FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
Mark One
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 31, 1997.
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________________ to
______________.
Commission file number 33-1983
SURETY CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 75-2065607
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
1845 Precinct Line Road, Suite 100, Hurst, Texas 76054
(Address of principal executive offices)
(817) 498-2749
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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 [ ]
Common stock outstanding on April 25, 1997, 5,751,882 shares
<PAGE>
SURETY CAPITAL CORPORATION
INDEX
PART I - FINANCIAL INFORMATION Page No.
- ------------------------------ --------
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1997 (unaudited) and
December 31, 1996 3
Consolidated Statements of Income for the Three Months Ended
March 31, 1997 and 1996 (unaudited) 4
Consolidated Statements of Shareholders' Equity for the Three
Months Ended March 31, 1997 and for the Years Ended December
31, 1996 and 1995 (unaudited) 5
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 1997 and 1996 (unaudited) 6
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
PART II. - OTHER INFORMATION
- ------------------------------
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
2
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, 1997 and December 31, 1996
(unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
------------- -------------
<S> <C> <C>
Assets:
Cash and due from banks $ 7,348,718 $ 6,094,457
Federal funds sold 9,186,000 16,772,000
Interest bearing deposits in financial institutions 190,361 285,842
Investment securities:
Available-for-sale 18,333,372 16,221,273
Held-to-maturity 21,394,594 22,561,270
------------- -------------
Total investment securities 39,727,966 38,782,543
Loans 113,766,109 105,696,491
Less: Unearned interest (2,628,783) (2,544,803)
Allowance for credit losses (1,309,983) (1,284,774)
------------- -------------
Net loans 109,827,343 101,866,914
Premises and equipment, net 3,895,853 3,970,193
Accrued interest receivable 973,560 1,083,336
Other real estate and repossessed assets 628,920 738,198
Other assets 798,889 607,214
Excess of cost over fair value of net assets acquired, net of
accumulated amortization of $836,097 and $719,288 at
March 31, 1997 and December 31, 1996, respectively 6,263,759 6,238,613
------------- -------------
Total assets $ 178,841,369 $ 176,439,310
============= =============
Liabilities and shareholders' equity:
Demand deposits $ 22,387,181 $ 23,878,744
Savings, NOW and money markets 48,909,520 48,372,642
Time deposits, $100,000 and over 21,128,716 20,276,235
Other time deposits 65,558,834 63,162,720
------------- -------------
Total deposits 157,984,251 155,690,341
Accrued interest payable and other liabilities 1,219,930 1,518,417
------------- -------------
Total liabilities 159,204,181 157,208,758
------------- -------------
Shareholders' equity:
Preferred stock, $.01 par value, 20,000,000 shares authorized,
none issued at March 31, 1997 and December 31, 1996 -- --
Common stock, $.01 par value, 20,000,000 shares authorized,
5,786,171 and 5,763,737 shares issued at March 31, 1997 and
December 31, 1996, respectively, and 5,751,882 and 5,748,119
outstanding at March 31, 1997 and December 31, 1996, respectively 57,862 57,637
Additional paid-in capital 16,850,067 16,752,003
Retained earnings 3,009,595 2,509,771
Treasury stock, 34,289 shares at March 31, 1997 and 15,618 shares
at December 31, 1996 carried at cost (172,828) (74,539)
Unrealized loss on available-for-sale securities, net of tax (107,508) (14,320)
------------- -------------
Total shareholders' equity 19,637,188 19,230,552
------------- -------------
Total liabilities and shareholders' equity $ 178,841,369 $ 176,439,310
============= =============
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
3
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
for the three months ended March 31, 1997 and 1996
(unaudited)
Three Months Ended
March 31, March 31,
1997 1996
---------- ----------
Interest income:
Commercial and real estate loans $1,728,838 $1,093,805
Consumer loans 334,726 333,669
Insurance premium financing 1,133,770 680,901
Federal funds sold 194,670 342,506
Investment securities:
Taxable 542,050 404,255
Tax-exempt 79,801 76,508
Interest bearing deposits 5,611 19,004
---------- ----------
Total interest income 4,019,466 2,950,648
---------- ----------
Interest expense:
Savings, NOW and money market 302,560 244,542
Time deposits, $100,000 and over 270,827 270,330
Other time deposits 826,848 699,152
Other interest expense -- 6,612
---------- ----------
Total interest expense 1,400,235 1,220,636
---------- ----------
Net interest income before
provision for credit losses 2,619,231 1,730,012
---------- ----------
Provision for credit losses 75,000 30,000
---------- ----------
Net interest income 2,544,231 1,700,012
---------- ----------
Noninterest income 566,348 397,269
---------- ----------
Noninterest expense:
Salaries and employee benefits 1,192,833 901,179
Occupancy and equipment 357,955 265,848
General and administrative 764,669 566,818
---------- ----------
Total noninterest expense 2,315,457 1,733,845
---------- ----------
Income before income taxes 795,122 363,436
Income tax expenses:
Current 295,298 119,526
---------- ----------
Net income $ 499,824 $ 243,910
========== ==========
Net income per share of common stock $ 0.09 $ 0.06
========== ==========
Weighted average shares outstanding 5,749,858 4,319,721
========== ==========
The accompanying notes are an integral part
of the consolidated financial statements.
4
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the three months ended March 31, 1997 and
for the years ended December 31, 1996 and 1995
(unaudited)
<TABLE>
<CAPTION>
Unrealized
Gain/
Common Stock (Loss) on
--------------------- Additional Retained Available-
Par Paid-in Earnings/ Treasury for-Sale Total
Shares Value Capital (Deficit) Stock Securities Equity
---------- -------- ----------- ---------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 3,040,829 $30,408 $8,113,214 $(75,102) $(2,839) $8,065,681
---------- -------- ----------- ---------- ----------- ------------ -----------
Sale of Common Stock 459,500 4,595 1,192,587 1,197,182
Purchase of Treasury Stock $(50,830) (50,830)
(10,166 shares)
Net Income 886,886 886,886
Exercise of stock options 16,266 163 50,668 50,831
Change in unrealized
gain/(losses) on
available-for-sale
securities, net of
tax, $74,544 144,722 144,722
---------- -------- ----------- ---------- ----------- ------------ -----------
Balance at December 31, 1995 3,516,595 35,166 9,356,469 811,784 (50,830) 141,883 10,294,472
---------- -------- ----------- ---------- ----------- ------------ -----------
Sale of Common Stock 2,239,218 22,392 7,371,901 7,394,293
Purchase of Treasury Stock (23,709) (23,709)
(5,452 shares)
Net Income 1,697,987 1,697,987
Exercise of stock options 7,924 79 23,633 23,712
Change in unrealized
gain/(losses) on
available-for-sale
securities, net of
tax, $(81,147) (156,203) (156,203)
---------- -------- ----------- ---------- ----------- ------------ -----------
Balance at December 31, 1996 5,763,737 57,637 16,752,003 2,509,771 (74,539) (14,320) 19,230,552
---------- -------- ----------- ---------- ----------- ------------ -----------
Purchase of Treasury Stock (98,289) (98,289)
(18,671 shares)
Net Income 499,824 499,824
Exercise of stock options 22,434 225 98,064 98,289
Change in unrealized
gain/(losses) on
available-for-sale
securities, net of
tax, $(52,419) (93,188) (93,188)
---------- -------- ----------- ---------- ----------- ------------ -----------
Balance at March 31, 1997 5,786,171 $57,862 $16,850,067 $3,009,595 $(172,828) $(107,508) $19,637,188
========== ======== =========== =========== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
5
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the three months ended March 31, 1997 and 1996
(unaudited)
<TABLE>
<CAPTION>
March 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 499,824 $ 243,910
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Provision for credit losses 75,000 30,000
Provision for depreciation 185,653 132,125
Amortization of intangible assets 116,809 48,741
Gain on sale of available-for-sale securities (4,312)
Gain on sale or disposal of assets 12,080
Net increase in unearned interest on loans 83,980 154,154
Net increase in other assets (105,167) (584,397)
Net decrease in accrued interest payable and other liabilities (246,068) (131,861)
------------ ------------
Net cash provided by (used in) operating activities 617,799 (107,328)
------------ ------------
Cash flows from investing activities:
Net increase in loans (6,064,512) (633,284)
Payments received on purchased medical claims receivables 4,153,841 4,086,207
Purchases of medical claims receivables (6,368,211) (3,593,814)
Purchases of available-for-sale securities (5,970,938) (4,702,650)
Proceeds from sales of available-for-sale securities 2,745,774
Proceeds from maturities of available-for-sale securities 971,770 3,850,040
Purchases of held-to-maturity securities (1,992,500)
Proceeds from maturities of held-to-maturity securities 1,166,676 6,015,000
Proceeds from maturities of interest bearing deposits in financial
institutions 95,481 563,821
Purchases of bank premises and equipment (111,313) (48,265)
Proceeds from sale of other real estate and repossessed assets 137,984
Net cash acquired through acquisition 4,020,574
------------ ------------
Net cash (used in) provided by investing activities (9,243,448) 7,565,129
------------ ------------
Cash flows from financing activities:
Net increase (decrease) in deposits 2,293,910 (2,154,165)
Principal payments on notes payable (375,000)
Purchase of treasury stock (98,289) (6,129)
Exercise of stock options 98,289 6,129
Proceeds from the sale of stock 7,792,691
------------ ------------
Net cash provided by financing activities 2,293,910 5,263,526
------------ ------------
Net (decrease) increase in cash and cash equivalents (6,331,739) 12,721,327
Beginning cash and cash equivalents 22,866,457 23,217,018
------------ ------------
Ending cash and cash equivalents $ 16,534,718 $ 35,938,345
============ ============
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
6
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the three months ended March 31, 1997 and 1996
(unaudited)
<TABLE>
<CAPTION>
March 31,
------------------------------------
1997 1996
---------------- ----------------
<S> <C> <C>
Supplemental schedule of noncash investing and financing activites:
Transfers of repossessed collateral to other assets $ 226,562
Additions to loans to facilitate the sale of other real estate and
other assets 67,089
Adjustments to other assets subsequent to acquisition 141,955
Net cash acquired through acquisitions:
Interest bearing deposits in financial institutions 274,242
Investment securities 21,214,629
Net loans 18,476,948
Premises and equipment, net 1,270,401
Other assets 896,832
Excess of cost over fair value of net assets acquired 3,738,208
Deposits (49,237,113)
Other liabilities (654,721)
----------------
Net cash acquired through acquisitions $ (4,020,574)
================
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
7
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The financial statements included herein have been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included
in annual financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to
such rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading.
These condensed financial statements should be read in conjunction with the
financial statements and the notes thereto included in the Company's latest
annual report on Form 10-K. In the opinion of the Company, all adjustments
consisting only of normal recurring adjustments necessary to present fairly
the financial position of the Company as of March 31, 1997, and the results
of its operations and its cash flows for the indicated periods have been
included. The results of operations for such interim period are not
necessarily indicative of the results to be expected for the fiscal year
ending December 31, 1997.
2. Loans, net:
At March 31, 1997 and December 31, 1996, the loan portfolio was composed of
the following:
March 31, December 31,
1997 1996
------------- -------------
Insurance premium financing $ 45,696,751 $ 39,168,604
Installment loans 11,883,880 12,631,520
Commercial loans 23,475,695 22,745,139
Real estate loans 24,291,985 24,774,167
Medical claims receivable 8,417,798 6,377,061
------------- -------------
Total gross loans 113,766,109 105,696,491
Unearned interest (2,628,783) (2,544,803)
Allowance for credit losses (1,309,983) (1,284,774)
------------- -------------
Loans, net $ 109,827,343 $ 101,866,914
============= =============
Activity in the allowance for credit losses is as follows:
Three Months Three Months
Ended Ended
March 31, 1997 March 31, 1996
-------------- --------------
Beginning Balance $ 1,284,774 $ 702,927
Provision for credit losses 75,000 30,000
Bank acquisition 614,700
Loans charged off, net of
recoveries (49,791) (45,135)
----------- -----------
Ending balance $ 1,309,983 $ 1,302,492
=========== ===========
Loans on which the accrual of interest has been discontinued amounted to
approximately $107,000 and $144,000 at March 31, 1997 and December 31,
1996, respectively.
8
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
3. Stock Option Plans:
The Company has two long-term incentive stock option plans for key senior
officers of the Company. The stock option plans provide these key employees
with options to purchase shares of the Company's Common Stock at an
exercise price equal to the fair market value of such Common Stock on the
date of grant. On July 16, 1996, the Company adopted a stock option plan
for directors of the Company who are not employees of the Company. This
plan is a formula plan pursuant to which annual options to purchase 2,000
shares of the Company's Common Stock at an exercise price equal to the fair
market value of such Common Stock on the date of the grant are
automatically granted to each non-employee director of the Company.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS:
General
The Company is a bank holding company registered under the Bank Holding Company
Act of 1956, as amended. The Company changed the name of its subsidiary bank to
Surety Bank, National Association ("Surety Bank"), effective January 1, 1995, in
order to establish name recognition for Surety Bank and to avoid confusion with
other similarly named banks.
The information presented below reflects the lending and related funding
business of the Company:
Three Months Three Months
Ended Ended
March 31, March 31,
1997 1996
------------- -------------
INSURANCE PREMIUM FINANCING:
Average balance outstanding $ 40,522,934 $ 22,577,950
Average yield 11.2% 12.1%
Interest income $ 1,133,770 $ 680,901
CONSUMER, COMMERCIAL AND REAL
ESTATE FINANCING:
Average balance outstanding $ 65,391,318 $ 50,866,149
Average yield 12.6% 11.2%
Interest income $ 2,063,564 $ 1,427,474
COST OF FUNDS:
Average balance outstanding (1) $153,910,269 $129,814,967
Average interest rate 3.6% 3.8%
Interest expense $ 1,400,235 $ 1,220,636
AVERAGE MONTHLY AMOUNTS:
Total interest income $ 1,339,822 $ 983,549
Total interest expense $ 466,745 $ 406,879
Provision for loan losses $ 25,000 $ 10,000
Noninterest income $ 188,783 $ 132,423
Noninterest expense $ 771,819 $ 577,948
(1) Includes $0 and $80,144 of short term borrowings and $0 and $6,612 of
interest expense on short term borrowings for the three months ended
March 31, 1997 and 1996, respectively.
Note: Average balances are computed using daily balances throughout each period.
10
<PAGE>
AVERAGE BALANCE SHEET
<TABLE>
<CAPTION>
Three Months Ended March 31, 1997
-------------------------------------------------------
Average Average
Balance Interest Rate
------- -------- ----
<S> <C> <C> <C>
ASSETS:
Interest earnings assets:
U.S. Treasury and agency securities and
due from time $38,574,038 $ 627,462(1) 6.5%
Federal funds sold 14,263,442 194,670 5.5%
Loans(2) 105,914,252 3,197,334(3) 12.1%
Allowance for credit losses (1,305,685) N/A N/A
-------------- ------------- -------
Total interest earning assets 157,446,047 4,019,466 10.2%
-------------- ------------- -------
Cash and due from banks 4,880,230
Premises and equipment 3,913,767
Accrued interest receivable 976,387
Other assets 7,024,890
--------------
Total assets $174,241,321
==============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing liabilities:
Interest bearing demand deposits $38,792,033 $ 257,006 2.6%
Savings deposits 7,619,983 45,554 2.4%
Time deposits 85,266,970 1,097,675 5.1%
-------------- ------------- -------
Total interest bearing liabilities 131,678,986 1,400,235 4.2%
-------------- ------------- -------
Net interest income $2,619,231
=============
Net interest spread 6.0%
-------
Net interest income to average earning assets 6.6%
=======
Noninterest bearing deposits 22,231,281
Accrued interest payable and other liabilities 818,347
--------------
Total liabilities 154,728,614
Shareholders' equity 19,512,707
--------------
Total liabilities and shareholders' equity $174,241,321
==============
</TABLE>
(1) Interest income on the tax exempt securities does not reflect the tax
equivalent yield.
(2) Loans on nonaccrual status have been included in the computation of average
balances.
(3) The interest income on loans does not include loan fees. Loan fees are
immaterial and are included in noninterest income.
11
<PAGE>
Three Months Ended March 31, 1997 Versus Three Months Ended March 31, 1996.
- ---------------------------------------------------------------------------
Surety Capital Corporation (the "Company") and its wholly owned subsidiary,
Surety Bank, National Association ("Surety Bank"), reported an increase of
104.9% in net earnings of $499,824 as compared to $243,910 during the three
months ended March 31, 1997 and 1996, respectively. Earnings per share were
$0.09 and $0.06 for the three months ended March 31, 1997 and 1996,
respectively. The increase in net earnings is principally attributed to an
increase in yields realized on the loan portfolio along with an increase in the
average balance of loans outstanding. The yields earned by the Company on its
loan portfolio during the three months ended March 31, 1997 and 1996 were 12.1%
and 11.5%, respectively, while the average cost of funds for the Company for the
same periods was 3.6% and 3.8%, respectively. The average balance of loans
outstanding was $105,914,252 and $73,444,099 for the three months ended March
31, 1997 and 1996, respectively. The loan-to-deposit ratio as of March 31, 1997
and 1996 was 70.3% and 55.0%, respectively. It is the goal of the Company to
increase its loan production in order to improve Surety Bank's loan-to-deposit
ratio, which will result in a transfer from Surety Bank's overnight federal
funds sold (with a 5.5% yield for the first three quarters of 1997) to the
higher yielding loan portfolio (with a 12.1% yield for the first three quarters
of 1997).
Total interest income increased 36.2% to $4,019,466 from $2,950,648, while total
interest expense increased 14.7% to $1,400,235 from $1,220,636, resulting in a
51.4% increase in net interest income before provision for credit losses to
$2,619,231 from $1,730,012. The Company's loan growth between these two periods
was concentrated within commercial loans and insurance premium financing. Real
estate lending decreased by 10.6% to $24,291,985 from $27,172,579, commercial
lending increased by 13.9% to $23,475,695 from $20,614,367, consumer lending
decreased by 8.3% to $11,883,880 from $12,958,709, medical claims factoring
increased by 218.6% to $8,417,798 from $2,641,814, and insurance premium
financing increased by 82.5% to $45,696,751 from $25,044,108. The overall net
growth in the loan portfolio is attributed to management's marketing efforts.
The average volume of consumer, commercial, and real estate lending increased
28.6%, with an increase in the average yields on those loans from 11.2% to
12.6%. The 79.5% increase in the average volume of insurance premium financing
loans was accompanied by a yield of 11.2% and 12.1% on those loans for the three
months ended March 31, 1997 and 1996, respectively. The average balance of
interest bearing deposits increased 16.6%, while the average rate paid decreased
from 4.3% to 4.2%.
The Company recorded a $75,000 provision for loan losses during the three months
ended March 31, 1997 compared to a $30,000 provision for loan losses during the
three months ended March 31, 1996. As the Company's ratio of net charge-offs to
average loans remained unchanged for these periods, the Company provided
amounts, through charges to earnings, to maintain the allowance for loan losses
at an adequate level. Management believes that all known losses in the portfolio
have been recognized.
The Company's noninterest income increased 42.6% to $566,348 from $397,269 for
the three months ended March 31, 1997 and 1996, respectively. This increase
compares to a corresponding increase in average noninterest bearing deposits of
36.0% to $22,231,281 from $16,349,451 for these same periods. Noninterest income
is generated primarily from fees associated with noninterest and interest
bearing accounts.
Noninterest expense increased 33.5%, primarily the result of a 32.4% increase in
salaries and employee benefits, a 34.6% increase in occupancy and equipment
expenses, and a 34.9% increase in general and administrative expenses. The
increase in salaries and benefits was due primarily to additional staffing
required by the First National Bank Midlothian, Texas and the Providers Funding
Corporation acquisitions. Increases in general and administrative expenses
relate primarily to the operation of the Midlothian branch, medical claims
factoring division and legal and professional fees.
Parent Company Only Results of Operations.
- ------------------------------------------
The Company did not own Surety Bank prior to December 30, 1989. Since that time,
the Company has served as a parent company to Surety Bank and has wound down the
Company's own separate business activities. For the three months ended March 31,
1997, the Company had only nominal interest income of approximately $6,000, and
approximately $33,000 in noninterest expenses. The noninterest expenses, which
increased 17.9% from the same period in the prior year, consisted primarily of
legal and professional fees incurred in the operation of the Company and in the
maintenance of the Company's public company status under applicable securities
laws and regulations.
12
<PAGE>
ALLOWANCE FOR CREDIT LOSSES
The Company recorded a $75,000 provision for credit losses during the three
months ended March 31, 1997 compared to a $30,000 provision during the three
months ended March 31, 1996. The Company's provision for credit losses is based
upon quarterly loan portfolio reviews by management. The purpose of the reviews
is to assess loan quality, analyze delinquencies, ascertain loan growth,
evaluate potential charge-offs and recoveries, and assess general economic
conditions in the market economy. Credit losses different from the allowance
provided by the Company are likely, and credit losses in excess or deficient of
the allowance for loan losses are possible. Loan losses in excess of the amount
of the allowance could and probably would have a material adverse effect on the
financial condition of the Company.
The ratio of charge-offs, net of recoveries, to average loans during the three
months ended March 31, 1997 was 0.05%. The ratio of the allowance for credit
losses to total loans was 1.2% on March 31, 1997 as compared to 1.5% on March
31, 1996. The allowance for credit losses was $1,309,983 on March 31, 1997.
CURRENT TRENDS AND UNCERTAINTIES
Economic trends and other developments could adversely affect the Company's
operations. Regulatory changes may increase the Company's cost of doing business
or otherwise impact it adversely.
LIQUIDITY
The Company's investment securities portfolio, including federal funds sold, and
its cash and due from bank deposit balances serve as the primary sources of
liquidity. At March 31, 1997, 15.6% of Surety Bank's interest bearing
liabilities were in the form of time deposits of $100,000 and over. Although
unlikely, if a large number of these time deposits matured at approximately the
same time and were not renewed, Surety Bank's liquidity could be adversely
affected. Currently, the maturities of Surety Bank's large time deposits are
spread throughout the year, and Surety Bank monitors those maturities in an
effort to minimize any adverse effect on liquidity.
Over the long term, the ability of the Company to meet its cash obligations will
depend substantially on its receipt of dividends from Surety Bank, which are
limited by banking statutes and regulations.
CAPITAL RESOURCES
Shareholders' equity at March 31, 1997 was $19,637,188 as compared to
$19,230,552 at December 31, 1996. The Company had consolidated net income of
$499,824 for the three months ended March 31, 1997.
Under the regulatory risk-based capital framework, Surety Bank is expected to
meet a minimum risk-based capital ratio to risk-weighted assets ratio of 8%, of
which at least one-half, or 4%, must be in the form of Tier 1 (core) capital.
The remaining one-half, or 4%, may be either in the form of Tier 1 (core) or
Tier 2 (supplementary) capital. The amount of the loan loss allowances that may
be included in capital after the transition period is limited to 1.25% of
risk-weighted assets. The ratio of Tier 1 (core) and the combined amount of Tier
1 (core) and Tier 2 (supplementary) capital to risk-weighted assets for Surety
Bank was 11.10% and 12.29%, respectively, at December 31, 1996 and 11.04% and
12.19%, respectively, at March 31, 1997. In addition, Surety Bank is expected to
maintain a Tier 1 capital to total assets ratio (Tier 1 leverage ratio) of at
least 3%. Surety Bank is currently, and expects to continue to be, in compliance
with these capital requirements.
While the Company believes it has sufficient financing for its working capital
needs until the end of its 1997 fiscal year, there can be no assurance that the
Company's present capital and financing will be sufficient to finance future
operations thereafter. If the Company sells additional shares of common and/or
preferred stock to raise funds, the terms and conditions of the issuances and
any dilutive effect may have an adverse impact on the existing shareholders. If
additional financing becomes necessary, there can be no assurance that the
financing can be obtained on satisfactory terms. In this event, the Company
could be required to restrict its operations.
13
<PAGE>
The Board of Governors of the Federal Reserve System (the "Federal Reserve") has
announced a policy sometimes known as the "source of strength doctrine" that
requires a bank holding company to serve as a source of financial and managerial
strength to its subsidiary banks. The Federal Reserve has interpreted this
requirement to require that a bank holding company, such as the Company, stand
ready to use available resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity. The Federal
Reserve has stated that it would generally view a failure to assist a troubled
or failing subsidiary bank in these circumstances as an unsound or unsafe
banking practice, a violation of Regulation Y, or both, justifying a cease and
desist order or other enforcement action, particularly if appropriate resources
are available to the bank holding company on a reasonable basis. The requirement
that a bank holding company, such as the Company, make its assets and resources
available to a failing subsidiary bank could have an adverse effect upon the
Company and its shareholders.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1996, FASB issued Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("SFAS 125"). This Statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. This Statement requires that after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets when
control has been surrendered, and derecognizes liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This Statement is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. In December 1996, FASB issued Statement of
Financial Accounting Standards No. 127, "Deferral of the Effective Date of
Certain Provisions of FASB Statement No. 125." This Statement deferred the
effective date of FASB Statement No. 125 for secured lending, repurchase
agreement, dollar-roll, securities lending, and similar transactions to
transactions occurring after December 31, 1997.
In February 1997, FASB issued Statement of Financial Accounting Standards No.
128, "Earnings per Share" ("FAS 128"). FAS 128 simplifies the standards for
computing earnings per share ("EPS") previously found in APB Opinion No. 15,
"Earnings per Share" ("Opinion 15"), and make them comparable to international
EPS standards. FAS 128 replaces the presentation of primary EPS with a
presentation of basic EPS. Basic EPS excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Diluted EPS is
computed similarly to fully diluted EPS pursuant to Opinion 15. FAS 128 also
requires dual presentation of basic and diluted EPS on the face of the income
statement for entities with complex capital structures and a reconciliation of
the numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation. FAS 128 is effective for financial
statements issued for periods ending after December 31, 1997, including interim
periods; earlier application is not permitted. Basic EPS under FAS 128 will be
the same as disclosed in the financial statements and fully diluted EPS will not
be materially different. FAS 128 requires restatement of all prior-period EPS
data presented.
In February 1997, FASB issued Statement of Financial Accounting Standards No.
129, "Disclosure of Information about Capital Structure" ("FAS 129"). FAS 129
establishes standards for disclosing information about an entity's capital
structure, including the pertinent rights and privileges of various securities
outstanding. FAS 129 is effective for financial statements issued for periods
after December 15, 1997.
Management believes that the adoption of these pronouncements will not have a
material impact on the financial statements of the Company.
14
<PAGE>
IMPACT OF INFLATION, CHANGING PRICES AND MONETARY POLICIES
The financial statements and related financial data concerning the Company in
this report have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars without considering changes in the
relative purchasing power of money over time due to inflation. The primary
effect of inflation on the operations of the Company is reflected in increased
operating costs. Unlike most industrial companies, virtually all of the assets
and liabilities of a financial institution are monetary in nature. As a result,
changes in interest rates have a more significant effect on the performance of a
financial institution than do the effects of changes in the general rate of
inflation and changes in prices. Interest rates do not necessarily move in the
same direction or in the same magnitude as the prices of goods and services.
Interest rates are highly sensitive to many factors which are beyond the control
of the Bank, including the influence of domestic and foreign economic conditions
and the monetary and fiscal policies of the United States government and federal
agencies, particularly the Federal Reserve Bank. The Federal Reserve Bank
implements national monetary policy such as seeking to curb inflation and combat
recession by its open market operations in United States government securities,
control of the discount rate applicable to borrowing by banks and establishment
of reserve requirements against bank deposits. The actions of the Federal
Reserve Bank in these areas influence the growth of bank loans, investments and
deposits, and affect the interest rates charged on loans and paid on deposits.
The nature, timing and impact of any future changes in federal monetary and
fiscal policies on the Bank and its results of operations are not predictable.
On March 25, 1997, the Federal Open Market Committee decided to tighten money
market conditions slightly, expecting the federal funds rate to rise one-quarter
percentage (1/4%) point to approximately five and one-half percent (5-1/2%).
This action was taken in light of persisting strength in demand, which is
progressively increasing the risk of inflationary imbalances developing in the
economy that may eventually undermine the long expansion. In these
circumstances, the slight firming of monetary conditions is viewed as a prudent
step that affords greater assurance of prolonging the current economic expansion
by sustaining the existing low inflation environment through the rest of this
year and next. The experience of the last several years has reinforced the
conviction that low inflation is essential to realizing the economy's fullest
growth potential. No change was made in the Federal Reserve discount rate, which
remains at five percent (5%).
15
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Bank is a defendant in two related cases: Tennessee Ex Rel. Douglas
Sizemore, Commissioner of Commerce and Insurance for the State of
Tennessee, et al. vs. Surety Bank, N.A., filed in June 1995 in the Federal
District Court for the Northern District of Texas, Dallas, Division (the
"Anchorage Case"), and United Shortline Inc. Assurance Services, N.A. et
al. vs. MacGregor General Insurance Company, Ltd., et al., now pending in
the 141st Judicial District Court of Tarrant County, Texas (the "MacGregor
Case").
The claimant in the Anchorage Case is the Tennessee Commissioner of
Commerce and Insurance ("Tennessee"), appointed by the Chancery Court for
the State of Tennessee, Twentieth Judicial District, Davidson County, to
liquidate Anchorage Fire and Casualty Insurance Company ("Anchorage"),
including Anchorage deposits at the Bank. Tennessee seeks to recover
compensatory and punitive damages on various alleged causes of action,
including violation of orders issued by a Tennessee court, fraudulent and
preferential transfers, common law conversion, fraud, negligence, and bad
faith, all of which are based on the same underlying facts and course of
conduct. The plaintiff in the MacGregor Case, United Shortline Inc.
Assurance Services, N.A. ("Shortline"), is the holder of a Florida judgment
against MacGregor General Insurance Company, Ltd. ("MacGregor") who seeks
to recover funds allegedly belonging to MacGregor which were held by the
Bank.
Both cases arise out of the Bank's alleged exercise of control over funds,
representing the Bank's collateral, held in accounts at the Bank under
agreements with Anchorage and MacGregor. The Bank asserts that it had a
right to exercise control over its collateral under contractual agreements
between the Bank and the respective insurance companies or the Bank and the
policy holders, and also in order to protect the Bank against the
possibility of inconsistent orders regarding the same funds. Tennessee also
seeks to recover funds allegedly transferred in and out of the
Anchorage/MacGregor accounts at the Bank during an approximate four month
period in 1993.
When the MacGregor case was initially filed, Shortline sought a restraining
order against the Bank concerning the MacGregor funds. When the Bank
received notice of competing claims to some or all of these funds by
Tennessee, the Bank intervened and interpled approximately $600,000 into
the court's registry. Shortline now seeks, inter alia, damages against the
Bank from an alleged wrongful offset wherein the Bank allegedly exercised
control over the MacGregor funds at the Bank pursuant to agreements with
MacGregor. The Bank moved for and obtained a summary judgment that its
intervention and interpleader of funds was proper. Shortline also sought
and obtained a summary judgment from the trial court that the funds
interpled by the Bank into the court's registry belonged to Shortline.
Tennessee appealed the summary judgment to the Fort Worth Court of Appeals.
The Fort Worth Court of Appeals affirmed the trial court's ruling that the
Bank's intervention and interpleader was proper but reversed the trial
court's ruling that the funds in the court belonged to Shortline.
Currently, Shortline and Tennessee have made application to the Texas
Supreme Court to allow an appeal of the ruling from the Fort Worth Court of
Appeals.
In the Anchorage case, Tennessee claims that the Bank allegedly transferred
funds in and out of the Anchorage accounts after allegedly receiving notice
of court orders prohibiting such transfers. Discovery in this case is in
the initial stages and the damages sought by Tennessee are not yet certain.
The Bank believes both of these cases lack merit and intends to defend them
vigorously. The outcome of both of these cases is uncertain at this time.
Item 2. Changes in Securities.
Not applicable.
16
<PAGE>
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
27 Financial Data Schedule*
---------------------------------
* Filed herewith.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended March
31, 1997.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: April 25, 1997 SURETY CAPITAL CORPORATION
By: /s/ C. Jack Bean
----------------
C. Jack Bean
Chairman
By: /s/ B.J. Curley
---------------
B.J. Curley
Vice President, Chief Accounting
Officer & Secretary
18
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<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 0
<INT-BEARING-DEPOSITS> 190,361
<FED-FUNDS-SOLD> 9,186,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 18,333,372
<INVESTMENTS-CARRYING> 21,394,594
<INVESTMENTS-MARKET> 21,504,372
<LOANS> 111,137,326
<ALLOWANCE> (1,309,983)
<TOTAL-ASSETS> 178,841,369
<DEPOSITS> 157,984,251
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,219,930
<LONG-TERM> 0
0
0
<COMMON> 57,862
<OTHER-SE> 19,579,326
<TOTAL-LIABILITIES-AND-EQUITY> 178,841,369
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<INTEREST-TOTAL> 4,019,466
<INTEREST-DEPOSIT> 1,400,235
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<SECURITIES-GAINS> 4,312
<EXPENSE-OTHER> 2,315,457
<INCOME-PRETAX> 795,122
<INCOME-PRE-EXTRAORDINARY> 499,824
<EXTRAORDINARY> 0
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<NET-INCOME> 499,824
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.09
<YIELD-ACTUAL> 0.100
<LOANS-NON> 107,000
<LOANS-PAST> 79,946
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