38.9    250,340  38.0
 Commercial loans.  177,685   14.9    146,265   13.9     123,445   13.4     109,387   13.6     87,233  13.2
 Home equity
  secured.........   47,351    4.0     45,307    4.3      44,001    4.8      33,762    4.2     25,539   3.9
 Other consumer
  loans...........    7,005    0.6      5,031    0.5       5,571    0.6       5,961    0.7      5,662   0.9
                 ----------  ------ ---------- ------   --------  ------   --------  ------  -------- -----
    Subtotal......1,063,734   89.3    946,890   89.8     819,754   89.2     697,955   86.7    554,554  84.2
                 ----------  ------ ---------- ------   --------  ------   --------  ------  -------- -----
    Total loans
     outstanding..1,210,592  101.6  1,070,759  101.5     932,694  101.5     816,748  101.5    668,348 101.5
Less:

 Loan loss
  reserve.........  (19,114)  (1.6)   (15,889)  (1.5)    (14,184)  (1.5)    (11,767)  (1.5)   (10,122) (1.5)
                 ----------  ------ ---------- ------   --------  ------   --------  ------  -------- -----
 Net loans
  receivable.....$1,191,478  100.0% $1,054,870 100.0%   $918,510  100.0%   $804,981  100.0%  $658,226 100.0%
                 ==========  ====== ========== ======   ========  ======   ========  ======  ======== =====


</TABLE>


    Loan Maturity.  The following table sets forth certain information at
March 31, 2008 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity.  Demand loans and
overdrafts are reported as due in one year or less.  Loan balances are net of
undisbursed loan proceeds, unearned discounts, unearned income and allowance
for loan losses.

                                           Due After
                           Due Within      1 Through      Due Over
                             1 Year         5 Years       5 Years
                           After March    After March    After March
                            31, 2008        31, 2008       31, 2008    Total
                           -----------    -----------    -----------   ------
                                            (In thousands)

Construction and land
 development..............    $447,181      $  33,215    $     972    $481,368
Commercial real estate....     164,030         93,141       34,936     292,107
Multi-family
 residential..............      20,626         21,845        2,820      45,291
Commercial loans..........     132,272         33,702        5,136     171,108
One-to-four family
 construction.............      35,303             -            --      35,303
One-to-four family
 residential, home equity,
 and other consumer
 loans....................      66,662         32,486       67,153     163,301
                           -----------    -----------  -----------  ----------
   Total..................    $866,074       $214,389     $111,015  $1,191,478
                           ===========    ===========  ===========  ==========



                                          2

<PAGE>



     The following table sets forth the dollar amount of all loans due more
than one year after March 31, 2008 which have fixed interest rates and have
floating or adjustable interest rates.  Loan balances are net of undisbursed
loan proceeds, unearned discounts, unearned income, and allowance for loan
losses.

                                                      Adjustable
                                        Fixed Rates     Rates         Total
                                        -----------   ----------    ----------
                                                    (In thousands)
Construction and land
 development..........................   $   28,953   $    5,234    $   34,187
Commercial real estate................       45,353       82,724       128,077
Multi-family real estate..............        4,183       20,482        24,665
Commercial loans......................       27,444       11,392        38,836
One-to-four family construction.......            -           --            --
One-to-four family residential, home
 equity, and other consumer loans.....       94,901        4,738        99,639
                                         ----------   ----------    ----------
   Total..............................   $  200,834   $  124,570    $  325,404
                                   ==========   ==========    ==========

     Multi-Family and Commercial Real Estate Lending.  Commercial real estate
loans, including multi-family, totaled $345.2 million, or 29.0% of net loans
receivable at March 31, 2008.  The Bank originates commercial real estate
loans primarily secured by owner-occupied business facilities, apartment
buildings, warehouses, mini-storage facilities, industrial use buildings,
office and medical office buildings, hospitality facilities, commercial land
development and retail shopping centers located in its market area.
Commercial real estate loans typically range in principal amount from $500,000
to $10.0 million.  At March 31, 2008, the largest commercial real estate loan
on one property had an outstanding balance of $16.0 million and is secured by
a destination resort and surrounding real estate located in the Bank's market
area. At March 31, 2008, the Bank had three other loans with net balances in
excess of $10.0 million, which are secured by commercial real estate. All of
these loans were performing according to their terms at March 31, 2008.

     Commercial adjustable rate mortgage loans are originated with rates which
generally adjust annually after an initial period ranging from one to five
years.  These adjustable rate mortgage loans have generally utilized Prime or
FHLB Advance Rates as indices, with principal and interest payments fully
amortizing over terms of 15 to 25 years, and are generally due in ten years.
The Bank  has also originated fixed rate commercial loans due in five to 10
years, (with amortization terms of ten to 25 years), along with 15 year fully
amortizing loans.  Commercial real estate loans originated with interest rates
fixed for the initial three, five and ten year terms generally contain
prepayment penalties during their fixed rate period ranging from 1.0% to 5.0%
of the loan's outstanding balance.

     The Bank requires appraisals or evaluations on all properties securing
commercial real estate loans.  The Bank considers the quality and location of
the real estate, the credit of the borrower, the cash flow of the project and
the quality of management involved with the property.  The Bank generally
imposes a minimum debt coverage ratio of approximately 1.20 times for
originated loans secured by income producing commercial properties.  The Bank
generally obtains loan guarantees from financially capable parties based on a
review of personal financial statements, or if the borrower is a corporation,
the Bank also generally obtains personal guarantees from corporate principals
based on a review of the principals personal financial statements.

     Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one-to-four
family residential lending.  However, loans secured by such properties usually
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than  one-to-four family residential mortgage
loans.  Because payments on loans secured by commercial properties often
depend upon the successful operation and management of the properties,
repayment of such loans may be affected by adverse conditions in the real
estate market or the economy.  If we foreclose on a commercial and
multi-family real estate loan, our holding period for the collateral typically
is longer than for one-to-four family residential mortgage loans because there
are fewer potential purchasers of the collateral.  Additionally, commercial
and multi-family real estate loans generally have relatively large balances
compared to residential mortgage loans.  Accordingly, if we make any errors


                                       3

<PAGE>



in judgment in the collectibility of our commercial and multi-family real
estate loans, any resulting charge-offs may be larger on a per loan basis than
those incurred with our residential or other consumer loans. The Bank seeks to
minimize these risks by limiting the maximum loan-to-value ratio to 80% and
carefully reviewing the financial condition of the borrower, the quality of
the collateral and the management of the property securing the loan.  Because
of  the Bank's commitment to its pricing and profitability targets, the
balances in the multi-family loan portfolio declined in this aggressively
priced arena during the year.

     Construction and Land Development Loans.  Construction lending provides
the Bank the opportunity to achieve higher interest rates and fees with
shorter terms to maturity than does its other real estate lending activities.
Construction lending, however, generally involves a higher degree of risk than
permanent financing for a finished residence or commercial building, because
of the inherent difficulty in estimating both the estimated cost of the
project, the property's value at completion and the market demand for the
property upon completion.  If the estimated cost of construction proves to be
inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to complete the project.

     The nature of these loans is such that they are generally more difficult
to evaluate and monitor.  To address this risk, and because of the level of
construction loans in the Bank's portfolio, the Bank has personnel dedicated
specifically to monitoring the progress of its construction projects, and
making on-site inspections of the property.  The Bank also has an experienced
appraisal staff, and members of senior management with related appraisal
education and experience, who review appraisals utilized by the Bank in
analyzing prospective construction projects.  In addition, in an effort to
monitor the available inventory in its markets, the Bank also regularly
reviews the overall building and development activity in its markets. Also, to
mitigate the risks related to construction lending, the Bank primarily deals
with experienced builders, with acceptable credit histories, sound financial
statements and a proven track record in the industry.  In addition, the Bank
utilizes the services of experienced inspectors to monitor the progress and
draw process in the more complex construction projects.  Finally, members of
the Bank's senior management and loan committees also have a significant
amount of experience in the areas of construction lending, appraisals, and
loan underwriting, further mitigating the Bank's risk in this area.

     The Bank actively originates construction loans through both its Mortgage
Loan Division and its Commercial Loan Division.  The Bank's Mortgage Loan
Division generally oversees the single family custom construction loans, and
to a lesser extent, speculative construction loans (i.e., loans for homes that
do not have a contract with a buyer for the purchase of the home upon
completion of the construction) to smaller contractors building a limited
number of speculative homes per year.  These construction loans are further
broken down in the first two lines of the table below (speculative
construction one-to-four family and custom construction one-to-four family).
The Bank's Commercial Lending Division is responsible for the speculative
construction projects for the Bank's larger builders (including large
one-to-four family developments), in addition to the Bank's multi-family
construction loans, non-residential commercial construction loans, and the
Bank's land development loans.

     At March 31, 2008 and 2007, the composition of the Bank's construction
loan portfolio was as follows:

                                                 At March 31,
                                ----------------------------------------------
                                       2008                     2007
                                --------------------     ---------------------
                                Amount (1)   Percent     Amount (1)    Percent
                                ---------    -------     ---------     -------
                                            (Dollars in thousands)

Speculative construction
 one-to-four family...........   $ 27,206       5.21%    $  16,597      3.82%
Custom/presold construction
 one-to-four family...........      8,097       1.55        11,979      2.76
Commercial/speculative
 construction one-to-four
 family.......................    236,536      45.33       177,602     40.93
Commercial construction multi
 family.......................     11,732       2.25         6,986      1.61
Commercial construction-
 nonresidential...............     59,541      11.41        47,490     10.94
Land development..............    178,726      34.25       173,270     39.94
                                ---------     -------    ---------    -------
  Total.......................   $521,838     100.00%     $433,924    100.00%
                                =========     =======    =========    =======

__________
 (1)     Includes loans in process.

                                         4

<PAGE>



     Speculative construction one-to-four family loans increased 63.9% from
March 31, 2007 to $27.2 million at March 31, 2008.  These loans are made to
home builders who generally build one or two speculative construction homes
per year, and the increased activity in this period was a result of an active
real estate market in the Bank's markets.  Because of the nature of these
loans, a buyer for these homes is found by the builder either during the
construction phase or shortly after completion of the home's construction.
The Bank generally includes interest reserves in the construction loan amount;
however, there is no assurance that this amount will be sufficient to cover
all interest expense for the life of the loan.  If a buyer is not found in a
timely manner, the builder will incur additional interest, marketing and other
expenses until the home is sold.  As a result, these loans carry a higher
degree of risk than loans on homes already completed and custom construction
loans (discussed below) for which there is a buyer.

     Custom construction for one-to-four family loans decreased 32.4% from the
prior year to $8.1 million at March 31, 2008.  Unlike speculative construction
loans, custom construction loans are made to customers who have entered into a
contract with a builder to build them a custom home.  The construction portion
of these loans are generally for a period of one year or less, and the Bank
generally commits to the long-term take-out financing for the customer at the
time the construction loan is originated.  As a result, the risk for custom
construction loans is generally less than for speculative construction loans.

     Commercial speculative construction one-to-four family residential loans
increased 33.2% from the prior year to $236.5 million at March 31, 2008.
Commercial speculative construction loans include loans made to the Bank's
larger contractors, who build a significant number of speculative construction
one-to-four family homes each year.  The Bank has established relationships
with experienced builders in this regard, which, along with an active
residential market in the Pacific Northwest, resulted in this significant year
over year growth in this portion of the Bank's construction portfolio.  The
Bank generally limits the loan to value to 85% of the discounted value of the
completed dwellings, and further manages its risk by limiting the number of
homes that can be under construction at any one time, when appropriate.

     The commercial construction multi-family portion of the Bank's portfolio
increased 68.0% from the prior year, to $11.7 million at March 31, 2008. The
Bank's relationships are more heavily concentrated with one-to-four family
contractors and developers than multi-family contractors at this time.  These
loans are generally for the construction of apartment units in the Bank's
primary market areas.

     Non-residential commercial construction loans increased 25.4% from the
prior year to $59.5 million at March 31, 2008.  These loans are made for a
variety of non-residential real estate properties, including but not
necessarily limited to the retail properties, owner occupied commercial real
estate, office space, mini-storage facilities, hospitality related uses, and
other non-residential uses.  These loans are generally made to the ultimate
end user of the property (i.e., these loans are more similar to custom
construction than speculative construction loans).  However, as a result of
the inherent risks noted above, these loans carry higher risks than completed
properties.  Non-residential commercial construction loans receive the same
degree of monitoring by the Bank as other construction loans contained in the
Bank's loan portfolio, to mitigate the inherent risks of these loans.

     Land development loans increased 3.1% from the prior year, to $178.7
million at March 31, 2008.  This has been a significant part of the Bank's
strategy in each of its markets, and fiscal 2008 was a successful year of
growth in this category.  Most of these loans carry interest rates tied to the
Prime rate, which allows the Bank to fund the loans profitability with
short-term borrowings.  In addition to the Bank's extensive experience in this
area (see the discussion regarding the Bank's subsidiary, Westward Financial
Services, contained in the section entitled "-- Real Estate Development
Subsidiary), the Bank has continued to expand its expertise by hiring
additional members of senior management dedicated to monitoring this portion
of the Bank's lending activities.  In addition, the Bank has developed
relationships with some of the area's strongest real estate developers, which
has played a significant part of the Bank's success in this area.  This,
however, does not mitigate the inherent risks in this type of lending.  While
the Bank generally limits its exposure to 75% of the discounted value of the
completed lots, it can take a year or more to complete a large development,
therefore increasing the risk to the Bank and its valuations used at the time
the loan is closed.  During the period from the time the loan is closed until
the lots are developed, the market conditions can change significantly,
exposing the Bank to additional risks in the event the lots can not ultimately
be sold at or near the values estimated at

                                        5

<PAGE>



the time of the appraisal.  The Bank's management regularly monitors the
housing demand in its markets, home and finished lot prices, and related
measures in its efforts to mitigate this risk.  However, no assurances are
made that these or other measures can or will fully mitigate such risks.
Currently, the demand for building lots is minimal in the Bank's markets, as a
result of the slow housing market and the high levels of inventory in both
finished homes and developed lots.

     The vast majority of the Bank's construction loan activity is
concentrated in the Pacific Northwest.  While the Pacific Northwest is not
experiencing the dramatic declines seen in other parts of the country, the
market is slowing and the Bank's performance is being adversely impacted.  If
the market does not improve, it will likely have a significant impact on the
Bank's performance, especially in these higher risk construction lending
categories.

     Commercial Loans.  The Bank's loan portfolio also includes a wide range
of commercial loans to small and medium sized businesses.  This portfolio
presently includes lines of credit with floating rates and maturities of one
year or less and term loans for the purchase of equipment, real estate and
other operating purposes with maturities generally not exceeding ten years.
These loans are secured by a variety of business assets including equipment,
real estate, accounts receivable and inventory.  These types of loans
constituted $177.7 million, or approximately 14.9% of the Bank's net loan
portfolio at March 31, 2008. The majority of these loans carry personal
guarantees.  Under certain conditions, the Bank also offers unsecured credit
to qualified borrowers.

     Commercial lending carries increased risks compared to residential
mortgage lending as a result of the heavy reliance upon the future income of
the borrower and the uncertain liquidation value of the collateral.  In the
event of default, the liquidation of collateral is often insufficient to cover
the outstanding debt.  To mitigate these inherent risks, the Bank combines a
conservative lending policy with experienced lending personnel responsible for
the ongoing management  and monitoring of their assigned accounts.

     One-to-Four Family Residential Loans.  In the past, a significant lending
activity of the Bank was the granting of conventional loans to enable
borrowers to purchase existing homes or construct new homes.  The Bank's real
estate loan portfolio also includes loans on two-to-four family dwellings, and
loans made to purchase or refinance improved buildings to be used for
residential housing.  At March 31, 2008, approximately 12.3% of the Bank's net
loans receivable consisted of loans secured by one-to-four residential real
estate.

     The Bank's lending practices generally limit the maximum loan-to-value
ratio on one-to-four family residential mortgage loans to 97% of the appraised
value as determined by an independent appraiser, with the condition that
private mortgage insurance generally be required on any home loans with
loan-to-value ratios in excess of 80% of the appraised value.  The Bank places
this insurance with carriers approved by the Freddie Mac.  The coverage
generally limits the Bank's exposure to 72% of the loan amount.  If private
mortgage insurance is required, the borrower pays the premium at loan closing
and any recurring premiums through an escrow reserve account established with
the Bank for such period of time as the Bank requires the insurance coverage
to be in force.

     The Bank presently originates both fixed-rate and ARMs secured by
one-to-four family properties with a loan term not exceeding 30 years.
Certain consumer safeguards are built into the ARM instruments used by the
Bank, which  include limits on annual and lifetime interest rate adjustments.
The Bank generally originates these loans in accordance with guidelines
established by the secondary market.

     Consumer Loans.  The Bank makes a variety of loans for consumer purposes.
Included among these are home equity loans, home equity lines of credit, loans
secured by personal property, such as automobiles, boats, and other vehicles,
loans secured by deposit accounts, unsecured loans, and loans for mobile homes
located in mobile home parks.
     Horizon Bank offers 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, 2008, the Bank
held $54.4 million of consumer loans or 4.6% of net loans receivable,
approximately $3.7 million of which is unsecured.

                                      6

<PAGE>



     Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciating assets such as automobiles, boats and other vehicles.  In
such cases, any repossessed collateral for a defaulted consumer loan may not
provide an adequate source of repayment of the outstanding loan balance as a
result of the greater likelihood of damage, loss or depreciation.  The
remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment.  In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy.  Furthermore, the application
of various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount that can be recovered on such loans.

     Consumer loans are made based on an evaluation of the borrower's
creditworthiness, including income, other indebtedness, and satisfactory
credit history, and the value of the collateral.  Designated officers of the
Bank or members of the Bank's Loan Committee approve consumer loan requests.

     Secured loan amounts typically do not exceed 90% of the value of the
collateral, or 90% 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, real
estate developers, and builders.  The Bank does not actively utilize mortgage
brokers in the origination of loans.

     The Bank accepts completed loan applications from all of its offices and
processing is substantially centralized.  Detailed  information is obtained to
determine the creditworthiness of the borrower and the borrower's ability to
repay.  Significant items appearing on the loan applications and accompanying
material are verified through the use of written credit reports, financial
statements, and confirmations.  After analysis of the loan application,
supporting documents and the property to be pledged as loan security,
including an appraisal of the property by either a staff appraiser or an
independent fee appraiser, the application is forwarded to the Bank's Loan
Committee.  Loan approval requires the signatures of two or three members of
the Loan Committee depending on the size of the loan.  The Loan Committee
consists of officers of the Bank who are appointed by the Bank's Board of
Directors.  The Bank generally requires its mortgage notes to be guaranteed
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.

     Loan assumption requests of adjustable rate loans are handled by the Bank
in a manner similar to new loan requests.  Secondary market 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.

     Loan Originations, Purchases and Sales.  Currently, the Bank emphasizes
the origination of 15 to 30 year fixed rate loans on terms and conditions
which will permit them to be sold in the secondary market, while originating
ARM loans and shorter term fixed-rate loans for its own portfolio.

     In addition to originating loans, Horizon Bank may purchase real estate
loans in the secondary market.  The Bank's purchases in the secondary market
depend upon the demand for mortgage credit in the local market area and the
inflow of funds from traditional sources.  Loan purchases enable the Bank to
utilize funds more quickly, particularly where sufficient loan demand is not
obtainable locally.

     The Bank is a qualified servicer for both Freddie Mac and Federal
National Mortgage Association ("Fannie Mae").  The Bank's general practice is
to close its fixed-rate, one-to-four family residential loans on Freddie Mac
loan documents in order to facilitate future sales to Freddie Mac as well as
to other institutional investors.  From time to time, depending upon interest
rates and economic conditions, the Bank has sold participation interests in
loans in order to provide additional funds for lending, to generate servicing
fee income and to decrease the dollar amount of its intermediate and long-term
fixed-rate loans.  The sale of loans in the secondary mortgage market reduces
the Bank's interest rate risk and allows the Bank to continue to make loans
during periods when deposit flows decline or funds are

                                        7

<PAGE>



otherwise unavailable for lending purposes.  As of March 31, 2008, the Bank
was servicing loans for others aggregating approximately $109.0 million for
which it generally receives a fee payable monthly of 0.25% to 0.375% 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.

     The Bank also buys and sells portions of commercial loans through
participations with other financial institutions.  As of March 31, 2008, the
Bank was servicing commercial loans for others aggregating approximately $55.0
million for which it generally receives a fee payable monthly of 0.25% to
0.375% per annum of the unpaid balance of each loan. The Bank has numerous
options in this regard, and will continue to buy and sell, loan participations
to assist its liquidity, concentration and diversification efforts.

     Loan Commitments.  The Bank is a party to financial instruments with
off-balance-sheet risk (loan commitments) made in the normal course of
business to meet the financing needs of its customers and to reduce its own
exposure to fluctuations in interest rates.  Loan commitments involve, to
varying degrees, elements of credit and interest-rate risk in excess of the
amount recognized in the balance sheet.  The contract amounts of those
commitments reflect the extent of the Bank's exposure to credit loss from
these commitments.  The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.

     Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee.  Because many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements.  The amount of collateral
obtained, if it is deemed necessary by the Bank upon extension of credit, is
based on management's credit evaluation of the counterparty.  Collateral held
varies but may include accounts receivable, inventory, property, plant and
equipment and  commercial properties.

     Standby letters of credit are conditional commitments issued by the Bank
to guarantee the performance of a customer to a third party.  Those guarantees
are primarily issued to support public and private borrowing arrangements,
including commercial paper, bond financing, and similar transactions.  Except
for certain long-term guarantees, the majority of guarantees expire in one
year.  The credit risk involved in issuing letters of credit is essentially
the same as that involved in extending loan facilities to customers.
Collateral supporting those commitments, for which collateral is deemed
necessary, generally amounts to 100% of the commitment amount at March 31,
2008.

     The following is a summary of the off-balance-sheet financial instruments
or contracts outstanding as of the dates indicated.

                                                       At  March 31,
                                                 -------------------------
                                                    2008           2007
                                                 -----------   -----------
                                                      (In thousands)

Commitments to extend credit....................   $ 361,763    $  379,549
Credit card arrangements........................      10,510        10,105
Standby letters of credit.......................       2,047         3,056


     Loan Origination and Other Fees.  In addition to interest earned on
loans, the Bank receives fees for originating loans.  Loan origination fees
are a percentage of the principal amount of the mortgage loan which are
charged to the borrower at the closing of the loan.

     The Bank's loan origination fees are generally 0% to 2.5% on conventional
residential mortgages and 0% to 1.5% for commercial real estate loans.  The
total amount of deferred loan origination fees and unearned discounts at March
31, 2008 was $4.5 million.  Any unamortized loan fees, net of related direct
costs, are recognized as income at the time the loan is sold, paid down or
paid off.

                                            8

<PAGE>


     Income from loan origination and commitment fees varies with the volume
and type of loans and commitments made and purchased and with competitive
conditions in mortgage markets, which in turn responds to the demand for and
availability of money.  The Bank experiences an increase in loan fee income
and other fee income, such as appraisal and loan closing fees, during periods
of  low interest rates because of the resulting demand for mortgage loans.
The Bank also receives other fees and income from charges relating to existing
loans, which include late charges, and fees collected in connection with a
change in terms or other loan modifications.  These fees and charges have not
constituted a material source of income.

     Delinquent Loans, Loans in Foreclosure and Foreclosed Property.  Loans
are defined as delinquent when any payment of principal and/or interest is
past due.  While the Bank generally is able to work out a satisfactory
repayment schedule with a delinquent borrower, the Bank will usually undertake
foreclosure proceedings if the delinquency is not otherwise resolved within 90
days.  Property acquired by the Bank as a result of foreclosure or by deed in
lieu of foreclosure is classified as "real estate owned" until such time as it
is sold or otherwise disposed of. As of March 31, 2008, there were no loans in
the loan portfolio over 90 days delinquent and accruing interest and 13 loans
on non-accrual status.  The Bank had one real estate owned at March 31, 2008.
Total non-performing assets represented $12.3 million or 0.88% of total assets
at March 31, 2008 compared to $1.0 million or 0.07% of total assets at March
31, 2007.

     The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.


                                              At March 31,
                             ---------------------------------------------
                               2008      2007     2006      2005     2004
                             -------   -------   -------   ------   ------
                                        (Dollars in thousands)

Non-accrual loans........... $11,608   $   226   $ 1,161   $1,481   $   --
Loans 90 days or
 more delinquent and
 accruing interest..........      -         --        --        -      339
Restructured loans..........      -         --        --       -        --
Real estate acquired through
 foreclosure................     655       725        --       -        63
                             -------   -------   -------   ------   ------
  Total..................... $12,263   $   951   $ 1,161   $1,481   $  402
                             =======   =======   =======   ======   ======
As a percentage of net
 loans......................    0.97%     0.02%     0.13%    0.18%    0.06%
As a percentage of total
 assets.....................    0.88%     0.07%     0.10%    0.15%    0.05%


     Additional interest income which would have been recorded had nonaccruing
loans been current in accordance with their original terms was considered
immaterial as of March 31, 2008.  No interest income was recorded on
nonaccrual loans for the year ended March 31, 2008.

     Potential Problem Loans.  At March 31, 2008, the Bank had identified
loans totaling $12.1 million which were considered impaired, the majority of
which are included in the above non-accrual totals. Two lending relationships
contributed to the majority of the increase in these totals, including a
residential developer in Snohomish County with inventory consisting of 17
homes (four of which are in escrow with sales pending), eight residential
building lots and one commercial development project for a 7.4 acre site in
Monroe, Washington. Horizon Financial charged off over $700,000 in the fourth
quarter of fiscal 2008 for these projects.

     Subsequent to March 31, 2008, the Bank accepted a deed in lieu of
foreclosure for one property included in the above impairment analysis.
Approximately $1.8 million in principal balances were moved to real estate
owned and $200,000 was charged against the allowance for loan losses based on
the present value calculation of expected cash flows at the time of
repossession.

     Reserve for Losses.  The Bank has an active ongoing credit review
function.  The provision for loan losses is maintained at a level sufficient
to provide for probable 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, historical
industry 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

                                        9

<PAGE>



of the collateral and guarantees securing the loans.  The reserve is based
upon factors and trends identified by management at the time financial
statements are prepared, but the ultimate recovery of loans is susceptible to
future market factors beyond the Bank's control, which may result in losses or
recoveries differing significantly from those provided for in the financial
statements.

     The Bank maintains an allowance for credit losses sufficient to absorb
losses inherent in the loan portfolio.  The Bank has established a systematic
methodology to ensure that the allowance is adequate.  The Bank reviews the
following information, on a quarterly basis, to estimate the necessary
additions to its loan loss reserve:

     *    All loans classified during the previous analysis. Current
          information as to payment history, or actions taken to correct the
          deficiency are reviewed, and changes are made, as appropriate.  If
          conditions have not improved, the loan classification is reviewed to
          ensure that the appropriate action is being taken to mitigate loss.

     *    All loans past due on scheduled payments.   The Bank reviews all
          loans that are past due 30 days or more, taking into consideration
          the borrower, nature of the collateral and its value, the
          circumstances that have caused the delinquency, and the likelihood
          of the borrower correcting the conditions that have resulted in the
          delinquent status.

     *    Composition of the Bank's portfolio.  The Bank also analyzes its mix
          of loans when establishing appropriate allowances for loan losses.
          For example, reserves for losses on the Bank's one-to-four family
          mortgage portfolio (on a percentage basis) are lower than the
          percentage reserve estimates for commercial or credit card loans.
          Therefore, the Bank's allowance for loan losses is likely to change,
          as the composition of the Bank's loan portfolio changes.

     *    Current economic conditions. The Bank takes into consideration
          economic conditions in its market area, the state's economy, and
          national economic factors that could influence the quality of the
          loan portfolio in general.

     *    Trends in the Bank's delinquencies.  Prior period statistics are
          reviewed and evaluated to determine if the current conditions
          warrant changes to the Bank's loan loss allowance.

     *    Historical loss rates.  Industry loss rates and the Bank's loss rate
          experience (where applicable) are  also considered when analyzing
          the adequacy of the Bank's loan loss allowance.

     As required by Statement of Accounting Standard ("SFAS") No. 114,
Accounting by Creditors for Impairment of a Loan, 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 the Bank applies SFAS No. 5, Accounting for
Contingencies.  A reserve factor is applied to homogeneous loan pools that is
consistent with the Bank's experience in that loan pool type or with
historical industry experience if management believes such guidelines are more
appropriate. The applied percentage is also influenced by other economic
factors as noted above.

     The calculated amount is compared to the actual amount recorded in the
allowance at the end of each quarter and a determination is made as to whether
the allowance is adequate, yet not excessive.  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.


                                         10

<PAGE>


     *    Construction and Land Development - This segment of the Bank's
          portfolio is near the higher end of the risk spectrum as a result of
          the numerous risks throughout the land development and construction
          process.  In both of these categories, risks are elevated because of
          difficulties in accurately estimating the total costs of real estate
          development projects, the value of the completed projects upon
          completion, and the ultimate demand for the finished lots and
          dwellings upon completion.  In the event the cost estimates prove to
          be inaccurate, the Bank may be required to advance additional funds
          to complete the project.  Insufficient market demand for the
          finished products may have a material impact on the Bank's
          performance if its borrowers are unable to carry their interest
          obligations in a slow market.  This is the case currently, as the
          slow housing market is adversely impacting the Bank's performance,
          and if conditions do not improve, future performance may be
          materially impacted.

     *    Multi-Family Residential - While there have been minimal losses in
          this segment of the portfolio, the rental market is susceptible to
          the effects of an economic downturn.  Although the Bank monitors
          loan-to-value ratios, the conditions that would create a default
          would carry through to a new owner which may require that the Bank
          discount the property or hold it until conditions improve.

     *    Commercial Real Estate - As with multi-family loans, the
          classification of commercial real estate loans closely corresponds
          to economic conditions which will limit the marketability of the
          property, resulting in higher risk than a loan secured by a
          single-family residence.  Commercial real estate loans have
          historically been assigned higher reserve levels than one-to-four
          family residential loans, but lower than commercial business loans.

     *    Commercial Business Loans - These types of loans carry a higher
          degree of risk, relying on the ongoing success of the business to
          repay the loan.   Collateral for commercial credits is often
          difficult to secure, and even more difficult to liquidate in the
          event of a default.  If a commercial business loan demonstrates any
          credit weakness, the reserve is increased to recognize the
          additional risk.

     *    Consumer Loans - The consumer loan portfolio has a wide range of
          factors, determined primarily by the nature of the collateral and
          the credit history and capacity of the borrower.   The loans tend to
          be smaller in principal amount and secured by second deeds of trust,
          automobiles, boats, and other vehicles.  Loans for automobiles,
          boats, and other vehicles, generally experience higher than average
          wear in the environment and hold a higher degree of risk of loss in
          the event of repossession.

     *    Unsecured Credit Cards - As a result of 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, 2008
was adequate at that date.  Although management believes that it uses the best
information available to make these determinations, future adjustments to the
allowance for loan losses may be necessary.

     While the Bank believes it has established its existing allowance for
loan losses in accordance with accounting principles generally accepted in the
United States of America, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to
significantly increase or decrease its allowance for loan losses.  In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not
be necessary should the quality of any loans deteriorate as a result of the
factors discussed above.  Any material increase in the allowance for loan
losses may adversely affect the Bank's financial condition and results of
operations.

     The Bank's allowance for losses at March 31, 2008 totaled $19.1 million
and $15.9 million at March 31, 2007.  The Bank's loan loss reserve as of March
31, 2008 and 2007, was 1.60% and 1.51% of net loans receivable, respectively.

                                        11

<PAGE>



    The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.  For each of these periods, management
reviewed the changes in the composition and size of the Bank's loan portfolio,
along with the economic conditions in effect during each period, using the
methodologies presented in the paragraphs above within this section.

                                         Year Ended March 31,
                             ---------------------------------------------
                               2008      2007     2006      2005     2004
                             -------   -------   -------   -------  ------
                                       (Dollars in thousands)

Allowance at beginning of
 period....................  $15,889   $14,184   $11,767   $10,122  $ 8,506
Provision for loan losses..    4,100     1,850     2,575     1,700    1,915
                             -------   -------   -------   -------  -------
Recoveries:
 First mortgage loans......       -         --        --        --       --
 Construction and land
   development.............       -         --        --        --       --
 Commercial real estate....       -         --        --        --       --
 Multi-family residential..       -         --        --        --       --
 Commercial loans..........       16        -          1       168       79
 Credit card loans.........        7        41         6         5        6
 Other consumer loans......       -          9        -          1        1
                             -------   -------   -------   -------  -------
  Total recoveries.........       23        50         7       174       86

Charge-offs:
 First mortgage loans......       -         --        --        --       --
 Construction and land
  development..............     (702)       -         --        --       --
 Commercial real estate....       -         --        --        --       --
 Multi-family residential..       -         --        --        --       --
 Commercial loans..........      (60)      (75)      (33)     (105)    (253)
 Credit card loans.........      (51)      (51)      (54)     (104)    (124)
 Other consumer loans......      (85)      (69)      (78)      (20)      (8)
                             -------   -------   -------   -------  -------
 Total charge-offs.........     (898)     (195)     (165)     (229)    (385)

   Net charge-offs.........     (875)     (145)     (158)      (55)    (299)
                             -------   -------   -------   -------  -------
Allowance at end of period.  $19,114   $15,889   $14,184   $11,767  $10,122
                            =======   =======   =======   =======  =======
Allowance for loan losses
as a percentage of net loans
receivable at the end of the
period.....................     1.60%     1.51%     1.54%     1.46%    1.48%

Net charge-offs as a percentage
of average loans outstanding
during the period..........     0.08%     0.01%     0.02%     0.01%    0.05%

Allowance for loan losses
as a percentage of nonperforming
assets at end of period....   155.87% 1,670.06% 1,221.35%   794.53% 2,518.51%


                                      12

<PAGE>


<TABLE>

     The following table sets forth the breakdown of the allowance for loan losses by loan category for the
periods indicated.

                                                         At March 31,
                    ---------------------------------------------------------------------------------------
                          2008             2007             2006              2005              2004
                    ---------------- ----------------  ---------------   ----------------  ----------------
                            Percent          Percent           Percent           Percent           Percent
                            of Loans         of Loans          of Loans          of Loans          of Loans
                            in Each          in Each           in Each           in Each           in Each
                            Category         Category          Category          Category          Category
                            to Total         to Total          to Total          to Total          to Total
                    Amount   Loans   Amount   Loans    Amount   Loans    Amount   Loans    Amount   Loans
                    ------   -----   ------   -----    ------   -----    ------   -----    ------   -----
                                                   (Dollars in thousands)

                 <c>      <c>     <c>      <c>      <c>      <c>      <c>      <c>      <c>      <c>

First mortgage
 loans...........   $ 1,293   6.8%    $1,030   6.5%     $  974   6.9%     $  984   8.4%     $ 998    9.9%
Construction and
 land
 development.....     8,030  42.0      6,321  39.8       4,242  29.9       2,528  21.5      2,179   21.5
Commercial real
 estate..........     4,953  25.9      4,557  28.7       5,081  35.8       4,858  41.3      4,118   40.7
Multi-family
 residential.....       496   2.6        548   3.4         755   5.3         760   6.5        585    5.8
Commercial loans.     3,421  17.9      2,661  16.7       2,329  16.4       1,983  16.9      1,674   16.5
Credit card
 loans...........       270   1.4        183   1.2         210   1.5         216   1.8        217    2.1
Other consumer
 loans...........       651   3.4        589   3.7         593   4.2         438   3.7        350    3.5
                    ------- ------   ------- ------    ------- ------    ------- ------   -------  ------
 Total allowance
  for loan
  losses.........   $19,114 100.0%   $15,889 100.0%    $14,184 100.0%    $11,767 100.0%   $10,121  100.0%
                    ======= ======   ======= ======    ======= ======    ======= ======   =======  ======
</TABLE>


<PAGE>
The Bank had an allowance of $70,000 and $110,000 for real estate acquired
through foreclosure at March 31, 2008 and 2007, respectively.  There was no
allowance for real estate acquired through foreclosure as of March 31, 2006,
2005 and 2004.

Investment Activities
---------------------

     Under Washington law, banks are permitted to own U.S. government and
government agency obligations, commercial paper, corporate bonds, mutual fund
shares, and debt and equity obligations issued by creditworthy entities,
whether traded on public securities exchanges or placed privately for
investment purposes.  The Bank holds a diverse portfolio of money market
instruments, U.S. Treasury obligations, federal agency securities, municipal
securities, common stock, preferred stock and corporate notes.

     The FDIC has adopted the Federal Financial Institutions Examination
Council statement of policy on securities activities and accounting
procedures.  This policy requires that institutions establish prudent policies
and strategies for securities activities, identify certain securities trading
practices that are unsuitable for an investment portfolio, recommends
procedures for selection of a securities dealer, and limits investment in high
risk mortgage securities and disproportionately large holdings of long-term
zero coupon bonds.

     The policy addresses concerns about speculative or other non-investment
activities in the securities investment portfolios of depository institutions.
Speculative securities activities can impair earnings or capital and, in some
cases, may cause the failure of the institution.  The policy establishes a
framework for structuring securities activities and clarifies various
accounting issues concerning investment accounts versus trading accounts.

     The amortized cost of the Bank's investment securities of the type
described above at March 31, 2008 was $38.7 million with a market value of
$41.2 million compared to an amortized cost of $48.0 million and market value
of $53.2 million at March 31, 2007. The Bank also invests in mortgage-backed
securities.  At March 31, 2008, these securities had an amortized cost of
$38.7 million and a market value of $39.1 million compared to an amortized
cost and market value of $26.4 at March 31, 2007. The majority of these
mortgage-backed securities are backed by government agencies.

                                       13

<PAGE>



For further information concerning the Bank's investment securities portfolio,
see Notes 3 and 4 of the Notes to the Consolidated Financial Statements
contained in Item 8 of this Form 10-K.

     The following table presents the amortized cost of the Bank's investment
securities portfolio.  The market value of the Bank's investment securities
portfolio at March 31, 2008 was approximately $80.4 million.  This table also
includes interest-bearing deposits and cash equivalents.


                                                      At March 31,
                                            --------------------------------
                                               2008       2007        2006
                                            ---------  ----------   --------
                                                      (In thousands)
Investment securities:
 U.S. Government:
  Available for sale....................... $  33,107   $  41,350   $  45,925
  Held to maturity.........................        -          370         370
                                             --------    --------    --------
                                               33,107      41,720      46,295
Mortgage-backed securities(1):
  Available for sale.......................    38,646      26,220      23,559
  Held to maturity.........................        30         148         482
                                             --------    --------    --------
                                               38,676      26,368      24,041
  Other securities(2):
  Available for sale.......................     5,569       6,325       8,836
  Held to maturity.........................        -           -           --
                                             --------    --------    --------
                                                5,569       6,325       8,836
                                             --------    --------    --------
  Total investments........................    77,352      74,413      79,172

Interest-bearing deposits and cash
 equivalents...............................    25,324      46,212      33,630
                                             --------    --------    --------
                                             $102,676    $120,625    $112,802
                                             ========    ========    ========

_______
(1)   Consists of mortgage-backed securities and collateralized mortgage
      obligations ("CMOs").
(2)   Consists of corporate debt securities, marketable equity securities and
      mutual funds.

     At March 31, 2008, 2007 and 2006 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.



                                           14

<PAGE>



<TABLE>

    The following table sets forth the scheduled maturities, amortized cost, market values and average
yields for the Bank's investment securities at March 31, 2008.

                                                         At March 31, 2008*
                      ------------------------------------------------------------------------------------
                          1 Year        More than       More than       More than           Total
                          or Less     1 to 5 Years    5 to 10 Years     10 Years     Investment Securities
                      -------------   -------------   -------------   -------------  ---------------------
                      Amor-   Aver-   Amor-   Aver-   Amor-   Aver-   Amor-   Aver-  Amor-           Aver-
                      tized    age    tized    age    tized    age    tized    age   tized   Market  age
                      Cost    Yield   Cost    Yield   Cost    Yield   Cost    Yield  Cost    Value   Yield
                      -----   -----   -----   -----   -----   -----   -----   -----  -----   -----   -----
                                                          (Dollars in thousands)

                  <c>     <c>      <c>     <c>     <c>     <c>    <c>     <c>    <c>      <c>     <c>
U.S. government,
 agency securities,
 state and political
 subdivisions:
  Available for
    sale............ $6,726   2.55%  $12,212   4.46%  $10,171  4.18%  $3,998  5.18%  $33,107  $33,679  4.07%
   Held to
    maturity........     -      --        --     --        -     --       -     --        -        -     --
                    -------   -----  -------   -----  -------  ----- -------  -----  -------  ------- ------
                      6,726   2.55    12,212   4.46    10,171  4.18    3,998  5.18    33,107   33,679  4.07
Mortgage-backed
 securities:
   Available for
    sale............     -      --       533   5.50    11,360  4.94   26,753  4.78    38,646   39,100  4.84
   Held to
    maturity........      7   6.39        12   6.67         3 12.62        8 10.55        30       35  8.27
                    -------   -----  -------   -----  -------  ----- -------  -----  -------  ------- ------
                          7   6.39       545   5.52    11,363  4.94   26,761  4.78    38,676   39,135  4.84
Other:
   Available for
    sale............  5,569   6.42        -      --        -     --       -     --     5,569    7,562  6.42
   Held to
    maturity........     --     --        -      --        -     --       -     --        -        -     --
                    -------   -----  -------   -----  -------  ----- -------  -----  -------  ------- ------
                      5,569   6.42        -      --        -     --       -     --     5,569    7,562  6.42

   Total............$12,302   4.30%  $12,757   4.51%  $21,534  4.58% $30,759  4.83%  $77,352  $80,376  4.62%
                    =======   =====  =======   =====  =======  ===== =======  =====  =======  ======= ======
</TABLE>
                                                    15
<PAGE>




Real Estate Development Subsidiary
----------------------------------

     Westward Financial Services, Inc ("Westward"), a land development
company, is a wholly owned subsidiary of the Bank.  Westward has been in the
real estate development business since the 1970s, primarily focused on
residential land development.  Westward completed a 110 lot residential
development in north Bellingham ("Stoneybrook"), in fiscal 2006.  Income
attributable to Westward totaled $24,378, $45,932 and $364,668 for fiscal
years 2008, 2007 and 2006, respectively.  The majority of the lot sales for
the "Stoneybrook" development occurred prior to fiscal 2007, which accounts
for the differing income amounts in these periods.

     In October 2004, Westward entered into a real estate development joint
venture in Greenbriar Northwest LLC ("GBNW") (50% owned by Westward and 50% by
Greenbriar Construction , an established residential land development company
headquartered in Bellingham,Washington).   This joint venture involves
approximately 85 acres of land in south Bellingham and current plans include
developing the property into 739 residential units in a new neighborhood to be
known as "Fairhaven Highlands."   The investment in real estate is recorded as
an asset on the Corporation's balance sheet, and the related debt is recorded
as a liability.  At March 31, 2008, the real estate joint venture has a
carrying amount of approximately $17.6 million, with a related borrowing of
approximately $22.4 million.  One-half of the borrowing expense related to the
joint venture is recognized as an expense on the Corporation's financial
statements as incurred, with the remainder being capitalized.  The Corporation
is presently not recognizing any income related to this joint venture, as it
is in the early stages of development.  For additional details on this joint
venture, please see Note 1 - Nature of Operations and Summary of Significant
Accounting Policies, of the Notes to the Consolidated Financial Statements
contained in Item 8 of this Form 10-K.

Bank Owned Life Insurance
-------------------------

     At March 31, 2008, the Bank held $20.3 million in bank owned life
insurance ("BOLI"), compared to $19.4 million at March 31, 2007.  These
policies are with Northwestern Mutual Life, Mass Mutual and New York Life,
three of the highest rated BOLI providers.  All three of these firms continue
to receive high ratings from AM Best, Fitch, Standard & Poors and Moodys.

Deposit Activities and Other Sources of Funds
---------------------------------------------

     General.  Savings accounts and other types of deposits have traditionally
been important sources of the Bank's funds for use in lending and for other
general business purposes.  In addition to deposit accounts, the Bank derives
funds from loan repayments, loan sales, and borrowings and operations.  The
availability of funds from loan sales is influenced by general interest rates
and other market conditions.  Loan repayments are a relatively stable source
of funds while deposit inflows and outflows vary widely and are influenced by
prevailing interest rates and money market conditions.  Borrowings may be used
on a short-term basis to compensate for reductions in deposits or deposit
inflows at less than projected levels and may be used on a longer term basis
to support expanded lending activities.

     Deposits.  Horizon Bank offers several deposit accounts, including
Regular Passbook and Statement Savings Accounts, Personal and Business
Checking Accounts, Money Market with and without Check Access and Certificates
of Deposit Accounts with maturities ranging from 30 days up to ten years.
Certificates of deposit account requirements vary according to minimum
principal balances, the time period the funds must remain on deposit and the
interest rate determined for each term and minimum balance.


                                        16

<PAGE>



     The following table sets forth certain information concerning the
deposits at the Bank.


                                        Year Ended March 31,
                       -----------------------------------------------------
                             2008               2007              2006
                       ----------------- ----------------- -----------------
                                Weighted          Weighted          Weighted
                       Average  Average  Average  Average  Average  Average
      Type             Balance    Rate   Balance    Rate   Balance    Rate
------------------     -------    ----   -------    ----   -------    ----
                                       (Dollars in thousands)

Savings............... $19,241    0.92% $ 24,029    0.69%  $35,275    0.54%
Checking.............. 144,786    0.32   156,200    0.33   147,523    0.29
Money Market.......... 195,139    3.35   173,483    3.64   143,434    2.41
Time Deposits......... 633,501    4.89   551,671    4.60   458,017    3.50
                      --------    ----- --------    ----- --------   ------
  Total...............$992,667    3.83% $905,383    3.56% $784,249    2.55%
                      ========    ===== ========    ===== ========   ======


     The following table indicates the Bank's time deposits by time remaining
until maturity as of March 31, 2008 for amounts of $100,000 or more.


                                               Certificates
                    Maturity Period             of Deposit
              --------------------------      --------------
                                              (In thousands)

              Three months or less...........    $  63,030
              Over three through six
               months........................      115,605
              Over six through twelve
               months........................       93,911
              Over twelve months.............       14,735
                                               -------------
               Total.........................     $287,281
                                               =============


     The Bank has a number of different programs designed to attract both
short-term and long-term savings of the general public by providing a wide
assortment of accounts and rates.  These include traditional savings accounts,
nonnegotiable time deposits with minimum deposits of $100,000 and terms of 30
days to five years called Jumbo Certificates of Deposit, nonnegotiable,
nontransferable time deposits with minimum deposits of $500 and terms from 30
days to five years at fixed rates, 12-month to ten-year variable rate fixed
term certificates, individual retirement accounts ("IRAs"), qualified
retirement plans, transaction accounts such as regular checking, and money
market deposit accounts ("MMDAs") with and without limited check access.

     The Bank's practice on early withdrawal penalties is applicable only to
time deposits.  Management believes that in periods of rising interest rates
this practice will discourage depositors from making premature withdrawals for
the purpose of reinvesting in higher rate time deposits.

    The minimum amount required to open a time deposit varies from $500 to
$100 ,000, depending on the type of time deposit.  Pricing of rates on time
deposits with maturities from 30 days to ten years are determined periodically
by the Bank, based upon local market rates, national money market rates, and
yields on assets of the same maturity.

     The Bank's Personal MMDA currently has a $1,000 minimum deposit and has a
tiered pricing program, with interest rates that vary by account dollar
balance -- $1,000, $10,000, $25,000, $50,000 and higher.  The Bank's Business
MMDA has tiers of $1,000, $10,000, $50,000, $100,000 and higher, with a $1,000
minimum deposit.  These accounts have no maturity requirements, no regulatory
interest rate ceilings, and limited check writing privileges.  The interest
rates on these accounts are adjusted by the Bank periodically, based on money
market conditions.   The Bank currently has a $10,000 minimum deposit  money
market and has a tiered pricing program, with interest rates that vary by
account dollar balance -- $10,000, $25,000, $50,000 and higher.  The Bank also
offers a $25,000 and a $50,000 minimum deposit money market, which have tiered
pricing programs, with interest rates that vary by account dollar balance --
$25,000, $50,000, $100,000, $250,000 and higher.  These accounts have no
maturity requirements, no regulatory interest rate

                                            17

<PAGE>



ceiling, and no check writing privileges.  The interest rates on the account
are adjusted by the Bank periodically or as dictated by money market
conditions.

     The large variety of deposit accounts offered by the Bank has increased
its ability to retain deposits and has allowed it to be competitive in
obtaining new funds, although the threat of disintermediation (the flow of
funds away from the Bank into direct investment vehicles, such as common
stocks and mutual funds) still exists.  The Bank's ability to attract and
retain deposits and its cost of funds have been, and will continue to be,
significantly affected by capital and money market conditions.

     Horizon Bank attempts to control the flow of deposits by pricing its
accounts to remain competitive with other financial institutions in its market
area but does not necessarily seek to match the highest rates paid by
competing institutions.

     The senior officers of the Bank meet periodically to determine the
interest rates which the Bank will offer to the general public. These officers
consider the amount of funds needed by the Bank on both a short-term and
long-term basis, the rates being offered by the Bank's competitors,
alternative sources of funds and the projected level of interest rates in the
future.

     The Bank's deposits are obtained primarily from residents of Northwest
Washington.  Horizon Bank attracts deposits by offering a wide variety of
services and convenient branch locations and service hours.

     For further information concerning the Bank's savings deposits, reference
is made to Note 8 of the Notes to the Consolidated Financial Statements
contained in Item 8 of this Form 10-K.

     Brokered Deposits.  The Bank also utilizes brokered deposits as a
supplemental source of funding, when appropriate.  During fiscal 2008, the
Bank increased its balances in brokered deposits from $79.4 million at March
31, 2007 to $121.0 million at March 31, 2008.  The rates paid on these
deposits are comparable to the rates on similar term from the Bank's
alternative sources of funding (such as wholesale borrowings, discussed
below).  The Bank intends to continue utilizing brokered deposits to support
its funding needs, when appropriate.

     Borrowings.   In December 1998, the Bank joined the FHLB of Seattle which
provides it with access to a variety of wholesale funding options.  The Bank
has a committed line of credit up to 25% of total assets, subject to the Bank
pledging sufficient collateral and maintaining the required stock investment
in the FHLB.  Committed lines of credit agreements totaling approximately
$272.7 million and $248.5 million were available to the Bank, of which, $192.0
million and $143.5 million were outstanding at March 31, 2008 and 2007,
respectively.

     The following table sets forth information regarding FHLB of Seattle
advances to the Bank at the end of and during the periods indicated.  The
table includes both long- and short-term borrowings.


                                                   Year Ended March 31,
                                             ------------------------------
                                                2008       2007      2006
                                             ----------  --------  --------
                                                  (Dollars in thousands)

Maximum amount of borrowings outstanding
  at any month end........................    $ 212,500  $195,000  $149,000
Approximate average borrowings
  outstanding.............................      177,874   165,237   134,070
Approximate weighted average rate paid
  on borrowings                                    4.44%     4.74%     3.68%
Balance outstanding at end of period......    $ 192,000  $143,500  $149,000
Weighted average rate paid on borrowings
  at end of period........................         3.15%     5.03%    4.39%

                                           18

<PAGE>



     The Bank has other borrowed funds in the form of retail repurchase
agreements.  These agreements are collateralized by securities held by a
safekeeping agent not under control of the Bank.  These advances are
considered overnight borrowings and bear interest rates that fluctuate daily
based on current market rates.  The Bank had $21.9 million and $14.4 million
outstanding as of March 31, 2008 and 2007, respectively.

     The Bank also had $850,000 and $1.0 million outstanding as of March 31,
2008 and 2007, respectively, in the form of a TT&L note option which is
included in other borrowed funds.

     At March 31, 2008, the Bank had $214.8 million in borrowings from all
sources, compared to $159.0 million at March 31, 2007.  Access to these
wholesale borrowing sources allows management to meet cyclical funding needs
and assists in interest rate risk management efforts.

     For additional information on borrowings, see Note 9 of the Notes to the
Consolidated Financial Statements contained in Item 8 of this Form 10-K.

Competition
-----------

     The Bank faces strong competition in its market area in originating loans
and attracting deposits.  Competition in originating loans is primarily from
other commercial banks, thrift institutions, mortgage companies, credit unions
and consumer finance companies.  The Bank competes for loan originations
primarily through interest rates and loan fees it charges and through the
efficiency and quality of services it provides borrowers.  Competition is
affected by, among other things, the general availability of lendable funds,
general and local economic conditions and current interest rate levels.

     In attracting deposits, the Bank competes primarily with other commercial
banks, thrift institutions, credit unions and brokerage firms.  The Bank
competes for customer deposits principally on the basis of convenience and
quality of its banking services and the investment opportunities that satisfy
the requirements of investors with respect to rate of return, liquidity, risk
and other factors.  The primary factors in competing for deposits are interest
rates and the convenience of office locations.  In light of the deregulation
of interest rate controls on deposits, the Bank has faced increasing
competition for deposits from commercial banks, other thrift institutions and
non-regulated financial intermediaries.

Personnel
---------

     At March 31, 2008, Horizon Bank employed 272 full-time and 43 part-time
employees.  Horizon Bank employees are not represented by any collective
bargaining agreement.  Management of Horizon Bank considers its relations with
its employees to be good.

     Executive Officers of the Registrant

     The executive officers of the Corporation and the Bank are as follows:

                         Age at
Name                 March 31, 2008                Position
----------------     --------------   -------------------------------------

V. Lawrence Evans          61         Chairman of the Board of the Corporation
                                      and of the Bank

Richard P. Jacobson        45         Chief Executive Officer, President,
                                      Chief Financial Officer and Director of
                                      the Corporation and Chief Executive
                                      Officer, Chief Financial Officer and
                                      Director of the Bank

                      (table continued on following page)

                                       19

<PAGE>



                         Age at
Name                 March 31, 2008                Position
----------------     --------------   -------------------------------------

Dennis C. Joines           58         Executive Vice President and Director of
                                      the Corporation and President, Chief
                                      Operating Officer and Director of the
                                      Bank

William N. Gasperetti      61         Executive Vice President of the Bank

Steve L. Hoekstra          57         Executive Vice President of the Bank

Kelli J. Holz              39         Vice President of the Corporation and
                                      Senior Vice President of the Bank

     The following is a description of the principal occupation and employment
of the executive officers of the Corporation and the Bank during at least the
past five years:

     V. LAWRENCE EVANS is Chairman of the Board of Horizon and Horizon Bank,
positions he has held since July 2001 and July 1997, respectively.  Mr. Evans
joined Horizon Bank in 1972 and served as its Executive Vice President from
1983 to 1990.  Mr. Evans served as President of the Bank from May 1990 to
April 2002 and as Chief Executive Officer of the Bank from March 1991 to
December 31, 2007.  He served as President and Chief Executive Officer of
Horizon from October 13, 1995 to December 31, 2007.

     RICHARD P.  JACOBSON is President, Chief Executive Officer and a Director
of Horizon and Chief Executive Officer and a Director of Horizon Bank,
positions he has held since January 1, 2008.   Mr. Jacobson also serves as
Chief Financial Officer of Horizon and Horizon Bank, a position he has held
since March 2000. Mr. Jacobson joined Horizon Bank in 1987 and was appointed
Vice President/Finance and Corporate Secretary in December 1994.  In March
1998, he was appointed Senior Vice President of the Bank and in March 2000, he
was appointed Executive Vice President of the Bank.

     DENNIS C. JOINES became Executive Vice President and a Director of
Horizon and President, Chief Operating Officer and a Director of Horizon 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.

     WILLIAM N. GASPERETTI joined the Bank in December 2007 as Executive Vice
President and Chief Credit Officer. Mr. Gasperetti has over 34 years of
experience in the local and national banking markets, including eight years
with the Resolution Trust Corporation.  Prior to joining the Bank, he was
Senior Vice President/Senior Commercial Real Estate Income Property Lender for
Cascade Bank from 2004 to 2008.  Prior to that, he was employed by Pacific NW
Bank in a similar position from 1997 to 2004.

     STEVE L. HOEKSTRA joined the Bank in June, 2002 as Executive Vice
President, Commercial Banking.  Mr. Hoekstra has over 25 years of experience
in the local commercial banking industry. Most recently, he led the Bellingham
commercial and over retail team for Frontier Bank.  Prior to that, Mr.
Hoekstra was employed for 22 years by SeaFirst/Bank of America, where his
titles included Commercial Credit Administrator, Sales Team Leader, Equipment
Financing and Leasing Specialist and Dealer Banking.

     KELLI J. HOLZ, CPA, joined the Bank in 1988.  From 1991 to 1998 she was
the Manager of the Internal Audit Department.  In March 1998, she was
appointed Vice President.  In March 2007, she was appointed Senior Vice
President of the Bank and is currently the Vice President of Horizon and
Senior Vice President and Controller of Horizon Bank.

                                        20

<PAGE>



Regulation and Supervision
--------------------------

     The Bank.

     General.  As a state-chartered, federally insured commercial bank,
Horizon Bank is subject to extensive regulation and must comply with various
statutory and regulatory requirements, including prescribed minimum capital
standards.  Horizon Bank is regularly examined by the FDIC and its state
regulators, and files quarterly and periodic reports concerning its activities
and financial condition with its regulators.  The Bank's relationship with
depositors and borrowers also is regulated to a great extent by both federal
and state law, especially in such matters as the ownership of deposit accounts
and the form and content of loan documents.

     Federal and state banking laws and regulations govern all areas of the
operation of the Bank, including reserves, loans, mortgages, capital, issuance
of securities, payment of dividends and establishment of branches.  Federal
and state bank regulatory agencies also have the general authority to limit
the dividends paid by insured banks and bank holding companies if such
payments are deemed to constitute an unsafe and unsound practice.  The
respective primary federal regulators of the Corporation and the Bank have
authority to impose penalties, initiate civil and administrative actions and
take other steps intended to prevent banks from engaging in unsafe or unsound
practices.

     State Regulation and Supervision.  As a state-chartered commercial bank,
the Bank is subject to applicable provisions of Washington law and
regulations of the Washington State Department of Financial Institutions.
State law and regulations govern the Bank's ability to take deposits and pay
interest, to make loans on or invest in residential and other real estate, to
make consumer loans, to invest in securities, to offer various banking
services to its customers, and to establish branch offices.  The Bank is
subject to periodic examination and reporting requirements by and of the
Washington State Department of Financial Institutions, Division of Banks.

     Federal Deposit Insurance Corporation.  The Bank's deposits are insured
up to applicable limits by the Deposit Insurance Fund of the FDIC. The Deposit
Insurance Fund is the successor to the Bank Insurance Fund and the Savings
Association Insurance Fund, which were merged effective March 31, 2006.  As
insurer, the FDIC imposes deposit insurance premiums and is authorized to
conduct examinations of and to require reporting by FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in any
activity the FDIC determines by regulation or order to pose a serious risk to
the fund.  The FDIC also has the authority to initiate enforcement actions
against savings institutions, after giving the OTS an opportunity to take such
action, and may terminate the deposit insurance if it determines that the
institution has engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.

     Under regulations effective January 1, 2007, the FDIC adopted a new
risk-based premium system that provides for quarterly assessments based on an
insured institution's ranking in one of four risk categories based upon
supervisory and capital evaluations.  Well-capitalized institutions (generally
those with capital adequacy, asset quality, management, earnings and
liquidity, or "CAMELS" composite ratings of 1 or 2) are grouped in Risk
Category I and assessed for deposit insurance at an annual rate of between
five and seven basis points.  The assessment rate for an individual
institution is determined according to a formula based on a weighted average
of the institution's individual CAMEL component ratings plus either five
financial ratios or, in the case of an institution with assets of $10.0
billion or more, the average ratings of its long-term debt.  Institutions in
Risk Categories II, III and IV are assessed at annual rates of 10, 28 and 43
basis points, respectively.  The Corporation's expense related to this
assessment for the year ended March 31, 2008 was $510,714.  The net expense
for the year ended March 31, 2008 was $0 as a result of the offset of the
Bank's one-time assessment credit in fiscal 2008.

     Deposit Insurance Fund-insured institutions are required to pay a
Financing Corporation assessment, in order to fund the interest on bonds
issued to resolve thrift failures in the 1980s.  For the semi-annual period
ended December 31, 2007, the Financing Corporation assessment equaled 1.14
basis points for each $100 in domestic deposits.  These assessments, which may
be revised based upon the level of DIF deposits, will continue until the bonds
mature in the years 2017 through 2019. For 2007, the Bank incurred $113,000 in
FICO assessments.

                                           21

<PAGE>



     The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement
with the FDIC.  It also may suspend deposit insurance temporarily during the
hearing process for the permanent termination of insurance, if the institution
has no tangible capital.  If insurance of accounts is terminated, the accounts
at the institution at the time of the termination, less subsequent
withdrawals, shall continue to be insured for a period of six months to two
years, as determined by the FDIC.  Management is aware of no existing
circumstances which would result in termination of the Bank's deposit
insurance.

     Prompt Corrective Action. The FDIC is required to take certain
supervisory actions against undercapitalized savings institutions, the
severity of which depends upon the institution's degree of
undercapitalization.  Generally, an institution that has a ratio of total
capital to risk-weighted assets of less than 8%, a ratio of Tier 1 (core)
capital to risk-weighted assets of less than 4%, or a ratio of Tier 1
(leverage) capital to total assets of less than 4% (3% or less for
institutions with the highest examination rating) is considered to be
undercapitalized.  An institution that has a total risk-based capital ratio
less than 6%, a core capital ratio of less than 3% or a leverage ratio that is
less than 3% is considered to be significantly undercapitalized and an
institution that has a tangible capital to assets ratio equal to or less than
2% is deemed to be critically undercapitalized.  In most instances, the FDIC
is required to appoint a receiver or conservator for a savings institution
that is critically undercapitalized. FDIC regulations also require that a
capital restoration plan be filed with the FDIC within 45 days of the date a
savings institution receives notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized.  Compliance with the plan
must be guaranteed by any parent holding company in an amount of up to the
lesser of 5% of the institution's assets or the amount which would bring the
institution into compliance with all capital standards.  In addition, numerous
mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion.  The FDIC also could take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.

     At March 31, 2008, the Bank was categorized as "well capitalized" under
the prompt corrective action regulations of the FDIC.

     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 shareholders' equity and non-cumulative
perpetual preferred stock, less most intangible assets.  Tier 2 capital
includes such items as qualifying general loan loss reserves, cumulative
perpetual preferred stock, mandatory convertible debt, term subordinated debt
and limited life preferred stock; however, the amount of term subordinated
debt and intermediate term preferred stock (original maturity of at least five
years but less than 20 years) that may be included in Tier 2 capital is
limited to 50% of Tier 1 capital.

     The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios.  The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets.  Most banks are required to maintain a minimum leverage ratio of
at least 4% to 5% of total assets.  At March 31, 2008, the Bank had a Tier 1
leverage capital ratio of 9.1%.   Horizon Bank has not been notified by the
FDIC of any higher capital requirements specifically applicable to it.   The
FDIC retains the right to require an institution to maintain a higher capital
level based on the institution's particular risk profile.

     FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets.  Assets are placed in
one of four categories and given a percentage weight based on the relative
risk of that category.  In addition, certain off-balance-sheet items are
converted to balance-sheet credit equivalent amounts, and each amount is then
assigned to one of the four categories.  Under the guidelines, the ratio of
total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets
must be at least 8%, and the ratio of Tier 1 capital to risk-weighted assets
must be at least 4%.  In evaluating the adequacy of a bank's capital, the FDIC
may also consider other factors that may affect the bank's financial
condition.  Such factors may include interest rate risk exposure, liquidity,
funding and market risks, the quality and level of earnings, concentration of
credit risk, risks arising from nontraditional activities, loan and


                                          22

<PAGE>



investment quality, the effectiveness of loan and investment policies, and
management's ability to monitor and control financial operating risks.  At
March 31, 2008, the Bank determined that its total risk-based capital ratio
was 11.0% and its Tier 1 risk-based capital ratio was 9.7%.

     The Washington State Department of Financial Institutions requires that
net worth equal at least 5% of total assets.  Intangible assets must be
deducted from net worth and assets when computing compliance with this
requirement.  At March 31, 2008, Horizon Bank had a net worth of 9.2% of total
assets.

     Horizon Bank's management believes that, under the current regulations,
the Bank will continue to meet its minimum capital requirements in the
foreseeable future.  However, events beyond the control of the Bank, such as a
downturn in the economy in areas where the Bank has most of its loans, could
adversely affect future earnings and, consequently, the ability of the Bank to
meet its capital requirements.  For additional information concerning the
Bank's capital, see Note 12 of the Notes to the Consolidated Financial
Statements contained in Item 8 of this Form 10-K.

     Federal Deposit Insurance Improvement Act ("FDICIA").  In general, FDICIA
requires the Bank to conduct an annual independent audit of its financial
statements, appoint an independent audit committee of outside directors,
report on and assess management's responsibilities for preparing financial
statements, and establish an internal control structure.

     An independent accountant must attest to and report on the assertions in
management's reports concerning these internal controls with the desired
outcome of efficient and effective operations; the safeguarding of assets;
reliable financial reporting and compliance with applicable laws and
regulations.

     As the primary regulator of the Bank, the FDIC has outlined the
requirements for compliance with FDICIA, but does not provide specific
guidance on the internal control structure, documentation, or procedures to
test the Bank's effectiveness.  It is up to each bank to establish, document
and design procedures to evaluate and test the internal control structure over
financial reporting and compliance with designated laws and regulations that
minimally include loans to insiders and dividend restrictions.

     In brief, to ensure compliance, the Bank has established and coordinated
a management team that identifies and documents existing controls with
consideration given to the Bank's control environment, risk assessment,
control activities, information and communication systems, and monitoring
activities.  In addition, management establishes internal control procedures,
develops and selects criteria for evaluation, tests the effectiveness of
controls, and ensures that proper written documentation is in place.

     Under FDICIA, the Audit Committee has several responsibilities that
include but are not limited to overseeing the internal audit function;
conducting periodic meetings with management, the independent public
accountant, and the internal auditors; review of significant accounting
policies, and audit conclusions regarding significant accounting estimates;
review of the assessments prepared by management and independent auditor on
the adequacy of internal controls and the resolution of identified material
weaknesses and reportable conditions in internal controls; and the review of
compliance with laws and regulations.

     Federal Home Loan Bank System.  The FHLB of Seattle serves as a reserve
or central bank for the member institutions within its assigned region. It is
funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLBs. It makes loans (i.e., advances) to members in
accordance with policies and procedures established by the Federal Housing
Finance Board and the Board of Directors of the FHLB of Seattle.  As a member,
the Bank is required to purchase and hold stock in the FHLB of Seattle, based
on formulas established by the FHLB.   As of March 31, 2008, Horizon Bank held
stock in the FHLB of Seattle in the amount of $8.9 million.  See "Business --
Savings Activities and Other Sources of Funds -- Borrowings."

    Federal Reserve System. The Federal Reserve Board requires, under
Regulation D, that all depository institutions maintain reserves on
transaction accounts and nonpersonal time deposits.  These reserves may be in
the form of cash or non-interest bearing deposits with the regional Federal
Reserve Bank.  Negotiable order of withdrawal

                                            23

<PAGE>



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 the reserve requirements, as are any non-personal time deposits at
a savings bank.  As of March 31, 2008, the Bank's deposit with the Federal
Reserve Bank and vault cash exceeded its reserve  requirements.

     Privacy Standards.  The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA"), which was enacted in 1999, 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. The Bank is subject to FDIC
regulations implementing the privacy protection provisions of the GLBA. These
regulations require the Bank to disclose its privacy policy, including
identifying with whom it shares "non-public personal information," to
customers at the time of establishing the customer relationship and annually
thereafter.

     Anti-Money Laundering and Customer Identification.  Congress enacted the
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on
October 26, 2001 in response to the terrorist events of September 11, 2001.
The USA Patriot Act gives the federal government new powers to address
terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing, and broadened anti-money
laundering requirements. In March 2006, Congress re-enacted certain expiring
provisions of the USA Patriot Act.

     The Corporation.

     General.  The Corporation, as the sole stockholder of the Bank, is a bank
holding company and is registered as such with the Federal Reserve.  Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"),
and the regulations of the Federal Reserve.  As a bank holding company, the
Corporation is required to file with the Federal Reserve annual, quarterly and
periodic reports and such additional information as the Federal Reserve may
require.  The Federal Reserve may examine the Corporation  and any of its
subsidiaries, and charge the Corporation for the cost of the examination. The
Federal Reserve also has extensive enforcement authority over bank holding
companies, including, among other things, the ability to assess civil money
penalties to issue cease and desist or removal orders and to require that a
holding company divest subsidiaries (including its bank subsidiaries).  In
general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.

     The Bank Holding Company Act.  Under the BHCA, the Corporation is
supervised by the Federal Reserve.  The Federal Reserve has a policy that a
bank holding company is required to serve as a source of financial and
managerial strength to its subsidiary banks and may not conduct its operations
in an unsafe or unsound manner.  In addition, Federal Reserve policy provides
that bank holding companies should serve as a source of strength to its
subsidiary banks by being prepared to use available resources to provide
adequate capital funds to its subsidiary banks during periods of financial
stress or adversity, and should maintain the financial flexibility and capital
raising capacity to obtain additional resources for assisting its subsidiary
banks.  A bank holding company's failure to meet its obligation to serve as a
source of strength to its subsidiary banks will generally be considered by the
Federal Reserve to be an unsafe and unsound banking practice or a violation of
the Federal Reserve's regulations or both.

     The Corporation and any subsidiaries, other than the Bank, that it may
control are considered "affiliates" of Horizon Bank within the meaning of the
Federal Reserve Act, and transactions between Horizon Bank and its affiliates
are subject to numerous restrictions.  With some exceptions, the Corporation
and its subsidiaries are prohibited from tying the provision of various
services, such as extensions of credit, to other services offered by the
Corporation, or our affiliates.

     Sarbanes-Oxley Act of 2002.  The Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley Act") was signed into law on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with the
recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to
increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws.  The Sarbanes-Oxley Act

                                        24

<PAGE>



generally applies to all companies that file or are required to file periodic
reports with the Securities and Exchange Commission ("SEC"), under the
Securities Exchange Act of 1934 ("Exchange Act").

     The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules.  The Sarbanes-Oxley Act
represents significant federal involvement in matters traditionally left to
state regulatory systems, such as the regulation of the accounting profession,
and to state corporate law, such as the relationship between a board of
directors and management and between a board of directors and its committees.

     Acquisitions.  The BHCA prohibits a bank holding company, with certain
exceptions, from acquiring ownership or control of more than 5% of the voting
shares of any company that is not a bank or bank holding company and from
engaging in activities other than those of banking, managing or controlling
banks, or providing services for its subsidiaries.  Under the BHCA, the
Federal Reserve may approve the ownership of shares by a bank holding company
in any company the activities of which the Federal Reserve has determined to
be so closely related to the business of banking or managing or controlling
banks as to be a proper incident thereto.  These activities include operating
a savings institution, mortgage company, finance company, credit card company
or factoring company; performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing
property on a full-payout, non-operating basis; selling money orders,
travelers' checks and U.S. Savings Bonds; real estate and personal property
appraising; providing tax planning and preparation services; and, subject to
certain limitations, providing securities brokerage services for customers.

     Dividends.  The Federal Reserve's policy statement on the payment of cash
dividends by bank holding companies expresses the Federal Reserve's view that
a bank holding company should pay cash dividends only to the extent that the
company's net income for the past year is sufficient to cover both the cash
dividends and a rate of earning retention that is consistent with the
company's capital needs, asset quality and overall financial condition.  The
policy statement indicates that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.

     Capital Requirements. The Federal Reserve has established capital
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for banks.  The Federal Reserve regulations
provide that capital standards will be applied on a consolidated basis in the
case of a bank holding company with $150 million or more in total consolidated
assets. The Corporation's total risk based capital must equal 8% of
risk-weighted assets and one- half of the 8%, or 4%, must consist of Tier 1
(core) capital.  At March 31, 2008, the Corporation's capital position was in
excess of these requirements with total risk based capital of 11.1% of
risk-weighted assets and Tier 1 (core) capital of 9.8% of risk-weighted
assets.

     Stock Repurchases.  Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, are required to
give the Federal Reserve prior written notice of any purchase or redemption of
its outstanding equity securities if the gross consideration for the purchase
or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding 12 months, is equal to 10% or
more of their consolidated net worth.  The Federal Reserve may disapprove such
a purchase or redemption if it determines that the proposal would constitute
an unsafe or unsound practice or would violate any law, regulation, Federal
Reserve order, or any condition imposed by, or written agreement with, the
Federal Reserve.

Taxation
--------

     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 10 of
the Notes to the Consolidated Financial Statements contained in Item 8 of this
Form 10-K for additional information concerning the income taxes payable by
the Bank.

                                          25

<PAGE>



     Tax Bad Debt Reserves. Historically, savings institutions such as the
Bank, which met certain definitional tests primarily related to their assets
and the nature of their businesses, were permitted to establish a reserve for
bad debts and to make annual additions to the reserve.  These additions may,
within specified formula limits, have been deducted in arriving at the Bank's
taxable income.  For purposes of computing the deductible addition to its bad
debt reserve, the Bank's loans were separated into "qualifying real property
loans" (i.e., generally those loans secured by interests in residential real
property) and all other loans ("non-qualifying loans").  The following
formulas were used to compute the bad debt deduction with respect to
qualifying real property loans:  (i) actual loss experience or (ii) a
percentage equal to 8% of taxable income.  The deduction with respect to
non-qualifying loans was computed under the experience method.  Reasonable
additions to the reserve for losses on non-qualifying loans were based upon
actual loss experience and would reduce the current year's addition to the
reserve for losses on qualifying real property loans, unless that addition was
also determined under the experience method.  The sum of the additions to each
reserve for each year was the Bank's annual bad debt deduction.

     The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996."  The new
rules eliminated the 8% of taxable income method for deducting additions to
the tax bad debt reserves for all financial institutions for tax years
beginning after December 31, 1995.  These rules also required that all
institutions recapture all or a portion of their bad debt reserves added since
the base year (last taxable year beginning before January 1, 1988).  The Bank
has previously recorded a deferred tax liability equal to the bad debt
recapture and as such the new rules will have no effect on the net income or
federal income tax expense.  For taxable years beginning after December 31,
1995, the Bank's bad debt deduction is determined under the experience method
using a formula based on actual bad debt experience over a period of years or,
if the Bank is a "large" association (assets in excess of $500 million) on the
basis of net charge-offs during the taxable year.  The rules allowed an
institution to suspend bad debt reserve recapture for the 1996 and 1997 tax
years if the institution's lending activity for those years was equal to or
greater than the institution's average mortgage lending activity for the six
taxable years preceding 1996 adjusted for inflation.  For this purpose, only
home purchase or home improvement loans were included and the institution
could have elected to have the tax years with the highest and lowest lending
activity removed from the average calculation.  If an institution was
permitted to postpone the reserve recapture, it must have begun its six year
recapture no later than the 1998 tax year.  The unrecaptured base year
reserves would not be subject to recapture as long as the institution
continues to carry on the business of banking.  In addition, the balance of
the pre-1988 bad debt reserves continue to be subject to provisions of present
law referred to below that require recapture in the case of certain excess
distributions to stockholders.

     Distributions.  If a stock institution distributes amounts to
stockholders and the distribution is treated as being from its accumulated bad
debt reserves, the distribution will cause the institution to have additional
taxable income.  A distribution to stockholder is deemed to have been made
from accumulated bad debt reserves to the extent that (i) the reserves exceed
the amount that would have been accumulated on the basis of actual loss
experience, and (ii) the distribution is a "non-dividend distribution."  A
distribution in respect of stock is a non-dividend distribution to the extent
that, for federal income tax purposes, (i) it is redemption of shares, (ii) it
is pursuant to a liquidation or partial liquidation of the institution, or
(iii) in the case of current distribution, together with all other such
distributions during the taxable year, it exceeds the institution's current
and post-1951 accumulated earnings and profits.  The amount of additional
taxable income created by a non-dividend distribution is an amount that, when
reduced by tax attributable to it, is equal to the amount of the distribution.

     Minimum Tax.  In addition to regular corporate income tax, corporations
are subject to an alternative minimum tax which generally is equal to 20% of
alternative minimum taxable income (taxable income, increased by tax
preference items and adjusted for certain regular tax items).  The preference
items which are generally applicable include an amount equal to 75% of the
amount by which a financial institution's adjusted current earnings (generally
alternative minimum taxable income computed without regard to this preference
and prior to reduction for net operating losses) exceeds its alternative
minimum taxable income without regard to this preference and the excess of the
institution's bad debt deduction over the amount deductible under the
experience method, as discussed below.  Alternative minimum tax paid can be
credited against regular tax due in later years.

    Audits.  The Bank has not been audited by the Internal Revenue Service
during the past five years.

                                           26

<PAGE>



     Washington Taxation.

     The Bank is subject to a business and occupation tax which is imposed
under Washington law at the rate of 1.50% of gross receipts; however, interest
received on loans secured by mortgages or deeds of trust on residential
properties is not subject to such tax.  The Bank's  business and occupation
tax returns were audited in November 1995.

Available Information
----------------------

     The Corporation's Internet address is www.horizonbank.com.  You may
access, free of charge, copies of the following documents from the
Corporation's website by using the "Investor Relations" button:

     1.   Annual Reports on Form 10-K;

     2.   Quarterly Reports on Form 10-Q; and

     3.   Current Reports on Form 8-K.

     The Corporation makes these reports and certain other information that it
files available on its website as soon as reasonably practicable after filing
or furnishing them electronically with the SEC.  These and other SEC filings
the Corporation are also available, free of charge, from the SEC on its
website at www.sec.gov.  The information contained on the Corporation's
website is not incorporated by reference into this document and should not be
considered a part of this Annual Report on Form 10-K.  The Corporation's
website address is included in this document as an inactive textual reference
only.

Item 1A.  Risk Factors.
-----------------------

     An investment in our common stock is subject to risks inherent to our
business.  Before making an investment decision, you should carefully consider
the risks and uncertainties described below together with all of the other
information included or incorporated by reference in this report.  The risks
and uncertainties described below are not the only ones that affect us.
Additional risks and uncertainties that management is not aware of or focused
on or that management currently deems immaterial may also impair our business
operations.  This report is qualified in its entirety by these risk factors.

     If any of the following risks actually occur, our financial condition and
results of operations could be materially and adversely affected.  If this
were to happen, the value of our common stock could decline significantly, and
you could lose all or part of your investment.

The Maturity and Repricing Characteristics of Our Assets and Liabilities are
Mismatched and Subject Us to Interest Rate Risk Which Could Adversely Affect
Our Net Earnings and Economic Value.

     Our financial condition and operations are influenced significantly by
general economic conditions, including the absolute level of interest rates as
well as changes in interest rates and the slope of the yield curve.  Our
profitability is dependent to a large extent on our net interest income, which
is the difference between the interest received from our interest-earning
assets and the interest expense incurred on our interest-bearing liabilities.

     Our activities, like all financial institutions, inherently involve the
assumption of interest rate risk.  Interest rate risk is the risk that changes
in market interest rates will have an adverse impact on our earnings and
underlying economic value.  Interest rate risk is determined by the maturity
and repricing characteristics of our assets, liabilities and off-balance-sheet
contracts.  Interest rate risk is measured by the variability of financial
performance and economic value resulting from changes in interest rates.
Interest rate risk is the primary market risk affecting our financial
performance.

     The greatest source of interest rate risk to us results from the mismatch
of maturities or repricing intervals for rate sensitive assets, liabilities
and off-balance-sheet contracts.  Additional interest rate risk results from
mismatched

                                           27

<PAGE>



repricing indices and formulae (basis risk and yield curve risk), and product
caps and floors and early repayment or withdrawal provisions (option risk),
which may be contractual or market driven, that are generally more favorable
to customers than to us.

     Additionally, our portfolio is heavily concentrated in Prime rate based
loans. At March 31, 2008, we had $722.7 million in Prime based loans,
representing 59.7% of total loans. As such, the Corporation is adversely
impacted during periods of rapidly declining rates, as has been evident in the
second half of the fiscal year ended March 31, 2008. The Federal Reserve Open
Market Committee ("FOMC") reduced its fed funds target by 300 basis points
from September 2007 through March 2008, which had a significant adverse impact
on the Corporation's net interest margin and earnings, with its Prime based
loans adjusting instantly when Prime changes, while liability costs are
impacted much more slowly and will take time to reprice in a lower rate
environment. Also, no assurances can be made that liability rates will be able
to be reduced by the same magnitude as Prime rate changes in a very
competitive environment for attracting deposits.

     Our primary monitoring tool for assessing interest rate risk is
asset/liability simulation modeling, which is designed to capture the dynamics
of balance sheet, interest rate and spread movements and to quantify
variations in net interest income resulting from those movements under
different rate environments.  The sensitivity of net interest income to
changes in the modeled interest rate environments provides a measurement of
interest rate risk.  The net market value of equity is estimated by separately
valuing our assets and liabilities under varying interest rate environments.
The extent to which assets gain or lose value in relation to the gains or
losses of liability values under the various interest rate assumptions
determines the sensitivity of net equity value to changes in interest rates
and provides an additional measure of interest rate risk.

     The interest rate sensitivity analysis we perform incorporates
beginning-of-the-period rate, balance and maturity data, using various levels
of aggregation of that data, as well as certain assumptions concerning the
maturity, repricing, amortization and prepayment characteristics of loans and
other interest-earning assets and the repricing and withdrawal of deposits and
other interest-bearing liabilities into an asset/liability computer simulation
model.  We update and prepare simulation modeling at least quarterly for
review by senior management and the directors. We believe the data and
assumptions are realistic representations of our portfolio and possible
outcomes under the various interest rate scenarios.  Nonetheless, the interest
rate sensitivity of our net interest income and net market value of equity
could vary substantially if different assumptions were used or if actual
experience differs from the assumptions used.

Our Loan Portfolio Contains a Large Percentage of Construction and Land
Development Loans, Commercial Real Estate Loans and Commercial Business Loans
Which Involves a Higher Risk of Loss than Other Types of Lending.

     We have had a significant increase in our commercial real estate
construction and land development lending and commercial business lending
since March 31, 2003.   Commercial and multi-family real estate, construction
and land development and commercial business loans may expose a lender to
greater risk of loss than loans secured by residential real estate and
consumer loans because the type of collateral securing these loans and the
large dollar value typically involved.  These loans also have greater credit
risk than residential real estate for the following reasons and the reasons
discussed under "Item 1. Business-Lending Activities."

     *     Commercial and Multi-family Mortgage Loans.  These loans typically
           involve higher principal amounts than other types of loans, and
           repayment is dependent upon income being generated from the
           property securing the loan in amounts sufficient to cover operating
           expenses and debt service.

     *     Construction and Land Development Loans.  This type of lending
           contains the inherent difficulty in estimating both a property's
           value at completion of the project and the estimated cost
           (including interest) of the project.  If the estimate of
           construction cost proves to be inaccurate, we may be required to
           advance funds beyond the amount originally committed to permit
           completion of the project.  If the estimate of value upon
           completion proves to be inaccurate, we may be confronted at, or
           prior to, the maturity of the loan with a project the value of
           which is insufficient to assure full repayment.  In addition,
           speculative construction loans to a builder are often associated
           with homes

                                           28

<PAGE>


           that are not pre-sold, and thus pose a greater potential
           risk to us than construction loans to individuals on their personal
           residences. Construction loans on land under development or held
           for future construction also poses additional risk because of the
           lack of income being produced by the property and the potential
           illiquid nature of the security.

     *     Commercial Loans.  Repayment is dependent upon the successful
           operation of the borrower's business.

Joint Ventures in Real Estate Development May Expose Us to Additional Risk.

     As indicated in the Real Estate Development Subsidiary section of Part 1,
Item 1 of this Form 10-K, the Bank's wholly owned subsidiary (Westward) is a
land development company which periodically enters into joint ventures to
develop residential real estate.  While Westward has successfully partnered in
various real estate developments since the 1970s, there can be no guarantee
that success in this area will necessarily continue into the future.  This
activity may present additional risk to us, as we are exposed as an equity
investor in the land being developed.  Adverse movements in the value of the
raw land or the values of the fully developed lots negatively affects our
financial performance.  Adverse changes in real estate development regulations
(i.e. environmental regulations, project density requirements, and other
related development regulatory matters) may also negatively impact our success
in this regard. In addition, this development activity exposes us to potential
reputation risk, as some members of our communities might not necessarily
approve of our involvement as a real estate development partner.  In addition,
certain projects may be perceived negatively by residents of the area where
the properties are being developed, instead of favoring to leave the land in
an undeveloped state.  For these and potentially other reasons related to real
estate development, our joint ventures in real estate development may expose
us to additional risk, and no assurances can be provided regarding continued
success in this area.

Our Profitability Depends Significantly on Economic Conditions in Our Primary
Market Area.

     Our success depends primarily on the general economic conditions of the
State of Washington and the specific local markets in which we operate.
Unlike larger national or other regional banks that are more geographically
diversified, we provide banking and financial services to customers located
primarily in Whatcom, Skagit, Snohmish and Pierce Counties of Washington.  The
local economic conditions in our market areas have a significant impact on the
demand for our products and services as well as the ability of our  ustomers
to repay loans, the value of the collateral securing loans and the stability
of our deposit funding sources.  A significant decline in general economic
conditions, caused by inflation, recession, acts of terrorism, outbreak of
hostilities or other international or domestic occurrences, unemployment,
changes in securities markets or other factors could impact these local
economic conditions and, in turn, have a material adverse effect on our
financial condition and results of operations.

Housing Market Slowdown and the Effects of the Sub-Prime Market.

     The potential impacts of sub-prime loans originated by others in Horizon
Bank's markets in recent years could adversely impact Horizon Bank's
performance.  These sub-prime loans are cited as contributing to the slowdowns
in the housing markets across the country.  As homeowners face significant
increases in their housing payments when these sub-prime loans reset, this
will likely have an adverse affect on the economy with an increasing supply of
housing units on the market.  It is predicted that these adverse impacts will
result in increased numbers of houses listed for sale (for those facing
unaffordable increases in their monthly housing payments) and it will also
likely increase the number of foreclosures on residential units.

     The housing market slowdown is adversely impacting the Bank's
performance, and may continue into the future. Housing inventories are higher
than the prior year period and housing sales activity for the quarter ended
March 31, 2008 was lower than recent years in all of Horizon Bank's markets.
In the quarter ended March 31, 2008, loans on non-accrual increased to 0.88%
of assets, a significant increase over previous year levels. In addition,
Horizon Bank's delinquency levels (loans 30 to 89 days past due) totaled $30.6
million at March 31, 2008, which are significantly higher than prior year
levels. No reassurance can be provided that these levels will improve. Horizon
Bank experienced loan charge-offs

                                           29

<PAGE>


of $875,000 during the fiscal year ended March 31, 2008, $777,000 of which
occurred in the March quarter. While this level of losses is manageable,
additional larger losses may occur in the future, especially if the current
housing market slowdown continues.

If Our Allowance for Loan Losses Is Not Sufficient to Cover Actual Loan
Losses, Our Earnings Could Decrease.

     We make various assumptions and judgments about the collectibility of our
loan portfolio, including the creditworthiness of our borrowers and the value
of the real estate and other assets serving as collateral for the repayment of
many of our loans.  In determining the amount of the allowance for loan
losses, we review our loans and the loss and delinquency experience, and
evaluate economic conditions.  If our assumptions are incorrect, the allowance
for loan losses may not be sufficient to cover losses inherent in our loan
portfolio, resulting in the need for additions to our allowance.  Material
additions to the allowance could materially decrease our net income.  Our
allowance for loan losses was 1.6% of net loans at March 31, 2008.

     In addition, bank regulators periodically review our allowance for loan
losses and may require us to increase our provision for loan losses or
recognize further loan charge-offs.  Any increase in our allowance for loan
losses or loan charge-offs as required by these regulatory authorities may
have a material adverse effect on our financial condition and results of
operations.

If External Funds Were Not Available, this Could Adversely Impact Our Growth
and Prospects.

     We rely on deposits and advances from the FHLB-Seattle and other
borrowings to fund our operations.  Although we have historically been able to
replace maturing deposits and advances if desired, no assurance can be given
that we would be able to replace such funds in the future if our financial
condition or the financial condition of the FHLB or market conditions were to
change.

     Although we consider such sources of funds adequate for our liquidity
needs, we may seek additional debt in the future to achieve our long-term
business objectives.  There can be no assurance additional borrowings, if
sought, would be available to us or, if available, would be on favorable
terms.  If additional financing sources are unavailable or are not available
on reasonable terms, our growth and future prospects could be adversely
affected.

Strong Competition Within Our Market Area May Limit Our Growth and
Profitability.

     Competition in the banking and financial services industry is intense.
We compete in our market areas with commercial banks, savings institutions,
mortgage brokerage firms, credit unions, finance companies, mutual funds,
insurance companies, and brokerage and investment banking firms operating
locally and elsewhere.  Some of these competitors have substantially greater
resources and lending limits than we do, have greater name recognition and
market presence that benefit them in attracting business, and offer certain
services that we do not or cannot provide.  In addition, larger competitors
may be able to price loans and deposits more aggressively than we do.  Our
profitability depends upon our continued ability to successfully compete in
our market areas.  The greater resources and deposit and loan products offered
by some of our competitors may limit our ability to increase our
interest-earning assets.  For additional information see Item 1, "Business
Competition."

The Loss of Key Members of Our Senior Management Team Could Adversely Affect
Our Business.

     We believe that our success depends largely on the efforts and abilities
of our senior management.  Their experience and industry contacts
significantly benefit us.  The competition for qualified personnel in the
financial services industry is intense, and the loss of any of our key
personnel or an inability to continue to attract, retain and motivate key
personnel could adversely affect our business.

                                           30

<PAGE>


If Our Common Stock Was No Longer Included in the Russell 2000 or Russell 3000
Indices There Could be a Reduction in Liquidity and Prices for Our Stock.

     Our common stock is included in the Russell 2000 and Russell 3000
indices.  Inclusion in these indices may have positively impacted the price,
trading volume and liquidity of our common stock, in part, because index funds
or other institutional investors often purchase securities that are in these
indices.  Conversely if our market capitalization falls below the minimum
necessary to be included in either or both of these indices at any annual
reconstitution date, the opposite could occur. Firms that attempt to predict
which companies may no longer qualify to be included in the Russell 2000 Index
identified Horizon as a likely deletion from the Index in 2008. No reassurance
can be given that Horizon will or will not be included in the Russell 2000 and
Russell 3000 indices, or similar indices, in the future.

We Are Subject to Extensive Government Regulation and Supervision.

     We are subject to extensive federal and state regulation and supervision
primarily through Horizon Bank and certain non-bank subsidiaries.  Banking
regulations are primarily intended to protect depositors' funds, federal
deposit insurance funds and the banking system as a whole, not shareholders.
These regulations affect our lending practices, capital structure, investment
practices, dividend policy and growth, among other things.  Congress and
federal regulatory agencies continually review banking laws, regulations and
policies for possible changes.  Changes to statutes, regulations or regulatory
policies, including changes in interpretation or implementation of statutes,
regulations or policies, could affect us in substantial and unpredictable
ways.  Such changes could subject us to additional costs, limit the types of
financial services and products we may offer and/or increase the ability of
non-banks to offer competing financial services and products, among other
things.  Failure to comply with laws, regulations or policies could result in
sanctions by regulatory agencies, civil money penalties and/or reputation
damage, which could have a material adverse effect on our business, financial
condition and results of operations.  While we have policies and procedures
designed to prevent any such violations, there can be no assurance that such
violations will not occur.  See Item 1, "Business -- Regulation and
Supervision."

The Level Of Our Commercial Real Estate Loan Portfolio May Subject Us To
Additional Regulatory Scrutiny.

     The FDIC, the Federal Reserve and the Office of the Comptroller of the
Currency, have promulgated joint guidance on sound risk management practices
for financial institutions with concentrations in commercial real estate
lending.  Under the guidance, a financial institution actively involved in
commercial real estate lending should perform a risk assessment to identify
concentrations. A financial institution may have a concentration in commercial
real estate lending if, among other factors,  (i) total reported loans for
construction, land development, and other land represent 100% or more of total
capital or (ii) total reported loans secured by multifamily and non-farm
residential properties, loans for construction, land development and other
land and loans otherwise sensitive to the general commercial real estate
market, including loans to commercial  real estate related entities, represent
300% or more of total capital.  Management should also employ heightened risk
management practices including board and management oversight and strategic
planning, development of underwriting standards, risk assessment and
monitoring through market analysis and stress testing.  While we believe we
have implemented policies and procedures with respect to our commercial real
estate loan portfolio consistent with the guidance, bank regulators could
require us to implement additional policies and procedures consistent with
their interpretation of the guidance which could result in additional costs to
us.

Our Information Systems May Experience an Interruption or Breach in Security.

     We rely heavily on communications and information systems to conduct our
business.  Any failure, interruption or breach in security of these systems
could result in failures or disruptions in our customer relationship
management, general ledger, deposit, loan and other systems.  While we have
policies and procedures designed to limit the effect of the failure,
interruption or security breach of our information systems, there can be no
assurance that any such failures, interruptions or security breaches will not
occur or, if they do occur, that they will be adequately addressed.  The
occurrence of any failures, interruptions or security breaches of our
information systems could damage our reputation, result in a loss of customer
business, subject us to additional regulatory scrutiny, or expose us to civil
litigation and

                                      31

<PAGE>



possible financial liability, any of which could have a material adverse
effect on our financial condition and results of operations.

We Rely on Dividends From Our Subsidiaries For Most of Our Revenue.

     Horizon Financial  is a separate and distinct legal entity from its
subsidiaries.  We receive substantially all of our revenue from dividends from
our subsidiaries.  These dividends are the principal source of funds to pay
dividends on our common stock and interest and principal on our debt.  Various
federal and/or state laws and regulations limit the amount of dividends that
Horizon Bank and certain non-bank subsidiaries may pay to Horizon Financial.
Also, our right to participate in a distribution of assets upon a subsidiary's
liquidation or reorganization is subject to the prior claims of the
subsidiary's creditors.  In the event Horizon Bank is unable to pay dividends
to Horizon Financial, Horizon Financial may not be able to service debt, pay
obligations or pay dividends on Horizon Financial's common stock.  The
inability to receive dividends from Horizon Bank could have a material adverse
effect on our business, financial condition and results of operations. See
Item 1, "Business -- Regulation and Supervision."

If We Fail to Maintain an Effective System of Internal Control over Financial
Reporting, We May Not Be Able to Accurately Report Our Financial Results or
Prevent Fraud, and, as a Result, Investors and Depositors Could Lose
Confidence in Our Financial Reporting, Which Could Adversely Affect Our
Business, the Trading Price of Our Stock and Our Ability to Attract Additional
Deposits.

     In connection with the enactment of the Sarbanes-Oxley Act of 2002
("Act") and the implementation of the rules and regulations promulgated by the
SEC, we document and evaluate our internal control over financial reporting in
order to satisfy the requirements of Section 404 of the Act.  This requires us
to prepare an annual management report on our internal control over financial
reporting, including among other matters, management's assessment of the
effectiveness of internal control over financial reporting and an attestation
report by our independent auditors addressing these assessments.  If we fail
to identify and correct any significant deficiencies in the design or
operating effectiveness of our internal control over financial reporting or
fail to prevent fraud, current and potential shareholders and depositors could
lose confidence in our Company's internal controls and financial reporting,
which could adversely affect our business, financial condition and results of
operations, the trading price of our stock and our ability to attract
additional deposits.

Item 1B.  Unresolved Staff Comments
-----------------------------------

     None.

                                      32

<PAGE>



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, 2008   Feet     Owned
                                    ------  --------------   ----     -----
                                            (In thousands)
Bellingham Main Office and Whatcom
Mortgage Center.....................  1971      $2,619      19,179    Owned
  1500 Cornwall Avenue
  Bellingham, WA 98225

Bellingham/Meridian.................  1987         705       4,650    Owned
  4110 Meridian Street
  Bellingham, WA 98226

Ferndale Office.....................  1976         224       3,692    Owned
  Third and Main
  Ferndale, WA 98248

Lynden Office.......................  1981         548       3,702    Owned
  Third and Grover Streets
  Lynden, WA 98264

Blaine Office.......................  1976         534       3,610    Owned
  Fourth & "H" Streets
  Blaine, WA 98230

Mount Vernon Office.................  1976         182       3,275    Owned
  1503 Riverside Dr.
  Mount Vernon, WA 98273

Anacortes Office....................  1987         628       3,650    Owned
  1218 Commercial Avenue
  Anacortes, WA 98221

Snohomish Office....................  1987         147       1,388    Owned
  620 2nd Street
  Snohomish, WA 98290

Puyallup Office, Pierce Mortgage
Center (1)..........................  2007         724       3,402    Leased
  413 29th Street NE
  Puyallup, WA 98372

Burlington Office, Skagit Commercial Center
and Skagit Mortgage Center..........  1994       1,033       3,980    Owned
  1020 S. Burlington Blvd
  Burlington, WA  98232

                        (table continued on the following page)

                                            33
<PAGE>



                                              Net Book
                                     Year    Value as of    Square   Leased/
                                    Opened  March 31, 2008   Feet     Owned
                                    ------  --------------   ----     -----
                                            (In thousands)

Edmonds Office......................  1994      $1,881      15,265    Owned
  130 Fifth Avenue South
  Edmonds, WA  98020

Murphy's Corner Office..............  2000       1,532       3,720    Owned
  12830 Bothell Everett Hwy.
  Everett, WA 98208

Barkley Office......................  1999       2,735      14,691    Owned
  2122 Barkley Blvd.
  Bellingham, WA 98228

Holly Street Office.................  1999         327       4,000    Owned
  211 E. Holly Street
  Bellingham, WA 98227

Alabama Office......................  1999         661       4,500    Owned
  802 Alabama Street
  Bellingham, WA 98228

Marysville Office...................  2004       2,106       4,126    Owned
  3617 88th St NE
  Marysville, WA 98270

Lynnwood Office.....................  2003       2,085       4,230    Owned
  19405 44th Avenue W.
  Lynnwood, WA 98036

Lakewood Office, Pierce Commercial
Center..............................  2005       1,999       4,773    Owned
  10318 Gravelly Lake Dr. SW
  Lakewood, WA 98499

Everett Office, Snohomish Commercial
Center and Snohomish Mortgage
Center..............................  2006       6,441      16,000    Owned
  9929 Evergreen Way
  Everett, WA 98204

Whatcom Commercial Center...........  2003         336       5,200    Leased
  2211 Rimland Drive, Suite 230
  Bellingham, WA 98226

-----------
(1)  Opened in June 2007.

     At March 31, 2008, the aggregate book value of the Corporation's premises
and equipment was $27.8 million.

                                            34
<PAGE>




Item 3.  Legal Proceedings
--------------------------

     Neither the Corporation nor the Bank is engaged in any legal proceedings
of a material nature at the present time.  From time to time the Bank is a
party to legal proceedings wherein it enforces its security interest in loans
made by it.

Item 4.   Submission of Matters to a Vote of Security Holders
-------------------------------------------------------------

     Not applicable.

                                       PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters
---------------------------------------------------------------------------
         and Issuer Purchases of Equity Securities
         -----------------------------------------

     Horizon Financial's common stock is traded on the NASDAQ Global Select
Market under the symbol HRZB.  The following table presents the high and low
sales prices as reported by the NASDAQ and dividends paid for the last two
fiscal years.  All share prices shown below are adjusted for the 5-for-4 stock
split, paid in the form of a stock dividend in October 2006.  The Corporation
has approximately 4,500 stockholders.

     2008 Fiscal Year
     Quarter                High           Low          Dividend
     ------------------    ------        ------         --------

     Fourth                $17.46        $11.68          $0.135
     Third                  22.00         15.12           0.135
     Second                 22.98         17.85           0.130
     First                  23.87         20.49           0.130

     2007 Fiscal Year
     Quarter                High           Low          Dividend
     ------------------    ------        ------         --------

     Fourth                $25.00        $20.47          $0.125
     Third                  25.90         22.24           0.125
     Second                 25.84         19.46           0.125
     First                  21.94         16.25           0.120

Dividend Policy
---------------

     Horizon Financial historically has paid cash dividends on its common
stock.  The Corporation must adhere to certain regulatory requirements
governing the distribution of dividends, and there can be no assurance that
the Corporation will continue to declare cash dividends in the future.  See
"Business -- Regulation and Supervision" in Item 1 of this Form 10-K for
additional information regarding dividend restrictions.

Stock Repurchases
-----------------

     The Corporation has conducted various stock buy-back programs since
August 1996.  In March 2006, the Board of Directors approved a stock
repurchase program that continued through the 2007 fiscal year, allowing the
Corporation to repurchase up to 5% of total shares outstanding, or
approximately 625,000 shares, adjusted for the 5-for-4 stock split paid in the
form of a 25% stock dividend in October 2006. This marked the Corporation's
seventh stock repurchase program.  During the year ended March 31, 2008, the
Corporation repurchased 399,700 shares at an average price of $17.62.  On
March 27,2008, the Board of Directors authorized the repurchase of 300,000
shares, or approximately 2.5% of the Corporation's outstanding shares of
common stock for a 12 month period.

                                          35

<PAGE>





     The following table sets forth the Corporation's repurchases of its
outstanding common stock during the fourth quarter of the year ended March 31,
2008.

                               Issuer Purchases of Equity Securities
                     ---------------------------------------------------------
                                                                     (d)
                                                                   Maximum
                                                     (c)          Number (or
                                                 Total Number    Approximate
                                                   of Shares     Dollar Value)
                                                  (or Units)    of Shares (or
                         (a)                     Purchased as  Units) that May
                       Total           (b)          Part of        Yet to Be
                      Number of      Average       Publicly       Purchased
                      Shares (or    Price Paid    Announced       Under the
                        Units)      per Share      Plans or        Plans or
   Period             Purchased      (or Unit)     Programs        Programs
------------------   -----------    ----------   ------------   --------------

January 1, 2008 -
  January 31, 2008..    53,600       $13.749       334,000(1)      266,000
February 1, 2008 -
  February 29, 2008.    28,700        14.190       362,700(1)      237,300
March 1, 2008 -
  March 31, 2008....    37,000        12.622       399,700(1)      200,300

                     -----------    ----------   ------------   --------------
Total...............   119,300       $13.506       399,700(1)      300,000(2)
                     ===========    ==========   ============   ==============
-----------
(1)  Reflects purchases made under the repurchase plan authorized by the Board
     of Directors in March 2007. This program expired on March 31, 2008.
(2)  Reflects new repurchase plan authorized by the Board of Directors in
     March 2008. The fiscal 2007 repurchase plan authorized by the Board of
     Directors expired on March 31, 2008 with 200,300 shares remaining
     unpurchased.

Equity Compensation Plan Information

     The equity compensation plan information presented under subparagraph (d)
in Part III, Item 12 of this report is incorporated herein by reference.

                                         36

<PAGE>




     Performance Graph.  The following graph compares the cumulative total
shareholder return on the Corporation's Common Stock with the cumulative total
return on the NASDAQ Index and the SNL Western Bank Index which encompasses
ten western states.  Total return assumes reinvestment of all dividends.



                              [GRAPH APPEARS HERE]

                                          Period Ending
                    ----------------------------------------------------------
Index*              03/31/03  03/31/04  03/31/05  03/31/06  03/31/07  03/31/08
------------------  --------  --------  --------  --------  --------  --------
Horizon Financial
 Corp.               100.00    126.85    132.79    185.66    204.85    131.53
NASDAQ - Composite   100.00    148.69    149.07    174.46    180.56    169.93
SNL Western Bank
 Index               100.00    136.89    149.88    169.24    180.14    148.66


*Source: SNL Financial LC, Charlottesville, VA Used with permission. All
rights reserved.

                                      37

<PAGE>




Item 6.  Selected Financial Data
--------------------------------

     The following table sets forth certain information concerning the
financial position of the Corporation at and for the dates indicated.

                                            At March 31,
                     ------------------------------------------------------
                         2008       2007        2006       2005      2004
                     ---------  ----------  ----------  --------  ---------
                                           (In thousands)
Financial Condition Data:
------------------------

Total Assets........$1,392,178  $1,270,327  $1,116,728  $997,570  $858,876
Loans Receivable,
 net................ 1,191,478   1,054,870     918,510   804,981   658,226
Cash and Investment
  Securities........   114,562     133,075     125,216   125,966   161,071
Deposits............ 1,038,792     975,295     834,299   746,849   670,259
Borrowings..........   214,791     158,958     159,837   135,787    67,469
Stockholders'
  Equity............   128,317     123,855     113,323   107,024   109,307

                                        Year Ended March 31,
                     ------------------------------------------------------
                         2008       2007        2006       2005      2004
                     ---------  ----------  ----------  --------  ---------
                          (In thousands, except per share information)
Operating Data:
--------------

Interest Income.....  $100,243     $92,600     $69,388   $52,182    $48,979
Interest Expense....   (46,645)    (40,133)    (24,896)  (16,144)   (15,509)
Net Interest Income.    53,598      52,467      44,492    36,038     33,470
Provision for Loan
  Losses............    (4,100)     (1,850)     (2,575)   (1,700)    (1,915)
Noninterest Income..     7,044       5,838       5,411     5,713      7,415
Noninterest Expense.   (29,180)    (27,861)    (24,770)  (21,619)   (19,772)
Income before
  Provision for
  Income Taxes......    27,362      28,594      22,558    18,432     19,198
Provision for
  Income Taxes......    (8,949)     (9,566)     (6,903)   (5,369)    (6,332)
Net Income..........   $18,413     $19,028     $15,655   $13,063    $12,866

Per Common Share:(1)
  Fully-diluted
    earnings........    $1.51       $1.53       $1.25      $1.01     $0.96
  Dividends.........     0.530       0.495       0.456      0.424     0.392
  Book Value........    10.79       10.11        9.16       8.53      8.40
  Weighted average
    shares out-
    standing........12,196,783  12,409,092  12,542,845  12,952,542 13,357,556


----------
(1)  Restated for the 5-for-4 stock split paid in the form of a 25% stock
dividend distributed on October 23, 2006.

                                       38

<PAGE>




Key Operating Ratios:
--------------------

     The table below sets forth certain performance ratios of the Corporation
for the periods indicated.  These ratios are calculated based on month end
balances.

                                                        At and for the
                                                      Year Ended March 31,
                                                    -----------------------
                                                    2008      2007     2006
                                                    ----      ----     ----
Return on average assets (net income divided
  by average total assets).......................   1.37%    1.57%    1.48%

Return on average equity (net income divided
  by average equity).............................  14.53    16.11    14.32

Dividend payout ratio (dividends declared
  per share divided by fully-diluted
  earnings per share)............................  35.10    32.35    36.54

Equity to assets ratio (average equity
  divided by average total assets)...............   9.22     9.74    10.35

Interest rate spread (difference between
  average yield on interest-earning assets and
  average cost of interest bearing liabilities)..   4.24     4.60     4.54

Net yield on earning assets (net interest
  income as a percentage of average interest
  earning assets)................................   4.37     4.73     4.66

Efficiency ratio (noninterest expense divided
  by the sum of net interest income and
  noninterest income)............................  48.12    47.79    49.64

Non-performing loans ratio (non-performing
  loans divided by net loans)....................   0.97%    0.02%    0.13%

Non-performing asset ratio (non-performing
  assets divided by total assets)................   0.88%    0.07%    0.10%


Item 7.  Management's Discussion and Analysis of Financial Condition and
------------------------------------------------------------------------
         Results of Operations
         ---------------------

     The following discussion is intended to assist in understanding the
financial condition and results of operations of the Corporation and the Bank.
The information contained in this section should be read in conjunction with
the Consolidated Financial Statements and the accompanying Notes contained in
Item 8 of this Form 10-K.

Forward Looking Statements
--------------------------

     Management's Discussion and Analysis of Financial Condition and Results
of Operations and this Form 10-K contain certain forward-looking statements
which are based on assumptions and describe future plans, strategies and
expectations of the Corporation.  Management desires to take advantage of the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
and is including this statement for the express purpose of availing the
Corporation of the protections of the safe harbor with respect to all
forward-looking statements in this Form 10-K.    These forward-looking
statements are generally identified by use of the words "believe,"  expect,"
"intend," "anticipate," "estimate," "project," or similar words.  The
Corporation's ability to predict results of the actual effect of future plans
or strategies is uncertain.  Factors which could have a material adverse
effect on the Corporation's operations include, but are not limited to,
changes in interest rates, general economic conditions, legislative/regulatory
changes, monetary and fiscal policies of the U.S. government, including
policies of the U.S. Treasury and the Federal Reserve Board, the quality or
composition of the loan or investment portfolios, increase in the housing
supply in our market area, demand for loan products, deposit flows,
competition, demand for financial services in the Corporation's market areas
and

                                           39

<PAGE>



accounting principles and guidelines.  These risks and uncertainties should be
considered in evaluating forward-looking statements and you should not rely
too much on these statements.

General
-------

     The Corporation's results of operations depend primarily on revenue
generated as a result of its net interest income and non-interest income.  Net
interest income is the difference between the interest income the Corporation
earns on its interest-earning assets (consisting primarily of loans and
investment securities) and the interest the Corporation pays on its
interest-bearing liabilities (consisting primarily of customer savings and
money market accounts, time deposits and borrowings).  Non-interest income
consists primarily of service charges on deposit and loan accounts, gains on
the sale of loans and investments, and loan servicing fees. The Corporation's
results of operations are also affected by the provisions for loan losses and
other expenses.  Other expenses consist primarily of noninterest expense,
including compensation and benefits, occupancy, equipment, data processing,
marketing, automated teller machine costs and, when applicable, deposit
insurance premiums.  The Corporation's results of operations may also be
affected significantly by general and local economic and competitive
conditions, changes in market interest rates, governmental policies and
actions of regulatory authorities, as well as other factors identified under
the caption "Forward Looking Statements" above.

Business Strategy
-----------------

     The Bank's business strategy is to operate as a well-capitalized,
profitable and independent community bank, dedicated to commercial lending,
home mortgage lending, consumer lending, small business lending and providing
quality financial services to local personal and business customers.  The Bank
has sought to implement this strategy by: (i) focusing on commercial banking
opportunities;  (ii) continued efforts towards the origination of residential
mortgage loans, including one-to-four family residential construction and land
development loans; (iii) providing high quality, personalized financial
services to individuals and business customers and communities served by its
branch network; (iv) selling many of its fixed rate mortgages to the secondary
market; (v) focusing on asset quality; (vi) containing operating expenses; and
(vii) maintaining capital in excess of regulatory requirements combined with
prudent growth.

Operating Strategy
------------------

     The Corporation serves as a holding company for the Bank and other
subsidiaries whereby it provides strategic oversight, management, access to
capital and other resources and activities typically performed by bank holding
companies.  The operating strategy of the Corporation has been to expand and
diversify its consolidated operations across a variety of companies and/or
operating units that are engaged in complementary, but different, businesses
and/or operating strategies.  This diversification strategy is expected to
continue as opportunities arise, although there are no specific acquisitions
or new business formations planned at this time.  The Bank currently has two
offices in Pierce County (south of King County), with the remaining offices
all located north of King County.  Management has further indicated that the
market areas just outside King County (including, but not necessarily limited
to Snohomish, Pierce, Kitsap and Thurston counties) are logical areas for
potential future expansion, as these markets have characteristics most similar
to those in which the Bank has experienced previous success.

     The primary business of the Bank is to acquire funds in the form of
deposits and wholesale funds, and to use the funds to make commercial,
consumer, and real estate loans in its primary market area.  In addition, and
to a lesser extent, the Bank invests in a variety of investment grade
securities including, but not necessarily limited to U.S. Government and
federal agency obligations, mortgage-backed securities, corporate debt, equity
securities, and municipal securities.  The Bank intends to continue to fund
its assets primarily with retail and commercial deposits, although, FHLB
advances, brokered deposits, and other wholesale borrowings, will also likely
be used as a supplemental source of funds.

     The Corporation's profitability depends primarily on its net interest
income, which is the difference between the income it receives on the Bank's
loan and investment portfolio and the Bank's cost of funds, which consists of
interest paid on deposits and borrowings. The Bank reviews its opportunities
with respect to both assets and liabilities.  In the past two fiscal years,
for example, the Bank chose to concentrate its commercial lending efforts on
growing its Prime

                                        40
<PAGE>



based loan portfolio, at a time when many lenders were offering fixed rate
real estate loans at sub-Prime rates.  In this regard, the Bank's loan
portfolio growth is heavily concentrated in the active real estate development
and construction markets in the Puget Sound region.  Through its relationships
with established real estate developers and builders, the Bank's experienced
loan officers were successful at growing this portion of the Bank's portfolio,
which is primarily Prime based business.  This was beneficial in previous
years, with the FOMC's (Federal Reserve's Open Market Committee) efforts to
increase short terms interest rates, which have in turn increased the Prime
lending rate.  With the FOMC's 50 basis point reduction on September 18, 2007,
25 basis point reduction on October 31, 2007, 25 basis point reduction on
December 11, 2007, 125 basis point reduction in January 2008 and 75 basis
point reduction  in March 2008, the Corporation is experiencing a decline in
its net interest margin.  This rapid pace of easing monetary policy by the
FOMC will contribute to further declines in the Corporation's net interest
margin.  The results of this strategy are discussed in more detail in the
section entitled "Comparison of Operating Results for the Years Ended March
31, 2008 and March 31, 2007 - Net Interest Income."   On the liability side of
the balance sheet, these changing rates also impact the Bank's earnings.
Management acknowledges that there is a lag effect in this regard, in both
increasing and decreasing rate environments as the rates on the Bank's
certificate of deposit liabilities do not adjust instantly, rather the impact
occurs more gradually as the certificates of deposit mature and reprice in a
changing interest rate environment.

     Net interest income is also affected by the relative amounts of
interest-earning assets and interest-bearing liabilities.  When
interest-earning assets equal or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. The
Corporation's profitability is also affected by the level of the Bank's other
income and expenses.  Other noninterest income includes income associated with
the origination and sale of mortgage loans, loan servicing fees, deposit
account related fees, and net gains and losses on sales of interest-earning
assets.  This portion of the Bank's income is heavily dependent on the Bank's
success at originating and selling one-to-four family mortgage loans into the
secondary market.  In addition, the Bank's ability to generate fee income on
its deposit accounts impacts this portion of the Bank's income stream.  In
fiscal 2006, the Bank introduced an Overdraft Protection service, which
increased the deposit related fee income and is discussed in more detail in
the section entitled "Comparison of Operating Results for the Years Ended
March 31, 2007 and March 31, 2006."

     Other noninterest expenses include compensation and benefits, occupancy
and equipment  expenses, deposit insurance premiums, data servicing expenses
and other operating costs.  In fiscal 2006, the Bank began a Bank-wide
efficiency initiative, soliciting input from all employees and implementing
many of the suggestions it received.  This is an ongoing process, as
management continues to look for ways to improve efficiency. To encourage
employees to participate in this initiative, the Bank includes a profitability
component to the incentive portion of the employee's pay, and efficiency
accounts for one-third of this profitability component.  Also during fiscal
2006, the Bank formed a Core Data Processor task team, to analyze ways to best
utilize its new data processing system.  At the time of conversion in November
2004, the focus was appropriately placed on converting the data from the
previous system.  Subsequently, the focus shifted to ensuring that the Bank
was taking advantage of the benefits offered by the new system, and this is a
process that will continue in future years along with the efficiency
initiative discussed above.

     Finally, the Corporation's results of operations are also significantly
affected by general economic and competitive conditions, particularly changes
in market interest rates, government legislation, regulation, and monetary and
fiscal policies.

Critical Accounting Estimates
-----------------------------

     Management recognizes that loan losses occur over the life of a loan, and
that the allowance for loan losses must be maintained at a level sufficient to
absorb probable losses inherent in the loan portfolio.  Management's
determination of the allowance is based on a number of factors, including the
level of non-performing loans, loan loss experience, credit concentrations,
reviews of the quality of the loan portfolio, collateral values, historical
industry loss experience, and uncertainties in economic conditions.  The
allowance is increased by the provision for loan losses, which is charged
against current period operating results and decreased by the amount of actual
loan charge-offs, net of recoveries.

     Management believes that the accounting estimate related to the allowance
for loan losses is a "critical accounting estimate" because: (i) it is highly
susceptible to change from period to period because it requires management

                                        41
<PAGE>




to make assumptions about future losses on loans; and (ii) the impact of a
sudden large loss could deplete the allowance and potentially require
increased provisions to replenish the allowance, which would negatively affect
earnings.

     The Corporation has an active ongoing credit review function.  The
allowance for loan losses is maintained at a level sufficient to provide for
estimated, probable 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, historical
industry 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.  Management believes 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 assist management in evaluating
the adequacy of the allowance, and continues to work on enhancing its
methodologies in this regard.

     As required by SFAS No. 114, Accounting by Creditors for Impairment of a
Loan, 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 the Bank
applies SFAS No. 5, Accounting for Contingencies.  Reserve factors are applied
to homogeneous loan pools which are consistent with the Bank's experience in
that loan pool type or with industry guidelines if management believes such
guidelines are more appropriate. The applied percentage is also influenced by
other economic factors in the Bank's market area, the state's economy, and
national economic factors that could influence the quality of the loan
portfolio in general.

     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 Corporation's senior management reviews and analyzes the loan
portfolio, charge-offs, and allowance on a quarterly basis.  Management then
discusses the development and calculation of this critical accounting estimate
with the executive committee of the Board of Directors. Horizon's audit
committee also reviews the Corporation's disclosures including this critical
accounting estimate.

     Management reviewed and evaluated the loan portfolio and the adequacy of
the allowance at March 31, 2008 and believes that the allowance at 1.60% of
net loans, or $19.1 million is adequate for the risk inherent in the loan
portfolio and the current economic environment.  The allowance was 1.51% of
net loans or $15.9 million at March 31, 2007.  In fiscal 2008, the loan
portfolio grew 12.9% to $1.2 billion at March 31, 2008 from $1.1 billion at
March 31, 2007.  The loan portfolio has experienced substantial growth
especially in construction and land development loans. At March 31, 2008,
construction and land development loans totaled $486.5 million, an increase of
$81.2 million or 20% from $405.3 million at March 31, 2007.  The increase in
the allowance is primarily attributable to the substantial growth in this
higher risk portion of the loan portfolio. The Bank's Allowance for Loan and
Lease Losses ("ALLL") analysis also considered the potential impacts of
sub-prime loans originated by others in the Bank's markets in recent years.
These loans are cited as contributing to the slowdowns in the housing markets
across the country.  As homeowner's face significant increases in their
housing payments when these sub-prime loans reset, this will have potential
adverse affects on the economy with an increasing supply of housing units on
the market.  It is predicted that these adverse impacts will result in
increased numbers of houses listed for sale (for those facing unaffordable
increases in their monthly housing payments), a decline in prices and it will
also likely increase the number of foreclosures on residential units.

     Economic data from the Federal Reserve showed a slowdown in overall
economic activity in recent quarters.  Economic conditions in the region
remain do remain stronger than reported national trends, however we continue
to see increasing signs of a slowing housing market, including increasing
inventories and overall slower sales activity.  We are seeing a slowdown in
our land acquisition and development progress and are closely watching a
number of relationships.

                                        42
<PAGE>


     The Bank's loan portfolio showed increasing signs of strain at March 31,
2008.  During the fiscal year ended March 31, 2008, it was necessary to
recognize $875,000 in writeoffs relating primarily to two of the Bank's
builder/developer relationships.  In addition, the loans relating to these
writeoffs were placed on non-accrual status, bringing our total non-accruing
loans to $11.6 million at March 31, 2008 compared to $226,000 at March 31,
2007. This brings the Bank's total non-performing assets/total assets ratio to
0.88% at March 31, 2008 compared to 0.07% at March 31, 2007.  In addition, the
Bank's delinquency levels (loans 30 to 89 days past due) totaled $30.6 million
at March 31, 2008 compared to $3.0 million at March 31, 2007.

     The factors discussed above led management to increase the allowance to
its current levels.

     The Bank recorded net charge-offs of $875,000 and $145,000, during the
years ended March 31, 2008 and 2007.

     The provision for loan losses has fluctuated depending on the growth and
mix of the loan portfolio and the level of charge-offs.  The provision for
loan losses was $4.1 million, $1.9 million and $2.6 million for the fiscal
years ended 2008, 2007 and 2006, respectively.

Critical Accounting Policies
----------------------------

     The Corporation's significant accounting principles are described in Note
1 of the Notes to Consolidated Financial Statements included in Item 8 of this
Form 10-K and are essential to understanding Management's Discussion and
Analysis of Financial Condition and Results of Operations.  The preparation of
financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and
assumptions which affect the reported amounts and disclosures.  Actual results
may differ from these estimates under different assumptions or conditions.
The following policies involve a higher degree of judgment than do our other
significant accounting policies detailed in Note 1 of the Notes to
Consolidated Financial Statements.

     Allowance for Loan Losses.  The Corporation reviews historical
origination and charge-off relationships, charge-off experience factors,
collection data, delinquency reports, estimates of the value of the underlying
collateral, economic conditions and trends and other information in order to
make the necessary judgments as to the appropriateness of the provision for
loan losses and the allowance for loan losses.  Loans are charged-off to the
allowance for loan losses when the Corporation repossesses and disposes of the
collateral or the account is otherwise deemed uncollectible.  The Corporation
believes that the allowance for loan losses is adequate yet not excessive to
cover probable losses inherent in its loan portfolio; however, because the
allowance for loan losses is based on estimates, there can be no assurance
that the ultimate charge-off amount will not exceed such estimates.

     Investments.  The Corporation classifies its investments as either
available-for-sale or held-to-maturity.  Available for sale securities are
reported at their fair value, which is determined by obtaining quoted market
prices.  Unrealized gains and losses on available for sale securities are
included in other comprehensive income and excluded from earnings.  Realized
gains and losses and declines in fair value determined to be other than
temporary are included in earnings.  The fair value of investments is
discussed in more detail in Notes 3 and 4 of the Notes to Consolidated
Financial Statements included in Item 8 of this Form 10-K.

     Long-Lived Assets and Intangibles.  The Corporation periodically assesses
the impairment of its long-lived assets and intangibles using judgment as to
the effects of external factors, including market conditions.  If actual
external conditions and future operating results differ from the Corporation's
judgments, impairment charges may be necessary to reduce the carrying value of
these assets to the appropriate market value.

     Accrued Taxes.  The Corporation estimates tax expense based on the amount
it expects to owe various tax authorities.  Taxes are discussed in more detail
in Note 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

                                        43
<PAGE>



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, 2008 and March 31, 2007
----------------------------------------------------------------------

     Total consolidated assets for the Corporation as of March 31, 2008, were
$1.4 billion, a 9.6% increase from the March 31, 2007 level of $1.3 billion.
This increase in assets was primarily attributable to the growth in loans
receivable to $1.2 billion at March 31, 2008 from $1.1 billion at March 31,
2007.  The growth in loans receivable was primarily attributable to a $81.2
million, or 20.0%, increase in construction and land development loans since
March 31, 2007.  The Bank continued its focus on expanding its relationships
with established residential real estate developers and one-to-four family
residential builders, which resulted in the continued growth in this component
of loans receivable during the period.  Also contributing to this increase is
a slowing pace of loan paydowns in this category, as the sales activity has
slowed compared to previous periods.  This has resulted in loan balances
remaining on the Corporation's balance sheet longer than in more active
periods for real estate sales.  Also increasing during the period was the
commercial loan category, as the Bank continues to focus on increasing its
commercial lines of credit balances to diversify its loan portfolio and expand
its relationships with businesses in its markets.  Commercial real estate
loans, primarily consisting of loans with initial fixed rate periods of three
to five years, moderated during the period as the Bank continued its trend
away from the lower returns available in this segment in favor of the returns
available in the construction and land development category.

     One-to-four family mortgage loans, net increased 18.6% to $146.9 million
at March 31, 2008 from $123.9 million at March 31, 2007. A portion of the
growth, approximately $16.2 million, is related to loans secured by one-
to-four family homes where builders were allowed to convert unsold speculative
construction inventory into rental homes to assist with cash flow needs. The
Bank continues its practice of selling most of its single-family long term
fixed rate loan production into the secondary market.  The Bank sold $79.9
million of real estate loans during fiscal year ended March 31, 2008, compared
to $83.0 million during the fiscal year ended March 31, 2007.

     The following is an analysis of the loan portfolio by major type of loan
at March 31, 2008 and 2007.

                                                      At March 31,
                                         -----------------------------------
                                            2008               2007
                                         ---------          ---------
                                                  (Dollars in thousands)
First mortgage loans:
  One-to-four family ...................  $165,824   13.7%   $149,885   14.0%
  One-to-four family construction.......    35,303    2.9      28,576    2.7
  Less participations sold..............   (54,269)  (4.5)    (54,592)  (5.1)
                                         ---------  -----   ---------  -----
       Subtotal.........................   146,858   12.1     123,869   11.6

  Commercial land development...........   178,726   14.8     173,270   16.1
  Commercial construction...............   307,809   25.4     232,078   21.7
  Multi-family residential..............    45,049    3.7      52,727    4.9
  Nonresidential commercial real
    estate..............................   300,109   24.8     292,212   27.3
  Commercial loans......................   177,685   14.7     146,265   13.7
  Home equity secured...................    47,351    3.9      45,307    4.2
  Other consumer loans..................     7,005    0.6       5,031    0.5
                                         ---------  -----   ---------  -----
       Subtotal......................... 1,063,734   87.9     946,890   88.4
                                         ---------  -----   ---------  -----
       Total loans receivable........... 1,210,592  100.0%  1,070,759  100.0%
                                         ---------  -----   ---------  -----

                            (table continued on following page)

                                             44
<PAGE>




                                                      At March 31,
                                         -----------------------------------
                                            2008               2007
                                         ---------          ---------
Less:
  Allowance for loan losses............    (19,114)           (15,889)
                                        ----------         ----------
        Total loans receivable, net.... $1,191,478         $1,054,870
                                        ==========         ==========

Net residential loans.................. $  145,565   12.2% $  122,839   11.7%
Net commercial loans...................    174,263   14.6     143,604   13.6
Net commercial real estate loans (1)...    818,215   68.7     738,861   70.0
Net consumer loans (2).................     53,435    4.5      49,566    4.7
                                        ----------  -----  ----------  -----
                                        $1,191,478  100.0% $1,054,870  100.0%
                                        ==========  =====  ==========  =====

-------
(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 70% of our total loan
portfolio consists of commercial real estate and construction and land
development loans.  These types of lending afford the Bank an opportunity to
receive interest at rates higher than those generally available from
one-to-four family residential lending.  These loans, however, also typically
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than single family residential mortgage
loans.  Because payments on loans secured by commercial real estate often
depend upon the successful operation and management of the properties,
repayment of such loans may be affected by adverse conditions in the real
estate market or the economy.  The Bank seeks to minimize these risks by
limiting the maximum loan-to-value ratio to between 75 and 85% and carefully
reviewing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan.

     Construction and land development lending generally involves a higher
degree of risk than permanent financing for a finished residence or commercial
building, because of the inherent difficulty in estimating both the estimated
cost of the project and the property's value at completion.  If the estimated
cost of construction proves to be inaccurate, the Bank may be required to
advance funds beyond the amount originally committed to complete the project.
To address this risk, and because of the level of construction loans in the
Bank's portfolio, the Bank has personnel dedicated specifically to monitoring
the progress of its construction projects, and making on-site inspections of
the properties.  In addition, in an effort to monitor the available inventory
in its markets, the Bank also regularly reviews the overall building and
development activity in its markets.  Also, to mitigate the risks related to
construction lending, the Bank primarily deals with experienced builders, with
acceptable credit histories, sound financial statements, and a proven track
record in the industry.  In addition, the Bank utilizes the services of
experienced inspectors to monitor the progress and draw process in the more
complex construction projects.  The Bank also has an experienced appraisal
staff, and members of senior management with related appraisal education and
experience, who regularly review the appraisals utilized by the Bank in
analyzing prospective construction projects.  Finally, members of the Bank's
senior management and loan committees also have a significant amount of
experience in the areas of construction lending, appraisals, and loan
underwriting, further mitigating the Bank's risk in this area. However, even
with strong underwriting, changing economic conditions can have an adverse
impact on the Bank's borrowers and on the Bank's loan portfolio. See the Asset
Quality section below for details on the Bank's non-performing assets and
comments regarding identified potential weaknesses in its loan portfolio.

     The Bank actively originates construction loans through its Mortgage Loan
Division and its Commercial Loan Division.  The Bank's Mortgage Loan Division
generally oversees the single family custom construction loans, and to a
lesser extent, speculative construction loans (i.e., loans for homes that do
not have a contract with a buyer for the purchase of the home upon completion
of the construction) to smaller contractors building a limited number of
speculative homes per year.  These construction loans are further broken down
in the first two lines of the table below (speculative construction
one-to-four family and custom construction one-to-four family). The Bank's
Commercial Lending Division is responsible for the speculative construction
projects for the Bank's larger builders (including large

                                       45
<PAGE>



one-to-four family developments), in addition to the Bank's multi-family
construction loans, non-residential commercial construction loans, and the
Bank's land development loans.

     The following table is provided to show additional details on the
Corporation's construction and land development loan portfolio:

                                  At March 31, 2008      At March 31, 2007
                                 -------------------   --------------------
                                 Amount      Percent    Amount      Percent
                                 ------      -------    ------      -------

                                          (Dollars in thousands)
Speculative construction
  one-to-four family...........  $27,206        5.2%    $16,597       3.8%
Custom construction one-
  four-family..................    8,097        1.6      11,979       2.8
                                --------      -----    --------     -----
    Total one-to-four family...   35,303        6.8      28,576       6.6
Commercial speculative
  construction one-to-four
  family.......................  236,536       45.3     177,602      40.9
Commercial construction
  multi-family.................   11,732        2.2       6,986       1.6
Commercial construction
  non-residential..............   59,541       11.4      47,490      11.0
Land development...............  178,726       34.3     173,270      39.9
                                --------      -----    --------     -----
    Total construction and
      land development.........  486,535       93.2     405,348      93.4
                                --------      -----    --------     -----
    Total construction loans... $521,838      100.0%   $433,924     100.0%
                                ========      =====    ========     =====

     The tables below display the characteristics of the available for sale
and held to maturity portfolios at March 31, 2008:

                                              At March 31, 2008
                                     ---------------------------------------
                                                   Unrealized
                                     Amortized       Gain/         Estimated
                                        Cost         (Loss)        Fair Value
                                     ---------     ----------      ----------
                                                (In thousands)
Available For Sale Securities
  State and political subdivisions
   and U.S. government agency
   securities ......................  $33,107        $   572        $33,679
  Marketable equity securities......      569          2,194          2,763
  Mutual funds......................    5,000           (201)         4,799
  Mortgage-backed securities
   and CMOs.........................   38,646            454         39,100
                                      -------         ------        -------
      Total available-for-sale
        securities..................   77,322          3,019         80,341

Held To Maturity Securities
  State and political subdivisions
   and U.S. government agency
   securities.......................       --             --             --
  Mortgage-backed securities
   and CMOs.........................       30              5             35
                                      -------         ------        -------
      Total held to maturity
        securities..................       30              5             35
                                      -------         ------        -------
      Total securities..............  $77,352         $3,024        $80,376
                                      =======         ======        =======


                                             46

<PAGE>




                                      Maturity Schedule of Securities
                                             at March 31, 2008
                               ----------------------------------------------
                                Available For Sale       Held To Maturity
                               ---------------------    ---------------------
                               Amortized   Estimated    Amortized   Estimated
                                 Cost     Fair Value      Cost     Fair Value
                                 ----     ----------      ----     ----------
                                                (In thousands)
Maturities:
  Less than one year.......... $ 6,726     $ 6,760        $ 7         $ 7
  Over one year to five
    years.....................  12,745      13,159         12          12
  Over five to ten years......  21,531      21,828          3           6
  Over ten years..............  30,751      31,032          8          10
                               -------     -------        ---         ---
                                71,753      72,779         30          35

Mutual funds and marketable
  equity securities...........   5,569       7,562         --          --
                               -------     -------        ---         ---
   Total investment
     securities............... $77,322     $80,341        $30         $35
                               =======     =======        ===         ===

     Total liabilities also increased 10.2% to $1.3 billion at March 31, 2008,
from $1.1 billion at March 31, 2007.  This increase in liabilities was
primarily the result of growth in other borrowed funds, which increased 38.7%
to $192.3 million at March 31, 2008 from $138.7 million at March 31, 2007.
During the fiscal year ended March 31, 2008 the Bank borrowed an additional
$48.5 million from the FHLB to support asset growth and help manage interest
rate risk.

     Also contributing to the growth in liabilities during the fiscal year
ended March 31, 2008 was the growth in the balance of deposits, which
increased 6.5% to $1.04 billion at March 31, 2008 from $975.3 million at March
31, 2007.  The following is an analysis of the deposit portfolio by major type
of deposit at March 31, 2008 and 2007:

                                                    At March 31,
                                               -----------------------
                                                   2008         2007
                                               ----------   ----------
                                                   (In thousands)
        Demand Deposits
          Savings............................  $   17,933   $   21,628
          Checking...........................      72,434       78,294
          Checking (noninterest-bearing).....      70,438       91,703
          Money Market.......................     183,063      187,912
                                               ----------   ----------
                                                  343,868      379,537
                                               ----------   ----------
        Time certificates of deposit
          Less than $100,000.................     286,657      273,022
          Greater than or equal to $100,000 .     287,281      243,346
          Brokered certificates of deposit...     120,986       79,390
                                               ----------   ----------
        Total certificates of deposit........     694,924      595,758
                                               ----------   ----------
          Total deposits.....................  $1,038,792   $  975,295
                                               ==========   ==========

     Also included in the March 31, 2008 balance sheet is an investment in
real estate for a joint venture and the corresponding borrowing.  During the
year ended March 31, 2005, the Bank's subsidiary (Westward Financial
Services), as a 50% partner in the Greenbriar NW LLP ("GBNW"), purchased an 85
acre parcel of land in Bellingham, Washington for future residential
development.  GBNW intends to develop the property in future years, into a
neighborhood community to be known as Fairhaven Highlands.   The $17.6 million
shown on the Corporation's balance sheet as an asset at March 31, 2008
represents the current level of the investment in real estate joint ventures,
including the Fairhaven Highlands joint venture.  This amount also includes
the remaining net investment in other residential development joint ventures.
The $22.4 million shown in the liability section of the balance sheet
represents the corresponding wholesale borrowing used to fund the investment
in the Fairhaven Highlands joint venture, which includes costs that have been

                                         47

<PAGE>



incurred and capitalized since the acquisition of the property.  At this time,
the partnership is in the process of meeting with the appropriate public and
private entities, in its preliminary planning efforts relating to the future
development of the property, including an Environmental Impact Statement which
is currently in the process of being completed.

     Stockholders' equity at March 31, 2008 increased 3.6% to $128.3 million
from $123.9 million at March 31, 2007.  This increase was primarily
attributable to net income of $18.4 million for the year ended March 31, 2008
partially offset by the effects of $6.4 million in dividends paid to
stockholders and the Corporation's share repurchase program.  The Corporation
repurchased shares totaling $7.1 million during the year ended March 31, 2008
compared to $2.9 million for the year ended March 31, 2007.  The Corporation
remains strong in terms of its capital position, with a stockholder equity-
to-assets ratio of 9.2% at March 31, 2008, compared to 9.8% at March 31, 2007.

Comparison of Operating Results for the Years Ended March 31, 2008 and March
----------------------------------------------------------------------------
31, 2007
--------

     Net Interest Income.  Net interest income in fiscal 2008 was $53.6
million, a 2.2% increase from $52.5 million in fiscal 2007.  Total interest
income increased 8.3% in fiscal 2008 to $100.2 million from $92.6 million in
fiscal 2007.

     Interest income on loans in fiscal 2008 was $96.3 million, an 8.7%
increase from $88.6 million in fiscal 2007.  The increase in fiscal 2008 was
primarily a result of the growth in loans receivable, as the Bank experienced
significant loan growth during the year, increasing the loan portfolio to $1.2
billion at March 31, 2008, compared to $1.1 billion at March 31, 2007.

     Also included in interest income for the year ended March 31, 2008 and
2007 were approximately $5.1 million and $4.8 million, respectively, of
deferred fee income recognition.  Most of these fees were related to the
Bank's commercial loan portfolio for the years ended March 31, 2008 and 2007,
which resulted in large part from the success in increasing the real estate
development loan portfolio.  These development loans typically are shorter
term in nature, so the deferred fee recognition during the life of the loan is
greater than what would be recognized for a comparable loan fee on a longer
amortizing loan.  The table below presents an analysis of deferred fee
recognition for the past two fiscal years:

                                              Year Ended March 31,
                                              --------------------
                                                 2008      2007
                                               -------    -------
                                                  (In thousands)
     Commercial loan deferred fees...........  $ 4,240    $ 4,076
     One-to-four real estate mortgage
       loan deferred fees....................      854        684
                                               -------    -------
         Total...............................  $ 5,094    $ 4,760
                                               =======    =======

     Interest and dividends on investments and mortgage-backed securities
remained relatively unchanged at $3.9 million in fiscal 2008, compared to $4.0
million in fiscal 2007.

     Total interest expense in fiscal 2008 increased 16.2% to $46.6 million
from $40.1 million in fiscal 2007. Interest on deposits increased
significantly to $38.1 million in fiscal 2008 from $32.3 million in fiscal
2007, as a result of increased growth in average deposits outstanding to
$992.9 million compared to $906.0 million at March 31, 2007.  Also
contributing to the increase was the higher level of interest rates paid
during much of the year ended March 31, 2008 compared to the previous period.
At March 31, 2008, approximately 67% of the Bank's deposits were in the form
of certificates of deposit, including $121.0 million in brokered certificates
of deposit.  While management continues its efforts to increase core deposits
as a funding source, the competitive marketplace for core deposit dollars has
resulted in limited success in this regard.

     Interest on borrowings increased to $8.6 million in fiscal 2008 from $7.9
million in fiscal 2007. The increase was a result of a higher level of average
borrowings outstanding during the year ended March 31, 2008 of $193.3 million

                                    48

<PAGE>



compared to $166.3 million during the year ended March 31, 2007.  The Bank
continues to utilize wholesale borrowings in order to further leverage its
balance sheet and better manage its interest rate risk profile.

     Provision for Loan Losses.  Provisions for loan losses are charges to
earnings to bring the total allowance for loan losses to a level considered by
management as adequate to provide for known and inherent risks in the loan
portfolio, based on management's continuing analysis of factors underlying the
quality of the loan portfolio at the time the financial statements are
prepared.  These factors include changes in portfolio size and composition,
actual loss experience, current economic conditions, detailed analysis of
individual loans for which full collectibility may not be assured, and
determination of the existence and realizable value of the collateral and
guarantees securing the loans.  The ultimate recovery of loans is susceptible
to future market factors beyond the Corporation's control, which may result in
losses or recoveries differing significantly from those provided for in the
financial statements.  The following table summarizes the allowance for loan
losses, charge-offs, and loan recoveries:

                                              Year Ended March 31,
                                              --------------------
                                                 2008      2007
                                               -------    -------
                                             (Dollars in thousands)

     Allowance at beginning of period......   $15,889   $ 14,184
     Provision for loan losses.............     4,100      1,850
     Charge offs, net of recoveries........      (875)      (145)
                                              -------   --------
     Allowance at end of period............   $19,114   $ 15,889
                                              =======   ========
     Allowance for loan losses as a
       percentage of net loans receivable
       at the end of the period............      1.60%      1.51%

     Net charge-offs as a percentage
       of average loans outstanding
       during the period...................      0.08%      0.01%

     Allowance for loan losses as a
       percentage of nonperforming assets
       at the end of period................    155.87%  1,670.06%

     The allowance for loan losses is established as losses are estimated to
have occurred through the provision for loan losses charged to earnings.  Loan
losses are charges against the allowance when management believes the
uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if
any, are credited to the allowance.

     The provision for loan losses was $4.1 million for the year ended March
31, 2008 compared to $1.9 million for the year ended March 31, 2007.  These
provisions reflect management's ongoing analysis of changes in loan portfolio
composition by collateral categories, balances outstanding, overall credit
quality of the portfolio, peer group analysis, historical industry loss
experience, and current economic conditions.  The allowance for loan losses
was $19.1 million, or 1.60% of net loans receivable at March 31, 2008 compared
to $15.9 million, or 1.51% of net loans receivable at March 31, 2007.  The
increased allowance level resulted from continued loan portfolio growth in the
higher-risk lending categories of construction and land development,
commercial real estate and commercial business loans during the period, which
amounted to $992.5 million, or 83.3% of total loans receivable at March 31,
2008, versus $896.6 million, or 83.7% at March 31, 2007.

     Non-Performing Assets.  As of March 31, 2008, there were no loans in the
loan portfolio over 90 days delinquent and accruing and 13 loans on nonaccrual
status.  At March 31, 2008, total non-performing loans were $11.6 million.
Non-performing assets grew significantly in the final quarter of our fiscal
year.  Two lending relationships contributed to the majority of the increase
in our non-accrual figures, including a residential developer in Snohomish
County with inventory consisting of 17 homes (four of which are in escrow with
sales pending), eight residential building lots and one commercial development
project for a 7.4 acre site in Monroe, Washington.  The Bank had one property

                                      49

<PAGE>



in the real estate owned category totaling $655,000 at March 31, 2008.  Total
non-performing assets represented $12.3 million, or 0.88% of total assets at
March 31, 2008 compared to $951,000 or 0.07% of total assets at March 31,
2007.

     The following table summarizes the Corporation's non-performing assets:

                                                        At March 31,
                                                    -------------------
                                                      2008        2007
                                                      ----        ----
                                                   (Dollars in thousands)
     Non-Performing Assets
       Accruing loans 90 days past due..........    $     --   $     --
     Non-accrual loans..........................      11,608        226
     Restructured loans.........................          --         --
                                                    --------   --------
      Total non-performing loans................      11,608        226
      Total non-performing loans/net loans......        0.97%      0.02%
     Real estate owned..........................         655        725
                                                    --------   --------
      Total non-performing assets...............      12,263        951
                                                    --------   --------
      Total non-performing assets/total assets .        0.88%      0.07%

     The majority of the Corporation's loan portfolio consists of commercial
loans and single-family residential loans secured by real estate in the
Whatcom, Skagit, Snohomish, and Pierce County areas of Washington. Economic
conditions in the region remain relatively healthy (compared to national
trends), however we are seeing increasing signs of a slowing housing market,
including increasing inventories and overall slower sales activity.

     Construction and land development, commercial real estate and
multi-family real estate loans have larger individual loan amounts, which have
a greater single impact on the total portfolio quality in the event of
delinquency or default. The Bank is closely watching the construction and land
development loan portfolio, and believe there is a potential for significant
additions to non-performing loans or real estate owned in the near future.

     The Corporation considers the allowance level to be appropriate, as a
result of the changing portfolio mix and the current economic environment.
While the Bank believes it has established its existing allowance for loan
losses in accordance with accounting principles generally accepted in the
United States, there can be no assurance that regulators, in reviewing the
Bank's loan portfolio, will not request the Bank to significantly increase or
decrease its allowance for loan losses.  In addition, because future events
affecting borrowers and collateral cannot be predicted with certainty, there
can be no assurance that the existing allowance for loan losses is adequate or
that substantial increases will not be necessary should the quality of any
loans deteriorate as a result of the factors discussed elsewhere in this
document.  Any material increase in the allowance for loan losses may
adversely affect the Bank's financial condition and results of operations.

     Noninterest Income.  Noninterest income in fiscal 2008 increased to $7.0
million, from $5.8 million in fiscal 2007.  Service fee income increased 10.0%
to $3.6 million in fiscal 2008 from $3.3 million in fiscal 2007.  The net gain
on the sale of loans servicing released increased 2.5% to 848,000 in fiscal
2008, compared to $827,000 in fiscal 2007.  Mortgage loan originations were
strong in fiscal 2008, and the Bank continued its practice of selling most of
its single-family long term fixed rate loan production into the secondary
market.

     There was a net gain on sales of investment securities of $480,000 in
fiscal 2008 compared to a net loss of $(10,000) in fiscal 2007.  The gains in
fiscal 2008 were primarily attributable to management's decision to sell
selected equity securities from the Bank's investment portfolio.  The losses
in fiscal 2007 were a result of management's decisions to replace certain
investment securities during the year in its efforts to improve future
returns.  Other noninterest income increased 12.5% to $1.9 million for the
year ended March 31, 2008  from $1.7 million for the year ended March 31,
2007.  The primary reason for the increase from the prior period was
additional income related to the purchase of approximately $5.0 million of
bank owned life insurance.


                                       50

<PAGE>



     Noninterest Expense.  Noninterest expense in fiscal 2008 increased to
$29.2 million, a 4.7% increase from $27.9 million in fiscal 2007.
Compensation and employee benefits increased slightly in fiscal 2008 to $16.6
million from $16.3 million in fiscal 2007.  Building occupancy expense was
$4.7 million in fiscal 2008, a 9.8% increase from $4.3 million in fiscal 2007.
Increases in compensation and employee benefits and building and occupancy
expenses resulted from the opening of a full service retail facility and
mortgage loan center in Puyallup, Washington in June 2007.

     Other noninterest expenses increased 8.5% to $6.1 million in fiscal 2008
from $5.6 million in fiscal 2007 as a result of increased operating expenses
related to the opening of the Bank's Puyallup retail office and loan center,
consulting expenses, increased State of Washington Business & Occupation tax
as a result of the growth in the loan portfolio of taxable commercial loans,
as well as a valuation write-down of the Bank's other real estate owned of
$70,000.

Comparison of Operating Results for the Years Ended March 31, 2007 and March
----------------------------------------------------------------------------
31, 2006
--------

     Net Interest Income.  Net interest income in fiscal 2007 was $52.5
million, a 17.9% increase from $44.5 million in fiscal 2006.  Total interest
income increased 33.5% in fiscal 2007 to $92.6 million from $69.4 million in
fiscal 2006.

     Interest income on loans in fiscal 2007 was $88.6 million, a 34.5%
increase from $65.9 million in fiscal 2006.  The increase in fiscal 2007 was
as a result of a combination of factors, including:  1) the growth in loans
receivable, as the Bank experienced significant loan growth during the year,
increasing to $1.1 billion at March 31, 2007, compared to $918.5 million at
March 31, 2006; and 2) an increasing Prime lending rate throughout the fiscal
year.  With a portfolio of Prime based loans in excess of $450 million
throughout the year ($605.5 million at March 31, 2007) each quarter point
increase in the Prime lending rate equated to an annualized increase in
interest income on those types of loans of over $1.0 million.  The Prime
lending rate increased to 8.25% in June 2006, where it remained at March 31,
2007, compared to 7.75% at March 31, 2006.

     Also included in interest income for the year ended March 31, 2007 and
2006 were approximately $4.8 million and $3.5 million, respectively, of
deferred fee income recognition.  In fiscal 2007 and 2006, most of these fees
were related to the Bank's commercial loan portfolio, that resulted in large
part from the success in increasing the real estate development loan
portfolio.  These development loans typically are shorter term in nature, so
the deferred fee recognition during the life of the loan is greater than what
would be recognized for a comparable loan fee on a longer amortizing loan.
The table below presents an analysis of deferred fee recognition for the past
two fiscal years:

                                                  Year Ended March 31,
                                                 ---------------------
                                                  2007           2006
                                                 -------       -------
                                                     (In thousands)

     Commercial loan deferred fees.............. $ 4,076       $ 2,960
     One-to-four real estate mortgage
       loan deferred fees.......................     684           519
                                                 -------       -------
         Total.................................. $ 4,760       $ 3,479
                                                 =======       =======

      Interest and dividends on investments and mortgage-backed securities was
$4.0 million in fiscal 2007, a 13.6% increase from $3.5 million in fiscal
2006.  Contributing to this increase was the restructuring of approximately
$13.0 million of the investment securities portfolio during the quarter ended
March 31, 2006.  The proceeds from those lower-yielding securities were
reinvested in highly rated, higher-yielding investments.  Also contributing to
the change in fiscal 2007 was a reduction in dividend income on the Bank's
FHLB stock.  At March 31, 2007, Horizon Bank held $7.2 million in FHLB of
Seattle stock and received dividends in the amounts of $14,500 in fiscal 2007
compared to $29,500 in fiscal 2006. The FHLB of Seattle has been operating
under a regulatory directive since May 2005.  In December 2006, the FHLB of
Seattle announced that quarterly cash dividends would resume with payment of a
cash dividend in December 2006.  On January 29, 2007, the FHLB of Seattle
declared a similar dividend ($0.10 per share), payable in February 2007.
Subsequently, on May 2, 2007, the FHLB announced a cash dividend of $0.15 per
share, payable May 18, 2007.  The Bank's stock ownership in the FHLB of
Seattle is expected to remain stable, increasing only

                                    51

<PAGE>



if necessary to support its borrowing needs.  The FHLB of Seattle also revised
its requirements related to borrowings outstanding and stock levels required
to support borrowings, and, therefore, the Bank's existing level of FHLB stock
will support a higher level of wholesale borrowings, decreasing the likelihood
that the Bank will need to purchase additional stock to support its borrowing
activities.

     Total interest expense in fiscal 2007 increased 61.2% to $40.1 million
from $24.9 million in fiscal 2006.  Interest on deposits increased
significantly to $32.3 million in fiscal 2007 from $20.0 million in fiscal
2006.  Also contributing to the increase was the increasing level of interest
rates during the year which resulted in an increase in interest expense,
including interest paid on the Bank's deposits.  At March 31, 2007,
approximately 61% of the Bank's deposits were in the form of certificates of
deposit, including $79.4 million in brokered certificates of deposit.  As
such, an increasing interest rate environment affects the Bank's deposit
interest expense more dramatically than if a larger portion of the Bank's
funding were in the form of lower cost checking and liquid savings accounts.
While management continues its efforts to decrease its reliance on
certificates of deposit as a funding source, the competitive marketplace for
core deposit dollars has resulted in only moderate success in this regard.
During fiscal 2007, the Bank's increase in deposit interest expense lagged the
increase in its interest income on loans (in dollar terms).  This was the
result, in large part, to the immediate impact to interest income from the
Bank's Prime based loan portfolio (with each increase in the Prime lending
rate), and the lagged effect of increased interest expense on certificates of
deposit, since these certificate of deposit rate increases do not occur
instantaneously, instead lagging until the maturity of the certificate of
deposit.  In addition, even if current market interest rates were not
increasing, the Bank's interest on deposits would continue to increase, since
the current prevailing market rates to attract deposits are higher than the
rates being paid on its renewing deposits.

     Interest on borrowings increased to $7.9 million in fiscal 2007 from $4.9
million in fiscal 2006. The increase was a result of a higher level of average
borrowings outstanding during the year ended March 31, 2007 of $166.3 million
compared to $127.3 million during the year ended March 31, 2006 along with the
increasing interest rate environment in fiscal 2007.  The significant increase
in fiscal 2007 was related to funding the Bank's loan growth during the year.
The vast majority of this borrowing growth was in short term borrowings,
consistent with the shorter term, Prime based loan growth the Bank experienced
during the year.  The Bank continues to utilize wholesale borrowings in order
to further leverage its balance sheet and better manage its interest rate risk
profile.

     Provision for Loan Losses.  Provisions for loan losses are charges to
earnings to bring the total allowance for loan losses to a level considered by
management as adequate to provide for known and inherent risks in the loan
portfolio, based on management's continuing analysis of factors underlying the
quality of the loan portfolio.  These factors include changes in portfolio
size and composition, actual historical industry loss experience, current
economic conditions, detailed analysis of individual loans for which full
collectibility may not be assured, and determination of the existence and
realizable value of the collateral and guarantees securing the loans.

                                                Year Ended March 31,
                                               ---------------------
                                                  2007        2006
                                               --------     --------
                                                 (Dollars in thousands)
     Allowance at beginning of period .......  $ 14,184     $ 11,767
     Provision for loan losses...............     1,850        2,575
     Charge offs, net of recoveries..........      (145)        (158)
                                               --------     --------
     Allowance at end of period..............  $ 15,889     $ 14,184
                                               ========     ========
     Allowance for loan losses as a
       percentage of net loans receivable
       at the end of the period..............     1.51%        1.54%
     Net charge-offs as a percentage of
       average loans outstanding during
       the period............................     0.01%        0.02%
     Allowance for loan losses as a
       percentage of nonperforming assets
       at the end of period.................. 1,670.06%    1,221.35%

                                         52

<PAGE>




     The provision for loan losses was $1.9 million for the year ended March
31, 2007 compared to $2.6 million for the year ended March 31, 2006.  This
change resulted from management's ongoing analysis of changes in loan
portfolio composition by collateral categories, overall credit quality of the
portfolio, peer group analysis, and current economic conditions.  The
allowance for loan losses was $15.9 million, or 1.51% of net loans receivable
at March 31, 2007 compared to $14.2 million, or 1.54% of net loans receivable
at March 31, 2006.  The increased allowance level resulted from continued loan
portfolio growth in the higher-risk lending categories of construction and
land development, commercial real estate and commercial business loans during
the period, which comprised $896.6 million, or 83.7% of total loans receivable
at March 31, 2007, versus $770.2 million, or 82.6% at March 31, 2006.

     As of March 31, 2007, there were no loans in the loan portfolio over 90
days delinquent and five loans on non- accrual status.  The Bank had one real
estate owned at March 31, 2007. Total non-performing assets were $951,000, or
0.07% of total assets at March 31, 2007 compared to $1.2 million, or 0.10% of
total assets at March 31, 2006.

                                                   At March 31,
                                              ---------------------
                                                 2007       2006
                                                 ----       ----
                                              (Dollars in thousands)
Non-Performing Assets
  Accruing loans 90 days past due............ $   --      $    --
  Non-accrual loans..........................    226        1,161
  Restructured loans.........................     --           --
                                              ------      -------
    Total non-performing loans...............    226        1,161
    Total non-performing loans/net loans.....   0.02%        0.13%
  Real estate owned..........................    725           --
                                              ------      -------
    Total non-performing assets..............    951        1,161
                                              ------      -------
    Total non-performing assets/total
      assets.................................   0.07%        0.10%

     Noninterest Income.  Noninterest income in fiscal 2007 increased to $5.8
million, from $5.4 million in fiscal 2006.  Service fees increased 12.7% to
$3.3 million in fiscal 2007 from $2.9 million in fiscal 2006.  The primary
reason for this increase was the implementation of our overdraft protection
service during fiscal 2006, which, together with the increase in deposits,
resulted in increased fee income.

     There was a net loss on sales of investment securities of $(10,000) in
fiscal 2007 compared to a net loss of $(476,000) in fiscal 2006.  The losses
in fiscal 2007 were a result of management's decisions to replace certain
investment securities during the year in its efforts to improve future
returns.  The losses in fiscal 2006 were a result of the restructuring of
approximately $13.0 million of lower-yielding securities during the fourth
quarter of fiscal 2006.  The proceeds from these sales have since been
reinvested in highly rated, higher-yielding investments.  The securities sold
were yielding approximately 170 basis points lower than the securities
purchased, therefore the effect of this restructuring was to increase interest
income from these securities by over $220,000 in fiscal 2007.  Other
noninterest income decreased slightly to $1.7 million for the year ended March
31, 2007 from $1.9 million for the year ending March 31, 2006.

     Noninterest Expense.  Noninterest expense in fiscal 2007 increased to
$27.9 million, a 12.5% increase from $24.8 million in fiscal 2006.
Compensation and employee benefits increased 11.7% in fiscal 2007 to $16.3
million from $14.6 million in fiscal 2006.  Building occupancy expense was
$4.3 million in fiscal 2007, a 19.7% increase from $3.6 million in fiscal
2006.  Increases in compensation and employee benefits and building and
occupancy expenses resulted primarily from the opening of a full service
retail office in Lakewood, Washington in fiscal 2006 and a full service
regional facility in Everett, Washington in June 2006.

     Other noninterest expenses increased 13.4% to $5.6 million in fiscal 2007
from $5.0 million in fiscal 2006.  The increase in fiscal 2007 was primarily
attributable to additional transfer agent and investor relations expenses, and
increased business & occupation tax as a result of the shifting loan portfolio
from non-taxable mortgage loans to taxable commercial loans.

                                      53

<PAGE>


<PAGE>
<TABLE>

Average Balances, Interest and Average Yields/Costs
---------------------------------------------------

     The following table presents at the date and for the periods indicated, the average balances of assets
and liabilities and the total dollar amount of interest income and interest expense, as well as the
resulting yields earned and rates paid.

                                                           Year Ended March 31,
                At March 31,   ----------------------------------------------------------------------------
                    2008                 2008                      2007                      2006
               --------------- ------------------------  ------------------------  ------------------------
                       Average                   Average                   Average                   Average
                        Yield/ Average           Yield/  Average           Yield/  Average           Yield/
               Balance   Cost  Balance  Interest  Cost   Balance  Interest  Cost   Balance  Interest  Cost
               -------  ------ -------  -------- ------  -------  -------- ------  -------  -------- ------
                                                 (Dollars in thousands)

            <c>      <c>    <c>      <c>      <c>     <c>      <c>      <c>     <c>       <c>     <c>
Interest-earning
assets:
 Loans re-
  ceiv-
  able(1)....$1,191,478 8.47% $1,137,051 $ 96,320 8.47% $1,017,460 $88,589  8.71%   $862,893  $65,857  7.63%
 Investment
  securi-
  ties(2)....    53,020 4.00      56,470    2,259 4.00      64,805   2,678  4.13      70,621    2,556  3.62
 Mortgage-backed
  securities.    39,130 5.06      32,854    1,664 5.06      27,150   1,333  4.91      21,573      975  4.52
             ---------- ----  ---------- -------- ----  ---------- -------  ----   ---------  -------  ----
  Total interest-
   earning
   assets.... 1,283,628 8.17   1,226,375  100,243 8.17   1,109,415  92,600  8.35     955,087   69,388  7.27

Interest-bearing
liabilities:
 Deposits.... 1,038,792 3.83     992,667   38,072 3.83     905,383  32,251  3.56     784,249   19,988  2.55
 Borrowings..   214,791 4.44     193,272    8,573 4.44     166,276   7,882  4.74     127,284    4,908  2.68
             ---------- ----  ---------- -------- ----  ---------- -------  ----   ---------  -------  ----
  Total interest-
   bearing lia-
   bilities.. 1,253,583 3.93   1,185,939   46,645 3.93   1,071,659  40,133  3.74     911,533   24,896  2.70
                                         --------                  -------                    -------
Net interest
 income......                            $ 53,598                  $52,467                    $44,492
                                         ========                  =======                    =======
Interest rate
 spread......                                     4.24%                     4.60%                      4.54%
                                                  ====                      ====                       ====
Net interest
 margin......                                4.37%                    4.73%                     4.66%
                                             ====                     ====                      ====
Ratio of average
 interest-earning
 assets to
 average interest-
 bearing
 liabilities.                    103.39%                   103.46%                   104.38%
                                 ======                    ======                    ======

----------
(1)  Average balances include nonaccrual loans, if any.  Interest income on nonaccrual loans has been
     included.
(2)  The yield on investment securities is calculated using historical cost basis.

</TABLE>

                                                    54

<PAGE>



Rate/Volume Analysis
--------------------

     The table below sets forth certain information regarding changes in
interest income and interest expense for the Corporation for the periods
indicated.  For each category of interest-earning asset and interest-bearing
liability, information is provided on changes attributable to (1) changes in
volume (change in volume multiplied by old rate); (2) changes in rates (change
in rate multiplied by old volume); (3) changes to rate-volume (changes in rate
multiplied by the change in volume); and (4) the total changes (the sum of the
prior columns).
<PAGE>
<TABLE>

                                                            Year Ended March 31,
                                    ----------------------------------------------------------------------
                                              2008 vs. 2007                      2007 vs. 2006
                                    ---------------------------------   ----------------------------------
                                           Increase (Decrease)                Increase (Decrease)
                                                  Due to                             Due to
                                    ---------------------------------   ----------------------------------
                                                        Rate/                              Rate/
                                     Volume    Rate    Volume   Total   Volume     Rate   Volume    Total
                                    -------  -------   -----   ------   -------   ------  ------   -------
                                                               (In thousands)

                                 <c>      <c>       <c>     <c>      <c>       <c>     <c>      <c>
Interest income:
  Interest and fees  on loans.....  $10,413  $(2,399)  $(283)  $7,731   $11,797   $9,274  $1,661   $22,732
  Investment securities and other
   interest-bearing securities....     (115)      27      --      (88)       (9)     490      (1)      480
                                    -------  -------   -----   ------   -------   ------  ------   -------
 Total interest income............  $10,298  $(2,372)  $(283)  $7,643   $11,788   $9,764  $1,660   $23,212
                                    =======  =======   =====   ======   =======   ======  ======   =======
Interest expense:
 Deposit accounts.................  $ 3,090  $ 2,493   $ 239   $5,822   $ 3,002   $8,051  $1,209   $12,262
 Borrowings.......................    1,280     (508)    (82)     690     1,209    1,417     349     2,975
                                    -------  -------   -----   ------   -------   ------  ------   -------
 Total interest expense...........  $ 4,370  $ 1,985   $ 157   $6,512   $ 4,211   $9,468  $1,558   $15,237
                                    =======  =======   =====   ======   =======   ======  ======   =======

</TABLE>




Liquidity and Capital Resources
-------------------------------

     The Bank maintains liquid assets in the form of cash and short-term
investments to provide a source to fund loans, savings withdrawals, and other
short-term cash requirements.  At March 31, 2008, the Bank had liquid assets
(cash and marketable securities with maturities of one year or less) with a
book value of $37.4 million.

     As of March 31, 2008, the total book value of investments and
mortgage-backed securities was $77.4 million compared to a market value of
$80.4 million with an unrealized gain of $3.0 million. As of March 31, 2007,
the total book value of investments and mortgage-backed securities was $74.4
million compared to a market value of $79.6 million with an unrealized gain of
$5.2 million.  The Corporation foresees no factors that would impair its
ability to hold debt securities to maturity.

     As indicated on the Corporation's Consolidated Statement of Cash Flows
contained in Item 8 of this Form 10-K, the Corporation's primary sources of
funds are cash flow from operations, which consist primarily of mortgage loan
repayments, deposit increases, loan sales, borrowings and cash received from
the maturity or sale of investment securities.  The Corporation's liquidity
fluctuates with the supply of funds and management believes that the current
level of liquidity is adequate at this time.  If additional liquidity is
needed, the Corporation's options include, but are not necessarily limited to:
(i) selling additional loans in the secondary market; (ii) entering into
reverse repurchase agreements; (iii) borrowing from the FHLB of Seattle; (iv)
accepting additional jumbo, brokered, and/or public funds deposits; or (v)
accessing the discount window of the Federal Reserve Bank of San Francisco.

     Stockholders' equity as of March 31, 2008 was $128.3 million, or 9.2% of
assets, compared to $123.9 million, or 9.7% of assets at March 31, 2007.  The
Bank continues to exceed the 5.0% minimum tier one capital required by the
FDIC in order to be considered well-capitalized.  The Bank's total
risk-adjusted capital ratio as of March 31, 2008 was

                                    55

<PAGE>



11.0%, compared to 12.0% as of March 31, 2007.  These figures remain well
above the well-capitalized minimum of 10% set by the FDIC.

     The Corporation has conducted various buy-back programs since August
1996. In March 2008, the Board of Directors approved a new stock repurchase
plan that runs concurrent with the 2009 fiscal year, allowing the Corporation
to repurchase up to 2.5% of total shares outstanding, or approximately 300,000
shares.  This marked the Corporation's tenth stock repurchase plan. In fiscal
2008, under the previous plan, the Corporation repurchased 399,700 shares at
an average price of $17.62.  For additional information concerning the
Corporation's repurchase activities during the fourth quarter of fiscal 2008,
see Item 5 of this Form 10-K.

     Management intends to continue its stock buy-back programs from time to
time as long as repurchasing the stock is perceived to contribute to the
overall growth of stockholder value.   The number of shares of stock to be
repurchased and the price to be paid is the result of many factors, several of
which are outside of the control of the Corporation. The primary factors,
however, are market and economic factors such as the price at which the stock
is trading in the market, the number of shares available in the market; the
attractiveness of other investment alternatives in terms of the rate of return
and risk involved in the investment; the ability to increase the value and/or
earnings per share of the remaining outstanding shares, the corporation's
liquidity and capital needs, and regulatory requirements.  Presently, it is
management's belief that purchases made under the current Board approved plan
will not materially affect the Corporation's capital or liquidity position.

Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------

     The Corporation continues to be exposed to interest rate risk.
Currently, the Corporation's assets and liabilities are not materially exposed
to foreign currency or commodity price risk.  At March 31, 2008, the
Corporation had no off-balance sheet derivative financial instruments, nor did
it have a trading portfolio of investments.

     In fiscal 2008 and fiscal 2007, the Corporation continued to outsource
its interest rate risk modeling to a third party provider that utilizes an IPS
Sendero model.  This model analyzes the Corporation's major balance sheet
components, and attempts to estimate the changes to the Corporation's income
statement and economic value of equity, under a variety of interest rate
change scenarios.  The figures contained in the table presented under Item 7A
of this Form 10-K below, in the Quantitative Disclosures About Market Risk
section, were derived from this model.  While numerous assumptions go into
this modeling, and undue reliance should not be placed on the specific
results, management believes that this improved modeling will enhance its
interest rate risk management efforts.

     Similar to the analysis performed one year ago, the current interest rate
risk modeling continues to show the Bank's balance sheet as moderately asset
sensitive over a 12-month time period.  The Bank's continued focus on shorter
term, variable rate assets has contributed to the Bank's performance in this
regard.  This strategy has allowed the Bank to utilize wholesale borrowing and
brokered deposits as a supplemental source of funds to its retail and
commercial deposit gathering efforts, without significantly impacting the
Bank's interest rate risk profile.  In addition, the Bank has been successful
at increasing its demand deposit base in recent years, further enhancing the
Bank's interest rate risk profile.  Accordingly, the interest rate risk
modeling performed each quarter during fiscal 2008 shows that the Bank
continues to operate within the interest rate risk tolerance limits set by its
Board of Directors.

     With the current level of interest rates at March 31, 2008 and the
associated prepayment assumptions in the low-rate environment, interest rate
risk modeling predicts moderate improvement in the Bank's performance in a
moderately higher rate environment over a 12-month time period.  However, as
interest rates increase, prepayment assumptions can change significantly,
therefore it would be inappropriate to assume that significantly higher rates
would have a sustained positive effect on the Bank's and the Corporation's
performance.  Further, an increase in rates, without a corresponding increase
in certain indices (such as Prime), would adversely affect the Corporation's
performance.

     For example, if it becomes necessary for the Corporation to increase the
rates it pays to attract funds in a rising rate environment (as is the case
currently), an absence of a corresponding increase in the Prime lending rate
would, of course, negatively affect performance.  In addition, depending on
timing differences, the magnitude of various rates

                                     56

<PAGE>



change in future periods, and the composition of the Corporation's balance
sheet, future modeling efforts may show the Corporation's returning to a
liability sensitive position.  Management continues to monitor these areas, in
its ongoing effort to manage the Corporation's interest rate risk.

Contractual Obligations
-----------------------

     In the normal course of business, the Corporation enters into contractual
obligations that meet various business needs.  These contractual obligations
include time deposits to customers, borrowings from the FHLB of Seattle and
lease obligations for facilities. See Notes 8, 9 and 14 of the Notes to
Consolidated Financial Statements included in Item 8 of this Form 10-K for
additional information.  The following table summarizes the Corporation's
long-term contractual obligations at March 31, 2008:

                               Less than  One to  Three to
                                  One     Three     Five
                                  Year    Years     Years    Total
                               --------  --------  -------  --------
                                         (In thousands)

Time deposits................  $558,566  $122,208  $14,150  $694,924
Long-term borrowings.........   100,291   114,500       --   214,791
Operating lease obligations..       419       869      763     2,051
                               --------  --------  -------  --------
   Total.....................  $659,276  $237,577  $14,913  $911,766
                               ========  ========  =======  ========

Off-Balance Sheet Arrangements
------------------------------

     In the normal course of business, the Corporation makes off-balance sheet
arrangements, including credit commitments to its customers to meet their
financial needs.  These arrangements involve, to varying degrees, elements of
credit and interest rate risk not recognized in the consolidated statement of
financial condition.  The Bank makes personal, commercial, and real estate
lines of credit available to customers as well as stand by letters of credit
or financial guarantees.

     Commitments to extend credit to customers are subject to the Bank's
normal credit policies and are essentially the same as those involved in
extending loans to customers.  See Note 17 of the Notes to Consolidated
Financial Statements included in Item 8 of this Form 10-K for additional
information.

Impact of Inflation
-------------------

     The Consolidated Financial Statements and related financial data
presented herein have been prepared in accordance with accounting principles
generally accepted in the United States of America.  These principles
generally require the measurement of financial position and operating results
in terms of historical dollars, without considering changes in the relative
purchasing power of money over time as a result of inflation.

     Unlike most industrial companies, virtually all the assets and
liabilities of a financial institution are monetary in nature.  The primary
impact of inflation is reflected in the increased cost of our operations.  As
a result, interest rates generally have a more significant impact on a
financial institution's performance than do general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the prices of goods and services.  In a period of rapidly rising
interest rates, the liquidity and maturities structures of our assets and
liabilities are critical to the maintenance of acceptable performance levels.

     The principal effect of inflation on earnings, as distinct from levels of
interest rates, is in the area of noninterest expense.  Expense items such as
employee compensation, employee benefits and occupancy and equipment costs may
be subject to increases as a result of inflation.  An additional effect of
inflation is the possible increase in dollar value

                                    57

<PAGE>



of the collateral securing loans that we have made.  Our management is unable
to determine the extent, if any, to which properties securing loans have
appreciated in dollar value as a result of inflation.

Recent Accounting Pronouncements
--------------------------------

     For a discussion of new accounting pronouncements and their impact on the
Corporation, see Note 1of the Notes to Consolidated Financial Statements
contained in Item 8 of this Form 10-K.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------

     Quantitative Disclosures About Market Risk.  The table below represents
the balances of the Bank's financial instruments at March 31, 2008.  The
expected maturity categories take into consideration projected prepayment
rates as well as actual amortization of principal.  In preparation of the
table, numerous assumptions were made regarding prepayment rates and deposit
account interest sensitivity.


<PAGE>
<TABLE>

                                     Over 1       Over 2      Over 3                Carrying      Fair
                  Average  Within    Year to      Years       Years       Beyond      Value       Value
                   Yield   1 Year    2 Years    to 3 Years  to 5 Years   5 Years      Total       Total
                   -----  --------  ----------  ----------  ----------  ----------  ----------  ----------
                                              (Dollars in thousands)

                <c>    <c>       <c>         <c>         <c>         <c>         <c>         <c>
Interest-Sensitive
Assets:

Loans receivable.. 8.47%  $922,707  $  103,390  $  104,176  $   40,748  $   20,457  $1,191,478  $1,190,418
Mortgage-backed
  securities...... 5.06%     8,837       5,138       3,729       6,289      15,137      39,130      39,135
Investments and
  other interest-
  earning assets.. 4.00%    30,332       2,535       3,241       6,403      10,509      53,020      53,020
Total Interest
 Sensitive Assets. 8.35%   961,876     111,063     111,146      53,440      46,103   1,283,628   1,282,573
Cumulative Totals.   --    961,876   1,072,939   1,184,085   1,237,525   1,283,628          --          --

Interest-Sensitive
Liabilities:

Checking accounts. 0.57%     7,244      24,753      24,753      24,606      61,516     142,872     169,997
Money market
  ultimate
  accounts........ 3.35%   128,144      13,730      13,730       7,846      19,614     183,064     187,912
Savings accounts.. 0.92%     3,587       1,793       1,793       3,074       7,686      17,933      21,628
Certificates of
  deposit......... 4.89%   566,655      56,137      62,235       9,754         143     694,924     677,364
Other
  borrowings(1)... 4.44%   130,291      68,000      16,500          --          --     214,791     215,452
Total Interest
  Sensitive
  Liabilities..... 3.74%   835,921     164,413     119,011      45,280      88,959   1,253,584   1,272,353
Cumulative Totals.   --    835,921   1,000,334   1,119,345   1,164,625   1,253,584          --          --

Off-Balance Sheet
Items:
Commitments to
  extend credit... 6.08%   208,882          --          --          --          --     208,882     208,882
Unused lines of
  credit.......... 6.74%   152,882          --          --          --          --     152,882     152,882
Credit card
  arrangements.... 8.40%    10,510          --          --          --          --      10,510      10,510
Stand by letters
  of credit.......   --      2,047          --          --          --          --       2,047       2,047
                          --------  ----------  ----------  ----------  ----------  ----------  ----------
Total Off-Balance
  Sheet Items.....        $374,321  $       --  $       --  $       --  $       --  $  374,321  $  374,321
                          ========  ==========  ==========  ==========  ==========  ==========  ==========
-------
(1) Includes borrowing related to investment in real estate for a joint venture.

</TABLE>

                                                58

<PAGE>





     As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table.  For
example, although certain assets and liabilities may have similar maturities,
they may react in different degrees to changes in market interest rates.  In
addition, in the event of changes in interest rates, expected rates of
prepayments on loans and withdrawals from savings accounts might deviate
significantly from those assumed in presenting the table.  Therefore, the data
presented in the table should not be relied upon as necessarily indicative of
actual future results.

Item 8.  Financial Statements and Supplementary Data
----------------------------------------------------

(a)  (1)  Financial Statements.                                       Page
          --------------------                                        ----
          Management's Annual Report on Internal Control Over
            Financial Reporting                                        60
          Report of Independent Registered Public Accounting Firm      61
          Consolidated Statement of Financial Position as
            of March 31, 2008 and 2007                                 63
          Consolidated Statement of Income for the Years Ended
            March 31, 2008, 2007 and 2006                              64
          Consolidated Statement of Stockholders' Equity and
            Comprehensive Income for the Years Ended
            March 31, 2008, 2007 and 2006                              65
          Consolidated Statement of Cash Flows for the
            Years Ended March 31, 2008, 2007 and 2006                  66
          Notes to Consolidated Financial Statements                   67

                                    59

<PAGE>



Management's Annual Report on Internal Control Over Financial Reporting:
-----------------------------------------------------------------------

   MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Horizon Financial Corp. and its subsidiaries ("the Company") is
responsible for establishing and maintaining adequate internal control over
financial reporting, and for performing an assessment of the effectiveness of
internal control over financial reporting as of March 31, 2008. The Company's
internal control over financial reporting is a process designed under the
supervision of the Company's management, including the Chief Executive Officer
and Chief Financial Officer, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States of America.

The Company's system of internal control over financial reporting includes
policies and procedures that (i) pertain to the maintenance of records that,
in reasonable detail, accurately and fairly reflect transactions and
dispositions of assets of the Company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the
United States, and that receipts and expenditures of the Company are being
made only in accordance with authorizations of Management and Directors of the
Company; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the Company's
assets that could have a material effect on the financial statements.

Management recognizes that there are inherent limitations in the effectiveness
of any system of internal control, and accordingly, even effective internal
control can provide only reasonable assurance with respect to financial
statements preparation and fair presentation. Further, because of changes in
condition, the effectiveness of internal control may vary over time.

Under the supervision and with the participation of the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer,
the Company performed an assessment of the effectiveness of the Company's
internal control over financial reporting as of March 31, 2008 based upon
criteria in Internal Control Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO"). Based on this
assessment, Management determined that the Company's internal control over
financial reporting was effective as of March 31, 2008.

Dated June 11, 2008

                                      60

<PAGE>




             Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders
Horizon Financial Corp. & Subsidiary

We have audited the accompanying consolidated statement of financial position
of Horizon Financial Corp. & Subsidiary (the "Company") as of March 31, 2008
and 2007, and the related consolidated statements of income, stockholders'
equity and comprehensive income, and cash flows for each of the years in the
three-year period ended March 31, 2008. We also have audited the Company's
internal control over financial reporting as of March 31, 2008, based on
criteria established in Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). The
Company's management is responsible for these financial statements, for
maintaining effective internal control over financial reporting, and for its
assessment of the effectiveness of internal control over financial reporting
included in the accompanying Management Report on Internal Controls over
Financial Reporting.  Our responsibility is to express an opinion on these
financial statements, an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audits.

We conducted our audits in accordance with auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement and whether
effective internal control over financial reporting was maintained in all
material respects. Our audits of financial statements included examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audits also include, performing such other procedures
as we considered necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions.

The Company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. The Company's
internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the Company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts
and expenditures of the Company are being made only in accordance with
authorization of management and directors of the Company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Company's assets that could have a
material effect on the financial statements.

                                       61

<PAGE>



Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Horizon Financial Corp. & Subsidiary as of March 31, 2008 and 2007, and the
results of their operations and cash flows for each of the years in the
three-year period ended March 31, 2008, in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, Horizon Financial Corp. & Subsidiary maintained, in all material
respects, effective internal control over financial reporting as of March 31,
2008, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway
Commission.

/s/Moss Adams LLP

Bellingham, Washington
June 11, 2008

                                       62

<PAGE>


                                                       HORIZON FINANCIAL CORP.
                                  CONSOLIDATED STATEMENT OF FINANCIAL POSITION
                                                       MARCH 31, 2008 AND 2007
------------------------------------------------------------------------------

                                     Assets
                                                       Dollars in Thousands
                                                     ------------------------
                                                         2008        2007
                                                     ----------    ----------
Cash and cash equivalents                            $   22,412    $   40,833
Interest-bearing deposits                                 2,912         5,379
Investment securities
  Available-for-sale (amortized cost 2008: $38,676;
   2007: $47,675)                                        41,241        52,865
  Held-to-maturity (estimated fair value 2008: $0;
   2007: $372)                                                -           370
Mortgage-backed securities
  Available-for-sale (amortized cost 2008: $38,646;
   2007: $26,220)                                        39,100        26,233
  Held-to-maturity (estimated fair value 2008: $35;
   2007: $157)                                               30           148
Federal Home Loan Bank ("FHLB") Stock                     8,867         7,247
Loans held for sale                                       2,644         4,493
Loans receivable, net of allowance for loan losses of
  $19,114 in 2008 and $15,889 in 2007                 1,191,478     1,054,870
Investment in real estate joint venture                  17,567        17,169
Accrued interest and dividends receivable                 7,916         6,626
Premises and equipment, net                              27,778        27,631
Net deferred income tax assets                            6,253         3,733
Real estate owned                                           655           725
Other assets                                             23,325        22,005
                                                     ----------    ----------
TOTAL ASSETS                                         $1,392,178    $1,270,327
                                                     ==========    ==========

                        Liabilities and Stockholders' Equity

Deposits                                             $1,038,792    $  975,295
Accrued interest payable and other liabilities            5,746         9,508
Other borrowed funds                                    192,343       138,715
Borrowing related to investment in real estate
  joint venture                                          22,448        20,243
Advances by borrowers for taxes and insurance               414           454
Income tax currently payable                              2,174           237
Deferred compensation                                     1,944         2,020
                                                     ----------    ----------
     Total liabilities                                1,263,861     1,146,472
                                                     ----------    ----------
COMMITMENTS AND CONTINGENCIES (Notes 14 & 17)
STOCKHOLDERS' EQUITY
  Serial preferred stock, $1 par value, 10,000,000
   shares authorized; none issued or outstanding
  Common stock, $1 par value, 30,000,000 shares
   authorized; 11,892,208 and 12,254,476 issued
   and outstanding, respectively                         11,892        12,254
  Additional paid-in capital                             50,597        51,489
  Retained earnings                                      63,906        56,770
  Accumulated other comprehensive income                  1,922         3,342
                                                     ----------    ----------
     Total stockholders' equity                         128,317       123,855
                                                     ----------    ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY           $1,392,178    $1,270,327
                                                     ==========    ==========

       See accompanying notes to these consolidated financial statements.

                                       63
<PAGE>


                                                       HORIZON FINANCIAL CORP.
                                              CONSOLIDATED STATEMENT OF INCOME
                                     YEARS ENDED MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

                                                 Dollars in Thousands
                                      (except for number of per share amounts)
                                       --------------------------------------
                                             2008        2007        2006
                                          --------     --------    --------
INTEREST INCOME
 Interest and fees on loans               $ 96,320      $88,589     $65,857
 Investments and mortgage-backed
  securities
   Taxable interest                          3,279        3,492       3,136
   Nontaxable interest income                  479          293         196
   Dividends                                   165          226         199
                                          --------      -------     -------
     Total interest income                 100,243       92,600      69,388
                                          --------      -------     -------
INTEREST EXPENSE
 Interest on deposits                       38,073       32,251      19,988
 Interest on other borrowings                8,572        7,882       4,908
                                          --------      -------     -------
     Total interest expense                 46,645       40,133      24,896
                                          --------      -------     -------

     Net interest income                    53,598       52,467      44,492

PROVISION FOR LOAN LOSSES                    4,100        1,850       2,575
                                          --------      -------     -------
     Net interest income after provision
      for loan losses                       49,498       50,617      41,917
                                          --------      -------     -------
NONINTEREST INCOME
 Service fees                                3,601        3,274       2,905
 Net gain on sales of loans - servicing
  retained                                     176           23          55
 Net gain on sales of loans - servicing
  released                                     848          827       1,040
 Net gain (loss) on sale of investment
  securities                                   480          (10)       (476)
 Other                                       1,939        1,724       1,887
                                          --------      -------     -------
     Total noninterest income                7,044        5,838       5,411
                                          --------      -------     -------
NONINTEREST EXPENSE
 Compensation and employee benefits         16,595       16,328      14,614
 Building occupancy                          4,698        4,280       3,575
 Data processing                               957          862         887
 Advertising                                   812          751         720
 Other expenses                              6,118        5,640       4,974
                                          --------      -------     -------
     Total noninterest expense              29,180       27,861      24,770
                                          --------      -------     -------

INCOME BEFORE PROVISION FOR INCOME TAX      27,362       28,594      22,558

PROVISION FOR INCOME TAX
 Current                                    10,704       11,058       6,903
 Deferred                                   (1,755)      (1,492)          -
                                          --------      -------     -------
     Total provision for income tax          8,949        9,566       6,903
                                          --------      -------     -------

NET INCOME                                $ 18,413      $19,028     $15,655
                                          ========      =======     =======

BASIC EARNINGS PER SHARE                  $   1.52      $  1.55     $  1.26*
                                          ========      =======     =======
DILUTED EARNINGS PER SHARE                $   1.51      $  1.53     $  1.25*
                                          ========      =======     =======

*restated for the 5 for 4 stock split in the form of a 25% stock dividend
 distributed on October 23, 2006.

     See accompanying notes to these consolidated financial statements.

                                       64

<PAGE>



<TABLE>

                                                                                     HORIZON FINANCIAL CORP.
                                     CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                                                                   YEARS ENDED MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------------------------------------

                                                     (In thousands, except number of shares)
                                     ---------------------------------------------------------------------
                                          Common Stock                                         Accumulated
                                     ---------------------  Additional               Unearned     Other
                                     Number of    At Par      Paid-In     Retained   ESOP     Comprehensive
                                       Shares      Value      Capital     Earnings   Shares    Income(Loss)
                                     ---------    --------   ---------    --------   --------  -----------

                                   <c>        <c>         <c>          <c>          <c>       <c>
Balance, March 31, 2005                10,038     $10,038     $54,737      $38,939      $(72)     $3,382
Comprehensive income
  Net income                                -           -           -       15,655         -           -
  Other comprehensive income
    Change in unrealized gains on
     available-for-sale securities,
     net tax benefit of $34                 -           -           -            -         -         (64)
       Total other comprehensive income
  Comprehensive income
Recognition of ESOP shares released         -           -           -            -        72           -
Cash dividends on common stock at
 $.57 per share                             -           -           -       (5,651)        -           -
Stock options exercised                    73          73         391            -         -           -
Stock award plan                            -           -          22            -         -           -
Tax benefit associated with stock
 options                                    -           -         179            -         -           -
Treasury stock purchased                    -           -           -            -         -           -
Retirement of treasury stock             (213)       (213)     (1,213)      (2,952)        -           -
                                       ------      -------    -------      -------     -----     -------

Balance, March 31, 2006                 9,898       9,898      54,116       45,991         -       3,318
                                       ------      -------    -------      -------     -----     -------
Comprehensive income
  Net income                                -           -           -       19,028         -           -
  Other comprehensive income
    Change in unrealized gains on
     available-for-sale securities,
     net tax of $13                         -           -           -            -         -          24
       Total other comprehensive income
  Comprehensive income
Cash dividends on common stock at $.495
 per share                                  -           -           -       (6,074)        -           -
5 for 4 stock split in the form of a
 25% stock dividend                     2,453       2,453      (2,453)           -         -           -
Cash paid in lieu of fractional shares      -           -           -          (10)        -           -

Stock options exercised                    22          22         137            -         -           -
Stock award plan                            3           3         289            -         -           -
Tax benefit associated with stock
 options                                    -           -          55            -         -           -
Treasury stock purchased                    -           -           -            -         -           -
Retirement of treasury stock             (122)        (122)      (655)      (2,165)        -           -
                                       ------      -------    -------      -------     -----     -------

Balance, March 31, 2007                12,254       12,254     51,489       56,770         -       3,342
                                       ------      -------    -------      -------     -----     -------
Comprehensive income
  Net income                                -            -          -       18,413         -           -
  Other comprehensive income
    Change in unrealized gains on
     available-for-sale securities,
     net tax benefit of $764                -            -          -            -         -      (1,420)
       Total other comprehensive income
  Comprehensive income
Cash dividends on common stock at
 $.53 per share                             -            -          -       (6,385)        -           -
Stock options exercised                    28           28        166            -         -           -
Stock award plan                            9            9        669            -         -           -
Tax benefit associated with stock
 options                                    -            -         44            -         -           -
Treasury stock purchased                    -            -          -            -         -           -
Retirement of treasury stock             (399)        (399)    (1,771)      (4,892)        -           -
                                       ------      -------    -------      -------     -----     -------

Balance, March 31, 2008                11,892      $11,892    $50,597      $63,906     $   -     $ 1,922
                                       ======      =======    =======      =======     =====     =======

</TABLE>

<TABLE>
                                                      Treasury                          Total
                                                      Stock          Stockholders'      Comprehensive
                                                      at Cost        Equity             Income
                                                      --------       ------------       -------------

                                                   <c>             <c>                <c>
Balance, March 31, 2005                                $    -          $107,024
Comprehensive income
  Net income                                                -            15,655           $15,655
  Other comprehensive income
    Change in unrealized gains on
     available-for-sale securities,
     net tax benefit of $34                                 -               (64)              (64)
                                                                                          -------
       Total other comprehensive income                                                       (64)
                                                                                          -------
  Comprehensive income                                                                    $15,591
                                                                                          =======
Recognition of ESOP shares released                         -                72
Cash dividends on common stock at
 $.57 per share                                             -            (5,651)
Stock options exercised                                     -               464
Stock award plan                                            -                22
Tax benefit associated with stock
 options                                                    -               179
Treasury stock purchased                               (4,378)           (4,378)
Retirement of treasury stock                            4,378                 -
                                                      -------          --------

Balance, March 31, 2006                                     -           113,323
                                                      -------          --------

Comprehensive income
  Net income                                                -            19,028           $19,028
  Other comprehensive income
    Change in unrealized gains on
     available-for-sale securities,
     net tax of $13                                         -                24                24
                                                                                          -------
       Total other comprehensive income                                                        24
                                                                                          -------
  Comprehensive income                                                                    $19,052
                                                                                          =======
Cash dividends on common stock at $.495
 per share                                                  -            (6,074)
5 for 4 stock split in the form of a
 25% stock dividend                                         -                 -
Cash paid in lieu of fractional shares                      -               (10)
Stock options exercised                                     -               159
Stock award plan                                            -               292
Tax benefit associated with stock
 options                                                    -                55
Treasury stock purchased                               (2,942)           (2,942)
Retirement of treasury stock                            2,942                 -
                                                      -------          --------

Balance, March 31, 2007                                     -           123,855
                                                      -------          --------
Comprehensive income
  Net income                                                -            18,413           $18,413
  Other comprehensive income
    Change in unrealized gains on
     available-for-sale securities,
     net tax benefit of $764                                -            (1,420)           (1,420)
                                                                                          -------
       Total other comprehensive income                                                    (1,420)
                                                                                          -------
  Comprehensive income                                                                    $16,993
                                                                                          =======
Cash dividends on common stock at
 $.53 per share                                             -            (6,385)
Stock options exercised                                     -               194
Stock award plan                                            -               678
Tax benefit associated with stock
 options                                                    -                44
Treasury stock purchased                               (7,062)           (7,062)
Retirement of treasury stock                            7,062                 -
                                                      -------          --------

Balance, March 31, 2008                               $     -          $128,317
                                                      =======          ========

</TABLE>

            See accompanying notes to these consolidated financial statements.

                                                   65

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                          CONSOLIDATED STATEMENT OF CASH FLOWS
                                     YEARS ENDED MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

           Increase (Decrease) in Cash and Cash Equivalents

                                                    Dollars in Thousands
                                            ---------------------------------
                                               2008        2007       2006
                                            ---------   ---------   ---------
Cash Flows From Operating Activities
  Net income                                $  18,413   $  19,028   $  15,655
Adjustments to reconcile net income to net
cash provided by operating activities
  Depreciation                                  2,102       1,878       1,608
  Amortization and deferrals, net                 597         212        (482)
  Stock dividends - FHLB stock                      -           -         (29)
  Provision for loan losses                     4,100       1,850       2,575
  Provision for loss - Real estate owned           70         110           -
  Net gain on sale of mortgage loans held-
   for-sale                                      (848)       (827)     (1,040)
  Proceeds from sales of mortgage loans held-
   for-sale                                    76,976      75,649      94,683
  Origination of mortgage loans held-for-sale (74,279)    (74,063)    (94,824)
  Net gain/loss on sale of investment
   securities                                    (480)         10         476
  Stock award plan compensation                   678         292          22
  Excess tax benefits from the exercise of
   stock options                                  (44)        (55)       (179)
  Provision for deferred income tax            (1,755)     (1,492)          -
Changes in assets and liabilities
  Interest and dividends receivable            (1,290)     (1,441)       (686)
  Interest payable                             (1,885)      1,448       1,116
  Federal income tax payable                    1,937       1,045        (477)
  Other assets                                   (795)     (5,701)     (1,296)
  Other liabilities                            (2,067)      1,168         341
                                            ---------   ---------   ---------
    Net cash flows from operating activities   21,430      19,111      17,463
                                            ---------   ---------   ---------
Cash Flows From Investing Activities
  Investment in interest-bearing deposits, net  2,467       4,060      (5,532)
  Purchases of investment securities -
   available-for-sale                         (16,065)     (3,395)    (23,555)
  Proceeds from sales and maturities of
   investment securities - available-for-sale  25,064      10,482      35,590
  Purchases of mortgage-backed securities -
   available-for-sale                         (20,177)    (18,319)    (12,174)
  Proceeds from sales and maturities of
   mortgage-backed securities - available-
   for-sale                                     7,751      15,658       6,969
  Proceeds from maturities of mortgage-backed
   securities - held-to-maturity                  488         334         403
  Purchase of FHLB stock                       (1,620)          -           -
  Net change in loans                        (141,305)   (139,257)   (115,550)
  Purchases of bank premises and equipment     (2,249)     (3,192)     (5,143)
  Net change in investment in joint venture      (398)       (241)        276
                                            ---------   ---------   ---------
    Net cash flows from investing activities (146,044)   (133,870)   (118,716)
                                            ---------   ---------   ---------
Cash Flows From Financing Activities
  Net change in deposits                       63,497     140,996      87,450
  Advances of other borrowed funds            738,628     369,654     229,995
  Repayments of other borrowed funds         (685,000)   (372,500)   (207,500)
  Borrowing related to inv. in real estate
   joint venture                                2,205       1,967       1,555
  Common stock issued, net                        194         149         464
  Tax benefit associated with stock options        44          55         179
  Cash dividends paid                          (6,313)     (5,977)     (5,572)
  Treasury stock purchased                     (7,062)     (2,942)     (4,378)
                                            ---------   ---------   ---------
    Net cash flows from financing activities  106,193     131,402     102,193
                                            ---------   ---------   ---------
Net Change In Cash And Cash Equivalents       (18,421)     16,643         940
Cash and Cash Equivalents, beginning of year   40,833      24,190      23,250
                                            ---------   ---------   ---------
Cash And Cash Equivalents, end of year      $  22,412   $  40,833   $  24,190
                                            =========   =========   =========
Supplemental Disclosures Of Cash Flow
 Information
  Cash paid during the year for interest    $  48,529   $  38,684   $  23,780
                                            =========   =========   =========
  Cash paid during the year for income tax  $   8,717   $   9,949   $   7,201
                                            =========   =========   =========
Noncash Investing And Financing Transactions
  Property taken in settlement of loans     $       -   $     835   $       -
                                            =========   =========   =========

      See accompanying notes to these consolidated financial statements.

                                       66

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------


NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations - Horizon Financial Corp. (the "Corporation" or
"Company"), through its wholly-owned subsidiary, Horizon Bank (the "Bank"),
provides a full range of commercial, mortgage and consumer lending services to
borrowers and a full range of customer services to depositors through 19
full-service offices, four commercial loan centers, and four real estate loan
centers located in Whatcom, Skagit, Snohomish, and Pierce Counties of
Washington State. The Bank is a state-chartered commercial bank, the deposits
of which are insured by the Federal Deposit Insurance Corporation ("FDIC").

Financial Statement Presentation and Use of Estimates - The financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States of America and reporting practices
applicable to the banking industry. All per share data included in the
financial statements have been restated to reflect all stock splits and
dividends.

In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of revenues and
expenses for the period and assets and liabilities as of the balance sheet
date. Actual results could differ from estimated amounts. Material estimates
that are particularly susceptible to significant change relate to the
determination of the allowance for losses on loans, the valuation of real
estate acquired in connection with foreclosures or in satisfaction of loans
and deferred tax assets. In connection with the determination of the estimated
losses on loans and foreclosed assets held for sale, management obtains
independent appraisals for significant properties.

Principles of Consolidation - As of March 31, 2008, 2007 and 2006, and for the
years then ended, the consolidated financial statements include the accounts
of the Company, and its wholly-owned subsidiary, the Bank. Westward Financial
Services, Inc. ("Westward"), a land development Company, is a wholly-owned
subsidiary of the Bank, and its accounts are also included in the
consolidation. All material inter-Company balances and transactions have been
eliminated.

In October 2004, the Bank's wholly-owned subsidiary, Westward, entered into a
real estate development joint venture in Greenbriar Northwest LLC ("GBNW"), an
established residential land development company headquartered in Bellingham,
Washington. The Company believes that GBNW is a variable interest entity.
Under the Financial Accounting Standards Board ("FASB") Interpretation No.
("FIN") 46, GBNW is consolidated in the accompanying financial statements. The
Company accounts for the unowned portion of the joint venture's real estate as
a minority interest. The minority interest is recognized within other
liabilities. The assets of the real estate joint venture have a carrying value
of approximately $17.6 million, with a related borrowing of approximately
$22.4 million.

Cash and Cash Equivalents - For purposes of reporting cash flows, cash and
cash equivalents include cash on hand and noninterest-bearing amounts due from
banks with maturities of three months or less.

Included in cash and cash equivalents are legally reserved amounts which are
required to be maintained on an average basis in the form of cash and balances
due from the Federal Reserve Bank and other banks. Reserve requirements were
$500,000 for the years ended March 31, 2008 and 2007.

The Company maintains cash balances at several banks. Accounts at each
institution are insured by the FDIC up to $100,000.

Investments in Interest-Bearing Deposits - Investments in interest-bearing
deposits consist principally of funds on deposit with the FHLB and short-term
certificates of deposit with western Washington financial institutions. They
mature within one year and are carried at cost. Amounts, at times, may exceed
FDIC insured limits.

Investments and Mortgage-Backed Securities - The Company classifies its
securities into one of three categories:  (1) held-to-maturity, (2)
available-for-sale, or (3) trading. The Company had no trading securities at
March 31, 2008 and 2007. Investment securities are categorized as
held-to-maturity when the Bank has the positive intent and ability to hold
those securities to maturity. Securities which are held-to-maturity are stated
at cost, adjusted for amortization of premiums, and accretion of discounts
which are recognized as adjustments to interest income.

                                       67

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 and 2006
------------------------------------------------------------------------------

NOTE 1 -  NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)

Investment securities categorized as available-for-sale are generally held for
investment purposes (to maturity), although unanticipated future events may
result in the sale of some securities. Available-for-sale securities are
recorded at fair value, with the net unrealized gain or loss included as other
comprehensive income within the statement of stockholders' equity, net of the
related tax effect. Realized gains or losses on dispositions are based on the
net proceeds and the adjusted carrying amount of securities sold, using the
specific identification method.

Declines in the fair value of individual held-to-maturity and
available-for-sale securities below their cost that are other than temporary
are recognized by write-downs of the individual securities to their fair
value. Such write-downs would be included in earnings as realized losses. In
estimating other-than-temporary impairment losses, management considers (1) he
length of time and the extent to which the fair value has been less than cost,
(2) the financial condition and near-term prospects of the issuer, and (3) the
intent and ability of the Company to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair value.
Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method.

Premiums and discounts are recognized in interest income using the interest
method over the period to maturity.

Federal Home Loan Bank Stock - The Bank's investment in FHLB stock is a
restricted investment carried at par value ($100 per share), which reasonably
approximates its fair value. As a member of the FHLB system, the Bank is
required to maintain a minimum level of investment in FHLB stock based on
specific percentages of its outstanding FHLB advances.  The Bank may request
redemption at par value of any stock in excess of the amount the Bank is
required to hold. Stock redemptions are at the discretion of the FHLB.

Loans Held for Sale - Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated market value in
the aggregate. Net unrealized losses, if any, are recognized through a
valuation allowance by charges to income.

Mortgage loans held for sale can be sold with the mortgage servicing rights
retained by the Company. The carrying value of mortgage loans sold is reduced
by the cost allocated to the associated mortgage servicing rights. Gains or
losses on sales of mortgage loans are recognized based on the difference
between the selling price and the carrying value of the related mortgage loans
sold.

Loans Receivable - Loans receivable that management has the intent and ability
to hold for the foreseeable future or until maturity or pay-off are reported
at their outstanding principal adjusted for any charge-offs, the allowance for
loan losses, and any net deferred fees or costs on originated loans and
unamortized premiums or discounts on purchased loans.  Interest income is
accrued on the daily unpaid principal balance using the simple-interest
method. Loan origination fees, net of certain direct loan origination costs,
are deferred and recognized as an adjustment of the yield on the related
loans, using the interest method.

Impaired Loans and Revenue Recognition - A loan is considered impaired when
management determines that it is probable that all contractual amounts of
principal and interest will not be paid as scheduled in the loan agreement.
These loans include nonaccruing loans past due 90 days or more and other loans
that management considers to be impaired.

When a loan is placed on nonaccrual status, all interest previously accrued,
but not collected, is reversed and charged against interest income. Income on
nonaccrual loans is then recognized only when the loan is brought current, or
when, in the opinion of management, the borrower has demonstrated the ability
to resume payments of principal and interest.  Interest income on restructured
loans is recognized pursuant to the terms of new loan agreements. Interest
income on impaired loans is monitored and is recognized based upon the terms
of the underlying loan agreement. However, the recorded net investment in
impaired loans, including accrued interest, is limited to the present value of
the expected cash flows of the impaired loan, the observable fair market value
of the loan, or the fair value of the loan's collateral.

                                       68

<PAGE>


                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)

Provision for Loan Losses - Management estimates the provision for loan losses
by evaluating known and inherent risks in the loan portfolio. These factors
include changes in the size and composition of the loan portfolio, actual loan
loss experience, current and anticipated economic conditions, detailed
analysis of individual loans for which full collectibility may not be assured,
and determination of the existence and realizable value of the collateral and
guarantees securing the loans. The allowance for loan losses is based upon
factors and trends identified by market factors beyond the Company's control,
which may result in losses or recoveries differing significantly from those
provided in the financial statements.

The majority of the Company's loan portfolio consists of commercial loans and
single-family residential loans secured by real estate in the Whatcom, Skagit,
Snohomish, and Pierce County areas of Washington. Real estate prices in these
markets are stable at this time. However, the ultimate collectibility of a
substantial portion of the Company's loan portfolio may be susceptible to
changes in local market conditions in the future.

The allowance for loan losses is established as losses are estimated to have
occurred through the provision for loan losses charged to earnings. Loan
losses are charges against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.

While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as an
integral part of their examination process periodically review the estimated
losses on loans. Such agencies may require the Company to recognize additional
losses based on their judgment about information available to them at the time
of their examination.

Mortgage Servicing Rights - Servicing assets are recognized as separate assets
when rights are acquired through sale of financial assets. Generally, for
sales of mortgage loans, a portion of the cost of originating the loan is
allocated to the servicing right based on relative fair value. Fair value is
based on market prices for comparable mortgage servicing contracts, when
available, or alternatively, is based on a valuation model that calculates the
present value of estimated future net servicing income. The valuation model
incorporates assumptions that market participants would use in estimating
future net servicing income, such as the cost to service, the discount rate,
the custodial earnings rate, an inflation rate, ancillary income, prepayment
speeds, and default rates and losses. Capitalized servicing rights are
reported in other assets and are amortized into non-interest income in
proportion to, and over the period of, the estimated future net servicing
income of the underlying financial assets.

Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost.  Impairment is determined by stratifying
rights into tranches based on predominant risk characteristics, such as
interest rate, loan type and investor type. Impairment is recognized through a
valuation allowance for an individual tranche, to the extent that fair value
is less than the capitalized amount for the tranche. If the Company later
determines that all or a portion of the impairment no longer exists for a
particular tranche, a reduction of the allowance may be recorded as an
increase to income.

Servicing fee income is recorded for fees earned for servicing loans. The fees
are based on a contractual percentage of the outstanding principal or a fixed
amount per loan and are recorded as income when earned. The amortization of
mortgage servicing rights is netted against loan servicing fee income.

Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation. Major renewals or betterments are capitalized and
depreciated over their estimated useful lives. Depreciation is computed by the
straight-line method over the estimated useful lives of thirty-five years for
buildings and three to ten years for equipment.

Bank Owned Life Insurance - The carrying amount of bank owned life insurance
approximates its fair value. Fair value of bank owned life insurance is
estimated using the cash surrender value net of surrender charges. The Bank
owns approximately $20.3 million and $19.4 million in bank owned life
insurance as of March 31, 2008 and 2007, respectively, which is included in
other assets.

                                      69

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)

Goodwill - Goodwill was recognized in connection with the purchase of branch
assets and related liabilities. The Company performs periodic evaluations for
impairment. During the years ended March 31, 2008 and 2007, impairment testing
was performed and goodwill was found not to be impaired. At March 31, 2008 and
2007, goodwill in the amount of $545,000 was included in other assets.

Real Estate Owned - Other real estate owned includes properties acquired
through foreclosure. These properties are recorded at the lower of cost or
estimated fair value. Losses arising from the acquisition of property, in full
or partial satisfaction of loans, are charged to the allowance for loan
losses.

Subsequent to their transfer to other real estate owned, these assets continue
to be recorded at the lower of cost or fair value (less estimated cost to
sell), based on periodic evaluations. Generally, legal and professional fees
associated with foreclosures are expensed as incurred. Costs incurred to
improve property prior to sale are capitalized; however, in no event are
recorded costs allowed to exceed fair value. Subsequent gains, losses, or
expenses recognized on the sale of these properties are included in
noninterest income or expense.

Income Taxes - The Company reports income and expenses using the accrual
method of accounting and files a consolidated tax return which includes its
subsidiary. Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled 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 Company's financial statements and its
tax returns.

Earnings Per Share - Basic earnings per share amounts are computed based on
the weighted average number of shares outstanding during the period after
giving retroactive effect to stock dividends and stock splits. Diluted
earnings per share amounts are computed by determining the potential number of
additional shares that may be outstanding from stock options and grants using
the treasury stock method.

Financial Instruments - All financial instruments held or issued by the
Company are held or issued for purposes other than trading. In the ordinary
course of business, the Bank enters into off-balance-sheet financial
instruments consisting of commitments to extend credit. These commitments are
recorded in the financial statements when they are funded.

Advertising Costs - The Company expenses advertising costs as they are
incurred.

Share Based Payment - The Company adopted Statement of Financial Accounting
Standard No. 123R, Share-Based Payment, (SFAS 123R) on April 1, 2006 using the
"modified prospective" method. Under this method, awards that are granted,
modified, or settled after March 31, 2006 are measured and accounted for in
accordance with Statement 123R. Also under this method, expense is recognized
for unvested awards that were granted prior to April 1, 2006 based upon the
fair value determined at the grant date under Statement 123, Accounting for
Stock-based Compensation. For the years ended March 31, 2008 and 2007, the
Company recognized $678,000 and $292,000, respectively, in stock option and
restricted stock award compensation expense as a component of salaries and
benefits. As of March 31, 2008, there was approximately $577,000 of total
unrecognized compensation cost related to nonvested options and restricted
stock awards which are scheduled to amortize over the next four years.

Prior to the adoption of SFAS 123R, the Company recognized the financial
effects of stock options under the intrinsic value method as permitted by
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and as such, recognized no compensation cost for employee stock
options.

                                       70

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING P0LICIES
(Continued)

The following table provides pro forma disclosures for the year ended March
31, 2006 had the Company accounted for stock-based compensation using SFAS
123R for the year presented:

Net income as reported                          $15,655
Additional compensation for fair value of
  stock options, net of tax                         (31)
                                                -------
Pro forma net income                            $15,624
                                                =======

Earnings per share
  Basic
    As reported                                 $  1.26
                                                =======
    Pro forma                                   $  1.26
                                                =======
   Diluted
     As reported                                $  1.25
                                                =======
     Pro forma                                  $  1.25
                                                =======

Prior to the adoption of SFAS 123R, the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash
flows in the Consolidated Statement of Cash Flows. Statement 123R requires the
cash flows resulting from the tax benefits resulting from tax deductions in
excess of the compensation cost recognized for those options (excess tax
benefits) to be classified as financing cash flows. The $44,000, $55,000, and
$179,000 excess tax benefit for the years ended March 31, 2008, 2007 and 2006,
respectively, classified as a financing cash inflow would have been classified
as an operating cash inflow if the Company had not adopted SFAS 123R.

Transfers of Financial Assets - Transfers of financial assets are accounted
for as sales, when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been
isolated from the Company, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain
effective control over the transferred assets through an agreement to
repurchase them before their maturity.

Comprehensive Income - Accounting principles generally require that recognized
revenue, expenses, gains, and losses be included in net income. Although
certain changes in assets and liabilities, such as unrealized gains and losses
on available-for-sale securities, are reported as a separate component of the
equity section of the balance sheet, such items, along with net income, are
components of comprehensive income.

The components of other comprehensive income and related tax effects are as
follows for the years ended March 31:

                                                   2008     2007      2006
                                                  ------   ------    ------
                                                    (Dollars in Thousands)
                                                  -------------------------
Unrealized holding gains (losses) on available-
 for-sale securities                             $(1,705)   $ 27     $(574)
Reclassification adjustment for losses (gains)
 realized in income                                 (480)     10       476
                                                 -------    ----     -----
Net unrealized gains                              (2,185)     37       (98)
Tax effect                                           765     (13)       34
                                                 -------    ----     -----
    Net-of-tax amount                            $(1,420)   $ 24     $ (64)
                                                 =======    ====     =====

Recent Accounting Pronouncements - In July 2006, the FASB issued FIN No. 48,
Accounting for Uncertainty in Income Taxes (an interpretation of SFAS No.
109). Under FIN No. 48, a tax position shall initially be recognized in the
financial statements when it is more likely than not the position will be
sustained upon examination by the tax authorities.  Such tax positions shall
initially and subsequently be measured as the largest amount of tax benefit
that is greater than 50% likely of being realized upon ultimate settlement
with the tax authority, assuming full knowledge of the position and all
relevant facts. The adoption of FIN No. 48 on April 1, 2007, did not have a
material impact on the Company's consolidated financial statements, results of
operations, or liquidity.

                                       71

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS
157). SFAS 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements. This Statement applies to other
accounting pronouncements that require or permit fair value measurements.
Accordingly, this Statement does not require any new fair value measurements.
This Statement is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. Implementation of this Statement beginning April 1, 2008, is not
expected to have a material impact on the Company s' consolidated financial
statements.

In February 2007, the Financial Accounting Standards Board released Statement
No. 159, Fair Value Option for Financial Assets and Financial Liabilities.
This Statement permits entities to choose to measure many financial
instruments and certain other items at fair value. This Statement is effective
for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those years. Implementation of this Statement
beginning April 1, 2008, is not expected to have a material impact on the
Company s' consolidated financial statements.

In March 2008, the Financial Accounting Standards Board ("FASB") issued
Statement No. 161, Disclosures about Derivative Instruments and Hedging
Activities, an Amendment of FASB Statement No. 133 ("FAS 161"). FAS 161 amends
FAS 133, Accounting for Derivative Instruments and Hedging Activities ("FAS
133"), to amend and expand the disclosure requirements of FAS 133 to provide
greater transparency about (i) how and why an entity uses derivative
instruments, (ii) how derivative instruments and related hedge items are
accounted for under FAS 133 and its related interpretations, and (iii) how
derivative instruments and related hedged items affect an entity's financial
position, results of operations and cash flows. To meet those objectives, FAS
161 requires qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair value amounts of gains and
losses on derivative instruments and disclosures about credit-risk related
contingent features in derivative agreements. FAS 161 is effective on April 1,
2009, and is not expected to have a material impact on our consolidated
financial statements as we currently do not have any derivative instruments.

Reclassifications - Certain reclassifications have been made to prior years'
financial statements to conform to the current year presentation. These
reclassifications have no significant effect on the Company's previously
reported financial position or results of operations.

NOTE 2 - INTEREST-BEARING DEPOSITS

Interest bearing deposits consisted of the following at March 31:

                                                          2008       2007
                                                        -------     -------
                                                       (Dollars in Thousands)
                                                        --------------------
FHLB interest-bearing demand deposits                    $2,712     $5,079
Certificates of deposit                                     200        300
                                                         ------     ------
                                                         $2,912     $5,379
                                                         ======     ======

The Company has funds on deposit with the FHLB in a demand account. This
account acts like a savings account and earns interest based on the daily
federal funds rate. These funds are uninsured deposits held at the Federal
Home Loan Bank of Seattle. The FHLB of Seattle, a federally chartered
corporation, is one of 12 district FHLB institutions, which operate under the
supervision of the Federal Housing Finance Board. The Finance Board is an
independent agency of the executive branch within the U.S. Government which
ensures that the FHLB operates in a safe and sound manner, remains adequately
capitalized, and raises funds in the capital markets.

NOTE 3 - INVESTMENT SECURITIES

The Company's investment policy requires that the Company purchase only
high-grade investment securities. Purchases of debt instruments are generally
restricted to those rated A or better by a nationally recognized statistical
rating organization.

                                       72

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 3 - INVESTMENT SECURITIES (Continued)

The amortized cost and estimated fair values of investments, together with
unrealized gains and losses, are as follows as of March 31, 2008 and 2007,
respectively:

                                               2008
                        -----------------------------------------------------
                                       (Dollars in Thousands)
                        -----------------------------------------------------
                                               Gross      Gross
                                             Unrealized Unrealized
                                    Gross     Losses      Losses    Estimated
                        Amortized Unrealized 12 Months Greater Than   Fair
                           Costs    Gains     or Less   12 Months     Value
                        --------- ---------- --------- -----------  ---------
Available-For-Sale
 Securities
 State and political
  subdivisions and
  U.S. government
  agency securities      $33,107    $  703     $  (3)     $(128)     $33,679
 Marketable equity
  securities                 569     2,209       (15)         -        2,763
 Mutual funds              5,000         -      (201)         -        4,799
                         -------    ------     -----      -----      -------
    Total available-
     for- sale
     securities           38,676     2,912      (219)      (128)      41,241
                         -------    ------     -----      -----      -------
    Total investment
     securities          $38,676    $2,912     $(219)     $(128)     $41,241
                         =======    ======     =====      =====      =======

Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2008, the
Company has evaluated these securities and has determined that the decline in
value is temporary and is related to the change in market interest rates since
purchase. The decline in value is not related to any company or industry
specific event. At March 31, 2008, there are six investment securities with
unrealized losses. The Company anticipates full recovery of amortized cost
with respect to these securities at maturity or sooner in the event of more
favorable market interest rates.


                                               2007
                        -----------------------------------------------------
                                       (Dollars in Thousands)
                        -----------------------------------------------------
                                               Gross      Gross
                                             Unrealized Unrealized
                                    Gross     Losses      Losses    Estimated
                        Amortized Unrealized 12 Months Greater Than   Fair
                           Costs    Gains     or Less   12 Months     Value
                        --------- ---------- --------- -----------  ---------
Available-For-Sale
 Securities
 State and political
  subdivisions and
  U.S. government
  agency securities      $41,350    $   60     $(124)     $(178)     $41,108
 Marketable equity
  securities                 323     5,559         -          -        5,882
 Mutual funds              5,000         -      (126)         -        4,874
 Corporate debt
  securities               1,002         -        (1)         -        1,001
                         -------    ------     -----      -----      -------
    Total available-for-
     sale securities      47,675     5,619      (251)      (178)      52,865
                         -------    ------     -----      -----      -------
Held-To-Maturity
 Securities
 State and political
  subdivisions and U.S.
  government agency
  securities                 370         2         -          -          372
                         -------    ------     -----      -----      -------
    Total held-to-maturity
     securities              370         2         -          -          372
                         -------    ------     -----      -----      -------
    Total investment
     securities          $48,045    $5,621     $(251)     $(178)     $53,237
                         =======    ======     =====      =====      =======

                                       73

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 3 - INVESTMENT SECURITIES (Continued)

The amortized cost and estimated fair value of investment securities at March
31, 2008, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.

                                              (Dollars in Thousands)
                                  --------------------------------------------
                                   Available-For-Sale      Held-To-Maturity
                                  --------------------   ---------------------
                                  Amortized  Estimated   Amortized  Estimated
                                    Cost     Fair Value    Cost     Fair Value
                                  ---------  ----------  ---------  ----------

State and political subdivisions
 and U.S. government agencies
  One year or less                 $ 6,726    $ 6,760     $   -      $   -
  More than one to five years       12,212     12,613         -          -
  More than five to ten years       10,171     10,379         -          -
  Over ten years                     3,998      3,927         -          -
                                   -------    -------     -----      -----
                                    33,107     33,679         -          -

Mutual funds and marketable/
 equity securities                   5,569      7,562         -          -
                                   -------    -------     -----      -----
     Total investment securities   $38,676    $41,241     $   -      $   -
                                   =======    =======     =====      =====

Proceeds from sales of investment securities and gross realized gains and
losses on investment sales were as follows for the years ended March 31:

                                                 2008       2007       2006
                                                 ----       ----       ----
                                                   (Dollars in Thousands)
                                                 ---------------------------
Proceeds from sales of investments               $454      $3,748    $15,857
                                                 ====      ======    =======
Gross gains realized on sales of investments     $450      $  287    $     -
                                                 ====      ======    =======
Gross losses realized on sales of investments    $  -      $ (316)   $  (565)
                                                 ====      ======    =======

Information about concentrations of investments in particular industries for
marketable equity securities and corporate debt securities at March 31
consists of the following:

                                           2008               2007
                                      ---------------     --------------
                                               Market             Market
                                      Cost     Value      Cost    Value
                                      ----     ------     ----    ------
                                             (Dollars in Thousands)
                                      ----------------------------------
Marketable equity securities
  Banking                             $560    $2,122     $  309    $1,933
  Government agency stocks               9       641         14     3,949
                                      ----    ------     ------    ------
     Total                            $569    $2,763     $  323    $5,882
                                      ====    ======     ======    ======

Corporate debt securities
  Private utilities                   $  -    $    -     $1,002    $1,001
                                      ----    ------     ------    ------
     Total                            $  -    $    -     $1,002    $1,001
                                      ====    ======     ======    ======

At March 31, 2008 and 2007, U.S. government agency and corporate debt
securities of $5.6 million were pledged as collateral for deposits of state
and local government agencies and deposits for trust accounts in excess of
$100,000, as required by Washington State Law.

                                       74

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 4 - MORTGAGE-BACKED SECURITIES

Mortgage-backed securities at March 31 consist of the following:

                                               2008
                        -----------------------------------------------------
                                       (Dollars in Thousands)
                        -----------------------------------------------------
                                               Gross      Gross
                                             Unrealized Unrealized
                                    Gross     Losses      Losses    Estimated
                        Amortized Unrealized 12 Months Greater Than   Fair
                           Costs    Gains     or Less   12 Months     Value
                        --------- ---------- --------- -----------  ---------
Available-for-sale
 securities              $38,646     $603     $    -      $(149)     $39,100
Held-to-maturity
 securities                   30        5          -          -           35
                         -------     ----     ------      -----      -------
    Total mortgage-
     backed securities   $38,676     $608     $    -      $(149)     $39,135
                         =======     ====     ======      =====      =======

Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2008, the
Company has evaluated these securities and has determined that the decline in
value is temporary and is related to the change in market interest rates since
purchase. The decline in value is not related to any company or industry
specific event. At March 31, 2008, there were 22 mortgage-backed securities
with unrealized losses. The Company anticipates full recovery of amortized
cost with respect to these securities at maturity or sooner in the event of a
more favorable market interest rate environment.

                                               2007
                        -----------------------------------------------------
                                       (Dollars in Thousands)
                        -----------------------------------------------------
                                               Gross      Gross
                                             Unrealized Unrealized
                                    Gross     Losses      Losses    Estimated
                        Amortized Unrealized 12 Months Greater Than   Fair
                           Costs    Gains     or Less   12 Months     Value
                        --------- ---------- --------- -----------  ---------
Available-for-sale
 securities              $26,220     $178      $(37)      $(128)     $26,233
Held-to-maturity
 securities                  148        9         -           -          157
                         -------     ----      ----       -----      -------
    Total mortgage-
     backed securities   $26,368     $187      $(37)      $(128)     $26,390

                         =======     ====      ====       =====      =======

The amortized cost and estimated fair value of mortgage-backed securities at
March 31, 2008, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right
to prepay obligations with or without prepayment penalties.

                                              (Dollars in Thousands)
                                  --------------------------------------------
                                   Available-For-Sale      Held-To-Maturity
                                  --------------------   ---------------------
                                  Amortized  Estimated   Amortized  Estimated
                                    Cost     Fair Value    Cost     Fair Value
                                  ---------  ----------  ---------  ----------
Mortgage-backed securities
  One year or less                 $     -    $     -      $  7        $  7
  More than one to five years          533        546        12          12
  More than five to ten years       11,360     11,449         3           6
  After ten years                   26,753     27,105         8          10
                                  -------     -------      ----        ----

     Total                        $38,646     $39,100      $ 30        $ 35
                                  =======     =======      ====        ====

All of the above mortgage-backed securities are rated AAA by a nationally
recognized statistical rating organization.

                                       75

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 4 - MORTGAGE-BACKED SECURITIES (Continued)

Proceeds from sales of mortgage-backed securities and gross realized gains and
losses on mortgage-backed security sales were as follows for the year ended
March 31:

                                                      2008     2007     2006
                                                     ------   ------   ------
                                                      (Dollars in Thousands)
                                                     ------------------------
Proceeds from sales of mortgage-backed securities    $2,080   $8,748   $1,054
                                                     ======   ======   ======
Gross gains realized on sales of mortgage-backed
 securities                                          $   19   $   28   $   65
                                                     ======   ======   ======
Gross losses realized on sales of mortgage-backed
 securities                                          $    -   $   (9)  $    -
                                                     ======   ======   ======

NOTE 5 - LOANS RECEIVABLE

Loans receivable (collateralized principally by properties in the Whatcom,
Skagit, Snohomish, and Pierce Counties of Washington State) at March 31
consist of the following:
                                               (Dollars in Thousands)
                                              -----------------------
                                                 2008         2007
                                              ----------   ----------
First mortgage loans
  1-4 family                                  $  165,824   $  149,885
  1-4 family construction                         35,303       28,576
  Less participations                            (54,269)     (54,592)
                                              ----------   ----------
     Net first mortgage loans                    146,858      123,869
Commercial construction                          307,809      232,078
Commercial land development                      178,726      173,270
Multi family residential                          45,049       52,727
Commercial real estate                           300,109      292,212
Commercial loans                                 177,685      146,265
Home equity secured loans                         47,351       45,307
Other consumer loans                               7,005        5,031
                                              ----------   ----------
                                               1,210,592    1,070,759
Less:
  Allowance for loan losses                      (19,114)     (15,889)
                                              ----------   ----------
                                              $1,191,478   $1,054,870
                                              ==========   ==========

The Company originates both adjustable and fixed interest rate loans. At March
31, 2008, the Company had adjustable and fixed rate loans as follows:

              Fixed Rate                            Adjustable Rate
  --------------------------------          --------------------------------
                       (Dollars in                               (Dollars in
                        Thousands)                                Thousands)
  Term to Maturity      Book Value          Term to Maturity      Book Value
  ----------------      ----------          ----------------      ----------
Less than one year       $187,347          Less than one year      $697,841
One to three years         70,622          One to three years        85,562
Three to five years        21,648          Three to five years       36,556
Five to fifteen years      71,932          Five to fifteen years      1,916
Over fifteen years         37,168          Over fifteen years             -
                         --------                                  --------
                         $388,717                                  $821,875
                         ========                                  ========

                                       76

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 5 - LOANS RECEIVABLE (Continued)

Loans serviced for others were approximately $108.9 and $126.0 million,
respectively, as of March 31, 2008 and 2007, respectively. The Bank generally
receives a monthly fee of 0.25% to 0.375% per annum of the unpaid balance of
each loan that is serviced for others. Loans sold are without right of
recourse to the Bank by the buyer of the loan interests in the event of
default by the borrower. At March 31, 2008, the balance and activity in the
servicing asset is immaterial.

The allowance for loan losses at March 31, and changes during the year are as
follows:

                                               2008      2007     2006
                                             -------   -------   -------
                                               (Dollars in Thousands)
                                             ---------------------------
Balance, beginning of year                   $15,889   $14,184   $11,767
Provision for loan losses                      4,100     1,850     2,575
Loan chargeoffs                                 (898)     (195)     (165)
Loan recoveries                                   23        50         7
                                             -------   -------   -------
Balance, end of year                         $19,114   $15,889   $14,184
                                             =======   =======   =======

The following is a summary of information pertaining to impaired and
non-accrual loans:

                                                        March 31,
                                                  -------------------
                                                    2008        2007
                                                  -------     -------
                                                (Dollars in Thousands)
                                                  -------------------

Impaired loans without a valuation allowance      $     -     $     -
Impaired loans with a valuation allowance          12,147       1,434
                                                  -------     -------
     Total impaired loans                         $12,147     $ 1,434
                                                  =======     =======
Valuation allowance related to impaired loans     $ 1,972     $   577
Total non-accrual loans                           $11,608     $   226
Total loans past-due 90 days or more and still
  accruing                                        $     -     $     -

                                                  Years Ended March 31,
                                               ----------------------------
                                                2008       2007       2006
                                               ------     ------     ------
                                                 (Dollars in Thousands)
                                               ----------------------------
Average investment in impaired loans           $1,899     $2,324     $2,261
                                               ======     ======     ======
Interest income recognized on impaired loans   $  228     $  276     $    -
                                               ======     ======     ======

No additional funds are committed to be advanced in connection with impaired
loans.

Subsequent to March 31, 2008, the Bank accepted a deed in lieu for one
property included in the above impairment analysis. Approximately $1.8 million
in principal balances were moved to real estate owned and $200,000 was charged
against the allowance for loan losses based on the present value calculation
of expected cash flows at the time of repossession.

                                       77

<PAGE>

                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 6 - ACCRUED INTEREST AND DIVIDENDS RECEIVABLE

Accrued interest and dividends receivable at March 31 are summarized as
follows:

                                                    2008        2007
                                                  -------     -------
                                                 (Dollars in Thousands)
                                                  -------------------
Investment securities                              $  435     $  528
Mortgage-backed securities                            160        111
Loans receivable                                    7,318      5,980
Dividends on marketable equity securities               3          7
                                                   ------     ------
                                                   $7,916     $6,626
                                                   ======     ======
NOTE 7 - PREMISES AND EQUIPMENT

Premises and equipment at March 31 consisted of:

                                                    2008        2007
                                                  -------     -------
                                                 (Dollars in Thousands)
                                                  -------------------
Buildings                                        $ 19,960    $ 19,988
Equipment                                          14,544      12,576
                                                 --------    --------
                                                   34,504      32,564
Accumulated depreciation                          (13,719)    (11,925)
                                                 --------    --------
                                                   20,785      20,639
Land                                                6,993       6,992
                                                 --------    --------
Balance, end of year                             $ 27,778    $ 27,631
                                                 ========    ========

NOTE 8 - DEPOSITS

A comparative summary of deposits at March 31 follows:
                                                    2008        2007
                                                  -------     -------
                                                 (Dollars in Thousands)
                                                  -------------------
Demand deposits
  Savings                                        $   17,933   $ 21,628
  Checking                                           72,434     78,294
  Checking (noninterest-bearing)                     70,438     91,703
  Money Market                                      183,063    187,912
                                                 ----------   --------
                                                    343,868    379,537

Time certificates of deposit
  Less than $100,000                                286,657    273,022
  Greater than or equal to $100,000                 287,281    243,346
  Brokered CD's                                     120,986     79,390
                                                 ----------   --------
                                                    694,924    595,758
                                                 ----------   --------
     Total deposits                              $1,038,792   $975,295
                                                 ==========   ========
                                       78
<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 8 - DEPOSITS (Continued)

Time certificate of deposit accounts, classified by variable and fixed rates,
and their maturities at March 31 were as follows:

                                               2008
                                 --------------------------------
                                 Variable      Fixed
                                   Rate        Rate        Total       2007
                                 -------     --------    --------    --------
                                             (Dollars in Thousands)
                                 --------------------------------------------
Within one year                  $ 6,321     $552,245    $558,566    $512,062
 One to two years                  7,617       51,040      58,657      42,020
 Two to three years                1,324       62,227      63,551      14,525
 Three to four years                 489        4,107       4,596       9,426
 Four to five years                  413        5,647       6,060      13,903
 Over five years                   3,351          143       3,494       3,822
                                 -------     --------    --------    --------
                                 $19,515     $675,409    $694,924    $595,758
                                 =======     ========    ========    ========

The terms of variable rate certificates of deposit allow customers to make
additional deposits to existing certificates of deposit at any time.

The weighted average nominal interest rate on all deposits at March 31, 2008
and 2007, was 3.83% and 3.56%, respectively.

Interest expense on all deposit accounts for the years ended March 31 is
summarized as follows:
                                                 (Dollars in Thousands)
                                              -----------------------------
                                                2008       2007       2006
                                              -------    -------    -------
Money market                                  $ 6,534    $ 6,316    $ 3,456
Checking                                          466        510        426
Savings                                           176        167        189
Certificates of deposit                        30,897     25,258     15,917
                                              -------    -------    -------
Balance, end of year                          $38,073    $32,251    $19,988
                                              =======    =======    =======

NOTE 9 - OTHER BORROWED FUNDS

The Bank is a member of the FHLB of Seattle. As a member, the Bank has a
committed line of credit up to 25% of total assets, subject to the Bank
pledging sufficient collateral and maintaining the required stock investment
in the FHLB. Committed lines of credit agreements totaling approximately
$272.7 million and $248.5 million were available to the Bank, of which, $192.0
million and $143.5 million were outstanding at March 31, 2008 and 2007,
respectively. Included in these amounts is the borrowing related to the
investment in real estate in a joint venture of $22.4 million and $20.2 illion
as of March 31, 2008 and 2007, respectively. These advances bear interest
rates ranging from 2.36% to 5.09% and 2.75% to 5.69% per annum in 2008 and
2007, respectively. Maturities for the advances are $77.5 million in fiscal
2009, $101.0 million in fiscal 2010, and $13.5 million in fiscal 2011.

The maximum outstanding, average outstanding balances and average interest
rates on advances from the FHLB were as follows for the year ended March 31:

                                                2008       2007       2006
                                              -------    -------    -------
                                                 (Dollars in Thousands)
                                              -----------------------------

Maximum outstanding at any month end         $212,500    $195,000   $149,000
Average outstanding                           177,874     165,237    134,070
Weighted average interest rates:

  Annual                                        4.44%        4.74%      3.68%
                                                ====         ====       ====
  End of year                                   3.15%        5.03%      4.39%
                                                ====         ====       ====

                                       79

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 9 - OTHER BORROWED FUNDS (Continued)

The Bank has other borrowed funds in the form of retail repurchase agreements.
These agreements are collateralized by securities held by a safekeeping agent
not under control of the Bank. These advances are considered overnight
borrowings and bear interest rates that fluctuate daily based on current
market rates. The Bank had $21.9 million and $14.4 million outstanding as of
March 31, 2008 and 2007, respectively.

The Bank also had $850,000 and $1.0 million outstanding as of March 31, 2008
and 2007, respectively, in the form of a TT&L note option which is included in
other borrowed funds.

At March 31, 2008 and 2007, U.S. government agency and corporate debt
securities of $35.8 million and $16.3 million, respectively, were pledged as
collateral for retail repurchase agreements.

NOTE 10 - INCOME TAX

A reconciliation of the Company's income tax provision to the statutory
federal income tax rate for the years ended March 31 is as follows:

                                              2008        2007       2006
                                             ------      ------     ------
                                                 (Dollars in Thousands)
                                             -----------------------------

Provision for income tax at the statutory
 rate of 35 percent                          $9,577     $10,008     $7,895
Increase (decrease) in tax resulting from:
  Nontaxable income                            (572)       (469)      (539)
  Nondeductible expense                          46          29         15
  Dividends received deduction                  (52)        (52)       (48)
  Other, net                                    (50)         50       (420)
                                             ------      ------     ------
     Income tax provision                    $8,949      $9,566     $6,903
                                             ======      ======     ======

The nature and components of the Company's net deferred tax assets
(liabilities), established at an estimated tax rate of 35% are as follows at
March 31:
                                                       2008        2007
                                                     --------   ---------
                                                    (Dollars in Thousands)
                                                     --------------------
Deferred Tax Assets
  Deferred compensation agreements                   $   681    $   707
  Financial reporting loan loss reserve not
   recognized for tax purposes                         6,344      5,215
  Financial reporting accrued expenses not
   recognized for tax purposes                           329        403
  Other deferred tax assets                            2,173      1,404
                                                     -------    -------
     Total deferred assets                             9,527      7,729
                                                     -------    -------
Deferred Tax Liabilities
  Deferred loan fees for tax purposes in excess
   of amounts deferred for financial reporting          (255)      (264)
  Tax effect of unrealized gains on available-for-
    sale securities                                   (1,098)    (1,862)
  FLHB stock dividends                                  (793)      (793)
  Other deferred tax liabilities                      (1,128)    (1,077)
                                                     -------    -------
     Total deferred liabilities                       (3,274)    (3,996)
                                                     -------    -------
     Net deferred tax assets                         $ 6,253    $ 3,733
                                                     =======    =======

The Company 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.

                                       80

<PAGE>

                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 10 - INCOME TAX (Continued)

The Company adopted the provisions of FASB Interpretation No. 48. Accounting
for Uncertainty in Income Taxes, on April 1, 2007. The Company had no
unrecognized tax benefits which would require an adjustment to the April 1,
2007 beginning balance of retained earnings. The Company had no unrecognized
tax benefits at April 1, 2007 and at March 31, 2008.

The Company recognizes interest accrued and penalties related to unrecognized
tax benefits in tax expense. During the years ended March 31, 2008 and 2007,
the Company recognized no interest and penalties.

The Company files federal and various state and local tax returns. With few
exceptions, the Company is no longer subject to U.S. Federal or state/local
tax examinations by tax authorities for years before 2005.

NOTE 11 - BENEFIT PLANS

Deferred Compensation Plan - The Company has entered into deferred
compensation agreements with certain of its officers. The agreements provide
for additional retirement benefits payable over a 12 to 20 year period
following retirement. In connection with these agreements, the Company has
acquired life insurance policies on the individual officers covered by the
deferred compensation agreements. At March 31, 2008 and 2007, the cash
surrender values of these policies included in other assets aggregated $2.1
million and $1.9 million, respectively.

The Company performs a present value calculation using an appropriate discount
rate on an annual basis to ensure that deferred compensation plan obligations
are adequately estimated in the accompanying financial statements. The
discount rate was 3.30%, 2.67%, and 2.72% in 2008, 2007 and 2006,
respectively. Deferred compensation expense amounted to $213,000, and $137,500
for the years ended March 31, 2007 and 2006, respectively. No deferred
compensation expense was recognized in 2008.

Employee Incentive Plan - The Company has an incentive plan with employees
meeting certain performance requirements. Payments made to employees pursuant
to the plan are based upon earnings, growth in deposits, and loans and
attainment of certain corporate objectives. Costs of the plan were $1.0
million, $2.3 million, and $2.1 million for the years ended March 31, 2008,
2007 and 2006, respectively.

Employee Stock Ownership Plan - The Company has a noncontributory employee
stock ownership plan ("ESOP") for those employees who have completed a minimum
of two years of service. The Company's contribution is determined annually by
the Board of Directors. Participants receive distributions from the ESOP only
in the event of retirement, disability or termination of employment. The
primary purpose of the ESOP is to acquire shares of the Company's common stock
on behalf of ESOP participants.

In April 1996, the Company issued a loan to the ESOP in the amount of
$500,000, to purchase 40,000 shares of the Company's common stock in the open
market. The loan was to be repaid over a period of ten years, with annual
ayments including interest due on March 31 of each year. The ESOP shares
initially were pledged as collateral for this debt. As the obligation was
reduced, shares were released from collateral and allocated to the
participants' accounts at a rate of 10% a year. In May 1997, the Company
issued a 15% stock dividend which added an additional 5,400 shares to the
unallocated ESOP shares. In May 1999, the Company made an additional loan to
the ESOP in the amount of $154,725, to purchase 12,500 shares of common stock
in the open market. The loan was to be repaid over seven years with annual
payments including interest due March 31. In April 2001, the Company issued a
15% stock dividend which added an additional 4,789 shares to the unallocated
ESOP shares. In July 2002, the Company issued a 25% stock split which added an
additional 7,342 shares to the unallocated ESOP shares. In October 2006, the
Company issued a 5-for-4 stock split paid in the form of a 25% stock dividend
which added an additional 21,023 shares to the allocated ESOP shares. As of
March 31, 2006, all loans secured by ESOP shares were paid off, and the
remaining shares released. Shares released for allocation were 9,175 for the
year ended March 31, 2006. Shares outstanding for the years ended March 31,
2008, 2007 and 2006 were 266,565, 263,262 and 229,411, respectively.

Dividends paid on shares of stock are reinvested and the new shares purchased
are allocated to the participants. Compensation expense for the ESOP plan was
$15,000, $10,000, and $105,000 for the years ended March 31, 2008, 2007 and
2006, respectively.

                                       81

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 11 - BENEFIT PLANS (Continued)

401(k) Plan - Effective January 1, 1993, the Company adopted a defined
contribution 401(k) retirement and savings plan (the "Plan") covering
substantially all employees. The Company contributes three percent of
participating employees' eligible salary to the Plan and a discretionary
amount determined annually by the Board of Directors. Total Company
contributions to the Plan which were recorded as employee benefits expense
amounted to $525,000, $490,000, and $500,000 for the years ended March 31,
2008, 2007 and 2006, respectively.

Stock Option and Restricted Stock Award Plans - In 2005, Shareholders approved
an Incentive Stock Plan (the "Plan") to promote the best interest of the
Company, our subsidiaries and our shareholders, by providing an incentive to
those key employees who contribute to our success. The Plan allows for
incentive stock options and restricted stock grants to be awarded. The maximum
number of shares that may be issued under the Plan is 937,500 common shares.
At March 31, 2008, 795,903 common shares were available for grant. Shares
issued and outstanding are adjusted to reflect common stock dividends and
splits. Options and awards are granted at fair market value and may or may not
vest immediately upon issuance based on the terms established by the Board of
Directors. Options and awards are generally exercisable within one to five
years from date of grant and expire after ten years. Dividends are paid on
restricted stock grants and are not paid on incentive stock options. Certain
options provide for accelerated vesting if there is a change in control.

The Company measures the fair value of each stock option grant at the date of
grant, using the Black Scholes option pricing model. The expected term of the
options is developed by considering the historical share option exercise
experience, historical share retention practices of employees and assumptions
about their propensity for early exercise in the future. Expected volatility
is estimated using daily historical volatility. We believe that historical
volatility is currently the best estimate of expected volatility. The dividend
yield is the annualized yield on our common stock on the date of grant. The
risk free interest rate is the yield on the grant date of U.S. Treasury zero
coupon issues with a maturity comparable to the expected term of the option.
The weighted average fair value of options granted during the twelve months
ended March 31, 2008, 2007 and 2006 was $4.75, $4.18, and $3.81 per share, as
adjusted, respectively. The following assumptions were used in arriving at the
fair value of options granted during the twelve months ended March 31:

                                                2008       2007      2006
                                               ------     ------    ------
Risk-free interest rate                        4.213%      5.27%     4.17%
Dividend yield rate                            2.702%     2.417%    2.613%
Price volatility                               31.06%     24.77%    25.27%
Weighted average expected life of options      4.45 yr.   3.78 yr   5.50 yr.

The following tables summarize option activity under the Plan as of March 31,
2008 and 2007 and changes during the year then ended:

                                            Weighted    Weighted
                                             Average     Average    Aggregate
                                  Number    Exercise    Remaining   Intrinsic
                               Outstanding  Price per  Contractual  Value (in
Stock Options                   Under Plan    Share       Total       2007
-----------------------------  -----------  ---------  -----------  ---------

Balance, March 31, 2007          184,475      10.05       4.84        2,184
  Granted                         39,362      19.95
  Exercised                      (28,531)      6.81
  Forfeited, expired or
   cancelled                      (2,085)     19.26
                                 -------     ------       ----       ------
Balance, March 31, 2008          193,221     $12.45       5.40       $  761
                                 =======     ======       ====       ======
Exercisable, March 31, 2008      128,256     $ 8.91       3.66       $  761
                                 =======     ======       ====       ======

                                       82

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                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 11 - BENEFIT PLANS (Continued)

The weighted average grant date fair value of options granted during the
twelve months ended March 31, 2008, 2007 and 2006 was $4.75, $4.18, and $3.81
per share, as adjusted, respectively. The total intrinsic value, the amount by
which the fair value of the underlying stock exceeds the exercise price of an
option on the exercise date, of options exercised for the years ended March
31, 2008, 2007 and 2006 was $215,000, $364,000, and $1.4 million,
respectively.

                  Options Outstanding                 Options Exercisable
 -------------------------------------------------  ----------------------
                           Weighted
                           Average       Weighted
 Range of                  Remaining     Average                  Average
 Exercise    Number        Contractual   Exercise   Number        Exercise
 Prices      Outstanding   Life          Price      Exercisable   Price
 ---------   -----------  ------------   --------   -----------   --------

$5 to $10       97,727      2.67 years    $ 6.78       97,727      $ 6.78
$10 to $15       8,126      5.07 years    $11.87        7,813      $11.77
$15 to $20      63,400      8.21 years    $17.65       22,716      $17.09
$20 to $25      23,968      9.24 years    $21.97            -      $    -

The following table summarizes restricted stock award activity under the Plan
as of March 31, 2008 and 2007 and changes during the years then ended:

                                                    Weighted      Weighted
                                                     Average     Aggregate
                                                      Grant      Remaining
                                       Outstanding  Price per   Contractual
Restricted Stock Awards                 Under Plan    Share    Term (in Years)
-----------------------------------    -----------  ---------  --------------
Balance, March 31, 2007                   31,682     $18.91         1.86
  Granted                                 30,500      21.88
  Vested                                  (8,751)     18.73
  Forfeited, expired or cancelled         (1,670)     20.01
                                          ------     ------         ----
Balance, March 31, 2008                   51,761     $20.66         0.91
                                          ======     ======         ====

The total intrinsic value of restricted stock vested for the years ended March
31, 2008 and 2007 was $173,000 and $76,000, respectively.  No restricted stock
vested for the year ended March 31, 2006.

NOTE 12 - STOCKHOLDERS' EQUITY

Capital Requirements - The Company and Bank are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Company's and the Bank's financial statements.
Under capital adequacy guidelines within the regulatory framework for prompt
corrective action, the Bank must meet specific capital adequacy guidelines
that involve quantitative measures of each entity's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. Capital classifications are also subject to qualitative judgments
by the regulators about components, risk weightings, and other factors.

Quantitative measures are established by regulation to ensure capital
adequacy, require maintenance of minimum amounts and ratios of total and Tier
1 capital (as defined in the regulations) to risk-weighted assets, and of Tier
1 capital to average assets as illustrated in the following table. Management
believes, as of March 31, 2008, that each entity meets all capital adequacy
requirements to which they are subject. Additionally, as of March 31, 2008,
the Bank was categorized as well capitalized under the regulatory framework
for prompt corrective action. There are no conditions or events since that
notification that management believes have changed the Bank's category.

                                       83

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                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 12 - STOCKHOLDERS' EQUITY (Continued)

                                                                To Be Well
                                                               Capitalized
                                                               Under Prompt
                                              For Capital       Corrective
                                               Adequacy           Action
                             Actual            Purposes         Provisions
                         --------------     --------------    --------------
                         Amount    Ratio    Amount   Ratio    Amount   Ratio
                         ------    -----    ------   -----    ------   -----
As of March 31, 2008
 (in thousands)
Total Capital
  (to Risk Weighted
   Assets)
    Consolidated        $142,881   11.08%  $103,198  >8.00%     N/A
    Horizon Bank        $142,118   11.02%  $103,157  >8.00%  $128,947  >10.00%
Tier I Capital
  (to Risk Weighted
   Assets)
    Consolidated        $125,815    9.75%  $ 51,599  >4.00%     N/A
    Horizon Bank        $125,058    9.70%  $ 51,579  >4.00%  $ 77,368  > 6.00%
Tier I Capital
  (to Average Assets)
    Consolidated        $125,815    9.10%  $ 55,300  >4.00%     N/A
    Horizon Bank        $125,058    9.05%  $ 55,300  >4.00%  $ 69,125  > 5.00%

                                                                To Be Well
                                                               Capitalized
                                                               Under Prompt
                                              For Capital       Corrective
                                               Adequacy           Action
                             Actual            Purposes         Provisions
                         --------------     --------------    --------------
                         Amount    Ratio    Amount   Ratio    Amount   Ratio
                         ------    -----    ------   -----    ------   -----
As of March 31, 2007
 (in thousands)
Total Capital
  (to Risk Weighted
   Assets)
    Consolidated        $136,606   12.03%  $ 90,870  >8.00%     N/A
    Horizon Bank        $136,337   12.00%  $ 90,862  >8.00%  $113,578  >10.00%

Tier I Capital
  (to Risk Weighted
   Assets)
    Consolidated        $119,942   10.56%  $ 45,435  >4.00%     N/A
    Horizon Bank        $119,674   10.54%  $ 45,431  >4.00%  $ 68,147  > 6.00%
Tier I Capital
  (to Average Assets)
    Consolidated        $119,942    9.64%  $ 49,751  >4.00%     N/A
    Horizon Bank        $119,674    9.63%  $ 49,728  >4.00%  $ 62,160  > 5.00%

Holding Company Loans - Under federal regulations, the Bank is limited, unless
previously approved, as to the amount it may loan to the holding company and
any one affiliate, to 10% of its capital stock and surplus, and the total of
loans to the holding company and affiliates must not exceed 20% of capital and
surplus. Further, all such loans must be fully collateralized. In addition,
dividends paid by the Bank to the Company would be prohibited if the effect
thereof would cause the Bank's capital to be reduced below applicable minimum
capital requirements.

Dividend Reinvestment Plan - As a service to its stockholders of record, the
Bank offers a Dividend Reinvestment and Stock Purchase Plan ("Reinvestment
Plan"). Under the terms of the Reinvestment Plan, dividends and optional cash
payments may be reinvested toward the purchase of additional shares of stock.
No brokerage commission or fees are charged to acquire shares through the
Reinvestment Plan.

Stock Repurchase Plans - The Company has conducted various stock buy-back
programs since August 1996. In March 2005, the Company announced a plan to
repurchase up to 1,250,000 shares, or approximately 10% of the Company's
outstanding common stock. During fiscal 2006, 266,065 shares were repurchased
and subsequently retired at a cost of $4.4 million. In March 2006, the Company
announced a plan to repurchase up to 625,000 shares, or approximately 5% of
the Company's outstanding common stock. During fiscal 2007, 144,580 shares
were repurchased and subsequently retired at a cost of $2.9 million. In March
2007, the Company announced a plan to repurchase up to 600,000 shares, or
approximately 5% of the Company's outstanding common stock. During fiscal
2008, 399,700 shares were repurchased and subsequently retired at a cost of
$7.1 million. Share information related to stock repurchases has been restated
to reflect stock splits and dividends.

                                       84

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

Stock Split - The Company's Board of Directors, at its September 26, 2006
Board meeting, announced a 5 for 4 stock split paid in the form of a 25% stock
dividend to be issued October 23, 2006 for shareholders of record October 6,
2006.

NOTE 13 - EARNINGS PER SHARE

The numerators and denominators, adjusted for stock splits and dividends, of
basic and diluted earnings per share are as follows:

                                          (Dollars in Thousands)
                                  -------------------------------------
                                      2008         2007         2006
                                  -----------  -----------  -----------
Net income (numerator)            $    18,413  $    19,028  $    15,655
Shares used in the calculation
(denominators)
  Basic earnings per weighted
   average share outstanding       12,097,615   12,287,805   12,422,000
  Effect of dilutive stock
   options                             99,168      121,287      120,845
                                  -----------  -----------  -----------
  Diluted shares                   12,196,783   12,409,092   12,542,845
                                  ===========  ===========  ===========
Basic earnings per share          $      1.52  $      1.55  $      1.26
                                  ===========  ===========  ===========
Diluted earnings per share        $      1.51  $      1.53  $      1.25
                                  ===========  ===========  ===========

Anti-dilutive shares outstanding
 related to options to acquire
 the Company's common stock            40,593            -            -
                                  ===========  ===========  ===========

NOTE 14 - COMMITMENTS AND CONTINGENCIES

Employment Agreement - The Company has entered into employment agreements with
members of senior management that provide for potential payments upon change
in control, disability, termination without cause, or death. The arrangements
generally provide severance payments at 2.99 times the then current
compensation levels and continuation of certain benefits.

Long-Term Lease Commitments - The Company has entered into lease agreements
for certain parcels of land and branch offices. Future noncancelable lease
payments under these agreements are as follows for the years ending March 31:

                                                (Dollars in
                                                 Thousands)
                                                 ----------
                   2009                            $  419
                   2010                               429
                   2011                               440
                   2012                               443
                   2013                               240
                Thereafter                             80
                                                   ------
                                                   $2,051
                                                   ======

Rent expense charged to operations was $410,000, $293,000, and $294,000 for
the years ended March 31, 2008, 2007 and 2006, respectively.

NOTE 15 - RELATED PARTY TRANSACTIONS

Certain directors, executive officers, and principal stockholders are Bank
customers and have had banking transactions with the Bank. All loans and
commitments to loan included in such transactions were made in compliance with
applicable laws on substantially the same terms (including interest rates and
collateral) as those prevailing at the time for comparable transactions with
other persons and do not involve more than the normal risk of collectibility
or present any other unfavorable features.

                                       85

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 15 - RELATED PARTY TRANSACTIONS (Continued)

The aggregate balances and activity during the years ended March 31, 2008 and
2007, are as follows and were within regulatory limitations:

                                            (Dollars in Thousands)
                                             -------------------
                                               2008        2007
                                             -------     -------
Balance, beginning of year                   $13,505     $15,528
New loans or advances                          8,355       5,155
Repayments                                    (8,135)     (7,178)
                                             -------     -------
Balance, end of year                         $13,725     $13,505
                                             =======     =======
Interest earned on loans                     $   948     $ 1,130
                                             =======     =======

Deposits from related parties totaled approximately $3.9 million and $3.8
million at March 31, 2008 and 2007, respectively.

The Company leases office space from a limited partnership in which one of the
Company's directors is a part owner. Lease expense for this office space was
$156,000, $151,000 and $123,000 for the fiscal years ended March 31, 2008,
2007 and 2006, respectively. The future commitments related to this lease are
included in the totals disclosed in Note 14 regarding Long-Term Lease
Commitments.

NOTE 16 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK

Most of the Bank's business activity is with customers located within Whatcom,
Skagit, Snohomish, and Pierce Counties. Investments in state and municipal
securities involve governmental entities within the state of Washington. The
Bank originates commercial, real estate, and consumer loans. Generally, loans
are secured by deposit accounts, personal property, or real estate. Rights to
collateral vary and are legally documented to the extent practicable. Although
the Bank has a diversified loan portfolio, local economic conditions may
affect borrowers' ability to meet the stated repayment terms.

NOTE 17 - FINANCIAL INSTRUMENTS

The Bank is a party to financial instruments with off-balance-sheet risk (loan
commitments) in the normal course of business to meet the financing needs of
its customers and to reduce its own exposure to fluctuations in interest
rates. Loan commitments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet.
The contract amounts of those commitments reflect the extent of the Bank's
exposure to credit loss from these commitments. The Bank uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The amount of collateral
obtained, if it is deemed necessary by the Bank upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant and
equipment, and income-producing commercial properties.

Unfunded commitments under commercial lines-of-credit, revolving credit lines
and overdraft protection agreements are commitments for possible future
extensions of credit to existing customers. These lines-of-credit are
uncollateralized and usually do not contain a specified maturity date and may
be drawn upon to the total extent to which the Company is committed.

                                        86

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                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------


NOTE 17 - FINANCIAL INSTRUMENTS (Continued)

Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements,
including commercial paper, bond financing, and similar transactions. Except
for certain long-term guarantees, the majority of guarantees expire in one
year. The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers. Collateral
supporting those commitments, for which collateral is deemed necessary,
generally amounts to 100% of the commitment amount at March 31, 2008.

The Bank has not been required to perform on any financial guarantees and has
not incurred any losses on its commitments for the years ended March 31, 2008,
2007 and 2006.

The following is a summary of the off-balance-sheet financial instruments or
contracts outstanding at March 31:

                                           (Dollars in Thousands)
                                            --------------------
                                              2008        2007
                                            -------     --------
Commitments to extend credit                $361,763    $379,549
Credit card arrangements                      10,510      10,105
Standby letters of credit                      2,047       3,056

NOTE 18 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used to estimate the fair value of
the following classes of financial instruments:

Cash Equivalents and Interest-Bearing Deposits - Due to the relatively short
period of time between the origination of these instruments and their expected
realization, the carrying amount is estimated to approximate fair value.

Investment and Mortgage-Backed Securities -  Fair values are based on quoted
market prices or dealer quotes, if available. If a quoted market price is not
available, fair value is estimated using quoted market prices for similar
securities.

Federal Home Loan Bank Stock -  FHLB Stock is carried at $100 par value. This
investment is considered restricted, as a minimum, the investment must be
maintained in order to obtain borrowing commitments from FHLB. The Company may
redeem its investment only at par value, which is used as the estimated market
value.

Loan Receivables and Investment in Real Estate in a Joint Venture - For
certain homogeneous categories of loans, such as those written to FHLMC
standards, fair value is estimated using the quoted market prices for
securities backed by similar loans, adjusted for differences in loan
characteristics. For variable rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values.

Loans Held for Sale - The fair value of loans held for sale is based on the
estimated value at which the loans could be sold in the secondary market.

Accrued Interest Income and Expense Accounts - Due to the short-term nature of
these amounts, recorded book value is believed to approximate fair value.

Deposit Liabilities, Repurchase Agreements, Other Borrowed Funds, and
Borrowing Related to Investment in Real Estate in a Joint Venture - The fair
value of demand deposits, savings accounts, certain money market deposits, and
federal funds purchased, is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit, repurchase
agreements and other borrowed funds are estimated by discounting the estimated
future cash flows using the rates currently offered for these instruments with
similar remaining maturities.

Off-Balance-Sheet Instruments - The Company's off-balance-sheet instruments
include unfunded commitments to extend credit and borrowing facilities
available to the Company. The fair value of these instruments is not
considered practicable to estimate because of the lack of quoted market price
and the inability to estimate fair value without incurring excessive costs.

                                       87

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 18 - DISCLOSURES ABOUT FAIN VALUE OF FINANCIAL INSTRUMENTS (Continued)

The carrying amounts and estimated fair values of the Bank's financial
instruments at March 31, are as follows:

                                            (Dollars in Thousands)
                                 --------------------------------------------
                                          2008                  2007
                                 ---------------------  ---------------------
                                 Carrying               Carrying
                                  Amount    Fair Value   Amount    Fair Value
                                 --------   ----------  --------   ----------
Financial Assets
  Cash and cash equivalents    $   22,412  $   22,412  $   40,833  $   40,833
  Interest-bearing deposits         2,912       2,912       5,379       5,379
  Investment securities            41,241      41,241      53,235      53,237
  Mortgage-backed securities       39,130      39,135      26,381      26,390
  Federal Home Loan Bank stock      8,867       8,867       7,247       7,247
  Loans held-for-sale               2,644       2,644       4,493       4,493
  Loans receivable              1,191,478   1,190,418   1,054,870   1,049,670
  Investment in real estate in
   a joint venture                 17,567      17,567      17,169      17,169
  Accrued interest and dividends
   receivable                       7,916       7,916       6,626       6,626

Financial Liabilities
  Demand and savings deposits     343,868     343,868     379,537     379,537
  Time deposits                   694,924     677,364     595,758     590,370
  Accrued interest payable          1,566       1,566       3,450       3,450
  Other borrowed funds            192,343     193,003     138,715     138,009

  Borrowing related to investment
   in real estate in a joint
   venture                         22,448      22,448      20,243      20,243

NOTE 19 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION

Condensed balance sheet at March 31:

                                                (Dollars in Thousands)
                                                 --------------------
                                                   2008        2007
                                                 --------    --------
    Cash                                         $    216    $    138
    Investment in Bank                            127,560     123,586
    Investment Securities - available for sale        235           -
    Other assets                                    1,912       1,663
                                                 --------    --------
                                                 $129,923    $125,387
                                                 ========    ========

    Other liabilities                            $  1,606    $  1,532
    Stockholders' equity                          128,317     123,855
                                                 --------    --------
                                                 $129,923    $125,387
                                                 ========    ========

                                       88

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 19 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION (Continued)

Condensed statement of income for the years ended March 31, 2008, 2007 and
2006:

                                                 (Dollars in Thousands)
                                              ---------------------------
                                                2008      2007      2006
                                              -------   -------   -------
Income
  Cash dividends from Bank subsidiary         $13,961   $ 9,149   $ 9,981
  Interest                                          -         -         2
                                              -------   -------   -------
     Total income                              13,961     9,149     9,983
                                              -------   -------   -------

Expenses
  Compensation                                    851       426       164
  Other                                           221       372       346
                                              -------   -------   -------
     Total expenses                             1,072       798       510
                                              -------   -------   -------
Income before undistributed income of
 subsidiary and benefit equivalent to income
 taxes                                         12,889     8,351     9,473
Benefit equivalent to income taxes                141       279       178
                                              -------   -------   -------
Income before undistributed income of
 subsidiary                                    13,030     8,630     9,651
Undistributed income of subsidiary              5,383    10,398     6,004
                                              -------   -------   -------
     Net income                               $18,413   $19,028   $15,655
                                              =======   =======   =======


                                                 (Dollars in Thousands)
                                              ---------------------------
                                                2008      2007      2006
                                              -------   -------   -------
Cash flows from operating activities

  Net income                                 $ 18,413  $ 19,028   $15,655
Adjustments to reconcile net income to net
 cash flows from operating activities
   Equity in undistributed income of
    subsidiary                                 (5,383)  (10,398)   (6,004)
   Other operating activities                     478       127       (66)
                                             --------  --------   -------
     Net cash flows from operating
      activities                               13,508     8,757     9,585
                                             --------  --------   -------
Cash flows from investing activities
  Other investing activities                     (250)        -        22
                                             --------  --------   -------
     Net cash flows from investing
      activities                                 (250)        -        22
                                             --------  --------   -------
Cash flows from financing activities
  Sale of common stock                            194       149       464
  Dividends paid                               (6,312)   (5,977)   (5,572)
  Treasury stock purchased                     (7,062)   (2,942)   (4,378)
                                             --------  --------   -------
     Net cash flows from financing
      activities                              (13,180)   (8,770)   (9,486)
                                             --------  --------   -------
Net change in cash                                 78       (13)      121
Cash, beginning of year                           138       151        30
                                             --------  --------   -------
Cash, end of year                            $    216  $    138   $   151
                                             ========  ========   =======

                                       89

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2008, 2007 AND 2006
------------------------------------------------------------------------------

NOTE 20 - SELECTED QUARTERLY FINANCIAL DATA (IN THOUSANDS) (UNAUDITED)

                                         (Dollars in Thousands)
                            --------------------------------------------------
                                        Year Ended March 31, 2008
                            --------------------------------------------------
                            1st Quarter  2nd Quarter  3rd Quarter  4th Quarter
                            -----------  -----------  -----------  -----------

Interest income               $24,899      $25,892      $25,909      $23,543
Interest expense               11,458       11,949       12,109       11,129
Net interest income            13,441       13,943       13,800       12,414
Provision for loan losses         400          800          900        2,000
Noninterest income              1,703        1,612        1,516        2,213
Noninterest expense             7,255        7,452        7,422        7,051
                              -------      -------      -------      -------
Income before provision for
 income tax                     7,489        7,303        6,994        5,576
Provision for income tax        2,473        2,390        2,282        1,804
                              -------      -------      -------      -------
     Net income               $ 5,016      $ 4,913      $ 4,712      $ 3,772
                              =======      =======      =======      =======
Basic earnings per share
 (adjusted for stock splits
 and dividends)               $  0.41      $  0.40      $  0.39      $  0.32
                              =======      =======      =======      =======
Diluted earnings per share
 (adjusted for stock splits
 and dividends)               $  0.41      $  0.40      $  0.39      $  0.31
                              =======      =======      =======      =======

                                         (Dollars in Thousands)
                            --------------------------------------------------
                                        Year Ended March 31, 2007
                            --------------------------------------------------
                            1st Quarter  2nd Quarter  3rd Quarter  4th Quarter
                            -----------  -----------  -----------  -----------

Interest income               $21,183      $22,993      $24,299      $24,125
Interest expense                8,501        9,860       10,877       10,895
Net interest income            12,682       13,133       13,422       13,230
Provision for loan losses         700          700          450            -
Noninterest income              1,474        1,437        1,419        1,508
Noninterest expense             6,550        6,876        7,054        7,381
                              -------      -------      -------      -------
Income before provision for
 income tax                     6,906        6,994        7,337        7,357
Provision for income tax        2,324        2,344        2,454        2,444
                              -------      -------      -------      -------
     Net income               $ 4,582      $ 4,650      $ 4,883      $ 4,913
                              =======      =======      =======      =======
Basic earnings per share
 (adjusted for stock splits
 and dividends)               $  0.37      $  0.38      $  0.40      $  0.40
                              =======      =======      =======      =======
Diluted earnings per share
 (adjusted for stock splits
 and dividends)               $  0.37      $  0.37      $  0.39      $  0.40
                              =======      =======      =======      =======

                                       90
<PAGE>



Item 9.  Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
         Financial Disclosure
         --------------------

     Not applicable.

Item 9A.  Controls and Procedures
---------------------------------

     (a) Evaluation of Disclosure Controls and Procedures: An evaluation of
the Corporation's disclosure controls and procedures (as defined in Rule
13(a)-15(e) of the Exchange Act was carried out under the supervision and with
the participation of the Corporation's Chief Executive Officer, Chief
Financial Officer and several other members of the Corporation's senior
management as of the end of the period covered by this report.  The
Corporation's Chief Executive Officer and Chief Financial Officer concluded
that the Corporation's disclosure controls and procedures as currently in
effect are effective in ensuring that the information required to be disclosed
by the Corporation in the reports it files or submits under the Exchange Act
is (i) accumulated and communicated to the Corporation's management (including
the Chief Executive Officer and Chief Financial Officer) in a timely manner,
and (ii) recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms.

     (b) Changes in Internal Controls: There have been no changes in our
internal control over financial reporting (as defined in 13a-15(f) of the Act)
that occurred during the quarter ended March 31, 2008, that have materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. The Corporation continued, however, to implement
suggestions from its internal auditor and independent auditors on ways to
strengthen existing controls.  The Corporation does not expect that its
disclosure controls and procedures and internal controls over financial
reporting will prevent all error and fraud.  A control procedure, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control procedure are met.  Because of
the inherent limitations in all control procedures, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within the Corporation have been detected.  These inherent limitations
include the realities that judgements in decision-making can be faulty, and
that breakdowns in controls or procedures can occur because of simple error or
mistake.  Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the control.  The design of any control procedure is based in part upon
certain assumptions about the likelihood of future events and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, controls become inadequate because of
changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate.  Because of the inherent limitations in cost-
effective control procedures, misstatements due to error or fraud may occur
and not be detected.

     (c) Management's Annual Report on Internal Control over Financial
Reporting.  Management's report and the independent registered public
accounting firm's attestation report are included in Item 8 of this Annual
Report on Form 10-K for the year ended March 31, 2008 under the captions
entitled "Management's Annual Report on Internal Control over Financial
Reporting" and " Report of Independent Registered Public Accounting Firm."

      The Corporation intends to continually review and evaluate the design
and effectiveness of its disclosure controls and procedures and to improve its
controls and procedures over time and to correct any deficiencies that it may
discover in the future.  The goal is to ensure that senior management has
timely access to all material financial and non-financial information
concerning the Corporation's business.  While the Corporation believes the
present design of its disclosure controls and procedures is effective to
achieve its goal, future events affecting its business may cause the
Corporation to modify its disclosure controls and procedures.

Item 9B.  Other Information
---------------------------

     There was no information to be disclosed by the Corporation in a current
report on Form 8-K during the fourth quarter of fiscal 2008 that was not so
disclosed.

                                  91

<PAGE>





                                PART III

Item 10.  Directors, Executive Officers and Corporate Governance
----------------------------------------------------------------

Directors and Executive Officers

     The information contained under the section captioned "Proposal I --
Election of Directors" is included in the Company's Definitive Proxy Statement
for the 2008 Annual Meeting of Stockholders ("Proxy Statement") and is
incorporated herein by reference.

     For information regarding the executive officers of the Corporation and
the Bank, see the information contained herein under the section captioned
"Item 1.  Business - Personnel - Executive Officers of the Registrant."

Audit Committee Financial Expert

     The Audit Committee of the Corporation is composed of Directors James A.
Strengholt (Chairman) and Robert C. Tauscher.  Each member of the Audit
Committee is "independent" as defined in the NASDAQ Stock Market listing
standards.  The Corporation's Board of Directors has determined that there is
no "audit committee financial expert," as defined in the SEC's Regulation S-K.
The Board believes that the current members of the Audit Committee are
qualified to serve based on their experience and background.

Code of Ethics

     The Board of Directors have adopted Officer and Director Codes of Ethics.
The Codes are applicable to each of the Corporation's directors and officers,
including the principal executive officer and senior financial officers, and
requires individuals to maintain the highest standards of professional
conduct.   A copy of the Code of Ethics applicable to the principal executive
officer and senior financial officers was filed as an exhibit to the
Corporation's Annual Report on Form 10-K for the fiscal year ended March 31,
2007.  The Corporation has not made the Codes of Ethics available on its
website.  The Corporation will provide a copy of the Codes of Ethics free of
charge upon request.

Compliance with Section 16(a) of the Exchange Act

     The information contained under the section captioned "Section 16(a)
Beneficial Ownership Reporting Compliance" is included in the Corporation's
Proxy Statement and is incorporated herein by reference.

Item 11.  Executive Compensation
--------------------------------

     Information regarding management and director compensation and
transactions with management and others is incorporated by reference to the
section captioned "Executive Compensation" and "Director's Compensation" in
the Proxy Statement.

Item 12.  Security Ownership of Certain Beneficial Owners and Management and
----------------------------------------------------------------------------
          Related Stockholder Matters
          ---------------------------

     (a)  Security Ownership of Certain Beneficial Owners.

     The information contained under the section captioned "Security Ownership
of Certain Beneficial Owners and Management" is included in the Corporation's
Proxy Statement and is incorporated herein by reference.

     (b)  Security Ownership of Management.

     The information contained under the sections captioned "Security
Ownership of Certain Beneficial Owners and Management" and "Proposal I --
Election of Directors" is included in the Corporation's Proxy Statement and
are incorporated herein by reference.

                                 92

<PAGE>



     (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.

     (d)  Equity Compensation Plan Information

     The following table summarizes share and exercise price information about
the Corporation's equity compensation plans as of March 31, 2008.


                                                                 Number of
                                                                securities
                                                                 remaining
                                                               available for
                          Number of                           future issuance
                         securities                            under equity
                        to be issued      Weighted-average     compensation
                       upon exercise of   exercise price     plans (excluding
                         outstanding      of outstanding        securities
                      options, warrants  options, warrants     reflected in
Plan category             and rights        and rights          column (a))
--------------------  -----------------  -----------------  ------------------
                             (a)                (b)                 (c)
Equity compensation
 plans approved by
 security holders:
  1995 Stock Option
  and Incentive
  Plan...............       115,228             7.88                   --
  2005 Incentive
  Stock Plan.........        77,993            19.19              795,903

Equity compensation
 plans not approved
 by security holders.            --               --
    Total............       193,221           $12.45              795,903


Item 13.  Certain Relationships and Related Transactions, and Director
----------------------------------------------------------------------
          Independence
          ------------

     The information contained under the sections captioned "Meetings and
Committees of the Board of Directors and Corporate Governance -- Corporate
Governance -- Related Party Transactions" and "Meetings and Committees of the
Board of Directors and Corporate Governance Matters -- Corporate Governance --
Director Independence" are included in the Company's Proxy Statement and are
incorporated herein by reference.

Item 14.  Principal Accounting Fees and Services
------------------------------------------------

     The information contained under the section captioned "Independent
Auditors" is included in the Corporation's Proxy Statement and is incorporated
herein by reference.

                                  PART IV

Item 15.  Exhibits and Financial Statement Schedules
----------------------------------------------------

(a)  Exhibits
     --------

       3.1    Articles of Incorporation of Horizon Financial, Corp.
              (incorporated by reference to Exhibit 3.1 to the Registrant's
              Current Report on Form 8-K dated October 13, 1995)
       3.2    Bylaws of Horizon Financial Corp. (incorporated by reference to
              Exhibit 3.2 to the Registrant's Current Report on Form 8-K dated
              October 13, 1995)
       10.1   Amended and Restated Employment Agreement with V. Lawrence Evans
              (incorporated by reference to the Registrant's Annual Report on
              Form 10-K for the year ended March 31, 1996)
       10.2   Deferred Compensation Plan (incorporated by reference to the
              Registrant's Annual Report on Form 10-K for the year ended March
              31, 1996)

                                       93

<PAGE>



       10.3   1986 Stock Option and Incentive Plan (incorporated by reference
              to Exhibit 99.1 to the Registrant's Registration Statement on
              Form S-8 (File No. 33-99780))
       10.4   1995 Stock Option Plan (incorporated by reference to Exhibit
              99.2 to the Registrant's Registration Statement on Form S-8
              (File No. 33-99780))
       10.5   Bank of Bellingham 1993 Employee Stock Option Plan (incorporated
              by reference to Exhibit 99 to the Registrant's Registration
              Statement on Form S-8 (File No. 33-88571))
       10.6   Severance Agreement with Dennis C. Joines (incorporated by
              reference to the Registrant's Annual Report on Form 10-K for the
              year ended March 31, 2002)
       10.7   Severance Agreement with Richard P. Jacobson, as amended
              (incorporated by reference to the Registrant's Current Report on
              Form 8-K dated January 23, 2008)
       10.8   Severance Agreement with Steve Hoekstra (incorporated by
              reference to the Registrant's Quarterly Report on Form 10-Q for
              the quarter ended June 30, 2002)
       10.9   Stock Incentive Plan (incorporated by reference to Exhibit 99 to
              the Registrant's Registration Statement on Form S-8 (File No.
              333-127178))
       10.10  Form of Incentive Stock Option Award Agreement under the 2005
              Stock Incentive Plan (incorporated by reference to Exhibit 99.1
              contained in the Registrant's Current Report on Form 8-K dated
              July 27, 2005)
       10.11  Form of Non-qualified Stock Option Award Agreement under the
              2005 Stock Incentive Plan (incorporated by reference to Exhibit
              99.1 contained in the Registrant's Current Report on Form 8-K
              dated July 27, 2005)
       10.12  Form of Restricted Stock Award Agreement under the 2005 Stock
              Incentive Plan (incorporated by reference to Exhibit 99.1
              contained in the Registrant's Current Report on Form 8-K dated
              July 27, 2005)
       10.13  Transition Agreement with V. Lawrence Evans (incorporated by
              reference to the Registrant's Current Report on Form 8-K dated
              March 25, 2008)
       14     Code of Ethics (incorporated by reference to the Registrant's
              Annual Report on Form 10-K for the year ended March 31, 2007)
       21     Subsidiaries of the Registrant (incorporated by reference to the
              Registrant's Annual Report on Form 10-K for the year ended March
              31, 2007)
       23     Consent of Moss Adams LLP, Independent Registered Public
              Accounting Firm
       31     Certification of Chief Executive Officer and Chief Financial
              Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
       32     Certification of Chief Executive Officer and Chief Financial
              Officer Pursuant to Section 906 of the Sarbanes-Oxley Act

(b)    Financial Statement Schedules

       The Consolidated Financial Statements and Notes thereto are included in
Item 8 of this Form 10-K.

                                    94

<PAGE>



                            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 11, 2008              By:  /s/Richard P. Jacobson
                                       --------------------------------------
                                       Richard P. Jacobson
                                       Chief Executive Officer, President and
                                       Chief Financial Officer
                                       (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/Richard P. Jacobson       By:  /s/Robert C. Diehl
     ----------------------------      --------------------------------------
     Richard P. Jacobson               Robert C. Diehl
     Chief Executive Officer,          Director
     President and Chief
     Financial Officer
     (Principal Executive and
     Financial Officer)

Date:   June 11, 2008             Date:   June 11, 2008


By:  /s/V. Lawrence Evans         By:  /s/James A. Strengholt
     ----------------------------      --------------------------------------
     V. Lawrence Evans                 James A. Strengholt
     Chairman of the Board             Director

Date:   June 11, 2008             Date:   June 11, 2008


By:  /s/Dennis C. Joines          By:  /s/Robert C. Tauscher
     ----------------------------      --------------------------------------
     Dennis C. Joines                  Robert C. Tauscher
     President, Chief Operating        Director
     Officer and Director of
     Horizon Bank, and Executive
     Vice President and Director
     of Horizon Financial Corp.

Date:   June 11, 2008             Date:   June 11, 2008


By:  /s/Kelli J. Holz             By:  /s/Gary E. Goodman
     ----------------------------      --------------------------------------
     Kelli J. Holz                     Gary E. Goodman
     Principal Accounting Officer      Director

Date:   June 11, 2008             Date:   June 11, 2008

                                95

<PAGE>




By:  /s/Richard R. Haggen
--------------------------------
Richard R. Haggen
Director

Date: June 11, 2008


                                96

<PAGE>





















































                          EXHIBIT INDEX


Exhibit 23  Consent of Moss Adams LLP, Independent Registered Public
            Accounting Firm

Exhibit 31  Certification of Chief Executive Officer and Chief Financial
            Officer Pursuant to Section 302 of the Sarbanes-Oxley Act

Exhibit 32  Certification of Chief Executive Officer and Chief Financial
            Officer Pursuant to Section 906 of the Sarbanes-Oxley Act

<PAGE>



                                Exhibit 23

         Consent of Independent Registered Public Accounting Firm

<PAGE>



           CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Horizon Financial Corp. and Subsidiary

We consent to the incorporation by reference in the Registration Statements on
Form S-8 (No. 33-99780 and No. 333-127178) of our report dated June 11, 2008
relating to the consolidated statement of financial position of Horizon
Financial Corp. and Subsidiary as of March 31, 2008 and 2007, and the related
consolidated statements of income, stockholders' equity and comprehensive
income, and cash flows for each of the years in the three-year period ended
March 31, 2008, and in our same report, with respect to Horizon Financial
Corp. and Subsidiary's internal control over financial reporting as of March
31, 2008, appearing in this Annual Report on Form 10-K of Horizon Financial
Corp. and Subsidiary, for the year ended March 31, 2008 and 2007.

/s/Moss Adams LLP

Bellingham, Washington
June 11, 2008

<PAGE>



                               Exhibit 31

                     Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934

I, Richard P. Jacobson, certify that:


1.  I have reviewed this Annual Report on Form 10-K of Horizon Financial
    Corp.;

2.  Based on my knowledge, this report does not contain any untrue statement
    of a material fact or omit to state a material fact necessary to make the
    statements made, in light of the circumstances under which such
    statements were made, not misleading with respect to the period covered by
     this report;

3.  Based on my knowledge, the financial statements, and other financial
    information included in this report, fairly present in all material
    respects the financial condition, results of operations and cash flows of
    the registrant as of, and for, the periods presented in this report;

4.  I am responsible for establishing and maintaining disclosure controls and
    procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
    internal control over financial reporting (as defined in Exchange Act
    Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

    a)   Designed such disclosure controls and procedures, or caused such
         disclosure controls and procedures to be designed under our
         supervision, to ensure that material information relating to
         the registrant, including its consolidated subsidiaries, is made
         known to us by others within those entities, particularly during the
         period in which this report is being prepared;

    b)   Designed such internal control over financial reporting, or caused
         such internal control over financial reporting to be designed under
         our supervision, to provide reasonable assurance regarding
         the reliability of financial reporting and the preparation of
         financial statements for external purposes in accordance with
         generally accepted accounting principles;

    c)   Evaluated the effectiveness of the registrant's disclosure controls
         and procedures and presented in this report our conclusions about the
         effectiveness of the disclosure controls and procedures, as of the
         end of the period covered by this report based on such evaluation;
         and

    d)   Disclosed in this report any change in the registrant's internal
         control over financial reporting that occurred during the
         registrant's most recent fiscal quarter (the registrant's fourth
         fiscal quarter in the case of an annual report) that has materially
         affected, or is reasonably likely to materially affect, the
         registrant's internal control over financial reporting; and

5.  I have disclosed, based on our most recent evaluation of internal control
    over financial reporting, to the registrant's auditors and the audit
    committee of the registrant's board of directors (or persons performing
    the equivalent functions):

    a)   All significant deficiencies and material weaknesses in the design or
         operation of internal control over financial reporting which are
         reasonably likely to adversely affect the registrant's ability to
         record, process, summarize and report financial information; and

    b)   Any fraud, whether or not material, that involves management or other
         employees who have a significant role in the registrant's internal
         control over financial reporting.




Date: June 11, 2008

                                        /s/Richard P. Jacobson
                                        -----------------------------------
                                        Richard P. Jacobson
                                        Chief Executive Officer, President and
                                        Chief Financial Officer

<PAGE>



                                Exhibit 32

     CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
                        OF HORIZON FINANCIAL CORP.
           PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


     The undersigned hereby certify, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form
10-K, that:

     1. the report fully complies with the requirements of Sections 13(a) and
        15(d) of the Securities Exchange Act of 1934, as amended, and

     2. the information contained in the report fairly presents, in all
        material respects, the company's financial condition and results of
        operations.


/s/Richard P. Jacobson
---------------------------------
Richard P. Jacobson
Chief Executive Officer and Chief
Financial Officer

Dated: June 11, 2008

<PAGE>