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, 2009               OR

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

                      Commission File Number: 0-27062

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

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

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


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

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

Common Stock, par value $1.00 per share           The NASDAQ Stock Market LLC
--------------------------------------------      ---------------------------
          (Title of each class)                   (Name of each exchange on
                                                       Which registered)

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

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

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

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

    Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
(section 232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such
files). YES       NO
            -----    -----

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

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

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

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

    The aggregate market value of the voting stock held by nonaffiliates of
the  registrant, based on the closing sales price of the registrant's common
stock as quoted on the NASDAQ Stock Market under the symbol "HRZB" on
September 30, 2008, was $108,600,169 (11,960,371 shares at $9.08 per share).
As of June 2, 2009, the registrant had 11,980,796 shares of common stock
outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

     1.   Certain portions of the registrant's Proxy Statement for the 2009
Annual Meeting of Stockholders, which is expected to be filed pursuant to
Regulation 14A within 120 days after the end of the registrant's fiscal year
ended March 31, 2009. (Part III).

                               HORIZON FINANCIAL CORP.
                          2009 ANNUAL REPORT ON FORM 10-K
                                 TABLE OF CONTENTS

                                                                         Page

Forward-Looking Statements ............................................   (ii)
Available Information..................................................  (iii)
PART I.
   Item 1.   Business..................................................     1
   Item 1A.  Risk Factors..............................................    38
   Item 1B.  Unresolved Staff Comments.................................    48
   Item 2.   Properties................................................    49
   Item 3.   Legal Proceedings.........................................    50
   Item 4.   Submission of Matters to a Vote of Security Holders.......    50
PART II.
   Item 5.   Market for Registrant's Common Equity, Related Stockholder
               Matters and Issuer Purchases of Equity Securities.......    51
   Item 6.   Selected Financial Data...................................    53
   Item 7.   Management's Discussion and Analysis of Financial
               Condition and Results of Operations.....................    55
   Item 7A.  Quantitative and Qualitative Disclosures About
               Market Risk.............................................    77
   Item 8.   Financial Statements and Supplementary Data...............    78
   Item 9.   Changes in and Disagreements with Accountants
               on Accounting and Financial Disclosure..................   114
   Item 9A.  Controls and Procedures...................................   114
   Item 9B.  Other Information.........................................   114
PART III.
   Item 10.  Directors, Executive Officers and Corporate Governance....   115
   Item 11.  Executive Compensation....................................   115
   Item 12.  Security Ownership of Certain Beneficial Owners
               and Management and Related Stockholder Matters..........   115
   Item 13.  Certain Relationships and Related Transactions,
               and Director Independence...............................   116
   Item 14.  Principal Accounting Fees and Services....................   116
PART IV.
   Item 15.  Exhibits and Financial Statement Schedules................   116

SIGNATURES.............................................................   118

                                      (i)

<PAGE>



Forward-Looking Statements

     "Safe Harbor" statement under the Private Securities Litigation Reform
Act of 1995:  This Form 10-K contains certain "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements may be identified by the use of words such as
"believe," "expect," "anticipate," "intend," "should," "plan," "project,"
"estimate," "potential," "seek," "strive," or "try" or other conditional verbs
such as "will,"  "would," "should," "could," or "may" or similar expressions.
These forward-looking statements relate to, among other things, expectations
of the business environment in which we operate, projections of future
performance, perceived opportunities in the market, potential future credit
experience, and statements regarding our strategies. Our ability to predict
results or the actual effects of our plans or strategies is inherently
uncertain. Although we believe that our plans, intentions and expectations, as
reflected in these forward-looking statements are reasonable, we can give no
assurance that these plans, intentions or expectations will be achieved or
realized. Our actual results, performance, or achievements may differ
materially from those suggested, expressed, or implied by forward-looking
statements as a result of a wide variety or range of factors including, but
not limited to: the credit risks of lending activities, including changes in
the level and trend of loan delinquencies and write-offs that may be impacted
by deterioration in the housing and commercial real estate markets and may
lead to increased losses and non-performing assets in our loan portfolio,
result in our allowance for loan losses not being adequate to cover actual
losses, and require us to materially increase our reserves; changes in general
economic conditions, either nationally or in our market areas; changes in the
levels of general interest rates, and the relative differences between short
and long term interest rates, deposit interest rates, our net interest margin
and funding sources; deposit flows; fluctuations in the demand for loans, the
number of unsold homes and other properties and fluctuations in real estate
values in our market areas; adverse changes in the securities markets
including changes in the ability of the issuers of trust preferred securities
we own to repay their obligations; results of examinations of us by the
Federal Reserve Bank of San Francisco and our bank subsidiary by the Federal
Deposit Insurance Corporation ("FDIC"), the Washington State Department of
Financial Institutions, Division of Banks ("DFI") or other regulatory
authorities, including the possibility that any such regulatory authority may,
among other things, require us to increase our reserve for loan losses,
write-down assets, change our regulatory capital position or affect our
ability to borrow funds or maintain or increase deposits, which could
adversely affect our liquidity and earnings; the possibility that we will be
unable to comply with the conditions imposed upon us by the Order to Cease and
Desist issued by the DFI and the FDIC, including but not limited to our
ability to increase our capital, reduce our non-performing assets and reduce
our reliance on brokered certificates of deposit, which could result in the
imposition of additional restrictions on our operations; our ability to
control operating costs and expenses; the use of estimates in determining fair
value of certain of our assets, which estimates may prove to be incorrect and
result in significant declines in valuation; difficulties in reducing risk
associated with the loans on our balance sheet; staffing fluctuations in
response to product demand or the implementation of corporate strategies that
affect our work force and potential associated charges; computer systems on
which we depend could fail or experience a security breach, or the
implementation of new technologies may not be successful; our ability to
manage loan delinquency rates; our ability to retain key members of our senior
management team; costs and effects of litigation, including settlements and
judgments; increased competitive pressures among financial services companies;
changes in consumer spending, borrowing and savings habits; legislative or
regulatory changes that adversely affect our business including changes in
regulatory polices and principles, including the interpretation of regulatory
capital or other rules; the availability of resources to address changes in
laws, rules, or regulations or to respond to regulatory actions; adverse
changes in the securities markets; the inability of key third-party providers
to perform their obligations to us; changes in accounting policies, principles
and practices, as may be adopted by the financial institution regulatory
agencies or the Financial Accounting Standards Board, including additional
guidance and interpretation on accounting issues and details of the
implementation of new accounting methods; the economic impact of war or any
terrorist activities; other economic, competitive, governmental, regulatory,
and technological factors affecting our operations; pricing, products and
services; our ability to lease excess space in Company-owned buildings; and
other risks detailed in this Form 10-K. Any of the forward-looking statements
that we make in this Form 10-K and in the other public statements we make may
turn out to be wrong because of the inaccurate assumptions we might make,
because of the factors illustrated above or because of other factors that we
cannot foresee. Additionally, the timing and occurrence or non-occurrence of
events may be subject to circumstances beyond our control. We caution readers
not to place undue reliance on any forward-looking statements. We do not
undertake and specifically disclaim any obligation to revise any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements. These
risks could cause our actual results for the remainder of 2009 and beyond to
differ materially from those expressed in any forward-looking statements by,
or on behalf of, us, and could negatively affect the Corporation's operating
and stock performance.

                                      (ii)

<PAGE>



     As used throughout this report, the terms "we", "our", or "us" refer to
Horizon Financial Corp. and our consolidated subsidiary, Horizon Bank.

                            Available Information

     The Company's annual report to shareholders, annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and press releases
are posted on the Corporation's Investor Relations page at
www.horizonbank.com. These reports are posted as soon as reasonably
practicable after they are electronically filed with the Securities and
Exchange Commission ("SEC"). All of the Company's SEC filings are also
available free of charge at the SEC's website at www.sec.gov or by calling the
SEC at 1-800-SEC-0330.


                                      (iii)

<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, 2009, the Corporation had total assets of $1.5 billion, total
deposits of $1.2 billion and total stockholders' equity of $93.0 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
deposits are insured by the FDIC up to applicable limits.

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

     In the Corporation's primary market areas, there have been an increasing
number of adverse employment announcements.  During our fiscal year ended
March 31, 2009, unemployment in Washington State reached 9.2% as compared to
4.8% in March 2008.  Contributing to this rise in unemployment were layoffs of
3,400 at Washington Mutual, 5,500 at Boeing, 1,500 at Microsoft and 750 at
Starbucks as well as an expected loss of 20,000 jobs in the construction
field. These reports led management to the conclusion that the challenges
being faced in the housing markets are not likely to improve in the near
future and will continue to challenge our borrowers in the real estate
construction and land development business sector.

     Over the last five years the Corporation has engaged in construction and
land development lending and accumulated a portfolio of $437.1 million of
these loans at March 31, 2009. Recent economic events have dramatically
impacted the Corporation with respect to this area of our operations. First,
the national economy is in a deepening recession due in part to the slow
housing market. Many of our construction borrowers, who rely on the sales of
homes to repay loans, are not able to find buyers. Some of these borrowers, in
turn, have defaulted on loans, which has impaired our ability to recognize
interest and has resulted in significant charge-offs and related provisions
for loan losses.

     In connection with continuing turmoil in the economy, and more
specifically, with our construction and land development loan portfolio, we
recorded a net loss of $33.4 million for the fiscal year ended March 31, 2009.
This loss was primarily the result of considerable increases in the provision
for loan losses during the year, a tightening interest margin caused by recent
interest rate reductions, and increased amounts of non-accrual loans. As a
result of our net loss, the Bank was "adequately capitalized" at that date as
further described in Note 12 - "Stockholders' Equity" of the Notes to the
Consolidated Financial Statements contained in Item 8 of this Form 10-K. Our
net loss has had a negative impact

                                   1

<PAGE>



on our operations, liquidity and capital adequacy and has resulted in mandates
by our regulators to require that we take certain actions to enhance our
operations and profitability, as noted below.

Regulatory Action
-----------------

     As noted in a Form 8-K filing on March 2, 2009, the Bank on February 26,
2009 entered into a Stipulation and Consent to the issuance of an Order to
Cease and Desist (the "Order") by the FDIC and the Washington Department of
Financial Institutions ("DFI").

     Under the terms of the Order, the Bank cannot declare dividends without
the prior written approval of the FDIC and the DFI. Other material provisions
of the Order require the Bank to:

   *  strengthen the Bank's board of directors' oversight of management and
      operations of the Bank;
   *  increase and subsequently maintain specified capital levels;
   *  enhance its practices and written policies for determining the adequacy
      of the allowance for loan and lease losses;
   *  eliminate loans classified as "Loss" and "Doubtful" at its regulatory
      examination, and reduce the loans classified as "Substandard" as a
      percent of capital;
   *  not extend additional credit to borrowers whose loan had been classified
      as "Loss" and is uncollected;
   *  develop a plan to reduce delinquent loans;
   *  develop a plan to reduce the amount of construction and land development
      loans;
   *  develop a three year strategic plan outlining specific goals for loans,
      investments and deposits, acceptable to the FDIC;
   *  enhance its written funds management and liquidity policy;
   *  not increase brokered deposits and develop a plan to reduce brokered
      deposits; and
   *  prepare and submit progress reports to the FDIC and the DFI.

     The Order will remain in effect until modified or terminated by the FDIC
and the DFI.

     In addition, on February 6, 2009, the Federal Reserve Bank of San
Francisco ("Federal Reserve") notified the Corporation that in light of the
seriousness of the FDIC's supervisory concerns, immediate efforts by the Board
of Directors and management are essential to return the Corporation to a
satisfactory condition for purposes of Section 914 of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989. As a result of this
notification neither the Corporation nor the Bank may appoint any new director
or senior executive officer or change the responsibilities of any current
senior executive officers without notifying the Federal Reserve. In addition,
neither the Corporation nor the Bank may make indemnification and severance
payments without complying with certain statutory restrictions including prior
written approval of the Federal Reserve and concurrence from the FDIC.

     For additional information regarding the terms of the FDIC order, see
Item 1A, "Risk Factors -- Risks Related to our Business - We are subject to
increased regulatory scrutiny and are subject to certain business limitations.
Further, we may be subject to more severe future regulatory enforcement
actions if our financial condition or performance weakens" herein.

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

     In response to these financial challenges and increased regulatory
supervision, we have taken and are continuing to take a number of tactical
actions aimed at preserving existing capital, reducing our substandard loans,
reducing our lending concentrations in the area of construction and land
development and associated capital requirements and increasing liquidity. The
tactical actions taken include, but are not limited to the following: slowing
loan originations, growing retail deposits, reducing brokered deposits,
seeking loan participation and sales arrangements with other lenders or
private equity sources, reducing personnel and other operating costs, and
eliminating the payment of dividends. Our goal is to return to profitability
by reducing our size, stabilizing our losses, managing our problem assets and
reducing overall expenses. We are working on the following objectives as a
basis for long-term success of our franchise:

                                   2

<PAGE>



   *  Improve Asset Quality. We have taken proactive steps to resolve our
      non-performing loans, including negotiating repayment plans,
      forbearances, loan modifications and loan extensions with our borrowers
      when appropriate. We also have substantially reduced or ceased lending
      activities for newly originated loans and redirected the focus of the
      loan department operations and other personnel to monitor and attempt to
      reduce our exposure to a further deterioration in asset quality. We have
      applied more conservative underwriting practices to our new loans,
      including, among other things, requiring more detailed credit
      information in certain circumstances, increasing the amount of required
      collateral or equity requirements, reducing loan-to-value ratios and the
      amount of loans originated to one borrower.

   *  Reduce Asset Base and Improve Regulatory Capital Ratios. We expect to
      reduce our asset base which should help reduce our risk profile and
      improve capital ratios through reductions in the amount of outstanding
      loans and securities through normal principal amortization, possible
      asset sales, and a corresponding reduction of liabilities.

   *  Continued Expense Control. Beginning in 2008 and continuing into 2009,
      management has undertaken several initiatives to reduce noninterest
      expenses, and will continue to make it a priority to identify cost
      savings opportunities throughout all phases of operations. Personnel
      reductions included a reduction in force of 27 full time employees
      during the last quarter of 2008. These reductions in personnel, along
      with strategic reductions in other non-interest expense areas will, we
      anticipate, result in savings of over $3.0 million on an annual basis.

   *  Reduce Reliance on Wholesale Funding Sources. We will continue to focus
      on our strategy of reducing our reliance on wholesale funding sources,
      which include Federal Home Loan Bank ("FHLB") advances and brokered
      certificates of deposits, while increasing core deposits and other
      retail deposit products through our branch deposit network. We are
      required under the Order to develop a plan to eliminate our reliance on
      brokered certificates of deposits. Retail deposits have increased during
      the 2009 fiscal year 5.5% to $968.4 million at March 31, 2009. The
      funding obtained will continue to be utilized to retire wholesale
      fundings at their maturities.

     We are also evaluating various strategic options and will seek the
assistance of investment banking services to evaluate and potentially pursue
the prospects of private equity investment or other capital raising
alternatives. While we continue to act upon both tactical and strategic
alternatives to raise capital and restructure our balance sheet, as has been
widely publicized, access to capital markets is extremely limited in the
current economic environment, and we can give no assurances that in the
current financial environment our efforts will be successful and will result
in sufficient capital preservation or infusion. Our ability to decrease our
levels of non-performing assets is also dependent on market conditions as our
construction loan borrowers rely on an active real estate market as a source
of repayment, and the sale of loans in this market is difficult. If the real
estate market does not improve, our level of non-performing assets may
continue to increase.

     While we believe that we are taking appropriate steps to respond to these
economic risks and regulatory actions, further deterioration in the economic
environment or severe regulatory actions could adversely affect our continuing
operations.

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

     General. The Bank's loan portfolio, net totaled $1.1 billion at March 31,
2009, representing approximately 77.0% of its total assets. On that date,
13.6% of net loans receivable consisted of loans secured by mortgages on
one-to-four family residential properties, 4.6% consisted of loans secured by
mortgages on multi-family residential properties, and 79.4% consisted of
construction and land development loans, commercial loans and commercial real
estate loans. The balance of the Bank's outstanding loans at that date
consisted of secured and unsecured consumer loans and loans secured by savings
deposits.

     The Bank originates both fixed rate and adjustable rate mortgages
("ARMs") secured by residential and commercial and multi-family real estate
and commercial loans to small-medium sized businesses and professionals.

                                   3

<PAGE>



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

     In order to enable it to make the yields on its loan portfolio and
investments more interest rate sensitive, the Bank has implemented a number of
measures. Those measures include the: (i) origination of long-term, fixed-rate
mortgage loans when such loans are written to specifications promulgated by
the Federal Home Loan Mortgage Corporation ("Freddie Mac") and qualify for
sale in the secondary market, (ii) origination of ARM loans on residential and
commercial properties subject to market conditions, (iii) origination of
variable rate commercial and consumer loans, and (iv) increased emphasis on
originating shorter term loans for its portfolio, and selling much of its
long-term mortgage loan production into the secondary market. As described
above, however, we are currently minimizing our loan originations, and
focusing on resolving our problem loans.

                                    4

<PAGE>


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


                                                         At March 31,
                    ----------------------------------------------------------------------------------------
                          2009             2008              2007               2006               2005
                    ---------------   ---------------   ---------------    ---------------   ---------------
                    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.... $ 167,048   14.9% $  165,824   13.9% $  149,885   14.2%  $148,515   16.2%  $167,454  20.8%
 One-to-four
  family
  construction...    28,290    2.5      35,303    3.0      28,576    2.7     20,971    2.3     16,464   2.1
 Participations
  sold...........   (42,853)  (3.8)    (54,269)  (4.6)    (54,592)  (5.2)   (56,546)  (6.2)   (65,125) (8.1)
                 ----------  -----  ----------  -----  ----------  -----   --------  -----   -------- -----

   Subtotal......   152,485   13.6     146,858   12.3     123,869   11.7    112,940   12.3    118,793  14.8
                 ----------  -----  ----------  -----  ----------  -----   --------  -----   -------- -----

 Construction and
  land develop-
  ment...........   408,787   36.4     486,535   40.8     405,348   38.4    262,358   28.6    162,726  20.2
 Multi-family
  residential....    51,970    4.6      45,049    3.8      52,727    5.0     70,080    7.6     73,397   9.1
 Commercial real
  estate.........   281,481   25.0     300,109   25.2     292,212   27.7    314,299   34.2    312,722  38.9
 Commercial
  loans..........   201,973   18.0     177,685   14.9     146,265   13.9    123,445   13.4    109,387  13.6
 Home equity
  secured........    58,228    5.2      47,351    4.0      45,307    4.3     44,001    4.8     33,762   4.2
 Other consumer
  loans..........     7,717    0.7       7,005    0.6       5,031    0.5      5,571    0.6      5,961   0.7
                 ----------  -----  ----------  -----  ----------  -----   --------  -----   -------- -----
   Subtotal...... 1,010,156   89.9   1,063,734   89.3     946,890   89.8    819,754   89.2    697,955  86.7
                 ----------  -----  ----------  -----  ----------  -----   --------  -----   -------- -----
   Total loans
   outstanding... 1,162,641  103.5   1,210,592  101.6   1,070,759  101.5    932,694  101.5    816,748 101.5
                 ----------  -----  ----------  -----  ----------  -----   --------  -----   -------- -----

Less:
 Allowance for
  loan losses....   (38,981)  (3.5)    (19,114)  (1.6)    (15,889)  (1.5)   (14,184)  (1.5)   (11,767) (1.5)
                  ---------  -----  ----------  -----  ----------  -----   --------  -----   -------- -----
  Net loans
   receivable....$1,123,660  100.0% $1,191,478  100.0% $1,054,870  100.0%  $918,510  100.0%  $804,981 100.0%
                 ==========  =====  ==========  =====  ==========  =====   ========  =====   ======== =====

                                                       5
</TABLE>

<PAGE>





     As reflected in the table above, approximately 66.0% of our total net
loan portfolio consists of commercial and multi-family real estate and
construction and land development loans. Management has made the strategic
decision to reduce the level of exposure to these types of loans during the
economic slowdown and has dramatically reduced its lending secured by this
type of collateral. In particular, management intends to continue these
efforts to reduce its concentration in construction and land development
loans. These loans are typically greater in amount, more difficult to evaluate
and monitor and, therefore, involve a greater degree of complexity and risk
than single family residential mortgage loans. Because payments on loans
secured by commercial and multi-family real estate often depend upon the
successful operation and management of the properties, and construction and
land development loans are dependent on home sales, repayment of such loans
are being challenged at this time by adverse conditions in the real estate
market and our local economy. As part of its strategic plan, the Bank intends
to reduce these risks by reducing the overall percentage of concentration in
commercial and multi-family real estate and construction and land development
loans until such time real estate markets stabilize and the economy shows
signs of recovery.

     Loan Maturity. The following table sets forth certain information at
March 31, 2009 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, 2009       31, 2009    31, 2009      Total
                           -----------   -----------  -----------    ------
                                           (In thousands)
Construction and land
  development............   $295,768      $ 41,213     $  1,725   $  338,706
Commercial real estate...    120,205       137,914       35,384      293,503
Multi-family residential.     20,591        29,237        2,330       52,158
Commercial loans.........    168,189        34,105        5,895      208,189
One-to-four family
  construction...........     28,290            --           --       28,290
One-to-four family
  residential, home
  equity, and other
  consumer loans.........     81,773        42,167       78,874      202,814
                            --------      --------     --------   ----------
    Total................   $714,816      $284,636     $124,208   $1,123,660
                            ========      ========     ========   ==========

     The following table sets forth the dollar amount of all loans due more
than one year after March 31, 2009 which have fixed interest rates and have
floating or adjustable interest rates. Loan balances are net of undisbursed
loan proceeds, unearned discounts, unearned income, and allowance for loan
losses.

                                                      Adjustable
                                        Fixed Rates     Rates         Total
                                        -----------   ----------    ----------
                                                    (In thousands)
Construction and land
  development.......................     $ 37,516       $  5,422    $  42,938
Commercial real estate..............       74,018         99,280      173,298
Multi-family real estate............       17,337         14,230       31,567
Commercial loans....................       28,547         11,453       40,000
One-to-four family construction.....           --             --           --
One-to-four family residential,
  home equity, and other
  consumer loans....................       93,731         27,310      121,041
                                         --------       --------    ---------
    Total...........................     $251,149       $157,695     $408,844
                                         ========       ========     ========

     Multi-Family and Commercial Real Estate Lending. Commercial real estate
loans, including multi-family loans, totaled $333.5 million, or 29.7% of net
loans receivable at March 31, 2009. 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

                                            6

<PAGE>



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, 2009, the largest commercial real estate loan on one property had an
outstanding balance of $15.9 million and is secured by a destination resort
and surrounding real estate located in the Bank's market area. At March 31,
2009, the Bank had seven other loans with net balances in excess of $10.0
million, which are secured by commercial real estate. All of these loans were
performing according to their repayment terms at March 31, 2009.

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

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

     Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one-to-four
family residential lending. However, loans secured by such properties usually
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one-to- four family residential mortgage
loans. Because payments on loans secured by commercial properties often depend
upon the successful operation and management of the properties, repayment of
such loans may be affected by adverse conditions in the real estate market or
the economy. If we foreclose on a commercial and multi-family real estate
loan, our holding period for the collateral typically is longer than for
one-to-four family residential mortgage loans because there are fewer
potential purchasers of the collateral. Additionally, commercial and
multi-family real estate loans generally have relatively large balances
compared to residential mortgage loans. Accordingly, if we make any errors in
judgment in the collectibility of our commercial and multi-family real estate
loans, any resulting charge-offs may be larger on a per loan basis than those
incurred with our residential or other consumer loans. The Bank seeks to
minimize these risks by limiting the maximum loan-to-value ratio to 80% and
carefully reviewing the financial condition of the borrower, the quality of
the collateral and the management of the property securing the loan. The
Bank's balance of multi-family loans declined during the year ended March 31,
2009 due to the economy and a change in focus from originations of loans to
resolving problem assets as we reduced our concentration risk and sought to
comply with the Order.

     Construction and Land Development Loans. Construction lending
historically provided the Bank the opportunity to achieve higher interest
rates and fees with shorter terms to maturity than does its other real estate
lending activities. The vast majority of the Bank's construction loan activity
is concentrated in the Pacific Northwest. Market conditions in the Pacific
Northwest have declined and the Bank's performance is being adversely impacted
as described above. If the market does not improve, it will likely continue to
have a significant adverse impact on the Bank's performance. As part of the
Bank's strategic plan, the Bank expects to significantly reduce its exposure
to construction loans over time and has ceased originating new construction
loans.

     Although construction lending has afforded us the opportunity to achieve
higher interest rates and fees with shorter terms to maturity than one-to-four
family mortgage lending, construction lending is considered to involve a
higher degree of risk. At the time these types of loans are made, the value of
the collateral securing the loan must be estimated based on the projected
selling price at the time the residence or commercial real estate property is
completed and on estimated building and other costs (including interest
costs). Changes in the demand, such as for new housing and higher than
anticipated building costs may cause actual results to vary significantly from
those estimated. Accordingly, the Bank

                                           7

<PAGE>



may be confronted, at the time the property is completed, with a loan balance
exceeding the value of the collateral. Because construction loans require
active monitoring of the building process, including cost comparisons and
on-site inspections, these loans are more difficult and costly to monitor.
Increases in market rates of interest may have a more pronounced effect on
construction loans by rapidly increasing the end-purchasers' borrowing costs,
thereby reducing the overall demand for the project. Properties under
construction are often difficult to sell and typically must be completed in
order to be successfully sold also complicates the process of working out
problem construction loans. This may require us to negotiate repayment plans,
forbearances, loan modifications or loan extensions to our borrowers or to
advance additional funds and/or contract with another builder to complete
construction. Furthermore, in the case of speculative construction loans,
there is the added risk associated with identifying an end-purchaser for the
finished project.

     To address these risks, and because of the level of construction loans in
the Bank's portfolio, the Bank has personnel dedicated specifically to
monitoring the progress of its construction projects, and making on-site
inspections of the properties. The Bank also utilizes the services of
experienced inspectors to monitor the progress and draw process in the more
complex construction projects. The Bank has an experienced appraisal staff,
and members of senior management with related appraisal education and
experience, who review appraisals utilized by the Bank in analyzing
prospective construction projects. In addition, in an effort to monitor the
available inventory in its markets, the Bank also regularly reviews the
overall building and development activity in its markets.  In some instances,
borrower arrangements include available lines of credit that can only be used
to meet the ongoing maintenance requirements known as "interest reserves."  As
of March 31, 2009, we had eight commercial borrowers with commitments of $30.8
million with $1.0 million in available interest reserves. Also at that date,
there were 71one-to-four family construction loans with commitments of $124.0
million with $3.3 million in available interest reserves. The interest
reserves serve to meet the loan payment terms during the construction phase.

     The Bank 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 set forth 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, 2009 and 2008, the composition of the Bank's construction
loan portfolio was as follows:
                                                 At March 31,
                                ----------------------------------------------
                                       2009                     2008
                                --------------------     ---------------------
                                Amount (1)   Percent     Amount (1)    Percent
                                ---------    -------     ---------     -------
                                            (Dollars in thousands)

Speculative construction
  one-to-four family..........   $ 19,280      4.4%      $ 27,206        5.2%
Custom/presold construction
  one-to-four family..........      9,010      2.0          8,097        1.6
Commercial/speculative
  construction one-to-four
  family......................    142,315     32.6        236,536       45.3
Commercial construction -
  multi-family................      8,439      1.9         11,732        2.2
Commercial construction -
  nonresidential..............     71,453     16.4         59,541       11.4
Land development..............    186,580     42.7        178,726       34.3
                                 --------    -----       --------      -----
   Total......................   $437,077    100.0%      $521,838      100.0%
                                 ========    =====       ========      =====
-----------------
(1)  Includes loans in process.

                                         8

<PAGE>



     Speculative construction one-to-four family loans decreased 29.1% from
March 31, 2008 to $19.3 million at March 31, 2009. These loans are made to
home builders who generally build one or two speculative construction homes
per year. Because of the nature of these loans, a buyer for these homes is
found by the builder either during the construction phase or shortly after
completion of the home's construction. The Bank generally includes interest
reserves in the construction loan amount; however, there is no assurance that
this amount will be sufficient to cover all interest expense for the life of
the loan. If a buyer is not found in a timely manner, the builder will incur
additional interest, marketing and other expenses until the home is sold. As a
result, these loans carry a higher degree of risk than loans on homes already
completed and custom construction loans (discussed below) for which there is a
buyer.

     Custom construction for one-to-four family loans increased 11.3% from the
prior year to $9.0 million at March 31, 2009. 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 is generally for a period of one year or less, and the Bank
generally commits to the long-term take-out financing for the customer at the
time the construction loan is originated. As a result, the risk for custom
construction loans is generally less than for speculative construction loans.

     Commercial speculative construction one-to-four family residential loans
decreased 39.8% from the prior year to $142.3 million at March 31, 2009 to
reduce our concentration and comply with the Order. In the past, commercial
speculative construction loans included loans made to the Bank's larger
contractors, who built 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, prior to this year, in
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
decreased 28.1% from the prior year, to $8.4 million at March 31, 2009. 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 20.0% from the
prior year to $71.5 million at March 31, 2009. These loans are made for a
variety of non-residential real estate properties, including, but not
necessarily limited to, 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.

     Land development loans increased 4.4% from the prior year, to $186.6
million at March 31, 2009 as a result of draws on previously existing
commitments.  In the past, this type of lending has been a significant part of
the Bank's strategy in each of its markets. Most of these loans carry interest
rates tied to the Prime rate, which allows the Bank to fund the loans with
short-term borrowings at a profitable margin over cost. There are significant
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, home and finished lot prices, and related measures in
its efforts to mitigate this risk. However, as demonstrated by recent economic
conditions, no assurances can be made that these or other measures can or will
fully mitigate such risks. Currently, the demand for building lots is minimal
in the Bank's market areas, as a result of the slow housing market and the
high levels of inventory in both finished homes and developed lots, adversely
affecting the ability of the Bank's construction loan borrowers to repay their
loans.

                                         9

<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 $202.0 million, or approximately 18.0% of the Bank's net loan
portfolio at March 31, 2009. The majority of these loans carry personal
guarantees. Under certain conditions, the Bank also offers unsecured credit to
qualified borrowers.

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

     One-to-Four Family Residential Loans. In the past, a significant lending
activity of the Bank was the granting of conventional loans to enable
borrowers to purchase existing homes or construct new homes. The Bank's real
estate loan portfolio also includes loans on two-to-four family dwellings, and
loans made to purchase or refinance improved buildings to be used for
residential housing. At March 31, 2009, 13.6% of the Bank's net loans
receivable consisted of loans secured by one-to-four residential real estate.
As part of its strategic plan, and subject to market conditions, the Bank
expects to continue originating fixed rate residential loans, primarily for
sale, while retaining residential ARM loans.

     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 Freddie Mac. The coverage generally
limits the Bank's exposure to 72% of the loan amount. If private mortgage
insurance is required, the borrower pays the premium at loan closing and any
recurring premiums through an escrow reserve account established with the Bank
for such period of time as the Bank requires the insurance coverage to be in
force.

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

     Consumer Loans. The Bank makes a variety of loans for consumer purposes.
Included among these are home equity loans, home equity lines of credit, and,
to a much lesser extent, loans secured by personal property, such as
automobiles, boats, and other vehicles, loans secured by deposit accounts,
unsecured loans, and loans for mobile homes located in mobile home parks.

     Horizon Bank offers consumer loans in order to provide a wider range of
financial services to its customers and to achieve shorter terms and higher
interest rates normally typical of such loans. At March 31, 2009, the Bank
held $65.9 million of consumer loans or 5.9% of net loans receivable,
approximately $3.2 million of which is unsecured. At that date, $58.2 million
or 5.2% of net loans receivable were home equity loans. These loans are
generally originated with a maximum loan-to-value ratio of 70% at the time of
origination, with either a fixed or adjustable interest rate and are fully
amortizing over terms ranging from 10 to 20 years.

     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

                                           10

<PAGE>



likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the
amount that can be recovered on such loans.

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

     Loan Solicitation and Processing. The primary sources for loan
originations are attributable to deposit customers, current borrowers, walk-in
customers, and referrals from existing customers, real estate agents, real
estate developers, and builders. The Bank does not actively utilize mortgage
brokers in the origination of loans.

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

     Loan assumption requests of adjustable rate loans are handled by the Bank
in a manner similar to new loan requests. Secondary market standards are
generally applied to each request and full credit underwriting is required.
For fixed rate loans, a sale or transfer of the secured property generally
results in the Bank enforcing its due on transfer rights contained in the
mortgage instrument.

     Loan Originations, Purchases and Sales. Currently, the Bank emphasizes
the origination of 15 to 30 year fixed rate residential 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, the 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. Historically the Bank has not purchased a significant
amount of loans.

     The Bank is a qualified servicer for both Freddie Mac and the 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. 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, 2009, the Bank was servicing
loans for others of $42.9 million for which it generally receives a fee
payable monthly of 0.25% to 0.375% per annum of the unpaid balance of each
loan. In February 2001, the Bank began selling much of its current loan
production on a servicing released basis, and plans to continue doing so for
many of the long-term fixed rate loan originations. All sales of loan
interests by the Bank are made without right of recourse to the Bank by the
buyer of the loan interests in the event of default by the borrower.

     The Bank has the ability to buy and sell portions of commercial real
estate loans through participations with other financial institutions. As of
March 31, 2009, the Bank was servicing commercial loans for others aggregating
approximately $31.0 million for which it generally receives a fee payable
monthly of 0.25% to 0.375% per annum of the unpaid balance of each loan. The
Bank has numerous options in this regard, and will continue to buy and sell,
loan

                                           11

<PAGE>



participations to assist its liquidity, concentration and diversification
efforts. At this time we do not plan to purchase loan participations until
after we have completed our balance sheet deleveraging strategy.

     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, 2009.

     We are currently reducing our outstanding commitments in order to reduce
our exposure to potential losses.

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

                                                       At  March 31,
                                                 -------------------------
                                                    2009           2008
                                                 -----------   -----------
                                                      (In thousands)

Commitments to extend credit...................   $212,627       $361,763
Credit card arrangements.......................     10,675         10,510
Standby letters of credit......................      3,523          2,047

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

     The Bank's loan origination fees are generally 0% to 2.5% on conventional
residential mortgages and 0% to 1.5% for commercial real estate loans. The
total amount of deferred loan origination fees and unearned discounts at March
31, 2009 was $3 million. Any unamortized loan fees, net of related direct
costs, are recognized as income at the time the loan is sold, paid down or
paid off.

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

                                           12

<PAGE>



     Delinquent Loans, Loans in Foreclosure and Foreclosed Property. Loans are
defined as delinquent when any payment of principal and/or interest is past
due. While the Bank generally is able to work out a satisfactory repayment
schedule with a delinquent borrower, the Bank will usually undertake
foreclosure proceedings if the delinquency is not otherwise resolved within 90
days. Property acquired by the Bank as a result of foreclosure or by deed in
lieu of foreclosure is classified as "other real estate owned" until such time
as it is sold or otherwise disposed of. As of March 31, 2009, there was one
loan in the loan portfolio over 90 days delinquent and accruing interest and
53 loans on non-accrual status. As described below under the heading "Other
Real Estate Owned", the Bank had 14 properties in the real estate owned
category totaling $19.2 million at March 31, 2009. Total non-performing assets
represented $104.7 million or 7.13% of total assets at March 31, 2009 compared
to $12.3 million or 0.88% of total assets at March 31, 2008.

     The following tables summarize the Bank's non-performing assets and
restructured loans within the meaning of SFAS No. 15, Accounting by Debtors
and Creditors for Trouble Debt Restructuring at the dates indicated.

                                              At March 31,
                             ---------------------------------------------
                               2009      2008      2007     2006     2005
                             -------   -------   -------   ------   ------
                                        (Dollars in thousands)

Non-accrual loans (1)...... $ 84,924  $ 11,608  $    226  $ 1,161  $ 1,481
Loans 90 days or more
 delinquent and
 accruing interest.........      500        --        --       --       --
Real estate acquired
 through foreclosure.......   19,227       655       725       --       --
                            --------  --------  --------  -------  -------
   Total................... $104,651  $ 12,263  $    951  $ 1,161  $ 1,481
                            ========  ========  ========  =======  =======

Non-performing loans as a
 percentage of net loans...     7.60%     0.97%     0.02%    0.13%    0.18%

Non-performing assets as a
 percentage of total
 assets....................     7.13%     0.88%     0.07%    0.10%    0.15%

Troubled debt
 restructured loans........ $ 26,383        --        --       --       --
                            ========  ========  ========  =======  =======
-----------------
(1) Additional interest income of $3.1 million would have been recorded had
    nonaccruing loans been current in accordance with their original terms
    during the year ended March 31, 2009. No interest income was recorded on
    nonaccrual loans for the year ended March 31, 2009.

    The following table summarizes the Bank's non-performing assets at March
31, 2009 by county and by classification:

<TABLE>

 Non-performing
 Assets ("NPAs")
      by                Whatcom     Skagit    Snohomish     King     Pierce   Thurston     Total    % of
Classification (1)      County      County     County      County    County    County      NPAs     NPAs
                        ------      ------     ------      ------    ------    ------      ------   ----

                     <c>         <c>        <c>         <c>       <c>       <c>         <c>      <c>
                                                  (Dollars in thousands)
One-to-four
 family residential...$    100    $    381   $    640     $    --   $    --   $    --     $  1,121    1.0%
One-to-four family
 construction.........      --          --        605          --     2,095        --        2,700    3.0
                       -------      ------    -------     -------   -------   -------     --------  -----
   Subtotal...........     100         381      1,245          --     2,095        --        3,821    4.0
Commercial land
 development..........  10,138         162     32,040          --    15,586     2,286       60,212   57.0
Commercial
 construction (2).....     362       1,371      6,763      12,568    11,625     3,994       36,683   35.0
Multi-family
 residential..........      --          --         --          --        --        --           --     --
Commercial real
 estate...............      --          --         --          --        --        --           --     --
Commercial business...      --          --        721       1,497        33        --        2,251    2.0
Home equity secured...      73         249         --          --     1,345        --        1,667    2.0
Other consumer........      17          --         --          --        --        --           17     --
                       -------      ------    -------     -------   -------   -------     --------  -----
   Subtotal...........  10,590       1,782     39,524      14,065    28,589     6,280      100,830   96.0
Total non-performing
 assets............... $10,690      $2,163    $40,769     $14,065   $30,684   $ 6,280     $104,651  100.0%
                       =======      ======    =======     =======   =======   =======     ========  =====
Percent of total
 non-performing
 assets...............      10%          2%        39%         14%       29%        6%         100%
------------
(1)  Other real estate owned is included in the table according to its location and classification.
(2)  The commercial construction totals include $10.7 million in condominium construction projects, with the
     majority of the remaining balance consisting of various commercial speculative one-to-four family
     construction projects.

                                                    13
</TABLE>

<PAGE>


     In addition, at March 31, 2009 the Bank identified $172.2 million of
additional potential problem loans, primarily single family construction and
land development loans. These potential problem loans are loans that do not
meet the criteria for placement on non-accrual status or troubled-debt
restructuring, therefore, they are not included in the non-performing loan
totals. Management has concerns as to the ability of the borrower to comply
with present loan repayment terms, and may result in the future inclusion of
such loans in the non-accrual category.

     Commercial construction, commercial land development, commercial real
estate and multi-family residential real estate loans represent larger
individual loan amounts, which have a greater single impact on the total
portfolio quality in the event of delinquency or default. Further, while the
Bank believes that the loss potential for its non-performing assets is
properly reserved currently, the Bank is closely watching its construction and
land development loan portfolio, and believes there is a potential for
significant additions to non-performing loans, charge-offs, provisions for
loan and lease losses, and/or real estate owned in the future if the housing
market conditions do not improve.

     The Bank has added personnel and redirected the duties of certain lending
staff members to address the needs of these special credits. The Bank's Chief
Credit Officer and Commercial Banking Manager are actively managing the Bank's
problem credits, with attention to marketing existing non-performing assets,
negotiating repayment plans, forbearances, loan modifications and loan
extensions with our borrowers when appropriate, and obtaining control of
properties, where necessary. In addition, the Bank is enhancing certain
borrowers' marketing efforts by providing attractive financing programs to
buyers of homes currently financed by the Bank. Generally, these loans are
granted at the lowest secondary market rates to credit-worthy borrowers and
include an initial fixed rate period of not more than five years.  Management
elected to employ this strategy based on its belief that it was in the Bank's
best interest to transfer the primary source of repayment for these properties
to a homeowner with other sources of income, as opposed to having the primary
source of repayment remain with the builder's ability to sell the property.

     Other Real Estate Owned. Other real estate owned is carried at the lesser
of book value or market value less selling costs. The costs related to
maintenance and repair or other costs of such properties, are generally
expensed with any gains or shortfalls from the ultimate sale of other real
estate owned being shown in other noninterest income or expense.

     The following table summarizes changes in the other real estate owned
portfolio for the periods indicated.

                                        For the Year Ended March 31,
                                            2009            2008
                                         --------         -------
                                               (In thousands)

Balance at beginning of period.........  $    655         $   725
Additions to other real estate owned...    31,669              --
Valuation adjustments..................      (539)            (70)
Disposition of other real
  estate owned.........................   (12,558)             --
                                         --------         -------
Balance at end of period...............  $ 19,227         $   655
                                         ========         =======

     The Corporation recognized $445,000 in losses related to the disposition
of properties during the year ended March 31, 2009.  At March 31, 2009 there
were 14 projects totaling $19.2 million held in other real estate owned, six
of which are located in Snohomish County, three in Skagit County, two in
Whatcom County, two in Pierce County and one project located in King County.
The six projects in Snohomish County include one 7.44 acre parcel of
commercially zoned raw land, three projects with 17 completed homes and 60
building lots and two projects with six finished homes.  The Skagit County
properties include one home and two projects with two complete homes and 13
building lots.  The Whatcom County properties include one single family
residence and one project with 16 building lots.  The Pierce County properties
include one single family residence and a condominium project with 58 unsold
units (out of an original 62 unit project).  The King County property is a
condominium conversion project with 14 unsold units (out of an original 57
unit project) located in Ballard, Washington, just north of Seattle.  In
addition to its efforts to market these properties directly to potential
purchasers, the Bank enlists the services of various industry experts to
assist in these disposition

                                      14

<PAGE>



efforts.  Of the real estate owned detailed above, the majority of the
finished homes are presently under purchase and sale agreements.  The
remaining properties remain available for sale.

     Management of the Bank continually evaluates loans on nonaccrual status
for possible foreclosure or deed in lieu opportunities, at which time these
loans would then become other real estate owned. Management views this as an
ordinary part of the collection process and efforts are continually maintained
to reduce and minimize such non-performing assets.

     Reserve for Losses.  The Bank has an active ongoing credit review
function. The allowance for loan losses is maintained at a level sufficient to
provide for probable loan losses based on evaluating known and inherent risks
in the loan portfolio. These factors include changes in the size and
composition of the loan portfolio, actual loan loss experience, historical
industry loan loss experience, current and anticipated economic conditions,
detailed analysis of individual loans for which full collectibility may not be
assured, and determination of the existence and realizable value 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 provision for loan losses was $65.0 million for the year ended March
31, 2009 compared to $4.1 million for the year ended March 31, 2008. These
provisions reflect management's ongoing analysis of changes in loan portfolio
composition by collateral categories, balances outstanding, overall credit
quality of the portfolio, historical industry loss experience, and current
economic conditions. The increased loan loss provision in fiscal 2009 was a
result of a variety of factors, including the decline in the regional housing
market and its adverse impact on the Bank's loan portfolio, particularly in
the construction and land development portfolio. Also contributing to the
elevated provision for loan losses during the year ended March 31, 2009 was
the increase in delinquencies on performing loans, with those 30 to 89 days
past due at March 31, 2009 totaling $83.9 million, compared to $30.6 million
at March 31, 2008.

     The allowance for loan losses was $39.0 million, or 3.5% of net loans
receivable at March 31, 2009, compared to $19.1 million, or 1.6% of net loans
receivable at March 31, 2008. The level of the allowance was a result of a
combination of factors, primarily the higher level of non-performing loans at
March 31, 2009 of $85.4 million compared to $11.6 million at March 31, 2008.

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

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

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

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

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

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

                                      15

<PAGE>



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

     As required by Statement of Accounting Standard ("SFAS") No. 114,
Accounting by Creditors for Impairment of a Loan, each individual loan,
previously classified by management, or newly classified during the quarterly
review, is evaluated for loss potential, and a specific amount or percentage
deemed to be at risk is added to the overall required reserve amount. For the
remaining portion of the portfolio the Bank applies SFAS No. 5, Accounting for
Contingencies.  A reserve factor is applied to homogeneous loan pools
aggregated into sub-pools by loan grades 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.

     Other factors that are considered as part of the methodology for
measuring the allowance for loan losses include the trends in non-performing
loans, net charge-offs and delinquencies on performing loans, with those 30 to
89 days past due.  In addition, the trends in the real estate market are
monitored in order to better understand the future impact to our borrowers.
The majority of the Corporation's loan portfolio consists of commercial loans
and single-family residential loans secured by real estate in the Whatcom,
Skagit, Snohomish, King and Pierce County areas of Washington. Regional
economic conditions continue to deteriorate, except for a small improvement in
Pierce County, where housing inventories have dropped according to RealEstats,
Inc.  For the month ended March 31, 2009, the available housing inventory
levels (measured in months) for Snohomish, Skagit, Pierce, King and Whatcom
counties were 14.5, 16.0, 10.9, 11.5 and 10.4, respectively.  This compares to
the same month one year earlier when available housing inventory levels
(measured in months) were overall more favorable for Snohomish, Skagit,
Pierce, King and Whatcom counties when they were 11.4, 10.3, 12.4, 8.0 and
7.7, respectively.  This information provides some indication of the
challenges facing the sale of real estate in the counties we serve.

     The calculated amount is compared to the actual amount recorded in the
allowance at the end of each quarter and a determination is made as to whether
the allowance is adequate, yet not excessive. Management increases the amount
of the allowance for loan losses by charges to income and decreases the amount
by loans charged off (net of recoveries).

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

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

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

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

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

                                      16

<PAGE>



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

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

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

     Management believes that the allowance for loan losses at March 31, 2009
was adequate at that date. Although management believes that it uses the best
information available to make these determinations, future adjustments to the
allowance for loan losses may be necessary.

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

                                      17

<PAGE>




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

                                           Year Ended March 31,
                             ----------------------------------------------
                               2009     2008       2007      2006     2005
                             -------  -------    -------    ------   ------
                                        (Dollars in thousands)
Allowance at beginning
  of period................ $ 19,114  $15,889    $14,184   $11,767  $10,122
Provision for loan losses..   65,000    4,100      1,850     2,575    1,700
                            --------  -------    -------   -------  -------
Recoveries:
  First mortgage loans.....       --       --         --        --       --
  Construction and
    land development.......       --       --         --        --       --
  Commercial real estate...       --       --         --        --       --
  Multi-family residential.       --       --         --        --       --
  Commercial loans.........      133       16         --         1      168
  Credit card loans........        2        7         41         6        5
  Other consumer loans.....       --       --          9        --        1
                            --------  -------    -------   -------  -------
    Total recoveries.......      135       23         50         7      174

Charge-offs:
  First mortgage loans.....   (3,379)      --         --        --       --
  Construction and
    land development.......  (39,035)    (702)        --        --       --
  Commercial real estate...       --       --         --        --       --
  Multi-family residential.       --       --         --        --       --
  Commercial loans.........   (2,289)     (60)       (75)      (33)    (105)
  Credit card loans........      (95)     (51)       (51)      (54)    (104)
  Other consumer loans.....     (470)     (85)       (69)      (78)     (20)
                            --------  -------    -------   -------  -------
    Total charge-offs......  (45,268)    (898)      (195)     (165)    (229)

  Net charge-offs..........  (45,133)    (875)      (145)     (158)     (55)
                            --------  -------    -------   -------  -------
Allowance at end of period. $ 38,981  $19,114    $15,889   $14,184  $11,767
                            ========  =======    =======   =======  =======

Allowance for loan losses
  as a percentage of net
  loans receivable at the
  end of the period........    3.47%     1.60%     1.51%     1.54%    1.46%

Net charge-offs as a
  percentage of average
  loans outstanding during
  the period...............    3.70%     0.08%     0.01%     0.02%    0.01%

Allowance for loan losses
  as a percentage of non-
  performing assets at
  end of period............   37.25%   155.87% 1,670.06% 1,221.35%  794.53%

                                         18

<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,
                    ---------------------------------------------------------------------------------------
                          2009             2008             2007              2006              2005
                    ---------------- ----------------  ---------------   ----------------  ----------------
                            Percent          Percent           Percent           Percent           Percent
                            of Loans         of Loans          of Loans          of Loans          of Loans
                            in Each          in Each           in Each           in Each           in Each
                            Category         Category          Category          Category          Category
                            to Total         to Total          to Total          to Total          to Total
                    Amount   Loans   Amount   Loans    Amount   Loans    Amount   Loans    Amount   Loans
                    ------   -----   ------   -----    ------   -----    ------   -----    ------   -----
                                                   (Dollars in Thousands)

                 <c>      <c>     <c>      <c>      <c>       <c>      <c>       <c>    <c>      <c>
First mortgage
 loans............. $ 3,593    9.2%  $ 1,293    6.8%   $ 1,030    6.5%   $   974    6.9%  $   984    8.4%
Construction and
 land development..  24,069   61.7     8,030   42.0      6,321   39.8      4,242   29.9     2,528   21.5
Commercial real
 estate............   3,181    8.2     4,953   25.9      4,557   28.7      5,081   35.8     4,858   41.3
Multi-family
 residential.......     539    1.4       496    2.6        548    3.4        755    5.3       760    6.5
Commercial loans...   6,901   17.7     3,421   17.9      2,661   16.7      2,329   16.4     1,983   16.8
Credit card loans..     242    0.6       270    1.4        183    1.2        210    1.5       216    1.8
Other consumer
  loans............     456    1.2       651    3.4        589    3.7        593    4.2       438    3.7
                    -------  -----   -------  -----    -------  -----    -------  -----   -------  -----
  Total allowance
   for loan losses. $38,981  100.0%  $19,114  100.0%   $15,889  100.0%   $14,184  100.0%  $11,767  100.0%
                    =======  =====   =======  =====    =======  =====    =======  =====   =======  =====

     The Bank had a valuation allowance of $539,000, $70,000 and $110,000 for real estate acquired through
foreclosure at March 31, 2009, 2008, and 2007, respectively. There was no allowance for real estate acquired
through foreclosure as of March 31, 2006, and 2005.

                                                        19
</TABLE>

<PAGE>



Investment Activities

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

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

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

     The amortized cost of the Bank's investment securities available for sale
at March 31, 2009 was $27.1 million with a market value of $28.1 million
compared to an amortized cost of $38.7 million and market value of $41.2
million at March 31, 2008. The Bank also invests in mortgage-backed
securities. At March 31, 2009, mortgage-backed securities had an amortized
cost of $37.6 million and a market value of $38.8 million compared to an
amortized cost of $38.7 million and market value of $39.1 million at March 31,
2008. The majority of these mortgage-backed securities are backed by
government agencies.

     During the year ended March 31, 2009, the Corporation recorded a $309,000
other than temporary impairment ("OTTI") charge related to 15 non-agency
collateralized mortgage obligations. These collateralized mortgage obligations
are included in investments available for sale where the default rates,
declines in investment ratings and loss severities of the underlying
collateral indicate credit losses are expected to occur. These securities were
valued by third party pricing services using readily available market quotes.
There were no similar charges recorded during the year ended March 31, 2008.
For further information concerning the Bank's investment securities and
mortgage-backed securities portfolio, see Notes 3 and 4 of the Notes to the
Consolidated Financial Statements contained in Item 8 of this Form 10-K.

                                    20

<PAGE>




<PAGE>
     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, 2009 was $66.9 million. This table also  includes
interest-bearing deposits.


                                                      At March 31,
                                            --------------------------------
                                               2009       2008        2007
                                            ---------  ----------   --------
                                                      (In thousands)
Investment securities:
 U.S. Government:
  Available for sale....................... $  26,565   $  33,107   $  41,350
  Held to maturity.........................        --          --         370
                                            ---------   ---------   ---------
                                               26,565      33,107      41,720
Mortgage-backed securities(1):
  Available for sale.......................    37,563      38,646      26,220
  Held to maturity.........................         8          30         148
                                            ---------   ---------   ---------
                                               37,571      38,676      26,368
Other securities(2):
  Available for sale.......................       562       5,569       6,325
  Held to maturity.........................        --          --          --
                                            ---------   ---------   ---------
                                                  562       5,569       6,325
                                            ---------   ---------   ---------
   Total investments.......................    64,698      77,352      74,413

Interest-bearing deposits..................   126,159       2,912       5,379
                                            ---------   ---------   ---------
                                            $ 190,857   $  80,264   $  79,792
                                            =========   =========   =========

(1)  Consists of mortgage-backed securities and collateralized mortgage
     obligations ("CMOs").
(2)  Consists of marketable equity securities.

     At March 31, 2009, 2008 and 2007 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.

                                        21

<PAGE>



<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, 2009.


                                                         At March 31, 2009
                      ------------------------------------------------------------------------------------
                          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............ $1,718   4.43%  $11,593  4.28%  $10,205   4.23% $ 3,049  4.85%  $26,565  $27,173  4.33%
  Held to maturity..     -      --        --    --        -      --       -     --        -        -     --
                    -------   ----   -------  ----   -------   ----  -------  ----   -------  -------  ----
                      1,718   4.43    11,593  4.28    10,205   4.23    3,049  4.85    26,565   27,173  4.33

Mortgage-backed
 securities (1):
  Available for
    sale............     --     --     1,383  5.89    11,055   4.84   25,125  4.93    37,563   38,782  4.94
  Held to maturity..     --     --        --    --         8  11.82       --    --         8       11 11.82
                    -------   ----   -------  ----   -------   ----  -------  ----   -------  -------  ----
                         --     --     1,383  5.89    11,063   4.84   25,125  4.93    37,571   38,793  4.94

Other securities (2):
  Available for
    sale............    562   9.43        --    --        -      --       -     --       562      910  9.43
  Held to maturity..     -      --        --    --        -      --       -     --        -        -     --
                    -------   ----   -------  ----   -------   ----  -------  ----   -------  -------  ----
                        562   9.43        --    --        -      --       -     --       562      910  9.43

    Total........... $2,280   5.66%  $12,976  4.45%  $21,268   4.55% $28,174  4.92%  $64,698  $66,876  4.73%
                     ======   ====   =======  ====   =======   ====  =======  ====   =======  =======  ====
-----------
(1) Consists of mortgage-backed securities and CMOs.
(2) Consists of marketable equity securities.

</TABLE>

                                                              22

<PAGE>



Federal Home Loan Bank ("FHLB") Stock
-------------------------------------

     The investment in the FHLB of Seattle stock totaled $7.25 million as of
March 31, 2009.  The investment in the FHLB stock is a restricted investment
carried at par value ($100 per share), which approximates its fair value.

     Management has evaluated the FHLB stock for impairment by giving
consideration to the length of time the situation persists with the FHLB,
commitments by the FHLB to make payments, the impact of regulatory changes and
the liquidity position.  We have reviewed the most recent unaudited financial
statements included in the Form 10-Q filing.  Their most recent Form 10-Q
filing noted that the FHLB did not meet one of the three statutory capital
requirements.  The three capital requirements are 1) risk-based capital, 2)
capital-to-asset ratio, and 3) leverage capital ratio.  The FHLB did not meet
the risk-based capital requirements as of March 31, 2009, but was in
compliance with the other two statutory capital ratios.  It was further noted
in their Form 10-Q that a recovery in the market value of the private-label
securities occurred in January and February 2009, which allowed the FHLB to
redeem $669,000 of Class B capital stock.  On February 28, 2009, stock
redemptions were once again halted when the private-label securities were
downgraded by a rating agency.  The FHLB of Seattle Board of Directors have
taken steps to restore the risk-based capital by suspending the issuance of
Class A stock, issuing only Class B stock (considered permanent capital) and
suspended the redemption and repurchase of Class A and Class B stock and the
payment of dividends until such time the deficiency of the risk-based capital
ratio is corrected.

     The FHLB of Seattle reported a $16.3 million loss for the quarter ended
March 31, 2009.  The FHLB of Seattle attributes its first quarter 2009 net
loss primarily to $71.7 million of OTTI charges on certain of its
private-label mortgage-backed securities that are classified as
held-to-maturity.  As a result of its net loss for the first quarter 2009, the
FHLB of Seattle also reported a $1.1 billion accumulated other comprehensive
loss and total capital of $961 million as of March 31, 2009, as compared with
total capital of $1.8 billion as of December 31, 2008.  The OTTI recognized in
accumulated other comprehensive loss is accreted to the carrying value of each
security on a prospective basis, based on the amount and timing of future cash
flows, over the remaining life of each security.  The accretion increases the
carrying value of each security and does not affect earnings unless the
security is subsequently sold or has an additional OTTI charge that is
recognized in earnings.  The FHLB of Seattle's first quarter 2009 OTTI charge
reflects the effects of isolating the portion of the loss that is directly
associated with the other than temporary impairment of the private-label
mortgage-backed securities.  As a result of our review and intent to hold the
security until recovery, which may be to maturity, the Corporation has not
recorded an "other than temporary impairment" on its investment in FHLB of
Seattle stock.

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. Income attributable to Westward totaled $25,400,
$24,378, and $45,932 for fiscal years 2009, 2008 and 2007, respectively and
was related to reconveyance fees received during the periods.

     In October 2004, Westward entered into a real estate development joint
venture in Greenbriar Northwest LLC ("GBNW") (50% owned by Westward and 50% by
Greenbriar Construction, an established residential land development company
headquartered in Bellingham, Washington). This joint venture involves
approximately 85 acres of land in south Bellingham and current plans include
developing the property into 739 residential units in a new neighborhood to be
known as "Fairhaven Highlands." The investment in real estate is recorded as
an asset on the Corporation's balance sheet, and the related debt is recorded
as a liability. At March 31, 2009, the real estate joint venture has a
carrying amount of approximately $18.0 million, with a related borrowing of
approximately $24.4 million. One-half of the borrowing expense related to the
joint venture is recognized as an expense on the Corporation's financial
statements as incurred, with the remainder being capitalized. The Corporation
is presently not recognizing any income related to this joint venture, as it
is in the early stages of development.  As of March 31, 2009, we conducted a
review of the accounting treatment and measured the value of the GBNW joint
real estate development for potential impairment and whether to continue with
capitalizing interest.  We took the following steps to ensure compliance with
generally accepted accounting principles: (1) performed a recoverability test
under SFAS 144 (Accounting for the Impairment or Disposal of Long-

                                           23

<PAGE>



Lived Asset), which was followed by step (2) evaluated the capitalization of
interest in conformity with SFAS 34 (capitalization of interest cost).  The
conclusion of the recoverability test determined that the Fairhaven Highland
development was positively accretive, which then supported the continuation
for capitalization of interest during the development phase of the project.
For additional details on this joint venture, please see Note 1   Nature of
Operations and Summary of Significant Accounting Policies and Note 15
Related Party Transactions, of the Notes to the Consolidated Financial
Statements contained in Item 8 of this Form 10-K.

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

     At March 31, 2009, the Bank held $20.1 million in bank owned life
insurance ("BOLI"), compared to $20.3 million at March 31, 2008. These
policies are with Northwestern Mutual Life, Mass Mutual and New York Life,
three of the highest rated BOLI providers. All three of these firms continue
to receive high ratings from AM Best, Fitch, Standard & Poors and Moodys.

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

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

     Deposits. The Bank provides a wide variety of deposit accounts and
deposit services designed to attract both short-term and long-term deposits of
business and personal customers 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 (checking) accounts designed for business and personal depositors,
and money market deposit accounts ("MMDAs") with and without limited check
access.

     The following table sets forth certain information concerning the
deposits at the Bank.
                                        Year Ended March 31,
                       -----------------------------------------------------
                             2009               2008              2007
                       ----------------- ----------------- -----------------
                                Weighted          Weighted          Weighted
                       Average  Average  Average  Average  Average   Average
      Type             Balance   Rate    Balance   Rate    Balance    Rate
------------------     -------   ----    -------   ----    -------    ----
                                       (Dollars in thousands)

Savings...........  $   17,348   0.60%  $ 19,241   0.92%   $ 24,029   0.69%
Checking..........     143,313   0.23    144,786   0.32     156,200   0.33
Money Market......     171,044   1.70    195,139   3.35     173,483   3.64
Time Deposits.....     808,954   3.89    633,501   4.89     551,671   4.60
                    ----------   ----   --------   ----    --------   ----
  Total...........  $1,140,659   3.03%  $992,667   3.83%   $905,383   3.56%
                    ==========   ====   ========   ====    ========   ====

                                           24
<PAGE>



    The following table indicates the Bank's time deposits by time remaining
until maturity as of March 31, 2009 for amounts of $100,000 or more.

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

              Three months or less...........    $  41,252
              Over three through six months..       47,941
              Over six through twelve months.      162,597
              Over twelve months.............       51,518
                                                 ---------
                Total........................    $ 303,308
                                                 =========

     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 and
higher, depending on the type of time deposit. Pricing of rates on time
deposits with maturities from 30 days to ten years are determined periodically
by the Bank, based upon local market rates, national money market rates, and
yields on assets of the same maturity.

     The minimum opening deposit for all business and personal savings and
money market (MMDA) accounts except for time deposits is $100.  Many accounts
have minimum deposit balance requirements to avoid service charges as well as
tiered interest rate pricing to encourage depositors to deposit funds with the
Bank.  Minimum deposit balance requirements vary from $0 to $50,000 depending
upon the type of account.  These accounts have no maturity requirements, no
regulatory interest rate ceilings, and either limited check writing privileges
or no check writing privileges, depending upon the type of account.  The
interest rates on these accounts are adjusted by the Bank periodically, based
on money market conditions.  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 minimum opening deposit for all business and personal transaction
accounts is $100.  Many accounts have minimum deposit balance requirements to
avoid service charges as well as tiered interest rate pricing to encourage
depositors to deposit funds with the Bank.  Minimum deposit balance
requirements vary from $0 to $50,000 depending upon the type of account.

     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 market 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, but to be very competitive.  The focus is to retain
existing customers and attract new ones in a manner that meets our financial
objectives.

     Notwithstanding the foregoing, we are currently limited by the FDIC in
the rates we may offer on all interest-bearing accounts.  Interest rates are
limited to 0.75% over the effective yield paid on deposits of comparable size
and maturity in our normal market area.  The FDIC has also issued a new rule
affecting institutions that are less than well capitalized which is effective
January 1, 2010.  Under the new rule, the FDIC will publish a weekly schedule
of national rates, which will be a simple average of rates paid by U.S.
depository institutions as calculated by the FDIC.  The FDIC will deem the
national rate to be the prevailing rates in all market areas unless it agrees
with evidence provided by the

                                        25

<PAGE>




institution that it is operating in an area where prevailing deposit interest
rates are higher.  Overall levels of confidence in the banking system as well
as confidence in Horizon Bank affected our ability to generate additional
deposit business during the year.  This was mitigated by actions of the
federal government when, on October 3, 2008, President George W. Bush signed
the Emergency Economic Stabilization Act of 2008, which temporarily raised the
basic limit on federal deposit insurance coverage from $100,000 to $250,000
per depositor.  The temporary increase in deposit insurance coverage became
effective upon the President's signature.  The legislation provided that the
basic deposit insurance limit would return to $100,000 after December 31,
2009.  On October 14, 2008, the FDIC announced a new program - the Temporary
Liquidity Guarantee Program- to strengthen confidence and encourage liquidity
in the banking system by providing, among other things full coverage of
non-interest bearing deposit transaction accounts, regardless of dollar
amount.  This was later clarified in the issuance of the final rule as
including all transaction accounts earning interest rates of no more than
0.50%.  The unlimited insurance on transaction accounts is set to expire on
December 31, 2010.  On May 20, 2009, President Barack Obama signed legislation
extending the increase of the basic limit on federal deposit insurance
coverage from $100,00 to $250,000 per depositor until December 13, 2013.
However, the unlimited insurance on transaction accounts has not been extended
beyond its current date of December 31, 2009.  Horizon Bank has participated
in the Temporary Liquidity Guarantee Program with respect to the unlimited
transaction account insurance.

     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.

     The Bank has signed an agreement with Qwickrate, an internet-based
certificate of deposit listing service, to utilize their program to raise
institutional time deposits to supplement the liquidity needs of the Bank.

     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 historically utilized brokered deposits
as a supplemental source of funding, when appropriate. During fiscal 2009, the
Bank increased its balances in brokered deposits from $121.0 million at March
31, 2008 to $261.4 million at March 31, 2009. The rates paid on these deposits
are comparable to the rates on similar term from the Bank's alternative
sources of funding (such as other wholesale borrowings, discussed below). We
are required under the Order to eliminate our reliance on brokered deposits
and may not accept or renew additional brokered deposits.  Brokered deposit
maturities are $105.1 million, $111.1 million and $45.2 million for the years
ended March 31, 2010, 2011, and 2012, respectively.

     Borrowings. In December 1998, the Bank joined the FHLB of Seattle which
provides it with access to a variety of wholesale funding options. The Bank
has a committed line of credit up to 25% of total assets, subject to the Bank
pledging sufficient collateral and maintaining the required stock investment
in the FHLB. Committed lines of credit agreements totaling $129.5 million and
$272.7 million were available to the Bank, of which, $129.5 million and $192.0
million were outstanding at March 31, 2009 and 2008, respectively.

                                        26

<PAGE>




     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,
                                             ------------------------------
                                                2009       2008      2007
                                             ----------  --------  --------
                                                  (Dollars in thousands)

Maximum amount of borrowings outstanding
  at any month end.........................   $238,000   $212,500  $195,000

Approximate average borrowings outstanding.    164,807    177,874   165,237

Approximate weighted average rate
  paid on borrowings.......................      2.71%      4.44%     4.74%

Balance outstanding at end of period.......   $129,500   $192,000  $143,500

Weighted average rate paid on borrowings
  at end of period.........................      2.39%      3.15%     5.03%

     The Bank has other borrowed funds in the form of retail repurchase
agreements. These agreements are collateralized by securities held by a
safekeeping agent not under control of the Bank. These advances are considered
overnight borrowings and bear interest rates that fluctuate daily based on
current market rates. The Bank had $8.6 million and $21.9 million outstanding
as of March 31, 2009 and 2008, respectively.

     The Bank also had $716,000 and $850,000 outstanding as of March 31, 2009
and 2008, respectively, in the form of a Treasury Tax and Loan note option
which is included in other borrowed funds.

     At March 31, 2009, the Bank had $138.8 million in borrowings from all
sources, compared to $214.8 million at March 31, 2008. Access to these
wholesale borrowing sources allows management to meet cyclical funding needs
and assists in interest rate risk management efforts.

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

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

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

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

Personnel
---------

     At March 31, 2009, Horizon Bank employed 224 full-time and 41 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.

                                      27

<PAGE>



     Executive Officers of the Registrant

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

                      Age at
                     March 31,
Name                  2009                        Position
--------------------  ----     -----------------------------------------------

V. Lawrence Evans      62      Chairman of the Board of the Corporation and of
                               the Bank

Richard P. Jacobson    46      Chief Executive Officer, President and Director
                               of the Corporation and Chief Executive Officer,
                               President and Director of the Bank

Greg B. Spear          43      Chief Financial Officer of the Corporation and
                               the Bank

William N. Gasperetti  62      Executive Vice President of the Bank

Steve L. Hoekstra      58      Executive Vice President of the Bank

Kelli J. Holz          40      Senior Vice President of the Corporation and of
                               the Bank

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

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

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

     GREG B. SPEAR, CPA, joined the Corporation and the Bank in October 2008
as Chief Financial Officer. Mr. Spear served as the Chief Financial Officer
and Vice Chairman for the past eight years for Columbia Bancorp, and Columbia
River Bank, where he built a strong financial team capable of handling the
busy cycles and stresses associated with today's complex financial reporting.
Prior to joining Columbia Bancorp, he spent four years as the Chief Financial
Officer of Linn-Benton Bank, of Albany, Oregon, which was acquired by Umpqua
Holdings in 2001. Before that, he spent 14 years with various financial
institutions, where he preformed a variety of increasingly responsible
positions, including security sales, branch management, auditing and financial
management. A 25-year banking veteran, he is a graduate of the University of
La Verne where he earned his Bachelor of Science in Accounting. He also
obtained a Bachelor of Science in Business Administration from California
State University, Chico.

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

                                      28

<PAGE>



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

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

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

     The following is a brief description of certain laws and regulations
which are applicable to the Corporation and the Bank. The description of these
laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, does not purport to be completed and is qualified
in its entirety by reference to the applicable laws and regulations.

     Legislation is introduced from time to time in the United States Congress
that may affect the Corporation's operations. In addition, the regulations
governing the Bank may be amended from time to time by the FDIC or the DFI.
Any such legislation or regulatory changes in the future could have an adverse
effect. We cannot predict whether any such changes may occur.

     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.

     Insurance of Accounts and Regulation by the FDIC. Horizon Bank is a
member of the FDIC. The FDIC insures deposits up to the applicable limits and
imposes deposit insurance premiums. Under new legislation, through December
31, 2013, the insurance limit is $250,000. The FDIC is also Horizon Bank's
principal federal regulator. As such, the FDIC is authorized to conduct
examinations of and to require reporting by Horizon Bank. The FDIC may
prohibit Horizon Bank from engaging in any activity determined by law,
regulation or order to pose a serious risk to the institution, and may take a
variety of enforcement actions in addition to the Order in the event Horizon
Bank violates a law, regulation or order, engages in an unsafe or unsound
practice, or under certain other circumstances. The FDIC

                                      29

<PAGE>



also has the authority to seize Horizon Bank or to terminate Horizon Bank's
deposit insurance if it were to determine that Horizon Bank has engaged in
unsafe or unsound practices or is in an unsafe or unsound condition.

     The FDIC assesses deposit insurance premiums on each FDIC-insured
institution quarterly based on annualized rates for four risk categories
applied to its deposits, subject to certain adjustments. Each institution is
assigned to one of four risk categories based on its capital, supervisory
ratings and other factors. Well capitalized institutions that are financially
sound with only a few minor weaknesses are assigned to Risk Category I. Risk
Categories II, III and IV present progressively greater risks to the DIF.
Under FDIC's risk-based assessment rules, effective April 1, 2009, the initial
base assessment rates prior to adjustments range from 12 to 16 basis points
for Risk Category I, and  are 22 basis points for Risk Category II, 32 basis
points for Risk Category III, and 45 basis points for Risk Category IV.
Initial base assessment rates are subject to adjustments based on an
institution's unsecured debt, secured liabilities and brokered deposits, such
that the total base assessment rates after adjustments range from 7 to 24
basis points for Risk Category I, 17 to 43 basis points for Risk Category II,
27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for
Risk Category IV.  The rule also includes authority for the FDIC to increase
or decrease total base assessment rates in the future by as much as three
basis points without a formal rulemaking proceeding.  In addition to the
regular quarterly assessments, due to losses and projected losses attributed
to failed institutions, the FDIC has adopted a rule imposing a special
assessment of 5 basis points on the amount of each depository institution's
assets reduced by the amount of its Tier 1 capital (not to exceed 10 basis
points of its assessment base for regular quarterly premiums) as of June 30,
2009, to be collected on September 30, 2009.  The special assessment rule also
permits the FDIC to impose two additional special assessments, each of the
same amount or less, based on assets, capital and deposits as of September 30,
2009 and December 31, 2009, to be collected, respectively, on December 31,
2009 and March 30, 2010.  The FDIC has announced that the first of the
additional special assessments is probable and the second is less certain.

     The FDIC has authority to increase insurance assessments. A significant
increase in insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Bank. There can be no
prediction as to what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC. Management of the
Bank is not aware of any practice, condition or violation that might lead to
termination of the Bank's deposit insurance.

     In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation to recapitalize a predecessor deposit insurance fund. This payment
is established quarterly and during the fiscal year ending March 31, 2009
averaged 1.12 basis points of assessable deposits. The Financing Corporation
was chartered in 1987, by the FHLB board solely for the purpose of functioning
as a vehicle for the recapitalization of the Federal Savings and Loan
Insurance Corporation.

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

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could take any one of a number of discretionary supervisory actions, including
the issuance of a capital directive and the replacement of senior executive
officers and directors.

     At March 31, 2009, the Bank was categorized as "adequate" under the
prompt corrective action regulations of the FDIC.

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

     The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets. Most banks are required to maintain a minimum leverage ratio of
at least 4% to 5% of total assets. At March 31, 2009, the Bank had a Tier 1
leverage capital ratio of 6.1%. Pursuant to the Stipulation and Consent to the
Issuance of an Order to Cease and  Desist issued by the FDIC and DFI, Horizon
Bank has been required to increase its Tier 1 capital to 10% of total assets.

     FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in one
of four categories and given a percentage weight based on the relative risk of
that category. In addition, certain off-balance-sheet items are converted to
balance-sheet credit equivalent amounts, and each amount is then assigned to
one of the four categories. Under the guidelines, the ratio of total capital
(Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least
8%, and the ratio of Tier 1 capital to risk-weighted assets must be at least
4%. In evaluating the adequacy of a bank's capital, the FDIC may also consider
other factors that may affect the bank's financial condition. Such factors may
include interest rate risk exposure, liquidity, funding and market risks, the
quality and level of earnings, concentration of credit risk, risks arising
from nontraditional activities, loan and investment quality, the effectiveness
of loan and investment policies, and management's ability to monitor and
control financial operating risks. At March 31, 2009, the Bank determined that
its total risk-based capital ratio was 8.6% and its Tier 1 risk-based capital
ratio was 7.3%.

     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, 2009, Horizon Bank had a net worth of 6.34% 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 and will endeavor to meet the higher capital requirements
imposed by the Order. However, events beyond the control of the Bank, such as
an inability to raise additional capital, or a continued downturn in the
economy in areas where the Bank has most of its loans, could adversely affect
future earnings and, consequently, the ability of the Bank to meet its capital
requirements. For additional information concerning the Bank's capital, see
Note 12 of the Notes to the Consolidated Financial Statements contained in
Item 8 of this Form 10-K.

     Emergency Economic Stabilization Act of 2008 ("EESA"). In October 2008,
the EESA was enacted.  The EESA authorizes the Treasury Department to purchase
from financial institutions and their holding companies up to $700 billion in
mortgage loans, mortgage-related securities and certain other financial
instruments, including debt and equity securities issued by financial
institutions and their holding companies in a troubled asset relief program
("TARP"). The purpose of TARP is to restore confidence and stability to the
U.S. banking system and to encourage financial institutions to increase their
lending to customers and to each other. Under the  TARP Capital Purchase
Program ("CPP"), the Treasury will purchase debt or equity securities from
participating institutions. The TARP also will include direct purchases or
guarantees of troubled assets of financial institutions. Participants in the
CPP are subject to executive compensation limits

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<PAGE>



and are encouraged to expand their lending and mortgage loan modifications.
Horizon has not received funds from, nor anticipates participating in, the
CPP.

     EESA also increased FDIC deposit insurance on most accounts from $100,000
to $250,000 through December 31, 2009 and provides authority to the SEC to
suspend mark-to-market accounting requirements for any issuer or class of
category of transactions.

     Temporary Liquidity Guaranty Program. Following a systemic risk
determination, the FDIC established a Temporary Liquidity Guarantee Program
("TLGP") on October 14, 2008. The TLGP includes the Transaction Account
Guarantee Program ("TAGP"), which provides unlimited deposit insurance
coverage through December 31, 2009 for noninterest-bearing transaction
accounts (typically business checking accounts) and certain funds swept into
noninterest-bearing savings accounts. Institutions participating in the TAGP
pay a 10 basis points fee (annualized) on the balance of each covered account
in excess of $250,000, while the extra deposit insurance is in place. The TLGP
also includes the Debt Guarantee Program ("DGP"), under which the FDIC
guarantees certain senior unsecured debt of FDIC-insured institutions and
their holding companies. Under the program, the FDIC will guarantee timely
payment of newly issued senior unsecured debt issued on or before October 31,
2009. The guarantee on debt issued before April 1, 2009, will expire no later
than June 30, 2012. The guarantee on debt issued on or after April 1, 2009,
will expire not later than December 31, 2012. Depending on the term of the
debt maturity, the nonrefundable DGP fee ranges from 50 to 100 basis points
(annualized) for covered debt outstanding until the earlier of maturity or
June 30, 2012. The TAGP and DGP are in effect for all eligible entities,
unless the entity opted out on or before December 5, 2008. Horizon did not opt
out of these programs. The TLGP has been amended to allow participants to seek
approval of applications to issue guaranteed convertible debt.

     The American Recovery and Reinvestment Act of 2009. On February 17, 2009,
President Obama signed The American Recovery and Reinvestment Act of 2009
("ARRA") into law.  The ARRA is intended to revive the US economy by creating
millions of new jobs and stemming home foreclosures. For financial
institutions that have received or will receive financial assistance under
TARP or related programs, the ARRA significantly rewrites the original
executive compensation and corporate governance provisions of Section 111 of
the EESA. Among the most important changes instituted by the ARRA are new
limits on the ability of TARP recipients to pay incentive compensation to up
to 20 of the next most highly-compensated employees in addition to the "senior
executive officers," a restriction on termination of employment payments to
senior executive officers and the five next most highly-compensated employees
and a requirement that TARP recipients implement "say on pay" shareholder
votes. Further legislation is anticipated to be passed with respect to the
economic recovery. However, the executive compensation limitations contained
in the ARRA will not have an effect on Horizon, since it is not a participant
in TARP.

     In February 2009, the Administration also announced its Financial
Stability Plan ("FSP") and Homeowners Affordability and Stability Plan
("HASP"). FSP is the second phase of TARP, to be administrated by the
Treasury. Its four key elements include:

   *  a development of a public/private investment fund essentially structured
      as a government sponsored enterprise with the mission to purchase
      troubled assets from banks with an initial capitalization from
      government funds;

   *  the continuation of the Capital Assistance Program under which the
      Treasury will purchase additional preferred stock available only for
      banks that have undergone a new stress test given by their regulator;

   *  an expansion of the Federal Reserve's term asset-backed liquidity
      facility to support the purchase of up to $1 trillion in AAA rated asset
      backed securities backed by consumer, student, and small business loans,
      and possible other types of loans; and

   *  the establishment of a mortgage loan modification program with $50
      billion in federal funds further detailed in the HASP.

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<PAGE>



     The HASP is a program aimed to help seven to nine million families
restructure their mortgages to avoid foreclosure. The plan also develops
guidance for loan modifications nationwide. HASP provides programs and funding
for eligible refinancing of loans owned or guaranteed by Fannie Mae or Freddie
Mac, along with incentives to lenders, mortgage servicers, and borrowers to
modify mortgages of "responsible" homeowners who are at risk of defaulting on
their mortgage. The goals of HASP are to assist in the prevention of home
foreclosures and to help stabilize falling home prices.

     These programs are not expected to have any direct impact on Horizon
since it is not a participant in TARP and these related programs. Horizon will
benefit from these programs if they help stabilize the national banking system
and aid in the recovery in the housing market.

     Standards for Safety and Soundness. The federal banking regulatory
agencies have prescribed, by regulation, guidelines for all insured depository
institutions relating to: internal controls, information systems and internal
audit systems;  loan documentation; credit underwriting; interest rate risk
exposure; asset growth; asset quality;  earnings and compensation, fees and
benefits. The guidelines set forth the safety and soundness standards that the
federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. Each insured
depository institution must also implement a comprehensive written information
security program that includes administrative, technical, and physical
safeguards appropriate to the institution's size and complexity and the nature
and scope of its activities. The information security program also must be
designed to ensure the security and confidentiality of customer information,
protect against any unanticipated threats or hazards to the security or
integrity of such information, protect against unauthorized access to or use
of such information that could result in substantial harm or inconvenience to
any customer, and ensure the proper disposal of customer and consumer
information. Each insured depository institution must also develop and
implement a risk-based response program to address incidents of unauthorized
access to customer information in customer information systems. FDIC
regulations establish deadlines for the submission and review of safety and
soundness compliance plans.

     Real Estate Lending Standards. FDIC regulations require Horizon Bank to
adopt and maintain written policies that establish appropriate limits and
standards for real estate loans. These standards, which must be consistent
with safe and sound banking practices, must establish loan portfolio
diversification standards, prudent underwriting standards (including
loan-to-value ratio limits) that are clear and measurable, loan administration
procedures, and documentation, approval and reporting requirements. Horizon
Bank is obligated to monitor conditions in its real estate markets to ensure
that its standards continue to be appropriate for current market conditions.
Horizon Bank's Board of Directors is required to review and approve Horizon
Bank's standards at least annually. The FDIC has published guidelines for
compliance with these regulations, including supervisory limitations on
loan-to-value ratios for different categories of real estate loans. Under the
guidelines, the aggregate amount of all loans in excess of the supervisory
loan-to-value ratios should not exceed 100% of total capital, and the total of
all loans for commercial, agricultural, multifamily or other non one-to-four
family residential properties should not exceed 30% of total capital. Loans in
excess of the supervisory loan-to-value ratio limitations must be identified
in Horizon Bank's records and reported at least quarterly to Horizon Bank's
Board of Directors. Horizon Bank is in compliance with the record and
reporting requirements. As of March 31, 2009, Horizon Bank's aggregate loans
in excess of the supervisory loan-to-value ratios were $40.9 million and 45.0%
of total capital and Horizon Bank's loans on commercial, agricultural,
multi-family or other non land development and one-to-four family residential
properties in excess of  the supervisory loan-to-value ratios were $29.1 and
32.1% of total capital.

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

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

     As the primary regulator of the Bank, the FDIC has outlined the
requirements for compliance with FDICIA, but does not provide specific
guidance on the internal control structure, documentation, or procedures to
test the Bank's

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<PAGE>



effectiveness. It is up to each bank to establish, document and design
procedures to evaluate and test the internal control structure over financial
reporting and compliance with designated laws and regulations that minimally
include loans to insiders and dividend restrictions.

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

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

     Federal Home Loan Bank System. The FHLB of Seattle serves as a reserve or
central bank for the member institutions within its assigned region. It is
funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLBs. It makes loans (i.e., advances) to members in
accordance with policies and procedures established by the Federal Housing
Finance Board and the Board of Directors of the FHLB of Seattle. As a member,
the Bank is required to purchase and hold stock in the FHLB of Seattle, based
on formulas established by the FHLB. As of March 31, 2009, Horizon Bank held
stock in the FHLB of Seattle in the amount of $7.25 million. See "Business
Savings Activities and Other Sources of Funds -- Borrowings."

     Federal Reserve System. The Federal Reserve Board requires, under
Regulation D, that all depository institutions maintain reserves on
transaction accounts and nonpersonal time deposits. These reserves may be in
the form of cash or non-interest bearing deposits with the regional Federal
Reserve Bank. Negotiable order of withdrawal accounts and other types of
accounts that permit payments or transfers to third parties fall within the
definition of transaction accounts and are subject to the reserve
requirements, as are any non-personal time deposits at a savings bank. As of
March 31, 2009, the Bank's deposit with the Federal Reserve Bank and vault
cash exceeded its reserve  requirements.

     Privacy Standards. The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA"), which was enacted in 1999, modernized the
financial services industry by establishing a comprehensive framework to
permit affiliations among commercial banks, insurance companies, securities
firms and other financial service providers. The Bank is subject to FDIC
regulations implementing the privacy protection provisions of the GLBA. These
regulations require the Bank to disclose its privacy policy, including
identifying with whom it shares "non-public personal information," to
customers at the time of establishing the customer relationship and annually
thereafter.

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

     The Corporation.

     General. The Corporation, as the sole stockholder of the Bank, is a bank
holding company and is registered as such with the Federal Reserve. Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"),
and the regulations of the Federal Reserve. As a bank holding company, the
Corporation is required to file with the Federal Reserve annual, quarterly and
periodic reports and such additional information as the Federal Reserve may
require. The Federal Reserve may examine the

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<PAGE>



Corporation  and any of its subsidiaries, and charge the Corporation for the
cost of the examination. The Federal Reserve also has extensive enforcement
authority over bank holding companies, including, among other things, the
ability to assess civil money penalties to issue cease and desist or removal
orders and to require that a holding company divest subsidiaries (including
its bank subsidiaries). In general, enforcement actions may be initiated for
violations of law and regulations and unsafe or unsound practices.

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

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

     Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley Act") was signed into law on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with the
recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to
increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally
applies to all companies that file or are required to file periodic reports
with the Securities and Exchange Commission ("SEC"), under the Securities
Exchange Act of 1934 ("Exchange Act").

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

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

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

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<PAGE>



dividends. On December 22, 2008, the Corporation suspended the payment of
dividends on its common stock in connection with its strategy to preserve and
manage its capital.

     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, 2009, the Corporation's capital position was in
excess of these requirements with total risk based capital of 8.63% of
risk-weighted assets and Tier 1 (core) capital of 7.35% 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. The Corporation has no plans to repurchase its common stock.

Taxation
--------

     Federal Taxation.

     General. The Corporation and the Bank report their consolidated income on
a fiscal year basis using the accrual method of accounting and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Corporation. Reference is made to Note 10 of the
Notes to the Consolidated Financial Statements contained in Item 8 of this
Form 10-K for additional information concerning the income taxes payable by
the Bank.

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

     The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996."  The new
rules eliminated the 8% of taxable income method for deducting additions to
the tax bad debt reserves for all financial institutions for tax years
beginning after December 31, 1995. These rules also required that all
institutions recapture all or a portion of their bad debt reserves added since
the base year (last taxable year beginning before January 1, 1988). The Bank
has previously recorded a deferred tax liability equal to the bad debt
recapture and as such the new rules will have no effect on the net income or
federal income tax expense. For taxable years beginning after December 31,
1995, the Bank's bad debt deduction is determined under the experience method
using a formula based on actual bad debt experience over a period of years or,
if the Bank is a "large" association (assets in excess of $500 million) on the
basis of net charge-offs during the taxable year. The rules allowed an
institution

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<PAGE>



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 September 2008 and an additional $208,000 was paid in
March 2009.

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

     An investment in our common stock is subject to significant risk
including, but not limited to, the risks inherent in 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 in this report. In addition to the risks and uncertainties described
below, other risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially and adversely affect our
business, financial condition, and results of operations. The value or market
price of our common stock could decline due to any of these identified or
other risks, and you could lose all or part of your investment.

                        Risks Related to our Business

     The following risks are related to our business. 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.

We are subject to increased regulatory scrutiny and are subject to certain
business limitations. Further, we may be subject to more severe future
regulatory enforcement actions if our financial condition or performance
weakens.

     In light of the current challenging operating environment and our recent
operating results, we have been working closely with our federal and state
banking regulators. In this regard, the management and the boards of directors
of Horizon Financial and the Bank have focused particular attention on the
areas of asset quality, capital management, and liquidity, seeking to improve
performance in each area in view of current unfavorable economic conditions.

     Horizon Financial and the Bank have also been subject to increased
regulatory scrutiny. As part of this scrutiny, on February 26, 2009 the Bank
entered into a Stipulation and Consent to the Issuance of an Order to Cease
and Desist ("Order") with the Federal Deposit Insurance Corporation and the
Washington State Department of Financial Institutions.  The Order is a result
of a regulatory examination conducted by the FDIC in September 2008. Under the
terms of the Order, the Bank cannot declare dividends without the prior
written approval of the FDIC and the DFI. Other material provisions of the
Order require the Bank to:

  *  strengthen the Bank's board of directors oversight of management and
     operations of the Bank;

  *  increase and subsequently maintain specified capital levels;

  *  enhance its practices and written policies for determining the adequacy
     of the allowance for loan and lease losses;

  *  eliminate loans classified as Loss and Doubtful at its regulatory
     examination, and reduce the loans classified as Substandard as a percent
     of capital;

  *  not extend additional credit to borrowers whose loan had been classified
     as Loss and is uncollected;

  *  develop a plan to reduce delinquent loans;

  *  develop a plan to reduce the amount of construction and land development
     loans;

  *  develop a three year strategic plan outlining specific goals for loans,
     investments and deposits, acceptable to the Federal Deposit Insurance
     Corporation;

  *  enhance its written funds management and liquidity policy;

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  *  not increase brokered deposits and develop a plan to reduce brokered
     deposits; and

  *  prepare and submit progress reports to the Federal Deposit Insurance
     Corporation and the Washington State Department of Financial
     Institutions.

The Bank is implementing a comprehensive plan to achieve full compliance with
the Order. No monetary penalties were imposed or recommended by the FDIC and
DFI in connection with the Order. The Order will remain in effect until
modified or terminated by the FDIC and the DFI.

     In addition, on February 6, 2009, the Federal Reserve Bank of San
Francisco  notified the Corporation that in light of the seriousness of the
Federal Deposit Insurance Corporation's supervisory concerns, immediate
efforts by the Board of Directors and management are essential to return
Horizon Financial to a satisfactory condition for purposes of Section 914 of
the Financial Institutions Reform, Recovery and Enforcement Act of 1989. As a
result of this notification neither Horizon Financial nor Horizon Bank may
appoint any new director or senior executive officer or change the
responsibilities of any current senior executive officers without notifying
the Federal Reserve. In addition, neither Horizon Financial nor Horizon Bank
may make indemnification and severance payments without complying with certain
statutory restrictions including prior written approval of the Federal Reserve
and concurrence from the Federal Deposit Insurance Corporation.

     Our failure to comply with the Order or Federal Reserve notification may
result in additional regulatory action, including the assessment of civil
money penalties against the Bank and its officers and directors or enforcement
of the Order through court proceedings.

     Prior to the issuance of the Order and since the time of the FDIC's
examination, we had undertaken a number of initiatives designed to address the
weaknesses identified during the examination. We are continuing to address the
issues raised by our regulators, many of which are being corrected, but any
current or past actions, violations or deficiencies could be the subject of
future regulatory enforcement actions taken by the FDIC or the DFI. Such
enforcement actions could involve penalties or limitations on our business at
Horizon Bank or Horizon Financial and negatively affect our ability to
implement our business plans and the value of Horizon Financial's common
stock.

We are required to seek additional capital by our federal and state
regulators, but that capital may not be available and without additional
capital other courses such as selling assets, looking for a merger partner or
other alternatives may need to be pursued.

     As noted above, under the terms of the Order, the Bank is required to
develop and adopt a plan to increase and subsequently maintain specified
capital levels. Our ability to comply with the Order is contingent on current
and future economic conditions and on our financial performance which may
ultimately require us to seek additional capital. We have been required by the
Federal Deposit Insurance Corporation and the Washington State Department of
Financial Institutions pursuant to the Order to increase our Tier 1 capital to
10% of the Bank's total assets. In connection with the requirement to raise
additional capital, we may elect to do so through the issuance of, among other
things, our common stock or securities convertible into our common stock,
which could dilute your ownership interest in Horizon Financial.

     Capital market conditions are currently unfavorable, and we do not
anticipate any material improvement in these markets in the near term.
Accordingly, we cannot be certain of our ability to raise additional capital
on any terms. If we cannot raise additional capital and/or continue to
down-size operations or complete a strategic merger or sale, we may not be
able to sustain further deterioration in our financial condition and other
regulatory actions may be taken against us.

     In addition to the foregoing, we currently have a number of risks to our
capital position, including but not limited to the following:

  *  we may have further losses from the sale of our assets in order to
     satisfy the Order to decrease our substandard loans and maintain
     sufficient liquidity;

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  *  we may have increased provisions for loan losses because of the continued
     decline in the ability of our borrowers to meet their contractual
     obligations coupled with the continued decline in the value of the
     collateral securing their loans;

  *  there may be a continued decline in our revenue as a result of the
     increases in our nonaccrual loans;

  *  there is risk that we will not be able to sufficiently reduce our
     expenses to restore us to profitability; and

  *  there may be further increases in FDIC insurance premiums and if this
     occurs it may place additional pressure on our earnings.

Our business is subject to general economic risks that could adversely impact
our results of operations and financial condition.

  *  Negative changes in economic conditions, particularly a further economic
     slowdown in our local markets, including Whatcom, Skagit, Snohomish, King
     and Pierce Counties, could increase our exposure to losses.

     Our business is directly affected by market conditions, trends in
industry and finance, legislative and regulatory changes, and changes in
governmental monetary and fiscal policies and inflation, all of which are
beyond our control.  In 2007, the housing and real estate sectors experienced
an economic slowdown that is still continuing.  Further deterioration in
economic conditions, in particular within our primary market area in the
Whatcom, Skagit, Snohomish, King and Pierce County real estate markets, could
result in the following consequences, among others, any of which could
negatively impact our business materially:

  *  loan delinquencies may continue to increase;

  *  problem assets and foreclosures may continue to increase;

  *  demand for our products and services may decline further;

  *  collateral for loans made by us, especially real estate, may continue to
     decline in value, in turn reducing a customer's borrowing power and
     reducing the value of assets and collateral securing our loans; and

  *  the increase in workload could challenge our credit administration and
     commercial banking team.

Further downturns in the real estate markets in our primary market area could
hurt our business.

     Our business activities and credit exposure are primarily concentrated in
Whatcom, Skagit, Snohomish, King and Pierce Counties. Our real estate secured
loan portfolios have been affected by the downturn in the residential and
commercial real estate markets in our primary market area. We anticipate that
further declines in the real estate markets in our primary market area will
hurt our business. As of March 31, 2009, a significant portion of our loan
portfolio consisted of loans secured by real estate located in our local
market areas. If real estate values continue to decline, the collateral for
our loans will provide less security. As a result, our ability to recover on
defaulted loans by selling the underlying real estate will be diminished, and
we would be more likely to suffer losses on defaulted loans.

     The overall credit quality of our construction and land development loan
portfolio is impacted by trends in residential and commercial real estate
prices. We continually monitor changes in our primary market area as well as
national economic factors because changes in these factors can impact our
construction loan portfolio and the ability of our borrowers to repay their
loans. Across the United States over the past year, residential and commercial
real estate markets have experienced significant adverse trends, including
accelerated price depreciation. These conditions led to significant increases
in loan delinquencies and credit losses, as well as increases in loan loss
provisions, which in turn have had a negative affect on earnings for many
banks across the country. Likewise, we have also experienced loan
delinquencies in our construction and land development loan portfolio. The
current slowdown in residential and

                                       40

<PAGE>



commercial real estate markets may continue to negatively impact real estate
values and the ability of our borrowers to liquidate properties. Despite
reduced sales prices, the lack of liquidity in the residential and commercial
real estate markets and tightening of credit standards within the banking
industry may continue to diminish all sales, further reducing our borrowers'
cash flows and weakening their ability to repay their debt obligations to us.
As a result, we may experience a further negative material impact on our
earnings and financial condition.

We may be required to make further increases in our provisions for loan losses
and to charge off additional loans in the future, which could adversely affect
our results of operations.

     For the year ended March 31, 2009, we recorded a provision for loan
losses of $65.0 million compared to  $4.1 million for the year ended March 31,
2008, which reduced our results of operations for the year ended March 31,
2009. We also recorded net loan charge-offs of $45.1 million for the year
ended March 31, 2009 compared to  $875,000 for the year ended March 31, 2008.
We are experiencing increasing loan delinquencies and credit losses.
Generally, our non- performing loans and assets reflect operating difficulties
of individual borrowers resulting from weakness in the economy of the Pacific
Northwest. In addition, slowing housing and developed lot sales have been a
contributing factor to the increase in non-performing loans as well as the
increase in delinquencies. At March 31, 2009, our total non-performing loans
had increased to $85.4 million compared to $11.6 million at March 31, 2008. In
that regard, our portfolio is concentrated in construction and land
development loans and commercial and multi-family loans, all of which have a
higher risk of loss than residential mortgage loans. While commercial
construction and land development loans represented $408.8 million or 36.38%
of our total loan portfolio at March 31, 2009, they represented $96.9 million
or 92.0% of our non-performing assets at that date. If current trends in the
housing and real estate markets continue, we expect that we will continue to
experience increased delinquencies and credit losses. Moreover, if the
recession continues we expect that it will continue to negatively impact
economic conditions in our market areas and that we could experience
significantly higher delinquencies and credit losses. An increase in our
credit losses or our provision for loan losses would adversely affect our
financial condition and results of operations.

An inadequate allowance for loan losses would reduce our future earnings.

     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 our loss and delinquency experience, and evaluate
economic conditions. Management recognizes that significant new growth in loan
portfolios, new loan products and the refinancing of existing loans can result
in portfolios comprised of unseasoned loans that may not perform in a
historical or projected manner. If our assumptions are incorrect, our
allowance for loan losses may not be sufficient to cover actual losses,
resulting in additions to our allowance. Material additions to our allowance
could materially decrease our net income. Our allowance for loan losses was
3.47% of net loans, and 45.6% of nonperforming loans, at March 31, 2009. In
addition, bank regulators periodically review our allowance for loan losses
and may require us to increase our provision for loan losses or recognize
additional loan charge-offs. Any increase in our allowance for loan losses, or
loan charge-offs as required by these regulatory authorities, could have a
material adverse effect on our financial condition and results of operations.

Liquidity risk could impair our ability to fund operations and jeopardize our
financial condition.

     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. Retail deposits are our primary source of liquidity.  At March 31,
2009, we had $1.2 billion of deposits and $261.4 million or 21.3% of our total
deposits were in brokered certificates of deposit.  The Bank, however, is
operating under the Cease and Desist Order and as a result is not permitted to
accept or renew brokered deposits and is limited on the pricing for deposits
to 75 basis points above the market average.  As a result, we are restricted
in our liquidity options.


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     In addition to deposits, we have a borrowing line with the FHLB of
Seattle but no additional amounts may be borrowed under that line as of March
31, 2009.  We also have the ability to borrow up to $7 million from the
discount window at Federal Reserve Bank of San Francisco and additional
amounts through the use of reverse repurchase agreements.  A secondary source
of liquidity is from the sale of loans or other assets but the prices for
these assets is often below the carrying value of the asset.  Consequently,
even though we may increase liquidity by the sale of the asset, we would
recognize a loss and further reduce our capital if we were to sell assets at
below their carrying value.  In addition to the foregoing, our liquidity risk
is further increased by the Order which increases our reputation risk and may
erode customer confidence and thereby result in a further loss of liquidity.

Our real estate lending also exposes us to the risk of environmental
liabilities.

     In the course of our business, we may foreclose and take title to real
estate, and could be subject to environmental liabilities with respect to
these properties. We may be held liable to a governmental entity or to third
persons for property damage, personal injury, investigation and clean-up costs
incurred by these parties in connection with environmental contamination, or
may be required to investigate or clean up hazardous or toxic substances, or
chemical releases at a property. The costs associated with investigation or
remediation activities could be substantial. In addition, as the owner or
former owner of a contaminated site, we may be subject to common law claims by
third parties based on damages and costs resulting from environmental
contamination emanating from the property. If we ever become subject to
significant environmental liabilities, our business, financial condition and
results of operations could be materially and adversely affected.

If external funds were not available, this could adversely impact our growth
and prospects.

     We rely on retail deposits, brokered deposits, and advances from the
Federal Home Loan Bank of Seattle and other borrowings to fund our operations.
Although we have historically been able to replace maturing deposits and
advances as necessary, we might not be able to replace such funds in the
future if, among other things, our results of operations or financial
condition or the results of operations or financial condition of the FHLB of
Seattle or market conditions were to change. In addition, as a result of the
Order, we no long have access to the brokered deposit markets.

     Although we consider these sources of funds adequate for our liquidity
needs, we may be compelled or elect to seek additional sources of financing in
the future. Likewise, we may seek additional debt in the future to achieve our
long-term business objectives or for other reasons. Additional borrowings, if
sought, may not be available to us or, if available, may not be available on
reasonable terms. If additional financing sources are unavailable or not
available on reasonable terms, our financial condition, results of operations
and future prospects could be materially adversely affected.

Recent negative developments in the financial industry and credit markets may
continue to adversely impact our financial condition and results of
operations.

     Negative developments continued into 2009 from 2008 in the sub-prime
mortgage market and the securitization markets for such loans, together with
other factors, have resulted in uncertainty in the financial markets in
general and a related general economic downturn. Many lending institutions,
including us, have experienced substantial declines in the performance of
their loans, including construction and land development loans, multifamily
loans, commercial loans and consumer loans. Moreover, competition among
depository institutions for deposits has increased significantly. In addition,
the values of real estate collateral supporting many construction and land,
commercial and multifamily and other commercial loans and home mortgages have
declined and may continue to decline. Bank and holding company stock prices
have been negatively affected, as has the ability of banks and holding
companies to raise capital or borrow in the debt markets compared to recent
years. These conditions may have a material adverse effect on our financial
condition and results of operations. In addition, as a result of the foregoing
factors, there is a potential for new federal or state laws and regulations
regarding lending and funding practices and liquidity standards, and bank
regulatory agencies are expected to be aggressive in responding to concerns
and trends identified in examinations, including the expected issuance of
formal enforcement orders. Further negative developments in the financial
industry and the impact of new

                                        42

<PAGE>



legislation in response to those developments could restrict our business
operations, including our ability to originate or sell loans, and adversely
impact our results of operations and financial condition.

Our loan portfolio contains a large percentage of construction and land
development loans, commercial real estate loans and commercial business loans
which involve a higher risk of loss than other types of lending.

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

  *  Commercial and Multi-family Mortgage Loans. These loans typically involve
     higher principal amounts than other types of loans, and repayment is
     dependent upon income being generated from the property securing the
     loan in amounts sufficient to cover operating expenses and debt service,
     which can be significantly affected by conditions in the real estate
     markets or in the economy. The liquidation values of these properties may
     be adversely affected by risks generally incident to interests in real
     property. If we foreclose on these loans, our holding period for the
     collateral typically is longer than for one-to-four family residential
     mortgage loans because there are fewer potential purchasers of the
     collateral. Additionally, these loans generally have relatively large
     balances to single borrowers or related groups of borrowers. Accordingly,
     if we make any errors in judgment in the collectibility of our commercial
     real estate mortgage loans, any resulting charge-offs may be larger on a
     per loan basis than those incurred with our residential or other consumer
     loans. Because the resale market for this type of loan is less liquid
     than the well-established secondary market for residential loans, should
     we decide to sell any of these loans, we may incur losses on any sale.

  *  Construction and Land Development Loans. Although we are not originating
     new construction loans, we historically have originated a significant
     amount of residential and 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 and we may incur
     a loss. There are also risks associated with the timely completion of the
     construction activities for their allotted costs, as a number of factors
     can result in delays and cost overruns, and the time needed to stabilize
     income producing properties or to sell residential tract developments.
     This type of lending also typically involves higher loan principal
     amounts and is often concentrated with a small number of builders. As a
     result, construction loans often involve the disbursement of substantial
     funds with repayment dependent, in part, on the success of the ultimate
     project and the ability of the borrower to sell or lease the property or
     refinance the indebtedness, rather than the ability of the borrower or
     guarantor to repay principal and interest. 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. Market conditions may result in borrowers having difficulty
     selling lots or homes in their developments for an extended period, which
     in turn could result in an increase in delinquencies and non-accrual
     loans. Additionally, if the current economic environment continues for a
     prolonged period of time or deteriorates further, collateral values may
     further decline and are likely to result in increased credit losses in
     these loans.

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

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Our investment in Federal Home Loan Bank stock may be impaired.

     At March 31, 2009, we owned $7.25 million of stock of the FHLB. As a
condition of membership in the FHLB, we are required to purchase and hold a
certain amount of FHLB stock. Our stock purchase requirement is based, in
part, upon the outstanding principal balance of advances from the FHLB and is
calculated in accordance with the Capital Plan of the FHLB. Our FHLB stock has
a par value of $100, is carried at cost and is subject to recoverability
testing per SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. The FHLB recently announced that it had a risk-based
capital deficiency under the regulations of the Federal Housing Finance Agency
(the "FHFA"), its primary regulator, as of December 31, 2008, and that it
would suspend future dividends and the repurchase and redemption of
outstanding common stock. As a result, the FHLB did not pay a dividend for the
fourth quarter of 2008 or the first quarter of 2009. The FHLB has communicated
that it believes the calculation of risk-based capital under the current rules
of the FHFA significantly overstates the market risk of the FHLB's
private-label mortgage-backed securities in the current market environment and
that it has enough capital to cover the risks reflected in the FHLB's balance
sheet. As a result, we have not recorded an other-than-temporary impairment on
our investment in FHLB stock. However, continued deterioration in the FHLB's
financial position may result in impairment in the value of those securities.
We will continue to monitor the financial condition of the FHLB as it relates
to, among other things, the recoverability of our investment.

Joint ventures in real estate development may expose us to additional risk.

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

Our deposit insurance assessments will increase substantially, which will
adversely affect our profits.

     Our assessment for federal deposit insurance from the Federal Deposit
Insurance Corporation for the year ended March 31, 2009 was $793,217 at an
average assessment rate of seven basis points for deposits. Deposit insurance
assessments will increase in 2009 due to recent strains on the FDIC deposit
insurance fund resulting from the cost of recent bank failures and an increase
in the number of banks likely to fail over the next few years. The current
rates for FDIC assessments range from 12 to 50 basis points of the deposit
assessment base, depending on the financial health of the insured institution.
Effective April 1, 2009, FDIC assessments increased to a range of 12 to 45
basis points. Additional premiums are charged for institutions that rely on
excessive amounts of brokered deposits, including Certificate of Deposit
Account Registry Services ("CDARS"), and excessive use of secured liabilities,
including FHLB and FRB advances. The FDIC may adjust rates from one quarter to
the next, except that no single adjustment can exceed three basis points
without a rulemaking proceeding. In May 2009, the FDIC approved a special
assessment of five basis points applied to the amount of assets reduced by the
amount of Tier 1 capital as of June 30, 2009 (not to exceed 10 basis points of
the deposit assessment base). Two additional special assessments, each of the
same amount or less, may be imposed for the third and fourth quarters of 2009.
The FDIC has announced that the first of the additional special assessments is
likely and the second is less certain.

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Current levels of market volatility are unprecedented.

     The capital and credit markets have been experiencing volatility and
disruption for more than a year, reaching unprecedented levels. In some cases,
the markets have produced downward pressure on stock prices and credit
availability for certain issuers without regard to those issuers underlying
financial strength. If current levels of market disruption and volatility
continue or worsen, our ability to access capital may be adversely affected,
which in turn could adversely affect our business, financial condition and
results of operations.

We could see declines in our uninsured deposits which would reduce the funds
we have available for lending and other funding purposes.

     The Federal Deposit Insurance Corporation in the fourth quarter of 2008
increased the federal insurance of deposit accounts from $100,000 to $250,000
and provided 100% insurance coverage for noninterest-bearing transaction
accounts for participating members including the Bank. These increases of
coverage, with the exception of IRA and certain retirement accounts, were
scheduled to expire at the end of 2009, but were extended by the FDIC in May
2009 until through December 31, 2013. With the increase of bank failures,
depositors are reviewing deposit relationships to maximize federal deposit
insurance coverage. We may see outflows of uninsured deposits as customers
restructure their banking relationships in setting up multiple accounts in
multiple banks to maximize federal deposit insurance coverage.

Our ability to foreclose on single family home loans may be restricted.

     New legislation proposed by Congress may give bankruptcy judges the power
to reduce the increasing number of home foreclosures. Bankruptcy judges would
be given the authority to restructure mortgages and reduce a borrower's
payments. Property owners would be allowed to keep their property while
working out their debts. This legislation may restrict our collection efforts
on one-to-four family loans. Separately, the administration has announced a
voluntary program under the TARP law which provides for government subsidies
for reducing a borrower's interest rate, which a lender would have to match
with its own money.

Fluctuations in interest rates could reduce our profitability and affect the
value of our assets.

     Like other financial institutions, we are subject to interest rate risk.
Our primary source of income is net interest income, which is the difference
between interest earned on loans and investments and the interest paid on
deposits and borrowings. We expect that we will periodically experience
imbalances in the interest rate sensitivities of our assets and liabilities
and the relationships of various interest rates to each other. Over any
defined period of time, our interest-earning assets may be more sensitive to
changes in market interest rates than our interest-bearing liabilities, or
vice versa. In addition, the individual market interest rates underlying our
loan and deposit products (e.g., Prime) may not change to the same degree over
a given time period. In any event, if market interest rates should move
contrary to our position, our earnings may be negatively affected. In
addition, loan volume and quality and deposit volume and mix can be affected
by market interest rates. Changes in levels of market interest rates could
materially affect our net interest spread, asset quality, origination volume,
and overall profitability.

     Recently, interest rates dropped quickly and significantly. Since
September 18, 2007, the U.S. Federal Reserve decreased its target for federal
funds rate from 5.25% to 0.25%, for a total decrease of 500 basis points.
Sudden significant decreases in these short-term market interest rates
negatively impact our net interest margins as our assets tend to reprice
faster than our liabilities in the short-term. However, sudden and significant
increases in short-term market rates can also adversely affect our net
interest margins and the value of our assets. We principally manage interest
rate risk by managing our volume and mix of our earning assets and funding
liabilities. In a changing interest rate environment, we may not be able to
manage this risk effectively. If we are unable to manage interest rate risk
effectively, our business, financial condition and results of operations could
be materially harmed.

     Changes in the level of interest rates also may negatively affect our
ability to originate real estate loans, the value of our assets and our
ability to realize gains from the sale of our assets, all of which ultimately
affect our earnings. At March 31, 2009, we had $251.1 million in loans due
after one year with fixed rates of interest, representing 21.6%

                                           45

<PAGE>



of our total loan portfolio and 17.1% of our total assets. Our most recent
"rate shock" analysis  indicates that our net portfolio value would be more
adversely affected by a decrease in interest rates than by an increase. See
Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Asset and Liability Management and Market Risk."

We could be subject to additional assessments to guarantee public funds in
Washington State.

     We accept state and local fund deposits from public treasurers in
Washington State as a Qualified Public Depositary under the State's Public
Deposit Protection Act administered by the Public Deposit Protection
Commission, or the Commission. As of March 31, 2009 we held $23.3 million in
public funds. Washington law requires qualified banks and thrifts to pledge
eligible collateral into a collateral pool administered by the Commission to
mutually guarantee with other members of the pool against a loss of funds
suffered by a public treasurer as a result of a failure by a member of the
pool. As a result of the closing of the Bank of Clark County on January 16,
2009 we were assessed approximately $55,000. Legislation was recently enacted
that requires all public depositaries to pledge 100% eligible collateral
against public funds held on deposit. Thus, each public depositary is
individually responsible for the protection of uninsured public funds they
hold. Our maximum liability should any member(s) of the collateral pool
default on their uninsured public funds is limited to 100% of public funds we
hold. Assessments for loss are based on a pro rata share of public funds held.
Our estimated share of total public funds on March 31, 2009 was approximately
0.38%.

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.

Our information systems may experience an interruption or breach in security.

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

                                      46

<PAGE>




Recently enacted legislation and other measures undertaken by the Treasury,
the Federal Reserve and other governmental agencies may not be successful in
stabilizing the U.S. financial system or improving the housing market.

     Emergency Economic Stabilization Act of 2008. On October 3, 2008,
President Bush signed into law the Emergency Economic Stabilization Act of
2008 (EESA) which, among other measures, authorized the Treasury Secretary to
establish the Troubled Asset Relief Program (TARP). The EESA gives broad
authority to the Treasury to purchase, manage, modify, sell and insure the
troubled mortgage related assets that triggered the current economic crisis as
well as other troubled assets. The EESA includes additional provisions
directed at bolstering the economy, including: authority for the Federal
Reserve to pay interest on depository institution balances; mortgage loss
mitigation and homeowner protection; temporary increase in Federal Deposit
Insurance Corporation insurance coverage from $100,000 to $250,000 through
December 31, 2009; and authority to the SEC to suspend mark-to-market
accounting requirements for any issuer or class of category of transactions.

     Pursuant to the TARP, the Treasury has the authority to, among other
things, purchase up to $700 billion  of mortgages, mortgage-backed securities
and certain other financial instruments from financial institutions for the
purpose of stabilizing and providing liquidity to the U.S. financial markets.

     The EESA followed, and has been followed by, numerous actions by the
Federal Reserve, Congress, Treasury, the SEC and others to address the current
liquidity and credit crisis that has followed the sub-prime meltdown that
commenced in 2007. These measures include homeowner relief that encourages
loan restructuring and modification; the establishment of significant
liquidity and credit facilities for financial institutions and investment
banks; the repeated lowering of the federal funds rate; emergency action
against short selling practices; a temporary guaranty program for money market
funds; the establishment of a commercial paper funding facility to provide
back-stop liquidity to commercial paper issuers; coordinated international
efforts to address illiquidity and other weaknesses in the banking sector.

     In addition, the Internal Revenue Service has issued an unprecedented
wave of guidance in response to the credit crisis, including a relaxation of
limits on the ability of financial institutions that undergo an ownership
change to utilize their pre-change net operating losses and net unrealized
built-in losses. The relaxation of these limits may make significantly more
attractive the acquisition of financial institutions whose tax basis in their
loan portfolios significantly exceeds the fair market value of those
portfolios.

     Moreover, on October 14, 2008, the FDIC announced the establishment of a
Temporary Liquidity Guarantee Program (TLGP) to provide full deposit insurance
for all non-interest bearing transaction accounts and guarantees of certain
newly issued senior unsecured debt issued by FDIC-insured institutions and
their holding companies. Under the program, the FDIC will guarantee timely
payment of newly issued senior unsecured debt issued on or before October 31,
2009. The guarantee on debt issued before April 1, 2009, will expire no later
than June 30, 2012. The guarantee on debt issued on or after April 1, 2009,
will expire not later than December 31, 2012. The Bank has elected to
participate in the TLGP.

     The actual impact that EESA and such related measures undertaken to
alleviate the credit crisis will have generally on the financial markets,
including the extreme levels of volatility and limited credit availability
currently being experienced, is unknown. The failure of such measures to help
stabilize the financial markets and a continuation or worsening of current
financial market conditions could materially and adversely affect our
business, financial condition, results of operations, access to credit or the
trading price of our common stock.

     American Recovery and Reinvestment Act of 2009. On February 17, 2009,
President Obama signed The American Recovery and Reinvestment Act of 2009, or
ARRA, into law. The ARRA is intended to revive the US economy by creating
millions of new jobs and stemming home foreclosures. In addition, the ARRA
significantly rewrites the original executive compensation and corporate
governance provisions of Section 111 of the EESA, which pertains to financial
institutions that have received or will receive financial assistance under
TARP or related programs. The specific impact that these measures may have on
us is unknown.


                                           47

<PAGE>



                         Risks Relating to Our Common Stock

     The price of our common stock may fluctuate significantly, and this may
make it difficult for you to resell the common stock when you want or at
prices you find attractive.

     We cannot predict how the shares of our common stock will trade in the
future. The market price of our common stock will likely continue to fluctuate
in response to a number of factors, including the following, most of which are
beyond our control, as well as the other factors described in this "Risk
Factors" section:

  *  actual or anticipated quarterly fluctuations in our operating and
     financial results;
  *  developments related to investigations, proceedings or litigation that
     involve us;
  *  actions of our current shareholders, including sales of common stock by
     existing shareholders and our directors and executive officers;
  *  fluctuations in the stock prices and operating results of our
     competitors;
  *  regulatory developments, whether affecting the industry in general or us
     in particular; and
  *  other developments related to the financial services industry.

     The Order requires us to increase our capital levels which may involve
the sale of our securities. We are not restricted from issuing additional
common stock, including any preferred or debt securities that are convertible
into or exchangeable for, or that represent the right to receive, common stock
or any substantially similar securities.  As a result of any such issuance,
our shareholders may experience significant dilution of their ownership
interests, and the newly issued securities could have rights superior to those
of our common stock. This could in turn result in a decline in the market
price of our common stock.

Anti-takeover provisions could negatively impact our shareholders.

     Provisions in our articles of incorporation and bylaws, the corporate law
of the State of Washington and federal regulations could delay or prevent a
third party from acquiring us, despite the possible benefit to our
shareholders, or otherwise adversely affect the market price of our common
stock. These provisions include: supermajority voting requirements for certain
business combinations with any person who beneficially owns 10% or more of our
outstanding common stock; the election of directors to staggered terms of
three years; advance notice requirements for nominations for election to our
Board of Directors and for proposing matters that shareholders may act on at
shareholder meetings, a requirement that only directors may fill a vacancy in
our Board of Directors and a voting requirement of at least a majority of the
outstanding shares of capital stock entitled to vote to remove any of our
directors, and that this removal may be made only for cause. Our articles of
incorporation also authorizes our Board of Directors to issue and set the
voting and other terms of preferred stock without shareholder approval, and
preferred stock could therefore be issued as a defensive measure in response
to a takeover proposal. In addition, because we are a bank holding company,
purchasers of 10% or more of our common stock may be required to obtain
approvals under the Change in Bank Control Act of 1978, as amended, or the
Bank Holding Company Act of 1956, as amended (and in certain cases such
approvals may be required at a lesser percentage of ownership).  Specifically,
under regulations adopted by the Federal Reserve, (a) any other bank holding
company may be required to obtain the approval of the Federal Reserve to
acquire or retain 5% or more of our common stock and (b) any person other than
a bank holding company may be required to obtain the approval of the Federal
Reserve to acquire or retain 10% or more of our common stock.

     These provisions may discourage potential takeover attempts, discourage
bids for our common stock at a premium over market price or adversely affect
the market price of, and the voting and other rights of the holders of, our
common stock. These provisions could also discourage proxy contests and make
it more difficult for holders of our common stock to elect directors other
than the candidates nominated by our Board of Directors.

Item 1B. Unresolved Staff Comments

     None.

                                       48

<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, 2009   Feet     Owned
                                    ------  --------------   ----     -----
                                            (In thousands)
Bellingham Main Office and Whatcom
Mortgage Center.....................  1971      $2,283      19,179    Owned
 1500 Cornwall Avenue
 Bellingham, WA 98225

Bellingham/Meridian.................  1987         667       4,650    Owned
 4110 Meridian Street
 Bellingham, WA 98226

Ferndale Office.....................  1976         202       3,692    Owned
 Third and Main
 Ferndale, WA 98248

Lynden Office.......................  1981         510       3,702    Owned
 Third and Grover Streets
 Lynden, WA 98264

Blaine Office.......................  1976         497       3,610    Owned
 Fourth & "H" Streets
 Blaine, WA 98230

Mount Vernon Office.................  1976         229       3,275    Owned
 1503 Riverside Dr.
 Mount Vernon, WA 98273

Anacortes Office....................  1987         584       3,650    Owned
 1218 Commercial Avenue
 Anacortes, WA 98221

Snohomish Office....................  1987         168       1,388    Owned
 620 2nd Street
 Snohomish, WA 98290

Puyallup Office, Pierce CML
Center (1)..........................  2007         586       3,402    Leased
 413 29th Street NE
 Puyallup, WA 98372

Burlington Office, Skagit Commercial
Center and Skagit Mortgage Center...  1994         981       3,980    Owned
 1020 S. Burlington Blvd
 Burlington, WA  98232

Edmonds Office......................  1994       1,828      15,265    Owned
 130 Fifth Avenue South
 Edmonds, WA  98020

                          (table continued on following page)

                                          49

<PAGE>


                                              Net Book
                                     Year    Value as of    Square   Leased/
                                    Opened  March 31, 2009   Feet     Owned
                                    ------  --------------   ----     -----
                                            (In thousands)

Murphy's Corner Office..............  2000      $1,480       3,720    Owned
 12830 Bothell Everett Hwy.
 Everett, WA 98208

Barkley Office......................  1999       2,598      14,691    Owned
 2122 Barkley Blvd.
 Bellingham, WA 98228

Holly Street Office.................  1999         293       4,000    Owned
 211 E. Holly Street
 Bellingham, WA 98227

Alabama Office(2)...................  1999         621       4,500    Owned
 802 Alabama Street
 Bellingham, WA 98228

Marysville Office...................  2004        2010       4,126    Owned
 3617 88th St NE
 Marysville, WA 98270

Lynnwood Office.....................  2003       1,986       4,230    Owned
 19405 44th Avenue W.
 Lynnwood, WA 98036

Lakewood Office, Pierce
Mortgage Center.....................  2005       1,892       4,773    Owned
 10318 Gravelly Lake Dr. SW
 Lakewood, WA 98499

Everett Office, Snohomish
Commercial Center and Snohomish
Mortgage Center.....................  2006       6,196      16,000    Owned
 9929 Evergreen Way
 Everett, WA 98204

Whatcom Commercial Center...........  2003         319       5,200    Leased
 2211 Rimland Drive, Suite 230
 Bellingham, WA 98226

--------------
(1)  Opened in June 2007.
(2)  Closed March 2009.

     At March 31, 2009, the aggregate book value of the Corporation's premises
and equipment was $26.2 million.

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

     Neither the Corporation nor the Bank is engaged in any legal proceedings
at the present time, which, singly or in the aggregate, would have a material
effect on our business, financial condition or results of operations. 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.

                                            50
<PAGE>


                                  PART II

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

     Horizon Financial's common stock is traded on the NASDAQ Global Select
Market under the symbol HRZB. The following table presents the high and low
sales prices as reported by the NASDAQ and dividends paid for the last two
fiscal years. All share prices shown below are adjusted for the 5-for-4 stock
split, paid in the form of a stock dividend in October 2006. The Corporation
has approximately 4,200 stockholders.

     2009 Fiscal Year
     Quarter                High           Low          Dividend
     ------------------    ------        ------         --------
     Fourth                $ 3.45        $0.77          $     --
     Third                   6.09         1.30                --
     Second                 10.98         5.03              0.05
     First                  14.99         6.00             0.135


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

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



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

     Horizon Financial historically has paid cash dividends on its common
stock. On December 22, 2008, the Corporation suspended the payment of
dividends on its common stock in connection with its strategy to preserve and
manage its capital. The Corporation must adhere to certain regulatory
requirements governing the distribution of dividends, and there can be no
assurance that the Corporation will continue to declare cash dividends in the
future. See "Business -- Regulation and Supervision" in Item 1 of this Form
10-K for additional information regarding dividend restrictions.

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

     The Corporation has conducted various stock buy-back programs since
August 1996. In March 2008, the Board of Directors approved a new stock
repurchase plan that runs concurrent with the 2009 fiscal year, allowing the
Corporation to repurchase up to 2.5% of total shares outstanding, or
approximately 300,000 shares. This marked the Corporation's tenth stock
repurchase plan. The Corporation did not repurchase any shares during the
fourth quarter, or during the year ended March 31, 2009 in connection with its
strategy to preserve and manage capital. In addition, the Board did not renew
its stock repurchase plan that would have run concurrent with the 2010 fiscal
year.

                                        51

<PAGE>



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.

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

                          [Graph appears here]


                                          Period Ending
                    ----------------------------------------------------------
Index*              03/31/04  03/31/05  03/31/06  03/31/07  03/31/08  03/31/09
------------------  --------  --------  --------  --------  --------  --------
Horizon Financial
 Corp.               100.00    104.68    146.36    161.49    103.69    13.99
NASDAQ - Composite   100.00    100.25    117.33    121.43    114.29    76.55
SNL Western
  Bank Index         100.00    109.49    123.63    131.60    108.60    55.88
SNL Bank $1B - $5B
  Indes              100.00    107.24    125.11    124.15     98.16    57.13


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

                                      52

<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,
                    ---------------------------------------------------------
                        2009       2008        2007        2006       2005
                    ----------   ---------   ---------   --------   ---------
                                           (In thousands)
Financial Condition
Data:
-------------------

Total Assets...... $1,467,971  $1,392,178  $1,270,327  $1,116,728    $997,570
Loans Receivable,
 net..............  1,123,660   1,191,478   1,054,870     918,510     804,981
Cash and
 Investment
 Securities.......    218,160     114,562     133,075     125,216     125,966
Deposits..........  1,229,764   1,038,792     975,295     834,299     746,849
Borrowings........    138,788     214,791     158,958     159,837     135,787
Stockholders'
 Equity...........     93,026     128,317     123,855     113,323     107,024

                                         Year Ended March 31,
                      ------------------------------------------------------
                          2009       2008        2007       2006      2005
                      ---------  ----------  ----------  --------  ---------
Operating Data:             (In thousands, except per share information)
---------------
Interest Income...    $77,665   $ 100,243     $92,600     $69,388     $52,182
Interest Expense..    (39,354)    (46,645)    (40,133)    (24,896)    (16,144)
                     --------    --------     -------     -------     -------
Net Interest
 Income...........     38,311      53,598      52,467      44,492      36,038
Provision for
 Loan Losses......    (65,000)     (4,100)     (1,850)     (2,575)     (1,700)
Noninterest
 Income...........      6,349       7,044       5,838       5,411       5,713
Noninterest
 Expense..........    (33,555)    (29,180)    (27,861)    (24,770)    (21,619)
  Income (loss)
   before Provision
   (Benefit) for
    Income Taxes..    (53,895)     27,362      28,594      22,558      18,432
  Benefit (Provision)
   for Income
   Taxes..........     20,529      (8,949)     (9,566)     (6,903)     (5,369)
                     --------    --------     -------     -------     -------
Net Income (Loss).   $(33,366)   $ 18,413     $19,028     $15,655     $13,063
                     ========    ========     =======     =======     =======

Per Common Share:(1)
 Fully-diluted
  earnings (loss).     $(2.79)      $1.51       $1.53       $1.25       $1.01
 Dividends........      0.185       0.530       0.495       0.456       0.424
 Book Value.......       7.76       10.79       10.11        9.16        8.53
 Weighted average
  shares
  outstanding..... 11,945,835  12,196,783  12,409,092  12,542,845  12,952,542

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

                                         53

<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,
                                                    -----------------------
                                                    2009      2008     2007
                                                    ----      ----     ----

Return on average assets (net income (loss)
  divided by average total assets)...............  (2.31)%    1.37%    1.57%

Return on average equity (net income (loss)
  divided by average equity)..................... (28.31)    14.53    16.11

Dividend payout ratio (dividends declared
  per share divided by fully-diluted
  earnings (loss) per share).....................  (6.63)    35.10    32.35

Equity to assets ratio (average equity
  divided by average total assets)...............   6.34      9.22     9.74

Interest rate spread (difference between average
 yield on interest-earning assets and average
 cost of interest bearing liabilities)...........   2.80      4.24     4.60

Net yield on earning assets (net interest
 income as a percentage of average interest
 earning assets).................................   2.86      4.37     4.73

Efficiency ratio (noninterest expense divided
  by the sum of net interest income and
  noninterest income)............................  75.13     48.12    47.79

Non-performing loans ratio (non-performing
 loans divided by net loans).....................   7.60      0.97     0.02

Non-performing asset ratio (non-performing
 assets divided by total assets).................   7.13      0.88     0.07

                                           54

<PAGE>


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.

Financial Overview
------------------

     Horizon Financial Corp. is the bank holding company for Horizon Bank and
reported some of the following highlights for the fiscal year ended March 31,
2009:

     *    The net loss for the fiscal year ended March 31, 2009 was $33.4
          million or $2.79 per diluted share compared to net income of $18.4
          million or $1.51 per diluted share for the year ended March 31,
          2008.
     *    During the 2009 fiscal year, we charged off $309,000 associated
          with our measurement for other than temporary impairment ("OTTI") of
          our private label mortgage-backed securities.
     *    The interim measurement of our goodwill asset resulting from a
          qualifying event gave rise to the complete write-off of the $545,000
          goodwill asset during the fiscal year 2009.
     *    A gain in the amount of $767,000 was recognized during the fiscal
          year 2009 resulting from the life insurance benefit paid on the
          death of a retired executive officer.
     *    A loss of $777,000 was recognized during fiscal year 2009 from the
          permanent loss in value associated with the in-kind distribution of
          securities from redemption of our investment in the Shay AMF Ultra
          Short-Term Bond Mutual Fund.
     *    A one-time gain of $579,000 was recognized during fiscal year 2009
          from the sale of equity securities.
     *    An $800,000 unfunded loan commitment liability expense was
          recognized during fiscal year 2009.
     *    The loan loss provision for the fiscal year ended March 31, 2009
          was $65.0 million as compared to $4.1 million for the prior year.
     *    The total noninterest expense for the fiscal year ended March 31,
          2009 was $33.6 million as compared to $29.2 million for the prior
          period ended March 31, 2008.
     *    Total non-performing assets increased from $12.3 million as of
          March 31, 2008 to $104.7 million as of March 31, 2009.
     *    Total assets were $1.47 billion as of March 31, 2009 as compared to
          $1.39 billion as of March 31, 2008.
     *    Gross loans were $1.2 billion as of March 31, 2009 as compared to
          $1.2 billion as of March 31, 2008.
     *    Total deposits were $1.2 billion as of March 31, 2009 as compared
          to $1.0 billion as of March 31, 2008.
     *    The net interest margin was 2.86% for the year ended March 31, 2009
          as compared to 4.37% for the same period in 2008.
     *    The regulatory Tier 1 capital ratio of March 31, 2009 was 6.2% as
          compared to 9.1% at March 31, 2008.

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

     The Corporation's business strategy is to return the Bank to a
well-capitalized and profitable community bank, dedicated to a diversified
base of commercial lending, home mortgage lending, consumer lending, small
business lending and providing competitive deposit and cash-management
services to our personal and business customers.  The Corporation has sought
to implement this strategy by: (i) focusing on commercial banking
opportunities;  (ii) providing competitive, personalized financial services to
individuals and business customers and communities served by its branch
network; (iii) selling many of its fixed rate mortgages to the secondary
market; (iv) focusing on asset quality; (v) prudently managing our operating
expenses; and (vi) meeting the capital requirements set forth in the Order.

     As a result of the U.S. recession and the impact from a downturn in the
housing market, the Bank has focused its efforts on improving asset quality,
deleveraging the balance sheet, raising capital, managing liquidity and
growing

                                       55

<PAGE>




core deposits.  Beginning with the quarter ended September 30, 2008, the Bank
expanded its special assets team, which is responsible for working out problem
assets that have grown substantially over the six months ended March 31, 2009,
by shifting personnel within the Bank.  The Bank has continued to focus on
core deposit growth to enhance its liquidity position.  At March 31, 2009, the
Bank's core deposits increased $34.5 million, or 5.5% to $665.0 million from
$630.5 million at March 31, 2008.  See "Business   Deposit Activities and
Other Sources of Funds   Deposits" for an analysis of the deposit portfolio by
major type of deposit.  In addition, the Bank has performed an extensive
review of potential expense reductions.  In evaluating the controllable
expenses, the Bank determined the need to make several strategic staffing
reductions.  As of November 4, 2008, the Bank completed a reduction in force
of 27 full-time positions and identified several areas where responsibilities
will be shifted to accommodate the revised staffing levels. In the weeks
leading up to the November 4, 2008 strategic staffing reduction, other
positions were not filled when vacated by the employees previously occupying
these positions.  These reductions in personnel, along with strategic
reductions in other noninterest expense areas have resulted in savings of over
$3.0 million on an annual basis. In connection with the reduction in
personnel, the Corporation incurred approximately $135,000 in severance
related expenses during the year ended March 31, 2009.

Critical Accounting Policies and Estimates
------------------------------------------

     The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions which affect the reported amounts and disclosures.
Changes in these estimates and assumptions are considered reasonably possible
and may have a material impact on the consolidated financial statements and
thus actual results could differ from the amounts reported and disclosed.

     Our financial statements are based on the selection and application of
significant accounting policies which require management to make significant
estimates and assumptions as detailed in Note 1 of the Notes to Consolidated
Financial Statements included in Item 8 of this Form 10-K.  We believe the
following policies and estimates involve a higher degree of judgment:

     Allowance for Loan and Lease Losses and Reserve for the Unfunded Loan
Loss Commitments.  The allowance for loan and lease losses ("ALLL") represents
management's estimate of the measured accounting loss.  The foundation of the
ALLL is based on the loan grading system, which rates our loans from low risk
to high risk.  Those loans that are considered high risk undergo more careful
evaluation when estimating the contingent loss.  The ALLL is divided into two
separate categories.  The first group is comprised of individual impaired
loans.  An impaired loan exists when it is probable that the Bank will be
unable to collect all amounts due (including both interest and principal)
according to the contractual terms of the loan agreement.  When a loan is
determined to be impaired, we then measure the impairment using either the
discounted cash flows or the current fair value, less selling costs when the
source of repayment is the liquidation of collateral.  The second group of the
ALLL is comprised of all other loans that are pooled into homogenous
categories and a historical loss rate is applied for measuring the estimated
accounting loss.

     For additional information regarding the allowance for loan losses, see
the Asset Quality section in this Management's Discussion and Analysis and
Provision for Loan Losses in Note 1 in the Notes to the Consolidated Financial
Statements included in Item 8 of this Form 10-K.

     The reserve for unfunded loan loss commitments is established to absorb
inherent losses associated with our commitments to lend funds, such as with a
letter or line of credit.  The adequacy of the ALLL and the reserve for
unfunded loan loss commitment are monitored on a regular basis and are based
on management's evaluation of numerous factors, which include the quality of
the current loan portfolio, the trend in the loan portfolio's risk ratings,
current economic conditions, loan concentrations, past-due and non-performing
trends, evaluation of specific loss estimates for all significant problem
loans and charge-offs and recoveries.

     Management believes that the ALLL and the reserve for unfunded loan loss
commitments were adequate as of March 31, 2009.  However, there is no
assurance that future loan losses will not exceed the levels provided for in
the ALLL and could possibly result in additional charges to the provision for
loan and leases losses.  In addition, the Bank's

                                    56

<PAGE>




regulatory agencies as part of their periodic examination may require
additional charges to the provision for loan and lease losses in future
periods if warranted as a result of their review.

     Investments. The Corporation classifies its investments as either
available-for-sale or held-to-maturity.  Available for sale securities are
reported at their fair value, which is determined by obtaining quoted market
prices.  Unrealized gains and losses on available for sale securities are
included in other comprehensive income and excluded from earnings.  Realized
gains and losses and declines in fair value determined to be other than
temporary are included in earnings.  During the year ended March 31, 2009, the
Corporation recorded a $309,000 other than temporary impairment related to 15
non-agency collateralized mortgage obligations.  These collateralized mortgage
obligations are included in investments available for sale where the default
rates, declines in investment ratings and loss severities of the underlying
collateral indicate credit losses are expected to occur.  These securities
were valued by third party pricing services using readily available market
quotes.  There were no similar charges recorded during the year ended March
31, 2008. The fair value of investments is discussed in more detail in Notes 3
and 4 of the Notes to Consolidated Financial Statements included in Item 8 of
this Form 10-K.

     Long-Lived Assets and Intangibles. The Corporation periodically measures
for impairment of its long-lived assets and intangibles using a methodology
that takes into account external factors, including market conditions, changes
in competition, a significant change in expectations and an adverse change.
If actual external conditions and operating results differ from the
Corporation's expectations, then impairment charges may be necessary to reduce
the carrying value of the asset(s) to the appropriate market value.

     Management measures the goodwill for impairment on an annual basis at the
fiscal year-end on a broad basis at the consolidated level since it is not
identifiable to a "reporting unit."  During most of fiscal 2009, volatility in
the stock market and particularly financial institutions and their holding
companies, were a significant contributing factor causing fluctuations in the
Corporation's common stock during the interim reporting periods.  Management
considered this as well as other factors ("the business climate") in
evaluating whether or not goodwill was impaired.  As part of the process,
management considered the "business climate" as a potential trigger for an
interim measurement under SFAS 142, but deemed the economic environment to be
abnormally volatile and irrational to conclude that an interim assessment of
goodwill was required based on stock volatility alone.

     During the third quarter of fiscal 2009, the Corporation recorded a
non-cash charge of $545,000 related to the impairment of goodwill.  The
interim test for impairment was performed as of December 31, 2008 rather than
an earlier period as a result of two events: (1) Horizon Bank was informed in
December  2008  by the Federal Deposit Insurance Corporation and the State of
Washington Department of Financial Institutions that a Cease and Desist  Order
would be issued and forthcoming, and (2) Horizon Bank's decision to close a
branch office that was directly associated with the creation of the original
goodwill asset signaled potential impairment.  This impairment charge had no
effect on the Company's or the Bank's cash balances, liquidity or regulatory
ratios.  At March 31, 2008, the $545,000 balance of goodwill was included in
other assets.  For additional information regarding goodwill, see "Goodwill"
below and Note 1 in the Notes to the Consolidated Financial Statements
included in Item 8 of this Form 10-K.

     Valuation of Deferred Tax Assets.  Deferred tax assets and liabilities
are reflected at currently enacted income tax rates applicable to the period
in which the deferred tax assets or liabilities are expected to be realized or
settled using the asset liability method.  As changes in tax laws or rates are
enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.  Deferred taxes result from temporary differences
in the recognition of certain income and expense amounts between the
Corporation's financial statements and its tax returns.  The Corporation
evaluates the deferred tax assets and liabilities at least annually and at
March 31, 2009 believes, based upon the available evidence, that all deferred
tax assets will be realized in the normal course of operations.  Accordingly,
these assets have not been reduced by a valuation allowance.

     Accrued Taxes.  The Corporation estimates tax expense based on the amount
it expects to owe various tax authorities.  Taxes are discussed in more detail
in Note 10 of the Notes to Consolidated Financial Statements included in Item
8 of this Form 10-K.  Accrued taxes represent the net estimated amount due or
to be received from taxing authorities.  In estimating accrued taxes,
management assesses the relative merits and risks of the appropriate tax

                                     57

<PAGE>



treatment of transactions taking into account statutory, judicial and
regulatory guidance in the context of the Corporation's tax position.

Comparison of Financial Condition at March 31, 2009 and March 31, 2008
----------------------------------------------------------------------

     Overview.  Total consolidated assets for the Corporation as of March 31,
2009, were $1.5 billion, a 5.4% increase from the March 31, 2008 level of $1.4
billion.  This increase in assets was primarily attributable to the growth in
interest bearing deposits to $126.2 million at March 31, 2009 from $2.9
million at March 31, 2008.  The growth in interest bearing deposits was a
result of the strategy to enhance the Bank's liquidity position, accomplished
in part by utilizing brokered deposits and by paying above average retail
deposit rates in our local markets.   Net loans receivable decreased 5.7% to
$1.1 billion at March 31, 2009 compared to $1.2 billion at March 31, 2008.
The decrease in net loans receivable was attributable to a combination of
factors, including a $80.5 million decrease in commercial construction loans
as the Bank worked to decrease its balances in this business line.  Commercial
construction includes commercial speculative one-to-four family (large
one-to-four family developments and condominium projects), multi-family and
commercial buildings.  During the period ended March 31, 2009, the commercial
business loan category increased $24.3 million, or 13.7% as the Bank continues
to focus on increasing its commercial lines of credit balances in order to
diversify its loan portfolio and expand its relationships with businesses in
its markets.

     Loans.  One-to-four family mortgage loans, net of participations sold,
increased 3.8% to $152.5 million at March 31, 2009 from $146.9 million at
March 31, 2008.  The Bank implemented a key lending program to help the Bank's
commercial builder/developers sell inventory, which focused on offering
special mortgages to prospective home buyers.  The Bank had net sales of $68.5
million of one-to-four family real estate loans during the twelve months ended
March 31, 2009, compared to $86.7 million during the twelve months ended March
31, 2008 as a result of a slowdown in the  real estate market.

     The following is an analysis of the loan portfolio by major type of loan
at March 31, 2009 and 2008.

                                                      At March 31,
                                         -----------------------------------
                                            2009               2008
                                         ---------          ---------
                                                  (Dollars in thousands)
First mortgage loans:
  One-to-four family....................  $167,048   14.4%   $165,824   13.7%
  One-to-four family construction.......    28,290    2.4      35,303    2.9
  Less participations sold..............   (42,853)  (3.7)    (54,269)  (4.5)
                                        ----------  -----  ----------  -----
     Subtotal...........................   152,485   13.1     146,858   12.1
  Commercial land development...........   186,580   16.0     183,827   15.2
  Commercial construction...............   222,207   19.1     302,708   25.0
  Multi-family residential..............    51,970    4.5      45,049    3.7
  Nonresidential commercial real
    estate..............................   281,481   24.2     300,109   24.8
  Commercial loans......................   201,973   17.4     177,685   14.7
  Home equity secured...................    58,228    5.0      47,351    3.9
  Other consumer loans..................     7,717    0.7       7,005    0.6
                                        ----------  -----  ----------  -----
     Subtotal........................... 1,010,156   86.9   1,063,734   87.9
                                        ----------  -----  ----------  -----
     Total loans receivable............. 1,162,641  100.0%  1,210,592  100.0%
                                        ----------  -----  ----------  -----
Less:
  Allowance for loan losses.............   (38,981)           (19,114)
                                        ----------         ----------
     Total loans receivable, net........$1,123,660         $1,191,478
                                        ==========         ==========

Net residential loans...................$  149,625   13.3% $  145,565   12.2%
Net commercial loans....................   193,687   17.2     174,263   14.6
Net commercial real estate loans (1)....   716,743   63.8     818,215   68.7
Net consumer loans (2)..................    63,605    5.7      53,435    4.5
                                        ----------  -----  ----------  -----
                                        $1,123,660  100.0% $1,191,478  100.0%
                                        ==========  =====  ==========  =====

                        (footnotes on following page)

                                    58

<PAGE>


-----------
(1)  Includes construction and development, multi-family and commercial real
     estate loans.
(2)  Includes home equity and other consumer loans.

     As reflected in the table above, approximately 63.8% of our total net
loan portfolio consists of commercial and multifamily real estate and
construction and land development loans.  Management has made the strategic
decision to reduce the level of exposure to these types of loans during the
economic slowdown and has dramatically reduced its lending to this type of
borrower.  Management intends to continue these efforts to reduce its
concentration in construction and land development loans.

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

                                  At March 31, 2009      At March 31, 2008
                                 -------------------   --------------------
                                 Amount      Percent    Amount      Percent
                                 ------      -------    ------      -------
                                          (Dollars in thousands)
Speculative construction
  one-to-four family........... $ 19,280        4.4%   $ 27,206       5.2%
Custom construction one-
  to-four family...............    9,010        2.1       8,097       1.6
                                --------      -----    --------     -----
    Total one-to-four family...   28,290        6.5      35,303       6.8
Commercial speculative
  construction one-to-
  four family..................  142,315       32.6     236,536      45.3
Commercial construction
  multi-family.................    8,439        1.9      11,732       2.2
Commercial construction
  non-residential..............   71,453       16.3      59,541      11.4
Land development...............  186,580       42.7     178,726      34.3
                                --------      -----    --------     -----
   Total construction and
     land development..........  408,787       93.5     486,535      93.2
                                --------      -----    --------     -----
   Total construction loans.... $437,077      100.0%   $521,838     100.0%
                                ========      =====    ========     =====

    Investment Securities.   The investment portfolio is comprised of the
following securities; government agencies, municipal bonds, mortgage-backed
securities, collateralized mortgage obligations ("CMOs") and common stock.
The total carrying amount of these securities was $66.9 million as of March
31, 2009 as compared to $80.4 million as of March 31, 2008, which represents a
decrease of $13.5 million or 16.8%.  During the fiscal year ended March 31,
2009, we elected not to renew maturing securities or replace pre-payments to
principal.

     The table below presents the available for sale and held-to-maturity
amortized cost, fair value and unrealized gain or loss as of March 31, 2009:

                                              At March 31, 2009
                                     ---------------------------------------
                                                   Unrealized
                                     Amortized       Gain/         Estimated
                                        Cost         (Loss)        Fair Value
                                     ---------     ----------      ----------
                                                (In thousands)
Available For Sale Securities
  State and political subdivisions
    and U.S. government agency
    securities......................  $26,565        $   608        $27,173
  Marketable equity securities......      562            348            910
  Mortgage-backed securities
    and CMOs........................   37,563          1,219         38,782
                                      -------         ------        -------
      Total available-for-

       sale securities..............   64,690          2,175         66,865
Held To Maturity Securities
  State and political subdivisions
    and U.S. government agency
    securities......................       --             --             --
  Mortgage-backed securities
    and CMOs........................        8              3             11
                                      -------         ------        -------
      Total held to maturity
       securities...................        8              3             11
                                      -------         ------        -------
      Total securities..............  $64,698         $2,178        $66,876
                                      =======         ======        =======

                                       59

<PAGE>



     The table below presents the available for sale and held-to-maturity
maturity schedule of the securities as of March 31, 2009:

                                     Maturity Schedule of Securities
                                            at March 31, 2009
                            ------------------------------------------------
                              Available For Sale        Held To Maturity
                            -----------------------  -----------------------
                            Amortized    Estimated   Amortized    Estimated
                              Cost       Fair Value     Cost      Fair Value
                            ---------    ----------  ---------    ----------
                                             (In thousands)
Maturities:
  Less than one year........ $ 1,718      $ 1,734       $--          $--
  Over one year to five
   years....................  12,976       13,668        --           --
  Over five to ten years....  21,260       21,685         8           11
  Over ten years............  28,174       28,868        --           --
                             -------      -------       ---          ---
                              64,128       65,955         8           11

Marketable equity
 securities.................     562          910        --           --
                             -------      -------       ---          ---
   Total investment
    securities.............. $64,690      $66,865       $ 8          $11
                             =======      =======       ===          ===

     Federal Home Loan Bank ("FHLB") Stock.  The investment in the FHLB of
Seattle stock totaled $7.25 million as of March 31, 2009.  The investment in
the FHLB stock is a restricted investment carried at par value ($100 per
share), which approximates its fair value.

     Management has evaluated the FHLB stock for impairment by giving
consideration to the length of time the situation persists with the FHLB,
commitments by the FHLB to make payments, the impact of regulatory changes and
the liquidity position.  We have reviewed the most recent unaudited financial
statements included in the Form 10-Q filing.  Their most recent Form 10-Q
filing noted that the FHLB did not meet one of the three statutory capital
requirements.  The three capital requirements are 1) risk-based capital, 2)
capital-to-asset ratio, and 3) leverage capital ratio.  The FHLB did not meet
the risk-based capital requirements as of March 31, 2009, but was in
compliance with the other two statutory capital ratios.  It was further noted
in their Form 10-Q that a recovery in the market value of the private-label
securities occurred in January and February 2009, which allowed the FHLB to
redeem $669,000 of Class B capital stock.  On February 28, 2009, stock
redemptions were once again halted when the private-label securities were
downgraded by a rating agency.  The FHLB of Seattle Board of Directors have
taken steps to restore the risk-based capital by suspending the issuance of
Class A stock, issuing only Class B stock (considered permanent capital) and
suspended the redemption and repurchase of Class A and Class B stock and the
payment of dividends until such time the deficiency of the risk-based capital
ratio is corrected.

     The FHLB of Seattle reported a $16.3 million loss for the quarter ended
March 31, 2009.  The FHLB of Seattle attributes its first quarter 2009 net
loss primarily to $71.7 million of OTTI charges on certain of its
private-label mortgage-backed securities that are classified as
held-to-maturity.  As a result of its net loss for the first quarter 2009, the
FHLB of Seattle also reported a $1.1 billion accumulated other comprehensive
loss and total capital of $961 million as of March 31, 2009, as compared with
total capital of $1.8 billion as of December 31, 2008.  The OTTI recognized in
accumulated other comprehensive loss is accreted to the carrying value of each
security on a prospective basis, based on the amount and timing of future cash
flows, over the remaining life of each security.  The accretion increases the
carrying value of each security and does not affect earnings unless the
security is subsequently sold or has an additional OTTI charge that is
recognized in earnings.  The FHLB of Seattle's first quarter 2009 OTTI charge
reflects the effects of isolating the portion of the loss that is directly
associated with the other than temporary impairment of the private-label
mortgage-backed securities.  As a result of our review and intent to hold the
security to maturity, the Corporation has not recorded an "other than
temporary impairment" on its investment in FHLB of Seattle stock.

     Asset Quality and Non-Performing Assets.  The Corporation manages its
credit risk exposure through managing the loan concentrations, and the
application of its underwriting policies, procedures, and monitoring
practices.

                                       60

<PAGE>



Delinquent and problem loans, however, are a part of any financial
institution.  When a borrower fails to make payments, the Corporation
implements certain strategies that are designed to work with the borrower in
order to collect delinquent loans.  In those cases where collection efforts
are exhausted, the Bank works to gain control of the property through
foreclosure or other available means.

     Allowance for Loan and Lease Losses.  There are several elements that
contribute to management's estimate of the allowance for loan and lease losses
(ALLL). The foundation of our ALLL begins with a proper loan grading system.
The loan grading system ensures that loans are properly graded based on the
risk profile which takes into account such factors as net worth, cash flow,
capacity to service debt, eligible collateral and financial capacity of
guarantors (if applicable).  Our loan grading system ranges from 1 - 8, with a
"1" being considered a prime borrower of strong financial capacity and an "8"
being a loan classified as a loss.  Loans that are identified to be "high"
risk (rating a 6 or above) are defined as adversely classified.  The loan
grading system is the responsibility of our Credit Administration, which
administers the internal controls and oversight to ensure the loan grading
system identifies and monitors all loans graded.  We regularly evaluate our
loan portfolio to evaluate the accuracy of risk ratings throughout the life of
the loans.

     The measurement of the ALLL is a culmination of the two separate
measurements performed in accordance with FASB SFAS No. 5 and 114.  SFAS No.
114 is the work performed to measure individual loans for impairment when it
is probable that the Bank will be unable to collect all amounts due (including
both interest and principal) according to the contractual terms of the loan
agreement.  These loans are often defined as adversely classified and are
measured by the most appropriate method using either the present value of the
expected future cash flows, or the net realizable value (fair value of
collateral less costs to complete and sell), or the loan's observable market
price.  The majority of our impaired loans as of the reporting period were
measured using the net realizable value since the loans were dependent upon
the sale of collateral to meet the obligation.  The process of measuring for
impairment includes obtaining market appraisals and estimating the costs to
complete and sell the loan.  The measured impairment for each loan is then
aggregated and becomes part of the ALLL.

     The loans that are not impaired are aggregated into separate pools based
on loan type and loan risk (grade) in accordance with FASB SFAS No. 5.  A loan
loss rate is applied to each pool using the higher amount obtained from
historical data published from relevant sources or the Bank's own loan loss
experience.  The ALLL reflects the aggregate amount of the two separate
measurements, which as of March 31, 2009 totaled $39.0 million.  The
methodology for measuring the ALLL is documented in our policies and reflects
management's best estimate of future probable loan losses, which have been
carefully reviewed and approved by our Board of Directors.

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

                                      61

<PAGE>



     The following table summarizes the allowance for loan losses,
charge-offs, and loan recoveries:

                                             Year Ended March 31,
                                             ------------------
                                               2009       2008
                                             -------    -------
                                             (Dollars in thousands)
Allowance at beginning of period...........  $19,114    $15,889
Provision for loan losses..................   65,000      4,100
Charge offs, net of recoveries.............  (45,133)      (875)
                                             -------    -------
Allowance at end of period.................  $38,981    $19,114
                                             =======    =======

Allowance as a percentage of gross loans
  receivable at the end of the period......     3.35%      1.58%

Allowance for loan losses as a percentage
  of net loans receivable at the end of
  the period...............................     3.47%      1.60%

Net charge-offs as a percentage of average
  loans outstanding during the period......     3.70%      0.08%

Allowance for loan losses as a percentage
  of non-performing loans at the end of the
  period...................................    45.63%    164.67%

Allowance for loan losses as a percentage
  of nonperforming assets at the end of
  period...................................    37.25%    155.87%

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

     The provision for loan losses was $65.0 million for the fiscal year ended
March 31, 2009 compared to $4.1 million for the year ended March 31, 2008.
These provisions reflect management's ongoing analysis of changes in loan
portfolio composition by collateral categories, balances outstanding, overall
credit quality of the portfolio, historical industry loss experience, and
current economic conditions.  The allowance for loan losses was $39.0 million,
or 3.47% of net loans receivable at March 31, 2009, compared to $19.1 million,
or 1.60% of net loans receivable at March 31, 2008.  The increase in the
provision for loan losses contributing to a higher allowance was a result of a
combination of factors: (1) higher level of non-performing loans at March 31,
2009 of $85.4 million compared to $11.6 million at March 31, 2008,  (2) an
increase of net charge-offs to $45.1 million as of March 31, 2009 from
$875,000 at March 31, 2008 and (3) an increase in delinquencies on performing
loans, with those 30 to 89 days past due at March 31, 2009 totaling $83.9
million, compared to $30.6 million at March 31, 2008.  In addition, the
increase in our provision for loan losses and the allowance during the fourth
quarter ended March 31, 2009 was in response to a significant internal
downgrade of loans, primarily real estate construction projects where the land
values of the underlying collateral had declined and where the cash flows of
these developers was proving insufficient to secure their loans.  We ordered
new appraisals for many of the impaired loans and exercised judgment to
further stress a significant number of the impaired loans in order to reflect
the fair values based on other available third-party sources or comparable
known indicators of fair values.   This was done in response to the volatile
changes in real estate market prices and management's decision to carefully
evaluate appraisals that were three months or older.  In the past, we relied
on appraisals that were up to 12 months in age, but in light of the current
economic conditions, we decided in the fourth quarter of 2009 no to rely on
appraisals three months or older.  Some of the sources of information relied
upon by management include internet websites that publish fair values of
properties and track market changes in real estate values as well as published
subscriptions to industry experts such as RealEstats.  These steps taken by
management identified a continued and significant decline in the net
realizable values of the properties that serve as collateral for these loans.
The impaired loans are primarily centered in Pierce, Snohomish and King
counties.  In many cases, our updated net realizable values reflected
significant declines in values from appraisals and other documentation
obtained as recently as June and September 2008.  This information resulted

                                       62

<PAGE>



in more loans measured for losses on an individual basis in accordance with
SFAS 114 and it directly influenced the larger provision for loan loss, which
increased our ALLL for the year ended March 31, 2009.

     Since March 2008, we have experienced a steady decline in many of our
credit quality metrics.  There has been a gradual increase in the level of
non-performing loans, net charge-offs and delinquency rates, which have all
contributed to an increase in the ALLL.  During the year ended March 31, 2008
and earlier, the ALLL was largely influenced by the measured losses based on
the application of FASB SFAS No. 5, which pooled loans by category and loan
grading.  There were a small amount of adversely classified loans that were
individually measured for impairment.  Because real estate values were holding
steady and in many instances rising in the periods prior to March 31, 2008,
the ALLL was not impacted by impaired loans, therefore the measurement was
influenced more extensively by historical loss rates that were obtained from
relevant sources (i.e. Federal Reserve Bank).  As the economy in the Puget
Sound began to experience layoffs and real estate activity and prices began to
drop, then our construction and land development borrowers began to struggle
to sell the assets required to payoff their loans.  This resulted in a
significant transformation and change in the composition of the ALLL.  In the
second half of 2008 and the quarter ended March 31, 2009, the level of
impaired loans increased as borrowers migrated from delinquent status to
non-accrual status and we began to order appraisals and value each loan in
accordance with FASB SFAS 114.  The deterioration in the economy and the
impact to our borrowers resulted in a significant increase in our provisions
for loan losses, charge-offs and an increase in the ALLL for future probable
losses.

     Other factors that are considered as part of the methodology for
measuring the allowance for loan and lease losses include market conditions.
The majority of the Corporation's loan portfolio consists of commercial and
single- family residential loans secured by real estate in the Whatcom,
Skagit, Snohomish, King and Pierce County areas of Washington.   Regional
economic conditions continue to deteriorate, except for a small improvement in
Pierce County, where housing inventories have dropped according to RealEstats,
Inc.  For the month ended March 31, 2009, the available housing inventory
levels for Snohomish, Skagit, Pierce, King and Whatcom counties were 14.5,
16.0, 10.9, 11.5 and 10.4 months respectively.  This compares to the same
month one year earlier when available housing inventory levels were overall
more favorable for Snohomish, Skagit, Pierce, King and Whatcom counties when
they were 11.4, 10.3, 12.4, 8.0 and 7.7 months respectively.  This information
provides some indication of the challenges facing the sale of real estate in
the counties reflected in the geographic distribution table of our
non-performing assets that is subsequently presented.

     The allowance for loan losses at March 31, 2009 represents our best
estimate of the losses inherent in the loan portfolio, given the changing
portfolio mix and the current economic environment.  While the Bank believes
it has established its existing allowance for loan and lease losses in
accordance with accounting principles generally accepted in the United States,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request the Bank to significantly increase or decrease its
allowance for loan losses.  In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed elsewhere in this document.
Any material increase in the allowance for loan losses would adversely affect
the Bank's financial condition and results of operations.

     Unfunded Loan Loss Liability.  During the fourth quarter ended March 31,
2009, we reclassified to a liability account our exposure for credit losses
related to off balance sheet loan commitments.  The liability represents our
estimate of probable losses associated with commitments to extend credit,
which include credit card commitments, undrawn lines of credit, commercial and
standby lines of credit.  We had previously included the liability as a
component of the allowance for loan and lease losses.  Following the
reclassification, the liability is included as a component of "other
liabilities" on the balance sheet.

     The probable losses are measured based on an evaluation of estimated
losses using historical loss rates and other factors such as economic factors,
delinquency rates and risk characteristics of the commitments.  The unfunded
loan loss liability as of March 31, 2009 was $800,000, and represents our best
estimate for future probable losses on undrawn commitments that are off
balance sheet.

                                       63

<PAGE>



     Non-Performing Assets.  As of March 31, 2009, there was one loan in the
loan portfolio over 90 days delinquent and accruing interest and 53 loan
relationships on non-accrual status.  At March 31, 2009, total non-performing
loans were $85.4 million compared to $11.6 million at March 31, 2008.  The
Bank had 14 properties in the other real estate owned ("OREO") category
totaling $19.2 million at March 31, 2009.  Total non-performing assets
represented $104.7 million, or 7.13% of total assets at March 31, 2009
compared to $12.3 million or 0.88% of total assets at March 31, 2008.

     The following tables summarize the Bank's non-performing assets and
restructured loans within the meaning of SFAS No. 15, Accounting by Debtors
and Creditors for Trouble Debt Restructuring:

                                                At March 31,
                                            -------------------
                                              2009       2008
                                            --------    -------
                                           (Dollars in thousands)

Accruing loans............................. $    500    $    --
Non-accrual loans..........................   84,924     11,608
                                            --------    -------

   Total non-performing loans..............   85,424     11,608
   Total non-performing /net loans.........     7.60%      0.97

Other real estate owned....................   19,227        655
                                            --------    -------
   Total non-performing assets............. $104,651    $12,263
                                            --------    -------
   Total non-performing loans/gross loans..     7.35%      0.96%
   Total non-performing assets/total
    assets.................................     7.13%      0.88%
   Total non-performing assets to total
    capital plus reserves..................    79.28%      8.32%

   Troubled debt restructuring at the end
    of the period.......................... $ 26,383    $    --
                                            ========    =======

     Other Real Estate Owned.   Other real estate owned ("OREO") is carried at
the lesser of book value or market value less selling costs.  The costs
related to maintenance and repair or other costs of such properties, are
generally expensed with any gains or shortfalls from the ultimate sale of OREO
being shown in other noninterest income or expense.

     The following table summarizes changes in the OREO portfolio during the
years ended March 31, 2009 and 2008:

                                          For the Year Ended March 31,
                                              2009        2008
                                            --------     -------

Balance at beginning of period............  $    655     $   725
Additions to other real estate owned......    31,669          --
Valuation adjustments.....................      (539)        (70)
Disposition of other real estate owned....   (12,558)         --
                                            --------     -------
Balance at end of period..................  $ 19,227     $   655
                                            ========     =======

     Investment in Real Estate Joint Venture.  The investment in real estate
for a joint venture as of March 31, 2009 was $18.0 million.  The largest
component of the joint venture was created in year 2005 when Westward
Financial, a 50% partner in GBNW (Greenbriar Northwest LLC), purchased an 85
acre parcel of land in Bellingham, Washington for future development known as
Fairhaven Highlands.  The smaller portion of the joint venture includes some
residual from the net investment in a residential development joint venture
that has been completed and closed. In connection with the joint venture,
there is a $24.4 million liability presented on the Consolidated Statements of
Financial Position,

                                       64

<PAGE>



which represents the corresponding wholesale borrowing obtained from the FHLB
which was used to fund the investment in the Fairhaven Highlands joint
venture.  At this time, the partnership is in the process of meeting with the
appropriate public and private entities in connection with its planning
efforts relating to the future development of the property. Presently, a
Preliminary Draft Environment Impact Statement ("EIS") is being prepared
utilizing consultants hired by the City of Bellingham. According to city
officials, a preliminary draft of the EIS is expected to be published towards
the end of June 2009.  While this project is still in its planning and
pre-permit phase, management continues to believe that this will be a viable
development project in the future. However, no assurances can be made as to
when (or if) this project will be approved for future development.  The joint
venture is exposed to the same risks experienced by any land developer,
including but not necessarily limited to regulatory risks, environmental
risks, adverse response from neighboring property owners, fluctuations in
market values, and the demand for finished lots at such time as the
development might be completed in the future.

     As of March 31, 2009, we conducted a review of the accounting treatment
and measured the value of the GBNW joint real estate development for potential
impairment and whether to continue with capitalizing interest.  We took the
following steps to ensure compliance with generally accepted accounting
principles: (1) performed a recoverability test under SFAS 144 (Accounting for
the Impairment or Disposal of Long-Lived Asset), which was followed by step
(2) evaluated the capitalization of interest in conformity with SFAS 34
(capitalization of interest cost).  The conclusion of the recoverability test
determined that the Fairhaven Highland development was positively accretive,
which then supported the continuation for capitalization of interest during
the development phase of the project.

     Goodwill.   During the fiscal year 2009, we charged-off our $545,000
goodwill asset.  Our approach to measuring the goodwill for impairment has
been conducted on an annual basis at the fiscal year-end on a broad basis at
the consolidated level since it is not identifiable to a "reporting unit."
During most of year 2008, volatility in the stock market and particularly
financial institutions and their holding companies, were a significant
contributing factor causing fluctuations in the Corporation's common stock
during these interim periods.  Management considered this as well as other
factors ("the business climate") in evaluating whether or not goodwill was
impaired.  As part of the process, management considered the "business
climate" as a potential trigger for an interim measurement under SFAS 142, but
deemed the economic environment to be abnormally volatile and irrational to
conclude that an interim assessment of goodwill was required based on stock
volatility alone.  In addition, the goodwill asset reflected an immaterial
amount, which totaled $545,000, representing 0.038% of the Corporation's
assets at June 30, 2008 and September 30, 2008.

     The process behind management's decision not to proceed with an interim
impairment test on June 30, 2008 and September 30, 2008 (at a time when our
carrying value of the equity exceeded the market capitalization of the
Corporation) and to wait until the annual test period at March 31, 2009 was
based on three considerations: (1) Management believed at the time the
volatility in the stock market was an indicator, but it did not provide a
definitive gauge for measuring Horizon's fair value since unprecedented
economic conditions were creating the biggest sell-off in stocks, short sales
were increasing in volume, government intervention was growing and market
liquidity was evaporating from the commercial paper and overnight markets.
These conditions impacted the stock market in ways we could not directly
contribute to the Corporation at the time when the Corporation's local market
was experiencing some economic softening, but not nearly the downturn that was
being experienced in other parts of the United States, (2) Horizon considered,
but did not identify, any "qualifying" events and/or circumstances in
accordance with SFAS 142 that would give rise to an interim measurement and,
(3) The goodwill represented an immaterial amount of Horizon's total assets,
which based on the preceding two points did not lead management to allocate
resources to perform the second step of the impairment test, which is to
allocate the fair value of all the assets and liabilities of the reporting
unit in the same manner as determining goodwill in a business combination.
These three conditions were individually considered and management concluded
that no impairment test was necessary for the quarterly periods ended June 30,
2008 and September 30, 2008.

     Management later identified a qualifying event that indicated the need to
perform an interim test for impairment as of December 31, 2008 based on two
events: (1) the Bank was informed in  December  2008  by the FDIC and DFI that
a  Order would be issued and forthcoming, and (2) the Corporation's decision
to close a branch office that was directly associated with the creation of the
original goodwill asset signaled potential impairment.  The accounting
guidance in SFAS 142 (Goodwill and Other Intangible Assets) led management to
perform the interim impairment test

                                       65

<PAGE>



of the goodwill based on these events meeting the definition for "adverse
action."  The first step of the impairment test was to compare the actual
market capitalization with the carrying value, which supported the need to
proceed with the second step to allocate the measured fair value to each of
the assets and liabilities.  However, after evaluation of the events leading
up to the interim impairment test and consideration of the resources needed
both internally and externally to measure the fair value of the assets and
liabilities, management made the decision to charge-off the entire balance of
goodwill of $545,000 at the quarter ended December 31, 2008 due to its
relative carrying amount in comparison to the total assets of $1.47 billion,
which management deemed to be immaterial.

     Deposits.   Total liabilities also increased 8.8% to $1.4 billion at
March 31, 2009, from $1.3 billion at March 31, 2008.   This increase in
liabilities was primarily the result of growth in deposits, which increased
18.4% to $1.23 billion at March 31, 2009 from $1.04 billion at March 31, 2008
as brokered certificates of deposit ("CDs") were utilized to fund loan growth
and repay borrowed funds from the FHLB.  As the Bank receives funds from other
sources (i.e. its retail deposit base, loan paydowns, sale of loans, etc.),
the Bank will allow the brokered certificates of deposit to mature and runoff.
This strategy is consistent with the Bank's current operating strategy as
required by its regulators to reduce reliance on brokered certificates of
deposit from current levels.

     The following is an analysis of the deposit portfolio by major type of
deposit at March 31, 2009 and 2008:

                                               At March 31,
                                        ------------------------
                                            2009         2008
                                        ----------    ----------
                                              (In thousands)
  Demand Deposits
    Savings............................ $   15,850    $   17,933
    Checking...........................     83,286        72,434
    Checking (noninterest-bearing).....     80,103        70,438
    Money market.......................    133,022       183,063
                                        ----------    ----------
                                           312,261       343,868
                                        ----------    ----------
  Time certificates of deposit
    Less than $100,000.................    352,785       286,657
    Greater than or equal to $100,000..    303,308       287,281
    Brokered certificates of deposit...    261,410       120,986
                                        ----------    ----------
  Total certificates of deposit........    917,503       694,924
                                        ----------    ----------
   Total deposits...................... $1,229,764    $1,038,792
                                        ==========    ==========

     Borrowings.   The Bank has two available borrowing lines of credit that
it uses to provide a source of cash and manage liquidity.  The lines of credit
are with the Federal Home Loan Bank of Seattle and the other is with the
Federal Reserve Bank of San Francisco.  As of March 31, 2009, our borrowing
capacity at the FHLB was $129.5 million and at the FRB it was approximately
$7.0 million.  As of March 31, 2009, we had outstanding at the FHLB a total of
$129.5 million as compared to $192.0 million at March 31, 2008.  We had no FRB
borrowings as of March 31, 2009 and 2008.  During the fiscal year ended March
31, 2009, we reduced our borrowings by increasing retail deposits and brokered
certificates of deposit.

     Stockholders' Equity.   Stockholders' equity at March 31, 2009 decreased
27.5% to $93.0 million from $128.3 million at March 31, 2008.  This decrease
was primarily attributable to a net loss of $33.4 million for the year ended
March 31, 2009.  In March 2008, the Board of Directors approved a new stock
repurchase plan that runs concurrent with the 2009 fiscal year, allowing the
Corporation to repurchase up to 2.5% of total shares outstanding, or
approximately 300,000 shares.  This marked the Corporation's tenth stock
repurchase plan.  The Corporation did not repurchase any shares during the
fourth quarter, or during the year ended March 31, 2009 in connection with its
strategy to preserve and manage capital. The Corporation had a stockholder
equity-to-assets ratio of 6.34% at March 31, 2009, compared to 9.22% at March
31, 2008.

                                       66

<PAGE>



Comparison of Operating Results for the Years Ended March 31, 2009 and March
----------------------------------------------------------------------------
31, 2008
--------

     General.  The Corporation recognized a net loss of $33.4 million for the
year ended March 31, 2009 compared to net income of $18.4 million for the year
ended March 31, 2008.  Diluted loss per share for the year ended March 31,
2009 was $(2.79) on weighted average diluted shares outstanding of 11,945,835,
compared to diluted earnings per share of $1.51 on weighted average diluted
shares of 12,196,783 for the year ended March 31, 2008.

     Net Interest Income. Net interest income before provision for loan loss
of $65.0 million in fiscal 2009 was $38.3 million, a 28.5% decrease from $53.6
million in fiscal 2008.  Total interest income decreased 22.5% in fiscal 2009
to $77.7 million from $100.2 million in fiscal 2008.  Interest income on loans
in fiscal 2009 was $74.0 million, a 23.1% decrease from $96.3 million in
fiscal 2008.  The decrease in fiscal 2009 was a result of a combination of
factors, including 200 basis point reductions in the prime lending rate from
March 2008 to March 2009. Each 25 basis point decline in the prime rate,
equates to a reduction of approximately $1.0 million in interest income on an
annual basis.  Also contributing to this decline was $4.9 million in
non-accrual interest reversals related to the increase in non-accrual loans
during the year ended March 31, 2009 compared to no interest reversals for the
year ended March 31, 2008.

     Also included in interest income for the years ended March 31, 2009 and
2008 were $3.6 million and $5.1 million, respectively, of deferred fee income
recognition.  Most of these fees were related to the Bank's commercial land
development and commercial construction loan portfolios.  Real estate
development loans typically are shorter term in nature so the deferred fee
recognition during the effective life of the loan is greater than what would
be recognized for a comparable loan fee on a longer amortizing term loan.
However, due to current economic conditions, the effective life of these loans
has increased similar to that of longer amortizing loans, therefore
contributing to the decrease in deferred loan fee income.  The table below
presents an analysis of deferred fee recognition for the past two fiscal
years:

                                                       Year Ended March 31,
                                                        -----------------
                                                         2009       2008
                                                        ------     ------
                                                         (In thousands)

Commercial loan deferred fees.........................  $3,023     $4,240
One-to-four real estate mortgage loan deferred fees...     611        854
                                                        ------     ------
    Total.............................................  $3,634     $5,094
                                                        ======     ======

     Interest on investments and mortgage-backed securities decreased 7.8% to
$3.6 million for the year ended March 31, 2009 from $3.9 million for the year
ago period.  Contributing to this decline was a drop in interest income
received from non-agency collateralized mortgage obligations and the
elimination of the Federal Home Loan Bank's cash dividend during the third
quarter of fiscal 2009.  The decline in non-agency collateralized interest
income is as a result of rising delinquency rates and foreclosures within the
mortgages contained in the security.  The drop in interest income from the
non-agency collateralized mortgage obligations occurred during the same period
when management identified an other than temporary impairment of the
securities, which is discussed in the subsequent section under "Noninterest
Income."

     Total interest expense in fiscal 2009 decreased 15.6% to $39.4 million
from $46.6 million in fiscal 2008.  Interest on deposits decreased to $34.6
million in fiscal 2009 from $38.1 million in fiscal 2008, as a result of an
overall lower level of interest rates compared to the previous period.  At
March 31, 2009, approximately 74.6% of the Bank's deposits were in the form of
certificates of deposit, including $261.4 million in brokered certificates of
deposit.  While management continues its efforts to increase core deposits as
a funding source, the competitive marketplace for core deposit dollars has
resulted in limited success in this regard.  The Bank's average cost of
deposits decreased 80 basis points to 3.03% for the year ended March 31, 2009
from 3.83% for the year ended March 31, 2008.

     Interest on borrowings decreased to $4.7 million in fiscal 2009 from $8.6
million in fiscal 2008. The decrease in interest expense in the year was a
result of a lower average balance of borrowings outstanding during the twelve
months ended March 31, 2009 of $175.1 million compared to $193.3 million
during the year ended March 31, 2008, as

                                       67

<PAGE>



well as lower interest rates during the current period.  The Bank's average
cost of funds decreased 94 basis points to 2.99% for the year ended March 31,
2009 from 3.93% for the year ended March 31, 2008.

     The effect of the changes in the interest-earning asset yield and
interest-bearing liability costs have reduced the net interest margin from
4.37% for the year ended at March 31, 2008 to 2.86% for the year ended March
31, 2009.  The most significant factor to the decline in the net interest
margin occurred from the drop in loan yields as a result of variably priced
loans tied to the Prime rate re-pricing lower and the reversal of interest
income from the increase in non-accruing loans.  Management believes that
these pressures on loan yields will likely result in a continued gradual
downward trending of its net interest margin in the near future.

     Provision for Loan Losses. The provision for loan losses represents an
expense against current period income that allows the Corporation to establish
an appropriate allowance for loan losses. Charges to the provision for loan
losses result from our ongoing analysis of probable losses in the Bank's loan
portfolio. For the year ended March 31, 2009 the provision for loan losses was
$65.0 million, compared to $4.1 million for the year ended March 31, 2008
primarily due to deteriorating credit quality indicators in the commercial
construction and land development loan portfolio. Risks contributing to this
increase in provision are discussed in more detail in the section entitled
"Asset Quality - Allowance for Loan Loss."

     Noninterest Income.  Noninterest income in fiscal 2009 decreased to $6.3
million, from $7.0 million in fiscal 2008.  Service fee income decreased 6.2%
to $3.4 million in fiscal 2009 from $3.6 million in fiscal 2008 due in large
part to the decrease in loan origination and related fees.  The Bank
originated $303.1 million in loans during fiscal 2009 compared to $545.8
million in the year ended March 31, 2008.  The net gain on the sale of loans
servicing released decreased 1.8% to $833,000 in fiscal 2009, compared to
$848,000 in fiscal 2008.  The Bank continued its practice of selling most of
its single-family long term fixed rate loan production into the secondary
market.

     There was a net loss on sales of investment securities of $500,000 in
fiscal 2009 compared to a net gain of $480,000 in fiscal 2008 due to
management's decision to sell selected equity securities from the Bank's
investment portfolio as well as the redemption in-kind distribution for its
$5.0 million investment in the AMF family of mutual funds, which occurred due
to the continuing decline in the net asset value as a result of the
unprecedented disruption in the mortgage-backed securities markets.  Also
contributing to the loss in fiscal 2009 was an impairment loss of $309,000,
which was the difference between the fair value and carrying value and it was
deemed permanent based on our methodology for measuring OTTI.  The impairment
loss resulted from the Bank recognizing an OTTI on selected non-agency
collateralized mortgage obligation securities.  We analyze our investment
securities for OTTI based on: (1) the investment rating of the security, (2)
the probability that we will collect all amounts due on the security, (3)
whether the fair value of the security is significantly below its carrying
value and (4) whether the economic environment is not likely to improve the
borrower's ability to repay the debt.

     Other noninterest income increased 35.7% to $2.6 million for the year
ended March 31, 2009 from $1.9 million for the year ended March 31, 2008.  The
primary reason for the increase from the prior period was additional income
related to a death benefit realized from the settlement of a bank-owned life
insurance policy of $767,000.

     Noninterest Expense.  Noninterest expense in fiscal 2009 increased to
$33.6 million, a 15.0% increase from $29.2 million in fiscal 2008.
Compensation and employee benefits increased slightly in fiscal 2009 to $16.8
million from $16.6 million in fiscal 2008.  Building occupancy expense
remained almost unchanged from fiscal 2008 at $4.7 million.

     Other real estate owned/collection expense increased to $2.6 million for
the fiscal year ended March 31, 2009 from $162,000 for the year ended March
31, 2008 as a result of increased legal, appraisal, collection and related
expenses pertaining to delinquent and non-performing assets.  FDIC insurance
premiums increased to $793,000 for the year ended March 31, 2009 from $113,000
in fiscal 2008.  The Federal Deposit Insurance Reform Act of 2005 provided
banks with a one-time assessment credit to be used against future premiums.
For the Bank, that amounted to a credit of approximately $649,000.  This
credit was utilized beginning April 1, 2007 and was fully depleted at June 30,
2008, accounting for the difference between these periods.  We currently
anticipate that our FDIC premiums will increase as a result of: (1) the Bank
is no longer considered to be "well capitalized" for regulatory capital
purposes, (2) our higher

                                       68

<PAGE>



risk profile based on the recent FDIC examination and (3) future special
assessments by the FDIC.  Other noninterest expense increased 12.1% to $6.5
million for the year ended March 31, 2009 compared to $5.8 million for the
year ended March 31, 2008.  During the third quarter of fiscal 2009 the Bank
charged off the entire balance of goodwill of $545,000.  Management performed
a valuation analysis as a result of the Corporation's market capitalization
being less than its stockholder's equity at December 31, 2008.  The valuation
analysis compared the implied fair value of the goodwill with the carrying
amount of the goodwill on the balance sheet.  The conclusion of the valuation
analysis was that the carrying value of the goodwill was impaired.  In
addition, during fiscal 2009 the Bank recognized $800,000 expense related to
the reserve for unfunded loan commitments.

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

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

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

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

                                                       Year Ended March 31,
                                                       --------------------
                                                         2008        2007
                                                       --------    --------
                                                          (In thousands)

Commercial loan deferred fees.........................  $4,240      $4,076
One-to-four real estate mortgage loan deferred fees...     854         684
                                                        ------      ------
    Total.............................................  $5,094      $4,760
                                                        ======      ======

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

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

     Interest on borrowings increased to $8.6 million in fiscal 2008 from $7.9
million in fiscal 2007. The increase was a result of a higher level of average
borrowings outstanding during the year ended March 31, 2008 of $193.3 million
compared to $166.3 million during the year ended March 31, 2007.

     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

                                       69

<PAGE>



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

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

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

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

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

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

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

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

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

                                       70

<PAGE>



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

     Other noninterest expenses increased 7.9% to $5.8 million in fiscal 2008
from $5.4 million in fiscal 2007 as a result of increased operating expenses
related to the opening of the Bank's Puyallup retail office and loan center,
consulting expenses, increased State of Washington Business & Occupation tax
as a result of the growth in the loan portfolio of taxable commercial loans,
as well as a valuation write-down of the Bank's other real estate owned of
$70,000.

                                       71

<PAGE>


<TABLE>

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

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

                    At                                    Year Ended March 31,
                 March 31,    ------------------------------------------------------------------------------
                   2009                 2009                      2008                       2007
                  -------     -------------------------  ------------------------   ------------------------
                                                Average                   Average                    Average
                   Actual     Average            Yield/  Average           Yield/   Average           Yield/
                  Balance     Balance   Interest   Cost  Balance  Interest   Cost   Balance  Interest   Cost
                  -------     -------   -------- ------  -------  -------- ------   -------  -------- ------
                                                       (Dollars in thousands)

               <c>         <c>        <c>      <c>   <c>        <c>      <c>     <c>       <c>      <c>
Interest-earning
 assets:
 Loans
  receivable (1)..$1,123,660 $1,221,081  $74,049  6.06% $1,137,051 $ 96,320  8.47% $1,017,460 $88,589  8.71%
 Investment
  securities (2)..   161,489     79,979    1,583  1.98      56,470    2,259  4.00      64,805   2,678  4.13
 Mortgage-backed
  securities......    38,790     39,072    2,033  5.20      32,854    1,664  5.06      27,150   1,333  4.91
                  ---------- ----------  -------  ----  ----------  -------  ----  ---------- -------  ----
  Total interest-
   earning
   assets......... 1,323,939  1,340,132   77,665  5.79   1,226,375  100,243  8.17   1,109,415  92,600  8.35

Interest-bearing
 liabilities:
 Deposits......... 1,229,764  1,140,659   34,606  3.03     992,667   38,072  3.83     905,383  32,251  3.56
 Borrowings.......   138,788    175,111    4,748  2.71     193,272    8,573  4.44     166,276   7,882  4.74
                  ---------- ----------  -------  ----  ----------  -------  ----  ---------- -------  ----
  Total interest-
   bearing
   liabilities.... 1,368,552  1,315,770   39,354  2.99   1,185,939   46,645  3.93   1,071,659  40,133  3.74
                                         -------                    -------                   -------

Net interest
 income...........                       $38,311                    $53,598                   $52,467
                                         =======                    =======                   =======

Interest rate
 spread...........                                2.80%                      4.24%                     4.60%
                                                  ====                       ====                      ====

Net interest
 margin...........                          2.86%                      4.37%                     4.73%
                                            ====                       ====                      ====

Ratio of average
 interest-earning
 assets to average
 interest-bearing
 liabilities......               101.85%                    103.39%                    103.46%
                                 ======                     ======                     ======

-------------------
(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.


                                                     72

</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,
                               -------------------------------------------------------------------------
                                         2009 vs. 2008                          2008 vs. 2007
                               ------------------------------------   ----------------------------------
                                      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.. $7,118  $(27,367)  $(2,022)  $(22,271)  $10,413  $(2,399)  $(283)  $7,731
 Investment securities and
  other interest-bearing
  securities.................  1,306    (1,210)     (403)      (307)     (115)      27      --      (88)
                              ------  --------   -------   --------   -------  -------  ------   ------

 Total interest income....... $8,424  $(28,577)  $(2,425)  $(22,578)  $10,298  $(2,372) $ (283)  $7,643
                              ======  ========   =======   ========   =======  =======  ======   ======

Interest expense:
 Deposit accounts............ $5,667  $ (7,950)  $(1,183)  $ (3,466)  $ 3,090  $ 2,493  $  239   $5,822
 Borrowings..................   (806)   (3,332)      313     (3,825)    1,280     (508)    (82)     690
                              ------  --------   -------   --------   -------  -------  ------   ------

 Total interest expense...... $4,861  $(11,282)  $  (870)  $ (7,291)  $ 4,370  $ 1,985  $  157   $6,512
                              ======  ========   =======   ========   =======  =======  ======   ======

</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, 2009, the Bank had liquid assets
(cash and marketable securities with maturities of one year or less) with a
book value of $146.1 million.

     As of March 31, 2009, the total amortized cost of investments and
mortgage-backed securities was $64.7 million compared to a market value of
$66.9 million with a net unrealized gain of $2.2 million.  As of March 31,
2008, the total amortized cost of investments and mortgage-backed securities
was $77.4 million, compared to a market value of $80.4 million with a net
unrealized gain of $3.0 million.  The primary reasons for this change relate
to an in-kind distribution redemption for its $5.0 million investment in the
AMF family of mutual funds, the measurement of an OTTI on selected non-agency
collateralized mortgage obligation securities, as well as declining values in
the Corporation's portfolio of equities, which are heavily concentrated in the
financial sector.

     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. Retail deposits are our primary source of liquidity.  At March 31,
2009, we had $1.2 billion of deposits and $261.4 million or 21.3% of our total
deposits were in brokered certificates of deposit.  The Bank, however, is
operating under the Cease and Desist Order and as a result is not permitted to
accept or renew brokered deposits and is limited on the pricing of deposits to
75 basis points above the market average.  As a result, we are restricted in
our liquidity options.

     In addition to deposits, we have a borrowing line with the FHLB of
Seattle but no additional amounts may be borrowed under that line as of March
31, 2009.  We also have the ability to borrow up to $7 million from the
discount

                                       73

<PAGE>



window at Federal Reserve Bank of San Francisco and additional amounts through
the use of reverse repurchase agreements.

     A secondary source of liquidity is from the sale of loans or other assets
but the prices for these assets is often below the carrying value of the
asset.  Consequently, even though we may increase liquidity by the sale of the
asset we would recognize a loss and further reduce our capital if we were to
sell assets at below their carrying value.

     In addition to the foregoing our liquidity risk is further increased by
the Order which increases our reputation risk and may erode customer
confidence and thereby result in a further loss of liquidity.

     Stockholders' equity as of March 31, 2009 was $93.0 million, or 6.3% of
assets, compared to $128.3 million, or 9.2% of assets at March 31, 2008.  The
Bank continues to exceed the 5.0% minimum Tier 1 capital required by the FDIC
in order to be considered well-capitalized.  However, pursuant to the
Stipulation and Consent to the Issuance of an Order to Cease and  Desist
issued by the FDIC and DFI, Horizon Bank has been required to increase its
Tier 1 capital to 10% of total assets. The Bank's total risk-adjusted capital
ratio as of March 31, 2009 was 8.58%, compared to 11% as of March 31, 2008.
These figures are less than the well-capitalized minimum of 10% set by the
FDIC. The Corporation is adequately capitalized on all measures established
under the regulatory guidelines.

     We currently have a number of risks to our capital position, including
but not limited to the following:

     *   we may have further losses from the sale of our assets in order to
         satisfy the Order to decrease our substandard loans and maintain
         sufficient liquidity;

     *   we may have increase provisions for loan losses because of the
         continued decline in the ability of our borrowers to meet their
         contractual obligations coupled with the continued decline in the
         value of the collateral securing their loans;

     *   there may be a continued decline in our revenue as a result of the
         increases in our nonaccrual loans;

     *   there is risk that we will not be able to sufficiently reduce our
         expenses to restore us to profitability;

     *   it is not known whether investors will be willing to invest
         additional equity capital in the Corporation that is needed to enable
         us to meet the capital requirements contained in the Order; and

     *   there may be further increases in FDIC insurance premiums and if this
         occurs it may place additional pressure on our earnings.

     The Corporation has conducted various buy-back programs since August
1996. In March 2008, the Board of Directors approved a new stock repurchase
plan that runs concurrent with the 2009 fiscal year, allowing the Corporation
to repurchase up to 2.5% of total shares outstanding, or approximately 300,000
shares.  This marked the Corporation's tenth stock repurchase plan.  The
Corporation did not repurchase any shares during the fourth quarter, or during
the year ended March 31, 2009 in connection with its strategy to preserve and
manage capital and the Board elected to not renew the stock repurchase plan
for fiscal year 2010.  The Board elected not to renew the stock repurchase
plan for the fiscal year 2010.

     When the Corporation is repurchasing shares, the number of shares of
stock to be repurchased and the price to be paid is the result of many
factors, several of which are outside of the control of the Corporation. The
primary factors, however, are market and economic factors such as the price at
which the stock is trading in the market; the number of shares available in
the market; the attractiveness of other investment alternatives in terms of
the rate of return and risk

                                       74

<PAGE>



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.

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

     The Corporation continues to be exposed to interest rate risk.
Currently, the Corporation's assets and liabilities are not materially exposed
to foreign currency or commodity price risk.  At March 31, 2009, the
Corporation had no off-balance sheet derivative financial instruments, nor did
it have a trading portfolio of investments.

     In fiscal 2009 and fiscal 2008, the Corporation continued to outsource
its interest rate risk modeling to a third party provider that utilizes an IPS
Sendero model.  This model analyzes the Corporation's major balance sheet
components, and attempts to estimate the changes to the Corporation's income
statement and economic value of equity, under a variety of interest rate
change scenarios.  The figures contained in the table presented under Item 7A
of this Form 10-K below, in the Quantitative Disclosures About Market Risk
section, were derived from this model.  While numerous assumptions go into
this modeling, and undue reliance should not be placed on the specific
results, management believes that this improved modeling will enhance its
interest rate risk management efforts.

     Similar to the analysis performed one year ago, the current interest rate
risk modeling continues to show the Bank's balance sheet as moderately asset
sensitive over a 12-month time period.  The Bank's continued focus on shorter
term, variable rate assets has contributed to the Bank's structure in this
regard.  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 2009 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, 2009 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, an absence of a
corresponding increase in the Prime lending rate would, of course, negatively
affect performance.  In addition, depending on timing differences, the
magnitude of various rates changing in future periods, and the composition of
the Corporation's balance sheet, future modeling efforts may show the
Corporation's return to a liability sensitive position.  Management continues
to monitor these areas, in its ongoing effort to manage the Corporation's
interest rate risk.

                                       75

<PAGE>



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, 2009:

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

Time deposits.........  $644,474   $261,291  $10,256      $1,482  $   917,503
Long-term borrowings..   115,288     23,500       --          --      138,788
Operating lease
 obligations..........       425        828      267          54        1,574
                        --------   --------  -------      ------   ----------
   Total..............  $760,187   $285,619  $10,523      $1,536   $1,057,865
                        ========   ========  =======      ======   ==========

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

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

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

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

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

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

     The principal effect of inflation on earnings, as distinct from levels of
interest rates, is in the area of noninterest expense.  Expense items such as
employee compensation, employee benefits and occupancy and equipment costs may
be subject to increases as a result of inflation.  An additional effect of
inflation is the possible increase in dollar value of the collateral securing
loans that we have made.  Our management is unable to determine the extent, if
any, to which properties securing loans have appreciated in dollar value as a
result of inflation.

                                       76

<PAGE>



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

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

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

     Quantitative Disclosures About Market Risk.  The table below represents
the balances of the Bank's financial instruments at March 31, 2009.  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                Carrying
                   Average    Within    Year to      Years       Years      Beyond       Value    Fair 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... 6.06%  $  856,196  $  145,873 $   73,609  $   32,734  $   15,248  $1,123,660  $1,190,418
Mortgage-backed
 securities........ 5.20%      17,000       8,027      4,817       4,448       4,498      38,790      38,793
Investments and
 other interest-
 earning assets.... 1.98%     137,290       4,225      4,131       7,427       8,416     161,489     161,489
Total Interest
 Sensitive Assets.. 5.80%   1,010,486     158,125     82,557      44,609      28,162   1,323,939   1,390,700
Cumulative Totals..   --    1,010,486   1,168,611  1,251,168   1,295,777   1,323,939          --          --

Interest-Sensitive
 Liabilities:

Checking accounts.. 0.40%      19,156      30,694     29,583      20,260      63,696     163,389     169,997
Money market
 ultimate
 accounts.......... 1.70%      93,115       9,977      9,977       5,701      14,252     133,022     187,912
Savings accounts... 0.60%       3,170       1,585      1,585       2,717       6,793      15,850      21,628
Certificates of
 deposit........... 3.89%     650,055     190,994     68,543       7,787         124     917,503     677,364
Other borrowings
 (1)............... 2.71%     118,788      20,000         --          --          --     138,788     215,452
Total Interest
 Sensitive
 Liabilities....... 2.99%     884,284     253,250    109,688      36,465      84,865   1,368,552   1,272,353
Cumulative Totals..   --      884,284   1,137,534  1,247,222   1,283,687   1,368,552          --          --

Off-Balance Sheet
 Items:

Commitments to
 extend credit..... 5.27%      77,959          --         --          --          --      77,959      77,959
Unused lines of
 credit............ 4.63%     134,668          --         --          --          --     134,668     134,668
Credit card
 arrangements......12.23%      10,675          --         --          --          --      10,675      10,675
Stand by letters
 of credit.........   --        3,523          --         --          --          --       3,523       3,523
                           ----------  ---------- ----------  ----------  ----------  ----------  ----------
Total Off-Balance
 Sheet Items.......        $  226,825  $       -- $       --  $       --  $       --  $  226,825 $   226,825
                           ==========  ========== ==========  ==========  ==========  ==========  ==========
-----------
(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

                                       77

<PAGE>



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
----------------------------------------------------
                                                                        Page
(a)  (1)  Financial Statements.                                         ----
          Management's Annual Report on Internal Control Over
           Financial Reporting                                           79
          Report of Independent Registered Public Accounting Firm        80
          Consolidated Statement of Financial Position as of
           March 31, 2009 and 2008                                       82
          Consolidated Statement of Operations for the Years Ended
           March 31, 2009, 2008 and 2007                                 83
          Consolidated Statement of Stockholders' Equity and
           Comprehensive Income (Loss) for the Years Ended
           March 31, 2009, 2008 and 2007                                 84
          Consolidated Statement of Cash Flows for the Years Ended
           March 31, 2009, 2008 and 2007                                 85
          Notes to Consolidated Financial Statements                     87

                                       78

<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 subsidiary ("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, 2009. 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, 2009 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, 2009.

Dated June 10, 2009

                                       79

<PAGE>




             Report of Independent Registered Public Accounting Firm

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

We have audited the accompanying consolidated statements of financial position
of Horizon Financial Corp. & Subsidiary (the "Company") as of March 31, 2009
and 2008, and the related consolidated statements of operations, stockholders'
equity and comprehensive income (loss), and cash flows for each of the years
in the three-year period ended March 31, 2009. We also have audited the
Company's internal control over financial reporting as of March 31, 2009,
based on criteria established in Internal Control -- Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
("COSO"). The Company's management is responsible for these financial
statements, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control
over financial reporting included in the accompanying Management Report on
Internal Controls over Financial Reporting.  Our responsibility is to express
an opinion on these financial statements, and an opinion on the effectiveness
of the Company's internal control over financial reporting based on our
audits.

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

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


                                    80

<PAGE>



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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Horizon Financial Corp. & Subsidiary as of March 31, 2009 and 2008, and the
results of their operations and cash flows for each of the years in the
three-year period ended March 31, 2009, in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, Horizon Financial Corp. & Subsidiary maintained, in all material
respects, effective internal control over financial reporting as of March 31,
2009, 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 10, 2009

                                    81

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                  CONSOLIDATED STATEMENT OF FINANCIAL POSITION
                                                       MARCH 31, 2009 AND 2008
------------------------------------------------------------------------------
                                      ASSETS
                                                            In Thousands
                                                      -----------------------
                                                         2009        2008
                                                      ----------   ----------
Cash and cash equivalents                             $   17,881   $   22,412
Interest-bearing deposits                                126,159        2,912
Investment securities
   Available-for-sale (amortized cost 2009: $27,127;
     2008: $38,676)                                       28,083       41,241
Mortgage-backed securities
   Available-for-sale (amortized cost 2009: $37,563;
     2008: $38,646)                                       38,782       39,100
   Held-to-maturity (estimated fair value 2009: $11;
     2008: $35)                                                8           30
Federal Home Loan Bank ("FHLB") Stock                      7,247        8,867
Loans held for sale                                        4,745        2,644
Loans receivable, net of allowance for loan losses of
  $38,981 in 2009 and $19,114 in 2008                  1,123,660    1,191,478
Investment in real estate joint venture                   17,985       17,567
Accrued interest and dividends receivable                  6,629        7,916
Premises and equipment, net                               26,195       27,778
Net deferred income tax assets                            15,164        6,253
Income tax receivable                                     12,442           --
Real estate owned                                         19,227          655
Other assets                                              23,764       23,325
                                                      ----------   ----------
TOTAL ASSETS                                          $1,467,971   $1,392,178
                                                      ==========   ==========

                         LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits                                              $1,229,764   $1,038,792
Accrued interest payable and other liabilities             4,093        5,746
Other borrowed funds                                     114,348      192,343
Borrowing related to investment in real estate
  joint venture                                           24,440       22,448
Advances by borrowers for taxes and insurance                377          414
Income tax payable                                            --        2,174
Deferred compensation                                      1,923        1,944
                                                      ----------   ----------
       Total liabilities                               1,374,945    1,263,861
                                                      ----------   ----------
COMMITMENTS AND CONTINGENCIES (Notes 14 and 17)

STOCKHOLDERS' EQUITY
  Serial preferred stock, $1 par value, 10,000,000
    shares authorized; none issued or outstanding
  Common stock, $1 par value, 30,000,000 shares
    authorized; 11,980,796 and 11,892,208 issued
    and outstanding, respectively                         11,981       11,892
  Additional paid-in capital                              51,298       50,597
  Retained earnings                                       28,333       63,906
  Accumulated other comprehensive income                   1,414        1,922
                                                      ----------   ----------
       Total stockholders' equity                         93,026      128,317
                                                      ----------   ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY            $1,467,971   $1,392,178
                                                      ==========   ==========

        See accompanying notes to these consolidated financial statements.

                                    82
<PAGE>

                                                       HORIZON FINANCIAL CORP.
                                          CONSOLIDATED STATEMENT OF OPERATIONS
                                     YEARS ENDED MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

                                                Dollars in Thousands
                                      (except for number of per share amounts)
                                       ---------------------------------------
                                              2009        2008       2007
                                            --------    --------   --------
INTEREST INCOME
  Interest and fees on loans                $ 74,049    $ 96,320   $ 88,589
  Investment securities
    Taxable interest                           2,992       3,279      3,492
    Nontaxable interest income                   506         479        293
    Dividends                                    118         165        226
                                            --------    --------   --------
      Total interest income                   77,665     100,243     92,600
                                            --------    --------   --------

INTEREST EXPENSE
  Interest on deposits                        34,606      38,073     32,251
  Interest on other borrowings                 4,748       8,572      7,882
                                            --------    --------   --------
      Total interest expense                  39,354      46,645     40,133
                                            --------    --------   --------
      Net interest income                     38,311      53,598     52,467

PROVISION FOR LOAN LOSSES                     65,000       4,100      1,850
                                            --------    --------   --------
      Net interest income (loss) after
        provision for loan losses            (26,689)     49,498     50,617
                                            --------    --------   --------

NONINTEREST INCOME
  Service fees                                 3,379       3,601      3,274
  Net gain on sales of loans - servicing
    retained                                       6         176         23
  Net gain on sales of loans - servicing
    released                                     833         848        827
  Net gain (loss) on sale of investment
    securities                                  (191)        480        (10)
  Other than temporary impairment on
   investment securities                        (309)         --         --
  Other                                        2,631       1,939      1,724
                                            --------    --------   --------
      Total noninterest income                 6,349       7,044      5,838
                                            --------    --------   --------

NONINTEREST EXPENSE
  Compensation and employee benefits          16,804      16,595     16,328
  Building occupancy                           4,711       4,698      4,280
  Real estate owned/collection expense         2,578         162        118
  FDIC insurance                                 793         113        109
  Data processing                                975         957        862
  Advertising                                    601         812        751
  Goodwill impairment                            545          --         --
  Other expenses                               6,548       5,843      5,413
                                            --------    --------   --------
      Total noninterest expense               33,555      29,180     27,861
                                            --------    --------   --------

INCOME (LOSS) BEFORE PROVISION
(BENEFIT) FOR INCOME TAX                     (53,895)     27,362     28,594

PROVISION FOR INCOME TAX (BENEFIT)
  Current                                    (11,954)     10,704     11,058
  Deferred                                    (8,575)     (1,755)    (1,492)
                                            --------    --------   --------
      Total provision (benefit) for
        income tax                           (20,529)      8,949      9,566
                                            --------    --------   --------
NET INCOME (LOSS)                           $(33,366)   $ 18,413   $ 19,028
                                            ========    ========   ========

BASIC EARNINGS (LOSS) PER SHARE               $(2.79)      $1.52      $1.55
                                              ======       =====      =====
DILUTED EARNINGS (LOSS) PER SHARE             $(2.79)      $1.51      $1.53
                                              ======       =====      =====

       See accompanying notes to these consolidated financial statements.

                                    83
<PAGE>



<TABLE>

                                                                                     HORIZON FINANCIAL CORP.
                              CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
                                                                   YEARS ENDED MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------------------------------------

                                               (In thousands, except number of shares)
                           ---------------------------------------------------------------------------------
                                                                      Accumu-
                                                                      lated
                                                                      Other                         Total
                                Common Stock                          Compre-                      Compre-
                           -------------------  Additional            hensive  Treasury  Stock-    hensive
                           Number of   At Par    Paid-In   Retained   Income    Stock    holders'  Income
                            Shares     Value     Capital   Earnings   (Loss)   at cost   Equity    (Loss)
                           ---------  --------  ---------  --------  --------  -------   -------   -------

                        <c>        <c>       <c>        <c>       <c>       <c>       <c>       <c>
BALANCE, March 31, 2006       9,898   $ 9,898    $54,116   $ 45,991   $3,318    $   --   $113,323
Comprehensive income
 Net income                      --        --         --     19,028       --        --     19,028  $ 19,028
 Other comprehensive income
  Change in unrealized gains
   on available-for-sale
   securities, net of tax
   expense of $13                --        --         --         --       24        --         24        24
                                                                                                   --------
    Total other comprehensive
     income                                                                                              24
                                                                                                   --------
 Comprehensive income                                                                              $ 19,052
                                                                                                   ========
Cash dividends on common stock
 at $.495 per share              --        --         --     (6,074)      --        --     (6,074)
5 for 4 stock split in the
 form of a 25% stock
 dividend                     2,453     2,453     (2,453)        --       --        --         --
Cash paid in lieu of
 fractional shares               --        --         --        (10)      --        --        (10)
Stock options exercised          22        22        137         --       --        --        159
Stock award plan                  3         3        289         --       --        --        292
Tax benefit associated with
 stock options                   --        --         55         --       --        --         55
Treasury stock purchased         --        --         --         --       --    (2,942)    (2,942)
Retirement of treasury stock   (122)     (122)      (655)    (2,165)      --     2,942         --
                             ------   -------    -------    -------   ------    ------    -------

BALANCE, March 31, 2007      12,254    12,254     51,489     56,770    3,342        --    123,855
                             ------   -------    -------    -------   ------    ------    -------
Comprehensive income
 Net income                      --        --         --     18,413       --        --     18,413  $ 18,413
  Other comprehensive income
   Change in unrealized gains
    on available-for-sale
    securities, net tax
    benefit of $764              --        --         --         --   (1,420)        -     (1,420)   (1,420)
                                                                                                   --------
    Total other comprehensive
     income                                                                                          (1,420)
                                                                                                   --------
 Comprehensive income                                                                              $ 16,993
                                                                                                   ========
Cash dividends on common stock
 at $.53 per share               --        --         --     (6,385)      --        --     (6,385)
Stock options exercised          28        28        166         --       --        --        194
Stock award plan                  9         9        669         --       --        --        678
Tax benefit associated with
 stock options                   --        --         44         --       --        --         44
Treasury stock purchased         --        --         --         --       --    (7,062)    (7,062)
Retirement of treasury stock   (399)     (399)    (1,771)    (4,892)      --     7,062         --
                             ------   -------    -------    -------   ------    ------    -------
BALANCE, March 31, 2008      11,892    11,892     50,597     63,906    1,922        --    128,317
                             ------   -------    -------    -------   ------    ------    -------
Comprehensive loss
 Net loss                        --        --         --    (33,366)      --        --    (33,366) $(33,366)
  Other comprehensive income
   (loss)
   Reclassification for net
    losses and OTTI realized
    in income, net of tax
    expense of $174              --        --         --         --      326        --        326       326
   Change in unrealized losses
    on available-for-sale
    securities, net tax benefit
    of $449                      --        --         --         --     (834)       --       (834)     (834)
                                                                                                    -------
    Total other comprehensive
     loss                                                                                              (508)
                                                                                                    -------
 Comprehensive loss                                                                                $(33,874)
                                                                                                   ========
Cash dividends on common stock
 at $.185 per share              --        --         --     (2,207)      --        --     (2,207)
Stock options exercised          20        20        114         --       --        --        134
Dividend reinvestment plan       45        45        265         --       --        --         --
Stock award plan                 24        24        318         --       --        --        342
Tax benefit associated with
 stock options                   --        --          4         --       --        --          4
                             ------   -------    -------    -------   ------    ------    -------
BALANCE, March 31, 2009      11,981   $11,981    $51,298    $28,333   $1,414    $   --    $93,026
                             ======   =======    =======    =======   ======    ======    =======

               See accompanying notes to these consolidated financial statements.

                                                   84

</TABLE>
<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                          CONSOLIDATED STATEMENT OF CASH FLOWS
                                     YEARS ENDED MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

                Increase (Decrease) in Cash and Cash Equivalents

                                                       In Thousands
                                             --------------------------------
                                                2009        2008       2007
                                             ---------   ---------  ---------
CASH FLOWS FROM OPERATING ACTIVITIES
  Net income (loss)                          $ (33,366)  $  18,413  $  19,028
Adjustments to reconcile net income (loss)
to net cash provided by operating activities
  Depreciation                                   2,123       2,102      1,878
  Amortization and deferrals, net                1,449         597        212
  Provision for loan losses                     65,000       4,100      1,850
  Provision for loss   real estate owned           539          70        110
  Loss on sale of real estate owned                445          --         --
  Goodwill impairment                              545          --         --
  Net gain on sale of mortgage loans
   held-for-sale                                  (833)       (848)      (827)
  Proceeds from sales of mortgage loans
   held-for-sale                                68,448      76,976     75,649
  Origination of mortgage loans held-for-sale  (69,716)    (74,279)   (74,063)
  Net (gain)/loss on sale of investment
   securities                                      191        (480)        10
  Other-than-temporary impairment on investment
   securities available for sale                   309          --         --
  Stock award plan compensation                    342         678        292
  Excess tax benefits from the exercise of
   stock options                                    (4)        (44)       (55)
  Provision for deferred income tax             (8,575)     (1,755)    (1,492)
Changes in assets and liabilities
  Interest and dividends receivable              1,287      (1,290)    (1,441)
  Interest payable                                 324      (1,885)     1,448
  Federal income tax (receivable) payable      (14,616)      1,937      1,045
  Other assets                                    (979)       (795)    (5,701)
  Other liabilities                               (430)     (2,067)     1,168
                                             ---------   ---------  ---------
    Net cash flows from operating activities    12,483      21,430     19,111
                                             ---------   ---------  ---------

CASH FLOWS FROM INVESTING ACTIVITIES
  Investment in interest-bearing deposits,
   net                                        (123,247)      2,467      4,060
  Purchases of investment securities -
   available-for-sale                           (6,125)    (16,065)    (3,395)
  Proceeds from sales and maturities of
   investment securities - available-for-sale   14,204      25,064     10,482
  Purchases of mortgage-backed securities -
   available-for-sale                           (2,728)    (20,177)   (18,319)
  Proceeds from sales and maturities of
   mortgage-backed securities -
   available-for-sale                            6,780       7,751     15,658
  Proceeds from maturities of mortgage-backed
   securities - held-to-maturity                    21         488        334
  Purchase of FHLB stock                         1,620      (1,620)        --
  Net change in loans                          (22,798)   (141,305)  (139,257)
  Purchases of bank premises and equipment        (540)     (2,249)    (3,192)
  Proceeds from the sale of other real estate
   owned                                         4,612          --         --
  Net change in investment in joint venture       (418)       (398)      (241)
                                             ---------   ---------  ---------
    Net cash flows from investing activities $(128,619)  $(146,044) $(133,870)
                                             ---------   ---------  ---------

        See accompanying notes to these consolidated financial statements.

                                    85

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                              CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
                                     YEARS ENDED MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

                                                         In Thousands
                                             --------------------------------
                                                2009        2008       2007
                                             ---------   ---------  ---------
CASH FLOWS FROM FINANCING ACTIVITIES
  Net change in deposits                     $ 190,972   $  63,497  $ 140,996
  Advances of other borrowed funds             191,008     738,628    369,654
  Repayments of other borrowed funds          (269,003)   (685,000)  (372,500)
  Borrowing related to investment in real
   estate joint venture                          1,992       2,205      1,967
  Common stock issued                              134         194        149
  Tax benefit associated with stock options          4          44         55
  Cash dividends paid                           (3,502)     (6,313)    (5,977)
  Treasury stock purchased                          --      (7,062)    (2,942)
                                             ---------   ---------  ---------
    Net cash flows from financing activities   111,605     106,193    131,402
                                             ---------   ---------  ---------

NET CHANGE IN CASH AND CASH EQUIVALENTS         (4,531)    (18,421)    16,643

CASH AND CASH EQUIVALENTS, beginning of year    22,412      40,833     24,190
                                             ---------   ---------  ---------

CASH AND CASH EQUIVALENTS, end of year       $  17,881   $  22,412  $  40,833
                                             =========   =========  =========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
  Cash paid during the year for interest     $  39,030   $  48,529  $  38,684
                                             =========   =========  =========
  Cash paid during the year for income tax   $   4,100   $   8,717  $   9,949
                                             =========   =========  =========

NONCASH INVESTING AND FINANCING TRANSACTIONS
  Property taken in settlement of loans      $  31,669   $      --  $     835
                                             =========   =========  =========
  Bank financed sale of other real estate
   owned                                     $   7,502   $      --  $      --
                                             =========   =========  =========
  In-kind distribution of mutual funds       $   3,278   $      --  $      --
                                             =========   =========  =========

      See accompanying notes to these consolidated financial statements.

                                    86

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies

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

Regulatory Matters - On February 26, 2009, the Bank entered into a Stipulation
and Consent to the Issuance of an Order to Cease and Desist ("Order") with the
FDIC and the Washington State Department of Financial Institutions ("DFI").
The Order was effective March 3, 2009.

The Order is a result of a regulatory examination conducted by the FDIC in
September 2008. Under the terms of the Order, the Bank cannot declare
dividends without the prior written approval of the FDIC and the DFI. Other
material provisions of the Order require the Bank to:

     *     Strengthen the Bank's board of directors' oversight of management
           and operations of the Bank;
     *     Increase and subsequently maintain specified capital levels;
     *     Enhance its practices and written policies for determining the
           adequacy of the allowance for loan and lease losses;
     *     Eliminate loans classified as "Loss" and "Doubtful" at its
           regulatory examination, and reduce the loans classified as
           "Substandard" as a percent of capital;
     *     Not extend additional credit to borrowers whose loan had been
           classified as "Loss" and is uncollected;
     *     Develop a plan to reduce delinquent loans;
     *     Develop a plan to reduce the amount of construction and land
           development loans;
     *     Develop a three year strategic plan outlining specific goals for
           loans, investments and deposits, acceptable to the FDIC;
     *     Enhance its written funds management and liquidity policy;
     *     Not increase brokered deposits and develop a plan to reduce
           brokered deposits; and
     *     Prepare and submit progress reports to the FDIC and the DFI.

The Bank has implemented a comprehensive plan to achieve full compliance with
the Order. No monetary penalties were imposed or recommended by the FDIC or
DFI in connection with the Order. The Order will remain in effect until
modified or terminated by the FDIC and the DFI.

In connection with the FDIC order, the Federal Reserve Bank of San Francisco
("FRB") has notified the Company that neither the Company nor the Bank may
appoint any new director or senior executive officer or change the
responsibilities of any current senior executive officers without notifying
the FRB. In addition, neither the Company nor the Bank may make
indemnification and severance payments without complying with certain
statutory restrictions including prior written approval by the FRB and
concurrence from the FDIC.

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

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

                                    87

<PAGE>


                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies (Continued)

Principles of Consolidation - As of March 31, 2009, 2008 and 2007, and for the
years then ended, the consolidated financial statements include the accounts
of the Company, and its wholly-owned subsidiary, the Bank. Westward Financial
Services, Inc. ("Westward"), a land development company, is a wholly-owned
subsidiary of the Bank, and its accounts are also included in the
consolidation. All material inter-company balances and transactions have been
eliminated.

In October 2004, the Bank's wholly-owned subsidiary, Westward, entered into a
real estate development joint venture in Greenbriar Northwest LLC ("GBNW"), an
established residential land development company headquartered in Bellingham,
Washington. The Company believes that GBNW is a variable interest entity.
Under the Financial Accounting Standards Board ("FASB") Interpretation No.
("FIN") 46R, GBNW is consolidated in the accompanying financial statements.
The Company accounts for the unowned portion of the joint venture's real
estate as a minority interest. The minority interest is recognized within
other liabilities. The assets of the real estate joint venture have a carrying
value at March 31, 2009 of approximately $18.0 million, with a related
borrowing of approximately $24.4 million.

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

Included in cash and cash equivalents are legally reserved amounts which are
required to be maintained on an average basis in the form of cash and balances
due from the Federal Reserve Bank of San Francisco ("FRB") and other banks.
Reserve requirements were $500,000 for the years ended March 31, 2009 and
2008.

The Company maintains cash balances at several banks. Accounts at each
institution are insured by the FDIC up to applicable limits.

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

Investments and Mortgage-Backed Securities - The Company classifies its
securities into one of three categories:  (1) held-to-maturity, (2)
available-for-sale, or (3) trading. The Company had no trading securities at
March 31, 2009 and 2008. Investment securities are categorized as
held-to-maturity when the Company 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.

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

Declines in the fair value of individual held-to-maturity and
available-for-sale securities below their cost that are other than temporary
are recognized by write-downs of the individual securities to their fair
value. Such write-downs would be included in earnings as realized losses. In
estimating other-than-temporary impairment losses, management considers (1)
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.

                                    88

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies (Continued)

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. In
January 2009, the FHLB announced it suspended excess FHLB stock redemptions
and dividend payments. As a result of the FHLB's announcement, the Company
evaluated the carrying value of its FHLB stock investment at March 31, 2009
for impairment. Based on the FHLB's most recent publicly available financial
results, its capital position and its bond ratings, the Company concluded such
investment was not impaired at March 31, 2009.

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

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

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

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

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

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

The majority of the Company's loan portfolio consists of commercial loans and
single-family residential loans secured by real estate in the Whatcom, Skagit,
Snohomish, King and Pierce Counties of Washington. Regional economic
conditions have deteriorated and future events affecting borrowers and
collateral cannot be predicted with certainty. Available housing inventory
levels have increased and real estate prices in these markets are decreasing
at this time. The ultimate collectibility of a substantial portion of the
Company's loan portfolio is susceptible to local market conditions.

                                    89

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies (Continued)

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

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

Reserve for Unfunded Commitments - A reserve for unfunded commitments is
maintained at a level that, in the opinion of management, is adequate to
absorb probable losses associated with commitments to lend funds under
existing agreements. Management determines the adequacy of the reserve for
unfunded commitments based upon reviews of individual credit facilities,
current economic conditions, the risk characteristics of the various
categories of commitments and other relevant factors. The reserve is based on
estimates, and ultimate losses may vary from the current estimates.  These
estimates are evaluated on a regular basis and, as adjustments become
necessary, they are reported in earnings in the periods in which they become
known. Draws on unfunded commitments that are considered uncollectible at the
time the funds are advanced are charged to the allowance. Provisions for
unfunded commitment losses, and recoveries on loans previously charged off,
are added to the reserve for unfunded commitments, which is included in the
accrued interest payable and other liabilities section of the Consolidated
Statement of Financial Condition.

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

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

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

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

Bank Owned Life Insurance - The carrying amount of bank owned life insurance
approximates its fair value. Fair value of bank owned life insurance is
estimated using the cash surrender value net of surrender charges. The Bank
owns approximately $20.1 million and $20.3 million in bank owned life
insurance as of March 31, 2009 and 2008, respectively, which is included in
other assets.

                                    90

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies (Continued)

Goodwill - Goodwill generally arises from business combinations accounted for
under the purchase method. Goodwill that is deemed to have an indefinite life
as a result of a purchase business combination is not subject to amortization
and is instead tested for impairment no less than annually.

During the third quarter of fiscal 2009, the Company recorded a non-cash
charge of $545,000 related to the impairment of goodwill. The Company
identified a qualifying event that indicated the need to perform an interim
test for impairment as of December 31, 2008 based on two events: 1) the Bank
was informed in December 2008 by the FDIC and the State of Washington
Department of Financial Institutions ("DFI") that a Cease and Desist Order
("C&D") would be issued and forthcoming, and 2) the Bank's decision to close a
branch office that was directly associated with the creation of the original
goodwill asset. The accounting guidance in SFAS No. 142 (Goodwill and Other
Intangible Assets) led management to perform the interim impairment test of
goodwill based on these events meeting the definition for "adverse action."
The first step of the impairment test was to compare the Company's actual
market capitalization with its carrying value, which supported the need to
proceed with the second step to allocate the measured fair value to each of
the assets and liabilities.

This impairment charge had no effect on the Company's or the Bank's cash
balances, liquidity or regulatory ratios. At March 31, 2008, the balance of
goodwill was included in other assets. The following table presents the
changes in the carrying amount of goodwill for the years ended March 31:

(In thousands)                               2009     2008
                                            -----    -----

  Balance, beginning of period              $ 545    $ 545
  Goodwill write-off                         (545)      --
                                            -----    -----
  Balance, end of period                    $  --    $ 545
                                            =====    =====

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

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

Income Taxes - The Company reports income and expenses using the accrual
method of accounting and files a consolidated tax return which includes its
subsidiary. Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled using the asset
liability method. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
Deferred taxes result from temporary differences in the recognition of certain
income and expense amounts between the Company's financial statements and its
tax returns.

The Company evaluates the deferred tax assets and liabilities at least
annually and at March 31, 2009 believes, based upon the available evidence,
that all deferred tax assets will be realized in the normal course of
operations. Accordingly, these assets have not been reduced by a valuation
allowance.

Earnings (Loss) 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 based on the weighted average numbers of shares
outstanding plus the potential number of additional shares that may be
outstanding from stock options and grants using the treasury stock method.

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

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

                                    91

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies (Continued)

Share Based Payment - The Company adopted Statement of Financial Accounting
Standard No. 123R, Share-Based Payment, (SFAS 123R) on April 1, 2006 using the
"modified prospective" method. Under this method, awards that are granted,
modified, or settled after March 31, 2006 are measured and accounted for in
accordance with SFAS 123R. Also under this method, expense is recognized for
unvested awards that were granted prior to April 1, 2006 based upon the fair
value determined at the grant date under Statement 123, Accounting for
Stock-based Compensation. For the years ended March 31, 2009, 2008 and 2007,
the Company recognized $342,000, $678,000, and $292,000, respectively, in
stock option and restricted stock award compensation expense as a component of
salaries and benefits. As of March 31, 2009, there was $163,000 of total
unrecognized compensation cost related to nonvested options and restricted
stock awards which are scheduled to amortize over the next four years.

Statement 123R requires the cash flows resulting from the tax benefits
resulting from tax deductions in excess of the compensation cost recognized
for those options (excess tax benefits) to be classified as financing cash
flows. The $4,000, $44,000, and $55,000 excess tax benefit for the years ended
March 31, 2009, 2008 and 2007, respectively, classified as a financing cash
inflow would have been classified as an operating cash inflow if the Company
had not adopted SFAS 123R.

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

Comprehensive Income (Loss) - 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 (loss).

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

 (In thousands)                                2009      2008      2007
                                              ------    ------    ------
Unrealized holding gains (losses) on
  available-for-sale securities             $(1,283)   $(1,705)   $  27
Reclassification adjustment for losses
 (gains) and OTTI realized in income            500       (480)      10
                                            -------    -------    -----
Net unrealized gains (losses)                  (783)    (2,185)      37
Tax effect                                      275        765      (13)
                                            -------    -------    -----
    Net-of-tax amount                       $  (508)   $(1,420)   $  24
                                            =======    =======    =====

Recent Accounting Pronouncements - In October 2008, the FASB issued FASB Staff
Position No. FAS 157-3, Determining the Fair Value of a Financial Asset When
the Market for The Asset Is Not Active ("FSP 157-3). FSP 157-3 clarifies the
application of FAS 157 in a market that is not active. The FSP is intended to
address the following application issues: (a) how the reporting entity's own
assumptions (that is, expected cash flows and appropriately risk-adjusted
discount rates) should be considered when measuring fair value; (b) how
available observable inputs in a market that is not active should be
considered when measuring fair value; and (c) how the use of market quotes
(for example, broker quotes or pricing services for the same or similar
financial assets) should be considered when assessing the relevance of
observable and unobservable inputs available to measure fair value. FSP 157-3
is effective on issuance, including prior periods for which financial
statements have not been issued. The Corporation adopted FSP 157-3 for the
quarter ended September 30, 2008 and the effect of adoption on the
consolidated financial statements was not material.

                                    92

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies (Continued)

In December 2008, the FASB has issued FASB Staff Position (FSP) FAS 140-4 and
FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of
Financial Assets and Interests in Variable Interest Entities. FSP 140-4
requires additional disclosures by public companies about transfers of
financial assets and interests in variable interest entities. The FSP amends
both FASB Statement 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, and FASB Interpretation (FIN) No.
46 (Revised December 2003), Consolidation of Variable Interest Entities, to
require:

     *     Additional disclosures about transferors' continuing involvements
           with transferred financial assets;
     *     Additional disclosures about a public entities' (including
           sponsors) involvement with variable interest entities;
     *     Disclosures by a public enterprise that is: (a) a sponsor of a
           qualifying special-purpose entity (SPE) that holds a variable
           interest in the qualifying SPE but was not the transferor of
           financial assets to the qualifying SPE; and (b) a servicer of a
           qualifying SPE that holds a significant variable interest in the
           qualifying SPE but was not the transferor of financial assets to
           the qualifying SPE.

The Corporation adopted FSP 140-4 and FIN 46(R)-8 for the quarter ended
December 31, 2008 and the effect of the adoption on the consolidated financial
statements was not material.

In April 2009, the FASB issued FSP 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability have Significantly
Decreased and Identifying Transactions That Are Not Orderly. This FSP provides
additional guidance for estimating fair value in accordance with FASB
Statement No. 157, Fair Value Measurements, when the volume and level of
activity for the asset or liability have significantly decreased and also
includes guidance on identifying circumstances that indicate a transaction is
not orderly. This FSP emphasizes that even if there has been a significant
decrease in the volume and level of activity for the asset or liability and
regardless of the valuation technique(s) used, the objective of a fair value
measurement remains the same. Fair value is the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
(that is, not a forced liquidation or distressed sale) between market
participants at the measurement date under current market conditions. This FSP
is effective for interim and annual reporting periods ending after June 15,
2009, and is not expected to have a material impact on our financial
statements.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition
and Presentation of Other-Than-Temporary Impairments. This FSP amends the
other-than-temporary impairment guidance in U.S. GAAP for debt securities to
make the guidance more operational and to improve the presentation and
disclosure of other-than-temporary impairments on debt and equity securities
in the financial statements. This FSP does not amend existing recognition and
measurement guidance related to other-than-temporary impairments of equity
securities. This FSP is effective for interim and annual reporting periods
ending on or after June 15, 2009, and is not expected to have a material
impact on our consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments, to require disclosures
about fair value of financial instruments in interim financial statements as
well as in annual financial statements. This FSP also amends APB Opinion No.
28, Interim Financial Reporting, to require those disclosures in all interim
financial statements. This FSP is effective for interim and annual reporting
periods ending after June 15, 2009, and will result in additional disclosure
pertaining to the fair value of financial instruments in future interim
reporting periods.

In April 2009, the FASB issued FSP FAS 141(R)-1, Accounting for Assets
Acquired and Liabilities Assumed in a Business Combination That Arise from
Contingencies, which amends and clarifies FASB Statement No. 141R (revised
2007), Business Combinations, to address application issues raised by
preparers, auditors, and members of the legal profession on initial
recognition and measurement, subsequent measurement and accounting, and
disclosure of assets and liabilities arising from contingencies in a business
combination. This FSP is effective for assets or liabilities arising from
contingencies in business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. This FSP is not expected to have a material impact on our
consolidated financial statements.

                                    93

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 1 - Nature of Operations, Regulatory Matter and Summary of Significant
Accounting Policies (Continued)

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

Note 2 - Interest-Bearing Deposits

Interest bearing deposits consisted of the following at March 31:

(In thousands)                                    2009       2008
                                                 ------     ------

FHLB interest-bearing demand deposits           $  3,883    $ 2,712
FRB interest-bearing demand deposits             121,001         --
Certificates of deposit                            1,275        200
                                                --------    -------
                                                $126,159    $ 2,912
                                                ========    =======

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

Note 3 - Investment Securities

The Company's investment policy requires that the Company purchase only
investment grade 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 fair values of investments, together with
unrealized gains and losses, are as follows as of March 31, 2009 and 2008,
respectively:

                                              2009
                      ------------------------------------------------------
                                              Gross       Gross
                                            Unrealized  Unrealized
                                  Gross       Losses      Losses    Estimated
                     Amortized  Unrealized  12 Months  Greater Than   Fair
(In thousands)         Costs      Gains      or Less    12 Months     Value
                      -------    -------    ---------  -----------   -------
Available-For-Sale
 Securities
  State and political
   subdivisions and
   U.S. government
   agency securities   $26,565    $  934     $  --       $(326)      $27,173
  Marketable equity
   securities              562       454      (106)         --           910
                       -------    ------     -----       -----       -------
   Total available-
    for- sale
    securities          27,127     1,388      (106)       (326)       28,083
                       -------    ------     -----       -----       -------
   Total investment
    securities         $27,127    $1,388     $(106)      $(326)      $28,083
                       =======    ======     =====       =====       =======

Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2009, the
Company has evaluated these securities and determined that the decline in
value was temporary and related to the change in market interest rates since
purchase as well as the current instability in the credit markets. The decline
in value was not related to any company or industry specific event. At March
31, 2009, there are six investment securities with an amortized cost of $3.2
million with unrealized losses exceeding a twelve month period. The Company
anticipates full recovery of amortized cost with respect to these securities
at maturity or sooner in the event of more favorable market interest rates.

                                    94

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 3 - Investment Securities (Continued)

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

The amortized cost and estimated fair value of investment securities at March
31, 2009, 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.

                                   Available-For-Sale      Held-To-Maturity
                                  ---------------------  ---------------------
                                  Amortized  Estimated   Amortized  Estimated
 (In thousands)                      Cost    Fair Value     Cost    Fair Value
                                   --------  ----------   --------  ----------
State and political subdivisions
 and U.S. government agencies
   One year or less                $ 1,718    $ 1,734      $   --    $   --
   More than one to five years      11,593     12,250          --        --
   More than five to ten years      10,205     10,137          --        --
   Over ten years                    3,049      3,052          --        --
                                   -------    -------      ------    ------
                                    26,565     27,173          --        --

Marketable/ equity securities          562        910          --        --
                                   -------    -------      ------    ------
      Total investment securities  $27,127    $28,083      $   --    $   --
                                   =======    =======      ======    ======

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

(In thousands)                                    2009       2008       2007
                                                -------    -------    -------
Proceeds from sales and maturities of
 investments                                    $14,204    $25,064    $10,482
                                                =======    =======    =======
Gross gains realized on sales and maturities
 of investments                                 $   586    $   461    $   287
                                                =======    =======    =======
Gross losses realized on sales and maturities
 of investments                                 $  (777)   $    --    $  (316)
                                                =======    =======    =======

                                    95

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 3 - Investment Securities (Continued)

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

                                          2009               2008
                                    ----------------    ----------------
                                              Market              Market
 (In thousands)                      Cost     Value      Cost     Value
                                    ------   -------    ------   -------
Marketable equity securities
  Banking                            $555     $810       $560     $2,122
  Government agency stocks              7      100          9        641
                                     ----     ----       ----     ------
     Total                           $562     $910       $569     $2,763
                                     ====     ====       ====     ======

The following table shows securities, which were pledged to secure borrowings,
public deposits, repurchase agreements and other items, as permitted or
required by law at March 31, 2009:
                                                            Book      Market
(In thousands)                                              Value     Value
                                                           -------   -------
To the Federal Home Loan Bank to secure borrowings         $ 5,528   $ 5,778
To the Federal Reserve Bank to secure borrowings             8,001     8,341
To state government to secure public funds                   4,426     4,507
To secure repurchase agreements                             29,232    30,554
To the Federal Reserve Bank to secure customer tax
 payments                                                    1,081     1,151
Other pledged investments                                    2,343     2,471
                                                           -------   -------
                                                           $50,611   $52,802
                                                           =======   =======

Securities with a book value of $52.7 million and market values of $53.9
million were pledged at March 31, 2008.

Note 4 - Mortgage-Backed Securities

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

                                              2009
                      ------------------------------------------------------
                                              Gross       Gross
                                            Unrealized  Unrealized
                                  Gross       Losses      Losses    Estimated
                     Amortized  Unrealized  12 Months  Greater Than   Fair
(In thousands)         Costs      Gains      or Less    12 Months     Value
                      -------    -------    ---------  -----------   -------

Available-for-sale
 securities           $37,563    $1,839      $    --      $(620)     $38,782
Held-to-maturity
 securities                 8         3           --         --           11
                      -------    ------      -------      -----      -------
  Total mortgage-
   backed securities  $37,571    $1,842      $    --      $(620)     $38,793
                      =======    ======      =======      =====      =======

Management evaluated securities for other-than-temporary impairment at least
on an annual basis, and more frequently when economic or market concerns
warrant such evaluation. Consideration is given to: (1) the length of time and
extent to which the fair value has been less than cost, (2) the financial
condition and near tem prospects of the issuer and (3) intent and ability to
retain a security for a period of time sufficient to allow for any anticipated
recovery in fair value.  Declines in the fair value of available for sale and
held to maturity securities below their cost that are deemed to be
other-than-temporary are reflected in earnings as realized losses. For the
year ended March 31, 2009, the Company recognized other-than-temporary
impairment losses of $309,000 (pre-tax), related to private-label
mortgage-backed securities acquired in the like-kind exchange of its
investment in the Shay AMF family of mutual funds.

Certain investment securities shown above currently have fair values less than
amortized cost and therefore contain unrealized losses. At March 31, 2009, the
Company has evaluated these securities and has determined that the decline in
value is temporary. At March 31, 2009, there were 78 small balance
mortgage-backed securities with an amortized cost of $2.5 million with
unrealized losses for a period greater than twelve months.

                                    96

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 4 - Mortgage-Backed Securities (Continued)

                                              2008
                      ------------------------------------------------------
                                              Gross       Gross
                                            Unrealized  Unrealized
                                  Gross       Losses      Losses    Estimated
                     Amortized  Unrealized  12 Months  Greater Than   Fair
(In thousands)         Costs      Gains      or Less    12 Months     Value
                      -------    -------    ---------  -----------   -------

Available-for-sale
 securities           $38,646      $603      $   --      $(149)      $39,100
Held-to-maturity
 securities                30         5          --         --            35
                      -------      ----      ------      -----       -------
  Total mortgage-
   backed securities  $38,676      $608      $   --      $(149)      $39,135
                      =======      ====      ======      =====       =======

The amortized cost and estimated fair value of mortgage-backed securities at
March 31, 2009, 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.


                                   Available-For-Sale      Held-To-Maturity
                                  ---------------------  ---------------------
                                  Amortized  Estimated   Amortized  Estimated
 (In thousands)                      Cost    Fair Value     Cost    Fair Value
                                   --------  ----------   --------  ----------
Mortgage-backed securities
  One year or less                 $    --     $    --     $   --    $   --
  More than one to five years        1,383       1,418         --        --
  More than five to ten years       11,055      11,548          8        11
  After ten years                   25,125      25,816         --        --
                                   -------     -------     ------    ------
    Total                          $37,563     $38,782     $    8    $   11
                                   =======     =======     ======    ======

Proceeds from sales and maturities of mortgage-backed securities and gross
realized gains and losses on mortgage-backed security sales were as follows
for the year ended March 31:
                                             2009      2008      2007
                                           -------    -------   ------
(In thousands)
Proceeds from sales and maturities of
 mortgage-backed securities                $    --    $6,780    $7,751
                                           =======    =======   ======
Gross gains realized on sales and
 maturities of mortgage-backed securities  $    --    $   19    $   28
                                           =======    =======   ======
Gross losses realized on sales and
 maturities of mortgage-backed securities  $    --    $   --    $   (9)
                                           =======    =======   ======

                                    97

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

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:

(In thousands)                                            2009        2008
                                                      ----------   ----------
First mortgage loans
  1-4 family                                          $  167,048   $  165,824
  1-4 family construction                                 28,290       35,303
  Less participations                                    (42,853)     (54,269)
                                                      ----------   ----------
     Net first mortgage loans                            152,485      146,858
Commercial construction                                  186,580      302,708
Commercial land development                              222,207      183,827
Multi family residential                                  51,970       45,049
Commercial real estate                                   281,481      300,109
Commercial loans                                         201,973      177,685
Home equity secured loans                                 58,228       47,351
Other consumer loans                                       7,717        7,005
                                                      ----------   ----------
                                                       1,162,641    1,210,592
Less:
  Allowance for loan losses                              (38,981)     (19,114)
                                                      ----------   ----------
  Total loans receivable, net                         $1,123,660   $1,191,478
                                                      ==========   ==========

The Company originates both adjustable and fixed interest rate loans. At March
31, 2009, the Company had adjustable and fixed rate loans as follows:

          Fixed Rate                                  Adjustable Rate
---------------------------------           ---------------------------------
                          (In                                         (In
                       Thousands)                                  Thousands)
  Term to Maturity     Book Value           Term to Maturity       Book Value
--------------------   ----------           -------------------    ----------
Less than one year     $326,022             Less than one year      $424,635
One to three years      113,980             One to three years        65,784
Three to five years      54,265             Three to five years       50,608
Five to fifteen years    91,742             Five to fifteen years      3,341
Over fifteen years       32,264             Over fifteen years            --
                       --------                                     --------
                       $618,273                                     $544,368
                       ========                                     ========

Loans serviced for others were $73.8 million and $108.9 million, respectively,
as of March 31, 2009 and 2008, respectively. The Bank generally receives a
monthly fee of 0.25% to 0.375% per annum of the unpaid balance of each loan
that is serviced for others. Loans sold are without right of recourse to the
Bank by the buyer of the loan interests in the event of default by the
borrower. At March 31, 2009, the balance and activity in the servicing asset
was immaterial.

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

(In thousands)                             2009        2008       2007
                                         --------    -------    -------
Balance, beginning of year               $ 19,114    $15,889    $14,184
Provision for loan losses                  65,000      4,100      1,850
Loan chargeoffs                           (45,268)      (898)      (195)
Loan recoveries                               135         23         50
                                         --------    -------    -------
Balance, end of year                     $ 38,981    $19,114    $15,889
                                         ========    =======    =======

                                    98

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 5 - Loans Receivable (Continued)

The following is a summary of information pertaining to impaired and
non-accrual loans:
                                                              March 31,
                                                        --------------------
(In thousands)                                            2009         2008
                                                        --------     -------
Impaired loans without a valuation allowance            $     --     $    --
Impaired loans with a valuation allowance                148,892      12,147
                                                        --------     -------
    Total impaired loans                                $148,892     $12,147
                                                        ========     =======

Valuation allowance related to impaired loans           $ 26,502     $ 1,972

Total non-accrual loans                                 $ 84,924     $11,608

Total loans past-due 90 days or more and still accruing $    500     $    --

Troubled debt restructured loans                        $ 26,383     $    --

                                                     Years Ended March 31,
                                                 ---------------------------
(In thousands)                                     2009      2008      2007
                                                 -------    ------    ------
Average investment in impaired loans             $70,869    $1,899    $2,324
                                                 =======    ======    ======
Interest income recognized on impaired loans     $ 4,942    $  228    $  276
                                                 =======    ======    ======

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 are summarized as
follows:

(In thousands)                                          2009       2008
                                                       ------     ------
Investment securities                                  $  321     $  435
Mortgage-backed securities                                183        160
Loans receivable                                        6,125      7,318
Dividends on marketable equity securities                  --          3
                                                       ------     ------
                                                       $6,629     $7,916
                                                       ======     ======

Note 7 - Premises and Equipment

Premises and equipment at March 31 consisted of:
(In thousands)                                         2009       2008
                                                     --------    --------
Buildings                                            $ 19,926    $ 19,960
Equipment                                              14,909      14,544
                                                     --------    --------
                                                       34,835      34,504

Accumulated depreciation                              (15,633)    (13,719)
                                                     --------    --------
                                                       19,202      20,785
Land                                                    6,993       6,993
                                                     --------    --------
Balance, end of year                                 $ 26,195    $ 27,778
                                                     ========    ========

                                    99

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 8 - Deposits

A comparative summary of deposits at March 31 follows:

(In thousands)                                         2009          2008
                                                     --------      --------

Demand deposits
  Savings                                           $   15,850    $   17,933
  Checking                                              83,286        72,434
  Checking (noninterest-bearing)                        80,103        70,438
  Money Market                                         133,022       183,063
                                                    ----------    ----------
                                                       312,261       343,868

Time certificates of deposit
  Less than $100,000                                   352,785       286,657
  Greater than or equal to $100,000                    303,308       287,281
  Brokered certificates of deposit                     261,410       120,986
                                                    ----------    ----------
                                                       917,503       694,924
                                                    ----------    ----------
    Total deposits                                  $1,229,764    $1,038,792
                                                    ==========    ==========

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

                                                 2009
                                    ------------------------------
                                    Variable    Fixed
(In thousands)                        Rate       Rate       Total      2008
                                    -------    --------   --------   --------
Within one year                     $ 4,962    $639,512   $644,474   $558,566
Over one to two years                 1,758     184,693    186,451     58,657
Over two to three years                 499      74,341     74,840     63,551
Over three to four years                420       6,065      6,485      4,596
Over four to five years               2,049       1,722      3,771      6,060
Over five years                       1,357         125      1,482      3,494
                                    -------    --------   --------   --------
                                    $11,045    $906,458   $917,503   $694,924
                                    =======    ========   ========   ========

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, 2009
and 2008, was 3.03% and 3.83%, respectively.

Interest expense on all deposit accounts for the years ended March 31 is
summarized as follows:

(In thousands)                             2009       2008        2007
                                         -------    -------     -------
Money market                             $ 2,909    $ 6,534     $ 6,316
Checking                                     335        466         510
Savings                                      103        176         167
Certificates of deposit                   31,259     30,897      25,258
                                         -------    -------     -------
Balance, end of year                     $34,606    $38,073     $32,251
                                         =======    =======     =======

                                    100

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 9 - Other Borrowed Funds

The Bank is a member of the FHLB of Seattle. As a member, the Bank has a
committed line of credit up to 25% of total assets, subject to the Bank
pledging sufficient collateral and maintaining the required stock investment
in the FHLB.  Committed lines of credit agreements totaling $129.5 million and
$272.7 million were available to the Bank, of which, $129.5 million and $192.0
million were outstanding at March 31, 2009 and 2008, respectively. Included in
these amounts is the borrowing related to the investment in real estate in a
joint venture of $24.4 million and $22.4 million as of March 31, 2009 and
2008, respectively. These advances bear interest rates ranging from 0.58% to
4.05% and 2.36% to 5.09% per annum in 2009 and 2008, respectively. Maturities
for the advances are $106.0 million in fiscal 2010 and $23.5 million in fiscal
2011.

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

(In thousands)                               2009        2008        2007
                                           --------    --------    --------
Maximum outstanding at any month end       $238,000    $212,500    $195,000

Average outstanding                         164,807     177,874     165,237

Weighted average interest rates:
  Annual                                      2.71%       4.44%       4.74%
                                              ====        ====        ====
  End of year                                 2.39%       3.15%       5.03%
                                              ====        ====        ====

The Bank has other borrowed funds in the form of retail repurchase agreements.
These agreements are collateralized by securities held by a safekeeping agent
not under control of the Bank. These advances are considered overnight
borrowings and bear interest rates that fluctuate daily based on current
market rates. The Bank had $8.6 million and $21.9 million outstanding as of
March 31, 2009 and 2008, respectively. At March 31, 2009 and 2008, U.S.
government agency and corporate debt securities of $30.6 million and $35.8
million, respectively, were pledged as collateral for retail repurchase
agreements.

The Bank also had $716,000 and $850,000 outstanding as of March 31, 2009 and
2008, respectively, in the form of a Treasury Tax and Loan note option which
is included in other borrowed funds.

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:

(In thousands)                               2009        2008        2007
                                           --------    --------    --------

Provision (benefit) for income tax at
 the statutory rate of 35 percent          $(18,863)    $9,577     $10,008
Increase (decrease) in tax resulting from:
  Nontaxable income                            (768)      (572)       (469)
  Nondeductible expense                          40         46          29
  Dividends received deduction                  (11)       (52)        (52)
  Other, net                                   (927)       (50)         50
                                           --------     ------     -------
      Income tax provision (benefit)       $(20,529)    $8,949     $ 9,566
                                           ========     ======     =======

At March 31, 2009, a return to accrual adjustment related to loan charge offs
in the amount of $852,000 is included under the caption "Other, net" within
the income tax rate reconciliation table.

                                    101

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

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% are as follows at
March 31:

(In thousands)                                           2009        2008
                                                       -------     -------
Deferred Tax Assets
  Deferred compensation agreements                     $   673      $  681
  Financial reporting loan loss reserve not
   recognized for tax purposes                          13,577       6,344
  Financial reporting accrued expenses not
   recognized for tax purposes                             170         329
  Other deferred tax assets                              3,712       2,173
                                                       -------     -------
      Total deferred assets                             18,132       9,527
                                                       -------     -------

Deferred Tax Liabilities
  Deferred loan fees for tax purposes in excess of
   amounts  deferred for financial reporting              (245)       (255)
  Tax effect of unrealized gains on available-for-sale
   securities                                             (761)     (1,098)
  FLHB stock dividends                                    (819)       (793)
  Other deferred tax liabilities                        (1,143)     (1,128)
                                                       -------     -------
      Total deferred liabilities                        (2,968)     (3,274)
                                                       -------     -------
      Net deferred tax assets                          $15,164     $ 6,253
                                                       =======     =======

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

The Company adopted the provisions of FASB Interpretation No. 48. Accounting
for Uncertainty in Income Taxes, on April 1, 2007. The Company had no
unrecognized tax benefits which would require an adjustment to the April 1,
2007 beginning balance of retained earnings. The Company had no unrecognized
tax benefits at April 1, 2007, March 31, 2008 and March 31, 2009.

The Company recognizes interest accrued and penalties related to unrecognized
tax benefits in tax expense. During the years ended March 31, 2009 and 2008,
the Company recognized no interest and penalties.

The Company files federal and various state and local tax returns. With few
exceptions, the Company is no longer subject to U.S. Federal or state/local
tax examinations by tax authorities for years before 2006.

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 10 to 20 year period
following retirement. In connection with some of these agreements, the Company
has acquired life insurance policies on the individual officers covered by the
deferred compensation agreements. At March 31, 2009 and 2008, the cash
surrender values of these policies included in other assets aggregated $2.2
million and $2.1 million, respectively.

The Company performs a present value calculation using an appropriate discount
rate on an annual basis to ensure that deferred compensation plan obligations
are adequately estimated in the accompanying financial statements. The
discount rate was 3.49%, 3.30%, and 2.67% in 2009, 2008 and 2007,
respectively. Deferred compensation expense amounted to $129,000, $0, and
$213,000 for the years ended March 31, 2009, 2008 and 2007, respectively.

Employee Incentive Plan - The Company has an incentive plan with employees
meeting certain performance requirements. Payments made to employees pursuant
to the plan are based upon earnings, growth in deposits, and loans and
attainment of certain corporate objectives. Costs of the plan were $15,000,
$1.0 million, and $2.3 million for the years ended March 31, 2009, 2008 and
2007, respectively.

                                    102
<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 11 - Benefit Plans (Continued)

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

In April 1996, the Company issued a loan to the ESOP in the amount of
$500,000, to purchase 40,000 shares of the Company's common stock in the open
market. The loan was to be repaid over a period of ten years, with annual
payments including interest due on March 31 of each year. The ESOP shares
initially were pledged as collateral for this debt. As the obligation was
reduced, shares were released from collateral and allocated to the
participants' accounts at a rate of 10% a year. In May 1997, the Company
issued a 15% stock dividend which added an additional 5,400 shares to the
unallocated ESOP shares. In May 1999, the Company made an additional loan to
the ESOP in the amount of $154,725, to purchase 12,500 shares of common stock
in the open market. The loan was to be repaid over seven years with annual
payments including interest due March 31. In April 2001, the Company issued a
15% stock dividend which added an additional 4,789 shares to the unallocated
ESOP shares. In July 2002, the Company issued a 25% stock split which added an
additional 7,342 shares to the unallocated ESOP shares. In October 2006, the
Company issued a 5-for-4 stock split paid in the form of a 25% stock dividend
which added an additional 21,023 shares to the allocated ESOP shares. As of
March 31, 2006, all loans secured by ESOP shares were paid off, and the
remaining shares released. Shares released for allocation were 9,175 for the
year ended March 31, 2006. Shares outstanding for the years ended March 31,
2009, 2008 and 2007 were 264,218, 266,565 and 263,262, respectively.

Dividends paid on shares of stock are reinvested and the new shares purchased
are allocated to the participants. Compensation expense for the ESOP plan was
$24,000, $15,000, and $10,000 for the years ended March 31, 2009, 2008 and
2007, respectively.

401(k) Plan - Effective January 1, 1993, the Company adopted a defined
contribution 401(k) retirement and savings plan (the "Plan") covering
substantially all employees. The Company contributes three percent of
participating employees' eligible salary to the Plan and a discretionary
amount determined annually by the Board of Directors. Total Company
contributions to the Plan which were recorded as employee benefits expense
amounted to $550,000, $525,000, and $490,000 for the years ended March 31,
2009, 2008 and 2007, respectively.

Stock Option and Restricted Stock Award Plans - In 2005, shareholders of the
Company approved an Incentive Stock Plan (the "Plan") to promote the best
interest of the Company, our subsidiaries and our shareholders, by providing
an incentive to those key employees who contribute to our success. The Plan
allows for incentive stock options and restricted stock grants to be awarded.
The maximum number of shares that may be issued under the Plan is 937,500
common shares. At March 31, 2009, 804,971 common shares were available for
grant. Options and awards issued and outstanding are adjusted to reflect
common stock dividends and splits. Options and awards are granted at fair
market value and may or may not vest immediately upon issuance based on the
terms established by the Board of Directors. Options and awards are generally
exercisable within one to five years from date of grant and expire after ten
years. Dividends are paid on restricted stock grants and are not paid on
incentive stock options. Dividends paid on restricted stock are considered in
the calculation of earnings per share. Certain options provide for accelerated
vesting if there is a change in control.

The Company measures the fair value of each stock option grant at the date of
grant, using the Black Scholes option pricing model. The expected term of the
options is developed by considering the historical share option exercise
experience, historical share retention practices of employees and assumptions
about their propensity for early exercise in the future. Expected volatility
is estimated using daily historical volatility. We believe that historical
volatility is currently the best estimate of expected volatility. The dividend
yield is the annualized yield on our common stock on the date of grant. The
risk free interest rate is the yield on the grant date of U.S. Treasury zero
coupon issues with a maturity comparable to the expected term of the option.
The weighted average fair value of options granted during the years ended
March 31, 2009, 2008 and 2007 was $2.59, $4.75, and $4.18 per share, as
adjusted, respectively.

                                    103

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 11 - Benefit Plans (Continued)

The following assumptions were used in arriving at the fair value of options
granted during the years ended March 31:

                                             2009        2008       2007
                                            ------      ------     ------
Risk-free interest rate                     1.000%      4.213%      5.27%

Dividend yield rate                         0.000%      2.702%     2.417%

Price volatility                            78.14%      31.06%     24.77%

Weighted average expected life of options    5.90 yr.    4.45 yr    3.78 yr.

The following tables summarize option activity under the Plan as of March 31,
2009 and 2008 and changes during the years then ended:

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

BALANCE, March 31, 2008          193,221     $12.45        5.40      $ 761
  Granted                          7,000       3.90
  Exercised                      (20,161)      6.64
  Forfeited, expired or
   cancelled                     (23,804)     13.72
                                 -------     ------        ----      -----
BALANCE, March 31, 2009          156,256     $12.61        4.54      $  --
                                 =======     ======        ====      =====
EXERCISABLE, March 31, 2009      115,558     $11.26        3.38      $  --
                                 =======     ======        ====      =====

The total intrinsic value, the amount by which the fair value of the
underlying stock exceeds the exercise price of an option on the exercise date,
of options exercised for the years ended March 31, 2009, 2008 and 2007 was $0,
$215,000, and $364,000, respectively.

               Options Outstanding                 Options Exercisable
---------------------------------------------  -------------------------------
                            Weighted
                            Average       Weighted
Range of                   Remaining      Average                    Average
Exercise       Number      Contractual    Exercise      Number       Exercise
Prices       Outstanding      Life         Price      Exercisable     Price
----------   -----------   ----------     --------    -----------    -------
$ 0 to $ 5      7,000       9.72 years     $ 3.90            0       $ 0.00
$ 5 to $10     67,511       1.35 years     $ 6.92       67,511       $ 6.92
$10 to $15      8,126       4.07 years     $11.87        8,126       $11.87
$15 to $20     53,785       6.92 years     $17.56       30,004       $17.31
$20 to $25     19,834       7.30 years     $21.97        9,917       $21.97

                                    104

<PAGE>



Note 11 - Benefit Plans (Continued)

The following table summarizes restricted stock award activity under the Plan
as of March 31, 2009 and 2008 and changes during the years then ended:

                                                  Weighted      Weighted
                                                   Average      Aggregate
                                                    Grant       Remaining
                                   Outstanding    Price Per    Contractual
Restricted Stock Awards             Under Plan      Share     Term (in Years)
---------------------------------   ----------     -------    --------------
BALANCE, March 31, 2008               51,761        $20.66          0.91
  Granted                                 --            --
  Vested                             (23,234)        20.76
  Forfeited, expired or cancelled     (4,819)        20.54
                                      ------        ------          ----
BALANCE, March 31, 2009               23,708        $20.58          0.47
                                      ======        ======          ====

The total intrinsic value of restricted stock vested for the years ended March
31, 2009, 2008 and 2007 was $0, $173,000, and $76,000, 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 and the Bank's financial statements
and operations. Under capital adequacy guidelines within the regulatory
framework for prompt corrective action, the Bank must meet specific capital
adequacy guidelines that involve quantitative measures of each entity's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices.  Capital classifications are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.

Quantitative measures are established by regulation to ensure capital
adequacy, require maintenance of minimum amounts and ratios of total and Tier
1 capital (as defined in the regulations) to risk-weighted assets, and of Tier
1 capital to average assets as illustrated in the following table. Management
believes, as of March 31, 2009, that each entity meets all capital adequacy
requirements to which they are subject. Additionally, as of March 31, 2009,
the Bank was categorized as adequately capitalized under the regulatory
framework for prompt corrective action.

                                                                To Be Well
                                                                Capitalized
                                                                Under Prompt
                                             For Capital         Corrective
                              Actual      Adequacy Purposes  Action Provisions
                          --------------  -----------------  -----------------
                          Amount   Ratio   Amount     Ratio   Amount   Ratio
                          ------   -----   ------     -----   ------   -----
As of March 31, 2009
Total Capital
 (to Risk Weighted
  Assets)
   Consolidated          $107,625  8.63%  $99,756    >8.00%    N/A
   Horizon Bank          $106,958  8.58%  $99,722    >8.00%  $124,653  >10.00%
Tier I Capital
 (to Risk Weighted
  Assets)
   Consolidated         $ 91,592   7.35%  $49,878    >4.00%    N/A
   Horizon Bank         $ 90,912   7.29%  $49,861    >4.00%  $ 74,792  > 6.00%
Tier I Capital
 (to Average Assets)
   Consolidated         $ 91,592   6.16%  $49,878    >4.00%    N/A
   Horizon Bank         $ 90,912   6.11%  $49,861    >4.00%  $ 74,336  > 5.00%

                                    105
<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 12 - Stockholders' Equity (Continued)

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

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

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

Stock Repurchase Plans - The Company has conducted various stock buy-back
programs since August 1996. In March 2006, the Company announced a plan to
repurchase up to 625,000 shares, or approximately 5% of the Company's
outstanding common stock. During fiscal 2007, 144,580 shares were repurchased
and subsequently retired at a cost of $2.9 million. In March 2007, the Company
announced a plan to repurchase up to 600,000 shares, or approximately 5% of
the Company's outstanding common stock. During fiscal 2008, 399,700 shares
were repurchased and subsequently retired at a cost of $7.1 million. Share
information related to stock repurchases has been restated to reflect stock
splits and dividends. In March 2008, the Company announced a plan to
repurchase up to 300,000 shares, or approximately 2.5% of the Company's
outstanding common stock. The Company did not repurchase any shares during
fiscal 2009.

Note 13 - Earnings (Loss) Per Share

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

(In thousands)                            2009          2008        2007
                                      -----------   -----------  -----------
Net income (loss) (numerator)         $   (33,366)  $    18,413  $    19,028
Shares used in the calculation
 (denominators)
   Basic earnings per weighted
    average share outstanding          11,945,835    12,097,615   12,287,805
   Effect of dilutive stock options            --        99,168      121,287
                                      -----------   -----------  -----------
   Diluted shares                      11,945,835    12,196,783   12,409,092
                                      ===========   ===========  ===========
Basic earnings (loss) per share           $(2.79)       $1.52        $1.55
                                          ======        =====        =====
Diluted earnings (loss) per share         $(2.79)       $1.51        $1.53
                                          ======        =====        =====
Anti-dilutive shares outstanding
 related to options to acquire the
 Company's common stock                   133,259        40,593           --
                                      ===========   ===========  ===========

                                    106

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 14 - Commitments And Contingencies

Employment Agreement - The Company has entered into employment agreements with
members of senior management that provide for potential payments upon change
in control, disability, termination without cause, or death. The arrangements
generally provide severance payments at 1.99 to 2.99 times the then current
compensation levels and continuation of certain benefits.

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

                                                  (In Thousands)
                   2010                               $  425
                   2011                                  439
                   2012                                  389
                   2013                                  241
                   2014                                   26
                Thereafter                                54
                                                      ------
                                                      $1,574
                                                      ======

Rent expense charged to operations was $445,000, $410,000, and $293,000 for
the years ended March 31, 2009, 2008 and 2007, respectively.

Note 15 - Related Party Transactions

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

The aggregate balances and activity during the years ended March 31, 2009 and
2008, are as follows and were within regulatory limitations:

 (In thousands)                           2009         2008
                                        --------     -------

Balance, beginning of year              $ 13,725     $13,505
New loans or advances                      6,146       8,355
Repayments                               (18,171)     (8,135)
                                        --------     -------
Balance, end of year                    $  1,700     $13,725
                                        ========     =======
Interest earned on loans                $    492     $   948
                                        ========     =======

Deposits from related parties totaled $3.0 million and $3.9 million at March
31, 2009 and 2008, respectively.

In October 2004, the Bank's wholly-owned subsidiary, Westward, entered into a
real estate development joint venture in Greenbriar Northwest LLC ("GBNW")
(50% owned by Westward and 50% owned by Greenbriar Construction, an
established residential land development company headquartered in Bellingham,
Washington). The investment in real estate is recorded as an asset on the
Company's balance sheet, and the related debt is recorded as a liability.
One-half of the borrowing expense related to the joint venture is recognized
as an expense on the Company's financial statements as incurred, with the
remainder being capitalized. As of March 31, 2009, the Bank conducted a review
of the accounting treatment and measured the value of the GBNW joint real
estate development for potential impairment and whether to continue with
capitalizing interest.  The Bank took the following steps to ensure compliance
with generally accepted accounting principles:  (1) performed a recoverability
test under SFAS No. 144 Accounting for the Impairment or Disposal of
Long-Lived Assets, which was followed by step (2) evaluated the capitalization
of interest in conformity with SFAS No. 34, Capitalization of Interest Cost.
The conclusion of the recoverability test determined that the Fairhaven
Highland development was positively accretive, which then supported the
continuation for capitalization of interest during the development of the
project.

                                    107

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 16 - Significant Group Concentrations of Credit Risk

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

Note 17 - Financial Instruments

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

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

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

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, 2009.

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, 2009,
2008 and 2007.

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

(In thousands)                          2009         2008
                                     --------      --------
Commitments to extend credit         $212,627      $361,763
Credit card arrangements               10,675        10,510
Standby letters of credit               3,523         2,047

                                    108

<PAGE>

                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 18 - Disclosures About Fair Value of Financial Instruments

Statement No. 157 Fair Value Measurements establishes a fair value hierarchy
which requires an entity to maximize the use of observable inputs and minimize
the use of unobservable inputs when measuring fair value. The standard
describes three levels of inputs that may be used to measure fair value:

        Level 1 - Quoted prices for identical assets or liabilities in active
                  markets that the entity has the ability to access as of the
                  measurement date.

        Level 2 - Significant other observable inputs other than Level 1
                  prices, such as quoted prices for similar assets or
                  liabilities, quoted prices in markets that are not active
                  and other inputs that are observable or can be corroborated
                  by observable market data.

        Level 3 - Significant unobservable inputs that reflect a company's own
                  assumptions about the assumptions that market participants
                  would use in pricing an asset or liability.

The following table presents the Company's financial assets measured at fair
value on a recurring basis at March 31, 2009:

  (In thousands)                    Level 1     Level 2    Level 3    Total
                                   ---------   --------   ---------  -------
   Assets
   Available for sale securities      $910     $65,955     $   --    $66,865
                                      ====     =======     ======    =======
   Total                              $910     $65,955     $   --    $66,865
                                      ====     =======     ======    =======

The following table presents the Company's assets measured at fair value on a
nonrecurring basis at March 31, 2009, and the total losses resulting from
these fair value adjustments for the year ended March 31, 2009:

                                                                 Total
(In thousands)     Level 1     Level 2     Level 3     Total     Losses
                  ---------   ---------   --------   --------   -------

Assets
Impaired loans     $   --      $   --     $148,892   $148,892   $45,268
Other real estate
 owned                 --          --       19,227     19,227       539
Goodwill               --          --           --         --       545
                   ------      ------     --------   --------   -------
Total              $   --      $   --     $168,119   $168,119   $46,352
                   ======      ======     ========   ========   =======

In accordance with FASB Statement 114, Accounting by Creditors for Impairment
of a Loan, impaired loans, with carrying amounts of $148.9 million had
specific valuation allowances totaling $26.5 million at March 31, 2009, which
were included in the allowance for loan losses.

                                    109

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 18 - Disclosures About Fair Value of Financial Instruments (Continued)

SFAS No. 107 requires disclosure of the estimated fair value of certain
financial instruments and the methods and significant assumptions used to
estimate their fair values. Additionally, certain financial instruments and
all nonfinancial instruments are excluded from the scope of SFAS 107. The
carrying amounts and estimated fair values at March 31, 2009 and 2008 for the
Company's financial instruments in accordance with SFAS 107 are as follows:

                                         2009                   2008
                               ---------------------     --------------------
                               Carrying                  Carrying
(In thousands)                  Amount    Fair Value     Amount    Fair Value
                               --------   ----------     --------  ----------
Financial Assets
  Cash and cash equivalents   $   17,881   $   17,881  $   22,412   $   22,412
  Interest-bearing deposits      126,159      126,159       2,912        2,912
  Investment securities           28,083       28,083      41,241       41,241
  Mortgage-backed securities      38,790       38,793      39,130       39,135
  Federal Home Loan Bank stock     7,247        7,247       8,867        8,867
  Loans held-for-sale              4,745        4,745       2,644        2,644
  Loans receivable             1,123,660    1,134,413   1,191,478    1,190,418
 Investment in real estate
   in a joint venture             17,985       21,800      17,567       17,567
Accrued interest and dividends
 receivable                        6,629        6,629       7,916        7,916

Financial Liabilities
  Demand and savings deposits    312,261      312,261     343,868      343,868
  Time deposits                  917,503      927,128     694,924      677,364
  Accrued interest payable         1,890        1,890       1,566        1,566
  Other borrowed funds           114,348      115,484     192,343      193,003
  Borrowing related to
   investment in real estate
   in a joint venture             24,440       24,440      22,448       22,448

The following methods and assumptions were used to estimate the fair value of
the following classes of financial instruments (under SFAS No. 157) and for
estimating the fair value for financial instruments not recorded at fair value
(under SFAS No. 107):

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

Investment and Mortgage-Backed Securities - Securities fair values are
determined by obtaining quoted prices on nationally recognized securities
exchanges (Level 1) or through the use of alternative approaches, such as
matrix or model pricing, when market quotes are not readily available (Level
2). Available for sale securities are carried at fair value. Held to maturity
securities are carried at cost on the financial statements.

Federal Home Loan Bank Stock - FHLB Stock is carried at $100 par value. This
investment is considered restricted, at a minimum, the investment must be
maintained in order to obtain borrowing commitments from FHLB. The Company may
redeem its investment only at par value, which is used as the estimated market
value. In January 2009, the FHLB announced it suspended excess FHLB stock
redemptions and dividend payments. As a result of the FHLB's announcement, we
evaluated the carrying value of our FHLB stock investment at March 31, 2009
for impairment. Based on the FHLB's most recent publicly available financial
results, its capital position and its bond ratings, we concluded such
investment was not impaired at March 31, 2009.

Loan Receivables - 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.

                                    110

<PAGE>



                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 18 - Disclosures About Fair Value of Financial Instruments (Continued)

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.

Impaired Loans - A loan is considered impaired when, based upon currently
known information, it is deemed probable that the Company will be unable to
collect all amounts due as scheduled according to the original terms of the
agreement.  Impaired loans are measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or, as a
practical expedient, based on the loan's observable market price or the fair
value of the collateral based on an appraisal, if the loan is collateral
dependent. Impaired loans, which are collateral dependent, are included in the
nonrecurring basis table above.

Investment and Borrowing in Investment in Real Estate in a Joint Venture -
The fair value of the investment in real estate in a joint venture was
determined based on an appraisal of the underlying collateral. The borrowing
associated with the investment is an adjustable rate borrowing; therefore, the
recorded book value is believed to approximate fair value.

Real Estate Owned - The fair value of foreclosed real estate is generally
based on estimated market prices from independently prepared appraisals or
negotiated sales prices with potential buyers and are included in the
nonrecurring basis table above.

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

Deposit Liabilities, Repurchase Agreements and Other Borrowed Funds - 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.

Note 19 - Parent Company (Only) Financial information

Condensed balance sheet at March 31:

  (In thousands)                                   2009       2008
                                                --------     --------
   Cash                                          $   233     $    216
   Investment in Bank                             92,373      127,560
   Investment Securities - available for sale        209          235
   Other assets                                      211        1,912
                                                 -------     --------
                                                 $93,026     $129,923
                                                 =======     ========
   Other liabilities                             $    --     $  1,606
   Stockholders' equity                           93,026      128,317
                                                 -------     --------
                                                 $93,026     $129,923
                                                 =======     ========
                                    111
<PAGE>


                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 19 - Parent Company (Only) Financial information (Continued)

Condensed statement of income for the years ended March 31, 2009, 2008 and
2007:

(In thousands)                                 2009         2008        2007
                                             --------    --------    --------
Income
  Cash dividends from Bank subsidiary        $  2,207    $ 13,961    $  9,149
  Interest                                          8          --          --
                                             --------    --------    --------
      Total income                              2,215      13,961       9,149
                                             --------    --------    --------
Expenses
  Compensation                                    599         851         426
  Other                                           362         221         372
                                             --------    --------    --------
      Total expenses                              961       1,072         798
                                             --------    --------    --------
Income before undistributed income of
 subsidiary and benefit equivalent to income
 taxes                                          1,254      12,889       8,351
Benefit equivalent to income taxes                 75         141         279
                                             --------    --------    --------
Income before undistributed income of
 subsidiary                                     1,329      13,030       8,630
Undistributed income (loss) of subsidiary     (34,695)      5,383      10,398
                                             --------    --------    --------
      Net income (loss)                      $(33,366)   $ 18,413    $ 19,028
                                             ========    ========    ========

(In thousands)                                 2009         2008        2007
                                             --------    --------    --------
Cash flows from operating activities
  Net income (loss)                          $(33,366)   $ 18,413    $ 19,028
Adjustments to reconcile net income to net
  cash flows from operating activities
  Equity in undistributed income of
   subsidiary                                  34,696      (5,383)    (10,398)
  Other operating activities                    2,055         479         127
                                             --------    --------    --------
      Net cash flows from operating
       activities                               3,385      13,509       8,757
                                             --------    --------    --------
Cash flows from investing activities
  Other investing activities                        -        (250)         --
                                             --------    --------    --------
      Net cash flows from investing
       activities                                  --        (250)         --
                                             --------    --------    --------
Cash flows from financing activities
  Sale of common stock                            134         194         149
  Dividends paid                               (3,502)     (6,313)     (5,977)
  Treasury stock purchased                         --      (7,062)     (2,942)
                                             --------    --------    --------
      Net cash flows from financing
       activities                              (3,368)    (13,181)     (8,770)
                                             --------    --------    --------
Net change in cash                                 17          78         (13)
Cash, beginning of year                           216         138         151
                                             --------    --------    --------
Cash, end of year                            $    233    $    216    $    138
                                             ========    ========    ========

                                    112

<PAGE>

                                                       HORIZON FINANCIAL CORP.
                                                 NOTES TO FINANCIAL STATEMENTS
                                                 MARCH 31, 2009, 2008 AND 2007
------------------------------------------------------------------------------

Note 20 - Selected Quarterly Financial Data  (Unaudited)

                                  Year Ended March 31, 2009 (unaudited)
                            --------------------------------------------------
(In thousands)              1st Quarter  2nd Quarter  3rd Quarter  4th Quarter
                            -----------  -----------  -----------  -----------

Interest income               $21,408      $20,757      $19,225     $16,275
Interest expense               10,180        9,834        9,946       9,394
Net interest income            11,228       10,923        9,279       6,881
Provision for loan losses       3,000       12,000       10,000      40,000
Noninterest income              2,258        1,477          977       1,637
Noninterest expense             7,585        8,114        8,315       9,541
                              -------      -------      -------    --------
Income before provision for
 income tax                     2,901       (7,714)      (8,059)    (41,023)
Provision for income tax          881       (3,109)      (2,939)    (15,362)
                              -------      -------      -------    --------
   Net income                 $ 2,020      $(4,605)     $(5,120)   $(25,661)
                              =======      =======      =======    ========
Basic earnings per share
 (adjusted for stock splits
 and dividends)                 $0.17       $(0.39)      $(0.43)    $(2.15)
                                =====       =====         =====     ======
Diluted earnings per share
 (adjusted for stock splits
 and dividends)                 $0.17       $(0.39)      $(0.43)    $(2.15)
                                =====       =====         =====     ======

                                  Year Ended March 31, 2008 (unaudited)
                            --------------------------------------------------
(In thousands)              1st Quarter  2nd Quarter  3rd Quarter  4th Quarter
                            -----------  -----------  -----------  -----------

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

For the fiscal year ended March 31, 2009, the Bank charged off loans totaling
$45.3 million and received recoveries of $135,000. At March 31, 2009, the
allowance for loan losses was $39.0 million, or 3.35% of total loans, compared
to $19.1 million, or 1.58% of total loans at March 31, 2008. The majority of
the increase in the allowance for loan losses occurred in the fourth quarter
of 2009 in the amount of $40.0 million due in large part to the significant
internal downgrade of loans, primarily real estate construction projects where
the land values of the underlying collateral had declined and where the cash
flows of these borrowers was deteriorating from a slowdown in real estate
sales that was necessary to keep the loan(s) current. During the fourth
quarter, the Bank received updated and/or new appraisals as well as exercised
judgment to further stress the impaired loan analysis in order to reflect the
fair values based on available third-party sources along with comparable known
fair values.

                                    113

<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, 2009, 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, 2009 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 2009 that was not so
disclosed.

                                       114

<PAGE>




                                   PART III

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

Directors and Executive Officers

     The information contained under the section captioned "Proposal I --
Election of Directors" is included in the Company's Definitive Proxy Statement
for the 2009 Annual Meeting of Stockholders ("Proxy Statement") and is
incorporated herein by reference.

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

Audit Committee Financial Expert

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

Code of Ethics

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

Compliance with Section 16(a) of the Exchange Act

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

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

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

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

     (a)  Security Ownership of Certain Beneficial Owners.

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

     (b)  Security Ownership of Management.

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

                                       115

<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, 2009.


                                                                 Number of
                                                                 securities
                                                                 remaining
                                                                available for
                                                               future issuance
                                                                under equity
                   Number of securities   Weighted-average      compensation
                    to be issued upon     exercise price of   plans (excluding
                        exercise of           outstanding        securities
                   outstanding options,   options, warrants      reflected
Plan category      warrants and rights        and rights       in column (a))
-----------------  -------------------    -----------------   ----------------
                            (a)                   (b)                (c)
Equity compensation
 plans approved by
 security holders:
  1995 Stock Option
   and Incentive
   Plan............       82,512                 $ 8.12                --
  2005 Incentive
   Stock Plan......       73,744                 $17.65           804,971

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

  Total............      156,256                 $12.61           804,971


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

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

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

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

PART IV

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

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

                                       116

<PAGE>



      10.3    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))
      10.4    Severance Agreement with Dennis C. Joines (incorporated by
              reference to the Registrant's Annual Report on Form 10-K for the
              year ended March 31, 2002)
      10.5    Severance Agreement with Richard P. Jacobson, as amended
              (incorporated by reference to the Registrant's Current Report on
              Form 8-K dated January 23, 2008)
      10.6    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)
      10.7    Stock Incentive Plan (incorporated by reference to Exhibit 99 to
              the Registrant's Registration Statement on Form S-8 (File No.
              333-127178))
      10.8    Form of Incentive Stock Option Award Agreement under the 2005
              Stock Incentive Plan (incorporated by reference to Exhibit 99.1
              contained in the Registrant's Current Report on Form 8-K dated
              July 27, 2005)
      10.9    Form of Non-qualified Stock Option Award Agreement under the
              2005 Stock Incentive Plan (incorporated by reference to Exhibit
              99.1 contained in the Registrant's Current Report on Form 8-K
              dated July 27, 2005)
      10.10   Form of Restricted Stock Award Agreement under the 2005 Stock
              Incentive Plan (incorporated by reference to Exhibit 99.1
              contained in the Registrant's Current Report on Form 8-K dated
              July 27, 2005)
      10.11   Transition Agreement with V. Lawrence Evans (incorporated by
              reference to the Registrant's Current Report on Form 8-K dated
              March 25, 2008)
      10.12   Change in Control/Severance Agreement with Greg B. Spear
              (incorporated by reference to the Registrant's Current Report on
              Form 8-K dated October 24, 2008)
      10.13   Order to Cease and  Desist with the Federal Deposit Insurance
              Corporation and the Washington Statement Department of Financial
              Institutions (incorporated by reference to the Registrant's
              Current Report on Form 8-K dated February 26, 2009)
      10.14   Stipulation and Consent to the Issuance of an Order to Cease and
              Desist (incorporated by reference to the Registrant's Current
              Report on Form 8-K dated February 26, 2009)
      14      Code of Ethics (incorporated by reference to the Registrant's
              Annual Report on Form 10-K for the year ended March 31, 2007)
      21      Subsidiaries of the Registrant (incorporated by reference to the
              Registrant's Annual Report on Form 10-K for the year ended March
              31, 2007)
      23      Consent of Moss Adams LLP, Independent Registered Public
              Accounting Firm
      31.1    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
      32.1    Certification of Chief Executive Officer Pursuant to Section 906
              of the Sarbanes-Oxley Act
      32.2    Certification of 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.

                                       117

<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 10, 2009               By: /s/Richard P. Jacobson
                                        ------------------------------------
                                        Richard P. Jacobson
                                        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/Richard P. Jacobson                  By: /s/Robert C. Diehl
    -----------------------------               -----------------------------
    Richard P. Jacobson                         Robert C. Diehl
    Chief Executive Officer and President       Director
    (Principal Executive)


    Date:   June 10, 2009                       Date:   June 10, 2009




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


     Date:  June 10, 2009                       Date:  June 10, 2009




By: /s/Greg B. Spear                        By: /s/Robert C. Tauscher
    -----------------------------               -----------------------------
    Greg B. Spear                               Robert C. Tauscher
    Chief Financial Officer                     Director
    (Principal Financial Officer)

     Date:  June 10, 2009                       Date: June 10, 2009




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


    Date: June 10, 2009                         Date: June 10, 2009

                                       118

<PAGE>

                                EXHIBIT INDEX


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  32.1   Certification of Chief Executive Officer Pursuant to Section
                906 of the Sarbanes-Oxley Act

Exhibit  32.2   Certification of Chief Financial Officer Pursuant to Section
                906 of the Sarbanes-Oxley Act

<PAGE>



                                  Exhibit 23

           Consent of Independent Registered Public Accounting Firm

<PAGE>



           CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors
Horizon Financial Corp. and Subsidiary

We consent to the incorporation by reference in the Registration Statements on
Form S-8 (No. 333-99780 and No. 333-127178) and on Form S-3 (No. 333-155525)
of our report dated June 10, 2009 relating to the consolidated statements of
financial position of Horizon Financial Corp. and Subsidiary as of March 31,
2009 and 2008, and the related consolidated statements of operations, changes
in stockholders' equity and comprehensive income (loss), and cash flows for
each of the years in the three-year period ended March 31, 2009, and in our
same report, with respect to Horizon Financial Corp. and Subsidiary's internal
control over financial reporting as of March 31, 2009, appearing in this
Annual Report on Form 10-K of Horizon Financial Corp. and Subsidiary, for the
years ended March 31, 2009 and 2008.

/s/ Moss Adams LLP

Bellingham, Washington
June 10, 2009

<PAGE>



                                Exhibit 31.1

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

I, Richard P. Jacobson, certify that:

1.  I have reviewed this Annual Report on Form 10-K of Horizon Financial
    Corp.;

2.  Based on my knowledge, this report does not contain any untrue statement
    of a material fact or omit to state a material fact necessary to make the
    statements made, in light of the circumstances under which such statements
    were made, not misleading with respect to the period covered by this
    report;

3.  Based on my knowledge, the financial statements, and other financial
    information included in this report, fairly present in all material
    respects the financial condition, results of operations and cash flows of
    the registrant as of, and for, the periods presented in this report;

4.  I am responsible for establishing and maintaining disclosure controls and
    procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
    internal control over financial reporting (as defined in Exchange
    Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

    a)  Designed such disclosure controls and procedures, or caused such
        disclosure controls and procedures to be designed under our
        supervision, to ensure that material information relating to the
        registrant, including its consolidated subsidiaries, is made known to
        us by others within those entities, particularly during the period in
        which this report is being prepared;

    b)  Designed such internal control over financial reporting, or caused
        such internal control over financial reporting to be designed under
        our supervision, to provide reasonable assurance regarding the
        reliability of financial reporting and the preparation of financial
        statements for external purposes in accordance with generally accepted
        accounting principles;

    c)  Evaluated the effectiveness of the registrant's disclosure controls
        and procedures and presented in this report our conclusions about the
        effectiveness of the disclosure controls and procedures, as of the end
        of the period covered by this report based on such evaluation; and

    d)  Disclosed in this report any change in the registrant's internal
        control over financial reporting that occurred during the registrant's
        most recent fiscal quarter (the registrant's fourth fiscal quarter in
        the case of an annual report) that has materially affected, or is
        reasonably likely to materially affect, the registrant's internal
        control over financial reporting; and

5.  I have disclosed, based on our most recent evaluation of internal control
    over financial reporting, to the registrant's auditors and the audit
    committee of the registrant's board of directors (or persons performing
    the equivalent functions):

    a)  All significant deficiencies and material weaknesses in the design or
        operation of internal control over financial reporting which are
        reasonably likely to adversely affect the registrant's ability to
        record, process, summarize and report financial information; and

    b)  Any fraud, whether or not material, that involves management or other
        employees who have a significant role in the registrant's internal
        control over financial reporting.

Date: June 10, 2009

                               /s/ Richard P. Jacobson
                               --------------------------------------
                               Richard P. Jacobson
                               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, Greg B. Spear, certify that:

1.  I have reviewed this Annual Report on Form 10-K of Horizon Financial
    Corp.;

2.  Based on my knowledge, this report does not contain any untrue statement
    of a material fact or omit to state a material fact necessary to make the
    statements made, in light of the circumstances under which such statements
    were made, not misleading with respect to the period covered by this
    report;

3.  Based on my knowledge, the financial statements, and other financial
    information included in this report, fairly present in all material
    respects the financial condition, results of operations and cash flows of
    the registrant as of, and for, the periods presented in this report;

4.  I am responsible for establishing and maintaining disclosure controls and
    procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
    internal control over financial reporting (as defined in Exchange
    Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

    a)  Designed such disclosure controls and procedures, or caused such
        disclosure controls and procedures to be designed under our
        supervision, to ensure that material information relating to the
        registrant, including its consolidated subsidiaries, is made known to
        us by others within those entities, particularly during the period in
        which this report is being prepared;

    b)  Designed such internal control over financial reporting, or caused
        such internal control over financial reporting to be designed under
        our supervision, to provide reasonable assurance regarding the
        reliability of financial reporting and the preparation of financial
        statements for external purposes in accordance with generally accepted
        accounting principles;

    c)  Evaluated the effectiveness of the registrant's disclosure controls
        and procedures and presented in this report our conclusions about the
        effectiveness of the disclosure controls and procedures, as of the end
        of the period covered by this report based on such evaluation; and

    d)  Disclosed in this report any change in the registrant's internal
        control over financial reporting that occurred during the registrant's
        most recent fiscal quarter (the registrant's fourth fiscal quarter in
        the case of an annual report) that has materially affected, or is
        reasonably likely to materially affect, the registrant's internal
        control over financial reporting; and

5.  I have disclosed, based on our most recent evaluation of internal control
    over financial reporting, to the registrant's auditors and the audit
    committee of the registrant's board of directors (or persons performing
    the equivalent functions):

    a)  All significant deficiencies and material weaknesses in the design or
        operation of internal control over financial reporting which are
        reasonably likely to adversely affect the registrant's ability to
        record, process, summarize and report financial information; and

    b)  Any fraud, whether or not material, that involves management or other
        employees who have a significant role in the registrant's internal
        control over financial reporting.

Date: June 10, 2009

                                    /s/ Greg B. Spear
                                    -------------------------------
                                    Greg B. Spear
                                    Chief Financial Officer

<PAGE>



                                Exhibit 32.1

                  CERTIFICATION OF CHIEF EXECUTIVE OFFICER
                         OF HORIZON FINANCIAL CORP.
         PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


     The undersigned hereby certify, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form
10-K, that:

   1. the report fully complies with the requirements of Sections 13(a) and
      15(d) of the Securities Exchange Act of 1934, as amended, and

   2. the information contained in the report fairly presents, in all material
      respects, the company's financial condition and results of operations.



/s/ Richard P. Jacobson
---------------------------
Richard P. Jacobson
Chief Executive Officer

Dated: June 10, 2009

<PAGE>



                                Exhibit 32.2

                 CERTIFICATION OF 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/ Greg B. Spear
--------------------------
Greg B. Spear
Chief Financial Officer

Dated: June 10, 2009

<PAGE>