Horizon Financial Corp. F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

Horizon Financial Corp. (HRZB)

F1Q09 Earnings Call

July 23, 2008 12:00 pm ET

Executives

Laury Evans - Chairman and Chief Executive Officer

Richard P. Jacobson – CEO

Dennis C. Joines - President, Chief Operating Officer, Exec. VP, Director,

Analyst

Jeffrey Rulis - D.A. Davidson & Co.

Sara Hasan - McAdams Wright Ragen

Mike Lipman - FTN Midwest Securities Corp.

Kristin Hotti - Howe Barnes Hoefer & Arnett Inc.

Aries [Esru] – Morgan Stanley

Presentation

Operator

Welcome to the Horizon Financial conference call. (Operator Instructions)

Before we get started, management has asked me to remind you that this call may contain forward-looking statements that are within the meaning of the Federal Securities Safe Harbor laws. Actual results from the timing of certain events could differ materially from those projected in any forward-looking statements due to a number of factors.

Specific factors include, among other things, changes on the level and trend of loan delinquencies and write off, results of examinations by our banking regulators, our ability to manage loan delinquency rates, the ability to successfully expand existing relationships, deposit pricing , and the ability to gather low-cost deposits, access in new markets and expansion plans, expense management and the efficiency ratio, expanding or maintaining the net interest margin, interest rate risk for local and national economic environment and other risk and uncertainties discussed from the time to time in Horizon’s Financial filings with the Security and Exchange Commission.

Accordingly, undue reliance should not be placed on forward-looking statements and these forward-looking statements speak only as of this day of this call. Horizon Financial is under no obligation to update this information as further events and developments take place that may change these forward-looking-statements. Investors are encouraged to read the SEC report of Horizon, particularly, its form 10-K for the fiscal year end March 31, 2008. For meaningful questionnaire discussion rate why actual results may vary from those anticipated by management.

And now I am going to turn the conference to you, Mr. Evans, Chairman of Horizon Financial Corporation.

Laury Evans

Thank you for joining us for our first quarter fiscal 2009 conference call. With me today are Dennis Joines, President of Horizon Bank and Chief Operating Officer for the company and Richard Jacobson, CEO, who also continues to fill the role of Chief Financial Officer. As you know I continue to serve as chairman of the board and I am working with senior management team and I will continue to actively be involved for several more years.

We reinstated our search for the Chief Financial Officer as the person we had expected to bring on board is no longer available following the dissolution of the Frontier Washington Banking merger. I want to commend Rich for his excellent work the past few months and in effect doing double duty and I know Kelli Holz and the rest of the accounting staff have also really stepped up to the play. With that said I like to get right into the update of the local economy and then turn the call over to Rich who will review our asset quality. And then we will go over the income statement and balance sheet before we open it up to questions.

As we move in to the summer month we are seeing further signs of a slowing economy. Although according to the Puget Sound Economic Forecaster, we are not in a recession and may not feel recession in the region. According to Conway and Peterson, the economist behind this publication, employment growth has declined steadily reaching 2.1% in the first quarter of this year. They predict the employment growth will drop further to 0.6% next year. This is the lowest phase since the last recession. Year-over-year employment was up 1.1% in June which marked the fifth straight month in which the year-over-year increase was less than 2%. Prior to the past five months the last time Washington registered a year-over-year growth rate of less than 2% was in 2004.

Under the primary elements slowing employment growth is the slowdown in the construction industry which accounted for about 1/5 of the employment gains in the last four years providing relatively good paying work to more than 130,000 people. According to the Washington State Employment situation report for June, Construction payrolls declined by 900 jobs in June. This was a seven consecutive month of monthly decline.

Construction payrolls were down by 4500 from a year ago after a year-over-year decline of 2700 in May. Despite the slowdown over the past ten months the phase of employment decline in the construction industry was slower in Washington State than in the nation as a whole. Nationally, construction payrolls have declined year-over-year since March 2007.

The non-residential sector continues to be significantly stronger than the residential sector in the state. Non-residential employment grew in June from one year prior by 1700 where residential construction employment declined by over 2700. Single family housing permit on an annualized basis have dropped more than 20,000 in the latter half of 2005 to less than 9000 in the first quarter of this year. As housing affordability fell in the region, multifamily construction grew and total residential building permits have been steady at 27,000 units for the past three years. According to Conway Peterson if the economy decelerates as they predict, the household formation rate will follow suit and the new household formation will decline from 26,600 in 2007 to 20,700 which will impact both the housing and employment market in our area.

Washington unemployment rates grows to 5.5% in June compared to 5.3% in May and 4.2% last year. These rates are seasonally adjusted and show unemployment rate is now on par with the national average. Seasonality adjusted employment rate in June for Bellingham was 5.6% up from 4.2% a year ago. Mt. Vernon-Anacortes and Skagit County was 6.3% up from 4.2% a year ago. The unemployment rate in Tacoma which is in Pierce County largest city it was up to 6.5% from 4.8%. Unemployment rate in Snohomish County continues to benefit from Boeing’s manufacturing line but if too rose to 4.5% from 4.0% last year.

While it is too early to call a turn in the Real Estate market. We saw a few bright spots in the maze Northwest MLS report., Prices in most counties were down compared to a year ago but up slightly compared to May. Northwest MLS reported 6470 pending sale system wide during June. Highest volumes since August 2, 2007 when there were 7751 pending sales. These are offers made and accepted but not yet closed and compared to the same month a year ago pending sales were down nearly 30%. Eleven of the 19 Counties in the MLS service area reported increases in the number of pending sales last month from May.

Region wide new listings were at the lower levels in February with 13,187 additional new listings of single family home and condominiums to inventories. With those additions the number of active listings in the MLS database totaled 50,143 about an 11% more than a year ago. On an percentage basis there has not been a year-over-year change this small since December 2005 when inventory rose 2.3% from December 2004. Some of the information provided to us by real estate are RE stats, real estate stats in the month of June showed overall inventory levels at Whatcom County 7.1, Skagit County 8.4, Snohomish County 14.5, highest level of all the other counties that we are operating in. King County 8.7, Pierce County 9.8, and Thurston County 5.6 and I would remind you that anything in excess of four to six months would be an equilibrium market. Anything excess is six with the excess we consider having excess inventory at the buyer’s market.

Prices for sale of the single family homes and condominiums combined that close during June dipped 5.7% from a year ago. Median price for last month’s completed sales were $314,900 down from a year ago median of $334,000 but compared to May prices rose about 1%. I believe that the slowing of the permit activity combined with affordable interest rates on performing loans helped stabilize our market. As the summer progresses we will see if buyers move off the fence and into homes. While we are clearly seeing issues in our market, I continue to believe that a strong commercial base in the region anchored by Boeing, Microsoft, Costco, Pack Cars and others will serve the region well over the coming months.

With that I will turn it over to Rich who will talk a little bit about our asset quality. How it has changed from the first quarter of 2009.

Rich Jacobson

There is no question that our markets are feeling the effects of this economic cycle. The economic forecaster noted that a more optimistic scenario for their forecast would require several favorable developments including a quick and robust rebound by the US economy, fewer lay-offs in the construction industry, and additional hiring of Boeing. While we hope that this more optimistic scenario comes to pass, we are not relying on the market to turn around to resolve the performance issues on our own portfolio.

We reported a profit for the first quarter of fiscal 2009 earning $2 million which included a $3 million provision for loan losses. This fiscal quarter we saw a substantial increase in our non-performing assets with $35.8 million going into non-accrual status and other real estate owned increasing to $2.8 million bringing our total non-performing assets to $38.6 million.

We recorded the $3 million provision for loan losses which essentially covered our net charge-offs for the quarter. So, at the end of June the ratio of non-performing loans to net loans was 2.88% and non-performing assets to total assets was 2.67%. The reserve for loan losses stands at $19.1 million or 1.54% of net loans receivable. As you can see from the release, our commercial or multi-family real estate loans are performing well as are the commercial and industrial loans in our portfolios. The largest part of the increase in non-performers is for land development and speculative residential construction projects. Over half of these problem loans are in Snohomish County, about a quarter in Whatcom County, about a fifth in Pierce County, and we have just one property and real estate on Skagit County.

We provided some detail on non-performers in the release and I can provide some additional color here as well. Whatcom County totaled $9 million in non-performers and that includes $2.4 million in the north part of our County consisting of one parcel of the land that is yet to be developed and one residential lot development. The balance of $6.6 million corresponds to two properties that are currently raw land waiting to be developed. Skagit County’s figures that one real estate owned at $660,000. Snohomish County’s non-performers total over $20 million in five separate developers account for the majority of these totals and the vast majority of these dollars are in single family homes and developed residential lots. At Pierce County, the $8.2 million shown here is primarily related to one condo project in the Gig Harbor Area which we believe to be well- secured.

We are updating appraisals regularly and working with our borrowers to maintain performance. In some cases we are asking for additional collateral or identifying other sources of re-payment. Although I would like to tell you that we are at the end of this cycle the evidence is not there yet. These non-performing assets are secured with substantial collateral backing these loans and this is an important point regarding these non-performing assets. The balances we placed here reflect the fact that we do not expect to collect the interest on these loans but we do expect to collect these remaining principal balances. We did charge-offs approximately $3 million this quarter and this non-performing figures are the totals after those charge-offs. As we receive new appraisals and see properties in the market sold we are updating valuations quickly. The charge-offs for the quarter were a result of such updated evaluations.

Our past practices to build reserves as our portfolio expanded in the construction and development categories it is serving us well in this challenging housing market. This quarter we booked a $3 million provision and have those $3 million in charge-offs. So our allowance for loan losses stands at $19.1 million representing 1.54% of net loans. Our challenge over the next few quarters will be to manage our construction portfolio and to work with builders to achieve a successful completion of their projects and work to sell existing inventory.

While our pipeline of new construction projects is minimal, construction balances will increase as we complete our funding commitments. We continue to look for opportunities to diversify our loan mix and reduce our concentration in construction and land development. Our focus on new business development will be to build our commercial and industrial loan portfolio. It is possible that we will have minimal growth in the loan portfolio this year even with the growth we experienced in our first fiscal quarter end of June 30^th. Instead of growth we will be focusing on preserving capital, improving credit quality, and diversifying our loan mix.

At this point I will turn it over to Dennis for a review of the income statement and balance sheet.

Dennis Joines

Our profits in the first quarter at fiscal 2009 were $2 million or $0.17 per diluted share. Down from $3.8 million or $0.31 per diluted share in the linked quarter and $5 million or $0.41 per diluted share in the first quarter of fiscal 2008. So, despite the margin compression Rich discussed and the higher provisions for loan losses, we still reported a profitable quarter. But at first quarter, net interest income was $11.2 million down 10% on a sequential quarter basis and 16% year-over-year. Interest income was down 14% year-over-year while interest expense was down 11% compared to the year ago quarter.

First quarter non-interest income was $2.3 million up 2% from the prior quarter and up 33% from the year ago quarter with solid growth in fee income and contribution from loan and securities sales. In the first quarter we recognized $579,000 in gains from the sale of equities including a portion of Freddie Mac common stock compared to a gain of $480,000 in immediate prior quarter which also included Freddie shares along with other selected financial stock. Of the Federal reserves that signaled that the rate catch from earlier this year are over we are still feeling the impact of more than 300 basis points reduction and short-term interest rates over the past year on our net interest margin. With the latest cuts our yield on earning assets fell 88 basis points in the quarter compared to the linked quarter and 205 basis points from the first quarter of last year.

Our funding 24:16 cost are much slower to move with interest rates so our cost of funding was down 42 basis points from the March quarter and 87 basis points from the year ago. The non-interest margin in the first quarter fell 48 basis points to 3.4% from the prior quarter and was down 121 basis points from the same quarter one year ago. As we mentioned in the release, 23 basis points of the margin decline for the quarter was due to reversal of interest on those non-performing loans.

Non-interest expense with $7.6 million in the first quarter up 8% from the prior quarter and 5% from the year ago quarter. Compensation costs were up 14% and accounted for most of the growth in overhead. The part of that difference in the linked quarter relates to the reversal of incentive accruals in the March quarter was temporary reduced this line in that particular quarter. Our efficiency ratio in the first quarter was 56.25% compared to 48.21% in the prior quarter and 47.91% a year ago, adversely affected by a combination of factors including reduced income due to the reversal of interest on non-accrual loans.

Turning to the balance sheet, total assets grew 11% to $1.45 billion at June 30, 2008 from $1.30 billion at June 30, 2007 due in part to continued funding of existing commitments our loan portfolio grew $54 million or 5% for the first quarter of the year to $1.25 billion compared to $1.19 billion on March 31, 2008. We do not anticipate much growth in future quarters and are working diligently to limit growth in efforts to preserve capital ratio as Rich pointed out.

Demand for residential mortgages was down in the June quarter of last year’s peak levels but in line with the prior quarter production. Most of that production is sold into the secondary market but we did grow the portfolio mortgage part 24% year-over-year. As we have said before, we do not originate sub-client paper and all our loans are under written to prudent guidelines.

Commercial and commercial real estate loan originations were off 51% from the same quarter a year ago. We continue to see net commercial loans grow which was 23% year-over-year and 13% over the past quarter alone. Construction and land development loans were up 19% from the previous year and 4% compared to the immediate prior quarter as we have mentioned earlier to help fund projects that are in the pipeline as they continue to build out. Deposits were up 11% year-over-year to $1.1billion with 30% of our deposits in demand account and 68% in time certificates.

Shareholder equity grew 11% year-over-year with total book value at $10.69 per share and tangible book at $10.63 or $0.63 per share. We remain a well capitalized bank with equity and assets at 8.8% and total capital, the risk adjusted assets of 10.6%. So we believe based on current information our capital base remains strong and more importantly adequate to allow us to weather the current economic cycle.

Finally, I want to mention that the recent performance in the financial sector and the short interest ratio in stock which went to 17% in June and as higher than we ever seen it by a significant factor. Just yesterday, we received information from NASDAQ where it showed the short interest in the SMP 500 financial services sector hitting an all time high increasing 212.6% for the 12 months ended June 30, 2008. This is certainly adversely affecting our stock price and we look forward to the time when the short interest decline.

With that I will turn it back to Laury.

Laury Evans

That naked covering of shorts in the uptake rule is certainly something that the industry really needs to look at. Before I open it up to questions, I would like to say a word about our capital management policy and our dividends to shareholders as we have stated in the release, we have view cash dividend as very important to our shareholders and we declared a cash dividend this last quarter of 131/2 cents per share which is about $1.6 million in total cash. Capital preservation and capital strength is our number one priority and we will continue to carefully review dividend payments in light of our capital requirement, liquidity, the needs of our shareholders, the requirements of our regulators, income and all the other factors that going to declare any dividend. With that said, our goal is to continue to pay dividends as long as it is prudent , of course for us, and as long as it makes sense for the long term benefit of the company. With that said – Randy, we are ready to open it up for questions.

Question-and-Answer-Session

Operator

(Operator Instructions) and we will get the question from Jeff Rulis with D.A. Davidson & Co, please go ahead.

Jeffrey Rulis - D.A. Davidson & Co.

You have touched on the comp and employee benefits cost that was up sharply and it was as you described it. The difference was really the reversal of the incentive accruals. So, going forward, the base level for comp and expense that was a good number in Q1 going forward?

Richard P. Jacobson

The June number is, Jeff, that March number if we were to estimate a normalized number would have been closer to 4.3. So then now you think you can see the progression from last June to March to now but the others, again, we did not hit our targets and March is the end of our fiscal year. So, March was the time that we needed to reverse out those accruals.

Jeffrey Rulis - D.A. Davidson & Co.

Next, and then on the securities gains, your last couple of quarters has been around a half a million. Do you expect that continue? It seems kind of elevated.

Mr. Richard P. Jacobson

Tough to tell, Jeff. We will have to keep looking at those options as we progress and some of the factors will be, how we analyze the potential need for additions to the loan loss reserve, is it appropriate to recognize those gains to move money into reserves. We will have to address that question as the quarter progresses. So, unfortunately I cannot give real specific guidance there.

Jeffrey Rulis - D.A. Davidson & Co.

And have you recently had a safety and soundness exam or scheduled for one?

Mr. Richard P. Jacobson

No, not yet. That is something that we would anticipate in the fall.

Operator

Our next question is from Sara Hasan with McAdams Wright Ragen.

Sara Hasan - McAdams Wright Ragen

I am just wondering if you could talk a little bit more, I know you did talk a little bit but why would not you build your reserves a little bit more as non-performers are kind of accelerating? I mean, the loan devaluations on your constructions and development loans so low at origination that you would not expect loss or…, I am just curious about how you are thinking about it.

Richard P. Jacobson

It is a great question Sarah and that is something that we have to keep analyzing and maybe future quarters where we do have to elevate that but that is just an on-going process. As you probably know, some portions of the loan loss reserve do not get reflected in total capital. I believe it is anything over 125 basis points. They don’t get included in total capital. So by allowing the money to go to equity that does help support capital it is just that really a couple of different equations there that we have to constantly manage. So, the nice part about the quarter was the delinquency levels falling down because we did see that the loans that were on the March delinquency 30 to 89 days delinquent transitioned into the non-accruals. So that was the one minor bit of improvement if you will for the story. So if that were growing as the non-performers were growing. I think it is fair to say that we have to look at larger additions. I think the other parts there is we kept our reserve ratios higher over the past few years. Some folks did allow their reserve to loan ratios to drop down significantly lower than what we did. We had to maintain these levels up close to 150 basis points. So we elevated the 160 last quarter and we are still in that range between 150 and 160 basis points.

Sara Hasan - McAdams Wright Ragen

And then, could you talk maybe what the average LCD on that construction portfolio as in what it would have been on that land portfolio? Do you have that information or maybe you could share with us the maximum that you would have done in the last cycle?

Richard P. Jacobson

You think about add originations. So…

Sara Hasan - McAdams Wright Ragen

Yes. I have it lately.

Richard P. Jacobson

SO compared with our land development loan up to 75% on the actual development part but on the spec construction when it moves to the construction it goes up to 80% loan to value. So some of the write downs are indeed a result of the fact that as we get current devaluations it was apparent that some of those projects were not going to be able to clear the loan balance. So we charge those off this quarter. But those are the two biggest areas at 75% on the development and 80% on the spec construction

Operator

Our next question is from Kristin Hotti – Howe, Barnes, Hoefer & Arnett.

Kristin Hotti – Howe, Barnes, Hoefer & Arnett Inc.

In the last quarter’s conference call you had noted that subsequent to this last quarter you are expecting some more NIM instability and I was wondering if you could comment on that and also on a related note if you could comment on specific initiatives to build core deposits and diversify away from the whole spending base?

Richard P. Jacobson

I will talk to the margin and let Dennis talk about the deposit side, Kristin. On the margin we would be looking really further out in the June quarter and have to go again look at those notes from March but we knew that there would be some pressure in June because in March the Fed hit us to at 75 basis points. So at the time of that call we knew there will be more pressure for the June quarter. Again with so many of our loans that is between 50% and 60% tied to prime we knew that the loan part would have some pressure in the June quarter. On the deposit site, now you are absolutely right. That is where we need to improve. I will turn in over to Dennis to talk about what we are doing there.

Dennis C. Joines

Yes, that is a good question. We have a couple of initiatives underway. We are bringing in two new positions to the company. One is a position we call a professional banker and what those rules as that individual joins the company they will primarily call on middle market, non-borrowing, high deposit businesses and they will be partnering with our commercial lenders out there to bring in the total relationship and just as importantly call on those type of companies that again don’t borrow but they have a propensity to have a lot of cash and delivering cash management products to that particular customer base.

In addition, we also have introduced private banking this year where we are now focusing on dealing with business owners and high affluent type of costumers in our communities and we are putting products and services together to attract that and to get more wallet share from the customers we now have but more importantly attract new customers along the way and not to leave out our retail offices operations. We have had a successful campaign with our fundraiser program there and we continue to focus in making sure we are disciplined with our retail offices that we are really executing the marketing plan that each office has independently and that is primarily to drive that core deposit growth.

Richard P. Jacobson

Kristin, I think the other part of the equation is going to be, not allowing the excessive levels of loan growth that maybe we had in a last couple of years. We need to slow that part down to make sure the core deposits can at least cover more of their share. The core deposit simply could not keep up with the phase of loan growth that we allowed to flow unto the balance sheet over the last three to four years. So that will be the other part of the equation that should reduce the reliance on the non-core funding sources. You know the other piece that I left down is a focus on calling on C&I customers. As you probably know they tend to have much higher level of demand deposit balances and as we continue to wanting to grow as we diversify our loan portfolio and grow that particular segment that will also help us drive what we want to accomplish with the core deposit increases.

Kristin Hotti – Howe, Barnes, Hoefer & Arnett Inc.

Thanks. Just going back to the NIM question just to clarify. You did remark that the first quarter of fiscal mileage is likely to see further NIM compression but I was looking at down the road to the next quarter—the second quarter of fiscal ’09 whether we could see some further stability that you could talk about in the margin given the repricing – the Fed repricing should working its way through the balance sheet now.

Richard P. Jacobson

Yes. That should be. That should be the case, Kristine. I guess the big question mark there is again the whole non-performing question. I certainly would not have predicted that one when we talked in April that we would have that impact on margin reversing out because of non-accruals. So, if you take that part out of the equation and look at the other things coming through if we do not have further reductions in the prime rate hitting the loan portfolio then we should see some stabilizing forces. On the funding side, the challenge there is we have that a couple of quarters where we have been able to reprice and a lot of the CDs but there is a little more pressure now too on the funding side. So the marginal difference that we were seeing last quarter to reprice CDs that is narrowing. Those maturing deposits maybe coming in to the high fours last quarter repricing maybe with the three handle. It is in the upper 3% range low 4% to attract fund these days in this market. So, while it can get better on the deposit side it is certainly not sufficient enough to turn the margin around. Yes.

Kristin Hotti – Howe, Barnes, Hoefer & Arnett Inc.

Just a follow on from I think it was Sara’s question. With respect to appraisals, can you give us some notion of how current appraisals might be on the average for at least the land construction portfolio. What percentage may have been reappraised during the last six months when a lot of the depreciation in values may have occurred that kind of an idea.

Richard P. Jacobson

Kristin that would be too big of a gas formula. Now, I could not pinpoint an exact number there for you. We are working through these. So many of these loans are short-term. They are maybe 18-month type loans that we are looking at these regularly but I couldn’t hang a number on a percentage, Kristine, as to how many we have hit but we are working through this weekly.

Kristin Hotti – Howe, Barnes, Hoefer & Arnett Inc.

What is driving the order in which you are looking at the appraisal for example?

Richard P. Jacobson

Two things. Size of the loan, the exposure we have there and the markets. We would be looking at Snohomish and Pierce County issues firs because those are the two markets that are most stressed on our markets. So, the larger loans in those two markets are where we have been starting over the last six months and working our way down.

Kristin Hotti – Howe, Barnes, Hoefer & Arnett Inc.

One just last question, did you have any buy backs in the quarter.

Richard P. Jacobson

No. Nor do we expect any in the future quarter.

Operator.

And our next question is from Michael Lipman with FTN Midwest Securities.

Michael Lipman - FTN Midwest Securities Corp.

I just want a little follow up I guess on your though of that capital management. I guess – can you kind of walk us through further your – the potential for dividend count or capital raise and have you performed sensitivity analyses on for instance if the market kind of plunders though 2009, what would happen?

Richard P. Jacobson

Yes, we are sure and we are sure Michael. We are modeling those events. I am not all the way to 2009 though. We are to the middle of 2009 in our modeling and we are working to keep projecting out so we can have support for those analysis at future quarterly board meetings where they talk about the dividends. So I sure cannot give a guidance in the dividends and that is absolutely a factor as we project. And here is where we are approaching. We are approaching at –Okay, we put the portfolio up there. What is the best estimate as of today? Now, let us stress this, move things if things were to get worse and then substantially worst to look at where that would potentially bring all of our capital ratios. So, that is the process we are going through and format similar to what you are seeing out there. Many folks here over the last couple of months. So, it is just a matter of extending out through the rest of 2009. Now, we are not to be ended 2009 in our analysis yet.

Michael Lipman - FTN Midwest Securities Corp.

That is true. What is you highest general take that things has deteriorated so quickly in some places but I guess your outlook in terms of PTMPA and losses at this point was not even too hard a question to answer.

Richard P. Jacobson

Yes, it is. That is a work in progress and I hate to hang a number out there, Michael that we have to refine as we go forward. So, that is something we will have to talk about in a future time.

Michael Lipman - FTN Midwest Securities Corp.

Okay. Just we can get a little bit on the OREO front. How is the market for disposing of OREO or is it active or pretty much of a standstill right now?

Richard P. Jacobson

Once you get these things written down. This is the nice part about some of the charge-offs. We have some examples the $3million of charge-offs we had in one of the projects we have for sales now that we were able to price them right and we are really taking a close look at that. It is to our advantage in some cases to take the property back and perhaps a borrower really struggle to get down to the right price and to get the property moved. Once that we get the control of it we would rather recognize these small losses now and get them off the books. So, again, that is one example forced sales we have going. And there is another project we have talked about for a couple of quarters. I think we are down to three homes in that project. Now it is the same story. Once we get the word out there that we are willing to either provide some financing incentives or we are allowing some short sales just equated these balances but the key there is getting them price right and that is where it is to our advantage in some cases to take control of the property

Michael Lipman - FTN Midwest Securities Corp.

Okay. Great. And then just last in the loan growth front. Commercial growth was very strong in the quarter. I was just hoping if you kind of comment on commercial growth and to a more general degree just average loan growth going forward, I guess through the end of the year.

Richard P. Jacobson

Well, with the commercial growth the C&I business, that is really where we based our focus. In fact we have over the last number of quarters but as we are out there in the business development efforts that we are doing out there absolutely is tailored to go after that type of business. This last quarter, some of our existing customers drew on their borrowing lines and so we just planned – I am just making that a focus and we would like to see that level of growth continue but time will tell. As far as loan growth has a hole we do not look as of total outstanding loan portfolio, we do not see loan growth really continuing in staying pretty flat. The activity on the construction and development, primarily what you will see any increase there would be defined and existing relationships we have now with the build out. But on the mortgage side we do not expect the mortgage portfolio to grow beyond where it is today either. So, we do not anticipate much in the way a growth whatsoever.

Michael Lipman - FTN Midwest Securities

Got you.

Richard P. Jacobson

Michael, if you think about the situation the loan department is in, we are not having our loan officers go after the construction development. So, it is a big shift in focus for all of the producers and to reiterate, one thing that Dennis said earlier is a pretty important part of this equation is the C&I type business brings the deposit that is the core deposit piece we have absolutely been missing in the last few year when you think of the construction and development community. Those folks don’t sit on deposits. They get that money back working they are big believers in leverage. So, that is the other primary reason that we have to work away from some of the concentrations that we have in the construction development and improve the C&I.

Operator

And we have a follow up question from Sara Hasan with McAdams Wright Ragen.

Sara Hasan - McAdams Wright Ragen

Could you remind me what is going on in the development subsidiary at this point in time?

Richard P. Jacobson

Yes. The development for Haven Highlands we have one project going on. It is about an 82-acre project and we have voluntarily offered and we are doing an environmental impact statement and that is in the process of being done. That probably will not be complete until this fall some time and to go through permitting process that would take us probably into next year. So, we are ways away from, the way I look at this, this is an excellent times to be going through the permitting process. Obviously, the housing market is not conducive to bringing new projects on line and I think the timing – I think the timing will be about right.

Operator

And we have our question from Aries [Esru] with Morgan Stanley.

Aries [Esru]– Morgan Stanley

Yes. Sorry I am a stock broker in Tacoma, Washington and not an analyst. So bear with me. My question is – if I understand correctly, you have three $38 million roughly in non-performing loans. You have reserve for $90 million. Back of the envelope arithmetic tells me that that means that you will be taking, if things don’t get worst, $3 million reserves for the next quarter for the next one and a half yeas. Is that correct or what am I missing?

Richard P. Jacobson

Unfortunately it is not that – it is not that straight forward. It is …

Aries [Esru]– Morgan Stanley

I do not think so but I could use some clarification.

Richard P. Jacobson

That is really an analysis where we have to look at the old portfolio not just this $38 million. We have to do our best job at estimating what else could be coming down the road and it really plan for those losses and I think the key part here again is that $38 million. That means we are not collecting interests. If there are further write downs there, that would hopefully be minimal to that $38 million but we expect to collect most of those dollars, most of those principal dollars back. So, we cannot just look at the non-performers in a loan loss reserve. There is a pretty extensive analysis that goes into how much money you should have set aside at any given time.

Aries [Esru]– Morgan Stanley

Can you a little bit about what the industry standards are in that regard then?

Richard P. Jacobson

No. unfortunately because there really are not – the banks are so different with their portfolio mixes and there is not a template out there that people follow. The best thing I could do is just point to maybe some averages you could take a look at S&L has some great resources that show what different peer banks with different geographic regions have. I am thinking of the chart that we reviewed at our annual meeting of shareholders yesterday that had a range of maybe 120 basis points of loans up to 180 basis points of loans for a couple of different averages but most folks are certainly increasing most provisions now as the should be in this housing market but no I cannot give a general template answer there.

Aries [Esru]– Morgan Stanley

Do I understand correctly that should some of these loans situations improved that they would be removed – they would be removed from that $38 million figure then?

Richard P. Jacobson

That is correct.

Aries [Esru]– Morgan Stanley

Do I also understand correctly that if we do not improve you do have collateral that you could you take possession of which would also reduce that number?

Richard P. Jacobson

It would not reduce the number. I mean, you think the collateral – it stays there until you dispose of that property bill. As you dispose of that, as you sell some of the homes and lots that is what it takes before you can reduce that. It would shift it from a non-performing loan into a non-performing assets so it would move to a different part there but that is still part of the whole non-performing category.

Operator

And at this time there are no questions in the queue.

Dennis C. Joines

This time I would like to thank everyone very much for their time and continued interest in Horizon Financial and if you need additional information, please feel free to contact us at any time.

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