<PAGE>

                                 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, 1997
                                      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:        (515) 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:
$6,332,729.

         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 12,
1997, was $6.4 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 12, 1997, there were issued and outstanding 425,540
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, 1997.

         Part III of Form 10-KSB - Proxy Statement for the Annual Meeting of
Stockholders held in October 1997.

         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. On that date, the Company issued 506,017 shares of
common stock at a price of $10.00 per share in the Conversion. 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 on the Nasdaq SmallCap Market under the Symbol "HZFS".

        At June 30, 1997, the Company had $86.0 million of assets and
stockholders' equity of $8.4 million (or 9.8% 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 
(515) 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.

        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 "Business of the Bank -
Originations of Loans and Mortgage-Backed Securities." At June 30, 1997,
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, gains from sales of securities, service fee income and
dividends on FHLB stock. The Bank does not originate loans to fund leveraged
buyouts and has no loans to non-United States corporations or foreign
governments.

        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.

                                       1
<PAGE>

        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, 1997, the apartment complex was 94% leased. At June
30, 1997, the Company's equity investment in the project was $208,000,
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. The Bank competes in loan
originations and in deposit gathering activities with the eleven financial
institutions and three credit unions serving its primary market area. See " -
Competition." The Bank estimates its share of the savings market in its
primary market area to be approximately 10%.

        Oskaloosa, Iowa is located in Mahaska County, approximately 60 miles
southeast of Des Moines, Iowa. Mahaska County has a population of
approximately 22,000 people. Oskaloosa, with a current population of
approximately 10,500 persons, is the county seat and the largest city in
Mahaska County. Oskaloosa has a mostly 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

                                       2
<PAGE>

the Clow Valve Company, the Pella Corporation, Cargill, Vermeer Manufacturing,
the V.A. Medical Center, 3-M Company, William Penn College and the Mahaska
County Hospital.

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 seven 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 with terms generally not greater than 15 years. The Bank also
originates and sells from time to time 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, 1997, the Bank's net loan portfolio
totaled $52.2 million.

        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 one outside director and two other members of
the Loan Committee is required to approve real estate loans of $200,000 or
more. Loan Committee approval is currently required for unsecured and secured
consumer loans of more than $80,000 and $100,000, respectively, and unsecured
and secured commercial business loans of more than $25,000 and $50,000,
respectively. The Board of Directors must approve all commercial business loans 
with a balance exceeding $200,000.

        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, 1997, 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 $970,000, however, at
June 30, 1997 the Board of Director's of the Company had a self-imposed
$800,000 limit. At June 30, 1997, the Bank had two loans or groups of loans to
related borrowers with outstanding balances in excess of the Board's self
imposed limit but not in excess of regulatory limits. The largest of such
lending relationships totaled $857,000 and consisted of a $260,000 commercial
real estate loan and five loans totaling $597,000 secured by residential real
estate. The other lending relationship in excess of the Board's self imposed
limit was a $800,000 line of credit on residential real estate with an
outstanding balance of $806,000. At June 30, 1997, all of the foregoing loans
were performing in accordance with their terms.

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

                                       3
<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,
                                                    -------------------------------------------------------------------------------
                                                                1997                      1996                        1995
                                                    -------------------------   ------------------------    -----------------------
                                                       Amount         Percent     Amount        Percent       Amount        Percent
                                                      --------       --------    --------      ---------    ---------      --------
                                                                                     (In Thousands)
<S>                                                    <C>            <C>         <C>           <C>          <C>            <C>
 Real Estate:
 One- to four-family............................       $34,625          64.9%     $32,511          64.7%     $ 30,849         65.4%
 Commercial real estate.........................         3,944           7.4        3,801           7.5         3,900          8.2
 Multi-family...................................           658           1.2          789           1.6           931          2.0
 Residential construction ......................           829           1.6        1,335           2.7           507          1.1
                                                       -------         -----      -------         -----      --------       ------
     Total real estate loans....................        40,056          75.1       38,436          76.5        36,187         76.7
                                                       -------         -----      -------         -----      --------       ------
Other Loans:
 Consumer Loans:
  Automobile....................................         4,051           7.6        3,516           7.0         3,598          7.6
  Home improvement..............................         2,353           4.4        1,966           3.9         1,845          3.9
  Deposit account...............................           222            .4          175            .4           327           .7
  Other.........................................         1,541           2.9        1,428           2.8         1,406          3.0
                                                       -------         -----      -------         -----      --------       ------
     Total consumer loans.......................         8,167          15.3        7,085          14.1         7,176         15.2
 Commercial business loans......................         5,124           9.6        4,707           9.4         3,807          8.1
                                                       -------         -----      -------         -----      --------       ------
     Total other loans..........................        13,291          24.9       11,792          23.5        10,983         23.3
                                                       -------         -----      -------         -----      --------       ------
     Total loans receivable, gross..............        53,347        100.00%      50,228         100.0%       47,170        100.0%
                                                                      ======                      =====                      =====

Less:
 Loans in process...............................           732                        730                         315
 Deferred fees and discounts....................            74                         76                          86
 Allowance for losses...........................           348                        318                         291
                                                       -------                    -------                   ---------
 Total loans receivable, net....................       $52,193                    $49,104                    $ 46,478
                                                       =======                    =======                    ========
</TABLE>

                                       4
<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,
                                                    ----------------------------------------------------------------------------
                                                             1997                       1996                       1995
                                                    --------------------------  -----------------------  -----------------------
                                                     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..........................      $ 4,627            8.7%    $ 4,865           9.7%     $ 4,995          10.6%
  Commercial real estate.......................        1,015            1.9       1,171           2.3          705           1.5
  Multi-family.................................           87             .1          92            .2          240            .5
  Residential construction.....................           --             --         146            .3          317            .7
                                                     -------          -----     -------        ------      -------        ------
     Total real estate loans...................        5,729           10.7       6,274          12.5        6,257          13.3

  Consumer.....................................        7,831           14.7       6,884          13.7        6,879          14.6
  Commercial business..........................        4,839            9.1       4,479           8.9        3,596           7.6
                                                     -------          -----     -------        ------      -------        ------
     Total fixed-rate loans....................       18,399           34.5      17,637          35.1       16,732          35.5
                                                     -------          -----     -------        ------      -------        ------
Adjustable Rate Loans:
 Real estate:
  One- to four-family..........................       29,998           56.2      27,646          55.0       25,854          54.8
  Commercial real estate.......................        2,929            5.5       2,630           5.2        3,195           6.8
  Multi-family.................................          571            1.1         697           1.4          691           1.5
  Residential construction.....................          829            1.6       1,189           2.4          190            .4
                                                     -------          -----     -------        ------      -------        ------
     Total adjustable rate real estate loans...       34,327           64.4      32,162          64.0       29,930          63.5

  Consumer.....................................          336             .6         201            .4          297            .6
  Commercial business..........................          285             .5         228            .5          211            .4
                                                     -------          -----     -------        ------      -------        ------
     Total adjustable rate loans...............       34,948           65.5      32,591          64.9       30,438          64.5
                                                     -------          -----     -------        ------      -------        ------
     Total loans, receivable, gross............       53,347          100.0%     50,228         100.0%      47,170         100.0%
                                                                      =====                     =====                      =====

Less:
 Loans in process..............................          732                        730                        315
 Deferred fees and discounts...................           74                         76                         86
 Allowance for loan losses.....................          348                        318                        291
                                                     -------                    -------                    -------
     Total loans receivable, net...............      $52,193                    $49,104                    $46,478
                                                     =======                    =======                    =======
</TABLE>

                                      5
<PAGE>

        The following table illustrates the interest rate sensitivity of the
Bank's loan portfolio at June 30, 1997. 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)
     Due During
    Years Ending
      June 30,
    ------------
<S>                    <C>            <C>        <C>         <C>      <C>           <C>     <C>          <C>      <C>  
1998(2).............   $    476       9.36%      $  --         --%    $ 1,394       9.38%   $2,973       9.68%    $ 4,843     9.55%
1999 to 2002........      1,738       8.81          --         --       4,828       9.33     1,479       8.81       8,045     9.12
2003 and following..     37,013       8.29         829       7.77       1,945       9.56       672       7.86      40,459     8.33
                        -------                  -----                 ------               ------                 -------
   Total............    $39,227                  $ 829                $ 8,167               $5,124                 $53,347
                        =======                  =====                 ======               ======                 =======
</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.

                                       6
<PAGE>

         The total amount of loans due after June 30, 1998 which have
predetermined interest rates is $13.7 million, while the total amount of loans
due after such date which have floating or adjustable interest rates is $34.8
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 customers, 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 Loan and Mortgage-Backed Securities." At June 30,
1997, the Bank's permanent one- to four-family residential mortgage loans
totaled $34.6 million, or 64.9%, of the Bank's gross loan portfolio.

         The Bank currently originates ARM loans and, to a lesser extent,
fixed-rate loans for retention in the Bank's loan portfolio. During the year
ended June 30, 1997, the Bank originated $6.3 million of adjustable-rate, one-
to four-family real estate loans (including $1.2 million of residential
construction loans) and $1.9 million of fixed-rate one- to four-family loans
(including $212,000 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
for portfolio are generally originated up to a maximum term of 15 years.
Fixed-rate mortgage loans originated by the Bank in excess of 15 years are
generally sold in the secondary market. The Bank originated $350,000 of fixed
rate loans for sale during fiscal 1997.

         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 seven-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 75.7% of the loans secured
by one- to four-family real estate originated by the Bank during fiscal 1997

                                       7
<PAGE>

were originated with adjustable rates of interest.  See "- Originations of Loans
and Mortgage-Backed Securities."

         At June 30, 1997, the Bank was not servicing any loans other than
loans it originated. As of June 30, 1997, the Bank's residential ARM loan
portfolio totaled $30.0 million, or 56.2% of the Bank's gross loan portfolio
as compared to the residential fixed-rate, mortgage loan portfolio which
totaled $4.6 million, or 8.7% 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.

         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 seven-year loans on one- to four-family residential
property. Typically, the spread between a one-year ARM and a seven-year ARM
has been 150 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 $12.0
million, $5.0 million and $6.0 million of mortgage-backed and related
securities during fiscal 1997, 1996 and 1995, 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, 1997, the
Bank's construction loan portfolio totaled $829,000, or 1.6% 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.

         Construction loans are obtained primarily from builder references and
individuals who have previously borrowed from the Bank, as well as from
referrals from existing customers. The application process 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

                                       8
<PAGE>

of the subject property.  Loans are based on the lesser of current appraised
value or the cost of construction (land plus building).

         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, 1997, $658,000, or 1.2%, of the Bank's gross loan
portfolio consisted of multi-family loans and $3.9 million, or 7.4%, 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, 1997, 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 $500,000.

         Multi-family and commercial real estate lending affords the Bank an
opportunity to receive interest at rates higher than those generally available
from one- to four-family residential lending. 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,

                                       9
<PAGE>

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 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, 1997, the Bank's consumer loans totaled $8.2 million, or 15.3% 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, 1997, the outstanding balances
on automobile loans and home improvement totaled $4.1 million and $2.4
million, or 49.6% and 28.8% of the Bank's gross consumer loan portfolio,
respectively.

         In addition, Horizon Federal commenced offering Visa and MasterCard
credit cards in April 1994. Both types of lending generally present more
credit risk to the Bank than one- to four-family residential lending. At June
30, 1997, the Bank had $26,000 of credit card loans outstanding and $94,000 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

                                      10
<PAGE>

recovered on such loans. At June 30, 1997, non-performing consumer loans
totaled $130,000, or 1.6% of total consumer loans and .2% of the Bank's gross
loan portfolio. See "Asset Quality - Non-Performing Assets."

         Commercial Business Lending. The Bank also originates commercial
business loans. At June 30, 1997, Horizon Federal had $5.1 million in
commercial business loans outstanding, representing 9.6% of the Bank's gross
loan portfolio. 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.

         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 largest commercial business loan outstanding at June 30, 1997 was
an $806,000 business line of credit to a builder of one- to four-family
residential properties. At June 30, 1997, this line of credit was performing
in accordance with its terms.

         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, as well as real estate. 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.

                                      11
<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 the years ended June 30, 1997, 1996, and 1995, the Bank's dollar volume
of adjustable-rate real estate loan originations exceeded the dollar volume of
the same type of fixed-rate 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
1997, 1996 and 1995 the Bank purchased $12.0 million, $5.0 million and $6.0
million, respectively, of mortgage-backed and related securities. The Bank
funded its purchases of mortgage-backed and related securities, specifically
collateralized mortgage obligations, during fiscal 1997, with advances from the
FHLB. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Asset/Liability Management" in the Annual Report. 

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

<TABLE>
<CAPTION>
                                                                   Year Ended June 30,
                                                   --------------------------------------------------
                                                     1997                1996                  1995
                                                   --------            ---------             --------
                                                                     (In Thousands)
<S>                                                <C>                  <C>                  <C>
Originations by type:
 Adjustable rate:
  Real estate
   - one- to four-family ..............            $  5,153             $  5,186             $  4,091
   - multi-family .....................                --                   --                     35
   - commercial real estate ...........                 664                  715                  520
   - residential construction .........               1,154                2,245                1,253
  Non-real estate
   - consumer .........................                 102                 --                     72
   - commercial business ..............                --                   --                    158
                                                   --------             --------             --------
         Total adjustable-rate ........               7,073                8,146                6,129
                                                   --------             --------             --------

 Fixed rate:
  Real estate
   - one- to four-family ..............               1,650                1,102                  726
   - multi-family .....................                  23                   10                 --
   - commercial real estate ...........                 362                1,209                 --
   - residential construction .........                 212                  627                  115
  Non-real estate
   - consumer .........................               5,676                4,000                6,193
   - commercial business ..............               1,356                1,057                1,857
                                                   --------             --------             --------
         Total fixed-rate .............               9,279                8,005                8,891
                                                   --------             --------             --------
         Total loans originated .......              16,352               16,151               15,020

Total loan purchases ..................                --                   --                   --
Total loan sales ......................                (602)              (1,724)                --
Total loan repayments .................             (13,473)             (11,048)              (8,983)
Increase (decrease) in other items, net                 812                 (753)                  32
                                                   --------             --------             --------
         Net increase .................            $  3,089             $  2,626             $  6,069
                                                   ========             ========             ========
</TABLE>

                                      12
<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,
                                                    ------------------------------------------------
                                                      1997               1996                 1995
                                                    ---------           --------            --------
                                                                     (In Thousands)
<S>                                                 <C>                 <C>                 <C>
Purchases:
  Mortgage-backed and related securities            $   --              $   --              $  2,961
  CMOs ..................................             12,259               5,179               3,053
                                                    --------            --------            --------
         Total ..........................           $ 12,259            $  5,179            $  6,014
                                                    --------            --------            --------

Sales:
  Mortgage-backed and related securities              (3,191)               (631)               --
  CMOs ..................................               (971)             (1,071)               --
                                                    --------            --------            --------
         Total ..........................             (4,162)             (1,702)               --
                                                    --------            --------            --------

Repayments:
  Mortgage-backed and related securities                (702)             (1,717)             (1,710)
  CMOs ..................................               (683)               (211)               --
  Increase (decrease) in other items, net               (120)               (110)               --
                                                    --------            --------            --------
         Net increase (decrease) ........           $  6,592            $  1,439            $  4,304
                                                    ========            ========            ========
</TABLE>

Asset Quality

         General. When a borrower fails to make a required payment on a 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.

                                      13
<PAGE>

         The following table sets forth the Bank's loan delinquencies by type,
by amount and by percentage of category at June 30, 1997. 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          
                              -------------------------- -------------------------- 
                                              Percent of                 Percent of 
                                                Loan                        Loan    
                              Number  Amount  Category   Number   Amount  Category  
                              ------  ------  ---------- ------   ------ ---------- 
<S>                           <C>     <C>     <C>        <C>      <C>    <C>
Real Estate:
  One- to four-family ..       17      $651      1.9%       5      $136      .4%    

  Commercial real estate       --        --      --        --        --      --     

Consumer ...............       26       125      1.5       12        65      .8     

Commercial business ....        1         6       .1        1       269     5.3     
                               --      ----                --      ----             

     Total .............       44      $782      1.5%      18      $470      .9%    
                               ==      ====                ==      ====
</TABLE>
         
<TABLE>
<CAPTION>
                                                Loans Delinquent For:
                              -------------------------------------------------------
                                   90 Days and Over                Total
                              -------------------------- ----------------------------
                                              Percent of                   Percent of
                                                 Loan                         Loan
                              Number  Amount   Category   Number   Amount   Category
                              ------  ------  ----------  ------   ------  ----------
                                     (Dollars in Thousands)
<S>                           <C>     <C>      <C>         <C>      <C>     <C>
Real Estate:
  One- to four-family ..        13      $410      1.2%      35     $1,197     3.5%

  Commercial real estate         1         9       .2        1          9      .2

Consumer ...............        26       130      1.6       64        320     3.9

Commercial business ....         1       140      2.7        3        415     8.1
                                --      ----               ---     ------

     Total .............        41      $689      1.3%     103     $1,941     3.6%
                                ==      ====               ===     ======
</TABLE>

                                      14
<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
become doubtful. As a matter of policy, the Bank does not generally accrue
interest on loans past due 90 days or more. For all periods presented, the
Bank has had no troubled debt restructurings (which involve forgiving a
portion of interest or principal on any loans or making loans at a rate
materially less than that of market rates). Foreclosed assets include assets
acquired in settlement of loans. There were no loans deemed to be in-substance
foreclosed at June 30, 1997.

<TABLE>
<CAPTION>
                                                                        At June 30,
                                                          ----------------------------------------
                                                           1997             1996             1995
                                                           ----             ----             ----
<S>                                                      <C>              <C>               <C>
Non-accruing loans:
  One- to four-family.............................        $   318            $504             $450
  Commercial real estate..........................              9              --              --
  Consumer........................................            130             151               68
  Commercial business.............................             12              43               27
                                                          -------            ----             ----
     Total........................................            469             698              545
                                                          -------            ----             ----

Accruing loans 90 days or more:
  One- to four-family.............................             92              --               --
  Commercial......................................            128              --               --
                                                          -------            ----             ----
      Total.......................................            220              --               --
                                                          -------            ----             ----


Foreclosed assets:
  One- to four-family.............................            137
  Commercial real estate..........................            206             205              190
  Consumer........................................             13              32                6
                                                         --------            ----             ----
     Total........................................            356             237              196
                                                          -------            ----             ----

Total non-performing assets.......................        $ 1,045            $935             $741
                                                          =======            ====             ====
Total as a percentage of total  assets............           1.22%           1.27%            1.06%
                                                            =====            ====             ====
</TABLE>

         For the fiscal year ended June 30, 1997, gross interest income which
would have been recorded had the non-accruing loans been current in accordance
with their original terms amounted to $57,000, of which $37,000 was included
in interest income at such date.

         At June 30, 1997, there were no non-accruing loans to a single
borrower or group of related borrowers in excess of $84,000. At June 30, 1997,
there were approximately $330,000 of non-accruing loans contained in the
foregoing table which are not described in "Other Loans of Concern" or
"Classified Assets" below. These loans are not required to be classified by
the OTS and are adequately capitalized such that management does not
anticipate any losses relating to these loans.

         Other Loans of Concern. In addition to the non-performing assets set
forth in the table above, as of June 30, 1997, there was also an aggregate of
$402,000 in net book value of loans ($319,000 secured by single family
residences, $75,000 secured by other commercial business and $8,000 in secured
consumer loans) with respect to which known information about the possible

                                      15
<PAGE>

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 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, 1997, the Bank had classified a total of $386,000 of its assets as
substandard, none as doubtful and $83,000 as loss. All portions of a loan
which are classified as loss are reserved for at a rate of 100%.

         At June 30, 1997, total classified assets comprised $469,000, or 5.6%
of the Bank's capital, or .55% 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

                                    16
<PAGE>

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, 1997, the Bank had an allowance for loan losses of
$348,000, or approximately .65% 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.

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

<TABLE>
<CAPTION>
                                                                        Year Ended June 30,
                                                               --------------------------------------
                                                               1997            1996             1995
                                                               ----            ----             ----
                                                                      (Dollars in Thousands)
<S>                                                            <C>             <C>              <C>  
Balance at beginning of period .............................   $ 318           $ 291            $ 379

Charge-offs:
  One- to four-family ......................................     (15)           --               --
  Commercial real estate ...................................    --               (29)             (78)
  Commercial business ......................................    (150)           (227)            --
  Consumer .................................................     (62)            (63)             (17)
                                                               -----           -----            -----
    Total charge-offs ......................................    (227)           (319)             (95)
                                                               -----           -----            -----

Recoveries:
  Commercial business ......................................    --                11             --
  Consumer .................................................       5               7                5
                                                               -----           -----            -----
    Total recoveries .......................................       5              18                5

Net charge-offs ............................................    (222)           (301)             (90)
Additions charged to operations ............................     252             328                2
                                                               -----           -----            -----
Balance at end of period ...................................   $ 348           $ 318            $ 291
                                                               =====           =====            =====

Ratio of net charge-offs during the period to average
 loans outstanding during the period .......................   .43 %             .63%             .21%
                                                               =====           =====            =====
</TABLE>


                                      17
<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,
                                     -------------------------------------------------------------------
                                             1997                  1996                  1995
                                     -------------------  --------------------- ------------------------
                                                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.............       $116        64.9%    $128          64.7%    $129          65.4%
Multi-family....................          2         1.2        2           1.6        2           2.0
Commercial real estate..........         12         7.4       11           7.5       11           8.2
Residential construction........          2         1.6        3           2.7        1           1.1
Consumer........................        103        15.3       80          14.1       78          15.2
Commercial business.............         95         9.6       60           9.4       40           8.1
Unallocated.....................         18          --       34            --       30            --
                                      -----       -----     ----         -----     ----         -----
     Total......................      $ 348       100.0%    $318         100.0%    $291         100.0%
                                      =====       =====     ====         =====     ====         =====
</TABLE>

Investment Activities

         Horizon Federal must maintain minimum levels of investments that
qualify as liquid assets 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 imposed by
the 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, 1997, the Bank's
liquidity ratio (liquid assets as a percentage of net withdrawable savings
deposits and current borrowings) was 7.12%. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Annual
Report and "Regulation - Liquidity."

         Federally chartered savings institutions have the authority to invest
in various types of liquid assets, including United States 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

                                      18
<PAGE>

for each type of security. It is 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, 1997, the Bank's mortgage-backed and related
securities totaled $22.4 million, or 26.1% 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.

         Historically, most of the Bank's mortgage-backed securities were
long-term, fixed-rate securities. In more recent years, the Bank has begun to
purchase other types of mortgage-backed and related securities consistent with
its asset/liability management objectives. In this regard, the Bank emphasizes
the purchase of adjustable-rate, mortgage-backed and related securities for
asset/liability management purposes and in order to supplement the Bank's
origination of ARM loans. At June 30, 1997, all of the Bank's mortgage-backed
and related securities carried adjustable rates of interest.

         The Bank's portfolio of Government National Mortgage Association
("GNMA"), FNMA and Federal Home Loan Mortgage Corporation ("FHLMC")
certificates are 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 carried by
one- to four-family performing residential mortgage loans.

         At June 30, 1997, the Bank held $18.1 million of Collateralized
Mortgage Obligations ("CMOs") having estimated lives which ranged from less
than one year up to 23 years. CMOs are special types of pass-through debt in
which the stream of principal and interest payments on the underlying
mortgages or mortgage-backed securities is used to create classes with
different maturities and, in some cases, amortization schedules, as well as a
residual interest, with each such class possessing different risk
characteristics. Management believes these securities may represent attractive
alternatives relative to other investments due to the wide variety of maturity
and repayment options available through such investments. The CMOs acquired by
the Bank are not interest only, principal only or residual interests.

         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

                                      19
<PAGE>

available for sale are carried at fair value. At June 30, 1997, all of the
Bank's investment, mortgage-backed and related securities were classified as
available for sale.

         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,
                                                           ----------------------------------------------------------------------
                                                                    1997                   1996                  1995
                                                           ----------------------- ----------------------   ---------------------
                                                             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.............................     $   103          1.6%   $   105         2.9%   $   100         2.7%
  Federal agency obligations.............................         849         13.3        839        22.9        848          --
  Small business administration loans....................         971         15.3      1,021        27.8      1,236        32.9
  Equity Securities(1)...................................         589          9.3        247         6.7         --          --
                                                              -------        -----    -------       -----    -------       -----
     Subtotal............................................       2,512         39.5      2,212        60.3      2,184        58.2
FHLB stock...............................................         956         15.0        559        15.2        471        12.5
                                                              -------        -----    -------       -----    -------       -----
     Total investment securities and FHLB stock..........       3,468         54.5      2,771        75.5      2,655        70.7

Other Interest-Earning Assets:
  Interest-bearing deposits with banks...................       2,890         45.5        900        24.5      1,100        29.3
                                                              -------        -----    -------       -----    -------       -----
     Total...............................................     $ 6,358        100.0%   $ 3,671       100.0%   $ 3,755       100.0%
                                                              =======        =====    =======       =====    =======       =====

Average remaining life or term to repricing of
 investment securities and other interest-earning
 assets excluding FNMA stock and FHLB stock..............         5.5                     9.3                   10.3 

Mortgage-Backed and Related Securities:
  FNMA...................................................     $ 1,399          6.2%   $ 3,413        21.6%   $ 4,938        34.3%
  FHLMC..................................................         704          3.1      1,688        10.6      2,235        15.5
  GNMA...................................................         924          4.1      1,834        11.6      2,188        15.2
  CMOs...................................................      18,138         80.9      8,895        56.1      5,016        34.8
  Other..................................................       1,265          5.7          8          .1         22          .2
                                                              -------        -----    -------       -----    -------       -----
    Total mortgage-backed and related securities.........     $22,430        100.0%   $15,838       100.0%   $14,399       100.0%
                                                              =======        =====    =======       =====    =======       =====
</TABLE>

---------------------------
(1) Consists primarily of FNMA Stock and stocks of publicly traded thrift
institutions and thrift holding companies.

                                      20
<PAGE>

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


<TABLE>
                                                                  At June 30, 1997
                                 -----------------------------------------------------------------------------------
                                    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 ........  $  103         $--          $ --           $ --           $  103         $  103
Federal agency obligations ........    --            --             849           --              849            849
Small business administration
   loans ..........................    --            --            --              971            971            971
                                     ------         -----        ------         ------         ------         ------

       Total ......................  $  103         $--          $  849         $  971         $1,923         $1,923
                                     ======         =====        ======         ======         ======         ======

Weighted average yield ............     9.0%         --%            4.0%           7.9%           6.2%           6.2%
</TABLE>

         The following table sets forth the contractual maturities of the
Bank's mortgage-backed and related securities at June 30, 1997; however, the
expected average life to maturity of this portfolio is generally two to 10
years.

<TABLE>
<CAPTION>
                                                              Due in                                 At   
                                          -------------------------------------------------        June 30,
                                                        One to         5 to          10 and         1997
                                          Less than   Less than 5   Less than 10      Over         Balance
                                          One Year      Years          Years         Years       Outstanding
                                          ---------   -----------   ------------    -------      -----------
                                                                 (In Thousands)
<S>                                         <C>        <C>           <C>            <C>            <C>    
FHLMC ...............................       $ --       $  --         $  --          $   704        $   704
FNMA ................................         --          --            --            1,399          1,399
GNMA ................................         --          --            --              924            924
CMOs ................................         --         4,353         1,975         11,810         18,138
Other ...............................         --          --             363            902          1,265
                                            -----     --------       -------        -------        -------
                                                      
 Total ..............................       $ --       $ 4,353       $ 2,338        $15,739        $22,430
                                            =====     ========       =======        =======        =======
</TABLE>
                                                    
         At June 30, 1997, the Bank's portfolio of investment and
mortgage-backed securities contained no securities of any issuer with an
aggregate book value in excess of 10% of the Bank's stockholders' equity,
excluding those issued by the United States 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.

                                      21
<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.
At June 30, 1997, the Bank had total FHLB advances of $19.1 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 6 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.

         The following table sets forth the savings flows at the Bank during
the periods indicated.


                                           Year Ended June 30,
                             ---------------------------------------------
                               1997              1996              1995
                             --------          --------           --------
                                        (Dollars in Thousands)

Opening balance .........    $ 54,759          $ 51,330           $ 49,969 
Deposits ................     157,275           129,814            109,818
Withdrawals .............     156,443           128,381            109,994
Interest credited .......       2,050             1,996              1,537
                             --------          --------           --------
                            
Ending balance ..........    $ 57,641          $ 54,759           $ 51,330
                             ========          ========           ========
                            
Net increase ............    $  2,882          $  3,429           $  1,361
                             ========          ========           ========
                            
Percent increase ........        5.26%             6.68%              2.72%
                             ========          ========           ========
                          
                                      22
<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,
                                                 -----------------------------------------------------------------------------
                                                         1997                       1996                          1995
                                                 ---------------------     -----------------------      ----------------------
                                                  Amount       Percent      Amount         Percent       Amount        Percent
                                                  ------       -------      ------         -------       ------        -------
                                                                            (Dollars in Thousands)
<S>                                              <C>           <C>          <C>             <C>          <C>            <C>
Transactions and Savings Deposits:

Commercial Demand...........................     $ 1,964          3.4%      $   745           1.36%      $   599         1.17%
Checking Accounts (0.0% to 4.8%)............       4,788          8.3         4,581           8.36         3,659         7.13
Savings Accounts (2.3% to 4.9%).............      16,829         29.2        14,635          26.73        10,057        19.59
Money Market Accounts (2.0% to 2.5%)........         836          1.5         1,006           1.84         1,385         2.70
                                                 -------        -----       -------         ------       -------       ------
                                                                                                        
Total Non-Certificates......................      24,417         42.4        20,967          38.29        15,700        30.59
                                                 -------        -----       -------         ------       -------       ------
                                                                                                        
Certificates:                                                                                           
                                                                                                        
 0.00 -  3.99%..............................          52           .1            77            .14         4,520         8.81%
 4.00 -  4.99%..............................       5,354          9.3         7,656          13.98         4,707         9.17
 5.00 -  5.99%..............................      18,288         31.7        18,513          33.81         8,646        16.84
 6.00 -  6.99%..............................       7,359         12.7         4,724           8.63        12,935        25.20
 7.00 -  7.99%..............................       2,004          3.4         2,656           4.85         4,354         8.48
 8.00 -  8.99%..............................         160           .3           154            .28           353          .69
 9.00% and above............................           7           .1            12            .02           114          .22
                                                 -------        -----       -------         ------       -------       ------
                                                                                                        
Total Certificates..........................      33,224         57.6        33,792          61.71        35,629        69.41
                                                 -------        -----       -------         ------       -------       ------
Total Deposits..............................     $57,641       100.00%      $54,759         100.00%      $51,329       100.00%
                                                 =======        ======      =======         ======       =======       ======
</TABLE>

         The following table shows rate and maturity information for the
Bank's certificates of deposit as of June 30, 1997.


<TABLE>
<CAPTION>
                                            0.00-     4.00-      6.00-       8.00-       9.00%                 Percent
                                            3.99%     5.99%      7.99%       8.99%      or more     Total     of Total
                                    ---------------------------------- -------------------------  ---------   ---------
                                                                 (Dollars in Thousands)
Certificate accounts maturing
in quarter ending:
<S>                                         <C>     <C>         <C>          <C>         <C>    <C>               <C>  
September 30, 1997..................        $ 52    $ 6,044     $  895       $   6       $ ---  $   6,997         21.1%
December 31, 1997...................         ---      3,857        595         ---         ---      4,452         13.4
March 31, 1998......................         ---      3,341        622         ---         ---      3,963         11.9
June 30, 1998.......................         ---      2,501      2,053          60         ---      4,614         13.9
September 30, 1998..................         ---        678        910         ---         ---      1,588          4.8
December 31, 1998...................         ---        937         49         ---         ---        986          3.0
March 31, 1999......................         ---      1,117        466          82           7      1,672          5.0
June 30, 1999.......................         ---      1,162        280         ---         ---      1,442          4.3
September 30, 1999..................         ---        867        797         ---         ---      1,664          5.0
December 31, 1999...................         ---        610        773         ---         ---      1,383          4.2
March 31, 2000......................         ---        202      1,133           7         ---      1,342          4.0
June 30, 2000......................          ---        341        279         ---         ---        620          1.9
Thereafter..........................         ---      1,985        511           5         ---      2,501          7.5

Total...............................        $ 52    $23,642     $9,363       $ 160        $  7    $33,224        100.0%
                                            ====    =======     ======       =====        ====    =======        =====

   Percent of total.................         .2%      71.0%      28.2%        .5 %         .1%     100.0%
                                            ===      =====      =====         ===          ==     ======
</TABLE>

                                      23
<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,
1997.


<TABLE>
<CAPTION>
                                                                                            Maturity
                                                                     Over         Over      ---------
                                                    3 Months       3 to 6       6 to 12       Over
                                                    or Less        Months       Months      12 months         Total
                                                    -------        ------       ------      ---------         -----
                                                                         (In thousands)
<S>                                                  <C>           <C>          <C>            <C>           <C>    
Certificates of deposit of less
 than $100,000..............................         $5,073        $4,002       $7,932         $12,976       $29,983

Certificates of deposit of
 $100,000 or more...........................            359           300          645             222         1,526

Public funds(1).............................          1,565           150          ---             ---         1,715
                                                     ------        ------      -------       ---------      --------

Total certificates of
 deposit....................................         $6,997        $4,452       $8,577         $13,198       $33,224
                                                     ======        ======       ======         =======       =======
</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 positive
rate of return. 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. At
June 30, 1997, the Bank had $19.1 million in FHLB advances

         The following table sets forth the maximum month-end balance and
average balance of FHLB advances. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Annual Report for a
discussion on the increase in the Bank's borrowings.


                                                   Year Ended June 30,
                                               --------------------------
                                                1997        1996       1995
                                                ----        ----       ----

Maximum Balance:
  FHLB advances..............................  $19,107    $11,171     $8,718

Average Balance:
  FHLB advances..............................  $13,254    $ 9,521     $5,274


                                      24
<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,
                                                    -------------------------
                                                    1997      1996       1995
                                                    ----      ----       ----
                                                      (Dollars in Thousands)

FHLB advances...................................   $19,102    $9,661    $8,718
                                                   =======    ======    ======

Weighted average interest
 rate of FHLB advances..........................     5.71%     5.49%     6.04%


Subsidiary Activities

         As a federally chartered savings bank, Horizon Federal is permitted
by OTS regulations to invest up to 2% of its assets, or $1.7 million at June
30, 1997, 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 $20,600. 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
products to customers of Horizon Federal. For the fiscal year ended June 30,
1997, HISI had a net gain of $6,500.

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 United States Government. Accordingly, the Bank is subject to
broad federal regulation and oversight extending to all its operations.
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. 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,
and the deposits of the Bank are insured by the FDIC. As a result, the FDIC
has certain regulatory and examination authority over the Bank.




                                      25
<PAGE>




         Certain of these regulatory requirements and restrictions are
discussed below or elsewhere in this document.

         Federal Regulation of Savings Associations. The OTS has extensive
authority over the operations of savings associations. As part of this
authority, the Bank is 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 September 23, 1996 and December
31, 1989, respectively. Under agency scheduling guidelines, it is likely that
another examination will be initiated in the near future. 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. 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 the fiscal year ended June 30, 1997, was $24,700.

         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 instance, no savings institution
may invest in non-investment grade corporate debt securities. In addition, the
permissible level of investment by federal associations in loans secured by
non-residential real property may not exceed 400% of total capital, except
with approval of the OTS. Federal savings associations are also generally
authorized to branch nationwide. The Bank is in compliance with the noted
restrictions.

         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, 1997, the Bank's lending limit
under this restriction was approximately $970,000. The Bank is in compliance
with the loans-to-one-borrower limitation.

         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.




                                      26
<PAGE>



         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 FDIC and such insurance is backed by the full
faith and credit of the United States 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.

         The FDIC is authorized to increase assessment rates, on a semiannual
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 United States Treasury or for any other reason
deemed necessary by the FDIC.

         As is the case with the SAIF, the FDIC is authorized to adjust the
insurance premium rates for banks that are insured by the BIF of the FDIC in
order to maintain the reserve ratio of the BIF at 1.25% of BIF insured
deposits. As a result of the BIF reaching its statutory reserve ratio, the
FDIC revised the premium schedule for BIF insured institutions to provide a
range of .04% to .31% of deposits. The revisions became effective in the third
quarter of 1995. In addition, the BIF rates were further revised, effective
January 1996, to provide a range of 0% to .27%. The SAIF rates, however, were
not adjusted. At the time the FDIC revised the BIF premium schedule, it noted
that, absent legislative action (as discussed below), the SAIF would not
attain its designated reserve ratio until the year 2002. As a result, SAIF
insured members would continue to be generally subject to higher deposit
insurance premiums than BIF insured institutions until, all things being
equal, the SAIF attained its required reserve ratio.

         In order to eliminate this disparity and any competitive disadvantage
between BIF and SAIF member institutions with respect to deposit insurance
premiums, legislation to recapitalize the SAIF was enacted in September 1996.
The legislation provided for a one-time assessment to be imposed on all
deposits assessed at the SAIF rates, as of March 31, 1995, in order to


                                      27
<PAGE>



recapitalize the SAIF. It also provided for the merger of the BIF and the SAIF
on January 1, 1999 if no savings associations then exist. The special
assessment rate was established at .657% of deposits by the FDIC and the
resulting assessment of $331,000 was paid in November 1996. This special
assessment significantly increased noninterest expense and adversely affected
the Company's and the Bank's results of operations for the year ended June 30,
1997. As a result of the special assessment, the Bank's deposit insurance
premiums was reduced to zero based upon its current risk classification and
the new assessment schedule for SAIF insured institutions. These premiums are
subject to change in future periods.

         Prior to the enactment of the legislation, a portion of the SAIF
assessment imposed on savings associations was used to repay obligations
issued by a federally chartered corporation to provide financing ("FICO") for
resolving the thrift crisis in the 1980s. Although the FDIC has proposed that
the SAIF assessment be equalized with the BIF assessment schedule, effective
October 1, 1996, SAIF-insured institutions will continue to be subject to a
FICO assessment as a result of this continuing obligation. Although the
legislation also now requires assessments to be made on BIF-assessable
deposits for this purpose, effective January 1, 1997, that assessment will be
limited to 20% of the rate imposed on SAIF assessable deposits until the
earlier of December 31, 1999 or when no savings association continues to
exist, thereby imposing a greater burden on SAIF member institutions such as
the Bank. Thereafter, however, assessments on BIF- member institutions will be
made on the same basis as SAIF-member institutions. The rates to be
established by the FDIC to implement this requirement for all FDIC-insured
institutions is uncertain at this time, but are anticipated to be about a 6.5
basis points assessment on SAIF deposits and 1.5 basis points on BIF deposits
until BIF insured institutions participate fully in the assessment.

         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, 1997, 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 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



                                      28
<PAGE>


debt and equity investments in such subsidiaries are deducted from assets and
capital. All subsidiaries of the Bank are includable subsidiaries.

         At June 30, 1997, the Bank had tangible capital of $6.2 million, or
7.4% of adjusted total assets, which is approximately $5.0 million above the
minimum requirement of 1.5% of adjusted total assets in effect on that date.

         The capital standards also require core capital equal to at least 3%
of adjusted total assets. Core capital generally consists of tangible capital
plus certain intangible assets, including a limited amount of purchased credit
card relationships. As a result of the prompt corrective action provisions
discussed below, however, a savings association must maintain a core capital
ratio of at least 4% to be considered adequately capitalized unless its
supervisory condition is such to allow it to maintain a 3% ratio. At June 30,
1997, the Bank had no intangibles which were subject to these tests.

         At June 30, 1997, the Bank had core capital equal to $6.2 million, or
7.4% of adjusted total assets, which is $3.7 million above the minimum
leverage ratio requirement of 3% 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, 1997,
the Bank had no capital instruments that qualify as supplementary capital, and
$265,000 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
a $9,000 exclusion from capital and assets at June 30, 1997.

         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.

         OTS regulations also require that every savings association with more
than normal interest rate risk exposure to deduct from its total capital, for
purposes of determining compliance with such requirement, an amount equal to
50% of its interest-rate risk exposure multiplied by the



                                      29
<PAGE>


present value of its assets. This exposure is a measure of the potential
decline in the net portfolio value of a savings association, greater than 2%
of the present value of its assets, based upon a hypothetical 200 basis point
increase or decrease in interest rates (whichever results in a greater
decline). Net portfolio value is the present value of expected cash flows from
assets, liabilities and off-balance sheet contracts. The rule will not become
effective until the OTS evaluates the process by which savings associations
may appeal an interest rate risk deduction determination. It is uncertain as
to when this evaluation may be completed. Any savings association with less
than $300 million in assets and a total capital ratio in excess of 12% is
exempt from this requirement unless the OTS determines otherwise.

         On June 30, 1997, the Bank had total capital of $6.5 million
(including $6.2 million in core capital and $265,000 in qualifying
supplementary capital) and risk-weighted assets of $45.0 million (including
$286,000 in converted off-balance sheet assets); or total capital of 14.4% of
risk-weighted assets. This amount was $2.9 million above the 8% requirement in
effect on that date.

         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.


                                      30
<PAGE>



         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. Company shareholders do not have preemptive
rights, and therefore, if the Company is directed by the OTS or the FDIC to
issue additional shares of Common Stock, such issuance may result in the
dilution in the percentage of ownership of the Company.

         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 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.

         Generally, savings associations, such as the Bank, that before and
after the proposed distribution meet their capital requirements, may make
capital distributions during any calendar year equal to the greater of 100% of
net income for the year-to-date plus 50% of the amount by which the lesser of
the association's tangible, core or risk-based capital exceeds its capital
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of their net income for the most recent four quarter
period. However, an association deemed to be in need of more than normal
supervision by the OTS may have its dividend authority restricted by the OTS.
Horizon Federal 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. See "--Regulatory Capital Requirements."

         The OTS has proposed regulations that would revise the current
capital distribution restrictions. Under the proposal a savings association
may make a capital distribution without notice to the OTS (unless it is a
subsidiary of a holding company) provided that it has a CAMEL 1 or 2 rating,
is not of supervisory concern, and would remain adequately capitalized (as
defined in the OTS prompt corrective action regulations) following the
proposed distribution. Savings associations that would remain adequately
capitalized following the proposed distribution but do not meet the other
noted requirements must notify the OTS 30 days prior to declaring a capital
distribution. The OTS stated it will generally regard as permissible that
amount of capital distributions that do not exceed 50% of the institution's
excess regulatory capital plus net income to date during the calendar year. A
savings association may not make a capital distribution without prior approval
of the OTS and the FDIC if it is undercapitalized before, or as a result of,
such a distribution. As under the current rule, the OTS may object to a
capital distribution if it would constitute an unsafe or unsound practice. No
assurance may be given as to whether or in what form the regulations may be
adopted.




                                      31
<PAGE>


         Liquidity. All savings associations, including the Bank, are required
to maintain an average daily balance of liquid assets equal to a certain
percentage of the sum of their average daily balance of net withdrawable
deposit accounts and borrowings payable in one year or less. For a discussion
of what the Bank includes in liquid assets, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" in the Annual Report. This liquid asset ratio requirement
may vary from time to time (between 4% and 10%) depending upon economic
conditions and savings flows of all savings associations. At the present time,
the minimum liquid asset ratio is 5%.

         In addition, short-term liquid assets (e.g., cash, certain time
deposits, certain bankers acceptances and short-term United States Treasury
obligations) currently must constitute at least 1% of the association's
average daily balance of net withdrawable deposit accounts and current
borrowings. Penalties may be imposed upon associations for violations of
either liquid asset ratio requirement. At June 30, 1997, the Bank was in
compliance with both requirements, with an overall liquid asset ratio of 7.12%
and a short-term liquid assets ratio of 6.98%.

         Accounting. An OTS policy statement applicable to all savings
associations clarifies and re-emphasizes that the investment activities of a
savings association must be in compliance with approved and documented
investment policies and strategies, and must be accounted for in accordance
with GAAP. Under the policy statement, management must support its
classification of and accounting for loans and securities (i.e., whether held
for investment, sale or trading) with appropriate documentation. The Bank is
in compliance with these amended rules.

         OTS accounting regulations, which may be made more stringent than
GAAP by the OTS, require that transactions be reported in a manner that best
reflects their underlying economic substance and inherent risk and that
financial reports must incorporate any other accounting regulations or orders
prescribed by the OTS.

         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 1996, as amended (the
"Code"). Such assets primarily consist of residential housing related loans
and investments. At June 30, 1997, 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


                                      32
<PAGE>

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 not permissible 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."

         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 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 in December 1995 and received a rating of
"satisfactory."

         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.



                                      33
<PAGE>

         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, 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 unless such
other associations each qualify as a QTL and were acquired in a supervisory
acquisition.

         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."

         The Company must obtain approval from the OTS before acquiring
control of any other SAIF-insured association. Such acquisitions are generally
prohibited if they result in a multiple savings and loan holding company
controlling savings associations in more than one state. However, such
interstate acquisitions are permitted based on specific state authorization or
in a supervisory acquisition of a failing savings association.

         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. 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, 1997, 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. See "--Liquidity."



                                      34
<PAGE>

         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. In addition, all long-term
advances are required to provide funds for residential home financing.

         As a member, the Bank is required to purchase and maintain stock in
the FHLB of Des Moines. At June 30, 1997, the Bank had $955,600 in FHLB stock,
which was in compliance with this requirement. In past years, the Bank has
received substantial dividends on its FHLB stock. For the year ended June 30,
1997, dividends paid by the FHLB of Des Moines to Horizon Federal totaled
$47,000, compared to $36,000 received in fiscal 1996. The $13,900 dividend
received for the quarter ended June 30, 1997 reflects an annualized rate of
7.00%, the same rate as received in calendar 1996. Over the past five fiscal
years such dividends have averaged 7.73%.

         Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies
on advances targeted for community investment and low- and moderate-income
housing projects. These contributions have affected adversely the level of
FHLB dividends paid and could continue to do so in the future. These
contributions could also have an adverse effect on the value of FHLB stock in
the future. A reduction in value of the Bank's FHLB stock may result in a
corresponding reduction in the Bank's capital.

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.



                                      35
<PAGE>

         The percentage of specially computed taxable income that is used to
compute a savings association's bad debt reserve deduction under the
percentage of taxable income method (the "percentage bad debt deduction") is
8%. The percentage bad debt deduction thus computed is reduced by the amount
permitted as a deduction for non-qualifying loans under the experience method.
The availability of the percentage of taxable income method permits qualifying
savings associations to be taxed at a lower effective federal income tax rate
than that applicable to corporations generally (approximately 31.3% assuming
the maximum percentage bad debt deduction).

         Under the percentage of taxable income method, the percentage bad
debt deduction cannot exceed the amount necessary to increase the balance in
the reserve for "qualifying real property loans" to an amount equal to 6% of
such loans outstanding at the end of the taxable year or the greater of (i)
the amount deductible under the experience method or (ii) the amount which
when added to the bad debt deduction for "non-qualifying loans" equaled the
amount by which 12% of the amount comprising savings accounts at year-end
exceeds the sum of surplus, undivided profits and reserves at the beginning of
the year.

         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 must recapture that portion of the reserve that exceeds the
amount that could have been taken under the experience method for post-1987
tax years. At June 30, 1997, the Bank's post-1987 excess reserves amounted to
approximately $280,000. The recapture will be approximately $55,000 per year
and will occur over a six-year period which began in Fiscal 1997. 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
taxable years beginning after 1986 and before 1996, corporations, including
savings associations such as the Bank, were also subject to an environmental
tax equal to 0.12% of the excess of alternative minimum taxable income for the
taxable year (determined without regard to net operating losses and the
deduction for the environmental tax) over $2 million.

         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,


                                      36
<PAGE>

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, 1997, the Bank's Excess for tax
purposes totaled approximately $1.6 million.

         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 SEI 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.

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.



                                      37
<PAGE>

         The Bank serves Mahaska County and that portion of Marion County in
and around Knoxville, Iowa. There are eight commercial banks, three savings
banks, other than Horizon Federal, and three credit unions which compete for
deposits and loans in Horizon Federal's primary market area. The Bank
estimates its share of the savings market in its primary market area to be
approximately 10%.

Employees

         At June 30, 1997, the Bank had a total of 25 full-time and five
part-time employees. The Bank's employees are not represented by any
collective bargaining group. Management considers its employee relations to be
good.

Executive Officers of the Company and the Bank Who Are Not Directors

         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.

         Sharon K. McCrea - Ms. McCrea, age 55, joined Horizon Federal in
1959, as a teller, was appointed Assistant Treasurer in 1974 and promoted to
Treasurer and Comptroller of the Bank in 1979. Ms. McCrea is in charge of the
accounting department of the Bank.

         Kent R. Frankenfeld - Mr. Frankenfeld, age 41, joined the Bank in
October 1994, as Vice President in charge of Marketing and Product
Development. Mr. Frankenfeld was the Vice President of a savings bank located
in Des Moines, Iowa prior to joining the Bank.

Item 2.  Description of Property

         The Bank conducts its business through its 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, 1997. 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, 1997 was approximately $1.1 million. See Note 6 of
Notes to Consolidated Financial Statements in the Annual Report.


<TABLE>
<CAPTION>
                                                                                  Total
                                                                               Approximate
                                                        Date                     Square             Net Book Value at
                     Location                         Acquired                   Footage              June 30, 1997
--------------------------------------------------   ----------                 ---------           -----------------

<S>                                                     <C>                        <C>                   <C>     
Main Office:
 301 First Avenue East                                  1964                       4,230                 $303,000
 Oskaloosa, Iowa

Branch Offices:
 509 A Avenue, West                                     1992                       3,277                 $651,000
 Oskaloosa, Iowa

 1022 West Pleasant Street                              1979                       1,598                 $128,000
 Knoxville, Iowa
</TABLE>

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

                                      38
<PAGE>


         The Bank maintains an on-line data base with a service bureau
servicing financial institutions. The net book value of the data processing
and computer equipment utilized by the Bank at June 30, 1997 was approximately
$93,000.

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 their
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 the fiscal
year ended June 30, 1997.

                                    PART II

Item 5.  Market for Common Equity and Related Stockholder Matters

         Page 40 of the attached 1997 Annual Report to Stockholders is
incorporated herein by reference.

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

         Pages 4 through 14 of the attached 1997 Annual Report to Stockholders
are incorporated herein by reference.

Item 7.  Financial Statements

         The following information appearing in the Company's 1997 Annual
Report to Stockholders for the year ended June 30, 1997, is incorporated
herein by reference.

Annual Report Section                                     Pages in Annual Report
---------------------                                     ----------------------

Independent Auditors' Report                                        15

Consolidated Balance Sheets as of June 30, 1997 and 1996            16

Consolidated Statements of Operations for the Years Ended
 June 30, 1997, 1996 and 1995                                       17

Consolidated Statements of Stockholders' Equity for Years
 Ended June 30, 1997, 1996 and 1995                                 18

Consolidated Statements of Cash Flows for Years Ended
 June 30, 1997, 1996 and 1995                                       19

Notes to Consolidated Financial Statements                        20 - 39

                                      39
<PAGE>

         With the exception of the aforementioned information, the Company's
Annual Report to Stockholders for the year ended June 30, 1997, 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.

                                   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 in October 1997, a copy of which will be filed not
later than 120 days after the close of the fiscal year.

Executive Officers

         Information regarding the business experience of the executive
officers of the Company and the Bank contained in Part I 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
in October 1997, a copy of which will be filed not later than 120 days after
the close of the fiscal year.

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 in October 1997, a copy of which will be filed not
later than 120 days after the close of the fiscal year.

                                      40
<PAGE>

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 in October
1997, a copy of which will be filed not later than 120 days after the close of
the fiscal year.

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 in October 1997, a copy of which
will be filed not later than 120 days after the close of the fiscal year.

Item 13.          Exhibits and Reports on Form 8-K

                  (a)  Exhibits

                  See Index to Exhibits.

                  (b)  Reports on Form 8-K

                  No reports on Form 8-K were filed during the three-month
         period ended June 30, 1997.

                                      41
<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 25, 1997                     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 25, 1997                      Date: September 25, 1997


/s/ Gary L. Rozenboom                         /s/ Dwight L. Groves
-----------------------------------------     ---------------------------------
Gary L. Rozenboom, Director                   Dwight L. Groves, Director

Date: September 25, 1997                      Date: September 25, 1997


/s/ Norman P. Zimmerman                       /s/ Sharon K. McCrea
-----------------------------------------     ---------------------------------
Norman P. Zimmerman, Director                 Sharon K. McCrea, Treasurer and
                                              Comptroller,  (Principal Financial
                                              and Accounting Officer)

Date: September 25, 1997                      Date: September 25, 1997


<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 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 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 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 Peat Marwick LLP

27       Financial Data Schedule (electronic filing only)