U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the Fiscal Year Ended June 30, 2000
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to __________
Commission File Number: 0-27951
SECURITY FINANCIAL BANCORP, INC.
(Name of small business issuer in its charter)
DELAWARE 35-2085053
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9321 Wicker Avenue, St. John, Indiana 46373
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (219) 365-4344
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 Exchange Act 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 in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of the Form 10-KSB
or any amendment to this Form 10-KSB.|_|
The issuer's gross revenues for the fiscal year ended June 30, 2000 were
$20,814,000.
The aggregate market value of the voting and non-voting common equity held
by non-affiliates was $31,755,915, based upon the price ($17 1/8 per share) as
quoted on the Nasdaq SmallCap Market for September 1, 2000. Solely for purposes
of this calculation, the shares held by the directors and officers of the
registrant are deemed to be held by affiliates.
The number of shares outstanding of the registrant's Common Stock as of
September 1, 2000 was 1,938,460.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 1999 Annual Report to Stockholders and of the Proxy Statement
for the 2000 Annual Meeting of Stockholders are incorporated by reference in
Parts II and III, respectively, of this Form 10-KSB
<PAGE>
INDEX
Part I
Page
Item 1. Description of Business..............................................4
Additional Item - Executive Officers of the Registrant..............30
Item 2. Description of Properties...........................................33
Item 3. Legal Proceedings...................................................33
Item 4. Submission of Matters to a Vote of Security Holders.................34
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters..........................................................34
Item 6. Management's Discussion and Analysis or Plan of Operation...........34
Item 7. Financial Statements................................................34
Item 8. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................34
Part III
Item 9. Directors, Executive Officers, Promoters, and Control Persons;
Compliance with Section 16(a) of the Exchange Act................34
Item 10. Executive Compensation..............................................34
Item 11. Security Ownership of Certain Beneficial Owners and Management......34
Item 12. Certain Relationships and Related Transactions......................35
Item 13. Exhibits and Reports on Form 8-K....................................35
<PAGE>
This report contains certain "forward-looking statements" within the
meaning of the federal securities laws. These statements are not historical
facts, rather they are statements based on Security Financial Bancorp, Inc.'s
current expectations regarding its business strategies, intended results, and
future performance. Forward-looking statements are preceded by terms such as
"expects," "believes," "anticipates," "intends," and similar expressions.
Management's ability to predict results or the effect of future plans or
strategies is inherently uncertain. Factors that could affect actual results
include interest rate trends; the general economic climate in the market area in
which Security Financial Bancorp, Inc. operates, as well as nationwide; Security
Financial Bancorp, Inc.'s ability to control costs and expenses; competitive
products and pricing; loan delinquency rates; and changes in federal and state
legislation and regulation. These factors should be considered in evaluating the
forward-looking statements, and undue reliance should not be placed on such
statements. Security Financial Bancorp, Inc. assumes no obligation to update any
forward-looking statements.
PART I
Item 1. DESCRIPTION OF BUSINESS
General
Security Financial Bancorp, Inc. (Security Financial), headquartered in
St. John, Indiana, was formed in September 1999 as the holding company for
Security Federal Bank & Trust (Security Federal) in connection with the
conversion of Security Federal from a mutual to a stock form of ownership. The
conversion was completed on January 5, 2000 through the sale of 1,938,460 shares
of common stock by Security Financial at a price of $10.00 per share. Security
Financial's sole business activity is the ownership of all of Security Federal's
capital stock. Security Financial does not transact any material business other
than through its subsidiary, Security Federal. Security Financial is subject to
the regulation of the Office of Thrift Supervision and the Securities and
Exchange Commission. Security Financial is listed on the Nasdaq SmallCap Market
under the symbol SFBI.
Security Federal's principal business is attracting deposits from the
general public and originating loans secured by one-to-four-family residential
real estate properties located in its market area. Security Federal is regulated
by the Office of Thrift Supervision and the Federal Deposit Insurance
Corporation. Security Federal's deposits are federally insured by the Federal
Deposit Insurance Corporation. Security Federal is a member of the Federal Home
Loan Bank System.
Market Area
Security Federal is headquartered in St. John, Indiana which is in Lake
County. Security Federal's primary deposit gathering and lending area is
concentrated in the communities surrounding its five banking offices located in
Lake County and one banking office located in Porter County, as well as Cook and
Will Counties in Illinois. Lake and Porter Counties are located in the northwest
corner of Indiana, immediately southeast of Chicago, Illinois. It is
approximately 30 miles from the heart of Lake County to the heart of neighboring
Chicago. Several major highways, truck lines, and railways serve the area,
providing versatility and convenience of transportation. Expanding airport
facilities provide service for corporate and business needs. While primarily a
home to several steel manufacturers, Lake County has a diversified mix of
industry groups, including insurance and financial services, manufacturing,
service, government, and retail. The major employers in the area include U.S.
Steel, NIPSCO Industries, Inc., Whiteco Industries, Porter Memorial Hospital,
Valparaiso University, Valparaiso Community Schools, McGill Manufacturing, and
Hunt Wesson.
3
<PAGE>
Competition
Security Federal faces intense competition for the attraction of deposits
and origination of loans in its primary market area. Its most direct competition
for deposits has historically come from the several commercial banks operating
in Security Federal's primary market area and, to a lesser extent, from other
financial institutions, such as brokerage firms, credit unions, and insurance
companies. Particularly in times of high interest rates, Security Federal has
faced additional significant competition for investors' funds from short-term
money market securities and other corporate and government securities. Security
Federal's competition for loans comes primarily from the commercial banks and
loan brokers operating in its primary market area. Competition for deposits and
the origination of loans may limit Security Federal's growth in the future.
Lending Activities
Loan Portfolio Analysis. The following table presents the composition of
Security Federal's loan portfolio at the dates indicated. Security Federal had
no concentration of loans exceeding 10% of total loans receivable other than as
disclosed below.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------
2000 1999
------------------------- ------------------------
Percent Percent
Amount of Total Amount of Total
------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
One-to four-family (1) $ 76,050 57.08% $ 86,086 57.44%
Multi-family and commercial real estate 18,045 13.54 16,420 10.96
Construction 767 .58 6,414 4.28
-------- ------ -------- ------
Total real estate loans 94,862 71.20 108,920 72.68
Consumer and other loans:
Automobile 9,378 7.04 15,980 10.66
Home equity and second mortgage 16,031 12.03 17,478 11.66
Other 1,118 .84 1,616 1.08
-------- ------ -------- ------
Total consumer and other loans 26,527 19.91 35,074 23.40
Commercial business loans 11,837 8.89 5,867 3.92
-------- ------ -------- ------
Total loans 133,226 100.00% 149,861 100.00%
====== ======
Less:
Net deferred loan origination fees 84 76
Allowance for loan losses 1,449 1,469
-------- --------
Net loans $131,693 $148,316
======== ========
</TABLE>
(1) Excludes loans available for sale.
One-to-four-family Real Estate Loans. Currently, Security Federal
originates loans secured by one-to-four-family residences primarily located in
its primary market area. In the past, Security Federal purchased ARM loans
originated through correspondent relationships and secured by properties located
outside of its primary market area, many of which Security Federal continues to
hold in its portfolio.
4
<PAGE>
Security Federal offers a variety of fixed- and adjustable-rate mortgage
loan products. The loan fees charged, interest rates, and other provisions of
Security Federal's mortgage loans are determined by Security Federal on the
basis of its own pricing criteria and market conditions. Generally, all loans
originated by Security Federal conform to Fannie Mae and Freddie Mac
underwriting standards. Security Federal's fixed-rate loans typically have
maturities of 10 to 30 years, although 30-year loans constitute the largest
percentage of originations. Security Federal also offers five- and seven-year
balloon mortgages based on a 30-year amortization schedule. Security Federal's
ARM loans are typically based on a 15-year or 30-year amortization schedule.
Interest rates and payments on Security Federal's ARM loans generally are
adjusted annually after a specified period ranging from one to three years to a
rate typically equal to 2.75% above the one-year constant maturity Treasury
index. Security Federal currently offers ARM loans with initial rates below
those that would prevail under the foregoing computation, determined by Security
Federal based on market factors and competitive rates for loans having similar
features offered by other lenders for such initial periods. The maximum amount
by which the interest rate may be increased or decreased in a given period on
Security Federal's ARM loans is generally 2% per adjustment period and the
lifetime interest rate cap is generally 6% over the initial interest rate of the
loan. Security Federal qualifies the borrower based on the borrower's ability to
repay the ARM loan based on the maximum interest rate at the first adjustment in
the case of one-year ARM loans and based on the initial interest rate in the
case of ARM loans that adjust after three or more years. Security Federal does
not originate negative amortization loans. The terms and conditions of the ARM
loans offered by Security Federal, including the index for interest rates, may
vary from time to time. Security Federal believes that the annual adjustment
feature of its ARM loans also provides flexibility to meet competitive
conditions as to initial rate concessions while preserving Security Federal's
return on equity objectives by limiting the duration of the initial rate
concession.
Borrower demand for ARM loans versus fixed-rate mortgage loans is a
function of the level of interest rates, the expectations of changes in the
level of interest rates, and the difference between the initial interest rates
and fees charged for each type of loan. The relative amount of fixed-rate
mortgage loans and ARM loans that can be originated at any time is largely
determined by the demand for each in a competitive environment. As a result of
the low interest rate environment in recent years, Security Federal has
experienced a strong customer preference for fixed-rate loans.
The retention of ARM loans in Security Federal's loan portfolio helps
reduce Security Federal's exposure to changes in the interest rates. There are,
however, unquantifiable credit risks resulting from the potential of increased
costs due to changed rates to be paid by the customer. It is possible that,
during periods of rising interest rates, the risk of default on ARM loans may
increase as a result of repricing and the increased costs to the borrower.
Furthermore, because the ARM loans originated by Security Federal generally
provide, as a marketing incentive, for initial rates of interest below the rates
that would apply were the adjustment index used for pricing initially
(discounting), these loans are subject to increased risks of default or
delinquency. Another consideration is that although ARM loans allow Security
Federal to increase the sensitivity of its asset base to changes in interest
rates, the extent of this interest sensitivity is limited by the periodic and
lifetime interest rate adjustment limits. Because of these considerations,
Security Federal has no assurance that yields on ARM loans will be sufficient to
offset increases in Security Federal's cost of funds.
While fixed-rate one-to-four-family residential real estate loans are
normally originated with 10- to 30-year terms and Security Federal permits its
ARM loans to be assumed by qualified borrowers, such loans typically remain
outstanding for substantially shorter periods. This is because borrowers often
prepay their loans in full upon sale of the property pledged as security or upon
refinancing the original loan. In addition, substantially all mortgage loans in
Security Federal's loan portfolio contain due-on-sale clauses providing that
Security Federal may declare the unpaid amount due and payable upon the sale of
the property securing the loan. Security Federal enforces these due-on-sale
clauses to the extent permitted by law and as business judgment dictates. Thus,
average loan maturity is a function of, among other factors, the level of
purchase and sale activity in the real estate market, prevailing interest rates,
and the interest rates payable on outstanding loans.
Security Federal requires title insurance insuring the status of its first
lien on real estate secured loans and also requires that the fire and extended
coverage casualty insurance (and, if appropriate, flood insurance) be maintained
in an amount at least equal to the outstanding loan balance.
Security Federal's residential mortgage loans typically do not exceed 80%
of the appraised value of the property. Security Federal's lending policies
permit Security Federal to lend up to 95% of the appraised value of the
property; however, Security Federal generally requires private mortgage
insurance on the portion of the principal amount
5
<PAGE>
that exceeds 80% of the appraised value of the property. Security Federal
obtains appraisals on all first mortgage real estate loans from outside
appraisers.
Multi-Family and Commercial Real Estate Loans. Security Federal originates
and purchases mortgage loans for the acquisition and refinancing of multi-family
and commercial real estate properties. Security Federal began offering
commercial loans in 1996.
Multi-family and commercial real estate loans are fully amortizing loans
that are generally originated with fixed interest rates with rates tied to the
U.S. Treasury index but are occasionally originated with variable rates with
rates tied to the prime lending rate. The maximum term for a fixed-rate
multi-family loan generally is generally 10 years. The maximum loan-to-value
ratio for a multi-family or commercial loan is 75%.
At June 30, 2000, the largest multi-family loan had a committed balance of
$1.5 million and was secured by an apartment building located in Temecula,
California and was performing according to its original terms. This is a loan
participation with a correspondent bank.
At June 30, 2000, Security Federal's commercial real estate loans were
secured by office, retail, and owner occupied properties, all of which are
located in Indiana and Illinois. At June 30, 2000, Security Federal's largest
commercial real estate loan had an outstanding balance of $1.7 million. The loan
is secured by a strip center located in Dyer, Indiana. At June 30, 2000, this
loan was performing according to its original terms.
Multi-family and commercial real estate lending affords Security Federal
an opportunity to receive interest at rates higher than those generally
available from one-to-four-family residential lending. However, loans secured by
these properties usually are greater in amount and are more difficult to
evaluate and monitor and, therefore, involve a greater degree of risk than
one-to-four-family residential mortgage loans. Because payments on loans secured
by income producing properties are often dependent on the successful operation
and management of the properties, repayment of these loans may be affected by
adverse conditions in the real estate market or the economy. Security Federal
seeks to minimize these risks by generally limiting the maximum loan-to-value
ratio to up to 75% for multi-family and commercial real estate loans and by
strictly scrutinizing the financial condition of the borrower, the cash flow of
the project, the quality of the collateral, and the management of the property
securing the loan. Security Federal also generally obtains loan guarantees from
financially capable parties based on a review of personal financial statements.
Residential Construction Loans. Security Federal originates residential
construction loans to local home builders and to individuals for the
construction and acquisition of personal residences.
Construction loans to individuals are made on the same terms as Security
Federal's mortgage loans, but provide for the payment of interest only during
the construction phase, which is usually six months, with a contingency for an
additional six months. At the end of the construction phase, the loan converts
to a permanent mortgage loan.
Before making a commitment to fund a construction loan, Security Federal
requires an appraisal of the property by an independent certified appraiser.
Security Federal also reviews and inspects each project before disbursement of
funds during the term of the construction loan. Loan proceeds are disbursed
after inspection based on the percentage of completion.
Construction lending affords Security Federal the opportunity to earn
higher interest rates with shorter terms to maturity relative to single-family
permanent mortgage lending. Construction lending, however, is generally
considered to involve a higher degree of risk than single-family permanent
mortgage lending because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated cost of the
project. These loans are generally more difficult to evaluate and monitor. If
the estimate of construction cost proves to be inaccurate, Security Federal may
be required to advance funds beyond the amount originally committed to protect
the value of the project. If the estimate of value upon completion proves to be
inaccurate, Security Federal may be confronted with a project whose value is
insufficient to ensure full repayment. Projects may also be jeopardized by
disagreements between borrowers and builders and by the failure of builders to
pay subcontractors. Loans to builders to construct homes for which no purchaser
has been identified carry more risk because the payoff for the loan depends on
the builder's ability to sell the property before the construction loan is due.
6
<PAGE>
Security Federal has attempted to minimize the foregoing risks by, among
other things, limiting its construction lending to residential properties. It is
also Security Federal's general policy to obtain regular financial statements
from builders so that it can monitor their financial strength and ability to
repay.
Consumer and Other Loans. Another significant lending activity of Security
Federal is the origination of consumer and other loans. Security Federal's
consumer and other loans consist primarily of home equity and second mortgage
loans and automobile loans. Most of these loans are made to existing customers.
Security Federal originates home equity loans in the form of lines of credit.
Security Federal's home equity loans have variable interest rates tied to the
six-month U.S. Treasury index. In the future, Security Federal intends to tie
these variable interest rates loans to the prime lending rate. Security Federal
imposes a maximum loan-to-value ratio on its home equity loans of 80% after
considering both the first and second mortgage loans. The maximum loan-to-value
rate on Security Federal's second mortgage loans is 80%. Both Security Federal's
home equity and second mortgage loans are limited in term to 120 months.
Security Federal's home equity loans and second mortgages may have greater
credit risk than one-to-four-family residential mortgage loans because they are
secured by mortgages subordinated to an existing first mortgage on the property,
which, in most cases, is held by Security Federal.
Security Federal also originates consumer loans secured by automobiles
and, occasionally, boats and other recreational vehicles. Automobile loans are
secured by both new and used cars and light trucks. Both new and used cars are
financed for a period of up to 60 months and the rate on such loans is fixed for
the term of the loan. In the past, Security Federal also offered indirect
automobile loans. The indirect automobile loans were originated through
automobile dealers in Indiana and Illinois. These dealers provided Security
Federal applications to finance vehicles sold by their dealerships. At June 30,
2000, $7.1 million, or 76.0%, of all automobile loans were indirect automobile
loans. Security Federal no longer offers indirect automobile loans.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
rapidly depreciating 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. The remaining deficiency often does not
warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability and thus are more
likely to be adversely affected by job loss, divorce, illness, or personal
bankruptcy. Furthermore, the application of various Federal and state laws,
including Federal and state bankruptcy and insolvency laws, may limit the amount
that can be recovered on such loans. Such loans may also give rise to claims and
defenses by a consumer loan borrower against an assignee of such loans such as
Security Federal, and a borrower may be able to assert against such assignee
claims and defenses that it has against the seller of the underlying collateral.
Commercial Business Loans. Security Federal makes commercial business
loans primarily in its market area to a variety of professionals, sole
proprietorships, and small businesses. Security Federal offers a variety of
commercial lending products, including term loans for fixed assets and working
capital, revolving lines of credit, letters of credit, and Small Business
Administration guaranteed loans. Secured commercial business loans are generally
made in amounts up to $500,000, although Security Federal's policy would permit
it to lend up to its legal lending limit of $3.0 million. Unsecured lines of
credit generally are made for up to $250,000. Term loans are generally offered
with fixed rates of interest of up to 5 years. Business lines of credit have
adjustable rates of interest and are payable on demand, subject to annual review
and renewal. Business loans with variable rates of interest adjust on a daily
basis and are generally indexed to the prime rate as published in The Wall
Street Journal.
In making commercial business loans, Security Federal considers the
financial statements of the borrower, Security Federal's lending history with
the borrower, the debt service capabilities of the borrower, the projected cash
flows of the business, and the value of the collateral. Commercial business
loans are generally secured by a variety of collateral, primarily equipment,
assets, and accounts receivable, and are supported by personal guarantees.
Depending on the collateral used to secure the loans, commercial loans are made
in amounts of up to 75% of the adjusted value of the collateral securing the
loan. Security Federal generally does not make unsecured commercial loans. In an
effort to increase its emphasis on commercial loans, Security Federal intends to
hire an experienced commercial loan officer with the primary responsibility of
increasing commercial business and real estate loan volume.
7
<PAGE>
Unlike mortgage loans, which generally are made on the basis of the
borrower's ability to make repayment from his or her employment or other income
and which are secured by real property whose value tends to be more easily
ascertainable, commercial 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 loans may be substantially dependent on the success of the business
itself. Further, any collateral securing such loans may depreciate over time,
may be difficult to appraise, and may fluctuate in value. At June 30, 2000,
Security Federal's largest commercial loan was for $1.8 million to an insurance
company located in Deerfield, Illinois.
Loans to One Borrower. The maximum amount that Security Federal may lend
to one borrower is limited by federal regulations. At June 30, 2000, Security
Federal's regulatory limit on loans to one borrower was $4.1 million. At that
date, Security Federal's largest amount of loans to one borrower, including the
borrower's related interests, was $2.5 million and consisted of two loans. This
loan was performing according to its original terms at June 30, 2000.
Maturity of Loan Portfolio. The following table presents certain
information at June 30, 2000 regarding the dollar amount of loans maturing in
Security Federal's portfolio based on their contractual terms to maturity, but
does not include potential prepayments. Demand loans, loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as
becoming due within one year. Loan balances do not include undisbursed loan
proceeds, unearned discounts, unearned income, and allowance for loan losses.
<TABLE>
<CAPTION>
Multi-Family Home Equity
One-to- and and
Four- Commercial Second Other Commercial Total
Family(1) Real Estate Construction Automobile Mortgage Consumer Business Loans
--------- ----------- ------------ ---------- -------- -------- -------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Amounts due in:
One year or less $ 2,783 $ 833 $ 767 $ 349 $ 5,220 $ 232 $ 5,766 $ 15,950
More than one year to
three years 5,202 4,183 -- 6,097 1,381 533 708 18,104
More than three years
to five years 4,787 3,324 -- 2,932 1,263 84 3,597 15,987
More than five years
to 10 years 10,760 9,705 -- -- 2,353 269 1,766 24,853
More than 10 years
to 20 years 26,281 -- -- -- 3,715 -- -- 29,996
More than 20 years 26,237 -- -- -- 2,099 -- -- 28,336
-------- -------- -------- -------- -------- -------- -------- --------
Total amount due $ 76,050 $ 18,045 $ 767 $ 9,378 $ 16,031 $ 1,118 $ 11,837 $133,226
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
(1) Excludes loans available-for-sale.
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<PAGE>
The following table presents the dollar amount of all loans due after June
30, 2001, which have fixed interest rates and have floating or adjustable
interest rates.
Due After June 30, 2001
Fixed- Adjustable-
Rate Rate Total
---- ---- -----
(Dollars in thousands)
Amounts due in:
Real estate loans:
One-to-four-family (1) $ 33,677 $ 39,590 $ 73,267
Multi-family and commercial real estate 4,865 12,347 17,212
-------- -------- --------
Total real estate loans 38,542 51,937 90,479
-------- -------- --------
Consumer and other loans:
Automobile 9,029 -- 9,029
Home equity and second mortgage 6,307 4,504 10,811
Other 645 241 886
-------- -------- --------
Total consumer and other loans 15,981 4,745 20,726
-------- -------- --------
Commercial business loans 1,850 4,221 6,071
-------- -------- --------
Total loans $ 56,373 $ 60,903 $117,276
======== ======== ========
(1) Excludes loans available for sale.
Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of a loan is substantially less than
its contractual term because of prepayments. In addition, due-on-sale clauses on
loans generally give Security Federal the right to declare loans immediately due
and payable if, among other things, the borrower sells the real property with
the mortgage and the loan is not repaid. The average life of a mortgage loan
tends to increase, however, when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
tends to decrease when rates on existing mortgage loans are substantially higher
than current mortgage loan market rates.
Loan Solicitation and Processing. Security Federal's lending activities
follow written, non-discriminatory, underwriting standards and loan origination
procedures established by Security Federal's Board of Directors and management.
Loan originations come from a number of sources. The customary sources of loan
originations are mortgage brokers, loan correspondents, loan origination
officers, realtors, referrals and existing customers. Various executive officers
have the authority to approve secured and unsecured loans as permitted by the
Board of Directors. Currently, Mr. Hyland has authority to approve secured and
unsecured loans with balances of up to and including $500,000 and $250,000,
respectively. Larger loans must be approved by either Mr. Hyland and at least
two other members of Security Federal's corporate loan committee, four members
of the corporate loan committee, or the loan committee of the Board. Any loans
exceeding $2.0 million must be approved by the Board.
Loan Originations, Purchases and Sales. Security Federal's mortgage
lending activities are conducted primarily by its correspondent banks and
brokers and commissioned loan personnel operating at its full service banking
offices and loan offices. All loans originated by Security Federal are
underwritten by Security Federal pursuant to Security Federal's policies and
procedures. Security Federal originates both adjustable-rate and fixed-rate
mortgage loans. Security Federal's ability to originate fixed- or
adjustable-rate loans is dependent upon the relative customer demand for such
loans, which is affected by the current and expected future level of interest
rates. Security Federal recently has sought to expand its commercial lending to
enhance the yield on its loan portfolio and to encourage business relationships
with the borrowers, including through checking and other accounts and other
loans. Additionally, as part of its mortgage banking operation, Security Federal
purchases whole loans and, to a limited extent, loan participations, all with
servicing released.
9
<PAGE>
In an effort to manage its interest rate risk position, Security Federal
generally sells the fixed-rate mortgage loans with terms in excess of 15 years
that it originates. However, Security Federal has retained and will retain
selected 30-year fixed-rate loans in order to build its loan portfolio and
increase the yield on its interest-earning assets. The sale of loans in the
secondary mortgage market reduces Security Federal's risk that the interest
rates paid to depositors will increase while Security Federal holds long-term
fixed-rate loans in its portfolio. It also allows Security Federal to continue
to fund loans when savings flows decline or funds are not otherwise available.
Security Federal currently generally sells loans, servicing released without
recourse to Fannie Mae. Gains, net of origination expense, from the sale of such
loans are recorded at the time of sale. Generally a loan is committed to be sold
and a price for the loan is fixed after the loan is approved and the interest
rate is accepted by the customer. This eliminates the risk to Security Federal
that a rise in market interest rates will reduce the value of a mortgage before
it can be sold.
In the past, Security Federal generally retained the servicing rights on
the mortgage loans it sold. Servicing loans for others generally consists of
collecting mortgage payments, maintaining escrow accounts, disbursing payments
to investors, and foreclosure processing. In October 1998, however, Security
Federal sold the servicing rights related to approximately $920.0 million in
loans serviced for others. In August 1999, Security Financial arranged for the
sale of the remaining servicing rights held by Security Federal, relating to
approximately $320.0 million in loans serviced for others. Currently, all loans
sold by Security Federal are sold servicing released.
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<PAGE>
The following table presents total loans (including loans held for sale)
originated, purchased, sold, and repaid during the periods indicated.
For the Year Ended
June 30,
2000 1999
---- ----
(In thousands)
Total loans at beginning of period $ 151,746 $ 230,332
Originations:
Real estate:
One-to-four-family 7,732 60,910
Multi-family and commercial real estate 3,475 7,620
Construction 1,841 3,256
--------- ---------
Total real estate 13,048 71,786
Consumer and other:
Automobile 802 1,022
Home equity and second mortgage 2,339 2,977
Other 767 1,249
--------- ---------
Total consumer and other 3,908 5,248
Commercial business 3,120 1,271
--------- ---------
Total loans originated 20,076 78,305
Purchases:
Real estate:
One-to-four-family 14,676 211,065
Multi-family and commercial real estate 1,650 --
Construction -- 15,164
--------- ---------
Total real estate 16,326 226,229
Consumer and other:
Automobile -- --
Home equity and second mortgage -- --
Other -- --
--------- ---------
Total consumer and other -- --
Commercial business 3,775 --
--------- ---------
Total loans purchased 20,101 226,229
Sales and repayments:
Real estate:
One-to-four-family (35,726) (334,502)
Multi-family and commercial real estate (2) (1,333)
Construction (8,202) (25,033)
--------- ---------
Total real estate (43,930) (360,868)
Consumer and other:
Automobile (7,550) (10,101)
Home equity and second mortgage (6,306) (6,250)
Other (1,323) (1,994)
--------- ---------
Total consumer and other (15,179) (18,345)
Commercial business (776) (3,884)
--------- ---------
Total sales and repayments (59,885) (383,097)
--------- ---------
Less:
Loans in process -- 119
Deferred loan fees (8) 38
Allowance 20 (180)
--------- ---------
12 (23)
--------- ---------
Net loan activity (19,696) (78,586)
--------- ---------
Total loans at end of period $ 132,050 $ 151,746
========= =========
11
<PAGE>
Loan Commitments. Security Federal issues commitments for loans
conditioned upon the occurrence of certain events. Commitments are made in
writing on specified terms and conditions and are honored for up to 90 days from
approval. At June 30, 2000, Security Federal fixed-rate loan commitments
totaling $1.3 million, ranging in rates from 7.875% to 8.750%. Security Federal
had no variable rate loan commitments outstanding at June 30, 2000.
Loan Fees. In addition to interest earned on loans, Security Federal
receives income from fees in connection with loan originations, loan
modifications, and late payments and for miscellaneous services related to its
loans. Income from these activities varies from period to period depending upon
the volume and type of loans made and competitive conditions.
Security Federal charges loan origination fees for fixed-rate loans, which
are calculated as a percentage of the amount borrowed. As required by applicable
accounting principles, loan origination fees and discount points in excess of
loan origination costs are deferred and recognized over the contractual
remaining lives of the related loans on a level yield basis. Discounts and
premiums on loans purchased are accreted and amortized in the same manner. At
June 30, 2000, Security Federal had $84,000 of net deferred loan fees. Security
Federal recognized $50,000 and $38,000 of net deferred loan fees during the
years ended June 30, 2000 and 1999, respectively, in connection with loan
refinancings, payoffs, sales, and ongoing amortization of outstanding loans.
Nonperforming Assets and Delinquencies. When a borrower fails to make a
required loan payment, Security Federal attempts to cure the deficiency by
contacting the borrower and seeking the payment. A late notice is mailed after
30 days of delinquency. In most cases, deficiencies are cured promptly. If a
delinquency continues beyond the 30th day of the delinquency, a phone call to
the borrower is usually made on the 45th day of delinquency. On or about the
60th day of delinquency, Security Federal sends a certified letter to the
borrower giving the borrower 10 days in which to work out a payment schedule.
While Security Federal generally prefers to work with borrowers to resolve
problems, Security Federal will institute foreclosure or other proceedings after
the 90th day of a delinquency, as necessary, to minimize any potential loss.
Management informs the Board of Directors monthly of the amount of loans
delinquent more than 60 days, all loans in foreclosure, and all foreclosed and
repossessed property that Security Federal owns.
Security Federal ceases accruing interest on mortgage loans when, in the
judgment of management, the probability of collection of interest is deemed to
be insufficient to warrant further accrual. Security Federal does not accrue
interest on mortgage loans past due 90 days or more when the estimated value of
collateral and collection efforts are deemed insufficient to ensure full
recovery. The amount of interest foregone on nonaccrual loans was not material
during fiscal 2000 or fiscal 1999.
12
<PAGE>
The following table presents information with respect to Security
Federal's nonperforming assets at the dates indicated. For the years presented,
Security Federal has had no impaired loans or 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).
<TABLE>
<CAPTION>
At June 30,
2000 1999
---- ----
Nonaccruing loans: (Dollars in thousands)
<S> <C> <C>
Real estate:
One-to-four-family $1,084 $1,705
Multi-family and commercial real estate -- --
Construction -- 42
------ ------
Total real estate 1,084 1,747
Consumer and other:
Automobile 221 213
Home equity and second mortgage 229 107
Other 246 40
------ ------
Total consumer and other 696 360
Commercial business -- --
------ ------
Total nonaccruing loans (1) 1,780 2,107
Loans past due 90 days and accruing interest -- --
------ ------
Total nonperforming loans 1,780 2,107
Real estate owned 347 295
------ ------
Total nonperforming assets (2) $2,127 $2,402
====== ======
Loan allowance as a percentage of total loans 1.09% 0.98%
Loan allowance as a percentage of non-performing loans 81.40% 69.72%
Total nonperforming loans as a percentage of total loans 1.34% 1.41%
Total nonperforming assets as a percentage of total assets 1.12% 1.25%
</TABLE>
(1) Total nonaccruing loans equals total nonperforming loans.
(2) Nonperforming assets consist of nonperforming loans, impaired loans, real
estate owned and other repossessed assets.
13
<PAGE>
The following table sets forth the delinquencies in Security Federal's
loan portfolio as of the dates indicated.
<TABLE>
<CAPTION>
At June 30, 2000 At June 30, 1999
--------------------------------------------- --------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
-------------------- -------------------- ------------------- --------------------
Number Principal Number Principal Number Principal Number Principal
of Balance of of Balance of of Balance of of Balance of
Loans Loans Loans Loans Loans Loans Loans Loans
----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
One-to-four-family 18 $1,447 16 $ 933 10 $ 635 23 $1,705
Multi-family and
commercial
real estate -- -- -- -- -- -- -- --
Construction -- -- -- -- -- -- 1 42
Consumer and other:
Automobile 23 260 18 206 8 91 18 213
Home equity
and second
mortgage 3 102 7 229 4 106 5 107
Other -- -- 32 246 7 14 13 40
Commercial business -- -- -- -- 2 523 -- --
------- ------ ------ ------ ------ ------ ------ ------
Total 44 $1,809 73 $1,614 31 $1,369 60 $2,107
======= ====== ====== ====== ====== ====== ====== ======
Delinquent loans to total loans 0.91% 1.41%
</TABLE>
Real Estate Owned. Real estate acquired by Security Federal as a result of
foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned
until sold. When property is acquired it is recorded at fair market value at the
date of foreclosure, establishing a new cost basis. If the fair value declines,
Security Federal records a valuation allowance through expense. Costs after
acquisition are expensed. At June 30, 2000, Security Federal had $347,000 of
real estate owned, consisting of $60,000 of vacant land and the remainder in
residential property.
Asset Classification. The Office of Thrift Supervision has adopted various
regulations regarding problem assets of savings institutions. The regulations
require that each insured institution review and classify its assets on a
regular basis. In addition, Office of Thrift Supervision examiners have
authority to identify problem assets during examinations and, if appropriate,
require them to be classified.
There are three classifications for problem assets: substandard, doubtful,
and loss. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions, and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover possible losses related to assets
classified substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital. Assets that do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention." Security Federal monitors "special mention"
assets.
14
<PAGE>
The aggregate amounts of Security Federal's classified and special mention
assets at the dates indicated were as follows:
At June 30,
2000 1999
---- ----
(In thousands)
Classified assets:
Loss $ -- $ 210
Doubtful -- --
Substandard 1,891 2,899
Special mention 825 669
At June 30, 2000, assets designated substandard consisted of real estate
owned of $347,000 and residential mortgage loans totaling $1.5 million and
assets designated as special mention consisted of $825,000 in residential
mortgage loans.
Allowance for Loan Losses. In originating loans, Security Federal
recognizes that losses will be experienced and that the risk of loss will vary
with, among other things, the type of loan being made, the creditworthiness of
the borrower over the term of the loan, general economic conditions, and in the
case of a secured loan, the quality of the security for the loan. The allowance
method is used in providing for loan losses. Accordingly, all loan losses are
charged to the allowance and all recoveries are credited to it. The allowance
for loan losses is established through a provision for loan losses charged to
operations. The provision for loan losses is based on management's evaluation of
the collectibility of the loan portfolio, including past loan loss experience,
known and inherent risks in the nature and volume of the portfolio, information
about specific borrower situations and estimated collateral values, and economic
conditions.
At June 30, 2000, Security Federal had an allowance for loan losses of
$1.4 million. Although management believes that it uses the best information
available to establish the allowance for loan losses, future adjustments to the
allowance for loan losses may be necessary and results of operations could be
significantly and adversely affected if circumstances differ substantially from
the assumptions used in making the determinations. Furthermore, while Security
Federal believes that it has established its existing allowance for loan losses
as required by generally accepted accounting principles, there can be no
assurance that regulators, in reviewing Security Federal's loan portfolio, will
not request Security Federal to increase significantly its allowance for loan
losses. In addition, because future events affecting borrowers and collateral
cannot be predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not be
necessary should the quality of any loans deteriorate as a result of the factors
discussed above. Any material increase in the allowance for loan losses may
adversely affect Security Federal's financial condition and results of
operations.
15
<PAGE>
The following table presents an analysis of Security Federal's allowance
for loan losses.
Year Ended June 30,
2000 1999
---- ----
(Dollars in thousands)
Allowance for loan losses, beginning of period $ 1,469 $ 1,289
Charge-offs:
Real estate:
One-to-four-family (119) (69)
Multi-family and commercial real estate -- --
Construction -- (230)
Consumer and other:
Automobile (183)
Home equity and second mortgage --
Other (172) (104)
Commercial business --
------- -------
Total charge-offs (291) (586)
------- -------
Recoveries:
Real estate:
One-to-four-family 9 1
Multi-family and commercial real estate -- --
Construction --
Consumer and other:
Automobile 7
Home equity and second mortgage --
Other 37 8
------- --
Commercial business -- --
------- -------
Total recoveries 46 16
------- -------
Net charge-offs (245) (570)
Provision for loans losses 225 750
------- -------
Allowance for loan losses, end of period $ 1,449 $ 1,469
======= =======
Net charge-offs to average interest-earning loans 0.17% 0.29%
Allowance for loan losses to total loans 1.09 0.98
Allowance for loan losses to nonperforming loans 81.40 69.72
Net charge-offs to beginning allowance for loan losses 16.67 44.22
16
<PAGE>
The following table presents the approximate allocation of the allowance for
loan losses by loan category at the dates indicated. Management believes that
the allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses in
any other category.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------------------
2000 1999
--------------------------------------- ------------------------------------
Percent of Percent of
Gross Loans Gross Loans
Percent of in Each Percent of in Each
Allowance Category Allowance Category
to Total to Total to Total to Total
Amount Allowance Gross Loans Amount Allowance Gross Loans
------ --------- ----------- ------ --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One-to-four-family (1) $ 662 45.69% 57.08% $ 668 45.47% 57.44%
Multi-family and commercial
real estate 138 9.52 13.54 342 23.28 10.96
Construction 10 0.69 0.58 7 0.48 4.28
Consumer loans and other:
Automobile 192 13.25 7.04 243 16.54 10.66
Home equity and second mortgage 48 3.31 12.03 50 3.40 11.66
Other 192 13.25 0.84 9 0.62 1.08
Commercial business loans 143 9.87 8.89 51 3.47 3.92
Unallocated 64 4.42 -- 99 6.74 --
------ ------ ------ ------ ------ ------
Total allowance for loan losses $1,449 100.00% 100.00% $1,469 100.00% 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
(1) Excludes loans held for sale.
Securities Activities
Security Federal is permitted under federal law to invest in various types
of liquid assets, including U.S. Government obligations, securities of various
federal agencies and of state and municipal governments, deposits at the Federal
Home Loan Bank of Indianapolis, certificates of deposit of federally insured
institutions, certain bankers' acceptances, and federal funds. Within certain
regulatory limits, Security Federal may also invest a portion of its assets in
commercial paper and corporate debt securities. Savings institutions like
Security Federal are also required to maintain an investment in Federal Home
Loan Bank of Indianapolis stock. Security Federal is required under federal
regulations to maintain a minimum amount of liquid assets.
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," requires that securities be
categorized as "held to maturity," "trading securities," or "available for
sale," based on management's intent as to the ultimate disposition of each
security. Statement of Financial Accounting Standards No. 115 allows debt
securities to be classified as "held to maturity" and reported in financial
statements at amortized cost only if the reporting entity has the positive
intent and ability to hold those securities to maturity. Securities that might
be sold in response to changes in market interest rates, changes in the
security's prepayment risk, increases in loan demand, or other similar factors
cannot be classified as "held to maturity." Debt and equity securities held for
current resale are classified as "trading securities." These securities are
reported at fair value, and unrealized gains and losses on the securities would
be included in earnings. Security Federal does not currently use or maintain a
trading account. Debt and equity securities not classified as either "held to
maturity" or "trading securities" are classified as "available for sale." These
securities are reported at fair value, and unrealized gains and losses on the
securities are excluded from earnings and reported, net of deferred taxes, as a
separate component of equity. At June 30, 2000, all of Security Federal's
mortgage-backed securities and investment securities were classified as
"available for sale."
17
<PAGE>
All of Security Federal's securities carry market risk insofar as
increases in market rates of interest may cause a decrease in their market
value. They also carry prepayment risk insofar as they may be called before
maturity in times of low market interest rates, so that Security Federal may
have to invest the funds at a lower interest rate. Security Federal's investment
policy permits engaging in hedging activities directly related to its mortgage
banking activities. Investments are made based on certain considerations, which
include the interest rate, yield, settlement date and maturity of the
investment, Security Federal's liquidity position, and anticipated cash needs
and sources. The effect that the proposed investment would have on Security
Federal's credit and interest rate risk and risk-based capital is also
considered. Security Federal purchases securities to provide necessary liquidity
for day-to-day operations. Security Federal also purchases securities when
investable funds exceed loan demand.
The following table presents the amortized cost and fair value of Security
Federal 's securities, by accounting classification and by type of security, at
the dates indicated.
<TABLE>
<CAPTION>
2000 1999
------------------------ ------------------------
Amortized Fair Amortized Cost
Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
Securities available for sale:
Obligations of U.S. Treasury and U.S. government
securities $ 23,776 $ 23,531 $ 13,963 $ 13,893
Mortgage-backed securities available for sale:
Fannie Mae 2,543 2,518 1,441 1,448
Freddie Mac 1,068 1,048 2,529 2,532
-------- -------- -------- --------
Total 3,611 3,566 3,970 3,980
-------- --------
Net unrealized losses on securities
available for sale (290) (60)
-------- --------
Total securities available for sale $ 27,097 $ 27,097 $ 17,873 $ 17,873
======== ======== ======== ========
</TABLE>
All of Security Federal's mortgage-backed securities are issued or
guaranteed by agencies of the U.S. Government. Accordingly, they carry lower
credit risk than mortgage-backed securities of a private issuer. However,
mortgage-backed securities still carry market risk, the risk that increases in
market interest rates may cause a decrease in market value, and prepayment risk,
the risk that the securities will be repaid before maturity and that Security
Federal will have to reinvest the funds at a lower interest rate.
At June 30, 2000, Security Federal did not own any securities other than
U.S. Government and agency securities, which had an aggregate book value in
excess of 10% of Security Federal's retained earnings at that date.
18
<PAGE>
The following presents the activity in the mortgage-backed securities and
securities portfolios for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
2000 1999
---- ----
(In thousands)
<S> <C> <C>
Mortgage-backed securities (1):
Mortgage-backed securities, beginning of period $ 3,980 $ 6,794
Purchases 959 --
Sales -- --
Repayments and prepayments (1,318) (2,792)
Increase (decrease) in net premium -- --
Increase (decrease) in unrealized gain (55) (22)
-------- --------
Net increase (decrease) in mortgage-backed securities (414) (2,814)
-------- --------
Mortgage-backed securities, end of period $ 3,566 $ 3,980
======== ========
Securities (2):
Securities, beginning of period $ 13,893 $ 17,055
Purchases 20,624 30,059
Sales -- --
Maturities and calls (11,092) (33,380)
Increase (decrease) in net premium 281 217
Increase (decrease) in unrealized gain (175) (58)
-------- --------
Net increase (decrease) in securities 9,638 (3,162)
-------- --------
Securities, end of period $ 23,531 $ 13,893
======== ========
</TABLE>
(1) All mortgage-backed securities are classified as available for sale.
(2) All securities are classified as available for sale.
The following table presents certain information regarding the carrying
value (which equals fair value), weighted average yields, and maturities or
periods to repricing of Security Federal's debt securities at June 30, 2000, all
of which are available for sale.
<TABLE>
<CAPTION>
Less Than One to After Five to After
One Year Five Years Ten Years Ten Years Totals
----------------- ----------------- ------------------- ------------------- -----------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
2000 (Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available
for sale:
Investment securities
Obligations of the
U.S. Treasury and
U.S. government
agencies $ 6,811 6.00% $10,829 6.33% $ 2,944 8.00% $ 2,947 8.35% $23,531 6.84%
Mortgage-backed
securities -- -- 11 7.01 455 8.01 3,100 6.23 3,566 6.46
------- ------- ------- ------- -------
Total $ 6,811 6.00% $10,840 6.33% $ 3,399 8.00% $ 6,047 7.26% $27,097 6.79%
======= ==== ======= ==== ======= ==== ======= ==== ======= ====
1999
Securities available
for sale:
Investment securities
Obligations of the
U.S. Treasury and
U.S. government
agencies $ 8,982 4.85% $ 4,911 5.74% $ -- --% $ -- --% $13,893 5.18%
Mortgage-backed
securities -- -- 26 7.04 1,757 7.00 2,197 6.00 3,980 6.44
------- ------- ------- ------- -------
Totals $ 8,982 4.85% $ 4,937 5.74% $ 1,757 7.00% $ 2,197 6.00% $17,873 5.46%
======= ==== ======= ==== ======= ==== ======= ==== ======= ====
</TABLE>
19
<PAGE>
Deposit Activities and Other Sources of Funds
General. Deposits are the major external source of funds for Security
Federal's lending and other investment activities. In addition, Security Federal
also generates funds internally from loan principal repayments and prepayments
and maturing investment securities. Scheduled loan repayments are a relatively
stable source of funds, while deposit inflows and outflows and loan prepayments
are influenced significantly by general interest rates and money market
conditions. Security Federal may use borrowings from the Federal Home Loan Bank
of Indianapolis to compensate for reductions in the availability of funds from
other sources. Presently, Security Federal has no other borrowing arrangements
aside from Federal Home Loan Bank of Indianapolis advances.
Deposit Accounts. A majority of Security Federal's depositors reside in
Indiana and Illinois. Security Federal's deposit products include savings
accounts, checking and NOW accounts, certificates of deposit, individual
retirement accounts, and money market accounts. Deposit account terms vary with
the principal differences being the minimum balance deposit, early withdrawal
penalties, and the interest rate. Security Federal reviews its deposit mix and
pricing weekly. Security Federal does not utilize brokered deposits and
currently does not and does not intend to solicit jumbo certificates of deposit
at rates above those available generally in the market.
Security Federal believes that it is competitive in the interest rates it
offers on its deposit products. Security Federal determines the rates paid based
on a number of factors, including rates paid by competitors, Security Federal's
need for funds and cost of funds, borrowing costs, and movements of market
interest rates. Historically, Security Federal has relied predominately on
certificates of deposit with terms of more than one year.
In the unlikely event Security Federal is liquidated, depositors will be
entitled to full payment of their deposit accounts before any payment is made to
Security Financial as the sole stockholder of Security Federal.
The following table indicates the amount of Security Federal's jumbo
certificates of deposit by time remaining until maturity as of June 30, 2000.
Jumbo certificates of deposits have principal balances of $100,000 or more.
2000 1999
------------------ --------------------
Weighted Weighted
Maturity Average Average
Period Amount Rate Amount Rate
------ ---- ------ ----
Three months or less $ 4,904 5.37% $ 7,679 4.71%
Over three through six months 2,817 5.61 2,852 4.72
Over six through twelve months 3,450 6.02 3,195 4.75
Over twelve months 992 6.09 201 5.00
------- -------
Total $12,163 5.67% $13,927 4.72%
======= ==== ======= ====
20
<PAGE>
The following table presents information concerning average balances and
rates paid on Security Federal's deposit accounts at the dates indicated.
<TABLE>
<CAPTION>
For the Year Ended June 30,
----------------------------------------------------------------------
2000 1999
--------------------------------- ----------------------------------
Percent Percent
of Total Average of Total Average
Average Average Rate Average Average Rate
Balance Deposits Paid Balance Deposits Paid
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
Savings accounts $ 45,480 28.17% 2.40% $ 46,412 22.54% 2.47%
Money market accounts 6,377 3.95 2.62 6,232 3.03 2.65
NOW accounts 7,963 4.93 1.42 16,353 7.94 0.68
Certificates of deposit 95,501 59.14 4.99 124,857 60.63 5.15
Non-interest-bearing deposits:
Demand deposits 6,156 3.81 -- 12,065 5.86 --
-------- ------ -------- ------
Total average deposits $161,477 100.00% $205,919 100.00%
======== ====== ======== ======
</TABLE>
Deposit Flow. The following table presents the balances, with interest
credited, and changes in dollar amounts of deposits in the various types of
accounts offered by Security Federal between the dates indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------------------------
2000 1999
------------------------------------- ----------------------
Percent Increase Percent
Amount of Total (Decrease) Amount of Total
------ -------- ---------- ------ --------
<S> <C> <C> <C> <C> <C>
Savings accounts $ 41,914 27.65% $ (3,442) $ 45,356 27.34%
Money market deposits 7,573 5.00 1,483 6,090 3.67
NOW accounts 6,296 4.15 (3,395) 9,691 5.84
Fixed-rate certificates maturing:
Within 1 year 70,150 46.28 (9,866) 80,016 48.23
After 1 year, but within 2 years 13,891 9.16 2,035 11,856 7.15
After 2 years, but within 5 years 6,616 4.36 381 6,235 3.76
After 5 years 624 .41 (837) 1,461 0.88
-------- ------ -------- -------- ------
Total certificates 91,281 60.21 (8,287) 99,568 60.02
Non-interest-bearing deposits:
Demand deposits 4,525 2.99 (664) 5,189 3.13
-------- ------ -------- -------- ------
Total $151,589 100.00% $(14,305) $165,894 100.00%
======== ====== ======== ======== ======
</TABLE>
Time Deposits by Rates and Maturities. The following table presents the
amount of time deposits in Security Federal categorized by rates and maturities
at the dates indicated.
<TABLE>
<CAPTION>
Period to Maturity from June 30, 2000
------------------------------------------------------------------------ At
Less than 1-2 2-3 3-4 After June 30,
One Year Years Years Years 4 Years Total 1999
-------- ----- ----- ----- ------- ----- ----
<S> <C> <C> <C> <C> <C> <C> <C>
0.00 - 4.00% $ 44 $ 9 $ 2 $ -- $ 8 $ 63 $ 90
4.01 - 5.00% 10,749 1,778 967 1,001 26 14,521 66,388
5.01 - 6.00% 47,541 4,877 1,932 299 237 54,886 24,539
6.01 - 7.00% 11,787 7,169 2,320 45 353 21,674 8,125
Over 7.00% 29 58 50 -- -- 137 426
------- ------- -------- -------- ------- ------- -------
Total $70,150 $13,891 $ 5,271 $ 1,345 $ 624 $91,281 $99,568
======= ======= ======== ======== ======= ======= =======
</TABLE>
21
<PAGE>
Deposit Activity. The following table presents the deposit activity of
Security Federal for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
2000 1999
---- ----
(In thousands)
<S> <C> <C>
Beginning balance $ 165,894 $ 234,376
Net deposits (withdrawals) before interest credited (19,634) (75,318)
Interest credited 5,329 6,836
--------- ---------
Net increase (decrease) in deposits (14,305) (68,482)
--------- ---------
Ending balance $ 151,589 $ 165,894
========= =========
</TABLE>
Borrowings. Security Federal has the ability to use advances from the
Federal Home Loan Bank of Indianapolis to supplement its supply of lendable
funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank of
Indianapolis functions as a central reserve bank providing credit for savings
associations and certain other member financial institutions. As a member of the
Federal Home Loan Bank of Indianapolis, Security Federal is required to own
capital stock in the Federal Home Loan Bank of Indianapolis and is authorized to
apply for advances on the security of the capital stock and certain of its
mortgage loans and other assets, principally securities that are obligations of
or guaranteed by the U.S. Government or its agencies, provided certain
creditworthiness standards have been met. Advances are made under several
different credit programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At June 30, 2000, Security
Federal had the ability to borrow a total of approximately $68.2 million from
the Federal Home Loan Bank of Indianapolis. At that date, Security Federal had
no advances outstanding.
The following tables presents certain information regarding Security
Federal's use of Federal Home Loan Bank of Indianapolis advances during the
periods and at the dates indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
2000 1999
---- ----
(Dollars in thousands)
<S> <C> <C>
Maximum amount of advances outstanding at any month end $ 5,000 $32,466
Approximate average advances outstanding 1,320 25,749
Approximate weighted average rate paid on advances 6.62% 6.11%
</TABLE>
<TABLE>
<CAPTION>
At June 30,
2000 1999
---- ----
(Dollars in thousands)
<S> <C> <C>
Balance outstanding at end of period $ -- $ 5,000
Weighted average rate paid on advances N/A 5.54%
</TABLE>
Trust Services
In 1997, Security Federal established a Trust Services department within
Security Federal, which provides trust and investment services to individuals,
partnerships, corporations, and institutions. Security Federal believes that the
trust department allows it to provide investment opportunities and fiduciary
services to both current and prospective customers. Consistent with Security
Federal's operating strategy, Security Federal will continue to emphasize the
growth of its trust service operations to grow assets and increase fee-based
income. Security Federal has implemented several policies governing the
practices and procedures of the trust department, including policies relating to
maintaining confidentiality of trust records, investment of trust property,
handling conflicts of interest, and maintaining impartiality. At June 30, 2000,
the trust department managed 273 accounts with aggregate assets of $11.6
million. The trust department is monitored by the Board of Directors' Trust
Committee.
22
<PAGE>
Personnel
As of June 30, 2000, Security Federal had 74 full-time employees and 16
part-time employees, none of whom is represented by a collective bargaining
unit. Security Federal believes that its relationship with its employees is
good.
Subsidiary Activities
Security Financial's sole subsidiary is Security Federal. The following
are descriptions of Security Federal's wholly owned subsidiaries.
The Boulevard, Inc. The Boulevard, Inc. (Boulevard) was originally formed
in 1970 but later became inactive until 1999. It currently operates as a wholly
owned service corporation of Security Federal. Boulevard is a certified
insurance agent and currently acts as a sub-agent for other insurance agencies,
offering insurance products including property and casualty and life and health
insurance. Boulevard also intends to offer financial services in the near
future.
Other Subsidiaries. Security Federal has two other wholly owned
subsidiaries: Strategic Financial Corp. and Family Home Service Corp. Strategic
Financial Corp. and Family Home Service Corp. have both been inactive since
1997.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, Security Financial is required by
federal law to file reports with, and otherwise comply with, the rules and
regulations of the Office of Thrift Supervision. Security Federal is subject to
extensive regulation, examination, and supervision by the Office of Thrift
Supervision, as its primary federal regulator, and the Federal Deposit Insurance
Corporation, as the deposit insurer. Security Federal is a member of the Federal
Home Loan Bank System and, with respect to deposit insurance, of the Savings
Association Insurance Fund managed by the Federal Deposit Insurance Corporation.
Security Federal must file reports with the Office of Thrift Supervision and the
Federal Deposit Insurance Corporation concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other savings
institutions. The Office of Thrift Supervision and/or the Federal Deposit
Insurance Corporation conduct periodic examinations to test Security Federal's
safety and soundness and compliance with various regulatory requirements. This
regulation and supervision establishes a comprehensive framework of activities
in which an institution can engage and is intended primarily for the protection
of the insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such regulatory
requirements and policies, whether by the Office of Thrift Supervision, the
Federal Deposit Insurance Corporation, or the Congress, could have a material
adverse impact on Security Financial, Security Federal, and their operations.
Certain of the regulatory requirements applicable to Security Federal and to
Security Financial are referred to below or elsewhere in this report. The
description of statutory provisions and regulations applicable to savings
institutions and their holding companies set forth in this report does not
purport to be a complete description of such statutes and regulations and their
effects on Security Federal and Security Financial.
23
<PAGE>
Holding Company Regulation
Security Financial is a nondiversified unitary savings and loan holding
company within the meaning of federal law. Under prior law, a unitary savings
and loan holding company, such as Security Financial was not generally
restricted as to the types of business activities in which it may engage,
provided that Security Federal continued to be a qualified thrift lender. See
"Federal Savings Institution Regulation - QTL Test." The Gramm-Leach-Bliley Act
of 1999 provides that no company may acquire control of a savings association
after May 4, 1999 unless it engages only in the financial activities permitted
for financial holding companies under the law or for multiple savings and loan
holding companies as described below. Security Financial will not qualify for
the grandfather and will be limited to such activities. Upon any non-supervisory
acquisition by Security Financial of another savings institution or savings bank
that meets the qualified thrift lender test and is deemed to be a savings
institution by the Office of Thrift Supervision, Security Financial would become
a multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would generally be limited to activities
permissible for bank holding companies under Section 4(c)(8) of the Bank Holding
Company Act, subject to the prior approval of the Office of Thrift Supervision,
and certain activities authorized by Office of Thrift Supervision regulation.
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
institution or savings and loan holding company, without prior written approval
of the Office of Thrift Supervision and from acquiring or retaining control of a
depository institution that is not insured by the Federal Deposit Insurance
Corporation. In evaluating applications by holding companies to acquire savings
institutions, the Office of Thrift Supervision considers the financial and
managerial resources and future prospects of Security Financial and the
institution involved, the effect of the acquisition on the risk to the deposit
insurance funds, the convenience and needs of the community, and competitive
factors.
The Office of Thrift Supervision may not approve any acquisition that
would result in a multiple savings and loan holding company controlling savings
institutions in more than one state, subject to two exceptions: (i) the approval
of interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, federal regulations do prescribe such restrictions
on subsidiary savings institutions as described below. Security Federal must
notify the Office of Thrift Supervision 30 days before declaring any dividend to
Security Financial. In addition, the financial impact of a holding company on
its subsidiary institution is a matter that is evaluated by the Office of Thrift
Supervision, and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings institutions are
governed by federal law and regulations. These laws and regulations delineate
the nature and extent of the activities in which federal associations may
engage. In particular, many types of lending authority for federal association
(e.g., commercial, non-residential real property loans and consumer loans) are
limited to a specified percentage of the institution's capital or assets.
Capital Requirements. The Office of Thrift Supervision capital regulations
require savings institutions to meet three minimum capital standards: a 1.5%
tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the
highest rating on the CAMELS rating system), and an 8% risk-based capital ratio.
In addition, the prompt corrective action standards discussed below also
establish, in effect, a minimum 2% tangible capital standard, a 4% leverage
ratio (3% for institutions receiving the highest rating on the CAMEL financial
institution rating system), and, together with the risk-based capital standard
itself, a 4% Tier 1 risk-based capital standard. The Office of Thrift
Supervision regulations also require that, in meeting the tangible, leverage,
and risk-based capital standards, institutions must generally deduct investments
in and loans to subsidiaries engaged in activities as principal that are not
permissible for a national bank.
24
<PAGE>
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the Office of Thrift Supervision capital
regulation based on the risks believed inherent in the type of asset. Core (Tier
1) capital is defined as common stockholders' equity (including retained
earnings), certain noncumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights and credit card
relationships. The components of supplementary capital currently include
cumulative preferred stock, long-term perpetual preferred stock, mandatory
convertible securities, subordinated debt and intermediate preferred stock, the
allowance for loan and lease losses limited to a maximum of 1.25% of
risk-weighted assets and up to 45% of unrealized gains on available-for-sale
equity securities with readily determinable fair market values. Overall, the
amount of supplementary capital included as part of total capital cannot exceed
100% of core capital.
The capital regulations also incorporate an interest rate risk component.
Savings institutions with "above normal" interest rate risk exposure are subject
to a deduction from total capital for purposes of calculating their risk-based
capital requirements. For the present time, the Office of Thrift Supervision has
deferred implementation of the interest rate risk capital charge. At June 30,
2000, Security Federal met each of its capital requirements.
The following table presents Security Federal's capital position at June
30, 2000.
<TABLE>
<CAPTION>
Capital
Excess -----------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
------- ------- ------ ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Tier I Capital (to risk-weighted assets) $26,506 $ 4,687 $21,819 22.6% 4.0%
Core Capital (to adjusted assets) 26,506 7,321 19,185 14.5 4.0
Total Capital (to risk-weighted assets) 27,606 9,373 18,233 23.6 8.0
</TABLE>
Prompt Corrective Regulatory Action. The Office of Thrift Supervision is
required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the institution's degree of
undercapitalization. Generally, a savings institution that has a ratio of total
capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core)
capital to risk-weighted assets of less than 4%, or a ratio of core capital to
total assets of less than 4% (3% or less for institutions with the highest
examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3%, or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized," and a savings institution
that has a tangible capital to assets ratio equal to or less than 2% is deemed
to be "critically undercapitalized." Subject to a narrow exception, the Office
of Thrift Supervision is required to appoint a receiver or conservator for an
institution that is "critically undercapitalized." The regulation also provides
that a capital restoration plan must be filed with the Office of Thrift
Supervision within 45 days of the date a savings institution receives notice
that it is "undercapitalized," "significantly undercapitalized," or "critically
undercapitalized." Compliance with the plan must be guaranteed by any parent
holding company. In addition, numerous mandatory supervisory actions become
immediately applicable to an undercapitalized institution, including, but not
limited to, increased monitoring by regulators and restrictions on growth,
capital distributions, and expansion. The Office of Thrift Supervision could
also take any one of a number of discretionary supervisory actions, including
the issuance of a capital directive and the replacement of senior executive
officers and directors.
25
<PAGE>
Insurance of Deposit Accounts. Security Federal is a member of the Savings
Association Insurance Fund. The Federal Deposit Insurance Corporation maintains
a risk-based assessment system by which institutions are assigned to one of
three categories based on their capitalization and one of three subcategories
based on examination ratings and other supervisory information. An institution's
assessment rate depends upon the categories to which it is assigned. Assessment
rates for Savings Association Insurance Fund member institutions are determined
semiannually by the Federal Deposit Insurance Corporation and currently range
from zero basis points for the healthiest institutions to 27 basis points for
the riskiest.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation (FICO) to recapitalize the predecessor to the Savings Association
Insurance Fund. During 1999, FICO payments for Savings Association Insurance
Fund members approximated 6.1 basis points, while Bank Insurance Fund members
paid 1.2 basis points. By law, there is equal sharing of FICO payments between
Savings Association Insurance Fund and Bank Insurance Fund members beginning on
January 1, 2000.
Security Federal was not required to pay any premiums for fiscal 2000.
Payments toward the FICO bonds amounted to $18,000. The Federal Deposit
Insurance Corporation has authority to increase insurance assessments. A
significant increase in Savings Association Insurance Fund insurance premiums
would likely have an adverse effect on the operating expenses and results of
operations of Security Federal. Management cannot predict what insurance
assessment rates will be in the future.
Insurance of deposits may be terminated by the Federal Deposit Insurance
Corporation upon a finding that the institution has engaged in unsafe or unsound
practices; is in an unsafe or unsound condition to continue operations; or has
violated any applicable law, regulation, rule, order, or condition imposed by
the Federal Deposit Insurance Corporation or the Office of Thrift Supervision.
The management of Security Federal does not know of any practice, condition, or
violation that might lead to termination of deposit insurance.
Loans to One Borrower. Federal law provides that savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. A savings institution may not make a loan or extend credit to a single or
related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if secured by specified readily-marketable collateral. At June 30,
2000, Security Federal's limit on loans to one borrower was $4.1 million and
Security Federal's largest aggregate outstanding balance of loans to one
borrower was $2.5.
QTL Test. Federal law requires savings institutions to meet a qualified
thrift lender test. Under the test, a savings association is required to either
qualify as a "domestic building and loan association" under the Internal Revenue
Code or maintain at least 65% of its "portfolio assets" (total assets less: (i)
specified liquid assets up to 20% of total assets; (ii) intangibles, including
goodwill; and (iii) the value of property used to conduct business) in certain
"qualified thrift investments" (primarily residential mortgages and related
investments, including certain mortgage-backed securities) in at least 9 months
out of each 12-month period.
A savings institution that fails the qualified thrift lender test is
subject to certain operating restrictions and may be required to convert to a
bank charter. As of June 30, 2000, Security Federal maintained 88.1% of its
portfolio assets in qualified thrift investments and, therefore, met the
qualified thrift lender test. Recent legislation has expanded the extent to
which education loans, credit card loans, and small business loans may be
considered "qualified thrift investments."
Limitation on Capital Distributions. Office of Thrift Supervision
regulations impose limitations upon all capital distributions by a savings
institution, including cash dividends, payments to repurchase its shares, and
payments to shareholders of another institution in a cash-out merger. Under the
current regulation, an application to and the prior approval of the Office of
Thrift Supervision is required prior to any capital distribution if the
institution does not meet the criteria for "expedited treatment" of applications
under Office of Thrift Supervision regulations (i.e., generally, examination
ratings in the two top categories); the total capital distributions for the
calendar year exceed net income for that year plus the amount of retained net
income for the preceding two years; the institution would be undercapitalized
following the distribution, or the distribution would otherwise be contrary to a
statute, regulation, or agreement with Office of Thrift Supervision. If an
application is not required, the institution must still provide prior notice to
the Office
26
<PAGE>
of Thrift Supervision of the capital distribution if, like Security Federal, it
is a subsidiary of a holding company. In the event Security Federal's capital
fell below its regulatory requirements or the Office of Thrift Supervision
notified it that it was in need of more than normal supervision, Security
Federal's ability to make capital distributions could be restricted. In
addition, the Office of Thrift Supervision could prohibit a proposed capital
distribution by any institution, which would otherwise be permitted by the
regulation, if the Office of Thrift Supervision determines that such
distribution would constitute an unsafe or unsound practice.
Liquidity. Security Federal is required to maintain an average daily
balance of specified liquid assets equal to a monthly average of not less than a
specified percentage of its net withdrawable deposit accounts plus short-term
borrowings. This liquidity requirement is currently 4%, but may be changed from
time to time by the Office of Thrift Supervision to any amount within the range
of 4% to 10%. Monetary penalties may be imposed for failure to meet these
liquidity requirements. Security Federal's liquidity ratio for June 30, 2000 was
24.3%, which exceeded the applicable requirements. Security Federal has never
been subject to monetary penalties for failure to meet its liquidity
requirements.
Assessments. Savings institutions are required to pay assessments to the
Office of Thrift Supervision to fund the agency's operations. The general
assessments, paid on a semi-annual basis, are computed upon the savings
institution's total assets, including consolidated subsidiaries, as reported in
Security Federal's latest quarterly thrift financial report. The assessments
paid by Security Federal for the fiscal year ended June 30, 2000 totaled
$52,000.
Transactions with Related Parties. Security Federal's authority to engage
in transactions with "affiliates" (e.g., any company that controls or is under
common control with an institution, including Security Financial Bancorp and its
non-savings institution subsidiaries) is limited by federal law. The aggregate
amount of covered transactions with any individual affiliate is limited to 10%
of the capital and surplus of the savings institution. The aggregate amount of
covered transactions with all affiliates is limited to 20% of the savings
institution's capital and surplus. Certain transactions with affiliates are
required to be secured by collateral in an amount and of a type described in
federal law. The purchase of low quality assets from affiliates is generally
prohibited. The transactions with affiliates must be on terms and under
circumstances, that are at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions are prohibited from lending to any
affiliate which is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
Security Federal's authority to extend credit to executive officers,
directors, and 10% shareholders ("insiders"), as well as entities such persons
control, is also governed by federal law. Such loans are required to be made on
terms substantially the same as those offered to unaffiliated individuals and
not involve more than the normal risk of repayment. Recent legislation created
an exception for loans made pursuant to a benefit or compensation program that
is widely available to all employees of the institution and does not give
preference to insiders over other employees. The law limits both the individual
and aggregate amount of loans Security Federal may make to insiders based, in
part, on Security Federal's capital position and requires certain board approval
procedures to be followed.
Enforcement. The Office of Thrift Supervision has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers, and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. The Federal Deposit Insurance Corporation has the authority to recommend
to the Director of the Office of Thrift Supervision that enforcement action to
be taken with respect to a particular savings institution. If action is not
taken by the Director, the Federal Deposit Insurance Corporation has authority
to take such action under certain circumstances. Federal law also establishes
criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines prescribing Standards for Safety and Soundness.
The guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the Office of Thrift
Supervision determines that a savings institution fails to meet any standard
prescribed
27
<PAGE>
by the guidelines, the Office of Thrift Supervision may require the institution
to submit an acceptable plan to achieve compliance with the standard.
Federal Home Loan Bank System
Security Federal is a member of the Federal Home Loan Bank System, which
consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank
provides a central credit facility primarily for member institutions. Security
Federal, as a member of the Federal Home Loan Bank, is required to acquire and
hold shares of capital stock in that Federal Home Loan Bank in an amount at
least equal to 1.0% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year or 1/20 of
its advances (borrowings) from the Federal Home Loan Bank, whichever is greater.
Security Federal was in compliance with this requirement with an investment in
Federal Home Loan Bank stock at June 30, 2000 of $5.3 million.
The Federal Home Loan Banks are required to provide funds for the
resolution of insolvent thrifts in the late 1980s and to contribute funds for
affordable housing programs. These requirements could reduce the amount of
dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members. If dividends were reduced or interest on future
Federal Home Loan Bank advances increased, Security Federal's net interest
income would likely also be reduced. Recent legislation has changed the
structure of the Federal Home Loan Banks' funding obligations for insolvent
thrifts, revised the capital structure of the Federal Home Loan Banks, and
implemented entirely voluntary membership for Federal Home Loan Banks.
Management cannot predict the effect that these changes may have with respect to
its Federal Home Loan Bank membership.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally provide
that reserves be maintained against aggregate transaction accounts as follows:
for accounts aggregating $44.3 million or less (subject to adjustment by the
Federal Reserve Board), the reserve requirement is 3%; and for accounts
aggregating greater than $44.3 million, the reserve requirement is $1.329
million plus 10% (subject to adjustment by the Federal Reserve Board between 8%
and 14%) against that portion of total transaction accounts in excess of $44.3
million. The first $5.0 million of otherwise reservable balances (subject to
adjustments by the Federal Reserve Board) are exempted from the reserve
requirements. At June 30, 2000, Security Federal complied with the foregoing
requirements.
FEDERAL AND STATE TAXATION
Federal Taxation
General. Security Financial and Security Federal report their income on a
fiscal year ending June 30, consolidated basis using the accrual method of
accounting. The federal income tax laws apply to Security Financial and Security
Federal in the same manner as to other corporations with some exceptions,
including particularly Security Federal's reserve for bad debts discussed below.
The following discussion of tax matters is intended only as a summary and does
not purport to be a comprehensive description of the tax rules applicable to
Security Federal or Security Financial. Security Federal's federal tax returns
have been either audited or closed under the statute of limitations through tax
year ended June 30, 1996.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995,
thrift institutions that qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986, as amended, were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans, generally secured
by interests in real property improved or to be improved, under the percentage
of taxable income method or the experience method. The reserve for nonqualifying
loans was computed using the experience method.
28
<PAGE>
Federal legislation enacted in 1996 repealed the reserve method of
accounting for bad debts for tax years beginning after 1995 and required savings
institutions to recapture or take into income certain portions of their
accumulated bad debt reserves. Thrift institutions eligible to be treated as
"small banks," those with assets of $500 million or less, are allowed to use the
experience method that applies to "small banks," while thrift institutions that
are treated as large banks, those with assets exceeding $500 million, are
required to use only the specific charge-off method. As a result, the percentage
of taxable income method of accounting for bad debts is no longer available for
any financial institution.
A thrift institution required to change its method of computing reserves
for bad debts will treat the change as a change in method of accounting,
initiated by the taxpayer, and having been made with the consent of the Internal
Revenue Service. Any adjustment required to be taken into income with respect to
a change in accounting method generally will be taken into income ratably over a
six-taxable year period, beginning with the first taxable year beginning after
1995, subject to a 2-year suspension if the "residential loan requirement" is
satisfied. Under the residential loan requirement provision, the recapture
required by the new legislation will be suspended for each of two successive
taxable years, beginning with Security Federal's 1996 taxable year, in which
Security Federal originates a minimum of certain residential loans based upon
the average of the principal amounts of these loans that Security Federal makes
during its six taxable years preceding its current taxable year.
Security Federal is required to recapture or take into income over a six
year period the excess of the balance of its tax bad debt reserves as of June
30, 1996 over the balance of the reserves as of June 30, 1988. As a result,
Security Federal will incur an additional tax liability of approximately
$224,000, beginning in 1998 over a six-year period.
Distributions. If Security Federal makes "non-dividend distributions" to
Security Financial, they will be considered to have been made from Security
Federal's unrecaptured tax bad debt reserves, including the balance of its
reserves as of June 30, 1988, to the extent of the "nondividend distributions"
and then from Security Federal's supplemental reserve for losses on loans, to
the extent of those reserves, and an amount based on the amount distributed but
not more than the amount of those reserves will be included in Security
Federal's income. Non-dividend distributions include distributions in excess of
Security Federal's current and accumulated earnings and profits, as calculated
for federal income tax purposes, distributions in redemption of stock, and
distributions in partial or complete liquidation. Dividends paid out of Security
Federal's current or accumulated earnings and profits will not be so included in
Security Federal's income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Therefore, if Security Federal makes a non-dividend
distribution to Security Financial, approximately one and one-half times the
amount of the distribution not in excess of the amount of the reserves would be
includable in income for federal income tax purposes, assuming a 34% federal
corporate income tax rate. Security Federal does not intend to pay dividends
that would result in a recapture of any portion of its bad debt reserves.
Savings Association Insurance Fund Recapitalization Assessment. Federal
legislation enacted in 1996 levied a 65.7 cent fee on every $100 of thrift
deposits held on March 31, 1995. For financial statement purposes, this
assessment was reported as an expense for the quarter ended September 30, 1996.
The law includes a provision which states that the amount of any special
assessment paid to capitalize the Savings Association Insurance Fund under this
legislation is deductible in the year of payment.
29
<PAGE>
State Taxation
Indiana imposes an 8.5% franchise tax based on a financial institution's
adjusted gross income as defined by statute. In computing adjusted gross income,
deductions for municipal interest, the bad debt deduction computed using the
reserve method, and pre-1990 net operating losses are disallowed. Security
Federal's state franchise tax returns have not been audited for the past five
tax years.
Utilization of Operating Loss Carryforwards
Security Federal has generated operating losses, a portion of which were
used to offset and recoup tax liabilities from prior periods as allowed by the
Internal Revenue Code. The amount of operating losses that were not used are
being carried forward and will be used to offset future tax liabilities until
these deductions are exhausted. Security Federal has operating loss
carryforwards for Indiana income tax purposes totalling $417,000. These
carryforwards expire in 2013, and management anticipates that these
carryforwards will be fully utilized during fiscal 2001.
ADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the executive
officers of Security Financial Bancorp and Security Federal.
<TABLE>
<CAPTION>
Name Age (1) Position Held
<S> <C> <C>
John P. Hyland 49 Director, President, and Chief Executive Officer of Security Financial
and Security Federal
James H. Foglesong 54 Executive Vice President and Chief Financial Officer of Security
Financial and Security Federal
Joann Duhon 43 Executive Vice President, Retail Banking, of Security Federal
John F. Nicholas 36 Executive Vice President, Mortgage Banking, of Security Federal
Kevin Dunn 46 Executive Vice President, Audit/CRA/Compliance, of Security Federal
Joann Halterman 46 Vice President, Human Resources/Marketing, of Security Federal
Kent R. Huntoon 36 Vice President, The Boulevard, Inc., of Security Federal
Thomas W. Baranko 31 Assistant Vice President and Trust Officer of Security Federal
</TABLE>
(1) As of June 30, 2000.
The executive officers of Security Financial and Security Federal are
elected annually and hold office until their successors have been elected and
qualified or until they are removed or replaced.
Biographical Information
Below is certain information regarding the directors and executive
officers of Security Federal. Unless otherwise stated, each director and
executive officer has held his or her current occupation for the last five
years.
John P. Hyland has served as President and Chief Executive Officer of
Security Financial and Security Federal since September 1999 and October 1998,
respectively. Prior to joining Security Federal, Mr. Hyland served as Director,
President, and Chief Executive Officer of Southwest Financial Bank and Trust,
Orland Park, Illinois, and as Director and Vice President for Southwest
Financial Corporation, the holding company for Southwest Financial Bank and
Trust.
30
<PAGE>
James H. Foglesong has served as Executive Vice President and Chief
Financial Officer of Security Financial and Security Federal since September
1999 and November 1995, respectively. Prior to joining Security Federal, Mr.
Foglesong served as Executive Vice President and Chief Financial Officer of
First of America Bank Northwest Indiana, LaPorte, Indiana.
Joann Duhon joined Security Federal in 1996 as Assistant Vice President,
Regional Branch Manager. In July, 1997, Ms. Duhon was appointed Executive Vice
President, Retail Banking. Prior to joining Security Federal, Ms. Duhon was a
Branch Manager for Peoples Bank, East Chicago.
John F. Nicholas joined Security Federal in May 1996 as a Staff Appraiser
and, in November 1996, was appointed to Assistant Vice President and CRA
Officer. In 1997, Mr. Nicholas was appointed Manager, Residential Construction
Lending. In 1998, Mr. Nicholas was appointed Executive Vice President, Mortgage
Banking. Prior to joining Security Federal, Mr. Nicholas was a real estate
appraiser with Richard Adomatis & Associates.
Kevin Dunn joined Security Federal in 1996 as an Assistant Vice President.
In May 1998, Mr. Dunn was appointed Interim President and Chief Executive
Officer, a position in which he served until October 1998. Since October 1998,
Mr. Dunn has served as Executive Vice President, Audit/CRA/Compliance. Prior to
joining Security Federal, Mr. Dunn was a Certified Thrift Examiner with the
Office of Thrift Supervision, Central Region.
Joann Halterman joined Security Federal in 1976 as a Teller. In 1998, Ms.
Halterman was appointed as Assistant Vice President, Human Resources and, in
February 1999, was appointed Vice President, Human Resources/Marketing.
Kent R. Huntoon joined Security Federal in 1996 as Retail Sales Manager,
Trust Officer and Insurance Manager and Vice President and General Manager of
The Boulevard, Inc., a wholly owned subsidiary of Security Federal. Prior to
joining Security Federal, Mr. Huntoon served as a registered representative of
Prudential Insurance Co. of America.
Thomas W. Baranko has served as Assistant Vice President, Trust and Trust
Officer of Security Federal since April 1997. Prior to joining Security Federal,
Mr. Baranko served as Trust Officer of Sand Ridge Bank, Highland, Indiana.
31
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTIES
Properties
The following table sets forth Security Federal's offices, as well as
certain additional information relating to these offices, as of June 30, 2000.
<TABLE>
<CAPTION>
Original Date of Net Book
Lease or Date Leased Lease Value of
Location Owned or Owned Expiration Property (1)
----- -------- ---------- ------------
<S> <C> <C> <C> <C>
Main Office:
9321 Wicker Avenue
St. John, Indiana 46373 Owned 1988 N/A $ 4,014,747
Branch Offices:
2930 Ridge Road
Highland, Indiana 46322 Leased 1997 2019 280,634
2090 E. Commercial Avenue
Lowell, Indiana 46356 Leased 1997 2012 186,136
7007 Calumet Avenue
Hammond, Indiana 46324 Owned 1992 N/A 196,697
4518 Indianapolis Avenue
East Chicago, Indiana 46312 Leased 1992 2002 97,011
552A Indian Boundary Road
Chesterton, Indiana 46304 Leased 1997 2007 64,070
</TABLE>
(1) Represents the net book value of land, buildings, furniture, fixtures, and
equipment owned by Security Federal.
Security Federal also owns properties in Winfield Township and Highland,
which are located in Lake County, Indiana. The net book value of these
properties as of June 30, 2000 was $325,095 and $162,762, respectively.
ITEM 3. LEGAL PROCEEDINGS
Security Financial is not a party to any pending legal proceedings.
Periodically, there have been various claims and lawsuits involving Security
Federal, such as claims to enforce liens, condemnation proceedings on properties
in which Security Federal holds security interests, claims involving the making
and servicing of real property loans, and other issues incident to Security
Federal's business. Security Federal is not a party to any pending legal
proceedings that it believes would have a material adverse effect on the
financial condition or operations of Security Federal.
32
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information under the sections titled "Stock Listing" and "Price Range
of Common Stock" on page 41 in Security Financial's 2000 Annual Report to
Stockholders is incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The information under the section titled "Management's Discussion and
Analysis of Financial Condition and Results of Operations" on pages 6 through 13
in Security Financial's 2000 Annual Report to Stockholders is incorporated
herein by reference.
ITEM 7. FINANCIAL STATEMENTS
The information under the section titled "Consolidated Financial
Statements" on pages 14 through 33 in Security Financial's 2000 Annual Report to
Stockholders is incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information under the section titled "Section 16(a) Beneficial
Ownership Reporting Compliance" on page 9 in Security Financial's Proxy
Statement for the 2000 Annual Meeting of Stockholders is incorporated herein by
reference.
ITEM 10. EXECUTIVE COMPENSATION
The information under the section titled "Executive Compensation" on page
8 in Security Financial's Proxy Statement for the 2000 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the section titled "Stock Ownership" on page 3 in
Security Financial's Proxy Statement for the 2000 Annual Meeting of Stockholders
is incorporated herein by reference.
33
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the section titled "Transactions with Management" on
page 10 in Security Financial's Proxy Statement for the 2000 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) (1) The following are filed as a part of this report by means of
incorporation by reference to Security Financial's 2000 Annual
Report to Stockholders:
o Report of Independent Auditors
o Consolidated Statements of Financial Condition as
of June 30, 2000 and 1999
o Consolidated Statements of Operations for the
Years Ended June 30, 2000 and 1999
o Consolidated Statements of Stockholders' Equity
for the Years Ended June 30, 2000 and 1999
o Consolidated Statements of Cash Flows for the
Years Ended June 30, 2000 and 1999
o Notes to Consolidated Financial Statements
(2) All financial statement schedules are omitted because they are
not required or applicable, or the required information is
shown in the consolidated financial statements or the notes
thereto.
(3) Exhibits
3.1 Certificate of Incorporation of Security Financial
Bancorp, Inc.(1)
3.2 Bylaws of Security Financial Bancorp, Inc. (1)
4.0 Form of Stock Certificate of Security Financial
Bancorp, Inc. (1)
10.1 ESOP Loan Documents (2)
10.2 Employment Agreement between Security Federal Bank
& Trust and John P. Hyland (2)
10.3 Employment Agreement between Security Financial
Bancorp, Inc. and John P. Hyland (2)
10.4 Security Federal Bank & Trust Employee Severance
Compensation Plan (2)
10.5 Security Financial Bancorp, Inc. Supplemental
Executive Retirement Plan
13.0 Security Financial Bancorp, Inc. 1999 Annual
Report to Stockholders
21.0 Subsidiary information is incorporated herein by
reference to Part I, Item 1, "Business--Subsidiary
Activities"
27.0 Financial Data Schedule
--------------------
(1) Incorporated herein by reference from the Exhibits
to Form SB-2, Registration Statement and
amendments thereto, initially filed on September
20, 1999, Registration No. 333-87397.
(2) Incorporated herein by reference from the exhibits
to the Form 10-QSB for the quarter ended March 31,
2000, filed May 12, 2000.
(b) Reports on Form 8-K
On July 7, 2000, Security Financial filed a Current Report on Form 8-K
reporting that Security Financial had issued a press release announcing
the date, October 19, 2000, of its annual meeting of stockholders.
34
<PAGE>
CONFORMED
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SECURITY FINANCIAL BANCORP, INC.
Date: September 29, 2000 By: /s/ John P. Hyland
-------------------------------------
John P. Hyland
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ John P. Hyland President, Chief Executive September 29, 2000
------------------------- Officer, and Director
John P. Hyland (principal executive officer)
/s/ James H. Foglesong Executive Vice President and September 29, 2000
------------------------- Chief Financial Officer (principal
James H. Foglesong financial and accounting officer)
Chairman of the Board
-------------------------
Mary Beth Bonaventura
/s/ Lawrence R. Parducci Vice Chairman of the Board September 29, 2000
------------------------- and Corporate Secretary
Lawrence R. Parducci
/s/ Howard O. Cyrus, Sr. Director September 29, 2000
-------------------------
Howard O. Cyrus, Sr.
Director
-------------------------
Dr. Peter Ferrini
/s/ Tula Kavadias Director September 29, 2000
-------------------------
Tula Kavadias
/s/ Robert L. Lauer Director September 29, 2000
-------------------------
Robert L. Lauer
</TABLE>
35
<PAGE>
Director
-------------------------
Philip T. Rueth
/s/ Robert A. Vellutini Director September 29, 2000
-------------------------
Robert A. Vellutini
Director
-------------------------
Richard J. Lashley
Director
-------------------------
John Wm. Palmer
