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, 2006          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 incorporation                (I.R.S. Employer
or organization)                                               I.D. Number)

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

                      Common Stock, par value $1.00 per share
                      ---------------------------------------
                                 (Title of Class)

     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 of 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 if the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.  See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check
one):

Large accelerated filer     Accelerated filer  X    Non-accelerated filer
                       ----                   ----                        ----


     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, 2005, was $218,211,554 (9,918,707 shares at $22.00 per share).
As of June 6, 2006, the registrant had 9,841,632 shares of common stock
outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

     1.   Portions of the registrant's Proxy Statement for the 2006 Annual
Meeting of Stockholders. (Part III).

<PAGE>



                             HORIZON FINANCIAL CORP.
                         2006 ANNUAL REPORT ON FORM 10-K
                              TABLE OF CONTENTS
                                                                         Page
                                                                         ----
 PART I.
   Item 1. Business
             General...................................................   1
             Lending Activities........................................   1
             Investment Activities.....................................  12
             Real Estate Development Subsidiary........................  15
             Bank Owned Life Insurance.................................  15
             Deposit Activities and Other Sources of Funds.............  15
             Competition...............................................  18
             Personnel.................................................  18
             Regulation and Supervision ...............................  20
             Taxation..................................................  25
             Available Information.....................................  27
   Item 1A. Risk Factors...............................................  27
   Item 1B. Unresolved Staff Comments..................................  31
   Item 2. Properties..................................................  32
   Item 3. Legal Proceedings...........................................  34
   Item 4. Submission of Matters to a Vote of Security Holders.........  34
PART II.
   Item 5. Market for Registrant's Common Equity, Related Stockholder
           Matters and Issuer Purchases of Equity Securities...........  34
   Item 6. Selected Financial Data.....................................  36
   Item 7. Management's Discussion and Analysis of Financial Condition
           and Results of Operations...................................  37
             Forward Looking Statements................................  37
             General...................................................  38
             Business Strategy.........................................  38
             Operating Strategy........................................  38
             Critical Accounting Estimate..............................  39
             Critical Accounting Policies..............................  41
             Comparison of Financial Condition at March 31, 2006
               and March 31, 2005......................................  41
             Comparison of Operating Results for the Years Ended
               March 31, 2006 and March 31, 2005.......................  44
             Comparison of Operating Results for the Years Ended
               March 31, 2005 and March 31, 2004.......................  48
             Average Balances, Interest and Yields/Costs...............  51
             Rate/Volume Analysis......................................  52
             Liquidity and Capital Resources...........................  52
             Quantitative and Qualitative Disclosures About Market
               Risk....................................................  53
             Effects of Interest Rate Floors...........................  54
             Contractual Obligations...................................  54
             Off-Balance Sheet Arrangements............................  54
             Impact of Inflation.......................................  54
             Recent Accounting Pronouncements..........................  55
   Item 7A. Quantitative and Qualitative Disclosures About Market
               Risk....................................................  55
   Item 8. Financial Statements and Supplementary Data.................  56

                         (continued on following page)

                                       (i)

<PAGE>



   Item 9.  Changes in and Disagreements with Accountants on
              Accounting and Financial Disclosure.....................   88
   Item 9A. Controls and Procedures...................................   88
   Item 9B. Other Information.........................................   88
PART III.
   Item 10. Directors and Executive Officers of the Registrant.          89
   Item 11. Executive Compensation....................................   89
   Item 12. Security Ownership of Certain Beneficial Owners and
              Management and Related Stockholder Matters..............   89
   Item 13. Certain Relationships and Related Transactions............   90
   Item 14. Principal Accounting Fees and Services....................   90
PART IV.
   Item 15. Exhibits and Financial Statement Schedules................   90

                                      (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, 2006, the Corporation had total assets of $1.1 billion, total
deposits of $834.3 million and total equity of $113.3 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 18 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.  In fiscal 2002, the Bank acquired a bank site in Lynnwood, which
was remodeled and opened for business in March 2003.  The Bank opened
commercial banking/loan centers in Bellingham, and Everett and expanded its
operations in Burlington during the first quarter of fiscal 2004. In November
2004, the Bank opened a full service office in Marysville. In April 2005, the
Bank opened a full service office in Lakewood, located in Pierce County, just
south of Tacoma.  Future plans for the Bank include a full service regional
facility scheduled to open in June 2006, which will replace the Bank's
existing office and commercial banking center in south Everett.

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

     General.  The Bank's loan portfolio, net totaled $918.5 million at March
31, 2006, representing approximately 82.3% 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, 7.6% consisted of loans secured by
mortgages on multi-family residential properties, and 76.2% 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, business, and commercial real estate.

     The Bank has no significant concentration of credit risk other than that
a substantial portion of its loan portfolio is secured by real estate located
in the Bank's primary market area, which the Bank considers to be Whatcom,
Skagit, Snohomish and Pierce counties in Washington.  This concentration of
credit risk could have a material adverse effect on the Bank's financial
condition and results of operations to the extent there is a material
deterioration in the counties' economic and real estate values.

     In order to 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: (i) adoption of a policy under which the
Bank generally originates long-term, fixed-rate mortgage loans when such loans
are written to specifications promulgated by the Federal Home Loan Mortgage
Corporation ("Freddie Mac") and qualify for sale in the secondary market, (ii)
origination of ARM loans on residential and commercial properties subject to

                                         1

<PAGE>



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 on 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 2001.  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.


<TABLE>
                                                          At March 31,
                    ----------------------------------------------------------------------------------------
                          2006             2005              2004               2003               2002
                    ---------------   ---------------   ---------------    ---------------   ---------------
                    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..... $148,516   16.2%  $167,454   20.8%   $173,908   26.4%  $308,997   53.1%  $502,094   88.3%
 One-to-four family
  construction....   20,971    2.3     16,464    2.1      14,165    2.2     22,680    3.9     20,231    3.6
 Participations
  sold............  (56,546)  (6.2)   (65,125)  (8.1)    (74,279) (11.3)  (137,173) (23.6)  (228,874) (40.3)
                   --------  -----   --------  -----    --------  -----   --------  -----   --------  -----
    Subtotal......  112,941   12.3    118,793   14.8     113,794   17.3    194,504   33.4    293,451   51.6

 Construction and
  land develop-
  ment............  262,358   28.6    162,726   20.2     132,436   20.1     74,576   12.8     61,238   10.8
 Multi-family
  residential.....   70,079    7.6     73,397    9.1      53,344    8.1     56,930    9.8     26,971    4.8
 Commercial real
  estate..........  314,299   34.2    312,722   38.9     250,340   38.0    181,097   31.1    125,173   22.0
 Commercial loans.  123,445   13.4    109,387   13.6      87,233   13.2     55,326    9.5     38,647    6.8
 Home equity
  secured.........   44,001    4.8     33,762    4.2      25,539    3.9     21,442    3.7     23,417    4.1
 Other consumer
  loans...........    5,571    0.6      5,961    0.7       5,662    0.9      6,900    1.2      5,293    0.9
                   --------  -----   --------  -----    --------  -----   --------  -----   --------  -----
   Subtotal.......  819,753   89.2    697,955   86.7     554,554   84.2    396,271   68.1    280,739   49.4
                   --------  -----   --------  -----    --------  -----   --------  -----   --------  -----
   Total loans
    outstanding...  932,694  101.5    816,748  101.5     668,348  101.5    590,775  101.5    574,190  101.0

Less:
 Loan loss
  reserve.........  (14,184)  (1.5)   (11,767)  (1.5)    (10,122)  (1.5)    (8,506)  (1.5)    (5,887)  (1.0)
                   --------  -----   --------  -----    --------  -----   --------  -----   --------  -----
   Net loans
    receivable.... $918,510  100.0%  $804,981  100.0%   $658,226  100.0%  $582,269  100.0%  $568,303  100.0%
                   ========  =====   ========  =====    ========  =====   ========  =====   ========  =====
</TABLE>
     Loan Maturity.  The following table sets forth certain information at
March 31, 2006 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, 2006        31, 2006       31, 2006    Total
                           -----------    -----------    -----------   ------
                                                (In thousands)
Commercial, commercial
 real estate, multi-
 family, construction
 and land development......  $ 490,568     $ 199,311      $  67,896  $ 757,775
One-to-four family
 construction..............         --            --         20,971     20,971
One-to-four family
 residential, home
 equity, and other
 consumer loans............     55,564        58,324         25,876    139,764
                             ---------     ---------      ---------  ---------
   Total...................  $ 546,132     $ 257,635      $ 114,743  $ 918,510
                             =========     =========      =========  =========

                                        2

<PAGE>



     The following table sets forth the dollar amount of all loans due after
one year after March 31, 2006 which have fixed interest rates and have
floating or adjustable interest rates.  Loan balances do not include
undisbursed loan proceeds, unearned discounts, unearned income, and allowance
for loan losses.

                                                      Adjustable
                                        Fixed Rates     Rates         Total
                                        -----------   ----------    ----------
                                                    (In thousands)

Commercial, commercial real estate,
  multi-family construction and land
  development........................    $ 77,795       $189,412     $267,207
One-to-four family construction......      20,971             --       20,971
One-to-four family residential, home
  equity, and other consumer loans...      45,968         38,232       84,200
                                         --------       --------     --------
    Total............................    $144,734       $227,644     $372,378
                                         ========       ========     ========

     Multi-Family, and Commercial Real Estate Lending.  Commercial real estate
loans, including multi-family, totaled $384.4 million, or 41.9% of net loans
receivable at March 31, 2006.  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, 2006, the largest commercial real estate loan
on one property had an outstanding balance of $17.0 million and is secured by
a destination resort and surrounding real estate located in the Bank's market
area.  This loan was performing according to its terms at March 31, 2006.  At
March 31, 2006, the Bank had two other loans with net balances in excess of
$10.0 million, which are secured by commercial real estate.

     Commercial adjustable rate mortgage loans are originated with variable
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 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.  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.  The continued year-over-year
increase in the commercial real estate portfolio is attributable to the Bank's
desire to meet the growing demand in this sector of the lending market.

     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.

                                         3

<PAGE>



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 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.

     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.  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 review each appraisal 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.

     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, 2006 and 2005, the composition of the Bank's construction
loan portfolio was as follows:

                                                 At March 31,
                                ----------------------------------------------
                                       2006                     2005
                                --------------------     ---------------------
                                Amount (1)   Percent     Amount (1)    Percent
                                ---------    -------     ---------     -------
                                            (Dollars in thousands)
Speculative construction one-
 to-four family...............   $  8,675      3.10%      $  6,792      3.80%
Custom/presold construction
 one-to-four family...........     12,296      4.30          9,673      5.40
Commercial/speculative
 construction one-to-four
 family.......................     95,534     33.70         66,167     36.90
Commercial construction
 multi family.................      6,927      2.40          5,545      3.10
Commercial construction-
 nonresidential...............     56,328     19.90         46,372     25.90
Land development..............    103,568     36.60         44,342     24.90
                                ---------    ------       --------    ------
 Total........................   $283,329    100.00%      $179,190    100.00%
                                =========    ======       ========    ======
-------------
(1)  Includes loans in process.

     Speculative construction one-to-four family loans increased 27.8% from
the prior year to $8.7 million at March 31, 2006.  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.  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.

                                       4

<PAGE>



     Custom construction for one-to-four family loans increased 27.1% from the
prior year to $12.3 million at March 31, 2006.  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 or speculative
construction loans.

     Commercial speculative construction one-to-four family residential loans
increased 44.4% from the prior year to $95.5 million at March 31, 2006.
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 24.9% from the prior year, to $6.9 million at March 31, 2006, and is
the smallest portion of the Bank's construction portfolio at this time.  This
is primarily because 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 21.5% from the
prior year to $56.3 million at March 31, 2006.  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 132.0% from the prior year, to $103.6
million at March 31, 2006.  This has been a significant part of the Bank's
strategy in each of its markets, and fiscal 2006 was a successful year of
growth in this category.  Most of these loans carry interest rates tied to
Prime, 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.  The Bank, as mentioned earlier, has personnel dedicated to
ongoing monitoring and reporting on this area of the Bank's loan portfolio. 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 the time of the appraisal.  The Bank's management regularly
monitors the housing demand in its markets, the anticipated supply of building
lots, absorption rates, 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.

     In addition, since the vast majority of the Bank's construction loan
activity is concentrated in the Pacific Northwest, an economic downturn in
this area could have a significant impact on the Bank's performance,
especially in these higher risk construction lending categories.

                                         5

<PAGE>



     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 $123.4 million, or approximately 13.4% of the Bank's net loan
portfolio at March 31, 2006.  Under certain conditions, the Bank also offers
unsecured credit to qualified borrowers.

     Commercial lending carries increased risks compared to residential
mortgage lending due to the heavy reliance upon the future income of the
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 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, 2006, 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.  Under
certain conditions, ARM borrowers are allowed to convert to a fixed rate loan
beginning on the first interest rate change date and ending on the fifth
interest rate change date from the date of the loan note.  In addition,
certain consumer safeguards are built into the ARM instruments used by the
Bank.  These safeguards include limits on annual and lifetime interest rate
adjustments.  The Bank generally originates these loans in accordance with
guidelines established by the 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 actively markets consumer loans in order to provide a wider
range of financial services to its customers and to achieve shorter terms and
higher interest rates normally typical of such loans.  At March 31, 2006, the
Bank held $49.6 million of consumer loans or 5.4% of net loans receivable,
approximately $3.5 million of which is unsecured.

     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.

                                         6

<PAGE>



     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 co-signed
individually by the principals on loans made to entities other than natural
persons.  Certain lending personnel have been given limited loan approval
authority by the Board of Directors.

     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 otherwise unavailable
for lending purposes.  As of March 31, 2006, the Bank was servicing loans for
others aggregating approximately $99.5 million for which it generally receives
a fee payable monthly of .25% to .375% per annum of the unpaid balance of each
loan.  In February 2001, the Bank began selling much of its current loan
production on a servicing released basis, and plans to continue doing so for
many of the long-term fixed rate loan originations.  All sales of loan
interests by the Bank are made without right of recourse to the Bank by the
buyer of the loan interests in the event of default by the borrower.

     The Bank also buys and sells portions of commercial loans through
participations with other financial institutions.  The lead bank in a
participation lending relationship generally receives a servicing fee of .25%
to .375%.

                                         7

<PAGE>



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,
2006.

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

                                                       At  March 31,
                                                 -------------------------
                                                    2006           2005
                                                 -------------------------
                                                      (In thousands)

          Commitments to extend credit...........  286,188(1)     $219,647
          Credit card arrangements...............    9,775           9,087
          Standby letters of credit..............    5,237           1,824

         -----------
         (1) The increase in commitments to extend credit at March 31, 2006
             was the result of growth in the Bank's construction and land
             development loan portfolio.

     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 2.0% for commercial real estate loans.  The
total amount of deferred loan origination fees and unearned discounts at March
31, 2006 was $5.3 million.  Any unamortized loan fees are recognized as income
at the time the loan is sold, paid down or paid off.

     Income from loan origination and commitment fees varies with the volume
and type of loans and commitments made and purchased and with competitive
conditions in mortgage markets, which in turn responds to the demand for and
availability of money.  The Bank experiences an increase in loan fee income
and other fee income, such as appraisal and loan closing fees, during periods
of  low interest rates 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

                                         8

<PAGE>



in connection with a change in terms or other loan modifications.  These fees
and charges have not constituted a material source of income.

     Loan Modifications.  The Bank offers a loan modification program to
assist existing customers who are considering refinancing their home loans.
For a fee the Bank will modify customers' loans under the program.  No new
principal is required and only the interest rate and payment amounts are
changed.  All other terms and conditions remain the same.  In fiscal 2006, the
Bank modified $5.2 million of real estate loans, compared to $7.8 million
during fiscal 2005 when interest rates were lower and there was greater
refinance activity.

     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 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, 2006 there were no loans in
the loan portfolio over 90 days delinquent and nine loans on non-accrual
status.  The Bank had no real estate owned at March 31, 2006. Total
non-performing assets represented $1.2 million or 0.10% of total assets at
March 31, 2006 compared to $1.5 million or 0.15% of total assets at March 31,
2005.

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

                                              At March 31,
                             ---------------------------------------------
                               2006      2005     2004      2003     2002
                             -------    ------   ------    ------   ------
                                        (Dollars in thousands)

Non-accrual loans........... $ 1,161   $ 1,481   $   --    $  242   $   --
Loans 90 days or more
 delinquent and accruing
 interest...................      --        --      339       350      618
Restructured loans..........      --        --       --        --       --
Real estate acquired through
 foreclosure................      --        --       63     1,072      340
                             -------   -------   ------    ------   ------
  Total..................... $ 1,161   $ 1,481   $  402    $1,664   $  958
                             =======   =======   ======    ======   ======
As a percentage of net
 loans......................   0.13%     0.18%    0.06%     0.29%    0.17%
As a percentage of total
 assets.....................   0.10%     0.15%    0.05%     0.20%    0.12%


     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, 2006.  No interest income was recorded on
nonaccrual loans for the year ended March 31, 2006.

     Reserves 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 estimated loan losses based on evaluating known and inherent
risks in the loan portfolio.  These factors include changes in the size and
composition of the loan portfolio, actual loan loss experience, 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 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

                                         9

<PAGE>



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.

     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.  Management increases the amount of the allowance
for loan losses by charges to income and decreases the amount by loans charged
off (net of recoveries).

     The following comments represent management's view of the risks inherent
in each portfolio category.

     *    One-to-Four Family Residential - Market conditions in the Bank's
          primary market area have, over the long term, supported a stable or
          increasing market value of real estate.  Absent an overall economic
          downturn in the economy, experience in this portfolio indicates that
          losses are minimal provided the property is reasonably maintained,
          and marketing time to resell the property is relatively short.

     *    Multi-Family Residential - While there have been minimal losses 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 classifi-
          cation of commercial real estate loans closely corresponds to
          economic conditions which will limit the marketability of the
          property, resulting in higher risk than a loan secured by a
          single-family residence.  Commercial real estate loans have
          historically been assigned higher reserve levels than one-to-four
          family residential loans, but lower than commercial business loans.


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

                                        10

<PAGE>



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

     *    Unsecured Credit Cards - Due to the unsecured nature of these
          accounts, these types of loans represent the highest degree of risk.
          The Bank, therefore, uses a higher percentage factor than any other
          loan classification, when estimating future potential loan losses.

     Management believes that the allowance for loan losses at March 31, 2006
was adequate yet not excessive 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 generally accepted accounting principles, 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 established an allowance for losses for the year ended March 31,
2006 in the amount of $14.2 million and $11.8 million for the year ended March
31, 2005.  The Bank's loan loss reserve as of March 31, 2006 and 2005, was
1.54% and 1.46% of net loans receivable, respectively.

     The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.

                                          Year Ended March 31,
                             ---------------------------------------------
                               2006      2005     2004      2003     2002
                             -------    ------   ------    ------   ------
                                       (Dollars in thousands)
Allowance at beginning of
 period....................  $11,767   $10,122  $ 8,506    $5,887   $4,977
Provision for loan
 losses....................    2,575     1,700    1,915     2,740    1,089
Recoveries:
 First mortgage loans......       --        --       --        --       --
 Commercial loans..........        1       168       79        --       --
 Credit card loans.........        6         5        6         8        4
 Other consumer loans......       --         1        1        --        4
                             -------   -------  -------    ------   ------
  Total recoveries.........        7       174       86         8        8

Charge-offs:
 First mortgage loans......       --        --       --        --      (28)
 Commercial loans..........      (45)     (105)    (253)      (54)    (148)
 Credit card loans.........      (54)     (104)    (124)      (71)      (5)
 Other consumer loans......      (66)      (20)      (8)       (4)      (6)
                             -------   -------  -------    ------   ------
 Total charge-offs.........     (165)     (229)    (385)     (129)    (187)

 Net charge-offs...........     (158)      (55)    (299)     (121)    (179)
                             -------   -------  -------    ------   ------
Allowance at end of period.  $14,184   $11,767  $10,122    $8,506   $5,887
                             =======   =======  =======    ======   ======

                      (table continued on following page)

                                       11

<PAGE>



                                         Year Ended March 31,
                             ---------------------------------------------
                               2006      2005     2004      2003     2002
                             -------    ------   ------    ------   ------
                                       (Dollars in thousands)
Allowance for loan losses
as a percentage of net
loans receivable at the
end of the period.........    1.54%     1.46%     1.48%     1.35%    0.96%

Net charge-offs as a
percentage of average
loans outstanding during
the period................    0.02%     0.01%     0.05%     0.02%    0.03%

Allowance for loan losses
as a percentage of
nonperforming assets at
end of period.............1,235.31%   794.53% 2,518.51%   511.09%  614.70%


<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,
                    ---------------------------------------------------------------------------------------
                          2006             2005             2004              2003              2002
                    ---------------- ----------------  ---------------   ----------------  ----------------
                            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>
One-to-four family
 residential, home
 equity, and other
 consumer loans.... $   974   6.9%   $ 1,052    8.9%   $ 1,574   15.6 %   $ 1,780   20.9%   $ 2,105   35.8%
Commercial,
 commercial real
 estate, multi-
 family, construc-
 tion and land
 development.......  13,210  93.1     10,715   91.1      8,547   84.4       6,726   79.1      3,782   64.2
                    ------- -----    -------  -----    -------  -----     -------  -----    -------  -----
  Total allowance
   for loan losses. $14,184 100.0%   $11,767  100.0%   $10,121  100.0%    $ 8,506  100.0%   $ 5,887  100.0%
                    ======= =====    =======  =====    =======  =====     =======  =====    =======  =====

</TABLE>


The Bank had an allowance of $0, $0, $0, $0 and $50,000 for real estate
acquired through foreclosure at March 31, 2006, 2005, 2004, 2003 and 2002,
respectively.

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.

                                     12

<PAGE>



     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, 2006 was $55.1  million with a market value of
$60.5 million.  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 Bank also invests in mortgage-backed securities.  At March 31, 2006,
these securities had an amortized cost of $24.0 million and a market value of
$23.8 million.

     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, 2006 was approximately $84.4 million.  This table also
includes interest-bearing deposits and cash equivalents.

                                                      At March 31,
                                            --------------------------------
                                               2006       2005        2004
                                            ---------  ----------   --------
                                                      (In thousands)
Investment securities:
 U.S. Government:
  Available for sale.......................  $ 45,925   $ 54,034   $ 57,397
  Held to maturity.........................       370        370        369
                                             --------   --------   --------
                                               46,295     54,404     57,766
Mortgage-backed securities(1):
  Available for sale.......................    23,559     18,353     27,363
  Held to maturity.........................       482        885      1,544
                                             --------   --------   --------
                                               24,041     19,238     28,907
Other securities(2):
  Available for sale.......................     8,835     12,762     20,266
  Held to maturity.........................        --         --         --
                                             --------   --------   --------
                                                8,835     12,762     20,266
                                             --------   --------   --------

  Total investments........................    79,171     86,404    106,939

Interest-bearing deposits and cash
 equivalents...............................    33,630     27,158     39,199
                                             --------   --------   --------
                                             $112,801   $113,562   $146,138
                                             ========   ========   ========
---------
(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, 2006, 2005 and 2004 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.

                                       13
<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, 2006.

                                                      At March 31, 2006*
                   ------------------------------------------------------------------------------------
                       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........... $ 5,657  4.51%  $33,621  4.21%  $3,716  4.06%  $ 2,931  4.61%  $45,925  $45,208  4.26%
 Held to
  maturity.......      --    --       370  4.30       --    --        --    --       370      374  4.30
                 -------  -----  -------  -----   ------ -----   ------- -----   -------  ------- -----
                    5,657  4.51    33,991  4.21    3,716  4.06     2,931  4.61    46,295   45,582  4.26

Mortgage-backed
securities:
 Available for
  sale...........     --     --     1,525  4.80    3,306  5.24    18,728  4.59    23,559   23,350  4.69
 Held to
  maturity.......     --     --       443  6.41       --    --        39  9.94       482      497  6.70
                 -------  -----  -------  -----   ------ -----   ------- -----   -------  ------- -----
                      --     --     1,968  5.16    3,306  5.24    18,767  4.60    24,041   23,847  4.73
Other:
 Available for
  sale...........  7,827   5.47    1,008   5.28       --    --        --    --     8,835   14,930  5.45
 Held to
  maturity.......     --     --       --     --       --    --        --    --        --       --    --
                   7,827   5.47    1,008   5.28       --    --        --    --     8,835   14,930  5.45
                 -------  -----  -------  -----   ------ -----   ------- -----   -------  ------- -----
   Total.........$13,484   5.07  $36,967   4.29   $7,022  4.62   $21,698  4.60   $79,171  $84,359  4.54%
                 =======         =======          ======         =======         =======  =======

--------------
*   At March 31, 2006, yields on the Bank's tax-exempt obligations had not been computed on a tax equivalent
basis.

</TABLE>
                                                         14

<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 recently completed a 110 lot
residential development in north Bellingham ("Stoneybrook"), with the final 11
lots closed  in the first quarter of fiscal 2006.  Income attributable to
Westward totaled $364,668, $491,143 and  $522,429 for fiscal years 2006, 2005,
and 2004, respectively.  The majority of the lot sales for the "Stoneybrook"
development occurred in fiscal years 2005 and 2004, 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"), an established residential land
development company headquartered in Bellingham,Washington (50% owned by
Westward and 50% by Greenbriar Construction, a Bellingham based real estate
development company).   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, 2006, the real estate joint venture has a carrying amount of
approximately $16.9 million, with a related borrowing of approximately $18.3
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, 2006, the Bank held $13.7 million in bank owned life
insurance ("BOLI"), compared to $13.6 million at March 31, 2005.  The majority
of the Bank's BOLI assets are concentrated in two policies, each in the
approximate amount of $5.9 million.   These two policies were purchased in
March and April 2002, for approximately $5.0 million per policy.  These
policies are with Mass Mutual and New York Life, two of the highest rated BOLI
providers.  Both 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.

                                        15

<PAGE>



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

                                        Year Ended March 31,
                       -----------------------------------------------------
                             2006               2005              2004
                       ----------------- ----------------- -----------------
                                Weighted          Weighted          Weighted
                       Average  Average  Average  Average  Average  Average
      Type             Balance    Rate   Balance    Rate   Balance    Rate
------------------     -------    ----   -------    ----   -------    ----
                                       (Dollars in thousands)

Savings.............  $ 35,275    0.54% $ 40,956    0.53% $ 39,611    0.73%
Checking............   147,523    0.29   131,440    0.33   107,933    0.46
Money Market........   143,434    2.41   134,144    1.26   122,314    1.08
Time Deposits.......   458,017    3.50   383,161    2.86   373,725    2.99
                      --------    ----  --------    ----  --------    ----
 Total..............  $784,249    2.55% $689,701    1.92% $643,583    2.06%
                      ========    ====  ========    ====  ========    ====

    The following table indicates the amount of the Bank's deposits by time
remaining until maturity as of March 31, 2006 of $100,000 or more.

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

              Three months or less...........   $   21,487
              Over three through six months..       47,528
              Over six through twelve months.       87,058
              Over twelve months.............       83,863
                                                ----------
               Total.........................   $  239,936
                                                ==========

    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 competitive rates and local market rates, national
money market rates, and yields on assets of the same maturity.

    The Bank's Personal MMDA currently has a $1,000 minimum deposit and has a
tiered pricing program, with interest rates that vary by account dollar
balance -- $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

                                        16

<PAGE>



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 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 2006, the
Bank increased its balances in brokered deposits from $27.5 million at March
31, 2005 to $52.9 million at March 31, 2006.  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.

     Borrowings.  In December 1998, the Bank joined the FHLB of Seattle which
provides it with access to a variety of wholesale funding options.  In
addition, the Bank's securities portfolio provides additional borrowing
capacity in the reverse repurchase markets.  The Bank also has other borrowed
funds in the form of retail repurchase agreements.  These agreements are
collateralized by securities held by a safekeeping agent not under control of
the Bank.  These funds are considered overnight borrowings and bear interest
at rates that fluctuate daily based on current market rates.  At March 31,
2006, the Bank had $159.8 million in borrowings, compared to $135.8 million at
March 31, 2005.  Access to these wholesale borrowings allows management to
meet cyclical funding needs, and assists in interest rate risk management
efforts.

     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,
                                             ------------------------------
                                                2006       2005      2004
                                             ----------  --------  --------
                                                  (Dollars in thousands)
Maximum amount of borrowings outstanding
 at any month end..........................   $149,000   $129,500  $ 64,500


Approximate average borrowings outstanding..   134,070     89,920    56,381

Approximate weighted average rate paid on
 borrowings.................................     3.86%      3.26%     4.06%

                                          17

<PAGE>



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

Balance outstanding at end of period.......   $149,000   $129,500   $64,500

Weighted average rate paid on borrowings...      4.39%      3.28%     3.84%

     The Bank also has other borrowed funds in the form of retail repurchase
agreements.  These agreements are collateralized by securities held by a
safekeeping agent not under control of the Bank.  These advances are
considered overnight borrowings bearing interest rates that fluctuate daily
based on current market rates.  The Bank had $10.8 million and $5.8 million in
retail repurchase agreements outstanding as of March 31, 2006 and 2005,
respectively.

     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, 2006, Horizon Bank employed 247 full-time and 29 part-time
employees.  Horizon Bank employees are not represented by any collective
bargaining agreement.  Management of Horizon Bank considers its relations with
its employees to be good.

     Executive Officers of the Registrant

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

                         Age at
Name                 March 31, 2006                Position
----------------     --------------   -------------------------------------
V. Lawrence Evans          59         Chairman of the Board, Chief Executive
                                      Officer and President of the
                                      Corporation; and Chairman of the Board
                                      and Chief Executive Officer of the Bank

                    (table continued on following page)

                                       18

<PAGE>



                         Age at
Name                 March 31, 2006                Position
----------------     --------------   -------------------------------------
Dennis C. Joines           56         President, Chief Operating Officer and
                                      Director of the Bank; Executive Vice
                                      President and Director of the
                                      Corporation

Richard P. Jacobson        43         Vice President and Secretary of the
                                      Corporation and Executive Vice President
                                      and Secretary of the Bank

Steve L. Hoekstra          55         Executive Vice President of the Bank

Kelli J. Holz              37         Vice President of the Corporation and
                                      the Bank

David E. McCrea            43         Senior Vice President of the Bank

Frank  Jeretzky            58         Senior Vice President of the Bank

Jane L. VanVoorst          54         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 joined the Bank in 1972 and served as the Bank's
Executive Vice President from1983 to 1990.  Mr. Evans served as President of
the Bank from May 14, 1990 to April 23, 2002.  He has served as Chief
Executive Officer of the Bank since March 26, 1991 and as Chairman of the
Bank's Board of Directors since July 1997.  Mr. Evans also serves as Chairman
of the Board, President and Chief Executive Officer of the Corporation.

    DENNIS C. JOINES became President and Chief Operating Officer of the Bank
and a Director of the Corporation and the Bank on April 23, 2002.  He joined
the Bank following an extensive career in the Pacific Northwest banking
industry for over 30 years.  Most recently, Mr. Joines was Senior Vice
President/National Small Business and SBA Manager for Washington Mutual Bank
from 2001 to 2002.  Prior to that time, he served in a variety of key roles at
KeyBank from 1993 to 2001.

    RICHARD P.  JACOBSON joined the Bank in 1987 and was appointed Vice
President/Finance and Corporate Secretary in December 1994.  In March 1998,
Mr. Jacobson was appointed Senior Vice President of the Bank.  In March 2000,
he was appointed Executive Vice President of the Bank and is currently the
Chief Financial Officer.

    STEVE L. HOEKSTRA joined the Bank in June, 2002 as Executive Vice
President, Commercial Banking.  Mr. Hoekstra has 25 years of experience in the
local commercial banking industry. Most recently, he led the Bellingham
commercial and 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 and is currently the Controller of the Bank.

    DAVID E. MCCREA joined the bank in July 2005 as Senior Vice President of
Bank Operations and Compliance.  Mr. McCrea has 24 years of banking
experience, spending the last ten years at Frontier Bank as Senior Vice
President, Manager of Branch Operations and Compliance.

                                       19

<PAGE>



    FRANK JERETZKY joined the Bank in 2004 as Senior Vice President, Senior
Commercial Real Estate Lending Executive. Previously, Mr. Jeretzky was a
Commercial Real Estate Specialist for First Mutual Bank from 1996 until 2004.

    JANE L. VANVOORST joined Horizon Bank in May, 2002 as Vice President,
Consumer Lending Manager.  In March 2004, she was appointed Senior Vice
President, Retail Sales Manager.  Previously, Mrs. VanVoorst was Senior  Vice
President, District Retail Leader for Key Bank from 1998 to 2002.

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.

    The FDIC is an independent federal agency that insures the deposits, up to
applicable limits, of depository institutions.  As insurer of the Bank's
deposits, the FDIC has examination, supervisory and enforcement authority over
the Bank.  The Bank pays deposit insurance premiums based on a risk-based
system established by the FDIC.  Under this system, an institution's insurance
assessment varies according to the level of capital the institution holds, the
balance of insured deposits during the preceding two quarters, and the degree
to which it is the subject of supervisory concern.  In addition, regardless of
the potential risk to the insurance fund, federal law requires the ratio of
reserves to insured deposits at $1.25 per $100.

    The FDIC may terminate the deposit insurance of any insured depository
institution 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 termination, less subsequent withdrawals, will
continue to be insured for a period of six months to two years, as determined
by the FDIC.  Management is not aware of any existing circumstances that could
result in termination of the deposit insurance of the Bank.

    On February 8, 2006, the President of the United States signed into law a
deficit reduction bill that included significant deposit insurance reform
provisions. The deposit insurance reform provisions will merge the two deposit
insurance funds into a single fund; increase deposit insurance coverage for
individual retirement accounts to $250,000;

                                        20

<PAGE>



maintain coverage for standard accounts at $100,000 while providing for
periodic increases in coverage for standard accounts and individual retirement
accounts because of inflation; authorize revisions to the current risk-based
system for assessing insurance premiums; provide insurance premium assessment
credits to offset future FDIC insurance premiums under the new risk-based
assessment system to banks that capitalized the deposit funds prior to 1996;
provide the FDIC with flexibility to manage the new insurance fund by setting
the designated reserve ratio between 1.15% and 1.50% of insured deposits,
thereby eliminating the fixed 1.25% designated reserve ratio; and impose a cap
on the growth of the insurance fund by requiring a premium dividend to
depository institutions of 50% of the excess premiums when the insurance fund
exceeds 1.35% of insured deposits and 100% of the excess above 1.50%.

    The merger of the two deposit insurance funds is expected to occur no
later than July 1, 2006.  All other important provisions, including the new
risk-based assessment system, must be implemented through FDIC rulemaking that
is expected to be completed by the end of 2006.

    Prompt Corrective Action.  Federal statutes establish a supervisory
framework based on five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized.  An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a
risk-based capital measure, a leverage ratio capital measure and certain other
factors.  The federal banking agencies have adopted regulations that implement
this statutory framework.  Under these regulations, an institution is treated
as well capitalized if its ratio of total capital to risk-weighted assets is
10% or more, its ratio of core capital to risk-weighted assets is 6% or more,
its ratio of core capital to adjusted total assets (leverage ratio) is 5% or
more, and it is not subject to any federal supervisory order or directive to
meet a specific capital level.  In order to be adequately capitalized, an
institution must have a total risk-based capital ratio of not less than 8%, a
Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of
not less than 4%.  Any institution which is neither well capitalized nor
adequately capitalized is considered undercapitalized.

    Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized.  Failure
by the Bank to comply with applicable capital requirements would, if
unremedied, result in restrictions on its activities and lead to enforcement
actions, including, but not limited to, the issuance of a capital directive to
ensure the maintenance of required capital levels.  Banking regulators will
take prompt corrective action with respect to depository institutions that do
not meet minimum capital requirements.  Additionally, approval of any
regulatory application filed for their review may depend on compliance with
capital requirements.

    Capital Requirements. Federally insured savings institutions, such as
Horizon Bank, are required to maintain a minimum level of regulatory capital.
FDIC regulations recognize two types, or tiers, of capital: core ("Tier 1")
capital and supplementary ("Tier 2") capital.  Tier 1 capital generally
includes common stockholders' equity and noncumulative perpetual preferred
stock, less most intangible assets.  Tier 2 capital, which is limited to 100%
of Tier 1 capital, includes such items as qualifying general loan loss
reserves, cumulative perpetual preferred stock, mandatory convertible debt,
term subordinated debt and limited life preferred stock; however, the amount
of term subordinated debt and intermediate term preferred stock (original
maturity of at least five years but less than 20 years) that may be included
in Tier 2 capital is limited to 50% 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, 2006, the Bank had Tier 1
leverage capital of 10.0%.   Horizon Bank has not been notified by the FDIC of
any higher capital requirements specifically applicable to it.

    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

                                        21

<PAGE>


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 investment quality, the effectiveness
of loan and investment policies, and management's ability to monitor and
control financial operating risks.  At March 31, 2006, the Bank's determined
that its total risk-based ratio was 12.6% and its Tier 1 risk-based capital
ratio was 11.1%.

    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, 2006, Horizon Bank had a net worth of 10.1% 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 14 of the Notes to the Consolidated Financial
Statements contained in Item 8 of this Form 10-K.

    Federal Deposit Insurance Improvement Act ("FDICIA").  Horizon Bank has
more than $1.0 billion in assets and therefore, is required to comply with the
provisions of  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.

    The FDIC as the primary regulator of the Bank 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 in an
amount equal to .50% of home mortgage loans and pass through securities plus
2.5% of the advances outstanding.   As of March 31, 2006, Horizon Bank held

                                         22

<PAGE>



stock in the FHLB of Seattle in the amount of $7.2 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.  NOW accounts and other types of accounts that permit payments
or transfers to third parties fall within the definition of transaction
accounts and are subject to Regulation D reserve requirements, as are any
non-personal time deposits at a savings bank.  Under Regulation D, a bank must
establish reserves equal to 3% of the first $47.6 million of transaction
accounts, of which the first $7.0 million is exempt, and 10% of the remainder.
Currently, there is no reserve requirement on nonpersonal time deposits with
original maturities of less than 1.5 years.  As of March 31, 2006, the Bank
was in compliance with the Federal Reserve Bank's reserve requirements.

    Privacy Standards.  On November 12, 1999, the Gramm-Leach-Bliley Financial
Services Modernization Act of 1999 was signed into law.  The purpose of this
legislation is to modernize 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 Gramm-Leach-Bliley Act.  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.  The
regulations also require the Bank to provide its customers with initial and
annual notices that accurately reflect its privacy policies and practices.  In
addition, the Bank is required to provide its customers with the ability to
"opt-out" of having the Bank share their non-public personal information with
unaffiliated third parties before they can disclose such information, subject
to certain exceptions.

    The Bank is subject to regulatory guidelines establishing standards for
safeguarding customer information.  These regulations implement certain
provisions of the Gramm-Leach-Bliley Act.  The guidelines describe the
agencies' expectations for the creation, implementation and maintenance of an
information security program, which would include administrative, technical
and physical safeguards appropriate to the size and complexity of the
institution and the nature and scope of its activities.  The standards set
forth in the guidelines are intended to insure the security and
confidentiality of customer records and information, protect against any
anticipated threats or hazards to the security or integrity of such records
and protect against unauthorized access to or use of such records or
information that could result in substantial harm or inconvenience to any
customer.

    Anti-Money Laundering and Customer Identification.  In response to the
terrorist events of September 11, 2001, the Uniting and Strengthening America
by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism
Act of 2001 (the "USA Patriot Act") was signed into law on October 26, 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.  The Bank Secrecy Act, Title III of the USA Patriot
Act, takes measures intended to encourage information sharing among bank
regulatory agencies and law enforcement bodies.  Further, certain provisions
of Title III impose affirmative obligations on a broad range of financial
institutions.  Title III of the USA Patriot Act and the related FDIC
regulations impose the following requirements with respect to financial
institutions:

    1.   establishment of anti-money laundering programs;

    2.   establishment of a program specifying procedures for obtaining
         identifying information from customers seeking to open new accounts,
         including verifying the identity of customers within a reasonable
         period of time;

    3.   establishment of enhanced due diligence policies, procedures and
         controls designed to detect and report money laundering;

                                      23

<PAGE>



    4.   prohibitions on correspondent accounts for foreign shell banks and
         compliance with record keeping obligations with respect to
         correspondent accounts of foreign banks.

Bank regulators are directed to consider a holding company's effectiveness in
combating money laundering when ruling on Federal Reserve Act and Bank Merger
Act applications.  The Bank's policies and procedures have been updated to
reflect the requirements 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 reports and
such additional information as the Federal Reserve may require and will be
subject to regular examinations by the Federal Reserve.  The Federal Reserve
also has extensive enforcement authority over bank holding companies,
including, among other things, the ability to assess civil money penalties to
issue cease and desist or removal orders and to require that a holding company
divest subsidiaries (including its bank subsidiaries).  In general,
enforcement actions may be initiated for violations of law and regulations and
unsafe or unsound practices.

    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, the Federal Reserve 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 is required to file quarterly and periodic reports with
the Federal Reserve and provide 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 Corporation and any subsidiaries that it may control are considered
"affiliates" within the meaning of the Federal Reserve Act, and transactions
between the Corporation's bank subsidiary and 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 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


                                       24

<PAGE>



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
Federal Reserve also indicated that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.

    Capital Requirements. The Federal Reserve has established capital 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, 2006, the Corporation's capital position was in excess of these
requirements with total risk based capital of 12.6% of risk-weighted assets
and Tier 1 (core) capital of 11.1% 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 12 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.

    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

                                       25

<PAGE>



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.

    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.

                                        26

<PAGE>




 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 the
Corporation's 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 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.

                                       27

<PAGE>



    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.  We also utilize market value analysis, which addresses
changes in estimated net market value of equity arising from changes in the
level of interest rates.  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 Includes Loans with a Higher Risk of Loss.

    We originate commercial and multi-family real estate loans, construction
and land development loans, commercial loans,  consumer loans and residential
mortgage loans primarily within our market areas. Generally, types of loans
other than the residential mortgage loans have a higher risk of loss than
residential mortgage loans.  We had $819.8 million outstanding in these loans
at March 31, 2006.  We have had a significant increase in our commercial real
estate and construction and land development lending since March 31, 2003.
Commercial and multi-family real estate, construction and land development,
commercial, and consumer loans may expose a lender to greater credit risk than
loans secured by residential real estate because the collateral securing these
loans may not be sold as easily as residential real estate.  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 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.

    *    Consumer Loans.  Consumer loans (such as personal lines of credit)
         are collateralized, if at all, with assets that may not provide an
         adequate source of payment of the loan due to depreciation, damage,
         or loss.

                                        28

<PAGE>



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 would negatively affect 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 customers
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.

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 1.52% of total loans at March 31, 2006.

    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,

                                       29

<PAGE>



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.

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.

We Are Subject to Extensive Government Regulation and Supervision.

    We are subject to extensive federal and state regulation and supervision
primarily through the 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."

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,

                                      30

<PAGE>



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 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.

                                       31

<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, 2006    Feet     Owned
                                 ------   --------------   ------    -------
                                          (In thousands)

Bellingham Main Office and
 Whatcom  Mortgage Center........ 1971        $1,728       19,179     Owned
 1500 Cornwall Avenue
 Bellingham, WA 98225

Bellingham/Meridian.............. 1987           761         4650     Owned
 4110 Meridian Street
 Bellingham, WA 98226

Ferndale Office.................. 1976           259         3692     Owned
 Third and Main
 Ferndale, WA 98248

Lynden Office.................... 1981           526         3702     Owned
 Third and Grover Streets
 Lynden, WA 98264

Blaine Office.................... 1976           604        3,610     Owned
 Fourth & "H" Streets
 Blaine, WA 98230

Mount Vernon Office.............. 1976           233        3,275     Owned
 1503 Riverside Dr.
 Mount Vernon, WA 98273

Anacortes Office................. 1987           713        3,650     Owned
 1218 Commercial Avenue
 Anacortes, WA 98221

Snohomish Office................. 1987           150        1,388     Owned
 620 2nd Street
 Snohomish, WA 98290

Everett Office................... 1991            49         1972     Leased
 909 S.E. Everett Mall Way,
 #E-500
 Everett, WA 98208

Burlington Office, Skagit
 Commercial Center and Skagit
 Mortgage Center................. 1994         1,110        3,980     Owned
 1020 S. Burlington Blvd
 Burlington, WA  98232

                         (table continues on following page)

                                       32

<PAGE>



                                            Net Book
                                  Year     Value as of     Square    Leased/
                                 Opened   March 31, 2006    Feet     Owned
                                 ------   --------------   ------    -------
                                          (In thousands)

Edmonds Office................... 1994        $1,987       15,265     Owned
 130 Fifth Avenue South
 Edmonds, WA  98020

Murphy's Corner Office........... 2000         1,613        3,720     Owned
 12830 Bothell Everett Hwy.
 Everett, WA 98208

Barkley Office................... 1999         2,910       14,691     Owned
 2122 Barkley Blvd.
 Bellingham, WA 98228

Holly Street Office.............. 1999           382        4,000     Owned
 211 E. Holly Street
 Bellingham, WA 98227

Alabama Office................... 1999           719        4,500     Owned
 802 Alabama Street
 Bellingham, WA 98228

Marysville Office (1)............ 2004         2,309        4,126     Owned
 3617 88th St NE
 Marysville, WA 98270

Lynnwood Office.................. 2003         2,287        4,230     Owned
 19405 44th Avenue W.
 Lynnwood, WA 98036

Lakewood Office, Pierce
 Commercial Center and Pierce
 Mortgage Center (2)............. 2005         2,216        4,773     Owned
 10318 Gravelly Lake Dr. SW
 Lakewood, WA 98499

Everett Office................... 2006(3)      5,374       16,000     Owned
 9929 Evergreen Way
 Everett, WA 98204

Whatcom Commercial Center........ 2003           344        5,200     Leased
 2211 Rimland Drive, Suite 230
 Bellingham, WA 98226

Snohomish Commercial Center...... 2003            43        1,700     Leased
 906 S. Everett Mall Way,
 Suite 140
 Everett, WA 98208

--------------
(1)  Opened in November 2004.
(2)  Opened in April 2005.
(3)  Scheduled to open June 2006. Replaces the Bank's existing leased retail
     office, Snohomish Commercial Center and Snohomish Mortgage Center.

                                       33

<PAGE>



     At March 31, 2006, the aggregate book value of the Corporation's premises
and equipment was $26.3 million.

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 Stock Market
under the symbol HRZB.  The common stock began trading on the Nasdaq Stock
Market at the time of Horizon Bank's conversion to stock form in August 1986.
The following table presents the high and low prices as reported by the Nasdaq
Stock Market and dividends paid for the last two fiscal years.  These prices
represent quotations by the dealers and do not necessarily represent actual
transactions, and do not include retail markups, markdowns or commissions.
The Corporation has approximately 4,500 stockholders.

     2006 Fiscal Year
     Quarter                High         Low         Dividend
     ------------------    ------      -------       --------

     Fourth..............  $26.35       $21.23        $0.145
     Third...............   23.42        18.85         0.145
     Second..............   22.70        20.07         0.140
     First...............   22.50        17.67         0.140

     2005 Fiscal Year
     Quarter                High         Low         Dividend
     ------------------    ------      -------       --------

     Fourth..............  $22.02       $17.55        $0.135
     Third...............   22.00        18.59         0.135
     Second..............   20.42        17.37         0.130
     First...............   20.07        16.73         0.130

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.

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

     The Corporation has had various buy-back programs since August 1996.  As
of March 31, 2006, repurchases of the Corporation's outstanding common stock
have resulted in the repurchase of 1,942,730 shares.  This amount includes the
212,852 shares that were repurchased at an average price of $20.517 per share
during the year ended March 31, 2006 under the Corporation's repurchase
program approved by the Board of Directors in March 2005 for a 12 month

                                       34

<PAGE>



period.  On March 28, 2006, the Board of Directors authorized the repurchase
of 500,000 shares, or approximately 5% of the Corporation's outstanding shares
of common stock for a 12 month period.

     The following table sets forth the Corporation's repurchases of its
outstanding common stock during the fourth quarter of the year ended March 31,
2006.

                               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, 2006 -
 January 31, 2006....    --             --        202,552 (1)      797,448

February 1, 2006 -
 February 28, 2006...  2,400          23.819      204,952 (1)      795,048

March 1, 2006 -
 March 31, 2006......  7,900          24.447      212,852 (1)      787,148
                      ------          ------      ----------       ---------

Total................ 10,300           24.30      212,852 (1)      500,000 (2)
                      ======          ======      ==========       ==========

------------
(1)  Reflects purchases made under the repurchase plan authorized by the Board
     of Directors in March 2005.
(2)  Reflects new repurchase plan authorized by the Board of Directors in
     March 2006.

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.

                                       35

<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,
                        ------------------------------------------------------
                         2006        2005        2004        2003        2002
                        ------      ------      ------      ------      ------
                                            (In thousands)
Financial Condition Data:
------------------------

Total Assets........$1,116,728    $997,570    $858,876    $819,872   $772,063
Loans Receivable,
 net................   918,510     804,981     658,226     582,269    568,303
Cash and Investment
 Securities.........   125,216     125,965     161,071     197,296    171,346
Deposits............   834,299     746,849     670,259     646,722    628,782
Borrowings..........   159,837     135,787      67,469      53,763     29,121
Stockholders'
 Equity.............   113,323     107,024     109,307     106,244    100,600

                                          Year Ended March 31,
                        ------------------------------------------------------
                         2006        2005        2004        2003        2002
                        ------      ------      ------      ------      ------
                                            (In thousands)
Operating Data:
---------------

Interest Income.....   $69,388     $52,182     $48,979     $50,698    $53,312
Interest Expense....    24,896      16,144      15,509      19,461     26,541
                       -------     -------     -------     -------    -------
Net Interest
 Income.............    44,492      36,038      33,470      31,237     26,771
Provision for Loan
 Losses.............    (2,575)     (1,700)     (1,915)     (2,740)    (1,089)
Noninterest Income..     6,423       6,517       7,881       6,939      4,393
Noninterest
 Expense............    25,782      22,423      20,238      17,346     14,891
Income before
 Provision for Income
 Taxes..............    22,558      18,432      19,198      18,090     15,184
Provision for Income
 Tax................    (6,903)     (5,369)     (6,332)     (5,950)    (5,130)
                       -------     -------     -------     -------    -------
Net Income..........   $15,655     $13,063     $12,866     $12,140    $10,054
                       =======     =======     =======     =======    =======

Per Common Share:(1)
 Fully-diluted
  earnings..........   $  1.56     $  1.26     $  1.20     $  1.12    $  0.91
 Dividends..........      0.57        0.53        0.49        0.45       0.38
 Book Value.........     11.45       10.66       10.50       10.07       9.35
 Weighted average
  shares
  outstanding....... 9,937,600  10,212,190  10,480,785  10,674,506 10,921,233

-----------
(1)  Restated for 15% stock dividend effective May 11, 2001 and 25% stock
     split effective July 23, 2002.

                                       36
<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,
                                                     ------------------------
                                                      2006     2005     2004
                                                     ------   ------   ------

Return on average assets (net income divided by
 average total assets)..............................  1.48%    1.43%    1.55%

Return on average equity (net income divided by
 average equity).................................... 14.32    12.11    11.94

Dividend payout ratio (dividends declared per share
 divided by fully-diluted earnings per share)....... 36.54    42.06    40.83

Equity to assets ratio (average equity divided by
 average total assets).............................. 10.35    11.84    13.02

Interest rate spread (difference between average
 yield on interest-earning assets and average cost
 of interest bearing liabilities)...................  4.54     4.21     4.24

Net yield on earning assets (net interest income as
 a percentage of average interest earning assets)...  4.66     4.34     4.42

Efficiency ratio (noninterest expense divided by
 the sum of net interest income and noninterest
 income)............................................ 50.64    52.69    48.94

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 at 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 statement in this Form 10-K.  These forward-looking statements
are generally identified by use of the word "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar words.  The Corporation's
ability to predict results of the actual effect of future plans or strategies
is uncertain.  Factors which could 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, demand for loan products, deposit flows,
competition, demand for financial services in the Corporation's market areas
and 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.

                                      37

<PAGE>



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.

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 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 does not presently engage in any activities outside of
serving as a shell parent company for the Bank.  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 only one office in Pierce County (south
of King County), with the remaining offices all located north of King County.
Management hopes to provide additional support to its Lakewood Office in
Pierce County at some point in the future, however, no additional offices are
planned at this time.  Management has further indicated that the market areas
just outside of 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 reviewed 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
increasing its Prime based loan portfolio, at a time when many lenders were
offering fixed rate real estate loans at sub-Prime rates.  In this regard, the
Bank's loan portfolio growth was heavily concentrated in the active real
estate development markets in the Puget Sound region.  Through its excellent
relationships with established real estate developers, the Bank's experienced

                                      38

<PAGE>



loan officers were successful at increasing this portion of the Bank's
portfolio, which is primarily Prime based business.  This has been beneficial
in the past year, with the Federal Reserve's Open Market Committee's ("FOMC")
efforts to increase short terms interest rates, which have in turn increased
the Prime lending rate on a regular basis.  The results of this strategy are
discussed in more detail in the section entitled "-- Comparison of Operating
Results for the Years Ended March 31, 2006 and March 31, 2005 -- Net Interest
Income."  On the liability side of the balance sheet, the impact of these
increasing rates has also impacted the Bank's earnings, however at a more
moderate level to date.  Management acknowledges that there is a lag effect in
this regard, as the rates on the Bank's certificates of deposit liabilities do
not adjust instantly, rather the impact occurs more gradually as the
certificates of deposit mature and reprice in this higher rate environment.
These increases in liability expenses will continue even after the FOMC stops
its current tightening cycle, as long as the rates being offered for new
certificates of deposit are higher than those maturing (as is the case
currently).

     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
enhanced 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, 2006 and March 31, 2005."

     Other noninterest expenses include compensation and benefits, occupancy
and equipment expenses, deposit insurance premiums, data servicing expenses
and other operating costs.  In fiscal 2005, the Bank's efficiency ratio was
adversely impacted by a conversion of the Bank's core data processor. However,
management believes that the conversion will assist in achieving improving
efficiencies, as the new core system contains improvements that will allow the
Bank to grow more efficiently.  In fiscal 2006, the Bank began  a Bank-wide
efficiency initiative, soliciting input from all employees and implementing
many of the suggestions made during the project.  This will be an ongoing
process, as management continues to look for ways to improve efficiency.  To
encourage employees to participate in this initiative, the Bank has added a
profitability component to the incentive portion of employee's pay, and an
efficiency counts 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 the conversion
in November 2004, the focus was 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 is a process that
will continue in future years.

     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 Estimate
----------------------------

     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, a
review 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 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.

                                      39

<PAGE>



     The Corporation has 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.  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, 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.  A reserve factor is applied
to homogeneous loan pools that is 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, 2006 and believes that the allowance at 1.54% of
net loans, or $14.2 million is adequate yet not excessive for the risk
inherent in the loan portfolio and the current economic environment.  The
allowance was 1.46% of net loans or $11.8 million at March 31, 2005.  In
fiscal 2006, the loan portfolio grew 14.1% to $919.0 million at March 31, 2006
from $805.0 million at March 31, 2005.  The loan portfolio has experienced
substantial growth especially in construction and land development loans. At
March 31, 2006, construction and land development loans totaled $262.4
million, an increase of $99.6 million from $162.7 million at March 31, 2005.
The increase in the allowance is primarily attributable to the substantial
growth in this higher risk portion of the loan portfolio.  In addition, while
fiscal 2006 was a period that showed continued improvement in the economic
environment in the Bank's markets, these markets also experienced significant
housing price increases, well in excess of wage growth.  These factors,
coupled with the increasing energy costs, increasing commodity prices, and the
lagging effects of the Federal Reserve's tightening cycle, led management to
increase the allowance to its current levels.

     The Bank recorded net charge-offs of $158,000, $55,000, $300,000,
$121,000 and $179,000 during the years ended March 31, 2006, 2005, 2004, 2003
and 2002, respectively.  Consumer loans (including home equity) totaled $48.8
million or 5.3% of the net loan portfolio at March 31, 2006.  Visa card loans
and unsecured consumer loans accounted for all of the Bank's charge-offs.

     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 $2.6 million, $1.7 million, $1.9 million, $2.7 million and
$1.1 million for the fiscal years ended 2006, 2005, 2004, 2003, and 2002,
respectively.

                                      40

<PAGE>



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
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, 2006 and March 31, 2005
----------------------------------------------------------------------

     Total consolidated assets for the Corporation as of March 31, 2006, were
$1.1 billion, an 11.9% increase from the March 31, 2005 level of $997.6
million.  This increase in assets was primarily attributable to the growth in
loans receivable to $918.5 million at March 31, 2006 from $805.0 million at
March 31, 2005.  This loan growth was primarily attributable to the increase
in commercial loans during this period, as the Bank continued its practice of
selling most of its single-family fixed rate loan production into the
secondary market.  The Bank sold $103.7 million of real estate loans in fiscal
2006, compared to $106.4 million in fiscal 2005.  The Bank sells real estate
loans during periods of increased loan volume to improve cash flow and to
manage its interest rate risk profile.


                                      41

<PAGE>



     The following is an analysis of the loan portfolio by major type of loan
at March 31, 2006 and 2005.

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

First mortgage loans:
  One-to-four family....................  $148,516       $167,454
  One-to-four family construction.......    20,971         16,464
  Participations sold...................   (56,546)       (65,125)
                                          --------       --------
     Subtotal...........................   112,941        118,793

  Construction and land
   development..........................   262,358        162,726
  Residential commercial
   real estate..........................    70,079         73,397
  Nonresidential commercial real
   estate...............................   314,299        312,722
  Commercial loans......................   123,445        109,387
  Home equity secured...................    44,001         33,762
  Other consumer loans..................     5,571          5,961
                                          --------       --------
     Subtotal...........................   819,753        697,955
                                          --------       --------
     Subtotal...........................   932,694        816,748

Less:
  Allowance for loan losses.............   (14,184)       (11,767)
                                          --------       --------
     Total loans receivable.............   918,510        804,981


Net residential loans...................   111,967   12%  117,809   15%
Net commercial loans....................   121,117   13   107,404   13
Net commercial real estate loans........   636,657   70   540,698   67
Net consumer loans......................    48,769    5    39,070    5
                                          --------  ---  --------  ---
                                          $918,510  100% $804,981  100%
                                          ========  ===  ========  ===

                                       42

<PAGE>



     Also contributing to the change in assets was the decline in investment
and mortgage-backed securities, available for sale, which, combined, decreased
7.6% to $83.5 million at March 31, 2006 from $90.3 million at March 31, 2005
as management allowed these funds to shift to loans receivable during the
year.  The tables below display the characteristics of the available for sale
and held to maturity portfolios at March 31, 2006:

                                                  At March 31, 2006
                                          ----------------------------------
                                          Amortized      Gain/     Estimated
                                            Cost        (Loss)    Fair Value
                                          ---------    --------   ----------
                                                    (In thousands)
Available For Sale Securities
  State and political subdivisions and
   U.S. government agency securities...... $45,925       $ (717)    $45,208
  Marketable equity securities............   1,824       6,226       8,050
  Mutual funds............................   5,000         (131)      4,869
  Corporate debt securities...............   2,011           (1)      2,010
  Mortgage-backed securities and CMOs.....  23,559         (208)     23,351
                                           -------       ------     -------
    Total available-for-sale securities...  78,319        5,169      83,488

Held To Maturity Securities
  State and political subdivisions and
   U.S. government agency securities......     370            4         374
  Mortgage-backed securities and CMOs.....     482           15         497
                                           -------       ------     -------
    Total held to maturity securities.....     852           19         871
                                           -------       ------     -------
    Total securities...................... $79,171       $5,188     $84,359
                                           =======       ======     =======

                                        Maturity Schedule of Securities
                                               at March 31, 2006
                                ----------------------------------------------
                                 Available For Sale       Held To Maturity
                                ---------------------   ----------------------
                                Amortized   Estimated   Amortized   Estimated
                                   Cost     Fair Value    Cost      Fair Value
                                ---------   ----------  ---------   ----------
                                                (In thousands)
Maturities:
  Less than one year............ $ 6,660     $ 6,644       $ --       $ --
  Over one year to five years...  36,155      35,577        813        821
  Over five to ten years........   7,022       6,916         --         --
  Over ten years................  21,658      21,432         39         50
                                 -------     -------       ----       ----
                                  71,495      70,569        852        871

Mutual funds and marketable
 equity securities..............   6,824      12,919         --         --
                                 -------     -------       ----       ----
   Total investment securities.. $78,319     $83,488       $852       $871
                                 =======     =======       ====       ====

                                       43

<PAGE>



     Total liabilities also increased 12.7% to $1.0 billion at March 31, 2006,
from $890.5 million at March 31, 2005.  This increase was the result, in large
part, of growth in deposits, which increased 11.7% to $834.3 million at March
31, 2006 from $746.8 million at March 31, 2005.  The following is an analysis
of the deposit portfolio by major type of deposit at March 31, 2006 and 2005:

                                                At March 31,
                                           ---------------------
                                             2006         2005
                                           --------     --------
                                               (In thousands)
     Demand Deposits
      Savings............................. $ 30,808     $ 40,863
      Checking............................   79,774       83,268
      Checking (noninterest-bearing)......   80,778       63,503
      Money Market........................  156,867      134,761
                                           --------     --------
                                            348,227      322,395
                                           --------     --------

     Time certificates of deposit
      Less than $100,000..................  246,136      240,178
      Greater than or equal to $100,000...  239,936      184,276
                                           --------     --------
                                            486,072      424,454
                                           --------     --------
     Total deposits....................... $834,299     $746,849
                                           ========     ========

     Also contributing to the growth was an increase in other borrowed funds
to $141.5 million at March 31, 2006, from $119.1 million at March 31, 2005.
During the year, the Bank borrowed an additional $20.0 million from the FHLB
to help manage interest rate risk and support the growth in assets.

    Also included in the March 31, 2006 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, purchased an 85 acre parcel of land in
Bellingham, Washington for future development.  The partnership intends to
develop the property in future years, into a neighborhood community to be
known as Fairhaven Highlands.   The $16.9 million shown on the Corporation's
balance sheet as an asset at March 31, 2006 represents the current level of
the investment in real estate joint ventures, including the Fairhaven
Highlands joint venture.  At March 31, 2005, the $17.2 million total
investment in joint ventures included a remaining portion of a residential
development joint venture that has since been completed and closed.  The $18.3
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 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.

     Stockholders' equity at March 31, 2006 increased 5.9% to $113.3 million
from $107.0 million at March 31, 2005.  This increase was primarily
attributable to the increase in net income to $15.7 million at March 31, 2006
from $13.1 million at March 31, 2005.  This change includes the effects from
the Corporation's share repurchase program, with repurchases totaling $4.4
million for the year ended March 31, 2006 compared to $8.7 million for the
year  ended March 31, 2005.  The Corporation remains strong in terms of its
capital position, with a stockholder equity-to-assets ratio of 10.2% at March
31, 2006, compared to 10.7% at March 31, 2005.

Comparison of Operating Results for the Years Ended March 31, 2006 and March
----------------------------------------------------------------------------
31, 2005
--------


     Net Interest Income.  Net interest income in fiscal 2006 was $44.5
million, a 23.5% increase from $36.0 million in fiscal 2005.  Total interest
income increased 33.0% in fiscal 2006 to $69.4 million from $52.2 million in
fiscal 2005.

     Interest income on loans in fiscal 2006 was $65.9 million, a 23.5%
increase from $48.1 million in fiscal 2005.  The increase in fiscal 2006 was
as a result of a combination of factors, including: 1) the growth in loans
receivable, as

                                      44

<PAGE>



the Bank experienced significant loan growth during the year, increasing to
$918.5 million at March 31, 2006, compared to $805.0 million at March 31,
2005; and 2) an increasing Prime lending rate throughout the fiscal year.
With a portfolio of Prime based loans in excess of $400 million throughout the
year ($444.9 million at March 31, 2006) 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 7.75% at March 31, 2006, compared to 5.75% at March 31, 2005.

     Also included in interest income for the year ended March 31, 2006, 2005
and 2004 were approximately $2.3 million, $1.5 million and $3.0 million,
respectively, of deferred fee income recognition.  In fiscal 2006 and 2005,
most of these fees were related to the Bank's commercial loan portfolio, that
resulted in large part to 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,
                                                --------------------
                                                  2006       2005
                                                -------    --------
                                                   (In thousands)

     Commercial loan deferred fees.............. $2,960     $1,793
     One-to-four real estate mortgage
       loan deferred fees.......................    519        813
                                                 ------     ------
        Total................................... $3,479     $2,606
                                                 ======     ======

     Interest and dividends on investments and mortgage-backed securities was
$3.5 million in fiscal 2006, a 12.8% decrease from $4.1 million in fiscal
2005.  This decrease was attributable to lower levels of investments and
mortgage-backed securities outstanding during the respective periods, as
average total investments decreased 17.5% to $92.2 million at March 31, 2006
compared to $111.8 million at March 31, 2005. The decline in the investment
portfolio balances in these years was primarily attributable to the funding of
the Bank's lending activities.  To enhance the Bank's profitability,
management chose to direct its available funds to fund loans receivable, in
lieu of purchasing securities for its investment portfolio.  Also contributing
to the decline in fiscal 2006 was a reduction in dividend income on the Bank's
FHLB stock.  At March 31, 2006, Horizon Bank held $7.2 million in FHLB of
Seattle stock and received dividends in the amounts of $29,500 in fiscal 2006
compared to $162,800 in fiscal 2005.  The FHLB of Seattle announced that,
despite the dividend paid to shareholders on March 31, 2005, it had
indefinitely suspended the payment of dividends.  The FHLB of Seattle is
operating under a regulatory directive and in April 2005 announced that all
future dividends would be suspended until its financial position and
performance improves.  On May 18, 2005, the FHLB of Seattle announced a
three-year dividend suspension; therefore, the Bank's investment income will
be reduced accordingly over this time period.  Stock ownership in the FHLB of
Seattle is expected to remain stable, increasing only if necessary to support
the Bank's borrowing needs.  The FHLB of Seattle recently revised its stock
requirement related to borrowings outstanding, 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 2006 increased 54.2% to $24.9 million
from $16.1 million in fiscal 2005.  Interest on deposits increased
significantly to $20.0 million in fiscal 2006 from $13.2 million in fiscal
2005. As discussed in the paragraphs above, the increasing level of interest
rates during the year resulted in an increase in interest income, however, it
also caused an increase in interest expense, including interest paid on the
Bank's deposits.  At March 31, 2006, approximately 58% of the Bank's deposits
were in the form of certificates of deposit, including $52.9 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 2006, 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

                                       45

<PAGE>



the maturity of the certificate of deposit.  In addition, even if interest
rates were not increasing, the Bank's interest on deposits would continue to
increase, as long as the prevailing market rates to attract deposits are
higher than the rates being paid on its renewing deposits.

     Interest on borrowings increased to $4.9 million in fiscal 2006 from $2.9
million in fiscal 2005. The increase was a result of a higher level of
borrowings outstanding during the year ended March 31, 2006 of $159.8 million
compared to $135.8 million during the year ended March 31, 2005 along with the
increasing interest rate environment in fiscal 2006.  The significant increase
in fiscal 2006 was related to funding the Bank's significant 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,
                                          ---------------------------
                                           2006      2005       2004
                                          ------    ------     ------
                                             (Dollars in thousands)

Allowance at beginning of period......... $11,767   $10,122    $ 8,506
Provision for loan losses................   2,575     1,700      1,915
Charge offs, net of recoveries...........    (158)      (55)      (299)
                                          -------   -------    -------
Allowance at end of period............... $14,184   $11,767    $10,122
                                          =======   =======    =======
Allowance for loan losses as a
 percentage of net loans receivable at
 the end of the period...................    1.54%     1.46%      1.48%

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

Allowance for loan losses as a percentage
 of nonperforming assets at the end of
 period.................................. 1235.31%   794.53%   2518.51%

     The provision for loan losses was $2.6 million for the year ended March
31, 2006 compared to $1.7 million for the year ended March 31, 2005.  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 $14.2 million, or 1.54% of net loans receivable
at March 31, 2006 compared to $11.8 million, or 1.46% of  net loans receivable
at March 31, 2005.  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 $770.2 million, or 82.6% of total loans receivable
at March 31, 2006, versus $658.2 million, or 80.6% at March 31, 2005.

     In addition, commercial and multi-family loans have larger individual
loan amounts, which have a greater single impact on the total portfolio
quality in the event of delinquency or default.  The Corporation considers the
allowance level to be appropriate, as a result of the changing portfolio mix
and the current economic environment.

     As of March 31, 2006, there were no loans in the loan portfolio over 90
days delinquent and nine loans on non- accrual status.  The Bank had no real
estate owned at March 31, 2006. Total non-performing assets were $1.2 million,
or 0.10% of total assets at March 31, 2006 compared to $1.5 million, or 0.15%
of total assets at March 31, 2005.

                                       46

<PAGE>



                                                     At March 31,
                                                  ------------------
                                                   2006        2005
                                                  ------      ------
                                                (Dollars in thousands)
Non-Performing Assets
  Accruing loans 90 days past due..............   $   --      $   --
  Non-accrual loans............................    1,161       1,481
  Restructured loans...........................       --          --
                                                  ------      ------
    Total non-performing loans.................    1,161       1,481
    Total non-performing loans/net loans.......     0.13%       0.18%
  Real estate owned............................       --          --
                                                  ------      ------
    Total non-performing assets................    1,161       1,481
                                                  ------      ------
    Total non-performing assets/total assets...     0.10%       0.15%

     Noninterest Income.  Noninterest income in fiscal 2006 decreased slightly
to $6.4 million, from $6.5 million in fiscal 2005.  Service fees increased
23.6% to $3.9 million in fiscal 2006 from $3.2 million in fiscal 2005.  The
primary reason for this increase was the implementation of our overdraft
protection service during July 2005, which, together with the increase in
deposits, resulted in increased fee income.

     There was a net loss on sales of investment securities of $(476,000) in
fiscal 2006 compared to a net gain of $476,000 in fiscal 2005.  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 lower than the securities purchased, therefore the effect of this
restructuring is expected to increase interest income from these securities by
over $220,000 in fiscal 2007.  Other noninterest income was essentially
unchanged at $1.8 million for the periods ending March 31, 2006 and 2005.
Included in these numbers was the recognition of approximately $300,000 and
$446,000, respectively, in profits on the real estate development project from
a joint venture of the Bank's wholly owned subsidiary, Westward Financial
Corp.  As of March 31, 2006 all lot sales have been concluded for this
project.  As a result of the current status of the development of these lots,
no sales activity is currently anticipated for fiscal 2007 from the Bank's
real estate joint venture activities.

     Noninterest Expense.  Noninterest expense in fiscal 2006 increased to
$25.8 million, a 15.0% increase from $22.4 million in fiscal 2005.
Compensation and employee benefits increased 15.7% in fiscal 2006 to $14.6
million from $12.6 million in fiscal 2005.  Building occupancy expense was
$3.6 million in fiscal 2006, a 20.5% increase from $3.0 million in fiscal
2005.  Increases in compensation and employee benefits and building and
occupancy expenses resulted from the full year operating expenses for two full
service retail offices in Marysville and Lakewood.

     Other noninterest expenses increased 14.4% to $6.0 million in fiscal 2006
from $5.2 million in fiscal 2005.  The increase in fiscal 2006 was primarily
attributable to increased expenses related to the Bank's charter conversion
and increased Businees & Occupation tax attributable to the shifting loan
portfolio from non-taxable mortgage loans to taxable commercial loans.

     Data processing expenses decreased in fiscal 2006 to $886,000 from
$901,000 in fiscal 2005. Expenses for the year ended March 31, 2005 included
one time conversion related costs related to the Bank's core processor
conversion completed in November 2004.

     Advertising and marketing expenses increased slightly to $720,000 in
fiscal 2006 from $688,000 in fiscal 2005, due in part to increased advertising
expenses to support the Bank's new Marysville and Lakewood offices.  The
decreases in fiscal 2005 were primarily attributable to management's decision
to reduce this expense.  The increases in fiscal 2006 and 2004 were related to
market research and brand positioning of the Bank in its various markets.


                                      47

<PAGE>



     Net Income.  Net income of $15.7 million for fiscal 2006 represents a
19.8% increase from net income of $13.1 million for fiscal 2005.  Basic
earnings per share for 2006 was $1.57 on weighted average shares outstanding
of 9,937,600 compared to basic earnings per share of $1.28 on weighted average
shares of 10,212,190 in fiscal 2005.

Comparison of Operating Results for the Years Ended March 31, 2005 and March
----------------------------------------------------------------------------
31, 2004
--------

     Net Interest Income.  Net interest income in fiscal 2005 was $36.0
million, a 7.7% increase from $33.5 million in fiscal 2004.  Total interest
income increased 6.5% in fiscal 2005 to $52.2 million from $49.0 million in
fiscal 2004.

     Interest income on loans in fiscal 2005 was $48.1 million, a 9.8%
increase from $43.8 million in fiscal 2004.  The increase in fiscal 2005 was
primarily attributable to the growth in loans receivable, as the Bank
experienced significant loan growth during the year, increasing to $805.0
million at March 31, 2005, compared to $658.2 million at March 31, 2004.
Included in these amounts for 2005, and 2004 were approximately $1.5 million
and $3.0 million, respectively, of deferred fee income recognition.  Fiscal
2004 was a year which included a significant number of one- to-four family
loan refinances, which significantly impacted the deferred fee recognition in
that year.   The table below shows the breakdown of deferred fee recognition
for the past two fiscal years:

                                             Year Ended March 31,
                                             --------------------
                                               2005      2004
                                             ---------  ---------
                                                (In thousands)

      Commercial loan deferred fees..........  $1,793    $1,658
      One-to-four real estate mortgage loan
        deferred fees........................     813     2,434
                                               ------    ------
         Total...............................  $2,606    $4,093
                                               ======    ======

     Interest and dividends on investments and mortgage-backed securities was
$4.1 million in fiscal 2005, a 21.1% decrease from $5.1 million in fiscal
2004.  This decrease was a result of a lower level of investments and
mortgage-backed securities outstanding during the year, as total investments
decreased 28.0% to $102.7 million at March 31, 2005 as compared to $142.6
million at March 31, 2004. The decline in the investment portfolio balance was
primarily attributable to the funding of the Bank's lending activities.  Also
contributing to the decline in fiscal 2005 was a reduction in dividend income
on the Bank's FHLB stock.  At March 31, 2005, Horizon held $7.2 million in
FHLB of Seattle stock and received dividends in the amounts of $162,800 in
fiscal 2005, compared to $335,700 in fiscal 2004.  On May 18, 2005, the FHLB
of Seattle announced a three-year dividend suspension; therefore, the Bank's
investment income will be reduced accordingly over this time period.

     Total interest expense in fiscal 2005 increased 4.1% to $16.1 million
from $15.5 million in fiscal 2004.  Interest on deposits was essentially
unchanged at $13.2 million in fiscal 2005 and 2004.  This occurred despite
increased deposits outstanding as a result of the overall decline in interest
rates.

     Interest on borrowings increased to $2.9 million in fiscal 2005, compared
to $2.3 million in fiscal 2004.  The increase in fiscal 2005 was attributable
to a higher level of borrowings outstanding of $135.8 million for the year
ended March 31, 2005 compared to $67.5 million for the year ended March 31,
2004.  The increase in fiscal 2005 was related to funding the Bank's
significant loan growth during the year.  During the year ended March 31,
2006, the Bank continued 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 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.

                                      48

<PAGE>



     The provision for loan losses was $1.7 million for the year ended March
31, 2005 compared to $1.9 million for the year ended March 31, 2004.  This
change resulted from management's ongoing analysis of changes in loan
portfolio composition by collateral categories, overall credit quality of the
portfolio,  historical industry analysis, and current economic conditions.
The allowance for loan losses was $11.8 million, or 1.46% of  net loans
receivable at March 31, 2005, compared to $10.1 million, or 1.48% of net loans
receivable at March 31, 2004.  The increased allowance level resulted from
continued loan portfolio growth in the higher-risk lending categories of
commercial and multi-family construction/permanent loans and commercial
business loans during the period, which comprised $639.0 million, or 79.4% of
net loans receivable at March 31, 2005, versus $453.0 million, or 68.8% at
March 31, 2004.

     As of March 31, 2005, there were no loans in the loan portfolio over 90
days delinquent and 16 loans on non-accrual status.  The Bank had no real
estate owned at March 31, 2005.  Total non-performing assets were $1.5
million, or 0.15% of total assets at March 31, 2005 compared to $402,000, or
0.05% of total assets at March 31, 2004.

                                                  At March 31,
                                               ------------------
                                                2005        2004
                                               ------      ------
                                            (Dollars in thousands)
Non-Performing Assets
  Accruing loans 90 days past due...........   $   --      $  339
  Non-accrual loans.........................    1,481          --
  Restructured loans........................       --          --
                                               ------      ------
    Total non-performing loans..............    1,481         339
    Total non-performing loans/net loans....     0.18%       0.05%
  Real estate owned.........................       --          63
                                               ------      ------
    Total non-performing assets.............    1,481         402
                                               ------      ------
    Total non-performing assets/total
     assets.................................     0.15%      0.05%

     Noninterest Income.  Noninterest income in fiscal 2005 was $6.5 million,
a decrease of 17.3% from $7.9 million in fiscal 2004.  Contributing to the
decrease in fiscal 2005 was the decrease in the net gain on the sale of loans
(servicing released) of 55.3% to $983,000 from $2.2 million in fiscal 2004.
The primary reason for the decline was attributable to a lower amount of loans
sold in the current year of $90.3 million versus $201.9 million in fiscal
2004, which had a much more active residential refinance market than fiscal
2005.  This decrease was offset by the increase in service fees of 10.7% to
$3.2 million in fiscal 2005 from $2.9 million in fiscal 2004.  The primary
reasons for this increase was the growth in deposits (which increased deposit
related fees) and revisions to the Bank's fee schedules during the year.

     The net gain on sales of investment securities decreased to $476,000 in
fiscal 2005 from $689,000 in fiscal 2004.  The gains in these periods were
primarily attributable to management's decisions in these years to sell
selected securities from the Bank's investment portfolio.  Other non-interest
income decreased slightly to $1.8 million in fiscal 2005 from $1.9 million in
fiscal 2004.

     Noninterest Expense.  Noninterest expense in fiscal 2005 increased to
$22.4 million, a 10.8% increase from fiscal 2004 of $20.2 million.
Compensation and employee benefits increased 9.7%  to $12.6 million in fiscal
2005 from $11.5 million in fiscal 2004 as a result of the overall growth in
employment at the Bank, including key additions to staff as the Bank continued
its efforts to enhance its commercial banking expertise, along with staffing
expenses for the Bank's Lynnwood office in fiscal 2004, and the Marysville and
Lakewood offices in fiscal 2005.

     Building occupancy expense was $3.0 million in fiscal 2005, a 12.3%
increase from $2.6 million in fiscal 2004. The increase in fiscal 2005 was
primarily attributable to the opening of a full service retail office in
Marysville, Washington.

     Other noninterest expenses increased 10.5% to $5.2 million in fiscal 2005
from $4.7 million in fiscal 2004.  The increase in fiscal 2005 was primarily a
result of increased expenses related to accounting and auditing services for

                                       49

<PAGE>



compliance with the internal control provisions of the Sarbanes-Oxley Act of
2002, and expenses related to opening the Marysville office in November 2004.

     Data processing expenses increased in fiscal 2005 to $901,000 from
$558,000 in fiscal 2004.  The primary reason for this increase relates to the
core data processor conversion effective November 4, 2004.  This core data
processor conversion will allow the Bank to better serve its growing
commercial customer base, compared to its previous data processor which
targeted traditional thrift institutions.  The other significant contributing
factor to this difference relates to an abnormally low level of expenses in
fiscal 2004, as a result of a renegotiation of the Bank's contract with it
core data processor at the time, which included substantial concessions in the
first quarter of fiscal 2004, and a reduced monthly expense thereafter.

     Advertising and marketing expenses decreased 12.3% to $688,000 in fiscal
2005 from $784,000 in fiscal 2004.  The decreases in fiscal 2005 were
primarily attributable to management's decision to reduce this expense.

     Net Income.  Net income of $13.1 million for fiscal 2005 represents a
1.5% increase from net income of $12.9 million for fiscal 2004.  Basic
earnings per share for 2005 was $1.28 on weighted average shares outstanding
of 10,212,190 compared to basic earnings per share of $1.23 on weighted
average shares of 10,480,785 in fiscal 2004.

                                      50

<PAGE>




<TABLE>
Average Balances, Interest and Average Yields/Costs
---------------------------------------------------

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

                At March 31,                               Year Ended March 31,
               --------------- ----------------------------------------------------------------------------
                    2006                 2006                      2005                      2004
               --------------- ------------------------  ------------------------  ------------------------
                       Average                   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
  receivable
  (1).......$  918,510  7.63% $862,893  $65,857   7.63%  $718,918  $48,131   6.69%  $613,474  $43,842  7.15%
 Investment
  securities
  (2).......    77,193  3.62    70,621    2,556   3.62     89,052    3,227   3.62    107,832    3,787  3.51
 Mortgage-
  backed
  securi-
  ties......    23,833  4.52    21,573      975   4.52     22,751      824   3.62     36,780    1,350  3.67
            ----------  ----  -------   ------- ------   --------  ------- ------   --------  ------- -----
   Total
    interest-
    earning
    assets.. 1,019,536  7.27   955,087   69,388   7.27    830,721   52,182   6.28    758,086   48,979  6.46
Interest-
 bearing
liabilities:
 Deposits...   834,299  2.54   787,734   19,988   2.54    689,425   13,219   1.92    641,691   13,225  2.06
 Borrowings.   141,561  3.86   127,284    4,908   3.86     89,820    2,925   3.26     56,318    2,285  4.06
            ----------  ----  -------   ------- ------   --------  ------- ------   --------  ------- -----
  Total
   interest-
   bearing
   liabili-
   ties.....   975,860  2.72   915,018   24,896   2.72    779,245   16,144   2.07    698,009   15,510  2.22
                                        -------                    -------                   -------

Net interest
 income.....                            $44,492                    $36,038                   $33,470
                                        =======                    =======                   =======

Interest rate
 spread.....                                      4.54%                      4.21%                     4.24%
                                                ======                    =======                    ======

Net interest
 margin.....                                      4.66%                      4.34%                     4.42%
                                                ======                    =======                    ======

Ratio of
 average
 interest-
 earning
 assets to
 average
 interest-
 bearing
 liabilities.                                   104.38%                   106.621%                   108.61%
                                                ======                    =======                    ======
------------
(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.

                                                    51

</TABLE>

<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).



<TABLE>

                                                         Year Ended March 31,
                              -----------------------------------------------------------------------------
                                         2006 vs. 2005                          2005 vs. 2004
                              ------------------------------------     ------------------------------------
                                      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...................... $9,615   $6,758     $1,353    $17,726    $7,640   $(2,860)   $(491)    $4,289
 Investment securities and
  other interest-bearing
  securities.................   (714)     235        (41)      (520)   (1,164)      101      (23)    (1,086)
                              ------   ------     ------    -------    ------   -------    -----     ------
 Total interest-earning
  assets..................... $8,901   $6,993     $1,312    $17,206    $6,476   $(2,759)   $(514)    $3,203
                              ======   ======     ======    =======    ======   =======    =====     ======
Interest expense:
 Deposit accounts............ $1,887   $4,272     $  610    $ 6,769    $  947   $  (887)   $ (66)    $   (6)
 Borrowings..................  1,219      539        225      1,983     1,359      (451)    (268)       640
                              ------   ------     ------    -------    ------   -------    -----     ------
 Total interest-bearing
  liabilities................ $3,106   $4,811     $  835    $ 8,752    $2,306   $(1,338)   $(334)    $  634
                              ======   ======     ======    =======    ======   =======    =====     ======
</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, 2006, the Bank had liquid assets
(cash and marketable securities with maturities of one year or less) with a
book value of $49.5 million.

     As of March 31, 2006, the total book value of investments and
mortgage-backed securities was $79.2 million compared to a market value of
$84.4 million with an unrealized gain of $5.2 million. As of March 31, 2005,
the total book value of investments and mortgage-backed securities was $86.4
million compared to a market value of $91.6 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, 2006 was $113.3 million, or 10.1% of
assets, compared to $107.0 million, or 10.7% of assets at March 31, 2005.  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, 2006

                                       52

<PAGE>



was 12.6%, compared to 13.7% as of March 31, 2005.  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 2006, the Board of Directors approved a new stock repurchase
plan that runs concurrent with the 2007 fiscal year, allowing the Corporation
to repurchase up to 5% of total shares outstanding, or approximately 500,000
shares.  This marked the Corporation's seventh stock repurchase plan. In
fiscal 2006, under the previous plans, the Corporation repurchased 212,852
shares at an average price of $20.52.  For additional information concerning
the Corporation's repurchase activities during the fourth quarter of fiscal
2006, 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, although
at reduced levels compared to prior years.  Currently, the Corporation's
assets and liabilities are not materially exposed to foreign currency or
commodity price risk.  At March 31, 2006, the Corporation had no off-balance
sheet derivative financial instruments, nor did it have a trading portfolio of
investments.

     In fiscal 2006 and fiscal 2005, 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 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 2006 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, 2006 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

                                       53

<PAGE>



course, negatively affect performance.  In addition, depending on timing
differences, the magnitude of various rates 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.

Effects of Interest Rate Floors
-------------------------------

     Periodically, the Corporation is able to establish interest rate floors
on certain loans, in order to enhance profitability.  At March 31, 2006, the
Corporation had $444.9 million in commercial loans tied to the Prime lending
rate.  Of these Prime based loans, approximately 100% will increase
accordingly when Prime increases as the current rates are above any floors in
place.  While these floors provide an overall better return for the
Corporation, the information provided in this section is intended to provide
additional information regarding the degree to which the Corporation's
earnings may be  affected with future changes in the Prime lending rate.  We
continue to monitor these measures, as these floors may provide a benefit to
the Bank in the future, when the Prime rate declines from current levels.

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, 2006:

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

Time deposits..........  $323,641  $130,868   $27,163     $4,400    $486,072
Long-term borrowings...    80,337    69,000    10,500         --     159,837
Operating lease
 obligations...........       242       331       131        119         823
                         --------  --------   -------     ------    --------
     Total.............  $404,220  $200,199   $37,794     $4,519    $646,732
                         ========  ========   =======     ======    ========

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 due to inflation.

                                       54

<PAGE>



     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 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 due
to inflation.

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

     For a discussion of new accounting pronouncements and their impact on the
Corporation, see Note 1 of 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, 2006.  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.


<TABLE>

                                         Over 1    Over 2      Over 3                  Amortized      Fair
                      Average   Within   Year to    Years       Years        Beyond       Cost        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......  7.63%  $520,688  $143,386  $129,119   $ 77,031    $   48,286  $  918,510  $  906,941
Mortgage-backed
 securities...........  4.52%     6,820     4,155     4,329      6,898         1,631      23,833      19,437
Investments and
 other interest-
 earning assets.......  3.62%    34,046    26,137     8,083      2,689         6,238      77,193      83,333
Total Interest
 Sensitive Assets.....  7.27%   561,554   173,678   141,531     86,618        56,155   1,019,536   1,009,711
Cumulative Totals.....    --    561,554   735,232   876,763    963,381     1,019,536          --          --

Interest-Sensitive Liabilities:

Checking accounts.....  0.45%    8,077     27,971    27,971     27,581        69,952     160,552     160,552
Money market
 ultimate accounts....  2.41%  109,807     11,765    11,765      6,723        16,807     156,867     156,867
Savings accounts......  0.54%    6,161      3,081     3,081      5,281        13,204      30,808      30,808
Certificates of
 deposit..............  3.50%  343,879    100,586    17,790     19,417         4,400     486,072     483,555
Other
 borrowings(1)........  3.86%   77,095     69,810     5,311      6,540         1,081     159,837     158,202
Total Interest
 Sensitive
 Liabilities..........  2.72%  545,019    213,213    65,918     65,542       104,444     994,136     989,984
Cumulative Totals.....    --   545,019    758,232   824,150    889,692       994,136          --          --

                                   (table continues on following page)

                                                   55

</TABLE>
<PAGE>



<TABLE>
                                         Over 1    Over 2      Over 3                  Amortized      Fair
                      Average   Within   Year to    Years       Years        Beyond       Cost        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>
Off-Balance Sheet Items:
Commitments to
 extend credit........  8.32%   185,260        --        --         --            --     185,260     185,260
Unused lines of
 credit...............  8.26%   100,928        --        --         --            --     100,928     100,928
Credit card
 arrangements......... 12.66%     9,775        --        --         --            --       9,775       9,775
Stand by letters
 of credit............    --      5,237        --        --         --            --       5,237       5,237
                               --------  --------  --------   --------    ----------  ----------  ----------
Total Off-Balance
 Sheet Items..........  8.44%  $301,200  $     --  $     --   $     --    $       --  $  301,200  $  301,200
                               ========  ========  ========   ========    ==========  ==========  ==========

-----------
(1) Includes borrowing related to investment in real estate for a joint venture.

</TABLE>

     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                                        57
            Report of Independent Registered Public Accounting Firm     58
            Consolidated Statement of Financial Position as of
             March 31, 2006 and 2005                                    60
            Consolidated Statement of Income for the Years Ended
             March 31, 2006, 2005 and 2004                              61
            Consolidated Statement of Stockholders' Equity for the
             Years Ended March 31, 2006, 2005 and 2004                  62
            Consolidated Statement of Cash Flows for the Years Ended
             March 31, 2006, 2005 and 2004                              63
            Notes to Consolidated Financial Statements                  64

                                       56

<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, 2006. 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, 2006 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, 2006.

The Company's independent registered public accounting firm, Moss Adams LLP
who audits the Company's consolidated financial statements, have issued an
attestation report on Management's assessment and on the effectiveness of the
Company's internal control over financial reporting. This report follows.

Dated June 9, 2006

                                       57

<PAGE>



MOSS-ADAMS LLP
------------------------------------------------------------------------------
CERTIFIED PUBLIC ACCOUNTANTS

           REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying consolidated statement of financial position
of Horizon Financial Corp. and  Subsidiary (the "Company") as of March 31,
2006 and 2005, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended March 31, 2006. We also have audited management's assessment included in
the accompanying Management Report on Internal Control over Financial
Reporting that Horizon Financial Corp. maintained effective internal control
over financial reporting as of March 31, 2006, based on criteria established
in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO"). Horizon
Financial Corp. and Subsidiary'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. Our responsibility is to express an opinion
on these financial statements, an opinion on management's assessment, and an
opinion on the effectiveness of the Horizon Financial Corp. and Subsidiary'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 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,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we considered necessary in the circumstances. We believe that
our audits provide a reasonable basis for our opinion.

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. A 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
authorizations 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.

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.

                                        58
<PAGE>




MOSS-ADAMS LLP
------------------------------------------------------------------------------
CERTIFIED PUBLIC ACCOUNTANTS


In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Horizon Financial Corp. and Subsidiary as of March 31, 2006 and 2005, and
the results of their operations and cash flows for each of the three years in
the period ended March 31, 2006, in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion,
management's assessment that Horizon Financial Corp. and Subsidiary maintained
effective internal control over financial reporting as of March 31, 2006, is
fairly stated, in all material respects, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Furthermore, in our opinion, Horizon
Financial Corp. and Subsidiary maintained, in all material respects, effective
internal control over financial reporting as of March 31, 2006, 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 9, 2006

                                        59

<PAGE>




                                                      HORIZON FINANCIAL CORP.
                                CONSOLIDATED STATEMENT OF FINANCIAL POSITION
                                                     MARCH 31, 2006 AND 2005
------------------------------------------------------------------------------

                                   ASSETS
                                                       2006          2005
                                                  -------------  -----------

Cash and cash equivalents                        $   24,190,455 $ 23,250,411
Interest-bearing deposits                             9,439,105    3,907,349
Investment securities
  Available-for-sale (amortized cost 2006:
      $54,761,238; 2005: $66,796,424)                60,136,991   71,824,994
  Held-to-maturity (estimated fair value 2006:
      $374,351;  2005: $382,909)                        369,747      369,596
Mortgage-backed securities
  Available-for-sale (amortized cost 2006:
      $23,558,861; 2005: $18,353,299)                23,350,699   18,510,439
  Held-to-maturity (estimated fair value 2006:
      $496,632; 2005: $926,329)                         482,021      885,137
Federal Home Loan Bank Stock ("FHLB")                 7,247,400    7,217,900
Loans receivable, net of allowance for loan losses
  of $14,184,212 in 2006 and $11,767,029 in 2005    918,510,043  804,980,578
Loans held for sale                                   5,251,440    4,068,859
Investment in real estate in a joint venture         16,927,899   17,204,265
Accrued interest and dividends receivable             5,185,152    4,498,756
Premises and equipment, net                          26,316,872   22,781,657
Net deferred income tax assets                        2,253,710    2,299,225
Income tax currently receivable                         807,932      330,862
Other assets                                         16,258,419   15,440,447
                                                  -------------  -----------
TOTAL ASSETS                                     $1,116,727,885 $997,570,475
                                                  =============  ===========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits                                         $  834,299,089 $746,849,411
Accounts payable and other liabilities                6,919,314    5,570,071
Other borrowed funds                                141,560,791  119,066,193
Borrowing related to investment in real estate
  in a joint venture                                 18,275,909   16,720,745
Advances by borrowers for taxes and insurance           466,821      518,774
Deferred compensation                                 1,882,795    1,821,094
                                                  -------------  -----------
   Total liabilities                              1,003,404,719  890,546,288
                                                  -------------  -----------
COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
  Serial preferred stock, $1 par value,
    10,000,000 shares authorized; none issued
    or outstanding
  Common stock, $1 par value, 30,000,000 shares
    authorized; 9,898,168 and 10,037,903 issued
    and outstanding, respectively                     9,898,168   10,037,903
  Additional paid-in capital                         54,115,619   54,737,070
  Retained earnings                                  45,990,967   38,939,268
  Unearned Employee Stock Ownership Plan("ESOP")
    shares                                                           (72,101)
  Accumulated other comprehensive income              3,318,412    3,382,047
                                                  -------------  -----------
   Total stockholders' equity                       113,323,166  107,024,187
                                                  -------------  -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY       $1,116,727,885 $997,570,475
                                                  =============  ===========

See accompanying notes to these financial statements.
------------------------------------------------------------------------------

                                        60

<PAGE>


                                                      HORIZON FINANCIAL CORP.
                                            CONSOLIDATED STATEMENT OF INCOME
                                  YEARS ENDED MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

                                              2006        2005        2004
                                           ----------  ----------  ----------
INTEREST INCOME
 Interest on loans                        $65,856,892 $48,131,012 $43,842,447
 Investment and mortgage-backed securities
  Taxable interest                          3,135,949   3,598,339   4,474,212
  Nontaxable interest income                  195,873     148,884     111,519
  Dividends                                   199,117     303,661     551,436
                                           ----------  ----------  ----------
   Total interest income                   69,387,831  52,181,896  48,979,614
                                           ----------  ----------  ----------
INTEREST EXPENSE
 Interest on deposits                      19,987,799  13,218,857  13,224,629
 Interest on other borrowings               4,907,927   2,924,988   2,284,728
                                           ----------  ----------  ----------
   Total interest expense                  24,895,726  16,143,845  15,509,357
                                           ----------  ----------  ----------
   Net interest income                     44,492,105  36,038,051  33,470,257

PROVISION FOR LOAN LOSSES                   2,575,000   1,700,000   1,915,000
   Net interest income after provision     ----------  ----------  ----------
     for loan losses                       41,917,105  34,338,051  31,555,257
                                           ----------  ----------  ----------
NONINTEREST INCOME
 Service fees                               3,916,693   3,167,678   2,860,089
 Other                                      1,887,032   1,824,286   1,938,208
 Net gain on sales of loans servicing
  retained                                     55,017      65,669     195,354
 Net gain on sales of loans servicing
  released                                  1,040,499     982,788   2,198,500
 Net gain (loss) on sale of investment
  securities                                 (476,452)    476,327     689,350
                                           ----------  ----------  ----------
   Total noninterest income                 6,422,789   6,516,748   7,881,501
                                           ----------  ----------  ----------
NONINTEREST EXPENSE
 Compensation and employee benefits        14,614,088  12,635,243  11,520,922
 Building occupancy                         3,575,265   2,967,481   2,641,378
 Other expenses                             5,986,170   5,231,541   4,733,971
 Data processing                              886,385     901,042     557,803
 Advertising                                  720,115     687,503     784,149
                                           ----------  ----------  ----------
   Total noninterest expense               25,782,023  22,422,810  20,238,223
                                           ----------  ----------  ----------

INCOME BEFORE PROVISION FOR INCOME TAX     22,557,871  18,431,989  19,198,535

PROVISION FOR INCOME TAX
 Current                                    6,902,850   5,948,892   8,281,271
 Deferred                                                (579,477) (1,949,104
                                           ----------  ----------  ----------
   Total provision for income tax           6,902,850   5,369,415   6,332,167
                                           ----------  ----------  ----------
NET INCOME                                $15,655,021 $13,062,574 $12,866,368
                                           ==========  ==========  ==========

BASIC EARNINGS PER SHARE                       $ 1.57      $ 1.28      $ 1.23
                                               ======      ======      ======
DILUTED EARNINGS PER SHARE                     $ 1.56      $ 1.26      $ 1.20
                                               ======      ======      ======

See accompanying notes to these financial statements
------------------------------------------------------------------------------

                                        61

<PAGE>


<PAGE>
<TABLE>
                                                                                    HORIZON FINANCIAL CORP.
                                                             CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                                                                 YEARS ENDED MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------------------------------------

                                          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, 2003              10,550,113 $10,550,113 $57,352,824 $32,527,963  $(216,309)  $6,028,927
Comprehensive income
  Net income                                                             12,866,368
  Other comprehensive income
   Change in unrealized gains
    (losses) on available-
    for-sale securities, net tax
    (benefit) of $(413,523)                                                                        (802,720)
     Total other comprehensive
      income
  Comprehensive income
Recognition of ESOP shares released                                                     72,104
Cash dividends on common stock at
 $.49 per share                                                          (5,121,345)
Dividend reinvestment plan               39,601      39,601     646,876
Stock options exercised                 129,857     129,857     685,606
Treasury stock purchased
Retirement of treasury stock           (314,240)   (314,240) (1,791,482) (3,347,150)
                                     ----------  ----------  ----------  ----------   --------    ---------
BALANCE, March 31, 2004              10,405,331  10,405,331  56,893,824  36,925,836   (144,205)   5,226,207
Comprehensive income
  Net income                                                             13,062,574
  Other comprehensive income
    Change in unrealized gains
     (losses) on available-
     for-sale securities, net tax
     (benefit) of $(950,022)                                                                     (1,844,160)
      Total other comprehensive
       income
  Comprehensive income                        -           -           -           -          -            -
Recognition of ESOP shares released           -           -           -           -     72,104            -
Cash dividends on common stock at
 $.53 per share                               -           -           -  (5,382,724)         -            -
Stock options exercised                  83,452      83,452     413,713           -          -            -
Treasury stock purchased                      -           -           -           -          -            -
Retirement of treasury stock           (450,880)   (450,880) (2,570,467) (5,666,418)         -            -

                                     ----------  ----------  ----------  ----------   --------    ---------
BALANCE, March 31, 2005              10,037,903  10,037,903  54,737,070  38,939,268    (72,101)   3,382,047
Comprehensive income
  Net income                                  -           -           -  15,655,021          -            -
  Other comprehensive income
    Change in unrealized gains
     (losses) on available-
     for-sale securities, net tax
     (benefit) of $(34,265)                   -           -           -           -          -      (63,635)
      Total other comprehensive
       income                                 -           -           -           -          -            -
  Comprehensive income                        -           -           -           -          -            -
Recognition of ESOP shares released           -           -           -           -     72,101            -
Cash dividends on common stock at
 $.57 per share                               -           -           -  (5,651,939)         -            -
Stock options exercised                  73,117      73,117     390,970           -          -            -
Stock award plan                              -           -      22,127           -          -            -
Tax benefit associated with stock
 options                                      -           -     178,921           -          -            -
Treasury stock purchased                      -           -           -           -          -            -
Retirement of treasury stock           (212,852)   (212,852) (1,213,469) (2,951,383)         -            -
                                     ----------  ----------  ----------  ----------   --------    ---------
BALANCE, March 31, 2006               9,898,168 $ 9,898,168 $54,115,619 $45,990,967  $       -   $3,318,412
                                     ==========  ==========  ==========  ==========   ========    =========

See accompanying notes to these financial statements

</TABLE>
<PAGE>

<PAGE>
<TABLE>
                                                                                 HORIZON FINANCIAL CORP.
                                                         CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                                                             YEARS ENDED MARCH 31, 2006, 2005, AND 2004
-------------------------------------------------------------------------------------------------------

                                                      Treasury                          Total
                                                      Stock          Stockholders'      Comprehensive
                                                      at Cost        Equity             Income
                                                      --------       ------------       -------------

                                                   <c>             <c>                <c>
BALANCE, March 31, 2003                               $      -       $106,243,518
Comprehensive income
  Net income                                                 -         12,866,368       $  12,866,368
  Other comprehensive income
    Change in unrealized gains(losses) on available-
     for-sale securities, net tax (benefit) of $(413,523)    -           (802,720)           (802,720)
                                                                                         ------------
      Total other comprehensive income                       -                  -            (802,720)
                                                                                         ------------
  Comprehensive income                                       -                  -       $  12,063,648
                                                                                         ============
Recognition of ESOP shares released                          -             72,104
Cash dividends on common stock at $.49 per share             -         (5,121,345)
Dividend reinvestment plan                                   -            686,477
Stock options exercised                                      -            815,463
Treasury stock purchased                            (5,452,872)        (5,452,872)
Retirement of treasury stock                         5,452,872                  -
                                                    ----------        -----------
BALANCE, March 31, 2004                                      -        109,306,993
Comprehensive income
  Net income                                                 -         13,062,574       $  13,062,574
  Other comprehensive income
    Change in unrealized gains (losses) on available-
     for-sale securities, net tax (benefit)
     of $(950,022)                                           -         (1,844,160)         (1,844,160)
                                                                                         ------------
     Total other comprehensive income                        -                  -          (1,844,160)
                                                                                         ------------
  Comprehensive income                                       -                  -       $  11,218,414
                                                                                         ============
Recognition of ESOP shares released                          -             72,104
Cash dividends on common stock at $.53 per share             -         (5,382,724)
Stock options exercised                                      -            497,165
Treasury stock purchased                            (8,687,765)        (8,687,765)
Retirement of treasury stock                         8,687,765                  -
                                                    ----------        -----------
BALANCE, March 31, 2005                                      -        107,024,187
Comprehensive income
  Net income                                                 -         15,655,021       $  15,655,021
  Other comprehensive income
    Change in unrealized gains (losses) on available-
     for-sale securities, net tax (benefit)
     of $(34,265)                                            -            (63,635)            (63,635)
                                                    ----------        -----------        ------------
     Total other comprehensive income                        -                  -             (63,635)
                                                                                         ------------

  Comprehensive income                                       -                  -       $  15,591,386
                                                                                         ============
Recognition of ESOP shares released                          -             72,101
Cash dividends on common stock at $.57 per share             -         (5,651,939)
Stock options exercised                                      -            464,087
Stock award plan                                             -             22,127
Tax benefit associated with stock options                    -            178,921
Treasury stock purchased                            (4,377,704)        (4,377,704)
Retirement of treasury stock                         4,377,704                  -
                                                    ----------        -----------
BALANCE, March 31, 2006                            $         -       $113,323,166
                                                    ==========        ===========

See accompanying notes to these financial statements
    5
</TABLE>

                                                            62
<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                        CONSOLIDATED STATEMENT OF CASH FLOWS
                                  YEARS ENDED MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

                Increase (Decrease) in Cash and Cash Equivalents

                                           2006          2005        2004
                                       -----------   -----------  -----------
CASH FLOWS FROM OPERATING ACTIVITIES
 Net income                           $ 15,655,021  $ 13,062,574 $ 12,866,368
Adjustments to reconcile net income
to net cash provided by operating
activities
 Depreciation                            1,607,508     1,249,181    1,085,060
 Amortization and deferrals, net          (482,354)     (773,550)     799,212
 Stock dividends - FHLB stock              (29,500)     (203,000)    (376,400)
 Provision for loan losses               2,575,000     1,700,000    1,915,000
 Tax benefit associated with stock
  options                                  178,921             -            -
 Stock award plan compensation              22,127             -            -
 Provision for deferred income tax               -      (579,477)  (1,949,104)
Changes in assets and liabilities
 Interest and dividends receivable        (686,396)     (466,749)     588,459
 Interest payable                        1,115,676       595,593        3,692
 Federal income tax payable               (477,070)   (1,706,135)     469,271
 Net change in loans held for sale      (1,182,581)   (2,735,359)   1,504,800
 Other assets                             (817,972)      684,132     (283,008)
 Other liabilities                         163,197    (3,205,660)    (331,490)
                                       -----------   -----------  -----------
  Net cash flows from operating
   activities                           17,641,577     7,621,550   16,291,860
                                       -----------   -----------  -----------
CASH FLOWS FROM INVESTING ACTIVITIES
 Investment in interest-bearing
  deposits, net                         (5,531,756)   16,860,049   39,162,020
 Purchases of investment securities -
  available-for-sale                   (23,555,000)  (11,465,000) (28,598,597)
 Proceeds from sales and maturities of
  investment securities - available-
  for-sale                              35,590,187    22,330,851   17,142,983
 Purchases of mortgage-backed securities-
  available-for-sale                   (12,174,432)            -  (12,811,737)
 Proceeds from sales and maturities of
  mortgage-backed securities - available-
  for-sale                               6,968,869     9,009,616   22,589,915
 Proceeds from maturities of mortgage-
  backed securities - held-to-maturity     402,965       658,745    1,248,403
 Net change in loans                   115,550,010) (147,608,780) (78,599,106)
 Purchases of bank premises and
  equipment                             (5,142,723)   (6,837,167)  (2,344,477)
 Net change in investment in joint
  venture                                  276,366   (17,204,265)           -
 Net change in other real estate owned           -        63,432    1,008,909
                                       -----------   -----------  -----------
  Net cash flows from investing
   activities                         (118,715,534) (134,192,519) (41,201,687)
                                       -----------   -----------  -----------
CASH FLOWS FROM FINANCING ACTIVITIES
 Net change in deposits                 87,449,678    76,590,193   23,537,058
 Advances from other borrowed funds    229,994,598   142,297,351   20,706,102
 Repayments of other borrowed funds   (207,500,000)  (90,700,000)  (7,000,000)
 Advances on borrowing related to inv.
  in real estate in a joint venture      1,555,164    16,720,745            -
 Common stock issued, net                  464,087       497,165    1,501,940
 Cash dividends paid                    (5,571,822)   (5,328,273)  (5,033,942)
 Treasury stock purchased               (4,377,704)   (8,687,765)  (5,452,872)
                                       -----------   -----------  -----------
  Net cash flows from financing
   activities                          102,014,001   131,389,416   28,258,286
                                       -----------   -----------  -----------
NET CHANGE IN CASH AND CASH
EQUIVALENTS                                940,044     4,818,447    3,348,459

CASH AND CASH EQUIVALENTS, beginning
 of year                                23,250,411    18,431,964   15,083,505
                                       -----------   -----------  -----------
CASH AND CASH EQUIVALENTS, end of
 year                                 $ 24,190,455  $ 23,250,411 $ 18,431,964
                                       ===========   ===========  ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
 Cash paid during the year for
  interest                            $ 23,780,049  $ 15,548,251 $ 15,505,666
                                       ===========   ===========  ===========
 Cash paid during the year for income
  tax                                 $  7,201,000  $  7,661,000 $  7,812,000
                                       ===========   ===========  ===========

NONCASH INVESTING AND FINANCING
TRANSACTIONS
 Property taken in settlement of
  loans                               $          -  $          - $    382,086
                                       ===========   ===========  ===========
 Property sold through seller
  financing                           $          -  $          - $          -
                                       ===========   ===========  ===========

See accompanying notes to these financial statements
------------------------------------------------------------------------------

                                        63

<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

Nature of Operations - Horizon Financial Corp. (the "Company"), through its
wholly-owned subsidiary, Horizon Bank (the "Bank"), provides a full range of
commercial and mortgage lending services to borrowers and a full range of
customer services to depositors through 18 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. 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.

All per share data included in the financial statements have been restated to
reflect all stock splits and dividends as well as the Company's ongoing share
repurchase activities.

Principles of Consolidation - As of March 31, 2006, 2005, and 2004, 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 the Bank, and its accounts are also included in the
consolidation. All material intercompany balances and transactions have been
eliminated.

In October 2004, the Bank's wholly owned subsidiary, Westward Financial
Services, Inc ("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 our consolidated balance sheet.  The Company also accounts for
the unowned portion as a minority interest.  The investment in real estate is
recorded as an asset and the related debt is recorded as our liability.  The
real estate joint venture has a carrying amount of approximately $16.9
million, with a related borrowing of approximately $18.3 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
$7,467,000 and $5,021,000 for the years ended March 31, 2006 and 2005,
respectively.

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.

Investments and Mortgage-Backed Securities - The Company classifies its
securities into one of three categories:  (1) held-to-maturity, (2)
available-for-sale, or (3) trading. Investment securities are categorized as
held-to-maturity when the Bank has the positive intent and ability to hold
those securities to maturity. Securities which are held-to-maturity are stated
at cost, adjusted for amortization of premiums, and accretion of discounts
which are recognized as adjustments to interest income.

------------------------------------------------------------------------------

                                        64

<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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-then- temporary impairment losses, management considers (1)
the 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. The Company had no trading securities at
March 31, 2006 and 2005.

Noncash Investing and Financing Transactions - Noncash investing and financing
transactions consist principally of securitizing mortgage loans and exchanging
them for Federal Home Loan Mortgage Corporation ("FHLMC") participation
certificates. At the time of the securitization, the pool of loans are
reclassified from the loan portfolio and are aggregated in a participation
certificate in the available-for-sale investment portfolio. A separate
mortgage servicing right is established using an estimate of fair market value
and reorganized upon securitization. The transaction does not result in the
recognition of income or expense in the income statement.

Federal Home Loan Bank Stock - The Bank's investment in 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.  At
this time, the FHLB has ceased paying dividends on FHLB stock.

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.

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 deferred fees or costs on originated loans and
unamortized premiums or discounts on purchased loans.  Interest income is
accrued on the unpaid principal balance.

Loan origination fees, net of certain direct loan origination costs, are
deferred and recognized as an adjustment of the yield on the related loans,
using the interest method.

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

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                                        65

<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

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

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

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

The allowance for loan losses is established as losses are estimated to have
occurred through a 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.

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                                        66

<PAGE>

                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation. Major renewals or betterments are capitalized and
depreciated over their estimated useful lives. Depreciation is computed on the
straight-line method over the estimated useful lives of 35 years for buildings
and three to ten years for equipment.

Bank Owned Life Insurance - The carrying amount of Bank Owned Life Insurance
approximates its fair value.  air value of Bank Owned Life Insurance is
estimated using the cash surrender value net of surrender charges. The Bank
owns approximately $14.0 million in Bank Owned Life Insurance as of March 31,
2006 and 2005, and is included in Other Assets.

Goodwill - Goodwill was recognized in connection with the purchase of branch
assets and related liabilities. The Company performs periodic evaluations for
impairment. During the current year impairment testing was performed and
Goodwill was found not to be impaired. At March 31, 2006 and 2005, Goodwill in
the amount of $545,336 was included in Other Assets.

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

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

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

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

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

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

Stock Options - The Company recognizes the financial effects of stock options
under the intrinsic value method in accordance with Accounting Principles
Board Opinion No. 25 Accounting for Stock Issued to Employees ("APB 25").
Generally, stock options are issued at a price equal to the fair value of the
Company's stock as of the grant date.

Under APB 25, options issued in this manner do not result in the recognition
of employee compensation in the Company's financial statements. Disclosures
required by Statement of Financial Accounting Standard ("SFAS" or "Statement")
No. 123 Accounting for Stock-Based Compensation, as amended are as follows.

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                                        67

<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

The pro forma information recognizes, as compensation, the value of stock
options granted using an option valuation model known as the Black Scholes
model. Pro forma earnings per share amounts also reflect an adjustment for an
assumed purchase of treasury stock from proceeds deemed obtained from the
issuance of stock options. The estimated fair value for options issued for the
years ended March 31, 2006, 2005, and 2004 is estimated at $71,884, $51,032,
and $2,317, respectively. The following assumptions were used to estimate the
fair value of the options for the year ended March 31:

                                                  2006      2005      2004
                                                 ------    ------    ------
Risk-free interest rate                           4.17%     4.26%     1.93%
Dividend yield rate                               2.613%    2.875%    3.02%
Price volatility                                 25.27%    25.47%    38.84%
Weighted average expected life of options         5.50 yr.  6.20 yr.  3.72 yr.

Management believes that the assumptions used in the option pricing model are
highly subjective and represent only one estimate of possible value, as there
is no active market for the options granted. The fair value of the options
granted will be allocated to pro forma earnings over the vesting period of the
options.

Pro forma disclosures for the years ended March 31:

                                              2006        2005        2004
                                           ----------  ----------  ----------

Net income as reported                    $15,655,021 $13,062,574 $12,866,368
Additional compensation for fair value of
 stock options, net of tax                    (30,790)    (19,501)    (51,593)
                                           ----------  ----------  ----------
Pro forma net income                      $15,624,231 $13,043,073 $12,814,775
                                           ==========  ==========  ==========
Earnings per share
 Basic
  As reported                                  $ 1.57      $ 1.28      $ 1.23
                                               ======      ======      ======
  Pro forma                                    $ 1.57      $ 1.28      $ 1.22
                                               ======      ======      ======

 Diluted
  As reported                                  $ 1.56      $ 1.26      $ 1.20
                                               ======      ======      ======
  Pro forma                                    $ 1.56      $ 1.26      $ 1.20
                                               ======      ======      ======

The remaining unrecognized compensation for fair value of stock options was
$53,900, $25,516, and $579 for options granted during the years ended March
31, 2006, 2005, and 2004, respectively.

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.

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                                     68

<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

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

                                             2006        2005          2004
                                           --------   ----------    ---------
Unrealized holding gains on available-
 for-sale securities                      $(574,352) $(2,317,855)  $ (531,242)
Reclassification adjustment for
 losses(gains) realized in income           476,452     (476,327)    (685,001)
                                           --------   ----------    ---------
Net unrealized gains                        (97,900   (2,794,182)  (1,216,243)
Tax effect                                   34,265      950,022      413,523
                                           --------   ----------    ---------
 Net-of-tax amount                        $ (63,635) $(1,844,160)  $ (802,720)
                                           ========   ==========    =========

Recent Accounting Pronouncements - In December 2004, the FASB issued SFAS No.
123(R), Share-Based Payment, which is a revision of FASB Statement No. 123,
Accounting for Stock-Based Compensation.  Statement 123(R) supersedes APB No.
25, Accounting for Stock Issued to Employees, and amends FASB Statement No.
95, Statement of Cash Flows.  Generally, the approach in Statement 123(R) is
similar to the approach described in Statement 123.  However, Statement 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair
values.  Pro forma disclosure is no longer an alternative.  The Securities and
Exchange Commission's ("SEC") new rule allows public companies to implement
Statement 123(R) at the beginning of their next fiscal year, instead of the
next reporting period, after June 15 or December 15, 2005, as applicable. The
SEC's new rule does not change the accounting required by Statement 123(R);
only the compliance deadlines have been altered.  The Company expects to adopt
Statement 123(R) on April 1, 2006.

As permitted by Statement 123, the Company currently accounts for share-based
payments to employees using Opinion 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have a
significant impact on the Company's results of operations, although it will
have no impact on the Company's overall financial position.  The impact of
adoption of Statement 123(R) cannot be predicted at this time because it will
depend on levels of share-based payments granted in the future.  However, had
the Company adopted Statement 123(R) in prior periods, the impact of that
standard would have approximated the impact of Statement 123 as described in
the disclosure of pro forma net income and earnings per share in Note 1 to the
consolidated financial statements.  Statement 123(R) also requires the
benefits of tax deductions in excess of recognized compensation cost to be
reported as a financing cash flow, rather than as an operating cash flow as
required under current literature.  This requirement will reduce net operating
cash flows and increase net financing cash flows in periods after adoption.

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

NOTE 2 - INTEREST-BEARING DEPOSITS

Interest bearing deposits consisted of the following at March 31:

                                                 2006       2005
                                              ---------   ---------
FHLB Demand                                  $9,139,080  $3,607,324
Certificates of deposit                         300,025     300,025
                                              ---------   ---------
                                             $9,439,105  $3,907,349
                                              =========   =========

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                                        69
<PAGE>


<PAGE>
                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 2 - INTEREST-BEARING DEPOSITS (Continued)

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 FHLBank of
Seattle.  The FHLB of Seattle, a federally chartered corporation, is one of 12
district FHLB Banks, 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 Banks
operate in a safe and sound manner, remain adequately capitalized, and can
raise 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.

The amortized cost and estimated market values of investments, together with
unrealized gains and losses, are as follows as of March 31, 2006 and 2005,
respectively:
                                                 2006
                         -----------------------------------------------------
                                               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          $45,925,265  $   27,654  $(13,495) $(731,974)$45,207,450
 Marketable equity
  securities            1,824,224   6,445,011  (219,000)         -   8,050,235
 Mutual funds           5,000,000           -  (130,916)         -   4,869,084
 Corporate debt
  securities            2,011,749           -    (1,407)      (120)  2,010,222
  Total available-     ----------   ---------  --------   --------  ----------
   for-sale
   securities          54,761,238   6,472,665  (364,818)  (732,094) 60,136,991
                       ----------   ---------  --------   --------  ----------
Held-To-Maturity Securities
 State and political
  subdivisions and U.S.
  government agency
  securities              369,747       4,604         -          -     374,351
  Total held-to-       ----------   ---------  --------   --------  ----------
   maturity securities    369,747       4,604         -          -     374,351
  Total investment     ----------   ---------  --------   --------  ----------
   securities         $55,130,985  $6,477,269 $(364,818) $(732,094)$60,511,342
                       ==========   =========  ========   ========  ==========

Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2006, 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, 2006, there are approximately 51 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 a more favorable market interest rate.

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                                        70

<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 3 - INVESTMENT SECURITIES (Continued)

                                                 2005
                         -----------------------------------------------------
                                               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           $54,034,115 $  203,765  $(10,170) $(836,288)$53,391,422
 Marketable equity
  securities             1,824,224  6,027,209  (335,000)         -   7,516,433
 Mutual funds            5,000,000          -   (70,493)         -   4,929,507
 Corporate debt
  securities             5,938,085     49,547         -          -   5,987,632
  Total available-      ----------  ---------  --------   --------  ----------
   for-sale securities  66,796,424  6,280,521  (415,663)  (836,288) 71,824,994
                        ----------  ---------  --------   --------  ----------
Held-To-Maturity Securities
 State and political
  subdivisions and U.S.
  government agency
  securities               369,596     13,313         -          -     382,909
                        ----------  ---------  --------    -------  ----------
  Total held-to-
   maturity securities     369,596     13,313         -          -     382,909
  Total investment      ----------  ---------  --------    -------  ----------
   securities          $67,166,020 $6,293,834 $(415,663) $(836,288)$72,207,903
                        ==========  =========  ========    =======  ==========

The amortized cost and estimated fair value of investment securities at March
31, 2006, 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.

                                                     2006
                                  --------------------------------------------
                                   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              $ 5,657,462 $ 5,641,510  $       -  $        -
  More than one to five years    33,621,001  33,055,405    369,747     374,351
  More than five to ten years     3,715,837   3,632,244          -           -
  Over ten years                  2,930,965   2,878,291          -           -
                                 ----------  ----------   --------  ----------
                                 45,925,265  45,207,450    369,747     374,351
                                 ----------  ----------   --------  ----------
Corporate debt securities
  One year or less                1,002,826   1,001,419          -           -
  More than one to five years     1,008,923   1,008,803          -           -
                                 ----------  ----------   --------  ----------
                                  2,011,749   2,010,222          -           -
                                 ----------  ----------   --------  ----------
Mutual funds and marketable
 equity securities (liquid)       6,824,224  12,919,319          -           -
                                 ----------  ----------  ---------  ----------
Total investment securities     $54,761,238 $60,136,991  $ 369,747  $  374,351
                                 ==========  ==========  =========  ==========

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                                        71
<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 3 - INVESTMENT SECURITIES (Continued)

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

                                                2006        2005       2004
                                             ----------  ---------  ---------

Proceeds from sales of investments          $15,856,955 $9,576,300 $6,839,100
                                             ==========  =========  =========
Gross gains realized on sales of
 investments                                $         - $  484,877 $  688,001
                                             ==========  =========  =========
Gross losses realized on sales of
  investments                               $  (565,245)$   (8,550)$   (3,000)
                                             ==========  =========  =========

Please refer to Note 4 for information on gross gains and losses on mortgage-
backed security sales.

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

                                           2006                  2005
                                   --------------------  --------------------
                                                Market                Market
                                      Cost      Value       Cost      Value
                                   ---------  ---------  ---------  ---------
Marketable equity securities
 Banking                          $  309,009 $2,025,755 $  309,009 $1,603,753
 Government agency stocks          1,515,215  6,024,480  1,515,215  5,912,680
                                   ---------  ---------  ---------  ---------
                                  $1,824,224 $8,050,235 $1,824,224 $7,516,433
                                   =========  =========  =========  =========
Corporate debt securities
 Finance companies                $        - $        - $2,255,452 $2,260,271
 Private utilities                 1,008,923  1,008,803  1,016,324  1,037,265
 Manufacturing companies           1,002,826  1,001,419  2,666,309  2,690,096
                                   ---------  ---------  ---------  ---------
Total                             $2,011,749 $2,010,222 $5,938,085 $5,987,632
                                   =========  =========  =========  =========

At March 31, 2006 and 2005, U.S. government agency and corporate debt
securities of $3,370,000 were pledged as collateral for deposits of state and
local government agencies and deposits for trust accounts in excess of
$100,000, as required by Washington State Law.

NOTE 4 - MORTGAGE-BACKED SECURITIES

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

                                                   2006
                        ------------------------------------------------------
                                                Gross      Gross
                                              Unrealized Unrealized
                                      Gross     Losses     Losses    Estimated
                         Amortized Unrealized 12 Months Greater Than    Fair
                           Cost       Gains    or Less   12 Months     Value
                        ---------- ---------- --------- -----------  ---------
Available-for-sale
 securities            $23,558,861   $103,178  $(2,946) $(308,394) $23,350,699
Held-to-maturity
 securities                482,021     14,611        -          -      496,632
                        ----------    -------   ------   --------   ----------
  Total mortgage-
   backed securities   $24,040,882   $117,789  $(2,946) $(308,394) $23,847,331
                        ==========    =======   ======   ========   ==========


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                                        72
<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 4 - MORTGAGE-BACKED SECURITIES (Continued)

Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2006, 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, 2006, there are approximately 32 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.

                                                 2005
                        ------------------------------------------------------
                                                Gross      Gross
                                              Unrealized Unrealized
                                      Gross     Losses     Losses    Estimated
                         Amortized Unrealized 12 Months Greater Than    Fair
                           Cost       Gains    or Less   12 Months     Value
                        ---------- ---------- --------- ----------- ----------
Available-for-sale
 securities            $18,353,299  $275,108  $ (8,644) $(109,324) $18,510,439
Held-to-maturity
 securities                885,137    41,192         -          -      926,329
                        ----------   -------   -------   --------   ----------
  Total mortgage-backed
   securities          $19,238,436  $316,300  $ (8,644) $(109,324) $19,436,768
                        ==========   =======    ======   ========   ==========

The amortized cost and estimated fair value of mortgage-backed securities at
March 31, 2006, 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.

                                                     2006
                                ----------------------------------------------
                                 Available-For-Sale      Held-To-Maturity
                                ----------------------  ----------------------
                                Amortized   Estimated    Amortized  Estimated
                                  Cost      Fair Value     Cost     Fair Value
                                ----------  ----------   ---------  ----------
Mortgage-backed securities
 One year or less              $         -  $         -  $       -  $        -
 More than two to five years     1,524,936    1,512,521    442,558     447,092
 More than five to ten years     3,306,102    3,284,180          -           -
 After ten years                18,727,823   18,553,998     39,463      49,540
                                ----------   ----------   --------   ---------
Total                          $23,558,861  $23,350,699  $ 482,021  $  496,632
                                ==========   ==========   ========   =========

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

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

                                                  2006      2005        2004
                                               ---------   --------   --------
Proceeds from sales of mortgage-backed
 securities                                   $1,053,664  $       -  $       -
Gross gains realized on sales of mortgage-     =========   ========    =======
 backed securities                            $   65,266  $       -  $       -
Gross losses realized on sales of mortgage-    =========   ========    =======
 backed securities                            $        -  $       -  $       -

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

------------------------------------------------------------------------------

                                        73
<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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:

                                                      2006           2005
First mortgage loans                              -----------    -----------
 1-4 Family                                      $148,515,674   $167,453,805
 1-4 Family construction                           20,971,473     16,464,259
 Less participations                              (56,546,403)   (65,124,970)
                                                  -----------    -----------
  Net first mortgage loans                        112,940,744    118,793,094
Construction and land development                 262,357,779    162,726,012
Residential commercial real estate                 70,079,590     73,396,638
Non-residential commercial real estate            314,298,926    312,721,631
Commercial loans                                  123,445,073    109,386,699
Home equity secured                                44,001,033     33,761,920
Other consumer loans                                5,571,110      5,961,613
                                                  -----------    -----------
                                                  932,694,255    816,747,607
Less:
 Allowance for loan losses                        (14,184,212)   (11,767,029)
                                                  -----------    -----------
                                                 $918,510,043   $804,980,578
                                                  ===========    ===========

The Company originates both adjustable and fixed interest rate loans. At March
31, 2006, the Company had adjustable and fixed rate loans as follows:

              Fixed Rate                         Adjustable Rate
-----------------------------------     -----------------------------------
  Term to Maturity       Book Value     Term to Maturity        Book Value
---------------------    ----------     ---------------------   -----------
Less than one year      $ 8,975,910     Less than one year     $551,340,008
One to three years       15,626,353     One to three years      203,571,683
Three to five years      15,610,889     Three to five years      22,826,497
Five to fifteen years    63,833,438     Five to fifteen years     1,246,030
Over fifteen years       49,663,446     Over fifteen years                -

Loans serviced for others are $99,548,943 and $103,174,983, respectively, as
of March 31, 2006 and 2005.

The Bank generally receives a monthly fee of 0.25% to 0.375% per annum of the
unpaid balance of each loan. The sold loans are sold without right of recourse
to the Bank by the buyer of the loan interests in the event of default by the
borrower.

The allowance for loan losses at March 31, and changes during the year are as
follows:
                                           2006        2005        2004
                                        ----------   ----------   ----------

Balance, beginning of year             $11,767,029  $10,121,532  $ 8,506,133
Provision for loan losses                2,575,000    1,700,000    1,915,000
Loan chargeoffs                           (164,884)    (228,805)    (385,335)
Loan recoveries                              7,067      174,302       85,734
                                        ----------   ----------   ----------
Balance, end of year                   $14,184,212  $11,767,029  $10,121,532
                                        ==========   ==========   ==========

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                                        74

<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 5 - LOANS RECEIVABLE (Continued)

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

                                                           March 31,
                                                      -------------------
                                                       2006         2005
                                                      ------       ------
                                                        (in thousands)

Impaired loans without a valuation allowance          $    -       $    -
Impaired loans with a valuation allowance              5,114        1,481
                                                      ------       ------
  Total impaired loans                                $5,114       $1,481
                                                      ======       ======
Valuation allowance related to impaired loans         $  856       $  300

Total non-accrual loans                               $1,161       $1,481
Total loans past-due 90 days or more and still
  accruing                                            $    -       $    -

                                                    Years Ended March 31,
                                               ------------------------------
                                                2006        2005        2004
                                               ------      ------      ------
                                                      (in thousands)

Average investment in impaired loans          $ 5,070     $   964     $     -
                                               ======      ======      ======
Interest income recognized on impaired loans  $     -     $     -     $     -
                                               ======      ======      ======
Interest income recognized on a cash basis on
 impaired loans                               $     -     $     -     $     -
                                               ======      ======      ======

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

NOTE 6 - ACCRUED INTEREST AND DIVIDENDS RECEIVABLE

Accrued interest and dividends receivable at March 31 is summarized as
follows:
                                                          2006       2005
                                                       ---------   ---------

Investment securities                                 $  574,224  $  810,762
Mortgage-backed securities                               115,947     117,578
Loans receivable                                       4,491,739   3,545,045
Dividends on marketable equity securities                  3,242      25,371
                                                       ---------   ---------
                                                      $5,185,152  $4,498,756
                                                       =========   =========

NOTE 7 - PREMISES AND EQUIPMENT

Premises and equipment at March 31 consisted of:
                                                          2006       2005
                                                       ---------   ---------

Buildings                                            $15,043,322 $14,983,220
Equipment                                             15,851,771  10,988,914
                                                      ----------  ----------
                                                      30,895,093  25,972,134
Accumulated depreciation                             (11,570,643)(10,182,899)
                                                      ----------  ----------
                                                      19,324,450  15,789,235
Land                                                   6,992,422   6,992,422
                                                      ----------  ----------
Balance, end of year                                 $26,316,872 $22,781,657
                                                      ==========  ==========

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                                        75
<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 8 - DEPOSITS

A comparative summary of deposits at March 31 follows:

                                                        2006         2005
                                                    ----------    ----------
Demand deposits
 Savings                                           $30,808,479  $ 40,862,597
 Checking                                           79,773,877    83,268,122
 Checking (noninterest-bearing)                     80,778,457    63,503,350
 Money Market                                      156,866,546   134,760,821
                                                   -----------   -----------
                                                   348,227,359   322,394,890
                                                   -----------   -----------
Time certificates of deposit
 Less than $100,000                                246,135,499   240,178,675
 Greater than or equal to $100,000                 239,936,231   184,275,846
                                                   -----------   -----------
                                                   486,071,730   424,454,521
                                                   -----------   -----------
Total deposits                                    $834,299,089  $746,849,411
                                                   ===========   ===========

Time certificate of deposit maturities at March 31 are as follows:

                                            2006
                            ------------------------------------
                             Variable       Fixed
                               Rate         Rate       Total         2005
                            ----------  -----------  -----------  -----------

Within one year            $ 9,485,796 $314,155,402 $323,641,198 $251,677,037
One to two years             3,999,251  107,315,246  111,314,497   76,881,549
Two to three years           1,763,408   17,789,890   19,553,298   53,288,458
Three to four years          6,781,314   10,571,724   17,353,038   14,298,128
Four to five years           1,181,954    8,627,647    9,809,601   23,534,311
Over five years              4,400,098            -    4,400,098    4,775,038
                            ----------  -----------  -----------  -----------
                           $27,611,821 $458,459,909 $486,071,730 $424,454,521
                            ==========  ===========  ===========  ===========

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, 2006
and 2005, was 2.54%  and 1.92%, respectively.

Interest expense on deposits for the years ended March 31 is summarized as
follows:
                                            2006        2005         2004
                                        ----------   ----------   ----------

Money market                           $ 3,456,228  $ 1,685,321  $ 1,323,697
Checking                                   425,861      427,990      500,240
Savings                                    189,153      215,997      288,768
Certificates of deposit                 15,916,557   10,889,549   11,111,924
                                        ----------   ----------   ----------
Balance, end of year                   $19,987,799  $13,218,857  $13,224,629
                                        ==========   ==========   ==========

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                                        76
<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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.
Committed lines of credit agreements totaling approximately $205.6 million and
$186.2 million were available to the Bank, of which, $149.0 million and $129.0
million were outstanding at March 31, 2006 and 2005, respectively.  Included
in these amounts is the borrowing related to investment in real estate in a
joint venture of $18,275,909 and $16,720,745 as of March 31, 2006 and 2005
respectively.  These advances bear interest ranging from 2.67% to 5.08% and
2.06% to 5.27% per annum, respectively. Maturities for the advances are
$69,500,000 in fiscal 2007, $69,000,000 in fiscal 2008, $4,500,000 in fiscal
2009, and $6,000,000 in fiscal 2010.

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

                                                       In Thousands
                                               -----------------------------
                                                 2006       2005       2004
                                               -------    -------    -------
Maximum outstanding at any month-end          $149,000   $129,500    $64,500
Average outstanding                            134,070     89,820     56,318
Weighted average interest rates:
 Annual                                           3.86%      3.26%      4.06%
                                                  ====       ====       ====
 End of year                                      4.39%      3.28%      3.84%
                                                  ====       ====       ====

The Bank also has other borrowed funds in the form of retail repurchase
agreements. These agreements are collateralized by securities held by a
safekeeping agent not under control of the Bank. These advances are considered
overnight borrowings bearing interest rates that fluctuate daily based on
current market rates. The Bank had $10,804,693 and $5,773,338 outstanding as
of March 31, 2006 and 2005, respectively.

At March 31, 2006 and 2005, respectively, U.S. government agency and corporate
debt securities of $14,261,377 and  $9,383,333 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:

                                              2006       2005         2004
                                           ---------   ---------   ---------
Provision for income tax at the statutory
 rate of 35 percent                       $7,895,255  $6,451,195  $6,721,000
Increase (decrease) in tax resulting from:
 Nontaxable income                          (538,803)   (639,726)   (354,380)
 Nondeductible expense                        15,281      12,759       6,041
 Dividends received deduction                (48,766)    (34,469)    (53,000)
 Other, net                                 (420,117)   (420,344)     12,506
                                           ---------   ---------   ---------
Income tax provision                      $6,902,850  $5,369,415  $6,332,167
                                           =========   =========   =========

------------------------------------------------------------------------------

                                        77

<PAGE>

                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 10 - INCOME TAX (Continued)

The nature and components of the Company's net deferred tax assets
(liabilities), established at an estimated tax rate of 35% and 34.25%,
respectively, are as follows at March 31:

                                                          2006         2005
                                                       ---------    ---------
Deferred Tax Assets
 Deferred compensation agreements                     $  659,000   $  624,000
 Deferred loan fees for financial reporting in excess
  of amounts deferred for tax purposes                         -    1,225,000
 Financial reporting loan loss reserve not
  recognized for tax purposes                          4,636,000    3,927,000
 Financial reporting accrued expenses not
  recognized for tax purposes                            264,000      234,000
 Other deferred tax assets                               708,000      215,000
                                                       ---------    ---------
   Total deferred assets                               6,267,000    6,225,000
                                                       ---------    ---------
Deferred Tax Liabilities
 Deferred loan fees for tax purposes in excess of
  amounts deferred for financial reporting              (275,000)           -
 Tax effect of unrealized gains on available-for-
  sale securities                                     (1,849,178)  (1,803,663)
 FLHB stock dividends                                   (793,000)    (776,000)
 Other deferred tax liabilities                       (1,096,112)  (1,346,112)
                                                       ---------    ---------
   Total deferred liabilities                         (4,013,290)  (3,925,775)
                                                       ---------    ---------
   Net deferred tax assets (liabilities)              $2,253,710   $2,299,225
                                                       =========    =========

The Company believes, based upon the available evidence, that all deferred
assets will be realized in the normal course of operations. Accordingly, these
assets have not been reduced by a valuation allowance.

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, 2006 and 2005, the cash
surrender values of these policies included in Other Assets aggregated
$1,828,884 and $2,389,722, respectively.

The Company performs a present value calculation using an appropriate discount
rate on an annual basis to ensure that those obligations are adequately
estimated in the accompanying financial statements. The discount rate was
2.72%, 3.00%, and 3.50% in 2006, 2005, and 2004, respectively. Deferred
compensation expense amounted to $137,500, $150,000 and $150,000 in 2006,
2005, and 2004, respectively.

Employee Incentive Plan - The Company has an incentive plan with employees
meeting certain service 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 $2,058,000,
$1,347,000, and $1,657,000 for the years ended March 31 2006, 2005, and 2004,
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.

------------------------------------------------------------------------------

                                        78

<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 11 - BENEFIT PLANS (Continued)

In April 1996, the Company issued a new loan to the ESOP in the amount of
$500,000, to purchase 40,000 shares of common stock in the open market. The
loan is to be repaid over a period of ten years, with annual payments
including interest due on March 31. The ESOP shares initially were pledged as
collateral for its debt. As the obligation is reduced, shares are released
from collateral and allocation 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 is to be
repaid over seven years with annual payments including interest due March 31.
In April 2001, the Company issued a 15% stock dividend which added an
additional 4,789 shares to the unallocated ESOP shares. In July 2002, the
Company issued a 25% stock split which added an additional 7,342 shares to the
unallocated ESOP shares. Shares released for allocation were 9,175 for the
year ended March 31, 2006 and 9,180 for the years ended March 31, 2006, 2005,
and 2004. The ESOP shares relating to the loans outstanding as of March 31
were as follows:

                                              2006        2005        2004
                                             ------     -------     -------
Number of shares
 Allocated shares                            84,093      74,918      65,738
 Unallocated shares                               -       9,175      18,355
                                             ------     -------     -------
   Total ESOP shares                         84,093      84,093      84,093
                                             ======     =======     =======
Fair value
 Unallocated shares                         $     -    $171,206    $340,118
                                             ======     =======     =======

Dividends paid on unallocated shares of stock are reinvested and the new
shares purchased are allocated to the participants. Compensation expense for
the ESOP plan is based upon the fair value of shares committed to be released
each year.

401(k) Plan - Effective January 1, 1993, the Company adopted a defined
contribution 401(k) retirement and savings plan (the "Plan") covering
substantially all employees. The Company contributes three percent of
participating employee's eligible salary to the Plan and a discretionary
amount determined annually by the Board of Directors. Total contributions to
the Plan amounted to $500,000, $450,000, and $430,000 for the years ended
March 31, 2006, 2005, and 2004, respectively.

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 financial statements. Under capital
adequacy guidelines within the regulatory framework for prompt corrective
action, the Company must meet specific capital adequacy guidelines that
involve quantitative measures of each entity's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. Capital classifications are also subject to qualitative judgments
by the regulators about components, risk weightings, and other factors.

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. Management believes, as of March 31, 2006, that
each entity meets all capital adequacy requirements to which they are subject.

As of March 31, 2006, the Bank was categorized as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-
ased, and Tier 1 leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.

------------------------------------------------------------------------------

                                        79
<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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, 2006
(in thousands)
 Total Capital
  (to Risk Weighted Assets)
   Consolidated           $124,523  12.63%   $78,861  >8.00%     N/A
   Horizon Bank           $124,365  12.62%   $78,861  >8.00%  $98,576 >10.00%
 Tier I Capital
  (to Risk Weighted Assets)
   Consolidated           $109,435  11.10%   $39,431  >4.00%    N/A
   Horizon Bank           $109,277  11.09%   $39,430  >4.00%   59,146  >6.00%
 Tier I Capital
  (to Average Assets)
   Consolidated           $109,435  10.03%   $43,655  >4.00%    N/A
   Horizon Bank           $109,277  10.02%   $43,633  >4.00%  $54,541  >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, 2005
(in thousands)
 Total Capital
  (to Risk Weighted Assets)
   Consolidated           $116,231  13.68%   $67,978  >8.00%    N/A
   Horizon Bank           $116,211  13.68%   $67,978  >8.00%  $84,972 >10.00%
 Tier I Capital
  (to Risk Weighted Assets)
   Consolidated           $103,069  12.13%   $33,989 >4.00%     N/A
   Horizon Bank           $103,049  12.13%   $33,989 >4.00%   $50,983  >6.00%
 Tier I Capital
  (to Average Assets)
   Consolidated           $103,069  10.83%   $38,080 >4.00%      N/A
   Horizon Bank           $103,049  10.82%   $38,080 >4.00%   $47,601  >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 - In October 2002, the Company announced a plan to
repurchase up to 1,065,000 shares, or approximately 10% of the Company's
outstanding common stock. During fiscal 2003, 195,700 shares were repurchased
and subsequently retired under this plan at a cost of $2,772,168. During
fiscal 2004, 162,400 shares were repurchased and subsequently retired under
this plan at a cost of $2,698,586.  In September 2003, the Company announced a
plan to repurchase up to 1,050,000 shares, or approximately 10% of the
Company's outstanding common stock. During fiscal 2004, 151,840 shares were
repurchased and subsequently retired under this plan at a cost of $2,754,286.
In total, the Company repurchased 314,240 shares and subsequently retired at a
cost of $5,452,872.  In March 2004, the Company announced a plan to repurchase
up to 1,040,000 shares, or approximately 10% of the Company's outstanding
common stock.  During fiscal 2005, 450,880 shares were repurchased and
subsequently retired


------------------------------------------------------------------------------

                                        80
<PAGE>




                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 12 - STOCKHOLDERS' EQUITY (Continued)

at a cost of $8,687,765.  In March 2005, the Company announced a plan to
repurchase up to 1,000,000 shares, or approximately 10% of the Company's
outstanding common stock.  During fiscal 2006, 212,852 shares were repurchased
and subsequently retired at a cost of $4,377,704.  All share information has
been restated to reflect stock splits and dividends.

Stock Option and Award Plans - The Company may grant options and/or awards for
a maximum of 750,000 shares of authorized common stock to certain officers and
key employees under the 2005 Incentive Stock Plan.   The activity during the
year ended March 31, 2005 was under the 1995 Stock Option and Incentive Plan,
which allowed for a maximum of 595,125 shares, as restated, of authorized
common stock to be awarded.  Options and awards are granted at no less than
fair market value and may or may not vest immediately upon issuance based on
the terms established by the Board of Directors. Options and awards are
generally exercisable within one to five years from date of grant and expire
after ten years.

                                 Shares of Common Stock    Weighted Average of
                                 -----------------------   -------------------
                                 Available for    Under    Exercise Price of
                                 Option/Award     Plan     Shares Under Plan
                                 -------------  --------   -----------------
Balance, March 31, 2004             $ 9,595     $307,465
 Authorized                               -            -
 Granted                            (12,500)      12,500    $17.96 - 21.430
 Exercised                                -      (97,117)   $ 4.19 - 14.625
 Lapsed                               2,945       (2,945)   $ 4.19 - 14.625
 Expired                                (40)           -
                                    -------      -------
Balance, March 31, 2005                   -      219,903
 Authorized                         750,000            -
 Restricted stock awards            (10,080)
 Granted                            (15,080)      15,080    $20.46 - 22.150
 Exercised                                -      (80,621)   $ 6.46 - 21.425
 Lapsed                               3,178       (3,178)   $ 6.46 - 21.425
 Expired                             (3,030)           -
                                    -------      -------
Balance, March 31, 2006            $724,988     $151,184
                                    =======      =======

                       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   93,752       3.497 years   $  7.57        93,753    $  7.57
 $10 to $15   33,000       6.372 years   $ 11.66        24,751    $ 11.66
 $15 to $20    7,500       8.937 years   $ 19.11         3,500    $ 19.19
 $20 to $25   16,932       9.417 years   $ 20.84           500    $ 21.42

At March 31, 2006, 876,172 shares of common stock were reserved for issuance
pursuant to stock plans and options.


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                                        81
<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 13 - EARNINGS PER SHARE

The numerators and denominators of basic and diluted earnings per share are as
follows:

                                             2006        2005        2004
                                          ----------  ----------  ----------

Net income (numerator)                   $15,655,021 $13,062,574 $12,866,368
Shares used in the calculation
(denominators)
 Basic earnings per weighted
  average share outstanding                9,937,600  10,212,190  10,480,785
 Effect of dilutive stock options             96,676     149,843     205,260
                                          ----------  ----------  ----------
 Diluted shares                          $10,034,276 $10,362,033 $10,686,045
                                          ==========  ==========  ==========
Basic earnings per share                      $ 1.57      $ 1.28      $ 1.23
                                              ======      ======      ======
Diluted earnings per share                    $ 1.56      $ 1.26      $ 1.20
                                              ======      ======      ======

At March 31, 2006, 2005, and 2004, there were options to purchase 151,184,
219,903, and 307,465 shares of common stock outstanding.  As of March 31,
2006, 2005, and 2004, all options to purchase shares of common stock were
included in the diluted net income per share calculation.

NOTE 14 - COMMITMENTS AND CONTINGENCIES

Employment Agreement - The Company has entered into a four-year employment
agreement with the Company's president at an amount approximating his current
level of compensation. In the event of specified termination of the
president's employment following a change in control of the Company (as
defined), the agreement provides the president with severance payments of up
to 2.99 times his annual compensation plus continuation of certain benefits.

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

        2007                 $ 241,856
        2008                   224,744
        2009                   107,097
        2010                    67,260
        2011                    63,600
        Thereafter             118,645
                              --------
                             $ 823,202
                              ========

Rent expense charged to operations was $293,947, $266,606, and $248,661 for
the years ended March 31, 2006, 2005, and 2004.

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.

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                                        82

<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 15 - RELATED PARTY TRANSACTIONS (Continued)

The aggregate balances and activity during 2006, 2005, and 2004 are as follows
and were within regulatory limitations:
                                           2006         2005         2004
                                        ----------   ----------   ----------

Balance, beginning of year             $14,546,791  $15,690,253  $19,851,634
New loans or advances                    9,042,488    4,880,489    7,572,429
Repayments                              (7,998,539)  (6,023,951) (11,733,810)
                                        ----------   ----------   ----------
Balance, end of year                   $15,590,740  $14,546,791  $15,690,253
                                        ==========   ==========   ==========
Interest earned on loans               $ 1,074,469  $ 1,050,208  $ 1,080,891
                                        ==========   ==========   ==========

Deposits from related parties totaled approximately $3,822,000, $3,674,000 and
$1,663,000 at March 31, 2006, 2005, and 2004, 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
$177,000 for the fiscal year ended March 31, 2006.  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
not be drawn upon to the total extent to which the Company is committed.

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, 2006.

-----------------------------------------------------------------------------

                                        83
<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

NOTE 17 - FINANCIAL INSTRUMENTS (Continued)

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, 2006,
2005, and 2004.

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

                                                    2006          2005
                                                -----------   -----------
Commitments to extend credit                   $286,188,167  $219,646,651
Credit card arrangements                          9,774,729     9,087,129
Standby letters of credit                         5,237,171     1,824,000

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 market value.

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

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

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 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.


------------------------------------------------------------------------------

                                        84
<PAGE>




                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

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

                                       2006                      2005
                             -----------------------   -----------------------
                              Carrying                  Carrying
                               Amount     Fair Value     Amount     Fair Value
                             ----------   ----------   ----------   ----------
Financial Assets
 Cash and cash equivalents  $24,190,455  $24,190,455  $23,250,411  $23,250,411
 Investment securities       60,506,738   60,511,342   72,194,590   72,207,903
 Mortgage-backed securities  23,832,720   23,847,331   19,395,576   19,436,768
 Interest-bearing deposits    9,439,105    9,439,105    3,907,349    3,907,349
 Federal Home Loan Bank
  stock                       7,247,400    7,247,400    7,217,900    7,217,900
 Loans receivable           918,510,043  912,192,000  804,980,578  803,378,000
 Loans held-for-sale          5,251,440    5,251,440    4,068,859    4,068,859
 Investment in real estate
  in a joint venture         16,927,899   16,927,899   17,204,265   17,204,265
 Accrued interest and
  dividends receivable        5,185,152    5,185,152    4,498,756    4,498,756

Financial Liabilities
 Demand and savings
  deposits                  348,227,359  348,227,359  322,394,890  322,394,890
 Time deposits              486,071,730  483,554,646  424,454,521  414,263,468
 Accounts payable and other
  liabilities                 4,917,849    4,917,849    4,683,923    4,683,923
 Accrued interest payable     2,001,825    2,001,825      886,148      886,148
 Other borrowed funds       141,560,791  139,925,916  119,066,193  117,781,243
 Borrowing related to
  investment in real estate
  in a joint venture         18,275,909   18,275,909   16,720,745   16,720,745

NOTE 19 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION

Condensed balance sheet at March 31:

                                            In Thousands
                                        -------------------
                                          2006       2005
                                        --------   --------
    Cash                              $     151   $      30
    Investment in Bank                  113,165     107,004
    Other assets                          1,442       1,355
                                       --------    --------
                                      $ 114,758   $ 108,389
                                       ========    ========

    Other liabilities                 $   1,435   $   1,365
    Stockholders' equity                113,323     107,024
                                       --------    --------
                                      $ 114,758   $ 108,389
                                       ========    ========

------------------------------------------------------------------------------

                                        85
<PAGE>



                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

Condensed statement of income for the years ended March 31, 2006, 2005, and
2004:
                                                         In Thousands
                                                   --------------------------
                                                    2006      2005      2004
Income                                             ------    ------    ------
 Cash dividends from Bank subsidiary              $ 9,981  $ 14,081   $ 9,028
 Interest                                               2         3         5
                                                  -------   -------   -------
   Total income                                     9,983    14,084     9,033
                                                  -------   -------   -------
Expenses
 Compensation                                         164       126       108
 Other                                                346       237       239
                                                  -------   -------   -------
   Total expenses                                     510       363       347
Income before equity in undistributed income of   -------   -------   -------
 subsidiary and benefit equivalent to income taxes  9,473    13,721     8,686
Benefit equivalent to income taxes                    178       123       118
Income before equity in undistributed income of   -------   -------   -------
 subsidiary                                         9,651    13,844     8,804
Equity in undistributed income of subsidiary        6,004      (781)    4,062
                                                  -------   -------   -------
   Net income                                     $15,655   $13,063   $12,866
                                                  =======   =======   =======


                                                    2006      2005      2004
Cash flows from operating activities              -------   -------   -------
 Net income                                       $15,655   $13,063   $12,866
Adjustments to reconcile net income to net
 cash flows from operating activities
  Equity in undistributed income of subsidiary     (6,004)      781    (4,062)
  Other operating activities                          (66)     (345)     (271)
                                                  -------   -------   -------
   Net cash flows from operating activities         9,585    13,499     8,533
Cash flows from investing activities              -------   -------   -------
 Other investing activities                            22        22        22
                                                  -------   -------   -------
   Net cash flows from investing activities            22        22        22
Cash flows from financing activities              -------   -------   -------
 Sale of common stock                                 464       497       926
 Dividends paid                                    (5,572)   (5,328)   (4,458)
 Treasury stock purchased                          (4,378)   (8,688)   (5,453)
                                                  -------   -------   -------
   Net cash flows from financing activities        (9,486)  (13,519)   (8,985)
                                                  -------   -------   -------
Net change in cash                                    121         2      (430)
Cash, beginning of year                                30        28       458
                                                  -------   -------   -------
Cash, end of year                                 $   151   $    30   $    28
                                                  =======   =======   =======

------------------------------------------------------------------------------

                                        86
<PAGE>


                                                     HORIZON FINANCIAL CORP.
                                               NOTES TO FINANCIAL STATEMENTS
                                              MARCH 31, 2006, 2005, AND 2004
------------------------------------------------------------------------------

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

                                          Year Ended March 31, 2006
                              -----------------------------------------------
                              1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
                              ----------- ----------- ----------- -----------
Interest income                 $15,536     $16,666     $18,194     $18,992
Interest expense                  5,262       5,908       6,604       7,122
                                 ------      ------      ------      ------
Net interest income              10,274      10,758      11,590      11,870
Provision for loan losses           725         750         800         300
Noninterest income                1,766       1,721       1,746       1,189
Noninterest expense               6,087       6,273       6,736       6,686
Income before provision for      ------      ------      ------      ------
  income tax                      5,228       5,456       5,800       6,073
Provision for income tax          1,516       1,661       1,817       1,909
                                 ------      ------      ------      ------
Net income                      $ 3,712     $ 3,795     $ 3,983     $ 4,164
                                 ======      ======      ======      ======

Basic earnings per share
 (adjusted for stock splits
  and dividends)                 $ 0.37      $ 0.38      $ 0.40      $ 0.42
                                 ======      ======      ======      ======
Diluted earnings per share
 (adjusted for stock splits
  and dividends)                 $ 0.37      $ 0.38      $ 0.40      $ 0.42
                                 ======      ======      ======      ======

                                          Year Ended March 31, 2005
                              -----------------------------------------------
                              1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
                              ----------- ----------- ----------- -----------
Interest income                $ 12,178    $ 12,890    $ 13,294    $ 13,819
Interest expense                  3,731       3,881       4,086       4,446
                                 ------      ------      ------      ------
Net interest income               8,447       9,009       9,208       9,373
Provision for loan losses           300         325         350         725
Noninterest income                1,769       1,775       1,580       1,393
Noninterest expense               5,214       5,713       5,815       5,681
                                 ------      ------      ------      ------
Income before provision for
 income tax                       4,702       4,746       4,623       4,360
Provision for income tax          1,428       1,439       1,399       1,103
                                 ------      ------      ------      ------
Net income                      $ 3,274     $ 3,307     $ 3,224     $ 3,257
                                 ======      ======      ======      ======
Basic earnings per share
 (adjusted for stock splits
  and dividends)                  $0.32       $0.32       $0.32       $0.32
                                 ======      ======      ======      ======
Diluted earnings per share
 (adjusted for stock splits
  and dividends)                  $0.31       $0.32       $0.31       $0.32
                                 ======      ======      ======      ======

During fiscal 2005, the Bank charged off loans totaling $229,000 and received
recoveries of $174,000.  At March 31, 2005, the allowance for loan losses was
$11,767,029, or 1.46% of total loans, compared to $10,121,532, or 1.48% of
total loans at March 31, 2004.  A large portion of the increase in the
allowance for loan losses occurred in the fourth quarter of 2005 in the amount
of $725,000 due in large part to the significant commercial loan growth in the
quarter.  Management believes the current balance of the allowance for loan
losses is adequate given the mix of our current loan portfolio and existing
economic conditions.


-----------------------------------------------------------------------------

                                        87
<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, 2006, 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, 2006 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 2006 that was not so
disclosed.

                                      88

<PAGE>



                                   PART III

Item 10.  Directors and Executive Officers of the Registrant
------------------------------------------------------------

     The information contained under the section captioned "Proposal I --
Election of Directors" is included in the Company's Definitive Proxy Statement
for the 2006 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 Fred R.
Miller (Chairman), James A. Strengholt 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 year ended March 31, 2004.
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.

                                      89

<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, 2006.

                                                                 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...............     136,252             $ 9.40               --
  2005 Incentive
   Stock Plan.........      14,932              20.76          724,988

Equity compensation
 plans not approved by
 security holders.....          --                 --               --
                           -------             ------          -------

   Total..............     151,184              10.52          724,988
                           =======             ======          =======

Item 13.  Certain Relationships and Related Transactions
--------------------------------------------------------

     The information contained under the section captioned "Transactions with
Management" in the Proxy Statement is 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)

                                      90

<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 (incorporated by
               reference to the Registrant's Quarterly Report on Form 10-Q for
               the quarter ended June 30, 2002)
        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)
        14     Code of Ethics (incorporated by reference to the Registrant's
               Annual Report on Form 10-K for the year ended March 31, 2004)
        21     Subsidiaries of the Registrant
        23     Consent of Moss Adams LLP, Independent Registered Public
               Accounting Firm
        31.1   Certification of Chief Executive Officer Pursuant to Section
               302 of the Sarbanes-Oxley Act
        31.2   Certification of 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.

                                       91

<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 9, 2006                    By:  /s/V. Lawrence Evans
                                          ------------------------------
                                          V. Lawrence Evans
                                          Chairman of the Board,
                                          Chief Executive Officer, and
                                          President
                                          (Duly Authorized Representative)

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates  indicated.


By:  /s/V. Lawrence Evans              By:  /s/Robert C. Diehl
     ------------------------------         ----------------------------
     V. Lawrence Evans                      Robert C. Diehl
     Chairman of the Board,                 Director
     Chief Executive Officer,
     and President

     Date:   June 9, 2006                   Date:   June 9, 2006


By:  /s/Richard P. Jacobson            By:  /s/Fred R. Miller
     ------------------------------         ----------------------------
     Richard P. Jacobson                    Fred R. Miller
     Principal Financial Officer            Director

     Date:  June 9, 2006                    Date:   June 9, 2006


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

     Date:  June 9, 2006                    Date:  June 9, 2006


By:  /s/Kelli J. Holz                  By:  /s/Robert C. Tauscher
     ------------------------------         ----------------------------
     Kelli J. Holz                          Robert C. Tauscher
     Principal Accounting Officer           Director

     Date: June 9, 2006                     Date: June 9, 2006

                                       92

<PAGE>



By:  /s/Richard R. Haggen              By:  /s/Gary E. Goodman
     ------------------------------         ----------------------------
     Richard R. Haggen                      Gary E. Goodman
     Director                               Director

     Date: June 9, 2006                     Date: June 9, 2006

                                       93

<PAGE>



                                 EXHIBIT INDEX


Exhibit 21     Subsidiaries of the Registrant

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

Exhibit 31.1   Certification of Chief Executive Officer Pursuant to Section
               302 of the Sarbanes-Oxley Act

Exhibit 31.2   Certification of 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 21

                         Subsidiaries of the Registrant





Parent
------

Horizon Financial Corp.



                                                         Jurisdiction
                               Percentage                or State of
Subsidiaries (a)              of Ownership               Incorporation
----------------              ------------               -------------

Horizon Bank                      100%                    Washington

Westward Financial
 Services, Inc. (b)               100%                    Washington

----------
(a)  The operation of the Corporation's wholly owned subsidiaries are included
     in the Consolidated Financial Statements contained in the Item 8 of this
     Form 10-K.

(b)  Wholly-owned subsidiary of Horizon Bank.

<PAGE>



                                   Exhibit 23

         Consent of Independent Registered Public Accounting Firm

<PAGE>



MOSS-ADAMS LLP
------------------------------------------------------------------------------
CERTIFIED PUBLIC ACCOUNTANTS

                                                                  Exhibit 23


         CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Horizon Financial Corp.

We consent to the incorporation by reference in the Registration Statement on
Form S-8 (No. 33-99780) of Horizon Financial Corp. pertaining to the 1995
Stock Option Plan and the Registration Statement on Form S-8 (No. 333-127178)
pertaining to the Horizon Financial Corp. 2005 Incentive Stock Plan; of our
report dated June 9, 2006 relating to the consolidated statement of financial
condition of Horizon Financial Corp. as of March 31, 2006 and 2005, and the
related consolidated statements of income, stockholders' equity, and cash
flows for each of the years in the three-year period ended March 31, 2006, and
our report dated June 9, 2006, with respect to Horizon Financial Corp.
management's assessment of the effectiveness of internal control over
financial reporting and the effectiveness of internal control over financial
reporting, appearing in this Annual Report on Form 10-K of Horizon Financial
Corp., for the year ended March 31, 2006.

/s/Moss Adams LLP

Bellingham, Washington
June 9, 2006

<PAGE>



                                Exhibit 31.1

                           Certification Required
     by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934

I, V. Lawrence Evans, 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    The registrant's other certifying officer(s) and I are 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    The registrant's other certifying officer(s) and 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 9, 2006
                                      /s/V. Lawrence Evans
                                      -------------------------------------
                                      V. Lawrence Evans
                                      Chief Executive Officer and President

<PAGE>



                                 Exhibit 31.2

                           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    The registrant's other certifying officer(s) and I are 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    The registrant's other certifying officer(s) and 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 9, 2006
                                        /s/Richard P. Jacobson
                                        -----------------------------
                                        Richard P. Jacobson
                                        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/V. Lawrence Evans                    /s/Richard P. Jacobson
----------------------------            -----------------------------
V. Lawrence Evans                       Richard P. Jacobson
Chief Executive Officer                 Chief Financial Officer

<PAGE>

Dated: June 9, 2006


<PAGE>