Horizon Financial F2Q08 (Qtr End 09/30/07) Earnings Call Transcript

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Horizon Financial (OTCPK:HRZB) Q2 2008 Earnings Call October 18, 2007 4:30 PM ET

Executives

Laury Evans - Chairman and Chief Executive Officer

Rich Jacobson - Executive Vice President and ChiefFinancial Officer

Analysts

Michael Lipman - FTN Midwest Securities

Lou Katzer - D.A. Davidson

Ross Haberman - Haberman Funds

Brian Martin - Howe Barnes Hoefer & Arnett

Operator

Ladies and gentlemen, thank you for standing by. And welcometo the Horizon Financial Second Quarter Fiscal 2008 Conference Call. At thistime, all participants are in a listen-only mode. Following today’spresentation instructions will be given for the question-and-answer session(Operator Instructions). As a reminder this conference is being recorded today,Thursday, October 18, 2007.

I would now like to turn the conference over to Mr. LauryEvans, Chairman and CEO. Please go ahead sir.

Laury Evans

Thank you, Nicole. Good afternoon, everybody. Thank youfor joining us today for our First Quarter fiscal 2008 conference call. Asusual, Rich Jacobson, EVP and Chief Financial Officer, is here with me today;Dennis Joines is out today recovering from a minor traffic accident; he will beback on Monday.

Before we get started I need to remind you that this callmay contain forward-looking statements that are within the meaning of the Federal Securities Safe Harbor laws. Actual results from thetiming of certain events could differ materially from those projected in anyforward-looking statements due to a number of factors.

Specific factors include, among other things, mortgage andbusiness loan production, net loan growth, gain on sale of loans, loanparticipations, credit quality, our ability to attract low-cost deposits, netinterest margin expectations, risks associated with growing the bank, interestrate exposure, and general economic conditions.

Horizon Financial is under no obligation to update thisinformation as future events or developments take place that may change theseforward-looking statements.

As is customary I'd like to start with a brief update onthe local economy, and then turn the call over to Rich to review the balancesheet, asset quality, income statement and our net interest margin. After thatwe will open it up to questions.

Washington State economy continues to outperformthe national averages on almost every metric. You may remember that our lastcall, we talked about Washington State being ranked as the 5th Best State in which to do business by ForbesMagazine. This Quarter, the Tax Foundation ranked Washington State as the 11thBest State on its State Business Tax Index.

Unemployment in the state continues at record lows. InSeptember, the unemployment rate was 4.3, down from 4.6% a year ago. Thepreliminary figure is not seasonally adjusted or reflects non-farm payroll. Theemployment growth in the past Quarter improved with September employmentgrowth, up 3.7% year-over-year, with the largest growth in services,construction, and manufacturing.

Western Washington continues to be the major driverof the state's strong economic performance. Bellingham's unemployment in September wasonly 3.9%. This number is up from the number I reported last Quarter, but stillat historic lows. Mount Vernon-Anacortes Area also is showing excellent jobgrowth with unemployment dropping to 4.1% in September from 4.6% a year ago.

Tacoma's unemployment rate was 4.6%,down from 4.8 in September of 2006. Theunemployment rate in Snohomish County, where the Boeing 747, 767, 777,and the 787 Dreamliner are assembled, is down to 4.2% in September from 4.6%last year.

While our housing market has slowed down somewhat, we arestill seeing price appreciation in most of the markets, particularly at the lowend, where there is greatest demand. Frankly, the more moderate pace of thismarket is probably better for the long-term health of the economy than theextraordinary appreciation we have seen in the last few years.

The Washington Center for Real Estate Research from Washington State University publishes a report showing thepace of home sales is slowing, but the median price is continuing to increase,growing 8.1% from a year ago. Housing prices in Skagit County are up 8.7%; Snohomish County is up 10.6%; Whatcom County is up 3.4%; and Pierce County is up 5% year-over-year.

And I make a comment that looking at the Septemberactivity for each of those markets, the statement can still be made that priceappreciation is happening in those markets at the margin, but at much lowernumbers than I just stated.

In each of these markets, resale and building permits aredown from one year ago, except Skagit County, which shows a 3.6% increase inpermits and a 3.2% increase in resale. Washington State total overall showed an 11.6%drop in sales of existing homes and a 16.1% drop in building permits. Anothernote is that the Internet addresses for the information sources used in thiscall is located in the news release.

I'd also like to highlight the City of Bellingham's recent business survey that wasreleased in September. For those of you who are not familiar with Bellingham, it is located 90 miles north of Seattle, an hour south of Vancouver, British Columbia.

Our hometown is also home to the Western WashingtonUniversity campus and the 12,500 students, the Conoco Philips and BP oilrefinery that supply much of the region's refined petroleum products, and arelatively diverse small business community.

In fact, about one-third of Bellingham's businesses generated revenues between$100,000 and $500,000 in 2006. More than two-thirds of the survey participantsrated Bellingham as a good or very good place to do business. Largebusinesses, those with 12 or more employees, were the most enthusiastic withmore than 60% of them rating it very good or excellent.

More than three Quarters of those surveyed rated the localeconomy as good, and 12% rated it excellent. They also were very optimisticabout the future, with more than half expecting improving conditions and 36%thinking the economy will remain unchanged, and two third predicted the companyrevenues will grow.

This report on Bellingham has a lot of good information onit, and I think it certainly marks the difference between what is happening inthe small business markets or the commercial side, and the changing mortgagemarkets.

In Bellingham, in addition to our headquartersoffice, we have five other branches in Bellingham and nine in Whatcom County, and about two thirds of ourdeposits are in Whatcom County. While the deposit market datathat just came out are as of the end of June, I think the changes in the marketare interesting and demonstrate the strength of our franchise.

We continue to hold the number one ranking in both theCounty and the City, with our market share in Bellingham increasing to 26.1%, up from25.3% last year. In the County, our deposit market share also grew 22.9% from22.6%. In dollar terms, our deposits grew 11% to $488 million in Bellingham and grew 9% to $655 million inthe County.

Our second biggest market share is in Skagit County, where we have three branches.Our market share increased to 12 Basis Points to 8.19%, giving us a ranking ofnumber four in that marketplace. Deposits in this marketplace grew 10% lastyear to $157 million.

Snohomish is not very far behind with $147 million indeposits, which grew 13% last year, but that is a much bigger market so ourranking is 12th. They're at 1.65% of total deposits, which is up six BasisPoints. In our newest market, Pierce County, we have two relatively newoffices with $29 million in deposits, which is $10 million or 53% from lastyear.

There's plenty of room for growing market share here asthat represents 34 Basis Points of the total market, up from 24 Basis Pointsfrom last year. Since those numbers came out, our deposits grew another $10million to $998 million, which is an 8% increase from last year, and about a 1%above last Quarter. Core deposits grew 5% and account for 39% of our depositbase.

With that overview, I’d like to turn it over to Rich.

Rich Jacobson

Thank you, Laury. Looking at the balance sheet first, theassets grew 9% year-over-year and 3% on a sequential Quarter basis. Net loansincreased to 11% for the year to $1.15 billion and increased 6% from the JuneQuarter.

While the overall market for both residential andcommercial real estate has cooled off from the fast pace we’ve seen over thelast few years, there’s still healthy activity and appreciation in the market,along with a strong business climate.

Credit quality remains excellent with non-performingassets at just 5 Basis Points of total assets, down 2 Basis Points from lastQuarter's level, and down 13 Basis Points from a year ago. Almost all of the$731,000 we list as non-performing assets are concentrated in one single-familyresidence on our books as real estate owned, on the books for $725,000.

As shown in the release, we continue to build ourreserves, based on the growth in the loan portfolio, we set aside $800,000 inprovisions for loan losses in the Second Quarter, bringing the year-to-datetotal to $1.2 million.

We had very low charge-offs at $39,000 during the Quarter,and $66,000 so far this year. For both periods the net charge-offs were justslightly below the year-ago periods. Our reserve for loan losses now is justover $17 million at 1.48% of net loans, compared to $15.5 million or 1.5% ofnet loans at this time last year.

Now, turning to the income statement, we started off ourFiscal Year 2008 last Quarter with the record profits in the First Quarter, Ishould say, and almost achieved that same level of performance in our SecondQuarter.

Diluted earnings per share, was $0.40 in this most recentQuarter compared to $0.41 in the linked Quarter and $0.37 in the year agoQuarter. For the first six months of our Fiscal Year, earnings per share camein at $0.81, a 9% year-over-year increase compared to the same period a yearago.

In the most recent Quarter, earnings grew 6% to $4.9million compared to $4.65 million in the Second Quarter last year, and downslightly from $5 million in the June Quarter. For the first half of Fiscal2008, we're $9.9 million, up 8% from $9.2 million a year ago.

Last Quarter, we indicated that the pressures on ourmargins were starting to ease and our margin did expand just a bit whencompared to last Quarter. The net interest margin was 4.63% this Quarter, up 2Basis Points from the linked Quarter, but off 14 Basis Points from the year agoQuarter. Year-to-date, the net interest margin was 4.62%, which was off 18Basis Points from the first half of last year.

Now, with 50 Basis Point cut in the prime lending rate,which occurred right near the end of the Quarter, we will see some marginpressure again in the near term. As we note in the body of the release, over$670 million of our loan portfolio are tied to prime. Partially offsetting thisis just under $140 million in prime-based and short-term wholesale borrowings,and there will be a more gradual impact on the deposit side as the CDs willre-price more gradually.

Well, we do have $100 million in CDs re-pricing in thisQuarter and more than half of all of our CDs re-pricing in the next six months.But this will, of course, lag the immediate impact that we experienced with ourprime-based loans, so we expect the margin to contract in the 5-10 Basis Pointrange next Quarter.

For the Second Quarter, net interest income was $13.9million, up 4% on a sequential Quarter basis and 6% year-over-year. Interestexpense also grew at 4% compared to the prior Quarter, but compared to a yearago interest expense was up 21%.

Year-to-date, net interest income grew 6% to $27.4million. Second Quarter non-interest income was $1.6 million, down 5% from theprior Quarter and up 12% from the year ago Quarter, with growth in fee incomehelping to offset lower gains from sale on loans.

Year-to-date non-interest income grew 14% to $3.3 million,with service fees up 9% and gains on sale of loans up 13%. Non-interest expensewas $7.5 million in the First Quarter, up 3% from the linked Quarter and up 6%year-over-year.

In the first half of our Fiscal Year, operating expensesgrew 10% to $14.7 million. The increases were primarily due to higher occupancycosts from our new Puyallup office and from advertisingmarketing expenses as we work to enhance our brand in all markets.

Our efficiency ratio in the Quarter was 47.91%, unchangedfrom the June Quarter, but up from 47.19% in the year ago Quarter, andyear-to-date the efficiency increased to that 47.91% level from 46.74% a yearago.

Our return on equity and return on asset figures remainstrong in the Quarter, with ROE at 15.49% compared to 16.02% in the year agoQuarter. Return on assets was 1.48% for the Second Quarter compared to 1.53% inthe year ago Quarter.

Shareholder equity grew 9% year-over-year with book valueup to $10.56 per share and tangible book at $10.50 per share. We remain awell-capitalized bank with equity to assets at 9.51%, which still gives usplenty of equity to fund our future growth.

With that, I will turn it back over to Laury.

Laury Evans

Great. Thanks, Rich, and with that Nicole, I think we’dlike to open it up to questions.

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question comes from theline of Michael Lipman. Please state your company name followed by yourquestion.

Michael Lipman - FTNMidwest Securities

Hey, guys. Good afternoon.

Rich Jacobson

Hi.

Michael Lipman - FTNMidwest Securities

With FTN Midwest Securities to state that. First of all, Iguess my first question is did you repurchase any shares in the Quarter?

Rich Jacobson

Yes, we did. That was near the end of body of the release.Let me get that for you. We repurchased 147,000 shares during the first half ofthe year. That's the total for the first six months of our Fiscal Year, 147,200shares.

Michael Lipman - FTNMidwest Securities

And am I correct, was it 80 some thousand in the FirstQuarter?

Rich Jacobson

Yes, I think it was 80,600, in fact. I can get thatnumber, but that sounds familiar, Michael, yes.

Michael Lipman - FTNMidwest Securities

Okay. I guess, going forward, do you intend to keep,actively repurchase?

Rich Jacobson

Yes, we think that's an important tool for us. It's justone of many, but yes, that is something that we expect to keep as one of ouroptions.

Michael Lipman - FTNMidwest Securities

Okay. I guess the provision surprised me a little in theQuarter. I was wondering if this was pretty much a function only of loan growthor did you have any change to your risk weighting of certain loans or assets inthe Quarter?

Laury Evans

Yes, Michael. Our benchmark for loan loss reserve isrunning around 150 Basis Points. So we had quite a bit of loan growth in theQuarter and we felt like we needed to maintain that.

You will see it is a little over 1.48, I think that'swhere we ended up, but I think going forward, and especially in this kind of amarket that maintaining our loan loss reserve near our stated benchmark I thinkis an important thing that we are working on.

Michael Lipman - FTNMidwest Securities

Right. Your NPAs obviously are remaining very low and I'mvery impressed in fact, a lot of banks throughout this country seem to be in aquite different trend. Are you seeing anything in the way of, you have a lot ofhomebuilder exposure, are you seeing any in the way of weakening demand,pricing for homebuilders in your area?

Laury Evans

That's a very good question and the reason it's a verygood question is we obviously have a changing real estate market, and whenwe've gone through these business cycles before and we have managed our waythrough these cycles many, many times, we expect the inventory levels toincrease as we go into the winter.

And with that, we expect the sales to decrease in ourmarkets and for the inventories to increase, and we’ve been working with ourbuilders. We like our builders that work with good projects and have othersources of income.

And we put, to start with, we put limits on the builderswhen they get into these projects and of course sometimes there's a little lagin terms of when we approve a loan and the houses or the lots come online, butI would anticipate our non-performings to move up gradually or increase overthe next 18 months. How much of that is going to happen, I can't really giveyou a definite answer. I do like the fact that we're in the Northwest here andthe economy here is stronger than what's happening on a national basis.

Our employment has been good. Our population has been onthe increase and we have had a certain amount of in migration that has helpedthe overall market. So that's a long-winded answer to your question, but I doexpect the non-performings to increase, but I think on a comparative basis, Ithink we're going to look pretty good.

Michael Lipman - FTMMidwest Research

I definitely appreciate the answer. I guess, in terms ofthat too, do you go and take a look at particular developments in the areas asthey come due?

Laury Evans

We are on-site when we originate the loan and we aredoing, I would say, Quarterly to semi-annual reviews. The loan officers are outthere quite a bit, but upper management is out in the field reviewing projectseither Quarterly or at least semi-annually, that's a practice we feel is prettyimportant.

Rich Jacobson

Yeah, Michael, on our five-person loan committee, I meanbefore those loans are booked, at least one and more often more than one personin that committee has set foot on the property.

Michael Lipman - FTMMidwest Research

Excellent. I don't know if you have this number handy, whatwould you say is the average size of your typical C&D loan? I mean that'skind of a -- maybe…

Laury Evans

We like the smaller projects. These are running anywherefrom ten lots and up to maybe 40, somewhere in that range and so those are theprojects we like.

Rich Jacobson

Michael, to just highlight something Laury had mentionedearlier, if we were doing a 40-lot development, a typical start limit might be,okay, we will approve the 40 lots, but we want to see a start limit of maybesix or eight or 10 at the most, just so they can phase their way into theseprojects.

Michael Lipman - FTMMidwest Research

Got you, excellent. I guess on that same line, how areyour – your loan growth was phenomenal, again, how are the pipelines looking,more strength, there's continued strength in C&D; I know it's going intothe winter, and along with that, how is commercial growth looking?

Laury Evans

Well, we're putting more of an emphasis on the commercial,the C&I business. Obviously, we like to diversify our loan basis, but wehave a number of good builders out there that have good projects and we will bevery selective going forward, and I think the pipeline looks fairly consistent,going forward.

Rich Jacobson

One other thing, Michael, that you might have picked upon, looking at the June numbers compared to September numbers, we actually putsome more one-to-four family on the books, maybe some short-term product.

One product of this recent shakeout of some of themortgage folks is some of the Realtors are more inclined to send their businessback to the bank like Horizon, (inaudible) people who have been in business fora long time and some of the mortgage brokers have disappeared, and we choseduring this Quarter, to keep a few of those loans on our books, but that lookedlike a good return for us. So that's why you see the increase in thatone-to-four family residential line Quarter-over-Quarter.

Michael Lipman - FTMMidwest Research

Got you. So did that contribute then to the lower loangain action?

Rich Jacobson

Yes.

Michael Lipman - FTMMidwest Research

Would you, I guess, foresee continuing to hold some ofthose mortgages as opportunistically, I guess?

Rich Jacobson

If they are -- you said the right word, opportunistically.If the pricing is right, if they're the short-term, we're still not going toput those long-term fixed-rate loans on the books, but if the product and thepricing is right, then yes, we will.

Michael Lipman - FTMMidwest Research

Okay. And I will not tie up this line forever, but I guessis double-digit loan growth possible in Fiscal '08, do you think?

Laury Evans

That double-digit loan growth, we're certainly -- I wouldexpect our loan growth to slow down a little bit between now, our Fiscal Yearend runs through March 31st, and so…

Michael Lipman - FTMMidwest Research

Right.

Laury Evans

I think having been through these annual cycles beforemany, many times, and what's going to happen in December, in January andFebruary, we'll probably see some pretty slow activity. So I would anticipatethat it will be a little slower going forward.

Michael Lipman - FTMMidwest Research

Okay. Great, I really appreciate the answers. Thank you.

Laury Evans

Thanks Michael.

Operator

Thank you. Our next question comes from the line of LouKatzer. Please state your company followed by your question.

Lou Katzer - D.A.Davidson

HI Guys, I am from D.A. Davidson. Just a quick questionregarding the NPAs that you guys moved into other real estate owned. Do youhave any idea when you're anticipating the sale of those?

Rich Jacobson

It's actually one property. It's one dwelling in Skagit County and we're working on that.

Lou Katzer - D.A.Davidson

Okay. You're working on it. No ideas of the timeline,though?

Laury Evans

I would say that we're going to -- we just got control ofthat through -- and there was also an IRS redemption period that we had to waiton, but we're going to make our best efforts to try to get rid of that in thenext six months.

Lou Katzer - D.A.Davidson

Cool. Okay.

Laury Evans

Those kinds of assets are just need to be dealt with andwe need to move on.

Lou Katzer - D.A.Davidson

Great, yeah. And then you guys talked about the rate cutand how it's going to affect you in the near term and do you kind of -- in thelonger-term are you expecting any benefit from the rate cut? Is that going tohelp you out in any way?

Rich Jacobson

Well, that'd take a while. We'd have to look far down theroad before I could come to that assertion. With that, as many loans as we havetied to prime, we need the time for the deposits and our other liabilities tocatch up. So I really couldn't make the case that even further rate cuts wouldbe to a benefit.

Lou Katzer - D.A.Davidson

All right. I think that's all I have. Thanks, guys.

Rich Jacobson

Sure.

Laury Evans

Thank you.

Operator

Thank you. Our next question comes from the line of RossHaberman. Please state your company followed by your question.

Ross Haberman -Haberman Funds

How are you, gentlemen? Ross Haberman, Haberman Funds. Howare you?

Rich Jacobson

Hi, Ross.

Laury Evans

Doing terrific.

Ross Haberman -Haberman Funds

Sorry, no, no. I'm just trying to figure out how topreface this. If your margin is going to stay flat to down a little bit,because of the drop in rates, and you see a little pickup in thenon-performers, nothing terrible, are you expecting that loan growth is goingto be able to offset both of those two other negative factors?

Laury Evans

That's a good question. That could -- I think the best waywe could characterize that is maybe being partially offset. We've had quite abit of growth. The growth that we had this last Quarter came toward the end ofthe Quarter. Of course as the prime cut also came toward the end of theQuarter. So I look forward to some partial offset, going forward. We're goingto get some liability savings as well.

We may not again, it will help partially offset some ofthat decline in the prime rate, revenues from the prime rate cut, like in themoney market area and some of the CDs as they re-price. The good news is, isthe consumer is pretty short on the CD side of the market. So as the ratesdrop, we'll be able to take advantage of that probably over the next six ornine months, quite a bit of that will re-price. So, total offset, I'm havingtrouble with that, partial offset, definitely.

Ross Haberman -Haberman Funds

Playing into that equation, would you be inclined to, ifyou're not going to see as much loan growth as you would like to see, or hopeto see, would more aggressively buying back shares help you to keep on growingthat earnings per share, given this scenario I'm laying out?

Laury Evans

Yeah. I think that's something we're going to have toevaluate. We bought a few more shares in the Second Quarter as opposed to thefirst, and putting our capital to work, we just have to evaluate the returnthat we're getting on the asset side, and it's another tough question.

Also the dividend level and -- are we increasing that? Wecertainly have some room to do that, I think. It's just a good question, Ross,and I don't know that I can totally answer that. Rich, you have any?

Rich Jacobson

No. It's just certainly something that's part of theequation. I think somebody used the word opportunistically earlier in the call,and that would apply here as well. As we've got those opportunities, we willcertainly have to look at that.

Ross Haberman -Haberman Funds

One final question; acquisitions, what do you think aboutthem at this point? Multiples, prices for everyone are coming down. VentureKick (ph) cancelled their IPO a couple of months -- a couple weeks ago. Is thatmore on the front burner today than it was a Quarter or two ago?

Laury Evans

Yeah. I think we've been working in that area and wecertainly are looking for opportunities adjacent to our market areas, be ableto expand our market areas. And so Ross, I think you've hit on something therethat there might be better opportunities, going forward.

Pricing expectations from the seller's standpoint isdeclining and that's a good thing, and with these pressures on margins andearnings may give us an opportunity to find somebody that can supplement ourneed for liabilities and also give us some new markets.

Ross Haberman -Haberman Funds

Got it. Okay, again, the best of luck. We'll stay intouch. Thank you.

Laury Evans

Thanks, Ross.

Rich Jacobson

Thanks, Ross.

Operator

(Operator Instructions) Our next question comes from theline of Brian Martin. Please state your company followed by our question.

Brian Martin - HoweBarnes Hoefer & Arnett

Hi, guys.

Rich Jacobson

Hi, Brian.

Laury Evans

Hello Brian.

Brian Martin - HoweBarnes Hoefer & Arnett

Howe Barnes, Hoefer & Arnett. The loan growth youtalked a little bit about it Laury. Specifically within the constructioncategory, can you just give a little color on the growth within that component,what was driving that this Quarter?

Laury Evans

I think it's been driven primarily by commitments thathave been made in the past and we're certainly not adding a lot of new businessin that area at this point, but we've got a number of projects that we'refinishing up. Like I say, I think the markets out here are still somewhatstronger than the national markets and driven by employment and population.

So these are good things, but I think we're going to havea slower winter and I think slower activity sales-wise, going forward for thenext four or five months, and I think most of our builders understand that andare adjusting their activities accordingly.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay. How about just on the deposits side, I know youtalked about the loans that reset with prime, the non-maturity deposits, whattype of cutting in the prices were you able to do there? Will you be able toget maybe 30 Basis Points versus 50 on the loan side? Does that seem…?

Rich Jacobson

Or more, Brian, or more. We've actually been working onthis for a while, even in anticipation of a potential cut. So when I look atwhat we're doing now and I compare with where the rates were, on the moneymarket accounts for example, some of that I looked at just yesterday comparingtoday's rates to rates in August are down 40-45 Basis Points. So we're movingin that direction quickly and that's in the $225 million to $250 million rangeof deposits in that category.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay. And how about the CD rates? The CDs that re-price --I know they obviously take a little time here, but what are they -- where arethey starting at and where are they going to? What are the current rates todayon that CD funding?

Rich Jacobson

Great question, and there's less of an impact there, lessof a benefit than what we're going to see on the liquid accounts. What we'relooking at for the maturing interest rates, and what we think we're going tohave to pay, to either keep money here or attract some new funds, that's not inthe 50 Basis Points range.

It's probably closer to the 20 Basis Point savings range.So that will be welcomed, but again, certainly not enough to offset that 50Basis Point cut in the prime rate.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay. And just competitively speaking, with the rate cuts,I guess how would you characterize the competitors in the market? Were they asaggressive as you thought they were as they would be or not as aggressive,still a little bit too highly priced?

Laury Evans

You're talking about the liability side.

Brian Martin - HoweBarnes Hoefer & Arnett

Correct.

Laury Evans

I think they have been fairly aggressive out here, and ithas taken a little while for that to sink in and to -- for most of ourcompetitors to start to lower the rates, but I think there that movement is infull gear at this point.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay. Alright, and just maybe, just trying to understandthis, these builders that you obviously see things flowing in the inventorybuilding, given where your credit quality is at, how are these builders able to-- can you just give a scenario or two as to how these builders are best ableto withstand the rising inventory levels, when -- just given across the rest ofthe country what we're seeing?

What makes these builders different, or maybe just how youguys put the deals in place? So I guess just something to give us a little bitof comfort, other than the actual NPA numbers?

Laury Evans

Okay. Good question. I think the smart builder out thereis a builder that has inventory that is lowering his prices. Some cycles, yousit on your product until you come around to spring again, and this is probablya cycle that you don't want to do that and you want to get rid of the inventoryand re-group and look for opportunities.

Because I think the smart builders have been raising somecash and will look for some opportunities and there will be some terrificopportunities over the next 6-12 months on, let's say developed land that'salready out there.

But the smart builders are raising cash, and one of theways they're doing that are they're unloading their inventory. I'll give youone example of a builder we have who had about nine properties that he wastrying to move, and so he came up with a creative marketing campaign calledbeat the bank.

And I think this was beat the bank to foreclosure orsomething, but he slashed his prices, he sold six, in a two-week time period hesold six of the nine houses, and got rid of that carry, the overhead and thecarry, and yes, he didn't make as much money on it, but he is around, going tobe around for another day, and I think that's a good example.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay. I appreciate the color. Just a couple last thingshere. This market normalizes, which I guess everyone seems to be in agreement,we're not there yet, and you talked obviously about non-performings tricklingup at whatever rate they do. How about on the charge-off side? Where do youview charge-off levels in a more normalized market?

Laury Evans

Well, I don't really look at the charge-off levels beingall that much higher than you’ve seen the last year or two. I think they'regoing to be -- I think there's good value in the properties that we've gotmoney invested into and I think that will hold through this, and so I don't seethe charge-offs -- our charge-offs have been running, Rich, 100, 125 a year, maybe up to 150?

Rich Jacobson

It's been pretty consistent. I think if we look back threeyears now, they will be very consistent. And I think, Brian one of the reasonsthat this will stay reasonable is just what Laury was talking about on thatexample with the builders selling those nine homes.

We have still been experiencing some price appreciationout here, in this economy. And that's what makes it a little different fromsome of the economies around the country, that the builders have the room.

Maybe they had this expectation they were going to get ahigher price, but they’ve been able to move those prices down and still make alittle money to get out of the project. So, I think that's where we differ fromsome other parts of the country, where some of the builders may have had tolook at some pretty tough losses just to get out of the projects.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay, last two. The 30 to 89-day bucket, can you give anycolor on where that's at as of -- I guess in advance of the call report here?Any change, I guess, anything unusual in that number relative to June 30number?

Laury Evans

Now, I don't think that we see anything out there at thispoint.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay. And last thing was the data and maybe you guys havealready given color on this, but the Fairhaven Highlands project that you guyshave, can you just give an update on where you are with that? And is that inzoning, I mean do you have any concerns with this slowdown in regards to thatproject, or…?

Laury Evans

Not really. I think the timing is going to work out well.The project itself is -- we're having an environmental impact statement beingdone, which is a little unusual for a residential project, but because of someof the questions that have been raised about it, we're having a full-blownenvironmental impact statement being done and that probably will be completedin the next four or five months.

In fact, the scoping is still being worked out on that,but the Company has been hired and so I think by the time we get to the hearingexaminer and I think the timing is going to be such that we're probably lookingat maybe spring of 2009, let's say and by that time I think the market will becoming back, so…

Brian Martin - HoweBarnes Hoefer & Arnett

Okay, so the zoning is already been complete, or that'sstill -- that's all that's being worked on in the building. I guess what beginsin the spring of '09? Is that when the actual building would start?

Laury Evans

That's when we would be getting our flat approval andbeing able to start to put in roads, and it's in phases.

Brian Martin - HoweBarnes Hoefer & Arnett

I got you.

Laury Evans

And so we would be working on Phase I.

Brian Martin - HoweBarnes Hoefer & Arnett

Okay, all right. I appreciate all the time. Thanks,gentlemen.

Laury Evans

Thanks, Brian.

Operator

(Operator Instructions) It appears that we have no furtherquestions. Please continue.

Laury Evans

Great. Thank you, Nicole. As always, I want to thank eachand every one of you for your time and continued interest in Horizon Financialand please feel free to give myself or Rich a call at any time. Thank you verymuch. That's it, Nicole.

Operator

Thank you ladies and gentlemen. That does conclude ourcall for today. Thank you for your participation. You may now disconnect.

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