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

                                   FORM 10-KSB

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

      For the fiscal year ended June 30, 2003

                                       OR

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

      For the transition period from ____________ to ____________

              Commission file number 0-24036

                     HORIZON FINANCIAL SERVICES CORPORATION
                 (Name of small business issuer in its charter)

               Delaware                                  42-1419757
  (State or other jurisdiction of           (I.R.S. Employer Identification No.)
   incorporation or organization)

  301 First Avenue East, Oskaloosa, Iowa                 52577-0008
 (Address of principal executive offices)                (Zip Code)

Registrant's telephone number, including area code: (641) 673-8328

           Securities Registered Pursuant to Section 12(b) of the Act:

                                      None

           Securities Registered Pursuant to Section 12(g) of the Act:

                     Common Stock, par value $0.01 per share
                                (Title of class)

      Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 |_|.

      Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained herein, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. |X|

      State the issuer's revenues for its most recent fiscal year: $6,429,335.

      The aggregate market value of the voting stock held by non-affiliates of
the Registrant, computed by reference to the average of the closing bid and
asked price of such stock as reported on the Nasdaq System as of September 5,
2003, was $7.57 million. (The exclusion from such amount of the market value of
the shares owned by any person shall not be deemed an admission by the
Registrant that such person is an affiliate of the Registrant.)

      As of September 5, 2003, there were issued and outstanding 764,111 shares
of the Registrant's Common Stock.

                       DOCUMENTS INCORPORATED BY REFERENCE

      Part II of Form 10-KSB - Annual Report to Stockholders for the fiscal year
ended June 30, 2003.

      Part III of Form 10-KSB - Proxy Statement for the Annual Meeting of
Stockholders to be held in October 2003.

      Transitional Small Business Disclosure Format: YES |_|; NO |X|.

<PAGE>

                                     PART I

Item 1. Description of Business

General

      The Company. Horizon Financial Services Corporation (the "Company"), a
Delaware corporation, was formed in March 1994 to act as the holding company for
Horizon Federal Savings Bank ("Horizon Federal" or the "Bank") upon the Bank's
conversion from the mutual to the stock form (the "Conversion"), which occurred
on June 28, 1994. All references to the Company, unless otherwise indicated, at
or before June 28, 1994 are to the Bank and its subsidiary on a consolidated
basis. The Company's common stock trades over-the-counter on the Nasdaq Bulletin
Board under the Symbol "HZFS".

      At June 30, 2003, the Company had $91.3 million of assets and
stockholders' equity of $10.4 million (or 11.4% of total assets).

      The executive offices of the Company are located at 301 First Avenue East,
Oskaloosa, Iowa 52577, and its telephone number at that address is (641)
673-8328.

      Horizon Federal. Horizon Federal, a wholly owned subsidiary of the
Company, is a federally chartered stock savings bank headquartered in Oskaloosa,
Iowa. Its deposits are insured up to applicable limits, by the Federal Deposit
Insurance Corporation (the "FDIC"), which is backed by the full faith and credit
of the United States. Horizon Federal's primary market area covers Mahaska
County, that portion of Marion County in and around Knoxville, Iowa and to a
lesser extent, Wapello County, Iowa. The Bank services its market area through
its three full service offices, two of which are located in Oskaloosa, Iowa and
one which is located in Knoxville, Iowa.

      In April, 2003, the Bank opened a mortgage loan origination office in
Pleasant Hill, Iowa which serves Polk County and surrounding areas. The Bank has
also received approval from the Office of Thrift Supervision to establish a
retail banking office in Pleasant Hill, Iowa which is scheduled to open in the
spring of 2004.

      The principal business of the Bank consists of attracting deposits from
the general public and using such deposits, together with borrowings and other
funds, primarily to originate one-to-four family residential mortgage loans. To
a lesser extent, the Bank also originates consumer loans, commercial business
loans, multi-family and commercial real estate loans and residential
construction loans. The Bank also invests in mortgage-backed and related
securities, as well as investment securities. See "Originations of Loans and
Mortgage-Backed Securities." At June 30, 2003, substantially all of the Bank's
real estate mortgage loans (excluding mortgage-backed securities) were secured
by properties located in Iowa.

      The Bank's revenues are derived principally from interest on mortgage
loans and securities, service fee income and dividends on Federal Home Loan Bank
("FHLB") stock. The Bank does not originate loans to fund leveraged buyouts and
has no loans to non-United States corporations or foreign governments.


                                       1
<PAGE>

      The Bank currently offers a variety of deposit accounts having a wide
range of interest rates and terms. The Bank's deposits include commercial
demand, savings, checking, money market and certificate accounts. The Bank only
solicits deposits in its primary market area and does not accept brokered
deposits.

      Horizon Federal's operations are materially affected by general economic
conditions, the monetary and fiscal policies of the federal government and the
policies of the various regulatory authorities, including the Office of Thrift
Supervision ("OTS") and the Board of Governors of the Federal Reserve System
("Federal Reserve Board").

      During fiscal 1995, the Company entered into a joint venture low income
apartment housing project to take advantage of certain tax benefits available
under Section 42 of the Internal Revenue Code of 1986, as amended. The apartment
housing project is composed of 62 units and is located in Des Moines, Iowa. At
June 30, 2003, the apartment complex was 95% leased. At June 30, 2003, the
Company's equity investment in the project was $110,310, representing a 16.5%
limited partnership interest in the project. The Company will receive tax
credits of approximately $42,000 per year through 2005.

Forward-Looking Statements

      When used in this Annual Report on Form 10-KSB or future filings by the
Company with the Securities and Exchange Commission, in the Company's press
releases or other public or shareholder communications, or in oral statements
made with the approval of an authorized executive officer, the words or phrases
"will likely result", "are expected to", "will continue", "is anticipated",
"estimate", "project", "believe" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors--including regional
and national economic conditions, changes in levels of market interest rates,
credit risks of lending activities, and competitive and regulatory
factors--could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.

      The Company does not undertake--and specifically disclaims any
obligation--to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.

Market Area

      Horizon Federal primarily serves Mahaska County and that portion of Marion
County in and around Knoxville, Iowa. The Bank has three offices, two of which
are located in Oskaloosa, Iowa and one which is located in Knoxville, Iowa,
approximately 25 miles west of Oskaloosa. In 2003 the Bank opened a loan
production office in Pleasant Hill, Iowa, a suburb on the East side of Des
Moines, Iowa. This office is currently making single family residential
construction and end loans in Polk County and surrounding counties. The Bank
competes in loan originations and in deposit gathering activities with the ten
financial institutions and three credit unions


                                       2
<PAGE>

serving its primary market area. See "Competition." The Bank estimates its share
of the savings market in its primary market area to be approximately 18%.

      Oskaloosa, Iowa is located in Mahaska County, approximately 60 miles
southeast of Des Moines, Iowa. Mahaska County has a population of approximately
22,000. Oskaloosa, with a current population of approximately 10,500, is the
county seat and the largest city in Mahaska County. Oskaloosa primarily has an
agricultural economy and, to a lesser extent, light industrial and retail
economies. Its light industrial economy, however, is mainly agricultural
support. Major employers in the area include the Clow Valve Company, the Pella
Corporation, Cargill, Vermeer Manufacturing, the V.A. Medical Center, 3-M
Company, William Penn University and the Mahaska County Hospital.

      Local economic conditions in the Bank's Mahaska and Marion markets are
somewhat sluggish. Some area employers are laying off employees and some are
cutting employees' hours from 40 to 32 hours per week. Currently, farm prices
for both grain and livestock are volatile but farmers are not struggling. We are
currently experiencing decline in some lines of retail business in these
markets. Local economic conditions in Polk County are better and offer the Bank
a good opportunity to extend its lending area.

      Mahaska and Marion County economic conditions and strong competition may
affect the financial condition and results of operations of the Company and the
Bank. In the event current economic and market conditions persist or worsen in
the Mahaska and Marion County markets, loan demand and existing loans may be
affected. No assurances can be given that the Bank will be able to maintain or
increase its loan portfolio, which could adversely affect the financial
condition and results of operations of the Company and the Bank. Additionally,
the establishment of a branch office typically affects net income adversely in
the short term until business reaches a level consistent with profitable
operations. Conversely, these results could be positively affected by the Bank's
expansion of its lending area.

Lending Activities of the Bank

      General. Historically, the Bank originated fixed-rate one-to-four family
mortgage loans. Since the early 1980s, however, the Bank has emphasized, subject
to market conditions, the origination and holding in portfolio of short- and
intermediate-term (one, three and five year) loans that convert to annual
adjustable-rate mortgage ("ARM") loans after their initial period. Management's
strategy has been to increase the percentage of assets in its portfolio with
more frequent repricing characteristics or shorter maturities. During periods of
low demand for one-to-four family loans, the Bank may seek to invest in
mortgage-backed and related securities. The Bank also originates for its loan
portfolio fixed-rate, first lien mortgages for certain budgeted amounts. The
Bank also originates and sells in the secondary market 15 year and 30 year
fixed-rate loans.

      The Bank primarily focuses its lending activities on the origination of
loans secured by first mortgages on owner-occupied, one-to-four family
residences. To a lesser extent, the Bank also originates consumer loans,
commercial business loans, commercial and multi-family real estate loans and
residential construction loans. See "Originations of Loans and Mortgage-Backed
Securities." At June 30, 2003, the Bank's net loan portfolio totaled $65.0
million.


                                       3
<PAGE>

      Several loan officers of the Bank and all members of the Board of
Directors serve as Loan Committee members on a rotating basis. At any given
time, the approval of at least three directors is required to approve real
estate loans over $350,000. Loan Committee approval is currently required for
unsecured and secured consumer loans of more than $100,000 and $120,000,
respectively, and unsecured and secured commercial business loans of more than
$50,000 and $200,000, respectively. The Board of Directors must approve all
commercial business loans with a balance exceeding $350,000.

      The aggregate amount of loans that the Bank is permitted to make under
applicable federal regulations to any one borrower, including related entities,
or the aggregate amount that the Bank can invest in any one real estate project
is, with certain exceptions, generally the greater of 15% of unimpaired capital
and surplus or $500,000. See "Regulation -- Federal Regulation of Savings
Banks." At June 30, 2003, the maximum amount which the Bank could lend to any
one borrower and the borrower's related entities under the applicable federal
regulations was approximately $1,310,000, however, at June 30, 2003 the Board of
Directors of the Bank had a self-imposed $800,000 general limitation.

      The Bank reserves the right to change or discontinue lending programs to
respond to regulatory or competitive factors.


                                       4
<PAGE>

      Portfolio Composition. The following table presents the composition of the
Bank's loan portfolio in dollar amounts and in percentages (before deductions
for loans in process, deferred fees and discounts and allowances for losses) as
of the dates indicated.

<TABLE>
<CAPTION>
                                                                                 At June 30,
                                                  ------------------------------------------------------------------------------
                                                           2003                      2002                        2001
                                                  ---------------------     ----------------------       -----------------------
                                                   Amount       Percent      Amount        Percent        Amount         Percent
                                                  -------       -------     -------        -------       -------         -------
                                                                           (Dollars in Thousands)
<S>                                               <C>            <C>        <C>             <C>          <C>             <C>
Real Estate:
 One-to-four family .......................       $34,975         53.3%     $38,553          58.7%       $41,515          63.0%
 Commercial real estate ...................         7,117         10.9        7,020          10.7          6,703          10.1
 Multi-family .............................           796          1.2        1,363           2.1          1,458           2.2
 Residential construction .................         2,357          3.6        1,475           2.2          1,381           2.1
                                                  -------        -----      -------         -----        -------         -----
     Total real estate loans ..............        45,245         69.0       48,411          73.7         51,057          77.4
                                                  -------        -----      -------         -----        -------         -----

Other Loans:
 Consumer Loans:
  Automobile ..............................         2,996          4.6        3,171           4.8          3,482           5.3
  Home improvement ........................            86           .1          299            .5            361            .5
  Deposit account .........................           297           .4          265            .4            198            .3
  Other ...................................         3,656          5.6        3,121           4.8          2,946           4.5
                                                  -------        -----      -------         -----        -------         -----
     Total consumer loans .................         7,035         10.7        6,856          10.5          6,987          10.6
 Commercial business loans ................        13,308         20.3       10,386          15.8          7,856          12.0
                                                  -------        -----      -------         -----        -------         -----
     Total other loans ....................        20,343         31.0       17,242          26.3         14,843          22.6
                                                  -------        -----      -------         -----        -------         -----
     Total loans receivable, gross ........        65,588        100.0%      65,653         100.0%        65,900         100.0%
                                                                 =====                      =====                        =====

Less:
 Loans in process .........................            --                        --                           --
 Deferred fees and discounts ..............            25                        17                           85
 Allowance for losses .....................           556                       537                          369
                                                  -------                   -------                      -------
 Total loans receivable, net ..............       $65,007                   $65,099                      $65,446
                                                  =======                   =======                      =======
</TABLE>


                                       5
<PAGE>

      The following table shows the composition of the Bank's loan portfolio by
fixed- and adjustable-rate at the dates indicated.

<TABLE>
<CAPTION>
                                                                                              At June 30,
                                                                    ----------------------------------------------------------------
                                                                           2003                   2002                  2001
                                                                    ------------------     ------------------     ------------------
                                                                     Amount    Percent      Amount    Percent      Amount    Percent
                                                                    -------    -------     -------    -------     -------    -------
                                                                                         (Dollars in Thousands)
<S>                                                                 <C>          <C>       <C>          <C>       <C>          <C>
Fixed-Rate Loans:
   Real estate:
     One-to-four family .......................................     $11,826      18.0%     $10,891      16.6%     $11,088      16.8%
     Commercial real estate ...................................       3,318       5.1        2,882       4.4        2,760       4.2
     Multi-family .............................................         796       1.2          854       1.3          897       1.4
     Residential construction .................................       2,357       3.6        1,475       2.2        1,244       1.9
                                                                    -------     -----      -------     -----      -------     -----
       Total fixed-rate real estate loans .....................      18,297      27.9       16,102      24.5       15,989      24.3
                                                                    -------     -----      -------     -----      -------     -----

     Consumer .................................................       6,845      10.4        6,800      10.4        6,927      10.5
     Commercial business ......................................      10,187      15.6        8,676      13.2        7,311      11.1
                                                                    -------     -----      -------     -----      -------     -----
       Total fixed-rate loans .................................      35,329      53.9       31,578      48.1       30,227      45.9
                                                                    -------     -----      -------     -----      -------     -----

Adjustable-Rate Loans:
   Real estate:
     One-to-four family .......................................      23,149      35.3       27,662      42.1       30,427      46.2
     Commercial real estate ...................................       3,799       5.8        4,138       6.3        3,943       6.0
     Multi-family .............................................          --        --          509        .8          561        .8
     Residential construction .................................          --        --           --        --          137        .2
                                                                    -------     -----      -------     -----      -------     -----
       Total adjustable-rate real estate loans ................      26,948      41.1       32,309      49.2       35,068      53.2

     Consumer .................................................         190        .3           56        .1           60        .1
     Commercial business ......................................       3,121       4.7        1,710       2.6          545        .8
                                                                    -------     -----      -------     -----      -------     -----
       Total adjustable-rate loans ............................      30,259      46.1       34,075      51.9       35,673      54.1
                                                                    -------     -----      -------     -----      -------     -----
       Total loans, receivable, gross .........................      65,588     100.0%      65,653     100.0%      65,900     100.0%
                                                                                =====                  =====                  =====

Less:
   Loans in process ...........................................          --                     --                     --
   Deferred fees and discounts ................................          25                     17                     85
   Allowance for loan losses ..................................         556                    537                    369
                                                                    -------                -------                -------
       Total loans receivable, net ............................     $65,007                $65,099                $65,446
                                                                    =======                =======                =======
</TABLE>


                                       6
<PAGE>

      The following table illustrates the interest rate sensitivity of the
Bank's loan portfolio at June 30, 2003. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The table does not reflect the effects of possible prepayments
or enforcement of due-on-sale clauses.

<TABLE>
<CAPTION>
                                        Real Estate
                           ----------------------------------------
                                                     Residential                                Commercial
                               Mortgage(1)          Construction            Consumer              Business               Total
                           ------------------    ------------------     -----------------    ------------------     ----------------
                                     Weighted              Weighted              Weighted              Weighted             Weighted
                                      Average               Average               Average               Average              Average
                           Amount      Rate      Amount      Rate       Amount     Rate      Amount      Rate       Amount    Rate
                           ------    --------    ------    --------     ------   --------    ------    --------     ------  --------
                                                                    (Dollars in Thousands)
<C>                        <C>         <C>       <C>         <C>       <C>         <C>       <C>         <C>       <C>        <C>
      Due During
     Years Ending
       June 30,

2004(2) ..............     $11,051     7.02%     $ 2,357     6.41%     $ 1,657     8.02%     $ 5,924     7.62%     $20,989    7.20%
2005 to 2008 .........      14,904     6.79           --       --        4,067     8.14        4,252     7.65       23,223    7.18
2009 and following ...      16,933     7.31           --       --        1,311     7.53        3,132     7.68       21,376    7.38
                           -------               -------               -------               -------               -------
   Total .............     $42,888     7.05%     $ 2,357     6.41%     $ 7,035     8.00%     $13,308     7.64%     $65,588    7.25%
                           =======               =======               =======               =======               =======
</TABLE>

----------
(1)   Includes one-to-four family, multi-family and commercial real estate
      mortgage loans.

(2)   Includes demand loans and loans having no stated maturity.


                                       7
<PAGE>

      The total amount of loans that are due after June 30, 2004 and have
predetermined interest rates is $29.7 million, while the total amount of loans
due after such date with floating or adjustable interest rates is $14.9 million.

      One-to-Four Family Residential Mortgage Lending. Residential loan
originations are generated by the Bank's marketing efforts (which include radio
ads, newspaper ads and direct mail), its present and walk-in customers, and
referrals from real estate brokers and builders. The Bank focuses its lending
efforts primarily on the origination of loans secured by first mortgages on
owner-occupied, single-family residences in its market area. See "Originations
of Loans and Mortgage-Backed Securities."

      The Bank currently originates ARM loans and fixed-rate loans for retention
in the Bank's loan portfolio. During the fiscal year ended June 30, 2003
("fiscal 2003"), the Bank originated $6.0 million of adjustable-rate,
one-to-four family real estate loans (including $126,000 of residential
construction loans) and $13.8 million of fixed-rate one-to-four family loans
(including $3.3 million of residential construction loans). The Bank's
one-to-four family residential mortgage originations are primarily in its market
area.

      The Bank currently originates adjustable-rate, one-to-four family
residential mortgage loans with a maximum term of 30 years. Fixed-rate loans
originated for its portfolio are generally originated up to a maximum term of 30
years. Fixed-rate mortgage loans originated by the Bank in excess of 15 years
are generally sold in the secondary market. The Bank originated $10.9 million of
fixed-rate loans for sale during fiscal 2003.

      One-to-four family loan originations are generally made in amounts of up
to 95% of the appraised value or selling price of the security property,
whichever is less. For loans originated with loan-to-value ratios of greater
than 80%, the Bank typically requires private mortgage insurance to reduce the
Bank's exposure to 80% of the appraised value or selling price of the security
property.

      The Bank currently offers one-year, three-year and five-year balloon loans
that convert into ARM loans with annual adjustment after the initial term. Rates
are determined in accordance with market and competitive factors. The Bank's ARM
products generally carry interest rates which, pursuant to the terms of the
note, may be reset to a stated margin over the index utilized by the Bank, which
is currently the National Average Contract Rate for Previously Owned Homes. The
adjustable-rate loans currently originated by the Bank provide for a maximum 2%
annual cap, and a maximum 6% lifetime cap on the interest rate over the rate in
effect on the date of origination. The annual and lifetime caps on interest rate
increases reduce the extent to which these loans can help protect the Bank
against interest rate risk and may cause these loans not to be as sensitive as
the Bank's cost of funds. The Bank's ARM loans are not convertible into
fixed-rate loans. All of the Bank's one-to-four family loans are not assumable,
do not contain prepayment penalties and do not produce negative amortization.
Approximately 30.3% of the loans secured by one-to-four family real estate
originated by the Bank during fiscal 2003 were originated with adjustable rates
of interest. See "Originations of Loans and Mortgage-Backed Securities."


                                       8
<PAGE>

      At June 30, 2003, the Bank was not servicing any loans other than loans it
originated. As of June 30, 2003, the Bank's residential ARM loan portfolio
totaled $23.1 million, or 35.3% of the Bank's gross loan portfolio as compared
to the residential fixed-rate, mortgage loan portfolio which totaled $11.8
million, or 18.0% of the Bank's gross loan portfolio. ARM loans decrease the
risk associated with changes in interest rates but involve other risks,
primarily because as interest rates rise, the payment by the borrower may rise
to the extent permitted by the terms of the loan, thereby increasing the
potential for default. At the same time, the market value of the underlying
property may be adversely affected by higher interest rates increasing potential
losses from defaults.

      In underwriting residential real estate loans, the Bank evaluates both the
borrower's ability to make monthly payments, employment history, credit history
and the value of the property securing the loan. Potential borrowers are
qualified for fixed-rate loans based upon the stated rate of the loan. Borrowers
on adjustable-rate loans are currently qualified at a rate then in effect for
five-year loans on one-to-four family residential property. Typically, the
spread between a one-year ARM and a five-year ARM has been 100 basis points or
more. The Bank generally requires that for mortgage loan applications an
appraisal of the security property be performed by an independent fee appraiser
approved by the Bank. In connection with origination of residential real estate
loans, the Bank generally requires an opinion from an attorney regarding the
title to the property, and fire and casualty insurance in an amount not less
than the amount of the loan.

      To supplement loan demand in the Bank's primary market area the Bank
purchases mortgage-backed and related securities. The Bank purchased $6.4
million, $4.9 million and $4.6 million of mortgage-backed and related securities
during fiscal 2003, the fiscal year ended June 30, 2002 ("fiscal 2002") and the
fiscal year ended June 30, 2001 ("fiscal 2001"), respectively. See "Originations
of Loans and Mortgage-Backed Securities."

      Residential Construction Lending. The Bank makes construction loans to
individuals for the construction of their residences and, from time to time, to
established builders and developers for the construction of residential homes
without an underlying sales contract. At June 30, 2003, the Bank's construction
loan portfolio totaled $2.4 million, or 3.6% of its gross loan portfolio. As of
that date substantially all of these loans were in the Company's primary market
area.

      Construction loans to individuals for their residences are structured to
be converted to permanent loans at the end of the construction phase which
typically runs from six months to one year. These construction loans have rates
and terms which match one-to-four family loans then offered by the Bank, except
that during the construction phase the borrower pays interest only. The maximum
loan-to-value ratio of owner occupied single family construction loans is 95%.
Residential construction loans are generally underwritten pursuant to the same
guidelines used for originating permanent one-to-four family residential loans.
The application process for construction loans includes a submission to the Bank
of the plans and costs of the project to be constructed. These items are used as
a basis to determine the appraised value of the subject property. Loans are
based on the lesser of current appraised value or the cost of construction (land
plus building).


                                       9
<PAGE>

      The uncertainties inherent in estimating construction costs and the market
for a project upon completion makes it relatively difficult to evaluate
accurately the total loan funds required to complete a project, the related
loan-to-value ratios and the likelihood of ultimate success of the project.
Construction loans to borrowers other than owner-occupants also involve many of
the same risks discussed below regarding commercial real estate loans and tend
to be more sensitive to general economic conditions than many other types of
loans.

      Multi-Family/Commercial Real Estate Lending. Horizon Federal also makes
real estate loans secured by multi-family and non-residential properties.
Horizon Federal's multi-family residential loans are primarily secured by
apartment buildings located within the Bank's market area. The commercial real
estate loans originated by the Bank are primarily secured by office buildings,
churches, storage facilities, and other income-producing properties. At June 30,
2003, $.8 million, or 1.2%, of the Bank's gross loan portfolio consisted of
multi-family loans and $7.1 million, or 10.9%, of the Bank's gross loan
portfolio consisted of commercial real estate loans.

      Commercial real estate lending entails significant additional risks as
compared with residential property lending. Commercial real estate loans
typically involve large loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans is typically dependent on the
successful operation of the real estate project and as such may be subject to a
greater extent than residential loans to adverse conditions in the economy
generally. In dealing with these risk factors, the Bank generally limits itself
to a real estate market and/or borrowers with which it has knowledge and
experience.

      Appraisals on properties securing multi-family and commercial real estate
property loans originated by the Bank are performed by an independent fee
appraiser approved by the Bank at the time the loan is made. All appraisals on
multi-family and commercial real estate loans are reviewed by the Bank's
management. In addition, the Bank's underwriting procedures generally require
verification of the borrower's credit history, income and financial statements,
banking relationships and income projections for the property. In recent years,
personal guarantees have been obtained for all or most of the Bank's
multi-family and commercial real estate loans. While the Bank continues to
monitor multi-family and commercial real estate loans on a regular basis after
origination, updated appraisals are not normally obtained after closing unless
the Bank believes that there are questions regarding the status of the loan or
the value of the collateral.

      At June 30, 2003, the Bank had no multi-family or commercial real estate
loans to one borrower, or group of borrowers, which had an existing carrying
value in excess of $656,500. The Bank had only eight commercial and multi-family
real estate loans which exceeded $300,000 at June 30, 2003, all of which were
performing in accordance with their repayment terms.

      Multi-family and commercial real estate lending affords the Bank an
opportunity to receive interest at rates higher than those generally available
to one-to-four family residential lending. Nevertheless, loans secured by such
properties are generally larger and involve a greater degree of risk than
one-to-four family residential mortgage loans. Because payments on loans secured
by multi-family and commercial real estate properties are often dependent on the
successful operation or management of the properties, repayment of such loans
may be subject to adverse conditions in the real estate market or the economy.
If the cash flow from the project is


                                       10
<PAGE>

reduced (for example, if leases are not obtained or renewed), the borrower's
ability to repay the loan may be impaired. Horizon Federal's current lending
guidelines generally require, in the case of loans secured by multi-family or
commercial income-producing property, that the property securing such loans
generate net cash flow of 125% of debt service after payment of all operating
expenses, excluding depreciation, and a loan-to-value ratio of no more than 75%.

      Consumer Lending. Management believes that offering consumer loan products
helps reinforce and expand the Bank's customer base. In addition, because
consumer loans generally have shorter terms to maturity and/or adjustable rates
and carry higher rates of interest than do residential mortgage loans, they can
be useful asset/liability management tools. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Asset/Liability
Management" in the Annual Report to Stockholders attached hereto as Exhibit 13
(the "Annual Report"). The Bank currently originates substantially all of its
consumer loans in its primary market area. At June 30, 2003, the Bank's consumer
loans totaled $7.0 million, or 10.7% of the Bank's gross loan portfolio.

      Horizon Federal offers a variety of consumer loans for various purposes
with terms up to 15 years. The majority of lending is for automobiles, home
improvement and other personal purposes. The Bank originates consumer loans on
both a direct and an indirect basis. Direct loans are made when the Bank extends
credit directly to the borrower. Indirect loans are obtained when the Bank
purchases loan contracts from retailers of goods or services which have extended
credit to their customers. Horizon Federal began its indirect lending program in
January 1993 with selected automobile dealers located in the Bank's lending
area. At June 30, 2003, the outstanding balances on automobile loans and home
improvement totaled $3.2 million and $86,000, or 4.9% and .1% of the Bank's
gross consumer loan portfolio, respectively.

      In addition, Horizon Federal offers Visa and MasterCard credit cards. Both
types of lending generally present more credit risk to the Bank than one-to-four
family residential lending. At June 30, 2003, the Bank had $40,000 of credit
card loans outstanding and $224,000 of unused credit available under its credit
card program.

      The underwriting standards employed by the Bank for consumer loans include
a determination of the applicant's payment history on other debts and an
assessment of the ability to meet existing obligations and payments on the
proposed loan. Although creditworthiness of the applicant is a primary
consideration, the underwriting process also includes a comparison of the value
of the security, if any, in relation to the proposed loan amount.

      Consumer loans may entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured, or are secured
by rapidly depreciable assets such as automobiles. 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. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability and
thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
bankruptcy and insolvency laws, may limit the amount which can be recovered on
such loans. At June 30, 2003, non-performing consumer loans totaled $333,000, or
4.7% of


                                       11
<PAGE>

total consumer loans and .5% of the Bank's gross loan portfolio. See "Asset
Quality - Non-Performing Assets."

      Commercial Business Lending. The Bank also originates commercial business
loans. The Bank offers commercial business loans to service existing customers,
to consolidate its banking relationships with these customers, and to further
its asset/liability management goals. Most of the Bank's commercial business
loans have been extended to finance local businesses and include short-term
loans to finance machinery and equipment purchases, inventory and accounts
receivable. Commercial loans also involve the extension of revolving credit for
a combination of equipment acquisitions and working capital in expanding
companies. At June 30, 2003, commercial business loans totaled $13.3 million, or
20.3% of the Bank's gross loan portfolio.

      The maximum term for loans extended on machinery and equipment is based on
the projected useful life of such machinery and equipment. Generally, the
maximum term on non-mortgage lines of credit is one year. The loan-to-value
ratio on such loans may not exceed 75% of the value of the collateral securing
the loan.

      The two largest commercial business loans outstanding at June 30, 2003
were a $760,000 business line of credit to a builder of one-to-four family
residential properties and a $650,000 business line of credit loan to a trucking
company. At June 30, 2003, these lines of credit were performing in accordance
with their repayment terms. The Bank had only nine other commercial business
loans in excess of $225,000 at June 30, 2003, all of which were performing in
accordance with their repayment terms at such date.

      Unlike residential mortgage loans, which generally are made on the basis
of the borrower's ability to make repayment from his or her employment and other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial business loans are of higher risk and typically
are made on the basis of the borrower's ability to make repayment from the cash
flow of the borrower's business. As a result, the availability of funds for the
repayment of commercial business loans may be dependent upon the success of the
business itself. The Bank's commercial business loans almost always include
personal guarantees and are usually, but not always, secured by business assets,
such as accounts receivable, equipment and inventory. However, the collateral
securing the loans may depreciate over time, may be difficult to appraise and
may fluctuate in value based on the success of the business.

      The Bank recognizes the generally increased credit risks associated with
commercial business lending. Horizon Federal's commercial business lending
policy emphasizes credit file documentation and analysis of the borrower's
character, management capabilities, capacity to repay the loan, the adequacy of
the borrower's capital and collateral. Analysis of the borrower's past, present
and future cash flows is also an important aspect of Horizon Federal's credit
analysis.


                                       12
<PAGE>

Originations of Loans and Mortgage-Backed Securities

      The Bank originates real estate loans through marketing efforts, the
Bank's customer base, walk-in customers and referrals from real estate brokers.
The Bank originates both adjustable-rate and fixed-rate loans. Its ability to
originate loans is dependent upon the relative demand for fixed-rate or ARM
loans in the origination market, which is affected by the term structure
(short-term compared to long-term) of interest rates, as well as the current and
expected future level of interest rates and competition. During each of fiscal
2003, 2002 and 2001 the Bank's dollar volume of fixed rate real estate loan
originations exceeded its adjustable-rate real estate loan originations.

      The Bank does not generally purchase loans or loan participations. In
times of low levels of loan demand, the Bank has invested its excess funds in
mortgage-backed and related securities. During fiscal 2003, 2002 and 2001 the
Bank purchased $6.4, $4.9 and $4.6 million, respectively, of mortgage-backed and
related securities. During fiscal 2003, the Bank funded its purchases of
mortgage-backed and related securities primarily with sales and repayments of
mortgage loans and mortgage-backed and related securities and customer deposits.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Asset/Liability Management" in the Annual Report.


                                       13
<PAGE>

      The following table shows the loan origination, purchase and repayment
activities of the Bank for the periods indicated.

<TABLE>
<CAPTION>
                                                                                         Year Ended June 30,
                                                                             ------------------------------------------
                                                                               2003             2002             2001
                                                                             --------         --------         --------
                                                                                       (Dollars in Thousands)
<S>                                                                          <C>              <C>              <C>
Originations by type:
 Adjustable-rate:
  Real estate
   - One-to-four family .......................................              $  5,858         $  7,296         $  6,234
   - Multi-family .............................................                    --               --               --
   - Commercial real estate ...................................                   451            1,504              782
   - Residential construction .................................                   126               --               --
  Non-real estate
   - Consumer .................................................                   178               --               --
   - Commercial business ......................................                 1,083            1,238              515
                                                                             --------         --------         --------
         Total adjustable-rate ................................                 7,696           10,038            7,531
                                                                             --------         --------         --------

 Fixed-rate:
  Real estate
   - One-to-four family .......................................                10,511            8,980            9,186
   - Multi-family .............................................                    --               --              387
   - Commercial real estate ...................................                   950            1,338              366
   - Residential construction .................................                 3,279            3,520            2,294
  Non-real estate
   - Consumer .................................................                 6,116            5,556            4,247
   - Commercial business ......................................                 6,002            4,882            3,618
                                                                             --------         --------         --------
         Total fixed-rate .....................................                26,858           24,276           20,098
                                                                             --------         --------         --------
         Total loans originated ...............................                34,554           34,314           27,629

Total loan purchases ..........................................                    --               --              172
Total loan sales ..............................................               (10,420)         (11,055)          (5,150)
Total loan repayments .........................................               (23,816)         (23,852)         (20,779)
Decrease (increase) in other items, net .......................                  (410)             246            1,157
                                                                             ========         --------         --------
         Net (decrease) increase ..............................              $    (92)        $   (347)        $  3,029
                                                                             ========         ========         ========
</TABLE>


                                       14
<PAGE>

      The following table shows the purchase, sale and repayment activities of
the Bank's mortgage-backed and related securities for the periods indicated.

<TABLE>
<CAPTION>
                                                                         Year Ended June 30,
                                                                 --------------------------------------
                                                                  2003             2002           2001
                                                                 -------         -------        -------
                                                                         (Dollars in Thousands)
<S>                                                              <C>             <C>            <C>
    Purchases:
      Mortgage-backed and related securities ................    $ 6,387         $ 4,855        $ 4,660
      Collateralized Mortgage Obligation ....................         --              --             --
                                                                 -------         -------        -------
           Total ............................................    $ 6,387         $ 4,855        $ 4,660
                                                                 =======         =======        =======

    Sales:
      Mortgage-backed and related securities ................         --            (430)          (773)
      Collateralized Mortgage Obligation ....................         --          (2,970)        (2,932)
                                                                 -------         -------        -------
           Total ............................................         --          (3,400)        (3,705)
                                                                 =======         =======        =======

    Repayments:
      Mortgage-backed and related securities ................     (3,874)         (3,284)        (1,099)
      Collateralized Mortgage Obligation ....................       (460)           (605)          (419)
      Net (Amortization)/Accretion MBS and CMOs .............        (72)            (60)           (11)
      Increase/(decrease) in other items, net ...............         52            (117)           626
                                                                 -------         -------        -------
           Net increase/(decrease) ..........................    $ 2,033         $(2,611)       $    52
                                                                 =======         =======        =======
</TABLE>

Asset Quality

      General. When a borrower fails to make a required payment on a residential
loan, the Bank attempts to cause the delinquency to be cured by contacting the
borrower. In the case of loans secured by real estate, a late notice is sent by
the 11th of the month if payment for the prior month is not received. If the
delinquency is not cured by the 15th of the month, an attempt to contact the
borrower is made by telephone. Additional written and verbal contacts are made
with the borrower to the extent necessary, and if required a personal visit by a
loan officer of the Bank is arranged. If the delinquency is not cured or a
payment plan arranged by the 61st day of delinquency or shortly thereafter, the
matter is generally referred to the Bank's collection manager and action to
foreclose on the property is initiated. After 90 days of delinquency, interest
income on loans is reduced by the full amount of accrued and uncollected
interest. If foreclosed, the property is sold at a sheriff's sale and may be
purchased by the Bank. Delinquent consumer loans are handled in a similar
manner. The Bank's procedures for repossession and sale of consumer collateral
are subject to various requirements under Iowa consumer protection laws.

      Real estate acquired by Horizon Federal as a result of foreclosure or by
deed in lieu of foreclosure is classified as real estate owned until it is sold.
When property is acquired, it is recorded at the lower of cost or estimated fair
value at the date of acquisition, and any write-down resulting therefrom is
charged to the allowance for losses on loans. After acquisition, all costs
incurred in maintaining the property are expensed. However, costs relating to
the development and improvement of the property are capitalized to the extent of
net realizable value.


                                       15
<PAGE>

      The following table sets forth the Bank's loan delinquencies by type, by
amount and by percentage of category at June 30, 2003. The amounts presented
represent the total remaining principal balances of the loans, rather than the
actual payment amounts which are overdue.

<TABLE>
<CAPTION>
                                                                    Loans Delinquent For:
                         -----------------------------------------------------------------------------------------------------------
                                 30-59 Days                  60-89 Days             90 Days and Over                Total
                         -------------------------  -------------------------  -------------------------  --------------------------
                                        Percent of                 Percent of                 Percent of                  Percent of
                                           Loan                       Loan                       Loan                        Loan
                         Number  Amount  Category   Number  Amount  Category   Number  Amount  Category   Number  Amount   Category
                         ------  ------ ----------  ------  ------ ----------  ------  ------ ----------  ------  ------  ----------
                                                                    (Dollars in Thousands)
<S>                        <C>   <C>         <C>       <C>  <C>        <C>       <C>   <C>       <C>       <C>    <C>        <C>
Real Estate:
One-to-four family ...     16    $  719      2.1%      13   $  460     1.3%      38    $1,928    5.5%       67    $3,107      8.9%
Multi-family .........      1       344     43.2       --       --      --       --        --     --         1       344     43.2
Commercial real estate      3       133      1.9        4    1,002    14.1       --        --     --         7     1,135     16.0
Consumer .............     21       133      1.9       23      128     1.8       40       332    4.7        84       593      8.4
Commercial business ..     11     1,445     10.8        3      129     1.0        8       395    3.0        22     1,969     14.8
                           --    ------                --   ------               --    ------              ---    ------
   Total .............     52    $2,774      4.3%      43   $1,719     2.6%      86    $2,655    4.1%      181    $7,148     11.0%
                           ==    ======                ==   ======               ==    ======              ===    ======
</TABLE>


                                       16
<PAGE>

         Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in the Bank's loan portfolio. Loans are
placed on non-accrual status when the collection of principal and/or interest
becomes doubtful. As a matter of policy, the Bank does not generally accrue
interest on loans past due 90 days or more. Foreclosed assets include assets
acquired in settlement of loans.

                                                            At June 30,
                                                 ------------------------------
                                                  2003        2002        2001
                                                 ------      ------      ------
                                                    (Dollars in Thousands)
Non-accruing loans:
   One-to-four family ......................     $1,928      $1,383      $  966
   Commercial real estate ..................         --          --         122
   Consumer ................................        332         252         253
   Commercial business .....................        395         282          53
                                                 ------      ------      ------
       Total ...............................      2,655       1,917       1,394
                                                 ------      ------      ------

Accruing loans 90 days or more:
   One-to-four family ......................         --          --          --
   Commercial ..............................         --          --          --
                                                 ------      ------      ------
       Total ...............................         --          --          --
                                                 ------      ------      ------

Foreclosed assets:
   One-to-four family ......................         84         206          45
   Commercial real estate ..................        260          --          --
   Consumer ................................         --           4           5
                                                 ------      ------      ------
       Total ...............................        344         210          50
                                                 ------      ------      ------

Total non-performing assets ................     $2,999      $2,127      $1,444
                                                 ======      ======      ======
Total as a percentage of total assets ......       3.28%       2.41%       1.61%
                                                 ======      ======      ======

      For fiscal 2003, gross interest income which would have been recorded had
the non-accruing loans been current in accordance with their original terms
amounted to $291,000, of which $133,000 was included in interest income for such
period.

      At June 30, 2003, there were no non-performing loans to a single borrower
or group of related borrowers in excess of $246,900. At June 30, 2003, there was
a $10,000 nonaccruing loan contained in the foregoing table which was not
described in "Other Loans of Concern" or "Classified Assets" below.

      Other Loans of Concern. In addition to the non-performing assets set forth
in the table above, as of June 30, 2003, there was also an aggregate of $254,000
in net book value of loans of which $79,000 were secured by single family
residences, $170,000 were secured by commercial real estate and $5,000 were
secured consumer loans with respect to which known information about the
possible credit problems of the borrowers have caused management to have doubts
as to the ability of the borrowers to comply with present loan repayment terms
and which may result in the future inclusion of such items in the non-performing
asset categories.

      Classified Assets. Federal regulations provide for the classification of
loans and other assets, such as debt and equity securities considered by the OTS
to be of lesser quality, as "substandard," "doubtful" or "loss." An asset is
considered "substandard" if it is inadequately


                                       17
<PAGE>

protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. "Substandard" assets include those characterized by
the "distinct possibility" that the insured institution will sustain "some loss"
if the deficiencies are not corrected. Assets classified as "doubtful" have all
of the weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full" on the basis of currently existing facts, conditions and values, "highly
questionable and improbable." Assets classified as "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.

      When an insured institution classifies problem assets as either
substandard or doubtful, it may establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution classifies
problem assets as "loss," it is required either to establish a specific
allowance for losses equal to 100% of that portion of the asset so classified or
to charge-off such amount. An institution's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the regulatory authorities, who may order the establishment
of additional general or specific loss allowances.

      In connection with the filing of its periodic reports with the OTS and in
accordance with its classification of assets policy, the Bank regularly reviews
problem loans and real estate acquired through foreclosure to determine whether
such assets require classification in accordance with applicable regulations. On
the basis of management's review of its assets, at June 30, 2003, the Bank had
classified a total of $2,737,000 of its assets as substandard, $274,000 as
doubtful and $27,000 as loss. All portions of a loan which are classified as
loss are reserved for at a rate of 100%.

      At June 30, 2003, total classified assets comprised $3,038,000, or 29.1%
of the Bank's capital, or 3.3% of the Bank's total assets.

      Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the risk
inherent in its loan portfolio and changes in the nature and volume of its loan
activity. Such evaluation, which includes a review of all loans for which full
collectibility may not be reasonably assured, considers among other matters, the
estimated fair value of the underlying collateral, economic conditions,
historical loan loss experience and other factors that warrant recognition in
providing for an adequate loan loss allowance. Although management believes it
uses the best information available to make such determinations, future
adjustments to the allowance may be necessary, and net income could be
significantly affected, if circumstances differ substantially from the
assumptions used in making the initial determinations. At June 30, 2003, the
Bank had an allowance for loan losses of $556,000, or approximately .85% of
total loans. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Results of Operations -- Provision for Losses on
Loans" in the Annual Report.


                                       18
<PAGE>

      The following table sets forth an analysis of the Bank's allowance for
losses on loans.

<TABLE>
<CAPTION>
                                                                                         Year Ended June 30,
                                                                                  ---------------------------------
                                                                                   2003         2002          2001
                                                                                  -----        -----          -----
                                                                                        (Dollars in Thousands)
<S>                                                                               <C>          <C>            <C>
Balance at beginning of period ........................................           $ 537        $ 369          $ 379

Charge-offs:
   One-to-four family .................................................             (34)        (108)            (2)
   Commercial real estate .............................................              --           --             --
   Commercial business ................................................             (66)          (2)          (161)
   Consumer ...........................................................            (123)         (55)          (127)
                                                                                  -----        -----          -----
     Total charge-offs ................................................            (223)        (165)          (290)
                                                                                  -----        -----          -----

Recoveries:
   One-to-four family .................................................               1           --             --
   Consumer ...........................................................               5            1              4
                                                                                  -----        -----          -----
     Total recoveries .................................................               6            1              4
                                                                                  -----        -----          -----

Net charge-offs .......................................................            (217)        (164)          (286)
Additions charged to operations .......................................             236          332            276
                                                                                  -----        -----          -----
Balance at end of period ..............................................           $ 556        $ 537          $ 369
                                                                                  =====        =====          =====

Ratio of net charge-offs during the period to average loans
outstanding during the period .........................................             .33%         .25%           .44%
</TABLE>

      During fiscal 2003, 2002 and 2001, management recorded provisions for loan
losses of $236,000, $332,000 and $276,000, respectively. These provisions were
primarily the result of charge-offs on loans and foreclosed assets incurred
during the periods, as well as a result of management's assessment of additional
credit risk associated with the increased level of the Bank's consumer and
commercial business portfolios during such periods.


                                       19
<PAGE>

      The distribution of the Bank's allowance for losses on loans at the dates
indicated is summarized as follows:

<TABLE>
<CAPTION>
                                                                 At June 30,
                                  ---------------------------------------------------------------------------
                                         2003                       2002                         2001
                                  --------------------      --------------------        ---------------------
                                               Percent                   Percent                     Percent
                                              of Loans                  of Loans                     of Loans
                                               in Each                   in Each                     in Each
                                              Category                  Category                     Category
                                              to Total                  to Total                     to Total
                                  Amount        Loans       Amount        Loans         Amount        Loans
                                  ------      --------      ------      --------        ------       --------
                                                            (Dollars in Thousands)
<S>                                 <C>        <C>           <C>         <C>             <C>          <C>
One-to-four family....              $122        53.3%        $100         58.7%          $ 62          63.0%
Multi-family..........                 2         1.2            3          2.1              2           2.2
Commercial real estate                29        10.9           22         10.7             44          10.1
Residential construction               7         3.6            4          2.2              5           2.1
Consumer..............               183        10.7          170         10.5            113          10.6
Commercial business...               160        20.3          168         15.8             61          12.0
Unallocated...........                53         ---           70          ---             82           ---
                                    ----       -----         ----        -----           ----         -----
   Total..............              $556       100.0%        $537        100.0%          $369         100.0%
                                    ====       =====         ====        =====           ====         =====
</TABLE>

Investment Activities

      Horizon Federal must maintain investments that qualify as liquid assets in
order to meet the safety and soundness standards under OTS regulations.
Liquidity may increase or decrease depending upon the availability of funds and
comparative yields on investments in relation to the return on loans.
Historically, the Bank has maintained liquid assets at levels above the minimum
requirements previously imposed by OTS regulations and at levels believed
adequate to meet the requirements of normal operations, including repayments of
maturing debt and potential deposit outflows. Cash flow projections are
regularly reviewed and updated to assure that adequate liquidity is maintained.
At June 30, 2003, the Bank's liquidity ratio (liquid assets as a percentage of
net withdrawable savings deposits and current borrowings) was 9.1%. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Annual Report.

      Federally chartered savings institutions have the authority to invest in
various types of liquid assets, including U.S. treasury obligations, securities
of various federal agencies, certain certificates of deposit of insured banks
and savings institutions, certain bankers' acceptances, repurchase agreements
and federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly.

      Generally, the investment policy of the Bank, as established by the Board
of Directors, is to invest funds among various categories of investments and
maturities based upon the Bank's liquidity needs, asset/liability management
policies, investment quality, marketability and performance objectives. Subject
to the Board's direction, the Investment Committee meets monthly to review the
Bank's investments and objectives for its investment portfolio. The Bank's
investment policy has established methods and strategies for each type of
security. It is


                                       20
<PAGE>

the Bank's general policy to purchase investment securities which are U.S.
government securities or federal agency obligations or other issues that are
rated investment grade.

      The Bank has a portfolio of mortgage-backed and related securities and has
utilized such investments to complement its mortgage lending activities. At June
30, 2003, the Bank's mortgage-backed and related securities totaled $11.5
million, or 12.6% of total assets. For information regarding market values of
the Bank's mortgage-backed and related securities portfolio, see Note 2 of the
Notes to Consolidated Financial Statements in the Annual Report.

      The Bank's portfolio of Government National Mortgage Association ("GNMA"),
FNMA and Federal Home Loan Mortgage Corporation ("FHLMC") certificates consist
of modified pass-through mortgage-backed securities that generally represent
undivided interests in underlying pools of fixed-rate, or certain types of
adjustable-rate, single-family residential mortgages issued by these
government-sponsored entities. GNMA's guarantee to the holder of timely payments
of principal and interest is backed by the full faith and credit of the U.S.
government. FNMA and FHLMC provide the certificate holder a guarantee of timely
payments of interest and scheduled principal payments, whether or not they have
been collected. Under the OTS risk-based capital requirements, GNMA
mortgage-backed securities have a zero percent risk weighting and FNMA, FHLMC
and "AA" or higher-rated mortgage-backed securities have a 20% risk weighting,
in contrast to the 50% risk weighting for one-to-four family performing
residential mortgage loans.

      OTS guidelines regarding investment portfolio policy and accounting
require insured institutions to categorize securities and certain other assets
as held for "investment," "sale," or "trading." The portion of the investment
securities portfolio which is held with the intent to hold to maturity is
accounted for on an amortized cost basis. Securities which are categorized as
available-for-sale are carried at fair value. At June 30, 2003, all of the
Bank's investment, mortgage-backed and related securities were classified as
available-for-sale.


                                       21
<PAGE>

      The following table sets forth the composition of the Bank's portfolio of
investment and mortgage-backed securities at the dates indicated.

<TABLE>
<CAPTION>
                                                                                               At June 30,
                                                                    ---------------------------------------------------------------
                                                                             2003                  2002                 2001
                                                                    ------------------     -----------------     ------------------
                                                                    Carrying     % of      Carrying    % of      Carrying     % of
                                                                      Value      Total       Value     Total       Value      Total
                                                                    --------     -----     -------     -----     --------     -----
                                                                                           (Dollars in Thousands)
<S>                                                                  <C>         <C>        <C>        <C>        <C>         <C>
Investment Securities:
   U.S. government securities ..................................     $    --        --%     $   --        --%     $    --        --%
   Federal agency obligations ..................................          --        --          --        --          996      16.9
   Small business administration loans .........................         623       6.8         667       8.9          693      11.7
   Equity securities (1) .......................................       2,406      26.2       1,908      25.6        1,714      29.0
   Corporate Bonds .............................................       2,603      28.3          --        --           --        --
                                                                     -------     -----      ------     -----      -------     -----
     Subtotal ..................................................       5,632      61.3       2,575      34.5        3,403      57.6
   FHLB stock ..................................................         509       5.5         509       6.8          480       8.1
                                                                     -------     -----      ------     -----      -------     -----
     Total investment securities and FHLB stock ................       6,141      66.8       3,084      41.3        3,883      65.7
Other Interest-Earning Assets:
   Interest-bearing deposits with banks ........................       3,049      33.2       4,374      58.7        2,028      34.3
                                                                     -------     -----      ------     -----      -------     -----
     Total .....................................................     $ 9,190     100.0%     $7,458     100.0%     $ 5,911     100.0%
                                                                     =======     =====      ======     =====      =======     =====

   Average remaining life or term to repricing
   of investment securities and other interest-
   earning assets excluding FHLB stock .........................          1.43 years             1.20 years            2.18 years

Mortgage-Backed and Related Securities:
   CMOs ........................................................     $    --       --%      $  462       4.9%     $ 4,129      34.0%
   FHLMC .......................................................       1,021       8.8          --        --          437       3.6
   FNMA ........................................................       6,737      58.4       3,077      32.3          696       5.7
   GNMA ........................................................       3,786      32.8       5,972      62.8        6,859      56.6
   Other (2) ...................................................          --        --          --        --            1        .1
                                                                     -------     -----      ------     -----      -------     -----
     Total mortgage-backed and related
     securities ................................................     $11,544     100.0%     $9,511     100.0%     $12,122     100.0%
                                                                     =======     =====      ======     =====      =======     =====
</TABLE>

(1)   Consists primarily of stocks of publicly traded financial institutions and
      holding companies, and mutual funds.

(2)   Consists of interest only stripped mortgage-backed security. See Footnote
      2 of Notes to Consolidated Financial Statements contained in the Annual
      Report.


                                       22
<PAGE>

         The composition and maturities of the debt investment securities
portfolio, excluding equity securities and FHLB stock, are indicated in the
following table.

<TABLE>
<CAPTION>
                                                                                      At June 30, 2003
                                                       --------------------------------------------------------------------------
                                                       Less Than      1 to 5       5 to 10    Over 10       Total Debt Investment
                                                        1 Year         Years         Years     Years             Securities
                                                       ---------     --------      --------   --------      ---------------------
                                                       Carrying      Carrying      Carrying   Carrying       Book          Market
                                                         Value         Value         Value      Value        Value         Value
                                                       --------      --------      --------   --------      ------         ------
                                                                                  (Dollars in Thousands)
<S>                                                      <C>           <C>           <C>        <C>           <C>           <C>
U.S. government securities .....................         $  --         $  --         $  --      $ --          $ --          $ --
Federal agency obligations .....................            --            --            --        --            --            --
Small business administration loans ............            --            --            --       623           623           623
                                                         -----         -----         -----      ----          ----          ----
Total ..........................................         $  --         $  --         $  --      $623          $623          $623
                                                         =====         =====         =====      ====          ====          ====
Weighted average yield .........................            --%           --%           --%     7.88%         7.88%         7.88%
</TABLE>

      The following table sets forth the contractual maturities of the Bank's
mortgage-backed and related securities at June 30, 2003; however, the expected
average life to maturity of this portfolio is generally two to ten years.

<TABLE>
<CAPTION>
                                                                   Due in                                  At
                                          ------------------------------------------------------        June 30,
                                                          1 to           5 to            10 and           2003
                                          Less than     Less than      Less than          Over          Balance
                                           1 Year        5 Years       10 Years           Years       Outstanding
                                          ---------     ---------      ---------         -------      ------------
                                                                 (Dollars in Thousands)
<S>                                         <C>            <C>           <C>             <C>             <C>
FHLMC .......................               $ --           $ --          $   --          $ 1,021         $ 1,021
FNMA ........................                 --             --           1,044            5,693           6,737
GNMA ........................                 --             --              --            3,786           3,786
CMOs ........................                 --             --              --               --              --
                                            ----           ----          ------          -------         -------
Total .......................               $ --           $ --          $1,044          $10,500         $11,544
                                            ----           ----          ======          =======         =======
</TABLE>

      At June 30, 2003, the Bank's portfolio of investment and mortgage-backed
securities contained two mutual funds of one issuer with an aggregate book value
of $1.3 million, or 15.4% of the Bank's stockholders' equity, and five corporate
bonds of various issuers with an aggregate book value of $2.5 million, or 30.1%
of the Bank's stockholders' equity. There were no other securities of any issuer
with an aggregate book value in excess of 10% of the Bank's stockholders'
equity, excluding securities issued by the U.S. government or its agencies.

      For additional information on the Bank's investment and mortgage-backed
securities, see Note 2 of the Notes to Consolidated Financial Statements in the
Annual Report.


                                       23
<PAGE>

Sources of Funds

      General. The Bank's primary sources of funds are deposits, amortization
and repayment of loan principal (including mortgage-backed securities), sales or
maturities of investment securities, mortgage-backed securities and short-term
investments, FHLB advances and funds provided from operations.

      Borrowings, primarily FHLB advances, are used to compensate for seasonal
reductions in deposits or deposit inflows at less than projected levels, and may
be used on a longer-term basis to support lending activities including purchases
of mortgage-backed securities. At June 30, 2003, the Bank had total FHLB
advances of $5.5 million.

      Deposits. Horizon Federal offers a variety of deposit accounts having a
wide range of interest rates and terms. The Bank's deposits consist of
commercial demand, savings, checking, money market and certificate accounts. The
certificate accounts currently range in terms from six months to five years. The
Bank relies primarily on advertising (including radio, newspaper and direct
mail), competitive pricing policies and customer service to attract and retain
these deposits. Horizon Federal solicits deposits from its market area only and
does not use brokers to obtain deposits. The flow of deposits is influenced
significantly by general economic conditions, changes in money market and
prevailing interest rates and competition. The composition of the Bank's
deposits is set forth in Note 8 of the Notes to Consolidated Financial Statement
in the Annual Report.

      The deposit accounts marketed by the Bank have allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. The Bank has become more susceptible to short-term fluctuations
in deposit flows as customers have become more interest rate conscious. The Bank
endeavors to manage the pricing of its deposits in keeping with its
asset/liability management and profitability objectives. The ability of the Bank
to attract and maintain savings accounts and certificates of deposit, and the
rates paid on these deposits, has been and will continue to be significantly
affected by market conditions.


                                       24
<PAGE>

      The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Bank for the periods
indicated.

<TABLE>
<CAPTION>
                                                                                 At June 30,
                                                     --------------------------------------------------------------------
                                                            2003                     2002                     2001
                                                     ------------------       ------------------       ------------------
                                                     Amount     Percent       Amount     Percent       Amount     Percent
                                                     ------     -------       ------     -------       ------     -------
                                                                           (Dollars in Thousands)
<S>                                                 <C>            <C>       <C>            <C>       <C>            <C>
Transactions and Savings Deposits:

Commercial Demand ............................      $ 1,637        2.2%      $ 1,315        1.8%      $   942        1.4%
Checking Accounts (0% to .75%) ...............        9,925       13.3         9,151       12.7         7,737       11.1
Savings Accounts (.75% to 1.5%) ..............       32,720       44.0        31,754       44.2        23,681       33.9
Money Market Accounts (0%) ...................          213         .3           362         .5           313         .4
                                                    -------      -----       -------      -----       -------      -----

Total Non-Certificates .......................       44,495       59.8        42,582       59.2        32,673       46.8
                                                    -------      -----       -------      -----       -------      -----

Certificates:

0.00 - 3.99% .................................       19,116       25.7%       13,197       18.3%        1,486        2.1%
4.00 - 4.99% .................................        5,219        7.0         8,499       11.8         8,893       12.7
5.00 - 5.99% .................................        4,981        6.7         4,171        5.8         7,695       11.0
6.00 - 6.99% .................................          612         .8         3,485        4.8        14,147       20.3
7.00 - 7.99% .................................           --         --            20         .1         4,978        7.1
                                                    -------      -----       -------      -----       -------      -----

Total Certificates ...........................       29,928       40.2        29,372       40.8        37,199       53.2
                                                    -------      -----       -------      -----       -------      -----
Total Deposits ...............................      $72,423      100.0%      $71,954      100.0%      $69,872      100.0%
                                                    =======      =====       =======      =====       =======      =====
</TABLE>

      The following table shows rate and maturity information for the Bank's
certificates of deposit as of June 30, 2003.

<TABLE>
<CAPTION>
                                          0.00-          3.00-         4.00-         5.00-        6.00%                      Percent
                                          2.99%          3.99%         4.99%         5.99%       or more       Total        of Total
                                         -------        ------        ------        ------       -------      -------       --------
                                                                           (Dollars in Thousands)
<S>                                      <C>            <C>           <C>           <C>           <C>         <C>             <C>
Certificate accounts maturing
in quarter ending:

September 30, 2003 ...............       $ 2,767        $  100        $2,925        $   98        $164        $ 6,054         20.23%
December 31, 2003 ................         4,123           805            90            --         392          5,410         18.08
March 31, 2004 ...................         2,904           241           188            --          56          3,389         11.32
June 30, 2004 ....................         1,291           232           123            47          --          1,693          5.66
September 30, 2004 ...............         1,100           498            82            26          --          1,706          5.70
December 31, 2004 ................           935           354            --            13          --          1,302          4.35
March 31, 2005 ...................           909           163            --           112          --          1,184          3.95
June 30, 2005 ....................           611           238             4           102          --            955          3.19
Thereafter .......................           523         1,322         1,807         4,583          --          8,235         27.52
                                         -------        ------        ------        ------        ----        -------        ------

Total ............................       $15,163        $3,953        $5,219        $4,981        $612        $29,928         100.0%
                                         =======        ======        ======        ======        ====        -------        ======

Percent of total .................         50.67%        13.21%        17.44%        16.64%       2.04%         100.0%
                                         -------        ------        ------        ------        ----        =======
</TABLE>


                                       25
<PAGE>

      The following table indicates the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of June 30, 2003.

<TABLE>
<CAPTION>
                                                                                    Maturity
                                                           ------------------------------------------------------------
                                                                           Over        Over
                                                           3 Months       3 to 6      6 to 12      Over 12
                                                            or Less       Months       Months       Months       Total
                                                           --------       ------      --------     -------      -------
                                                                               (Dollars in Thousands)
<S>                                                         <C>           <C>          <C>         <C>          <C>
Certificates of deposit of less than
$100,000 .........................................          $4,902        $4,950       $4,682      $12,155      $26,689

Certificates of deposit of
$100,000 or more .................................             702           461          400        1,226        2,789

Public funds(1) ..................................             150           300           --           --          450
                                                            ------        ------       ------      -------      -------

Total certificates of deposit ....................          $5,754        $5,711       $5,082      $13,381      $29,928
                                                            ======        ======       ======      =======      =======
</TABLE>

----------
(1)   Deposits from governmental and other public entities.

      Borrowings. Although deposits are the Bank's primary source of funds, the
Bank's policy has been to utilize borrowings, primarily FHLB advances, when they
are a less costly source of funds or can be invested at a profitable interest
rate spread. In addition, the Bank may rely upon borrowings for short-term
liquidity needs.

      Horizon Federal may obtain advances from the FHLB of Des Moines upon the
security of its capital stock in the FHLB of Des Moines and certain of its
mortgage loans. Such advances may be made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities.

      The following table sets forth the maximum month-end balance and average
balance of FHLB advances.

                                                         Year Ended June 30,
                                                    ----------------------------
                                                     2003      2002       2001
                                                    ------    ------     -------
                                                       (Dollars in Thousands)

      Maximum Balance:
          FHLB advances ....................        $5,568    $8,591     $10,006

      Average Balance:
          FHLB advances ....................        $5,556    $6,747     $ 9,756


                                       26
<PAGE>

      The following table sets forth certain information as to the Bank's FHLB
advances at the dates indicated. For additional information on the Bank's
advances, see Note 9 of the Notes to Consolidated Financial Statements in the
Annual Report.

                                                      At June 30,
                                        ---------------------------------------
                                           2003           2002           2001
                                        ---------      ---------      ---------
                                                 (Dollars in Thousands)

      FHLB advances ................    $   5,545      $   5,571      $   9,593
                                        =========      =========      =========

      Weighted average interest
      rate of FHLB advances ........         5.21%          5.21%          5.49%

Subsidiary Activities

      As a federally chartered savings bank, Horizon Federal is permitted by OTS
regulations to invest up to 2% of its assets, or $1.8 million at June 30, 2003,
in the stock of, or loans to, service corporation subsidiaries. As of such date,
the net book value of Horizon Federal's investment in its service corporation
was approximately $101,000. Horizon Federal may invest an additional 1% of its
assets in service corporations where such additional funds are used for
inner-city or community development purposes and up to 50% of its total capital
in conforming loans to service corporations in which it owns more than 10% of
the capital stock. In addition to investments in service corporations, federal
associations are permitted to invest an unlimited amount in operating
subsidiaries engaged solely in activities in which a federal association may
engage.

      Horizon Federal has one service corporation, Horizon Investment Services,
Inc. ("HISI"), an Iowa corporation, located in Oskaloosa, Iowa. HISI, which
changed its corporate name in August 1995 from SEI Service Corporation, was
organized by the Bank in 1983 in order to offer a variety of investment products
to customers of Horizon Federal. For the fiscal year ended June 30, 2003, HISI
had a net income of $8,600.

Regulation

      General. Horizon Federal is a federally chartered savings bank, the
deposits of which are federally insured and backed by the full faith and credit
of the U.S. government up to applicable limits set by the FDIC. The Bank is
subject to broad federal regulation and oversight extending to all of its
operations, principally by its primary federal regulator, the OTS. Horizon
Federal is a member of the FHLB of Des Moines and is subject to certain limited
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board"). As the savings and loan holding company of the Bank, the
Company also is subject to federal regulation and oversight, principally by the
OTS. The purpose of the regulation of the Company and other holding companies is
to protect subsidiary savings associations. The Bank is a member of the Savings
Association Insurance Fund ("SAIF"), which together with the Bank Insurance Fund
(the "BIF") are the two deposit insurance funds administered by the FDIC. As a
result, the FDIC has certain regulatory and examination authority over the Bank.
Certain of these regulatory requirements and restrictions are discussed below or
elsewhere in this document.


                                       27
<PAGE>

      USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 was
enacted in response to the terrorist attacks in New York, Pennsylvania and
Washington, D.C., which occurred on September 11, 2001. The Patriot Act is
intended to strengthen U.S. law enforcement's and the intelligence communities'
abilities to work cohesively to combat terrorism on a variety of fronts. The
potential impact of the Patriot Act on financial institutions of all kinds is
significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and imposes various regulations,
including standards for verifying client identification at account opening, and
rules to promote cooperation among financial institutions, regulators and law
enforcement entities in identifying parties that may be involved in terrorism or
money laundering.

      Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into
law the Sarbanes-Oxley Act of 2002, or the SOA. The SOA is the most far-reaching
U.S. securities legislation enacted in many years, and includes many substantive
and disclosure-based requirements. The stated goals of the SOA 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 SOA generally applies to all companies, both U.S. and
non-U.S., that file or are required to file periodic reports with the Securities
and Exchange Commission under the Securities Exchange Act of 1934 (the "Exchange
Act").

      The SOA creates an independent auditing-oversight board under the SEC. It
also increases penalties for corporate wrongdoers, forces faster and more
extensive financial disclosure, and creates avenues of recourse for aggrieved
shareholders. The SOA also contains separate provisions that require signed
certifications to be made by the chief executive officer and the chief financial
officer of all public companies, and provides criminal penalties of up to $1.0
million and imprisonment of up to 10 years for an officer that provides a
certification knowing it to be untrue.

      The SOA also addresses functions and responsibilities of audit committees
of public companies. Each audit committee is directly responsible for the
appointment, compensation and oversight of the work of the Company's outside
auditors, and the auditors must report directly to the audit committee. Each
audit committee member must be independent, which under the Act means that he or
she cannot (other than in his or her capacity as a member of the audit
committee, the board or any other board committee) accept any consulting,
advisory or other compensatory fees from the Company or be affiliated with the
Company or any of its subsidiaries. Each audit committee must establish
procedures to receive and respond to any complaints and concerns regarding the
Company's accounting, accounting controls or auditing matters. These procedures
would include enabling the Company's employees to transmit concerns regarding
questionable accounting or auditing matters by confidential, anonymous
submission. In recognition of the audit committee's independent status, each
audit committee is authorized to engage independent counsel and other advisors.
The Company must also provide the appropriate funding, as determined by the
audit committee, for payment of compensation to the auditors and advisors of the
audit committee.

      Federal Regulation of Savings Associations. The OTS has extensive
authority over the operations of savings banks, such as Horizon Federal. As part
of this authority, the Bank is


                                       28
<PAGE>

required to file periodic reports with the OTS and is subject to periodic
examinations by the OTS and the FDIC. The last regular OTS and FDIC examinations
of the Bank were as of June 30, 2002 and June 30, 2001, respectively. Under
agency scheduling guidelines, another review is scheduled for October 20, 2003.
When these examinations are conducted by the OTS and the FDIC, the examiners may
require the Bank to provide for higher general or specific loan loss reserves
and take other corrective actions. All savings associations are subject to a
semi-annual assessment, based upon the savings association's total assets, to
fund the operations of the OTS. The Bank's OTS assessment for fiscal 2003 was
$28,600.

      The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Bank and the Company.
This enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.

      In addition, the investment, lending and branching authority of the Bank
is prescribed by federal law, and it is prohibited from engaging in any
activities not permitted by such laws. For example, the permissible level of
investment by federal associations, subject to safety and soundness
restrictions, (1) in loans secured by non-residential real property may not
exceed 400% of total capital, (2) in commercial loans may not exceed 20% of
assets, provided that amounts in excess of 10% of assets may only be small
business loans, (3) in loans related to leasing of tangible personal property
may not exceed 10% of assets, and (4) in loans for personal, family and
household purposes, when combined with commercial paper and corporate debt
securities, may not exceed 35% of assets. Federal savings associations are also
generally authorized to branch nationwide. The Bank is in compliance with the
noted restrictions. Federal associations such as Horizon Federal may designate
under which investment authority (or basket) it made a loan or investment if
that loan or investment is authorized under different sections of the law.

      The Bank's general permissible lending limit for loans-to-one borrower is
equal to the greater of $500,000 or 15% of unimpaired capital and surplus
(except for loans fully secured by certain readily marketable collateral, in
which case this limit is increased to 25% of unimpaired capital and surplus). At
June 30, 2003, the Bank's lending limit under this restriction was approximately
$1.3 million.

      The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, asset quality, earnings standards, internal
controls and audit systems, interest rate risk exposure and compensation and
other employee benefits. Any institution which fails to comply with these
standards must submit a compliance plan. A failure to submit a plan or to comply
with an approved plan will subject the institution to further enforcement
action.

      Insurance of Accounts and Regulation by the FDIC. Horizon Federal is a
member of the SAIF, which is administered by the FDIC. Deposits are insured up
to applicable limits by the


                                       29
<PAGE>

FDIC and such insurance is backed by the full faith and credit of the U.S.
government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF of the BIF. The FDIC also has the authority to initiate enforcement
actions against savings associations, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has engaged in unsafe or unsound practices, or is in an unsafe
or unsound condition.

      The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions will be made by the FDIC for each semi-annual assessment period. As
of June 30, 2003, the Bank was classified as a well-capitalized institution.

      The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the U.S. Treasury or for any other reason deemed necessary
by the FDIC.

      Regulatory Capital Requirements. Federally insured savings associations,
such as the Bank, are required to maintain a minimum level of regulatory
capital. The OTS has established capital standards, including a tangible capital
requirement, a leverage ratio (or core capital) requirement and a risk-based
capital requirement applicable to such savings associations. These capital
requirements must be generally as stringent as the comparable capital
requirements for national banks. The OTS is also authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.

      The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual preferred stock and related income. In addition, all
intangible assets, other than a limited amount of purchased mortgage servicing
rights, must be deducted from tangible capital for calculating compliance with
the requirement. At June 30, 2003, the Bank did not have any intangible assets
or purchased mortgage servicing rights.

      The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. In determining compliance with the
capital requirements, all


                                       30
<PAGE>

subsidiaries engaged solely in activities permissible for national banks or
engaged in certain other activities solely as agent for its customers are
"includable" subsidiaries that are consolidated for capital purposes in
proportion to the association's level of ownership. For excludable subsidiaries
the debt and equity investments in such subsidiaries are deducted from assets
and capital. All subsidiaries of the Bank are includable subsidiaries.

      At June 30, 2003, the Bank had tangible capital of $8.2 million, or 9.2%
of adjusted total assets, which is approximately $6.9 million above the minimum
requirement of 1.5% of adjusted total assets in effect on that date.

      The capital standards also effectively require core capital equal to at
least 3% to 4% of adjusted total assets. Core capital generally consists of
tangible capital plus certain intangible assets, including a limited amount of
purchased credit card receivables. At June 30, 2003, the Bank had no intangible
assets which were subject to these tests. At June 30, 2003, the Bank had core
capital equal to $8.2 million, or 9.2% of adjusted total assets, which is $4.6
million above the minimum leverage ratio requirement of 4% as in effect on that
date.

      The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. Total capital consists of core
capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. The
OTS is also authorized to require a savings association to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At June 30, 2003, the Bank had no
capital instruments that qualify as supplementary capital, and $529,000 of
general loss reserves, which was less than 1.25% of risk-weighted assets.

      Certain exclusions from capital and assets are required to be made for the
purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. Horizon Federal had no
exclusions from capital and assets at June 30, 2003.

      In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight, ranging
from 0% to 100%, based on the risk inherent in the type of asset. For example,
the OTS has assigned a risk weight of 50% for prudently underwritten permanent
one-to-four family first lien mortgage loans not more than 90 days delinquent
and having a loan-to-value ratio of not more than 80% at origination unless
insured to such ratio by an insurer approved by the FNMA or FHLMC.

      On June 30, 2003, the Bank had total capital of $8.7 million (including
$8.2 million in core capital and $529,000 in qualifying supplementary capital)
and risk-weighted assets of $61.7 million (including $1.17 million in converted
off-balance sheet assets); or total capital of 14.1% of risk-weighted assets.
This amount was $3.8 million above the 8% requirement in effect on that date.


                                       31
<PAGE>

      The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally defined
to be one with less than either a 4% core capital ratio, a 4% Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is authorized to impose the additional
restrictions that are applicable to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any company
controlling an undercapitalized association must agree that it will enter into a
limited capital maintenance guarantee with respect to the institution's
achievement of its capital requirements.

      Any savings association that fails to comply with its capital plan or is
"significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more of additional specified actions and operating
restrictions, which may cover all aspects of its operations and include a forced
merger or acquisition of the association. An association that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized associations. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings association, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized association is also
subject to the general enforcement authority of the OTS and the FDIC, including
the appointment of a conservator or a receiver. The OTS is also generally
authorized to reclassify an association into a lower capital category and impose
the restrictions applicable to such category if the institution is engaged in
unsafe or unsound practices or is in an unsafe or unsound condition.

      The imposition by the OTS or the FDIC of any of these measures on the
Company or the Bank may have a substantial adverse effect on the Company's
operations and profitability.

      Release from Supervisory Agreement. The Bank was required to enter into a
Supervisory Agreement with the OTS on August 27, 1999. The Supervisory Agreement
generally required the Bank to (i) comply with specified federal laws and
regulations regarding management and financial policies, the establishment and
maintenance of records and interest-risk management policies and procedures and
to (ii) take certain corrective actions regarding the disposal of certain of the
Bank's securities classified as high-risk, the maintenance of at least a
moderate level of interest rate risk, the prior receipt of a "no objection" from
the OTS before the Bank buys, exchanges or otherwise changes positions with any
security it owns, and the development of loan underwriting policies and
procedures. Following regulatory examination, the Bank was released by OTS from
the Supervisory Agreement as of November, 2002.

      Limitations on Dividends and Other Capital Distributions. OTS regulations
impose various restrictions on savings associations with respect to their
ability to make distributions of capital, which include dividends, stock
redemptions or repurchases, cash-out mergers and other transactions charged to
the capital account. OTS regulations also prohibit a savings association from
declaring or paying any dividends or from repurchasing any of its stock if, as a
result, the


                                       32
<PAGE>

regulatory capital of the association would be reduced below the amount required
to be maintained for the liquidation account established in connection with its
mutual to stock conversion.

      Assuming the absence of supervisory problems, savings associations that
before and after the proposed distribution remain well-capitalized, may make
capital distributions during any calendar year equal to the greater of 100% of
net income for the year-to-date plus retained net income for the two preceding
years (less any dividends paid). However, an institution deemed to be in need of
more than normal supervision by the OTS may have its dividend authority
restricted by the OTS. The Bank may pay dividends in accordance with this
general authority.

      Savings associations proposing to make any capital distribution need only
submit written notice to the OTS 30 days prior to such distribution. Savings
associations that do not, or would not meet their current minimum capital
requirements following a proposed capital distribution, however, must obtain OTS
approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period based on safety and soundness concerns.

      Qualified Thrift Lender Test. All savings associations, including the
Bank, are required to meet a qualified thrift lender ("QTL") test to avoid
certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. As an alternative, the savings association
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code of 1986, as amended (the "Code"). Such assets
primarily consist of residential housing related loans and investments. At June
30, 2003, the Bank met the test and has always met the test since its
effectiveness.

      Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities
impermissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "- Holding Company Regulation."

     If the Bank fails the QTL test, the Company must obtain the approval of the
OTS prior to continuing after such failure, directly or through its other
subsidiaries, any business activity other than those approved for multiple
savings and loan holding companies or their subsidiaries. In addition, within
one year of such failure, the Company must register as, and will become subject
to, the restrictions applicable to bank holding companies. The activities
authorized for a bank holding company are more limited than are the activities
authorized for a unitary or multiple savings and loan holding company. See
"Qualified Thrift Lender Test."

      Community Reinvestment Act. Under the Community Reinvestment Act ("CRA"),
every FDIC insured institution has a continuing and affirmative obligation
consistent with safe and sound banking practices to help meet the credit needs
of its entire community, including low and moderate income neighborhoods. The
CRA does not establish specific lending requirements or programs for financial
institutions nor does it limit an institution's discretion to develop the


                                       33
<PAGE>

types of products and services that it believes are best suited to its
particular community, consistent with the CRA. The CRA requires the OTS, in
connection with the examination of the Bank, to assess the institution's record
of meeting the credit needs of its community and to take such record into
account in its evaluation of certain applications, such as a merger or the
establishment of a branch, by the Bank. An unsatisfactory rating may be used as
the basis for the denial of an application by the OTS.

      The federal banking agencies, including the OTS, have recently revised the
CRA regulations and the methodology for determining an institution's compliance
with the CRA. Due to the heightened attention being given to the CRA in the past
few years, the Bank may be required to devote additional funds for investment
and lending in its local community. The Bank was examined for CRA compliance for
June 2002 and received a rating of "outstanding."

      Transactions with Affiliates. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain of these transactions, such as loans to an affiliate, are
restricted to a percentage of the association's capital. Affiliates of the Bank
include the Company and any company which is under common control with the Bank.
In addition, a savings association may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of most affiliates. The Bank's subsidiaries are not deemed affiliates; however,
the OTS has the discretion to treat subsidiaries of savings associations as
affiliates on a case by case basis.

      Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.

      Holding Company Regulation. The Company is a unitary savings and loan
holding company subject to regulatory oversight by the OTS. As such, the Company
is required to register and file reports with the OTS and is subject to
regulation and examination by the OTS. In addition, the OTS has enforcement
authority over the Company and its non-savings association subsidiaries which
also permits the OTS to restrict or prohibit activities that are determined to
be a serious risk to the subsidiary savings association.

      As a unitary savings and loan holding company that has been in existence
prior to May 4, 1999, the Company generally is not subject to activity
restrictions. If the Company acquires control of another savings association as
a separate subsidiary, it would become a multiple savings and loan holding
company, and the activities of the Company and any of its subsidiaries (other
than the Bank or any other SAIF-insured savings association) would become
subject to such restrictions.


                                       34
<PAGE>


      Federal Securities Law. The stock of the Company is registered with the
SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
The Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the SEC under the Exchange Act.

      Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. For
example, if the Company meets specified current public information requirements,
each affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.

      Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts). At June 30, 2003, the Bank was in compliance with these
reserve requirements. The balances maintained to meet the reserve requirements
imposed by the Federal Reserve Board may be used to satisfy liquidity
requirements that may be imposed by the OTS.

      Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.

      Federal Home Loan Bank System. The Bank is a member of the FHLB of Des
Moines, which is one of 12 regional FHLBs that administer the home financing
credit function of savings associations. Each FHLB serves as a reserve or
central bank for its members within its assigned region. Each is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures, established by the board of directors of the FHLB,
which are subject to the oversight of the Federal Housing Finance Board. All
advances from the FHLB are required to be fully secured by sufficient collateral
as determined by the FHLB.

      As a member, the Bank is required to purchase and maintain stock in the
FHLB of Des Moines. At June 30, 2003, the Bank had $509,200 in FHLB stock, which
was in compliance with this requirement. In past years, the Bank has received
substantial dividends on its FHLB stock. For fiscal 2003 and 2002, dividends
paid by the FHLB of Des Moines to Horizon Federal totaled $15,300 and $17,000
respectively. The $3,850 dividend received in June 2003 for FHLB's quarter ended
May 31, 2003 reflects an annualized rate of 3%, .52% less than the average rate
for fiscal 2002. Over the past five fiscal years such dividends have averaged
5.1% per annum. Recently, the FHL Bank System has been under pressure by its
regulator to register its stock with the SEC, which may increase the FHLB of Des
Moines' dividend if the proposal is approved. In addition, the FHLB of Des
Moines recently adopted a new capital plan changing


                                       35
<PAGE>

the components of its capital stock structure. It is uncertain what effect, if
any, the new capital plan will have on the Bank.

Federal and State Taxation

      Federal Taxation. For years prior to 1997, savings associations such as
the Bank that meet certain definitional tests relating to the composition of
assets and other conditions prescribed by the Code, were permitted to establish
reserves for bad debts and to make annual additions thereto which may, within
specified formula limits, be taken as a deduction in computing taxable income
for federal income tax purposes. The amount of the bad debt reserve deduction
for "non-qualifying loans" was computed under the experience method. The amount
of the bad debt reserve deduction for "qualifying real property loans"
(generally loans secured by improved real estate) was computed under either the
experience method or the percentage of taxable income method (based on an annual
election). Under the experience method, the bad debt reserve deduction is an
amount determined under a formula based generally upon the bad debts actually
sustained by the savings association over a period of years.

      In August 1996, legislation was enacted that repealed the reserve method
of accounting (including the percentage of taxable income method which was used
in prior years) used by many thrifts to calculate their bad debt reserve for
federal income tax purposes. Thrift institutions with $500 million or less in
assets may, however, continue to use the experience method. As a result, the
Bank recaptured that portion of the reserve that exceeded the amount that could
have been taken under the experience method for post-1987 tax years. The
recapture was approximately $56,000 per year over a six-year period which began
in fiscal 1997 and ended in fiscal 2002. The legislation also requires thrift
institutions to account for bad debts for federal income tax purposes on the
same basis as commercial banks for tax years beginning after December 31, 1995.
As a result, the Company computes its bad debt deduction on the experience
method.

      In addition to the regular income tax, corporations, including savings
associations such as the Bank, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income for fiscal years before fiscal
2001 and 100% for fiscal 2001 and 2002.

      To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the association's supplemental reserves
for losses on loans ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of June 30, 2003, the Bank's Excess for tax purposes totaled
approximately $1.3 million.


                                       36
<PAGE>

      The Company, the Bank and its subsidiary file consolidated federal income
tax returns on a fiscal year basis using the accrual method of accounting.

      The federal income tax returns of the Company for the last three years are
open to possible audit by the Internal Revenue Service (the "IRS"). No returns
are being audited by the IRS at the current time. In the opinion of management,
any examination of still open returns (including returns of subsidiary and
predecessors of, or entities merged into, the Bank) would not result in a
deficiency which could have a material adverse effect on the financial condition
of the Bank and its subsidiary.

      Iowa Taxation. Iowa imposes a franchise tax on the taxable income of both
mutual and stock savings banks. The tax rate is 5%, which may effectively be
increased, in individual cases, by application of a minimum tax provision.
Taxable income under the franchise tax is generally similar to taxable income
under the federal corporate income tax, except that, under the Iowa franchise
tax, no deduction is allowed for Iowa franchise tax payments and taxable income
includes interest on state and municipal obligations. Interest on U.S.
obligations is taxable under the Iowa franchise tax and under the federal
corporate income tax. For Iowa state tax purposes, the Company and Horizon
Investment Services, Inc. file income tax returns and the Bank files a franchise
tax return.

      Delaware Taxation. As a Delaware holding company, the Company is exempted
from Delaware corporate income tax but is required to file an annual report with
and pay an annual fee to the State of Delaware. The Company is also subject to
an annual franchise tax imposed by the State of Delaware.

Effect of New Accounting Standards

      Statement of Financial Accounting Standards (SFAS) No. 145, Rescission of
SFAS No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Correction was
issued April 2002. This Statement rescinds SFAS No. 4, Reporting Gains and
Losses from Extinguishment of Debt, and an amendment of that Statement, SFAS No.
64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This
Statement also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor
Carriers. This Statement amends SFAS No. 13, Accounting for Leases, to eliminate
an inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. The provisions of this Statement related to the rescission of
Statement 4 shall be applied in fiscal years beginning after May 15, 2002. The
provisions in paragraphs 8 and 9(c) of this Statement related to Statement 13
shall be effective for transactions occurring after May 15, 2002. All other
provision of this Statement shall be effective for financial statements issued
on or after May 15, 2002. The effect of implementation of this Statement was not
material.

      SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, was issued June 2002. This Statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF)


                                       37
<PAGE>

Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The provisions of this Statement are effective for exit and
disposal activities that are initiated after December 31, 2002.

      In October 2002, SFAS No. 147, Acquisitions of Certain Financial
Institutions, which amends SFAS No. 72, Accounting for Certain Acquisitions of
Banking or Thrift Institutions, and no longer requires the separate recognition
and subsequent amortization of goodwill that was originally required by SFAS No.
72, was issued. SFAS No. 147 also amends SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, to include in its scope long-term
customer-relationship intangible assets (such as core deposit intangibles). The
effects of implementation on the Company's financial statements were not
material.

      In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness to Others, an
interpretation of SFAS No. 5, 57, and 107 and a rescission of FASB
Interpretation No. 34. This Interpretation elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under guarantees issued. The Interpretation also clarifies that a
guarantor is required to recognize, at inception of a guarantee, a liability for
the fair value of the obligation undertaken. The initial recognition and
measurement provisions of the Interpretation are applicable to guarantees issued
or modified after December 31, 2002, and were not material to the Company's
financial statements. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 15, 2002 and have
been included in these financial statements.

      In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of SFAS No. 123. This
Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation. In addition,
this Statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures of both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. Certain of the disclosure modifications are
required for fiscal years ending after December 15, 2002 and are included in the
notes to these consolidated financial statements.

      In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). FIN 46 addresses consolidation by business
enterprises of variable interest entities that have certain characteristics. It
requires a business enterprise that has a controlling interest in a variable
interest entity (as defined by FIN 46) to include the assets, liabilities, and
results of the activities of the variable interest entity of the consolidated
financial statements of the business enterprise. FIN 46 applies immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date.
For variable interest acquired before February 1, 2003, it applies in the first
fiscal year or interim period beginning after June 15, 2003. The impact of
adopting FIN 46 will not be material as the Company does not presently have any
variable interest entities.


                                       38
<PAGE>

      In April 2003, the FASB issued SFAS No. 149, Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends SFAS No. 133
for decisions made (1) as part of the Derivatives Implementation Group process
that effectively required amendments to SFAS No. 133, (2) in connection with
other FASB projects dealing with financial instruments, and (3) in connection
with implementation issues raised in relation to the application of the
definition of a derivative, in particular, the meaning of "an initial net
investment that is smaller than would be required for other types of contracts
that would be expected to have a similar response to changes in market factors,"
the meaning of "underlying," and the characteristics of a derivative that
contains financing components. SFAS No. 149 is generally effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The Company will adopt SFAS No. 149 as indicated
above and such adoption is not expected to have a material effect on its
financial position or results of operations.

      In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. SFAS
No. 150 established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or asset in some circumstances). Many of those instruments were
previously classified as equity. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003, except for mandatory redeemable financial instruments of nonpublic
entities. The Company will adopt SFAS No. 150 on July 1, 2003 and such adoption
is not expected to have a material effect on its financial position or results
of operations.

Competition

      Horizon Federal faces strong competition, both in originating real estate
loans and in attracting deposits. Competition in originating real estate loans
comes primarily from commercial and savings banks, and to a lesser extent,
credit unions located in the Bank's market area. Commercial banks, savings
banks, credit unions and finance companies provide vigorous competition in
consumer lending. The Bank competes for real estate and other loans principally
on the basis of the quality of services it provides to borrowers, the interest
rates it charges, loan fees it charges, and the types of loans it originates.
See "Lending Activities."

      The Bank attracts all of its deposits through its retail banking offices,
primarily from the communities in which those retail banking offices are
located. Therefore, competition for those deposits is principally from
commercial banks, savings banks, credit unions and investment banking firms
located in these communities. The Bank competes for these deposits by offering a
variety of account alternatives at competitive rates and by providing convenient
business hours, branch locations and interbranch deposit and withdrawal
privileges at each.

      The Bank serves Mahaska County and that portion of Marion County in and
around Knoxville, Iowa. There are nine commercial banks, one savings bank, other
than Horizon Federal, and three credit unions which compete for deposits and
loans in Horizon Federal's


                                       39
<PAGE>

primary market area. The Bank estimates its share of the savings market in its
primary market area to be approximately 18%.

Employees

      At June 30, 2003, the Bank had a total of 33 full-time and 7 part-time
employees. The Bank's employees are not represented by any collective bargaining
group. Management considers its employee relations to be good.

      The following information as to the business experience during the past
five years is supplied with respect to executive officers of the Company and the
Bank who do not serve on the Company's Board of Directors. There are no
arrangements or understandings between the persons named and any other person
pursuant to which such officers were selected.

      Vicki Hladik - Ms. Hladik, age 42, joined Horizon Federal in 1995 as
Assistant Treasurer and was promoted to Controller and Treasurer of the Bank in
2001 and Chief Financial Officer in 2002. Ms. Hladik is in charge of the
accounting department of the Bank.

      Kent R. Frankenfeld - Mr. Frankenfeld, age 46, joined the Bank in October
1994, as Vice President in charge of Marketing and Sales. Mr. Frankenfeld is
department head for the retail division of the Bank.

Item 2. Description of Property

      The Bank conducts its business through three offices, two of which are
located in Oskaloosa, Iowa and one in Knoxville, Iowa. The following table sets
forth information relating to each of the Bank's offices as of June 30, 2003.
The total net book value of the Bank's premises and equipment (including land,
buildings and leasehold improvements and furniture, fixtures and equipment) at
June 30, 2003 was approximately $1.97 million. See Note 6 of Notes to
Consolidated Financial Statements in the Annual Report.

                                              Date       Total Approximate
                 Location                   Acquired      Square Footage
      ----------------------------          --------     -----------------
      Main Office:                             1964             4,230
         301 First Avenue East
         Oskaloosa, Iowa

      Branch Offices:
         509 A Avenue West                     1992             3,277
         Oskaloosa, Iowa

         1022 West Pleasant Street             1979             4,159
         Knoxville, Iowa

      Horizon Federal believes that its current facilities are adequate to meet
the present and foreseeable needs of the Bank and the Company in Oskaloosa and
Knoxville, Iowa.

      In April 2003, the Bank opened a mortgage loan origination office in
Pleasant Hill, Iowa which serves Polk County and surrounding areas. The Bank has
also received approval from the


                                       40
<PAGE>

Office of Thrift Supervision to establish a retail banking office in Pleasant
Hill, Iowa which is scheduled to open in the spring of 2004.

Item 3. Legal Proceedings

      Horizon Federal is involved, from time to time, as plaintiff or defendant
in various legal actions arising in the normal course of its businesses. While
the ultimate outcome of these proceedings cannot be predicted with certainty, it
is the opinion of management, after consultation with counsel representing
Horizon Federal in the proceedings, that the resolution of these proceedings
should not have a material effect on Horizon Federal's results of operations.

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

      No matter was submitted to a vote of security holders through the
solicitation of proxies or otherwise during the fourth quarter of fiscal 2003.


                                       41
<PAGE>

                                     PART II

Item 5. Market for Common Equity and Related Stockholder Matters

      Page 48 of the attached 2003 Annual Report to Stockholders is incorporated
herein by reference.

Securities Authorized for Issuance Under Equity Compensation Plan.

      The following table provides information as of June 30, 2003 related to
our equity compensation plans in effect at that time.

<TABLE>
<CAPTION>
                                            Equity Compensation Plan Information
--------------------------------------------------------------------------------------------------------------------
                                Number of Securities to be    Weighted-average Exercise      Number of securities
                                  Issued Upon Exercise of       Price of Outstanding        Remaining Available for
                                   Outstanding Options,         Options, Warrants and        Future Issuance Under
        Plan Category               Warrants and Rights                Rights              Equity Compensation Plans
--------------------------------------------------------------------------------------------------------------------
<S>                                       <C>                           <C>                          <C>
  Equity Compensation Plans
 Approved by Security Holders             31,800                        $5.50                        ____
--------------------------------------------------------------------------------------------------------------------
Equity Compensation Plans Not
 Approved by Security Holders             ______                        _____                        ____
--------------------------------------------------------------------------------------------------------------------
            Total                         31,800                        $5.50                        ____
--------------------------------------------------------------------------------------------------------------------
</TABLE>

Item 6. Management's Discussion and Analysis or Plan of Operation

      Pages 4 through 18 of the attached 2003 Annual Report to Stockholders are
incorporated herein by reference.

Item 7. Financial Statements


      The following information appears in the Company's 2003 Annual Report to
Stockholders for fiscal 2003, and is incorporated herein by reference.

<TABLE>
<CAPTION>
Annual Report Section                                           Pages in Annual Report
---------------------                                           ----------------------
<S>                                                                       <C>
Independent Auditors' Report                                              20

Consolidated Balance Sheets as of June 30, 2003 and 2002                  21

Consolidated Statements of Operations for the Years Ended
June 30, 2003, 2002 and 2001                                              22

Consolidated Statements of Changes in Stockholders' Equity
and Comprehensive Income for Years Ended
June 30, 2003, 2002 and 2001                                              23

Consolidated Statements of Cash Flows for Years Ended
June 30, 2003, 2002 and 2001                                              24

Notes to Financial Statements                                             25
</TABLE>


                                       42
<PAGE>

      With the exception of the aforementioned information, the Company's Annual
Report to Stockholders for fiscal 2003, is not deemed filed as part of this
Annual Report on Form 10-KSB.

Item 8. Changes in and Disagreements with Accountants on Accounting and
        Financial Disclosure

      There has been no Current Report on Form 8-K filed within 24 months prior
to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.

Item 8A. Controls and Procedures

     We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the design and operation of our disclosure controls and
procedures. Based on this evaluation our Chief Executive Officer and Chief
Financial Officer concluded that, as of June 30,2003, our disclosure controls
and procedures were effective to provide reasonable assurance that the
information we are required to disclose in the reports we file or submit under
the Securities Exchange Act 1934 is recorded processed, summarized, and reported
within the time periods specified in the SEC's rules and forms.

     Any control system, no matter how well designed and operated, can provide
only reasonable (not absolute) assurance that its objectives will be met.
Furthermore, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, have been detected.

                                    PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
        with Section 16(a) of the Exchange Act

Directors

      Information concerning Directors of the Company is incorporated herein by
reference from the definitive proxy statement for the Annual Meeting of
Stockholders to be held on October 23, 2003, a copy of which was filed with the
Securities and Exchange Commission (the "SEC") on September 23, 2003.

Executive Officers

      Information regarding the business experience of the executive officers of
the Company and the Bank contained in Part I under the caption "Employees" of
this Form 10-KSB is incorporated herein by reference.

Compliance with Section 16(a)

      Information concerning compliance with Section 16(a) of the Securities
Exchange Act of 1934 is incorporated herein by reference from the definitive
Proxy Statement for the Annual Meeting of Stockholders to be held on October 23,
2003, a copy of which was filed with the SEC on September 23, 2003.


                                       43
<PAGE>

Item 10. Executive Compensation

      Information concerning executive compensation is incorporated herein by
reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on October 23, 2003, a copy of which was filed with the
SEC on September 23, 2003.

Item 11. Security Ownership of Certain Beneficial Owners and Management

      Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the definitive Proxy
Statement for the Annual Meeting of Stockholders to be held on October 23, 2003,
a copy of which was filed on September 23, 2003.

Item 12. Certain Relationships and Related Transactions

      Information concerning certain relationships and related transactions is
incorporated herein by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held on October 23, 2003, a copy of which
was filed on September 23, 2003.

Item 13. Exhibits and Reports on Form 8-K

      (a)   Exhibits - See Index to Exhibits.

      (b)   Reports on Form 8-K - The following is a description of the Form 8-K
            filed during the three-month period ended June 30, 2003:

                  On April 25, 2003, a current report of Form 8-K was filed to
                  announce the results of operations and the financial position
                  of the Company as of, and for the three months ended, March
                  31, 2003.

                                       44
<PAGE>

                                   SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) 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 SERVICES
                                            CORPORATION


Date: September 29, 2003                By: /s/ Robert W. DeCook
     -------------------                        --------------------------------
                                                Robert W. DeCook, President and
                                                Chief Executive Officer
                                                (Duly Authorized Representative)

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


     /s/ Robert W. DeCook                        /s/ Thomas L. Gillespie
-----------------------------------------      ---------------------------------
Robert W. DeCook, Director, President and      Thomas L. Gillespie, Director and
Chief Executive Officer (Principal             Vice President
 Executive Officer)

Date: September 29, 2003                       Date: September 29, 2003
     ------------------------------------            ---------------------------


     /s/ Gary L. Rozenboom                       /s/ Michael F. Cooney, III
-----------------------------------------      ---------------------------------
Gary L. Rozenboom, Director                    Michael F. Cooney, III, Director

Date: September 29, 2003                       Date: September 29, 2003
     ------------------------------------            ---------------------------


     /s/ Norman P. Zimmerman                     /s/ Vicki Hladik
-----------------------------------------      ---------------------------------
Norman P. Zimmerman, Director                  Vicki Hladik, Treasurer and
                                               Chief Financial Officer

Date: September 29, 2003                       Date: September 29, 2003
     -------------------------------                ----------------------------


                                       45
<PAGE>

                                Index to Exhibits

Exhibit
 Number                             Document
--------    --------------------------------------------------------------------

  3         The Articles of Incorporation and Bylaws, filed on March 18, 1994 as
            exhibits 3.1 and 3.2, respectively, to Registrant's Registration
            Statement on Form S-1 (File No. 33-76674), are incorporated herein
            by reference.

  4         Registrant's Specimen Stock Certificate, filed on March 18, 1994 as
            Exhibit 4 to Registrant's Registration Statement on Form S-1 (File
            No. 33-76674), is incorporated herein by reference.

  10.1      Registrant's Employee Stock Ownership Plan, filed on March 18, 1994
            as Exhibit 10.3 to Registrant's Registration Statement on Form S-1
            (File No. 33-76674), is incorporated herein by reference.

  10.2      Employment Agreements between the Bank and Messrs. DeCook and
            Gillespie, filed as Exhibits 10.1 and 10.2, respectively, to
            Registrant's Annual Report on Form 10-KSB for the fiscal year ended
            June 30, 1994 (File No. 0-24036), are incorporated herein by
            reference.

  10.3      1994 Stock Option and Incentive Plan, filed as Exhibit 10.3 to
            Registrant's Annual Report on Form 10-KSB for the fiscal year ended
            June 30, 1994 (File No. 0-24036), is incorporated herein by
            reference.

  10.4      Recognition and Retention Plan, filed as Exhibits 10.4 to
            Registrant's Annual Report on Form 10-KSB for the fiscal year ended
            June 30, 1994 (File No. 0-24036), is incorporated herein by
            reference.

  13        Annual Report to Stockholders

  21        Subsidiaries of the Registrant

  23        Consent of KPMG

  31.1      Certification of Robert W. DeCook pursuant to Section 302 of
            Sarbanes-Oxley Act of 2002.

  31.2      Certification of Vicki Hladik pursuant to Section 302 of
            Sarbanes-Oxley Act of 2002.

  32        Certifications of Robert W. DeCook and Vicki Hladik pursuant to
            Section 906 of the Sarbanes-Oxley Act of 2002.


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